News On The Tax Front--The latest tax news.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
Investor or trader? If you're an investor, any losses you incur are limited to offsetting your gains or up to $3,000. On the other hand, if you're a trader, your losses are fully deductible against ordinary income. In Frank Chen (T.C. Memo. 2004-132) the taxpayer was employed full-time as a computer chip engineer and received some $75,000 in wages for the year at issue. The taxpayer engaged in 323 trades during the first six months of the year, but 303 of those trades occurred during a three-month period. The taxpayer held most of the securities for less than a month. The taxpayer claimed trader status and claimed his $85,000 loss from the trades as a fully deductible, ordinary loss incurred in a trade or business. The Court disagreed. It found the taxpayer was not a trader in securities, could not use the mark-to-market election and his net loss was deductible only to the extent of $3,000 for the year. The Court noted in order to qualify as a trader (as opposed to an investor) the taxpayer's purchases and sales of securities during the year must have constituted a trade or business. In determining whether a taxpayer who manages his own investments is a trader, and thus engaged in a trade or business, relevant considerations are the taxpayer's investment intent, the nature of the income to be derived from the activity, and the frequency, extent, and regularity of the taxpayer's securities transactions. The taxpayer's transactions were frequent, regular and continuous only for a three-month period while he keep his full-time job as an engineer.
In The Connell Business Company, et al. (T.C. Memo. 2004-131) the taxpayer argued that the IRS was estopped from asserting a deficiency because the Service had previously assessed and then abated most of the assessments. The Court held that the abatement of an assessment is not a binding action that will stop the IRS from issuing another deficiency notice.
The IRS has issued for public comment (JS-1748) model documents that can be used as trust or custodial agreements for Health Savings Accounts (HSAs). These documents, which can be reviewed at www.irs.gov (see links below), are being released in proposed form in order to give the public the opportunity to comment on the content before being issued in final form. Comments may be filed online at the above website or verbally by calling (202) 622-4HSA. The link to the model Health Savings Custodial Account is: www.irs.gov/pub/irs-dft/d5305c.pdf. The link to the model Health Savings Trust Account is: www.irs.gov/pub/irs-dft/d5305b.pdf.
The IRS has issued final and temporary regulations (T.D. 9133) with respect to the definition of a passenger automobile for purposes of the dollar limits on depreciation deductions for passenger automobiles. These regulations affect taxpayers that use vans and light trucks in their trade or business. (If they meet certain requirements, these vehicles are subject to higher depreciation limits than passenger autos.) T.D. 9069 and the proposed regulations provide that a truck or van is not subject to these limits if it is a qualified nonpersonal use vehicle as defined in Sec. 1.274-5T(k). This rule applies to vehicles placed in service on or after July 7, 2003. The IRS has amended the effective date provision to allow taxpayers to use the exclusion for qualified nonpersonal use vehicles for vehicles placed in service prior to July 7, 2003 (but on or after January 1, 2003), and to permit taxpayers either to amend tax returns for open taxable years, or to treat the change as a change in method of accounting by filing a Form 3115, Application for Change in Accounting Method. Check the full text of the new regulations for other rules that apply to taxpayers who treated such property as property for which Sec. 280F(a) does not apply in earlier years.
The IRS has issued proposed regulations (REG-131486-03) under Section 1374 that provide for an adjustment to the amount that may be subject to tax under Section 1374 in certain cases in which an S corporation acquires assets from a C corporation in an acquisition to which Section 1374(d)(8) applies. These proposed regulations provide guidance to certain S corporations that acquire assets from a C corporation in a carryover basis transaction.
The IRS has announced (Notice 2004-45; IRB 2004-28) that it is aware that certain promoters are advising taxpayers to take highly questionable, and in most cases meritless, positions described below in order to avoid U.S. taxation and claim a tax benefit under the laws of the United States Virgin Islands (USVI). Promoters may also be advising taxpayers to take similar positions with respect to other U.S. possessions. This notice alerts taxpayers that the Service intends to challenge these positions in appropriate cases. The Service may impose civil penalties on taxpayers or persons who participated in the promotion or reporting of these positions. In addition to being subject to other penalties, any person who willfully attempts to evade or defeat tax by means of an arrangement such as the one described in this notice, or who willfully counsels or advises such evasion or defeat, may be guilty of a criminal offense under federal law.
In Rev. Rul. 2004-67 the IRS extended the ability to participate in group trusts described in Rev. Rul. 81-100, 1981-1, to eligible governmental plans under Sec. 457(b) and clarifies the ability of Roth individual retirement accounts described in Sec. 408A and deemed individual retirement accounts described in Sec. 408(q) to participate in these group trusts. In addition, the ruling provides related model language for eligible governmental plans under Sec. 457(b).
In Internal Revenue News Release IR-2004-82 the IRS and the Japanese National Tax Agency respectively have issued guidance regarding the commencement of application of the new income tax treaty between the United States and Japan in each country.
The IRS has issued Rev. Proc. 2004-38 (IRB 2004-27) informing owners of qualified low-income housing projects how to obtain the waiver from the IRS of the annual recertification of tenant income (waiver) provided in Sec. 42(g)(8)(B).
Notice 2004-43 (IRB 2004-27) provides transition relief for individuals in states where high deductible health plans (HDHPs) as described in Section 223(c)(2) are not available because state laws require health plans to provide certain benefits without regard to a deductible or below the minimum annual deductible of section 223(c)(2)(A)(i). The transition relief covers months before January 1, 2006, for state requirements in effect on January 1, 2004.
In many courts, financial hardship can never excuse a failure to remit payroll tax deductions to the IRS, because such deductions are a trust fund held for the benefit of the employees and the U.S. The employer has no right to the money no matter how much financial difficulty it is in. However, in the 9th Circuit an employer is not categorically precluded from pleading financial hardship as a defense to the penalty when payroll taxes and employee trust funds are involved. That didn't help the taxpayer in Pacific Wallboard & Plaster Co. (2004-1 USTC 50,248; U.S. District Court, Dist. Ore.). The taxpayer's controller was embezzling funds and failed to remit employee tax deposits for some 3 years. The taxpayer paid the penalty to the IRS, but after uncovering the embezzlement, sought a refund of the penalty, claiming undue hardship. The Court noted that under Sec. 1.6161-1(b) "undue hardship" means more than an inconvenience to the taxpayer. It must appear that substantial financial loss, for example, loss due to the sale of property at a sacrifice price, will result . . . The Court found that it appeared the company had the money but chose to use it for other purposes. There was no evidence the taxpayer tried to borrow additional funds, or to delay repayment of some loans or obligations. The Court held that taxpayer failed to prove undue hardship.
Loans made by qualified pension plans are subject to a number of rules and restrictions. If the rules with respect to a loan are not met, the loan may be a prohibited transaction and subject to excise taxes under Sec. 4975. In Ralf Zacky (T.C. Memo. 2004-130) the taxpayer was the sole trustee of the plan and made loans from the plan to himself and his corporation. The Court found that, because the individual was a trustee the loans were prohibited transactions and that they were not corrected by repayment with appropriate interest. The Court found the taxpayer liable for the first- and second-tier excise tax.
You can't have it both ways. In John Marretta (T.C. Memo. 2004-128) the Court found that the taxpayer was liable for the fraud penalty for tax evasion. The Court noted the taxpayer had pleaded guilty to criminal fraud for his failure to declare the amount of the distributions he received from a Ponzi scheme. During his plea hearing, he admitted (1) that he failed to report as income the distributions he received from the scheme, (2) that the distributions were taxable income, and (3) that, when he filed his federal income tax returns for the years at issue without reporting the distributions as income, he acted voluntarily with the specific intent to violate a known legal duty.
Simply writing a letter to the IRS requesting a refund, innocent spouse relief, etc. isn't the same as giving the IRS official notice of your claim for a refund, etc. You've got to use the prescribed form, etc. In Marion Goldin (T.C. Memo. 2004-129) the taxpayer's husband had claimed losses related to a tax shelter which the IRS disallowed. The taxpayer sought innocent spouse treatment and did file a formal request on Form 8857, but not within the required 2 years of paying the tax. The Court denied her refund claim. The Court also found that relief could not be granted under an earlier law allowing innocent spouse relief.
If the IRS assesses you additional taxes, you'll probably be liable for interest on the unpaid amount. But the IRS can abate interest if the assessment of tax is delay unreasonably by a ministerial act. In 1996 the law was changed to include unreasonable delay by a managerial act of the IRS. In Charles Durham (T.C. Memo. 2004-125) the taxpayer argued that the audit of his return took almost 4 years and that the interest should be abated. But the Court found that the delay was caused by a managerial act and that provision of the abatement rules was added in 1996. The Court held the because the audit of his return began before the change in the law, it did not apply to his case.
If you inherit property, your basis is stepped up to the fair market value at the date of death. If you sell the property the same day, you won't have any gain, no matter what the decedent's basis in the property. But the rules are different when it comes to income that the decedent was entitled to receive at the time of his or her death. Such amounts are called income in respect of decedent. In Jack Carson Coleman (T.C. Memo. 2004-126) before his death, decedent sold his business. As part of the sales transaction, he signed a 10-year agreement not to compete in consideration of 120 monthly payments of $1,000. As of the date of decedent's death, the unexpired portion of the agreement consisted of 108 monthly payments and was included in decedent's estate. For estate tax purposes the remaining payments were assigned a value of $81,000, which reflected 75 percent of their face value (108,000 x 75%). The decedent's estate was subsequently closed and the taxpayer received a one-third interest in the unexpired portion of the agreement. For the tax year at issue the taxpayer received payments totaling $3,666 in accordance with the agreement. He did not report these payments on his federal income tax return for the year. The Court held that the payments were income in respect of a decedent and thus the share the taxpayer received were includible in his income as ordinary income. The Court also held that he was not entitled to a stepped up basis in the funds. The law specifically excludes income in respect of a decedent from the stepped up basis rules.
The full House has passed H.R. 4520 by a 251-178 vote. The bill now needs to be reconciled with the Senate version. Many believe this will be a difficult conference.
The IRS has issued final and temporary regulations (T.D. 9132) that provide the rules for determining the annual depreciation allowance under Section 168 for MACRS property as a result of a change in the use of such property. Changes in the use include a conversion of personal use property to a business or income-producing use, a conversion of MACRS property to personal use, or a change in the use of MACRS property that results in a different recovery period, depreciation method, or both.
If the IRS assesses you additional taxes, you'll probably be liable for interest on the unpaid amount. That's generally true even if it isn't your fault the additional tax is outstanding for an extended period of time. For example, the IRS waits the full time period before sending you a notice of deficiency. There's an exception to the general rule. If there's an IRS delay caused by the dilatory performance of ministerial acts by the Service, the interest will generally be abated. In Thomas Frederick Dadian and Lois Ann Dadian (T.C. Memo. 2004-121) the Court found that of the 2-1/2 year delay, 6 months was preventable by the IRS and thus the interest was available for abatement. The remaining 2-year delay was not due to ministerial delay, and thus was not subject to abatement under the rules.
Failure to file a return and avoiding IRS notices won't help your case. In Michael Stein (T.C. Memo. 2004-124) the taxpayer procrastinated so long that the IRS filed substitute returns for him. The Service also used a zero-cost basis to determine the income from security sales. The Court held the taxpayer forfeited his opportunity to contest the underlying deficiencies in a proceeding in the Tax Court under Section 6330(d) because of his deliberate refusal of delivery of the statutory notices.
The IRS has issued (T.D. 9131) amendments to regulations under Sections 263A and 448. The amendments apply to taxpayers changing a method of accounting under the regulations and are necessary to conform the rules governing those changes to the rules provided in general guidance issued by the IRS for changing a method of accounting. Specifically, the amendments will allow taxpayers changing their method of accounting under the regulations to take any adjustment under Section 481(a) resulting from the change into account over the same number of taxable years that is provided in the general guidance.
In Rev. Rul. 2004-65 (IRB 2004-27) the IRS ruled that an employer has reduced retiree health coverage, within the meaning of Section 420(c)(3)(E), if an individual who has coverage for retiree health benefits ("covered individual") accepts an offer from the employer to waive such coverage in exchange for enhanced pension benefits.
The IRS has reported (Announcement 2004-57; IRB 2004-27) that it is withdrawing the proposed age-discrimination regulations under Sections 411(b)(1)(H) and 411(b)(2) related to qualified plans, including cash balance pension plans issued in December 2002. The proposed regulations addressed conditions under which cash balance plans and cash balance conversions would not be considered to violate these age-discrimination rules. The withdrawal will provide Congress an opportunity to review and consider the Administration's legislative proposal and to address cash balance and other hybrid plan issues through legislation. The IRS does not intend to issue guidance on compliance with the age-discrimination rules under these Sections for cash balance plans, cash balance conversions, or other hybrid plans or hybrid plan conversions while these issues are under consideration by Congress.
The Department of Justice announced that a federal bankruptcy entered a permanent injunction against Las Vegas-based telemarketing firm National Audit Defense Network, known as NADN. The injunction order, submitted jointly by NADN's bankruptcy trustee and by the Justice Department, prohibits NADN from selling abusive tax schemes and from preparing federal income tax returns. The order also gives the Justice Department "full and complete access" to NADN's records, including customer information. NADN's earlier court papers acknowledged that the company's database had more than 640,000 customers. Court papers estimate that customers who followed NADN's tax advice have underpaid $324 million in federal income taxes over the past three years alone. NADN ceased operating on May 27, 2004.
The IRS has issued final regulations (T.D. 9130) concerning required minimum distributions under section 401(a)(9) for defined benefit plans and annuity contracts providing benefits under qualified plans, individual retirement plans, and section 403(b) contracts. The regulations also contains a change to the separate account rules in the final regulations concerning required minimum distributions for defined contribution plans. These final regulations provide the public with guidance necessary to comply with the law and will affect administrators of, participants in, and beneficiaries of qualified plans; institutions that sponsor and administer individual retirement plans, individuals who use individual retirement plans for retirement income, and beneficiaries of individual retirement plans; and employees for whom amounts are contributed to section 403(b) annuity contracts, custodial accounts, or retirement income accounts and beneficiaries of such contracts and accounts.
In Antoinette J. Dato-Nodurft (T.C. Memo. 2004-119) the taxpayer contended that, because she and her former husband were not legally separated during the year at issue, the payment she received from her former husband is not alimony. The Court did not agree. It said the relevant inquiry is whether the payment was made pursuant to a written separation agreement within the meaning of section 71(b)(2)(B). The taxpayer contended that the separation agreement she and Mr. Nodurft executed was not legally binding, and that payments made pursuant to the separation agreement should not be considered alimony. The taxpayer asserted in the petition that "Taxpayer and Former Husband were advised in the office of the Judge Advocate of Kaneohe Bay, Hawaii, USMCB, said 'separation' documents were not legally binding as they are not issued from a civilian court of law." The Court said the taxpayer's contention fails to appreciate that a payment made pursuant to a written separation agreement may be alimony under Section 71 even though the agreement may not be an enforceable instrument under state law.
A taxpayer may raise at the Section 6330 hearing (Collection Due Process hearing) any relevant issue with regard to the Service's collection activities, including spousal defenses, challenges to the appropriateness of the intended collection action, and alternative means of collection. If a taxpayer received a statutory notice of deficiency for the years in issue or otherwise had the opportunity to dispute the underlying tax liability, the taxpayer is precluded from challenging the existence or amount of the underlying tax liability. That's what the Court said in James L. Jensen (T.C. Memo. 2004-120). Since the taxpayer had received a notice of deficiency, he could not challenge the underlying tax liability.
Previously Reported In Daily Update
Mail should be delivered to separate address . . . Dishonest employees love to be in control of the mail. It means they can intercept bills, letters from customers, bank advices, IRS and state notices, etc. If your company is large enough, you won't be able to check all the incoming mail. And you don't have to. You can have someone in the mailroom or another employee control it. In the case of a small company, consider having all bills, payments, bank statements, official correspondence, etc. delivered to a post office box. That will allow you to review the mail before your bookkeeper or any other employee can see it. Ideally, you should be opening payments from customers, running a tape on the total checks and comparing that to the deposits for the day, but it's unlikely you'll have the time to do that every day. However, even if you do the check once a week, and vary the day you do so, you'll deter most employees from trying to cash the incoming checks. In the case of accounts payable, you may not want to review every incoming invoice, but you could look at a sample. You should also be looking for any dunning letters indicating bills haven't been paid. If you use an outside service for some accounting functions, you should get all the mail. For example, if your outside accountant prepares the payroll, all correspondence, forms, etc. should be mailed to you. In one recent case the company's accountant wasn't making the deposits for the payroll taxes. The company would have discovered the problem if the owner had received the correspondence from the IRS or if he made the deposits directly.
Monitor employee's driving . . . Think your employees are driving to fast? Or using a company vehicle for personal purposes? You can buy units that will measure the average speed, top speed, etc., some for less than $400. Units containing a GPS (global positioning unit) are also available. You can tell where an employee has been and when. For a monthly fee you can even go further and check on the whereabouts of a vehicle at any time. Prices for the units and services vary, but in most cases they are definitely cost effective. Taking a dangerous employee out of a company car, stopping abuse of company vehicles, etc. can provide substantial savings.
Watch IRA withdrawals carefully . . . Amounts withdrawn from an IRA or other qualified plan before age 59-1/2 is generally subject to a 10% penalty. What happens if you're over the threshold but your spouse isn't and you take the money out of the wrong account? That's what happened to one taxpayer. He mistakenly withdrew funds from his wife's IRA when he meant to take the money from his. (Both accounts were at the same broker.) The IRS hit the taxpayer with a penalty. The taxpayer took the issue to the Tax Court and in a Summary Opinion (which can't be cited) the Court said it concurred with the taxpayers' contentions that there was little reason to withdraw funds from that IRA and incur an unnecessary 10-percent tax under Section 72(t) when the funds could have been withdrawn from the other account without imposition of the additional tax. Nevertheless, the Tax Court said it's a court of limited jurisdiction and lacks general equitable powers. In short, the Tax Court, though it sympathized, couldn't do anything to help.
Throwing a company picnic? . . . Talk to your attorney first. If an employee is injured at a company function, he or she could be entitled to workers' compensation benefits. Some courts have held that if the company compels an employee to participate in a recreational activity, it becomes work related. You might be able to reduce your exposure by keeping any work related business at the activity to a minimum. For example, no company speeches, and you might want to hand out those sales awards some other time. Again, check with your attorney. But keeping business out of the company picnic might also make sense from a business standpoint. Employees are coming to the picnic to have fun. Trying to conduct anything more than a minimal amount of business might put a damper on the affair.
Asset tracking . . . Most businesses don't keep good track of their fixed assets. That could prove costly. While it's unlikely a visitor or an employee will ride away with the company van, small items such as tools, electronic equipment, etc. often disappear. There's plenty of inexpensive software out there to track fixed assets. Even a generic data base program or, for shorter lists a spreadsheet will work. Then take a regular inventory. Do it at least once, preferably twice a year. Just go around the shop checking off items on the list. You can do this at a slow time of the year. Here are some good reasons for tracking:
Mortgage rates rising--fees declining . . . There's no denying mortgage rates are rising. That's the bad news. The good news is that the rising rates are putting a damper on the refinancing boom. And, for mortgage lenders, refinancing is easier than writing new loans for home purchases. That's giving lenders an incentive to cut fees, offer better terms, etc. to get the business.
National Association of Unclaimed Property Administrators . . . Looking to see if old Aunt Agnes has money in a bank account she's forgotten about? Trying to marshall all the assets for an estate for which you're the executor? The first place to try is NAUPA, the National Association of Unclaimed Property Administrators. The web site is www.unclaimed.org. Keep in mind that only dormant accounts will generally show up. That is, accounts that have not been accessed for a number of years (the time period depends on the state). And not all property will be included. Generally, it's limited to bank accounts, safe deposit box contents, stocks, mutual funds, bonds, dividends, uncashed checks and wages, insurance policies, CD's, trust funds, utility deposits, and escrow accounts. But that covers a lot of ground so it's a great place to start. And, if you find a dormant bank account in old Uncle Fred's name, you might want to look further for other property.
Define your terms . . . Substantial, significant, material, timely, etc. are all great words. But put them in a contract and you're asking for trouble. What's a better approach? If at all possible, indicate a specific amount. For example, you can reject the order if you find more than 10% defective parts. Or, you're entitled to a discount if your order is more than 3 days late. Talk to your attorney before agreeing to any language.
CD's can fade . . . Sounds strange, but it's true. We won't go into the technical details, but the info on CD's can fade because of environmental conditions or just rough handling of the CD. It's too early to tell if the mere passage of time will affect them. This may not be an issue if you're just backing up files for the short term. Then all you may need to do is take reasonable care, i.e., put the CD in a case, don't expose it to a clearly adverse environment, and buy quality CD media. For longer storage (5 years or more) you may want to take other measures, such as creating additional backups, storing in a special environment, etc.
Closing a business? . . . It's not unusual for a business owner to just close a small business on retirement, because it's not doing well, because of illness, etc. with no thought to selling. We know of one case where the owner had the business in back of his residence and thought he couldn't sell it because of the location. While many small businesses that are winding down may not sell for much, you can almost always get something. Planning ahead can increase any proceeds materially. If you're retiring, you should be able to find someone to take over or sell out to, given enough time. But even if you've got to sell quickly because of a death or other catastrophe, you should still be able to sell your customer list, tools, etc. to a competitor. If you don't know how to go about it, talk to your accountant. He should have some ideas.
Sweepstakes winnings not gambling income . . . You can take a deduction for gambling losses up to the amount of your winnings. That's why you should always hold onto your losing tickets, etc. But in a Technical Advice Memorandum (TAM 200417004) the IRS held that winnings from a "no purchase necessary" marketing sweepstakes were not gains from wagering transactions because the taxpayer did not furnish consideration for the chance to win the prize. Thus, he could not deduct gambling losses against the sweepstakes winnings.
Designated beneficiaries take precedence . . . In most states, if you name a beneficiary for your life insurance, IRA, pension plan, etc. the asset will pass to the name individual regardless of any designation in your will. Thus, you should be very careful not to leave the asset to a different party in your will. In addition, while such assets are usually excluded from your probate estate, they are includable in your estate for tax purposes.
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