Tax Update Blog: August 2004 Archives

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A MESSAGE FROM REMY WELLING, IRS WHISTLEBLOWER

August 26, 2004

Remy Welling is a 22-year IRS veteran whose story of insider influence on behalf of Micrel, Inc., at the IRS was covered in recent New York Times and Tax Analysts articles. Ms. Welling sent us an email responding to our coverage of the story. We reproduce her message below (all emphasis in original).

   I was reading your online bulletins. I wanted 
   to respond briefly. I was very happy to see 
   you were discussing it and taking an interest 
   in it. Pro or con. 

   Yes, my story is true. It was very well 
   documented. 

   As far as my concerns generally with undue 
   influence: it is true that revenue agents are 
   not easily pushed aside.  But orders typically 
   go from former IRS executives to current 
   IRS executives to current line managers to 
   current line employees. To disobey would 
   be insurbordination. 

   For Micrel, it was not that I was just asked 
   merely to "close an examination". I was 
   actually ordered to sign or authorize a 
   "Closing Agreement" (IRC Sec 7121), of 
   course - a binding contract - or else. This is 
   a document that is seldom if ever used. 
   And we are not even permitted to have a 
   signed Closing Agreement (IRC Sec 7121) 
   in a Joint Committee Case before the Joint 
   Committee reviews it, per the Larry Langdon 
   Memo. These were extraordinary Orders. 

   And there was a SMOKING GUN from the 
   very beginning. Or should I say Smoking 
   Guns. For one thing, in Jan 2002, the 
   taxpayer had re-stated their financial 
   statements lower by $64,000,000 for  Stock 
   Options Expenses due to APB 25. Since it 
   was not meeting APB 25, I knew it was not 
   meeting the definition of ISO - in both cases - 
   the options needed to be greater than or 
   equal to the FMV on the date of grant. 
   I also knew that the Stock Option plans 
   were not fully and materially disclosed to 
   the SEC. There were many problems. Any 
   yet I was supposed to okay this, sight 
   unseen on a binding contract, stating that 
   even if the Stock Option Plan did not meet 
   the requirments of IRC Sec 422(b)(4), the 
   Incentive Stock Option Plan was still valid.  

   This particular case was not an isolated 
   incident either. But I was not going to 
   "break ranks" as they say. But when I was 
   handed so much evidence, what was I to 
   do? It was hard to say or do nothing. It was 
   a dilemma for me. And believe me, I struggled 
   with it for some time. And I still am.

   A lot of what I think is wrong in the IRS 
   began with the Restructuring Act of 1998 
   and Sec 1203(b) The Ten Deadly Sins and 
   the pressure it has put on the agents and 
   the managers of the Internal Revenue 
   Service. 

   Thank you.

   Sincerely

   Remy Welling

Our main post on the case is here. Our discussion of Micrel's response to the New York Times is here.

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IMBIBE AND INVEST? THE DANGERS OF TRADING WHILE TIPPLING

August 26, 2004

During those happy times when the market seems to be headed ever upwards (oh, the '90s were so much fun!), it almost seems like investors are trading under the influence. In a case issued by the Tax Court today, we find an actual instance of trading while tippled:

   On each day that Paine Webber was open 
   for business, petitioner visited its office and
   invested approximately $500,000 to 
   $1 million in speculative securities. From the 
   time that petitioner arrived at Paine Webber’s 
   office, usually 6 to 6:30 a.m., he started 
   drinking alcoholic beverages, supplied by 
   Paine Webber, until he was high and happy 
   but not stumbling drunk. He authorized each 
   of his trades, and he was informed and
   knowledgeable as to all of his trades. Some 
   of the trades resulted in gains, and some of 
   them resulted in losses.

   During 1980, petitioner had exhausted most
   of his funds, and he ceased his regular 
   involvement with Paine Webber.

We thought they only did this in Las Vegas. Maybe that's what they mean by "full service" brokerage.

   In or about 1985, petitioner and his wife sued
   Paine Webber, Osborne, and others 
   (collectively, the defendants) in a U.S. 
   District Court, alleging that the defendants 
   were liable for securities fraud, negligence, 
   and breach of fiduciary duty in the handling 
   of petitioner’s accounts. The court dismissed 
   the lawsuit as time barred by the applicable 
   period of limitations and for failure to plead 
   properly as to fraud. That dismissal was 
   affirmed by the Court of Appeals for the 
   Ninth Circuit.

All that free liquor, and no gratitude whatever.

   On his 1986 Federal income tax return, 
   petitioner claimed an $800,000 deduction 
   for a casualty or theft loss. On his 1997,
   1998, and 1999 Federal income tax returns, 
   petitioner claimed that he was entitled to 
   deduct with respect to that loss NOL 
   (net operating loss) carryovers of $726,572, 
   $726,572, and $703,308, respectively.

How's that again? He claimed an 1986 loss of $800,000, generating $700,000+ losses each year for 1997, 1998, and 1999? Maybe the tax preparer lingered at Paine Webber before working on these returns.

   Petitioner argues in his brief that he is 
   entitled to deduct the NOL carryovers at 
   issue. According to petitioner, those 
   carryovers are attributable to a theft that 
   petitioner suffered in that “in essence Paine 
   Webber stole his money from him by
   supplying him with alcoholic beverages and 
   allowed him to make unwise investments 
   that benefitted them directly” in the form of
   higher commissions.

Even in the investment world, candy is dandy, but liquor is quicker.

Tax Court Judge Laro said the taxpayer failed to establish that there even was a net operating loss.

Even if there were a loss, the tax law doesn't allow you to use NOL deductions at your convenience. You are required to carry them back to years before the NOL incurred unless you make an election to carry the losses forward on your original timely return for the loss year. In 1986, the carryback period was three years (it's two years now). You have to claim the refund for the prior years within three years of the due date for the loss year return. The return for 1986, the loss year, was due April 15, 1987, so the refund claim was due April 15, 1990.

The only way the taxpayer could have used a 1986 loss eleven years later would be if would not have been offset by income in 1983-1985 or 1987-1996. Even then, you can only use a loss once. The taxpayer failed to introduce evidence in to the court to support that any NOLs would have survived until 1997.

The result? A loss by the taxpayer on all issues, $576,661 in additional taxes, and $115,372.20 in penalties.

The moral? Don't drink and day-trade. Oh, and don't sleep on those NOL carrybacks, either.

Cite: Michael E. Yoakum v. Commissioner, T.C. Memo. 2004-191

After August 26, use this link.

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QUICK GUIDE TO OVERTIME RULES

August 26, 2004

The estimable BenefitsBlog highlights a well-done decision-tree guide to the new overtime rules that took effect this week. This pdf-format guide gives the non-lawyer a handy way to work through the overtime pay thickets.

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WE BLOGROLL!

August 25, 2004

We'd like to mention a couple changes to our blogroll - the list of links on the left side of the Tax Update page.

David Hogberg, an Iowa ur-blogger, has moved on to the Emerald City (Washington, D.C.). His "Cornfield Commentary" blog is now "Hog Haven," reflecting, perhaps, the D.C. fauna. In response to his abandoning our fair state, he is now linked under "Gigablogs," rather than "Regional Commentators."

David's place among the Regional Commentators is taken by "Cop Talk," a weblog by an anonymous Des Moines policeman. Lots of local flavor, but of universal interest.

Visit our Blogrolled friends. These guys are good!

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WILL VALUES FUND EXTENSION FIX IOWA DEPRECIATION RULES?

August 25, 2004

The Des Moines Register today reports that Governor Vilsack will call a one-day legislative session to re-enact the "Grow Iowa Values Fund." The paper cites the Governor as saying he has reached a "general" agreement with legislative leaders on a plan to restore the GIVF in a package that also re-couples federal and Iowa depreciation rules and changes workers compensation rules.

The Iowa Supreme Court nullified the law that originally enacted the GIVF, finding that the Governor's item-veto of tax cuts and other provisions in the enacting legislation rendered the entire bill invalid. The fund has been in limbo since then.

It is not yet clear how the depreciation fix will work. Iowa refused to go along with federal "bonus" depreciation enacted for assets placed in service from 9/12/01 through 12/31/04. Iowa taxpayers have been required to keep separate depreciation records for state regular tax and alternative minimum tax ever since. This affects a number of other Iowa tax computations, including inventory valuation. Iowa has also failed to increase the cap for "Section 179" expensing to the current federal level of $100,000. Section 179 allows taxpayers to deduct in the year of purchase fixed asset costs that would otherwise be recovered by depreciation.

One solution would be to allow taxpayers to file amended returns taking the federal deduction amounts for Iowa; this seems unlikely, as it would cause the state to pay interest on the refunds. A more likely solution would be to allow a "catch-up" deduction for Iowa returns, enabling taxpayers to write off in 2004 the difference between accumulated federal and Iowa depreciation. A truly lame solution would only couple federal and Iowa depreciation for assets purchased from a given date - say, starting 1/1/2004. This solution would require taxpayers to continue to maintain separate federal and Iowa depreciation schedules for years to come, until assets purchased under the federal "bonus" depreciation rules run out their lives.

This depreciation mess could have been avoided, but they just wouldn't listen.

UPDATE: Not everyone wants the fund revived. Good points, but we find the "Cassandra" reference confusing.

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TAXPAYER V. THE EARTH'S ROTATION

August 24, 2004

In this busy world, who hasn't wished for more hours in the day? Alexander Firsow probably has.

Mr. Firsow deducted losses with respect to two rental properties he owned with his wife. The tax law normally treats rental losses as “passive,” deductible only to the extent of “passive” income, or upon disposal. “Active” taxpayers can deduct up to $25,000 in rental real estate losses, but only if their adjusted gross income is less than $150,000.

A special rule exempts “materially-participating rental real estate professionals” from “per se” passive treatment. Qualifying taxpayers may apply the same passive loss rules that apply to non-real estate activities to determine if their real estate losses are passive. This generally requires 500 hours of participation in an activity, or split among multiple activities of at least 100 hours each.

To qualify as a “materially-participating rental real estate professionals,” taxpayers have to clear two hurdles:

      ·They have to participate in real estate 
      activities more than 750 hours, and 

     ·Their real estate participation has to exceed
      their participation in any other activity.

MAYBE IF THEY HADN'T GONE FISHING...

Mr. Firsow prepared a spreadsheet for the IRS examiner showing participation in a Sanibel Island rental property of 606 hours in 1999 and 494 hours in 2000. Even though Mr. Firsow used a real computer to prepare the spreadsheet, the IRS agent wasn't convinced, and the case went to Tax Court.

The sharp-eyed judge, noting that the taxpayers were Maryland residents, sensed a weakness in the argument:

   Petitioners spent no more than 2 weeks per
   year at the Sanibel property, performing 
   maintenance work, but also fishing off the 
   pier.

The arithmetic: 14 days x 24 hours = 336 hours available to work (less fishing time).

Add 300 hours of work at the other property: 336 + 300 =636.

636 < 750.

The ruling: IRS > Taxpayer.

The moral? Do the math. Or, consider investing in property on Venus, which has a “day” 243 Earth-days long.

Cite: Firsow v. Commissioner, T.C. Summary Opinion 2004-112.

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FUN WITH 527s

August 24, 2004

It's probably bad news when Internal Revenue Code sections become part of our political discourse, but Section 527 has achieved that dubious distinction. Section 527 "Political Organizations" have become the preferred "soft money" vehicle under the McCain-Feingold campaign finance law.

Because they are a creature of the tax law, "527s" have to file reports with the IRS. The IRS posts these disclosure reports on their website here. For example, you can find the pro-Kerry "MoveOn.org Voter Fund" disclosure forms, as will as the anti-Kerry "Swift Boat Veterans for Truth" forms. The forms show that MoveOn.org spent $3.1 million in the second quarter, vs. the Swift Boaters' $60,403.

To save time for you political junkies out there, here are links to some recent disclosure filings (pdf format):

MoveOn.org Voter Fund

Form 8872, Political Organization Report of Contributions and Expenditures:

Second Quarter 2004
First Quarter 2004
Year-end 2003

Swift Boat Veterans for Truth

Form 8872, Political Organization Report of Contributions and Expenditures:

Second Quarter, 2004 (only filing; new organization)

Have fun!

(Thanks to Tax Analysts for the tip).

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HIGH FINANCE SCIENCE FICTION

August 23, 2004

We have no idea what today's Eighth Circuit Case, Qwest Corporation v. WorldCom, Inc., is about - we only looked at it long enough to see that it isn't a tax case - but for some reason it reminds of of the classic film "Godzilla v. the Smog Monster."

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WHAT THIS TOWN NEEDS IS A GOOD AFTERNOON NEWSPAPER

August 19, 2004

Register delivery running late

"Delivery of today's Des Moines Register is running up to five hours behind schedule today due to production-related problems."

We'll just read the Tribune today...

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WE WALK A FINE LINE...

August 18, 2004

...by provoking the Professor without making him angry.

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IRS ISSUES SEPTEMBER 2004 AFRs

August 18, 2004

The IRS has issued (Rev. Rul. 2004-69) the minimum interest rates for loans made in September 2004:

-Short Term (demand loans and loans with terms of 1-3 years): 2.34%
-Mid-Term (loans from 3-9 years): 3.84%
-Long-Term (over 9 years): 5.03%

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

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MICREL DENIES ASSERTIONS OF NY TIMES STORY

August 16, 2004

Micrel, Inc., named in stories by The New York Times and Tax Analysts about assertions of improper insider influence at the IRS, has issued a press release denying aspects of the story.

From the press release:

   "There was never a closing agreement 
   between the IRS and Micrel, as the article 
   implies. Micrel cooperated fully with the 
   IRS during an audit of the company that 
   lasted 18 months and was completed in 
   July of this year,” added Mr. Zinn. “While 
   the false statements in the article are almost 
   too numerous to mention, Micrel has an 
   obligation to its shareholders to correct the 
   record. In particular, at no time was there 
   ever a proposed deal to escape any tax 
   obligation of the Company, nor did we ever 
   have an estimated tax bill of $58 million. 
   Moreover, Micrel and the IRS never 
   cooperated to keep Micrel’s shareholders 
   uniformed on some basic terms of its 
   stock-option plan as the article asserts. In 
   addition, there is absolutely no truth to the 
   allegations that the stock option feature in 
   question enriched the Company’s four top 
   executives by as much as $20 million or 
   that Micrel ran its stock-option plan in 
   violation of the law,” Mr. Zinn stated.

Those of us who follow politics too closely probably tend to read too much into these things. The statement "In particular, at no time was there ever a proposed deal to escape any tax obligation of the Company..." could contain multitudes. If you dispute the legitimacy of an asserted tax, you aren't "escaping" it if there is never an assessment.

Saying that "there is no truth" in an allegation that the plan enriched executives by "as much as $20 million" leaves open the possibility that they were enriched by,say, $19.95 million.

The Micrel release adds "...nor did we ever have an estimated tax bill of $58 million." The source for the $58 million figure appears to be Micrel's pleadings in its own malpractice lawsuit related to the stock-option issue. Tax Analysts article mentions the $58 million number here:

   Based on its projections, Micrel claims that 
   revamping the 30DPM as a nonqualified 
   disposition could ‘‘total in excess of $52 
   million dollars and may eventually total as 
   much as $58.6 million. The pricing differential
   alone exceeds $12 million in cash, as well 
   as equity, lost to Micrel and is also a direct 
   and proximate result of the incorrect advice
   given to Micrel by defendants.’’

In short, he $58 million figure is the cost of "revamping" the stock option program, not the cost of the tax bill, as the Times article would lead one to believe.

Overall, the Micrel release attacks specific numbers used in the stories without necessarily debunking the stories themselves.

The Micrel press release goes on to illustrate how taxpayer confidentiality rules can keep a veil over the truth or falsehood of the allegations:

   “Unfortunately, we are precluded from 
   debating the specifics of the Times’ 
   assertions by an overriding concern for the 
   privacy of our employees and the 
   confidentiality of personal information,” 
   explained Mr. Zinn. “However, neither can 
   we remain silent after the New York Times 
   has used the uncorroborated statements of 
   one individual to cast Micrel in a negative 
   light and therefore felt obligated to come 
   forth with this public statement.”

The Micrel statements may be true, but, as they point out, there is no way to verify them in light of taxpayer confidentiality rules. As a practical matter, we suspect that the information could be sanitized by the company before release while still protecting employee confidentiality - at least other than the "four top executives" mentioned in the release. The executives could waive confidentiality, but they apparently choose not to do so. This reliance on privacy provisions by a public company seems incongrous, but is perfectly legitimate under the tax laws.

In a way, it is interesting that Micrel finds the stories cast it "in a negative light." In a coldly rational world, one would expect a firm to do all in its power to avoid unnecessary taxes. Shareholders like not paying taxes. Micrel is apparently sensitive to perceptions; there must still be social pressure to be a "good" corporate citizen, or to at least to be seen as one.

Our prior coverage of the issue may be found here.

The Tax Analysts coverage of the Micrel release is here.

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NO FUNNEL CAKE AT THIS CARNIVAL

August 16, 2004

The Iowa State Fair week "Carnival of the Capitalists" is up at "The Frozen North." Go there, read posts on business and economics, and become a better human being.

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UNTOUCHED BY HUMAN HANDS

August 16, 2004

It was probably inevitable, in this day of electronic filing, but this bit from last week's Notice 2004-54 makes us wistful:

   This notice authorizes income tax return 
   preparers to sign original returns, amended 
   returns, and requests for filing extensions 
   by means of a rubber stamp, mechanical 
   device, or computer software program. 
   These alternative methods of signing must 
   include either a facsimile of the individual 
   preparer's signature or the individual 
   preparer's printed name.

We should look at this as progress; our illegible scrawl at the bottom of a piece of paper doesn't add any magical charm to the process not provided by the laser-printed sans-serif fonts. We sure wouldn't want to go back to the days when tax returns were reproduced on carbon paper by grumpy chain-smoking secretaries. Still, it marks the end of an era somehow.

Of course, we remain partial to signet rings and sealing wax.

UPDATE!

From a real secretary:

   First of all, I would like to take exception to 
   your characterization of secretaries as 
   "grumpy chain-smoking secretaries."  My 
   recollection of secretaries (my mother was 
   one) was that they bent over backwards to 
   be right hands to their 'men' bosses, to be 
   smart but not smart aleck, efficient but not 
   uppity, helpful, polite and proper.  And 
   certainly never publicly grumpy.  OK, maybe 
   a few chain smokers.  But not the majority.

We defer to our correspondent's judgement with respect to secretaries in general - she is certainly right. But she never met the ones at the place where we started our career after they were asked to retype a consolidated 1120...

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THEY WON'T LIKE HIM WHEN HE'S ANGRY

August 13, 2004

Professor Maule does his best Lou Ferrigno imitation on legislators who want to expand the phone excise tax to Voice-over-internet protocol (VOIP) providers:

   The logic underlying these bills would have 
   inspired previous Congresses to have taxed 
   Henry Ford to pay for horse troughs and to 
   have taxed laser printer manufacturers on 
   behalf of the dying manual-typewriter 
   industry.

And then he gets angry. Read it all.

UPDATE!

Professor Maule sends a note saying that the analogies in the excerpt above are the brainchild (brainchildren?) of Declan McCullagh, Chief Political Correspondent, C-Net news.com. We should have noted that ourselves, and we thank the Professor for calling that to our attention.

Lord knows we don't want him angry with us...

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HOW TO FIND IF IT'S LIKE-KIND

August 13, 2004

In the misty early days of the tax law, Congress saw fit to exclude from tax the gains from exchanges of "like-kind" property. While the provisions have been trimmed back on occasion, these transactions, now known as "Section 1031" exchanges, still are available for a remarkably broad range of property.

In strictly economic terms, these rules make no sense - a gain is a gain, whether paid in cash or widgets, and they should be taxed - or not taxed - the same way. But let's not fret about broader policy implications when it's time to use a perfectly-good tax break.

HOW IT WORKS.

If a transaction qualifies under Section 1031 of the tax code, no gain is recognized if only "like-kind" property is involved. The "basis" of the property (its cost, adjusted for any depreciation) of the property given up in the exchange becomes the basis of the property received. This means the gain isn't permanently avoided; it instead is deferred until the property received in the exchange is sold.

If cash or other non like-kind property is involved ("boot"), gain is recognized to the extent of boot received. No losses are allowed in like-kind exchanges.

Section 1031 isn't a "rollover" provision. If you receive cash, you can't qualify for like-kind treatment by using the cash to buy replacement like-kind property. The tax law does allow escrows and intermediaries to receive cash on the taxpayer's behalf for a limited time without losing Section 1031 treatment.

WHAT IS LIKE-KIND?

Property qualifies for Section 1031 treatment only if it is held or used in a trade or business, or for investment. This means personal use property doesn't qualify. The tax law also specifically prevents the use of Section 1031 to defer gain on inventory (including inventory of real estate "dealers"), stocks, securities, debt instruments, partnership interests, interests in trusts, and "choses in action."

That leaves a lot of things that do qualify under Section 1031.

Real estate is usually easy to qualify as "like-kind." The tax law considers most real estate to be "like-kind." For example, a factory building in an urban industrial zone would be considered "like-kind" to farmland, and an apartment building would be like-kind to timber acreage held for investment.

PERSONAL PROPERTY - NAICS RULES

Personal property is another matter. The only guidance the tax code itself provides for whether personal property qualifies is the statement "... livestock of different sexes are not property of a like kind." While clear and concise, this statement doesn't much help to determine whether you can swap a packaging machine for a forklift.

Court decisions and Treasury regulations have fleshed out the definition of "like-kind" over the past 86 years. A few years back the Treasury greatly simplified things by ruling that items in the same four-digit "Standard Industrial Classification" code issued by the Commerce Department would be considered "like-kind." The Commerce Department failed to cooperate, dropping the SIC system in 1997 and replacing it with the "North American Industry Classification System" (NAICS).

Yesterday the Treasury issued new regulations to replace the SIC codes with the NAICS codes. The NAICS codes are available on the Internet here. Items within the same six-digit NAICS code are considered automatically to be like-kind if they begin with the number 31, 32 and 33. For example, "Cabs for construction machinery manufacturing" are like-kind to "Log debarking machinery, portable, manufacturing" because they are both classified in the NAICS 333120 class.

These "safe-harbor" rules don't apply to NAICS classes ending in "9" - that is, "miscellaneous" items - but taxpayers are allowed to argue that such items are like kind anyway.

BE CAREFUL OUT THERE!

The like-kind exchange rules have many procedural traps. The rules allowing excrows and intermediaries are technical and unforgiving of errors. Special rules can make it difficult for exchanges between related parties to qualify. If you want to qualify for Section 1031 treatment, be sure to contact your tax advisor.

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FAVORITISM FOR IRS ALUM ON EXAM?

August 12, 2004

The Tax Analysts article on alleged favoritism and cronyism involving a former high-level IRS executive now with a national accounting firm leaves us troubled, and perhaps a tad jealous. It would certainly be nice if, when faced with a hopeless tax case, we could get a "no change" report forced through without so much as a real audit, just by sheer force of our personality. If a whistleblower's story is true, there exist forceful personalities with such powers.

Remy Welling, a 22-year IRS veteran, is the whistleblower. Her story, in short:

She was asked by her manager, Ron Yokoo, to close an examination of Micrel Inc. sight unseen. When she balked, she was pressured to sign off. She contacted the Senate Finance Committee, which declined to get involved, as did the General Accounting Office. The Treasury Inspector General, which is the inspection arm that oversees IRS administration, eventually sided with her supervisors and then began investigating Ms. Welling for disclosing taxpayer information to the FBI. Ms. Welling's attempts to get help from the SEC and the Senate Permanent Subcommittee on Investigations failed.

Now Ms. Welling is likely to lose her job, even though it looks like the IRS may have had a slam-dunk case worth around $50 million, because she allegedly violated taxpayer confidentiality rules in her contacts with other agencies.

Ms. Welling says the IRS was so eager to close the case because of the influence of a former IRS official. Her manager, Mr. Yokoo,

   ... told her that it would be futile to challenge
   the closing agreement because the Micrel
   case was being handled on Micrel’s behalf 
   by Jim Casimir — a former IRS national 
   director of Appeals who left the IRS in 2000 
   to head PricewaterhouseCoopers’ IRS tax 
   dispute resolution practice in Los Angeles — 
   and that he ‘‘would stop at nothing’’ to seal the 
   ISO deal.

THE TAX ISSUE

It appears that Micrel was in real tax trouble. The company had an "Incentive Stock Option," or "ISO," plan. These options enable employees to defer taxable income from the exercise of stock options until they sell their stock. (ISOs also have major AMT problems, but that's another story). Further, the sale of ISO stock is treated as capital gain. By contrast, employees exercising non-ISO options recognize ordinary income at the time they exercise the options.

ISOs have to meet a long list of rules - one of which is the requirement that the exercise price cannot be less than the fair value of the option stock at the date the option is granted (Sec. 422(b)(4)). The Micrel plan apparently ran afoul of this rule because option prices would be "reset" to the lowest stock price for the month in which the option was granted. Tax Analysts reports that Micrel eventually sued its prior accounting firm for approving this aspect of their ISO plan. Micrel then hired Mr. Casimir's firm to help deal with the tax fallout.

CONFIDENTIALITY - PROTECTING TAXPAYERS OR BREEDING INSIDER DEALS?

The tax law over time developed elaborate safeguards to protect taxpayer confidentiality. At one time tax returns were actually considered "public records," but only open to inspection under presidential order. The confidentiality rules are now much stricter -- preventing your neighborhood stalker from reviewing your deductions, but also providing cover for potential insider dealing and corruption.

Lawsuits by organizations such as Tax Analysts have forced the IRS to release documents such as private letter rulings. These disclosures help prevent the development of "secret law" available only to those with connections. Still, as long as returns themselves are confidential, the possibility exists for insider dealing at the examination level.

How big of a problem is it? If Ms. Welling is correct, it is a big problem:

   [Ms. Welling] accused some firms like PwC and 
   former IRS officials of leading an organized 
   effort to undermine legitimate IRS collections.

   ‘‘All they have to do is step into the room 
   and we leave,’’ she said. ‘‘They hire all the 
   old IRS executives. They bully us around. 
   They’re like the old Arthur Andersen.’’

It's not clear whether the problem is that bad. In our experience, IRS agents aren't easily intimidated. Still, the former IRS executives don't get hired by national accounting firms merely to reward their years of public service. There is at least an impression that they still have strings to pull. While the IRS has rules to prevent abuses, rules are never perfect. The only real cure for such abuse is transparency - that is, making returns and examination results public.

Such a cure might be worse than the disease. It's hard to make a case that it's worth exposing individual finances to public view to eliminate IRS abuses. The argument for confidentiality in returns for public companies like Micrel is less compelling, considering the extensive disclosures they already make under SEC rules. The tax returns of public companies would certainly make popular reading for their non-public competitors.

In any case, we aren't aware of any push to loosen the confidentiality rules. Unless that changes, we can expect controversies over insider influence at the IRS to erupt every few years.

UPDATE: Micrel has issued a press release on The New York Times coverage of this story. We discuss the Micrel response here.

UPDATE II: Remy Welling responds to Tax Update posts.

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ALUMNI PRIVILEGES AT IRS?

August 10, 2004

Today's New York Times tells a senior IRS auditor's story of a "secret deal" between higher-ups and a former high-level IRS executive to approve a a $51 million tax benefit without a proper audit. The auditor says the former IRS executive, now with a national accounting firm, took advantage of the his connections to shortcut the audit process for a taxpayer. The auditor now may lose her job because her efforts to go outside channels to prevent the alleged shortcutting may have run afoul of taxpayer confidentiality rules.

Tax Analysts has more, but unfortunately the article is subscription-only.

More from us on this later.

UPDATE: Warren Rojas of Tax Analysts emails to tell us that they have a link to a pdf version of their coverage. Here it is. It's much more detailed than the NYT article and provides rare insight to the IRS audit process.

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EXACTLY WHY IS THIS BAD NEWS?

August 06, 2004

From today's TaxBase (Tax Analysts) comes a happy story wrapped in a mourning shroud:

   IRS Employees Win Second Jobs Competition -- 
         And Lose More Jobs

   For the second day in a row, the IRS 
   announced August 5 that an internal group 
   has won a public-private jobs competition, 
   which will still result in more than 200 job 
   losses at the IRS.

   The competition was held over an IRS 
   initiative to restructure its Modernization 
   and Information Technology Services 
   (MITS), which is responsible for information 
   systems products and services for tax 
   return processing. The winning plan, 
   created by an employee-management team 
   that included members of the IRS employees 
   union, calls for cutting the number of MITS 
   employees down from nearly 280 to 60 in 
   the IRS’s 10 centers across the country.

   The union decried the competition as a 
   result of the IRS trying to meet the Bush 
   administration’s “unstated quota” for federal 
   agencies regarding opening up a certain 
   percentage of their jobs to private-sector 
   competition.

OK, maybe we're a bit slow. Let's see if we have this right:

-IRS employees, including union members, have figured out ways to do the same work with 220 fewer people. This means the IRS can use these 220 salaries to fight offshore tax fraud or abusive corporate tax shelters.

And that's a bad thing?

Well, maybe replacement jobs will satisfy the National Treasury Employees Union, if they are all unionized, and if they aren't required to be too well-trained:

   IRS Officials Criticize Arbitration Ruling

   A decision handed down in a labor dispute 
   could hinder the IRS’s ability to sniff out 
   abusive tax shelters, according to IRS 
   officials, including Commissioner Mark 
   Everson.

   On July 9 an arbiter struck down a tougher 
   set of qualifications for revenue agents 
   aimed at strengthening the accounting 
   skills of the IRS’s enforcement personnel. 
   Everson told Tax Analysts he was “shocked” 
   by the “horrific” decision...

   When the new requirements were put in 
   place, already-employed revenue agents 
   were not required to meet the new 
   requirements, but other Service employees 
   wanting to apply for the positions were. 
   The union has called the rules "unnecessary 
   obstacles on internal candidates." In an 
   interview with Tax Analysts, NTEU President 
   Colleen Kelley charged the Service with 
   "unilaterally changing the requirements for 
   the job with no substantiation."

One might almost get the impression that the union wants to keep unneeded workers on the payroll while making sure they aren't required to obtain skills to do jobs that actually need doing.

UPDATE: The Washington Post has run two stories on the IRS job cuts (hat tip to the TaxProf Blog).

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FUN WITH FASB?

August 05, 2004

Dave McClure, an editor for the CPA Technology Advisor publication, called to ask why in the world we do this. You will have to look to his article for a complete answer, but we deny any links to productivity.

In the course of our conversation, Mr. McClure mentioned that there is a a "Financial Accounting Blog." We're thrilled that our esteemed auditing colleagues have a blog to call their own. Their blog seems to be slacking off this summer, so we know the authors are real auditors! (Ow! Just kidding, guys!)

Anyway, we've added it to our blogroll over on the left under "Economics Nerds."

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SAY WHAT?

August 02, 2004

Quote of the day:

   If you believe in a progressive tax system -- 
   and, more important, that your government 
   has a positive role to play in society -- you 
   should wear the moniker "girlie man" 
   proudly. That is, assuming you are a man. 
   As for me, I come from a time and place 
   where men were men and women were 
   liberal tax policy advocates. But I cannot 
   get over the fact that the strap on my high 
   heels keeps breaking.

-David Brunori, in today's "Politics of State Taxation" column in State Tax Notes.

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IF YOUR PARTNER IS YOU, ARE YOU A PARTNER AT ALL?

August 02, 2004

No, we aren't talking about whether the institution of marriage has been extended to imaginary friends.

The Treasury introduced the concept of "disregarded entities" into the tax law a few years ago, and the metaphysical implications continue to reverberate. A "disregarded entity" exists for state law purposes - it can be sued, for example - but it is not considered a separate entity from its owner under the tax law. Single-member limited liability companies and qualified Subchapter-S subsidiaries are common examples.

Last week the Treasury issued a ruling (Rev. Rul. 2004-77) discussing whether an entity can form a partnership with its own disregarded entity. The fact pattern had a corporation forming a partnership with its own wholly-owned LLC as the other partner. The ruling holds that the partnership is not a partnership at all, but is instead another disregarded entity, taxed as on the corporate "partner's" return.

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