Time for an Entity Review?

Much has happened in the tax arena lately, particularly relating to entities and structuring businesses and investments. Good practice dictates that one periodically review business and investment structures. Due to recent changes in the tax law, now may be the time for a review even if it has not been that long since your last review. Continue Reading...

Proposed Regulations May Spark Year-End Transfers

Treasury has recently issued Proposed Regulations under Section 2704. Section 2704 affects the valuation of interests in corporations and partnerships. Most notably, the proposed changes would disregard restrictions on liquidation that are not mandated by federal or state law and disregard the ability of most nonfamily member owners to block the removal of covered restrictions. Combining these two rules may result in gifts of interests in family held entities to be valued in a fashion similar to the "fair value" standard rather than the "fair market value" standard previously applicable.

The Proposed Regulations rules are proposed to apply transfers occurring after the date the regulations are published as final regulations. Comments will be considered at a public hearing currently for December 1, 2016. So, the Proposed Regulations should not take effect until after that date - probably no earlier than 2017.

One should make a careful determination whether they should make transfers of interests in closely-held entities before the end of 2016 to avoid the application of the proposed rules to the valuation of the gift. Even those transfer could be caught by the proposed rules if the transferring person dies within three years of the transfer and after the date that the proposed regulations become final.

See, Proposed Section 2704 Regulations Would Impose Major Restrictions on Valuation Discount Planning for a more detailed discussion of the proposal.

New Non-discrimination Rules for Health Insurance Plans

Fully insured health plans have not been subject to any the nondiscrimination requirements. Those plans could discriminate on eligibility, contributions, and benefits, without triggering adverse tax consequences to either the plan or the plan participants.

The Patient Protection and Affordable Care Act (Affordable Care Act or Obamacare) has changed that. Fully insured group health plans that are not grandfathered under the Affordable Care Act or that do not meet the exception for small employer plans will have to comply with the nondiscrimination rules of Code Section 105(h)(2). Accordingly, plans that are now subject to the nondiscrimination rules cannot discriminate regarding either eligibility to participate in the plan or the benefits provided under the plan. Plans that discriminate in favor of highly compensated individuals will face severe penalties.

Implementation of the new rules has been delayed. The IRS, Department of Labor (DOL), and Department of Health and Human Services (HHS) will not require compliance with these rules until additional guidance is issued. And, at this point, we have no indication of when that guidance will be issued. So, compliance with the rules is delayed indefinitely. But, any fully insured group health plan offered by your business will eventually have to be examined to determine whether it must and, if so, whether it will pass the nondiscrimination rules.

A fully insured plan that is found to be discriminatory faces severe penalties. It may be subject to a civil action to compel it to provide nondiscriminatory benefits. Additionally, the plan or plan sponsor could be subject to an excise tax of $100-per-day for each individual who was discriminated against (i.e., for all participants who do not meet the definition of a highly compensated individual).

Fiscal Cliff Avoided

I saw an editorial cartoon the other day. It was of Wiley Coyote going off the cliff. He seemed to be doing this regularly in the Roadrunner and Coyote cartoons. In this case, he was able to scramble, out of thin air, back to the edge of the precipice.

Early Jan. 1, 2013, the Senate, by a vote of 89-8, passed H.R.8, the “American Taxpayer Relief Act” (the Act). Late on that same day—hours after the government had technically gone over the “fiscal cliff”—the House of Representatives, by a vote of 257 to 167, also passed the bill. The Act, which the President is expected to quickly sign into law, prevents many of the tax hikes that were scheduled to go into effect this year and retains many favorable tax breaks that were scheduled to expire. However, it increases income taxes for some high-income individuals and slightly increase transfer tax rates.

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"Now that's a fine mess you've gotten us into!"

Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself.
- Mark Twain, a Biography

The so-called “fiscal cliff” is looming, and I don’t see how we can avoid going over the edge. The election is now over, but nothing has really changed. Before the election we had Obama as President, a Democratic majority in the Senate, and a Republican majority in the House. Today, we still have the same thing.

The day after the election, Democratic and Republican leaders claimed to be willing to work towards a bi-partisan solution, but it sounds more like posturing than substance, and I don’t think there is enough time left before January 1, 2013 to avoid the tax calamity that will automatically happen on that date.

Though both sides agreed not to draw lines in the sand, congressional leaders did just that, staking out unchanged bargaining positions. Harry Reid, Senate Democratic leader, said he wanted to avoid the tax increases except for the wealthy and he would like to see substantial measures enacted during the lame-duck session of Congress that starts next week. Speaker John Boehner, Republican leader of the House, said that while he was open to tax reform, and saw considerable common ground on that, he continued to find tax increases unacceptable. Boehner repeated his previous objections to moving forward during the lame-duck session, except with temporary, stop-gap legislation to avoid the cliff. Vice President Joe Biden, saying the administration would like to move "right now," claimed "a clear, clear sort of mandate" on the tax issue, citing in particular doing "something on corporate taxes sooner than later".

It is thus apparent on the day after the election that the clarity it was supposed to have brought has yet to arrive.

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Real Estate Transferred to FLP Escapes Inclusion in Estate

In a case involving an asserted estate tax deficiency of over $2.5 million, the Tax Court has held that real estate transferred to a family limited partnership (FLP) did not have to be included in the transferor's gross estate under Code Sec. 2036 because the transfer was a bona fide sale for an adequate and full consideration in money or money's worth.  Estate of Joanne Harrison Stone, TC Memo 2012-48.

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Tax Court Rejects Cost Segregation Study of Apartment Complex

A new Tax Court case deals with a taxpayer's claims that numerous assets in a rental apartment complex were depreciable as short-lived personal property rather than as residential rental property written off over 27.5 years. Amerisouth, TC Memo 2012-67. The Court disallowed most of the deductions, which were based on an overaggressive cost segregation study.

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Ranch Owner Didn't Materially Participate in Ranch Activities

The Tax Court in Iverson, TC Memo 2012-19, has disallowed losses incurred in a cattle ranch owned by Mr. Iverson. The taxpayer was the founder and an executive with a company based in Minnesota and appeared to use the ranch to entertain clients of his Minnesota company. So, the decision is not surprising in that regard. The decision could nonetheless spell trouble for other ranch owners. The court seemed to focus on the fact that the taxpayer did not live at the ranch, did not keep detailed records on participation in ranch activities, and had a full-time paid ranch manager who ran the day to day activities of the ranch. Many owners of ranches in Texas do not live and work full-time at their ranch and have paid employees who handle the day to day activities. Where the taxpayers do not keep extensive files, to-do lists, home and mobile phone records, business plans, project descriptions and instructions to employees documenting and establishing their active involvement in the regular, continuous, and substantial management and day-to-day activities of ranch, they may have difficultly persuading the fact finder that they have the necessary involvement in the ranch activities to avoid passive activity classification. This would particularly be true of taxpayers who do not live at the ranch or actually “work” the ranch when they are at the ranch.

Highlights of Tax Changes Becoming Effective in 2013

There are many important tax changes taking effect in 2013, as well as some that took effect late last year and thus are “new.” They are the result of tax legislation enacted in prior years, or are triggered by effective dates in regs, rulings and other guidance, or will occur by default in 2013 absent Congressional action. The following is a list derived from Checkpoint of the key non-inflation-indexed tax changes, categorized by those affecting businesses and individuals. In addition, a list of provisions that expired at the end of last year is provided.

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How Today's Low Interest Rates Affect Tax and Estate Planning

Interest rates have dropped significantly in recent months and may remain low given the state of the economy. Sagging rates can have a significant impact on many tax and estate planning strategies. Lower interest rates affect the income, estate, and gift tax values of many types of transfers. In many cases, the drop in rates produces more favorable results for persons engaging in certain types of transactions. In other cases, however, the lower rates result in higher tax costs. This post examines how low interest rates affect key tax and estate planning transactions and strategies.

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IRS Instructs Examiners How to Seek Approval to Apply Economic Substance Doctrine

In a July 15th directive from IRS's Large Business & International (LB&I) Division, the IRS issued guidance to managers and examiners on when to seek the approval of the Director of Field Operations (DFO) for asserting the economic substance doctrine. The directive lays out a multi-step analysis for examiners to complete before submitting their requests to the DFO.

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"Gang of Six" tax proposals

I don't know about any of you, but I didn't see any specifics mentioned in the news reports yesterday about the tax proposals that are part of the newest compromise proposal to fix the debt ceiling. But I am happy to report that RIA included them this morning in their daily update. Here they are:

  • A single corporate tax rate between 23% and 29% and shift to a competitive territorial tax system.
  • Tax simplification that involves reducing the number of tax expenditures (i.e., tax breaks) and reducing individual tax rates. There would be three tax brackets with rates in the range of 8%–12%, 14–22%, and 23%–29%. To the extent future Congresses find that the dynamic effects of tax reform result in additional revenue beyond initial targets, this revenue would go to additional rate reductions and deficit reduction, not to new spending.
  • Permanent repeal of the alternative minimum tax (AMT).
  • Reform, rather than elimination, of tax breaks for health, charitable giving, homeownership, and retirement.
  • Retention of the earned income tax credit and child tax credit, or creation of an alternative that would provide at least the same level of support for qualified beneficiaries.

The bipartisan plan calls for the Senate Finance Committee within six months to report a comprehensive tax reform package using the listed items to deliver “real deficit savings by broadening the tax base, lowering tax rates, and generating economic growth.”

IRS tool makes it easier for employers to keep track of important tax deadlines

The IRS has a new online tool to make it easier to remember important tax return and deposit deadlines. It's called the “IRS Calendar Connector” and it doesn't cost anything to download it to a computer desktop. The calendar includes deadlines for all types of taxes, including income, employment, and excise taxes. However, employers may customize the calendar to only include deadlines for certain types of taxes. For example, a calendar that was customized to only show employment tax deadlines would display semiweekly and monthly payroll tax deposit due dates and the deadlines for filing employment tax returns. Employers may choose whether they want to see a list of deadlines by day, week, or month. The “settings” option allows users to check for updates, which will refresh in real time. The settings may also be adjusted to have the calendar start up at the time a user logs onto his or her computer.

The “Calendar Connector” may be downloaded at http://www.tax.gov/irscalendarconnector/. In addition, the IRS also has a monthly online calendar on its website at  http://www.tax.gov/calendar/, and Publication 509 (http://www.irs.gov/pub/irs-pdf/p509.pdf) that provides tax calendars and deadline dates for 2011.

Highlights of New Items on 2010 Form 1040

Politicians say they want to simplify the tax laws; yet they continue to make the law more complicated. This year is no different. The 2010 Form 1040 reflects a number of new tax breaks. Some are straightforward. Others are complex. Some present choices. But they all provide an opportunity to save money.

Here is a list of the key changes for this filing season:

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Brief Summary of Recent Income Tax Changes

The tax laws enacted in the last couple of years contain important income tax and information reporting provisions that are effective for the first time in 2011. Here's a summary of the key tax changes for 2011, broken down into three categories: Personal Income Taxes, Retirement Plan Changes, and Tax Changes for Businesses and Investors.

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IRS Successfully Recharacterizes S Corporation Dividends as Salary

Many tax advisors have recommended that their clients use the S election to reduce their social security and medicare tax liability. This type of planning has been on the IRS’ radar screen for a while. Now we have a case where the S corporation did pay some wages to its owner, and a District court found that the portion of the dividend distributions that the IRS claimed to be salary substitutes were in fact salary, making them subject to social security and medicare taxes. The moral of the story: you better have good factual support for what a service corporation is paying the professionals working for the service business.

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Joint Committee on Taxation Publishes Analysis of Tax Expenditure Estimates

The Joint Committee on Taxation (JCT) periodically publishes an analysis of tax expenditures. The JCT has recently published another of its periodic tax expenditure analyses. The analyses are designed to aid policymakers and the public in understanding “the actual size of government, the uses to which government resources are put, and the tax and economic policy consequences that follow from the implicit or explicit choices made in fashioning legislation.” Tax expenditures are defined as “revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” As described by the JCT, tax expenditures include any reductions in income tax liabilities that result from special tax provisions or regulations that provide tax benefits to particular taxpayers. The estimates in the report are based on the provisions in federal tax law as enacted through Dec. 15, 2010. The report discusses the concept and measurement and tax expenditures, and also provides estimates of tax expenditures for the tax period covered as well as tables showing the distributions of tax returns and selected individual tax expenditures by income class. The document “Estimates of Federal Tax Expenditures for Fiscal Years 2010-2014” can be downloaded at http://www.jct.gov/publications.html.

What I don’t understand is why the progressive rate structure (which is probably the single largest tax expenditure in the entire Internal Revenue Code) is not included in the list of tax expenditures. Actually, I do understand. But that is just another example of how the government mischaracterizes its actions and the information it provides us. The progressive rate structure meets the definition of a tax expenditure; yet it is not included. You can draw your own conclusion from that fact.

IRS Still Says That Trust's Material Participation Depends on Trustees' Activities

In a new private letter ruling, IRS continues to take the position that trusts materially participate in an activity for purposes of the Code Sec. 469 passive activity loss (PAL) rules only when their trustees participate in the operations of the activity on a regular, continuous, and substantial basis.

Query: Does this mean that you look at the participation of all of a corporate trustee's employees, but not the agent's of an individual trustee?

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Joint Committee on Taxation Description of Business Tax Changes in President's 2010 Budget

The staff of the Joint Committee on Taxation has released a comprehensive study on the business tax changes included in the President's FY 2010 budget proposal, as submitted to Congress on May 7, 2009.  For a list of the proposed business tax changes, read on.

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Latest IRS Pronouncements on Tax Avoidance Transactions and Transactions of Interest

Notice 2009-59 updates the IRS' list of “listed transactions” published in Notice 2004-67, 2004-2 CB 600, by adding four transactions designated as listed transactions after the 2004 notice was issued. Notice 2009-55 carries a list of transactions designated as “transactions of interest” for various disclosure and penalty purposes.

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Tax Court Clarifies Classification of LLP and LLC Interests Under PAL Rules

The Tax Court held that the taxpayers' ownership interests in limited liability partnerships (LLPs) and limited liability companies (LLCs) are excepted from classification as “limited partnership interests” under the temporary regulations by operation of the general partner exception. Thus, they could use all seven tests for material participation in the temporary regulations, instead of only the three available for participation of individuals that are limited partners.

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What are your chances for being audited?

The IRS has issued its annual data book, which provides statistical data on its 2008 fiscal year. The data book provides valuable information about how many tax returns IRS examines, and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections. A total of 1,391,581 individual income tax returns were audited during FY 2008 (Oct. 1, 2007 through Sept. 30, 2008) out of a total of 137.8 million individual returns that were filed in the previous year. This works out to 1.0% of all individual returns filed (about the same as the audit rate for the preceding year).

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Large Number of Significant Tax Provisions Expire in 2009

A recent report by the Joint Committee on Taxation included a list of expired and expiring tax provisions from 2008 through 2020. The report serves as a reminder that numerous key provisions — many of them only recently extended by the Emergency Economic Stabilization Act and the American Recovery and Reinvestment Act of 2009 — are currently slated to be on the books only through 2009, while others last only through 2010. While these provisions may ultimately be extended (and some of them surely will be), one, where possible, should take action now to prevent losing out on tax breaks.

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Seventh Circuit Allows Closely Held Corporation to Deduct $17 Million Bonus

The Seventh Circuit reversed the Tax Court's holding that a closely held corporation could deduct only about $7 million of a $17 million CEO bonus based on a percentage of pretax net income. The appellate court's decision rejected the Tax Court's view that a repayment agreement in the event of IRS challenge was evidence that a dividend had been intended. It also rejected the Tax Court's methodology which concluded the CEO was overpaid relative to the compensation of CEOs of publicly held corporations in the same business. Menard, Inc. v Commissioner (CA 7 3/10/2009)

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Treasury Official: No required minimum distribution relief for 2008

In a Dec. 17 letter to Rep. George Miller (D-CA), Chairman of the House Committee on Education and Labor, a Treasury official has said that IRS will not relieve retirement plan account participants and IRA owners of the need to take required minimum distributions (RMDs) for 2008. The only relief these taxpayers can look forward to is the Pension Act's waiver of the requirement to take RMDs for 2009.

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Worker, Retiree, and Employer Recovery Act of 2008

The Congress passed this Act last Thursday, December 11, and the president is expected to sign it.

The Act should help give older Americans some much needed financial flexibility as they struggle to manage their finances during this difficult economic time. A key provision in the Act is designed to help alleviate the financial burden facing seniors who have seen their retirement savings shrink dramatically. The new provision provides relief to senior citizens by allowing them to continue to keep money in retirement accounts that they are typically required by law to withdraw once they reach age 70 1/2.

The Act also includes important provisions that ease funding requirements for employer-sponsored pension plans. Absent the new legislation, these plans would have been forced to make significantly increased contributions during the current financial crunch when they are very short on cash. The new law provides pension funding relief for both single-employer and multi-employer plans.

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30 Day Reprieve on Filing Franchise Tax Returns Under the New Law

In an April 22, 2008 News Release, the Texas Comptroller, Susan Combs, announced that businesses unable to meet the May 15 due date for the franchise tax will have an additional 30 days to submit revised franchise tax returns or request an extension without penalty. The Comptroller stated that her office recognizes that the complexity of the revised franchise tax, and the newness of the enhanced electronic reporting methods, have caused concern among tax practitioners and taxpayers throughout Texas. The extension will enable businesses to avoid the 5% penalty that would have been imposed if they had not filed by May 15.

IRS Gives Guidance On Personal That Won't Prevent Code Sec. 1031 Tax-Free Exchange Of Residence

The IRS has issued Revenue Procedure 2008-16 (2008-10 IRB). The Revenue Procedure provides guidelines for limited personal uses that won't prevent a dwelling unit from qualifying as property held for trade or business or investment use under the Section 1031 like-kind exchange rules.

The IRS says it recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes. “In the interest of sound tax administration,'' the IRS has provided taxpayers with a safe harbor under which a dwelling unit (real property improved with a house, apartment, condominium, or similar improvement that provides basic living accommodations including sleeping space, bathroom, and cooking facilities) will qualify as property held for productive use in a trade or business or for investment for Code Sec. 1031 purposes even though they occasionally use the dwelling unit for personal purposes.

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IRS Criminal Prosecutions in the News

You wouldn't ordinarily think of the NYTimes as a hot source for new tax developments. But some recent actions by the IRS criminal division involve subjects that are high enough profile to warrant reporting by the NY Times.

First, there is the recent prosecution of Wesley Snipes, a well know actor. His case ended, for the most part, in a victory for Snipes. While he was found guilty of some misdemeanors, the jury apparently believed that he did not have the requisite criminal intent to be guilty of felony tax evasion. As noted in the article, it can be difficult to prove criminal intent where the accused has any reason whatsoever to justify his or her conduct.

Another case, with not quite a high a profile, involves what the NYTimes refers to as "penny-ante tax fraud." The case involves alleged "inflated appraisals" of property that was appraised at less than $5,000. Not exactly your normal "badge" of organized crime.

Makes you wonder if the IRS is spending its resources trying to turn civil tax cases into unwinnable criminal prosecutions.

Zero Tax Rate on Long-Term Capital Gain and Dividend Income

Beginning this year and continuing through at least 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate. The amount of income taxed at 0% depends on the interplay between an individual's filing status, his taxable income, and how much of that taxable income consists of long-term capital gain and dividends.
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Taxpayer Advocate Recognizes Conflict of Interest Between Return Preparers and Their Clients

The National Taxpayer Advocate has released its 2007 Annual Report to Congress in IR 2008-4. The Advocate highlights the issues raised by newly amended Code Sec. 6694, the return preparer's penalty, and how it may affect the way tax preparers dispense advice. The Report says that new standard may, in some cases, lead to conflicts of interest between preparers and their clients.
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Senate Bill on Tax Patents Introduced

On Nov. 15, Senate Finance Committee Chair Max Baucus (D-MT) and committee ranking minority member Chuck Grassley (R-IA) introduced legislation to prohibit the Patent and Trademark Office (PTO) from granting patents for common tax strategies and tax planning inventions. 

“America's patent system promotes innovation and competitiveness in all industries. However, the growing number of attorneys and accountants applying for patents of tax strategies and techniques is cause for concern,” Baucus said. “Taxpayers should not have to pay a toll charge or worry that they're violating patent law when they try to file their tax returns. Tax practitioners should be able to provide advice and services to their clients without paying a fee to the patent holder.”

Grassley added that tax patents “undermine the integrity and fairness of the federal tax system. They put taxpayers in the undesirable position of having to choose between paying more than legally required in taxes or paying a royalty to a third-party for use of a tax planning invention that reduces those taxes. Congress needs to level the playing field and improve options for taxpayers.”

Court Awards $180,000 and Attorney's Fees for Failure to Provide Plan Documents

An Alabama District Court awarded nearly $180,000 in penalties and attorney's fees against a doctor who was also a plan administrator when the doctor did not provide requested plan documentation as required under ERISA. Cromer-Tyler v. Teitel, et. al., (2007, DC AL) 2007 WL 2684863. The doctor delayed delivering the requested documents for over 4-1/2 years.The court imposed a maximum penalty of $110 per day, or $179,960. The court also ordered the doctor to pay attorney's fees.

IRS Refuses to Follow the 6th Circuit

It’s almost as if the IRS is trying to prove my recent personal commentary correct. In a recent action on decision (AOD 2007-004,10/01/2007), the IRS announced that it won't acquiesce in the Sixth Circuit's holding in U.S. v. Roxworthy, (2006, CA6) 98 AFTR 2d 2006-5964, 457 F3d 590. That case reversed a district court order enforcing an IRS summons on a corporate taxpayer's vice president for memoranda prepared by the company's outside audit/consulting firm. The Appeals Court found that the memoranda were prepared in anticipation of litigation and were protected by the work product doctrine. IRS disagreed with that conclusion and stated that a document prepared in anticipation of an audit is not prepared in anticipation of litigation.

This puts the IRS out of line, not only with the Sixth Circuit, but with a recent district court decision which rejected the IRS's request to examine “tax accrual workpapers.” In a case involving Textron, Inc. and its subsidiaries,  the found that the workpapers were privileged under the work product privilege (see U.S. v. Textron INC. and Subsidiaries, (DC RI 8/28/2007) 100 AFTR 2d 2007-5848. Since the IRS now says that it will not follow these decisions, even in the 6th Circuit, one must hope that any taxpayer with the resources to fight the IRS over the privilege issue will be rewarded, not only with a victory, but with attorneys fees as well. Continue Reading...

Noose Tightened Further on Patented Tax Strategies

The Treasury this week issued proposed regulations that would add patented transactions to the list of reportable transactions. As noted in our July 20, 2007 post, Congress is moving towards making tax planning techniques unpatentable. While classifying a transaction as a reportable transaction does not make it incorrect or illegal, the fact that a taxpayer must report a transaction has a chilling effect on taxpayers entering into such transactions. After all, who wants to face the resources of the government to prove they have properly reported a transaction, no mater how defensible their reporting might be?

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More New Hires will Qualify for Jobs Tax Credit

Recent changes to the Jobs Tax Credit may allow many more employers to claim a tax credit for new hires, particularly in the Texas Panhandle and Tri-State area. Before the changes, the law provided a tax credit to employers who hired disadvantaged workers. The tax credit can be as much as $2,400 for each person hired.

The credit has been expanded to include a new category of eligible workers: individuals who are at least 18 year old, but less than 40 on the date of hire, and who reside in a county that lost population through the 1990s. The IRS has just identified those counties, and they include:

  • Bailey, Briscoe, Castro, Collingsworth, Cottle, Deaf Smith, Floyd, Gray, Hall, Hemphill, Hockley, Hutchinson, Lamb, Oldham, Roberts, and Wheeler in Texas
  • Harding and Quay in New Mexico
  • Beaver, Cimmaron, Custer, Dewey, Ellis, Greer, Harper, Harmon, Kiowa, Roger Mills, and Woodward in Oklahoma.

A list of all counties meeting that definition can be found in the Instructions to IRS Form 8850. The new law becomes effective for hires made after May 25, 2007. 

The “catch” in the law is the requirement that employers must submit a certification request to their state workforce agency within 28 days of the date of hire using IRS Form 8850.

The employee does not actually have to be a “disadvantaged” person. They only have to reside in one of the listed counties at the time of hire and throughout the period they receive wages that qualify for the credit. In fact, highly paid or managerial employees who happen to reside in a listed county will qualify.

New Return Preparer Penalties Effectively Increase Return Disclosure Requirements

Buried in legislation enacted last May are major changes to the rules imposed on return preparers. The law was passed without much possibility for discussion or input from tax practitioners or even the IRS. It came as a such a surprise to the IRS that the IRS delayed the effective date of the new standards and sanctions under Section 6694(a).

Some of the effects of these new rules are likely to be:

  • conflicts arising from the fact that taxpayers need only meet a substantial-authority test on most tax positions, but preparers must meet a more-likely-than-not test that, if not met, requires a disclosure on the return.
  • an increase in the fees of return preparers to cover the increased work necessitated by and the increased exposure to higher penalties.
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Vanguard IRA Notice

For all of you with IRA's at Vanguard, please immediately see the article published by Forbes.com entitled "Disinherited by Vanguard" .  This article discusses the notice Vanguard has sent you regarding their new policy to combine IRA beneficiary desginations if you have more than one IRA at their company.  This new policy could have dramatic unintended consequences if you are not aware of your new beneficiary designation.  Although you will need to subscribe to this website (if you have not already done so), it is a free and immediate subscription.

Transfer of Relinquished Property to Related Person Gets Favorable Like-Kind Treatment

The Service recently ruled (PLR 200728008) that Section 1031(f) will not trigger gain recognition in an otherwise qualifying like-kind exchange when the taxpayer transfers relinquished property (through a qualified intermediary (QI)) to a related person and acquires replacement property (through a QI) from an unrelated person, even if the related person disposes of the relinquished property within two years of its acquisition of such property.

This is the third time the Service has issued a letter ruling that addressed whether Section 1031(f)(4) applies when a taxpayer transfers relinquished property (through a QI) to a related person and the related person disposes of the relinquished property within two years. (See PLR. 200709036 and PLR 200712013). These three letter rulings may encouragte taxpayers looking to structure transactions with similar facts.

Taxpayers should remain cautious, however, in considering whether a related party's participation in a like-kind exchange will implicate Section 1031(f). The related party's purpose for acquiring the property may  determine whether the transaction qualifies for tax deferal. That is, if the related party acquired the property to subdivide it or construct improvements before selling (to preserve nondealer status for the exchanging taxpayer), or to list the property for sale immediately (seeking to extend the 180-day parking period permitted under Rev. Proc. 2000-37), the Service might not reach a similar conclusion.

Taxpayers should also be aware that this PLR should not be confused with the fact situation of earlier unfavorable rulings where the taxpayer acquired replacement property (through a QI) from a related person. Specifically, in Rev. Rul. 2002-83, 2002-2 CB 927, the Service concluded that a taxpayer transferring relinquished property (through a QI) to an unrelated person in exchange for replacement property (through a QI) owned by a related person must recognize gain if the related person receives cash or non-like-kind property. The Tax Court reached a similar conclusion in Teruya Brothers Ltd., 124 TC 45 (2005).

Florida District Court contradicts Tax Court and Federal Court of Claims on 6-year Statute of Limitations

In what is probably another case of "bad facts make bad law," a Florda District Court allowed the IRS to proceed to the merits in a "Son of BOSS" case, despite the IRS' making it's assessment against the taxpayer more than 3 years after the taxpayer filed a return.  Brandon Ridge Partners v. U.S., (CA Fl 7/30/2007) 100 AFTR 2d ¶2007-5107.

The case contradicts two recent decisions, one in the Federal Claims Court (Grapevine Imports Ltd. v. U.S., (Ct. Fed. Cl., 7/17/2007) 100 AFTR 2d ¶2007-5065) and the other in the Tax Court (Bakersfield Energy Partners, LP, (6/14/2007) 128 TC No. 17. Both of these recent cases relied on the Supreme Court's decision in Colony Inc v. Com., (1958, S Ct) 1 AFTR 2d 1894 , 357 US 28. In Colony the Supreme Court held that the 6-year statute does not apply unless there has been an omission of an item of gross income, not simply the overstatement of basis or cost of the item sold. Under that reasoning, if you report the gross amount of the sales proceeds from each sale, there can be no omission of gross income, which is necessary for the 6-year statute to apply.

The District Court's reasoning in Brandon RIdge seems quite strained, probably because it takes a maze-like path to find a distinction from the prior decisions that is no more than the size of a pin hole if the distinction exists at all. Not only does it hold, contrary to the Supreme Court, Tax Court, and Court of Claims, that the reporting of an improper amount of gain amounts to an omission of gross income, but it also holds that reporting of the gross amount of the sales proceeds is not sufficient to adquately apprise the IRS that an omission of gross income has occurred. (Adquate disclosure of the omission is also sufficient to prevent the 6-year statute from applying.)

The moral of the story: If you have a situation, like Son of BOSS, where the IRS claims the 6 year statute of limitations applies because of overstating basis or cost of an item sold, you are better off fighting the statute of limitation issue in the Tax Court than the District Court (particularly if that DIstrict Court happens to be in Florida).

House Judiciary Committee acts against patenting tax planning techniques

On July 18, the House Judiciary Committee approved a patent reform bill (H.R. 1908) that included a provision making tax planning techniques unpatentable. The provides that a patent couldn't be obtained for “a tax planning method”—a plan, strategy, technique, or scheme that's designed to reduce, minimize, or defer a taxpayer's tax liability, or that when implemented has that effect. However, an unpatentable tax planning method wouldn't include the use of tax preparation software or other tools used solely to perform or model mathematical calculations or prepare tax or information returns. The provision would cover tax planning with regard to any federal, state, county, city, municipality, or other governmental levy, assessment, or imposition (whether measured by income, value, or otherwise).