Swallows Holding Decision Now Available

Posted on February 19, 2008 by Russ

The Third Circuit Court of Appeals ruling in Swallows Holding, Ltd. v. Commissioner is now available online. The summary of the ruling is:

“This case, grounded in the principles of administrative law, requires that we review the validity of an Internal Revenue Service (IRS) regulation. The Tax Court, in considering this regulation, analyzed it under the factors provided in National Muffler Dealers Ass’n v. United States, 440 U.S. 472, 477 (1979), and concluded that the regulation was invalid. In coming to this conclusion, the Tax Court explained that the standard established in National Muffler had not been replaced by Chevron U.S.A., Inc. v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984), and that the result under either standard would be the same. We do not agree with the outcome reached by the Tax Court. We have determined that the result would not be the same under Chevron analysis as it would be under National Muffler and that the regulation here should be given Chevron deference.”

The TaxProf Blog has more.

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Foreign Taxpayers Better File on Time…

Posted on February 18, 2008 by Russ

…or at least within 18 months of their due date. Why? IRS regulations hold that if a foreign corporation files after that date they cannot take any deductions.

Consider a hypothetical corporation, Foreign Company Ltd., which has US source gross income of $100,000, and “necessary and ordinary” deductions of $100,000 for $0 net income. However, Foreign Company Ltd. didn’t file. Under the IRS regulations, it’s taxed at up to 35% of $100,000 (plus penalties and interest, of course).

This doesn’t seem right, and the Tax Court agreed that these regulations were wrong in Swallows Holding, Ltd. v. Commissioner (126 T.C. No. 6). The IRS appealed to the Third Circuit Court of Appeals, and Tax Analysts is reporting (in an opinion that has yet to be released—I’ll post a link to the ruling when it’s released) that the appeals court has reversed the Tax Court.

The Tax Court decision notes that in a 1940 case the Fourth Circuit held that there’s no reference as to time in the then regulations. I’m not sure that the two cases are at odds with each other (the current regulation was issued in 1990), but if they are this would be the kind of case that the Supreme Court would be likely to take (resolving a difference between rulings between two different appeals courts).

In any case, if you’re a principal of a foreign entity with US source income you’re now on notice. If you don’t file the tax return within 18 months of the due date you won’t get to deduct anything.

Hat Tip: Roth Tax Updates

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Fast Food Mogul to Sample 36 Months of ClubFed Cuisine

Posted on February 17, 2008 by Russ

Karl James is the former president of Golden West Taco, Inc., one of the largest franchises of Taco Bell (which is based here in Irvine). Back in 2000 Golden West Taco went into Chapter 11 Bankruptcy protection. Yet Taco Bells were doing quite well at the time–remember that chihuahua?

There was a reason the company (and its owner, Karl James) went into bankruptcy. Mr. James “fraudulently diverted” (for the layman, read that as “stole”) about $3 million of company funds for his personal use. He transfered assets, including residences in the upscale communities of Rancho Santa Fe and Palm Springs to his nominees, used offshore companies with off the balance sheet accounts, and otherwise obfuscated the books. I should point out that these actions are considered bankruptcy fraud.

Mr. James went a step further. In transferring the assets from his company to himself he created income. And he didn’t report that income. In total, he deprived creditors of Golden West Taco of $1,121,829. He committed tax fraud to the tune of $1,169,957 . To his credit, he pleaded guilty and has agreed to make restitution (he’s already repaid $2,014,363).

However, he won’t be eating at Taco Bell for awhile. He’ll be spending three years at ClubFed followed by three years of supervised release. It’s a pretty big price to pay for tacos.

News Story: NBC San Diego

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States of Opportunity

Posted on February 17, 2008 by Russ

Last Tuesday, the Wall Street Journal ran an excellent editorial titled “States of Opportunity.”

“But one reason to conclude that taxes are also a motivator is because the eight states without an income tax are stealing talent from other states. They are Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming, and each one gained in net domestic migrants. Each one except Florida — which has sky-high property taxes on new homesteaders — also ranked in the top 12 of destination states.

“Politicians who think taxes don’t matter might want to explain the Dakotas. North Dakota ranked second worst in out-migration last year, while South Dakota ranked in the top 10 as a destination. The two are similar in most regards, with one large difference: North Dakota has an income tax and South Dakota doesn’t.”

The editorial also contrasts California, which has lost 1.5 million residents, with Nevada, which is booming. Perhaps our legislature will begin to think logically about this and start cutting taxes. And maybe pigs will fly….

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Legislature Approves $1 Billion in Cuts; $13.5 Billion to Go

Posted on February 17, 2008 by Russ

California’s legislature sent a $1 billion bipartisan package of budget cuts to Governor Schwarzenegger; the Governator signed the package yesterday. The budget cuts will come primarily from school funding and from Medi-Cal (California’s medical program for low income individuals).

Yet Californians should carefully watch their wallets. Assembly Speaker Fabian Nunez (D-Los Angeles) wants the $13.5 billion shortfall to be balanced 50% from spending cuts and 50% from revenue increases. For those who aren’t in government, revenue increases are more commonly referred to as tax increases. Given California’s abysmal ranking as a state to do business, politicians in Sacramento should be talking about tax cuts instead of tax increases to balance the budget.

If California implements tax cuts, these might lead to more businesses locating in California and more tax revenue. But that’s thinking outside of the box, and the Democrats in control of the legislature in Sacramento rarely do that. Luckily for California’s taxpayers, the budget requires a 2/3 vote—Republicans in both houses must approve the budget balancing methods for it to pass into law. Expect a very contentious legislative session this Spring in Sacramento.

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Crack Tax Redux

Posted on February 17, 2008 by Russ

New York is facing a budget shortfall this coming year. Governor Eliot Spitzer has an interesting idea about how to fill the gap: a crack tax. I’ve written about these taxes before. Many states have these taxes (21 at last count); however, they sometimes don’t survive the courts.

In any case, Governor Spitzer’s proposal is to tax marijuana $3.50/gram and cocaine $200.00/gram. The proposal is estimated to bring in $13 million if it is enacted into law.

That doesn’t seem certain. Jeffrion Aubry (D-Queens) vows to fight this “boneheaded” proposal. And given that it would only bring in $13 million, other revenue enhancers (or cuts in spending) will be needed to balance New York’s budget.

News Story: Washington Post

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One Last Electronic Filing Delay

Posted on February 17, 2008 by Russ

If you are going to file Form 982 you will not be able to electronically file until March 3rd. Form 982 is the new form that allows taxpayers to not have to claim canceled home mortgage debt as income. You can submit a paper return with Form 982 today, though.

Hat Tip: Don’t Mess with Taxes

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1031 Swaps for Vacation Homes

Posted on February 17, 2008 by Russ

The IRS gave the go-ahead to §1031 exchanges for vacation homes. Do note there are significant restrictions. If you own a second home and are considering a §1031 exchange, make sure you follow the restrictions. Joe Kristan has the details on the IRS’ pronouncement (Revenue Ruling 2008-16).

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Louisiana Loves Gamblers

Posted on February 15, 2008 by Russ

And that’s not a good thing.

Assume you’re an amateur gambler. You add up your winning and losing sessions for the year, and find that you have $150,000 of wins and $100,000 of losses. You get to deduct the $100,000 of losses on your federal income tax.

But if you’re a resident of Louisiana, you can’t do that on your state return. Louisiana penalizes anyone who takes itemized deductions. The formula for calculating the LA itemized deductions is:

57.5% * [(Fed. Itemized ded’ns) – (Fed. Standard ded’n)]

This is especially bad for amateur gamblers, because gamblers must include all of their wins as part of their Adjusted Gross Income but none of their losses. At least Louisiana gives a deduction from income of the amount of federal income tax you pay…

So Louisiana joins my list of states where a gambler shouldn’t reside. Here’s the complete list:

Connecticut
Illinois
Indiana
Louisiana
Massachusetts
Michigan
Minnesota (because of its AMT)
Mississippi (Only MS gambling deductions are allowed)
New York
Ohio
West Virginia
Wisconsin

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Taxing the Virtual World

Posted on February 14, 2008 by Russ

Let’s suppose you’re playing an online role playing game such as Second Life. You’ve accumulated quite a bit of virtual property, and have a stash of virtual money. James Doe offers you $5,000 for your virtual money and virtual property—that’s 5,000 real U.S. Dollars—and you elect to accept them. Do you have a real taxable event that would interest the IRS or just a virtual event?

I’ve written about this in the past, and I came to the conclusion that sooner or later the virtual world would intersect with the IRS. An article in the New York University Law Review by Professor Leandra Lederman of Indiana University’s School of Law suggests that,

“…in virtual worlds that are intentionally commodified, such as Second Life, tax doctrine and policy counsel taxation of even in-world sales for virtual currency, regardless of whether the participant cashes out. However, as in game worlds, participants should not be taxed on purely in-world trades of non-currency items. This approach would allow entertainment value to go untaxed without creating a new tax shelter for virtual commerce.”

The good news? She doesn’t believe that pure virtual transactions in a virtual world should result in the IRS taking a bite (though a literal reading of the Tax Code could be interpreted that such transactions are subject to tax).

The IRS is aware of this issue and, sooner or later, it will be added to their priority guidance list. I suspect that sometime in the next few years if you trade virtual dollars for real dollars you will also receive a real 1099.

The abstract of the paper is available here. The full paper is not available online.

Thanks to the TaxProf Blog for the heads-up about this interesting subject.

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