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Tax Update Blog: January 2011 Archives

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Soak the rich: a long and futile tradition

January 31, 2011

Within five years of the enactment of the first income tax, the top rate went from 7% to 77%. Joseph Thorndike covers the history of "soaking the rich" in the Weekend Wall Street Journal (via the TaxProf). It features this great chart tax rates changing over the years:

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That chart should always be paired with this one, showing collections as a percent of gross domestic product:

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No matter how high the rates go, it seems that you just can't get federal revenues over 20% of GDP. The high rates just distort economic decisions and weaken the economy by funnelling efforts into non-taxable channels.

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Storage shed not 'residence' for homebuyer credit, thanks to girlfriend

January 31, 2011

While the first-time homebuyer credit was a futile and insane waste of money, it does provide some tax geek amusement. For example, an IRS e-mailed advice to the field from last October headlined Individual Who Sometimes Lived in Storage Shed During Home Construction Qualifies as First-Time Home Buyer (Tax Analysts, $link)

The Key facts:

During the period of * * * through * * *, the taxpayer lived with his girlfriend, and sometimes at the homes of relatives and other friends. When the taxpayer began construction of the new residence in late 2008, he also lived in a storage shed/dwelling unit on the property where he was constructing his new home. The storage shed had a stove, refrigerator, bathroom, sleeping apparatus, and heat.

The taxpayer spent about 40% of his time in the storage shed/dwelling unit, and most of the rest of the 60% of his time living with his girlfriend.

While the storage shed qualified as a "residence," it wasn't a "principal" residence because he spent most of his time at his girlfriend's. That meant the taxpayer qualified as a "first-time" homebuyer.

Still, this ruling raises many questions for enquiring minds, like:

- Did the girlfriend spend any time in the shed?
- Did he only live in the shed when he was in the doghouse?
- If not, why the shed? She didn't let him smoke at her place?

Alas, the IRS leaves these important questions unanswered.

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Tax Shelter figures get 50-month sentence

January 31, 2011

Two prominent figures in the high-end marketed tax shelters of the 1990s and early part of the last decade were sentenced for tax crimes last week. From the Department of Justice Press Release:

Quellos founder and former CEO JEFFREY I. GREENSTEIN, 48, of Mercer Island, Washington, and former Quellos tax attorney CHARLES H. WILK, 52, of Seattle, pleaded guilty in September 2010. Today both men paid the IRS $7 Million in penalties related to their personal gain realized from the design, promotion and implementation of the fraudulent tax shelter, which they called POINT. The estimated tax loss from the scheme is $240 million. Those losses have since been repaid by the taxpayers.

Most of the big tax shelters at least involved real transactions, even if they were rigged to create tax losses without economic substance. Not so here, according to the press release:

Greenstein and Wilk did not tell clients, or the attorneys who evaluated the proposals, that the POINT transaction was predicated on a sham. They knew but did not disclose that there was no offshore investment fund, and that no shares of stock were actually purchased and possessed by any offshore investment fund. They knew that the purported offshore investment fund was merely a shell entity with nominee administrators and no assets or employees.

Other than that, it was a great shelter. Jack Townsend has more, including observations of the way tax shelter promoter sentences seem to vary inexplicably.

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Got $5 million to spare? Now might be the time to spare it.

January 31, 2011

The tax law passed at the end of 2010 extending the Bush-era tax cuts also quintupled the lifetime gift-tax exemption, to $5 million. That provision expires at the end of 2012. This could mean there is a two-year window for large family gifts. The Smartmoney Tax Blog has more.

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If I get paid 'under the table,' that's not taxable, right?

January 31, 2011

Wrong. TaxGrrrl explains.

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Happy Birthday, Insureblog!

January 31, 2011

Hank Stern and his insurance-guru buddies have been running Insureblog for six years as of today.

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Why we don't hire politicians to do our tax returns

January 29, 2011

At Radio Iowa, O. Kay Henderson reports on reaction by Senate Leader Gronstal to the Governor's proposal to reduce the top corporation tax rate from 12% to 6%:

"Read his words: a flat rate of six percent," Gronstal said. "He rewards only companies that are making more than $25 million a year."

According to Gronstal, small corporations with profits of less than $25 million are already paying the six percent rate, so those small businesses won’t get a tax break.

Somebody tell the Iowa Department of Revenue. The rate schedule shown on the corporation tax return, Form IA 1120:

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$25,000, $25 million -- it's all the same to Senator Gronstal! I wonder if he does his 1040 that way?

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Branstad: shift tax from corporations to slots players

January 28, 2011

20110128-1.jpgNew Iowa Governor Terry Branstad proposed to increase Iowa's gambling tax while cutting the top corporation income tax rate in half. The Des Moines Register reports on his budget proposals released yesterday:

The proposal would increase casino taxes from 22 percent or 24 percent to 36 percent. The increase would raise an estimated $200 million and set the rate at one even level for all casinos and at a rate the Legislature originally intended, Branstad said.

The extra money collected from casinos would allow the state to lower its sliding-scale corporate income tax, now ranging from 6 percent for companies making $25 million or less in net income to 12 percent for companies that make $250 million or more.*

Branstad, who said all Iowans must take part in budget sacrifice, proposed lowering the corporate tax rate to a flat 6 percent.

*An alert reader points out that the Register's rate schedule is a bit off. The actual rates:

6% to $25,000;
8%, $25,000-$100,000
10%, $100,000-$250,000
12% over $250,000

A reduction in Iowa's highest-in-the-nation corporation tax rate is long overdue. So is a comprehensive clean-up of Iowa's tax law, which is a rats nest of special-interest breaks and corporate welfare tax credits. While the Governor is proposing an improvement over the current system, funding it with a raid on the Polk County Board's Prairie Meadows pinata passes up an opportunity to combine a corporate rate reduction with a cleanup of the corrupt system of special interest tax breaks. If the legislature is interested, there is another way.

More coverage at Radio Iowa.

Link: Budget Documents from the Governor’s Budget Address 2011

Related: Iowa tax cut debate misses the point

Flickr image courtesy of liz_noise under Creative Commons license

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This man probably feels quite regulated

January 28, 2011

Some Illinois taxpayers are in need of a new tax return preparer. Sidney Dove, the proprietor of "Sid's Tax" in Joliet, needs to find a new line of work:

A federal court in Chicago has permanently barred Sidney Dove, a tax-return preparer from Joliet, Ill., from preparing federal income tax returns for others, the Justice Department announced today. U.S. District Judge Charles Kocoras also ordered Dove, who does business under the name "Sid’s Tax," to prepare a list of every person for whom he has prepared a federal income tax return since Jan. 1, 2006, and to provide the list to the government.

It's a safe bet that everybody on that customer list has a good chance of hearing from the IRS. But why did the nice judge decide that Mr. Dove should stay away from tax returns?

The court found that an Internal Revenue Service investigation of Dove revealed a pattern of overstated deductions for charitable contributions, employee business expenses and Schedule C business expenses. The court also found that Dove prepared a number of returns that significantly understated individuals’ tax liabilities because they contained positions that had no possibility of being sustained on the merits. For example, according to the court, Dove habitually deducted 10 percent of his customers’ income as charitable donations without ensuring that the customers had documents to support the deductions.

So the charitable deduction isn't a gimme. Remember that. Also keep in mind that there are other factors in choosing a preparer than the size of your refund.

Advocates of the new IRS preparer regulation regime would have you think that there is no oversight of non-CPA tax practice. Mr. Dove might not agree.

It's also hard to see where the giving Mr. Dove a preparer ID number and forcing him to take a Trivial Pursuit "competency test" would have avoided this problem. Somebody who concocts deductions won't stop doing so because he attends a class that says you can't invent deductions.

Related: Yes, I still don't want to regulate preparers

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What the Tax Court's 'Mayo' gambling decision means

January 28, 2011

From Poker and Taxes (link fixed):

The holding’s significance: Although professional gamblers may still only deduct gambling losses to the extent of gambling winnings, the taxpayer may further deduct the “ordinary and necessary” expenses incurred with the taxpayer’s business of gambling. This may cause a professional gambler to have business loss, which may be applied against other income.

Professor Maule has more.

Related: Tax Court: pro gamblers can't deduct net gambling losses, but their other gambling expenses aren't limited to winnings

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My Barbara Walters interview

January 28, 2011

OK, my Robert D. Flach Wandering Tax Pro interview, but that's as close as I will get to Babs. Thanks, Robert!

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Iowa tax cut debate misses the point

January 27, 2011

An Iowa House subcommittee yesterday passed a bill calling for a 20% across-the-board tax cut in income tax rates. Its prospects for passage are uncertain, and the Governor hasn't yet come out for it. Radio Iowa says the bill would reduce state revenues by $204 million. Meanwhile, a proposal for a repeal of the corporation tax is believed to be circulating.

Reaction divides on predictable lines, according to the Radio Iowa report:

John Gilliland of the Iowa Association of Business and Industry told lawmakers over two-thirds of Iowa businesses are partnerships, limited liability companies or sole proprietorships and therefore pay individual income taxes.

“This piece of legislation directly puts money back into those small businesses so they can invest and grow and hire people and bring more Iowans back to work,” Gilliland said.

Victor Elias of the Iowa Child and Family Policy Center said with legislators contemplating deep cuts in state spending, a deeper reduction in taxes on top of that makes no sense.

“We’re going to be sacrificing the future of our children and the future of our economy on the altar of ‘tax cuts no matter what,’” Elias said.

The Des Moines Register today has a piece by Fred Hubbell, who ran the Department of Economic Development for awhile in the wake of the film tax credit scandal:

First, the key reason Iowa does not need reductions in business taxes to spur economic growth is that Iowa's overall taxes are already well below average compared to other states. Yes, it's true Iowa's nominal corporate tax rate at 12 percent is one of the highest, and commercial property taxes are high, too.

To really know what a business pays in taxes, one must take into account Iowa's generous list of business tax credits, which in fiscal 2006, according to the Iowa Department of Revenue, added up to $139 million and in fiscal 2010 was already $188 million. The Revenue Department projects that figure to grow to $233 million in fiscal 2012. As a result, because of these tax credits, each year several of Iowa's largest employers pay little or no Iowa taxes.

For a defense of the current system, it sounds an awful lot like an indictment of it. Mr. Hubbell inadvertently gets to the point: Iowa has a rotten system that favors "several of Iowa's largest employers" while imposing the highest corporate tax rates in the nation, high individual rates and absurd complexity on smaller businesses lacking the connections and good fortune to qualify for tax credit goodies from the Department of Economic Development.

Talking about lower rates without talking about fixing the whole Iowa tax system could well doom the attempt to lower tax rates. The state is trying to close a $700 million or so revenue gap, and it seems unlikely to enact a bill to make that gap bigger. But by getting rid of the corporate welfare tax credits, throwing out the special favor tax provisions added to Iowa's income tax by generations of feckless legislators, and repealing the deduction for federal taxes, you could get the individual rate much lower than 7%, and probably repeal the corporation tax, without reducing state revenue. It's called the Quick and Dirty Iowa Tax Reform, and it's outlined below. A simple system with low rates will be much better for growing business than the current system of high complexity and high rates alleviated by loopholes for those with connections at IDED.

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From Bern to Bangalore

January 27, 2011

The Swiss banking system may have a reputation as a place to stow cash to evade taxes, but they hardly have a monopoly. An indictment handed down yesterday charges a New Jersey businessman with hiding his cash in India. The Wall Street Journal reports:

A New Jersey businessman was indicted Wednesday on charges that he conspired to evade U.S. taxes by hiding offshore bank accounts in India.

The indictment didn't identify the bank by name, saying only that the institution "was one of the largest international banks in the world and was headquartered in England." A person familiar with the case said the bank was HSBC Holdings PLC.

Prosecutors alleged that Vaibhav Dahake held undeclared bank accounts from 2001 to 2010 in India and the British Virgin Islands.

The suspect's attorney says the indictment is designed to frighten taxpayers into participating in an upcoming repeat of the "amnesty" for offshore bank accounts. Whether or not that's true, it does show that offshore bank secrecy is a fragile bulwark against the IRS.

UPDATE, 1/28: TaxGrrrl has more.

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Want to commit an ordinary tax crime?

January 27, 2011

Peter Pappas runs down the most common types of tax prosecutions.

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State of the Union -- taxed!

January 27, 2011

The President called for corporate tax rate reduction -- without losing revenue -- and made a nod to individual tax reform, but didn't sound like he will lead the charge for tax simplification. He also got on the bandwagon for repealing the hated 1099 expansion enacted for 2012 in his own health care bill. Howard Gleckman at TaxVox pretty much covers it here:

What he said: We need a competitive corporate tax system with low rates and fewer tax preferences that raises the same amount of money as the current corporate tax system.

What he didn’t say: How we’d get there and–except for a passing reference to ending oil subsidies–which business tax breaks he’d repeal. What role business must play in helping reduce the deficit.

What he said: We should simplify the individual tax code.

What he didn’t say: That’d he’d take the lead in such an initiative. Instead he said merely that he would be “prepared to join” a congressional effort to restructure the individual code. This moves the nation about six inches in the direction of a serious rewrite of the tax law.

So -- just words. Dean Zerbe at Forbes says it will be at least two years before the words turn into action.

Robert D. Flach notices that the President's call for tax simplification was almost in the same breath as a call for complication -- a permanent college tuition tax credit.

The Tax Foundation agrees that tax reform is needed, but doesn't think that it's just a matter of beating up oil companies and closing loopholes.

The TaxProf has a roundup and TaxGrrrl has a poll. Kay Bell and Janet Novack ponder what it all means. And Christopher Bergin at Tax.com is just bummed.

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Lessons learned the hard way: why employers should use EFTPS to check their payroll tax deposits

January 26, 2011

EFTPS.JPGWe mentioned yesterday a sad story about small businesses allegedly swindled by their third party payroll provider. But keeping your payroll in-house doesn't always keep you out of payroll tax trouble either, as a case decided yesterday against a Des Moines businessman shows.

The businessman owned a distribution company. Somehow the company got behind on its payroll taxes, but the owner apparently didn't find out until he asked his outside accountant to respond to notices from the IRS looking for the taxes. Then, according to the court, the owner made what proved to be a terrible mistake -- he paid other creditors ahead of the IRS.

Last February a U.S. district court judge in Des Moines ruled that paying the other creditors was a "willfull" act that triggered personal liability for the owner, Charles Colosimo, as a "responsible person." The Eighth Circuit Court of Appeals upheld the decision yesterday. The appeals ruling explains (citations omitted):

"The term willfully does not connote a bad or evil motive, but rather means a voluntary, conscious, and intentional act, such as the payment of other creditors in preference to the United States." Willfulness is generally a question of fact, but if a responsible person knew of payments to other creditors after he was aware of the failure to pay over withholding taxes to the government, his actions are willful as a matter of law.

Being surprised by a bill for unpaid payroll taxes is a severe, sometimes even fatal, blow to a business. It's even worse if you are a "responsible party," because that follows a responsible party even if the business was incorporated. That's why business owners should know how to use the Electronic Federal Tax Payment System to check online to make sure their payroll taxes are current.

Cite: Colosimo, CA-8, No. 10-1593
Link: Prior Tax Update coverage.

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Tax Court: pro gamblers can't deduct net gambling losses, but their other gambling expenses aren't limited to winnings

January 26, 2011

A professional gambler -- arguing without a lawyer -- convinced the Tax Court to overturn an old ruling by allowing the deduction of non-gaming losses.

Gamblers cannot deduct gaming losses that exceed their gambling winnings, the court ruled, and professional status does not change that. But professional gamblers have other expenses away from the table -- travel, for example -- and the court ruled such expenses aren't considered "gambling losses" and aren't limited to gambling winnings. Tax-blogging poker maven Russ Fox has the details.

Cite: Mayo, 136 TC No. 4

UPDATE: Roger McEowen has more.

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More on the 'John Edwards Shelter'

January 26, 2011

The Smartmoney tax blog has a bit of history on the use of S corporations to reduce employment taxes -- the issue in a recent case involving a Des Moines-area CPA.

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Tax Court: the play call wasn't bad, but they muffed the handoff

January 25, 2011

A Denver psychiatrist got together with a tax advisor to put together the tax structure for his practice. What they came up with was an LLC owned 95% by the psychiatrist and 5% by a professional corporation owned by the psychiatrist. The 95% was further split between a 10% "general partner" interest an 85% "limited" interest. A second corporation was formed to receive a "management fee" for services to the entity and to provide deductible and excludable health insurance benefits to the doctor.

One important goal was to limit self-employment taxes -- the 15.3% tax imposed on the self employed in place of employer and employee social security taxes -- to earnings on the 10% "general partner" interest.

The psychiatrist, Dr. Robucci, used a Mr. Carson to put together the structure. And it just might have worked. But it didn't, and the psychiatrist will have to cough up significant taxes and penalties because, according to the Tax Court opinion, the follow-through was lacking:

It is not that Mr. Carson's goal of directing some of Dr. Robucci's income to a third-party corporate management service provider and bifurcating Dr. Robucci's interest in Robucci LLC so that he would be separately compensated for the use of his intangibles was obviously unreasonable. On the contrary, had it been more carefully implemented, it well might have been realized, at least in part.

What went wrong?

Although Robucci P.C. and Westsphere were properly formed under Colorado law to carry out legitimate corporate functions, the fact that they were nothing more than empty shells, devoid of property, personnel, or actual day-to-day activities, i.e., of substance, should have sent warning signals to Dr. Robucci that those corporations were not effecting any meaningful change in the prior conduct of his medical practice.

The taxpayer failed to convince the Tax Court that the corporation actually did anything. As a result, the court disregarded the existence of the corporation for tax purposes and treated the LLC as owned 100% directly by the doctor -- leaving him liable for self-employment taxes on all of the practice income and costing him the tax-free status of his fringe benefits:

The result is that Dr. Robucci is treated as a sole proprietor for Federal tax purposes, which was his status before the formation of Robucci LLC and the corporations. It follows, and we hold, that the net income arising from his psychiatric practice during the years in issue, including any amounts paid to Robucci P.C. and Westsphere [the management corporation], was self-employment income of Dr. Robucci subject to self-employment tax under section 1401.

The court also held that the circumstances of the structure, including the lack of substantial activity in the P.C., should have tipped off the doctor that something was wrong. As a result, the doctor wasn't entitled to rely on the tax advisor and was liable for penalties.

The Moral? A good tax idea isn't worth much unless you follow through.

Cite: Robucci, T.C. Memo 2011-19

UPDATE, 1/31/2011: Marc Ward has more.

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Texas-sized payroll-provider scam

January 25, 2011

Terrible news out of San Antonio for many small businesses, from MySanAntonio.com:

An employee leasing services executive was arrested Monday in one of San Antonio's largest-ever tax fraud cases, accused of keeping $66 million in payroll taxes that should have gone to the IRS.

That means thei IRS will be visiting the leasing service's clients to get that money.

The indictment accuses Mire of having management roles in professional employer organizations (PEOs) that collected payroll taxes from their clients — usually small businesses, mom and pop operations like roofing companies and metal fabricators — that were never paid to the government, along with fees for workers compensation insurance that was never provided.

If you use a third-party payroll provider, make sure that you sign up for the Electronic Federal Tax Payment System so you can check to make sure your payroll taxes are being deposited. If your provider says that their system doesn't let you do that, you may want to find a new provider.

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IRS allows charities with up to $50,000 in receipts to go with 'postcard' filing for 2011

January 25, 2011

The IRS has made life easier for volunteer charity treasurers everywhere by allowing more charities to use the 990-N "postcard" filing instead of a full 990 or 990-EZ. The 990-N is little more than contact information; New Rev. Proc. 2011-15 raises the maximum revenue for the 990-N from $25,000 to $50,000. That makes me happy as it eliminates the 990 I do for my luncheon club for the current fiscal year.

Roger McEowen has the details.

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Counting on Social Security?

January 25, 2011

Don't count on all of it, says Janet Novack at Forbes. I agree.

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New name, same old stuff

January 25, 2011

Governor Branstad proposed eliminating Iowa's Department of Economic Development while campaigning last year. Based on comments from his appointment to run the department, it looks like that might just mean a new name for the same old game.

Debi Durham's complaints about the vote to eliminate the Grow Iowa Values slush fund last week hinted that she wants the state to stay in the game of taxing you to lure and subsidize your competitors. She expands on that in an interview with the Des Mones Register:

"At the end of the day, Iowa will have incentives for job creation," she said in an interview. "And I don't know that they'll look that much different" than what the state has today.

And they won't work any better. The real way to improve Iowa's business climate doesn't give economic development officials much to do.

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Why some corporations don't want lower tax rates

January 24, 2011

Whenever tax reform is proposed -- I mean cutting the rates, broadening the base, and simplifying the system -- opponents will always find corporations against tax cuts. Howard Gleckman explains this seeming paradox at TaxVox:

Keep in mind the statutory tax rate in the U.S. is 35 percent, but companies can often lower their bill thanks to dozens of deductions and credits. At one end were the winners: Cisco reported an effective income tax rate of 19.8 percent, Johnson & Johnson 22 percent, and GE just 3.6 percent. At the other end: Wal-Mart paid 33.6 percent, and Disney paid 36.5 percent–more than the statutory rate.

This all happens mostly because some companies can shift nearly all of their profits to low-tax countries while others, due to the nature of their business, can’t. But whatever the cause, the effect is that the winners are very likely to fight like Tiger Moms to preserve their tax preferences even as they argue for lower rates. Those who get the short end of the tax stick today will use all of their influence to drive down rates and, if they can get away with it, convince Congress to add a beneficial tax break or two.

It would be silly to expect anything different. No CEO who likes his corner office is going to advocate for changes that will reduce his firm’s after-tax income. Such a step would make for a somewhat awkward shareholder’s meeting.

The same dynamic works in Iowa. Some taxpayers in Iowa actually get subsidies from the state through the corporation tax system; five companies received checks over $500,000 in the last six months of 2009. These large and influential taxpayers aren't going to spend much effort to lower the rates for taxpayers unlucky enough to not have big credits to ease the pain of Iowa's highest-in-the-nation 12% corporation tax rate. Sure, the high rates are bad for the state overall, but the winners in the current system will fight to keep it. Don't expect any of the five big research credit recipients to work very hard to pass the Quick and Dirty Iowa Tax Reform.

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I want my free stuff and I want it now!

January 24, 2011

TaxGrrrl often features reader questions in her excellent blog. She doesn't send bills to the people who send her questions. The thanks she gets?

I sent you a tax question three weeks ago. When are you going to answer it?

Her answer is much more polite than mine might have been.

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No 1099-G in your mailbox? You may still have a taxable state refund to report.

January 24, 2011

Missouri is joining other overly-thrifty states by not mailing 1099-G forms to report tax refunds it issued in 2010. Instead taxpayers will have to go to a state web site to see their 1099-G, reports The Missouri Taxguy.

If your business tries to pull that little trick, you can expect nasty penalties from IRS. Don't be surprised if thousands of Missourians get letters in two years asking about that state tax refund that they didn't report on their 2010 1040 when no 1099-G showed up.

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Wall Street Journal spotlights area CPA S corporation court loss

January 22, 2011

Today's Weekend Wall Street Journal picks up on the case of the local CPA who only paid himself a $24,000 salary on around $200,000 in income from his S corporation. He took the rest through his K-1, avoiding FICA tax on the K-1 amount. The U.S. District Court in Des Moines last month ruled that the CPA had to pay employment taxes on an additional $67,000 for two tax years.

The article says the CPA plans to appeal the decision. It quotes him as saying "The IRS can disallow a tax deduction for unreasonably high compensation, but the law doesn't give it the authority to raise pay in order to collect extra payroll taxes." The article adds:

Independent tax expert Robert Willens in New York says this will be a hard argument to win.

The article then goes on to discuss the problems of determining S corporation owner compensation:

What is a fair ratio of profits to pay? There isn't one answer, experts say. A company with substantial capital or assets, such as a manufacturer, often is able to justify lower pay than one selling personal services like a law or accounting firm. Says Mr. Willens: "I would tell a client that for personal services, 70% would be the absolute floor and might not get the job done," he says.

I don't think percentage estimates are that useful. There are many factors that come into play. The argument for paying high compensation would normally be stronger in a professional firm than in a manufacturing or distributive business, because more of the profit would be due to the owners' work. I don't think the IRS can force a struggling business to give its owner a raise to make the salary "reasonable." If you have an absentee owner, or minor children owning interests in a family business, zero can be a reasonable number.

In a professional practice, the place to start is probably the compensation of non-owner professionals. A full-time attorney or CPA owner who gets paid less than the hired help is asking for trouble.

UPDATE, 1/24: The TaxProf has more. The Iowa LLC blog also weighs in.

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Cold and snowy

January 21, 2011

Have a warm weekend!

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On Jordan Creek in West Des Moines. Click image to enlarge.

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New 'Economic Development' Director falls into old ways

January 21, 2011

If we have learned anything about tax credit programs in the last few years in Iowa, it's that they don't work. After the film credit program blew up in 2009, Governor Culver had his agency heads evaluate Iowa's tax credit programs. The report couldn't identify a single tax credit program that clearly had a positive return on the state's investment. Considering the $400 million or so spent on the dozens of credits, that's pretty sad.

But Economic Development officials would have nothing to do if they couldn't take money from existing businesses to lure and subsidize their competitors. So Governor Branstad's new Economic Development Director hates to see cuts in smokestack-chasing tax credits:

Department of Economic Development Director Debi Durham expressed disappointment Thursday that the Iowa House voted Wednesday to cut a key economic development program.

“It's kind of contrary to the whole idea of creating jobs,” Durham said when the topic of the Grow Iowa Values Fund came up during a meeting of the Department of Economic Development Board.

But House Speaker Kraig Paulsen isn't convinced:

"Government doesn't create jobs, except government jobs," Paulsen said.

Why don't these credit programs work? Two reasons. The first is opportunity costs. The money that goes to the subsidized businesses wouldn't have been burned in a furnace; if taxpayers were allowed to keep the money-- instead of giving it to the state to hand out as credits -- they would have spent or saved it according to their own "economic development" needs, and almost certainly more wisely than the state. The subsidies kill that.

The second reason: businesses aren't stupid. Taking money from your taxpayers to troll for new businesses is like taking your wife's purse into a bar to buy drinks for the girls. The girls reasonably assume you'll raid their purses when you get the chance, and any pickups you do get aren't exactly going to be prizes.

If you really want to impress business and make Iowa a place for new businesses to start and prosper, bribes won't work. You need a simple system with low rates -- something like the Tax Update's Quick and Dirty Iowa Tax Reform.

UPDATE, 1/22: Corporate welfare tax credit failures in Pennsylvania and Indiana.

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Iowa film credits: the view from Hollywood

January 21, 2011

Paul Whitefield on Iowa's film tax credit experience in the LA Times:

Among the alleged transgressions: Hollywood types bought a Land Rover and other luxury vehicles with the state’s money; filmmakers used estimates rather than actual expenses, as well as counting out-of-state salaries toward the tax credits; and in one case, someone -- gasp -- “provided no proof of payment for nearly $500,000 in expenses.”

You’re kidding.

This is what happens when amateurs try to deal with professionals. There should be warning signs, like in the car ads on TV: Professional Hollywood people only. Closed-set negotiations. Do not attempt at home, or in Iowa.

Take the Land Rover purchase, for example. Did the folks in Iowa actually think that a big-shot movie producer was going to be content snorting coke in the back of a Chevy Malibu?

Sorry, rubes!

Related: Buy them a Benz and they will come!

UPDATE: TaxGrrrl on film credits at AOL's WalletPop.

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Picking and choosing bonus depreciation deductions

January 21, 2011

Sometimes taxpayers want to take bonus depreciation on some assets, but not others. You have to do it by "asset class," as Paul Neiffer explains.

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Foreign bank addresses for online gamblers

January 21, 2011

The IRS treats overseas online gambling accounts as foreign financial accounts that must be reported on form TD F 90-22.1 -- the "FBAR" form. The form requires you to list the addresses of the foreign "financial institution." This isn't easy to find for online gambling sites, but Russ Fox has compiled a list of online gambling site physical addresses. This is an excellent public service by Russ, but note his disclaimer, too:

Note: This list is presented for informational purposes only. It is believed accurate as of January 1, 2011. However, I do not take responsibility for your use of this list or for the accuracy of any of the addresses presented on the list.

So be careful out there, and think twice about using such an account if you can't get reporting information from them.

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IRS goes secret shopping

January 21, 2011

It's not just big companies that use "secret shoppers." The IRS has them too, as a South Carolina preparer named Scennie Murdaugh has learned the hard way:

Murdaugh caught the attention of the Internal Revenue Service after an IRS fraud detection center identified a pattern of suspicious deductions on the tax returns that she prepared.

Due to these suspicious deductions, an undercover operation was initiated, and an undercover agent went to Murdaugh's business in April 2006.

According to authorities, the undercover agent provided Murdaugh information that should have resulted in a tax due of $762. Murdaugh prepared the undercover agent's tax return and claimed more than $10,000 in false charitable deductions and moving expenses, court documents report.

This may mean the end of Ms. Murdaugh's tax career, but she apparently has other skills. From a recent case in the South Carolina Supreme Court:

The State also called as a witness Scennie Murdaugh, an employee of the club where the shooting occurred. Murdaugh, who was working that night, testified and identified petitioner as the person firing the gun. The trial judge refused to allow petitioner to attempt to impeach Murdaugh with nine alleged incidents of preparing false tax returns, holding these alleged prior bad acts were not probative of Murdaugh's credibility under Rule 608(b), SCRE.

So there's always club work.

Ms. Murdaugh was sentenced to 12 months for tax violations. As she will presumably spend it in a federal facility, she's unlikely to run into her trigger-happy club customer.

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IRS fighting demutualization holding in another venue

January 20, 2011

The switch by many mutual insurers to stockholder ownership in recent years has provided a windfall to many policyholders. The IRS has long argued that insurance company shares received in demutualizations had zero basis. In 2009 the Federal Circuit upheld a Court of Claims decision (Fisher) against the IRS that allowed taxpayers to consider premiums paid as stock basis, reducing their gain when the stock is sold.

The IRS is now litigating the issue in another forum. We are informed that the IRS Office of Chief Counsel has authorized this letter to taxpayers claiming refunds based on the prior Claims Court decision:

Your protective claim for refund in the amount of $______________ for the year____________ is currently held in suspense by this office. As you may be aware, there was a recent decision concerning the basis of stock received in a demutualization, which was affirmed in an unpublished and non-precedential opinion. (Eugene A. Fisher, Trustee, Seymour P. Nagan Irrevocable Trust v. United States, 82 Fed.Cl. 780, 102 A.F.T.R.2d 2008-5608, 2008-2 USTC P 50,481, affirmed Fed. Cir. 2009-5001.) The United States is actively litigating the demutualization issue in another Court (Dorrance v. US, Civil Action No. 09-cv1284-PHX-ROS (D. Arizona)). Once the law on taxpayers' basis in stock received in a demutualization becomes well defined, we will act on your claim for refund. If you are not willing to wait for a final resolution of that issue, you can bring a refund suit after your claim has been pending for six months without the Internal Revenue Service taking action. See Page 2 of Publication 5. We would encourage you to wait until the issue is finally resolved. If it is determined that you are entitled to a refund, you will receive the refund plus interest.

So the demutualization battle continues, and shareholders of insurers like Principal, Prudential and Sun who have filed for refund claims will have to keep waiting.

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Ways and Means opens tax reform hearings today

January 20, 2011

The House Ways and Means Committee kicks off tax reform hearings this morning, reports the TaxProf. Taxpayer Advocate Nina Olson, who recently said that tax complexity is the greatest problem for taxpayers, is scheduled to testify.

The Joint Committee on Taxation has prepared a background book for the hearings. It's a gold mine of current and historical tax data, including some wonderful charts. This one shows the components of the federal revenue stream, illustrating the increasing burden of individual and payroll taxes and the declining role of corporation and payroll taxes:

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This one shows how the slow post-1986 erosion of the tax base has exploded in the last few years:

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The next two should always be read together. First, Top marginal rates since 1970, in current dollars:

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Next, the share of GDP collected as federal taxes since 1934:

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Whether top marginal rates are 90%, 70%, or 28%, it seems that the government's cut of GDP stays between 17% and 20%. That should give pause to those who think federal spending can be sustained at its current level if we would only go after "the rich." We should also ponder the linkage between the plunge in tax revenue in the past few years and the increase in "tax expenditures."

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Sound advice that will be devoutly ignored

January 20, 2011

State tax policy guru David Brunori is no Tea Party guy:

I have always considered myself a liberal in the sense that I believe the government has a role to play in making society a better place. In other words, I do not agree with President Reagan when he said that "government is the problem."

It's not always the problem, but that's the way to bet. Anyway, Mr. Brunori realizes that if you want a big government, you have to be willing to pay for it. And that means you, not some rich guy out there:

First, my liberal friends need to stop making this issue about screwing the rich. I personally do not care if you we have a 99 percent marginal rate – provided it is on more income than I earn. But most Americans do not buy into the class war arguments. No one has the stomach for fleecing the rich guys simply because they are rich. We learned that particularly well in Washington state where the voters overwhelmingly rejected a tax that would have fallen on only the top two percent of taxpayers.

Sound advice. Unfortunately, to many politicians and pundits, it actually is about screwing the rich. When a tax proposal is introduced, the first question for so many is whether it helps "the rich" -- the folks who disproportionally pay taxes -- disproportionally.

Mr. Brunori's whole post is full of tax policy wisdom, but I like his closing paragraph the best:

Government services should be important enough that people are willing (however grudgingly) to pay real broad based taxes. If people are not willing to pay real taxes (i.e., taxes on income, sales, and property) for government services, we should question the value of those services. We should shelter the poor and dispossessed from paying for this burden. But we should recognize that focusing solely on the rich will usually not work.

By all means, read the whole thing.

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And try to fit it all in one grocery bag

January 20, 2011

Excellent advice on what your tax return preparer needs from you by Robert D. Flach.

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You can't take it with you, but maybe your spouse can use it

January 20, 2011

Joel Schoenmeyer explains the new estate tax exemption "portability" rules at Death and Taxes.

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IRS issues Applicable Federal Rate (AFR) for February 2011

January 19, 2011

The IRS has issued (Rev. Rul. 2011-04) the minimum required interest rates for loans made in February 2011:


-Short Term (demand loans and loans with terms of up to 3 years): 0.51%

-Mid-Term (loans from 3-9 years): 2.33%

-Long-Term (over 9 years): 4.15%

The Long-term tax-exempt rate for Section 382 ownership changes in February 2011 is 4.47%.

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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Feeter, Twitbook, or something

January 19, 2011

Follow the Tax Update on Twitter or like us on Facebook, if you dare!

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Is the IRS really writing up cowl lamp violations for S corporations?

January 19, 2011

20110119-1.jpgA few years ago an Iowa county prosecutor got in trouble for prosecuting "cowl lamp" violations. A cowl lamp is an obsolete auto accessory not seen on new cars since the 1930s or so. In that case, the prosecutor was using it as a way to let people off the hook for more serious problems, like drunk driving. When you see law enforcement writing up violations of obsolete and irrelevant laws, something is wrong.

An instructor at a regional CPA school recently identified such a potential tax cowl lamp violation. More disturbing, two IRS representatives at the school said the IRS was writing up penalty notices for that very violation.

A colleague at the school tells me that the IRS reps say the service is writing up penalty violations for S corporations who fail to report the dates of S corporation distributions on their 1120-S filings. They cite Sec. 6037(a) (my emphasis):

Every S corporation shall make a return for each taxable year, stating specifically the items of its gross income and the deductions allowable by subtitle A, the names and addresses of all persons owning stock in the corporation at any time during the taxable year, the number of shares of stock owned by each shareholder at all times during the taxable year, the amount of money and other property distributed by the corporation during the taxable year to each shareholder, the date of each such distribution, each shareholder’s pro rata share of each item of the corporation for the taxable year, and such other information, for the purpose of carrying out the provisions of subchapter S of chapter 1, as the Secretary may by forms and regulations prescribe.

We can only hope they're kidding. The date of an S corporation distribution has been irrelevant in determining shareholder taxes since at least 1982, when the current version of Subchapter S was enacted. If S corporation distributions exceed accumulated S corporation income, triggering corporation dividend treatment, the dividend is pro-rated across all of the distributions for the year under Sec. 1368. Timing might matter if a shareholder is redeemed out for the year, but you don't need to report the timing separately to IRS to determine that.

If the timing of distributions were important to the IRS, you'd think it would be important enough for them to ask for it in their instructions, but nothing in IRS instructions for Form 1120-S through 2009 requires that the timing of distributions be reported. The dates of distributions aren't called for anywhere on the 1120-S or K-1s, and with good reason --- they don' t make any difference. They don't affect the computation of any tax by the corporation, and the shareholders don't need the information.

Yet, according to the IRS agents at the school, the IRS is assessing penalties to some taxpayers for not reporting information because of the obsolete provisions of Section 6037, which was never changed to conform with the 1982 S corporation reforms.

The term for piece of tax law that has been rendered irrelevant by subsequent changes elsewhere in the law is "deadwood." If the IRS is really writing up penalties for failing to comply with deadwood law, while mailing millions in fraudulent tax refunds to convicts in prison, Commissioner Shulman has much more serious problems to deal with than his tax preparer power grab. If a taxpayer of mine were ever hit with such a penalty, I would appeal it based on the language of Sec. 6037(a), saying that by not asking for it in its forms and instructions, the IRS has failed to request the information "by forms and regulation."

Has anybody seen the IRS assert a penalty for not disclosing the dates of S corporation distributions? Respond in the comments or by email.

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A real rabbi commits fake tax fraud -- now that would be news!

January 19, 2011

Russ Fox reports on a fraudulent rabbi who has pleaded guilty to scamming the IRS and state tax agencies out of $4.5 million through an elaborate scheme of claiming refunds for prisoners and dead people: A Fake Rabbi Commits Real Tax Fraud

Berkowitz variously misrepresented to a number of individuals that he worked with that he was a tax preparer, a certified public accountant, a rabbi, an attorney, and/or that he operated a tax preparation business.

The theological implications of equating rabbis with CPAs are staggering.

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Good thing they have extra personnel to divert to preparer registration

January 19, 2011

The TaxProf reports GAO: IRS Telephone Help Wait-Time at 6-Year High

Too bad Commissioner Shulman is too busy with his ridiculous preparer regulation power grab to mind the store.

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'Call it Iowa's Field of Nightmares'

January 19, 2011

The LA Times updates Hollywood on those rubes in Iowa:

The Iowa debacle goes well beyond that of a bribery scandal in Louisiana in which a former top film office official was given a two-year prison sentence in 2009 for steering tax credits to a local producer.

Iowa rapidly expanded its film credit program in 2007, developing one of the most aggressive tax incentives in the country, one that was touted by the local film office as "half-priced" filmmaking. Producers of more than 150 projects applied for funding.

Buy them a Benz and they will come!

In related news, Tom Wheeler and three others named in the updated film indictments issued Friday entered non-guilty pleas yesterday.

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Defending CPA tax pros

January 18, 2011

Robert D. Flach has put up another one of his occasional posts where beats up on my profession:

Don't assume that because a person has the initials "CPA" after his name he is an expert when it comes to federal and state income taxes!

He then spends his next 10 paragraphs elaborating on our shortcomings. And that's fine, to a point. Not all CPAs are qualified tax preparers. By the same token, not every lawyer is capable of defending you on a murder charge. But the guy you want by your side when the state wants to send you to the chair is definitely going to be a lawyer. And while not all CPAs should be your tax advisor, many of the best tax advisors are CPAs.

That doesn't mean everybody should hire a CPA to do their tax returns. Millions of tapayers do just fine going to an unenrolled preparer like Mr. Flach, or a storefront franchise preparer, or by booting up Turbotax. Enrolled Agents are often excellent return preparers. In many cases a lawyer, or a lawyer-CPA, could be the best match for your needs.

Who should consider a CPA? Certainly you should if you run a business; the bigger the business, the more likely it is that you will want a CPA. As you start needing reviewed or audited financials for your lenders or investors, you are likely to engage a CPA firm. There are often cost and convenience advantages of having the same firm help you with your taxes as with your financials. From what I have seen, CPAs are far more likely to have experience in business tax issues, from entity structuring to multi-state and international issues.

Even if you don't have a business, sometimes a CPA may be the right tax professional for you. While you don't have to be a CPA to be a tax pro, and not all CPAs are qualified tax pros, many are. A solo CPA may well be the best tax pro in your community, or she might be the one with the most experience in some issue that you face. And while Robert says we CPAs are expensive, that's not always true -- and when it is, you might find that nothing costs more than cheap tax advice.

As far as competency goes, I think CPAs who practice in tax tend to be more competent than non-CPA preparers (I don't have enough experience with EAs to put them on a curve). If you could chart the competence of tax pros, I believe the chart would look something like this:

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I'm not saying there aren't extremely capable unenrolled preparers -- Robert, for example -- or inept CPAs. You find both colors at each tail of the competence curve. But in my experience, the right end of the competence curve will have more CPAs.

So how should you pick a tax pro? Ask around. Bankers and lawyers often know who the best local tax pros are. Mr. Flach is correct that having initials after your name doesn't necessarily give you tax superpowers. That's just as true, by the way, of having a $64.25 IRS-issued preparer ID number or of passing some Accenture-run tax Trivial Pursuit "competency exam." But it's quite possible that someone with "CPA" after their name is the best pro for you.

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The Swiss Bank Wiki

January 18, 2011

I mentioned yesterday that Wikileaks is set to spill identifying information of some Swiss bank account holders. International Tax Lawyer Phil Hodgen has some thoughts:

1. If your name might show up on Wikileaks as a Bank Julius Baer customer? Do. Not. Wait. One. Day. Get yourself to a lawyer. Don’t whine. Be decisive and act.

2. If you are a Bank Julius Baer customer and you are lucky enough to have avoided Mr. Elmer’s list? Be proactive. Take remedial action, fast.

3. If you feel comfortable at the moment, remember that it just takes one rogue individual to leak your private affairs to the world. Be serious, get serious, and take serious action.

Jack Townsend of the Federal Tax Crimes blog has more.

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Snake-eyes?

January 18, 2011

TaxGrrrl explains how to deduct gambling losses.

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Winter driving conditions Carnival

January 18, 2011

The roads may be slick, but the highway is clear to Kay Bell's new Carnival of Taxes!

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Kay rounds up tax posts from around the blog world on everything from blogging tax deductions to AMT basics. Check it out!

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The Iowa Department of Revenue to-do list

January 17, 2011

After partying their way into office on Friday, the Branstad Administration gets to work this week. One of the new faces is Courtney Kay-Decker, the new head of the Iowa Department of Revenue.

20110117-2.jpgThe Department of Revenue historically hasn't had much of a tax policy-making role; that's up to the Governor. But there is still plenty for the new Director to do to make Iowans' tax lives easier. My suggestions:

Create an independent appeals function in the Iowa Department of Revenue. Now if the Department makes an assessment, going to court is almost the only meaningful way to get a fair hearing.

Redesign forms so they gather the information the Department wants. The Department routinely issues notices to taxpayers with different federal and state AGI, usually a result of U.S. Treasury interest income, muni-bond income, and, sometimes, federal tax payments. If the Department wants a reconciliation of federal and Iowa income, they should redesign the forms in a reconciliation format. You would start at federal AGI and list out the differences.

Redesign the Iowa Capital Gain Deduction reporting forms. Iowa allows taxpayers to exclude certain capital gains from businesses where they have for ten years both "held" the business and "materially participated in it. The Iowa 1040 has a line (line 23) for the "Iowa capital gain deduction." Taxpayers often carelessly assume that they can just deduct all of their capital gains on that line, not just the much less common "10 and 10" gains. As a result, the Department audits almost every Iowa Capital Gain Deduction claim -- an easily avoided waste of time for Department personnel.

Two simple steps would greatly reduce erroneous claims: creating a form with a checklist showing the requirements that have to be met to claim the form (Say, "Form 150"), and then changing the line 23 description to "Form 150 gain deduction." This would help keep taxpayers from carelessly taking deductions they don't qualify for while enabling the department to gather on the new form the information it now gets on audit.

Change the Department's culture to avoid stubborn and stupid tax positions. The Department has irritated judges, exasperated taxpayers and embarrassed itself by clinging stubbornly to foolish and poorly-supported positions over the years. The America Online sales tax fiasco is only the most prominent example, but not the only one. In its now-abandoned positions on taxation of investment income of non-resident partners and the effect of grantor trusts on holding periods, only the threat of litigation made the Department stop being ridiculous. Its bizarre pre-2006 definition of "holding period" continues to be the subject of tax controversy.

Release detailed "sanitized" revenue data. The IRS releases volumes of data enabling private scholars and think tanks to analyze and evaluate tax policy. Iowa has nothing similar. It would be helpful to have annual releases showing amounts reported on tax returns by line, as well as the amounts claimed annually for each tax credit.

Advocate for taxpayers and for tax simplification. Yes, I said that the Department hasn't had a policy role. It should -- if only to point out how adding complexity to the tax system -- for example, by increasing the number of items where Iowa tax law doesn't conform with federal law -- makes life hard both for taxpayers and the Department.

Changing a bureaucracy is never easy; we'll see soon whether the incoming administration wants to even try to change the Department of Revenue.

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Wiki-whistleblowers?

January 17, 2011

If folks with hidden offshore bank accounts didn't have enough to worry about, what with IRS success in breaching Swiss bank secrecy, they now may have another reason to lose sleep. There are reports (see here and here) that a Swiss banker has turned over 2,000 names of customers of the Swiss bank Julius Baer to Wikileaks.

Julian Assange, the Wikileaks operator, has had all sorts of legal trouble for posting secret diplomatic cables on his site. Diplomatic secrets are one thing; secret bank accounts are much more serious. It will be interesting to see whether private efforts succeed in shutting down Mr. Assange where government efforts have failed.

Offshore tax evasion isn't getting any safer. Folks with offshore accounts may want to discreetly contact a good attorney to get things right while it's still optional.

UPDATE: More from the Junior Deputy Accountant.

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Why many employers have overwithheld from their employees this year

January 17, 2011

My new post at IowaBiz.com looks at the 2 percentage-point reduction in the employee FICA tax for 2011.

IowaBiz.com is the Des Moines Business Record's blog for entreprenuers. I'm there twice a month, but there's good stuff there every day.

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Saturday's the new Wednesday!

January 17, 2011

Tax season seems to already be taking its toll on holdout paper return preparer Robert D. Flach. From his blog this weekend:

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While he is struggling with the day of the week (a problem that becomes even more serious as tax season proceeds), he still is doing fine at rounding up worthwhile tax blog posts.

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Inaugural Friday film follies

January 15, 2011

hh44.jpgIowa's Attorney General had a busy day yesterday. He attended the Governor's inaugural in the morning, and took a break in the afternoon to announce another film tax credit scandal guilty plea:

Attorney General Tom Miller Friday afternoon entered into a plea agreement with a newly charged defendant in the Iowa Film Office case. Miller charged Chase Brandau, 25, of Minneapolis, with Theft in the Second Degree, a Class D Felony, through a Trial Information document filed with the Polk County Clerk of Court. Brandau pleaded guilty to the charge and agreed to continue to cooperate with the ongoing investigation of the Iowa Film Office case.

Brandau, Wendy Weiner Runge, Zachary LeBeau, Matthias Saunders own Polynation Pictures and produced the film “The Scientist.” Weiner Runge is charged with one count of Ongoing Criminal Conduct, one count of Theft in the First Degree, and three counts of Fraudulent Practice in the First Degree. Weiner Runge’s trial is currently scheduled for February 7. Felony charges have been dismissed against LeBeau in exchange for his cooperation. Saunders pleaded guilty to the felony charge of Theft in the First Degree in exchange for his cooperation.

A criminal charge is merely an accusation and defendants are presumed innocent until and unless proven guilty.

All owners of Polynation Pictures except Ms. Weiner Runge have agreed to cooperate now, which must make owner meetings awkward. With the knowledge of prosecution tactics that I picked up watching television, it seems that everyone is being flipped to turn against Ms. Weiner Runge. It's possible, though, that they are all being aimed at the designated tax credit scapegoat, former Film Office director Tom Wheeler.

Where crimes have been committed, the criminals should bear the consequences. It would be nice, though, if the 143 legislators who voted for the film program, and the governor who oversaw its implosion, had to accept some responsibility too. No, they shouldn't go to jail, but an abject apology would be appropriate.

Other coverage from the Chicago Tribune.

Related: Let them eat canapes.

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The Governor returns to a familiar return

January 14, 2011

20111114-1Terry Branstad becomes Iowa's Governor again today after a 12-year break. If Rip Van Winkle, CPA had gone to sleep preparing a 1999 return after Tom Vilsack took office and woke with a fresh 2010 Iowa 1040 in front of him, he could get right to work. Even the rates are unchanged, except for inflation adjustments. The instructions on a few lines might trip him up, but he could get zip right along. Until he reached page 2.

On page 2 of the 1040 he would hit a reference to "Form 148" for tax credits. There he would stumble on the biggest change in Iowa's tax law since the last Branstad administration -- the proliferation of targeted tax credits. By my count, the 1999 1040 contained 13 credits of all kinds; the 2010 return shows 36. RVW, CPA would see, among others, a Wind Energy Production Credit, a Soy-Based Transformer Fluid Credit, an E85 Gasoline Promotion Credit, and two Film Tax Credits.

All of this might make him actually look at the instructions, where he would find other new complications that have crept into the Iowa tax law, including special computations in Iowa for taxable social security income. He would also find a whole bunch of items that where Iowa has strayed from the federal rules:

-Educator Expense deduction

-Tuition and Fee deduction

-Itemized Deduction for State Sales / Use Tax Paid

-50% bonus depreciation for property acquired after December 31, 2008 (and 100% -bonus as of 9/9/2010)

-Increased section 179 expensing of $250,000 for tax years beginning in 2009 and 500,000 for 2010 and 2011.

-Increase in the Iowa earned income tax credit for families with three or more children and married taxpayers

-Exclusion of the first $2,400 of unemployment compensation

-Deduction for the one-time registration fee related to the purchase of certain new vehicles

-Tax free treatment of IRA distributions donated to charity

20110114-2.jpgIn short, Governor Branstad returns to the same Iowa tax system he left behind 12 years ago, only even more complicated and loophole-ridden. He returns to an Iowa business tax climate rated the sixth-worst out of 50 states by the Tax Foundation -- bad enough that it will still be worse than Illinois even after this week's big honking tax increase.

Our new old Governor has his work cut out for him. He has urged cutting Iowa's highest-in-the-nation corporate tax rate in half, but other than coming out for a repeal of the scandal-ridden film tax credits, he has focused more on property tax issues than income tax issues.

What should he do? If he asked me for a to-do list, I would suggest, in order:

1. Kill the film credits dead dead dead.

2. Swear off and work to repeal economic development tax credits and targeted tax breaks.

3. Change Iowa's "code conformity" legislation so that federal changes would be automatically adopted in Iowa unless a law is passed to decouple. Now decoupling is the default.

4. Push a business-friendly, simple income tax system -- something like the Quick and Dirty Iowa Tax Reform.

Iowa's income tax needs a re-do badly. Nothing in Governor Branstad's history suggests he's likely to make radical changes. One his top aides is a veteran of Iowans for Tax Relief, a powerful group whose at-all-costs commitment to Iowa's deduction for federal taxes has done much to block tax reform. Unfortunately, if Rip goes back to sleep for another four years, he'll probably have no trouble recognizing Iowa's tax system when he stirs.

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Covering all of the Basis

January 14, 2011

Estate attorney Joel Schoenmeyer explains how the basis rules of the new estate tax law work:

One of the few benefits of the federal estate tax system (from the taxpayer's POV) is that it is accompanied by a step-up in basis. In plain language, that the value of the decedent's property as of the date of his or her death becomes its basis. Basis is no longer the cost the decedent paid for it. An example:
Mary Smith bought shares in ABC Company over 50 years, paying a total of $50,000 for the stock. At the time of her death in 2009, the shares were worth $1,000,000. At Mrs. Smith's death, the basis for the stock became $1,000,000.

Basis is then used to compute capital gain when the property is sold. (If the ABC Company shares are sold after her death for $1,500,000, then there's a taxable gain of $500,000 at sale. If the shares were sold by Mrs. Smith during life for $1,500,000, then the taxable gain would have been a whopping $1,450,000.)

It's part of his series on the new estate tax rules at Death and Taxes.

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Mrs. Congresscritter gets 30 days for tax cheating

January 14, 2011

From The Hill's blog:

The wife of Rep. John Tierney (D-Mass.) was sentenced to 30 days in jail Thursday after pleading guilty to helping her brother engage in tax fraud.

Patricia Tierney, 59, pleaded guilty in October to four counts of helping her brother, fugitive Robert Eremian, prepare false federal tax returns.

The prosecutors seem to think her husband was ignorant. When you see the work they do in Congress, it's hard to argue with that.

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Mystery Tax Theater 3000

January 14, 2011

From the Tax Policy Blog, 1/13/2011:

Former Minnesota Governor Tim Pawlenty has an interesting plan for tax reform: "require every member of Congress to do their own taxes." In response to a question on ABC's "Good Morning America" about reducing the deficit, Pawlenty commented on the complexity of the current tax code. He proposed a system where Congressmen do not get the "help of an accountant, a lawyer or a tax specialist."

From the Tax Update Blog, 9/20/2010, a modest proposal:

- All Congresscritters would be required to prepare their own tax returns. - They would be required to do so on a live, scheduled webcast.

- The webcast would carry a comment bar on one side of the screen, allowing observers to comment real time on the Congresscritter's efforts.

- Congresscritters could use tax prep software, as long as the screen was visible to the internet audience.

- Congresscritters could use paper filing only if an aide were putting the numbers on the screen simultaneous with the paper entries.

- The webcasts and the returns themselves would be available for public viewing.

This would require Congresscritters to feel the pain of their own work, with the added benefit of real-time mockery (and audience assistance).

Done right, it would be like Mystery Science Theater 3000, but even more funny.

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Thanks, Illinois

January 13, 2011

The big honking tax increase passed yesterday in Illinois doesn't reduce Iowa's tax burden, but it at least makes Iowa look a little less bad by comparision. While Iowa still has the 45 best (sixth worst) business tax climate, Illinois will tumble from 23rd best to 36th, reports the Tax Policy Blog.

Looked at properly, though, it makes Iowa's tax system even more depressing. Illinois can pass an enormous tax increase that is likely to stagger that state's economy, but Iowa's same-old tax system is still significantly worse. The new 5% Illinois tax rate and 9.5% corporate rate are below the Iowa rates, even taking into account the benefits of Iowa's deduction for federal taxes.

Legislators, there is an alternative.

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Single-factor apportionment -- one factor too many?

January 13, 2011

New Jersey is planning have its corporate taxpayers allocate their income to New Jersey using the "single factor sales formula," reports David Brunori at Tax.com. Iowa pioneered single-factor apportionment, which taxes corporations by their ratio of in-state sales to total sales. The traditional three-factor formula also took into account the ratios of in-state to out-of state payroll and property. Why is New Jersey doing this?

The Democrats bought into the fallacy that single-factor apportionment will lead to economic growth and job creation. But there is no evidence that watering down the apportionment formula leads to more jobs or more investment.

The idea is to reward locally-based businesses by not including property and payroll in the apportionment base, while sticking it to out-of-state sellers by ignoring their property and payroll. It's a very old-economy way of looking at things.

Defenders of Iowa's highest-in-the-nation corporate tax rate often say it doesn't matter because single-factor apportionment makes up for it. But with 20 or so states using either single-factor apportionment or factors giving extra weight for sales, whatever advantage single-factor provides has eroded. Far better to just ditch the Iowa corporation tax -- a minor factor in the Iowa revenue picture -- and go with the Quick and Dirty Iowa Tax Reform.

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Snowed-in Cavalcade

January 13, 2011

If you can't find the big trowel you need to dig out from the snow, maybe you should just climb on the new Cavalcade of Risk!

20110113-1.jpg

Among the gems in the premier roundup of insurance and risk-management blog posts is Insureblog's visit to the dodgy world of Stranger-owned Life Insurance.

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Florida dentist slow to catch on

January 12, 2011

What is it with Florida dentists? They seem to have tax troubles way out of proportion to their numbers. I don't think you can be stupid and still make it through dental school, but it does seem that you can do so and be remarkably slow to catch on.

That's the case with a Florida dentist featured in a Tax Court case yesterday. He served a four-year sentence for tax evasion, but he still doesn't get this tax thing. The Tax Court was hearing his objection to 75% civil fraud penalties on 14 years of unpaid taxes. It went badly for him:

Notwithstanding his recent incarceration, petitioner's denials and defiance of his tax obligations continued through the time of trial of these cases. He admitted that he did not file returns for any of the years in issue. He did not dispute any of the facts establishing his receipt of substantial taxable income during the years in issue, and his receipt of specific items of income was deemed admitted pursuant to Rule 90 by his failure to respond to requests for admissions.

He hasn't exactly become remorseful:

Petitioner argues that he had no intention of breaking the law and that his admitted failure to file returns was not fraudulent. His filings and his testimony are replete with implausible and inconsistent explanations of his behavior. He claims that he acted in accordance with the directions of the "trustees", but there is no evidence that anyone other than petitioner and his wife controlled any of the transactions or earned any of the income attributed to him. He admits that the trusts were funded by "gifts" from him, that his personal expenses were paid from trust bank accounts, and that properties purchased in the names of various trusts were used by him for professional and personal purposes. According to his testimony, the beneficiaries of the trusts were his children and grandchildren. He claims that his accountant made mistakes reporting pension plan distributions, and he asserts that his criminal conviction resulted from false testimony. He asserts that


My decision to quit paying the tax was made in 1992, not before, and was the result of a letter sent, asking for the basis for their taxing me which received a reply after about 3 months, which was no answer to my question, but simply stated to ignore any correspondence received from them until I received an answer.

That sounds like somebody who sent one of those stupid "show me the law" letters to the IRS and then stopped paying taxes when the IRS didn't take it seriously.

He also asserts the venerable, "I did nothing wrong, and it's the accountant's fault anyway" defense:

In a statement at the conclusion of the trial, he alleged that he was a "victim" of tax shelter promoters at some unidentified time, that thereafter he was repeatedly audited, that he was convicted because of misconduct by his accountant, and that his object was "civil disobedience".

Using a "complex scheme" of trusts and multiple bank accounts to hide money for 14 years seemed like a funny form of civil disobedience to Judge Cohen:

Petitioner's excuses are unpersuasive, and we do not believe that he acted as he did for nonfraudulent reasons. He has not presented evidence of any consultations with competent tax professionals or reliance on any legal authority for his positions. He incorporated boilerplate frivolous arguments about the Paperwork Reduction Act in his petition and alleged in his pretrial memorandum that the IRS lacks delegated authority to collect tax. Perhaps he believes that feigning lack of understanding or sincere beliefs will help him avoid the consequences of his deliberate choices. In view of his education, sophistication and success in conducting his profession and business transactions, persistence after his criminal conviction, and acknowledged "civil disobedience", we reject any suggestion of good faith.

The Moral? If four years of prison time and $775,000 of civil fraud penalties won't convince you that the income tax is real, you have serious issues with reality.

Cite: Goldston, T.C. Memo. 2011-9

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Out of death comes life

January 12, 2011

The estate tax changes enacted last month have stirred the Death and Taxes blog to life with "25 Things You Need To Know About The New Estate Tax Laws." Here's Thing 6:

6. The exemption amount for decedents dying in 2011 or 2012 is $5 million. So, to take an example:

John Smith is a widower with two kids, Sam and Dave. Sam and Dave are John's only beneficiaries under his Will. John leaves an estate worth $5 million when he dies on January 18, 2011. No federal estate tax will be due at John's death. If John's estate was instead worth $7 million given the above facts, an estate tax would be due on $2 million (the amount by which John's estate exceeded the exemption amount for 2011).

Read the whole, er, things.

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Illinois jacks up income tax; still broke.

January 12, 2011

After years of reckless spending and delusional pension bookkeeping, Illinois politicians sent their taxpayers the tab this morning, reports the Chicago Tribune:

Under the bill that went to Quinn, the current 3 percent personal income tax rate would go to 5 percent until 2015, when it would drop to 3.75 percent. To gain more support among lawmakers, the plan would further lower the tax rate in 2025 to 3.25 percent.

For businesses, the current 4.8 percent corporate rate would go to 7 percent until 2015, when it would drop to 5.25 percent. [ed: it's really worse: the true rate goes from 7.3% to 9.5% for 2011)

The plan calls for the corporate rate to fall in 2025 to the current 4.8 percent.

The tax increases, which would take effect retroactively to Jan. 1, would raise an estimated $6.5 billion over a full-year period.

But this is being coupled with spending cuts to restore the state to solvency, right?

Sen. Emil Jones III, D-Chicago, said black senators received a promise from Quinn that he would designate $250 million more to education over each of the next four years.

Poor Illinois, stuck with a corrupt bipartisan ruling class and without a clue.

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Snow buzz

January 12, 2011

Noted "Jersey Shore" fan Robert D. Flach has posted his Wednesday "Buzz" roundup of tax blog posts. Check it out.

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He never would have done this if he had to take a competency test and send $14.25 to Accenture

January 12, 2011

A man who set up a tax service after spending 18 years working at the IRS has pleaded guilty to inflating deductions. From Delewareonline.com:

Investigators say Bright routinely included false deductions and credits on his clients' tax forms that included education credits, IRA deductions, charitable donations, unreimbursed business expenses and earned-income tax credits.

In addition, Bright falsely reported married taxpayers as single or head of household to take higher deductions.

Surely he misbehaved only because he never took a competency test that would have tested his knowlege of the size of the standard deduction.

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Iowa Film Fiasco felonies? Wheeler charges upgraded, more film figures charged

January 11, 2011

Things got much more serious yesterday for former Iowa Film Office Director Tom Wheeler. The Attorney General's office dropped the former misdemeanor malfeasance charge against the besieged bureaucrat and replaced it with three seven felony misconduct charges related to the now-suspended Film Tax Credit program.

The Attorney General also charged film credit broker Chad Witter with scandal-related charges -- the first brought against an industry middleman. Two film industry figures -- Bruce Heppner-Elgin and Dennis Brouse -- also were hit with felony charges. Rod Boshart reports:

In the five felony counts brought against Witter and Brouse, prosecutors allege they knowingly made false statements for the purpose of procuring state economic development assistance for the Changing Horse film entity and did take possession of property exceeding $10,000 in value belonging to the state by unlawfully reporting fraudulent or inflated spending claims for tax credits.

...

The five felony charges against Heppner-Elgin allege he knowingly made false statements for the purpose of procuring state economic development assistance for “The Offering” and “Splatter” film projects, and that he did take possession of property exceeding $10,000 in value belonging to the state by unlawfully reporting fraudulent or inflated spending claims for tax credits. Court records indicate he drafted and submitted “deal memos” which, by falsely inflating expenditures, enabled Iowa Film Production Services to obtain about $5 for every $2 that it actually spent.

While I cannot find the actual charges on-line [UPDATE: see A.G. link below], it wouldn't be surprising if they follow a road map laid down in the State Auditor's report from last October. That report said that Mr. Brouse's production company, working with Mr. Witter, approached Kent Feeds (report page 26):

According to the Kent Feeds representative, they declined to sign the contract for the first project which included the $1,000,000.00 value. The representative stated he told Mr. Witter the amount was grossly overvalued and they would not sign the contract. After the value was removed, Kent Feeds signed a contract which did not include a value for the sponsorship.

According to the report, the production company claimed film credits based on the $1,000,000 value anyway.

The Auditor's report said that Mr. Heppner-Elgin's Iowa Film Production Services claimed tax credits for $7.8 million in non-qualifying expenses, including $1.3 million for which the Auditor found no proof of payment (Report page 32).

Mr. Heppner-Elgin was an early booster of the film credit. He showed up in a Tax Update post from January 29, 2007 (I believe my first [UPDATE: No, this was first] post on the Iowa Film Credit proposals), where I quoted from a no-longer available article in the Iowa City Press Citizen:

Business subsidies are bad enough when the business is going to stick around, but subsidies for people who you know will pack up and leave at the end of a project? Maybe we should just pay California taxes and skip the middlemen.

Then there's this [from the Press Citizen]:

Bruce Heppner-Elgin, founder of the Iowa Digital Filmmakers Guild and a Washington resident, knows of dozens of filmmakers across the state who will be lobbying for the bill to pass.

"The film incentives are very important in that they first off give a level playing field so we can compete with states around us," Heppner-Elgin said. "There is money out there that Iowa is missing."

Nothing compared to what will be missing when Harold Hill leaves town.

Well, you 143 legislators who voted for this program (only 3 voted "no") -- we tried to warn you.

UPDATE: The Attorney General's office now has a web page up for the new charges. They are serious indeed, with "Class B" felonies, punishible by up to 25 years in prison, asserted against Mr. Heppner-Elgin, Mr. Witter, and Mr. Brouse. Mr. Witter faces up to 10 years. The Trial Information documents, all PDF format:

Wheeler
Heppner-Elgin
Witter and Brouse

Other Coverage:

Des Moines Register
Forbes

Tax Update Film Coverage highlights:

HAROLD HILL GULLS THE HOUSE (4/11/2007)
Why 'Cash for Clunkers' is like the Iowa Film Credit (8/7/2009)
Let them eat canapes (8/25/2009)
Buy them a Benz and they will come! (9/18/2009, the day the scandal broke)

Complete Tax Update Film Credit Coverage

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Tax Court: the salesman's pitch isn't going to get you out of tax shelter penalties

January 11, 2011

The Tax Court yesterday ruled that a taxpayer who invested in a bad tax shelter couldn't rely on the opinion of his lawyer -- who got a fee for selling the deal -- to avoid penalties. Judge Holmes explains how the advice of attorney Garza and accountants Turner and Stone fell short (my emphasis):

We find that both these advisers not only participated in structuring the transaction, but arranged the entire deal. Garza set up the LLCs, provided a copy of the opinion letter, and coordinated the deal from start to finish. And both Garza and Turner & Stone profited from selling the transaction to numerous clients. Garza charged a flat fee for implementing it and wouldn't have been compensated at all if Palmlund decided not to go through with it. He wasn't being paid to evaluate the deal or tweak a real business deal to increase its tax advantages; he was being paid to make it happen. And Turner & Stone charged $8,000 for preparing Palmlund's tax returns -- $6,500 more than usual. The extra fees were not attributable to an extraordinarily complex return -- Palmlund's returns were always complex due to his various business interests -- but, we find, were the firm's cut for helping to make the deal happen. Because Palmlund's advisers structured the transaction and profited from its implementation, they are promoters. Palmlund therefore could not rely on their advice in good faith.

The moral? If the drug dealer tells you it's legal, you'll still get in trouble for smoking dope, and if the promoter tells you the tax shelter is legit, that doesn't help if the judge finds otherwise.

Cite: 106 Ltd., 136 T.C. No. 3

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Tea parties and tax reform

January 10, 2011

Is there a principled small-government position on tax policy?

Martin Sullivan says the fight over the Ethanol and biofuel subsidies in the Bush-era tax extension bill last month previews a split in Republican ranks on tax policy:

In one side were the farm state legislators trying to keep corn prices high and the profits flowing from ethanol distilleries all over the Midwest. Their ringleader was Senate Finance Committee ranking minority member Chuck Grassley, R-Iowa, who was just reelected to his sixth term with 64.5 percent of the vote. He cosponsored legislation with Senate Budget Committee Chair Kent Conrad, D-N.D., to extend the credit, along with tariffs on imported ethanol, for five years.

But for the first time, there was serious opposition to the three-decade-old ethanol subsidy: The Tea Party Movement:

"If you're wondering which of America's leaders are serious about cutting wasteful government spending, you might start by examining who's behind the effort to extend tax breaks to America's corn ethanol industry," wrote Tea Party activist Tammy Henry on her blog. David Horowitz on Redstate.com, another right-leaning blog, blasted conservatives for allowing inclusion of ethanol subsidies in the tax bill: "If Republicans lack the will to strike out at the heart of the dependency and welfare state after a stunning electoral victory, then when will they assert themselves?" And similarly from Lurita Doan on the conservative website Townhall.com: "Why allow pork, such as the ethanol subsidy, to besmirch GOP efforts to restore fiscal sanity?"

Mr. Sullivan notes that some folks identified with libertarianish outfits, like Cato's Michael Cannon and Americans for Tax Reform's Grover Norquist, are unabashed loophole lobbyists. That's a position I've always found puzzling. If you don't think the government is competent to control the economy by writing checks to favored industries, why would you think they should try to do the same thing with targeted tax breaks? Spending is spending, and running it through a tax return doesn't change it into something better.

Mr. Sullivan can't resist some of the conventional nonsense about the Tea Party movement:

... the Tea Party is more famous for passion than for logic...No doubt the reform-minded academic highbrows will be squeamish about allying themselves with the anti-intellectualism of the Tea Party.

Mr. Sullivan doesn't identify the towering intellectuals in Congress or elsewhere that the Tea Party is against. It's hard to see where reliance on intellectual rigor has been a big part of politics since maybe 1789. For what it's worth, the Tea Parties would claim a few intellectuals in their corner, like Hayek and, in their view, Jefferson, Locke and Adam Smith.

Still, Mr. Sullivan accurately notes the tension illustrated by the ethanol debate. It's broader than an intra-party squabble. It's a battle between outsiders and insiders. As he points out, "Targeting tax breaks to favored constituencies comes naturally to politicians." To many traditional Republicans, the battle for power is just a fight over who controls the goodie faucet. The Tea Party activists want the faucet shut off.

The TaxProf has more.

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A 75% increase in the Illinois income tax?

January 10, 2011

They're thinking about it. They're also looking at a 49% increase in their corporation tax. With a third-world quality state government, things aren't looking good for our neighbors.

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Family values: 33 month sentence for wife, but only 24 months for mistress

January 10, 2011

With both his wife and his mistress -- and his kids by the mistress -- living in his house, Ohio real estate magnate and convicted tax evader Thomas Parenteau probably never lacked for dinner-table conversation topics. Now a federal judge has made an already interesting domestic situation even more interesting by sentencing the wife to more prison time than the mistress for their roles in his tax evasion.

The Justice Department press release reports that Mrs. Parenteau received a 33-month sentence lasst week. The other woman, Pamela McCarty, received only a 24-month term.

Why the difference? We can guess from the press release:

Marsha Parenteau conspired with her husband, his accountant Dennis Sartain, McCarty and others to launder unlawful proceeds generated from nearly $19 million in fraudulently obtained loans against a personal residence.

Marsha Parenteau was called as a witness by her husband at his trial in July 2010, in which Thomas Parenteau was convicted of conspiracy to commit tax fraud, money laundering, bank fraud, obstruction of justice and other felony charges.

...

According to court testimony and documents, McCarty was a real estate agent, whom witnesses during court proceedings described as Thomas Parenteau’s mistress. McCarty previously pleaded guilty to conspiring with other individuals at Your Home Source, real estate brokerage company, to defraud the United States by impairing and impeding the IRS by falsely understating amounts paid to workers. McCarty also admitted conspiring with Thomas Parenteau, Marsha Parenteau, Sartain and others to launder unlawful proceeds generated from more than $6 million in fraudulently obtained loans against a personal residence...

McCarty participated pro-actively with the government in the investigation of the Parenteaus and Sartain by wearing a recording device and taping conversations with her co-conspirators.

So the other woman didn't remain loyal. How about that. But as bad as a 24 or 33-month sentence is, they came out much better than Mr. Parenteau's accountant, who got 11 years. Mr. Parenteau hasn't been sentenced yet, but if the accountant got 11 years, his domestic arrangements may well be simplified for quite some time.

Related: Taxes might have been the least complicated part of this relationship

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Is it smart for Farmers to file by March 1 to skip estimated payments?

January 07, 2011

Farmer-CPA Paul Neiffer isn't so sure:

These days, many of the form 1099′s needed to file an income tax return are not received until late in February and in many cases, several corrected form 1099s are mailed during March. By filing on March 1, the farmer may end having to file an amended tax return and may get in such a hurry to get the return done, that many deductions might be missed.

That might mean farmers should file estimated tax by January 15 for all of last year -- a sweet deal unavailable to us non-farmers, who have to pay throughout the year. Read Paul's whole post for details.

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Regulatory response to failure: do what failed nationwide!

January 07, 2011

Californian Russ Fox:

There’s a debate over whether licensing tax professionals will do any good. California requires all tax professionals to have licenses, and we have plenty of Bozo tax preparers.

But when we all send $14.25 to Accenture, preparer regulation will surely eliminate bozo preparers nationwide.

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I'm still probably a hamburger-chomping moron and imbecile, though

January 07, 2011

When I posted about a report of IRS employee Albert Bront threatening to kill some of his fellow G-men, a reader added perhaps the most epic Tax Update reader comment ever. A taste:

How pathetic is it that the greatest country founded on the principles of individual freedom, liberty and the presumption of innocence, has degenerated to a point where imbeciles with an I.Q. of a shoe size (yes, I do mean you Joe Kristan) cast aspersions about people they know absolutely nothing about based solely upon lies and propaganda of the omnipotent big brother. Joe the moron, had you even tried scratching the surface of the story that you cobbled together about Mr. Bront, you would have found out that Mr. Bront was not a collection agent, but an International Examiner with 26 years of loyal, dedicated and devoted service at the highest level, a slew of performance awards and hundreds of millions of dollars in additional tax revenues generated for the very same agency that, based upon a libelous claim of a jilted, envious, crazy and Prozac taking ex-wife, used Gestapo tactics to provoke an altercation during the execution of the illegally obtained search warrant

And:

The hamburger chomping, malleable morons of your ilk, no doubt, have been licking their fingers from the juicy tidbit you posted about the 'rogue' IRS agent, but a simpleton like you would not even deign, or has the mental acumen, to find or print the truth.

Yes, there's more, much more. Anyway, Albert Bront has pleaded guilty to one count of filing a false tax return for himself and two counts of assisting in preparation of false tax returns. From Forbes:

Blont was more creative than many. Sure, he left off income. But according to court documents, he took a $17,000 mortgage interest deduction concerning a house–a gift from his mother–that in fact had no mortgage. He claimed a $12,000 deduction for alimony that in fact was not paid.

Other reported ploys included filing phony tax returns in the names of relatives who thought he was just being helpful and pocketing $10,000 in claimed refunds.

Now that doesn't mean I'm not a hamburger-chomping moron, cretin, etc., but this does add context that readers may find useful.

Hat tip: TaxProf and reader Mike.

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Depreciation questions from yesterday's class on the new tax law, or, no, you can't convert that big SUV to personal use after taking 100% bonus depreciation

January 06, 2011

Roger McEowen and I yesterday presented a seminar-webcast through the Iowa Bar Association on the new tax law extending the Bush-era tax cuts. I had never presented a webcast before, and it was a bit strange. We had an in-room audience of 6 or 7, and over 300 over the wire. I think it went all right, and we got some great questions that are worth repeating.

If a taxpayer enters into a contract to build a new machine shed prior ot September 8th, but it is not completed or placed into service until after September 8th, does the 50% Bonus or the 100% Bonus apply? Does it make any difference if there is a down payment made when the contact was signed?

This is sort of a trick question. Assuming the property is qualifying property -- that is, with a life up to 20 years, rather than 39-year real estate -- if construction is under way by 9/8, or it was under contract, it only qualifies for 50% bonus. That could possibly be the case with an agricultural structure, but probably not otherwise. A down payment should make no difference. Correction: as noted in the comments, the Joint Committee on Taxation says that property placed in service after 9/8/2010 qualifies for 100% bonus depreciation as long as there was no binding contract in place at 1/1/2008.

Can 50% bonus depreciation be elected after 9/8/10 in lieu of 100% bonus?

The law as written doesn't provide a choice of 50% depreciation for assets qualifying for 100% depreciation.

Perhaps the most interesting question:

Does 100% bonus depreciation get recaptured if a piece of property is converted to personal use after the first year?

This question arose after I had explained that there appears to be nothing that keeps you from taking 100% bonus depreciation on the cost of a "large" sport-utility vehicle, one big enough (>6,000 lbs) to not be subject to the limits on deductions for passenger automobiles. The unstated thought: buy a big SUV, use it for business one year, deduct the whole thing, and take it home on January 1 next year.

Interestingly, the general rule of the tax law is that there is no recapture of bonus depreciation. Old temporary regulation Sec. 1.168(k)-1T(f)(6)(iv) covers that issue. The regular depreciation rules normally work the same way (old Reg. Sec. 1.168(i)-4(c)).

BUT!

While the big sport-utes aren't subject to the Sec. 280F depreciation limits for passenger cars, they are still "listed property" under Sec. 280F(d)(4):

(A) In general. Except as provided in subparagraph (B) , the term “listed property” means—

(i) any passenger automobile,

(ii) any other property used as a means of transportation

If the business use of listed property falls below 50% in any year during its life, Section 280F(b)(2) requires you to recapture into income all depreciation you have taken in excess of the amount that you would have been allowed under the "alternative depreciation system" -- that is, computed on a straight line basis over (for an SUV) a five-year life, with the first year counting as a half-year. So for a $50,000 SUV, if you took $50,000 bonus depreciation in Year 1 and took it out of service in Year 2, you would have $45,000 of taxable income in year 2.

So, clever idea, but nope.

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Mother Jones' Fables

January 06, 2011

From Mother Jones:

Arriving at the Capitol on Wednesday to witness the Ohio Republican take the Majority Leader's gavel was Dennis Albaugh, an Iowa business scion known as "the prince of pesticides" and ranked by Forbes as the 105th richest American in 2008.

From Dictionary.com:

sci·on    /ˈsaɪən/ [sahy-uhn] –noun

1. a descendant.

2. Also, cion. a shoot or twig, esp. one cut for grafting or planting; a cutting.

That implies that Mr. Albaugh inherited his money, and is just a fat cat of leisure out to preserve his underserved millions. Not quite, as Forbes explains:

The Prince of Pesticides. Iowa farmboy shunned family business when older brother took over for parents; earned 2-year agriculture business degree from Des Moines Area Community College. Spent 7 years selling fertilizer, seeds for local coop; then salesman for Thompson Hayward. Founded Albaugh Inc. 1979. Mortgaged home to buy a truck and weedkiller to sell to a customer in South Dakota. Truck sprang a leak; entire supply vanished by end of trip. Rented new truck, chemicals with credit; broke even. Barely turned a profit throughout the 1980s. Began selling glyphosate, the main ingredient in Monsanto's Roundup herbicide, in 2001, soon after chemical went off patent in the U.S. Bought factory in Argentina to manufacture glyphosate, gain edge over competition.

Yep, just your typical trust baby with an Ivy League education and inherited wealth. Except for the trust part, and the inheritance, and the 2-year DMACC degree.

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2011 College Savings Iowa deduction max set at $2,865

January 06, 2011

The deduction for contributions to the College Savings Iowa Section 529 plan for Iowa individual tax returns has been set for 2011 at $2,865 per donor, per donee. The amount was $2,811 for 2010. That means a married couple with two children can deduct $11,460 in CSI contributions for the kids this year. Radio Iowa has more.

While you have until year-end to make your 2011 contributions, making them sooner means you get the advantage of tax-free investment buildup longer. You can also contribute more than the maximum deductible amount. There is no deduction on the federal return, but CSI provides all of the usual benefits of Section 529 plans.

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Waterloo Dentist ESOP meets its Waterloo

January 05, 2011

An Iowa dental professional corporation is learning that Employee Stock Ownership Plans aren't for the faint of heart. The Tax Court yesterday allowed the IRS to strip the corporation's ESOP of its tax-exempt status going all the way back to 1987. Tax Court Judge Laro lays out the background:

Petitioner is a professional corporation that reports its income and expenses on the basis of the calendar year. It employs its principal shareholder, Michael C. Hollen (Dr. Hollen), as a dentist and as a corporate officer. Its principal place of business was in Iowa when the petition was filed.

Petitioner began sponsoring the ESOP on November 1, 1986.2 The ESOP's administrator is Dr. Hollen; he also is the ESOT's trustee. The ESOP's plan year initially ended on October 31 but was changed in 2001 to end on December 31. As of its plan year ended December 31, 2002, the ESOP had 15 participants and/or beneficiaries.

The ESOT's primary asset was stock in petitioner.

The Tax Court ruled that the plan was disqualified for four separate reasons, each of which by itself could be grounds for disqualification:

- It failed to amend its plan document to keep up with tax law changes.
- It failed to credit participant accounts under the plan vesting schedule.
- It failed to use an independent appraiser
- It allocated amounts to the dentist in excess of the amounts allowed under the tax law.

Many ESOPs were set up in Iowa in the 1980s by a former associate of this ESOPs' appraiser; the case doesn't say whether this is one of them, though the timing of the plan set-up coincides with that associate's career. That associate was later enjoined from ERISA practice by the Eighth Circuit. Perhaps not coincidentally, Iowa has been a hotbed for ESOP litigation (see here and here, for example). Some of these ESOP companies have learned the hard way that while they have important tax advantages, ESOPs exact a considerable compliance cost -- and if you don't pay that cost, the consequences can be severe. It's daunting to imagine the income and excise tax cost of an employee plan disqualified all of the way back to 1987.

Cite: Michael C. Hollen DDS PC, T.C. Memo. 2011-2

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Why stop prisoner tax fraud when you can beat up on law-abiding preparers?

January 05, 2011

Interesting set of priorities you have, Commissioner Shulman. You have committed enormous institutional resources to imposing a massive new preparer regulation and registration regime. You are forcing practitioners to spend millions of dollars and hours in pointless paperwork on pain of being put out of business. Meanwhile, you let actual criminals -- in prison -- steal millions by filing fraudulent tax returns:

The IRS has not shared prisoner tax return information with Federal and State prison officials to help combat tax fraud by inmates. ... The Inmate Tax Fraud Prevention Act of 2008, signed October 15, 2008 and amended in July 2010, provides the IRS with the authority to disclose information on prisoners who have filed a false tax return to the head of the Federal Bureau of Prisons and State departments of corrections. The law also requires TIGTA to provide Congress with a report on the IRS’s progress in sharing prisoner tax information.

TIGTA found that the IRS had not provided any information on prisoner returns to either the Federal Bureau of Prisons or State Departments of Corrections as of October 2010. Prison officials told TIGTA that receiving Federal tax return information on prisoners would help reduce both tax fraud and other illegal activity....

TIGTA also found that the IRS may have understated the amount of prisoner tax fraud in a 2009 report to Congress. In that report, the IRS identified 44,944 false/fraudulent prisoner tax returns during Calendar Year 2009. However, the IRS’s report was limited to only those tax returns the IRS identified and chose to evaluate for fraud. TIGTA identified 540,984 tax returns that were filed by prisoners in 2009, of which 54,410 were not identified by the IRS as having been filed by a prisoner.

Well, at least we have the comfort of knowing that all legal preparers will have to pay $64.25 for our PTIN fee, including the $14.25 paid to Accenture to administer us.

Via the TaxProf. More from The Examiner and Instapundit.

Related: IRS continues power grab, but hands out indulgences

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Off the forbidden list?

January 05, 2011

Now that TaxVox has moved to a new blogging platform, my links there seem to work. Before when one clicked a Tax Update link to TaxVox, an error message appeared. Time will tell if they no longer hate me, or if they just need to tweak their software to reject our links.

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Sweet deal in North Liberty

January 05, 2011

Something weird is happening in North Liberty, Iowa. From the Iowa City Press-Citizen:

A group of North Liberty residents and business owners filed a petition in November for a temporary injunction to halt a sales transaction for land on the city's west side.

The city plans to partner with the 380 Development Group to purchase 64 acres of land for $11 million and then sell 24 acres to the UICCU for $1.

UICCU is a credit union.

So the city will give an $4+ million gift to a tax-exempt business that competes with other taxable banks in the area. One developer and the credit union benefits, while all of the other taxpayers in town, including unsubsidized competitors, pick up the tab. That just seems crazy.

I hope this item from the story isn't true:

During the three-hour hearing, the city argued that its method for pursuing the project was standard for municipalities.

If so, it's no wonder people are complaining about commercial property taxes. It's not cheap to buy prime development land to give away, and when you do somebody gets stuck with the tab.

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IRS continues power grab, but hands out indulgences

January 04, 2011

The IRS preparer-regulation isn't really about improving the quality of tax returns. If it were, it would concentrate on policy improvements, compliance-friendly regulation, and an information technology system that would enable it to spot patterns of problem return preparation as the returns are filed.

No, it's all about the power. That's why the the new rules apply to preparers across the board, the compliant and the non-compliant, the competent and the incompetent, alike.

But power is also about handing out favors. The IRS handed out a favor to the legal and accounting industry, and to enrolled agents and actuaries, in its newly-issued rules for preparer registration last week. The new rules (Notice 2011-6) back off the "competency test" requirement for non-signing preparers in law firms, accounting firms, actuary firms and enrolled agent practices. Tax Analysts reports ($link):

Particularly favorable to much of the return preparation industry is that the new rule excludes such supervised staff from the competency exam and continuing education requirements set out in proposed regulations on Circular 230 standards of practice. That issue was raised repeatedly in public comments and hearings on the PTIN regs. Such supervised individuals will be treated as subject to the ethics rules of Circular 230 -- disreputable conduct, for instance -- but are not permitted to practice before the IRS or sign tax returns, the IRS said.

This will be a huge help in accounting firms, where new accountants often prepare the initial draft of returns to be reviewed and signed by partners. Under the original rules, interns or new professionals who have yet to pass the CPA exam would have had to pass the as-yet-to-be-determined "compentency test" before they could help on tax returns. Auditors who prepare schedules used on corporate returns might also have been subject to the new rules. No more.

It's nice that one of the more foolish parts of the preparer regulation regime is gone, at least for now. Yet the foolish system itself remains in place. Like airport security, it burdens the non-offenders with an elaborate compliance system that's mostly for show, while doing little to actually make anybody safer.

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Bottomless Mimosa Carnival!

January 04, 2011

The New Year's festivities may be a blurry memory by now, but your glass is always full at Kay Bell's Carnival of Taxes.

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You'll find timely posts on everything from 2011 tax changes to ways to reduce your small business taxes this year. Party on!

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Frying KFC

January 04, 2011

Roger McEowen of the ISU Center for Agricultural Law and Taxation is not impressed by last week's Iowa Supreme Court ruling subjecting KFC to Iowa's income tax:

That is plainly a policy-based argument. Policy decisions are to be left for elected officials, not the Court. That’s particularly the case when there is a U.S. Supreme Court opinion squarely on point to the contrary.

Joseph Henchman of the Tax Policy Blog chimes in on Iowa's position:

The states that have adopted this aggressive posture argue correctly that Quill directly involves only sales taxes. But the principles raised by the Court in Quill-the risk to interstate commerce of states overstepping with their tax powers-apply equally to any tax. It's silly to think that the states are severely limited with sales taxes but can do whatever they want with corporate income taxes.

Not too silly for the Iowa Supreme Court.

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Do you really want that 1-percent LLC owner to have as much voting power as the 99-percent owner?

January 04, 2011

That's the default provision under Iowa's LLC law. Rush Nigut explains.

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Start your 2011 year-end planning now!

January 03, 2011

So I say at my new post at IowaBiz.com. The Tax Update is taking today off, resuming regular programming tomorrow.

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