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Tax Update Blog: November 2010 Archives

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Missouri panel: kill film tax credits

November 30, 2010

The report of the Missouri Tax Credit Review Commission discusses Missouri's tax credit for Filmmakers:

This tax credit serves too narrow of an industry and fails to provide a positive return on investment to the state. There is currently no longterm opportunity for the location of production facilities for films in Missouri. Accordingly, the Commission recommends that the credit be eliminated during the 2011 legislative session.

Apparently Iowa's incoming Governer feels the same way.

Related: Let them eat canapes.

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We'll have a conference to agree just how important it is that we agree.

November 30, 2010

Those of us hoping for Congressional action to deal with the huge backlog of unfinished tax business didn't get a lot of hope from White House Press Secretary Robert Gibbs yesterday. Congressional big shots will meet the President today -- to work out a tax deal? Not exactly, reports Tax Notes ($link):

The meeting will simply be the beginning of negotiations, White House Press Secretary Robert Gibbs said during a briefing with reporters.

"I do not expect that we'll come out after an hour, an hour-and-a-half, and have full agreement on this," Gibbs said. "I hope there is agreement on the notion of how important it is to get this done by the end of the year."

Yeah, we've only been waiting 8 years or so for a deal, and there will be a huge tax increase on everybody January 1 if nothing happens. No rush.

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Cyber monday hangover: have you paid your consumers use tax?

November 30, 2010

The Tax Policy Blog has a seasonal reminder: if you don't pay sales tax on your online purchases, you are supposed to pay consumers use tax to your home state. But more than likely, you will just make your state revenue officers sad:

But officials know from political and administrative experience that use taxes are practically unenforceable, and the only other way to get the revenue -- forcing out-of-state companies to collect the taxes -- has been severely limited. Brick-and-mortar retailers have also claimed unfairness at their having to collect sales tax while their online and out-of-state competitors escape the same obligation. Of course, the proposal on the table is to impose a greater obligation on out-of-state and Internet companies: force them to collect thousands of different sales taxes, while brick-and-mortar retailers need to track only one.

But the law is the law, and if you are in a complying mood, you can download the Iowa Consumers Use Tax Return and file away.

More from Kay Bell and State 29.

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Bloggers beware: copyright-troll newspaper chain moves into Iowa

November 30, 2010

A newspaper chain notorious for suing bloggers for copyright violations has set up shop in Iowa. Stephens Media, owner of newspapers in nine states, including the Las Vegas Review-Journal, has purchased the Ames Tribune and some other Iowa newspapers from the Omaha World-Herald Company. The Des Moines Register reports:

The purchase includes the Boone News-Republican, Dallas County News, Nevada Journal, Ames Advertiser, Ames About People & Advertiser, Tri-County Times and the Algona Upper Des Moines in Algona.

The chain teamed up with an outfit known as "Righthaven" to sue bloggers who excepted LVRJ articles. They dismissed with the usual preliminaries to copyright suits, like cease-and-desist letters, and went straight to court for "violations" as minor as using several paragraphs from an article in a blog post.

They have apparently backed off the sue-first approach after losing a ruling against a blogger who could afford to fight back. Even so, it would be wise to not excerpt from any Stephens Media articles, in case they change their mind; the lawyers would be just too costly. It would be safer still not to even link to any of them. You can download browser plug-ins to block their sites, just to help you to not accidentally provoke a lawsuit.

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Lame.

November 29, 2010

The lame-duck session of Congress resumes today, with four big sets of tax issues at stake:

- Will they pass a 2010 "AMT patch," preventing a tax increase of thousands of dollars for 20 million taxpayers for this year?

- Will they extend any of the Bush-era tax cuts?

- Will they pass an "extenders" bill to pass the usual ugly dozens of provisions that routinely are enacted "temporarily" for a year or two at a time to conceal their full cost? These include provisions like biodiesel and ethanol subsidies and the R&D credit.

- Will they do anything to keep the estate tax from roaring back to life next year with a 55% top rate and a $1 million exemption? The current rate is 0%, and the 2009 rate was 45% with a $3.5 million exemption.

The was no progress in any of this before the Thanksgiving break, and it is unclear whether anything can happen in what's left of this Congress. Out of the four items on this to-do list, the AMT patch is the only one that I feel confident that Congress will pass (though less so every day). The usual army of lobbyists may get an extender bill through, but that's no sure thing.

The Bush-era tax cuts are really up to the President, and it's not at all clear he would sign a tax cut for the top two brackets. It seems unlikely that Congress will pass a tax bill that doesn't extend all of the Bush-era tax cuts. He's supposed to meet with Congressional "leaders" next week to work out a plan. We'll see. The Intrade betting market on 2011 rates hasn't budged, indicating that nobody really knows what will happen.

I have no confidence that this Congress will address the estate tax.

It's not that a possible compromise is inconceivable. Economist Diana Furchtgott-Roth lays out a plan in today's Tax Notes online ($link):

The simplest and obvious solution would be to extend the 2010 tax rates on income and capital for the next two years, address the AMT, and reinstate the estate tax at 2009 levels. According to revenue estimates published by Treasury in July, these measures would cost $475 billion.

Those outside Washington know there is room in the budget for spending cuts -- both in discretionary and in entitlement programs -- to pay for extending taxes. For instance, there's the $13 billion for a high-speed rail that won't even cover a small fraction of the system's cost -- time for it to go.

Unfortunately, what makes sense outside Washington has only limited ability to affect what happens there.

Related: WSJ, Democrats Gird for Tax-Relief Battle (via Going Concern).

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Corporate Tax: there is no good or evil. There are only incentives, and those too weak to lobby for them.

November 29, 2010

Joseph Thorndike channels Lord Voldemort's tax advisor at Tax.com, dismissing complaints about the "evil" of Google reducing its tax burden through it's international corporate structure:

Ultimately, I think the only real measure of a tax avoidance strategy is whether it's legal, not whether it's consistent with the "spirit" of the law, whatever that is. The whole notion of the law's "spirit" assumes that tax loopholes appeared in the law by accident. As opposed to being secreted there deliberately by well-paid lobbyists and their congressional allies. Often, the spirit of the law is tax avoidance, not tax payment.

My bottom line is this: Don't like corporate tax avoidance? Then get your representatives to close the loopholes. Don't believe that's possible (either because corporate tax lawyers are too smart or politicians too venal)? Then change the tax system. Because a tax system that depends on the willingness of taxpayers (corporate or individual) to willingly pay more than their minimum due is not a tax system for the real world. Taxpayers are never charitable with the government. Never have been, never will be.

That's why I don't get too upset at politicians who use legal methods to use lower their taxes. What are they supposed to do -- invent a whole new alternative system that is somehow ideal and pay their taxes that way? I get more upset at political businessmen who have already made their pile and now want to make it harder for anybody else to do so.

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Last week in taxes...

November 29, 2010

...as rounded up by Bruce the Missouri Tax Guy.

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Black Friday

November 26, 2010

Iowa has a sales tax holiday on clothes in August. South Carolina has a sales tax holiday on guns on Black Friday weekend.

You know what to do.

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Flickr photo by k@t marsh


Thanks to Kay Bell for the reminder.

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Another guilty plea in Iowa film fiasco

November 26, 2010

A Minnesota filmmaker has pleaded guilty to charges arising from film credits for "The Scientist," a film brought to market thanks to the Iowa Film Credit Program. Matthias Saunders of Minneapolis pleaded guilty this week to first-degree theft. Filmmaker Zach LeBeau had earlier agreed to cooperate with processors in exchange for having charges against him dropped.

This leaves Wendy Weiner Runge and Tom Wheeler as the still-exposed targets of this series of indictments. Ms. Runge, President of Polynation Pictures, faces one count of ongoing criminal conduct and 11 counts of "fraudulent practice." Mr. Wheeler faces a charge of "misdeanor malfeasance in office."

Whatever the merits of the case against Ms. Runge, if any, it's hard to believe that she is the only person out there who should be worried. The State Auditor reported that fully 80% of the tax credits issued under the program were issued improperly, with millions of dollars milked from the state for imaginary or grossly-inflated expenses and through the use of strawmen LLCs to funnel cash improperly out-of-state.

Where filmmakers criminally bilked the state, charges are in order. Still, the charges will do nothing to recover the tens of millions of taxpayer dollars shoveled down the rathole thanks to feckless legislators and careless administration by the Governor's office and its sub-agencies. The best we can hope is that lawmakers will be a little less eager to go along the next time Harold Hill wants tax money for his new project for River City.

Related: States Slashing Film Tax Subsidies

Prior coverage: It's a bad idea even when they aren't looting

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In-school suspension

November 26, 2010

Austin Peay accounting professor Dan Meyer has suspended his Tick Marks blog. Tick Marks is one of the longest-running tax and accounting blogs out there, and Mr. Meyer is a gentleman. I hope he returns soon.

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Have a great Thanksgiving!

November 24, 2010

The Tax Update is on the road today, wishing you good travels. Be careful out there!

20101124-1
Flickr image courtesy U.S. Fish and Wildlife Service - Northeast Region under Creative Commons license.

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Hiding government spending by running it through tax returns

November 23, 2010

When you buy a cell phone with a mail-in rebate, the guy at the store will tell you that your price is the list price minus the rebate. And he’ll be right. If the guy at the cell phone store gave the cute blonde next to you one of those rebate coupons while making you pay full price, you'd clearly be getting a worse deal than the blonde. You might even be grumpy that the clerk was spending the store's money on the blonde to try to get a date while sticking you with the full price.

Targeted tax breaks work the same way, yet some otherwise sensible commenters insist that spending that is run through a tax returns is transformed into something else. From Michael F. Cannon at the Cato Institute:

The tax code’s countless credits, deductions, and exclusions let people keep a portion of their earnings, provided they use the money how the government wants them to use it. Tax loopholes therefore have a lot in common with government spending: they give power to politicians, inhibit freedom, reduce economic output, unjustly enrich special-interest groups, et cetera.

But to call them “tax expenditures” or “tax subsidies” or ”backdoor spending in the tax code” is to claim that when the government fails to take a dollar from you, it is spending that dollar. It implies that your dollar actually belongs to the government, which is graciously letting you keep it.

20101123-2.jpgTo his credit, Mr. Cannon realizes that the tax breaks are corrupting and distortive. But whether you call them "tax expenditures" or, say, "tribbles," they are still spending, just as a matter of simple accounting. By definition they reduce your accrued tax expense to the government and the accrued receivable the government would have from you. On the government's books, a credit to a receivable has to be debited to an expense or asset account, and since they aren't buying an asset from you, it's an expense by default.

The true nature of these things is most obvious when the credits are refundable, like the earned income credit, or transferable like the Iowa film credits. People eligible for the earned income credit typically have no tax liability to offset. In that case the government sends them a check for the full amount of the credit, even though no tax was ever paid. There's no way that this is somehow the government "failing to take a dollar" from somebody. That some EIC recipients would actually owe a little tax otherwise doesn't change its nature as a welfare payment.

In the case of the film credits, the film companies typically had no Iowa tax. Because the tax credits were transferable, the filmmakers sold their credits at a discount to banks and insurance companies for cash. The buyers got to pay their Iowa taxes at a discount, while the filmmakers got sweet money. The economic reality: the state allowed the film companies to factor its tax receivables. The effect on the state was no different than if the state had just written checks to the film companies directly.

With targeted deductions and non-refundable credits, the effects are a little less obvious and blatant, but the reality is the same -- favored taxpayers get a better deal than the rest of us. It's like a footrace where some of the runners have to carry weighted backpacks.

Rather than quibbling about what targeted tax breaks are called, we should focus on the real truth of Mr. Cannon's post:

Tax loopholes therefore have a lot in common with government spending: they give power to politicians, inhibit freedom, reduce economic output, unjustly enrich special-interest groups, et cetera.

Get rid of them, and go with lower rates for everybody.

Related:

Greg Mankiw, The Blur Between Spending and Taxes
TaxVox (who hates the Tax Update, unless this link works), Americans Against Tax Reform
Tax Policy Blog, Deductions, Credits and Tax Reform

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The Irwin Schiff legacy

November 23, 2010

20101123-1.jpgDreamiscles are not just a sweet frozen treat. They are also little cherubic collectible figurines. The ceramic Dreamsicles made good money for their creators. Unfortunately, it appears they made unwise decisions in choosing their tax advisors. The Broward-Palm Beach New Times reports that Kristin Haynes and her husband fell in with the ideas of tax protest pied piper Irwin Schiff, failed to report their income, and fled to Honduras.

As Honduras has no extradition treaty with the U.S., things went along reasonably well under the circumstances until last June, reports the New Times:

On June 22, the pair flew from Honduras to Fort Lauderdale and were nabbed by federal agents as they went through customs at the airport. Eventually they cut plea deals and pleaded guilty to five counts of failing to file tax returns (for the years 1999 to 2003). Last Tuesday, November 16, a federal judge in Washington sentenced them to prison -- 40 months for him, two years for her. They've also been ordered to pay more than $800,000 in penalties, fines, and interest.

The article doesn't explain why the couple tried to reenter the U.S. Considering that Mr. Haynes apparently served time in the 1990s for tax evasion, they should have had no illusions about what was waiting for them.

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FBARing the door to expats

November 23, 2010

U.S. Citizens in the U.K. are lining up to ditch their US Citizenship, reports Kay Bell:

The Financial Times of London reports that three times as many Americans renounced their citizenship in 2009 as did in 2008.

The trend, says the newspaper, was particularly noticeable in the United Kingdom, where there's a waiting list at the U.S. embassy in London of folks looking to renounce their citizenship.

Kay is puzzled, asking:

We all have complained about taxes at some point, but would you really leave your U.S. roots behind so that you'd never have to pay them again?

Perhaps. If the alternative is horrific and whimsical fines for innocently failing to to file the FBAR foreign financial account reporting form -- even while paying taxes in full -- someone who has started a new life overseas might be tempted to burn the bridge back.

Expect more of this until the Treasury calls off its war on overseas Americans.

Related: When you shoot the jaywalkers, the jaywalkers might leave town

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Muscatine!

November 22, 2010

The rolling party that is the Iowa State University Center for Agricultural Law and Taxation hit the river town of Muscatine this morning. Initial results:

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But if you want to join the fun this year, time is dwindling! Sign up today for the remaining schools in Griswold (December 6-7) or Ames (December 13-14).

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Red-light cameras are for (electoral) losers

November 22, 2010

From Dallasnews.com:

Democrats were not the only losers on Election Day. Traffic cameras designed to catch red-light runners also took a ballot box beating as they were voted down in Houston and at least four other cities nationwide.

Are they paying attention in Des Moines, Cedar Rapids, and Clive?

Via Instapundit.

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Iowa makes the top ten!

November 22, 2010

No, not in football - in individual tax rates. But in the corporate rate competition, we're number one!

Of course, Iowa is lower in effective rates because it allows a deduction for federal income taxes. It would be simpler and more efficient to get to the same place by building the effect of the deduction into the system with lower rates. Yet Iowa's most powerful lobby won't stand for it -- and therefore blocks worthwhile tax reform in Iowa - because that would result in "a tax on a tax."

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Missouri Roundup

November 22, 2010

Bruce, the Missouri Tax Guy, rounds up last week in tax blogs.

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I got mine, screw the rest of you

November 22, 2010

Now that he has built an empire, Warren Buffet wants the government to make it harder for anybody else to:

Bloomberg: Buffett Tells ABC Rich Americans Should Be Paying `A Lot' More in Taxes

Of course, nothing is stopping Warren from, say, multiplying the tax he pays by 2 on his personal return and sending a bigger check to the government. Berkshire Hathaway shareholders might have something to say if he tried that on his corporate return.

Via the TaxProf.

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Snipes hunt nears end

November 19, 2010

The Defendant Snipes had a fair trial; he has had a full, fair, and thorough review of his conviction and sentence by the Court of Appeals; and he has had a full, fair, and thorough review of his present claims, during all of which he has remained at liberty. The time has come for the judgment to be enforced.

Wesley Snipes has lost what appears to be his final appeal of his 2008 tax conviction and three-year prison sentence. A federal district court has rejected his request for a new trial and ordered him to report to start his sentence when directed by the Bureau of Prisons.

UPDATE, 11/20: The TaxProf has a roundup.

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Congressional tax action on hold until after Thanksgiving

November 19, 2010

Congress has gone since 2002 without dealing with the December 31, 2010 expiration of the Bush-era tax cuts. What's another week or two? At least that seems to be how they are thinking, reports TaxGrrrl:

Democratic leaders met this week to talk turkey and decided on two things:

1. A vote on the Bush tax cuts won’t happen until after Thanksgiving; and
2. The Bush tax cuts will be extended for those making $250,000 or less.

And that’s all we have. That means there’s a lot, obviously, that we don’t know.

So being crushed at the polls has done nothing to chasten the House Democratic leadership.

Republicans will be loath to allow only the lower-bracket tax cuts to be extended. They are likely to insist that all of the tax cuts be extended, including those for the top two brackets. While the Democrats still have a majority in the lame-duck session, it's not clear that the sixty-some House Democrats who lost their seats this month will follow Nancy Pelosi's leadership on this issue. Expect the Republicans to fight hard to keep all of the tax cuts linked in one package.

Meanwhile, the Intrade betting market is providing no useful guidance, as the minimal trading in tax rate futures shows little change from last week. It's unfortunate that these markets don't trade more. If they had more volume, they could provide useful guidance for tax planners, and they could even, in theory, enable taxpayers to hedge against tax increases. Maybe if the Board of Trade would sponsor a market...

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Criminal borrowing

November 19, 2010

When a small business fails to remit payroll withholding to the IRS, sometime they justify it to themselves as only a short-term loan to tide the business over tough times. The IRS doesn't look at it that way at all, as a South Dakota manufacturer has learned the hard way:

The former owner and president of two businesses in Brookings, South Dakota, who collected taxes from his employees and then failed to account for and pay those federal income and FICA taxes, was sentenced November 15, 2010, to 21 months in federal prison.

Michael D. Hoppe, age 60, from Watertown, South Dakota, received the prison term after a May 27, 2010, guilty plea in federal court in Sioux Falls. Hoppe was convicted of one count of failing to account for and pay taxes.

Mr. Hoppe will also have to pay $670,000 in restitution for taxes not remitted from July 2005 through January 2009.

The IRS seems to be much more willing to pursue criminal charges for payroll tax nonpayment than they used to be. As risky as non-remittance has always been, it's even more foolish now.

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Zapper Zapped

November 19, 2010

There are some technologies that the IRS doesn't appreciate at all. High in the IRS black book of bad modernity is "zapper" software, which is software designed to hide from the IRS revenues recorded in other accounting software. The IRS displayed its feelings in this Justice Department press release:

WASHINGTON - Theodore R. Kramer pleaded guilty to one count of conspiracy to defraud the United States before U.S. District Court judge John Corbett O'Meara in Detroit, the Department of Justice and Internal Revenue Service (IRS) announced today. The court set sentencing for March 15, 2011.

According to court documents, Kramer was a self-employed computer software salesman. Kramer sold a computer software program called Journal Sales Remover (JSR) to business, including two Detroit-area strip clubs. JSR's design was to remove a portion of a business's sales from the business's computerized books. JSR thus created the appearance that a business received less income than it actually did.

In 2001, the owner of two Detroit-area strip clubs requested that Kramer load the JSR program onto his clubs' computer systems so that the club owner could report less income to the IRS. From about 2001 to about 2004, Kramer periodically visited the clubs to run the JSR program to remove a substantial amount of the clubs' sales from their computers. The club owner then provided the reduced sales figures to his accountant. With Kramer's assistance, the club owner understated his clubs' gross receipts by more than $500,000.

Kramer faces a maximum sentence of five years in prison.

It seems that IRS investigators are quite familiar with strip clubs.

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Don't miss the steam train Cavalcade!

November 19, 2010

Fall in with the new Cavalcade of Risk on your way high-speed steam train to Grandma's for Thanksgiving!

Lots of good stuff always in the blog world's roundup of insurance and risk-management posts.

Via Insureblog.

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Sometimes it doesn't pay to do a favor

November 18, 2010

Usually the favors you do come back to you in the form of good deeds from others. Not for Adnrzej Gosek.

The Pennsylvania contractor did a favor for fellow contractor David Porath, according to a Justice Department press release:

Porath gave Gosek checks made out to companies in Brooklyn, N.Y., purportedly for work done at New York Presbyterian Hospital (NYPH) by the Brooklyn companies as sub-contractors to Porath's company. However, the companies had not performed the work. The checks totaled approximately $229,100 in 2000; $1.19 million in 2001; $760,000 in 2002; $50,000 in 2003; and $125,000 in 2004.

The Brooklyn companies cashed the checks and Gosek delivered the cash back to Porath, less approximately five percent. Based upon these checks to the Brooklyn companies, Porath took false deductions on his company's and his personal federal tax returns, allowing Porath to fraudulently reduce his taxable income.

Mr. Gosek pleaded guilty to conspiracy to commit tax fraud, and he could face up to five years in prison.

The Moral? Some favors are best left undone, and helping someone cheat on taxes is one of them.

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Fixing FBAR

November 18, 2010

The curent rules for reporting foreign bank accounts are a mess. Many taxpayers have innocently exposed themselves to horrendous fines for foot-fault violations of these obscure rules -- even when they are fully tax compliant. The Treasury's shoot-the-pickpockets enforcement policy makes a bad situation worse.

Now comes a voice of sanity, via Russ Fox, in the form of recommendations from the Internal Revenue Service Advisory Council:

Our summarized recommendations include: (a) extending the due date to October 15 to coincide with the final filing deadline for most income tax returns; (b) providing coordinated electronic filing for income tax filers, developing an easy to use electronic filing portal for non-income tax filers, and adopting the well established “mailbox” rule for paper filers, (c) requesting guidance in connection with a reasonable cause penalty relief to encourage and accommodate filings when accounts have been disclosed and income has been substantially reported; (d) changing the filing threshold, and (e) providing an exemption from the filing requirement for employee benefit plans and U.S. officers and employees of publicly traded corporations and their subsidiaries.

That's a good start.

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Leftish think tank: film credits stink

November 18, 2010

The left-of-center Center for Budget and Policy Priorities chimes in on the policy behind state tax credits for filmmakers:

Film subsidies don’t pay for themselves, so state taxpayers bear the burden. The economic activity induced by these subsidies generates insufficient tax revenue to offset their cost. As noted above, estimates of revenue gains range from $0.07 to $0.28 cents per dollar of awarded subsidy. The only studies claiming that a state film subsidy pays for itself were financed by the Motion Picture Association of America and/or a state office of film and tourism

The study notes that the credits are a very expensive way to "create jobs," pointing at Massachussetts' experience:

-Massachusetts lost $88,000 in tax revenue for every new job created by the Commonwealth’s film tax credit and filled by a Massachusetts resident.

- Every dollar of state tax revenue lost because of the film tax credit generated less than 69 cents in income for the Commonwealth’s residents. The Commonwealth could have given its citizens a bigger financial boost at a lower cost by repealing its film tax credit, recouping the tax revenue, and sending them checks in the mail.

So both left-side and right-side policy bodies find film credits futlle. Who supports them? Just filmmakers and the politicians who love them.

Related: Let them eat canapes.

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IRS issues Applicable Federal Rates (AFR) for December 2010

November 18, 2010

The IRS has issued (Rev. Rul. 2010-29) the minimum required interest rates for loans made in December 2010:


-Short Term (demand loans and loans with terms of up to 3 years): 0.32%

-Mid-Term (loans from 3-9 years): 1.53%

-Long-Term (over 9 years): 3.53%

The Long-term tax-exempt rate for Section 382 ownership changes in December 2010 is 3.67%.

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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(Economic) substance abuse in Carroll, Iowa

November 17, 2010

If you think the 20% and 40% "economic substance" penalties in the Obamacare legislation are just a threat for elaborate tax shelters from fancy-pants big city law and accounting firms, a Tax Court case yesterday out of Carroll, Iowa will make you think again.

20101117-1.jpgA Carroll couple had operated a trucking business out of their home since 1967. They lawyered up in 2000 and set up three new entities -- two C corporations and an LLC. One C corporation had the trucking operations, while the other was a "consulting" business that provided "management services" to the trucking business. Real estate was put into the LLC, which filed as a partnership.

The 87-page Tax Court opinion outlines a confusing series of payments between the controlled entities that resulted in no taxable income in the C corporations and reduced taxable income on the 1040. The taxpayers testified in their own defense, to no avail:

Before turning to the issues presented, we shall comment on the respective testimonies of [the couple], who were the only witnesses at the trial in these cases. We found those testimonies to be in certain material respects questionable, implausible, vague, inconsistent, unpersuasive and/or self-serving. We shall not rely on the respective testimonies...

The court said the arrangements amounted to a tax-avoidance scheme:

Based upon our examination of the entire record before us, we find that the only intended objective of the respective transactions between (1) (a) Transfer and Consulting and (b) Leasing and Consulting, under which Consulting purported to provide to each of those companies certain services, and (2) the [taxpayers] and Consulting, under which Consulting purported to agree to buy the [taxpayers'] residence, was the... tax-avoidance objective of having Consulting pay the [taxpayers'] personal living expenses with funds which Transfer and Leasing paid to Consulting and for which Transfer and Leasing claimed tax deductions for their respective taxable years at issue.

Here's where the Obamacare penalty changes come in:

On that record, we find that the respective transactions at issue were not entered into for nontax business reasons, were entered into only for tax-avoidance reasons, and did not have economic substance.

New Section 6662(b)(6) provides a non-waivable penalty for tax understatements attributable to transactions that lack "economic substance." The penalty is 40% (20% if there was "adequate disclosure") of the understatement. The taxpayers in Carroll were hit with a 20% "accuracy related" penalties in the neighborhood of $20,000. If the new rules applied to the years at issue (they don't), they might have faced a penalty twice as large, with no opportunity for a "reasonable cause" reduction (though the judge in this case rejected "reasonable cause" arguments for penalty reduction, despite the use of an attorney to set up the structure and prepare tax returns).

The Moral? The Tax Court doesn't like it if they think you are trying to deduct personal expenses, and the new economic substance penalties will raise the stakes.

Cite: Sundrup, Et. Al, T.C. Memo 2010-249

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High rates and loopholes? How innovative!

November 17, 2010

Robert Goulder at Tax.com thinks he's found something exciting in Virginia Senator Mark Warner:

Warner proposes that Congress: (i) Retain the tax breaks for the bottom 98% of us; (ii) Allow the tax breaks for the top 2% to expire* as scheduled; and (iii) Take the same amount of money that would otherwise be spent on favors for the top 2% over the next two years -- roughly $65 billion -- and plow it directly into business incentives that are far more likely to create jobs. Those measures might include a more generous R&D tax credit, increased allowances for expensing and depreciation, and -- my personal favorite -- reducing the employer share of payroll taxes for firms that hire new workers.

Great. Take money off the top from businesses and then give some of it back if they spend it the way the economic supergeniuses in Congress direct. Sounds a lot like... what we have right now, with higher rates. Ingenious.

Warner might just out-fox the GOP at their own game. If this tax debate is really about jobs, as we're being told, then why not cut to the chase. I've yet to meet an economist who disagrees that these business-friendly tax breaks aren't a superior vehicle for stoking job growth than tinkering with the individual rate structure.

If there's any evidence that Congress will do a better job of deciding how businesses spend money than businessmen, it has evaded detection. As far as him not meeting economists that think fine-tuning the economy through tax breaks is the way to job creation, he needs to get out more.

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If it's Wednesday...

November 17, 2010

...it's time for Robert D. Flach's "Buzz" roundup of the latest and greatest in the tax blog world.

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Looking for year-end tax tips?

November 17, 2010

Bruce from Missouri has some today.

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Sorry Charlie

November 16, 2010

Charles Rangel walked out of his Congressional ethics hearing yesterday. This means he is putting up no defense against 13 ethics charges, including failure to properly report taxable income from his rental property in the Dominican Republic.

I listened to a replay of the hearing on the way home from Mason City last night on the satellite radio, and the dapper Mr. Rangel put on a bizarre and sad performance. He was apparently hoping to get more time to find a new lawyer after his prior law firm withdrew from his defense in September. His emotional, self-pitying yet egotistical monlogue never explained why the old law firm chose to run out on one of the more powerful Congresscritters, but listening to him made me suspect he might have been a difficult client.

California Democrat Zoe Lofgren, committee chair, dryly recited the history of the two year-old case and the committee's communication with Mr. Rangel, implying that his failure to secure counsel by now was Mr. Rangel's own fault.

It's unclear whether a lawyer would make any difference anyway. There's no way they would expel Mr. Rangel, so the only question is whether they will slap him on the wrist with the flat side of the ruler or the edge. Yet to hear Mr. Rangel, you'd think he was going to get a dreadful punishment, like having to buy his suits off the rack.

UPDATE: Subcommittee finds Rangel guilty on 11 charges, including the tax omissions. The case proceeds to the full Ethics committee for the ritual wrist-slap.

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Principal Financial Group loses $400 million $100 million motion

November 16, 2010

Des Moines-based insurance giant Principal Financial Group last week lost a motion for summary judgment on a $444* million tax dispute with the IRS. The U.S. Court of Federal Claims turned down PFG's motion asserting that the IRS failed to assess the tax within the statute of limitations. From the opinion:

Plaintiff, Principal Life Insurance Company and Subsidiaries (plaintiff or Principal) argues that it is entitled to certain overpayments because its taxes were not timely assessed by the Internal Revenue Service (IRS). Defendant responds that the taxes in question were timely assessed and that even if they were not, they are not recoverable as an overpayment. Plaintiff is wrong; defendant is right. It remains to explain why.

The decision gets into technical details about the rules governing tax payments, deposits and assessments and concludes the IRS assessment was timely. That doesn't mean Principal will ultimately lose the case -- it can still go to trial on other issues -- but they won't win by a foot fault.

Cite: PRINCIPAL LIFE INSURANCE COMPANY AND SUBSIDIARIES, US Ct. Claims, No. 07-0006T

*UPDATE: an insider tells me that the amount at stake in the summary judgment motion was closer to $100 million than $400 million. The Tax Update appreciates the correction and regrets the error.

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Will the 1099 rule be the first part of Obamacare to be repealed?

November 16, 2010

It looks that way. Max Baucus, Senate Finance Committee Chairman, says he will introduce a stand-alone bill to repeal the Obamacare provision that vastly expands the Form 1099 requirements for businesses. Business taxpayers currently are required to issue 1099s to non-corporate service providers paid over $600 in a year. Obamacare expands the requirements to sellers of merchandise and to corporate vendors. It has proven hugely unpopular.

That doesn't mean it's a done deal, but if there is mainstream Democratic support for the repeal -- a universal goal of Republicans -- chances for passage look good.

Even so, that probably won't undo the provision requiring landlords to issue 1099s starting next year. This sleazy little provision was tacked on to the "Small Business Jobs Act" with little debate earlier this year. It will certainly create a lot of busy work for landlords, who have not had to put up with 1099-Misc reporting until now, but it sure won't "create jobs."

More from Kay Bell.

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The problems of year end deductions...

November 16, 2010

...is the topic of my new post at IowaBiz.com.

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Mason City Monday

November 15, 2010

The Tax Update was up bright and early today to get ready for the ISU Center for Agricultural Law and Taxation farm tax school at North Iowa Area Community College in Mason City.

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This one is sold out, so if you want to attend one of the last three schools -- in Muscatine, Griswold and Ames -- sign up today!

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Helping your boss, his wife, and his mistress evade taxes may be unwise

November 15, 2010

An Ohio accountant was sentenced last week to 11 years in prison on federal tax charges. It would take me at least that long to understand the situation that led to his sentence.

From the Department of Justice press release:

According to court testimony and documents, Dennis G. Sartain of Hilliard, Ohio, was the accountant for convicted Columbus-area home builder, Thomas Parenteau. Sartain conspired with Parenteau to commit tax-fraud and money-laundering schemes through which the pair defrauded the IRS of more than $1 million and defrauded banks into lending more than $18 million to Parenteau and his nominees. A jury convicted Parenteau for his role in these crimes in July of this year after a two-month trial.

The rest of the cast:

Marsha Parenteau, Mr. Parenteau's wife and a real estate broker in partnership with...

Pamela McCarty, Mr. Parenteau's mistress, mother of two of his children, and prosecution witness in his federal tax evasion trial.

A little background from the Columbus Dispatch:

McCarty said she decided to cooperate with the government after admitting herself to a Gahanna treatment facility in June 2008 to deal with alcoholism and emotional problems. When she returned home, she said Parenteau screamed at her, threatened her life and threw her against a wall in the mansion they shared at 4500 Dublin Rd.

Although Parenteau fathered McCarty's two daughters, who were born in 2002 and 2004, he remained married and in business with his wife, Marsha. The Parenteaus obtained the 30,000-square-foot mansion on Dublin Road, in Norwich Township near Hilliard, in 2003 for $1.8 million through a trust, with McCarty as the trustee. At various times, Parenteau shared the house with both women.

Mr. Parenteau had a very, um, understanding wife. Given the 11-year term that the accountant got, it's likely that the sentencing judge will be less accomodating. In addition to the 11 years, he got a brutal "I told you so" from the prosecutor, who had offered him a 2-year sentence in exchange for cooperation against Mr. Parenteau:

"I gave you a chance in 2006 to save yourself and your family, and you chose a different direction," Assistant U.S. Attorney Richard Rolwing told Sartain yesterday. "You were given every opportunity for years to reduce that sentence."

...

"You drank the Kool-Aid, and you followed him in everything he asked you to do,"

The Moral? Just because somebody can pull of seemingly impossible domestic arrangements doesn't mean he can do the same thing with the tax law.

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Harley turns down corporate welfare

November 15, 2010

State Tax Notes reports ($link) that Harley-Davidson has turned down $25 million in tax credits offered by Wisconsin:

Harley-Davidson had initially accepted the tax credits, but the Journal Sentinel reported that the company later rejected the offer over concerns that its business plan might not meet the credit program's requirements.

Although the company has turned down the credits, Harley-Davidson will still keep its manufacturing facilities in Wisconsin, the paper reported. Company spokesman Bob Klein told the Journal Sentinel that Harley-Davidson did not reject the proposal to secure a better deal from the state.

This is tragic. How will state economic development officials be able to say they "created or saved" the Harley jobs?

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What are the odds of an Obama compromise on Bush rates?

November 12, 2010

Tax planners got all excited yesterday when top White House aide David Axelrod hinted to the Huffington Post website that the President might be ready to extend the 2010 tax rates for top earners. Absent new legislation, the top marginal rate will rise from 35% to 39.6% in 2011 -- and higher when phase-outs are counted.

But if the Axelrod statements are a trial balloon, the President isn't ready to climb aboard just yet. CNN reports on comments he made in Seoul:

"That is the wrong interpretation because I haven't had a conversation with Democratic and Republican leaders," Obama said of a Huffington Post article suggesting that in advance of negotiations with lawmakers next week, the White House has calculated that giving in on tax cuts for the rich is the only way to get the middle class cuts extended too.

"Here's the right interpretation -- I want to make sure that taxes don't go up for middle class families starting on January 1st," Obama said at a news conference at the conclusion of the G-20 Summit here. "That is my number one priority for those families and for our economy. I also believe that it would be fiscally irresponsible for us to permanently extend the high income tax cuts."

So what will happen? In sports, the betting lines do a good job of forecasting game results. So lets see what the Intrade lines are on rates.

Intrade, the online prediction market, has prediction markets for 2011 tax rates. The technical details are not entirely clear -- I'm not sure whether phaseouts of itemized deductions count, but I don't think so. Given that, two Intrade submarkets are of special interest:

- One that forecasts a top 2011 rate in excess of 38%, and
- One that forecasts a top 2011 rate in excess of 36%.

Here are the prices as of this morning:

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The >38% market currently shows a bid price of 40 and an ask price of 55. If the rates are in excess of 38%, the market will close at 100; if not, they will close out at zero. That means the market is about evenly split at the last trade between those who think the top rates will go into effect as enacted and those who don't. The market price fell sharply immediately after the election, indicating that speculators feel the new Congress changes things:

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The >36% market is more interesting. It is trading at over 85, which means the traders think that an increase over the current 35% top rate is almost certain. This would seem to indicate that the markets predict that the top rates will go up, but not all the way to 39.6%. How does this square with a choice between extending current top rates and letting them expire? Perhaps it implies some "millionaire tax" on very high incomes. Or, perhaps, it's an anomaly in a lightly-traded market. If you think the odds are good that the Bush-era rates will be temporarily extended, this market may offer a speculative opportunity.

Of course, the markets are always subject to change. For your convenience, here are live embedded charts for your convenience whenever you read this post:

>38% Market:



Chart by Intrade

>36% Market:



Chart by Intrade

In real life, the best thing to do is stay flexible so you can best shift income and deductions between 2010 and 2011, depending on what Congress does in the next few weeks.

Thanks to Going Concern for the CNN link

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Waterloo, Iowa preparer get 30 months for earned income tax credit fraud

November 12, 2010

Most people think of tax fraud as hiding income from the IRS, but thanks to the earned income credit, some folks fraudulently overstate their income. A little wage or self-employment income can lead to a nice government check at the bottom of the wage scale.

A northeast Iowa preparer has learned the hard way that it's just as illegal to commit tax fraud by overstating income as by understating it. A federal judge recently sentenced Yoshida Ford of Waterloo to 30 months for EIC fraud. Ms. Ford pleaded guilty to falsifying two returns - her own and one other - but admitted that she had prepared many other false returns at sentencing.

The Moral? Refundable tax credits like the EIC are a massive temptation to cheat. You can bet that every return Ms. Ford prepared has gotten special attention from IRS.

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The thrill of victory

November 12, 2010

California tax blogger Russ Fox is also a poker maven. The cards have been coming up his way. So how does he square up things with the tax man?

Well, luck, skill, or a roll of the die was with me: I did win that free trip to the Bahamas. Come early January I’ll be winging my way 2,492 miles to Nassau and then on to the Atlantis Resort on Paradise Island. I’ll be given $1000 in spending money (to buy the airline ticket), a hotel room, and an entry into a poker tournament. I will not be sent a Form 1099-MISC. So how should I account for this on my tax return?

First, I do need to include these items.

The whole post is a great read and an excellent example about how to think about the taxation of prizes and winnings.

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Veterans Day

November 11, 2010

Today is Veterans Day. It is appropriate to remember all of those veterans who are still with us, but we should also keep in our thoughts those who didn't make it home. Like 2nd Lt. Richard Duer:

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"Dick" Duer was the bombardier on a B-24 that took flak on a mission to bomb submarine pens in Toulon, France on July 5, 1944. The pilot died in the air, and the co-pilot tried to get the plane back to base in Venosa, Italy. The damaged plane was unable to maintain its altitude, so the copilot attemped to ditch it in a bay in northwest Corsica. Dick Duer died in the wreck; only four members of the ten member crew survived, including my father.

You can find more about Dick Duer's crew and their final mission here.

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Zero Option!

November 11, 2010

20101111-1.jpgWhen the Soviets parked a bunch of SS-20 missiles in Eastern Europe, President Reagan countered by deploying U.S. missiles in Western Europe. But in addition to a stick, he offered a carrot: the "Zero Option," where both sides would clear all of their missiles from the continent. Conventional opinion derided this as unrealistic and a mere ploy. Ten years later, there was no Soviet Union.

The "National Committee on Fiscal Responsibility" issued a zero option of its own yesterday as one of three tax reform options to reduce the federal deficit. The "Zero Plan" is summarized as follows:

* Consolidate the tax code into three individual rates and one corporate rate

* Eliminate the AMT, Pease, and PEP

* Eliminate all $1.1 trillion of tax expenditures

* Dedicate a portion of savings to deficit reduction and apply the rest to reduce all marginal tax rates

* Add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero expenditure low

If no "tax expenditures" were added back, the plan would reduce individual rates to 8, 14 and 23%, with a flat 26% corporate rate. There would be no reduced rate for capital gains, greatly simplifying tax lives for most of us.

This is an excellent idea. I would only apply more of the savings to reducing rates and add a dividends paid deduction to integrate the individual and corporate systems -- a huge simplification. Nancy Pelosi isn't crazy about it, but her friends didn't like the first zero option either.

There is already plenty of discussion of the plan. The TaxProf has a roundup. Other blogs weighing in include:

Robert D. Flach
Tax Vox (Whether they want me to link to them or not).
Tax Policy Blog
Tick Marks
Iowa Center For Fiscal Responsibility
Kay Bell

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'TurboTax defense' not golden for Au

November 11, 2010

Gold is "Au" in the periodic tale of elements. Unfortunately for a couple named Au, a golden name doesn't buy success in the Tax Court.

According to a Tax Court opinion yesterday, Phu M. and Yvonne D. Au claimed a net loss from gambling on their 2006 tax return. Unfortunately for them, the tax law doesn't allow you to deduct net gambling losses; gambling losses are deductible only to the extent there are gambling winnings to offset.

The couple fell back on the Geithner defense of blaming the software (in this case, H&R Block's "TaxCut," rather than the Secretary of the Treasury's favored Turbotax). From the Tax Court opinion:

Petitioners contend that they followed the instructions on the tax preparation software that they used in preparing their 2006 tax return, asserting that the software was "approved by the IRS". They indicate that they were unaware of the provisions of the Code and that they did not consult any Internal Revenue Service (IRS) publications or professional tax advisers before claiming deductions equaling almost half of their reported income in 2006.

That failed to satisfy the court:

The software instructions are not in the record, so we cannot determine how the error occurred. We doubt that the instructions, if correctly followed, permitted a result contrary to the express language of the Code. Petitioners may have acted in good faith but made a mistake. In the absence of evidence of a mistake in the instructions or a more thorough effort by petitioners to determine their correct tax liability, we cannot conclude that they have shown reasonable cause for the underpayment of tax on their 2006 return.

With no showing of reasonable cause, the court upheld the IRS assessment of a 20% "accuracy-related" penalty.

The Moral? Unless you are bucking for a cabinet position, don't bother to blame the software.

Cite: Au, T.C. Memo. 2010-247

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You'd better waste your $20 million, or we won't waste our $80 million!

November 11, 2010

Or, as the headline writer for the Des Moines Register put it,

$80 million at stake if Iowa doesn't fund passenger rail

Well, duh. The $318 million dollar rail boondoggle announced just before the election requires Iowa to spend $20 million to get the feds to kick in for their share of a project that nobody would ever dream of financing with their own money. Even if the ridiculously optimistic passenger usage would occur, Iowa would still be on the hook for $3 million each year -- $12 per ticket -- for a slower, less reliable and more expensive alternative to the Megabus.

The article makes the loss of the federal wastage to help Iowa waste its own money look like some kind of a threat. Don't throw us into that briar patch! The "deficit reduction" commission issued its draft report yesterday. Absurd rail pork like this should be the first thing to go.

Related: Will new Governor stop Iowa's crazy train?

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Grassley and Company pledge 2010 AMT patch

November 10, 2010

The leaders of each party in the House and Senate tax writing committees have pledged to "do everything possible" to pass an "AMT patch for 2010." Failure to do so will increase the tax on millions of taxpayers by thousands of dollars for this year. They made their pledge in a letter to IRS Commissioner Shulman -- sort of creepy in itself, when you think about it.

Dear Commissioner Shulman:

Under present law, more than 21 million taxpayers will be subject to higher taxes in 2010 unless legislation is enacted to limit the reach of the Alternative Minimum Tax (AMT). We realize that this fact is causing concern for many taxpayers and is creating administrative difficulties for the IRS as the agency prepares for the upcoming filing season.

As the leaders of the Congressional tax-writing committees, we want to assure you that Congress is working on legislative relief. We will work to craft the AMT provision so that, in the aggregate, not one additional taxpayer faces higher taxes in 2010 due to the onerous AMT. Such legislation will allow the personal credits against the AMT and the exemption amounts for 2010 to be set at $47,450 for individuals and $72,450 for married taxpayers filing jointly.

We plan to do everything possible to enact AMT relief legislation in a form mutually agreeable to the Congress and the President. We urge the Internal Revenue Service to take all steps necessary to plan for changes that would be made by the legislation.

"We plan to do everything possible to enact AMT relief legislation in a form mutually agreeable to the Congress and the President." Coming from a coven of politicians that have failed to even solve the estate tax problem on time, that sure is reassuring. The value of the AMT Patch could exceed $7,000 for some taxpayers. If you had AMT last year, you may want to make sure you have some extra cash on hand in April, just in case.

More coverage:

TaxGrrrl
TaxProf

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IRS provides some good news to auto, truck and implement dealers

November 10, 2010

The "inventory capitalization" rules of Section 263A have long been a sore point between vehicle dealers and the IRS. The rules, enacted in the 1986 tax reform act, require retailers with over $10 million in gross receipts to capitalze some additional costs into inventory - particularly "purchasing, storage and handling" costs.

Yesterday the IRS provided new safe-harbor guidance for vehicle dealers to use in computing their Section 263A adjustments. New Rev. Proc. 2010-44 allows dealers to make two elections that have the effect of allowing dealers to exclude most storage and handling costs from their inventory computation -- allowing them to deduct those costs as incurred, rather than when the inventory is sold.

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This guidance applies to dealers of new or used autos, trucks, recreational vehicles, motorcycles, boats, farm machinery and equipment, and construction machinery and equipment. As it will solve a lot of disputes on examination, I expect this guidance to be popular.

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Jury says Kansas woman 'common law wife' of prosperous farmer, saving her millions in estate taxes

November 10, 2010

Roger McEowen reports:

In this case, a Kansas farmer died in 2001, leaving his entire multi-million dollar estate to his partner (Theresa Beat) who claimed she was the decedent’s common-law wife. They had been in a “relationship” for over twenty years beginning at a time that they were both married to other persons. She was named the executor, and claimed a 100 percent marital deduction on the decedent’s federal estate return and Kansas inheritance tax returns for the entire value of the estate. That wiped out tax at both the federal and state levels. But, both the IRS and the Kansas Department of Revenue (KDOR) disagreed with her characterization as the decedent’s common-law wife. If she was not the decedent’s spouse at the time of his death, then the estate could not claim any marital deduction with the result that a substantial amount of tax would be due at both the federal and state levels – with interest and penalties.

They never filed joint income tax returns or anything, but a federal jury decided that they were still common-law married -- a decision that, if it holds up, could save the common-law widow $2.8 million in estate taxes, interest and penalties. The IRS seems likely to appeal.

The Moral? If you want to be married for tax purposes, a trip to the courthouse or the chapel can save you a lot of trouble with the IRS.

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Tax show trials

November 10, 2010

The show trial in Russia has a long and inglorious tradition, but the institution has changed with the time. No longer are the stars "kulaks and wreckers." Now the trumped-up crime of choice is tax evasion.

Mikhail Khodorkovsky, who was once an oil magnate, has been rotting for years in Russian prisons on tax charges that are a flimsy pretext for a political prosecution. Now the Soviet Russian leadership is ready to extend his sentence, reports The Atlantic:

Last Tuesday, Khodorkovsky addressed the court, speaking out against not just his own incarceration but the entire political environment of today's Russia. His address received wide attention and has inspired responses from Western journalists. Though Khodorkovsky may be an unlikely protagonist, they say, he has found himself at the center of a real tale of injustice and thwarted hope for an open and lawful society.

Politically-motivated tax charges? Good thing that could never happen here!

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Giving unto Ceasar watch

November 10, 2010

Sometimes funds meant for Caesar and God go astray.

From San Diego:

A San Diego resident who used his position as a pastor to bilk a man out of nearly $12.9 million and failed to pay taxes for three years was sentenced today to 6 1/2 years in federal prison.

From New Jersey:

Monsignor Patrick Brown, a Morris County, New Jersey, pastor at St. Vincent de Paul Catholic Church, pleaded guilty to tax evasion charges after a lengthy IRS probe.

Brown raised the attention of IRS enforcement with rumors of a high-flying lifestyle full of opulent gift-giving and international travel.

Prosecutors say between 2004 and 2009, Brown diverted more than $60,000 worth of parish funds into his bank accounts, according to the New Jersey Star-Ledger.

From North Carolina:

The Charlotte Observer reported three Greater Salem Church properties are scheduled for auction Friday at the Mecklenburg County Courthouse. The notices say the church has defaulted on a mortgage taken out in 2008.

Pastor Anthony Jinwright was convicted in May on charges of conspiracy, tax evasion and filing false tax returns. He faces up to 53 years in prison and is being held in the Mecklenburg County jail.

His wife, Harriet Jinwright, was convicted of conspiracy and tax evasion and faces up to 20 years in prison.

Pastor Jinwright was blessed with a fleet of vehicles that included a Bentley, five Lexus cars, and a Maybach.

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Flickr Creative Commons photo by jorbasa

"Woe unto you, scribes and Pharisees, hypocrites! for ye devour widows' houses, and for a pretense make long prayer: therefore ye shall receive the greater damnation."

And perhaps a stretch in the federal concrete parsonage, too.

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Dallas County defendant defeated

November 09, 2010

The Cowboys aren't the only Dallas residents who've had a tough time of it lately. A Dallas County, Iowa man just had a tax-evasion conviction and 51-month prison sentence affirmed by the federal Eighth Circuit Court of Appeals.

The indictment charged the defendant, Richard Rosenquist, with engaging in a long series of actions to illegally avoid tax, including tax returns with only zeroes and attempts to conceal assets from the IRS. He was convicted in a 2009 jury trial and sentenced to 51 months in prison, followed by three years of supervised release.

The appeals court rejected technical challenges to the indictment and upheld the conviction and sentence.

The Moral? Filing "zero" returns when you have income isn't just foolish and expensive; it can get you a ticket to jail.

Cite: Rosenquist, CA-8, No 10-1307 (11/4/2010)

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Posner prose

November 09, 2010

The TaxProf has some of 7th Circuit appeals judge Richard Posner's memorable tax quotes. Lots of good stuff, including these two sad observations:

"It is a long time since American government operated on the principle that government governs best which governs least. Much modern legislation involves targeting government largesse on politically influential groups and the burdens of government on politically impotent ones. Not infrequently the legislation benefits a tiny handful of individuals or firms or even a single firm—the latter is especially common in tax legislation.... "

And:

"There is no limit to the subtleties that lawyers steeped in the economics of income and wealth could excogitate in defense of this or that inclusion or exclusion."

They're all worth reading. You don't have to be a lawyer to enjoy his work at the Becker-Posner Blog, where he spars with Nobel Economist Gary Becker

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Will new Governor stop Iowa's crazy train?

November 09, 2010

Just Maybe. State 29 passes on this from the Cedar Rapids Gazette about the proposed $318 million Chicago-Iowa City Amtrak route:

“We’re going to do a full analysis and review of this whole situation,” Branstad said. “What are the benefits, what are the costs, what are the obligations? It’s my understanding there are state obligations and subsidies required down the road and we need to review that.”

Costs: $318 million in taxpayer money up front, including $20 million from Iowa. Iowa would pay $3 million in operating subsidies annually for the 250,000 projected riders; this $12 per ticket subsidy would get the ticket prices down to $42, higher than the most exensive Megabus ticket. That doesn't include Amtrak federal subsidiesof probably another $20 plus per rider -- assuming that the ridership goals are met, which is unlikely.

Benefits? A more-expensive and less-reliable, but slower, alternative to the reliable and comfortable Megabus. But wait, there's more! The Des Moines Register reports on what the train boosters claim:

State officials said their economic studies project $25 million in increased business activity along the train route, plus jobs for nearly 600 people a year for four years during design and construction.

Iowa City Chamber of Commerce President Nancy Quellhorst said the train will be significant in the city's future. "It will fuel job growth, improve the environment, increase tourism and improve the quality of life," she said.

But the Register also reports that the magic doesn't work at train stations that Iowa already has:

Osceola Mayor Fred Diehl, whose community hosts Iowa's busiest train station along Amtrak's California Zephyr line, hasn't seen any economic growth around the historic depot, which hosted 11,556 passengers in 2009. "Sadly, no, although we are hoping to develop something" as part of station renovation plans, Diehl said last week.

There are no hotels or motels surrounding Osceola's depot, and a nearby cafe that once hosted coffee drinkers closed years ago.

That's a sweet deal. Let's spend $318 million to duplicate this roaring success.

Related: But where will they put the zeppelin port?

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Does the municipal government have a duty to protect your armed fortress from the IRS?

November 08, 2010

It probably never occured to the village fathers of Plainfield, N.H. that they might have a duty to help an anti-tax couple in their armed standoff with federal agents. But with lots of time to ponder these things in prison, it has occurred to the couple, Ed and Elaine Brown. From Boston.com:

Ed and Elaine Brown's lawsuit says because they paid their Plainfield property taxes, the town should have shielded them from federal authorities. The couple, who insist the federal income tax is unconstitutional, holed up in their home after being sentenced to five years in prison for tax evasion.

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It's hard enough for municipal officials to keep the sewers working, fill the potholes and find jobs for nephews without figuring out how to augment the defenses at the local tax protester's armed survival compound. I'm no lawyer, but it seems unlikely that the local judge will find that the local authorities were required to mount an armed insurrection against federal authority. Besides, it's all part of the conspiracy.

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Can a cash-basis farmer choose how much prepaid expense to deduct?

November 08, 2010

Cash-basis farmers can generally prepay their expenses for next year and deduct them on this year's return. What happens if the farmer overdoes it and wants to save some of the deductions until next year? Farmer-CPA Paul Neiffer explains:

The general rule for cash basis farmers is that all cash expense are deducted when paid. However, if the farmer can document that part of these prepayments were in fact, either a (1) deposit or (2) inputs for the 2012 crop, these payments would be considered non-deductible in 2010, but rather in deductible in 2011.

This allows a farmer some flexibility, but it does not let a farmer simply pick and choose how much they want to deduct.

Don't overdo it. Like other taxpayers, farmers may see a big rate hike for 2011. Where possible, taxpayers should stay flexible so to see what the lame-duck Congress does before committing to whether expenses should go on the 2010 or 2011 returns.

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The Missouri roundup

November 08, 2010

Bruce the Missouri Tax Guy rounds up last week in the tax blogs. His links to the Tax Update are much appreciated.

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Let's compromise and do what I want

November 08, 2010

Christopher Bergin at Tax.com thinks the President will propose a temporary extension of the Bush-era tax cuts, but that a triumphalist Republican House will turn it down:

Here’s my scenario. Having little choice, President Obama is signaling a compromise on continuing tax cuts for people he thinks are rich – those families making more than $250,000 a year. He will propose something like: let’s permanently extend the tax cuts for the middle class and extend the tax cuts for the rich for a couple of years – all in the name of the economy.

The Republicans, many of whom foolishly think they have some kind of mandate now – will say, "No way, Jose. It’s the whole loaf or no loaf. Extend all the tax cuts permanently."

A headline this weekend makes me wonder if it will even get that far:

Obama calls for compromise, won't budge on tax cuts

The President's weekly radio address didn't show much inclination to compromise on the top rates.

The 2010 "AMT patch" is the only tax legislation that seems likely to me to emerge from the lame-duck Congress.

Related: The election: what do they mean by that?

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What if you are donating it to an arson awareness organization?

November 05, 2010

If you want a great big deduction for allowing the local fire department to burn down your house, the Tax Court yesterday threw a fire blanket over your flaming hopes. The court ruled that a Wisconsin couple could not get a big charitable donation for allowing the local fire department to tear down a lake home that they planned to replace.

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Flickr image courtesy dvs under Creative Commons license


The Court focused on two issues --

- The appropriate way to value allowing the fire department to burn down a house, and
- The "quid pro quo" benefit to the taxpayers of allowing the fire department to burn down the house.

The taxpayers wanted to deduct the fair market value of the house to be torn down. They hired an appraiser and claimed a $77,000 deduction, which they later raised to over $200,000. The Tax Court, however, decided there was less to the donation than it would appear.

When the taxpayers agreed to donate the house to train firemen, there were lots of strings attached. The firemen didn't get the full value of a house. They instead got a very restricted set of rights:

By transferring the lake house to the VFD without the underlying land, however, petitioners created a substantial restriction or condition on the property's marketability; namely, the lake house could not remain indefinitely on the land upon which it was sited.

Petitioners attached two additional restrictions or conditions on the lake house incident to its donation; namely, the permissible use of the lake house was restricted to firefighter and police training exercises and there was a condition that the lake house be burned down relatively soon after the conveyance.

The asset donated amounted to the right to move the house or torch it. Expert witnesses said the remote location of the house made it worthless as a prospect for moving. As for the right to ignite, while it may have a market value among the Arson-American community, the court found insufficient evidence to decide that the recreational blaze value exceeded the value to the donors of having the house removed.

The court rejected other approaches to valuation. The court ruled that caselaw holds that "the value of the public benefit of the donation" -- the value of the training to the firefighters -- was not relevant. They also said that the reduction of the value of the house to be caused by the fire was not the proper measure, as the gift wasn't of an unrestricted interest in the entire property.

This decision was a "regular" decision, so the Tax Court likely meant this case as a precedent for other fire-donation cases. It will be hard for planners figure out how to donate enough unrestricted house to qualify for a big donation while still making sure space is cleared for the replacement house quickly.

Cite: Rolfs, 135 TC No. 24

Additional Coverage:

TaxProf
Peter Pappas

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Execrable = likely?

November 05, 2010

Howard Gleckman at TaxVox, the tax policy site that apparently hates for me to link to them, thinks that the lame duck Congress is likely to temporarily extend all of the Bush-era income tax cuts. His take on two of the options:

Temporarily extend all the tax cuts--including the AMT patch, the business tax cuts, and Making Work Pay--for a year or two. This increasingly looks like the deal, but are Obama and the resurgent Hill Republicans prepared to sign on? Will angry House Democrats agree, especially as they hear more talk of a government spending freeze?

Kick the can down the road. It is hard to imagine Congress simply leaving town without addressing the tax cuts in some way. Both parties risk a huge backlash if they don’t act. That’s why I’m betting Congress extends the tax cuts for just a few months so they can resume their bickering again next spring. This is execrable tax policy, but it just might serve everyone’s political needs.

Maybe. It's not clear that the President is ready to go along, though.

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More on the election

November 04, 2010

The tax blog world is pondering the consequences of the Republican gains in this week's elections.

Kay Bell thinks we'll see a temporary extension of the Bush-era tax cuts for top earners. I'm not convinced, but we'll see.

David Brunori at Tax.com asks "Did the Anti-Taxers win on Tuesday?"

The Tax Policy Blog reports that Washington state decided not to listen to Bill Gates' daddy, rejecting a "millionaires tax" income tax. Washington will remain without a state income tax. Peter Pappas has more.

At TaxVox, Kim Reuben reports that the status-quo won:

For better or worse, in most cases the voters said no and the status quo remained. As the New York Times’ David Leonhardt writes, "voters mostly chose the status quo, rejecting measures that would have raised new taxes but also those that would have repealed existing ones."

Russ Fox rounds up California's tax ballot initiatives: "We Want It All But Don’t Tax Us To Get It"

Finally, The TaxProf has a big-media roundup.

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Ottumwa!

November 04, 2010

The Tax Update is participating in the ISU Center for Agricultural Law and Taxation Farm Tax School today in Ottumwa. Posts will go up as time permits during the day.

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Places still remain for upcoming schools in Muscatine, Griswold and Ames, but they are selling fast. Mason City is sold out. Register at the CALT website today!

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The election: what do they mean by that?

November 03, 2010

Now that the balance of power in D.C. and Des Moines has shifted somewhat to red, whither tax policy?

At the federal level, a lame-duck Congress has a huge tax agenda, including:

- The fate of the estate tax, which is scheduled to revive worse than ever on January 1.

- The fate of the Bush-era tax cuts. Absent Congressional action, the top effective tax rate will go from 39.6% on January 1, from 35%. The capital gain rate will rise from 15% to 20%, and the rate on dividends will increase astronomically, from 15% to 39.6%

- The AMT patch. If Congress doesn't act, the AMT exemption for joint filers will fall from the 2009 amount of $70,950 to $45,000, increasing taxes for this year by thousands of dollars for millions of taxpayers.

- The extenders. Dozens of tax breaks, from the research credit to biofuel subsidies, have expired. They have been extended a year at a time to disguise their true multi-year cost. Extension has been pretty much automatic, until now.

It's unlikely that the lame ducks will accomplish much. I expect an AMT patch to pass (though you should bet the other way if they offer points). I would bet against the extenders getting past the lame ducks, though it could happen. Action on the Bush tax cuts and the estate tax seems unlikely to me. It would require a triumphal GOP to work out a deal with a President whose response to disagreement so far has been to repeat himself slower and louder. The same dynamics bode poorly for the next Congress when it meets in January.

What about Iowa?

The new Republican Governor has a House majority, but the Democrats still control the Iowa Senate. Senate Majority Leader Gronstal, last seen trying to raise individual rates by repealing federal tax deductibility, seems unlikely to go along with incoming Governor Branstad's plan to halve the 12% corporate tax rate. The best bet would be for no movement in tax policy, except for a continued reliance on futile economic development tax credits that has been getting the state nowhere for many years now.

But maybe, just maybe, gridlock could be averted. At the federal level, a chastened Administration could work out a tax reform plan with the enemy opposition. In Iowa, the Quick and Dirty Tax Reform Plan offers the two parties common ground of simplification and loophole-closing. Well, we can dream, anyway.

More tea-leaf reading from TaxVox. Linda Beale has her folk-marxist take. Peter Pappas does a little end-zone dance in Florida.


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Election hangover buzz

November 03, 2010

Robert D. Flach serves up his mid-week collection of hot tax blog links.

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Flickr image courtesy Americo Nunes under Creative Commons license

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Don't be an international scam victim

November 03, 2010

Nobody is really going to come to you from across the ocean with a risk-free opportunity to make a bunch of money. Sadly, the belief in financial unicorns leads many to grief, as Andrew Mitchel notes:

I don’t get as frustrated as I used to when I get calls from victims that are involved in international financial scams and I can’t convince them that they are involved in a scam. The scammers have brain washed their victims into believing that the money is at their fingertips.

The call usually comes to me when the millions of dollars were supposed to have already been transferred, but the money had to be held up due to an unforeseen tax. Therefore, the money never got transferred. The victim then calls me to see if they can somehow reduce this tax.

That Nigerian prince-in-exile isn't to be trusted with your bank account information.


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Crop failure: Farmer's Section 179 deduction comes up weeds

November 02, 2010

With the Section 179 deduction raised to a maximum of $500,000 this year and next, it's going to be a big part of many tax lives. But an Eastern Iowa farm couple yesterday was tripped up by an obscure limit on the deduction.

The Section 179 deduction allows taxpayers to fully deduct property in the year it is placed in service; otherwise it would be capitalized and depreciated over several tax years. Only a few years ago, the Section 179 deduction was limited to $15,000 per year, per taxpayer. "Stimulus" bills have raised it drastically in recent years.

The farmers put property in service in 2004, 2005 and 2006. They purchased the property in their own names. But the farm operations were actually run in a corporation called "Circle T." The farmers leased the property to their farm corporation and to "C & A, Inc.," an unrelated corporation. Here's where things got messy.

The tax law restricts Section 179 deductions of non-corporate taxpayers when their property will be rented out. Such leased property is normally ineligible for the Section 179 deduction, unless two requirements are met. The Tax Court explains (my emphasis):

Non-corporate lessors may expense the cost basis of section 179 property by meeting a two-prong test. First, the term of the lease, taking into account options to renew, must be less than 50 percent of the class life of the leased property. Sec. 179(d)(5)(B). Second, petitioners' section 162 business expenses for the leased property claimed during the initial 12-month period following the transfer of the property to the lessee must exceed 15 percent of the rental income produced by such property.

The first test allows very short-term leased property to get Section 179 treatment; the second test requires that there be significant non-rental expenses in the business. Unfortunately, the Tax Court found that the taxpayers failed to adequately document their lease agreements:

Petitioners assert that they satisfied the first prong because they annually renewed the terms of the leases of their farm-related property with Circle T and C & A. Petitioners therefore contend that the lease term is a year long so as to be less than 50 percent of the class life of the farm-related property. Respondent argues the lease terms are indefinite and therefore petitioners cannot satisfy the first prong. We agree.

All lease agreements between petitioners and Circle T and C & A were oral, and none of the farm-related property lease agreements was memorialized in writing. Moreover, petitioners have not presented any evidence regarding the terms for the leased farm-related property. The failure of a party to introduce evidence, which, if true, would be favorable to that party gives rise to the presumption that the evidence would be unfavorable if produced.

The Tax Court found that the lease terms weren't one-year renewable leases, but were instead "indefinite"; as a result, the court said that it could not conclude that the leases were for less than 50% of the useful life of the property. That made the property fail the non-corporate lessor rules, so its cost has to be recovered over a period of years through depreciation. Adding insult to injury, the court imposed the 20% "accuracy-related penalty" for the tax understatement, saying that the taxpayers failed to show any evidence of their tax preparer's qualifications.

The moral: Beware the non-corporate lessor rules, and document your related-party transactions carefully.

Cite: Thomann, TC Memo 2010-241

UPDATE, 11/3: Paul Neiffer has more.

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Election Day Carnival!

November 02, 2010

It was a busy morning at the polls today:

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Celebrate your freedom at the new Carnival of Taxes at Kay Bell's place. No matter how you vote, it's always a victory party at the blog world's best roundup of tax-related posts!

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That's an outrage! A scandal! A... never mind.

November 02, 2010

David Cay Johnston at Tax.com, October 25, 2010:

The number of Americans making $50 million or more, the top income category in the data, fell from 131 in 2008 to 74 last year. But that’s only part of the story.

The average wage in this top category increased from $91.2 million in 2008 to an astonishing $518.8 million in 2009. That’s nearly $10 million in weekly pay!

You read that right. In the Great Recession year of 2009 (officially just the first half of the year), the average pay of the very highest-income Americans was more than five times their average wages and bonuses in 2008. And even though their numbers shrank by 43 percent, this group’s total compensation was 3.2 times larger in 2009 than in 2008, accounting for 0.6 percent of all pay. These 74 people made as much as the 19 million lowest-paid people in America, who constitute one in every eight workers.

Back in 1994, when the top category the government reported on was $20 million or more of compensation, only 25 people were in that rarefied atmosphere, and their average earnings came to just under $45 million in 2009 dollars.

What does this all mean? It is the latest, and in this case quite dramatic, evidence that our economic policies in Washington are undermining the nation as a whole.

Ryan J. Donmoyer of Bloomberg News, November 1, 2010 (via the TaxProf):

The Social Security Administration asked its inspector general to investigate how a $32.3 billion mistake skewed its statistics on 2009 wages in the U.S.

Two people were found to have filed multiple W-2 forms that made them into multibillionaires, an agency official said yesterday. Those reports threw statistical wage tables out of whack and, in figures released Oct. 15, made it appear that top U.S. earners had seen their pay quintuple in 2009 to an average of $519 million.

The agency yesterday released corrected tables that showed the average incomes of the top earners, in fact, declined 7.7 percent to $84 million each.

Oops.

David Cay Johnston reports on the correction here. Update: He also responds with a comment to this post.

It was still funny, David. It's not the job of every blog post to provide complete context for everything; that's what links are for, and I linked to both your original post and your admirably prompt correction. As John Riggins once wisely said, whether or not he remembered it, "loosen up. You're too tight."

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Don't pay somebody else's income tax!

November 02, 2010

The dangers of buying real estate from foreigners: my new post at IowaBiz.com.

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FAIR Tax isn't just a bad tactic; it's a bad idea.

November 02, 2010

The Wall Street Journal and the Cato Institute's Daniel Mitchell have branded the "FAIR Tax" sales tax proposal a loser issue for political candidates. In a more-in-sorrow-than-anger tone, the Journal notes the difficulties of candidates who embrace this national sales tax:

In 16 House and three Senate races so far, Democrats have blasted GOP candidates for at one point or another voicing an interest in the FAIR tax. In Kentucky's Senate race, Democrat Jack Conway is running a TV spot charging that Republican "Rand Paul wants a new 23% sales tax on groceries, clothes, prescriptions, everything."

FAIR tax proponents are right to say these Democratic attacks are unfair and don't mention the tax-cutting side of the proposal, but the attacks do seem to work.

The Journal concludes:

Our advice to the FAIR taxers is that voters will start to take the idea seriously once the income tax is on the road to repeal. Until then, our advice to candidates would be to avoid the FAIR tax and focus on goals that are more achievable and less politically self-destructive.

There's a better reason not to push the FAIR Tax: it's a bad idea.

It should be enough to say "23% sales tax" to stop the discussion. I don't know of any sales tax nearly that high that has ever been effectively administered. The ceiling for an effective sales tax seems to be around 10%.

Yet it's worse. As people generally understand sales taxes, the FAIR tax has a 30% rate -- it would be about 30% of the price computed without the sales tax. FAIR Tax fans say that the "tax inclusive" rate is theoretically accurate, but this would go against almost universal practice for obvious practical reasons. In real life, it would never raise the revenue supporters expect, as the rate would be high enough to trigger massive non-compliance.

Further, it would be administered by the states. Supporters say this would enable you to get rid of the IRS, but I'd rather deal with them any day than the 50 state revenue agencies.

Finally, the FAIR Tax includes a strange "prebate" to low income taxpayers. That will require determining who is low-income -- a challenge when there is no income tax. This would be an administrative nightmare.

That the current income tax is ugly enough to drive people into the arms of the FAIR Tax says terrible things about the income tax, but that doesn't make the FAIR tax pretty.

Related: Huckabee Hawks the FAIR tax.

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The film-credit double-dip

November 01, 2010

The real meat of the Iowa Film Program was two separate 25% tax credits -- an "expenditure credit" for the filmmakers and an "investment credit" for the investors. These credits were "transferable," which means they were sold to third parties at a discount for cash.

The two 25% tax credits led the Iowa Film Office to promote "half- price filmmaking," leading a stampede of grifters film artists to Iowa to cash in make art and causing film trucks to appear all over the landscape. But there was just one little problem: a provision in the investment credit law saying that no investment credit was allowed for an expense for which an expenditure credit was claimed.

But nobody noticed. Even though the Film Office promoted "Half-price filmmaking" on its web site and in the press, the drafters of the legislation never said anything. Neither did the Department of Revenue. The Attorney General's Office was silent until after the program collapsed in scandal in September 2009; at that point somebody read the law closely and noticed the little sentence. But by then, according to the State Auditor report issued this week, $12 million in excess credits had already been issued based on this error -- $4 for every Iowan.

It's hard to imagine a more damning indictment of the negligence of Iowa's political class. All but three of the 150 state legislators voted for it. One legislator in particular was a tireless booster of the credit. The "Half-price filmmaking" was no secret. But nobody who drafted or voted for the bill spoke up. The tax administrators who drafted the rules for the credits never spoke up. And the money just gushed, until things blew up.

Related: Auditor report: millions of real taxpayer dollars paid for imaginary film expenses

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Denison, 2010!

November 01, 2010

It's a gorgeous, crisp fall morning in Western Iowa, where I am speaking at the ISU Center for Agricultural Law and Taxation at the Boulders Conference Center in Denison. Also speaking are CALT director Roger McEowen and IRS Practitioner Liason Kristy Maitre.

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The audience includes Tax Update Twitter friend @BluffsCPA. You, too, can follow us on Twitter or "like" us on Facebook.

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About those '16 tax cuts'

November 01, 2010

Even a New York Times blogger is puzzled by the President's claim of "16 different tax cuts for America’s small businesses over the last couple years." From the post:

More substantively, half of these "tax cuts" are actually incentives that reward businesses for taking actions they might not otherwise take — in other words, you have to spend money to get the tax benefit. For example, only businesses that already provide health insurance to their employees now would consider the health-care credit a tax cut. Of course, while firms using the incentive for the first time would see their expenses rise, the credit would offset 35 to 50 percent of the added cost.

The bottom line:

In other words, those inclined to be suspicious of Mr. Obama probably won’t take much comfort in this enumeration.

Of course, minor tax breaks today aren't much comfort when you're looking at a whopping tax increase tomorrow.

Via Going Concern.

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New York imposes mandatory e-filing on preparers in 2011

November 01, 2010

New York will no longer allow taxpayers to opt out of e-filing if they use a paid preparer in 2011, reports Russ Fox.

That's unfortunate. New York does a terrible job of matching partnership withholding to partner returns, and attaching an explanation has helped re-connect partners and their money. It looks like it's back to the system of responding to notices to get withholding properly credited.

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It's worth the wait if the wait is forever

November 01, 2010

A front-page Des Moines Register piece this morning finally points out some obvious issues with the $310 million rail link between Chicago and Iowa City. From the story Is rail expansion in Iowa worth the wait? :

The Amtrak passenger train that could be hauling travelers between Iowa City and Chicago within five years won't be the quickest way to get to the Windy City, nor will it be the cheapest.

Cars, buses and planes will get you there faster. And only air travel is more expensive.

So why would nearly 250,000 passengers ride the rails each year? It's a question more than a few transportation and public policy experts are asking.

Why, indeed? The idea that 684 people each day who wouldn't already forego their cars for the Megabus would do so to ride a more costly, slower and less reliable Amtrak is hard to grasp.

The piece notes that none of the economic miracles touted to arise from passenger rail have occurred where train routes already run. There is no economic boom near the Amtrak Osceola station -- a pattern that also holds along the existing Chicago-Twin Cities route.

The usual suspects are quoted boosting the route. Typical is this from Nancy Quellhorst of the Iowa City Chamber of Commerce:

"It will fuel job growth, improve the environment, increase tourism and improve the quality of life."

They say this stuff in the face of overwhelming evidence to the contrary everywhere else the trains run. Faith-based policy lives, at least where passenger rail is concerned.

Related: Off the rails

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