The 2% Solution

Posted on May 1, 2006 by Russ

Today the Tax Court looked at an ambiguous section of the Tax Code. Suppose an S Corporation is owed a refund, with interest. What interest rate should be used? The general “corporate overpayment” rate, the “large corporation” overpayment rate, or the “non-corporate” rate?

All corporations start as C Corporations. Many corporations immediately become small business corporations, or S Corporations. Sometimes a corporation will convert to being an S Corporation during its life. Today’s case involves such a corporation. Corporations that convert from C to S can owe a “Built-In Gains Tax.”

Garwood Irrigation Company owed such a tax, and prepaid it. In fact, they overpaid the tax and were due a refund. Last year, the Tax Court decided the amount of the refund. The IRS computed the refund using §6621 (a)(1) of the Internal Revenue Code, and assumed that Garwood was a large corporation:

Section 6621(a)(1) provides:
SEC. 6621. DETERMINATION OF RATE OF INTEREST.
(a) General Rule.–
(1) Overpayment rate.–The overpayment rate established under this section shall be the sum of–-
(A) the Federal short-term rate determined under subsection (b), plus
(B) 3 percentage points (2 percentage points in the case of a corporation).
To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substituting “overpayment” for “underpayment”) exceeds $10,000, subparagraph (B) shall be applied by substituting “0.5 percentage point” for “2 percentage points”.

As the Tax Court notes, the dispute is based on what a large corporate overpayment is. Subsection (c)(3) states,

(3) Large corporate underpayment.–For purposes of this subsection–
(A) In general.–The term “large corporate underpayment” means any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000.
(B) Taxable period.–For purposes of subparagraph (A), the term “taxable period” means–
(i) in the case of any tax imposed by subtitle A, the
taxable year, or
(ii) in the case of any other tax, the period to which the underpayment relates.

Confused? Well, the Internal Revenue Code can confuse anyone, including Tax Court judges. As the Court notes, “This creates a question as to why Congress did not more artfully express the incongruity in dollar thresholds, if petitioner’s argument is assumed to be correct.”

Because the statutes are ambiguous, the Court looks at the legislative history to resolve the dispute. The Court discovers that the large overpayment statute was designed for C Corporation; the petitioner, Garwood Irrigation Corporation, is not one. So that rules out the 1/2% rate of interest. However, Garwood is a corporation, so the Court throws out the 3% that Garwood wanted. Garwood will have to settle for a measly 2% above the federal short-term rate. But that is 1 1/2% more than the IRS wanted to give.

Case: Garwood Irrigation Corp. v. Commissioner

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ABBA May Need a Souper Trooper

Posted on April 30, 2006 by Russ

…on the tax front.

Bjorn Ulvaeus, a member of the Swedish pop group ABBA, has been charged with tax evasion. He is accused of not paying 87 million kronor ($11.7 million) in taxes on royalties from ABBA’s songs and musicals.

The Swedish government accuse Ulvaeus of setting up offshore entities to avoid paying taxes. Mr. Ulvaeus’ attorney denies the charges.

Additionally, The Local reports that a second member of ABBA, Anni-Frid Reuss-Lyngstad, is accused of owing 12 million kronor in unpaid tax, interest, and penalties. She is accused of illegally moving her share of royalty income to a Panama based company.

ABBA’s songs are featured in the musical “Mamma Mia,” which is currently appearing on Broadway and in Las Vegas. Conveniently, two of ABBA’s songs are Money, Money, Money and SOS.

UPI News Story Link

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The Tax Court Believes the AMT Is Unfair, But You Still Have to Pay It

Posted on April 26, 2006 by Russ

Is the Alternative Minimum Tax Unfair? Of course it is. But do you have to pay it? Certainly. And that’s the crux of today’s Tax Court case.

Our unlucky petitioners earned quite a bit of money, reporting wage income of $323,498. Among their itemized deductions were the following:

  • State and local income taxes $39,189
    Real estate taxes 4,935
    Personal property taxes 230

After they submitted their tax return, the IRS notified them that they owed $7,364 of AMT.

The petitioners couldn’t understand why they lost their tax deductions that they legitimately (and correctly) took. (The petitioners live in California, a very high tax state.) Unfortunately, the three tax items listed above are considered “preference items” and are one of the ways you can get thrown into the AMT nightmare.

The Tax Court noted that they were “not unsympathetic” with the petitioners, as the AMT has had some unintended consequences.

“The unfortunate consequences of the AMT in various circumstances have been litigated since shortly after the adoption of the AMT. In many different contexts, literal application of the AMT has led to a perceived hardship, but challenges based on equity have been uniformly rejected. [Citations omitted.]” Speltz v. Commissioner, 124 T.C. 165, 176 (2005)

But the Court must apply the law as written, and the petitioners owe the AMT.

Case: Schick v. Commissioner, T.C. Summary 2006-67

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A Fire Is No Excuse

Posted on April 26, 2006 by Russ

Today the Tax Court looked at a casualty loss case. Many times when casualty loss cases make their way to Tax Court, there’s a dispute about whether or not there really was a loss. Not today.

A fire destroyed the victim’s office on the university campus where he worked as a Professor of Economics. He lost a litany of belongings, which he detailed as follows:

Books on economics $2,000
Books by “famous authors” 1,000
Books on Africa 5,000
African journals & magazines 3,000
Book manuscript 15,000
Memorabilia (awards, plaques, etc.) 3,000
Briefcases, fans, etc. 2,000
Computer printer 250
Labor/inconvenience/distress 2,000

The unlucky victim did receive $12,000 in compensation from the university’s insurance company. The IRS denied a portion of his casualty loss.

When you have a casualty loss, such as a fire, your loss for tax purposes is based on the lessor of your basis in the assets you lose, or the fair market value of the assets. As the Tax Court notes,

“Petitioner, however, has not produced any evidence as to what his bases or costs in the various items may have been. Indeed, while they may have had value to petitioner, it is clear that the memorabilia had no costs to petitioner, and petitioner would have no bases in these items. With respect to what petitioner describes as “Labor/Inconvenience/Distress”, as we understand petitioner’s testimony, the deduction was for mental upset, having to prepare new lecture notes, etc., and for teaching. These are not items of property the losses of which are deductible as casualty losses.”

One point that the Tax Court made is that the petitioner did not avail himself of any professional advice. As Albert Einstein said, “The hardest thing in the world to understand is the income tax.” When in any doubt, get professional tax advice. Any competent tax professional could have set this professor on the right track.

Case: Ayittey v. Commissioner, T.C. Summary 2006-65

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Honesty Is the Best Policy

Posted on April 26, 2006 by Russ

It’s still election season, and here in the Bronze Golden State, Democrats will vote on June 6th for their candidate for Governor to oppose the Governator. It’s rare we see such frank honesty as that given by one candidate, Phil Angelides.

Mr. Angelides wants to increase taxes on all corporations, and all families making $500,000 a year or more. He also supports Proposition 82, so his proposed tax increases are on top of those tax increases. The economic development offices in Las Vegas, Phoenix, and Denver are thrilled with you, Mr. Angelides.

California is already among the worst states in the US for business. If Mr. Angelides is elected Governor, he’s definitely aiming for the #50 spot. But at least he’s honest about it.

News Story: Sacramento Bee

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Some Interesting Tax Court Cases

Posted on April 26, 2006 by Russ

Yesterday, there were three interesting Tax Court decisions. Joe Kristan of Roth Tax Updates has an excellent post on the first case. In that case, Merlo v. Commissioner, the unlucky taxpayer found out the “gotcha” of incentive stock options. If you are the recipient of such options, take a look at Joe’s post on this case now. ISO’s have a wonderful tax advantage…but if the option tanks….

The second case has to do with something quite basic: a change of address. In Pragasm v. Commissioner, the taxpayer wanted to have a hearing on a collection (levy/lien) dispute. The IRS said that they weren’t required to hold one because the taxpayer never responded to their notices. The Court sided with the IRS. Just a reminder, if you move, notify the IRS (and your state tax agency, if applicable); you can download Form 8822 here and mail it (certified mail, return receipt requested, of course) to the IRS.

The third case has to do with regulatory requirements. Last May, the Tax Court ruled in Zapara v. Commissioner that the IRS failed to comply with §6335(f) of the I.R.C. That section requires the IRS to sell seized property within sixty days following a request by the taxpayer (and have the proceeds of the sale credited against the tax, penalties, and interest owed). The taxpayers in that case had, the Court ruled, requested such a sale and the IRS did not sell the property (in this case, stock).

The IRS asked the Tax Court to reconsider their May 2005 decision. The IRS claimed that the taxpayers untimely raised a new issue, that the evidence doesn’t support the decision, and that the Court doesn’t hold the power to make the relief ordered in the earlier decision. The IRS lost on all three counts, and the motion for reconsideration was denied (decision here).

Why is this final case important? The Tax Court usually rules based on regulations and paperwork. If you can show paperwork/backup for your actions, and that you followed the regulations/Tax Code, you will usually win. This holds true for the IRS, too. The IRS’s paperwork showed the request to sell the stock, and the stock wasn’t sold. The moral is clear: document, document, document; and you have an excellent chance of winning your case.

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How Big Is the Tax Gap?

Posted on April 26, 2006 by Russ

The “Tax Gap” is difference between the amount of tax that the IRS should collect if everyone followed the law and the amount that it actually collects. There are three components of the gap: nonfiling, under-reporting, and underpayment. Of course, the ridiculous complexity of the Tax Code is also a contributing factor.

Last February, the IRS estimated the Tax Gap at $290 billion. This morning’s Wall Street Journal reports that the IRS is likely underestimating the problem. The report, from the Department of the Treasury’s Inspector General for Tax Administration (TIGTA), concludes that:

“…the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and voluntary compliance. The IRS has significant challenges in both obtaining complete and timely data and developing the methods for interpreting the data…We concluded that, despite the significant efforts undertaken in conducting the individual taxpayer National Research Program (NRP) for under-reporting, the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and the VCR.”

The report is interesting and is available here. You can find the Wall Street Journal’s article here (paid subscribers only).

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Crime Blog Time

Posted on April 21, 2006 by Russ

It’s Friday, and Tax Day has come and gone. But the memory lingers, so let’s look at some scofflaws as the week ends:

Louis Ratfield of Lake Worth, FL has been in trouble with the government before. The IRS secured a restraining order against him for promoting a “constitutional common-law trust” to avoid paying taxes. There is no such trust, of course. He allegedly continued to promote the trust. He was arrested on Tuesday on 56 counts of preparing false income tax returns. Each count could net him three years in prison. Ratfield has also been in trouble with the SEC, apparently absconding with investors’ money.

James Hubb of Clayton, MO used $25,000 of his business’ money for plumbing at his house (it may have been for a bathtub—some bathtub!). Besides the bathtub, quite a bit more money was taken from his business and used for personal expenses. That’s not necessarily illegal, as long as it is disclosed and reported as income. It wasn’t, and Hubb has pled guilty. He faces up to eight years in prison and a fine of up to $350,000.

In Massachusetts, Laurence Greenburg and Russell Skidds sold partially defatted beef tissue as partially defatted chop beef. That violated the Federal Meat Inspection Act. Compounding their problems, they didn’t report all the income, causing them to file false tax returns. They were convicted on Tuesday.

Finally, H&R Block settled a 1998 RAL (Return Anticipation Loan) lawsuit for $35 million. H&R Block still faces a lawsuit filed by the California Attorney General. Given the nature of class action lawsuits, it’s likely that the lawyers will get most of the money from that settlement.

News Stories:
Lake Worth, FL, Clayton, MO, Malden, MA and H&R Block

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An Affair in Tax Court

Posted on April 20, 2006 by Russ

The scene is the doctor’s office, where the doctor is romancing his patient. Just a little problem: the patient is married to a policeman. The policeman finds out and vows to sue the doctor, or get paid a large sum. The doctor doesn’t have it, so he makes a counteroffer. And then someone takes out a gun….Well, no, this is a tax blog. But this case does make its way into Tax Court, not a mystery novel.

The salient facts (above) are true (except for the gun). Throw in one more—the doctor eventually pays the policeman $25,000 as “free money” in the hopes that this affair blows over. As the Court noted,

“Petitioner then stated: “Now Doc, this isn’t blackmail money”, to which [the Doctor] replied: “No, I didn’t say it was blackmail money; I said I hope it helps you, both of you.” At the end of the meeting, petitioner warned [the doctor] that he should never again speak to or look at [his wife] or come to their home.”

The petitioner and the doctor contacted his state medical board and reported the affair. The doctor apologized. The doctor’s accountant then prepared a Form 1099-MISC reporting the $25,000 payment. The question before the court: is the payment a gift or income for the petitioner? The IRS held it was income; the petitioner believed it was a gift. (Gifts are tax-free to the recipient.)

Believe it or not, the Supreme Court has issued an opinion on point. In Commissioner v. Duberstein, 363 U.S. 278, 285-
286 (1960), the Court held, “And, importantly, if the payment proceeds primarily from “the constraining force of any moral or legal duty,” or from “the incentive of anticipated benefit” of an economic nature, Bogardus v. Commissioner, 302 U.S. 34, 41, it is not a gift.”

The Tax Court concluded,

“the $25,000 payment by [the doctor] was not the result of detached and disinterested generosity or paid out of affection, respect, admiration, or charity. Instead it was paid to avoid a lawsuit, to avoid public and professional embarrassment, and to assuage his own feelings of guilt or moral obligation. Therefore, the $25,000 payment in 1999 is not a gift and is includable in petitioners’ gross income for that year.”

Somehow, a moral for this story seems like an oxymoron.

Case: Peebles v. Commissioner, T.C. Summary 2006-61

Hat Tip: TaxProf Blog

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T-Day

Posted on April 17, 2006 by Russ

Today is the deadline. You have until midnight tonight to file your taxes. The question were asked every year (usually around 9pm) is, “We just realized that we need to file our taxes…What do we do?”

The answer is to file an extension. If you are our client, we can file Form 4868 electronically for you. Otherwise, print the form up, and mail it, using certified mail, return receipt requested. Spend the extra $4.25. (For a story on what happens when you don’t spend the money, see Joe Kristan’s report on why you spend the money here.) Many post offices now have automated machines that can do certified mail; look for the “Automated Postal Center” (or similar verbiage).

Remember, an extension is an extension of time to file, not pay. So make an estimate of what you owe and send it with your extension. If you don’t file an extension, you’re subject to the failure to file penalty (5% a month up to 25%), so even if you don’t pay anything with your extension it’s well worth your time to file it.

Don’t forget to file an extension for your state taxes, if your state requires it. California does not require an extension to be mailed (the extension is automatic); however, many states do require an extension to be filed.

This year, for both the IRS and California, an extension is for six months. You have until October 16th (the 15th falls on a Sunday) to file your taxes if you file an extension.

If you’re out of the country working, you have an extra two months to file and pay your taxes to the IRS, until June 15th (not June 17th). You need to attach an explanation to your return stating that you were out of the country, and why (work).

Finally, if you call our office today wanting to schedule an appointment to do your taxes today, it’s not going to happen. Like most tax preparers, we wouldn’t be able to do an acceptable job on your return if we started it today.

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