Tax Update Blog: February 2005 Archives

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EVADING TAXES ON $450 MILLION? THAT'S NOT A SMALL NUMBER. THAT'S A VERY BIG NUMBER.

February 28, 2005

The IRS may have landed a big one. The Department of Justice today announced the indictment of a Washington D.C. "telecommunications entrepreneur" Walter Anderson on charges of evading taxes on up to $450 million of income over five years. From the press release:

The indictment alleges that over a five-year period, Walter Anderson personally earned nearly a half billion dollars through investments in business ventures he conducted through offshore corporations he set up to make it appear that he was not personally earning these amounts.

The press release says the charges could merit an 80-year sentence.

The release reminds us that "Every defendant is presumed innocent until and unless found guilty."

Tax Analysts also has coverage.

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TAX-OPTION BORDER COUNTIES: 'MORE BAD TAX POLICY'

February 28, 2005

David Brunori of Tax Analysts today notes the recent proposal to allow Iowa's border counties to opt out of the income tax:

More Bad Tax Policy -- Iowa

Fresh on the heels of the absurd proposal to exempt everyone under 30 years of age from income taxation, some Iowa legislators have another wacky idea. They want to let people who live along the border opt out of paying state income taxes. The proposal (HB 139) would allow residents along the South Dakota line to vote on whether they want to pay income taxes. They could substitute higher sales and property taxes for their income taxes. South Dakota does not impose an income tax -- and this is how the Iowa General Assembly would like to compete.

The proposed law would set up a five-mile zone along the state line. People in the zone could opt out of income taxation and pay higher sales taxes. The higher sales tax rates would be effective in the zone. So how many people do you think would shop in the zone? The zone would also have higher property taxes -- and property taxes are a big hit in Iowa. How long would it be before people in the zone demand property tax relief? Heck, they're already demanding property tax relief. How long do you think it would take before people just outside the zone want a similar deal?

Of course. Once the border counties opted out, the counties bordering the border counties (border border counties? Border Counties once removed?) would want the same option. And then the counties next to them...

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ANNOUNCING 'TAXUPDATEBLOG.COM.'

February 27, 2005

We have added a new, easier-to-remember web address for the Tax Update. You can now get to the current page of Tax Update posts via www.taxupdateblog.com. You traditionalists may continue to access it via the sonorous www.rothcpa.com/taxupdates.php address.

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SUNDAY MORNING COMING DOWN

February 27, 2005

Thanks to Jeff at Tusk and Talon for organizing last night's blogger get-together at Wellmans. It was great to meet the many talented bloggers, whom you can meet here (or see here). Mr. Hogberg traveled all of the way from D.C., winning the "long drive for a party" award. And now to keep a promise to link to Stef in the morning. This blog is a gentleman, after all.

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TSUNAMI CLEARS IRS HURDLE

February 25, 2005

After weeks of suspense, the IRS says the Tsunami makes the grade; it is officially a "qualified disaster."

This is an important designation; in addition to helping secure tax-free status for disaster benefits, it distinguishes the Tsunami from the Ed Wood movie Glen or Glenda ("an unqualified disaster").

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RABYS EVISCERATE 'TAX HONESTY' CLAIMS

February 25, 2005

The Tax Prof has pulled another worthy item from behind the Tax Analysts subscriber firewall today - an evisceration of the claims of a "We The People Foundation" tax release.

Not often have we seen a press release trumpeting a taxpayer’s court defeat as a “historic and courageous first step in restoring constitutional order to the administration and enforcement of our nation’s tax laws.” Even less often have we seen one that hails a per curiam rejection of the taxpayer’s appeal as a “dramatic development” that “effectively puts the IRS and DOJ on notice that violations of taxpayer’s Due Process Rights will no longer be tolerated.”

The Rabys apply their formidable combined brain to disassemble and demolish the We The People tax protester nonsense with scholarly rigor far beyond our mere drive-by mockery.

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GOVERNOR SIGNS DEPRECIATION BILL

February 25, 2005

Press release from the Governor's office:

Thursday, February 24, 2005

DES MOINES - The Governor signed HF 102 late today, a bill allowing taxpayers an additional method to take advantage of depreciation allowances enacted in HF 2581. HF 102 allows taxpayers to include the additional depreciation as part of their tax return for the next year. Under HF 2581, the taxpayer was restricted to filing amended returns in order to receive the benefit. The bill is effective upon enactment and applies retroactively to tax years ending after May 5, 2003.

UPDATE: The Department of Revenue has sent its guidance on the new depreciation rule to its email list. The text is available if you click the "read more" section below. It is similar to the draft guidance we noted Wednesday; it adds the provision that you can skip the Iowa 4562A if you have no pre-May 6, 2003 bonus depreciation, and it says that you can continue to decouple Iowa depreciation from federal bonus depreciation is you want to.

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'Republic of Texas' Again Pushes for Independence

February 24, 2005

The separatist Republic of Texas group, which largely dissolved after an abortive uprising in the Davis Mountains left several of its leaders dead or in prison in 1997, has reformed, and is again pushing its message that Texas should be a free and independent nation, 1200 WOAI news reported today.

Too late for Richard Simkanin, though. You remember him:

The judge recalled that Simkanin threatened to kill federal judges and that he surrendered his Texas driver's license but continued to drive with a homemade identification card...

While under investigation, Simkanin posted
a warning on his Web site that spoke of the
"fury of a fire" that would consume his
adversaries. He wrote to the treasury
secretary that he had repatriated himself
from the United States to the "Republic of
Texas."

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REFORM PANEL NOW TAKES ELECTRONIC COMMENTS (IF YOU USE MS WORD)

February 24, 2005

The President's Advisory Panel on Tax Reform has moved its comment-gathering process into the late 20th Century. The panel now will accept "Transmission by Email as a MS Word attachment to comments@taxreformpanel.gov."

They also say they will accept "Typewritten statements." We hope they don't really enforce the typewriter part.

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IMAGINE HOW MAD THE AUTHOR WOULD BE IF THE REVIEWER DIDN'T LIKE THE BOOK

February 23, 2005

David Cay Johnston works the tax beat for The New York Times. His stories have led to IRS and congressional action to shut down tax shelters; only Janet Novack of Forbes has done similar heavy lifting on the tax beat.

Mr. Johnston is the Times at its best: a smart and capable full-time specialist on an unglamorous beat that would hardly rate part time coverage from almost any other daily.

Mr. Johnston also seems to have some of the foibles of the Times culture: a thin skin, a touch of arrogance, and inability to admit even the possiblity of ideological slant.

Last February Sheldon D. Pollock, a Tax Professor, reviewed Mr. Johnston's book Perfectly Legal for Tax Analysts. The review found the book enjoyable and informative, but overly simplistic and ideological (go here for the full review text*). This paragraph gives the flavor:

If the reader can get past the hype in the subtitle and opening chapters (which publishers encourage because it sells books), there is to be found an important account of the IRS's declining state of health and its increasingly moribund capacity to enforce our tax laws. In that respect, Johnston's book is incredibly depressing to those of us who worry about the possible collapse of the income tax as the principal source of revenue of the federal government. If Perfectly Legal is infuriatingly simplistic in its political assumptions, it nevertheless makes a positive contribution to the public discourse over our troubled tax system. On top of that, it's fun to read.

Tax Analysts today - a year later - has a response from Mr. Johnston (click here for full text)*. It's an extraordinary, bitter document. I have excerpts and commentary below, but you should read the whole thing.

It starts:

Authors are wisely advised to ignore reviews, so when I
saw red after reading Prof. Sheldon D. Pollack's review
of my book Perfectly Legal I set it aside. A year has passed
and on rereading I am still steamed.

While praising my book, Prof. Pollack ignores important facts and in so doing builds a false case that I am motivated by ideology rather than facts garnered through nine years of pioneering work for which I won a Pulitzer Prize and was a Pulitzer finalist three other times.

Paraphrase: "I won a prize, and lost three others, so I can't be biased."

Taxation based on ability to pay -- progressive taxation --
and the birth of democracy are intertwined. Plato,
Aristotle, Adam Smith, Karl Marx, David Riccardo, John
Stuart Mill -- every classic worldly philosopher has
embraced that principle, which I show from official
government data no longer applies in the world's
longest-surviving democracy.

That sentence on the essence of democracy really would have been stronger without the "Karl Marx" part.

Mr. Johnston goes on to say that the review misses the "core finding" of his book, "that our tax system forces the middle and upper middle classes to subsidize the highest-income Americans." He provides two paragraphs of data to support his point. But rather than letting the argument do the talking, he goes after the reviewer:

Yet on those hard facts not a word from the professor, further evidence that he is either a careless reader or deliberately ignores inconvenient facts.

Paraphrase: "It's not a considered disagreement. My reviewer is either sloppy or dishonest."

Finally, the professor says I view Washington "through a simplistic political model. The rich control politics, big corporations and special interests dominate Washington. . . . "

I did not write that the rich "control." What I point out is
that most Americans never meet members of Congress
except for a handshake on the hustings, while what I
call the political donor class gets private meetings to
explain what they want from our lawmakers.

Every politician, I wrote, says donors cannot buy their
vote, and that all those campaign gifts buy is access. I
accept that. But when the only people who get
meaningful access are donors then their concerns are
at the forefront in Congress.

Paraphrase: "I didn't say the rich control the process; they just have their way with it."

Nowhere do I fault the rich for exercising their First Amendment right of petition. I specifically say they have every right to seek policies that favor them. I lay fault at the feet of the tens of millions of Americans who know the name of Jennifer Lopez's lover but not of their representative or senators. I call for Americans to put time into the work of being informed citizens instead of amusing themselves with trivia to the detriment of our wonderful nation. I also urge reform of how we finance campaigns.

Turn off that television, you lazy ignorant people! Study the Code!

There is a lot of other news in Perfectly Legal.
Appreciating it requires an open mind about our national
myth -- in the classical sense of that word -- that our
tax system is progressive.

Perfectly Legal uses hard facts to cut through that myth
and show how the system really operates. I wish Prof.
Pollack had read my work with care and then judged it
on whether the many new facts support a new
paradigm, rather than ignoring those facts and
retreating to the comfort of his ideological assumptions.

Paraphrase: "I'm not biased, you're biased!"

By the way, Perfectly Legal, a national bestseller, also won an award. It was chosen Investigative Book of the Year by the 5,000-member organization of my peers, Investigative Reporters and Editors (IRE). And instead of the usual paper certificate they gave it a medal.

Paraphrase: "And I won a Pulitzer! And I lost three others! So there."

It's a good thing the reviewer liked the book, or Mr. Johnston might have been angry.

For a calmer dissent from Mr. Pollack's review, read this* from Paul Streckfus. Interestingly, Mr. Streckfus doesn't seem to think that Mr. Pollack missed the point; instead, he thought Mr. Pollack was wrong to disagree with it:

Pollack also accuses Johnston of viewing the world "through a simplistic political model: The rich control politics, big corporations and special interests dominate Washington, and the political stooges of the wealthy and powerful write the tax code for the benefit of their masters." Simplistic maybe, but how does this view differ from reality? Has Pollack not watched the Republican Congress in action in recent years? And Democrats in their heyday were not much better when it came to pleasing their wealthy contributors.

*We thank Tax Analysts for permission to reproduce this copyrighted material.

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IOWA DEPARTMENT OF REVENUE AND FINANCE DRAFTS DEPRECIATION GUIDANCE

February 23, 2005

The Department of Revenue and Finance has put together draft guidance on the depreciation "catch-up" passed recently by the Iowa legislature. We understand that it is to be released in final form when the Governor signs HF 102.

The guidance notes that if you have already filed 2004 returns without catch-up 2003 depreciation, you will be able to catch up on the 2005 return.

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WHAT A GUY (AND WHAT A LAWYER)

February 23, 2005

Some guys just don't know when to let go. Take Stanley Baumann.

Mr. Baumann got in trouble with the IRS because he tried to deduct gambling losses against the income from his drywall business. Under the tax law, gambling losses can only offset gambling income.

Mr. Baumann also got into trouble with his wife, Tomi. The Tax Court gives a taste of why she might have been upset:

Tomi provided information and documents to substantiate that Stanley physically assaulted her numerous times, that Stanley had threatened Tomi’s life with a shotgun during the divorce action, that he had tried to burn their house while she and her children were inside, that he was charged with arson, that he was taken to a psychiatric hospital after he attempted suicide with a shotgun, and that he had threatened the life of her older son (from a previous marriage).

Remember, it's absence that makes the heart grow fonder - not arson.

The IRS decided that Tomi was an "innocent spouse," and therefore shouldn't be on the hook for the understatement of income on the joint return.

Attorney Frederick O'Laughlin had been representing the couple in their tax battle, but when the couple split, he had to pick sides. He sided with Stanley. Frederick filed in Tax Court to keep Tomi on the hook for the couple's taxes. He argued that Stanley wasn't given enough opportunity to fight the innocent spouse relief administratively.

What with the arson and suicide threats and beatings and all, the Tax Court sided with Tomi.

Cite: Baumann v. Commissioner, TC Memo 2005-31

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IRS MAKES A TAX SHELTER SETTLEMENT OFFER TO EXECUTIVES - CAN THEY REFUSE?

February 22, 2005

The IRS has issued a blanket settlement offer for a widely-sold tax shelter for corporate executives involving stock options.

The plan, which was sold by national accounting firms (most famously to Sprint executives), involves executives "selling" stock options to family partnerships using long term notes at bargain prices. Normally an executive recognizes salary income when a stock option is exercised, to the extent the value of the stock exceeds the exercise price. The shelter tried to shift the income to other family members, and to defer it over a period of up to 30 years.

The plan would require executives to pay all of the taxes on the options, but only half of the 20% penalty that the IRS would otherwise seek.

The IRS listed this transaction as "abusive" in Notice 2003-47.

The deadline for taking the offer is May 23, 2005.

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DR. MAULE, PLEIOTROPE?

February 22, 2005

The protean Professor Maule goes word-sleuthing in Subchapter S.

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BUT DO THEY OFFER FREE OIL CHANGES?

February 22, 2005

The IRS has a car for sale:

1967 Ferrari P4. Minimum auction price: $2 million

This 1967 Ferrari was seized from a Florda businessman, Walter Medlin, for nonpayment of federal taxes. Now it can be yours!

But you will probably need more than $2 million. From The Arizona Republic:

"Oh, it's worth much more than that," said Mike Sheehan, a Southern California resident and longtime Ferrari specialist, who valued the car at something closer to $10 million.

Apparently this is one of only three 1967 P4s in the world.

The IRS has decided to auction the vehicle, even though there are times that a pristine V-12 Ferrari with 450 horsepower and a top speed of 210 mph might come in handy for them.

If the Ferrari isn't for you, the IRS auto auction website also has this baby:

1994 Ford Econoline, 175,000 miles. Comes with tires.

Thanks to TaxGuru.net for the tip.

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WHITHER IOWA'S TAXES?

February 21, 2005

This legislative session has been bubbling with talk of tax changes. The Governor put the ball in play last year by proposing elimination of the Iowa deduction for federal taxes, coupled with a reduction in individual rates. Legislative response has ranged from the thoughtful (David Miller's comprehensive tax overhaul) to the impractical (the proposal to let border counties opt out of the income tax) to the risible (no taxes for the youngsters!).

Your author was interviewed last week by a reporter for The Des Moines Register on aspects of Iowa's tax system. We have no idea if or when her story will come out, or whether any of our interview will be in it, but we'll pass along some of the points we hope we got across. These are, of course, only Joe Kristan's points; my colleagues may or may not agree with any of them.

THE TAX SYSTEM EXISTS TO COLLECT TAXES.

With insights like that, you may be thinking that the interview didn't last long, but bear with me. It's evident that any attempt to get the tax system to do things besides funding the government makes it harder for taxpayers to comply and for the authroties to administer.

The tax system is used for many worthy causes. It's used to promote investment, to promote charities, to help state businesses, to lure businesses, and so on. Unfortunately, each tax break imposes a cost on every taxpayer; they make it harder to figure taxes out, and they increase the risk that others will use the complexity to game the system. This is important because

EVERY TAX BREAK IS PAID FOR BY OTHER TAXPAYERS.

Iowa doesn't get to run a deficit. If somebody gets a tax break, it means somebody else is paying more.

I used a little newsroom fable to try to make this point:

Reporter Bill goes to his editor for a raise because his car is old and he needs a new one. He has done a statistical study explaining how good it would be for the paper for him to have a car -- better stories, more circulation, and so on.

The editor feels his pain, but has no money in the budget for raises. He has an idea, though: he will reduce the state tax withholding from Reporter Bill's paycheck by enough to cover his car payments. He will make it up to the state by increasing the withholding from everyone else in the newsroom.

Just imagine how excited everyone in the newsroom will be to help Bill pay for his car - especially when the editor explains how it's for the good of the paper.

Targeted tax credits work much the same way as the Reporter Bill withholding system. Bill isn't necessarily a bad guy, and neither are people who use targeted tax credits. Still, you can't escape that they are getting others to pay taxes for them.

WE LOVE TO USE TAX CREDITS

Nothing is more fun in tax practice than figuring out a way to use an obscure tax credit to wipe out someone's liability. Our clients are worthy folks, and as long as the credits are out there, Roth & Company taxpayers are the most deserving folks we can imagine.

But Roth & Company clients, and everyone else, also deserve a tax system that's not a nightmare to figure out and comply with. If taxes can be made simple at low rates, Iowa's 19 economic development income tax credits won't be missed much. Nobody in South Dakota is promoting an income tax so they can use tax credits, as far as we know.

ARE MORE CREDITS WHAT WE NEED?

If 19 credits haven't made Iowa an economic juggernaut, it's still possible that a few more might just do the trick. But Charlie Brown thought the same thing about Lucy holding the football, and he hasn't kicked it yet. Maybe it's time to look at a different approach.

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IOWA DEPRECIATION SUMMARY

February 21, 2005

The Iowa Senate passed HF 102 last week to smooth over some of the depreciation confusion caused by last year's special session. While Governor Vilsack has not yet signed it into law, the combined House-Senate approval margin of 148-0 makes a veto unlikely.

WHAT THE SPECIAL SESSION DID LAST YEAR

The 2003 tax law made two big changes in federal depreciation rules:

-It increased the "bonus depreciation" rate to 50% for new assets placed in service after May 5, 2003, and

-it increased the maximum Section 179 deduction to $100,000. Section 179 allows taxpayers to deduct amounts paid for fixed assets that would otherwise have to be capitalized and deducted through depreciaton over a period of years.

Iowa originally declined to go along with these new rules. The special session last finally adopted the new rules, but by then most 2003 Iowa returns had already been filed without using the deductions. The Department of Revenue ruled (unwisely) that the only way to claim the increased deductions was to file amended returns.

WHAT THE NEW LAW DOES

The new law gives Iowans three options for catching up with depreciation:

1. File an amended 2003 return to claim the increased depreciation.
2. "Catch up" the 2003 depreciation on 2004 returns - saving you the headache of filing an extra 2003 return.
3. Continue to compute Iowa depreciation for 2003 asset purchases under the old rules (no bonus depreciation, $25,000 maximum 179 deduction).

WHAT THE BILL DOESN'T DO

The bill does not change the rules for bonus depreciation for assets placed in service before May 6, 2003. Federal bonus depreciation took effect September 11, 2001. Taxpayers must continue to maintain separate federal and Iowa depreciation schedules for assets placed in service from 9/11/2001 through May 5, 2003.

The bill also doesn't give exact procedures for claiming "catch-up" depreciation on 2004 returns. We believe the Department of Revenue will not be too fussy about how this is claimed; we will post any additional guidance they might issue.

The legislature gets some credit for a sensible fix before tax season got entirely away. Of course, they created the mess in the first place, but they fixed what they broke.

It would have been better to allow taxpayer to match up their Iowa depreciation back to 2001, but we can't wish for everything.

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PRESIDENT'S DAY CARNIVAL!

February 21, 2005

This week's Carnival of the Capitalists is up at The Raw Prawn. The Carnival is a weekly roundup of economics and business weblog posts. Much good stuff this week:

-Smart guy Arnold Kling forecasts the end of the newspaper.
-New tax blogger Russ Fox weighs in on state proposals for mileage taxes, in lieu of gas taxes.
-Des Moines blogger Brian Gongol honors President's Day by discussing whether a good LBO could have prevented the Civil War.
-Activist David Gross looks at avoiding taxes via voluntary low income.

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HAPPY PRESIDENT'S DAY!

February 21, 2005

And what better way is there to celebrate than to browse Presidential 1040s?

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WHAT DOES IT TAKE TO GET A REALLY LONG TAX SENTENCE?

February 19, 2005

It looks like Jeff Weakley has done about everything he can do to qualify for a long stay at Club Fed:

-He hasn't filed a tax return since 1985.
-He has helped manage a conspiracy to launder money and commit tax fraud via a "Warehouse Bank," enabling members to conduct anonymous cash transactions.
-The conspiracy mailed over $10 million in cash "wrapped in aluminum foil" as part of the conspiracy.
-He forged a family tree in a second-hand bible to get a false social secuirty number under an alias.

His sentence? 30 months in prison.

30-months in the federal can is no picnic, of course. Still -- a vast conspiracy of money laundering and tax evasion would seem to rate at least as long a prison term as Sudafed smuggling.

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DEPARTMENT OF REVENUE: ART PATRON?

February 18, 2005

Four Iowa Senators have proposed perhaps the greatest gift ever to our state's starving artist community. Their gift comes in the form of SF 132,

  An Act providing an individual income tax credit for charitable
      contributions of fine art or written materials made by the
      artist or author and including retroactive applicability date
      provisions.

As a credit, this would provide a dollar-for-dollar reduction in Iowa taxes for the "fair market value" of the artwork, based on "appraised value of the fine art or written materials as established pursuant to requirements set by rules adopted by the director." This means that artists and authors could pay their Iowa income tax by donating their own artwork to charity.

As only authors and artists are truly qualified to judge literature and art, the "rules adopted" would have our state's authors and artists deciding each others tax liabilities. Given the humanity and generosity of the artistic community, the effect on their tax liabilities would be just dandy.

In the age of the internet, everyone's an author and everyone's an artist. Upon the (unlikely) enactment of SF 132, I plan to scam the state make a generous contribution of an original digital artwork, "Tacks Shelter, Volume 2." It is an ironic and iconic view of the tax system, and I'm sure it's worth just an incredible amount of money. Behold:

Tacks Shelter, Volume 2. Copyright Joe Kristan, All Tax Credits Reserved

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TAXPROF HAS RABYS (ON SWAPS)

February 18, 2005

No, he's not frothing at the mouth. The TaxProf pulls a discussion of Section 1031 by Burgess Raby and William Raby from behind the Tax Analysts subscriber firewall today. The Rabys walk through the Tax Court's recent Teruya opinion on related-party like-kind exchanges. We discussed the opinion here.

From the Rabys' conclusion:

Section 1031 exchanges between related parties are permitted, but
the tax practitioner needs to think through the details to avoid
unexpected consequences. The lesson of the Teruya opinion is that if the effect of what happened in a multiparty exchange is the same as if an exchange had occurred between related parties, the mere fact that unrelated parties were involved, especially when involved as qualified intermediaries, will not change the outcome.

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BEATING A DEAD HORSE

February 17, 2005

The tax law frowns on subsidizing hobbies via tax deductions. Section 183, known as the "hobby loss" rule, prohibits taxpayers from deducting losses from activities "not engaged for profit." But how can you tell whether somebody really doesn't expect to make money from something?

Sometimes it's easy, actually. Consider the loss record from a dentist's horse breeding venture:

Tax Court Judge Laro was unsympathetic from the start of his opinion:

This is yet another case of a high-salaried taxpayer
claiming that she may reduce the income taxes payable on her
salary by deducting losses incurred in a pastime that is
allegedly engaged in for profit.

If the financial results weren't bad enough,

We also note that petitioner throughout her
testimony repeatedly referred to her horses as her “babies” and
opted not to dispose of her “babies” even when they were aged,
unable to breed, expensive to maintain, and/or unprofitable.

THE MORAL: If you are trying to avoid hobby loss treatment, don't lose money every year, and never call your horses your "babies" in front of the judge.

Cite: Giles v. Commissioner, T.C. Memo. 2005-28.

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MARCH 2005 APPLICABLE FEDERAL RATES (AFRs) ARE OUT

February 17, 2005

The IRS has issued (Rev. Rul. 2005-13) the minimum interest rates for loans made in March 2005:

-Short Term (demand loans and loans with terms of up to 3 years): 3.08%
-Mid-Term (loans from 3-9 years): 3.83%
-Long-Term (over 9 years): 4.52%

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

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SENATE PASSES DEPRECIATION CATCH-UP

February 17, 2005

The Iowa Senate passes HF 102! 49-1. Now it's up to the Governor.

UPDATE: The Legislature's web site now shows the vote has 49-0.

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CATCH-UP DEPRECIATION: IS TODAY THE DAY?

February 17, 2005

The depreciation catch-up bill (HF 102) is on the agenda for debate today in the Iowa Senate. The Tsumami deduction bill is also up for debate. Stay tuned.

Update: Done.

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TIMING IS EVERYTHING

February 17, 2005

On February 9, Treasury Secretary snow send Carly Fiorina a nice letter, reproduced by Tax Analysts:

February 9, 2005

Ms. Carleton S. Fiorina
Chairman and CEO
Hewlett-Packard Company
3000 Hanover Street
Palo Alto, CA 94304

Dear Carly:

Thank you for your kind letter. I appreciated the opportunity to discuss President Bush's economic plan with you.

As you know, the President strongly supported repeal of the extraterritorial income exclusion as part of a package of changes to our tax laws that increase the competitiveness of American manufacturers and other job creating sectors of the U.S. economy. The Treasury Department worked closely with Congress to enact the needed changes. The input of the business community was vital in this endeavor. I look forward to continuing to work with you in our ongoing efforts to enhance the competitive position of U.S. workers and businesses operating in today's global marketplace.

                                          Sincerely,


                                          John W. Snow

It no doubt made her day:

Wed Feb 9, 5:04 PM ET

Carly Fiorina has stepped down as chairman and chief executive of Hewlett-Packard, effective immediately.

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INCREASE IN FICA CAP? COUNT ON IT.

February 17, 2005

The President has said he won't rule out increasing the amount of salary and self-employment income subject to self-employment tax. This almost guarantees that any Social Security reforms will include a singificant increase in the FICA base (currently $90,000).

Whether this will be enough to move Congress from converting social security from an entirely unfunded transfer payment system to something resembling a funded retirement plan remains unclear.

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'FUNDAMENTAL REFORM'? DON'T GO THERE, SAY WITNESSES

February 17, 2005

The first round of witnesses at the president's tax reform panel said that "fundamental" tax reform just isn't going to happen. From today's report by Tax Analysts:

"The notion that we should scrap the code is a waste of time," said the panel's first witness, former IRS Commissioner Fred T. Goldberg Jr. "You shouldn't bother thinking about it." Once the panel takes into consideration the limitations Bush has put on reform to come up with revenue-neutral options that retain benefits for encouraging home buying and charitable giving, "you've got an income tax."

If you don't tear the plant up by the roots, said Goldberg, you better plan to keep trimming it:

"If we cut the shrubbery it's going to grow back," Goldberg said of the current code. Tinkering with the current system would produce a solution that will last about 10 to 15 years before reverting to a complicated mess, Goldberg said, while radical sector-based reform would add about 10 more years.

Some witnesses proposed simplifying the income tax and supplementing it with a value-added tax (yuk).

An abbreviated free version of the Tax Analyst's story is here. The TaxProf has all of the official statements (and witness Powerpoint presentations!) linked here.

The panel next meets March 3. We can only hope C-span will cover it this time. Must-see TV!

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WHAT 29 WANTS, 29 GETS

February 16, 2005

The enigmatic State 29 asked awhile back

Do you know of any insurance blogs out there?

Today we received the following e-mail (it was stuck in our spam filter for a couple of days):

Good morning!

A friend of mine pointed me to this item on your blog:

"The mysterious State29 has a puzzler:

   Do you know of any insurance blogs out there?
   I've Googled and found practically nothing.  It was either
   people complaining about particular insurance
   companies or obvious dead ends.
   Considering all the lawyers and accountants with blogs
   you'd think there would be at least a couple of good
   insurance bloggers."

FWIW, my blog is 99.9% original content, and there are precious few "profit center" links:

http://insureblog.blogspot.com/

And the friend who pointed me to your site has also started up a blog, which
has a little more industry-news-related content:

http://HealthInsurance411.net

Thanx for your time, and Happy Valentine's Day!

Henry Stern, LUTCF

So there you go! Another tribute to the blogical powers of State 29, scourge of the Iowa deer herd!

UPDATE!!!!! 29's also a bankruptcy specialist!

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WHAT, ME HURRY?

February 16, 2005

Returns held hostage by Iowa Senate, Day 14. Today's Iowa Senate action:

The Senate convened at 8:34 a.m.

The Journal was approved.

The Senate adjourned at 8:39 a.m. until 8:30 a.m. Thursday, February 17, 2005.

February 22 marks the tax season midpoint. No hurry, guys.

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TAX REFORM PANEL CONVENES TODAY...

February 16, 2005

...but they aren't on the C-Span TV schedule. So we got all that popcorn for nothing.

The list of today's witnesses is here.

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TSUNAMI, SALES TAX DEDUCTIONS ADVANCE AT STATEHOUSE

February 16, 2005

The Iowa House has passed a "code conformity" bill (HF 186) that would give Iowans the ability to deduct January 2005 Tsunami relief contributons on their 2004 Iowa returns. This would allow Iowans to take the same Tsumani deductions on both their federal and Iowa income tax returns.

The bill also gives Iowans the ability to deduct sales taxes in lieu of state income taxes on their state tax returns. This deduction would only be available if you also used the sales tax deduction on your federal returns.

The Senate has already passed a version of Tsunami relief, and this bill is expected to be noncontroversial, when they get around to it.

The depreciation catch-up bill still awaits action.

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YOU MAY ALREADY HAVE WON!

February 16, 2005

Great find from the BenefitsBlog:

Did you know that the Social Security Administration keeps a database of individuals who have been identified by the Internal Revenue Service as having qualified for pension benefits under private retirement plans? The database is maintained by SSA pursuant to the requirements of ERISA. You can access information about the database here.

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ACTION ON IOWA 'CATCH-UP' DEPRECIATION?

February 15, 2005

Not today. Today's Senate floor action, in full:

The Senate convened at 8:33 a.m.

The Journal was approved.

House messages received: HF 186, HF 216, HF 227, and HF 253

The Senate adjourned at 8:39 a.m. until 8:30 a.m. Wednesday, February 16, 2005.

The 2004 tax returns for businesses with 2003 depreciation and Section 179 deductions will wait another day, at least.

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MIKE NELSON - LAWGIVER

February 15, 2005

Michel Nelson works in the Trust Department for Iowa Savings Bank in Carroll, Iowa. In his spare time he writes tax proposals for the administration.

In this article Mike called for action against arrangments where charities set up, in effect, "dead pools" using life insurance policies on large numbers of individuals. The charities and the insureds get a small cut of the death benefits, with promoters receiving a pool of insurance policies that they can sell or hold as an investment. Mike disapproves:

Permitting evasion of the essential protection provided by insurable interest requirements through the device of a perfunctory pass through a charitable entity, is bad for the life insurance community, its existing policy holders, and the public in general. It is better to bring these plans to an end now rather than be "Spitzerized" later.

The Administration springs into action on Mike's cue; the fiscal 2006 federal budget (page 116) imposes a 25% excise tax on life insuarnce benefits if a charity and a third party have ever owned the policy. This would take effect for policies issued after February 7, 2005:

The Treasury Department has learned of arrangements involving life insurance contracts in which both charities and non-charities have an interest. In these arrangements, a participating charity typically has an insurable interest in the insured individuals, who are also donors to the charity. The non-charity participant or participants have no relationship to the insured, except by reason of this arrangement. The Treasury Department is concerned that, in many cases, such arrangements do more to facilitate investment by private investors in life insurance contracts than to further a charity's exempt purposes. Moreover, these arrangements may inappropriately afford benefits to private investors that would not otherwise be available without the charity's involvement.

The February 7 effective date should just about end sales of these deals until either the provision is enacted or the dead pool industry succeeds in killing it.

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WORKIN' LIKE DEMONS, THEY ARE!

February 14, 2005

Today's Iowa Senate floor action, in full:

The Senate convened at 1:05 p.m.

The Journal was approved.

The Senate recessed at 1:20 p.m. for a Rules & Admin. meeting.

The Senate reconvened at 1:23 p.m.

SR 8 – by Iverson, et al.

Honoring Sen. Larson & 372nd Engineer Group

SR 8 – Adopted, voice vote

SR 9 – by Iverson

Honoring 132nd Fighter Wing of Iowa Air National Guard

SR 9 – Adopted, voice vote

The Senate adjourned at 1:30 p.m. until 8:30 a.m. Tuesday, February 15, 2005.

Yep, they must be plum tuckered out. Well, it won't hurt to make all those tax returns wait another day...

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HR Blogging

February 14, 2005

B. Janell Grenier, of BenefitsBlog fame, is now also posting on an H.R. related group blog with the chewy name "The Greater Valley Forge HR Law Link." Like the continuing BenefitsBlog, it has lots of good stuff. Lord knows that Valley Forge is no stranger to Human Resources issues.

George Washington discusses complaints about the mule meat being served in the cafeteria with his HR Director.

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ROMANCE FOR CAPITALISTS

February 14, 2005

For those of us who get misty-eyed at the demise of the 30-year bond, romance awaits at the Carnival of the Capitalists, hosted this week at Weekend Pundit. The Carnival is a weekly roundup of economics and business related blog posts.

The many worthwhile posts include economist Arnold Kling on weighing risks of reforming (or not reforming) Social Security, and Iowa's own Brian Gongol on the use of taxes in "Regulating Tastes and Preferences."

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WHAT THE LEGISLATURE IS UP TO

February 14, 2005

Here's your one-stop update on the tax doings of Iowa's elected wise ones.

BILLS THAT SHOULD BE IN A HURRY, BUT AREN'T

TSUNAMI: The Senate last week passed the bill (SF 76) to give Iowans the same 2004 deduction for Tsunami relief donations made in January 2005 allowed for federal taxes. The House version of this bill (HF 70) languishes in the Ways and Means Committee.

DEPRECIATION: The bill (HF 102) to allow Iowans to "catch up" their 2003 "bonus" depreciation and Section 179 deduction has passed the House entirely and has cleared the Senate Ways and Means Committee. The bill has been gathering dust on the floor of the Senate for nearly two weeks now. Hundreds of tax returns around the state are stalled pending passage of this bill. Maybe they have something more important to work on.

They reconvene this afternoon; let's hope they move things along.

(UPDATE: Not today!)

BILLS THAT ARE INTERESTING

Senator David Miller has proposed a sweeping overhaul of Iowa's tax system - property, income and sales taxes. He would expand the sales tax base to include groceries, change Iowa's individual income tax base to federal adjusted gross income, and redo the property tax base. Perhaps most boldly, he would repeal Iowa's corporate income tax.

Iowa's corporate tax makes no sense. Its 12% rate is only tolerable for Iowa corporations because single factor apportionment based on sales eliminates 90% or more of taxable income from the tax base for decent-sized Iowa C corporations. The Iowa tax primarily ensnares non-Iowa corporations that make the mistake of creating taxable nexus here, or who can't avoid doing so for other reasons (say, they have to use I-80 for their trucks). All in all, corporate income taxes netted $144 million in revenue for Iowa in fiscal year 2003 - 1.7% of an $8.26 billion revenue base.

In real life, the corporate tax is mostly a plaything for the state's economic development department, giving them a frame to hang Iowa's 19 economic development credits. It it would be better for economic development to have no corporate tax than our byzantine high-rate tax with lots of loopholes.

David Brunori of Tax Analysts specializes in state and local taxes. He is certainly not a "small government" kind of guy, but he has concluded that state corporate income taxes just don't work:

I am no fan of the state corporate income tax. Not because I think corporations should not pay taxes, but because I don't think the states can effectively and efficiently levy a tax on corporate income.

BILLS THAT ARE DYING A DESERVED DEATH

We have noted the proposal to exempt Iowans under 30 from personal income taxes. We have not commented on another proposal to freeze property taxes for those over 65. Both proposals appear doomed. Those of us left in the middle who would otherwise pick up the slack can breath a small sigh of relief.

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ON THE COVER OF THE ROLLING STONE - TAX PROF EDITION

February 12, 2005

The TaxProf Blog today shines his "Spotlight" on Drake University professor Martin Begleiter. The post shows that our local U. has some true tax academic firepower:

Marty is currently at work on drafting the 7th edition of Scoles, Halbach, Roberts and Begleiter, Problems and Materials on Decedents’ Estates and Trusts (Aspen, forthcoming 2006), of which he was recently named a co-author. Following the publication of the new edition of the book, he intends to update his 2001 Drake Law Review article on the Iowa Trust Code to review amendments to the Code and developing case law. He also intends to return to one of his early interests: the guardian ad litem and virtual representation. In 1984, Marty authored what is generally considered the primary work on the role of the guardian ad litem. With the increase in the use of virtual representation in the new trust codes, he wants to return to the area to explore the issues raised by the use of virtual representation to confer jurisdiction and the dangers of potential conflicts of interests.

The TaxProf profiles a tax professor each week. We assume Jim Monroe must also be on the target list, if only for his famous private clients.

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TAX REFORM PANEL STILL WORKING ON THIS 'INTERNET' THINGIE

February 10, 2005

The President's Tax Reform Panel launched a website today and announced the witnesses for its first meeting. The witnesses are all familiar names in the tax policy world, which makes it unlikely that they will, for example, say that the income tax is already unconstitutional because federal reserve notes are not backed by specie.

The comment section of the site, reproduced below, seems a bit, well, analog...

None of this newfangled e-mail or web submission stuff, thank you very much!

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KEEPING IT CLEAN, HONDA-STYLE

February 10, 2005

The IRS has certified the 2005 Honda Insight, Honda Civic Hybrid, and Honda Accord Hybrid as eligible for the clean-fuel 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.

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TAXABLE TALK, A CALIFORNIA-BASED TAX BLOG, DEBUTS

February 10, 2005

Russ Fox, of Clayton Financial and Tax of Orange County, CA, has launched a new blog, Taxable Talk. He explains:

After reading Hugh Hewitt's Blog, starting a blog for Clayton Financial and Tax became a necessity, not a project for "tomorrow" (whenever that is). There are already some excellent blogs covering taxes (see the blogroll on the right--if yours isn't included, email me a link and I'll add it on), but only the Leonard Letter looks at taxes from a California perspective. My goal is to focus on taxes and how they impact what we, as citizens and taxpayers, get to keep in our pockets.

Welcome to the little tax blogospere, Russ! We'll get you on the blogroll shortly.

Coincidentally, we were in Orange County just this week. It looks like this:

A view of Newport Beach, 2-8-2005

Compare and contrast:

Back home in Des Moines, 2-10-2005

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SECTION 1031 BASICS

February 10, 2005

Yesterday's post on the Teruya Brothers case omitted many details of the workings of Section 1031 in the interests of brevity (ok, maybe "less excessive length" is more accurate).

Some basics about Section 1031:

Large classes of property can never qualify for a Section 1031 like-kind exchange. These include:

-Inventory
-Stocks, bonds, notes, indebtedness, or other securities
-Partnership interests
-Choses in action
-Interests in trusts.

WHAT IS "LIKE-KIND?" In general, real estate is like-kind to other real estate. For example, a farm is like-kind to an apartment building. Personal property is more complicated. Two items are generally like-kind if they are in the same "general asset class" of Rev. Proc. 87-56, or if they are in the same 4-digit "product class" of Division D ("Manufacturing") of the Federal listing of Standard Industrial Codes.

But beware: livestock of different sexes are never "like-kind."

PERSONAL-USE PROPERTY DOES NOT QUALIFY. You can exchange any "like-kind" property that has been "held for investment" or for "use in a trade or business" for other "like-kind" property that will be held for investment or use in a trade or business. You can't get like-kind exchange treatment for your refrigererator, no matter how valuable it has become.

DON'T TRY THIS AT HOME! There are any number of foot-faults that can cause a like-kind exchange to fail. It is a technical area, especially when escrows or intermediaries are involved.

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A LIKE-KIND EXCHANGE DISASTER (RELATIVELY SPEAKING)

February 09, 2005

A frequent theme of the Tax Update is the danger of engaging in tax relationships with related parties.

Teruya Brothers, LTD is a Hawaii real estate developer. When the time came to sell two choice properties for around $13 million, Teruya Brothers decided to use a Section 1031 like-kind exchange to avoid the tax.

Unfortunately, they got a subsidiary involved. The result: a $4 million tax bill.

HOW THEY TRIED TO USE SECTION 1031

Section 1031 is designed to let taxpayers swap "like-kind" property without paying current tax; gain is deferred by carrying the "basis," or cost, of the property given up to the property received in the swap. This defers the gain until the property received in the swap is someday sold.

Over the years the tax law has made it easier to have what looks like a sale be treated as a section 1031 swap. The law allows taxpayers to park cash with an intermediary when a property is sold. If the seller can identify a replacement property within 45 days of a sale, and the intermediary can close on it within 180 days, the transfer of the property from the intermediary to the seller can be treated as a Section 1031 swap. (We generalize here - don't do this at home.)

THE TROUBLE WITH RELATED PARTIES

The section 1031 rules say that if you swap with a related party, and the related party sells your old property within two years, the transaction is disqualified from the benefits of section 1031 treatment.

WHERE TURUYA BROTHERS STUMBLED

When Teruya Brothers sold the Royal Towers Apartments and the Ocean Vista Condominiums in 1996, it had the proceeds deposited with a qualified intermediary. The intermediary acquired the replacement property from Times Super Market, a Hawaii grocery chain; the intermediary then transferred the replacement property to Teruya Brothers, all in compliance with the 45-day and 180-day limits.

There was only problem: Teruya Brothers owned 62.5% of Times Super Market.

What's the problem, you might ask? After all, if you swap with an unrelated intermediary, why would you care where the intermediary got the property?

Unfortunately for Teruya Brothers, the IRS has for some time taken the position this fact pattern is taxed as

1. An exchange between the Teruya Brothers and Times Super Market, followed by

2. A sale to the third party by Times Super Market.

In other words, the related party -- not the intermediary -- is considered the other party in the swap. Looked at this way, the sale is disqualified because the related party has sold the property acquired in the swap within two years - in fact, it sold it immediately.

The Tax Court today said the IRS position is correct.

LESSONS FROM THE TAX COURT

Teruya Brothers said that they should still qualify for tax-free treatment because the deal wasn't primarily for tax avoidance. If today's decision is upheld on appeal, it will pretty much ratify the IRS view that you can't sell to a third party through an intermediary and use the proceeds to acquire replacement property from a related party.

Cite: Teruya Brothers and Subsidiaries v. Commissioner, 124 T.C. No. 4.

Royal Towers Apartments, Salt Lake, HI

UPDATE: More on the basics of Section 1031 here.

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WHISTLE A FARRAGO

February 09, 2005

Quote of the day:

Petitioner filed a timely petition in which he sets out a farrago of nonsense as to why the notice of deficiency is invalid and he does not owe the tax determined.

-Tax Court Special Trial Powell, foreshadowing a defeat for petitioner today in Whistle B. Currier v. Commissioner, T.C. Memo 2005-21.

The case is the usual tax protestor nonsense, notable only for a $2,000 penalty for frivolous arguments, and for using "farrago":

farrago

/fraago/

• noun (pl. farragos or US farragoes) a confused mixture.

— ORIGIN Latin, ‘mixed fodder’, from far ‘corn’.

(Oxford Compact English Dictionary)

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MORE ON 'EXTRAORDINARY' OFFICE BUILDINGS

February 09, 2005

The Tax Prof today pulls an analysis of Assaf v. Commissioner by Raby and Raby from behind the Tax Analysts subscriber firewall. The article talks about some of the passive loss issues we addressed here. It also addresses rental activities and "excess passive income" rules that apply to some S corporations.

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PAY MORE TAX? IT'S NOT 'RESPONSIBLE'!

February 08, 2005

Members of the group "Responsible Wealth" think their taxes are too low. They held a press conference in Washington yesterday to call on Americans to reject their tax cuts. They feel the work of the government is so important that you should take your tax cut and return it to the Bureau of the Public Debt.

Oh, our mistake. They want you "take the pledge" to use your windfall to fund non-governmental charities. They even provide a helpful list of charities, a list that leans to the "progressive" side.

Whether or not they realize it, the "Responsible Wealth" folks are paying unintended tribute to the tax cuts. By saying you should send your tax cuts to private charities, they also say that you can make better decisions than the government about where your wealth goes. We can assume that's not their point.

Their web site has a handy tax savings calculator to help you determine how much you have have saved from the Bush tax cuts; this way you know exactly how much of your money to... not send to the government!

Thanks to Tax Analysts for the pointer.


Heleny Cook, member of group that says you shouldn't send your money to the government

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OFFICER DOWN

February 07, 2005

Cop Talk has closed up shop. There's nothing else like it. We'll miss it.

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QUOTE OF THE DAY

February 07, 2005

"It must be remembered, however, that an ant has a very limited brain, even more limited than a college student, impossible though that sometimes seems."

Gordon Tullock, The Economics of Non-Human Societies, page 36.

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MARDI GRAS OF THE CAPITALISTS

February 07, 2005

The Carnival of the Capitalists for this Mardi Gras week is up at Catallarchy. The Carnival is a weekly roundup of economics and business blogs.

Two posts should be read together: one covers "a new type of marketing in which consumers and product enthusiasts can participate," and one covers some dangers that may arise when "raving fans" let their enthusiasm run amok.

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MORE ON WHY YOUR SIBLING ISN'T YOUR RELATIVE

February 03, 2005

The TaxProf has yanked another good piece from behind the Tax Analysts copyright firewall. "Stock Ownership Attribution and Siblings" is an in-depth discussion of the Garber Industries case that we discussed Monday.

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STATE OF THE SEARCHLIGHT

February 03, 2005

Tax reform seems to be taking a back seat to Social Security on the Presidents agenda. The State of the Union address spent 10 minutes on Social Security and about one minute on tax reform.

Senate Minority Leader Harry Reid responded for the Democrats. He repeatedly invoked his hometown of Searchlight, Nevada. It appears he even has written a history of his hometown (currently #471,987 on the Amazon bestseller list).

In addition to its place in Senate history, the Senator's hometown has its own little niche in the tax law -- but from a book not written by the Senator.

SOME DEDUCTIONS ARE JUST TOO PERSONAL

Ralph Vitale was a technical writer for the U.S. Treasury, but he harbored greater literary ambitions. He decided his Great American Novel would be "a story about the experiences of two men who travel cross-country to patronize a legel brothel in Nevada."

A stickler for verisimilitude, Mr. Vitale incurred significant "research" expenses. As a good Treasury employee, he attempted to comply faithfully with Section 274, recording the time, the other party, and the business purpose of his expenses. The result was "Searchlight, Nevada" (currently # 2,217,075 in the Amazon bestseller list).

The IRS tried to disallow all of Mr. Vitale's expenses on "hobby loss" grounds. The Tax Court decided that Mr. Vitale was genuinely seeking to profit from the book. The court drew the line at the "interview" expenses at the brothel:

However, no deduction is allowed for the interview expenses. We find that the expenditures incurred by petitioner to visit prostitutes are so personal in nature as to preclude their deductibility. In evaluating whether certain expenses are personal or qualify as business expenses under section 162, the Court has found that some expenses are so "inherently personal" that they almost invariably are held to come within the ambit of section 262.

Cite: Vitale v. Commisioner, T.C. Memo. 1999-131.

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EACH DEFEAT BRINGS US CLOSER TO VICTORY!

February 03, 2005

The "Tax Honesty" folks, also known as tax protestors, have chosen an unenviable lot. They continue to argue against the very existence of the tax law in the face abundant contrary evidence from judges, juries, federal marshals and prison wardens.

Their thirst for scraps of evidence to support their worldview enables them to find hope in the oddest places -- including court decisions that they lose.

Robert Schulz is affiliated with "We The People," a "Tax Honesty" group. The IRS servied him with summons seeking documentation. Schulz hied to a New York District Court to quash the summonses. The Court turned him down, saying that he had to wait until the IRS went to court to enforce the summons. He appealed, and the Second Circuit turned him down again.

Mr. Schulz, in the face of serial courtroom defeats, declared victory:

The court has expressly recognized that the IRS, as has been asserted in the right-to-petition lawsuit, routinely violates people's due process rights in their day-to-day administrative practices.

Well, no. The judge just said that Mr. Schulz had no grounds to fight the summons in court until the IRS tries to enforce it in court. As the decision says:

The IRS has not initiated any enforcement procedure against Schulz and, therefore, what amount to requests do not threaten any injury to Schulz. Of course, if the IRS should, at a later time, seek to enforce these summonses, then the procedures set forth in § 7604(b) will afford Schulz ample opportunity to seek protection from the federal courts.

Mr. Schulz's spin was picked up and distributed by the World Net Daily internet news service; Schulz trumpeted his defeat as a victory in a quixotic and doomed anti-tax class action lawsuit that tax protestors always seem to be pursuing.

In the immortal words of Monty Python's Black Knight, 'tis just a flesh wound!

In real life, the IRS will eventually get around to enforcing the summons in court. It's safe to predict that he will lose and again declare victory.

Link to case: Robert L. Schulz v. IRS, CA-2 (1-25-05) (Note: link seems to be working erratically).

(Hat Tip: Taxguru.net)

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IOWA BONUS DEPRECIATION CATCH-UP BILL HEADS TO SENATE VOTE

February 02, 2005

The Senate Ways and Means Committee has approved HF 102, the bill that would allow Iowa taxpayers to "catch-up" their allowable 2003 "bonus" depreciation and Sec. 179 deductions on their 2004 returns.

The bill now goes to the full Senate for final vote. It was passed by the Iowa House January 25, 99-0.

Governor Vilsack's office has not taken a position on the bill, as far as we know. An aide to Governor Vilsack had said they were waiting to see whether there were any amendments before taking a position. It appears that the Senate Ways and Means Committee approved the House language without change.

Without the bill, the Department or Revenue would require taxpayers to amend 2003 returns to take the extra deductions. The deductions were originally enacted in last September's special session, after most 2003 Iowa returns were filed.

Click here for prior Tax Update coverage of this issue.

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GET TO WORK, KID

February 02, 2005

Every businessman knows how hard it can be to find good help. Jeffrey Dumond faced this problem with his Des Moines vending machine service business. Fortunately, he was able to find two employees whose background he knew intimately.

Unfortunately, the IRS didn't buy in. In a Tax Court decision handed down Monday, Mr. Dumond's employee deductions were disallowed. What's more, he was slapped with negligence penalties for claiming the deductions.

Well, maybe it didn't help that one of the employees was 5 years old. The other was ten. And they were his children.

From the decision:

Petitioner testified that the services provided by his children included: Riding along on the weekly routes to the vending machines, putting candy bars into the machines, sorting the totes full of candy, breaking down the cardboard and sorting out the recyclable products of waste produced by the business. The older child also helped with counting money. Petitioner testified that his children worked approximately 10 hours per week. Petitioner admitted, however, that he did not know for sure how often his children worked every week and that he did not keep any record of their hours.

It also didn't help that there was no set pay scale for the kids, or that he deposited their "paychecks" into his own bank account.

Bottom line: $2,520 in additional tax and $504 in penalties.

THE LAW: Mr. Dumond told the judge that he paid the kids what the “law allowed for, so that they [his children] would not have to file taxes." It's not so. There is no freebie deduction for salaries paid to kids.

THE MORAL: The red-face test is a good guide to paying salaries for your kid. It's hard to say even the most precocious 5 year-old is ready for the work force without blushing. If you pay your kids, make sure they're doing real jobs, and treat them like real employees.

Cite: Dumond v. Commisioner, T.C. Summary Opinion 2005-11.

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BASIS CHEATING: A DISSENT

February 01, 2005

Study says basis cheating costs Treasury $29 billion annually.

TaxGuru.net demurs.

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FULL-SERVICE OFFICE FACILITIES FOR LAWYERS? EXTRAORDINARY!

February 01, 2005

The Tax Court issued a rare taxpayer victory in a "passive loss" case yesterday, siding with the taxpayers in a case involving a busy part-time law instructor.

Rehab Assaf is an attorney in Oklahoma City. She is also a bit of an entrepreneur. She teaches at the Oklahoma City University Law School and owns an office building with her husband. The building is held in a partnership: AGI Consulting, LLC. AGI offers a ready-made law office setup for solo attorneys:

AGI employed an office staff consisting of at least three clerical support personnel to provide legal support services. Services included client intake, answering phones, taking messages, filing documents at the courthouse and State capitol, process serving, express mailing, binding briefs, conducting legal research, typing briefs and legal memoranda, taking dictation, managing a file room, and photocopying. AGI also maintained an updated law library and conference facilities for its tenants. AGI provided other services including a security service, trash removal, janitorial services, coffee service, and general utilities. AGI owned the office equipment it leased to the law firm and “nine or ten” other tenant attorneys.

AGI had losses of about $34,000 in 1999 and 2000. The IRS said the losses were "passive." Under rules enacted in 1986 "passive" losses can only offset passive income, unless the "passive activity" (great oxymoron) is disposed of.

The status of most businesses as "passive" or "non-passive" is based on the time spent in the business by the taxpayer. If you "materially participate" in an activity, it is not passive. Material participation" is usually based on whether you spend 500 hours in the activity.

Real estate is different. Real estate income is usually treated as passive no matter how much time is spent on the business. (click "Read more" at the bottom of this post if you want to subject yourself to more details on this)

An exception applies if the real estate is rented in conjunction with "extraordinary personal services"; tax regulations cite hospital rooms as an example.

Arguing for herself, Ms. Assaf convinced the court that these services met the test for "extraordinary":

Witnesses for petitioners testified that AGI’s services to its tenants were unique in the area close to the courthouse, and that they would not have moved onto the premises if the support services were not provided. We find of particular significance that AGI performed legal research for its attorney-tenants. Overall, testimony established that the services were the crucial determinant in attorneys’ choosing to lease from AGI, and we found the testimony on behalf of petitioners credible and compelling. We therefore find the payments to AGI were principally for the services provided and not for the space leased.
(Emphasis added; citation omitted).

Once the court ruled that the services were "extraordinary," Ms. Assaf still had to convince the court that she "materially participated" in the business. This meant she had to convince the court that she spent 500 hours in the business each year to escape passive treatment.

The Tax Court can be hard to persuade on this score, but Ms. Assaf was up to the job:

Although this Court has not always accepted a post-event narrative of participation, we find petitioner wife’s description of her participation, when combined with witness testimony and the objective evidence in the record, to be credible, and we therefore conclude that petitioner wife materially participated in the activity by participating for more than 500 hours during the year.

The Moral? If you provide serious business services with your lease space, you may not have a "passive activity."

Cite: Assaf v. Commissioner, T.C. Memo 2005-14.

UPDATE: More here from Raby and Raby on Assaf and related issues.

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