Tax Update Blog: November 2006 Archives

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TOYOTA: MAY I HAVE SOME MORE CORPORATE WELFARE?

November 30, 2006

Poor Toyota. The tax law that has the government pay a rebate to buyers of "hybrid" cars only subsidizes 60,000 vehicles for each manufacturer. Toyota has hit its ceiling, and sales have fallen off. Toyota wants more welfare. From the TaxProf:

The AP reports today that Toyota hybrid sales have plummeted since the loss of the full $3,600 tax credit on October 1 and that the company is pushing for the restoration of the credit:

Toyota North American President Jim Press urged Congress Wednesday to extend federal tax credits for hybrid vehicles and accelerate its buying of hybrids and alternative fleet vehicles to help address energy concerns.

"Help address energy concerns?" Give me a break.

This provision shows that the energy saving is incidental to this "green" tax break. By limiting the subsidies allowed to Toyota, the law steers buyers to the Big 3 automakers, who still have plenty of hybrids to sell before maxing out their subsidy. If the bill was really designed to save energy, it wouldn't distinguish between manufacturers, as long as lots of green cars get sold.

Still, it's hard to weep for Toyota. Live by the dole, die by the dole.

And remember: the Hybrid tax credit doesn't reduce alternative minimum tax.

Link: IRS fact sheets and releases on Hybrid credit.

Related: HYBRID HURRY

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WHAT'S DUMBER THAN 'REFUND ANTICIPATION LOANS'?

November 30, 2006

How about "pay-stub refund anticipation loans?"

Refund anticipation loans, issued against anticipated tax refunds after a return is prepared, are high-cost loans on a par with "payday" loans. Now there is a new product that combines these two forms of usury: the pay-stub RAL. A press release from two consumer organzations describes the product:

To receive a pay stub RAL, the taxpayer will have an estimated tax return prepared by the tax preparer based upon his last pay stub from the end of December -- hence the name "pay stub" RAL. The pay stub RAL is made based upon the anticipated refund shown by that estimated tax return. The holiday RAL is based upon a year to date pay stub from which a tax preparer can estimate whether the taxpayer will have a refund.

The press release says these things are offered "by all major players in the RAL industry." In addition to the ridiculous fees and interest rates on the loans, the loans lock the ~~suckers~~ borrowers into using the preparer to do the actual tax return.

The law allows consenting adults to do many stupid things, like refund anticipation loans, payday loans, and car title loans. The pay-stub RAL is just one more. Don't be stupid; avoid these loans.

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WHY TERRORISTS HAVE TO KEEP FIGHTING

November 30, 2006

The bloody-minded Irish Republican Army finally tires of its trademark mahyem and murder, and now this happens:

ALLEGED IRA chief Thomas �Slab� Murphy, along with his family, faces a �10 million tax bill after a probe by Irish and British investigators.

The family, which owns property worth �1.5million in Manchester, had it frozen last week by the Assets Recovery Agency in a move to prevent them and their associates selling it to meet part of the bill.

Peace is heck. Maybe the IRS can bring al-Queda to its knees?

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BANKING ORGANIZATIONS COME OUT AGAINST IRS 'TEFRA' REGULATION PROPOSAL

November 29, 2006

The American Bankers Association and America's Community Bankers have submitted comments urging the withdrawal of the 'TEFRA' regulations for S corporation banks. These rules would disallow a portion of interest expense for S corporation banks holding tax-exempt bonds. The proposed regulations directly conflict with the statute, and they ought to be withdrawn.

The ACB comments are here. I can't find a link to the ABA comments, so I have reproduced them below in the extended entry.

Roth & Company also submitted comments to the Treasury on these misbegotten proposed regulations; they can be found here.

American Bankers Association comments on 
proposed S corporation bank rules.

Laura Fields
CC: PA: LPD: PR: (Reg - 158677 - 05)
Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington, DC 20044

Re: IRS Proposed Regulations (REG - 158677 - 05) Clarifying Applicability of Code's Special Rules for Banks to S Corporations

Dear Ms. Fields

The American Bankers Associations (ABA) is pleased to submit comments on the IRS Proposed Regulations Clarifying Applicability of the Code's Special Rules for Banks to S Corporations (the "Proposed Regulations"). The ABA brings together all categories of banking institutions to best represent the interests of a rapidly changing industry. Its membership -- which includes community, regional and money center banks and holding companies as well as savings associations, trust companies and savings banks -- makes ABA the largest banking association in the country.

ABA Position

The ABA strongly urges that the Service withdraw the Proposed Regulations for the following reasons:

* The Service has made it clear on many occasions that while the issue was still on audit or in litigation, the National office would not take any position until resolution. Because the issue is currently under litigation, it is not appropriate for the Service to finalize any regulations prior to resolution by the courts.
* The Service's issuance of these Proposed Regulations indicates that the issue is not as clear as the Service had indicated in its audit report. Therefore, legislative clarification is required.
* Some view the issuance of the Proposed Regulations as a way for the Service to boost its position unfairly in the upcoming litigation on the issue.
* As discussed below, the dispute is not whether special bank rules apply to sub S banks, but whether the language of section 1363(b)(4) makes section 291 inapplicable after the first three years of S conversion. The Service argues that if the special bank rules did not apply to sub S banks because of section 1363(b), it would have been unnecessary for Congress to make the section 585 rule inapplicable to S corporation banks -- "thereby making it superfluous." This argument is quite difficult to follow. Simply put, Congress intended that sub S banks be excluded from using the reserve method and included such language in the Code when it allowed banks elect sub S in section 1361(b)(2)(A). The fact that Congress was aware of the language of 1363(b)(4), which provides an exception for sub S banks with respect to the application of section 291, and did not do anything about it at that time, clearly shows that it intended to leave it that way.
* The Service's conclusion that, "if section 291(a)(3) and (e)(1)(B) applies to an S corporation bank in the absence of section 1363(b)(4), section 1363(b)(4) does not affect the continuing application to that bank of section 291(a)(3) and (e)(1)(B)" is flawed. It is the existence of section 1363(b)(4) that makes section 291 (i.e., section 291(a)(3) and (e)(1)(B)) specifically applicable to a sub S bank, and it is the same section 1364(b)(4) that makes section 291 applicable only for the first three years of conversion. Thus, section 1363(b)(4) provides both the application and the limitation of the application of section 291 to sub S banks. In the absence of section 1363(b)(4), a sub S bank would compute its taxable income in the same manner as an individual under section 1363(b) -- without the application of section 291 -- because section 291 does not apply to individuals. What section 1363(b)(4) does is simply to clarify when section 291 applies to a sub S corporation.
* The Service's continued reference to existing regulations does not support its position in anyway. First, the referenced regulations do not provide that the special bank rules in the Code override or supersede the application of section 1363(b) and section 1363(b)(4) to sub S banks. By providing that special bank rules apply to a parent S corporation bank or a bank that has made a QSub election, the regulations simply factor in the application of bank specific rules that would have been inoperative because of the deemed liquidation resulting from the QSub election. Indeed, there is no disagreement on the question of whether section 291 applies to QSubs. The fact is that there is nothing in the referenced regulations that negate the application of the 3-year rule that is specifically stated in section 1363(b). Therefore, reference to these regulations in support of its position shows a misreading by the Service.
* Even if the Proposed Regulations are left to stand, they should apply prospectively, after the outcome of ongoing litigation, and only if such outcome is favorable to the Service.
* The Service states that the Proposed Regulations would apply to taxable years of corporations beginning on or after August 24, 2006. They caution that no inference should be drawn from this effective date regarding prior taxable years. However, it is impossible not draw an inference from the effective date of the Proposed Regulations. The obvious implication is that no published guidance previously existed to specifically apply section 291 to S corporations after the first three years of S conversion (as provided in the referenced regulations), so the Service cannot justify the position taken before the effective date of the any final regulations. If, as the Service claims, Congress did not intend to exclude sub S banks from the application of provisions in the Code that apply to all banks, then Congress, not the Service, should be the one to solve the problem. Regulations cannot override the statute, which is clear on its face -- it provides that a sub S corporation (bank or not) shall compute its tax like an individual (section 291 does not apply to individuals), but if the S corporation was a C corporation in any of the preceding 3 years, it will be subject to section 291. In its fourth year of being a sub S corporation, the entity will no longer be subject to section 291 because it was not a C corporation in any of the preceding 3 years.
* The Service claims that when banks were allowed to elect sub S status in 1996, nothing in the rules stated that the general rule of section 1363(b) prevented special bank rules from applying to sub S banks. While this is true, it is also true that nothing in the rules stated that the application of section 1363(b) and section 1363(b)(4) did not apply, nor could be superseded by any other rules in the Code.
* Notwithstanding the above, any new law or change in current law should provide grandfathering for sub S banks that own QTEOs that were purchased before the date of enactment. Such banks entered into the transaction based on current law, which provides that Section 291 would apply to such banks' tax computation for only the first three years of S conversion. As a result, these banks priced the QTEOs to reflect the 20% interest disallowance for three years and 100% deduction for years after that. A change in the law without a grandfathering provision would put these banks at a huge disadvantage, resulting in significant losses.

The Proposed Regulations

In general, the Proposed Regulations provide that an S Corporation bank is subject to all special rules applicable to banks in the Internal Revenue Code (the "Code") regardless of the provisions that apply to sub S corporations under Subchapter S of the Code. In effect, the Proposed Regulations provide that, although the general rule of section 1363(b) and the exception provided in section 1363(b)(4) apply to sub S corporations (bank or not), their application to sub S banks are superseded or overridden by the applicability of special bank rules contained in other sections of the Code. The Proposed Regulations note that, "[w]hen Congress allowed banks to become S corporations, it did not intend to deny them the benefits, or shield them from the burdens, ordinarily applicable to banks." Furthermore, according to the Proposed Regulations, the fact that Congress explicitly, and therefore, intentionally made only the section 585 reserve method for bad debts inapplicable to S corporation banks provides support for the assertion that Congress did not intend to exclude sub S banks from the applicability of the special bank rules contained in the Code.1

According to the Proposed Regulations, if the Code's special bank rules were rendered inapplicable by section 1363(b), the restriction contained in 1361(b) regarding the use of section 585 reserve method would be superfluous. That is, since section 585 reserve method is a special bank rule, if the special bank rules did not apply to S corporation banks because of section 1363(b), it would have been unnecessary for Congress to make that rule inapplicable to S corporation in section 1361(b).

To support its position, the Proposed Regulations refer to existing regulations under section 1361, which provide that, "If an S corporation is a bank, or if an S corporation makes a valid QSub election for a subsidiary that is a bank, any special rules applicable to banks under the Internal Revenue Code continue to apply separately to the bank parent or bank subsidiary as if the deemed liquidation of any QSub under paragraph (a)(20) of this section had not occurred (except as other published guidance may apply section 265(b) and section 291(a)(3) and (e)(1)(B) not only to the bank parent or bank subsidiary but also to any QSub . . .)."2

The Proposed Regulations conclude that, "if section 291(a)(3) and (e)(1)(B) applies to an S corporation bank in the absence of section 1363(b)(4), section 1363(b)(4) does not affect the continuing application to that bank of section 291(a)(3) and (e)(1)(B)."

Background

Subchapter S of the Code (sections 1361 through 1379) provide tax rules governing entities that are referred to as sub S corporations. In 1996, Congress passed legislation allowing banks to operate as sub S corporations and as a result sub S banks are governed by the rules of Subchapter S. Section 1363(b), which has been in the Code since 1984, provides the general rule on how a sub S corporation computes its tax. It provides that "[t]he taxable income of an S corporation shall be computed in the same manner as in the case of an individual. . ." Section 1363(b)(4) provides an exception to this general by stating that section 291 shall apply to the S corporation's computation of tax if such corporation (or any predecessors) was a C corporation for any of the three preceding tax years. (Section 291 has been in the Code since 1982.) Section 291 (i.e., 291(a)(3) and 291(e)(1)(B)) is a special rule that applies to financial institutions that are corporations. Specifically, under the section 291 special rule, the amount allowed as a deduction for tax- exempt interest expense for a financial institution under section 265(b) is subject to a 20% disallowance.

Section 265(b)(1) provides the general rule for interest expense deduction applicable to financial institutions that invest in tax- exempt obligations. Under the general rule, there is a 100% deduction disallowance for interest expense allocable to such exempt obligations. Section 265(b)(2) provides the method for determining the amount of the bank's total interest expense that is allocable to tax-exempt obligations, and therefore subject to the 100% disallowance. Section 265(b)(3) provides an exception from the 100% disallowance rule for tax-exempt obligations that qualify as QTEOs. For these QTEOs, the general rule of 100% disallowance does not apply. However, for a financial institution that is a corporation, Section 291 provides a 20% interest disallowance for such QTEOs.

Based on the language of section 1363(b)(4), sub S banks have determined that: (1) after the first 3 years of sub S election (conversion from C corporation to S corporation) the S corporation bank is no longer subject to the section 291 20% disallowance for QTEOs, and (2) a sub S bank with no C corporation history is not subject to the section 291 20% disallowance at any time. In other words, the sub S bank with a C corporation history would start to compute its taxable income in the same manner as an individual after the first three years of S election and the sub S bank without a C corporation history would do the same from day one -- without the application of the 20% disallowance contained in section 291.

In the past year, the Internal Revenue Service (the "Service") started audit activities with respect to this issue, claiming that section 291 is a special bank rule that applies to banks, including sub S banks, regardless of the provisions of section 1363(b) and section 1363(b)(4), which state that a sub S corporation shall compute its taxable income in the same manner as an individual, except that ". . . section 291 shall apply to the S corporation's computation of tax if such corporation (or any predecessors) was a C corporation for any of the three preceding tax years".

In the audit reports generated by the Service, the Service referenced the same regulations referred to in the Proposed Regulations to support its claim that the special bank rule contained in section 291 applies to sub S banks at all times (not just in the first three years of S conversion). The taxpayer on audit responded to the Service's claim by pointing out that the referenced regulations do not in any way support the Service's position that the exception provided in section 1363(b)(4) does not prevent the application of section 291 to a sub S bank after the first 3 years of S conversion. In fact, according to the taxpayer, the referenced regulations explicitly provide that other published guidance will be needed to specifically apply section 265(b) and section 291 (i.e., 291(a)(3) and 291(e)(1)) to the sub S bank -- meaning that these sections do not apply unless such guidance is published. No guidance was published until the taxpayer decided to challenge the Service's position in court.

Conclusion

The ABA urges that the Service withdraw the Proposed Regulations, because they are in direct conflict with the clear language of the statute applicable to sub S corporations. The tax laws state that the 20% interest disallowance rule will only apply to an S corporation (holding "qualified tax exempt obligations" (QTEOs)) if such S corporation was a C corporation in any of the three preceding years. In effect, after its first three years of S election, the S corporation shall compute its taxable income in the same manner as an individual -- without applying the disallowance rule. The language of the statute applies to all S corporations -- whether or not they are banks. Thus, the Proposed Regulations improperly apply the interest disallowance rule to sub S banks holding QTEOs, thereby establishing a rule that is in direct conflict with the statute. Furthermore, the Proposed Regulations would not only remove one of the benefits of making the S election (the TEFRA disallowance relief enjoyed only by sub S corporations), they would greatly impact the purchase of QTEOs by sub S banks in a manner that would jeopardize the ability of municipalities to obtain financing for important projects through tax-exempt bonds.

Again, we appreciate the opportunity to submit this comment letter, and hope that the Service will give due consideration to the concerns raised here. Please feel free to contact me if you have any questions or if you would like to discuss this further.

Sincerely,

Francisca N. Mordi
American Bankers Association
Washington, D.C.

FOOTNOTES

1 The section 585 reserve method for bad debt is a special bank rule. Section 1361(b)(2)(A) provides that a bank that uses die section 585 reserve method for bad debts is ineligible to make the S election.

2 Treas. Reg. � 1.1361-4(a)(3)).

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ANOTHER BOTTOM 10 FINISH!

November 29, 2006

The Small Business & Entrepreneurship Council has released its "Small Business Survival Index" for 2006. It ranks states on their policy environments for small business.

Iowa has the 41st best ranking, or, more accurately, 10th worst. The The top 10:

1. South Dakota
2. Nevada
3. Wyoming
4. Alabama
5. Washington
6. Florida
7. Mississippi
8. Colorado
9. Texas
10. Michigan

The bottom 10:

41. Iowa
42. Vermont
43. Massachusetts
44. Hawaii
45. New York
46. Minnesota
47. Maine
48. Rhode Island
49. California
50. New Jersey

The best states on the list are have low income tax rates or no income tax. The worst states, like Iowa, have high income tax rates, which they try to ameliorate with targeted tax breaks. This list shows how well that works.

The full list.

These rankings has results that track fairly well with with the Tax Foundation's annual ranking of state business tax climates, with the strange exception of Michigan, which doesn't usually score so well on these things.

Via About: Business Law / Taxes: U.S.

Link: Full Tax Foundation State Business Tax Climate Index

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AROUND THE TAX BLOG WORLD AT TICK MARKS

November 29, 2006

Dan Meyer is touring the tax and accounting blog world this week over at Tick Marks. He will be covering some new blogs this week, but first he reviews the state of some older blogs, here and here. We thank him for his kind mention of the Tax Update.

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OF COURSE IT'S 'POP.' WHAT ELSE WOULD YOU CALL IT?

November 28, 2006

This is no surprise:

I talk correctly. Other places, they have an accent! Take this quiz to evaluate whether you talk right.

And yes, I am from Chicago, give or take a few suburbs.

Via Virginia Postrel.

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THE TAX AGENDA IN IOWA'S UPCOMING LEGISLATIVE SESSION

November 28, 2006

David Yepsen discusses the incoming Iowa Senate Majority Leader Mike Gronstal's agenda in today's Des Moines Register. The column is based on Mr. Gronstal's comments in a recent recording of Iowa Press for IPTV.

Given the pent-up demand for spending programs after the Democrats' many years in the legislative wilderness, tax increases seem likely. Mr. Yepsen's column addresses them in the order I think they are likely to pass. From the column:

- Cigarette taxes. An increase will be considered as a public-health measure to discourage teen smoking, but it's a "tossup" whether it will pass.

I think it will pass sooner than a fidgety smoker can light up on the way out of a smoke-free restaurant.

- Gas tax. An increase is "possible" to pay for more road work.

And it's "possible" that I will use my computer today.

- Tax reform. Some Democrats want to eliminate the ability of Iowans to deduct the federal income taxes they pay before calculating their state income-tax bills - then lower tax rates. It would make Iowa's tax system simpler, more progressive and more competitive for executives looking to locate here.

Doing that "remains to be seen," he said, because many Republicans hate the idea. "If we can't find some common ground with Republicans on tax reform in this state, I don't have a lot of interest in shoving some solutions down people's throats."

Mr. Yepsen is way too optimistic if he thinks the tax system will be "simpler." Governor-elect Culver is all about "targeted" tax breaks, which always add complexity. If federal deductibility is eliminated, the rates will be lowered, but probably not enough keep the package from being a tax increase overall. They'll want the money.

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BUY A COPY OF ENTREPRENEUR MAGAZINE TODAY

November 28, 2006

In fact, buy lots of copies of their December issue, and tell them it's because of this article discussing year-end tax planning that uses me as a source.

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WHAT HAPPENED?

November 24, 2006

Our hosting renewal somehow went astray, that's what, perhaps via our otherwise invaluable spam filtering. We're back, obviously, but it appears we've lost about two weeks worth of posts. I will see if the good folks at our hosting service can work their magic and recover it.

I apologize for any inconvenience.

UPDATE:

Using Google's caching feature, I've restored most of the entries, but I still have to upload images; I will do that when I'm back in the office. The last few posts before the site went down may be lost forever.

This has been a valuable education in the limits of hosting providers and how dependent we are on them. Resolved: to see whether there is a good way to back up the site, in case the hosting provider loses some or all of the site, or in case we need to move to another host for some reason.

UPDATE II (11/27/06). I have the remaining entries restored, except for graphics, which I will restore as soon as I have time. Please pardon the missing jpg and gif files until then.Fortunately, I left the site open on my work computer while I was out of town, so I was able to restore the lost entries from the browser's html source view.

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CITIZENS OF THE DELUSIONAL CONSTITUTION FOUNDATION

November 22, 2006

A reader forwarded a link to a page by "Citizens of the American Constitution" trumpeting a "1040 Checkmate." The page discusses an Illinois case where the government dropped criminal charges against a Robert Lawrence, a tax protester. To read their version, the government ran away with its tail between its legs:

The DOJ knew that it stood a significant chance of losing the case, and if that happened, the press and others would quickly spread the word, and leave only fools to ever file a 1040 again. Oscar Stilley�s pleadings and documents made these points quite clear:

* IRS Form 1040 violates the federal Paperwork Reduction Act (PRA) and is therefore a legally invalid form.

* Under the Public Protection clause of the PRA, no person can be penalized for failing to file a 1040 if the IRS fails to fully comply with the PRA.

* The PRA statutes explicitly provide that a PRA challenge is a complete defense and can be raised in any administrative or judicial proceeding.

* The IRS Individual Form 1040 has not and cannot comply with the requirements of the PRA because no existing statute authorizes the IRS to impose or collect the federal income tax from individuals. That lack of bona fide authority makes it impossible for IRS to avoid violating the PRA.

We The People Foundation has researched the facts, law and circumstances surrounding this case, and has determined that:

* A public trial would have opened a �Pandora�s Box� of legal evidence and government testimony under oath that would establish the IRS 1040 form as both fraudulent and counterfeit.

* Oscar Stilley�s PRA defense �checkmated� the DOJ and IRS

* The Office of Management and Budget (OMB) appears to have been complicit with IRS in deceiving the public and in helping perpetuate the 1040 fraud by promulgating federal regulations that negate the plain language of the PRA laws passed by Congress and by allowing the IRS to continually skirt the explicit requirements of those statutes

My reader asked if there was anything to this. A little digging shows the story isn't quite what the tax protest crowd would have you believe.

The real story is laid out in an order in the U.S District Court of Illinois, Central Division, on a motion to compel the government to pay Mr. Lawrence's attorneys fees. The government moved that the case be dismissed a few days before trial when the judge wouldn't permit them to correct calculation errors in the taxes allegedly evaded by Mr. Lawrence.

Mr. Lawrence said he should be reimbursed his legal fees because the government "knew" his argument -- that the Paperwork Reduction Act makes him immune from the income tax -- was unassailable. The judge disagreed (emphasis mine):

Lawrence�s main argument in support of this motion is that the Government�s prosecution was vexatious, frivolous, and in bad faith because the Government knew that the PRA provided Lawrence with a full defense to liability for failing to file income taxes. However, Lawrence fails to recognize that the posture of the instant motion does not permit the Court to address the merits of the PRA defense. In this Motion for Attorney�s Fees, the only question before the Court is whether the Government�s prosecution of Lawrence was vexatious, frivolous, or in bad faith and the Court finds that it was not. In light of the cases that had addressed the PRA of 1980, as of the time that Lawrence was prosecuted, the Government had good reason to believe that the PRA defense (even based on the amended PRA of 1995) would not provide someone who failed to pay income taxes with a valid defense. Lawrence spends numerous pages of his brief addressing the merits of the PRA defense and arguing that even though the Seventh Circuit found that the PRA of 1980 was not a valid defense to the allegations in Lawrence�s indictment, that the PRA of 1995 would provide Lawrence with that defense. However, Lawrence has failed to cite any cases that support his argument. He claims that the law is clear on this point; however, not one court has held that the PRA of 1995 is a complete defense to a prosecution for a failure to file income taxes. Accordingly, Lawrence cannot argue that the government�s indictment of Lawrence was frivolous or vexatious.

Even if a defendant like Lawrence is eventually successful at convincing a court that the PRA of 1995 provides individuals like Lawrence with a valid defense for failing to pay taxes, something that appears unlikely in light of the cases addressing the PRA of 1980 defense, Lawrence�s argument that the Government should have known that this was the law at the time that Lawrence was prosecuted is ridiculous.

The "Tax Honesty Movement," as tax protesters like to call themselves, have a habit of trumpeting any court victory as a vindication of their deluded legal theories. Whenever a tax protester is acquitted by a jury, or has the criminal charges dismissed, they say it "proves" their theories. Of course, by their logic O.J.'s acquittal "proves" that multiple homicides are legal in Brentwood. The "Tax Honesty" folks' honesty runs out before they point out that no court has ever ruled that their theories actually work to avoid taxes.

Link: The Tax Protester FAQ, explaining why the "Tax Honesty" theories don't work.

UPDATE:: The Tax Honesty folks in full regalia! (via LGF). A question for these folks: if this stuff works, why do you have to wear those silly masks?

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ROTH & COMPANY COMMENTS ON PROPOSED BANK S CORPORATION RULES

November 21, 2006

Roth & Company today submitted its comments on the proposed regulations on the application of the "TEFRA disallowance" of interest expense to S corporations. Our view: the statute clearly says the 20% disallowance of Section 291 goes away after three years as an S corporation. The proposed regulations say otherwise.

Our comments our reproduced below in the extended entry. November 22 is the deadline for submitting comments at www.regulations.gov.

Prior Tax Update Coverage:

IRS ISSUES CHALLENGE TO S CORPORATION BANK DEDUCTION

RE: Section 291 �TEFRA� Interest Expense Disallowance � New Proposed Regulations; Document RS-2006-0459-0001

We are a public accounting firm in Des Moines, Iowa, serving over 125 Iowa community banks. We currently provide income tax return services to over 75 Subchapter S banks.

We believe the proposed regulations on the application of Section 291 to S corporation banks issued in August 2006 (REG-158677-05) are fundamentally flawed and should be withdrawn.

�TEFRA� Disallowance and S Corporation Banks.

TEFRA, the 1982 tax bill, added Code Section 291(a)(3) to disallow the interest deduction for 20% of interest expense attributable to bank-qualified tax-exempt securities. This provision is known in the industry as the �TEFRA disallowance.�

In 1996, Congress amended Section 1361 to allow banks and bank holding companies to become Subchapter S corporations. 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 the S election. When Congress enacted legislation allowing banks to become S corporations, it did not alter this provision.

Hundreds of banks made S corporation elections following the 1996 changes. Banks routinely stopped computing the Section 291 disallowance in their fourth S corporation year. This position was discussed in detail at several national banking conferences. In discussions with IRS personnel, national bank tax experts were told that written guidance on this issue was unnecessary given the clear language of the statute. The IRS has issued guidance addressing specific bank issues (e.g., Notice 97-4, 1997-1 CB 351) without addressing TEFRA disallowance.

The Proposed Regulations Are Not Authorized By Statute.

The IRS has recently changed its position. It now asserts that the rule of Section 291(a)(3) does not apply to prevent TEFRA disallowance after the third S corporation year. Likewise, the proposed regulations declare that the TEFRA disallowance continues to apply to S corporation banks after the third S corporation year.

The unambiguous terms of Section 291(a)(3) allow S corporation banks to stop computing the 20% TEFRA disallowance beginning with their fourth S corporation year.

If Congress had intended to require Subchapter S banks to continue applying the 20% TEFRA disallowance after three S years, it would have changed the statute to require the disallowance. Congress has amended Subchapter S many times since 1996 without changing Section 1363(b)(4) or otherwise addressing how Section 291(a)(3) applies to banks.

Congress has not given the Treasury authority to issue �legislative� regulations under the financial institution S corporation rules. There is no provision under Section 1361 comparable to that provided for passive losses by Section 469(l), for example. Absent such authority, the Treasury may not override a specific statutory provision; as the proposed regulations attempt to do just that, they overreach. We therefore urge the Treasury to withdraw the proposed regulations.

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UPDATED TAX PATENT LIST

November 21, 2006

Via the TaxProf, here is an updated list of patents and pending patents for tax strategies.

As I've said before, tax patents are really a bad idea. It's hard enough to comply with the tax law without having to worry about a patent jackal trying to extract tribute from you in the process.

Unfortunately the bar seems to be wishy-washy on this issue, presumably out of deference to the patent attorneys.

Prior Tax Update coverage:

TAX PATENTS: A LIVE CASE

ABA ON TAX PATENTS: MEND, DON'T END?

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

PATENTLY ABSURD

PAY YOUR TAXES ON TIME! (PATENT PENDING)

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COMMISSIONER EVERSON TOUTS INCREASED ENFORCEMENT

November 21, 2006

IRS Commissioner Everson issued a statement yesterday on IRS enforcement efforts for the government's fiscal year ended September 30, 2006. From the release:

The bottom line for our enforcement efforts shows that dollars collected rose again last year. There�s a strong trend line going up. Fiscal 2005 was a watershed year for us, with a number of big initiatives that helped push enforcement revenues up 10% to $47.3 billion. In Fiscal 2006, enforcement revenues � the monies we get from our collection, examination, and document matching activities � increased to a record $48.7 billion. Our exam dollars were down slightly this year because of the big bump from the Son of Boss settlement initiative in 2005. Even with that, our overall dollars collected jumped nearly 3% in 2006 principally because of a strong rise in collections.

The statement says that audits of individuals and S corporations are up:

If you earn more than $100,000 or you�re a millionaire, you�re a lot more likely to be audited these days than just a few years ago.

* Audits of individuals with income of $1,000,000 and higher increased to 17,015 from 12,835, a nearly 33% increase in just one year. About 1 in every 16 of these taxpayers faced audits last year. If you�re earning that kind of money and we notice a problem, you�re going to hear from us.
* Audits of individuals with incomes over $100,000 surpassed 257,000, an 18% increase from 2005. That�s the highest figure in more than a decade, and well over double the 92,000 completed in fiscal year 2001.

Pass-through entities are also getting hit hard:

Our business numbers reflect that we have placed more emphasis in the growing area of these flow-through returns involving S corporations and partnerships:

* Audits of S corporation returns increased to 13,984 from 10,417, a 34% increase. This is the highest level since 2000.

* For partnerships, audits of these flow-through returns increased to 9,777 from 8,489, a 15% increase. This category is at the highest level since 1998.

* Audits of small businesses organized as corporations remained about the same. 17,871 audits were completed in 2006, up slightly from 17,858 in 2005.Both of these figures are more than double the 7,294 audits of small businesses in 2004.

It seems that the IRS is paying special attention to pass-throughs that generate losses. Go figure.

The tax-exempt sector isn't being neglected, either:

* Our Exempt Organization area audited 7,079 returns this year, an increase of 43% from the previous year. We�re at the highest level since 2000.

* In addition to increased exam activity, we introduced a new program in 2004 using non-traditional compliance contacts to expand our enforcement presence within the tax-exempt community. These compliance contacts have been instrumental in addressing problem areas in sectors such as hospitals, executive compensation and credit counseling. In Fiscal 2006, we completed over 5,200 of these new compliance contacts, over and above the traditional examination program. This is a 31% increase from the previous year. Before 2004, we weren�t doing any of these contacts.

Getting down to brass ~~knuckles~~ tacks:

In our collection activities, levies and liens continue to top their 1998 levels. Levies increased by 36% to 3,742,276.Liens rose nearly 20% to 629,813.

The Commissioner tells a story of an IRS that has again found its footing after the tax-shelter wars of the 1990s and the taxpayer bill of rights hearings. It will be interesting to see whether these enforcement levels continue.

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DECEMBER 2006 APPLICABLE FEDERAL RATES (AFR) ISSUED

November 21, 2006

The IRS has issued (Rev. Rul. 2006-61) the minimum interest rates for loans made in December 2006:

-Short Term (demand loans and loans with terms of up to 3 years): 4.97%
-Mid-Term (loans from 3-9 years): 4.73%
-Long-Term (over 9 years): 4.9%

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

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250,000 VISITORS

November 21, 2006

We had our 250,000 metered visitor last night.

The nice thing about the site meter is the way it can precisely count an inaccurate figure. I didn't install Sitemeter for the home page until October 2003, and I didn't add it to the archive pages until November 2004. As most visitors find their way here via search engines or links, the archives are where the action is.

Visitor number 250,000 is typical. He came all the way from Curitiba, Brazil to visit this old post, which features a picture of a Maybach, Mercedes' lavishly excessive extreme (+$350,000) luxury model. He presumably got here via Google's image search, but I'm sure our Brazilian guest was fascinated by our discussion of the sales tax deduction tables in that post.

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BUILDING A BETTER TAX BOMB

November 21, 2006

Darryl Jones, a visiting professor at Stetson University College of Law, has the quote of the day:

Antiabuse provisions published by the IRS are the legal drafting equivalent of a U.N. watchdog issuing a written prohibition against the development of nuclear arms with detailed instructions on how to build that which is prohibited.

From "Black-Letter Subchapter K," in today's Tax Analysts online ($link)

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IF I DID IT, HERE'S HOW THE IRS WILL TAX IT

November 20, 2006

Whenever somebody says that a tax protester's acquittal "proves" that "there is no law" requiring you to pay tax, I point out that by that logic the O.J. Simpson acquittal "proves" there is no law against murder.

Now O.J. has a revolting book out, "If I Did It." He is said to have arranged for his royalties on the book to be paid to others to keep his "if he did it" victims' estates from collecting on the civil judgment against him for their deaths.

The TaxProf today links some pieces that say he's a lot more likely to get away with cheating the relatives than the IRS. One writer notes:

Or suppose he precontracted with the publisher to write the book (as is quite common). Now it's probably a work for hire. If so, he becomes taxable on all of the compensation, regardless of the nominal recipient.

I just wonder whether he's any closer to catching "the real killer."

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TEN YEARS OF NOT FILING RETURNS = ONE YEAR OFF FROM YOUR LAW PRACTICE

November 17, 2006

From Radio Iowa:

A Waterloo attorney who specializes in tax law will not be able to practice law for at least a year -- because he failed to pay his own taxes. Waterloo attorney Gary D. Iverson did not file his own state or federal tax returns for nearly a decade, from 1992 to 2001. He owes as much as four-hundred thousand dollars in back taxes to the State of Iowa and the federal government.

The Iowa Supreme Court has ruled Iverson's law license will be suspended for a least a year. A panel of lawyers that reviews charges of attorney misconduct had recommended that Iverson's license to practice law be suspended for at least two years.

But the Iowa Supreme Court decided on just a year's suspension, citing Iverson's full acknowledgment that he had failed to pay taxes and his need to work to repay them. The court also noted that Iverson had not tried to shift the blame for his failure to pay taxes, and took all the blame himself.

He didn't try to shift the blame? The man's a tax attorney. Where could he shift the blame? His software?

I like to think the Iowa Board of Accountancy would give me a deal like that if I were to stop filing returns until 2015, but I won't take that chance. I wonder how the IRS Director of Practice deals with this sort of thing.

Link: Iowa Supreme Court Attorney Disciplinary Board vs. Gary D. Iversen

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MILTON FRIEDMAN DIES, BUT HIS TAX LEGACY LIVES

November 17, 2006

Legendary economist Milton Friedman died Thursday at 94. He left behind his wife, two children, four grandchildren, three great-grandchildren, and the mondern income tax.

In World War II Mr. Friedman devised income tax withholding as a temporary measure to pay the government's enormous wartime expenses. The most famous advocate of free markets and small government was, in a quirk of fate, also the author of an essential tool of government expansion.

Though not a tax specialist, Mr. Friedman had a large role in the development of tax policy in the past 50 years. From a Tax Policy Blog post on his 94th birthday:

Friedman was also instrumental in developing policy proposals using the theory of the negative income tax. The Earned Income Tax Credit, which Friedman actually opposed in its implementation, is viewed as somewhat resembling the negative income tax model.

He also was an early exponent of a "flat tax." From the Tax Analysts piece on his death ($link)

Friedman is widely considered the father of the modern flat tax. The consumption-based flat tax popularized and championed by economists Robert Hall and Alvin Rabushka commands center stage in current policy debate. But the Hall-Rabushka tax plan drew its inspiration from the flat rate tax on income that Friedman proposed in 1962.

In his classic brief for libertarian ideology, Capitalism and Freedom, Friedman devoted relatively few pages to taxation. But those pages loom large in the political history of contemporary tax reform. The book challenged the legitimacy of progressive taxation when it enjoyed nearly universal support (a few legal skeptics like Walter Blum and Harry Kalven notwithstanding).

Mr. Friedman anticipated the looming problem the shrinking income tax base that we have discussed. From the Tax Analysts piece:

More important, a flat rate tax would leave no room for punitive taxation of the rich; people would be unable to impose higher taxes on the rich without imposing the same heavy burden on themselves. In other words, a flat rate tax would constrain the freedom of a vindictive political majority to work its will on a well-heeled economic minority.

His view of tax preferences, as laid out in the Tax Analysts piece, is dead-on:

Friedman loathed tax preferences, insisting that they violated canons of fairness. Using the tax law to advance social goals was unjust, vitiating the principle that all people should be treated equally under the law

His thoughts on tax policy debates are as fresh as ever even as the new majorities in Congress and the Iowa legislature prepare to go the other way.

Additional Links on Friedman and Tax Policy:

Daniel Shaviro

Dallas Federal Reserve District Bio

Wikipedia

Megan McCardle

Arnold Kling

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PHONE-Y REFUNDS FOR BUSINESSES

November 17, 2006

When the IRS finally conceded defeat in the Spanish-American War phone excise tax battle, it announced that it would let individuals claim refunds of the tax using a simple formula on their 2006 1040s. That meant individuals did not have to go through 41 months of phone records to file a claim for a refund of the discredited tax.

Now the IRS has announced (IR-2006-179) a similar program for business filers. Business taxpayers will compare their April 2006 and September 2006 phone bills. The April bills included the tax, and the September bills didn't. They figure the federal tax percentage in the two bills and use the difference to determine how much the now-defunct tax was as a percentage of their phone bill. They will then multiply this by their phone expenses from March 2003 through July 2006 to determine the excise tax refund.

The refund, to be claimed on Form 8913, will be limited to 2% of the phone bill for businsesses with up to 250 employees, or 1% for larger employers. Businesses will also be allowed to instead determine the refund by going through the 41 monthly phone bills.

The IRS press release provides an example:

For example, if a business has an April 2006 telephone bill of $1,000, which includes federal telephone excise tax of $28, the tax percentage is 2.8 percent. If the September 2006 bill is $1,100 including federal telephone excise tax of $16.50, the tax percentage is 1.5 percent. The business� long-distance excise tax percentage is 1.3 percent (2.8 percent for April minus 1.5 percent for September). The business multiplies 1.3 percent by its total phone expenses over the 41-month period to arrive at the amount of its refund. If this business had more than 250 employees, its refund would be limited to 1 percent of its total phone expenses for the period. If the business had 250 or fewer employees, the 2-percent cap would apply and would not limit the amount of the refund.

This is a more complex formula than the one for individuals; they claim their refund based on the number of exemptions on their 1040s. It isn't perfect, as the 41-month period doesn't coincide exactly with anybody's annual telephone expense, but it probably will be more popular than a phone-bill by phone-bill analysis.

Link: IRS Q&A on individual phone excise tax refunds

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SMALL BUSINESS: HELP IS ON THE WAY!

November 17, 2006

Tax Analysts reports ($link) that John Kerry is coming to the rescue of small business:

Senate taxwriter John F. Kerry, D-Mass., on November 16 said the priorities for the Senate Small Business and Entrepreneurship Committee in the 110th Congress will include the creation of tax incentives to encourage investment in small businesses. Kerry will chair that committee in the next session.

In a conference call with reporters, Kerry said the committee next year will work to make healthcare more available to small businesses while also examining tax incentives targeting small businesses. "I have the ability through the Finance Committee and the Small Business Committee to join that effort in a significant way," he said.

Is it a good idea to be "targeted" by Senator Kerry?

The article adds that the new Congress will also pass an increased minimum wage. That should help small businesses by increasing their costs. Nice work. Senator Kerry, of course, knows about small business because he married into a small business family.

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DID CONGRESS SABOTAGE THE SALVATION ARMY KETTLE CAMPAIGN?

November 16, 2006

Starting next year the tax law will insist that taxpayers have at least a receipt, cancelled check or credit card statement for any charitable gift. This tightens up the current rule that requires donations of $250 or more to have a written receipt from the charity.

Dr. Maule thinks this is unworkable, and that it may hurt charitable giving:

But what should taxpayers do when given the opportunity to put cash into a collection plate or donation basket? That's one of the interesting questions. Will people continue to give, despite not having the deduction, because they give for reasons other than tax savings? I surely hope so. But I doubt it. I think some people either will refrain from giving or will reduce what they give because of the lost tax benefit.

I am unconvinced. I don't think people drop cash in the collection plate based on the deduction; they know that they don't have any evidence to show the IRS when they do that. I think it will mostly affect the Dr. Frank Burns-types who hallucinate regular cash donations.

By January 2008, Dr. Maule and I will be able to tell who is right. The annual Salvation Army Kettle Campaign is a great laboratory experiment on whether tax deductions affect giving. At lest here in Des Moines, I know the Army carefully tracks giving by kettle location. By comparing the 2006 season giving with the 2007 campaign nationwide, we should have a pretty good idea of whether tax is big factor.

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NCAA DEFENDS TAX EXEMPTION; BOBBY STOOPS SALARY TOPS $3 MILLION

November 16, 2006

The NCAA yesterday responded to a letter from outgoing Ways and Means Chairman Thomas questioning whether the NCAA deserves tax exemption:

NCAA president Myles Brand defended college sports� tax-exempt status, responding to questions from Congress by saying diverse competition from non-scholarship lacrosse to basketball�s Final Four, however lucrative, is all related to education.

�The fundamental purpose of intercollegiate athletics is the education of student-athletes in both the classroom and on the field or court,� Brand wrote in a 25-page response, made public today, to the House Ways and Means Committee. �The scale of the sport does not alter the fundamental purpose.�

Athletes can learn a lot from college. Like, "don't leave incriminating voicemails," "don't mug your fellow students," and "don't drag your girlfriend on the staircase by the hair." Oh, I know, they aren't all like that. Many athletes find their lives transformed by the sterling examples of their coaches.

One condition of tax exemption is that an organization operate "exclusively" for its exempt purpose. The NCAA still has many unmet needs to contend with. Only about 42 of the 119 NCAA Division I football coaches earned $1 million or more in 2006. While the NCAA has achieved much, much remains to be done.

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IRS: LAND OF LOST LAPTOPS?

November 16, 2006

News item from today's Tax Analysts online report: ($link)

An IRS spokeswoman confirmed on November 15 that 478 IRS laptop computers, many containing taxpayer information, have been lost or stolen since 2002.

The spokeswoman told Tax Analysts that 112 of the laptops contained "sensitive data," which is defined as personal identification information and can include taxpayers' Social Security numbers. The data was encrypted on all but 33 of 112 laptops, the spokeswoman said.

That's a lot of laptops. Is Pierre Pierce dating IRS agents now?

I wonder if there is any data for how often laptops are stolen. It would be interesting to see whether the IRS is any more prone to laptop loss than anybody else.

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LAME EXTENDERS

November 15, 2006

As I expected, Congress is moving to renew the "expired provisions" that were caught up in this summer's battle over estate tax repeal. The provisions include the R&D credit, deductions for college tuition, the deduction for state and local sales taxes, and deductions for teacher expenses. Congress passes them for a year or two at a time to keep their true cost from showing up in budget computations. The San Jose Mercury News reports:

Lawmakers are working to get it done, most likely once Congress reconvenes after Thanksgiving. Senate Finance Committee Chairman Charles Grassley, R-Iowa, and top Democrat Max Baucus, D-Mont., met Monday evening with House Ways and Means Committee Chairman Bill Thomas, R-Calif., to discuss strategy on passing a package of tax breaks including the R&D credit...

Grassley and Baucus issued statements Tuesday pledging action on the R&D credit.

"We need to give taxpayers the same certainty about tax provisions that affect their bottom line," Grassley said. "I hope the House and Senate use the lame duck session to redeem themselves from lameness and pass a solid extenders package including the R&D tax credit."

I don't doubt that the extenders will pass. I do wish the lawmakers would stop first and read this piece at the Tax Policy Blog on the unwisdom of the provisions they are rushing to extend:

The primary problem is that tax credits erode the tax base. As the tax base shrinks, lawmakers will attempt to make up the lost revenue by increasing tax rates--leading to higher rates for everyone. Some Democratic leaders, poised to take over Congress next year, have already begun to suggest that raising tax rates will be necessary to pay for �middle-class tax cuts.� But Tax Foundation studies have shown that tax rates are already twice as high as they otherwise would be if the tax base were not worn down with tax credits:

Indeed. Unfortunately, the few who benefit a lot have more friends in Congress than the multitude that gets fleeced a little at a time.

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JUDGE POSTPONES KPMG TRIAL INDEFINITELY

November 15, 2006

Judge Lewis Kaplan has postponed the criminal trial of 16 former KPMG executives and employees until a dispute over legal fees is settled. The trial will not resume until an appeals court determines whether the firm has to advance legal fees to the defendants.

The judge has been critical of the government's past efforts to prevent KPMG from paying the defendant's legal costs.

Links:

MSNBC
Financial Times
Tax Analysts ($link)

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1040 MAKEOVER?

November 14, 2006

Tax Analysts reports this morning ($link) that the IRS is considering a makeover of Form 1040. It would be the first makeover of everybody's favorite form since 1977. From the Tax Analysts report:

In the proposed redesign, "a large number" of lines from the current 1040 would be removed and put on a new Schedule O, an IRS official said. The IRS has not yet publicly announced the proposed overhaul, but officials confirmed it after the Government Accountability Office said in its latest IRS financial audit that a redesign was ongoing.

According to one IRS official, the proposal is "100 percent" a burden reduction initiative. The IRS has recently redesigned several of its forms to reduce taxpayer burden, but this would be one of its most ambition undertakings in that area.

Here's what page 1 of our form looks like now:

And here's what it looked like before the last makeover:

Schedule O, eh? What they really need is a Schedule O-Oh:

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CALIFORNIA LLC TAX FATALLY FLAWED?

November 14, 2006

It looks like another California court is on the verge of ruling California's tax on LLCs unconstitutional. California imposes a tax on LLCs based on their size - a tax that can reach over $11,000 for a moderately-sized business that so much as sneezes in California. The tax isn't apportioned based on business activity inside and outside of California.

From CCH Tax News:

A tentative decision issued by a San Francisco Superior Court would hold that California's limited liability company (LLC) fee scheme amounts to an unfairly apportioned tax in violation of the U.S. Constitution's Commerce and Due Process Clauses and that it cannot be reformed. Consequently, the court decision would require a full refund of the LLC fees paid by the LLC for the tax years at issue, plus interest and costs. The proposed decision will become final unless, within 15 days, either party specifies additional issues or makes new proposals.

Similar to the decision in Northwest Energetic Services, LLC v. California Franchise Tax Board issued by another superior court in San Francisco (see TAXDAY 2006/04/19, S.4), the court's tentative decision finds that the LLC fee is actually a tax as its purpose is to raise revenues and it is deposited in the general fund, rather than dedicated to regulating LLCs in California. Furthermore, because it is applied against the taxpayer's worldwide income rather than its California-source income it is an unapportioned tax in violation of the U.S. Constitution's Commerce and Due Process Clauses. The decision in the instant case goes further than the decision in Northwest , however, in holding that the governing statute cannot be reformed.

California has published a standard procedure for claiming refunds of the tax. The procedure can be found by scrolling down at this link, or you can find the relevant part reproduced below in the extended entry.

Prior Tax Update Coverage:

CLAIMING CALIFORNIA LLC REFUNDS

CALIFORNIA, HERE WE COME (WITH OUR REFUND CLAIMS)

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TAX UPDATE JOINS 'TAXBLOGGER.ORG'

November 14, 2006

The Tax Update is now a "founding member" of "Taxblogger.org." What is it?

TaxBlogger.org is a loose confederation of bloggers, writers, and other tax freaks who like to write and talk about taxes. Join now in this first round and you�ll be able to claim �founder� membership status which means that your seal will say �founding member� and you�ll get a prominent link on this site.

I trust this somehow also involves frequent flier miles. I will provide a handy link to taxblogger.org in the blogroll to your left, as well as the attractive "certified" seal.

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DODGE ARTICLE ON CONSTITUTIONAL TESTS FOR TAX PROVISIONS

November 13, 2006

Tax Professor Joseph Dodge has written an analysis of the Constitution's treatment of tax cases. As Professor Dodge's essay in Tax Stories was cited in the government's still-pending request for rehearing in the Murphy case, which held the taxation of non-physical personal injury recoveries unconstitutional, this piece is very timely.

The abstract makes it clear that he believes the Murphy panel got it wrong (emphasis mine):

Among the conclusions reached herein are the following: (1) in general, a federal tax provision is constitutional if it either entails income under the Sixteenth Amendment or results in an indirect tax; (2) Murphy is not a proper case for reaching the indirect tax issue; (3) the Sixteenth Amendment only refers to gross income, and gross income means gross receipts; (4) although there is no constitutional requirement of capital recovery, capital is now limited to basis; (5) there is no basis in human capital or the capacity to enjoy life; (6) emotional suffering does not result from a realized loss of any portion of any asset; (7) a cash receipt cannot be excluded on the theory that it is a substitute for an untaxed psychic state; (8) direct tax is limited to head taxes, mandatory requisitions (taxes on states), and taxes on real estate, all because of their existence; (9) Congress can disallow basis; and (10) Congress can impose personal consumption taxes and personal wealth taxes.

Hat Tip: Legal Theory Blog.

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TAXING TEEN TRAUMA

November 13, 2006

The Iowa Department of Revenue today posted a new policy letter ruling that the Zeno zit zapper, formally known as the "Zeno Acne Clearing Device," is subject to Iowa sales tax:

This device removes pimples by applying a controlled heat dose to a pimple by way of a metal pad. The pad is held on the pimple for two and a half minutes. When this is done two or three times within a 24 hour period, most pimples are eliminated. The device works by killing the bacteria which are inside the pimple.

You ask if sales of this device in Iowa would be taxable. The device is tangible personal property, and no exemption works to exclude its sale from the tax imposed on sales of tangible personal property in Iowa by � 423.2(1) of the 2005 Iowa Code Supplement. Subsection 423.3(60) of the 2005 Code Supplement excludes from tax �the sales price from the sale or rental of prescription drugs, durable medical equipment, mobility enhancing equipment, prosthetic devices, and other medical devices intended for human use or consumption.� However, a careful reading of the subsection reveals that the Zeno device is not included within the definition of any of the exempt drugs or devices. No other exemption is applicable to its circumstances, so Walgreen�s sales of the devices are taxable.

Good thing we've at least got that cleared up.

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THE SOFTWARE MADE ME DO IT!

November 13, 2006

Henry Broderick from New Jersey understated his taxable income by about $56,000, leaving him with no tax on his return. When the IRS asserted a penalty for understating his income by over $5,000, he manfully stepped up and blamed the software. The Tax Court lacked sympathy:

Petitioner blames defects in his income tax return on software that he claims to have used in preparing the Form 1040 return. Such a program is only an aid for preparation of a return and depends on careful entry of accurate information, which petitioner manifestly failed to do. Petitioner admits that he has the education to prepare and review his income tax return, and that he had an opportunity to review his return prior to filing it. Accordingly, petitioner's use of software in preparing his return does not constitute reasonable cause for the errors in his return or for the deficiency in this case.

It sure is easy to accept what the computer gives you when it makes you happy. That doesn't make it right.

Cite: Henry Broderick, T.C. Summ. Op. 2006-182.

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DEMOCRATS TO PUSH AMT REFORM?

November 13, 2006

The Washington Post reports that AMT reform will be high on the new Democratic Congressional Majority's tax agenda. In a way it's not surprising, as AMT hit's high-tax "blue states" particularly hard. One strange article even called AMT "Bush's Secret Tax on Democrats." It didn't work, apparently, considering how the election turned out.

The AMT is, of course, insane. It requires taxpayers to compute their income and tax two different ways, and then pay whichever tax is higher. It would be like having to fill out two different forms with the same information to get license plates.

Unfortunately, efforts to fix AMT have run into a horrible fiscal problem: the government has come to depend on its revenue. That's why every year Congress has temporarily increased the amount of income exempt from AMT; these patches push off for another year a massive increase in the numbers of taxpayers subject to AMT. A permanent fix is just too expensive. From the Washington Post:

In the past, Congress has patched the AMT one year at a time, primarily by increasing the exemption amount. Next year, to hold the number of affected taxpayers steady at about 4 million, the patch would cost about $50 billion, according to the Joint Committee on Taxation. Getting rid of the tax altogether would be even more expensive: more than $1 trillion over the next decade, by various estimates. Budget experts doubt that Democrats can do it without reneging on their promise to reduce the budget deficit or winning an agreement from Republicans to raise taxes elsewhere.

This makes Virginia Postrel's hope that the new Congress might go for a comprehensive 1986-style tax reform more plausible; given the size of the problem, you probably can't really fix AMT without redesigning the whole tax system. That would, of course, require serious behavior and bi-partisan cooperation, neither of which abound in Washington.

Hat tip: The TaxProf.

Other bloggers are weighting in. Ann Althouse is in a mocking mood. Harvard professor Greg Mankiw says AMT should be combined with an elimination of the state and local tax deduction; that would get rid of AMT by renaming it the regular tax.

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WORLD ENDS; WOMEN, MINORITIES HARDEST HIT

November 13, 2006

The Tax Prof calls attention to a paper that says the tax law provision making non-physical personal injuries taxable - the provision overturned in Murphy - is racist and sexist. From the abstract for "I Think, Therefore I Am; I Feel, Therefore I Am Taxed: D�scartes, Tort Reform, and the Civil Rights Tax Relief Act":

Both section 104(a)(2) and the Civil Rights Tax Relief Act are premised on the assumption that physical and nonphysical injuries should be compensated (and taxed) differently. The paper explores the philosophical history of the distinction between the mind and the body, and argues that a distinction between physical and nonphysical harm � for the purposes of law � is a destructive dualism that has the effect of discriminating against women and minorities.

Last I looked, the plaintiffs bar looked pretty white and male. The pain these provisions cause those poor fellas shouldn't be ignored!

Really, the idea of worrying about whether this provision or that provision "has the effect of discriminating" is a fools errand. Until every racial and sex group has identical economic demographics, any tax law will discriminate against somebody. The earned income credit discriminates against old folks - they don't have kids. It discriminates against white folks - they're on average more likely to earn too much to qualify. Who cares? Either it's good tax policy or it's not; trying to fine-tune it based on racial effects is a step to madness.

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NO WAY THE TREASURY EMPLOYEES UNION GOES FOR THIS

November 10, 2006

The TaxProf notes the following news from India:

20 Eunuchs to Collect Taxes in India:

One cash-strapped Indian city has launched a unique collection service to dislodge payment from tax deadbeats: Door-to-door eunuchs.

If you don't know what a eunuch is, click on the handy link. We'll just say that half the population can't qualify, and the other half doesn't want to.

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MURPHY LAWYERS RESPOND TO REHEARING PETITION

November 10, 2006

The attorneys for Marrita Murphy have filed thier response to the governments request for a rehearing of the case, which ruled taxation of personal injury damages unconstitional (via the TaxProf).

Link: Full Tax Update Murphy coverage.

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IRS SAYS DON'T GET FANCY WITH TRAVEL PER-DIEM REIMBURSEMENTS

November 10, 2006

Many taxpayers reimburse their employees for out-of-town travel meals using the IRS-approved "per diem" rates. Instead of making the employees turn in meal receipts, the employer pays a fixed amount for each day of travel. The employee gets a deduction, subject to the 50% disallowance for meals and entertainment, and the employee doesn't have to pick up the per diem as income.

Unless. Unless the employer is a bit too generous and routinely reimburses in excess of the allowed per-diem. Then the employee has to pick up the entire payment - not just the excess - in income. That's the holding in Revenue Ruling 2006-56, issued yesterday by the IRS.

The ruling lays out the case of a trucking company that reimburses employees for meals based on miles traveled; the formula leads to reimbursements that often exceed the per-diem amounts. This fails the requirement that the reimbursement be under an "accountable" plan, so the entire payment becomes taxable.

The current per diem rates can be found at the US General Services Administration website.

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ELECTION'S OVER, BUT THE CARNIVALS ROLL ON

November 10, 2006

The November Carnival of Taxes is up, as is the new Cavalcade of Risk. Enjoy!

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TAXPAYER BEAT'S IRS' DEAD HORSE

November 09, 2006

Tax Court Judge Holmes manages to tie up a messy case in a pithy way:

In December 1997, Raymond Murphy sent a check to Philip Hunt for $225,000. Murphy says the check was for interest that he owed Hunt on two living horses; the Commissioner says the check was a repayment of principal on a dead one. If Murphy is right, the entire amount is deductible; if he isn�t, none is.

The ruling? Murphy's right, it's deductible.

Cite: Raymond T. Murphy, T.C. Memo 2006-243.

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FIVE YEARS OF TAX UPDATES

November 09, 2006

Five years ago today was the first edition of the Tax Update. It was an e-mail edition, which I later started posting on our web site as an afterthought. I still do the e-mail version every two weeks or so, using mostly selected and slightly-polished posts from this blog (send me an e-mail if you want to get on the e-mail list). Thanks to all of you readers for humoring my efforts here.

Thanks to Kathy Morrison for reminding me of the anniversary, and for preventing hundreds of typos while proofreading the email version over the last five years.

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MOWERS SELL NEWAYS

November 09, 2006

Tom and Dee Mower, who are scheduled to begin serving sentences for tax evasion this month, have sold Neways, the Utah-based multi-level marketing company they founded. The Provo Daily Herald has a big story on the sale. The terms of the sale were not disclosed, but prior reports said the Mowers hoped to sell the company for $600-700 million.

Prior Tax Update coverage: NEWAYS FOUNDERS SENTENCED

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BLOGGERS ON TAX POLICY IN A DEMOCRAT-CONTROLLED CONGRESS

November 09, 2006

Bloggers are weighing in on tax policy under Charlie Rangel and Max Baucus.

Virginia Postrel maybe has better eyes than me. She sees hope for comprehensive tax reform:

How about a loophole-closing, rate-flattening 1986- style tax reform from the new Congress? It would be a lobbyist nightmare, and a repudiation of the Clinton administration's zillions of tax credits for good behavior (extended by the Bushies). But if I squint really hard I can see it happening. Charles Schumer is talking the right way: "I don't think we want taxes to move higher at all; the kinds of things we're talking about easily funded about rearranging federal priorities making sure that some of the shelters are closed -- the offshore shelters and things like that. But the Democrats are against increasing taxes. We want to become more fiscally responsible." Not that I actually think this is anything other than Election Day spin.

Russ Fox at Taxable Talk sees only darkness, with a silver lining:

First, forget estate tax reform. I can't see it passing, unless it's something like a $2 million exemption with 45% rates above that. Second, forget any other major changes in the Tax Code. The Democrats have said they'd like to see new programs (that cost money), but unless tax revenues increase, those aren't likely to happen. I see two years of gridlock, which isn't necessarily bad.

Bitter blogger D