Tax Update Blog: May 2005 Archives

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HANG 'EM FIRST, AND LET THEM SORT IT OUT ON APPEAL

May 31, 2005

Supreme Court overturns Arthur Andersen Conviction

WASHINGTON (AP) -- The Supreme Court on Tuesday overturned the conviction of the Arthur Andersen accounting firm for destroying Enron Corp.-related documents before the energy giant's collapse.

In a unanimous opinion, justices said the former Big Five accounting firm's June 2002 obstruction-of-justice conviction -- which virtually destroyed Andersen -- was improper. The decision said jury instructions at trial were too vague and broad for jurors to determine correctly whether Andersen obstructed justice.

Corpses always like to win on appeal.

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TAX PROFESSORS KNOW HOW TO SPEND A THREE DAY WEEKEND

May 31, 2005

Professor Maule spent part of his weekend writing a 1900-word essay on the Section 199 deduction and how it affects Costco's in-store bakeries:

The example in the legislative history is, as the Costco letter points out, ambiguous and confusing. Does it mean that all receipts from the sale of products produced by the in-store bakery are ineligible? Does it mean that the receipts should be allocated between those arising from sales to retail customers and those sold to, for example, restaurants for re-sale? Does it mean that receipts from items that undergo additional processing qualify, such as sliced bread used by the bakery to make sandwiches sold to customers? Costco's letter notes that a fourth interpretation exists, because one could argue that even a cake prepared by the bakery is not ready for immediate consumption because the "normal" way in which individuals consume a cake is not to dig into it immediately. It needs to be unpackaged and cut into individual slices.

How he barbecued anything while doing this is beyond us, but the Costco problem is a handy illustration of the folly of the Section 199 policy of trying to tax "manufacturing" income different from other earnings.

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TAXING BUSINESSES: WRONG, BUT HANDY?

May 31, 2005

The TaxProf today pulls a comprehensive writeup on different ways businesses are taxed from today's State Tax Notes from behind the Tax Analysts subscriber firewall. The author is Richard M. Bird, a professor at the University of Toronto. The article starts this way:

Cynics have sometimes said that economists cannot agree about anything. An important issue, on which many economists do agree, however, is that, although it is obviously convenient to collect revenues through taxing businesses, there is little justification for taxing them. In the end, all taxes affect people in economic terms. There is little to gain, and potentially much to lose, by confusing the issue and pretending to tax companies, and not people. Of course, it is not always clear exactly which people -- owners, workers, or consumers -- end up paying business taxes, but somebody definitely will pay. Hiding who really pays the bills is not a good way to ensure accountable public sector decisions.

The article covers the arguments for taxing businesses anyway (efficiency and fairness), and surveys business taxes around the world.

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NOW HE HAS MORE TIME TO FIND THE REAL HIJACKERS

May 31, 2005

Federal Judges must love cases like this:

LAWRENCE STEPHEN MAXWELL, ET AL.,
APPELLANTS
v.

JOHN W. SNOW, IN HIS OFFICIAL CAPACITY AS SECRETARY OF
THE TREASURY, UNITED STATES DEPARTMENT OF TREASURY,
APPELLEE

Lawrence S. Maxwell, appearing pro se, argued the cause on his own behalf and was on the joint briefs for appellants. With him on the joint briefs were Vasilios S. Lambros representing 55 legal entities and 507 other pro se individuals.

The lead plaintiff filed the suit after the IRS failed to provide 19 types of information to his satisfaction, including:

(1) "return information" as described in the Internal Revenue Code, 26 U.S.C. § 6103(b)(2), (2) records showing how his "taxable income" was determined, (3) records showing that he was given notice of a duty to file a tax, (4) records identifying him as an individual subject to taxation, (5) records indicating his citizenship and residency, purportedly because as a citizen and resident of the U.S. he would not be liable for income tax, (6) records showing that he "resided or worked within one of the specified areas of federal jurisdiction of the United States government," purportedly because only such records would establish federal jurisdiction to tax him, and (7) records indicating the specific code sections showing him liable for a particular tax or requiring him to fill out certain forms.

Not surprisingly, the court didn't buy these standard tax protester honesty movement arguments, nor did they accede to the plaintiff's request to rule:

...among other things, Appellants are not citizens, that Texas is not a part of the United States, and that the United States itself is unconstitutional because it is not a republican form of government.

This was probably meant to reassure Texans the rest of the US is still part of their country.

OTHER MAXWELL PROJECTS

A quick Googling shows that Mr. Maxwell is sort of a polymath of delusion. His internet ouevre covers a conspiracy to hide the identity of the true masterminds of the destruction of the World Trade Center, made all the more persuasive by making sure every paragraph has at least one word in ALL CAPS.

We are not worthy of Mr. Maxwell's efforts on behalf of us credulous "taxpayers." Just ask him:

My take? Americans are not very bright. Americans don't think. They accept what they are told. They don't TEST what they are told. They are lazy, and naive to the point of being undeserving of liberty. And for that reason they will sacrifice liberty for what they perceive to be security. And as long as the talking-heads can convince the general public that the federal government can PROTECT THEM, the sheeple will patriotically give up every right they have if it makes them feel safe -- while singing GOD BLESS AMERICA.

No wonder he knows so much about the tax law, too. As a sheeple, I am glad that the tax case is over, so he can spend more time finding the real hijackers. Baaa.

Links: Maxwell v. O'Neill (District Court case being appealed)

Maxwell v. Snow (above, on appeal)

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TOP OF THE WORLD, MA!

May 27, 2005

The Tax Update is featured in the June Journal of Accountancy article "Would You, Could You, Should You Blog?" Order up the limo! OK, the taxi...

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NEW ADVENTURES IN LEGAL REASONING

May 27, 2005

Our post on "Humpty Dumpty Law at Iowa Department of Revenue and Finance" triggered an enlightening three-way correspondence among Mike Ralston, Director of the Iowa Department of Revenue and Finance; attorney George Davis, and your author.

As expected, we haven't (yet) persuaded the Director to change the Department's eccentric interpretation of the word "held." The department doesn't adopt the federal tax rules that say asset holding periods survive tax-free exchanges. We have learned more about the origin of the Department's position, though. Per Mr. Ralston:

I'm told there has been only one Iowa case litigated regarding the Iowa capital gain exclusion since the change in 1998 to remove the cap on the amount of the deduction. In James & Linda Bell, the Administrative Law Judge and the Director ruled that the reference to "held" in Iowa Code Section 422.7(21) is to ownership. To the best of my knowledge, the department has taken a consistent position that any transfer of property starts a new ten year holding period.

The Bell discussion of this issue is a jaw-dropper:

The capital gain tax laws originate with the sale of an asset. An asset cannot be sold unless it is owned. As a result, the reference to "held" is to ownership. "The holding period for a capital asset is the length of time that the taxpayer owned the property before disposing of it through sale or exchange." 2001 U.S. Master Tax Guide 1777, p.465 CCH Editorial Staff Publication. The mingling of the "material participation" with a leasehold interest is not sufficient. The clear meaning of the statute is for "held" to mean ownership. The protester does not meet the holding requirement when it is defined as ownership.

It is astounding that the Department would rely on an out-of-context quote from the "Master Tax Guide" for its position on interpreting its statute. The "Master Tax Guide" is certainly a handy reference, but it is about as authoritative as a recent Tax Update post. The reference is the classic freshman mistake of drawing a conclusion from the first paragraph read without digging further for the details

Even more astounding, as George Davis points out, is the tacit admission that they think they are relying on the federal rules for holding periods. After all, the "Master Tax Guide" is a reference to the federal tax law. If they had accurately followed through all of the references in the guide to their sources, they would have found that held doesn't equate to "owned," and that there are many instances where holding period tacks when an asset changes hands.

If the Department follows the approach of Bell, it is compelled to follow the federal holding period rules, as Bell purports to do. Of course, Bell misreads the federal rules, as an accurate reading of those rules shows that holding periods in fact do survive like-kind exchanges. If the Department corrects the Bell misreading, its position has no basis.

It remains to be seen whether the Department will relent before somebody has to take this to district court. I would love to see the look on the judge's face when the Department attorneys fall back on their "Master Tax Guide" cite.

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I OWE TAX ON WHAT???

May 27, 2005

This is certainly new to us:

The Danish Sperm Tax

Posted on May 26, 2005 by Andrew Chamberlain

Will a tax on sperm donation lead to a worldwide decline in fertility? From Reuters:

The source of the world's biggest sperm bank may soon run dry if Danish authorities decide to tax donors, Cryos International Sperm Bank said on Wednesday.

Denmark, with the world's highest income tax levels, wants sperm donors to pay tax on the 500 crown (US$84) reimbursement men receive for their services.

From the new Tax Foundation "Tax Policy Blog"

If we have to start planning for this, I'm going back to being a bagboy. And please, no "loophole" or "tax shelter" jokes.

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RABY BROS. ON 'DEAD PEASANTS' AND INSURABLE INTERESTS

May 27, 2005

The TaxProf has made available the previously-firewalled article, "Life Insurance Without an 'Insurable Interest'," to those without subscriptions to Tax Analysts. The article, by Burgess and William Raby, talks about the recent Tillman case, in which a corporation's right to proceeds on on employee life insurance policy was lost because the company had no "insurable interest" in the employee.

We discussed the case here.

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TOP TREASURY TAX POLICY POST FINALLY FILLED

May 27, 2005

The long-vacant top tax policy post at the Treasury finally has an appointee. President Bush announced that he will nominate Phillip D. Morrison as Assistant Secretary for Tax Policy. The post has either been vacant or filled on an "acting" basis since early last year.

With the President's Advisory Commission on Tax Reform set to release its report in the coming weeks, Mr. Morrison will have his hands full. He leaves a post with Delloite and Touche. He was the Treasury's International Tax Counsel from 1989 to 1992.

Mr. Morrison has an article on the prospects for reforming the taxation of international activity available here. An excerpt:

n certain respects, it is still true that the United States has the harshest, and therefore the most anti-competitive, anti-deferral regime of all the OECD countries. Check-the-box has also made Subpart F taxation elective with respect to dividend, interest, rent and royalty payments among CFCs, except in those jurisdictions where per se corporations must be used, thereby creating an unfair situation for those latter companies. With improved transfer pricing clarity and enforcement in the last 15 years, the foreign base company sales and services rules have only capital export neutrality as support and CEN has been somewhat discredited in recent years. Likewise, the lack of sensible loss allowance rules in Subpart F and the lack of a meaningful de minimis rule create a certain level of unfairness and complexity that should be carefully considered. Given these continuing issues, it would be surprising if Subpart F reform were not the subject of at least some renewed debate during 2005-2006 if there is any corporate tax reform debate at all, though many tax directors may be inclined to let sleeping dogs lie.

Link: Tax Analysts Coverage (free)

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GIVE THAT ESTATE PLANNER A GOLD STAR

May 26, 2005

Few estate plans face the ultimate test - a trial in court. Fewer still play for the stakes of the Charles Porter Schutt Estate. The IRS asserted an estate tax deficiency on the estate of this DuPont family millionaire of over $11 million.

Whatever the estate planners charged, they earned it.

Bucking the trend of recent cases involving family limited partnerships, the Tax Court declined to pull the assets of two "Delaware business trusts" set up by Mr. Schutt into his taxable estate. The case is somewhat complicated, but it seems that his desire to perpetuate the family investment philosophy was key to the estate's victory. Whoever documented that angle fact should at least get a dinner out from the beneficiaries.

Cite: ESTATE OF CHARLES PORTER SCHUTT V. COMMISSIONER, T.C. Memo. 2005-126

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CAR DONATION CURBS - THEY'RE WORKING

May 26, 2005

The enigmatic State 29 forwards an article form the Quad City Times, "Tax law change means fewer vehicles being donated to the Salvation Army"

From the article:

Major James Frye, the administrator of the Salvation Army’s Adult Rehabilitation Center in Davenport, told a news conference that many people are under the erroneous impression they can no longer donate motor vehicles to the agency.
.
He emphasized that persons wishing to donate vehicles valued in excess of $500 still may do so. However, they can no longer use the vehicle’s Blue Book value to determine the tax deduction and instead must use the actual price the vehicle is sold for at auction.

Major Frye is correct. Unfortunately for the Army, the donation curbs drastically change the economics of many car donations. Take the example from a GAO study of car donations we discussed last year. The example showed a taxpayer taking a $2,400 deduction for a donated truck sold at auction for $375. Assuming a combined 20% federal and state tax rate for the donor, the donation is worth $480 in saved taxes - so the donor was better off donating the car than selling it.

Now the deduction for the same car would be limited to $375, resulting in a $75 tax savings. Many would-be donors will just sell the car now; assuming they would also sell it for $375, they'd be money ahead to do so.

WHAT TO DO?

I recommend you consider a donate cash or appreciated securities to the Salvation Army. No charity makes better use their resources.

Oh, and just sell the car.

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TREASURY INSPECTOR GENERAL, IRS CLASH OVER S-CORPORATION EMPLOYMENT TAXES

May 26, 2005

The office of the internal IRS watchdog, the Treasury Inspector General for Tax Administration, says that S corporations are abusing the employment tax law:

One of the criteria for judging a tax system is whether similarly situated taxpayers are treated the same. Given equal amounts of income subject to employment taxes, owners of single-shareholder S corporations and sole proprietors are similarly situated for employment tax purposes. However, a fundamental and significant inequity is created between sole proprietors and owners of single-shareholder S corporations by the manner in which taxable income is determined, since sole proprietors pay employment taxes as a percent of all profits, while owners of single-shareholder S corporations pay employment taxes on only the portion of profits they unilaterally select as their salaries.

TIGTA is referring here to the "John Edwards" shelter. This is the practice of taking only part of your S corporation earnings as salary, and leaving the rest as S corporation earnings. S corporation income is subject to income tax as earned (even if left in the company), but not employement taxes. 2004 Vice-presidential candidate John Edwards used this structure for his law practice.

TIGTA proposes a severe remedy:

The IRS Commissioner should consult with Treasury regarding whether the detrimental effects of Revenue Ruling 59-221 should be reversed through the issuance of new regulations or through the drafting of new legislation, either of which should subject all ordinary operating gains of an S corporation that accrue to a shareholder (including the shareholder’s spouse and dependent children) holding more than 50 percent of the stock in the S corporation to employment taxes.

THE IRS DEMURS

The IRS disagrees, according to the TIGTA report. The IRS says that any fix should address all business entities, not just S corporations. The IRS also says that the TIGTA proposal strays from the idea that employment taxes should relate to actual employment income.

WE DEMUR TOO

The employment tax rules are obsolete in this age of S corporations, limited liability companies and other funky pass-through entities. Congress passed a law thwarting the last attempt to address employment tax issues in the context of limited liability companies; in the ten years since, Treasury has shrunk from the issue.

The TIGTA proposal quite easily could leave S corporations worse off than LLCs for employment tax purposes. Under one set of proposed regulations, LLC owners could avoid employment taxes on much income simply by having two classes of ownership - an option unavailable to S corporation shareholders.

The flat "tax it all" rule of the TIGTA proposal also ignores the real life issues of small businesses. A start-up, for example, shouldn't be forced to pay a "reasonable" salary to its owner while it is struggling to get established. A single owner could have a large enterprise with a full administrative staff and for which invested capital is the largest source of income; it makes no more sense to treat that such income as "employment" income than it would to so treat Microsoft dividends.

If Congress does seriously address social security reform, it seems likely they will address employment tax issues of all pass-throughts to help fund it.

LINK: TIGTA Report Reference Number: 2005-30-080

Related Tax Update Post: 'JOHN EDWARDS SHELTER' TARGETED BY IRS

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STILL WORKING AT 71? YOU STILL MAY NEED TO START COLLECTING RETIRMENT BENEFITS

May 25, 2005

The BenfitsBlog notes a common mistake made by business owners. If you own 5% or more of the business, you have to start taking distributions from the business retirement plan. This is different from non-owners, who get to defer payouts until they actually quit working.

She notes the severe consequences: a 50% penalty on the amount of the minimum required distribution you failed to withdraw.

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PERSUADER NOT PERSUASIVE TO TAX COURT

May 25, 2005

It's normal for songwriters to complain that they aren't receiving full royalties; there is even a small industry of "royalty auditors" who pore over record company ledgers to make sure artists get what's theirs.

Robert Poindexter achieved success as an R&B songwriter; one of his hits, "It's a Thin Line Between Love and Hate," topped the R&B charts in 1971 -- the version by his own group "The Persuaders" (you can hear it by clicking the Persuaders link).

Mr. Poindexter tried a novel approach to perceived royalty underpayments: he didn't pay taxes on the royalties he did receive. He apparently argued that the IRS should shake more royalties out of the record company before he paid taxes on the royalties he actually got.

The Tax Court wasn't, um, persuaded:

Petitioner’s position in this case is based upon the erroneous impression that he should not have to pay income tax on his 2000 royalty income until respondent forces Warner Chappell to admit petitioner is owed additional royalties for that year or at least until respondent investigates Warner Chappell. Petitioner is misinformed as to respondent’s obligation and as to the authority of this Court. As the Court attempted to explain to petitioner at trial, this case is solely about determining his correct tax liability for the year 2000 since the additions to tax have been resolved. Petitioner’s claim for increased royalties from Warner Chappell has no bearing on the matters before this Court.

The moral: "The sweetest woman in the world
Could be the meanest woman in the world
If you make her that way..."

...but the IRS still wants its taxes even when you are shorted on your royalties.

Cite: Robert Eugene Poindexter v. Commissioner, T.C. Memo. 2005-122

PS: That picture makes me wonder what Star Trek episode they were on.

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AGAIN THROUGH THE LOOKING GLASS: WHICH IS TO BE MASTER?

May 25, 2005

The Iowa Department of Revenue explained how it figures what the tax law means in a recent protest response:

Statutes allowing exemptions from taxation are to be strictly construed with all rational doubt regarding the meaning of any words or phrases contained in them resolved against exemption and in favor of taxation.

A reader* who has some experience in this area points out a case where the Iowa Supreme Court seems to take a different view. In N. F. SORG v. IOWA DEPARTMENT OF REVENUE (no link available) the court said:

"Taxing statutes are strictly construed against the taxing body--liberally in favor of the taxpayer. It must appear from the language of the statute the tax assessed against taxpayer was clearly intended." Scott County Conservation Bd. v. Briggs, 229 N.W.2d at 127 , quoting Dodgen Industries, Inc. v. Iowa State Tax Commission, 160 N.W.2d 289 , 296 (Iowa 1968); see Iowa Movers & Warehousemen's Ass'n v. Briggs, 237 N.W.2d 759 , 769 (Iowa), cert. denied, 429 U.S. 832 , 50 L.Ed.2d 96 (1976). Construing § 422.43 and the applicable definitions in § 422.42 liberally in favor of Sorg and strictly against the Department, we cannot find language signaling a clear legislative intent to tax in the situation before us.

(Emphasis added.)

So which is it? In Sorg, The court says the law leans in favor of the taxpayers; the Department now says the opposite. As Humpty Dumpty told Alice, "The question is, which is to be master -- that's all."

* Thanks to reader Richard Lyford, who successfully argued Sorg at the Iowa Supreme Court.

Related Post: HUMPTY DUMPTY LAW AT IOWA DEPARTMENT OF REVENUE AND FINANCE

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PROPOSED REGS CLARIFY PARTNERSHIP COMPENSATION ISSUES

May 24, 2005

The Treasury has issued proposed regs that, if finalized, will answer some long-nagging questions on partnership taxation. This will make it much easier to use partnership and LLC equity as compensation.

The regulations cover a lot of ground, and we're far from fully grasping them. The most important point we've noted so far: partnerships won't recognize gain from the issuance of partnership interests. This will enable taxpayers to use LLC options without worrying about triggering gain on exercise to old partners.

We will discuss this more as we get the opportunity; in the meantime Professor Maule already has some thoughts on the proposed regulations.

Links:
Proposed regulations.
Notice 2005-43, containing proposed revenue procedure on taxation of partnership interests.

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DO YOU KNOW WHERE (ELSE) YOUR PENSION CONSULTANT IS?

May 24, 2005

The BenefitsBlog collects links commenting on the SEC's recent report on conflicts of interest and double-charging in the pension consulting industry. She has a longer discussion of the report here.

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REPEAL AMT WITHOUT TAX REFORM?

May 24, 2005

The ranking members of the Senate Finance Committee, including Senator Grassley, have introduced a bill to repeal the alternative minimum tax independent of tax reform. The bill provides no offset for the $600 billion to $1 trillion revenue reduction slated for the bill over the next ten years.

This is a high-powered bipartisan lineup (tri-partisan, if you count Senator Jeffords as an independent). Still, it's hard to imagine this passing outside of tax reform; it could kill any tax reform effort by forcing it to include a big tax increase. Maybe that's the point.

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ADMINISTERING AN ESTATE IN STYLE

May 24, 2005

Isaac Stern made great music while alive. His executor apparently played his estate like a Stradivarius after he died:

Mr. Moorhead evidently paid himself $313,000 in executor's fees, which the court called “outrageous, improper and unjustified.” He also spent $250,000 on a Central Park West apartment that he supposedly used as an office, and employed a full-time office manager.

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LATE TO THE CARNIVAL

May 24, 2005

This week's Carnival of the Capitalists went up yesterday at Ideologic LLC. The Carnival is a weekly roundup of economics and business web posts. Lots of entries this week, from notes on the real estate market to some new movie about Reagan's strategic defense initiative or something.

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IT SHOULDN'T BE NECESSARY TO POINT OUT SOME THINGS...

May 23, 2005

From a Tax Court decision issued today:

As already explained, there was no disclosure on the returns that petitioner and Mrs. Corrigan were divorced and, therefore, not entitled to file a joint return. Likewise, it was not reasonable to claim joint filing status at a time when petitioner knew he was divorced. Accordingly, petitioner may be subject to the substantial understatement additions to tax for 1987 and 1988...

Yes, but maybe it was an "open" divorce...

Cite: Corrigan v. Commissioner, T.C. Memo. 2005-119

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STAYIN' ALIVE: DEATH COSTS SPOUSE IOWA CAPITAL GAIN EXEMPTION

May 23, 2005

The Iowa Department of Revenue wants to encourage immortality. That seems to be the message of a tax policy letter posted on the Department website this morning, anyway.

Iowa has a rule that waives taxes on the sale of some real estate used in a business and "held" for over ten years. Through its interpretation of the statute, the Department of Revenue says that held doesn't mean what it means elsewhere in the tax law. This means that if you are a farmer, maybe you'd better sell the farm before you, um, buy the farm.

In the letter issued today, a farm couple owned thier farm as tenants in common, with the husband "materially participating" in the farm operation. The husband died in December 2003, having owned the farmland for more than ten years.

The widow inherited the farm, and later sold it. The Department says that only "her" 1/2 share qualified for the capital gain exclusion; the inherited half started a new holding period.

The Department says that the tax would have been avoided if the farm had been held in a joint tenancy, rather than as tenants in common:

If the ownership had been in joint tenancy, both the husband and wife would have been deemed to own 100% of the farmland, and the wife would have been entitled to the capital gain deduction on the sale of the entire property. However, because the farmland was held as tenants in common, the capital gain deduction only applies to the original one-half interest held by the wife.

Some might say that is a picayunish distinction without a difference. While that may be true, it still behooves businsess and farm owners to carefully consider how they title their real estate if they care to use the Iowa exclusion.

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JUNE 2005 APPLICABLE FEDERAL RATES ARE OUT

May 23, 2005

The IRS has issued (Rev. Rul. 2005-32) the minimum interest rates for loans made in June 2005:

-Short Term (demand loans and loans with terms of up to 3 years): 3.46%
-Mid-Term (loans from 3-9 years): 4.01%
-Long-Term (over 9 years): 4.57%

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

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SMALL BALL TAX REFORM?

May 20, 2005

If the President's Advisory Panel on Tax Reform listens to this weeks advice from four former top Treasury policy wonks, they won't be swinging for the fences. They would instead be recommending incremental changes to the existing tax system.

Our guess? A tax base that will resemble the current AMT system - no state and local tax deduction, especially - larger exemptions, and expanded retirement savings options. We may turn out to be wrong, but at least we're consistent.

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STATE 29 WANTS US DEAD

May 20, 2005

How else do you explain this? We will become meth-addled wrecks, we will...

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THANKS, CHAD

May 20, 2005

Chad at Tusk and Talon said some nice things about us and some other Iowa bloggers. In our case, he was too kind, but thanks!

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CAFETERIA TO STAY OPEN LATE

May 19, 2005

The IRS yesterday modified the "use it or lose it" rule for cafeteria plans. Such plans may now reimburse expenses incurred up to 2 1/2 months after year end (Notice 2005-42)

For example, if you defer $500 in 2005 under your cafeteria plan, expenses incurred through March 15, 2006 may be reimbursed using the $500 of 2005 deferrals. The rule had only allowed reimbursements of expenses through December 31 of the deferral year.

This will only apply for employers who amend their plan to allow the extended reimbursement period; such amendments have to be made before December 31 to be effective this year.

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BILL SEEKS TO RETURN SHARP OBJECTS TO TODDLERS

May 19, 2005

A bipartisan group of advocates of bad tax policy led by Sen. Voinovich of Ohio yesterday announced a bill to preserve targeted state tax incentives.

Such incentives became illegal in the 6th U.S. Circuit, which includes Ohio, Michigan, Ohio and Tennessee, when the 6th Circuit Court of Appeals ruled that they violate the U.S. Constitution's commerce clause. Iowa has around 20 tax credits that likely would be struck down under the same analysis.

The 6th Circuit decision provides a golden opportunity for states to abandon their circular firing squad system of targeted incentives to bribe businesses to locate in their states. These incentives tax existing businesses to lure and subsidize their competitors, but the bribees generally have vocal and influential support. This support is evident in Tax Analysts's list of co-sponsors of the "Economic Development Act of 2005":

Seeking to protect a tax incentive program he championed as governor of Ohio, Sen. George V. Voinovich, R-Ohio, announced May 18 that he and Rep. Patrick J. Tiberi, R-Ohio, Sen. Debbie Stabenow, D- Mich., and Rep. Ben Chandler, D-Ky., would introduce legislation to overturn a recent federal appeals court decision.

...

The Senate version is being cosponsored by every senator in the Sixth Circuit, including Mike DeWine, R-Ohio; Carl Levin, D-Mich.; Lamar Alexander, R-Tenn.; Mitch McConnell, R-Ky.; Jim Bunning, R-Ky.; and Majority Leader Bill Frist, R-Tenn

Truly an impressive display of support for foolish tax policy.

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TELL US HOW YOU REALLY FEEL, BRUCE

May 19, 2005

Bruce Bartlett does not appear enthused about the prospect of replacing the income tax with a national retail sales tax:

"It's ludicrous," Bartlett said. "It's idiotic. It's moronic. It'll never happen."

Other than that, he appears to have raised no objections at a symposium on tax reform yesterday.

Tax Analysts commentator David Brunori said states should plan to have their concerns ignored in the tax reform debate:

"I cannot imagine the states gaining more influence," Brunori said. "The people who are having the debate do not care about the state fiscal systems."

But do they care about coffee cup integrity?

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WE'RE CLUELESS. PLEASE PROVIDE ONE ON THE ATTACHED FORM

May 18, 2005

A real live letter from the Iowa Department of Revenue and Finance:

(Click on letter for larger version)

Short version:

-We lost your tax returns.
-We can't find them.
-Please explain what we did with them.

We have a number of potential responses in mind - "I'll tell you where you put my return if you can tell me why she never called me back. Signed, P.P." - that sort of thing.

We invite you to suggest responses in the comments. Keep it clean!

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LINK TO SECTION 199 POWERPOINT SLIDES

May 17, 2005

The Powerpoint slides for my presentation last friday at the Iowa Bar Association Spring Tax Institute are available here. My apologies for the lack of powerpoint skills, reflected in the lack of labels on the slides.

UPDATE: I see the slides don't look very good on the site. I will try to fix that later. If you really want to dive into the ugly issues created by Section 199, head on over to Prof. Maule's place.

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HUMPTY DUMPTY LAW AT IOWA DEPARTMENT OF REVENUE AND FINANCE

May 17, 2005

"When I use a word," Humpty Dumpty said in a rather scornful tone," it means just what I choose it to mean -- neither more nor less."

"The question is," said Alice, "whether you can make words mean so many things."

"The question is," said Humpty Dumpty, "which is to be master -- that's all."

                          -Alice in Wonderland

Statutes allowing exemptions from taxation are to be strictly construed with all rational doubt regarding the meaning of any words or phrases contained in them resolved against exemption and in favor of taxation

                       -Iowa Dept. of Revenue, in 
                        protest response released yesterday.

The spirit of Humpty lives on at the Iowa Department of Revenue tax policy section. Follow us through the looking glass for a peek at a protest response posted on the Department website yesterday.

Michael Fereday tried to take advantage of the Iowa "ultra-long term" capital gain deduction, which allows some taxpayers to avoid Iowa taxes on the sales of business assets or real estate held for more than 10 years. Mr. Fereday appeared to meet all of the requirements for the deduction, and his "holding period" for the property began in 1986.

But the Department can make words mean so many things -- even "held."

Because many federal tax rules - in particular, lower capital gain rates - turn on how long an asset is held, the tax law has developed a detailed set on "holding period" rules.

In 2002, Mr. Fereday sold property he had acquired in a 1997 like-kind exchange. In such exchanges, the basis and holding period of like-kind property given up carries over to the replacement property acquired in the exchange; the exchange itself isn't taxed. The property swapped away in the 1997 exchange had been acquired in 1986, giving him a 16-year holding period.

THE ROLE OF FEDERAL TAX LAW IN IOWA TAX LAW

Like most states, Iowa's tax rules piggyback the federal tax law. If they didn't do so, each state would have to re-invent the wheel; it is much easier to simply latch on to the extensive body of federal tax law that has evolved since 1913. Iowa specifically recognizes this in its "code conformity" provision for computing taxable income. The Department's own rules indicate that they will lean on federal definitions:

Federal rulings and regulations. In determining whether “taxable income,” “net operating loss deduction” or any other deductions are computed for federal tax purposes under, or have the same meaning as provided by, the Internal Revenue Code, the department will use applicable rulings and regulations that have been duly promulgated by the Commissioner of Internal Revenue, unless the director has created rules and regulations or has exercised discretionary powers as prescribed by statute which call for an alternative method for determining “taxable income,” “net operating loss deduction,” or any other deductions, or unless the department finds that an applicable Internal Revenue ruling or regulation is unauthorized according to the Iowa Code.

Yet the Department doesn't think this means "held" has the same meaning for federal purposes as it does in Iowa:

The Iowa capital gains deduction is unique to Iowa. The Internal Revenue Service does not have such a deduction. Therefore, without specific statutory authority, there is no reason to include like-kind exchange provisions in the interpretation of the Iowa statute.

WHAT PART OF 'HELD' DON'T YOU UNDERSTAND?

The Department is simply wrong. While some specifics of the Iowa capital gains deduction are indeed unique, the concept of different rates based on holding period length has been in the Code for many years.

Iowa has had no difficulty adapting federal holding period rules for other "unique" Iowa purposes. For example, Iowa has a special exclusion for farmers for sales of cattle or horses held for 24 months. The Department adopted federal holding period rules for this deduction, which has no direct federal counterpart. (Subrule 40.38(2))

If the legislature doesn't provide a specific definition of a word when it passes a tax law, the sound and sensible assumption is that it means the same thing that it means elsewhere in the tax law.

Yet, incredibly, the Department says that unless the legislature provides a definition for every term in a statute, the Department gets to make one up. In fact, they say, they must do so, and in the most taxpayer-hostile manner possible.

LET'S MAKE THIS HARD

This exclusion is itself an item of complexity created by the legislature. Rather than having low rates on a broad base, Iowa has high rates and lots of narrowly-focused exclusions. Not to be outdone, the Department has made it more narrow and more complicated.

The Department's approach illustrates why states normally piggyback on federal law. Without federal tax rules to guide them, Iowa taxpayers have to guess whether an otherwise sensible transaction causes an Iowa problem. The Department has never provided comprehensive guidance as to its own holding period rules here, so taxpayers have to guess what the Department will do, or seek transaction by transaction guidance -- an expensive and slow process. If the Department instead simply adopted the federal definitions, taxpayers would be able to know where they stand.

Of course, we charge by the hour, so maybe we should just shut up. Useless busy work for tax practitioners - Iowa's path to progress!

(Thanks for George Davis for the tip).

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RIDING SHOTGUN DOWN THE INSTALANCHE

May 15, 2005

We experienced a second-degree "instalanche" last week. The Instapundit linked to the TaxProf's mention of our post about the New York Times selective editing of a chart on marginal rates -- so we were linked to a post linked by the great Professor Reynolds. Andrew Sullivan also linked to the TaxProf's post, giving the Tax Prof sort of an eight-run home run, as these things go.

The TaxProf and the Tax Update both use "Sitemeter" to monitor our visitors, enabling us to see how much traffic an Instapundit link generates. The Tax Prof's traffic spike is something to behold:

From around 1500 visits on Tuesday to 15,000 on Wednesday - a testament to the force of an instalanche.

How many of those vistors made the extra click to the our post? Not a large fraction:

Certainly a noticable traffic increase, and a much appreciated one. Still, it shows that the power of an Instapundit link weakens greatly after the primary link. This small sample seems to show most people read Instapundit like I do - frequently checking out the first link, but not often following through further links. Instapundit filters out a lot of blogosphere noise for folks. Here he links a post that tells the story well; sensibly, most folks have seen what they need after their visit to the TaxProf, so they return to Instapundit, or maybe to work.

CHASING MOBY LINK

So how do you move up to a "first-degree" Instapundit link? One could follow the TaxProf's lead by posting lots of smart, well-written and graphically attractive articles. But that takes talent and work.

We choose another path. We will stalk the photo that Instapundit will be compelled to link to: a protest babe unloading a lawn mower from an RX8 while wearing a Nikon D-70. Come, Queequeg...

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I WIN! I WIN!

May 13, 2005

David Brunori, the Tax Analysts state tax commentator at large, issued a challenge Monday:

   As an aside, which of these was uttered during the Spanish
   American War?

      a. Damn the torpedoes, full speed ahead

      b. Sighted sub, sunk same

      c. You may fire when ready, Gridley

      d. I have not yet begun to fight

      e. Who's your daddy?

A rich prize, said Mr. Brunori, awaited the first person to email the correct answer. Rising to the bait, the Tax Update fired back the correct answer, c. Mr. Brunori responded with good news (we won) and bad news (we were the eighth response).

The prize arrived today:

Well, he didn't say the mug would be intact...

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JUST BECAUSE THEY ARE OUT TO GET YOU, DOESN'T MEAN THEY SHOULDN'T

May 13, 2005

From U.S. v. Byock, a 3rd Circuit case, as reported by Tax Analysts:

The Byocks offered no evidence to suggest that the assessments were incorrect or to otherwise dispute the assessments... On appeal, as in the District Court, the Byocks do not dispute that they owe the back taxes. Instead, they focus solely on their belief that this complaint was filed as a personal vendetta and that the IRS made these assessments only after Matthew Byock reported an IRS employee to the District Director's Office. This allegation has no bearing on the Byocks' liability for taxes owed.

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DEAD PEASANT INSURANCE - ARE THERE ANY WAYS LEFT TO LOSE?

May 13, 2005

The purchase of life insurance on large groups of employees has always been controversial. The practice is politely called "COLI," for "Corporate-Owned Life Insurance." It is more rudely known as "dead peasant insurance."

While it sounds ghoulish, COLI was tax-motivated. The goal was to deduct the interest on purchases of large pools of insurance, while collecting the cash-value buildup of the policies tax-free.

ONCE, TWICE, THREE TIMES A LOSER

Most, though not all, courts that have ruled on this issue have disallowed the tax benefits. Congress changed the law to make sure that it didn't work. Now it's gotten even worse for the COLI corporations. In a decision issued this week, the 10th Circuit court of Appeals has held that a COLI-owning corporation didn't even have an insurable interest in a now-dead employee, and it may have to pay the policy proceeds to his family.

Camelot Music used the COLI scheme to try to reduce its corporate taxes. The Third Circuit ruled the plan a "sham" in 2002, disallowing the tax benefits. Camelot employee Filipe Tillman was insured for $340,000 when he died, and Camelot collected the proceeds. His widow sued under Oklahoma insurance law to collect the policy proceeds; Oklahoma law provides that if you don't have an insurable interest in a decedant, the proceeds are payable to the insured's estate. The 10th Circuit overturned a lower court ruling and upheld the widow's claim.

It's not accurate to say that the COLI-buyers bought policies in a vampire-like ploy to profit from employeed deaths. It is accurate to say that the tax shelter doesn't work if the employer doesn't get to keep any policy death benefits. For Camelot, it is a debacle - no tax benefits, no policy proceeds - just insurance premium payments.

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TAX PROF HIGHLIGHTS FLP, S-CORP ESOP ARTICLES

May 12, 2005

The TaxProf today links to two useful articles in full text.

CARE AND FEEDING OF FAMILY LIMITED PARTNERSHIPS

This piece, from Tax Analysts, discusses the lessons of recent IRS court victories in family partnership planning. It is part of the TaxProf's series of articles that he makes available by arrangement with Tax Analysts.

THE SLOW DEATH OF THE SESOP

Beckett G. Cantley writes how S corporation ESOPs have been effectively taken out of the toolkit of small business tax planners in this piece from the Akron Tax Journal. This article is a nice summary of the new rules limiting family-owned S corporation ESOPs.

Thanks are due to Paul Caron, the TaxProf blog proprietor.

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MENU DAY AT TAX REFORM PANEL

May 11, 2005

The President's Advisory Panel on Tax Reform spends the next two days reviewing options for a new system. Naturally, the TaxProf has the scoop.

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HIGH-SPEED TAX EVADER SLOWS IT DOWN

May 11, 2005

Fast-driving Al Thompson doesn't do everything quickly. His cooperation with the IRS is slow enough that a California court has reopened discovery and extended filing deadlines, at IRS request. Mr. Thompson, a.k.a Walter Thompson, apparently can't be rushed when it comes to providing information to the IRS, according to the court:

Focusing on the government's diligence, it is apparent that the unusual circumstances of this case, particularly defendants' lack of cooperation, have impeded the government's ability to conduct discovery. Since the inception of the litigation, Mr. Walter Thompson and the other defendants have defied court orders, refused to comply with the Federal Rules of Civil Procedure and the Eastern District Local Rules, and filed unintelligible and non-responsive papers with the court. As a result of his defiance of the court's preliminary injunction, Mr. Walter Thompson was held in civil contempt and incarcerated on two occasions. Further, on January 28, 2005, Mr. Walter Thompson was convicted (Tax Update coverage here)for filing a false claim against the United States, filing a false income tax return, and failing to withhold taxes from the paychecks of Cencal Sales, Inc. employees. Mr. Thompson's lack of cooperation and unavailability have no doubt obstructed the government's efforts to obtain discovery.

Mr. Thompson achieved notoriety when he boased about not withholding on his income taxes in a full-page ad in USA Today.

The ad was signed by four others. To see how well they have done, click their names:

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

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THE GREEN MACHINE FOR THE GATED COMMUNITY

May 11, 2005

The IRS has certified the 2006 Lexus RX 400h sport-utility vehcile as eligible for the clean fuel deduction.

Individuals purchasing these in 2005 can get an above-the-line deduction of up to $2,000. 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 complete list of qualifying clean-fuel vehicles is here.

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WILL HE NOW BE 'JOHNNY FELONY'?

May 10, 2005

Commenting on the recent Anderson's Ark trials, "Johnny Liberty" of the "Institute for Communications Resources" had this to say:

If you want to learn about how the justice system really works, attend one of these upcoming trials as an observer.

Sound advice - when compared to attending such a trial as a defendant, anyway. And that may the only sound advice Mr. Liberty, a.k.a. John David Van Hove, has to offer about taxes. Unfortunately, he won't be able to take it.

The Justice Department yesterday announced Mr. Liberty's arrest:

On April 7, 2005, a federal grand jury sitting in Honolulu, Hawaii indicted Mr. Van Hove for corruptly endeavoring to obstruct and impede the due administration of the tax laws, willful failure to file individual income tax returns, and wire fraud. The indictment had been sealed pending the defendant's arrest.

Mr. Liberty and the ICR website appear to sell schemes for avoiding taxes by achieving "sovereignty." It's not looking like they work.

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WHAT'S WRONG WITH THIS PICTURE?

May 10, 2005

Zimran Ahmed, via his "Winterspeak" blog, provides pithy and scary-smart economics commentary from his perch at the University of Chicago. A recent post reproduced a New York Times illustration of marginal tax rates at different income levels:

The "marginal rate" is the amount of tax paid on the next dollar earned; if you earn $100 more and pay an additional $15 tax as a result, your marginal rate is $15.

The Times chart credits a forthcoming book from the American Enterprise Institute, Towards Fundamental Tax Reform.

Some parts of the chart made sense. The many peaks at odd income levels look reasonable because of the tax law's many deduction and credit phase outs at different income levels. The "zero" marginal rate that appears to run from $30,000 or so to maybe $65,000 is puzzling. That makes sense at some lower income levels, where the earned income credit functions, but it doesn't look right at what most people consider lower-middle class to middle class income levels.

We went to the AEI webpage, where we find the book available on pdf format, to try to find how this worked. The chart in the book only cites "Author's Calculations," so we didn't find our answer (Now we have; see update at bottom). But we did notice a subtle difference between the Times version of the chart and the original. Do you notice?

Look on the left. The original chart shows marginal rates well below zero for the lowest income levels - a negative income tax, in effect. The Times leaves this out.

It's easy to assume that the Times just didn't want to emphasize how progressive the system is at the lowest income levels. The chart would be consistent with that. Or maybe they just thought the chart didn't quite fit the space with the far left end, or they cut it off there for artistic reasons. Still, it seems that there is less information in the far right side, which they left in. While there may be an explanation other than political leanings for the way the chart was edited, bias does seem to fit the data.

UPDATE!

Via Marginal Revolution, we find an explanation for the zero bracket. They assume a family of four with kids in college:

Once the EIC reaches its ending eligibility point of $35,000, the family faces a 0% rate because the child and dependent care tax credit (CDCTC) and the education credits (Hope and Lifetime Learning credits) are offsetting all taxable income, so the family is receiving a constant refund equal to the maximum value of the additional CTC. At $65,000, the education credits reach their maximum, and the regular CTC begins to be applied to offset taxable income. This causes the additional CTC to phase out at a rate of 14.4%, since the 15% tax bracket interacts with the IRA deductions.

EIC = Earned Income Credit
CTC = Child Tax Credit

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DID HE HAVE TO REMOVE HIS TINFOIL HAT?

May 10, 2005

Professor Maule relates a touching story of the contributions of young government lawyers to their fellow man:

We met several people who complained that some government department or other was beaming invisible rays at their heads. One of these poor souls came in on a quiet Friday afternoon, so another clerk and I took him over to the Lexis terminal, at that point an imposing stand-alone console about the size of a small desk. We turned it on, typed in "Stop beaming rays at John Doe's head," hit "enter" and turned it off. Doe left happily, the voices in his head now silent, and we returned to our duties, knowing that we had helped one American citizen obtain justice in an imperfect world.

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DUE DATE MEANS DUE DATE; CLARK MCLEOD'S 2001 TAX LOSS

May 09, 2005

The Department of Revenue added two interesting releases to its website this morning.

DUE DATE MEANS APRIL, NOT OCTOBER

Iowa permits an automatic extension of returns if 90% of the return is paid in by the return due date. Sioux City businessman William Feiges came up short of the 90% of their 2002 taxes when the April 30, 2003 due date for Iowa 1040s rolled around. They paid in an additional $125,000 by October 31 - the due date for extended returns.

The Departement of Revenue assessed Mr. Feiges a 10% late return penalty. Mr. Feiges argued that as long has he was 90% paid in by the October date, his April extension was valid.

The Department said that April, not October, is the date that you need to have 90% paid in. That is also the answer we would give.

Cite: Protest Resolution, December 17, 2004

CLARK MCLEOD WINS AMT ARGUMENT

Telecom entrepreneur Clark Mcleod had a net operating loss carryback to 1999 and 2000. The Department initially said that the regular tax itemized deduction phase-out shouldn't be adjusted for AMT purposes in computing the alternative minimum tax operating loss. Mr. McLeod protested, and the Department (correctly) reversed itself, agreeing that the Iowa AMT NOL should be adjusted in the the same way as the federal NOL for the (stupid) phase out. The change gives Mr. Mcleod an additional refund of $8,364.

The Department's letter does not give the year in which the loss arose, but it presumably was 2001.

Cite: Protest response, January 27, 2005.

THANKS FOR SHARING

These letters provide useful lessons for Iowa taxpayers and practitioners. It's good that these letters are public, as they help prevent the Department from having a secret body of law for the well-connected.

They also provide an unintended lesson: this stuff is public. Whether or not he meant to tell us, we all know about Mr. Mcleod's 2001 Iowa NOL.

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VIEW FROM THE SPRING TAX INSTITUTE, IOWA CITY

May 07, 2005

Yesterday I discussed the new Section 199 deduction at the Iowa Bar Associciation Spring Tax Institute (I will post my outline later). While I was the only non-lawyer in the room, as far as I know, I think I emerged unscathed.

There were many smart people there, but the most noteworthy might have been living legend Orville Bloethe, attending his 51st consecutive Spring Tax Institute.

Orville presented on "Iowa Estate Planning and Probate Issues" - not my cup of tea, but the lawyers seemed to take in every word.

Dave Repp started the day's show, talking about Asset Protection Planning. By lunch time he was done and in a position to relax.

Terence Cuff of Loeb & Loeb, Los Angeles, did a great job as keynote speaker. He explained the practical problems of putting together partnership agreements in as clear and sensible a way as I've seen.

But it was a long day. After the excitement of my presentation, attendee Wayne Reames was emotionally drained...

It was a great experience. Thanks to Jason Stone for the invitation and the hospitality.

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REMEMBERING IN IOWA CITY

May 07, 2005

A University of Iowa Student reading names of Holocaust victims yesterday afternoon as part of a 24-hour reading in memory of victims of the Shoah.

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HIRE MORE, WORK THEM LESS, PAY THEM MORE? NAH...

May 05, 2005

The TaxProf noted this in yesterday's Wall Street Journal about the turnover problems in big-firm public accounting (I believe link only works for WSJ subscribers). The article says:

To combat the problem, the Big Four are trying to move from a culture of overloading and underpaying youngsters to nurturing and better rewarding them. They are hiring larger numbers of them, and offering bigger bonuses, more vacation and special referral fees.

But is our profession ready to do more than pay lip service to the problem? This excerpt from the article makes you wonder:

Still, Ms. DiCenso opted to quit when she received her bonus check in September -- for $2,000. In her view, that translated into $2.86 an hour in overtime pay. "I could have made more working at a fast-food restaurant," she says, although acknowledging the valuable skills she learned.

At the national firm where I started my career, one of my friends spent six months in charge of "bundle control" in an audit of a Fortune 500 company. It was her responsibility to distribute audit files in the morning and make sure she know where they all were at the end of the day. It's that kind of valuable skill that makes the CPA certificate "the poor man's MBA." That was 20 years ago, and while big company audits have changed, I'm not sure the mindset has.

Are we as a profession smart enough to meet the challenges of the Sarbanes-Oxley era? It's not clear we are.

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IT WAS THE 10TH SHOT THAT GOT ME DRUNK

May 05, 2005

The tax and economics blogs have been tossing around the idea of whether taxes are a big cause of bankruptcy. Todd Zywicky (Volokh Conspiracy) cites impressionistic evidence that tax forces a significant portion of bankruptcies. Looking at the numbers, Harvard Law prof Elizabeth Warren disagrees via the TaxProf, who also posts a Zywicki response.

Victor Fleisher weighs in today, and his comment rings true with what we see in practice:

The problem that I have with this debate is that I don't understand what people mean when they say that a single factor --- whether it's tax, medical problems, gambling, or whatever, "causes" bankruptcy.

Bankruptcy happens when cash outflows exceed cash inflows for too long. A typical individual debtor has a number of significant outflows. It seems dangerous to choose just one as the "cause" and draw policy conclusions based on that one "cause." Warren and others have written about the rising cost of medical care causing bankruptcy. The jist seems to be that everything is going along fine, and then bam, an unforeseen illness or injury occurs, and things fall apart. Todd Z seems to be saying the same thing here about tax liabilities. I don't get it. Perhaps the medical care, or the tax liability, was the last straw. But you could just as easily say that low wages, or insufficient savings rate, or excessive consumption "caused" the bankruptcy. Am I missing something?

Which brings me to a broader point -- I would argue that one of the worst ways to figure out the "cause" of a bad event is to ask people why they think it happened. Ask someone why they got into a car accident and the top five reasons will never include "I'm a crappy driver."

As amazing as it seems, you do find businesses whose owners have a new Lexus every year and live in big houses, but somehow are unable to scrape up cash to make their payroll taxes. If you ask, they'll say it's the taxes that cause the problem.

More common are businesses that just aren't going well, in spite of their owners best efforts. They need to buy inventory or supplies to take care of their customers for one more week, and they fall to the temptation to use withheld taxes to meet their cash needs

It's also worth noting that income taxes are unlikely to be an immediate cause of bankruptcy because money-losing businesses generally don't have taxable income - so they don't have income tax. Sometimes they even get a cash infusion by carrying losses back for a refund. Unfortunately loss carryback is now a stingy two years; it should be at least three, which is the audit statute of limitations period. If an old year is under audit, and the the carryback period for the year under audit has expired, income taxes can trigger a crisis.

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FUTUREMAN PLEADS GUILTY TO TAX EVASION

May 04, 2005

Roy Wooten, master percussionist for the Flecktones, has pleaded guilty to one count of income tax evasion. (UPDATE 8-16-05: Futureman Sentenced)

The online version of the Nashville Tennessean reports:

Authorities say Wooten falsely filed forms saying he was exempt from income tax. The grand jury indictment says that he conducted his affairs in cash to avoid detection and concealed a taxable income over the four years of about $379,000, on which he owed more than $100,000 in taxes.

TAX PROTESTER ARGUMENTS: FOOLISH OR CRAZY?

Mr. Wooten, who performs as Futureman, has been in tax trouble for some time. About a year ago the Sixth Circuit ruled Mr. Wooten was incompetent to assist in his own defence on the tax charges. The court said then of Mr. Wooten:

   He subsequently appeared
   before the district court when ordered to do
   so, but his participation in the district court
   proceedings was defined by his insistence
   on responding to virtually every question
   with arcane, pseudo-legal jargon commonly
   associated with tax protestor literature. He
   also repeatedly proclaimed his beliefs that
   the federal government is bankrupt, the
   Department of the Navy runs the country
   under Admiralty Law and the Uniform
   Commercial Code, the Internal Revenue
   Service is really a foreign debt collector
   based in Puerto Rico and that Wooten, who
   lives in Nashville, is not actually a resident
   of the United States. Wooten also filed
   volumes of pleadings, many signed only
   with his thumb print, that the district court
   found virtually indecipherable. Faced with
   these abnormalities, the district court, 
   fearing that Wooten might not be competent
   to assist in his own defense, ordered a
   competency evaluation. 

It's likely that Mr. Wooten will go behind bars. The maximum sentence for tax evasion is five years; presumably he has negotiated a plea deal, but he is unlikely to avoid jail time altogether. Sentencing is set for August 8.

We're not sure it's clinically insane to use tax protestor arguments, but it certainly is nuts. It's a tragedy anytime somebody has to pay such a stiff price for swallowing the tax protester Kool-aid. Now his band will have to make other plans for awhile, and Mr. Wooten will have to squander part of his career in prison.

Mr. Wooten is one of the most talented musicians it's been my pleasure to see. Here is a review of a 2002 perfomance which I attended. After the performance he stayed around and chatted with fans, including my (then) 11 year-old son. He seems like a nice man; here's hoping he can get this mess behind him quickly.

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8TH CIRCUIT: I-80 TRUCK STOP TOO BIG TO JUST BE A GAS STATION

May 04, 2005

Sometimes bigger just isn't better. The owners of "the World's Largest Truckstop!" learned that the hard way today from the 8th Circuit.

Size matters in computing tax because of the way gas stations are depreciated under the tax law. A "retail motor fuels outlet" is allowed to write off its buildings over 15 years; other commercial buildings are depreciated over 39 years.

To qualify, the Walcott truck stop would have to have at least 50% of its 50,528 square feet of floor space devoted to petroleum marketing. The I-80 folks told the courts that they crossed the 25,264 ft. threshold as follows:

Chrome Shop / Trucker Store	10,136
First Floor Restrooms	         2,354
Video Game Room			   379
Counters for Gasoline Cashier	 1,313
Storage Area			   502
Trucker Store Offices		   292
Stairs				   158
Corridor			   311
Second Floor (showers, TV Lounge,	
movie theater, phone rooms,	
and office space)		11,573
				______
Total				27,018

They probably felt compelled to leave out the restaurant space for marketing reasons, but having gotten gas there myself, I feel they arguably could have included that, too.

No matter. The court said that the upstairs space didn't count, leaving them well short of the 50% mark:

Iowa 80's position is that the services provided at its building are aimed to attract the professional truck drivers to fuel at its facilities. As such, Iowa 80 contends that those services are used to market petroleum. Iowa 80 explains that because between 70% and 80% of its business is dependent on those services, the floor space those services occupy are "devoted" to the marketing of petroleum. The import of Iowa 80's argument would mean that any service provided at its facility that can be said to "attract truckers" is a service devoted to the marketing of petroleum as contemplated by Congress.

The proper inquiry, however, is a comparison of the services offered by Iowa 80 to the services provided at a traditional service station or other similar markets.

The I-80 Truck Stop at Walcott is quite a place. If you haven't been there, you should take their virtual tour. It has a food court, a retail area larger than many grocery stores, showers, a lounge - everything the over-the-road drivers need, in one place. They also sell gas and diesel. They are to a normal gas station what the Mall of America is to a strip mall.

The I-80 folks argued that the 50% requirement should be interpreted liberally to reflect the realities of their business. The court said that was up to Congress. As a result, they were too big to just be a gas station. Decision for IRS.

Cite: I-80 Group , Inc., and Subsidiaries v. Internal Revenue Service, No. 04-2826.

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WHY STOP DIGGING NOW?

May 04, 2005

Tax Notes today reports a Department of Justice press release about a California attorney who wouldn't leave bad enough alone.

The release says the lawyer, James Davis, failed to file returns for 1999 through 2001, skipping out on $360,000 of taxes. He tried to hide the income from the IRS via a bogus non-profit, the "California Fire Marshal Officer's Association."

Then things got a little crazy:

The IRS executed search warrants on Davis's residence and business on July 16, 2002. After the IRS executed the warrants, Davis sent threatening letters to various individuals who had information relevant to the IRS's investigation. The letters accused those individuals of filing "false reports with the IRS" and threatened a multi-million dollar lawsuit against them. Davis also threatened to file criminal reports against these individuals naming them as "suspects" and created a website offering a "$10,000 reward for the arrest and conviction" of these individuals.

Ah, the citizen's arrest website. If only Goober had the Internet...

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PLAY "GUESS HOW THE CASE CAME OUT"

May 03, 2005

Today we challenge you to guess the winner of a tax case by reading a revealing passage from the "findings of fact." Answer in the extended entry. This one should be easy. Go!

Petitioner claimed $15,7411 of automobile expenses as unreimbursed employee business expenses for 2000. He testified that he daily maintained a mileage log by recording the odometer reading for each sales call on the day that he made the sales call, then transferred this information into a spreadsheet on his personal computer because, as he testified, he wanted to have a "more efficient paperless office." Petitioner maintained no other paper records for the business use of his automobile. The mileage log contained entries that were inconsistent with and in fact contradicted other evidence before the Court. For example, there were numerous entries on the same day on both the flight log and the mileage log that showed times and distances traveled that could not have taken place on the same day.

Ready?

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ARE IOWA VALUES FUND TAX CREDITS UNCONSTITUTIONAL?

May 03, 2005

The new Grow Iowa Values Fund legislation (H.F. 868) headed to the Governor's desk relies heavily on new and improved targeted tax credits to launch the Iowa economy into the 21st century. Yes, we know, it's a little late, but better late than never.

The reliance on these credits isn't surprising; targeted tax credits have been at the core of Iowa's economic development efforts for years. While they haven't made Iowa an economic juggernaut, the 19 existing credits have their grateful and vocal constituencies.

But what if they are illegal?

A COMMERCE CLAUSE VIOLATION?

The U.S. Court of Appeals for the Sixth Circuit has ruled that Ohio's investment tax credit scheme is unconstitutional as a violation of the commerce clause (Cuno v. Daimler-Chrysler, Inc):

Specifically, any corporation currently doing business in Ohio, and therefore paying the state's corporate franchise tax in Ohio, can reduce its existing tax liability by locating significant new machinery and equipment within the state, but it will receive no such reduction in tax liability if it locates a comparable plant and equipment elsewhere. Moreover, as between two businesses, otherwise similarly situated and each subject to Ohio taxation, the business that chooses to expand its local presence will enjoy a reduced tax burden, based directly on its new in-state investment, while a competitor that invests out-of-state will face a comparatively higher tax burden because it will be ineligible for any credit against its Ohio tax.

(emphasis added)

This ruling, if its application expands to our Eighth Circuit, would likely invalidate the tax credits in H.F. 868; indeed, it would undo almost all of Iowa's 19 existing credits. An excellent writeup in yesterday's State Tax Notes (available to all today thanks to the invaluable efforts of the TaxProf) outlines how the ruling's logic threatens similar credits in other states:

If Cuno is expanded nationally or its rationale is accepted by a Minnesota court, it is very likely the Minnesota statutes at issue in Olson would be struck down, as they are very similar to the Ohio statutes. The most obvious similarity is that both programs provide credits against corporate franchise tax for investments and purchases made within Ohio or within specific designated areas in Minnesota. In both states, the investments must represent increased economic activity. In Minnesota, businesses qualifying for the credits must increase their employment or capital investment by a set percentage. Under the invalidated Ohio statutes, businesses receive credits depending on how much their individual investment compares with overall new investments within a county.

The paragraph would be just as accurate if you substitute "Iowa" for "Minnesota." In fact, cases challenging targeted credits have been filed in Minnesota and Nebraska, both of which are in the same circuit as Iowa.

The authors of the Tax Analysts article expect the Supreme Court to decide the issue. Unless they reverse the Sixth Circuit, all of the legislature's economic development efforts may be worthless. <insert your own smart-alec comment here>

IS THERE ANOTHER WAY?

Sometimes it's said that politicians will do the right thing, after all alternatives have been exhausted. The courts might get Iowa to consider whether a low-rate, simple tax system with a broad base might be more attractive to businesses than our byzantine system with all of its credits and incentives.

The current system taxes Iowa's existing businesses to lure and subsidize their competitors. It's sort of like trying to attract girls by beating your wife. And anyone you attract that way probably isn't much of a catch.

UPDATE: Chad makes a good point down in the comments:

I've been thinking about this and wonder whether these tax credits/corporate welfare subsidies violate the Iowa Constitution's equal protection clause in the same way differential tax rates on land based and water based casinos do. Certainly the Newton racetrack sales tax giveaway seems spot on for violation.

We've had similar thoughts.

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IS IT TIME FOR LAW SCHOOL?

May 03, 2005

Professor Maule posts an essay on the ideal preparation for law school. It looks like it's time for me to sit for the LSAT.

What matters more than major, in many respects, is undergraduate course selection.

The Professor's recommendations:

-"Take a course in business basics..." I think I'm there.

-"Take a course in American history, not so much as to learn events but to understand the significance and context of those events." I knew my history major would eventually be useful for something.

-"Take a course in French-Norman-English history." Thanks, Dr. Abels.

-"If you haven't had Latin, and even if you have, take a year of French." Checque.

-"Speaking of looking up things, take an undergraduate law course, especially one that focuses on procedure." Gola has taken care of that.

-"Take a course that involves reading and understanding the Constitution. If you need to ask why, think again." See history major, above.

-"Take a course in understanding how something complex works and how its parts interrelate. In other words, take a course in one of the "hard" sciences, or engineering, or computer programming." Check.

-"Take a course that requires you to write." Does this site count?

-"Take a course that requires you to stand up in front of your classmates and explain something." Check.

-"Take a course in psychology" No problem.

-"Yes, there is much benefit in taking off a year or two between college and graduate school." How about 20 or so?

I'm ready. Now if I can just take care of this house payment stuff, and getting the kids through school, I am the perfect law school candidate. All reasonable subsidy offers will be considered.

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MAY DAY WEEK CARNIVAL

May 02, 2005

Capitalists of the world, unite! ...at this week's Carnival of the Capitalists, hosted at Incite.

The Carnival is a weekly roundup of economics and business weblog postings. We especially like this from "Slacker Manager":

So here's the next step for the intrepid Slacker Manager in-training: give away all your work. This is incredibly challenging for lots of managers.

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MOUSE TO ADDRESS CAT CONVENTION

May 02, 2005

I will be discussing the the new federal deduction for producers, also known as the "Section 199 deduction," Friday in Iowa City as part of the Iowa Bar Association's Spring Tax Institute.

I follow a real high-powered guy on the program, but mercifully there is a break between his act and mine.

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HOW TO TELL A PRACTITIONER FROM AN ACADEMIC

May 02, 2005

The TaxProf celebrates the passing of the statute of limitations on his 2001 returns.

The running of the three-year statute on returns is indeed a joyous event. For non-extended returns that don't have something really ugly in them, the statute for 2001 expired April 15.

The filing of a timely 1040 distinguishes the tax academic from the practitioner. For real practitioners, the statute doesn't expire until at least August, as we routinely extend our own returns. Some of us are on the hook until October 15, the three-year anniversary of the expiration of our second 2001 extension.

Also, practitioners aren't likely to attend something like this:

4 - 5 p.m Panel Moderator: Wendy Gerzog, Baltimore School of Law (visiting at Seattle University School of Law)

Anthony C. Infanti, University of Pittsburgh School of Law
Everyday Law for Gays and Lesbians (and Those Who Care About Them)

Nancy Shurtz, University of Oregon School of Law
Queer Theory and the Quest for the Essential Taxpayer

From 4-5 p.m., real practioners are on the golf course or at the bar at continuing education events...

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