The IRS has opened the door for cafeteria plans to pay costs of over-the-counter medication (Rev. Rul. 2003-102).
Many employers sponsor cafeteria plans - also known as "Section 125 plans" or "flex plans." Such plans allow employees to have part of their compensation withheld before tax to pay for the employee share of health insurance and other benefits. Employers like such plans because they don't pay social security taxes on the withheld portions.
Many such plans feature a "flexible spending account." Employees have money withheld pre-tax for out-of-pocket medical expenses; the plan reimburses the employees tax-free for documented out-of-pocket health costs.
The IRS now says these reimbursements can be made for over-the-counter remedies, such as cold pills and aspirin. Dietary supplements don't qualify, though.
Or, your tax dollars at work! A U.S. District Judge in Florida issued the following order. It seems like a lot of work for the refund amount...
FRANK HEATLEY AND BETTY HEATLEY
INTERNAL REVENUE SERVICE,
UNITED STATES DISTRICT COURT
MIDDLE DISTRICT OF FLORIDA
 This cause comes before the Court on the Response by United States to Order Entered March 24, 2003 (Doc. 5 1) filed April 10, 2003.
 Based on the foregoing, it is ordered as follows:
1. The Clerk is directed to substitute the United States of America as the proper Defendant. (See Doc. 37, ¶1)
2. The Clerk is directed to enter judgment providing that the Plaintiffs Frank Heatley and Betty Heatley recover of the Defendant United States of America the sum of $2.78, with interest thereon at the rate of 5 percent as provided by law, and their costs of action.
3. The United States of America shall pay the Special Master, Kenton V. Sands, attorney's fees in the amount of $1,612.50.
4. The Clerk is directed to CLOSE the file.
 DONE and ORDERED in Chambers, in Orlando, Florida this 17th day of April, 2003.
ANNE C. CONWAY
United States District Judge
In a way, it represents a taxpayer victory; the IRS had argued for a $1 refund. Still, the "Special Master" looks like the real winner.
The House Ways and Means Committee set up a confrontation with the Senate yesterday when it passed its Chairman's bill to repeal the "Extraterritorial Income" (ETI) Exclusion.
The World Trade Organization has ruled the ETI to be an illegal trade subsidy; the European Community has threatened $4 billion in trade sanctions if the ETI is not repealed.
The Ways and Means bill, designed by Chairman William Thomas, combines the ETI repeal with a variety of other provisions, including some not obviously related to international trade. The Ways and Means bill is scored as a $60 billion tax cut. The much less ambitious Senate bill is "revenue neutral."
C CORPORATION TAX CUTS
The centerpiece of the Ways and Means plan is a phased-in reduction in tax rates for C corporation manufacturers. The marginal rate for C corporation manufacturing income from $75,000 to $1 million would be reduced from the current 34% to 33% in 2004-2006; a 32% rate would apply for 2007-2011 on income up to $5 million; the 32% rate would apply on income up to $20 million when fully phased-in for 2012.
These rates would apply to income from "domestic production" activities, including manufacturing, construction and agricultural income. Unlike the the Senate bill, no lower rates would apply to S corporation or partnership production income.
NON-TRADE PROVISIONS INCLUDE DEPRECIATION, BANK S CORPORATION RELIEF
The Ways and Means Committee bill provides a number of provisions targeted at smaller businesses and banks. These include:
-C corporations with gross receipts under $20 million would be exempt from alternative minimum tax; the current threshold is $7.5 million.
-Extension of the $100,000 Sec. 179 deduction annual limitation through 2007. The provision is currently scheduled to expire after 2005. Section 179 permits taxpayers to deduct certain property expenditures that would otherwise have to be recovered through depreciation over a period of years.
-Taxpayers would be permitted to depreciate leasehold improvements, other than building structural improvements, over 15 years, for property placed in service before 2006.
- IRAs could hold stock of an S corporation bank to the extent the shares are held on the date of enactment of the proposal. In addition, IRAs would have a 120-day window to get rid of bank S corporation shares without risking "prohibited transaction" treatment following the S corporation election.
The prognosis for the conflicting ETI repeal bills is cloudy. It remains to be seen whether the bills will be reconciled in conference. Pamela Olson, the Bush Administration's lead voice on tax policy, said nice things about the Ways and Means bill while stopping short of an outright endorsement. Senate Minority Leader Daschle, in contrast, said the Ways and Means bill is an "outrageous demonstration of irresponsibility."
FOR MORE INFORMATION...
-The Joint Committee of Taxation Technical Explanation of HR 2896 (pdf format).
-Washington Post story about the passage of the Ways and Means Bill.
- Senate bill text (S 1637)
-Tax Update coverage of Finance Committee bill.
The updated text of HR 2896 will be linked when it becomes available.
UPDATE: Text of HR 2896 is available.
While California endures disaster of epic scope, at least the IRS is giving some Californians a break. The IRS has waived (IR-2003-126) penalties for late filing of employment and excise taxes, and extended the deadlines for other payments and for tax returns, for "affected taxpayers" in Los Angeles, San Bernardino, San Diego and Ventura counties.
The excise and employment tax waiver applies to payments due from October 21, 2003 through November 7, 2003. The extension of time to file returns and make other tax payments runs from October 21 through December 29 for returns and payments otherwise due during that period.
The "affected taxpayers" eligible for the relief include "individuals and businesses located in the disaster area, those whose tax records are located in the disaster area, and relief workers."
Starting this year, "qualified dividends" are taxed at a 15% top federal rate. The tax law has a rule to prevent people from claiming dividends on stock held for very short periods: taxpayers must hold the shares for over 60 days of the 120 day period beginning 60 days before the ex-dividend date.
Barron's this week points out a weird result that occurs if you buy a stock the day before the ex-dividend date (subscription required for link). The holding period for a stock begins under the tax law on the day after the trade date. If you buy a stock on the day before it goes ex-dividend, the holding period starts on the ex-dividend date. Since the law says you have to hold the stock over 60 days to qualify for the 15% rate, you cannot qualify, because there are only 60 days left in the 120 day holding period.
The Moral: if you want to capture a dividend at the 15% rate, buy at least 2 days before the stock goes ex-dividend.
Remember: it's the tax law; it doesn't have to make sense!
Last December we reported how one Crystal Foster received a $500,000 refund she wasn't entitled to, how she spent the money (a Mercedes was involved), and how she was reluctant to return the funds to the IRS.
Ms. Foster now has something to show for her efforts, but not what she would have wished for - three years room and board at Club Fed.
A "REPARATIONS" SCAM
It turns out that the 25 year-old Ms. Foster participated in a scheme hatched by her father, an accountant for the Veterans Administration, to claim slavery reparations on her tax return. The tax law has no such credit, but the IRS estimates that it has accidentally paid $30,000,000 in claims for reparations. The $500,000 paid to Ms. Foster may be the largest such accident. The Washington Post reports that "IRS spokeswoman Michelle Lamishaw said yesterday that the IRS received nearly 80,000 tax returns claiming $2.7 billion in nonexistent slavery credits in 2001 alone."
Ms. Foster's father, Robert Foster (or, as he said in court, "Robert Foster, copyright"), received a 13-year sentence for his part in the reparations scheme.
It was an quick conclusion for a criminal tax case. Ms. Foster cashed her refund check on October 29, 2001, and was sentenced less than two years later.
The Senate Finance Committee held hearings today on the proposal to tax proceeds on life insurance policies for employees who had been retired for 12 months or more.
The Treasury issued its written testimony this afternoon; the administration, in the person of Gregory Jenner, Deputy Assistant Secretary (Tax Policy), seems unenthusiastic:
"Limiting the tax advantages of COLI to situations in which the insured individual remains an employee would severely limit the use of COLI to fund retiree benefit plans. Retirees are, by definition, no longer employees, yet the obligation of businesses to fund their benefits often continues. As described earlier, COLI is often well-suited for that purpose. Such a restriction would result in businesses using less-efficient means of funding these benefits, or dropping the benefits altogether."
The Senate Finance Committee this week held hearings on the U.S. tax shelter industry. The Committee found that the industry is one part of the economy that is doing quite well.
One booming sector of the shelter industry is the part that arranges with offshore or U.S. government entities to lease public infrastructure and lease it back to the entity (Lease-in Lease-out, or "LILO") transactions; another variant is the Sale-in, Lease-out ("SILO") transaction. These cases involve an up-front payment to the government agency; all future sale or lease payments between the buyer and seller offset, so only the first transaction is cash. The buyer then depreciates the "leased" property.
The Committee heard testimony that the LILO/SILO shelter is going strong even though the IRS says it doesn't work (Rev. Rul. 2002-69). An anonymous witness, speaking from behind a screen through a voice-altering microphone, testified:
A minimum of $20 to $30 billion dollars a year of foreign infrastructure is purportedly leased or sold in this manner. As I said, most of the existing infrastructure of Europe -- bridges, railroads, waterways, subways, air traffic control systems, and the like -- have been leased to Americans under these deals. Investment bankers scour the countryside looking for municipalities that are interested in the easy money of the up-front payment to enter the deal. Foreign officials are routinely enticed to enter into these transactions through promoter sponsored golf outings, expense paid trips, and similar arrangements.
So maybe you can buy the Brooklyn Bridge, if you get good lease financing.
The committee heard from a parade of whistleblowers and disillusioned professionals, as well as from a host of government officials.
One highlight was testimony from a Senior Manager of a national accounting firm that many tax shelters rely on hiding bad facts, rather than tricky but correct use of the tax law:
"These abusive tax shelters also require a distortion or concealment of facts. They require not only intellectual dishonesty, but also deception, secrecy, and even conspiracy. The reason for such fact distortion or concealment is simple—the promoters know that these transactions could never survive the light of day in court."
Several IRS and Treasury officials also testified that they are working hard to prevent taxpayers who actually pay taxes from being chumps. Senator Grassley did not seem cheered by the day's testimony:
"It seems nothing is safe from the illicit tax shelter promoter. Even our bridges, subways, and water systems are all ripe for the picking. It's hard to believe that city assets are helping tax shelter promoters. Roads and bridges built with tax dollars are leased out to shelter promoters so major corporations can get a phony tax deduction. Even the subway system of Washington, D.C., our nation's capital, has been leased as part of a shelter scheme. We need to shut down this type of tax shelter and all others in the process."
Grassley and the administration officials emphasized the need for disclosure of shelters; B. John Williams, former IRS Chief Counsel, noted that one important disclosure requirement lacks penalty provisions for failure to comply.
You can access all of the Committee testimony here (pdf files).
Much of the country took time off today to observe the 17th birthday of the Internal Revenue Code of 1986. President Reagan signed the Tax Reform Act of 1986 on October 22, 1986.
Many folks partied raucously...
Naturally, some folks had difficulty restraining their excitement:
But calm was soon restored.
The Tax Update, along with rest of the Roth & Company web presence, was knocked out of service yesterday. The cause apparently was - strange as this may sound - al-Queda sympathizers. The story goes that they went after one or more sites hosted by the hosting company we use in a "Denial of Service" (DoS) attack.
DoS attackers plant programs on unprotected networks; on signal, the programs all attempt to contact the targeted site, overwhelming the system. To learn more about the attack on our host, go here. To learn how to keep your system from being used in a DoS attack, visit here.
We regret any inconvenience our absence caused.
As part of his September 30 plea agreement for failing to withhold or remit federal employment taxes, Richard Simkanen was "required to post the filed plea documents on Arrow Custom Plastic's website within seven days of his guilty plea." As of this morning, there appear to be no plea documents at the business site, "arrowplastics.com."
The documents are on another site, arrowplastics.net, which we found by clicking on a link on Mr. Simkanen's weblog (the "about me" link on the right side of the page). The documents can be linked in the lower left corner of the page, tucked underneath a much larger plea for donations to cover legal costs and a handsome picture of Mr. Simkanen. Perhaps the government accepts the posting on the ".net" website, rather than the businesses ".com" site, as compliance with the plea agreement. A Google search lists both versions, with the ".com" first. Google also comes up with this page, which gives an idea of how Mr. Simkanen got in trouble in the first place.
Sentencing is scheduled for January 2, 2004.
It's seems like just yesterday when Congress was roasting the IRS for abusing taxpayers. Times change. Starting tomorrow, the Senate Finance Committee will hold hearings on taxpayers beating up the IRS with tax shelters.
According to The New York Times (registration required), the hearings will put the heat on the tax shelter industry, which is reputed to have cost the government $14 billion or more in 2000.
The hearings will feature a witness appearing behind a screen with his voice altered. It's understandable; it would be embarrassing to be linked to many of the shelters out there.
The IRS has announced the limitations applicable to pension and profit-sharing plan contributions for 2004. Some key numbers are as follows:
|401(k) elective deferrals||$13,000, plus $3,000 additional for taxpayers 50 and over. (was $12,000 and $2,000)|
|Deferral available via a SIMPLE plan||$9,000. ($8,000 for 2003)|
|Amount of compensation to be taken into account in computing profit-sharing contributions||$205,000 ($200,000 for 2003)|
|IRA contributions||$3,000, plus $ 500 additional for taxpayers 50 and over (unchanged)|
Thanks to The Benefits Blog.
The IRS has issued (Rev. Rul. 2003-107) the minimum interest rates for loans made in November 2003:
Short Term (demand loans and loans with terms of 1-3 years): 1.5%
Mid-Term (loans from 3-9 years): 3.32%
Long-Term (over 9 years): 4.99%
Historical AFRs are available on the “Links” page at www.rothcpa.com.
The Iowa Department of Revenue and Finance has announced that the interest rate on tax underpayments and overpayments will be 6% for 2004. The rate for 2003 is 7%.
Many Iowans who own S corporation stock are eligible to claim state tax refunds. The refund opportunity arises from a surprising position taken by the Iowa Department of Revenue and Finance in a recently published declaratory order (In the Matter of Michael J. Humes).
Iowa has for several years allowed S corporation shareholders an "apportionment credit" based on the ratio of S corporation sales in Iowa to sales everywhere. This credit is designed to give S corporations much the same benefit for out-of-state sales that C corporations have long enjoyed.
We, along with most practitioners, understood that the credit would be reduced based on the amount of S corporation income distributed in excess of the amount of federal taxes attributable to that income (or, prior to 2002, distributions in excess of 1/2 of the federal taxes). The declaratory judgment, in the words of one Des Moines attorney active in S corporation matters, "turns all of this on its head."
The gist of the declaratory ruling is that distributions of S corporation income do not reduce the apportionment credit. We have discussed the ruling with its author at the Department of Revenue and Finance, and he confirms this understanding. While the state may change its rules for future years, the door is now open for taxpayers who have claimed the S corporation apportionment credit to claim refunds based on the declaratory ruling.
HOW CAN I TELL IF I MIGHT QUALIFY?
If your returns for open years include a Form 134, you may qualify. If line 22 of the form is greater than zero, you probably do.
1999 PROCRASTINATORS NEED TO ACT NOW
Taxpayers who filed extended Iowa returns in 1999 need to act quickly; they have until October 31, 2003 to claim refunds before the three-year statute of limitations expires. The claims should be filed on an Iowa 1040X with an amended Form 134.
Contact Joe Kristan at Roth & Company for further information.
The IRS has released the cents-per-mile rates that will apply for 2004 for automobile use deductions (Rev. Proc. 2003-76).
-- The rate for business use will rise to 37.5 cents, from the 2003 rate of 36 cents.
-- The rate for charitable use will remain at 14 cents.
-- The rate for medical mileage will rise to 14 cents; it was 12 cents for 2003.
-- The mileage rate for moving expenses will rise to 14 cents; it was 12 cents for 2003.
The Congressional Joint Committe on Taxation yesterday issued a summary of the tax rules governing corporate owned life insurance (pdf format). It is perhaps the best short guide available to this arcane area of the tax law.
The Joint Committee report summarizes the tax law on:
-tax-free treatment of policy proceeds and buildup
-deductibility of interest used to buy policies
-the cases on "dead peasant" or "janitor insurance" arrangements, where corporations insured large numbers of employees to arbitrage deductible interest expense against tax-free cash value buildup.
The IRS changed the rules for determining S corporation and partnership tax years in 2002. The new rules require many such "pass-through" businesses to switch from a fiscal year to a calendar tax year, with an extra short tax year ending either December 31, 2002 or December 31, 2003. This caused some pass-through owners to include as much as 23 months of S corporation (or partnership) taxable income on a single 1040.
A new IRS pronouncement (Rev. Proc. 2003-79) allows owners of many pass-through entities with short 2002 or 2003 tax years to spread their short year income out over four years.
FISCAL YEARS AND YOU
Owners of "pass-through" entities - that is, an S corporations or partnerships - report on their 1040 their share of pass-through income for entities whose tax years end during the calendar year. For example, a shareholder of an S corporation with a May 2003 year end would report the income for that fiscal year on his 2003 1040. This has the effect of deferring the tax on his S corporation income earned from June 1, 2002 through December 31, 2002 to 2003.
Such deferral has not been popular with tax collectors, so they have gradually reduced the availability of non-calendar tax years for pass-through entities. The restriction announced in 2002 applied directly to pass-throughs owned by tax-exempt organizations such as Employee Stock Ownership Plans (ESOPs).
CLAIMING THE SPREAD
Owners of pass-throughs with a short period ending in 2002 have until April 12, 2004 to file amended returns to spread the short period income over four years. If the short year ends in 2003, the owners can claim the short-year income over four years starting with their original 2003 1040. Taxpayers must include Form 8082 with the original or amended return.
When Richard Simkanin pleaded guilty to tax charges on September 30, he agreed to post the plea documents on the website of his company, Arrow Custom Plastics, within seven days, according to a Justice Department press release.
As of this morning, there is no sign of the plea documents on the Arrow site.
There is, however, an acknowledgement of the plea on Mr. Simkanin's personal weblog, with a link to a site with a, well, an "alternative" view of the guilty plea and the tax law. Not an alternative with any sensible basis in the tax law, mind you, but an an alternative nonetheless.
Presumably the government required him to post the plea agreement at the Arrow site because the site had been used to post materials asserting that income tax withholding wasn't required by law. Mr. Simkanin's plea related to failing to withhold or remit employment taxes.
The tax law in its wisdom remembers the both the large and the small - at least when it comes to vehicles. While giant business SUVs get extra deductions, "greener" vehicles also enjoy the benevolence of the Code. A "qualified clean-fuel vehicle" placed in service in 2003 qualifies its owner for a $2,000 tax deduction.
This deduction is availabe whether or not the car is used for business, regardless of whether the taxpayer itemizes. There will be no separate line for it on the 2003 return; instead, taxpayers will write the words "clean fuel" next to the deduction on line 33 of their form 1040.
This deduction will decline to $1,500 for vehicles purchased in 2004; if you are going to be green, it's best to do it now.
A provision in Senator Grassley's "JOBS" bill would limit the amount of "Section 179 deduction" available for passenger vehicles weighing over 3 tons. The provision, pointed out this week by the Wall Street Journal (subscription required), would limit the Section 179 deduciton for such vehicles to $25,000. The current limit is $100,000.
The tax law now favors the puchase of sport utility vehicles and other big units. While smaller cars are subject to strict depreciation and Section 179 limits -- the maximum deduction is based on a $15,300 vehicle cost for 2003 - SUVs over 6000 lbs are exempt. While The JOBS bill will restrict the Section 179 deduction for SUVs, it would not subject them to the other auto depreciation limits.
Any new limits would take effect for vehicles purchased after the date of enactment. The future of the JOBS bill is uncertain.
The IRS has set up an online guide to qualified plans for trustees and administrators. The guide has sections on how to keep your plan out of trouble and how to fix any problems that arise. It also discusses the different kinds of plans available, including SEPs and SIMPLE plans.
The IRS has issued (Rev. Proc. 2003-75) the official 2003 depreciation limits for passenger automobiles. The so-called "luxury" car limits kick in for 2003 vehicles costing over $15,300.
For cars placed in service in 2003 not using the "bonus" depreciation - used cars, for example - the annual depreciation limits are:
1st Tax Year.................$3,060
2nd Tax Year................$4,900
3rd Tax Year................$2,950
Each Succeeding Year...$1,775
For cars using 30% bonus depreciation - the maximum available for cars placed in service before May 5, 2003 - the limits are as follows:
1st Tax Year.................$7,660
2nd Tax Year................$4,900
3rd Tax Year................$2,950
Each Succeeding Year...$1,775
The limits for cars using 50% depreciation are:
1st Tax Year...............$10,710
2nd Tax Year................$4,900
3rd Tax Year................$2,950
Each Succeeding Year...$1,775
Taxpayers can circumvent these limits by exclusively using fine vehicles like this:
The Dallas-Ft. Worth Star Telegram brings us word of a tax strategy that seems perhaps unwise in retrospect:
1. Stop withholding or paying any employment taxes for your employees; and
2. Buy a full-page ad in USA Today to tell the world about your tax-saving plan.
Mr. Richard Simkanin fully implemented this strategy when he, along with some like-minded folks, purchased the ad in March 2001. He has apparently had a change of heart, given his guilty plea this week to a felony count of failure to collect, withhold or account for taxes on employees of his business.
Mr. Simkanin's plea bargain requires him to post his plea documents on his website within seven days, which had been a repository for anti-government and anti-tax material. There are at least two places to look for the plea documents in the coming days: here and here.
The bonus depreciation rules of the new tax law reward the "do-it-yourselfer." While used equipment is ineligible for the 50% first-year bonus depreciation, purchasers of used equipment can take bonus depreciation on costs they incur to make it fit for service. If they buy the used equipment with the refurbishing already completed and included in the purchase price, the whole unit is considered "used" equipment, and no bonus is available, under IRS regulations issued last month.
Example: Casey buys a used locomotive for his railroad for $200,000 in September, 2003. He spends another $50,000 in his shop rebuilding its electric motors before year-end. He can take bonus depreciation on the $50,000, and his total depreciation deduction for the rebuilding costs in 2003 is $28,571.
If Casey instead paid $250,000 to buy the locomotive with the rebuild work already completed, he would get no bonus depreciation on the $50,000 rebuild cost built into the purchase price; his 2003 deduction for the rebuild price would be only $7,143.
The committee also delayed the effective date of the proposal, in whatever form it is approved. It had been slated to take effect for policies sold after September 17; now policies sold before the bill is signed by the President will also be grandfathered.
The article quotes Senator Charles Grassley, Finance Committee Chairman, as saying the committee will have a hearing on the proposal the week of October 13. Tha article says
"(Grassley) said that lobbyists who oppose the committee's COLI provision visited 'every office in the Capitol' during the past week, but that even the industry recognizes some change is needed because it 'put forth some legislation.'"
If you are considering such insurance, you now have a window to make your decision before the new rules apply.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to