Tax Update Blog: August 2006 Archives

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MURPHY - CATALYST FOR REFORM, OR JUDICIAL POWER GRAB?

August 31, 2006

As word on the Murphy decision seeps out of the tax world into the mainstream media, a new set of reactions begins to emerge. As one might expect, the reaction outside of the tax community is different to that of us tax drones, and it reflects their philosophical approach to taxes.

Bruce Bartlett, writing in National Review online, sees it as a step towards a national consumption tax:

I would like to see the court go further in regards to the question of whether interest constitutes income. To economists, some portion of the interest we receive on our savings is merely compensation for loss — loss of the immediate enjoyment we would receive if we consumed our income today instead of saving it.

The New York Sun editorial page says:

Time and a higher court will tell whether Ms. Murphy gets to keep her $20,665 in tax payments. We wish her luck. Whatever the final result, Ms. Murphy has performed a service by offering three judges an opportunity to give the IRS a scare. No other person or institution in America is above the law, and there's no reason the IRS should be the exception.

While I am sympathetic to these sentiments, these folks miss the bigger picture. The Constitution allocates the taxing power, and the legislative power, to Congress, subject only to a requirement that "direct" taxes be apportioned among the states according to population. The courts tended to use the "apportionment" requirement to assert themselves in tax policy until the 16th amendment was passed, removing the issue of whether taxes on income were "direct" taxes. Since then, the courts have wisely deferred to the elected branches in determining how the taxing power is to be exercised.

It is unwise to invite the judiciary back to the tax policy table. These folks may be cheered by a judicial meddling in tax policy that they endorse, but not all judges are conservative, and they won't all meddle in ways that the Sun or Mr. Bartlett would approve.

The traditional role of the courts in tax policy is to hold the executive branch - the IRS - accountable to the law as enacted. There have been any number of decisions overturning the IRS on this score. Murphy doesn't "scare" the IRS. It scares Congress itself by subjecting their policy choices to black-robed second-guessing.

The Murphy decision, if upheld, will make it impossible for legislators to make tax policy with any certainty that it will pass muster with the judges that then happen to be on the bench. Better for the courts to step back from the brink and let tax policy arguments take place in the branches directly accountable to the tax-paying voters.

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ANOTHER REASON TO NEVER CHECK YOUR EMAIL

August 31, 2006

News Item:

RadioShack Corp. notified about 400 workers by e-mail that they were being dismissed immediately as part of planned job cuts.

That's pretty cold, but it could be worse. Back in the 1980s I heard a second-hand story of an office of a national accounting firm summoning the fired employees over the office intercom system. That must have been a real morale-builder.

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PRINCIPAL WAIVES HSA SET-UP FEES

August 30, 2006

Did you know that Des Moines insurance behemoth Principal Financial Group does health savings account administration? I'm embarrassed to say I didn't know until I saw a report today (no link available) that Principal is waiving setup fees on HSAs set up through Principal Direct Connect. Information about their accounts is here.

Principal apparently leverages its 401(k) administration infrastructure into HSA administration. Their presence in the HSA administration market should make it much easier for employers to make the leap into high-deductible insurance plans.

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AMITY SHLAES ON MURPHY

August 30, 2006

Excellent article by Amity Shlaes in Bloomberg.com on the implications of the Federal Circuit's recent Murphy decision (Hat tip: TaxProf Blog). From the article:

There is another signal from Murphy, subtler but equally distressing. Americans tend to believe that activity that is taxed is somehow suspect, whereas untaxed activity is more virtuous. Now the court is confirming to citizens what their lawyers already tell them: Litigation is virtuous. More virtuous than buying a lottery ticket, for lottery winnings are taxable.

The hope is that the Supreme Court, which is likely to hear the case, will lay Murphy to rest. Then Congress can alter the law if it likes. But as it stands, Murphy is dangerous. It confirms what Americans already believe: The world owes them.

You'll want to read the whole thing.

Prior Tax Update Coverage of Murphy:

More Murphy

Murphy's Law, Indeed

HAD A TAXABLE NON-PHYSICAL INJURY? MAYBE YOU NEED TO FILE A REFUND CLAIM

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ANOTHER BAD DAY FOR AMT-ISO VICTIMS

August 30, 2006

The Tax Court rejected pleas for relief from another taxpayer who was socked with alternative minimum tax from exercising incentive stock options. This taxpayer exercised incentive stock options for PMC-Sierra stock in 2000, paying $183,263 for stock valued at $2,910,251. This was non-taxable for regular tax, but resulted in $2,726,988 of AMT taxable income.

As in so many of these cases, the stock value collapsed and the taxpayer had nothing to show for the ISOs but an AMT bill of $786,000 or so.

The taxpayer tried to compromise her liability with the IRS; when they rejected her offer in compromise, she sued in Tax Court, saying the IRS "abused its discretion" in refusing to compromise the liability. Citing the Speltz case, where the court rejected a similar pleading from an Eastern Iowa McCleod employee, the court turned down the claim.

Cite: Wai, T.C, Memo. 2006-179.

THEY SHOULD HAVE SUED ME!

Tax Analysts reports another AMT-ISO case with some strange arguments. The taxpayer sued for a refund in the U.S. District Court for Central California on the grounds that she should have been sued under four different legal arguments for having exercised her stock options, and that therefore she shouldn't have had any income. The district court said that there was no evidence that any of those arguments would have succeeded, but I hope for her sake that the statute of limitations has expired for all of the things she thinks she should have been sued for.

Cite: Hernandez, DC CD-California, Case No. Case No. CV 04-9365.

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GREAT MOMENTS IN TAX LITIGATION

August 30, 2006

From a pleading before the Court of Federal Claims seeking punitive damages from IRS for not issuing an employment tax refund:

[f]or the claimant with the Federal Claim No.: _________________ is with the damage by the loss of the love and nurturing of the children and for the freedom for the use of his property for the pain of the body and mind for the loss.

I tried to figure out what that means, but the pain of the mind left me at a loss.

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CAVALCADE OF MONEY LAUNDERING

August 30, 2006

This week's edition of the Cavalcade of Risk, a collection of risk-management blog postings, is up at the Dayton Daily News "Making Cents" blog.

Don't miss Hank Stern's explanation of how a seemingly staid product like an annuity can be used for illicit money laundering -- and why this can be trouble for agents.

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GRASSLEY TO HOLD EXECUTIVE COMP HEARINGS

August 29, 2006

Senate Finance Committee Chairman Grassley will hold a hearing September 6 to look at stock option backdating and executive compensation tax issues. The press release says:

Chairman Grassley is exploring the extent of abuse of executive compensation tax restrictions with an eye toward possible legislation.

It's hard to say any tax law changes are needed here. The backdating of stock options already violates tax rules and has led to some securities law indictments.

The last time Congress tackled executive compensation issues, the result was the awful "Section 409A" rules on deferred compensation. Passed in the Enron political preening frenzy, these rules apply to every business with non-qualified deferred compensation, even if just a simple retirement bonus plan. They are so complicated and poorly written that after nearly two years the IRS still hasn't been able to come up with workable regulations. The situation is so bad that the AICPA threw up its hands earlier this month and called for either drastic revisions or outright repeal.

It's probably too much to hope that Senator Grassley will decide that they should undo the damage done already, rather than add yet more complexity to the already baroque tax code.

Link: BenefitsBlog Section 409A link collection.

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YET ANOTHER AMT-ISO VICTIM LOSES IN TAX COURT

August 29, 2006

The Tax Court shot down another taxpayer attempt to avoid alternative minimum tax from ISO exercise yesterday. Neild Montgomery was an executive for MCG Holdings, a Nevada telephone company. When he left the company his options vested and he exercised shares worth $10 million or so.

Unlike many AMT ISO victims, he sold some of his shares - $2.4 million worth, which went a long way towards covering the AMT due. That was wise, becasue whild ISO exercise doesn't trigger regular tax, the amount that the stock value exceeds the exercise price is considered taxable income in computing AMT. Like so many telecom stocks, MGC (later Mpower) stock collapesed and the company eventually went through Chapter 11. Mr. Montgomery had a $2.4 million tax bill for stock that ended up worthless.

When it came time to pay his AMT. Mr. Montgomery asserted a number of arguments against having to pay AMT. He said the company had made a mistake and disqualified his ISOs. The Tax Court disagreed. He said that he had a "risk of forfeiture" because of securities law rules that kept him from being taxable on his stock. His disposition of $2.4 million of stock hurt this argument. His other arguments were the same one shot down in the recent Merlo and Spitz cases.

The Moral? Again: if you exercise ISOs, figure out whether you can pay the AMT if the company goes under before the one-year capital gain period expires. If you can't, it may be better to sell some shares to make sure you can pay your taxes and forego the capital gain benefits.

Cite: Montgomery, 127 T.C. No. 3.

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BACK TO SCHOOL CARNIVALS

August 29, 2006

The kids go back to school but the grown-ups are stilly partying at this week's blog carnivals.

The Carnival of the Capitalists is at Business and Technoloty Revolution. Be sure to check out the Insureblog's contribution on small businesses dropping their health plans.

At the Carnival of Personal Finance, at My First Million at 33, they have a system up to vote for your favorite post. I like "10 Steps for Personal Finance Organization" from No Credit Needed Blog.

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HAROLD HILL WANTS TO MAKE A MOVIE IN IOWA

August 28, 2006

A young independent filmmaker has generously offered to shoot her first film right here in Iowa, if we pay her a big enough bribe. From this morning's Des Moines Register:

Cedar Rapids will play a starring role in "Conditional Love," a movie project launched by former Iowan Lisa Arbuckle - unless Atlanta, Ga., gets the part.

Arbuckle has her heart set on shooting the feature film in Cedar Rapids. It's the setting for her screenplay and the place she called home until moving her family to Arizona in April 2005 to pursue her movie-making dreams.

But money talks. Georgia offers a package of film production tax incentives that could be worth about $200,000 to Arbuckle's project.

Well, don't let the door hit you in the Atlanta on the way out, Lisa.

Of course, the "economic development professionals" just love this:

"We ask legislators to give an incentive package to the film industry itself and that will lure the big production companies in," said Becky Gruening, director of tourism at the Greater Des Moines Convention and Visitors Bureau.

And what fabulous tourist attractions would this new film create?

She and producer Donnelly also scouted shooting locations in Cedar Rapids and nearby Benton County - including a jail, hospital, high school, club and liquor store.

Oh, yeah, that will pull them in, especially the liquor store.

The politicians are always ready to take a little bit of money from the rest of us to give it to Hollywood:

Film industry tax incentive bills that received little attention during the 2006 session are likely to get a closer look in 2007, said Rep. Jamie Van Fossen, a Davenport Republican who currently heads the House's tax policy committee.

In considering film production tax breaks, the idea isn't to portray Iowa as "the next Hollywood," said Van Fossen, "but there's a little bit of a successful record of films coming out of the state."

The film industry has been remarkably successful in getting other states to authorize bribes to filmmakers. The would be bribe recipients say that Iowa is one of four states without film credits.

If you wonder what this is really about, Ms. Arbuckle's chief bribe-seeker producer, Terence Donnelly, spells it out for the rubes:

For tax credits to really have value to filmmakers, they need to be transferable, said Donnelly, whose previous projects include working as assistant director for the filming of "The Exorcist" in 1973.

That means being able to sell the tax credits to another business that can use them, which would raise a lot of cash up front for the production company, he said.

In other words, the state pays virtually a direct cash subsidy by offering tax credits that the producer can sell at a discount to cover their production costs. Yes, that's what we Iowans want: let's pay taxes to subsidize film makers. Dollars for Hollywood! Lord knows they don't have enough money.

Tags: harold hill.

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'A BAD WEEK FOR DENTISTS'

August 28, 2006

Two dentists and a jeweler in tax trouble; details at Taxable Talk.

If they end up at the same federal facility, maybe they can go into business together.

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SEPTEMBER 2006 APPLICABLE FEDERAL RATES (AFR) ISSUED

August 25, 2006

The IRS has issued (Rev. Rul. 2006-44) the minimum interest rates for loans made in September 2006:

-Short Term (demand loans and loans with terms of up to 3 years): 5.13%
-Mid-Term (loans from 3-9 years): 5.01%
-Long-Term (over 9 years): 5:21%

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

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NEW RULES ON DONATIONS OF PERSONAL PROPERTY KICK IN SEPTEMBER 2

August 25, 2006

If you donate appreciated long-term capital gain property to charity, you can deduct the fair-market value of the property, even if you paid a lot less. If the donation is of an item other than publicly-traded stock or securites, the tax law requires you to support the donation with a "qualified appraisal."

The recently enacted pension bill (H.R. 4) adds new restrictions for donations of tangible personal property, like art. If the property is sold in the year it is donated, the charitable deduction will be limited to the cost basis. If the property is sold within three years of the contribution, the donor will have to recapture as income the amount the charitable deduciton exceeded basis. This takes effect for donations after September 1, 2006.

Be careful with any restrictions on the sale that you might impose as a condition of the gift; the IRS could say that the restriction reduces the value of the property, therefore also reducing your charitable deduction.

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MORE MURPHY

August 24, 2006

As promised, bitter blogger Daniel Shaviro took his turn at the Murphy decision, the one that ruled that taxing personal non-physical damages was a constitutional violation. Bitter? Bitter and personal:

Ginsburg has one policy-minded hobby horse in the opinion. He abhors the idea that, under the Sixteenth Amendment, Congress can define income however it damn pleases. But again, if common sense were permitted under his theory of judging (if his biases can even be dignified with such a term), he would recognize that this (simply including gross and net receipts of cash) is not the place where policing by the courts is needed to make sure that our government remains one of limited and enumerated powers.

Meanwhile, Dr. Maule takes on a correspondent who unwisely suggested that the doctor's initial post was so off-base that he should take it down. You can view the massacre here.

The Wall Street Journal Law Blog has also finally noticed the excitement in the tax blogosphere. The Taxprof notes that big-time media is also picking up the story.

Academic response to Murphy is overwhelmingly negative, but if you want to hear a few good words about it, visit the comments at the TaxProf's place.

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IRS ISSUES CHALLENGE TO S CORPORATION BANK DEDUCTION

August 24, 2006

Hundreds of community banks have become S corporations since they were first allowed to do so in 1997. The ability to distribute dividends without a second level of tax has been a boon to the bank shareholders.

Many tax rules for banks were drafted before banks could be S corporations. The Treasury has apparently decided that Congress didn't do an adequate job when it changed the law, so now it's trying to rewrite the S corporation bank rules.

TEFRA DISALLOWANCE

In 1982 Congress restricted the deductibility of interest expense for banks with tax-exempt bond investments. `Code Section 291(a)(3) disallows the interest deduction for 20% of interest attributable to municipal bonds. This provision is called "TEFRA Disallowance," after the name of the 1982 tax bill.

Section 1363(b)(4), an S corporation provision enacted in 1984, provides that Section 291 ceases to apply to S corporations beginning with the fourth year after their S election. When Congress enacted the 1996 legislation allowing banks to become S corporations, it left this provision in place. As a result, banks routinely stopped computing the 20% TEFRA disallowance. (Another provision, which disallows 100% of interest deductions attributable to "non-qualified" municipal bonds, was not affected by S corporation elections).

In recent years the IRS apparently decided that Congress really didn't mean to write the S corporation rules that let the TEFRA disallowance lapse after three years. It has challenged a number of banks who have ignored this disallowance. Yesterday they raised the stakes by proposing new regulations that would apply the 20% TEFRA disallowance to S corporation banks even after three years have passed.

CAN THEY DO THAT?

We think the language of the statute is clear, and that the 20% TEFRA disallowance goes away three years after the S election takes effect. We also don't believe that Congress granted broad enough regulatory authority to override the statute (in contrast to the passive loss rules and consolidated returns, for example). We think the IRS is exceeding its authority here.

That said, taxpayers need to know how to deal with this issue. S corporations have three choices right now:

1. Continue to file returns ignoring the 20% TEFRA disallowance, or
2. Adopt the IRS position, starting either in 2006 or 2007, or
3. File amended returns adopting the IRS position for open past years and future years.

We believe the statute provides adequate authority to continue to ignore the TEFRA disallowance. If the regulations become final taxpayers who continue to ignore the disallowance will have to file a special disclosure form, Form 8275-R, to avoid penalties for their 2007 returns (due in 2008) if the IRS challenges the deductions and wins. Filing this form will go a long way towards ensuring a visit from the IRS

FIGHT THE POWER!

Roth & Company will file a comment protesting the new regulations. If Congress had wanted to impose TEFRA disallowance on S corporation banks, they have had plenty of chances to do so when they have enacted other S corporation bank legislation. It's not the Treasury's place to fix the statute.

The comment deadline is November 22. You can submit comments at www.irs.gov/regs or on paper to:

CC:PA:LPD:PR (REG-158677-05), Room 5203, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington DC 20044.

If you file on paper, they want a signed original and eight copies.

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FORESHADOWING

August 24, 2006

Bitter blogger tax prof Daniel Shaviro is back from vacation, and he promises a piece on the Murphy decision holding taxation of non-physical personal damages unconstitutional. I don't think he's going to agree with it:

Two quick thoughts, admittedly before reading it, are: (a) I am inclined to wonder if the good Judge has graduated from marijuana, his vice in the good old days, to crack cocaine; and (b) under the radical right judges we have these days, all kinds of doctrine that has been good since the 1930s is up for grabs.

Tax author Kaye A. Thomas has posted an article on Murphy: Judicial activism at its worst.

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LEGAL OBSERVATION OF THE DAY

August 24, 2006

From a U.S. District Court order holding a taxpayer in contempt for failing to respond to a summons:

Apparently, Respondent believes there is a legal distinction between "Charles David Saunders" the person and "Charles David Saunders" the Living Soul. The Court has been unable to locate any precedent that supports such a distinction.

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MURPHY'S LAW, INDEED

August 23, 2006

With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely to stand. I think there are two major flaws in the decision.

WHAT IS INCOME?

The first flaw is the decisions conclusion that the "framers" of the 16th amendment authorizing the modern income tax would have not considered damages for emotional distress "income." Joseph M. Dodge, in his essay in "Tax Stories," notes that there were at least two competing conceptions of income at the time. One concept was based on the "principal and income" concepts of trust law. One was the "Haig-Simons" concept, which more or less covers most of what we think of as income now. Murphy ignores this debate entirely and concludes on the thin evidence of an Attorney General opinion and a House committee report that "income" was a settled concept.

WHO CARES IF IT'S INCOME?

Once the Murphy court decided that damages for personal injuries weren't "income," they concluded that the tax on them was unconstitutional without further discussion. This appears to be the weakest part of their analysis.

The federal government has broad taxing powers. The courts struck down the pre-1913 income tax as a violation of the constitutional requirement that "direct" taxes be apportioned among the states based on population. Many non-income taxes are recognized as constitutional, including gift, estate and excise taxes. As one professor puts it:

Thus, in order to invalidate the tax in the Murphy case, it is not enough to hold that the award is not "income." It would be necessary further to hold that the tax is a "direct" one, prohibited by Article I -- and to explain why it is not otherwise authorized by the Necessary and Proper Clause. The court of appeals did not perform these analyses, and thus its opinion is woefully incomplete. My very rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124).

(Emphasis added).

My point? Even if it's not income, compensatory damages are still subject to Congress's power to tax unless they are imposing a "direct" tax, which they probably aren't.

The TaxProf has a good roundup of links and discussion of Murphy (not mine, alas). One theme of a number of these links is the notion that the Murphy decision is just about a narrow issue of personal injury damages. It claims no such modest goals. It subjects every item subject to income to a test of what the word income meant in 1913; it settles on a "common understanding" of the term and potentially subjects every item now subject to the income tax to the 1913 definition. Every day many millions of dollars are exchanged in transactions undreamed of in 1913. Under this logic, what income can Congress safely tax?

I doubt the full D.C. Circuit, or the Supreme Court if it comes to that, will be willing to throw out the long-settled Glenshaw Glass approach of deference to Congress and introduce such disruption to the tax law.

Links:

Tax Update initial discussion of Murphy

Stuart Levine's discussion

UPDATE: Dr. Maule takes his shot at the decision:

Where the court goes haywire is its conclusion that section 104(a)(2) is unconstitutional. This conclusion reflects a total misunderstanding of how the Internal Revenue is structured. There is no need to comment on, or decide, the constitutional validity of section 104(a)(2), and doing so opens up a hornet's nest of problems.

Well worth reading in full.

ONE MORE UPDATE: The TaxProf now has commentary from 10 academics on Murphy. They don't have much good to say about the legal basis for the decision. One makes the point that the rest of us have perhaps been reluctant to make (glass houses and all that):

By the way, wasn't the opinion's author they guy who lost a seat on the Supreme's for smoking dope?

Like totally, dude!

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HAD A TAXABLE NON-PHYSICAL INJURY? MAYBE YOU NEED TO FILE A REFUND CLAIM

August 22, 2006

The Federal Appeals Court for the D.C. Circuit came out with a shocker of a tax case today (hat tip: Volokh Conspiracy). A 3-judge panel ruled that damages for personal injuries were not understood as income when the 16th Amendment was ratified; as a "return of human capital," says the court, such payments are not taxable.

In sum, every indication is that damages received solely in compensation for a personal injury are not income within the meaning of that term in the Sixteenth Amendment. First, as compensation for the loss of a personal attribute, such as wellbeing or a good eputation, the damages are not received in lieu of income. Second, the framers of the Sixteenth Amendment would not have understood compensation for a personal injury -- including a nonphysical injury -- to be income. Therefore, we hold § 104(a)(2) unconstitutional insofar as it permits the taxation of an award of damages for mental distress and loss of reputation.

A few years back Congress legislated that only damages for "physical" injuries would be tax-exempt, while damages for emotional injuries and the like would be taxable. This decision would strike that down. Taxpayers who extended 2002 until October 2003 with taxable injury income on their 2002 returns can keep their rights to a refund alive by filing a claim by October 15, 2006.

My initial thoughts: I would be very surpised to see this decision hold up, as it goes against what I understand to be the accepted constitutional wisdom. Constitutional attacks on the definition of income have failed almost invariably. Conventional scholarship, I believe, holds that "income" was not a particularly well-defined term when the income tax was enacted, and it took a series of Supreme Court cases, such as Glenshaw Glass and Eisner v. Macomber, to come to the current understanding. To say the "framers" of the 16th amendment would have said such damages would not be income relies on a settled definition of income that probably did not exist at the time.

Of course, I would not have expected any three judges to rule this way. The government will surely appeal, and the full D.C. circuit is likely to hear it; if the case survives the full panel, the Supreme Court will surely take the case. We'll be hearing a lot more about this decision in the coming weeks, for sure.

This holding would be huge, if upheld. If it is, expect a wave of challenges to other parts of the tax law covering all sorts of items that weren't thought of in 1913, from original issue discount to gain on stock option excercise. It will be a golden era for tax litigators and a nightmare for Congress and the Treasury.

Cite: Murphy, No. 05-5139 (CA-DC)

UPDATE: After thinking about it during the lunch hour, the obvious occurred to me: this thing is going to trigger lots of refund claims in all sorts of areas starting right now. A great many corporations extend their return, and their 2002 statute of limitations expires September 15. Let the gold rush begin.

The TaxProf now has a post up on Murphy, including this from UCLA lawprof Steve Bank:

More importantly, during this period, the definition of income was far from settled. The income tax was only five years old and Congress was borrowing from economic definitions, legal definitions, and popular definitions. The economic understanding of the term “income” at the time was arguably evenly split between those advocating an accretion tax notion of income (e.g., Haig) and those advocating a consumption tax notion of income (e.g., Fisher). The latter would not have supported a tax on capital gains, although the Supreme Court held that it was permissible in a 1921 decision. As I have argued in the context of tax-free reorganizations, the provisions adopted in 1918 were an attempt to compromise between these conflicting definitions of income so as to assure a proper revenue to pay for war expenses while still maintaining the appearance of fairness and responding to heavy lobbying from business and the wealthy. The notion of taxing people who recovered damages during this war period may have violated our sense of fair play when war profiteers were seeking to avoid paying tax on their bounty.

This from the Appellate Law and Practice blog: "And so the misguided fires of tax protesters are stoked once again."

"How Appealing" also weighs in.

Also a good comment thread has started at the Volokh (Orin Kerr) post listed above.

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BACK-TO-SCHOOL CARNIVAL

August 22, 2006

Parents are celebrating the start of school this week, and the party goes on at the Carnival of Personal Financie, hosted this week at the MoneyBlog Network.

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BAD TIMING, FOOT FAULT LEADS TO TAX DEBACLE FOR SOLV-EX EXEC

August 22, 2006

Timing is everything in the tax law. Your tax life is divided up into arbitrary 12-month periods, so your low income in those lean years you spent sharing a trailer after college does nothing to reduce your tax now that you are driving that new BMW.

Timing is also important in the energy business. Solv-Ex was a corporation with a technology that it claimed would turn the tar sands of Canada into an inland sea of petroleum. Many Iowans bought Solv-Ex shares in the 1990s, only to see their investment disappear into the Athabaska basin. The company became a target of short sellers, and a critical article in Barrons didn't help. The company failed amid bitter recriminations against the short sellers, whom management accused of unfairly maligning the company. The Solv-Ex shareholders can only ponder whether what failed with $30 oil would have succeeded at $70.

Meanwhile, John Rendall, former Chairman and CEO of Solv-Ex, has more pressing business: picking up the pieces of his tax life. Mr. Rendall pledged 2,660,000 shares of Solv-Ex stock on a margin account with Merrill Lynch in 1997 to secure loans that financed Solv-Ex activities. 2,500,000 of the shares were purchased for one cent each, while the remaining shares had more basis.

WHO IS TAXABLE ON A MARGIN CALL?

Later in 1997 Merrill Lynch made a margin call. When Mr. Rendall failed to add cash to the account, Merrill Lynch sold 634,000 shares to pay off $4,229,479 of margin debt. They returned the remaining pledged shares to Mr. Rendall.

So far, things aren't going well for Mr. Rendall. His company is sinking and his broker just sold $4 million of his company's stock out from under him. Now comes the IRS to pile on. The IRS said that Mr. Rendall was taxable on the gain on the stock sales, and that his basis in the sold shares was $63,400 - the penny-per-share he had paid long before.

Mr. Rendall disagreed. He told the Tax Court that the stock sold out of his margin account was taxable to Merrill Lynch. He said that the shares were sold "for Merrill Lynch's protection of their massive short position" (that short-seller conspiracy had many tentacles). He also said that the shares were "fraudulently procured" and that there was no need for Merrill Lynch to force the sale because they were still adequately procured. Finally, he argued that that if he were taxable on the sale he should be allowed to offset his high-basis shares first against the sales proceeds.

YOUR STOCK, YOUR MARGIN ACCOUNT, YOUR TAX

The Tax Court yesterday rejected Mr. Rendall's position. The court said there was no evidence of fraud on the part of Merrill Lynch; because the margin loan was by its terms payable on demand, it didn't matter why Merrill Lynch called it. The sale paid off a $4 million dollar debt from Mr. Rendall to Merrill Lynch, so he received a direct benefit out of the deal. Finally, the court said that long-established law makes the pledgor the owner of pledged property, not the creditor:

As the pledgor of the Solv-Ex common stock held by Merrill Lynch, Mr. Rendall remained the owner of and, therefore, was taxable on Merrill Lynch's sale of the pledged shares. As stated by the Court of Appeals for the First Circuit in Old Colony Trust Associates v. Hassett, 150 F.2d 179, 182 (1st Cir. 1945): "A pledgee who has not foreclosed has only a special interest or property in the stock during the continuance of the pledge. The pledgor retains the title and gains from sales of the collateral are taxed to the pledgor."

HOW TO SELL THE HIGH-COST SHARES FIRST

The Court also ruled against Mr. Rendall on the basis issue. The tax law has a default "First-in, First-out" (FIFO) rule for stock sales. Unless the taxpayer adequately identifies the shares to be sold prior to sale, the oldest shares are considered the first ones sold.

The tax regulations give the requirements for identifying shares:

Where the stock is left in the custody of a broker or other agent, an adequate identification is made if --

(a) At the time of the sale or transfer, the taxpayer specifies to such broker or other agent having custody of the stock the particular stock to be sold or transferred, and

(b) Within a reasonable time thereafter, confirmation of such specification is set forth in a written document from such broker or other agent.

Coulda, woulda, shoulda... didn't. Mr. Rendall failed to provide any instructions to Merrill Lynch as to which shares should be sold, even though he was warned that the sale was coming. This was an expensive foot-fault. As the oldest pledged shares were the 1-cent shares, that was the basis for the $4,229,479 sale, leaving him with a $4,166,079 taxable gain.

Mr. Rendall also lost two other issues that we plan to address in another post.

The Moral? When your broker sells your shares on a margin call, you, not the broker, get to pay any tax due. If you want them to use your high-basis shares, you need to let them know ahead of time.

Cite: Rendall, T.C. Memo 2006-174

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FACT OF THE DAY

August 22, 2006

Attrition rate for IRS revenue agents this year: 20% (Attributed to Kevin Brown, commissioner of the IRS Small Business/Self-employed Division).

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QUOTE OF THE DAY

August 22, 2006

"When you're headed for a cliff . . . slowing the speed of the car from 60 to 30 when you're approaching the cliff is not adequate to get the job done."

-U.S. Comptroller General David Walker on Administration plans to cut the budget deficit in half by 2009, as quoted by Tax Analysts ($link)

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TIF TIFF

August 21, 2006

The Des Moines Register has been running a series on the rampant use of Tax Increment Financing (TIF) for "economic development." The Tax Policy Blog summarizes how TIF works:

Lawmakers issue debt, using the proceeds to subsidize economic development—including malls, parking garages and street landscaping—on the theory that development projects will increase future property tax revenue by enough to repay the debt with a profit.

Tax Policy Blog thinks TIF is a bad idea, calling it a "shell game":

The only problem is that state and local governments almost never keep score on the costs and benefits of projects, which often end up a net loser for taxpayers.

When you think of it, if you have to do things like TIF, it tells you your property tax system is dysfunctional. If you need TIF to attract businesses, it means the taxes are so bad that no business will show up unless you don't make them pay taxes. In reall life, though, it's likely that TIFs are just finagled by playing communities against each other, or just by influencing friendly politicians. Taxing existing businesses to lure and subsidize competition - the Iowa way!

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THE MAULE LAW INSTITUTE

August 21, 2006

Professor James Maule, the prolific Villanova tax scholar, takes issue with the way the TaxProf blog "ranks" law schools by the number of downloads of tax articles via "SSRN," an electronic download service. Tongue in cheek (I think), he suggests that tax schools instead be ranked by the number of BNA portfolios authored by their faculty.

The thing is, Dr. Maule has personally authored 14 portfolios, meaning that by himself he is the strongest tax school in the known universe.

Dr. Maule has also said that he thinks law school should be required for tax practitioners. That's interesting, because the second-ranked school after Dr. Maule in BNA authorship is... Iowa State University! Interesting - because ISU has no law school. By his own standards, then, they have no business in the tax field at all! How can they do that?

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ONLY AT THE FAIR

August 18, 2006

I'm spending the afternoon at the Iowa State Fair. I'm posting this while watching a country band at the State Farm stage, trying to recover from the excitement of seeing the one, the only...

...The Man of Butter!

Don't you wish you were here?

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PRESIDENT SIGNS PENSION BILL

August 18, 2006

The President signed H.R. 4, "The Pension Protection Act of 2006," into law yesterday. Starting today, employers wanting to ensure their employees need to follow a somewhat elaborate procedure to make the policy proceeds tax free. For example, they have to obtain a signed consent from the employee before they buy the policy. Look for many foot faults with this provision.

The Benefitsblog has a good summary of the signing, with links (including video!).

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PROJECT RUNWAY: TAX COURT EDITION

August 18, 2006

From the TaxProf Blog:

In Nicely v. Commissioner, T.C. Memo. 2006-172 (8/17/06), the Tax Court refused to let a welder deduct the cost of the Rocky Wolverine boots he wore to work. What makes the case particularly interesting is that one of the requirements for deducting work clothing under § 162 is that the clothing must not be suitable for personal wear outside of work. In denying the deduction, the Tax Court noted tongue in cheek that "petitioner acknowledged at trial that he was wearing Rocky Wolverine boots."

Manolo could have helped, surely.

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'THE TAX LAW SHOULD BE AN OPEN ROAD, NOT A TOLL ROAD'

August 18, 2006

The New York State Bar Association Tax Division addresses the policy issues in patenting tax advice in a letter to tax policymakers (hat tip: Tax Analysts ($link)). They conclude such patents are unwise:

The patenting of ideas or strategies relating to areas involving legal issues raises difficult issues not limited to the tax area. The tax laws, however, are perhaps unique in that they impose universal affirmative obligations of compliance on U.S. citizens and residents. The entrepreneur that wishes to set up a new business requiring some patented technology to operate always has the choice to pay the royalty or not to engage in the business in question, and will weigh the costs against the expected profits. But when the same entrepreneur enters into even the simplest transaction - for example, incorporating his sole proprietorship - he has no choice but to seek tax advice, if for no other reason than to report the transaction correctly on his tax return. The patenting of tax strategies would invariably increase the cost to taxpayers of complying with their tax obligations, a result we think is indefensible as a policy matter. For this reason, we believe that tax strategies and tax ideas should be generally available to all taxpayers. The tax law should be an open road, not a toll road.

Exactly. While they don't say it quite so bluntly, the enforcement of tax patents would require practitioners to have to spend time making sure they aren't infringing on some patent. Inevitably rent-seeking patent jackals would file for patents on everything in sight, and luckless practitioners and taxpayers engaging in routine transactions would have to either pay extortion or spend time and money fighting the alleged patents.

Folks in the technology business might say, "Welcome to our world, tax boy. Welcome to Hell." The point is well taken, but two wrongs don't make a right. And while not everyone has to invent things or market products, everybody has to comply with the tax law. That's expensive enough without having to pay a toll charge to a holder of some dubious tax patent.

In related news, I have chosen not to participate in the Stratford patent webcast on tax patents mentioned here. I decided I lack the time to prepare for it, and I don't want to blunder in and make a fool of myself. Sure, I don't let it stop me here, but that's different...

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A SHOUT-OUT FOR TAX REFORM

August 17, 2006

Pejman Yousefzadeh, the scary-smart* Chicago lawyer-blogger, has a piece today on the need for tax reform at TechCentralStation.com.

Pejman makes good points in favor of a consumption tax (though not, mercifully, the "FAIR Tax), though he has nice things to say about a Forbes-style flat-rate income tax. Unfortunately, if anybody in Washington is serious about tax reform at the moment, they're keeping it to themselves.

*Scary-smart, but he likes soccer? And the Bears? Well, who doesn't have a character flaw or two?

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FREE TO BE STUPID

August 17, 2006

Professor Maule noted a newspaper article about how H&R Block is drawing some heat for its refund anticipation loan services. The Professor weighs the propriety of granting refund anticipation loans and their effective interest rates, and finds both wanting:

Two questions popped up as I read the article. First, is it appropriate for the company that is preparing the tax return and thus calculating the refund to make loans based on that refund? Second, is it appropriate to charge interest at the rates being charged?

The first question should be answered in the negative because there is a conflict of interest. The higher the loan, the more interest income is generated for H&R Block. This puts the company in the position of trying to maximize the refund, when the company should be maximizing the client's compliance with the tax law. Every "close call" is going to be affected, subtly or not so subtly, by the impact on the lending activity. It's best to leave the refund anticipation loan to some other lender, to whom the customer can go after he or she is handed a copy of the return by the preparer. H&R Block, after all, should stick to tax return preparation and not open up a bank.

The second question must be answered in the negative. According to the story, and I've read similar reports elsewhere, the annualized interest rates on these refund anticipation loans are as high as 700 percent. SEVEN HUNDRED PERCENT? Toss in the fact that roughly 80 percent of the people using refund anticipation loans are low-income, and suddenly there is a recipe for all sorts of unacceptable situations.

There is no question in my mind that refund anticipation loans are sleazy. Should they be illegal? My firm doesn't do refund anticipation loans, and anybody who can do arithmetic knows that they're a bad deal, on a par with car title loans or "payday loans." Still, while I recoil at the practice, consenting adults should normally be allowed to engage in finance, foolish or not, if all terms are disclosed.

But should the preparer be allowed to make the loan? Dr. Maule is on firm ground when he points out the conflict of interest when the preparer who computes the refund benefits from the resulting usery. When effective rates approach 700%, a refund lender has a lot of incentive to generate a big refund. Dr. Maule makes a good policy argument for separating the preparation function from the loan-sharking lending function. Perhaps a 100% excise tax on interest income received by preparers from refund loans would do the trick.

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SUNKEN ARK CLAIMS ANOTHER VICTIM

August 17, 2006

It's a staple of shipwreck lore. As the ship goes below the water, it creates a whirlpool that sucks down swimmers who survived the initial disaster.

Anderson's Ark, the failed tax scheme, works much the same way. The Ark set up tax schemes where taxpayers would ship cash overseas pretending that they were making payments for deductible business expense. The Ark would keep the funds for them, net of their cut. The organizers have gotten long prison terms, and the participants are getting sucked down by the sinking ship:

DENVER — A Grand Junction woman was the latest to be convicted in a tax fraud case that’s landed numerous defendants, including a Montrose couple, in hot water.

A federal jury convicted Kris Smith, 52, of filing two false federal income tax returns, failure to file a partnership federal income tax and filing a false refund claim. She faces a maximum sentence of 10 years in prison and a $100,000 fine for each violation.

Smith was found to be a member of Anderson’s Ark Associates and of utilizing a “complex business organization,” a type of tax scheme used to eliminate current-year taxes. The jury found she’d also recovered a refund of more than $70,000.

The Moral? If a tax scheme involves eliminating your income using "fees" to offshore entities, head to the lifeboats.

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THE GREAT BURNING BATTERY RECALL

August 16, 2006

I have a Dell laptop computer at home, so last night I went through the little routine at dellbatteryprogram.com to see if I was recalled. It took about 5 minutes, and sure enough, I have one of the home arson kits in my unit. It was very easy to walk through the program, and they say I will get my new battery in 20 days.

While an exploding P.C. is a low probability hazard, the consequences could be pretty severe, expecially if I were to fall asleep with it on my lap. At least they make the recall process reasonably simple and painless.

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THE BUH-BYE FILE

August 16, 2006

The Death and Taxes blog has a good piece on the value of having an "If I'm hit by a truck" file for your family members to track down your stuff:

I'd suggest that the file contain, at a bare minimum:

-your estate planning documents (originals or copies; if copies, you should leave a note about where your originals are kept)

-a somewhat current list (updated once or twice a year?) of your assets, including things like retirement benefits and life insurance

-contact numbers -- who should be informed of your death?

-documents (formal or informal) setting forth burial and funeral instructions

-if you feel so inclined, a "letter of affirmation, or blessing," as mentioned in the article

An excellent idea. I suggest using a big binder where you can just clip in the most current Annual (or semi-annual) statement from each investment account you have.

I would add to the list a page with computer passwords, or at least a page telling where a list of your passwords can be found. Many of us keep our financial life on Quicken or other financial management software; many of us also manage our investment accounts online. If our heirs can log on (after we're gone, of course), it will save them a lot of trouble in settling our affairs.

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YET ANOTHER LOSS FOR AMT-ISO VICTIMS

August 16, 2006

The Tax Court rejected yet another attempt to avoid the AMT consequences of incentive stock options gone bad yesterday.

While most employee stock options are taxable as ordinary income when exercised, incentive stock options are not, at least in computing regular tax; if you hold onto the stock for one year after exercising the option, you get capital gain on the sale, rather than ordinary income. The catch? It's all taxable for alternative minimum tax on exercise.

A Mark Spitz (not the Mark Spitz, as far as I can tell) exercised his ISOs and then saw the share value collapse before a year went by. He then had to pay AMT on the amount the value at exercise of the now-worthless shares exceeded thier exercise price. Like every ISO-AMT victim before him (including Iowan Ron Speltz), he lost.

Cite: Spitz, T.C. Memo 2006-168.

The Moral? If you exercise ISOs, exercise caution, too. If you can't afford to pay the AMT if the shares go bad, sell enough shares to make sure you stay solvent.

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THE SKEDADDLE OPTION

August 16, 2006

The Wall Street Journal law blog reports that the option backdating scandal has created its first fugitive:

Comverse Technology’s former CEO, Kobi Alexander, is regarded as a fugitive by the U.S. government, which last week charged him with conspiracy related to backdated stock options, his attorney said. Here’s the WSJ story.

Robert Morvillo of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer said he last spoke to Alexander about two weeks ago, when Alexander was in Israel as part of a regular summer trip to his native country (and where Comverse has operations). But now Morvillo says he has no idea of his whereabouts.

With 90+ companies enmeshed in the backdating fiasco, those countries without extradition treaties may experience boom times.

In other backdating news, the Wall Street Journal reports ($link) that some of the companies with backdated option problems were fervent opponents of requirements to expense stock options. Well, if you are willing to cheat your shareholders, why wouldn't you also want to pull the wool over their eyes?

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STATE FAIR CARNIVALS

August 16, 2006

The Iowa State fair is going strong through Sunday. You absolutely won't want to miss the giant, heavily-fed and carefully-groomed creatures on display. Oh, and there are lots of cool farm animals, too.

You also don't want to miss this week's blog carnivals.

The Carnival of the Capitalists is at Barrymoltz.com this week. I like the "Sox First" blog piece that says public companies should disclose more information when they change auditors.

The Carnival of Personal Finance appears at "Frank the Financially Savvy Athiest,"(there has to be more than one, no?) including a post on "401(k) insurance" from the Insureblog. It looks like it's really a form of disability insurance that builds up your retirement income if you become disabled during your working life.

Last but not least, the Cavalcade of Risk is at MyMoneyForest.com this week. If risk is scary, you can ease into it with this post on bond investing fundamentals.

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THIS MUST MEAN TAXES AREN'T HIGH ENOUGH

August 15, 2006

This headline at the TaxProf Blog says it all:

State Tax Revenues Surged 7.7% in FY 2006, Eclipsed by 8.4% Spending Increase

The National Conference of State Legislatures has a firm faith in the ability of our elected representatives to spend faster than we can feed them money:

For FY 2007, NCSL projects state tax revenues to increase 3.0% and spending to increase 7.6%.

Words fail me.

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THE LEATHERSTOCKING TALES

August 15, 2006

What does Ferdinand Marcos have to do with partnership taxes? You'd be surprised.

Robert L. Steele was the "tax matters partner" for the Leatherstocking 1983 Partnership, a cattle-feeding shelter. The tax matters partner is responsible for adminstering tax filings and IRS matters for a partnership. Mr. Steele also had some unusual outside business interests, as laid out yesterday by the Tax Court:

In or about August 1986, Steele and three of his coconspirators (we refer collectively to Steele and one or more of the conspirators as coconspirators) traveled to Hawaii to meet with Ferdinand Marcos (Marcos), who was then in exile there. The coconspirators offered to help Marcos return to power in the Philippines. The coconspirators first offered to return Marcos to power peacefully in return for at least $180,000. In September 1986, Marcos transferred $180,000 to the coconspirators by wiring that amount from a foreign account to an account of one of Steele's corporate entities, Commonwealth Group, Ltd. In October 1986, Marcos wired another $1 million to the Commonwealth account.

When the peaceful efforts failed, the coconspirators offered to return Marcos to power forcefully by way of a coup. The coconspirators told Marcos that they wanted $100 million if the coup succeeded and that $15 million of that amount would have to be paid immediately. In or about December 1986, the coconspirators directed Steele's cousin, Michael Seifert (Seifert), a solicitor in London, to open bank accounts on the Isle of Man in the names of nominee corporations in order to receive and conceal funds relating to the planned coup...

...The planned coup collapsed in March 1987 when two of the coconspirators (other than Steele) were arrested in New Jersey trying to buy weapons from one or more undercover agents.

To make a long story short, Mr. Steele ended up in federal prison (he's a fugitive now), but continued as tax matters partner for Leatherstocking. Among his acts was to extend the statute of limitations for an ongoing partnership audit by IRS.

The other partners tried to keep IRS from assessing taxes against the partners on the grounds that he was too conflicted to serve, what with the federal investigation, stealing from partners, and all. The Tax Court didn't buy it.

The Moral? When choosing a tax matters partner, remember that imprisoned coup plotters may not be the best people to entrust with tax responsibilities.

Cite: LEATHERSTOCKING 1983 PARTNERSHIP, T.C. Memo 2006-165

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DEAD LAND WALKING

August 14, 2006

We've talked about how a whiff of a threat of condemnation can enable a holder of appreciated real estate to punt taxes on the sale of the real estate into the misty future. A California Congresscritter has a remarkable nose for this sort of thing: he apparently can smell a threat of condemnation where nobody else can (hat tip: Stuart Levine).

The tax break for condemned property allows taxpayers to avoid tax on a sale made "under threat or imminence" of condemnation, if the taxpayer reinvests in similar property within two years. The L.A. Times reports that he claimed the benefits of this provision, Section 1033, even though nobody was threatening to condemn his property. As the gain is $10 million, there's real money at stake.

If his returns are to be believed, he is as unlucky at being selected to have his land condemned as he is lucky at real estate investing; he claimed two additional Section 1033 breaks on subsequent deals.

Unfortunately for the Congressman, he can't seem find any government agency that wanted to condemn the property; the only agency interested in his property at the moment seems to be the IRS, and he probably would rather they weren't.

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DEADLINE LOOMS FOR TOYOTA, LEXUS HYBRIDS

August 14, 2006

The available tax credits for Toyota and Lexus hybrid cars will all soon be used up. As a result, Toyota and Lexus hybrid cars bought after September 30 will not qualify for the full credit. As the credit is worth up to $3,150 for a Prius, it's no small incentive for buying an ugly car.*

The credit will remain available for GM and other makes. The TaxProf has a full rundown.

And remember: while some other energy credits also reduce alternative minimum tax in 2006, the hybrid car credit does not.

*The credit is reduced by 50% for two quarters, and 75% for two mor, until it finally disappears 4th quarter 2007.

UPDATE: A commenter noted that the post incorrectly stated that the credit was eliminated September 30, instead of starting to phase out. The post has been modified accordingly.

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TOWERING BLUNDER

August 14, 2006

A California dentist who used an offshore tax scheme has found that the IRS has teeth, too:

A jury convicted a Danville dentist of evading federal taxes and he now faces up to five years in prison and a $250,000 fine when sentenced, according to the U.S. Department of Justice.

The Aug. 10 verdict in U.S. District Court in San Francisco concerns Roy Albert Lewis, who was convicted of defrauding the Internal Revenue Service for a period of 10 years beginning in 1995.

The scheme involved Lewis paying for bogus consulting and management services to a Colorado firm that promoted tax evasion strategies. Prosecutors said the Denver-based firm, Tower Executive Resources, took money from Lewis and transferred funds to an offshore bank account controlled by Lewis.

We first encountered Tower Executive Resources here when its founders were sentenced for their roles in the tax scam, which involved deducting "consulting" fees that were actually remittances to controlled offshore tax accounts. Mr. Lewis isn't the first Tower client to come to grief, nor is he likely to be the last. His father, an oral surgeon, is awaiting trial on similar charges.

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ONE NATION, UNDER WATER?

August 14, 2006

Is the United States bankrupt? One economist says so:

Boston University economist Laurence Kotlikoff sure thinks so. And his argument is surprisingly compelling.

The gist of his case is that national "bankruptcy" isn't simply when a government can't pay its bills in the current fiscal year. Instead, it's an evaluative determination based on the likely paths of future spending and taxes that, in the absence of divine intervention, there's simply no way a nation can meet its future obligations.

By that measure, today the U.S. Treasury is a bankrupt entity, according to Kotlikoff. The reason is simple—just have a look at the growth of Medicare, Medicaid and Social Security lurking over the horizon in the Congressional Budget Office's startling long-term budget projections.

I hope he's wrong, but I wouldn't bet that way. (Cross posted at Chequer-board.net.)

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A BIRTHDAY AT TICKMARKS

August 14, 2006

The proprietor of the Tickmarks blog turned 50 yesterday. Congratulations!

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WANT TO DEDUCT YOUR DONATION? CHECK, CREDIT CARD, OR RECEIPT ONLY

August 11, 2006

In one of the old M*A*S*H books - I'm not sure if it was the original hit book or one of the lame paperback sequels - Dr. Frank Burns would meticulously keep track of his charitable donations for the IRS. He was rather creative - he would buy a pack of cigarettes and write it down as a donation to "Little Sisters of the Poor" - but he had something to show the IRS when they came around.

This won't work anymore. The new pension bill (H.R. 4) awaiting the President's signature requires a cancelled check or a written receipt from the donee organization to support any cash contribution. Credit card receipts should also work. This takes effect for 2007.

These new requirements are in addition to the existing rule that gifts of $250 or more require a written receipt from the charity; for these gifts, a cancelled check alone isn't enough.

So when you sit down with your preparer in April 2008, it's not going to be enough to say, "oh, I'm very generous, I'm sure I put $5 cash in the collection plate each week." No receipt or cancelled check, no deduction.

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A BLOG FOR EVERYTHING: OPTION BACKDATING

August 11, 2006

A Technorati search led me to Vangal, a blog devoted to stock option backdating. I don't care for their blog page format -- you only see headlines and you have to click on the story to read anything else -- but it's updated frequently and appears to be very much on top of the expanding backdating scandal.

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CORPORATE OWNED LIFE INSURANCE TAKES ANOTHER HIT

August 10, 2006

The new pension bill (H.R. 4) strikes another blow against corporate-owned life insurance. The bill, which will apply to policies issued after the day the president signs it (expected to be August 17), will restrict the tax-free status of corporate or bank-owned life insurance to a narrowed class of employees, and then only if an elaborate set of notifications are made and documented.

This is a big deal in the insurance world because it fences in the sacred tax-free status of life insurance proceeds. Many tax shelters in the 1990s were set up to game this tax-free status, including the notorious "dead peasant" policies.

The bill will add new Sec. 101(j) to the Internal Revenue Code. This provision restricts tax-free life insurance proceeds to the amount paid for the policies unless the policy is on the life of:

- Somebody who was an employee within 12 months of death; or

- A highly-compensated employee (as of the date the policy is issued). This covers 5% owners, directors, employees with over $100,000 compensation, or anybody else in the top 35% of compensation at a company.

A policy can also still be tax-free to the extent the proceeds are paid to a family member of the insured, the insured's estate, or trusts for the benefit of the insured or the beneficiary. Amounts used to fund a buy-sell agreement will also be tax-exempt, but only to the extent it's actually used to fund the buy-sell.

Even if the policy meets these new requirements, it will be taxable unless the company meets the new "notice and consent" requirements. These require:

- A written notification to the insured employee, including the maximum amount of insurance the employer might buy;

- Written notification to the employee that the employer or other policyholder will be the beneficiary of death proceeds, and

- Written employee consent to the purchase.

These have to be received before the policy is issued. As they're learning in the option world, backdating won't cut it. You will have to have the consents before you buy the policy.

The new law also will require employers with insurance on employees issued covered by 101(j) to file a new tax form each year to report information on the policies.

If you are pondering buying life insurance for your business or bank, keep an eye on the White House website to make sure he hasn't signed the bill yet. If he has, you'd better make sure your new policy qualifies, and that you have the notifications and consents in hand, before you pull the trigger on the new insurance contract.

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MORE STOCK-OPTION BACKDATING INDICTMENTS

August 10, 2006

The Stock-option backdating scandal has generated more indictments. Two executives at Comverse Technology Inc. were charged with securities fraud yesterday. The Wall Street Journal law blog has a chronology of life at the Comverse executive suite once a reporter inquired about the option grant dates; the Journal computes the odds that they would have picked such happy option grant dates by coincidence at one in 6 billion.

The Wall Street Journal is keeping a scorecard; there are over 90 firms implicated, all of which face big tax bills when the IRS gets around to these companies. Maybe the IRS should hire back Remy Welling, who was fired for trying to blow the whistle on a similar scheme two years before the nationwide scandal broke. Or at least they could apologize.

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MORE EVIDENCE THAT IRS EMPLOYEES ARE FELLOW HUMANS, DEEP DOWN

August 10, 2006

The Treasury Inspector General for Tax Administration reports that IRS employees use e-mail, well, a lot like everybody else:

IRS employees are violating provisions of the personal use policy with their email usage. Specifically, we found inappropriate email messages in 74 percent of the employee mailboxes reviewed. These inappropriate email messages contained chain letters, jokes, offensive content, and sexually explicit content.

Jokes! How dare they! I wonder what IRS jokes look like?

Why did the chicken cross the road?

Who cares, if he didn't have adequate documentation of the trip's business purpose under Section 274!

UPDATE: The TaxProf has more.

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HAPPY 132ND, HERBERT

August 10, 2006

Herbert Hoover, the only son of Iowa to be elected president, was born 132 years ago today in West Branch. Things went badly while he was president. His tarnished reputation is burnished by his great humanitarian feats before and after his presidency, which he survived by 31 years.

In a completely unrelated note, I have learned that "hoover" is a verb in the U.K. It means "to vacuum," as with a Hoover vacuum cleaner.

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UNDEDUCTIBLE UNMENTIONABLES

August 09, 2006

One little-noticed provision in the new H.R. 4, the new pension bill awaiting the President's signature, cracks down on the donation of used household goods to charity. The Joint Committee on Taxation's report on the bill shows this isn't a small issue:

As recently reported by the IRS, the amount claimed as deductions in tax year 2003 for clothing and household items was more than $9 billion.

I have always thought that Goodwill and the Salvation Army would be economic behemoths if the clothing donations they received wore really worth the amount clamed as deductions for them. $9 billion is about the annual revenue of CSX, the railroad holding company, for example.

To crack down, the new tax law will forbid deductions for household items not in "good" condition. Also, the IRS will be:

...authorized to deny by regulation a deduction for any contribution of clothing or a household item that has minimal monetary value, such as used socks and used undergarments.

At least now if former President Clinton gets audited for his $2 per-pair deduction of used underwear, it won't matter whether it's boxers or briefs. Under the new law, though, he can still get a deduction for them if they appraise out at over $500. The Red Cross may be able to use the fabric.

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BLUFF CALLED?

August 09, 2006

Tax Analysts ($link) reports that we might see another vote on Estate Tax Reform next month. They report this morning that if it doesn't pass then, he will try again in January.

This makes it look like Senator Frist was bluffing when he said there would be no more votes on anything in the bill that failed in the Senate last week. If so, the bluff failed. Senator Frist must not be a very good poker player; he should spend the recess reading.

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INSURANCE FRAUD = TAX FRAUD

August 09, 2006

The Tax Court didn't have much trouble deciding that a couple that admitted to defrauding an insurance company also defrauded the IRS by not reporting the fraud as income. Taxable Talk has the story.

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ET TU, U2?

August 09, 2006

Bono and his band have been talking to their tax people, and now U2 is moving their royalty management company from their native Ireland.

The Emerald Isle has long allowed "artists" to have tax-free royalty income, but now that will be capped at 250,000 euros, or about $310,000. The band is moving their royalty management company to Holland, where royalties are "virtually tax free."

This comes on the heels of the flight of the Rolling Stones from English to Dutch jurisdiction, for much the same reason. While old rock stars take their acts to casinos, they take their portfolios to Rotterdam.

The move may have been in the works for some time; in this picture, Bono is talking with then-Treasury Secretary Paul O'Neill. I think Bono made O'Niell believe he would move the company to the U.S. if Mr. O'Niell would wear silly clothes for the cameras.

More linkage at the TaxProf Blog.

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POLITICAL MADMAN RESPONDS

August 08, 2006

I'm having a little dialogue with The Political Madman about tax compliance costs. The debate started when I linked to a Tax Policy Blog post that said that tax complexity was a cause of tax evasion.

Kyle noted the post and implied that the size of the tax preparation economy might be a sign of poor civic-mindedness, with people paying to reduce their obligations. I replied that reducing taxes is normal and healthy, but that there are other reasons to hire professionals. Kyle has a new installment in our discussion where he discusses these reasons and despairs of ever solving them:

...even a moderately large-scale overhaul of the tax code would not eliminate fear of the IRS or the average citizen's inability to work at the speed of a tax professional.

Economists like to talk about behavior at the margins. You will never get rid of all fear of the IRS, or make it possible for all taxpayers to do their returns as quickly as a preparer, but the less complexity there is, the location of the margin -- the place where it's not worth it to pay a preparer -- will move.

The Madman adds:

And regardless of the tax system, the "free-lance bureaucrat" system will almost certainly always be in place, as the government decides what behavior it would like to encourage and tax professionals help their clients find the best way to fit said encouraged behavior into their plans for fiscal benefit.

I don't dispute that a class of tax professionals will always exist. What can change is the size of our tribe. My view is that the government should stay out of the business of encouraging different types of behavior; government intervention inevitably becones a spoils system, where the politically powerful carve for themselves and bollix up the tax law to their own benefit. While no system put together by politicians will ever get rid of favoritism and game playing, I know that the system doesn't have to be as complex as it is; I've seen it done as recently as 1986.

The Madman also asks:

So I guess my question, going forward, is this: How does one go about fixing this problem?

You can't make the cost of compliance disappear entirely, but you can reduce it at the margins. How? By making a simpler tax law, eliminating tax favors to this constituency or that. It's easy to identify the costs of using new tax breaks when they come into play, like the "production deduction" because they hit our billing reports. If the provision were repealed, we would have that much less work to do when we prepare a business return, and businesses would have that much less in-house time they'd have to spend digging up the information we need to take the deduction.

But if the Madman is right and simplification is off the table, well, I can look forward to a busy career and a comfortable retirement.

Thanks much to the Madman for a fun discussion.

UPDATE:Hank Stern asks in the comments whether I think the "FAIR Tax," a proposal for a national retail sales tax, would be a good solution. No, I don't. I discussed the issue when I was filling in at Chequer-Board.net back in March.

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APPEARANCE OF FRAUD

August 08, 2006

Ever wondered what an e-mail phishing scam looked like? Well, some look like this:

Don't try clicking on the link; I disabled it because I didn't want anybody accidentally scammed by following the link. If you could, though, you would get this page:

(click image to enlarge)

Everything the overseas scammers need to ruin you financially is here: Your social security number, your credit card information, and your ATM card pin. I wonder how many Russian gangsters are having a good time with this? Or perhaps I'm too hard on the Russians; the web host for this scam is in Poland, at an address starting with http://light.unikol.com.pl/. (No, I'm not).

Remember: THE IRS WILL NOT CONTACT YOU VIA E-MAIL. THEY DO NOT NEED YOUR CREDIT CARD NUMBER TO SEND YOU A REFUND!

I love the sentence in the first page of the scam, "Please submit the tax refund request and allow us 6-9 days in order to process it." I think that's just a mistranslation of "Please allow us 6-9 days to steal your identity, empty your bank accounts, and buy lots of new stereo equipment for our girlfriends apartments on your credit card."

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CASH BALANCE PLANS BLESSED BY SEVENTH CIRCUIT

August 08, 2006

The Chicago-based Court of Appeals for the Seventh Circuit reversed a trial court and ruled that IBM's cash-balance plan does not discriminate against older employees. Benefitsblog has the scoop. These controversial plans are used to help sponsors deal with their dinosaur defined benefit plans. The new pension bill cleared away limits on these going forward, but the new ruling will be a relief for businesses that had already gone forward with cash balance arrangements.

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WHY DON'T THEY CRACK DOWN ON OFFSHORE TAX HAVENS? ASK A FIRST WIFE

August 08, 2006

Tax Analysts' Lee Sheppard has a provocative thesis ($link) at Tax Analysts today: we won't see a crackdown on offshore tax havens because Senators and their cronies want a place to hide cash from the ex. She also says that Congress could shut down offshore tax cheating with new information reporting requirements, if it were serious. As if.

Tax Analysts really should find a way to make the occasional piece available for free permalinking. Sure they sell their content (and it's worth buying), but these pieces deserve a bigger audience -- and free samples can move a lot of product.

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CARNIVALS WITHOUT CORN DOGS

August 08, 2006

It's time to link to this week's blog carnivals.

At this week's Carnival of the Capitalists (at "The Business of America is Business" blog), Iowa entrepreneur and radio host Brian Gongol declares "Iowa's Economic Destiny at Risk." Unless if you want a crummy one!

At the "Carnival of Personal Finance" (hosted at "Get Rich Slowly"), sole-practioner Brian Brown, CPA explains how you can profit by running your life like a business.

And tax people party too, at Tax Carnival #3 at Don't Mess with Taxes. Check out "7 habits of Highly Defective Taxpayers" from Gina's Tax Blog.

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ASSETS SALES: PAY NOW, DEDUCT LATER

August 07, 2006

Johnson & Johnson is buying Pfizer's consumer products unit, and Newsweek's Alan Sloan (H/T: TaxProf) has figured out that the buyer will get a tax break from the deal:

That's because the deal is set up as an asset purchase, and J&J is paying with cash. That makes the purchase price tax-deductible to J&J.

WHY ASSET DEALS ARE GOOD FOR BUYERS

Mr. Sloan overstates the case, but the article illustrates one reason why buyers of corporations prefer asset purchases: they get to step up the basis of the purchased assets to their purchase price. To the extent this is allocated to inventory or fixed assets, the price is recovered through depreciation; to the extent it is allocated to "intangibles," like consumer goodwill, it is amortizable over 15 years. If you buy stock, in contrast, your purchase price becomes your basis in the stock, and the buyer doesn't recover any of the stock basis on its tax return until it sells the stock, perhaps many years later. The ability to amortize the purchase price makes buyers willing to pay a higher price for assets than for stock.

WHY THEY AREN'T ALWAYS SO GOOD FOR SELLERS

Sellers, in contrast, often prefer stock deals because they have a higher basis in thier stock than in the underlying assets. If the corporation is owned by individuals, an asset sale triggers two taxes: a gain at the corporation level and a second gain on a deemed stock sale when the corporation is liquidated and the sales proceeds are paid out. As the benefits of an asset sale to the buyer are spread over 15 years, but the costs hit the sellers right away, the economics often dictate a stock deal.

PASS-THROUGHS MAKE ASSET SALES WORK BETTER FOR SELLERS

When an S corporation is involved, asset deals work for both parties. Unless the S corporation is subject to the "built-in gain tax," which can apply in the first 10 years after the S corporation election, there is no double-tax on an asset sale. Even if the built-in gain tax applies, the amount of double tax is normally limited to the value the sold assets had when the S election took effect. The corporation recognizes gain on the asset sale, but the gain increases the S corporation owners' stock basis and can be distributed without a second tax.

As buyers also have powerful non-tax reasons to buy assets instead of stock - not least of which are potential undisclosed tax liabilities - many owners find an S corporation can pay off hansomely when it's time to sell the business. Partnerships (including LLCs) have similar results on asset sales.

A larger C corporation with wholly-owned subsidiaries may also be tax-indifferent to an asset sale, looking at things solely within the consolidated corporation return, as consolidated subsidiary stock basis tracks the basis of assets inside the subsidiary, more or less.

THE MORAL: If you think you will someday cash out of your small business, using a pass-through entity, like an S corporation or a partnership, can save you a lot of money at the end.

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PENSION ACT LINKS AT BENEFITS BLOG

August 07, 2006

The Benefitsblog has assembled a great set of links to the new pension act in this post.

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WHEREVER YOU ARE, S CORPORATION LOAN GUARANTEES DON'T WORK

August 07, 2006

S corporations, as longtime readers know, don't generally pay federal taxes. Instead thier income and loss passes through to their owners' 1040s, and the owners pay the taxes.

The ability to reduce personal tax by corporation losses can be a powerful tax planning tool, but it has its limits. The most important limit is "basis." Shareholders can only deduct S corporation losses to the extent of their basis in S corporation stock and the amount of money they have loaned to to the corporation. The ability to deduct for loans is further limited by requirements that the taxpayer be "at-risk" and have an "actual economic outlay."

These requirements tripped up William Maloof. He guaranteed $4 million in bank loans to S corporations that he owned and deducted losses based on the bank loans. The IRS said that the guarantee wasn't enough and that he owed over $3 million in taxes for an 11-year period beginning in 1990. The 6th Circuit court of appeals last week upheld the IRS, citing many other court cases holding that guarantees just don't work.

An interesting sidelight: the taxpayer argued that the case should be decided using 11th Circuit precedent, which he thought was more favorable than the 6th Circuit. Why? He argued that he lived with his mother in the Florida (11th Circuit), rather than with his wife in Ohio. This prompted tax blogger Stuart Levine to make the immortal comment: "Note to Counsel: Your client's name is 'Maloof' not 'Oedipus.'" In any case, the Sixth Circuit said the result would have been the same in the Eleventh Circuit anyway.

The Moral? If you want to deduct S corporation losses, don't guarantee the loan. Borrow from the bank yourself and make your own loan to the corporation. To see how it is done, look at Miller, T.C. Memo 2006-125, discussed here.

Cite: Maloof, No. 05-1967 (CA-6, 8/4/2006)

UPDATE: The TaxProf has more.

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WHY DO PEOPLE HIRE TAX HELP?

August 05, 2006

Kyle just took a couple of days off; now he's back and he's on fire - he even has a rare tax post.

Kyle saw my link to a Tax Foundation piece saying that Americans spend $265 billion annually complying with the tax code. He wonders if that reflects badly on our civic-mindedness:

At what point did it become socially acceptable to hire professionals to make sure you're making the minimum-possible contribution to that fund?

Sure, saving money is a good reason to have hire a tax professional, or any other kind. Hiring a tax professional can save you money on your return, and if spending $300 on a tax professional saves you $1,000 in taxes, most people would consider that a good investment rather than a mark of poor citizenship. But that's not the only reason people hire a tax pro.

Sometimes it just makes for the best use of your time. If it would take you 12 hours to do your return, but the tax pro can give you 12 hours of your life for the price of a return, that's not a bad deal. For the same reason, many folks will take a car to Jiffy Lube. It's not that they can't change their own oil, and cheaper, but Jiffy Lube will do it faster with less mess and hassle (like getting rid of the used oil).

The urge to outsource tax compliance is especially urgent for a business. It's hard enough to please your custormers; let somebody else keep the taxman happy. If you run a business in multiple states, unless you are very large it's much cheaper to outsource your tax compliance because of the expense of staff and software.

Of course, many people just fear the IRS. It's not that they're trying to chisel their obligation down; they just want some assurance that they won't make a misstep and go to jail. Such fears are overblown, but a lot of folks have them.

Finally, keep in mind what a complex tax code is all about. Enacting a zillion incentives and tax preferences into the law is really a means of outsourcing social and economic policy. A complex tax code in theory fine-tunes behavior into favored channels. Give to charity, but not too much, and more to some charities than to others. Buy municipal bonds, but not too many. Buy a house, but not too big of a house. You get the idea.

To the extent that the tax law is a policy tool, the tax professional inevitably becomes a sort of free-lance bureaucrat, helping to implement the will of Congress. That's not a role we prize, and that's not how we like to think of ourselves, but if the tax law is a policy tool, it's logically inescapable. This means much of the cost of tax compliance is simply a cost of implementing legislation that ends up being paid by the taxed.

If you want to cut the cost of tax compliance, don't ask so much of the tax law. If tax law were used to merely raise revenue, rather than as the Swiss Army Knife of public policy, people would spend a lot less to comply with it.

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RISK CAVALCADE #5

August 05, 2006

I have inexcusably neglected to note the fifth edition of the Cavalcade of Risk, a compilation of insurance and risk-management blog postings. It is at Workers' Comp Insider this week. Notable among the pieces are Bob Vineyard's Insure Blog post on emergency care and personal responsibility. Check it out.

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PENSION BILL PASSES

August 04, 2006

While the estate tax bill went down in flames last night, the pension reform bill (H.R. 4; big pdf file) sailed through the Senate; the President is expected to sign the bill.

The pension bill is quite complicated. The bill's principal purpose is to shore up defined benefit plans, unless you work in the airline industry. It also includes important 401(k) and IRA provisions and a package of charitable reforms. It's nothing but bad news for the Wyobraska Wildlife Museum and its patrons, as the bill closes the "dead critter loophole."

Baluchithere model on display at the Wyobraska Wildlife Museum, Gering, Nebraska. Rumors that the museum is making space in its extinct beast wing for a defined benefit plan display are unconfirmed at this time.

We'll have more coverage of the pension bill provisions later.

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ESTATE TAX REFORM FAILS. NOW WHAT?

August 04, 2006

This year's estate-tax battle came to an end last night when the estate tax reduction bill - lashed to a minimum-wage hike and a package of tax breaks in an attempt to gain support - fell three votes short of the 60 needed to clear the Senate. This "Trifecta" bill would have increased the lifetime estate tax exemption to $5 million, with a graduated system of two rates - 15% and 30% - on amounts in excess of $5 million.

THE ROLE OF OVERREACH IN THE ESTATE TAX

One theme runs through the long-running battle over the estate tax: overreach.

In the 1990s, supporters of the estate tax - we'll call them "Democrats" as a convenient shorthand - put the tax in jeopardy by ignoring its creep into the lives of middle class taxpayers. With its $600,000 exemption unchanged since 1976, inflation and rising housing values were forcing many merely comfortable taxpayers to deal with estate planning lawyers, two-trust wills, and the like to avoid a confiscatory and numbingly complex tax with rates starting at 37%.

The folks that were having to consult with estate planning lawyers are also the folks best able to donate to politicians. They are a powerful constituency, even if they aren't a majority of the electorate. With a complacent belief that "only a few" folks were really subject to estate tax, many Democrats stuck with a "soak the rich" approach and failed to notice the rising opposition until it was almost too late to prevent repeal.

Then it was the turn of the opponents of the estate tax - let's call them "Republicans" for convenience - to reach beyond their grasp. They first did this in 2001 when they voted in the current version of the estate tax law. It increases the lifetime exemption and reduces the top rate until the estate tax disappears entirely in 2010. The estate tax then rises from the grave in full force in 2011 with a $1,000,000 exemption and a 60% top marginal rate.

The one-year repeal was all that Congress could do under its budget rules, but the repeal authors assumed that they would have plenty of time to kill the estate tax entirely. Egged on by the dodgy disciple of total estate tax repeal, Grover Norquist, and his allies, the Republican leadership refused to consider any solution short of total repeal. But their political strength ebbed and the Republican opportunity to enact an estate tax with much lower rates and a much higher exemption slipped away.

Senator Frist finally gave up on total repeal this year and fell back on a "compromise" estate tax bill. His understanding of "compromise" was flawed, though; "compromise" involves getting somebody to agree with you. The new proposal failed to attract enough Senate Democrats, even when tied in an ugly bundle with a higher minimum wage and a grab-bag of politically popular tax breaks.

NOW WHAT?

No estate tax legislation is likely to pass until after elections. If the Democrats make the predicted gains this November, it may be their turn to overreach again and stonewall estate tax reform, and the wheel will start another turn.

In an ideal world, the politicians would enact a rational estate tax with much lower top rates and a much larger exemption, while eliminating valuation games and uncertainty and repealing the raft of special interest breaks that become unnecessary when rates fall. Just adjusting the original 1976 lifetime exemption for inflation would result in a lifetime exemption in excess of $2 million. Alas, hope for a rational estate tax has receded beyond the horizon.

Meanwhile, taxpayers and their advisors have to muddle along with a tax law that's here today, gone tomorrow, and back the next day. Advisors will encourage taxpayers fall back on the basic estate tax planning tools. These include:

-Making full use of the $12,000 per donor, per donee annual gift exclusion. Two parents with two kids can put $480,000 out of the reach of the estate tax over 10 years this way alone.

-Using the lifetime estate tax exclusion through gifts, to the extent it doesn't result in gift tax. While the lifetime estate tax exclusion is currently $2 million, only $1 million can be used before gift taxes apply. Using the $1 million exemption now to gift assets likely to go up in value puts inflation on your side in the estate planning process, as the inflated value of the $1 million will pass tax-free at death.

- Consider how you own your assets. If one spouse has assets that exceed the estate tax exclusion, giving some to the other spouse might be all that is required to avoid the estate tax.

- An old-fashioned two-trust will - leaving enough assets to use up all of the first spouse to die's lifetime exemption to a trust for the children, passing the rest tax-free to a trust for the surviving spouse - will continue to be part of the standard estate planning toolkit.

Links:

Washington Post
New York Times
Wall Street Journal ($link)
TaxProf Blog roundup
Mauled Again

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MY MONTEL MOMENT?

August 04, 2006

I have been approached by Stratford Publications to participate in a webcast on tax scheme patents, on the "strength" of this post. I certainly think tax patents aren't a great idea, but I don't claim mastery of the subject.

I ask my readers:

1. Do you know of anybody who has actually done some serious writing or speaking in opposition to patenting tax strategies?

2. Have you any experience with Stratford webcasts, and if so, what are your thoughts?

3. Should I participate? Or should I get Guy Goma to speak in my place?

If you have any thoughts, I'd love to hear from you; send me an email or put your thoughts in the comments below.

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THERE MUST BE ANOTHER SIDE TO THIS STORY

August 03, 2006

In case you were wondering whether the Senate was covering everything important, you can be reassured by this headline on Michigan Senator Stabenow's website:

Senate Committee Releases Report Critical of Canadian Trash

All right, then. When they issue a report in praise of trash, let us know.

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MORE ON EXTENDERS

August 03, 2006

Senate Majority Leader Frist says that if the estate tax reduction bill isn't passed, the Senators will never see their loved ones - meaning their recurring expiring provisions - again.

Yesterday Senate Democrats vowed to try to pass the extenders "every week the Senate remains in session" and to try to block adjournment until they succeed. The TaxProf has a roundup.

It's always inspiring to watch the World's Greatest Deliberative Body in action.

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THE WAGES OF COMPLEXITY IS CHEATING

August 03, 2006

Just because it's an obvious point doesn't make it wrong:

Tax Complexity Leads to Tax Cheating

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SHUT UP AND DEAL

August 02, 2006

Russ Fox is a man of many talents. Not only does he practice tax and author a high-quality tax blog, he has the answer to the question your spouse may be asking lately:

I don't lose at poker because I don't play. I guess I wasn't born with the poker gene. Still, lots of famous people play poker, and if you do too, Russ's new book will help you, so just buy it!

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FRIST: DO AS I SAY, AND NOBODY GETS HURT

August 02, 2006

Senate Majority Leader Frist raised the stakes in his attempt to pass the estate tax reform yesterday, saying that neither the minimum wage nor the "extenders" will pass this year if they aren't passed with the current estate tax bill. Frist and House Republicans combined the three pieces of legislation last week in an attempt to get the 60 votes needed to get the estate tax cuts through the Senate.

The big question: is he bluffing?

With respect to the minimum wage, I think he's dead serious. Republicans don't want to pass a higher minimum wage, deep down; including it in the estate tax bill was a measure of how badly they want to pass the estate tax changes. In contrast, it's not clear the Democrats are eager for minimum wage legislation, as they like having it as a campaign issue, in spite of its doubtful economic logic.

As for the "extenders," I suspect it is a bluff. These provisions have been renewed regularly for one or two years at a time since the 1980s. They are only extended "temporarily" as a cynical budget gimmick. The "temporary" extension means their budgeted "cost" to the fisc is only counted for one or two years at a time, even though there is no intention to allow the research credit, to name one such provision, to lapse. These items continue to be punted down the road a year at a time, to be reenacted (often retroactively) and paid with some new loophole closer to be named later. If the estate tax doesn't pass, the extenders are likely to be enacted in a lame-duck season or retroactively by a new Senate.

Myself, I'd like the estate tax provisions passed (in spite of their failure to truly simplify the estate tax system) without either the minimum wage increase or the expiring provisions. The current estate tax structure is awful from a tax policy standpoint. The minimum wage hike just makes it harder for the unskilled to get that first job to start them up the ladder while giving a raise to middle-class kids working at the grocery store after school. Targeted tax breaks are economic snake-oil that clutter up the code on behalf of favored political donors and the tax professionals who help harvest the breaks; letting them lapse would help recover some of the revenue lost by the estate tax provisions. But then, I'm not up for re-election this fall.

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SENATE HEARINGS ON OFFSHORE TAX HAVENS TODAY

August 01, 2006

The Senate Homeland Security committee holds hearings today on the use of offshore tax havens. The TaxProf has the witness lineup. You can listen in by going here and clicking on the link for Dirksen 106 (Real Player required).

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MYSTERIOUS WAYS

August 01, 2006

John and Thelma Smoll used "God's Helping Hands Living Estate Plan Trust" to try to avoid taxes. The Tax Court says it's fraud. Taxable Talk has the unholy details.

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COMING INTO AN INHERITANCE? DON'T BE GRABBY

August 01, 2006

The Death and Taxes blog has a helpful parable today for folks coming into an inheritance. Sometimes you can reduce estate taxes by selectively "disclaiming" interests in an inheritance. This usually doesn't work if you have already benefitted from property you are trying to disclaim.

Death and Taxes tells the sad story of a mom who inherited stock from her husband and immediately re-registered the stock jointly in her name and her son's. Then she finds out that she could have disclaimed the stock and greatly reduced the estate tax:

Unfortunately, Son also learns that Mom's reregistration of X Corporation stock makes a disclaimer of this asset impossible. If Mom had seen an estate planning attorney right after Dad died, she could have saved her Son a LOT of money.

The Moral? See your attorney before you start doing things with the estate property.

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SHEPPARD: PROSECUTION OVERREACHED ON KPMG PARTNER INDICTMENTS

August 01, 2006

Lee Sheppard has an important piece in Tax Analysts today ($link) where she finds the prosecution case in the KPMG partner indictments wanting. She concludes:

What we may have here is another Martha Stewart case if the government loses a civil case on the underlying shelter. That is, we could have charges of conspiracy to defraud the United States by means of obstruction and false statements sustained against the Stein defendants even though there was no underlying crime. Judge Kaplan should dismiss the tax evasion charges in the superseding indictment, if not the whole thing.

Ms. Sheppard isn't known for sympathy with shelter promoters. It's a bad sign for the prosecution if they have lost her. If you have a subscription to Tax Analysts, the piece is worth the read.

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CORRECTION

August 01, 2006

A post yesterday (since corrected) referred to David Cay Johnston's piece on the film America: From Freedom to Fascism, as a "review." The Johnston piece was a story about the movie, rather than a review.

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