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

You generally can't avoid taking a salary if you're a corporate officer. In Charlotte's Office Boutique, Inc. (121 TC--, No. 6) the corporation paid the 50% shareholder and officer amounts characterized as royalties. The Court found them to be wages subject to employment taxes. It noted that, notwithstanding the manner in which an employer characterizes payments made to an employee, the critical fact is whether a payment is actually received as compensation for employment. An officer who performs substantial services for a corporation and who receives remuneration in any form for those services is considered an employee, and his or her wages are subject to the employer's payment of federal employment taxes. The shareholder performed vital and substantial services for the corporation as its president, that she and her labor were the corporation's principal generator of income. In fact, with the exception of a small number of outside laborers, who expended minimal labor in the corporation's business, the president and her husband were the only individuals who actually worked for the corporation. Their services, while arguably not long in hours, were indispensable to the corporation's business. The Court recognized that the record contains a licensing and sale agreement between the corporation and the president which provides for payment of royalties to the president for its use of certain intangible property rights. The Court said it also understands that a royalty may be paid for the use of valuable intangible property rights. The Court did not believe, however, that the payments of any of the disputed amounts were royalties based on the facts. Whereas the president had used the referenced intangible property in her sole proprietorship to earn self-employment income subject to self-employment tax, the Court did not believe that she can avoid the payment of federal employment taxes simply by declaring that she will be paying royalties to herself through a controlled corporation for its use of that property. The Court also denied the taxpayer relief under section 530 of the Revenue Act of 1978. (When applicable, section 530 affords a taxpayer such as petitioner relief from employment taxes notwithstanding that the relationship between the taxpayer and the individual performing services would otherwise require the payment of those taxes.) The Court also found the taxpayer liable for additions to tax for failure to deposit the required amount of taxes.

In Fact Sheet FS-2003-16 the IRS reported that during the past three years it has seen an increase in scams and fraud involving the automotive sales industry. Some scam artists have knowingly assisted narcotics traffickers in laundering their ill-gotten gains, while others submit false loan documents to financial institutions to obtain car loans. Special agents of IRS Criminal Investigation have investigated and recommended to the Department of Justice for prosecution numerous individuals involved in the automotive sales industry. These investigations vary from tax evasion to employment tax fraud to money laundering conspiracies to violations of the Bank Secrecy Act. In addition, the IRS has more than 1,000 open audits of the tax returns of new and used car dealers for a variety of issues. Normally, when the Form 8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business) is filed, a correlating Form 4789, Currency Transaction Report, is filed by a financial institution when the same cash is deposited with the financial institution. For example, if a dealer receives a cash payment of over $10,000 for a vehicle, the dealer must file a Form 8300 with the IRS. When the dealer deposits that cash into a financial institution, the financial institution is also required to report the $10,000 or over cash transaction to the IRS by filing a Currency Transaction Report, Form 4789. When a discrepancy is found between the filings of Forms 8300 for cash sales and the filings of Forms 4789 for currency deposits, it's often an indication of a possible violation of the currency reporting laws. The IRS reported that, for the latest 8 month period, 73% of those convicted have been sent to prison for an average of 55 months.

The IRS has issued final regulations (T.D. 9088) that provide guidance regarding the application of the rules of section 482 governing qualified cost sharing arrangements (QCSA). These regulations provide guidance regarding the treatment of stock-based compensation for purposes of the rules governing qualified cost sharing arrangements and for purposes of the comparability factors to be considered under the comparable profits method. These final regulations are the first in a series of regulatory guidance under Section 482 through which the IRS intends to update, clarify and improve current regulatory guidance in the transfer pricing area. A broader regulatory project on the treatment of QCSAs and a regulatory project on the transfer pricing of services are in progress, and the IRS intends to issue proposed regulations with respect to each project in the near term. These final regulations set forth explicit provisions clarifying that stock-based compensation is taken into account in determining the operating expenses treated as intangible development costs of a controlled participant in a QCSA under Reg. Sec. 1.482-7.

The IRS has issued corrections to the final and temporary regulations (T.D. 9080) relating to the reduction of tax attributes under Sections 108 and 1017 of the Code. These temporary regulations affect taxpayers that excluded discharge of under Section 108.

In Rev. Rul. 2003-99 (IRB 2003-34) the IRS published a list of rulings that are now obsolete. The IRS also announced that it is continuing its program of reviewing rulings (including revenue rulings, revenue procedures, and notices) published in the Internal Revenue Bulletin to identify and publish lists of those rulings that, although not specifically revoked or superseded, are no longer considered determinative because (1) the applicable statutory provisions or regulations have been changed or repealed; (2) the ruling position is specifically covered by statute, regulations, or subsequent published position; or (3) the facts set forth no longer exist or are not sufficiently described to permit clear application of the current statute and regulations.

The IRS has issued Rev. Proc. 2003-71 (IRB 2003-36) to explain the procedures applicable to the submission and processing of offers to compromise a tax liability under Section 7122 of the Code. These procedures reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998. The revenue procedure supplements and clarifies the procedures identified in Reg. Sec. 301.7122-1.

Included versus includible. Sounds like double talk, but it wasn't in James G. Robinson and Barbara L. Robinson (2003-2 USTC 50,590; U.S. Court of Appeals, Federal Circuit). The Court reversed and remanded a Court of Federal Claims holding. The case involved an employer's deduction for a transfer of restricted stock to an employee under Sec. 83(h). The Court of Appeals held that the corporation could take a deduction for the amount of income includible in the employee's income, and did not have to be limited to the amount actually included. Some taxpayers may want to consider refund claims based on this ruling. However, some practitioners believe the IRS will appeal this decision to the Supreme Court.

If you're late in paying your taxes, underpay your estimated taxes, or the IRS redetermines your liability for a year and you owe additional taxes, you'll also be assessed interest. Generally, the IRS can't abate interest. There is an exception if the interest is the result of an error or delay by an officer or employee of the IRS in performing a ministerial act, or any payment of any tax described in Section 6212(a) to the extent that any error or delay in payment is attributable to the officer's or employee's being erroneous or dilatory in performing a ministerial act. The final regulations note that a managerial act is an administrative act that occurs during the processing of a taxpayer's case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel. In John D. and Kim M. Hinterleitner (T.C. Memo. 2003-228) the Court held that the interest that was added to the taxpayers' tax liabilities was due to the taxpayers' actions, not the Service's.

The blackout that affected electric customers in the Northeast may provide incentive for Congress to move on energy legislation now in both houses. Both the Senate and the House have versions that would provide tax incentives for conservation as well as production of both renewable and traditional fuels.

You may be entitled to innocent spouse relief for tax liabilities on a joint return if you can show you signed the return under duress. That was the taxpayer's argument in David J. Price (T.C. Memo. 2003-226). The taxpayer and his spouse filed for divorce, and part of the judgment required to file joint federal and state income tax returns for back years 1992 through 1996. The judgment also stated that 100 percent of any tax refund as to those years would go to Ms. Price and, should Mr. Price fail to sign releases or cooperate in the referenced joint filings, that Ms. Price had the exclusive right to file those joint returns on their behalf. The Court held that the state law which applied in the divorce proceeding, did not constitute duress and found the taxpayer liable for the tax liabilities.

In David Russell Jacobson (T.C. Memo. 2003-227) the taxpayer testified that he made certain charitable contributions. The Court noted that in order to be deductible, contributions of money must be substantiated by a canceled check, a receipt from the donee, or other reliable written records. (The rule only applies to contributions of $250 or more at any one time.) The Court refused to accept his uncorroborated statement regarding the contributions.

A transfer of property by deed in lieu of foreclosure constitutes a sale or exchange for federal income tax purposes. But when is the sale recognized for tax purposes? In Robert K. and Dawn E. Lowry (T.C. Memo. 2003-225) the taxpayers reported a gain on the exchange of property in 1993, the year in which the partnership in which they were partners received a "covenant not to sue" from the lender on loans outstanding. The covenant was secured by a Deed of Trust and conditioned on a release by the partnership to the lender and the conveyance of the property. It wasn't until the following year that title company could remove certain exceptions raised by the title report and provide title insurance as required by the escrow instructions. The Court noted that the test to be applied to determine whether a transaction is a closed one is a practical test, and the transaction should be regarded in its entirety. Although other factors may be considered, passage of title is usually conclusive. And it appeared beyond dispute that title passed in 1994. In a second issue in the case, the Court found the taxpayers liable for the negligence penalty since they were unable to convince the Court that they relied on professional advice.

Tax law provides that if the benefits under a life insurance contract are reduced during the 15-year period beginning on the issue date of the contract and a cash distribution is made to the policyholder as a result of the reduction in benefits, all or a portion of the distribution may be included in the gross income of the policyholder. In Rev. Rul. 2003-95 (IRB 2003-33) the IRS ruled on the tax consequences of a reduction in benefits in a life insurance policy under three different situations.

If you're married but file separate returns, you can lose some tax benefits. For example, you're not entitled to the $25,000 of active rental losses. But whether or not the rule applies depends on whether or not you lived apart from your spouse for the year. In James C. DuBois (T.C. Memo. 2003-222) the IRS argued that the taxpayer's base amount for the taxation of social security payments was zero. That is, that the applicable percentage of all his social security payments had to be included in his income because the taxpayer was married and filed his returns as married, filing separately but did not live apart form his spouse on each day of the year. The taxpayer claimed he did live apart from his wife at all times during the year and that the zero base income rule did not apply. The Court found the taxpayer's testimony credible in light of the record as a whole.

The IRS has just issued Notice 2003-59 (IRB 2003-35), modifying the automatic consent procedures of Rev. Proc. 2002-9 for filing Form 3115 requesting a change to either the service cost method or the simplified production method for self-constructed assets under Sections 1.263A-1(h)(2)(i)(D) and 1.263A-2(b)(2)(i)(D) of the Regulations. This notice informs taxpayers that the Service has decided that a taxpayer will be permitted, after May 8, 2003, to timely file Forms 3115 to make these changes under Rev. Proc. 2002-9 for its most recent taxable year ending on or before May 8, 2003. To qualify under this notice, a taxpayer that wishes to file a Form 3115 on or after August 13, 2003, must do so under Rev. Proc. 2002-9 requesting to make a change for its most recent taxable year ending on or before May 8, 2003, and in addition to complying with the requirements of Rev. Proc. 2002-9, must include the following statement on top of the form: "Automatic Change Filed Under Notice 2003-59."

If you want to submit an offer in compromise for your tax liability, best to do it now. The IRS has announced (IR-2003-99) that, beginning November 1, 2003, the IRS will charge a $150 application fee for the processing of offers in compromise. The Service said that it expects that this fee will help offset the cost of providing this service, as well as reduce frivolous claims or those filed simply as a delaying action. To submit an OIC, a taxpayer must use the May 2001 version of the Form 656 "Offer in Compromise" package. All taxpayers who file an OIC will have to pay the application fee with their submission unless the offer is based solely on doubt as to liability, or the taxpayer's total monthly income falls at or below income levels based on the Department of Health and Human Services poverty guidelines. Taxpayers who claim the poverty guideline exception must certify their eligibility using Form 656-A, "Offer in Compromise Application Fee Instructions and Certification." Form 656-A, which will not be accepted by the IRS before November 1, will be available on the IRS Web site soon.

The IRS has announced (IR-2003-100) tax relief for those hit by the power blackout in the Northeastern United States. The IRS will consider as timely any tax returns or payments due from today through next Friday, Aug. 22, if they are completed by Aug. 22, 2003. However, the law does not allow the agency to abate interest on any overdue taxes during this period. While the IRS cannot extend the time for making employment and excise tax deposits, it will waive penalties on such deposits due during this period for affected taxpayers due to reasonable cause if the deposits are made by Aug. 22, 2003. For the purposes of this tax relief, affected taxpayers include individuals and businesses located in the blackout area, and those whose tax records, including records needed for tax deposits, are located in the area of the power blackout. To qualify for this relief, affected taxpayers should put "NORTHEAST BLACKOUT" in red ink at the top of the return relying on this relief. Individuals or businesses located in the blackout area--or taxpayers outside the area that were directly affected by the power blackout--should contact the IRS if they receive penalties for filing returns or paying taxes late. The IRS will monitor this ongoing situation to determine if any additional relief is warranted.

President Bush has announced that he does not think additional tax cuts are needed over the short term, anticipating that current cuts will stimulate an economic rebound.

If you operate as a corporation, you can't simply ignore it. In David D. Le & Kim Huong Le (T.C. Memo. 2003-219) the taxpayer argued that he did not operate his medical practice as a corporation. The Court found otherwise. The Court noted that during the relevant years a business checking account in the name of the corporation was open and that account was actively used by the corporation to cash all of the nondiverted checks that the corporation received for services performed by the taxpayer in his capacity as the corporation's employee. Second, the taxpayer filed 1990 and 1991 federal corporate income tax returns reporting the corporation's income and expenses for those years as corporate items. Those returns, which were signed personally by petitioner in his capacity as a corporate officer, reveal that the taxpayer considered himself an officer of a corporation and that it was realizing income and incurring expenses as if it were an active and ongoing corporate business. The returns also reveal that the corporation owned assets as of the end of both 1990 and 1991. Given the additional fact that the corporation during the subject years also reported and paid corporate estimated income tax to the State of California, the Court did not accept the taxpayers' claim that the corporate form of the medical practice was abandoned by them before the subject years.

In Brief:

Previously Reported In Daily Update

Corporation estimated tax payment . . . Regular (C) corporations that have an estimated tax payment due September 15, 2003, may postpone 25% of the payment to October 1, 2003. This is a one-time change written into the Jobs and Growth Tax Relief Reconciliation Act of 2003. For example, if a corporation owes an estimated tax payment of $4,000 due Sept. 15, 2003, then the corporation could opt to pay $3,000 (75 percent) by Sept. 15, 2003, and the remaining $1,000 (25 percent) by Oct. 1, 2003.

Custodial accounts . . . While the estate tax exclusions have increased significantly ($1,000,000 for 2003 and $1,500,000 for 2004 and 2005 with additional increases scheduled) and the estate tax may essentially disappear in 2010, you've still got to plan for it currently. One mistake many taxpayers still make is that after transferring property to a minor under a Uniform Gifts to Minors Act (or Model Gifts of Securities to Minors Act or Uniform Transfers to Minors Act) they act as custodian of the property. If, at the time of your death, you're the custodian of property you gifted, the full amount will be included in your estate. And, should you have a taxable estate (over $1,000,000 in 2003) the tax rate on the first dollar will be 41%. And the rates go to 50%. You can't escape the rule by making a $10,000 transfer with your wife acting as custodian and she making a $10,000 gift with you acting as custodian.

Changing life insurance companies? . . . If you cash in a whole life policy there are generally tax consequences. You can avoid them by doing a Section 1035 exchange. Talk to your agent or the company. More importantly, make sure there are no problems with acquiring the new policy before canceling the old. You don't want to find out that you can't be covered, or can't be covered for the quoted amount because of health, occupation, lifestyle, etc. issues. Caution. If you think you might have a problem, don't rely solely on the agent. Double check with the company.

Want to get out of a car lease? . . . It may or may not be easy. It depends on a number of factors. You may have more luck if you go back to the dealer you leased the vehicle from and you're interested in another model he has. If the financing was provided by the auto company, you'll have a better chance. You might also try these two web sites -- www.leasetrader.com and www.swapalease.com.

Whose income is it? . . . The answer is not always obvious. You can't simply assign income you earn to a trust or other entity. The judicially-created assignment of income doctrine applies in determining which taxpayer must include an item of income. Under the doctrine, income from personal services (e.g., wages) must be included in the gross income of the person who rendered the services. For example, you're a licensed plumber and you have a corporation that is licensed to do plumbing in your county. If you contract personally to do a job for a customer, but have him cut the check to your corporation, the income still belongs to you personally. Only if the corporation contracts to do the job is the income taxable to the corporation. Similarly, income from property (e.g., rents) must be included in the gross income of the person who owns the property. And ownership of property isn't dependent solely on in whose name title exists. The IRS and courts can look to who exercises control over the property.

Applicable federal rates increase sharply . . . We've just posted the Applicable Federal Rate (AFR) for September, 2003. The rates have turned sharply higher. (They're based on the rates on U.S. Treasury issues, which have jumped recently.) The short-term rate has gone from 1.21% to 1.52%; the mid-term rate from 2.70% to 3.43%; and the long-term rate from 4.36% to 5.08% (all based on annual compounding). The AFR for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest jumped from 3.2% to 4.2%. It's anticipated that rates will go up again in October, and could continue to increase after that. If you were considering setting up loans to or from your corporation, relatives, etc., you might want to do so before the rates increase further. Keep in mind that the blended rate for demand loans for 2003 is 1.52%.

Nominee interest and dividends . . . You may receive a Form 1099-DIV or 1099-INT with your name and social security number but that actually belong to someone else. For example, you and your sister share a joint bank account, and the bank reported $100 of interest on a 1099 in your name and social security number. If you encounter this situation, report the total amount of the interest or dividends you received on your tax return (Schedule B). After the last entry, put a subtotal of all the interest (or dividends). Below the subtotal, enter "Nominee Distribution" and show the interest (dividends) you received as a nominee. Subtract this amount from the subtotal and enter the result on the total line. You must also give the actual owner a Form 1099-DIV or 1099-INT and file Form 1096 with the IRS.

Don't have the information to file? . . . Not having the required information generally isn't a valid excuse for failure to file a return. You may get some sympathy if your records are destroyed by fire or similar casualty. And the IRS now often extends filing deadlines if you or your records are in a Presidentially declared disaster area. But even in those cases, you'll have to file a return at some point. What if you can't get all the information by the deadline? First, try to exhaust all avenues and document your efforts. You might want to consider getting a CPA or professional preparer involved. Chances are you can much information from outside sources such as your employer, bank, etc. That should get you pretty close. Then file the return using the best information you have. If, later, you uncover errors or better information, file an amended return. Don't write ESTIMATED on the top of the return. That's inviting trouble. However, you might want to attach a statement indicating that you've used your best efforts to reconstruct your records following a fire or other casualty. By the way, some excuses such as "inadvertently discarded" or "spouse threw out with my belongings", etc. won't carry much weight. You're responsible for safeguarding your records.

Charitable contributions to foreign organizations . . . You generally can't deduct gifts to foreign organizations. However, you may be able to deduct gifts to certain U.S. organizations that transfer funds to foreign charities and certain Canadian, Israeli, and Mexican charities. For more information, get IRS Publication 526, Charitable Contributions.

Don't overinvest in office space . . . Everyone wants to modify their office space to make it as comfortable as possible. But that can be expensive. If you're renting, you may have to move at the end of the lease. Even if you own your own building, your situation could change. You might have to move to larger quarters, you may have to lease excess space to others, or the business may fail or you might sell out. If you're renting, you may be able to walk away from any improvements you've made. If you own the building, it could be more costly. Special modifications you thought attractive may have to be ripped out for the new tenant. The same is true if you sell. Another point. Permanent modifications to the structure, such as new walls, have a much longer depreciable life for tax purposes than movable partitions. Construction work can be costly. Try to keep the changes to a minimum and try to make changes that would improve the building for any tenant (e.g., more windows in old buildings, lobby improvements, etc.). The advice doesn't hold as well for retail space. You've got to build the space to sell your stock. If that requires strange fixtures, brick interior walls, vaulted ceilings, etc., you can't skimp.

Cultural sensitivity . . . There are plenty of stories of management mistakes because the customers' culture, language, etc. weren't taken into account in designing a product, producing an ad, or even picking the right color. Smaller companies can't do major tests to take into account all potential customer groups, but you can certainly check the major ones. That's true even if your market is strictly U.S. or even local. There's a good chance your market is represented by your work force, friends, etc. Run the product, ad, etc. by them before committing.