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Tax Update Blog: October 2009 Archives

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Happy Beggar's night!

October 30, 2009

For obscure historical reasons, Des Moines-area kids go trick-or-treating on "Beggar's night," October 30, so time to go home and prepare for the little critters. We require them to tell jokes (Sample: "Why didn't the skeleton cross the road? He didn't have any guts.").

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Have a great Halloween, and don't eat all of your candy at once!

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5-year 2008, 2009 loss carrybacks for everybody?

October 30, 2009

The silver lining of the bill to extend the scandal-plagued Popular First-time Homebuyer Credit might be a five-year net operating loss carryback. A Senate Finance Committee release says:

The legislation also expands the net operating loss carryback (NOL) provision to allow U.S. companies of every size to carry back losses incurred in either 2008 or 2009 against income arned in any of the five prior years, limited to 50 percent of the taxpayer’s income in the fifth year.

Aside from the weird "50 percent" limitation, this would be a welcome source of cash for many taxpayers. Absent this legislation, taxpayers with NOLs could only recover taxes paid in the last two years, with remaining losses carrying forward to offset future income, assuming the taxpayer can stay in business.

The stimulus legislation authorized taxpayers to carry back only 2008 losses for five years, but that provision was limited to entities with $15 million or less of gross receipts, severely limiting its usefulness.

Of course, this won't apply to Iowa taxpayers trying to carry back losses on state returns. Individuals will only get Iowa's standard two year carryback, and Iowa no longer allows corporations to carry back NOLs at all; they only carry forward.

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Obama, Geithner embrace homebuyer credit

October 30, 2009

The Obama administration has come out for an extension of the fraud-ridden, insane, Popular First-time Homebuyer Tax Credit. For some reason, this pinata for scammers stimulus device is popular with tax scammer Treasury Secretary Geithner:

Treasury Secretary Tim Geithner and HUD Secretary Shaun Donovan called on Congress to approve three important measures to improve housing and the housing market for Americans: extension of the First Time Homebuyers Tax Credit for a limited period, extension of higher loan limits for home mortgages, and secure funding for the Housing Trust Fund.

"We welcome efforts taken by Congress to extend the First Time Homebuyers Tax Credit for a limited period. This credit has brought new families into the housing market and contributed to three consecutive months of rising home prices nationwide," said Secretaries Geithner and Donovan. "In extending the credit, we urge Congress to include strict measures to combat tax fraud and protect responsible homeowners. We also urge Congress to act swiftly to extend the loan limits that currently apply to most mortgages, helping make rates more affordable for middle-class families. Finally, we will work with Congress to identify a financing source for the Housing Trust Fund, which will help provide decent housing for families hardest hit by the current economic downturn."

Coming from the Treasury Secretary himself, we can have great faith that there will be no non-compliance.

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Mandatory electronic filing for paid preparers?

October 30, 2009

The IRS plans to require paid preparers to e-file returns unless their clients specifically opt out, Tax Analysts reports ($link):

Paid tax return preparers will soon be required to e-file, David Williams, director of the IRS Office of Electronic Tax Administration, said October 29. Speaking at an American Institute of Certified Public Accountants conference in Washington, Williams also discussed the challenges and benefits of the modernized e-filing system (MEF) that is scheduled to become operational for the most commonly used forms in the 1040 family on February 17, 2010.

Williams said agreement has been reached in the Senate to include in legislation to extend the first-time home buyer credit a mandate for paid return preparers to use e-filing. He said the mandate could allow achievement of the 80 percent e-filing goal originally set by Congress for 2007.

One more reason not to like that bill.

Taxpayers who use paid preparers will be allowed to opt out of e-filing, Williams said, adding that he thinks many will do so. He declined, however, to comment on how an opt-out might be documented or how the mandate might be enforced.

It might be like some state-mandated e-filing opt-outs, where the taxpayer has to sign a form saying they don't want to e-file. Proud pencil-and-paper holdout Robert D. Flach is likely to have some interesting thoughts on this.

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Blogs for everything: estate tax edition

October 30, 2009

The new blog "Future of the Federal Estate Tax" covers just what you think it would. As the estate tax heads towards a one-year doom in 2010, this blog promises to be a must-read.

Via the TaxProf.

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Homebuyer credit extension a done deal? NOL carrybacks enhanced?

October 29, 2009

Senate Majority Leader Harry Reid says Senate Democrats will push an extension of the insane Popular First Time Homebuyers Credit that will make it available to more buyers with higher incomes.

The plan isn't final yet, but Bloomberg reports that the income limits for the $8,000 credit will double - to $250,000 for joint filers and $150,000 for single taxpayers. It would also allow non "first-time" homebuyers to get a $6,500 credit if they move from a house they've lived in for five years.

Bloomberg also says the bill would contain net operating loss legislation -- presumably an increase in the 2-year carryback period for 2009 losses.

To underline the bipartisan nature of economic illiteracy among congresscritters:

Senate Minority Leader Mitch McConnell, a Kentucky Republican, agreed that most lawmakers support the unemployment and homebuyer measures. “We’re not that far away from an agreement,” he said earlier today.

It's nice to know that a majority of the millionaires in the Senate think it's wise to spend $40,000 to $80,000 of our money for each new home sale caused by the credit, even though the credit is rife with fraud.

The credit extension would be tied to an extension of unemployment benefits; the provisions may still be changed, and it has to be reconciled with a House bill that has no homebuyer credit provision.

If they extend it this time, does anybody believe they won't try to extend it again every time it is set to expire?

Kay Bell and TaxGrrrl have more.

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Tax breaks for the runaway bride

October 29, 2009

TaxGrrrl ponders the tax implications of donating slightly-used engagement rings and wedding dresses to charity.

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If at first you fail, fail again?

October 29, 2009

Persistence isn't always a good idea, as Russ Fox points out:

It’s not a good thing when the Tax Court can give as a citation your prior failed attempt in Tax Court.

There's no merit in doubling down on dumb.

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Snipe hunting for film credits

October 28, 2009

The Iowa Attorney General's office says it may try to recover some of the $32 million in tax credits already issued in response to the well-publicized looting abuses in the program.

It's not clear exactly how this would work. The easiest thing to do mechanically would be to revoke the tax credit certificates that you attach to a return to claim the credits. There's just one little problem with this: film credits are "transferable," so almost all of them were sold by the filmmakers to third parties. That would punish third parties, not the offending filmmakers. It also invites lawsuits from taxpayers who paid good money for credits had been issued by a duly-authorized state authority, only to have them go away.

So maybe they plan to go after the filmmakers themselves to get cash repayments of the credits already issued. As the Des Moines Register reports, that's not easy:

Deb Copeland of Des Moines, a casting director, said she, too, is skeptical the state could successfully recover any money from recipients of tax credits. She noted that movie financing is complicated, and the tax breaks in some cases were distributed among dozens of moviemakers and investors.

Some companies that formed to make movies in Iowa are now defunct.

"It would be like a blood-out-of-a-turnip sort of thing," she said.

Movie companies typically set up a new LLC for each project. Once the film is done, the production LLC closes shop, the Land Rovers, Benzes and other properties used in the film are distributed, and only a shell remains. The state's lawyers will have to march through the LLC, possibly through a rats nest of other entities, to catch up with the proceeds of the sold credits.

They'll likely be as successful as many a young snipe hunter.

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If it's Wednesday, it's Waterloo!

October 28, 2009

Part of the happy crowd this morning at the Center for Agricultural Law and Taxation school in Waterloo, at Hawkeye Community College.

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This is the second of eight of these that I am speaking at this fall, thanks to CALT director Roger McEowen. If you haven't signed up already, sign up today!

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Whither the homebuyer credit?

October 28, 2009

Last night it seemed like a renewal of the $8,000 homebuyer credit (or as ABC radio news calls it, "the Popular Homebuyer Credit") seemed a done deal. This morning Tax Analysts isn't so sure($link):

As passed by the House September 22, H.R. 3548 would extend unemployment insurance payments for jobless workers in states with high unemployment rates. The additional benefits would be offset by a one-year extension of the 0.2 percent FUTA payroll surtax.

But negotiations to add an expanded loss carryback benefit and some sort of extension of the $8,000 home buyer credit, now scheduled to expire November 30, appeared to have failed.

Sen. Johnny Isakson, R-Ga., one of the main proponents of renewing the home buyer credit, said he remains "cautiously optimistic" that senators will pass an extension.

How well does this magic bean for the economy really work?

The main argument for the tax credit is that it stimulates the economy and stabilizes the housing market. Seen purely as a stimulus, the tax credit is highly inefficient. The National Association of Realtors claims that the credit created 350,000 new sales; the Calculated Risk blog calculates that this means the government is paying $43,000 for every extra house sold (since most sales would have happened anyway). According to the Wall Street Journal, Goldman Sachs estimates 200,000 new sales, implying a cost of $80,000 per marginal sale.

It's expensive and insane, so our Congressional supergeniuses will work day and night to keep it going.

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Buzzed

October 28, 2009

Robert D. Flach has posted a new "Buzz" rounding up tax blog posts. Check it out! (UPDATE: link fixed).

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Flicker image under Creative Commons license from _PaulS_'s photostream

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Eat the Rich

October 28, 2009

The IRS is geared up to go after offshore wealth by trying to untangle complex offshore structures.

The economy has become more international. It's not unusual for a midwest livestock producer to have Canadian interests. We see more cross-border structures because more business is done across borders. What are the chances this new initiative will be able to tell the difference between a structure driven by business needs and one set up to dodge taxes?

More from TaxGrrrl and Peter Pappas.

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Non-solicitation agreements

October 28, 2009

No, we aren't talking about Eliot Spitzer's parole terms. Christine Branstad explains at IowaBiz.com.

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Uh oh.

October 27, 2009

It looks like the IRS is leaning towards a massive increase in preparer regulation:

Shulman told the conference attendees that he saw several areas of consensus coming out of those meetings. First, he said, “the status quo is not optimal. Unethical and unqualified preparers can inflict tremendous harm on taxpayers and hurt the integrity of the tax system.”

The second area of consensus, according to Shulman, was that “we need to find a way to ensure that return preparers demonstrate their competency.” The third point was that “return preparers must maintain competency through ongoing education programs.”

Shulman acknowledged that the outcome of the review “could represent a big shift for the tax return preparer community.” However, he did not announce what that outcome would be.

Consensus my... foot. Count me out. The market already provides incentives to maintain competency, as do IRS criminal and civil sanctions. All an IRS-run CPE regime will lead to is create a great wallowing ineffective and expensive bureaucracy imposing useless and annoying costs on legitimate preparers while missing the back-alley scammers altogether.

Consumers can look for higher costs and fewer providers as the big franchised preparers game the system, gobble up market, and jack up prices. Meanwhile, return prep problems will persist -- not because preparers are stupid, but because the tax law is.

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Not just Anyone can be a partner.

October 27, 2009

It's not enough to have an LLC. How you own it and how well you document it matter a lot, as a Michigander learned the hard way in Tax Court yesterday.

The taxpayer set up an LLC that ran an employment service. The LLC got behind on its payroll taxes. The IRS said that the LLC had only one owner, making it a disregarded entity, and that owner was on the hook for the employment taxes.

The taxpayer argued that he wasn't the owner at all. He said a controlled corporation owned the LLC, called Paradym, was the owner. He failed to convince the Tax Court:

Petitioner's argument that Back Porch Workout owned Paradym is not credible. Petitioner formed Paradym, and he has not offered any evidence to indicate that he transferred any of his membership units in Paradym since it was formed. Since its inception, petitioner has held himself out as owner of Paradym.

Although petitioner offered a Form 1065, U.S. Return of Partnership Income, for Paradym for tax year 2005, that document is not credible. Attached to the Form 1065 were two Schedules K1, Partner's Share of Income, Deductions, Credits, etc. The first Schedule K-1 was issued to Back Porch Workout and indicated that Back Porch Workout owned a 100-percent ownership interest in Paradym. The second Schedule K-1 was issued to "Anyone" with an address listed as "None" in Kalamazoo, Michigan. The purported Schedule K-1 showed a zero-percent ownership interest in Paradym. Not only was the Form 1065 created in 2007 after respondent had begun collection proceedings, but petitioner testified that the second Schedule K-1 was fabricated because it was the only way to process a partnership return for Paradym using petitioner's and Mr. Idahosa's tax return preparation software.

The judge wasn't convinced, ruling that the taxpayer owned the LLC, the LLC is a disregarded entity, and the taxpayer is on the hook.

The Moral: Pay your payroll taxes, and don't wait until the IRS collections people are involved to try to put them in another entity.

Cite: Comensoli, T.C. Mmeo 2009-242

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ABC News covers the film credit fiasco

October 27, 2009

Fans of Iowa's film credits said they would make Iowa famous. They have, in a way. They have made national network news. ABC covered the story Sunday:

It has the sad story of the casting director who moved from LA to Iowa and a makeup artist who lost her film makeup contracts. To ABC's credit, they at least talk to one opponent of the credits, for at least 3 or 4 seconds. To their discredit, they fail to note that the casting director and makeup jobs are generated by a credit that has cost every Iowan $10 so far, and may end up costing us $121 each, even those of us who never get to see Mira Sorvino.

Related: First things first.

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So how are film credits working out in other states?

October 27, 2009

The Des Moines Register finally asks the question that nobody bothered to ask in 2007 when Iowa enacted it's scandal-plagued film credit: how's it going in other states. Not so great:

Even as some researchers have identified a clear boost in spending that would not occur without incentives, others have used data to show the dollars spent failed to create significant long-term jobs or boost state government's own bottom line.

Many state governments have turned to tax credits for filmmaking in hard economic times, as Louisiana did after Hurricane Katrina. But as the recession has thrust states into deeper economic troubles, leaders in some states have moved to cap, reduce or, in the case of Wisconsin, eliminate incentives completely.

There's no way the Iowa credit could "boost the state government's own bottom line." Not only do the credits subsidize 50% of production costs, including luxury cars for the producers, but those receiving money from the film production -- actors and vendors alike -- are exempt from income and sales taxes on their film receipts.

Iowa's scandals aren't unprecedented:

State incentive programs have been subject to embarrassing scandals and costly lawsuits.

In June, Mark Smith, a former state film official in Louisiana, was sentenced in federal court to two years in prison and fined $67,500 for accepting cash bribes totaling $135,000 in exchange for giving state tax credits to a film producer.

Smith pleaded guilty in 2007 of taking the bribe, which a federal judge said tarnished the state's fledgling industry. Also in Louisiana, the FBI is investigating a film studio investment controversy that has affected more than two dozen current and former players and coaches of the New Orleans Saints professional football team, who collectively could lose nearly $2 million.

No wonder the Saints are playing hard this year. They need the money.

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A broken-down nag of a thoroughbred tax shelter

October 27, 2009

Old scams can always find new suckers.

Three Utah men saddled up the old phoney-loan, phoney basis cattle-feeding shelters of the 1970s. The cattle shelters created big phoney deductions by "buying" cattle with non-recourse loans for improbably high amounts that were never intended to be paid. It appears that the Utah men did much the same thing, only with horses. Now they have pleaded guity to tax charges and face some prison time. Their customers face heart-to-heart talks with the IRS.

Russ Fox has the details.

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Wow that Cow Cavalcade!

October 27, 2009

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Catch the current Cavalcade of Risk at Workers' Comp Insider, with the latest and greatest insurance and risk management news from the internets. Hank Stern's "Social Security Disability: FYI" is especially useful. If you want disability coverage (and you do), get your own, because you need more than Social Security to fall back on.

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Scenes from Sheldon

October 26, 2009

It's morning in Sheldon!

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And we have 125 160 or so eager tax practitioners at the Sheldon CALT farm tax school.

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A great crowd with lots of smart questions.

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Homebuyer credit: end it, don't mend it.

October 26, 2009

In the wake of rampant fraud in the first-time homebuyer credit -- including home "purchases" by four-year-olds -- a congresscritter proposes to "solve" the problem, reports Kay Bell:

Key provisions of H.R. 3901 would:

* Establish a minimum age of 18 to claim the credit. This was sparked by reports that individuals as young as 4 had filed for the credit.
* Require proof via a copy of documentation by the taxpayer when filing that an qualifying residence actually had been bought. In some cases, credit claims were made before the property purchase closed.

The bill also would give the IRS the authority to scan prior returns to determine eligibility.

In addition, H.R. 3901 would require more electronic returns to be filed by return preparers.

Only a congresscritter would look at an economically insane and fraud-ridden program and think "Let's fix this." Tax Vox has the right fix:

This program, as they used to say up in the North End of Boston, needs to take two in the hat.

But all the lobbyists feel otherwise.

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Top scientists: Tax Simplification fights fraud!

October 26, 2009

Science provides support for the intuitively obvious, according to the latest work out of Australia:

Queensland University of Technology visiting Professor James Alm said economics experiments showed that a simple tax system led to more honest reporting in tax returns and thus greater revenue.

"This experimental finding is further borne out in real life - countries that have removed complicated deductions and credits have found not only that they got more honest reporting but they had also gained a wider tax base," said Professor Alm, an economist from the Andrew Young School of Policy Studies at Georgia State University, whose research is funded by the US Internal Revenue Service.

Unfortunately, while tax simplification is only good for all of us, it is hell on the Iron Triangle of lobbyists, legislative fund-raisers, and those who have learned to game the system at the expense of the rest of us.

This bit is interesting:

He said a series of experiments that mimicked the naturally occurring environment had shown that, when completing their tax return roughly 50 per cent of people are always honest, 20 per cent always cheat and about 30 per cent are sometimes honest and sometimes not, depending on situational incentives.

I think that's true to a point, but when people lose confidence in the system entirely, the compliant 50% will also give up if they feel like fools for following the rules.

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Sunlight is a great disinfectant, but it has drawbacks for the vampire community

October 26, 2009

Christopher Bergin is not happy with a recent IRS attempt to hide its inner workings :

Defending the order, an IRS spokesman said that it is consistent with the policy articulated in President Obama’s January memo and reflects “the IRS’s long-standing commitment to accountability through transparency.” Excuse me, I’m about to spit up again. From my perch – and it’s a pretty informed one – the IRS has had a long-standing commitment to avoiding public scrutiny as much as it can.

Apparently you have to destroy transparency to save it at IRS.

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Sir, I need to see your lounging license.

October 26, 2009

Why I love northern Minnesota:

A Minnesota man has pleaded guilty to driving his motorized La-Z-Boy chair while drunk.

A criminal complaint says 62-year-old Dennis LeRoy Anderson told police he left a bar in the northern Minnesota town of Proctor on his chair after drinking eight or nine beers.

I wonder if it takes snowmobile treads so it can be used more than four months a year.

Via Going Concern.

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It all starts with Sheldon.

October 26, 2009

This year's Iowa State University Center For Agricultural Law and Taxation Farm Tax School kicks off today in Sheldon, Iowa. I will tag along with a group of stellar practitioners led by CALT leader Roger McEowen. This is the first of eight schools, so if you can't make it to Sheldon today, hope lives!

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A victory for bitter ex-mothers-in-law everywhere

October 23, 2009

Unhappy business associates long ago began wielding 1099 forms as a weapon, as tax lawyer Peter Pappas attests:

I have seen many cases where a disgruntled ex-partner or creditor rifled off an erroneous 1099-C just to get the taxpayer audited by the IRS.

What works for bitter businessmen works for bitter domestic relationships. When a former son-in-law in Illinois failed to settle an asserted loan by his ex-mother-in-law to her satisfaction, she gave up on collecting but issued a 1099-C reporting the amount as debt forgiveness income.

Ex-Son-in-Law took it badly, and fought back. He sued Ex-Mom, claiming that because she wasn't required to issue a 1099-C, it was fraudulent for her to do so.

The judge noted that Ex-Mom was not in fact required to file:

The filing of information returns is governed by § 6050P of the Internal Revenue Code, which provides, in relevant part, that "[a]ny applicable entity which discharges (in whole or in part) the indebtedness of any person during any calendar year shall make a return. . . ." 26 U.S.C. § 6050P(a) An "applicable entity" is a governmental agency, a financial institution, or other organization in the business of lending money.

Ex-Mom isn't an "applicable entity," so Ex-Son said that not only was she not required to file, she was forbidden to, and the filing, even if accurate, was fraudulent. The court disagreed:

..the court holds that the filing of a Form 1099-C by someone other than an applicable entity is not fraudulent or actionable per se under § 7434; nothing in § 6050P or any other applicable provision of the IRC forbids the voluntary filing of a truthful and accurate Form 1099-C.

Ex-Mom isn't out of the woods yet. Ex-Son can still argue that the contents of the filing were fraudulent. But the mere filing of a 1099 by someone who doesn't have to isn't fraud.

While this is unfortunate for Ex-Son, it is clearly the right result. Businesses that have to issue gobs of 1099s face expensive penalties if they fail to issue all that they are supposed to, so they err on the side of issuing too many, rather than too few. Sound policy doesn't punish taxpayers for too much third party reporting. As the court pointed out, truly malicious reporting can still be punished.

Cite: Cavoto v. Hayes, USDC-ED IL, No. 1:08-cv-06957

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IRS bags a Deere

October 23, 2009

Ag implement giant and big local employer Deere & Company had a bad day in Tax Court yesterday, likely costing it millions in research credits.

The research credit rules reward taxpayers who increase their R&D expenses as a percentage of their sales. Deere argued that it could leave revenue from overseas divisions out of the gross receipts calculations. The IRS thought otherwise, and the Tax Court sided with the IRS.

The decision covered fiscal years ending in 1997 through 2001, showing just how long it can take a big corporate tax case to move through the system -- not even counting a possible appeal to the Seventh Circuit.

Cite: Deere & Company, 113 T.C. No. 11.

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Iowa 2010 interest rates on overpayments, underpayments declines to 5%

October 23, 2009

Iowa has announced that the interest rate on late taxes or refunds will be 5% annually for 2010. The rate for 2009 is 8%.

Link: Historic Iowa interest rates.

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Sarah Palin, meet Eleanor Roosevelt

October 22, 2009

Yesterday I disagreed with the conclusions of a reader-blog post on the Talking Points Memo website. The TPM post, written by "Ecclesiastes," said Sarah Palin should include in gross income the proceeds of a charity auction of a dinner date with her.

Somebody linked to my post in the TPM comment section, prompting an ungenerous comment by Mr. E:

So if one CPA mis-applies a Revenue Ruling, the problem goes away?

When an Old Testament prophet says you have misapplied a Revenue Ruling, you check your work. While Ecclesiastes may be correct that all is truly vanity, I still think I have the tax law right.

It turns out that the ruling that I applied to the Palin dinner-date has a history going back to Eleanor Roosevelt, strangely enough. According to a standard treatise, Bittker and Lokken's Federal Taxation of Income, Estates, and Gifts, Mrs. Roosevelt had her own radio show, but she refused to accept payment for it, and the sponsor instead made payments to a charity. The IRS ruled that she did not have to pick up the sponsorship in gross income.

Subsequent rulings have refined the IRS position; it is no longer clear that Mrs. Roosevelt's radio shows would be tax free today. The more recent rulings, including the one I cited in saying that Ms. Palin likely has no gross income, distinguish between revenues that arise only because of the fund-raising event and those that someone would earn anyway, but assigns to charity. Bittker and Lokken explain:

A 1971 ruling states that an individual is not taxed "in a case where the individual does not participate directly or indirectly in the contract pursuant to which his services are made available [by the exempt organization] to the third party and if he has no right to receive, or direct the use or disposition of the amounts so paid." Entertainers performing at a specially scheduled benefit night should ordinarily have little difficulty in satisfying the requirements of these rulings, but they may find it hard to extricate themselves from existing contractual arrangements and shift to an exempt organization income "which would normally be that of the individual artist."

As far as I can tell, nobody says Ms. Palin had already arranged to auction herself as a dinner date, and then assigned the proceeds to charity as a tax dodge. You could argue that a dinner date is not "entertainment" (just ask my old dates), but it seems awfully nit-picky to say that this is fundamentally different from singing at a charity benefit; it's merely a different sort of performance, with an audience of one.

I use lots of weasel-words like "likely" and "seem" here, as I did in yesterday's post. That's partly because I'm no Old Testament prophet (they get to flatly say that I misapplied a ruling, with no explanation or citations), but mostly because there's no IRS precedent dealing specifically with celebrity dinner auctions. You can only make an educated guess.

I have found nothing in repeated electronic searches of IRS rulings and court cases that directly addresses this situation. There appears to be no case where the IRS has ruled against, or taken to court, a taxpayer who was a dinner-date auction "prize." The IRS has in fact neglected the scourge of charity dinner-dates.

As a policy matter, why should the IRS ever go after a celebrity dinner-date? It's not as though the celebrity date is assigning income she would otherwise earn to a third party to save taxes. An IRS attack would be... vanity.

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The Code is 23!

October 22, 2009

Today is the 23rd anniversary of the Internal Revenue Code of 1986, enacted when President Reagan signed the Tax Reform Act of 1986 into law.

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October 22, 1986: President Reagan signs the Tax Reform Act of 1986.

At the national firm I worked for then, we were preparing a big client seminar on the tax reform. We got our first copy of the actual legislation only days before we were to go on, and we literally ripped the book into sections so each presenter could study the portion they were planning to discuss (I got the passive loss rules). Thank goodness for the internet.

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Tax Court: When debt is disputed, IRS needs more than a 1099 to assess debt forgiveness tax

October 22, 2009

When the credit card company settles your account for less than you owe, the tax law says you have "cancellation of indebtedness" income. The bank has to issue a 1099-C, and if you don't report the debt forgiveness income listed on the form, the IRS comes calling. If the taxpayer fights the IRS, they IRS usually wins.

Not always. The Tax Court yesterday ruled that the IRS couldn't rely on the 1099-Cs to assess tax on a Pennsylvania couple who disputed their credit card balance:

In this case, respondent may not rely on the Forms 1099-C submitted by CitiFinancial and Chase as evidence of the amount of debt that was definite and liquidated. Section 6201(d) provides that in any court proceeding, if a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return and has fully cooperated, the Commissioner shall have the burden of producing reasonable and probative information concerning the deficiency in addition to the information return. Petitioners have asserted reasonable disputes with respect to the amounts reported by CitiFinancial and Chase. Respondent has failed to produce reasonable and probative information independent of the third-party information returns.

The Moral? If you can show that you have a dispute with the credit card issuer over the balance, the IRS needs more than the bank's say-so to assess debt forgiveness tax.

Cite: McCormick, T.C. Memo. 2009-239

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But it's free!

October 22, 2009

Peter Pappas reports "VITA Tax Return Preparation Volunteers are Wrong 41% of the Time."

No word on how many of these returns were prepared by ACORN.

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Fraud? You mean 'confidence'!

October 22, 2009

So the first time homebuyer credit is riddled with fraud. TaxGrrrl reports:

The IRS announced earlier this week that it is investigating more than 100,000 “doubtful claims” related to the credit. In fact, to date, the IRS has instigated 107,000 civil claims related to the credit – about 8% of the taxpayers who’ve applied for the credit. A quick turn of the math shows that to be up to $800 million in potentially false credit.

So naturally Chris Dodd (D, Countrywide) thinks we should do more of this:

Critics have said the current credit is a costly way to spur a relatively small number of sales.

Dodd acknowledges the criticism but thinks there’s more than dollars and cents at stake.

"There’s a multiplier that I can’t put a price on, and it’s confidence," he said. "And I think we’re getting close to people feeling that sense of confidence and optimism again."

It's a confidence game, for sure.

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Demutualization: what to do now?

October 22, 2009

Now that an appeals court has upheld the Fisher case allowing a taxpayer to offset gain on the stock of a de-mutualized insurance company with life premiums paid, what should taxpayers do now? Roger McEowen has some thoughts. He also lists demutualization transactions and discusses the practicalities of refund filings.

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McNulty: Iowa will stop taxing investment income of non-resident partners

October 21, 2009

Iowa appears to have quietly dropped its indefensible policy of attempting to tax non-residents on interest, dividends and capital gains of Iowa-based investment partnerships. Jim McNulty, a tax policy wonk at the Iowa Department of Revenue, yesterday told the tax policy committee of the Iowa Association of Business and Industry that the Department has "backed off" its position that all investment income of an investment partnership is "business income" apportionable to Iowa. This is consistent with stories we've heard from other Iowa tax pros.

Asked whether the Department will provide written guidance making its new position public, Mr. McNulty said Iowa may rewrite its regulations in this area.

Iowa should also rewrite the instructions to its S corporation and partnership non-resident K-1 forms, which now treat all interest and dividend income as business income. It should do so before the next filing season so everybody knows the new policy, not just those who happen to attend meetings with DOR employees.

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A tax problem for Palin?

October 21, 2009

Talking Points Memo says Sarah Palin may have to report taxable income from a charity auction of a dinner date with the former vice-presidential candidate (via the TaxProf). She would then be allowed to deduct the $63,000 proceeds, but would probably be out cash because of the phase-out of itemized deductions at higher income levels. TPM bases its conclusion on Treasury Reg. Sec. 1.61-2(c), which reads:

Payment to charitable, etc., organization on behalf of person rendering services. The value of services is not includible in gross income when such services are rendered directly and gratuitously to an organization described in section 170(c). Where, however, pursuant to an agreement or understanding, services are rendered to a person for the benefit of an organization described in section 170(c) and an amount for such services is paid to such organization by the person to whom the services are rendered, the amount so paid constitutes income to the person performing the services.

TPM is probably wrong. The dinner date is likely covered by Rev. Rul. 68-503, reprinted below, which interprets the regulation in the context of an entertainer who performs at a fund-raiser. The ruling holds that the entertainer is not taxable on the proceeds of a fund-raising performance where the entertainer isn't entitled to any of the proceeds. The IRS would likely apply this ruling to a charitable dinner date. You can draw distinctions between a dinner date auction and a fund-raising performance, but the main difference seems to be the size of the audience, which shouldn't affect the tax results.

Update, 10/22/2009: Sarah Palin, meet Eleanor Roosevelt

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When the IRS gets 60 cents of your next dollar

October 21, 2009

Of all of the bad tax policies that have wormed their way into the tax law in the last 25 years, one of the worst is the proliferation of income-based "phase-outs" of deductions and credits. These can boost marginal tax rates -- the rates on each additional dollar earned -- to shocking levels. TaxVox has a great discussion of the problem, with this observation:

People lose confidence in a system that leaves them in a fog about the tax rates they face. And considering that we are going to have to rely on this revenue-raising structure more than ever in the coming years, that it not a good thing at all.

In boning up for the Farm Tax Schools I will be participating in starting next week (you can still enroll!), I noticed how the phase-out of the $8,000 first-time homebuyer credit over a $20,000 range of income adds 40% to the marginal tax rates of qualifying taxpayers in the phaseout range. That means a 60% effective rate on each dollar earned in that range, which starts at $75,000 for single filers, before even counting state taxes. That's just crazy.

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Another Des Moines embezzlement?

October 21, 2009

Stealing from the boss makes news again in Iowa:

The finance director for a Des Moines-based temporary employment company is in federal custody in Florida following his arrest on a wire fraud charge stemming from his alleged embezzlement of more than $1 million, court records show.

Randy Stringer, 46, of Clive was taken into custody by an agent of the Federal Bureau of Investigation last Thursday in Miami on an arrest warrant claiming that in July he illegally transmitted $2,000 to a woman in the Dominican Republic. The money allegedly was embezzled from Stringer’s employer DES Staffing Services Inc.

The Des Moines Register reports that court filings say the owner "became suspicious of Stringer’s behavior including frequent foreign travel and evasiveness when questioned by company finances and particularly 'why Quick Cash seemed to be repeatedly short of cash.'"

Embezzlement in a small business can be hard to spot. Often it only comes to light when something doesn't make sense to the owner - like when a business that seems to have good sales isn't making any money. Unfortunately, a lot of money can be gone by the time the owner puts two and two together. If the suspect really took the money, he'll face a hefty tax bill, but that doesn't help the guy who's out $1 million.

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Not every quest is deductible

October 21, 2009

20091021-1.gifA reader adopted as a child asks TaxGrrrl whether she can deduct expenses of finding her birth mother. TaxGrrrl answers:

Unfortunately, no, the expenses associated with your search are not deductible. You can only deducted attorney’s fees as an individual in limited circumstances which include certain tax advice; defending a lawsuit that was filed against you on a work-related issue; or for your business. As a side note, you can only take that deduction as a miscellaneous 2% deduction on your Schedule A.

You may think that it’s deductible because fees (including attorney’s fees) related to an adoption may be taken as a credit on your tax return. However, those expenses relate to fees incurred while adopting or trying to adopt a child, not for an adopted child trying to locate a birth parent.

It is not a train, or a plane, or a snort, or a dog, or a deduction, or a credit.

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If it's not a tax, why does the IRS make me pay it?

October 21, 2009

Lapsed conservative Bruce Bartlett opposes a payroll tax cut to stimulate the economy. One of his arguments is that the payroll tax isn't a tax. The Tax Policy Blog makes the obvious reply: Payroll Taxes Are Taxes.

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Film credits, hayseeds and sophisticates

October 20, 2009

The Wall Street Journal editorial page picks up on Iowa's film credit fiasco:

Iowa's program lured Tinsel Town with a whopping 50% tax credit for production costs in the state—payroll, food, living expenses. They even let the Rodeo Drive tax refugees apply the credit to the purchase of a car. In this field of schemes, one director bought a new Mercedes. Iowa's cash for clunkers.

Hey, didn't somebody point that out awhile back?

Now the Iowa program is falling apart amid allegations of weak oversight and abuse—the usual problems that occur when a tax system loads up its survival on loopholes. Iowa's Democratic Governor Chet Culver has temporarily suspended the tax-credit program, asserting, "Iowans will not be taken for suckers." We knew that, but what about Iowa's politicians?

An entertainment lawyer comments on yesterday's WSJ news article; he seems to think we rubes are just being too sensitive:

In reading the article, it seems that everyone was probably acting within the technical limits of the law. No one has claimed that these expenditures were not allowable under the program. However, having the state pay for half of a film producer's Mercedes clearly went against the local sensibilities. This isn't about math or money as much as it is about a clash of cultures. It's like inviting a rock musician or famous athlete over for dinner. You're very excited until you see what they're really like, and then you can't wait for them to leave.

That's not quite right. Credits were claimed for the costs of brokers selling the credit. Other credits were claimed for expenses clearly labeled as non-Iowa expenses -- only Iowa expenses qualify -- without even running them through an Iowa strawman. And over $6 million of credits were granted for expenditures that were never actually made with money. Iowans actually seem to like having the movie stars around. We're just not crazy about paying $121 per Iowan for the privilege.

Now it appears at least one movie maker is running to Michigan to take their money, demonstrating that the only way we'd ever have a film industry permanently is to give it permanent subsidies.

The WSJ editorial page gets it right:

The larger issue beneath the Iowa fiasco has to do with using tax credits as a policy tool. Almost without exception, we think tax credits are bad policy.

Related: Let them eat Canapes.

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Passive losses go to the dogs

October 20, 2009

The "passive loss" rules disallow losses when a taxpayer fails to "materially participate" in a loss-generating activity. The tax law has a number of ways you can "materially participate" in a business activity, but the most common is to spend 500 or more hours working in the activity.

As is usual under the tax law, it's up to the taxpayer to prove how much time was spent. This can trip up someone claiming losses from a part-time sideline activity -- somebody like Francis Bogus.

Mr. Bogus was a network technician at Verizon who seems to have had a passion for the puppies, owning over 100 greyhounds. He hired professionals to take care of his dogs. The IRS said that he failed to spend enough time with the dogs to "materially participate." The Tax Court said that he may well have participated enough, but he failed to prove it:

As previously noted, petitioner did not keep a diary, appointment book, calendar, or any other similar type of record of his participation in the activity. We are left with petitioner's self-serving testimony and exhibits that, when viewed in the most favorable light, fail to prove that petitioner materially participated in this activity and, when viewed in the least favorable light, support respondent's position that this is a passive activity. "The Court is not bound to accept the unverified, undocumented testimony of taxpayers, and we decline to do so in the instant case." Carlstedt v. Commissioner, supra (citing Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976)).

We believe that petitioner was regularly involved in his activity for profit but, unfortunately, was unable to demonstrate and corroborate his material and substantial participation. Petitioner could have maintained a calendar, appointment book, diary, or other record of his participation in the activity to enable him to meet his burden of proof. Lastly, we believe that having been engaged in greyhound dog racing for over 25 years, petitioner has found trustworthy and experienced individuals to breed, raise, board, train, and race his greyhounds. It would follow that this would require less material participation by petitioner than if he were just starting the activity and learning how to operate the business. Therefore, on the basis of the entire record, we hold that petitioner has not met his burden of proving that he has materially and substantially participated in the activity in question, and respondent's determinations are sustained

The taxpayer's losses will be deferred until the dogs turn a profit, or until he disposes of the activity.

The Moral? If you have a business on the side, keep an appointment calendar.

Cite: Bogus, T.C. Summary Opinion 2009-160

More on material participation rules below.

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Attorney's conviction upheld for offshore tax evasion schemes

October 20, 2009

Utah attorney Dennis Evanson, sentenced to ten years and the loss of his Hummer for involvement in setting up offshore trusts as part of a tax dodging scheme, lost his appeal yesterday.

Prior coverage: DID HE MAKE ENOUGH TO MAKE THIS WORTHWHILE?

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If you prepare the joint return, can you be an 'innocent spouse'?

October 20, 2009

Surely there's a set of facts that will enable a spouse who prepares the joint tax return to win "innocent spouse" status, but it isn't Owen Smith's set of facts. The former H&R Block employee and IRS veteran prepared joint returns including income from his wife's restaurant business. The returns left off a lot of income. The Tax Court wouldn't let Mr. Smith off the hook:

Petitioner and Ms. Lyman's tax returns reported large deductions that significantly reduced their joint tax liabilities during the years at issue. Because petitioner prepared and signed those returns, he would have noticed the net losses and resulting deductions repeatedly claimed for Ms. Lyman's business. Presumably, such large losses, caused by understated gross receipts, over a period of years would cause him to question how he and Ms. Lyman were able to maintain their standard of living. Consequently, petitioner could be expected to know that the returns contained understatements, thus raising his duty to inquire.

The Moral? The more you should know, the harder it is to play dumb.

Cite: Smith, T.C. Memo. 2009-237

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Rental losses when your daughter moves back in?

October 20, 2009

Probably not. The TaxGrrrl explains.

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Federal tax receipts lowest share of GDP since 1950

October 20, 2009

What happened to federal receipts when incomes got clobbered in the recession:

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Source: TaxVox

TaxVox's Bob Williams discusses projected revenues going forward and sees darkness:

Whether we’re above or below our 50-year average has no evaluative importance. What does matter, however, is that all three revenue paths fall far short of the 23.6 percent of GDP that CBO projects the government will spend in 2019. Maybe Congress and the president—and his successors—will manage to cut one-fifth of projected expenditures over the coming decade and balance the federal budget, but that’s a very tall order in the face of baby boomer retirements and soaring health costs. Reaching fiscal balance will take some combination of spending cuts and tax increases.

Spending cuts sure don't seem to be on the agenda, which means big honking tax increases loom. All the more reason taxpayers will take a hard look at the Roth IRA conversion opportunity available in 2010.

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On fire and going the wrong way on the freeway

October 20, 2009

Christopher Bergin at Tax.com:

At its latest meeting the task force talked about something called the ReadyReturn system, under which the government would prepare tax returns for many of our citizens. Excuse me? OK, the ReadyReturn system is a nice little idea, but isn’t this like changing the windshield wipers while the car is on fire?

If that's the "big idea" for the current tax reform panel, tax reform will always have a bright future, because it won't ever actually happen.

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Don't tell anybody, but...

October 19, 2009

...the Federal Circuit Court of Appeals on October 9 apparently upheld the taxpayer victory in the Fisher demutualization case, without comment.

It seems to be a secret. I can't find it in Tax Analysts, and the Thompson/RIA Citator shows nothing.

Very strange. Not long ago a panel of the Federal Circuit went rogue and threatened to hollow out the income tax before thinking better of it. Now they get a closely watched case affecting every policyholder of a mutual insurance company that has gone public, and they can't rouse themselves to an opinion.

The case allows taxpayers to offset premiums paid on mutual insurance policies against the proceeds of stock sold in a demutualization transaction. It will be interesting to see how the IRS and Congress address the case, now that they have lost on appeal in a court with nationwide jurisdiction. It remains unclear whether you get your entire premium as basis, or the IPO price, or some other number (limited by your premiums paid, presumably). It will also be interesting to see how far creative tax advisors will take the Fisher "open transaction" approach in other areas.

Prior Tax Update Coverage: IRS LOSES DEMUTUALIZATION ARGUMENT IN COURT OF CLAIMS

(Hat tip: Frank Carroll)

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IRS issues Applicable Federal Rates (AFR) for November 2009

October 19, 2009

The IRS has issued (Rev. Rul. 2009-35) the minimum required interest rates for loans made in October 2009:

-Short Term (demand loans and loans with terms of up to 3 years): 0.71%

-Mid-Term (loans from 3-9 years): 2.59%

-Long-Term (over 9 years): 4.01%

The Long-term tax-exempt rate for Sec. 382 ownership changes during November is 4.33%

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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First things first.

October 19, 2009

Unrelated but related headlines:

Moviemakers: Lift freeze on current film projects.

Before they entered the Capitol, the group emphasized the importance of the incentive program.

"We have very little time left before the remaining projects, which are still holding on, go bye-bye," said Neil Wells, a local actor, director and producer.

And:

Des Moines Schools will face $15 million budget cut

The Des Moines Independent Community School District, which has more than 30,000 enrolled students, will take the biggest hit from Gov. Chet Culver’s order to cut 10 percent across-the-board from the budget.

Sure, education budgets will be slashed and programs will be cut. But we've got a film to finish, people! Priorities!

The Wall Street Journal today has a piece on the film credit fiasco. It has nothing really new to those who following the story, though it does provide insight into what the film program has done to Iowa's strategic manicure sector. It does spend a lot of time on the manicurists and extras who are losing their temporary jobs, but it leaves out an important number: the potential $363 million cost of the program, which is about $121 per Iowan -- even Iowans who don't get to give manicures to Susan Sarandon.

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7,500 offshore amnesty participants?

October 19, 2009

The IRS estimates 7,500 taxpayers took advantage of the offshore financial account amnesty that ended last week, TaxGrrrl reports. I wouldn't be surprised if the number ends up significantly higher when the last-minute filers are counted.

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Misadventures in business deductions

October 19, 2009

Claiming imaginary business deductions is a great way to lower the taxes shown on client tax return, except for the going to prison part. Oh, and the part about all the clients getting audited and paying the taxes and penalties.

Kansas City preparer Donald Biusnell last week received a three-year sentence after pleading guilty to cutting taxes by $1.1 million for clients with phony deductions.

A Topeka-based multi-level-marketing version of this ploy called "Renaissance -- The Tax People" blew up a few years ago. Not long ago a former IRS district director who served on the operation's "dream team" of tax advisors received a two-year sentence. Now Todd Strand, former National Marketing Director at RTTP, has received a 51-month sentence. Russ Fox has more.

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$1.1 million, one loan

October 19, 2009

The IRS has switched positions and agreed that taxpayers can deduct interest on loans up to $1.1 million used to buy a house. Roger McEowen explains. Lots of folks would be happy to sell you a $1.1 million house about now.

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Hatched.

October 19, 2009

hatch100.jpg"Survivor" Richard Hatch is finally off the federal correctional island. Imprisoned for failing to pay tax on $1 million earned on national television, Mr. Hatch doggedly, but ineffectively, insisted he was a victim of circumstance and that the network was supposed to pay his taxes.

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Me and Hank

October 18, 2009

It was "Family Weekend" at DePaul University in Chicago. Hank Stern of Insureblog fame and I both are covering costs for freshmen there, so it was a rare chance for Iowa to meet up with Ohio.

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Iowa Dad and Ohio Dad.

Hank is a great guy as well as a great blogger. His wife and daughter were very nice, and quite patient with our blog talk. I only wish we had more time to visit. Maybe next year!

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Kathy: Thanks and Good Luck!

October 16, 2009

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Today is the end of an era at Roth & Company, as Kathy Morrison retires. Kathy has been with us since the early days. She's an old-school administrative pro -- cheerful, capable, and always professional. Her career started in the days of steno pools and manual typewriters, and it's not likely that we'll ever find another person who can "take a letter" (not that she has ever had to at Roth & Company).

Thanks, Kathy, and keep in touch!

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Don't hold your breath for Iowa film credit revival

October 16, 2009

It could be some time before Iowa turns back on the Film Credit money spigot, based on Governor Culver's comments in an interview with The Des Moines Register:

The future of the Iowa filmmaking tax credit will remain unknown until key state investigations are complete, Culver said.

When asked about the program's future, Culver said, "I can't give you an answer to that question because we have to complete our investigation before the taxpayers of Iowa know if that's been a net plus or a net negative for them."

Culver suspended the program last month after he became aware that the full purchase prices of two luxury vehicles were used

Net positive or net negative? Gee, that's a toughie. Of the $32 million credits issued so far, over $6 million were for imaginary expenditures. Untold millions more were spent outside of Iowa, but run through Iowa strawmen to qualify for the credit. Of course, at least one Mercedes, one Range Rover, and one iPod were bought for film directors in Iowa with taxpayer money. And don't forget that they buy T-shirts here. And the swell parties! And the chance to see Mira Sorvino has to be worth $32 million by itself, right? Or $363 million, but who's counting?

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2010 IRA contribution limit remains $5,000

October 15, 2009

There will only be minor inflation adjustments affecting IRA contributions in 2010, according today's announcement from the IRS.

The maximum contribution IRA contribution for 2010 remains at $5,000, and the addtitional "catch-up" amount for those who reach age 50 by the end of 2010 remains at $1,000.

A few of the income phase-outs for IRA contributions will change. The beginning of the phase-out of the deduction traditional IRA contributions for married taxpayers filing separately will start at adjusted AGI of $56,000, rather than $55,000; the phase-out for taxpayers who don't participate in a plan but who have a spouse who does, and who file joint returns, will begin at $167,000, instead of $166,000. The start of the phaseout range for other joint filers will remain at $89,000.

The start of the Roth IRA adjusted AGI phaseout range will increase by $1,000 in 2010, to $167,000, for joint filers; the start of the phaseout range remains at $105,000 for other taxpayers.

For more on IRA deduction limits, check out IRS Publication 590.

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2010 401(k) deferral limit to remain at $16,500

October 15, 2009

2010 looks much like 2009 for retirement plan contribution limits. The IRS today announced its 2010 inflation adjustments for retirement plans. The maximum deferral for 401(k) plan contributions for 2010 remains at $16,500, the same as 2009. The extra deferral for those turning 50 by the end of 2010 remains $5,500.

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2010 FICA max to remain at $106,800

October 15, 2009

The maximum income subject to the 6.2% FICA tax applied to both employers and employees will remain at $106,800 for 2010. That means the maximim FICA that can be withheld from any employee for 2010 will again be $6,621.60.

There is no maximum for the 1.45% Medicare component of the federal payroll tax. Self-employed taxpayers pay both the employer and employee sides of these taxes via self-employment tax.

This is the first year without a cost-of-living increase in the FICA base since annual adjustments began in 1975.

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October 15, ready or not.

October 15, 2009

October 15 is a big day in the tax world. Today is the final day to file extended 1040s. If you aren't filing electronically, go to the post office and use Certified Mail, Return Receipt Requested, unless you trust the IRS and the Postal Service much more than I do.

It's also the last day to file for the federal offshore reporting amnesty. The TaxProf and Peter Pappas have more on this.

As much as I hate extended returns (and I do, with a white-hot blazing fury that can shatter watches and frighten staff accountants and puppies), they are necessary, and sometimes even helpful, as Robert D. Flach explains, and they don't hurt:

There is an “urban tax myth” that extending your return will help to avoid an audit. In my opinion, if you are going to be audited you are going to be audited based on the information reported on the return, regardless of when it is actually submitted.

I can't remember the last time I filed my own return without extending, and I haven't been audited (knock wood). You are much more likely to get examined based on an amended return than an extended one, so if you have to extend to get it right, extend. Just don't wait until October 10 to start trying to put together the correct information.

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How do they do that?

October 15, 2009

People often ask how states without income taxes pay their bills. The Tax Foundation has just come out with a study examining that question, and Stateline.org has put the findings into a nice picture (via TaxProf Blog):

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Short answer: sales taxes. David Brunori has more at Tax.com.

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Going old school on the mob

October 15, 2009

Just like they did with Capone, they still get Chicago gangsters on tax charges:

Rudolph C. "Rudy" Fratto, 65, of Darien, who comes from a family of alleged mobsters, admitted to failing to pay more than $140,000 in federal taxes on more than $800,000 in income from 2001 to 2007, according to his plea agreement in a case investigated by the Internal Revenue Service.

Fratto evaded the taxes by having various firms pay him through a defunct business whose checking account he controlled. One of those businesses included a gaming company in the northwest suburbs that specializes in lotteries and paid him about $58,000 in 2005 for handyman work.

No matter what they do to close the tax gap, I doubt if they'll ever get these guys to sweat out complete and accurate 1040s.

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Hitting the brake with your foot on the gas

October 15, 2009

Tax Analysts reports ($link) that some congresscritters are trying to attach an extension of the $8,000 homebuyer credit to an unemployment insurance bill. The credit is slated to die November 30.

As a matter of economics, the credit is of course insane. That matters not when congresscritters seek votes and the all-important lobbyist money. Still, it would be nice if this effort to prop up the price of homes in the face of a glut would face up to simultaneous government efforts to push home prices down.

Off the top of my head, some tax and government policies that prop up home values:

- The homebuyer credit
- The mortgate interest deduction
- Easy money from the Federal Home Loan Bank, Fannie Mae, Freddie Mac, etc.

Government programs that work to push down home prices, either by subsidies or increasing supply:

- The low-income housing credit, which subsidies residential space.
- Section 8 subsidies
- Rehab credits for old buildings

When you have one foot on the brake and the other on the gas, you don't get anywhere, and it's bad for the car.

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Iowa's poor business tax climate: why tax credits don't help

October 14, 2009

There are two basic approaches to using state tax rules to attract businesses. One is to have a low tax rate with a broad base and simple rules. Or you can have a high tax rate, but use targeted tax breaks, start-up incentives, and tax credits to attract "targeted" businesses. Iowa takes the second approach, and the result is the fifth-worst ranking in the current Tax Foundation Business Tax Climate Index.

We asked Kail Padgett, one of the authors of the index, why Iowa scored so poorly in spite of having over two dozen busines tax credits. The answer:

The tax credits actually count against Iowa in terms of its business tax climate. Tax credits are symptomatic of an underlying problem in the tax structure. A state shouldn’t need to entice businesses with incentives. A neutral tax code with lower rates and broader bases provides a sound business environment.

North Carolina is just facing up to the problems with these credits:

Do government incentives aimed at luring businesses to a state or city work?

There’s already a body of evidence that they often do not. And news out of North Carolina this week shows just how quickly these headline-grabbing deals can go awry. While the business press on Dell Computers this week focused on its new smart phones and $3.9 billion bid for tech services provider Perot Systems, in North Carolina the news on Dell was all about the closure this coming January of its plant in Forsyth county. The move will put 900 people out of work. And it’s doing collateral damage to the local incentives system that offered the Texas-based computer maker $280 million in potential tax breaks and grants to locate the plant in the state four years ago.

(via Knowledge Problem)

David Brunori chimes in from Tax.com:

The lesson is stark. Tax and other development incentives are no guarantee that a company will do what they promise they will do. Dell is closing the plant for business reasons. And those reasons are simply that it can't make money despite the state's generous offer.

Far better to have low rates for everyone than to try to have the venture capital supergeniuses at the Iowa legislature and the Iowa Department of Economic Development decide what the "right" businesses are.

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Can you incorporate your job?

October 14, 2009

With individual tax rates set to rise and talk of a corporate rate cut, more folks will try tax planning like Mr. Clark suggested to Mr. Martin, an agent for a Knoxville, Tennessee RE/MAX office:

Mr. Clark advised Mr. Martin to conduct his business through a corporation. Mr. Clark thought that "A C corporation, if he [Mr. Martin] is accumulating equity, pays taxes at 15 cents on the dollar. It doesn't have [a] self-employment tax obligation. A sole proprietorship has both income tax obligation and self-employment tax obligations." Mr. Martin did not consult an attorney or anyone other than Mr. Clark regarding the advisability or consequences of conducting his business through a C corporation. Mr. Clark "set up the corporation" and its accounts for Mr. Martin.

The corporation conducts no business apart from Mr. Martin's real estate activity with RE/MAX. Mr. Martin deposits his commission checks into the corporation's bank account. The corporation pays a large portion of Mr. Martin's business expenses and many of the Martins' personal expenses.

The IRS didn't much care for this setup and treated the payment of the corporation of Mr. Martin's expenses as wages - taxing them at his personal rates and subjecting them to the 15.3% combined employer-employee FICA and Medicare tax.

Based on the Tax Court's opinions about Mr. Clark, Mr. Martin had an uphill battle:

Unfortunately, Mr. Martin's confidence in Mr. Clark appears to have been misplaced. Mr. Clark testified that he is not an attorney, an accountant, or an enrolled agent. His 6-year employment with the IRS, primarily matching Forms W-2 and 1099 with the individuals' returns, does not necessarily qualify him to prepare tax returns let alone advise clients regarding business planning, business accounting, or various complicated problems involving Federal taxation.

...

Mr. Clark prepared the unusually obscure petitions filed in these cases. During the trial Mr. Martin relied almost entirely on Mr. Clark's testimony to explain petitioners' positions in their cases. That testimony for the most part is void of relevant content.

Except for that, things went fine. Oh, and except for the decision:

Mr. Martin is an employee of the corporation and the payments made to him are wages, the corporation may not deduct the employment taxes until the contest has been resolved, and petitioners have failed to identify or substantiate any deductions not allowed by respondent.

The Moral? It's hard to successfully incorporate your job, and it's even harder to get at your money if you do.

Cite: Martin, T.C. Memo 2009-234.

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Why a 'new jobs' credit will fail

October 14, 2009

From TaxVox:

In a very nice story last week, Lou Wilin of the Findley Ohio Courier asked employers in his hard-hit state whether the credit would encourage to them to hire. Overwhelmingly, they said no: "People do not staff plants based on tax credits," said Jed Osborn, plant controller for Ball Corp. "You just do not hire people to stand around," Osborn said. "They have to have a reason to be there."

No orders means no jobs, tax credits or no tax credits.

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There's still time to double-check!

October 14, 2009

If you are like a certain tax blogger, you may be one of those people who sometimes doesn't file until the last week of the extension period. Extensions run out tomorrow. If you still haven't filed, William Perez has a last-minute checklist for you at About.com.

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Will Enron CFO Supreme Court case affect tax crime law?

October 14, 2009

Tax fraud isn't supposed to happen accidently, explains attorney Jack Townsend:

Since the tax law requires willfulness, defined as the intentional violation of a known legal duty, then the legal standard must be knowable so that the defendant -- any defendant, even the hypothetical reasonable defendant -- charged with the crime must be able to ascertain the legal standard in order to intend to violate the standard.

Is it fair to apply this sort of standard to fuzzy concepts like economic substance? When the tax law is obscure and uncertain, where do you draw the line between "non-deductible" and "illegal" in a tax shelter?

These questions might get addressed when the Supreme Court takes up the criminal conviction of Enron executive Jeff Skilling for failure to provide "honest service" at Enron, as Mr. Townsend discussed in his Federal Tax Crimes blog.

Update, 10/15/2009: More here.

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Got Deductions?

October 14, 2009

The IRS rules that a double-mastectomy patient cannot deduct infant formula expenses as a medical expense, reports the TaxProf. Tax attorney and mom-of-the-year nominee TaxGrrrl has more.

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October 15 looms!

October 13, 2009

Tax season really ends Thursday at 11:59:59 pm, when the extensions for 2008 1040s expire. That's also when the truly, positively final deadline for participating in the IRS offshore account amnesty runs out. Unless, of course, you qualify for an extension to next June 30.

We got a comment last night to a post that shows how the current regime of offshore account reporting puts some taxpayers between a rock and a hard place:

What is the position where you are a US citizen married to a non-US citizen spouse and residing outside the US and an employee of a legitimate foreign business in which you have the authority to write checks on office accounts but do not have access to the business' bank statements and in fact do not know the total that is in the account. Also, to make it worse once you tell the employer that because they were unfortunate enough to hire you, an American citizen, they now need to disclose to you the account balances so you can report this to foreign tax authorities (the IRS), they refuse. Can you blame them though? Good luck other americans looking for any executive jobs outside the USA! This is ridiculous. Why does the IRS treat citizens abroad like this? Clearly we cannot use US bank accounts to pay our salaries in and pay our bills, etc.

Even the IRS seems to realize that the requirement to report foreign accounts that you can sign checks for, but don't own, is dumb. Notice 2009-62 extended the FBAR amnesty deadline for such filers to June 30, 2010, with this explanation:

In light of the additional time needed for the Department of the Treasury to address issues pertaining to FBAR filing requirements and the need to provide administrative relief for (i) persons with signature authority over, but no financial interest in, a foreign financial account, and (ii) persons with a financial interest in, or signature authority over, a foreign commingled fund, this Notice provides that those persons have until June 30, 2010, to file an FBAR for the 2008 and earlier calendar years with respect to these foreign financial accounts. Thus, eligible persons that avail themselves of the administrative relief provided in this Notice may need to file FBARs for the 2008, 2009 and earlier calendar years on or before June 30, 2010, to the extent provided in future guidance.

More on the October 15 deadlines from Kay Bell, TaxGrrrl, and The New York Times.

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A buyers market in Cedar Rapids residential real estate?

October 13, 2009

It might be a good time to get some deals on Cedar Rapids rental real estate. A federal bankruptcy judge has ordered the liquidation of 460 properties owned by Robert Miell, who awaits sentencing on tax, mail fraud and perjury charges arising out of phony insurance claims for storm losses. It looks like some banks will be making unwelcome additions to their real estate portfolios.

Link: Bankruptcy Court order converting case to Chapter 7 status.

Prior Tax Update Coverage:

Girlfriend's financial maneuvers get Cedar Rapids landlord jailed while awaiting tax evasion sentence

They got Capone on tax charges. The Cedar Rapids Landlord, too.

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Debt dangers in estate planning for closely-held businesses

October 13, 2009

Roger McEowen reviews recent decisions saying that loans to your family business fail to qualify as "interests" in the businesses qualifying for estate tax.

Related: Estate planning vs. income tax planning in the auto-parts business

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Harold Hill Follies: four weeks later.

October 12, 2009

hh44.jpgThe daily disclosures of chicanery and incompetence from the Iowa Film Credit program have slowed down, four weeks after the scandal exploded with a 4:56 p.m. Friday document dump from the Governor's office. The film credit program is dead in the water, and it is likely to stay that way for quite some time:

A legislative leader said Tuesday that lawmakers might suspend Iowa's troubled film promotion operation for up to a year while they figure out how to deal with questionable spending and accounting procedures.

In an interview with The Associated Press, House Speaker Pat Murphy said the attorney general's decision to open a criminal investigation into the Iowa Film Office tax credit program complicates the issue. Lawmakers might want to wait until legal questions are settled before delving into the matter, he said.

The future of the program seems to be increasingly in doubt. Where politicians at first seemed to think giving money to Hollywood was a good idea in spite of everything, the most powerful legislator now says there is only a 50-50 chance the film program will survive:

According to Gronstal, he and other legislators right now "see very little in terms of potential benefits" to the state from the film tax credits which have been awarded already.

But they buy T-shirts here! And don't forget the swanky parties!

We are even beginning to see some serious talk in both parties about re-examining Iowa's awful high-rate, loophole-ridden tax system. Ed Failor, the powerful string-puller who runs the loophole lobby Iowans for Tax Relief, has come out for throwing out the whole system:

"You take the Values Fund, you take the Power Fund, you take film tax credits and all the tax credits and those sorts of things and it’s government picking winners and losers — and that’s always a bad idea," Failor says. "What’s a good idea is leveling the playing field so people find Iowa a good place to find a job, start a business and raise a family."

Failor advocates elimination of the state income tax, both for corporations and for individuals.

Hard to believe. If you get rid of the individual income tax, you'd get rid of federal deductibility. It's not like ITR to give up on that. It will be a lot easier to take Mr. Failor seriously if he proposes other taxes and spending cuts to make up the 50 percent share of the state budget paid by personal income taxes.

But even discussion of tax credits by ITR is a real change. They've generally been either supportive or neutral towards "economic development" tax breaks, and they didn't speak up against the film credit when it was enacted. Now they may be finally climbing on the bandwagon of tax credit reform. Few Republican legislators will buck ITR on tax policy, and Mr. Failor may be giving them cover to oppose tax credits under a smokescreen of the improbable notion of scrapping the individual income tax.

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Hey! How about we stop paying to build apartments nobody wants to live in!

October 12, 2009

From the Iowa Department of Duh:

The state has been advised to stop providing tax credits that sparked affordable housing in downtown Des Moines.

A recent market analysis completed for Iowa Finance Authority says the affordable rental apartment market in Des Moines' downtown area soon will be saturated and the state agency should halt issuing tax credits for created low-income housing.

Downtown apartment development was one of the last bright spots in a market plagued by unsold condominiums, foreclosures on landmark projects and an impending tidal wave of office space.

You mean that we should stop subsidizing more housing units while hundreds of apartments, condos and houses sit empty and unsold? That's crazy talk!

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Know your customer!

October 12, 2009

Especially when you are offering discounts to them for buying big-ticket items with cash to avoid sales taxes:

Albany, N.Y.--A Long Island, N.Y.-based jeweler charged as part of an ongoing sting operation involving sales tax collection pleaded guilty to sales tax evasion and was ordered to pay more than $200,000, according to a release from the state Department of Taxation and Finance.

Frucci's Jewelers Ltd., of Garden City South, N.Y., was sentenced recently in Nassau District Court and paid $207,596, which includes what it owed in back state and local taxes plus interest and penalties, the Oct. 2 release states.

...

The Frucci case is the first to arise from an undercover investigation that the state agency dubbed "Operation Goldrush."

Conducted by the state tax department's Special Investigations Unit in Nassau County and the department's Petroleum, Alcohol and Tobacco Bureau, Operation Goldrush launched in February 2008 and, at that time, had identified 11 jewelry stores that, according to the tax department, offered sales-tax-free purchases to undercover investigators if they paid with cash.

The Moral? Paying in cash doesn't make taxes go away. Not legally, anyway.

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Can you cut corporate rates while raising individual rates?

October 12, 2009

The U.S. has the second highest corporate tax rate in the OECD. There is a growing sentiment to reduce the U.S. corporate rate to make U.S. businesses more competitive. TaxVox notes some practical problems with doing so, especially as individual rates go up:

President Obama’s interest in raising the top rate on wealthy individuals only increases the challenges. If we cut the corporate rate from 35 percent to, say, 25 percent but at the same time raise the top individual rate from 35 percent to something over 40 percent…well, you can see the problem. Many high earners will turn themselves into corporations to dodge the higher individual rate.

TaxVox notes another problem with corporate reform:

Is corporate tax reform likely to happen? Nope. And the sticking point won’t just be populists who resist lower corporate rates. It also will be those businesses who paid good money for the messy tax system we have. As long as they oppose efforts to close the special interest tax benefits that so benefit their own bottom lines, the U.S. will be stuck with a corporate tax rate that is far higher than our international competitors.

Can you say "research credits"?

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Buzzing

October 12, 2009

Robert D. Flach rounds up some good tax blogging.

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How tax preparer regulation tastes like chicken

October 11, 2009

To see the future of the tax prep industry if the IRS imposes a new testing and certification regime, go to beakfast with Econlog's David Henderson in Santa Fe, New Mexico (emphasis mine):

I sat with a woman who runs a Mexican restaurant in a small town in Colorado. We talked about various things, including her criticism of "factory farms" that, in her view and that of many others, are producing unhealthy food.

...

She was telling me about some chickens she had cooked that are from a small farm near Durango. People had commented on the wonderful aroma and flavor and asked what was special about the dish. She answered that it was simply healthily grown chicken. So I asked the woman, "Didn't it cost a lot more?"

"Yes," she said, and I was willing to pay that price they were charging, but here's the problem. It's illegal for me to use those chickens."

"Why is it illegal?", I asked.

"Because," she answered, "The chicken farmers raise only a few hundred chickens at a time and they have to get USDA certification. Getting that certification is very expensive and it isn't worth it for them."

The light bulb went on for me. I pointed out to her that this is an example of what I called, in my 1976 Ph.D. dissertation on why safety legislation for coal mines did little for safety but wiped out thousands of small mines, "economies of scale in compliance."

She got it and we both agreed that there are market mechanisms for certification and that the USDA is not needed.

Substitute "H&R Block and Jackson Hewitt" for "factory farms" and "IRS" for "USDA," and that tells you what you need to know about the proposals for stricter preparer regulation. Oh, and substitute stand-alone preparers and small local shops for the chickens.

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Sugar-coated roses

October 10, 2009

Hey!

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Can't you see we're still blooming here?

Snow already. It may be a long winter.

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Estate planning vs. income tax planning in the auto-parts business

October 09, 2009

When you go to the bank for a loan for your business, the banker will usually consider loans that you make to your business to be about the same as equity.

The estate tax rules don't look at it that way.

There is a special estate tax deduction for a "qualified family-owned business interest." Section 2057 lets you reduce your taxable estate by as much as $675,000 if more than half of the taxable estate consists of such "qualified" interests.

Duane and Lois Farnam died owning Farnam's Genuine Auto Parts, which has stores in Minnesota, North Dakota and South Dakota. Their estates claimed the Section 2057 deduction. Unfortunately, much of their investment in the business was in the form of loans. The Eighth Circuit yesterday said that the loans don't count as an interest in a family-owned business:

Even without the context of the statute as a whole, the plain and ordinary meaning of the words "interest in an entity," is that the person who holds that interest has an ownership interest in it. In contrast, it strains common understanding to say that a person holds an interest in an entity merely because he or she is a creditor of that entity

One of the judges on the panel disagreed:

No one questions that prior to the deaths of Lois and Duane Farnam, they, along with their son, were vested with full ownership of their family auto parts supply business. Part of that ownership interest was in the form of indebtedness owing to the Farnams, not as mere creditors of the family corporation, but by virtue of family shareholder loans made by the Farnams as part of the family's plan for the structure and ownership of this family business. To determine, as has the majority, that such debt interest does not constitute a "qualified family-owned business interest" ignores the real life practicalities of family business planning and is directly opposed to the congressional intent reflected in section 2057.

A sensible dissent, but it didn't carry the day.

This is a case where income tax planning conflicts with estate planning. If the business was a C corporation, standard income tax planning would favor using lots of debt to capitalize the business so the owners can take cash out as deductible interest, rather than non-deductible dividends. This case shows that such income tax planning can be expensive when you file the estate tax return.

The Moral: The estate tax is hard. Qualifying for special breaks for small businesses requires careful work with an estate tax specialist.

Cite: Farnam, CA-8, No. 08-3196.

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Filing single, acting double

October 09, 2009

Can married folks save taxes by filing single? No. TaxGrrrl explains.

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Healthcare Reform = 70-80% marginial rates?

October 09, 2009

Yes, but not for "the rich," but for those between 100% and 200% of the poverty line.

The TaxProf has more.

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The $8,000 homebuyer tax credit is running out. Or is it?

October 09, 2009

The $8,000 "first-time homebuyer" tax credit is set to expire on November 30, so you need to move quickly if you want to close on a house by then.

Or maybe not. The politicians are reportedly considering an extension for the credit.

If they extend it once, they probably will extend it every year. Why? As Kay Bell explains:

The first-time homebuyer credit, like many tax breaks before it and unfortunately many more that will come after it, is flat out pandering to political special interests that wield a lot of power, and political action committee money, in election years.

But Russ Fox sees the silver lining at his spiffy new blog home.

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The autumn days are growing short...

October 09, 2009

...and so are the days of the IRS offshore financial account amnesty. The October 15 deadline is less than a week away.

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Peter Pappas reminds you to file on time if you want to qualify, even if you don't have complete information. Jack Townsend explains how the IRS is "encouraging" folks to bring their accounts in from the cold.

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Standing on the platform Cavalcade!

October 09, 2009

It's time to climb on board the newest Cavalcade of Risk! The Health Business Blog hosts the new edition of the blog world's roundup of insurance and risk management posts.

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Notable posts this week include a sad lesson in insurance needs from the summer storms in Eldora, Iowa, by IowaBiz.com contributor Lara Utter, and a harrowing example of pastry risk from Insureblog.

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Yes, People still start new S corporations. Why?

October 08, 2009

Business attorney Rush Nigut poses a provocative question:

Does Anyone Form an S Corporation Anymore?

The title of this post may be a little tongue-in-cheek, but I would say at this point I am forming perhaps 2-3 times as many LLCs as S corporations.

It still doesn't mean you should rule out the S corporation as your entity of choice. It could be the entity for your situation. Joe Kristan, an accountant with Roth and Company in Des Moines, explains in a recent post who can and should own a S corporation.

It's not surprising that you see more LLCs formed than S corporations, because LLCs can be used to form almost every kind of tax business entity - even S corporations, oddly enough.

Yet S corporations endure. Why?

- They are easier for many investors to understand. All income and expense items go to owners straight-up in percentage to their stock ownership. In contrast, mult-owner LLCs are normally taxed as partnerships, which can require complex special allocations of income and deductions even in seemingly simple situations.

- Iowa has a special tax credit for S corporations that is unavailable to other pass-through entities. This "Form 134 credit" can greatly reduce Iowa taxes for businesses with significant out-of-state sales.

- Self-employment/payroll tax savings. S corporation K-1 income is not subject to self-employment or payroll taxes. LLC K-1 income of a member active in the business normally is all subject to self-employment tax. (But be careful - the IRS frowns on S corporation employees who don't take at least a "reasonable" salary.)

- W-2 vs. K-1. An S corporation owner/employee gets a W-2 and has income tax withheld like other employees. An LLC member who works in the business isn't supposed to get a W-2; instead, the "salary" should be reported as a "guaranteed payment" on the K-1; the taxes are supposed to be paid in quarterly estimates, rather than by withholding. Some taxpayers just don't like this.

LLCs are great tools, and they can do many things S corporations can't do. Yet S corporations are still an important item in the tax toolbox.

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Tax credits for all good things

October 08, 2009

Even though we're supposed to be in a recovery, it's not so much of one that you can tell.

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People aren't hiring. How do our Congressional supergeniuses propose to deal with it? They propose to pass a law paying people to hire people:

The idea of a tax credit for companies that create new jobs, something the federal government has not tried since the 1970s, is gaining support among economists and Washington officials grappling with the highest unemployment in a generation.

(via Peter Pappas)

Why hasn't it been tried since the '70s? Maybe because it didn't work then, either. I'm not sure which economists think it's a great idea, but Harvard economist Greg Mankiw isn't sold:

Usually, these proposals measure marginal jobs by comparing employment to some base year. Thus, a company gets a tax credit for employment that exceeds, say, 90 percent of employment in 2007. But then, the incentive goes mainly to companies in regions and industries that have been expanding or shrinking only slightly. Those regions and industries that have been deeply contracting do not have an incentive for marginal hires, because their employment levels are now well below the base levels. The playing field is tilted against those regions and industries that have been hit hardest--a result that seems to diminish both equality and efficiency.

Also, how do you handle newly formed companies? Government should not penalize start-ups by subsidizing only employment by their incumbent competitors. But if new companies get the hiring credit, then existing companies are incentivized to create new wholly-owned subsidiaries in order to qualify for the tax break (while contracting employment in the parent company). Similarly, they are incentivized to outsource work to start-ups that get the credit.

Too many people think that if they want a good thing, all they have to do is pass a law, or a tax credit, that encourages the good thing, and good things will happen. It really doesn't work that way. If it did, we could just pass a "happy fun times tax credit" and send Congress home. Though if they stayed home, it would be progress.

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How many senators do you own?

October 08, 2009

Christopher Bergin at Tax.com:

The ethanol tax credit is a shining example of how Congress operates. It uses the tax code to pick winners and losers. And unless you own a Senator or two – and I certainly don’t – that would make you a loser. And me, too.

Indeed. Read the whole thing.

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Special effects, Iowa film credit style.

October 07, 2009

Some filmmakers set up strawman Iowa entities to qualify purchases from non-Iowa vendors for the 50% transferable film tax credit subsidy, according the film credit accountant report issued this week.

WHO reports that not all of these middlemen were set up by the filmmakers. One was an existing company owned by the head of the Iowa Motion Picture Association, the biggest booster of the film credits.

Some legitimate, pre-existing Iowa companies also served as "pass through" entities. One of them - Full Spectrum - is owned by Kent Newman. He is also the Executive Director of the Iowa Motion Picture Association.

"Let's be very clear. The original bill says that labor, goods and services can be out-sourced through an Iowa vendor," says Newman.

Newman says Full Spectrum served as the "pass through" on two films, " South Dakota" and "Sam Steele's Junior Detective Agency." He estimates up to 50% of the expenditures on each film were the result of out of state purchases. However, he says that's because many specialty items were not available in Iowa.

Film credit boosters say that the credits are wonderful because they come back to Iowa businesses. Yet they also say its ok to give credits for stuff from outside of Iowa because you can't buy all the stuff you need to make a movie in Iowa. If you're the middleman for the deal, maybe that makes sense, but not if you are one of the chump Iowa taxpayers funding the sweet deal.

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LLCs aren't limited partenrships

October 07, 2009

If you are a "limited partner," the tax law's "passive loss" rules make it much more difficult to deduct losses than if you own an S corporation or are a general partner. The IRS has been saying limited liability company owners are "limited partners" for purposes of the passive loss rules, making their deductions much harder to come by.

The Tax Court recently said the IRS approach is wrong, noting the differences under state law between limited partners and LLC members. They applied this approach yesterday in a case involving a couple that operated a charter fishing boat. They couple conducted all of the activity of running the boat, but because it was short of 500 hours, the IRS said they were "limited partners" and their losses were passive, and non-deductible.

The Tax Court disagreed. Victory for taxpayer.

Cite: Hegarty, T.C. Summ. Op. 2009-153

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Iowa Film credits: Strawman LLCs to develop your economy

October 06, 2009

The rules of the Iowa Film Credit looting economic development program required that funds be spent in Iowa to qualify for the credit. When it wasn't enough to pretend to spend money, or to claim credit for the cost of selling tax credits, the filmmakers pretended that the money they spent was spent in Iowa. From the accountant report on the credit issued yesterday:

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In certain instances, limited liability companies (LLC's) were established as Iowa-based companies to purchase property and services from in-state and out-of-state companies, as well as labor. By passing these costs through the Iowa-established business, the expenditures were claimed as qualifying Iowa expenditures. However, there were instances where the majority of the purchases of property and labor appeared to have originated from out-of-state sources. In certain instances, we were unable to verify that all of the entities had been established as Iowa based business and/or were registered with the Iowa Secretary of State's office incorporated in Iowa.

In certain films the total amount of expenditures that were run through Pass Through entities exceeds 40% of the total qualifying expenditures, with some totaling more than one million dollars.

In short, they ran expenditures through Iowa strawmen and claimed the credit.

Sure, the filmmakers basically made up $6.7 million of the $64 million or so of expenditures that were awarded the 50 percent state tax credit subsidy. They claimed another $250,000 (at least) just for the cost of marketing the transferable credits, and unknown millions more were run through strawmen. But let's not be hasty. Let's not let a few bad apples screw up the program. Let them eat canapes.

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The Tax Update will be on the road and away from the computer most of the day today. To catch up on the fallout on the accountant report on the film credit, and the newly-launched criminal investigation, here are some links:

Tax Policy Blog: Iowa Film Credit Report Reveals More Problems; Criminal Investigation Forthcoming
Des Moines Register: Criminal probe begun into film tax incentives
O Kay Henderson: The “film tax credit" report is out
Ed Tibbetts: Film program scandal in for a long run
Tax Analysts ($link): Review Slams Iowa Film Credit Program; AG Launches Criminal Investigation

Tax Update links:

Coverage of accountant report

Complete film credit coverage

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Method Man not methodically tax compliant?

October 06, 2009

A musician known as Method Man is in tax trouble. The TaxProf has a roundup.

This seemed like a puzzling case, as John Wesley wasn't known as a tax dodger, but I now understand that the man in tax trouble is a different sort of method man.

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Rainy Octoberfest Carnival!

October 06, 2009

Kay Bell is hosting the traditional Octoberfest Carnival of Taxes.

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If it's raining where you are, come inside where Kay's personal chef serves up some warm, fresh bloggy tax goodness!

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The Iowa 'let's pretend' film tax credit

October 05, 2009

Hollywood is a fantasy factory. The special effects carry over into their accounting, where they turned pretend expenditures into real money, according to the new outside accountant report on the Iowa Film Credit program. From the report:

Organizations were contracted by production companies to provide advertising for the films, often referred to as "sponsorships". In return, the sponsoring organization would generally receive advertising from the production company in the film or on merchandise related to the production. In these situations, no cash was exchanged, but the amount was included as an Iowa qualifying expenditure. In certain productions, we identified this situation multiple times, with some amounts exceeding $1,000,000 for each sponsorship.

A specific production had 4 sponsorships at $1,250,000 each, totaling more than 75% of the total qualifying expenditures. We were able to identify a total of 12 sponsorships exceeding $1,000,000 or more for each sponsorship, all of which were listed as qualifying Iowa expenditures totaling $13,400,000.

$13.4 million x 50% = $6.7 million tax credits issued for nothing. At least nothing worth paying cash for. So all of you folks who think we should carefully examine these tax credits because they are such a good thing, so we can continue to have parties with these wonderful film people: yeah, let's not be hasty.

Link: More Tax Update Coverage of the Film Credit accountant report

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Iowa's wheeler-dealer tax credit

October 05, 2009

Iowa today released the accountant's report on the film credit debacle. It reveals a few new wrinkles on this state-authorized looting of the treasury. My favorite: tax credits were issued to cover the cost of the middlemen who secured the tax credit:

Often, the tax certificates awarded to the investors and producers were transferred to other taxpayers. The tax credits are purchased by the taxpayer from the investors and producers at a negotiated discount. Brokers are used to find buyers for the tax credits. Fees are paid to the brokers by the investors and producers, usually structured on a contingent fee basis of 3 to 4 percent of the certificate value. In many cases, the broker's fees were included as qualifying Iowa expenditures used to calculate the Iowa credits, even though the certificates had not yet been issued. Thus, the expenditure for broker's fees actually occurred after the issuance of the certificate.

We identified amounts for broker's fees included in the qualifying expenditures which exceed $100,000 for certain films. The total amount of broker's fees included in the productions exceeded $500,000, generating in excess of $250,000 in tax credits.

So Iowa taxpayers paid half the income of the middlemen in the film credit deals. I propose we just establish a new "middleman tax credit," where you issue tax credits just for the cost of selling tax credits -- cutting out Hollywood entirely. It looks like we're almost there anyway.

Now the Attorney General has launched a criminal investigation into the film credit fiasco. We'll learn whether paying criminal defense attorney fees will be a qualifying film expenditure.

More later.

UPDATE: The Iowa 'let's pretend' film tax credit

Related stories:

Radio Iowa (Via TheBeanWalker.com)

Des Moines Business Record

Des Moines Register

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Film credit regrets

October 05, 2009

Now that Iowa's film credit program has exploded in corruption and mismanagement, one of our legislative leaders is inching towards contrition:

"If it’s all just a great big give-away with no long-term job creation or economic growth in this state or people having full-time employment, then this isn’t a very good deal for the state of Iowa," said Senate Majority Leader Mike Gronstal, D-Council Bluffs.

hh44.jpgThat's the sort of thing you should think of before you blow $363 million or so. Better wise late than never, though. And if his party turns against tax credits before the Republicans figure it out, they might inoculate themselves against much of the fallout from the fiasco.

If Sen. Gronstal and his party colleagues turn decisively against the state's tax credit giveaways while the Republicans dither, it will blow the biggest opportunity for real tax reform in Iowa ever.

For those who think these tax credits might somehow be a good thing, the Des Moines Register's report today on how they got enacted should give you pause. Presumably a "good" tax credit would be one enacted with careful consideration of alternatives and of the costs and benefits. Dream on:

When Iowa lawmakers were considering creation of an income tax credit for filmmakers in 2007, they passed a major amendment without knowing it would increase the state's cost by tens of millions of dollars annually.

The amendment - allowing filmmakers to sell their unused tax credits - was approved by the House Economic Growth Committee by a voice vote with little discussion and no objections from either Republicans or Democrats.

What did that little amendment do?

Before the amendment was adopted, the nonpartisan Legislative Services Agency estimated in a memo to lawmakers that the credit would cost less than $800,000 in revenue losses this fiscal year, which ends June 30. After the amendment was adopted, no new estimate was prepared.

By spring 2009, the film tax credits had clearly gained in popularity. An estimate in March by the Iowa Department of Revenue and Finance placed this year's revenue loss far above $800,000 - at $26.3 million.

And surely much more now.

The film credit is only one of over two dozen "economic development" credits, all passed piecemeal over the years in response to this or that lobbyist. The idea that these somehow come together as a coherent or effective economic development plan, or ever could, is ludicrous. If you really want to improve Iowa's bottom-scraping business tax climate and improve the economy, go with the Tax Update's quick and dirty tax reform:

- Repeal Iowa's futile corporation income tax.
- Repeal every economic development tax credit (including the research credit)
- Lower the top individual rate to 4% or lower. To do so, we have to...
- Repeal federal tax deductibility on Iowa returns.
- Repeal every other crummy tax break, including "Endow Iowa" credits and the tuition break for contributions to private schools. Lower tax rates are worth more.
- Conform to federal law in the definition of taxable income by default.

Then if you really want to get somewhere, amend the state constitution to limit spending to the increase in population growth plus inflation, absent a supermajority vote in both Iowa houses. But even tax reform is probably a pipe dream. Iowa needs something like this, but our politicians hardly seem to be up to it.


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No simple way to prepare complexity

October 05, 2009

Monica Lawver gets the debate over preparer regulation right, I think:

I know I sound like a broken record, but I just keep coming back to what I believe to be the real problem: complexity.

As long as the tax law is such a horrendously complicated mess, there will always be problems with preparation, and all the CPE and barriers to entry in the world will just make the system even more expensive.

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Swiss craftsmanship

October 05, 2009

Reports of the death of Switzerland as a tax shelter may be exaggerated, reports Jack Townsend at Federal Tax Crimes blog:

Switzerland has demonstrated over and over that it will protect its premium franchise in the tax haven business, so that it can continue -- perhaps not at the same level -- to enable taxpayers in other countries evade taxes for a fee that includes a healthy share of the taxes evaded for its enablement services.

Not much comfort for the UBS account holders. By the way, the IRS offshore amnesty expires in another ten days.

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30 pieces of silver or 30 percent of the gross

October 05, 2009

The new IRS program that pays whisleblowers rewards up to 30 percent of additional taxes collected is getting lots of new business, according to the IRS.

The TaxGrrrl ponders whether that's a good thing. Senator Grassley thinks so. Peter Pappas also has some thoughts.

The program hugely increases the risks to clients and firms of engaging in evasion. A lot of the tax shelter cases involved tens of millions in taxes at the individual level, and even more when corporations were involved. A low-level staff accountant who sniffs out a bad deal might find 30 percent of that adequate compensation for giving up a dream of CPA glory.

While there is always something creepy about the IRS being able to horn in on confidential client-professional relationships, the professionals haven't exactly been models of virtue during the past decade's tax shelter debacles.

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A tax bee?

October 05, 2009

How do you think a quiz show of tax preparers -- a "tax bee" -- would go over? Mary O'keeffe floated the idea, and Kay Bell is moving the ball.

My guess is that the ratings would be somewhere between the test pattern and the Sham-Wow! guy's greatest outtakes. Yet I was surprised that reality shows became popular. Maybe it will work if they make the contestants eat bugs and try to get an internet connection to e-file from exotic and remote locations.

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Bad news, good news

October 02, 2009

September didn't go well for Iowa's tax collectors:

The latest monthly revenue report issued by the Legislative Services Agency shows state tax collections plummeted by 19.2 percent – marking the eighth straight monthly decline and increasing the likelihood that the governor will have to order an across-the-board budget cut or take other measures to address the slump in revenues.

Through the first quarter, state revenues are running 9.1 percent below last year which translates to a drop of $141.1 million compared to the first three months of fiscal 2009.

The I-jobs borrow and spend program doesn't seem to be showing great results just yet. But there is one nugget of good news:

More film projects leaving Iowa as tax-credit incentive suspended

Considering what the film credits cost, we can only wish them happy trails and hope the door doesn't hit them on their way out to shake down some other state.

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Government licence doesn't confer competence

October 02, 2009

Peter Pappas helps clarify some of the points of those favoring additional regulation and licensing of tax preparers:

The purpose of tax preparer regulation is to reduce the number of incompetent and unscrupulous preparers. Consequently, competent preparers will of course benefit from it. The goal of all regulatory/licensing regimes is to benefit those who meet certain pre-determined standards and exclude those who do not.

There are two assumptions here:

1. Additional regulation will actually do good things, and
2. The cost of the additional regulation will not exceed the benefits.

We could reduce the number of unscrupulous preparers just by taking half of the preparers out and shooting them. Sure, we'd get rid of a lot of competent and honest preparers too, but it would get rid of a lot of quacks. Licensing, while less drastic, would do much the same thing. There would be fewer incompetents, but many competent seasonal preparers would throw in the towel rather than go through the hassle of testing and dealing with a new IRS bureau. It's not at all clear the work product would improve. Higher prep fees would send more folks to Turbotax and do without outside help, which hardly improves return quality. It would also enable licensed quacks to charge more.

Peter does make a good point:

Joe’s argument could be applied to all professions and all regulatory regimes.

He is exactly right. There are hundreds of entrenched regulatory regimes (I work in one). But hundreds of wrongs, or maybe wrongs, don't make a right.

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The taxpayers' wary watchdog

October 01, 2009

Iowans for Tax Relief, "The Taxpayers' Watchdog," has revamped its webpage.

Check out the "latest news" from their shiny new page:

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Relax! It seems nothing has happened in Iowa's tax or spending picture between August 11 and September 30 that was worth rousing the taxpayers' watchdog. Oh, wait...

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Who can own an S corporation? Who should?

October 01, 2009

Find out at my post today on the Business Record's IowaBiz.com.

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Tom Arnold still wants more of your money

October 01, 2009

While auditors work to add up the bill for our Film Credit Fiasco, Governor Culver is seeking the advice of policy experts:

Actor Tom Arnold (and Iowa native) told Channel 13 news he took part in a conference call Monday with Governor Chet Culver about the film tax credit fiasco. Arnold said he talked about the frustration of a couple "knuckleheads" from the film industry that caused the problems. He also said he supports tax credits and thinks they have been very beneficial to Iowa. He wants them restored.

Yes, it was just a couple of bad apples. Like every one of the 18 films that have gotten our money so far, none of whom appear to have fully documented their expenses, and only two of which have turned in receipts at all.

Every Iowan will be thrilled to pay $121 to help fund Tom Arnold's projects, so film crews can buy T-shirts.

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Preparer regulation: a lesson on barriers to entry

October 01, 2009

Why would an industry support increased regulation? To suppress competition, of course. The summary of speakers at yesterday's Chicago forum on tax preparation in today's Tax Analysts online edition is revealing:

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The big franchises will run their trainees through a cookie-cutter course geared to the IRS test, and perhaps even be allowed to test their own employees. After all, we can trust franchised return preparers to adhere to the highest standards.

Meanwhile, independent would-be preparers will have to study themselves and take any required tests at the always user-friendly times and places designated by the IRS. The net result is a barrier to entry to competitors for H&R Block and Jackson Hewitt, allowing them to get more business and raise their prices.

Will the public get a better value for the higher prices? I'm guessing that "increased prices" motivates the big franchises more than "better product."

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Let's make you spend more on me

October 01, 2009

The TaxProf notes that the Tax Policy Center says 47% of households will pay no income tax this year. He includes a little chart:

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Who does pay federal taxes? Those evil rich folks:


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So what happens when only a few taxpayers bear the burden of federal spending? This:


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Chart by Heritage Foundation via Fundmastery Blog.


More from Peter Pappas and TaxGrrrl.

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