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!
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The entire ISO statute should be repealed - tax breaks and tax penalties alike.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.
Background here: TAX COURT TO MCLEOD AMT VICTIMS: SORRY, BUT YOU'RE STILL SCREWED
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.
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%)
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.
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.
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
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.
And the TaxProf has more.
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.
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.
The TaxProf has more.
An 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.
Quatloos.com 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.
If you use your car for business, Bruce the Taxguy has some advice on keeping track of your business mileage.
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.
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.
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.
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.
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.
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.
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?
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.
Can professionals live without the billable hour? Rush Nigut tells about the movement towards flat-fee pricing for legal services today at IowaBiz.com.
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.
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
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.
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.
The Tax Guy reviews the much-misunderstood head of household filing status, including a handy chart.
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.
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.
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.
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.
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.
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."
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.
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.
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.
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.
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.
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?
Congratulations to Shawn Johnson of West Des Moines on her gold medal! Not to mention her three silvers.
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.
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.
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.
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%
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.
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.
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.
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.
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.
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.
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.
Link: Tax Foundation coverage.
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.
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.
Related: MATH IS HARD
We note with sadness the death of Des Moines business leader Marvin Pomerantz. The Des Moines Register has the story.
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...
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.
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:
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.
Yesterday 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.
So 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:
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.
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).
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 blog.pappastax.com.
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.
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).
Roger 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.
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.
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 TampaBay.com:
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.
Rush Nigut says we need a specialized court to deal with business matters today at IowaBiz.com.
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.
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.
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.
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.
EUGENE A. FISHER, TRUSTEE,
SEYMOUR P. NAGAN IRREVOCABLE TRUST,
THE UNITED STATES,
IN THE UNITED STATES COURT OF FEDERAL CLAIMS
(Filed: August 6, 2008)
Trial; Mutual insurance company -- participating policyholders;
Demutualization; Gain on sale of stock received in exchange for
ownership rights; Basis allocation rule -- Treas. Reg. §
1.61-6; "Open transaction" doctrine -- Burnet v. Logan;
Limited exception to Treas. Reg. § 1.61-6 where impossible
or impractical to value property; Pierce, Inaja Land and Warren
construed; Mutual ownership rights found not to be susceptible
of valuation; Expert reports on valuation; "Open transaction"
exception to Treas. Reg. § 1.61-6 applicable;
Burgess J. W. Raby, Tempe, Arizona, for plaintiff.
Benjamin C. King, Jr., Tax Division, United States Department of Justice, Washington, D.C., with whom was Eileen J. O'Connor, Assistant Attorney General, for defendant.
Since its infancy, the Federal income tax law has provided that gross income includes gains derived from dealings in property and that such gains generally equal the amount realized less the seller's cost basis in the property sold. Though clear in principle, these rules are not always easily applied -- particularly, where the property sold was first acquired, for a lump sum, as part of a larger assemblage, and, especially, where the values of the individual components of that grouping are not readily ascertainable. For generations, courts faced with the scenario just-described have grappled with two possibilities: to treat the property sold as having little or no cost basis, so that most or all the sale proceeds are taxable, or to treat the property as sharing the cost basis of the entire bundle, such that no gain is realized until all the capital represented by that basis is recovered. These are among the possible outcomes in this tax refund suit, which involves insurance policy rights that were acquired as an indivisible package, but then separated and sold as part of a demutualization of the insurance provider.
I. FINDINGS OF FACT
Trial in this case was conducted in Phoenix, Arizona. Based on the record at trial, including the parties' joint stipulations, the court finds as follows:
Prior to 2000, Sun Life Assurance Company (Sun Life) was a Canadian mutual life insurance and financial services company that conducted business in Canada, the United States and other countries. A mutual insurance company has no shareholders, but instead is owned by its participating policyholders, which possess both ownership rights, such as voting and distribution rights, as well as the more typical contractual insurance rights.1 Their voting rights differ from those possessed by traditional shareholders in that each policyholder has but a single vote, regardless of how many policies it owns or the amounts thereof. Once the mutual company pays its claims and operating expenses, the profits belong to the policyholders. Typically, some of those profits are returned to the policyholders as dividends, which reduce premium payments, while the remainder is retained as surplus, often accumulating from year to year. Payment of such policy dividends is largely at the discretion of the board elected by the participating policyholders. The ultimate goal of this arrangement is to provide insurance at the lowest possible cost.
On June 28, 1990, the Seymour P. Nagan Irrevocable Trust (the Trust) purchased a life insurance policy from Sun Life on Seymour Nagan and Gloria Hagan. The policy was for $500,000, with annual premiums at $19,763.76 per year. Under this "participating policy," plaintiff's ownership rights included the ability --
to vote on matters submitted to participating policy holders . . . to participate in the distribution of profits of Sun Life of Canada from all its businesses, to participate in any distribution of demutualization benefits, and in the unlikely event of a liquidation if Sun Life of Canada were ever to become insolvent, to participate in the distribution of any remaining surplus after satisfaction of all obligations.
Plaintiff's right to receive distribution of profits took the form of an annual dividend representing the amount, if any, of profits not retained in surplus. These ownership rights could not be sold separate from the policy and were terminated when the policy ended.
On January 27, 1998, the Sun Life Board (the Board) requested the insurer's management to develop a plan to convert the company into a publicly-traded stock company through a so-called "demutualization."2 On September 28, 1999, the Board voted to recommend that the policyholders approve the demutualization. It perceived that the conversion would permit the reorganized company to provide stock options to its employees, offer more diversified products and obtain, more readily, capital financing for its businesses, including those unrelated to providing insurance.
On October 29, 1999, Sun Life proposed a plan to its policyholders to demutualize. Under the plan, the policyholders would retain their insurance coverage at premiums that would be unaffected by the demutualization, but would receive shares of stock in a new holding company, Sun Life of Canada Holding Corp. (Financial Services), which would become the corporate parent of Sun Life. Those shares were to be exchanged for the ownership rights possessed by the participating policyholders, with approximately 20 percent of the shares being allocated to compensate for the loss of voting control and the remaining 80 percent of the shares being allocated to compensate for the loss of other ownership rights, including the right to receive a liquidating distribution.3 Under the plan, eligible policyholders -- those that had policies in force as of January 27, 1998 -- did not have to take stock in exchange for their shares. Those in the United States, for example, could elect to sell the shares issued in connection with a planned initial public offering, an option referred to as the "cash election." If the policyholder took this election, it would receive an amount determined "by multiplying the number of Financial Services Shares sold . . . by the Initial Share Price at which the number of Financial Services Shares are sold in connection with the initial public offering." Policyholders were informed as to how many shares they would be issued in a "share allocation statement."
On December 15, 1999, the Board certified that the demutualization plan had been approved by the eligible policyholders. In early March of 2000, Sun Life began its initial public offerings and received various regulatory approvals to proceed with the demutualization.4 On May 19, 2000, in response to a request from the company, the Internal Revenue Service (IRS) issued Private Letter Ruling 200020048, which dealt with various tax aspects of the demutualization. In that ruling, the IRS noted that the aforementioned ownership rights "cannot be obtained by any purchase separate from an insurance contract issued by [Sun Life]." It ruled that, under section 354(a)(1) of the Internal Revenue Code of 1986 (26 U.S.C.) (the Code), "[n]o gain or loss will be recognized by the Eligible Policyholders on the deemed exchange of their Ownership Rights solely for Company stock." It further opined that the "basis of the Company stock deemed received by the Eligible Policyholders in the exchange will be the same as the basis of the Ownership rights surrendered in exchange for such Company Stock," that is, "zero." The IRS did not rule on the tax treatment to be afforded the cash received in lieu of shares exchanged for ownership rights.
When the demutualization took effect, plaintiff received 3,892 shares of Financial Services stock in exchange for its voting and liquidation rights. Opting for the "cash election," plaintiff permitted Sun Life to sell those shares on the open market for $31,759.00. It reported this amount, unreduced by any basis adjustment, on its federal income tax return for 2000 and paid the resulting tax of $5,725.00. On February 11, 2004, plaintiff filed a timely claim seeking a refund of its money, and, upon the denial of that claim, filed the instant suit. On March 14, 2005, plaintiff filed a motion for partial summary judgment; on December 20, 2005, following the completion of discovery, defendant filed a cross-motion for summary judgment. On May 2, 2006, the case was reassigned to the undersigned. After a referral for alternative dispute resolution did not lead to a settlement, the court, on November 15, 2006, denied the pending dispositive motions. It found that the proceeds from the sale of the Financial Services stock could not be deemed a distribution by Sun Life of a policy dividend, or the equivalent thereof, so as to be excluded from gross income as a return of capital under the annuity rules of section 72 of the Code.5 The court then concluded that it could not resolve, as a matter of law, plaintiff's claim that no capital gain was realized on the sale of the Financial Services Stock because the proceeds were offset by plaintiff's basis in the stock, finding that the claim presented material questions of fact that required a trial.
Trial in this case began on June 18, 2007. At trial, the parties' expert witnesses assigned dramatically different values to the basis of the ownership rights. Plaintiff's expert, Eugene Cole, testified that he could not form an opinion as to the fair market value of the ownership rights because he found the ownership rights to be inextricably tied to the policy; in his view, the ownership rights added value to the policy but never had a separate value. Defendant's expert, Mark Penny, determined that the fair market value of the ownership rights was zero. He emphasized that none of the premiums were specifically dedicated to acquiring the ownership rights, that there was no available market for the ownership rights, and that it was highly unlikely, at the time the policy was acquired, that a demutualization would occur. The latter assertion was also made by defendant's expert on the insurance industry, James Reiskytl.
We begin with common ground. Section 61(a)(3) of the Code provides that gross income includes "[g]ains derived from dealings in property." Section 1001(a) indicates that "[t]he gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 1011 for determining gain." This "language provides a straightforward test for realization" of income, the Supreme Court has stated, to wit, "to realize a gain or loss in the value of property, the taxpayer must engage in a 'sale or other disposition of [the] property." Cottage Sav. Ass'n v. Comm'r of Internal Revenue, 499 U.S. 554, 559 (1991); see also Phil. Park Amusement Co. v. United States, 126 F. Supp. 184, 187-88 (Ct. Cl. 1954). Section 1011(a) states that "adjusted basis" is the basis determined under section 1012, with adjustments not herein relevant, which the latter section generally sets as "the cost of such property." See United States v. Hill, 506 U.S. 546, 554-55 (1993).
The rules become a bit more complicated when a taxpayer transfers only a portion of an asset previously-acquired. Then, the basis of the latter asset generally must be apportioned between the portions disposed of and retained. Treas. Reg. § 1.61-6(a) provides --
When a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts, and the gain realized or loss sustained on the part of the entire property sold is the difference between the selling price and the cost or other basis allocated to such part. The sale of each part is treated as a separate transaction and gain or loss shall be computed separately on each part. Thus gain or loss shall be determined at the time of sale of each part and not deferred until the entire property has been disposed of.
Under this regulation, "where property is acquired for a lump sum and interests therein are subsequently disposed of separately, in order to compute the gain or loss from each disposition an allocation or apportionment of the cost or other basis to the several units must be made." Fasken v. Comm'r of Internal Revenue, 71 T.C. 650, 656-57 (1979), acq. 1979-2 C.B. 1; see also Gladden v. Comm'r of Internal Revenue, 262 F.3d 851, 853 (9th Cir. 2001) ("This regulation tells us that when property is acquired in a lump-sum purchase but then divided and sold off in parts, the cost basis of the property should generally be allocated over the several parts.").6 This apportionment is done by dividing the cost basis of the larger property among its components in proportion to their fair market values at the time they were acquired.7
Of course, for this formula to work, one must be able to derive the fair market values of the component parts of the larger property. The regulations presume these values are obtainable, stating that "only in rare and extraordinary cases will property be considered to have no fair market value." Treas. Reg. § 1.1001-1(a); see also Likins-Foster Honolulu Corp. v. Comm'r of Internal Revenue, 840 F.2d 642, 650 (9th Cir. 1988).8 But, what if, despite this regulatory bravado, it proves impractical or impossible to derive the values needed for the basis apportionment formula, at least without engaging in undue speculation? Does that mean that none of the basis of the originally-acquired property is allocable to the part disposed of or that all of it is allocable thereto until exhausted? These questions, of course, beg a deeper inquiry as to how, if at all, Treas. Reg. § 1.61-6 applies in such circumstances -- whether, for example, conditions not immediately apparent, perhaps those lying in the substructure of the income tax, serve to delimit the regulation? The parties vigorously dispute whether this is the case, with defendant arguing that the regulation, by its terms, is controlling, and plaintiff asseverating that the regulation, in the circumstances of this case, is inapposite. Deciding who is correct requires the court to study the evolution of the regulation, particularly with reference to the concepts of income realization and return of capital, as they have metamorphosed over time.
While the earliest Revenue Acts defined income to include "gains from sales or dealings in property," see Revenue Act of 1916, ch. 463, § 2(a), 39 Stat. 756, 757 (1916); Tariff Act of 1913, ch. 16, § II(B), 38 Stat. 114, 167-68 (1913), neither they, nor the supporting Treasury Regulations, provided much guidance on how to calculate such gains. Revenue laws in 1918 and 1921 conditioned the realization of income on the receipt of property with a "fair market value, if any."9 Early regulations interpreted this statutory language as conditioning the occurrence of a taxable event on the receipt of property with a cash equivalency, stating that to "complete or close a transaction from which income may be realized," there must be a "change into the equivalent of cash."10 Shortly after these regulations were promulgated, the Treasury Department, in 1921, issued the progenitor of Treas. Reg. § 1.61-6. That regulation, Treas. Reg. 45, art. 43 (1921), dealt with the subdivision of real estate into lots and provided:
Where a tract of land is purchased with a view to dividing it into lots or parcels of ground to be sold . . . the cost . . . shall be equitably apportioned to the several lots or parcels . . . to the end that any gain derived from the sale of any such lots or parcels which constitute taxable income may be returned as income for the year in which the sale was made. This rule contemplates that there will be a measure of gain or loss on every lot or parcel sold, and not that the capital invested in the entire tract shall be extinguished before any taxable income shall be returned. . . .
See also Treas. Reg, 62, art. 43 (1922); Heiner v. Mellon, 304 U.S. 271, 275 (1938) (citing cases applying the early versions of the regulation).
Other regulations promulgated around this same time took a different tack, however. They recognized that apportioning a basis among assets acquired as a bundle might, in some situations, prove impractical, requiring income recognition to be deferred until the original cost of the whole bundle was recovered. One of these, Treas. Reg. 45, art. 39 (1921), applied to common stock "received as a bonus with the purchase of preferred stock or bonds." It provided, generally, for the apportionment of basis between the various securities purchased, but indicated that "if that should be impracticable in any case, no profit on any subsequent sale of any part of the stock or securities will be realized until out of the proceeds of sales shall have been recovered the total cost." See also Treas. Reg. 62, art. 39 (1922). Similarly, Treas. Reg. 45, art. 1567 (1921), which dealt with the non-taxable exchanges, provided that where a taxpayer received two kinds of property in such an exchange, the cost of the property originally-possessed had to be apportioned among the new properties. Id. But, "[i]f no fair apportionment is practicable," the regulation continued, "no profit on any subsequent sale of any part of the property received in exchange is realized until out of the proceeds of sale shall have been recovered the entire cost of the original property." Id.; see also Treas. Reg. 62, art. 1567 (1922); Green v. Comm'r of Internal Revenue, 33 B.T.A. 824, 828 (1935) (discussing the evolution of this regulation).
The use of "cash equivalency" principles to govern the realization of income soon proved unworkable. See 64 Cong. Rec. 2851 (1923) (stmt. of Rep. Green); Hearings Before the S. Finance Comm., 67th Cong. 199 (1921) (stmt. of Dr. T.S. Adams, Tax Advisor, Treas. Dept.). This led Congress, in 1924, largely to abandon these principles in favor of enacting the predecessor of section 1001(a) of the Code and, with it, the concept of "amount realized" -- defined, as it is today, to include the fair market value of property other than money or money equivalents received in a transaction. See Revenue Act of 1924, Pub. L. No. 68-176, § 202(c), 43 Stat. 253, 255 (1924); see also Campbell v. United States, 661 F.2d 209, 216 (Ct. Cl. 1981); Warren Jones Co. v. Comm'r of Internal Revenue, 524 F.2d 788, 791-92 (9th Cir. 1975). The accompanying Committee Reports criticized prior law as being "so indefinite that it can not be applied with accuracy, nor consistency," H.R. Rep. No. 68-179, at 13 (1924), reprinted in J.S. Seidman, Legislative History Of Federal Income Tax Laws 1938-1861, at 686 (1938), leading to "[g]reat difficulty . . . in administering" the law, S. Rep. No. 68-398, at 13-14 (1924), reprinted in Seidman, supra, at 686-87. See also Kwall, supra, at 994. The implication was clear -- Congress desired more certainty in determining the timing and amount of the gains realized upon sales or exchanges. See Bradley T. Borden, "Reverse Like-Kind Exchanges: A Principled Approach," 20 Va. Tax Rev. 659, 665-66 (2001).
Into this evolving legal environment was born the so-called "open transaction" doctrine, an accouchement traced to Burnet v. Logan, 283 U.S. 404 (1931). In that case, Mrs. Logan sold stock of a closely-held corporation which assets included stock in a second corporation that owned a mine lease. Id. at 409. She and the other shareholders, which included her mother, exchanged the stock for cash and a stream of annual payments corresponding to the amount of iron ore extracted from the mine. The IRS argued that, at the time of the sale, the right to receive the mining royalties could be estimated based upon the amount of reserves at the mine and that the transaction should be taxed based upon the value of that estimate. Id. at 412.11 The Supreme Court demurred, holding that Mrs. Logan was entitled to recoup her capital investment in the stock before paying income tax based on the supposed market value of the mineral payments. It reasoned:
As annual payments on account of extracted ore come in, they can be readily apportioned first as return of capital and later as profit. The liability for income tax ultimately can be fairly determined without resort to mere estimates, assumptions, and speculations. When the profit, if any, is actually realized, the taxpayer will be required to respond. The consideration for the sale was $2,200,000 in cash and the promise of future money payments wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty. The promise was in no proper sense equivalent to cash. It had no ascertainable fair market value. The transaction was not a closed one. . . . She properly demanded the return of her capital investment before assessment of any taxable profit based on conjecture.
Id. Notably, Mrs. Logan's mother owned stock in the same company and sold it on the same terms. She, however, died and her payments under the same sales agreement were valued for estate tax purposes. Id. at 413-14.12 The Supreme Court, however, summarily dismissed the notion that the valuation of the payment stream for estate tax purposes should be used for income tax purposes, stating "[s]ome valuation -- speculative or otherwise -- was necessary in order to close the estate. It may never yield as much, it may yield more." Id.; see also 1 Mertens Law of Fed. Income Tax'n § 5:15 (2008).
As viewed by the Logan Court, then, the income tax law did not resolve every doubt in favor of taxation -- irreducible values could exist in that world, with the effect of postponing the recognition of income. In the years that followed, the predecessor regulations to Treas. Reg. § 1.61-6 and the "open transaction" doctrine developed like a pavane -- intertwined in theory, but rarely touching in the decisional law. A dozen years after Logan, in Pierce v. United States, 49 F. Supp. 324 (Ct. Cl. 1943), it was not the taxpayer, but the United States, that claimed that a transaction was still open. In that case, the First National Bank of the City of New York, in order to give its stockholders the benefits of investments in securities that could not then be lawfully held by a bank, organized a separate company, First Security Company, to invest in such securities. Each of the certificates of stock in the bank was endorsed with a statement that the stockholder had an interest in the dividends or profits, and, in case of dissolution, in the distribution of capital of the Security Company, ratable with its interest in the bank. Id. at 329. Via this arrangement, the shareholders also had limited control over the Security Company, albeit control exercised through the votes of the holders of two-thirds of the bank stock. Neither the bank stock by itself, nor the interest represented by the endorsement, could be transferred separately from the other. Between 1928 and 1932, the plaintiffs' testator bought thirty-five shares of the bank stock with the endorsements. The Banking Act of 1933, however, banned the securities arrangement used by the bank, causing the Security Company to be dissolved; transferable interests in the proceeds of the dissolution were issued to the bank stockholders and the endorsements were removed from the stockholders' certificates of bank stock. The plaintiffs' testator received his interest in the proceeds of the dissolution on December 6, 1933, and promptly sold them on January 29, 1934, allegedly at a loss, on account of which they sought a refund of income taxes.
The United States contended that --
the sale by plaintiffs' testator of the declarations of interest in the dissolution of the Security Company may not be treated separately as showing a loss, since his interest in the Security Company was acquired in combination with his stock in the bank, and the answer to the question whether a loss or profit resulted from the transaction cannot be had until the bank stock is sold, so that it may be known how much the combined investment has sold for.
Id. at 330. While conceding that "in some instances apportionment of the amount of a single purchase price to several items purchased for that single total price may be had," defendant asseverated that the situation presented was "not a proper case for such an apportionment, since it would not be practicable here." Id. The court took the latter contention to mean that "no particular value could be assigned to the interest in the Security Company represented by the indorsement on the bank stock, as of the date of the purchase of the bank stock, with any degree of assurance that that assignment of value was correct, or even approximately so," requiring the "answer to the question of profit or loss" to wait "till the bank stock is sold." Id. Readily agreeing with this proposition, the court reasoned that "an attempt here to attribute a certain value to the interests in the Security Company acquired by plaintiffs' testator involves us largely in guess-work." Id. Rejecting plaintiffs' attempt to value the endorsement, the court found that "we do not think that the situation calls for such a rough estimate, when by patience the exact answer may be obtained." Id.13 The upshot, the court concluded, was that "the Commissioner acted within his powers in refusing to permit the deduction." Id.
The focus of our inquiry next shifts to Inaja Land Co., Ltd. v. Comm'r of Internal Revenue, 9 T.C. 727 (1947), acq. 1948-1 C.B. 2, an "open transaction" case much debated by the parties here. There, the taxpayer owned about 1,200 acres of land on the banks of a river that it had purchased for $61,000. The land was used for fishing and for grazing. In 1934, the City of Los Angeles began altering the flow of the water in the river; ultimately it paid the taxpayer $50,000 for a perpetual easement to allow water to flow over the land toward the city. A tax dispute arose over the treatment of this money. The Tax Court found that the amount received constituted proceeds from the disposition of an interest in real property, that is, the easement. It concluded, however, that it would be wholly impracticable and impossible to apportion a cost basis to the easement involved because the easement could not be described by metes and bounds as the flow of water was likely to change over time and was not predictable. Id. at 735. Citing Logan, the Tax Court reasoned that "[a]pportionment with reasonable accuracy of the amount received not being possible, and this amount being less than petitioner's cost basis for the property, it can not be determined that petitioner has, in fact, realized gain in any amount." 9 T.C. at 736. It concluded that "[a]pplying the rule . . ., no portion of the payment in question should be considered as income, but the full amount must be treated as a return of capital and applied in reduction of petitioner's cost basis." Id.
In Pierce and Inaja Land, then, the courts made short shrift of basis allocations that lacked a rational foundation. The First Circuit would reach the same result in Warren v. Comm'r of Internal Revenue, 193 F.2d 996 (1st Cir. 1952), another case involving hybrid securities. There, the taxpayer purchased preferred stock of a business trust and received, as an endorsement on the stock, a guaranty of the payment of a liquidating dividend. Upon the liquidation of the trust in 1939, the taxpayer exchanged his shares of stock for cash and a claim, evidenced by certificates, against the guarantor of the liquidating dividend. The Commissioner asserted that the latter certificates had a minimal basis and that considerable income was generated when they were sold in 1944. Id. at 999. The Tax Court agreed -- but, the First Circuit did not. Citing the regulations that would become Treas. Reg. § 1.61-6,14 the latter court stated that "[n]ormally when a taxpayer acquires an aggregate of assets for a single purchase price, on subsequent sale of any portion he must allocate a part of the price he originally paid to the portion being sold on the basis of its proportionate value at the time of purchase so that gain or loss on the partial sale can be determined. Id. at 1001. But, "[i]n some situations," the court noted, "where at the time of the acquisition of the aggregation there was no separate market for the different parts of the aggregate, rational apportionment of the purchase price between the several elements purchased cannot be made." Id. Recognizing that this principle derived from the bonus stock regulation which did not apply, by its terms, to the situation presented, the court, nonetheless, observed that "if the regulation enunciates a sound rule, as unquestionably it does, a similar principle ought to govern analogous situations where the price paid for a bundle of assets cannot be allocated among them on a rational basis." Id. Remanding the case to the Tax Court, the First Circuit concluded that if "[i]t is wholly impracticable to make such an allocation of the purchase price, proper tax treatment would be to treat the cash disbursement upon liquidation in 1939 as a return of capital going to reduced basis, and to recognize no loss until the last part of the package, the guaranty, was sold in 1944." Id.15
While all these cases were percolating through the system, the Treasury Department periodically reissued the regulations dealing with the sale of real property in lots and bonus stock. These iterations, however, were triggered by the passage of new revenue acts and reflected nothing new by way of substance. See Treas. Reg. 118, § 39.22(a)-8 (1953) (bonus stock); id. at § 39.22(a)-11 (sale of real property in lots); Treas. Reg. 111, § 29.22(a)-8 (1943) (bonus stock); id. at § 29.22(a)-11 (sale of real property in lots); Treas. Reg. 103, § 19.22(a)-8 (1940) (bonus stock); id. at § 19.22(a)-11 (sale of real property in lots); Treas. Reg. 94, art. 22(a)-8 (1936) (bonus stock); id. at art. 22(a)-11 (sale of real property in lots); Treas. Reg. 86, art. 22(a)-8 (1935) (bonus stock); id. at art. 22(a)-11 (sale of real property in lots).16 During the later 1940s and early 1950s, the Commissioner sometimes saw fit to argue that the apportionment principles reflected in the regulation dealing with real property lots ought to apply, by analogy, to other forms of real and personal property -- with varying levels of success. See, e.g., Comm'r of Internal Revenue v. Cedar Park Cemetery Ass'n, 183 F.2d 553, 557 (7th Cir. 1950); Atwell v. Comm'r of Internal Revenue, 17 T.C. 1374, 1379-80 (1952); W.D. Haden v. Comm'r of Internal Revenue, 5 T.C.M. (CCH) 250 (1946). In an apparent effort to lessen the need to make such extending analogies, the Treasury Department, in 1957, promulgated Treas. Reg. § 1.61-6 -- patterned after the provision previously applied to real property lots, but applicable now to most forms of property. See Computation of Taxable Income, 22 Fed. Reg. 9419, 9422 (Nov. 26, 1957).
Nevertheless, even after this new and broader regulation was promulgated, both taxpayers and the Commissioner continued to invoke the "open transaction" doctrine -- and, at times, did so successfully. Sometimes, as in Logan, the doctrine was pressed by taxpayers claiming that no gain should be realized upon the sale of a portion of a given property until the basis of the entire original property acquired was recovered.17 In other instances, defendant invoked the doctrine in seeking either to: (i) postpone income to years in which the statute of limitations on assessments was still open; or (ii) argue that no loss should be deducted upon the sale or exchange of a portion of a property until all the interests comprising the property have been sold or exchanged.18 So things remained until the scope of the "open transaction" doctrine was tapered by the passage of several amendments to the Code. Principal among these was section 453, enacted by the Installment Sales Revision Act of 1980, Pub. L. No. 96-471, 94 Stat. 2247, which provided a new method of reporting gains on an installment basis, to be applied, unless the taxpayer elects out. See 26 U.S.C. § 453(d). Yet, the legislative history of this section confirms that Congress envisioned that the "open transaction" doctrine would still be available, albeit, to use the words in one report, in "rare and extraordinary" circumstances.19 And it bears noting that none of these statutes directly addressed the impact of the doctrine on basis allocations -- the form of the doctrine pertinent here. Accordingly, while these statutes undoubtedly narrowed the scope of the doctrine,20 they did not defenestrate it -- the doctrine survives, albeit in more limited form, but with its basic rationale unscathed, leaving the courts to apply it as appropriate. See Gladden v. Comm'r of Internal Revenue, 262 F.3d 851, 855 (9th Cir. 2001) (recognizing the continuing viability of the doctrine); Davis, 210 F.3d at 1348 (same).21
So what can we deduce from this tour d'horizon? One lesson taught, pure and simple, is that the "open transaction" doctrine first enunciated in Logan -- and the appurtenant method for recovering basis -- has long constituted an exception to the general rule requiring, upon the disposition of a portion of an asset, an allocation of basis. The regulation and the doctrine have coexisted for decades, and, despite defendant's claims, they continue to do so. Certainly, the notion, advanced by defendant, that the "open transaction" doctrine met its demise with the promulgation of Treas. Reg. § 1.61-6 in 1957 cannot be squared with the many decisions that have applied the doctrine since. Nor, incidentally, can it be reconciled with the IRS' own rulings. Thus, in Rev. Rul. 77-414, 1977-2 C.B. 299, the IRS described the general requirements of Treas. Reg. § 1.61-6, but then caveated that "when it is impractical or impossible to determine the cost or other basis of the portion of the property sold, the amount realized on such sales should be applied to reduce the basis of the entire property and only the excess over the basis of the entire property is recognized as gain."22 Indeed, over the last half century, defendant has periodically trotted the doctrine out in seeking to disallow deductions, arguing, as it did for decades prior, that the transactions upon which these deductions were predicated were not closed. See, e.g., Smith v. Comm'r of Internal Revenue, 78 T.C. 350, 377-78 (1982); Hutton v. Comm'r of Internal Revenue, 35 T.C.M. (CCH) 16 (1976); Grudberg v. Comm'r of Internal Revenue, 34 T.C.M. (CCH) 669 (1975). Accordingly, the court sees no reason to hesitate in concluding that the "open transaction" doctrine endures as a viable, albeit limited, exception to the general rule enunciated in Treas. Reg. § 1.61-6.
It remains to trace, more precisely, the contours of this exception -- a task complicated by the fact that the "open transaction" doctrine has "flowered into various rather disparate branches." Lykken, 42 Okla. L. Rev. at 581; see also Mertens, supra, at § 5:15; Bittker & Lokken, supra, at ¶ 41.6.1. Some decisions that rely on Logan premise "open transaction" treatment on contingencies that impact the value of the compensation received and focus on what amount, if any, should be realized in the year of the sale. The debate in these cases is over income realization. Other cases premise "open transaction" treatment on the inability to separate out the values corresponding to the portions of a previously-acquired asset being sold or retained, and focus on what amount, if any, should be viewed as the basis of the portion sold. The debate in these cases -- as here -- is on return of capital. Encompassed within this latter category are not only cases in which it is simply impractical or impossible to determine the value of a component of a larger whole, but also, as is illustrated by Pierce, a particular species in which the doctrine was triggered because the part disposed of was, when first acquired, inseparable or indivisible from the part retained. Nonetheless, despite the variety of scions that have been engrafted onto the stock of Logan, it bears repeating that the "open transaction" exception is still limited, "confined in its application to those situations that present elements of value so speculative in character as to prohibit any reasonably based projection of worth." Campbell, 661 F.2d at 215; see also Treas. Reg. § 1.1001-1(a).
We return, at last, to the facts. The experts in this case had markedly divergent views not only as to the value of the ownership rights that were transferred under the demutualization, but even as to whether those rights were susceptible of valuation. Plaintiff's valuation expert, Mr. Cole opined that traditional methods could not be used to value the "ownership rights" associated with the policy because those rights were neither separable nor alienable. While convinced these rights added to the value of the policy, he concluded that, prior to the demutualization of Sun Life, their fair market value, separate from the policy itself, was "not determinable." One of defendant's experts, Mr. Reiskytl, previously worked at a mutual insurance company. He confirmed many of the premises underlying Mr. Cole's opinion. Contrasting the ownership rights of mutual policyholders to those of traditional shareholders, Mr. Reiskytl observed that "[u]nlike shareholder ownership rights that are separate from the contractual rights of the insurance policy, the mutual policyholder's ownership rights are inextricably tied to the underlying insurance contract." (Emphasis in original). He further noted that the policyholder ownership rights could not be "separately purchased, transferred or sold." and that "[t]here is no separately determinable or identifiable price for these ownership rights at the time of purchase of an insurance policy." Yet, in a somewhat self-contradictory fashion, Mr. Reiskytl proceeded to set a value for these rights, specifically concluding, based upon various factors, that they had "no" value.23 Defendant's other expert, Mr. Penny, also recognized that "the subject ownership rights could not be purchased nor [sic] sold separate from the purchase of an insurance policy." But, he essentially turned a blind eye to this fact in concluding that the value of the ownership rights was "best stated at zero during the 1990 calendar year." To derive this value, Mr. Penny purportedly used cost-and market-based approaches to valuation, based on his view of the cost of replacing asset and its market value, respectively.24 Yet, he did so, conspicuously, without considering any comparable properties, serving to highlight the fact that there were neither such comparables, nor, for that matter, any market in which the ownership rights or some derivative could be sold.
All the experts subscribed to the same, basic definition of "fair market value" -- essentially, the "price at which the property would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or to sell and both having reasonable knowledge of the relevant facts." United States v. Cartwright, 411 U.S. 546, 551 (1973) (citing Treas. Reg. § 20. 2031-1(b)); see also Campbell, 661 F.2d at 221; Union Pacific R. Co., Inc. v. United States, 524 F.2d 1343, 1383 (Ct. Cl. 1975); Treas. Reg. § 1.170A-1(c)(2). Yet, in applying that definition, Mr. Cole believed that the circumstances prevented him from determining a value for the ownership rights, while Mr. Penny saw some of the same circumstances as reasons for setting that value at zero. So what caused those differences? It would appear that the experts parted company in deciding whether the nature of the ownership rights made them "impossible or impractical" to value or simply valueless. And that disagreement, in turn, undoubtedly stemmed from unstated differences as to what is meant by the phrase "impossible or impractical" -- a phrase that, despite dozens of "open transaction" cases, has received little in the way of direct definition. That the phrase "impossible or impractical" has largely been left undefined almost undoubtedly derives from the fact that most "open transaction" cases are heavily fact-driven. Nonetheless, a synthesis of the decisional law yields several factors that have proven pivotal in deciding whether a rational basis exists for determining fair market value.
The first of these focuses on the marketability of the asset -- both in terms of whether it is separately sellable or alienable and, if so, whether an established or private market exists in which to effectuate that sale. Several cases, among them the decisions in Pierce and Warren, have relied on the fact that an asset is not separately sellable to indicate that it lacks an ascertainable market value, particularly where that inalienability is inherent in the asset itself and not superimposed as a contractual limitation. See Pierce, 49 F. Supp. at 330; Warren, 193 F.2d at 1001.25 Likewise, courts frequently highlight the absence of any market in which to sell assets of the type at issue as suggesting that the targeted asset is not susceptible to valuation.26 A second factor focuses on whether there are any proxies that may be used to estimate the needed value -- for example, recent sales or exchanges of assets comparable to the one being valued. Because having such comparables is essential to using the comparable sales or market approach to valuation,27 the absence thereof not only deprives these methods of any utility, but also provides further indication that the value of the asset cannot rationally be ascertained. See Estate of Wiggins, 72 T.C. at 712. In similar vein, valuation methods that depend upon some bartering or exchange convention -- that the value of an item received in an arms-length transaction is equal to the value of the item given up28 -- are also unavailing if the taxpayer, via the barter, acquired a group of items of which the object to be valued is only part. Finally, an asset is more likely to be deemed insusceptible of valuation if its value is "contingent upon facts and circumstances not possible to foretell with anything like fair certainty." Logan, 283 U.S. at 413. Contingencies whose impact cannot be reasonably estimated, in particular, frustrate the use of methodologies that derive the value of an asset based upon the present value of an income stream, e.g., the income capitalization or discounted cash flow approaches.29 While not all contingencies prevent such present value calculations, it remains that "open transaction" treatment has been applied in "those situations that present elements of value so speculative in character as to prohibit any reasonably based projection of worth." Campbell, 661 F.2d at 215.30
Logic and experience suggest that the presence vel non of the above factors ought to be reflected in the ability (or inability) of an expert to value an asset reliably using accepted valuation methods. See McCormac, 424 F.2d at 620. The latter methods, of course, are not intended to produce results with talismanic precision, for it is well-accepted that fair market value is "incapable of mathematical precision and implicates methods of judgment." United States v. 1,378 Acres of Land, More or Less, Situate in Vernon County, State of Miss., 794 F.2d 1313, 1318-19 (8th Cir. 1986).31 Yet, empirically-speaking, if an expert lacks any rational basis upon which to value an asset, that ought to be strong indication that the asset is insusceptible of valuation. The burden of demonstrating this, of course, lies squarely upon the one invoking the exception -- here the plaintiff -- which must show that there was not "enough hard information in place from which willing buyers and willing sellers could construct soundly based equations of value." Campbell, 661 F.2d at 215; see also Bernice Patton Testament Trust, 2001 WL 429809, at * 2; Rosenberg v. United States, 3 Cl. Ct. 432, 437 (1983) (P. Miller, J.). Ultimately, it falls to the court to consider the record evidence bearing on the factors listed above, with particular focus given the expert opinions provided, and to determine, as a factual matter, whether plaintiff has proven that a rational basis for establishing the value of the asset in question is lacking.32
With this background, and after carefully weighing the evidence, the court finds that this case presents one of the "rare and extraordinary" situations in which the "open transaction" exception to Treas. Reg. § 1.61-6 should apply. Of the experts who testified, the court is persuaded that Mr. Cole most accurately considered the realities of the circumstances presented here and the limitations on valuation inherent therein. In particular, he focused on the fact that the ownership rights were, at the outset, inextricably tied to the underlying insurance policy and were not separately sellable. Both he and, to a certain extent, Mr. Reiskytl, viewed this fact as an important indication that the ownership rights lacked a determinable fair market value at the time the policy in question was first acquired. Mr. Penny also, of course, was aware of this fact, but he concluded -- wrongly, in the court's estimation -- that the presence of the limitation meant that the value of the ownership rights was "best set at zero." That conclusion is not only contradicted by many of the "open transaction" cases discussed above, but also clashes with the Supreme Court's observations in Helvering v. Tex-Penn Co., 300 U.S. 481 (1937), a case in which the taxpayers, in a corporate reorganizations, received stock that was restricted against sale for a defined period. The Court there held that "the shares of . . . stock, regard being had to their highly speculative quality and to the terms of a restrictive agreement making a sale thereof impossible, did not have a fair market value, capable of being ascertained with reasonable certainty, when they were acquired by the taxpayers." Id. at 499; see also State Street Trust Co., 124 F.2d 948, 951 (restricted stock with speculative value had no fair market value); Mailloux v. Comm'r of Internal Revenue, 320 F.2d 60, 62 (5th Cir. 1963). Unless the Code specifies otherwise,33 an appraiser must take an asset as he finds it -- the definition of "fair market value" anticipates a "hypothetical" sale not a "hypothetical" asset and does not permit an expert the expediency of squaring a circle that, indeed, is round. Here, one of the critical features that could not be ignored was the fact the ownership rights were indivisible from the insurance policy.
Notably, Mr. Penny readily admitted that there was neither a market upon which to gauge the value of the ownership rights nor any assets that could be deemed comparable to those rights, so as to allow for accurate application of the market method of valuation. Rather, he, and to a lesser extent, Mr. Reiskytl, set the value of the ownership rights at zero because Sun Life had not incurred any costs in establishing those rights -- that is, because prior to the demutualization, Sun Life had neither associated any cost with the ownership rights on its books nor accounted for the rights in pricing its policies. But, it is hard to see how either fact is relevant, let alone dispositive here. There is, to be sure, a cost replacement method for appraising the value of an asset -- but that method does not establish value based upon the historical costs incurred by the seller with respect to an asset, but rather relies on the cost to the purchaser of replacing or reproducing the asset.34 Indeed, various courts have rejected claims that an asset has a value of zero because the entity or individual creating it did not associate specific past costs or future liabilities with that asset. For example, in Piper, supra, the Tax Court considered common stock subscription warrants that were acquired by the taxpayer with other stock as part of a reorganization and later sold. The Tax Court viewed the fact that the corporation had not allocated any costs to the warrants as evidence that the warrants were insusceptible of valuation, noting that "[t]hey were not reflected in the capital account of the corporation and did not represent an absolute equitable ownership therein." 5 T.C. at 1110.35 This result is consistent with cases suggesting that "open transaction" principles apply where costs are not identifiable to a particular asset, but instead represent investment in the business as a whole -- indeed, that argument has been made by the IRS itself in seeking to disallow deductions. See, e.g., Capital Blue Cross v. Comm'r of Internal Revenue, 431 F.3d 117, 125-27 (3d Cir. 2005); see also Drybrough v. Comm'r of Internal Revenue, 45 T.C. 424, 434-35 (1966); Mertens, supra at § 5:16. It would seem, then, that the fact that no specific costs were allocated by Sun Life to the ownership rights merely reflects that those rights related to values associated with the business as a whole -- the rights to vote for the entire board, to receive proceeds from the company's liquidation and to receive distributions in the case of a demutualization. That no more specific accounting of these rights is available does not support defendant's case, but rather is further indication that the rights are not susceptible to valuation.36
Contrary to defendant's experts, that the future financial benefits associated with the ownership rights here were speculative does not mean that those rights should be valued at zero. If that were true then virtually all of the "open transaction" cases, beginning with Logan itself, should have been decided differently. Indeed, one of the reasons why the Supreme Court held that Mrs. Logan was not required to recognize gain was because "the promise of future money payments [was] wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty." Logan, 283 U.S. at 413; see also Campbell, 661 F.2d at 215. At all events, many of the economic assumptions made by defendant's experts in diminishing the value of the ownership rights to zero do not withstand scrutiny. Those experts, for example, ascribed no value to the voting rights associated with the policies, even though those rights allowed the participating policyholders to elect the Board, which, in turn, established the policies under which dividends were paid and initiated the demutualization process. Also part and parcel of the opinions expressed by those same experts was the illogical view that no value should be ascribed to the demutualization or liquidation distribution rights -- even though those rights entitled the policyholders to share potentially in a surplus that during the period in question exceeded $5.7 billion (Canadian). The notion, moreover, that any distribution of the value of the company could not have been anticipated here because demutualizations such as that conducted by Sun Life were unprecedented -- a view unhesitatingly offered by both of defendant's experts -- is flatly contradicted by Sun Life's own plan of demutualization. An actuarial report, dated September 28, 1999, that was attached to the plan of demutualization thus stated that "[i]n the last ten years, there have been several demutualizations in the U.S.A., the U.K. Australia, and, most recently, South Africa," adding that "they are precedents." Other sources also indicate that such demutualizations were commonplace by the time the policy in question was purchased.37 In short, the evidence supports plaintiff's claim that the ownership rights did have value, albeit one that was not derivable.38
If nothing else, these facts are antithetical to the claim that the stock distributions made with respect to the ownership rights were a "windfall." Defendant's repeated and pejorative use of that term seemingly proceeds from the notion that, as in Orphic hymns, the value associated with the ownership rights here sprung from the aether, somehow sparked by the demutualization itself. As characterized by Mr. Scanlon, one of defendant's witnesses, these rights were "embedded values" that were not "monetized" until the demutualization occurred. But, if there is any meaningful distinction to be made between "embedded values" that were not previously "monetized" and ownership rights that were "impossible or impractical" to value at the time they were first acquired, it is almost certainly one without a difference.39 Nor is there the slightest support for the suggestion, again made by one of defendant's witnesses, that the allocation of stock here was a "windfall" because it was mandated by Canadian and state regulatory agencies. A silent premise in this argument, of course, is that those agencies acted arbitrarily or at least with considerable largesse in requiring compensation to be paid for the loss of ownership rights that -- in defendant's view -- were valueless. But, the court is no more inclined to believe this charge, sans any shred of evidence to support it, than it would be to ascribe similar conduct to Congress and Federal agencies. Without any evidence to the contrary, the more logical conclusion is that such agencies, and the legislatures that empowered them, sincerely believed that the ownership rights had value and that the policyholders were entitled to be compensated for their loss.40 The "windfall" tag, therefore, lacks evidentiary adhesive and does not stick.
At all events, the assertion that the ownership rights here ever had a "zero" value is thoroughly rebuffed by the actuarial study provided by Sun Life to its policyholders with the plan for demutualization. That study focused on whether the stock to be provided in the demutualization adequately compensated those policyholders for the ownership rights that were being relinquished. It recognized, as a first principle, that the stock allocation "should fairly compensate for what policyholders lose in the demutualization; namely, voting control of the insurance company and the right to share in the insurance company's residual value if it is wound up." It noted that the demutualization plan "provided for a fixed allocation of 75 Financial Service Shares to each Eligible Policyholder, regardless of the number of policies held, and for a variable allocation to each Eligible Policy of a number of Financial Services Shares which depends on its Cash Value, the number of years it has been in force and its annual premium." The study stated that it --
regarded the fix allocation as compensation for loss of voting control and the variable allocation as compensation for loss of the right to share in residual value. It is appropriate that the fixed allocation be the same to each Eligible Policyholder, since each has one vote and all the votes should be treated as equal. It is appropriate that the variable allocation differ among Eligible Policyholders because they have different customer attachments to, different financial interest in, and different rights to receive surplus distributions from, Sun Life of Canada.
In concluding that the compensation for the lost ownership rights was "fair," "equitable," and "appropriate," the report cited several other facts that suggest that the ownership rights had value prior to the demutualization, including that: (i) value comparable to that being offered in the Sun Life demutualization had been allocated to voting rights in other prior demutualizations; (ii) the loss of voting control could indirectly impact policy dividends, the payment of which was "largely at the discretion of [Sun Life's] board of directors; and (iii) the "primary historical sources of surplus" for Sun Life had been its "individual participating policies." Finally, and importantly, the report recognized that the distribution of stock was a "zero-sum game," that is to say, that certain policyholders would be harmed if the plan struck the wrong balance between the value of the voting rights and the residual rights. Of course, there would be no such harm -- and, concomitantly, no need to strike such a careful balance -- if either right properly were characterized as a "windfall."41
In sum, based on the record, the court simply cannot credit defendant's "zero" valuation of the ownership rights. The opinions of its experts, "like any other judgment . . . can be no better than the soundness of the reasons that stand in support of them." Fehrs v. United States, 620 F.2d 255, 265 (Ct. Cl. 1980); Campbell, 661 F.2d at 222. And, the court finds that the premises upon which these opinions were based were faulty and contrary to the facts.42 The record here instead supports the opinion rendered by plaintiff's valuation expert that the value of the ownership rights was not discernible, leading the court to conclude that plaintiff has borne its burden of proof in this case. That the facts in this case parallel strikingly those in several "open transaction" cases involving stock and other forms of securities, among them Pierce (which remains binding precedent in this circuit) and Warren, serves only to confirm that this is an appropriate situation in which to apply the "open transaction" exception to Treas. Reg. § 1.61-6. That being the case, and the amount received by plaintiff being less than its cost basis in the insurance policy as a whole, the court finds that plaintiff, in fact, did not realize any income on the sale of the stock in question and, therefore, is entitled to the requested refund.
The court need go no further. Some might see this case as a revivification of the "open transaction" doctrine. It is not. It represents, rather, an unusual and unique result -- one based on long-standing, though not often-invoked, legal principles, to be sure, but ultimately driven by relatively unique facts. Be that as it may, the court finds that plaintiff has met its burden and is entitled to the refund requested. The Clerk will enter judgment for plaintiff in the amount of
IT IS SO ORDERED.
Francis M. Allegra
1 Mutual insurance companies have a long provenance in this country, with one of the first established by Benjamin Franklin. See generally, Gregory N. Racz, "No Longer Your Piece of the Rock: The Silent Reorganization of Mutual Life Insurance Firms," 73 N.Y.U. L. Rev. 999 (1998); Edward X. Clinton, "The Rights of Policyholders in an Insurance Demutualization," 41 Drake L. Rev. 657 (1992) (hereinafter "Clinton").
2 As an alternative to the demutualization, the Board considered paying policyholders a greater percentage of the company's then-existing surplus. As of June 1999, that surplus amounted to approximately $5.7 billion (Canadian).
3 The plan provided for a fixed allocation of seventy-five Financial Services shares for the loss of voting control. A "time-weighted" variable allocation of shares was provided in exchange for the policyholders' rights to receive surplus distributions. This variable allocation was determined under a formula that considered the cash value of the policy or policies held, the number of years the policy or policies had been in force, and the annual premiums.
4 The cash surrender value of plaintiff's policy as of this time was $185,172.79. Total policy premiums paid through this time were $194,343.64.
5 Section 72 of the Code provides rules governing the reporting of income corresponding to annuities received under annuity, endowment or life insurance contracts. Section 72(e)(2) excludes from gross income certain amounts not received as annuities, among them "any amount received which is in the nature of a dividend or similar distribution," as defined in section 72(e)(1)(B). In its November 15, 2006, opinion, the court held that the amounts received by plaintiff did not qualify for exclusion under these provisions, finding that plaintiff "received those proceeds upon an entirely unrelated sale of the stock it received in the demutualization." In its post-trial brief, plaintiff asks the court to reconsider this ruling. The court sees no basis for doing so.
6 The regulation offers the following example:
B purchases for $25,000 property consisting of a used car lot and adjoining filling station. At the time, the fair market value of the filling station is $15,000 and the fair market value of the used car lot is $10,000. Five years later B sells the filling station for $20,000 at a time when $2,000 has been properly allowed as depreciation thereon. B's gain on this sale is $7,000, since $7,000 is the amount by which the selling price of the filling station exceeds the portion of the cost equitably allocable to the filling station at the time of purchase reduced by the depreciation properly allowed.
Treas. Reg. § 1.61-6(a) (Example (2)).
7 See Beaver Dam Coal Co. v. United States, 370 F.2d 414, 416-17 (6th Cir. 1966); Fairfield Plaza, Inc. v. Comm'r of Internal Revenue, 39 T.C. 706, 712 (1963), acq. 1963-2 C.B. 3; Ayling v. Comm'r of Internal Revenue, 32 T.C. 704, 711 (1959), acq. 1959-2 C.B. 3; Cleveland-Sandusky Brewing Corp. v. Comm'r of Internal Revenue, 30 T.C. 539, 545 (1958), acq. 1958-2 C.B. 3; John D. Byram v. Comm'r of Internal Revenue, 34 T.C.M. (CCH) 626, 626 (1975); see also Am. Smelting & Refining Co. v. United States, 423 F.2d 277, 289 (Ct. Cl. 1970).
8 In 1934, Judge Learned Hand took issue with the predecessor of this regulation, stating "'fair market value' is not nearly so universal a phenomenon as to justify such a comment, and the implication is misleading." Helvering v. Walbridge, 70 F.2d 683, 684 (2d Cir. 1934).
9 See Revenue Act of 1921, Pub. L. No. 98, § 202(c), 42 Stat. 227 (1921); Revenue Act of 1918, Pub. L. No. 254, § 202(b), 40 Stat. 1057, 1060 (1919) ("[w]hen property is exchanged for other property, the property received in exchange shall for the purposes of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any"); see also Jeffrey L. Kwall, "Out of the Open-Transaction Doctrine: A New Theory for Taxing Contingent Payment Sales," 81 N.C. L. Rev. 977, 992 (2003) (hereinafter "Kwall").
10 Treas. Reg. No. 45, art. 1563 (1919); see also Loren D. Prescott, Jr., "Cottage Saving Association v. Commissioner: Refining the Concept of Realization," 60 Fordham L. Rev. 437, 445-46 (1991).
11 As to 1916, the year of sale, the Commissioner acknowledged that "no taxable income had been derived from the sale when made" because that consideration had not exceeded Mrs. Logan's basis of her stock. Logan v. Comm'r of Internal Revenue, 42 F.2d 193, 194 (2d Cir. 1930, aff'd sub nom., Burnet v. Logan, 283 U.S. 404 (1931). As to later years (1917-1920), however, the Commissioner claimed that a "a portion of each payment under the contract was a return of capital and a portion represented gain." Logan v. Comm'r of Internal Revenue, 12 B.T.A. 586, 599-600 (1928), rev'd, 42 F.2d 193 (2d Cir. 1930), aff'd sub nom., Burnet v. Logan, 283 U.S. 404 (1931).
12 In making this estimate, the Commissioner projected the amount of contingent payments the shareholders would receive by examining the mine's capacity, a projected price for the mine's product, and the mine's projected useful life. Id. at 411 n.1.
13 The court particularly focused on the fact that the endorsement was not separately sellable from the shares, noting that "the locking device increases the practical difficulty of attributing a correct valuation to either piece of property as of the time of purchase, since the very fact of the restraint usually affects the value of the combination and each of its components in amounts difficult to measure." Pierce, 49 F. Supp. at 330.
14 The opinion, indeed, quoted, at length, from Reg. 111, § 29.22(a)-8, dealing with bonus stock, and Reg. 111 § 29.22(a)-11, dealing with the sale of real property in lots.
15 Further instructive in this regard is Piper v. Comm'r of Internal Revenue, 5 T.C. 1104, 1109 (1945), in which the Tax Court held that there was no practical basis upon which to allocate a cost basis between common stock subscription warrants that were acquired by the taxpayer along with shares of common stock. In so concluding, the court stated that "[w]here there is no market value, as in the situation with respect to the warrants, there is no practical basis upon which an allocation can be made and the taxpayer is entitled to recover his entire original basis before gain or loss will be recognized." For other earlier cases applying the "open transaction" exception in cases involving proposed basis allocation, see United Mercantile Agencies, Inc. v. Comm'r of Internal Revenue, 23 T.C. 1105, 1116-17 (1955), acq. 1955-2 C.B. 3 (acquired claims from the liquidators of four banks held to be too speculative to have ascertainable market value); Axton v. Comm'r of Internal Revenue, 32 B.T.A. 613, 615 (1935) (types of stock received in exchange for other stock were not susceptible to valuation so as to allow allocation of old basis).
16 Subsequent regulations did not contain provisions corresponding to ar« Close It
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.
...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.
Make balloons part of your Illinois travel kit!
Larken 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.
Sure, 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.
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 Mchenrycountyblog.com
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.
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.
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.
The 20 factors used to determine employee status are listed below in IRS Rev. Rul. 87-41.
Rev. Rul. 87-41, 1987-1 C.B. 296.
Internal Revenue Service
EMPLOYMENT STATUS UNDER SECTION 530(D) OF THE REVENUE ACT OF 1978
Section 3121.-Definitions, 26 CFR 31.3121(d)-1: Who are employees.
(Also Sections 3306, 3401; 31.3306(i)-1, 31.3401(c)-1.)
Employment status under section 530(d) of the Revenue Act of 1978. Guidelines are set forth for determining the employment status of a taxpayer (technical service specialist) affected by section 530(d) of the Revenue Act of 1978, as added by section 1706 of the Tax Reform Act of 1986. The specialists are to be classified as employees under generally applicable common law standards.
Click here to go directly to legal analysis of ruling
In the situations described below, are the individuals employees under the common law rules for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24 respectively, subtitle C, Internal Revenue Code)? These situations illustrate the application of section 530(d) of the Revenue Act of 1978, 1978-3 (Vol. 1) C.B. xi, 119 (the 1978 Act), which was added by section 1706(a) of the Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. ___ (the 1986 Act) (generally effective for services performed and remuneration paid after December 31, 1986).
In each factual situation, an individual worker (Individual), pursuant to an arrangement between one person (Firm) and another person (Client), provides services for the Client as an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work.
The Firm is engaged in the business of providing temporary technical services to its clients. The Firm maintains a roster of workers who are available to provide technical services to prospective clients. The Firm does not train the workers but determines the services that the workers are qualified to perform based on information submitted by the workers.
The Firm has entered into a contract with the Client. The contract states that the Firm is to provide the Client with workers to perform computer programming services meeting specified qualifications for a particular project. The Individual, a computer programmer, enters into a contract with the Firm to perform services as a computer programmer for the Client's project, which is expected to last less than one year. The Individual is one of several programmers provided by the Firm to the Client. The Individual has not been an employee of or performed services for the Client (or any predecessor or affiliated corporation of the Client) at any time preceding the time at which the Individual begins performing services for the Client. Also, the Individual has not been an employee of or performed services for or on behalf of the Firm at any time preceding the time at which the Individual begins performing services for the Client. The Individual's contract with the Firm states that the Individual is an independent contractor with respect to services performed on behalf of the Firm for the Client.
The Individual and the other programmers perform the services under the Firm's contract with the Client. During the time the Individual is performing services for the Client, even though the Individual retains the right to perform services for other persons, substantially all of the Individual's working time is devoted to performing services for the Client. A significant portion of the services are performed on the Client's premises. The Individual reports to the Firm by accounting for time worked and describing the progress of the work. The Firm pays the Individual and regularly charges the Client for the services performed by the Individual. The Firm generally does not pay individuals who perform services for the Client unless the Firm provided such individuals to the Client.
The work of the Individual and other programmers is regularly reviewed by the Firm. The review is based primarily on reports by the Client about the performance of these workers. Under the contract between the Individual and the Firm, the Firm may terminate its relationship with the Individual if the review shows that he or she is failing to perform the services contracted for by the Client. Also, the Firm will replace the Individual with another worker if the Individual's services are unacceptable to the Client. In such a case, however, the Individual will nevertheless receive his or her hourly pay for the work completed.
Finally, under the contract between the Individual and the Firm, the Individual is prohibited from performing services directly for the Client and, under the contract between the Firm and the Client, the Client is prohibited from receiving services from the Individual for a period of three months following the termination or services by the Individual for the Client on behalf of the Firm.
The Firm is a technical services firm that supplies clients with technical personnel. The Client requires the services of a systems analyst to complete a project and contacts the Firm to obtain such an analyst. The Firm maintains a roster of analysts and refers such an analyst, the Individual, to the Client. The Individual is not restricted by the Client or the Firm from providing services to the general public while performing services for the Client and in fact does perform substantial services for other persons during the period the Individual is working for the Client. Neither the Firm nor the Client has priority on the services of the Individual. The Individual does not report, directly or indirectly, to the Firm after the beginning of the assignment to the Client concerning (1) hours worked by the Individual, (2) progress on the job, or (3) expenses incurred by the Individual in performing services for the Client. No reports (including reports of time worked or progress on the job) made by the Individual to the Client are provided by the Client to the Firm.
If the Individual ceases providing services for the Client prior to completion of the project or if the Individual's work product is otherwise unsatisfactory, the Client may seek damages from the Individual. However, in such circumstances, the Client may not seek damages from the Firm, and the Firm is not required to replace the Individual. The Firm may not terminate the services of the Individual while he or she is performing services for the Client and may not otherwise affect the relationship between the Client and the Individual. Neither the Individual nor the Client is prohibited for any period after termination of the Individual's services on this job from contracting directly with the other. For referring the Individual to the Client, the Firm receives a flat fee that is fixed prior to the Individual's commencement of services for the Client and is unrelated to the number of hours and quality of work performed by the Individual. The Individual is not paid by the Firm either directly or indirectly. No payment made by the Client to the Individual reduces the amount of the fee that the Client is otherwise required to pay the Firm. The Individual is performing services that can be accomplished without the Individual's receiving direction or control as to hours, place of work, sequence, or details of work.
The Firm, a company engaged in furnishing client firms with technical personnel, is contacted by the Client, who is in need of the services of a drafter for a particular project, which is expected to last less than one year. The Firm recruits the Individual to perform the drafting services for the Client. The Individual performs substantially all of the services for the Client at the office of the Client, using materials and equipment of the Client. The services are performed under the supervision of employees of the Client. The Individual reports to the Client on a regular basis. The Individual is paid by the Firm based on the number of hours the Individual has worked for the Client, as reported to the Firm by the Client or as reported by the Individual and confirmed by the Client. The Firm has no obligation to pay the Individual if the Firm does not receive payment for the Individual's services from the Client. For recruiting the Individual for the Client, the Firm receives a flat fee that is fixed prior to the Individual's commencement of services for the Client and is unrelated to the number of hours and quality of work performed by the Individual. However, the Firm does receive a reasonable fee for performing the payroll function. The Firm may not direct the work of the Individual and has no responsibility for the work performed by the Individual. The Firm may not terminate the services of the Individual. The Client may terminate the services of the Individual without liability to either the Individual or the Firm. The Individual is permitted to work for another firm while performing services for the Client, but does in fact work for the Client on a substantially full-time basis.
LAW AND ANALYSIS
This ruling provides guidance concerning the factors that are used to determine whether an employment relationship exists between the Individual and the Firm for federal employment tax purposes and applies those factors to the given factual situations to determine whether the Individual is an employee of the Firm for such purposes. The ruling does not reach any conclusions concerning whether an employment relationship for federal employment tax purposes exists between the Individual and the Client in any of the factual situations.
Analysis of the preceding three fact situations requires an examination of the common law rules for determining whether the Individual is an employee with respect to either the Firm or the Client, a determination of whether the Firm or the Client qualifies for employment tax relief under section 530(a) of the 1978 Act, and a determination of whether any such relief is denied the Firm under section 530(d) of the 1978 Act (added by Section 1706 of the 1986 Act).
An individual is an employee for federal employment tax purposes if the individual has the status of an employee under the usual common law rules applicable in determining the employer-employee relationship. Guides for determining that status are found in the following three substantially similar sections of the Employment Tax Regulations: sections 31.3121(d)-1(c); 31.3306(i)-1; and 31.3401(c)-1.
These sections provide that generally the relationship of employer and employee exists when the person or persons for whom the services are performed have the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so.
Conversely, these sections provide, in part, that individuals (such as physicians, lawyers, dentists, contractors, and subcontractors) who follow an independent trade, business, or profession, in which they offer their services to the public, generally are not employees.
Finally, if the relationship of employer and employee exists, the designation or description of the relationship by the parties as anything other than that of employer and employee is immaterial. Thus, if such a relationship exists, it is of no consequence that the employee is designated as a partner, coadventurer, agent, independent contractor, or the like.
As an aid to determining whether an individual is an employee under the common law rules, twenty factors or elements have been identified as indicating whether sufficient control is present to establish an employer-employee relationship. The twenty factors have been developed based on an examination of cases and rulings considering whether an individual is an employee. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed. The twenty factors are designed only as guides for determining whether an individual is an employee; special scrutiny is required in applying the twenty factors to assure that formalistic aspects of an arrangement designed to achieve a particular status do not obscure the substance of the arrangement (that is, whether the person or persons for whom the services are performed exercise sufficient control over the individual for the individual to be classified as an employee). The twenty factors are described below:
1. INSTRUCTIONS. A worker who is required to comply with other persons' instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the RIGHT to require compliance with instructions. See, for example, Rev. Rul. 68-598, 1968-2 C.B. 464, and Rev. Rul. 66-381, 1966-2 C.B. 449.
2. TRAINING. Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner. See Rev. Rul. 70-630, 1970-2 C.B. 229.
3. INTEGRATION. Integration of the worker's services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business. See United States v. Silk, 331 U.S. 704 (1947), 1947-2 C.B. 167.
4. SERVICES RENDERED PERSONALLY. If the Services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results. See Rev. Rul. 55-695, 1955-2 C.B. 410.
5. HIRING, SUPERVISING, AND PAYING ASSISTANTS. If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status. Compare Rev. Rul. 63-115, 1963-1 C.B. 178, with Rev. Rul. 55-593 1955-2 C.B. 610.
6. CONTINUING RELATIONSHIP. A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals. See United States v. Silk.
7. SET HOURS OF WORK. The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control. See Rev. Rul. 73-591, 1973-2 C.B. 337.
8. FULL TIME REQUIRED. If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor on the other hand, is free to work when and for whom he or she chooses. See Rev. Rul. 56-694, 1956-2 C.B. 694.
9. DOING WORK ON EMPLOYER'S PREMISES. If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Rev. Rul. 56-660, 1956-2 C.B. 693. Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer's premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required. See Rev. Rul. 56-694.
10. ORDER OR SEQUENCE SET. If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker's own pattern of work but must follow the established routines and schedules of the person or persons for whom the services are performed. Often, because of the nature of an occupation, the person or persons for whom the services are performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so. See Rev. Rul. 56-694.
11. ORAL OR WRITTEN REPORTS. A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control. See Rev. Rul. 70-309, 1970-1 C.B. 199, and Rev. Rul. 68-248, 1968-1 C.B. 431.
12. PAYMENT BY HOUR, WEEK, MONTH. Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on § straight commission generally indicates that the worker is an independent contractor. See Rev. Rul. 74-389, 1974-2 C.B. 330.
13. PAYMENT OF BUSINESS AND/OR TRAVELING EXPENSES. If the person or persons for whom the services are performed ordinarily pay the worker's business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker's business activities. See Rev. Rul. 55-144, 1955-1 C.B. 483.
14. FURNISHING OF TOOLS AND MATERIALS. The fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship. See Rev. Rul. 71-524, 1971-2 C.B. 346.
15. SIGNIFICANT INVESTMENT. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer- employee relationship. See Rev. Rul. 71-524. Special scrutiny is required with respect to certain types of facilities, such as home offices.
16. REALIZATION OF PROFIT OR LOSS. A worker who can realize a profit or suffer a loss as a result of the worker's services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee. See Rev. Rul. 70-309. For example, if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risK to support treatment as an independent contractor.
17. WORKING FOR MORE THAN ONE FIRM AT A TIME. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. See Rev. Rul. 70-572, 1970-2 C.B. 221. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.
18. MAKING SERVICE AVAILABLE TO GENERAL PUBLIC. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship. See Rev. Rul. 56-660.
19. RIGHT TO DISCHARGE. The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer's instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications. Rev. Rul. 75-41, 1975-1 C.B. 323.
20. RIGHT TO TERMINATE. If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer- employee relationship. See Rev. Rul. 70-309.
Rev. Rul. 75-41 considers the employment tax status of individuals performing services for a physician's professional service corporation. The corporation is in the business of providing a variety of services to professional people and firms (subscribers), including the services of secretaries, nurses, dental hygienists, and other similarly trained personnel. The individuals who are to perform the services are recruited by the corporation, paid by the corporation, assigned to jobs, and provided with employee benefits by the corporation. Individuals who enter into contracts with the corporation agree they will not contract directly with any subscriber to which they are assigned for at least three months after cessation of their contracts with the corporation. The corporation assigns the individual to the subscriber to work on the subscriber's premises with the subscriber's equipment. Subscribers have the right to require that an individual furnished by the corporation cease providing services to them, and they have the further right to have such individual replaced by the corporation within a reasonable period of time, but the subscribers have no right to affect the contract between the individual and the corporation. The corporation retains the right to discharge the individuals at any time. Rev. Rul. 75-41 concludes that the individuals are employees of the corporation for federal employment tax purposes.
Rev. Rul. 70-309 considers the employment tax status of certain individuals who perform services as oil well pumpers for a corporation under contracts that characterize such individuals as independent contractors. Even though the pumpers perform their services away from the headquarters of the corporation and are not given day-to-day directions and instructions, the ruling concludes that the pumpers are employees of the corporation because the pumpers perform their services pursuant to an arrangement that gives the corporation the right to exercise whatever control is necessary to assure proper performance of the services; the pumpers' services are both necessary and incident to the business conducted by the corporation; and the pumpers are not engaged in an independent enterprise in which they assume the usual business risks, but rather work in the course of the corporation's trade or business. See also Rev. Rul. 70-630, 1970-2 C.B. 229, which considers the employment tax status of sales clerks furnished by an employee service company to a retail store to perform temporary services for the store.
Section 530(a) of the 1978 Act, as amended by section 269(c) of the Tax Equity and Fiscal Responsibility Act of 1982, 1982-2 C.B. 462, 536, provides, for purposes of the employment taxes under subtitle C of the Code, that if a taxpayer did not treat an individual as an employee for any period, then the individual shall be deemed not to be an employee, unless the taxpayer had no reasonable basis for not treating the individual as an employee. For any period after December 31, 1978, this relief applies only if both of the following consistency rules are satisfied: (1) all federal tax returns (including information returns) required to be filed by the taxpayer with respect to the individual for the period are filed on a basis consistent with the taxpayer's treatment of the individual as not being an employee ('reporting consistency rule'), and (2) the taxpayer (and any predecessor) has not treated any individual holding a substantially similar position as an employee for purposes of the employment taxes for periods beginning after December 31, 1977 ('substantive consistency rule').
The determination of whether any individual who is treated as an employee holds a position substantially similar to the position held by an individual whom the taxpayer would otherwise be permitted to treat as other than an employee for employment tax purposes under section 530(a) of the 1978 Act requires an examination of all the facts and circumstances, including particularly the activities and functions performed by the individuals. Differences in the positions held by the respective individuals that result from the taxpayer's treatment of one individual as an employee and the other individual as other than an employee (for example, that the former individual is a participant in the taxpayer's qualified pension plan or health plan and the latter individual is not a participant in either) are to be disregarded in determining whether the individuals hold substantially similar positions.
Section 1706(a) of the 1986 Act added to section 530 of the 1978 Act a new subsection (d), which provides an exception with respect to the treatment of certain workers. Section 530(d) provides that section 530 shall not apply in the case of an individual who, pursuant to an arrangement between the taxpayer and another person, provides services for such other person as an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work. Section 530(d) of the 1978 Act does not affect the determination of whether such workers are employees under the common law rules. Rather, it merely eliminates the employment tax relief under section 530(a) of the 1978 Act that would otherwise be available to a taxpayer with respect to those workers who are determined to be employees of the taxpayer under the usual common law rules. Section 530(d) applies to remuneration paid and services rendered after December 31, 1986.
The Conference Report on the 1986 Act discusses the effect of section 530(d) as follows:
The Senate amendment applies whether the services of [technical service workers] are provided by the firm to only one client during the year or to more than one client, and whether or not such individuals have been designated or treated by the technical services firm as independent contractors, sole proprietors, partners, or employees of a personal service corporation controlled by such individual. The effect of the provision cannot be avoided by claims that such technical service personnel are employees of personal service corporations controlled by such personnel. For example, an engineer retained by a technical services firm to provide services to a manufacturer cannot avoid the effect of this provision by organizing a corporation that he or she controls and then claiming to provide services as an employee of that corporation.
* * * [T]he provision does not apply with respect to individuals who are classified, under the generally applicable common law standards, as employees of a business that is a client of the technical services firm.
2 H. R. Rep. No. 99-841 (Conf. Rep.), 99th Cong., 2d Sess. II-834 to 835 (1986).
Under the facts of Situation 1 the legal relationship is between the Firm and the Individual, and the Firm retains the right of control to insure that the services are performed in a satisfactory fashion. The fact that the Client may also exercise some degree of control over the Individual does not indicate that the Individual is not an employee. Therefore, in Situation 1, the Individual is an employee of the Firm under the common law rules. The facts in Situation 1 involve an arrangement among the Individual, Firm, and Client, and the services provided by the Individual are technical services. Accordingly, the Firm is denied section 530 relief under section 530(d) of the 1978 Act (as added by section 1706 of the 1986 Act), and no relief is available with respect to any employment tax liability incurred in Situation 1. The analysis would not differ if the acts of Situation 1 were changed to state that the Individual provided the technical services through a personal service corporation owned by the Individual.
In Situation 2, the Firm does not retain any right to control the performance of the services by the Individual and, thus, no employment relationship exists between the Individual and the Firm.
In Situation 3, the Firm does not control the performance of the services of the Individual, and the Firm has no right to affect the relationship between the Client and the Individual. Consequently, no employment relationship exists between the Firm and the Individual.
SITUATION 1. The Individual is an employee of the Firm under the common law rules. Relief under section 530 of the 1978 Act is not available to the Firm because of the provisions of section 530(d).
SITUATION 2. The Individual is not an employee of the Firm under the common law rules.
SITUATION 3. The Individual is not an employee of the Firm under the common law rules.
Because of the application of section 530(b) of the 1978 Act, no inference should be drawn with respect to whether the Individual in Situations 2 and 3 is an employee of the Client for federal employment tax purposes.« Close It
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.
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
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!
Tyler Cowen has more on "Windfall" profits.
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.
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.
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
(Photo via KCRG and Side Notes.
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?")
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.
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.
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.
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.
Working outdoors in Downtown Des Moines.
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
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.
Iowa's annual state sales tax holiday for "select clothing and footwear" runs today and tomorrow. The Department of Revenue Website gives some guidance:
* 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
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?
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.
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.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to