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
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:
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.
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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
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.