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Tax Update Blog: July 2009 Archives

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'Tax-exempt' doesn't mean 'no tax return'

July 31, 2009

It might seem perverse, but tax-exempt entitites can face brutal penalties for failing to file tax returns. An outfit dedicated to finance a school in Isreal recently learned that lesson the hard way. The outfit, "American Friends of Yeshivat Ohr Yerushalayim Inc," failed to file Form 990 for 2000, 2001 and 2002 on time. A federal court in New York ruled that they were subject to the $100-per-day penalty for late filing. These added up over $82,000, which would cover a fair amount of Tuition at any school I know about.

The charity claimed that the loss of records in a move was to blame, but the judge didn't buy it:

Plaintiff states in its answers to interrogatories that [bookkeeper] Fishman sent 40 boxes to Chicago, of which were returned to Mrs. Fishman's home residence after Kogan refused delivery. Mrs. Fishman returned from a trip some time later to find the boxes waterlogged on her porch. Instead of making any efforts to salvage the financial records, Mrs. Fishman simply disposed of them. Having shown little regard for the maintenance of its records, American Friends cannot now argue that the loss of the documents constituted a "reasonable cause" for American Friends' late filing.

If you are on the board of a charity, the first thing you should do is make sure they have kept up with their federal tax filing requirements. If not, you might want to find a different charity to spend your time with. Oh, and don't leave your records out in the rain.

Cite: American Friends of Yeshivat Ohr Yerushalayim Inc, DC-ED NY, No. 1:04-cv-01798

IRS Links:

IRS page on small exempt organization filing requirements

ABC's for Exempt Organizations

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Getting my picture on the cover of the Rolling Stone

July 31, 2009

The Tax Update Blog is featured in an article in the August 2009 Journal of Accountancy. I'll need extra copies for Mom.

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Ricki Lee Jones Sentenced.

July 31, 2009

Subtle spelling differences matter. Rickie Lee Jones is a singer-songwriter. But Ricki Lee Jones is a St. Louis-area contracter who pleaded guilty to tax charges arising from a scheme to skim funds from a environmental remediation project for personal use; he will spend 15 months in prison. He also has to reimburse the IRS $2.4 million and BP Amoco, his customer, $1.2 million.

While Ricki has his problems, Rickie is doing fine, as far as I know.

Note the spelling error on the YouTube video. The one who is singing isn't the one who's going to Club Fed.

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Cash for Clunkers runs out of your money

July 31, 2009

The insane program to use your tax money to buy cars for other people has run out of cash. Lawmakers are debating whether to use more of your money to buy other people more cars.

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Flickr photo by Beadmobile


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Cool July Cavalcade

July 31, 2009

This week's Cavalcade of Risk comes from Insurance Copywriter in blistering-hot Phoenix, where it is 113 degrees. Meanwhile, I think we have yet to hit 90 this July in Des Moines (who needs San Diego, anyway?).

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Don't miss InsureBlog's analysis of the Soylent Green provisions of "health care reform."

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Don't take your work into the bathroom

July 30, 2009

It's only natural for an entrepreneur to get aggressive in deducting expenses. The Tax Court yesterday said a Shaklee dealership went a bit overboard.

An Oklahoma couple set up their Shaklee business in a C corporation. The corporation, RS Tyson and Accociates, Inc., used its owners as one of its principal vendors. They presumably used this structure instead of a Schedule C sole proprietorship to avoid self-employment taxes. The corporate deductions for 2003 included, among other things:

- $24,000 in rent paid for corporation use of the couple's home
- $12,000 paid in "equipment lease" charges to the couple
- $4,209 in "travel expenses" on behalf of the couple.

The Tax court Provides some details. On the lease, the Court says:

RS Tyson deducted rental expenses for the use of Mr. and Mrs. Tyson's home of $24,000 for 2003. RS Tyson claims that during 2003 it rented most of Mr. and Mrs. Tyson's home for Shaklee business purposes. Supposedly, Mr. and Mrs. Tyson's living room was the meeting room, the dining room was where training and makeovers took place, the kitchen was where Mrs. Tyson made "Shaklee shakes", and the bathroom by the office also was used for makeovers. The dining room was where Mr. and Mrs. Tyson ate dinner...

The purported rental agreement has little reality beyond tax planning. The purported rental was not at arm's length, and we disregard it for lack of economic substance.

The judge didn't care for the travel costs either:

RS Tyson has not established how the cost of a family trip for Mr. and Mrs. Tyson to Disneyland and a personal trip for Mr. and Mrs. Tyson to Branson, Missouri, were ordinary or necessary to its businesses. Furthermore, RS Tyson has failed to substantiate the claimed travel expenses in accordance with sections 162 and 274. Accordingly, we sustain respondent's determination on this issue.

In addition to disallowing the deduction, the Court upheld penalties for taking unsupported deductions.

While the Tax Court opinion doesn't say so, the involvement of a Shaklee distributor and the presence of a Des Moines-based attorney for an Oklahoma taxpayer couple may indicate that the return was prepared by a suburban Des Moines tax firm that is fighting an IRS injunction lawsuit. The preparer didn't testify in this case, which the judge said was a bad fact for the taxpayers.

Cite: Tyson, T.C. Memo 2009-176

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A 10-year sentence is plenty, assuming fire ants are involved

July 30, 2009

A Miami man convicted of buying and looting like-kind exchange intermediary companies will face 400 years in prison if the prosecution has its way. Edward Okun was convicted of stealing $126 million in proceeds that he held in trust to close like-kind exchanges. Bloomberg.com reports:

The [400-year sentence] request is justified by Okun’s “almost pathological greed and his total disregard for the plight of his victims,” Assistant U.S. Attorney Michael Dry said in papers filed in federal court in Richmond, Virginia.

“No expense was too great for Okun, because he constantly spent his victims’ money in his own version of Lifestyles of the Rich and Famous,” Dry said in the filing, citing Okun’s 131- foot yacht, multimillion-dollar homes, a jet, a helicopter and a $56,252 dinner bill with friends in the Bahamas in 2007, which included shots of cognac for $1,008 each.

Mr. Okun argues that a 10-15 year sentence is plenty, according to the report.

Perhaps the scariest part of the scam was the way that he bought existing companies with a good reputation. Exploiting their existing reputations, he took advantage of their referral networks to loot them. If you use a like-kind exchange intermediary, there's always a lot of money at stake. Be very sure you know who you are dealing with. A bank trust department isn't a bad place to start.

Prior coverage: WHEN A LIKE-KIND EXCHANGE IS TOO TAX FREE


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Sure I'll have another Crown Royal. Make it a double. The rich guy is buying.

July 30, 2009

So the top 1% of taxpayers now pay more federal income taxes than the bottom 95%. That's before they get hit with a big honking tax increase in 2011, when the top rate goes from 35% to 39.6% - or maybe 45%.

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But Congress isn't done yet, reports Tax Analysts ($link):

[Congresscritter Mike] Ross also said the new agreement would exempt all businesses with annual payrolls of less than $500,000 from the requirement to provide health insurance or pay a penalty payroll tax. The penalty rate would then phase in and reach full strength for businesses with $750,000 or more in annual payroll. Ross said the provision would exempt more than 80 percent of small businesses from the mandate.

Yep, it will exempt all the Amway salesmen, part-time handymen, and solo practitioner CPAs. Only businesses that have managed to actually grow and hire some people will get punished. What could possibly go wrong?

Related: The 'it's a tax on somebody else' fallacy

UPDATE, 7/31: The TaxProf has more.

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Bringing your foreign bank accounts in from the cold?

July 30, 2009

The IRS provides new information on how to take advantage of the offshore account amnesty, including a form letter for tax pros to use (via the Federal Tax Crimes blog).

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We're stiffing you on your bills, but if we ever pay we'll throw in tax-free interest

July 30, 2009

Kay Bell reports that interest the IOUs that California is issuing instead of cash will qualify as tax-exempt municipal bond interest.

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Home is where the job is

July 29, 2009

The tax law doesn't allow you to deduct your communting expenses. You can only deduct business travel if it is "away from home."

A barge crewman living in Florida learned yesterday that your "home" is where you work, as far as the IRS is concerned. Jess Canterbury worked on barges working out of New York serving ports along the east coast. He deducted his travel expenses from his Jacksonville, Florida on his tax reuturn. The Tax Court said that doesn't work:

Petitioner testified at trial that he took the job with Reinauer because he received more pay for less work. Indeed, he earned twice as much working as a barge mate in New York compared with working in Jacksonville; moreover, following a 2-week work period, petitioner received 2 weeks off rather than only 1 week. Petitioner's daughter also lived in Jacksonville. The rate of pay, the time off, and the proximity to his daughter suggest that it was personal choice and not business exigencies that dictated the decision by petitioner to maintain his residence in Jacksonville and commute to New York.

Consequently, because petitioner's position with Reinauer lasted more than 1 year, and further because most of his assignments originated in New York, his principal place of employment, and therefore his tax home, was in New York for the relevant period.

The Moral? You may not live at work, but as far as the tax law is concerned, your home is where your job is.

Cite: Canterbury, T.C. Summ. Op. 2009-118

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But I thought health reform was supposed to save money!

July 29, 2009

Congress is in a frenzy to find money to pay for health care "reform." Taxes on everything from Botox to insurance companies to "Cadillac" insurance plans are in play (Now that the government owns GM, you'd think they'd like Cadillacs).

Back in campaign season, we heard all about how painless health care reform would be. Everyone would get wonderful insurance, nobody would have to pay, and it would save money. If it's saving money, why do we need new taxes? We should be able to pay for it with fairy dust and unicorns eggs.

More from Tax Policy Blog and TaxVox. The TaxProf has a roundup.

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Salinas preparer pleas to fabricating deductions

July 29, 2009

From thecalifornian.com:

The U.S. Attorney’s Office said Lydia Hernandez admitted she had prepared and filed 39 false returns for 13 clients from 2002 to 2005 through her Salinas business, Lydia Hernandez Tax Services. They said she told prosecutors that she helped reduce her client’s taxable incomes to allow them to obtain bigger refunds.

An IRS investigation found Hernandez had knowingly filed for some clients who owned businesses unqualified deductions including gifts, dry cleaning, cell phone expenses, gym fees and union dues, the U.S. Attorney’s Office said.

Ms. Hernandez now faces prison time and ruinous fines. If that prospect doesn't deter dishonest preparers, an IRS-enforced continuing education program probably won't do the trick either.

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Another UBS client pleads guilty

July 29, 2009

Swiss bank secrecy let this man down:

Jeffrey Chernick, 70, today admitted in federal court in Fort Lauderdale, Florida, he didn’t declare $8 million held at UBS, the largest Swiss bank by assets. He’s the third UBS client to plead guilty since the bank gave more than 250 customer names to the Internal Revenue Service under a Feb. 18 agreement to avoid prosecution for helping wealthy Americans evade taxes.

Secret offshore accounts aren't so secret anymore. If you have one, you might sleep better if you take advantage of the offshore account amnesty. But don't dawdle; it expires September 23.

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Is today your lucky day?

July 29, 2009

If you are holding a winning Powerball ticket, check out the latest post from Bruce the Tax Guy before you do anything else.

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Make sure your crimes are committed by unionized Treasury employees.

July 28, 2009

Congress this year ended the pilot program to outsource collection of delinquent taxes to private collections. Opponents of the program insisted that private collectors just couldn't be trusted to deal with taxpayers fairly, honestly and confidentially. Only official government employees, ideally members of the Treasury Employees union, can be trusted with such delicate and important work.

Like this:

A revenue officer for the Internal Revenue Service has been indicted by a federal grand jury on charges that he urged people who owed taxes to refinance with a mortgage company for which he worked.

Mark Claybrooks, 41, of Brentwood worked as an IRS revenue officer in Walnut Creek, contacting people who were delinquent with their taxes. From 2003 to 2005, he also worked for Faith Mortgage Group in Antioch, refinancing personal-residence loans.

From 2002 to 2008, Claybrooks recommended to at least two people that they "pay off delinquent federal income tax obligations by refinancing with Faith Mortgage Group," according to an indictment handed up Wednesday by a grand jury in Oakland.

Good thing the poor taxpayers were protected from the scourge of private collection agencies.

Related Coverage:

Tax Prof
Kay Bell
Tax Rascal
Monica Lawver, with additional examples of the importance of unionized government tax employees.

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Last of the Mohicans

July 28, 2009

The Wandering Tax Pro, Robert Flach, posts about how he refuses to use computers to prepare tax returns. He wears this as a badge of honor.

With my penmanship, preparing returns by hand has never been an option. I was fortunate to start my tax career just as the PC revolution was taking hold in the accounting world in the mid-'80s. I understand his reasoning - by doing it by hand, he understands how the numbers flow and how the forms work. But he gets this wrong:

During the session on common mistakes made by preparers at the IRS Tax Forum I attended two years ago the instructor went so far as to say that those who use tax software to generate 1040s have basically become nothing more than glorified data entry clerks. I totally agree!

As complex as the tax law is, computers are a huge productivity benefit in a tax practice. I have 1040s that have passive loss carryforwards from dozens of activities. The carryforwards have to be computed and carried forward separately for regular tax and alternative minimum tax. The returns might also have investment interest carryforwards, capital loss carryforwards, and investment interest carryforwards - all computed separately for regular tax and AMT. Doing these computations manually would add countless labor hours to the return - hours either the preparer or the client has to pay for. And then every carryforward would have to be manually entered correctly the following year, adding still more time to the process. With intelligent review, the computer gets the right answer much faster.

The biggest benefit from using computers is the ease of fixing mistakes. I know, as I prepared my share of manual returns at the beginning of my career, including consolidated corporate returns and partnership returns. With a manual return, every mistake has to be walked through multiple forms to be corrected. If you have K-1s, they all have to be re-pencilled. And everybody makes mistakes, especially when tired during tax season. When you find a mistake on review using a computer, you can fix the one number and all of the changes will flow through all of the affected forms.

Sure, you can screw up with a computer-preparered return. No doubt the tax return is a "black box" to some preparers, who just enter numbers and accept what comes out the other end without question. And sure, there can be software errors. But you can screw up manual returns too - everyone makes mistakes - and those mistakes are much harder to fix . I'm willing to bet that software catches many more errors than it introduces. Say what you will about Turbotax (we use CCH Pro-System), the returns foot.

Mr. Flach does note that he's one of the few, the proud, the little band of manual preparers. While I respect his preferences, the rest of the world doesn't use computers to do returns because they're lazy and stupid. They use them because the improvements they bring in efficiency and computational accuracy far outweigh the drawbacks.

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Browns' retirement planning completed

July 28, 2009

I failed to notice until this morning that tax holdouts Ed and Elaine Brown were convicted on weapons charges while I was out on vacation. The Browns had retreated to their fortress-like New Hampshire home after their tax evasion convictions, holding out for months until federal agents disguised as sympathizers arrested the couple.

It's probably good that they are used to fortress-like accomodations:

No sentencing date has been set, but one of charges alone carries a mandatory 30-year sentence. Both Browns are in their 60s. They are already serving 5-year sentences for tax evasion.

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At least they don't have to worry about their 401(k) plans now.

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Got LLCs?

July 27, 2009

Marc Ward passes on some good advice on using LLCs in Iowa. You should read the whole thing, but this is especially true:

Read the operating agreement. This gem is from Frank Carroll. He noted that he has run across a lot of lawyers including in-house counsel that will read a particular section of the act, such as the provision that calls for unanimous votes to amend the operating agreement, and assume that it is the new law in the Tall Corn State. Of course readers of this blog should know otherwise. The operating agreement will still control if it speaks to the issue. The statute is the default rule in the absence of words to the contrary in the operating agreement.

LLCs are great tools, but they can be dangerous to the careless.

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Are all the judges wrong about the law, or is it just you?

July 27, 2009

Tax protest figure Devy Kidd:

Federal prosecutors of the Department of Justice Tax Division, Robert Metcalfe and Robert Fay, their superiors in the Department of justice, Federal District Court Judges Filip and Der-Yeghiayan, and the 27 judges of the 7th Circuit are all flagrantly guilty of covering up the fraud of the federal income tax, and of conspiracy to violate the First and Fifth Amendment rights of Bill Benson. Take notice that such action is a felony under Title 18, Section 241.

If all 27 judges in the 7th Circuit - and for that matter, every federal judge at every level - agree that your argument is wrong, there is a much a simpler explanation than a vast conspiracy.

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Can there be a bad tax cut?

July 27, 2009

Yes. The Tax Policy Blog explains:

That is, suppose the Democrats gave up on trying to force (via regulation) radio stations to give "equal time" to differing political viewpoints. And now instead, suppose they put into law a (nonrefundable) "Talk Radio Fairness Tax Credit" that would be given to radio stations based upon the number of hours in a day that a liberal talk show host was on the air. (There would be a department within the IRS to determine who qualifies as a liberal host.)

So the big media giants like Clear Channel or Cumulus could get huge tax reductions on their tax bills for putting on the air Ed Schultz, Rachel Maddow, or Thom Hartmann in place of say Sean Hannity, Glenn Beck or Rush Limbaugh.

According to some who have the de facto position of supporting all tax cuts and who abhor the term "tax expenditures," this must not only be a good tax cut (because all tax cuts are good), it's also not a "subsidy" to the political left because tax expenditures aren't like spending. It would just be a reduction in taxes or the government taking less of the people's money (which is always good).

Substitue "film tax credits" for "talk show credits" and they already are describing tax policy in Iowa.

Related: What's wrong with a little corporate welfare?

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It's (tax) holiday season!

July 27, 2009

August is the big month for "back to school" sales tax holidays. In Iowa, footware and clothing costing under $100 is sales tax-free on August 7 and 8. Kay Bell has a list of sales tax holidays nationwide.

Of course, you don't have to be going back to school to take advantage of these. You even can use it to get a new outfit to wear to South Carolina to take advantage of their November 27-28 sales tax holiday on guns.

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Flickr photo by k@t marsh


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I got a big gift. Is it taxable?

July 27, 2009

TaxGrrrl has the answer:

Gifts of cash are not taxable to the recipient for federal income tax purposes. So, when your mom writes you a check for $10,000, you don’t have to do a thing except tell her thank you.

There may be a gift tax, but that's paid by the giver.

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Can you believe it? Plotting to kidnap the judge doesn't help you beat a tax rap!

July 24, 2009

20071231-2.jpgRobert Beale hasn't displayed impressive judgement in his tax life, but you have to give him credit for chutzpah.

Mr. Beale started believing wacky tax protester arguments and stopped paying his taxes, instead diverting the funds offshore. When this got him indicted, he skipped bail and spent 14 months on the run. When he was caught and locked up pending trial, he plotted to set up a "common law court" to arrest the judge -- unwisely using a monitored prison phone to organize things. He ended up being convicted of the tax charges, earning an 11-year sentence from the judge he plotted to "take out." He got another four years for the plot against the judge.

Mr. Beale's appeal brings to mind the the guy who murdered his parents and pleaded for mercy as an orphan:

Beale's next argument is that he is entitled to a new trial because the presiding district court judge did not recuse herself after learning of the attempt by Beale's "Common Law Court" to intimidate her through issuing a warrant for her arrest. Although there is some dispute as to whether Beale properly moved for recusal, the judge asked him at the beginning of the trial whether he wanted recusal, to which he responded, "by authority of the one Supreme Court in the original jurisdiction under the Lord Jesus Christ, and the law of God, I order that your bond be seized and I order that you recuse yourself from this case."

I'm no lawyer, but I think it's normally the judge that gives defendants orders in a courtroom, not the other way around.

The appeals court said Mr. Beale would have had an argument...

...if it were not for the fact that Beale and his colleagues on the "Common Law Court" intended to have a "provost marshal" serve their arrest warrant on the presiding judge. Beale clearly intended the judge to learn of this threat when she was arrested by his "provost marshal." The only thing he did not intend was that she would learn of his plot through the filing of a criminal complaint by the government. Furthermore, Beale's intent to manipulate the judicial system was clearly expressed when he was recorded saying that after he had intimidated the presiding judge, "no judge in the whole Court will have anything to do with me." (citations omitted). Remanding for a new trial with a different judge would be an undue reward for an attempt to cow the entire federal bench into submission.

The Moral? The tax law doesn't go away just because you threaten the judge.

Related: SO MUCH FOR THE 'ARREST THE JUDGE' DEFENSE STRATEGY

Cite: Beale, CA-8 No. 08-3205

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Hidden tax prep fee deductions

July 24, 2009

Can you deduct postage? If you use it to mail your stuff to your tax preparer, you might. Robert D. Flach covers the ins and outs of deducting the costs of people like me.

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Des Moines revenue-camera decision looms

July 24, 2009

Why traffic cameras are a crock.

Related: How much does the Des Moines City Council hate its voters?

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The political uses of stupid

July 24, 2009

Martin Sullivan of tax.com on the proposal to finance health insurance destruction by taxing health insurance companies:

Armed with our understanding of simple economics we know there is no real difference between taxing the sellers or buyers of insurance. But a lot of people don't. And there is a world of political difference -- particularly in this Congress -- between taxing unions and taxing big, bad insurance companies. Keep your eye on this trick. It may be just what the doctor ordered to break the logjam in the Finance Committee.

One hopes our wobbly Senator is smarter than that.

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Hope and change, tax edition

July 23, 2009

From the official Obama campaign website:

FACT #3: Under the Obama Plan, No One Will Pay Higher Tax Rates Than They Paid in The 1990s. Barack Obama believes that any responsible candidate must put forward specific ideas of how they would pay for their proposals to put us back onto the path of fiscal responsibility. That is why he has called for repealing a portion of the tax cuts passed in the last eight years for families making over $250,000. But he would limit all rates to be at or below what they were in the 1990s. Families making over $250,000 would pay the 1990s marginal income tax rates – of 39.6 and 36 percent – and capital gains and dividend tax rates of 20%.

From today's Wall Street Journal:

President Barack Obama, looking to pay for his ambitious health-care plan and shore up public support, endorsed a surtax on families earning $1 million a year for the first time Wednesday.

That means a 45% top rate - considerably higher than the Clinton-era peak. But it will only affect the rich, right? Don't count on it:

P.P.S.: On tax increases, Obama said
I don't want that final one-third of the cost of health care to be completely shouldered on the backs of middle-class families who are already struggling in a difficult economy. And so if I see a proposal that is primarily funded through taxing middle-class families, I'm going to be opposed to that ... [E.A.]

In standard Washspeak, this means Obama is open to a health reform that taxes middle class families as long as it isn't "primarily" or "completely" funded by taxes on middle class families. But 49% funded by taxes on middle class families? ... However you interpret these sentences, it's hard to see how Obama hasn't given a flashing green light to non-trivial tax increases on middle class families.

Ask not for whom the toll for "healthcare reform" tolls. It tolls for thee.

Related:

The 'it's a tax on somebody else' fallacy

The surtax will hit only a few businesses: just the good ones

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Eastern Iowa lumberyard owner admits to tax charges

July 23, 2009

20090723-3.JPGThe owner of a lumberyard in Hopkinton, Iowa has pleaded guilty to bankruptcy fraud and tax charges. Court documents report that Keith Chapman diverted more than $450,000 in receipts for Chapman Lumber Company, Inc. for personal purposes:

Defendant opened the mail at Chapman Lumber. Between June 10, 1999, and February 2005, defendant diverted some of the accounts receivable checks made payable to Chapman Lumber and deposited them into the Wells Fargo account. Defendant transferred funds from the Wells Fargo account into his personal bank account. Defendant also wrote checks on the Wells Fargo account to purchase items and services for his or others' benefit, and not for business purposes, such as a membership in a country club, jewelry, golf equipment, and clothing, among other items.

The standard IRS examination program has procedures to find this sort of skimming. Large purchases of personal items are pretty easy for an agent to identify. Mr. Chapman now faces prison, and likely financial ruin. All in all, skimming seems to be a flawed financial strategy.

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The Church of the Sharpie Cross

July 23, 2009

More than one taxpayer has invoked the Deity in vain upon receiving a property tax bill. One Chicago-area taxpayer took it a step further. John Kass of the Chicago Tribune reports:

This is the story of Chicago banker George Michael, who lives in a gorgeous $3 million mansion in Lake Bluff. Being a man of logic and finance, he didn't much like his $80,000 yearly property-tax bill.

So he found an Internet outfit called the Church of Spiritual Humanism. According to the church's Web site, it's not big on faith, but it's all about reason:

"If you agree that Religion must be based on Reason, you can be ordained right now for free, and be still able to practice your own religious traditions by simply clicking the button below:

"ORDAIN ME."

And lo, Michael clicked "Ordain Me," and it was done.

So suddenly his house, including the racquetball court, was a tax-exempt church, he thought. The state wasn't convinced, so he submitted a photo to bolster his case:

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But something about the cross on the house didn't look right. A few questions later, Mr. Michael admitted that the cross was added with a magic marker to the photo. For some reason Mr. Michael didn't win his property tax exemption.

The Moral: If you are going to present altered photos in your tax appeal, buy a copy of Photoshop and learn how to use it. Sharpie-shop doesn't cut it.

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McEowen: what was IRS thinking when it tried to make LLCs automatically passive?

July 23, 2009

Roger McEowen addresses recent taxpayer victories over IRS attempts to make limited liability companies "per-se passive" under the passive activity rules:

In any event, it is curious why the IRS even challenged the taxpayers in this case. If they were to win on their argument that losses by “limited partners” in an LLC or LLP are always passive, then the income from such interests would also be passive. That would certainly lead to the sheltering of this “passive” income in some other form of tax shelter.

Related:

Claims Court agrees with Tax Court: LLC losses not automatically passive

Tax Court: LLC and LLLP owner losses don't have to be passive

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Not FDIC insured

July 23, 2009

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Bruce The Tax Guy posts the history of the piggy bank.

Flickr image by alancleaver_2000.

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How much does the Des Moines City Council hate its voters?

July 22, 2009

Traffic cameras are a sure indicator of a political class that holds its citizens in contempt. The Des Moines city council will consider this slap in the face to its voters Monday when it votes on whether to install speeder cameras and red-light cameras around the city. KCCI reports:

Police said the cameras would be clearly marked so drivers can see them.

"(The) chief would actually like to put signs below the cameras that say what it is. We don't want the cameras to be secretive," said Lavorato.

Good, folks will find that helpful.

The KCCI article doesn't mention the revenue effects of the cameras, but you can be sure that it really is about the ticket revenue, not traffic safety.

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The Laffer Curve on drugs

July 22, 2009

20090722-2.jpgTaxGrrrl reports that Oakland may embrace a Marijuana tax. Iowa is way ahead of them:

SEC. 43. 453B.7 TAX IMPOSED - RATE OF TAX

An excise tax is imposed on dealers at the following rates:

1. On each gram of processed marijuana, or each portion of a gram, five dollars.
2. On each gram or portion of a gram of any taxable substance sold by weight other than marijuana, two hundred fifty dollars.
3. On each unprocessed marijuana plant, seven hundred fifty dollars.
4. On each ten dosage units of any taxable substance other than unprocessed marijuana plants that is not sold by weight, or portion thereof, four hundred dollars.

The difference, of course, is that the Iowa tax is imposed at brutal rates, and is really just another way to punish pot users and dealers. The Oakland tax would be 1.8% of the sales price. While I'm not plugged into the pot markets, I can't imagine it costs enough to make the Oakland tax anywhere near as high as Iowa's; it would be lower unless pot sells for $277 per gram, or about $7,875 per ounce. If you ever wonder if there are real-life examples of the Laffer Curve, this has to be one. If Oakland passes the tax, you can be sure that tax will raise more revenue than the Iowa tax.

Update: "E-stoned.com" purports to have current pot prices. The "good weed" quote is $250/oz. That would mean the Iowa rate would work out to about 56.68%, vs. Oakland's 1.8%. Your mileage may vary.

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Claims Court agrees with Tax Court: LLC losses not automatically passive

July 22, 2009

Last month the Tax Court shot down an IRS argument that limited liability company losses are automatically "passive" under rules drafted for old-fashioned limited partnerships. Yesterday the Court of Claims agreed with the Tax Court. Ruling for the taxpayer on summary judgement, the Claims Court explicitly followed the Tax Court, explaining:

Finally and most importantly, an LLC is not "substantially equivalent" to a limited partnership. As discussed above, unlike a limited partnership, an LLC allows all members to participate in the business while retaining limited liability.

I'm surprised the IRS even pursued this line of argument. If they had won, they would have undermined their own regulations that keep taxpayers from forming "passive income generators" to enable them to deduct passive losses.

Cites:

Claims Court: Thompson, NO. 06-211 T (Fed Cl)

Tax Court: Garnett, 132 T.C. No. 19

Related: Tax Court: LLC and LLLP owner losses don't have to be passive

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Great moments in direct sales

July 22, 2009

Maybe they should have used Craigslist:

MIAMI — The body of a shark was left lying in the middle of downtown Miami street after two men tried to sell it to several fish markets.

The men apparently carried the five or six-foot-long fish around on the city’s Metromover downtown train, prompting calls to police.

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Flickr photo by DanielHP

Another reason to oppose the $100 million proposed downtown Des Moines trolley line.

The Moral: know your distribution channels!

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Social media butterfly

July 22, 2009

The Tax Update now has both a Twitter feed and a Facebook page. Be a follower, be a friend!

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IRS Releases Applicable Federal Rates (AFR) for August 2009

July 21, 2009

The IRS has issued (Rev. Rul. 2009-22) the minimum required interest rates for loans made in August 2009:

-Short Term (demand loans and loans with terms of up to 3 years): 0.83%

-Mid-Term (loans from 3-9 years): 2.8%

-Long-Term (over 9 years): 4.26%

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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Gee, are we getting fleeced or something?

July 21, 2009

At some point, even the biggest suckers can figure out when they've been had. The Des Moines Register reports that the Iowa Legislature is beginning to catch on that their tax credit subsidy to Hollywood may not be the world's best idea:

"I think it needs to be looked at some more," said Sen. Joe Bolkcom, D-Iowa City, who is chairman of the Senate Ways and Means Committee. "We're probably being more generous than we need to be."

Sen. Randy Feenstra, R-Hull, who voted against expanding the tax break for movie makers, is more blunt.

"We gave the movie industry a tax deduction," he said, "but our businesses, our schoolteachers and our flood victims didn't get anything."

The break is a "transferable" credit, which means the filmmakers can sell them to finance their projects. In other words, it's a straight cash subsidy, only less efficient. The credit covers 50% of Iowa film costs, making it one of the most generous in the nation. But all is not well:

Budget problems are causing some lawmakers to talk about repealing the tax break, estimated by state officials to cost Iowa as much as $50 million this year in uncollected revenue.

But it's unlikely that enough legislators will wise up anytime soon:

House Majority Leader Kevin McCarthy, D-Des Moines, describes himself as a "movie nerd" and has expressed enthusiasm for the Iowa productions.

Senate President Jack Kibbie, D-Emmetsburg, said he believes the credit will prove to be beneficial to the state. Kibbie said he would consider legislation guaranteeing the credit in future years.

Sen. Brad Zaun, R-Urbandale, a member of the Senate Ways and Means Committee, said he would not support a reduction of the movie credit. "I think, considering the productions that have been brought to the state of Iowa, that it's working," he said.

If "working" means "taking money from your struggling business and from your employees to give it to other businesses with good lobbyists," it's working just fine.

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How Iowans report S corporation income from non-Iowa sales

July 21, 2009

Iowa's C corporations face the highest stated corporation tax rate in the country, yet Iowa collects a relative pittance in corporate taxes. A big reason is the use of "single factor" apportionment, allocating income to Iowa based only on the ratio of Iowa destination sales to total sales. This minimizes the tax on Iowa-based corporations while sticking it to non-Iowa companies that sell here, at least when compared to the traditional allocation formula that also takes into account in-state property and payroll.

It's not so simple for S corporations, as an Iowa couple recently learned. Iowans have to include 100% of their S corporation income in their gross income. They may be eligible for a credit on Form 134 attributable to non-Iowa sales; this credit is supposed to enable Iowa S corporation shareholders to get a result similar to single-factor apportionment, but it is a complex and poorly-designed credit that goes to zero if an S corporation distributes all of its taxable income to shareholders. Worse, the Form 134 credit is not available at all with respect to partnership income.

If the Form 134 credit doesn't work, the Iowa taxpayer can claim the traditional credit for taxes paid in other states on their non-Iowa S corporation income.

The couple's CPA apparently filed a return leaving out the couple's non-Iowa S corporation income. In affirming the examining agent's disallowance of this approach, the Department of Revenue explained:

The simplified explanation of this situation is: 1) a resident taxpayer with apportionable S corporation income must report the gross income to Iowa, and 2) the taxpayer is allowed a choice of credits for the non-Iowa portion of the S corporation income. One credit is the S corp apportionment credit, identified above, which uses form IA 134. Alternatively, a taxpayer may take a credit for taxes paid to another state on non-Iowa income, using form IA 130.

The Department is correct in this case.

As a policy matter it would be far better for Iowa to repeal the corporate tax and allow Iowa S corporations to elect to be taxed (that is, not taxed) as C corporations for Iowa purposes; Iowans would then be taxed on distributions from the corporations. Not bloody likely, I'm afraid.

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Making a list, checking it twice...

July 21, 2009

The IRS has updated its lists of "Listed Transactions (Notice 2009-59) and "Transactions of Interest" (Notice 2009-55). If you do one of these deals and fail to disclose it, the penalties can be ugly. If you do disclose, don't be surprised when the IRS comes by with further questions.

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Tallest Midget Watch

July 21, 2009

There seems to be a ranking for everything. Even Tax Blogs (via Robert D. Flach). Their composite ranking puts the Tax Update at #6, just behind the TaxProf.

1. Consumerism Commentary

2. Tax Policy Center: The Numbers

3. TaxGirl

4. California Tax Attorney Blog

5. TaxProf Blog

6. Tax Update


Whatever the formula is, it needs work. In real life, the rankings go something like this:

1. The Tax Prof

2 - Everyone else.

But in the meantime, we're number 6!

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Good thing Congress banned the outsourcing of federal tax collections

July 21, 2009

Now that the IRS private collection program has been closed, all collection action is undertaken by IRS agents, who invariably perform at the highest level of professionalism. For example:

IRS agent Albert Bront, 49, of Valencia, California, screamed “I’m going to kill all of you!” when U.S. Treasury agents served a search warrant at his home as part of an investigation into whether Mr. Bront had filed false tax return. He is being held without bail pending a July 28 preliminary hearing in Los Angeles.

Peter Pappas has another tale of IRS professionalism, when an IRS collection agent approcached a client of his. The client e-mailed Mr. Pappas:

Well he came and went. He told me that I shouldn’t have hired an attorney and wanted to know how much I paid Mr. Pappas.

He then began interrogating me and asking me detailed questions about my intentions, my finances and how I came to own the business.

I repeatedly told him that I was represented by an attorney and he continued to say that I didn’t need one and that I should not have hired one.

Mr. Pappas' complaints to the IRS and his congresscritters have produced no results. Could the private sector ever match that level of professionalism?

UPDATE, 1/7/2011: Mr. Bront has pleaded guilty.

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The 'it's a tax on somebody else' fallacy

July 20, 2009

Of all the lame arguments for the health care surtax, one of them is this one by the reliably pro-tax Center for Budget and Policy Priorities (via the Tax Prof):

20090720-1.jpg

Does the argument that something "only affects a few people" really support any argument? If the health bill required that everybody making over $1 million AGI have their entrails sliced from their bodies without anesthesia and burned in front of them, would it be OK just because it would only affect a few wealthy taxpayers?


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The surtax will hit only a few businesses: just the good ones

July 20, 2009

One of the "arguments" for the proposed surtax to finance the destruction of health care in this country is summarized by this chart, from a Ways and Means Committee press release:

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This sort of argument tries to dance around the issue of whether the tax is wise or not by saying hey, it won't affect many people anyway. The lameness of this argument becomes apparent when you think about what they are counting. For this purpose, a "business" means every Schedule C, Schedule E, or Schedule F filed in the country. It embraces every free-lance writer, part-time musician, moonlighting handyman or Mary Kay salesman in the country. It counts every Shaklee business the same as a family-held multi-state manufacturer or retailer. In short, it's a garbage number.

When you look at how much economic activity gets hit by the surtax, the picture looks different:

20090720-3.jpg
Source: The Tax Foundation

The surtax means pass-through businesses that account for 60% of small business profits will be sending more money to the government instead of developing new products, opening new locations, and hiring new employees. Or, more likely, they will be spending money on people like me to change their tax strategies to keep their money from going into the black hole of out-of-control government spending.

Related: Department of Meaningless Statistics

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When you get a notice from a tax agency, make sure it's from a tax agency.

July 20, 2009

Just because something looks official and it says you owe taxes doesn't make it true. Scammers long ago caught on to the money-making potential of official-looking messages. For example, two outfits have just been enjoined from sending notices to businesses that look like Indiana tax notices.

Even if the notice is from a real tax agency, there's a good chance that it is wrong. In fact, it is rare that we see a notice from the Iowa Department of Revenue that is actually correct. When you get a notice, and you aren't positive that it's right, contact your tax professional.

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Expanding the Tax Update Social Media Empire

July 20, 2009

The Tax Update now has a Facebook page. You can access our Facebook, and our Twitter page, by clicking the banners on the right side of the page. We hope you like.

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Silly quote of the day

July 20, 2009

David Cay Johnston on health care spending in Tax Analysts ($link):

Other countries have all realized that buying healthcare wholesale, through government, is cheaper than buying it retail through a hodgepodge of employer-based plans that create the illusion that healthcare is a tax-free benefit.

You mean, like Medicare? Yes, that's sure a fiscal winner.

Will Wilkinson gets it right:

Of course, the government, like individuals and families, has a limited budget. So if the government is going to pay for medical care, it has to ration. And that very fact is an argument for limiting the government to only paying for the care of people who are unable to pay for a minimum of care themselves.

Unless, of course, you want the Bureau of Surgery to decide that your mother doesn't really need that hip replacement, because she has a perfectly good wheelchair.

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Health care:surely the President wouldn't break a promise?

July 18, 2009

The government that brought us profitable and money-saving innovations like Fannie Mae, Freddie Mac, Amtrak and the Postal Service now is going to try its hand at health insurance. It is so confident in the savings that will result that it is imposing several big honking tax increases to pay for them:

-An increase in the top individual marginal rate from the current 35% to 45%;
-An increase in the top rate on dividends and capital gains from the current 15% to 25.4%;

As Greg Mankiw notes, it's puzzling that they are bothering, as President Obama promised to not increase rates above the 39.6 percent of the Clinton era. Surely they don't believe he was lying?

One item in this Hooverite increase in taxes in a recession jumps out: this "Health Care Surcharge" is only expected to raise $544 billion over 10 years. In real life, of course, it will raise much less, while the costs of the programs will be much higer. Anybody who thinks only "the rich" will pay for this debacle is badly deluded.

The TaxProf has an excellent roundup.

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Additional Resources on Taxes

July 17, 2009

While the Tax Update takes its summer vacation, we have serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." The following are "additional resources" included at the end of the chapter. You can buy your own copy of the book at Lulu.com by clicking on the link. We'll be back to our normal schedule on Monday.

Five websites:

The Tax Update Blog (http:// www.taxupdateblog.com)
Tax Girl (http://www.taxgirl.com)
The Tax Lawyer's Blog (http://blog.pappastax.com)
BenefitsBlog (http://www.benefitscounsel.com/benefitsblog/)
The official IRS Website (http://irs.gov)

Five Books:

IRS Publication 15 ("Circular E" Employers Tax Guide).
IRS Publication 17 (Your Federal Income Tax).
The Truth About Paying Fewer Taxes, by S. Kay Bell.
Tax Savvy for Small Business, by Frederick Daily
2009 State Tax Handbook, by CCH

Five Questions to ask yourself:

1.   Do I really know that I am collecting sales taxes on 
     the right things?
2.   Have I considered whether I have liability for taxes 
     in other states lately?
3.   Have I checked my payroll tax account online to 
     make sure my payroll clerk or payroll provider has 
     been making the payments?
4.   Has my business outgrown my old tax professional?
5.   Is my business structure the right one?  Why?

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Get to know a good Tax Professional

July 16, 2009

This tax stuff isn't easy. Get to know a good tax professional for your business. Don't assume the guy who's always done your 1040 is right for your business. Ask around, starting with your banker and your lawyer. They may know somebody who is the right fit for your business.

Next: Additional Resources on Taxes

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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Sales and Use Taxes

July 15, 2009

We all know about sales taxes. What most of us don't know is how complicated the rules are. In Iowa, for example, services are exempt from sales taxes. Unless, of course, they are "enumerated" services, in which case they are taxable (sorry, foot reflexologists). An item that is taxable if purchased by a consumer is exempt if bought by a manufacturer, but only if the item is incorporated in the final product. Milky Way bars are tax-exempt in Iowa because they use flour, but a flour-free recipe makes Milky Way Midnight bars taxable.

Which is a long way of saying: find out whether what you are selling is taxable. The base Iowa sales tax rate is 6%. Few things are more unpleasant than having a sales tax examiner present a bill for 6% of your gross for the last three years.

If customers say they are buying for resale, demand a valid resale certificate. Otherwise their non-compliance could become your liability.

"Use taxes" are a backstop for the sales tax system. If you purchase an item that would be subject to sales tax in your home state, but you buy it free of sales tax from another state - maybe over the Internet - you are supposed to pay a use tax for the item to your home state. While the rule is widely ignored by consumers, businesses ignore it at their peril. If you are an Iowa business, for example, it's only a matter of time before you host a use tax examiner. When they go through all of your internet purchases, it's amazing how quickly the delinquent tax can add up. Get in the habit of paying use tax on your catalog and internet purchases if you don't pay sales tax at the source.

Next: Get to know a good Tax Professonal

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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The wonderful nightmare of state taxes

July 14, 2009

No taxpayer is more popular with politicians than one who can't vote. That makes out-of-state businesses a favorite target of cash-hungry pols.

Many growing businesses quickly expand beyond their home state. It's surprisingly easy to become liable for income taxes in new states - it can take as little as delivering goods in a company vehicle. Any activity in a state beyond soliciting sales for fulfillment from out of state can give you "nexus," making you fair game for state income tax enforcers.

For taxes other than income taxes, it's even easier to fall into their clutches. You can get nexus for sales taxes and "doing business" taxes just by having independent agents selling your goods in a state. More states are adopting "franchise" or "gross receipts" taxes to take advantage of the lower nexus standard. Texas, Ohio, Pennsylvania and Michigan are among the most aggressive, but none of the states are shy on this front.

States are becoming more sophisticated in using data mining to identify potential out-of-state taxpayers. As you add new customers, ask yourself what new sales tax obligations will result.

Remember: If you don't file state tax returns in a state, there may be no statute of limitations if they come after you.

Next: Sales and Use Taxes

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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Federal Income Taxes

July 13, 2009

If your business is taxed on your 1040, your taxes are paid the same way you pay your personal taxes. If your business is part time, you may be able to pay all of your business tax just through withholding on your regular job. As your business grows, you may find yourself needing to make quarterly "estimated tax payments."

The tax law provides three primary ways for individuals to avoid estimated tax penalties through a combination of withholding and estimated tax payments (withholding payments are normally treated as evenly made through the year):


• You can pay 90 percent of your current liability;
• You can pay 100% of your prior year liability
(110% if your adjusted gross income for the prior
year exceeded $150,000; or
• You can adjust your payments as your income
fluctuates during the year.

You can switch among your methods for the year. For example, if you have a bad first quarter, you can pay your first quarter payment based on the first quarter results. If you go gangbusters the rest of the year, you can switch to paying based on your prior year liability. You can find the details for this in IRS Publication 505.

Corporations have slightly different estimated tax payment rules.

Next: The wonderful nightmare of state taxes

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.


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Mind your payroll tax obligations

July 10, 2009

It's a good bet that more businesses fail because of failure to pay payroll taxes than for any other tax-related reason. When cash is tight, it's tempting to put off the IRS to pay that howling vendor. For many businesses, it's a fatal mistake.

When you start a new business the IRS will tell you how frequently you should pay your payroll taxes when they assign your tax identification number. They will update your payment schedule based on the size of your payroll remittances. Keep up with your schedule religiously. If the IRS requires electronic payment for your business, pay electronically; the IRS will penalize you for paying the right amount if you pay it the wrong way.

IRS payroll tax penalties start at 2% for taxes paid as little as one day late and quickly reach 15%. Of course the IRS also charges interest on late payments. And if the business goes under before you pay the payroll taxes, any "responsible person" who fails to remit payroll taxes - whether or not an owner - may be assessed the entire amount of unpaid taxes. The states are no more forgiving.

Many taxpayers outsource their payroll tax obligations to a payroll service. That may well be a wise expenditure, saving you time to grow your business. Even so, you can't outsource your responsibility for payroll taxes. Be sure to sign up for EFTPS, the Electronic Federal Tax Payment System; this will enable you to check online to see whether your provider is remitting your payroll taxes on schedule.

Next: Federal Income Taxes

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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Keeping books and records

July 09, 2009

To fill your cigar box you have to keep track of how much is in there. It's shocking how many businesses founder because they don't know where they stand financially.

A very small business should start with an off-the-shelf business accounting program like Quickbooks or Peachtree. You should either learn to use it or hire somebody who does. Make sure you keep your source documents, like receipts and purchase orders. You will need them to verify your expenses should the IRS come calling.

For some expenses, you need extra information with your records. For travel and entertainment expenses, you need to record the time, place, people involved and business purpose of the expense. If you use a personal car in your business, you should keep a daily record of your business mileage. When the IRS comes calling, you'll be glad you went to the trouble.

Next: Mind your payroll tax obligations

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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Just what kind of business are you running anyway?

July 08, 2009

Just like the guy who learned in high school that he had been writing prose all along, everybody who has a business has chosen an entity, whether they know it or not.
With rare and specialized exceptions, your business will be one of these, as far as the tax law is concerned:

	
•	Proprietorship 
•	Partnership
•	S corporation 
•	C corporation
Wait a second - where are LLCs? Limited liability companies, a relatively new critter in the business world, are chameleons. They can be any of these four things (but they usually are proprietorships when they have one owner and partnerships if there are multiple owners).

The first proprietorship came into business the first time a caveman traded a nice sharp rock for a mastodon burger. If you do business by yourself without the benefit of a state law organization, you are a sole proprietor. Most sole proprietorships report their earnings on their individual tax return, Form 1040, by attaching a Schedule C. If you are a farmer, you use Schedule F. If you are renting real estate, you use Schedule E.

Which entity is best? That's a discussion to have with your tax advisor. If you don't know what to do, start with the partnership or proprietor formats; if nothing else, they are the easiest formats to change. C corporations are the only ones that can cause your income to be taxed twice -- when earned and when distributed -- so make sure you really know what you're doing before you go that way.

Next: Keeping books and records

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

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Keep your eye on the cigar box.

July 07, 2009

While the Tax Update takes its summer vacation, we are serializing my chapter in "How Business Gets Done: Words of Wisdom by Central Iowa Experts." You can buy your own copy at Lulu.com by clicking on the link.

Every business, from the humblest hot dog stand to the biggest swaggering conglomerate, has one thing in common: the need to end the day with more cash in the cigar box.

That's not the same as having the lowest taxes. The businesses with the lowest taxes are the ones that have folded. You can look it up. While paying taxes isn't the best thing in the world, it's preferable to business failure.

Your job is to make money. Treat taxes like any other expense: lower them as much as you can without hurting your profitability. The guy with the full cigar box wins, not the guy with the most deductions. If you end up spending your time fighting the IRS over underpaid or late-filed taxes, you won't be filling the cigar box.

Next: Just what kind of business are you running anyway?

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Summer break

July 06, 2009

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Flickr image courtesy AdamL212

It's time for the annual Tax Update summer break. To keep our legions of readers amused, Tax Update is serializing the chapter I wrote in "How Business Gets Done: Words of Wisdom by Central Iowa Experts," starting tomorrow through the technical wonder of scheduled postings. My chapter is a basic introduction to bookkeeping and taxes for the budding entrepreneur.

For coverage of breaking tax news while I am away, visit the "Tax Nerds" in the blogroll on the right. We will resume our regular programming July 20. See you then!

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Happy Independence Day!

July 03, 2009

The Tax Update is taking the day off. If you are at the Iowa City Jazz Fest, maybe I'll see you there tonight.

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Have a great day!

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Taxpayer advocate calls for raising taxpayer costs, reducing preparer supply

July 02, 2009

The National Taxpayer Advocate has issued her annual report. Along with a number of sensible recommendations is this clunker:

The Advocate reiterates her longstanding recommendation that the government do more to protect taxpayers by regulating unenrolled federal tax return preparers, including by requiring initial testing and continuing professional education, and recommends that the IRS step up enforcement actions against preparers who fail to perform due diligence or consciously facilitate noncompliance.

The report has a critical unstated assumption: that such regulation would do more good than harm. Not bloody likely. The predictable unintended consequences:

- The supply of preparers would go down as folks will not want to screw around with the bureaucracy for what is for many just seasonal work.

- Unenrolled tax preparers will go underground, not signing returns. It is, after all, legal for folks to do their own returns (for now, anyway). These folks will be very difficult to track. A single mom trying to figure out her earned income credit in a housing project isn't going to lose sleep over whether the lady helping her with the paperwork in her apartment is licensed.

- Honest preparers will get caught up in paperwork mistakes of their own making, or made by the new IRS preparer bureaucracy, and will lose their seasonal income before the problems get ironed out.

- Resources that could be used to develop computerized enforcement tools to identify dishonest filing patterns will instead be used shuffling CPE paperwork and harassing preparers.

Finally, it is highly unlikely that all of this will result in a better product. We all remember when Fortune magazine would have a tax return preparered by different preparers and get as many results as preparers. The real reason for poor return prep quality is a poor quality of tax law. That root problem will exist until my modest reform proposal is finally adopted:

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

For a contrary view on the Taxpayer Advocate report, see Peter Pappas. Dan Meyer also has more.

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Footloose? Not in Des Moines

July 02, 2009

Des Moines likes to market itself as a hip, happening place. As long as it has an "ordinance to provide for prohibition, license, regulation and supervision of public dances within the city of Des Moines," it's going to be hard to make that claim with a straight face. The Des Moines Register explains:

And for those looking to take away a layer of bureaucracy, repealing the ordinance seems like an easy way to do that. The ordinance states that, "The room where dancing is conducted shall be illuminated to a minimum of two footcandles, as measured by a photometer at a plane 30 inches above the floor."

I suppose a strobe wouldn't count.

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Broke? Just go out and make more!

July 02, 2009

So you've maxed out all of your credit cards, and you find that they aren't letting you just roll the balances into new ones. You buy a new car every year, you have your hair cut at the same place John Edwards goes, you eat at the steakhouse every night, and you can't make your mortgage payments because the credit card companies have cut off your cash advances.

It's off to the credit counselor. He sits you down and lays it on the line: you need to make more money. Maybe knock off convenience stores, or something.

David Brunori is providing just that sort of insightful advice to broke states in his post States Should Raise Income Taxes to Solve their Budget Problems:

The CBPP says that raising income taxes on the wealthiest citizens can help close budget deficits. Indeed, the report says that raising the personal income tax 1 percentage point on households making more than $500,000 would raise a whopping $8 billion nationwide. The CBPP maintains that raising taxes on the really rich is less harmful to the economy than cutting services. The CBPP is right, of course. There's nothing unfair about closing budget deficits by enacting a little tax increase on a guy making $500,000. The people subject to the tax are making more than 99 percent of the population. Call me a big fat liberal, but using that extra tax revenue to support services for the unemployed family needing healthcare and education doesn't bother me one iota.

Because every dollar spent by the states is for unemployed families needing healthcare and education.

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In case you missed the excitement yesterday

July 01, 2009

Heroism and tragedy downtown yesterday, just blocks from my office, as a boat went over the Center Street Dam. The Des Moines Register has the story. It was strange to watch it unfold on the Des Moines Register twitter feed while I worked:

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KCCI has harrowing video.

Our thoughts and prayers to the victim's family.

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Tax Court: LLC and LLLP owner losses don't have to be passive

July 01, 2009

The IRS lost a battle it should never have fought yesterday in Tax Court. The court shot down a bid to treat as "per se" passive losses from limited liability companies or limited liability limited partnerships.

Nebraskans Paul and Alicia Garnett invested in LLCs and LLLPs that operated farming businesses in Iowa. The Garnetts claimed that they "materially participated" in the entities and deducted losses shown on the K-1s from the LLCs and LLLPs. The IRS assessed about $360,000 in deficiencies from these losses from 2000 to 2002, saying that the losses were passive no matter what. "Passive" losses are allowed only to the extent of "passive" income, or when the activity is sold.

The IRS applied Sec. 469(h)(2), which says:

Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates.

The taxpayers argued that LLCs and LLLPs are not "limited partners" under these rules, and they are therefore subject to the regular "material participation" rules for determining whether a loss is passive. The Tax Court looked at the state law rules governing these entities to sort it out. The court found that Iowa law gives allows powers to LLC members and LLLP owners beyond those allowed traditional limited partners. They also said limited liability wasn't enough to make an owner a "limited partner" under Sec. 469(h)(2):

Thus, while limited liability was one characteristic of limited partners that Congress considered in the enactment of section 469(h)(2), it clearly was not, as respondent suggests, the sole or even determinative consideration. To the contrary, the more direct and germane consideration was the legislative belief that statutory constraints on a limited partner's ability to participate in the partnership's business justified a presumption that a limited partner generally does not materially participate and made further factual inquiry into the matter unnecessary.

We do not believe that this rationale properly extends to interests in L.L.P.s and L.L.C.s. As previously discussed, members of L.L.P.s and L.L.C.s, unlike limited partners in State law limited partnerships, are not barred by State law from materially participating in the entities' business. Accordingly, it cannot be presumed that they do not materially participate. Rather, it is necessary to examine the facts and circumstances to ascertain the nature and extent of their participation. That factual inquiry is appropriately made, we believe, pursuant to the general tests for material participation under section 469 and the regulations thereunder.

My view: This is a stupid argument for the IRS to make. When Sec. 469(h) was written, LLCs and LLLPs barely existed. The differences between these new entities and the old limited partnerships are profound, and it is common for LLC and LLLP members to work full time in roles analogous to general partners in limited partnerships. The new entities just aren't comparable to limited partnerships.

Just from the standpoint of the IRS, this is an unwise argument to make. If losses from these entities are per se passive, so is income. An IRS "victory" in this case could open up a world of opportunities for entrepreneurs, who would suddenly find they had lots of passive income from their LLCs that they could shelter with traditional tax shelter partnerships.

Yesterday's ruling doesn't close the case; it was a "summary judgment" motion on the 469(h)(2) issue. The IRS might still challenge the losses under the normal "material participation" standards.

Cite: Garnett, 132 T.C. No. 19.

Below: tax law standards for material participation

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Weapons trial begins for tax holdouts Ed and Elaine Brown

July 01, 2009

Tax-defying couple Ed and Elaine Brown, who held out for months in a fortress-like compound in New Hampshire after they were convicted of tax evasion, were back in court yesterday to face weapons charges arising out of the holdout. It got interesting quickly when Mr. Brown tried to fire his lawyer just as the trial was to begin. The trial judge denied Mr. Brown's requiest.

Mr. Brown said the lawyer wasn't willing to conduct the defense the way Mr. Brown directed. I wonder why? Maybe it has to do with this:

In court filings, the Browns say they are not the people named in the indictment. They sign their motions: “Edward-Lewis:Brown” and “Elaine-Alice:Brown.”

“We are not the EDWARD BROWN and ELAINE BROWN,” they wrote, saying if the court continues to deny their contention, “we will again be forced to retreat from this collusive and hostile arena.”

The funky punctuation defense has a poor record in federal courts.

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The trial continues today.

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Nerd v. Nerd

July 01, 2009

Two of the esteemed "tax nerds" in our blogroll, Peter Pappas (Tax Lawyer's Blog) and Robert D. Flach (The Wandering Tax Pro) are in the middle of a virtual cage match over what return items increase audit risks and the relative virtues of CPAs vs. other preparers. I hope to post on the battle, but meanwhile I refer you to Monica Lawver's cool-headed coverage.

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July Cavalcade!

July 01, 2009

Summer is in full swing, but you can cool off at the Cavalcade of Risk this week at the Disease Management Care Blog.

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The roundup of insurance and risk management blog posts includes an Insureblog must-read on the legal dangers employees may face running "health risk assessments" of their employees.

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