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Tax Update Blog: April 2006 Archives

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April 28, 2006

When one door closes, another comes off its hinges entirely. State 29 has new posts!

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April 28, 2006

A congressman yesterday criticized the concept of high-deductible health insurance and Health Savings Accounts in a congressional hearing yesterday:

Rep. John Barrow, D-Ga., argued that insurance is a group enterprise in which individuals are pooled together to mitigate costs. Rather than empowering low-income individuals, Barrow said, the HSA initiative would force them into high-deductible health plans (HDHPs) that have been stripped of many needed services.

“Everything you’re doing is fundamentally opposed to the whole notion of insurance,” Barrow said. “We’re not insuring. It’s just pushing folks to go more and more bare.”

repbarrow.jpgIf Mr. Barrow entrusted an assistant with $100 and sent him out to buy his congressional groceries, he wouldn't consider that "grocery insurance." Yet somehow he thinks that "insurance" should be defined as giving Blue Cross money to buy your health-care groceries, like routine prescriptions and regular office visits.

In Mr. Barrow's world, "good" insurance covers day-to-day living expenses. As insurance companies aren't in business to lose money, they will include these costs in their premiums. The insured will pay these costs either directly through higher premiums, or through reduced wages if the employer pays the premiums.

That's where the magical money tree comes in. Mr. Barrow's concept works if the insurance company nurses a grove of magical money trees that blossom with cash every time the company loses money on a health insurance contract.

The idea of HSAs and high-deductible insurance is to make it easier to buy health insurance the same way they buy auto and home insurance: to protect against catastrophe. After all, you don't turn in your oil changes or house painting to State Farm. Why should you run your Rogaine through Blue Cross? Except, of course, to pick the fruit of the magical money tree.

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April 27, 2006

Governor Vilsack and legislative leaders finally shook hands today on a budget deal that includes a phased-in tax break for Social Security and pension income.

The Des Moines Register reports:

-the compromise would increase the amount of exempt pension earnings taxable income for seniors to $24,000 for single filers and $32,000 for joint filers. The break would be at $18,000 for singles and $24,000 for joint filers for a two year interim.

-it would also phase out taxes on social security earnings entirely over nine years, no matter how high the income.

This is an important part of a long-term plan to make Iowa the retirement mecca of the plains. Even now only three states have older populations than Iowa. With tax policy like this, we'll get rid of the rest of those rowdy young whippersnappers in no time.

Prior Coverage:



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April 27, 2006

Sad, sad news at "Who's Makin' Bacon":


Bacon was easily the best of the fresh blogs that sprouted in the Iowa blogforest after the collapse of that mighty oak, State 29. I guess I can scrap my plans to raise funds to buy him (her?) wi-fi access at the Statehouse.

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April 27, 2006

U.S. District Court Judge Linda Reade today turned down a request by a TouchPlay slot machine video lottery vendor to block enforcement of the ban on the machines signed into law last month. The ruling brushed aside contractual and constitutional arguments for a permanent injunction against the ban. The decision dismissed the vendor's injunction request "with prejudice" and assessed the vendor the court costs, which I think is the way the courts say "and don't let the door hit you on the way out."

Link (pdf): Hawkeye Commodity Promotions, Inc. v. Miller, et. al., No C-06-2026-LRR (USDC ND-Iowa).

Video lottery machine alongside ATM terminal: a charming scene soon to fade into Iowa history.

UPDATE: The Des Moines Register has coverage here.

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April 27, 2006

Tax Notes reports that we may have an agreement on the tax reconciliation bill that has been stalled in conference since December. The article cites House Ways and Means Chairman Thomas as saying the bill is likely to include a two-year extension (to 2010) of the 15% rate for dividends and capital gains, a two year extension (to ) of the $100,000+ Section 179 deduction, and a one-year partial AMT fix, perhaps combined with an indexed larger exemption. This is less generous, but more permanent, than the fix that had been in the Senate bill, and would swell the ranks of AMT taxpayers in 2006.

Link: permanent subscriber-only link to Tax Analysts story.

Center for Tax Studies coverage

Prior Coverage:



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April 27, 2006

The AMT, that is. But it's the law, fair or not. Russ Fox explains.

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April 27, 2006

Something about $3 gasoline makes politicians feel they need to look busy and concerned. The results run the gamut from ineffectual to harmful.

The ineffectual was illustrated yesterday when some top Congressional taxwriters demanded copies of the tax returns of some of the large oil companies. Maybe if they look hard enough, they'll find a tax form that shows where the companies are hiding the 50-cent gasoline that the congresscritters seem to think is out there somewhere. (Hat tip: The TaxProf.)

The harmful? Just look back to the last "energy bill." You'd think they would be chastened by that disaster, but that is not their way. Will they be foolish enough to try another "windfall profits" tax? Don't count it out.

(Cross-posted at

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April 26, 2006

From today's Des Moines Register editorial page:

It's fiscal madness to lower taxes on the fastest-growing segment of the population (the elderly) while shifting the burden onto the shrinking part of the population (young workers).

A demographic crunch is about to hit Iowa. The state will soon be starved for young workers. The last thing Iowa should be doing is increasing the burden on them.

Finally, if the Legislature is going to muck around with the income tax, it ought to take the time to do a comprehensive overhaul, not just single out one group for a quickie election-year giveaway.


Maybe there's hope yet for the Newspaper Central Iowa Depends Upon. If they can apply these standards to the Iowa Values Fund and the "economic development" pork cornucopia, we'll be making real progress.

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April 26, 2006

screw.jpgThe Tax Court shot down another attempt by an unhappy alternative minimum tax-payer to avoid the disastrous tax consequences incentive stock options.

This sad tax problem got national press when eastern Iowan Ronald Speltz was hit with a $206,000 tax bill for exercising McCleod ISOs that were nearly worthless by the time the tax bill came due.

When you exercise an incentive stock option, you get favorable tax treatment. You have no income for the "spread" -- the excess of the stock price over the amount paid to exercise the option -- and you have capital gain on the eventual sale of the shares. This contrasts with the more-common "non-qualified" options, which generate ordinary income immediately on exercise:


There are two big catches in the favorable treatment of ISOs:

1. You have to hold on to the shares for a year after exercise to qualify, and

2. the favorable treatment doesn't apply when computing AMT; you report the spread is all ordinary wage income on Form 6251. This becomes a huge problem if the stock craters between the time you exercise the options and tax day.

Robert Merlo exercised options for 46,125 shares of Exodus Communications, Inc. on December 21, 2000. His exercise price was 20 cents per share, and the stock value at exercise was $23.3125. This gave him a "spread" of $1,066,064.

When the taxes came due the next April 15, the stock value had gone down to about $10.18. At this point, selling his shares would have still netted Mr. Merlo enough cash to pay his tax. He took another path.


When he filed his 2000 return, he reported the bargain element as the difference between the exercise price and the value on April 15, 2001, rather than the exercise date. He held onto his shares and rode them down until Exodus made its, well, exodus by declaring bankruptcy on September 26, 2001.

The IRS noted that the tax law requires the bargain element to be measured on the date the option is exercised, not the subsequent tax return due date, and assessed him additonal AMT of about $170,000. Mr. Merlo didn't care for this. He apparently realized his initial return position wasn't going to work, so he raised a number of other issues:

1. He wasn't "vested" in his ISO shares under Code Section 83, and therefore had no income.

2. His AMT capital loss deduction on the worthlessness of the stock was not subject to the $3,000 annual limit on capital losses, so he had a net operating loss to carry back and get an offsetting tax refund.

3. The AMT treatment was just wrong, somehow.

The court disposed of the "vesting" argument last July, holding that the shares weren't subject to risk of forfeiture. Mr. Merlo had argued that he might lose his job because selling the shares was against the company's insider trading policy. The court said that even if that were true, it didn't matter, as long has he wouldn't have to forfeit share proceeds:

The evidence in the instant case shows that petitioner had no substantial risk of losing the rights to his shares of Exodus stock. There is no evidence that Exodus could have ever compelled petitioner to return his shares after he exercised his ISO; no sellback provision is present; nor is there any evidence that Exodus could have compelled petitioner to forfeit his shares of stock.

The court had no trouble ruling that the annual capital loss limitation applies for AMT purposes as well:

This Court has never addressed whether the capital loss limitations of sections 1211 and 1212 apply for purposes of calculating a taxpayer's AMTI. However, section 1.55-1(a), Income Tax Regs., states:

        Except as otherwise provided by statute, regulations, 
        or other published guidance issued by the Commissioner, 
        all Internal Revenue Code provisions that apply in 
        determining the regular taxable income of a taxpayer 
        also apply in determining the alternative minimum 
        taxable income of the taxpayer.

We find no statute, regulation, or other published guidance that purports to change the treatment of capital losses for AMT purposes.

Not a surprising result. AMT is mostly the regular tax system with a few specific changes. If the tax law doesn't specify that something is computed differently for AMT, regular rules apply.

The "just wrong" defense didn't get very far, either:

Petitioner also advances several "policy and legal considerations". Essentially, petitioner is arguing that, under principles of equity, he should be allowed to carry back his AMT capital loss to reduce his AMTI. Petitioner feels that applying the capital loss limitations of sections 1211 and 1212 to the calculation of his AMTI results in harsh and unfair tax consequences.

This Court has previously stated:

        The unfortunate consequences of the AMT in 
        various circumstances have been litigated since 
        shortly after the adoption of the AMT. In many 
        different contexts, literal application of the 
        AMT has led to a perceived hardship, but challenges 
        based on equity have been uniformly rejected. * * *
        * * * "it is not a feasible judicial undertaking 
        to achieve global equity in taxation * * *. And if 
        it were a feasible judicial undertaking, it still 
        would not be a proper one, equity in taxation being 
        a political rather than a jural concept." * * * the 
        solution must be with Congress.

Congress broke it; only Congress can fix it.

The moral? ISOs are a dangerous bargain. They carry a lure of future regular tax savings at the cost of current AMT. If the shares tank, you just get the AMT. If you can't afford the AMT if the shares become worthless, sell enough shares when you exercise the options to make sure you'll be solvent at tax time.

Cite: Merlo, 126 T.C. No. 10.





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April 25, 2006

A "prominent" St. Louis attorney has been laid low by tax charges:

Prominent local attorney Charles Polk Jr. pleaded guilty Monday in U.S. District Court to one felony count of tax evasion and one felony count of interstate transportation of money over $5,000 obtained by fraud.

The U.S. attorney's office said Polk, 45, of the 3400 block of Tiverton Drive in St. Charles, admitted Monday to obtaining more than $45,000 by fraud from the St. Louis Metropolitan Sewer District (MSD).

Mr. Polk does seem to be something of a big shot in St. Louis. For example, he was in the "Leadership Circle" of the St. Louis Regional Chamber and Growth Association, and his wife is the COO of the St. Louis United Way.

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April 25, 2006

The IRS has issued (Rev. Rul. 2006-24) the minimum interest rates for loans made in May 2006:

-Short Term (demand loans and loans with terms of up to 3 years): 4.85%
-Mid-Term (loans from 3-9 years): 4.84%
-Long-Term (over 9 years): 5:00%

Historical AFRs are available via the “Links” page at

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April 25, 2006

The excellent Benefits Blog marks its third birthday.

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April 25, 2006

fe.jpgYou were caught importing hundreds of pounds of pot. You've been in jail since 1989. You've forfeited over a million dollars. Can things get any worse?

Hello, IRS!

The Tax Court yesterday held Charles McHan liable for taxes and penalties of more than $500,000 for failing to report the income from his mid-1980s "import" business.

Aside from the sad human interest angle, I find the case mostly interesting for the matter-of-fact reconstruction of the taxpayer's marijuana income. Not surprisingly, the income wasn't properly reported on the taxpayer's original return:

Petitioners did not provide any books and records or otherwise disclose to their tax return preparer any information relating to petitioner’s drug transactions, and petitioners failed to provide to their tax return preparer and to respondent any books and records with respect to the illegal drug transactions in which petitioner participated.

Imagine the look on the preparer's face if the taxpayer had included that information along with his W-2s and 1099s.

The IRS analysed the profitability of the drug smuggling business:

For example, respondent’s agent determined that petitioner paid on average $275 per pound for the marijuana purchased from the Texas source. Also, to take into account amounts paid by petitioner to the Colonel on the purchase of marijuana from Texas source, respondent’s agent added $20 per pound, allowing petitioner a total cost of goods sold in the amount of $295 pound.

The IRS seems to have made no Section 263A inventory capitalization computation for the taxpayers. Does this mean he qualified for the "small reseller" exemption, as he wasn't a manufacturer?

Actually, the tax law has a special rule that disallows all expenses other than costs of sales (what you paid for your "inventory") in computing taxable income from illegal activities. As a result there are no otherwise deductible expenses to capitalize into inventory. So while dealing drugs is dangerous and foolish, at least you don't have to mess with Section 263A.

The taxpayer argued that they didn't really make any money from the business, and that he was just accomodating his buddies. The court didn't buy that:

There is nothing in the record which would indicate that petitioner sold marijuana for philanthropic reasons, expecting no profit for his efforts. Common sense would dictate the conclusion that anyone who is in an illegal and dangerous business such as the dealing of drugs would demand a very large profit for his enormous risks.

The moral? If you're going to smuggle illegal drugs, the Tax Court expects you to make sure it pays well.

Link: McHan, T.C. Memo 2006-84

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April 24, 2006

From the TaxProf:

Presidential Candidate Admits to Reading Tax Code and Regs "Cover to Cover"

Does he start over every time they change? Anybody who would make a more dangerous president than even me.

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April 24, 2006

lx.gifThey must really like odd trees in Hawaii, judging by their tax return instructions:

You may deduct up to $3,000 per exceptional tree for qualified expenditures you made during the taxable year to maintain the tree on your private property. The tree must be designated as an exceptional tree by the local county arborist advisory committee under chapter 58, HRS. Qualified expenditures are those expenses you incurred to maintain the exceptional tree (excluding interest) that are deemed “reasonably necessary” by a certified arborist.

While this is one income tax break Iowa doesn't have (one of the few, actually), our property tax rules speak for the trees:

The Department of Natural Resources, Forestry Bureau offers landowners property tax benefits to owners of forest or woodland. Landowners must enroll a minimum of two acres with 200 trees per acre. Acres exempted in 2000 were 559,843 acres. There are currently 36,145 exemptions.

A cynic might expect developers to plant 200 doomed saplings on each acre of development ground that is a season or two away from construction, just to get a tax break...

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April 22, 2006

Defenders of the tax-shelter practices of the 1990s like to say that "the courts haven't found them illegal." That's a bit less true now, according to the weekened Wall Street Journal today ($ link). The paper reports that the tax court this week ruled a Son of Boss partnership out of Omaha didn't work:

Tax Court Judge David Laro, in Washington, D.C., in an opinion not yet released, granted the IRS summary judgment earlier this week in its case against now-defunct RJT Investments X LLC, which was based in Omaha, Neb. The IRS argued that RJT used scam accounting to create large losses in order to slash its federal taxes.

In 2004, the IRS settled out of court with about 1,200 businesses and collected $3.8 billion in taxes due, interest and penalties that were less than the maximum allowed by the law. At the time, the IRS warned 600 other taxpayers that had taken advantage of the shelter that if they didn't come forward and settle, the IRS would disallow all the tax benefits and assess the full 40% penalty that the law allows.

"The RJT Investments case is the first concrete manifestation of the fruits of that commitment," said IRS Commissioner Mark Everson in a statement. ""We will continue to fight these cases as long as we have to."

The "not ruled illegal" argument has always been disingenous, given that it takes years for tax shelter cases to come to trial.

As the decision hasn't yet been released, it's hard to tell how much impact the RJT case will have. According to the journal, "In the RJT case, RJT didn't challenge the IRS on the merits of the case. Instead RJT defended the case on a jurisdictional issue, which the judge rejected."

The Omaha locatiion of this shelter may mean that our Eighth Circuit will be a key player in the tax shelter wars on appeal. The WSJ cites an RJT attorney as saying an appeal is in the works.

Tax Analysts has more on its free site here.

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April 21, 2006

Senator Grassley uses a paid preparer for his tax needs. That's an act of courage, considering:

"Any Joe can hang a shingle and prepare income tax returns. There are no requirements at all," Senate Finance Committee Chair Chuck Grassley, R-Iowa, said. "It’s incredible that we have legal requirements for a barber to cut your hair, but there are no requirements for someone to prepare your taxes.

It must be terrifying for a congressman to put his tax life in the hands of some Joe Shmoe with no Congressional authorization whatever. Fortunately, one can still find solace in the sanctioned chair of a licensed barber.


Hat tip: Tickmarks blog.

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April 20, 2006

The TaxProf on Monday noted that Vice-President Cheney took an extra-large charitable contribution deduction on his 2005 return. The big deduction was made possible by Hurricane Katrina relief legislation. Normally charitable deductions are limited to 50% of your adjusted gross income; the Katrina legislation boosted this to 100% of AGI for 2005 only. The Vice-President's contributions reached 77% of his AGI.

Commenters on the Tax Prof's blog, as well as some left-side bloggers, politely expressed their disapproval of the Vice-Presidential return:

"Why is this man not in jail?" intones "Beverly Hill"

"REPREHENSIBLE, totally devoid of any moral values, ...a true, dyed-in-the-wool Robber Baron," notes "tony"

"So, it really has been about money afterall. All the greed, selfishness, vainty, hubris, and cold-hearted egomaniacal, theivery is a wicked game of King-of-the-hill. War sold as democracy, theft disguised as charity, writing laws that benefit oneself and hurt most everyone else, all are putrid mutations of market-based economy run amok. What a shining example of reprehensible human charactistics Mr. Dick Cheney is," coos "Vanna"

And so on through dozens of comments and links from other blogs.

All right, then.


These commenters all have a common misconception: that Mr. Cheney made money by making donations to charity. It actually doesn't work that way.

The income tax is computed as a percentage of taxable income. A deduction reduces the taxable income upon which the tax is computed. The way the arithmetic works, the value of the deduction is simply the deduction amount multiplied by the tax rate.

Assume a taxpayer who has $1000 of taxable income subject to a 35% rate. His tax with and without the deduction:


So this taxpayer gave $100 to charity. He reduced his taxes by $35. This means that bottom line, he is $65 poorer than he was before he made the contribution, net of the $35 tax savings.

Now lets see what this means to Mr. Cheney. His charitable gifts in 2005 totaled $6,869,655. At the top 35% federal rate, this lowered his taxes by $2,404,379. That means he ended up $4,475,276 poorer for his donations, net of tax savings.


Some of the outrage over the Cheney return seems to be because the return resulted in a tax refund. Unless your refund exceeds the amount of tax you pay through estimated tax and withholding, refunds are not a particularly good thing. They mean the government had use of your money interest-free. In Mr. Cheney's case, the government had almost $2 million of his cash interest free. Assuming that the average balance of the "interest free loan" was $900,000, this means the government earned $36,000 on his money before refunding it, at a 4% interest rate.


The benefit of the Katrina relief is the ability to deduct contributions in excess of 50% AGI currently. If your deduction exceeds that amount, the excess carries over for the next five years.

Lifting the 50% AGI limit for 2005 allowed Mr. Cheney to deduct an extra $2,460,152 in 2005, reducing his 2005 taxes by about $861,000. Absent the Katrina break, the excess amount would have carried over to subsequent years; any unused amount would have expired after five years.

Based on his 2000-2004 income, it seems likely that Mr. Cheney would have had enough income in the carryover period to use up a $2.4 million contribution carryover. The advantage of the Katrina deduction, then, was timing - he got to use the deduction earlier.


The Vice-President took advantage of an unexceptional tax break that got him his deduction a bit sooner than he would have gotten it anyway. It's hard to see why he should be criticized, just as I saw no reason to criticize John Edwards for structuring his law practice to reduce his employment tax costs. While we should expect our elected officials to comply with the tax law, we shouldn't expect them to fail to take tax breaks to which they are entitled. That would amount to expecting our elected officials to be stupid.

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April 19, 2006

Greetings, readers.

After a rather hectic run at the end of tax season, I'm staying home the rest of this week. I'm doing school runs, paying bills and cleaning up around the house, and other things that have been delayed under the exigencies of tax season.

I'm not entirely isolated from work. I am checking in via e-mail and answering client questions that can't wait, but mostly I'm re-adjusting to civilian life for a few days. I'm catching up on non-tax reading, sleeping, and dusting off the bicycle.

But - keep checking in! Tomorrow I will talk about the Presidential and vice-presidential tax returns, if I can rouse myself enough between naps.

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April 18, 2006

As I linger over my coffee and the morning paper at home today, I see that David Yepsen has a sensible piece explaining in simple terms the problems with Iowa's tax system, and the outline for the solution. He discusses a recent Tax Foundation study which says that today is Iowa's "tax freedom day":

For example, the foundation said that in 2004, Iowa's individual income-tax collections were $663 per person, which ranked us a more reasonable 24th. Our corporate income-tax collections averaged $30 per person, which ranked Iowa a low 46th nationally.

So how can an income-tax system with the fifth-highest rates generate a burden that is 24th? How can a corporate income-tax system with the highest top rate in the country create a load that is near the bottom?

It's a bunch of Rube Goldberg tax breaks.

Mr. Yepsen says the state would be wise to go with either a "Democratic" approach of repealing the deductibility of federal taxes on Iowa returns or a "Republican" approach of a flat tax. I say do both. By getting rid of federal deductibility and the raft of loopholes economic development, ethanol, etc. tax breaks, you should be able to get Iowa's top rate down to maybe 4% and eliminate our worthless corporate tax at the same time. The lower the rates, the better for everyone. Except maybe those of us who charge by the hour for tax planning, that is, and for the "economic development" professionals who peddle loopholes for a living.

Mr. Yepsen also mentions a new Iowa tax reform group, "Iowans for Discounted Taxes," which I hadn't heard of before. According to Mr. Yepsen, the group has a strange proposal to enact a simplified tax system and let Iowans use either the current system or their new one. As a tax professional, that should delight me, because that would mean I would do everyone's taxes twice and choose the lower bottom line. As somebody who just finished tax season, though, the thought of doing two Iowa returns for everyone gives me the willies. Still, it's good to see a true tax reform group springing up. The biggest tax lobby in the state, Iowans for Tax Relief, is just a loophole lobby, pretty much useless in the tax reform debate.

UPDATE: I see my old buddy and lapsed Iowan David Hogberg is on the board of Iowans for Discounted Taxes. Small world...

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April 17, 2006


Of course we can redo your return today to add that extra $10 charitable deduction you just remembered!

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April 14, 2006

The Des Moines Reg1ster today recounts the sad story of the Langes, a West Des Moines couple who learned about certified mail the hard way - by losing a $7,685 refund forever. We covered this sad tale here.

The Langes lost their refund because they were unable to show they had filed for it on time - even though their accountant's records supported their claim.

There are two surefire ways to make sure you can prove you filed on time: electronic filing and certified mail.

When you file electronically, the transmitter gets an acknowledgement your return has been accepted. I'm aware of no case where the IRS has questioned the timeliness of an electronic filing.

If you file on paper, the $4.25 extra you have to spend on your certified mail receipt is well-spent. Be sure to take your package to the post office, where the postal clerk will hand-postmark your certified mail receipt, sending you away with a mighty weapon if you ever need to prove you filed on time.

Certified mail is one of our favorite topics:





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April 13, 2006

While the April 15 tax deadline for 1040s is well known (April 17 this year), you may have some other April 15 deadlines. Don't neglect these:

Individual estimated tax payemnts are also due on Apriil 17th this year, as are corporation estimated tax payments for calendar year taxpayers.

Calendar year returns for partnerships, trusts and estates are due April 17.

Finally, if you filed your 2002 1040 without extending it, April 17 is the last day you can file to claim a refund for that year.

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April 13, 2006

For reasons that require no explanation, posting has been light the last few days and will continue that way for a little while. For a tax blog fix, you might want to visit some of my blog friends.

Joel at Death and Taxes is pondering Richard Nixon's will.

Russ at Taxable Talk explains why some Paypal users might not be sleeping well these days.

The Tax Foundation has declared April 26 "Tax Freedom Day." The Center on Budget and Policy Priorities says it's a crock; the Tax Foundation responds.

And the TaxProf never disappoints; just head over there and look around.

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April 12, 2006

A "Simplified Employee Plan," or SEP, is an old last-minute tax-saving favorite of Self-employed taxpayers. A SEP is an Individual Retirement Account for a Self-employed taxpayer and employees. You can set up and fund these as late as the due date of your tax return - even after April 17 if your return is properly extended. Taxpayers with SEPs can deduct contributions to their SEP-IRA of up to 25% of their self-employment income.

But be careful - you can't discriminate in a SEP, so any employees of your business also have to participate. If you have more than one business, you may have to cover employees of all of your businesses. If you are by yourself, though, SEPs are easy and can be set up just by executing IRS Form 5305-SEP. You can learn more about SEPs from IRS Publication 560.

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April 12, 2006

Starlets at the Academy Awards receive lavish gift bags worth north of $100,000, just for being special. It's about time tax preparers got some of that.

mm-thumb.gifMaybe that time is coming. The Tickmarks blog reports that Bank of America is distributing iPod shuffles and stress balls to friendly tax preparers. Good, good. Of course, we wouldn't want other banks to feel slighted, so we are prepared to accept gifts from all comers. The Tax Update Blog is partial to good bourbon, if you're interested.

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April 11, 2006

April 17 is the due date for 1040s this year. It's also the due date for funding your 2005 IRA. Whether you have a traditional IRA, a Roth IRA, or an "Education IRA" (Coverdell account), if you don't fund it by next Monday, you never can, and an important tax opportunity is lost forever.

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April 11, 2006

Perhaps the only thing more intimidating to me than finding out that Tax Professor and prolific tax scholar James Maule is reading my tax posts is to find that he is responding to them.

I feel new IRS proposals on taxpayer confidentiality don't open the door to tax preparers selling their clients data; I feel that door is already ajar. Dr. Maule demurs:

The simple fact of the matter is that the proposed language simply says "a tax return preparer may not disclose or use a taxpayer's tax return information prior to obtaining a consent from the taxpayer." No longer must the disclosure be "AS THE TAXPAYER MAY DIRECT." What is currently a two-prong test, requiring both taxpayer direction and consent, becomes a one-prong test satisfied by getting the taxpayer's signature on a document prepared by the preparer and not originating with the taxpayer.

I believe that a crafty preparer can get a lot of taxpayers to "direct" him to sell tax data to all comers, regardless of Dr. Maule's distinction. Still, I agree wholeheartedly with Dr. Maule's main point: that preparers shouldn't be allowed to sell their client data to third parties; that's where I would like the regulations to be focused.

Dr. Maule embraces my idea for a 200% excise tax on proceeds of selling taxpayer data, and he helpfully provides draft statutory language. I would narrow his language slightly to protect preparers who charge a client for photocopies when he provides returns to third parties at the client's requiest. My changes are in boldface:

No tax return preparer shall transfer or otherwise make available to any other person, other than the taxpayer, in any manner whatsoever, a taxpayer's tax information in exchange for money or other consideration whether or not measurable in money or money's worth. Any tax return preparer who does transfer or otherwise make available to any other person, other than the taxpayer, in any manner whatsoever, a taxpayer's tax information in exchange for money or other consideration paid by the transferee or a party other than the taxpayer, whether or not measurable in money or money's worth, shall be liable for a tax equal to 200% of the proceeds of such a transfer.

Dr. Maule also says I am wrong to call him "irate" about the proposed disclosure rules. I'll accept that. I don't want to make him angry.

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April 11, 2006

There really is a Hogwarts School of Witchcraft and Wizardry, and it's in Massachussetts. At least I hope so, as that's the only way the state's new "mandatory" health insurance plan will work. The InsureBlog summarizes key features, with added sarcasm:

The legislation calls for uninsured residents by July 1, 2007, to purchase new, low-cost health insurance plans or forfeit their personal state tax exemption -- worth about $150 -- in the first year.

Fail to purchase insurance, it costs you $150 per year. Yeah, I can see folks quaking in their boots over that one.

The legislation also would require employers with 11 or more workers to provide health care coverage or pay an annual fee of $295 per employee

Provide health insurance or pay $295 per year. That’s a tough decision too.

Econlog's Arnold Kling explains the big picture:

A single-payer system, with the state directly providing insurance to modest-income residents, would have been less costly and more transparent. Instead, the politicians' plan will force insurance companies to offer no-deductible health insurance to people on modest incomes, at premiums ranging from $1000 to $2000 per year. My guess is that the insurance companies will not be willing to pay for more than about $2000 per person per year in claims, and they will demand that the state provide reinsurance for the rest. Given average health care spending in Massachusetts of $6000, "the rest" could be a big number.

A very big number.

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April 10, 2006

Most tax practitioners have had some version of this conversation:

Client: I got a notice from IRS. What did you do wrong?

Practitioner: What does the notice say?

Client: I think it says I didn't file my taxes.

Practitioner: Well, did you?

Client: Well, I gave you all my stuff.

Practitioner: And I sent the return to you. Did you get it?

Client: I have an envelope from you right here.

Practitioner: What's in it?

Client: Well, a bunch of paper, and some envelopes.

Practitioner: And what do the envelopes say?

Client: Here's one addressed to "Internal Revenue Service Center." What's that for?

Returns don't file themselves. If you aren't filing electronically, get your return mailed. It's always a good idea to take paper returns to the post office and spend the extra money to send it "Certified Mail, Return Receipt Requested."

If you want to file electronically, be sure to return the e-file authorization to the preparer right away. Even if you owe, the practitioner can arrange for the withdrawal from your account to wait until April 17, so holding onto the authorization doesn't keep the money in your account any longer; it just increases the chances that you'll forget to file.

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April 10, 2006

It's official. There's a lot more AMT going around lately.

The IRS last week released its latest "Statistics of Income Bulletin." Among other items, the Bulletin documents how the number of taxpayers subject to alternative minimum tax (AMT) jumped from 2002 to 2003. You can see it in the chart below, adapted from one in the Bulletin:

Source: Individual Income Tax Rates and Shares, Mudry and Parisi. SOIB, Winter 2006.

The chart measures how many taxpayers were in AMT in 2003 and 2002, arranged by adjusted gross income (AGI). The number of AMT returns went up 24% from 2002 to 2003. The incidence of AMT increased in the $100,000 - $200,000 range by 11%, but it more than doubled in the $200,000 to $500,000 range.


The increase in AMT is largely attributable to the rate cuts enacted in 2001 and the reduced rates on dividends and capital gains. It's a matter of the arithmetic. The AMT is computed with fewer deductions, at purportedly lower rates. When the individual rates were cut the AMT rates stayed the same. Inevitably many individuals found their individual regular taxes lowered below the AMT threhhold.

The arithmetic of the AMT and regular tax rate structure hits the $200,000 - $500,000 bracket the hardest. For most of that range, the tax on a given amount of income under the AMT system is barely under the regular rate. State and local taxes are deductible for regular tax, but not for AMT, so almost everyone in that range who lives in a state with an income tax finds that they owe AMT.

The capital gain and dividend rate cuts also push a lot of folks into AMT, at all income ranges. While the stated rates for capital gains are the same under both system, AMT has fewer deductions. If you have the same rate for two taxes, but one has fewer deductions, the one with fewer deductions tends to be higher.


The best way to avoid AMT is to project your income and try to time your state and local tax payments to match your income. If you are close to the AMT, you may find that you should get out of muni bonds, which often increase state taxes and push you into AMT. But for many taxpayers, the only way to get out of AMT is to kick thier kids out of the house (personal exemptions don't apply to AMT) and move to a low-tax state like Florida or beautiful South Dakota.

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April 08, 2006

Every year it happens. After the return is filed, the taxpayer remembers that they sold some stock, or they get a corrected 1099, or they find a 1099 they forgot to give to the accountant. What to do?

It depends on what the error is.


If you owe a lot of money - say, more than 10% of your total tax - you should file an amended return by the April 17 due date. Otherwise you may incur late payment penalties.


If the error is small, there's less of a hurry. Your preparer will be a lot more friendly about correcting a return after April 15. If you will have an additional refund coming when you correct the error, the IRS pays interest. Let the smoke clear and file an amended return if the refund is significant.

Costs and benefits come into play here. You don't want to pay your preparer to file for a $10 refund; let it go. If it's the preparers fault, let him take it off the bill rather than generate IRS attention.

But if the refund is significant, don't be shy - file away. You have three years after the due date, so let your preparer have a few days off before asking where the amended return is.

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April 07, 2006

From TaxProf Paul Caron:

Tax Prof Jack Bogdanski has launched The Complete Internal Revenue Code Podcast Project. The goal: to make the entire Internal Revenue Code available via podcast.

So if playing your old Tiny Tim favorites in the car hasn't driven the family over the edge, you now know what to download.

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April 07, 2006

Tax season is entering its last ten days, so we will helpfully nag remind you of important tax items that may slip your mind in the tax frenzy.

We will start by reminding you that your tax return is due April 17 this year because April 15 falls on a weekend. Unless, of course, you live in one of the New England states that celebrate Patriot's Day to commemorate the rout of the Redcoats between Concord and Boston back in '75. Then you have until April 18.

If you don't bother to extend (Form 4868), you will be hit with a penalty starting at 5% of the amount you owe; this increases by 5% per month until it maxes out at 25%.

If you do extend but don't pay at least 90% of your balance due by the deadline, you will pay a 1/2% penalty on the shortfall, plus 1/2% for each additional month you are late. If you extend and have at least 90% of your taxes paid, you have no penalties as long as you actually file and pay up by the October 15 extended due date.


Iowa returns are due May 1 this year (the usual April 30 deadline is on a Sunday). Extensions are automatic - no form needed - if you have paid in at least 90% of your taxes. If you need to add a little to get up to 90%, use Form IA-1040-V.

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April 07, 2006

dman.jpgA correspondent who wishes to remain anonymous witnessed Congressman Manzullo's dismal performance the other day at the Small Business Committee inquisition of the IRS Commissioner:


thanks for the report, which was spot on. I attended the hearing and Manzullo's performance was just appalling.

Among his other gems:

· he scoffed at the notion that IRS wanted to create a level playing field for small business owners

· he continually equated S-corps with ‘the little guy’ notwithstanding the fact that either of us could show him a list of not-so-small small businesses

· he claimed to be offended by “poor scholarship” while he fabricated ‘facts’ left and right

· he came out completely against the administration’s FY07 legislative proposal to have credit card companies report to IRS gross payments to S-corps (presumably because it wouldn’t be required of large businesses—as if K-Mart is skimming off of the top of its credit card sales)

And I cannot even begin to adequately describe the painfully long interchange in which Commissioner Everson finally got him to understand the not-so-complex concept of backup withholding.

The only thing more embarrassing than the performance of some of our representatives is knowing that we sent them there in the first place, and are likely to keep doing so.

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April 07, 2006

wotf.jpgThe Tax Update got its first Instalanche yesterday. The power of the instalanche is wondrous to behold. We got more visitors yesterday than we have had in any previous month, and by 7:30 this morning we already had as many visitors as we usually have in a day, just on the afterglow of the Insta-link.

It won't make me rich and famous, but it was fun. It's interesting how much the Instalanche hourly traffic pattern...


...resembles the streamflow of of Walnut Creek after a good rain.

Source: USGS

Like Walnut Creek after a gullywasher, Tax Update traffic will settle to its accustomed levels, but like Walnut Creek in flood, it's fun to watch.

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April 06, 2006

This is a bit off the topic of taxes, and I don't really have time, but I have to say something about the Central Iowa Employment Training Consortium debacle. CIETC is an agency I had never heard of, with a mission of training people for jobs. Quite a difficult mission, too, in that it takes 70 employees to cover central Iowa, including three making over $300,000 per year. It has money, a whiff of sex, and now, dumpsters!

Document Dump at CIETC; Dumpsters Impounded

DES MOINES, Iowa -- The scandal roiling through a state-affiliated employment agency deepened early Thursday morning as state troopers surrounded dumpsters behind the offices of the Central Iowa Employment Training Consortium.

CIETC is a non-profit agency housed inside the state's Workforce Development offices near the statehouse.

An anonymous caller to KCCI-TV said a secretary to former Workforce Development deputy director Jane Barto was inside the offices at 4 o'clock Thursday morning, dumping documents. Capitol police and state troopers arrived and have now confiscated one dumpster outside the offices and several inside. NewsChannel 8 witnessed troopers interviewing a woman who was in tears.

While shocking and depressing in a way, it is absolutely the funniest thing to happen here since the Mingo state legislature bachelor party, and it promises to only get better. The Des Moines Register is doing a nice job on this.

Des Moines Register Coverage:





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April 06, 2006

Some more comments on the GAO report on incompetent retail preparers that I ranted about yesterday.

From TickMarks:

It will be interesting to see how the tax blogging community addresses this issue in the next day or two. Some initial thoughts: H R Block really did not need this implication on top of other recent legal problems; the Senators MIGHT have been premature in their comments since other cities were not reviewed and the movement to specify ethics as part of state requirements for annual CPE seems to get buttressed by this audit.

From Taxable Talk:

The study showed that 10 out of 19 sample returns, side income that the preparer was told about wasn't reported. Many preparers missed opportunities to save taxes on returns. None of the firms surveyed were named. Other errors found included unwarranted refunds (of over $1500), and unwarranted extra tax (of over $1500). Only two states, California and Oregon, require licensing of paid tax preparers.

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April 06, 2006

From the New York Times:


At 22, Sarah Patterson has already spent several years in the working world, but she has yet to report her income to the government. For one thing, Ms. Patterson, of Manhattan, works in a cash business, with no withholding tax. But she is also worried about how to list her profession on a 1040 form — she is a foot fetish model. "What I do is not commonly considered work," explained Ms. Patterson, who said she earns more than $100 an hour for letting men ogle or stroke her shapely feet. "When they ask for your occupation, I can't imagine there would be a little box to check describing my job." She can take home up to $400 for working a foot-fetish party where clients take turns enjoying her feet, she said. Private sessions can be even more lucrative.

Via the TaxProf

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April 06, 2006

dman.jpgCongressman Donald Manzullo went out of his way yesterday to illustrate why people find Congress contemptible.

IRS Commissioner Everson and Taxpayer Advocate Nina Olsen appeared before Mr. Manzullo's small business committee yesterday to talk about proposals to improve small business reporting. The recent "National Research Project" audits showed that the biggest non-compliance problems are with sole proprietors. One proposal would require withholding on payments to chronically non-compliant small-business taxpayers.

That idea was just too much for Mr. Manzullo:

An often animated committee Chair Donald A. Manzullo, R-Ill., spared no adjectives, accusing a “disgraceful” IRS of “poor scholarship” on a “lousy” study, telling Olson and Everson that the proposals “stink” and are “stupid.”

“The IRS should hang their heads in shame,” he said.

I don't know about the IRS, but Mr. Manzullo sure has no shame. He is the principal author of arguably the worst tax legislation in recent years, the execrable Section 199 deduction. Like his colleagues, he writes a tax law that is byzantine, illogical and impossible to enforce and administer, and then he beats on the luckless people whose job it is to administer his laws.

When he really got rolling, he deftly invented facts to make his point:

He told Everson the odds of an audit were much higher for small businesses than for others and that the tax collectors should spend their time chasing corporate bad actors such as Enron Corp.

"How much did those clowns gyp the American people out of? How many corporations out there are the Enrons?" Manzullo asked.

Actually, the largest corporations get audited at a rate of 44% per year. Schedule C individuals get audited at well under 10% of that rate. And never mind that Enron lost money and actually didn't owe taxes.

I make a living helping small businesses comply with the tax law. All Mr. Manzullo seems to care about is giving my clients' competitors a leg up by making it easier for them to cheat.

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April 05, 2006

In response to the GAO report of retail tax preparer incompetence, Iowa's Senior Senator had this to say:

"Any Joe can hang a shingle and prepare income tax returns. There are no requirements at all," Senate Finance Committee Chair Chuck Grassley, R-Iowa, said. "It’s incredible that we have legal requirements for a barber to cut your hair, but there are no requirements for someone to prepare your taxes. Americans have a right to expect that when they hire a tax preparer they’re going to get honest, straightforward advice.”

Although not asked to respond, obscure tax blogger Joe Kristan had this to say:

Any Chuck who has spent the last 20 years on the Senate's taxwriting committee has a lot of nerve ripping on Joe Preparer. As head Senate taxwriter, he should be wondering how the tax system got to the point that it routinely baffles people who make a living working with it. I'd like to see him try to prepare the returns the GAO used on those retail preparers.

Back to you, Chuck.

Cross-posted at

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April 04, 2006

If this excuse has been tried in Tax Court before, I've missed it:

Petitioner contends that the section 6651 and 6654 additions to tax are not applicable because her parents raised her to believe that the Internal Revenue Service was an illegal organization and taught her not to file tax returns or pay taxes. As a result, petitioner believes that if she ever filed a return or paid taxes she would be “disowned” by her parents.

The Tax Court today ruled that you can't skip your taxes just because your Mom and Dad say you can.

The facts in the case don't indicate whether the parents wrote a note to the IRS excusing their daughter from tax payments for that year.

Cite: Ruth Ann Gillings, T.C. Memo 2006-65

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April 04, 2006

You can celebrate the Cubs glorious opening day thrashing of the Redlegs by visiting this weeks Carnival of the Capitalists and Carnival of Personal Finance. Always good stuff!

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April 04, 2006

When life hands you lemons, it's the American way to try to make lemonade. When your investment is a lemon, it's tempting to try to use the tax law as a sweetener. Especially when the water is already added.


Sealodge International, Inc. operated an underwater hotel in Key Largo, Florida. Not insolvent; I mean really underwater. Originally designed to house ocean researchers, it was put into service as a novelty hotel in 1986. No word on how the valet parking worked.

Running an underwater hotel has to have its financial clallenges. From 1990 to 1994 it lost annually amounts from $5,434 to $21,067. In 1994, the owners of Sealodge decided it was lemonade time. The owners sold their stock to a not-for-profit entity, the Maine Resources Development Corporation.

Ian Koblick, owner of 45% of Sealodge, sold his 45% interest to MRDC for $90,000. It appears that he had about $50,000 invested, and a fair amount of time. He made his lemondade the following April 15 when he claimed on his tax return that the stock that he sold to charity for $90,000 was actually worth $900,000, and that he was entitled to a charitable deduction for the $810,000 difference. The IRS disagreed, and the issue ended up in Tax Court.


In valuing a going business, you normally place a value on future cash flows. Tax Court Judge Goeke didn't look at it that way. The court decided that replacement cost was the place to start in valuing the company, and he decided that number was about $1,060,000. He then multiplied that by 45% to reflect Mr. Koblick's interest.


In a reversal of the usual arguing positions seen in estate tax valuations, the IRS said a 22% valuation discount was warranted to reflect lack of marketability and a minority interest. The Court decided that only a 6% discount was warranted because the shareholders all donated their interests to the non-profit at the same time in a plan.


While the owners won the valuation argument, they lost the battle. The Court's replacement price was about $3 million less than that argued by the taxpayer; combined with the 6% discount, the value of the stock ended up at an amount even lower than the IRS determined. The value of the donated stock was pegged at $429,300; when reduced by the $90,000 paid by the non-profit, the charitable deduction ended up at $339,300.


Even at $339,300, that translates into a federal tax savings of up to $135,000 at the 39.8% rate then in effect. Combined with the $90,000 that the charity actually paid, Mr. Koblick pocketed up to $225,000 on maybe a $50,000 investment. As lemonade goes, it could have been a lot more sour.

Cite: Ian G. and Tonya A. Koblick, T.C. Memo 2006-63.

I think they could still make money if they fixed it up like Captain Nemo's place:


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April 04, 2006

Martin A. Sullivan on tax incentives in Today's Tax Analysts online:

Tax incentives sap the strength from the tax system. By draining resources from administration, by creating complexity, by affording new opportunities for tax planning, and by raising perceptions of unfairness, they draw it away from its core purpose: raising revenue efficiently and fairly.

$ Link

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April 03, 2006

Like a great meal, Babette Davis's tax-fraud scheme was wonderful while it lasted. But like a cheesecake and cocktail dessert buffet, it had unfortunate consequences.

Ms. Davis was convicted of dummying-up W-2 forms and using them to file for fraudulent tax refunds for her Milwaukee-area friends:

At first, the participants provided Davis with their W-2 Forms, which Davis then altered. As the fraud progressed over time, Davis began to use blank W-2 Forms. She supplied the participants with wage and withholding amounts as well as personal information for made-up dependants. Davis suggested to participants that they file their tax returns at particular H&R Block locations. The participants usually filed their returns electronically and then applied for refund anticipation loans from H&R Block. While awaiting the loan disbursements, Davis maintained a watchful eye, sometimes calling H&R Block to learn the loans' status, and also accompanying participants to pick up the loan checks and cash them.

As the mastermind, Davis took a portion of the funds as a fee for her "services," ranging from $500 up to half the value of the refund. Davis was also a participant in the fraud, having filed false claims on her own tax returns for 1997 and 1998.

The IRS started sniffing around, as could be expected. They learned that the ringleader was known as "Miss T." When they asked Ms. Davis about Ms. T, she tried to throw the dogs off the trail by pointing the finger at one "Michael Wimpy." This worked for awhile, as the agents spent some time figuring out that there really was a Michael Wimpy, but he was dying of AIDS in Minnesota while the fraud took place. So they came back after Ms. Davis, and eventually she was convicted and sentenced to 41 months behind bars.

Ms. Davis didn't much care for the sentence, so she appealed it to the 7th Circuit Court of Appeals. She said not only should she not have gotten extra time added for obstructing justice, but in fact should have her sentence reduced for "accepting responsibility." The appeals court ruled that blaming a dead man was a funny way of accepting responsibility.

Cite: United States v. Babette Davis, No. 05-2489 (3-30-2005, CA-7)

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April 03, 2006

Dr. Maule finds it interesting that the Chairman of the Ways and Means Committee blames the lobbyists for the state of the tax law. He correctly points out that the Chairman of the Ways and Means Committee does have a certain amount of influence:

Yet there is no requirement that Congress do or not do something because lobbyists are pushing for their favorite proposal. Members of Congress can say to lobbyists, "Thank you for the information, you argue well, but the needs of the nation surpass those of your client. Sometimes the good of the whole must transcend the desired privileges of the few." Congress can then reform the tax law. So for Bill Thomas to criticize the lobbyists as he has is to give them too much credit and too much responsibility. The ultimate responsibility for what gets enacted rests with 535 members of Congress, not with lobbyists.

It's worth reading in full.

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April 03, 2006

The things a man's gotta do to read the paper in peace.

The construction crane at the new Mulberry Street parking ramp. Click picture for larger view.

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April 02, 2006

The authors of Freakonomics turn their attention to the tax gap in today's New York Times. They discuss what makes people comply with the tax law and the sorts of measures that deter cheating (short answer: third-party reporting). They also discuss how matching social security numbers wiped out millions of "dependents," like poor "Fluffy," overnight.

UPDATE: They also have bonus information on the Freakonomics website.

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April 02, 2006

The e-mail version of my little screed on worthlessness of the Iowa corporation income tax was picked up the The Des Moines Register this morning.

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