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Tax Update Blog: December 2006 Archives

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LAST DAY OF THE TAX YEAR

December 31, 2006

It's a bit much to expect to do a year's worth of tax planning in one day, but you can still do a few things, if you really try.

The easiest deduction you can get today is to give a charitable contribution by credit card. We have some ideas here.

If you can get a check for a deductible expense issued and postmarked today, that will also work. For most folks, the most likely deduction would be for a state estimated tax payment. There's no mail today, so if you need something done today that needs postmarking today, you have a challenge on your hands. Some main post offices will postmark today, but you probably won't be able to get a certified mail receipt.

If you really need something shipped today, your best bet might be a UPS Store or Fed-ex office, if you can find one open. The IRS recognizes certain shipping services waybills as postmarks. Details here.

Finally, don't forget to cast your vote for Taxpayer of the Year. The voting will be held open until Tuesday sometime.

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TAXPAYER OF THE YEAR, 2006: THE POLLS REMAIN OPEN

December 30, 2006

"Survivor" star Richard Hatch and actor Wesley Snipes are pulling away from the field in our first-ever "Taxpayer of the Year" poll, but a dark horse could still make a move. You can learn more about the nominees here, or just vote below. Make a difference and vote!


Who is the 2006 Taxpayer of the Year?
Marrita Murphy
Tommie Underwood
Wesley Snipes
Walter Anderson
Ruth Harrell
Treasury Secretary Paulson
David Guardino
Richard Hatch
  
Free polls from Pollhost.com

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W-H-O RADIO JOE

December 29, 2006

I am slated to be on WHO radio (AM-1040) at 4:35 pm (central) today to talk about year-end tax planning. If you are outside WHO's enormous range, you can listen on the internet here. Brian Gongol is the host, filling in for Steve Deace.

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POLLS EVERYWHERE

December 29, 2006

The TaxProf has a poll going, too. He asks what year-end planning moves you made in December. Go there after you take my poll!

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TAXPAYER OF THE YEAR NOMINEES, 2006

December 29, 2006

As year-end bears down like a runaway train, lets pause for a moment and consider which worthy taxpayer should be our 2006 Taxpayer of the Year. The only requirement for the award is that the taxpayer has done something, for good, for ill, or for humor (usually unintended) on the tax scene in 2006. I will list a few names and put the issue to a reader vote. If you feel I missed somebody worthy, make a note in the comments.

The initial slate of nominees:

Marrita Murphy, whose whistleblower lawsuit looked for awhile like it would upset decades of accepted tax law.

Tommie Underwood, ex-IRS agent who claimed his dead father-in-law as a dependent.

Wesley Snipes, actor and proponent of an, er, alternative theory of the tax law.

Walter Anderson, who pleaded guilty in America's "biggest tax evasion" case.

Ruth Harrell, who deducted $5,625 for cleaning her husband's UPS uniforms because that's how much she estimated having them cleaned professionally would cost.

Treasury Secretary Paulson, who took a big pay cut, but gets to diversify his portfolio tax-free.

David Guardino, the clairvoyant who was convicted of tax evasion, even though he had to see it coming.

Richard Hatch, convicted of failing to report $1 million of income the entire nation saw him earn on television.

Ladies and Gentlemen, it's up to you:


Who is the 2006 Taxpayer of the Year?
Marrita Murphy
Tommie Underwood
Wesley Snipes
Walter Anderson
Ruth Harrell
Treasury Secretary Paulson
David Guardino
Richard Hatch
  
Free polls from Pollhost.com

Vote early, vote often.

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YEAR-END CHECKLIST

December 29, 2006

On the last business day of the year, let's review a few last-minute items for your year-end tax planning:

Consider whether you need to get your checks issued by year end to get your deduction this year.

Can you benefit by having your broker sell some loser stocks today for you?

Do you have an S corporation? Do you know where your basis is?

If you are starting a retirement plan for 2006, have you executed your plan documents?

Did you make your year-end charitable gifts?

Did you make your College Savings Iowa Section 529 plan contribution?

If you aren't going to have alternative minimum tax for 2006, did you consider paying your 4th quarter state estimated tax, and maybe your balance due, this year? Look here for a discussion of the economics of prepaying your taxes.

If you are an Iowan, maybe you should pay your fourth quarter federal estimated tax now to get a 2006 deduction.

Did you use your annual personal gift tax exclusion?

And, if you really want a deduction this year, and the stars are right, you can consider this. This sort of gift keeps on giving.


Happy new year! We wish you many happy returns next April.

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DEDUCT NOW, PAY LATER

December 29, 2006

If you are still looking for a last-minute deduction, remember: charitable donations made with credit cards before the end of the day December 31 are deductible this year, even if you don't pay your credit card bill until next year. Many charities make it easy to donate on their websites. Here are a few:

Salvation Army

American Diabetes Association

Alzheimer's Association

National Parkinson's Foundation


Your alma mater would appreciate some help:

Cornell College

Southern Illinois University Foundation

Drake University

University of Northern Iowa

Iowa State University

University of Iowa


Or you can give "to care for him who shall have borne the battle and for his widow and his orphan" at one of these sites:

Soldier's Angels

The Injured Marine Semper Fi Fund

The United Warrior Survivor Foundation

Naval Special Warfare Foundation

USO


If you want your gift to be close to home, consider the Iowa Donor Network, the organization that coordinates organ donations in Iowa; and the Hospice of Central Iowa.

If your favorite charity isn't set up to take online gifts, you probably can still get them an online contribution by visiting the Network for Good website.

If you are trying strictly to save money, charitable donations aren't for you; a tax deduction at best reduces the cost of your donation. But if you are willing to give to help others, the tax man will make it a little easier.

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DON'T MOST BABYSITTERS DRIVE 676 MILES EVERY DAY?

December 28, 2006

wdi.jpgThey used to hold a flea market at the old Waukegan Drive-in theater near where I grew up. I remember finding treasures like used dictaphone machines and primitive adding devices that I would take home and try to operate. One thing I never saw there was a tax return preparer. Maybe I just wasn't looking in the right flea market.

A Department of Justice Press Release has the story (emphasis mine):

JUSTICE DEPARTMENT ASKS FEDERAL COURT TO BAR FLEA MARKET TAX PREPARER FROM PREPARING FEDERAL TAX RETURNS FOR OTHERS

Florida Woman Allegedly Promotes Scam Claiming Bogus Fuel Tax Credits for Customers

WASHINGTON - The Justice Department announced today that it has sued a federal income tax preparer in U.S. District Court in Miami seeking to bar her from preparing tax returns for others. According to the government’s civil injunction complaint, Tashanna McFarland of Miramar, Fla., prepared federal tax returns claiming fraudulent fuel tax credits, a scam that the complaint explains is a serious enforcement problem for the Internal Revenue Service (IRS). The suit alleges that McFarland operates her tax preparation business out of a booth at a flea market in Miami.


Your honor, that's not a booth, technically. It's a card table!

Federal law imposes a fuel tax on gasoline and diesel fuel sold in the United States. The tax is included in the purchase price at the pump. Businesses can claim a fuel tax credit in certain rare circumstances, but most businesses and consumers who use cars or trucks on roads and highways are not eligible for the credit. According to the government’s complaint, McFarland claimed the fuel credit on her customers’ returns so they could claim tax refunds to which they were not entitled.

If they'd just call it an "ethanol credit," maybe that makes it ok?

The complaint says that on a return for one customer—a babysitter—McFarland claimed that the customer purchased 16,451 gallons of gasoline for business-related purposes. The suit notes that for such a claim to be accurate, the babysitter (whose total income for the year was $9,316) would have had to spend approximately $36,192 for gasoline that year—nearly four times her total income—and would had to have driven approximately 246,765 miles during the year, an average of 676 miles each day, seven days a week.

What do you expect? Good sitters are few and far between. Still, that doesn't sound right; it's the parents that would drive that far for a sitter, not the other way around.

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LIKE SEASON'S GREETINGS FROM THE MORTICIAN

December 28, 2006

This happy e-mail header starts my day off just right:

"Happy New Year from Bankruptcy-Divorce.com"

Yes, it's always good to have things to look forward to for the coming year. No wonder people drink a lot on New Year's Eve.

bdcom.JPG

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WISE WORDS ON TAX POLICY

December 28, 2006

Villanova tax law professor Jim Maule offers some free advice to the new Congress:

Jettison the dozens of exclusions, deductions, and credits directed toward special interests, put an end to special low tax rates, remove the working poor from the tax rolls, and restore progressivity so that someone with $30,000,000 of taxable income is taxed at meaningfully higher rates than someone with $1,000,000 or $400,000 of taxable income. Done properly, a genuine reform would permit reduction of tax rates so that there would not be as much incentive for special interest groups to seek special tax breaks and would permit repeal of the AMT.

I disagree with Dr. Maule's emphasis on progressivity. I don't really care whether the multi-millionaire has to pay at a higher rate than the mere millionaire, and I think steps to make it so - especially higher marginal rates - do more harm than good. I also think that the working poor are pretty much off the tax rolls, unless "working poor" has been defined upward so as to mean nothing. I think the elimination of the bottom of the income tax base is a bigger problem than excess income tax on the working poor.

Yet I think Dr. Maule is dead-on about the "dozens of exclusions, deductions and credits directed towards special interests." I especially wish Iowa's policy makers would heed this comment of Dr. Maule's:

The Pennsylvania individual income tax, with few exclusions, almost no deductions, a handful of credits, a prohibition against using a loss in one category of income to offset income in another category, and a rate of just over 3 percent, simply doesn't attract the sorts of power brokering, back room dealing, hideaway dinner meetings, and disguised lobbyist favors that have infected the federal income tax.

Here in Iowa we have a rate of nearly nine percent and a boatload of credits and deductions. Pennsylvania has the right idea here.

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OTHER YEAR-END PLANNING LINKS

December 28, 2006

If you've had all the year-end planning tips from me that you can stand, maybe you should get out and see the tips at Don't Mess With Taxes and Gina's Tax Articles.

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WHEN DO I HAVE TO PAY IT TO DEDUCT IT THIS YEAR?

December 28, 2006

Tomorrow is the last "business day" of the year. If you have a business, what do you have to do before 2007 to get a 2006 deduction?

CASH BASIS TAXPAYERS

If you file your business returns on a "cash basis," you generally can get your deduction if the check for a deductible expense is postmarked by December 31. If you are talking big numbers, you should consider a wire transfer, or at least a certified mail receipt to prove you sent the check on time. Postage meter postmarks are almost worthless in trying to prove a timely payment.

There is one common expense that can be paid after year-end by a cash-basis taxpayer without losing the deduction: pension and profit-sharing contributions. If your plan is in place by year-end, you have until the due date of the 2006 return to fund the 2006 contributions; if you extend the return, you also extend the funding deadline.

ACCRUAL BASIS TAXPAYERS: RELATED PARTIES

Life is a bit more complicated for accrual-basis taxpayers. They have less flexibility in controlling their income and deductions, but they usually have more ability to deduct unpaid income.

There are some expenses that accrual-basis taxpayers can only deduct on a cash basis. If you owe money to a "related party," there is no deduction until the related party has to take the payment into income. For example, a calendar-year corporation cannot deduct a bonus to its sole shareholder for 2006 unless the bonus is paid by year-end and included on the shareholder's 2006 W-2. The same goes for interest, rent, or any other accrued expense.

The related party rules can be tediously complex. For purposes of deducting accrued expenses of C corporations, related parties include 50% owners and other corporations with 50% or more common control. "Family members" of 50% owners also are related parties; for this purpose, "family" is:

...brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants

This does cut off, though. You are considered to own what your husband owns directly, but you aren't considered to own what your husband's brother owns, even though your husband is considered to own it. A famous tax commentary explains this elegantly:

A fortiori, this limitation ensures that stock owned by Bittker will not be attributed to his parents and then from them to their parents, and so on back to Adam and Eve, and then down through the family of man to Eustice.

For S corporations and partnerships, the related party net is wider. You are considered a "related party" if you own any stock in the S corporation or any capital interest in the partnership. The constructive ownership rules also extend out one level further. So while your husband's brother's C corporation may deduct an expense accrued to you at December 31, 2006 that isn't paid until January 2007, his S corporation may not.

The related party rules can also apply to trusts. If you are accruing an expense to somebody who might be related, ask your tax advisor to help sort out whether it needs to be paid by December 31 to get a 2006 deduction.

ACCRUAL BASIS TAXPAYERS: NON-RELATED PARTIES

If an expense is accrued to a non-related party, the deduction timing depends on what the expense is for. Accrued compensation must be paid within 2 1/2 months after year-end to be deductible in the year it was accrued. Most other accrued expenses must be paid within 8 1/2 months of year-end under the "recurring item" rules we discussed last week.

But be careful - if you sign a service contract or insurance contract by year-end, you won't get a deduction unless payment on the contract is also made by year-end, under new Revenue Ruling 2007-03.

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THERE'S STILL TIME TO FUND YOUR COLLEGE SAVINGS IOWA PLAN

December 27, 2006

December 31 is the last day you can fund a contribution to College Savings Iowa and still get a deduction on your 2006 Iowa personal tax return for it.

College Savings Iowa is Iowa's "Section 529" plan. Earnings in a Section 529 plan grow tax free, and are tax exempt if they are withdrawn for college costs. The Iowa plan invests in low-cost Vanguard funds, popular among people who don't care to squander their investments on high-priced fund managers.

You may deduct College Savings Iowa contributions in 2006 of $2,500 per donor, per donee. That means a married couple with two children can deduct up to $10,000 on their Iowa return. Visit the College Savings Iowa website for details, or to enroll online. The CSI website says checks must be received by January 6, 2007 to be credited for 2006.

Even if you already have a child in college, this is a good deal for Iowans. To the extent you can funnel your tuition payments through CSI, you can get an Iowa tax deduction for tuition up to the Iowa contribution limits.

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WSJ ON UNINTENDED CONSEQUENCES OF COMP DEDUCTION CAP

December 27, 2006

The TaxProf links today to a Wall Street Journal piece ($link) on the tax-law origins of the stock option backdating scandals -- a topic we have discussed here.

First, it passed a law, pushed by President Clinton, seeking to rein in executive pay by limiting the tax break for it. The 1993 law said companies couldn't deduct yearly compensation of more than $1 million for any one of their top five officers. But it exempted certain kinds of pay linked to performance, which included stock options. Companies rushed to restructure pay plans to grant more options. In 1994, the first year the law was in effect, the value of option grants to CEOs at S&P 500 firms leapt by 45% on average, according to Mr. Murphy, and nearly doubled again over the next two years. The 1993 law "deserves pride of place in the Museum of Unintended Consequences," said Christopher Cox, chairman of the Securities and Exchange Commission, this fall.

The sensible thing would be to allow the consenting adults on public company boards to set their own pay levels and policies. Don't bet on Congress being sensible.

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FORD AND TAXES

December 27, 2006

wiford.jpgFormer President Gerald Ford died yesterday. While taxes didn't play a large role in his brief term in office, the tax law had a large part in getting him to the White House.

Mr. Ford wasn't Richard Nixon's elected Vice-President. Spiro Agnew was Mr. Nixon's running mate in both his elections, including the 1972 drubbing of George McGovern. Things went downhill rapidly in the second Nixon term. Less than nine months after taking his second oath of office, Mr. Agnew resigned and pleaded "no contest" to tax evasion charges. The charges arose from bribes received by Mr. Agnew as Governor of Maryland.

For the first time, the 25th Amendment to the constitution kicked in, and Mr. Ford was nominated for the Vice-Presidency and confirmed by the Senate. Less than a year after that, Mr. Ford capped his resume when President Nixon resigned in disgrace.

There was one significant piece of tax legislation in the Ford administration, the Tax Reform Act of 1976. The current structure of the estate and gift tax dates from the 1976 act, as do the $3,000 capital loss cap, the limits on vacation home losses, and the "at-risk" rules of Section 465. President Ford left behind a top tax rate of 70% (starting at $100,000 on joint returns), a top capital gains rate of 35%, and a top corporate rate of 26%. No wonder there were a lot of C corporations then.

As his term saw the pardon of a disgraced former president, the fall of Saigon, and the risible "Whip Inflation Now" campaign, tax policy probably won't be what historians talk about when Mr. Ford's name comes up. He failed to win re-election in his own right, but a few years of President Carter made Mr. Ford look pretty good by comparison. Given the awful political hand he was dealt, he held things together well. Rest in peace, President Ford.

Link: Pajamas Media Ford Roundup

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YEAR-END CARNIVALS

December 27, 2006

Start your uninhibited celebration of the end of 2006 by visiting this week's blog carnivals. The Carnival of the Capitalists is at Worker Bees, and the Carnival of Personal Finance is (logically enough) at My Personal Finance Blog.

These "carnivals" are roundups of topical blog postings. Much good reading is available at each one. Bring your own adult or alternative beverage.

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MURPHY'S LAW UNDONE?

December 26, 2006

A three-judge panel of the Federal Circuit Court of Appeals shocked the tax world in August when they barred as unconstitutional the taxation of emotional damages. The broad language of the Murphy decision threatened many long-accepted elements of the tax law.

Last Friday the same three judges had second thoughts. They have vacated their own decision and scheduled a rehearing on it in April.

The IRS had petitioned the appeals court for an "en banc" rehearing, in which all 12 (I think) D.C. Circuit appeals judges would re-hear the case. The three original Murphy panel members ordered the rehearing "on the court's own motion," so they will do the rehearing themselves.

Presumably the three judges wouldn't have bothered with the rehearing -- including a full briefing schedule and oral arguments -- absent serious doubts about their original decision.

Hat tip: The TaxProf, who has an excellent set of links to the relevant documents and prior coverage.

Link: Complete Tax Update Murphy Coverage.

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YEAR-END PLANNING - WHERE TO DRAW THE LINE?

December 26, 2006

I'm a big fan of year-end tax planning. Still, you can overdo a good thing. Dr. Maule discusses a recent New York Times story that points in that direction, anyway:

In the story, To-Do List: Wrap Gifts. Have Baby, David Leonhardt provides an interesting array of observations:

1. Modern medical technology has made it easier for women to select a day for their child's birth.
2. For four of the seven years from 1997 through 2003, December has pushed September aside as the month with the highest number of births; data for years since 2003 has not been released.
3. Since the early 1990s, the tax code has provided an increasing number of tax benefits based on the existence of, and number, of a taxpayer's children.
4. The tax value of a child being born before the end of the year, in contrast to after the beginning of the next year, is in the thousands of dollars.
5. Among the tax breaks are the dependency exemption deduction, the child tax credit, the earned income tax credit, and the medical expense deduction.

From these observations, Leonhardt concludes that the tax law is encouraging people to have children in December.

Accelerating childbirth seems like a somewhat drastic step to take for tax reasons, but it's never been a close call in my family. I did suggest a December wedding 19 years ago for tax reasons, but one look from my June bride made it clear that non-tax considerations would govern.

The TaxProf has more.

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DON'T STOP GIVING YET

December 26, 2006

Just because it's December 26 doesn't mean you should stop giving - at least not if estate planning matters to you.

The tax law allows you to give $12,000 tax-free to any individual donee each year. Gifts that qualify for this "annual exclusion" are not subject to gift tax and don't eat into your lifetime estate and gift tax exclusion.

With the lifetime estate tax exclusion up to $2 million, the $12,000 annual gift exclusion may seem less important. Unfortunately, current law is set to expire. If you have the good fortune to survive 2010, the exclusion will fall back to $1 million, and the tax rate goes back up to 55%. Unless they want to count on Congress acting sensibly, taxpayers who might face estate taxes under the post-2010 rules should tax advantage of the annual exclusion.

A married couple with two children can make transfer $48,000 to them tax-free each year under the annual exclusion. In addition to getting the $48,000 out of their taxable estates, they also move all future earnings on that $48,000 to the next generation. Assuming a modest 4% annual return, annual gifts of $48,000 add up to over $576,000 10 years.

And remember: once 2006 is over, the 2006 annual gift tax exclusion is gone forever.

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DES MOINES REGISTER ON BUSINESS BLOGS

December 24, 2006

Today's business section of the Des Moines Register has a nice article about local business blogs. I like it, as it says nice things about this site. It also points out a law blog that is new to me, www.rushonbusiness.com. It looks like it may be a good place to follow the Microsoft shakedown trial now underway at the Polk County Courthouse.

The Register piece features Mike Sansone, Des Moines' disciple of business blogging. Which reminds me: he's supposed to organize this winter's Iowa Blogger Bash. We're waiting for our invitations, Mike!

As I said, I like the article. I do have one quibble: The Register's web site provides the URL for the blogs in the article, but it doesn't link to them. It's not that much extra work to add a link, and it helps the reader. But that's a quibble with the web site, not the article. I'm curious to see if any of the Register's own bloggers have any comments on it.

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IRS: SIGNING THE DEAL ISN'T ENOUGH TO EARN A DEDUCTION

December 22, 2006

The IRS yesterday spelled out (Rev. Rul. 2007-03) the rules for when deductions are available to accrual method taxpayers for insurance and service contracts. It also issued a procedure (Rev. Proc. 2007-14) for taxpayers to change their accounting methods to conform with the new revenue ruling.

CONTRACTS FOR SERVICES

The ruling said that an accrual-method taxpayer who signs a contract for services to be performed in a subsequent year cannot deduct the costs under the contract until the earlier of the performance of the services or the due date for payment under the contract. If the performance of services occurs after payment, it has to meet the tax law's "economic performance" requirements to be deductible.

CONTRACTS FOR INSURANCE

The ruling applies the same basic pattern to insurance contracts. Signing the contract doesn't accrue the liability for tax purposes; the liability doesn't create a deduction until payment is due.

ECONOMIC PERFORMANCE

The tax law applies two tests to determine when an expense may be accrued. The first test, the "all events" test, occurs when "all events" have taken place to determine the existence of the liability; the amount of the liability must also be determinable with "reasonable" accuracy.

The second test requires "economic performance" to occur. The ruling recaps how these rules apply to services and insurance (emphasis mine):

Section 1.461-4(d)(2) provides that if a liability of a taxpayer arises out of the providing of services or property to the taxpayer by another person, economic performance occurs as the services or property is provided.

Section 1.461-4(g)(5) provides that if a liability of a taxpayer arises out of the provision to the taxpayer of insurance, economic performance occurs as payment is made to the person to which the liability is owed.

The tax law does provide some leeway:

Section 1.461-5(b)(1) provides a recurring item exception to the general rule of economic performance. Under the recurring item exception, a liability is treated as incurred for a taxable year if: (i) at the end of the taxable year, all events have occurred that establish the fact of the liability and the amount can be determined with reasonable accuracy; (ii) economic performance occurs on or before the earlier of (a) the date that the taxpayer files a return (including extensions) for the taxable year, or (b) the 15th day of the ninth calendar month after the close of the taxable year; (iii) the liability is recurring in nature; and (iv) either the amount of the liability is not material or accrual of the liability in the taxable year results in better matching of the liability against the income to which it relates than would result from accrual of the liability in the taxable year in which economic performance occurs.

In other words, if the all-events test is met, you normally get the deduction if economic performance occurs within 8 1/2 months of year-end. This provision accounts for the "recurring item elections" routinely seen in tax returns for new businesses.

THE MORAL: If you want the deduction under an insurance or service contract this year, you'll need to pay this year.

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WHAT DID NIXON SAY WHEN HE BUMPED INTO FORD?

December 22, 2006

Two tax violators made the list of Christmastime pardons issued yesterday. President Bush pardoned a San Antonio man convicted in 1985 on income tax charges and a Georgia man convicted of alcohol tax violations ($link).

Sometimes the motivation to seek a pardon is clear, as in the case of the pardoned Iowa meth dealer who gets to go home from prison 12 years early.

But why would somebody who finished serving his sentence almost 20 years ago bother to go through the pardon process? If Google is any indication, the San Antonio man has developed a business, and maybe the pardon helps him deal with some licensing issues. Good luck and congratulations to him.

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THE GOOD STUFF

December 21, 2006

The Essential Iowa website has a feature up on Templeton Rye, the legendary bootleg whiskey of west-central Iowa. It is now being distilled and marketed legally.

I'm sure the packaging is a little more sophisticated than the "brand's" historic customers are used to:

trye.jpg
Alleged historical sample of "Templeton Rye"

One taste and you'll want to sing.

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IT'S LOSER TIME!

December 21, 2006

While we all like to remember our good investments, this is the time of year to give some thought to your losers. We often neglect these red-headed stepchildren of our portfolios. It's not pleasant to think of that stock or mutual fund we purchased with such high hopes, only to see them cruelly dashed by an unforgiving market. We let them lurk in the recesses of our brokerage accounts, in the vague hope that someday they will redeem themselves.

Well, forget about it. They're toast. So make them do something useful for once. Sell them, and take the losses on your tax return.

Capital losses are deductible to the extent of your capital gains, plus $3,000. If you have losers in the portfolio, paying taxes on your capital gains this year is at least partly optional.

To deduct these losses, keep a few simple rules in mind:

The loss has to be realized in a taxable account. Selling a loser in an IRA or 401(k) plan doesn't give you a deductible loss.

Be sure the trades are executed no later than December 31. For long positions, the trade date controls.

If you have a loss on a short sale, the settlement date has to be no later than December 31.

You can't buy the same stock within either 30 days before the sale or 30 days afterwards. If you do, the "wash sale" rules disallow your loss.

Don't pay optional capital gain taxes; send your losers out with a smile.

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EXTENDER BILL SIGNED

December 21, 2006

President Bush signed the extender bill into law yesterday. In addition to temporarily re-enacting the usual suspects, the bill enhances Health Savings Accounts and provides alternative minimum tax relief to those who got clobbered from carelessly managing their incentive stock options during the telecom bust.

The Tax Prof and Don't Mess With Taxes also have coverage.

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SCHULING STAYS ON AT IOWA DEPARTMENT OF REVENUE

December 21, 2006

schuling.JPGGovernor-elect Chet Culver announced that Des Moines Attorney Mark Schuling will stay on as Director of the Iowa Department of Revenue. Mr. Schuling took the post a year ago after Mike Ralston resigned to become president of the Iowa Association of Business and Industry. From the Cedar Rapids Gazette online:

Schuling became director of the Iowa Department of Revenue one year ago. He had been a practicing attorney for 25 years in Des Moines and has worked in private practice on tax litigation. During four of those years, he was an assistant attorney general in the Iowa Attorney General's Office and advised the department on statutes, rules, and declaratory rulings.

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HOLIDAY RISK PARTY

December 21, 2006

The new Cavalcade of Risk is up. This roundup of blog posts on insurance and risk managment is at InsureBlog this week. Among the usesful posts linked there are 15 Ways to Lower Your Car Insurance. They don't list the one that worked best for me: "Turn 25." Too bad I can't do that again.

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TARGETED STATE TAX BREAKS: DISCLOSE OR DISPOSE?

December 20, 2006

The Iowa Fiscal Partnership, a left-side think tank in Des Moines, issued a useful report on Iowa's economic development tax breaks yesterday. The report calls for more disclosure of Iowa's economic development tax breaks:


“The problem is that itʼs hard to tell how effective these tax breaks are in promoting new economic activity,” said Victor Elias, senior policy associate at the Child and Family Policy Center (CFPC) in Des Moines and co-author of the report for the nonpartisan Iowa Fiscal Partnership (IFP).

“These tax breaks have almost no reporting requirements and individual recipients remain unknown,” Elias said. “This is the publicʼs business, and no one is minding it.”


As Mike Ralston pointed out when he was state Revenue Director, you can go to jail for disclosing this information under current Iowa law. This is so even though some of these breaks are "refundable," meaning the state actually gives cash to businesses if the tax breaks exceed their tax liability.

To beneficiaries of these breaks, that's a feature, not a bug. It allows you to get subsidized without annoying questions from reporters, legislators and lobbyists for your competitors. For the public, though, it's a bad deal - it's subsidies to private interests with no accountability.

The report recommends sunlight as a cure for this problem. The recommendations include:

• An annual Economic Development Tax Expenditure Report, showing all such tax expenditures, shall be provided to the General Assembly within three months of the close of the state's fiscal year.

• All data in the Economic Development Tax Expenditure Report and the state's new tax credits tracking system shall be public record under Iowa's Public Records law and made available online through a searchable data base.

• A searchable data base of economic development tax expenditures, by company, shall be available to the public online within three months of the close of the state's fiscal year.

• Sunset provisions for each economic development tax expenditure shall be included to force a review of its annual cost and to determine if it is accomplishing the intended public purpose.

• Provisions should assure the state's ability and authority to recapture tax credits from businesses that do not accomplish stated goals.

The report also tells how other states handle these issues. In some states (e.g., Minnesota), you can actually look at the tax forms for these breaks for individual companies.

This all makes sense if you think these breaks make sense in the first place. Right now these breaks are an insider game with no accountability. As long as the state taxes existing businesses to lure and subsidize their competitors, disclosure is only fair.

Still, that begs the question: should the state be granting these breaks in the first place? Almost certainly not. Any "targeted" tax break is by definition a form of central economic planning. Even Japan has moved away from its discredited "industrial policy." If they can't pull it off in Tokyo, what chance do the economic geniuses at the statehouse have?

Far better to simplify the tax system by culling the loopholes and lowering rates for everyone -- not just the folks with the best connections at the Capitol.

Links:

Iowa Fiscal Partnership press release

Full Report (pdf)

Des Moines Register coverage.

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JANUARY 2007 APPLICABLE FEDERAL RATES (AFR) ISSUED

December 20, 2006

The IRS has issued (Rev. Rul. 2007-02) the minimum interest rates for loans made in January 2007:

-Short Term (demand loans and loans with terms of up to 3 years): 4.88%
-Mid-Term (loans from 3-9 years): 4.58%
-Long-Term (over 9 years): 4.73%

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

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YEAR-END PLANNING: START A RETIREMENT PLAN?

December 19, 2006

Sometimes a business can accomplish a lot of tax savings by setting up a retirement plan before year-end. While Simplified Employee Plans (SEPs) don't have to be set up until your tax return due-date, full-fledged qualified plans must be in place before year end. But - if the documents are in place, the plan can be funded anytime before the due date of your return, including extensions.

A full-fledged profit-sharing plan can be especially helpful if you are profitably self-employed and don't control any other businesses. Such taxpayers may be able to set up a plan by year-end and make as much as a $44,000 deductible contribution to their own retirement savings via a "solo-401(k)" profit-sharing arrangement. It's a sweet deal - you reduce your current taxes merely by taking money from one pocket and putting it into another, figuratively.

If you think you might qualify, though, you'd better get to work - you'll have to move fast to get the paperwork in place by December 31.

You can also find some other year-end business planning tips at About.com.

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WITHERING ON THE VINES

December 19, 2006

SEE UPDATE

Earlier this year class-action plaintiffs lawyer Larry Vines won a Tax Court victory allowing him to make a late mark-to-market election for his day-trading losses. This "Section 475(f)" election, which has to be made by the non-extended due-date of the return for the year preceding the year the election takes effect.

An important factor in Mr. Vines' case is that he made no trades between the time he should have filed the election and the time he made the election (Another factor might be that he could afford to pay white-shoe firm Sullivan and Cromwell to litigate his case). The mark-to-market election turned Mr. Vines' $14 million or so in day-trading losses into an ordinary deduction right away, instead of a capial loss deductible at the rate of $3,000 per year for hundreds of years.

Another taxpayer tried to win permission to make a late Section 475(f) election yesterday, but without success. This taxpayer tried to make the election for 1999, 2000 and 2001 in October 2001, trading all the way. The Tax Court said the facts here dictated a different result than in Vines' case (citations omitted):

Unlike the taxpayer in Vines (who filed the election only months late and discontinued trading during the brief interlude), petitioners and SPK continued their trading activities in the meantime. The facts here present yet another example where a taxpayer seeks to use hindsight to make the mark-to-market election when it is most advantageous. Accordingly, petitioners and SPK are deemed not to have acted reasonably and in good faith and are not qualified for section 9100 relief.

The moral: If you're going to be late, don't overdo it.

Cite: Knish, T.C. Memo. 2006-268

Prior Tax Update Coverage: TAX COURT GIVES CLASS-ACTION MAGNATE AND DAY-TRADER A MULLIGAN

UPDATE: In the comments, Jeff Jacobs corrects an error I made:

Yes, I agree with you about the reasons for Vines' success. But I do have to point out that Vines' attorney - David Aughtry - is managing partner of the Atlanta office of Chamberlain Hrdlicka. It is an excellent Houston-based law firm, but it is hardly "white-shoe" [which Sullivan & Cromwell certainly is].

He is, of course, correct. I made the mistake of relying on my memory of the case, when I should have re-read it before posting. I made the additional mistake of getting two law firms wrong in one post; he hired Caplin and Drysdale (not Sullivan and Cromwell) to represent him before the IRS in trying to get them to consent to his accounting method change (The case did involve a friend of Mr. Vines named Sullivan, which somehow remained in the wrong place in my eroding short-term memory). It was the failure of this attempt that led to the Tax Court litigation, which Mr. Aughtry handled successfully.

My apologies for the error and my thanks to Mr. Jacobs for setting me straight.

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TAX COURT DOESN'T PENALIZE DOUBLING DOWN ON S CORP SALARY

December 19, 2006

The tax preparer for an S corporation inadvertently double-deducted the owner's salary on the corporation return. The IRS was miffed and tried to impose a substantial underpayment penatly on the taxpayer. The Tax Court yesterday ruled in the taxpayer's favor:

The error underlying petitioner's income omission of $173,093, wherein his accountants failed to remove that amount from salaries generally when they separately stated it as officer compensation in the electronically stored version of petitioner's S corporation's Form 1120S, resembles the kind of isolated computational error generally intended to give rise to relief.

Tax lawyer-blogger Kreig Mitchell comments:

My problem with this type of case is that the IRS did not concede the case at the administrative level or in court. It is this type of denial at all cost stance of the IRS that results in a number of taxpayers simply paying the tax – especially if they cannot afford to take the IRS to court. I suppose the lesson is that taxpayers should not let the IRS bully them, especially when the IRS takes a frivolous position.

Link: Thrane, T.C. Memo 2006-269

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TAX CARNIVAL

December 19, 2006

The Carnival of Taxes now appears twice a month! The second December edition is up at Don't Mess With Taxes.

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DECEMBER SHADOWS

December 18, 2006

The Polk County Courthouse casts a long December shadow on the Federal Building in Des Moines this afternoon.

chshadow.jpg

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I SUPPOSE THEY DO GO TOGETHER

December 18, 2006

It somehow seems fitting that these arrived today in the same package:

bnae&t.JPG

Administering an estate or trust, and covering your backside - everything the fiduciary needs.

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IOWA CAPITAL GAINS DEDUCTION NOT REDUCED BY OTHER LOSSES

December 18, 2006

An email to preparers from the Iowa Department of Revenue has this nugget:

Capital Gains Deduction: Beginning January 1, 2006, Iowa follows Federal holding period rules. The material participation requirements have not changed.

In addition to the legislative change, the department has revised its position on another aspect of the capital gains deduction. Previously, the department had taken the position that in order to claim a capital gain exclusion for individual income tax, a taxpayer must be in a net capital gain position on the federal return. If a taxpayer was in a net capital gain position, then the capital gain exclusion could exceed the capital gains reported on the federal return if the qualifying gain was offset by non-qualifying capital losses (such as stock sales). After a review by the Attorney General's office, the department has changed its position on this issue and will allow a capital gain exclusion from qualifying gains even if the taxpayer was in a capital loss position on the federal return.

This is helpful. If you have a big capital gain, standard tax planning suggests that you harvest capital losses in your portfolio to offset them on the federal return. Now it is clear that doing so won't cost you your Iowa "10 and 10" capital gain exclusion. This exclusion applies to sales of business land and assets if you have "materially participated" in the business for 10 years and have held the property for at least that long.

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PATTERN RECOGNITION

December 18, 2006

David O'Bryant, a St. Louis tax preparer, has caught the attention of the IRS. The tax agency is suing for a permanent injunction to prevent Mr. O'Bryant from preparing any more returns.

Perhaps the problems arose because Mr. O'Bryant's returns tended to follow a pattern:

O’Bryant frequently claims false Schedule C income and expenses in identical amounts for multiple customers. For example, many of the 76 O’Bryant-prepared 2003 returns that the IRS has examined listed 2,400 for gross receipts. Twelve of the returns claimed $210 as a deduction for “professional subscriptions,” and eighteen of the 76 returns claimed a $688 deduction for union dues. IRS examinations revealed that these deductions were false.

I suppose it could be just an amazing coincidence that all these Schedule C's grossed $2,400 for the year.

The worst thing about hiring a scam preparer is that it comes back to haunt you. From the request for injunction:

17. IRS agents examined at least 157 returns that O’Bryant prepared for 54 customers for the 2002 through 2004 tax years.

18. The agents determined that every one of the 157 returns they examined contained one or more false or inflated Schedule A deductions for charitable contributions, personal property taxes, or other miscellaneous deductions.

And that's just 157 so far. As part of the injunction, the IRS wants Mr. O'Bryant's customer list, including addresses, phone numbers, and social security numbers.

The injunction request also has this nugget:

7. In 2001, O’Bryant began preparing returns for a Jackson Hewitt franchise in St. Louis, where he worked through 2005.

8. O’Bryant also taught a tax-preparation course from 2002 through 2004 while he worked at the Jackson Hewitt franchise.

That's a vivid thought. I wonder how many thousands of returns get prepared in St. Louis every year by folks who learned everything they know from Mr. O'Bryant?

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CORPUS DELINDA EST

December 18, 2006

Joel at Death and Taxes has a shattering discussion of alternatives in handling the asset we all leave behind at death:

-freeze-drying ("the decedent's body is flash-frozen to minus 18 C..., then dipped in liquid nitrogen at a temperature of minus 196 C.... The body, which is then brittle, is subjected to sound waves that reduce it to powder. The body can then be cremated or buried in a coffin made of cornstarch, which, when placed in the ground, will degrade in about a year").

Brr...

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MISSOURI VALLEY CARNIVALS

December 18, 2006

We can celebrate the ascendancy of the mighty Missouri Valley Conference in men's basketball here in Iowa* with new editions of the Carnival of the Capitalists and the Carnival of Personal Finance.

The Capitalists are partying at The Entrepreneurial Mind, with a Christmas-themed list. Brian Gongol is there with an important discussion of the unintended baneful consequences of a higher minimum wage.

The personal finance party is at A Penny Saved this week. Don't miss Insureblog's discussion of hidden rate increases in your health insurance bills.

* Iowa's Missouri Valley Conference teams have swept their instate "major" conference rivals this year in basketball; Drake and the University of Northern Iowa have both swept Iowa and Iowa State. Just to rub it in, Bradley came over from Peoria Saturday and whipped Iowa State.

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TAX TIP: DON'T ASSUME A STUPID TAX COURT JUDGE

December 15, 2006

I read Tax Court opinions daily, and the thinking and knowledge behind them is up to a pretty high standard. Clearly, being stupid does not get you a seat on the Tax Court. The judges have strong backgrounds. For example, consider Judge Diane Kroupa's C.V.:

B.S.F.S. Georgetown University School of Foreign Service, 1978; J.D. University of South Dakota Law School, 1981. Prior to appointment to the Court, practiced tax law at Faegre & Benson, LLP in Minneapolis, MN. Minnesota Tax Court Judge from 1995 to 2001 and Chief Judge from 1998 to 2001. Attorney-advisor, Legislation and Regulations Division, Office of Chief Counsel and served as attorney-advisor to Judge Joel Gerber, United States Tax Court, 1984-1985. Admitted to practice law in South Dakota (1981), District of Columbia (1985) and Minnesota (1986). Member, American Bar Association (Tax Section), Minnesota State Bar Association (Tax Section), National Association of Women Judges (1995 to present), American Judicature Society (1995 to present). Distinguished Service Award Recipient (2001) Minnesota State Bar Association (Tax Section).

She's clearly no lightweight. So why did taxpayer Kai-Chung C. Lam traipse into her courtroom with a case that had to assume that the judge would be a moron?

Mr. Lam is an entrepreneur Tennessee. On audit, the IRS disallowed lots of expenses deductions because there was no evidence that the expenses were ever incurred.

For example:

Petitioner submitted a few documents that appear to have been drafted by third parties, but the amounts listed were crossed out, and petitioner wrote in different amounts. Petitioner explained that he made these alterations after negotiating a better price for the services, but he did not explain why he, and not the third party, made the alteration.

Aw, come on, Judge! I'm sure you always get bills from, say, the power company, scratch off their number, write in your own number and send the check, and they're just fine with that.

I love this part:

Petitioner presented documents and offered testimony regarding the repair and maintenance expenses claimed as deductions. Petitioner did not introduce a single receipt, though, that showed he paid a repair or maintenance expense for either of his businesses.

Petitioner suggested that some of the individuals and businesses with whom he dealt did not differentiate between receipts and invoices. Petitioner suggested that we therefore treat the invoices he submitted as receipts.

Petitioner testified that he used service providers who did not know how to read or write, so petitioner would occasionally himself prepare the invoice for the work done. Petitioner also presented invoices from a numbered "receipt book" he kept for use by service providers who did not produce their own documentation.

What a helpful guy - he goes out of his way to hire out service work to illiterates, and he even prepares their invoices! Lord knows how the illiterates get their other customers to pay.

Unlike his vendors, Judge Kroupa isn't illiterate - unfortunately for Mr. Lam. His apparent operating assumption - that she would be stupid enough to believe him - failed to pan out, and he owes $65,645 in additional taxes and $13,129 in penalties.

Cite: Lam, T.C. Memo 2006-265.

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EAT MORE, LOSE WEIGHT

December 15, 2006

The Des Moines Partnership, our local chamber of commerce-like body, has issued its legislative agenda for 2007. It is the Partnership's usual crony-capitalism agenda, including support for municipal property seizures to benefit "economic development," new tax loopholes, and Vision Iowa make-work projects.

They also say they support prpoposals to "Streamline government to reduce costs and increase efficiencies" -- while advocating more government intervention in the economy. That's a recipe for streamlined goverment in the same way eating more dessert is the path to weight loss.

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BLOGS OF THE SEASON

December 15, 2006

The Tick Marks blog is running its annual review of tax-related blogs, the Twelve Blogs of Christmas. The newest addition to his list is Joel Sheonmeyer's worthy Death and Taxes, covering two of my favorite topics.

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IRS GUIDANCE ON YEAR-END GIVING

December 15, 2006

This week the IRS issued a helpful summary (IR-2006-192) of the rules on charitable giving. They also covered the changes in the charitable giving rules made earlier this year. Some highlights:

To be deductible, clothing and household items donated to charity after Aug. 17, 2006, must be in good used condition or better. However, a taxpayer may claim a deduction of more than $500 for any single item, regardless of its condition, if the taxpayer includes a qualified appraisal of the item with the return.

So no deduction for your your old briefs, unless they appraise out at over $500.


Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of the year count for 2006. This is true even if the credit-card bill isn’t paid until next year. Also, checks count for 2006 as long as they are mailed this year.

If you mail a big check, a certified mail receipt with a postmark will help a great deal if you get audited.

Check that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, available online and at many public libraries, lists most organizations that are qualified to receive deductible contributions. The searchable online version can be found on IRS.gov under, “Search for Charities.” In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even though they often are not listed in Publication 78.


For individuals, only taxpayers who itemize their deductions on Schedule A can claim a deduction for charitable contributions. This deduction is not available to people who choose the standard deduction, including anyone who files a short form (1040A or 1040EZ).

For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes a description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes a description of the property and its condition.

The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value of the vehicle is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return.

Giving is worthy, but deducting is wise. Make sure you document your gifts. And remember, if you donate property other than publicly-traded securities, and your donation exceeds $5,000, you'll need a qualified appraisal.

The Tax Prof has more.

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STOCK UP ON FIXED ASSETS?

December 14, 2006

December is the year-end for most closely-held businesses. If you are looking for a way to reduce your 2006 tax bill from the business, you might be able to do so by moving up some asset purchases.

The tax law's "Section 179" allows you to expense equipment and software purchases of up to $108,000 in 2006 that would otherwise have to be capitalized and depreciated or amortized over several years. If you are going to buy some new equipment soon anyway - say, new computers, printers, or machinery - you may be able to reduce your 2006 taxes by getting them in place before year end.

But be careful: if you have over $430,000 of fixed asset additions in a year, the Section 179 deduction begins to phase out. The $108,000 limit applies with S corporations and partnerships at the company and the owner levels. And you have to have either wage or other active business income to use the Sec. 179 deduction. Sometimes retirees find that they don't have enough "active" income to take the deduction.

Link: Publication 946 on Section 179 deduction and depreciation.

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BETTER BITTER BLOGGER BUDGET BOOK

December 14, 2006

Brilliant but bitter tax professor and blogger Daniel Shaviro has a new book out, "Taxes, Spending, and the U.S. Government's March Towards Bankruptcy." A must-have for tax policy geeks, especially those on the left.

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TAX COURT CALLS 'NO DO-OVERS' ON STOCK DEAL

December 14, 2006

If you ever do a $24 million transaction involving your family business, get your tax advice before closing the deal.

That's the lesson of yesterday's Tax Court decision in Becker v. Commissioner. Becker Holding Corporation (BHC), owned by the Becker family, was a significant player in the Florida citrus industry. Richard Becker and his son, William, had a falling out, and they negotiated a deal to buy out William's stock in BHC for $23,953,934. They closed the deal on April 1, 1991.

The Tax Court opinion shows where the trouble starts (emphasis mine):

In the fall of 1991, William Becker's accountant, Richard Lynch (Mr. Lynch), informed William Becker that BHC missed tax advantage opportunities by not allocating any portion of the consideration to the covenant not to compete. Mr. Lynch suggested that William Becker meet with Mr. Dempsey (BHC's chief financial officer) to discuss the possible allocation of a portion of the purchase price to the covenant not to compete in exchange for additional consideration or a shorter noncompete period. In February 1992, William Becker and Mr. Lynch met with BHC, Mr. Dempsey, and an accountant for BHC to discuss redrafting the purchase documents. However, the discussions terminated, and no agreement was reached.

No deal? No kidding. To allocate part of the deal to a covenant not to compete, William would have to agree to convert some of his capital gain to ordinary income - leading to a higher tax. "Oh, by they way, we just realized we screwed up the agreement for our tax purposes. Will you agree to change the deal and pay extra tax so we can get more deductions?"

The holding company then went ahead and made its own allocation to a non-compete and filed the return accordingly, while William ignored the unilateral allocation and treated it all as capital gain. As is its policy in such "whipsaw" cases, the IRS assessed deficiencies on both William and BHC and let them fight it out.

To make a long opinion short, the Tax Court said that the time to allocate part of the purchase price to a non-compete was before the deal closed. Without a clear indication that both parties agreed to a non-compete, the court wasn't willing to believe that one was implied (citations omitted):

The purchase documents explicitly and unambiguously allocate the entire $23.9 million of consideration to William Becker's stock. At the time the purchase documents were executed, there was no mutual intent to allocate a portion of the consideration to the covenant not to compete. Therefore, we conclude that 100 percent of the consideration paid by BHC to William Becker is allocable to the purchase of William Becker's stock, and none of the consideration is allocable to the covenant not to compete.

I don't know about you, but I think $23,953,934 is a lot of money. If you have that much involved, it's likely worth few hours of professional time up front to figure out the tax consequences.

Cite: Becker, T.C. Memo. 2006-264

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CARNIVALS OF THE SEASON

December 14, 2006

I'm delinquent in noting this week's carnivals. Kirk Walsh hosts this weeks Carnival of Personal Finance, and the Sama Blog has the Carnival of the Capitalists. Lots of good reading at each.

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OBLIVION CAN BE A DESTINY

December 13, 2006

"Economic development leaders" plan a July 2007 referendum on a 1-cent increase in our 6-cent local sales tax. They're calling the plan "Project Destiny." From yesterday's Des Moines Register:

Residents in Polk, Dallas and Warren counties are expected to vote next summer on a sales-tax increase that was pulled from the November ballot because of concerns about public distrust caused by the CIETC salary scandal.

Supporters say the 10-year tax increase is designed to generate $750 million, which would be used to lower property taxes in 45 cities and support Des Moines-area cultural attractions such as Urbandale's Living History Farms and Polk County's Wells Fargo Arena.

A midsummer vote when nothing else is on the ballot is a classic recipe to slip something through in a low-interest, low-turnout election. Even so, it seems unlikely to pass. Whether or not they like it, the pro-tax increase forces are saddled with two unofficial, but real, spokesmen:

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Sure, memories are short, but I think it's going to be a long time before people are ready to trust our local governments with a lot of new tax money.

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MUTUAL FUND INVESTORS: DON'T BUY A TAX LIABILITY

December 12, 2006

While putting money away in mutual funds for long-term savings is a good idea, this time of year you should look before you invest. The tax law requires mutual funds to distribute thier accumulated dividends from their portfolio, and their accumulated capital gains, annually. Many do so in December. If you're not careful, you could get a year's worth of tax liability on your 1099 for the privilege of owning fund shares for as little as one day.

Visit your favorite mutual fund's website and to find their tax dividend plans for December before you send them your money; you might be a lot happier next April if you wait a few days before making your next investment.

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STRANGE NEW DEDUCTION HIDDEN IN TAX BILL

December 12, 2006

Don't Mess with Taxes has the scoop on a one-year tax deduction for mortgage insurance tucked into the new "extender" tax bill. It is only available for taxpayers with incomes under $110,000, and only for mortgages obtained in 2007.

Presumably this will join the parade of "temporary" tax breaks that get extended forever.

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MEET NORMAN BATES, EX-IRS AGENT

December 12, 2006

nbirs.jpgTax Analysts this morning reports ($link) that the firing of Tommie Underwood, an IRS agent, has been upheld by the Federal Court of Appeals for the Federal (D.C.) Circuit. Given the difficulty of firing members of the Treasury Employees Union, that's news. The offense? From the brief opinion:

It is undisputed that Underwood's stepfather died in 2000, and that Underwood understated his tax liability by reporting him as a dependent on his 2001 tax return. The finding that he did so willfully is supported by substantial evidence, including the fact that he was employed as a Tax Examining Assistant and had familiarity with reading and interpreting tax regulations and guidelines.

I just wonder what the grounds for appeal were?

"'E's not dead, your honor. 'E's just sleeping!

"Father, I'd like you to meet the nice circuit court judges."

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IOWA LAW BLOGGER ON CUSP OF TENURE

December 12, 2006

Congratulations to longtime Iowa blogger Tung Yin, professor at the U of Iowa law school, for being approved for tenure and full professorship by the tenured faculty at Iowa. Dr. Mr. Yin is proprietor of the Yin Blog, a fixture in our permalinks.

Now that he has tenure, will Dr. Yin drop the mask of geniality? Does he forsake game-show blogging for devastating exposes of the incompetence of the Board of Regents and the iniquity of the Iowa basketball program?

Oh, that's not a mask? Anyway, great news.

UPDATE: Tung Yin informs me that he's not a "doctor," strictly speaking. Close enough for government work, I say.

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WE'RE HERE

December 11, 2006

The blog went down (but not the archives). It's fixed. Sorry about the downtime.

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WHAT GOT EXTENDED

December 11, 2006

The tax bill passed early Saturday is called the "extender" bill because it extends the life of a passel of perennially-expiring tax provisons. These provisions have been repeatedly enacted for a year or two at a time, some for about two decades now, in a cynical game to conceal their true size. By pretending that they won't be re-enacted every time they expire, Congress avoids counting their true cost over their 5-year and 10-year budgeting periods.

The provisions extended by the new bill, and their lives, are listed below (courtesy of RIA):

-Research credit—two years (in 2007, an additional Alternative Simplified Credit that does not use gross sales as a factor in the regular credit would be available).

-Work Opportunity Tax Credit/Welfare-to-Work Tax Credit—two year extension for both credits, but for 2007 the two credits would be combined and modifications would apply.

-Above the line deduction for tuition expenses—two years.

-New markets tax credit—one year.

-State and local sales tax deduction—two years.

-Earned Income Tax Credit (EITC) for combat pay—through 2007.

-Qualified Zone Academy Bonds—through 2007.

-Above-the-line deduction for teacher classroom expenses— two years.

-Indian employment tax credit— two years through 2007.

-Accelerated depreciation for business property on Indian reservation— two years through 2007.

As many of these provisions expired at the end of 2005, this means the interested lobbyists will barely be back from Cancun and Vail before it's time to get back to work on another extension.

Other Tax Update coverage of the extender bill:

PROTECTING ANOTHER VITAL AMERICAN INDUSTRY

CONGRESS THROWS BONE TO AMT-ISO VICTIMS

LAST GOP TAX BILL ADDS HSA IMPROVEMENTS

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LESS TO THE AMT-ISO BONE THAN MEETS THE EYE?

December 11, 2006

Kaye Thomas has an excellent discussion of the new tax break designed to help taxpayers who incurred big alternative minimum tax bills from the exercise of incentive stock options.

The article points out a feature that I had missed: under the bill, the 20% annual refundable minimum tax credit is computed on a declining amount. If you have a $1 million carryforward, your maximum credit is $200,000 the first year, $160,000 the second year (20% of the remaing $800,000), and so on.

My prior article on this break, now updated, is here.

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TAX BLOGGER ON TAXPAYER ADVOCACY PANEL

December 10, 2006

Kay Bell, proprietor of the Don't Mess With Taxes blog, is on the IRS Taxpayer Advocacy Panel. Cool.

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PROTECTING ANOTHER VITAL AMERICAN INDUSTRY

December 09, 2006

Another provision buried in the "extender" bill passed in the wee hours today:

SEC. 412. CAPITAL GAINS TREATMENT FOR CERTAIN SELF CREATED MUSICAL WORKS MADE PERMANENT.

This bill makes permanent the ability of songwriters to get capital gain treatment when they sell the rights to their songs to Paul McCartney or Michael Jackson. The rest of us, who pay ordinary income taxes for our work, pay tribute to their low-taxed artistic greatness.

Yes, our struggling pop composers in Nashville and L.A. now have a repreive from the... I don't know what. The yellow horde of low-paid Asian singer-songwriters? This is a tax AND trade bill, after all.

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CONGRESS THROWS BONE TO AMT-ISO VICTIMS

December 09, 2006

We've discussed the disastrous alternative minimum tax consequences that can arise from incentive stock options several times (for example, here and here). The ISO-AMT rules clobbered many employees of telecom and tech companies by leaving them with a big tax liability for the purchase of employer stock that ended up worthless.

The ISO-AMT victims have been pushing for legislative relief ever since. This morning Congress threw them a bone that will allow many taxpayers to recover over the next few years the AMT attributable to their old ISO exercises. Perversely, some taxpayers may have to quit their jobs to cash in.

AMT CREDITS

One of the cruel jokes of the ISO-AMT is that it creates a "minimum tax credit." This credit reduces regular tax - not AMT - in future years, but only by the amount the regular tax exceeds your AMT that year. This amount generally varies between little and nothing for the ISO-AMT victims.

The new law allows individuals with minimum tax credit carryforwards to use a portion of them regardless of whether they would otherwise be subject to AMT, during the six year period starting in 2007. The extra minimum credit allowed under this provision is "refundable," which means that the IRS will issue a check for it even if you have no tax paid in for the year through estimated payments or withholding.

The formula for this credit is confusing and perverse. It works like this, best I can tell:

1. Determine your "long-term unused minimum tax credit" ("LTUMTC"). This is your minimum tax credit carryforward that originated from AMT at least four years earlier. For 2007, that means minimum tax credits from AMT incurred in 2003 or earlier. Note that this applies to AMT credits arising for any reason - though I suspect that most folks with large AMT credit carryforwards are ISO victims.

2. Determine your "AMT refundable credit amount. This the greater of $5,000 (or your LTUMTC, if less than $5,000), or
20% of your LTUMTC.

3. Reduce this amount by a goofy phase-out formula: 2 percentage points for each $2,500 your income exceeds a threshold amount. This eliminates your AMT refundable credit over a $122,500 range. The phaseout ranges for 2007:


Complete
Taxpayer's status Threshold phaseout
in 2007 amount after
----------------------------------------------------
Married or surviving spouse $234,600 $357,100
Heads of households 195,500 318,000
Unmarried (not surviving spouse) 156,400 278,900
Married filing separately 117,300 178,550

So, if a taxpayer's income is low enough, they can recover their entire AMT liability from their tech stock debacle in 2000-2001 between 2007 and 2012. If they have a good tech job, though, they're still out of luck.

It's not hard to imagine cases where taxpayers will be better off quitting their jobs so they can qualify for the credit. If you have a $400,000 per-year tech job and a $5 million AMT credit carryforward, you would earn more if you quit your job; quitting would entitle you to a $1 million check annually the first year from IRS for your unused minimum credit carryforward.

I love the tax law.

Other coverage of the extender bill provisions:

LAST GOP TAX BILL ADDS HSA IMPROVEMENTS

UPDATE: The refundable credit is computed on a declining balance. In my example above, the maximum credit would be $1 million the first year (20% of $5 million), $800,000 the second year (20% of $4 million), $640,000 the third year (20% of $3.2 million) and so on. Thanks to Kaye A. Thomas, who has an excellent article up about this break.

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LAST GOP TAX BILL ADDS HSA IMPROVEMENTS

December 09, 2006

The "extender" bill that capped 12 years of GOP tax policy early this morning includes some important improvements in the taxation of health savings accounts.

HSAs are IRA-like savings accounts for taxpayers covered by high-deductible health insurance plans. If you meet the tax law requirements, you can make deductible contributions to the plans. Withdrawals are tax-free to the extent of your unreimbursed health costs; unused amounts accumulate tax-free for tax-free withdrawals against future expenses; they can also be withdrawn as taxable penalty-free payments at retirement.

ONE-TIME FLEX-PLAN ROLLOVER PROVISION

One strange provision allows taxpayers to roll health flexible spending account ("cafeteria plan") balances into HSAs. The rollover is available only one time, and its limited to the balance in your flex plan account as of September 21, 2006. It can be done through December 31, 2011. You have to meet several requirements:

- You have to qualify to have an HSA.
- The funds have to be rolled directly into the HSA; you can't take the funds in cash from the flex-plan and roll them into the HSA.
- The employer has to allow all employees who are covered by qualifying high-deductible plans to make the rollover.

CAP ON PLAN DEDUCTIBLE LIMITATION LIFTED

The tax law had limited HSA contributions to the lesser of an indexed annual limit or the maximum deductible under the qualifying high-deductible plan. The law repeals the second limitation starting in 2007. If you have the lowest qualifying family insurance plan deductible in 2007 - $2,200 - your maximum 2007 HSA contribution will be $5,650, instead of $2,200.

NO CONTRIBUTION REDUCTION FOR PLANS STARTED MID-YEAR

Up until now, employers who first became eligible for HSAs in mid year - say, because their employers switched to high-decuctible coverage in mid year - could only make a pro-rated HSA contribution. For example, if your employer's family coverage became HSA eligible with a $5,000 deduction on July 1, 2006, you could only contribute $2,500 to your HSA in 2006.

The new law allows you to make a full HSA contribution if you are HSA-eligible on the last day of the year. The catch: you have to stay HSA qualified for 12 months, or part of your HSA contribution gets recaptured in income with a 10% excise tax to boot.

DISCRIMINATION IN EMPLOYER CONTRIBUTIONS ALLOWED ON BEHALF OF NON-HIGHLY COMPENSATED

The HSA rules allow employers to contribute to employee HSAs. Until now the contributions had to be "compararable" for all employees. The new rules allow employers to discriminate against "highly-compensated" employees when making contributions to employee HSAs.

ONE-TIME IRA CONTRIBUTION RULE

The new rules allow taxpayers to make a one-time contribution to their HSA from an IRA, starting next year. The contribution is limited to the annual HSA contribution limit ($5,650 for 2007 for family coverage). This will be most attractive to employees who are new to HSAs; they will be able to fully fund the HSA tax-free on the first date of eligibility. As HSAs function as self-insurance reserves, this should make the transition to high-deductible plans less frightening to those used to first-dollar coverage or low co-pays.

The bill also makes some technical changes that make it easier for employees with flex plans to transition to HSAs.

Bottom line: it will be a little easier to move into HSAs, and a little less complicated to use them. That's a good thing, though small consolation for a bill full of provisions that will expire either next year or in 2011.

Links:

Text of Bill
Senate Explanation
House Explanation

Tax Prof Blog big media roundup

HSA Coalition coverage of new HSA provisions

Prior Tax Update coverage of extender bill politics


HSA basics: a Q&A

UPDATE II -- Full Tax Update new law coverage:

WHAT GOT EXTENDED

PROTECTING ANOTHER VITAL AMERICAN INDUSTRY

CONGRESS THROWS BONE TO AMT-ISO VICTIMS

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WELCOME HOME, WESLEY

December 08, 2006

Wesley Snipes returned from his overseas filming today to the embrace of the U.S. Marshals, the AP reports:

ORLANDO, Fla. - Wesley Snipes surrendered to authorities Friday on tax fraud charges, two months after he was indicted, according to a law enforcement official familiar with the investigation.

Snipes flew into an Orlando airport on a private jet and voluntarily surrendered, said the official, who confirmed the arrest on the condition of anonymity because it hadn’t been announced publicly. Snipes was to appear in federal court in Ocala on Friday morning, the official said.

If the federal sentencing guidelines are any indication, Mr. Snipes may have found a new home for the next 63 to 78 months, if he is found guilty.

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JUST WHAT I WANTED - ANOTHER BIG TAX BILL

December 08, 2006

The congresscritters cut a deal on the "extenders" package yesterday. This is an early Christmas present for those of us who charge by the hour for tax advice.

The package retroactively reenacts a number of tax breaks that expired at the end of 2005. The provisions reinstated for 2006 and 2007 include, among other things:

* an expanded and modified version of the research credit ($16.5 billion over 10 years);
* the deduction for state and local sales taxes ($5.5 billion);
* the above-the-line deduction for qualified higher education expenses ($3.3 billion);
* the above-the-line deduction for teachers' classroom expenses ($379 million);
* expensing for brownfields remediation costs ($349 million);
* tax incentives for investment in the District of Columbia ($392 million);
* tax incentives for Indian employment and business property depreciation on Indian reservations ($405 million);
* the 15-year straight-line cost recovery for qualified leasehold and restaurant improvements ($5.2 billion);

Of course, this is all dishonest. They have no intention of letting these expire after 2007, either. The "temporary" extension accomplishes two things, from the point of view of a congresscritter:

- They can pretend their favoritism to well-connected constituencies isn't eroding the tax base as much as it really is, and

- They can expect lobbyists for these tax breaks to show up at their fund-raisers as they try to get the provisions re-enacted next year.

Worse for the rest of us, the extenders are only part of it. The bill explanation alone is 130 pages. Now we get to open this lovely package and see what surprises are in it.

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DEPARTMENT OF ECONOMIC DEVELOPMENT REPORT PRAISES DEPARTMENT OF ECONOMIC DEVELOPMENT PROGRAMS

December 08, 2006

In advance of a report by the state auditor on econimic development incentives, the Iowa Department of Economic Development spun its own report yesterday saying how great their programs are. From today's Des Moines Register:

Companies that receive state incentives to expand have created or retained about 72 percent of the 15,173 jobs pledged, according to a report released Thursday.

The companies also say they've invested 96 percent of the $2.44 billion pledged for new offices, factories and equipment. The Iowa Department of Economic Development said 227 companies were required to report their progress.

The report shows the state's economic development efforts are working well, said Michael Blouin, IDED director. The report shows that the nearly 11,000 jobs created and retained pay an average hourly wage of $18.75 - or about $39,000 annually.

So by their own reckoning, that's less than half of the 25,000 they were claiming before the election, at a cost of about $7,400 per job. But that's only part of the story:

To create the jobs, the state has awarded those 227 companies $81.8 million in loans and grants, and paid out about $51 million of it. The amount does not include tax breaks provided to companies.

So the $7,400-per-employee bribe doesn't even include Iowa's 24 economic development tax credits? And what's worse, there's no way to show how many of these jobs would be created without the bribes. Surely some of them would. And most importantly, there's no estimate of how many jobs are lost because businesses avoid Iowa and its high taxes that are imposed to bribe other businesses.

Mike Blouin, Director of the Department of Economic Development, falls back on the favorite excuse of economic development professionals:


Blouin said the report won't change the minds of people "philosophically opposed to economic development incentives for job creation."

"In an ideal world, I wouldn't disagree with them. Our problem is that we're competing with everyone else in the world for the jobs," he said.

No, by taxing our existing businesses to lure and subsidize their competitors, we only compete with the other loser states. We quietly smother with high taxes the vast majority of businesses that don't get the incentives so that Mr. Blouin and other economic development professionals can call press conferences to highlight their successful bribes.

The states with real growth do it with low taxes, not with incentives and subsidies. We're not even in the game with them.

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CLOTHING SUBTRACTED, VALUE ADDED?

December 08, 2006

Not for computing the value-added tax in Norway. Don't mess with Taxes has the scoop on strippers at the Arctic Circle.

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GOING OVER THE AMT CLIFF

December 07, 2006

The Wall Street Journal, in a rare editoral page convergence with the Des Moines Register, ripped the alternative minimum tax yesterday. Their editorial ($link) included this chart of how AMT will increase sharply next year under current law:

amtbump.gif

Arnold Kling at Econlog sees the chart and ponders why so many taxpayers would suddenly face AMT.

The answer lies in the way Congress has been kicking the AMT problem down the road a year or two at a time since 2001. As Dr. Kling notes, the Bush tax cuts lowered the regular tax rates without lowering the AMT rates. As AMT applies when it is higher than regular tax, the arithmetic makes more folks AMT taxpayers.

Congress has fought the arithmetic with "temporary" increases in the AMT exemption. The 2006 exemption is set at $62,550 for joint filers and $42,500 for single taxpayers. Without further legislation, the exemption reverts in 2007 to its "permanent" level of $45,000 for joint filers and $33,750 for single filers. That will be enough to make millions of Americans pay AMT. Hence the jump in the chart above.

Why such obviously foolish tax policy? It's part of Congress' old game of making tax breaks "temporary" to disguise their true cost - the same game involved with the tax breaks in the "extenders" bill that is supposed to come out this week to preserve some other popular tax breaks, including the research credit. With AMT the numbers are so big for each year's temporary break that it is becoming hard for them to pull off.

The silver lining? They might be forced to look at actual tax reform; they might be forced into good policy because they have exhausted the alternatives.

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CONGRESS VOTES GOLD MEDAL FOR IOWAN BORLAUG

December 07, 2006

Congress yesterday voted to honor Iowa's Nobel Laureate Norman Borlaug with a gold medal. Considering his accomplishments, it's a modest award.

Des Moines hosts the World Food Prize organization, dedicated to carrying on Dr. Borlaug's work in fighting hunger. If you are so inclined, you can donate to the World Food Prize organization or to the Norman Borlaug Heritage Foundation, a non-profit "dedicated to promoting education programs and projects which reflect the lifetime achievements and philosophy of Dr. Norman Borlaug." The Norman Borlaug Heritage foundation is preserving Dr. Borlaug's childhood home near Cresco, which we visited last fall.

borlaugbarn.JPG

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DES MOINES FACES TAX INCREASE

December 07, 2006

A news item from today's Des Moines Register:

Des Moines' growing $347 million debt will likely force the City Council to enact a property tax increase next year, according to a report given to City Council members Wednesday.

Why such a problem?

While Des Moines leaders have kept the tax rate in check, they also faced mammoth challenges similar to many older cities to improve and rebuild roads and bridges, and to maintain services.

Yes, it is important to maintain vital city services. Especially municipal sports bars.

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YEAR-END PLANNING FOR S CORPORATIONS: BEWARE OF BASIS!

December 07, 2006

For most businesses, 2006 has been a good year. Yet even in the best of times, life in business can be hard, and somebody is going to lose money. When this happens, an S corporation's tax return can be the silver lining to the dark financial cloud. The tax law often allows S corporation owners to deduct their share of the company's losses on their tax return, allowing them to claim tax refunds for some much-needed cash.

The tax law has important limits on your ability to deduct losses from an S corporation. They apply in the following order:

1. You have to have basis in your S corporation stock, or in debt that you have personally loaned to the S corporation.

2. Your basis must be "at-risk"; and

3. You have to get past the "passive activity" rules.

BASIS AND THE "AT-RISK" RULES

The tax law allows S corporation owners to deduct losses only to the extent of their basis in S corporation stock. That basis normally starts at what you pay for the stock. Your share of corporation taxable income and your capital contributions increase your basis; it goes down for your share of corporation losses and your S corporation distributions.

If you loan money to the S corporation, you can count the loan as basis. While this can be a handy way to get your year-end losses, it is fraught with danger. The tax law requires such loans to have "substance" and to be "at-risk." The courts have been tough in the last few years in enforcing these standards.

For example, Donald Oren, the owner of the Dart trucking companies, had multiple S corporations. He borrowed money from one corporation and loaned it to another one with tax losses so he would have basis. That corporation sent the money right back to the first corporation in another loan. The courts said the loan had no substance and was not "at-risk," and losses of about $14 million disappeared from his tax returns.

GETTING GOOD BASIS

Here are some things you can do to make sure you have good basis for your losses:

- If you own multiple S corporations, you should consider holding them in a holding company structure. This structure, which wasn't available in the years when Mr. Oren had his losses, allows you to combine the basis of all of your S corporations while still preserving their separate legal identities.

- If you must get cash for your basis from a related entity, get it in the form of a distribution instead of a loan, and contribute it to the capital of the loss company. And for good measure, don't loan it right back to the first company.

- If you insist on loaning funds to the loss corporation to get your basis, get the loan from a bank or some other unrelated third party. Loans from relatives or business associates may not be "at-risk," as one central Iowa farmer learned the hard way. Borrow the funds personally and then loan them to the company. A guarantee of a third party loan to your S corporation does nothing to get you additional basis.

We will talk about dealing with the passive activity limits on S corporation issues in another post.

Related:

DOING THE BASIS HOKEY POKEY

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

S CORPORATION SHAREHOLDER WINS BASIS CASE IN TAX COURT

S CORPORATION OWNERS TEMPT FATE, WIN

RING AROUND THE ROSEY FAILS AN S CORPORATION SHAREHOLDER

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THE TAX UPDATE CUSTOMER SERVICE PLEDGE

December 07, 2006

The Tax Update gives you its solemn word that we will never post colonoscopy photos on this site. Because we care!

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A CAVALCADE OF RISK THAT WILL LIVE IN INFAMY...

December 06, 2006

Just in time for Pearl Harbor Day, the new Cavalcade of Risk is up. By reading the contributions by Arnold Kling, Hank Stern, and others, you can give yourself a quick seminar on the problems of today's health insurance market, and a quick primer on the solutions.

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IRA DONATIONS TO CHARITY - A TAX EFFICIENT WAY TO GO.

December 06, 2006

As you can tell by your stuffed mailbox, this is high season for charitable fund raising. Somewhere in your mailbox you are likely to find something telling you what a great deal it is to have your IRA give a bunch of money to charity. If you are charitably inclined, IRA gifts can be a great way to go, but not everybody qualifies.

HOW IT WORKS

If you are age 70 1/2 by December 31, 2006, you can have your IRA give up to $100,000 directly to charity without paying tax. This has a number of advantages over taking money out of the IRA yourself and then writing a check to the charity:

- It doesn't increase your "top line" income - your adjusted gross income, or AGI. Increasing your AGI has some unpleasant possible side effects, like increasing the taxable amount of your social security income and reducing your itemized deductions.

- Because the contribution goes directly to charity, it doesn't hit your return either as income or as a deduction. This keeps the contribution from bumping into the 50% of AGI limit that normally applies to charitable gifts.

Of course, this only makes sense if you plan on giving to charity in the first place, but if you do, this is a very tax-efficient way to go. But make arrangements now; you need to give your IRA trustee a little time to get the paperwork together.

This is an installment in our series on 2006 year-end tax planning. To see the whole series, click here.

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WHERE TO WATER THE HORSE IN DES MOINES

December 06, 2006

Back in the old days, Des Moines had municipal horse watering troughs around the city. One still operates, even in December:

troughonscott.jpg

It's on Scott Avenue on the southeast side. I think the closest any horses get to it any more is when they are in a truck on the way to the nearby rendering plant.

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CRP: THE TRADE OR BUSINESS OF NOT FARMING

December 05, 2006

jdcrp.JPGThe IRS took the unusual step today of publishing a "proposed" revenue ruling (Notice 2006-108) on the self-employment tax treatment of Conservation Reserve Program rental payments. The proposed ruling holds that CRP payments should be treated as self-employment income, even if you aren't otherwise a farmer.

The ruling leans heavily on the 6th Circuit's Weubker decision, which ruled that CRP income of a farmer was taxable self-employment income. From the proposed ruling:

The Sixth Circuit noted that the taxpayers were required under the CRP contract to perform tasks intrinsic to the farming trade or business (e.g., tilling, seeding, fertilizing, and weed control) that required the use of their farming equipment. Id. at 903. In addition, under the court’s view, the CRP payments were not payments of rent for the use or occupancy of property and therefore were not rentals from real estate excluded from SECA by section 1402(a)(1).

This is interesting for a couple of reasons. For Iowans, it reinforces the view of the Iowa Department of Revenue that CRP participants are "materially participating" in farming for purposes of the exclusion on gains on sale of land by those who have "materially participated" in farming for ten years. Will this also lead Iowa to treat people who have never actually farmed as "farmers" for this purpose? I doubt if Iowa has this in mind, but if the "gentleman farmer" does the actual (minimal) work required to maintain land as CRP land, maybe on weekends, it should constitute "material participation" under the rule that treats you as materially-participating in an activity if you do all of the work that an activity requires. As the Iowa rules follow the federal (summarized here), it seems like it should work, but I suspect the Iowa Department of Revenue won't like it.

If CRP participation isn't "rental," it also raises the possibility that CRP receipts can be "passive" income under the Section 469 passive activity rules. Land rent doesn't qualify as passive income; this rule prevents taxpayers from using rental land to enable them to take otherwise deferred passive losses. This rule may provide an end run around that restriction.

This is interesting. We'll be following this as commentary develops.

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11 'KEY FACTS' ON AMT

December 05, 2006

The Tax Policy Center has a nice little piece up on "The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections." Fact No. 4:

4. Two main factors behind the explosive growth in AMT: it is not indexed for inflation and the 2001-2006 tax cuts cut regular income tax without a permanent AMT fix. The AMT is not indexed for inflation and, therefore, it affects taxpayers with lower real incomes over time. The 2001-2006 tax cuts more than doubled the projected share of taxpayers who will face the AMT in 2010, from 16.0 percent to 33.6 percent. If the tax cuts had not been enacted and the AMT had been indexed for inflation along with the regular income tax in 1985, the number of AMT taxpayers would have remained between 300,000 and 400,000 through 2010.

This chart shows how the political pressure for an AMT fix might build:

1001046_table.gif


Why is it so hard to fix? Fact No. 9:

9. Repeal would be expensive and regressive. Repealing the AMT in 2007 would reduce revenues by $750 billion through 2016 if the 2001-2006 tax cuts expire as scheduled, and $1.3 trillion if they are extended. Almost 90 percent of the benefits of repeal would go to households with income above $100,000 in 2010.

Where do we look for reform? Raising other taxes or getting rid of the regular tax deduction for state and local taxes. Facts Nos. 10 and 11:

10. Simple reforms could spare most AMT taxpayers. Indexing the AMT for inflation and allowing personal credits against the AMT would reduce the number of AMT taxpayers in 2010 by over 85 percent.

11. Paying for reform is a key issue. Without revenue offsets, the reform above would reduce revenues by $520 billion over the next ten years (if the tax cuts sunset, $940 billion if they are extended). Rolling back the high-income rate cuts and the lower tax rates on dividends and capital gains enacted since 2001 would offset more than half of the revenue loss. If the tax cuts sunset, repealing the deduction for state and local taxes, as proposed by President Bush's tax reform panel, would more than offset the cost of reforming or repealing the AMT.

Of course, when the incidence of taxes is as skewed to the high end of the income scale as it is now, any provision that reduces any sort of tax is going to be "regressive." Good tax policy shouldn't die just because it fails to screw the top 20% of the income distribution a little bit more.

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WHY IT'S NO FUN TO GO TO MOVIES WITH PROBATE LAWYERS

December 05, 2006

Because right away they want to contest Lex Luthor's inheritance:

Last night I spent 2-1/2 hours (!) watching Superman Returns on DVD. I knew I was in trouble from the opening scene, in which Lex Luthor (played by Kevin Spacey) apparently inherits a bunch of property from a wealthy older woman by having her sign a new Will -- with Luthor as the only witness -- just seconds before her (suspicious) death. I suppose it's interesting that the older woman was played by Noel Neill (Lois Lane in the old TV series "Adventures of Superman"), but I really just felt like I was in Bizarro World -- would any court in Metropolis really uphold a Will executed under those circumstances?

I suppose if you can accept a flying man with an ex-girlfriend too dimwitted to know she's had his baby, and the idea that some bald guy with a stupid girlfriend can grow a green island in the middle of the Atlantic, you can get past the villian taking liberties with the Metropolis probate system.

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LAME DUCK CARNIVALS

December 05, 2006

While Congress meets in its lame duck sessions, the blog carnivals just roll on. So far this week we have these roundups of blog posts:

Don't Mess with Taxes hosts the Carnival of Taxes.

Money and Values hosts the Carnival of Personal Finance.

Good reading! The Cavalcade of Risk should be up tomorrow.

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BAR ASSOCIATION RIPS S CORPORATION BANK 'TEFRA' PROPOSED REGULATIONS

December 04, 2006

The TaxProf Blog today reports that the American Bar Association's Tax Section submitted comments cricizing the proposed regs that would disallow bank interest deductions under the 'TEFRA' rule. From the comments:

We believe that, if the Service seeks to attain the result provided by the Proposed Regulations, Congress would need to amend section 1363(b)(4).

Exactly so, and that's what we say in our own comments on the regulations.

Related: BANKING ORGANIZATIONS COME OUT AGAINST IRS 'TEFRA' REGULATION PROPOSAL

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I WANT TO BE A MAILBOX MAN

December 04, 2006

uspsbox.gifNews item from the Seattle Post-Intelligencer:

A Sumner man who earned $2.1 million from the U.S. Postal Service installing and maintaining mailboxes was sentenced last week in U.S. District Court in Tacoma to a year in jail for not paying taxes on that income.

Guy V. Flake had contracted with the Postal Service from 1998 through 2000.

That works out to $700,000 per year for "installing and maintaining mailboxes." That sounds like a better job than Ramona Cunningham had. The plea agreement says Mr. Flake was a "general contractor," so maybe he had employees installing mailboxes by the boatload. Still, it doesn't look like a bad gig. Too bad he boggled it by not paying his taxes.

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YEAR END PLANNING: GIVE IT UP!

December 04, 2006

To charity, that is. December sees a lot of charitable contributions. While strictly speaking charitable contributions aren't a good financial move - you give up a dollar to save maybe 42 cents in taxes - some ways of giving are more tax efficient.

Gifts of appreciated property are the most tax-efficient way to contribute to charity for most folks. If you give appreciated property, you can avoid paying tax on the appreciation, while still getting a tax deduction for the full appreciated value.

Like they say on the car ads, though, some restrictions apply. These include:

- Contributions of property valued at $5,000 or higher, except for publicly-traded securities, require a "qualified appraisl" and disclosure on Form 8283. No appraisal, no deduction.

- A new law requires donors of tangible personal property to "recapture" into income appreciation on the property if the charity sells it within three years of the date of gift. This rule applies to gifts after September 1, 2006.

- Strict new rules apply to facade easements and gifts of "taxidermy property."

In short, gifts of publicly-traded stock or mutual fund shares are the easiest.

If you are going to make such a gift, you ought to get on it. Sometimes charities, especially smaller ones, struggle with the paperwork on stock gifts. I've seen gifts fail to close before year-end because the charity didn't accept contributed stock in time. Starting now makes it easier for the charity to do its part.

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PROJECTING YOUR 2006 AMT

December 03, 2006

A reader asks:

Your Dec. 1 column advises different tax strategies depending on whether you're subject to the AMT. The only problem is that as of Dec. 1 the IRS has not posted a 2006 AMT form (6251). How can taxpayers decide whether they're subject to the AMT without the 2006 form?

Good question. There should be few changes to the AMT form. The biggest change is the increased exemption amounts legislated last May for 2006, and the change in the breakpoints for the 15% bracket for regular tax. To help those who want to estimate their 2006 AMT, I have dummied up a 2006 form by updating the 2005 form with the new exemption and 15% bracket figures. You can find them in the extended entry below; to see them in full size, click on them.

Remember - these are not official forms, so don't use them to prepare your 2006 returns.

Click here to see the article the correspondent refers to.

UPDATE: Doh! Kerry Kerstetter kindly points out the IRS Draft AMT form is up at the IRS website, here. Instructions are here.

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IT'S DECEMBER - ONE MONTH TO CORRECT THEM ALL

December 01, 2006

We plan to issue regular tips on year-end planning throughout December. We'll get started by reproducing our article from the December issue of 50 Plus Lifestyles, the Des Moines Register's special publication for the Beatles Generation. It's in the extended ("read more") entry below. It lays out the basics of the individual year-end tax planning process.

UPDATE: Go here for 2006 AMT exemption figures and a mock-up of a 2006 AMT form.

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IRS ISSUES GUIDANCE ON 2005, 2006 DEFERRED COMP W-2s

December 01, 2006

The IRS yesterday told taxpayers how to report deferred compensation on W-2s for 2005 and 2006. The guidance (Notice 2006-100) covers deferred compensation that is taxable to employees under the execrable Section 409A. Income taxable under this section, enacted in 2004, is subject to both regular income tax and a 20% penalty tax.

Last year the IRS didn't require employers to report amounts taxable under Section 409A on employee W-2s, but they warned that employers might someday be required to issue late W-2s with the 409A amounts included. This notice does so:

Employers and payers, including employers and payers who relied on Notice 2005-94 for calendar year 2005, which suspended employers' and payers' reporting requirements with respect to deferrals of compensation includible in gross income under § 409A, are required to file an original or a corrected information return and furnish an original or a corrected payee statement (Form W-2 or 1099- MISC) for calendar year 2005 reporting any previously unreported amounts includible in gross income under § 409A for calendar year 2005 as determined under guidance provided by this notice for calendar year 2006.

While Section 409A also has provisions requiring employers to include non-taxable deferrals under non-qualified plans as an information item on W-2 forms, Notice 2006-100 says this requirement will not apply for 2005 and 2006.

The Treasury is expected to finally issue permanent regulations under Section 409A around year-end. We can expect all of the awful provisions of this misbegotten code section to be in effect by the end of next year.

Links:

IRS press release on Notice 2006-100

Benefits Blog Section 409A links.

Prior Tax Update Coverage:

SECTION 409A DEFERRED COMPENSATION TRANSITION RELIEF EXTENDED THROUGH 2007

IRS DEFERS DEFERRED COMPENSATION W-2 REQUIREMENT

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NO END ZONE DANCE FOR CLASS ACTION LAWYER

December 01, 2006

rmbo.jpgLanny Vines has had his ups and downs. He made a fortune as a class action lawyer. He then lost a fortune - $25 million - when he tried his hand at day-trading.

Mr. Vines was able to deduct his day trading losses thanks to a Tax Court victory that is the tax equivalent to winning a football game in the last minute with an onside kick and a two-point conversion. He got the court to agree that the IRS abused its powers by not letting him file a late election to be treated as a trader.

Yesterday the Tax Court shot down his attempt to do the tax equivalent of an end-zone dance. The court ruled that Mr. Vines could not make the IRS pay his legal fees for his Tax Court case.

Still, Mr. Vines has let us know where he stands on an important issue. We expect him to be a good sport next time he loses one of his class-actions by offering to pay the other side's legal bills.

The TaxProf has more.

Link: Vines, T.C. Memo. 2006-258

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'THE CREDIT PHASE-OUT IS A BLATANT SOP TO COMPANIES (READ FORD AND GM) BRINGING UP THE REAR IN THIS TECHNOLOGY AREA.'

December 01, 2006

Don't Mess With Taxes weighs in on the Toyota request for more corporate welfare hybrid car tax credits.

She thinks Toyota should get more credits. I don't think any of them should get any.

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BILL BRADLEY DON'T GET AROUND MUCH ANYMORE

December 01, 2006

Not if he really believes this:

"There's nothing that people care more about than the tax code."

Of all people, former Senator Bradley should know better. Among many other things, basketball is a higher concern at the moment for more people than the tax code about now. Even Iowa basketball, even this year.

Via Dr. Maule.

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