Tax Update Blog: May 2008 Archives
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THE TRUTH ON EXPIRING PROVISIONS
May 30, 2008
I always suspected this was true, but I never heard of a congresscritter admitting it in so many words:
I never understood the “why” about expiring tax provisions until one very late night markup of the “extenders bill” several years ago while I was working for the Ways and Means Committee. Bleary-eyed, one of usually twinkly-eyed members plopped down in a chair next to me in back of the dais–just to take a little rest away from his member’s seat. I asked him "why do we have to do this every year?…why can’t we just pass these things permanently?"His eyes suddenly twinkled again, as he looked at me with a combination of amusement and disbelief. He said: "Are you kidding me?… We couldn’t do that!… Why, I’d lose all my friends!…Who would come visit me and say kind things to me and do nice things for me then, if they didn’t have to come back every year to ask for these tax provisions?!!"
(via TaxVox; my emphasis.)
Senator Grassley, of course, has been on the Senate taxwriting committee throughout the "extenders" era. He must have lots of friends.
Related: YIN: TEMPORARY TAX PROVISIONS ARE GOOD
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IRS INNOVATIONS IN DATA SECURITY
May 30, 2008
Want to throw the tax system into turmoil? Go back to filing paper returns. At least that's the conclusion of George Jakabcin, IRS assistant deputy associate chief information officer for systems integration. Tax Analysts reports ($link):
If some event led half of the current e-filers to switch back to paper, "we would be in a world of hurt," Jakabcin said. "We no longer have the capability to process the additional 43 million returns manually. We no longer have the facilities, we don't have the IT infrastructure in place to support them, we don't have the people, and some would begin to argue that we are beginning to lose the expertise."There is, he said, "no going back."
Hmmm.... maybe we all file paper next year, just for fun.
Well, if we did stop e-filing, the IRS would surely adapt with their accustomed cleverness. From the same Tax Analysts piece:
After a Veterans Administration laptop with thousands of personal records went missing two years ago, some IRS employees took to somehow locking their own laptops to toilets, according to Kathleen Walters, acting IRS director of privacy and information protection."They figured that if someone stole a toilet through the roof, someone's going to notice it," Walters said.
So... did they flush?
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NEW 1040 Q&A BLOG
May 30, 2008
Robert Flach, "The Wandering Tax Pro," has set up a new blog, "Ask the Tax Pro," devoted exclusively to answering 1040 questions.
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IRS - THE UBER-BUREAUCRACY
May 30, 2008
Jim Maule is exasperated with Congress using the tax law as an all-purpose public policy tool:
I object to the Internal Revenue Service being turned into a institution that is focused more on the technical requirements of energy production activities than on administering revenue laws. I wonder why financial incentives to produce and conserve energy aren't administered by the Department of Energy.
This point is almost always ignored in discussing tax complexity. Every specialized tax credit - like the "agricultural chemicals security credit" included in the new farm bill - adds a little more to the power of the IRS. Thanks to these sorts of provisions, the IRS is a powerful public policy player in energy, housing, research and development, charitable giving, regulation of non-profits, employment policy, retirement policy, and now, fertilizer. Congress is well on the way to turning the IRS into a shadow super-agency with influence across the whole range of public policy. The IRS Commissioner is a bigger player in some policy matters than the cabinet secretary nominally overseeing the area.
It's hard enough for IRS agents to just determine somebody's income. Having them oversee research and development, or fertilizer, isn't very promising.
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A TAX SNITCH BLOG
May 30, 2008
There is now a "Tax Whistleblower Blog," run by the proprietor of www.rewardtax.com. It's a clever private-sector response to the program to give cash awards to tax whistleblowers.
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DES MOINES, WHAT ARE YOU TELLING ME?
May 29, 2008
Paul Graham ponders what "messages" cities send:
Great cities attract ambitious people. You can sense it when you walk around one. In a hundred subtle ways, the city sends you a message: you could do more; you should try harder.The surprising thing is how different these messages can be. New York tells you, above all: you should make more money. There are other messages too, of course. You should be hipper. You should be better looking. But the clearest message is that you should be richer.
What I like about Boston (or rather Cambridge) is that the message there is: you should be smarter. You really should get around to reading all those books you've been meaning to.
Tim Lee says St. Louis sends a different message:
Here in St. Louis, the message is "you should have met the right people in school." The cliche here is that the first thing St. Louisans ask when they meet each other is "what high school did you go to?" The answer tells them about the speaker's social class and often his religious background. Also, if you want to be successful in Missouri you don't don't go to the highly-ranked Washington University, but to the University of Missouri in Columbia, which is where the kids of other rich and powerful Missourians go to school. Needless to say, moving to St. Louis in your 20s isn't a brilliant career move:
Arnold Kling says Tim Lee is right. Maybe that's why I only lasted a year there. I never got invited to the Veiled Prophet Ball, after all. I did notice even then that St. Louis had a strange small-town feel.
What about Des Moines? On one hand, there is some of the small-town feel; people do ask what high school you went to, and the municipalities are run by and for a network of old political families. In business, though, it's not so insular. While there are a few prominent old families, the scene here is dominated by financial institutions like Principal and Wells Fargo, which are run by people who moved here from small towns all over Iowa, or from out of state. While it doesn't hurt to be friends with, say, the Ruan family, it's not required.
So what message does Des Moines send? A few candidates:
- Your name should end with a vowel so you can get a job with Polk County.
- Why aren't you at your kids' soccer game?
- Make enough money to buy a nice Florida condo.
Comments are open for your thoughts.
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TAX COURT UPHOLDS FAMILY LIMITED PARTNERSHIP HOLDING PUBLIC STOCK
May 29, 2008
A Minnesotan who owned a lot of Dell stock sat down to do some estate planning. Guided by an attorney, the taxpayer and his wife set up a family limited partnership for themselves and their four daughers. They immediately funded it with shares of Dell stock. A week or so later, they gifted partnership interests to their daughters. When they filed their gift tax returns for 1999, they reported the taxable gifts at a discounted value because they were in a partnership. They made additional gifts of discounted partnership interests over the next few years.
Valuation discounts are a big reason people establish family limited partnerships. The tax law considers a limited partnership interest to be a different animal than their underlying assets. Given a choice between buying Dell stock and an interest in a limited partnership owning Dell stock, people would rather just buy the stock. You can sell the stock with a phone call, but the LP interest is more trouble to unload. That's why the courts value LP interests at a discount.
The IRS attacked the taxpayer on several fronts. First, they said that the gift of the partnership interest was really in substance a gift of the stock. The IRS cited the Senda case, where the taxpayers were sloppy with their paperwork. The Tax Court this week said the Minnesota case is different:
The facts in the instant case are distinguishable from those of both the Shepherd and Senda cases. On November 3, 1999, the partnership was formed, petitioners transferred 70,000 Dell shares to the partnership, and Janelle, as trustee, transferred 100 Dell shares to the partnership. On account of those transfers, petitioners and Janelle received partnership interests proportional to the number of shares each transferred to the partnership. It was not until November 8, 1999, that petitioners are deemed to have made (and, on that date, they did make)5 a gift of LP units to Janelle, both as custodian for I. under the Minnesota UTMA and as trustee. Petitioners did not first transfer LP units to Janelle and then transfer Dell shares to the partnership, nor did they simultaneously transfer Dell shares to the partnership and LP units to Janelle.
They IRS also tried to collapse the partnership formation and the gift as a "step transaction," but the Tax Court disagreed. Finally, the IRS challenged the amount of the discount. It came out to be a duel of valuation experts, and here the IRS did better. The taxpayers expert argued for minority discounts of 10% to 15.3%, for gifts made in different years, and for lack of marketability discounts of 35% or more. The IRS expert argued for minority discounts of 3.4% to 14.8% and marketability discounts of 12.5%. The Tax Court settled on minority discounts from 4.53% to 14.34%; the Court allowed a 12.5% marketability discount.
The Moral? If you get the paperwork right and follow the formalities, you can make discounted gifts of interests in family partnerships holding only publicly-traded stock, but don't expect discounts of 30% or more.
Cite: Holman, 130 T.C. No. 12.
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IS MARTIN ICE CREAM MELTING?
May 29, 2008
When C corporations sell their assets, two taxes result. The C corporation pays tax on its gain, and the shareholders also pay tax when the sales proceeds are distributed.
The taxpayer in Martin Ice Cream was able to avoid some of the corporate level tax by selling "personal goodwill" to the buyer of the corporation assets; he convinced the Tax Court that his personal efforts were critical to the success of the company, and his customer relationship was a separate asset outside the company.
This doesn't work with every set of facts, as one taxpayer recently learned. Marc Ward has the, er, scoop at Iowa LLC Blog.
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YOU CAN'T TELL A BLOG BY ITS COVER
May 29, 2008
I stumbled across "The Accounting Onion" this morning. I was hoping it would be a CPA version of the real thing, with articles covering inventory valuation issues at Homeless Depot. Sadly, it's just accounting stuff.
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YOU MEAN I SHOULDN'T TAX YOU TO SUBSIDIZE YOUR COMPETITOR?
May 28, 2008
State 29 reports that Bettendorf is beginning to see the folly of directing tax breaks to favored businesses. The news hasn't moved west to Cedar Rapids, apparently.
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HEAD SHRINKER, SHRINK THINE OWN HEAD
May 28, 2008
Tennessee clinical psychologist will be on the receiving end of some behavior modification therapy courtesy of the IRS. Considering the poor judgment he used in his tax planning, some sort of treatment seems warranted. From Chattanoogan.com:
Authorities said Gregory J. Williams has agreed to enter a guilty plea to making a false income tax statement.He faces up to three years in prison and a fine up to $100,000 as well as restitution of $158,665 for tax years 200-2005.
Prosecutors said in 1998-1999, Williams' aunt began talking to him about the fallacies of the federal tax system. She provided him anti-tax literature and brought some individuals to his home to discuss anti-tax issues.
Always trust tax content from your aunt. She may not know what she's talking about, but she loves you!
Prosecutors said these included a group called Global Prosperity as well as the Haggerty Trading System. Williams became convinced to become a non-filer, it was stated.
Global Prosperity? Strike one.
About 2003, Williams became involved with Eddie Kahn, who founded the Guiding Light of God Ministries, which offered to handle his correspondence with the IRS.
Hire Wesley Snipes' tax advisor? Strike two.
In 2004, he obtained a book written by Pete Hendrickson entitled "Cracking The Code."
He swings at a pitch far off the plate. Strike 3.
Mr. Williams has pleaded guilty to filing a false return. If the tax loss is the $150,000+ indicated in the story, federal sentencing guidelines indicate a 21-27 month enforced residential treatment program.
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0% CAPITAL GAIN RATES?
May 28, 2008
It's true! The Wandering Tax Pro has details.
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APPLICABLE FEDERAL RATES (AFR) ISSUED FOR JUNE 2008
May 28, 2008
The IRS has issued (Rev. Rul. 2008-28) the minimum interest rates for loans made in jUNE 2008:
-Short Term (demand loans and loans with terms of up to 3 years): 2.08%
-Mid-Term (loans from 3-9 years): 3.20%
-Long-Term (over 9 years): 4.46%
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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HELPING TORNADO VICTIMS
May 28, 2008
A reader asks how to help the tornado victims in Northeast Iowa. I know the Salvation Army is there operating four feeding stations; you can donate to them at www.salvationarmy.org; specify "Iowa Tornado Relief." The Des Moines Register has more relief information.
UPDATE: The Des Moines Business Record reports:
The Iowa Concern Hotline is collecting information from people who want to donate goods or services to help victims of tornadoes that struck Sunday. To have items included on a list of donated goods, call (800) 447-1985. The information will be compiled in a database that will be used to direct items where they are needed. Please note that the Iowa Concern Hotline is gathering information only. It asks that people do not attempt deliver items to storm damaged areas
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WELCOME TO PARKERSBURG
May 27, 2008
A former employee forwards this picture of her in-laws' home in Parkersburg, Iowa:
A description of the scene:
The entire house was leveled except for one closet. In the closet was a box of glass angels. Not a single one was broken. Yet one of their cars was in their living room and the other one was down the street a half a block.
Awful. Our thoughts are with those who have to put their lives back together in Northeast Iowa.
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WE CAN'T MOVE HOMES WE ALREADY HAVE. LET'S SUBSIDIZE SOME MORE!
May 27, 2008
The Des Moines Register has an article from another world today - a world where there are no unsold houses and unrented apartments, and the huddled masses mob real estate offices every time another home is listed for sale. In that world, we need government subsidies to help these poor underhoused folks:
The national credit crisis is shrinking the market for tax credits - key to financing affordable housing - and threatening projects in Iowa, officials say.Here's why: The investors who bought the tax credits in the past - many large banks and finance companies like Freddie Mac and Fannie Mae - are posting losses from failing subprime mortgages and no longer need credits to reduce their federal tax liability.
That means less money - or possibly no funding - for some tax-credit housing projects, especially developments in rural Iowa or those with niche markets like renters with disabilities.
Meanwhile in the world the rest of us live in, one of the largest home developers in the area has shut down because it couldn't move its inventory fast enough, Downtown is full of empty loft apartments, and Des Moines area apartment vacancies are at some of the highest levels in years:
Source: CBRE January 2008 Apartment Survey
Yet we're supposed to believe we need to subsidize more homebuilding right now, and that the devalued credits are somehow a problem for the rest of us.
The article notes that one of the tax credit developers is well-connected state senator Jack Hatch. Not that tax credits are an insiders game or anything.
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EAGLES IN ORANGE JUMPSUITS
May 27, 2008
A few years ago anti-tax author Lynne Meredith was sentenced to prison for involvement with tax evasion schemes. Last week one of her loyal readers had his turn in a federal appeals court.
James Ellet read Ms. Meredith's opus "Vultures in Eagle's Clothing: Lawfully Breaking Free from Ingnorance Related Slavery." Note the clever "IRS" in the title. From the Second Circuit opinion:
Ellett sought to persuade the jury that the prosecution did not prove the willfulness element of tax evasion, because he sincerely believed that, as a native of one of the 50 states who worked for a private employer, he was exercising a "nontaxable right" to engage in labor. Ellett testified that he formulated this belief by reading portions of Vultures in Eagle's Clothing at least one hundred times and by spending hours researching the topic in a law library.
No matter how closely you study something stupid, it remains stupid.
The Second Circuit rejected Mr. Ellet's appeal, which was based on the idea that he should have been allowed to litigate his tax liability in the civil courts before being prosecuted. This case is a sad illustration of how much damage foolish tax protester theories can cause.
Cite: United States v. Ellett, No. 07-3862-CR
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MAULED AGAIN
May 27, 2008
Prof. Maule has posted a new installment in our friendly debate over the government's role in the economy. He says:
Thus, though I object to government intervention to help professional sports owners build stadiums (see Tax Revenues and D.C. Baseball), and to rescue a film industry segment, I think it is necessary for a government to step into a market and preserve its freedom when the market fails to deliver food, fuel, and other essential goods. Given the choice between a market hijacked by speculators, cheaters, shoddy artisans, defective manufacturers, cronyism-afflicted traders, and others whose greed surpasses their respect for the market's consumers, and a market patrolled by representatives of the citizenry, I'll opt for the latter.
Unlike me, Dr. Maule believes that the "representatives of the citizenry" won't just make things worse. But they pretty much always do.
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SEP-TIC FAILURE
May 23, 2008
Simplified employee pensions, or SEPs, are a very handy way for a self-employed taxpayer to shelter money for retirement. They require minimal paperwork, they can be set up as late as the exteneded due date of your tax return, and they can enable a self-employed taxpayer or a small corporation to avoid tax on up to 25% of business income just by saving for retirement.
Once you have employees, though, SEPs aren't nearly as useful, as you have to treat all employees as generously as yourself. Aaron D. Brown learned this lesson the hard way in Tax Court this week.
Mr. Brown set up a SEP through the Vanguard Group for the employees of his S corporation, Aaron D. Brown Mortgage, Inc. The corporation had two employees: Mr. Brown and his wife, Leslie Brown. The company made a $7,200 2003 contribution to Mr. Brown's SEP-IRA in April 2004, and the corporation deducted the $7,200. When the IRS noticed that Mrs. Brown didn't also get a SEP contribution, they disallowed the deduction for the contribution to Mr. Brown's SEP, because all employees have to share in SEP contributions.
The taxpayers tried to salvage the deduction:
Petitioners argued at trial that they have been caught by a mere "technicality". The Court disagrees with petitioners' contention that the failure of the corporation to contribute to an IRA in favor of an employee, Mrs. Brown, was a mere technicality. The requirement, aimed at fairness and equitable treatment for employees, is one of the few basic provisions of the SEP regime.Even if the provision could fairly be characterized as a "technicality", it is one that was brought to the attention of the president of the corporation, Mr. Brown, more than once in the agreement. Mr. Brown, as president, signed and agreed to the provisions contained in the agreement, including the requirement that each employee receive from the corporation a contribution to his or her IRA.
The tax law is nothing but technicalities, especially in the pension area; ignore them at your peril.
No doubt Mrs. Brown was thrilled that the Tax Court defended her interest in her employer's fairness and equity by disallowing the SEP deduction for their joint return.
Cite: Brown, T.C. Summary Opionion 2008-56.
Related: The Audacity of Paying More Taxes than Necessary
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COOKING ON GAS
May 23, 2008
Dodgy tax preparers like to take big credits for off-road fuel use. They identify themselves to the IRS by getting a tad aggressive.
A federal court last week barred Grace Macholko, proprietress of "Fast Income Tax Services" of Dallas, from preparing tax returns, largely because she gave her clients large fuel credits they hadn't earned:
In one example alleged in the government complaint, Machoko claimed that a customer, reportedly a cook, purchased 53,000 gallons of gasoline for off-highway business use in 2005. The customer, whose total reported income for the year was $1,571, would have had to spend approximately $116,000 (assuming $2.20 per gallon) to purchase that volume of gasoline.
With her profound understanding of economics and tax law, Ms. Machoko's talents are wasted as a preparer. She should be a senator.
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BOGGLING A BOONDOGGLE
May 23, 2008
This Congress can't even get a boondoggle right.
In a frenzy to override the expected veto of the grotesque farm bill, the Congressional leadership sent the President a copy of the bill that was missing 34 pages. The President vetoed the bill, and Congress was so busy to get on with taking your money and giving it to millionaires that they overrode the veto of a bill that was never properly sent to the President in the first place. Way to go!
What a bunch of boobs. These are just the folks we should trust with more control of our lives and livelihoods. Let's start with energy and health care...
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WHY OUR $25,000 LEGISLATORS AREN'T MILLIONAIRE INVESTMENT BANKERS
May 23, 2008
Defenders of "economic development" tax credits sometimes will cite some business in Iowa as living proof that the credits are more than a waste of money. But common sense should tell you that part-time state legislators and full-time bureaucrats aren't likely to be very good at making business investments.
In a fine post on the failure of Wells Dairy to meet its "job creation" goals, State 29 lists some great moments in economic development:
Several years ago, the State of Iowa funded the Iowa Agricultural Finance Corp, which was supposed to be this venture capital-like fund exclusively for Iowa businesses that had ties to agricultural-related businesses. It should have been a hit, right? It has been a disaster. Take a look at this PDF and see what it "invested" in:* Rudi's Organic Bakery. $13 million. Failed and moved to Colorado.
* Wildwood Harvest. $7.1 million. The company has never generated a profit.
* ProdiGene. $6 million. No employees in Iowa. "Struggled" and was fined by the USDA.
* Sioux-Preme Packing Company. $5 million. Profitable. Acquired in 2006 by Hilco Equity, a company out of Chicago, Illinois.
* Iowa Quality Beef. $3 million. Shut down in 2004 and 540 employees laid off.
* Ag Waste Recovery Systems. $150,000. No sales, no employees, and is considered an "idle corporation".
If a business can't attract private funding, there's probably a good reason for it. The state shouldn't compete with private lenders and it shouldn't bankroll losers. You can't grow an economy by taxing your existing businesses to lure and subsidize competitors. If you want to understand why tax credits are the same as subsidies, go here.
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EIN VOICE
May 22, 2008
The Des Moines Partnership, our local chamber of commerce, has a newsletter, "One Voice." The newsletter title is vaguely creepy, with its implied message to those who disagree with the Partnership's priorities to shut up and get with the program.
The newsletter title is apparently inspired by this part of the Partnership's mission statement:
All of this creates a true partnership between business, government, and the public, so we can pursue our economic and community betterment goals with one voice, one mission, one focus.
Sounds familiar. I wonder if they have posters.
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I DIDN'T KNOW 'HEART' WAS PATAGONIAN
May 22, 2008
Great story and picture placement from today's desmoinesregister.com email newsletter.
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THE LAW FOUGHT THE TAX LAW; THE TAX LAW WON
May 22, 2008
A police officer's target practice deduction misfires in Tax Court:
Petitioner claimed deductions for the cost of ammunition and for target range fees. Petitioner was required to maintain a certain skill level with his weapon. Petitioner could have used the district gun range at no cost, but he sometimes practiced at private practice ranges. Petitioner failed to explain why he chose to spend money at a private range when he could use a district gun range for free. Petitioner is not entitled to a deduction for fees paid to private target ranges since he has not established that the expense is ordinary and necessary.The Court is satisfied that petitioner was required to purchase ammunition as part of his employment as a police officer. Although petitioner failed to provide details as to the exact amount of this expenditure, the Court will allow petitioner $65 for this item.
$65? Unless you're a reloader, you aren't going to get much practice in for $65.
Cite: Snead, T.C. Summary Opinion 2008-57
Russ Fox has more.
Flickr image by kcdsTM
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AN ARGUMENT FOR A 'ROTH' IRA AND 401(K)
May 22, 2008
With "Roth" IRAs and 401(k)s, you forego a current tax benefit for your contribution to a retirement account in exchange for being able to make retirement withdrawals tax-free. Your implied bet is that you will get a bigger benefit from future tax-free withdrawals than you would from deducting your contribution now. If your tax rates are likely to be higher at retirement than today, it favors a Roth plan.
Greg Mankiw has a piece that makes the Roth plan sound like a good bet. He quotes a letter from the Congressional Budget Office:
With no economic feedbacks taken into account and under an assumption that raising marginal tax rates was the only mechanism used to balance the budget, tax rates would have to more than double. The tax rate for the lowest tax bracket would have to be increased from 10 percent to 25 percent; the tax rate on incomes in the current 25 percent bracket would have to be increased to 63 percent; and the tax rate of the highest bracket would have to be raised from 35 percent to 88 percent. The top corporate income tax rate would also increase from 35 percent to 88 percent.
The farm bill boondoggle isn't going to help any.
If the betting markets are any indication, we won't have to wait long for higher rates.
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YIN: TEMPORARY TAX PROVISIONS ARE GOOD
May 22, 2008
George Yin, the former chief of staff of the Joint Committee on Taxation, makes an unusual argument. Guest-blogging at Tax Vox, Mr. Yin argues that temporary tax provisions are a good thing:
Consider, for example, the research credit, first enacted in 1981 for a temporary period and generally extended for only one or two years at a time ever since. By passing and continuing the program in temporary increments, Congress has had to take its cost into account for every one of its over 25 years of existence. Each year the credit has been due to expire, Congress has had to determine how to “pay for” its continuation. Even when Congress has simply let the deficit swell and not paid for the continuation, the cost of the program has no doubt crowded out other Congressional spending.If, instead, the program had been first enacted on a “permanent” basis, the cost of continuation would have disappeared long ago off of the Congressional budget radar screen. The program’s cost, about $8 billion per year, would simply be part of the “baseline” cost of maintaining current law and not require any Congressional approval.
This argument would be more convincing if Congress had ever actually decided "hey, we just can't afford the extenders this year. We'll skip them and save the money!" It just doesn't happen. The congresscritters have no intention of letting them expire. But by only passing them for a year at a time, they conceal the true cost of the provisions under Congressional accounting rules - a set of rules that makes Enron accounting look prudent and responsible.
But while I disagree with Mr. Yin's point, I'm glad he is finally taking some good advice.
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'AEGIS' TRUST PROMOTERS CONVICTED
May 22, 2008
Six promoters of the "Aegis" scam trust scheme have been convicted of tax fraud conspiracy charges. According to press reports, over 600 wealthy taxpayers were conned into the scheme, which used offshore trusts to illegally conceal taxable income. One unhappy customer was the founder of the Hooters restaurants.
The Tax Prof and A Taxing Matter have more. You can view the original indictment here.
The Moral? If you believe it when someone offers to magically hide your income offshore, you may need to bring the income back onshore to pay your lawyers someday.
.
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LLC S CORPORATIONS: A BAD IDEA?
May 21, 2008
While limited liability companies are normally taxed as partnerships, you can elect to have them taxed as corporations. If you want to have the LLC be an S corporation, with its income taxed to its owners, the LLC operating agreement can't violate the "one class of stock rule" that requires S corporation shares to all have the same economic rights.
Marc Ward says that could be a problem:
An LLC will be treated as having only one class of "stock" so long as the governing provisions of the LLC (primarily the articles of organization/certificate of organization and the operating agreement) provide that all of the outstanding membership interests/transferable interests "confer identical rights to distribution and liquidation proceeds." Lackadaisical drafting of the operating agreement or over reliance on forms can lead to unfortunate results in this regard.
These "unfortunate results" could include retroactive loss of S corporation status and years of back corporation tax payments.
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WATCHING THE DETECTIVES
May 21, 2008
A decorated Washington D.C. homicide detective was smart enough to crack tough murder cases, but not smart enough to stay away from tax protester arguments. Now he's going to get acquainted with the results of law enforcement himself.
Michael C. Irving served 18 years with the D.C. police force. Apparently he learned tax protester arguments from another member of the force and began to de-tax himself, declaring himself exempt from withholding and filing zero tax returns. Long story short, he was convicted on two felony tax evasion counts last week.
The moral? If your work buddy says you don't have to pay taxes, that won't help much when the IRS disagrees.
Links:
Department of Justice Press Release
Federal Crimes Blog
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TAX COURT TO DIVORCED DAD: NO 8332, NO DEPENDENCY EXEMPTION
May 20, 2008
William Ward's divorce settlement gave his ex the kids, but gave him the dependency deductions for his two kids as long as he was current on his child support. Mr. Ward kept current on the paymments, but when tax time came around for 2004, his ex wouldn't sign Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. In fact, she claimed the kids on her own return.
Yesterday the Tax Court ruled that he is just out of luck, as far as the tax law is concerned.
Although a separation or divorce agreement stating that the dependency exemption deduction belongs to the noncustodial parent and containing the custodial parent's signature may serve as an equivalent to Form 8332 in certain circumstances, the agreement here does not meet the requirements of section 152(e)(2). In particular, petitioner's ex-wife makes no agreement not to claim the dependency exemption deduction herself.
The Tax Court said that the dependency exemption is conditioned on his staying current on the child support; as long as his entitlement to the exemptions is subject to a condition, he can't claim it without an 8332.
The Tax Court noted that he had gone to family court and forced the ex to pay him the value of the exemptions in cash. If she holds out on the 8332 again, he'll have to go back to family court, rather than Tax Court.
Cite: Ward, T.C. Summ. Op. 2008-54
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ANOTHER GOOD REFERENCE FOR AMERICAN RIGHTS LITIGATORS
May 20, 2008
Kenneth Heath, a Michigan engineer, read Irwin Schiff's book and decided he didn't need to pay taxes. When the IRS came after him, he turned to American Rights Litigators and Guiding Light of God Ministries -- outfits run by Eddie Kahn, who also served as Wesley Snipes' de-taxing advocate. Like Mr. Snipes, he tried to buy off the IRS with worthless "bills of exchange."
And like Mr. Snipes, he's going to federal prison. The Sixth Circuit Court of Appeals upheld his 21-month sentence yesterday.
Cite: U.S. v. Heath, No. 07-1215
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TOUR DE FORBES
May 20, 2008
Janet Novack has two pieces in the new issue of Forbes that deserve careful reading.
Read My Lips discusses the Presdiential candidate tax positions:
As president, Senator John McCain (R–Ariz.) aims to balance the budget while extending the Bush-era income tax cuts, doubling the personal exemption and eliminating the alternative minimum tax. The Democratic candidates say they’ll raise taxes only on the well-off—those making over $200,000 for Senator Barack Obama (D–Ill.) and $250,000 for Senator Hillary Clinton (D–N.Y.)—while showering tax breaks and health insurance on working families. (At press time Clinton is still hanging in.)Anyone who believes any of this likely already owns Florida swampland.
The article also has thoughts on how to plan your investments around likely tax policy changes in the next administration.
Tax Shelters 2.0 tells how the IRS tax shelter crackdown has gotten the national accounting firms out of the retail tax shelter market, opening the door to smaller operaters, often using twists on the same old discredited schemes. Buyer beware.
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BUT IT'S WORTH A TRY!
May 20, 2008
"You'd have to download a lot of iTunes, watch a lot of porn, and drink a lot of beer to raise $20 billion."
- David Brunori on efforts to close the $20 billion California budget gap ($link).
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KENTUCKY V. DAVIS ROUNDUP AT TAXPROF BLOG
May 20, 2008
Paul Caron has analysis and a media roundup of yesterday's Supreme Court decision allowing states to discriminate in favor of their own municipal bonds.
I like this from Gregory Germain's analysis in the TaxProf post:
The decision found common cause between the Court's most liberal and the most conservative justices in agreeing that the dormant commerce clause simply does not apply to traditional state and municipal activities. In fact, Justice Souter, a master in the art of sophistry, contended that the local municipal bond market should be viewed as entirely separate from the market for interstate municipal bonds. As so viewed, there would be no discrimination taking place in the locally-defined market. This theory, which defines the relevant market without regard to the economic motives of those engaged in the market, escapes me. But the broader argument, recognizing that the dormant commerce clause simply does not apply to the traditional functions of governmental entities, is entirely consistent with the holding first advanced last term in United Haulers.
And this:
Only three justices agreed with Justice Souter's contorted (and unnecessary) attempt to apply the old market participant exception to Kentucky's bond issuance activities. I commend this portion of the opinion to those who enjoy reading a detailed analysis of how many angels can dance on the head of a pin.
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SUPREME COURT: STATES CAN FAVORABLY TAX THEIR OWN MUNI BONDS
May 19, 2008
As expected, the Supreme Court today ruled that states may tax their own municipal bonds more favorably than those issued by other states.
Link: Department of Revenue of Kentucky v. Davis.
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QUESTING AFTER PINNACLES
May 19, 2008
The IRS has won a prelimnary injunction against "Pinnacle Quest International," a multi-level marketing organization alleged to have sold fraudulent tax schemes and tax protest scams via conferences on luxury cruise ships.
We first covered Pinnacle Quest here.
The name reminds me of my typical golf outing, where I am questing after a Pinnacle in the trees somewhere. Such quests are seldom successful.
Link: Copy of Preliminary Injunction
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DON'T KNOW MUCH ABOUT AGI
May 19, 2008
The TaxProf and the Tax Policy Blog make sport of both the Denver Post and Colorado senator Ken Salazar for his cluelessness on how a tax return works.
The Denver Post quoted the senator as saying:
Sen. Ken Salazar, a Denver Democrat who supports the bill, disputed the idea that it pays rich farmers. The bill allows payments to farmers with adjusted gross incomes of $750,000 or less.That number doesn't take into account deductions for the cost of running a farm, Salazar said.
"A farmer with an adjusted gross income of $750,000 might be losing his shirt" after paying for fuel, a new tractor and other expenses, Salazar said.
The story failed to note that the senator is exactly wrong; AGI is computed after farm expense deductions, as a glance at page one of a tax return will show. It's amazing that such an item could slip through, given the layers and layers of fact checking in a big newspaper. Almost as amazing as the idea that one of the 57 states could elect a senator who doesn't even understand his own 1040.
Farm "income or (loss)," Line 18, goes into AGI, line 37. Click to enlarge
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CHEATING
May 19, 2008
From Russ Fox's weekend roundup of tax cheats:
- The Florida preparer who went the extra mile for her clients by inventing deductions for them, and
- The Arizona preparer who eased his clients tax problems by stealing their money. No money, no problems.
Also, Tax Grrrl tells the touching story of the Maryland woman who provided vocational training for convicts: she used them to help claim phony tax refunds. It's nice to know that somebody is preparing inmates to return to parasitical lives on the outside.
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TAX ID NUMBERS - THE FAQ
May 19, 2008
Joel Shoenmeyer covers the basics of getting and using a tax identification number at Death and Taxes.
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HAVE A NON-TAXING WEEKEND!
May 16, 2008
The Principal building, 801 Grand, looms over Nationwide's Walnut Street building in Downtown Des Moines.
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IRS SNATCHES BACK ISO-AMT REFUND
May 16, 2008
Incentive Stock Options are a textbook case of grim unintended consequences from a tax break. Unlike regular "non-qualified" stock options, ISOs don't generate taxable salary income when they are exercised; if you hold on to them for one year after exercise and then sell them, any gain you have is long-term capital gain, taxed at preferential rates. This is supposed to be a tax break.
But there's a catch: the "bargain element" on the ISOs - the difference between their value and the price paid to exercise the options - IS taxable for alternative minimum tax in the year the option is exercised, even if the stock received on exercise isn't sold. If the stock becomes worthless between the exercise date and the sale date, the taxpayer pays AMT when the stock is exercised, but can only take the loss on the sale to the extent of other capital gains, plus $3,000 per year. Taxpayers have argued that there should be an AMT "net operating loss" rather than a capital loss, so that they could retroactively recover the AMT through an NOL carryback, but the Merlo decision rejected that argument.
The McLeod nightmare ISOs
This problem became all too real for many employees at McLeod Communications in Cedar Rapids -- perhaps most famously, Ronald Speltz.
Another McLeod employee, Bryce Nemitz, attempted to use the NOL carryback argument. Mr. Nemitz sold McLeod stock he had received from exercising ISOs in 2001. McLeod stock had tanked, so he had a huge loss compared to the amount he had to pay AMT on. On an amended 2001 return filed in November 2002, he computed an NOL that he carried back to 1999 and 2000. Things went well at first, as the IRS issued him carryback refunds of $53,942 for 1999 and $1,476,656 for 2000. Then the IRS realized what it had done and asked for the money back.
Did the IRS assess too late?
By the time the case reached Tax Court, the Merlo decision settled the issue of whether a loss on the sale of ISO shares could generate a net operating loss, rather than a capital loss ("no"). Mr. Nemitz tried to save the day by arguing that the IRS had asked for the money back too late, missing the three-year statute of limitations.
The IRS pointed out that assessments can be made on erroneous net operating loss carrybacks, the statute of limitations runs out three years after the filing of the return that generated the loss to be carried back - in this case, the 2001 return, under Code Sec. 6501(h).
Not really an NOL claim?
Mr. Nemitz argued that the refund was governed by Sec. 6501(a), the usual three-year statute of limitations for timely-filed returns, which would have expired for 1999 and 2000 by the time the deficiency notice was issued in 2005. He cleverly argued that since the amount carried back turned out not to qualify as an NOL under Merlo, it wasn't really an NOL, and so it didn't trigger the extended NOL statute of limitations. He also argued that the special NOL carryback statute applied only to regular NOLs, not AMT NOLs.
The Tax Court didn't go for either argument. Regarding the "it wasn't really an NOL" point, the court said:
The record establishes, and we have found, that petitioners claimed a net operating loss, and not a capital loss, for AMT purposes in the 2001 amended return and that they carried back that net operating loss for AMT purposes in the 1999 amended return and the 2000 amended return.
In other words: you claimed it as an NOL and the refund was erroneously issued as a result of the NOL claim, so the NOL statute applies.
Then the court addressed the claim that the special NOL statute only applies to "regular" losses:
As we understand it, petitioners are arguing that, because section 6501(h) refers only to a net operating loss carryback, and not to a net operating loss carryback for AMT purposes, that section does not apply to the deficiency for each of their taxable years 1999 and 2000 that is attributable to the carryback to each of those years of the net operating loss for AMT purposes that they claimed in the 2001 amended return.Section 6501(h) applies in the case of a deficiency attributable to the application of a net operating loss carryback. The only provision in the Code that allows a net operating loss carryback is section 172(b). That section, which is entitled "Net Operating Loss Carrybacks and Carryovers", allows, inter alia, a taxpayer to carry back a net operating loss. Section 172(b) does not refer to, or distinguish between, a net operating loss for regular tax purposes and a net operating loss for AMT purposes. See Plumb v. Commissioner, 97 T.C. 632, 638 (1991). That section provides rules that apply to both the carryback of a net operating loss for regular tax purposes and the carryback of a net operating loss for AMT purposes. .
Like section 172(b), section 6501(h) does not refer to, or distinguish between, a net operating loss for regular tax purposes and a net operating loss for AMT purposes. If Congress had intended that section 6501(h) not apply with respect to the carryback of a net operating loss for AMT purposes, it would have so stated. It did not.
Bottom line: Mr. Nemitz has to pay back over $1.5 million to the IRS, in the hopes of getting some of it back over time under the relief provisions enacted in late 2006 for ISO victims.
The case has a sad note aside from the woeful consequence to the taxpayer; it was one of the last cases argued by our friend Burns Mossman, who died last year. It made me misty-eyed to see his name at the top of the opinion. If Burns couldn't pull it out, I'd say it was hopeless to start with.
Cite: Bryce E. and Michelle S. Nemitz, 130 T.C. No. 9.
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YOU CAN TELL IT'S A BAD DAY WHEN...
May 16, 2008
It can't be a good sign for a taxpayer when his Tax Court judge starts his opinion with a history of the taxpayer's record of failure in Tax Court:
John Green has not had much success in Tax Court. In 1993, Green wanted to escape paying income tax on money he’d embezzled ten years earlier, claiming he was exempt because he is a Native American. We held him liable for both the tax and penalties.
Sure enough, things went downhill from there for Mr. Green. Russ Fox has the gory details.
Cite: John O. Green, T.C. Memo. 2008-130
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WHAT TO DO ABOUT SCREWED-UP REBATE CHECKS?
May 16, 2008
So not only has the IRS miscalculated the amount of Uncle Sugar's Crazy Fun Bux rebates, it has sent a good chunk of them to the wrong accounts. If you haven't gotten yours, IRS says to trust them, you'll get yours. If you've gotten somebody else's rebate, and you spend it, you get yours, too -- good and hard, according to the IRS.
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STUPID IS AS STUPID DOES
May 15, 2008
"IRS says up to 350,000 tax rebate checks wrong".
Bad ideas, badly executed. Bipartisanship at work!
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WEB SITES FOR SALE: THE MORE YOU PAY, THE MORE YOU DEDUCT?
May 15, 2008
The retail cattle feeding tax shelters of the 1970s used a simple scheme to generate deductions: Sell a cow worth $500 for $5,000 (heck, $10,000 - who cares?) to the tax shelter - but accept a non-recourse note from the shelter as payment. The shelter would then depreciate the $10,000 "cost" of the the cow, but with no intention of ever paying off the note.
Now comes word from Virginia of a new economy twist on this old scheme involving Virginia CPA John T. Hoang:
The complaint alleged that Hoang, through his company Tax Smart Technology Services, sold customers Web sites worth almost nothing. But the sales contracts between Tax Smart and customers falsely stated that the Web sites were worth tens of thousands, hundreds of thousands or even millions of dollars. Hoang then allegedly prepared customers’ federal income tax returns, improperly using the false values to claim large depreciation deductions. The lawsuit asserts that Hoang used offsetting sham promissory notes to create the appearance of sales of valuable assets, while in reality customers paid Hoang a small sum and Hoang then provided customers a worthless Web site and a large tax deduction. The government complaint estimates that the harm from Hoang’s misconduct exceeds $6.1 million.
Mr. Hoang has now consented to a permanent injunction barring him from preparing returns or promoting this scheme.
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THE MCCAIN TAX PLAN
May 15, 2008
Roni Deutch profiles John McCain's tax proposals. There are a lot of items that are sensible there, but there's also this:
The more revolutionary aspect of his plan is the offering of an optional flat tax system. This system would be held out as an alternative to the current progressive system and the myriad of credits, exemptions, deductions, carryover rules, and different tax rates for different forms of income. McCain’s plan would be to tax all taxpayers on all income sources at one single rate. The flat rate would be set at 19% for first two years, 17% thereafter.
Optional flat taxes are just weird. In real life everyone would compute their tax under the "regular" and optional systems and pay the lower amount. That way we could do taxes three ways:
1. The current regular tax;
2. The Alternative Minimum Tax, and
3. The optional flat tax.
Oh, joy.
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MORE GREAT MOMENTS IN ECONOMIC DEVELOPMENT
May 15, 2008
The Tax Policy Blog notes a new Michigan tax credit "for Construction of Entertainment Complexes," noting that "Tax credits for the construction of entertainment complexes are ridiculous."
That must be why Des Moines and Polk County skipped the tax credits and went with direct subsidies instead.
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WHY TAX CREDITS ARE THE SAME AS SPENDING
May 15, 2008
Daniel Shaviro has a concise explanation:
My favorite example of the core point made by tax expenditure analysis remains one that I got from David Bradford. Let's cut both taxes and spending by $50 billion, David pretended to urge, by zeroing out $50 billion of military spending (to buy advanced weapons) and enacting instead $50 billion worth of "tradable tax credits" that would go to the very same weapons suppliers for the very same weapons. At the end of the day, everything would be exactly the same, but taxes and spending would each be reported as $50 billion lower. Without a tax expenditure concept, it is hard to show as crisply that nothing in this scenario has genuinely changed.
State economic development tax credits work exactly the same way. It's money that the state takes from some taxpayers to give to their friends. And if you think the politicians in Des Moines are smart enough to invest taxpayer money in private businesses, why aren't they millionaire venture capitalists instead of $25,000-per-year legislators?
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HOW TO APPROACH CORPORATE WELFARE
May 14, 2008
The Mall of America wants a subsidy. Some wise perspective from James Lileks:
It’s come to this: unless the state gives the Mall of America more money to build a new addition, it won’t get built.Well, don’t build it, then.
See? That’s not so hard. I understand that there are other markets that would love to have the Mall of America, and some day soon we may behold the distressing sight of the Mall jacked up, put on trucks and moved to Iowa, but if you can’t afford to build an addition without state money, perhaps the fundamentals of the proposal aren’t sound.
I just hope that this doesn't give Iowa's economic development people any ideas. Mike Tramantino may already be trying to locate a mall-moving service.
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IRS GOES FORWARD WHERE IOWA DEPARTMENT OF REVENUE CHICKENS OUT
May 14, 2008
In 2005 and 2006, the Iowa Department of Revenue web site had a system that enabled taxpayers and their advisors to access taxpayer account information. It a great too for confirming estimated tax payments when preparing tax returns. In our practice, taxpayer errors in estimated taxes - forgetting payments they made, or reporting payments that weren't made - generate more taxpayer notices than any other cause. The website easily prevented hundreds of tax return errors, and notices, statewide.
Iowa shut down this feature for this year's tax season. The Department director cites information security concerns in defending this decision. Now it looks like the IRS is going where Iowa fears to tread. Tax Analysts reports ($link):
Taxpayers will be able to access their personal account information on the IRS Web site by the fall, an IRS official said during a May 13 IRS Tax Talk Today webcast.Beth Jones, the director of electronic products and services support in the IRS Wage and Investment Division, called the creation of the "my IRS account" service "a big step."
Maybe a successful federal program will cause Iowa to reconsider.
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IGOR SELLS HIS BANKERS?
May 14, 2008
Last month we noticed that California billionaire Igor Olenicoff stands to get a laughably light sentence after pleading guilty to a filing false returns in a tax scheme involving $52 million. Now comes news that the bankers who helped the Newport Beach real estate mogul with his scheme have been indicted on federal tax charges. The Wall Street Journal reports:
As part of a widening probe, the U.S. has charged a former UBS AG banker and a Liechtenstein consultant with helping clients avoid taxes by opening secret bank accounts, destroying documents, using Swiss credit cards and filing false tax returns.One client was billionaire California real-estate developer Igor Olenicoff. Mr. Olenicoff set up a web of secret bank accounts in Switzerland and Liechtenstein to avoid taxes on $200 million in assets, a person familiar with the U.S. case said. Mr. Olenicoff has been cooperating with investigators in the wake of his December guilty plea to a criminal count of filing a false 2002 U.S. tax return. He was ordered to pay $52 million.
The story also provides a hint on why Mr. Olenicoff may face a light sentence:
The case could lead to other U.S. clients: The indictment says the two financiers -- former UBS private banker Bradley Birkenfeld and Liechtenstein financial adviser Mario Staggl -- courted rich Americans and helped some of them avoid paying taxes.
So Mr. Olenicoff's cooperation might be leading the IRS to other rich tax evaders, as well as their enablers. This could get interesting.
The TaxProf has a big-media roundup and a link to the indictment.
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SMALL CHARITIES: TOMORROW IS YOUR DEADLINE
May 14, 2008
A new deadline looms tomorrow for many charities. Non-profits with annual receipts under $25,000 have never had to make annual filings with the IRS -- until now. From an IRS release:
Beginning this year, most organizations whose gross receipts are normally $25,000 or less must file Form 990-N, also known as the e-Postcard. Previously these small organizations did not have an annual filing requirement."The e-Postcard is fast and easy. An organization just quickly answers a few questions online," said Steven T. Miller, Commissioner of the Tax Exempt and Government Entities Division of the IRS. "It’s free, totally paperless and will help ensure integrity and transparency in the tax-exempt community."
To file your "e-postcard" by the May 15 deadline, go here.
Larger charities and foundations who file on a calendar year also have to file their 990-series forms by tomorrow, unless they get an extension.
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NO DO-OVERS WHEN THE SWAP TAKES TOO LONG
May 13, 2008
A reader poses a Section 1031 problem:
After selling property using a qualified escrow arrangment, Taxpayer A contracts to purchase replacement like kind property. The contract requires the seller, Taxpayer B, to replat the property, but that doesn't happen and the deal doesn't close in 180 days.Can Taxpayer A get an extension of his 180-day deadline?
If you enter into a deferred like-kind "Section 1031" exchange, you have 45 days to identify replacement property and 180 days to close, or the exchange fails to qualify and the escrowed proceeds become taxable. Unfortunately for Taxpayer A, there are no extensions or do-overs. The sale of his original property is now taxable. He may or may not have a case against Taxpayer B under contract law, but as far as the tax law is concerned, he loses.
Link: IRS Fact Sheet on Like-kind Exchanges.
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WE THE TARGETED
May 13, 2008
Robert Schulz, head of the tax protest organization "We the People Foundation," says he has turned over to IRS the names of 225 people who received "legal termination of tax withholding" kits from the foundation. From PostStar.com:
Schulz, the founder of the We the People Foundation and We the People Congress, was ordered to provide the names, addresses, phone numbers and Social Security numbers of the people who received his "Legal Termination of Tax Withholding" -- a packet of information that purports to sh