News On The Tax Front--The latest tax news.
Victims Of Terrorism Tax Relief Act of 2001--The new law contains two important provisions. The first allows businesses to claim an extra 30% depreciation in the year an asset is placed in service. The second provides for a 5-year carryback of NOLs (up from 2). Both provisions are temporary.
Taxpayer Loses on Four Issues--Wins on One--The most important one was a big abandonment loss that was disallowed.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
The Internal Revenue Service issued a nationwide warning (IR-2002-08) for taxpayers not to be misled into filing slavery reparation claims. The IRS has recently seen a significant surge in these false filings, and the agency urged taxpayers not to fall victim to this tax refund scam. There is no provision in the tax law that allows African- Americans to get tax credits or refunds related to slavery reparations. Unscrupulous promoters are deceiving people into paying money for advice on how to file these false claims, in which they generally seek $40,000 to $80,000. Recently, the IRS has seen an increase in the number of people filing false claims for reparations. In 2001, the agency received nearly 80,000 returns claiming more than $2.7 billion in false reparation refunds. The IRS is now taking a tough stance on this issue and will treat these claims as frivolous returns, subject to a penalty.
In Mark D. McGhan (2002-1 USTC 50,134; U.S. Court of Appeals, 9th Circuit) the Court upheld an unreported Tax Court decision that went against an individual with tax protestor arguments. The Court found his argument that his compensation was not taxable to be frivolous. It sided with the IRS in holding the Service was not required to prepare a substitute return.
Think you can use the Fifth Amendment to use as an excuse for not filing? It won't work. That's what the Court said in Joe Sabino, Daniel K. Stewart, Donna G. Stewart (2002-1 USTC 50,137; U.S. Court of Appeals, 6th Circuit).
The IRS has frequently attacked transactions as tax shelters because they lacked economic substance and/or business purpose, that the taxpayer was not at risk in the transaction, or that there was no chance of making a profit without considering the tax benefits. In Compaq Computer Corporation and Subsidiaries (2002-1 USTC 50,144; U.S. Court of Appeals, 5th Circuit) overturned a Tax Court ruling. The Court of Appeals found the taxpayer was entitled to foreign tax credits in connection with transactions involving American Depository Receipts (ADRs). The Court held the transactions did have economic substance and there was a business purpose.
If the IRS delays in resolving a tax dispute because of administrative or ministerial delays or unreasonable errors or delays resulting from managerial acts, you can request an abatement of interest. The Court found that wasn't the case in William B. Berry and Marjorie S. Berry (T.C. Memo. 2001-323). While the case did take long to process, the taxpayer was unable to show the delay was related to the acts that would allow for an abatement of interest.
If you claim the targeted jobs credit (TJC) you must reduce your wage expense by the amount of the credit. (Similar rules apply to many other credits.) In Charles C. Allen, III and Barbara N. Allen, et al. (118 TC--, No. 1) the taxpayers argued that they should be allowed to use the full amount of the wages (unreduced by the credit) in computing their alternative minimum taxable income (AMTI) for the alternative minimum tax. The Court didn't agree. Moreover, the Court noted that both parties relied on the Staff of Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986 (J. Comm. Print (1987) (Blue Book) but said the Blue Book isn't part of the statute's legislative history.
It's generally difficult for the IRS to prove fraud. The law requires much more proof than sustaining a simply understatement of income. However, in Howard Levine, et ux. (T.C. Memo. 2002-12) the Court found that the IRS clearly and convincingly proved the taxpayer's fraud. The Court took note of the fact that the taxpayer was a trained bookkeeper and tax return preparer (he didn't report the income from his sideline of bookkeeping and tax preparation), yet failed to keep records, consistently filed late, and made misstatements to the examining agents.
The Senate has picked up the stimulus package again. While discussions are ongoing, they are less than encouraging. Fed Chairman Greenspan's comment of last week that the stimulus package may no longer be needed and, in fact, could be a negative, is likely to impact the outcome.
A business entity that isn't automatically classified, such as an LLC, may be able to elect to be taxed as a corporation or as a partnership. The election is made on Form 8832, and must be filed within 75 days of the date the election is to be effective. The IRS has made exceptions for late filing on a case-by-case basis. In Rev. Proc. 2002-15 (IRB 2002-6) the IRS is providing guidance for a newly formed entity that requests relief for a late initial classification election filed within 6 months of the due date of the initial election. You must have a reasonable cause for the late filing. The procedures in Rev. Proc. 2002-15 are in lieu of a letter ruling. That can save the user fee. If you don't meet the requirements of this revenue procedure, you can still file a letter ruling. The new procedure applies to ruling requests pending the IRS national office on February 11, 2002 and to requests received after that date.
In Notice 2002-7 (IRB 2002-6) the IRS announced that it, the Department of Labor's Pension and Welfare Benefits Administration and the Pension Benefit Guaranty Corporation are providing additional relief in connection with employee benefit plans because of the September 11, 2001 terrorist attack. Affected taxpayers may have more time to comply with funding requirements. If this notice might apply to you, please read the full text. There are strict time limits.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made a number of changes to the rules for 401(k) plans. In Notice 2002-4 (IRB 2002-2) the IRS provided guidance with respect to the effect on distributions from a 401(k) plan. The notice also provides guidance under Sec. 414(v) on the application of the universal availability requirement, the nondiscrimination test for matching contributions, and catch-up contributions for individuals over age 50.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made changes to IRAs, SEPs, and SIMPLE IRAs. Rev. Proc. 2002-10 (IRB 2002-4) provides guidance to drafters of IRAs, SEPs and SIMPLE IRA plans; guidance to users of IRS model IRAs and plans; and transitional relief for users of IRAs and plans that have not been approved by the Service.
In Nicole Rose Corp., Formerly Quintron Corporation (117 TC--, No. 27) the taxpayer entered into negotiations for the sale of its stock or assets to another corporation. The taxpayer used a complicated series of transactions to create a $22 million loss on the sale of the business. The IRS disallowed the loss. The Tax Court agreed, noting that there was no business purpose for the transactions. Moreover, the transactions also lacked economic substance. It didn't help that the Court noted that the claimed deduction was related to an interest that the taxpayer held for less than a day.
Senator Daschle has proposed acting on the four noncontroversial provisions in the stimulus package. Once these are passed, he suggests that both sides could discuss additional measures. The measures that might be passed immediately are rebate checks for low-income taxpayers; bonus depreciation for business investment; additional unemployment benefits; and fiscal relief for the states.
The IRS has issued proposed regulations that provide rules that facilitate compliance by withholding agents where foreign individuals who are claiming reduced rates of withholding under an income tax treaty receive an unexpected payment from the withholding agent, yet do not possess the required individual taxpayer identification number. Under the rules, certain withholding agents could obtain an individual taxpayer identification number on an expedited basis. (See REG-159079-01)
The Taxpayer Relief Act of 1997 created Sec. 7436 of the Code, which provides Tax Court review rights concerning certain employment tax determinations (i.e., whether a worker is an employee or an independent contractor). As originally enacted, Sec. 7436 authorized the Tax Court only to review determinations by the Service that a taxpayer's workers should be classified as employees for purposes of subtitle C (which governs employment taxes) of the Code, or that the taxpayer for whom the services were performed is not entitled to treatment under section 530(a) of the Revenue Act of 1978 (which relieves a taxpayer of employment tax liability in certain circumstances). Section 7436(a) requires that the determination(s) involve an actual controversy and that the determination(s) be made as part of an examination. The law was expanded in 2000 to also authorize the Tax Court to determine the proper amount of employment tax under the determinations of worker status and Sec. 530 treatment. Notice 2002-5 (IRB 2002-3) provides details on the new rules.
Tax law contains some strict rules with respect to the deduction of expenditures related to manufacturing. Sec. 263A requires the capitalization of both direct and indirect costs. Many expenditures are quickly recovered when the manufactured product is sold (you get a deduction through cost-of-goods sold). In Plastic Engineering & Technical Services Inc. (T.C. Memo. 2001-324) the taxpayer deducted on the "other deductions" line of its tax return the license costs of a patent used in its manufacturing process. The Court found the annual license fee for the patent had to be allocated to cost-of-goods produced. The Court rejected the taxpayer's argument that there was a difference between contingent royalties and minimum royalties.
Taxes are deductible only by the person on whom they are imposed. A similar rule applies to expenses and interest. In Robert Griffin, et ux. (T.C. Memo. 2002-6) the taxpayer deducted real estate taxes on his personal return on property owned by his S corporation. The Court disallowed the deduction. (The taxpayer argued that the payments should be deductible because he paid them to prevent foreclosure on loans he guaranteed personally. The Court didn't agree.) This is not an unusual situation. Either for convenience or because the business is short of cash, a shareholder pays the expenses of a corporation (or other entity). Generally, no deduction is allowed. There are two ways around the problem. Make a loan or capital contribution to the business and have it pay the tax. Alternatively, you can make the payment and have the business reimburse you by way of an expense report.
For married taxpayers living in community property states, income that is community property under the laws of the state or jurisdiction in which the spouses reside is generally taxed in equal shares to the husband and the wife. Thus, if a husband and wife do not elect to file a joint return, each spouse is generally required to report one-half of the community income on his or her married filing separate individual return (separate return). Section 66 contains four exceptions to the general rule that community income is taxed in equal shares to the husband and the wife. The IRS has issued proposed amendments to the regulations that provide guidance to this code section. (REG-115054-01)
You may be able to discharge some or all of your debts in bankruptcy. However, you've got to follow some strict rules. In the case of a tax liability, you've got to have filed valid returns for the years at issue. In In re Paul C. Wright, Debtor (2002-1 USTC 50,127; U.S. Court of Appeals, 9th Circuit) the taxpayer argued that he filed returns because the IRS prepared the delinquent returns. The Court didn't agree. It noted he did not sign the returns under penalty of perjury, a requirement for a valid return. The fact that the IRS interviewed him and administered an oral oath in connection with the interview didn't sway the Court.
While you should have receipts and other documentation for any tax deductions, the IRS and the courts can allow a deduction without complete documentation under the Cohan rule. But you'll have to convince the court that you did, indeed, incur an expense and give the court some basis for estimating the amount. For example, you can show you spent money on business cards, but don't have the receipt. The court might allow a $20 deduction based on the average cost of 500 business cards. In Aziz A. Tokh and Susan K. Tokh (2002-1 USTC 50,128; U.S. Court of Appeals, 7th Circuit) the Court found that the taxpayers did not persuade them they incurred the expense. The Court also noted that while the Tax Court has sometimes followed this practice, it was not mandatory.
Failure to deposit withheld employment taxes is a serious issue with the IRS. And an officer, owner, employee, or other responsible individual be held personally liable (the corporate veil or an LLC won't protect you here). But the IRS has to show that you willfully failed to remit the withheld taxes. That's often easy. It was in Edward J. Loew (2002-1 USTC 50,126; U.S. Court of Appeals, 9th Circuit). The Court noted that willfulness was shown because he paid other creditors ahead of the IRS.
Know what you're signing. Always a good rule to follow. In Francisco Aguirre, et ux. (117 TC--, No. 26) the taxpayer made the mistake of signing a Form 4549. The Court noted that by doing so the taxpayer and his wife consented to the immediate assessment and collection of their tax liabilities. Moreover, they waived the opportunity to obtain prepayment judicial review of their tax liabilities for the years included within the form.
There has always been controversy between taxpayers and the IRS concerning the capitalization of intangibles. The 1992 Supreme Court case of INDOPCO, Inc. reinforced the Service's position and made matters worse for taxpayers. Requiring a taxpayer to capitalize an expenditure is bad enough. It means that there is no current deduction for the expenditure. At best, the cash outlay may be deductible over a number of years. But the uncertainty of whether or not an item should be capitalized makes the issue even worse. The IRS has just announced that it is reviewing the application of section 263(a) of the Internal Revenue Code to expenditures that result in taxpayers acquiring, creating, or enhancing intangible assets or benefits and is expected to issue a notice of proposed rulemaking that will recognize that many expenditures that create or enhance intangible assets or benefits do not create the type of future benefits for which capitalization under section 263(a) is appropriate, particularly when the administrative and record keeping costs associated with capitalization are weighed against the potential distortion of income.
The Enron bankruptcy may have consequences in two areas of tax law. First, it's more than likely legislation will be introduced to change some of the rules surrounding employer securities in 401(k) plans. Second, the possibility that Enron used tax vehicles and offshore tax havens to conceal the company's true financial condition may prompt legislation in the tax shelter area.
As a result of the projected operating deficits, some Democrats have suggested postponing some of the tax cuts enacted last summer. That's unlikely to happen. However, the chances of additional tax reductions may have decreased.
It's been close to 15 years since the IRS did its last dreaded TCMP (Taxpayer Compliance Measurement Program) audit. The audits helped to identify issues the Service should target to generate the most revenue when doing regular audits. The IRS has reported that currently about 25% of all audits result in no changes. That means the Service is not targeting the right taxpayers and is wasting time auditing taxpayers it shouldn't while not auditing those it should be. The IRS is now proposing to try and get similar data using a less intrusive approach. While some 50,000 individuals would be subject to the audits, a much smaller number would have to undergo the detailed scrutiny of the old TCMP audits. The question now is whether or not Congress will approve of this new approach.
The IRS has published a new revenue procedure (Rev. Proc. 2002-9, IRB 2002-3) detailing the procedure by which a taxpayer may obtain automatic consent to change the methods of accounting described in the Appendix to Rev. Proc. 2002-9. (The list includes a number of accounting method changes of interest to small business owners.) This revenue procedure clarifies, modifies, amplifies, and supersedes Rev. Proc. 99-49, IRB 1999-52. It also consolidates automatic consent procedures for changes in several methods of accounting that were published subsequent to the publication of Rev. Proc. 99-49, and provides new automatic consent procedures for changes in several other methods of accounting.
Filing as head-of-household is probably the most advantageous status. In James E. Briggsdaniels (T.C. Memo. 2001-321) the Tax Court found the taxpayer failed to prove he provided over half the cost of maintaining for more than half the year a household as the principal place of abode for any of his sons. Thus, the Court denied the taxpayer head-of-household status. Since he couldn't show he provided more than one of the support for any of his sons, the Court denied the taxpayer the dependency exemptions for them. Finally, because none of the children was an EIC (earned income credit) qualifying child, the taxpayer didn't qualify for the credit because, based on his income, he exceed the phaseout limitations.
The IRS normally adds interest to any late payments of tax. In Kenneth D. Hanks (T.C. Memo. 2001-319) the taxpayer went to Court to try and secure an abatement. But an abatement is only mandated only if there is an error or delay by the IRS in performing a ministerial or managerial act. In this case the taxpayer simply argued that the civil and criminal examination process he underwent took too long. Unfortunately, that wasn't what the law intended. The Court denied an abatement of the interest.
In Fennel Trust (T.C. Memo. 2001-316) one of the two co-trustees of a trust filed a suit in Tax Court in response to a deficiency notice from the IRS. The Tax Court held that no valid petition had been filed since the trustee failed to show that he had the capacity to unilaterally bring an action on the trust's behalf. The Court dismissed the petition for lack of jurisdiction.
In Rev. Proc. 2002-1 the IRS published revised procedures for issuing letter rulings. In Rev. Proc. 2002-2, it issued the new procedures for furnishing technical advice.
This year's Form 1040 series contains a small change that could save headaches for many taxpayers. By checking a box on your 1040 you can select a third party designee will enable that person -- be it friend, family member or paid preparer -- to talk directly with the IRS to correct questions during the processing of the return. Such errors include simple math errors and data omissions, such as an incorrect Social Security Number. The designation also enables the third party to discuss the status of a refund, payment or other notice with IRS representatives. The third party designation does not eliminate the need for a Power of Attorney for issues dealing with examinations, under reported income, appeals and collections notices, etc.
Deadlines are deadlines. In David Gilmartin (2002-1 USTC 50,120; U.S. District Court, So. Dist. N.Y.) the Court held that the taxpayer's petition to quash two summonses for records from third parties was denied because the request was made 12 days too late. Other summonses sent to his employer and to a school were not quashed because the Court held those parties were not third-party recordkeepers. Thus, the IRS did not have to give him notice the summonses were filed.
President Bush is still determined to get Congress to pass a stimulus plan that would provide some $90 billion in tax reductions and help for unemployed individuals.
More than one bill has been introduced in Congress that would restrict the amount of employer's stock that can be put in a 401(k) and other types of defined contribution plans. Even ESOPs (Employee Stock Ownership Plans) may be restricted from putting all their assets in employer stock.
The IRS is not limited to the normal 3-year statute of limitations if you omit more than 25% of your gross income on your tax return. In CC&F Western Operations Limited Partnership, CC&F Investors, Inc. (2002-1 USTC 50,119; U.S. Court of Appeals, 1st Circuit) the taxpayer argued that there were enough clues on the return to adequate apprise the IRS of the omission. The Court did not agree with that argument. It found that the disclosure was not sufficient to prevent the Service from using a 6-year statute of limitations.
Victims Of Terrorism Tax Relief Act of 2001
Congress has, on a number of occasions, provided special relief to members of the U.S. armed forces who serve in combat zones, and, on several occasions to provide tax relief for service members and other individuals whose lives have been affected by particular instances of hostile action involving the U.S. In this Act, Congress has provided a number of relief provisions to those affected by the September 11th terrorist attack. Since the new law affects only a limited number of taxpayers, we have just included the highlights below. Affected individuals include those who died or were injured in the terrorist attacks on September 11, the Oklahoma City bombing in 1995, and bioterrorism involving anthrax on or after September 11 and before January 1, 2002. It provides similar benefits to terrorist victims as the code gives to the families of soldiers, sailors, and civilian government employees killed in war zones or in terrorist attacks abroad.
The new law will:
Surviving spouses or executors of the Sept. 11 or anthrax victims may file amended tax returns for 2000 at any time until April 15, 2004, and may claim the tax relief for 2001 when they file the decedent's return. Survivors or executors of those killed in Oklahoma City may file amended returns for 1994 and 1995 until Jan. 23, 2003.
Survivors or executors of these "Killed In Terrorist Action" (KITA) victims should put "KITA-Oklahoma City," "KITA-9/11" or "KITA-Anthrax," as appropriate, at the top of any amended or original tax returns claiming this relief and send them to the Internal Revenue Service, P.O. Box 4053, Woburn MA 01888. If using a private delivery service, they should send them to IRS, 310 Lowell St., Stop 661, Andover MA 01810.
The IRS is now finalizing a new Publication 3920, "Tax Relief for Victims of Terrorist Attacks," which will include details on preparing refund claims. The IRS expects to make Pub. 3920 available in February on its Web site at www.irs.gov. Pub. 3920 will also be available by calling (toll-free) 1-800-TAX-FORM (1-800-829-3676). Taxpayers with questions about KITA relief may call (toll-free) 1-800-829-1040.
See Internal Revenue Service News Release IR-2002-07 for additional information.
President Bush signed this legislation on January 23, 2002. Taxpayers affected by the attack and their advisers should check the full text of the law. There are a number of provisions and many can have important tax consequences.
Taxpayer Loses on Four Issues--Wins on One
In this case, George Tsakopoulos, et ux.(T.C. Memo. 2002-8), there were several issues. The taxpayer owned an interest in several real estate ventures. One (Stockton) had been used as a gasoline dispensing and vehicle washing and repair facility. This soil and groundwater on this property was contaminated with products from the former operations. Two other properties were shopping centers. Finally, two properties were raw land. There were a number of issues here, most of which are frequently encountered by real estate investors.
Abandonment loss. The taxpayer claimed that he abandoned the Stockton property (in which he had a 22% interest; his brother held the remaining interest) because the cost of cleaning up the environmental problems was more than he was willing to pay. He did incur substantial costs, but decided to cut his losses. He transferred the property to his brother by deed. The taxpayer claimed an abandonment loss of nearly $400,000.
The Court held that abandonment cannot occur if the transferor intends for a particular person to be the transferee. In an earlier case a court said that abandonment must be made by the owner, without being pressed by any duty, necessity, or utility to himself, but simply because he no longer desires to possess the thing; and, further, it must be made without any desire that any other person shall acquire the same; for if it were made for a consideration it would be a sale or barter, and if without consideration, but with intention that some other person should become possessor, it would be a gift. Under California law, abandonment occurs only when you leave the property "free to the occupation of the next comer, whoever he may be, without any intention to repossess or reclaim it for himself in any event, and regardless and indifferent as to what may become of it in the future".
This an important point. Letting a relative take over a property would be considered a gift. Letting a customer take equipment might be considered a sale for future consideration. Either way, you could end up being denied an abandonment loss which could reduce ordinary income dollar-for-dollar. If the transfer is considered a sale, there can be other tax consequences, depending on your particular tax situation. Here the taxpayer lost a deduction worth close to $400,000. Whether or not a property is abandoned is determined by the facts. Talk to your tax adviser before taking action. Doing so after the fact may be too late.
Roofing Work. The taxpayer had roofing work done on two of his shopping center properties. On one the contractor determined that the original work was poorly done and he decided to tear off the original roof and put on a new one. On the second property, the taxpayer replaced the roof on an area equal to some 10% of the property. The taxpayer deducted the cost of both jobs; the IRS claimed the expenditures had to be capitalized.
If an expenditure is truly for a repair, the amount can be deducted immediately, no matter how large the expense. However, in order to be a repair, the work must neither materially add to the value of the property nor appreciable prolong its life, but keep it in an ordinarily efficient operating condition. Work in the nature of a replacement, to the extent it arrests deterioration and appreciably prolongs the life of the property must be capitalized.
This is not an easy area to understand. Even disinterested parties have frequently made mistakes here. The taxpayer cited a number of cases to support his position, but the Court held that they were distinguishable from the instant case because they involved instances in which the repairs were of a recurring nature, part of a regular maintenance program, or necessary due to storm damage. The taxpayer presented an expert witness, Robert Cox, who testified that the entire roof was not replaced, that many components were reused, and that the work was of poor quality so that it did not prolong the life of the roof nor materially add to its value. Mr. Cox concluded that the work was "merely incidental repairs". The IRS countered with testimony from the contractor who did the work. The contractor testified that the entire roof was removed and replaced from scratch. The contractor provided a 10-year warranty on the work. The Court found the work to be a capital expenditure, not a repair.
The same contractor worked on the second shopping center. Here, only a portion of the total roof area was replaced, but the work on that section was similar. That is, the entire roof was torn off and replaced. The Court ruled that this too was a capital expenditure, not a deductible expense, despite the fact that only a small portion was replaced.
Real estate taxes on unimproved property. You can deduct real estate taxes on property held for investment. However, If property is held for future production, you must capitalize direct and indirect costs allocable to the property (e. g., purchasing, storage, handling, and other costs), even though production has not begun. If property is not held for production, indirect costs incurred prior to the beginning of the production period must be allocated to the property and capitalized if, at the time the costs are incurred, it is reasonably likely that production will occur at some future date. Thus, for example, a manufacturer must capitalize the costs of storing and handling raw materials before the raw materials are committed to production. A real estate developer must capitalize property taxes incurred with respect to property if, at the time the taxes are incurred, if it is reasonably likely that the property will be subsequently developed.
The Court noted that the year in which the real estate taxes were paid, taxpayer filed a document with the County outlining plans to subdivide the property. The taxpayer testified that he filed the application to change the zoning of the property from SPA to residential zoning because the SPA zoning was depressing the value of his property. He also testified: "I filed this application to give attention to County of Sacramento. My properties are ready to be developed". The Court found that it was the taxpayer's intention and reasonably likely that the property would be developed when the taxpayer paid the property taxes for the year in question. Thus, the Court held that the taxes paid must be capitalized for that year.
Business purpose not shown. Just because you have an invoice and a canceled check, doesn't mean you'll be assured a deduction. You still might have to show the business purpose for the expense. Here the taxpayer lost on two expenditures. The first was a $30,000 payment to a roofing company. The taxpayer could not provide any credible testimony to show the business purpose. The Court denied the deduction.
The second expenditure challenged was a $7,472 payment to Consolidated Electrical Distributors. Again, the taxpayer could provide no evidence as to the business purpose of the payment. Although the payment was made from a business account of the taxpayer's, the IRS pointed to instances in which taxpayer paid personal expenses from this bank account. The taxpayer countered that there could have been no other purpose for the payment but for a business purpose. The Court sided with the IRS. The taxpayer conceded that some expenses paid from his business bank account were not for business purposes.
The taxpayer may have lost on the second issue even without the added burden of having paid personal expenses out of the business account. However, the point is important. Avoid paying personal expenses out of the business account. Write yourself a salary check or take a distribution. Check with your tax adviser. He may have other ideas, depending on your situation.
Cancellation of indebtedness income. If a debtor cancels or forgives a debt you owe, you generally have income equal to the amount forgiven. The IRS argued that the taxpayer owed his brother $111,229 for the amount his brother paid for the taxpayer's share of the cleanup expenses on the Stockton property. The IRS contended that because the taxpayer has not repaid the amount and his brother has not attempted to collect it, the taxpayer should have recognized the amount as cancellation of indebtedness income in the year the property was transferred to his brother. The brother testified that it was common for him to advance to the other owners the funds to pay the expenses on a property. He further testified that he treated the advances as loans and interest accrued on the advances. He also stated that he does not pursue collection on these loans actively. The Court found the brother's testimony credible. It held that the taxpayer did not have any cancellation of indebtedness income for the year in question.
Previously Reported In Daily Update
Escape clauses . . . If you're in a joint venture, partnership, even a special marketing approach, with another business or even another individual, you should ask your attorney about escape clauses in any agreement. The clauses should allow you to back out of the joint venture, etc. if the other party engages in any illegal practices, declares bankruptcy, etc. You don't want to find yourself or your business in the news or in financial difficulty simply because the other party is in trouble. Talk to your attorney. He should be able to advise you on your potential exposure and provide the proper wording.
Disability proceeds not taxable . . . The general rule for proceeds received from disability policies is that the they are not taxable if you, the employee, pay the premiums. If your employer pays the premiums in full, any proceeds are fully taxable (there are certain, limited, exceptions to this rule). If you pay part of the premium and the employer pays part, a percentage of the proceeds are taxable, based on the percentage of the employer's contribution. In a recent letter ruling (LR 200204021) an employer asked the IRS what the tax consequences would be if the company paid the disability premiums on a group policy, and included the amount of the premiums attributable to each employee in the employee's income for the year (e.g., included the amount on the employee's W-2). The IRS held that any proceeds received by the employee would be nontaxable. (The employer went a step further. The company would "gross up" the employee for taxes the employee would have to pay. That payment would also be taxable.) Here the company gets a tax deduction for the full amount of the premiums paid. The employee has taxable income, but his cash outlay is much less (it's equal to just his marginal tax rate times the amount of the premium included in his income) than if he had paid for the policy. And the proceeds are nontaxable. If, as an employer, you don't want to pay the premiums, you might consider buying a group policy and charging employees for their share of the cost. In a Tax Court case (Bouquet, T.C. Memo. 1994-212) the Court held that in such a situation the employer simply acted as an agent. (The employees signed agreements to reimburse the corporation for the expense.) Here again, the proceeds paid on disability were not taxable. While the employees were out of pocket the premiums, they were less than they would have paid under individual policies. Talk to your tax adviser and financial adviser on the relative merits of each approach.
Unemployment insurance could be going up . . . When you pay unemployment taxes to your state, the amounts go into a special fund. When the fund gets depleted because of unemployment claims, the state is forced to raise the rate. That's when is or will be happening soon in many states. Rates may also be going up for worker's compensation, but for other reasons. There isn't too much you can do about it. However, your rates for both are usually based on only a part of the worker's wage. For example, you probably pay unemployment insurance on only the first $8,500 of wages. Hiring two part-time employees for $8,500 each will be twice as expensive as hiring one full-time employee for $17,000. High turnover will also raise your total payments. These charges may not be a big consideration for some businesses, but they can be for those that have many low-wage workers. For worker's compensation coverage, make sure your employees are properly classified and you're not listing more employees than you have. Review your charges for unemployment insurance and worker's compensation. There may be steps you can take to save several thousand dollars a year, even for a small business. Talk to your accountant, or, for worker's compensation, your insurance agent. He or she may have suggestions.
Personal property taxes . . . Not all states have personal property taxes, and for the ones that do, the impact can vary greatly. Personal property taxes are typically levied on equipment, furniture and fixtures, etc. and inventory. If you're a service business or otherwise have no inventory and only a few hard assets, don't bother reading further. But if you're a manufacturer, have inventories, etc., there may be ways to reduce your personal property taxes. Here are some tips:
Accounting for property held for sale or lease . . . It's not unusual for a retailer or wholesaler of equipment, furniture, etc. to lease property to customers in the ordinary course of business. But when is leased equipment in inventory and when is it not? In recent Technical Advice (TAM 200203001) the IRS held that when the equipment is first leased it has to be removed from inventory. That's true even if the equipment is also held for sale. The Service held that while in the leasing operation, the equipment should be depreciated. The IRS also held that the equipment would not be returned to inventory until such time as it was permanently withdrawn from the leasing operation. That might occur when it was no longer offered for lease. At that time depreciation would stop. Idle periods between leases wouldn't mean the equipment would automatically revert to inventory. Note that the leases in this situation were true leases. The lease terms were for much less than the life of the equipment. In addition, leasing was a substantial portion of the company's overall business. The proper tax treatment can depend on the facts. Check with your tax adviser to be sure.
Shipping rates to increase again . . . The major package carriers (FedEx, UPS, etc.) have announced increases in their rates. While the basic rates are increasing, of more concern to many businesses are accessory fees, such as an increased charge for residential delivery, a higher charge for not including your account number on your delivery slip, an increase in the cost of having a bad address (including a bad zip code), etc. What can you do? Here are some options:
Finally, make sure your employees understand the rules, the cost, and the reasons for trying to save money.
Home office deduction for employees . . . While the rules have been eased for self-employed individuals who use a portion of their residence for a home office, they haven't change with respect to employees who use their home for business. The rule is, the home office must be for the convenience of the employer. It can't be just appropriate or helpful to your business. Getting a letter from your boss may not mean much. For example, you're required to do paperwork after hours, but your office closes at 5 and is closed on weekends. You may be able to take a home office deduction. On the other hand, assume the office is open until midnight and on weekends, but getting home after 7 would add two hours to your trip because the trains don't run as often. Too bad. Having an office at home would be for your convenience, not your employer's. The facts are critical. Best advice, check with a tax professional.
Filing electronically? . . . The IRS continues to push this method. It can be easier for taxpayers and it costs the government much less to process an electronically filed return. Most taxpayers can file electronically using either a paid preparer or computer software over the net. In addition, taxpayers in 37 states and the District of Columbia can e-file their federal and state tax returns in one transmission to the IRS. The IRS forwards the state data to the appropriate state tax agency. The following states allow electronic filing--Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia.
Charitable contributions of property . . . If you make a charitable contribution of property, you're allowed a deduction for the fair market value of the property at the time of the contribution. Many taxpayers make contributions of clothing (used or new) they no longer need. While special rules apply to property contributions in excess of $5,000 (you'll need an appraisal), that's not true for smaller contributions. The charity will usually give you a receipt (clothing bin drops are an exception; best to avoid them except for small contributions). The receipt should detail the items donated and the condition. The charity should sign the receipt. You should add (as soon as possible) the age and original cost of the articles. The charity won't value the property; that's your responsibility. If your total noncash contributions for the year exceed $500 you'll have to attach a Form 8283 to your return.
Rental rates attractive . . . If you're look for new or additional space for your business, rates are trending to an intermediate-term low. You might also consider locking in these rates if your lease comes up for renewal soon. The landlord might be receptive since he'll know he's locked in a tenant for another 5 years. There are a number of factors to consider. Talk to a competent leasing agent. He or she should be able to give you tips on how much negotiating room you have and what concessions you can get from the landlord. For example, 2 years ago when the market was booming many building owners significantly reduced or completely stopped the practice of providing free alterations, even to new tenants. That's changed considerably. Important. Markets vary. Some are very soft; others are off only slightly.
Ad rates attractive . . . On more than one occasion we've advised readers that dropping all advertising to save cash is often not a good move. Now might be a particularly attractive time to advertise. Almost every form of media is hurting. Newspaper ad pages are down, so are magazines. Some TV air time his gone unused. We don't know about radio, but it can't be much different. If published ad rates haven't dropped for your media choice, try negotiating. If rates have dropped, you might want to see if you can get an even better bargain. Consider your market and your customers. And also consider the possibility of getting a jump or stealing market share from your competitors.
Don't ignore customer complaints . . . Doing so could be fatal. That's particularly true in the current economic environment. Unless you offer a unique product or service, your customers may go elsewhere. Most customers don't complain without a good reason. Those complaints can alert you to a problem with your product or service that you wouldn't have known about without customer feedback. Sometimes rectifying the problem can be expensive, but just as often the cost may be nominal. Certainly much less than the loss of business and having a customer go to one of your competitors.
IRS may not disclose return of child to parent . . . Don't automatically assume the IRS will disclose to you the information on your minor son or daughter's tax return. In a recent IRS legal memorandum (ILM 200152042) the IRS held that it can't disclose such information unless the child signs a disclosure consent, earned income is or should have been reported on the child's return, or state law establishes estate guardianship.
Copyright 2002 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536