Tax Update Blog: December 2004 Archives
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IRS ISSUES STATEMENT ON TSUNAMI DEDUCTION
December 29, 2004
The statement, in full:
Aid for Tsunami Victims May be Tax Deductible
Contributions to domestic, tax-exempt, charitable organizations that provide assistance to individuals in foreign lands qualify as tax-deductible contributions for federal income tax purposes provided the U.S. organization has full control and discretion over the uses of such funds.
Publication 3833, Disaster Relief: Providing Assistance through Charitable Organizations (PDF 507K), explains how the public can use charitable organizations to help victims of disasters, and how new organizations can obtain tax-exempt status
Contributions are deductible for the year in which they are actually made.
SOME PLACES TO GIVE:
American Red Cross (via Amazon.com)
Salvation Army South Asia Relief Fund
Command Post list of donation sites (not all are U.S. Charities)
If the donation is made on a credit card by 12/31/04, it is deductible this year, even when the credit card bill is paid later.
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LAST KID PICKED
December 28, 2004
One common self esteem-crushing childhood experience is being the last one standing when teams are picked at recess. Bruce Bartlett brings back that old feeling:
In the tax area, the most prolific blogger is tax professor Paul Caron of the University of Cincinnati. I find him useful because he really keeps on top of the scholarly research among other tax professors. In most cases, this research is available on the Internet in the form of working papers that may be available months or even years before they appear in inaccessible law reviews. This is extremely valuable to me in terms of keeping ahead of the curve on tax research.
Other tax professor bloggers are James Maule of Villanova University and Daniel Shaviro of New York University. They tend to talk more about current tax policy issues from an academic point of view. What I like about both of them is that they are highly opinionated. Neither pulls any punches in saying what they think is stupid about recent or proposed tax legislation. I don’t always agree with them, but they always make me think.
Another tax perspective comes from Kerry Kerstetter, a certified public accountant. His commentary is less academic and more practical. He offers advice on real world tax problems, especially those faced by small businessmen. And he seems to find every cartoon dealing with taxes that appears anywhere.
Now, who does that leave out? Sigh.
Hey, guys, pick me! I can hit! I'm small, but I'm slow! Don't pick those new kids!
Thanks to the Instapundit for the pointer. Thanks a lot.
That's ok. I really didn't want to play your dumb game.
*sulk*
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ANDERSON'S ARK SINKS
December 28, 2004
A Seattle federal court jury yesterday handed down six conspiracy and tax fraud convictions in the Anderson's Ark tax scheme. The accused ringleader, Keith Anderson (left), was among those convicted.
The Seattle Post-Intelligencer describes the operation:
Anderson Ark moved client cash into overseas bank accounts and falsely deducted the funds from income tax returns as "consulting" or "management" expenses. In order to make the deductions look legit, Anderson's Ark told its clients to send the money through an Anderson's Ark affiliate to a shell company operated by co-defendant Richard Marks.
Marks, 60, of Los Osos, Calif., would wire the money to Austrian bank accounts operated by co-defendant Wayne Anderson, Keith Anderson's 64-year-old brother from Fresno, Calif. The cash ultimately ended up in Costa Rican bank accounts.
If using an absurd defense were helpful, these guys certainly would have walked free:
Anderson asserted that he did not recognize the jurisdiction of the court because he is a "human being" rather than a "legal fiction entity."
According to Anderson, the court has jurisdiction only over someone who has accepted a Social Security number and thus has a fictitious identity.
Wow. Apparently in Mr. Anderson's world there were no federal crimes until 1935, when the Social Security Act passed. That means Al Capone was unjustly convicted!
After being found guilty yesterday of multiple counts of mail and wire fraud, money laundering, and aiding and assisting the filing of false tax returns, Anderson told the court: "I do not recognize legal fictions. I remind you that I retain all my God-given rights ... and have never consented to this jurisdiction."
The story fails to mention whether the federal marshals obtained Mr. Anderson's consent before escorting him to his new secure living quarters.
UPDATE: Tax Analysts Coverage
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DIVORCE IN HASTE, REPENT AT LEISURE
December 28, 2004
Mumtaz and Shagufta Ali were separated. Mumtaz owned a corporation called Spearmint Rhino Clubs. Because California is a "community property" state, Shagufta had a "community interest" in the property.
Spearment Rhino Clubs is a chain of "upscale gentlemen's clubs." They must be prosperous, because from June through December 2000, Spearmint Rhino paid Shagufta $24,000 per month. During this time, no divorce decree or other court order required the payments.
Mumtaz wanted this payment to be treated as alimony. If a payment is alimony, it is deductible to the payor and taxed to the recipient. Unfortunately for Mumtaz, the tax law requires the payments to be pursuant to "a divorce or separation instrument." Perhaps to repair the lack of any court document requiring the payments, a divorce judge filed a stipulation that "deemed" the distributions to be under court decree retroactively.
The Tax Court yesterday said that this instance of time travel was invalid for tax purposes: "...retroactive imposition of support by a Sate court does not have retroactive effect for Federal tax purposes."
THE MORAL: If money is changing hands in separation or divorce, be sure to ponder the tax implications before you write the check, as current time-travel technology cannot undo any unhappy tax result that becomes apparent in hindsight.
Cite: Mumtaz A. Ali, T.C. Memo. 2004-284.
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YEAR-END CARNIVAL!
December 27, 2004
The final Carnival of the Capitalists for 2004 is up at "Business Opportunities Weblog." This week's roundup of economics and business weblogs covers ground from the baleful results of government "initiatives" for innovation to marketing to women online. Don't miss it!
(update - link fixed)
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HELPING TSUNAMI VICTIMS
December 27, 2004
The survivors of the horrific Indian Ocean earthquake and tsunami need your help. Online donations are being accepted:
Links to other aid organizations may be found at:
vichaar.org (Indian weblog)
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TAX PROF PLAGARIZES TAX ANALYSTS! BUT IT'S OK...
December 27, 2004
...because he has permission!
The TaxProf Blog has entered into an arrangement with Tax Analysts to yank an article each day from behind the subscriber firewall for all to see. Tax Analysts provides great tax content, such as today's post from Raby and Raby on the dangers of self-dealing in qualified plans -- a subject we discussed recently.
Thanks are due the TaxProf for this terrific service.
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GIVING UNDER THE WIRE
December 23, 2004
In this season of giving, many taxpayers like to give in ways that help beyond their family circle. The tax law encourages this, so gifts to charity now can partially come back to you in April in the form of lower taxes.
If you want to deduct your gifts on your 2004 returns, some things to keep in mind:
-If you give by check, make sure that you have the checks in the mail postmarked no later than December 31, 2004.
- If you give appreciated stock to charity, make sure it gets into the charity's brokerage account by December 31. Many smaller charities tend tend to neglect this.
- If you donate by credit card in 2004, you can deduct the donation in 2004, even if you don't pay off your credit card bill until 2004.
Many worthy charities take credit card donations online. Here are links to some popular charity donation pages.
HELPING OTHERS
Salvation Army
Hospice of Central Iowa
BE TRUE TO YOUR SCHOOL
University of Iowa
Iowa State University
University of Northern Iowa
Drake University
Cornell College
Southern Illinois University
SUPPORT THE TROOPS AND THEIR FAMILIES
USO
Spirit of America
National Military Family Association
Want to make sure your intended charity is legitimate? You can look up a charity on the IRS Website, or you can look at its tax return at Guidestar.org.
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IRS SENDS SEASONS GREETINGS TO ESOP-OWNED S CORPORATIONS
December 23, 2004
Mixed in with their assortment of colorful holiday cards, about 1,700 S corporations with ESOPs are getting a thoughtful message from the IRS in their mail:
As you are aware, ESOPS are subject to various requirements under the Code which must be met in order for the ESOP to be tax-exempt and to qualify for other tax benefits. We have determined that many of the existing arrangements designed to take advantage of the S corporation ESOP rules would not only violate section 409(p), but also violate other qualification requirements of the Code.
The letter is being mailed to S corporations with ESOPs having 10 or fewer participants.
The letter reminds taxpayers that new rules imposing severe excise taxes on ESOP-S corporations with too few participants take effect January 1, 2005. The letter also warns taxpayers against a scheme that has been marketed to use S corporation ESOPs as a flaky tax shelter:
In these arrangements, taxpayers attempt to exclude the income of an operating business through the use of a combination of an S corporation and ESOP. In a typical case, the owner of an operating business creates an S corporation and causes the two entities to enter into an agreement under which the operating business pays a fee to the S corporation in exchange for management or other services. In addition, the S management corporation adopts an ESOP that becomes the sole shareholder of the S management corporation and in which the owner is the sole participant.
The IRS defeated a Des Moines-based prototype of this setup in Beals Bros. Management Corp. (TC Memo 2001-234)
TIME TO TERMINATE?
S corporations receiving these letters shouldn't panic, but they should do some thinking. If they use the Beals Bros. plan, they should probably do something else. If they are just small, they should make sure they comply with the Section 409(p) rules that take effect next month. If not, they may need to terminate their S elections; they can do so effective January 1, 2005 no later than next March 15.
UPDATE: BenefitsBlog has more.
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BIG MEDIA TAX ROUNDUP: FACADE EASEMENTS UNDER FIRE
December 23, 2004
The TaxProf has again rounded up tax stories from the big media.
One worth noting is the Washington Post story on the vow by Senator Grassley to shut down deductions for "facade easements," starting right now. These are charitable deductions taken for the promise not to alter the appearance of a historic buildings.
Grassley emphasized that, while targeting abuses, he continues to support legitimate deductions that promote preservation.
"Overvalued facade easements are pretty obvious," he said. "For example, it's ridiculous for people in Georgetown to take tens of thousands of dollars in charitable tax deductions for agreeing not to put aluminum siding on their million-dollar brick houses when local laws and regulations already prohibit such activity."
A historic facade?
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HOLIDAY TAX BACCHANALIA
December 22, 2004
OK, maybe "bacchanalia" is too strong a word for the weekly meeting of the Des Moines Wednesday Tax Forum, but it is clear they know how to have fun. A scene from today's festive session:
OK, maybe we don't much have a clue how to have fun.
The big news from today's session: Marvin Winick, the last original member of the group, announced he will be leaving after next week's meeting. The lunch club started meeting in 1960. It's clear he's pretty broken up over leaving the group:
OK, he does hide the pain well.
We will miss Marvin, and we hope he thinks of us when he is having a nice outdoor lunch in Florida or the Carribean on future January Wednesdays.
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DEFERRED COMP - SOME IMPORTANT DEADLINES FROM NEW TREASURY GUIDANCE
December 22, 2004
This week the IRS issued its first guidance on the non-qualified deferred compensation restrictions signed into law October 22. The guidance (Notice 2005-1) covers some key effective dates. These are very helpful, as many of these provisions take effect January 1, 2005.
WHY THIS IS IMPORTANT
The new deferred compensation rules (New Code Section 409A) require employees to take "deferred" amounts into income unless the deferral meets new requirements. For example, all deferral elections must be made prior to the year in which the income would otherwise be paid, and new restrictions apply to early withdrawals of deferred amounts. For a more complete rundown on the new rules, go here.
If the new rules are violated, the employee gets a double whammy:
-they have to include all amounts they are owed under the plan in income, whether or not they actually receive them, and
-they have to pay a 20% excise tax on top of the income tax on the deferral.
Notice 2005-1 gives employers and employees a little breathing space for dealing with these plans. Some questions, and answers, on the deadlines:
EMPLOYEE DEFERRAL ELECTIONS FOR 2005
Q. I have elected to defer $50,000 in salary I would otherwise be paid in 2005. The new rules take away the option I thought I would have to withdraw amounts early by taking a 10% "haircut." Now that I can't get the money out early, can I undo the election and take the money in 2005?
A. If your plan is amended by the employer to so allow, you may undo your 2005 deferral election and get paid that amount in 2005 without penalty before the end of 2005. (Notice 2005-1, Q&A 20)
Q. Can I just reduce my 2005 deferral, rather than eliminate it completely?
A. Yes. (Notice 2005-1, Q&A 20)
EMPLOYER PLANS: DEADLINES FOR CHANGES
Amounts that are deferred through 2004 under plans that aren't "materially modified" after October 3, 2004 are excluded from the new deferred compensation rules. Maintaining this "grandfather status" is important; if a plan is materially modified after 2004 and fails to comply with the new rules, all pre-2005 deferrals could be subject to tax and penalty. Notice 2005-1 answers some questions relating to "grandfathered" plans.
Q. We have a plan that allows employees to elect each quarter to defer income for the next quarter. Can we continue doing this for 2005?
A. No; all amounts deferred under elections made after 2004 under this circumstance would be subject to tax and penalty in 2005.
Q. Other than the quarterly elections, it appears our plan is otherwise in compliance with the new rules. If we amend the plan to require all deferral elections for 2005 to be made by the end of 2004, we will be in compliance. Will such a post 10/3/04 election blow our "grandfather"status for old deferrals?
A. No. "The amendment of a plan to bring the plan into compliance with the provisions of Section 409A will not be treated as a material modification." (Q&A 18) In fact, you can allow employees until March 15, 2005 to make elections that apply for compensation payable starting March 16, 2005. (Notice 2005-1, Q&A 21)
Q. We want to suspend our deferred compensation plan until the new rules get sorted out. Is that a "material modification" that jeopordizes our grandfather status?
A. No, as long as you don't do anything in 2005 that is otherwise out of compliance with the new rules. (Notice 2005-1, Q&A 18(c))
Q. This plan is a hassle. Can we just terminate it? Can we wait until next year to do so?
A. Yes. "Amending an arrangement on or before December 31, 2005 to
terminate the arrangement and distribute the amounts of deferred compensation
thereunder will not be treated as a material modification, provided that all
amounts deferred under the plan are included in income in the taxable year in
which the termination occurs." (Notice 2005-1, Q&A 18(c)).
OTHER ISSUES
For most operational purposes, the next big deadline is March 15 - the date that participants can alter elections under existing plans, if the plans so permit. You can put a hold on current plans without getting into trouble, and you can cancel plans until 2005. It is not certain to us, but it appears that you can freeze an existing plan as of December 31, 2004 and begin operating under a new plan in 2005, while protecting the grandfathered status of the pre-2005 deferrals.
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JUSTICE DEPARTMENT: NEVER MIND...
December 21, 2004
The Justice Department went after xelan, Inc. with both barrels, freezing over $500 million in investment accounts with great fanfare. xelan offshore marketed tax-savings arrangements to physicians.
The Justice Department promptly lost a critical court ruling and the assets were unfrozen. Now the Justice Department has quietly withdrawn its lawsuit, slinking away in embarassing defeat.
The Quatloos website says the department will now probably go after the participants in xelan's plans, rather than go after xelan itself:
Of course, as Yogi Bera would say, "It ain't over until it's over," and probably the next step will be for the IRS to start assessing some of the xelan participants, but that gives xelan the chance to win physician-by-physician, instead of (as the DOJ hoped) lose en masse.
In the interim, this is a stunning defeat for the DOJ, which is admitting defeat (at least for now) by voluntarily dismissing its injunction action. But anybody who thinks that the DOJ is permanently going away is crazy. Some very bright and experienced minds in Washington will lick their wounds for a couple of weeks, and then settle on a new strategy. So stay tuned
Prior Tax Update Coverage:
DOCTORS WIN A ROUND?
XELENT ADVENTURES OF XELAN
TaxProf Blog coverage
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GLASS HOUSES, STONES AND ALL THAT
December 21, 2004
Colorado disc jockey James P. Ellis turned in a tax cheat somewhere along the line and received a reward for doing so from the IRS. Then he did something foolish: he didn't report the reward on form 1040.
Result: tax and negligence penalties.
Cite: T.C. Summary Opinion 2004-170 (pdf format)
TaxProf Blog Coverage
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EARLY CHRISTMAS FOR CHOCOLATE-COVERED PRETZEL FANS
December 20, 2004
The Iowa Department of Revenue today released a policy letter settling the burning tax question: are chocolate-covered pretzels "prepared food" subject to sales tax, or "bakery items," exempt from sales tax?
Bakery items it is!
Quoth the policy letter:
First, concerning the pretzels baked in the candy shop, sales of these are pretty clearly exempted from tax under subparagraph (c) above. They are “bakery items sold by the seller which baked them,” and I do not think that the fact they are later dipped in chocolate brings them within the purview of paragraph (2), that is the pretzels and chocolate are not “two or more food ingredients mixed or combined by the seller for sale as a single item.” Why not? A “cake” is a baked good the sale of which would surely not be excluded from exemption if its baker/seller frosted it. Treating like items in a like fashion, it must then be said that anything done to a baked good which is the equivalent of frosting it should not remove the sale of the good from exemption. And is not dipping a pretzel in chocolate the equivalent of frosting it? Sales of chocolate covered donuts would obviously be exempt from tax; so must sales of chocolate covered pretzels.
Thusly pretzels achieve tax parity with chocolate-covered donuts, and so triumphs justice.
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IOWA TAXATION OF PENSIONS, 401(K) PLANS
December 20, 2004
Enigmatic Iowa-blogger State29 notes a letter to The Des Moines Register worrying about whether Iowa will start treating pension income better than 401(k) income.
The worry is probably misplaced. The current Iowa tax law (Section 422.7(31) - scroll down if you follow the link) provides an exclusion for up to $6,000 in retirement income per taxpayer. It is defined as follows:
For a person who is disabled, or is fifty-five years of
age or older, or is the surviving spouse of an
individual or a survivor having an insurable interest in
an individual who would have qualified for the
exemption under this subsection for the tax year,
subtract, to the extent included, the total amount of a
governmental or other pension or retirement pay,
including, but not limited to, defined benefit or defined
contribution plans, annuities, individual retirement
accounts, plans maintained or contributed to by an
employer, or maintained or contributed to by a
self-employed person as an employer, and deferred
compensation plans or any earnings attributable to the
deferred compensation plans...
(emphasis added)
The reference to defined contribution plans embraces 401(k) plans.
It is unlikely that Iowa would try to distinguision between pension and 401(k) plans for many reasons, not least of which is that a pension - only exclusion would be ridiculous. If additional pension breaks are enacted, only non-qualified plans run any risk of lost benefits because they are generally directed towards higher-paid employees.
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FIRST 2004 AJCA DEFERRED COMP GUIDANCE ISSUED
December 20, 2004
The IRS has issued its first rules under Code Section 409A for non-qualified deferred comp plans. Section 409A requires deferred compensation plans to meet new requirements to keep participants from paying tax on salary and wage income they defer to future years, if not part of a 401(k) or other "qualified" plan.
Links:
Notice 2005-01
Treasury Press Release on new rules
More as we get a chance to wade through them.
UPDATE: The BenefitsBlog has some initial thoughts. She notes that plan documents need not be amended until the end of 2005 "if the plan is operated in good-faith compliance" with the new rules.
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WINTER CARNIVAL
December 20, 2004
This week's Carnival of the Capitalists is up at the XTremeBlog. Topics in this week's installment of the recurring collection of economics and business weblog posts include the link between tax and savings rates, as well as a presumably unrelated post on "Vodka Arbitrage," which sounds good on this cold day.
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CREATIVITY ISN'T EVERYTHING, IN TAX
December 20, 2004
Dr. Roger L. Firestien's website has the motto: "creativity that gets results.(tm)"
It doesn't say they're always good results.
A recent result of Dr. Firestien's creative tax activities is a federal indictment on six tax felony charges. Dr. Firestien got involved in an "Anderson's Ark" tax scheme. Anderson's Ark setups involved an offshore entity in a tax haven -- say, Belize -- and sucking out all of your U.S. taxable income by paying the offshore entity "management fees" or some such. Anderson's Ark would take a cut and the rest could be withdrawn, supposedly, without any tax.
The maximum sentence for Dr. Firestien on these charges would be 28 years in prison and $1.5 million in fines, according to the Justice Department.
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JERRY KASNER, DRAKE ALUM AND TAX PROF, DIES IN CALIFORNIA
December 19, 2004
The TaxProf Blog notes the passing of Jerry Kasner, a Des Moines boy who made good. He was a tax professor and estate planning expert at the Santa Clara University School of Law.
From the Santa Clara press release:
Jerry Allan Kasner, a renowned law school faculty member, passed away on October 21, 2004 in Grass Valley, California at the age of 71.
He was born in Des Moines Iowa, on March 20, 1933. Professor Kasner received his B.S. in 1955 and his J.D. in 1957, both from Drake University. He was admitted to the Iowa State Bar in 1957 and the California State Bar in 1959. He was a professor of law for 38 years at Santa Clara University’s School of Law, from 1961 – 1998. He was completely dedicated to his students and law professor colleagues. In 1996 he received Santa Clara University’s Award for Sustained Excellence in Scholarship. He also received a distinguished alumnus award from Drake University Law School.
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TAX POLICY CHIEF STEPS DOWN
December 18, 2004
Just as the White House prepares to gear up its tax reform efforts, it has lost its top tax policy official. Gregory F. Jenner, Acting Assistant Treasury Secretary for Tax Policy, resigned "unexpectedly," effective noon yesterday.
Mr. Jenner had been nominated in July to be the permanent replacement for Pam Olson, who stepped down in January. The nomination was never confirmed.
The Washington Post cites the Treasury Department as saying his replacement will be named next week.
The timing seems odd. If we are on the cusp of major tax policy changes, this would be the time to be in that job from any career-planning standpoint. His predecessor, Pam Olson, seems to be as visible a player in tax policy lately. According to his Treasury Department Biography, Mr. Jenner was Senate Finance Committee Tax Counsel in 1986, so maybe he's seen enough major tax reform for one lifetime.
Maybe it's because he doesn't photograph well. We can find no photo of him via Mr. Google. Photos of his predecessor are easy to come by.
Links to coverage:
Tax Analysts
Washington Post
Wall Street Journal Online
UPDATE: The resourceful TaxProf found a photo.
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WHERE'S THE OUTRAGE?
December 18, 2004
What a rip. We're not supposed to sell bogus tax avoidance schemes to gullible people with big bucks any more.
-CPA Kerry M. Kerstetter at TaxGuru.net, shedding no tears over the new version of Circular 230, the document governing standards of tax practice before the IRS.
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BACK TO THE FUTURE: IRS ISSUES SALES TAX TABLES
December 17, 2004
Congress took a page out of pre-1986 tax law this year by allowing taxpayers to choose between deducting sales taxes and income taxes. The IRS was directed to come up with standard tables allowing people to take a sales tax deduction without having to collect their receipts for the year.
The IRS has just issued those tables. A single Iowa taxpayer with $100,000 and no dependent could take a sales tax deduction of $783, for example. Such a taxpayer would normally forego the sales tax deduction; the income tax deduction would probably be much larger.
If they bought some big-ticket items, they might take the sales tax deduction instead. Sales tax on cars, motorcycles, motor homes, recreational vehicles, SUVs, trucks, vans, and off-road vehicles can be taken in addition to the table amount. Or, you can just save all your receipts (please don't bring them to your preparers!).
So, if an Iowan buys something like this...
...she might just take the sales tax deduction instead (MSRP of $357,000 x 6% Iowa sales tax rate = $21,420 sales tax, + the amount from the tables).
Of course, then she will probably just be in alternative minimum tax anyway, and the deduction will be worthless.
For residents of non-income tax states, this is a big deal.
The tables are here (pdf format)
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A BUDDING CPA-BLOGGER?
December 17, 2004
CPA Milt Baker tiptoes into the blogosphere with CPASENSE.
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'ONLY LITTLE PEOPLE PAY TAXES' WATCH: UBERMENSCH EDITION
December 17, 2004
Somehow this CNN report doesn't surprise:
Hitler a tax dodger, says expert
BERLIN, Germany (Reuters) -- Adolf Hitler spent years evading taxes and owed German authorities 405,000 Reichsmarks -- equivalent to $8 million today -- by the time his tax debts were forgiven soon after he took power, a researcher says....
Hitler's record as a dictator who started World War II and sent millions of people to their deaths in concentration camps is well known. But the unearthed records show a new, previously undocumented side to his life: as an ordinary tax evader
Just goes to show; you can't trust a tyrannical mass-murdering monster for anything.
Getting out of taxes probably didn't really motivate his horrible career, but it was one of the perks. When Hitler became Chancellor, his tax life was good:
"That was the end of his tax problems," Dubon said. "It was all legalized, more or less."
Dubon said the head of the Munich tax office, Ludwig Mirre, excused Hitler from paying tax only after first formally writing to him to ask permission. An assistant to Hitler wrote back to Mirre: "Herr Hitler accepts your proposal."
Mirre was promoted a month later to head of the German tax office and given a 41 percent pay rise.
Just a humble civil servant doing his job...
(Thanks to reader Wayne Reames for the tip.)
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END OF WORLD SCHEDULED: OPTIONS MUST BE EXPENSED NEXT YEAR
December 16, 2004
The Financial Accounting Standards Board decided today to require companies to expense stock options awarded to employees starting next year. According to an AP story, the FASB did not specify exactly how the expense is to be determined, but it presumably will be based on the footnote disclosure of the item already required.
To some of us, this seems like a no-brainer -- of course they should be expensed. If a company gives away pieces of machinery or items of inventory to employees in lieu of paychecks, nobody would argue that this was somehow not compensation expense. Shares of stock are stand-ins for the corporation's underlying assets, and giving them away is economically akin to giving away the assets themselves.
Still, opposition is fierce. The AP article mentions their complaints:
Still, critics of stock-option expensing aren't backing down, keeping up their argument that deducting the option costs from earnings could allow inaccurate information to be entered into financial statements since most methods to value the options include some estimates about the future.
Anybody making this argument with a straight face should be in pictures. Every financial statement is based on estimates of the future. Depreciation is an estimate of the economic wastage of an asset. Banks have to estimate how many loans will go bad and expense that amount. Insurance company financial statements are based almost entirely on estimates of future losses.
And many companies, particularly in the tech sector, fear the new rules will curtail a key perk that helped startups keep workers loyal and hardworking before the companies began turning profits. "We need incentives that will help create jobs and foster the development of new products and services," said Bruce Hahn, director of public affairs for the Computing Technology Industry Association, in a prepared statement Thursday.
This argument boils down to "we don't want to do this because it reduces our reported earnings and is therefore inconvenient." It also is almost certainly wrong; the market can be expected to factor options into its estimate of future cash flows, whether or not they are on the financial statements. One could easily make similar arguments to wish away other expenses for the greater good - R&D comes to mind.
The tax law treats the "bargain element" of option exercise - the difference between the stock value and the exercise price - as deductible compensation at exercise. Maybe the FASB can revisit the issue as soon as public tech companies argue that the tax deduction is economically unsound.
And that, friends, is this year's financial accounting post. We return now to our regular programming.
UPDATE: Text of FASB pronouncement, FAS 123 (pdf format)
Thanks to BenefitsBlog for the links.
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THE PIGS ARE ALOFT!
December 16, 2004
We thought pigs would fly before the D.C. city council would make a sensible, taxpayer-friendly decision on financing a new baseball stadium. So, look out above!
Professer Maule has more:
Yes, baseball, like knitting, is a good thing. If people want baseball, or knitting, they can invest in it, make purchases of it (tickets, yarn), and support it. If enough people do so, it is viable. If people abandon it, then it fades away. It is not the government's right or duty to shore up a failed private enterprise unless the enterprise is crucial to national defense or survival of the nation.
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TAX PROF'S BIG MEDIA ROUNDUP
December 16, 2004
The TaxProf has another roundup of major media tax stories on his site. Highlights include Wall Street Journal pieces on proposed new requirements limiting accountants from selling "aggressive" tax planning to publicly-held audit clients and on widespread flouting of "nanny tax" rules.
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TREASURY: TAX REFORM STILL A 2005 PRIORITY
December 16, 2004
Contrary to speculation that tax reform would be a secondary priority to Social Security changes, a treasury spokesman yesterday said that the Treasury will deliver a tax reform proposal in "early 2005."
Both Pamela Olson, former tax policy chief at Treasury, and George Yin, Joint Committee of Taxation Chief of Staff, said AMT reform would be critical to any package, according to an article by Tax Analysts.
Of course, they may "fix" AMT by embracing it. Comments by Treasury Secretary Snow yesterday seem to point in the direction of an AMT like code with a broader base and fewer deduction, rather than a pure flat tax or national sales tax. Speaking of the President's plans, Snow said:
His goals are to make the code simpler and to increase long-run economic growth and job creation. He believes taxes should be applied fairly, and that reform should recognize the importance of home ownership and charity in our American society.
While those two sentences could contain multitudes, the references to home ownership and charity seem to telegraph a revised version of the current system with fewer deductions and lower rates, rather than a whole new system.
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ON THE COVER OF THE ROLLING STONE (L'AUDIENCE, C'EST MOI)
December 15, 2004
What we do for a living won't make us famous, if we're lucky. What small measure of fame we get from doing the Tax Update, we'll take.
Tax Analysts mentions the Tax Update in a survey of the (tiny) tax blogosphere this week. The have kindly allowed us to post it. Click "read more" for the article.
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'TIS THE SEASON FOR AT-RISK BASIS...
December 15, 2004
In a world of change, we find security in the traditions of the holiday season. We embrace the parties, the excitement of children, wrapping presents, and making sure we have enough basis in our pass-through entities to deduct our losses.
Yet change comes, even to hallowed traditions like basis-shifting. The IRS changed an important rule this year that makes it harder for many of us to use our losses.
THE BACKGROUND
Owners of "pass-through" entities -- partnerships and S corporations -- only get to deduct losses if they have "basis" in their ownership interests. Basis starts with your purchase price. Owners of pass-throughs increase their basis for their shares of income from the entity and for any capital contributions they make. Their basis is reduced by their shares of losses, deductions and distributions.
Pass-through owners also can get basis from debt. Partners can get basis from borrowings made by the partnership from partners or third parties; S corporation owners can get basis from loans they make directly to their corporations.
Basis gets attention this time of year because you need to have it by year-end to deduct this year's losses. Pass-though owners wanting to deduct their losses sometimes may have to make contributions or loans to their passthroughs at year-end to get their needed basis.
AT-RISK RULES: SOME BASIS IS MORE EQUAL THAN OTHER BASIS
Not all basis allows you to deduct losses. If your basis is not "at-risk," the tax law keeps you from using the losses until you dispose of the activity, or until you obtain "at-risk" basis. The at-risk rules are a relic of the tax shelter wars of the 1980s, but they still lurk today, dangerous and often overlooked.
To have "at-risk" basis, you need real money in the game. If you get your basis from a "non-recourse" loan - where the creditor can only repossess its collateral to satisfy the loan, but cannot proceed further against the debtor - you are normally not at risk. (A special exception applies to third-party real estate loans).
RELATED PARTY LOANS: BE VERY AFRAID
The at-risk rules go another step. If you borrow money from a lender who has "an interest in the activity," or who is "related to a person (other than the borrower)" with an interest in the activity, the losses will not be considered "at-risk." These related-party rules formerly only applied to a few activities, including farming and equipment leasing. The Treasury extended them to all activities for amounts borrowed after May 3, 2004.
A CAUTIONARY TALE FROM CENTRAL IOWA
Larry Van Wyk, a farmer from Monroe, Iowa, got a taste of the dangers of the at-risk related-party loan rules back when farmers were their primary target. He owned an S corporation farm 50-50 with his brother-in-law, Keith Roorda. On December 24, 1991, Larry borrowed $700,000 from Keith. The loan was fully-recourse, so the brother-in-law could proceed ruthlessly against Larry in the event of non-payment. Larry used about $250,000 to repay money he owned the S corporation and loaned the remainder to increase his basis to enable him to deduct losses.
Unfortunately, Larry's brother-in-law had "an interest in the activity" - he owned half of it. This made the deduction not "at-risk," even though no loan from a brother-in-law is without risk in a very real sense. The efforts of some of the finest tax attorneys west of the Mississippi were unavailing; the Tax Court agreed with the IRS, and Larry lost his losses.
WHO'S RELATED?
If you borrow from somebody who co-owns an activity with you, the borrowing will not be at-risk. You will not be at risk if you borrow from your co-owner's ancestors, descendents, siblings or spouse. Nor will you be at-risk if you borrow from a business owned 10% or more by your co-owner.
Also, an "interest in an activity" can extend beyond co-ownership. In some cases a person who does business with an activity can be considered to have "an interest in the activity"; so also may an employee.
In short, if you aren't getting your funds from an unrelated party, like your friendly community bank, or from your own assets, you need to be very careful. This is especially true in borrowings among family members.
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IOWA'S INCOME BY ZIP CODE
December 14, 2004
The IRS has issued its statistical summary of form 1040 information for 2001. It is full of time-wasting potential, of which we have taken prompt advantage.
The statistics are organized by state, and then further broken down by zip code. Just for fun, we sorted out the average adjusted gross income (AGI) for each Iowa zip code (total AGI for the zip code divided by returns filed from the code). The champion:
Des Moines, 50305. Average 2001 AGI: 154,815.
Unfortunately, that zip code consists only of post office boxes. While it may be a nice neighborhood, the housing would be a bit too cramped for our taste.
The runner-up:
Urbandale, 50323 Average 2001 AGI: $122,606
Second runner-up:
Des Moines, 50392 Average 2001 AGI: $122,529
Oops, that's the Principal Financial Group dedicated zip code. This income must be from those hard-working insurance guys who literally live at the office.
Third runner-up:
Cedar Rapids, 52411 Average 2001 AGI $92,073
And bringing up the rear:
Ames, Iowa 50013 $7,994. This appears to be a dedicated ISU zip code. Poor starving kids...
We extracted the Average AGI for all Iowa zip codes here. Enjoy!
(Thanks to TaxProf Blog for the tip)
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FORD ESCAPE QUALIFIES FOR HYBRID FUEL DEDUCTION
December 14, 2004
The IRS has certified the 2005 Ford Escape SUV as qualifying for the clean-fuel deduction. This $2,000 deduction is available to individual taxpayers for the year the vehicle is purchased.
This is the first SUV, and the first "big 3" American nameplate vehicle, to qualify for the deduction. The clean-fuel deduction is "above the line" and available to non-itemizers. There is no separate return line or form for the deduction; you just add $2,000 to the amount on line 35, which is the total of adjustments to income, and write "clean fuel" next to the total.
The 2005 Toyota Prius has also been certified. The 2004 Honda Insight and Civic Hybrid models also qualify.
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THE ROAD TO HELL - ERISA VERSION
December 13, 2004
The BenefitsBlog tells a sad story about a CPA whose good intentions led him to the the tax version of the warm place where so many good intentions lead.
Joseph Rollins was the sole trustee of his firm's 401(k) plan. He loaned plan money to firms in which he had a minoirty interest. His good deed was punished with "prohibited transaction" taxes of around $164,000.
Moral of the story: No matter how good an investment looks for a plan, ERISA fiduciaries, trustees, and certain owners and entities should get competent legal advice regarding application of the prohibited transaction rules when entering into transactions with retirement plans, especially in cases where common ownership exists or conflicts of interest issues are present.
Remember, the penalties for prohibited transactions are horrendous, even if the transactions don't hurt the plan.
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WE READ IT FOR THE ARTICLES
December 13, 2004
This week's Carnival of the Capitalists is up at SamaBlog, featuring an illustration that, while appreciated, seems a bit off topic. Not that there's anything wrong with that.
The Carnival is a weekly roundup of economics and business weblog postings. Among the many fine articles are whether professors have "an unusually strong desire for public service" (short answer: not bloody likely) and whether Santa Claus is really all about socialism. That must explain the red suit.
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BUY TODAY'S WALL ST. JOURNAL
December 10, 2004
The WSJ has a stunning and sometimes hilarious piece (this link might only work for online WSJ subscribers) about a private individual with an unusual hobby - infiltrating and exposing tax scams on the internet. Pressing business keeps us from a detailed recap of the article until later. It features several characters known to Tax Update readers, including star-crossed lovers Irwin Schiff and Cindy Neun.
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HEALTH SAVINGS ACCOUNT ROAD RULES
December 09, 2004
The HSA Coalition has issued a handy guide to Health Savings Account rules. It's available at this link (pdf format).
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LET IT SNOW
December 08, 2004
"Snow to Stay in Bush Cabinet for 2nd Term"
In other words, never mind.
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AMT TAX PLANNING IS DIFFERENT
December 08, 2004
Many taxpayers got an unpleasant surprise last April when they discovered that they were subject to the Alternative Minimum Tax. The AMT is a shadow tax computed at a lower top rate, with a large standard exemption but fewer deductions. It applies when it exceeds regular income tax.
The 2003 tax changes that lowered the regular tax rates did not change the AMT rates. This change often reduced regular tax enough to make it lower than the AMT. Surprise!
The item that causes AMT for most Iowans, and residents of other high-tax states, is the deduction for state and local income and property taxes. Now that sales tax are deductible in lieu of income taxes for regular tax (but not AMT!), residents of other states will be joining the AMT party.
CAPITAL GAIN AND AMT
While the same long-term capital gain top rate of 15% applies for both AMT and regular tax, taxpayers with large capital gains often find themselves facing AMT. Why? Think about it: a 15% tax with fewer deductions is likely to exceed a 15% tax with more deductions. If you are paying the top 8.98% rate on Iowa capital gains, you can get to AMT in a hurry.
WHO IS LIKELY TO SEE AMT?
For Iowa taxpayers AMT is widespread, and often impossible to avoid, for gross incomes between $150,000 and about $500,000. If your income includes large capital gains, this income range widens. If you are blessed with children, the AMT applies at lower income levels because there is no AMT dependent exemption.
HOW AMT PLANNING IS DIFFERENT
The common tax planning strategy of prepaying state and local income and property taxes by December 31 generally fails when AMT applies. Sometimes you can maximize the value of these deductions by paying just enough before December 31 to move you to the verge of AMT.
Other strategies still work for AMT. Charitable deductions are fully deductible for AMT, for example. Home mortgage interest on "acquisition" indebtedness - the loan to buy or remodel a residence - is also deductible, but home equity loan interest is not deductible for AMT.
To do serious AMT planning you need to compute projected taxable income for both 2004 and 2005. Timing discretionary income and deductions among years is often the way to minimize taxes when AMT lurks.
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IOWA TAX CHANGES NEXT YEAR?
December 08, 2004
Governor Vilsack outlined an ambitious tax agenda for 2005 yesterday in a speech to reporters. The Governor's plan is still being drafted, but he said its basic elements will include:
- A reduction in the top individual rate in exchange for eliminating federal tax deductibility, and
- An extension of sales taxes to additional services (including accountants and engineers, but not lawyers) in exchange for a lower sales tax rate.
DEADLOCK = MOVEMENT?
The prospects for the Governors plan are uncertain, of course. The Iowa Senate is evenly split and the Republicans have a one-seat majority in the Iowa house. Normally that would portend an uneventful session; still, legislators are at least talking about cooperation, according to a story in the Des Moines Register.
Legislative leaders from both parties agree with the Democratic governor that the nearly equal numbers of Republicans and Democrats in the new Legislature, rather than ending up in gridlock, have a good chance to forge bipartisan agreements setting a different direction for the state.
In the Senate, split 25-25, there is "an incredible opportunity to find common ground," said Democratic leader Michael Gronstal of Council Bluffs. Said Republican Jeff Lamberti of Ankeny, who will share the Senate president's post with Democrat Jack Kibbie of Emmetsburg, "There's a lot of room for a significant agenda."
If so, that will be quite a change from recent sessions, one of which ended up with the legislature and the Governor battling in the Iowa Supreme Court.
HEDGING AGAINST REPEAL OF FEDERAL TAX DEDUCTIBILITY
We aren't willing to handicap the odds of these changes passing. We do suggest that Iowans who will owe a large balance on their 2004 federal tax returns consider paying it before December 31, 2004. Paying deductible federal tax payments in the year they arise is often good strategy anyway; making the payments before year-end hedges against the possibility that Iowa will repeal its deduction for federal taxes effective January 1, 2005.
The Omaha World-Herald has additional coverage.
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TAX REFORM ON BACK BURNER?
December 08, 2004
Tax Analysts reports that some D.C. insiders expect tax reform to take a back seat to Social Security legislation next year.
House Majority Whip Roy Blunt said that Congressional Republicans will concentrate on making the 2001 and 2003 tax cuts permanent.
Tax Analysts quotes two other highly-placed sources as saying that tax reform will not be a 2005 project. Acting Treasury Secretary for Tax Policy Greg Jenner said it is "way too early to speculate" on the makeup of the blue-ribbon panel that will draft administration tax proposals. If the panel won't even be named for months, it is unlikely to finish its work next year.
Bill Archer, a former Ways and Means Chairman, said that he expects reform recommendations in 2006. Mr. Archer predicts incremental changes to the existing system, rather than what he called a "wholesale fruit basket turnover."
We don't know about wholesale, but you can find a retail Fruit Basket Turnover here. It looks like this:
"Fruit Basket Turnover," by Linda Rupard.
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NOT-ENTIRELY-REASSURING QUOTE OF THE DAY
December 08, 2004
Treasury people call this legislation a sea change, but I think it's probably more accurate to call it a tsunami.
-Fred Oliphant, Miller & Chevalier Chartered, discussing the new deferred compensation tax rules enacted in October. (Via Tax Analysts)
What is a "sea change," anyway? Mr. Google comes up with this.
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HOLIDAY SPIRIT AT 7TH AND MULBERRY
December 07, 2004
The crew at the site of the new EMC/Des Moines city garage has lots of room for presents under the tree.
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A TAX FIT FOR A KING?
December 07, 2004
The enigmatic State 29 reports that Representative Steve King supports a national sales tax, at a 23% rate.
Thoughtful enigma that he is, he asks the musical question,
I wonder what would happen to Roth CPA if such a thing was enacted?
Well, we always console ourselves with the idea that a simplified tax code would trigger such an economic boom that opportunities would abound. Still, we have our backup plans.
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TAX ENDS; TAXPAYERS HARDEST HIT
December 06, 2004
The Volokh Conspiracy catches The New York Times in an inanity:
A story in today's New York Times about the federal Superfund program observes: "Since 1995, when Congress did not renew a special tax on polluters, the cleanup money has come entirely from taxpayers." Huh? The money in Superfund always came from "taxpayers" -- that is, it has always come from those paying taxes.
The Volokh post goes on to say that the Superfund Tax was a tax on "chemical feedstocks," with no connection with the pollution output of the taxpayers. There was an excise tax like that (IRC Sec. 4661), but there was also a "Superfund Tax" even less connected to pollution.
Internal Revenue Code Section 59A, which expired at the end of 1995, imposed a .12% "environmental tax" on corporate Alternative Minimum Taxable Income. This tax was imposed on any corporation with AMTI over $2,000,000. Banks, insurance companies and (horrors!) accounting firms were subject to the same "superfund tax" as lead refiners and cyanide makers.
The Times must hate technical nit-pickers like us. Of course, we delude ourselves to think they will even notice.
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DEFERRED COMP PLAN CHANGES
December 06, 2004
The BenefitsBlog has prepared a good primer on the recent tax law changes that require a second look at all existing non-qualified deferred compensation plans. An excerpt:
Bottom Line: All nonqualified deferred compensation plans covered by the new rules will most likely have to be amended. The features of many current plans will no longer be permitted, and many plans will have to be redesigned. Employers will have to communicate these changes to affected participants.
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THE ECONOMIST SEES AMT AS ROUTE TO TAX REFORM
December 06, 2004
The TaxProf Blog notes an article in The Economist that suggests using the Alternative Minimum Tax as a backdoor to tax reform:
From the perspective of tax reform, however, the AMT is less an expensive problem than an opportunity. Why not use the AMT as the vehicle for tax reform? By 2009, it will be less costly to ditch the income tax and keep the AMT than to repeal the AMT and carry on with the income tax. The AMT is far from perfect —its personal exemption is not indexed; quirks in its structure can mean high marginal rates for some taxpayers; and it allows some needless deductions—but it is less riddled with loopholes than the current income tax. Thus it is a good starting-place for base-broadening, exemption-ending reform.
Does The Economist read the Tax Update?
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DOCTORS WIN A ROUND?
December 05, 2004
TaxGuru.com reports that Xelan, under attack by IRS as an abusive tax shelter for doctors, has won a round in court. TaxGuru quotes a press release saying that a receivership imposed earlier on the Doctors Benefit company has been dissolved. He has links to documents in the case.
Prior coverage here.
The San Diego Union Tribune also has a story. This procedural victory doesn't get Xelan out of the woods, but it does allow its customers access to their accounts.
UPDATE: the Doctors Benefit lawyers sent us the same press release. Click "read more" to see it. The IRS will be hugely embarrassed if they don't prevail on this one.