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Tax Update Blog: August 2008 Archives

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August 29, 2008


It's the first weekend of high school football and marching bands. It's not official, but summer is over. But why is the color guard hiding their heads?

Have a great weekend, and see you at the halftime show!

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August 29, 2008

The TaxProf tells us that ISO-AMT victims will have a new reason to enjoy the long weekend:

Senate Finance Committee Ranking Member Charles Grassley today announced that he has secured a commitment from the IRS to suspend the collection of the AMT (including interest and penalties) arising out of employees’ exercise of incentive stock options. The suspension gives Congress time to enact legislation that would ease these burdens on affected taxpayers.

The entire ISO statute should be repealed - tax breaks and tax penalties alike. It's a relic of forgotten origins with no policy justification.

As for Senator Grassley's efforts to help the AMT-ISO victims - the good Senator has been on the Finance Committee since 1986 or so, and has had a hand in dozens of tax bills. It's good that he's working to fix a bad law, but it makes me think of this article.


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August 29, 2008

I have no idea whether she will be a good pick for McCain, but I do know that today nobody is talking about the Obama speech last night. That must be worth something to McCain.

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August 29, 2008

The IRS has announced (Rev. Rul. 2008-47) the interest rates for tax overpayments and underpayments for the quarter beginning October 1. The rates are as follows.

- Individual overpayments and underpayments: 6% (from 5%)
- Corporate overpayments: 5% (from 4%)
- Corporate underpayments: 6% (from 5%)
- Large Corporation underpayments: 8% (from 7%)
- Corporation overpayments > $10,000: 3.5% (from 2.5%)

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August 29, 2008

The Tax Policy Blog tells us "The Internal Revenue Code Would Fit on Approx. 80 Rolls of Toilet Paper." It might work better than Metamucil.

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August 29, 2008

We can see why St. Louis-area auto dealer James Auffenberg wanted the criminal trail arising from his Virgin Islands tax planning moved to St. Criox. A district court judge there dropped 11 of the 35 counts in his indictment this week. The dropped counts were those that depended on whether the Virgin Islands income was "effectively connected" with a Virgin Islands trade or business. The court ruled that the term "effectively connected" was too vague to enforce because regulations had not been issued under the special code section enacted to combat Virgin Islands tax avoidance, Section 934.

That seems like an odd assertion. The entire foreign tax credit scheme in the income tax is based on the concept of "effectively connected" income. If that's "void for vagueness," a lot of people are filing returns under void tax law.

The judge's decision is based on the last paragraph of Sec. 934(b), which reads:

The determination as to whether income is derived from sources within the United States or is effectively connected with the conduct of a trade or business within the United States shall be made under regulations prescribed by the Secretary.

The judge ruled that this meant the entire code section was inoperative until regulations were issued. Looking at the conference report issued when the section was enacted, it seems that's news to Congress (emphasis added):

The provision generally codifies the existing rules for determining when income is considered to be from sources within a possession by providing that, as a general rule, for all purposes of the Code, the principles for determining whether income is U.S. source are applicable for purposes of determining whether income is possession source. In addition, the provision provides that the principles for determining whether income is effectively connected with the conduct of a U.S. trade or business are applicable for purposes of determining whether income is effectively connected to the conduct of a possession trade or business.

If the section just applies existing principles, then what was the code section about "under regulations prescribed by the Secretary" about? The Conference report says this:

The provision also grants authority to the Secretary of the Treasury to create exceptions to these general rules regarding possession source income and income effectively connected with a possession trade or business as appropriate. The conferees anticipate that this authority will be used to continue the existing treatment of income from the sale of goods manufactured in a possession. The conferees also intend for this authority to be used to prevent abuse, for example, to prevent U.S. persons from avoiding U.S. tax on appreciated property by acquiring residence in a possession prior to its disposition.

So according to the Conference Report, the regulation authority of the Sectionn 934(b) is to carve exceptions and to prevent abuses, not to make the section effective in the first place. Now one might argue that committee reports mean nothing when they conflict the the plain language of the statute, but that doesn't seem to be case here. The term "effectively connected" is a fixture of the tax law; the Secretary already has extensive regulations defining "effectively connected" in other contexts. Congress here just applied it to a new problem - Virgin Islands tax schemes.

Mr. Auffenberg still faces serious tax charges, but I wouldn't be surprised if the IRS appeals this ruling just to to correct what looks like a legal error.

Cite: United States et al. v. James A. Auffenberg Jr. et al.; No. 1:07-cr-004

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August 29, 2008

Are you in pre-holiday mode? Maybe you're looking forward to a long lunch and a short afternoon, but you need to look busy now? Then visit the new Cavalcade of Risk at Healthcare Manumission! Among the worthy pieces in this roundup of insurance and risk management blog are an Insureblog post on the extra insurance risk of extra pounds and the Cavalcade host's piece on whether the "change we have been waiting for" is a change at all.


Lunchtime on Court Avenue, Des Moines

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August 28, 2008

The judge in the criminal case involving tax shelters marketed by KPMG dropped 13 defendants from the case last summer. Five defendants remained under indictment.

The Second Circuit court of Appeals in New York upheld the trial judge's decision today. The courts held that the defendants were denied their right to counsel when the Department of Justice pressured KPMG to not pay employee and partner legal fees.

Cite: United States v. Stein,, CA-2, No. 07-3042-cr.

Media Roundup:

NY Law Journal
NY Times

And the TaxProf has more.

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August 28, 2008

When we last saw tax protest figure Joe Banister in court, he had been acquitted of tax conspiracy charges by a California federal jury. Tax protesters did a little victory jig at this "evidence" that their theories are other than delusional.

As we've pointed out, beating criminal charges doesn't mean you don't have to pay the tax. The Tax Court demonstrated this to Mr. Banister yesterday. It appears that Mr. Banister, a former IRS agent and defrocked CPA, never got around to filing a 2002 tax return. The IRS computers noticed that Mr. Banister was issued 1099s for $23,325 pension income and $387 in interest income, and a notice of deficiency was issued.

Mr. Banister doesn't seem to have denied that he got the income; he instead tried to get off on technicalities, or something:

He argues that respondent (1) denied him proper due process -- including an Appeals conference -- before issuing the notice of deficiency; (2) denied him a proper notice of deficiency "based upon a true 'Deficiency'"; and (3) determined the deficiency incorrectly by failing to consider his "expenses, losses and deductions, and exclusions (both business and non-business)."

The Tax Court didn't buy it, not least because Mr. Banister never said what these "expenses, losses and deductions, and exclusions" were.

Given his prominence in the tax protest movement, it's a little surprising that the IRS doesn't seem to have done any more than a 1099 match examination of Mr. Banister. Perhaps he just lives frugally enough to get by on less than $24,000 in income.

Cite: Banister, T.C. Memo 2008-201.


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August 28, 2008

We were chatting about hobby losses recently. Yesterday we get a new case where a taxpayer got in trouble under the "hobby loss" rules of Section 183. This wasn't just any taxpayer; it was an IRS auditor.

Section 183 says you can't take business losses if you aren't really trying to make money. The Tax Court says the auditor's conduct made it look like he wasn't in it for the money:

Petitioner did not carry on his greyhound activity in a businesslike manner. He did not maintain complete and accurate books and records regarding his greyhound activity, did not maintain a written business plan, and did not contemporaneously prepare budgets or financial analyses for his greyhound activity. Although petitioner claims to have prepared a "cost analysis plan", at trial he acknowledged that this plan was prepared only in the course of the audit and examination of the tax years at issue. His substantiation of claimed expenses was spotty and consisted largely of some canceled checks supported by his vague testimony. He had no written contracts with the third parties who trained, hauled, and raced his greyhounds

The first sentence is the key: he didn't run his "business" in a "businesslike manner." If they way you go about an activity makes it look like you aren't even trying, you'll lose on an exam. Many multi-level marketers have learned this the hard way.

Our IRS auditor also got hit with penalties:

Petitioner has not shown (or even expressly claimed) that he had reasonable cause or acted in good faith with respect to his understatements of income tax. Any such defense appears especially problematic in the light of petitioner's employment as an IRS auditor.


Cite: Whitecavage, T.C. Memo 2008-203

The TaxProf has more.

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August 28, 2008

erk.jpgAn upstate New York chiropractor is the latest not-so-satisfied customer of tax-scam outfit "American Rights Litigators." John Weisberg received a 21-month sentence this week for charges arising out of tax advice purchased from ARL, founded by tax-protest figure Eddie Kahn.

Mr. Weisberg joins a list of clients who got more than they bargained for from ARL, including Michigan engineer Kenneth Heath (21 months) and actor Wesley Snipes (3 years). The founder of ARL, Eddie Kahn, has been sentenced to 10 years for his role in the Snipes case. says this of Mr. Kahn's tax practice:

Eddie Kahn of "American Rights Litigators" represents the Hee-Haw contingent of the tax protestor movement...Eddie caters to the dumbest of the dumb, and his theories for not paying taxes are thus the dumbest of the dumb.

The moral? Don't buy your tax advice from the man in the bolo tie.

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August 28, 2008

If you use your car for business, Bruce the Taxguy has some advice on keeping track of your business mileage.

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August 27, 2008

One of the requirements for a home mortgage interest deduction is, understandably, a mortgage. The lender needs to go down to the courthouse and file the appropriate documents to make sure the loan is secured by the home.

We can only hope that real banks do a better job of documenting their mortgage than the effort shown in a Tax Court case yesterday. A California couple claimed a $42,950 home mortgage interest deduction for 2003. They said they paid the mortgage interest to their wholly-owned corporation. The Tax Court Special Trial Judge Goldberg had some questions about the loan documents (emphasis added):

Petitioners attempted to have the Court receive into evidence a document entitled "Promissory Note Secured by Deed of Trust". This document recited a promise on the part of petitioners to repay California Digital, Inc., $450,000 at an annual interest rate of 9.544 percent. Upon examination of the document, the Court suspected that it was self-serving and inauthentic. To wit, although the paper was lightly affixed with a raised, notary's stamp, it appeared in all other ways (printed on an ink-jet printer; multiple grammar and spelling errors; undated on signature line; not witnessed or signed by the notary) to be a poor reconstruction of a purported promissory agreement between petitioners and their corporation, California Digital, Inc.

If you are forging a document, folks, is it too much trouble to run the spell-checker?

When further questioned by the Court, petitioners finally admitted that the document was not an authentic copy of a promissory note but rather their attempt to reconstruct the terms of the loan that they testified was entered into between them and California Digital, Inc., in 1988. Petitioners insisted that a promissory note was, in fact, executed in 1988 but that they were unable to presently find a copy of it.

At this point, I suspect the taxpayers had an uphill battle.

Second, and also contrary to petitioners' testimony, there was no recordation of any mortgage on the property held by California Digital, Inc. Petitioners testified that the mortgage was recorded on the property on the morning of the Tax Court trial, 9 years after the purported title transfer.

Come on, judge - better late than never!

Apparently not. Decision for IRS.

The Moral: If you want to deduct mortgage interest, get down to the county courthouse to record the mortgage when you make the loan; don't wait until the Tax Court trial date. And when preparing the documents, remember that Dan Rather isn't on the Tax Court.

Cite: Reiter, T.C. Summary Opinion 2008-110.

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August 27, 2008

There clearly is no standardized intelligence exam for getting on reality TV shows. "Survivor" Richard Hatch is killing time in federal prison for not paying taxes on $1 million he won before a national TV audience. 2003 American Idol Ruben Studdard apparently didn't get the point.

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August 27, 2008

A Californian must really hate his state. What other explanation could there be for the initiative he is trying to get on the California Ballot in 2010 that has these provisions:

- Impose a one-time tax of 55% on property exceeding $20 million of a California resident or held in California by nonresident;

- Imposes a tax of between 36.5% to 54.3% when a resident dies or leaves California;

- Imposes additional 17.5% tax on total incomes of taxpayers with income exceeding $150,000 if single, $250,000 if married;

- Imposes additional 35% tax if incomes exceed $350,000 if single, $500,000 if married;

- Requires State to acquire shares of specified corporations (i.e. GM, Ford, ExxonMobil, etc.) to influence environmental practices.

If they get the needed 694,354 ballot signatures for this, it still faces some huge constitutional hurdles. It just goes to show - as bad as things are in California, there's always somebody working to make it worse.

More from the Tax Policy Blog and the TaxProf.

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August 26, 2008

Cable TV subscribers know the minor thrill that comes while flipping through the channels when you find that they've added a new channel to your subscription. The thrill quickly passes when you realize that there isn't much on the new channel, either.

That's the way it felt last week when the IRS finally issued proposed regulations for Section 336(e), which has been dormant since it was enacted in 1986. This section, which only becomes effective when final regulations are issued, allows C corporations selling the stock of a controlled subsidiary to elect to treat the sale as an asset sale.

Now the tax law has long provided for the treatment of the sale of a stock as an asset sale under Section 338(h)(10). Under these new regulations, though, the seller can make the election unilaterally, rather than with the consent of the buyer, and the buyer doesn't have to be another corporation.

Like with many cable channels, though, much of what is found in 336(e) is already available elsewhere. Usually buyers prefer asset sale treatment, so Section 338(h)(10) elections haven't been hard to negotiate when the buyer is a corporation. If the buyer is a partnership, a "cash merger" of the sold corporation into an LLC is taxed as an asset sale.

Still, cable channels and 336(e) do have niche markets. Sometimes you don't like the buyer to have one more club to use to extract concessions from you, so a unilateral electon can be handy. Sec. 336(e) will also be available for stock distributions, when there is no "buyer," strictly speaking. They may also make deals cleaner by eliminating the need for extra legal steps, like a merger. Tax Analysts has a good discussion of these issues ($link) for their subscribers.

These regulations, and the ability to make Sec. 336(e) elections, will take effect when they are published as final regulations. As it took almost 22 years for the proposed regulations to appear, don't hold your breath for the final regs.

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August 26, 2008

Prof. Maule has been lamenting the unwisdom shown in the making of tax law. He notes that aspiring presidents don't grasp the basics either:

In another link sent by Mary, Obama tried to explain his mortgage credit proposal , but he slipped up describing current law. When he claimed that homeowners who itemize "get a mortgage deduction, up to $1 million," he made a mistake so classic that I usually find a way to work it into the exam or a semester exercise in the basic tax course. The $1 million limitation is on the amount of the acquisition mortgage, the interest on which is deductible. So if the interest rate on the mortage is 6%, the deduction is limited to $60,000.

Senator McCain isn't flawless on this score, either, as his referring to a proposed $7,000 dependent exemption as a "credit" shows.

I have the answer to this problem, of course -- require that all Congresscritters do their returns in public themselves via a live webcast. They can use Turbotax or the software of their choice, as long as all input screens and output are broadcast live on the web, with a sidebar for running viewer commentary. Or, perhaps, selected tax pros could do the kibitzing - think "Mystery Science Theater 3000," tax geek version. Naturally, the whole comedy should also be available for playback on YouTube. I think this would have two useful results: Congresscritters would have a stake in tax simplification, and they would learn the difference between a deduction and a credit.

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August 26, 2008

I will be teaming up with Marc Ward to conduct half-day seminars in Cedar Rapids on December 8 and Des Moines on December 9. Marc will be covering the new Iowa LLC Act; I will talk about tax problems that often get overlooked in setting up LLCs. They are sponsored by the National Business Institute. I will post enrollment information when I get it.

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August 26, 2008

Sure, we have dreams of this blog making us enormous amounts of money. I still sometimes dream I can fly if I run into the wind, too. The Wandering Tax Pro wakens me. TWTP, a/k/a Robert D. Flach, set up a website called "Ask the Tax Pro." He tells the sad tale:

When I set up the separate ATTP blog, and required a small payment for my service, the questions stopped completely! I guess the blog reading public is only looking for free advice and is not willing to pay even a token amount for the benefit of a tax professional’s knowledge and expertise.

Amazon, Google and E-Bay seem to have internet business models that work. So do people who post naughty pictures and who run poker sites. Maybe we can turn the Tax Update into a strip poker tax auction search site?

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August 26, 2008

Yes, we have had visitors to the Tax Update from New Zealand - at least one, an expat who had worked in Antarctica. As a public service to him and others, and to annoy a judge without judgment, we'll pass on the following from Popehat (via Instapundit):

The names of the accused murderers whose names can't be run on the Web in New Zealand -- but can be printed in newspapers -- Nathan Tuiti Reo Mutunga Williams and Daniel Bobby Tumata. Remember, innocent until proven guilty.

You're welcome. I hope I can still visit someday. We now resume our regular tax programming.

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August 25, 2008

Can professionals live without the billable hour? Rush Nigut tells about the movement towards flat-fee pricing for legal services today at

If law firms go that way, accountants can't be far behind. Many audits and tax returns are already priced that way. It would sure help keep my billing timely. The hard part is figuring out how to price consulting services for open-ended projects, like acquisitions, without hourly billing. Maybe if we get a percentage of the sales price, professionals will behave better because they wouldn't have an incentive to show off and drag out the deal.

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August 25, 2008

Congress passed a special tax reduction those killed in the terror attacks. A widow of one of the victims committed suicide five weeks later. Last month a U.S. District Court in California ruled that the 9/11 tax relief didn't apply to her.

Very sad. It does illustrate the problem with these sympathy provisions. If you are going to tax dead people, do we really want to make some deaths count more than others? It's just as tragic if somebody dies in a car wreck, or takes her life because terrorists killed her husband, as when a terrorist kills somebody directly. Showing favoritism to one group, however sympathetic, is by definition unfair to everyone else who dies prematurely. No politician would ever be caught dead saying so.

Cite: ESTATE OF PRASANA KALAHASTHI, DC-CA Central District, No. 2:07-cv-05771

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August 25, 2008

Russ Fox's usual roundup of tax miscreants includes coverage of permanent injunction entered against Tacoma "tax decoder" Sharon Kukhan. As covered here, Ms. Kukhahn said she could "decode" IRS information to prove that you don't have to pay taxes. The court order says that Ms. Kukhahn has sold her special sauce to over 300 taxpayers in 43 states. Of course it doesn't work.

Ms. Kukhahn had already been shut down under a preliminary injunction.

As usual in these deals, Ms. Kukhahn will have to turn over her customer list; they can look forward to a little unwanted extra attention from the IRS.

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August 25, 2008

The Associated Press has run a profile on Charles Ulrich, the Minnesota CPA behind the recent IRS defeat on demutualization. The article had a piece of background information I didn't know: that the IRS had accused him of being an illegal tax shelter promoter, and demanded his client list. They backed off after the Taxpayer Advocate's office intervened, but that's still disgraceful IRS behavior.

Via The TaxProf.

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August 25, 2008

The Tax Guy reviews the much-misunderstood head of household filing status, including a handy chart.

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August 22, 2008

Earlier this week the IRS discussed the factors they look at to see whether a business has a real profit objective under the "hobby loss" rules. As a public service, the Tax Update reveals the secret factors that tell the IRS there REALLY is no profit objective.

* You tell the IRS that you need your Learjet to get from West Des Moines to Altoona for your business of slot machine gambling.

* You hold "board meetings" for your Mary Kay sole proprietorship in Aruba and Switzerland.

* "Financial records? We don't need no stinking financial records."

* Your business is a stand that sells celery sticks, carrots and "meat is murder" t-shirts at the Iowa State Fair.

The emergency nicotine relief wagon at the 2008 Iowa State Fair. The deep-fried Oreo wagon beckons in the background.

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August 22, 2008

Supporters of subsidies like those used to lure Microsoft's server farm to West Des Moines like to talk about "spillover effects," where the money spills into the rest of the economy, for example though data center construction. Economically, of course, that's nonsense, unless you assume that the money given to Microsoft would otherwise just disappear. Now it looks as though the "spillover" will be even less than you might expect -- unless you own a shipping container company:

A Microsoft spokeswoman confirmed that Microsoft plans to house the servers in shipping containers but declined to comment specifically on the size of the facility or the number of servers to be located there.

Shipping containers? What did you expect, cardboard boxes?

"We are still in the process of completing the design of the center. Once that is finalized, we will have an estimate for these questions," she wrote via e-mail.

However, Microsoft said its $500 million, 550,000-square-foot data center in Chicago will house up to 220 containers, each filled with as many as 2,000 servers, or 440,000 servers. The software maker said the server-filled containers are easier to transport, set up and maintain than servers on conventional racks, though not all observers agree.

So Microsoft will be assembling shipping containers full of servers, putting them on trains or trucks, and sending them here to be put together in a big steel barn like Lego bricks. The "spillover" Iowa will get will mostly be for the crane operator, unless there's a derailment somewhere in the state.

Flickr image by photohome uk.

More on the containerized servers here.


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August 22, 2008

The rivers have gone down, and the dreary work of rebuilding continues in Cedar Rapids and the rest of flood-ravaged Eastern Iowa. But life goes on, and next week so do taxes. Absent further IRS action, all Federal and Iowa tax returns and payments otherwise due since May 25 in flood-affected Iowa counties are due next Friday, August 29.

You can find a list of the flood-affected Iowa counties here; the Iowa guidance is here.


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August 22, 2008

Convicted tax evader Robert Beale is in hot water for allegedly saying that "God wants me to destroy the judge" that presided over his tax trial. He also is reputed to have said that God wanted him to "take out" the judge, presumably not for a candlelight dinner.

As it turns out, Mr. Beale's spiritual mentor is having tax troubles of his own. The Minneapolis Star-Tribune reports that the IRS is investigating the Brooklyn Park church where Mr. Beale once served on the board. The report says that the church is defying an IRS summons. The investigation involves the finances of the pastor of the church, Mac Hammond:

According to the petition, the IRS wants to examine Hammond's compensation, benefits and deals in which the church financed an airplane for him, which he in turn leased back to the church. The IRS also is asking for details on loans for Hammond's residence that were later forgiven by the church.

None of this getting by on locusts and wild honey stuff for this pastor:

Hammond's church's creed, often called the "prosperity Gospel," says that following God's word will lead not only to spiritual salvation but also earthly wealth.

"I think it's important that I not be embarrassed about the increase the Lord does bring me," Hammond said last year.

It's not clear from the story what role the Almighty had in the sale-leaseback deal.

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August 22, 2008

The tax law requires you to document the meals and entertainment expenses, including the parties involved and the business purpose. A North Carolina man must have been quite creative when he filled out his expense reports:

James Smith pleaded guilty to a tax evasion charge Thursday morning. He is the owner of a Charlotte paving company called Red Clay Industries.

Smith admitted in court that he wrote off payments to a company called Soft Touch Promotions as business expenses. Soft Touch Promotions was one of the names used by Sallie Saxon for her prostitution ring.

And to think "Mr. Smith" was his real name all along. He will have to pay up more than $19,000 in taxes and up to $30,000 in fines.

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August 21, 2008

In a tearful virtual press conference held at their corporate headquarters, Roth & Company spokesman Joe Kristan recanted his opposition to targeted tax breaks and vowed to accept massive government subsidies on behalf of the firm.

"We are really excited about the new Microsoft server farm. The bipartisan enthusiasm for taking money from taxpayers and giving it to selected businesses frankly moved us," said Kristan. "With Microsoft receiving tax breaks worth $40 million to create 50 jobs next year, and maybe 75 eventually, we realized that our 35-employee firm must be eligible for $28 million or so." While the Microsoft benefits are in the form of tax breaks, said Kristan, "We prefer cash. We've already created the jobs and have been doing so for years. We're willing to swallow our pride and take money for it. We could charge interest and muck up the tax law, but we're a good corporate citizen. We'll just take the money."

Kristan pointed out that it was a better deal for the state than the Microsoft server farm in a number of ways. "We're using a building that's already there. You don't have to put in roads or run fiber lines. Just write us a check. A wire transfer would be fine too."

Kristan said the firm was committed to creating "dozens, maybe hundreds of thousands of jobs" eventually -- "someday, somehow, somewhere."

The firm, which was started in 1990, plans to use the money on a number of projects. Kristan said it would be nice to have a couple of fully redundant sets of file servers for the office. "Not so much a server 'farm' as a server patio garden," he explained. The firm also plans to install a state of the art coffee maker to provide fresh brewed coffee from freshly-ground beans on demand. The remainder of the funds are expected to be used to fund energy independence, affordable health care and retirement security for the firm's owners.

"We thank Governor Culver, Senator Grassley, Congressman Boswell and Senator Gronstal for opening our eyes to the benefits of these targeted incentives," said Kristan. "We are confident that the necessary legislation will pass. All it will take is for our elected officials to give our proposal the same scrutiny they gave to the proposals by Microsoft and Google."

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August 21, 2008

The IRS has issued a new "fact sheet" (FS-2008-23) on the so-called "hobby loss" rules of Code Section 183. The tax law itself doesn't use the term "hobby loss"; it revers to "activities not engaged in for profit." Even if you aren't having any fun at all, the IRS will disallow loss deductions if they think you aren't serious about trying to show a profit.

The fact sheet lists the following factors the tax law uses to determine whether there is a profit objective:

* Does the time and effort put into the activity indicate an intention to make a profit?

* Do you depend on income from the activity?

* If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

* Have you changed methods of operation to improve profitability?

* Do you have the knowledge needed to carry on the activity as a successful business?

* Have you made a profit in similar activities in the past?

* Does the activity make a profit in some years?

* Do you expect to make a profit in the future from the appreciation of assets used in the activity?

The classic "bad facts" under the hobby loss rule would be someone with a full-time job - say, a dentist - who offsets a high level of salary income with losses from a farm - maybe a horse farm - that never comes close to showing a profit. Multi-level marketers also frequently have trouble with the hobby loss rules.

If you are really trying to make a living from your business, Section 183 isn't a problem. If you're just playing at it because you like the tax deduction, you have a problem.

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August 21, 2008

They got Al Capone on tax charges. They also got a Northwest Iowa mortician that way. Mark Rhode of Kingsley reportedly pleaded guilty to theft and tax evasion charges in Plymouth County District Court:

Rohde was arrested in May for allegedly stealing more than $160,000 from Mauer-Johnson Funeral Home in Le Mars. Police said Rohde, who had recently opened his own funeral home in Kingsley, stole the money over five years while he was a percentage partner with Mauer-Johnson owner Joel Johnson.

The plea agreement requires Rohde to pay Johnson $179,420.53 in restitution. He also agreed to pay $31,526.72 to the Iowa Department of Revenue.

Maybe next time he'll hit up the SBA for his start-up funding.

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August 21, 2008

CNN reports:

One of the negatives to earning a high salary is that your marginal tax rate is higher than other people's. While you might be earning more than your co-worker, he or she might be taking home a similar -- or higher -- amount per check because they aren't taxed as much.

Note to CNN: your "maginal" rate is the rate that applies to the next dollar of income. A 35% marginal rate means you pay 35 cents on the next dollar you earn. You can't reduce your after-tax income with an increase in your pre-tax income unless the marginal rate exceeds 100%. Yes, taxes may be too high, but they aren't that high.

The Tax Foundation explains this in some detail.

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August 21, 2008

Professor Maule has a valuable nugget of wisdom:

Theoretically, there is no limit to the number of products or activities that can be swept within the reach of a sin tax.

He even has a Pet Shop Boys reference!

If bottled water is sinful, like in Chicago, you know that virtue has gotten beyond our reach.

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August 21, 2008

The IRS says Conservation Reserve Program (CRP) payments are self-employment income. Recent legislation overrules this for taxpayers receiving social security benefits. Roger McEowen reports how the IRS is dealing with this change.

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August 20, 2008

A Cedar Rapids TV station is reporting that my current hometown, West Des Moines, gets to subsidize Microsoft's newest server farm:

Culver has scheduled a "major economic development announcement" on the west steps of the Statehouse on Thursday morning, at which he will announce Microsoft's plans to build a center in West Des Moines, said an official with knowledge of the announcement who spoke on condition of anonymity to avoid pre-empting Culver's announcement.

Good thing he didn't pre-empt the Governor's announcement there.

Microsoft is getting $36 million in tax breaks to generate jobs for maybe 50 server farmhands (75, according to this article) in the fastest-growing part of Iowa. You can do the math to see how much each "job" costs. The package includes property tax breaks so that I, along with other West Des Moines residents and businesses, can cover the costs of their street maintenance and police and fire protection. Lord knows Microsoft can't afford it. Do you think they'll give us free copies of Excel and Vista?

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August 20, 2008


Congratulations to Shawn Johnson of West Des Moines on her gold medal! Not to mention her three silvers.

Sadly, things didn't work out for Lolo Jones, who has cleared tougher hurdles than those on a track.

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August 20, 2008

David Cay Johnston, in a Tax Analysts piece reproduced at the TaxProf Blog, notes the elephant in the room in our housing policy: the way the tax law promotes excessive mortgage debt. As bad home loans are staggering the economy, the piece is worth reading. Here's a taste:

The news media typically report with a bias in favor of higher home (and stock) prices, which are presented as a good thing. This is a bizarre assumption unless you are a banker or real estate broker, whose income rises when people borrow more money or pay percentage commissions on artificially inflated prices.

A major reason housing costs so much is that Uncle Sam has effectively put his thumb on the scale on the side of the existing owners. Making mortgage interest tax deductible inflates the price of housing as people chase the subsidy. The mortgage interest deduction, representatives of the National Association of Realtors once told me, explains a third of the price of homes that cost more than $250,000.

Go to the Tax Prof to read the whole thing. I believe the Tax Analysts pieces reproduced there are available for only two weeks (correction: one week). Tax Analysts subscribers will continue to have access the whole thing here ($link).

Speaking of misguided tax law housing breaks, the TaxGrrrl makes an important point: First Time Home Buyers Are Cry-Babies.

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August 20, 2008

The Tax Foundation has begun a push against high corporate tax rates, saying they are bad for the economy and reduce economic competitiveness.

There are two notable responses from left-leaning academic bloggers. One is thoughtful:

Also, if we are mainly concerned about incentive effects, efficiency, and net U.S. national economic welfare, rather than distribution - and I think that is the main long-term issue here, as I'll explain in a moment - then it's not the average but the marginal U.S. corporate tax rate that we care about. So, insofar as companies can play games to save some tax inframarginally, but can't get to zero or boost up their sheltering when they make more profits, it's possible that they would be paying closer to 35% than to their average rates at the margin.

One, not so much:

That's because the statutory rate of 35% is only on paper. Corporations engage in aggressive tax planning that cheats the system, and they take advantage of a bountiful number of lucrative loopholes built into the system under the four decades of Reagan-style corporate favoritism and deregulation, including items such as accelerated depreciation, various expensing provisions that let corporations deduct before they really have an economic cost, and the lucrative research & development credit that lowers taxes dollar-for-dollar for R&D expenditures that corporations have to do anyway (so they do not serve as an incentive to greater development) and that corporations have often already done prior to the enactment of the one-year "extensions" of the credit that have been taking place as transitions to no-credit for years.

Some academics engage the system as it exists and struggle to find answers to real problems in tax and economics. Others go forth to do battle with Scrooge McDuck.

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August 19, 2008

Des Moines Register columnist Ken Fuson once had this to say about blogs:

One of the unexpected benefits of the Internet, other than the ability to look really busy at work while filling out your NCAA tournament brackets, is that people can design their own personal Web sites and then report and comment on the big issues of the day as often as they want. These are called blogs.

This has proved to be a boon to people who apparently are (A) unemployed, (B) independently wealthy, or (C) no longer content to wait on hold to get their daily fix of attention from a radio talk-show host.

The Des Moines Business Record e-mail bulletin reports today:

Jerry Perkins and Ken Fuson have asked for and received buyouts from The Des Moines Register, according to a memo from Editor Carolyn Washburn and Managing Editor Randy Brubaker to the newsroom.

The story says Mr. Fuson's last day will be September 5. That means his first blog post could come as early as September 6.

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August 19, 2008

The IRS has issued (Rev. Rul. 2008-46) the minimum interest rates for loans made in September 2008:

-Short Term (demand loans and loans with terms of up to 3 years): 2.38%
-Mid-Term (loans from 3-9 years): 3.46%
-Long-Term (over 9 years): 4.58%

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

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August 19, 2008

Peter Pappas at The Tax Lawyer's Blog reports:

John Tuzynski, IRS Chief of Employment Tax, SB/SE Speciality Programs, has announced that the IRS is expanding efforts to close the $15 billion dollar tax gap in the employment tax area. Specifically, Tuzynski stated that S corporation shareholder wages and the issue of reasonable compensation for services rendered would be a target area...

Tuzynski stated that tax return preparers would be subject to preparer penalties if they prepared S corporation returns that reflected a “less-than-market’ salary for services rendered by small business owners.

I haven't seen this pushed in S corporation examinations so far, but a threat to return preparers always gets my attention. What will they consider a "market" salary for a money-losing start-up S corporation? I would certainly want a pretty good salary if I were hired to run one from the outside, but can the IRS reasonably expect an S corporation owner-employee to bleed his own business just so he can pay extra employment taxes? And will the IRS really have the nerve to impose penalties on return preparers for not insisting a money-losing S corporation pay a "market" salary? And when did tax preparers suddenly receive the knowledge to know what a "market" salary is in all of the industries they serve?

If the IRS actually is serious about asserting "market" salaries - which I doubt - it will be wandering into a quagmire. It seems unwise to insist that an S corporation owner take a salary larger than Warren Buffet's. Even so, a taxpayer who works at his own profitable S corporation would be foolish to forego a salary entirely.

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August 19, 2008

Miguel Robleto may have been a humble clerk at the Oregon Department of Motor Vehicles, but he was able to hear opportunity when it knocked. His opportunity came in the form of a program to allow private contractors to administer drivers tests for spanish speaking individuals. Mr. Robleto set up a new business, Drive Master Examiners, and the money started pouring in: "Occasionally, busloads of migrant farm workers would arrive from Oregon fields to take the driving tests administered by DME." At $35 to $60 per examination, those were valuable busloads. He also had a side business doing tax returns for DME customers.

Unfortunately, Mr. Robleto declined to report all of his new wealth with the IRS. The IRS was able to determine from state records how many exams he provided. The IRS used this information and the DME fee schedule to compute his income, and it was much more than Mr. Robleto had reported.

Mr. Robleto largely came clean with the Tax Court, and the Court came up with an income lower than the IRS number, but still much higher than Mr. Robleto reported. The IRS argued for fraud penalties, which Mr. Robleto wasn't keen to pay:

Miguel argues that he was overwhelmed by all the customers he had, that he was totally inept in handling the financial aspects of his business, that he could not even pay his utility bills on time, that he had unopened envelopes of cash lying around his home and office, and that the preparation and filing of his and his wife's 2000, 2001, and 2002 joint Federal income tax returns surely constituted negligence, perhaps even gross negligence, but not fraud. For 2003 Miguel contends that because of the seizure of his records in the fall of 2003, he had no records or other information with which he could file his 2003 Federal income tax return, and he did not get the records back until sometime in 2006.

The Tax Court didn't buy it, largely because Mr. Robleto was himself a return preparer at the time, and sustained the 75% fraud penalty on the underpaid taxes.

The Moral: the IRS is unforgiving in any language; if you prepare returns for others, you'd better prepare your own properly.

Cite: Robleto, T.C. Memo 2008-195

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August 19, 2008

The IRS issued a new procedure (Rev. Proc. 2008-52) yesterday that governs automatic method changes. It has one provision that will be especially welcome for S corporation banks. The IRS will now allow S corporation banks with gross receipts of up to $50 million to automatically change to the cash method of accounting, except for a few items where special provisions control the timing of income.

The new procedure allows these banks to make this election without a user fee by filing a Form 3115, Application for Change in Accounting Method by the due date of the 1120-S; a copy of the 3115 will also have to be attached to the tax return.

Formerly, only banks with under $10 million gross receipts qualified for the automatic change for the cash method. The IRS had been granting changes to larger banks, but they had to use the cumbersome non-automatic procedure. Such banks had to wait to make the change until they received formal permission of the IRS. The procedure also required the bank to pay a fee of at least $3,800.

The change will allow banks to be on a cash method except for items covered by special tax code provisions. These "special" items include securities covered by mark-to-market accounting, original issue discount, and certain interest income on short term obligations.

The procedure also has rules for automatic changes of accounting method of banks making a "QSUB" election to be included on an S corporation return and changes to changing to the proper method for accounting for interest on nonperforming loans.

The procedure takes effect for accounting method changes filed starting today for 2008 returns. Taxpayers with method change applications outstanding may file amended applciations under the new procedure; the IRS will presumably refund the user fee from the original filing.

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August 18, 2008

Professor Maule has been reviewing the stupid tax provisions of the recently-enacated housing bill. His current post addresses the new homebuyer credit that has to be paid back over 15 years:

If the taxpayer would not have purchased the house but for the credit, isn't the Congress putting the United States Treasury into the same position as many sub-prime lenders put themselves when they made it possible for someone to acquire a home who wasn't financially ready to do so? If the banks making the bad loans are bailed out by the United States, who bails out the United States?

The answer: you and I, dear fellow taxpayer.

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August 18, 2008

A few months ago we mentioned the conviction of Utah attorney Dennis Evanson of charges involving setting up offshore tax evasion schemes for clients. I doubt whether that work was profitable once this is taken into account:

Attorney Dennis B. Evanson of Sandy, Utah, was sentenced today by U.S. District Judge Tena Campbell in Salt Lake City to 120 months in prison and 36 months supervised release, the Justice Department and Internal Revenue Service (IRS) announced. The court also ordered that Evanson forfeit four pieces of real property, a Hummer and a Toyota Tundra, and entered a money judgment in the amount of $2,774,133.04.

No! Not the Hummer!

Even if Mr. Evanson has money left after paying these items off, it won't do him much good for awhile.

Russ Fox has more.

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August 18, 2008

The Des Moines Register reports that Iowa, having given $40 million in special tax breaks to two server farms, now may get more. Of course the man in charge of taking money from you to give it to rich companies, Economic Development Director Mike Tramontina, takes the credit. But it looks like the server farm companies were looking to Iowa anyway:

Council Bluffs, Ames and Des Moines rank among the 10 lowest-cost locations nationwide for data centers, based on a report from Boyd Co. Council Bluffs is sixth-lowest nationally, with an annual cost of $12 million; Ames is eighth, at $12.1 million; and Des Moines is ninth, at $12.4 million. Costs include labor, power, and property and sales taxes, among other expenses.

So we likely paid Microsoft and Google richly - $500,000 per "job" - to do what they would have done anyway. Another triumph for economic development.

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August 15, 2008

From today's Wall Street Journal:

The new international tax rankings are out for 2008, and congratulations to Washington, D.C., are again in order. Our political class has managed to maintain America's rank with the second highest corporate tax rate in the world at 39.3% (average combined federal and state).

Only Japan is slightly higher overall, though if you are silly enough to base a corporation in California, Iowa, New Jersey, Pennsylvania, or other states with high corporate levies, your tax rate on business income is even higher than in Tokyo. For the first time, the U.S. statutory rate is now 50% higher than the average of our international competitors, continuing a long-term trend as the rest of the world keeps reducing corporate tax rates.

Source: The Tax Foundation

Link: Tax Foundation coverage.

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August 15, 2008

The GAO study on corporation taxes is turning out to be a rich source of unintended humor. The latest is this correction to a New York Times article (via Power LIne):

An article on Wednesday about a Government Accountability Office study reporting on the percentage of corporations that paid no federal income taxes from 1998 through 2005 gave an incorrect figure for the estimated tax liability of the 1.3 million companies covered by the study. It is not $875 billion. The correct amount cannot be calculated because it would be based on the companies paying the standard rate of 35 percent on their net income, a figure that is not available. (The incorrect figure of $875 billion was based on the companies paying the standard rate on their $2.5 trillion in gross sales.)

For the benefit of newspaper writers everywhere, we will explain the Times' error.

"Revenue" is what you sell something for. For example, when the Des Moines Register sells a paper for 50 cents 75 cents per copy, that increases their "revenue" by 75 cents.

"Expenses" are the costs of a business. For a newspaper, these include the cost of the newsprint and the cost of severance payments to all of the reporters who are being laid off because people aren't taking the newspaper anymore (UPDATE, 8/19/08: for example, this).

"Income" is what is left of the "revenue" after all of the "expenses" are paid. For the newspaper industry, this is largely a historical concept. When expenses are bigger than revenue, that is a "loss." That's a bad thing.

In short,

Revenue - Expenses = Income.

"Income" taxes are paid on the "income," not the "revenue."

You know, this level of business knowledge could explain a lot about why the newspaper business is struggling.


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August 15, 2008

We note with sadness the death of Des Moines business leader Marvin Pomerantz. The Des Moines Register has the story.

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August 14, 2008

Innocent spouse cases usually involve a wife pleading to get out of joint return liability for her scoundrel husband's tax misdeeds. A typical case would be a wife whose husband was stealing at work and not reporting the embezzlement. The"guilty" spouse is usually in charge of family finances and preparing the joint tax return.

That's why a case decided in the Tax Court yesterday was unusual. Here the taxpayer asking for "innocent spouse" relief was the husband. That's not the majority of cases, but it's not that unusual. He was also the household return preparer; that's unusual. But the real unusual part? He had already been convicted of tax evasion for the years involved.

Not surprisingly, the Tax Court decided he wasn't so innocent:

Petitioner argues that we should place little weight on his conviction for tax evasion and on the stipulated decision in docket No. 8493-96, wherein petitioner agreed he is liable for tax deficiencies and fraud additions to tax for 1986 and 1987. We simply note that the validity of petitioner's guilty plea has been litigated and decided by this and other courts.

Not exactly the sort of facts you'd like to have in one of these cases...

Cite: Taylor, T.C. Memo. 2008-193

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August 14, 2008

One of the risks of a trip to the Iowa State Fair is the possibility of consuming calories far in excess of your metabolic calorie burn rate. For other risks, check out the new Cavalcade of Risk. Posts include a primer on how FDIC insurance works when a bank fails and an Insureblog post on how your car insurerer may become your Big Brother.


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August 14, 2008

Smartypig is a Des Moines-bases "social savings" enterprise, where savers can make their savings accounts visible to friends or family. The idea is to encourage savings through your social support network - sort of like Weight Watchers, but for money.

Trustypig has a website that looks just like Smartypig. Unfortunately, Trustypig is just a ripoff of the Smartypig site by Romanian scammers.

The real site:


The scam site:


Via Brett Trout and Andy Brudtkuhl, who both explain how to fight the ripoff.

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August 14, 2008

The Tax Policy Blog notes a correction in the AP story on the GAO report about non-taxpaying corporations:

The AP has issued a correction of the corporate taxation story we criticized yesterday. The story had erroneously claimed that 25% of U.S. corporations paying no income tax in 2005 met the GAO's definition of a "large" corporation. (The actual proportion was 0.28%).

Those decimal points are tricky.

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August 13, 2008

20080813-1.jpgYesterday two Senators, Dorgan and Levin, were trumpeting a new Government Accountability Office study showing that 2/3 of Corporations pay no federal income tax. As it played to the narrative of evil corporations getting away with tax murder, it got lots of press, as the TaxProf's roundup shows.

But something didn't smell right about the numbers. I made a note to look at the study. Fortunately, I see that others got to it first.

First, the study does exclude the obvious non-payers - pass through entities like S corporations and mutual funds, whose owners normally pay the tax on corporate income directly. The study excludes subsidiaries on consolidated returns, whose taxes are paid via the parent company. So far, so good. But Martin Sullivan of Tax Analysts ($link) notes that there's still a lot less to the story of non-payment than meets the eye:

For example, IRS data for 2005 show that there are about 2 million corporations in the United States. (We are limiting our discussion here to subchapter C corporations.) Of these, 1.57 million had assets of less than $1 million.

How important are these corporations? They are small change. These entities -- accounting for 87 percent of the total of corporations -- held only 0.4 percent of all corporate assets.

20080813-2.jpgSo the shocking news is that tiny corporations often don't pay tax? Next they'll reveal that eating too much State Fair food will make you fat. I would wager that many of these asset-poor C corporations are professional corporations; as a matter of course, they pay all of their income out in bonuses and salary because any income left gets taxed at a flat 35%. There are zillions of these out there.

When you get to bigger businesses, the zero-tax numbers are much lower. The study found that around 25% of corporations with $250 million of more in assets paid no tax. But guess what? Business is hard. Sometimes businesses lose money - something Congress, with its deficits, should know something about. The Tax Policy Blog puts it this way:

The biggest "tax loophole" at work, however, is unprofitability. In the vast majority of cases, the corporation did not pay tax because it had no profits. The corporate income tax is a tax on profits, and if there are no profits, there are no taxes on those profits. Sen. Levin should be aware of this; General Motors in his home state lost $10.5 billion in 2005, and I'd be surprised if he thinks their "fair share" of taxes on profits should be anything higher than zero. As for corporations that had profits, almost all of them paid taxes.

Yes, there are unfair loopholes that enable taxpayers to pay no taxes. They're there because congresscritters, including Senators Levin and Dorgan, put them there. We'll know that Senator Dorgan is serious about closing loopholes when he votes to eliminate biofuel tax credits for his North Dakota constituents.

Other blog coverage:

The Tax Lawyer's Blog

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August 13, 2008

A UPS driver went to Tax Court to defend deductions for purchases used to keep up the appearances of the Brown Army. The judnge said he could deduct keeping tidy, but not keeping warm. The judge explained the rules for deducting work clothes:

Petitioner claimed business expense deductions for the costs of cleaning his State uniforms and purchasing clothing to keep him warm and dry when working for UPS. The costs to purchase and maintain work clothing may be deductible under section 162 if the taxpayer establishes that: (1) The clothing is required or essential in the taxpayer's employment; (2) the clothing is not suitable for general or personal wear; and (3) the clothing is not so worn.

While the tax law has strict substantiation rules for travel and entertainment costs, the rules are looser for other business expenses, and the judge cut the UPS man some slack:

With respect to the uniform cleaning, respondent does not dispute that petitioner has satisfied the legal requirements for deductibility. However, respondent disallowed the deductions for lack of substantiation. The Court accepts petitioner's testimony that he paid to have his State uniforms cleaned. Therefore, petitioner is entitled to deductions for these expenses. Petitioner did not provide any information as to the frequency or cost of his uniform cleaning. Estimating his expenses, see Cohan v. Commissioner, supra at 544, we allow $10 per week, or $500 for uniform cleaning for 2003 and 2004.

But he drew the line just inside the outerwear:

UPS required petitioner to wear clothing appropriate to the weather conditions at BWI. Petitioner purchased rain gear, long underwear, and watertight boots to wear when loading freight for UPS. Petitioner testified that the clothing and other items he purchased were suitable for general wear. No deduction is allowed for personal, living, or family expenses. Sec. 262(a). Since general-purpose clothing is considered a personal expense, petitioner is not entitled to any deduction for his costs to purchase or maintain clothes worn when working for UPS.

The Moral? If you can wear it outside of work, you can't deduct it, even if that's the only place you do wear it.

Cite: Cottrell, T.C. Summ. Op. 2008-101

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August 13, 2008

The judge threw the book at one of the executives who helped run 70 nursing homes, including some in Iowa. Steven Ewing received the maximum 10-year sentence for tax charges involved in skimming funds from the businesses. The funds financed a spending spree, according to coverage in the Des Moines Register:

According to court records, the executives diverted other money that could have paid for improved care and supervision of 6,000 seniors living in the company's 70 nursing homes. Instead, the money was used to pay for luxury cars for the executives, antiques, monthly trips to England and Australia, and shopping trips to the Gap, Saks Fifth Avenue and Wal-Mart.

As bad as prison will be, it sounds like it might be better than, say, one of his nursing homes:

George Baker Jr. was 54 years old when he burned to death in his wheelchair on the patio of the CLC University nursing home in Des Moines in 2002.

State inspectors cited the home for a lack of supervision, noting that Baker had been left alone on the patio to smoke cigarettes, despite having a pressurized container of oxygen strapped to his chair. When the tank exploded, Baker was consumed by fire before he could be rescued.

I understand that some prisons are now no-smoking zones.

Texas Attorney Gary Trebert was scheduled to be sentenced later based on a plea bargain (the original version of this post incorrectly said he had received a 10-year sentence; we apologize for the error).

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August 13, 2008

From a thoughtful comment one of yesterday's posts, I learn of a new tax blog, The Tax Lawyer's Blog. The author, Peter Pappas, is a tax lawyer working out of (I think) Orlando, Florida. As he says nice things about the Tax Update Blog, and I'm easily flattered, I will be stopping by there regularly. I will put him in the blogroll when I next update it, but for now go to

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August 12, 2008

One of the most infuriating things in tax practice is advising a client that even though the state's position on an issue is wrong, it will cost more to fight for the right result than the incorrectly-assessed taxes are worth. It's a rare client who will spend good money fighting for a principle.

That's why the decision ordering California to pay $137 million in damages to a Nevada electrical engineer is good news. Gilbert Hyatt moved from California to Nevada in October 1991. California tried to assess $49 million of additional taxes for 1991 and 1992 on Mr. Hyatt's earnings from a lucrative patent. The $137 million in damages are for "invasion of privacy and
emotional distress" arising out of the audit.

Russ Fox provides an excellent roundup of the case.

States are always happy to stick taxpayers with penalties for taking abusive positions. Turnabout is fair play. A few stiff penalties might make greedy state officials think twice before taking abusive positions that taxpayers can't afford to fight.

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August 12, 2008

The Iowa State Fair is up an running. If you can't get to the fairgrounds for a deep-fried Twinkie, you can still enjoy the fun at the new Carnival of Taxes, hosted by Kay Bell. This edition of the roundup of tax-related blog posts includes thoughts on claiming pets as dependents (don't try this at home, kids) and the tax implications of getting married (but if your decision depends on the tax implications, other problems certainly loom).

The butter Harry Potter at the 2007 Iowa State Fair

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August 12, 2008

20080812-1.jpgRoger McEowen of the ISU Center of Agricultural Law and Taxation examines the Court of Federal Claims decision against the IRS on gains on demutualized insurance company shares: Court Says IRS Position Wrong on Tax Impact of Insurance Company Demutualization. The article has a handy list of demutualized insurance companies.

Roger has set this year's dates for his popular farm tax schools.

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August 11, 2008

While having multiple taxing jurisdictions may seem inefficient, sometimes it makes sense to divide and conquer our little kings. The disappointing revenues of Chicago's bottled-water tax is a case in point. Revenues are less than half of what Mayor-for-life Dickie Daley was counting on. The Tax Policy Blog qotes that head of the Ilinois Retail Merchants Association:

"Single-bottle sales have not been dramatically hurt. It's the bulk purchase, the six-pack and the case that has just been killed. There's no reason someone is gonna pay $1.20 extra for a $4 dollar case of water when they can go to the suburbs to buy it without that."

No doubt Chicago is also losing sales tax revenue because Chicagoans are surely picking up other things besides water on their shopping trips. Way to go, Mr. Mayor.


A Chicagoan avoids the bottled water tax in a Flickr photo by Joe M500.

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August 11, 2008

You'd think Rhoda Toth would have put her financial troubles behind her when she won $13 million the Florida Lottery in the 1980s. But now the money's gone, and so is her freedom. She has been sentenced to two years in prison for tax evasion. From

Toth, 51, stood in federal court Friday hunched over a walker, braces on her wrists and left knee. She told a judge her multiple sclerosis left her with only a year or two to live. Despite admitting to filing a false tax return, she begged to be spared jail.

But along with money, she has run out of luck:

On Wednesday, an agent had videotaped her walking outside her Spring Hill home. Special Agent Frank DeRosa pointed out that the braces on her wrists and left knee seen in court Friday were conspicuously absent.

Her public defender said Toth didn't need to use her walker all the time. Kovachevich appeared unconvinced.

"It is what it is," the judge said, watching.

Then she sent Toth to prison.

The moral? If you are going to plead for leniency based on being crippled, make sure you looked crippled at least for the full week before the sentencing hearing.

Russ Fox has more.

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August 11, 2008

Rush Nigut says we need a specialized court to deal with business matters today at

Businesses need to have courts that will resolve their cases quicker and with greater efficiency especially when litigation costs are so significant. The way other states are moving on this it appears Iowa should consider a business court soon or face yet another hurdle in retaining and attracting good businesses.

An improvement in our business tax environment would also help.

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August 11, 2008

The Iowa Banking Law Blog notes the dangers to bankers of getting slack with their best loan accounts:

Although the temptation is great when times are good for a lender to accommodate its best customers by not insisting on quite the same level of detail and formality when documenting their loans, lenders should never forget that large credits are in many cases no more immune from a bad economy than are the smaller ones. In the event of bankruptcy by the borrower, the lender with a duly perfected lien in collateral is always in far better shape than the holder of an unsecured claim, regardless of how good the borrower’s balance sheet looked at one time.

It's part of their series on how lenders make their own lives more difficult.

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August 11, 2008

As part of a handy roundup of what you can - and can't - deduct as a charitable contribution, Robert D. Flach points out that you can't deduct the value of your blood donation.

But you should donate blood anyway, if you can. There are so many restrictions that eliminate potential donors from the pool (not least the tattoo craze) that it is extra important that those of us who do qualify to donate do so regularly.

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August 08, 2008

In a decision that will prompt thousands of tax refund claims, the Court of Federal Claims has ruled against the longstanding IRS position that assigns zero basis to stock received in insurance company demutualizations. The court ruled that basis should be allocated to the stock of the policy up to the amount of the sales price of the stock uner the "open transaction" doctrine.

The decision is a vindication of a position long held by Minnesota CPA C.D. Ulrich, who has fought the IRS on this front for years.

If you have sold stock received in a demutualization for any year in which the three-year statute of limitations is open, be sure to get your refund claim in. If you extended your 2004 return, you have until August 15 to file your claim (or October 15, if you used a second extension), using Form 1040X.

This week's decision isn't the final word. The IRS can be expected to appeal to the U.S. Court of Appeals for the Federal Circuit, and it is unlikely to issue refunds any time soon. Still, this is an important victory for mutual policyholders, and one that I had not expected. Hats off to Mr. Ulrich.

Cite: Eugene A. Fisher et al. v. United States; Ct. Claims No. 1:04-cv-01726. The case text is in the extended entry below.

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August 08, 2008

A new Tax Foundation report says Iowans have the 31st highest state and local tax burden. That's a better showing than our bottom-six business tax climate rating from the Tax Foundation.

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August 08, 2008

The Eighth Circuit Court of Appeals has turned down the appeal of Paul Bowman, an Algona, Iowa man who lost a tax-protester case in the Tax Court that we noted here.

Cite: Bowman, CA-8, NO. 072789.

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August 07, 2008

...his newest tax idea is speed cameras on the interstates to raise money to fight crime. Which seems like a very strange action against an Illinois governor's own interest, when you think about it.

Either Governor Blagojovich (pronounced "not yet indicted") has given up entirely on getting re-elected, or he really holds his electorate in utter contempt, with his absurd "crimefighting" rationale for this naked revenue grab.

(via Drudge)

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August 07, 2008

20080807-2.jpgLarken Rose, a tax protest figure and a longtime lurker on the old misc.taxes usenet board, lost his appeal of his conviction for failure to file tax returns earlier this week. Convicted in spite of his risible "Section 861 argument," Mr. Rose raised new procedural claims against evidence seized in a search of his home, but the court said his failure to raise the argument at trial barred him from doing so on appeal.

Not that it would have helped a great deal had he won - he has already served his sentence.

Cite: USA v. Larken Rose, CA-3 No. 05-5199.

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August 07, 2008

20080807-1.jpgSure, it came from a wiretap that led to her guilty plea on corruption and tax evasion charges, but former Chicago Alderman Arenda Troutman (D, 20th Ward) is capable of speaking the unvarnished truth:

Troutman was allegedly caught on tape during the probe comparing politics in Chicago to prostitution.

"Most aldermen, most politicians are hos," she said on one recording.

Troutman, who represented the 20th Ward, was charged in early 2007 with using her office to shake down real estate developers for cash and favors.

The story doesn't mention her political affiliation, but that's not really necessary in Chicago.

Link: Indictment

Other tax crime news

Russ Fox is back from vacation with a roundup of tax fraud, including two Minnesotans who have run afoul of the tax law. The Department of Justice tells of yet another Southern Canadian who has severe tax problems:

WASHINGTON – A federal court in St. Paul, Minn., found Nash Sonibare guilty of criminal contempt for violating a preliminary injunction order entered against him in 2006, the Justice Department announced today. The injunction prohibited Sonibare from preparing federal tax returns and required Sonibare to post a sign at his offices indicating he was not allowed to prepare returns. The court found that Sonibare violated the terms of the injunction beyond a reasonable doubt.

The court concluded that Sonibare prepared or directed others to prepare three tax returns just one month after the court barred him from preparing federal tax returns in 2006. To cover his actions, Sonibare fraudulently stamped or directed others to stamp the returns as “Self-Prepared.” Sonibare also violated a provision of the preliminary injunction requiring him to post a sign at his Little Canada and Roseville, Minn., offices informing visitors that he was not permitted to prepare tax returns.

So he thought that the judge would just forget about this "permanent injunction" thing?

Photo originally from Alderman Troutman's website via

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August 07, 2008

Trough good times and bad, California has dominated one critical segment of the entertainment industry. Now that segment is facing mounting competition from low-cost producers all over the internet; still, the state, desperate for revenue, seems to be preparing to kick it out of bed, figuratively speaking. From Tax Analysts ($link):

The California Assembly Revenue and Taxation Committee has passed legislation (AB 2914) that would tax pornography produced and sold in the state.


The bill provides for a broad 8.3 percent excise tax on explicit adult materials, including those purchased on the Internet, a 25 percent tax on admissions to adult entertainment venues, and an 8.3 percent gross receipts tax on the producers of adult materials.

It's difficult to imagine a business that could more easily move to a low-tax jurisdiction. The Laffer Curve would kick in for a producers' gross receipts tax at a rate very close to 0%; the chances of it actually generating any revenue are nil.

But here lies an economic development opportunity for Iowa. We (insanely) actually subsidize filmmakers. Our tax credits don't apply to that sort of film, but I'm confident an afternoon of "lobbying" by Jenna Jameson at the statehouse would resolve that technicality.

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August 07, 2008

Go green with Biodiesel!

A southeast Missouri farmer has plead guilty to Clean Water Act criminal violations. James Raulerson, 48, of Holland, Mo., admitted to dumping an undetermined amount of decomposing glycerin, methanol and oil generated from the Natural Biodiesel Plant LLC in Braggadocio, MO. The pollutants were discharged into the Belle Fountain Ditch, a water of the United States, killing more than 30,000 fish and other aquatic life. Raulerson faces up to three years in prison and $250,000 at his Nov. 24, 2008, sentencing.

Maybe "going green" doesn't refer to the river.

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August 06, 2008

The issue of whether workers are "employees" or "independent contractors" has been a battleground between businesses and the IRS for many years. The IRS prefers to have employees, as it is much easier to collect Social Security and Income Taxes through employer withholding than from Schedule C sole proprietors. An IRS fight on this issue can be a crisis, as unpaid employment taxes can build up quickly.

The issue is a live one for a Boone company in a court battle with the IRS. Porter Livestock is fighting an IRS assessment of $90,301.04; the IRS says that Porter Livestock's sales team should have been treated as employees. The company won a preliminary battle this week in the U.S. District Court in Des Moines, but the battle continues. The IRS moved for "summary judgment" on the issue. While the court said that the salesmen would be employees under the traditional rules, it ruled that it needed to hear additional evidence on whether the company qualified for "Section 530 relief."

Section 530 of the Revenue Act of 1978 gives a mulligan to employers who misclassify employees as independent contractors but have a "reasonable basis" for doing so. The court explained:

[A] taxpayer shall in any case be treated as having a reasonable basis for not treating an individual as an employee for a period if the taxpayer’s treatment of such individual for such period was in reasonable reliance on any of the following: (A) judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer; (B) a past Internal Revenue Service audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding positions substantially similar to the position held by this individual; or (C) long-standing recognized practice of a significant segment of the industry in which such individual was engaged.

Porter Livestock said that their old attorney had told them their treatment was proper. Inconveniently, the attorney is dead, and the court said it needed to hear additional evidence before it could decide whether Section 530 relief was warranted.

Lara Utter provides a nice summary of the independent contractor rules at IowaBiz, where she notes that the state of Iowa is also in the business of reclassifying independent contractors as employees.

The Moral? Think twice before treating someone as an independent contractor. The IRS might want to collect employment taxes when you can least afford them.

Cite: U.S. v. Raymond Porter et. al., No. 4:05-cv-00464-JEG (DC-SD Iowa)

The 20 factors used to determine employee status are listed below in IRS Rev. Rul. 87-41.

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August 06, 2008

News reports say that the IRS is enforcing the widely-ignored rules governing employee cell phones. The rules, which date back to the days when cell phones were a luxury good, require records for employee cell phones like those required for company cars.

This is one of the (many) cases where technical change has left Congress far behind, though TaxGirl reports that Congress is scrambling to repeal the cell phone rules.

A repeal would be a good thing, but the whole controversy provides a useful lesson in the clumsiness of legislation. Any time Congress or the state legislature reacts to a new technology or an economic event, it's very likely that their work will still be causing problems long after technical change and time have made their original assumptions sadly obsolete.

Still, at least this gives me an excuse to post a picture of the original Roth & Company car phone from 1991, alongside my only somewhat out-of-date Treo 650.


The old stone-a-phone is shown on top of its enormous recharger-brick and alongside its stylish carrying bag and antenna.

The TaxProf has more.

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August 06, 2008

A house doesn't make a home. Not in the tax law, anyway. The Tax Court reminded us of that yesterday in a decision regarding an airline pilot who flew out of New York and Miami but who maintained his residence in St. Martin in the Carribean, and later in France. He claimed that his foreign residence allowed his earnings to qualify for the foreign earned income exclusion. The court states the rule simply:

Because petitioner's place of employment was in the United States during the years at issue, his tax home was in the United States. Accordingly, he is not a qualified individual for purposes of the foreign earned income exclusion.

Your "tax home" is where you work, not where you live. This is the same rule that keeps an Iowa business owner who lives in Arizona from deducting as business expenses travel for his trips to Iowa. Only travel "away from home" qualifies as deductible business travel, and travel from your residence to your workplace is nondeductible "commuting," no matter how long the trip.

Cite: Brunet, T.C. Summ. Op. 2008-96

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August 06, 2008

The Tax Policy Blog on "windfall profits" taxes on oil companies:

According to the Congressional Research Service, the Carter-era windfall profits tax:

* Reduced domestic oil production by 3-6%; and
* Increased foreign oil imports by 8-16%.

If foreign producers have the capacity to offset all the lost domestic production, then the windfall profits tax will simply shift domestic consumption from domestic to foreign oil with no effect on pump prices at all. On the other hand, if foreign producers can't turn up the taps to offset reduced U.S. production—Saudi Arabia in particular may not be able to meet its ambitious production targets—then not only will we be more dependent on foreign oil, but pump prices will rise to bring demand in line with newly-reduced supply.

So there's your windfall profits tax in a nutshell: reduced domestic production, increased dependence on foreign oil, and pump prices either unchanged (best case) or higher (worst case).

"Windfall Profits" taxes are very strange. If you are against high energy prices, you would want to increase the supply. Who is most likely to increase the supply? The oil companies. What would make them want to seek new oil supplies? Potential profits. What if the profits happen? You punish the oil companies with a new tax!

Just bizarre.

Tyler Cowen has more on "Windfall" profits.

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August 05, 2008

The City of Des Moines is ready to spend taxpayer dollars to protect the city's taxi monopoly.

The Des Moines Register reports that Alpha Cab is suing to break the monopoly, enforced by absurd city rules designed to make it impossible to compete with TransIowa. The city is fighting the lawsuit:

Alpha Taxi is based in Des Moines but can operate only in the suburbs because owners Bill Chaney and Eric Tracey were denied a license to operate in the city. The two had asked Des Moines officials in April to reconsider regulations that require a 24-hour dispatch center, $1.5 million in liability insurance, at least eight taxis and at least 10 drivers.

Because it would be just terrible to have a poor guy trying to make a living just wait at a hotel looking for fares.

Des Moines officials have said the tough regulations are necessary to deter unqualified companies.

"There has to be some minimum," said Gary Fox, the city's transportation director. "One or two cabs cannot provide real service throughout the whole city."

Somebody needing a ride from Embassy Suites to the airport doesn't really care if he takes a cab that "provides "real service throughout the whole city." And 200 guys with their own cabs would provide more service than the current 100-cab, 180-driver monopoly company. This is a classic example of a regulation designed to protect a well-connected interest, rather than the public.

While the council is working to whittle down the restrictions, they don't have the courage to go all of the way:

The dispatch center requirement will stay, Fox said, because officials want to ensure the elderly woman who needs a ride to the grocery store gets one as easily as the businessman who needs a ride home to the suburbs from the airport.

Heaven forbid that drivers carry cell phones or hang out at the airport.

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August 05, 2008

Tax evasion charges against one of the defendants in the KPMG tax shelter trial will be tried separately from the rest of the case, WebCPA reports. The trial is set to begin next month.

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August 05, 2008

Marc Ward reports on the Small Bank Tax Equity Act, which would allow banks organized as LLCs to be taxed as partnerships, rather than corporations.

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August 05, 2008

From today's Des Moines Register:

A leading Iowa business group said last week the state budget "is in no position" to deal with an economic downturn or respond to the flood emergency, thanks to the additional spending by the governor and Legislature during the regular legislative session.

The Iowa Taxpayers Association, a tax-policy group not affiliated with the Muscatine-based Iowans for Tax Relief, released an analysis of the state budget approved by the Legislature.

The report says that the Legislature has raided a number of trust funds for general spending, including the Senior Living fund, the Environnment First Fund, the Health Care Trust Fund and the Rebuild Iowa Infrastructure Fund

It takes real leadership to put subsidies for Microsoft, Google, and Hollywood ahead of repairing dilapidated bridges and rebuilding washed-out roads.


(Photo via KCRG and Side Notes.

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August 05, 2008

While you ponder vacation, it's not too soon to start pondering your 2008 tax situation. Robert D. Flach has 10 Mid-Year Tax Moves. Though I'll admit that number 6 won't help most of us ("Getting married? Or divorced?")

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August 04, 2008

The Cato Blog has a theory:

Stevens’ house is in Alaska. The alleged home improvements, and all of the transactions alleged in the indictment, occurred in Alaska. Only the filing of the Senate Financial Disclosure Forms (SFDFs) are alleged to have taken place in District of Columbia. Thus, the §1001/SFDF offense is the only one that the DOJ can assert occurred in the District of Columbia.

Thus, the indictment alleges that Sen. Stevens violated §1001 “in the District of Columbia”.

If the DOJ were to charge Sen. Stevens with bribery or tax evasion, then there would be no credible argument that the alleged crime occurred in the District of Columbia, and Sen. Stevens would be entitled to have the case moved to Alaska.

In other words, they don't want an Alaska jury to hear the case.


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August 04, 2008

While the Soviet Union is no longer with us, the economic illiteracy that made it possible is alive and well in the U.S. Senate. Senators Grassley and Wyden are going after kulaks, I mean "speculators," by proposing that long-term capital gains of "oil speculators" be taxed at ordinary income rates:

"Essentially the current system is giving speculators tax incentives to bid up the prices of oil," said Democratic Sen. Ron Wyden of Oregon, who is circulating the draft legislation.

Sigh. Each oil futures trade requires two parties: one betting on a price increase, one betting on a price decline. There is just as much incentive to bid the prices down as up.

But if speculation is such a bad thing, why isn't it just as bad when it involves corn futures instead of oil futures? Other than there being no oil wells in Iowa, that is?

In any case, economists left and right agree that speculation identifies the price of oil; it doesn't move it any more than a thermometer moves the temperature.

Kay Bell has more on this misbegotten proposal.

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August 04, 2008

A titan of the 20th Century left us yesterday. Aleksander Solzhenitsyn fought an incredibly brave, clever and ultimately devastating battle against the great totalitarian power of his time. After being exiled from the Soviet Union, he lived to return after Communism fall, only to have Russia turn to gangster government before his death. Sometimes it seems like the main difference between Putinism and Stalinism is that Putinism uses tax charges in place of Article 58.


UPDATE: Tyler Cowen:

He did not in every way favor liberty, but he did more for liberty than almost any other person of the late 20th century.

Well said.

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August 02, 2008


Dan Meyer, proprietor of Tick Marks and an accounting prof at Austin Peay, stopped by Tax Update world headquarters yesterday on his way through town on a family trip. We had a nice chat, marred only because it was too brief.

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August 01, 2008




Working outdoors in Downtown Des Moines.

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August 01, 2008

A reader tells us that a hearing is set today in U.S. District Court in St. Louis on a federal suit requesting an injunction against a tax practice there. The complaint alleges spectacular practitioner abuses. The response to the complaint by the defendants, who are associated with Zerjav & Company, L.C. and Zerjav & Company, P.C., for the most part says the federal complaint is too vague to respond to. For example, the government's complaint Paragraph 93 says:

93. The Zerjav & Co. office staff refers to Tiger Zerjav as “the magician,” because the numbers on tax returns prepared by the staff are magically different after Tiger Zerjav reviews and edits the return. In one case, a Zerjav & Co. customer had a profit of $400,000 when a former staff member, who is a CPA, prepared the federal income tax return, but only a $160,000 profit after Tiger Zerjav reviewed and edited the tax return by writing down inventory

The response:

Denies the allegations of the first sentence of paragraph 93 of the complaint. Zerjav, Sr. is without information sufficient to admit or deny the allegations of the second sentence of paragraph 93 of the complaint concerning an unidentified customer and unidentified associate, and therefore denies the same.

Our prior post on this case generated a surprising amount of interest. We will follow up as events develop.

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August 01, 2008

Iowa's annual state sales tax holiday for "select clothing and footwear" runs today and tomorrow. The Department of Revenue Website gives some guidance:

"Clothing" means...

* any article of wearing apparel and typical footwear intended to be worn on or about the human body.

"Clothing" does not include...

* watches, watchbands, jewelry, umbrellas, handkerchiefs, sporting equipment, skis, swim fins, roller blades, skates, and any special clothing or footwear designed primarily for athletic activity or protective use and not usually considered appropriate for everyday wear.

Sure, sales tax holidays are bad tax policy. But we go to the fashion wars with the tax policy we have. So get your outfit together, and mark your calendar to go to South Carolina in November to get accessories during their new sales tax holiday for guns.


Flickr photo by k@t marsh

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August 01, 2008

The Court of Federal Claims yesterday gave the IRS another victory in a case involving a Jenkens & Gilchrist tax shelter based on artificial losses created by offsetting foreign currency positions in a partnership. The opinion is thorough and somewhat tedious, but I like how it recalls this episode where a skeptical attorney commented on a memo defending the shelter (my emphasis):

Mr. Waterman was not impressed with some aspects of the his colleagues' analysis. In a comment box addressing whether the "Evaluated Transaction" (the J&G strategy) lacked economic substance, the memorandum expressed that "the Evaluated Transaction consisted of an investment strategy intended to generate a pre-tax profit that far exceeds any 'expected' tax savings." Mr. Waterman's handwritten annotation reads "B.S."


Another paragraph titled "Tax-Structured Transaction" stated that "[o]ne may infer that the Evaluated Transaction qualifies for [an exception from a registration requirement] because (i) the trade constitutes a standard trade for the vehicle used and (ii) the tax consequences of the trade are fairly well established." PX 259 at 14. Mr. Waterman added another handwritten "B.S." below that paragraph.

The court dryly notes:

a document can bear the indices of credibility, the "B.S. memo" certainly reflects a lawyerly reaction to the SLK tax attorneys' expression of comfort.

I assume "B.S." is shorthand for some Latin term, but I can't figure out what. Can any of you lawyers out there help?

Cite: Stobie Creek Investments LLC et al. v. United States; Nos. 05-748T, 07-520T

PS: The TaxProf noted a ruling in this case back in April, when the court refused to allow expert testimony from Tax Professor Ira B. Shephard.

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August 01, 2008

When the IRS comes calling, nearly all tax advisors would recommend against the course allegedly taken by Randy Nowak of Mulberry, Florida. The Department of Justice says he tried to have the IRS agent murdered:

According to the complaint, Nowak attempted to hire a hit man to kill the IRS Revenue Officer because she was investigating his personal and professional tax liabilities to the IRS. Nowak is the owner of RJ Nowak Enterprises, Inc., a Polk County construction company. On July 29, 2008, Nowak met with an undercover FBI Task Force agent posing as a hit man and paid him $10,000 as a down payment for killing the IRS employee. Nowak also asked the undercover agent if he would be willing to burn down the IRS's office in Lakeland.

Right. Just kill a federal agent and destroy a federal office building, and then the exam just... goes away? I'm not sure he really thought this through very well.

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