News On The Tax Front--The latest tax news.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
The House has approved a bill that would extend the relief from the marriage penalty by making permanent the higher standard deduction and the higher ceiling on the 15-percent tax bracket for couples filing married, joint. However, it's unlikely the bill will get past the Senate because of the lack of revenue offsets. It may emerge later as part of another bill.
In Internal Revenue News Release IR-2004-59 the IRS cautioned that charities should be careful that their efforts to educate voters comply with the Internal Revenue Code requirements concerning political campaign activities. Organizations described in Section 501(c)(3) of the Code that are exempt from federal income tax are prohibited from participating or intervening in any political campaign on behalf of, or in opposition to, any candidate for public office. Charities, educational institutions and religious organizations, including churches, are among those that are tax-exempt under this Section. These organizations cannot endorse any candidates, make donations to their campaigns, engage in fund raising, distribute statements, or become involved in any other activities that may be beneficial or detrimental to any candidate. Even activities that encourage people to vote for or against a particular candidate on the basis of nonpartisan criteria violate the political campaign prohibition of Section 501(c)(3).
You can't simply transfer assets out of your name, your corporation, etc. to a relative or related party to avoid your obligations to creditors. In Self Heating and Cooling, Inc. (T.C. Memo. 2004-85) the taxpayer tried to save his assets from the IRS and state tax authorities by transferring them to a new corporation that would be owned by his sons. The Court held the corporation fraudulently transferred its property in violation of state law. Thus, the new corporation was liable for the debts as transferee.
The IRS has launched a new online form that gives tax professionals a faster, easier method of applying to become an authorized e-filer. Tax professionals now have an online application form that cuts processing time and reduces errors associated with using the paper Form 8633, Application to Participate in IRS e-file. Once the application is approved by the IRS, tax professionals can e-file returns for their clients. For more details see Internal Revenue News Release IR-2004-58.
If you're the officer of an S corporation and provide services to the corporation, you must take a salary. You can't simply take distributions. In Specialty Transport & Delivery Services, Inc. (2004-1 USTC 50,203; U.S. Court of Appeals, 3rd Circuit) the Court upheld the Tax Court ruling that the distributions were really remunerations for services rendered, thereby constituting wages for both FICA and FUTA purposes.
One reason for informing the IRS of any address change is that the Service is only required to send any notices to your last known address. If you don't inform them of a change and you don't get the notice in time, you may be precluded from contesting it. The best way to inform the IRS is by filing Form 8822. But there are other ways to give the IRS notice. In Thomas W. Hunter, Jr. (T.C. Memo. 2004-81) the Tax Court held that the taxpayer, who submitted Form 2848, Power of Attorney, with his new address to the IRS, gave the IRS clear and concise notification of his change of address.
In Nick Kikalos and Helen Kikalos (T.C. Memo. 2004-82) the taxpayer operated four retail stores selling cigarettes, beer, liquor, wine, and other products. During the year at issue, cigarette manufacturers employed "buy-down" programs to lower the cost of cigarettes at which retailers, sold to consumers. A buy-down is a discount given to a retailer for each carton of cigarettes sold during a given promotional period. The Tax Court sided with the IRS in finding the taxpayer had unreported buy-down income, promotional and coupon income, unreported income from vendor refunds and reimbursements, and unreported income from bulk sales. The Court also allowed the imposition of the accuracy-related penalty because the IRS met the required burden of production for the determination of the penalty.
In limited situations, taxpayers filing joint federal income tax returns may be relieved from joint and several liability pursuant to Section 6015. Known as innocent spouse relief, the taxpayer must satisfy a number of requirements. In Andrea J. Vuxta (T.C. Memo. 2004-84) the Tax Court found that the taxpayer did not carry her burden of establishing the requirements for innocent spouse relief with respect to most of the years at issue. However, the Court did find that for one year the taxpayer qualified for innocent spouse treatment.
When dealing with tax authorities, there are almost always deadlines. It may be as ordinary as a filing deadline or as unusual as the time limit for filing a petition with the Tax Court. Sections 6320 (pertaining to federal tax liens) and 6330 (pertaining to levies) establish procedures for administrative and judicial review of certain collection actions. As an initial matter, the IRS is required to provide a taxpayer with written notice that a federal tax lien has been filed and/or that the IRS intends to levy; the IRS is also required to explain to the taxpayer that such collection action may be challenged on various grounds at an administrative hearing. The law requires that the notice be sent by certified or registered mail to such person's last known address. The taxpayer has 30 days in which to appeal the notice. In Don Weber II (122 TC--, No. 12) the IRS followed the procedure but the letter was returned unclaimed. The Court noted the taxpayer did not file a petition with the Court within the 30-day period. In fact, notice was not filed until some 8 months later. The fact that he actually received the notice. In addition, a courtesy copy of the notice sent 8 months later was not a notice of determination under Section 6320 or 6330 and did not revive the 30-day period.
Tax law can conflict with other laws and you should check the tax consequences of your actions before engaging in a transaction. In this case (Richard R. Hamlett; T.C. Memo. 2004-78) the taxpayer sold stock in two S corporations in 1995. He did not deliver the shares until the full purchase price of $100,000 was paid, without restriction, in 1996 and the taxpayer transferred the stock to the buyer. In 1998 the taxpayer filed for bankruptcy. The bankruptcy trustee accused the taxpayer of bankruptcy fraud and the court found the sale of the corporations void ab initio. As a result, the sale of the stock in the corporations was void. The Tax Court held that, under the claim of right doctrine, the taxpayer had to report the sale as taxable income in 1996, the year he had unrestricted rights to the funds.
In Treasury Department News Release JS-1267 the IRS announced a tax treaty between the U.S. and Sri Lanka has been approved by the Senate.
There may be a good reason to cover an employee under your pension plan. Owners of most small corporations want to exclude employees. In Raymond B. Yates, M.D., P.C. Profit Sharing Plan, and Raymond B. Yates, Trustee (2004-1 USTC 50,200; Supreme Court of the United States, 02-458) the Court reversed an Appeals Court decision on the protections ERISA affords plan participants. The Court held that since the plan covered employees in addition to the sole shareholder and his spouse, the shareholder-employee was afforded the same protection as other plan participants and could receive favorable tax treatment under Sec. 401.
The IRS can issue a third-party summons to get your records from your bank, broker, etc. But before doing so it must provide you with notice to enable you to contest the action. In James Clay Boyd, Debra E. Boyd (2004-1 USTC 50,199; U.S. Court of Appeals, 6th Circuit) upheld a District Court decision that summonses issued to a chiropractor, a boat and auto dealer and two insurance companies were not third-party recordkeepers according to the list provided in Sec. 7609. Thus, the taxpayers were not entitled to the notice provided in Sec. 7603(c)(2)(E)(ii).
The IRS may soon be spending more time examining employee pension plans. The Service has noticed companies are trying to keep plan assets under the $100,000 reporting threshold for Form 5500, abuses in S corporation employee stock ownership plans (ESOPs), employee leasing schemes, and some blatant disregard of the rules for qualified plans. The Service is expected to increase audit emphasis on smaller plans, which have generally escaped scrutiny. Keep in mind that one of the penalties for failure to comply with the regulations is disqualification of the plan--a serious consequence.
Look for the House to introduce several tax bills that would make the individual tax cuts that are scheduled to expire in 2004, permanent. The bills are unlikely to pass the Senate because there are no offsetting revenue provisions.
In limited situations, taxpayers filing joint Federal income tax returns may be relieved from joint and several liability pursuant to Section 6015. Known as innocent spouse relief, the taxpayer must satisfy a number of requirements. In
Section 4940 imposes a tax on private foundations based on the foundation's net investment income. The IRS has announced (Notice 2004-35; IRB 2004-19) it intends to propose regulations modifying the regulations under Sec. 4940, with respect to distributions received by private foundations from trusts and estates.
Section 4942(a) imposes a tax on the amount of undistributed income of a private foundation for any taxable year that is not distributed by the first day of the second taxable year following such taxable year. Section 4942(c) defines undistributed income as the amount by which the distributable amount for the taxable year exceeds the qualifying distributions made out of the distributable amount. Section 4942(d) defines distributable amount as the minimum investment return (plus certain refunds of amounts previously taken into account as qualifying distributions), reduced by the taxes imposed on the private foundation under subtitle A and section 4940. The IRS has released Notice 2004-36 (IRB 2004-19) providing guidance to private foundations on the treatment of certain distributions received from split-interest trusts described in Sec. 4947(a)(2), in light of the courts' decisions in Ann Jackson Family Foundation v. Commissioner, 97 T.C. 534 (aff'd, 15 F 3d 917, 9th Cir. 1994).
The Department of Justice, working closely with the Internal Revenue Service, has stepped up efforts to identify, investigate and punish tax cheats. Of particular note are the government's efforts to enhance criminal enforcement, use civil injunctions to stop abusive tax schemes, and investigate promoters and users of tax shelters. The IRS is ramping up its enforcement efforts, particularly for high-income individuals and corporations. The Justice Department's Tax Division's criminal enforcement priorities include investigating and prosecuting schemes that involve:
The Tax Division is using civil power to stop illegal tax schemes by seeking and obtaining injunctions. Injunction cases include the following schemes:
In order to be eligible for a bad debt deduction for debts that become worthless, a taxpayer must prove that a bona fide debt existed and that the debt became worthless in the year in which he claimed the deduction. In B. Suri (T.C. Memo. 2004-71) the taxpayer did not provide any evidence such as written promissory notes to show that a debt actually existed. The IRS argued, and the Court agreed, that it appeared from the taxpayer's testimony that the funds advanced as claimed by the taxpayer were investments, not bona fide loans. There was no apparent investigation or evidence of the financial solvency of the alleged borrowers or evidence that they intended to repay petitioner for the advances. The Court disallowed the bad debt deduction.
The IRS has issued proposed (REG-139792-02) and temporary (T.D. 9121) regulations relating to the proper allocation of partnership expenditures for foreign taxes. The proposed regulations affect partnerships and their partners.
Dealing in cash is one of the 'badges of fraud'. Where a taxpayer fails to keep the required records, or if the records he or she maintains do not clearly reflect income, then the IRS may reconstruct the taxpayer's income in accordance with a method that clearly reflects the full amount of income received. In Bill Fred Hamilton and Connie Hamilton (T.C. Memo. 2004-66) the taxpayers were engaged in the business of coal brokering. The taxpayer frequently visited his bank and presented the tellers with checks that were drawn on accounts of various coal-related companies and made payable to other coal-related companies as well as to "cash". The taxpayer would endorse the checks and, in return, receive large amounts of cash. Occasionally, he would, instead of receiving cash, purchase cashier's checks payable to himself. In most of the transactions, the taxpayer would request and receive cash in amounts ranging between $9,000 and $9,999. The IRS determined that the taxpayers understated their income for 1988 by $515,993--the total amount of cash and cashier's checks the taxpayers received in their numerous bank transactions during the year. In arriving at this determination, the IRS used the specific-item method to reconstruct taxpayers' income, relying on evidence of the taxpayers' receipt of specific items of reportable income that did not appear on their income tax return. The Court found that the only support for the taxpayer's argument he used the cash to pay for business expenses is his own uncorroborated and self-serving testimony which the Court did not accept. The Court found the taxpayers understated their income and that they were liable for the fraud penalty.
Individuals may deduct ordinary and necessary expenses paid or incurred during the year for the production or collection of income, for the management, conservation or maintenance of property held for the production of income, or in connection with the determination, collection or refund of any tax. Legal fees that are personal expenses are not deductible. In Gary Lee Colvin (T.C. Memo. 2004-67) the taxpayer deducted legal fees in connection a suit of a condominium association. The Court noted that legal fees incurred in connection with the management, conservation, or maintenance of property held for use as a residence by the taxpayer are not deductible. The Supreme Court has held that the characterization of legal expenses depends on the activities from which the claim arises for which the expenses were incurred. The origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer, is the controlling basic test. The Court held that the expense here arose in connection with the management, conservation, or maintenance of property held for use by the taxpayer as a personal residence. Thus, the legal fees were not deductible.
The IRS has just released updates for two publications--Publication 1544, Reporting Cash Payments of Over $10,000 (Received in a Trade or Business) and Publication 594, What You Should Know About the IRS Collection Process.
The IRS has issued new guidance on the computation of total recoverable units for purposes of computing cost depletion under Sec. 611. This guidance was developed under the Industry Issue Resolution program (IIR). Rev. Proc. 2004-19 provides an elective safe harbor where an owner of domestic oil and/or gas properties may use an estimate of the properties' probable or prospective reserves for purposes of computing cost depletion. See Internal Revenue News Release IR-2004-31.
Rev. Proc. 2004-21 (IRB 2004-14) modifies the final withholding foreign partnership and withholding foreign trust agreements contained in Rev. Proc. 2003-64 by expanding the availability of certain simplified documentation, reporting and withholding procedures. It also makes a conforming change to the portion of the Qualified Intermediary (QI) withholding agrement.
You may be able to shift the burden of proof to the IRS, if you meet certain requirements. If you can shift the burden of proof, you stand a better chance of winning in court. In Robert Griffin and Julia Griffin (T.C. Memo. 2004-64) the Court of Appeals for the Eight Circuit held that the taxpayers did produce sufficient credible evidence to support their personal deducitons for the real property tax payments at issue. Accoringly, the Court of Appeals held that the burden of proff should be placed on the IRS. When the Tax Court reconsidered the case after remand from the Court of Appeals, it found the tax payments in question were made with respect to a separate trade or business in which Mr. Griffin was individually engaged.
If you prevail in your argument with the IRS, you may be able to recover reasonable litigation costs. Those costs can include attorney's fees, reasonable court costs, the cost of expert witnesses, studies or reports, etc. However, one of the requirements is that your net worth does not exceed $2 million. In George Kolitsopoulos (2004-1 USTC 50,187; U.S. District Court, Mid. Dist. Fla., Tampa Div.) the Court held the taxpayer was not entitled to recover his costs because he did not show that his net worth was no more than $2 million.
You've got to read the fine print. In Patrick M. Donovan (2004-1 USTC 50,189; U.S. District Court, No. Dist. Ohio) the Court found that the withdrawal of a offer by the taxpayer did not occur on the day he faxed the offer to the IRS, but some 10 days later when the IRS issued a letter with reference to the offer to the taxpayer.
Proving fraud is hard. The hurdles the IRS has to overcome are high. But in Edward D. Tonitis (T.C. Memo. 2004-60) the Court found the taxpayer's failure to file tax returns constituted fraud. The Court noted the taxpayer owned and operated a mortgage brokerage business and had a degree in finance. The taxpayer had argued that he did not need to file and advanced tax protest arguments. The Court also noted that the taxpayer had purchased two Unincorporated Business Trust Organizations (UBTOs) from an abusive trust promoter.
If your corporation pays the personal expenses of a shareholder, the amount is considered a constructive dividend. (The issue can be more complicated in the case of an S corporation.) In Stephen M. and Rebecca A. Kerns (T.C. Memo. 2004-63) the taxpayer's corporation purchased a permanent seat license that allowed him to buy six season tickets to football games at a stadium yet to be built. The corporation made the payments, but the taxpayer listed his home address and social security number on the application for the license. The taxpayer indicated in the agreement that he was not acquiring the license as an investment and that he intended to use the license himself, and not to distribute it or season tickets to others. The Court noted a shareholder receives a constructive dividend (to the extent of the corporation's earnings and profits) if the corporation pays a personal expense of its shareholder or the shareholder uses corporate property for a personal purpose.
In Rev. Rul. 2004-43 (IRB 2004-18) the IRS ruled on the tax treatment in an assets-over partnership merger. The Service ruled that Sec. 704(c)(1)(B) applies to newly created Sec. 704(c) gain or loss in property contributed by the transferor partnership to the continuing partnership in an assets-over partnership merger, but does not apply to newly created reverse Sec. 704(c) gain or loss resulting from a revaluation of property in the continuing partnership and that for purposes of Sec. 737(b), net precontribution gain includes newly created Sec. 704(c) gain or loss in property contributed by the transferor partnership to the continuing partnership in an assets-over partnership merger, but does not include newly created reverse Sec. 704(c) gain or loss resulting from a revaluation of property in the continuing partnership.
It appears that the IRS may be stepping up the number of audits of corporate executives. The agents will be investigating perks received by executives, stock options, deferred compensation arrangements, etc. At this time only large corporations are targeted.
An employee is an employee. In Barium & Chemicals, Inc. (T.C. Memo. 2004-59) the daughter of a shareholder of the corporation worked for the corporation but was paid by her father. Because of a company rule prohibiting the rehiring of employees who quit previously, the daughter could not be hired. A dispute among board members precluded a waiver. The daughter was paid from a separate corporate checkbook; her father withheld income taxes and social security and made deposits under the company's identification number. Because the tax deposits and the Forms 941 for the company did not agree, the IRS refunded the excess deposits. The company argued the daughter was an employee of her father and not the company. The Court found the daughter was an employee of the corporation. The corporation retained the benefits of her employment and it allowed the arrangement to continue.
Previously Reported In Daily Update
Corrected 1099s may be in the mail . . . Despite the fact that most taxpayers have filed their returns, brokerage houses may still be sending out corrected 1099s. If you receive a corrected 1099 what should you do? If the corrected one shows additional income or results in a higher tax (because less dividends qualify for the reduced tax on dividends), you'll have to file an amended return (Form 1040X). If you don't, you'll almost assuredly receive a notice from the IRS. If you file an amended federal return, you may or may not have to file an amended state return. That will depend on the nature of the changes.
Pricing pressures may be easing . . . Manufacturers, wholesalers, distributors, etc. have generally found it difficult to raise prices during the last few years. Some have put in stealth increases by reducing the size of the product or changing the formulation. But it now appears that pressure to keep prices down may be easing. Some companies are testing the waters with real increases. The trend is not universal. But you should keep a close eye on your competition. And be prepared for increases from your suppliers.
Last chance to refinance . . . Interest rates are expected to rise and home mortgage and some other borrowing rates could go up faster than rates on Treasury issues. If you've been waiting for a further drop in rates, now might be the time to act. That's good advice for business loans, too. Whether or not refinancing makes sense depends on a number of factors. Talk to your accountant or financial advisor. And, despite the lower rates, it's probably best to stay away from adjustable rate mortgages, unless you expect to sell the house within the next few years.
Investing in bonds? . . . Or any other fixed income security such as a CD? The best advice right now may be to stick with short-term investments. Interest rates are now expected to rise in the not too distant future. If that happens, bonds, bond funds, and other fixed income investments whose price can vary with the market, will decline. Fixed term investments such as bank CDs won't go down in price, but you should be able to do better by waiting until rates increase before committing funds for the longer term. Should you sell longer-term holdings? That depends on a number of factors. Talk to your investment advisor about the action you should take for your specific situation.
Overtime rules changing . . . President Bush has signed into law a bill that will change the overtime rules for many companies. Generally, employees who earn $23,660 or less ($455 per week) will automatically be entitled to overtime. That's up from the old threshold of $8,060. Workers earning more than $23,660 but less than $100,000 may be entitled to overtime depending on the qualifications and job description. The new law takes effect in 4 months. You can get more information at the Department of Labor (www.dol.gov) website.
Consignment sales can be dangerous . . . You leave something with a consignment shop and the business goes bankrupt. In one case the consigned products were sold along with the items the business owned. If you're trying to sell items with significant value, check the rules in your state.
Closing an internet sale . . . Make a "help" phone number readily visible throughout your web site. Offer FAQs or help sections that address common questions or problems. And be prepared to respond to the customer online through e-mail or telephone. While the web can display and explain your products and services and otherwise facilitate a sale, you may still need a live person to close the deal. Be ready to do that.
Retirement pay to partner not self-employment income . . . Net earnings from self-employment are subject to the self-employment tax. For partners that means their share of the "net income" of the partnership. But the law contains a special rule for retirement payments. Generally, if (1) the payments are made on a periodic basis pursuant to a written plan that provides for payments on account of retirement to partners generally or to a class or classes of partners to continue at least until the partner's death (to qualify as payments on account of retirement, the payments must constitute bona fide retirement income; generally, retirement benefits are measured by, and based on, such factors as years of service and compensation received) (2) the retired partner renders no service during the taxable year of the partnership which ends within or with the taxable year of the partner and in which the payment is received, (3) at the close of that taxable year of the partnership, no obligation exists from the partners to the retired partner except with respect to retirement payments under the plan or rights such as benefits payable on account of sickness, accident, hospitalization, medical expenses, or death; and (4) at the close of that taxable year of the partnership, the retired partner's share of the capital of the partnership has been paid to him in full, then the retirement payments are not subject to the self-employment tax. Since the self-employment tax can be costly and this, like many partnership issues, can be complex, be sure to get good advice.
Power Point presentation required notice . . . In a recent letter ruling (LTR 200407021) the Service held that Power Point presentations used to notify participants of a pension plan of the reduction of the company's contributions to the plan satisfied the notice requirements of Sec. 204(h) of the ERISA requirements. Please keep in mind that the ruling was detailed and only applies to the taxpayer who requested it.
Turn off that light! . . . Electricity is not cheap. Turning off a 100 watt bulb for 10 hours will save anywhere from 8 to 16 cents, depending on the costs in your area. Turning off a computer can easily save more than double that amount. Turning off 3 computers every weeknight of the year (Monday thru Thursday) will save between $150 and $300. Turning them off over the weekend will save between $100 and $200. That's for three units. You're likely to have many more in your office. On the other hand, don't turn them off if you're just going out for a couple of hours. Startup and shutdown often takes a heavier toll on equipment than running for many more hours. Use fluorescent bulbs wherever possible; they use about 1/4 the power and last much longer. Since they're more expensive they may not be cost efficient everywhere. They make sense in fixtures that are on for long periods of time but stick with a regular bulb for the supply closet. There are other easy, inexpensive ways to save electric. Investigate them.
Put it in writing . . . Have a dispute with your credit card company? Want to stop payment on a check? Disputing a bill? Calling the credit card company, bank, vendor, etc. is the quickest way to get things started, but you almost always want to follow up with a letter. And, make that letter certified, return receipt. Most agreements require notification by mail, but check the small print to be sure. Make sure you send the letter to the proper address (and send it certified, return receipt). For example, sending a letter to the same place you send your credit card payment probably won't do any good. Most companies have a separate address for disputes. That address is probably in that agreement, update, notification, etc. the bank, card company, etc. sent you that you threw out. Save those documents, preferably in a separate file for each bank account, card, etc.
Switching tax-exempt bond funds to avoid the AMT? . . . Many more taxpayers are concerned about the alternative minimum tax (AMT) than ever. Most municipal bonds and bond funds are exempt from federal income taxes. (Sometimes these funds generate regular interest and capital gains. These are taxable.) But while all the interest may be exempt from the regular tax, some may be subject to the AMT. For example, interest on some industrial development bonds is taxable for AMT purposes. You may want to switch into a pure municipal bond fund, one that doesn't generate income for the AMT. Think twice. First, the income that's taxable for AMT purposes is usually a small percentage of the fund's total income. Second, one reason funds have invested in these bonds is because the return is often higher. It may not even pay to work through the numbers if the income subject to the AMT is small. If it is significant, consider not only how the income in the pure fund compares to your current fund, but also the cost of switching and your chances for becoming subject to the AMT.
Copyright 2004 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
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