News On The Tax Front--The latest tax news.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
Make sure the IRS agent you're dealing with has the authority to bind the IRS. In Becker Holding Corp. (T.C. Memo. 2004-58) the Court found the Appeals officer did not have the authority to bind the IRS in a compromise agreement. The Court noted that the taxpayer had the responsibility to determine the extent of the Appeal officer's authority. However, the Court found that the taxpayer's agreement to a waiver of the period of limitations on an IRS assessment was valid. The Court did not agree with the taxpayer's argument that the waiver should be void because it was conditioned on the settlement agreement which was invalidated.
The rental of farmland under an arrangement where the owner materially participates in the production of commodities is subject to the self-employment tax. In Gerald E. Johnson and Dorothy Johnson (T.C. Memo. 2004-56) the taxpayers leased farmland and personal property to their wholly owned corporation. Although there was little or no other compensation being paid to the taxpayers for the services they provide to the corporation, the taxpayers argued it did not establish the required nexus between the rental payments and the material participation required to trigger the inclusion of the payments within the definition of self-employment income. The IRS countered that they failed to enter into a separate employment agreement with their corporation, and to the extent they did, it was so inextricably interrelated with the oral lease that the nexus is obvious and cannot be overlooked. In addition, the taxpayer's classification of all funds from the corporation as rent and none as wages demonstrates that there were not independent arrangements with respect to real estate rentals and compensation for services. The Court sided with the taxpayers, holding that the rent was not subject to the self-employment tax.
Income from real estate rents is usually not subject to the self-employment tax. (Rental of personal property is subject to the tax.) The rental of farmland under an arrangement where the owner materially participates in the production of commodities is subject to the self-employment tax. In Jere J. and Paulette M. Solvie (T.C. Memo. 2004-55) the taxpayers rented their hog barn at a agreed upon rate per rotation of hogs to their corporation. The Tax Court found the oral arrangement of the processing of hogs through the barn the production of commodities and subject to the self-employment tax.
The Senate may finally be reaching a solution to the impasse on the bill to replace the FSC Repeal and Extraterritorial Income Exclusion Act (ETI Act) with tax relief for domestic manufacturing activities and international tax reform. The bill may be taken up in the Senate a few weeks after it reconvenes from the Easter recess.
The IRS has corrected the final regulations (T.D. 9115) on the depreciation of property acquired in a like-kind exchange or after certain involuntary conversions.
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 Jeanine T. Foor (T.C. Memo. 2004-54) the IRS denied the taxpayer innocent spouse treatment. The Tax Court held that the taxpayer had satisfied most of the factors in Rev. Proc. 2000-15 and that the unpaid taxes resulted from underwithholding on the former spouse's wages. If the taxpayer had filed as single, her withholdings would have been more than her liability. The Court also noted the taxpayer's good faith efforts to comply with Federal income tax laws in the tax years following the tax year to which the request for relief related. The Court held the IRS agent abused his discretion.
There are a number of exceptions to the penalty for early distributions from qualified pension plans and IRAs. Unfortunately, financial hardship is not one of them. In Meleca Vulic (T.C. Memo. 2004-51) the Court sided with the IRS in finding the taxpayer liable for the 10% additional tax despite the fact that she argued she was compelled to withdraw the funds to save her home from foreclosure.
If you sell a patent, copyright, or similar intellectual property, the sale usually results in capital gain treatment. On the other hand, a license to use such property generates ordinary income. In Vision Information Services, LLC (T.C. Memo. 2004-53) the Court found that the agreement between the holder of certain intellectual property was a license to use the property, not a sale. The Court noted that the agreement contained such language that the license "is not a sale" and "Except as otherwise provided herein, title and all proprietary rights (patents, trade secrets, copyrights and trade marks) to the Software, and any copy made by . . . are held by . . . " You should have your tax advisor read any significant contracts to determine the tax effects before signing. That's true for both parties.
In Donald R. Cooley and Cathy A. Cooley (T.C. Memo. 2004-49) the Court sided with the IRS in finding the taxpayer guilty of fraud. The taxpayer admitted to understating his income for the years at issue. The Court noted the difference between the taxpayers' income as determined by the IRS and as reported by the taxpayer were 114%, 155%, 131%, 161%, and 88%, for the years at issue. The Court said that it concluded from the understatements of income that the taxpayer engaged in a pattern of consistently understating his gross receipts and overstating his business expense and that the consistent pattern of substantially understating income is a strong indicator of fraud. The taxpayer failed to maintain adequate records, although he indicated that he maintained his own records for both his business and personal accounts. In their amended federal income tax returns, the taxpayers admitted that they kept inadequate records which resulted in understatements of income. The Court also noted that the sophistication, education, and intelligence of the taxpayer are relevant to determining fraudulent intent.
You may be able to pay an outstanding tax liability on the installment basis. But the IRS doesn't have to agree to an installment agreement if it believes a taxpayer may abuse the privilege. In STA Painting Co. (2004-1 USTC 50,174; U.S. District Court, East. Dist. Pa.) the Court found that the IRS did not abuse its discretion in denying the taxpayer's proposal of an installment agreement. The IRS noted that the taxpayer defaulted on prior installment agreements and had defaulted on a payment in the past. In addition, the amount the taxpayer's unpaid liability had continued to escalate. The Court sided with the IRS in allowing the Service to proceed with a levy.
In Albert G. Cooper (T.C. Memo. 2004-50) the taxpayer contended that Service's motion for summary judgment should be denied because the IRS did not consider a letter the taxpayer allegedly sent to respondent declaring his intent to pursue a collection alternative or an offer in compromise. The taxpayer provided enough evidence to convince the Court that the taxpayer attempted to enter into an officer in compromise or other collection alternative and it should deny the Service's request for summary judgment.
The House has passed the Highway Reauthorization Act of 2004. The bill contains a tax provision that would extend by 2 years the increased ($100,000 deduction and $400,000 phaseout) of the Section 179 expense option. The bill would also provide AMT relief for corporations and coordinate farm income averaging and the AMT. Passage, however, is far from assured.
The IRS has reported (Notice 2004-30; IRB 2004-17) that it has become aware of a type of transaction in which S corporation shareholders attempt to transfer the incidence of taxation on S corporation income by purportedly donating S corporation nonvoting stock to an exempt organization, while retaining the economic benefits associated with that stock. This notice alerts taxpayers and their representatives that these transactions are tax avoidance transactions and identifies these transactions, and substantially similar transactions, as listed transactions for purposes of Sec. 1.6011-4(b)(2) of the Income Tax Regulations and Secs. 301.6111-2(b)(2) and 301.6112-1(b)(2) of the Procedure and Administration Regulations. This notice also alerts parties involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.
The IRS has reported (Announcement 2004-24; IRB 2004-14) that Publication 971, Innocent Spouse Relief (and Separation of Liability and Equitable Relief), revised March 2004, is now available from the IRS.
The Service announced the schedule for enrolled agents to renew their enrollment. Individuals enrolled to practice before the Internal Revenue Service who received their initial enrollment on or before November 1, 2003 and who have a social security number that ends with the numbers 0, 1, 2 or 3 (affected enrolled agents) must apply for renewal of enrollment between June 1, 2004 and July 31, 2004. See Announcement 2004-35; IRB 2004-17.
The IRS has published proposed regulations (REG-106681-02) that clarify that qualified REIT subsidiaries, qualified subchapter S subsidiaries, and single owner eligible entities that are disregarded as entities separate from their owners are treated as separate entities for purposes of any Federal tax liability for which the entity is liable.
House Ways and Means Committee Chairman William Thomas (R-Calif.) has added provisions to a bill that would pay for a highway reauthorization bill. Included is a provision to permanently increase the Section 179 expense option to $100,000 (and the phaseout to $400,000) for tax years beginning after December 31, 2005. The provisions would also provide some AMT (alternative minimum tax) relief. One provision would coordinate income averaging for farmers and the AMT.
The IRS has issued guidance (IR-2004-44) on certain kinds of abusive tax avoidance transactions involving S corporations and tax-exempt entities, such as charities. These transactions are structured to improperly shift taxation away from taxable S corporation shareholders to an exempt party, for the purpose of deferring or avoiding taxes. In Notice 2004-30, the IRS says it intends to challenge these transactions on a number of grounds. It further declares that these abusive transactions are considered "listed transactions." Participants in a listed transaction who are required to file tax returns must disclose their participation to the IRS. In addition, promoters of listed transactions must keep lists of investors and, in certain cases, register those transactions with the IRS. This notice is the first time the IRS has exercised its authority under the tax shelter regulations to specifically designate a tax-exempt party as a "participant" in a tax avoidance transaction. "These transactions are structured to eliminate tax on certain S corporation shareholders by inappropriately shifting income to a tax-exempt organization. This abuses the special status that the law gives to tax-exempt organizations." "Use of tax-exempt organizations as mere accommodation parties should not be permitted." In addition, the IRS will amend Form 8886, Reportable Transaction Disclosure Statement, to require parties filing the forms to identify the names of all parties to a listed transaction. This includes any tax-exempt parties that facilitate the transaction. The tax-exempt area is one of the IRS's four top service-wide priorities. The IRS will discourage and deter non-compliance within tax-exempt and government entities, and the misuse of such entities by third parties for tax avoidance or other unintended purposes.
Rev. Proc. 2004-25 (IRB 2004-16) extends the remedial amendment period under Sec. 401(b) with respect to certain disqualifying provisions until the end of the remedial amendment period for the Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. 107-16, (EGTRRA). This extension applies to all disqualifying provisions of new plans, that is, plans that have been put into effect after December 31, 2001, and to all disqualifying provisions arising from a plan amendment adopted after December 31, 2001.
The IRS has issued proposed regulations (REG-106681-02) that clarify that qualified REIT subsidiaries, qualified subchapter S subsidiaries, and single owner eligible entities that are disregarded as entities separate from their owners are treated as separate entities for purposes of any Federal tax liability for which the entity is liable.
The IRS has issued additional guidance (JS-1278) on Health Savings Accounts (HSAs). The guidance clarifies the types of preventive care that can be provided under a high deductible health plan (HDHP) and the interaction between an HDHP and other prescription drug benefits. In addition, guidance is being issued to provide transitional relief for the prescription coverage interaction as well as allowing HSAs to reimburse medical expenses incurred after the establishment of the HDHP (rather than the establishment of the HSA). Preventive Care HSAs can only be established by eligible individuals, who must have coverage by a high deductible health plan (HDHP). Generally, an HDHP cannot provide benefits before the deductible is satisfied, but there is an exception for benefits for preventive care. The guidance issued provides a safe harbor list of benefits that can be provided by an HDHP, generally clarifying that traditional preventive care benefits--such as annual physicals, immunizations and screening services--are preventive care for purposes of HSAs, as well as routine prenatal and well-child care, tobacco cessation programs and obesity weight-loss programs. The guidance also clarifies that preventive care generally does not include treatment of existing conditions. Comments are requested regarding whether other benefits should qualify as preventive care, including payments of certain drug costs benefits provided by employee assistance programs, mental health programs, or wellness programs. The safe harbor provides employers and plans with the flexibility in designing health benefits, allowing them to provide preventive care benefits that reduce health costs and encourage early identification of health conditions that may require medical attention. Interaction Of HDHP Benefits With Prescription Benefits and Transitional Relief. Prior guidance noted that an eligible individual must be covered by an HDHP and generally no other health plan that is not an HDHP. This guidance clarifies that individuals covered by a health plan that provides prescription drug benefits before the minimum annual deductible of an HDHP has been satisfied may not make contributions to an HSA. However, companion guidance also issued provides transition relief to those individuals covered by both an HDHP and by a separate health plan or rider that provides prescription drug benefits before the deductible of the HDHP is satisfied. Under the relief, such individuals continue to be eligible to contribute to HSAs before 2006. Medical Expense Transition Relief. Prior guidance provided that HSAs may only reimburse medical expenses incurred after the HSA is established. However, many individuals eligible to establish HSAs have been unable to locate trustees or custodians will and able to open HSAs at this time. Guidance issued today provides that for 2004, an HSA established by an eligible individual on or before April 15, 2005 may reimburse expenses incurred on or after the later of January 1, 2004 or the first day of the first month that the individual became an eligible individual. For more detail see Notice 2004-23 (provides a safe harbor for preventive care benefits); Notice 2004-25 (provides transition relief with respect to medical expenses incurred by eligible individuals); Rev. Rul. 2004-38 (clarifies rules for individuals covered by both prescription drug plans and HDHPs); and Rev. Proc. 2004-22 (provides transition relief for individuals covered by both prescription drug plans and HDHPs).
Payments made that provide future benefits may have to be capitalized. In Chief Industries, Inc. (T.C. Memo. 2004-45) the IRS argued that settlement payments made to an ex-CEO under an employment agreement were not currently deductible. The Court held otherwise. If found the payments were necessary to satisfy an employment agreement and defend against attacks on the company. The IRS had claimed that the settlement was associated with a redemption of the CEO's stock. The Court found that the redemption and the settlement agreement, though negotiated at the same time and under similar circumstances, the two transactions were not related.
Previously Reported In Daily Update
Deadline tomorrow . . . Taxpayers may file and pay on time electronically until midnight of the deadline day. E-filers may pay by authorizing a no-fee electronic funds withdrawal from a checking or savings account. If you can't file, get Form 4868 for an extension to August 15. The form has details, including various options for getting an extension by filing or paying electronically. There is also a special toll-free number for requesting an extension by phone--call 1-888-796-1074 (8:30am - 4:30pm local time, except Hawaii and Alaska use Pacific Time.) Don't forget, an extension gives extra time for filing only, not for paying any balance due. Interest will apply to any tax not paid by the April deadline, plus a late payment penalty if less than 90 percent of the total tax is paid on time. The interest rate, which may be adjusted each calendar quarter, is currently five percent per year, compounded daily. The penalty for failing to file on time is five percent per month of the balance owed. If a taxpayer files more than 60 days late, the minimum penalty is $100 or the balance due, whichever is less. The penalty for paying late is 0.5 percent per month of the balance owed. There is no late filing penalty on a refund return, but a taxpayer who fails to claim a refund within three years of the filing deadline generally loses the right to that refund.
Can't pay? . . . Can't pay the full amount with your return or extension? Here are some thoughts and options for your federal return:
Deadline approaching . . . If your records are in good shape there's still time to prepare your return. Business owners, especially those who haven't been diligent on recordkeeping during the year, may want to start thinking seriously about an extension. Get IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Filing for an extension often makes more sense than rushing through your return at the last minute. It doesn't increase your chances of an audit. But getting an extension to file doesn't mean you have an extension to pay. You'll have to estimate your tax liability and pay any remaining amount due. In tomorrow's tip we'll provide some options and suggestions on what to do if you can't pay the full amount due.
Investment expenses . . . Investment expenses such as investment publications, investment counseling advice, financial planning, office expenses, etc. may all be deductible (subject to the 2% floor on miscellaneous itemized deductions). However, you can't deduct the cost of attending an investment convention or seminar. The nondeductible expenses include travel to and from the meeting, the cost of attending the meeting, and meals and lodging while at the meeting.
Made any gifts last year? . . . If you made gifts to your children, relatives, etc., the gift was in cash (or readily tradeable securities, etc.) and the amount of the gift was no more than $11,000, you probably don't have to file a return. On the other hand, if the amount of the gift was more than $11,000 or you and your spouse elect to split gifts made last year, you'll have to file a Form 709. (There are still no tax consequences if the gift is no more than $22,000 and you and your spouse elect to split the gift.) Filing by the April 15th deadline is critical if you and your spouse elect to split gifts made in 2003. The election can't be made on a late filed return. (You can request an extension to file.) Even if the gift is less than filing threshold, you may want to file a return if the gift consists of real estate, stock in a closely held corporation, or any other property that's not readily traded. If you file, the IRS has only a limited time to challenge the valuation of the gift. If you don't file, that valuation could be challenged years later.
SBA 7(a) loan program . . . President Bush has signed a bill that will increase the 7(a) program's lending authority to at least $12.5 billion for 2004 and increase the cap on loans to $2 million from the current $750,000. The measure also allows lenders to make combination or "piggyback" loans.
Investment interest . . . Personal interest generally isn't deductible. There are only two exceptions, interest on a first and second home (including a home equity loan), and investment interest. Investment interest is generally margin interest. But you can only deduct investment interest up to the amount of your net investment income. Net investment income is generally limited to interest, nonqualified dividends, and short-term capital gains less investment expenses such as fees, investment advice, etc. Use Form 4952 (Investment Interest Expense Deduction) to calculate your allowable investment interest deduction. Read the instructions carefully.
Income averaging for farmers . . . Income averaging for most taxpayers died many years ago. But for farmers, or more specifically for taxpayers with farm income, income averaging is still alive. An individual engaged in farming my elect to compute his or her current year income tax liability by averaging, over a 3-year base period, all or a portion of his or her current year electible farm income. An individual engaged in a farming business includes a sole proprietor of a farming business, a partner in a partnership engaged in a farming business, and a shareholder of an S corporation engaged in a farming business. A report by from the Treasury Inspector General for Tax Administration showed that less than one-half of eligible taxpayers are taking advantage of the farm income averaging provision. The report noted that the vast majority of the returns, some 89%, were prepared by paid tax preparers. If you qualify, income averaging can almost always lower the tax liability for taxpayers with wide variations in income. Double check your return before filing.
Add sales tax to your state return? . . . More and more states are adding a line on their individual income tax returns asking you to pay sales tax on purchases made over the internet, by phone, or through the mail where you didn't pay tax on the original purchase. If you've got a business, you're supposed to report such purchases on your regular sales tax return. This isn't a new law. Most states have had the requirement for years. Now, often because they need the revenue, these states are getting more aggressive in enforcing the rule. Read the instructions for your state return carefully. New York allows taxpayers to pay an amount based on a table geared to their adjusted gross income. Large purchases must be reported separately. What if you don't include any sales tax on your return? We're not sure that would increase your audit chances if your AGI is relatively low. On the other hand, if your AGI is several hundred thousand dollars and you don't include anything, we wouldn't be surprised if you got a letter from the state. You should be concerned if you made any large purchases. Is there any way for the state to check on your out-of-state purchases? Some states have indicated that they're getting data from catalog merchants. It wouldn't be too difficult to correlate the information.
Get your dependents straight . . . If it's just you and your wife and your 12-year old daughter and 14-year old son, getting your dependents right on your tax return is easy. But it's often not that easy. Your 21-year old son may be a full-time student, but because he made $10,000 last year he decides to take himself as a dependent. While that may boost your tax bill, it's not that bad, unless you don't know about it and you too take him as a dependent. Or you and your spouse are separated or divorced and you both claim your daughter as a dependent. If there's any doubt, check before claiming a dependent. The IRS is taking a dim view of more than one taxpayer taking the dependency exemption.
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