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Tax Update Blog: December 2005 Archives

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December 30, 2005

Today's the last business day of the year for most taxpayers. We hope you've gotten your tax tax planning in hand by now so you can start celebrating the new year early. If not, there's still time to put a dent in your 2005 tax bill.

- Go online and make a charitable gift to a worthy cause with your credit card.

- If you won't pay alternative minimum tax for 2005, you can still prepay 2005 state and local taxes due next year. Iowans can prepay federal taxes due next year to deduct them on their 2005 Iowa returns.

- If you have a calendar-year S corporation with a loss, you can still make sure you have enough basis to deduct the loss.

- You can still close out long positions in loser stocks today and deduct the losses in 2005 (to the extent of 2005 capital gains + $3,000). For losses on short positions, though, it's too late for this year, as those aren't counted as tax losses until the settlement date.

- If you are a cash-basis taxpayer, you can write checks today for business expenses and deduct them this year.

- If you are an accrual-basis taxpayer, remember that expenses accrued to related cash-basis taxpayers have to be paid this year to be deductible this year.

- If you pay Iowa individual taxes, you can make a 2005 contribution to College Savings Iowa and deduct it on your 2005 Iowa return.

- You can help your estate planning by making personal gifts of up to $11,000 per donee, per donor. If you are a married couple, it doesn't matter which account the gift comes from, if you elect gift splitting on your 2005 Form 709. Remember, you will never have another chance to use your 2005 annual gift tax exclusion.

And remember, 2006 year-end planning can start January 1!

This is the final installment of our series on 2005 year-end tax planning.

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December 30, 2005

The TaxProf notes that willful failure to pay taxes is not a "serious" enough crime to merit disbarment from federal courts, according to a Fourth Circuit ruling.

The schmuck factor goes up another notch.

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December 30, 2005

Dr. Maule's blog "Mauled Again" won the "best law professor blog" award in Dennis Kennedy's "Best of Legal Blogging" awards. The runners-up were Paul Caron's TaxProf Blog and Tun Ying's (U of Iowa) Yin Blog.

Dr. Maule's post yesterday is a good example of his work. He takes on the Center of Budget and Policy Priorities for their opposition to repealing the phase-outs of itemized deductions and personal exemptions for high-income taxpayers. The CBPP's opposition to repeal seems to be entirely because these stupid phaseouts affect high-income taxpayers. Dr. Maule patiently explains why bad policy is, well, bad, even if it primarily screws the rich, and concludes:

It would be a shame if the Center on Budget and Policy Priorities continued to be duped, especially now that the PEP and Pease phaseout scam has been exposed and is on its way to a well-deserved but unfortunately slow-in-coming death.

All three of these top blogs are in our permanent blogroll. Coincidence? Well, probably, but if you want to be sure, a place on this blogroll could perhaps be purchased...

(Hat Tip: TaxProf Blog)

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December 29, 2005

Scene on the Des Moines skywalks:


Skywalk slot machine parlor video lottery installation

It's probably only a matter of time before they set up a unit at this convenient skywalk location:


But why stop there? Why not add a video lottery feature to the new credit-card parking meters they want to install in downtown Des Moines?

Sidewalk video lottery terminal: future dynamo of economic development

UPDATE: State 29 says what I'm too polite to say.

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December 29, 2005

The recent "tax gap" figures from the Commerce Department's Bureau of Economic Analysis have triggered divergent comments on the tax blogs.

Kerry Kerstetter of calls the tax gap "fictional," and says:

I saw a summary of that report yesterday and figured right away that this was another case of our rulers comparing apples and oranges. There are so many ways to calculate the value of economic activity in this country (GNP and GDP are just two), that it is impossible to match any of them up with what is shown on income tax returns. Anybody who claims that such a comparison is possible has been smoking far too much wacky weed to be trusted.

As we have seen for several years, the mainstream media don't care one whit about accuracy when it gets in the way of their agenda. Giving more power to the IRS has obviously been their goal for a very long time, and anything they can use to bolster that argument will be used regardless of its legitimacy.

Villanova's Dr. Maule says the gap is all too real:

The tax gap, for those unfamiliar with the term, is the difference between income that is reported to the IRS and income that should have been reported to the IRS. The BEA uses economic data from other sources, such as payroll information provided to state and federal agencies, to determine how much income of a particular sort was derived by taxpayers. It then uses IRS data to determine how much of that income was reported.

The tax gap for calendar year 2003, the latest year for which sufficient statistical information is currently available, is $1.0417 trillion. Yes, more than $1 trillion. Compute the tax on that amount, pay it to the Treasury, and re-determine the budget deficit.

Mr. Kerstetter has said that he believes people overpay their taxes. He bases this conclusion on what he sees in his own practice, where he typically gets refunds when taxpayers hire him. That's surely true, but it is also an example of "selection bias." The people who see Mr. Kerstetter want to pay their taxes -- or, perhaps more accurately, they don't want to get in trouble for not paying their taxes. These are the people most likely to have overpaid their taxes out of excessive caution.

He doesn't see those who aren't afraid to cheat. He doesn't see the restaurant owners who don't ring up the cash sales, the e-bay entrepreneurs who put their income off the books, or the business owners that have their company pay their personal expenses.

Tax cheating is in many ways more natural than tax paying. The government will still be there if any given person cheats on their taxes; why pay for it if it will be there anyway -- especially when you suspect that guy next door is cheating, too.

In "The Wisdom of Crowds," James Surowiecki explains what it takes to get people to pay their taxes:

When it come to solving the collective problem of how to get people to pay their taxes, then, there are three things that matter. The first is that people have to trust, to some extent, their heighbors, and to believe they will generally do the right thing and live up to any reasonable obligations. The political science professor John T. Scholz has found that people who are more trusting are more likely to pay their taxes and more likely to say it's wrong to cheat on them. Coupled with this, but different from it, is trust in the government, which is to say trust that the government will spend your tax dollars wisely and in the national interest. Not surprisingly, Scholz has found that people who trust the government are happier (or at least less unhappy) about paying taxes.

The third kind of trust is the trust that the state will find and punish the guilty, and avoid punishing the innocent... If people think that free riders -- people not paying taxes but still enjoying all the benefits of living in the United States -- will be caught, they'll be happier (or at least less unhappy) about paying taxes. And they'll also, not coincidentally, be less likely to cheat.

The "schmuck factor" is the inverse of these "three kinds of trust." The lower these levels of trust, the higher the schmuck factor. If you think you are paying for something your neighbors are getting for free, and they are getting away with it, you feel like a schmuck. Nobody wants to be schmucked.

I suspect that the rise of the tax shelter industry and the decline in audit coverage during the 1990s caused a lot of people to feel schmucked. The ridiculous degree of complexity that has crept into the tax law since 1986 surely hasn't helped. Along with the anti-enforcement legislation resulting from the farcical Congressional hearings on IRS abuses of the 1990s, these problems have raised the schmuck factor to dangerous levels.

Dr. Maule identifies (correctly, in my view) two steps needed to close the tax gap:

Congress must reform the income tax system so that it is easy to understand, inviting of compliance, and difficult to evade. Congress must also put in place safeguards that prevent noncompliance and punish tax evaders.

Unfortunately, the longer Congress waits, the more painful the fixes, and they don't seem to be in any hurry.

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December 28, 2005

State 29 notes that today is Iowa's 159th birthday. Our fine state joined the Union in 1846. James K. Polk was President, and as a reward he got to name Iowa's most populous county.

1846 was a busy year:

The Mexican War got underway, resulting in the acquisition of California and paving the way for the modern film industry.

Ether was first used as an anesthetic, setting the stage for California's other major industry.

The Donner Party set up the first modern diet camp in the Sierras. The party lost over 50% of their weight, though their weight-loss program would not meet current wellness standards.

Henry David Thoreau spent three days in jail for failure to pay poll tax. A friend paid the tax for him, a precursor to the modern executive tax gross-up.

We encourage you to celebrate this festive occasion responsibly in your own way.

celebrating 159.jpg

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December 28, 2005

Leave it to that old softie, Dr. Maule, to write about the tax implications of choosing your wedding date.

It's a sore subject at the Tax Update. If only my dear bride had listened to me and married in the middle of winter, I could have paid for our wedding with the tax savings. Of course, that says more about how miserably cheap about paying for the wedding broke I was than about the amount of tax savings. When a hasty December wedding did not appeal to the bride, I grudgingly cheerfully went along.

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December 28, 2005

The competition was stiff this year for the prestigious Tax Update "Taxpayer of the Year" designation. 2005 brought us the indictment of Richard Hatch, the underdressed Survivor, on tax charges; the spectacle of Dennis Kozlowski, the former Tyco exec, telling a judge how he plumb forgot about $25 million dollars of income when he signed his 1040; and Glenn Hightower, who chose to fight a $7.9 million federal tax assessment in Tax Court without a lawyer. Their efforts, distinguished as they are, still pale next to that of our winner, Mr. Willy Wetzel, who achieves our honor posthumously. Mr. Wetzel is the 2005 Taxpayer of the year because he died in a martial-arts battle with his tax preparer. The story is told in a case involving Mr. Wetzel's life insurance policy:

Willy Wetzel and his son, Roy Wetzel, were experts in the martial arts, including karate, and operated a [martial arts] school.... On the day of Willy Wetzel's death, Roy had been working on his father's income tax return. Willy visited his son and began reading the completed tax forms....As Willy Wetzel started to sign the tax forms, he threw the pen against the drapes and began to scream obscenities. He walked toward the front door mumbling that he was going to lose his house, car and everything. Grabbing a Hawaiian sword, Willy Wetzel turned and let out a battle cry called a "kewah." The fight began.

Willy began to remove the sword from its case when Roy attempted to grab the case. Willy kicked Roy and the sword was bent in half. The hand-to-hand fight continued for approximately twenty-five minutes. Roy made several attempts to reach the telephone to call for help, but was stopped each time by his father's tactics. Finally, Roy placed nanchukas sticks, used in karate, around his father's head to try to render him unconscious. Shortly after that Roy realized his father was dead.

The Moral: always be nice to your tax preparer.

Thanks to the TaxProf for alerting us to this story.

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December 27, 2005

OK, you've been busy. Packages to wrap, football to watch, dinner to cook, kids to haul... and you've neglected your tax planning. While real year-end tax planning is best started January 1, all is not lost. You can still get a 2005 charitable deduction, and help a good cause in the bargain.

If you write a check to charity and it's postmarked by December 31, it counts this year. It also counts this year if you go online and pay with your credit card -- even if you don't pay your credit card bill until next year.

Many worthy charities make it easy to give online. Here are a few of my favorites:

Salvation Army. If you want your charitable dollars to be used helping people who really need it, rather than to pay for administration and fund raising, the Army can't be beat.

Hospice of Central Iowa. The Hospice people do tremendous and underappreciated work to help those facing death, and their families.

And don't forget that it's winter in southwest Asia, which last month suffered enormous earthquake damage. You can help the Save the Children relief effort here.

If you want to find out whether your favorite charity takes online donations, the Network for Good is the place to go.

This is another installment in our series on 2005 year-end tax planning.

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December 23, 2005

Nice photo feature in the online Des Moines Register.

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December 23, 2005

From a ruling issued yesterday by Judge Mark W. Bennett in the U.S. District Court for the Northern District of Iowa:

Like the legendary Fawkes depicted in Harry Potter and the Chamber of Secrets, see Rowling, supra, at 320-22, the plaintiffs’ complaint has been born anew out of the ashes of its former existence. The plaintiffs’ third amended complaint sufficiently alleges facts demonstrating the existence of a RICO enterprise that is distinct from that inherent in a pattern of racketeering.

I hope this doesn't signal the introduction to federal juristiction of legal standards of the wizarding world:

a) torturing children for lying; b) utilizing a prison designed and staffed specifically to suck all life and hope out of the inmates; c) placing citizens in that prison without a hearing; d) allows the death penalty without a trial; e) allowing the powerful, rich or famous to control policy and practice; f) selective prosecution (the powerful go unpunished and the unpopular face trumped-up charges); g) conducting criminal trials without independent defense counsel; h) using truth serum to force confessions; i) maintaining constant surveillance over all citizens; j) allowing no elections whatsoever and no democratic lawmaking process; k) controlling the press.

Judge Bennett, may I withdraw my motion?

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December 23, 2005

Gifting looms large this time of year, and the tax world is no exception. Of course, it's easier for tax folk, for we tend to tell other people to give money away, but it's the thought that counts.

We tell people with enough money to worry about estate taxes to give generously each year to their family members. The Estate Tax doesn't look like it's going away, and gifting is a good way to to fend off the grim estate tax reaper. Taxpayers can give away $11,000 per year, per donee, without the gift counting against your lifetime estate and gift tax exemption. A couple with one married child and three grandchildren - five donees - can put $110,000 out of reach of the tax collector each year with annual gifts.

The flip side of the annual exclusion is that once the year is over, the opportunity is gone. The the couple with five donees that fails to use the annual exclusion has blown a $110,000 estate planning opportunity forever.


Making a gift should be easy, but creative taxpayers have found an amazing number of ways to screw it up:

- One taxpayer endoresed shares of stock to his son. He put them in a safe deposit box with a note that the stock belong to his son. The son never knew about it, so the gift didn't count.

- A farmer deeded properties to grandchildren as gifts and recorded the deeds, but never told the grandchildren and continued to run the farms as if he owned them. The gift didn't count.

- A taxpayer meant to forgive notes owed her by her kids, but never got around to it. The "gift" didn't count.

- A taxpayer wrote gift checks but died before they were cashed. The gifts didn't count.

If you want to make sure the gift counts in 2005, don't be too cute. If you give cash and you are close to the deadline, have the bank make an electronic transfer, or deliver a cashiers check. If you are giving away stock or mutual fund shares, get them to the donee account before year end. And make sure they know; if you never tell the donee that they have a gift, the tax law says they don't.

This is another installment in our series on 2005 year-end tax planning.

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December 23, 2005

Congress is going on break with the one-year alternative minimum tax punt and the tax reconciliation bill still not passed. Both houses have passed a tax reconciliation bill, but it has to go to conference. The house has also passed a stand-alone bill to keep the current law higher AMT exemption in place for one more year.

Republicans want to pass AMT relief as a stand-alone bill to leave room in the tax reconciliation to extend the 15% top dividend and capital gain rates beyond 2008. Democrats opposing the 15% rate extension ran out the clock before the recess and now nothing will happen until February.

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December 23, 2005

The Tax Policy Blog has two worthwhile posts up on "The Cost of Unstable Federal Tax Law."

The second post talks about how potential buyers of the Toyota Prius are waiting until January to buy the car because only purchases after December 31 qualify for the new hybrid car credit.

Of course, if these folks are subject to AMT in 2006, they are in for a nasty surprise: the credit doesn't count for AMT. If they are in AMT every year they may be better off closing the deal before year end to qualify for the current law clean fuel deduction.


The Cost of Unstable Tax Law
The Cost of Unstable Tax Law, Part II

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December 22, 2005

maytag.gifThe Maytag shareholder vote on the proposed merger with Whirlpool is scheduled for today. Here is our post on the tax consequences of shareholder approval.

I would guess that you can review the tax consequences of a vote to reject the deal here.

UPDATE: Maytag shareholders approve merger.

Maybe he can find some companionship now. (Thanks, InsureBlog!)

Link: The Maytag press release on the vote.

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December 22, 2005

Professor Maule has some thoughts about the fight to exclude "immoral" businesses from the benefits of hurricane relief legislation.

Like Professor Maule, I think the tax code is complicated enough without trying to make moral distinctions among legal businesses. If they insist on denying benefits to hurricane victims on moral grounds, though, I have some candidates of my own.

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December 22, 2005

Quote of the day number 1:

"The state is bound, like any other party is bound, to the contracts to which it freely and knowingly enters, and from which it benefits. Here the state seeks to abrogate that which it has promised but offers neither to forgo future payments or to refund past payments."

- Minnesota District Court Judge Michael Fetsch, in striking down a 75-cent per pack "tobacco health impact fee" enacted in violation of the tobacco settlement.

Quote of the day number 2:

"The judge made a significant error by ignoring the principal of separation of power which is the Legislature's authority to independently make decisions without being bound by prior agreements reached by the attorney general."

- Minnesota Governor Tom Pawlenty, who is still quite willing to cash the checks from the tobacco settlement negotiated by the attorney general.

More here.

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December 21, 2005

bestill.jpgThe 1993 IRS settlement with the Church of Scientology came into play in the Tax Court today. Michael Sklar, a Los Angeles CPA, attempted to deduct a portion of tuition paid to send his children to a Jewish day school. He reasoned that if the Scientologists can deduct their "auditing" and "training" fees as charitable contributions, it's only fair to let him similarly deduct the cost of a religious education for his children.

Fair or not, the Tax Court didn't agree. The Tax Court sidestepped the equal protection issue, falling back on established court rulings that religious eduction is not deductible as a charitable deduction.

Presumably Mr. Sklar won't continue the fight by other means -- differing in that respect from the Scientologists. One website devoted to the Scientologist battle with the IRS summarizes that fight:

On 1 October 1993, the Church of Scientology obtained tax exemption from the United States Internal Revenue Service (IRS). This ended 26 years of what the Church itself has described as a "war" against the IRS, in which it used extraordinary and in many cases illegal tactics - bugging of government offices, theft of mountains of classified files, private detectives pursuing senior government officials, thousands of lawsuits, full-page attack adverts in US daily newspapers, and so on.

The Moral? Moses had only 10 plagues; the Scientologists probably have dozens of attorneys.

Cite: Michael and Marla Sklar, 125 T.C. No. 4.

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December 21, 2005

I am tardy in noting this week's Carnival of the Capitalists and Carnival of Personal Financial Planning.

The InsureBlog graces this week's Capitalist gala (at Coyote Blog) with "Good (Insurance) News for Cancer Survivors." Henry Stern, the InsureBlog proprietor, has opened my eyes to the possibilities of getting health insurance in spite of dicey health profiles.

Over at the Personal Finance event, hosted by Political Calculations, The Happy Capitalist ponders whether money is what makes a capitalist happy.

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December 21, 2005

When a business has a bad year and loses money, sometimes the tax return is the silver lining to a dark cloud. When the business is run through a pass-through entity, like an S corporation or partnership, losses can pass through to the owners returns, reducing the owners taxes.

In theory, anyway.


The tax law only allows owners of pass-through entities to deduct pass-through losses to the extent of their basis in a pass-through entity. Basis starts with what you pay for the entity. It is increased by your share of earnings and capital contributions, and reduced by losses and distributions to owners. S corporation shareholders can get basis for losses by loaning money to their corporations, but NOT by guaranteeing S corporation debt. Partners get basis to the extent of their share of debt inside the partnership.

If you don't have basis in excess of your losses, you can only deduct the losses up to your basis; the excess losses carry forward to years in which you have income from the pass-through or make additional capital contributions.


Taxpayers have learned to their sorrow that you have to be careful when you make year-end loans or capital contributions to enable you to use losses. This is especially a problem when taxpayers use loans to obtain basis. If the loans contributions lack "substance" or are funded by borrowings that are not "at-risk," the deductions will be denied.


The Oren case illustrates this problem. An owner of multiple S corporations found that it needed to get basis in a loss corporation by year-end. One corporation then loaned money to the owner, who loaned it to the loss corporation, which then loaned it back to the corporation that made the first loan - the money all ending where it started.

While the taxpayer did all of the paperwork correctly, the courts ruled that there was no substance to the loans, because everyone ended up pretty much where they started. They also ruled the loan was not "at-risk" because it was borrowed from a related party.



- Don't borrow money from a related party (family member, another business you own, or a business owned by a family member, for example).

- Don't put money into the pass-through on December 31 and withdraw it on January 1. Leave the money in the business a decent lenght of time.

- Don't send the money right back where it came from.


- If you must borrow to fund the capital contribution, borrow from an unrelated party, like your friendly community banker.

- If you must use funds from a related business, take them out as a distribution, rather than a loan.

- Leave the money in the loss business for a decent length of time.

- Work closely with your tax advisor to make sure you do things right.


There are other limits on pass-through losses besides basis. The "passive loss" rules, for example, disallow many losses even when there is plenty of basis. At-risk limits can apply even to unrelated-party loans in many instances. If you're talking real money at year-end, get your tax pro involved.

This is an installment in our series on 2005 year-end planning.

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December 21, 2005

The TaxProf has links to the briefs in the Cuno case now before the Supreme Court. As a public choice theorist would predict, the proponents of taxing existing businesses to lure and subsidize their competitors are legion. Professor Caron's list of those filing Amici briefs in favor of corporate welfare:

    * AlphaGenics, Inc., Greater Baltimore Technology Council, 
MdBio, Inc., Technology Council of Maryland, Upsate Venture 
Association of New York, Inc., and 20/20 Genesytems, Inc.
    * Ashbrook Center for Public Affairs
    * City of New York
    * Council on State Taxation and National Association of 
    * Ford and GM
    * National Governors Association, National league of 
Cities, International Municipal Lawyers Association, Council
of State Governments, National Association of Counties, 
National Conference of State Legislators, U.S. Conference 
of Mayors, Government Finance Officers Association, and 
International City/County Management Association
    * Nissan
    * Pacific Legal Foundation
    * Tax Executives Institute, Inc.
    * Tax Foundation
    * The Right Place, Inc. and the City of Grand Rapids, MI
    * Thirty-Four States (AL, AZ, AR, CA, CO, CT, DE, GA, HA, 
ID, IL, IN, IA, KY, ME, MD, MA, MI, MO, NE, NV, NY, ND, OK, 
    * Washington Legal Foundation
    * Wayne County, MI

The complete list of those filing Amici briefs opposing corporate welfare:

It seems the plunderers are better-organized than the plundered.

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December 21, 2005

From the "Death and Taxes" Blog:

" my experience, estate planning lawyers are rarely called in to view secret sex tapes."

And when they are, they never invite the accountants.

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December 20, 2005

The IRS is getting ready to make partnerships and S corporations start filing the long-form book-tax reconciliation, schedule M-3, starting with 2005 returns due in 2006. The IRS has now published draft versions of the forms. C corporations with assets over $50 million led the way last year with the first M-3 filings; the threshold is $10 million for 2005 C corporation returns.

The M-3 is designed to make tax filings more transparent to examiners by making it more difficult to bury questionable deductions. Instead of the old 8-line summary in form M-1, M-3 filers face a three-page, 68-line inquisition that forces you to list out all of your differences between financial accounting and taxable income. The IRS hopes to prevent hide-the-ball tactics like that used by Long-term Capital Management, who buried a $106 million bogus tax shelter loss on M-1 in "net unrealized gains."

Here is a sample from the draft S corporation M-3:


We'll miss the, um, flexibility of the old format:



Draft Form 1120-S M-3

Draft Form 1065 M-3

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December 20, 2005

It's silver lining time.

Iowa has a personal tax system with high rates and byzantine complexity. Yet along with our workhouse gruel, we Iowans occasionally get a chocolate chip cookie. The College Savings Iowa tax deduction is one such tasty morsel.


College Savings Iowa is a state-sponsored Section 529 college savings plan. It is a reasonably well-run plan offering low-cost Vanguard funds, but it has an additional attraction for Iowans: you may deduct up to $2,375 per donee, per year in contributions to college savings Iowa on your Iowa tax return. That means a married couple with two children can deduct $9,500 in 2005 CSI contributions.

If your child is in college already, it's not too late to get CSI benefits. You can qualify for the Iowa deduction simply by funneling your current tuition payments through CSI.


While there is no federal deduction for contributions to Section 529 plans, the earnings accumulate tax-free and may be withdrawn tax-free to pay college costs.

There is also a special gift tax benefit for Section 529 plan contributions. You can take up to five years worth of gift tax exclusion - $55,000 - in a single year if the gift is to a Section 529 plan.


You have to make your CSI payments by December 31 to deduct them on your 2005 Iowa tax return. If you don't have an account yet, you may go online here to set one up.

This is an installment in our series on 2005 year-end tax planning.

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December 20, 2005

One of the factors in deciding whether to use the new "Roth" 401(k)s that become available January 1 is whether your tax rate at retirement might lower than it is now. A new report by the Congressional Budget Office makes a sobering case that tax rates are going nowhere but up over the long term:

Driven by rising health care costs and an aging population, federal spending for Medicare, Medicaid, and Social Security will claim a sharply increasing share of the nation’s economic output over the coming decades.

Even if taxation reached levels that were unprecedented in the United States, current spending policies could become financially unsustainable. An evergrowing burden of federal debt held by the public would have a corrosive and potentially contractionary effect on the economy.

As the U.S. tax system is now configured, federal revenues will grow faster than the overall economy. Under current law, taxpayers will face higher rates, with detrimental consequences for work, saving, and economic growth.

If taxation is restricted to the levels that prevailed in the past, the growth of spending on programs for the elderly will have to be reduced substantially. Limiting the growth of outlays for defense, education, transportation, and other discretionary programs would not be enough to ensure fiscal sustainability.

Likewise, economic growth alone is unlikely to bring the nation’s long-term fiscal position into balance. Moreover, issuing ever-larger amounts of debt or dramatically raising tax rates could significantly reduce economic growth.

In a "Roth" 401(k) plan, you don't get a current tax break for deferring part of your salary; instead, if you meet certain conditions, withdrawals from the plan are tax-free forever. This is different from conventional 401(k) deferrals, which are excluded from taxable income currently but are taxable on withdrawal. If your tax rate will be lower at retirement, Roth 401(k)s aren't as attractive.

There are many factors besides tax rates to consider in evaluating a Roth 401(k); this article covers them well.

Hat tip: Tax Policy Blog, which has some eye-opening charts to illustrate the dilemma.

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December 20, 2005

The IRS has increased its "user fees" for national office rulings, effective February 1, 2006.

Complete fee schedule here.

So act now! You'll never see these low, low prices again!

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December 20, 2005

The IRS has issued (Rev. Rul. 2006-04) the minimum interest rates for loans made in January 2006:

-Short Term (demand loans and loans with terms of up to 3 years): 4.38%
-Mid-Term (loans from 3-9 years): 4.48%
-Long-Term (over 9 years): 4.73%

Can you say "flat yield curve?" I knew you could!

Historical AFRs are available via the “Links” page at

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December 19, 2005

Last year Congress voted to allow Individual Retirement Accounts to own stock of bank S corporations (but not other S corporations). They proceeded to utterly botch the job. The legislation passed last year only allowed banks without holding companies to qualify for S corporation status with IRS owners. That allowed approximately one bank to take advantage of this provision.

Congress took a big step towards fixing the job when it passed legislation allowing bank holding companies with IRA owners to elect S corporation status. This fix was included in H.R. 4440, the "Gulf Opportunity Zone Act of 2005. The President is expected to sign the bill.


The bill only applies to IRAs that owned bank stock on October 22, 2004, and only to the extent they owned the stock on that day. Bank holding companies wanting to make an S election now have until March 15, 2006 to become S corporations for the 2006 calendar year.

Traditional IRAs will still not be ideal S corporation shareholders. Bank income will presumably be "Unrelated Business Taxable Income" to the IRA, making it taxable at corporate tax rates. When the traditional IRA makes a distribution to its owner, that distribution will also be taxable. This means there will still be two taxes on traditional IRAs owning bank holding company stock.


Absent special rules, this double tax on future earnings would be unavoidable. Under normal circumstances a purchase of stock out of an IRA by an IRA beneficiary leads to tax catastrophe in the form of a "prohibited transaction." The IRA would be considered terminated and fully taxable to the beneficiary and a 100% excise tax would apply to the stock purchase.

The tax law allows IRA beneficiaries a one-time chance to avoid this double tax on future bank earnings. The IRA beneficiary can safely buy bank or bank holding company stock out of an IRA if ALL of these conditions are met:

(1) The stock must have been held by the IRA as of October 22, 2004.

(2) The sale must be made pursuant to an S election by the bank.

(3) The sale must be for fair market value at the time of sale, as established by an independent appraiser, and the terms of the sale must be at least as favorable to the IRA as the terms would have been on a sale to an unrelated party.

(4) The IRA cannot pay any commissions, costs, or other expenses in connection with the sale.

(5) The stock must be sold in a single transaction for cash no later than 120 days after the S election is made.

These requirements are not to be trifled with. A violation of the prohibited transaction rules -- even a seemingly trivial one -- is an unmitigated tax disaster. But while these rules may seem like a lot of trouble, it's likely worth it for traditional IRA owners. Traditional IRAs are just not a tax efficient way to hold bank holding company stock.

Unfortunately, the IRA may have to pay "unrelated business income tax" on part of the bank sale price. It's still likely to be a better deal in the long run than paying UBIT on bank earnings.


Language of the H.R. 4440.

The TaxProf Blog roundup of H.R. 4440 links.

American Bankers Association press release praising IRA fix in original Senate bill.

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December 19, 2005

To many, paying for government is only an incidental function of the tax law. Some think its real function is as an all-purpose tool to make us better human beings -- or maybe just slimmer ones.

Not everyone thinks this is wise. The Tax Policy Blog notes a new article by two economists from the President's tax reform panel that thinks maybe the tax code isn't the Leatherman Tool of policymaking:

It is possible to argue that some activities should be encouraged by the tax system, either because they create social externalities or because there are other distortions in the economy that could be offset by appropriate tax remedies. Such arguments are usually difficult to support with empirical evidence, and they lead to special privileges and a myriad of tax breaks that are likely, on balance, to reduce the efficiency of the tax system.

Given the political process that determines the tax code, special provisions are likely to depend more on an interest group’s lobbying efforts than on careful estimates of social externalities or other considerations.

Gee, you think so?

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Congressional taxwriters address our unmet needs

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December 18, 2005

Roth IRAs have been an attractive option for many taxpayers for some years now. Starting in 2006 "Roth 401(k)" accounts will be available. Today the Online Wall Street Journal has an excellent free article on who should use the new Roth 401(k)s

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December 17, 2005

Five national-firm accountants jumped the fence and started Roth & Company 15 years ago today. A rare photo of the fab five, their first employee, and their first photocopier:

Left to right: Joe Kristan, Gordon Roth, Steve Weiss, Wayne Floerchinger, Tana Buchman, Tim Breitbach. Click on photo to enlarge.

Contrary to legend, we did not smuggle the photocopier out of the old firm in our briefcases one piece at a time. Note the stylish eyewear.

Gordon Roth and Steve Weiss have since been promoted -- they are clients now. Tana has also moved on, but Joe, Wayne and Tim have yet to find better work.

In our first year we had the good fortune to be joined by two national firm partners, Jerry Carlson and Les Heimsoth.

Jerry Carlson

Les Heimsoth

Over the years Greg Clausen, Ross Smith, Jay Anderson and Doug Ross have also joined the firm as shareholders. We have gone from one non-shareholder employee to 24.

The paychecks have all cleared in 15 years, for which we thank our clients and our fine employees. Here's to you!

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December 16, 2005

Paying state and local non-business taxes early is a time-honored tax planning tool. Sometimes, though, it's best to leave a tool in the box. While prepaying taxes is sometimes wise, sometimes it's nothing but an interest-fee loan to your friends at the Hoover Building.

Before pre-paying 2006 state and local income and property taxes, you need to answer some questions:

1. Can I even itemize this year? If not, and your taxes don't get you over the standard deduction, don't bother.

2. What is my AMT situation for 2005 and 2006? If your tax projection shows you will be paying alternative minimum tax this year, pre-paying your taxes will do you no good. By allocating your payments between two years, you may find that you can avoid AMT in both years and minimize your taxes. If you have AMT next year but not this year, pay up this year, or the deduction is wasted.

3. Is the deduction this year worth giving up use of the cash now? Assuming the amount will be deductible at the same marginal rate either year, this is a time value of money question: is the present value of getting a deduction a year earlier worth more than the lost earnings from the amount you prepay? The further ahead you have to prepay to get the deduction this year, the less you benefit.

In the chart below we compare the time value of accelerating a $1,000 deduction by one year -- reducing tax on April 15, 2006 instead of April 15, 2007 -- to the earnings you will lose on the money by prepaying an amount on December 31, 2005 instead of the actual due date. We compare some due dates for amounts that can be prepaid:

January 31: due date of Iowa fourth quarter estimated taxes.
March 1: due date of first Iowa property tax installment.
April 15: due date of most state individual tax returns.
April 30: due date of Iowa individual tax returns.
September 1: due date of second Iowa property tax installment.


Using a 4% discount rate, you can see that taxpayers in any bracket are better off making their first quarter state payments early. At the lowest brackets, however, it doesn't make sense to pay your March 2006 property taxes early; the value of accelerating the deduction by one year is less than the interest you would earn by waiting until March 1 to make your payment. Only taxpayers in the highest brackets should prepay their state balances due on April 15.


This chart only works if all of its simplifying assumptions are met, and real life seldom works that way. For example, if you are in AMT this year, prepaying never makes sense. If you will be in regular tax this year but AMT next year, you might want to prepay everything you can - maybe even your September property tax installment; then you aren't looking at when you get your deduction, but whether you will get it at all. If you will be in a much lower bracket next year, or you won't be able to itemize, you are probably better off prepaying.

One thing is certain: if you don't run the numbers, you won't be able to make an informed decision.

This is another installment in our series on 2005 year-end tax planning.

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December 16, 2005

gown.aspxNot all Tax Court cases are fun. In another case released yesterday, the Tax Court judge had to wade through over 100 disputed items for a Phoenix multi-level marketing outfit, involving close to $5 million in deficiencies. It looks like the MLM executives tried to deduct everything including their kitchen sink.

For example, the taxpayers built a lavish house and contented that it was deductible because it was not merely a "dwelling," but "a trophy house aka billboard in lieu of money spent for highway billboard or other media purchases, such as radio, t.v. and newsprint." The Tax Court didn't buy it. Just because a house is, as the judge put it, "remodeled to become more grandiose" doesn't exempt it from the tax law's strict tests for deductibility of home expenses.

The taxpayer's ("petitioners") attempts to deduct formalwear peg out the chutzpah meter:

Q And describe for the Court your method of operation with respect to wardrobe or costume for those in your company participating at the conventions?

A Well, if you're going to give the appearance of affluence you have to be capable of looking the part. And obviously wearing a different suit between the morning session and the evening session has bearing on it. More so with the women.

As I said earlier, we worked the tables, both my sons and their wives and my wife. We would visit all 5,000 people. We would talk to all five, shake hands with them, turn around and they would have met all three of the families during that last night at that last time. So it would be imperative that the gowns worn by the girls especially could not be the same ones that they had on at an earlier function because they were always a constant reference at the tables by the distributors saying "What a beautiful gown." "Isn't that gorgeous."

It was obviously over the top type dress. I mean you couldn't wear it to the grocery store or the gym or anything but it was done on purpose so that all the children and everybody else had matching outfits on and it just generated the enthusiasm backwards from them that they wanted to be and participate.

Q * * * The wardrobe we're talking about that was paid for by the companies?

A Yes.

Q And what was the policy as to whether the women could wear the dress more than once?

A No. The dress, once the dress had been seen it could not be seen again.

Q And then what happened to the dress?

A They all went to charity or were just given away to third parties.

Q And what rule, if any, with respect to the men?

A The men was a little bit easier because most of the time they would just have to have tuxedos. Our requirement on the men was that they just couldn't -- you can't just walk into and buy a tuxedo at Men's Wearhouse and expect somebody to say, "Gee, that's a great looking piece of garment." It's how it's tailored and how it fits that has more intensity to it.

The judge was unmoved by the contention that these ball gowns were really work uniforms. Perhaps his attitude was soured by some of the "uniforms":

Assuming arguendo that a once-wear policy would render clothing unsuitable for personal wear in petitioners' particular situation, Mr. Deihl's generalized testimony does little to show that each of the claimed charges was in fact for the purchase of such a once-wear item. As respondent notes, among the Neiman Marcus charges is one showing two turtlenecks at $165 each.

All in all, it was a bad day for the MLM deductions. This case is a study in the weaknesses of the Eddie Haskell approach to documenting your tax deductions.

Cite: Deihl v. Commissioner, T.C. Memo. 2005-287.

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December 16, 2005

Russ at Taxable Talk reports on an opinion that a Tax Court judge had way too much fun writing. It involves a guy with a little auto repair business whose recordkeeping seems more suitable for a crack dealer than a legitimate businessman:

He credibly explained that he kept most of his business receipts and records stuffed in duffel bags, which he stored in a loft above his repair shop. He also credibly testified that he was in the habit of employing recently released prisoners, encouraged in part to do so by his father, a retired sergeant in the county sheriff's office. Washington Car's records went missing in 2002, and Cox convinced us that one of his evidently not-quite-rehabilitated employees stole one of the duffels, no doubt thinking it contained cash instead of canceled checks, receipts, and bank statements. (That employee disappeared shortly thereafter.)

In spite of his serious recordkeeping shortcomings, the judge decided that the taxpayer was telling the truth and allowed his deductions despite the missing records. He started out the opinion this way:

Tax records are the ancient Egyptians of the modern age -- plagued not by boils, frogs, flies, and lice but by fire, flood, mold, and theft. The cursed tax records in this case belonged to Raleigh Cox, who owned a business that fixed used cars and then resold them. When audited, Cox failed to produce the records that would have supported many of his claimed business deductions, and blamed their absence on a thieving former employee. The parties have since settled most of these issues, but the Commissioner hardened his heart against Cox's deductions for cash purchases of used cars.

We must decide whether to let them go.

So remember to sprinkle your doorpost with lambs blood so the Angel of Death will pass over your backup tapes.

Cite: Cox v. Commissioner, T.C. Memo 2005-288

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December 15, 2005

Joel Schoenmeyer at Death and Taxes shows how a big-city bank generated serious badwill in handling a decedent's mortgage:

The claim arrived in the mail about two weeks later. (When I asked him about it, the attorney said he didn't recall our conversation, and stated that he had too many open files to be able to keep track of them all.) The claim included $500 for attorney's fees. When I told the attorney that my clients objected to paying these fees (since an out-of-court resolution could easily have been reached), the bank's attorney told me we could fight the fees in court, but that he would bill the estate for additional fees at a rate of over $200 per hour. Frustrated, my clients then agreed to allow the claim, at which point the attorney tried to tack on an additional $200 in fees for speaking with me on the phone about this matter.

The moral? Be thankful for your local community bank.

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December 15, 2005

Managing your top executive personnel can be difficult for any boss. Cheating on taxes doesn't make it any easier:

The prominent owner of a major Petaluma business faces up to 21 months in prison after pleading guilty to five counts of tax evasion in a federal court hearing on Thursday.

Lee Nobmann, 55, CEO of Golden State Lumber, had fought the charges ever since Jim O'Brien, the firm's former chief financial officer, reported questionable company behavior to the IRS after being fired in 2001.

Don't make the financial guy mad when you do stuff like this:

Federal authorities claim he intentionally failed to pay the government some $330,000 by attributing his private, personal expenses to the company, and writing them off as business expenses.

Nobmann said that his company, which earns $220 million per year, paid for his private, personal expenses, including credit card payments for his wife, and that he deposited rebates from vendors into his personal account without reporting them as his or his company's income.

Nice going. Next time do something more discreet, like leaving compromising photos on a shared directory on the office network.

The moral? Cheating on your taxes can be excellent blackmail fodder.

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December 15, 2005

Dan Meyer at TickMarks is a fine human being with an excellent tax and accounting blog from an academic perspective.

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December 14, 2005

That's what it looks like to me, anyway...



A gift idea from the TaxProf, who puts the "gag" in gag gifts.

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December 14, 2005

Had a good year in the stock market? You're not alone this year. If you're like the rest of us, you may have a few clinkers in the portfolio, too.

If you have sold stock from your taxable portfolio at a gain, it's time to unload some losers. Otherwise you are choosing to pay extra tax, and who wants to do that? A few things to keep in mind:

-We're only talking about your taxable portfolio here. Anything that happened in your 401(k) or IRA stays in your 401(k) or IRA.

-Capital losses are deductible to the extent of capital gain, plus (on 1040s) $3,000.

-Short-term and long-term losses can offset both types of capital gains. Short-term losses are first netted against short-term gains before counting against long-term gains, and vice-versa. If you have both types of gain, offset your short-term gains with your short-term losses first, because net short-term they are taxed at ordinary income rates.

-Don't wait until December 31. If you're broker is somewhere warm for the bowl games, he may not get to your sell order as quickly as you might like.

-Watch out for the "wash sale" rules. If you have losses in, say, GM, you can't sell part of your GM portfolio and recognize the loss to the extent you purchase other GM shares in the prior 30 days or the subsequent 30 days.

-If you have losses on a short position, remember that the settlement date, not the trade date, is the date the losses count -- so don't wait to take short losses at the last minute, even if your broker isn't leaving town.

UPDATE: 12/27/2005 A member of a Yahoo finance discussion group refers to this post, saying:

"I think that's only if you sell for a profit. A loss goes by the settlement date."

I should clarify: when I refer to a "short" position, I mean a classic short sale, where stock is borrowed in anticipation of a decline in value; if the short seller is correct, he profits from the price decline by repaying the borrowed stock with cheaper shares. If the stock price goes up, the short-seller has a loss; such a loss is recognized when the short sale is settled.

In a normal "long" position -- where stock is purchased in hopes that the stock price will rice -- the trade date is the date of the loss for tax purposes.

This is another installment in our 2005 year-end planning series.

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December 14, 2005

Senate Majority Leader Bill Frist says nothing will happen before year-end with the AMT punt fix and the Tax Reconciliation bill. So far the Senate Democrats haven't panicked like their house counterparts to pass a separate AMT fix. If the AMT fix has to be included in the Tax Reconciliation, Republicans may be unable to extend the reduced capital gain and dividend rates beyond 2008.

The status of Bill Thomas as a diabolical genius hangs in the balance.

The Tax Prof has a full roundup of big-media coverage.

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December 14, 2005

Remy Welling, a former IRS agent forced out of the agency after blowing the whistle on a sweetheart settlement, sheds a little light on the IRS audit selection process in this article.

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December 14, 2005

In ancient times people would try to solve their problems by appeasing a batch of fickle gods. Drought would be solved by sacrificing a goat to the rain god, or stress by sacrificing an in-law to the serenity god (that actually works).

In our modern times we have abandoned these superstitious rituals. Who needs the spirits? We have the tax law.

Hurricane Damage? Pass tax incentives.
College is expensive? Pass a tax credit.
Cold? Pass energy tax incentives.
Can't get business to move to Iowa? Pass corporate welfare tax incentives.

Fat Kids?

The government should consider the use of awards and tax incentives that encourage companies to develop and promote healthier products for young people.

No job too tough, no chore too rough! The tax law does it all!

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Congressional taxwriters solve another problem

(PS: Belated hat tip to Progressive Reactionaries.

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December 13, 2005

Russ Fox approaches despair while pondering the difficulties of computing the new Section 199 production deduction. His discussion at the Taxable Talk blog is a fine non-technical introduction to this foolish and devilishly-complex deduction.

The draft form for computing the deduction is available here.

For more on Section 199:

Online Article "The Domestic Production Activities Deduction—Proposed Regulations Under Section 199" by Elizabeth P. Askey, Pillsbury Winthrop Shaw Pittman LLP.

Professor Maule's thoughts on Section 199.

Outline for in-house CPE presentation on Section 199 that I presented last week.

My Powerpoint presentation on Section 199 for the Iowa Bar Association 2005 Spring Tax Institute.

Notice 2005-14: IRS initial guidance on Section 199

Proposed Section 199 Regulations

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December 13, 2005

I have uploaded my recent seminar at the University of Northern Iowa for the Cedar Falls chapter of the Institute of Management Accountants. You may access it here (it works much better with MS Explorer than with Firefox). The Powerpoint presentation covers my peculiar ideas of tax policy; I then discussed major recent legislation and how well it held up to my ideals (not well). For a bonus, you can see the winner and runners-up for my prestigious "Taxpayer of the Year" designation.

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December 12, 2005

While December 31 is the deadline for making deductible charitable contributions for this year, folks who have big plans for their 2005 deduction should get busy now.


Charitable gifts of appreciated property are tax-efficient. If the property has been held for over one year you can deduct the full value of the donated property, while never paying tax on the gain.

This benefit has some restrictions. If the donation exceeds $500, you must separately disclose the gift. A qualified appraisal is mandatory for gifts over $5,000, except for gifts of publicly-traded property.

While Big charities usually can handle gifts of stock quickly, they may not be able to quickly process a gift of, say, real estate or artwork. Small charities sometimes are baffled by a gift of stock. It can be very frustrating when a deduction gets pushed back a year because because the donation paperwork isn't processed before year-end, so you need to allow the charity plenty of time.

Remember also that gifts of appreciated property to public charities are subject to a limit of 30% of adjusted gross income; such gifts to private foundations are subject to a 20% limit.


The tax law has a one-time special on cash gifts this year. While normally cash gifts are deductible to the extent of 50% of AGI, the limit for this year was raised to 100% of AGI in the Katrina relief legislation.

Some taxpayers are using this rule to donate IRA balances to charity. Many taxpayer have IRA balances that are well in excess of their other income. The 100% of AGI limit allows taxpayers to withdraw their IRA balances, donate the entire proceeds to charity, and get a full current tax deduction.

This paperwork usually can be processed quickly, but not instantly. If you are serious about doing this, you should be starting the paperwork. Before pulling the trigger, though, keep in mind:

1. If you withdraw the IRA balance on or before age 59 1/2, you will have a 10% penalty, even if you donate it all to charity.

2. Congress is considering legislation that would let you donate IRA balances directly without withdrawing the money. Unfortunately, the final legislation may not be completed by year end, so we may not know this year whether this provision will be enacted at all.

This post is third in a series on 2005 year-end tax planning.

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December 12, 2005

The IRS has temporarily suspended the rules that would have required employers to report deferred compensation amounts on employee W-2s for 2005.

New Section 409A, which sets strict new rules on how non-qualified deferred compensation is treated, requires employers to disclose deferred amounts that are not yet taxable on W-2s. Similar rules apply for 1099 reporting for independent contractors. Notice 2005-94 suspends these requirements until further notice.

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December 12, 2005

When the state attorneys general extorted the multi-billion-dollar settlement from the tobacco companies, we were told that the money would be used to discourage tobacco use among kids. But like nicotine addicts who always will quit tomorrow, they can't stop themselves from spending the money everywhere else, according to a report by The Campaign for Tobacco Free Kids. Only four states are living up to their promises to direct the money to anti-smoking efforts; Iowa isn't one of them.

The settlement provides a huge flow of cash to the states from tobacco sales. Is it surprising that they don't want to use that money to kill their golden goose?

Hat tip: David Brunori, Tax Analysts($).

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December 12, 2005

Clarissa Potter has a job that looks about as rewarding as being the ethics advisor for the Crips. Tax Analysts's Lee Sheppard writes this morning about Clarissa Potter, who has taken the new job of "special counsel (legislation)" in the IRS Chief Counsel's office:

Her job is to apprise Congress of the practical ramifications of proposed legislation -- something she didn't do while working for Treasury's Office of Tax Legislative Counsel.

And therein lies the rub. No one does that job. No one tells Congress how proposed legislation will appear as an entry on a return, or how difficult it will be for the IRS to administer, unless some congressional aide just happens to ask someone at the IRS for assistance. That does happen sporadically, depending on personal relationships, but there is no system for it, Potter reported.

How depressing. It's clear that nobody has been looking very hard at practical aspects of tax law for, oh, about 20 years. The Section 199 "production deduction" is a model for a tax law whose administrative complexity far outweighs any possible benefit it might have.

It's nice, I guess, to have somebody at IRS with the job of pointing out poorly-conceived tax laws. But it shouldn't be necessary. It's the job of the Congresscritters to make sure the laws they pass aren't idiotic. As much as they have botched that project, it's asking an awful lot of Ms. Potter to come in now and fix things.

Tax Analysts Link (subscribers only)

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December 12, 2005

The Carnival of the Capitalists and The Carnival of Personal Finance are up for this week.

The Capitalists carnival is a weekly roundup of economics and business weblog hostings. It's worth a trip this week for the seasonal illustration alone, but you can read it for the articles, too. Henry Stern at InsureBlog is there, looking after your health and your wallet; because he cares, go cast a vote for InsureBlog in the 2005 Weblog Awards.

Over at the Personal Finance party, Amit explains why you young professionals out there (that means my age and younger, as long as I live) should contribute to a Roth IRA.

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December 09, 2005

Yes, Iowa ladies and gentlemen, boys and girls, wingnuts and moonbats, the way this winter is going, we'll all need an adult refreshment about February 4. The location will be somewhere in Des Moines and vicinity that serves adult beverages and has wi-fi. Details to be announced, suggestions are welcome. We can also commemorate Random's Return to the City, if she can it out of her driveway to the party. If you know an Iowa blogger who wouldn't read this page to save his/her life, please let them know. If you blog, please post a shout-out on your own page; my readership is mostly a bunch of tax geeks perhaps a niche following. Location will be announced when research is complete to my satisfaction.

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December 09, 2005

I am speaking at a seminar at UNI in Cedar Falls today, so this is probably it until late this afternoon.

I noticed from our Sitemeter stats that we had our 100,000th "visit" last night when someone from Hofstra University stopped by. I realize this is a meaningless number in so many ways for so many reasons. I didn't even add sitemeter to the archives for a long time, and I'm not sure exactly what a "visit" means. Still, it's a nice round number, and an excuse to say "thank you" to readers. So thank you, all of you who stop by, and do come back often.


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December 09, 2005

The House version of the Tax Reconciliation bill extending the 15% rate for dividends and capital gains passed by a surprisingly comfortable 234-197 vote yesterday. Whether by guile or by accident, Rep. Bill Thomas is one step closer towards achieving his diabolical plans.

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December 08, 2005

In our first piece on 2005 year-end tax planning I said you need to start with a 2005 tax projection. The first critical piece of knowledge this will produce is whether you are likely to pay alternative minimum tax in 2005. Tax planning for AMT is different.

If it looks like you have AMT this year, it changes your year-end tax planning. A lot of tax planning tricks don't work for AMT. For example, it usually doesn't make sense to prepay your state and local income and property taxes before year-end if you have 2005 AMT, as these items are not AMT-deductible.

If you are in AMT or close to it, you should continue your tax projections into 2006. By judiciously allocating your deductions between 2005 and 2006 - say, by prepaying some of your state and local taxes - you may be able to minimimize your taxes over a two-year period.

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December 08, 2005

deviousbill.jpgWhen Ways and Means Committee Chairman Bill Thomas left alternative minimum tax (AMT) relief out of his version of this year's Tax Reconciliation bill, he said he was doing it to spur debate on tax reform. Of course, I mocked this idea:

That's a bit like spurring debate on fire-sprinkler laws by committing arson.

Now Mr. Thomas may have the last laugh. He appears to have been playing a deeper game than he let on. It happens than AMT falls disproportionately on the "blue" states -- states where Democrats are ascendant. This is because blue states tend to have high state income taxes; these aren't deductible for AMT and therefore make AMT routine for two-earner upper-income couples in high-tax states. As a result, Democratic legislators overwhelmingly favor the AMT relief bill; failure to extend AMT relief set to expire this year would result in a big blue-state election year tax increase in 2006.

Mr. Thomas left the AMT relief out of the reconciliation bill so he could include an extension of lower capital gain and dividend rates under its revenue cap. For arcane reasons the reconciliation bill can pass with only 51 votes in the Senate.

Mr. Thomas's deeper game? If the 414-4 vote in favor of stand-alone AMT relief in the House yesterday is an indication, the Democrats will pass AMT relief anyway, so he didn't need to waste the budget cap in the reconciliation bill on it. If the Senate Democrats also pass stand alone AMT relief, and the Tax Reconciliation is enacted with extended capital gain and dividend rate relief, I will have a new respect for Mr. Thomas's machiavellian ways.

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December 08, 2005

We don't normally cover financial accounting issues here, but this article in the Tickmarks blog on financial accounting fraud is worth a look:

SEC Chairman Christopher Cox argued today that the complexity of accounting and auditing standards contributed to the fraud problems earlier in the decade. Cox argued that compliance with highly technical standards was used against investors instead of being used to protect investors and indicated that the PCAOB, SEC and FASB were looking at ways to streamline rules. One concern expressed was to reduce the number of sources of accounting standards. In a semi-related development, Cox also showed discomfort with the dominance of "Big Four" firms in public company audits and stated a desire to make it easier for non-Big Four firms to audit publicly-traded firms

The Sarbanes-Oxley rules have made it so difficult for accouning firms to qualify for public-company work that it has had the effect of giving the national firms a lucrative government-sanctioned oligopoly. While time will tell whether this will improve audit quality, there is reason to be sceptical.

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December 08, 2005

Members of the Presidents Commission on Tax Reform have complained that their work was hampered laws restricting their ability to have private meetings and use non-public documents. Tax professor Daniel Shaviro discusses the problem and proposes a modest solution:

As a result of this rule, as I myself have heard elsewhere, the sub-committees (sub-panels?) on the Panel could not discuss what they were doing with each other until the end of the process, when they had a public meeting. So there was next to no coordination between the parts in some important respects. Hence. perhaps, the fact that the so-called consumption tax prototype in the Panel's report was in some ways more of an income tax and less of a consumption tax than the so-called income tax prototype.

The problems the Panel faced suggest a sarcastic response, then a more serious response. The sarcastic response is: Why didn't the Administration just have Cheney appoint the same people as a Vice Presidential panel? Presto, no disclosure requirements and lots more political credibility.

It is strange the the Cheney energy policy task force was allowed private meetings, but not the Bush tax reform panel. Based on the disgust of tax reform panel members to these restrictions, we can assume that any future presidential advisory panels are strictly for show.

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December 07, 2005

If you are looking for information on Section 409A, Congress's fire into the crowd and bayonet the wounded response to the Enron deferred compensation abuses, BenefitsBlog has collected the links for you.

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December 07, 2005

The IRS may be gearing up for an overhaul of its automatic accounting method change procedures. It yesterday asked for comments (Notice 2005-97) on its procedures for allowing accounting method changes.

Taxpayers are not allowed to change accounting methods without IRS permission; the "automatic consent" procedures enable taxpayers to change methods by filing documents with their tax returns and without paying the customary $1,500 "user fee." The automatic consent procedures give taxpayers and practitioners a "mulligan," allowing the repair of faulty accounting methods while protecting against audit adjustments for the methods for prior years.

The Notice asks for comments in four areas:

1. Should any accounting method changes that are currently ineligible for automatic consent be made eligible for automatic consent?

2. Should any accounting method changes that are currently eligible for automatic consent be made ineligible for automatic consent?

3. Should modifications be made to any aspect (such as to the description or scope) of the accounting method changes currently eligible for automatic consent?

4. Should any modifications be made to the general procedures applicable to all automatic accounting method changes?

The IRS should make any method change it routinely grants eligible for automatic consent procedures. Otherwise the policy amounts to private law for the well-connected taxpayers and practitioners.

For example, word on the street has it that the service is routinely allowing S corporations of any size that lack inventories -- banks, for example -- to switch from accrual method accounting to "cash basis" accounting. Taxpayers often prefer cash basis because it provides more leeway to manipulate income at year-end. Probably for the same reason, the IRS has turned down non-automatic changes to cash method as a matter of course. Yet least one national firm is reportedly filing and winning method change requests for banks that had been believed ineligible for cash-basis accounting.

The logic for these new cash-basis change reportedly is that because the banks' individual shareholders are cash-basis taxpayers, cash basis accounting more "clearly reflects" income. I find this logic lame, but if the IRS doesn't they should make it official through automatic method change procedures. It would represent a surprising change in long-held IRS policy, and one they should share with more people than their potential future national-firm employers.

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December 07, 2005

Somebody forgot about the "give unto Caesar" rule:

CAMDEN — A Roman Catholic priest pleaded guilty Tuesday to making false statements on an income tax return, leading to more than $30,000 in unpaid taxes, federal officials reported.

The Rev. Daniel Sullivan, 56, of Tuckerton entered his plea before U.S. District Judge Joseph H. Rodriguez. Sentencing is scheduled for March 28, according to officials with the U.S. Attorney's Office Criminal Division in Camden.

Well, if he has taken a vow of poverty, the IRS is ready to help.

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December 06, 2005

If we could first know where we are, and whither we are tending, we could then better judge what to do, and how to do it. -Abraham Lincoln, from his "House Divided" speech of 1856.
What was said then, is true today in tax planning. If you don't know what your taxes will be if you do nothing before year-end, you don't know what steps to take to save money, or even if you need to take any steps at all.

A year-end tax projection is simply a mock up of what your tax return will look like, based on what has happened so far and what you know will happen the rest of the year (bonuses, additional paychecks, and so on). If you don't do this much, trying to do tax planning is like having to start on a trip in the dark without a map or any idea where you are.

This post is the first of a series of year-end planning tips for 2005.

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December 05, 2005

Glen Silver used tax protestor Tax Honesty arguments to avoid collection of taxes owed for 1995 and 1996 in front of the Tax Court. Duly impressed, the Tax Court fined him $3,000 for wasting its time with frivolous arguments. The judge noted that Mr. Silver was also litigating his 2001 and 2002 taxes before the Tax Court, and it would be unwise to try such arguments again.

Well, he did. And he was unwise. Now Mr. Silver, in addition to having to pay about $69,000 in taxes for 2001 and 2002, gets to pay a $25,000 fine for making frivolous arguments after having been warned against it.

What were the arguments Mr. Silver found so worthy as to risk a $25,000 fine?

In the petition in this case, petitioner alleged that he "did not receive any taxable income from any taxable source or activity during the years 2001 and 2002."

Unfortunately, he did nothing to prove the W-2 and 1099 income reported for him somehow didn't exist. He just said it wasn't taxable.


Cite: Glen B. Silver, T.C. Memo 2005-281

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December 05, 2005

deadbird.JPGThe White House apparently isn't ready to go to the mat for tax reform. The administration has floated trial baloons saying that a major tax reform may be pushed off until the next Congress is seated in 2007.

A set of articles not attributed to any specific member of the administration (see the TaxProf for links to several articles) says that the White House lacks the appetite and the time to take on a foredoomed crusade for tax reform. has this:

Time Magazine, in its latest edition, quoted a White House official as expressing doubt that a major proposal to change the tax code could attract Democratic support in a mid-term election year.

"No one wants to put something out there that's not going to go anywhere," the magazine cited a White House official as saying.

White House spokesman Scott McClellan says tax reform is just sleeping, saying tax reform "remains a priority."

It's not too surprising that tax reform is slipping off the radar. The Presidents Tax Reform Panel laid out an ambitious program that ends up reducing rates only two or three percentage points. The 1986 tax reforms, in contrast, reduced rates from 50% to 28%. Without big rate reductions, most politicians aren't ready to give up their cherished loopholes.

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December 03, 2005

The TaxProf passes on the news that two Texas property tax assessors are being prevented from marrying.

We can't have those people reproducing, after all. It's a slippery slope, though. First they came for the IRS agents, then the lawyers, and I was quiet. Then when they came for the accountants...

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December 02, 2005

As gas prices fall, so falls the auto mileage reimbursement rate. After rocketing to 48.5 cents per mile in September after Katrina (it had been 40.5 cents), the rate will decline to 44.5 cents, the IRS has announced. The rate for Katrina charitable mileage will also be 44.5 cents, while the rate for other charitable miles will be 14 cents.

For more on using the standard mileage rate, check out IRS Publication 463.

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December 02, 2005

It looks like taxing dirty bookstores is becoming an issue in the Iowa Republican Governors Campaign. Bob Vander Plaats came out for what appears to be a tax on "adult entertainment" this week:

As governor, Vander Plaats said that he will ask for legislation requiring those businesses that profit from the sale of porn to pay for education and treatment measures designed to stop sexual abuse before it occurs. The fund, generated by increased fees, will also assist in stepping-up enforcement plans such as better tracking of the sex-offender registry.

I wouldn't want to live within 2000 feet of the Iowa Department of Revenue agent who enforces this tax.

As Eddie Wedelstedt will tell you, this is a lucrative business:

Internet porn is booming. Annual revenues from the internet porn industry ($12 billion in the U.S. alone) exceed that of all professional football, baseball, and basketball franchises combined. Revenues also exceed that of ABC, CBS, and NBC combined. Child pornography alone is $3 billion annually.

"As the father of four children, I am alarmed by these statistics," Vander Plaats stated. "Of course, we must insist on the toughest penalties for sex-offenders. But we must also confront the research and be proactive in protecting our children from sexual predators and the grip of pornography addiction."

In any case, somebody in the Vander Plaats Campaign seems to have a one-track mind, or a sense of humor. A clip from the current version of the campaign home page:


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December 01, 2005

Khaled Ahmed is nothing if not audacious.

According to the findings of fact in a Tax Court opinion issued today, Mr. Ahmed built a little Medi-Cal fraud business that generated seven-figure income. With only a pharmacy degree, he opened medical clinics in low-income areas of Southern California. He did this by opening them in the name of an acquaintance from New York who knew nothing about the scheme. He then insured the health of the clinics patients in a novel way:

Also, Ahmed established a policy for his medical clinic that each patient was to receive either an x ray, a lab test, or a shot, and each patient was to be provided a prescription. These services and prescriptions were provided to each patient of Ahmed’s clinic regardless of the medical necessity and were intended to increase revenue for Ahmed’s pharmacies and clinic.

Ultimately Mr. Ahmed ran into non-tax trouble as a result of his unusual patient care approach: a federal indictment alleging $40 million in fraudulent billings. The trial date has been continued to next year.

Not surprisingly, Mr. Ahmed was perhaps less punctilious than might have been desired in fulfilling his tax obligations on his allegedly fraudulent billings. The Tax Court today upheld civil fraud penalties and fraudulent failure to file (75% of fraudulently understated taxes) of over $3.7 million for Mr. Ahmed and his controlled C corporation over a four-year period.

In his opinion, the judge noted:

Ahmed took affirmative steps to conceal from respondent his ownership of various assets. Ahmed repeatedly denied to respondent’s agent that he owned interests in the corporations nominally operating the pharmacies, the clinics, and the lab. Ahmed used other individuals’ names to perpetuate the concealment of his ownership of the nominee entities.

Maybe he just was a stickler for privacy?

Ahmed withheld from respondent’s agent information about Ahmed’s personal and nominee entity bank accounts. After the issuance of the notices of deficiency, Ahmed, as determined by the District Court, designed to place assets beyond the reach of the United States.

Asset protection - everybody's doing it!

Ahmed’s testimony lacked credibility and was replete with inconsistencies.

But your honor, foolish consistency is the hobgoblin of small minds!

Based on Ahmed’s pattern of understating his and K & M’s taxable income and of underpaying his and K & M’s Federal income tax liabilities, and the conduct described above, we conclude that respondent has established by clear and convincing evidence that both Ahmed and K & M acted willfully and with specific intent to underpay their correct Federal income tax due for each year in issue.

Why no criminal tax fraud charges? Maybe with the medical fraud case, it would have gotten in the way. Or maybe it would have seemed like piling on.


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December 01, 2005

schuling.JPGGovernor Vilsack has named Des Moines attorney Mark Schuling as the new Director of the Iowa Department of Revenue. He will take office December 15. Mr. Schuling replaces Mike Ralston, who stepped down to become Executive Director of the Iowa Association of Business and Industry.

Mr. Schuling, who will be taking a leave from the Brick Gentry law firm, has experience in tax practice and as an attorney with the Iowa Attorney General's Revenue division. With this background he may be able to bring some needed fresh thinking to the Department. While Mr. Ralston was conscientious and effective, as a non-lawyer he wasn't in a great position to challenge the conclusions of the Department's legal staff.

The new director has served on the Des Moines school board, including a term as president.

Mr. Schuling has lititgated two cases to decision in the U.S. Tax Court, most recently in 1995. He lost them both, but given the facts, it's hard to blame the attorney.


In John M. Estes, Jr., the head of a Des Moines funeral home business had been hit with negligence penalties. He had hired a bookkeeper who, from the looks of it, had at best questionable credentials. He eventually took over preparing Mr. Estes's 1040, which reported the funeral home income on Schedule C. Mr. Estes maintained no inventory of coffins, but instead ordered them as needed for a given burial. Yet suddenly in 1982 the return showed a beginning inventory of $25,740 - and no ending inventory. 1983 miraculously also showed a begininning inventory if $25,740, and 1984 showed $39,584 - again, with no ending inventory. As one year's ending inventory is the next year's opening inventory, this was remarkable. The effect was to understate each year's taxable income by the amount of the inventory overstatement.

Mr. Estes tried to avoid negligence penalties by blaming the new bookeeper, but the Tax Court didn't buy it:

Moreover, from our observation of both petitioners and Mr. Johnson [the bookkeeper] at trial, we are also unable to conclude that with their education and business experience petitioners could have reasonably relied upon Mr. Johnson to prepare accurate income tax returns. Prior to his employment by Mr. Estes, Mr. Johnson had no experience in bookkeeping or the preparation of income tax returns other than a few returns for his parents, and the record contains no evidence to support a finding that he led petitioners to believe otherwise. Therefore, we are convinced that petitioners could not have reasonably believed that Mr. Johnson was a competent preparer of income tax returns.

The Moral: just because you pay somebody to do your returns doesn't necessarily get you out of penalties.

Cite: John M. Estes, Jr., TC Memo 1992-531 (No link available)


Christine Deignan, a Davenport internist, started building a home with her husband. The marriage was done before the house, and she was ordered to pay for the completion of the house, with proceeds to be split with her ex. She bought his interest in the house for $65,000, completed it, and sold the property for $166,000. She then claimed a business loss of $179,596 on the home sale.

To win, Mr. Schuling had to somehow convince the Tax Court that the sale of one house is a business. Not surprisingly, he failed. Yet the taxpayer did do surprisingly well - she was allowed a capital loss on the house sale. That didn't help her in the year at issue, but she was able to carry the loss to future years to offset capital gains. Losses on home sales are ordinarily non-deductible personal expenses (last item on link). By salvaging capital loss treatment, Mr. Schuling's client came out better than she probably deserved.

Cite: Christine C. Deignan, TC Memo 1995-480 (no link available)

Mr. Schuling has a much longer list of published Iowa tax cases. If I have time, I'll look at a few of these in a future post.

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