Tax Update Blog: April 2004 Archives

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MORE TAX FUN FOR SENATOR KERRY

April 30, 2004

John Kerry is receiving more free tax advice. The Instapundit points to a story in the Boston Globe providing additional information on the sale of a painting that was reported on Senator Kerry's 2003 tax return. The Senator has already amended the return to correct a preparer error in determining the nature of the gain.

An Instapundit reader says the story suggests that the original return might have another error -- the return may have shown too little gain. Is it true?

THE FACTS

According to the Boston Globe story, Senator Kerry's wife bought a 1/2 interest in the painting around 1994 for $1,000,000. When the painting was sold in 2003 for $2,700,000, Senator Kerry's return reported 1/4 of the $700,000 gain, or $175,000.

Alert Instapundit reader David Walser noted an additional fact: The art dealer who owned the other 1/2 interest in the painting told the Boston Globe reporter that

   Over time, he reimbursed (Mrs. Kerry's)
   $1 million, her  original one-half stake in
   the purchase price. When he sold it last
   year to a private collector for $2.7 million,
   he shared the $700,000 profit with her.

If the other owner had "reimbursed" Mrs. Kerry $1,000,000, her basis in the painting would be zero. If the Kerrys had received 1/2 the gross proceeds, as the Senator's return seems to show, the Senator's 1/4 share of the gain should be $675,000, not $175,000.

SO THE RETURN IS WRONG?

Maybe not. Senator Kerry received his interest in the painting as a gift from his wife. The tax law (IRC Sec. 1042(b)(2)) says that a spouse who receives a gift from the other spouse also receives the donor spouse's basis in the gift. If Senator Kerry received his interest in the painting before Mrs. Kerry received any "reimbursements," his basis in his 1/4 interest would be the $500,000 shown on his return. In that case, however, Mrs. Kerry would have had to show a $500,000 gain on the $1,000,000 "reimbursement" she received from the other co-owner. Because she filed "married filing separately," we don't know how she reported the payments.

HOW SHOULD THE TRANSACTIONS BE REPORTED?

Not many folks we know would reimburse a co-owner their entire purchase price and yet split the gross proceeds on the sale. That said, we don't move in those circles of the art world (or any other circles of the art world, for that matter), so maybe it's not an unusual arrangement.

If the co-owner was reimbursing Mrs. Kerry after she had gifted the 1/2 interest to the Senator, she should have at the very least begun reporting gain once the reimbursements exceeded the $500,000 basis in the 1/4 interest she retained.

If any reimbursements were received before she gave the 1/4 interest to her husband, the Senator's basis should be reduced by 1/2 of the reimbursements, increasing his gain.

Of course, it's possible that the actual transactions differed from what the Boston Globe reported, and perhaps the gain is exactly as shown on the Senator's return.

WHAT DO WE LEARN FROM THIS?

These issues illustrate the drawbacks of married taxpayers filing separate returns. If the returns are prepared by separate preparers, errors can crop up because each preparer has incomplete information.

DOES THE INSTAPUNDIT HAVE A LOT OF NERVE SUMMONING HELP FROM TAX BLOGS?

Well, considering this post, one could draw that conclusion. But when the blogfather speaks, we can only hear and obey.

Prior coverage:

THE MANY FLAVORS OF ASSET SALES

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THE POLK COUNTY COURTHOUSE CLOCKS

April 29, 2004

Suggested Motto: "Right four times a day!"

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BEING A HAWAIIAN PRINCESS MUST PAY WELL

April 28, 2004

A Pennsylvania cafeteria worker claims to be a Hawaiian princess and obtains a $2.1 million refund of estimated federal taxes paid by the real Princess Abigail Kawananakoa. She used the right social security number and got the refund, no problem.

Except for the federal investigation and the need to return the money, that is.

Thanks to the TaxProf Blog for the tip.

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THE MANY FLAVORS OF ASSET SALES

April 28, 2004

The tax rules on asset sale gains are far from simple. Just ask John Kerry's tax preparer.

The presidential candidate has already amended his 2003 tax returns because his tax preparer misclassified a gain on the sale of a painting. Such gains are eligible for a reduced capital gain tax, but not the lowest capital gain rate. As a public service to those preparing returns for future candidates, we offer a quick rundown on the taxation of asset sales, from worst to best.

ORDINARY INCOME

Gains on the sale of some business assets are taxed as ordinary income, subject to the same regular tax rates - or alternative minimum tax rates - that apply to other income. The top ordinary income rate for individuals is 35%.

Oridnary gains include those on the sale of inventory and gain on the sale of depreciated property (but not buildings) that represents a recovery ("recapture") of prior depreciation.

Sometimes gain on depreciable property, including buildings, is ordinary even if the sale price is more than its original undepreciated cost, if the taxpayer has sold depreciable property at a loss in the previous five years.

A sale of a partnership interest can also be ordinary if a sale of assets by the partnership would result in ordinary income. Are you with us so far?

SHORT-TERM CAPITAL GAIN

Most property owned by non-business taxpayers is capital gain property of one sort or another. If the property sold at a gain has been held for one year or less, it is "short-term" gain. The tax rate for short-term gains is the same as ordinary income. The only tax-planning advantage of short-term capital gains is that they can be offset by short-term or long-term capital losses incurred in the same year (or those carried forward from prior years when net capital losses exceeded $3,000).

LONG-TERM COLLECTIBLES GAINS: 28%

If you sell a "collectible" that you have held for more than one year at a gain, the gain will be taxed at your ordinary rates or 28%, whichever is lower. For married taxpayers filing joint returns, this starts to be helpful in 2004 when taxable income hits the 33% bracket at $178,650. This is the provision that Senator Kerry's preparers mishandled.

The tax law defines a collectible as

   (A)  any work of art,

   (B)  any rug or antique,   

   (C)  any metal or gem,

   (D)  any stamp or coin, [or]

   (E)  any alcoholic beverage

GAIN ON DEPRECIATED COSTS OF BUILDINGS: 25%

A taxpayer who buys a building for business or rental use depreciates the building, deducting a portion of the building's cost each year for a period of years. For residential property, the depreciable life is currently 27.5 years; other buildings are depreciated over 39 years.

When a taxpayer sells a building, or other depreciable property, the cost used in determining whether the sale results in a gain is reduced by depreciation taken.

Example:

   A taxpayer purchases a duplex for 
   $275,000 and rents it for 10 years
   (we ignore the cost of land for now).  
   He then sells it for $300,000.  He would
   have taken a $10,000 depreciation 
   deduction each year, so his "basis" in
   the building would be $175,000:

   Original cost:         $275,000
   less depreciation:     (100,000)
   Basis:                 $175,000

The taxpayer would have a gain of $125,000 on the sale ($300,000 sale price less $175,000 basis). The gain attributable to the depreciation - $100,000 - would be taxed at a top rate of 25%. The remaining gain would normally be eligible for the lowest capital gain rate (unless the taxpayer had sold depreciable property for a loss in the prior five years).

The 25% rate is an advantage for joint filers with taxable income over $117,250; it also helps any taxpayers subject to alternative minimum tax, which has a minimum rate of 26%.

NIRVANA: THE 15% RATE

Any other long-term capital gains are eligible for the 15% maximum rate. Assets eligible for this rate include stocks, bonds (but beware of accrued interest and gains on bonds bought at a discount), land and similar investment property. Senator Kerry's tax preparers erroneously treated a sale of artwork as this kind of capital gain.

Long-term gains help all taxpayers. Taxpayers that would otherwise be in the 10% (joint income up to $14,300) or 15% (joint income up to $58,100) brackets pay a 5% maximum federal rate on "15%" long-term capital gains. If they hang on until 2008, this rate for low-bracket taxpayers is scheduled to fall to 0%.

WHAT ABOUT ALTERNATIVE MINUMUM TAX?

The same maximum rates apply in computing AMT.

A WORD ABOUT PARTNERSHIPS

Beware. If you are selling a partnership interest, many technical rules may affect the rates that apply.

WHAT ABOUT IOWA?

Unless you qualify for a special break for certain ultra-long-term capital gains (held at least 10 years), Iowa taxes capital gains at the same rate as ordinary income.

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THE SPEAKERPHONE MENACE

April 23, 2004

A Tax Court case issued yesterday gives all tax preparers a valuable lesson: if you call a client with an IRS agent in your office, don't use the speakerphone.

Padgett C. Price's CPA prepared tax returns for her law practice based on the business bank account checkbook. As it turns out, some firm income was deposited into Ms. Price's personal Merrill Lynch cash management account. As the CPA was unaware of these deposits, the income was not reported on the law practice tax returns.

The IRS agent examining the law practice got wind of the Merrill Lynch accounts and asked the CPA for them. The CPA got on the speakerphone to the client, Ms. Padgett. The client, unaware the agent was listening in, declared that the IRS would never get the Merrill Lynch records.

Things went downhill from there. Ms. Price was convicted of criminal tax fraud, was disbarred, and yesterday the Tax Court upheld civil fraud penalties against her.

Was the speakerphone the problem? The real problem was skimming the law practice income and not reporting it, compounded by clumsy attempts to cover it up. Still, the speakerphone incident didn't make it less likely that the agent would refer the case to criminal investigators.

Link: Padgett Coventry Price (pdf format)

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TREASURY INSPECTOR GENERAL PRESENTS IRS WITH CLUE

April 22, 2004

One function of the the Treasury Inspector General for Tax Administration apparently is to be a source of clues for the clueless.

TIGTA this week released a report on the IRS's "Lead Development Center," or "LDC", an office set up as a central bureau to identify abusive tax shelter promotors and monitor efforts to shut them down.

The report says the LDC effectively tracks promoter leads that it identifies, but that it neglects one important tool of promoter identification:

   Our review showed the LDC is not
   performing Internet research,
   independent of referred leads, to
   identify promoters.     

Why not? Well, they apparently are just too darn busy:

   The primary reason for not proactively
   monitoring the Internet is that leads
   received from other sources provided
   sufficient work for the LDC staff.  

So the IRS National Office can't make time for a someone to sit around running internet searches for flaky tax shelters? We assumed they already had; the Tax Update web statistics regularly list visitors from IRS who have entererd the names of known abusive shelters in their search engines (Anderson's Ark! Anderson's Ark!). Apparently they were rogue agents or something.

The TIGTA report kindly provided a clue for the IRS:

   We recommended the Director,
   Compliance, SB/SE Division, ensure the
   LDC becomes more proactive in
   researching the Internet to
   independently identify promoters of
   abusive tax schemes.  

   Management’s Response:  The
   Commissioner, SB/SE Division, agreed
   with our recommendation.  The SB/SE
   Division LDC Program Manager will
   continue to work with the SB/SE
   Division Strategy, Research, and
   Performance Management function to
   complete the current research study
   involving evaluation of LDC needs,
   identification of software, testing of
   software, and review of software
   suitability.  Also, the SB/SE Division
   LDC Program Manager will implement
   a process within the LDC to research
   the Internet and independently identify
   promoters of abusive tax schemes.

While the report doesn't document this, perhaps TIGTA will also provide the IRS with some key resources to help them with this "internet" thingie.

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DOWNTOWN PROGRESS PROCEEDS APACE

April 21, 2004

The view from Roth & Co. World Headquarters, 4/21/04.

April 19 view
April 13 view

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FREE TAX ADVICE - THE HARD WAY

April 20, 2004

Presidential candidates traditionally make their tax returns public. Revealing every questionable deduction on your return to the world does have one redeeming feature: free tax advice. Senator John Kerry has now taken advantage of some of that free advice to amend his 2003 tax returns.

COLLECTIBLES 28%, STOCKS 15%.

Senator Kerry sold a painting for a $175,000 gain on March 23, 2003. On his original return, Senator Kerry reported the gain as long-term capital gain eligible for the 20% lowest capital gain rate in effect at the time (the rate is 15% for sales after May 7, 2003).

A Texas CPA saw the return and pointed out that "collectibles," such as artwork, are ineligible for the lowest capital gain rate; they are instead taxed at a 28% maximum rate. A Kerry spokesman, while not refuting the CPA's statement, told Tax Analysts "We’re going to take a lot of punches from people from Texas.” But the Senator's campaign has now released an amended return correctly reporting the painting as 28% gain.

STATE RETURN NON-ISSUE

Senator Kerry files a Massachussetts state return. Massachussetts has a peculiar provision allowing taxpayers to voluntarily pay their taxes at a higher rate than the law requires. Some commentators say Senator Kerry is hypocritical for not voluntarily paying the higher rate on his return.

In fact, declining to pay extra tax is normal and healthy. After all, we make a living helping folks do just that. Most voters, we suspect, would consider a voluntary payment of extra tax to be cause for alarm. If a relative were found to be paying extra tax, many of us would discreetly inquire about a conservatorship and a nice rest home.

Tax Analysts has helpfully made the tax returns of President Bush, Vice-President Cheney, and Senator Kerry freely-available (pdf format) here. No links are provided for returns for presidential candidates Nader and Kucinich.

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TAXING YUMMY GOODNESS

April 19, 2004

The Iowa Department of Revenue has to make many tough calls, but none can be tougher than determining whether a Rice Krispy Bar is "candy." It matters; "candy" is subject to sales tax, where "cereal products" are exempt.

In a recent policy letter, the Department made the tough calls:

Issue:

   Chocolate Drizzle Rice Krispies Treats:  
   This snack consists of crispy rice and  
   marshmallow squares that are drizzled 
   with chocolate.     

Ruling:

   
   Exempt as a cereal product pursuant 
   to department rule 701 IAC 20.1(1)”e”.
   The fact that it is drizzled with 
   chocolate is not sufficient to constitute 
   a taxable candy-coated item.      

But not all news is good news.

Issue:

   
   Fruit Roll-ups Strawberry Sensation, 
   Fruit Gushers Watermelon Blast, Fruit
   Leather, and Scooby Doo Fruit Snacks:       

Ruling:

  These items all contain sugar as their 
  largest ingredient and are all classified 
  as taxable candy.        

Perhaps this work should be farmed out to a panel of experts.

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A BENEFITSBLOG MILESTONE

April 19, 2004

If you're counting, BenefitsBlog put up post #1000 last week. Congratulations to the author, B. Janell Grenier, who kindly links to the Tax Update with inexplicable regularity.

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MAY 2004 FEDERAL RATES ARE OUT

April 19, 2004

The IRS has issued (Rev. Rul. 2004-44) the minimum interest rates for loans made in May 2004:

Short Term (demand loans and loans with terms of 1-3 years): 1.50%
Mid-Term (loans from 3-9 years): 3.16%
Long-Term (over 9 years): 4.65%

Historical AFRs are available here and via the “Links” page at www.rothcpa.com.

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NEW DOG IN BLOGTOWN

April 19, 2004

Paul Caron, the mastermind of our favorite beach reading, has joined the Blogosphere with the "TaxProf Blog." The site has already beaten the Bush, Cheney and Kerry returns to powder in pursuit of its mission of providing "Resources, News & Information for Law School Tax Professors." Don't let that scare you - much of it is good reading for those not inclined to tenure. With the "Taxing Blog" and "Tax Analysts Alive" gone dark, this is a rare home for blogospheric discussion of tax policy issues.

We thank Dr. Caron for linking to us, and we are happy to link to his new site under the "Hardcore Tax Nerds" section of our blogroll, over to your left.

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BACK IN THE SADDLE

April 19, 2004

The Tax Update is back from an April 15 - related respite. We have been far from idle, though. Much has been accomplished since our last post:

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HOW TO AMUSE TAX PREPARERS ON AN APRIL EVENING

April 13, 2004

Tearing down the 7th & Mulberry ramp: the view from Roth & Company World Headquarters.

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LAST CARNIVAL OF TAX SEASON

April 13, 2004

The weekly Carnival of the Capitalists, a collection of weblog posts under the general theme of economics and business, is up at The Chicago Report. Don't miss the fun!

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TAX SEASON SUNRISE

April 12, 2004

Monday, April 12 - Downtown Des Moines

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GOT TAXES?

April 12, 2004

The IRS has a helpful summary of ways to remit your taxes, and what to do if you don't have the cash to pay them:

Electronic Options Help with Tax Payments (IR-2004-52)

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THINGS DUE APRIL 15

April 12, 2004

April 15 is the deadline for a few other things besides form 1040. A few of the other items due Thursday:

IRA CONTRIBUTIONS FOR 2003, regardless of whether the return is extended.

SEP CONTRIBUTIONS for self-employed taxpayers for 2003, unless the return is extended.

PENSION CONTRIBUTIONS for calendar-year partnerships, unless the return is extended.

PARTNERSHIP TAX RETURNS for calendar-year partnerships.

TRUST AND ESTATE TAX RETURNS for calendar-year trusts and estates.

GIFT TAX RETURNS are also due April 15.

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THE PRICE OF PEACE OF MIND: $4.05.

April 12, 2004

An enduring mystery of tax practice is the unwillingness of taxpayers who have paid hundreds of dollars to a preparer for a return owing thousands of dollars of taxes to spend $4.05 extra to mail the return "certified mail, return receipt requested."

The tax casebooks are full of instances where taxpayers have tried to prove timely-filing in the absence of a postmark. Absent a certified mail receipt, taxpayer victories are rare - and the ones that do exist certainly cost the taxpayer more in attorney fees than they would have spent on certified mail.

As April 15 looms, here is a recap of making sure your return is treated as timely-filed.

THE TECHNOLOGICAL SOLUTION

Electronic filing is hard to beat as a means of making sure your return or extension has been filed on time. Electronic filers get prompt acknowledgment of filing from the IRS. We are unaware of any case where the timeliness of an e-filed return has been disputed.

CERTIFIED OR REGISTERED MAIL

A timely certified mail or registered mail postmark can be a valuable possession. The penalty for late filing a return is 5% of the tax due, plus 5% for each additional month. It doesn't take much tax owing to exceed the cost of that certified mail postmark.

If you send certified mail, be sure to get the postmarked receipt and put it in a safe place. It also doesn't hurt to write the receipt number on the return or extension, just to be safe.

UPS AND OTHER PRIVATE DELIVERY SERVICES

The IRS now accepts receipts from some private delivery services, such as UPS and Federal Express, as proof of timely mailing. If you want to use such a service, be sure to review Notice 2002-62 to make sure the private delivery method you use qualifies.

DROPPING THE ENVELOPE IN THE BIN HELD BY THE POSTAL WORKER ON 2ND AVENUE AT 11:59 PM ON APRIL 15

For incorrigible optimists only.

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DOWN TO THE WIRE? MOVE THE WIRE!

April 09, 2004

Tax season is drawing to a close. Thursday evening hordes of pallid, red-eyed tax preparers will rush to their favorite nightspots to get rowdy, only to fall asleep in their first beer.

In other words, maybe you don't want these earnest but groggy professionals to finish your return just right now. Maybe it's best to let them rest up a bit first. Remember:

THE EXTENSION IS YOUR FRIEND!

Individual returns can be extended with Form 4868, no questions asked. All the government asks is a reasonable guess as to your tax, and that you pay in enough to have 90% of your total tax for 2003 paid in by April 15. You then have until August 15 to get it all right.

But won't that make my return more likely to be audited?

No. Returns get audited based on what's on them, not on when they are filed (ok, if you are just getting around to filing your 1987 return, you are likely to get audited).

But the statute of limitations will be open that much longer if I extend.

Yes, that is true. But let's put this in perspective: a tax practitioner very close to us who has been in this game since the Reagan administration has seen exactly no cases where an IRS agent discovered an issue in an open year on an extended return that would have been safely closed to the agent absent the extension.

In fact, sometimes keeping the statute open those few extra months actually helps taxpayers. Last summer tax scientists in Iowa discovered a new and improved tax break for S corporation shareholders based on a new position issued by the Iowa Department of Revenue. Those who had extended their 1999 returns were able to file refund claims, some for tens of thousands of dollars. Those who filed on time were out of luck - the statute of limitations for refunds had closed.

But what if I guess wrong when I guess my extension payment?

One word: "sandbag."

OK, some more words. If you pay in at least 90% of your balance due, you will only owe interest on the difference if you pay it by August 15. The interest rate is currently 5% - maybe more expensive than your home equity line, but probably cheaper than your credit card.

If you fall short of the 90% level, you will pay a 1/2% per month penalty in addition to the interest.

Where can I find this "extension" of which you speak?

Right here.

What about state returns?

Many states honor the federal extension. Iowa automatically extends your return to October if you are 90% paid in. Check your return instructions or your state's department of revenue website.

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ATTORNEY GENERAL GOES BACK TO US SUPREMES ON CASINO TAX

April 08, 2004

We may not have seen the last court decision on Iowa's casino tax.

Iowa Attorney General Tom Miller yesterday asked the U.S. Supreme Court to decide whether the Iowa Supreme Court misbehaved in its most recent ruling striking down the tax. The casinos sued to overturn the tax because it taxes land-based casinos at a higher rate than riverboats.

The U.S. Supreme Court had ruled that the Iowa court had misapplied federal "equal protection" law in striking down the tax, so it was not unconstitutional under U.S. constitution standards - standards with the Iowa court said it was trying to apply. The U.S. Court sent the case back to Iowa for proceedings "not inconsistent" with its ruling.

The Iowa Court then struck down the case anyway.

Attorney General Miller's new appeal says that the Iowa court failed to arrive at a ruling "not inconsistent" with the U.S. Court ruling.

Tom Flynn, an attorney for the casinos, quipped: "This has been a most interesting case, but it was my hope that it would be concluded in my lifetime. Now I am not so certain that it will."

Prior coverage:

TAKE THAT, U.S. SUPREME COURT: IOWA SUPREME COURT STRIKES DOWN CASINO TAX

WHAT IS IOWA'S TAX LAW? WHO KNOWS?

IF RACETRACK = RIVERBOAT, DOES BANK = CREDIT UNION?

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DOL: HEALTH SAVINGS ACCOUNTS ARE NOT ERISA PLANS

April 08, 2004

The Department of Labor yesterday announced that Health Savings Accounts will generally not be treated as "ERISA" plans (Field Assistance Bulletin 2004-1; pdf format). ERISA plans have many additional compliance burdens; by making clear that ERISA doesn't apply, the DOL makes it much more likely for employers to sponsor HSAs.

The DOL arrived at this conclusion even though, as Henry Aaron of the Brookings Institute has noted, HSAs can be viewed as defined contribution plans in drag with a health-expense kicker.

The key language of the DOL ruling:

   Accordingly, we would not find that 
   employer contributions to HSAs give 
   rise to an ERISA-covered plan where 
   the establishment of the HSAs is 
   completely voluntary on the part of 
   the employees and the employer does 
   not: 
   
   (i) limit the ability of eligible individuals 
   to move their funds to another HSA 
   beyond restrictions imposed by the 
   Code; 

   (ii) impose conditions on utilization of 
   HSA funds beyond those permitted
    under the Code; 

   (iii) make or influence the investment 
   decisions with respect to funds 
   contributed to an HSA; 

  
 (iv) represent that the HSAs are an 
   employee welfare benefit plan  
   established or maintained by the 
   employer; or 

   (v) receive any payment or 
    compensation  in connection with an
    HSA.

   The mere fact that an employer 
   imposes terms and conditions on 
   contributions that would be required 
   to satisfy tax requirements under the 
   Code or limits the forwarding of
   contributions through its payroll 
   system to a single HSA provider (or 
   permits only a limited number of HSA 
   providers to advertise or market their 
   HSA products in the workplace) would 
   not affect the above conclusions 
   regarding HSAs funded with employer 
   or employee contributions, unless the 
   employer or the HSA provider restricts
   the ability of the employee to move 
   funds to another HSA beyond those 
   restrictions imposed by the Code.

UPDATE: BenefitsBlog has more.

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IRS CHARM OFFENSIVE CONTINUES

April 07, 2004

The IRS maintained the tempo of its tax season charm offensive yesterday when Commissioner Everson got together for a press conference with the Department of Justice's lead Tax Prosecutor, Eileen O'Connor.

The tax officials touted a dozen successful recent tax prosecutions to make the point that "We have arrested the decline" in tax enforcement, in the words of Mr. Everson. This shows that they're arresting everything. No word on whether the arrested decline made bail.

The news release issued for the press conference may be found here.

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HEY IRS - PICK ME! PICK ME!

April 07, 2004

One of the joys of a subscription to Tax Analysts' online "Tax Notes Today" is their policy of printing letters to the Treasury Department. Today's edition has a gem from a gentleman from Leland, North Carolina:

   I am writing to you, seeking specific 
   answers to specific questions 
   regarding the correct application of 
   the federal income tax laws. I am not 
   writing to "protest" anything, or to 
   argue anything, only to request 
   information. I am not interested in 
   receiving information about "scams," 
   or about the consequences of not 
   paying "my taxes," or any other 
   response which does not specifically 
   answer the questions. I am merely 
   seeking clarification on what the law 
   itself requires.

It is certainly helpful that he placed the emphasis on the word "specific," as the reader might have otherwise missed it.

The letter goes on to ask tendentious questions asserting the lame arguments that the rules governing income sourcing for foreign tax credit rules somehow exclude U.S. source income from taxation. If this sort of letter doesn't at least get someone at IRS to take a peek at the writer's return, then maybe he'll just have to take out an anti-IRS ad in USA Today.

To see the lameness of the "Section 861" argument elegantly set forth, go here.

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WSJ DRAWS SURPRISING CONCLUSION ON GAO STUDY

April 06, 2004

The Wall Street Journal reported today on a General Accounting Office study saying more than 60% of U.S. corporations didn't pay any federal taxes for 1996 through 2000.

The Journal then adds:

   The latest report has given new 
   ammunition to the campaign of 
   Democratic presidential challenger Sen. 
   John Kerry, who has criticized 
   President Bush for failing to crack 
   down on corporate tax dodgers.

Of course, George Bush was the Governor of Texas for all years in the GAO study. The Journal article therefore buries the real news: either President Clinton is running for re-election, or the Governor of Texas has a previously-unreported power over federal corporate tax administration. We await further developments.

Links:
The GAO report summary (pdf format)
The full GAO report (pdf format)
The Wall Street Journal Article (available to WSJ online subscribers only)

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TAX TROUBLE IN PARADISE

April 06, 2004

Today's friendly tax compliance reminder from the Department of Justice tells the story of a member of the Hawaii state legislature who sought to outsource his tax liabilities:

   Mr. Suzuki admitted that he was
   employed until 1994 as comptroller of 
   Hawaiian Isles Enterprises, Inc. (HIE), a 
   company owned by his co-conspirator, 
   Michael H. Boulware. Until 1994, he also 
   prepared Mr. Boulware’s income tax 
   returns. HIE and its related entities 
   generate gross sales of approximately 
   $80 million dollars per year and are 
   engaged in the sales of tobacco, 
   coffee, and vending machine products 
   throughout the State of Hawaii. 

   Mr. Suzuki admitted, in his plea 
   agreement and open court, to his role 
   in creating offshore corporations and 
   bank accounts in the Kingdom of Tonga 
   and the Hong Kong Special 
   Administrative Region (HKSAR). The 
   corporations and bank accounts were 
   intended to obstruct a criminal 
   investigation being conducted by 
   Internal Revenue Service. Mr. Suzuki 
   admitted that Mr. Boulware 
   transferred approximately $3 million 
   dollars belonging to HIE to the Hong 
   Kong accounts. The concealed funds 
   included monies earmarked by Mr. 
   Boulware for an unsuccessful attempt 
   to purchase a bank in Ecuador. 

Mr. Suzuki apparently made use of his legislative perks:

   Mr. Suzuki admitted sending faxes in 
   furtherance of the scheme from his fax 
   machine located at the Hawaii State 
   Legislature. 

Mr. Suzuki pleaded guilty to conspiracy to defraud the Internal Revenue Service from June 1993 through February 2000. He is scheduled to be sentenced July 28. The charge carries a maximum penalty of five years in prison and a $250,000 fine.

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IT MUST HAVE BEEN TEMPTING...

April 05, 2004

A U.S. District Judge in Nashville got an opportunity most of us only dream of. A taxpayer who lost a tax case filed suit asking the judge to declare himself immune from federal taxes.

The plaintiff apparently reasoned that he lost his income tax case not because it was deficient in any way, but because the judge was afraid of the IRS.

The judge passed on this opportunity:

   Plaintiff asserts in his Motion that 
   federal judges are taxed in the same 
   manner as other taxpayers and are 
   subject to income tax prosecution. In 
   order to alleviate this perceived 
   pressure and undue influence, Plaintiff 
   moves to have the undersigned be 
   immune from federal prosecution for 
   income tax violations for the next ten 
   years. Plaintiff provides no facts or law
   to support his allegation that federal 
   judges in general, or the undersigned 
   in particular, are under undue pressure 
   because they have to pay income tax 
   on their income and are subject to 
   federal prosecution if they do not do 
   so or how a federal judge could declare 
   himself immune from federal 
   prosecution. This theory is bizarre, 
   without foundation or support, and 
   meritless. Accordingly, Plaintiff's 
   Motion is hereby DENIED

Of course, it's really tax practitioners that should have this kind of immunity, so we could help our clients comply with the law without fear...

Case: Leslie E. White (no link available).

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CARNIVAL IN APRIL

April 05, 2004

The new "Carnival of the Capitalists," a weekly compilation of business-related weblog posts, is up. This week's edition covers a lot of ground, from expensing stock options to outsourcing to the new ban on smoking in Irish pubs. Worth a visit.

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GRASSLEY: FARMERS LEAVING TAX CROP IN THE FIELDS

April 02, 2004

Senator Charles Grassley announced yesterday that a new Treasury study shows that most farmers who are eligible for a recently-enacted tax benefit have failed to claim it.

The study, prepared by the Treasury Inspector General for Tax Administration (TIGTA), shows that only about 52,000 farmers eligible for "income averaging" in 2001 took advantage of it. Another 64,000 or so farmers failed to use the special farm income-averaging provision and overpaid their 2001 taxes by more than $33 million.

Links:

Senator Grassley's press release (.pdf format)

The TIGTA study.

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TREASURY OBJECTS TO S CORPORATION - CHARITY TAX SHELTER

April 02, 2004

The Treasury yesterday moved to shut down a tax shelter using S corporations to artificially pawn off taxable income to charities without really giving up the income (Notice 2004-30).

The plan, reportedly marketed by one national accounting firm as "SC2" through a telemarketing center, had several steps:

- Issue warrants to S corporation shareholders pro-rata - say, 1000 warrants per each share. The single owner of a 100-share S corporation would receive 100,000 warrants to buy one additional share.
- make a class of non-voting shares - for example, turn 99 out of 100 shares non-voting shares.
- Donate the non-voting shares to charity - but not the associated warrants.
- Allocate 99% of the earnings to charity for a few years. This would work best with interest, dividend and capital gain income, which is non-taxable to charities.
- The owner of the one voting share then exercises his warrants, suddenly owning 100,001 shares to the charity's 99 nonvoting shares.
- Redeem the charity's 99 shares.

If it works as designed, most of the income isn't taxed because it is allocable to charity, yet the warrants enable the "donor" to reclaim almost all of the income eventually. Because the charity has no vote, it gets no say in the corporation.

Notice 2004-30 says:

   The Service intends to challenge the
   purported tax benefits from this 
   transaction based on the application of 
   various theories, including judicial 
   doctrines such as substance over 
   form. Under appropriate facts and 
   circumstances, the Service also may 
   argue that the existence of the 
   warrants results in a violation of the 
   single class of stock requirement of § 
   1361(b)(1)(D), thus terminating the 
   corporation's status as an S 
   corporation. 

The notice makes such arrangements a "listed transaction." Failure to fully disclose such a transaction subjects taxpayers to penalties.

Employee stock ownership plans owning S corporation shares are not subject to Notice 2004-30.

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MAYBE HE MOWED A LOT OF LAWNS FOR DAD

April 01, 2004

"Dr. Zuercher admitted he hid income owed to the Internal Revenue Service, falsely attributed $136,000 as salary paid to his teenage son, and caused the filing of false and fraudulent statements with an IRS collection officer, in order to prevent the garnishment of income earned by his dental practice."

-From a Department of Justice press release on the sentencing of the dentist to 21 months in prison. His CPA was sentenced to 6 months for helping the dentist prepare false returns.

Just consider this another friendly seasonal reminder from the government of your taxpaying obligations.

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THE FIRST TIME THE WORD 'HEART' HAS BEEN USED IN THE SAME SENTENCE AS THESE PROFESSIONS

April 01, 2004

"At the heart of every abusive tax shelter is a tax lawyer or accountant."

-Senator Charles Grassley, in a letter to Treasury Secretary Snow (via Tax Analysts)

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