Small Business Taxes & Management

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

New Filing Address for Returns Prepared by Professionals in 10 States

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

News On The Tax Front

Previously Reported In Daily Update

If the IRS believes you have underreported your income, it can use any of a number of methods to reconstruct your income. That's what the Service did in William B. McDermott and Donna McDermott (T.C. Memo. 2003-269). The taxpayer challenged the IRS findings. In Court the taxpayers showed that one of the deposits was an advance payment on a contract the income from which the taxpayers reported in full. The taxpayers were able to show the other deposits were gifts from the taxpayers' relatives.

You can deduct the remaining adjusted basis (generally, cost less depreciation to date) of assets that are abandoned. But, in order to take the deduction, you've got to be able to show remaining basis and that the assets were actually abandoned. And proving an asset is abandoned isn't as simple as it sounds. In Maintenance, Painting & Construction, Inc. (T.C. Memo. 2003-270) the taxpayer had a large, multi-year painting contract. At some point the company began storing on a lot in California some of the equipment that had become inoperable. The record does not indicate that petitioner documented the assets which it placed on the lot. The taxpayer also sold some of the equipment located on the lot for $30,000. The taxpayer reported on the return that the assets sold in the transaction were "VARIOUS ASSETS -- CA" and did not otherwise identify those assets. The taxpayer claimed an abandonment loss on other assets totaling $246,000. The Court found the taxpayer's recordkeeping inadequate. Noting that individual assets could not be tracked. Moreover, there was no documentation to support the abandonment of the assets nor the taxpayer's basis in them. Note. You might be able to get sympathy from the IRS and the courts for failing to trace small items, but there's no excuse for losing track of autos, trucks, or similar large and expensive equipment.

The IRS announced (IR-2003-119) new guidelines for sending facsimiles to the IRS that will make it easier for taxpayers and tax professional to correspond with the agency. The new guidelines will ines will expand the list of documents and information the IRS will accept via fax. The expanded guidelines stem from recommendations from tax professional organizations. The changes are aimed at reducing the burden on taxpayers and practitioners and shortening the time it takes to resolve tax inquiries and cases. The new guidelines became effective Oct. 1, 2003. The new fax guidelines apply only to taxpayers and their representatives who are engaged in an on-going contact with the IRS, such as an examination or resolving questions about tax returns that are being processed. The fax can only take place after a discussion with the IRS employee who is requesting the information. These general guidelines are applicable to all divisions and cover operations related to income tax, employment tax, excise tax, estate tax, gift tax, and generation skipping tax, as well as tax exempt and employee plans determinations. While the IRS has previously accepted forms via fax in limited situations (such as 1120-S elections and Powers-of-Attorney) the new guidelines permit an expanded number of forms and other types of documentation to be submitted by fax in the course of many return related inquiries. Additional details are available on IRS.gov under Tax Professional.

In David Lee Smith and Mary Julia Hook (T.C. Memo. 2003-266) the Court granted the Service's motion to dismiss the case for failure by the taxpayers to prosecute. The Court noted that the taxpayers, both experienced practicing lawyers, ignored the Court's orders and process. They failed to comply with Pretrial Orders and Court Rules requiring the preparation of their cases, including the requirement to meet and/or work with counsel for the IRS to exchange documents and information, stipulate facts, and otherwise to prepare for trial. The taxpayers were provided with additional time to remedy their failure to comply. In each of the numerous instances the cases were called for trial, or trial was resumed, they failed to correct or to remedy their prior failures, and little or no progress had been made from the time before, even though the Court took great pains to detail what was expected. The taxpayers were admonished that their failure to prepare for trial and/or comply with this Court's Orders, Rules and Procedures would result in a default.

You can't net gambling losses against winnings. That's what the Court held in In re Gary N. Berardi, Debtor (2003-2 USTC 50,648; U.S. Court of Appeals, 3rd Circuit). The Court noted that the law requires a taxpayer to report the full amount of winnings and then claim an itemized deduction for the losses. Moreover, the Court disallowed the taxpayer's claimed business deductions for lack of substantiation.

Employee or independent contractor? That's still a touchy issue. In Frederick C. Kumpel (T.C. Memo. 2003-265) the taxpayer claimed that two legal assistants were independent contractors. The IRS claimed they were employees. The Court looked at a number of factors, but noted that the control factor was the crucial test to determine the nature of a working relationship. While the taxpayer argued that the workers made their own hours, the Court noted the taxpayer was still in control. The Court said "This one aspect of the relationship, even if true, is not determinative." The Court found the workers were employees and that the taxpayer was liable for failure to pay or make deposits of employment taxes.

If in doubt, it's probably taxable. There are few exceptions. A settlement received in connection with suit where you were personally injured is generally nontaxable. In Emmanuel L. Roco (121 TC--, No. 10) an accountant sued the New York University Medical Center under the False Claims Act. In the action, the taxpayer claimed the Center had submitted false information to the United States which resulted in a substantial overpayment of Federal funds to it. The Center agreed to agreed to pay $15,500,000 to the U. S. in settlement of the case. The U. S. paid the taxpayer $1,568,087 as his share of the settlement proceeds. The taxpayer argued that the amounts received were not taxable. The Court sided with the IRS, noting the payment was in the form of a reward, and thus fully taxable.

The IRS has announced (IR-2003-118) the release new materials, including a CD-ROM, to help small businesses and plan administrators understand how to keep employee retirement plans eligible for tax-favored status. The materials explain the IRS programs available to assist employee-retirement plan administrators through the tax laws. The materials also explain how to correct errors in the plans, often without even having to notify or correspond with the IRS. The materials include IRS Publication 4224, Retirement Plan Correction Programs, a synopsis of the correction programs by the IRS, DOL (Department of Labor) and the Pension Benefit Guaranty Corporation. The IRS also has a CD-ROM, Publication 4050, that offers a more complete guide to the programs. The pamphlet and the CD-ROM can be ordered by calling 1-800-829-3676. You can also get the information on line by going to www.irs.gov/retirement/article/0,,id=96907,00.html.

You may be able to settle your tax debt for less than the full amount if you and the IRS agree to an offer in compromise. But the IRS does not have to agree with what you offer. In Robert M. Galvin and Christine Galvin (T.C. Memo. 2003-263) the IRS refused the taxpayer's offer to settle. The taxpayer owed taxes for a number of years, the earliest of which was 1980. The Court noted the taxpayers had entered into six installment agreements to pay their unpaid tax liabilities on which they defaulted by failing to make required payments and to timely pay other tax liabilities. Based on their income and expense information, the IRS determined that they could pay $721 per month. The taxpayers rejected the proposal. The taxpayers counteroffered with $250 per month. The IRS rejected that and sustained the proposed levy action. The IRS said that an installment agreement was not possible because payments of even $721 per month would never fully pay the liabilities. The IRS can only grant an installment agreement that provides for full payment within the statutory period for collection. An installment offer in compromise was discussed in detail but you have not pursued this alternative. The Court sided with the IRS, finding the Appeals Officer's rejection of the taxpayer's offer was reasonable.

Generally, the taxpayer bears the burden of proving an error in the Service's determinations. That is, the IRS is presumed correct. The courts have recognized a limited exception to the general rule where the notice of deficiency determines that the taxpayer failed to report income, particularly income derived from illegal activities. In such situations, the IRS must come forward with evidence establishing a minimal amount of foundation, which may consist of evidence linking the taxpayer with an income-producing activity. In Meri R. and William R. Kaufman (T.C. Memo. 2003-262) the Court noted that all of the facts upon which respondent relies to link Ms. Kaufman with criminal activity and to demonstrate the amount of misappropriated funds have been deemed admitted by operation of Rule 37(c) since the taxpayers failed to file any reply.

The IRS has certified the 2004 Toyota Prius as being eligible for the clean-burning fuel deduction. The certification means taxpayers who purchase a new hybrid vehicle may claim a tax deduction of up to $2,000 on Form 1040. Federal tax law allows individuals to claim a deduction for the incremental cost of buying a motor vehicle that is propelled by a clean-burning fuel. Hybrid vehicles obtain greater fuel efficiency and produce fewer emissions by combining a small gasoline engine with an electric motor and batteries. Under current law, the clean-burning fuel deduction will be reduced incrementally until it expires beginning 2007. Purchasers of IRS-certified cars will be able to claim a deduction of $2,000 if the vehicle is placed in service on or before Dec. 31, 2003. The $2,000 maximum deduction will be reduced by 25 percent for vehicles placed into service in 2004, by 50 percent in 2005 and by 75 percent in 2006. No deduction will be allowed for vehicles placed in service after Dec. 31, 2006. Under the law, the one-time deduction must be taken in the year the vehicle was originally used. The taxpayer must be the original owner. (IR-2003-114)

Dividends paid by domestic and certain qualified foreign corporations now qualify for the lower capital gain rates of 15% (5% for taxpayers in the 10% and 15% brackets). A qualified foreign corporation includes certain foreign corporations that are eligible for benefits of a comprehensive income tax treaty with the U.S. In addition, a foreign corporation that would not otherwise qualify is treated as a qualified foreign corporation with respect to any dividend it pays if the related stock is readily tradable on an established securities market in the U.S. Notice 2003-71 (IRB 2003-41) defines, for taxable years beginning on or after January 1, 2003, what it means to be readily tradable on an established securities market in the U.S. . The IRS intend to issue regulations under section 1(h) incorporating the principles outlined in this Notice.

A special, higher interest rate, applies to corporate underpayments of income tax. In Med James (121 TC--, No. 9) the taxpayer argued successfully that the tax deficiency did not exceed the $100,000 threshold because the corporation's net operating loss should be used to reduce the deficiency. That brought the total underpayment to less than $100,000.

The IRS has announced (Rev. Proc. 2003-75; IRB 2003-43) the limitations on depreciation deductions for owners of autos first placed in service in calendar year 2003, the special limitations on trucks and vans, and the maximum auto value for using the cents-per-mile valuation rule ($15,200). The depreciation limitations on autos are unchanged from 2002. However, the new limitations on trucks and vans are higher. We're currently updating our Vehicle Tables reference tables to reflect the new amounts, including the new lease inclusion amounts.

The new law lowers the tax on qualified dividends to 15% (5% for taxpayers in the 10% and 15% brackets). Qualified dividend income means dividends received during the taxable year from domestic corporations and "qualified foreign corporations." Subject to certain exceptions, a qualified foreign corporation is any foreign corporation that is either (1) incorporated in a possession of the United States, or (2) eligible for benefits of a comprehensive income tax treaty with the United States which the Secretary determines is satisfactory for purposes of this provision and which includes an exchange of information program. In Notice 2003-69 (IRB 2003-42) the IRS provided a list of the countries which have relevant treaties with the U.S. The IRS is working on guidance concerning whether foreign corporations are qualified foreign corporations under the treaty test.

Australia       Ireland        Poland
Austria         Israel         Portugal
Belgium         Italy          Romania
Canada          Jamaica        Russian Federation
China           Japan          Slovak Republic
Cyprus          Kazakhstan     Slovenia
Czech Republic  Korea          South Africa
Denmark         Latvia         Spain
Egypt           Lithuania      Sweden
Estonia         Luxembourg     Switzerland
Finland         Mexico         Thailand
France          Morocco        Trinidad and Tobago
Germany         Netherlands    Tunisia
Greece          New Zealand    Turkey
Hungary         Norway         Ukraine
Iceland         Pakistan       United Kingdom
India           Philippines    Venezuela
Indonesia

President Bush has signed a bill that will extend the authority for the IRS to share information with the Department of Education. The purpose of the information-sharing agreement is to administer student loans that are contingent on income.

The IRS has issued Rev. Rul. 2003-109 (IRB 2003-42), which provides an updated list of geographical areas that are included in the "North American area" for purposes of deducting convention expenses. Section 274(h) of the Code provides that expenses incurred by U.S. taxpayers for conventions, seminars, or similar meetings in the North American area that are otherwise deductible as ordinary and necessary business expenses will be allowed without regard to the additional statutory limitations applicable to foreign convention deductions. For this purpose, the North American area includes the U.S. and its possessions, Canada, Mexico, jurisdictions that have entered into Compacts of Free Association with the United States providing for such treatment, and jurisdictions that are beneficiary countries as defined in the Caribbean Basin Economic Recovery Act of 1983 and that have in effect a tax information exchange agreement with the United States.. Revenue Ruling 2003-109 reflects tax information exchange agreements in effect with such beneficiary countries, including the tax information exchange agreement with Antigua and Barbuda that recently came into effect.

The IRS has released several updated tax publications:

Pub. 1281 Backup Withholding on Missing and Incorrect Name/TINs
Pub. 1679 A Guide to Backup Withholding on Missing and Incorrect Name/TINs
Pub. 393 Federal Employment Tax Forms
Pub. 971 Innocent Spouse Relief

A bill is expected to be introduced into the Senate this week that would allow states to collect tax on internet and other remote (e.g., mail order) sales. The bill is a companion to one (H.R. 3184) introduced in the House last week. While the bills allow the collection of sales taxes from out-of-state sellers, the mechanics of collecting and paying the tax would be simpler than the current system. A number of states have agreed on the Streamlined Sales and Use Tax Agreement. Under this compact, there would be a centralized, one-stop, multistate registration system that sellers may elect to use to register with the member states; provided the seller may also elect to register directly with a member state. In addition, privacy and confidentiality controls would be placed on the multistate registration system so that it may not be used for any purpose other than the administration of sales and use taxes. Other requirements would be uniform definition of products and product-based exemptions, uniform rules for sourcing and attributing transactions to taxing jurisdictions, and uniform rules and procedures for other issues such as customer returns, tax returns and remittances, etc. There would also be a small business exception for sellers with remote taxable sales nationwide of less than $5 million in the preceding calendar year or less than $100,000 in gross remote taxable sales nationwide.

New Filing Address for Returns Prepared by Professionals in 10 States

The IRS is urging tax professionals (IR-2003-113) to be aware of changes that will affect where they send tax returns and payments for clients in 10 states starting in 2004. The changes are a result of redistributing workload among the 10 IRS processing centers to provide better service.

Tax professionals whose clients are in the Metro New York area and

Alabama
Arkansas
Delaware
Michigan
Montana
Rhode Island
Tennessee
Utah
Wyoming

will be filing their returns with different IRS centers during the 2004 filing season. For clients in Arizona and Washington, they will send returns with payments to different IRS addresses although other returns will continue to go to the IRS center in Fresno.

Because many tax professionals will need the addresses for IRS centers before the tax filing season, the IRS is providing them now.

For taxpayers who file paper returns, the new center addresses will be provided on the envelopes in the tax packages. Taxpayers who e-file will not be affected by these changes. More than a third of all individuals choose to e-file their federal tax returns.

Where to File 2003 Form 1040 for Tax Professionals

Client Address                            No Payment          Payment Enclosed**

Alabama, Florida, Georgia,          Atlanta, GA 39901-0002         P.O. Box 105093
Mississippi, North Carolina,                                   Atlanta, GA 30348-5093
Rhode Island, South Carolina,
West Virginia

Maine, Massachusetts, New             Andover, MA 05501-0002      P.O. Box 37002
Hampshire, New York, Vermont                                  Hartford, CT 06176-0002
		
Connecticut, District of          Philadelphia, PA 19255-0002     P.O. Box 80101
Columbia, Maryland, New Jersey,                             Cincinnati, OH 45280-0001
Pennsylvania		

Arkansas, Colorado, Kentucky,        Austin, TX 73301-0002        P.O. Box 660308
Louisiana, New Mexico, Oklahoma,                              Dallas, TX 75266-0308
Tennessee, Texas	

Alaska, California, Hawaii,          Fresno, CA 93888-0002        P.O. Box 7704
Idaho, Montana, Nevada, Oregon,                           San Francisco, CA 94120-7704 
Washington, Wyoming	
	
Delaware, Illinois, Indiana,         Kansas City, MO 64999-0002   P.O. Box 970011
Iowa, Kansas, Michigan,                                      St. Louis, MO 63197-0011
Minnesota, Missouri, Nebraska,
North Dakota, South Dakota,
Wisconsin	
	
Ohio, Virginia	                     Memphis, TN 37501-0002       P.O. Box 105017
                                                              Atlanta, GA 30348-5017

Arizona, Utah	                     Fresno, CA 93888-0002        P. O. Box 1214
                                                             Charlotte, NC 28201-1214




All APO and FPO addresses, American Samoa, nonpermanent residents of Guam or the 
Virgin Islands*, Puerto Rico (or if excluding foreign income under
Internal Revenue Code section 933), dual status alien, a foreign country:
U.S. citizens and those filing Form 2555, 2555-EZ, or 4563

	                          Philadelpia, PA 19255-0215     P.O. Box 80111
                                                            Cincinnati, OH 45280-0011

** The addresses listed in this column are different from the addresses listed on the back of the tax booklets. You must use the addresses in this column if you are a preparer.

Note for Form 1040A and 1040EZ returns:

If you are filing a client's Form 1040A or 1040EZ and are enclosing a payment, you will also use the addresses shown in the last column above.

If you are filing a client's Form 1040A and are not enclosing a payment, you will also use the addresses shown in the middle column except the +4 ZIP Code extension will be -0015 instead of -0002 (the Philadelphia +4 ZIP code extension remains -0215).

If you are filing a client's Form 1040EZ and are not enclosing a payment, you will also use the addresses shown in the middle column except the +4 ZIP Code extension will be -0014 instead of -0002 (the Philadelphia +4 ZIP code extension remains -0215).

Brookhaven Processing Center in Holtsville to Cease Processing Returns

In a separate announcement the IRS reported that the Brookhaven IRS Campus Submission Processing Center in Holtsville will cease processing tax returns as of September 30, 2003. Forms 1040, 1040A, 1040EZ, 1040X, and 4868 will now be processed at the Andover Processing Center in Andover Massachusetts.

Returns WITH PAYMENTS:

Internal Revenue Service
Andover, MA 05501-0102

Returns WITHOUT PAYMENTS:

Internal Revenue Service
Andover, MA 05501-0002

This change will be effective from October 1, 2003 until December 31, 2003. All returns sent to Brookhaven after October 1, 2003 will be transshipped to the Andover IRS Submission Processing Center. If a return is sent to Brookhaven by the October 15th extension due date it will be considered timely filed. This change will only effect the processing of individual tax returns. All other operations of the Brookhaven IRS Campus will proceed as normal.

In Brief:

Previously Reported In Daily Update

Undercapitalized? That can be costly . . . If you do business as a corporation or LLC, probably the primary reason you selected the form of organization is to avoid personal liability. But that could backfire if your business is highly leveraged (e.g., capitalized with $10,000 of equity and $100,000 of debt) as many small businesses are. Your creditors may be able to pierce the corporate veil, claiming the business is simply your alter ego. This is a complex issue. Discuss it with your attorney. You don't want to destroy the most important reason for choosing a form of organization.

Don't assume group rate is the best . . . If you're going to a convention, seminar, etc. the sponsor will probably have a group rate at a local hotel. While the room rate might be lower than standard, there could be hidden charges and higher rates for services. Investigate fully. You may do better by getting a room some distance from the convention, away from the business district. Your transportation costs will be higher, but the lower room rate may be more than offsetting.

Can't find a participant in your pension plan? . . . Or a former employee? It can be an important issue. The IRS has a Letter-Forwarding Program under which it will search its database if you can provide the individual's social security number. The Service will not give you the individual's address, but will forward a letter to them (e.g., to inform them they have money coming from a pension plan). The IRS cannot divulge the disposition of a letter submitted for forwarding. If the letter is returned, it is destroyed without informing the sender of the action taken. The Letter-Forwarding program serves as an acceptable method to satisfy the reasonable steps requirement a pension plan must make before the participant forfeits his benefits. For more information go to www.irs.gov/ep and click on "More Topics" and then "Contact Missing Participants or Beneficiaries".

New hire reporting . . . You must report all newly hired employees to a designated state agency shortly after the date of hire. New hire reports are matched against child support records to find parents who are not paying their child support. The Social Security Administration also used the information in the Supplemental Security Income (SSI) program by detecting unreported or underreported income. You generally must make the report to the agency with 20 days of hiring, but the amount of information and the time limit varies among the states. You can get information on the rules for any state by going to the Federal Office of Child Support Enforcement's Web site at www.acf.hhs.gov/programs/cse/newhire/employer/contacts/contacts.htm. Note. Some states require you to report payments to independent contractors also.

No free lunch . . . You may be required by law to give employees a lunch break. It can depend on a number of factors including the number of hours the employee is on duty during the day. Check with a human resources professional or someone from the labor department in your state. And check the rules on employees working through their lunch hour. Some individuals may want to work and take off early. That may or may not be allowed. Even if permitted, be sure you document it so the employees can't argue later they were denied a lunch break.

Excessive debt greatest reason for business failure . . . That's what some studies have shown. Many small businesses are seriously undercapitalized. You don't have to have a negative net worth to be in trouble. It's not unusual for a business owner to be waiting for a customer's check to clear in order to pay a supplier. That's a cause for concern. Whether or not you really have a serious problem requires an analysis of the age of the payables and receivables, the liquidity of inventory, and a number of other factors. Incidentally, capitalization is one of the important reasons frachises have a higher survival rate than small businesses in general. Most frachisors won't let you start without sufficient equity. That goes a long way to ensuring survival. There are, of course, other reasons including management and technical assistance, location selection, etc. that help.

Make every customer contact count . . . Every time you're on the phone, face-to-face, on e-mail, etc. with a customer, make the most of it. That could mean selling him or her more, telling them about new products in the works, etc. Take a minute to ask how a product purchased earlier is working, are they satisfied with the service, is there anything that the company could improve on, etc. And don't forget to thank them for their last order. Every contact is important. Done properly you might be able to sell additional product, perk the customer's interest in upcoming offerings, etc. and, help improve the company's relationship with the customer.

Thinking about writing your own contract, prenuptial agreement, etc.? . . . You might want to reconsider. There's a good chance if you end up in court the agreement won't stand up. The complex wording in many legal documents is there for a purpose--it's withstood the test of many court decisions. Documents that you might draft could be open to a much different interpretation than you intended. Moreover, a document you sign without legal advice could more easily be challenged. That could be bad news for the other party. But you don't need a lawyer for every transaction. You should be on safe ground if both parties are knowledgable (for example, you sign a contract to have special equipment constructed for your business) and you use a standard contract.

Get an identity . . . Small businesses can't do everything. Many succeed by finding an identity, then exploiting it as much as possible. For a restaurant it might be specializing in certain items other restaurants don't. Use these items to draw in customers. You can often get free publicity if the menu item, product, service is unique enough. For retailers, it might be specializing in a certain product. It doesn't work for every business, but it's worth a try. Particularly since the cost and risk of doing so may be low. The idea is for customers to think of you first. Another benefit? You may be able to charge a premium price (just don't overdo it; you might attract competition).

Encumbered property in your will . . . You probably have intentions of leaving specific amounts to certain parties in your estate. While you might have a good idea of the market value of the asset, individuals frequently forget that the property might have a lien on it. Generally, that will reduce the net value. For example, you know your son always enjoyed your 45-foot sailboat. Since it's worth about $250,000 you leave it to him and leave your Madison Inc. shares, also worth about $250,000 to your daughter. But the sailboat has a loan on it of $150,000. You've really given your son an asset worth only $100,000. You can, however, leave him the property free and clear. Ask your attorney to include a provision specifying that the encumbrance be paid out of the estate. With such a clause the estate would have to pay the loan off out of the general assets, leaving your son the sailboat free of debt. Bequests of business interests, such as shares in a closely held corporation, demand special attention.