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Tax Update Blog: August 2007 Archives

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BUSH PROPOSES HAIR O' THE DOG FOR HOUSING BUBBLE HANGOVER

August 31, 2007

20070831-4.jpgThe nation wakes up from its easy housing credit binge, and its head hurts. Now that the housing market is reeling from overindulgence in no-money-down loans and "creative" lending standards, it's time to return to more sober credit terms, right? Well, maybe not. Here is what the White House proposes in a "Fact Sheet" issued today:

1. The President Calls On Congress To Pass Federal Housing Administration (FHA) Modernization Legislation. The President's FHA modernization proposal would lower downpayment requirements, allow FHA to insure bigger loans, and give FHA more pricing flexibility. These reforms would empower FHA to reach more families that need help – first-time homebuyers, minorities, and those with low-to-moderate incomes – and offer more options to homeowners looking to refinance their existing mortgage.

But there's more!

2. The President Calls On Congress To Change A Key Housing Provision Of The Federal Tax Code So It Does Not Punish Families Who Are Forced To Sell Their Homes For Less Than Their Mortgage Is Worth. Current tax law counts cancelled mortgage debt on primary residences as taxable income. For example, if the value of a home declines and $20,000 of the homeowner's loan is forgiven, the tax code treats that $20,000 as taxable income. The President proposes temporary relief to ensure that cancelled mortgage debt on a primary residence is not counted as income.

That's just great. We already subsidize excessive home mortgage borrowing by allowing tax deductions for 100% of the purchase loan up to $1,000,000, split among two houses, plus an additional $100,000 of home equity. When you can't flip the house and then actually have to make payments, and you can't or won't, you get a better tax deal than those who binge on their credit cards.

The government encourages reckless borrowing through the tax code and insures it through the FHA. That's compassionate conservatism - compassion for reckless borrowers and lenders, paid for by the rest of us.

Too bad the President doesn't read Arnold Kling's blog.

Hat tip: The TaxProf.

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YOU CAN'T PHONE IN YOUR TAX FRAUD SENTENCE

August 31, 2007

Last week we wrote about an appeals court tossing out a home-confinement sentence for a Pennsylvania executive, with directions for the sentencing judge to add some prison time. Now a former Wal-Mart executive has likewise had a bad day before a federal appeals court:

The Eighth Circuit's U.S. Court of Appeals in St. Louis ruled Tuesday that Tom Coughlin, a former executive at Wal-Mart Stores Inc. of Bentonville, should be re-sentenced in the fraud case against him because the court's sentence was too lenient.

Coughlin was sentenced in August 2006 to 27 months of home detention, five years of probation and ordered to pay $461,000 in fines and restitution after pleading guilty to wire fraud and tax evasion.

A prison term of 27 to 33 months would be in line with federal guidelines.

The Moral: If you get caught at tax fraud, don't expect to stay at home.

Cite: USA v. Coughlin, CA-8, No 06-3294.

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ORGANIC VEDIC THUGGERY

August 31, 2007

20070831-2.jpgThere's a new Weekly Standard article up about the state of eminent domain in Iowa under the restrictions passed in 2006 on government property seizures. It makes the case that the reforms, passed over the Governor's opposition, still have loopholes.

This had escaped our notice:

Then there's the case of Maharishi Vedic City (population 420), a town founded in 2001 by followers of Maharishi Mahesh Yogi, the Transcendental Meditation guru. The city government named Sanskrit the official language, adopted the use of an alternative currency (the Raam Mudra), and banned the sale of any food not grown organically. Bob Palm owns a 149-acre farm on Vedic's border. When he and his brothers began toying with the idea of building a hog farm on their land, the Vedic city council made noises about seizing the farm and turning it into a public park because, as the city's attorney told the Associated Press, "It would be a very difficult situation for the city if a hog confinement is built on its boundaries." The city has drafted a proposal to buy the farm and "if that plan fails, they expect to use eminent domain to force the sale of Palm's land."

Sorry, buddy. The harmony of the Unified Field requires you to hit the road, and if you don't go along peacefully, armed men with the authority of the state will drag you away. Peace out.

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TAXING YOU TO LURE AND SUBSIDIZE YOUR COMPETITORS, IN SECRET

August 31, 2007

A retired Moline judge is unhappy with the shenanigans of the Davenport City Council in assembling in secret a package of economic development bribes to lure a company across the river from Rock Island. From Quad-Cities Online:

Davenport Mayor Ed Winborn, after an elaborate "internal investigation," reprimanded Ald. Keith Meyer for making available to the Dispatch/Argus the details of the proposed financial assistance package. But assuming that Ald. Meyer is guilty as charged, what exactly did he do wrong? And what exactly did the Dispatch/Argus do wrong in printing the preceding facts which I will take as true for purposes of this article?

Are the people of Davenport and Rock Island entitled to know that the IDED board will offer eServ 1 million in incentives to relocate on 53rd Avenue in Davenport? Are the people of Davenport and Rock Island entitled to know that City of Davenport will rebate 80% of the real estate taxes paid by eServ for the next 15 years?

It's too bad that the proper answer (yes) isn't obvious to everyone. Sadly, this sort of "incentive package" is common - witness the subsidies for insurer Aviva to move from downtown Des Moines to the suburbs.

Anyway, the Quad-Cities Online piece is good; read the whole thing.

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CAVALCADE OF LABOR DAY

August 31, 2007

The new Cavalcade of Risk is up at Health Affairs. On the second anniversary of Katrina, this collection of risk-management blog posts naturally has a number of disaster preparation posts. I'll merely add my own risk management tip: don't build below sea level in a hurricane-prone region, at least not with my tax money.

Among the non-Katrina posts, don't miss Hank Stern's grim take on helmet-less motorcyclists.

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THIS WILL BE A BUSY PLACE TODAY

August 31, 2007

This is the view of the Polk County Courthouse from Tax Update World Headquarters, taken this morning. A judge in this courthouse yesterday ruled that Iowa same-sex couples are entitled to get married, at least in Polk County.

20070831-1.jpg

I'm surprised there are no satellite uplink trucks there yet this morning.

Update: State 29 has more.

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CAN CORPORATIONS HIDE TAX ACCRUAL WORKPAPERS BEHIND THEIR LAWYER'S SKIRTS?

August 30, 2007

In a decision that has the potential to open a lucrative new sideline for law firms, a U.S. District Court in Rhode Island yesterday denied the IRS access to tax accrual workpapers under the "work product privilege."

Tax accrual workpapers document the computations and conclusions that corporations use in reporting their taxes on their financial statements. Such workpapers have been considered fair game for the IRS since the 1984 Supreme Court Arthur Young decision. As the workpapers have to document risky tax positions, the IRS likes to see them. Yesterday's district court decision allowed Textron to hide their workpapers from the IRS via the expedient of running them by their lawyers. From the decision:

Each year, Textron's tax accrual workpapers are prepared shortly after the corporation's tax return is filed. The first step in preparing the workpapers is that Textron's accountants circulate to Textron's attorneys a copy of the previous year's tax accrual workpapers together with recommendations regarding their proposed changes and/or additions for the current year. Textron's attorneys, then, review those materials, propose further changes to the spreadsheets and hazard litigation percentages which are returned to the accountants who compile the information and perform the mathematical calculations necessary to compute the tax reserve amounts. The attorneys and accountants, then, meet to give their approval so that the accountants may finalize the workpapers. (emphasis added)

The court said that the lawyers made all the difference:

The IRS's reliance on Arthur Young is misplaced because, although Arthur Young deemed tax accrual workpapers pinpointing the "soft spots" on a corporation's tax return relevant to examination of the corporation's return, it did not hold the attorney-client privilege inapplicable to legal conclusions of counsel contained in the workpapers.

It seems like a stretch to say that accounting workpapers become legal papers just by running them by a lawyer, so I think the chances are good the IRS will get a reversal on appeal. If the decision holds up, though, lawyers will now get a cut of that annual public company audit fee.

Cite: Textron Inc. and Subsidiaries, D.C. - R.I., No. 1:06-cv-00198

UPDATE: More from the TaxProf.

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NICE WEB SITE DESIGN

August 30, 2007

Tax Protest figure Bob Schulz has posted on the "We The People" website a court order enjoining his organization from selling "kits" purporting to free people from the federal tax system. The New York Times has a report today.

Mr. Schulz briefly made news in Iowa earlier this month when his organization challenged the use of electronic voting machines at the Ames straw poll. He lost that case too.

Here is the new look for the We The People website, GiveMeLiberty.org:

Picture 3.png

Link: WE THE ENJOINED

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GM, HONDA HYBRID CREDIT UPDATE

August 30, 2007

The IRS yesterday announced that GM and Honda Hybrids still qualify for the full hybrid car tax credit.

In IR-2007-150, the IRS says GM vehicles qualify for the credit as follows:

* Chevrolet Silverado Hybrid 2WD, Model Years 2006 and 2007: $250
* Chevrolet Silverado Hybrid 4WD, Model Years 2006 and 2007: $650
* GMC Sierra Hybrid 2WD, Model Years 2006 and 2007: $250
* GMC Sierra Hybrid 4WD, Model Years 2006 and 2007: $650
* Saturn Vue Green Line, Model Year 2007: $650
* Saturn Aura Hybrid, Model Year 2007 $1,300

20070830-1.jpg


The Honda credits were announced in IR-2007-151:

* Honda Accord Hybrid Model Year 2005: $650
* Honda Accord Hybrid, Model Year 2007: $1,300
* Honda Accord Hybrid Navi Model Year 2007: $1,300
* Honda Civic Hybrid Model Year 2007: $2,100

20070830-2.jpg

You can get detailed information on the credit here. Remember, this credit doesn't work for alternative minimum tax.

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TRADING PLACES, COUPLE STYLE

August 29, 2007

20070829.gifMelissa Quinn opened an E-trade account in 1999. Like many folks who got caught up in the day-trading frenzy, her account lost money.

Ms. Quinn was married to Lee Arberg. Mr. Quinn elected on his 1998 return to be treated as a "trader" marking his positions to market under Code Sec. 475(f) (a tactic we discussed here). This permitted him to treat his securities losses as ordinary, so that losses weren't subject to the usual $3,000 capital loss limit in 1998 and afterwards.

Unfortunately, it also appears he traded on his wife's account. Their 2000 return claimed a $380,595 mark-to-market loss on her account. The Tax Court ruled that the trades in Ms. Quinn's account couldn't be attributed to her husband, and therefore weren't covered by Mr. Arberg's mark-to-market election. This meant her losses were limited to $3,000, rather than $380,595.

The case provides a very nice summary of the different rules that can cover individual stock trades that is worth reproducing here (citations omitted, emphasis added):

For Federal tax purposes, transactions in securities are conducted in one of three capacities; i.e., as a dealer, a trader, or an investor, and the tax treatment of a given transaction turns upon which of these characterizations applies. Dealers are those who are engaged in the business of buying and selling securities and whose business involves sales to customers. As a result, a dealer's sales of securities are the equivalent of sales of inventory and produce ordinary gains and losses.Attendant business expenses are deductible under section 162(a) and interest is not subject to the restrictions under section 163(d) on the deduction of "investment interest".

Traders, like dealers, are engaged in the trade or business of selling securities, but they do so for their own account. Hence, their securities are not excluded from the definition of a capital asset due to the absence of customers, and sales thereof produce capital gains and losses under generally applicable principles. Because of the trade or business context, however, expenses are deductible under section 162(a) and the interest limitations of section 163(d) do not apply.

Investors likewise buy and sell for their own account, but they are not considered to be in the trade or business of selling securities. Expenses are deductible only under section 212 as itemized deductions, and deduction of interest is restricted by section 163(d). Their transactions, too, are capital in nature.

Nonetheless, a distinction, relevant here, exists between a trader and an investor with respect to capital treatment. Only a trader, and not an investor, is entitled to make a mark-to-market election pursuant to section 475(f), with the consequence that gains and losses are treated as ordinary in character under section 475(d)(3)(A)(i) and (f)(1)(D).


The Moral? If you want ordinary loss treatment, you need to make a timely Sec. 475(f) election, and you need to make the trades in your own account, not your spouse's.

Cite:Arberg and Quinn, T.C. Memo 2007-244

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IRS CAN'T USE ITS OWN TYPO AGAINST TAXPAYER

August 29, 2007

This took some nerve.

The IRS sent a notice of deficiency -- the proverbial "ticket to Tax Court" -- to to the partners of Petaluma FX Partners, LLC for an August 2000 taxable year-end. The tax notice partner filed a Tax Court petition based on the August year in the notice. Then the IRS told the Tax Court that the petition should be thrown out because it should have used a December tax year, rather than the August year in the IRS's own notice.

The Tax Court didn't go along:

In the case before us, respondent [IRS] made adjustments to partnership items for the correct taxable year of Petaluma, the calendar year ending December 31, 2000, yet notified the partners that those adjustments were for the taxable year ending August 31, 2000. The partners, however, could not have reasonably been misled by the error as Petaluma had no existence until the end of August 2000 and did not begin any business activities until October 10, 2000. There were no adjustments that respondent could have made to Petaluma with respect to a taxable year ending August 31, 2000.

The taxpayer lives to litigate another day.

Cite: Petaluma FX Partners LLC, T.C. Memo. 2007-254

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SOCIAL MEDIA: NOT JUST FOR TEENAGERS?

August 29, 2007

Mike Sansone has some thoughts on the business potential for "social media websites like Facebook and MySpace:

Are you among the thought-followers thinking that Social Media and Social Networking is a fad? Fad or not, there are some thing you may not know:

* There are over 500 groups specific to Des Moines at Facebook? Several are either for or against local businesses. Is this a tool you can use to build a community of customers?

If you still doubt the power of Facebook - how do you think Anthony Bowman, Dominique Douglas and Arvell Nelson became famous?

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SURVEY PHISHING

August 29, 2007

We've said it before, but it bears repeating:

THE IRS WON'T CONTACT YOU VIA E-MAIL.

A new phishing scam disguised as an IRS e-mail promises to credit $80 to a taxpayer on completion of a "survey," which includes important tax-related questions like "what is your credit card number?" Don't be fooled.

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

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THE 'FAIR TAX' AND THE 'REAL' RATE

August 28, 2007

Advocates of the "Fair Tax" national retail sales tax plan say they can eliminate all federal income and payroll taxes with a "23%" national retail sales tax. Even a cursory look at the plan shows that it really has a 30% rate, as we typically understand sales tax rates. Neal Boortz and other Fair Tax fans insist that it really is a 23% rate, properly understood.

20070828.gifPart of the reason Mr. Boortz & Co. are so insistent that it really is a 23% rate is marketing. Just as "Fair Tax" sounds better than "Big Honking National Retail Sales Tax," 23% sounds better than 30%.

Yet Mr. Boortz is also trying to draw a comparison between income tax rates and sales tax rates. Income tax rates are computed on a base out of which the tax is drawn, while sales taxes are computed on a base to which the tax is added. For example, a 33.33% income tax takes $33.33 out of $100 of income, where a 10% sales tax is added to a $100 sale, making for a total cost of $110. The income tax is about 50% of the $66.67 that the income tax-payer has left after taxes, while the tax remitted by the retailer is 10% of what he charged.

Mr. Boortz says that if the income tax rate above is measured based on pre-tax income, out of which the tax is paid, a sales tax rate should be measured based on the whole transaction, including the tax itself.

While this has a superficial logic, it fails at the computational level. The reason that income taxes are conventionally measured "tax inclusive" and sales taxes are measured "tax exclusive" is because in each case the conventional method is the shortest way home.

COMPUTING THE FAIR TAX

A "tax inclusive" sales tax requires the following computations:

Where X is the gross sales price including taxes,
T is the tax, and
P is the pre-tax price,

the tax computation is as follows:

T=.23X
and X-T=P

Then X-.23X = P
and .77X = P
and X=1.298701P.

This computation would have created hopeless supermarket checkout lines in the era of mechanical cash registers, so sales taxes have always been computed by skipping the intermediate steps. In this case, you would just add 29.89701% to the sales price. In real life, a legislature would round it to 30%, because decimals are hard.

Computing income taxes on a "tax exclusive" basis would similarly require an extra computation that is mathematically equivalent to a single-step computation at a different rate; not surprisingly, the single-step rate is what has traditionally been used.

So while Mr. Boortz thinks we're just being thick when we say the "real" rate under the Fair Tax is 30%, the 30% rate is just a shorter way of saying "T=.23X and P=X-T".

Related:

Tax Update coverage of the FAIR TAX KERFUFFLE

Reason Magazine blog: Bruce Bartlett Isn't Fair

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FAIR TAX KERFUFFLE

August 27, 2007

20070827-2.gifFormer Treasury official Bruce Bartlett outlined his case against the "FairTax" national sales tax plan in the Wall Street Journal this weekend (free link). He hammers on the fundamental bait-and-switch of the FairTax:


In reality, the FairTax rate is not 23%. [FairTAx supporters] Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. (This is known as the tax-inclusive rate.) Calculating it the conventional way that every other sales tax is calculated, with the tax on top of the price, yields a rate of 30%. (This is called the tax-exclusive rate.)

The distinction is confusing, but think of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

He also makes a surprising assertion of the origins of the FairTax:


It was originally devised by the Church of Scientology in the early 1990s as a way to get rid of the Internal Revenue Service, with which the church was then at war (at the time the IRS refused to recognize it as a legitimate religion). The Scientologists' idea was that since almost all states have sales taxes, replacing federal taxes with the same sort of tax would allow them to collect the federal government's revenue and thereby get rid of their hated enemy, the IRS.

Neal Boortz, talk show host and author of "The FairTax Book," is unhappy with the Scientology assertion:


What Bartlett did was very simple, and astonishingly careless. He mistook a group called Citizens for an Alternative Tax System (CATS) for the people who developed the FairTax.

Now CATS did have a plan for a national retail sales tax, but it was in no way connected with Americans for Fair Taxation (AFFT) and the FairTax. I was familiar with the CATS program. I had them on my radio repeatedly. As I've told you, I've been interested in this idea of replacing the income tax with the sales tax for some time.

The CATS idea was simply to do away with income taxes and replace them with a 17% sales tax. Payroll taxes would stay with you, as would many other federal tax levies. As you can see, this is substantially different from the program offered by the FairTax.

Mr. Boortz also says the rate is really 23%, basically because... he says so, in large highlighted print:


The 23 percent FairTax is not added to the price of everything you buy ... it is already included in the price of everything you will buy, just as the embedded taxes are included today. You remove one, you add the other.

That's just marketing. If an item costs $1 without a sales tax, and $1.30 with the tax, most people would call that a 30% tax. That's how sales taxes are conventionally measured.

Whether you call it 23% or 30%, the FairTax is far higher than any sales tax ever successfully imposed. As most states would be forced to give up their income taxes if the federal tax goes away, the effective combined federal and state rate would probably exceed 40%, even under the FairTaxers projections (Bartlett and others say the rate would have to be even higher). It just wouldn't work; the high rate would trigger massive evasion and loophole carving.

The Tax Guru and the TaxProf have more.

I detail my objections to the FairTax here.

UPDATE: More at Captain's Quarters.

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S CORPORATION TRUST NOL TRAP

August 27, 2007

A newly-released IRS legal memorandum (ILM 200734019) points out a potential trap for testamentary trusts that become electing small business trusts (ESBTs). The memorandum says that any net operating losses incurred by the trust from S corporation passthrough losses before the ESBT election takes effect do not carry over to the ESBT.

The tax law allows any trust that acquires S corporation stock at death to hold the stock for two years without terminating the S corporation status. Many such trusts find that an ESBT election is the only way to retain S corporation status. An ESBT is taxed like it is two trusts; it pays tax on its S corporation income at the highest individual tax rate under a special tax regime; it reports its other income on a conventional trust tax return.

Trusts often go for a period of months before they make their ESBT election. If the S corporation has a loss for this period, the resulting pre-ESBT NOL can only offset non-S corporation income after the ESBT election takes effect.

The Moral? Trusts that acquire S corporation stock need to evaluate whether to make an ESBT election immediately. They can retroactively elect ESBT status within 2 1/2 months of when they acquire the stock; otherwise they must wait until the start of the next tax year.

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TROUBLE IN THE BROWN COMPOUND

August 27, 2007

Are Ed Brown's people skills on par with his tax comprehension? That may be the case, according to an Associated Press report of disharmony in the convicted tax evader's fortified compound:


Some supporters of Ed and Elaine Brown, who were convicted of tax evasion and have refused to turn themselves in, are now keeping their distance.

In the more than six months since the Browns, holed up in their home, were convicted, they have hosted an ever-changing cast of backers.

Some relationships have ended bitterly: The Browns have squabbled with bloggers, radio hosts, and several spokesmen and assistants.

Mr. Brown appears to have rather stiff standards for his supporters. Anything short of an armed confrontation with the IRS is insufficient evidence of anti-tax ardor:


Doug Kenline, a blogger who set up a website dedicated to news about the Browns and who interviewed them for audio webcasts, was rejected by Ed Brown, who had learned that Kenline's wages were being taken by the IRS to cover unpaid back taxes, the Concord Monitor reported.

"I'm not talking anymore to people who aren't going to stand up for the lawful laws of this land," Brown said in an Internet recording of the conversation in which the two parted ways. "People can be slaves, and I'm not going to associate with them anymore."

That's harsh. The IRS has levied on Mr. Kenline's wages. What is he supposed to do - quit his job? Attack his employer? This bitter-end standard of tax resistance must pose a marital dilemma for Mr. Brown; the feds have seized his wife's dental office as part of their tax case. Is Mrs. Brown the next to go?

Prior Tax Update Coverage:

BACK AT THE NEW HAMPSHIRE STANDOFF

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PAYBACKS ARE HECK

August 27, 2007

20070827-1.gifLast year we told the story of Gene Haas, a prominent California businessman and Nextel Cup Team Owner. Mr. Haas was indicted for tax evasion, allegedly triggered when by his desire to get even with the government after he lost a patent lawsuit.

Now he has much more to avenge. The New York Times reports that he has reached a plea deal that will cost him two years in prison and $70 million in penalties and interest for cheating the government out of $34.3 million in taxes.

It could have been worse. If convicted for the $20 million tax evasion charged in the original indictment, Mr. Haas would have faced 6 1/2 to 8 years in prison under federal sentencing guidelines.

Taxable Talk and the TaxProf have details.

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TAX TROUBLE IN MEDIAPOLIS

August 24, 2007

A southeast Iowa restauranteur may be wishing he had been more careful with his taxes. From the Burlington HawkEye:

20070824.PNG

Arraignment for a Sperry man accused of tax evasion will have to wait until next month after a judge granted a continuance last week based on the request of attorneys who stated that they have negotiated a plea and would want to present oral arguments in open court.

Craig Lynn Murguia, 58, 19587 115th Ave., president of Country Horizons Inc., a corporation that operates two Mediapolis restaurants -- Apron Strings and Tumbleweed which was later known as Iowa Buffalo Company -- is charged with one count of tax evasion. The charge stems from him allegedly collecting withholding taxes from his employees but failing to file government tax returns or deposit the taxes he took out of his employees' paychecks.

It looks like he may have been skipping out on taxes across the board:

Murguia was arrested May 24 after a recent audit, completed by an agent of the Iowa Department of Revenue, found that from Jan. 1, 2002 to June 30, 2003, the former underpaid his sales tax, local-option sales tax and school local-option tax which amounted to a combined total of $14,454.

The report also says Mr. Murguia may be way behind on income tax filings, as far back as 1990. If convicted, Mr. Murguia faces both likely financial ruin and a prison sentence.

The Moral: Just because you haven't been caught yet doesn't mean you won't be. The longer the evasion goes on, the more likely you are to get in trouble.

Related: First, Stop Digging

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BUT I FOUND IT ON THE INTERNET - SO IT'S MINE!

August 24, 2007

Need a contract, but you don't want to pay a lawyer to draft one? Some folks use the Google Law Firm to find what they need. Over at IowaBiz.com today Brett Trout explains why this isn't such a hot idea:

I have seen companies steal terms of use agreements and privacy policies from websites that have nothing to do with their line of business. Not even taking the time to read the contracts, they unwittingly leave in the original company's name, address and preferred jurisdiction. An Iowa company looks pretty awkward explaining to a court why their contract dispute should be tried in Albuquerque.

Albuquerque, Algona - same thing, right?

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VARIABLE ANNUITIES - WHO BENEFITS?

August 24, 2007

From the Financeispersonal.com blog on variable annuities:

Are there any advantages? It turns out there are a few. The biggest advantage is that you can invest money tax deferred with out yearly limits much in the way you can with 401k or IRAs. In all cases it makes sense to shelter your money with a 401k first or an IRA before you consider an annuity, because you can invest in mutual funds just like you can with your annuity, but you can avoid all of the fees. The second advantage is that you are guaranteed to not lose any money, regardless of what happens to the stock market. This might be something which attracts those who have a very low risk tolerance.

Variable annuities also have numerous disadvantages. They generate very high commissions for the broker, so they are often pushed on people who really should not have them. They also have much higher fee structures than other investments, such as mutual funds. Usually these fees can be upwards of 2% or 4% of your annual return. On top of that, there are generally huge surrender fees in annuities which average to be about 7%.

Read the whole thing.

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WHAT THIS SENTENCE NEEDS IS A FEW MORE LINKS

August 23, 2007

You have to like this sentence from the Tax Policy Blog:

For more on why the mortgage interest deduction is bad tax policy, check out our previous blog posts herehere, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, and here.

Sometime they'll have to tell us how they really feel.

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APPEALS COURT SAYS TAX CHEAT CAN'T SERVE TIME IN HIS MANSION

August 23, 2007

The outcome would have been much better than you typically see in a tax evasion scheme. A Pennsylvania contractor pleaded guilty to committing tax fraud by having his construction company build a mansion. The company, an S corporation, deducted the costs, and the contractor failed to pay report the value of his new mansion as income on his tax return.

The trial judge sentenced him to a year of house arrest in the very same mansion.

The government wasn't amused, so it asked the Federal Court of Appeals for the Third Circuit to impose a harsher sentence. The court decided the government had a point:

We share with the Government concern about the message a sentence of probation for the indisputably serious offense of willful tax evasion sends to the public at large and would-be violators. Tomko’s sentence of probation included home confinement in the very mansion built through the fraudulent tax evasion scheme at issue in this case – an 8,000- square-foot house on approximately eight acres, with a home theater, an outdoor pool and sauna, a full bar, $1,843,500 in household furnishings, and $81,000 in fine art. The perverse irony of this gilded cage confinement was not lost on the Government, it is not lost on us, and it would not be lost on any reasonable public observer of these proceedings, including those would-be offenders who may be contemplating the risks associated with willful tax evasion.

The appeals court ordered a resentencing more in line with federal sentencing guidelines. This is likely to be a 12 to 18-month sentence, to be served in a more spartan setting.

Cite: William Tomko, CA-3, NO. 05-4997

UPDATE: The TaxProf has a roundup, with links; The TaxGrrrl weighs in.

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LORD, DO UNTO THOSE GUYS, GOOD AND HARD

August 23, 2007

20070823-1.jpgIf this works, the IRS is really going to have staffing troubles. A preacher is urging his flock to "imprecatory prayer" against those who want the IRS to revoke his church's tax exemption. The pastor had urged his congregants to support Mike Huckabee's presidential campaign.

That naturally leads to the question: what is he talking about? The TaxProf says the preacher, Wiley S. Drake, is "calling on his followers to pray for the deaths" of two leaders of Americans United for Separation of Church and State, the outfit leading the effort to yank the church's tax exemption.

It's not so clear to me that he wants the offenders smote. It seems likely that any of the conventional biblical plagues will do. As Eugene Volokh notes, Mr. Drake's call for imprecatory prayer invokes Psalm 109, which includes this passage:

Let his days be few;
and let another take his office.
Let his children be fatherless,
and his wife a widow.
Let his children be continually vagabonds, and beg:
let them seek their bread also out of their desolate places.
Let the extortioner catch all that he hath;
and let the strangers spoil his labor.
Let there be none to extend mercy unto him:
neither let there be any to favor his fatherless children.
Let his posterity be cut off;
and in the generation following let their name be blotted out.

Pretty stern stuff. Yet the same Psalm also says:

Let mine adversaries be clothed with shame;
and let them cover themselves with their own confusion, as with a mantle.

So perhaps a range of curses is available. Another explanation also seems to permit a range of divine retribution options:

Imprecatory prayer is a last resort appeal to God for justice. The so called 'curses' are simply the just penalty called for in the scriptures for the alleged crime. Imprecatory prayer is an appeal to the court of divine justice (1) for protection and (2) the appropriate punishment for the criminals.

Imprecatory prayer is most often used when the criminals are the rich and powerful or corrupt men in government. The prayer asks God to solve the problem and bring the criminal to repentance, or to judgment.

I'm not sure I understand all this, but it does seem like it can be an appeal for whatever divine punishment is approprate, from the whole array of divine punishments available. Maybe it's a single cricket that just won't shut up when you are trying to sleep, in the case of a minor offense, or a whole plague of locusts for a more serious violation of divine justice. If it catches on among people who feel wronged by IRS, and if it works, the Orkin Man might have to move in at IRS headquarters.

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HOW HAROLD HILL CLAIMS HIS IOWA FILM CREDITS

August 22, 2007

hh44.jpgThe Iowa Department of Revenue has proposed rules for the film industry tax breaks enacted this spring. There are two main sets of breaks -- an exclusion from income for taxpayers who provide goods and services for filmmakers, and a tax credit for 25% of the filmmakers costs. The credit can be sold, so the credit functions as a cash subsidy for filmmakers.

The credit will be claimed by submitting a new Iowa "Form Z" listing the film expenses to the Iowa Film Office. The production company can then sell the 25% credit at a discount to cover its own costs.

No other industry gets such a double-barreled break. So next time you write a check to Iowa to pay taxes so Tom Arnold doesn't have to, remember: out-of-state filmmakers are more important to the Legislature and the Governor than you are.

The proposed rules are here; scroll about halfway down or search "film" on your browser.

Link: Complete Tax Update Film Credit Coverage.

Tags: .

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UNNECESSARY? NOT WHEN IT'S YOUR MONEY

August 22, 2007

tigtaseal.jpgThe Treasury Inspector General for Tax Administration reports that there are 8 million "unnecessary" returns filed annually. I don't think unnecessary means what TIGTA thinks it means:

Fifteen percent of the unnecessary tax returns filed did not generate a refund, while 85 percent of these returns were filed to obtain a full refund of withheld taxes.

That sounds "necessary" to me - at least if you want your money back.

The report does make a good point, though -- many young people have too much withheld:

More than one-half of those filing to obtain a refund were under age 21, and 76 percent of those under age 21 indicated they could be claimed as dependents on other taxpayers' returns. These taxpayers would have been exempt from tax withholding because they earned less income than the amount required to file a return and they could be claimed as dependents on other taxpayers' return.

The Moral? If you had all of your tax refunded last year, and you expect to have the same thing happen this year (for example, you know you won't make more this year), you can file a W-4 saying you are exempt from withholding. You have more take-home pay now, and you don't have to file a return next year. You can earn up to $5,350 ($5,150 in 2006) in wages before you have to worry about paying taxes, as long as your "unearned income," like interest and dividends, is under $850.

Learn more from IRS Publication 929, Tax Rules for Children and Dependents.

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BACK TO SCHOOL CARNIVALS

August 22, 2007

The new Carnival of the Capitalists is up at Revenue River. The Carnival of Personal Finance is running at The Simple Dollar, where you can find the Insureblog's take on Costco's small-business health insurance plans.

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SEPTEMBER 2007 APPLICABLE FEDERAL RATES (AFR) RELEASED

August 21, 2007

The IRS has issued (Rev. Rul. 2007-57) the minimum interest rates for loans made in September 2007:

-Short Term (demand loans and loans with terms of up to 3 years): 4.82%
-Mid-Term (loans from 3-9 years): 4.79%
-Long-Term (over 9 years): 5.09%

Historical AFRs are available at the "links" page at www.rothcpa.com. You can also click here for the rates for prior months as reported in the Tax Update.

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INDEPENDENT CONTRACTOR OR EMPLOYEE?

August 21, 2007

Rush Nigut poses the eternal question today at IowaBiz.com.

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TRUSTS AND PASSIVE LOSSES

August 21, 2007

RMceowen.jpgRoger McEowen has a new article up at the home page for the Iowa State University's Center for Agricultural Law and Taxation. The piece takes the IRS to task for stubbornly clinging to a losing position on trust tax:

IRS argued that a trust’s material participation in a trade or business, under the passive loss rules, should be determined by evaluating only the trustee’s activities. As such, the IRS position was that the trustee’s activities were not enough to meet the material participation requirements under the statute. The trust maintained that it was the taxpayer, not the trustee, and that material participation should be determined by assessing the trust’s activities through its fiduciaries, employees and agents. The trust also maintained that, as a legal entity, it could participate only through the actions of those individuals. Their collective efforts on the ranching operations during 1994 and 1995, the trust argued, were regular, continuous and substantial.

The court agreed with the trust, and noted that the IRS argument that the trust’s participation in the ranch operations should be measured by referring to the trustee’s activities had no support within the plain meaning of the statute. The court ruled that the IRS position was arbitrary and capricious and, since IRS provided no caselaw or regulations to support its position, the IRS should not create controversy where there was none.

Despite being spanked in court, the IRS clings to the defeated position in a recent technical advice memorandum.

Mr. McEowan concludes:

When a government agency is told that its litigating position has “no support within the plain meaning of the statute” and “subverts common sense,” the agency has a responsibility either to appeal the court’s decision or develop reasonable regulations rather than continue maintaining its judicially-rejected position.

Makes sense to me.

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LET'S BUILD A MONEY PIT!

August 21, 2007

A consultant has told Polk County officials that a new hotel next to the Wells-Fargo Center will sprinkle pixie dust across downtown Des Moines, magically triggering economic growth and happy times. From the Des Moines Register:

A proposed hotel near the Iowa Events Center would generate nearly $39 million annually in direct spending and pump a total of $65.8 million a year into the Des Moines-area economy, according to a consultant’s report scheduled to be unveiled to city and Polk County leaders this afternoon.

The numbers, based on projections of what hotel guests would spend both inside and outside of the proposed 425-room hotel, include an estimated $43 million of economic impact from visitors, vacationers and business travelers who live outside Iowa.

We have several perfectly good but underutilized downtown hotels. It's amazing how just this one will do all these wonderful things. But between this and the PorkForest, will the tourists have enough money to get back home?

Before any government agency blunders into the hotel business, they should take a good look at the example of Illinois, where the state got hip deep in a capitol city hotel:

In 1982, a group of investors received a $15.5 million state-backed loan to build the hotel. It opened in 1985 as the Ramada Renaissance, but the borrowers quickly fell behind in making payments.

The state renegotiated the loan twice, providing extremely favorable terms that allowed the borrowers to skip loan payments if the hotel did not turn a profit. In the past 10 years, the borrowers have made only two payments on the loan and have not made a single payment since 2002.

If a hotel makes sense, private money will build it. If it doesn't make sense, why punish the taxpayers and the hotels that are already here by building the Angela Connolly Hilton?

(Hat tip: State 29)

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THEY'RE BOTH INEVITABLE, LEONA, EVEN FOR BIG PEOPLE

August 21, 2007

20070821.jpgLeona Helmsley, the hotelier who achieved infamy when it was reported during her tax evasion trial that she said "only little people pay taxes," has stepped up the basis of her assets. Ms. Helmsley died yesterday in Connecticut. From the Associated Press story:

Already experienced in real estate before her marriage, Helmsley helped her husband run a $5 billion empire that included managing the Empire State Building. She became a household name in 1989 when she was tried for tax evasion. The sensational trial included testimony from disgruntled employees who said she terrorized both the menial and the executive help at her homes and hotels.

That image of Helmsley as the "queen of mean" was sealed when a former housekeeper testified that she heard Helmsley say: "We don't pay taxes. Only the little people pay taxes."

She denied having said it, but the words followed her for the rest of her life.

Don't Mess With Taxes has more, and the Tax Girl has video of reactions to the news.

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TAX CREDITS AND THE RIPPLE EFFECT

August 20, 2007

20070820-1.jpgThe Des Moines Business Record examines Iowa's 33 tax credit programs in a piece called "The Ripple Effect." It's an appropriate title, as economic development credits are to economic development as Ripple wine is to healthy hydration.

The Business Record piece isn't shy about drawing conclusions; the author thinks that they just magically create jobs:

It's hard to argue with incentive programs that lead to hundreds of millions or even billions of dollars in new capital investment and the creation of thousands of new jobs in the state. The investments spurred by tax credit awards have been particularly valuable to many of Iowa's rural communities, said Michael Tramontina, director of the Iowa Department of Economic Development.

Actually, it's not that hard to argue with them. The argument starts with the idea of "opportunity costs." The piece says that there have been $1.23 billion of economic development credits issued over the past ten years. What else could have been done with that money? What if it had been left in the hands of the taxpayers, instead of doled out to well-connected businesses? What if it had been used to keep a key highway bridge from falling down?

Another issue is whether the credits reward taxpayers for things they would already do. While the economic development folks always claim responsibility for projects that get credits, many, perhaps most, of those projects would have happened anyway. The recent changes in Iowa's rehab tax credit actually issued new credits for rehabilitation work that had already been done.

The piece quotes economic development director Tramontina:

"You really have to consider how big those (ethanol plant) investments are," he said. "For a rural county to get an investment of $175 million to $225 million, that's more than the equivalent of adding an 801 Grand (building) in one of those counties." The dollar amount of the tax credits awarded to those plant projects has averaged about 7 percent of the total private investments, he said.

Time will tell whether this was a benefit. If these ethanol plants end up bankrupt and shuttered in a few years - a very real possibility, as they can survive only as long as they are richly subsidized by the taxpayers - all of these economic development funds will turn out to have been poured down a rathole.

The whole idea of tax credits implies that statehouse politicians are some kind of economic supergeniuses who can funnel taxpayer funds into the optimal economic activity for the state -- or at least better than private equity and credit markets. That's ridiculous. If they were so smart, they would be making millions as investment bankers rather than $21,380 as state legislators.

That doesn't bother the politicians:

What isn't slowing is the pace at which tax credits are being claimed. State officials estimate that by 2011, businesses and individual taxpayers will claim about $400 million in credits against their taxable income, compared with $157 million in credits actually used in fiscal 2004, the latest year for which data is available.

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As a recent report by the State Auditor's office shows, these credits often fail to meet their hype. For example The report showed that of 30,732 "pledged" jobs from the Grow Iowa Values fund credit program, only 13,730 had really been pledged under the terms of the program, and many of those were receiving other funding.

Bottom line? Economic development credits make Iowa business and employees that lack good statehouse connections pay higher taxes to lure and subsidize their wired-in competitors.

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FATHER FIGURE FRAUD

August 20, 2007

Roy Albert Lewis followed his father into the dental field. Now the father is following the son into federal prison.

Russ Fox reports that the father, Leroy Albert Lewis, was sentenced to two years in prison for participating in a Tower Executive Resources tax evasion scheme. He will also have to pony up $909,527 restitution.

The son received his own two year sentence in February.

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FORGIVENESS, JOINT VENTURE COVERAGE, AND E-MAIL SELF DISCIPLINE

August 20, 2007

IowaBizlogo.JPGThere is a good run of posts on IowaBiz.com. Brian Honnold's piece on insurance coverage gaps in joint ventures just might help you avoid a liability faux pas. Mitch Matthews could save you buckets of time with a "not-to-do list." And Victor Aspengren has an excellent bit of advice for managers.

Good stuff each day at IowaBiz.com.

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WATERLOO ORTHODONTIST LOSES 1988 TAX CASE FOR THE THIRD TIME

August 17, 2007

20070817.jpgMichael Hollen is an orthodontist in Waterloo, Iowa. He is something of an entrepreneur, owning a downtown building housing the CU restaurant and The Cellar bar. He also is an inventor, having come up with a clever device for landscapers with a fondness for rocks.

His efforts in Tax Court have been less successful. Yesterday he suffered his third defeat in a battle over his 1988 taxes.

Their first loss occurred in 2000, when the Tax Court ruled (T.C. Memo. 2000-99) that Mr. Hollen was required to pay tax on a land sale by a partnership in which he had owned an interest. Dr. Hollen, using an attorney, argued that he had previously transferred his interest in the partnership to his medical corporation, but the court said there was insufficient evidence that the transfer had occurred. The federal appeals court for the Eighth Circuit upheld the Tax Court in 2002, for his second court loss.

The years flew by. The IRS tried to collect, filing notice of intent to levy and a notice of tax lein. Dr. Hollen returned to Tax Court, this time without a lawyer, to fight the IRS efforts to collect the 1988 taxes. It's not clear from the opinion what Dr. Hollen's arguments were, but they apparently were the same as he raised with the IRS during the collection process. The Tax Court summarized these objections:

(1) The correctness of the underlying tax liability, (2) the liability of petitioner Joan L. Hollen (Ms. Hollen) for the tax, (3) the propriety of filing a tax lien against Ms. Hollen, (4) the timing of the tax lien filing, and (5) the possibility that a "slander of title action" might be pursued against the Internal Revenue Service (IRS) under Iowa law because the tax lien filing was filed against Ms. Hollen.

The court ruled that the correctness of the original assessment was no longer up for discussion, having been finally resolved when Dr. Hollen lost his appeal in 2002. With that settled, the court said it could only review the IRS collection actions for "abuse of discretion." During the collection process, the IRS had corrected an excessive penalty assessment, but had also denied "innocent spouse" relief from collection to Mrs. Hollen. The judge ruled that, considering everything, the IRS had not abused its discretion in trying to collect Dr. Hollen's taxes.

Dr. Hollen's original liability, with penalties, was $97,212.50. With interest, I estimate that comes to around $416,700 now. One hopes that the doctor has invested his money wisely in the meantime, as his battle against his 1988 taxes seems near an unsuccessful end.

The Moral? The Tax Court only gives you one shot at arguing over whether you owe your taxes. Once that's settled, it's only a matter of time before the IRS gets its way, if you have anything left for them to collect.

Cite: Hollen, T.C. Memo 2007-235

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GUILTY, IN STANDARD ENGLISH

August 16, 2007

Funky punctuation didn't help Frederick Kriemelmeyer, the LaCrosse dentist we mentioned yesterday. Jurrors found him guilty on four tax charges yesterday. From LaCrosseTribune.com

Frederick G. Kriemelmeyer, 58, faces a maximum penalty of 12 years in prison at his Oct. 8 sentencing before District Judge Barbara Crabb.

During the two-day trial, Crabb did not allow most of Kriemelmeyer’s defense, including claims that the indictment and other court documents weren’t legal because they were written in standard English, which Kriemelmeyer calls a "fictional" or "false conveyance of the language."

It turns out that funky punctuation wasn't his only defense:

In his closing argument Tuesday, Kriemelmeyer, who represented himself, told jurors he used a barter system with patients that allowed him to avoid paying taxes. Kriemelmeyer also said he was paid in silver, which Kriemelmeyer said isn’t taxable income because it’s not mentioned in the Internal Revenue Service code.

He should have used some of that silver for a good lawyer.

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FULL TAX COURT DENIES AMT NOL ON SALE OF ISO SHARES

August 16, 2007

20070816-3.jpegApparently seeking to be perfectly clear on an an issue that has provoked seemingly endless litigation, the full Tax Court ruled without dissent that a loss on a sale of shares acquired with incentive stock options is a capital loss in computing alternative minimum tax. Capital losses are limited to capital gains plus $3,000, which makes them much less useful than normal operating losses.

Yesterday's decision involved taxpayers who exercised incentive stock options in Veritas Software Corporation. Through March 2000 they paid $175,841 on the exercise to buy shares worth $5,922,522. In computing their regular tax, this generated no income, but the $5,746,681 excess of the stock's value over its purchase price was taxable income for AMT. As a result, the taxpayers paid over $1.6 million of AMT for 2000.

Their stock fared poorly in the subsequent months, and they unloaded 3/4 of their ISO shares for $2,756,758 less than they were worth when they were acquired. Because the acquisition value was used to compute their prior AMT, they had an AMT loss of that amount.

The taxpayers argued that their $2,756,758 loss should be treated as an ordinary loss, giving them a net operating loss for AMT purposes that could be carried back to reduce their 2000 AMT taxable income. The Tax Court instead ruled the loss a capital loss. Assuming that the taxpayer uses the AMT capital loss carryforwards to the tune of $3,000 per year, they should be about used up in a bit more than 900 years.

The result is unsurprising from a technical standpoint, as that is the obvious reading of the law; in fact, it has been reached from a slightly different angle in last year's reviewed Merlo decision (Merlo was affirmed by the Fifth Circuit last month).

The issuance of a fully-reviewed decision is unusual; this is only the fourth such decision this year. Perhaps the court is attempting to chase similar cases off its docket by making clear that further such efforts by AMT-ISO victims are futile.

Congress passed limited relief for AMT-ISO taxpayers last year.

Cite: Marcus, 129 T.C. No. 4

The TaxProf also has coverage.

Related Tax Update coverage:

MERLO AGES POORLY

YET ANOTHER AMT-ISO VICTIM LOSES IN TAX COURT

TAX COURT TO ISO-AMT VICTIMS: YOU'RE STILL SCREWED

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AUGUST BIZNESS

August 16, 2007

Be sure to visit IowaBiz.com regularly. If you haven't been there lately, you've missed good stuff like Mike Sansone's list of Web Strategy Must Reads and Brett Trout's question, What is Your Lawyer Hiding? From Mr. Trout's post:

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Attorneys make money because they know things you do not. In the past, some attorneys attempted to drive business by increasing the mystery associated with the profession. They did this by increasing the perception of the attorney/client knowledge gap. These attorneys parlayed hundred dollar words and a pedantic (I’ll only charge you $50 for that one) tone into repeat business. From the time I first entered the profession, however, I noted that these attorneys were typically the least knowledgeable and least skilled.

You'll want to read the whole thing.

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STATE FAIR CAVALCADE

August 16, 2007

If you're looking for a fresh roundup of blog posts on insurance and risk management, you are in luck! The new Cavalcade of Risk is up at InsuranceHelpHub.com.

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THE FAIR TAX AND HUGH

August 15, 2007

Talk radio host and blogger Hugh Hewitt has run afoul of fans of the "FAIR Tax" national retail sales tax plan:

Since dismissing the idea of the fair tax on my program on Monday, I have received about 100 e-mails denouncing me for my ignorance and demanding that I "read the book!" I of course believe in tax simplification and lower taxes as the key to economic growth, but a plan that begins with abolishing the mortgage interest deduction and the charitable deduction will not pass the Congress any time soon, and I am uninterested in crusades based on great leaps into the dark with only the flimsiest chance of success.

This illustrates two things: the misguided fervor of the FAIR Tax folks, and why real tax reform is so difficult.

I remain puzzled why anyone could possibly think a 30% national sales tax could be a good idea (and it is 30%, not the 23% advertised), or that it could ever happen.

It's not so puzzling that Mr. Hewitt takes two of the biggest tax breaks off the table in any tax reform debate. Economically, there's no justifying the home mortgage donation; the charitable deductionis also hard to defend strictly on economic terms. I'd trade these breaks in a heartbeat for a 15% rate, but Mr. Hewitt doesn't even want to talk about it out of fear of a backlash. That's sad, because it's such sacred cows that make our tax code the nightmare it is.

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IT WILL BE A COLD DAY BEFORE THIS COMPANY GETS ITS TAXES PAID

August 15, 2007

Businesses that fall behind on their payroll taxes sometimes seem to believe that there's no hole too deep for their lawyers to dig out of. Duluth, Minnesota web design firm Fifty Below Sales and Marketing, Inc. learned otherwise yesterday; the Eighth Circuit Court of Appeals ruled that the IRS was permitted to levy on their accounts without offering an installment payment plan.

From the court opinion, it sounds like Fifty Below had failed to keep up with two tax installment payment plans already, and had failed to keep up with it's current payroll tax obligations. Either failure is enough to get you in hot water - which sometimes is welcome in Duluth, but not this time. From the opinion (citations omitted):

This excerpt shows that the appeals officer took into account Fifty Below's history of failure to live up to two previous installment agreements and an earlier proposed Offer in Compromise, as well as its noncompliance with current obligations. These are legitimate considerations weighing against accepting a taxpayer's offer. He also took into account the multi-million dollar size of the taxpayer's existing liability, plus the fact that Fifty Below had continued to fall further and further behind as time went on, which the IRS refers to as "pyramiding" taxes, and which legitimately weighs against a taxpayer's request for a second (or third or fourth) chance.

Bottom line? The IRS might put Fifty Below six under.

Citation: Fifty Below Sales & Marketing Inc. v. United States; Nos. 06-3244, 06-3245

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TAX BREAKS AND PRECIOUS BODILY FLUIDS

August 15, 2007

The Tax Girl answers a reader question:

I regularly donate blood to the Red Cross. Can I deduct this on my taxes?

Short answer: no. But if you give a little more of yourself, a number of states, including Iowa, offer tax incentives to reimburse live organ donors for expenses incurred in giving, say, a spare kidney. Iowa offers a one-time deduction for travel and lodging costs and lost wages incurred in live donation, up to $10,000 (Iowa Code 422.7(44)).

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ADD PUNCTATION, SUBTRACT TAXES?

August 15, 2007

Russ Fox of Taxable Talk reports on an interesting case from LaCrosse, where a dentist is alleged to believe that funky punctuation is the key to a happy tax life:

As the LaCrosse Tribune reported, Dr. Kriemelmeyer is a believer in David Wynn Miller. Miller does not use standard English; instead, he used a dialect he invented called "In the Truth." It's got a lot of capital letters, prepositional phrases, and not much in the way of punctuation. You can see samples by going to Mr. Miller's website.

In any case, Dr. Kriemelmeyer challenged the indictment because it was in English—our English. That didn't work (the judge let the indictment stand). The dentist challenged the US flag in the courtroom. No, I'm not joking about that. He didn't win that argument.

David Wynn Miller believes that if you add extra punctuation to a tax return, you will somehow not have to pay taxes. At least, that's what I think he espouses. Dr. Kriemelmeyer is a follower of Mr. Miller, and is conducting his own defense.

Sure, it sounds like our dentist has been drinking too much Old Style, but, you, can't: BE! t0o, CAReful...

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YEPSONIAN RESPONSE

August 14, 2007

When the 35W bridge fell down, the response of David Yepsen and the Des Moines Register editorial board was, well, reflexive: "raise taxes!"

That assumes, of course, that the bridge fell because the government didn't have enough money to fix it - a questionable assumption.

The government gets billions of dollars. One of the most basic government functions is keeping bridges from collapsing. If the government isn't doing that much, where is all of that money going?

That question seems to finally be occurring to Register columnist Richard Doak. It has dawned on him that the "Iowa Values Fund" for carpetbagger corporations and the "Iowa Power Fund" to subsidize $4 corn don't come for free:

The centerpiece programs of Iowa's last three governors - Gov. Chet Culver's Iowa Power Fund, Gov. Tom Vilsack's Iowa Values Fund and Gov. Terry Branstad's various business-tax breaks - have essentially transferred public money to private businesses. Iowa could have built a lot of infrastructure for the hundreds of millions of dollars those programs cost.

Every time the state makes a grant, forgivable loan or special tax break to a business, there is less money to improve universities or state parks. Every time a city grants a tax abatement or creates a TIF district, it denies money for libraries or trails or new police cars.

Worse than that, these deals put businesses who aren't wired in at the Capitol or the county courthouse at a disadvantage - they pay taxes to lure and subsidize their plugged-in compeititors. It's good that Mr. Doak is at least starting to grope for the light.

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80-20 RULE AND TAX NONCOMPLIANCE

August 14, 2007

You likely have heard of "Pareto's rule":

Pareto's rule states that a small number of causes is responsible for a large percentage of the effect, in a ratio of about 20:80. Expressed in a management context, 20% of a person's effort generates 80% of the person's results. The corollary to this is that 20% of one's results absorb 80% of one's resources or efforts. For the effective use of resources, the manager's challenge is to distinguish the right 20% from the trivial many.

It looks like it works that way for tax noncompliance, if a Government Accountability Office study released yesterday is to be believed. Tax Analysts reports ($link):

According to the GAO, 61 percent of sole proprietors underreported income in 2001, but most by relatively small amounts. Half of the resulting tax understatements IRS examiners found were less than $903. But about 1 million of the sole proprietors, 10 percent of the total population, understated taxes by more than $6,200, the GAO said.

"Slightly more than 1 million sole proprietors accounted for most of the understatements," the report said, noting that "in this top group, the mean understatement of tax was $18,000."

The report looks at the tools that could deal with this issue, one of the largest causes of the "tax gap." It seems that most of the low-hanging fruit has already been picked. The biggest way to ensure compliance is to expand information reporting requirements. Of course, this increases the compliance burden on those who pay these proprietors. Still, that's likely the way Congress will go, starting with requiring credit card companies and third parties like e-Bay and Paypal to report remittances.

UPDATE: Here's the link to the report, courtesy of the TaxProf.

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GREEN TIDE IN TUSCALOOSA, AND OTHER TAX BLOGGER NUGGETS

August 14, 2007

Kay Bell of Don't Mess With Taxes reports on how tax breaks for hurricane reconstruction are being used to help the deserving poor Alabama fans who have had to deal with mediocre football in recent years:

According to the Associated Press, several condominium projects are being built near the University of Alabama football stadium. Featuring granite counter tops, king-size bathtubs, crimson couches and Bear Bryant wall art, the Tuscaloosa units are priced at up to $1 million each.

But in addition to wealthy Crimson Tide alumni, buyers include investors who plan to rent out the condos. And that entitles them to some of the tax benefits created under the Gulf Opportunity Zone Act of 2005.

That will help those people from New Orleans.

Russ Fox of Taxable Talk is back from vacation and on a roll. His latest post tells the sad story of an employer who used tax protester arguments to justify failing to withhold income taxes or pay employment taxes. The Tax Court wasn't amused, and assessed the taxes plus a $3,000 penalty for using stupid arguments.

Tick Marks talks about a defeat for a provision that would let Farm Credit Service do tax prep. As if there aren't enough subsidies in farm country.

Finally, the Wandering Tax Pro has a list of Tax Urban Legends. My favorite from his list:

· Putting it on the corporate credit card automatically makes it deductible (Putting a personal expense on a corporate credit card means that you owe the corporation money or you have additional taxable compensation).

That's right up there with one of my favorite tax myths: if you don't get a 1099, it's not taxable income.

Oh, and State 29 has a new look - and now with comments!

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DEFERRING TO OUR BETTERS

August 13, 2007

I'll be the last person to defend Iowa's first-in-the-nation caucuses as being somehow sacred, or even helpful to the selection of a president. After all, it's how we got Jimmy Carter; it's amazing that Iowa wasn't disbanded and split among its neighbors after that fiasco.

Still, my self-esteem was crushed by the rapier-like wit of California's Professor Bainbridge. Referring to Iowa, New Hampshire, and South Carolina, he asks:

How is it that we persist in allowing these unrepresentative, yahoo infested, pissant states decide who gets to run for President?

He seems a bit defensive about this today, saying he "was mostly being sarcastic." Mostly? Very subtle, Dr. Bainbridge's sarcasm. I guess that's why so many of us yahoos missed it.

The nation surely could use more of the savoir-faire and sophistication that California brings to the national debate. Like this:

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Not to mention the intellectual firepower that California brings to the table. Some examples:

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Charles Manson

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O.J.

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Nancy Pelosi

And, of course, the Professor himself, from the land where "We produce cutting edge technology, world class wine, and much of the nation's food crop," of which evidently the good Professor claims his fair share.

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Fortunately, Iowa has a defender in the great white north.

Oh, and State 29 has come out of retirement for this!

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GRASSLEY V. PRIVATE EQUITY

August 10, 2007

Iowa's own Chuck Grassley is looking to private equity funds to fix the AMT mess. It appears that he wants to make public investment partnerships taxable as corporations. It also appears he wants to tax "carried interests" taxable as ordinary income. From the New York Post:

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Iowa Senator Charles Grassley said he intends to link his proposal to boost taxes on publicly traded buyout firms to a fix of the alternative minimum tax, a pairing that may make it harder for opponents of the measure to vote against it.

"This is going to come when we deal with the alternative minimum tax," Grassley, a Republican, said in an interview yesterday. He said the bill deals with "issues of equity and fairness."

By going after carried interests, Senator Grassley and other congresscritters divert attention from their own negligence in managing the AMT. Their long-term budget projections assume AMT revenue that they never expect to collect. Increasing taxes on private equity can at best raise only a fraction of the trillion dollars needed to permanently the alternative minimum tax. By itself the annual "patch" to punt the projected expansion of AMT to 23 million more households back another year is now costing $45 billion annually.

If they really want to deal with the AMT, the only way to do so is as part of a broader reform that repeals tax breaks in exchange for lower rates. As it is so much easier to come out against hedge fund millionaires so it looks like you're doing something, that's the course we can expect Congress to take.

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WE WASTE MONEY. WE WANT MORE.

August 10, 2007

Two of the biggest pork spendthrifts in Congress have called for a gas tax increase in the wake of the Minnesota bridge disaster. Don Young (R. AK) and James Oberstar (D. MN), ranking members for their parties in the House Transportation Committee, proposed the 5-cent per gallon tax increase this weeks. The bill would raise $20 billion annually.

In 2004, these two produced a transportation bill with $24 billion worth of "earmarks," pork spending to buy votes in individual congressional districts. These included the notorious Alaska "Bridge to Nowhere," which would have been named "Don Young Way" - a $200+ million bridge from the Alaska mainland to an island with 50 residents.

These are just the guys I'd trust with another $20 billion each year.

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HAPPY HERBERT HOOVER DAY

August 10, 2007

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Today is the 133rd anniversary of the birth of the only president born in Iowa. It sure doesn't look like we'll see another one soon.

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WE THE ENJOINED

August 09, 2007

bs2.jpgThe anti-tax group "We The People" could appropriately change their name to "We The People Who May No Longer Sell De-taxing Kits." From a Department of Justice press release:

WASHINGTON -- A federal court in Binghamton, N.Y., today permanently barred Robert L. Schulz of Queensbury, N.Y., and his organizations, We the People Congress and We the People Foundation, from promoting a tax scheme that helped employers and employees improperly stop tax withholding from wages, the Justice Department announced. Schulz and his organizations called the scheme the Tax Termination Package.

In his decision entering the civil injunction order, U.S. District Judge Thomas J. McAvoy, found that Schulz “knew or had reason to know” that his statements in promoting the scheme were false. The court said that in promoting the scheme, Schulz and the We the People organizations “relied on fringe opinions of known tax protestors whose theories have repeatedly been rejected by courts across the country.” The court further noted that several of those tax protestors have been convicted of tax crimes.

The injunction requires We The People to display the injunction on their web site home page. Maybe they'll still have room for the link to their current featured link, "Protecting Ron Paul, the Rest of the '2nd Tier' and America." Mr. Paul's association with the tax protest fringe makes it hard to take him seriously.

The injunction also requires WTP to turn over their customer list to the IRS. If they've maintained such lists, the WTP patrons can look forward to becoming acquainted with IRS examiners in the near future.

Mr. Schulz is a fixture in the tax protest movement, and he is featured in the tax protest epic "America: From Freedom To Fascism."

Prior WTP coverage:

DC CIRCUIT: RIGHT TO PETITION INCLUDES RIGHT TO BE IGNORED

FEDS GO AFTER 'WE THE PEOPLE'

WE THE FORECLOSED

EACH DEFEAT BRINGS US CLOSER TO VICTORY!

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LOSING $67,738 FOR FUN AND...PROFIT?

August 09, 2007

20070809-3.gifAnother multi-level marketer came to grief in Tax Court yesterday.

Robert and Carol Berryman had full time jobs, and they sold Melaleuca products on the side. The Tax Court describes some of the key elements of their business model:

Petitioners timely filed their Federal income tax returns with attached Schedules C, Profit or Loss From Business, for the years in issue. On their respective Schedules C for 2002, 2003, and 2004, petitioners reported gross receipts from their Melaleuca activities of $5,300, $3,674, and $3,030. Petitioners then claimed losses of $49,590, $45,114, and $67,738 for 2002, 2003, and 2004, respectively. These losses included numerous personal expenses claimed as business deductions. For instance, petitioners claimed deductions for cat litter, golf balls, tickets to Oklahoma State University football games, and a Dish Network subscription. Petitioners also claimed a deduction for a life insurance policy they purchased. Petitioners offset these losses against combined wages of $95,824, $91,662, and $103,693 for 2002, 2003, and 2004, respectively.

The court found the model flawed:

The one financial success, at least before respondent caught on, that petitioners enjoyed with their Melaleuca activities was offsetting their losses against wages of $95,824, $91,662, and $103,693 for 2002, 2003, and 2004, respectively, to create substantial tax savings. Of course, this itself is an indication that petitioners were more interested in the tax savings realized by converting personal expenses into tax deductions than they were with operating a business for profit.

In sum, we are satisfied that petitioners' primary purpose for engaging in the promotion of Melaleuca products was not to profit. Accordingly, petitioners are not entitled to the deductions here in dispute beyond those allowed by respondent under section 183(b).



The Moral: if the only profit from your multi-level marketing business is a bigger tax refund, the IRS is likely to be unamused.

Cite: Berryman, T.C. Summ. Op. 2007-138

Related: Losing Money - Some Hobby

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IRS < KGB

August 09, 2007

If you think it can be tough dealing with the IRS - well, you're right, but it's a picnic compared to dealing with Soviet Russian tax authorities. From Forbes.com (emphasis added):

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MOSCOW (Thomson Financial) - All of the shares of Russian oil firm Russneft have been seized as part of a criminal probe into tax evasion and 'illegal business practices', the interior ministry said today.

On July 31, Moscow's Lefortovo 'approved the request to arrest 100 percent of the shares of this company. The shares have now been seized,' the ministry said in a statement.

The request was made by the ministry in relation to a criminal case against the company's former chief executive Mikhail Gutseriyev for tax evasion and 'illegal business activities', the statement said.

So you can have an entire company siezed by the government as part of an investigation into a former executive? Before anybody has been even charged, let alone convicted? It looks like the verdict has already been reached, so the investigation is just a formality. Anybody who invests a lot of money in Russia nowadays needs a psychiatrist.

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THE BEAST AIN'T STARVING

August 09, 2007

In the wake of the 35W bridge collapse, David Yepsen and others have argued that low taxes have starved essential highway repair work.

Let's go to the pictures:

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Source: Congressional Budget Office

In a study released yesterday, the Congressional Budget Office reports that in constant, inflation-adjusted dollars, the federal government is spending more on infrastructure than it ever has - to the tune of $80 billion annually. It's not that there isn't enough money.

It seems likely that the 35W bridge collapse was a matter of misjudgements made at the local level by those in charge of the bridge. There is no evidence that that some heroic whistleblower was silenced for trying to draw attention to an imminent bridge collapse.

If there isn't enough money to cover failing bridges, it's because congresscritters prefer to vote money for shiny new projects where they can cut ribbons to fixing the ones they have. $180 million indoor rainforest, anyone?

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TEACHERS ESCAPE DEFERRED COMP TRAP AIMED AT ENRON EXECS

August 08, 2007

The IRS yesterday announced (IR 2007-142) that Section 409A, the misbeggoten deferred compensation rules enacted in the wake of the Enron scandal, will not cause teachers to be hit with a 20% excise tax in 2007:

Under the 2004 law, when teachers and other employees are given an annualization election -- that is, they are allowed to choose between being paid only during the school year and being paid over a 12-month period -- and they choose the 12-month period, they are deferring part of their income from one year to the next. For instance, a teacher who chooses to get paid over a 12-month period, running from August of one year through July of the next year, rather than over the August to May school year, falls under this law.

The IRS clarified that the new rules do not require school districts to offer teachers an annualization election. Thus, school districts that have not been offering teachers this election are not required to start.

That doesn't mean teachers are off the hook forever:

School districts that offer annualization elections may have to make some changes in their procedures. The IRS announced that the new deferred-compensation rules will not be applied to annualization elections for school years beginning before Jan. 1, 2008, so school districts and teachers will have time to make any changes that are needed.

In other words, every school district in the country has to review how teachers are paid because Congress didn't like Ken Lay's deferred comp plan. Nice work, Congresscritters.

The TaxProf has more.

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HYBRID UPDATE

August 08, 2007

The IRS has updated the status of credits for hybrid vehicles.

Ford Hybrids remain fully eligible for the credit (IR 2007-140):

Ford Escape 2WD Hybrid, Model Year 2008 - $3,000
Ford Escape 2WD, Model Years 2005, 2006 and 2007 - $2,600
Ford Escape 4WD Hybrid, Model Year 2008 - $2,200
Ford Escape 4WD, Model Years 2005, 2006 and 2007 - $1,950
Mercury Mariner 4WD Hybrid, Model year 2008 - $2,200
Mercury Mariner 4WD, Model Years 2006 and 2007 - $1,950
Mercury Mariner 2WD Hybrid, Model Year 2008 - $3,000

Toyota hybrid models are still eligible for a reduced credit for vehicles purchased through September 30, 2007 (IR 2007-139):

2007 Prius: $787.50
2007 Highlander: $650.00
2007 Camry: $650
2007 Lexus RX400h: $550
2007 GS450h: $387.50

Remember: the hybrid credit doesn't work for alternative minimum tax.

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WADE IN OVER HIS HEAD

August 08, 2007

Investment "guru" and author Wade B. Cook now has plenty of time for his next book project. From SeattlePI.com:

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Self-styled financial guru Wade Cook, 57, was sentenced Thursday to seven years and four months in federal prison for income tax evasion, filing false tax returns and obstructing a tax investigation.

His wife, Laura, 54, was sentenced to 18 months in a separate federal prison after pleading guilty in May to obstructing the investigation


Seven years is a long tax sentence. The amount of taxes evaded is key to determining the length of a sentence, and that number was pretty big:

Zilly also ordered the Cooks to pay $3.8 million in federal taxes on the $9.5 million in royalties they earned but failed to declare between 1998 and 2000.

During the hearing, Wade Cook was animated, grinning at his family and occasionally laughing and shaking his head in apparent dismay as Assistant U.S. Attorney Robert Westinghouse argued before the judge. But his demeanor changed considerably after [Judge] Zilly pronounced sentence.

I'll bet it did.

Mr. Cook doesn't seem to expect to appear before Judge Zilly again anytime soon:

Asked afterward to comment on the outcome, Cook remarked, "I'm not going to tell you that this judge is an a**hole. I'm not going to say that."

Good thing he showed so much restraint.

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WE CAN ONLY TRUST IRS EMPLOYEES TO PROTECT CONFIDENTIAL INFORMATION

August 07, 2007

Opponents of private tax collection frequently cite confidentiality concerns; they argue that the use of private collectors puts private taxpayer information at risk.

The alternative, of course, is to use actual IRS personnel. A recent study by the Treasury Inspector General for Tax Administration shows that real IRS agents aren't necessarily invincible guardians of your privacy:

We made 102 telephone calls to IRS employees, including managers and a contractor, and posed as computer support helpdesk representatives. Under this scenario, we asked for each employee's assistance to correct a computer problem and requested that the employee provide his or her username and temporarily change his or her password to one we suggested. We were able to convince 61 (60 percent) of the 102 employees to comply with our requests.

60 percent? That's a success rate that scam telemarketers who prey on old folks would envy. It's a good thing we have official government employees operating the IRS computers; using private contactors could really crimp the style of the identity theft community.

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HOLIDAY HANGOVER

August 07, 2007

Iowa had it's annual sales tax holiday last weekend. The Tax Policy Blog is unimpressed:

Here are a few points about sales tax holidays that you are unlikely to hear from the news media or politicians:

(1) Sales tax holidays force higher taxes throughout the rest of the year and/or reduce state spending. This "for the children" sales tax holiday may raise taxes on the children's families the rest of the year or result in reduced spending by the state government - possibly lower spending "for the children."

(2) The value of the tax holidays is offset to a large degree by the time cost of waiting in line throughout the madness that erupts as a result of these tax holidays...

(3) Sales tax holidays can be an administrative nightmare for stores to implement - which items are tax-free and how much is tax-free? Local "Mom and Pop" stores are likely to be at a disadvantage compared to large-scale retailers like Wal-Mart or Target due to the store's logistics (scanning barcodes that have tax savings programmed in versus cash registers where the employees must look up what is tax-free).

More gimmickry masquerading as leadership from our legislators.

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HOW MANY AUDITORS DOES THE POPE HAVE?

August 07, 2007

Tax evasion is a national pastime in Italy. Can the spiritual power of the Roman Catholic Church change a way of life? The italian Premier thinks it's worth a try:

ROME -- Premier Romano Prodi has called on Roman Catholic priests to help him battle Italy's widespread tax evasion by invoking the seventh commandment -- thou shalt not steal.

Prodi made the appeal in an interview this week with Italian religious affairs weekly Famiglia Cristiana. His comments sparked criticism that he is blurring the lines between church and state, and on Thursday Prodi defended himself in a front-page letter to Italy's top daily.

"A third of Italians heavily evade taxes," Prodi told Famiglia Cristiana. "To change this mindset, everybody, starting with the teachers, must do their part, school and church included."

It's not clear how the church will respond, but they might have a better shot at tackling something less controversial - say, preaching against pasta and red wine.

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Will the Pope bless improved tax compliance?

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STEAMY WEEK CARNIVAL

August 07, 2007

The humidity is 100%, and it's 90 degrees. It's carnival time!

The new Carnival of Taxes is up at Don't Mess With Taxes. The Capitalist Carnival is at Linked Intelligence. Enough good stuff to keep you cool at each one.

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CAN HIGHER TAXES HOLD UP BRIDGES?

August 06, 2007

While the search for victims of the Minnesota bridge collapse continues, the search for scapegoats is just revving up. Proposed scapegoats include anybody who has cut taxes, or anybody who has opposed tax increases (more here).

The 35W bridge was primarily a state responsibility. Is Minnesota a skinflint tax state? No. Minnesota is ranked as having the 11th highest state tax burden out of the 50 states by the Tax Foundation for 2007. If Minnesota's "low" taxes caused bridge the bridge to collapse, then residents of 39 states with lower taxes would be wading to work every day.

Transportation spending has actually increased significantly at the federal level. The Bush administration has mastered the art of cutting taxes while spending like drunken congressmen.

If tax money were really tight in Minnesota, maybe they wouldn't be building a half-billion-dollar publicly-financed ballpark, or the billion-dollar light rail system. The light rail system averages 13,000 riders daily, while the 35W bridge carried 141,000 vehicles daily - cars, buses, and freight. Together, the costs of the ballpark and light rail would have built at least six new 35W bridges.

That's not to say light rail or the new ballpark caused the bridge to fall - but if you argue that tax cuts caused the bridge failure, you can say the same about every spending program, too.

UPDATE: More here.

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SETTLING TAX DEBTS WITH IRS ONLINE

August 06, 2007

The California Tax Attorney Blog has a useful piece up on settling tax debts with the IRS online:

The Online Payment Agreement (OPA) allows eligible individuals to apply for an installment agreement to pay off their tax liability. To qualify, you must have your bill from the IRS and have filed all required tax returns. You must owe less than $25,000 and be able to pay the entire liability within 60 months.

It's a good, brief summary.

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OFF TO CAMP

August 02, 2007

CampMitigwaLogo.gifNo posting Friday, as the Tax Update will be spending the weekend with the Webelos at Iowa's glorious Camp Mitigwa, in the rugged, remote and dangerous Des Moines River Valley wilderness.

Have a great weekend, and see you Monday!

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TAX 'CARRIED INTERESTS' AS ORDINARY INCOME - BECAUSE PARTNERSHIP TAX LAW ISN'T HARD ENOUGH?

August 02, 2007

The Senate held hearings this week on the taxation of "carried interests" in investment partnerships. Congress needs more money for things like corn subsidies - after all, corn prices are high, so corn subsidies need to keep pace. Fair's fair.

Believe it or not, it's not just a New York thing. There are Iowans doing these deals too (take note, Senator Grassley).

Here's how carried interests work. An investor group provides funds to buy a corporation, or multiple companies. We'll just say they invest $10 million. They give the money to investment managers who will invest the money for the group. While compensation arrangements vary, typically the investor group will get an annual fee of 2% of the value of the company and a "profits interest" or "carried interest" of 20% of the return generated by the investment.

The managers use the $10 million to buy a company. The company grows in value over five years by $2 million each year, net of enough dividends to pay the 2% annual fee. The company is sold for $20 million after the fifth year, generating a $10 million long-term capital gain.

The tax returns of the partners and managers reflect the following items from the fund:

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Click table to enlarge

Our senators cast their greedy little eyes on the $2 million capital gain that the fund managers get at the end of Year 5. Because they share 20% of the entity's profits, the managers share 20% of the capital gain. The managers pay a maximum federal rate of 15% on the capital gain under current tax law.

This is an unremarkable result from a technical tax point of view. In 1993 the IRS ruled that a "profits interest" in a partnership can be granted to a taxpayer without triggering current tax. A profits interest gives the recipient an interest only in future growth of a partnership. If the partnership is liquidated the day after a profits interest is issued, then the owner of the profits interest should in theory get nothing. Going forward, the recipient of the profits intesest is treated as a full partner in the partnership's growth. If the partnership generates capital gains, the managers get a K-1 reporting their share of the gains.

Some politicians don't like this result, though, because they say the managers' share of the appreciation is "compensation," like wages, and should be taxed as ordinary income at rates up to 35%.

While some smart academics have policy objections to this result, the politicians just seem upset with the idea that a small set of rich people are getting a better tax deal on their compensation than they are Joe Lunchbox.

Outside academia, there's less enthusiasm. The non-enthusiasm is justified.

WHAT'S THE PROBLEM? IS THE SOLUTION WORSE?

For starters, this result is not unique to the partnership area. It is very similar to the result when an employee makes a "Section 83(b) election" on the receipt of restricted stock from an employer. It's not all that different from the desired results of incentive stock options, without the AMT nightmares.

If you assume that the result is wrong, what do you do about it? The politicians probably would like to just tax the managers's share as ordinary income, but if you do that, how do you limit it to equity funds? It's hard to see how to draft it in a way that would either be easily avoided or that wouldn't drag in all sorts of other partnership arrangements, like family investment partnerships. This would also create an income and deduction mismatch, unless you taxed the investment partners on 100% of the capital gain and gave them an ordinary deduction for the carried interest, and made sure the ordinary deduction was exempt from the 2% of AGI floor on invesment expenses.

Another proposed solution would be to tax the managers on the "option value" of the profits interest. This would require the application of option pricing theory to non-public companies - never an easy task. Still another proposal, by one of the more active academics in this area, would apply a "cost of capital" computation to convert a portion of the carried interest to ordinary income.

These are the kinds of proposals that would only be made by somebody who isn't actually trying to run a business or prepare real tax returns.Subchapter K, the partnership rules, are notoriously complex. Only an academic would seek ways to make them worse.

Ultimately, it's not clear that there is a problem here that needs solving. So what if the management ultimately gets capital gains? As long as the tax law provides capital gain rates in the first place, why should the managers be left out? The carried interest is a gamble; they could (and often do) end up with no gain at all. The annual fee is already ordinary income; it seems like rough justice that the "safe" part of the management compensation is ordinary, while the risky part is capital gain.

As far as the tax law is concerned, the managers are partners. Trying to make the tax results from one set of partners differ from another requires a lot of arbitrary distinctions and a lot of complexity. It's not worth it to muck up an already baroque part of the tax law just because politicians and academics find hedge fund managers distasteful.

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NO PROPERTY TAXES IN THE HOOSIER STATE?

August 02, 2007

The Tax Policy Blog reports on a movement to eliminate property taxes in Indiana. Indiana has local income taxes, which would probably fill the revenue void in the unlikely event this happens. That doesn't seem like such a hot idea.

The movement is a reaction to rising property taxes. The Tax Policy Blog reveals the secret to controlling property tax increases:

If people want lower taxes, they're going to have to demand lower spending.

Imagine that.

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NOT FILING? A CHECKLIST

August 02, 2007

Mitchell Port posts his to-do list for people who haven't been filing their returns over at the California Tax Attorney blog.

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NEW CAVALCADE OF RISK

August 02, 2007

It's up at The Healthcare Economist. Lot's of great health-policy and insurance blogging.

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MORE TEARS THAN CRYER

August 01, 2007

The tax protest folks are pretty excited about lawyer Tom Cryer's acquittal on tax charges. While Mr. Cryer still has to pay his taxes, even though he won't go to jail, the "Tax Honesty" crowd acts like this somehow proves their theories right.

That's why it's instructive to visit another tax protestor case - one that's much more typical, and which Tax Honesty bunch won't be crowing about. From PilotOnline.com:


A long time Virginia Beach assistant principal broke down in tears Monday as a federal judge sentenced her to prison time for tax evasion.

Veta B. Faison and her husband, Louis T. Faison, a retired teacher, were sentenced after admitting they failed to pay any income taxes for seven years. The couple at one time called themselves tax protestors, but now admit their positions were misguided.

"I'm deeply sorry for what I've done," a sobbing Veta Faison told the judge. "I am ashamed of myself."


So a 59-year old woman now gets to do eight months in the federal pen. They've already had to pony up $148,000 in taxes.

For every "victory" by a Tom Cryer, there are scores of courtroom defeats for the tax protesters - defeats that bring financial ruin, destroy careers, and even get you thrown in jail. Remember that if you are tempted to believe there is "no law" requiring you to pay tax.

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