This provision modifies the Hope Credit for taxable years beginning in 2009, 2010, 2011, and 2012. The modified credit is referred to as the American Opportunity Tax Credit. The allowable modified credit is up to $2,500 per eligible student per year for qualified tuition and related expenses paid for each of the first four years of the student's post-secondary education in a degree or certificate program. The modified credit rate is 100 percent on the first $2,000 of qualified tuition and related expenses, and 25 percent on the next $2,000 of qualified tuition and related expenses.

Effective dates:

Internal Revenue Code Section:

American Opportunity Credit (RGS Paragraph #7533)

Letter 566 is the initial contact letter to use for the American Opportunity Credit.

Transcribed lines for the American Opportunity Credit: Form 8863, Education Credits (Hope and Lifetime Learning Credits), Form 1040, U.S. Individual Income Tax Return:

Taxpayers may claim a Tuition and Fees Deduction on Line 26 of the Form 1040 for TY 2003, Line 27 for TY 2004, Line 34 for TY 2005 through TY 2009. The Tuition and Fees Deduction can reduce income by up to $3,000 in TY 2003 and $4,000 beginning in TY 2004.

Generally, taxpayers can claim a deduction if all three of the following requirements are met:

An eligible educational institution is any college, university, vocational or other post secondary educational institution.

Generally qualifying expenses are limited to tuition and fees.

The taxpayer may not file married filing separately.

The deduction is phased out between $65,000 and $80,000 ($130,000 - $160,000 for joint returns).

No double benefit is allowed:

For additional information, refer to Publication 970, Tax Benefits for Education.

Acceptable Documentation:

Rule which may be used in the selection of cases includes:

Additional resources include:

Evaluating Taxpayer Responses:

For the initial contact, send Letter 566 or Letter 566-B with the audit report ( Form 4549/ Form 4549-EZ, Income Tax Examination Changes) and Explanation of Items (Form 886-A) to the taxpayer.

The Form 886-A should contain the following language:
We are questioning the Mortgage Interest Credit you claimed on Line 54 of your Form 1040 for TY 20XX and Line 10 and/or Line 11 of Schedule A. To help us complete the examination of your Mortgage Interest Credit and ensure your Mortgage Interest Deduction was reduced appropriately, please furnish copies of the following information:

If the taxpayer qualifies, he may claim the credit each year for part of the home mortgage interest paid. Form 8396, Mortgage Interest Credit, is used to compute the amount of the credit. If the certified indebtedness amount (loan) shown on the Mortgage Credit Certificate (MCC) is less than the total mortgage loan, the credit is figured on only the part of the interest paid that is allocable to the MCC loan.

The credit is an amount equal to the product of:

If the credit rate exceeds 20 percent, the tax credit for any year may not exceed $2,000 (IRC 25(a)(2)(A)).

A three-year carry forward is provided for the unused portion of such credit caused by the limitation imposed by IRC 26 and IRC 25(a)(2)(A) as amended by Economic Growth and Tax Relief Reconciliation of 2001 (P.L.107-16). In essence, the credit and carryover are limited to the tax less the following credits: Foreign Tax Credit, Credit for Child and Dependent Care, Credit for the Elderly or Disabled, Education Credits, Retirement Savings Contributions Credit, Child Tax Credit and the Adoption Credit. Form 8396, Mortgage Interest Credit, should be used to assist in the calculation of the allowable credit amount.

If the taxpayer itemized on Schedule A, he must reduce his home mortgage interest deduction by the amount of the Mortgage Interest Credit shown on Line 3 of Form 8396. He must do this even if part of that amount must be carried forward.

If the taxpayer sells the home during the first nine years after the closing date, he may be required to recapture all or part of the benefit received from the program. See Publication 523, Selling Your Home for more information.

Use the following to evaluate taxpayer responses:

RGS Standard Paragraphs 6306 — 6309 should be used as applicable on Form 886-A, Explanations of Items.

Tax Resources:

An eligible child for the purposes of claiming Adoption credit is an individual who:

The proper year for claiming the adoption credit or exclusion depends on whether the eligible child is a citizen or resident of the United States (including U.S. possessions) at the time the adoption effort begins and whether the adoption is final or in process. See the following tables.

NOTE: If the eligible child is not a U.S. citizen or resident, you cannot take the adoption credit or exclusion unless the adoption becomes final as shown in the following tables.

Taxpayers may claim the credit for as many children that qualify.

IDRS command code (CC) “ADOPT” using the primary SSN, will provide information from Form 8839 and identify the filters “fired” through Dependent Database (DDb). Examiners should research CC ADOPT to assist in identifying the selection criteria that must be considered as part of the examination.

Send Letter 566 as the initial contact letter (ICL) with a fill-in issue box for Adoption Credit.

If the taxpayer submitted valid documentation as indicated on CC RTVUE, ADOPT or TRDBV with indicator “1” or "Y" , send Form 886-H-Adopt-1 with the ICL to request documentation to verify the adoption expenses.

If the taxpayer did not submit documentation, as indicated on CC RTVUE, ADOPT or TRDBV with an indicator "0" or "N" , or the documentation submitted is invalid or incomplete, as indicated on CC RTVUE, ADOPT or TRDBV with indicator "2" or "I" , send Letter 886-H-Adopt-0 with the ICL to request documentation to verify the adoption and the expenses claimed.

Taxpayers must verify that a legal adoption has either been finalized or is in process. In addition, taxpayers must provide verification either of their expenses or of any special needs determination. Generally, if part of the credit claimed is a carry forward from a prior year, the taxpayer should provide a worksheet explaining how the carry forward was computed. However, for tax years beginning in 2011, there are no adoption credit carryforwards. Therefore, the taxpayer should not be asked for a credit carry forward worksheet for the 2011 tax year.

Proper documentation must be provided for each child claimed.

When the required documentation verifying the adoption is attached to the return (indicator Y or 1), examiners will only review proof of the expenses claimed to determine if they are substantiated and are reasonable and necessary Qualified Adoption Expenses (QAE).

Tax law requires the taxpayer to claim QAE that they incur for an In-Process adoption the year after the expense is paid. Examiners need to be aware of the timing of the expense and that the documentation the taxpayer provides may be for a prior year.

Following are guidelines to determine if the claimed expenses are allowable:

Acceptable proof of expenses are checks and receipts showing proof of payment.

The following expenses are not allowable and do not qualify for the Adoption Credit:

If the adoption is domestic and final, and is of a special needs child (as determined by the state where the adoption occurs), the taxpayer is entitled to claim the maximum amount of the credit (minus any amounts claimed for that child in a previous year) even if the taxpayer paid no qualified adoption expenses.

A child meets special needs if all of the following statements are true:

The taxpayer must provide both of the following documents when claiming the credit for a special needs child. Do not request verification of any expenses:

The following are acceptable documentation of the state's determination of special needs (this list not all inclusive)

Prior law allowed any unused adoption credit to be carried forward for up to five years. Current law allows a refund of all unused carryovers.

The year in which adoption expenses are first eligible to be claimed is the determining year for the maximum credit amount as well as the income limitation restriction. If the taxpayer qualifies for the full credit one year, they cannot increase that amount by carrying it forward to another year. Likewise, if they are limited or disqualified from taking the credit based on their MAGI, they cannot change that restriction, by moving the credit into another year. However, if the taxpayer incurs additional QAE in a subsequent year, the allowable credit for those expenses is subject to the limitations for the year in which they are eligible to be claimed. Any allowable credit must always be reduced by prior credits taken for the same child.

A Form 8839 is not required to be filed for years prior to 2010 in order to claim a carry forward of the credit. If the examiner has the necessary information to establish that a taxpayer was entitled to the credit in a prior year, and the amount of the allowable credit, the examiner would have the authority to allow the remaining balance of that credit in 2010. However, regardless of the year involved, the documentation requirements are the same. The taxpayer must still provide valid proof of the adoption process and QAE incurred or special needs designation.

Prepare Letter 2194, Alternative Minimum Tax Proposal Letter, and Form 4549/Form 4549-EZ (Examination Report), and issue to the taxpayer for the initial contact.

Based on the information reported on the return, the Examination Report (Form 4549/Form 4549-EZ) should include the largest determinable amount(s) as adjustments and tax preference items when computing the AMT on Form 6251.

Cases in Project Code 0097 and Project Code 0098 are systemically processed using Automated Correspondence Exam (ACE) processing. For the initial contact, Letter 566 is issued to the taxpayers and the cases are updated to Status 10 on AIMS.

Whipsaw cases in Project Code 0059 are manually processed by preparing Letter 566-B , Form 4549 / Form 4549 EZ (Examination Report) and Form 886 H DEP. The package is issued to taxpayers and the cases are updated to Status 22 on AIMS. The adjustments per the Examination Report include the disallowance of all dependents claimed on the returns and any other tax benefits claimed attributable to the dependency exemption such as Child Care Credit, Child Tax Credit, Education Credit or Filing Status.

Refer to IRM 4.19.14.5.7, Personal Exemptions and Dependents, for tests for qualifying dependent and recommended supporting documentation.

Refer to IRM 4.19.13.9, Taxpayer Replies, for procedures for working replies from the taxpayer

For a child of divorced or separated parents or parents who live apart at all times during the last 6 months of the calendar year, a non-custodial parent claiming a child as a dependent must file a Form 8332, Release/Revocation of Release of Claim to Exemption for child by Custodial Parent, or similar statement with his or her return.

Form 8332 is a written declaration signed by the custodial parent releasing his/her claim to an exemption for the child to the non-custodial parent for a single year, a specified number of years, or all future years. The non-custodial parent must attach a copy of the signed Form 8332 or similar statement to his/her return for each year for which the non-custodial parent is claiming an exemption for the child.

The filing requirements for Form 8332 or similar statement are based upon the year in which the divorce decree or separation agreement went into effect:

The scope of the examination must be expanded to include taxpayers that have been determined, from previous audits, not to be entitled to the dependency deduction. These cases must ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ and be established on the Audit Information Management System (AIMS) under Project Code 0059 and started within 30 days from the closure of the previous audit.

Pull IRPTR (Information Returns Processing Transcript Requests) if available.

These are batch cases and all cases will start in AIMS Status 10.

The Letter 718 (SC) will be the initial contact letter.

The second letter will be the Letter 525 (SC).

If the case needs to be pulled from batch due to a reject/filtering condition, prepare Form 3198Special Handling Notice for Examination Case Processing for the case file, along with the examination report. Show the applicable Reference Codes to adjust the self-employment income and tax.

Case processing:

Partners, under TEFRA §6222, and S Corporation shareholders, under IRC 6037(c), are generally required to file their returns consistently with the partnership/S Corporation return. However, there may be reasons why a member wishes to report items differently. Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), is used for this purpose. (Note that a partner in an electing large partnership must report all partnership items in a manner consistent with the partnership. IRC §6241)

Refer to IRM 4.29, Partnership Control System (PCS), and IRM 4.31, Pass-Through Entity Handbook, for additional information.

Submission Processing HQ analysts are the primary owners of any work request that sets the Unallowable Audit Code, or Action Code conditions that are active during return processing.

Examination HQ analysts notify Submission Processing of the Unallowable Conditions and Codes to be identified based on tax law.

Unallowable coding results in Freeze Code –Q, Unallowable tax hold or partial refund hold (TC 576). This freezes the tax module from refund and offset out.

The Unallowable Condition Code will generate a CP 19 or CP 20.

Unallowable coding:

If the UA issue is visually identified, Code and Edit and Error Correction employees edit the return using Form 3471, Edit Sheet, with the unallowable code(s). For specific processing information used by Submission Processing to code Unallowable and Action Codes, refer to Submission Processing IRMs:

Unallowable Code tolerances are as follows:

CP notices are sent to Exam when Unallowable filings are identified; however, they should not be relied upon as notification that a new case is received.

Correspondence Exam workload inventory procedures such as SSIVL (Statistical Sampling Inventory Validation) reports should be used to identify and start new UA or Audit Code inventory.

Audit Code cases will create in SC 02 PC 0000. The return will be routed through the clerical function.

CP 19/20 reports may be accessed via Control D by the query NRP66*.

Most UA accounts have frozen refunds and should be worked within 30 days of full AIMS creation.

When new Unallowable or Audit Code or Action Coded returns are opened into campus examination inventory, ensure BOD and PBC are correct for your campus. If the BOD or PBC is incorrect, re-route the case to the appropriate area.

Unallowable Condition - Exam classifiers or tax examiners experienced in the unallowable process will review the entire return via Command Codes RTVUE, BRTVU, or TRDBV .

Audit Code or Action Coded case - Exam classifiers or tax Examiner will review the entire physical return and Command Codes RTVUE, BRTVU, or TRDBV; as well as any other command code needed to classify the case correctly.

Keep in mind that Submission Processing employees, and computer programs identifying the unallowable conditions, are not trained on all tax law issues.

The last page of RTVUE will show the Unallowable Code and amount. It may also show if there is a change to adjusted gross income, itemized deductions, or a tax adjustment. If RTVUE shows “Per Return” side and “Per Computer” side are different, a math error notice should have been sent. If the math error resolved the unallowable issue, close the case per local procedures.

Process cases as follows:

Issue Initial Contact Letter (ICL) to notify taxpayer of unallowable issue(s) as follows:

If your Operation chooses not to use CP 19/CP 20 for initial contact:

Release any refund frozen in error.

Update AIMS to appropriate EGC and Status 22.

Suspend case for 45 days.

Process responses/no responses to Unallowable notices or letters as follows:

Transcripts titled, – QFRZALERT, will be sent to the associated campus when an unreversed TC 576 remains on a module longer than six months. Freezes should be resolved within fifteen days of receipt.

Additional Unallowable Program information may be found in the following:

UA 78 is when a taxpayer claims 5 or more vehicles as personal credits on Form 8834, 8910 and 8936 on their tax return.

UA 79 is when a taxpayer claims the same vehicle more than once on a combination of Forms 8834, 8910, and/or 8936.

These cases open in Source Code 03 and Project Code 0000.

See IRM 4.19.15.44 for appropriate 886A paragraphs and substantiation requirements.

Unallowable conditions 81 and 82 are based on taxpayers claiming the Rebate Recovery Credit on their 2008 tax return.

Refer to IRM 3.12.3.5.3 for the specific unallowable information.

These cases will open in SC 03 PC 0654.

When working replies refer to Rebate Recovery Credit information in the 2008 Publication 17.

The following are paragraphs that may be used on Form 886-A, Explanation of Items:

Unallowable conditions 83 and 86 are based on taxpayers claiming the First Time Homebuyer’s Credit on their 2009 tax returns.

Unallowable condition 84 is based on TY 2008 return.

Refer to IRM 3.12.3.5.3 for the specific unallowable information.

Refer to IRM 4.19.15.41 for appropriate 886A paragraphs and substantiation requirements.

1. Unallowable Code 87 is for taxpayers claiming the Excessive Motor Vehicle Excise Tax on their tax year 2009 or 2010 tax return. These cases are opened on AIMS in Source Code 03 and Project Code 0641.

Taxpayers are allowed additional Standard Deduction by filing a Schedule L or putting the amount paid on line 7 of their Schedule A.

Replies:

The following paragraphs can be used on Form 886-A, Explanation of Items:

Payers — Payer cases are initiated through ACE (Automated Correspondence Exam) processing ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡

Recipients — Open recipient cases on AIMS and initiate manually only upon verification by a payer of unreported alimony or pension income which would generate a deficiency for the recipient ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ ≡ .

All — Suspend all cases after initial contact for 45 days awaiting taxpayer response.

If the taxpayer does not respond to the letter, prepare the case for issuance of a Statutory Notice of Deficiency.

Close the case as a default if no response is received to the Statutory Notice of Deficiency after 105 days from its mail date.

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

Open a recipient case under the conditions noted in IRM 4.19.15.21.1 (2), Initial Contact and General Processing. The related payer case needs not be closed first. For example, alimony payments may be resolved with respect to one recipient and not another, or the payer case remains open for expanded issues only. Monitor a payer case through default if necessary when the conditions to open a recipient case have been met but additional supporting records are required to resolve the remainder of payments purported to be made to the same recipient. Copy all pertinent documents provided by the payer for inclusion in the recipient’s file in case the latter files an appeal. The burden of proof is on the Service for disputed income.

While thorough workpaper documentation is important regardless of the issue, it is particularly critical for alimony deductions/income because the outcome of one taxpayer’s case may impact one or more other taxpayers.

Examiners should note the following when applicable on Form 4700, Examination Workpapers (not all inclusive):

Taxpayers often deduct payments made to more than one spouse/former spouse. Record documentation received concerning each recipient separately in the payer’s workpapers.

If the payer audit results in a no-change, audit consideration of the recipient taxpayer(s) must be documented in the payer’s workpapers. The workpapers must indicate whether the audit was or was not expanded to the recipient taxpayer(s) and why.

Refer to IRM 4.19.13.2.3, Standard 3 — Workpapers Support Conclusions and IRM 4.19.13.5, Work Papers for All Cases for more information concerning workpapers.

Payers — Since payer cases are initiated systemically, it’s important to thoroughly research IDRS when working the first response.

Recipients — Perform IDRS research prior to establishing a recipient case on AIMS.

All — Review all related CEAS records including any for prior and subsequent years and for the cross-reference taxpayer(s) to determine if they contain pertinent information. However, do not "no change" a case solely because the same issue was examined for another tax year and not adjusted. Each year stands on its own merits.

Documentation must include the instrument that orders the payment of alimony with all amendments and proof of payment in the form of:

The instrument may require payments to third parties that could qualify as alimony. Documentation can include, but is not limited to:

Payments designated as not alimony can only be excluded from income if the recipient attaches a copy of the instrument designating the payments as not alimony to his/her return. The instrument must be attached to the return for each tax year for which the designation applies.

Unacceptable documentation includes but is not limited to:

Instruments of divorce or separation often contain legal terminology. Some frequently used terms relevant to alimony include:

Tax law states that for payments to be considered alimony, they must cease on the death of the recipient spouse. This "death contingency" can be stated in the instrument itself, codified in state law, or applied by operation of state or federal case law. The tax examiner must research state laws to reach a correct determination. The use of the word alimony in an instrument does not necessarily mean that the payments in question meet the requirements to be considered alimony under IRC 71.

QDRO — Although pension income paid to an alternative payee is not alimony, it is frequently deducted as such. Instruments can provide for the division of a pension between the plan participant and a non-participant spouse. This can be executed with a qualified domestic relations order (QDRO) that transfers the applicable percentage of distribution through the plan to a non-participant spouse.

However, the participant may be ordered to pay the required percentage directly to a non-participant spouse after distribution. Under a QDRO, separate Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., should be issued to each individual, the plan participant and non-participant spouse, showing only the amount of their respective distributions. If the QDRO is to a non-spouse, such as a child, only one Form 1099-R is issued to the participant showing the entire distribution. Unlike other property settlements, pension distributions are taxable to the recipients because those distributions were based on amounts previously contributed on a tax-deferred basis.

OPM Reporting — Problems may arise in connection with Form 1099-R issued from Office of Personnel Management (OPM). Prior to the year 2000, OPM reported the gross pension distribution on Form 1099-Rs to the participant spouse. The participant spouse then reported the gross amount of distribution as pension income and deducted the amount apportioned to the non-participant spouse as alimony. In the year 2000, OPM started issuing separate Form 1099-Rs to the participant spouse and non-participant spouse showing their respective distributions. The plan participant spouse was not notified of the change. Consequently, the participant spouse continued to deduct the apportionment, thereby creating a double deduction. A copy of both the front and back of the Annuity Statement must be received to verify the taxpayer claimed the entire pension amount.

DFAS Reporting — Military retirees frequently under report pension income due to Defense Finance and Accounting Services (DFAS) practices. In some instances DFAS issues a Form 1099-R to the participant spouse for the full amount of the distribution paid to the participant spouse and the non-participant spouse. In other instances, separate Form 1099-Rs are issued to the participant spouse and non-participant spouse showing only the amount of their respective distributions. When the non-participant spouse receives a Form 1099-R from DFAS, the participant spouse should not exclude the pension amount reported on the Form 1099-R that is issued to the non-participant spouse from taxable income. A copy of both the front and back of the Retiree Account Statement (DFAS-CL) must be received to verify the taxpayer claimed the entire pension amount. The plan participant can obtain the copies from MyPay at HTTP://MYPAY.DFAS.MIL

State and Local Government/Private Industry Pensions — Total distributions from the plan must be verified to ensure the taxpayer claimed the full amount received by all parties.

Disability Pensions — The non-taxable nature of a disability pension does not transfer to the non-participant spouse. The disabled participant spouse cannot take a deduction for non-taxable distributions transferred to a non-participant spouse unless they are first reported in taxable income. The non-participant spouse is required to report the income on his/her tax return. DFAS began a two-tier disability pension in 2005. Only a disability or CSRS (Civil Service Retirement System) is non-taxable. This may account for a discrepancy in the participant’s taxable income.