Tax Update Blog: October 2008 Archives
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Keeping up a cheerful facade in New Orleans
October 31, 2008
A few years ago "facade easements" were a big tax gimmick. Owners of old, I mean "historic" buildings would give a legal promise to a local preservation charity to not alter the outside of a building, and then take a big tax deduction for the fair market value of that gift.
A New Orleans hotel project that took a $7 million-plus deduction for a facade easement gift came to grief in Tax Court yesterday. The IRS won a battle of dueling appraisers when the Tax Court held that the entire building was worth just north of $12 million, and the facade easment was only worth $1,792,301 (why it's not $1,792,300 isn't explained).
Worse for the taxpayer, the Tax Court said taxpayer didn't have reasonable cause for a "gross valuation misstatement" - one of over 400% - and was subject to a penalty of 40% of the the underpaid taxes:
...petitioner must establish the fact that, in addition to obtaining a qualified appraisal, it made a good faith investigation of the value of the servitude. Petitioner offers a hotch-pot of arguments that, either together or separately, are not convincing.
The penalty is 40% of the understatement of tax attributable to the gross misstatement. As the taxpayer in this case is a partnership, the penalty depends on the tax status of the partners; assuming they are all top-bracket taxpayers, that should work out to a penalty of around $791,000. In contrast, the entire tax savings from the the $1,702,301 deduction works out to about $596,000. All in all, a pretty poor return on the facade donation project.
Cite: WHITEHOUSE HOTEL LIMITED PARTNERSHIP, 131 T.C. No. 10
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The end of tax strategy patents?
October 31, 2008
The Federal Circuit Court of Appeals has issued a decision that may signal the end of tax strategy patents. The decision restricts the ability to patent "business processes." Patent attorney Brett Trout explains:
The CAFC ruled that to be eligible for patent protection, an invention must fall into one of two categories: (1) it must be tied to a particular machine or apparatus, or (2) it must transform a particular article into a different state or thing. The court went on to note that business method claims are subject to the “same legal requirements for patentability as applied to any other process or method.” The CAFC declined however, to toss out software patents as a whole.This ruling will certainly come as a shock to the thousands of companies in possession of the over 50,000 business method patents the United States Patent and Trademark Office has already granted.
Ellen Aprill, "the nation's leading authority on tax strategy patents," according to the TaxProf, says some issues remain to be sorted out for tax patents:
Many, perhaps most, tax strategy patents call for the use of a computer. The opinion leaves open the question of what it means for a process to be tied to a “particular machine:” “We leave to the future cases the elaboration of the precise contours of machine implementation, as well as the answers to particular questions, such as whether or when recitation of a computer suffices to tie a process claim to a particular machine.” Thus, what is perhaps the most important practical question is left unresolved.
Tax stategy patents are unwise as a matter of policy. Taxpayers shouldn't have to worry about having to contest a royalty claim if their tax information becomes public in a Tax Court case.
The TaxProf and the BenefitsBlog have more.
Related: Patently Absurd
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Do-it-yourself wealth spreading
October 31, 2008
The Treasury Inspector General for Tax Administration reports:
The IRS failed to stop approximately $894 million in fraudulent refunds during PY 2006 when the fraud detection system was not operational. This amount is significantly higher than the IRS’ July 2006 estimate of about $200 million to $300 million and our August 2006 estimate of $318.3 million (both of these estimates were based upon data available at the time). The IRS had previously advised the Senate Appropriations Committee Staff that it did not plan to recover the fraudulent refunds paid because the IRS believed at the time that the total was only $200 million.
But they stopped most of the fraud, right? Well, no:
Source: TIGTA
So if you filed a fraudulent refund claim for 2006, you had an 80% chance of it getting through. That will make folks feel good about sending in their fourth quarter estimated taxes.
Kay Bell has more.
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Iowa tax interest rate falls to 8%
October 31, 2008
The interest rate on Iowa tax underpayments and overpayments will decline to 8% for 2009, the Department of Revenue has announced. The rate is 10% for 2008.
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Beggars Night tonight!
October 30, 2008
The Des Moines area has a strange tradition of doing trick-or-treat on October 30, rather than on Halloween. We also have a strange tradition of requiring the monsters to yield up a joke before releasing their candy.
If you need some joke ideas before setting out tonight, you can check out some classics from 2005 here. Remember, they start at 6:00, so drive carefully.
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Better to skip your mortgage payments than make your student loan payments.
October 30, 2008
David Plotinsky used student loans to help pay his way through law school. After graduating he consolidated his loans with an outfit that promised to forgive a chunk of his debt if he made 36 consecutive payments on time.
Mr. Plotinsky held up his end of the deal, and the lender knocked $3,043 off the loan balance. The lender also kept up its end of the deal to the IRS, reporting the $3,043 as debt forgiveness income on Form 1099-C.
Mr. Plotinsky didn't report the income on his 1040. The IRS noticed, and he ended up in Tax Court, where he argued that the forgiveness was a gift, rather than taxable income. Predictably, the Tax Court disagreed, finding that the forgiveness was an inducement by the loan company to consolidate his loans with them, rather than "disinterested generosity."
That's the right result as a matter of tax law. Still, it grates. If you stop paying your home mortgage on time and the lender gives up on you, up to $2 million of the debt-forgiveness will be tax-free. But if you get a reward for actually living up to your contract by making your student loan payments, hello IRS.
Cite: Plotinsky, T.C. Memo. 2008-244
UPDATE: The TaxProf has more.
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Tax fraud in Madison
October 30, 2008
A Madison heating contractor has more than tax troubles. Godfredo Macapugay and his wife, Elizabeth, were sentenced this week on charges of evading over $110,000 in federal taxes. Mr. Macapugay received 12 months and 1 day, while his wife got three years probation. Why the disparity?
At today's sentencing hearing for Elizabeth Macapugay, Judge Crabb that she was very troubled by Ms. Macapugay's conduct. The judge noted that Ms. Macapugay was a smart women, with a background in accounting, who knew exactly how much money her husband was making in the business, but intentionally failed to report those numbers to their tax return preparer. Judge Crabb explained that she had no tolerance for this kind of behavior. However, given that Mr. Macapugay was already incarcerated and facing certain deportation, and there were no other close relatives in the United States to take care of their two minor children, the judge ordered a probation sentence for Ms. Macapugay.
A year in the hole, then the bums rush to the airport and the old country. If the tax cheating highlighted his illegal status, it seems like a very bad move (not that tax cheating is ever a great move). It looks like the family will have to follow Mr. Macapugay to the old country if they want to stay together. Very sad.
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You don't think House Democrats are serious about getting rid of 401(k) plans?
October 30, 2008
Powerful House Democrats are eyeing proposals to overhaul the nation’s $3 trillion 401(k) system, including the elimination of most of the $80 billion in annual tax breaks that 401(k) investors receive.House Education and Labor Committee Chairman George Miller, D-California, and Rep. Jim McDermott, D-Washington, chairman of the House Ways and Means Committee’s Subcommittee on Income Security and Family Support, are looking at redirecting those tax breaks to a new system of guaranteed retirement accounts to which all workers would be obliged to contribute.
In other words, like Social Security, and we all know how fiscally sound that is.
Via Gongol.
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We're spreading already, thank you
October 30, 2008
The OECD, the organization of western economies, says the U.S. already has the second most progressive tax system among its members, trailing only Ireland.
Maybe there might be other ways to spread the wealth besides the tax system.
UPDATE: Greetings, Instapundit vistors!
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Michigan tax protest figure convicted of tax charges
October 29, 2008
Daniel Benham, a tax-protest scheme promoter, was convicted in U.S. District Court in Michigan last week of four counts of tax evasion.
Mr. Benham has been under an injunction since 2006 preventing him from selling "corporation sole" and "strategic withdrawal" plans purporting to get you out of paying taxes. They seem to have not worked for him.
You can get an idea of Mr. Benham's odd views in this web item, "The Sheeple's Fiat Currency.." Sentencing is set for next February.
Michigan seems to have more than its fair share of these folks.
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In the land of the lost deductions
October 29, 2008
The TaxGuy has a nice list of "More deductions many people miss."
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The campaign to 'protect' you from your 401(k) plan
October 29, 2008
Benefits Blog has dug up an interview with Teresa Ghilarducci, the mastermind behind the plan to replace 401(k)s with a "guaranteed" federal retirement plan paid for by a higher payroll tax. Because we all know that government retirement plans can never be insolvent.
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Late to the Cavalcade
October 29, 2008
A new edition of the Cavalcade of Risk went online last week. Among the many confections at this roundup of insurance and risk-management posts is some good news for white wine fans.
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Lower-of-cost-or-market: it didn't mean what they thought it meant
October 28, 2008
Some taxpayers who value inventories on the first-in, first-out, lower-of-cost-or-market (FIFO-LCM) method think that it gives them unfettered ability to write down inventory as needed to control taxable income. That's not necessarily so, as the Tax Court demonstrated yesterday.
A California Dodge dealer took over $300,000 in LCM markdown deductions on used cars in 1999 and 2000. The tax law specifically allows this method, but not only with restrictions. The Tax Court summarized the rules this way (citations omitted; my emphasis):
A taxpayer using the lower of cost or market method of valuing inventory may write-down a decline in the value of merchandise from its cost to a lower market value in the year in which the decline occurs, even though the goods have not been sold. This is referred to as an inventory write-down. If the market value of the inventory at the end of the year is lower than its cost, the taxpayer writes down the basis of the inventory to the lower market value, thereby reducing gross income. Deducting a reserve for price changes from the inventory or writing down inventory based on mere estimates, however, is not allowable. Further, we will not disturb the Commissioner's determination disallowing a taxpayers's write-downs without objective evidence substantiating an item-by-item comparison of cost-to-market value.
In short - you have to be able to demonstrate that each item has declined in value, and you can't just deduct a general valuation or obsolescence reserve.
The Dodge dealer went about the computation this way:
Petitioner's accountant determined market value for writedown purposes as the wholesale Kelly Blue Book value with the assumption that the automobiles were in average condition.8 Petitioner's accountant testified that it is necessary to know the make, model, and year of the automobile, as well as the automobile's condition, mileage, and equipment options to determine the Kelly Blue Book value. Yet petitioner's write-down records do not include complete information. Petitioner's records lack the make, model, and year of several automobiles and do not include the mileage, condition, or options of any automobiles. Petitioner argues that this method is the industry standard and any differences between the method used and a more detailed analysis would have been immaterial. We are not persuaded given the incomplete write-down records and absence of any corroborating evidence to support the estimated Kelly Blue Book values.
Lesson #1: At least with cars, the Tax Court says you need to do your computation car-by-car based on mileage, condition, options and the like. But then the dealer made a worse blunder:
In addition, petitioner did not then use its write-down calculations of $309,172.04 in 1999 and $344,207.67 in 2000 to determine its cost of goods sold. Rather, petitioner violated the regulations when it substituted a reserve amount of $340,181.09 as the write-down for both years.
Lesson #2: you can't deduct an inventory reserve. You can only deduct actual LCM markdowns, determined item-by-item.
There's no explanation of why the dealer went through the trouble of valuing inventory and then just trying to deduct a reserve. This made it easy for the judge - inventory reserves are clearly not deductible.
Cite: West Covina Motors, Inc., T.C. Memo. 2008-237
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Beale's 'Common Law Court' overruled
October 28, 2008
Convicted tax evader Robert Beale will now have something to look forward when he completes his 11-year tax evasion sentence.
Another sentence.
Mr. Beale, the former Minnesota entrepreneur who spent most of two years on the run after failing to show up when his tax trial was first scheduled, was convicted yesterday of conspiring to intimidate the judge in his trial. He was charged with conspiring with other members of a self-styled "common law court" to "arrest" the trial judge if she didn't dismiss the tax charges.
This seemingly foolproof plan came to grief when wardens got wind of it by listening in on Mr. Beale's calls from jail.
Flickr photo by Mr.Thomas
It just goes to show - you can't count on privacy when you use the wrong kind of cell phone.
Related: I MEANT THAT GOD WANTS ME TO BUY YOU DINNER AND DRINKS, YOUR HONOR
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Other than that, the tax system is just fine
October 28, 2008
Simply stated, comprehensive federal tax reform cannot take place without the states' approval. Yet the states lack the inclination as well as the resources to embrace far-reaching change. The current environment is barren of deep reflection. Given the power of the states' resistance, proposals for comprehensive tax reform might be a waste of time and effort. Seamless conformity is a fiction; our fractured system continues to ossify, devoid of effective criticism or viable alternatives. Our personal income tax regime lacks the flexibility to deal effectively with a host of possible contingencies.
From "Tax Credits: Teir Critical Role in Comprehensive Tax Reform," by Ralph Tower and Kevin Hall, in today's Tax Analysts Online ($link)
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A deduction big enough to litigate
October 27, 2008
Wellpoint, the insurance company, lost a $113,837,500 deduction today in Tax Court. They deducted payments to some states to settle a lawsuits, expenses the court ruled were capital in nature and therefore non-deductible. They also lost an $800,000+ deduction for related legal expenses.
If they made the payments because they had an opinion letter assuring that they could get a deduction, oops.
Cite: Wellpoint, Inc., T.C. Memo 2008-236. If that link doesn't work, try this one.
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The Wardrobe Watch
October 27, 2008
If ever there were a reporter and a story made for one another, it's Lee Sheppard of Tax Analysts and the Sarah Palin wardrobe kurfuffle. Ms. Sheppard is known for a knowledge of tax that rivals her knowledge of handbags, and she now has issued her take on the story ($link). She ratifies the obvious -- that the clothes are taxable to the Governor if she keeps them -- and she offers some advice:
Palin should keep the clothes, take them into income, and donate them when she is no longer using them. Why? Because they will not depreciate in value upon later donation as much as the cases say, for two reasons. First, Palin, whether or not she becomes vice president, is a historical figure, and that adds value to clothes she wore. Second, thrift and resale shops are not the only outlet for her used designer clothes, and would be the least desirable outlet.
She also offers her fashion take:
But what about the fashion choices made by Palin and her handlers? Should readers want to look like that? Only when they are heading to the opera. The clothes are too dressy for the use to which they are being put, though if Palin becomes vice president, they would be suitable for the traditional vice presidential task of attending state funerals.Piece by piece, our fashionista assessment: Red jackets are fine on camera, good with dark hair, and red is the Republican color. Black suits are not good on camera, though Palin's handlers may have thought they give her gravitas. Tight skirts are appropriate only if one is campaigning for a new boyfriend. The only excuse for high heels is that Palin is short (her running mate is also short by historical standards). And our readers know what we think of flesh-colored hose. But Palin is an American, and Americans like figure-skater hose.
Ann Althouse has a more favorable assessment, with the pictures to prove it.
Lee Sheppard attended one of the sessions of the NYU Tax Institute that I attended last week, so we have to note her outfit - a sleek black fashion ninja look.
Lee Sheppard, Tax Reporter and Fashionista, in action.
She also wore a pair of flat heavy-looking black boots that struck my Midwestern eyes as incongruous. Yet you have to respect her "I know so much about fashion that I can wear these boots, and still squash you like a bug" vibe.
Related: The tax costs of public service - Palin edition
UPDATE: Kay Bell chimes in on the Sheppard piece.
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What will be left in the cigar box?
October 27, 2008
Greg Mankiw looks at how the Obama and McCain tax plans affect your ability to save and accumulate wealth, taking into account corporate taxes, divedend and capital gain taxes, and estate and gift taxes:
If there were no taxes, so t1=t2=t3=t4=0, then $1 earned today would yield my kids $28. That is simply the miracle of compounding.Under the McCain plan, t1=.35, t2=.25, t3=.15, and t4=.15. In this case, a dollar earned today yields my kids $4.81. That is, even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes.
Under the Obama plan, t1=.43, t2=.35, t3=.2, and t4=.45. In this case, a dollar earned today yields my kids $1.85. That is, Obama's proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario. In a sense, putting the various pieces of the tax system together, I would be facing a marginal tax rate of 93 percent.
It looks like there's a lot of "wealth spreading" going on already. Or, actually, wealth destruction, as money taken in taxes doesn't get spread to the needy via some scientific leveling process. It gets spent on favored political constituencies, and often is spent inefficiently. Economists call this "dead-weight loss," a polite term for "waste."
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The Tax Cheat Boutique?
October 27, 2008
The gossip site Defamer.com reports that Robert Bernhoft, who held Wesley Snipes prison term down to a mere three years (it could have been much worse) is looking to set up a celebrity tax defense practice in Malibu.
And who doesn't want to hold their tax sentence down to only 36 months? That would seem like a good deal to Alan Fabian, a "a wealthy entrepreneur, religious philanthropist and well-connected political fundraiser" from Maryland who last week was sentenced to nine years in prison on tax and fraud charges. Russ Fox has the details.
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More on Argentina's pension nationalization
October 27, 2008
From Investor's Business Daily:
U.S. Democrats in Congress are mulling like-minded moves to scrap 401(k)s and transfer them into government-managed "guaranteed retirement accounts" with a 3% return, according to James Pethokoukis of U.S. News & World Report (full disclosure: Pethokoukis is a former IBD reporter).Before they charge ahead, they should look at what happened since Argentina's announcement: Its stock market lost 23% of its value in two days, for a 57% loss since January. The losses spread to other markets in Brazil, South Africa and Spain.
Via Benefitsblog.
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John McBama and tax reform
October 24, 2008
There's a great post at Tax Policy Blog about the political difficulties of tax reform. The post covers the sweeping reform proposals by Len Burman of the center-left Tax Policy Center. While not my ideal tax reform, it would be a lot better than what we have now. But how would it play in a presidential campaign? The Tax Policy Blog says it would play like this:
Did you know that Len Burman wants to tax your health insurance for the first time ever?Did you know that Len Burman favors socialist policies that would give welfare to those who pay no taxes?
Did you know that Len Burman wants to give big corporations huge tax breaks, some of which ship American jobs overseas?
Did you know that at a time when housing prices continue to plunge pushing the U.S. into financial turmoil, Len Burman wants to take away your mortgage interest deduction and your ability to deduct those high property taxes you are paying?
Did you know that Len Burman wants to eliminate tax credits for hard-working Americans like you that are struggling to afford the ever-rising costs of college tuition?
Did you know that Len Burman favors taxing your electricity and raising the price you pay at the pump?
That's not the kind of reform we need. I'll fight Washington insiders like Burman who are out of touch with main street America. I promise cutting taxes for families like yours who can't afford the higher taxes you'll be paying under my opponent's plan? I'm John McBama and I approve this message.
Sadly, I think this is exactly what would happen.
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Non-filer syndrome
October 24, 2008
The chief of staff for the Governor of New York has a novel defense for failing to file his tax returns for five years:
Lawyers for top Paterson administration aide Charles O’Byrne claimed Wednesday he failed to pay taxes for five years because he has “non-filer syndrome."“These are very high-functioning people who otherwise can complete all of the ordinary tasks in their lives,” O’Byrne lawyer Richard Kestenbaum insisted.
“But there is something that they can’t do, and many times that causes them not to be able to file their tax returns.”
There is another clinical term that often covers the same set of symptoms: "guilty as charged."
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What would George do?
October 24, 2008
I figured someday I would get a comment like this:
You're against government taking private property (businesses) but you are gung-ho for taking private property (personal income taxes) and even ramping up IRS actions against tax protesters?This strikes me as contradictory.
Is it just that you're ok with government stealing from individuals, but prefer they not do the same with businesses? Or is it something else?
First, I'm not "gung-ho" about taking property from tax protesters. A lot of folks who use tax protest arguments are more naive than devious. While I don't think they should be rewarded for using their absurd arguments, I realize that many of them end up in tragic financial straits. It's very sad. I can't work up much sympathy for the people who sell the tax protest schemes, though, considering the trouble they cause for those foolish enough to buy their stuff.
Second, I don't accept that there is a difference between taxing business and taxing "people." Only people pay taxes; sometimes they pay via a business, but every tax is borne by a human somewhere.
But I think the core of the commenter's argument is that taxes are theft, and so there is no distinction between avoiding taxes legally and avoiding them otherwise. Sure, there is an anarcho-capitalist argument to that effect, part of a view that no government is needed at all. It strikes me as the flip side of the argument that student communists made to me in college - it's a system that will work, but only when all other systems are abolished. Sure, we need a lot less government than we have, but I can't get excited about systems that can only work under conditions that will never occur.
My own views are more along the lines of George Washington. When early tax protesters arose against a whiskey tax in Washington's presidency, he raised an army to put down the protest. While George opposed taxation without representation, he believed that once taxes are levied by a legitimate representative government, we are obliged to go along (my emphasis):
I am perfectly in sentiment with you, that the business we are drawn out upon, should be effectually executed; and that the daring and factious spirit which has arisen (to overturn the laws, and to subvert the Constitution,) ought to be subdued. If this is not done, there is, an end of and we may bid adieu to all government in this Country, except Mob and Club Govt. from whence nothing but anarchy and confusion can ensue; for if the minority, and a small one too, are suffered to dictate to the majority, after measures have undergone the most solemn discussions by the Representatives of the people, and their Will through this medium is enacted into a law; there can be no security for life, liberty or property; nor if the laws are not to govern, can any man know how to conduct himself with safety for there never was a law yet made , I conceive, that hit the taste exactly of every man, or every part of the community; of course, if this be a reason for opposition no law can be execd. at all witht. force and every man or set of men will in that case cut and carve for themselves...
As a practical matter, somebody has to pay the government's bloated bills, and when the tax protesters don't the rest of us have to pay more. For that reason alone, I resent people who skip out on their taxes, whether via political influence, tax protester arguments or plain old tax evasion.
True, the tax law is a mess. It's far too complex, it's riddled with favors for the well-connected, and prospects for reform are dim. Even so, the implications of everybody deciding for themselves which laws to follow are as frightening now as they were during the Washington presidency. While someday things could get to the point where mass tax disobedience would be justified, that point is a lot closer to Zimbabwe than to the U.S.
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The mechanisms of owner restraint
October 23, 2008
"Yeah, small business owners never spend it all on yachts and jets."
So says a commenter to this post on how increasing the top individual rates directly taxes successful closely held businesses. The commenter is responding to my assertion that "usually" such taxpayers plow their after-tax earnings back into the business, rather than pulling it out for themselves or spending it on luxury goods. The comment also refers to a Cedar Rapids lawsuit where a business owner is accused of, well, spending business money on a yacht and a private jet.
The lawsuit is merely accusations at this stage, and it may turn out to be unfounded. But even if the allegations were proven, the case would illustrate the mechanisms that often keep business owners from going overboard on personal expenditures, even if they are so inclined.
The suit is brought by a minor shareholder who also was an officer of the company. He claims the majority owner spent excessively, impairing the value of his 2% stake. Now if the majority owner vindicates himself, it will only be after having to go through an expensive, time-consuming and potentially embarrassing federal court lawsuit.
If a minor disgruntled shareholder can cause this much difficulty, imagine the leverage a banker or a big venture equity investor has to control corporate expenditures. This sort of influence makes it hard for a business owner to pull out more cash than he needs to pay his taxes, or to blow money on executive baubles. Of course many business owners just want to keep growing the business, contenting themselves with a salary; these owners have no interest in joining the private jet set.
Perhaps the most egregious executive abuses come from public companies, where they can spend somebody else's money on the private jets and $6,000 shower curtains. The entrepreneur who reports the business income on his own 1040 would only be stealing from himself.
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The tax costs of public service - Palin edition
October 23, 2008
By the time this election is over, Sarah Palin may run up quite a tax bill. She's already likely to owe back taxes on her per-diems, and now the tax blogs want her to pay taxes on clothes and makeovers bought for her by the campaign.
As far as the clothes go, if she gets to keep them, she's taxable on them. If she doesn't, she has a pretty good argument that they are no more taxable than costumes worn by actors or outfits worn by models -- an argument that even anti-Palin partisan Linda Beale acknowledges. And what is politics but an act? I suspect that a campaign operative right now is writing a letter for the file saying that the clothes are just on loan.
Why hasn't this argument come up for other candidates? For the men it doesn't come up because all a man needs is a dark suit, a clean shirt and a subdued tie to look presentable.
For women, it's a lot more difficult and expensive to put together outfits when you are going to be on TV every day. The other women we've seen most often in this election season - Hillary Clinton, Cindy McCain, and Michelle Obama - are rich, and they can afford expensive outfits. So if you are going to run for office without a Y chromosome, make sure you have a lot of money first, because otherwise the tax bills will be a killer, if Beale & Co. have their way.
Other coverage:
The TaxProf's comprehensive post
Daniel Shaviro, who, while enjoying the discomfiture of a political enemy, seems to understand that this is a stupid issue.
Kay Bell
Tax Policy Blog
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You've lost a fortune in the market, so give away what's left
October 23, 2008
Estate planners have noted a perverse benefit of the recent bloodletting in the stock markets: when your net worth falls off the cliff, it solves a lot of estate tax problems. It also means you can give away a lot more shares of stock without gift tax than you could six months ago, seeing that they're much cheaper.
Of course, it's hard enough to convince wealthy clients to give property away to their layabout heirs when times are good. As Joel Schoenmeyer points out, it's even tougher when times are bad:
Of course, the problem with making a gift like this in times like these is the psychology. It's already difficult for people to get over the idea that, if they make a gift, the gifted property is permanently gone. Add on the fact that many people feel like any current market conditions are somehow different than what we've seen in the past (this recession/depression will never end, house prices will always go up, etc.). The bold can make a lot of money at times like these, but are you really bold enough to act now?
If you are sufficiently bold, and the market recovers before you die, your layabout heirs will be grateful.
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How increases in the top individual rate beat up the successful business
October 22, 2008
Senator Obama proposes to increase the top tax rates for "the rich." Those who support higher rates like to point out how few taxpayers will see the higher rates on their returns. When people point out that small businesses often pay taxes at individual rates, the rate hikers say most small businesses won't be affected.
If you count every moonlighter, Mary Kay seller and part-time real estate agent, sure, not many of these people will be at the top rate. But Tax Vox asks the right question: what about the serious ones? Because they're the ones that really matter.
My career has been spent working with the successful small businesses who would be hit by the proposed Obama rate increase. To understand what this would do to their businesses, and the economy, it might be helpful to see how this works. While these taxpayers are a small portion of taxpayers with K-1 or Schedule C income, they are the ones who build businesses and hire people.
The successful businesses might have sales of anywhere from $10 million to over $100 million. They might generate taxable income of $1 million to $20 million and up. They have dozens to over a hundred employees, with activities in one to twenty or more states.
So what happens to this money? Do the owners put it in a gilded vault and bathe in it, like Scrooge McDuck? Do they spend it all on airplanes and yachts?
These entrepreneurs typically have bankers or co-investors who impose strict limits on how much earnings can come out of the businesses. They usually only get to take enough cash out of the businesses to pay the individual tax that the business income adds to their returns. The banker or co-investor will stop the private jet in a hurry.
A taxpayer with $10 million taxable income, for example, might only take $4 million out of the business to send to the IRS and to pay state taxes. The rest of the money stays in the business to buy inventory, develop new product, open new locations and hire new employees.
When the federal tax rate for someone with $10 million in taxable income goes goes from 35% to 45%, that just means another $1 million comes out of the business to go to the IRS. That million is no longer available to develop a new product. It's no longer there to open a new location in a different state. It's just gone, as is the economic activity and job growth it would cause.
To preserve business cash, management will shift more if its time from managing the business to managing taxes. More complex structures, perhaps with offshore activities, become more attractive. This generates tax consulting fees, for which I am grateful, but they are wasted resources to the economy.
Are these taxpayers significant to the economy? I think they clearly are. A picture can help illustrate this. The chart on the left is the one typically used by tax-hike supporters to say that only other people get screwed. The chart on the right shows how the tax hike affects taxpayers by the amount of the tax burden they now bear. The top bracket taxpayers pay a huge portion of the income tax burden. These are the entrepreneurs we're talking about.
Charts via Freakonomics
The chart on the right is the more accurate version of how much cash the proposals to increase the top rate will suck out of the economy.
There used to be a bi-partisan understanding that taxing "the rich" hurts the most important closely-held businesses. That understanding seems to be a campaign casualty.
UPDATE, 10/23: The Mechanisms of Owner Restraint
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Just in case he wanted to get back in the business at age 92
October 22, 2008
Irving Schiff will be in prison until he's 92 on tax charges. It seems unlikely that he would want to step back into his old role as a disciple of the tax protest set, but just in case, the IRS has obtained a permanent injunction against his resuming tax practice. Russ Fox and Peter Pappas have more.
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Cry for Argentina
October 22, 2008
The government of Argentina is attempting to seize private pension plans. They say they are doing this to "protect" workers from stock fluctuations, but it is transparently a desperate ploy to prop up the government pension system.
BenefitsBlog notes that there is a movement to do the same thing in the U.S. It would be pushed with the same cynical goal of "protecting" us, and it would be an absolute disaster.
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No 'Built-in losses' for bank bad debts
October 22, 2008
Tax planning would be easy if you could just buy tax losses, but the tax law limits the ability of corporations to buy net operating loss carryforwards from other corporations. The "Sec. 382" rules limit the annual use of losses after a corporation changes hands to the value of the corporation multiplied by the "long-term tax-exempt rate, currently 4.94%. If you buy a loss corporation for $1,000,000, you can only use its NOLs at the rate of $49,400 per year.
What if the corporation you buy is about to lose a bunch of money? Can't you buy it just before those losses occur so you can deduct them on your own return? Sec. 382 fights this by applying the NOL limits to "built-in" losses. Except right now, for banks, anyway.
Guest-posting at Marc Ward's LLC blog, Christine Holbrook points out that the IRS has ruled that built-in loss limits won't apply to bad debt deductions taken by newly acquired banks (Notice 2008-83). That means if Wells Fargo buys Wachovia and has to write off humongous bad debts, they won't have to apply the Sec. 382 limits to the bad debt deduction. While the post questions the IRS authority to do this, really, who is going to stop them? But while the IRS is clearly doing this to help smooth the way to sorting out the banking mess, it may prove an awkward precedent for them when times get better.
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IRS final regs limit S corporation open account debt
October 21, 2008
The Treasury last week issued the long-awaited, or long-dreaded, final regulations (TD 9428) on advances to S corporations by their shareholders. While the final regs are less severe than their original proposal, they still promise plenty of unhappy surprises to S corporation owners. To understand why, let's review how debt enables S corp owners to deduct corporate losses.
S corporations generally pay no income tax on their own income. Instead, income and loss items pass through to the owners' 1040s. If the S corporation has losses, they might be deductible on the owners' returns if the owner has basis in their stock of the S corporation or in loans they have made to the S corporation. If there is no basis, the loss carries over until there is new basis.
Basis in stock starts with your purchase price; your basis increases by your share of S corp income and by contributions to corporation. It goes down by losses and by distributions.
If you have no basis in your stock, losses then reduce your basis in any loans made to the S corporation; corporate income restores debt basis before it restores stock basis.
This creates obvious tax planning opportunities for making big loans on December 31 of year 1 to give you basis to take losses, taking the money back on January 3, year 2, and then putting it back as needed the following December. The owners of Brooks AG, an Alabama S corporation, did this to the tune of hundreds of thousands of dollars, and the Tax Court upheld their deductions. The new regs are the overkill response.
If you have separate written loan instruments, the tax law tracks their basis separately. If the Brooks AG owners had written loans, they would have had income when they repaid the loan in year 2. If you have open account debt without a written debt instrument, like they actually did have, only the year-end balances matter.
The new regs place a $25,000 limit on the amount of year-end open account debt; it the year-end balance exceeds $25,000, it is considered a written loan, rather than open account debt, and future advances are considered a new loan.
EXAMPLE: Joe owns all of Joe Inc., an S corporation. He is out of stock basis at the end of 2008, so he loans the company $30,000 at the end of 2008 to to enable him to deduct $25,000 of corporate losses on his 1040. That leaves him a $5,000 basis is his open account loan.
In January 2009, a customer pays an overdue bill, enabling Joe to pay back his $30,000 advance. The company breaks even in 2009, and Joe loans the $30,000 back on open account in December 2009.
Unfortunately for Joe, he has $25,000 gain on the repayment in January; because the corporation had no taxable income, Joe's basis wasn't restored before repayment. The year-end advance is considered a different loan. Under the old rules, the 2009 repayment would not have triggered 2009 income if the loan were renewed by the end of 2009; this trick could still work, however, if the open account debt did not exceed $25,000.
So what should S corporation owners do now? The new regs apply to loans made starting this week. Loans outstanding over $25,000 at October 19 are not affected, but any new advances will not be part of their old loans, even if they are "topping off" a prior balance.
If you own all of an S corporation, the obvious route is to make contributions to capital, rather than loans. The advantages of having a loan, rather than equity, for a 100% owner are usually more theoretical than real. Just be sure that your accounting records reflect the contributions as capital, rather than debt, and any withdrawals as distributions, rather than loan repayments; also be sure that your corporate minutes note the capital contributions and distributions. As stock basis generally only is measured at year-end, this is a much more forgiving way to fund corporate losses.
If the S corporation has multiple owners, capital contributions may be hard to work, as they need to be pro-rata to ownership. Loans don't have to be pro-rata, but they're much more likely to trigger income.
The bottom line: if you need to loan over $25,000 to finance your S corporation losses at year end, be prepared to leave the funds in until future income restores your basis in the loan; otherwise, the new rules are likely to leave you with some unwanted taxable income when you repay the loan.
Remember: basis is only the first limit that applies to losses. You also have to get by the at-risk rules and the passive loss rules.
Related: IRS LOOKS TO TIGHTEN RULES ON S CORPORATION ADVANCES
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Forbes: Des Moines a 'high-tax' town
October 21, 2008
Des Moines ranks as America's seventh most taxing town for individuals in a new Forbes Magazine ranking:
Like several other cities with fairly high tax burdens, Des Moines doesn't levy its own income or sales tax; that honor belongs to Iowa. What accounts for Des Moines' high ranking? Property tax, which the city charges at a rate of $4.59 per $100 on 45% of a home's assessed value.
The "top" spot goes to Philadelphia, home of the illustrious tax professor Jim Maule. Our condolences, Professor.
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Iowa fiscal policy gets an 'F'
October 21, 2008
The libertarian Cato Institute gives Governor Culver a failing grade for his management of the states finances. They explain:
Chet Culver campaigned on a plan to increase the state's cigarette tax, and he followed through on that threat in 2007, with the effect of draining the wallets of Iowa smokers by about $140 million annually. This year, Culver has gone after businesses with a large corporate tax increase in the form of tax base broadening. On spending, Culver's performance has been equally poor, proposing increases in per capita spending averaging 8 percent annually.
The warning signs were always there:
Iowa's voters are so upset about this that they look poised to increase the majority of the Governor's party in both houses of the state legislature. It will be interesting to see how this works in a year or so, when the revenue pinch of the economic slowdown kicks in.
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S banks and the Treasury preferred stock plan
October 20, 2008
The Treasury has $125 million to buy preferred stock in smaller banks to provide them with lending capital. The obvious question is whether the plan will be modified for S corporation banks; S corporations are not permitted to have preferred stock.
Speaking at the New York University Institute of Federal Taxation yesterday, Jeffrey Van Hove, Deputy Legislative Counsel for the Treasury, says there is nothing in the works to relax the definition of preferred stock for S corporations. If there is to be any accommodation for S corporations in the plan, it will have to be a modification to enable the banks to issue debt to the Treasury that would be counted as capital with the bank regulators.
UPDATE, 11:00 a.m. The Treasury has issued application guidelines and a FAQ on their asset program, but they make no mention of S corporations.
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Raid 401(k)s, or destroy them?
October 20, 2008
Neither seem like wise ideas, but both are apparently up for discussion.
Tax Vox discusses the proposals of the candidates to allow early penalty-free withdrawals from 401(k)s. As these plans are designed as "retirement" savings plans, this seems like a bad idea, however sliced.
Meanwhile, Benefitsblog reports on a movement to replace private pensions, including 401(k) plans, with a "guaranteed" government plan fed by mandatory contributions. This might actually come into play should the Democrats sweep the elected branches of the federal government this year. It would be sort of like Social Security, only bigger. If anybody thinks this would be anything other than a political football, and a fiscal and actuarial disaster, they should think again.
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This could be an ethics violation
October 20, 2008
Russ Fox rounds up a busy week in tax fraud, highlighted by the case of a New Orleans attorney who is accused of stealing $30 million from his firm and squirreling $20 million of it in Switzerland.
It reminds me of a question an attorney friend says is the "legal ethics exam":
Q: A client comes in for a consultation, and at the end of the meeting asks to pay the bill in cash. The attorney says the fee is $100. The client hands over a crisp $100 bill and leaves. The attorney realizes that there are actually two $100 bills stuck together.Must he tell his partner?
Coming from a profession that long featured a take-home ethics exam, we accountants don't necessarily have all that much room to make fun of lawyers.
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IRS issues Applicable Federal Rates (AFR) for November 2008
October 20, 2008
The IRS has issued (Rev. Rul. 2008-50) the minimum interest rates for loans made in November 2008:
-Short Term (demand loans and loans with terms of up to 3 years): 1.63%
-Mid-Term (loans from 3-9 years): 2.97%
-Long-Term (over 9 years): 4.24%
Historical AFRs are available at the "links" page at www.rothcpa.com. You can also click here for the rates for prior months as reported in the Tax Update.
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Where in the world is the Tax Update
October 19, 2008
The Tax Update is on the road at tax school.
This primate facility is in the same town as the school. A free lifetime subscription to the Tax Update goes to the first commenter to identify the town.
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The Capone anniversary
October 17, 2008
They got Capone on tax charges. 77 years ago today, as a matter of fact.
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Leave Joe alone
October 17, 2008
The press has taken an unnatural interest in the tax life of Joe the Plumber, who had the nerve to ask a mildly unfriendly question to a presidential candidate. The Tax Prof and Kay Bell have the creepy details.
I'm with Side Notes on this:
Leave the plumber guy alone already. He is a conservative who asked Obama a question. He didn't ask McCain to be poster child for the Republican campaign. Yes, he's pro-McCain. No, the Q&A with Obama wasn't going to get him to change his mind. Yes, some of his ideas are really bad ones; he isn't a foreign policy or tax expert, he's just a guy. But he has the right to ask legitimate policy questions and debate his viewpoints with the candidate.
Would that they dig into the candidates' pasts like this. I mean, besides Sarah Palin, who they have dissected pretty thoroughly.
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2009 Gift tax exemption rises to $13,000
October 17, 2008
The IRS issued the inflation adjustments for income and gift taxes yesterday (Rev. Proc. 2008-66). The adjustments include updated rate tables and exemption amounts. A few highlights:
- The Standard deduction goes up $250 for singles, to $5,700, and by $500 for joint filers, to $11,400.
- The personal exemption rises from $3,500 to $3,650.
- The kiddie tax, which can apply to "children" up to age 24, will kick in at $950 of income.
The increase in the gift tax is no minor matter. The annual exclusion is availabe each year. A couple with two children can move $52,000 each year to the next generation free of estate and gift tax at that rate. If they do it every year, it definitely adds up.
The TaxProf has more.
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2009 401(k) limit: $16,500
October 17, 2008
The IRS has released the inflation-adjusted limits for 401(k) deferrals and plan contributions for 2009. Some highlights:
- The 401(k) elective deferral limit goes to $16,500, from $15,500.
- The "catch-up" amount for employees 50 years old and up in 401(k) plans increases to $5,500, from $5,000.
- The annual defined contribution plan limit goes to $49,000, from $46,000.
Via Benefits Blog
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2009 FICA MAX: $106,800
October 17, 2008
The Social Security Adminstration yesterday issued the inflation-adjusted FICA base for 2009; it will be $106,800. That means an employee's 6.2% FICA tax for 2009 will top out at $6,621.60. The 1.45% Medicare component has no wage limit. Employers pay a matching tax.
Self-employed taxpayers pay both sides of the FICA tax through their self-empoyment tax.
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So that's where the free money comes from?
October 16, 2008
Politicians like to promise to spend money as if they can pull it out of a stash of free cash that doesn't actually come out of someone's pockets. Senator Obama seems to think corporations can fill the role of cash pinata for politicians:
Because after eight years of failed policies, he and I both agree that what we're going to have to do is to re-prioritize, make sure that we're investing in the American people, give tax cuts not to the wealthiest corporations, but give them to small businesses and give them to individuals who are struggling right now...
The Tax Policy Blog has nonpartisan coverage of the candidate's tax whoppers. They rightfully note the folly of the assertion that "big corporations can afford to pay more taxes":
What Sen. Obama doesn't understand or doesn't want to tell the American public is that when Exxon Mobil writes that check to Uncle Sam, some PERSON is paying the price for that. In the short-run, that person could be a shareholder, a worker, or a consumer. But the fact that Exxon Mobil has a lower after-tax profit means that some PERSON is worse off. For example, Exxon Mobil would likely reduce its dividend payment, or its share price could fall, and that hurts every PERSON who was invested in Exxon Mobil at the time the tax was enacted.
Only two sets of people can pay corporation taxes: the owners and the employees. When you beat on corporations, you either beat on their employees or you beat on the 401(k) plans that invest in them. I don't think there are many people whose 401(k) accounts need more beating right now.
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The Floridian Duchy of Brinkle
October 16, 2008
Peter Pappas tells the story of a Florida couple who have declared themselves "soveriegn." They have used their independence try to avoid the IRS and property taxes, and to create their own currency. Having a country apparently isn't all it's cracked up to be:
And get this, the Brinkles complained to the Sentinel that they don’t have enough money to pay their heating and air conditioning bills because they are "scraping by on $1,300.00 per month of Social Security Benefits."SOCIAL SECURITY BENEFITS? Don’t they mean foreign aid?
Heh.
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KPMG Trial under way
October 16, 2008
The trial of the four remaining KPMG tax shelter defendants got going yesterday. The defendants will call it tax planning; the government will call it fraud. If the government shows that the shelters were built on transactions that never happened, that will be bad news for the defense. If the shelter transactions actually happened and the paperwork wasn't faked, the defendants should have a good shot at acquittal.
The TaxProf has a roundup.
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Maybe the justices don't watch TV
October 16, 2008
The Supreme Court apparently had more important things to do than to listen to Richard Hatch try to explain why he didn't report $1 million in taxable income that millions of TV viewers saw him earn. They declined to hear his appeal yesterday. TaxGrrrl and Russ Fox have more.
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Economic research we can believe in
October 16, 2008
Marginal Revolution is a favorite site because of the way they make economics interesting:
Pettijohn and and Jungeberg look at the characteristics of playboy playmates from 1960 to 2000 and find:Consistent with Environmental Security Hypothesis predictions, when social and economic conditions were difficult, older, heavier, taller Playboy Playmates of the Year with larger waists, smaller eyes, larger waist-to-hip ratios, smaller bust-to-waist ratios, and smaller body mass index values were selected. These results suggest that environmental security may influence perceptions and preferences for women with certain body and facial features.
I don't know what it means, but it does make make me want to review the data.
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Today's the day.
October 15, 2008
It's October 15. Today is the last day to file a timely extended 1040 for 2007. Unless you find pleasure in dealing with the IRS, make sure you get that extended return filed today. A few last minute tips:
- E-file if you can. That way you can get quick confirmation that the IRS has your stuff.
- If you don't e-file, spend a little extra to send your return certified mail, return receipt requested. When the IRS sends a late notice, that postmarked proof of mailing is a wonderful thing to have around.
- Don't cheap out on postage by stuffing a bunch of returns in the same envelope. Not all returns go to the same place, and you run the risk of mixing things up.
- If you don't get to the post office in time, run to Fed-Ex, UPS, or another private delivery company for IRS authorized for IRS filings.
- Don't push your preparer to the wire next time. It makes him crabby.
While we observe the passing of the extended due date today, we can also raise a toast to the expiration of the statute of limitations on 2004 extended 1040s and to the six-year "substantial understatment" statue for 2001 extended returns.
Once again, no return that we extended in 2004 was selected for audit by the IRS, and certainly not in the last six months before the expiration of the statute. If there is any additional risk of being audited from extending a return, it has yet to manifest itself at our office.
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Little scam on the prairie
October 15, 2008
How on earth does a California CPA end up causing tax nightmares for a bunch of nurse-anesthetists in North Platte, Nebraska? Blame a brother-in-law.
The California CPA is Lowell Baisden, whose tax troubles may be on the verge of becoming very serious indeed. From the North Platte Bulletin:
Insiders told the Bulletin that the federal investigation against Baisden is continuing and cooperation among those involved with him will determine how many indictments are issued.Baisden allegedly set up dummy corporations in Nevada and Wyoming for doctors and other professionals in Nebraska and California, according to federal officials. Federal officials said Baisden began his scheme with his brother-in-law, Dr. Michael Koning, an anesthesiologist who used to practice at Great Plains Regional Medical Center.
The story says the schemes involved setting up dummy corporations to receive salary income and then paying personal expenses out of the company. It looks like a variant of the system Mr. Baisden used on his own returns, to the Tax Court's bemusement.
Word gets around in small towns, and it sounds like everybody in the North Platte medical community soon heard about Mr. Baisden's tax magic. It made the brothers-in-law unpopular in some quarters. If you see your fellow professional buying a new car using money that you are sending to the IRS, it can grate. If you feel like a chump, sometimes you do something about it:
Baisden’s scheme became common knowledge at GPRMC, according to a hospital source. While some doctors and others bought into the plan, most didn’t.Numerous physicians and other employees doubted it was legal.
The scheme came unraveled after Dr. Andrew Chontos, a former North Platte surgeon now living in South Dakota, called a criminal investigator with the IRS in Denver and accused Baisden and Koning of criminal wrongdoing.
Dr. Chontos wasn't the only grumpy chump. Two anesthetists and a North Platte CPA also blew the whistle.
Now Mr. Baisden is out of the tax business by court order, and an indictment may be forthcoming. His customers at best face back taxes and penalties, with criminal charges possible, especially if they don't cooperate with the IRS.
The Moral? Too-good-to-be-true tax scams are always dangerous. In a small town, they might be suicidal. Those who are trying to negotiate their way out tax trouble meanwhile can ponder just who the chump is now.
Related: NORTH PLATTE, NEBRASKA: DEN OF TAX INIQUITY
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All Ph.d's to the front for checking, please
October 15, 2008
"Wal-Mart Treats its Part-Time Employees Better Than Universities Treat Adjuncts"
(via the TaxProf)
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Just in case you feel happy after yesterday's stock market surge
October 14, 2008
Remember what Cassandra Tyler Cowen had to say on October 6?
How to tell if things are going very badlyIf the Fed ends up guaranteeing commercial paper and/or interbank loans. Too many people are listening to Polonius.
Wall Street Journal, October 7:
Fed to Purchase Commercial Paper In New Facility Backed by Treasury
Wall Street Journal, Today:
Among the other key components of the plan is the FDIC temporarily guarantee, for a fee, certain types of new debt called senior unsecured debt issued by banks and thrifts. This would apply to debt issued by June 30 with maturities up to three years. One problem plaguing credit markets has been a fear among financial institutions that it is unsafe to lend to each other even for periods of a few days. U.S. officials hope this guarantee removes that fear, which could bring down short-term lending rates, such as the London interbank offered rate, or Libor, a benchmark for consumer and business loans.
My stomach hurts. (Update, 8:30 a.m.: it seems to make the stock market happy, though.)
Details of the new plan:
Preferred stock purchase program fact sheet
Preferred Stock term sheet
Exec Comp limits
Fed/Treasury Joint Statement
Paulson Summary
Later: Lots more at Economist's View (via Arnold Kling)
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It tolls for thee...
October 14, 2008
If you haven't filed your extended 1040, the hour is nigh. Tomorrow, October 15, is the drop dead date for 2007 1040s. If you don't file on time, all sorts of complications ensue, including potential penalties going back to April and the loss of elections that can only be made on a timely-filed return.
But if you want to subsidize the tax consulting profession, go right ahead and blow off that return. We can always use the stimulus.
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The Treasury gives banks an offer they can't refuse
October 14, 2008
WASHINGTON — The Treasury Department, in its boldest move yet, is expected to announce a plan on Tuesday to invest up to $250 billion in banks, according to officials. The United States is also expected to guarantee new debt issued by banks for three years — a measure meant to encourage the banks to resume lending to one another and to customers, officials said.
The Paulson hedge fund makes its biggest move yet. Move over, the big dog's moving in:
Treasury Secretary Henry M. Paulson Jr. outlined the plan to nine of the nation’s leading bankers at an afternoon meeting, officials said. He essentially told the participants that they would have to accept government investment for the good of the American financial system.
Say hello to your new Director, Secretary Paulson. You're issuing him some preferred stock, because we'd hate to see anything bad happen to your bank.
It's not just for the big banks:
Of the $250 billion, which will come from the $700 billion bailout approved by Congress, half is to be injected into nine big banks, including Citigroup, Bank of America, Wells Fargo, Goldman Sachs and JPMorgan Chase, officials said. The other half is to go to smaller banks and thrifts. The investments will be structured so that the government can benefit from a rebound in the banks’ fortunes.
It will be interesting to see how this works when it is formally announced today. Will community banks also get a big new partner? It will be particularly interesting for S corporation banks, as the S corporation rules do not permit preferred stock.
One hopes that this is temporary, but there are few things as permanent as a temporary government program. It sure looks as though the Treasury is backing off the program to buy up bad mortgage-backed securities in favor of directly recapitalizing the banking system.
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More on film credit second thoughts
October 14, 2008
The Wall Street Journal has a roundup of blog posts on the New York Times piece on state film credits that we mentioned yesterday.
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Air America: 70% top rates are just what we need now
October 14, 2008
Air America: Roll Back the Reagan Tax Cuts (Via the TaxProf).
The debate about whether or not to roll Bush’s tax cuts back to Clinton’s modest mid-30% rates is absurd. It’s time to roll back the horribly failed experiment of the Reagan tax cuts. And use that money to pay down Reagan’s debt and rebuild this nation.
Right, let's bring back the Carter-era good times!
Flickr Photo by dave_7
But why stop there? Roll back the Kennedy tax cuts too. If 70% rates are good, aren't 90% rates even better?
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Because that worked so well the last time...
October 14, 2008
Unbelievably, Congressional Democrats are pushing another round of "stimulus" rebates. Yeah, that sure stopped the recession and the mortgage crisis in its tracks the last time. Kay Bell and TaxGrrrl have the stupefying details.
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But what about Brad Pitt's economy?
October 13, 2008
There's nothing like a financial catastrophe to focus your spending priorities. Some states are pondering whether financing Hollywood projects is the best way to spend their shrinking tax revenues, according to the New York Times:
Already on the hook for billions to bail out Wall Street, taxpayers are also finding themselves stuck with a growing tab for state programs intended to increase local film production.One of the most shocking bills has come due in Louisiana, where residents are financing a hefty share of Brad Pitt’s next movie — $27,117,737, to be exact, which the producers will receive by cashing or selling off valuable tax credits.
These giveaways are purported to be needed for "economic development." Louisiana's credits have spurred economic development in that state's special tradition:
Until two years ago, Louisiana’s program offered a 15 percent credit for virtually the entire budget of a qualified film (and more for Louisiana resident wages), including money that may have been spent out of state. Things were fast and loose enough in Louisiana that Mark Smith, who oversaw the program, pleaded guilty last year to taking $67,500 in bribes to inflate budgets for a film production company that was not named by the authorities.
Of course Iowa has two separate 25% credits - one for expenses in Iowa, and one for investors in Iowa film projects. These credits can be transferred, so they are sold at a discount to raise project funds. If they are sold at a 10% discount - a typical rate - a $20 million project can get $9 million to the moviemakers while costing Iowa taxpayers around $10 million. Iowa also offers income and sales tax exclusions to vendors involved in film projects.
Michigan, at least, is slowly wising up:
Michigan, its own budget sagging, is in the middle of a hot political fight over a generous 40 percent rebate on expenditures to filmmakers that was carried out, with little opposition, only last April. Producers of films for studios like Warner Brothers and the Weinstein Company rushed to cash in, just as homegrown businesses were squeezed by a new business tax and surcharge. Rebellious legislators from both parties are now looking to put a cap on the state’s annual film spending, which some have estimated could quickly hit $200 million a year.
You mean Clint Eastwood's projects aren't the biggest problem in Michigan nowadays?
Via The TaxProf.
Related: Because Tom Arnold Needs a Subsidy
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A losing bet
October 13, 2008
Casino gambling is generally a losing proposition for the obvious reason that that's how casinos stay in business. Taxes only make it worse. We've discussed how the federal income tax abuses gamblers, but Russ Fox explains that some states are even worse.
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Firing people is bad enough...
October 13, 2008
...without getting sued for it. When times are bad, sometimes you have to let people go to keep the ship afloat. Rush Nigut talks about how to keep the layoffs themselves from sinking the boat in court in a very good post at IowaBiz.com.
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Tax Foundation lauds AOL's Iowa triumph
October 13, 2008
One advantage of procrastination is that sometimes somebody else will take care of the problem before you get to it (it works much better on spouses than kids, I find). For example, the Tax Foundation has taken a look at AOL's recent victory over the Iowa Department of Revenue, so I don't have to:
The Iowa Court of Appeals should be lauded for not knuckling under to their revenue officials' overreaching. The officials had demanded that America Online (AOL) cough up sales taxes for services it provided from 1995 to 1999 (conveniently back when everyone had AOL and such taxes meant something). AOL refused, saying that these transactions were interstate and thus beyond Iowa's taxing power, and demonstrated that to access AOL one must have gone through their Virginia servers. Iowa responded saying that they were local communications services. The court rejected that argument as contrary to the evidence and ruled for AOL.
Even though this was a blatant overreach by the Department, AOL has had to litigate this at both the district and appellate court levels, and Iowa still can take this to the Iowa Supreme Court. While the taxpayer has prevailed so far, it's only because AOL has the deep pockets to finance the fight. Iowa has taken equally abusive positions on other areas, like taxing non-residents on income from investment partnerships, and will continue to do so until somebody is willing to spend the time and money to fight them in court.
Iowa could really use an independent tax appeals function, similar to the IRS Appeals Division. Iowa could also use a tax administrative hearing function that would enable taxpayers to get an independent hearing on tax issues outside the Department of Revenue bureaucracy without having to file a lawsuit.
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Panic! It's October 13!
October 13, 2008
The final, drop dead, forget-about-it extended return deadline for 2007 extended 1040s is Wednesday, October 15. If you haven't gotten your tax information to your preparer yet, it is definitely time to panic. And if your preparer charges then you an arm and a leg for the doing the return because you brought your information in three days before the extended return deadline, well, don't do that next time.
October 15 is also the deadline for funding 2004 SEPs and Keogh plans for 2007, and for withdrawing excess contributions.
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Long-term minimum tax credits: what are they?
October 10, 2008
Cash is king right now, and the new tax law turns "long-term minimum tax credits" into cash over the next two filing seasons. This prompts a reader question:
In your very informative article 10/6/08 I have a Question on terms; long-term unused minimum tax credits vs. long-term AMT credits. Are they the same under this new legislation? Are they the "minimum tax credit" on from 8801, LIne 28?
The minimum tax credit arises when taxpayers incur alternative minimum tax from items whose timing differs for computing regular tax and AMT. The most famous example of this is incentive stock options, which are taxable upon exercise for computing AMT, but not until the option stock is sold for regular tax. The credit can also be generated by differences in AMT depreciation, amongh other things. Minimum tax credit does not result when AMT is caused by itemized deductions, like state income taxes, miscellaneous deductions, or home equity loan interest.
Minimum tax credits carry forward to reduce regular tax, but only to the level of AMT in a subsequent year. As a practical matter, many minimum tax credits have languished unusable for years.
The new rules enacted in the bailoug bill treat mimimum tax credits that were generated by AMT more than three years before the current tax year as a refundable credit, like wage withholding; half of existing long-term credit can be claimed as a refund in 2008, and the rest in 2009. That means credits generated by AMT in 2004 and earlier will create refunds in 2008.
You may have a long-term mimimum tax credit if you have an amount on your 2007 Form 8801, line 28. To see whether you are eligible to cash out some minimum tax credit in 2008, you need to dig out your 2005 return and turn to Form 8801. If there is is a number on line 19, you may have a long-term minimum tax credit you can use in 2008. If the number doesn't get smaller on your 2006 8801 line 19 or your 2007 8801 line 19, and your 2007 form 8801 line 28 is at least as high as your 2005 8801 line 19, the 2005 amount is your long-term minimum tax credit carryforward. If your line 19 declined in any of the years after 2005, your smallest line 19 amount for the period should normally be your long-term mimimum tax credit carryforward.
So if you have a Form 8801 on your 2007 1040, it's time to dig out your old returns and see if the IRS might have some extra cash for you next April.
Related: How the refundable AMT credit works
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Equity sale!
October 10, 2008
I've often thought I missed the boat when I didn't get in on the IPO of Des Moines' hometown favorite, Principal Financial Group, at $18.50.
Chart via WSJ.com.
Yikes. Why does the chance to get it cheaper than the IPO price make my stomach hurt?
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Iowa revenue estimators see downturn
October 10, 2008
Iowa has avoided much of the current economic storminess, but that is ending. The state's revenue estimators project weak revenues for the the current fiscal year and the fiscal year beginning next June. The gross corporate revenues projected for the June 2010 year, before refunds, is $408.1 million, down from the $431.1 million projected for the current year.
The entire corporate tax is expected to gross less than 6% of Iowa's projected tax receipts for the 2010 year. It also, net of refunds, generates less revenue than the cost of the 25-odd Iowa economic development credits. Does anybody really believe that a repeal of the corporation income tax wouldn't do more to attract business to Iowa than the current credit hodgepodge?
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Hey, it's countdown day!
October 09, 2008
10...9...08...
Update: I should say, meltdown day.
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Iowa's business climate: relatively better, actually worse
October 09, 2008
The Tax Foundation's new state business tax climate rankings came out this week. Iowa rose one spot on the list, to 44th best, or 7th worst, depending on whether you're the half-full glass type.
Unfortunately, it doesn't mean that Iowa did something to improve its business climate; according to Josh Barro, the author of this year's study, "It wasn't about Iowa doing better. It was about Maryland doing so much worse."
In fact, Iowa's tax climate actually got a little worse in absolute terms compared to last year. But Maryland passed a series of tax increases that knocked its tax climate all the way down from 25th best to 45th best, making it slightly worse than Iowa.
Source: The Tax Foundation. Click for larger view.
Iowa's business climate suffers from very high individual and corporate tax rates and a high degree of complexity, offset somewhat by a moderate sales tax and property taxes that, on average, are only a little worse than normal.
Mr. Barro notes that the Foundation's methods don't account for some aspects of Iowa's tax system that affect businesses on the ground. For example, Iowa's deductibility of federal taxes doesn't help the ranking, because the ablity to use the deduction can depend on skillful tax planning. The way Iowa's property taxes discriminate against non-farm commercial property also is not taken into account.
What about targeted incentives?
We asked Mr. Barro whether the Foundation gives credit for "targeted" tax breaks, like the recent Microsoft tax break package or the film subsidy program. They do - but not in the way the legislature would like:
"We rate that negatively. When you have a neutral tax system, the government is not discriminating between different kinds of activity. We prefer that state give corporate relief in a broad manner by cutting rates, rather than targeting."
Mr. Barro noted film credits as an especially bad way to "cut taxes." He notes, for example, that Michigan is being bled to subsidize Hollywood. After passing a big surcharge on business taxes last year, he says, "A quarter of the new revenue... is getting eaten up by the film tax credit."
As we've noted, there seems to be no momentum at all for fixing Iowa's broken business tax system. Still, there is a perverse hope in Maryland's tumble; if a state can go from 25th to 45th in one year, maybe a state could climb just as much with the right leadership.
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Illinois gets a responsible legislator. He'd rather not be.
October 09, 2008
We want our elected representatives to be responsible, but a Rockford, Illinois legislator learned that responsibility can have a steep price - in this case, $41,432. The Seventh Circuit Court of Appeals ruled that Charles Jefferson is a "responsible person" with respect to unpaid payroll taxes from a day care center.
Mr. Jefferson was the unpaid president of the board of directors of New Zion Day Care Center, Inc. Their finances were precarious, and they fell behind on payroll taxes. Mr. Jefferson secured a loan to get the taxes paid, but they got behind a second time when Velma Hayes, the center director, opted to pay other creditors first.
Because payroll withholding is such a big part of the tax collection system, the tax law lets the IRS go after those "responsible" for not remitting payroll taxes if their failure to remit is "willful." The court said that Mr. Jefferson met these standards, even though he was an unpaid board member:
Indeed, the record suggests that Jefferson was not only aware of New Zion's history of tax payment problems, but he was also aware of its current state -- Hayes generated monthly reports that were given to Jefferson and the other board members at each meeting, reports that showed a steadily increasing tax liability.2 Moreover, Hayes repeatedly informed the board that the day care was having difficulty paying its bills, including its tax obligations.By failing to heed these warnings, Jefferson recklessly disregarded a known risk that the taxes were not being paid. It is irrelevant whether Jefferson knew the taxes were going unpaid, as he claims.
The Moral? If you serve on a board of a non-profit, and you get any hint that payroll taxes aren't being remitted, scream and shout until they are, and resign if they continue to go unpaid. The tax law gives you no credit for your good deed of serving the community without pay.
Link: Charles E. Jefferson v. U.S., CA-7, No. 06-4082
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A Minnesota surprise for single-member LLCs
October 09, 2008
Tax Analysts reports ($link) that Minnesota proposes to impose sales tax on transactions between single-member limited liability companies and their owners. A Minnesota administrative law judge has just given their Department of Revenue the go-ahead to adopt the rule.
This would be a classic trap for the unwary. For income tax purposes, single member LLCs are treated at non-entities, with thier income and expenses reported on their owners returns. Imposing a sales tax on transactions that the income tax treats as non-events is an awful idea.
Link: Report of Administrative Law Judge
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They can't vote, but they win most elections
October 09, 2008
"Idiots not allowed to vote in Iowa"
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How to make a scary Halloween costume
October 09, 2008
Vegas Broker Admits He Impersonated IRS Agent
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The tax perils of Palin
October 08, 2008
The tax blogs have been beating Sarah Palins tax returns to death, particularly her per-diem reimburserments for family members for travel away from the state capital. They have also raised the issue that Anchorage, rather than Juneau, might be her tax home because of the amount of time she spends there. That would make her own per-diems taxable, too.
I have briefly covered some of the technical issues, and two law professors have smothered them here, so I won't go into them. My own impressions:
- Governor Palin will owe substantial back taxes. I don't see any way to exclude the per-diems paid for her family members. The amount will be pretty painful, given the size of the reimbursements involved.
- The tax home issue is the kind of issue only the most annoying IRS agent, or a politically-motivated professor, would raise. Common sense says that a governor's tax home is the state capital. You can make a reasonable technical argument otherwise based on the amount of time she spends in Anchorage, but it's a pointless and hair-splitting kind of argument. The issue would never have come up if she weren't on the national ticket.
- If they decide her tax home is really Anchorage, they should offset those per-diems that she would be taxable on by those she would have gotten for her time in Juneau.
- The Alaska state payroll processing badly needs to get some continuing education, and they need to either bring their per-diem policies in line with IRS rules or start putting them on the W-2.
- It's absurd to think she should face negligence penalties for reporting the amount on her W-2, which didn't have the per-diems on it, as income, absent some evidence that she had a hand in how the W-2s were prepared. I agree with Peter Pappas on this issue.
- She should consider stepping up from H&R Block. Storefront tax preparers are just fine for most returns, but the Palin return, with the schedule Cs and the extra scrutiny a governor will get, isn't most returns. Kerry Kerstetter notwithstanding, the extra bucks spent on a good CPA would be money well-spent. When there's real money on the table, nothing costs more than cheap tax help. That said, I can't imagine any preparer, CPA or not, would have investigated to see whether Alaska had done the W-2 right.
For more coverage of the Palin returns, you have plenty of choices:
The TaxProf
Kay Bell
Linda Beale
Roni Deutch
Lee Sheppard ($link)
The returns are here.
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Now THAT's a tax holiday
October 08, 2008
Most tax holidays are wimpy affairs - a weekend to buy some new clothes, or maybe a nice new gun.
Agency, Iowa doesn't care for this namby-pamby stuff. They're having a real tax holiday:
Each fiscal year, more than 600 residents living in Agency pay about $75,000 to the city in property taxes.Until next July they'll pay zero dollars.
That’s because a string of errors left the state with no choice but to refuse authorization of any levy for the city.
Unfortunately for the currently flush citizens of Agency, the city plans to jack up taxes for the next seven years to make it up.
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The mediocre and the inadequately illuminated
October 07, 2008
Instapundit says:
Yes, the political class isn't attracting the best talent in the nation. It's not even attracting the second-best.
Former Ways and Means Chairman Bill Thomas put it this way back in 2006 ($link):
"Don't think in this business that you're dealing with the best and the brightest," he said. "You're dealing with the available and the willing. One of the basic criteria is usually warm and vertical. That's optional in some instances."
A compelling argument for not giving them more to do.
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Good Morning!
October 07, 2008
Tyler Cowen yesterday:
How to tell if things are going very badlyIf the Fed ends up guaranteeing commercial paper and/or interbank loans. Too many people are listening to Polonius.
Wall Street Journal today:
Fed to Purchase Commercial Paper In New Facility Backed by Treasury
If you can't find me, I may be under my desk with my teddy bear.
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District 60, I hardly knew ye
October 07, 2008
I recently bemoaned some tax policy positions of two candidates of Iowa House District 60, and the need to have to choose between them. I now realize that I was misled by the yard signs all over the neighborhood; the district lines bulge down so that while I have District 60 on three sides, I am actually in District 59, where at least one of the candidates appears to have some recognition of the folly of taxing existing businesses to lure and subsidize their competitors.
Bluish area is District 60. The Tax Update executive mansion is marked by the X.
One of the candidates who I mentioned posted comments on the post. One comment defends his plan for the state to make "forgivable loans" to students, who wouldn't have to pay them back if they stay in Iowa for 10 years - a plan I called "indentured servitude." The candidate, Alan Koslow, comments:
These are forgivable loans. They are handled not as expenditures on the budget. They allow HS students to go on to college giving those with little hope a better future while those who want to leave the state can as it will be treated as a regular loan. How is this indentured servitude. Are you against student loans?
"They are handled not as expenditures on the budget." That's reassuring. It is real money going to pay tuition now, on the hope that it's never paid back, but we don't have to count it as spending. That will help the state's budget situation, like magic!
"Are you against student loans?" That's a separate issue from whether I'm against these student loans. The flight of young people is a symptom of Iowa's deeper economic disease. Treating this symptom alone is like treating a painful tumor with painkillers. It doesn't solve the real problem.
As far as whether student loans should be subsidized, it seems likely that the raft of subsidies, including Pell Grants, eight different federal tax breaks, and so on, only increases the price of higher education. Subsidized lending has proven to be a catastrophic idea in the housing market, and it seems no wiser in higher education.
"How is this indentured servitude" Indentured servants were poor immigrants whose passage to the American Colonies was paid by a promise to work for free for the person paying passage - say, for seven years. The similarity of binding a student to the state's boundaries for 10 years in exchange for paying for passage through college is obvious.
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$700,000,000,000 bailout: chump change compared to state pension shortfalls
October 07, 2008
If you think the solution for our current economic problems may be more government involvement, a quick look at how our various government agencies handle their own pensions obligations should give you pause:
The value of pension promises already made by US state governments will grow to approximately $7.9 trillion in 15 years. We study investment strategies of state pension plans and estimate the distribution of future funding outcomes. We conservatively predict a 50% chance of aggregate underfunding greater than $750 billion and a 25% chance of at least $1.75 trillion (in 2005 dollars). Adjusting for risk, the true intergenerational transfer is substantially larger. Insuring both taxpayers against funding deficits and plan participants against benefit reductions would cost almost $2 trillion today, even though governments portray state pensions as almost fully funded.
Also, as we head into the economic deep waters, we should keep in mind how they put the "Great" in the Great Depression (via Instapundit).
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CEMCO 'BLIPS' shelter denied Supreme Court hearing
October 07, 2008
The Supreme Court declined to review the IRS victory in CEMCO Investors, LLC, one of the heavily-marketed "son-of-boss" shelters of the late 90s marketed by major accounting and law firms.
The Supreme Court appears content with the state of the tax law, as they have no tax cases on their calendar for the current term.
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Remind me to never again mention the stock market here
October 06, 2008
Earlier today I said:
If he holds on to the shares that have already fallen in value from $180 to $80, he will be in a pickle if the shares decline more - and further stock declines are certainly possible in today's economy.
Image via WSJ.com.
Talk about a crummy time to be right. Dow down 723.45, 7.05%, so far today.
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Is there such a thing as a bad tax cut?
October 06, 2008
If you are the beneficiary, no. If you are the only beneficiary, it's a different story.
The Tax Policy Blog explains why targeted tax breaks, directed to a select (or politically well-connected) group, are just like spending. They criticize Grover Norquist and Americans for Tax Reform for their embrace of targeted tax breaks that help a few while screwing the rest of us. Iowans for Tax Relief has the same shortsighted approach as ATR. As the Tax Policy Blog puts it:
Suppose Congress was about to pass an earmark that sent a government check to some person or company for $1 million as a reward for doing something that had no public good value (beyond private gains). But then at the last second, the earmark was withdrawn and replaced with a $1 million tax credit for the same person or business. Should angry opponents of the corrupt spending earmark be appeased? No. They were right that wasteful government spending forces higher taxes onto taxpayers, but so do wasteful government tax credits. The only real difference is that the IRS is implicitly writing the check instead of the Department of XYZ.
Related: Why Tax Credits are the Same as Spending
UPDATE: Forgot to link at first; go here.
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How the refundable AMT credit works
October 06, 2008
A reader asks a question that identifies a tricky issue in dealing with ISOs and the minimum tax credit under the new rules enacted last week. I have changed some of his numbers so it works better as an example.
I exercised some ISO's early in Jan at $180 but the stock has fallen to $80 now. My original intent was to hold until next year for capital gains benefit but knew I had the option of selling them by end of year to make the income regular and avoid AMT calc. With the change in ISO-AMT rules, does this mean that if I paid $420k in AMT for tax year 2008 that I can claim $210k cash back on my 2009 return?
The reader leaves out some important facts, so I will make some up. We will assume that the reader has ISOs for 10,000 shares, and that his exercise price was $30. If he holds the ISO stock for a year, he will have no 2008 regular taxable income on his exercise of incentive stock options, but he will have $150 per share added to his income in computing alternative minimum tax, - $1,500,000 in total. We will assume that this increases his AMT by $420,000: 28% of $1,500,000. This should generate a $420,000 minimum tax credit that may offset future regular tax, but not AMT.
The new tax law makes 50% of long-term unused minimum tax credits refundable, the same as if it were from wage withholding. "Long-term" unused credits are those over three years old. That means any credits generated by 2008 tax won't become "long-term" until 2012. So the taxpayer will not be able to get 50% back as a refundable credit until 2012; it will only be available to reduce regular tax, but only to the level of AMT. As the rule allowing refunds of long-term minimum tax credit expires after 2012, the remaining 1/2 would never generate a cash refund; it would only offset regular tax. That may not happen for many years.
If the taxpayer's $420,000 AMT credit had originated in 2003 instead, it would be "long-term" in 2008, and he would, under the new law, be refunded $210,000 in 2008 and $210,000 in 2009.
Disqualifying disposition: opting out of ISO treatment
If the reader sells the stock in 2008 at $80, the results differ. If he sells shares acquired by exercising an ISO within 12 months of exercise of the option, he in effect elects out of ISO treatment and the resulting AMT problems. He will have $1,500,000 of ordinary compensation income per share ($180 value - $30 exercise price = $150 x 10,000 shares = $1,500,000). Assuming a 35% rate, that means he will owe $525,000 to the IRS on the shares for 2008. He will also have a capital loss of $700,000, the difference between the $1,500,000 exercise price and the $800,000 sales price at $80 per share. But very importantly, he will have $800,000 cash available to pay the $525,000 tax. If he holds on to the shares that have already fallen in value from $180 to $80, he will be in a pickle if the shares decline more - and further stock declines are certainly possible in today's economy.
The ISO tax benefit benefit our reader would get by holding onto the shares for a year after exercise is that any gain would then be taxed then at capital gain rates. If the stock stays at $80, the reader will have $500,000 capital gain taxable at 15%, unless the next president and Congress raise capital gain rates for 2009. That would reduce his regular federal tax on the ISO income to $75,000. But he would still probably be unable to use much of the minimum tax credit generated by his 2008 exercise of the ISOs for a number of years, with the big benefit not available 2012.
The bottom line? Our reader has to do some thinking on whether the savings of having capital gain treatment of ISOs is worth both the market risk on his stock and the high possibility of having to wait until 2012 to recover taxes due in 2008 if he retains ISO treatment. If the stock goes to zero before he sells it, he has a $420,000 AMT liability and no cash.
Oh, and one more thing: Congress should fix the problem going forward by repealing the ISO rules entirely. They create a dangerous AMT trap for the unwary, and they encourage behavior - holding stock after exercising an option - that would normally not make economic sense.
UPDATE, 10/10/08: more at Long-term minimum tax credits: what are they?
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Tax Carnival!
October 06, 2008
Kay Bell has posted a new Carnival of Taxes. Many many items this time in the premier roundup of tax-related blog posts.
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We have a bailout
October 03, 2008
The House has voted to approve the Senate's version of the bailout, 263-171. That means we get the tax provisions we discussed yesterday, including the AMT fix for 2008.
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Ex-Iowan wins six-figure hobby-loss case
October 03, 2008
Alan Miller became a successful entrepreneur while living in Van Meter, Iowa, about 20 miles west of Des Moines After making a success out of Electric Pump and Tool Services, he developed an interest in Paso Fino horses - an interest that led him to move to Florida and engage a prominent trainer to help him develop his herd.
Horses cost money, and Mr. Miller's schedule C's reflected that, according to a Tax Court opinion issued yesterday:
Beginning in 2002 and continuing in 2003, 2004, 2005, and 2006 Mr. Miller filed a Schedule C, Profit or Loss From Business, listing his principal business as "show horse breeding". In 2002 Mr. Miller reported losses of $95,571 on his Schedule C. In 2003 Mr. Miller reported losses of $126,377 on his Schedule C and losses of $9,223 on Form 4797, Sales of Business Property. In 2003 Mr. Miller sold three horses at a loss. In 2004 Mr. Miller reported Schedule C losses of $139,098 and losses of $13,742 on Form 4797. In 2004 Mr. Miller sold one horse at a loss
The IRS invoked the Section 183 "hobby loss" rules, saying that Mr. Miller wasn't really trying to make money. The court ruled for Mr. Miller and against the IRS. Mr. Miller had some important facts on his side:
- He kept good financial records
- He kept his business and personal horses separate, and did not deduct expenses for his personal mount.
- He kept logs of his business activity, recording 800-1000 hours per year on the horse breeding.
- He modified his business to fix bad results.
- He engaged experts to improve his busineses.
- He had a track record of success as an entrepreneur.
- He had a plausible plan to show a profit.
The more typical hobby loss facts feature a professional - a doctor, lawyer, dentist or accountant - who spends full time on his professional activity, keeps poor records, and has no hope of ever making money.
Congratulations to local attorney Ron Mountsier, who lawyered the winning case.
Cite: Miller, T.C. Memo 2008-224.
Related: Hobby losses dog IRS auditor
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District 60 offers two more reasons to flee Iowa
October 03, 2008
If you have any hope that Iowa will someday foresake absurd targeted tax breaks to pursue a business-friendly low-rate, low-loophole system, it doesn't come from the Tax Update's home district for the Iowa House, based on this piece in the Des Moines Register.
The Democrat in the race, Alan Koslow, has an ingenious plan to keep young folks in the state -- indentured servitude:
Koslow's plan is to offer forgivable loans to college students if they stay in Iowa for 10 years after they graduate. He also proposed a three-year income tax holiday for people younger than 25.
Apparently Iowa has this big pile of cash to lend that has escaped our notice. The Republican, Peter Cownie, offers no hope either:
Cownie, 28, said Koslow's plan would be expensive. Instead, he wants to bring high-tech and better-paying jobs to Iowa by continuing to offer companies financial incentives to build here. Microsoft announced in August that it will build a $500 million data center in West Des Moines after state lawmakers approved about $3 million in tax exemptions for the Redmond, Wash., software giant."Does Microsoft need those tax credits? No," Cownie said. "But it was needed to get those jobs for Iowa."
Corporate welfare. How innovative. Repeat after me: you can't grow your economy by taxing your existing businesses to lure and subsidize their competitors. At $500,000 per job, we'll all be bankrupt by the time we achieve full employment. Or does this corporate welfare come out of the same pile of free money that Mr. Koslow wants to use to hold the youngsters hostage?
Will we ever have somebody who will campaign on raising Iowa's business tax climate ranking from 45th out of 50 states?
By the way, Roth & Company has created 35 jobs, with exactly $0 state subsidies; we're still waiting for our $28 million.
If you want tax silliness on a national scale, the TaxProf has the scoop for you.
UPDATE: I goofed. I actually miss being in District 60 by a few blocks. I regret the error, if not the district boundaries.
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'Aegis' founder going away for 18 years.
October 03, 2008
Michael Vallone, the lead defendant in the Aegis offshore trust tax scheme, was sentenced to 223 months in federal prison yesterday. Mr. Vallone, 48, of Orland Park, Illinois, got this extraordinarly-long tax sentence for a nationwide scheme described in the Department of Justice press release:
Michael A. Vallone of Orland Park, Ill., was one of the founders and the executive
director of The Aegis Company, now defunct and formerly based in south suburban Palos Hills, which marketed and sold trust packages to some 650 wealthy taxpayer clients throughout the United States. Vallone and five co-defendants were convicted in May of participating in a nearly decade-long scheme to market and sell sham domestic and foreign trusts through a network of promoters, sub-promoters, managers, attorneys and accountants. Vallone and the others essentially diverted income from businesses into sham trusts for clients, hiding hundreds of millions of dollars in income for those clients and resulting in a $60 million tax loss to the United States, making the case one of the largest of its kind...
Mr. Vallone may have the unwelcome opportunity of being reunited with some of his clients who have gotten prison time for their use of Aegis services.
If somebody says they can make your taxes go away using trusts, keep in mind how well that worked out for Mr. Vallone.
Link: Tax Update Aegis coverage.
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Tax fraud, Indy-car style?
October 03, 2008
If you share the Tax Update's interest in Indy-car racing, you would be able to name only two open-wheel drivers: Danica and, um, the guy who dances, Julio somebody. Now the dancer has to tango his way out of tax fraud charges. E! Online, your tax authority, reports:
Hélio Castroneves, the former Indy 500 racing champ who won the fifth season of ABC's Dancing With the Stars, is in a heap of trouble today after the feds obtained an indictment against him for failing to pay millions in taxes from 1999 to 2004.The Brazilian-born Castroneves, 33, along with his sister, Katiucia, 35, and his Ohio-based lawyer, Alan Miller, 71, face conspiracy and tax-evasion charges for hatching a tax-dodging scheme using an offshore shell corporation based in Panama to hide upwards of $5.5 million from the Internal Revenue Service.
A conviction for evading taxes on $5.5 million would have a disastrous impact on the quality of his dance partners for several years.
The TaxProf and TaxGrrrl have more.
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How the internets work
October 03, 2008
Joel Schoenmeyer, the proprietor at "Death and Taxes," explains the facts of modern life:
Can I tell you what I'm tired of right now? I'm tired of getting calls from old media folks -- Martindale, West, Thompson, what have you -- telling me that I should pay a bunch of money so that they can teach me how to compete on the internet. Let me tell you something, guys -- I'm already competing on the internet. I already get many, many GOOD clients as a result of my website and this blog. I don't need a bunch of huge corporations, who finally decided that they should figure out whether this web thing is going to stick around, calling me and acting like they are experts. They aren't.
There's actually a pretty good book out about this sort of thing.
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Converting a corporate S corporation to an LLC S corporation
October 03, 2008
I am not sure why anyone would care to do this, but Marc Ward tells how it's done.
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The bailout: more on the tax provisions
October 02, 2008
While most of the tax provisions attached to the bailout bill that passed the Senate yesterday were extensions of the "expiring" tax breaks that never actually seem to expire, there are a few new ones. The three original tax provisions of the failed House bill are in there, but there are also a few odd new provisions.
For example, the bill makes all machinery and equipment placed in service in a farming business in 2009 5-year property. Considering that farmers already qualify for the $125,000 Sec. 179 deduction for such property, this is a nice little spiff for an industry enjoying some of its most profitable times ever.
The bill also extends the Section 199 domestic production boondoggle to our strategic film and television production industry; this will enable the economy to pull itself up by its sitcoms.
Oddly, the bill caps the Section 199 deduction for domestic oil production at 3%, vs. the usual 6%, so as not to encourage too much of that; heaven knows we don't need any more domestically-produced oil.
ISO-AMT victims will get to claim as cash refunds up to 50% of their unused long-term AMT credits, starting in 2008. The bill also abates all interest and penalties attributable to unpaid taxes on ISOs, with a credit for those who have already paid such interest and penalties.
The bill imposes information reporting on brokers, requiring them to report on 1099s the basis and gain on securities trades, starting in 2011.
And perhaps most importantly, the bill exempts children's wooden practice arrows from the 39-cent-per-shaft excise tax otherwise imposed on arrows. And why shouldn't Congress shaft us a bit more?
A roundup of the provisions is below the fold. You can check with the TaxProf and the TaxGrrl for additional coverage.
Links:
Related: Saving the economy, one tax preparer at a time
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Lead the way, Senator!
October 02, 2008
One of the perks of being a Senator appears to be breathtaking self-righteousness. Consider this from Senator Grassley:
Grassley insisted that Wall Street itself had an important role in a crisis that has focused more on Congress in the past week."I've suggested that it wouldn't be a bad thing if the leadership of these investment banks and financial institutions and Fannie May and Freddie Mac would take a Japanese approach to corporate governance. And I'm not talking about going out and committing suicide," Grassley, a Republican, told reporters during a morning conference call.
"The CEOs go before the board of the directors, before the public and before the stockholders and bow deeply and apologize for their mismanagement," Grassley said.
That's a great idea, Senator. And as a supreme moral leader, it would only be fitting for you and your fellow Congresscritters to set the right example. Senator Dodd and Congressman Frank could start by standing on the mall and undergoing a Cultural Revolution-style self-criticism for enabling and encouraging Fannie and Freddie to insolvency, and for being silent while their well-connected executives took fabulous salaries while shoveling cash to their campaign funds. They should then resign and join a Trappist monestary, living out the rest of their days in silence while they contemplate and atone for their deeds while sparing us any further legislative mastery. In fact, all of Fannie's favorites could do some bowing and scraping.
Senator Grassley, a member of the taxwriting committees since the 1980s, could then step up to the platform to apologize, along with all of his taxwriting colleagues, for continuing to encourage overinvestment and overleveraging in the housing market through expansion of tax incentives for home ownership, home speculation, and mortgage borrowing.
Then, once the congresscritters who have made all of this possible stand up and take their own responsibility, then by all means bring on the executives. By then the crowd should be about out of eggs and tomatoes.
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Can you welsh on a bad tax shelter deal?
October 02, 2008
Some tax shelters require the help of a tax-exempt third party. If the IRS explodes the shelter, can the taxpayer weasel out of his promises made to the tax-exempt entity in the tax shelter documents? A Mississippi case this week implies "no."
One of the heavily-marketed tax shelters of the late 1990s was "SC2." In a typical fact pattern a taxpayer with lots of interest and dividend-producing assets would contribute them to an S corporation and then contribute non-voting shares of the corporation to a charity for maybe 90% of the company. The charity would have the right to redeem the shares in, say, two years. In the meantime, the interest and dividend income would be allocated on K-1s to the tax-exempt charity, sheltering it from tax.
William Brown, an owner of Brown Bottling Group, Inc. in Mississippi, bought this shelter from national accounting firm KPMG in 2000, with the Austin Firefighters Relief and Retirement Fund acting as the enabling charity for the deal. Things went sour when the IRS declared such arrangements abusive (IRS Notice 2004-30). When the charity went to redeem its shares, the owners declined on the grounds that the shelter had failed. The charity sued.
The court ruled on summary judgement motions this week. Mr.Brown's defenses were shot down. While the case is not done, it looks likely that the charity will eventually get its cash.
One of Mr. Brown's arguments was that the charity had "unclean hands" and should not benefit from its participation in the shelter. The court disagreed:
Again, defendants do not contend that AFF entered into the transaction initially with unclean hands; rather, they argue that after the IRS concluded the SC2 transaction was an abusive tax avoidance transaction and declared that tax-exempt parties in these transactions, including AFF, would be treated as participants in the transactions, AFF, notwithstanding that it had been found to be a participant in the transaction, sued defendants to enforce the Redemption Agreement. Defendants posit that such acts by AFF "constitute wilful inequity toward Defendants which makes the unclean hands doctrine applicable to AFF's claims to enforce key elements of the now known to be illegal SC2 transaction." The court rejects this argument. Even if the court assumes that AFF's claims in this action have no merit, AFF still cannot reasonably be found to have acted with wilful inequity toward defendants merely by virtue of filing this lawsuit to enforce the Redemption Agreement or to otherwise enforce the terms of the SC2 transaction.
In other words, it's not bad faith to sue to enforce a contract.
The moral? Even if the tax shelter fails, promises to third parties made to avoid taxes may survive.
Cite: Austin Fire Fighters Relief and Retirement Fund v. Brown, DC-SD Mississippi, No. 3:07-cv-0028
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IRS overpayment, underpayment rates rise for 4th quarter
October 02, 2008
The interest rates for underpayments owed the IRS, and for refunds on overpayments, is rising 1 percentage point for the fourth quarter. The new rates, effective yesterday, are:
-Six (6) percent for overpayments [five (5) in the case of a corporation];
-Six (6) percent for underpayments;
-Eight (8) percent for large corporate underpayments; and
-Three and one-half (3.5) percent for the portion of a corporate overpayment exceeding $10,000.
Cite: IR-2008-111.
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Saving the economy, one tax preparer at a time
October 01, 2008
The text of the Senate version of the bailout is available, courtesy of The Wall Street Journal. It looks to be the House bill, with increased deposit insurance and the extension of expiring provisions, including the AMT patch.
It contains one provision dear to the hearts of tax preparers: it repeals the rule that subjected preparers to penalties for positions that would not be penalized if taken by taxpayers doing their own returns. Hey, it's a sacrifice we preparers are willing to make to save the financial system. We're just that nice.
It's pretty sad, actually. If the bailout is a good thing (I think it is, if only compared to the potential for disaster if nothing is done), you shouldn't have to bribe legislators to support it by attaching the extenders bill, which is a hodgepodge of largely bogus or silly tax breaks that are regularly re-enacted with a one or two year life to disguise their true cost, and to provoke regular visits from lobbyists bearing campaign money. Congress continues to earn it's 9% approval rating.
UPDATE: More on the tax provisions of the bailout.
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Why the spam industry has moved offshore
October 01, 2008
A U.S. district court yesterday applied Iowa's anti-spam law to an Arizona couple that ran a spamming service. And did they ever apply it:
IT IS ORDERED that judgment in the amount of Two Hundred Thirty Six Million Four Hundred Eighty Thousand Six Hundred Sixty Dollars ($236,480,660.00) shall be entered in favor of the plaintiff and against defendants Henry Perez and Suzanne Bartok, jointly and severally, on Kramer’s Iowa Code Chapter 714E claim.
The Iowa law has a $10 per spam penalty. It does not provide for staking spammers on a nest of fire ants, but only because Iowa has no fire ants.
Cite: Kramer v. Perez, USDC-SD Iowa, no. 3:04cv0153
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AOL wins Iowa sales tax at appeals court level
October 01, 2008
Was AOL offering telecommunication service "within Iowa"? The Iowa Court of Appeals today says no. More thoughts on this later. This lets AOL off the hook for substatial Iowa sales tax.
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The Madness
October 01, 2008
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Extenders + bailout?
October 01, 2008
Published reports say that the Senate may roll the current extension of the perpetually-expiring tax breaks, like the research credit, into the bailout legislation.
Let's hope they don't have to do the bailouts as often as they do extender bills.
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Nebraska wasn't big enough to hide this Winnebago
October 01, 2008
A Nebraska county treasurer is in hot water for what would, if true, be one of the lamest abuses of office ever recorded. Adams County Treasurer Julia Moller is charged with tax evasion and official misconduct. The alleged crime:
The Nebraska Attorney General says Moeller purchased a 2004 motor home in Nebraska, then took it to Texas to register and license it. In Texas, she allegedly produced a bogus receipt which indicated Moeller had paid $4,000 in sales taxes on the motor home in Nebraska.The Attorney General says Moeller actually had one of her employees make the false receipt. The employee is Moeller's daughter, Michelan Parr
If you are going to abuse your office, go the whole CIETC and take enough money to give you happy thoughts while serving your prison time.
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GAO: most Schedule E's are botched
October 01, 2008
The Government Accountability Office says 53% of returns reporting real esate income are wrong, to the extent of $12.4 billion in income. The GAO says that unsubstantiated rental expenses are the biggest single source of errors. Other common errors include deducting expenses that should be capitalized; running personal expenses through the schedule E, and leaving income off.
The GAO recommends more detail on Schedule E and more 3rd party reporting. As if being a landlord weren't fun enough.
Via the TaxProf.
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Worst things to do on receiving an IRS notice
October 01, 2008
There are a lot of wrong ways to handle an IRS notice, and Peter Pappas summarizes five of them in a guest post at the taxguy blog. Number 3 comes up surprisingly often:
3. Blame Everyone Else – I’m not sure if this one isn’t a chicken or egg problem. In other words, did the tax problem cause the taxpayer to blame everyone else, or did his blaming everyone else (i.e. not taking responsibility) cause the tax problem? Either way, the blaming does two things and both of them suck: 1) it causes the blamer not to take action himself to resolve the problem (after all, if it’s other peoples’ fault, he can’t do anything about it); and 2) it alienates the taxpayer from the people he needs the most.
Bruce, the taxguy proprietor, has asked me to guest-post. I may, if the week gets a bit less crazy.
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