The kennel must be pretty empty at Iowans for Tax Relief, "The Taxpayer's Watchdog." The Iowa Republican reports:
In the last week, the following ITR members have resigned:
Edward D. Failor, Jr – President, Iowans for Tax Relief
Katie Koberg-Vice President, Iowans for Tax Relief
Mary Earnhardt-Policy Director, Iowans for Tax Relief
Eric Branstad – Development Director, Iowans for Tax Relief
No doubt they all will go on to influential jobs elsewhere in politics. Meanwhile, we'll go down memory lane for my lone encounter with the head dog, Ed Failor, Jr. From the Tax Update archives, April 10, 2010:
Yesterday's post on tax issues in the Iowa Governor's race lamented the candidates' timid approaches to income tax reform:« Close ItFar better to adopt the key planks of the Quick and Dirty Iowa Tax Reform:
- Eliminate the corporation income tax
- Lower the to individual rate to 4 percent or less.
- Eliminate all corporate welfare and special interest tax breaks
- Allow Iowa S corporations to elect to be C corporations, taxable only on distributions to Iowa residents, for Iowa filing purposes.
This would require ending federal deductibility, the sacred cow of the powerful lobby Iowans for Tax Relief, and it would take away annual taxpayer checks to influential corporations via the refundable Research credit. That probably explains why candidates are reluctant to do the right tax policy thing.
That prompted a phone call from an unhappy Ed Failor, Jr., President of Iowans for Tax Relief, who felt this was unfair to his organization. I explained that I thought IFTR's hardline position in favor of deducting federal taxes on the Iowa return was an obstacle to improving Iowa's tax system. He said that IFTR was willing to give up deductibility if there were adequate protections against subsequent tax rate increases. I invited him to send an e-mail response. This arrived shortly afterwards:In 2003, House File 692, Division IV would have lowered the state income tax and eliminated federal deductibility. The bill included a contingent effective date for the elimination of federal deductibility. If a constitutional amendment requiring either a 60% majority of the Legislature to increase tax rates or a vote of the people to increase tax rates had been ratified, the rates in Division IV would have been applicable. If a constitutional amendment were not ratified, then the rates in a previous section of the bill would have been the applicable individual income tax rates, and federal deductibility would remain.
The legislation is available online at: http://coolice.legis.state.ia.us/Cool-ICE/default.asp?Category=billinfo&Service=Billbook&menu=false&ga=80&hbill=HF692
The lobbyist declarations for HF 692 (the Iowans for Tax Relief Lobbyists in 2003 were Boeyink/Failor (2)/Robinson, registered as “Undecided”) are also online at: http://coolice.legis.state.ia.us/Cool-ICE/default.asp?category=Lobbyist&Service=DspReport&ga=80&type=b&hbill=HF692.
After further review, the call on the field stands. IFTR's position is an obstacle for improving Iowa's tax system, in my humble opinion. Why? Because they are willing to give up federal deductibility as part of tax reform only on conditions that can probably never be met, given the difficult process of amending Iowa's constitution.
A straight-up swap of federal deductibility for lower tax rates would bring the top individual tax rate down from 8.98% to about 6.03% under current rates, or 5.29% under the Obamacare rates scheduled to take effect in 2013.
Getting the individual rate below 4% should be a goal for Iowa. Once the rate is that low, state taxes become a much smaller issue in business and personal decision-making. While repealing federal deductibility by itself doesn't get you there, it goes a long way, and getting rid of Iowa's rats nest of special interest exemptions and corporate welfare tax breaks should get you across the line. Getting there without repealing federal deductibility would be almost impossible.
In our phone call Mr. Failor argued that once the rates were lowered in exchange for exemptions, the political class would start to creep the rates back up again, so there should be no compromise until the constitutional guarantees sought by IFTR are enacted. He cited the way federal rates have come up after the base-broadening, rate-lowering 1986 federal tax reforms as proof.
I look at it another way. The Reagan-era reforms shifted the terms of the debate way down the rate scale. Prior to the 1986 reforms, the top individual rate was 50% and the top corporate rate was 46%. Immediately afterwards the top individual rate was 28% and the top corporate rate was 35%. Yes, rates have crept up since then (but not corporate rates). But would anybody argue that we should have left the top rates at 50% and 46% just because the 1986 tax reforms didn't include constitutional guarantees against gutless and feckless politicians? We have had a whole generation with far lower tax rates than we would have ever had absent tax reform. We had a long good economic run with the lower rates that only now, almost 25 years later, is petering out as a result of enduring and accelerating political irresponsibility.
So if we get the Iowa rate down to 3.99% without a constitutional guarantee against tax increases, or a constitutional limit on spending, politicians can ratchet up taxes again later. But then the baseline for debate is 3.99%, not 6.02% or 8.98%. Meanwhile, Iowans will benefit from the lower rate and the simple system for some years. Better one generation benefit from lower rates than none.
The IFTR position also assumes that it can protect federal deductibility forever. That's not necessarily so. Last year the legislature came within a whisker of repealing federal deductibility in a way that would have done nothing to improve the overall tax system.
The current Iowa income tax system is awful. With the exception of the Branstad-era cuts in the individual rate from an unbelievable 13% to 8.98%, Iowa's basic tax system is almost unchanged from the 1970s. If Rip Van Winkle, CPA woke up and started to do Iowa returns today, he would have almost no learning curve. And the results of this system?
- Iowa has the 5th-worst business tax climate in the country, according to the Tax Foundation, and is perennially in the bottom 10.
While the tax system isn't the only thing that makes Iowa a bad place for entrepreneurs, it's a big thing. If we have to trade in federal deductibility to get a low-rate, low-loophole tax system and a dynamic economy, it's a good trade -- even if it doesn't prevent future legislative foolishness. Insisting on constitutional guarantees in exchange for tax reform doesn't protect a good system in pursuit of something even better; it protects a rotten system in a hopeless pursuit of a perfect one.
The Iowa Film Credit scandal continues to find new ways to entertain. Lee Rood at the Des Moines Register reports:
A Minnesota filmmaker convicted of defrauding the state has filed a civil lawsuit seeking damages, with claims of defamation and other allegations.
Wendy Weiner Runge says the state has defamed and damaged her in name, reputation and business because of statements state employees have made to reporters, colleagues and the general public. Her lawsuit does not name individuals or specific instances in which she was allegedly defamed.
Wow. Let's review:
- The State Auditor reviewed the award of transferable tax credits to Ms. Runge's film, "The Scientist (Table 21 of the report). Of the $1,850,777.85 of credits awarded, the auditor reported that the documentation supported precisely none of them.
- Two others associated with the project pleaded guilty to defrauding the state.
- Ms. Runge herself copped a plea to one felony count in the middle of her trial on five felony counts for looting the program. She then declared "victory" on her now-erased blog.
I'm no lawyer, but doesn't a guilty plea pretty much take the teeth out of the defamation charges?
Paul Nieffer at Farm CPA Today isn't ready to say there's a farm price bubble yet, but he has some thoughts about what happens if this is a bubble, and it pops:
Good farmland in Grundy County, Iowa peaked out in 1981 at approximately $2,947 per acre. It bottomed in 1986 at $1,047 or a drop of about $1,900 or 65%. It took from 1986 until 2003 or 17 years for the average price of farm land in Grundy County to top $3,000. From start to finish, it took about 22 years for the cycle to finish. Now, what is not factored into this is that farm land continued to return cash rent each year. This probably averaged a 3% or so return each year.
Most crashes from any bubble usually correct from about 50-65% each time. Therefore, if prices are around $10,000 right now and this is the top, farm land may not fully stop sliding until it hits $3,500 – $5,000 in value.
Maybe this isn't a bubble, but I wouldn't bet the farm on it:
Chart via Gongol.
If the dollars are small and the costs are big, it may pay to wait to amend for this month's changes in Iowa's 2010 tax law. The ISU Center on Agricultural Law and Taxation explains.
Iowa's legislature saw fit to change the rules of the 2010 tax game this month, after most Iowans had probably already tallied their scorecards. So should we amend our Iowa 2010 returns right away?
I understand that the Iowa Department of Revenue is working on a legislative proposal that would enable taxpayers to take some of these fixes on 2011 returns, rather than amending their 2010 returns. The Department isn't really staffed to handle a flood of amended returns, and many taxpayers would rather not pay to have an amended 2010 return preparered if they can use their new 2010 deductions in 2011.
If you can take your Iowa 2010 $250 educator expense in 2011, it's hardly worth filing an amended return to claim a $17 refund. Even a big additional Section 179 deduction might be worth waiting for if it is coming out of an S corporation or partnership on a batch of K-1s, where each individual owner would also have to file an amended return.
Iowa may also come out with a streamlined amended return process for 2010 refunds. So it may well be worth waiting two or three weeks to see what the legislature and the Department of Revenue come up with before filing your refund claims.
When your tax return is likely the biggest monetary event of your year, considering the amount of taxes you pay, does it make sense to require every taxpayer in the country to crunch through their tax forms by April 15? Robert D. Flach weighs in:
* CPA Allan S. Boress suggests a change to the “tax season” that I have heard before over the years in his blog post "Let's Kill Tax Season Before it Kills Us" at ACCOUNTING WEB.
I have always been against this change. I am used to the 12-hour-a-day. 7-day-a-week tax filing season – and can put up with it knowing that on April 15th or so it is over – and I can work maybe 2 or 3 days a week at most the rest of the year.
I have a different point-of-view than Robert. I have a full-time job all year, and then a second one during tax season. Congress makes things more complicated every year. With the additional complication, information -- amended 1099s, K-1s, and so on -- comes in later every year. Tax season is becoming more and more a six-week death march. With so much complexity and so much money at stake, trying to do it all in such a brief window is unwise.
Of course we do plenty of extensions; without them, tax season would be impossible. But even getting a good extension number takes time and effort, and you have to make sure you actually mail or e-file the thing -- one more thing that can be screwed up.
Is the alternative better? I'm always glad when tax season ends, and I fear that a later due date would just extend the suffering. That's why Mr. Boress' rolling-due date proposal, based on birthdates, social security numbers, or something like that, has its attractions. Would it cause more problems than it solves? I don't know, but I think it deserves a closer look. What do you think, readers?
Michigan has an aggressive tax collection bureacracy and hair-trigger nexus for out-of-state taxpayers (pretty soon that will about the only kind left), so the new Michigan tax amnesty might be worth looking at. Brian Strahle has the scoop.
Headline typos are the worst typos.
Chicago is a strange place. From the Sun-Times:
He was the ringleader of an “elite” Special Operations Section that ransacked homes without warrants and shook down drug dealers for hundreds of thousands of dollars in cash.
On Tuesday, former Chicago Police Officer Jerome Finnigan, wearing an orange jump suit and shackles, admitted to those crimes as well as to the most outrageous charge — that as an officer, he ordered a hit on another cop.
But as part of his plea deal made public in federal court on Tuesday, Finnigan pleaded guilty only to the murder-for-hire charge and to a tax charge; an agreement where he would see no more than 13 years in prison for his crimes.
Apparently the law values the lives of Chicago police a lot less than the lives of IRS agents. From 2009:
So the lady from IRS is getting nosy, and she seems to be on to your foreign bank accounts. So do you get in touch with your lawyer, own up, and try to work out a civil settlement? Or do you go with Plan B and hire a biker named "Reaper" to kill the agent and burn down the local IRS office? Well, what could possibly go wrong with Plan B?
It didn't work out for Floridian Randy Nowak, who was sentenced yesterday to 30 years in federal prison for trying to do just that. It didn't work out largely because "Reaper" was an undercover FBI agent, which absolutely ruined what was already an insane and doomed plan (IRS exams don't just vanish if the agent does).
The "elite" home looter and pillager will be out of jail about when he turns 60. Meanwhile, the guy who went after the IRS agent will be 80 if he survives his sentence. As bad as trying to kill an IRS agent is, a would-be cop killer who also terrorizes citizens in violent illegal searches seems worse. Except in Chicago, apparently. Radley Balko, call your office.
Sometimes two stories have little in common, but they make a good headline together.
A real priest embezzled real money from his parishoners. He was sentenced to five years in the cement rectory. Yet, according this story, he remains "popular." Why?
Wigenton said the court received 231 letters in support of Brown, many of which detailed generous and kind acts by the priest who became beloved by his large, prosperous parish.
It's always easy to be generous with other peoples money.
Now, the fake priest:
A Florida CPA who pled guilty to a tax misdemeanor for assisting his client, a self-proclaimed priest, in hiding income from the IRS, has had his suspension from practice extended after the IRS Office of Professional Responsibility won an appeal challenging the original length and date of suspension.
No word if the fake priest was beloved by his fake parishoners.
Two Iowa universities are rated in the top 25 national universities -- if "Rate My Professors" is to believed. Iowa State is #7 in the country, while Northern Iowa is #17.
The TaxProf reports sad news: The Death of Jim Eustice.
Anybody who has practiced in corporate tax owes a debt to the Bittker and Eustice treatise on corporation tax law.
One of the most powerful political outfits in the state lost its leader yesterday when Ed Failor, Jr. resigned his post at Iowans for Tax Relief.
While it has also called for lower rates, the "Taxpayer's Watchdog" has built its existence around preserving tax breaks, most notably the deduction for state and local taxes. Its dogged refusal to contemplate trading the deduction for lower rates, combined with funding some successful primary challenges of legislators who have crossed it, has made Iowans for Tax Relief a powerful obstacle to serious tax reform.
This part of the organization's press release after last week's item veto of bonus depreciation and an expanded earned income credit underlines how the organization promotes bad tax policy:
Second, Governor Branstad took away important tax relief specifically targeted at low-income Iowa families with his veto pen. The Earned Income Tax Credit (EITC) would have helped Iowa working families make ends meet through a tax credit which would pay for important needs, like child care and groceries.
The earned income credit is refundable, and most recipients have little or no state tax liability -- making it a welfare program run through the tax code. Like Grover Norquist at Americans for Tax Reform, ITR apparently believes a spending program becomes something else when it is run through a tax return. The "Taxpayer's Watchdog" never barked when the Iowa Film Office was wasting tens of millions on the Iowa film credits, for example; the dog was also quiet when the legislature was enacting the boondoggle.
This map from the Tax Foundation gives an idea of what ITR has accomplished in Iowa tax policy:
The accomplishment? Iowa has one of the highest individual tax rates in the country, the highest corporate rate, and a tax law of Byzantine complexity.
It's unlikely that ITR will change its views as a result of a new leader. That means it will continue to be difficult to advance real tax reform, with low rates and few loopholes, in Iowa.
Life can be hard for a commission seller. Jessica tried it in 2006 for a St. Louis office supply business, working her territory in her 2001 Chevy Cavalier. Six months work earned her $3,307.
Tax time came around. The Tax Court takes up the story:
Petitioner brought her Forms W-2, Wage and Tax Statement, for all of the companies she worked for in 2006,4 as well as a shoebox full of receipts, to H&R Block, and a return preparer at H&R Block completed her return.
At least it was a shoebox. It's the grocery bags that scare me. The preparer deducted employee business expenses in a big way. The IRS ended up challenging over $17,000 of them -- not bad for $3,307 of income.
The Tax Court seems to question whether she got much value from her preparer:
It is not clear whether the return preparer made any attempt to distinguish deductible from nondeductible expenses or whether the return preparer simply added up the receipts and deducted the sum as unreimbursed employee business expenses.
The biggest expense was her Chevy. That deduction went awry:
Petitioner kept track of her automobile mileage using a daily mileage log. However, there are several problems with the mileage log. First, the mileage log simply notes the odometer reading on petitioner's car at the beginning and end of each day and includes no information regarding where petitioner drove, the purpose of the trip, or petitioner's business relationship to the persons she visited. Second, petitioner included in the mileage log the roughly 27 miles she drove each workday commuting to and from MV Marketing's office. Finally, petitioner conceded that she may have included some personal trips in the mileage log. Petitioner did not present any evidence at trial, such as appointment books, calendars, or maps of her sales territories, to corroborate the bare information contained in the mileage log, nor did she testify with any specificity regarding her vehicle expenses in 2006.
Well, the Court made an estimate and gave her some of her expenses, right? Wrong:
Although we do not doubt that petitioner used her Chevrolet Cavalier for business between June and December 2006, we have no choice but to deny in full petitioner's deduction for mileage expenses. For the reasons discussed in the preceding paragraph, petitioner's mileage log does not satisfy the adequate records requirement of section 274(d), petitioner did not present any documentary evidence to corroborate the mileage log, and petitioner's testimony was not detailed or specific enough to satisfy the requirements of section 274(d) and section 1.274-5T(c)(3), Temporary Income Tax Regs., supra. Moreover, we are not permitted to estimate petitioner's mileage because section 274(d) supersedes the Cohan rule. Consequently, petitioner's deduction for mileage expenses is denied in full.
The moral? The tax law has very specific substantiation requirements for deducting travel and entertainment expenses, including vehicle expenses. You must substantiate:
(1) the amount of the expense or item;
(2) the time and place of the travel, entertainment, or expense;
(3) the business purpose of the entertainment or expense; and
(4) the taxpayer's relationship to the person or persons entertained.
The mileage log needs to include this information, or you need to be able to be able to support it with other items, like a travel calendar. The tax law doesn't allow you to make a good guess. No substantiation, no deduction.
The Quad City Times reports that the trial of the former head of the Iowa Film Office, Tom Wheeler, has been delayed until August 15.
Mr. Wheeler was in charge of the film office when it was granting tens of millions of dollars in transferable film tax credits for fraudulent and imaginary expenses. The program has since been mostly shut down, and the current Governor has no plans to revive the tax credits.
While Mr. Wheeler has plenty to answer for, the criminal charges seem more like a search for a scapegoat than a quest for justice. If incompetence and mismanagement in state government is a crime, they might as well start locking the state buildings from the outside -- starting with the Capitol building, where they voted the film credits into law with only three "no" votes out of 150 legislators.
Kalona, Iowa is known more for its Amish and Mennonite communities than for tax protesters, but they apparently have one of those, too. A Kalona man was sentenced last week to six months in federal prison after pleading guilty to one count of failure to file tax returns.
According to the prosecution sentencing memo, David Lawrence Larson stopped filing returns after 1996 following a financial setback, and after receiving some "bad advice." The nature of the advice isn't specified, but one can get a good idea what it was from this:
He claimed that he wasn’t a “taxpayer” and submitted frivolous documents when initially contacted by the IRS. He placed various assets into the names of trusts. He resisted receipt of Forms 1099 and requests from banks for copies of his income tax returns.
In short, he went the tax protester route. Considering that he faces six months in prison, and that he is poor enough to require a government-appointed attorney, it's difficult to see where this worked out well for him.
There are few things more annoying a tax agency ignoring you when you respond to a client notice. It apparently isn't just happening to me. Brian Strahle notices the same thing:
I don't know about you, but I am seeing a lot more state tax notices being received by companies. Not only are they first time notices, but they are repeat notices, month after month. This is even after the taxpayer/company has responded to the first notice.
It often feels like the state taxing authority never looked at the response sent by the company. Actually, I recently called a state taxing authority because a company received a repeat notice, and the state said they were probably six months behind on processing incoming responses/mail, etc. Therefore, the company would continue to receive a repeat notice every month until the company's initial response was processed.
That's pathetic. If you can't process your mail, you should stop generating notices until you catch up. Otherwise you just squander taxpayer money generating notices you can't even deal with, and you squander the taxpayer's money and time by making them respond to zombie notices.
Fair's fair. When state agencies ignore taxpayer responses, we should be able to impose penalties on them, just like they impose on us if we ignore them.
The IRS has issued (Rev. Rul. 2011-11) the minimum required interest rates for loans made in May 2011:
-Short Term (demand loans and loans with terms of up to 3 years): 0.56%
-Mid-Term (loans from 3-9 years): 2.44%
-Long-Term (over 9 years): 4.19%
The Long-term tax-exempt rate for Section 382 ownership changes in May 2011 is 4.55%.
All of the recent Iowa tax legislation, including Section 179 and bonus depreciation changes, is rounded up by the ISU Center for Agricultural Law and Taxation.
Now that the Governor has vetoed bonus depreciation for Iowa, what happens now?
From the Des Moines Register coverage, it sounds like the Democrats are truly unhappy with the veto message because it also blocks an increase in Iowa's Earned Income Tax Credit:
Rep. Tyler Olson, D-Cedar Rapids, accused Branstad of reckless action that unraveled a carefully crafted compromise. "His insistence on rewarding special interests and big corporations at the expense of small businesses and middle-class families is bad for Iowa and a serious blow to bipartisanship," Olson said.
The Republicans, in contrast, don't sound like they are all that upset:
Iowa House Speaker Kraig Paulsen, R-Hiawatha, said: "I'm pleased the governor signed the Taxpayers Trust Fund, giving Iowa taxpayers a seat at the table. Obviously, I'm disappointed that he chose to veto portions of the bill. House Republicans will continue to fight for tax relief for Iowans."
That doesn't sound like somebody ready to lead a veto override battle, and the Democrats won't be able to override the veto without help.
While tax conformity is always good, Iowa has been non-conforming with bonus depreciation for so long that one more year probably isn't that big of a deal. I do like this part of the veto message:
As earlier indicated, it is my desire to approach tax policy in a comprehensive and holistic manner. As such, I urge members of the House and Senate to continue to work with my office on an overall tax reduction package that both fits within our sound budgeting principles while reducing those taxes that are impeding our state’s ability to compete for new business and jobs.
If the Governor is really willing to deal with Iowa's real tax problem -- a ridiculously complex income tax with absurdly high rates undermined by dozens of special interest deductions and tax credits -- then maybe it's all worth it. Maybe - just maybe - the time is right for real tax reform in Iowa.
Link: Radio Iowa Coverage
Prior Tax Update coverage:
Roni Deutch, the self-styled "Tax Lady" of late-night TV tax settlement ads, is having a tough time lately. The Sacremento Bee reports:
Attorney general spokesman Jim Finefrock said Wednesday that Sacramento Superior Court Judge Shellyanne W.L. Chang signed an order sought by Harris' office to set a July 22 trial date for Deutch on the contempt charges.
Judge Chang also froze Deutch's assets and appointed a receiver, Scott M. Sackett, who will take over "all the financial stuff," Finefrock said.
The California Attorney General's office accuses Ms. Deutch of swindling clients; the latest charges also accuse her of shredding documents in violation of a court order. She hasn't responded so far on her blog.
The Tax Lady isn't the only late-night tax star with legal troubles. Tax Masters is the subject of lawsuits in Minnesota and Texas, and of an ABC News Nightline report on its business practices.
The rap against the late-night TV tax debt resolution services is that they charge large up-front fees and then fail to actually resolve outstanding tax problems for their customers. The one time I saw the work of a late-night TV tax service, it was unimpressive, though I haven't seen any work from Ms. Deutch or Tax Masters.
The biggest problem I have with the "tax resolution" industry is that the late-night ads make it look like there's an easy fix for tax problems. If you think there is always a "pennies on the dollar" solution to a tax debt, you are more likely to get into tax trouble in the first place. In real life, it's very difficult to get the IRS to forgive a tax debt. From what I've seen, you have to be really broke, with no prospects for earning your way out, to get the IRS to compromise. That's not a very desirable "resolution."
Russ Fox has more.
Update, 4:15 pm: Governor item-vetoes 2011 Iowa bonus depreciation, enhanced earned-income credit. An insider tells me that since he let the "taxpayer relief fund" stand, there probably will not be an override. We'll see.
Iowa Senate Majority Leader Michael Gronstal on Wednesday offered what he described as a compromise to break a stalemate over the state's budget, but it was quickly rejected by Gov. Terry Branstad.
The Republican governor also indicated he may veto portions of a tax relief and supplemental spending bill approved earlier this week by the Iowa Legislature. The situation could be an ominous sign as the House and Senate try to move towards adjournment of their annual session next week.
Governor Branstad appears mostly upset with the bill's setting a budget for only one year at a time. The Governor is trying to reinstate two-year budgeting in Iowa. But bonus depreciation may also be a problem:
"Other issues, involving the taxes, I think are better to be resolved in a bill that deals with taxes, not supplemental appropriations," Branstad said.
At the very end of tax season, the Justice Department seized some big online poker sites, butting millions of bettor dollars in limbo. Gambling tax mavens Russ Fox and Taxdood now have updates that indicate the bettors may see their money again soon.
While Professor Maule has much more faith than I do in the ability of the government to do things effectively, he definitely gets this right:
It is my position that the constant tinkering with the tax law, such as the on-again, off-again bonus depreciation deduction, makes it even more challenging, if not impossible, for businesses, particularly small businesses, to do the long-term planning necessary for a viable business plan. I am convinced that, as I argued, “The bottom line, no pun intended, is that it is easier for businesses to make decisions if they know what lies ahead, regardless of what lies ahead, than if they don’t know what lies ahead. Businesses can react to higher tax rates and to lower tax rates, if they know what the tax rates will be, but their decision modeling suffers when virtually everything in the tax law remains open to change, perhaps retroactively, sometimes at a moment’s notice.
Amen, Brother Maule.
Great post from Phil Hodgen on the IRS jihad on foreign account filings. A sample:
think Mr. Shulman has decided that bankrupting a few thousand immigrants and Americans living abroad is worth it, pour encourager les autres.
But read the whole thing.
Back in blogging action after another season of preparing hand-crafted tax returns, Robert D Flach thinks I am encouraging taxpayers to squander their money by telling them to get a return receipt when they file using certified mail:
But the extra you spend to get a return receipt is a total waste of money. It means absolutely nothing – only that the IRS received an envelope from you that was postmarked on April 18th. It doesn't hurt to do this (except your wallet) - but it really doesn't help either.
But showing that the taxing agency did receive an envelope from the taxpayer shows that the taxpayer sent them an envelope. A client made a filing with a state. The state sent him a notice much later saying that not only was the return late, but that he had never filed one. Unfortunately, he did not ask for the return receipt. He has the postmarked certified mail stub, but now he has to battle with the state over whether the postmarked envelope was even sent to them. The time spent on that already would have paid for the return receipt many times over.
UPDATE, 4/22: Russ Fox has more examples of the usefulness of certified mail.
The Iowa House of Representatives yesterday sent SF 209 to Governor Branstad for signature. The bill allows Bonus depreciation on Iowa returns for tax years beginning on or after January 1, 2011.
2011 will be the first year that Iowa has coupled with federal bonus depreciation since 2005.
Earlier this month the Governor approved "coupling" provisions of SF 512. That bill tied Iowa's 2010 tax rules to federal rules, with the exception of bonus depreciation. That means the Iowa Section 179 limit is $500,000 for 2010 and 2011. Bonus depreciation, though, is only available on Iowa returns starting in 2011.
O Kay Henderson has more.
Update, 4/21/2011 Maybe not.
Maybe you spent hundreds of dollars to have a preparer do your the 1040 that reports your business income. Or maybe you spent the 32 hours the 1040 instructions say is the average estimated time it takes to do a business 1040. Either way, you've made a substantial investment in time or money.
But you still have to get it to the IRS. The best way is to file electronically. You get an electronic receipt to prove you filed on time, and any refunds come back much more quickly.
If you aren't filing electronically, now isn't the time to cheap out. You ought to spring for the extra $5.10 to file your return "certified mail, return receipt requested." It's well worth the time and trouble of going to the post office to get that postmarked receipt. The tax law is full of sad stories of taxpayers who lost thousands of dollars because they didn't have a postmark to document that they filed on time. Don't let it happen to you!
If there's no post office open or handy -- or you don't finish your return until after the post office closes -- you can also use a mailing receipt from one of the designated private delivery services authorized by IRS for timely return shipment. As private delivery services don't deliver to post office boxes, you'll want to refer to this list of service center street addresses. But be sure the delivery service will get the date right, and that the shipment date on their records is the one you want.
Or you could just take your chances with a late-night post office. Good luck with that.
And don't procrastinate, because Jiffy Express isn't a designated private delivery service.
Millions of Americans are doing their taxes over this last weekend of tax-season. Many of them will be disappointed by the results. While the best tax planning opportunities for 2010 expired 107 days ago, there are a few things you may be able to do to help make for a better tomorrow -- when your return is due.
SEP plans can help taxpayers with self-employment income. You can set up and fund a SEP as late as tomorrow -- or as late as October 15, if you extend. You can deduct up to 25% of your self-employment income, perhaps as much as $49,000. But SEPs have strict non-discrimination rules, so they work best if you have no employees.
Traditional IRAs can sometimes create a last-minute deduction. All IRA contributions are deductible for taxpayers who have wage or self-employment income and who do not otherwise participate in a pension plan. You can contribute up to the lesser of $5,000 ($6,000 if you were 50 at the end of 2010) or your wage and self-employment income. If you have an at-home spouse, you may be able fund a spousal IRA.
If you participate in a pension, profit-sharing or 401(k) plan at work, your deduction is limited depending on your income, per this chart:
If you have a Health Savings Account (HSA) and you haven't fully funded it, you can make a deductible contribution as late as tomorrow, April 18.
Is that all? Pretty much. After December 31, the game is mostly over, except for adding up the score. Go back and make sure:
-you caught all of your estimated tax payments;
-you've picked up any payments that you applied from last year's refund to 2010 taxes;
-you've picked up all of your charitable contributions, property taxes, and state tax withholding and payments on your Schedule A
-you've filled out Schedule M for the Making Work Pay Credit.
-you've checked your math.
Good luck. And make sure you file on time. More on that tomorrow.
This is our penultimate 2011 filing season tip. Tomorrow is the ultimate -- well, the last one, anyway.
Prom season coincides with tax season. If you are up late doing your tax return tonight while waiting for your daughter to come home, don't forget that some of the money she's spending tonight may reduce your Iowa taxes.
Iowa offers a "Tuition and Textbook Credit" of 25% of the first $1,000 of qualifying expenses. Check out how Iowa defines "textbook":
“Textbooks” means books and other instructional materials used in teaching those same subjects. This includes fees, books, and materials for extracurricular activities.Examples of extracurricular activities
Sporting events, speech activities, musical or dramatic events, driver's education (if paid to the K-12 school), awards banquets, homecoming, prom (clothing does not qualify), and other school-related social events
So while you can't get tax help for that prom dress, the tickets qualify. So do textbooks, instrument rentals and supplies used for band, and cleats and specialized sports equipment.
Sure, she's out too late. But if it helps cut your Iowa taxes, maybe it's not so bad.
There's two more days of tax season, so we'll have two more 2011 filing season tax tips!
It looks like Iowa will couple with bonus depreciation for 2011 after all.
The long-dormant conference committee working to reconcile the differing versions of the indigent defense appripriation bill (SF 209), passed over a month ago in each house, finally came to an agreement yesterday. We've confirned through a conference member that, in addition to finally paying the public defenders, the bill links allows federal bonus depreciation on Iowa returns for assets placed in service in 2011.
Just last week the Governor enacted the "code coupling" provisions of SF 512. These provisions had originally been included in SF 209, but were enacted separately when that bill bogged down in conference. SF 512 couples federal law for Iowa with the Internal Revenue Code as of January 1, 2011, except for bonus depreciation; it allows the $500,000 Section 179 limit for 2010 and 2011 assets on Iowa returns.
The conference bill text isn't yet available; we will link to it when it is. It is expected to pass both houses next week.
You have to clear three hurdles to deduct losses on your K-1 -- you have to have basis, and the basis has to be "at-risk." There's one more: you can't deduct net "passive" losses.
The Passive Loss Rules (Section 469) came into the tax law in 1986 to shut down the real estate tax shelters of the day. You can deduct "passive losses" only to the extent you have income from other "passive activities" (now there's a great oxymoron), or when the activity is disposed of in a taxable transaction.
There are three general categories of "activities."
Real Estate Rental is normally automatically passive, unless you qualify as a "materially participating real estate professional." If your adjusted gross income is under $150,000, you may be able to deduct "active participation" real estate losses.
Publicly-traded partnerships are passive, and a loss from one can only be offset by income from the same partnership, or on sale.
All other activities are passive if you fail to "materially participate" in them. The tests for material participation are in the extended "read more" area at the bottom of this post. These tests are mostly based on how much time you spend on activities that you own. If it's not a full--time job, it's wise to keep a calendar showing the time you spend on it, because the IRS will ask. If you try to make up implausible hours, remember that Tax Court judges are generally not bad at math.
If your K-1 activity turns out to be "passive," you have to work through Form 8582 and the related worksheets to figure what losses are allowed. Losses that aren't allowed carry forward to future years to offset future passive income, or until you sell the activity. These carryforward worksheets probably sell a lot of tax software -- especially because you have to track your passive loss carryforwards separately for alternative minimum tax.
So if you can deduct your K-1 losses -- congratulations! Except, of course, for the losing money part.
Related K-1 filing season tips:
Tax season isn't over, and neither are our 2011 filing season tax tips! We're here all weekend!
The tax regulations say you achieve "material participation" in for a tax year if:
-You participate at least 500 hours in one activity; or
-You participate at least 100 hours and at least 500 hours in more than one "100 hour" activities; or
-You participate at least 100 hours and more than anybody else, or
-You are the only participant; or
-You materially participated in five of the past ten years )or in any three years for a service activity).
There is also a "facts and circumstances" test, but don't count on it.
A special rule apples to real estate. If you are not a "real estate professional," losses are normally passive no matter what, unless you provide "extraordinary" personal services.
If you are a "real estate" professional," you can apply the normal material participation rules to determine whether you have a passive activity. To be a real estate professional, you have to spend at least half your working hours - not less than 750 hours annually - in "real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade."« Close It
While taxes aren't due today, it's not because the government realized it made a little paperwork mistake, so there really is no income tax this year (really, there is). It's because Washington D.C. observes Emancipation Day today, so the IRS says that moves all of the usual April 15 deadlines back to Monday, April 18. States with April 15 deadlines have generally gone along with this.
For some thoughts on our extended tax season and how to spend the last wonderful weekend of it:
William Perez (About.com): Welcome to April 15th
TaxGrrrl: It's Not Tax Day
Kay Bell: Final tax weekend tasks
Trish McIntire: Extensions
Stacie Clifford Kitts: Read This if you Need More Time to Pay Your Taxes
We tax people can start to feel sorry for ourselves this time of year. Going Concern puts our long workdays in perspective:
Pan Jie was a 25 year-old auditor in PwC’s Shanghai office, starting her career with the firm last October. She died of acute cerebral meningitis on April 10th, having “ignored the illness until a fever surged,” after catching the flu on March 31st. Reports have stated that Jie told a friend that “she had been working up to 18 hours a day and about 120 hours a week,” prior to her death.
I started my career at an office of PwC's predecessor, Price Waterhouse, and the office where I worked had a little bit of that culture. Some months after they canned me, a tax manager had a heart attack at his desk -- at 3 a.m. He survived; I never found out how he charged the cardiac event time.
IS THE TAX CODE VOID FOR VAGUENESS? Courts strike down laws on vagueness grounds when an intelligent person must necessarily be uncertain of their meaning...
And I love this bit: "All 46 tested tax professionals got a different answer, and none got it right. The professional who directed the test admitted ‘that his computation is not the only possible correct answer’ since the tax law is so murky."
Yet you can be jailed, or fined, or otherwise punished if you get an answer that is deemed "wrong." This sounds like the very definition of void for vagueness. But would any court have the backbone to so hold?
To answer the easy question: this argument is made all the time by tax protesters and it never, ever works. So, no judge would have the backbone, or death wish, to so hold.
Really, though, the problem is the opposite of vagueness. It's hyper-specificity. By having incredibly detailed rules for all sorts of transactions, combined with income phaseouts, limits, and picayune distinctions, the tax law requires punishing detail. Try this mouthful from the Section 199 "domestic production activity deduction" regulations:
Under Sec.199, the gross receipts that are considered DPGR are not limited to the gross receipts attributable to QPP MPGE entirely by a taxpayer.
Of course, DPGR, QPP and MPGE are defined in excruciating detail. Nothing vague about it -- the opposite, in fact. With enough time and professional advice, even complex returns can usually be computed "correctly" -- but at a prohibitive cost.
These problems come from asking a tax to do too much. As long as Congress treats the tax law as the Swiss Army Knife of public policy -- resulting in things like the Section 199 deduction, which gives special treatment to manufacturers and farmers -- this mess is what we will get.
So you can have basis in your partnership as a result of borrowings by the partnership. If that basis isn't considered "at-risk," a fat lot of good it does you.
The "at-risk rules" were enacted back in the Ford administration to combat an early generation of tax shelters based on buying cattle or equipment with loans that were "non-recourse" -- if the partnership didn't pay the loan, the lender could only get back the cows or the tractors, and the partners were scot-free. Because the debt increased partnership basis, this enabled partners to buy deductions by buying interests in leveraged partnerships holding depreciable assets.
The at-risk rules defer losses attributable to basis that is not "at-risk." On a K-1, the partner's share of debt is helpfully broken into three categories:
There is space for the "recourse" and "nonrecourse" liabilities of the partnership. The "non-recourse" liabilities are normally not "at-risk," so if you need the basis on that line to deduct your K-1 losses, you may be out of luck.
You'll also see a space for "qualified non-recourse financing." This is a tribute to the real-estate lobby of the 1970s, who won special treatment for non-recourse debt incurred in real estate activities. Nonrecourse debt that meets certain conditions - mostly debt from commercial lenders or government agencies - is "qualified nonrecourse financing" and is deemed to be "at-risk" under the tax law, even if it isn't in real life.
If your losses exceed your other basis, you compute your at-risk disallowance on Form 6198. If your losses have cleared this hurdle, though, you still may not be able to deduct them. We'll cover the "passive loss" rules tomorrow.
Related: Reading your 2010 K-1
This is another thrilling installment in our series of 2011 filing season tips. Clip them and save them!
It was Napoleon, I believe, who said is was important to execute deserters pour encourager les autres. The IRS takes a similar approach this time of year to encourage the rest of us to file our taxes in compliance with the law and on time. Just a few examples of the annual flurry of pre-April 15 tax crime news from the wire today:
The IRS audit rates are up. The IRS is getting better at tracking offshore accounts -- and not just in Switzerland. You don't have to like the IRS to see that the odds are getting worse all the time for tax evasion, and getting caught is becoming more of a matter of "when" than "if."
The long annual nighmare is over at the end of the day on Monday! If you're done with your returns, go celebrate with Bottomless Mimosas at Kay Bell's Carnival of Taxes!
There's enough good tax stuff at the premier roundup of tax blogging to hold out as long as the Mimosas do!
The Department of Revenue has posted a news release on the tax changes in SF 512 signed into law yesterday:
Deduction of Educator Expenses
Taxpayers who meet the requirements of an eligible educator in 2010, can deduct up to $250 of qualified expenses he or she paid in 2010 and claimed on line 23 of the federal return. This deduction is claimed as an Other Adjustment on line 24 of the IA 1040.
Tuition and Fees Deduction for Higher Education
Taxpayers who paid qualified tuition and fees for themselves, a spouse, or dependent(s) are able to take this deduction as claimed on line 34 of the federal return. This deduction is claimed as an Other Adjustment on line 24 of the IA 1040.
Election to Deduct State Sales/Use Tax as an Itemized Deduction in lieu of State Income Tax
Taxpayers will have the option of claiming an itemized deduction for either other state and local income taxes, or general sales taxes as claimed on the federal Schedule A, line 5. Iowa 1040 Schedule A has been modified to incorporate this change and is available on the Department Web site.
Earned Income Tax Credit (EITC)
The refundable Iowa credit is simply 7% of the federal credit, and there is no longer a need to recalculate the federal credit.
Tax Free Distribution from an IRA to Certain Charities for Individuals 70½ and Older
Taxpayers age 70½ and older can distribute up to $100,000 from their individual retirement account to certain charitable organizations without including the distribution in gross income.
Section 179 Asset Expensing
An increase in the Section 179 expense deduction changes the cap for Iowa taxpayers from $134,000 to $500,000 for tax years beginning in 2010. This phases out when purchases exceed $2,000,000. This brings the limit in line with the federal provisions.
Alternative Simplified Research Credit
Tax form IA 128S immediately replaces the Iowa Alternative Incremental Research Activities Credit, IA 128A, for tax years beginning on or after January 1, 2010. Electronic filing of this form will not be accepted by the Department until April 26, 2011.
Deduction Related to Small Business Health Insurance Credit
For federal tax purposes, taxpayers claiming this credit must reduce the deduction for health insurance premiums by the amount of the credit. Since the deduction is disallowed for federal tax purposes, neither will it be allowed as a deduction for Iowa purposes and no adjustment can be made on the Iowa return.
Iowa adopts the increase in the amount of start-up expenditures from $5,000 to $10,000 for 2010.
You have to have basis in your partnership or S corporation interest to deduct losses on your K-1. You also have to clear some other hurdles, but if you don't have basis, you don't even get to them. Your basis generally starts with your investment in your interest; it's increased by income items reported on your K-1, and by additional investments, and it's decreased by your share of losses, expenses and distributions.
With partnerships, there is an extra wrinkle: your basis also includes your share of debts owed by the partnership. That's not true for S corporations. But how do you know what your share of partnership debt is?
A properly-prepared partnership return will report each partners share of debt on part K of Schedule K-1:
You can add the amounts on these lines to the amount of basis you have otherwise to determine your basis in your partnership interest. The ability to use this "inside" partnership debt as basis is a reason why partners run out of basis less often than S corporation owners do.
You probably also have noticed the "Partner's capital account analysis" on part L of the K-1, just below the debt thing:
Can you use this as a shortcut to figuring your basis? Usually not. Sometimes you can if the "Tax basis" box is checked, but even that is unreliable. It's much safer to track your own basis year-by-year based on your original and subsequent investments, distributions and K-1 items.
So you have basis? Congratulations, but you still might not be able to deduct your losses. Your basis still has to be "at-risk," and your losses might be non-deductible if they are "passive." More tomorrow.
Prior posts on 2010 K-1s:
This is another installment of our thrilling series of 2011 filing season tips. They'll just keep coming through April 18!
We take for granted that in a technical field like taxation, more education is better. And that's true, until you screw up. The TaxProf reports on a Tax Court case yesterday where an advanced tax degree cost the recipient more than tuition.
The attorney and his wife had an insurance policy that they had borrowed against. They let it lapse, and the insurance company applied the cash value to the policy debt -- but the couple reported no gain or loss from the policy. Life insurance death benefits are tax free, but you have to do the whole death thing for that to work.
The Tax Court thought the attorney should know better:
Bruce Brown is a commercial litigation attorney who has been licensed since 1973. His wife, Carol Anfinson Brown, is also an attorney. She has a master of laws degree (LL.M.) in taxation. ...
Northwestern sent Mr. Brown a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 1099-R showed a gross distribution of $37,365.06 and a taxable amount of $29,093.30.
[T]he Browns’ experience, knowledge, and education weigh against them: both are licensed attorneys, and one has a master of laws degree (LL.M.) in taxation. In short, the Browns have failed to show that they had reasonable cause for and acted in good faith regarding the underpayment. We therefore find that the IRS correctly determined that the Browns are liable for the substantial understatement penalty under § 6662(a).
The Moral: If your credentials say you're smart, the Tax Court will hold you too it.
Cite: Brown, T.C. Memo 2011-83
Bruce, the Missouri Tax Guy, has some last-minute tax deductions for you.
At a carnival, you pay your money, you take your chances. But at the Cavalcade of Risk, you always win!
The newest edition of the unbeatable roundup of insurance and risk-management blog posts is up at Chatswood Moneyblog, and Hank Stern says it may be "the best yet," so you'd better join the Cavalcade.
Governor Branstad has used his item veto authority on SF 512, the bill containing the "code conformity" provisions for the Iowa income tax. The item veto removes budget transfer authority included in the bill; the item veto therefore enacts the federal code coupling language.
As a result, we finally have a 2010 Iowa tax law. Key points:
- Iowa conforms to the $500,000 Section 179 deduction limit for 2010 and 2011.
- Iowa adopts federal tax computation rules in effect as of 1/1/2011, including things like the educator expense deduction that have been a problem in other years.
- Iowa DOES NOT adopt federal bonus depreciation for 2010 or 2011.
I don't think the legislature can now undo the parts approved by the Governor in his item veto, but I'll let you know if I hear otherwise. I will update this post as events may warrant.
UPDATE, 5:46 pm: A reader asks in the comments:
So we can deduct front page tuition deduction and educator costs now on 2010 Iowa tax returns? Was it retroactive back to tax year 2008 by any chance?
The SF 512 provisions adopting the Internal Revenue Code changes through 1/1/11 "apply retroactively to January 1, 2010, for tax years beginning on or after that date" (Sec. 6 of the bill). So it goes back to 2010, but not further, if I understand it correctly, and the tuition deduction, the IRA donation exclusion, and the like are good now for Iowa 2010 1040s.
This old mortar sits in a peaceful waterfront park today in Charleston, but 150 years ago today it was wreaking havoc with the little Federal garrison at Ft. Sumter, starting the Civil War.
The consequences of the war, surely unintended by the operators of this gun, included the end of slavery, a horrific death toll, and the first Federal income tax. While the tax was repealed after the war, the idea stayed alive; the federal income tax came back in 1913, and is still with us. So while you struggle with your 1040, save a word of "thanks" for General P.G.T. Beauregard and the rest of the Confederates who attacked Ft. Sumter.
Yesterday we discussed how K-1 items carry to different spots on your 1040. If the K-1 has lots of losses, though, you may not be able to use them. There are three restrictions on K-1 losses for most of us:
1. You can't deduct losses in excess of your basis.
2. Even if you have basis to deduct losses, the basis has to be "at-risk," and
3. Even if the basis is "at-risk," losses that are "passive" might be limited.
So how do you know your basis? The K-1 might not be much help -- if it's an S corporation K-1, it's no help at all. It's best to track your own basis.
COMPONENTS OF BASIS
- Your basis starts with your initial investment in your ownership interest.
-It is increased by taxable income and deductible expenses, as reported in lines 1-12 of the 1120-S K-1, or lines 1-13 of the 1065 K-1.
-It is increased by tax-exempt income (like municipal bond income) and reduced by permanently non-deductible expenses (like the 50% non-deductible portion of meals and entertainment expenses); these are reported on line 16 of the 1120S K-1 and line 18 of the 1065 K-1.
- It is increased by capital contributions, which appear nowhere on the 1120S K-1 and on Part I, line L of the 1065 K-1.
- It is reduced by distributions, which are on line 16 of the 1120-S K-1 and Line 19 of the 1065 K-1.
If your losses exceed your basis, your losses are limited to your basis. If you have multiple deduction items, you have to prorate them to fit your basis.
Lets say you have an S corporation interest that starts 2010 with $3,000 in basis. You have a K-1 line 1 loss of 9,000, line 4 interest income of $2,000, and a charitable contribution passing through on line 12 (code A) of $1,000.
You have $5,000 in basis to deduct your $10,000 in in expenses - the opening $3,000 in basis plus the positive $2,000 interest income. You pro-rate the $10,000 expenses -- you can (potentially) deduct $4,500 of line 1 loss and $500 of charitable contributions. The remaining deductions carry forward until you increase your basis via contributions, loans, or future income.
This is, of course, a simple example. It gets more complicated if there are distributions during the year (they count first), and if there are non-deductible expenses, like meals and entertainment. Shareholders can count direct loans they make to an S corporation in basis -- but not borrowings by the S corporation from anybody else, and not guarantees of S corporation debt. You can learn more about S corporation basis at the IRS web site.
We'll talk about special wrinkles for partnership owner basis tomorrow.
This is another in our series of 2011 filing season tax tips. See you tomorrow!« Close It
Today is national Tax Freedom Day® by the reckoning of the Tax Foundation. The average American will have earned enough to settle 2011 government obligations today.
We'll celebrate by reproducing this great Tax Foundation chart showing the perverse marginal rate structure caused by the phase-outs of various credits and deductions as income rises.
Look carefully at the green line. You'll see that there is a negative marginal rate of over 50% for the working poor with kids -- a subsidy, in other words. The phase-out of these breaks leads to marginal rates of over 30% as the wages rise towards middle class status -- the highest marginal rates in any brackets. It's a great illustration of the folly of tax benefit phase-outs.
It looks like Minnesota taxpayers will be subsidizing another profitable business owned by a wealthy man. StarTribune.com reports that the Minnesota legislature is moving towards subsidizing a new football stadium for the Vikings:
The legislation, which has been repeatedly delayed by Republican legislators, closely followed an outline that the plan’s two Republican authors released a week ago. Under that plan, the state would commit to as much as a $300 million, largely through a series of so-called user fees including a sports memorabilia tax and Vikings lottery game.
A new Minnesota Stadium Authority would be created under the plan, and would have until Feb. 15, 2012 to select a site for the stadium.
This should go without saying by now, but we'll say it: taxpayer-financed stadiums are a boondoggle. Ask voters in Seattle:
Take, for example, the image problems created by the publicly funded Seattle Kingdome, an ugly, concrete domed stadium. After suffering maintenance problems that required even more public money, it became something of a public embarrassment for the city and was torn down in the late 1990s despite tens of millions of dollars debt still owed on the building.
But maybe it was worth it in the end:
"How do I read my K-1" is one of the most common searches used to find the Tax Update. It's always worth recounting what a K-1 does, and how to use the one you received to prepare your 1040.
One of the most common misconceptions about K-1s is the belief that issuers are under the same January 31 deadline that applies to 1099 forms. They are not. A Form 1120-S K-1 for a calendar-year S corporation is technically due March 15, but that deadline can be extended until September 15. Partnership and Estate and Trust K-1s are due April 15, but that deadline can also be extended to September 15.
WHY A K-1?
It helps to understand what the K-1 does. Pass-through entities -- partnerships and S corporations -- don't pay taxes on their own income; the owners pay the tax. If you have an operating business, this can get complicated and require some time to sort out before the K-1 can be issued.
Trusts and Estates also have K-1s; these entities can pay their own tax, but if they make distributions for the beneficiaries, the distributions carry the taxable income with them; the K-1s report how much income is carried out to the beneficiaries; they also break out income and deduction items that have to go to different places on your return. Here is this year's partnership K-1:
The K-1 reports to the owners their share of the taxable income of the pass-through entity. The owners report the items on the K-1 on the appropriate lines of their own returns. For example, an owner's share of partnership interest income, reported on line 5 of the K-1, goes to Schedule B on the partner's 1040.
The most confusing things on a K-1 may be the items that come with no description, other than a code letter. You have to go to the second page of the K-1 to find out what the codes are:
More on K-1s tomorrow!
This is part of our series of 2011 filing season tips. Watch for them through April 18!« Close It
When Russell Cole went away for 15 years on tax charges after being busted for defrauding the Best Buy chain of millions, he left behind some toys. The government will auction some of them the day after tax season end, reports the Minneapolis Star-Tribune:
Eleven luxury sports cars seized from convicted Best Buy vendor and Illinois businessman Russell Cole will go on sale April 19 at a government auction in Milwaukee. The fleet of high-quality, low-mileage exotic cars has drawn interest from across the globe, according to an IRS spokeswoman.
Among those on the auction block -- a 2003 Ferrari Enzo coupe, a 2006 Lamborghini Murcielago convertible, a 2008 Bentley Continental and a 2002 Aston Martin Vanquish.
If those are a little exotic for you, there's always the more pedestrian Porsche 911 Turbo or the 2005 Ford GT. You can find the whole auction inventory here.
Milwaukee will be a bit of a drive for me. Fortunately, the IRS also has some auction action April 19 closer to home. In nearby Adel, this Chevy Crew Cab:
And right here in Des Moines, this lovely F250:
And I was wondering what I would do with myself after tax season. For IRS auction action in your area, check out the IRS Auction Page.
States are starting to wise up to the folly of film credits, according to this story:
Joseph Fichera, CEO of Saber Partners and financial expert/media analyst, said money from Hollywood is really only made in the very short-term. "There is no real evidence to say that it boosts tourism in the long run just because a certain movie was filmed there," he said. "All it does is boost employment while production is in town."
Janet Novack explains:
Thanks to the temporary tax cut deal President Barack Obama and Republicans struck last December, you can write off the full cost of purchasing a new luxury SUV—provided it’s used 100% for business and its gross weight is 6,000 pounds or more. Qualifying 2011 models include the Porsche Cayenne Turbo (MSRP: $106,000) , the BMW X6 M (MSRP: $89,200) and the Ford Lincoln Navigator (MSRP: $62,635).
We covered this back in January.
So your high-schooler or college student is slaving away serving lattes to the masses to help pay for school. What can you do to show you appreciate the effort? Nothing beats the gift of tax shelter!
You can provide the funding for a Roth IRA for your hard-working student to the lesser of $5,000 or the student's wage and self-employment income. The student can take out all funds tax free after five years. If your student does well, the cash can be left to earn tax-free income until it's time to fund retirement -- again, with tax-free withdrawals.
You have until April 18 to fund a 2010 IRA. Your friendly community banker can help you out. If you are an online sort of person, Vanguard makes it easy to start an IRA online with an initial investment as low as $1,000. And it's not just for college students; you can help fund an IRA for your young graduate starting out in the working world.
Minnesota entrepreneur Robert Beale blundered away the fortune he earned in the tech business when he drank deeply of tax-protester theory. He fled before his scheduled tax evasion trial; after his arrest 14 months later, he was overheard trying to arrange for the detention/kidnapping of his trial judge by a "common law court" using a prison phone. None of this worked out well.
Yet he doesn't give up. He recently moved to have his conviction vacated. The grounds include:
He contends the Government has entered into a "stipulated agreement" that the indictment should be dismissed and judgment vacated...
The "stipulated agreement" which Beale alleges binds the Government is actually a document entitled "Certificate of Default and Binding Administrative Agreement and Confession of Judgment" dated September 7, 2010. See Docket No. 402, Ex. J ("Certificate of Default") at 2. The Certificate of Default alleges Beale sent the Government a "Notice of Counterclaim and Demand for Proof of Law, Proof of Fact and Proof of Claim and Contract" ("Notice") in August 2010, and that the Government did not respond to the Notice within the time specified. Id. at 3. Therefore, according to the Certificate of Default, the Government chose to "stand silent" and enter into "an agreement and contract by operation of the law."
In other words, he sent a bunch of tax protester stuff to the government from prison, telling the government that if they didn't respond soberly and on-time to his gibberish, he gets out of jail.
That didn't work either:
The Government was under no obligation to respond to the "Notice" sent by Beale in August 2010, and the Government's lack of response did not result in a "stipulated agreement" between the parties.
Nor did other motions. Mr. Beale remains a resident of a Yazoo City, Mississippi facility with a scheduled move-out date in 2021.
The headline says it all:
One hopes those last four years will be served in solitary, unless arrangements have been made with authorities in the afterlife.
The IRS campaign against offshore tax evasion has gone to the far east with a "John Doe" summons request for HSBC India Bank. The government seeks the names of U.S. taxpayers who might be parking funds in Indian accounts to hide them from the IRS.
Of course this is a worry for any such tax evaders. Unfortunately, it might also be bad news to Indian nationals who moved to the U.S. without closing their accounts back home; they might find that they have inadvertently failed to file the "FBAR" foreign account disclosure forms, with all of the nightmares that can bring.
Jack Townsend has more at the Federal Tax Crime Blog
While tax preparers can only dream of taking tomorrow off, our IRS counterparts might be in line for a little unscheduled vacation. Here's how they say a government shutdown would affect taxpayers:
- The April 18 due date stands.
- The government will continue to process electronically-filed returns. Paper returns may sit.
- IRS exams will stop for the duration.
The IRS emailed us this statement:
In the event the government shuts down after midnight on Friday, all taxpayers should continue filing their tax returns and paying their taxes as normal. The April 18 deadline remains in effect.
In the event the government shuts down, the IRS plans to continue accepting all tax returns -- both electronic and paper. Refunds will continue to be processed normally for electronically filed tax returns, and most taxpayers will not see delays for e-filed returns. However, taxpayers should expect delays for paper tax refunds.
The IRS encourages taxpayers to select e-file or Free File. Taxpayers can still expect to receive refunds in less than two weeks with direct deposit.
If people have already filed their return and the IRS has started processing their tax return, they generally will see no delays in their refunds being issued. The best source for information will be checking "Where's My Refund" at www.IRS.gov.
More details about IRS activities in case of a government shutdown will be available at www.IRS.gov.
If any taxpayer under examination has a year close because the statute of limitations runs during a government shutdown, it may be a good day to buy that pick-six ticket.
More on tax implications of a shutdown:
The practice of medicine can be exacting. A small imprecision in a dose, a small slip of the scalpel, and goodbye, patient.
Tax returns aren't like that. A Pennsylvania doctor learned about that yesterday from the Tax Court.
The doctor is a neonatologist married to a businessman -- one whose business apparently needed the support of the doctor's income. The business lost money, and the doctor's financial advisor, a Mr. Bagdis, is said to have offered some precise advice, according to Tax Court Judge Wells:
Petitioner was required to file a Federal income tax return for 1999. However, petitioner did not timely file her 1999 return because Mr. Bagdis advised her that her husband's business, Basement Doctor, had sustained significant losses during 1999 that would offset the couple's income from petitioner's salary, but that those losses needed to be calculated exactly before the couple filed their return. Petitioner followed Mr. Bagdis' advice and did not timely file her 1999 tax return. On February 21, 2001, respondent sent a delinquency notice to petitioner, informing her that respondent's records showed she had not filed a tax return for 1999 and asking her to file that return. On their 1999 return, the couple reported $153,786 in wages and salary income, but the couple reported a loss of $100,000 from Mr. Russell's business.
Substantially the same series of events took place with regard to the couple's 2000 tax return. Mr. Bagdis again advised petitioner that she should wait until he had every detail of the return correct, including exact figures for the losses from Basement Doctor. Respondent again sent delinquency notices to petitioner, dated July 8 and September 2, 2002, informing petitioner that respondent's records showed she had not filed a tax return for 2000 and asking her to file that return. The couple filed a joint tax return for their 2000 tax year on September 13, 2002. On that return the couple reported $163,793 in wages and salary income and another $100,000 loss from Basement Doctor.
It's a good thing they took the time to get precise numbers. What a remarkable coincidence that the precise loss was exactly $100,000 each year.
The same thing happened for 2001. But the doctor was beginning to doubt Mr. Bagdis' wisdom, at least a teeny bit. But not enough:
At some point during October 2004, IRS agents visited petitioner while she was working at Children's Hospital to serve her with a subpoena for records. Around the same time, petitioner understood that the IRS had also seized files from Mr. Bagdis' offices. After she received a subpoena from the IRS and learned of the IRS raid on Mr. Bagdis' offices, she became very concerned and asked to meet with Mr. Bagdis as soon as possible. When petitioner met with Mr. Bagdis, she received the same explanation from him: he expected that large losses from Basement Doctor would offset her salary income from 2001 and that she should wait to file her return until Mr. Bagdis could calculate the exact numbers. Petitioner continued to rely on Mr. Bagdis' advice.
At some point -- after a conversation with a nice man from the U.S. Attorney's office -- the doctor switched tax advisors. That may well have been a good move, but it turned out to be too late to avoid late filing penalties. The Tax Court wasn't convinced that Mr. Bagdis actually did insist on precision, but said that doesn't matter (citations omitted, emphasis added):
We have held that reliance on an attorney's advice that it was necessary to wait for complete information before filing a return does not constitute reasonable cause for a delay in filing. Instead, taxpayers have an obligation to file a timely return with the best available information, and to file a later amended return, if necessary. We have held that the unavailability of information needed to calculate the tax liability does not constitute reasonable cause for failing to file a timely return. Accordingly, insofar as petitioner relied on Mr. Bagdis' advice that she should wait for complete information before filing her return, we conclude that such reliance does not constitute reasonable cause.
The Moral: When it comes to filing your tax return, close really is good enough for government work, if the alternative is no return at all. If you have been waiting to see your preparer because your numbers aren't exact, bring in what you have. It might not be perfect, but it's much better than nothing.
This actually works as a 2011 filing season tip! So come back for more through April 18.
If you are going to do something futile and stupid, you might as well use a lot of zeros. From a Department of Justice Press Release:
Mark D. Leitner has been indicted by a grand jury in the Northern District of Florida for filing false liens against federal law enforcement, corruptly endeavoring to impede and impair the Internal Revenue Service (IRS), and public disclosure of another’s Social Security number in the commission of illegal activity, the Justice Department announced today.
According to the indictment, during the jury trial and after the jury returned the guilty verdict, Leitner caused false maritime liens to be publicly filed against the property of prosecutors, investigators and court personnel involved in the criminal trial. The liens falsely claimed that Leitner was owed $48.489 billion from each individual.
That's $48,489,000,000. With about seven or eight fewer digits, the leins might have been a real problem for the alleged victims, as potential creditors might have taken them seriously. Unless you are the federal government or a very large state, nobody will take a $48 billion lien seriously.
The bill to set Iowa tax rules for last year for the returns we are filing this month -- and, not incidentally, to pay public defenders who have been unwillingly pro bono since February -- has had a big week. It was amended and passed by the Iowa House last Thursday. The Iowa Senate amended and passed it yesterday, sending it back to the Iowa House, which didn't like what the Senate did, and sent it back. The Senate backed off and passed the House version. So now we can file our returns and the public defenders can get paid, right?
Not so fast. O Kay Henderson reports:
Senate Democrats have accepted a plan from House Republicans for paying the state’s past-due legal bills, but Republican Governor Branstad is still opposed to the idea.
“I was elected to solve a financial mess that was created by bad budgeting practices,” Branstad said Monday.
House Republicans want to give the governor authority to shift state spending from other programs to pay attorneys who’ve been representing clients who can’t afford an attorney and late this afternoon Democrats and Republicans in the Iowa Senate gave up their alternative and decided to go along with that plan. Branstad’s spokesman issued a statement this afternoon, after that Senate action, saying Branstad still believes the proposal would “perpetuate” bad budgeting practices of the past. On Monday, Branstad told reporters there wasn’t extra money in the state budget to shift around anyway.
So now it looks like the Governor will veto the bill. In theory, it seems that shouldn't matter, because the bill passed both houses unanimously, so the veto could be overturned. It's not at all clear that Statehouse Republicans are willing to override a veto by their newly-installed Governor.
What happens then to the tax provisions? As both houses agreed to a coupling of the Section 179 deduction and other tax rules, and agreed to omit bonus depreciation from coupling, the outlines of the ultimate bill seem clear. Yet a bill has to pass, or Iowa's 2010 Section179 limit is $134,000, rather than $500,000. The legislature has not bedazzled with brilliance so far.
Congress yesterday sent a repeal of the "Obamacare" Section 1099 business reporting rules to the President, who is expected to sign the repeal.
The bill saves businesses from the ridiculous requirement to issue 1099s to, say, Sam's Club. It also repeals the new rules that would have required owners of rental properties to begin issuing 1099s to their service providers starting with 2011 payments.
(An earlier version of this post erroneously reported that the rental rules remained in place. My apologies).
Kay Bell has more.
In a case that will interest participants in the Iowa film credit fiasco, the Tax Court yesterday ruled that transferable tax credits issued by Colorado were zero-basis assets that generated short-term capital gain when sold.
The taxpayers donated a conservation easement to a conservation organization and received $260,000 of Colorado income tax credits as a result. They made the donation on December 17, 2004; by month-end, they had sold credits worth $110,000 at a sales price of 82,500 -- a 25% discount from face.
The taxpayers reported the credit sale as a short-term capital gain on their 2004 tax returns, reducing their gain by expenses they incurred in in making the easement donation. When the IRS examined their return, they said the taxpayers had no basis in the credits, and that the gain was ordinary, not capital. The taxpayers counter-argued that the gain was long-term, with the same holding period as the donated land.
Tax Court Judge Wherry said the taxpayers were right that the credits generated capital gains:
The State tax credits petitioners sold do not represent a right to income; therefore, the substitute for ordinary income doctrine is inapplicable. None of the categories of property in section 1221 that Congress specifically excepted from the term capital asset is applicable to the State tax credits. Accordingly, we hold the State tax credits petitioners sold are capital assets.
The IRS won the rest of the issues. The judge ruled that nothing in the tax law allowed the taxpayers to allocate basis to the credits, so the entire proceeds were taxable gain. As for the holding period issue:
As we explained supra pp. 23-24, a Colorado taxpayer had no property rights in a conservation easement contribution State tax credit until the donation was complete and the credits were granted. The credits never were, nor did they become, part of petitioners' real property rights.
Instead, petitioners' holding period in their credits began at the time the credits were granted and ended when petitioners sold them. Since petitioners sold their State tax credits in the same month in which they received them, the capital gains from the sale of the credits are short term.
- A sale of transferable tax credits generates taxable income. One wonders how the fly-by-night film companies that looted the Iowa tax credit program reported their
looting sales of transferable credits.
- The 25% discount seems pretty steep. I understand that a 10% or so discount was typical in Iowa. In either case, you can see that there is a substantial discount on the sale of the credits; if there were no discount, the buyers of the credits wouldn't bother to buy them, and would just pay their taxes in cash.
- It seems possible that a recipient of transferable credits might qualify for long-term gain treatment by holding on to them for one year before selling them. For film companies who needed the cash right away, that wasn't much of an option.
Cite: Tempel, 136 TC No. 15
The IRS continues its shameful mismanagement of the foreign financial account "amnesty." Tax attorney Phil Hodgen relates another case:
Here’s what happened, IRS.
You had a low-income American living abroad. She screwed up her paperwork through ignorance. She owed no money at all to the United States for income tax. It’s a purely paperwork problem.
She was trying to clean up her paperwork by herself, without a lawyer or an accountant — because she can’t afford one.
You, IRS, were the people in full control of the situation, the ones with the complete knowledge of the procedures, and the Taxpayer’s options.
And naturally, the IRS chooses the option of shooting the jaywalker.
The horrific financial penalties that the Treasury imposes for foot-fault violations of foreign account reporting rules -- penalties enabled by a feckless Congress -- are bad enough. The whimsical and cruel enforcement of the penalties on inadvertent violators is worse. The entire FBAR amnesty and enforcement process has become a debacle. If Commissioner Shulman is just too darn busy with his pointless preparer regulation power-grab to intervene, he should resign in favor of somebody who doesn't act as though overseas citizens are all big-time tax cheats.
UPDATE, 11:11 AM The Senate passed SF 512, but after attaching an amendment. It looks like uncontroversial R&D credit stuff, but it still requires another vote in the House. We'll see if they take it up today. I feel good that they will get it done now that both houses have approved pretty much the same thing, but I never trust them.
UPDATE, 1:35 p.m. I was right not to trust them. Apparently the Senate bill had something about "transfer authority," a non-tax provision, that the House didn't like, so they refused to pass the Senate bill as amended. Back to the Senate.
DONE! 4:20 PM The Iowa Senate blinked. They "receded" from their amendment to the version of the bill passed by the House yesterday and passed the House-passed SF512, 49-0. So:
-For years beginning in 2010 and 2011, Iowa adopts $500,000 federal Sec. 179 limit.
-Iowa does not adopt bonus depreciation for 2010 or 2011.
-Iowa conforms with other federal tax changes up through 1/1/2011.
Governor still has to sign, but I'd be shocked if he didn't.
6:00 p.m. OK, maybe I'll be shocked. From O. Kay Henderson: Branstad will likely veto House GOP plan to pay state’s overdue legal bills
Can't anybody play this game?
It looks like our filing season nightmare will end today. The Iowa Senate is scheduled to pick up SF 512, the bill to update Iowa's tax code to federal changes, as its first item of business at 9:00 this morning. We will follow on the Senate Internet feed and update this post for any Senate action.
The bill would couple all Iowa rules to Federal rules for 2010, with the exception of bonus depreciation. Iowa will continue with old fashioned MACRS depreciation for 2010 and 2011. Iowa will adopt the Federal $500,000 Section 179 limit for deducting expenses that would otherwise be capitalized. Absent this bill, the Iowa 2010 Section 179 limit would be $134,000.
It was rumored that the bill would be considered yesterday, but the Senate didn't start its day until 1:00 p.m. and called it a day at 4:19 p.m. But who is in a hurry to want to know what the tax law is for the returns we are preparing for last year, anyway?
Besides, they had important boondoggles to get to. From the Des Moines Register:
The Iowa Senate approved a bill Monday that provides state tax credits for the construction of solar and wind energy systems.
The credits would be equal to 30 percent of the cost of construction or installation, subject to a maximum credit of $15,000 for commercial or agricultural construction or installation or $3,000 for residential construction or installation. The bill specifies that the tax credits will be refundable, or alternatively applied against tax liability for the following tax year, and clarifies that “residential” means a primary or vacation residence, and not a rental property.
Just great. Another refundable credit, another chance to squander millions, another invitation to fraud. Surely after the film credit fiasco, at least some Senators are wising up to this nonsense, right?
The proposal was approved 49-1 with Sen. Mark Chelgren, R-Ottumwa, casting the only negative vote.
I guess not. One doesn't count as "some."
A reader asks:
I just received a k-1 1065 from a new LLC which is included in my IRA this year.
Because my investment is included in my IRA portfolio do i have to report the income shown on the k-1?
That's a great question. It would have been an even better question to ask before buying an LLC in your IRA. That's because LLCs often generate income that is - surprise! - taxable to the IRA.
The tax law frowns on tax-exempt entities like IRAs holding business assets. While it's OK to hold investments that generate interest and dividends in an IRA, Congress thought it would be unfair for taxable businesses to have to compete against tax-exempts. That's why the tax law imposes the Unrelated Business Income Tax, or UBIT, on business income earned by tax exempt entities. The UBIT is, in general, the corporation tax system applied to business income earned by exempt entities.
When UBIT applies to an IRA, the IRA has to pay income tax itself on Form 990-T at rates up to 35 percent. State income taxes can also apply. Of course, the after-tax income of a traditional IRA may be taxed again when it is distributed to the IRA owner.
If you have income taxable to an IRA coming from an LLC taxed as a partnership, it should be on line 20 of the LLC's Form 1065 K-1, listed with code "V". In this case, "V" doesn't stand for "Victory."
The Moral: LLCs and IRAs are a poor mix unless the LLC only holds investments that generate interest and dividend income. If you own an LLC that generates business income in your IRA, it may need to file Form 990-T by April 18.
Some people find their purpose in life is making mistakes so we don't have to. Russ Fox celebrates these intrepid bad examples in his Bozo Tax Tips series:
Congress has decided to legislate through the Tax Code. There are hundreds of tax credits that now exist. These range from the Earned Income Credit, education credits, electric vehicle credits, and adoption credits. Some of these credits, such as the Earned Income Credit, are refundable credits: You can get a refund based on the credit even if you don’t have income.
Now, the Bozo mind works differently than yours and mine. They see a tax credit and think, "How can I get some free money? I’ll find a tax credit and the government will just send me money!"
Read the whole thing, and remember that refundable credits are a magnet for fraudsters.
Somewhat related: Smartmoney Tax Blog, How to Avoid Jail Time for Tax Blunders
Iowans who enjoy the whopping 65% state credit for contributions to private school tuition organizations can rest easy. The U.S. Supreme Court yesterday upheld an Arizona version of the credit. The court dismissed the suit on the grounds that the plaintiffs lacked standing to challenge the credit.
Also: Tax Update, Year-end planning and the Iowa School Tuition Organization Credit
UPDATE, 1:45 P.M.: Word from the Capitol is that the Iowa Senate will take up SF 512 after they get out of a caucus. We will post when any updates come through. You can follow here.
UPDATE, 4:19 p.m. : After a tough 3 1/3 hour day, our hardworking senators have packed it in until tomorrow without picking up SF 512. Words fail.
After waiting months to do anything about resolving Iowa's 2010 tax law, the Iowa House last Thursday in a single day passed a coupling bill through both the Ways and Means Committee and the House Floor. The bill couples the Iowa tax law to all federal provisions for 2010, with the exception of bonus depreciation. That means Iowa would recognize the new $500,000 limit for Section 179 for 2010 and 2011.
So now that this bill has been separated from the controversial tax reserve fund that had held it up, it should fly through the Senate, right? One would hope, but SF 512 isn't on the Senate calendar for today. Let's hope that's just an oversight. With only two weeks left in filing season, it would be nice to know the Iowa rules.
Anietra Hamper, the Columbus, Ohio anchoress who tried to deduct her underthings as business expenses, has no regrets. The Columbus Dispatch reports:
Other TV anchors told her they did it, and professionals who prepared her taxes over the years told her it was fine. She kept her business clothes in a separate room at home and recorded costs and kept receipts. When a 2009 IRS letter asked for documentation of her 2005 expenses, she sent it off.
"I knew I had followed their guidelines," she said.
That's why you don't hire TV news anchors to do your tax returns. This case never had a prayer.
Even the Internal Revenue Service acknowledged that former television news anchor Anietra Hamper kept meticulous records of the clothes and other items she bought for business use.
But detailed receipts weren't enough.
She's not the first person to learn that meticulous receipts don't necessarily make the expenses deductible.
Her tax preparer, a Mr. Lykins, feels she got a raw deal:
"Anietra felt, as well as I felt, that the clothing she purchased would be an ordinary, necessary job expense," he said. "The tax code says you can deduct all expenses ordinary and necessary to maintain your income."
But, Lykins said, what can and cannot be deducted is a gray area when it comes to business expenses.
Not so gray at all. A TV person can't deduct her suits, any more than I could deduct the suits I had to wear early in my accounting career.
Ms. Hamper feels she fought the good fight, and has paid a price for doing so:
Hamper can’t appeal the tax-court decision, so she said she’ll make arrangements to pay the IRS. She said she’s glad she fought for what she thought was right.
She’s not as happy about a New York Daily News story about the tax-court decision in her case. The story, which traveled around the world, listed thong underwear among the items she deducted.
Where could they have ever gotten that idea? Oh yeah, from the Tax Court opinion:
Petitioner's clothing purchases for work consisted of such items as traditional business suits, lounge wear, a robe, sportswear, active wear, lingerie, cotton bikini and cotton thong underwear, and evening wear. She also deducted expenses for an Ohio State jersey, jewelry, bedding, running and walking shoes, and dry cleaning costs.
When you are deducting thong underwear and bedding, you're not really in a gray area, unless TV news is much more interesting in Columbus than it is in Iowa.
Via the TaxProf
It's not just accountants working on the weekend in Downtown Des Moines.
A crew hangs a big banner to help EMC Insurance celebrate their 100th Anniversary at 7th and Mulberry yesterday.
Then how about this "tax cut":
Even their tax preparer, the owner of H&R Block in North Carolina, couldn't believe her eyes.
But a couple making $39,000 annually who have adopted five children in recent years qualifies for a $54,000 tax refund. That's because an adoption tax credit of $13,170 per child became refundable this year. Hence, David and Thelma Ward will be paid the amount left over after the credit is applied to their tax bill, reports CNN Money.
Another CPA informs me that he had a couple who got a $26,000 adoption credit refund for 2010 with taxable income of zero.
It's crazy to say that the family that doesn't get a $26,000 check next year with no taxable income is getting a $26,000 tax increase.
While the refundable adoption credit is a dramatic example of the absurdity of calling a subsidy a "tax reduction" just because it comes through your 1040, it's not the only one. The earned income credit is a long-standing example of a welfare program run through the tax system. Refundable credits at the corporate level, like Iowa's research credit, are subsidies in the same way -- when you pay no tax and get a state check, it's a subsidy as sure as if the legislature voted you an appropriation.
Very similar are "transferable" credits, like most film credits. Because film companies are set up to disappear after the production, they rarely have tax to pay of their own. By being allowed to sell their credits to parties that do owe tax, they can turn the credits to cash. They sell them at a discount to make the deal worthwhile to the buyer. The economics are that the state allows the film company to factor state tax receivables at a discount. It's spending state assets just the same as writing a check, except with a loss for the discount.
It's unfortunate how many people who sincerely want to shrink out-of-control government spending are blind to spending run through tax returns. Whether the government check is authorized by an appropriation or a tax code section, it still is money coming out of the pockets of the rest of us.
UPDATE, 4/4: I forgot to thank Taxdood for the Twitter hat-tip. Thanks!
You can operate a professional corporation as a C corporation and get tax-free fringe benefits unavailable to partnerships or S corporations. Sure, C corporations are subject to a flat 35% tax on every dollar of taxable income left at year end, but you just suck out all the earnings as salary at the end of the year. Right?
For an Orland Park, Illinois CPA firm, that failed spectacularly yesterday in Tax Court, and those fringe benefit tax savings are turning out to be quite expensive.
Like many professional C corporations, the firm sucked out all the cash as (purportedly) deductible expenses at year-end to take its taxes down to zero. The Illinois firm did this by paying "consulting fees" to entities controlled by the firm's owners. Tax Court Judge Morrison explains:
The firm made a number of payments to the related entities that it designated as "consulting fees". It now claims that these payments were compensation for the services of the founders. It paid PEM, as "consulting fees", $136,570 in 2001, $147,837 in 2002, and $81,467 in 2003. It paid Financial Alternatives, as "consulting fees", $755,000 in 2001, $468,306 in 2002, and $610,524 in 2003. And it paid MPS Ltd., as "consulting fees", zero in 2001, $250,000 in 2002, and $301,537 in 2003.
The IRS took exception:
In a notice dated December 5, 2007, the IRS determined the following deficiencies in tax: $317,729 for 2001, $284,505 for 2002, and $377,247 for 2003. The deficiencies primarily resulted from disallowance of the deductions for "consulting fees". The IRS also determined that the firm was not entitled to the $34,421 interest expense deduction in 2003. And, as a result of its disallowance of the "consulting fee" deductions for 2001 and 2003, the IRS determined that for 2003 the firm was entitled to neither the credit for prior-year minimum tax nor the deduction for the net operating loss carry forward.
The IRS also determined that the firm was liable for accuracy-related penalties under section 6662 in the following amounts: $63,546 in 2001, $56,901 in 2002, and $73,238 in 2003.
That's real money. Naturally the firm defended the deductibility of the payments, saying that they were intended to be compensation to firm owners for services, and the compensation amounts were reasonable.
The judge found otherwise. He said even if the payments were intended to be compensation, they were too high. He also said found that they weren't really intended as compensation:
We find that the firm intended for the payments to the related entities to distribute profits, not to compensate for services. As discussed above, [one of the owners] chose the amount to pay each year so that the payments distributed all (or nearly all) accumulated profit for the year. He did this for tax planning purposes. Each founder's percentage of the payments to the related entities was tied to hours worked, but the firm's intent in making the payments was to eliminate all taxable income. The firm did not intend to compensate for services.
This sounds a lot like business as usual for many professional C corporations. This case should put many C corporation law, medical and accounting firms on notice that they need to do more than just suck out their cash at the end of the year; they need to document that they are making reasonable salary payments. That could be a tough circle to square.
Not only were the expenses non-deductible to the corporation, the distributions were presumably taxable as dividends to the owners also. That's why the IRS likes to win excess compensation cases -- the owners still get taxed, but the corporation gets no deduction.
On the other hand, this case could be useful to S corporations. The IRS has an incentive to try to jack up the salaries of S corporation owner, which is the opposite of their goal for C corporation owners. S corporation earnings left in the company pass through without self-employment tax on a K-1; IRS likes to reclass such earnings as salary and subject them to employment taxes. This case makes a good argument that you don't have to treat all of the earnings of a professional practice as salary.
Cite: Mulcahy, Pauritsch, Salvador & Co. Ltd., T.C. Memo 2011-74
While the Tax Update is too humor-impaired at this point in tax season to play April Fools jokes, those crazy Tax Foundation guys are up to the job:
Parody is hard in the tax law, as their Congress Choosing Between Big-Government Newspaper Subsidy and Free-Market Newspaper Tax Credit shows. The story says a congresscritter named Papershill is proposing a 50% subsidy for publishing newspapers. Other critters come back with a "free market" alternative:
The counterproposal would provide a tax credit to each newspaper equivalent to 50% of expenses. Newspapers would submit their expenses for approval by a a subcommittee of elected officials to be eligible for the tax credit.
"Our idea is completely different from Papershill's," the sponsors said. "We're giving tax cuts, not a subsidy program, while still saving newspapers, creating lots of jobs, and making sure newspapers are supportive of what we in Congress say and do."
Early indications are that, while Papershill's plan is doomed to failure, the compromise is likely to pass.
"If it lowers someone's taxes, I'm all for it," said one congressman. "Those who are opposed to this tax credit are just big government lackeys who want to tax America's newspapers to death."
While the Tax Foundation is engaging in satire, Grover Norquist is supposed to be serious. Yet he sounds a lot like the fictional Tax Foundation congresscritter when he acts as though just because the ethanol subsidy is run through tax returns, it is no longer a subsidy:
Mr. Norquist said his group opposed revoking the ethanol measure unless it was offset with another tax break, because that would constitute a net tax increase. He said that is the purpose of the group's pledge, which dates from the mid-1980s.
By that logic, all you have to do is call any spending measure a tax credit, and any future cut in the subsidy becomes a tax increase. For Mr. Norquist and Americans For Tax Reform, that makes every day April Fools Day.
Estates of taxpayers who died last year can opt out of the estate tax altogether -- an attractive option if the estate is valued much over the $5 million exemption. Such estates are allowed only a limited step-up in the basis of thier assets. Taxable estates, in contrast, change the basis of their assets to their date of death value.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to