Tax Update Blog: November 2004 Archives

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HSAs: GROWING PAINS?

November 30, 2004

The Benefitsblog has a nice summary of issues involved in Health Savings Account implementation. It seems that some new HSA users and their health providers are confused on how they work, and how the medical bills should be computed.

Your Tax Update correspondent has an HSA, into which we rolled our old Medical Savings Account (MSA). He has switched to a new HSA administrator, but retains his old Wellmark high-deductible plan. We have had none of the billing problems described in the Benefitsblog post. Our new administrator had difficulties in arranging for the mutual funds for our HSA funds, but that appears to be ironed out now. Our experience with HSAs: so far, so good.

The Benefitsblog post also has lots of good links to timely HSA articles.

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TAX PRACTITIONERS AREN'T NUTS; WE'RE JUST TOO CLEAR TO UNDERSTAND

November 30, 2004

From a lecture titled "How Tax Thinks" (as repeated in the TaxProf Blog)

   Tax thinking boils a transaction down not to labels but 
   to who gets what why, and it forces you to examine 
   where and how it says that. The clarity of former tax 
   lawyers like Robert H. Jackson, Harry Blackmun, and 
   Sumner Redstone shows that -- far from being a 
   bunch of crazies speaking in tongues -- tax law 
   represents just the opposite.

Blinding clarity - that's the ticket!

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CHARITABLE SPLIT-DOLLAR - STILL DEAD

November 30, 2004

Smart people can convince themselves of the most amazing things when they really want to. Case in point: "charitable split-dollar" life insurance. Like many highly-marketed tax shelters that come to grief, these required the IRS to be willfully blind to their consequences. As usual, the IRS failed to cooperate.

The basic plan: Taxpayer buys a "split-dollar" life policy on his life, or that of his spouse (often through a life insurance trust). The taxpayer splits the policy benefit with a charity. The charity recovers any premiums it pays at the death of the insured. The insured gets the remainder of the death benefit.

The taxpayer contributes enough money to charity to cover the life insurance premiums. The charity is under "no obligation" (wink, wink) to pay the policy premiums - but it always does. The taxpayer gets to convert non-deductible life insurance premiums to deductible charitable contributions.

WHY IT NEVER WORKED

The Tax Court explained yesterday why this never worked in a case involving David Roark, a successful entrepreneur and philanthropist, and clearly a smart man. His financial advisor, a Mr. Pippinger of IDS-American Express, informed him of the plan and implemented it for him in 1998, when he made a $240,000 "donation" to the National Community Foundation (NCF).

For a charitable gift of $250 or more to be deductible, the donee must provide a written statement to the donee that no goods or services were provided in return for the gift. NCF provided such a letter to Mr. Roark. The IRS failed to accept the letter as valid. In his defense, Mr. Roark cited the NCF letter ans said he "had no idea" whether NCF would pay the premiums. The Tax Court didn't buy this Eddie Haskell-like innocence:

   We do not find this disavowal credible. The idea for 
   this deal, after all, came from Pippenger--his financial, 
   not his charitable, adviser. Roark had to have realized 
   that the intricacy of the plan, plus the fact that it was 
   being marketed so extensively by American Express, 
   suggested that as a practical matter NCF would of 
   course use money it got under such plans to pay for 
   insurance and not just add to its endowment.

In short, the Court found that there were goods or services provided for the gift, the receipt of which was not properly acknowledged, and the contribution failed the tax law's substantiation requirements and was therefore not allowable.

Congress has since explicitly outlawed charitable split-dollar plans, but the Roark case, and others that predate the Congressional action, show that charitable split-dollar was always too good to be true.

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A NEW DONALD REGAN?

November 29, 2004

The last "great" tax reform effort took place in 1986, during the second Reagan term. President Bush has embraced a tax reform agenda for his second term, so it's logical to compare his efforts with the 1986 project.

The Bush tax policy team seems to lack the firepower of the Reagan team. While Treasury Secretary John Snow has been an earnest salesman of administration tax initiatives, he doesn't appear to be a "player" in policy development. By comparision, the Reagan administration's tax reforms were developed by Donald Regan as treasury secretary. Regan then switched jobs with White House Chief of Staff James Baker in 1985, giving the Reagan tax reform agenda a powerful and credible team for its final legislative push.

The Washington Post reports that the Bush administration is looking to add some heft to its tax policy team. The post paraphrases a "senior adminstration official as staying Secretary Snow "can stay as long as he wants, provided it is not very long."

The article lists Bush Chief of Staff Andrew Card as one possible replacement. Others mentioned in the article are former senator Phill Gramm, economic advisor Josh Bolten, and Credit Suisse former co-CEO John Mack. Gramm and Card are credible first-line policymakers who might be suited for the delicate and difficult process of getting tax reform through Congress. We know less about Mr. Mack, who was forced out of Credit Suisse, apparently after attempting to arrange for a merger of the investment bank.

If these personnel changes play out, they will be more evidence that the administration is serious about tax reform.

Thanks to Pejmanesque for the pointer.

More speculation here: "Snow Removal" (Via Don)

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POST-TURKEY CARNIVAL

November 29, 2004

This week's "Carnival of the Capitalists," a weekly summary of economics and business weblog postings, is up at "Lachlan Gemmell - Software Startup." If you want to think about reducing the risks of a startup venture, or you just wonder at "The Insanity of Management Foot Dragging," you are bound to find good reading there.

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'WRONG' IS SUCH A HARSH WORD. WE PREFER 'PREMATURE'

November 29, 2004

Two Novembers ago we made the following observation:

   ESTATE TAX DIES, TAX CUTS LIVE. Still, the 
   Republican Senate matters. Even with the 60-vote 
   hurdle, the estate tax is probably really, positively, 
   dead. It had been scheduled to rise Zombie-like after 
   a one-year interment, but now it will not resurrect as 
   scheduled on January 1, 2011. The 2001 estate tax 
   repeal had significant Democratic support, and they 
   will work with the additional Republicans elected this 
   week to cross the 60-vote hurdle. The other 2001 tax 
   cuts slated to disappear after 2010, including the 
   reduction of the top individual rate to 35%, also are 
   likely to be made permanent.

We could lamely defend ourselves on the ground that we didn't say when this would happen, but we were talking about the just-completetd congressional session. Needless to say, the 2001 tax cuts and the estate tax repeal are not yet permanent.

ARE WE THERE YET?

The recent election may make us accidentally prescient by making the Senate more Republican.

Martin Sullivan counts Senatorial heads in an article in Tax Analysts today (Unfortunately, his article is only available to Tax Notes subscribers). He concludes that the 60 votes needed for repeal can probably be found in the more-Republican Senate that will be in session the next two years. Mr. Sullivan's arithmetic goes like this:

   55 Republican Senators
  - 2 Republicans who won't vote for estate tax repeal (1)
   +7 returning Democrats who have voted for repeal (2)
   60 

   (1) Chafee (RI) and McCain (AZ)
   (2) Baucus (MT), Bayh (IN), Wyden (OR), Nelson (NE),
   Lincoln (AR), Landrieu (LA) and Nelson (FL)

Mr. Sullivan counts four Republican "long shots" who might oppose estate tax repeal - Snowe and Collins of Maine, Voinovich of Ohio, and Specter of Pennsylvania. He balances them against three additional Democrats "who easily could vote for repeal" - Feinstein of California, Murray of Washington, and Johnson of South Dakota.

Senators Feinstein and Murray voted for repeal in a 2000 vote, but against it in 2002. Senator Johnson has never voted for repeal, but he barely survived a 2002 election and he saw his South Dakota Democratic colleage Tom Daschle unseated earlier this month. Mr. Sullivan says Senator Daschle's defeat might have "large intangible effects" that will cause Democrats to support Bush Administration measures:

   In the past when he asked his Democratic colleagues 
   to vote along party lines, he (Daschle) could point to 
   himself as an example of how a Democrat can survive 
   in a Republican state. But now Daschle's loss makes a 
   case for Democrats to vote conservatively. And if it 
   comes down to one vote, the Republican leadership 
   and the Republican White House will be able to apply 
   tremendous pressure.

Given our track record, we should avoid making any more predictions. The main chance for survival of the estate tax could be the budget deficit. If Senators feel a need to preserve the bulk of estate tax revenue, a repeal of the estate tax for 90% of estate tax-payers - by, for example, a $10-15 million per-couple exclusion - could keep a remnant of the estate tax alive.

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TAX PROF 'TAKES THE BOEING'

November 29, 2004

The Instapundit coined the term "taking the Boeing" for bloggers who have achieved corporate sponsorship. The reference is to the lavish private jets that surely are within the means of such "well paid" bloggers.

The TaxProf blog today announced that it has three sponsors: LexisNexis, Foundation Press and West Publishing.

We have an exclusive secret snapshot of the new official TaxProf jet:

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HOMETOWN BOY MAKES MESS

November 26, 2004

The Tax Update's roving correspondent is on his annual Thanksgiving pilgrimage home to see his family. Looking at the local paper, he finds this:

Gurnee accountant pleads guilty in client theft

   Michael Wright of Gurnee pleaded guilty
   Wednesday in Lake County Circuit Court
   to stealing more than $2.6 million from
   four of his business clients, and was 
   sentenced by Judge James Booras to 
   eight years in prison.

   The plea and sentence were conditional, 
   pending complete resolution of 
   restitution, at least agreements for a 
   repayment plan, and Booras set a Jan. 28
   date for finalizing the action.

   Wright, 41, was an accountant and 
   investment counselor, and worked with 
   the Cote and Wright firm in Gurnee.

   Victims included Grand Appliance Co., 
   Susman Linoleum and Rug Co. of Gurnee, 
   and two elderly women.

Now that's a full-service accountant: invest client money and squander it on high living for them too - so they don't have to. What a considerate felon.

The Tax Update didn't grow up with the thief or go to school with him, but the business victims were around when the correspondent was young. The elderly victims may be parents of his classmates.

Much more of this and CPAs will start getting Fact Sheets from the State's Attorney's office.

The Cote & Wright website is down, but a Google cache of it is still up. Here is the "mission statement" from the cached site:

It's not clear how well the mission statement was fulfilled. Given the embezzlement, the "trusted partner" statement takes on a sinister tone. As for the promised "peace of mind," if the client subscribes to the "no money, no worries" investment philosophy, Mr. Wright was just the man.

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PHYSICIAN, HEAL THY RETURN

November 23, 2004

Once again the IRS has felt it appropriate to issue a friendly reminder to the medical profession to comply with the tax law: a "fact sheet" on Taxes and the Medical Profession.

The fact sheet starts by reprising the sad story of Xelan, a company in hot water for involving hundreds of doctors in alleged tax scams. It also has this friendly chart showing prosecution and conviction stats for tax crimes by medical professionals, including average jail time:

And there is this friendly note: "In addition to criminal cases, IRS has thousands of taxpayers in the medical industry under audit."

This is the second "fact sheet" the IRS issued for the medical profession. As far as we know, the IRS has yet to issue fact sheets for lawyers and accountants.

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WHAT'S A HOYA? A BLOGGER WITH EXQUISITE TASTE.

November 23, 2004

A new blog from a tax professor at Georgetown, and she links to our site on her VERY FIRST POST! Woo-hoo!

Welcome to the burgeoning tax blogosphere, Clarissa Potter!

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PONCH AND JON, WE HAVE A REPORT OF A HIGH-SPEED TAX EVADER...

November 23, 2004

The TaxProf Blog has a comprehensive big media tax news roundup this morning.

Our favorite story was a New York Times account of a high-speed auto chase of a tax suspect. This is unusual in at least two ways - that the Times would cover a high speed chase, and that tax enforcement would be so exciting.

The fleeing suspect was Al Thompson, who participated in the brilliant tax scheme of buying an ad in USA Today saying that he didn't pay taxes or withhold taxes for his employees. The ad asserted that there is "no law" requiring the payment of taxes.

   The chase involving Mr. Thompson, at speeds of 80 to 
   100 miles an hour, began about 9:30 a.m. yesterday
   when federal agents went to Mr. Thompson's home to 
   arrest him.

   The pursuit quickly moved from residential streets onto
   Interstate 5, the main highway running the length of 
   the state. It ended when the California Highway Patrol 
   laid a strip of spikes on the road to flatten the tires on 
   Mr. Thompson's car.

   As he was trying to elude arrest, Mr. Thompson placed
   a cellphone call to Cindy Nuen, an associate in the 
   movement that denies the legitimacy of the tax system,
   according to an e-mail message she sent to other 
   members yesterday.

   "I'm going to make them take me," she quoted Mr. 
   Thompson as saying, adding that she asked what 
   she should do.

   "Just put the word out," Mr. Thompson said. Then, 
   apparently having run over the spikes, he said "they 
   got my tires, they got my car. Now they are out. They 
   have their guns pointed - O.K., they got me."

 
   Mr. Thompson refused to leave his car for 10 minutes,
   said Lt. Jeff Lee of the California Highway Patrol.

   "Eventually we persuaded him to come out and he 
   was arrested without incident or injury,"

Maybe that USA Today ad wasn't such a great move after all. The other businessmen who signed have not had great tax luck. Click on their names to find out how their USA Today tax plan worked out.

David Bosset
Nick Jesson
Dick Simkanin
Leonard Roberto (no tax charges yet noted).

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THANKSGIVING CARNIVAL

November 22, 2004

In this season of Thanksgiving, give a thankful thought to those pajama-clad bloggers who give us free reading material at work when you should be doing something else, and those that package this goodness into the weekly Carnival of the Capitalists, at no additional charge.

The Social Twister weblog hosts this weeks Carnival. From the falling dollar to selling skills, good stuff there in this weeks roundup of business and economic weblog posting.

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ONE STATE, TWO STATE, RED STATE, BLUE STATE

November 22, 2004

Our little map of the U.S. showing which states received more in federal spending than they paid in taxes has probably received more attention than anything else we've ever put up on this site. Other than the evenhanded Tax Prof, there seem to be two sorts of views of our map: Democrats complaining about ingrate red states and Republicans complaining about obtuse Democrats.

Somewhere, Roger Sherman is surely bemused.

UPDATE: The most sensible analysis of national voting patterns we've seen is here. It would be great if we could overlay that map with one showing tax payments and federal spending by county, but we have no idea where that could be found.

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TECHNICAL CORRECTIONS NEED TECHNICAL CORRECTION

November 22, 2004

Congressional taxwriters released a "discussion draft" of technical corrections for 2004 tax legislation. They have now adjourned, so no action will occur until the new Congress convenes next year.

The draft fails to address one item badly in need of technical correction. The American Jobs Creation Act (AJCA) allows banks with IRA shareholders to become S corporations. The language of the bill doesn't appear to cover holding companies, which own the vast majority of banks. As drafted, the provision applies to almost nobody.

We assume the bank-IRA provision is a mistake. Otherwise, it is one of the most narrowly-targeted provisions in subchapter S.

Tax Analysts reports a "Senate Finance Committee aide" says that taxwriters hope to incorporate public comments into the version that the next Congress will take up.

Link:

Joint Committee on Taxation Description of Tax Technical Corrections Act of 2004.

Tax Update discussion of Bank-IRA provision.

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IRS ANNOUNCES 2005 HEALTH SAVINGS ACCOUNT CONTRIBUTION LIMITS

November 22, 2004

The IRS has issued the 2005 limits for Health Savings Account (HSA) contributions (Rev. Proc. 2004-71). HSAs are IRA-like savings vehicles that are available to taxpayers with high-deductible health insurance plans. The 2005 contribution limits are:

Single coverage: $2,650 (or the annual deductible, if less). The 2004 limit was $2,600.

Family coverage: $5,250 (or the annual deductible, if less). The 2004 limit was $5,150.

The minimum deductibles for HSAs remain at $1,000 for single coverage and $2,000 for family coverage

Link: Treasury Press release on HSA contributions.

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TAX REFORM TRIAL BALLOONS

November 21, 2004

The Administration floated some tax reform trial balloons last week via the Washington Post and the Wall Street Journal. Second-term Tax Reform looks like it may be largely based on the President's first term policies and proposals, as we discussed recently. Still, the trial balloons have surprises.

The Washington Post story says

   ...the administration plans to push 
   major amendments that would shield 
   interest, dividends and capitals gains 
   from taxation, expand tax breaks for 
   business investment and take other 
   steps intended to simplify the system 
   and encourage economic growth, according
   to several people who are advising the 
   White House or are familiar with the 
   deliberations.

These sound like the first-term proposal for Lifetime Savings Accounts and Retirement Savings Accounts, which would enable most taxpayers to do all of their savings on a tax-free basis. It also sounds like the administration may move towards more generous fixed asset depreciation and expensing rules.

The Post says reform would eliminate the Alternative Minimum Tax (AMT) by adding one of its most important features to the regular tax. The AMT applies when it exceeds regular tax. State and local taxes aren't deductible for AMT. The lack of the state and local tax deduction is the most important cause of AMT for taxpayers in states with high income taxes.

Perhaps the biggest surprise in the Post article is the idea of eliminating the exclusion for employer-paid health insurance. While this is a big change, it is a logical extension of the philosphy behind Health Savings Accounts (HSAs). HSAs allow taxpayers with high-deductible health plans to make deductible contributions to the IRA-like HSAs; withdrawals used for health care costs are tax-free. The idea is to put make consumers more careful about incurring health costs because of the high deductibles. Eliminating the tax-free benefit is of a piece with this approach.

NO DEDUCTION FOR BUSINESS INTEREST?

By the time the administration is done with its individual planning, individuals might be almost entirely exempt from taxes on interest and dividends. The Wall Street Journal speculates that this might be paired with an elimination for the deduction of business interest expense:

   Mr. Bush has proposed new savings tax  
   breaks, essentially seeking accounts in
   which Americans could avoid taxes on 
   interest, dividends and capital gains. 
   By eliminating the tax  paid by 
   bondholders, CBIT would do much the same
   thing more broadly. Leveraged companies 
   would yelp, but that might just help 
   sell tax  reform.

All of these would push the tax system by degrees closer to a Hall-Rabushka flat tax, in which interest and dividends are tax-free, but not deductible to the payors. This approach appears to be what the administration has in mind, based on this passage from the Post article:

   Pamela F. Olson, a former Bush Treasury
   official in close contact with 
   administration tax planners, said the 
   president will pursue a tax system 
   where all income -- whether from wages, 
   dividends, capital gains or interest -- 
   is taxed only once. That would mean 
   eliminating taxes on dividends and 
   capital gains paid out of fully taxed 
   corporate profits. Most investment gains
   are currently taxed at 15 percent.

Will any of this pass? Some are sceptical that the administration will be able to pull off both social security reform and tax reform. We think there is a good chance of significant tax reform. When the President sets his mind to something, he keeps at it until gets his way. Just ask Saddam Hussein.

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DECEMBER 2004 FEDERAL RATES ARE OUT

November 18, 2004

The IRS has issued (Rev. Rul. 2004-106) the minimum interest rates for loans made in November 2004:

-Short Term (demand loans and loans with terms of up to 3 years): 2.48%
-Mid-Term (loans from 3-9 years): 3.56%
-Long-Term (over 9 years): 4.68%

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

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BETTER BITTER BLOGGER

November 17, 2004

The little tax blogosphere grows a bit today with the addition of "Start Making Sense." The proprietor of this new tax blog is Dan Shaviro, a New York University tax professor.

What leads to the conclusion that he might be a tad bitter? Why, the tag line on his blog, "These days I call myself a New Yorker rather than an American."

We sense he isn't entirely thrilled with the election results.

We welcome him to the Blogosphere. Oh, and there's no contradiction between being a New Yorker and an American. Yes, there once was, but not since that little misunderstanding with Lord Cornwallis was settled in 1781.

Thanks to the TaxProf for the tip.

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40.5 CENTS PER MILE!

November 17, 2004

The IRS has released the new standard mileage rates for 2005:

- Business use of auto: 40.5 cents per mile (was 37.5 cents)
- Medical rate: 15 cents per mile (was 14 cents)
- Charitable rate: remains at 14 cents.

Source: Rev. Proc. 2004-64 (pdf format)

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COUNT YOUR BLESSINGS - THEN GIVE THEM AWAY?

November 17, 2004

The end of the year is a traditional time to pause and contemplate our lot in life. We take stock, count our blessings – and plot to keep them from the tax man.

This year-end contemplation often results in charitable gifts. Giving to a worthy cause feels good. If you give the right way, the tax man can make it feel even better.

Giving away appreciated property is the most tax-efficient way to be generous. If you give away property that has grown in value, and you have held it for more than one year, the tax law usually lets you take a charitable deduction for the value of the property – without ever paying tax on the appreciation.

For example, if that stock you paid 20 cents for has grown to $1,000, you can give it to charity and take a $1,000 tax deduction. If you instead sold the stock and gave the cash to charity, you’d have to pay tax on that $999.80 gain.

The ability to give property to charity has its limits. If the property you donate isn’t publicly-traded stock, you have to get a “qualified appraisal” to claim a deduction over $5,000. If your deduction is between $500 and $5,000, you don’t have to get an appraisal, but you do have to disclose it on Form 8283, which means the IRS knows about it, and they can ask you to show how that bag of used underpants that you donated to Goodwill is really worth $4,900.

DOES CHARITY BEGIN IN THE DRIVEWAY?

Used cars have been a popular gift to charity in recent years. Congress has decided that taxpayers were taking deductions for their pre-owned treasures that were, well, perhaps a tad optimistic. For example, a GAO study showed an example of a taxpayer taking a $2,400 deduction for a 1983 pickup truck. The charity sold the truck for $375 at auction, and after expenses the charity netted $31.50.

The bad news for car donors: Congress recently added a new provision to the tax law -- a requirement that taxpayers donating cars to charity may deduct only the amount the charity receives when it sells the car. Under these rules, the donor of that 1983 pickup would have deducted $375, rather than $2,400.

The good news for car donors: this requirement doesn’t take effect until 2005. If you’ve been considering giving away that automotive classic gracing your front yard, you may get a more optimistic deduction if you have it towed to your favorite charity before January 1, 2005.

But remember: you have to donate to a real charity; your worthy brother-in-law doesn’t count. Also, if you don’t itemize, no charitable deduction for you!

(Note: this article will appear in this month's 50Plus Lifestyles supplement to the Des Moines Register. Look for it in an upcoming Saturday Des Moines Register or at your local Dahls. The Tax Update is a regular feature of 50Plus Lifestyles. Despite the name, they won't card you.)

Prior car donation coverage:

CAR DONATIONS: TIME TO TAKE ACTION?

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CONTINGENT FEE PROJECTS: IRS GUIDANCE UNDER NEW TAX SHELTER RULES

November 17, 2004

The recently-enacted "American Jobs Creation Act" (AJCA) has tough new penalties for taxpayers who fail to disclose potentially abusive transactions. A parallel set of penalties apply to tax advisors who assist in such transactions.

Transactions covered by these penalties include "transactions with contractual protection." This covers deals where the tax advisor (or shelter promoter) will refund fees if the promised tax breaks don't materialize. It also covers contingent fee transactions.

The AJCA allows the IRS to waive reporting requirements contingent fee transactions that aren't likely to be abusive. The IRS yesterday used this authority to waive AJCA reporting for three types of contingent fee projects (Rev. Proc. 2004-65):

- Work opportunity credit projects
- Welfare-to-work credit projects
- Indian employment credit projects.

This leaves many popular contingent fee arrangements reportable, including research credit studies and building cost componentization studies (where building costs are analyzed to isolate expenses eligible for shorter depreciation lives).

The IRS issued other tax-shelter guidance under AJCA yesterday. It is summarized in this IRS press release.

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HE DOES IT, SO WE DON'T HAVE TO

November 15, 2004

The TaxProf Blog somehow seems to catch every big-media article on tax policy, so we won't even try to keep up. Check out today's big-media roundup.

The good professor also links to an interesting New York Times op-ed by Michael Graetz, Yale law professor and Deputy Assistant Secretary for Tax Policy, U.S. Treasury, 1990-92. Mr. Graetz suggests combining a modified version of the Alternative Minimum Tax with a 14% Value Added Tax to simplify the tax system and eliminate tax returns for those with income under $100,000.

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WINNING BY LOSING - YEAR-END PLANNING FOR CAPITAL GAINS

November 15, 2004

Perhaps you have been blessed this year with a successful investment portfolio. Perhaps you have cashed out some of your winners. If you have a net capital gain, you may owe money in April. If so, those less-than-successful stocks in your portfolio are now a blessing in disguise. You can sell your loser stocks and deduct them to the extent of you capital gains, plus $3,000. It doesn’t matter whether the gains or losses are long-term or short-term – a long-term loss (i.e., on a stock held for more than one year) can offset a short-term gain, and a short-term loss can offset a long-term gain.

DON'T WASH THOSE LOSSES

Be careful with those losses. The “wash sale” rules say that if you buy a stock within 30 days before or after the loss sale, you don’t get to take the loss. You have to live without those Enron shares for 30 days if you want to deduct those losses this year.

   Example: Joe owns 10 Enron shares that
   he bought for $100.  He sells them for
   2 cents each on December 1, 2004, 
   realizing a loss of $998.00.  If he 
   buys another 10 shares of Enron on 
   December 20, (or November 20, for that
   matter), he doesn’t get to deduct the 
   loss on his 2004 tax return.  But if 
   he buys the shares on January 5, 2005 
   – more than 30 days after the loss 
   sale – he can deduct the December 1, 
   2004 loss on his 2004 tax return.

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DUBIOUS 'TAX WISDOM'

November 13, 2004

The TaxProf Blog notes a web page in homage to the progressive income tax, 'Tax Wisdom.org'. Reading their tax policy prescriptions is like reading Dr. Kervorkian's works on wellness and long life, but they probably present the case for steeply progressive income taxes as well as it can be presented. A taste of their Tax Wisdom:

    * Even a  steeply progressive income tax---right up to 99% on the 
   highest incomes---would impose no loss of purchasing power on 
   wealthy income earners
    * Reducing the income tax rates of rich citizens will weaken the 
   economy if Congress cuts spending to pay for the tax cuts
    * Increasing the amount of taxes collected from wealthy citizens 
   will actually provide a stimulus to the economy
    * The rich cannot get richer---in real terms---by getting their taxes 
   cut, but they can become richer if they pay more in taxes
    * The government is a major producer of Real Wealth
    * An increase in the size of government is almost always quite 
   desirable
    * Wealthy citizens who are wise should be lobbying for an 
   increase in government spending and an increase in their tax 
   rates.

The rich can become richer by paying more taxes? Yeah, and you can regain your svelte high-school figure by eating more cheeseburger and milk-shake dinners, too.

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NEW LAW SEMINAR SLIDES ONLINE

November 12, 2004

The Powerpoint slide show from our November 10 seminar on the American Jobs Creation Act are online here. See if you can find the pictures of two downtown Des Moines restaurants among the slides. Hint: one shot is an exterior detail.

WARNING: If you have dial-up access only, it may load painfully slowly.

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IRAs AS S CORPORATION BANK OWNERS: A LEGISLATIVE MESS

November 12, 2004

It's been said that watching lawmaking is as gut-turning as watching sausage-making. While that may be true, there is a significant difference: sausage is always useful at the end of the process.

The recently enacted "American Jobs Creation Act" has at least one provision so poorly drafted as to be useless. The provision enabling Banks with IRA owners to make S corporation elections is a mess.

The provision appears to be designed to enable C corporation banks with IRA-owned stock an opportunity to make an S corporation election. As drafted, however, it applies to almost nobody, and even where it might apply, it might be expensive to the IRA beneficiary.

S CORPORATION ELIGIBILITY

S corporations, as regular readers know, generally pay no taxes on their income; the income is instead taxed on the persona returns of their owners. Only individuals, estates and some trusts are permitted to own S corporation stock. IRAs are not permitted shareholders.

Banks were first allowed to become S corporations as a result of 1996 legislation. Some banks have been unable to make their S corporation elections because IRAs own bank stock. Severe "prohibited transaction" penalties often make it impossible for the IRA owner or the bank to buy the stock out of the IRAs.

THE NEW LAW: ELIGIBILITY

The AJCA allows "banks" with stock held by an IRA on October 22, 2004 to make S corporation elections. Thus the first problem with the new law - the rule is restricted to "banks." Almost all banks are owned in holding companies, which are not mentioned in the new rules. It appears that by its terms, the new rule only applies to the very small minority of banks that are not owned by holding companies.

NEW LAW: TWO TAXES?

If an IRA-owned bank qualifies to make an S election, the IRA S corporation income will often be taxed more harshly than non-IRA shares.

The tax law says the IRA will pay "unrelated business income tax" (UBIT) on their share of S corporation income. They will also pay a second round of UBIT on "any gain on the disposition of stock in the S corporation." UBIT is computed at corporate rates, which can be as high as 35%.

S corporation shareholders increase the basis of their shares by the S corporation income they pay tax on; they reduce their basis by cash distributions made by the S corporation to help owners pay their tax. This basis adjustment usually ensures that S corporation income is only taxed when it is earned; if the income is passed to shareholders through distributions, or recovered by a sale of the shares, the previously-taxed earnings aren't taxed again because they have increased basis.

The basis adjustment doesn't shelter built-in gain in the stock that exists when the S corporation election takes effect.

TRADITIONAL IRA: ANOTHER TAX

With traditional IRAs, however, there is a second tax. When the IRA beneficiary withdraws the earnings, they are taxable under the normal IRA rules. Distributions by Roth IRAs will be tax-free.

CHECKING OUT OF THE ROACH MOTEL

IRAs can be like Roach Motels for bank stock - it can check in, but not out. The "prohibited transaction" rules often make it impossible for owners of closely-held corporations to redeem stock out of an IRA, and they almost always prevent an individual from buying stock out of the IRA. Prohibited transactions are catastrophic, triggering a 100% tax. Until now, the only way to get stock out of an IRA has been the Department of Labor exemption letter process, an expensive and uncertain mechanism.

The new law gives IRAs a 120-day window following the S election to sell IRA stock without causing a prohibited transaction. It isn't clear whether this window opens on the date the S election is filed, or on the effective date of the election. The sale apparently would result in UBIT, but there would be no prohibited transaction.

SUMMARY

For now, the Bank-IRA-S corporation provisions of the new law are nearly useless because of they don't seem to encompass holding companies. Even if this hurdle is crossed, the provisions may be most useful for getting bank stock out of the IRA to enable the S election; the double tax on S corporation income in traditional IRAs makes them uneconomical vessels to hold S corporation stock. Roth IRAs, by contrast, may be perfectly content to pay UBIT, if the bank pays significant dividends.

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TODAY'S BAD TAX PLANNING MOVE

November 09, 2004

Maybe this sounded good at the time somehow, but nothing on the surface of this tax planning strategy seems promising:

1. Stop filing tax returns.
2. Create a website where you boast about not filing tax returns.
3. Run for Congress on a platform that nobody is required to pay income tax.

Last week Art Farnsworth's bid for Congress and his tax planning both came up short. Last Tuesday Mr. Farnsworth received 4,000 votes in Pennsylvania's 8th Congressional District; on Friday he was arrested and jailed for tax evasion.

Perhaps he didn't do enough to draw attention to himself.

Professor Maule urges more criminals to run for office on a full-disclosure platform. The TaxProf has the links.

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THERE ARE WORSE THINGS THAN SARBANES-OXLEY

November 09, 2004

China Accountant Gets Death For Embezzling Over CNY200M

   BEIJING (AP)--An accountant for a 
   science foundation run by China's 
   Cabinet was sentenced to death Tuesday
   for embezzling more than 200 million 
   yuan (US$25 million), the government 
   said.

Via the Online Wall Street Journal, which is free this week.

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TODAY'S DOSE OF CYNICISM

November 08, 2004

From Kausfiles: "Tax Reform--the Cure for Lameness in Ducks?"

   Why might Congress be more willing 
   than expected to cooperate with a 
   "lame duck" President Bush over the 
   next two years? Because thanks to the 
   President's proposal to overhaul the 
   tax code Republican lawmakers will be 
   happily swimming in campaign 
   contributions from businesses newly 
   desperate to buy influence lest they 
   lose out in the big revenue reshuffle. 
   ... It's certainly important, if you 
   are a Congressman trying to raise 
   money for yourself, that the dream of 
   tax reform be kept alive! At least for
   two years. Then it can be nibbled to 
   death. ... Washington D.C.'s economy 
   should be revived, if nobody else's. 
   ...

                           (emphasis in original)

We'd say "read the whole thing," but you just did.

Cynical? Certainly. Correct? Hmmmm...

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TRIBUNE ARTICLE HIGHLIGHTS TAX REFORM HURDLES

November 08, 2004

Any tax reform in the upcoming Bush second term has to overcome a three-way split among conservatives, according to a story in the Chicago Tribune:

   Conservatives are divided into three 
   main camps. One group supports a 
   national sales tax of more than 20 
   percent to replace the income tax. A 
   second favors one income tax rate of 
   less than 20 percent to replace the 
   current four tax brackets, and a third
   prefers reforming the current 
   income-tax system by ending many tax 
   preferences and reducing overall tax 
   rates.

Thanks to Econopundit for the pointer.

The TaxProf has another roundup of mass-media stories on tax reform and taxes today.

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INCITEFUL CARNIVAL

November 08, 2004

The Carnival of the Capitalists, a weekly collection of economics and business weblog posts, is at Incite blog this week. Don't miss the link to Econlog's discussion of evidence that the cost of government healthcare regulation exceeds $1,500 per household. Also much other worthwhile reading, including good stuff on building teams for venture capital projects and the hidden real-estate wealth of Sears.

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XELENT ADVENTURES OF XELAN

November 05, 2004

A reader points to this New York Times story about the IRS freezing $500 million of assets belonging to 4,000 + doctors and dentists. The assets were in "abusive tax shelters" run by Xelan, a San Diego company.

   About 4,000 doctors and dentists 
   across the nation bought tax-reduction
   plans in recent years from the company, 
   Xelan, evading $420 million in taxes, 
   not including interest and penalties, 
   a statement from the Justice 
   Department asserted.

The story says Xelan is under investigation for operating a bogus charity....

   One focus of Justice Department 
   scrutiny is the Xelan Foundation, 
   which was set up as a charity that 
   allows the donors - and not the 
   charity - to decide how their 
   contributions are to be used. 
   The government contends that the 
   foundation, which is registered with 
   the I.R.S., operated as an abusive 
   tax shelter. The Justice Department 
   said it found 29 instances of the 
   foundation's accepting pretax 
   contributions from doctors and 
   dentists, who then used the money for 
   their children's college tuition.

...and a bogus disability insurer:

   Xelan told doctors that they could put
   up to 100 percent of their income 
   tax-free into the supplemental 
   disability plan. Legitimate payments 
   for insurance are tax-deductible. 
   Xelan told the doctors that their 
   contributions were tax-free for seven 
   years, after which they would owe 
   taxes on the principal and gains.

   The I.R.S. maintains that the plan was 
   not insurance but a taxable 
   deferred-compensation program. The 
   $505 million in Vanguard accounts was 
   from the insurance plan, a Justice 
   Department lawyer said.

The moral? The old one - if it sounds too good to be true, in probably is. And don't trust companies that start with "X," perhaps.

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SMART KIDS PONDER PRESIDENT'S TAX WORDS

November 05, 2004

The smart kids also are paying attention to the President's tax policy thoughts.

Smart kid James Maule, a tax law professor at Villanova who has written perhaps 23.6% of the tax literature in our library, has some thoughts. They are well worth reading in full; here are some of the highlights:

   So does that mean the President would 
   not sign another special interest give
   away tax bill such as the American 
   Jobs Creation Act? Does he really 
   intend to oppose any more special 
   breaks for specific individuals or 
   entities or small groups of them? Is 
   he ready to stand up to legislators 
   on both sides of the aisle and oppose 
   their special interest group tax 
   legislation ritual? As I said yesterday,
   it's already messy and it will get 
   interesting.

   The President's statement also suggests 
   that simplification, as he sees it, 
   probably would not repeal the 
   charitable contribution deduction or 
   the home mortgage interest deduction. 
   This is probably his way of saying 
   that he understands the political 
   reality implicit in an attempt to 
   repeal a tax break that benefits a 
   wide cross-section of taxpayers rather
   than a small group. An interesting 
   question is "what else falls into that
   category?" 

    ...

   Will the Congress find a way to get 
   together and fix the problem? My 
   prediction is no, it will make it more
   complicated. When the day is done, 
   there will be more credits, more 
   anti-abuse rules, more definitions, 
   more limitations, and more phased-in, 
   phased-out provisions. The impact of 
   the looming financial problem 
   (deficits, Social Security, and 
   Medicare topping the list) will 
   contribute to the collapse of the 
   system.

Professor Maule, such Pollyana-ish optimisim doesn't become you!

Meanwhile, smart kid Paul Caron, a University of Cincinnati tax law professor and author of the TaxProf Blog, is keeping his predictions to himself, for now. He instead provides a roundup of big-media coverage of the President's tax reform agenda.

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PRESIDENT TALKS SECOND-TERM TAX POLICY

November 05, 2004

President Bush discussed tax policy for his second term in yesterday's press conference. Let's go to the transcript:

   Q Mr. President, as you look at your 
   second term domestic priorities, I 
   wonder if you could talk a little bit 
   about how you see the sequence of 
   action on issues beyond Social 
   Security -- tax reform, education. And
   if you could expand a little bit for 
   us on the principles that you want to 
   underpin your tax reform proposal -- 
   do you want it to be revenue neutral? 
   What kinds of things do you want to 
   accomplish through that process?

   THE PRESIDENT: I appreciate that. I 
   was anticipating this question; that, 
   what is the first thing you're going 
   to do? When it comes it legislation, 
   it just doesn't work that way, 
   particularly when you've laid out a 
   comprehensive agenda. And part of that
   comprehensive agenda is tax 
   simplification.

   The -- first of all, a principle would
   be revenue neutral. If I'm going to --
   if there was a need to raise taxes, 
   I'd say, let's have a tax bill that 
   raises taxes, as opposed to let's 
   simply the tax code and sneak a tax 
   increase on the people. It's just not 
   my style. I don't believe we need to 
   raise taxes. I've said that to the 
   American people. And so the 
   simplification would be the goal.

   Now, secondly, that obviously, that 
   it rewards risk and doesn't -- it 
   doesn't have unnecessary penalties in 
   it. But the main thing is that it 
   would be viewed as fair, that it would
   be a fair system, that it wouldn't be 
   complicated, that there's a -- kind of 
   that loopholes wouldn't be there for 
   special interests, that the code 
   itself be viewed and deemed as a very 
   fair way to encourage people to invest
   and save and achieve certain fiscal 
   objectives in our country, as well.

   One of the interesting debates will be,
   of course, in the course of 
   simplification, will there be 
   incentives in the code: charitable 
   giving, of course, and mortgage 
   deductions are very important. As 
   governor of Texas, when I -- some time
   I think I was asked about 
   simplification, I always noted how 
   important it was for certain 
   incentives to be built into the tax 
   code, and that will be an interesting 
   part of the debate. 

                                           (Emphasis added)

Now, it's dangerous to read a Presidential press conference transcript like a 1970s issue of Pravda, looking for clues to policy changes. Still, the President said he was anticipating the tax question, so we can assume that his answer provides clues to administration tax policy thinking.

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TAX REFORM? WHAT DOES HE MEAN BY THAT?

November 04, 2004

   Because we have done the hard work, we
   are entering a season of hope. We'll 
   continue our economic progress. We'll 
   reform our outdated tax code. We'll 
   strengthen the Social Security for the
   next generation. We'll make public 
   schools all they can be. And we will 
   uphold our deepest values of family 
   and faith.

                    From President Bush's victory speech.

It looks like "tax reform" is high on the President's second-term to-do list. Tax reform can mean many things. Some people think it means a national sales tax, or perhaps "flat tax" that excludes investment income. Others envision a cleanup of the existing system; these folks look to the Tax Reform Act of 1986, achieved the last time a Republican President had a second term.

The President advocated tax reform in his campaign without specifying what he meant. He promises to appoint a "blue ribbon commission" to recommend reforms, and he has called a national sales tax "an interesting idea that we ought to explore."

SALES TAX?

While not impossible, replacing the income tax with a national retail sales tax seems unlikely. It became an issue in a few elections. In South Carolina, opposition to a national sales tax allowed a Democrat to draw close in what had been expected to be an easy U.S. Senate campaign for Jim DeMint, and it may have had a role in the defeat of beer scion Pete Coors in his race for an open Senate seat from Colorado. Democrats think they can win by opposing a national sales tax, so it seems unlikely that the administration will spend its political capital trying to get the 60 votes needed to get a sales tax though the Senate.

PAST AS PROLOGUE?

The President's first term may tell us what his second term tax policies will look like. The first term has seen

- A lowering of rates.
- Increased expensing of business assets, in lieu of depreciation.
- Elimination of the estate tax, if only temporarily.
- Reduction in taxes on dividends and capital gains.
- Health Savings Accounts - a kind of super-IRA with a medical expense kicker.

AMT: FLAT TAX OF THE FUTURE?

The first term also saw a creeping expansion of the reach of the Alternative Minimum Tax (AMT), which applies a lower rate to a broader base of taxable income.

The Administration also floated proposals for "Lifetime Savings Accounts" and "Retirement Savings Accounts." These accounts would replace much of the baffling array of IRAs and retirement savings plans now in place. Generous contribution limits and withdrawal rules would enable most taxpayers to transfer all of their savings to these tax-sheltered vehicles.

Each of these items nudge the tax law in the direction of the "Hall-Rabushka" flat tax. If the Alternative Minimum Tax is simply adopted as a replacement to the regular income tax, and the LSA and RSA systems are adopted, the tax code looks very different:

- Single taxpayers with income below $40,250 and joint filers with income up to $58,000 are exempt from tax, sheltered by the AMT exemption. This alone could provide powerful political momentum for such a plan.
- Most interest, dividend, and capital gain income is tax-free, sheltered in LSAs or RSAs.
- If the Section 179 maximum of $100,000 is continued, most small businesses will be able to fully deduct their capital expenditures.

The result is not a "pure" flat tax; in a "real" flat tax, all capital expenditures are fully deductible, all interest, dividend and capital gain income is tax-free, and no deduction is allowed for interest expense. Yet, while perhaps not satisfying to flat-tax theorists, a system based on the current AMT, combined with the LSA and RSA provisions, begins to look a lot like the flat tax. By eliminating complexity and providing a generous exemption, it even could be a huge improvement over today's system.

Such an incremental approach seems likely; after all, it would continue the approach that won re-election. A pure sales tax or flat tax would probably founder in the face of united opposition from those who benefit from many aspects of the existing tax code. Incremental changes could move the tax law much of the way towards a consumption tax without threatening popular tax breaks, like as the home-mortgage interest deduction and the charitable deduction.

There are political and practical obstacles to tax simplification, but it is needed. Even those of us who make a living off of tax complexity find ourselves facing an embarrassment of riches.

UPDATES:

PRESIDENT TALKS SECOND-TERM TAX POLICY

SMART KIDS PONDER PRESIDENT'S TAX WORDS

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IOWA POSTS EXPLANATION OF EXASPERATING DEPRECIATION STANCE

November 04, 2004

The Iowa Department of Revenue has put a Q&A-format discussion of the new Iowa bonus depreciation and Section 179 rules on their website. It has a good explanation of how they (wrongly, in our view) apply the law coupling federal and Iowa depreciation rules for new property placed in service after May 5, 2003.

Unfortunately, they have failed to permit taxpayers to make the change on 2004 returns. This means many taxpayers will lose the benefit of the depreciation changes because they will not be able to justify the cost of filing amended 2003 returns.

Many taxpayers are waiting to see if the legislature will help when they return in January. Some legislators are sympathetic to taxpayers on this issue. Still, it is uncertain whether the legislature will act. With the Iowa Senate apparently split evenly between Democrats and Republicans, it's not clear whether they will be able to agree on when to eat lunch, let alone any legislation.

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ELECTION DAY!

November 02, 2004

For the vast portion of the electorate that chooses candidates based on tax policy, stop by the TaxProf's shop to see where the candidates stand on tax policy.

Or, you can just browse their tax returns. Or the wife's.

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COMPARE AND CONTRAST

November 01, 2004

Nollen Plaza today...

and Friday:

Fall is here.

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BLOGROLL UPDATES

November 01, 2004

Since the Quatloos Anti Tax Protestor Blog went dormant about when we linked to it, we have de-linked it in hopes it will re-ignite. We have instead listed the invaluable "Quatloos!" main site under "Giga-Blogs."

We have also linked the Fairmark.com "Tax Guide for Investors," even though they didn't call when their author came to Des Moines to run the Marathon.

We're...not...bitter.

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ELECTION WEEK CARNIVAL

November 01, 2004

The Carnival of the Capitalists flees to Canada this week, finding sanctuary from electoral politics at WillPate.org. From the future of outsourcing to issues in selling a small business, lots of good stuff at the Carnival this week.

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SAY WHAT YOU WANT, JUST SPELL MY NAME RIGHT

November 01, 2004

Dave McClure, author of the "Bleeding Edge" column for The CPA Technology Advisor, has written a two-part article about tax and accounting weblogs. The Tax Update is mentioned, but the author's name is misspelled.

Sigh... well, "Criston" is how it's pronounced, so give him points for that. Substitute K for C and a for o, and we're in business.

Part I
Part II (contains egregious spelling error)

Thanks to BenefitsBlog for the pointer. They spell her name right!

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