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Tax Update Blog: July 2006 Archives

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THE CASE OF THE MIRACLE PREPARER

July 31, 2006

Ron Lehrer was doing well with his Northern California construction business, but he wasn't happy with his tax preparer, Mary Ann Irrussi. He was grossing $2.5 million to $3 million annually and paying about $45,000 in Federal and state income taxes. He "...wanted a return preparer who would be more responsive to his needs, timely answer his questions, and reduce his inocme tax liability."

Mr. Lehrer thought he found what he was looking for in Anthony Borrelli, a St. Louis preparer. Suddenly tax life was good. The Borrelli-prepared returns "... reported a zero income tax liability for 1999, a $1,523 income tax liability for 2000 (entirely offset by a claimed earned income credit of $2,353), and a $2,325 income tax liability for 2001."

WHEN YOU HEAR ALARM BELLS, SEE WHERE THE SMOKE IS COMING FROM

Mr. Lehrer said "alarm bells did go off" when the tax results were so good, but he filed the returns anyway. It turns out the alarm bells went off for a good reason. Mr. Borrelli, the tax preparer, is now serving a "33-month sentence for crimes relating to filing fraudulent returns." Not surprisingly, Mr. Borrelli's clients got extra audit attention, and the IRS determined that $2,904,032 in extra federal tax for 1999 through 2001. The IRS also assessed the 20% "accuracy-related penalty," for an additional $580,706. By this point the $45,000 tax liabilities that prompted him to switch preparers must have looked pretty good.

Mr. Lehrer settled with the IRS on the deficiency, but went to Tax Court to try to avoid the penalties, on the grounds that he and his wife "reasonably relied" on the preparer.

DUE DILIGENCE, RELATIVELY SPEAKING

The Lehrers hired Mr. Borrelli "...after a relative’s recommendation and a few telephone conversations in which Mr. Borrelli cited some Code provisions." They didn't get any third-party references. Strike against the Lehrers.

The Tax Court found that the Lehrers did provide Mr. Borrelli with the information needed to correctly prepare their returns; score one for the taxpayer.

But the Lehrers lost the tiebreaker:

Although petitioner may have graduated only from high school, he has been managing a construction business generating millions of dollars in revenues for several years, and he personally engaged in hundreds of thousands of dollars of day trading during the years at issue. Petitioners’ income tax liability went from more than $40,000 a year when Ms. Irussi prepared returns for them to essentially zero when Mr. Borrelli prepared the returns. Yet the gross revenues from the construction business remained consistent. Petitioners offered no explanation for the reduced income tax reported on the returns other than the change in return preparer. We cannot excuse a taxpayer who makes little or no effort to discern whether the person the taxpayer has chosen to prepare a return is competent to give tax advice. We find that petitioners did not act in good faith in relying on Mr. Borrelli’s advice.(emphasis added)

The result? The Tax Court upheld the penalties.

The moral? If a relative puts you in touch with an out-of-town tax magician who makes your tax liabilities disappear, make sure it's not just smoke and mirrors.

Cite: Lehrer, TC Memo 2006-156.

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HEAT WAVE CARNIVAL

July 31, 2006

Stay cool with this week's Carnival of the Capitalists and Carnival of Personal Finance.

The Capitalists Carnival has a good piece on rising health insurance costs by the Insure Blog. He includes this depressing thought:

According to actuarial consultant firm Milliman, average medical expenses for a family of four rose by 9.6% last year. Interestingly, this tracked with average annual increases for the past 4 years, as well. Milliman expects that these rates will stay in the 9 to 10% range for the foreseeable future

Lots of good reading at both carnivals, as always.

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WSJ STORY ON MAN-LY PRIVATE ANNUITY

July 31, 2006

Can your annuity own a pocket watch?

That's the question raised in a Wall Street Journal front-pager ($link) today about the tax lives of the Dallas Wyly brothers, Sam and Charles. They set up private annuities and trusts on the Isle of Man that conveniently are invested in collectibles, jewelry and art kept at the Wyly brothers U.S. homes. A brief excerpt gives you the flavor:

The Isle of Man is a misty, quasi-independent republic of 75,000 people in the sea between England and Ireland. Much of the Wylys' network was set up from a medieval village at its southern tip by a British businessman known locally for greeting clients with a macaw perched on his shoulder. Ronald Buchanan long worked at an 18th-century mansion known as Lorne House, which was also the name of his business.

One of Mr. Buchanan's main associates working on Wyly trusts was an ex-stockbroker who is now wanted on fraud charges in South Africa. A review of court records, legal opinions and Wyly family memorandums, as well as interviews with lawyers and regulators, shows that the two men helped the Wyly brothers set up more than two dozen offshore companies and trusts over the past 15 years.

The story reminds me of the Melnik brothers, who set up an annuity in Bermuda and used the annuity as a personal piggy bank. The Tax Court had no difficulty disregarding the purported annuity, but declined to impose penalties. As a federal grand jury and a Congressional panel are looking into the Wyly's financial lives, the U.S. tax authorities may want to keep them from getting off as easily as the Melniks.

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FANTASY MOVIES

July 31, 2006

Hollywood thrives on fantasy. From the Wizard of Oz to Star Wars to Maid in Manhattan, films transport you to a different world for two glorious hours.

Of course, fantasy can also be bitter and paranoid. Take the new "documentary" America: Freedom to Fascism. This piece of work "shows" how the income tax (which is by the way an unconstitutional theft that exists only to pay money to bankers as interest on the national debt) is leading us inexorably down the road to fascism. The producer, Aaron Russo, no doubt hopes to unseat the income tax like Michael Moore unseated President Bush.

Some reviews are now out. They include one today from The New York Times Pulitzer-winning tax correspondent, David Cay Johnston (CORRECTION: the Johnston piece was a news story, not a "review"), and one from Friday's New York Sun.

The Times review piece notes that the movie plays fast and loose with facts before you even enter the theater:

Aaron Russo, the producer of films like “Trading Places” and “The Rose,” promotes his new film, “America: From Freedom to Fascism,” which opened Friday, as having had its international premiere before a packed audience “during the Cannes Film Festival.”

The film was not on the program at Cannes, however, not even for screenings made under the festival’s aegis without being in the awards competition. Mr. Russo, the film’s director, writer and producer, just set up an inflatable screen on a beach. Photographs posted at one of Mr. Russo’s Web sites depict an audience of fewer than 50 people spread out on a platform on the sand.

Here are some quotes from the reviews pieces that the producers might use to promote this film. I have added the exclamation points! and selectively edited, in the style of movie ads everywhere.

"...you'd almost have to be crazy yourself to believe a word of it!" - The New York Sun.
"Arguments made in court that the income tax is invalid are so baseless...!" - The New York Times

The thesis of the movie apparently is that every President and Congresscritter since Woodrow Wilson has been in on this conspiracy. If so, American fascism has to be the most disciplined and patient political force ever known.

For some more reviews:

C/Net news
Austin Chronicle
Rotten Tomatoes

Of course, the TaxProf is also on the case.

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ESTATE TAX REFORM LINKED TO MINIMUM WAGE HIKE

July 31, 2006

Maybe if everyone hates it enough, it will pass. That seems to be the logic behind the newest strategy to pass estate tax reform.

In a flurry of last-minute legislative duct-taping, the proposal to reduce the top estate tax rate to 30%, with a $5 million exemption, has been tied to an increase in the minimum wage and the "expiring provisions" extenders in hopes of getting 60 votes.

Most Republicans despise increases in the minimum wage, and most Democrats want the estate tax rates to stay high. By tying these two bitter pills together, and to the widely popular (if ill-advised) expiring provisions, Republicans hope to be able to get the 60 Senate votes they need.

Will they? Tax Analysts ($link) quotes a "legislative aide" as being confident of getting 60 votes for this "Trifecta" package. The Washington Post (hat tip: The Tax Prof) quotes Senate Democratic leaders as vowing to block the bill.

The expiring provisions include, among others:

- the deduction for state and local sales taxes;

- the expanded version of the research credit;

- the above-the-line deduction for qualified higher education expenses;

- the above-the-line deduction for teachers' classroom expenses;

- the work opportunity tax credit and the welfare-to-work tax credit.


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HIGH OF 99

July 30, 2006

A toasty Sunday in Des Moines. You can keep cool under an umbrella, though.

7-30 fountain.jpg

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WE DON'T NEED NO STINKIN' LAW DEGREES!

July 28, 2006

Dr. Maule notes approvingly that a new IRS requirement for additional coursework for new agents has been upheld. I agree with this conclusion, but then he adds:

Of course, I would prefer that all revenue agents, and all tax practitioners, earn a law degree, because the thinking process that is acquired or polished while studying law has become a sina qua non for tax analysis. Tax is more than running numbers. I've previously posted on why having an accounting degree or background is not a prerequisite for being a good tax practitioner and how it is not even a guarantee that one would be a good tax practitioner. Yes, it helps, but it is far from essential.

I object! Of course an accounting degree is not a prerequisite to being an effective tax practitioner, nor sufficient preparation by itself for a tax career. But a law degree isn't either.

WHAT IS TAX PRACTICE?

Is tax practice working with "the law?" Of course it is. This makes some folks - attorneys all - think that only lawyers should get to practice tax. That is, of course, arrant nonsense. There are any number of lawyers, including some that style themselves tax practitioners, that I wouldn't let within a mile of my tax return. There are also, of course, many fine tax practioners who have taken the holy orders of the legal profession, but any churchgoer knows that ordination doesn't a good preacher make.

Accountants have been involved in tax pracatice since the earliest days of the income tax. I think that by itself is strong evidence that we CPAs have a place in tax practice. Not all accountants are strong tax practitioners by any means, but many are. Accountants have a different role in the tax process. On a day-to-day basis, accountants can certainly do ordinary tax compliance more effectively than attorneys; this involvement, and an understanding of the underlying numbers, makes a good tax accountant a valuable advisor.

I think tax practice is best viewed as a different animal that combines elements of lawyering and accountancy. Different aspects of tax practice use different skills, but either law or accounting are a good start. And don't slight Enrolled Agents, whose training in some ways approaches an ideal synthesis of law and accounting.

I do think graduate tax courses are valuable to anybody pursuing a tax profession, but ultimately success in tax practice is a result of hard work, experience and good judgment - whether or not you have a CPA, a law degree, or an EA certificate.

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BACK INDOORS

July 28, 2006

Posting has been light the last couple of days because the Tax Update was with his eight-year old at beautiful Camp Mitigwa. It's as much fun as you can imagine having living in tents when it's 90 degrees with 90% humidity. More posting later as I get caught up.

This was neat: a family posted at the U.S. Embassy in Minsk, Belarus has a Cub Scout. They scheduled a session at Camp Mitigwa while visiting family in Iowa. That's a long way way to go for Cub Scout camp, but it sure beats any camp the Lukashenko regime would run.

lsminsk.jpg

I hope they had a good time at Mitigwa and that they can make it back here soon.

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KOHLER FAMILY WINS HIGH-STAKES DUEL OF APPRAISERS

July 26, 2006

fixtr.jpgIt would be sporting for the Kohler family, heirs to the fancy plumbing parts business, to send a bottle of champaign to Robert Schweihs. His efforts may have increased the family net worth by $65 million yesterday.

Frederic Kohler died owning 12.85% of The Kohler Company. The IRS and the family couldn't agree on the value of Mr. Kohlers stock, so the Tax Court held an appraisal duel. Mr. Scweihs, an author and a partner at Willamette Management Associates, was the family's champion; the IRS hired Scott Hakala of CBIZ, another appraisal firm.

As you might expect, the appraisal results differed. Mr. Schweihs valued the stock at $47,009,625; Mr. Hakala came up with a $144.5 million value on behalf of the IRS. That meant over $65 million of estate taxes and penalties were at stake.

Yesterday the Tax Court decided the winner. The Court accepted Mr. Schweihs value, giving the family a complete victory.

The Moral? If you have a lot at stake, the right appraiser can make all the difference.

Link: Kohler, T.C. Memo 2006-152

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SENATE REPUBLICANS LINK EXTENDERS, ESTATE TAX REFORM

July 26, 2006

The Senate Republican leadership yesterday pulled the "expiring provisions" from pending pension reform legislation. They will attach these popular provisions, some of which have been extended more or less annually for 20 years or so, to legislation reducing the estate tax rate and increasing the exemption in hopes of getting 60 votes. This probably delays any legislation until September at the earliest.

The estate tax legislation would reduce the top estate tax rate to 30%, with an exemption for the first $5 million of assets.

The expiring provisions include the research credit, the above the line deduction for teacher expenses, and the deduction for sales taxes.

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FUN WITH BILLING

July 26, 2006

The TaxProf poses an ethical tax puzzler for attorneys. If you are flying somewhere on behalf of a client, but work on another client's work on the plane, can you charge both?

It reminds me of the apocryphal question on the legal ethics exam:

Facts: You bill your client $100. Your client pays you in cash with a $100 bill. After you client leaves your office, you realize that the client gave you two $100 bills stuck together.

Question: Do you tell your partner?

One attorney I know likes to tell the story of a long-ago partner-in-charge who issued a memo forbidding "associates" from charging more than 24 hours of time per day. The order didn't cover partners, so they didn't have to turn in their time turners.

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THE DOGS BARK, BUT THE CAVALCADE MOVES ON

July 26, 2006

The 4th Cavalcade of Risk, a compilation of insurance and risk management blog posts, is up at MedBill Manager.

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ROCK IN EXEMPTION

July 25, 2006

rip.JPGThe Des Moines Register reported on the local anti-drug group "Rock in Prevention" this week. The organization works to keep kids off drugs using a pop-rock band that plays positive, anti-drug songs. The article focused on the compensation paid to the groups executive director and payments made to him for producing the group's compact disks.

The article brings to light some of the pitfalls of running an exempt organization. The first pitfall is that your tax returns are available on demand or on the internet (www.guidestar.org; free registration required). That means your friendly local paper might write an article showing how much you get paid.

TAX RULES FOR EXEMPT ORGANIZATIONS

It also gives us a chance to note the tax issues that arise in compensating employees of exempt organizations (note- these are issues that apply to all charities; we aren't looking specifically at Rock in Prevention's taxes here).

As a price of being tax-free, charities must operate "exclusively" for their charitable purpose. If the IRS says an executive is overpaid, they can argue that the organization is not operating exclusively for charity. If the courts agree, the organization can lose its exemption and get clobbered with back taxes.

Until a few years ago, revocation of exemption - sort of a death penalty for charities - was the only remedy the IRS had in dealing with exempt organizations. They were understandably reluctant to impose that penatly, so Congress stepped in with a new set of "intermediate sanctions." These allow the IRS to impose a 25% excise tax on the charity on any "excess benefit." This can be imposed instead of revoking the organization's tax exemption, or in additon to a revocation.

RESPONSIBILITIES OF MEMBERS OF CHARITY BOARDS

If you are on a charity board, you should examine your compensation and benefits packages with these rules in mind. You should take an especially close look at any non-salary business deals with employees or major contributors; the IRS will look closely at these, and if they find that things aren't being done at arms-length, the consequences could be unpleasant.

You also should make sure your organization is filing complete and accurate forms with the IRS. The IRS will cheerfully hit organizations with a $50 per day penalty for late filing of form 990, and that can add up in a hurry.

Related coverage: State 29.

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DES MOINES REGISTER TAKES UP SPELTZ CAUSE

July 25, 2006

The Des Moines Register yesterday weighed in on the plight of the Speltz family from Eastern Iowa. Ron Speltz was a McLeod Communication employee who participated in the McLeod "incentive stock option" plan and ended up owing hundreds of thousands of dollars of tax on stock that became worthless. From the editorial:

Here’s how it happened: In 1992, Ron took a job with McLeodUSA, then a small telecommunications start-up. Compensation included stock options, which he saved for a family nest egg. In 2000, he and June consulted a financial adviser on the best way to cash out the stock. The adviser told them to exercise the stock options and hold the stock for a year to take advantage of low tax rates on capital gains.

Then the stock price fell. What was once worth about $700,000 became worth about $2,000. Yet, they owed more than $250,000 in state and federal taxes due to a quirk in the Alternative Minimum Tax law that targets Incentive Stock Options (ISO-AMT).

It's not exactly correct to call the AMT issue a "quirk." It's a devil's bargain that has been in the tax code for 20 years. To get the tax benefits of ISOs - long-term capital gain tax on what would otherwise be ordinary compensation - you have to pay AMT when you exercise ISOs. You also have to hold on to the shares for a year to get the capital gain rates. If you sell the ISO shares before the year is up, the "bargain element" - the spread between the exercise price and the value at exercise - is ordinary income.

The editorial says Senator Grassley is trying to get some AMT-ISO relief in the pension reform bill now in conference committee.

The "financial advisor" issue is a new wrinkle, to me. If Mr. Speltz paid for financial advice, the advisor's malpractice insurance company must be sweating. If you are exercising ISOs, you should remember what Mr. Speltz learned the hard way: if you exercise ISOs, you should consider whether you could pay the resulting AMT if the stock becomes worthless before your taxes are due. If not, you should sell enough shares to make sure you stay solvent if the company doesn't - even if you have to pay ordinary income taxes in the bargain.

The correct solution to the ISO problem is to simply repeal the ISO provisions entirely - both the benefits and the AMT downside. Economically, you almost never exercise a stock option until you are ready to cash out. The ISO holding-period rule encourages behavior that would otherwise be economically irrational.

Hat tip: State 29.


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SURVIVOR: OKLAHOMA CITY?

July 25, 2006

hatch100.jpgOklahoma City is the latest stop in the odyssey of "Survivor" celebrity Richard Hatch:

Richard Hatch has been sent to a federal prison in Oklahoma as he serves a 51-month sentence for failing to pay taxes on the $1 million he won on the debut season of "Survivor."

Hatch, 45, of Newport, arrived last week at the Federal Transfer Center in Oklahoma City. It wasn't immediately clear why Hatch was moved or whether he will serve out his prison sentence at the facility, which is a hub for prisoners transferring through the federal system.

Sometimes winning $1 million isn't what it's cracked up to be.

Hat Tip: TaxGuru.net

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IRS GETS OKAY TO MAKE NEW AGENTS STUDY MORE ACCOUNTING

July 24, 2006

ckelley.jpgA federal labor panel, overturning an arbitrator's decision, has ruled that the IRS can require agents to have 30 accounting course hours. The National Treasury Employees Union (NTEU) had fought the requirement. Colleen Kelley, the union chief, said of the requirement:

...I can conclude only that the IRS imposed the additional requirements solely to serve as a bar to internal candidates, eliminating from consideration many highly qualified applicants for revenue agent positions and ignoring the significant value on-the-job experience offers. That in turn has had an inordinate impact on minorities and other protected classes

World Ends; Women, Minorities Hardest Hit, in other words.

As complicated as the tax law is, it's hard to fault the IRS for wanting agents to understand accounting. It's a requirement that would be challenged only in the strange world of public-employee unions. Given that the NTEU makes actually firing an incompetent agent close to impossible, minimum hiring requirements are one of the few tools the IRS has in trying to improve the competence of their agents.

Hat Tip: the TaxProf.

Links:

FLRA ruling
Washington Post coverage
Prior Tax Update coverage


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INSTAPUNDIT ASKS: 'IS THE I.R.S. GETTING BETTER?'

July 24, 2006

The Gigablogger asks:

IS THE I.R.S. GETTING BETTER? Helen had some sort of issue with her self-employment tax, wrote them a letter, and they very quickly (within a few weeks) fixed it and sent a refund check. She's had a couple of experiences like that lately; are they getting better?

Working with the IRS for a living, I have to say that I find it to be one of the best government agencies to deal with. Sure, it's grading on a low curve, but I would rather deal with 10 letters from the IRS than one letter from the Department of Labor or the state unemployment insurance people. If there is a real IRS error, you can usually work it out with them. I have good luck working out IRS notices with this approach:

1. Deal with them it writing. You waste a lot of time if you try to call them, and then you may need to send them a letter with supporting information when you are done.

2. When you write, be specific and have complete information. Include your name and social security number or tax ID number at the top of the letter. Refer to the notice by date and by the "reference number" they generally have; attach a copy of the notice to the letter.

3. Show them. Many erroneous notices relate to items that are on the return but were missed - for example, 1099 match notices that miss a dividend that you reported as, say, "Charles Schwab" because they are your broker, rather than "Microsoft" or "Instapundit." Send a copy of your Schedule B and explain where the information is reported. If the number they want is buried in another number, give them the detail they need.

4. Don't assume the IRS is right. While many IRS notices are right, a significant portion are in error. If they are in error, don't be afraid of them. They will normally fix an error if you explain it to them, and calling them on the mistake won't make them mad or get you in trouble.

5. Be polite. Don't take out your anger at the tax system on the clerk who will open your letter. Deal with them with courtesy and you are more likely to be taken seriously.

6. Be brief. Give them what they need to solve the problem; don't waste your time and theirs with a discussion of your tax return preparation technique.

7. If things get serious, get help. If you get letters with words like "Notice of Intent to Levy" or "Final Notice," get a tax pro involved immediately. And if you get a visit from a guy with a badge, call a good tax lawyer before you say another word.

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TAX NEWS BACKLOG

July 24, 2006

A lot of the tax news while I was gone was things thad didn't happen. The estate tax wasn't repealed; Congress didn't reach an estate tax compromise; LIFO wasn't repealed; and Barry Bonds wasn't indicted.

The Tax Policy blog had a lot of good posts, including this on how business play states for tax subsidies. They've also launched a weekly podcast.

Finally, a local anti-drug crusader has drawn attention for pulling over $300,000 from his "Rock in Prevention" non-profit organization. We will discuss the tax issues that may be involved in a future post.

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TAX CRIME TAKES NO VACATION

July 24, 2006

Even though the Tax Update took a vacation, the wheels of tax justice continued to grind.

The biggest story while I was out has to be the delay in the KPMG tax shelter trial. Now that the defendants can pay their lawyers, the judge is giving them more time to prepare their case. The trial, which had been set to start in September, now is slated to begin January 15, 2007. (UPDATE: A commenter says I need to check my facts, and I think the commenter is correct. While the judge is leaning on KPMG to pay the fees, and on the Justice Department to go along, KPMG is resisting.) In a related story, a federal judge in Texas ruled that a regulation against the "son-of-BOSS" tax shelter could not be applied retroactively. While that doesn't mean the shelter worked as advertised - the IRS can still challenge it on economic substance grounds - the decision is still good news for shelter investors who haven't settled this shelter.

In other tax crime news:

ANOTHER STUDIOUS TAXPAYER FALLS

Tax gadfly-attorney Larry Becraft lost another one. Mr. Becraft defended Robert Kelliher, an Illinois electricion, on charges of failure to pay because he believed "in good faith" that the tax law didn't apply to him. It was another instance of misguided study:

Kelliher's attorney, Lowell Becraft Jr., countered that his client had concluded that the income tax code didn't apply to him through the study of decades- and century-old court cases. Kelliher faces a maximum of 10 years in prison, a $250,000 fine and the cost of his prosecution when he is sentenced in October.

We have talked about the dangers of overstudying.

THIS WON'T BE GOOD FOR HIS BUSINESS

A Denver tax attorney was sentenced to two months in prison and 8 months of home dentention for helping a client evade taxes using offshore shell companies and trusts.

THE CHINESE RESTAURANT MENACE

The long arm of the tax law catches up with another Chinese restaurant, this one in Michigan.

NO JUSTICE, NO PIECE OF CLOTHING

A West Virginia strip club owner may stand naked before the law.

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AUGUST 2006 APPLICABLE FEDERAL RATES (AFR) ISSUED

July 24, 2006

The IRS has issued (Rev. Rul. 2006-39) the minimum interest rates for loans made in August 2006:

-Short Term (demand loans and loans with terms of up to 3 years): 5.26%
-Mid-Term (loans from 3-9 years): 5.21%
-Long-Term (over 9 years): 5:36%

Historical AFRs are available at the "links" page at www.rothcpa.com.

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BACK FROM THE WOODS

July 24, 2006

You can't fish forever.

100_0655.JPG

The Tax Update is back at work today.

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HIT THE ROAD

July 08, 2006

wagon.jpg

The Tax Update will be on vacation the next two weeks, so posting will be light to nonexistent. Visit the Tax Nerds on our blogroll if you need your tax fix meanwhile. See you in two weeks!

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LAWYER, CPA, FARMER: THREE-TIME LOSER!

July 07, 2006

Whatever problems Austin Mitchell of Salem, Missouri has, they aren't from lack of persistence. The lawyer-CPA yesterday lost a case involving losses on his farm. That would be unremarkable, except it's the third time he's lost a hobby-farm case involving the same farm.

The case shows that there are limits to hard work as a teenager:

Petitioner argued that his previous work on the family farm as a teenager indicates that he was previously successful in a similar activity. Petitioner did describe in detail how much corn was cropped due to his efforts, but he did not prove that the family farm was financially successful during those years. Accordingly, petitioner's prior work on the family farm does not support a finding for petitioner.

It also shows that credentials alone don't necessarily triumph:

Petitioner is a licensed CPA and has a legal practice. We find that petitioner is hard-working and dedicated to his professional pursuits. Petitioner's success in a CPA and legal practice, however, does not equate with petitioner conducting the farming activity with an honest and actual objective of making a profit.

Of course I'm trying to make money on my farm! I'm a CPA, buddy!

The moral: If you aren't a full-time farmer and you want to deduct farm losses, you'd better have books, records and a business plan to make money. Better yet, just make money.

Links:

Mitchell, T.C. Memo. 2006-145
Mitchell, T.C. Memo. 2001-269

TaxProf Blog coverage

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A PRESCRIPTION FOR THE SIDE EFFECTS OF THE PRESCRIPTION FOR THE SIDE EFFECTS

July 07, 2006

A eastern Iowa state senate candidate hasn't even won office yet, but he's already acts like a veteran politician: he has an abiding faith in the protean ability of the tax law to solve all problems. The problem he wants to solve is the difficulty of keeping our young folks in state when they get out of college. His solution? Tax Credits!


In this partnership, Iowa provides employers a partial tax credit for the amount of undergraduate educational debt that employers pay on behalf of their employees. Over the course of three years of employment, employers would pay a progressively increasing portion of the employee's educational debt up to a maximum of $25,000.

Taking a cue from the Governor's marketing efforts, he calls this the "Iowa Advantage Fund." He says this will have transformative powers:

College graduates will have the advantage of substantially reducing their college debt. This creates an incentive for them to remain in the state and for recent graduates who left the state to return.

Iowa employers will have the advantage of lower labor costs because of savings in reduced turnover costs and the tax credit. This creates an incentive for them to expand their hiring in Iowa.

Iowa will have the advantage of having more young people in their workforce and by creating an incentive for businesses to locate and expand their hiring in the state. This increases state tax revenues.

Even if this worked it would have a creepy feel of indentured servitude; young graduates would be bound to the land between the rivers until they at worked off their student loan debt. But it wouldn't work. It would be just one more tax incentive getting lost in an Iowa tax system that is already a senseless jumble of tax incentives. Consider:

- We have tax incentives to keep old folks who don't work.
- We have tax incentives for old buildings.
- We have tax incentives for "entertainment districts."
- We have tax incentives for "high-quality" new jobs.
- We have tax incentives for "new jobs" (presumably those of iffy quality).
- We have tax incentives for research.
- We have "Iowa Values" tax credits.
- We have ethanol and biofuels credits.
- We have tax incentives for companies that sell out-of-state.
- We have tax incentives for people to hold onto their businesses for at least ten years.
- We have about six tax incentives for venture capital.

If this stuff worked, by now Iowa would combine the historical and cultural grandeur of Paris with the entertainment facilities of Las Vegas, the energy economy of Saudi Arabia, and the research and venture capital dynamism of Silicon Valley.

But we don't. We have one of the most complicated state tax systems in the country and some of the highest tax rates. We have an economy that is struggling outside of a few metropolitan areas. And we have politicians who can't seem to see beyond ethanol in looking for solutions. Solving Iowas problems with these targeted "fixes" makes me think of somebody who takes sleeping pills at night, then takes meth to wake up in the morning, and then starts drinking to relax...

Hat tip: Side Notes, who has perceptive observations about why it's hard to keep them down on the farm.

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MORE ON GANDER MOUNTAIN

July 07, 2006

One of the nice things about the blogosphere is the way its many hands make for light work. Kyle the Political Madman saw yesterday's post about Gander Mountain's battle against targeted tax incentives for economic development and ran with it. He has put together a good post with fine set of links to anti-incentive websites and studies. Kyle dives deep where I skimmed the surface; it is good.

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CONSTRUCTIVE RECEIPT: YOU DON'T TOUCH IT, IT'S YOURS

July 06, 2006

Keith Scherbart sold corn through the Mennesota Corn Processors cooperative in the 1990s. The co-op made annual "value added" payments to its members based on its margins on corn deliveries.

In August 1994 and August 1995 the co-op sent a letter to its members saying the value-added payment for the year would be ready by November. The letter gave members the option to the member to defer the payment until the following year. Mr. Scherbart took them up on the offer and deferred the payments. When he filed his 1040s, he also deferred the taxes.

The IRS didn't go along with this, saying the members had "constructively received" the deferred amounts. Mr. Scherbart lost in the Tax Court. He appealed, and yestereday the Eighth Circuit Court of Appeals upheld the Tax Court. The appeals panel said that the value-added payments weren't sales proceeds to the members, but instead distributions of net proceeds by MCP acting as Mr. Scherbart's agents.

The Moral: If your agent has the cash, you have to pay the tax.

Links:

Eighth Circuit decision

Tax Court decision

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TAXING YOU TO LURE AND SUBSIDIZE YOUR COMPETITORS

July 06, 2006

Probably the most galling thing about "tax incentives" like the "Iowa Values Fund" is the when you see the state subsidizing a new competitor. The Tax Policy Blog tells how it's getting on Mark Baker's nerves. Mr. Baker is CEO of outdoors retailer Gander Mountain, and he discussed the issue in an interview with Budget and Tax News:

Interviewer: Gander Mountain has launched a national campaign in opposition to government subsidies in the outdoors retail industry. What is wrong with subsidies?

Baker: Competitors of Gander Mountain have successfully convinced state and local governments in several states to provide large tax incentives in order to build stores in their communities. They portray their stores as "destination retail" in order to secure the incentives, claiming that by having their store in a community it will draw millions of tourists, and their wallets, to the area. However, these retailers are in the marketplace to sell product and turn profit, and like all retailers they analyze the markets to determine where their customers live and shop.

Playing one community off another, these retailers push for tens of millions of dollars from taxpayers to help finance their stores. Even more troubling, in some cases they are persuading states to give them favorable "nexus rulings" that are costing taxpayers even more in lost sales tax collections.

Gander Mountain has two locations in Iowa, and they aren't getting state money, so it's up to you.

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OOH, LAS VEGAS

July 06, 2006

Irwin Schiff has been effectively removed from tax practice, but the pied piper of the zero-income 1040 was in business in Las Vegas for a long time before he was sent away. It's not surprising, then, that Las Vegas has its share of tax protester cases. The Tax Court dealt with two of them yesterday.

Las Vegas residents ("Vegans"?) Aaron Ball and Geoffrey Yuen filed returns showing zero income and tax; both returns also had statements with "frivolous" explanations of why they had no income, regardless of what their W-2s and 1099s said.

The IRS undertook collection action, and Messrs. Ball and Yuen fought back in Tax Court. They both lost, and the Tax Court hit Mr. Ball with a $5,000 fine for wasting the court's time.

The moral: the tax plan that got Irwin Schiff where he is today probably won't do you much good, either. In Vegas, the house always wins eventually.

Cites:

Ball, T.C. Memo 2006-141
Yuen, T.C. Memo 2006-138

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GOOD TAX ANALYSTS PIECE - AND YOU CAN'T SEE IT

July 05, 2006

Tax Analysts has a great daily tax publication. For those of us in the tax field, it's a gold-mine of news and great commentary. But unless you are willing to fork over four figures for a subscription, you'll never see it. That means it's unavailable to most non-professionals, and to professionals who happen to be less generous with their subscriber dollars.

Today's issue features an excellent discussion of international tax competitiveness issues by contributor Martin Sullivan, including this notable comment:

It's no longer the case that credits and faster depreciation are the big draw for corporate investment. These days lower corporate tax rates have far more appeal. There are several reasons why.

First, as economies have moved away from manufacturing -- as intangible assets become more important than plant and equipment and the rate of profitability per dollar of physical capital increases -- it's a straightforward matter of arithmetic that rates play a larger role than conventional incentives in determining the after-tax profit of investment decisions.

Second, as transportation and communication costs have dropped, and trade barriers and currency controls have also declined, there's more cross-border investment than ever. In the old days, say, before 1995, economists were thinking about how to use taxes to get a domestic firm to boost its domestic investment on the margin -- for example, by 3 percent or 4 percent. In that case -- that is, in the case of investment of borderline profitability -- traditional incentives can mean a lot.

But with increased capital mobility, economists have changed their thinking about the mechanics of motivating investment. Under the new paradigm, governments try to influence location decisions of multinationals. Because those decisions involve large chunks of investment -- not just those that are marginally profitable -- tax rates matter more than tax credits.

It's an observation that can apply to state taxes just as well - the age of incentives is over (not that they ever really worked well at all), and Iowa, with it's "Values Fund" and its highest-in-the-nation tax rate, is out of step.

SHINE YOUR LIGHT, TAX ANALYSTS

Unfortunately, these observations are muffled because Tax Analysts hides them behind its subscriber firewall. Tax Analysts is actually a tax-exempt organization with an educational mission:

Tax Analysts is a nonprofit, nonpartisan organization fostering informed debate on federal, state, and international tax policy. We seek to encourage the development of tax systems that are fair, simple, and economically efficient. We challenge lawmakers, policymakers, and administrators to take into account the rights and concerns of all taxpayers, not just special interests.

It seems that hiding all of its best commentary behind the subscriber firewalls doesn't do much to foster informed debate. Considering the price of a subscription, the only people who are likely to read these things are the "special interests" themselves. Tax Analysts used to have an arrangement with the TaxProf Blog to allow an article out from behind the firewall each day, but that's over. The CCH Center for Tax Studies blog apparently is allowed to reproduce the odd news piece, but that doesn't help Mr. Sullivan get to a broader audience.

Tax Analysts would be wise to renew the arrangement with the TaxProf Blog so that their excellent commentators can get more attention. They also should set up a group blog - outside the subscriber walls - for their commentators and others to volley tax ideas in a less-formal forum.

Link: Subscriber-only version of the Sullivan piece.

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CARNIVALS OF INDEPENDENCE

July 05, 2006

The Independence Day Week Carnival of the Capitalists and Carnival of Personal Finance are up. And there's a bonus Cavalcade this week!

The capitalists are celbrating over at MyMoneyForest, which features, among other good posts, an explanation of "Why a homeless person can make more than you on the internet." Because he has more time to pick up the empty e-cans and return them for deposit refunds?

The Personal Finance bash is up at Raising4boys.com, featuring “I am Glad That I Lost 40% in my First Investing Year.” Apparently the lessons learned were worth it. (UPDATE: link fixed)

The Cavalcade of Risk is over at Traderknowledge this week.

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HAPPY INDEPENDENCE DAY!

July 04, 2006

flags.jpg
West Des Moines 4th of July parade last night.

Have a great 4th!

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TAX PREPARERS, GET READY TO GET REGULATED

July 03, 2006

Senator Grassley was disturbed that barbers are subject to more government regulation than paid tax preparers. We thought that was a shame, and we hoped the Senator would work to repeal the barber regulations.

That's not what he had in mind.

Last week Senator Grassley's finance committee passed a bill (S. 832) that would regulate paid preparers. Paid preparers not subject to state regulation (e.g., lawyers and CPAs), will be subject to a new IRS license requirement. The licensing would include a "competency exam," renewals every three years, and a new IRS "Office of Professional Responsibility" with administrative law judges and authority to sanction preparers.

Also buried in the bill is a provision that will likely force most preparers to electronically file their clients' returns:

The proposal permits the IRS to expand the scope of returns filed electronically by paid return preparers. The present-law restrictions relating to the types of tax returns required to be filed electronically are removed and the number of returns that trigger the requirement to file electronically is lowered to five. The proposal also imposes a monetary penalty on any person required to file a return electronically that fails to do so.

I know somebody who won't like this.

I actually like e-filing. While some think it increases the risk of IRS examination, I haven't seen any evidence of that. I think a return that actually is touched by an IRS human is more likely to attract unwanted attention than an e-filed return. Still, I'll miss the thrill of racing down to the central post office late at night to drop off a last-minue filing.

Well, I won't, actually.

Link: The TaxProf roundup of S. 832

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IF YOU TAKE THE EXTENDED WARRANTY, IOWA WANTS A CUT

July 03, 2006

The Iowa Department of Revenue today published a declaratory order saying that extended warranties are "sales of personal property" subject to sales tax to the same extent as the property being warranted.

The order, issued to Caterpillar, says that while extended warranties can be subject to sales tax, they are exempt if they are sold on a property that is itself exempt because it was purchased for resale.

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