Small Business Taxes & Management

News On The Tax Front--The latest tax news.

In Brief:--Tax, business, and personal finance tips.

News On The Tax Front

Previously Reported In Daily Update

The IRS is aware (Notice 2004-28; IRB 2004-16) that certain promoters are advising taxpayers to take highly questionable, and in most cases meritless, positions, described below, on current and amended returns regarding income or alternative minimum tax ("AMT") due upon the exercise of nonstatutory or statutory stock options. This Notice alerts taxpayers that the Service intends to challenge such positions and will treat them as frivolous in appropriate cases. However, the Service will consider each position and will not reject or contest it solely because it is submitted along with a frivolous position. The Service also may apply civil or criminal penalties to taxpayers and to promoters of these positions. The positions being promoted include, but are not limited to, the following:

• The options should have been taxed at their grant date rather than their exercise date.
  
• The fair market value of stock purchased under an option is reduced by any restriction placed on the stock by the employer that prohibits the employee from selling the stock for a specified period of time.
  
• When, due to a margin call, a broker sells a taxpayer's stock that was purchased under a nonstatutory option, the stock having been pledged as security for a loan to pay the exercise price, that sale is a forfeiture of the stock that cause an ordinary loss rather than a capital loss.
  
• The purchase of the stock using borrowed funds was not in substance a purchase because the employee did not have the ability to repay the loan.
  
• Options should have been viewed as the economic equivalent of the underlying stock and thus were not subject to any taxation of the spread on exercise.

The IRS has issued regulations (REG-128309-03) providing guidance on the conditions under which a plan amendment may eliminate or reduce an early retirement benefit, a retirement-type subsidy, or an optional form of benefit (section 411(d)(6)(B) protected benefits) with respect to a participant's benefits attributable to service before the amendment. The proposed regulations would also provide guidance concerning how the notice requirements of section 4980F apply with respect to such plan amendments. These proposed regulations would generally affect plan sponsors of, and participants in, qualified retirement plans.

The IRS has announced (Rev. Proc. 2004-20; IRB 2004-13) the depreciation limitations on cars and light trucks, lease inclusion amounts and the maximum allowable passenger automobile value for applying the vehicle cents-per-mile valuation rule for calendar year 2004. The new depreciation limits are actually lower, by $100, than those for 2003. Thus, the maximum first-year depreciation for passenger autos is $2,960 for the first year (vs. $3,060 for 2003); for purposes of the 50% additional first-year depreciation, the amount is $10,610. For light trucks and vans, the depreciation limit is also lower by $100 from last year. Thus, first-year depreciation is limited to $3,260; $10,910 for the 50% additional first-year depreciation. The maximum value of a vehicle that's eligible for the cents-per-mile valuation rule for valuing the use of a company car for personal purposes is $14,800. We're in the process of updating our Vehicle Tables. We'll be posting the update page on Thursday, April 1.

Paper copies of the February 2004 annual revision of Publication 1542, per diem rates, are now available. This is the last regularly scheduled printed edition. All future revisions will be available on the IRS website at www.irs.gov. Paper copies will be available by request only. Beginning this year, interim revisions to Publication 1542 will be made each time changes to per diem rates are announced by the General Services Administration (GSA). A What's Hot article on the IRS website will announce the availability of each new revision on the Internet. The annual issue with the fiscal year per diem rates will be released on the Internet as soon as possible after GSA and the IRS announce those rates. We anticipate the annual issue being available in mid- to late-October. (Announcement 2004-20; IRB 2004-13)

The IRS announced (Notice 2004-27; IRB 2004-16) that it is aware that some taxpayers who acquired stock on the open market for investment have been advised that they may be able to deduct as a theft loss the decline in market value of their stock caused by disclosure of accounting fraud or other illegal misconduct of the officers or directors of the corporation that issued the stock. The purpose of this notice is to advise taxpayers that the IRS intends to disallow such deductions and may impose penalties under Sec. 6662. To claim a theft loss, a taxpayer must prove that the "loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal intent." In cases involving stock purchased on the open market, the courts have consistently disallowed theft loss deductions relating to a decline in the value of the stock that was attributable to corporate officers misrepresenting the financial condition of the corporation, even when the officers were indicted for securities fraud or other criminal violations.

The IRS has issued (REG-121475-03) proposed regulations that amend the final regulations on qualified zone academy bonds. These regulations provide guidance to State and local governments that issue qualified zone academy bonds and to banks, insurance companies, and other taxpayers that hold those bonds. These regulations provide guidance on the maximum term, permissible use of proceeds, and remedial actions for qualified zone academy bonds.

The IRS has issued temporary and proposed regulations (T.D. 9120; REG-129447-01) providing an alternative method of valuing assets for purposes of apportioning expenses under the tax book value method of Sec.1.861- 9T. The alternative tax book value method, which is elective, allows taxpayers to determine, for purposes of apportioning expenses, the tax book value of all tangible property that is subject to a depreciation deduction under Section 168 by using the straight line method, conventions, and recovery periods of the alternative depreciation system under Section 168(g)(2). The alternative method provided in the temporary regulations is intended to minimize basis disparities between foreign and domestic assets of taxpayers that may arise when taxpayers use adjusted tax basis to value assets under the tax book value method of expense apportionment.

The IRS has issued final regulations that (T.D. 9119) facilitate electronic filing of returns prepared by tax return preparers. They provide that preparers may avoid paper copies by retaining and furnishing to taxpayers copies of returns in an electronic or digital format prescribed by the IRS.

The law allows you to exclude from gross income amounts received in damages, by suit or settlement, for personal physical injuries or physical sickness. The underlying claim giving rise to the recovery must be "based upon tort or tort type rights" and the damages must have been received "on account of personal injuries or sickness". In Joseph Tamberella (T.C. Memo. 2004-47) the taxpayer was terminated by his employer and sued for, among other things, wrongful discharge. The taxpayer settled with his former employer. The settlement agreement specified that the first payment represented back wages. That amount was not in dispute. The settlement agreement specified that the second payment, in the amount of $89,840, represents a litigation settlement of claims. This was the amount in issue. The settlement agreement provided that the taxpayer "agrees to waive any right to reinstatement". The settlement agreement specifies that the parties agree that the $89,840 will be reported on a "Form 1099" and that the taxpayer "acknowledged that some or all of the monies" may be considered taxable. The taxpayer did not report the amount on the 1099 on his tax return. The Court found that, despite the fact he was hospitalized for mental illness and high blood pressure, there was nothing in the record to indicate that any portion of the settlement was for physical injury. The taxpayer presented no evidence, except for his self-serving, unverified and undocumented testimony that any portion of the award was for his personal physical injury. The Court held the full amount to be taxable.

The IRS has issued proposed regulations (REG-128309-03) that would permit employers to make simplifying changes in their retirement plan distribution options while protecting the rights of plan participants. These regulations interpret certain retirement plan provisions that were enacted under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The regulations are based on suggestions received in response to a solicitation of comments published by the IRS in 2002 and 2003. Under the proposed regulations, an employer could eliminate an optional form of benefit if the plan retains a similar form with the same value or if the plan permits participants to select among a specified group of core options that have the same value as the eliminated form. The regulations would allow plan sponsors with many different payment options to simplify the number available; however, they generally do not permit elimination of a lump sum payment option.

In Notice 2004-17 the IRS provided guidance with respect to payments received under the Smallpox Emergency Personnel Protection Act of 2003 (SEPPA). SEPPA authorizes the IRS to provide benefits to eligible individuals who sustain covered injuries as a result of the administration of covered countermeasures (including the smallpox vaccine). Payments received under SEPPA by eligible individuals for covered injuries are excluded from gross income for federal income tax purposes (except for amounts attributable to, and not in excess of, deductions allowed under Sec. 213 (relating to medical expenses) for any prior taxable year). Additionally, such payments do not constitute wages and are not subject to withholding for FICA, FUTA, and federal income tax purposes and do not constitute earnings from self-employment.

Before making a levy on a taxpayer, the IRS must issue a Notice of Intent to Levy. In Charles P. Durrenberger (T.C. Memo. 2004-44) it did so. The taxpayer filed a petition for lien or levy action under Sec. 6320 or 6330(d) in which he contended: (1) there had been no valid assessment of taxes; (2) he had not received a statutory notice and demand for payment of the taxes at issue; (3) he had not received a notice of deficiency; (4) respondent incorrectly determined his underlying tax liability; and (5) respondent improperly refused to permit him to record the Section 6330(b) hearing. The taxpayer claimed the Service's filing of a tax lien relating to his 1998 tax liability was appropriate was an abuse of discretion. The taxpayer argued that because his wages are exempt from garnishment under Texas law, the IRS may not levy on them. The Court held that federal tax collection statutes superseded state-created exemptions to tax collection. The Court held that the issuance of a levy was not an abuse of discretion.

The IRS has issued final, temporary and proposed regulations (T.D. 9117, REG-167265-03) under Section 1502 that govern the application of Section 108 when a member of a consolidated group realizes discharge of indebtedness income. These regulations affect corporations filing consolidated returns.

The Small Business/Self Employed (SB/SE) division of the Internal Revenue Service initiated its Examination Reengineering effort to improve the quality and consistency of income tax examinations. Some of the features of the reengineered field examination process are:

• Clearly communicated expectations of both the taxpayer and field agent through mandatory discussions between the revenue agent and taxpayer regarding the specific examination issues, required documentation, and a mutually agreed upon date to complete the examination.
  
• At the beginning of each examination, field agents and their managers will meet to discuss the agent's approach to the examination, the plan to close the examination, and the mutual commitment date arrived at with the taxpayer.
  
• Field agents will use standardized templates for every examination issue to gather the information necessary to resolve issues. Agents will use a standardized guide when deciding if additional issues need to be added to the examination. The agent will explain to the taxpayer if any additional issues are included in the examination.

Some of the features of the reengineered office examination process are:

• Clearly communicated expectations of both the taxpayer and the examiner prior to the initial appointment. Office examiners will provide the taxpayer with focused document requests that specifically identify the information needed.
  
• Improved flexibility in the scheduling process will enable examiners and taxpayers to reduce the time it takes to complete an examination.
  
• Office examiners will use standardized templates for every examination issue to gather the information necessary to resolve issues. Examiners will use a standardized guide when deciding if additional issues need to be added to the examination. The examiner will explain to the taxpayer if any additional issues are included in the examination.

With the final adjustments made, SB/SE will train all of its income tax field agents and office examiners during the 2004 fiscal year. Field agent training began in December 2003 and training for the office examiners began in January 2004. The redesigned examination process will benefit taxpayers and practitioners because the audits will be better focused on relevant issues, expectations between the examiner and taxpayer will be clearly communicated, and the time it takes to complete the examination may be reduced.

The IRS is advising farmers (IR-2004-38) who pledge part or all of their production to secure a CCC loan they may not be properly reporting market gain when they use CCC certificates in connection with paying off their loans. Farmers who pledge any of their production to secure a CCC loan can make a special election to treat the loan proceeds as income in the year received and obtain a basis in the commodity for the amount reported as income. A farmer can make the special election by reporting the CCC loan proceeds as income on line 7a of Schedule F for the year the loan is received and attaching a statement to the return showing the details of the CCC loan. While the election can be made without IRS consent, once it is made all CCC loans, in that year and in later years must be reported in the same manner until a change in accounting method is filed with the IRS. Farmers who do not make the special election should report market gain as income. For more information see Internal Revenue News Release IR-2004-38 and IRS Publication 225, Farmer's Tax Guide.

You can generally increase your basis in an S corporation (so that you can utilize any losses) by direct loans to the corporation (simply guaranteeing a loan made from a third party to the corporation won't work). But the general rule doesn't apply if you are not at risk with respect to the loan, that is, you are protected in some way from sustaining a loss on the loan. In Donald G. Oren, Beverly J. Oren (2004-1 USTC 50,165; U.S. Court of Appeals, 8th Circuit) the Court affirmed the Tax Court decision and held that the taxpayers were not at risk since there was possibility the taxpayers could sustain a loss. The loans had no economic substance and, thus, were not real economic outlays. The Court noted that the taxpayers observed all the formalities of a loan, buy there were no arm's length elements in the transactions. The Court also noted that in a prior case, it held that a circular lending arrangement, where no single obligation was likely to be called in without the entire cycle of loans being called in, yielded no funds that were genuinely at risk.

The most important thing your accountant told you when you first had employees was to make your payroll tax deposits on time. The penalty for not doing so is substantial. If your total tax deposits for the year exceed $200,000 (the rule is more complicated), you must make your deposits electronically. In F.E. Schumacher Company, Inc. (2004-1 USTC 50,166; U.S. District Court, No. Dist. Ohio, East. Div.) the taxpayer made his deposits on time, but failed to make the deposits electronically, even though required to do so. The Court held that the failure to deposit electronically, when required to do so, made the taxpayer liable for the failure to timely deposit penalties.

The IRS has released the following new or updated IRS Publications:

505 Tax Withholding and Estimated Tax
510 Excise Taxes for 2004
517 Social Security and Other Information for Members of the Clergy and Religious Workers
519 U.S. Tax Guide for Aliens
538 Accounting Periods and Methods
550 Investment Income and Expenses (Including Capital Gains and Losses)
783 Instructions on How to Apply for Certificate of Discharge of Property From Federal Tax Lien
784 How to Prepare an Application for Certificate of Subordination of Federal Tax Lien
929 Tax Rules for Children and Dependents
938 Real Estate Mortgage Investment Conduits (REMICs) Reporting Information
971 Innocent Spouse Relief (and Separation of Liability and Equitable Relief)
1024 How to Prepare an Application for a Certificate of Nonattachment of Federal Tax Lien
1600 Disaster Losses, Help From the IRS
3498 The Examination Process

The IRS announced the applicable federal rate (APR) for April, 2004. The rates are down slightly from those for March. The short-term rate declined to 1.47% from 1.58%; the mid-term rate decreased to 3.15% from 3.34%. The rates have been posted on our site at IRS Interest Rates or go to the IRS site at Index of Applicable Federal Rates.

The House Budget Committee has approved a resolution that would result in some $138 billion in tax cuts over a 5-year period. The spending plan would also extend the expanded 10% tax bracket, marrriage penalty reform, the dividend and capital gains cuts and the expensing rules for small businesses.

The IRS has issued temporary regulations (REG-153172-03)under Sections 337(d) and 1502 relating to the deductibility of losses recognized on dispositions of subsidiary stock by members of a consolidated group, the consequences of treating subsidiary stock as worthless, and when stock of a member of a consolidated group may be treated as worthless. The temporary regulations apply to corporations filing consolidated returns.

If you, your spouse, or a relative are living in an assisted living center or independent living accommodation, a portion of the monthly costs are probably for medical care. The medical care portion of the expenses should be deductible; the amount paid for living expenses (i.e., room and board) isn't. In Delbert L. and Margaret J. Baker (122 TC--, No. 8) the Court held the taxpayers could use the percentage method to allocate the monthly service fee of the facility to medical care. The Court found that the use of the percentage method was well established; the taxpayers did not have to use the actuarial method the IRS wanted.

In Alec Jeffrey Megibow (T.C. Memo. 2004-41) the Court denied the taxpayer a deduction for claimed business expenditures where the taxpayer failed to provide substantiation. The Court noted that the IRS requested the documentation on a number of occasions. The Court imposed the accuracy-related penalty for failing to maintain adequate records and to substantiate his deductions.

After passage of the IRS Restructuring and Reform Act of 1998, the IRS adopted a kindlier, gentler approach. That's changing. The Service has announced that enforcement activities are increasing. The IRS audit rate increased 14% from 2002 to 2003. And collection activities have also increased. Levies declined from a peak in 1997 of 3.7 million to a low of 219,000 in 2000. They've increased to 1.7 million in 2003. Likewise, liens declined from some 800,000 in 1995 to 168,000 in 1999, but have since increased to 503,000 in 2003. Seizures peaked at 10,700 in 1995 and bottomed out at 74 in 2000. They've increased to 399 in 2003.

The commissioners of the tax administrations of Australia, Canada, the United Kingdom and the United States have begun discussions to form a joint task force to increase collaboration and coordinate information about abusive tax transactions. The joint task force would exchange information about specific abusive transactions and their promoters and investors. (IR-2004-35)

A rollover of a retirement plan occurs when distributions from certain qualified plans are contributed or deposited into another qualified retirement plan within a 60-day time period. In Anthony J. and Denise D. Sadberry (T.C. Memo. 2004-40) the taxpayer claimed to have rolled over distributions from a nonqualified plan. The Court found that a rollover could not have occurred because the distributions were from nonqualified plans. In a second issue, the Court found the taxpayers liable for the 10% penalty on certain distributions from an annuity contract. The Court noted Section 72(q)(2) provides a number of exceptions to the 10-percent penalty for premature distributions from annuity contracts. These exceptions are similar, but not identical, to the exceptions provided under Section 72(t) with respect to distributions from qualified retirement plans. The taxpayers contended the distributions are excepted from the 10-percent penalty because the distribution proceeds were used to pay qualified higher education expenses. This exception, however, applies only to qualified plans. There is no such exception for distributions from nonqualified plans.

The IRS has issued a notice announcing its intention to propose regulations regarding the treatment of amounts that facilitate certain tax-free and taxable transactions and other restructurings, and that are required to be capitalized under Sec. 263. (Treasury Department News Release JS-1180 and IRS Notice 2004-18; IRB 2004-11)

The IRS has just released draft instructions for Schedule M-3, Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More. The IRS anticipates that the proposed Schedule M-3 will be used for tax returns ending on or after December 31, 2004. For a copy of the instructions, got to http://www.treas.gov/press/releases/reports/m3_instructions.pdf

In Brief:

Previously Reported In Daily Update

Deducting points . . . Points paid to acquire a home loan may be deductible, if they meet certain IRS criteria. The points must be designated as "loan origination fees", "loan discount," "discount points," or "points." No part of the points may be in lieu of appraisal, inspection, title, and attorney fees or other amounts that are ordinarily stated separately on the settlement statement. (There are other requirements.) Points paid in connection with a loan to acquire your principal residence or for a loan used to improve your principal residence are deductible in the year paid. Points paid to refinance a home mortgage aren't currently deductible, but may be amortized over the life of the loan. Any unamortized amount may be deducted in the year the mortgage is paid off.

Reporting a property sale on the installment basis? . . . If you did, the new capital gain rules apply to the payments received this year and in the future. That is, payments received before May 6, 2003 are taxed at the old capital gain rates--20% and 10%. Payments received on or after May 6, 2003 are taxed at the new rates--15% and 5%. Make sure you enter the payments correctly on Schedule D.

Let your child take his own exemption . . . That might make sense if he or she is in college and your AGI is high enough that you can't claim the Hope or lifetime learning credit. But don't assume that just because you can't take the credit, you'll be better off with your child taking it. Your child will have to have some relatively substantial earnings, $7,800, before his or her income will exceed the standard deduction and personal exemption. Only then will they be subject to any tax. And if there's no tax, the credit is worthless. In addition, keep in mind that the first $7,000 of taxable income is taxed at only 10%. Thus, a total of $14,800 will only use up only $700 of credit.

Like-kind exchange of vacation home . . . You can defer tax on the sale of a rental property or property used in a trade or business by effecting a like-kind exchange. For example, exchanging a apartment building in Chatham for a small strip mall in Greenfield. But the like-kind exchange rules only allow deferring the gain on property held for investment or productive use in a trade or business. That would generally exclude your vacation home, since it's held for personal purposes, not as an investment. But there could be some situations where a vacation home would qualify. If the property is rented for a significant portion of the year and your personal use is minimal (e.g., 14 days or less), or if the property, while not usually rented, was used very little for personal purposes and you can show that it was purchased and held for appreciation, a like-kind exchange may pass an IRS challenge. To show an investment intent, you should capitalize the taxes and interest on the property. There's no hard and fast rule here. Get good advice and plan early to establish a fact pattern.

Carryovers . . . The tax law limits many deductions for a variety of reasons. For example, capital losses can be used to offset capital gains or up to $3,000 can be used annually to offset ordinary income. Losses in excess of that amount can be carried forward and used in future years. If you're using tax software and have been careful in entering all your data, the program should carry forward such items automatically. However, if you're entering your data for the first time, switching software or doing your return by hand, it's easy to miss a carryover. Some of the more common carryover items are investment interest, capital losses, net operating losses, passive activity losses (which can be limited for several reasons), charitable contributions, business credits, and the Section 179 expense option which can be limited by your income.

Private aide deductible as medical expense . . . If, for medical reasons, you have to hire an aide to care for you, the cost of the aide should be deductible as a medical expense. What would constitute a medical reason? You don't have to be totally disabled, it could be because you can't bathe or dress yourself, need attention because of a stroke, etc. The aide doesn't have to be full-time, and doesn't have to be a licensed nurse. In one case a taxpayer was able to deduct amounts paid to a neighbor who assisted him with a wheelchair while on out-of-town assignments. In one case the court allowed a deduction for amounts paid to the taxpayer's daughter for care. But the IRS and courts draw the line on housekeeping duties. No deduction is allowed for amounts paid to cook or clean the house (or running personal errands such as shopping, etc.). That's true even if the individual was not physically able to cook. If the aide performs both medical assistance and housekeeping duties, you can only deduct amounts for medical assistance. The IRS has disallowed any deduction where the aide performed both medical and housekeeping duties. The courts have been more sympathetic, sometimes allowing 2/3 sometimes 75% of the cost as a medical expense. This can be a tricky area, but the deductions can be substantial. Keep good records and get professional advice. And don't forget to follow the employment tax rules. If the individual is your employee, you'll have to pay FICA, unemployment taxes, etc.

Form 2210 may help you avoid a penalty . . . The easiest way to avoid a penalty for underpaying your estimated taxes is to make sure you've paid in (in equal amounts for each required estimated tax date or through withholdings) at least as much as last year's tax liability. If you haven't, you could be liable for an estimated tax penalty. But all is not lost. You may be able to eliminate or at least reduce the penalty if your income was earned in unequal amounts during the year and your estimates cover the liability by quarter. For example, you didn't make the first two required estimated payments and you paid $3,000 in September and $7,000 in late December. Your liability for the year was $12,000. Assuming your liability for the prior year was the same amount and your income was earned equally throughout the year, you'd be liable for a penalty for underpaying the first two estimates and for the year as a whole. But if your business had no earnings during the first two quarters, you're underpayment penalty for the first two quarters would be $0 if you use the annualization of income method for computing your estimates instead of basing them on last year's liability. What to do? Get Form 2210 and, if you're not using a computer, get ready for a long evening. This is truly a tedious form to complete. If the penalty is small, say $5, you might just want to pay it and move on. But if you're using a computer, there are just a minimum number of entries to make.

Installment sale--electing out . . . If you sell real or personal property (other than property held as inventory), and you will receive any payments in a year after the year of sale, you can report the gain from the sale on the installment basis. Generally, it makes sense to spread the gain over a number of years, particularly if that's how you'll be paid. But there are situations when it makes sense to elect out of the installment method. For example, your income this year is very low and you're expecting it to increase in the future; you've got a big capital loss or capital loss carryforward that you want to use; etc. By reporting the sale on Form 6252 (Installment Sale Income) you'll be electing to take the gain into income as you receive payments. You can elect out of the installment method by simply reporting the entire gain in the year of sale. (Keep in mind that you'll have to pay all the tax with your 2003 return, even though you haven't received the cash.) That is, just put the entire gain on Schedule D or From 4797. Generally, once you file Form 6252 you may not later elect out of the installment method. However, if your original return was filed on time, you may make the election on an amended return filed no later than 6 months after the due date of your return. Write "Filed Pursuant to Section 301.9100-2" at the top of the amended return.

Want to speed that refund? . . . Electronic filing is the fastest way, but you can still reduce the wait time for your refund significantly if you elect direct deposit of your refund. It's easy. Just put the routing and account number of your bank account on your return and indicate whether the funds are to go to your checking or savings account. Double check the numbers before sending the return. If the account number is wrong, the IRS will cut you a check, but that will drag out the process.

Offer in compromise scams . . . The IRS has issued a consumer alert advising taxpayers to beware of promoters' claims that tax debts can be settled for "pennies on the dollar" through the Offer in Compromise (OIC) Program. The IRS noted that some promoters are inappropriately advising indebted taxpayers to file an OIC. The Service is concerned about unscrupulous promoters charging excessive fees to taxpayers who have no chance of meeting the program's requirements. Generally, a tax liability can only be compromised through an OIC if:

• there is doubt the tax liability is correct
  
• there is doubt the taxpayer can pay the full amount of the liability, or
  
• collection would be unfair, inequitable or create an economic hardship.

In addition, you've got to meet certain other requirements such as having filed required returns on time. Many taxpayers seek relief under the second reason. Using that approach you've got to be able to show you can't pay the full amount, not even using an installment plan, can't borrow from traditional sources and can't sell assets to raise cash. OICs do work for certain taxpayers, but they are not the easy answer portrayed in some ads.

Married, filing separately? . . . Many taxpayers think they can save taxes by filing married, separate. While it sometimes produces a lower tax, it doesn't do so often. Why? Because there are a number of special rules that come into play. Here are some of them:

• Your exemption amount for the alternative minimum tax will be half that for a joint return
  
• You cannot take the credit for child and dependent care expenses in most cases
  
• You cannot take the earned income credit
  
• You cannot take the education credits, the student loan deduction, or the tuition and fees deduction
  
• If you lived with your spouse at any time during the year, you'll have to include more (up to 85%) of your social security benefits
  
• You cannot roll over amounts from a traditional IRA to a Roth IRA
  
• If your spouse itemizes deductions, you cannot claim the standard deduction (you must itemize also)
  
• Special rules apply for the deduction for contributions to IRAs
  
• The special $25,000 allowance for passive rental losses is generally disallowed

Still, if you have some unusual circumstances and do your taxes by computer, you might want to try it both ways. It should be relatively easy to run the computations both ways--married, filing joint and married, filing separate.

State estate taxes . . . While the federal estate tax is becoming less of a concern to many individuals and could disappear entirely, that's probably not true for state estate taxes. Why? Estate taxes raise a considerable amount of revenue for a number of states. And many of those states are hard pressed for money. Another factor to consider is that you no longer get a full credit for state estate taxes on your federal estate tax bill. In fact, after 2004, you'll only get a deduction. Good planning can reduce the bite. You might consider moving to another state. But before doing so, check all the taxes in the new state, and make sure they won't be changing their rules.

Partnership K-1 errors . . . If you believe the partnership in which you are a partner has made an error on your Schedule K-1, notify the partnership and ask for a corrected K-1. Don't change any items on the K-1. Be sure the partnership sends a copy of the corrected K-1 to the IRS. If you are a partner in a partnership that does not meet the small partnership exception and you report any partnership item on your return in a manner different from the way the partnership reported it, you must file Form 8082.