IRS Tax Problems Relief

Charitable Remainder Trust

2008-07-09T10:48:00.000-07:00

Charitable remainder trust can be divided into separate trusts without adverse tax consequences

Rev Rul 2008-41, 2008-30 IRB

Mike Habib, EA

In the context of two fairly detailed factual situations, a new revenue ruling makes it clear that a charitable remainder trust (CRT) can be divided into two or more separate CRTs without adverse tax consequences. If properly effected, the separate trusts will continue to qualify as CRTs, the division won't be a sale, and no excise taxes will arise under Code Sec. 507(c), Code Sec. 4941 or Code Sec. 4945.

Background. In general, a charitable remainder trust (CRT) provides for a specified periodic distribution to one or more noncharitable beneficiaries for life or for a term of years with an irrevocable remainder interest held for the benefit of charity. A CRUT pays a unitrust amount at least annually to the beneficiaries as opposed to a charitable remainder annuity trust or CRAT, which pays a sum certain at least annually to the beneficiaries. (Code Sec. 664)

A CRT is exempt from income tax but is subject to tax on unrelated business taxable income. (Code Sec. 664(c))
Income, gift and estate tax deductions are allowed for the value of the charity's remainder interest in a CRT. (Code Sec. 170(f)(2), Code Sec. 2522(c)(2)(A), Code Sec. 2055(e)(2)(A)) To qualify as a CRT, numerous requirements must be met. They are spelled out in Code Sec. 664(d).

Situation 1 facts. A summary of the key facts in Situation 1 follows:
Trust qualifies as either a CRAT or CRUT. Under its terms, two or more individuals (recipients) are each entitled to an equal share of the annuity or unitrust amount, payable annually, during the recipient's lifetime, and upon the death of one recipient, each surviving recipient becomes entitled for life to an equal share of the deceased recipient's annuity or unitrust amount. Thus, the last surviving recipient becomes entitled to the entire annuity or unitrust amount for his or her life. Upon the death of the last surviving recipient, Trust's assets are to be distributed to one or more Code Sec. 170(c) charitable organizations (remainder beneficiaries).

The state court having jurisdiction over Trust has approved a pro rata division of Trust into as many separate and equal trusts as are necessary to provide one such separate trust for each recipient living at the time of the division, with each separate trust being intended to qualify as the same type of CRT.

The separate trusts may have different trustees. To carry out the division of Trust into separate trusts, each asset of Trust is divided equally among and transferred to the separate trusts. The recipients pay all the costs associated with the division of Trust into separate trusts.

Each of the separate trusts has the same governing provisions as Trust, except that: (i) immediately after the division of Trust, each separate trust has only one recipient, and each recipient is the annuity or unitrust recipient of only one of the separate trusts (that recipient's separate trust); (ii) each separate trust is administered and invested independently by its trustee(s); (iii) upon the death of the recipient, each asset of that recipient's separate trust is to be divided on a pro rata basis and transferred to the separate trusts of the surviving recipient(s), and the annuity amount payable to the recipient of each such separate CRAT is thereby increased by an equal share of the deceased recipient's annuity amount (the unitrust amount of each separate CRUT is similarly increased as a result of the augmentation of the CRUT's corpus, and each separate CRUT incorporates the requirements of Reg. § 1.664-3(b) with respect to the subsequent computation of the unitrust amount from that trust); and (iv) upon the death of the last surviving recipient, that recipient's separate trust (being the only separate trust remaining) terminates, and the assets are distributed to the remainder beneficiaries.

The remainder beneficiaries of Trust are the remainder beneficiaries of each of the separate trusts and are entitled to the same (total) remainder interest after the division of Trust as before.

Situation 2 facts. The facts are similar in Situation 2 except that the recipients are a married couple in the process of divorcing and on the death of the first recipient to die, the remainder of that separate trust goes to the charities. The trust assets do not first go to the survivor recipient as was the case before the division. Thus, the charity can wind up with more than under the original scenario but no increased charitable deduction is allowed.

Favorable rulings. IRS issued these favorable rulings with respect to both Situations 1 and 2:

(1) The pro rata division of a trust that qualifies as a CRT under Code Sec. 664(d) into two or more separate trusts does not cause the trust or any of the separate trusts to fail to qualify as a CRT under Code Sec. 664(d).

(2) The division is not a sale, exchange, or other disposition producing gain or loss, the basis under Code Sec. 1015 of each separate trust's share of each asset is the same share of the basis of that asset in the hands of the trust immediately before the division of the trust, and, under Code Sec. 1223, each separate trust's holding period for an asset transferred to it by the original trust includes the holding period of the asset as held by the original trust immediately before the division.

(3) The division does not terminate under Code Sec. 507(a)(1) the trust's status as a trust described in, and subject to, the private foundation provisions of Code Sec. 4947(a)(2) and does not result in the imposition of an excise tax under Code Sec. 507(c).

(4) The division does not constitute an act of self-dealing under Code Sec. 4941.

(5) The division does not constitute a taxable expenditure under Code Sec. 4945.

Cell Phone Deductibility

2008-07-09T10:43:00.000-07:00

IRS discusses easing of cell phone recordkeeping requirements [Information Letter 2008-0012]:

The IRS has issued an information letter in response to a question regarding the noted difficultly that states and localities are having drafting cell phone policies that comply with IRS recordkeeping requirements.

Under IRC §162(a), individuals may take deductions for all ordinary and necessary expenses incurred in carrying on a trade or business. The expenses are considered tax-free working condition fringe benefits, not subject to FITW, FICA, and FUTA, if they are incurred by an employee on behalf of an employer. Cell phones are currently included in the definition of “listed property,” as defined in IRC §280F(d)(4).

Expenses related to listed property may not be deducted under IRC §274(d), unless the employee substantiates by adequate records, or by sufficient evidence corroborating the employee's own statement: (1) the amount of the expenses; (2) the time and place of the expenses; (3) the business purpose of the expenses; and (4) the business relationship to the employee of the persons involved in the expenses. In addition, employees must document their personal use of the property, and the employer must include such use in the employee's income.

In the information letter, the IRS acknowledges the difficulty in documenting business cell phone use. The IRS is considering various changes to the cell phone substantiation requirements. There is currently legislation in Congress that would remove cell phones from the definition of listed property and allow employers to utilize a de minimus personal use policy.

The IRS is also considering possible regulatory changes that would provide a more streamlined substantiation process for cell phones.

LP Limited Partner Deductions

2008-07-08T07:17:00.000-07:00

Limited partner's investment interest from trader partnership deductible above-the-line

Rev Rul 2008-38, 2008-31 IRB; Ann. 2008-65, 2008-31 IRB

Mike Habib, EA

Earlier this year, IRS issued Rev Rul 2008-12, 2008-10 IRB 520 concluding that where a non-corporate limited partner doesn't materially participate in the partnership's activity, his distributive share of the interest expense on debt allocable to the entity's trade or business of trading securities is investment interest, subject to the Code Sec. 163(d)(1) deduction limitation. Because it received a number of queries as to where to report such interest, IRS has issued a new revenue ruling amplifying the earlier one and a new announcement clarifying where to report such interest.

Specifically, new Rev Rul 2008-38 provides that, in the case of an individual, interest paid or accrued on debt allocable to property held for investment described in Code Sec. 163(d)(5)(A)(ii) is (to the extent allowable after the application of the Code Sec. 163(d) limitation) a deduction described in Code Sec. 62(a)(1) and is therefore taken into account in determining the individual's adjusted gross income (AGI). New Ann. 2008-65, 2008-31 IRB clarifies that the limited partner described in Rev Rul 2008-12 properly includes the allowable amount of his distributive share of the trading partnership's interest expense in computing the limited partner's ordinary business income or loss on Schedule E of the partner's Form 1040.

Background. Deductions attributable to a trade or business carried on other than as an employee are deductible in arriving at AGI. (Code Sec. 62(a)(1))

The amount of investment interest that may be deducted in any tax year by a noncorporate taxpayer generally is limited to his net investment income for the year. (Code Sec. 163(d)(1)) Investment interest is any interest allowable as a deduction that is paid or accrued on debt properly allocable to property held for investment. (Code Sec. 163(d)(3)(A)) Property held for investment includes any interest held by a taxpayer in an activity involving the conduct of a trade or business that is not a passive activity and in which the taxpayer doesn't materially participate (as those terms are used in the Code Sec. 469 passive activity loss rules). (Code Sec. 163(d)(5)(A)(ii))

A taxpayer's activity includes an activity conducted through a partnership. (Reg. § 1.469-4(a)) An interest in an activity includes both an interest in property used in an activity and an interest in an activity held through a partnership. (Reg. § 1.469-2T(c)) Under Reg. § 1.469-1T(e)(6), an activity of trading personal property for the account of owners of interests in the activity isn't a passive activity (without regard to whether the activity is a trade or business activity).

Under Code Sec. 702(b), the character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share is determined as if such item were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership.

Facts in Situation 1 of new ruling. PRS is a partnership that is engaged solely in the trade or business of trading securities for its own account and not for customers. LP, an individual, owns an interest in PRS as a limited partner. He does not materially participate in the activity in which PRS is engaged. The tax year for PRS and LP is the calendar year. PRS incurs debt in its trade or business. In Year 1, LP's distributive share of PRS' tax items includes $200,000 of interest expense incurred by PRS on its debt. LP's net investment income for Year 1 is $150,000. During Year 1, his distributive share of PRS' interest expense is the only investment interest he paid or accrued. LP' distributive share of PRS' interest expense is not subject to any limitation under Code Sec. 465.

Result in Situation 1. LP may deduct $150,000 of his $200,000 distributive share of PRS's interest expense. Under Code Sec. 163(d)(2), the $50,000 of interest expense not allowed as a deduction for Year 1 is treated as investment interest paid or accrued in Year 2. His distributive share of PRS' Year 1 interest expense that is allowed under Code Sec. 163(d)(1) is deductible in arriving at his AGI under Code Sec. 62(a)(1). The investment interest limitation does not affect the character of LP's interest expense for other purposes. Thus, except for purposes of applying the investment interest limitation, LP's distributive share of PRS' interest expense deductions are characterized under Code Sec. 702(b). Accordingly, $150,000 of LP's distributive share of the Year 1 interest expense of PRS is deductible in arriving at LP's adjusted gross income.

Situation 2 facts and result. The facts are the same as in Situation 1 except that during Year 1 LP also pays $100,000 of interest expense on debt properly allocable to stocks and bonds held by LP for investment (within the meaning of Code Sec. 163(d)(5)(A)(i)). Under Code Sec. 163(d)(1), LP is allowed to deduct only $150,000 of his $300,000 of investment interest expense in Year 1. To the extent that this amount is attributable to debt incurred in PRS' trade or business, the deduction is taken into account in arriving at LP's AGI; to the extent it is attributable to the debt allocable to the stock and bonds held for investment, the deduction is reported as an itemized deduction. When an individual, such as LP, has both investment interest expense attributable to property described in Code Sec. 163(d)(5)(A)(i) and investment interest expense attributable to property described in Code Sec. 163(d)(5)(A)(ii) and his aggregate investment interest expense is greater than his net investment income, he must allocate his net investment income to the two categories of investment interest expenses using a reasonable method of allocation. One reasonable method is to allocate the net investment income to the two categories of investment interest in the same proportion that the amount of investment interest in each category bears to the total amount of investment interest (the pro rata method). As shown in Rev Rul 2008-38 this method would allow LP to deduction $100,000 above-the-line and $50,000 below the line.

Opportunity Letter - Offshore Account

2008-07-02T08:54:00.000-07:00

Judge: IRS can seek tax information from Swiss banking giant UBS in expanding investigation

Associated Press WorldStream via NewsEdge :

MIAMI_A federal judge agreed Tuesday to allow the IRS to serve legal papers on Swiss banking giant UBS AG in an expanding investigation into U.S. taxpayers who may have used overseas accounts to hide assets and avoid taxes.

The order from U.S. District Judge Joan Lenard came one day after the Justice Department requested authority for the IRS to issue "John Doe" summons to UBS. The summons are used in IRS tax fraud investigations when the identity of the people involved is not known.

Lenard said in a two-paragraph order that based on the government court filings, "there is a reasonable basis for believing such a group or class of persons may fail or may have failed to comply" with U.S. tax laws.

The summons will allow the IRS to obtain information about American taxpayers who have UBS accounts but did not file required forms detailing their taxable income.

"The order clears the way for the IRS to take the next steps against wealthy individuals who don't pay their taxes," said IRS Commissioner Doug Shulman in a written statement. "People with hidden foreign accounts can no long rest easy."

UBS has said it is cooperating with Swiss and U.S. investigations and will disclose records involving U.S. clients who might have broken tax laws.

U.S. taxpayers are required to report all foreign financial accounts if their total value exceeds $10,000 at any point during a given year, prosecutors said. Failure to report the accounts can result in a penalty of up to 50 percent of the amount in the accounts.

The Justice Department requested the summons after former UBS private banker Bradley Birkenfeld, 43, pleaded guilty in a Florida federal court to defrauding the IRS. Birkenfeld, who is cooperating with investigators, said in court that UBS has about $20 billion in assets in undeclared accounts for U.S. taxpayers.

Prosecutors said Birkenfeld and others helped California billionaire Igor Olenicoff hide $200 million in assets overseas. Olenicoff, who controls a real estate empire, pleaded guilty last year to tax charges and agreed to pay the IRS more than $52 million.

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Rules for claiming a dependent child

2008-07-02T07:18:00.000-07:00

Final regs on dependent child of divorced or separated parents or parents who live apart T.D. 9408, 07/01/2008; Reg. § 1.152-4

Mike Habib, EA

IRS has issued final regs on the rules for claiming a child as a dependent by parents who are divorced, legally separated under a decree of separate maintenance or a written separation agreement, or who live apart at all times during the last 6 months of the calendar year. They are effective for tax years beginning after July 2, 2008, and reflect amendments under the Working Families Tax Relief Act of 2004 (WFTRA) and the Gulf Opportunity Zone Act of 2005 (GOZA).

Background. A taxpayer may deduct an exemption amount for a dependent, defined generally as a qualifying child or a qualifying relative. Code Sec. 152(e), as amended by § 404 of GOZA, carries rules for parents who (1) are divorced or legally separated under a decree of divorce or separate maintenance, (2) are separated under a written separation agreement, or (3) live apart at all times during the last 6 months of the calendar year. A child of parents described in (1), (2), or (3), is treated as the qualifying child or qualifying relative of the noncustodial parent if the child receives over one-half of his support during the calendar year from the child's parents, the child is in the custody of one or both of the child's parents for more than half of the calendar year, and:

the custodial parent signs a written declaration that the custodial parent will not claim a child as a dependent for a tax year and the noncustodial parent attaches the declaration to the noncustodial parent's tax return (Code Sec. 152(e)(2); or
a qualified pre-'85 instrument allocates the dependency exemption to the noncustodial parent and the noncustodial parent provides at least $600 for the support of the child during the calendar year. (Code Sec. 152(e)(3))

A custodial parent is the parent having custody for the greater portion of the calendar year and the noncustodial parent is the parent who is not the custodial parent. (Code Sec. 152(e)(4)) If a child is treated as the qualifying child or qualifying relative of the noncustodial parent under Code Sec. 152(e), then that parent may claim the child for purposes of the dependency deduction under Code Sec. 151 and the child tax credit under Code Sec. 24, if the other requirements of those provisions are met.

In May of 2007, IRS issued proposed regs on the rules for a dependent child of divorced or separated parents or parents who live apart. IRS has now adopted the proposed regs as final regs, with some modifications.

Final regs. The final regs update the prior final regs, deleting obsolete provisions, revising language to improve clarity, and incorporating provisions in Reg. § 1.152-4T, which is removed. They also provide guidance on issues that have arisen in the administration of Code Sec. 152(e).

Custodial parent. Like the proposed regs, the final regs define the custodial parent as the parent with whom the child resides for the greater number of nights during the calendar year (the counting nights rule). In response to commentators' concern that this rule doesn't address how the child's residence for a night is determined (e.g., by the child's physical location at a given time such as midnight, or by where the child sleeps) and for which year the night of Dec. 31 to Jan. 1 is counted, the final regs clarify that, for purposes of Code Sec. 152(e), a child resides for a night with a parent if the child sleeps (1) at the parent's residence (whether or not the parent is present); or (2) in the company of the parent when the child does not sleep at a parent's residence (for example, if the parent and child are on vacation). The time that a child goes to sleep is irrelevant. A night that extends over two tax years is allocated to the tax year when the night begins: for example, the night that begins on Dec. 31, 2008, is counted for tax year 2008. (Reg. § 1.152-4(d))

To remedy any ambiguity caused by the proposed regs' failure to define custody, the final regs provide that a child is in the custody of one or both parents for more than one-half of the calendar year if one or both parents have the right under state law to physical custody of the child for more than one-half of the calendar year. But, a child isn't in the custody of either parent for purposes of Code Sec. 152(e) when the child reaches the age of majority under state law. (Reg. § 1.152-4(c))

Release of the right to claim a child. Under Code Sec. 152(e)(2), a custodial parent may release a claim to an exemption for a child by signing a written declaration that he will not claim the child as a dependent. The final regs retain the rule in the proposed regs that a written declaration not on Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, (or successor form) must conform to the substance of Form 8332. The final regs further provide that a release not on a Form 8332 must be a document executed for the sole purpose of releasing the claim. A court order or decree or a separation agreement cannot serve as the written declaration. If a release of a claim to a child is for more than one year, the noncustodial parent must attach a copy of the written declaration (rather than the original, as required in the proposed regs) to the parent's return for the first tax year for which the release is effective. Copies must also be attached to returns for later years. (Reg. § 1.152-4(e))

Revocation of release of claim. Under both the final and proposed regs, a custodial parent who released the right to claim a child could revoke the release for future tax years by providing written notice of the revocation to the other parent. The final regs require that the parent revoking the release notify, or make reasonable attempts to notify, in writing, the other parent of the revocation. What is a reasonable attempt is determined under the facts and circumstances, but mailing a copy of the written revocation to the noncustodial parent at the last known address or at an address reasonably calculated to ensure receipt satisfies this requirement. A revocation can be made on Form 8332, or successor form designated by IRS. A revocation not on the designated form must conform to the substance of the form and be in a document executed for the sole purpose of revoking a release. A taxpayer revoking a release may attach a copy rather than an original to the taxpayer's return for the first tax year the revocation is effective, as well as for later years. (T.D. 9408, 07/01/2008, Reg. § 1.152-4(e)(3))

The final regs also clarify that a multiple year written declaration executed in a tax year beginning on or before July 2, 2008, that satisfies the requirements for the form of a written declaration in effect at the time the written declaration was executed is treated as satisfying the requirements for the form of a release under the final regs. However, the rules for revoking a release of a claim to an exemption apply without regard to whether a custodial parent executed the release in a tax year beginning on or before July 2, 2008; such a release executed may be revoked. (Reg. § 1.152-4(e)(5))

Property Seizure Compliance

2008-07-02T07:15:00.000-07:00

TIGTA results of 2008 review IRS compliance with legal guidelines when conducting property seizures [Audit Report No. 2008-30-126]:

IRS has usually followed the numerous legal and internal guidelines that apply to seizures of taxpayers' property, the Treasury Inspector General for Tax Administration (TIGTA) said in a recent audit. TIGTA based its opinion on a review of a random sample of 50 of the 683 seizures conducted from July 1, 2006, through June 30, 2007.

Auditors identified 25 instances in which IRS did not comply with a particular Code requirement but, according to TIGTA, this represented an error rate of only about 1%. The problems identified in the audit included the following—10 instances in which expenses and proceeds resulting from the seizure weren't properly applied to the taxpayers' accounts; five instances in which the sales of seized properties weren't properly advertised; five instances in which the correct amounts of the liabilities for which the seizures were made weren't provided on the notices of seizures sent to the taxpayers; and five instances that were redacted from the publicly released version of the audit.

The audit is located at http://treas.gov/tigta/auditreports/2008reports/200830126fr.pdf .

Unemployment Benefits Extended

2008-07-02T07:13:00.000-07:00

New bill extends unemployment benefits for 13 weeks

The President has signed into law H.R. 2642, “The Supplemental Appropriations Act of 2008.”

Title IV of the bill authorizes an extension of unemployment insurance (UI) benefits. Individuals may be eligible for 13 weeks of extended benefits if they: (1) are fully or partially unemployed after July 5, 2008, (2) have exhausted their benefits in their regular UI claim, and (3) are ineligible to file a new claim.

The extension will be available to workers in all states, and can be used on top of the 26 weeks of benefits that typically are available. The maximum benefit is equal to the lesser of: (a) 50% of the maximum benefit that individuals received on their regular UI claim, or (b) 13 times the weekly benefit amount on their regular claim.

Extended benefits will be available through the week that begins June 29, 2009. The provision was included as part of an emergency war spending bill.

House passes AMT relief

2008-07-01T19:25:00.000-07:00

House passes AMT relief with bipartisan majority - President threatens veto

On June 25, the House by a vote of 233 to 189 approved H.R.6275, the “Alternative Minimum Tax Relief Act of 2008.” The bill will be sent to the Senate for consideration.

The bill would patch the alternative minimum tax (AMT) problem for 2008 by extending for one year AMT relief for nonrefundable personal credits and increasing AMT exemption amounts to $69,950 for joint filers and $46,200 for individuals. The one-year AMT patch would be fully offset with a variety of revenue raising measures, including taxing certain carried interests as ordinary income, barring large integrated oil companies from claiming the Code Sec. 199 domestic production activity deduction, freezing the Code Sec. 199 deduction at the 6% level for other producers of oil and natural gas, and requiring information returns for merchant payment card reimbursements.

On June 24, in a Statement of Administration Policy, President Bush indicated that he would veto the bill because of his strong opposition to provisions raising taxes on certain partners in partnerships and taxes on payments by U.S. subsidiaries to foreign affiliates and limiting the availability of the domestic production deduction for certain oil companies.

Shareholder Constructive Distribution

2008-07-01T09:52:00.000-07:00

Loan repayment to shareholder's spouse wasn't constructive distribution Beckley, 130 TC No. 18 (2008)

Mike Habib, EA

The Tax Court has ruled that payments made by a corporation to the wife of one of its shareholders represented repayment of money she advanced to a predecessor corporation. Despite the absence of a written loan agreement, the repayment wasn't a constructive distribution to the shareholder.

Facts in brief. In '88, Alan Beckley and Robert Ebert incorporated CT Inc., a software development company and each owned 50% of the company. CT often ran short of funds and in '88 through '99, it borrowed at least $106,834 from Alan's wife, Virginia. The corporation used the borrowed funds to develop a working model of Web-based video conferencing software. CT had financial problems and was dissolved in '98. In 2000, VDN, Inc., was incorporated to succeed to CT's business and to continued to develop business products. Alan was a shareholder in VDN. The working model of the video conferencing software developed by CT was transferred to VDN in 2000, but the latter did not execute a written loan assumption agreement with regard to CT's loan repayment obligation to Virginia. She did not make a claim against CT for repayment of the funds she lent to it, did not treat her loan to CT as a worthless loan, and did not claim an ownership interest in the working model.

In 2001, VDN paid Virginia $95,434. It treated $58,600 of that amount as interest which it reported on Form 1099–INT and the balance as repayment of principal. Virginia reported the interest portion of the payment on her return as interest. In 2002, VDN paid Virginia $70,000. Virginia treated the $70,000 as repayment of principal. On its returns for 2001 and 2002, VDN deducted the payments to Virginia as nonemployee compensation.

In 2003 Alan Beckley and Robert Ebert were terminated by VDN, and it made no further payments to Virginia.
When it audited the Beckleys' returns for 2001 and 2002, IRS didn't challenge their characterization of the amounts received from VDN, but asserted that one half of the amounts received by Virginia also were corporate distributions taxable as capital gain to Alan. IRS's theory was that VDN's payments to Virginia on her loan to CT were made without any legal obligation to do so and only on the basis of a personal moral obligation of Alan and Ebert to repay Virginia. Thus, it argued that VDN's payments represented constructive corporation distributions.

Amounts represented loan repayment. The Tax Court ruled that the facts didn't support IRS's theory that VDN's payments to Virginia were made to satisfy only personal moral obligations of Alan and of Ebert. Although VDN did not execute a written loan assumption agreement, it effectively purchased the working model from CT, assumed at least part of CT's obligation to repay Virginia's loan to CT, and thus, its payments to Virginia related to that original loan. Although there was no written agreement reflecting VDN's obligation to repay Virginia, its conduct in actually making payments to Virginia, which related to her loan to CT and to CT's transfer of the working model to VDN, established the loan repayment character of the payments. In addition, the Form 1099-INT that VDN mailed to Virginia and to IRS for 2001 reflected that $58,600 represented interest on a loan.

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Employment / Payroll Tax Adjustments

2008-07-01T09:49:00.000-07:00

Final regs include new process for reporting employment tax adjustments and refund claims
T.D. 9405, 06/30/2008, Reg. § 31.6011(a)-1, Reg. § 31.6011(a)-4, Reg. § 31.6011(a)-5, Reg. § 31.6205-1, Reg. § 31.6302-1, Reg. § 31.6402(a)-1, Reg. § 31.6413(a)-1, Reg. § 31.6403(a)-2

Mike Habib, EA

IRS has issued final regs on employment tax adjustments and refund claims, effective Jan. 1, 2009. The final regs modify the process for making interest-free adjustments for both underpayments and overpayments of Federal Insurance Contributions Act (FICA) and Railroad Retirement Tax Act (RRTA) taxes and Federal income tax withholding (ITW).

Background on interest-free adjustments and refunds. While generally interest must be paid to IRS on any tax underpayment and to a taxpayer on any tax overpayment, an exception applies to employment taxes. Where an incorrect amount of tax under Code Sec. 3101 (employee FICA tax), Code Sec. 3111 (employer FICA tax), Code Sec. 3201 (employee RRTA tax), Code Sec. 3221 (employer RRTA tax), or Code Sec. 3402 (ITW) is reported to IRS for any payment of wages or compensation, Code Sec. 6205(a) and Code Sec. 6413(a) allow employers to make interest-free adjustments for underpayments and overpayments, respectively.

Under the prior Code Sec. 6205(a) regs, if a return is filed and less than the correct amount of employee or employer portions of FICA or RRTA tax is reported and paid, the employer adjusts the underpayment (a) by reporting the additional amount due as an adjustment on a current return, or (b) by reporting such additional amount on a supplemental return. For overpayments of employment taxes, Code Sec. 6413(b) allows a refund claim to be filed when an interest-free adjustment cannot be made. Under the prior Code Sec. 6413 regs, IRS allows taxpayers to choose between filing a claim for refund and making an interest-free adjustment to correct an overpayment of employment taxes.

Late in 2007, IRS issued proposed regs on employment tax adjustments and refund claims (see Federal Taxes Weekly Alert 01/03/2008). The proposed regs have now been adopted with only minor changes.

Revised adjusted return process. The final regs are issued in connection with IRS's development of new forms to report adjustments to employment taxes which will replace the existing process of reporting adjustments on regularly filed employment tax returns. The regs are part of IRS's effort to reduce taxpayer burdens by allowing employers to make employment tax adjustments on a separately filed form as soon as an error is ascertained, rather than as a line adjustment on the regularly filed employment tax return. The new adjusted return will not affect the liability reported on the current return. Under the regs, the forms used to accept an assessment of employment taxes after an examination (Form 2504, Agreement and Collection of Additional Tax and Acceptance of Overassessment (Excise or Employment Tax), and Form 2504-WC, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment in Worker Classification Cases (Employment Tax)) constitute adjusted returns. (Reg. § 31.6205-1)

Interest-free adjustments. The final Code Sec. 6205 regs set out the procedures for making interest-free adjustments for underpayments of employment taxes. If a return is filed and less than the correct amount of employee or employer FICA or RRTA tax is reported, and the employer discovers the error after filing the return, the employer adjusts the resulting underpayment of tax by reporting the additional amount due on an adjusted return for the return period in which the wages or compensation was paid. The adjustment must be made by the due date of the return for the return period in which the error is ascertained, and the amount of the underpayment must be paid by the time the adjustment is made, or interest will begin to accrue from that date. An underpayment adjustment can only be made within the period of limitations for assessment. For underpayments of ITW where the incorrect amount was withheld, subject to limited exceptions, an adjustment can only be made for errors ascertained during the calendar year in which the wages were paid. (Reg. § 31.6205-1(b)(2))

The final regs also provide for interest-free adjustments of underpayments of FICA tax, RRTA tax, and ITW under certain circumstances where the underpayment arises because the employer failed to file an original return or failed to report and pay the correct type of tax. (Reg. § 31.6205-1(b)(3), Reg. § 31.6205-1(c)(3))

The final Code Sec. 6413(a) regs set out the procedures for making interest-free adjustments for overpayments of employment taxes. If an employer ascertains an overpayment error within the applicable period of limitations on credit or refund, it's required to repay or reimburse its employees the amount of overcollected employee FICA or RRTA tax before the expiration of that period. However, the requirement to repay or reimburse doesn't apply to the extent that taxes weren't withheld from the employee or if, after reasonable efforts, the employer cannot locate the employee. In such a case, the employer can make an adjustment for only the employer share of FICA or RRTA tax. An interest-free adjustment for an overpayment cannot be made once a claim for refund has been filed. (Reg. § 31.6413(a)-1)

Once an employer repays or reimburses an employee to the extent required, the employer may report both the employee and employer portions of FICA or RRTA tax as an overpayment on an adjusted return. The employer must certify on the adjusted return that it has repaid or reimbursed its employees to the extent required.

Under the final regs, the reporting of the overpayment constitutes an interest-free adjustment if the overpayment is reported on an adjusted return filed before the 90th day prior to expiration of the period of limitations on credit or refund. Similar rules apply for making interest-free adjustments for ITW overpayments, except that an interest-free adjustment can only be made if the employer ascertains the error and repays or reimburses its employees within the same calendar year that the wages were paid and reports the adjustment on an adjusted return. (Reg. § 31.6413(a)-2)

No repayment or reimbursement for interest-free adjustments of overpayments. Unlike in the proposed reg, in the final regs the employer isn't required to repay or reimburse the employee or to adjust the overpayment by the due date of the return for the return period following the return period in which the error is ascertained. (Reg. § 31.6402-2(a)(1)) After reconsideration, IRS determined there was insufficient reason to impose a timing restriction other than the period of limitations on credit or refund of taxes. (T.D. 9405, 06/30/2008)

Deposits, payments, and credits. An employer making an interest-free adjustment must pay the amount of the adjustment by the time it files an adjusted return. The timely payment satisfies the employer's deposit obligations for the adjustment. (Reg. § 31.6302-1(c)(7)) In determining the amount of accumulated taxes in an agricultural employer's lookback period (which determines the employer's deposit schedule), adjustments to tax liability made under the filing of adjusted returns or refund claims aren't taken into account; new agricultural employers are treated as having employment tax liabilities of zero for any lookback period before the date the employer started or acquired its business. (Reg. § 31.6302-1(g)(4))

If the underpayment amount isn't paid when the adjusted return is filed, interest begins to accrue as of the date the adjusted return is filed. (Reg. § 31.6205-1(b)(2))

The adjusted overpayment amount will be applied as a credit toward payment of the employer's liability for the calendar quarter (or calendar year for annual returns being adjusted) in which the adjusted return is filed, unless IRS notifies the employer that the credit will be applied to a different return period or that the employer isn't entitled to the adjustment under applicable laws or procedures. (Reg. § 31.6413(a)-2(b)(2))

Refunds for overpayments. As in the prior regs, instead of making an interest-free adjustment for an overpayment, employers can file a claim for refund for the amount of the overpayment. Furthermore, if an employer can't make an interest-free adjustment for an overpayment because the period of limitations for claiming a credit or refund for the overpayment will expire within 90 days or because IRS has otherwise notified the employer that it's not entitled to the adjustment, the employer can recover the overpayment only by filing a claim for refund. (Reg. § 31.6413(a)-2(d))

An employer can file a claim for refund of an overpayment of FICA or RRTA tax, but must certify that it has repaid or reimbursed the employee's share of FICA or RRTA tax to the employee or has secured the employee's written consent to allowance of the refund or credit. However, the employer isn't required to repay or reimburse the employee or obtain the written consent of the employee to the extent that the overpayment doesn't include taxes withheld from the employee or, after reasonable efforts, the employer cannot locate the employee or the employee, once contacted, will not provide the requested consent. (Reg. § 31.6402(a)-2(a)) The final regs under Code Sec. 6414 set out similar procedures for filing a claim for refund of overpaid ITW, except that an employer can't file a claim for refund of an overpayment of ITW for an amount the employer deducted or withheld from an employee. (Reg. § 31.6414-1(a))

IRS intends to issue guidance to provide examples of how the final regs apply in different factual scenarios. (T.D. 9405, 06/30/2008)

Sales Tax BOE Announcement

2008-06-30T09:49:00.000-07:00

Judy Chu Announces No More Paper Returns for Most BOE Taxpayers

Sales Tax Audit? Sales Tax Problem? BOE or SBE Issues? Get Sales Tax Resolution TODAY!

Business Editors/Government Writers

SACRAMENTO, Calif.--(BUSINESS WIRE)--June 27, 2008--Judy Chu, Ph.D., Chair of the State Board of Equalization (BOE), today announced that the BOE will begin transitioning existing sales and use taxpayers to electronic filing and eliminate the use of paper tax returns.

This month, more than 90 thousand taxpayers will be notified they will no longer be receiving paper returns from BOE, but rather be expected to file on-line. This first group of existing taxpayers transitioning to e-filing includes single location quarterly prepayment accounts that are comprised of medium to large size businesses that file and make prepayments twelve times a year. These taxpayers will be expected to e-file rather than use a paper return with the reporting of third quarter 2008 returns, due October 31.

In addition to existing accounts, beginning July 1 all new businesses that apply for a seller’s permit will be set up for e-filing. There are an estimated 165,000 new seller’s permits issued each year.

The BOE-file program offers taxpayers a fast and convenient method of reporting, enhances the ease of filing, improves government efficiencies in tax administration and helps the environment by using less paper. The BOE currently prints, mails, and processes over 3.5 million sales and use tax returns annually. The taxpayers transitioning to e-filing in this phase account for approximately 1.4 million of these returns. The BOE estimates savings of up to $1.8 million in 2008-2009 with a participation rate of 25 percent to 50 percent of those eligible for e-filing.

Over the next two years, the majority of existing sales and use tax accounts will be transitioned from paper to e-filing, phased in based on account type and reporting basis.

All businesses will receive BOE-file notices in their next quarterly tax returns, expected around July 1, 2008. Taxpayers may request a one-year exemption from on-line filing.

There are several e-filing options available on the BOE website at www.boe.ca.gov. The BOE offers a free option, BOE-file. In addition, taxpayers may also choose from two fee-based electronic service providers. Accountants, bookkeepers, and other third-party return preparers can e-file on behalf of the taxpayer as well.

BOE-file has options to make payments via credit card or by check for all taxes and fees it collects. Taxpayers may use Discover, MasterCard, American Express and Visa. A convenience fee is charged and retained by the credit card processor. Besides sales tax, the BOE also administers levies on alcohol, fuel, tobacco, tires, lumber, and a number of other environmental fees. Motor Vehicle Fuel taxes, the International Fuel Taxes Agreement program and the Underground Storage Tank Maintenance Fee returns can also be filed electronically. For information regarding e-filing options available for other programs administered by BOE, visit the BOE website at www.boe.ca.gov and click on the E-services icon.

The BOE launched its first free e-file system in 2005. More than 830,000 businesses are currently eligible to use BOE-file. There are currently 879,000 active sales and use tax accounts registered with the BOE.

For more information on the BOE-file program, visit:

BOE-file Program (http://www.boe.ca.gov/elecsrv/esrvcont.htm)

Frequently Asked Questions (http://www.boe.ca.gov/elecsrv/efiling/boefilefaqtaxp.htm)

Chair Judy Chu represents the Fourth Board of Equalization District, which includes Los Angeles County. She won election to the BOE in November 2006 and was elected Chair of the Board of Equalization in January 2008. Chair Judy Chu is also a voting member of the Franchise Tax Board.

The five-member California State Board of Equalization is a publicly elected tax board. The BOE collects more than $53 billion annually in taxes and fees supporting state and local government services. It hears business tax appeals, acts as the appellate body for franchise and personal income tax appeals, and serves a significant role in the assessment and administration of property taxes.

California State Board of Equalization

Anita Gore, 916-327-8988

State Keywords: California

Industry Keywords: Public Policy/Government; Government Agencies; Public Policy; State/Local; Professional Services; Accounting

Source: California State Board of Equalization

Sales Tax Audit? Sales Tax Problem? BOE or SBE Issues? Get Sales Tax Resolution TODAY!

Carbon Dioxide and the IRS?

2008-06-30T09:38:00.000-07:00

Gain from selling carbon dioxide allowances didn't generate foreign personal holding company income PLR 200825009

Mike Habib, EA

IRS has privately ruled that gain from the sale of surplus carbon dioxide allowances didn't constitute foreign personal holding company income (FPHCI) under Code Sec. 954(c). It concluded that the emissions allowances were excepted because they were intangible property used in the controlled foreign corporations' trade or business.

Facts. Taxpayer indirectly owns through a chain of foreign subsidiaries an unspecified percentage of the vote and value of Corporation A. The remaining interest is owned by unrelated parties. Corporation A engages in Industry M in Country A, where it is organized.

Taxpayer also indirectly owns 100% of the vote and value of Partnership B, a Country B entity that is treated as a controlled foreign partnership under Code Sec. 6038(e) . An unspecified percentage of Partnership B is directly owned by Corporation C, a controlled foreign corporation (CFC) of Taxpayer, organized in Country A. The remaining interest of Partnership B is directly owned by a domestic subsidiary corporation of Taxpayer. Partnership B engages in Industry M and other industries in Country B.

Countries A and B are members of the European Union (EU), which has developed the Emissions Trading Scheme (ETS) to regulate the emissions of carbon dioxide or its equivalent within certain industries, including Industry M. Beginning on Jan. 1, 2008, the ETS was expanded to include regulation of 5 other greenhouse gases. Corporation A and Partnership B are subject to the ETS.

Under the ETS, member states may emit specified amounts, measured in units, of the regulated greenhouse gases. The emissions capacity of each member state is represented by an allocation of allowances to it. Corporation A and Partnership B received carbon dioxide allowances from Country A and Country B, respectively, in Year 1 and Year 2. A business must surrender its allocated allowances for any year to the relevant authority in amounts equal to its emissions for the year. To the extent the measured emissions of a business exceed its allowances, a fine is imposed. However, to the extent a business has excess allowances, it may sell any surplus to another person. Corporation A and Partnership B had surplus allowances in Year 1 and Year 2, which were sold to unrelated purchasers.

Carbon dioxide allowances are traded over the counter and on exchanges such as the European Climate Exchange, the European Energy Exchange and Nordpool.

Background. Under Code Sec. 951(a), a U.S. shareholder of a CFC must include in gross income its pro-rata share of the CFC's subpart F income for the tax year.

A U.S. shareholder is any U.S. person (as defined in Code Sec. 957(c)) who owns (under Code Sec. 958) 10% or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. (Code Sec. 951(b))

A CFC is any foreign corporation if more than 50% of the total combined voting power of all classes of its stock or more than 50% of the total value of its stock is owned by U.S. shareholders on any day during the tax year of such foreign corporation. (Code Sec. 957(a))

Subpart F income includes foreign base company income. (Code Sec. 952(a))
Under Reg. § 1.952-1(g)(1), a CFC's distributive share of any item of income of a partnership is income that falls within a category of subpart F income, as defined in Code Sec. 952(a), to the extent the item of income would have been income in such category if received by the CFC directly.

Code Sec. 954(a) defines four categories of foreign base company income, including FPHCI.
Code Sec. 954(c)(1)(C) provides, in part, that FPHCI includes the excess of gains over losses from transactions in any commodity. Commodity, for this purpose, includes tangible personal property of a kind that is actively traded or with respect to which contractual interests are actively traded. (Reg. § 1.954-2(f)(2)(i)) There are, however, exceptions. For example, net commodities gain that is included in FPHC income for subpart F purposes does not include active business gains or losses from the sale of commodities, if substantially all of the CFC's commodities are property described in Code Sec. 1221(a)(1) (inventory), Code Sec. 1221(a)(2) (property used in a trade or business subject to depreciation), or Code Sec. 1221(a)(8) (supplies used or consumed by the CFC in its trade or business). (Code Sec. 954(c)(1)(C)(ii))

Code Sec. 954(c)(1)(B)(iii) provides that FPHCI includes the excess of gains over losses from the sale of property which does not give rise to any income. However, under Reg. § 1.954-2(e)(3)(iii), property that does not give rise to income excludes intangible property (under Code Sec. 936(h)(3)(B)) to the extent used or held for use in the CFC's trade or business.

Reg. § 1.954-2(a)(5) provides special rules for calculating FPHCI applicable to distributive shares of partnership income. Under Reg. § 1.954-2(a)(5)(ii)(A), the exclusion provided by Reg. § 1.954-2(e)(3) applies only if such exception would have applied to exclude the income from FPHCI if the CFC had earned the income directly, determined by taking into account only the activities of, and property owned by, the partnership and not the separate activities or property of the CFC or any other person.

Code Sec. 936(h)(3)(B)(iv) and Code Sec. 936(h)(3)(B)(vi) include in the definition of intangible property any franchise, license, or contract, or any similar item, which has substantial value independent of the services of any individual.

Reg. § 1.954-2(a)(2) provides coordination rules for overlapping categories under the FPHCI provisions. Under those rules, gain or loss from commodities transactions under Code Sec. 954(c)(1)(C) take priority over gain under Code Sec. 954(c)(1)(B).

Analysis. IRS said it was currently studying the question of whether carbon dioxide allowances should be viewed as commodities for purposes of Code Sec. 954(c)(1)(C). However, it stated that, solely for purposes of PLR 200825009, IRS believes it is appropriate at this point to analyze carbon dioxide allowances as property that does not give rise to income under Code Sec. 954(c)(1)(B)(iii). No inference is intended as to whether the allowances are properly considered commodities for purposes of Code Sec. 954 or any other Code section.

The ruling noted that Reg. § 1.954-2(e)(3)(iv) provides that intangible property is excluded from FPHCI to the extent used or held for use in the CFC's trade or business. But this is applied to CFC partners by taking into account only the activities of the partnership.

In this case, possession of carbon dioxide allowances is necessary to operate in Industry M. Because each allowance permits the holder to engage in a business activity otherwise unlawful, without penalty, the allocation of an allowance by a member state is the granting of an intangible property right to each business to emit carbon dioxide to a set limit. The value of the allowance is independent of the performance of services by any individual. Thus, for purposes of Code Sec. 954(c)(1)(B), the allowances are intangible property under Code Sec. 936(h)(3)(B). However, to qualify for the exclusion of Reg. § 1.954-2(e)(3)(iv), the intangible property of Corporation A and Partnership B must be used or held for use in Corporation A and Partnership B's trade or business.

Based on the facts presented, IRS concluded that Corporation A and Partnership B held the carbon dioxide allowances to offset emissions resulting from the operation of their businesses in Industry M. Thus, Corporation A and Partnership B held the emissions allowances for use in their trade or business. Therefore, the allowances are intangible property held for use in a trade or business within the meaning of Reg. § 1.954-2(e)(3)(iv) and gain from their sale is properly excluded from the definition of FPHCI found in Code Sec. 954(c)(1)(B)(iii) by Corporation A and Corporation C.

Bottom line. Gain from the sale of surplus carbon dioxide allowances by Corporation A and Partnership B does not constitute FPHCI within the meaning of Code Sec. 954(c) to Corporation A or Corporation C.

Tax man is coming soon

2008-06-27T15:27:00.000-07:00

House Subcommittee Passes IRS Funding Bill

The House Appropriations Financial Services Subcommittee this week passed a bill that would appropriate $11.4 billion to IRS for FY 2009.

The bill would grant IRS budget authority to spend $5.1 billion on enforcement, $2.2 on taxpayer services, and $3.8 billion on operations.

The total is about $40 million more than the president's request for the agency. The bill will next be considered by the full House Appropriations Committee before it goes to the House floor.

Closing the Tax Gap: An estimated $290 billion in taxes owed go unpaid every year. The IRS Oversight Board noted in a recent report that “the tax gap is an injustice to compliant taxpayers who ultimately are bearing the financial burden of those who do not pay what they owe, whether intentionally or not.”
• Enforcement: $5.1 billion, $337 million above 2008 and matching the President’s request, to catch tax cheats through audits, collection efforts, and technology improvements.

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As you can see from the above, over $5,000,000,000 (Five Billion), allocated for IRS enforcement. Enforcement will encompass aggressive collection efforts for collecting back taxes, and additional tax audits to ensure compliance and catch tax cheats.

So, if you owe the IRS, contact us today to resolve your tax matter. Don't let the IRS punish you, you could settle your tax debt for less than you owe.

Business Economic Stimulus

2008-06-26T10:04:00.000-07:00

Business Provisions of the Economic Stimulus Act of 2008

Mike Habib, EA

The Economic Stimulus Act of 2008 contains two provisions that provide tax benefits for businesses. The first provision increases the limit up to which a business can expense property purchased and placed in service during its 2008 tax year. The second provision provides an additional 50 percent special depreciation allowance for property acquired and placed in service during calendar year 2008.

Unlike the economic stimulus payments that millions of individuals have already received, the tax benefits for businesses are not automatic; businesses must act to take advantage of the new provisions by purchasing qualifying property.

The Joint Committee on Taxation estimates that businesses stand to lower their 2008 tax bills by roughly $45 billion as a result of the two business provisions in the Economic Stimulus Act of 2008; these provisions accelerate into 2008 the tax benefits that otherwise would not have been available until future years.

The following are some details about these two key tax benefits:

Section 179 Expensing

In general, section 179 provides that, instead of depreciating property, a business with a sufficiently small amount of annual property purchases may choose to expense the cost of the property. For taxable years beginning in 2008, the Economic Stimulus Act increased the section 179 expensing limit allowing more property to be currently expensed.
The Economic Stimulus Act increased the maximum section 179 expense deduction to $250,000 for qualified section 179 property that is placed in service in tax years that begin in 2008. This is a 95 percent increase from the previous limitation of $128,000.
The Economic Stimulus Act also increased the total amount of qualifying property a taxpayer may purchase before the section 179 expensing limit begins to be reduced. Under the new law, the $250,000 deduction amount is reduced only when a business acquires more than $800,000 of qualifying property. Prior to changes made by the Economic Stimulus Act, the reduction began when a business acquired more than $510,000 of qualifying property.
The new law does not alter the section 179 expense limit for sport utility vehicles, which remains at $25,000.
More than 4.5 million small businesses claimed the section 179 expense deduction for tax year 2005, the most recent year for which this information is available. These businesses placed almost $44 billion of section 179 property in service in 2005 and claimed related deductions of approximately $41 billion (data derived from Depreciation and Amortization forms filed with Forms 1040).

Special Depreciation Allowance

The Economic Stimulus Act also provided a 50 percent special depreciation allowance for property acquired and placed in service during 2008. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years. It is an annual allowance for the wear and tear, deterioration or obsolescence of the property.
Under the new law, a taxpayer is entitled to depreciate 50 percent of the adjusted basis (after subtracting any section 179 deduction taken on that property) of qualified property during the year the property is placed in service. For example, if the taxpayer purchased and placed in service in 2008 a single piece of property at a cost of $450,000 that qualified for section 179 expensing and the 50 percent special depreciation allowance, $250,000 of the cost could be immediately expensed (under section 179 ) and the remaining $200,000 of adjusted basis would be available for the 50 percent special depreciation allowance. The taxpayer would also be permitted to take regular depreciation on the remaining $100,000 of adjusted basis during that year. This is similar to the special depreciation allowance that was previously available for certain property placed in service generally before Jan. 1, 2005, often referred to as “bonus depreciation.”
The types of property that qualify for the 50 percent special depreciation allowance are section 168 property with a recovery period of 20 years or less, off-the-shelf computer software, water utility property and qualified leasehold improvement property.
To qualify for the 50 percent special depreciation allowance, a taxpayer must meet all of the following tests:

The taxpayer must have acquired the property after December 31, 2007, and before Jan. 1, 2009. If a binding contract to acquire the property existed before Jan. 1, 2008, the property does not qualify for the special depreciation allowance.
The property must be placed in service before Jan. 1, 2009 (before Jan. 1, 2010, for certain transportation property and certain property with a long productions period).
The original use of the property must begin with the taxpayer after Dec. 31, 2007. In other words, the property must be “new” property.

Prior to the enactment of the Economic Stimulus Act the total depreciation amount (including the section 179 deduction) a business could deduct for a passenger automobile was $2,960. The Economic Stimulus Act increased this limitation by $8,000. Therefore, the maximum limit is increased to $10,960 for automobiles for which the special bonus depreciation allowance is claimed.
Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the section 179 deduction) a business could deduct for a truck or van used in a business and first placed in service in 2008 was $3,160. The Economic Stimulus Act increased this limitation by $8,000. The new maximum limit is increased to $11,160 for trucks and vans for which the special bonus depreciation is claimed.

The Economic Stimulus Act is the most recent legislation that provides depreciation tax benefits. Previously, the Job Creation and Worker Assistance Act of 2002 allowed an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property for property acquired on or after Sept. 11, 2001, and generally placed in service before Jan. 1, 2005. The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property for property acquired after May 5, 2003, and generally placed in service before Jan. 1, 2005.

For professional tax advice contact us today.

Disaster Victims Tax Relief

2008-06-26T09:57:00.000-07:00

More disaster victims in Indiana, Iowa and Wisconsin qualify for tax relief IRS website [http://www.irs.gov/newsroom/article/0,,id=108362,00.html]

Mike Habib, EA

IRS has announced on its website that additional counties in Indiana, Iowa and Wisconsin have been declared disaster areas on account of recent severe storms, tornadoes and flooding. As a result, more victims of the disaster have additional time to make tax payments and file returns. Certain other time-sensitive acts also are postponed.

Who gets relief. Only taxpayers considered to be affected taxpayers are eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts. Affected taxpayers are those listed in Reg. § 301.7508A-1(d)(1) and thus include:

any individual whose principal residence, and any business entity whose principal place of business, is located in the counties designated as disaster areas;
any individual who is a relief worker assisting in a covered disaster area, regardless of whether he is affiliated with recognized government or philanthropic organizations;
any individual whose principal residence, and any business entity whose principal place of business, is not located in a covered disaster area, but whose records necessary to meet a filing or payment deadline are maintained in a covered disaster area, or whose tax professional/practitioner is located in a covered disaster area;
any estate or trust that has tax records necessary to meet a filing or payment deadline in a covered disaster area; and
any spouse of an affected taxpayer, solely with regard to a joint return of the husband and wife.

What may be postponed. Under Code Sec. 7508A, IRS gives affected taxpayers until the extended date (specified by county, below) to file most tax returns (including individual, estate, trust, partnership, C corporation, and S corporation income tax returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date falling on or after the onset date of the disaster (specified by county, below), and on or before the extended date.

IRS also gives affected taxpayers until the extended date to perform other time-sensitive actions described in Reg. § 301.7508A-1(c)(1) and Rev Proc 2007-56, 2007-34 IRB 388, that are due to be performed on or after the onset date of the disaster, and on or before the extended date. This relief also includes the filing of Form 5500 series returns, in the way described in Rev Proc 2007-56, Sec. 8. Additionally, the relief described in Rev Proc 2007-56, Sec. 17, relating to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 or 5498 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. IRS, however, will abate penalties for failure to make timely employment and excise deposits, due on or after the onset date of the disaster, and on or before the information return delayed date (specified by county, below), provided the taxpayer made these deposits by the information return delayed date.

IRS will waive the failure to deposit penalties for employment and excise deposits due on or after the onset date of the disaster, and on or before the deposit delayed date (specified by county, below , as long as the deposits were made by the deposit delayed date.

Affected counties and dates for storms, floods and other disasters in 2008 are as follows:
Arkansas: The following are presidential disaster areas qualifying for individual assistance: Arkansas, Benton, Cleburne, Conway, Crittenden, Grant, Lonoke, Mississippi, Phillips, Pulaski, Saline and Van Buren counties.

For these Arkansas counties, the onset date of the disaster was May 2, 2008, the extended date is July 21, 2008, the information return delayed date was May 19, 2008, and the deposit delayed date was May 19, 2008.

Colorado: The following are presidential disaster areas qualifying for individual assistance: Larimer and Weld counties.

For these Colorado counties, the onset date of the disaster was May 22, 2008, the extended date is July 25, 2008, the information return delayed date was June 6, 2008, and the deposit delayed date was June 6, 2008.

Georgia: The following are presidential disaster areas qualifying for individual assistance: Bibb, Carroll, Douglas, Emanuel, Jefferson, Jenkins, Johnson, Laurens, McIntosh and Twiggs counties.

For these Georgia counties, the onset date of the disaster was May 11, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Iowa: The following are presidential disaster areas qualifying for individual assistance: Adams, Allamakee, Benton, Black Hawk, Bremer, Buchanan, Butler, Cedar, Cerro Gordo, Chicksaw, Clayton, Crawford, Delaware, Des Moines, Fayette, Floyd, Freemont, Hardin, Harrison, Jasper, Johnson, Jones, Linn, Louisa, Mahaska, Marion, Mills, Monona, Muscatine, Page, Polk, Story, Tama, Union, Warren and Winneshiek counties.

For these Iowa counties, the onset date of the disaster is May 25, 2008, the extended date is July 28, 2008, the information return delayed date was June 9, 2008, and the deposit delayed date was June 9, 2008.

Indiana: The following are presidential disaster areas qualifying for individual assistance: Adams, Bartholomew, Brown, Clay, Daviess, Dearborn, Decaturm Greene, Hamilton, Hancock, Henry, Jackson, Jennings, Johnson, Knox, Marion, Monroe, Morgan, Owen, Parke, Putnam, Randolph, Rush, Shelby, Sullivan, Vermillion, Vigo and Wayne counties.

For these Indiana counties, the onset date of the disaster was May 30, 2008, the extended date is Aug. 7, 2008, the information return delayed date was June 16, 2008, and the deposit delayed date was June 16, 2008.

Maine: The following are presidential disaster areas qualifying for individual assistance: Aroostook and Penobscot counties.

For these Maine counties, the onset date of the disaster was April 28, the extended date is July 8, the information return delayed date was May 13, 2008, and the deposit delayed date was May 13, 2008.

Missouri: The following are presidential disaster areas qualifying for individual assistance: Barry, Jasper and Newton counties.

For these Missouri counties, the onset date of the disaster was May 10, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Mississippi: The following are presidential disaster areas qualifying for individual assistance: Bolivar, Warren, Washington and Wilkinson counties.

For these Mississippi counties, the onset date of the disaster was March 20, 2008, the extended date is July 7, 2008, the information return delayed date was April 4, 2008, and the deposit delayed date was April 4, 2008.

Oklahoma: The following are presidential disaster areas qualifying for individual assistance: Craig, Latimer, Ottawa and Pittsburg counties.

For these Oklahoma counties, the onset date of the disaster was May 10, 2008, the extended date is July 14, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Wisconsin: The following are presidential disaster areas qualifying for individual assistance: Crawford, Columbia, Dodge, Green, Sauk, Milwaukee, Racine, Richland, Vernon, Washington, Waukesha and Winnebago counties.

For these Wisconsin counties, the onset date of the disaster was June 5, 2008, the extended date is Aug. 13, 2008, the information return delayed date is June 20, 2008, and the deposit delayed date is June 20, 2008.

Claiming disaster loss on previous year's return. A taxpayer that sustains a loss attributable to a disaster occurring in a Presidential disaster area may elect to deduct that loss on his return for the tax year immediately preceding the tax year in which the disaster occurred. (Code Sec. 165(i)) Generally, a taxpayer must make this election by filing a return, an amended return, or a refund claim on or before the later of (i) the due date of his income tax return (determined without regard to any filing extension) for the tax year in which the disaster actually occurred, or (ii) the due date of his tax return (determined with regard to any filing extension) for the immediately preceding tax year. The election is irrevocable 90 days after it is made. (Reg. § 1.165-11(e)) Because of the new disaster area designation, taxpayers in affected counties designated as disaster areas in 2008 can elect to claim a 2008 disaster loss on their 2007 returns, instead of on their 2008 returns.

Observation: Claiming the disaster loss for the year before the loss occurred saves taxes immediately, without having to wait until the end of the year in which the loss was sustained. In some cases, the deduction may result in a net operating loss, which could result in a refund from an earlier year to which it is carried. On the other hand, deducting the loss in the year the loss actually occurred may result in bigger tax savings if the taxpayer is in a higher bracket in that year.

CFC Controlled Foreign Corporation Tax Problem?

2008-06-24T22:31:00.000-07:00

Regs crack down on tax avoidance repatriations of CFC earnings
Preamble to TD 9402, 06/23/2008; Reg. § 1.956-1T; Preamble to Prop Reg 06/23/2008; Prop Reg § 1.956-1

Mike Habib, EA

IRS has issued temporary and proposed regs to determine the basis of certain U.S. property acquired by a controlled foreign corporation (CFC) in certain nonrecognition transactions that are intended to repatriate earnings and profits of the CFC without income inclusion by the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Background. IRS is aware that certain taxpayers are engaging in certain nonrecognition transactions in which a CFC acquires certain U.S. property (within the meaning of Code Sec. 956(c)) without resulting in an income inclusion to the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Illustration: USP, a domestic corporation and the common parent of an affiliated group that files a consolidated tax return, owns 100% of the outstanding stock of US1 and US2, both domestic corporations that join USP in the filing of a consolidated tax return. US1 owns 100% of the stock of CFC, a controlled foreign corporation. US2 issues $100 million of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash. USP takes the position that: (i) US2's transfer of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash is an exchange to which Code Sec. 351 applies; (ii) US2 recognizes no gain on the receipt of $10 million of CFC stock and $90 million cash in exchange for its stock under Code Sec. 1032(a) ; (iii) CFC recognizes no gain on the issuance of its stock to US2 under Code Sec. 1032(a) ; (iv) CFC's basis in the US2 stock is zero under Code Sec. 362(a) ; and (v) US1 and US2 do not and will not have an income inclusion under Code Sec. 951(a)(1)(B) as a result of CFC holding the US2 stock (which constitutes U.S. property under Code Sec. 956(c) ). (Preamble to TD 9402, 06/23/2008)

IRS believes these transactions raise significant policy concerns because the transactions may have the effect of repatriating earnings and profits of a CFC without a corresponding dividend inclusion, or an income inclusion under Code Sec. 951(a)(1)(B) by reason of the CFC's investment in U.S. property.

Code Sec. 956 was enacted to require an income inclusion by U.S. shareholders of a CFC that invests certain earnings and profits in U.S. property on the ground that the investment is substantially the equivalent of a dividend being paid to them.

Under Code Sec. 951(a)(1)(B), each U.S. shareholder (as defined in Code Sec. 951(b)) of a CFC (as defined in Code Sec. 957(a)) must include in its gross income for its tax year in which or with which the tax year of the CFC ends, the amount determined under Code Sec. 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under Code Sec. 959(a)(2)).

Regs under Code Sec. 367(b) prevent the repatriation of a U.S. person's share of earnings and profits of a foreign corporation through what would otherwise be a nonrecognition transaction.

Under Code Sec. 362(a), for property acquired by a corporation in connection with a Code Sec. 351 transaction (relating to transfer of property to corporation controlled by transferor), the basis is the same as it would be in the hands of the transferor, increased by the amount of any gain recognized to the transferor on the transfer.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032)

Temporary regs. When a CFC acquires stock or obligations of a domestic issuing corporation, that constitute U.S. property under Code Sec. 956(c), from such corporation pursuant to an exchange in which the CFC's basis in the property is determined under Code Sec. 362(a), the temporary regs apply. As a result, solely for Code Sec. 956 purposes, the temporary regs cause the CFC's basis in the property to be no less than the fair market value of the property transferred by the CFC in exchange for the property. For this purpose, “property” has the meaning set forth in Code Sec. 317(a), but includes any liability assumed by the CFC in connection with the exchange notwithstanding Code Sec. 357(a). (Reg. § 1.956-1T(e)(6))

The temporary regs also apply when property whose basis is determined under the regs is transferred to a related person (related person transferee), or by a related person transferee to another related person, pursuant to an exchange in which the related person transferee's basis in the property is determined, in whole or in part, by reference to the transferor's basis in the property. This rule is intended to prevent taxpayers from attempting to avoid the general rule of the temporary regs by subsequently transferring the property to a related person in another nonrecognition transaction. (Reg. § 1.956-1T(e)(6))

Basis determined under the temporary regs applies only for purposes of determining the amount of U.S. property acquired or held by a CFC under Code Sec. 956 , and accordingly the amount of a U.S. shareholder's income inclusion under Code Sec. 951(a)(1)(B) with respect to the CFC. (Reg. § 1.956-1T(e)(6))

The temporary regs apply only to determine the basis of U.S. property acquired by a CFC pursuant to an exchange that is within their scope. All other basis determinations are made under the rules in Reg. § 1.956-1(e)(1)(4). (Preamble to Prop Reg 06/23/2008)

Illustration: Applying the facts from Illustration (1), the results are as follow under the temporary regs. The US2 stock acquired by CFC in the exchange constitutes U.S. property under Reg. § 1.956-1T(e)(6)(ii) because CFC acquires the US2 stock from US2, the issuing corporation. Therefore, because CFC's basis in the US2 stock is determined under Code Sec. 362(a), then for purposes of Code Sec. 956, CFC's basis in the US2 stock is, under Reg. § 1.956-1T(e)(6)(iii) no less than $90 million, the fair market value of the property exchanged by CFC for the US2 stock (the $10 million of CFC stock issued in the exchange does not constitute property for purposes of Reg. § 1.956-1T(e)(6)(iii)). Under Reg. § 1.956-1T(e)(6)(iv), for purposes of Reg. § 1.956-2(d)(1)(i)(a), CFC is treated as acquiring its basis of no less than $90 million in the US2 stock at the time of its transfer of property to US2 in exchange for the US2 stock. The result would be the same if, instead of CFC transferring $90 million of cash to US2 in the exchange, CFC assumes a $90 million liability of US2. Reg. § 1.956-1T(e)(6)(vi), Example 1.

Effective date. The temporary regs apply to U.S. property acquired in exchanges occurring on or after June 24, 2008. No inference is intended as to the basis of U.S. property acquired by a CFC pursuant to a comparable transaction occurring before that date. IRS may, where appropriate, challenge such pre-June 24 transactions under applicable provisions or judicial doctrines. (Reg. § 1.956-1T(f), Preamble to TD 9402, 06/23/2008)

IRS increases mileage rate

2008-06-24T22:27:00.000-07:00

Business standard mileage rate increases for last half of 2008 - other rates also rise

Mike Habib, EA

IRS has announced that the optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) will increase 8¢ from 50.5¢ to 58.5¢ per mile for business travel from July 1, 2008 to Dec. 31, 2008 to better reflect the real cost of operating an auto in this period of rapidly rising gas prices. The rate for using a car to get medical care or in connection with a move that qualifies for the moving expense will also increase 8¢ for the last half of 2008 from 19¢ to 27¢ per mile.

Observation: IRS's increase in the business standard mileage rate is undoubtedly a result of recent pressure brought to bear on IRS to take action to relieve taxpayers suffering from skyrocketing gas prices (see Newsstand e-mail 6/18/08). On June 11, 2008, Senator Norm Coleman (R-MN) sent a letter to IRS Commissioner Shulman, requesting that IRS increase the 2008 standard mileage rates to better reflect the high cost of travel. Coleman noted that in the past, in 2005, IRS raised the standard mileage rates for the last four months of the year, rather than waiting until year-end, due to a large increase in gas prices. Earlier, on June 6, 2008, National Treasury Employees Union (NTEU) President Colleen Kelley also wrote to Commissioner Shulman, on behalf of federal government employees, asking him to consider making a mid-year adjustment to the 2008 standard mileage rates.

Observation: The plight of taxpayers suffering from ever increasing gas prices has not been ignored by legislators. On May 19, 2008, Sen. Charles Schumer (D-NY) introduced a bill in the Senate, S. 3032, the “Reimburse Our American Drivers (ROAD) Act of 2008,” that would temporarily increase the standard mileage rate to 70¢ per mile on travel for business, medical, and moving expense-related purposes. Federal employees would also be allowed to use this rate. The rate would be in effect during all of 2008. The legislation has been referred to the Senate Finance Committee for consideration.

Observation: As the gas prices at the pump continue to rise at a record breaking pace, it is questionable whether the additional 8¢ per mile will provide significant relief to taxpayers, or turn out to be a matter of too little too late.

Background. The mileage allowance deduction replaces separate deductions for lease payments (or depreciation if the car is purchased), maintenance, repairs, tires, gas, oil, insurance and license and registration fees. The taxpayer may, however, still claim separate deductions for parking fees and tolls connected to business driving. (Rev Proc 2007-70, Sec. 5.04) IRS generally adjusts the standard mileage rate annually, based on a yearly study of the fixed and variable costs of operating an automobile.

Employers that require employees to supply their own autos may reimburse them at a rate that doesn't exceed the business mileage allowance for employment-connected business mileage, whether the autos are owned or leased. (Rev Proc 2007-70, Sec. 9.01) Additionally, an employee's personal use of lower-priced company autos may be valued at the optional mileage allowance if the conditions specified in Reg. § 1.61-21(e)(1) are met.

A separate rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction. (Rev Proc 2007-70, Sec. 7.02) The mileage rate for driving an auto for charitable use (14¢ per mile) is a statutory rate that's not adjusted for inflation. (Rev Proc 2007-70, Sec. 7.01)

When the new rates are effective. The revised standard mileage rates in Ann. 2008-63 apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2008, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2008; and (2) with respect to transportation expenses paid or incurred by the employee on or after July 1, 2008.

However, the standard mileage rates in Rev Proc 2007-70, 2007-50 IRB 1162, continue to apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes before July 1, 2008, and to mileage allowances paid: (1) to an employee before July 1, 2008, or (2) with respect to transportation expenses paid or incurred by the employee before July 1, 2008. All other provisions of Rev Proc 2007-70 remain in effect. (Ann. 2008-63)

As Seen On TV

2008-06-22T08:47:00.000-07:00

TV ads and TV Tax Relief Commercials claiming "Pennies On The Dollar" Tax Settlements - As Seen On TV

Mike Habib, EA

Many Tax Relief and Tax Negotiation firms advertise on TV claiming that they can settle your tax debt for "pennies on the dollar". Now, you, as a taxpayer must be informed of what options you have and should research these firms at the Better Business Bureau www.BBB.org

Here is our Customer BEWARE REPORT on certain Tax Negotiation Companies that advertise on TV claiming "pennies on the dollar" tax settlements.

Customer…Beware!

How To Keep From Getting Ripped Off?

Many “Tax Negotiation” companies out there will absolutely rip you off. These unscrupulous firms will take your money regardless of whether they can help you or not. They'll lie to you and tell you they can get all the penalties and interest wiped out. They'll lie to you and tell you they'll settle with the IRS for "pennies on the dollar" when they know damn well you don't possibly qualify for the Offer in Compromise program.

How do they get away with this? Easy, most of the people you talk to at these unscrupulous firms are sales representatives. They have NO license to protect. You don't actually speak to the EA (Enrolled Agent), the CPA (Certified Public Accountant) or the attorney that these firms claim to have. Nope, you speak to some slimy unlicensed salesman. Some of these firms make up titles like Tax Resolution Specialist, or Tax Consultant. What a scam! In fact, many of these unscrupulous firms aren't tax firms or law firms at all, they’re just sales organizations!

We NEVER take on any client that we don't believe we can truly help. But, I absolutely guarantee you that 90% of the unscrupulous tax negotiation firms that advertise on TV and the internet would take any client and their money regardless of whether they could help them or not. And that stinks!

So, what should you do?

1) Always speak with the “licensed representative” who is on the Power of Attorney, that will actually represent you, usually the principal / owner of the firm,

2) Stay away from any firm/website that doesn't clearly give the names and bios of the licensed representative (Enrolled Agents, CPAs & Attorneys),

3) Ignore guarantees, promises and so-called testimonials. They're nothing more than meaningless hype; instead check the Better Business Bureau rating – A MUST!

4) Ask tough questions. If the answers don't make sense, don't hire the firm. What kind of tough questions? Are you an EA, CPA or attorney? When they say, "I'm a tax resolution specialist", ask them, is that a State or Federal license?

5) Finally, use your good common sense. You know when something isn't right. You work too hard for your money to give it away to some slime ball that makes promises you know he can't keep. Only deal with someone who is “Licensed” and who “Specialize” is Tax Resolution.

Don’t get ripped off! Do the right thing-hire a Licensed Representative!

Compliments of: Mike Habib, EA http://www.myirstaxrelief.com/

State Employment Tax Changes

2008-06-20T07:03:00.000-07:00

Recap of recent state employment tax laws, developments, and changes taking effect in July

Several states and localities are making employment tax changes that take effect in July. In addition, several new employment tax laws and developments have occurred recently. Here are some of the highlights from the following states:

Alabama
Unemployment. Effective for benefit years beginning after July 5, 2008, a claimant must serve a one-week waiting period prior to receiving unemployment benefits. The maximum weekly benefit will also increase from $235 to $255 [L. 2008, H427].

California
Employment Taxes. A state of emergency was declared on June 12th in the following counties: Sacramento, San Joaquin, Stanislaus, Merced, Madera, Fresno, Kings, Tulare, and Kern, due to the drought. Affected employers may request up to a 60-day extension of time to file their state payroll reports and deposit state payroll taxes with the Employment Development Department (EDD). All requests will be evaluated on a case-by-case basis. For further information, contact the Taxpayer Assistance Center at (888) 745-3886 [EDD Announcement, 6/13/2008].

Wage and Hour. The California Court of Appeal has ruled that an employee who received a premium holiday pay rate for work performed on Labor Day, and who worked 12 hours on Labor Day and 60 hours during the week, was only entitled to overtime based on her regular pay rate. The employer is entitled to credit the time-and-a-half premium pay on holidays against otherwise earned overtime [ Advanced-Tech Security Services, Inc. v. Superior Court, Cal. Ct. App., Second App. Dist., Division Five, Dkt. No. B205186, 6/3/08].

Colorado
Unemployment. The Colorado Department of Labor & Employment (DLE) reminds employers to review adjustments to their account on line 15 of Form UITR-1, Unemployment Insurance Tax Report (Tax Report), before determining their tax payment for the quarter [DLE UI Quarterly News, 2nd Quarter 2008].

Connecticut
Employment Taxes. The state is setting up a joint task force on worker misclassification issues (i.e., employee vs. independent contractor) [L. 2008, H5113].

Unemployment. New registration requirements go into effect for professional employer organizations (PEOs), beginning in 2009 [L. 2008, H5113].

Wage Payment. Effective Oct 1, 2008, wage deductions are permitted for contributions that are attributable to automatic enrollment in IRC §401(k), 403(b), 408, 408A, or 457 retirement plans [L. 2008, S157].

District of Columbia
Time Off. Effective Nov. 13, 2008, all Washington, D.C. employers must provide paid leave for illness and absences associated with domestic violence, sexual abuse, or stalking of employees or their family members [D.C. Register, Vol. 55, No. 21, 005886, 5/23/08; DC Law 17-152, 5/13/08].

Idaho
Wage and Hour. Effective July 1, state employees who do not qualify for the executive exemption under Idaho law, or the administrative or professional exemption under federal law, and state employees not designated as exempt under any other complete exemption in federal law, are eligible for overtime compensation.

Illinois
Wage and Hour. The minimum wage rate will increase from $7.50 per hour to $7.75 per hour on July 1.
Iowa
Wage and Hour. Effective July 1, the following enterprises are exempt from Iowa minimum wage rules, regardless of whether sales are $300,000 or more: (1) enterprises engaged in the business of laundering, cleaning, or repairing clothing or fabrics; (2) enterprises engaged in construction or reconstruction; (3) hospitals and schools; and (4) public agencies.

Indiana
Wage Payment. A federal court has ruled that store managers who were no longer employed by a company were not entitled to unpaid bonuses, since one contingency for receiving the bonuses was continued employment. The bonuses did not qualify as wages under either Indiana wage payment or wage claim statutes because of the contingency [ Harney v. Speedway SuperAmerica, LLC, CA7, Dkt. No. 07-3488, 5/30/2008].

Withholding. Indiana law requires the withholding of adjusted gross income tax and local option income tax from a pension distribution, if the payee requests withholding. The withholding request must be made in writing and should include the payee's Indiana county of residence [Indiana Information Bulletin IT13, 06/01/2008].

Kansas
Withholding. Effective July 1, employers with an annual total withholding tax liability of over $45,000 (before July 1, over $100,000) may be required to remit taxes by electronic funds transfer [Kan. Stat. Ann. §75-5151, as amended by L. 2007, H2434, §13].

Unemployment. Wage reports, contributions returns, and payments due after June 30, 2008, must be filed electronically by employers with 250 or more employees, and third-party administrators with 250 or more client employees.

Kentucky
Wage and Hour. The minimum wage rate will increase from $5.85 per hour to $6.55 per hour on July 1.
Massachusetts
Wage and Hour. Effective July 13th, treble damages will be awarded for all wage and hour violations, even if there was no “willful misconduct” by the employer.

Maryland
Time Off. The Flexible Leave Act amends the state's family leave provisions, effective Oct. 1, 2008. The provision will apply to employers with 15 or more employees working in the state. Employers will not only be able to allow employees to take “leave with pay” for the birth or adoption of a child, but also to care for a spouse, child, or parent. “Leave with pay” includes sick leave, vacation time, and compensatory time. In cases where an employee earns more than one type of leave, the employee may elect the type and amount of paid leave to be used [L. 2008, H40].

Minnesota
Withholding. Effective beginning after Dec. 31, 2008, payments to independent contractors are subject to state backup withholding if they are subject to federal backup withholding. Previous legislation that required third-party bulk filers to withhold from independent contractors was deleted before the provision took effect [L. 2007, H3149].

Mississippi
New Hire Reporting. Beginning in July, certain employers, third-party employers, contractors, and subcontractors will be required to register and use the federal Department of Homeland Security E-Verify program for all new hires. Required compliance is phased in through July 2011, based on the number of employees.

Michigan
Wage and Hour. The minimum wage rate will increase from $7.15 per hour to $7.40 per hour on July 1.
Montana
Unemployment. Effective July 1, the administrative fund tax for governmental experience-rated employers is 0.09% of total wages.

Nevada
Employment Taxes. The Nevada Tax Commission has approved a tax amnesty program that calls for waiving interest and penalty on certain tax liabilities, including the modified business tax (on payroll). The program is scheduled to start on July 1, 2008, and end on Sept. 30, 2008. To be eligible for amnesty, a business or taxpayer must be in full compliance with state law and pay the entire tax due by the end of the amnesty period. The Nevada Department of Taxation is in the preliminary stages of developing specific guidelines and requirements for the program [ Nevada Press Release, 6/2/08].

Unemployment. Effective July 1, all unemployment tax payments of $10,000 or more (including interest and penalties) must be remitted electronically.

Wage and Hour. Effective July 1, the state minimum wage will increase to $5.85 per hour for employees who receive qualified health benefits, and to $6.85 per hour for all other employees.

New Jersey
Withholding. Employees are allowed to exclude certain employer-provided commuter transportation benefits from their taxable gross income, up to a maximum amount that is adjusted annually for inflation. The maximum amount for 2008 is $1,440, up from $1,410 for 2007. Amounts in excess of $1,440 must be included in an employee's gross wages on Form W-2 or other written statement [Div. Tax. Notice of Employee Commuter Transportation Benefit Limits, 06/02/2008].

Oklahoma
Withholding. A federal district court has suspended the enforcement of a statute that required contractors to withhold from workers who could not produce federal documents showing that they were authorized alien labor. The court found the Oklahoma law to be an attempt to regulate behavior, not to impose a new tax. The injunction continues until the merits of the case are finally decided [Chamber of Commerce of the U.S.A. v. Henry, DC OK, Dkt. No. CIV-8-109-C, 6/4/2008].

The governor has signed into law a tax amnesty bill. A taxpayer will be entitled to a waiver of penalty, interest, and other collection fees due on eligible taxes (including withholding taxes), if the taxpayer voluntarily files delinquent tax returns and pays the taxes due during the compliance initiative. The program is scheduled to take place from Sept. 15 until Nov. 14, 2008 [L. 2007, S2034 (c.395), §1].

Oregon
Time Off. The state Supreme Court has ruled that while employers are required to provide minimum rest breaks as per Or. Admin. R. § 839-020-0050(1)(b) , violations do not give rise to a wage claim for additional wages [Gafur v. Legacy Good Samaritan Hosp. & Med. Ctr., Or. Sup. Ct., Dkt. No. SC055175, 5/15/08].

Pennsylvania
Withholding. Effective July 1 through Dec. 31, 2008, Philadelphia tax rates are reduced to 3.98% for residents and 3.5392% for nonresidents. The tax rate that should be used is the rate in effect on the date that the taxable compensation is actually paid to the employee. For example, wage tax on a paycheck dated July 1, 2008, for wages paid for the period from June 16 to June 30, 2008, should be withheld at the rate in effect as of July 1, 2008 [Philadelphia Bill No. 080161, 05/22/2008; Important Notice: Wage Tax Rate Reduction, Philadelphia Dept. of Rev., 06/04/2008].

South Carolina
New Hire Reporting. New legislation requires all employers to verify the employment eligibility of new hires beginning as early as Jan. 1, 2009 [L. 2008, H4400].

Withholding. Effective June 4, 2008, withholding agents must withhold 7% state income tax on compensation paid to an individual that was reported on Form 1099, if the individual: (1) fails to provide a taxpayer identification or Social Security number; (2) fails to provide a correct taxpayer identification or Social Security number; or (3) provides an IRS-issued taxpayer identification number issued for nonresident aliens. There are exceptions to this rule [S.C. Code Ann. §12-8-595, as amended by L. 2008, H4400].

Texas
Unemployment. The state has begun mailing checks to experience-rated employers eligible to receive the surplus tax credit [TWC Tax Department Tip of the Month, June 2008].

Vermont
Withholding. Effective July 1, the state may grant EFT filers up to six additional days for payment (prior to that, four additional days).

Virginia
Withholding. The Virginia Supreme Court has ruled that the requirement in Va. Code Ann. § 58.1-1815 to “truthfully account for and pay over such tax” is violated by one who willfully fails either to “account for” or “pay over” the tax. Therefore, a criminal penalty could be assessed against a person who failed to pay his withholding tax obligation, even though he had truthfully accounted for the obligation [Gibson v. Cmwth. of Virginia, Va. Sup. Ct., Dkt. No. 072023, 6/6/2008 ].

West Virginia
Withholding. A business registration certificate may be revoked for repeated, willful refusal to remit state withholding taxes when due [West Virginia Administrative Decision 08-052 F, 06/08/2008].

Wage and Hour. The minimum wage rate will increase from $6.55 per hour to $7.25 per hour on July 1.
Wisconsin
Withholding. Wisconsin will follow federal rules that require “disregarded entities” to pay their own employment taxes and file their own employment tax reports, beginning with wages paid in 2009. As an “employer,” a disregarded entity must obtain a Wisconsin employer identification number [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

The state has issued a tax release that clarifies the circumstances under which “public speaking services” are subject to Wisconsin's nonresident entertainer prepayment law [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

Wyoming
Unemployment. Effective July 1, 2007, employers were required to submit “Wyoming Employee Wage Listings” as part of their quarterly reporting responsibilities. Beginning in 2009, the state may increase an employer's tax rate by a 2% penalty rate if the employer has failed to submit the wage listing [Wy. Quarterly Connection, 1st Qtr. 2008].

How to choose a business structure

2008-06-19T22:00:00.000-07:00

Choosing a Business Structure

FS-2008-22

Of all the choices you make when starting a business, one of the most important is the type of legal organization you select for your company. This decision can affect how much you pay in taxes, the amount of paperwork your business is required to do, the personal liability you face and your ability to borrow money. Business formation is controlled by the law of the state where your business is organized.

This fact sheet provides a quick look at the differences between the most common forms of business entities.

The most common forms of businesses are:

Sole Proprietorships
Partnerships
Corporations
Limited Liability Companies (LLC)

While state law controls the formation of your business, federal tax law controls how your business is taxed. Federal tax law recognizes an additional business form, the Subchapter S Corporation.

All businesses must file an annual return. The form you use depends on how your business is organized. Sole proprietorships and corporations file an income tax return. Partnerships and S Corporations file an information return. For an LLC with at least two members, except for some businesses that are automatically classified as a corporation, it can choose to be classified for tax purposes as either a corporation or a partnership. A business with a single member can choose to be classified as either a corporation or disregarded as an entity separate from its owner, that is, a “disregarded entity.” As a disregarded entity the LLC will not file a separate return instead all the income or loss is reported by the single member/owner on its annual return.

The answer to the question “What structure makes the most sense?” depends on the individual circumstances of each business owner.

The type of business entity you choose will depend on:

Liability
Taxation
Recordkeeping

Sole Proprietorship

A sole proprietorship is the most common form of business organization. It’s easy to form and offers complete control to the owner. It is any unincorporated business owned entirely by one individual. In general, the owner is also personally liable for all financial obligations and debts of the business. (State law may also govern this area depending on the state.)

Sole proprietors can operate any kind of business. It must be a business, not an investment or hobby. It can be full-time or part-time work. This includes operating a:

Shop or retail trade business
Large company with employees
Home based business
One person consulting firm

Every sole proprietor is required to keep sufficient records to comply with federal tax requirements regarding business records.

Generally, sole proprietors file Schedule C or C-EZ, Profit or Loss from Business, with their Form 1040. Sole proprietor farmers file Schedule F, Profit or Loss from Farming. Your net business income or loss is combined with your other income and deductions and taxed at individual rates on your personal tax return.

Sole proprietors must also pay self-employment tax on the net income reported on Schedule C or Schedule F. You may also be able to deduct one-half of SE tax on your 1040. Use Schedule SE, Self-Employment Tax, to compute this tax.

Sole proprietors do not have taxes withheld from their business income so you will generally need to make quarterly estimated tax payments if you expect to make a profit. These estimated payments include both income tax and self-employment taxes for Social Security and Medicare.

Partnership

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.

A partnership does not pay any income tax at the partnership level. Partnerships file Form 1065, U.S. Return of Partnership Income, to report income and expenses. This is an information return. The partnership passes the information to the individual partners on Schedule K-1, Partner’s Share of Income, Credits, and Deductions. Partnerships are often referred to as pass-through or flow-through entities for this reason.

Each partner reports his share of the partnership net profit or loss on his personal Form 1040 tax return. Partners must report their share of partnership income even if a distribution is not made.

Partners are not employees of the partnership and so taxes are not withheld from any distributions. Like sole proprietors, partners generally need to make quarterly estimated tax payments if they expect to make a profit.

General partners must pay self-employment tax on their net earnings from self employment assigned to them from the partnership. Net earnings from self- employment include an individual’s share, distributed or not, of income or loss from any trade or business carried on by a partnership.

Limited partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered.

Corporation

A corporate structure is more complex than other business structures. It requires complying with more regulations and tax requirements. It may require more tax preparation services than the sole proprietorship or the partnership.

Corporations are formed under the laws of each state and are subject to corporate income tax at the federal and generally at the state level. In addition, any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their personal tax returns.

The corporation is an entity that handles the responsibilities of the business. Like a person, the corporation can be taxed and can be held legally liable for its actions. If you organize your business as a corporation, you are generally not personally liable for the debts of the corporation. (Exceptions my exist under state law.)

When you form a corporation, you create a separate tax-paying entity. Unlike sole proprietors and partnerships, income earned by a corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called C corporations because Subchapter C of Chapter 1 of the Internal Revenue Code is where you find general tax rules affecting corporations and their shareholders.

A corporation files Form 1120 or 1120-A, U.S. Corporation Income Tax Return. If a shareholder is an employee, he pays income tax on his wages, and the corporation and the employee each pay one half of the social security and Medicare taxes and the corporation can deduct its half. A corporate shareholder pays only income tax for any dividends received, which may be subject to a dividends-received deduction.

Subchapter S Corporation

The Subchapter S corporation is a variation of the standard corporation. The S corporation allows income or losses to be passed through to individual tax returns, similar to a partnership. The rules for Subchapter S corporations are found in Subchapter S of Chapter 1 of the Internal Revenue Code.

An S corporation has the same corporate structure as a standard corporation. It is a legal entity, chartered under state law, and is separate from its shareholders and officers. There is generally limited liability for corporate shareholders. The difference is that the corporation files an election on Form 2553, Election by a Small Business Corporation, to be treated differently for federal tax purposes.

Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income. It is treated in the same way as a partnership, in that generally taxes are not paid at the corporate level.

An S corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows through to be reported on the shareholders’ individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed with Form 1120S for each shareholder. The Schedule K-1 tells shareholders their allocable share of corporate income and deductions. Shareholders must pay tax on their share of corporate income, regardless of whether it is actually distributed.

Limited Liability Company

A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute.

LLCs are popular because, similar to a corporation, owners generally have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation.

Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. Most states also permit “single member” LLCs, those having only one owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your state’s requirements and the federal tax regulations for further information. There are special rules for foreign LLCs.

For additional information on the kinds of tax returns to file, how to handle employment taxes and possible pitfalls, refer to Publication 3402, Tax Issues for Limited Liability Companies.

Which structure best suits your business?

One form is not necessarily better than any other. Each business owner must asses his or her own needs. It may be important to seek advice from business experts and professionals when considering the advantages and disadvantages of a business entity.

IRS urged to increase standard mileage rates

2008-06-19T21:57:00.000-07:00

IRS urged to increase standard mileage reimbursement rates

Several requests have been made to the IRS in recent days to increase its standard mileage rates.
The standard mileage rate for use of a car (including vans, pickups, and panel trucks) is currently 50.5 cents per mile for business-related travel, and 19 cents per mile for medical or moving expense-related travel. Employers paying a mileage allowance in excess of the standard rate must report the excess on Form W-2. The IRS generally adjusts the standard mileage rates annually, based on a yearly study of the fixed and variable costs of operating an automobile.

On May 19, 2008, Sen. Charles Schumer (D-NY) introduced a bill in the Senate called the “Reimburse Our American Drivers (ROAD) Act of 2008,” that would temporarily increase the standard mileage rate to 70 cents per mile on travel for business, medical, and moving expense-related purposes. Federal employees would also be allowed to use this rate. The rate would be in effect during all of 2008. The legislation has been referred to the Senate Finance Committee for consideration [S. 3032, 5/19/2008].

On June 6, 2008, National Treasury Employees Union (NTEU) President Colleen Kelley wrote a letter to IRS Commissioner Douglas Shulman, on behalf of federal government employees, asking him to consider making a mid-year adjustment to the 2008 standard mileage rates. Kelley noted that taxpayers would receive relief much sooner if there was direct IRS action to increase the standard mileage rate, rather than waiting for the merits of a rate increase to be debated in Congress [NTEU Letter to IRS, 6/6/2008].

On June 11, 2008, Senator Norm Coleman (R-Minn.) sent a letter to Commissioner Shulman, requesting that the IRS increase the 2008 standard mileage rates to better reflect the high cost of travel. Coleman noted that in 2005, the IRS raised the standard mileage rates for the last four months of the year, rather than waiting until year-end, due to a large increase in gas prices [Coleman Letter to IRS Commissioner, 6/10/08].

Claim of right relief under Code Sec. 1341(a)

2008-06-19T21:54:00.000-07:00

Appeals Court overturns oil company's large claim of right refund
Texaco v. U.S. (CA 9 6/13/2008) 101 AFTR 2d ¶ 2008–889

The Court of Appeals for the Ninth Circuit has reversed a district court award of an over $100 million refund claim to a large oil company, which had sought claim of right relief under Code Sec. 1341(a) because it was required to pay out pursuant to a settlement agreement sums that it had previously included in its gross income. The district court agreed with the taxpayer and ordered the government to pay the refund. The Ninth Circuit has now reversed, finding that the inventory exception in Code Sec. 1341(b)(2) barred the taxpayer from using Code Sec. 1341(a).

Background. Under the claim of right doctrine, income received without restriction—income the taxpayer has dominion and control over—must be reported in the year received, even if there's a possibility it may have to be repaid in a later year. If it is repaid, the repayment is deductible in the year paid. However, various factors may prevent the taxpayer from receiving enough benefit from the deduction to offset the tax paid on the receipt of the income.

Code Sec. 1341 provides relief to taxpayers who received income in one year under the claim of right rule and were required to make refunds in another year at a time when the tax benefits of the repayment were less than the tax paid in the earlier year. It corrects the inequity by a reduction in the tax for the year in which the repayment is made. In essence, the amount of the tax reduction is equal to the amount the taxpayer would have saved if he had never received the income and never made the repayment, except for the loss of interest or other compensation for the use of his money.

For a claim of right relief to apply: (1) an “item” must have been “included in gross income for a prior taxable year (or years),” (2) “because it appeared that the taxpayer had an unrestricted right to such item,” (3) a “deduction” must be “allowable for the taxable year,” (4) “because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item,” and (5) “the amount of such deduction” must exceed $3,000. (Code Sec. 1341(a))

Under the inventory exception, Code Sec. 1341(a) does not apply to any deduction allowable with respect to an item that was included in gross income by reason of the sale or other disposition of stock in trade (or other property of a kind which would properly have been included in the inventory of the taxpayer if on hand at the close of the prior tax year) or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. (Code Sec. 1341(b)(2))

Facts. Texaco was engaged in an integrated petroleum business. Between '73 and '81, it sold crude petroleum and refined petroleum products at prices that exceeded the price ceilings set by federal price regulations. Texaco included these overcharges as gross income on its corporate tax returns for the years '73 through '81. The Department of Energy (DOE) took various administrative actions against Texaco which eventually resulted in a consent degree requiring Texaco to pay $1,250,000,000 plus interest. Texaco made the payments and deducted the settlement amount on its federal income tax returns as ordinary and necessary business expenses. In February 2001, Texaco filed Refund Claims for the years '88, '90, '91, and '92, claiming that the tax benefit of the ordinary and necessary business expense deductions should have been calculated in accordance with Code Sec. 1341(a). IRS denied the refund claims on the ground that the Code Sec. 1341(b)(2) inventory exception rendered Code Sec. 1341(a) inapplicable.

In January 2004, Texaco filed a complaint against the U.S. in the District Court for the Northern District of California. On cross-motions for summary judgment, the district court determined that Code Sec. 1341(b)(2) did not preclude Texaco from seeking tax treatment under Code Sec. 1341(a), reasoning that the statute was ambiguous and sources outside the text of the statute supported Texaco's argument that Code Sec. 1341(b)(2) only prohibited the use of Code Sec. 1341(a) computation for “sales returns, allowances and similar items.”

Failed argument. Texaco argued that there is a “syntactical” ambiguity in Code Sec. 1341(b)(2), and that the phrase “by reason of the sale or other disposition of [inventory]” modifies the phrase “deduction allowable with respect to an item which was included in gross income” in such a way that “the question that must be answered is whether the deduction in the current year is allowable “by reason of the sale or other disposition of [inventory].” It then argued that “by reason of the sale or other disposition of [inventory]” should be limited to “sales returns, allowances, and similar items.”

The Ninth Circuit said that, even if such a construction were grammatically possible, it would not be reasonable. First, Code Sec. 1341(a) clearly states that its general rule applies when “an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item.” Accordingly, the Court said that there is no reason to interpret “included in gross income” in Code Sec. 1341(b)(2) as referring to anything other than the prior tax year or years. Moreover, the proposed interpretation would eviscerate Code Sec. 1341(b)(2) because a Code Sec. 1341(a) deduction is always based on calculations arising from a prior tax year and not on whether an item was included in gross income in the current year.

Second, the Court stressed that there is nothing in the statute that limits the definition of “sale or other disposition of stock in trade” to “sales returns, allowances, and similar items.” Texaco argued that such a limitation arises from Reg. § 1.1341-1(f). The Ninth Circuit, however, held that this reg does not limit Code Sec. 1341(b). It said that the reg says no more than that “sales returns and allowances and similar items” are examples of situations where the inventory exception applies; they do not delimit the exception.

Third, the Court said that Texaco's proposed interpretation of Code Sec. 1341(b) would reduce the final sentence of the section to surplusage. The final sentence of Code Sec. 1341(b)(2) provides that the bar to using a Code Sec. 1341(a) computation in the first sentence does not apply “if the deduction arises out of refunds or repayments made by a regulated public utility,” if required by a government agency, a court, or “made in settlement of litigation or under threat or imminence of litigation.” The Court observed that, although it may not be impossible for a public utility's refund or repayment to be based on “sales returns, allowances, and similar items,” it defies logic to believe that Congress in enacting the final sentence of Code Sec. 1341(b)(2) was concerned with only such a refund or repayment.

Company Car Benefit

2008-06-19T21:40:00.000-07:00

Why the company car is still a valued fringe benefit for company owners and key employees

A company car has long been an extremely popular “perk” or fringe benefit for company owners and key employees of medium sized or small enterprises. As this article demonstrates, this benefit yields substantial nontax as well as tax benefits for the owner or employee, as well as tax deductions for the employer.

To illustrate the benefits of the company auto, let's assume that Mr. Smith, the owner-employee of Widget, Inc., expects to drive an auto 8,500 miles a year for business (e.g., to visit customers, check on local suppliers and distributors), and 7,000 for personal driving (e.g., commuting and weekend trips; his family owns other cars used for other personal mileage). That's roughly 55% business and 45% personal usage. We'll assume Widget's having a good year and Smith wants to project a successful image to his business contacts, so Widget buys or leases a new $50,000 auto for his business/personal use.

The unique benefits that flow from the arrangement are as follows:

Smith's cost for personal use of the vehicle will be equal to the tax he pays on the fringe benefit value of his 45% personal mileage. By contrast, if Smith bought or leased the auto himself to be able to drive those personal miles, he'd have to use after-tax dollars to fund the entire purchase or lease cost of the car.
Assuming Smith's personal use is properly treated as fringe benefit income, Widget treats the car for tax purposes much the same way it would any other business asset, subject to severe depreciation deduction restrictions if the auto is purchased (somewhat mitigated by a bonus first-year writeoff if the auto is bought new and placed in service this year), and relatively mild deduction restrictions if the auto is leased. Out of pocket expenses associated with the car (insurance, oil and gas, maintenance, etc.) are completely deductible, including the portion that relates to Smith's personal use. If Widget finances the car, all of the interest it pays on the loan would be deductible as a business expense. By contrast, if Smith bought or leased the auto himself, he could only claim deductions for the business use portion of the otherwise allowable depreciation amount (or lease expense) and out of pocket expenses of running the car. And if he financed the car, the interest payments would be nondeductible under Code Sec. 163(h)(2)(A) (unless he used a home equity line of credit).
As a final benefit to Smith, the purchase or lease of the vehicle by Widget will have no effect on his credit rating.

Observation: It's important to note that providing an auto for an owner's or employee's personal and business use (or solely personal use) will not be free of complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit rules and treated as compensation income.

Tax Consequences of Personal Use

The value of an employee's personal use of a company auto is a taxable fringe benefit treated as noncash compensation paid to the employee (our references to the employee are references to both an employee-owner or a regular employee). It is included in his or her income unless excluded under the Code. (Reg. § 1.61-21(a)) Such personal driving has the following tax consequences:

For the employer: Although it furnishes a noncash fringe benefit to an employee that must be treated as compensation, the employer may deduct only the costs it incurs in providing the auto to its employee, not the auto's value to the employee. It may claim a depreciation deduction if it owns the auto or a deduction for leasing costs if it rents the auto. (Reg. § 1.162-25T(a)) Because the value of personal use of an auto is treated as compensation income, the employer must pay FICA taxes (i.e., for old age, survivors, and disability insurance (OASDI), and hospital insurance (HI)) on that value. However, the OASDI component of FICA taxes is payable on the value of personal use only to the extent the employee's other compensation does not exceed the OASDI wage base ($102,000 for 2008). The value also is subject to federal income tax withholding unless the employer elects not to withhold federal income tax. (Code Sec. 3402(s)(1); Ann. 85-113, 1985-31 IRB 31, 4)
For the employee: The personal use value appears on the employee's Form W-2 and is treated as salary on his Form 1040. FICA taxes must be withheld from the employee's pay on the value (but only on the HI part of the FICA taxes if he's already over the OASDI wage base).

As a general rule, the personal use of any vehicle results in compensation income. (Reg. § 1.61-21(a), Reg. § 1.61-21(b)(1)) However, mileage on an employer-provided auto is a nontaxable working condition fringe benefit to the extent that it is (1) employment related business mileage, and (2) substantiated to the employer (see below). The exclusion applies whether the employee is equipped with an upscale auto or an economy model. (Reg. § 1.132-5(a)(1), Reg. § 1.132-5(b)(1), Reg. § 1.132-5(c)(1))

Valuing Personal Use With the FMV Method

The value of any fringe benefit supplied to an employee generally is its FMV. In the auto context, the FMV is the amount an individual would have to pay—in an arm's length transaction—to lease an auto comparable to the one supplied by the employer, for a comparable period of time. (Reg. § 1.61-21(b)(4)) If the employer leases the auto supplied to the employee, it cannot use its lease cost as FMV. (Reg. § 1.61-21(b)(2))

Observation: The dealer that sold or leased the auto to the employer should be able to supply a statement of the auto's FMV leasing cost.

Once FMV has been established, the employer then multiplies it by the ratio of the employee's personal mileage on the car to total mileage. The result is charged to the employee as noncash compensation due to personal use of the auto. (Reg. § 1.61-21(b)(1), Reg. § 1.132-5(b)(1)(i)) The employer also must charge the employee with compensation income equal to the FMV of other employer-paid costs for goods or services relating to personal use (e.g., gas, maintenance, insurance).

Illustration: Continuing with our example of Widget, Inc., and Mr. Smith, an owner-employee, we'll assume Widget buys or leases a new $50,000 auto for him in January of 2008. The lease runs for three years. Widget also insures the auto and pays for maintenance. We'll assume that the lease would cost Smith $7,500 a year and the insurance and maintenance would cost $3,000. For 2008, Smith's employment-related business use of the auto is 55%, and his personal use is 45%.

Result. Under the general FMV personal use valuation method, Smith would be charged with $4,725 of compensation income in 2008 due to his personal use ($7,500 plus $3,000, times 45%). At a 35% effective tax rate, that ends up costing Smith only $1,653.75 ($4,725 × 35%). If Smith also charges all gas costs on a company credit card, and doesn't reimburse the employer for fuel consumed during personal driving, he would also have compensation income equal to 45% of total gas costs for 2008.

Valuing Personal Use With the Table-Value Method

Instead of using the general FMV method, employers have the choice of using one of three optional methods: the table value method (also know as the annual lease value method), the cents-per-mile method, or the commuting value method. (Reg. § 1.61-21(b)(1)) However, as a practical matter, because of the many restrictions placed on the cents-per-mile and commuting value methods, the table-value method is the only optional method that is effectively available for owners or key employees.

To apply the table value method, the first step is to determine the FMV of the auto as of the first date on which the auto is made available for the personal use of any employee of the employer. (Reg. § 1.61-21(d)(2)(i)(A))

As a general rule, an auto's FMV for purposes of determining annual lease value is the amount an individual would pay locally to purchase a comparably equipped auto. (Reg. § 1.61-21(d)(5)(i)) However, the employer can avail itself of the following safe-harbor valuation methods:

For an auto owned by the employer, the safe harbor value (for non-auto manufacturers) is the employer's cost of buying it (including sales tax, title and other expenses attributable to the purchase), provided the purchase is made at arm's length. (Reg. § 1.61-21(d)(5)(ii)(A))
The safe harbor value of an auto leased by the employer is either: (1) the manufacturer's suggested retail price less 8% (including sales tax, title and other purchase expenses) (Reg. § 1.61-21(d)(5)(ii)(C)), or (2) the retail value of the auto as reported in a nationally recognized publication that regularly reports new or used auto retail values, whichever is applicable (reported retail price). For the auto in question, the reported retail price must be reasonable. Pricing sources consist of publications and electronic data bases. (Reg. § 1.61-21(d)(5)(ii)(C)) Alternatively, where the employer leases the vehicle, it may use the manufacturer's invoice price (including options) plus 4% as a safe harbor estimate of FMV for all purposes under Reg. § 1.61-21(d)(5)(ii). (Notice 89-110, 1989-2 CB 447)

Once FMV is found, locate the dollar range in column (1) of the table below which corresponds to that FMV. The corresponding amount in column (2) is the auto's annual lease value. (Reg. § 1.61-21(d)(2)(i)(B)) Finally, multiply the annual lease value by the ratio of the employee's annual personal mileage of the auto to total annual mileage (employment-connected business driving plus personal driving). (Reg. § 1.132-5(b)(1)(i); Reg. § 31.3501(a)-1T, Q&A-7)

Annual Lease Value Table for Automobiles (Reg. § 1.61-21(d)(2)(iii))

Annual Lease
Automobile Fair Market Value Value
-------------------------------------------------------
$0-999 ................................... $ 600
1,000-1,999 .............................. $ 850
2,000-2,999 .............................. $ 1,100
3,000-3,999 .............................. $ 1,350
4,000-4,999 .............................. $ 1,600
5,000-5,999 .............................. $ 1,850
6,000-6,999 .............................. $ 2,100
7,000-7,999 .............................. $ 2,350
8,000-8,999 .............................. $ 2,600
9,000-9,999 .............................. $ 2,850
10,000-10,999 ............................ $ 3,100
11,000-11,999 ............................ $ 3,350
12,000-12,999 ............................ $ 3,600
13,000-13,999 ............................ $ 3,850
14,000-14,999 ............................ $ 4,100
15,000-15,999 ............................ $ 4,350
16,000-16,999 ............................ $ 4,600
17,000-17,999 ............................ $ 4,850
18,000-18,999 ............................ $ 5,100
19,000-19,999 ............................ $ 5,350
20,000-20,999 ............................ $ 5,600
21,000-21,999 ............................ $ 5,850
22,000-22,999 ............................ $ 6,100
23,000-23,999 ............................ $ 6,350
24,000-24,999 ............................ $ 6,600
25,000-25,999 ............................ $ 6,850
26,000-26,999 ............................ $ 7,250
28,000-29,999 ............................ $ 7,750
30,000-31,999 ............................ $ 8,250
32,000-33,999 ............................ $ 8,750
34,000-35,999 ............................ $ 9,250
36,000-37,999 ............................ $ 9,750
38,000-39,999 ............................ $10,250
40,000-41,999 ............................ $10,750
42,000-43,999 ............................ $11,250
44,000-45,999 ............................ $11,750
46,000-47,999 ............................ $12,250
48,000-49,999 ............................ $12,750
50,000-51,999 ............................ $13,250
52,000-53,999 ............................ $13,750
54,000-55,999 ............................ $14,250
56,000-57,999 ............................ $14,750
58,000-59,999 ............................ $15,250
For automobiles with a FMV greater than $59,999, the annual lease value is: (.25 × FMV) + $500. (Reg. § 1.61-21(d)(2)(iii))

The annual lease value method takes into account the FMV of insuring and maintaining the auto. The amount shown in the table can't be reduced by the FMV of any service included in the lease value, but not supplied by the employer. (Reg. § 1.61-21(d)(3)) For example, there is no reduction if the employee must pay his or her own insurance costs. The FMV of any other service supplied with the auto—such as a driver or chauffeur—must be added to the table lease value. (Reg. § 1.61-21(b)(5), Reg. § 1.61-21(d)(3)(i))

Illustration: Continuing with our example of Widget, Inc., suppose it supplied Mr. Smith, its owner-employee, with a new $50,000 auto on Jan. 1 of this year, and he uses it 55% for business driving and 45% for personal driving.

Under the table lease value method, Smith would have $5,962.50 of noncash compensation for the year due to his personal use of the auto ($13,250 annual lease value per table times 45%).

Observation: Special table value rules apply if the lease starts in the middle of the year or the auto is only made available for part of the year. Additionally, the table values are based on a four-year term.

The table value method does not take into account the FMV of fuel provided to the employee by the employer, whether in kind, via a reimbursement arrangement, or via direct charging of the cost of fuel to the employer. Therefore, where an employer provides fuel to an employee, its FMV is an additional fringe benefit to the employee and must be included in gross income (except for the gas used for employment-connected business driving). (Reg. § 1.61-21(d)(3)(ii)(A)) The FMV of fuel provided in kind by an employer may be determined based on all the facts and circumstances. Alternatively, but only for fuel provided in kind for miles driven within the U.S., Canada, or Mexico, fuel may be valued at 5.5¢ per mile for all miles driven by the employee. (Reg. § 1.61-21(d)(3)(ii)(B))

Observation: With gas hovering at over $4 a gallon in many areas, having personal mileage fuel valued at 5.5¢ per mile is an incredible bargain. As a practical matter, however, this rule is usable only if the employer maintains a gas pump on its premises (e.g., it has a fleet of cars or trucks).

Where an employer provides an employee with fuel by means of a reimbursement arrangement, or by allowing the cost of the fuel to be charged directly to it, the FMV of the fuel is the amount of the actual reimbursement or the amount charged, if the fuel is bought at arm's length. (Reg. § 1.61-21(d)(3)(ii)(C))

Pros and cons of valuation methods. The chief virtue of the general FMV valuation method is that the current arm's length cost of leasing a car (and insuring it) may be less than the valuation produced by the annual lease value method, which is based on a table that has not changed since it was first issued in temporary regs in '85. (TD 8063, 1986-1 CB 10) On the minus side, however, the FMV method may mean more “legwork” for the employer (i.e., in establishing the arm's length value of the auto's use) and can be a cumbersome method for an employer that maintains more than a few cars. The method also may be costly for the employee if he is given the use of an auto for a relatively short period of time (e.g., he's give the use of an auto that the company leases for only two years).

The annual lease value method's chief virtue is simplicity. An employer that uses this method can find the value of any employee's personal mileage on any auto by using a universal table that includes insurance and maintenance costs. On the minus side, however, the annual lease value method may bear little if any resemblance to actual lease values. Thus, this method may produce more taxable compensation income for employees than the FMV method.

Consistency Rules for Personal Use Valuation Methods

An employer is not required to use the same valuation method for all its autos. For example, it may use the FMV method for one auto and the annual lease value method for another. (Reg. § 1.61-21(c)(2)(ii)) However, once an employer chooses a valuation method for a particular auto, it is generally locked into that method for that auto. In other words, the election is binding for all later periods that the auto is made available to any employee. (Reg. § 1.61-21(d)(7)(ii), Reg. § 1.61-21(e)(5)(ii))

An employer is treated as having made the choice to use a particular valuation method when it values personal use with that method for income, employment tax, and reporting purposes. (Reg. § 1.61-21(c)(3)(i)) In general, the election to use the annual lease value or mileage rate method must be made for the first day on which the auto is made available to an employee. (Reg. § 1.61-21(d)(7)(i), Reg. § 1.61-21(e)(5)(i))

For income tax purposes, a company owner or employee may always use the general fair market valuation method to value an employer-provided benefit, even if the employer uses the table value method. (Reg. § 1.61-21(c)(2)(ii))

Caution: An employee tempted to use the general FMV method because it produces a lower valuation than the employer's use of the table value method should keep in mind that he or she will have to attach a statement to his return reconciling the amount included in income with the amount reported on his Form W-2.

In general, in the context of our discussion geared to a small or medium-sized firm, an owner or employee will use the annual lease value method to value his personal use of an employer-provided auto only if the employer uses that method. (Reg. § 1.61-21(c)(2)(ii))

Recordkeeping Requirements

Whether the general FMV or table value method is chosen, the only way to distinguish between employment-related business driving (which is excluded as a nontaxable working fringe benefit if properly substantiated) and personal driving (which is a taxable fringe benefit) is on the basis of mileage. (Reg. § 1.132-5(b))

Recommendation: Employees must keep a diary or similar record with detailed entries for employment-connected business usage of the auto (time, place, mileage, business purpose). These entries are needed to establish the non-taxable working condition fringe benefit portion of employees' usage. Employees also should enter beginning and ending odometer readings for the period of time involved. Total mileage less employment-connected business mileage will yield personal mileage, the value of which must be treated as taxable fringe benefit compensation income.

Business Auto Deductions for the Employer

If all personal use of the auto by an owner or employee (or a member of his or her family) is properly treated as fringe benefit compensation income, the auto will be treated as if it were 100% used for business. That means the employer may deduct all of its operating expenses (e.g., oil, gas, maintenance and repairs) and also may claim all of the otherwise allowable depreciation deductions or lease deductions. Rationale: Where personal use is treated as fringe benefit compensation income, the employer may deduct all of the otherwise allowable costs incurred in supplying that benefit. (Reg. § 1.162-25T; Reg. § 1.274-5T(e)(2))

Because of the so-called “luxury auto” deduction limits of Code Sec. 280F , however, employers will have to grapple with severe restrictions on depreciation and expensing deductions if the company auto is purchased (unless the vehicle is a heavy SUV, defined below), and relatively mild restrictions if it is leased (and no restrictions at all if the vehicle is a heavy SUV).

Purchased autos: The otherwise-allowable depreciation and Code Sec. 179 expensing deductions for a new business auto bought and placed in service in 2008 are limited to $10,960 for the placed-in-service year, $4,800 for the second tax year, $2,850 for the third, and $1,775 for each succeeding year. For new light trucks or vans (passenger autos built on a truck chassis, including minivans and sport utility vehicles (SUVs) built on a truck chassis) bought and placed in service in 2008, the limits are $11,160 for the placed-in-service year, $5,100 for the second tax year, $3,050 for the third, and $1,875 for each succeeding year. (Rev Proc 2008-22, 2008-12 IRB)

Caution: If the vehicle is used by a more-than-5% company owner, the above first-year limits—which are substantially more generous under the Economic Stimulus Act of 2008 than the normal first–year limits—apply only if business use exceeds 50% of total use. If it doesn't (or if the auto is bought used or the employer elects not to use bonus first year depreciation for autos and other 5-year assets), first-year depreciation will be limited to only $2,960 if the vehicle is an auto, and $3,160 if it's a light truck or van. (Code Sec. 168(k)(2)(D))

These rules are relaxed considerably if the company owned vehicle is a heavy SUV, one with a gross vehicle weight rating (GVWR) of over 6,000 pounds. Because such vehicles fall outside of the Code Sec. 280F(d)(5) definition of a passenger auto, the strict annual depreciation deduction limits don't apply. As a result, the employer may:

expense up to $25,000 of the cost of the heavy SUV under Code Sec. 179(b)(6);
claim bonus first year depreciation under the Economic Stimulus Act of 2008 of its cost as reduced by any expensing claimed (this is available only if the vehicle is bought new and placed in service in 2008); and
write off what's left of the cost of the vehicle, after subtracting the expensed amount and the bonus first year depreciation amount, under the normal depreciation rules applicable to 5-year property.

Caution: If the heavy SUV is used by a more-than-5% company owner, the above generous rules apply only if business use exceeds 50% of total use. If it doesn't, the vehicle isn't eligible for expensing, bonus first-year depreciation won't be available, and a slower (straight line) form of depreciation must be used to recover the cost of the vehicle. (Code Sec. 168(k)(2)(D), Code Sec. 280F(b)(1), Code Sec. 280F(d)(1))

Leased autos: A business that leases an auto for its owner or key employee may deduct the full lease payment, assuming personal use is properly treated as compensation income. However, unless the auto is modestly priced (e.g., for leases signed in 2008, it has a FMV under $18,500 if an auto, or under $19,000 if a light truck or van), the business must include a certain amount in income during each year of the lease. (Code Sec. 280F(c)) This income inclusion amount varies with the initial FMV of the leased auto, the lease term and the year of the lease, and is adjusted for inflation each year. Tables 5 and 6 of Rev Proc 2008-22, 2008-12 IRB, Sec. 4.03, carry the income inclusion tables for passenger autos, and light trucks and vans with a lease term beginning in 2008.

Observation: These addback amounts are relatively modest, even for higher-priced autos. For example, if a $50,000 auto is leased on Jan. 1, 2008 for a three-year term, the income inclusion amount would be $177 for 2008, $388 for 2009, and $575 for 2010.

Mileage rate method of deducting auto expenses: For the sake of completeness, it should be noted that instead of deducting actual business-related out-of-pocket expenses plus depreciation, an eligible business may deduct business-connected expenses of leased or purchased autos (including vans, pickups and panel trucks) by way of the standard mileage rate. This method yields a fixed deduction for each business mile traveled, regardless of actual expenses, cost of the auto, or its age. Assuming personal use is properly valued and treated as compensation income, even personal mileage would count as business mileage. The mileage rate, which is adjusted for inflation annually, is equal to 50.5¢ for each business mile traveled during 2008. The mileage rate deduction method is available only if a number of restrictions are met. For example, it's not available if the auto was written off in a previous year using accelerated depreciation, or if the business owns or leases five or more autos and uses them simultaneously. (Rev Proc 2007-70, 2007-50 IRB 1162)

A deduction computed under the standard mileage rate is in lieu of all operating and fixed costs of the automobile allocable to business purposes. Such items as depreciation (or lease costs), maintenance and repairs, tires, gasoline (including all taxes on the gasoline), oil, insurance and registration fees are included in operating and fixed costs. (Rev Proc 2007-70, 2007-50 IRB 1162, Sec. 5.03) However, the taxpayer may separately deduct parking fees and tolls attributable to business use of the auto. (Rev Proc 2007-70, 2007-50 IRB 1162, Sec. 5.04)

Observation: As a practical matter, the mileage rate method isn't an attractive writeoff for the company auto used by the owner or a key employee, because it's likely to be much smaller than the deductions that can be claimed by writing off actual out-of-pocket expenses and depreciation or lease costs.

Conclusion

The company auto still weighs in as a champion fringe benefit for the company owner or key employee. It can provide company owners or key employees with the use of a status-enhancing auto at a low tax cost while generating tax deductions for the company.

Get professional tax advisory HERE.

SFR - Substitute for return

2008-06-19T21:36:00.000-07:00

IRS may prepare substitute returns in worker classification cases
Chief Counsel Advice 200822026

A Chief Counsel Advice (CCA) has concluded that, in employment tax cases where worker classification issues are present, revenue officers have authority under Code Sec. 6020(b) to prepare employment tax returns, but the requirements of Code Sec. 7436 must be met before assessment.

Background. Where there is an actual controversy involving a determination by IRS that one or more individuals performing services for the taxpayer are employees as part of an examination, Code Sec. 7436 gives the Tax Court jurisdiction to determine certain “worker classification issues” (i.e., the proper amount of the additions to tax, additional amounts, and penalties that relate to the employment tax with respect to determinations of worker classification and whether the taxpayer is entitled to relief under § 530 of the Revenue Act of 1978). To meet Code Sec. 7436 's requirements, certain procedures must be followed before assessment of employment taxes. They are spelled out in Notice 2002-5, 2002-1 CB 320. For example, Notice 2002-5 provides generally that a taxpayer will first receive a “30-day” letter listing the proposed employment tax adjustments to be made and describing the taxpayer's right either to agree to the proposed adjustments or to protest the proposed adjustments to the IRS's Appeals function (Appeals) within 30 days of the date of the letter.

If the taxpayer does not respond to the “30-day” letter by agreeing to the proposed adjustments or by filing a protest to Appeals, the taxpayer will receive a Notice of Determination of Worker Classification (NDWC). The taxpayer may also receive the NDWC if the taxpayer files a protest with Appeals and the worker classification issues are not settled in Appeals. As indicated in Notice 2002-5, under Code Sec. 7436(d)(1), the mailing of the NDWC suspends the period of limitations for assessment of taxes attributable to the worker classification issues for the 90-day period during which the taxpayer can bring suit and precludes IRS from assessing the taxes identified in the NDWC before the expiration of the 90-day period during which the taxpayer may file a timely Tax Court petition.

If IRS erroneously makes an assessment of taxes attributable to the worker classification issues without first either issuing a NDWC or obtaining a waiver of restrictions on assessment from the taxpayer, the taxpayer is entitled to an automatic abatement of the assessment. However, under Notice 2002-5, once any procedural defects are corrected, IRS may reassess the employment taxes to the same extent as if the abated assessment had not occurred.

The amount of any tax imposed by the Code is to be assessed within 3 years after the return was filed, subject to certain specified exceptions. (Code Sec. 6501(a))

Under Code Sec. 6020(b), if a taxpayer fails to file a return when required, IRS may prepare a return based on its own knowledge and on information it obtains through testimony or other means. The failure-to-pay penalty under Code Sec. 6651(a)(2) applies to the amount of tax shown on the return, including, under Code Sec. 6651(g)(2) , any amount shown on a substitute return prepared by IRS. Absent the existence of a return under Code Sec. 6020(b), the Code Sec. 6651(a)(2) penalty doesn't apply to a nonfiler. [For discussion of recently issued regs on substitute returns, see Federal Taxes Weekly Alert 02/14/2008]

Facts. The Chief Counsel was asked to review a memorandum which addressed the issue of whether a revenue officer has authority under Code Sec. 6020(b) to prepare employment tax returns on behalf of taxpayers who fail to file such returns in a case in which worker classification issues are present and where the revenue officer did not refer the case to the Employment Tax Program as required under the Internal Revenue Manual (IRM).

For the years at issue, the taxpayer took the position that certain workers were independent contractors for federal tax purposes. However, for prior years, the taxpayer had treated the workers as employees. After reviewing the facts of the case, the revenue officer determined that the workers should have been treated as employees and prepared Substitute for Returns (SFRs) under Code Sec. 6020(b).

The taxpayer objected to the preparation of the SFRs and requested an appeal. The appeals officer concluded that the worker classification issue was undeveloped and that “the revenue officer did not have the authority to prepare Forms 941 under Code Sec. 6020(b) procedures because the IRM requires the issue to be referred to the Employment Tax Program,” and recommended the government concede the case.

Analysis. The CCA observed that the taxpayer failed to file an employment tax return and did not submit evidence to establish that no employment tax return was due. The revenue officer determined that some of the taxpayer's workers were employees and that an employment tax return should have been filed. The revenue officer prepared returns under Code Sec. 6020(b).

The CCA said that, because the revenue officer failed to meet Code Sec. 7436 's requirements, an assessment of employment taxes based on the Code Sec. 6020(b) return prepared by him is improper. However, the CCA said that the facts do not indicate that the government is required to concede the case. The CCA said that, under Notice 2002-5 , once the procedural defects are corrected and Code Sec. 7436 's requirements are met, employment taxes may be assessed.

Tax Scams for 2008 - Fuel Tax Credit Scams

2008-06-16T19:10:00.000-07:00

IRS Announces 'Dirty Dozen'
Tax Scams for 2008

Phishing Scams, Fuel Tax Credits, Frivolous Arguments, Hiding Income Offshore Top the 2008 Tax Scams

WASHINGTON — The Internal Revenue Service today issued its 2008 list of the 12 most egregious tax schemes and scams, highlighted by Internet phishing scams and several frivolous tax arguments.

Topping this year's list of scams is phishing, which encompasses numerous Internet-based ploys to steal financial information from taxpayers. New to the "Dirty Dozen" this year is a scheme, which IRS auditors discovered, that relates to unreasonable and/or excessive fuel tax credit claims.

"Taxpayers should be wary of scams and promises to avoid paying taxes that seem too good to be true," Acting IRS Commissioner Linda Stiff said. "There is no secret formula that can eliminate a person's tax obligations. People should be wary of anyone peddling any of these scams."

Tax schemes can lead to problems for both scam artists and taxpayers. Tax return preparers and promoters also risk significant penalties, interest and possible criminal prosecution.

The IRS urges taxpayers to avoid these common schemes:

1. Phishing

Phishing is a tactic used by Internet-based thieves to trick unsuspecting victims into revealing personal information they can then use to access the victims' financial accounts. These criminals use the information obtained to empty the victims' bank accounts, run up credit card charges and apply for loans or credit in the victims' names. Phishing scams often take the form of an e-mail that appears to come from a legitimate source. Some scam e-mails falsely claim to come from the IRS. To date, taxpayers have forwarded more than 33,000 of these scam e-mails, reflecting more than 1,500 different schemes, to the IRS. The IRS never uses e-mail to contact taxpayers about their tax issues. Taxpayers who receive unsolicited e-mail that claims to be from the IRS can forward the message to a special electronic mailbox, phishing@irs.gov, using instructions contained in an article titled "How to Protect Yourself from Suspicious E-Mails or Phishing Schemes." Remember: the only official IRS Web site is located at www.irs.gov.

2. Scams Related to the Economic Stimulus Payment

Some scam artists are trying to trick individuals into revealing personal financial information that can be used to access their financial accounts by making promises relating to the economic stimulus payment, often called a "rebate." To obtain the payment, eligible individuals in most cases will not have to do anything more than file a 2007 federal tax return. But some criminals posing as IRS representatives are trying to trick taxpayers into revealing their personal financial information by falsely telling them they must provide information to get a payment. For instance, a potential victim is told by phone or e-mail that he or she is eligible for a rebate but must provide a bank account number (or similar information) to get the payment. If the target is unwilling, the victim is then told that he cannot receive the rebate unless the information is provided. Individuals should remember that the only way to get a stimulus payment is to file a 2007 tax return. The IRS urges taxpayers to be extra-vigilant. The IRS will not contact taxpayers by phone or e-mail about their stimulus payment.

3. Frivolous Arguments

Promoters of frivolous schemes encourage people to make unreasonable and unfounded claims to avoid paying the taxes they owe. Most recently, the IRS expanded its list of frivolous legal positions that taxpayers should stay away from. Taxpayers who file a tax return or make a submission based on one of these positions on the list are subject to a $5,000 penalty. The most recent update of the list of frivolous positions includes: misinterpretation of the 9th Amendment to the U.S. Constitution regarding objections to military spending, erroneous claims that taxes are owed only by persons with a fiduciary relationship to the United States, a nonexistent "Mariner's Tax Deduction" related to invalid deductions for meals and the misuse of the fuel tax credit (see below). The complete list of frivolous arguments is on the IRS Web site at IRS.gov.

4. Fuel Tax Credit Scams

The IRS is receiving claims for the fuel tax credit that are unreasonable. Some taxpayers, such as farmers who use fuel for off-highway business purposes, may be eligible for the fuel tax credit. But some individuals are claiming the tax credit for nontaxable uses of fuel when their occupation or income level makes the claim unreasonable. Fraud involving the fuel tax credit was recently added to the list of frivolous tax claims, potentially subjecting those who improperly claim the credit to a $5,000 penalty.

5. Hiding Income Offshore

Individuals continue to try to avoid paying U.S.taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore debit cards, credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance plans. The IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions.

6. Abusive Retirement Plans

The IRS continues to uncover abuses in retirement plan arrangements, including Roth Individual Retirement Arrangements (IRAs). The IRS is looking for transactions that taxpayers are using to avoid the limitations on contributions to Roth IRAs. Taxpayers should be wary of advisers who encourage them to shift appreciated assets into Roth IRAs or companies owned by their Roth IRAs at less than fair market value. In one variation of the scheme, a promoter has the taxpayer move a highly appreciated asset into a Roth IRA at cost value, which is below annual contribution limits even though the fair market value far exceeds the amount allowed.

7. Zero Wages

Filing a phony wage- or income-related information return to replace a legitimate information return has been used as an illegal method to lower the amount of taxes owed. Typically, a Form 4852 (Substitute Form W-2) or a "corrected" Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer also may submit a statement rebutting wages and taxes reported by a payer to the IRS. Sometimes fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any of the variations of this scheme.

8. False Claims for Refund and Requests for Abatement

This scam involves a request for abatement of previously assessed tax using Form 843, "Claim for Refund and Request for Abatement." Many individuals who try this have not previously filed tax returns. The tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses Form 843 to list reasons for the request. Often, one of the reasons given is "Failed to properly compute and/or calculate Section 83-Property Transferred in Connection with Performance of Service."

9. Return Preparer Fraud

Dishonest tax return preparers can cause many problems for taxpayers who fall victim to their schemes. These scam artists make their money by skimming a portion of their clients' refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Some preparers promote the filing of fraudulent claims for refunds on items such as fuel tax credits to recover taxes paid in prior years. Taxpayers should choose carefully when hiring a tax preparer, especially one who promises something that seems too good to be true.

10. Diguised Corporate Ownership

Some people are going as far as forming domestic shell corporations in certain states for the purpose of disguising the ownership of a business or financial activity. Once formed, these anonymous entities can be used to facilitate underreporting of income, non-filing of tax returns, engaging in listed transactions, money laundering, financial crimes and even terrorist financing. The IRS is working with state authorities to identify these entities and to bring the owners of these entities into compliance.

11. Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust.

12. Abuse of Charitable Organizations and Deductions

The IRS continues to observe the misuse of tax-exempt organizations. Misuse includes arrangements to improperly shield income or assets from taxation, attempts by donors to maintain control over donated assets or income from donated property and overvaluation of contributed property. In addition, IRS examiners are seeing an upturn in instances where taxpayers try to disguise private tuition payments as contributions to charitable or religious organizations.

IRS Watches Scams That Fall Off the List

While the IRS has seen a decline in the occurrence of some of these scams, other problems, such as abuse of the American Indian Employment Credit and misuse of structured entity credits, continue to be areas of concern. The absence of a particular scheme from the Dirty Dozen should not be taken as an indication that the IRS is unaware of it or not taking steps to counter it.

How to Report Suspected Tax Fraud Activity

Suspected tax fraud can be reported to the IRS using IRS Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential.

Whistleblowers also could provide allegations of fraud to the IRS and may be eligible for a reward by filing Form 211, Application for Award for Original Information, and following the procedures outlined in Notice 2008-4, Claims Submitted to the IRS Whistleblower Office under Section 7623.

IRS Media Relations Office
Washington, D.C.
IR-2008-41, March 13, 2008

Tax Problem Resolution Services

2008-06-14T11:45:00.000-07:00

Tax Problem Resolution Services

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As an IRS licensed Enrolled Agent (EA) providing IRS Tax Problem Resolution Services, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

Specialized tax breaks for the farming industry

2008-06-04T09:43:00.000-07:00

Tax provisions directly affecting farmers in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act that directly affect farmers:

Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
A new deduction is allowed for endangered species recovery expenses incurred after 2008.
A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
The amount of farming losses (other than those losses arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.

Limitation on farming losses in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. Those incentives are paid for, in part, by a new limitation on farming losses for certain taxpayers. In essence, the new law limits agricultural losses that can be claimed to the greater of $300,000 ($150,000 for a married person filing separately) or the net farm income for the previous five years if the taxpayer receives any 2008 Farm Act commodity payments or Commodity Credit Corporation loans. Here is a closer look at this new limitation.

Except for passive activity rules in Code Sec. 469, the amount of farming losses that a taxpayer may claim is not limited under pre-2008 Farm Act law. The new provision, which is effective for tax years beginning after December 31, 2009, alters that situation by limiting the amount of farming losses that a taxpayer, other than a C corporation, may use to offset non-farm business income. The limitation amount is the greater of $300,000 ($150,000 in the case of a married person filing a separate return) or the total net farm income the taxpayer has received over the last five years. For example, assume a taxpayer has $300,000 of net farm income and $700,000 of non-farm income in 2010, and $1 million of net farm income in each tax year 2011 to 2014. In 2015, he incurs a $7 million farming loss. Under the new provision, his farming loss in 2015 is limited to the greater of (1) $300,000 or (2) $4.3 million (total net farm income for the prior five tax years). The $4.3 million of the farming loss allowed in 2015 may be carried back to the prior five tax years.

Losses that are limited in a particular year may be carried forward to subsequent years.
For partnerships and S corporations, the limit is applied at the partner or shareholder level. Farming losses arising by reason of fire, storm, or other casualty, or by reason of disease or drought, are disregarded for purposes of calculating the new limitation.

This provision only applies to eligible taxpayers who receive any direct or counter-cyclical payments under title I of the 2008 Farm Act (or any payment elected in lieu of any such payment), or any Commodity Credit Corporation loan. For purposes of this provision, the definition of “farming business” is broadened to include the processing of commodities, without regard to whether such activity is incidental, by a taxpayer otherwise engaged in a farming business with respect to such commodities.

Agricultural chemicals security tax credit created by the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. One fairly specialized new incentive addresses the need to safely secure agricultural chemicals. Agricultural chemicals and pesticides purchased for legitimate uses are increasingly vulnerable to theft because of the drug trade and national security threats. Some agricultural businesses may pay tens of thousands of dollars on new measures to secure their storage sites. In recognition of this, the 2008 Farm Act creates a new credit to help agricultural businesses afford the increasing expenses of protecting agricultural chemicals and pesticides.

The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.

I hope this information is helpful. If you would like more details about this or any other aspect of the new law, please do not hesitate to contact us.

Tax Provisions in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

2008-06-04T09:40:00.000-07:00

Overview of the tax changes in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act:

Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
A new deduction is allowed for endangered species recovery expenses incurred after 2008.
There is a one-year cut in the tax rate for a corporation's qualified timber gain. For tax years ending after May 22, 2008 and beginning on or before May 22, 2009, a 15% alternative tax applies on the portion of a corporation's taxable income that consists of qualified timber gain (or, if less, the net capital gain) for a tax year. In addition the rules for REITs (real estate investment trusts) holding timber property are liberalized temporarily.
A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
For property placed in service after 2008 and before 2014, all racehorses are classified as three-year property for depreciation purposes, regardless of their age.
Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
The amount of farming losses (other than those arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.
For large corporations (those with assets of at least $1 billion), estimated tax payments due in July, August, and September of 2012 are increased by 7.75% of the payment otherwise due, and the next required payment is reduced accordingly.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Tax relief for Peace Corps

2008-06-04T09:38:00.000-07:00

Tax relief for Peace Corps volunteers and employees in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) contains a wide-ranging package of tax cuts for military personnel and veterans. In addition, a provision in the 2008 Heroes Act will potentially enable more Peace Corps employees and volunteers to qualify for the homesale exclusion on the sale of their principal home. Here are the details of the new provision affecting Peace Corps volunteers.

An individual taxpayer may exclude up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a principal residence. To be eligible for the exclusion, the taxpayer must have owned and used the residence as a principal residence for at least two of the five years ending on the sale or exchange. A taxpayer who fails to meet these requirements by reason of a change of place of employment, health, or, to the extent provided under regulations, unforeseen circumstances is able to exclude an amount equal to the fraction of the $250,000/$500,000 that is equal to the fraction of the two years that the ownership and use requirements are met.

There are special rules relating to members of the uniformed services, members of the Foreign Service of the United States, and employees of the intelligence community that allow for an option to suspend the five-year test period for ownership and use during any period these individuals or their spouses serve on qualified official extended duty. This means that they may be able to meet the two-year use test even if, because of their service, they did not actually live in the home for at least the required two years during the five-year period ending on the date of sale. The five-year period can't be extended by more than ten years.

Under the 2008 Heroes Act, a new rule is created for Peace Corps volunteers and certain employees similar to the rules that already apply to the uniformed services, Foreign Service, and intelligence community. Under this new rule, which is effective for tax years beginning after December 31, 2007, an individual may elect to suspend for a maximum of ten years the five-year test period for ownership and use during certain periods that the employee or volunteer is serving outside the U.S.. If the election is made, the five-year period ending on the date of the sale or exchange of a principal residence does not include the period up to ten years during which the taxpayer or the taxpayer's spouse is serving as a Peace Corp volunteer or employee.

For example, let's say that Betty bought and moved into a home in 2002. She lived in it as her main home for two and one-half years. For the next four years, she did not live in it because she was serving outside the United States as a Peace Corps volunteer. She then sells the home at a gain in 2008. To meet the use test, Betty chooses to suspend the five-year test period for the four years she was serving in the Peace Corps. This means she can disregard those four years. Therefore, Betty's five-year test period consists of the five years before she went on qualified official extended duty in the Peace Corps. She meets the ownership and use test because she owned and lived in the home for two and one-half years during the testing period.

I hope this information is helpful. If you would like more details about this provision or any other aspect of the new law, please do not hesitate to contact us.

Military Personnel Tax Benefits

2008-06-04T09:31:00.000-07:00

Pension plan benefits for military personnel in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) provides several important pension plan benefits for military personnel. Specifically, the Act makes the following pension plan liberalizations for members of the military and their families:

Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
Permits a military death gratuity or amount received under the Servicemembers' Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.

Other military tax benefits in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) contains a wide-ranging package of tax cuts for military personnel and veterans. While many of the military tax benefits are pension plan-related, several important changes are not. Specifically, the 2008 Heroes Act makes the following nonpension-related liberalizations for members of the military and their families:

Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law this benefit was only available for tax years ending before 2008).
Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law this exception only applied for bonds issued before 2008).
Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations. This provision is important because length-of-service-based military retirement benefits are included in income but veterans' benefits based on a service-connected disability are excluded. Where individuals receive includible retirement benefits and are later retroactively determined to be eligible for service-connected disability benefits, the retirement benefits attributable to the disability are retroactively excluded. Under pre-2008 Heroes Tax Act law, individuals may claim a refund of the tax paid on the retroactively excluded benefits, subject to the statute of limitations on filing a refund claim (generally, the claim must be filed within three years of the filing of the tax return or within two years of the payment of the tax, whichever expires later). Effective for claims filed after the enactment date, the Act extends the time period for filing a refund claim. For a determination after the enactment date, the period is extended until one year after the date of the disability determination (if later than the time periods allowed under current law). The change applies to any tax year which begins five years before the date of the determination or thereafter. For a determination after 2000, and on or before the enactment date, the refund period is extended until one year after the enactment date (if later than the time periods allowed under current law).
Modifies the rules regarding differential pay. Some employers voluntarily agree to continue paying the compensation that service members would otherwise have received from the employer during their active duty. Under pre-2008 Heroes Act law, such “differential pay” isn't wages for federal income tax withholding purposes but under the new law is subject to withholding, effective for amounts paid after 2008. Additionally, effective for tax years beginning after 2008, differential pay will have to be treated as compensation for retirement plan purposes, and will qualify as compensation for purposes of the IRA contribution rules.
Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).

Please keep in mind that this is only a summary of these changes in the new law. If you would like more details about these provisions or any other aspect of the new law, please do not hesitate to contact us.

Heroes Earnings Assistance and Relief Tax Act of 2008

2008-06-04T09:29:00.000-07:00

Overview of tax changes in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) provides targeted tax relief for military members and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty. Here's a summary of the tax provisions in the Act:

New relief provisions. The 2008 Heroes Act makes the following liberalizations for members of the military and their families:

Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law, this benefit was only available for tax years ending before 2008).
Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law, this exception only applied for bonds issued before 2008).
Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
Includes differential wages paid by an employer to an employee who becomes active duty military in the calculation of wages for retirement plan and IRA purposes, effective for years beginning after 2008. Differential pay is also made subject to federal income tax withholding, effective for amounts paid after 2008.
Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations.
Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
Permits a military death gratuity or amount received under the Servicemembers' Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.
Entitles Peace Corps volunteers and certain employees to a similar tolling of the homesale exclusion ownership and use period that already applies to members of the uniformed services, Foreign Service, and intelligence community. The Act also makes permanent the special homesale exclusion rules for certain employees of the intelligence community and repeals the requirement that those employees move overseas in order to qualify for special treatment.
Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).
Retroactively clarifies that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.

Revenue raising provisions. To offset the cost of the new tax breaks (and the cost of various SSI liberalizations for the military), the Act:

Tightens the expatriation rules. U.S. citizens and long-term U.S. residents are subject to tax on their worldwide income. Taxpayers can avoid taxes by renouncing their U.S. citizenship or terminating their residence. The Act tightens the expatriation rules to ensure that certain high net-worth taxpayers can't renounce their U.S. citizenship or terminate their U.S. residency in order to avoid U.S. taxes. Under this provision, high net-worth individuals are treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residency. Gain is recognized to the extent that the aggregate gain recognized exceeds $600,000 (which will be adjusted for cost of living in the future). The provision, which applies for those who relinquish U.S. citizenship or terminate their U.S. residency on or after the enactment date, is estimated to raise $411 million over 10 years.
Treats foreign subsidiaries of U.S. companies performing services under a U.S. government contract as American employers for employment tax purposes. Under the new law, the domestic parent is jointly liable for employment taxes imposed on the foreign subsidiary. The new provision applies to services performed in calendar months beginning more than 30 days after the enactment date and is estimated to raise $846 million over ten years.
Increases the minimum penalty for a failure to file an individual tax return within 60 days of the due date to the lesser of $135 (up from $100) or 100 percent of the amount of tax required to be shown on the return, effective for tax returns required to be filed after 2008. The provision is estimated to raise $296 million over ten years.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Triangular Reorganizations Tax Resolution

2008-06-04T09:25:00.000-07:00

Temporary regs curb abuses in triangular reorganizations involving foreign corporations

T.D. 9400, 05/23/2008, Reg. § 1.367(a)-3T, Reg. § 1.367(b)-14T, Preamble to Prop Reg 05/23/2008

IRS has issued temporary (along with final and proposed regs) under Code Sec. 367(b) to curb abusive triangular reorganizations involving foreign corporations—sometimes referred to as “Killer B” transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48, and their text serves as the text of the proposed regs.

Statutory background. A U.S. person's transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354, Code Sec. 356, or Code Sec. 361 exchanges, generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent's stock provided by it to its subsidiary—or provided directly to a target corporation or its shareholders on the subsidiary's behalf—under a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent's stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target's stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent's stock that it exchanges for the target's stock in a reverse triangular merger. (Code Sec. 361)

A corporation's distribution of property to its shareholder with respect to its stock is included in the shareholder's gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation's current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation's stock, and any amount of the distribution in excess of the shareholder's basis is treated as gain from the sale or exchange of the corporation's stock. (Code Sec. 301(c)(2), Code Sec. 301(c))

Background on prior IRS notices. In Notice 2006-85, 2006-41 IRB 677, IRS announced that it would issue regs under Code Sec. 367(b) to curb abuses where triangular reorganizations involving foreign corporations had the effect of repatriating the subsidiary's foreign earnings to the parent without a corresponding dividend to the parent that would be subject to U.S. income tax (see Federal Taxes Weekly Alert 09/28/2006). The regs would treat the transfer of property from the parent to the subsidiary as a distribution of property under Code Sec. 301(c). IRS later issued Notice 2007-48, 2007-25 IRB 1428, to amplify and broaden the reach of Notice 2006-85 to cover transactions where the subsidiary acquires stock of its parent from a person unrelated to its parent, such as from the public on the open market (see Federal Taxes Weekly Alert 06/07/2007).

IRS has now issue final, temporary and proposed regs under Code Sec. 367(b) to address these other transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48 , and their text serves as the text of the proposed regs. The final regs revise an existing final reg and add a cross-reference.

Temporary regs. IRS has issued temporary regs that apply to triangular reorganizations where P or S (or both) is foreign and, in connection with the reorganization, S acquires, in exchange for property, all or a portion of the P stock that is used to acquire T's stock or assets. The “in connection with” standard is a broad standard that includes any transaction related to the reorganization even if the transaction is not part of the plan of reorganization. For example, the temporary regs apply to a triangular reorganization regardless of whether P controls S (under Code Sec. 368(c)) when S acquires the P stock that is used in the reorganization. (Reg. § 1.367(b)-14T(a)(1))

The temporary regs make adjustments for P and S that have the effect of a distribution of property from S to P under Code Sec. 301. The amount of the deemed distribution is equal to the amount of money plus the fair market value of other property that S used to acquire P stock. For this purpose, “property” has the meaning in Code Sec. 317(a) , but includes any liability assumed by S in exchange for the P stock (notwithstanding Code Sec. 357(a)) and any S stock used by S to acquire the P stock from a person other than P. To the extent S buys P stock from a person other than P, immediately after taking into account the deemed distribution to P, P is deemed to contribute to S the property deemed distributed to P. (Reg. § 1.367(b)-14T(b)(1))

The deemed distribution is treated as a transaction separate from, and occurring immediately before, the triangular reorganization. Thus, P is not be treated as receiving the property from S in exchange for P stock, and the transfer of P stock in the triangular reorganization is subject to the generally applicable provisions, e.g., Reg. § 1.1032-2. (Reg. § 1.367(b)-14T(b)(2)) The deemed distribution is treated as a distribution for all purposes of the Code. (Reg. § 1.367(b)-14T(c)(1)) Similarly, a deemed contribution of property is treated as a contribution of property for all purposes of the Code. For example, appropriate adjustments to P's basis in the S stock and other affected items must be made according to applicable Code provisions. (Reg. § 1.367(b)-14T(c)(2))

Ordering rules generally require the deemed distribution and, in cases where S buys P stock from a person other than P, the deemed contribution to be taken into account before the transfers undertaken under the triangular reorganization. If P controls S (under Code Sec. 368(c)) at the time of the purchase, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately before the purchase. If P doesn't control S (under Code Sec. 368(c) ) at the time that S purchases the P stock, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately after P acquires control of S. Thus, in a transaction where S purchases the P stock from a person other than P, after taking into account the adjustments made under these temporary regs, S's purchase and transfer of P stock under the triangular reorganization are taken into account under generally applicable Code provisions, such as Code Sec. 304, Code Sec. 354, Code Sec. 356, Code Sec. 358, and Code Sec. 368. (Reg. § 1.367(b)-14T(b)(3))

Under the temporary regs, appropriate adjustments are made if in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of the regs. (Reg. § 1.367(b)-14T(d)) For example, if S is a newly formed corporation and, in connection with the reorganization, P contributes to S another corporation with positive earnings and profits (S2) to facilitate S's purchase of the P stock or to facilitate the repayment of an obligation incurred by S to purchase the P stock, then, under the temporary regs, the earnings and profits of S may be deemed to include S2's earnings and profits. (T.D. 9400, 05/23/2008)

Effective date. For rules addressing transactions described in Notice 2006-85, the temporary regs are generally applicable to transactions occurring on or after Sept. 22, 2006. For rules addressing transactions described in Notice 2007-48, the temporary regs are generally applicable to transactions occurring on or after May 31, 2007. Other reg rules are generally applicable to transactions occurring on or after May 23, 2008. Limited transition relief applies. (Reg. § 1.367(b)-14T(e))

APA Tax Relief & Tax Resolution

2008-06-04T09:18:00.000-07:00

IRS expands advance pricing agreement procedures to include other issues relevant to transfer pricing

Rev Proc 2008-31, 2008-23 IRB

In a Revenue Procedure, IRS has expanded the procedures under which taxpayers secure an advance pricing agreement (APA) to include additional types of issues that may be resolved in the APA process.

Background. An APA generally combines a voluntary agreement between a taxpayer and IRS on an appropriate transfer pricing methodology (TPM) for covered transactions with an agreement between the U.S. and one or more foreign tax authorities that the TPM is correct. This kind of bilateral APA assures the taxpayer that the income from the transactions will not be subject to double taxation by the U.S. and the foreign tax authority. IRS and taxpayers also may execute unilateral APAs, which are agreements establishing an approved transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and IRS, but does not prevent foreign tax bodies from taking different positions. If a transaction covered by a unilateral APA is subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding, provided there is an applicable income tax treaty in force with the other country. The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee.

IRS has now updated Rev Proc 2006-9, 2006-2 IRB 278, which contains the procedures for applying for an APA.

Updated procedures. In Rev Proc 2008-31, IRS modifies the procedures in Rev Proc 2006-9 to state that the APA program also provides a process by which IRS and taxpayers may resolve other issues than transfer pricing arising under certain income tax treaties, the Code, or the regs for which transfer pricing principles may be relevant. For example, these issues would include: attribution of profits to a permanent establishment under an income tax treaty, determining the amount of income effectively connected with the conduct by the taxpayer of a trade or business within the U.S., and determining the amounts of income derived from sources partly within and partly without the U.S., as well as related subsidiary issues.

HEART Act Tax Relief

2008-06-02T14:14:00.000-07:00

House-passed Heroes Act would provide tax relief to military members & their families

On May 20, by a vote of 403-0 the House of Representatives unanimously approved H.R. 6081, the “Heroes Earnings Assistance and Relief Tax Act of 2008.” The bill, dubbed the HEART Act by its sponsors, is very similar to the version of H.R. 3997 (the “Heroes Earnings Assistance and Tax Relief Act of 2007”) that was passed by the House of Representatives in the waning days of 2007 but failed to pass the Senate. The bill would provide targeted tax relief for members of the military and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty.

Caution: Several of the HEART Act relief provisions would create significant compliance and plan amendment challenges for tax qualified retirement plans and their sponsors.

The press staff for Speaker of the House Nancy Pelosi (D-CA) has said that H.R. 6081 is the “final agreement with the Senate that is expected to be sent to the President by Memorial Day.”

Here's a roundup of the tax provisions in the HEART Act:

Clarify that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
Make permanent the ability to treat combat pay as earned income for purposes of the earned income tax credit.
Make permanent and modify provisions relating to qualified mortgage bonds used to finance residences for veterans.
Modify the Uniformed Services Employment and Re-employment Rights Act (USERRA) to allow the day before the date of death to be treated as the date the employee returned to work for purposes of triggering payment of benefits under a qualified plan. The bill would also permit an employer to make certain contributions to a qualified pension plan on behalf of an employee who is killed or become disabled in combat. These changes would apply to deaths and disabilities occurring after 2006.
Treat differential wages paid by an employer to an employee who goes on active military duty as wages for withholding, retirement plan, and IRA purposes. The wage withholding change would apply for remuneration paid after 2008; the other changes would apply for years beginning after 2008.
Provide small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty. The credit would apply for amounts paid after the enactment date and before 2010.
Extend the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs (DVA) disability determinations, effective for claims for credits or refunds filed after the enactment date.
Make permanent expiring rules that permit active duty reservists to make penalty-free withdrawals from retirement plans.
Make permanent an expiring provision authorizing the Social Security Administration (SSA) to disclose tax return information to the DVA for purposes of determining eligibility for certain veteran's programs.
Permit recipients of military death benefit gratuities to make tax-free rollovers of amounts received to a Roth IRA or a Coverdell Education Savings Account. In general, this provision would apply for payments made on account of deaths from injuries occurring after the enactment date, but such rollovers would be permitted for amounts received with respect to deaths from injury occurring after Oct. 6, 2001 and before the enactment date, if the rollover is completed no later than one year after the enactment date.
Effective for tax years beginning after 2007, liberalize the home sale exclusion rules for Peace Corps volunteers by making them similar to the rules that apply to those in the military, the foreign service, and the intelligence community. The bill also would make permanent the special home-sale exclusion rules for certain employees of the intelligence community, and for sales or exchanges after the enactment date, repeal the requirement that such employees move overseas in order to qualify for special treatment.
Effective for payments made before, on, or after the enactment date, provide an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
For distributions made after the enactment date, allow members of the reserves who are called to active duty to withdraw amounts held in a Flexible Spending Account (FSA) without penalty.
Retroactively clarify that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Debt Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.
Tighten the expatriation rules to ensure that certain high net-worth taxpayers can't renounce their U.S. citizenship or terminate their U.S. residency in order to avoid U.S. taxes. High-net-worth individuals would be treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residency. Gain would be recognized to the extent that the aggregate gain recognized exceeds $600,000 (which would be adjusted for cost of living in the future). The provision would apply for those who relinquish U.S. citizenship or terminate their U.S. residency on or after the enactment date.
For services performed in calendar months beginning more than 30 days after the enactment date, treat foreign subsidiaries of U.S. companies performing services under a U.S. government contract as American employers for employment tax purposes. The domestic parent would be jointly liable for employment taxes imposed on the foreign subsidiary.
Effective for tax returns required to be filed after 2008, increase the general penalty for failure to file tax returns within 60 days of the due date to the lesser of $135 or 100% of the amount required to be shown on the return.
Extend current law's excise tax for failure to comply with the mental health parity requirements for benefits for services furnished on or after the enactment date through Dec. 31, 2008.

IRS Employment / Payroll Tax Focus

2008-06-02T14:09:00.000-07:00

IRS focusing efforts on four employment tax initiatives

American Payroll Association 26th Annual Congress May 13-17 (Austin, TX)

John Tuzynski, IRS Chief, Employment Tax Operations, told attendees at APA's 26th Annual Congress that the IRS is focusing its efforts on the following four key employment tax initiatives: (1) worker classification, (2) tip reporting compensation, (3) officer compensation, and (4) fringe benefits.

Worker classification. Approximately 30% of IRS audits focus on the employee vs. independent contractor issue. The IRS may further review a personal income tax return which, over a period of several years, has only included 1099-source income.

Tip reporting. The IRS is looking for voluntary compliance in this area. Tuzynski believes some employers in the food and beverage industry may not be aware of the Attributed Tip Income Program (ATIP). ATIP provides benefits to employers and employees similar to those offered under other tip reporting agreements, including protection from audits. However, ATIP does not require employers to meet with the IRS to determine tip rates or eligibility.

Officer compensation. There are many S corporations with significant distributable income that report very little officer compensation, even though the officer provided key services to the corporation. These corporations may not be paying their fair share of employment taxes.

Fringe benefits. The IRS continues to target improper employee tool and equipment expense reimbursement plans.

New initiative. The IRS does not currently follow up on notices that it sends to employers asking them to begin backup withholding on employees with mismatches between their name and taxpayer identification number. Tuzynski said that the IRS will soon have a new initiative in this area.

Lien foreclosure suits by the IRS

2008-06-02T13:59:00.000-07:00

Levy couldn't force early distribution of taxpayer's state retirement account Chief Counsel Advice 200819001

In Chief Counsel Advice (CCA), IRS has concluded that it can't, after serving a notice of levy on a state retirement fund, exercise the taxpayer's right to suspend her membership in the fund in order to obtain an immediate distribution of her assets in the fund when she hasn't yet reached retirement age.

Facts. Married taxpayers, who we'll call Betty and Bob, have an unpaid joint income tax liability. Betty is 50 years old and not currently receiving benefits from a state retirement fund with which she has an account. Although she no longer works for the state, she has obtained other employment and is not retired. Under the terms of the retirement fund, she may elect to suspend membership in the retirement fund and receive a distribution of all assets in her account. If she doesn't elect, when she reaches retirement age, she'll be eligible to receive her retirement benefits from the account.

IRS served a notice of levy on the state retirement fund in order to collect Betty's assets in the fund. The fund will not distribute the assets unless Betty elects to suspend membership in the fund. The IRS revenue officer asks whether IRS can “elect” on Betty's behalf to suspend her membership in the fund.

Background. Under Code Sec. 6331(a), IRS can levy on all property and rights to property of a taxpayer on which there is a federal tax lien in order to collect delinquent taxes. Only property that is specifically enumerated in Code Sec. 6334(a) is exempt from levy, and funds in a state retirement fund aren't so enumerated.

Can force immediate distribution. The CCA concluded that IRS can't exercise Betty's right to suspend membership in the retirement fund in order to obtain an immediate distribution of her assets in the fund when she hasn't yet reached retirement age. IRS can levy on a retirement plan even if a participant has no immediate right to receive benefits. But, the fund is not obligated to turn over any assets under the levy until the taxpayer reaches the age in which she is eligible for retirement benefits under the plan or she voluntarily suspends her membership in the plan.

The CCA reasoned that while IRS's levy attaches to Bob and Betty's interest in the state retirement fund, it only extends to property rights and obligations that exist at the time of the levy. (Reg. § 301.6331-1(a)) Obligations exist for purposes of a levy when the liability of the obligor is fixed and determinable, even though the right to receive payment is deferred until a later date. Thus, even if Betty isn't currently receiving benefits from the retirement fund, if a present right to a future payment exists, the levy reaches that present right. (Rev Rul 55-210, 1955-1 CB 544)

On service of a notice of levy, IRS steps into the shoes of the taxpayer and acquires whatever rights to the property she had possessed before the notice of levy. As a result, the levy only reaches property rights that exist at the time of the levy. Although IRS's levy reaches Betty's future right to retirement benefits when she reaches retirement age, it doesn't entitle IRS to compel suspension of her membership in the fund. The state retirement fund would only have to honor the levy when the benefits become payable to the taxpayer under the terms of the retirement fund.

As an alternative to a levy, the CCA concluded that IRS may bring a lien foreclosure suit under Code Sec. 7403, i.e., an action in federal district court, to reach the funds. Lien foreclosure suits are typically brought where a third-party's rights are involved so that the courts can resolve all parties' rights to the property and force a sale. Because the administrative levy in this situation would not immediately entitle IRS to any assets, the CCA viewed a lien foreclosure suit as appropriate.

Observation: IRS enforces its tax lien—whether on realty or on personal property—by one of two methods: sale of seized property; or suit to enforce the lien. If IRS sues before it seizes a taxpayer's property, it can still avail itself of the seizure power later. Bringing suit doesn't foreclose that right. The ultimate end of either method is to sell the liened property for the tax debt. When IRS sues to enforce a lien, it is actually bringing a suit to foreclose its right in the property.

Aggressive Enforcement Program says the Commissioner

2008-05-13T09:34:00.000-07:00

New IRS Commissioner Shulman airs his philosophy to ABA audience:

The question of whether IRS will focus on services or enforcement poses a false choice, IRS Commissioner Douglas Shulman, who became the 47th Commissioner of Internal Revenue on March 24, 2008, told an American Bar Association audience on May 9.

The agency must do both of these and do them very well, he said. “Stated another way, IRS should do everything possible to make it as seamless and easy as possible for those taxpayers who are trying to pay the right amount of taxes to navigate our organization, get their questions answered, pay their taxes and get their way,” Shulman said. “But for those who understand their federal tax obligation, but fail to comply, we must have an aggressive enforcement program,” he added.

Shulman said he brought two “philosophical inclinations” to his job as Commissioner - the belief that IRS must understand the economic realities of the environment in which taxpayers operate and the belief that IRS must do everything possible to provide clear guidance to taxpayers. He also touched on “a few specific areas of focus,” including the need to continue on the path of modernizing IRS, the challenge of maintaining strong leadership and a dedicated workforce, addressing the increasing globalization of tax administration, and targeting the root causes of noncompliance.

In addition, Shulman stressed the importance of increased transparency. “When all parties are working from the same information, the opportunity for miscommunication and misunderstanding decreases dramatically,” he said. He elaborated on this subject with a cautionary note. “IRS personnel must not confuse greater transparency of information with greater authority over taxpayers,” Shulman said. “More than ever, the IRS will need consistent procedures, training, and an organizational commitment to using data in a way that is fair to taxpayers.”

On a lighter note, Shulman, who assumed his position on March 24, admitted to ignoring the sage advice of several former IRS commissioners—do not take office until after April 15.

For more information about Shulman, click here: http://www.irs.gov/irs/article/0,,id=98192,00.html

Tax Medicaid Rebates Adjustments

2008-05-13T09:22:00.000-07:00

IRS clarifies ruling allowing drug manufacturers to subtract Medicaid rebates from gross receipts

Rev Rul 2008-26, 2008-21 IRB

In a revenue ruling that clarifies an earlier one issued in 2005 on the same subject, IRS concludes that Medicaid Rebates that a pharmaceutical manufacturer pays to State Medicaid Agencies are adjustments to the sales price in calculating gross receipts rather than ordinary and necessary business expenses that are deductible from gross income under Code Sec. 162.

Observation: In lieu of the foregoing conclusion, the earlier ruling (Rev Rul 2005-28, 2005-19 IRB 997) stated that Medicaid Rebates incurred by a pharmaceutical manufacturer are purchase price adjustments that are subtracted from gross receipts in determining gross income. Also, unlike Rev Rul 2005-28, the current ruling specifically states that its holding is limited to Medicaid Rebates that a pharmaceutical manufacturer pays pursuant to the Medicaid Rebate Program established by the Omnibus Budget Reconciliation Act of 1990.

Observation: IRS had reached the opposite conclusion in Field Service Advice 200101004 where it concluded that rebates paid by pharmaceutical manufacturers to state Medicaid agencies under the Medicaid Rebate Program couldn't be excluded from the manufacturer's gross sales as a discount or price adjustment. Had IRS not changed its view in Rev Rul 2005-28 and Rev Rul 2008-26, an issue could have arisen as to whether Code Sec. 162(c)(3) would bar any business expense deduction for the rebates. It provides that no business expense deduction is allowed for any rebate made by a provider of services, supplier, physician or other person who furnishes items or services for which payment is or may be made under the Social Security Act, or in whole or in part out of federal funds under a state plan approved under such act, if the rebate is made in connection with the furnishing of such items or services or the making or receiving of such payments.

Background on Medicaid rebates. The Omnibus Budget Reconciliation Act of 1990 (the Act) established the Medicaid Rebate Program to increase Medicaid beneficiaries' access to prescription drugs. Under the Act, pharmaceutical manufacturers must sign a Rebate Agreement with the Department of Health and Human Service (HHS) to gain access to the Medicaid-funded segment of the pharmaceutical market.

The Rebate Agreements require pharmaceutical manufacturers to pay Medicaid Rebates directly to each State Medicaid Agency. A Medicaid Rebate is a portion of the price paid by State Medicaid Agencies to retailers for covered outpatient drugs dispensed to Medicaid beneficiaries. The amount of the Medicaid Rebate is designed to ensure that the Medicaid Program is charged no more for covered outpatient drugs than any other purchaser.

Facts of ruling. M, which uses an accrual method of accounting and files returns on a calendar year basis, manufactures and sells prescription drugs. In '92, it entered into a “Rebate Agreement” with HHS. In 2005, the following events occur:

M sells Product D, a prescription drug, to W, a wholesaler;
W sells Product D to R, a retail pharmacy;
R dispenses Product D to individual A, a Medicaid beneficiary, and then files a reimbursement claim with S, a State Medicaid Agency;
S approves the claim and then reimburses R for the cost of Product D plus a dispensing fee; and
M pays a Medicaid Rebate to S under the Rebate Agreement.

Background on tax treatment. In a manufacturing business, gross income means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. (Reg. § 1.61-3(a)) Ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business are deductible. (Code Sec. 162)

In Pittsburgh Milk Co, (1956) 26 TC 707, the Tax Court addressed whether allowances, discounts, or rebates paid by a milk producer to certain purchasers of its milk, in willful violation of state law, are adjustments to the purchase price of the milk resulting in a reduced sales price, or ordinary and necessary business expenses under Code Sec. 162 (in which case no deduction would be allowed under Code Sec. 162(c)). The court found that the allowances were part of the sales transaction and concluded that gross income must be computed with respect to the agreed net prices for which the milk was actually sold. Thus, under Pittsburgh Milk, where a payment is made from a seller to a purchaser, and the purpose and intent of the parties is to reach an agreed upon net selling price, the payment is properly viewed as an adjustment to the purchase price that reduces gross sales.

Rev Rul 76-96, 1976-1 CB 23, concluded that an automobile manufacturer that offered rebates to retail customers who independently negotiated a purchase price with the dealer could deduct the rebates as ordinary and necessary business expenses under Code Sec. 162 .

Analysis. Rev Rul 2008-26 notes that the Medicaid Rebate is paid by M to S pursuant to the terms of the rebate agreement. Under the purpose and intent test of Pittsburgh Milk , the Medicaid Rebate is a factor used in setting the actual selling price, negotiated and agreed to before the sale to W takes place.

Observation: In Rev Rul 2005-28 the foregoing sentence read as follows: “Under the purpose and intent test of Pittsburgh Milk , the Medicaid Rebate is made with the purpose and intent of reaching an agreed upon net selling price, and is negotiated and agreed to before the sale to W takes place.”

Accordingly, as noted above, in language that varies somewhat from that in Rev Rul 2005-28, Rev Rul 2008-26 concludes that Medicaid Rebates that a pharmaceutical manufacturer pays to State Medicaid Agencies are adjustments to the sales price in calculating gross receipts rather than ordinary and necessary business expenses that are deductible from gross income under Code Sec. 162.

Effect on other rulings. Rev Rul 2008-26 clarifies and supersedes Rev Rul 2005-28. Rev Rul 2008-26 notes that Rev Rul 2005-28 suspended, in part, Rev Rul 76-96. Rev Rul 2008-26 then states that IRS is reconsidering whether a rebate of the type described in Rev Rul 76-96 is an ordinary and necessary business expense or, alternatively, is an adjustment to the sales price in calculating gross receipts. Therefore, pending IRS's reconsideration of the issue and publication of subsequent guidance, IRS will not apply, and taxpayers may not rely on, the conclusion of Rev Rul 76-96 that rebates made by the manufacturer are ordinary and necessary business expenses deductible under Code Sec. 162.

Observation: Using somewhat different language, Rev Rul 2005-28 also said that Rev Rul 76-96 could not be relied on pending its reconsideration by IRS.

Observation: Thus, while Rev Rul 2008-26 nominally involved a drug manufacturer, its scope is far broader as a result of the reconsideration of the stated conclusion in the earlier ruling.

Observation: Should IRS conclude that rebates are allowed only as an adjustment to the sales price and are not deductible as ordinary and necessary business expenses, this could actually be good for taxpayers because (1) they would not be faced with the bar on deductions under Code Sec. 162(c), and (2) they could qualify for a potentially larger research credit if the credit is reinstated and its amount is again determined with reference to a taxpayer's research expenditures as measured under a formula taking into account its gross receipts.

Benefits of Passthrough Entities

2008-05-07T16:35:00.000-07:00

Which tax-free and tax-favored fringe benefits are passthrough owners entitled to?

Partnerships, LLCs treated as partnerships, and S corporations have distinct tax and nontax advantages. However, entrepreneurs considering these forms of business should be aware that fewer tax-free and tax-favored fringe benefits are available to owner-entrepreneurs of passthroughs than to shareholder-employees of C corporations. This Practice Alert reviews which fringe benefits can be made available on a tax-preferred basis to partners, members of LLCs taxed as partnerships, and more-than-2% S shareholder-employees. It helps practitioners advise clients who are thinking of operating a business as a passthrough, or are operating as a passthrough and are looking for ways to maximize their tax-free compensation.

Note that the statutory rules allowing or denying fringe benefits to passthrough owners are stated explicitly only in the context of partners and partnerships. However, under the default classification rules of Reg. § 301.7701-3(b)(1)(i), a domestic eligible entity with two or more members automatically is treated as a partnership unless it elects to be taxed as an association (i.e., as a corporation). And under Code Sec. 1372 , for fringe-benefit purposes, more-than-2% S corporation shareholder-employees are subject to the rules that apply to partners, and S corporations are treated as partnerships. As a result, unless otherwise noted, the tax consequences of fringes for members of LLCs taxed as partnerships and for more-than-2% S shareholder-employees are the same as they are for partners.

Working condition fringe benefits. Property or services supplied by an employer to an employee are tax-free working condition fringe benefits (WCFBs) if the employee would be entitled to a business expense deduction under Code Sec. 162 or Code Sec. 167 for the item had he paid for it himself. (Reg. § 1.132-5(a)(1)(i)) For WCFB purposes, the term “employee” includes partners who perform services for the partnership. (Reg. § 1.132-1(b)(2)(ii)) Thus, partners may receive the following WCFBs tax-free:

Business-related use of a company auto, if properly substantiated. (Reg. § 1.132-5(a)(1)) The personal-use value of the auto must, however, be treated as compensation income. (Reg. § 1.61-21(a)(1))
The business-use portion of company paid country club dues, even though the dues are completely nondeductible. (Reg. § 1.132-5(s))
Job-related education expenses paid by the firm. (Reg. § 1.132-1(f))
Job placement assistance. (Rev Rul 92-69, 1992-2 CB 51)

De minimis fringe benefits. For purposes of the tax-free de minimis fringe benefit rules, “employees” include any recipient of a fringe benefit. (Reg. § 1.132-1(b)(4)) So partners are entitled to get tax-free supper or supper money or local transportation fare if provided on an occasional basis in connection with overtime work. (Reg. § 1.132-6(d)(2)(i)) Other de minimis fringes include:

traditional birthday or holiday gifts of property (not cash) with a low fair market value (an undefined term in the regs), occasional theater or sporting event tickets, and fruit, books, or similar property provided under special circumstances (e.g., on account of illness, outstanding performance, or family crisis) (Reg. § 1.132-6(e)); and
traditional awards (such as a gold watch) upon retirement after lengthy service. (H Rept No. 99-426 (PL 99-514) p. 105)

Dependent care assistance. Partners are eligible for the Code Sec. 129 dependent care assistance exclusion. (Code Sec. 129(e)(3)) The exclusion is for amounts provided under a written plan of the employer and is limited annually to $5,000 ($2,500 for a married person filing separately). However, for a plan to qualify as a dependent care assistance program, no more than 25% of the amounts paid or incurred by the employer for dependent care assistance during the year may be provided for the class of individuals who are shareholders or owners (or their spouses or dependents), each of whom (on any day of the year) owns more than 5% of the stock or of the capital or profit interest in the employer. (Code Sec. 129(d)(4))

Educational assistance programs. Under Code Sec. 127, employers can set up educational assistance programs under which employees can receive up to $5,250 per year of graduate- or undergraduate-level educational assistance tax-free, whether or not job-related. Employees for this purpose include partners who have earned income from their partnerships, which, in turn, are treated as employers of these partners. (Code Sec. 127(c)(2); Code Sec. 127(c)(3); Code Sec. 401(c)(1)) However, no more than 5% of the cost of annual benefits may be provided for the class of individuals (and their spouses and dependents) each of whom (on any day of the year) own more than 5% of the stock or of the capital or profits interest in the employer. (Code Sec. 127(b)(1))

Athletic facilities. The Code Sec. 132(j)(4) exclusion for on-premises athletic facilities (e.g., swimming pool, gym) is available to partners (and their spouses and/or children). (Reg. § 1.132-1(b)(3))

No-additional-cost services and qualified employee discounts. For purposes of these tax-free fringes, partners who perform services for a partnership are treated as employed by the partnership. (Reg. § 1.132-1(b)(1))

Transportation fringes. A partner cannot exclude qualified transportation fringes under Code Sec. 132(f) (currently, the value of qualified parking up to $200 a month, and up to $115 a month of the combined value of transit passes and transportation in a commuter highway vehicle). (Code Sec. 132(f)(5)(E); (Reg. § 1.132-9(b), Q&A 24(a)) However, under the de minimis benefit rules, tokens or fare cards provided by a partnership to a partner that enable the recipient to commute on a public transit system (not including privately-operated van pools) are excludable from income if the value of the tokens or farecards in any month doesn't exceed $21. If the full value of a pass provided in a month exceeds $21, the full value of the benefit is includible. (Reg. § 1.132-9(b), Q&A 24(b)) In addition, if a partner would be able to deduct the cost of parking as a business expense (e.g., parking cost incurred in connection with traveling from the regular office to another business office), the value of the free or reduced-cost parking is excludable as a working condition fringe benefit.

Trust & Estate Tax Resolution

2008-05-07T16:32:00.000-07:00

Transfers to LLC were not includable in decedent's estate
Estate of Mirowski, TCMemo 2008-74

The Tax Court has held that assets the decedent transferred to a family limited liability company (LLC) shortly before she died were not includable in her gross estate under Section 2036(a).

Facts. The decedent's husband was a cardiologist who developed an implantable cardioverter defibrillator (ICD) device to prevent people who suffered from ventricular fibrillation from dying because they were not in a hospital near an external defibrillator. The husband died in 1990, and, pursuant to his will, his interest under the ICD patents license passed to the decedent. Sales of ICDs increased significantly after the husband's death, and royalties received under the ICD patents license increased dramatically from thousands of dollars a year to millions of dollars a year.

In 1992, the decedent created an irrevocable spendthrift trust for each of her three daughters and their respective issue and funded the trusts with the ICD royalties. After the funding, the decedent held a 51.09% interest in the royalties, and each trust held a 7.2616% interest in the royalties. The decedent named all three daughters as co-trustees of each of the trusts because she wanted them to have a close working relationship.

By 1998, after the royalties had increased dramatically, the decedent decided to begin to consolidate her investments in an account with Goldman Sachs. She finished the consolidation in early 2001. Prior to that, by early 2000, the decedent began to think of ways, in addition to the trusts, to provide for her daughters and grandchildren and to allow them to work together closely. She settled on an LLC to achieve her goals. On 8/31/00, the decedent's attorney sent the decedent and her daughters a draft articles of organization and operating agreement for the LLC. The family decided to wait until their next annual get-together, which was scheduled to take place in August 2001, to discuss this matter.

In the meantime, in January 2001, the decedent developed a diabetic foot ulcer and began medical treatment. Although such an ulcer requires care and treatment, a patient is expected to recover. In August 2001, the daughters and their families took their annual vacation together and held their annual meeting on 8/14/01, at which the decedent was not present. At the meeting, the daughters discussed with the decedent's lawyer:

(1) The decedent's plans to form the LLC
(2) The decedent's plans to make respective gifts of interests in the LLC to the daughters' trusts.
(3) The manner in which the LLC was to function
(4) The daughters' responsibilities with respect to the LLC.

After the meeting, the lawyer finalized the documents required for the decedent to form the LLC. Although the decedent understood that there could be tax benefits from forming the LLC, these benefits were not the most significant factor in her decision to form the LLC. Instead, the decedent had the following legitimate, nontax purposes for forming, and transferring the bulk of her assets to, the LLC:

(1) Joint management of the family's assets by her daughters and eventually her grandchildren.
(2) Maintenance of the bulk of the family assets in a single pool of assets in order to allow investment opportunities that would not be available if the decedent were to make separate gifts of a portion of her assets to each of her daughters or to their trusts.

(3) Providing for each of her daughters and then her grandchildren on an equal basis.

Additionally, the decedent wanted to provide additional protection from potential creditors for the interests in the family assets that she intended to provide her daughters and grandchildren.

At the time of the family meeting, the decedent's health was not rapidly deteriorating, and in fact, she was planning to have a cataract operation to enhance her vision and improve her quality of life. The following timeline shows the events in the weeks leading up to her death.

8/27/01: The decedent executed the LLC's articles of organization and operating agreement.
8/30/01: The LLC's articles of organization were accepted by the state for filing.
8/31/01: The decedent was admitted to the hospital for further treatment of her foot ulcer.
9/1/01: The decedent transferred property to the LLC, including the ICD patents and her 51.09% interest in the royalties; in exchange, she received a 100% interest in the LLC.
9/5-7/01: The decedent transferred to the LLC securities and cash worth more than $62 million that she held in the Goldman Sachs account. After the transfers to the LLC, the decedent retained more than $7.6 million of assets in her own name, which was more than enough to meet her living expenses.
9/7/01: The decedent gave a 16% interest in the LLC to each of her daughters' trusts.
9/10/01: Unexpectedly, the decedent's condition deteriorated significantly. She refused to consider amputation and all additional medical treatment. She developed sepsis and died the next day.

Pursuant to the decedent's will, the daughters' trusts inherited, in equal shares, the decedent's 52% interest in the LLC. As a result, after probate, the trusts would own collectively 100% of the LLC in three equal shares. The LLC continued as a valid functioning investment operation and managed business matters related to the ICD patents and license agreement. As the decedent hoped, the daughters, in their capacities as officers of the LLC and trustees of the trusts have actively worked together to manage the LLC's assets.

In 2002, the decedent's estate paid estimated gift tax of $11,750,623 with funds that the LLC distributed to it. Thereafter, the decedent's personal representatives reported the gifts of the 16% interests in the LLC at a value of $5.7 million each. They reported gift tax for 2001 of $9,729,280, which resulted in a $2,021,343 credit to the estate. The estate return showed estate tax of $14,119,863, which the estate paid with funds distributed from the LLC.

The IRS determined that there was an estate tax deficiency of $14,243,208. The Service said that the total of the date-of-death fair market value of all the assets the decedent transferred to the LLC of $71,153,000 was includable in her gross estate under Section 2036(a), an increase of $43,385,000 from the value of the decedent's LLC interests reported.

Transfers to the LLC. The estate argued that although the decedent's transfers to the LLC were transfers of property under Section 2036(a), they fell under the exception for a “bona fide sale for an adequate and full consideration in money or money's worth.” The estate pointed out that (1) the decedent had legitimate and substantial nontax reasons for forming and transferring assets to the LLC; (2) she received an interest in the LLC proportionate to the value of the assets transferred to it; (3) her capital account was properly credited with those assets; and (4) in the event of LLC's liquidation and dissolution, she had the right to a distribution of property from her capital account.

The IRS argued that the exception did not apply to the decedent's transfers because she had no legitimate, significant nontax reason for forming and transferring assets to the LLC. The Service urged the Tax Court to disregard the testimony of the decedent's children regarding the nontax reasons the decedent decided to form and fund the LLC because of their relationship to the decedent and the estate. The court refused to do so and found that the decedent had the following legitimate nontax reasons for forming and funding the LLC:

(1) Joint management of the family assets by the daughters and eventually the grandchildren.
(2) Maintenance of the bulk of the family's assets in a single pool to provide better investment opportunities.
(3) Providing for each daughter and grandchild on an equal basis.

The court also rejected the Service's other contentions that the exception did not apply:

(1) The decedent did not fail to retain sufficient assets outside of the LLC for her anticipated financial obligations. According to the court, the decedent's only anticipated significant obligation was the substantial gift tax liability resulting from her gifts of the 16% LLC interests to the daughters' trust. The court said that there was no express or unwritten agreement to use LLC assets to pay that liability, which the decedent could have paid by using a portion of the substantial assets she retained and did not transfer to the LLC, by using the distributions she expected to receive as a 52% interest holder in the LLC from the royalty payments, or by borrowing against her personal asserts and her 52% LLC interest.

(2) The LLC was a valid functioning investment operation and was managing the business matters related to the ICD patents and patent license.

(3) The decedent did not delay forming and funding the LLC until shortly before her death and her health began to fail. The court pointed out that the decedent's death was unexpected, so she and the daughters did not anticipate the estate taxes and obligations arising as a result of her death. Although the decedent had been treated for her foot ulcer for eight months and was admitted to the hospital a week before she died, until the day before she died, expectations were that she would recover

(4) The court said that the Service's contention that the decedent sat on both sides of her transfers to the LLC ignored the fact that the decedent fully funded the LLC and that the daughters' trusts did not contribute any assets. According to the IRS, the Service's argument would mean that single member LLCs would not be able to take advantage of the bona fide sale exception under Section 2036(a).

(5) Although the LLC distributed more than $36 million to the decedent's estate to pay estate obligations, including transfer taxes, the court again pointed out that the decedent died unexpectedly, and the parties did not discuss the estate obligations that would arise as a result of the decedent's death.

(6) The Service argued that, in substance, the decedent received only a 52% interest in the LLC in exchange for transfers to the LLC of 100% of its assets because she did not contemplate forming and funding the LLC without making the gifts to the daughter's trusts. As a result, according to the IRS, the decedent did not receive an interest in the LLC in proportion to her investment, and thus the bona fide sale exception to Section 2036 did not apply. The court rejected this argument, pointing out that although related, the transfers and the gifts were separate.

Gifts to the trusts. The estate acknowledged that the gifts of the 16% interests in the LLC to the trusts were transfers of property and were not bona fide sales for adequate and full consideration. It argued, however, that there was no express or implied agreement that the decedent would retain the possession or enjoyment of, or the right to income from, the property transferred. The IRS claimed that at the time she made the gifts and at the time of her death, there was an agreement, both express and implied, that the decedent retain the possession or enjoyment, or the right to the income from, the respective 16% interests in the LLC that she gave to the trusts.

The IRS argued that, as the LLC's general manager, the decedent under the LLC's operating agreement expressly retained the authority to decide the timing and amounts of distributions from the LLC. It also claimed that the operating agreement expressly gave the decedent, as the majority LLC holder (or as general manager), the authority to determine the timing and the amount of distributions when the LLC is liquidated and dissolved. The court rejected these contentions, pointing out that the operating agreement provided specific distribution methods, which had to be followed. Thus, there was no express agreement in the operating agreement (or elsewhere) that the decedent retain possession or enjoyment, or the right to income from the 16% gifts (Section 2036(a)(1)), or the right to designate persons who would possess or enjoy the 16% interests or the income from the interests (Section 2036(a)(2))

In support of its claim that there was an implied agreement that the decedent retained an interest or right described in Section 2036(a)(1) with respect to the 16% gifts, the court pointed out that the Service relied on essentially the same contentions that it used to argue that the LLC transfers were not bona fide sales. It did not fare any better here, as the court rejected the contentions for the reasons stated above.

Innocent Spouse Tax Relief

2008-05-07T16:30:00.000-07:00

Innocent spouse relief granted despite ex-husband's objection
Bishop, TC Summary Opinion 2008-33

The Tax Court agreed with the IRS and, over the objection of the taxpayer's ex-husband, held that the taxpayer was entitled to equitable relief under Section 6015(f) from her husband's tax underpayments.

Facts. The taxpayer married in 1982, and the couple had two children. The husband was previously a revenue agent who conducted income tax audits for the IRS. However, in 1995, he pled guilty to the charge of bribing a public official and was sentenced to 28 months in prison. He was released from prison in 1997 and rejoined his family. Thereafter, he began working as an auditor for a state agency. The taxpayer was employed as a claims processor for a health insurance company. The couple separated in 2003 and were divorced in 2004.

Before and after 2000, the taxpayer and her husband began to live beyond their means, incurring substantial expenses and debts. The husband was domineering; he controlled the couple's financial matters and prepared their federal income tax returns. During the years at issue (2000-2002), he decreased his tax withholding by increasing his exemptions and advised the taxpayer to do the same. These actions resulted in underpayments of tax for the years 2000-2002 and the failure to pay unpaid tax liabilities after they were assessed.

The taxpayer did not sign the joint federal income tax returns for 2000 and 2001, and her husband did not disclose or discuss the return's contents. However, she gave her Forms W-2 to the husband for those years, and they were attached to the returns. Not until late 2002 or early 2003 did the taxpayer become aware that the husband had made no payments on the unpaid taxes for 2000 and 2001 ($2,532 and $4,685, respectively).

The taxpayer did sign the couple's joint federal tax return for 2002. The total underpayment for that year was $6,105. The taxpayer subsequently corrected her withholding and entered into an installment agreement with the IRS to pay the balance of her tax due for 2003. At the time of the trial, she was current in paying her federal income tax.

Some time after the couple divorced, the taxpayer filed a request with the IRS for relief from joint and several liability under Section 6015(f) with respect to her unpaid federal income tax liability. Although the IRS initially determined that the taxpayer was not entitled to relief, on review, it changed its mind and concluded that she was entitled to relief. The ex-husband, however, objected, asserting that the taxpayer should pay her share of the taxes, which meant that the Tax Court had to determine whether the taxpayer was entitled to relief under Section 6015(f) for the relevant years.

Court's opinion. The court pointed out that because the taxpayer was seeking relief from underpayments of tax, rather than understatements of tax, relief was not available to her under Sections 6015(b) and (c), and her only avenue for relief was Section 6015(f)'s equitable relief. Under section 4.02(1) of Rev. Proc. 2003-61, 2003-2 CB 296, however, Section 6015(f) equitable relief will ordinarily be granted if each of the following elements is satisfied:

(1) On the date of the request for relief, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household at any time during the 12-month period ending on the date of the relief request.

(2) On the date the requesting spouse signed the joint return, he or she had no knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability.

(3) The requesting spouse will suffer economic hardship if the Service does not grant relief.

The court said that the taxpayer was divorced from the husband and would suffer economic hardship if relief was not granted. Also, she may not have been aware of the tax liabilities on the 2000 and 2001 returns because she did not sign them or discuss them and did not actually know that there were unpaid taxes until late 2002. The court, however, believed that the taxpayer should have had reason to know that the tax liabilities might exist because of the couple's mounting debts and severe financial situation. The court pointed out that she knew there were unpaid taxes for 2002 because she signed the return for that year and confronted her husband about the unpaid taxes for all three years. Additionally, the taxpayer knew about the tax liabilities when she joined the husband as a party in a chapter 13 bankruptcy proceeding in February 2003. Therefore, the court concluded that the taxpayer did not satisfy the knowledge element of Rev. Proc. 2003-61, section 4.02, and did not qualify for equitable relief under that section.

Luckily for the taxpayer, this did not end the inquiry. If a spouse fails to qualify for relief under section 4.02 of Rev. Proc. 2003-61, the IRS may still grant relief under section 4.03 of that Procedure. Section 4.03 lists factors that the Service will take into account in determining whether to grant equitable relief under Section 6015(f). No single factor is determinative, all factors are to be considered and weighed appropriately, and the list of factors is not exclusive.

(1) Marital status. The taxpayer and her husband separated in 2003 and divorced in 2004. (Factor weighed in favor of granting relief.)

(2) Economic hardship. The taxpayer's monthly income barely covered her monthly expenses. She was raising two children and had not received child support from her husband since 2004. In addition, when the husband was in prison, the taxpayer incurred considerable debt in order to support the family, which she was paying off. Therefore, the taxpayer would suffer economic hardship if relief was not granted. (Factor weighed in favor of granting relief.)

(3) Knowledge or reason to know. As mentioned above, the taxpayer had reason to know that her husband was not going to pay the tax liabilities. (Factor weighed against granting relief.)

(4) Nonrequesting spouse's legal obligation. The divorce decree did not contain a provision as to which spouse had a legal obligation to pay the outstanding tax liabilities. (Factor was neutral.)

(5) Significant benefit. The taxpayer did not receive significant benefit beyond normal support from the unpaid tax liabilities. (Factor was neutral.)

(6) Compliance with income tax laws. Tax compliance is a factor considered only against granting relief. The IRS did not contend that the taxpayer did not make a good faith effort to comply with her federal income tax obligations in years subsequent to 2002. (Factor did not apply.)

(7) Abuse. While the taxpayer was not physically abused by the husband, she suffered mental and emotional abuse at his hands. He yelled and threatened her, he accessed her bank account to pay pornography sites, and he had an affair, which led to the divorce. The taxpayer also feared he would retaliate against their children. (Factor weighed in favor of granting relief.)

The court found three factors in favor of relief, one against, and the rest neutral. Accordingly, it concluded that it would be inequitable to hold the taxpayer liable for the underpayments of tax, and she was entitled to relief under Section 6015(f).

Foreign earned income exclusion

2008-05-05T12:27:00.000-07:00

IRS fact sheet explains foreign earned income exclusion
IRS Fact Sheet May 2008

Mike Habib, EA

IRS has issued a fact sheet that explains the foreign earned income exclusion rules.

Observation: Although the fact sheet is a valuable summary of the complex foreign earned income rules that apply starting with the 2006 tax year, it does not contain references to Code sections or IRS guidance. We have added them for the reader's convenience.

Background. As noted in the fact sheet, U.S. citizens and resident aliens are taxed on their worldwide income, whether the person lives inside or outside of the U.S. However, qualifying U.S. citizens and resident aliens who live and work abroad may be able to exclude from their income all or part of their foreign salary or wages, or amounts received as compensation for their personal services. In addition, they may also qualify to exclude or deduct certain foreign housing costs. (Code Sec. 911)

General rule. To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must:

have foreign earned income (income received for working in a foreign country);
have a tax home in a foreign country; and
meet either the bona fide residence test or the physical presence test. (Code Sec. 911)

Exclusion amounts and limits. The foreign earned income exclusion amount is adjusted annually for inflation. For 2008, the maximum foreign earned income exclusion is up to $87,600 per qualifying person. If taxpayers are married and both spouses (1) work abroad and (2) meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $175,200 for the 2008 tax year. (Code Sec. 911(b)(2)(D), Rev Proc 2007-66, 2007-45 IRB 970, Sec. 3.30)

In addition to the foreign earned income exclusion, qualifying individuals may also choose to exclude or deduct from their foreign earned income a foreign housing amount. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction is limited, generally, to 30% of the maximum foreign earned income exclusion. For 2008, the housing amount limitation is $26,280 for the tax year. However, the limit will vary depending on where the qualifying individual's foreign tax home is located and the number of qualifying days in the tax year. (Code Sec. 911(c)(2)) The foreign earned income exclusion is limited to the actual foreign earned income minus the foreign housing exclusion. Therefore, to exclude a foreign housing amount, the qualifying individual must first figure the foreign housing exclusion before determining the amount for the foreign earned income exclusion. (Code Sec. 911(d)(7))

How to claim the exclusion. Since the foreign earned income exclusion is voluntary, qualifying individuals must choose to claim it. The foreign earned income exclusion and the foreign housing cost amount exclusion are claimed and figured using Form 2555, which must be attached to Form 1040. However, if only the foreign earned income exclusion is claimed, a shorter Form 2555-EZ may be used instead. Once the choice is made to exclude foreign earned income, that choice remains in effect for the year the election is made and all later years, unless revoked. (Code Sec. 911(e))

What isn't foreign earned income. Foreign earned income does not include the following amounts:

Pay received as a military or civilian employee of the U.S. Government or any of its agencies.
Pay for services conducted in international waters (not a foreign country).
Pay in specific combat zones, as designated by a Presidential Executive Order, that is excludable from income.
Payments received after the end of the tax year following the year in which the services that earned the income were performed.
The value of meals and lodging that are excluded from income because it was furnished for the convenience of the employer.
Pension or annuity payments, including social security benefits. (Code Sec. 911(b)(1)(B))

Self-employment income. A qualifying individual may claim the foreign earned income exclusion on foreign earned self-employment income. The excluded amount will reduce his regular income tax, but will not reduce his self-employment tax. Also, the foreign housing deduction - instead of a foreign housing exclusion - may be claimed.

Figuring the tax. A qualifying individual claiming the foreign earned income exclusion, the housing exclusion, or both, must figure the tax on the remaining non-excluded income using the tax rates that would have applied had the individual not claimed the exclusions. (Code Sec. 911(f))

Foreign tax credit or deduction. Once the foreign earned income exclusion is chosen, a foreign tax credit, or deduction for taxes, cannot be claimed on the income that can be excluded. (Code Sec. 911(d)(6)) If a foreign tax credit or tax deduction is claimed for any of the foreign taxes on the excluded income, the foreign earned income exclusion may be considered revoked.

Earned income credit. Once the foreign earned income exclusion is claimed, the earned income credit cannot be claimed for that year. (Code Sec. 32(c)(1)(C))

Timing of election. Generally, a qualifying individual's initial choice of the foreign earned income exclusion must be made with one of the following income tax returns:

a return filed by the due date (including any extensions);
a return amending a timely-filed return;
amended returns generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid; or
a return filed within 1 year from the original due date of the return (determined without regard to any extensions). (Reg. § 1.911-7(a)(2)(i)(D))

Revoking the exclusion. A qualifying individual can revoke an election to claim the foreign earned income exclusion for any year. This is done by attaching a statement to the tax return revoking one or more previously made choices. The statement must specify which choice(s) are being revoked, as the election to exclude foreign earned income and the election to exclude foreign housing amounts must be revoked separately. If an election is revoked, and within 5 years the qualifying individual wishes to again choose the same exclusion, he must apply for approval by requesting a ruling from IRS. (Code Sec. 911(e)(2))

If you are having tax problems either collection notices or audit and examination, contact our office today for a free consultation on how to resolve your tax matter.

Payroll Tax Audit? Now What Are Your Options?

2008-05-04T18:53:00.000-07:00

IRS or State Payroll Tax Audit & Employment Tax Audit

The word audit can strike a very real sense of fear into the hearts of even the most courageous of men. When you own a business, there is even more at stake than a few minor penalties or fees; you can lose everything you’ve worked so hard to create. If you are facing a payroll tax audit you need to make every effort to cooperate with your auditor. The best way to prepare for a payroll tax audit, and therefore survive the audit, is to keep excellent records for several years past on hand and have them stored completely and according to year in case you are faced with an audit many years after the fact.

The first thing you need to do in order to keep everything straight when it comes to surviving a payroll tax audit is to keep your accounting practices current. Many businesses do this by either outsourcing their payroll responsibilities to firms that deal exclusively with payroll matters, including payroll taxes, or hiring an in-house bookkeeper to handle their payroll. The benefits of either of these is great because laws regarding payroll taxes and withholdings change regularly and are so complex in general.

You should also insure that you have the proper resources in place when it comes to avoiding a payroll tax audit or at the very least coming away from one without owing any back taxes, fines, or penalties is one of the biggest responsibilities a business owner faces. If you aren’t willing to pay for outsourcing this responsibility to someone that is qualified as an outsider you very well may want to consider hiring a fulltime staff member who has the expertise and qualifications to devote to insuring accurate payroll deductions are made. As a licensed tax professional specializing tax problems resolution, I can represent you in your payroll tax audit to advocate your position and make sure your options and your rights are taken care of.

You should also take the time each year to review your records and check for mistakes. While it won’t help you avoid a payroll tax audit this little effort made each year can save you a great deal of time and many headaches should one arise. In addition you will find out during the course of the ‘internal audit’ whether or not any information is missing, incomplete, or inaccurate and handle it immediately rather than finding out two or three years after the fact.

If you find, during the course of your internal audit or review, that you are going to have problems with your payroll tax audit it would be wise to secure the services of our firm in order to help you deal with the outcome of your payroll audit and assist you when negotiating payment options and reducing penalties. The IRS is a formidable foe and you do not want to face them unprepared or alone if it can be avoided. It could cost considerably more than it has to. There are options available, even if you owe a considerable amount of money.

As a licensed tax professional specializing tax problems resolution, I may be able to negotiate some amazing things on your behalf when it comes to your payroll tax audit and a potentially negative or outright negative outcome. Honest mistakes are made every day when it comes to handling payroll taxes don’t allow your mistakes, when discovered through a payroll tax audit be the end of your business — especially when a well qualified and experienced tax professional like Mike Habib, EA can make all the difference in the world.

Sales Tax Audit? Now What Are Your Options?

2008-05-04T17:37:00.000-07:00

State Sales Tax & Use Tax Audits and Examination - why you need a tax professional on your side

Mike Habib, EA
myIRSTaxRelief.com

Among the most frightening words a business owner can hear are the words: sales tax audit. There are many reasons why this is a phrase that should be feared, not the least of which is that the negative outcome of a sales tax audit may cost you your business, your accounts receivable, your current business & personal assets, and can leave you starting over with nothing. There are options available to you though, keep reading to learn how you can survive this trying time.

Begin with the best possible defense - an exemplary system of record keeping when it comes to sales tax paid, received, and possible exemptions. Document everything and review your documents with an internal sales tax audit yearly. This gives you a great opportunity to catch mistakes that may have been made and correct them before an actual audit takes place. You will also want to review your documentation immediately prior to your audit.

When faced with a sales tax audit, or a use tax audit, you need to go to the tax resolution experts. Chances are that you either have a bookkeeper on staff or you use an outside bookkeeping firm in order to file sales and tax state reports. You may consider the valuable services of our firm for assistance with the your sales tax audit as well as dealing with the potential outcome and any consequences that may apply.

Many businesses find that the sting of owed sales tax is not nearly as lethal as the time and attention that must be dedicated to the process of a sales tax audit. This takes hours of work finding the documentation, defending the receipts for tax-exempt items, and time is money in the business world. Unfortunately, this is a necessary evil. The penalty for not complying with the taxing authorities in this matter are simply too devastating to consider.

When experiencing a sales tax audit you need to provide the auditor with a nice quiet place in which to work, all the documentation he or she needs and/or requests, and a basic overview of how your business operates. Be prepared to provide follow up documentation if necessary and to defend certain transactions along the way. The purpose of the sales tax audit in all honesty is to generate more money for the state so cooperate but don’t roll over.

Our firm is well-qualified and can assist you from the very beginning of your sales tax audit by speaking the language of your sales tax auditor. Many auditors are much more approachable when dealing with a licensed tax representative rather than dealing with individual taxpayers and business owners. Let our firm work for you and the tax savings are likely to pay for the service and so much more.

Having a tax expert on your team such as Mike Habib, EA often helps when enduring a sales tax audit. He knows the tax code and will be able to identify potential pitfalls prior to the audit in addition to being able to help you defend certain transactions that may fall within gray areas of the tax code or negotiate with your auditor if necessary. The most important thing you can do to prepare for a sales tax audit however is to avoid panic and let the tax experts do their job while you try going about your own as seamlessly as possible while waiting on the verdict.

For sales tax and use tax audit representation CLICK HERE.

Employee vs. Independent Contractor Tax Problems

2008-05-02T13:09:00.000-07:00

New bill seeks to reduce worker misclassifications

H.R. 5804, 4/15/08 [Taxpayer Responsibility, Accountability, and Consistency Act of 2008]

Rep. James McDermott (D-Wash) has introduced legislation that would revise employee vs. independent contractor rules and increase information reporting penalties The legislation is called the “Taxpayer Responsibility, Accountability, and Consistency Act of 2008,” and it primarily focuses on Section 530 of the Revenue Act of 1978. Under Section 530, employers that meet the following three requirements are protected from potentially large employment tax assessments, even though they incorrectly categorized a worker as an independent contractor: (1) reasonable basis, (2) substantive consistency, and (3) reporting consistency. An employer can meet the “reasonable basis” requirement if judicial precedent, IRS rulings, a past IRS audit, or industry practice supports the classification of a worker as an independent contractor. An employer meets the substantive consistency requirement if it (and any predecessor business) consistently treated the workers in question as independent contractors. The reporting consistency requirement is met if the employer has not classified the workers as employees on any required federal tax returns, including information returns.

New Rules. The new legislation would repeal Section 530 and replace it with a new Code section, IRC §3511, that would make it more difficult for employers to avoid employment tax liability if they misclassified a worker as an independent contractor. IRC §3511 would generally require employers to have a “reasonable basis” for classifying a worker as an independent contractor. The “reasonable basis” standard is met only if:

(1) The employer classified the worker as an independent contractor based on: (i) a written determination (as defined in IRC §6110(b)(1)) that it received addressing the employment status of either the worker in question, or another individual holding a substantially similar position with the employer; or (ii) an employment tax examination of the worker, or another individual holding a substantially similar position with the employer, that did not conclude that the worker should be treated as an employee; and

(2) The employer (or a predecessor) has not treated any other individual holding a substantially similar position as an employee for employment tax purposes for any period beginning after Dec. 31, 1977.

The new legislation would not allow an employer to rely on an examination commenced, or a written determination issued, more than seven years before the beginning of the period in question. For purposes of IRC §3511, the determination as to whether an individual holds a position substantially similar to a position held by another individual would be made in accordance with the Fair Labor Standards Act.

The IRS would issue its determination of worker status no later than 90 days after the filing of a petition with respect to employment status in any industry where employment is transient, casual, or seasonal (e.g., construction). The new statute would apply to services rendered more than one year after the date that the legislation is enacted. Section 530 would not apply to services rendered more than one year after the date that the legislation is enacted.

Increase in Information Reporting Penalties. Under current law, a taxpayer that doesn't file a correct information return may be subject to the following penalties:

a $15 per return penalty if corrected within 30 days after the due date, up to a maximum total penalty of $75,000 a year ($25,000 for small businesses);
a $30 per return penalty if corrected later than 30 days after the due date but before August 1, up to a maximum penalty of $150,000 a year ($50,000 for small businesses);
a $50 per return penalty if not corrected by August 1 (or if a return is not filed at all), up to a maximum penalty of $250,000 a year ($100,000 for small businesses).

A “small business” is defined as a concern whose average annual gross receipts for the three most recent tax years ending before the calendar year in which the returns are due (or for the entire period of its existence, if less than three years) are $5 million or less.

Increase in penalties. Under the new law, a taxpayer that doesn't file a correct information return would be subject to the following penalties:

a $50 per return penalty if corrected within 30 days after the due date, up to a maximum total penalty of $500,000 a year ($175,000 for small businesses);
a $100 per return penalty if corrected later than 30 days after the due date but before August 1, up to a maximum penalty of $1,500,000 a year ($500,000 for small businesses);
a $250 per return penalty if not corrected by August 1 (or if a return is not filed at all), up to a maximum penalty of $3,000,000 a year ($1,000,000 for small businesses).

The new law would also increase the penalties for failure to furnish a correct payee statement, intentional disregard of the rules, and failure to comply with other information reporting requirements (see IRC §6723).

To resolve your payroll tax problem contact us today.

1600% Increase in IRS Tax Levies since 2000

2008-05-02T13:03:00.000-07:00

TIGTA report "Trends in Compliance Year Activities Through Fiscal Year 2007" [Audit Report No. 2008-30-095]:

Fiscal year 2007 marked another period of improvement in IRS's compliance activities, continuing an eight-year period of upward trends in such endeavors, the Treasury Inspector General for Tax Administration (TIGTA) said in a new audit.

Many enforcement activities continued to increase despite a slight reduction in the staffing of the Collection and Examination functions, the audit said, adding that both functions plan to hire enforcement personnel during FY 2008. The Collection and Examination Enforcement budget was flat for FY 2006 through FY 2008, but President Bush's budget proposal for FY 2009 calls for an 8% increase, the audit noted. The amount of enforcement revenue collected increased by almost 74% in the last five years.

The number of Collection Field function (CFf) revenue officer personnel working assigned delinquent cases decreased by 4% to 3,724 by the end of FY 2007. “Although revenue officer staffing is down, many compliance activities continued to increase and results improved during FY 2007,” TIGTA said. Some of the improvements may be attributable to an FY 2005 organizational change in the Small Business/Self-Employed Division and efforts to improve business processes, the audit said. Activities showing positive results for the Collection function during FY 2007 included the following—dollars collected on Taxpayer Delinquent Accounts (TDAs) by Automated Collection System and CFf employees increased by 3% over FY 2006; the average amount collected per CFf staff year on TDAs increased by 2% over the preceding year; and the number of TDAs closed and the number closed by full payment increased by 7% and 6% respectively.

In FY 2007, the number of liens issued was 683,659, while levies totaled 3,757,190 and seizures totaled 676. All of these were upward movements. In comparison, in FY 2000, there were 287,517 liens issued, the number of levies was 219,778 and seizures amounted to 74.

The audit is available at http://treas.gov/tigta/auditreports/2008reports/200830095fr.pdf.

Tax Problems: Type of Tax Problems and how to resolve them

2008-04-30T23:25:00.000-07:00

Tax Problem Solver – Why You Need Professional Help

Tax problems come in different forms; IRS tax problems, State tax problems, and Sales tax problems. Tax authorities are constantly increasing their tax enforcement efforts through tax collection and tax audit.

When taxpayers receive the dreaded tax notice that their tax return or their business is going to be audited and examined, the first thing they should do is seek professional tax advice. Same thing when taxpayers receive collection letters threatening levying and garnishing their wages or paychecks, or the tax levy letter for their bank account, taxpayers should seek professional tax advice to resolve their tax problems.

The most common options to resolve your tax problems are:

Full Payment: paying the amount on the tax notice and avoiding the confrontation with the taxing authority. Most of the time, this option is not the best option for the taxpayer to resolve their tax problem, as often the tax bill is inaccurate.
Pay The Correct Tax Only: paying the actual amount of taxes if you can afford it is usually a good solution to your tax problem. This will entail working with the taxing authority to abate the penalty assessed. The success of penalty abatement is based on reasonable cause and not willful neglect.
Installment Agreement: paying the tax amount through an installment agreement is a common way to resolve your tax problem. You should seek professional tax advice, as the taxing authority will usually request a large monthly payment, while professional tax representatives will work on attaining an installment agreement that is reasonable and you can live with without causing a financial and economic hardship on you and your family.
Offer In Compromise: an offer in compromise, OIC, will usually be accepted by the taxing authority to resolve your tax problem if the amount offered to settle your tax problem is equal or exceed the taxpayer’s Reasonable Collection Potential, RCP. The IRS, or the State, or the Sales Tax Agency determines RCP by using the financial analysis tools like the 433-A for individuals and 433-B for business entities.

No matter which option is correct to resolve your tax problems, usually there are more than one viable option, it is essential that the taxpayer comply with the tax law going forward. That is, all tax returns are filed timely; all estimated income taxes and payroll deposits must be paid timely.

An experienced tax professional who specializes in tax representation would be the best person to have in your corner when the IRS, the State, or the Sales Tax Agency contacts you.

The most surprising fact of all after plumbing the depths of what to do when the IRS contacts you regarding a tax problem is how shallow the well really is. With the lull in activity on the IRS tax audit and collection front, there are relatively few pronounced tax-experts. The $345 billion dollar tax gap remains fascinating to the US Congress and the IRS. It is a high profile item!

The IRS released tax records on their most famous tax problem cases that imprisoned Al Capone, they inadvertently nabbed the Governor of New York allegedly spending tens of thousands of dollars for what they least expected. From Will Smith, to Wesley Snipes to Nicolas Cage IRS audits and collection are on the rise, and is expected to continue for many years to come!

So, do you have a tax problem yourself? Do yourself a favor and contact us today to assist you in resolving your tax problem. We resolve IRS tax collection and or audit problems, we resolve State tax audit and collection problems, and we resolve Sales tax problems.

Audits of S Corporations are on the rise

2008-04-30T15:35:00.000-07:00

TIGTA study finds modest audit rate increase for C corps but marked increase for passthroughs ( S Corps)

Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008–30–095

A recently released TIGTA (Treasury Inspector General for Tax Administration) report reveals that despite a slight uptick in FY 2007, IRS audits of corporations have declined dramatically over the last ten years. However, audits of S corporation and partnership returns increased substantially over the same period.

TIGTA's findings for business entities. The new TIGTA report examined IRS statistical data and found the following audit trends for business:

The number of corporate income tax returns examined (excluding returns for foreign corporations and S corporations) increased by just over 4% in FY 2007, after dropping by 1% in FY 2006. However, the number of examinations dropped by almost 45% since FY 1998, from 53,648 (1 of every 48 returns filed) to 29,664 (1 of every 75 returns filed). TIGTA notes that the 13% drop in the number of corporate income tax returns filed during the same 10-year period may have impacted the exam coverage rate. For FY 2007, the number of corporate tax returns examined with assets of less than $10 million grew by slightly over 12%, the number of corporate tax returns examined with assets of $10 million and greater decreased by almost 9%, and exams of those with assets of $250 million and greater decreased by almost 20%. Overall, however, the exam rate is much higher for large corporations than for those with assets of less than $10 million.
The number of S corporation exams declined by 75% from FYs 1998 to 2004, but increased by almost 176% from FYs 2004 to 2007; the increase in FY 2007 alone was slightly over 26%. Since FY 2004, however, the number of S corporation returns filed has increased by 16%. TIGTA notes that the increase in exam coverage can be partly attributed to an IRS research project studying the compliance of S corporations.
The number of partnership returns examined increased by 25% in FY 2007 and has increased by almost 141% since the 10-year low experienced in FY 2001. The number of returns filed increased by about 42% between FYs 2001 and 2007. About 1 of every 408 returns filed was examined in FY 2001. This increased to 1 of every 241 for FY 2008.

For more details on TIGTA's Report on audit rates and related IRS activities, click on this link: Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008–30–095.

For S Corp and C Corp audit representation CLICK HERE

IRS tax levy wage garnishment bank levy

2008-04-30T14:55:00.000-07:00

TIGTA issues statutory review of IRS compliance with legal guidelines when issuing levies [ Audit Report No. 2008-30-097 ]:

During the process of issuing levies, IRS has been complying with legal guidelines regarding proper notification and the protection of taxpayer rights, the Treasury Inspector General for Tax Administration (TIGTA) reported in a recent audit.

The agency is required to notify taxpayers a minimum of 30 calendar days before initiating any levy action to give taxpayers the chance to appeal the proposed levy. Since prior audits found that IRS had implemented tighter controls related to systemically generated levies, the latest annual audit on the subject focused on the issuance of manual levies.

Auditors looked at 30 Integrated Collection System and 30 Automated Collection System manual levies issued between July 1, 2006, and June 30, 2007. Analysis of these levies “showed revenue officers and customer service representatives continued to properly inform taxpayers of their rights at least 30 calendar days prior to issuing the levies,” TIGTA said.

The audit can be found at http://treas.gov/tigta/auditreports/2008reports/200830097fr.pdf

Offshore payroll tax problems

2008-04-30T10:49:00.000-07:00

Houses passes legislation that would make sure certain government contractors pay employment taxes - Foreign shell companies payroll tax problems

Mike Habib, EA
myIRSTaxRelief.com

The House of Representatives has passed legislation [H.R. 5719, Sec. 18, 4/15/08] proposed by Representatives Brad Ellsworth (D-Ind.) and Rahm Emanuel (D-Ill.) that seeks to end the practice of U.S. government contractors setting up shell companies in foreign jurisdictions to avoid paying payroll taxes. Under current law, US companies are required to pay Social Security and Medicare taxes for their American workers overseas. But some firms have been able to get around that requirement by hiring workers through offshore shell companies or foreign subsidiaries.

The legislation would amend the Internal Revenue Code and the Social Security Act to treat foreign subsidiaries of U.S. companies performing services under contract with the U.S. government as American employers for Social Security and Medicare tax purposes. The legislation would require any foreign company that is at least 50% owned by a U.S. federal contractor to pay payroll taxes for its American employees.

The bill was inspired by recent news that defense contractor KBR Inc. had avoided paying Social Security and Medicare taxes by creating shell companies in the Cayman Islands. A similar provision is being sponsored in the Senate by Senators John Kerry (D-Mass.) and Barack Obama (D-Ill.).

Tax shelter tax problem resolution

2008-04-29T09:01:00.000-07:00

District court allows $60 million of income to be offset by Son-of-Boss shelter

Sala v. U.S. (DC Co 4/22/08) 101 AFTR 2d ¶ 2008–720

Mike Habib, EA
myIRSTaxRelief.com

A district court has allowed an individual to offset $60 million of compensation income with losses from a Son-of-Boss transaction.

Facts. Carlos E. Sala had income in 2000 of more than $60 million. However, he claimed a tax loss that essentially nullified his tax burden. Sala achieved the loss through his involvement in a foreign currency options investment transaction known as Deerhurst. He claimed that the $60 million loss resulted from a series of steps that made use of an S corporation (Solid Currencies, Inc.) and an investment in a partnership (Deerhurst Investors, GP). These steps were orchestrated under a then-existing tax rule that disregarded short options as liabilities for purposes of establishing partnership basis. Under this rule, liabilities created by short options were considered too contingent to affect a partner's basis in the partnership.

IRS challenged this transaction, which is commonly known as a Son-of-Boss shelter, on various grounds. The district court faced these key issues:

(1) whether the transactions creating Sala's 2000 tax loss were sham transactions;
(2) whether Sala had a profit motive for entering into the transactions creating his 2000 tax loss;
(3) whether the transactions creating Sala's 2000 tax loss, as executed, allowed the tax loss; and
(4) whether any allowable tax loss was rendered retroactively disallowed by Reg. § 1.752-6.

Background. On June 24, 2003, IRS issued temporary and proposed regs which expanded the definition of liability under Code Sec. 752 to include “any fixed or contingent obligation to make payment without regard to whether the obligation is otherwise taken into account for purposes of the Internal Revenue Code.” This particular change, which was a part of broader regulatory changes in this area, was adopted as final Reg. § 1.752-1(a)(4)(ii) in May 2005. However, IRS made the reg retroactively effective for all assumptions of “liabilities” (as newly defined) by partnerships occurring after Oct. 18, '99, and before June 24, 2003. It did so through Reg. § 1.752-6 (also issued as a temporary reg), which requires a partner to reduce his basis in his partnership interest by the amount of any contingent obligation, assumed by the partnership between Oct. 18, '99, and June 24, 2003.

When it issued the temporary reg on June 24, 2003, IRS noted in an accompanying Treasury release that it had previously said in Notice 2000-44, 2000-2 CB 255, that Son of Boss transactions don't work.

District court sustains the shelter. The district court reached these pro-taxpayer conclusions:

(1) Sala's participation in the Deerhurst Program possessed a reasonable possibility of profits beyond the tax benefits, was entered into for a business purpose other than tax avoidance, and was motivated by a desire for profits above and beyond the tax benefits sought.

(2) Sala's basis in Solid Currencies was approximately $69 million—the value of the long options contributed plus the cash contributed—and Solid Currencies' basis in Deerhurst GP was an identical amount;

Observation: Sala transferred 24 foreign currency options to Solid Currencies and then to Deerhurst GP. The court said Solid Currencies' basis in Deerhurst GP was increased by the value of the long options, $60,987,867, but was not offset by the $60,259,569 cost of the short options. Accordingly, Solid Currencies' claimed basis in Deerhurst GP was approximately $69 million—the value of the cash plus the long options.

(3) the 24 options contracts contributed by Sala to Solid Currencies and by Solid Currencies to Deerhurst GP were separate financial instruments.

(4) Solid Currencies received property upon the liquidation of Deerhurst GP.

Observation: Upon liquidation of Deerhurst GP, Solid Currencies received a portion of Deerhurst GP's liquidated assets equal to the proportionate size of Solid Currencies' basis. Solid Currencies received approximately $8 million in cash and two foreign currency contracts. The foreign currency contracts were considered to be “property.” The value of the foreign exchange contracts distributed to Solid Currencies, therefore, was approximately $61 million—$69 million (Solid Currencies' original basis in Deerhurst GP) less the $8 million in cash. When Solid Currencies sold the foreign currency contracts, its loss was equal to the $61 million dollar value of the contracts, offset by any profit received from their sale.

(5) IRS exceeded its authority when issuing Reg. § 1.752-6(b)(2); and
(6) IRS exceeded its authority when making that reg retroactive.

Accordingly, Sala prevailed in using the Son-of-Boss transaction to offset about $60 million of income.

Observation: It remains to be seen whether IRS will appeal this case. But it has previously won a number of Son-of-Boss cases. In one winning case for IRS, the Seventh Circuit upheld the retroactive reg (see Cemco Investors, LLC v. U.S., CA 7, 101 AFTR 2d ¶2008-452).

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