Homes sold by estate beneficiary remained subject to federal estate tax liens

First American Title Insurance Co., et al. v. U.S. (CA9 3/27/2008) 101 AFTR 2d ¶ 2008-622

Mike Habib, EA

MyIRSTaxRelief.com

The Court of Appeals for the Ninth Circuit, affirming a district court, has held that title companies couldn't recover estate taxes that they paid after distressed homeowners informed them of IRS's threats to seize their homes based on an increased tax assessment on the estate from which they'd acquired their properties.

Facts. Roberta C. Smith died in '91 leaving an estate primarily consisting of three houses and stock in Frisko Freeze, a drive-in restaurant in Tacoma, Washington. A court admitted her will to probate, named her daughter, Penny Jensen, as the estate's personal representative, and gave Ms. Jensen the power to transfer the estate's real and personal property without further court order (a so-called non-intervention probate order).

Ms. Jensen deeded the three houses in the estate to herself and her husband. She filed a federal estate tax return and paid the estate tax. The Jensens later sold the houses to purchasers who obtained title insurance policies issued by the taxpayers in this case: First American Title Insurance Company, Commonwealth Land Title Insurance Company, and Chicago Title Insurance Company ("the Title Companies").

IRS audited the estate and increased the value of the Frisko Freeze stock by almost $150,000 more than was reported. After the estate failed to make installment payments on the estate taxes owed, IRS sent letters to the purchasers of the three houses threatening to seize and sell the houses unless they paid the remaining estate tax owed.

The homeowners gave the IRS letters to the Title Companies who paid about $189,372 in estate taxes under protest. They then filed refund claims. After IRS denied the claims, they brought their case to a district court. Specifically, they sued under 28 USCS 1346 to recover federal estate tax erroneously or illegally assessed and collected. The district court held in favor of IRS.

Background. Code Sec. 6324(a)(1) creates a special estate tax lien that attaches to the gross estate of a decedent for ten years from the date of death. Under the holding of U.S. v. Vohland, Lewis, (1982, CA9) 50 AFTR 2d 82-6112, probate property (which the three homes in the current case were) retains the special estate tax lien upon transfer to a purchaser unless IRS discharges the personal representative of the lien under Code Sec. 2204 . The gross estate is divested of the special estate tax lien to the extent that the gross estate is "used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof." (Code Sec. 6324(a)(1))

Failed arguments in district court. Before the district court, the Title Companies agreed that a special estate tax lien attached to the gross estate of Roberta Smith at her death in '91. They also acknowledged that Ms. Jensen, the estate's personal representative, didn't obtain a discharge of liability under Code Sec. 2204 before selling the properties in question. Rather, the Title Companies contended that the proceeds from the sale of the three homes were used to pay charges against the estate and expenses of its administration, thereby divesting the lien under Code Sec. 6324(a)(1). The court said that to prove that divestment occurred under Code Sec. 6324(a)(1), the Title Companies had to show that: (1) the sale proceeds satisfied charges against the estate or expenses of its administration; and (2) a court with proper jurisdiction allowed the satisfaction.

The Title Companies contended that they used the proceeds from the house sales to pay encumbrances, taxes, title insurance premiums, and real estate commissions and that these payments qualify as "charges against the estate or expenses of its administration." For example, the Title Companies said that one of the three houses was encumbered by a $124,000 deed of trust in the name of Roberta Smith. After the sale, First American Title paid $122,829.98 from the sale proceeds to the company owning the deed of trust. The Title Companies argued that if the deed of trust "was paid out of the proceeds of the sale of the property, the special lien was automatically divested." The Title Companies also claimed that a portion of the sale proceeds from the homes was used to satisfy loans Ms. Jensen may have incurred in "expenses of the estate" after her mother's death.

The court said that the arguments were too hypothetical to show that a material issue of fact was in dispute that would warrant denying summary judgment. However, the court said, even if it is assumed that the Title Companies used the sale proceeds from the three homes to satisfy the charges or expenses of the estate, the Title Companies still could not prevail because they did not establish that a court with proper jurisdiction allowed the payments.

The Title Companies contended that the state court non-intervention probate order met this second prong of the test. However the district court disagreed.

Ninth Circuit. The Ninth Circuit noted that 28 USCS 1346 is the general statute providing jurisdiction in the district courts for taxpayer suits against IRS. It said, however, that Code Sec. 7426 is the statute providing jurisdiction for suits by persons other than taxpayers. According to the Appeals Court, the problem for the Title Companies is that Code Sec. 7426(c) does not let them challenge the assessment of how much Frisko Freeze was worth, and the assessment is what they claim makes the taxes they paid too high.

The Ninth Circuit stressed that justice does not require that 28 USCS 1346 be embraced to avoid the Code Sec. 7426 limitation on challenges to assessments. Had Jensen paid the estate taxes when due, or paid the installments and not gone bankrupt, she could not have challenged the assessment, because she had agreed to it. There is no good reason why her failure to pay the estate's taxes should reopen the valuation of Frisko Freeze, Inc. True, the homeowners and the title insurers that stepped into their shoes did not have a chance to challenge the assessment. But the assessment was not really their problem. Their problem was that the real estate chain of title included an estate that had not paid its taxes. A third party that pays a tax to eliminate a tax lien on the third party's property is, under Code Sec. 7426(c), bound by the assessment on the property.

Resolve your tax problems and release federal tax liens by clicking here.

IRS Regs clarify Code Sec. 501(c)(3) exempt status and impact of excise taxes

Mike Habib, EA

MyIRSTaxRelief.com

T.D. 9390, 03/27/2008; Reg. § 1.503(c)(3)-1, Reg. § 53.4958-2

IRS has issued final regs clarifying the substantive requirements for tax exemption under Code Sec. 501(c)(3) and the relationship between those requirements and the imposition of Code Sec. 4958 excise taxes. The final regs adopt proposed regs issued in 2005 with some modifications.

Background. To qualify for tax exemption under Code Sec. 501(c)(3), an organization must be organized and operated exclusively for religious, charitable, scientific, or educational purposes. In addition, no part of its net earnings may inure to the benefit of any private shareholder or individual, no substantial part of its activities may include attempts to influence legislation, and the organization may not intervene in political campaigns. Under preexisting regs, an organization isn't exempt under Code Sec. 501(c)(3), if it is organized or operated for the benefit of private interests such as designated individuals, its creator or his family, the organization's shareholders, or persons controlled, directly or indirectly, by such interests. (Reg. § 1.501(c)(3)-1(d)(1)(ii))

Code Sec. 4958 imposes excise taxes on transactions that provide excess economic benefits to disqualified persons with respect to public charities and social welfare organizations described in Code Sec. 501(c)(3) and Code Sec. 501(c)(4) (certain social welfare organizations), which are collectively referred to by Code Sec. 4958(e) as "applicable tax-exempt organizations."

Final regs. Adopting the proposed regs, the final regs add several examples to illustrate the requirement that an organization serve a public rather than a private interest. They show that prohibited private benefits may involve non-economic benefits as well as economic benefits. In addition, they indicate that a prohibited private benefit may arise regardless of whether payments made to private interests are reasonable or excessive. (Reg. § 1.501(c)(3)-1(d)(1)(iii))

The proposed regs provided guidance on certain factors that IRS will consider in determining whether an applicable tax-exempt organization described in Code Sec. 501(c)(3) that engages in one or more excess benefit transactions continues to qualify for exemption. Two comments voiced the need to clarify the terms "significant" and "de minimis" as used in the proposed regs. One comment suggested adding examples combining potential de minimis values with other abating or negative factors and/or examples containing values that are not de minimis. The final regs contain a new example that illustrates the application of the revocation factors to an excess benefit transaction that is neither significant in comparison to the size and scope of the organization's exempt activities nor de minimis. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

One comment requested clarification of the term "repeated" as used in Example 3 of Prop Reg § 1.501(c)(3)-1(g). IRS says the term was used in that example to correspond to the third factor in the proposed regs, which looked to "whether the organization has been involved in repeated excess benefit transactions." In response to this comment, the third factor of the proposed regs has been revised to substitute the term "multiple" for the word "repeated." (Reg. § 1.501(c)(3)-1(f)(2)(ii)) The term "multiple" refers to both (1) repeated instances of the same (or substantially similar) excess benefit transaction, regardless of whether the transaction involves the same or different persons; and (2) the presence of more than one excess benefit transaction, regardless of whether the transactions are the same or substantially similar and regardless of whether they involve the same or different persons. (T.D. 9390, 03/27/2008)

The fourth factor under the proposed regs has been revised to make clear that implementation by an organization of safeguards that are reasonably calculated to prevent excess benefit transactions will be treated as a factor weighing in favor of continuing to recognize exemption regardless of whether such safeguards are implemented in direct response to the excess benefit transaction(s) at issue or as a general matter of corporate governance or fiscal management. (Reg. § 1.501(c)(3)-1(f)(2)(ii)) Thus, an organization may be treated as having implemented safeguards reasonably calculated to prevent excess benefit transactions even though the organization is contesting the existence of the excess benefit transaction(s) at issue. (T.D. 9390, 03/27/2008) An example is added to illustrate how implementation of safeguards, including preexisting safeguards, will be taken into account in determining whether to continue to recognize an organization's tax-exempt status. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

Observation: Thus, affected organizations should consider implementing such safeguards to help preserve exempt status should they engage in an excess benefit transaction.

Two comments suggested adding an example specifically addressing reasonable compensation. The new example added by these final regs does that. (Reg. § 1.501(c)(3)-1(f)(2)(iv), Example 6)

For professional audit representation CONTACT US HERE

Tax breaks for qualifying relatives are limited - what you should know
Internal Legal Memorandum 200812024

Mike Habib, EA
myIRSTaxRelief.com

An Internal Legal Memorandum (ILM) explains that various tax breaks are not allowed for qualifying relatives. Specifically, the ILM concludes that, apart from a dependency exemption, a taxpayer's qualifying relative may not qualify him for the earned income credit, head of household filing status, or the child tax credit, but in limited circumstances may qualify the taxpayer for the child and dependent care credit.

Background. A taxpayer is entitled to a deduction equal to the exemption amount for each person who qualifies as his "dependent." (Code Sec. 151(c))

A person qualifies as the taxpayer's dependent if the person is the taxpayer's qualifying child or qualifying relative. (Code Sec. 152(a)) The terms "qualifying child" and "qualifying relative" were added to Code Sec. 152 by the Working Families Tax Relief Act of 2004 (WFTRA), effective for tax years beginning after 2004. WFTRA established a uniform definition of a "qualifying child" for determining whether a taxpayer may claim certain child-related tax benefits. It established the term "qualifying relative" to identify individuals (other than a qualifying child) for whom a dependency exemption deduction may be allowed.

A "qualifying child" of a taxpayer is an individual who: (A) bears a certain relationship to the taxpayer, (B) has the same principal place of abode as the taxpayer for more than one-half of the tax year, (C) meets certain age requirements, and (D) has not provided over one-half of his or her own support for the calendar year. (Code Sec. 152(c)(1))

A "qualifying relative" is an individual: (A) who bears a specified relationship to the taxpayer (Code Sec. 152(d)(1)(A)); (B) whose gross income for the calendar year in which that tax year begins is less than the exemption amount (Code Sec. 152(d)(1)(B)); (C) with respect to whom the taxpayer provides over one-half of his or her support for the calendar year in which that tax year begins (Code Sec. 152(d)(1)(C)); and (D) who isn't a qualifying child of that taxpayer or of any other taxpayer for any tax year that begins in the calendar year in which that tax year begins. (Code Sec. 152(d)(1)(D))

Observation: An individual need not be technically related to a person to qualify as the person's qualifying relative. That's because, the specified relationships include in-laws and an individual who, for the tax year of the taxpayer, has as such individual's principal place of abode the home of the taxpayer and is a member of the taxpayer's household. (Code Sec. 152(d)(2))

Notice 2008-5, 2008-2 IRB, provides guidance on individuals who may be qualifying relatives of a taxpayer under Code Sec. 152(d). Specifically, it clarifies that, solely for purposes of Code Sec. 152(d)(1)(D), an individual is not a qualifying child of "any other taxpayer" if the individual's parent (or other person with respect to whom the individual is defined as a qualifying child) is not required by Code Sec. 6012 to file an income tax return and (i) does not file an income tax return, or (ii) files an income tax return solely to obtain a refund of withheld income taxes. Notice 2008-5 clarifies that a taxpayer may claim a dependency exemption deduction for an unrelated child of an unrelated individual who lived with the taxpayer as a member of the taxpayer's household for the entire year.

Illustration: Andrew supports as members of his household for the tax year an unrelated friend, Betty, and her 3-year-old child, Carole. Betty has no gross income, is not required by Code Sec. 6012 to file an income tax return, and does not file an income tax return for the tax year. Accordingly, because Betty does not have a filing requirement and did not file an income tax return, Carole is not treated as a qualifying child of Betty or any other taxpayer, and Andrew may claim both Betty and Carole as his qualifying relatives, provided all other requirements of Code Sec. 151 and Code Sec. 152 are met. (Notice 2008-5)

Earned income credit. An eligible individual may be allowed an earned income credit under Code Sec. 32 . In general, an eligible individual is (i) any individual who has a qualifying child for the tax year, or (ii) any other individual who does not have a qualifying child for the tax year, if certain requirements are met, such as age and residency, and that the individual is not a dependent of someone else. The ILM says that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 , may not use that individual for purposes of claiming the earned income credit because the credit requires that the dependent be a qualifying child, not a qualifying relative, of the taxpayer.

Head of household filing status. Under Code Sec. 2(b)(1), an individual is a head of a household if, and only if, he is not married at the close of his tax year, is not a surviving spouse, and either (1) maintains as his home a household which constitutes for more than one-half of the tax year the principal place of abode, as a member of such household, (i) a qualifying child of the individual, or (ii) any other person who is a dependent of the taxpayer, if the taxpayer is entitled to a deduction under Code Sec. 151 for the tax year, or (2) maintains a household which constitutes for such tax year the principal place of abode of the father or mother of the taxpayer, if the taxpayer is entitled to a deduction for the tax year for such father or mother under Code Sec. 151. A taxpayer cannot be considered a head of a household by reason of an individual who would not be a dependent for the tax year but for (i) Code Sec. 152(d)(2)(H) or (ii) Code Sec. 152(d)(3), relating to multiple support agreements. Thus, the ILM concludes that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 because that individual was a member of the taxpayer's household, but who does not have a specified familial relationship to the individual, may not claim head of household filing status.

Child tax credit. Under Code Sec. 24(a), a taxpayer may be allowed a credit of $1,000 for each qualifying child of the taxpayer. The ILM concludes that a taxpayer who may claim an individual as his or her qualifying relative under Notice 2008-5 may not use that individual for purposes of claiming the child tax credit because the credit requires that the dependent be a qualifying child, not a qualifying relative, of the taxpayer.

Observation: The ILM does not point out that an individual can be a taxpayer's qualifying child for child tax credit purposes without necessarily being the taxpayer's actual child. That's because, for this purpose, a qualifying child is defined to include a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of these relatives. (Code Sec. 26(c)(1), Code Sec. 152(c)(2))

Dependent care credit. A taxpayer with one or more qualifying individuals may be allowed a dependent care credit under Code Sec. 21. A "qualifying individual" is (1) a dependent of the taxpayer (as defined in Code Sec. 152(a)(1) who has not attained age 13, (2) a dependent of the taxpayer (as defined in Code Sec. 152 determined without regard to Code Sec. 152(b)(1), Code Sec. 152(b)(2), and Code Sec. 152(d)(1)(B)) who is physically or mentally incapable of caring for himself or herself and who has the same principal place of abode as the taxpayer for more than half of the year, or (3) the spouse of the taxpayer, if the spouse is physically or mentally incapable of caring for himself or herself and who has the same principal place of abode as the taxpayer for more than half of the tax year. The ILM states that Code Sec. 152(a)(1) provides that a dependent is a qualifying child, and as a result, the dependent care credit is limited to taxpayers with one or more qualifying children under the age of 13. A taxpayer who may claim an individual as his or her qualifying relative may not claim the dependent care credit, unless that qualifying relative is physically or mentally disabled.

Get professional tax representation by clicking here

Tax-exempt hospital's chairman of the board was liable for trust fund penalty - have a tax professional on your side

Mike Habib, EA

myIRSTaxRelief.com

Stephen Verret v. U.S. (DC TX 2/14/2008) 101 AFTR 2d ¶2008-572

A district court has found that the chairman of the board of a tax-exempt hospital was a responsible person liable for the Code Sec. 6672(a) trust fund penalty. The chairman, who played an active role in various aspects of the hospital's operation and could have ensured that the hospital paid its taxes, chose instead not to exert any authority over these business affairs. Further, since the chairman wasn't serving solely in an honorary capacity, he didn't qualify for the protection given voluntary board members under Code Sec. 6672(e).

Observation: The case once again demonstrates the perils faced by a taxpayer who becomes involved in a financially distressed company. As this case illustrates, the fact that a company is a tax-exempt entity will not shield a taxpayer who fails to carefully exercise his duties to make sure employment taxes are paid to IRS.

Background. Where an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a "responsible person," i.e., a person who: (1) is responsible for collecting, accounting for and paying over payroll taxes and (2) willfully fails to perform this responsibility. (Code Sec. 6672(a))

Unpaid volunteer board members of tax-exempt organizations who are solely serving in an honorary capacity, aren't involved in day-to-day financial activities, and don't know about the penalized failure are exempt from the penalty, unless that results in no one being liable for it. (Code Sec. 6672(e))

Facts. The primary business of Community Healthcare Foundation (Foundation), a Code Sec. 501(c)(3) tax-exempt organization, was the operation of Doctors Hospital. Under the hospital's by-laws, the Foundation provided that the Board of Trustees, which was comprised of voluntary and unpaid members of the community, would act as the governing body of the hospital. The by-laws also provided for a Chairman of the Board and a Chief Administrative Executive Officer (CEO).

Stephen Verret served in various capacities on the hospital's board during a 26-year tenure, including as Chairman of the Board from '99 until his departure in 2002. In addition, a company in which Verret was a majority stockholder performed electrical services for the hospital, and his wife was employed by the hospital as Chief Operating Officer from January through March 2001. Verret also contracted with, and was paid by, a business involved in the operation and management of hospitals to help recruit specialized physicians and increase the hospital's revenues.

Because of a steadily deteriorating financial situation, the hospital failed to remit employment withholding taxes during the first part of 2001. While the outstanding tax liability was ultimately satisfied with borrowed cash appropriated to buy medical equipment, the hospital's Executive Director David Cottey was informed by Verret, individually, and by the Board, collectively, that the payment of employment withholding taxes was of paramount importance. Under no circumstances, he was told, was he to fail to pay these taxes again. However, contrary to his repeated assurances throughout 2001, in November of 2001, Cottey told Verret and the Board that the income and FICA taxes for the employees were delinquent for the third and fourth quarters of 2001.

IRS found Verret and the hospital's Controller and Chief Financial Officer to be liable as responsible persons. Verret paid $407,098 in tax (and $1,821 in interest), and sought a refund in the district court. IRS responded by seeking a summary judgment against Verret.

Taxpayer is responsible person. The district court concluded that Verret clearly qualified as a responsible person under Code Sec. 6672. The court rejected his contention that he wasn't responsible for the hospital's day-to-day operations and that he didn't have the authority to decide what bills (including taxes) were paid. The by-laws clearly stated that the Board of Trustees had the final responsibility for the hospital's administrative activities and professional services and for the operation of the hospital. The uncontested facts showed that Verret: (1) served approximately 26 years in various capacities on the hospital's Board; (2) held the position of Board Chairman during the relevant periods; (3) negotiated and personally guaranteed a $500,000 working capital loan for the hospital; (5) took steps to ensure payment of delinquent withholding taxes on the previous occasion after Cottey had failed to do so; (6) actively participated in recruiting physicians and developing a new source of revenue for the hospital; (7) conversed with Cottey on almost a daily basis; (8) signed the hospital's Form 990 for '99 and 2000; (9) possessed, along with the Board, the authority to hire and fire high level employees; and (10) was a signatory on all of the hospital's checking accounts.

The district court also concluded that his failure to pay taxes was willful. The court reasoned that it was inconceivable that Verret, who spent significant amounts of time visiting the hospital and conversing with Cottey on a daily basis, was unaware of Cottey's failure to pay the employment taxes. If Verret didn't know of Cottey's failure to pay the tax liability during the third and fourth quarters of 2001, it was because he chose not to know. Verret could have exercised substantial control over the decision-making process to ensure that the hospital paid its taxes, but instead of verifying that the taxes were paid, he chose not to exert authority over Cottey or the hospital's business affairs. The court reasoned that this inaction, at a minimum, constituted gross negligence or reckless disregard and so a willful failure to collect, account for, or pay over the hospital's taxes.

The court also found that Verret didn't qualify for the protection afforded a voluntary board member under Code Sec. 6672(e). He wasn't serving solely in an honorary capacity as the Chairman of the Board. Rather, he played an active role in the management of the hospital, attending board meetings, negotiating and guaranteeing a loan, recruiting physicians, and signing the hospital's Form 990 for '99 and 2000.

IRSHas $1.2 Billion for People Who Have Not Filed a 2004 Tax Return

Mike Habib, EA

MyIRSTaxRelief.com

IRS-2008-46,March 19, 2008

IRS WASHINGTON-- Unclaimed refunds totaling approximately $1.2 billion are awaiting about 1.3 million people who failed to file a federal income tax return for 2004, the Internal Revenue Service announced today. However, to collect the money, a return for 2004 must be filed with anIRSoffice no later thanTuesday, April 15, 2008.

Those due a refund who did not file a 2004 tax return could collect even more money by also filing a 2007 tax return to claim the economic stimulus payment. To receive a payment, taxpayers must have a valid Social Security number, $3,000 of qualifying income and file a 2007 federal tax return. Millions of retirees, disabled veterans and low-wage workers who usually are exempt from filing a tax return must do so this year in order to receive the stimulus payment. Eligible people will receive up to $600 ($1,200 for married couples), and parents will receive an additional $300 for each eligible child younger than 17.

TheIRSestimates that half of those who could claim refunds for tax year 2004 would receive more than $552. In some cases, individuals had taxes withheld from their wages, or made payments against their taxes out of self-employed earnings, but had too little income to require filing a tax return. Some taxpayers may also be eligible for the refundable Earned Income Tax Credit.

In cases where a return was not filed, the law provides most taxpayers with a three-year window of opportunity for claiming a refund. If no return is filed to claim the refund within three years, the money becomes property of the U.S. Treasury. For 2004 returns, the window closes onApril 15, 2008. The law requires that the return be properly addressed, postmarked and mailed by that date. There is no penalty assessed by theIRSfor filing a late return qualifying for a refund.

"Time is getting short for claiming the tax refund you may be entitled to," said actingIRSCommissioner Linda E. Stiff. "But you can't get it unless you file the tax return. Don't take a chance on losing your tax refund. And this year, remember that you need to file a 2007 tax return in order to receive an economic stimulus payment."

TheIRSreminds taxpayers seeking a 2004 refund that their checks will be held if they have not filed tax returns for 2005 or 2006. In addition, the refund will be applied to any amounts still owed to theIRSand may be used to satisfy unpaid child support or past due federal debts such as student loans.

By failing to file a return, individuals stand to lose more than refunds of taxes withheld or paid during 2004. Many low-income workers may not have claimed the Earned Income Tax Credit (EITC). Although eligible taxpayers may get a refund when their EITC is more than what they owe in tax, those who file returns more than three years late would be able only to apply it toward the taxes they owe (if any). They would not be able to receive a refund if the credit exceeded their tax.

Generally, unmarried individuals qualified for the EITC if in 2004 they earned less than $34,458 and had more than one qualifying child living with them, earned less than $30,338 with one qualifying child, or earned less than $11,490 and had no qualifying child. Limits are slightly higher for married individuals filing jointly.

IRS issues proposed regs reflecting PPA changes and guidance for notice of retroactively effective plan amendments

Mike Habib, EA

myIRS.TaxRelief.com

Prop Reg § 1.411(d)-3(a)(1); Prop Reg § 54.4980F-1, Q&A 8(d); Prop Reg § 54.4980F-1, Q&A 9(f); Prop Reg § 54.4980F-1, Q&A 9(g); Prop Reg § 54.4980F-1, Q&A 11(a)(7); Prop Reg § 54.4980F-1, Q&A 18(a)(4); Prop Reg § 54.4980F-1, Q&A 18(a)(5); Prop Reg § 54.4980F-1, Q&A 18(b)(3); Preamble to Prop Regs 3/20/2008)

IRS has issued proposed guidance setting out when notice of a plan amendment that significantly reduces future benefit accruals must be sent to affected parties. The proposed regulations would amend previously issued Question and Answer-format regs on Code Sec. 4980F, and would largely provide guidance for changes made to Code Sec. 4980F by the Pension Protection Act of 2006 ("PPA," P.L. 109-280). The proposed regs would also establish timing rules for providing a section 204(h) notice for retroactive plan amendments, and would attempt to harmonize various other Code and ERISA notice requirements with those of Code Sec. 4980F.

Typically, the anti-cutback rules of the Code (Code Sec. 411(d)(6)) and ERISA (ERISA § 204(g)) protect the accrued benefit of a participant in a defined benefit plan by providing that this benefit cannot be reduced by plan amendment, except under very limited circumstances. Further, before a plan amendment providing for a significant reduction in future benefit accruals can take effect, Code Sec. 4980F generally requires that notice of the amendment be sent to the affected parties at least 45 days before the amendment's effective date.

ERISA § 204(h) contains parallel rules to Code Sec. 4980F, and the notice required to be sent to affected parties is called the "section 204(h) notice."

Other Code and ERISA notice requirements. Code Sec. 436 provides rules for limiting benefits and benefit accruals for single-employer plans with certain funding shortfalls. ERISA § 101(j) generally requires the plan administrator to provide written notice to plan participants and beneficiaries within 30 days after the plan becomes subject to this benefit limit.

ERISA § 4244A provides that a multiemployer plan in reorganization may adopt an amendment reducing or eliminating certain accrued benefits attributable to employer contributions. However, an amendment reducing or eliminating benefits may not be made unless notice is provided to plan participants, beneficiaries, and other affected persons at least 6 months before the first day of the plan year in which the amendment reducing benefits is adopted.

Similarly, ERISA § 4245 requires the suspension of benefits under insolvent multiemployer plans if the benefit payments exceed the plan's resource benefit level for the plan year. Again, plans subject to benefit suspensions must notify plan participants and beneficiaries that certain non-basic benefit payments will be suspended.

ERISA § 4281 provides rules requiring a terminated multiemployer plan to reduce benefits if the value of nonforfeitable benefits exceeds the value of the plan's assets. If benefits are to be reduced, the plan sponsor must notify PBGC, the plan participants, and the beneficiaries of the amendment reducing benefits. The notice must be provided no later than the earlier of (i) 45 days after the amendment is adopted, or (ii) the date of the first reduced benefit payment. To eliminate the need for a plan to provide multiple notices with substantially the same function and information to affected persons, the proposed regulations would provide that if a plan issues one of the above notices and meets the applicable standards for such notices, the plan would be treated as having complied with the requirement to provide a section 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 9(g)(3); Preamble to Prop Regs 3/20/2008)

Pension Protection Act notice requirements. Section 502(c) of the PPA amended Code Sec. 4980F(e)(1) (and ERISA § 204(h)) to add as a recipient of a section 204(h) notice any employer that has an obligation to contribute to the plan. This new disclosure requirement is effective for plan years beginning after December 31, 2007.

The proposed regs would reflect this requirement by adding contributing employers to the list of parties to receive 204(h) notice, and would provide a definition of contributing employer. (Prop Reg § 54.4980F-1, Q&A 1(a); Prop Reg § 54.4980F-1, Q&A 10(a); Preamble to Prop Regs 3/20/2008)

Commercial airlines. Section 402 of the PPA provides special funding rules for plans maintained by commercial passenger airlines or by airline caterers. These funding rules generally allow the airlines and airline caterers to restrict benefit accruals. If a plan amendment is adopted to comply with these special funding rules, any notice required under Code Sec. 4980F (or ERISA § 204(h) ) must be provided within 15 days of the amendment's effective date. The proposed regs would clarify that, consistent with the Joint Committee on Taxation's Technical Explanation to section 402 of the PPA, the section 204(h) notice must be provided at least 15 days before the plan amendment's effective date. (Prop Reg § 54.4980F-1, Q&A 9(f) ; Preamble to Prop Regs 3/20/2008)

Minimum present value rules. Code Sec. 417(e)(3) provides that, in determining the present value of a participant's accrued benefit for distribution, the present value of the benefit cannot be less than the present value determined using the applicable mortality table and the applicable interest rate. Section 302(b) of the PPA provided new actuarial assumptions for calculating the minimum present value of a participant's accrued benefit. Rev Rul 2007-67, 2007-48 IRB 1047, which included guidance on plan amendments adopting the new interest rate and mortality table, provided that amendments reflecting the new interest rate or mortality table for an annuity starting date in 2008 or later would not violate the anti-cutback rules.

The proposed regs would provide that a reduced single-sum distribution that's caused by an amendment to a traditional defined benefit plan adopting the new interest rate and mortality tables does not require a section 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 8(d); Preamble to Prop Regs 3/20/2008)

Section 204(h) notice timing rules for retroactively effective amendments. Reg. § 1.411(d)-3(a)(1) generally provides that a plan is not qualified if a plan amendment decreases the accrued benefit of any plan participant. These rules are generally based on the "applicable amendment date," which is defined as the later of (i) the amendment's effective date, or (ii) the date the amendment is adopted.

While the general rule under Reg. § 1.411(d)-3(a)(1) prohibits plan amendments that reduce a plan participant's accrued benefit, certain exceptions exist, such as those under Code Sec. 412(d)(2), providing special rules for retroactive plan amendments. Rev Proc 94-42, 1994-1 CB 717, sets forth the procedures that a plan sponsor must follow in filing notice with, and obtaining approval from, IRS for a retroactive amendment that reduces accrued benefits.

The proposed regulations would provide special timing rules for when a section 204(h) notice must be provided to affected parties where the amendment is permitted to reduce benefits accrued before the plan amendment's applicable amendment date. Specifically, the proposed regulations would clarify that the date on which these plan amendments are effective is the first day that the plan is operated as if the amendment were in effect (the date the amendment is put into effect on an "operational basis"). Thus, a section 204(h) notice must generally be provided at least 45 days (15 days for a multiemployer plan) before the amendment is effective (even if the amendment is not adopted until a later date). (Prop Reg § 54.4980F-1, Q&A 9(g); Preamble to Prop Regs 3/20/2008)

The same rules would apply to retroactive amendments made under the PPA's remedial amendment period (Section 1107), Code Sec. 418D, Code Sec. 418E, and ERISA § 4281.

Cash balance plan conversions. The proposed regulations provide a special timing rule for section 204(h) amendments to an "applicable defined benefit plan," as defined in Code Sec. 411(a)(13)(C)(i).

Observation: These plans are also called "statutory hybrid plans" in IRS guidance under Code Sec. 411 , and are more commonly known as cash balance plans.

The proposed regs would provide that any section 204(h) notice required to be provided for an amendment converting a traditional defined benefit plan to a cash balance (or other hybrid) plan that's first effective before Jan. 1, 2009, and that limits the amount of the distribution to the account balance as permitted under Code Sec. 411(a)(13)(A), will be considered timely if provided at least 30 days before the date the conversion amendment is first effective. This special timing rule reflects the 30-day timing rule described in Notice 2007-6, 2007-3 IRB 272, and may be used through the end of 2008. Thereafter, the general 45-day timing rule would apply to these conversions. (Prop Reg § 54.4980F-1, Q&A 18(b)(3)(iii); Preamble to Prop Regs 3/20/2008)

Multiemployer plans in endangered or critical status. Code Sec. 432 , relating to multiemployer plans that are in endangered or critical status based on their level of underfunding, permits a plan amendment to be adopted that reduces prior accruals under certain circumstances. For amendments for a plan in critical status, Code Sec. 432(e)(8)(C) requires that notice of the plan amendment be sent to, among other parties, plan participants and beneficiaries, at least 30 days before the general effective date of the reduction. Reg. § 54.4980F-1, Q&A 9(c) provides that a section 204(h) amendment made in the case of a multiemployer plan must be provided at least 15 days before the amendment's effective date. The proposed regs would provide that complying with the 30-day timing rule for the Code Sec. 432(e)(8)(C) notice would also satisfy the 15-day timing rule for the 204(h) notice. (Prop Reg § 54.4980F-1, Q&A 11(a)(7); Preamble to Prop Regs 3/20/2008)

However, for an amendment to which Code Sec. 432 applies for a multiemployer plan in endangered (as opposed to critical) status, the normal timing and content rules for a section 204(h) notice under Code Sec. 4980F would apply, so that any required section 204(h) notice would have to be provided at least 15 days, instead of 30 days, before the amendment's effective date. (Preamble to Prop Regs 3/20/2008)

Effective date. The regs are proposed to apply to 204(h) amendments effective after 2007. The 204(h) notice rules of Prop Reg § 54.4980F-1, Q&A 9(g)(2), regarding plan amendments with retroactive effective dates, apply to plan amendments that are effective after June 30, 2008. Finally, the 204(h) notice rules for cash balance (and other hybrid) plan conversions apply to amendments made effective after December 21, 2006, but not later than December 31, 2008.

A public hearing regarding the proposed regs will held July 10, 2008, at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, DC. Written or electronic comments regarding the proposed regs must be received by June 19, 2008. Outlines of topics to be discussed at the public hearing must be received by June 20, 2008.

How falling interest rates and the declining stock market affect tax and estate planning

Mike Habib, EA

myIRSTaxRelief.com

Interest rates have dropped significantly in recent months and may drop even more given the state of the economy. Sagging rates can have a significant impact on many tax and estate planning strategies. Lower interest rates affect the income, estate and gift tax value of many types of transfers. In many cases, the drop in rates produces more favorable results for clients engaging in certain types of transactions. In other cases, however, the lower rates result in higher tax costs. Likewise, stock values generally have declined significantly in recent days. This article examines how falling interest rates and the declining stock market affect key tax and estate planning transactions and strategies.

IRS valuation tables. The value of annuities (other than commercial annuities), life estates, term interests, remainders and reversions for estate, gift and income tax purposes is determined using tables issued by IRS under Code Sec. 7520. The value in a given month under the tables may be higher or lower than the value in an earlier or later month because the interest factor under the tables changes monthly. For charitable transfers, the interest rate for the month of the transfer or for either of the two preceding months may be used. (Code Sec. 7520(a))

The Code Sec. 7520 interest rate for April 2008 is 3.4%.

Observation: Over the past nine months from August 2007 to April 2008, the Code Sec. 7520 interest rate has ranged from a high of 6.2% (August 2007) to a low of 3.4% (April 2008). The rate hit an all-time low of 3.0% for transfers in July 2003 and has been as high as 11.6% (Apr. and May '89).

How falling rates affect various noncharitable planning strategies. The discussion that follows explains various noncharitable financial and estate planning strategies and shows how they stack up under current falling rates.

Private annuity. Historically, private annuities have offered a number of income, gift and estate tax advantages. They also can save estate administration expenses and offer other nontax advantages as well. In the typical private annuity transaction, a parent transfers property to his child in return for that child's unsecured promise to pay the parent a fixed, periodic income for life. If the fair market value of the property transferred equals the present value of the annuity under the Code Sec. 7520 valuation tables, there is no gift tax due.

Observation: Historically, one huge advantage of a private annuity has been the opportunity to transfer highly appreciated property, and spread, and pay tax on, the gain over several years as annuity payments are received. Additionally, there was the prospect of being taxed on less than the entire gain if the annuitant died before the expiration of his tabular life expectancy. However, in 2006, IRS issued proposed regs that would knock out the income tax advantages of selling appreciated property in exchange for a private annuity. They would do this by causing the property seller's gain to be recognized in the year the transaction is effected rather than as payments are received. The regs generally would apply for transactions entered into after Oct. 18, 2006. However, certain transactions effected before Apr. 19, 2007 would continue to be subject to the historical rules.

Entering into a private annuity when interest rates are lower results in a lower annual payment amount that the younger family member will have to make to the older family member to prevent a gift from arising on the transfer.

Observation: Even though the lower interest rate results in a lower annual payment to the senior family member, that person often will prefer a lower rate so as to be able to transfer property at the lowest possible cost to the younger family member.

illustration 1: In April 2008, Jones, age 70, transfers property worth $1 million to his daughter in exchange for a private annuity. She must make an annual payment of $96,752.97 to prevent a gift from arising on the transfer. This figure is determined by dividing $1 million by 10.3356, which is the annuity factor from Table S of IRS Publication 1457 for a 70-year old and an interest rate of 3.4%, which is the Code Sec. 7520 rate for April 2008.

illustration 2: By way of comparison, had the transfer occurred when the interest factor was 6.2% as it was for August 2007, the annual payment to prevent a gift would have been $119,323.20.

Observation: Those contemplating a private annuity and anticipating a further big drop in rates may want to wait before proceeding.

Observation: A private annuity may be a good strategy for an individual with a short life expectancy who is not expected to survive for too many years. However, the mortality component of the valuation tables cannot be used to determine the present value of an annuity if the person with the measuring life is terminally ill when the gift is completed. Under Reg. § 25.7520-3(b)(3) , an individual who is known to have an incurable illness or other deteriorating physical condition is considered terminally ill if there is at least a 50% probability that he will die within one year.

Observation: Stock values generally have been declining lately. Someone who is considering setting up a private annuity may want to fund it with stock that has undergone a steep decline in value from its high back to near its original purchase price. Such stock may be a good candidate for funding a private annuity because there would be little or no gain to report in the year of the transfer under the proposed regs if they take effect. Also, if the market turns around as it has often done in the past after steep downturns, the transaction can achieve considerable transfer tax savings. That's because, the child will end up with a sizeable amount of property with no gift or estate tax cost imposed on the post-transfer appreciation in its value.

Observation: Even individuals who lack the means to set up a private annuity should consider that now may be a good time to transfer stock to a junior family member. With prices as depressed as they are, in many cases blocks of stock can be transferred completely free of gift tax under the umbrella of the $12,000 annual exclusion. For example, 300 shares of stock that was previously worth, for example, $100 per share and that is now trading for $40 per share can be transferred to a single individual at no gift tax cost by virtue of the $12,000 annual exclusion. Here, too, if the stock bounces back to its earlier highs or beyond, the post-transfer appreciation will escape transfer tax costs.

Grantor retained annuity trust (GRAT). An individual can save transfer tax by setting up a GRAT. The individual retains an annuity interest for a specified term at the expiration of which the trust property goes to a child or other individual named at the outset. Gift tax is payable but only on the present value of the remainder interest, which is the value of the property transferred to the trust less the value of the retained annuity interest. A lower interest rate increases the value of the annuity retained by the grantor and thus reduces the value of the gift of the remainder in a GRAT.

The post-transfer appreciation in the value of the trust assets will escape transfer tax. However, this is so only if the grantor survives the trust term. If the grantor dies during the trust term, the trust property will be included in his gross estate under Code Sec. 2036(a) , which provides that property transferred by an individual during his lifetime is includible in his estate if he retains an interest for any period that does not in fact end before his death. But an individual who sets up a GRAT and dies before the end of the term would be no worse off than if he had not entered into the transaction except that he will have incurred the costs of setting up and administering the trust.

illustration 3: In April 2008, Smith transfers $1 million to a trust, which is to pay him an annual annuity of $80,000 for 10 years. At the end of the 10 years, the trust property is to go to Smith's daughter. The value of Smith's retained annuity is $668,696. This figure is determined by multiplying $80,000 by 8.3587, which is the annuity factor from Table B of IRS Publication 1457 for a 10-year term and an interest rate of 3.4%. The value of the gift of the remainder to Smith's daughter is $331,304.

Observation: Because a GRAT requires the grantor's survival of the term to be effective to reduce estate tax, it may not be suitable for use by an individual with a short life expectancy as a hedge against failing to survive until greater estate tax relief is phased in. However, such an individual may be able to realize some estate tax savings by establishing a GRAT with a relatively short term that he can be expected to survive.

illustration 4: By way of comparison, had Smith made the transfer when the interest factor was 6.2%, the value of the gift would have been $416,736.

observation: If interest rates decline more, gift tax costs of setting up a GRAT could be lowered. On the other hand, if they rise, gift tax costs could be increased.

Grantor retained income trust (GRIT). A GRIT is like a GRAT except that the grantor retains an income interest instead of an annuity interest. Code Sec. 2702 generally treats the grantor as making a gift of the full value of the property. However, the value of the gift of the remainder is determined under the valuation tables where the trust is funded with a personal residence of the grantor or the remainder goes to someone falling outside of the definition of family member, such as a nephew or niece. A lower interest rate results in a lower value for the retained interest and a higher value for the gift of remainder interest in a residence GRIT or other GRIT excepted from the Code Sec. 2702 rules.

illustration 5: Bailey establishes a personal residence GRIT in April 2008, retaining a ten-year term interest. At the end of the 10-year period, the residence is to go to his son. The value of the residence at the time of the initial transfer to the trust is $400,000. The remainder factor from Table B of IRS Publication 1457 is .715805 at the current interest factor of 3.4%, making the value of the gift $284,195.

illustration 6: Had Bailey engaged in the same transaction when the interest factor was 6.2%, the value of the gift would have been $219,187.

Observation: Thus, higher rates actually produce a better result for this strategy than when interest rates are lower. So one may want to wait until interest rates rise before engaging in this type of transaction. It should be noted, however, that lower home values also make this a good time to establish a personal residence gift because the gift tax cost will be lowered by the decline in the home's value relative to where it was during the housing boom. Thus, in holding out for a higher interest rate, taxpayers should consider how real estate values affect the decision of when to proceed with this strategy.

Grantor retained unitrust (GRUT). The interest factor does not affect the value of a gift of a remainder interest in a GRUT because the retained unitrust interest is the right to receive a fixed percentage of the trust's assets and changes in rates inure uniformly to the benefit of the unitrust holder and the remainderperson.

How declining rates affect various charitable planning strategies. The discussion that follows explains various charitable planning strategies and shows how they stack up under current declining rates.

Charitable remainder annuity trust (CRAT). With a charitable remainder annuity trust, the donor retains an annuity interest for himself or someone else such as a family member and names a charity to receive the remainder at the end of the annuity term. The donor gets a current income tax deduction for the present value of the charity's remainder interest. Now may not be a good time to establish a CRAT. That's because, a lower interest rate produces smaller income, gift and estate tax charitable deductions and a higher gift tax value for a gifted annuity interest.

Charitable remainder unitrust (CRUT). A change in the rate does not affect income tax deductions for charitable remainder unitrusts or gift tax costs in connection with them.

Charitable lead unitrust. Estate and gift tax factors are essentially unaffected by changes in the rates.
Charitable lead annuity trust. A lower interest rate results in a larger gift or estate tax deduction for the annuity interest going to the charity and a smaller value for any gift of the remainder interest going to a private beneficiary. Thus, it may be a good time to establish a charitable gift annuity if the grantor is going to give the remainder interest to a family member. If rates decline further, more savings can be realized by waiting. And remember, with a charitable transfer, the interest rate for the month of the transfer or for either of the two prior months can be used. Thus, one can wait and still be afforded some protection if rates unexpectedly rise instead of dropping further.

Charitable transfer of remainder interest in residence or farm. A lower interest rate provides higher income, estate and gift tax deductions for a transfer of a remainder interest in a residence or farm. Conversely, a higher interest rate provides lower income, estate and gift tax deductions for a transfer of a remainder interest in a residence or farm.

Pooled income funds in existence for more than 3 years. Charitable income, gift and estate tax deductions for transfers to pooled income funds that have been in existence for more than 3 years are not affected by changes in interest rates because values of respective interests are determined with reference to the funds' own rates of return. Any personal gift arising from the transfer also is not affected.

Did you know that forgiven credit card debt triggered taxable income

Mike Habib, EA
myIRSTaxRelief.com

A new Tax Court case illustrates how a taxpayer generally has taxable income when a credit card company agrees to accept a reduced payment in settlement of his or her account.

Background. A solvent debtor usually realizes income from the discharge of a debt. (Code Sec. 61(a)(12)) Debtors who are insolvent, in bankruptcy, or (in certain cases) farmers and noncorporate debtors whose debt is qualified real property business indebtedness do not recognize income on a cancellation of a debt. (Code Sec. 108(a)) Instead, they must reduce their loss or tax credit carryovers or the basis in their assets. (Code Sec. 108(b)) These reductions can cause the debtor's taxes to increase in future years.

In addition, cancellations of up to $2 million of mortgage debt on an individual taxpayer's main home in 2007 through 2009 are excluded from income, but the taxpayer's basis in the home must be reduced. (Code Sec. 108(a)(1)(E), Code Sec. 108(h))

The amount of COD income where indebtedness from a credit card account is discharged is the difference between the entire amount due on the accountand the amount paid for the discharge. If no consideration is paid for the discharge, the amount of COD income is equal to the entire amount due on the account.

Code Sec. 108(e)(5) provides an exception to Code Sec. 61(a)(12) where the buyer of property negotiates with the seller/creditor for a discharge of all or part of the purchase money indebtedness. Commonly such a discharge reflects a decline in the value of the property. The resulting discharge of indebtedness is characterized not as taxable income but in effect as a retroactive reduction of the purchase price.

Facts. Ancil Payne used his credit card with MBNA America Bank to pay hospital bills and receive cash advances during periods of unemployment. By Apr. 26, 2004, he accumulated $21,407 of debt on the card. Later in 2004, Mr. Payne and MBNA entered into an agreement whereby MBNA agreed to accept $4,592 as a full settlement of the account balance of $21,270, payable in installments over 4 months. Mr. Payne made the necessary payments, and MBNA issued him a Form 1099-C, Cancellation of Debt, reporting $16,678 of discharge of debt income.

On his 2004 joint return, he and his wife did not report any debt discharge income. Instead, they attached a statement to their return which disclosed that they received a Form 1099-C from MBNA that reported discharge of debt income of $16,678. The statement also explained that they believed the amount disclosed on the Form 1099-C was not subject to income tax.

IRS determined a deficiency for the Paynes' failure to report debt discharge income. The couple petitioned the Tax Court for a redetermination of the deficiency.

Failed argument. Before the Tax Court, the Paynes contended that their settlement with MBNA did not result in the discharge of indebtedness but was rather a retroactive reduction of the rate of interest charged by MBNA and thus a reduction of the "purchase price" of the loans under Code Sec. 108(e)(5). The Paynes argued that the lending of money in a generic credit card transaction constitutes the sale of property under Code Sec. 108(e)(5).

The Tax Court said that the Paynes were mistaken. It stressed that MBNA effectively lent them money to be used for health care costs and general living expenses. The only relationship between the parties was that of debtor and creditor, and thus the Tax Court held that Code Sec. 108(e)(5) did not apply.

Observation: Many individuals may be in a similar situation of needing a credit card workout. While getting the bank to agree to a big reduction in the debt is obviously a plus, as shown in this case, the debt discharge can trigger income. For some, however, the debt discharge income may not have practical tax consequences. For example, if the discharge occurs during a period of unemployment when the individual has little or no income from other sources, the individual effectively may owe little or no tax on it. While there probably is not much latitude to time a settlement, to the extent possible, individuals should try to arrange it during periods when the income from the discharge won't have severe tax consequences.

"Makeup" required minimum distributions salvage lifetime payouts to nonspouse IRA beneficiary

Mike Habib, EA
myIRSTaxRelief.com

A private letter ruling allows the nonspouse beneficiary of an IRA to salvage lifetime payouts even though she failed an essential rule requiring distributions to begin by the end of the year following the year of the IRA owner's death. She made up missed annual required minimum distributions (RMDs) and paid a penalty excise tax, but by doing so she avoided a tough 5-year payout rule.

Background. If an IRA owner dies before his required beginning date (RBD), namely Apr. 1 of the year following the year in which age 70 1/2; is attained, then as a general rule his entire interest must be distributed within 5 years of his death. (Code Sec. 401(a)(9)(B)(ii)) However, if any part of the IRA is (1) payable to (or for the benefit of) a designated beneficiary, (2) that part is to be distributed under regs over the life or life expectancy of the designated beneficiary, and (3) the distributions begin not later than 1 year after the date of the deceased's death (or a later date as prescribed by regs), then that part is treated, for Code Sec. 401(a)(9)(B)(ii) purposes, as paid out when distributions commence. (Code Sec. 401(a)(9)(B)(iii))

Reg. § 1.401(a)(9)-3, Q&A 3(a), says that where there's a nonspouse beneficiary for the IRA (or a qualified plan account), in order to satisfy the life expectancy payout rule in Code Sec. 401(a)(9)(B)(iii), "distributions must commence on or before the end of the calendar year immediately following the calendar year in which the [IRA owner or employee] died."

The determination of whether the five-year or lifetime payout rule applies depends on the provisions of the IRA. It may be silent as to which rule (5-year or lifetime payout) applies, specify which rule applies, or it may allow the owner (or beneficiary) to elect which rule applies. (Reg. § 1.401(a)(9)-3, Q&A 4)

(1) If the IRA does not contain one of the optional provisions described in (2) or (3), below, specifying the methods of distribution if an IRA owner dies before required distributions begin, then payouts are made over the life of the designated beneficiary (or over a period which doesn't extend beyond the life expectancy of the designated beneficiary). (Reg. § 1.401(a)(9)-3, Q&A 4(a)(1)) The lifetime payout also applies if neither IRA owner nor beneficiary make the choice in (3), below. (Reg. § 1.401(a)(9)-3, Q&A 4(c))

(2) The IRA may adopt a provision specifying either that (a) the 5-year payout rule applies to certain distributions even if there's a designated beneficiary for the IRA, or (b) that payouts in every case will be made under the 5-year rule. (Reg. § 1.401(a)(9)-3, Q&A 4(b))

(3) The IRA may allow the owner or beneficiary to choose between a 5-year or lifetime payout and may specify one or the other payout method if the choice isn't timely made. (Reg. § 1.401(a)(9)-3, Q&A 4(c)) Where the IRA calls for a choice to be made between 5-year and lifetime payouts, it must be made by the earlier of:

• Dec. 31 of the calendar year in which the distribution would have to start in order to meet the lifetime payout rule under Code Sec. 401(a)(9)(B)(iii) and Code Sec. 401(a)(9)(B)(iv) (i.e., for nonspouse beneficiaries, by Dec. 31 of the year following the year of the IRA owner's death), or
• Dec. 31 of the calendar year that includes the fifth anniversary of the IRA owner's death. (Reg. § 1.401(a)(9)-3, Q&A 4(c))

Any failure (by the IRA owner or beneficiary) to take the RMD for a tax year is subject to an excise tax equal to 50% of the amount by which the RMD exceeds the actual amount distributed during the tax year. (Code Sec. 4974(a))

Facts. A taxpayer we'll call Rachel Smith is the only child of a taxpayer we'll call Leonard Smith, who died in 2002 when he was 66 years old. Rachel, named as the sole beneficiary of Leonard's IRA X and IRA Y, was 30 years old when Leonard died. After Leonard's death, the IRAs were retitled "IRA X- Leonard Smith, Decedent IRA, Rachel Smith, Beneficiary," and "IRA Z (formerly IRA Y), Leonard Smith, Decedent IRA, Rachel Smith, Beneficiary." No distributions were made from either IRA in connection with their retitling.

IRA X provides, that where a required distribution has not commenced before the owner's death, the balance of the IRA must be distributed to the owner's nonspouse designated beneficiary over his or her life expectancy starting by Dec. 31 of the year following the year of the IRA owner's death. A nonspouse beneficiary may elect to receive distributions in accordance with the 5-year rule. IRA Y provides that if the owner dies before his RBD, his nonspouse beneficiary may receive distributions over his or her life expectancy beginning no later than the end of the year following the year of the IRA owner's death. The nonspouse beneficiary may choose to receive RMDs in accordance with the 5-year rule.

Rachel should have, but failed to, start taking RMDs over her life (or life expectancy) for 2003 (the year after her father died), and for 2004. However, the RMDs for 2003, 2004, and 2005 were taken in the aggregate in 2005, based on Rachel's life expectancy for each year using the distribution period spelled out in Reg. § 1.401(a)(9)-5 , Q& A 5(c)(1). In 2007, Rachel paid the Code Sec. 4974(a) penalty tax for her failure to timely receive RMDs for 2003 and 2004. The ruling says that Rachel represented, and evidence submitted in conjunction with the ruling request supported the representation, that she had not elected the Code Sec. 401(a)(9)(B)(ii) 5-year distribution rule for either IRA X or IRA Y (as retitled).

The essential question in PLR 200811028, was whether Rachel's failure to timely take RMDs for 2003 and 2004 resulted in her having to receive the balance from the two IRAs under the 5-year rule, or whether she could take RMDs from the IRAs over her life or life expectancy.

Favorable ruling. IRS concluded that Rachel could take RMDs from the two IRAs for 2003 through 2006, and all subsequent years, over her life expectancy. IRS reasoned that the "default" required distribution rule for both IRAs where the owner dies before his RMD and has designated a beneficiary is the life-expectancy rule and not the 5-year rule. In Rachel's case both IRAs provide that where an IRA owner dies before his RMD, distributions to a beneficiary are to be made under the life-expectancy rule unless the designated beneficiary chooses otherwise. Rachel hasn't elected the 5-year rule for either IRA and has paid the 50% excise tax on the distributions she should have but didn't receive in 2003 and 2004. Thus, IRS concluded that "the life-expectancy rule of Code Sec. 401(a)(9)(B)(iii) , the "default" rule, applies to distributions from both IRA X and IRA Y."

Observation: PLR 200811028 arrives at an extremely favorable result. It allows Rachel to spread out RMDs from the IRAs over 52.4 years (her life expectancy under the Single Life Table of Reg. § 1.401(a)(9)-9, Q&A 1, for the year following the year of her father's death), and to keep the tax-deferred earnings feature of the IRAs alive for that period of time. Had IRS ruled that the 5-year payout rule was triggered by her failure to timely begin making distributions, she would have had to deplete both IRAs by Dec. 31, 2007 (the end of the calendar year containing the fifth anniversary of Leonard's death).

Observation: Although private letter rulings can't be relied on by a taxpayer other than the one who requested it, those who are in a situation like Rachel's would appear to be in a strong position to request similar, favorable treatment from IRS.

Observation: The ruling illustrates the hazards of not receiving expert tax advice when dealing with post-death IRA distributions. In Rachel's case, she wound up having to take three-years' worth of RMDs in one year, quite possibly having to pay a higher marginal tax rate and claiming smaller writeoffs for deductions that are subject to AGI-based phaseouts, and paying a 50% excise tax to boot.

If you owe the IRS, you're better off resolving your tax debt now. As you know, tax problems do not go away by themselves! Stop IRS wage garnishment today, stop IRS bank levy today, and release IRS tax lien today.

As you can see from the statement below by Mr. Douglas H. Shulman, the new IRS Commissioner, he will first concentrate on Enforcement, then secondly its Service! Are you saying where is the kinder and gentler IRS?

Contact us today to resolve your tax problems.

Statement of Commissioner Douglas H. Shulman

I want to extend my thanks to the members of the Senate and the Senate Finance Committee, especially Chairman Baucus and Senator Grassley. I also want to thank President Bush for nominating me and Treasury Secretary Paulson for his support.

The Internal Revenue Service touches virtually every adult, every business and every non-profit organization in America. It is an honor to assume the leadership of this critical agency. I recognize the great responsibility I have been given and will work to ensure that the IRS is fair, impartial and respects the rights of all taxpayers.

As Commissioner, I will concentrate on both enforcement and service. For the majority of Americans who pay their taxes willingly and on time, there must be clear guidance, accessible education and outstanding service. Our aim should be to make it as easy as possible for citizens to pay the correct amount of taxes in the most efficient and least burdensome manner possible.

For taxpayers who intentionally evade paying taxes, there must be rigorous enforcement programs.

I am looking forward to working with the dedicated and talented IRS workforce, along with the broader tax community and important stakeholders to continue to build an efficient, effective and respected IRS.

Contact us today to resolve your tax problems.

Don't compromise on your representation! We represent taxpayers before the IRS and any taxing authority.

Mike Habib, EA

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

What are your chances for being audited? IRS's 2007 data book provides some clues


Mike Habib, EA

myIRSTaxRelief.com

IRS has issued its annual data book, which provides statistical data on its fiscal year (FY) 2007 activities. As this article explains, the data book provides valuable information about how many tax returns IRS examines (audits), and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections.

What are the chances of being examined? A total of 1,384,563 individual income tax returns were audited during FY 2007 (Oct. 1, 2006 through Sept. 30, 2007) out of a total of 134.5 million individual returns that were filed in the previous year This works out to 1.0% of all individual returns filed (slightly higher than the 0.97% audit rate for the preceding year).

Of the total number of returns audited, 503,267 (36.5%) were selected on the basis of an earned income tax credit (EITC) claim (down slightly from the 40.3% rate for FY 2006).

Only 22.49% of the audits were conducted by revenue agents, tax compliance officers, and tax examiners; the bulk of the audits (about 77.5%) were correspondence audits. These percentages are about the same as they were in FY 2006.

About 1.5 million individual returns were farm returns that showed gross receipts from farming (Schedule F). Of this group, only 5,705 (0.4%) were audited in 2007.

The no-change rate (returns accepted as filed after examination) was 12% for returns examined by revenue agents, tax compliance officers, or tax examiners, and 16% for correspondence exams.

Here's a roundup of selected audit rates from IRS' latest databook. Because the audit categories aren't organized the same way for individuals as they were for FY 2006, comparisons to the rates for the previous fiscal year aren't possible.

Following are the audit rates for individual nonbusiness returns that didn't claim the earned income tax credit:

• For "selected nonbusiness returns" (includes returns without a Schedule C (nonfarm sole proprietorship), Schedule E (supplemental income and loss), Schedule F (profit or loss from farming), or Form 2106 (employee business expenses), 4%.
• For returns with Schedule E or Form 2106 (excludes returns with a Schedule C, nonfarm sole proprietorship, or Schedule F, profit or loss from farming), 1.2%.
• For nonfarm business returns by size of total gross receipts: under $25,000, 1.3%; $25,000 under $100,000, 2%; $100,000 under $200,000, 6.2%; and $200,000 or more, 1.9%.

For returns with total positive income (TPI) of at least $200,000 and under $1 million, the audit rate was 2% for nonbusiness returns and 2.9% for business returns. For returns with TPI of $1 million or more, the audit rate was 9.3%.

The audit rates for entities were as follows:

• Fiduciary (estate and trust income tax returns), 0.1% (the same as for FY 2006);
• Corporations with less than $10 million of assets, 0.9% (up from 0.8% for FY 2006);
• Corporations with $10 million or more of assets, 16.8% (down from 18.6% for FY 2006);
• S corporations, 0.5% (up from 0.38% for FY 2006);
• Partnerships, 0.4% (up from 0.36% for FY 2006);
• Estate tax returns, 7.7% (down from 9.66% for FY 2006); and
• Gift tax returns, 0.6% (down from 0.77% for FY 2006).

IRS activity on other fronts. Here's a roundup of over valuable information carried in the new IRS Data Book.

Penalties. In fiscal year 2007, IRS assessed 27.3 million civil penalties against individual taxpayers, up from 25.9 million civil penalties assessed in the previous year. Of the FY 2007 assessments, 15.17 million (55%) were for failure to pay, followed by 7.72 million (28.2%) for underpayment of estimated tax. There were 327,822 assessments (1.1%) for "accuracy penalties"assessments of penalties under Code Sec. 6662 for negligence, substantial understatement of income tax, substantial valuation misstatement, substantial overstatement of pension liabilities, and substantial estate or gift tax valuation understatement, and understatement of reportable transactions under Code Sec. 6662A .

On the corporation side, there were a total of 762,718 civil penalty assessments (up from 701,785 for FY 2006), 82.9% for either failure to pay or underpayment of estimated tax.

Offers in compromise. In FY 2007, 46,000 offers in compromise were received by IRS, and 12,000 (26%) were accepted. Over recent years, these numbers have been dropping; in 2006 for example, 59,000 offers in compromise were received by IRS, and 15,000 (25.4%) were accepted.

Criminal cases. IRS initiated 4,211 criminal investigations in FY 2007. There were 2,837 referrals for prosecution and 2,155 convictions. Of those sentenced, 98.5% were incarcerated (a term that includes imprisonment, home confinement, electronic monitoring, or a combination thereof). By way of comparison, in FY 2006, IRS initiated 3,907 criminal investigations, there were 2,720 referrals for prosecution, and 81.7% were incarcerated.

Information returns. IRS received a total of 1.825 billion information returns in FY 2007, including Forms 1098 (mortgage interest, student loan interest, and tuition), 1099 (interest, dividends, etc.), 5498 (individual retirement arrangement and medical savings account), W-2 (wages), W-2 (gambling winnings), and Schedules K-1 (pass-through entities). Of the total, only 3.1% were submitted on paper.

For professional audit representation CLICK HERE

Investors suffered theft loss in connection with company that issued sub-prime loans

Mike Habib, EA

myIRSTaxRelief.com

A Chief Counsel Advice (CCA) has concluded that a theft occurred in connection with investors' losses on loans to a company engaged in writing sub-prime loans. However, it determined that whether and when a theft occurred for any particular investor, and what losses resulted from the theft, was a question of fact since the company had been engaged in legitimate business for many years before the theft occurred.

Facts. Taxpayers (investors) invested in notes issued by X, which had been in business as a lender for many years and later expanded into writing sub-prime mortgage loans. X sold unsecured and uninsured notes exclusively to State residents because the company wished to avoid being subject to federal securities regulations. X was a legitimate business that offered returns which were greater than those typically offered to bank depositors, but were commensurate with returns available from corporate bonds.

Later, X was acquired by Y, which was primarily engaged in the business of mortgage lending. X continued to exist, but its direct lending activities were curtailed. Most of the proceeds of X's borrowings were loaned to Y. The market for high-risk mortgages subsequently crashed, and Y suffered significant losses. Y's business deteriorated as the losses mounted, and it was only able to stay in business by using the cash X generated from the sale of its notes to the public for operating capital. When X distributed annual prospectuses to its investors (as required by State securities law), they represented that X continued to conduct substantial business of its own and showed X to be solvent by virtue of its loans to Y. Y's financial condition wasn't disclosed. Further, X and Y officers and directors made public statements misrepresenting X's financial condition.

In a few years, Y owed more to X's investors than the company was worth. The losses forced Y and its subsidiaries to cease operations and file for bankruptcy. Under a liquidation plan approved by the Bankruptcy Court, investors received a payout. Thousands of investors affected by the bankruptcy suffered losses. Several people associated with X were convicted of securities violations under State law. X's president pled guilty to a number of counts of securities fraud, while another insider was convicted of a number of counts of securities fraud in connection with X. One officer was indicted on criminal charges, including obtaining signature or property by false pretenses and breach of trust with fraudulent intent.

Background. A taxpayer can deduct a loss suffered during the tax year and not compensated for by insurance or otherwise. For an individual, a loss deduction is limited to losses incurred in a trade or business, or a transaction entered into for profit, or arising from fire, storm, shipwreck, or other casualty or from theft. ( Code Sec. 165(c) ) IRS broadly defines "theft" for purposes of Code Sec. 165(c)(3) so that a taxpayer need only prove that his loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal intent. (Rev Rul 72-112, 1972-1 CB 60)

A loss that is the direct result of fraud or theft is deductible under Code Sec. 165 , even though the theft is accomplished through a purported borrowing or offer to sell a security. (Vietzke, 37 TC 504 (1961) acq., 1962-1 CB 4) IRS ruled that where a taxpayer was induced to lend money to a corporation by fraudulent financial statements that didn't reflect large liabilities which made the corporation insolvent, the taxpayer was entitled to a theft loss deduction. The money was obtained by false representations constituting a misdemeanor under state law. IRS reached this conclusion based on the taxpayer's reliance on the misrepresentations and the specific intent to separate the taxpayer from his money through fraud. (Rev Rul 71-381, 1971-2 CB 126) However, the worthlessness of valid debt is not a theft loss. (Spring City Foundry Co. v. Comm. 13 AFTR 1164 , 292 U.S. 182)

Theft found. In X and Y's situation, the CCA concluded that the facts established that a theft had occurred. While IRS initially based its assessment on X and Y being in a legitimate business and suffering losses in the ordinary course of that business, the CCA reasoned that later facts revealed the nature of the insider's fraudulent statements: various insiders' statements downplayed X's true financial difficulties; financial statements issued to the investors presented X as a solvent enterprise; the statements didn't contain Y's balance sheet (which would have shown its insolvency); and X's financial statements treated the loans to Y as assets at face value. In addition the financial statements also indicate that X was engaged in the mortgage business on its own behalf, while, in fact, after its acquisition by Y, it existed only to raise capital for Y. Further, there were securities violations cases and an insider was indicted on criminal charges requiring a misappropriation of property as an element of the crime.

The CCA noted that not every securities violation is a theft of property, and a loss or taking of property is generally not a required element of securities fraud. Thus, losses on open market transactions are not theft losses even if the market values of the securities were inflated by insiders' fraud. However, in this case, criminal charges were brought against at least one Y's officers.

Deductible loss. The CCA, however, concluded that it remained a question of fact whether and when a theft occurred with regard to any particular investor, and what losses resulted from theft. The CCA found that a determination had to be made as to whether, or at what point, loans to X no longer represented bona fide debti.e., both parties intending that the money advanced be repaid. X had conducted substantial legitimate business for many years, issuing notes and repaying debts as they came due. It was a question of fact when a loan to X was no longer bona fide debt, but a theft, or when the officers' conduct with regard to the money entrusted to X by the investors amounted to an arrogation of those funds with the intent to deprive the investors of their enjoyment.

To the extent that IRS determines that an investor's losses were the result of the worthlessness of a security under Code Sec. 165(g), the CCA concluded that the loss occurred when the security was wholly worthless. (Reg. § 1.165-5(c)) To the extent that IRS determined an investor's loss resulted from theft, the loss was treated as sustained during the tax year in which the taxpayer discovered the loss. (Code Sec. 165(e), Reg. § 1.165-8) Where there is a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no part of the loss for which reimbursement may be received is sustained under Code Sec. 165 until the tax year in which it can be ascertained with reasonable certainty.

The CCA also concluded that the open transaction doctrine (treating payments to taxpayers as a return of capital and not ordinary income) was only proper for amounts actually or constructively received after the fraud was discovered. Thus, payments made by X in the year the fraud was discovered weren't income unless the taxpayer's basis was exceeded. While returns may be amended if an amount was reported as income but wasn't in fact actually or constructively received, the open transaction doctrine should not be applied retroactively. The proper remedy for taxpayers who have suffered a loss is a deduction.

For professional tax representation CLICK HERE

For professional audit representation CLICK HERE

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

IRS unveils 2008 list of notorious tax scams - the "Dirty Dozen"

Mike Habib, EA

myIRSTaxRelief.com

IRS has recently unveiled its latest list of notorious tax scams, which it calls the "Dirty Dozen," highlighted by Internet phishing scams and several frivolous tax arguments. New to the "Dirty Dozen" this year is a scheme, which IRS auditors discovered, that relates to unreasonable and/or excessive fuel tax credit claims.

Observation: Taxpayers should steer clear of these schemes and take steps to remedy the situation that they may have gotten involved in one of them.

"Dirty Dozen" for 2008. IRS has identified the following tax scams as this year's "Dirty Dozen:"

• Phishing. This is a tactic used by Internet-based thieves to trick unsuspecting victims into revealing personal information they can then use to access the victims' financial accounts. Phishing scams often take the form of an e-mail that appears to come from a legitimate source. IRS never uses e-mail to contact taxpayers about their tax issues.
• Economic stimulus payment scams. Some scam artists are trying to trick individuals into revealing personal financial information that can be used to access their financial accounts by making promises relating to the economic stimulus payment, often called a "rebate." To obtain the payment, eligible individuals in most cases will not have to do anything more than file a 2007 federal tax return. But some criminals posing as IRS representatives are trying to trick taxpayers into revealing their personal financial information by falsely telling them they must provide information to get a payment.
• Frivolous arguments. Promoters of frivolous schemes encourage people to make unreasonable and unfounded claims to avoid paying the taxes they owe. Most recently, IRS expanded its list of frivolous legal positions that taxpayers should stay away from. Taxpayers who file a tax return or make a submission based on one of the positions on the list are subject to a $5,000 penalty.
• Fuel tax credit scams. IRS is receiving claims for the fuel tax credit that are unreasonable. Some taxpayers, such as farmers who use fuel for off-highway business purposes, may be eligible for the fuel tax credit. But some individuals are claiming the tax credit for nontaxable uses of fuel when their occupation or income level makes the claim unreasonable. Fraud involving the fuel tax credit was recently added to the list of frivolous tax claims, potentially subjecting those who improperly claim the credit to a $5,000 penalty.
• Hiding income offshore. Individuals continue to try to avoid paying U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore debit cards, credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance plans. IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions.
• Abusive retirement plans. IRS continues to uncover abuses in retirement plan arrangements, including Roth IRAs. IRS is looking for transactions that taxpayers are using to avoid the limitations on contributions to Roth IRAs.
• Zero wages. Filing a phony wage- or income-related information return to replace a legitimate information return has been used as an illegal method to lower the amount of taxes owed.
• False claims for refund and requests for abatement. This scam involves a request for abatement of previously assessed tax using Form 843, "Claim for Refund and Request for Abatement."
• Return preparer fraud. Dishonest tax return preparers can cause many problems for taxpayers who fall victim to their schemes.
• Disguised corporate ownership. Some people are going as far as forming domestic shell corporations in certain states for the purpose of disguising the ownership of a business or financial activity. IRS is working with state authorities to identify these entities and bring their owners into compliance.
• Misuse of trusts. For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits.
• Abuse of charitable organizations and deductions. IRS continues to observe the misuses of tax-exempt organizations. These include arrangements to improperly shield income or assets from taxation, attempts by donors to maintain control over donated assets or income from donated property and overvaluation of contributed property. In addition, IRS is seeing an upturn in instances where taxpayers try to disguise private tuition payments as contributions to charitable or religious organizations.

For professional tax representation CLICK HERE

For professional audit representation CLICK HERE

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

IRS website provides guidance on S corporation election problems
Filing Requirements for Filing Status Change, on IRS website

Mike Habib, EA
myIRSTaxRelief.com

In a recent posting on its website, IRS explains the steps to be taken and forms to be filed by taxpayers requesting to change their filing status from a C Corporation (filing Form 1120) to an S Corporation (filing Form 1120S). In particular, IRS explains what to do if a taxpayer hasn't timely filed Form 2553, and either has or hasn't filed Form 1120S for the first year of the intended S corporation election.

Background. S corporations are incorporated entities with many of the same attributes as traditional C corporations, including limited liability, transferable ownership, and unlimited life. But unlike C corporations, S corporations are generally not subject to income tax. Instead, the business's profit or loss is passed through to the shareholders, who report it on their individual returns. To qualify, a corporation must elect S corporation status and meet a number of requirements. It can have no more than 100 shareholders, and only certain types of taxpayers can be shareholders. It can have only one class of stock.

Taxpayers elect S corporation status by filing Form 2553, Election by a Small Business Corporation, on or before the 15th day of the third month of the tax year for which the election is to be in effect.

Observation: Among other issues, the Tax Advocate's 2007 Report to Congress highlighted problems with the S corporation election process. If the election isn't timely filed or is incomplete, the S corporation return is converted to a C corporation return when filed. In past years, roughly 14% to 16% of total new S corporation filings were unpostable (i.e., the S corporation election was not approved). Approximately 20% of S corporation returns are unpostable for multiple years because of missing information or IRS processing errors.

C corporation requesting change to S corporation. A taxpayer requesting to change its filing status from a C corporation to an S corporation should timely fax or mail a paper copy of Form 2553 to the appropriate Service Center (as directed in Form 2553 instructions). The corporation will receive an acknowledgment and approval of the S corporation election. If it doesn't, it should follow-up with the Service Center where the Form 2553 was filed. The taxpayer should file (electronically, if required) its last C Corporation return (Form 1120) by the due date or extended due date.

Finally, the taxpayer should file (electronically, if required) an S corporation return (Form 1120S) by the due or extended due date. The filing of the initial Form 1120S return finalizes the change of the entity's filing requirement on IRS's records.

Failure to timely file Form 2553. If a taxpayer hasn't timely filed its election request to be treated as an S Corporation, it generally must request relief for the late election by requesting a private letter ruling and paying a user fee. However, certain relief provisions are available, as discussed below.

Where Form 1120S has been filed. If a taxpayer hasn't timely filed Form 2553, but has timely filed Form 1120S for the first year of the intended S corporation election, its Form 1120S can't be accepted and processed by the Service Center. When the Service Center notifies the taxpayer of the invalid S election, it should file a paper copy of Form 2553 with the Service Center, writing at the top of the form "Filed pursuant to Rev. Proc. 2003-43," and attaching a statement establishing reasonable cause for the failure to timely file Form 2553. The Form 2553 and attached statement should be mailed to the Service Center separate from any other returns or information being submitted. (Taxpayers not eligible to use Rev Proc 2003-43, 2003-23 IRB , must generally request a private letter ruling and pay a user fee.) The taxpayer should file (electronically, if required) the last C Corporation return (Form 1120) by the due or extended due date.

Where Form 1120S hasn't been filed. If a taxpayer hasn't timely filed Form 2553 and also hasn't filed Form 1120S, it can choose one of two options. (Taxpayers not eligible to use either option must generally request a private letter ruling and pay a user fee.) Under the first option, the taxpayer files a copy of Form 2553 with the initial Form 1120S within 6 months of the due date of the Form 1120S (excluding extensions). On Form 2553, it provides a statement establishing reasonable cause for the failure to timely file Form 2553.

Under the second option, the taxpayer mails or faxes a paper copy of Form 2553 with the appropriate Service Center, writing at the top of the form "Filed pursuant to Rev. Proc. 2003-43," and attaching to Form 2553 a statement establishing reasonable cause for the failure to timely file Form 2553. The Form 2553 and attached statement should be mailed to the Service Center separate from any other returns or information being submitted. The Form 2553 should be filed before filing of the Form 1120S, and the Form 1120S should not be filed until the taxpayer is notified that the S election has been accepted.

Finally, under both options, the taxpayer should then file (electronically, if required) the last C Corporation return (Form 1120) by the due or extended due date.

House passes Pension Protection Technical Corrections Act - final action delayed till after recess

Mike Habib, EA

myIRSTaxRelief.com

The House passed the "Pension Protection Technical Corrections Act of 2007" (H.R. 3361) by voice vote on Mar. 12, 2008. The bill would make technical corrections to the Pension Protection Act of 2006 (PPA). The Senate had passed their version of the "Pension Protection Technical Correction Act of 2007" (S. 1974), by unanimous consent on Dec. 19, 2007. Differences between the House and Senate versions will have to be worked out in conference, after Congress returns from its upcoming two-week recess, sources told RIA.

"There is one item, called smoothing, that we viewed as a particularly important technical correction but is not included in this bill because one of the parties to the process said it was not technical," said Paul Ryan (R-WI) in remarks on the House floor. "The Senate-passed bill included smoothing," Ryan added.

"I believe plans will freeze and workers will lose their pensions because asset smoothing is not addressed on the suspension calendar before we go out, before this critical April 15 deadline for pension funding," said Earl Pomeroy (D-ND).

According to a description of the bill provided by the House Ways and Means Committee, the bill would address the funding status of single-employer plans and multiemployer plans, interest rates, Pension Benefit Guaranty Corporation (PBGC), disclosure, prohibited transactions, benefit accrual standards, revenue, and increase in pension plan diversification. Specifically, the bill would include provisions on:

• the prohibition on increases in benefits while a waiver is in effect (ERISA § 302(c)(7)(A),Code Sec. 412(c)(7)(A));
• minimum funding standards (ERISA § 302(d)(1), Code Sec. 412(d)(1));
• the determination of target normal cost (ERISA § 303(b), (i), Code Sec. 430(b), (i));
• the determination of at-risk status (ERISA § 303(i)(4)(B), Code Sec. 430(i)(4)(B));
• quarterly contributions (ERISA § 303(j)(3), Code Sec. 430(j)(3));
• the definition of "prohibited payment" (ERISA § 206(g)(3)(E), Code Sec. 436(d)(5));
• small plans (ERISA § 206(g)(10), Code Sec. 436(k));
• the notice requirement for single employer plans (PPA §103(b), ERISA § 101(j));
• the definition of "single employer plan" (Code Sec. 436(l));
• the restrictions on funding of nonqualified deferred compensation plans by employers maintaining underfunded or terminated single-employer plans (PPA §116, Code Sec. 409A(b)(3)(A)(ii));
• the shortfall funding method (PPA §201(b));
• multiemployer plan notice requirements (ERISA § 305(b)(3)(D), (e)(8)(C), Code Sec. 432(b)(3)(D), (e)(8)(C));
• implementation and enforcement of the default schedule (ERISA § 305(c)(7), (e)(3)(C), Code Sec. 432(c)(7), (e)(3)(C));
• the restriction on payment of lump sums while a plan is in critical status (ERISA § 305(f)(2)(A), Code Sec. 432(F)(2)(A));
• a definition of the term "plan sponsor" (Code Sec. 432(i)(9));
• the excise tax on trustees for failure to adopt a timely rehabilitation plan (Code Sec. 4971(g)(4));
• the effective date of the excise tax provisions (PPA §212(c));
• the extension of the replacement of the 30-year Treasury Rates (PPA §301);
• the interest rate assumption for determination of lump-sum distributions (PPA § 302, Code Sec. 415(b)(2)(E));
• plans covered by the missing participant program (ERISA § 4050(d));
• defined benefit funding notice and disclosure of withdrawal liability (PPA §501, ERISA § 101(f));
• access to multiemployer pension plan information (PPA §502, ERISA § 101(k), (l), ERISA § 4221(e));
• disclosure of termination information to plan participants (PPA § 506, ERISA § 4041, ERISA § 4042);
• periodic pension benefit statements (PPA §508, ERISA § 209(a));
• notice to participants or beneficiaries of blackout periods (PPA §509, ERISA § 101(i)(8)(B));
• prohibited transaction rules relating to financial investments (PPA §611, ERISA § 408(b)(18)(C), Code Sec. 4975(d)(21)(C));
• preservation of capital (ERISA § 204(b)(5)(B)(i)(II), Code Sec. 411(b)(5)(B)(i)(II));
• application of present-value rules (ERISA § 203(f)(1)(B), Code Sec. 411(a)(13)(A)(ii));
• the effective date of PPA §701(e);
• an increase in the deduction limit for single-employer plans (Code Sec. 404);
• updating deduction rules for combination of plans (Code Sec. 404(a)(7));
• allowing direct rollovers from retirement plans to Roth IRAs (Code Sec. 408A(c)(3)(B), Code Sec. 408A(d)(3)(B));
• allowing rollovers by nonspouse beneficiaries of certain retirement plan distributions (Code Sec. 402(c)(11), Code Sec. 402(f)(2)(A));
• the use of excess pension assets for future retiree health benefits and collectively bargained retiree health benefits (Code Sec. 420);
• distributions from governmental retirement plans for health and long-term care insurance for public safety officers (PPA §845, Code Sec. 402(l));
• annuities to surviving spouses and dependent children of special trial judges (Code Sec. 3121(b)(5)(E), and Social Security Act sec. 210(a)(5)(E));
• provisions for recall (Code Sec. 7443B);
• requiring defined contribution plans to provide employees with the freedom to invest their plan assets (PPA §901, Code Sec. 401(a)(35)(E));
• increasing participation through automatic contribution arrangements (PPA §902, Code Sec. 414(w));
• the treatment of eligible combined defined benefit plans and qualified cash or deferred arrangements (PPA §903, Code Sec. 414(x)(1), ERISA § 210(e));
• extension of tier II railroad retirement benefits to surviving former spouses (PPA §1003); and
• no reduction in unemployment compensation as a result of pension rollovers (PPA §1105).

IRS eases rules for partial annuity exchanges

Mike Habib, EA
myIRSTaxRelief.com

In 2003, IRS issued a revenue ruling formally sanctioning partial annuity exchanges as qualifying for tax-free treatment under Code Sec. 1035. At the same time, it issued a notice warning that it would go after taxpayers who use partial exchanges to avoid tax under Code Sec. 72(e)(2). It has adopted the interim guidance as final rules in a new revenue procedures. The final guidance reflects modifications that are mostly pro-taxpayer.

Background. Code Sec. 72(e) governs the federal tax treatment of distributions from an annuity contract that are not received as an annuity. Under Code Sec. 72(e)(2), such amounts generally are taxed on an income-first basis. For this purpose, all annuity contracts issued by the same company to the same policyholder during any calendar year are treated as a single annuity contract. (Code Sec. 72(e)(12)) Code Sec. 72(q)(1) imposes a 10% penalty on withdrawals or surrenders of annuity contracts, unless one of the exceptions in Code Sec. 72(q)(2) applies. No gain or loss is recognized on the exchange of an annuity contract for another annuity contract. (Code Sec. 1035(a))

Partial exchanges. In late '99, IRS acquiesced to a Tax Court decision holding that the direct transfer of a portion of funds from one annuity contract to another qualifies as a nontaxable exchange under Code Sec. 1035. (Conway v. Comm., 111 TC 350 (1998), acq., 1999-2 CB xvi) See Federal Taxes Weekly Alert 12/2/1999)

Rev Rul 2003-76, 2003-2 CB 355 provided additional details on the tax consequences of partial annuity exchanges. Under the facts of that ruling, A owns, and is the obligee under, annuity contract B issued by Company B. A contracts with Company C to issue new annuity contract C. He assigns 60% of the cash surrender value of Contract B to Company C to be used to purchase Contract C. At no time during the transaction does A have access to the cash surrender value of Contract B that is used to purchase Contract C. No other consideration will be paid in this transaction. The terms of Contract B are unchanged by this transaction, and Contract B is not treated as newly issued. The ruling concluded that:

• The direct transfer by A of a portion of the cash surrender value of Contract B to Company C for Contract C is a tax-free exchange under Code Sec. 1035(a)(3).
• After the transaction, under Code Sec. 1035(d)(2), A's basis in Contract C equals 60% of his basis in Contract B immediately before the exchange, and his basis in Contract B equals 40% of his basis in it immediately before the exchange. That's because, basis is allocated ratably based on the percentage of the cash surrender value retained and the percentage transferred to the new contract.
• After the transaction, under Code Sec. 72, A's investment in Contract C equals 60% of his investment in Contract B immediately before the exchange and his investment in Contract B equals 40% percent of his investment in it immediately before the exchange, using the same ratable allocation approach.

IRS's concern about possible abuses. When it issued Rev Rul 2003-76, IRS, in Notice 2003-51, 2003-2 CB 362, expressed concern that some taxpayers may enter into a partial exchange to reduce or avoid the tax that would otherwise be imposed by Code Sec. 72(e)(2).

Illustration: Smith withdraws $100 from an annuity contract with a cash surrender value of $200 and investment in the contract of $80. The entire $100 withdrawal is included in income under Code Sec. 72(e)(2). If, instead, he assigns 50% of the contract's cash surrender value in a partial exchange, and then surrenders either the existing or new contract, only $60 is included in income and $40 is excluded as a return of investment in the contract. (Notice 2003-51, Sec. 3)

At that time, IRS said it was considering whether to issue regs to provide rules for determining when a partial exchange of an annuity contract followed by the surrender of, or distributions from, either the surviving annuity contract or the new annuity contract should be presumed to have been entered into for tax avoidance purposes. Pending the publication of final regs, IRS said it would consider all the facts and circumstances to determine whether a partial exchange and a subsequent withdrawal from, or surrender of, either the surviving annuity contract or the new annuity contract within 24 months of the date on which the partial exchange was completed should be treated as an integrated transaction, and thus whether the two contracts should be viewed as a single contract to determine the tax treatment of a surrender or withdrawal under Code Sec. 72(e). IRS said, if, however, a taxpayer could demonstrate that one of the conditions of Code Sec. 72(q)(2), or any other similar life event, such as a divorce or the loss of employment, occurred between the partial exchange and the surrender or distribution, and that the surrender or distribution was not contemplated at the time of the partial exchange, the taxpayer would not be treated as having entered into the surrender or distribution for tax avoidance purposes.

Final guidance. IRS has determined that it is in the interest of sound tax administration to adopt the provisions of Notice 2003-51 with changes, in the form of a revenue procedure. In doing so, IRS has determined that the 24-month period referred to above should be shortened to 12 months, and the subjective requirement that certain surrenders or distributions not have been "contemplated" at the time of the exchange should be removed.

Observation: The change from 24 to 12 months is favorable for taxpayers who may be contemplating partial exchanges. They will be able to make withdrawals one year after entering into the exchange without concern that IRS may want to try to treat the new and original contracts as one to extract a higher tax cost on the withdrawal.

In addition, IRS has determined it is appropriate to make these clarifications to the rules of Notice 2003-51:

• First, if the direct transfer of a portion of an annuity contract for a second annuity contract does not qualify as a tax-free exchange under Code Sec. 1035 and Rev Proc 2008-24 , it will be treated as a taxable distribution followed by a payment for the second contract.
• Second, the rule treating a transfer as a tax-free exchange if one of the Code Sec. 72(q)(2) conditions is met cannot be satisfied based on a payment described in Code Sec. 72(q)(2)(D) (distribution that is part of a series of substantially equal periodic payments) or Code Sec. 72(q)(2)(I) (distribution under an immediate annuity).
• Third, IRS won't require aggregation under Code Sec. 72(e)(12) or otherwise of two contracts that are the subject of a tax-free exchange under Code Sec. 1035 and Rev Proc 2008-24, Sec. 4.01, even if both contracts were issued by the same insurance company.

Rev Proc 2008-24 applies to the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract, regardless of whether the two annuity contracts are issued by the same or different companies. It doesn't apply to transactions (sometimes referred to as "partial annuitizations") in which the holder of an annuity contract irrevocably elects to apply only a portion of the contract to purchase a stream of annuity payments under the contract, leaving the remainder of the contract to accumulate income on a tax-deferred basis. (Rev Proc 2008-24, Sec. 3)

Effective date. Rev Proc 2008-24 is effective for transfers that are completed on or after June 30, 2008. (Rev Proc 2008-24, Sec. 5)

For IRS tax representation CLICK HERE

For IRS audit representation CLICK HERE

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

How to compare tax relief and resolution service companies?

Customer...Beware!

How To Keep From Getting Ripped Off?

Many "Tax Negotiation" companies out there will absolutely rip you off. These unscrupulous firms will take your money regardless of whether they can help you or not. They'll lie to you and tell you they can get all the penalties and interest wiped out. They'll lie to you and tell you they'll settle with the IRS for "pennies on the dollar" when they know damn well you don't possibly qualify for the Offer in Compromise program.

How do they get away with this? Easy, most of the people you talk to at these unscrupulous firms are sales representatives. They have NO license to protect. You don't actually speak to the EA (Enrolled Agent), the CPA (Certified Public Accountant) or the attorney that these firms claim to have. Nope, you speak to some slimy unlicensed salesman. Some of these firms make up titles like Tax Resolution Specialist, or Tax Consultant. What a scam! In fact, many of these unscrupulous firms aren't tax firms or law firms at all, they're just sales organizations!

We NEVER take on any client that we don't believe we can truly help. But, I absolutely guarantee you that 90% of the unscrupulous tax negotiation firms that advertise on TV and the internet would take any client and their money regardless of whether they could help them or not. And that stinks!

So, what should you do?

1) Always speak with the "licensed representative" who is on the Power of Attorney, that will actually represent you, usually the principal / owner of the firm,

2) Stay away from any firm/website that doesn't clearly give the names and bios of the licensed representative (Enrolled Agents, CPAs & Attorneys),

3) Ignore guarantees, promises and so-called testimonials. They're nothing more than meaningless hype; instead check the Better Business Bureau rating - A MUST!

4) Ask tough questions. If the answers don't make sense, don't hire the firm. What kind of tough questions? Are you an EA, CPA or attorney? When they say, "I'm a tax resolution specialist", ask them, is that a State or Federal license?

5) Finally, use your good common sense. You know when something isn't right. You work too hard for your money to give it away to some slime ball that makes promises you know he can't keep. Only deal with someone who is "Licensed" and who "Specialize" is Tax Resolution.

Don't get ripped off! Do the right thing-

Compliments of: Mike Habib, EA http://www.myirstaxrelief.com/

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

Final regs clarify treatment of loss from abandoned securities

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued final regs that provide guidance on the availability and character of a loss deduction from abandoned securities under Code Sec. 165. The regs, which adopt proposed regs issued in 2007, apply to securities abandoned after Mar. 12, 2008.

Background. If any security that is a capital asset becomes worthless during the tax year, the loss is treated as from the sale or exchange of a capital asseton the last day of the tax year. (Code Sec. 165(g)(1)) A security is defined as a share of stock in a corporation; a right to subscribe for or to receive a share of stock in a corporation; or a bond, debenture, note or certificate or other evidence of indebtedness issued by a corporation or government with interest coupons or in registered form. (Code Sec. 165(g)(2)) An exception from this capital loss treatment applies for certain worthless securities in a domestic corporation affiliated with the taxpayer. (Code Sec. 165(g)(3))

IRS had learned that some taxpayers had taken the position that a loss from the abandonment of a security was not subject to the loss characterization rules provided in Code Sec. 165(g). ( Preamble to Prop Reg )

Observation: A number of practitioners had considered the possibility of a taxpayer claiming an ordinary loss for abandoned securities and what hurdles to overcome to justify such treatment. [See Cummings' Corporate Tax Insights on Checkpoint 07/13/2004.

Abandoned securities. The final regs provide that for purposes of applying the Code Sec. 165(g) loss characterization rules, the abandonment of a security establishes its worthlessness to the taxpayer. A loss established by the abandonment of a security that is a capital asset is treated as a loss from the sale or exchange, on the last day of the tax year, of a capital asset, unless the Code Sec. 165(g)(3) exception applies. While a taxpayer doesn't have to relinquish legal title to property in all cases to establish abandonment, the regs require that to abandon a security a taxpayer has to permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. (Reg. § 1.165-5(i))

Abandoned or cancelled debt instruments. Generally, the treatment of a worthless debt is governed by Code Sec. 166. However, there's an exception to this rule under Code Sec. 166(e) where a debt is evidenced by a security as defined in Code Sec. 165(g)(2)(C). In that case, based on what IRS stated in Preamble to Prop Reg, the tax treatment of the debt securities is governed by the final regs.

For professional tax representation CLICK HERE.

Recurring item deduction exception allowed for payroll taxes on bonuses and vacation pay

Mike Habib, EA

myIRSTaxRelief.com

In a Revenue Procedure, IRS has provided a safe harbor accounting method for accrual method taxpayers that incur Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax (i.e., payroll tax) liabilities bonuses and vacation pay, as well as other compensation. Under the safe harbor, a taxpayer may be treated as satisfying the requirements for the recurring item exception in Reg. § 1.461-5(b)(1)(i) for its payroll tax liability in the same tax year in which all events have occurred that establish the fact of the compensation liability and the amount of the compensation liability can be determined with reasonable accuracy. Procedures are provided for taxpayers to obtain automatic IRS consent to change to this accounting method.

Background. Under Code Sec. 461(a), a deduction or credit must be taken for the tax year that is the proper tax year under the taxpayer's method of accounting used to compute its taxable income. Reg. § 1.461-1(a)(2)(i) provides that under an accrual method of accounting, a liability is incurred, and is generally taken into account for tax purposes, in the tax year in which:

(1) all the events have occurred that establish the fact of the liability;
(2) the amount of the liability can be determined with reasonable accuracy; and
(3) economic performance has occurred with respect to the liability (the "all events test").

Under the recurring item exception to the general rule of economic performance, a liability is treated as incurred for a tax year if:

• at the end of the tax year, all events have occurred that establish the fact of the liability and the amount can be determined with reasonable accuracy (Reg. § 1.461-5(b)(1)(i));


• economic performance occurs on or before the earlier of (i) the date that the taxpayer files a return (including extensions) for the tax year, or (ii) the 15th day of the ninth calendar month after the close of the tax year (Reg. § 1.461-5(b)(1)(ii));


• the liability is recurring in nature (Reg. § 1.461-5(b)(1)(iii)); and


• either the amount of the liability is not material or accrual of the liability in the tax year results in better matching of the liability against the income to which it relates than would result from accrual of the liability in the tax year in which economic performance occurs. (Reg. § 1.461-5(b)(1)(iv))

For many years, IRS's position was that FICA and FUTA taxes for accrual method taxpayers were incurred only in the tax year the compensation giving rise to the payroll tax liability was paid. However, IRS conceded the issue of deductibility of payroll taxes for year-end wages after the Court of Claims held in Eastman Kodak Co v. U.S., (Ct Cl 1976) 37 AFTR 2d 76-1200, that an accrual employer could deduct its share of FICA and FUTA on year-end wages in the year they were accrued, rather than in the following year when they were paid. (Rev Rul 96-51, 1996-2 CB 36, Rev Rul 2007-12, 2007-11 IRB 685, see Federal Taxes Weekly Alert 02/22/2007) However, the court in Eastman Kodak also held that the fact of the liability for payroll taxes on bonuses and vacation pay was not established in Year 1 because of the uncertainty at the end of Year 1 as to whether the employee will reach the payroll tax ceiling at the time of payment in Year 2.

Recognizing that the proper accrual of FICA and FUTA tax liabilities continues to be an area of uncertainty for taxpayers, IRS has provided a safe harbor for reasons of administrative convenience and to reduce further controversy.

Safe harbor accounting method. Rev Proc 2008-25 provides that solely for purposes of the recurring item exception in Reg. § 1.461-5, a taxpayer will be treated as satisfying the requirement for the recurring item exception in Reg. § 1.461-5(b)(1)(i) for its payroll tax liability in the same tax year in which all events have occurred that establish the fact of the related compensation liability and the amount of the related compensation liability can be determined with reasonable accuracy. Rev Proc 2008-25 doesn't apply to an employee's portion of FICA tax imposed under Code Sec. 3101 and deducted by the employer from wages paid to the employee.

Illustration: Calendar year X uses an accrual accounting method, including the recurring item exception. X properly changes to the Rev Proc 2008-25 safe harbor for its payroll tax liabilities. During Year 1, X's employee A earns $10,000 of vested vacation compensation for services performed during Year 1. X pays the vacation compensation to A in February and May of Year 2. Assume that, as of Dec. 31 of Year 1, all events have occurred to establish the fact of X's vested vacation compensation liability and the amount of the liability is determinable with reasonable accuracy. Solely in applying the recurring item exception, all events necessary to establish the fact of the payroll tax liability for the $10,000 vested vacation compensation incurred by X will be treated as having occurred in Year 1, and the amount of the payroll tax liability will be treated as being determined with reasonable accuracy in Year 1.

Illustration: Calendar year Y uses an accrual accounting method, including the recurring item exception. Y properly changes to the Rev Proc 2008-25 safe harbor for its payroll tax liabilities. On Dec. 28 of Year 1, Y's board of directors approves a bonus pool of $1,000,000 to be paid to Y's employees for services provided during Year 1. The $1,000,000 bonuses are paid to Y's employees on Jan. 5 of Year 2. Assume that, as of Dec. 31 of Year 1, all events have occurred to establish the fact of the bonus compensation liability and the amount of the liability is determinable with reasonable accuracy. Solely in applying the recurring item exception, all events necessary to establish the fact of the payroll tax liability for the $1,000,000 in bonuses incurred by Y will be treated as having occurred in Year 1, and the amount of the payroll tax liability will be treated as being determined with reasonable accuracy in Year 1.

Observation: Thus, taxpayers X & Y in Illustration 1 & 2 will be able to deduct their respective vacation pay and bonus compensation liability in Year 1.

A taxpayer within the scope of Rev Proc 2008-25 that wants to change its treatment of payroll tax liabilities to conform to the safe harbor method of accounting (including a change to use the recurring item exception for payroll tax liabilities) must follow the automatic change in accounting method provisions of Rev Proc 2002-9, 2002-1 CB 327, with the modifications specified in Rev Proc 2008-25, Sec. 5.

Effective date. Rev Proc 2008-25 is effective for tax years ending on or after Dec. 31, 2007. IRS will not challenge a taxpayer's use of the safe harbor method on a return filed before Mar. 11, 2008, if the taxpayer meets the requirements of Rev Proc 2008-25 in that tax year. If the taxpayer's use of the safe harbor method on a return filed before Mar. 11, 2008, is an issue under consideration in examination, appeals, or before a federal court, IRS will not further pursued the issue. Reg. §1.461-5(b)(1)(i)

Payroll tax relief, employment tax relief, payroll tax issues

New proposed regs address complex issue - capitalization of tangible assets - Part III

Mike Habib, EA
myIRSTaxRelief.com IRS has issued new comprehensive proposed regs on when amounts are treated as paid to acquire, produce, or improve tangible property. They replace controversial proposed regs that were issued on the same subject in 2006 and that IRS has now withdrawn. The new proposed regs would be effective for tax years beginning on or after the date that they are finalized.

Since the beginning of the week, we have included a series of articles on the topic. This article, the third in the series, explains how the proposed regs would differentiate between currently deductible repairs and improvement or betterments to property that have to be capitalized. For how the proposes regs would define materials and supplies that are deductible under Code Sec. 162, and prescribe new rules for when the deduction for these items may be claimed, see Part I . For how the proposed regs would treat amounts related to the acquisition or production of real or personal property, see Part II.

Observation: The regs would make several significant liberalizations by doing away with the so-called "restoration principle" and putting in place a new routine maintenance safe harbor. They also attempt to reflect the large body of case law on repairs vs. improvements and adopt all-encompassing guidelines where none existed before. However, the regs if adopted nonetheless may be difficult to apply to a particular taxpayer's facts and circumstances, as evidenced by the plethora of examples, many on them complex, that attempt to illustrate how the regs would affect "typical" capital and non-capital expenditures.

Out with the plan of rehabilitation doctrine. Under the judicially developed plan of rehabilitation doctrine, a taxpayer must capitalize otherwise deductible repair costs if they are incurred as part of a general plan of renovation or rehabilitation. The new proposed regs would specifically provide that repairs made at the same time as an improvement, but that do not directly benefit or are not incurred by reason of the improvement, don't have to be capitalized under Code Sec. 263(a) . However, a taxpayer would have to capitalize under Code Sec. 263A otherwise deductible repair costs if the taxpayer improves a unit of property and the otherwise deductible repair costs directly benefit or are incurred by reason of the improvement to the property. (Prop Reg § 1.263(a)-3(d)(4)) The preamble adds that when the proposed regs are finalized, the judicially-created plan of rehabilitation doctrine will be obsolete, particularly with regard to the assertion that the doctrine transforms otherwise deductible repair costs into capital improvement costs solely because the repairs are performed at the same time as an improvement, or are pursuant to a maintenance plan, even though the repairs do not improve the property. (Preamble to Prop Reg 03/07/2008)

Observation: Exs. 8 and 9 of Prop Reg § 1.263(a)-3(g)(4) illustrate how this rule is easier to state than to apply. In these examples, a company that owns a fleet of petroleum hauling trucks decides to replace the existing engine, cab, and petroleum tank of a truck with new components. All of these costs would have to be capitalized under the restoration rule, explained below. If the company decided to paint the truck cab and replace a broken tail-light (both deductible repairs if made separately) at the same time that the new components are installed, it would have to capitalize the painting cost (treated as an expense that directly benefits or is incurred by reason of the truck restoration), but it could currently deduct the cost of repairing the broken tail-light (treated as an expense that does not directly benefit and is not incurred by reason of the truck restoration).

Routine maintenance safe harbor. Under this new safe harbor, the cost of routine maintenance performed on a unit of property (see Part I) would be treated as not improving that unit of property (and therefore would be currently deductible). Routine maintenance would be the recurring activities that a taxpayer expects to perform as a result of its use of the unit of property to keep it in its ordinarily efficient operating condition. Examples: inspection, cleaning, and testing; and the replacement of parts of the unit of property with comparable and commercially available and reasonable replacement parts. Amounts paid for routine maintenance would include routine maintenance performed on (and with regard to) rotable and temporary spare parts (see Part I for the timing of the deduction for such parts).

The safe harbor would apply only if, at the time the unit of property is placed in service by the taxpayer, the taxpayer reasonably expects to perform the activities more than once during the class life (under the Code Sec. 168 alternative depreciation rules) of the unit of property.

Whether an expense is "routine maintenance" would depend on factors such as the recurring nature of the activity, industry practice, manufacturers' recommendations, the taxpayer's experience, and the taxpayer's treatment of the activity on its applicable financial statement (AFS), such as one required to be filed with the Securities and Exchange Commission). (Prop Reg § 1.263(a)-3(e))

However, routine maintenance wouldn't include amounts paid:

• to replace a component of a unit of property where the taxpayer has (1) properly deducted a loss for that component (other than a casualty loss under Reg. § 1.165-7) or (2) properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component;
• to replace a component of a unit of property if the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component;
• to repair damage to a unit of property for which the taxpayer has taken a basis adjustment as a result of a casualty loss or casualty event under Code Sec. 165; and
• to return a unit of property to its former ordinarily efficient operating condition, if the property has deteriorated to a state of disrepair and is no longer functional for its intended use. (Prop Reg § 1.263(a)-3(e)(2))

Capitalizing betterment costs. Taxpayers would have to capitalize betterment costs, a new term that consists of amounts paid:

• to ameliorate a material condition or defect that either existed before the taxpayer acquired the unit of property or arose during its production, whether or not the taxpayer was aware of the condition or defect at the time of acquisition or production;
• that results in a material addition (including a physical enlargement, expansion, or extension) to the unit of property; or
• that results in a material increase in capacity (including additional cubic or square space), productivity, efficiency, strength, or quality of the unit of property or the output of the unit of property. (Prop Reg § 1.263(a)-3(f)(1))

The question of whether an expense results in a betterment would be determined based on the facts and circumstances, including: the purpose of the expense; the physical nature of the work performed; the effect of the expense on the unit of property; and the taxpayer's treatment of the expense on its AFS. If a part can't be replaced with the same part (e.g., due to technological advancements or product enhancements), replacing it with an improved but comparable part wouldn't by itself, result in a betterment. In general, the appropriate comparison for determining whether an amount paid results in a betterment would be made by comparing the condition of the unit of property immediately after the expense with the condition of the property before the circumstances necessitating the expense. (Prop Reg § 1.263(a)-3(f)(2))

Observation: Exs. 9 through 11 of Prop Reg § 1.263(a)-3(f)(3), illustrate how difficult it would be to apply these rules, even in straightforward situations. These examples involve a small retail shop that suffers storm damage to some of its roof shingles. Redoing the entire roof with wood shingles wouldn't have to be capitalized as a betterment to the shop, and neither would redoing the entire roof with asbestos shingles if wood shingles became unavailable. However, redoing the entire roof with shingles made of a lightweight, composite material that's maintenance free, non-absorptive, has a 50year life and a Class A fire rating, would have to be capitalized as a betterment to the shop.

Capitalizing restoration costs. Restoration costs, which would have to be capitalized, would be amounts paid to:

• replace a component of a unit of property where the taxpayer has (1) properly deducted a loss for that component (other than a casualty loss under Reg. § 1.165-7 ) or (2) properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component;
• repair damage to a unit of property for which the taxpayer has properly taken a basis adjustment as a result of a casualty loss or casualty event under Code Sec. 165;
• return the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use;
• result in the rebuilding of the unit of property to a like-new condition after the end of its economic useful life (the time it may reasonably be expected to be useful to the taxpayer); or
• replace a major component or a substantial structural part of the unit of property (but this wouldn't apply if the amount is paid during the property's MACRS recovery period under Code Sec. 168(c)). (Prop Reg § 1.263(a)-3(g)(1))

The replacement of a major component or substantial structural part would be deemed to occur only if (a) the replacement costs are 50% or more of the replacement cost of the unit of property or (b) the replacement part or parts are 50% or more of the physical structure of the unit of property. (Prop Reg § 1.263(a)-3(g)(3)) These 50% thresholds would apply solely for purposes of the restoration rules (as opposed to the betterment or new or different use rules). (Preamble to Prop Reg 03/07/2008)

Capitalizing amounts to adapt property to a new or different use. Under this rule, the cost of adapting a unit of property to a new or different use would have to be capitalized. In general, a "new or different use" would mean a situation where the adaptation isn't consistent with the taxpayer's intended use of the property when he placed it in service. (Prop Reg § 1.263(a)-3(h)) For example, if the owner of a building consisting of 20 retail spaces converts three spaces into one larger space for an existing tenant by knocking down walls, the cost of the conversion wouldn't be treated as a new or different use because the combination of spaces is consistent with the owner's intended, ordinary use of the building. (Prop Reg § 1.263(a)-3(h)(2), Ex. 2)

Accounting method changes. Generally, a taxpayer's treatment of an amount paid to conform with the new proposed regs (e.g., a change to the routine maintenance safe harbor) would be a change in method of accounting under Code Sec. 446(e). (Preamble to Prop Reg 03/07/2008)

New proposed regs address complex issue--capitalization of tangible assets--Part II

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued new comprehensive proposed regs on when amounts are treated as paid to acquire, produce, or improve tangible property. They replace controversial proposed regs that were issued on the same subject in 2006 and that IRS has now withdrawn. The new proposed regs would be effective for tax years beginning on or after the date that they are finalized.

This article, second in a series, explains how the proposed regs would prescribe new rules for when to deduct or capitalize costs related to the acquisition or production of real or personal property. For an article explaining how the proposed regs would define materials and supplies that are deductible under Code Sec. 162, and prescribe new rules for when the deduction for these items may be claimed, see the article in yesterday's Newsstand e-mail. A future article will explain how the proposed regs would differentiate between a repair and an improvement or betterment to property.

Overview. Under the new proposed regs, as a general rule all costs that facilitate the acquisition or production of real or personal property would have to be capitalized, with exceptions for employee compensation and overhead costs. Investigatory expenses related to the acquisition of realty would not have to capitalized unless the expenses are "inherently facilitative." A complex, but extremely liberal, de minimis rule would allow taxpayers to expense the acquisition of assets that otherwise would have to be capitalized, if the acquisition cost is expensed on the taxpayer's financial statement and there is no distortion of income. Taxpayers would have the option to capitalize expenses that otherwise would be currently deductible.

General rule for transaction costs. In general, costs would have to be capitalized if they are paid to facilitate the acquisition or production of real or personal property, namely they are paid in the process of investigating or otherwise pursuing the acquisition. A separate subset of 11 costs called "inherently facilitative" costs would be singled out for capitalization whether related to real or personal property, and whether or not the property is actually acquired or produced. These include the costs of shipping, moving or appraising property, application fees, sales and transfer taxes, finder's fees, and architectural, engineering, environmental or inspection services related to specific properties. (Prop Reg § 1.263(a)-2(d)(3))

Amounts paid for employee compensation or overhead would be treated as amounts that don't facilitate the acquisition of real or personal property (but under Code Sec. 263A would have to be capitalized to property produced by the taxpayer or acquired for resale). However, the taxpayer could elect to capitalize employee compensation or overhead expenses related to an acquisition. (Prop Reg § 1.263(a)-2(d)(3)(ii)(D))

Observation: In other words, unless Code Sec. 263A applies, amounts paid for employee compensation or overhead while acquiring or deciding to acquire real or personal property would be currently deductible (unless the taxpayer makes a capitalization election). This rule parallels the rule in Reg. § 1.263(a)-4(e)(4)(i) allowing such costs relating to the acquisition of intangible assets to be deducted currently.

Real estate investigatory expenses. Costs relating to activities performed in the process of determining whether to acquire real property and which real property to acquire generally would be deductible pre-decisional costs, unless they are "inherently facilitative" expenses (e.g., the cost of an engineering study or a broker's fee). For example, a retailer could deduct currently the cost of hiring a consulting firm to suggest which areas of a city it should expand into (these costs aren't on the "inherently facilitative" list), but it would have to capitalize the cost of paying an appraiser to determine the value of the properties that the consulting firm recommends (appraisal fees are on the "inherently facilitative" list). (Prop Reg § 1.263(a)-2(d)(3)(ii)(C))

Generous de minimis exception. Under a new de minimis exception, taxpayers would be able to currently deduct the cost (including facilitative costs) of acquiring or product a unit of property (see Part I in yesterday's Newsstand e-mail), if all of these conditions are met:

(1) The taxpayer has an applicable financial statement (AFS), such as one required to be filed with the Securities and Exchange Commission, or a certified audited financial statement accompanied by an independent CPA's report and used for credit or reporting purposes.

(2) The taxpayer has at the beginning of the tax year, written accounting procedures treating as an expense for non-tax purposes the amounts paid for property costing less than a certain dollar amount.

(3) The taxpayer treats the amounts paid during the taxable year as an expense on its applicable financial statement in accordance with its written accounting procedures.

(4) The total aggregate of amounts paid and not capitalized under the de minimis rules do not distort the taxpayer's income for the tax year. (Prop Reg § 1.263(a)-2(d)(4)(iii))

The de minimis rule wouldn't apply to amounts paid to improve property, acquire property for resale, or for land.
Under a safe harbor, an amount deducted currently under the AFS de minimis rule for the tax year would be treated as not distorting income if that amount, added to the amounts deducted in the tax year as materials and supplies for units of property costing $100 or less (see Part I in yesterday's Newsstand e-mail), is less than or equal to the lesser of:

(a) 0.1% of the taxpayer's gross receipts for the tax year, or
(b) 2% of the taxpayer's total depreciation and amortization for the tax year as determined in its AFS. (Prop Reg § 1.263(a)-2(d)(4)(iii))

Illustration: X buys 10 printers at $200 each for a total cost of $2,000. Each printer is a separate unit of property. X has an applicable financial statement and a written policy at the beginning of the tax year to expense amounts paid for property costing less than $500. X treats the amounts paid for the printers as an expense on its applicable financial statement. Assuming the total aggregate amounts not capitalized under the de minimis rule for the tax year do not distort the taxpayer's income, X would not be required to capitalize the amounts paid for the printers. (Prop Reg § 1.263(a)-2(d)(3)(iv), Ex. 1)

Property to which a taxpayer applies the de minimis rule would not be treated upon sale or disposition as a capital asset under Code Sec. 1221 or as property used in the trade or business under Code Sec. 1231, and such property would not be treated as a material or supply. The cost of property to which the de minimis rule applies wouldn't have to be capitalized under Code Sec. 263A, to a separate unit of property, but may have to be capitalized as a cost of other property if incurred by reason of the production of the other property. (Prop Reg § 1.263(a)-2(d)(4)(iv))

Election out of de minimis exception. A taxpayer would be allowed to elect out of the de minimis exception for any unit of property during the tax year to which the de minimis exception would otherwise apply. The election would be made by treating the amount paid as a capital expense in its timely filed original Federal income tax return (including extensions) for the tax year in which the amount is paid. (Prop Reg § 1.263(a)-2(d)(3)(v))

Observation: The proposed regs make it clear that a taxpayer would be able to "elect out" of just enough of its acquisition costs to fall within the "non-distortion" safe harbor.

Illustration: Y is a member of an affiliated group that files a consolidated return. In 2008, Y buys 300 computers at $400 each for a total cost of $120,000. Each computer is a unit of property. Y has a written policy at the beginning of the taxable year to expense amounts paid for property costing less than $500, and treats the amounts paid for the computers as an expense on its applicable financial statement. In addition, in 2008 Y buys 300 desk chairs for $50 each for a total cost of $15,000. Y intends to deduct the amounts paid for the desk chairs when used or consumed as non-incidental materials and supplies because they are units of property costing less than $100 (see Part I in yesterday's Newsstand e-mail). For its 2008 tax year, Y has gross receipts of $125 million and reports $7 million of depreciation and amortization on its AFS. Thus, in order to meet the de minimis rule safe harbor for 2008, the sum of the amounts not required to be capitalized under the de minimis rule for 2008 ($120,000) plus the amounts Y intends to deduct as materials and supplies for 2008 ($15,000), must be less than or equal to $125,000 (0.1% of Y's total gross receipts of $125 million, which is less than $140,000 (2% of Y's total deprecation and amortization of $7 million). Since $135,000 ($120,000 + $15,000) exceeds $125,000, Y wouldn't meet the de minimis rule safe harbor for its 2008 tax year. As a result, to apply the de minimis rule to the $120,000 paid to acquire the computers, it would have to otherwise establish that this amount does not distort its taxable income in 2008.

However, if Y makes an election to capitalize the $10,000 paid to acquire 25 of the 300 computers at $400 each, Y would not have to capitalize the $110,000 paid to acquire the remaining 275 computers because this amount, when added to the $15,000 that Y intends to deduct in 2008 as materials and supplies, would not exceed the de minimis rule safe harbor of $125,000 for 2008. (Prop Reg § 1.263(a)-2(d)(3)(iv), Exs. 2 and 3.)

New guidance for S corporations undergoing F reorganizations

Mike Habib, EA
myIRSTaxRelief.com

A new revenue ruling provides guidance for S corporations that undergo a type F reorganization where the operating S corporation becomes a qualified Subchapter S subsidiary (QSub) of a new holding corporation. It also explains which employer identification number (EIN) each entity is to use and provides guidance for corporations that have already engaged in such a transaction.

Background on F reorganizations. Code Sec. 368(a)(1)(F) provides that a reorganization includes a mere change in identity, form, or place of organization of one corporation, however effected. In the case of an F reorganization, the acquiring corporation is treated (for purposes of Code Sec. 381 ) just as the transferor corporation would have been treated if there had been no reorganization. (Reg. § 1.381(b)-1(a)(2)) Under Code Sec. 381, a corporation that acquires the assets of another corporation in certain tax-free reorganizations or liquidations also carries over numerous tax items of the transferor (predecessor) corporation.

Rev Rul 64-250, 1964-2 CB 333, provides that when an S corporation merges into a newly formed corporation in a transaction qualifying as an F reorganization and the newly formed surviving corporation also meets the requirements of an S corporation, the reorganization does not terminate the S election

Background on QSubs. An S corporation cannot have a corporate shareholder. (Code Sec. 1361(b)(1)(B), Reg. § 1.1361-1(f)) This rule ordinarily prevents a subsidiary from being an S corporation. However, an S corporation can have an S corporation subsidiary if it owns 100% of the subsidiary's stock, the sub is not an ineligible corporation, and the S corporation parent elects (on Form 8869) to treat the subsidiary as a QSub. (Code Sec. 1361(b)(3)(B), Reg. § 1.1361-2, Reg. § 1.1361-3) A QSub isn't treated as a separate corporation for federal tax purposes; rather, its assets, liabilities, and items of income, deduction, and credit are treated as those of the parent S corporation. (Code Sec. 1361(b)(3)(A), Reg. § 1.1361-4)

Background on EINs. Rev Rul 73-526, 1973-2 CB 404, concludes that the acquiring corporation in an F reorganization should use the EIN of the transferor corporation. However, since its publication, the Code was amended to create QSubs. Also, for tax years beginning after Dec. 31, 2004, Congress amended Code Sec. 1361(b)(3)(E) to provide that, except to the extent provided by IRS, QSubs are not disregarded for purposes of information returns and for certain other purposes as provided in regs. For example, Reg. § 1.1361-4(a)(7) provides that a QSub is treated as a separate corporation for purposes of employment tax and related reporting requirements (effective for wages paid on or after Jan. 1, 2009), and Reg. § 1.1361-4(a)(8) provides that a QSub is treated as a separate corporation for purposes of certain excise taxes (effective for liabilities imposed and actions first required or permitted in periods beginning on or after Jan. 1, 2008).

Issue addressed in two situations. Rev Rul 2008-18 looks at whether the S election terminates in either of the two transactions described in it and what the proper EINs are for the participating entities.

Transaction in situation 1. B, an individual, owns all of the stock in Y, an S corporation. Y's EIN is 22-2222222. In Year 1, B forms Newco and contributes all of the Y stock to Newco. Newco meets the requirements for qualification as an S corporation and timely elects to treat Y as a QSub, effective immediately following the transaction, which qualifies as an F reorganization. In Year 2, Newco sells a 1% interest in Y to D.

Result in situation 1. Consistent with Rev Rul 64-250, Y's original S election does not terminate but continues for Newco. Newco must obtain a new EIN. Y must retain its EIN (EIN 22-2222222) even though a QSub election is made for it and must use its original EIN any time the QSub is otherwise treated as a separate entity for federal tax purposes (including for employment and certain excise taxes) or if the QSub election terminates. In Year 2, when Newco sells a 1% interest of Y to D, Y's QSub election terminates under Code Sec. 1361(b)(3)(C). Y must use its original EIN of 22-2222222 following the termination of its QSub election.

Transaction in situation 2. C, an individual owns all of the stock of Z, an S corporation. Z's EIN is 33-3333333. In Year 1, Z forms Newco, which in turn forms Mergeco. Pursuant to a plan of reorganization, Mergeco merges with and into Z, with Z surviving and C receiving solely Newco stock in exchange for Z stock. Newco meets the requirements for qualification as an S corporation and timely elects to treat Z as a QSub, effective immediately following the transaction, which qualifies as an F reorganization.

Result in situation 2. Consistent with Rev Rul 64-250, Z's original S election does not terminate but continues for Newco. Newco must obtain a new EIN. Z must retain its EIN (EIN 33-3333333) even though a QSub election is made for Z and must use its original EIN any time the QSub is otherwise treated as a separate entity for federal tax purposes (including for employment and certain excise taxes) or if the QSub election terminates.

Effective date. Rev Rul 2008-18 applies to F reorganizations occurring on or after Jan. 1, 2009. For F reorganizations occurring on or after Mar. 7, 2008 and before Jan. 1, 2009, taxpayers may rely on Rev Rul 2008-18. IRS says it is aware that, prior to the effective date of Rev Rul 2008-18 , some S corporations have undergone F reorganizations in a manner similar to those described in Situations 1 and 2 above in which the acquiring corporation continued to use the transferor corporation's EIN in an effort to comply with Rev Rul 73-526. In those cases, IRS says the acquiring corporation should continue to follow Rev Rul 73-526 and use the transferor corporation's EIN, and furthermore, after the F reorganization, the transferor (QSub) should use the parent's EIN until such time the transferor (QSub) is otherwise treated as a separate corporation for federal tax purposes (including for employment and certain excise taxes) or until such time that the QSub terminates. At that time, the QSub must obtain a new EIN.

New proposed regs address complex issue--capitalization of tangible assets

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued new comprehensive proposed regs on when amounts are treated as paid to acquire, produce, or improve tangible property. They replace controversial proposed regs that were issued on the same subject in 2006 and that IRS has now withdrawn. The new proposed regs would be effective for tax years beginning on or after the date that they are finalized.

This article explains how the proposed regs would define materials and supplies that are deductible under Code Sec. 162, and prescribe new rules for when the deduction for these items may be claimed. Future articles will explain other key aspects of the new proposed regs, such as how to treat amounts paid to sell property, transaction costs related to acquisitions, and what constitutes a repair versus an improvement or betterment to property.

Background: Costs are currently deductible as a repair expense under Code Sec. 162 if they are incidental in nature, and neither materially add to the value of the property nor appreciably prolong its useful life. Costs also are currently deductible if they are for materials and supplies consumed during the year. Expenses must be capitalized under Code Sec. 263 if they are for permanent improvements or betterments that increase the value of the property, restore its value or use, substantially prolong its useful life, or adapt it to a new or different use.

Observation: Current regs don't clearly address the issue of whether expenses should be deducted currently (e.g., as repairs or as materials or supplies) or capitalized. As a result, the issue has been central in many court cases over the years, dealing with questions such as how to treat environmental remediation expenses, and how to treat rotable spare parts used in repairs. The proposed regs issued in 2006 were an ambitious attempt to rectify the lack of guidance but were roundly criticized by practitioners. In the new proposed regs, IRS takes another crack at this ambitious project.

Overview of proposed regs. The new proposed regs include many of the provisions contained in the 2006 proposed regs, but also provide many additional rules that were not included in the 2006 proposed regs. For example, the new proposed regs would define "materials and supplies" (including a special 12-month rule and a $100 de minimis rule), and include: a book conformity de minimis rule for acquisitions of units of property; a safe harbor for routine maintenance; and an optional simplified method for regulated taxpayers. The new proposed regs also would make significant changes to the rules relating to unit of property and restorations, and allow for industry-specific repair allowance methods in future published guidance.

Materials and supplies. Current Reg. § 1.162-3, only a few sentences long, generally provides that charges for materials and supplies are deductible as expenses only in the amount that are actually consumed and used in operation during the year. The cost of incidental materials and supplies purchased during the year is deductible if no record of their consumption is kept and no physical inventory of them is taken at the beginning and end of the year. However, this method may be used only if it clearly reflects income.

IRS decided to revise Reg. § 1.162-3 , to provide clear and consistent treatment for those items that traditionally have been considered to be materials and supplies and to provide distinct, but coordinated, treatment for those items that should governed by Code Sec. 263(a) .

Observation: The revised rules for materials and supplies are brand-new; the subject wasn't covered in the withdrawn 2006 proposed regs.

Timing of deduction for materials and supplies. The cost of buying or producing non-incidental materials and supplies would be deductible in the tax year in which the materials and supplies are used or consumed in the taxpayer's operations. By contrast, the cost of buying or producing incidental materials and supplies that are carried on hand and for which no record of consumption is kept or physical inventories at the beginning and end of the year are not taken, would be deductible in the tax year in which these amounts are paid, provided taxable income is clearly reflected. (Prop Reg § 1.162-3(a))

For purposes of the deduction timing rule, rotable spare parts and temporary spare parts would be treated as used or consumed in the tax year in which the taxpayer disposes of the parts. In general, rotable spare parts are parts for machinery or equipment that can be reserviced or repaired when they malfunction and can be used repeatedly. Temporary spare parts are parts used temporarily until they can be replaced with new or repaired parts (and then the temporary parts are set aside to be reused). (Prop Reg § 1.162-3(b))

IRS explains that the rotable and temporary spare parts rule prevents taxpayers from prematurely deducting the cost of a unit of property by systematically replacing components with rotable spare parts. It anticipates that taxpayers with rotable or temporary spare parts that are not discarded after their original use generally will prefer to capitalize their costs under a new election in the proposed regs (see below) and treat those parts as depreciable assets. (Preamble to Prop Reg 03/07/2008)

IRS cautions taxpayers to recognize that the used or consumed standard for non-incidental materials and supplies generally is met later than the placed in service standard used for depreciation purposes. Additionally, they are reminded that after a material or supply is used or consumed, capitalization of the material or supply cost to another property may be required. For example, the cost of materials and supplies used in the production of inventory or a self-constructed asset generally must be capitalized under Code Sec. 263A . Similarly, the cost of producing materials and supplies generally must be capitalized as part of the production costs of the materials and supplies. The new proposed regs aren't intended to change this treatment. (Preamble to Prop Reg 03/07/2008)

New definition. The term materials and supplies would be defined as tangible property used or consumed in the taxpayer's business operations and that meets any of the following tests:

(1) it is not a unit of property (see below) and is not acquired as part of a single unit of property; or
(2) it is a unit of property with an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer's operations; or

(3) it is a unit of property with an acquisition cost or production cost (as determined under Code Sec. 263A) of $100 or less; or

(4) it is identified in published IRS guidance as materials and supplies eligible for the rules in Reg. § 1.162-3. (Prop Reg § 1.162-3(d))

Under Prop Reg § 1.263(a)-3(d)(2), for property other than buildings, property used in plants such as manufacturing facilities, and network assets (e.g., railroads), all the components that are functionally interdependent (i.e., one component's placement in service by the taxpayer is dependent on the placement in service of another component by the taxpayer) comprise a single unit of property. However, one component or a group of them would have to be treated as a separate unit of property if (a) for book purposes the taxpayer uses an economic life different from that assigned to the unit of property of which the component is a part, or (b) for depreciation purposes the component is treated as being in a different MACRS class than the property of which it is a component, or written off using a different depreciation method than the property of which it is a component.

For example, a computer and printer are two different units of property. A truck trailer and its wheels generally would be treated as one unit of property, but if the taxpayer for book purposes uses a different economic useful life for the tires than for the trailer, the tires would have to be treated as separate units of property. (Prop Reg § 1.263(a)-3(d)(2)(iv), Exs. 7 & 8)

What is economic useful life? For purposes of applying the 12-month rule (see the second item in the list above), the new proposed regs generally would adopt the economic useful life definition in Reg. § 1.167(a)-1(b) and would provide that, the measurement period for economic useful life begins when the item is first used or consumed in the taxpayer's trade or business. The time prior to when an item is used or consumed would not be taken into consideration in determining the economic useful life of the asset, even though the item may have been placed in service (ready and available for its intended use) for depreciation purposes. (Prop Reg § 1.162-3(d)(2)(i))

However, a special rule applies to taxpayers with an applicable financial statement (AFS), such as one required to be filed with the Securities and Exchange Commission, or a certified audited financial statement accompanied by an independent CPA's report and used for credit or reporting purposes. Here, for purposes of the 12-month economic useful life test, the taxpayer must determine economic useful life in a way that's consistent with the economic useful life used for purposes of determining depreciation in the books and records supporting the AFS. An exception applies if a taxpayer does not assign a useful life to certain property in its AFS (e.g., the item is currently expensed in the taxpayer's AFS because it is considered de minimis). (Prop Reg § 1.162-3(d)(2)(ii))

Election to capitalize materials or supplies. Taxpayers would be given the option to elect to treat the cost of a material and supply as a capital expenditure. In general, the election would be made separately for each material and supply and would be revocable only with the IRS's consent. The election would be made by capitalizing the cost of the material and supply in the year the cost is incurred and beginning depreciation of the item in the year it is placed in service. (Prop Reg § 1.162-3(e))

Like-Kind Exchanges Under IRC Code Section 1031

Mike Habib, EA
myIRSTaxRelief.com

Whenever you sell a business or an investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.

The exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities and property that are not like-kind. If you receive cash, relief from debt, or property that is not like-kind, however, you may trigger some taxable gain in the year of the exchange. There can be both deferred and recognized gain in the same transaction when a taxpayer exchanges for like-kind property of lesser value.

This fact sheet, the 21st in the Tax Gap series, provides additional guidance to taxpayers regarding the rules and regulations governing deferred like-kind exchanges.

Who qualifies for the Section 1031 exchange?

Owners of investment and business property may qualify for a Section 1031 deferral. Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031.

What are the different structures of a Section 1031 Exchange?

To accomplish a Section 1031 exchange, there must be an exchange of properties. The simplest type of Section 1031 exchange is a simultaneous swap of one property for another.

Deferred exchanges are more complex but allow flexibility. They allow you to dispose of property and subsequently acquire one or more other like-kind replacement properties.

To qualify as a Section 1031 exchange, a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the Income Tax Regulations. .

A reverse exchange is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.

What property qualifies for a Like-Kind Exchange?

Both the relinquished property you sell and the replacement property you buy must meet certain requirements.

Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

Both properties must be similar enough to qualify as "like-kind." Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.

Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. As an example, cars are not like-kind to trucks.

Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:

* Inventory or stock in trade
* Stocks, bonds, or notes
* Other securities or debt
* Partnership interests
* Certificates of trust

What are the time limits to complete a Section 1031 Deferred Like-Kind Exchange?

While a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.

The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient.

Replacement properties must be clearly described in the written identification. In the case of real estate, this means a legal description, street address or distinguishable name. Follow the IRS guidelines for the maximum number and value of properties that can be identified.

The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

Are there restrictions for deferred and reverse exchanges?

It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable.

If cash or other proceeds that are not like-kind property are received at the conclusion of the exchange, the transaction will still qualify as a like-kind exchange. Gain may be taxable, but only to the extent of the proceeds that are not like-kind property.

One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.

You can not act as your own facilitator. In addition, your agent (including your real estate agent or broker, investment banker or broker, accountant, attorney, employee or anyone who has worked for you in those capacities within the previous two years) can not act as your facilitator.

Be careful in your selection of a qualified intermediary as there have been recent incidents of intermediaries declaring bankruptcy or otherwise being unable to meet their contractual obligations to the taxpayer. These situations have resulted in taxpayers not meeting the strict timelines set for a deferred or reverse exchange, thereby disqualifying the transaction from Section 1031 deferral of gain. The gain may be taxable in the current year while any losses the taxpayer suffered would be considered under separate code sections.

How do you compute the basis in the new property?

It is critical that you and your tax representative adjust and track basis correctly to comply with Section 1031 regulations.

Gain is deferred, but not forgiven, in a like-kind exchange. You must calculate and keep track of your basis in the new property you acquired in the exchange.

The basis of property acquired in a Section 1031 exchange is the basis of the property given up with some adjustments. This transfer of basis from the relinquished to the replacement property preserves the deferred gain for later recognition. A collateral affect is that the resulting depreciable basis is generally lower than what would otherwise be available if the replacement property were acquired in a taxable transaction.

When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

How do you report Section 1031 Like-Kind Exchanges to the IRS?

You must report an exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred.

Form 8824 asks for:

* Descriptions of the properties exchanged
* Dates that properties were identified and transferred
* Any relationship between the parties to the exchange
* Value of the like-kind and other property received
* Gain or loss on sale of other (non-like-kind) property given up
* Cash received or paid; liabilities relieved or assumed
* Adjusted basis of like-kind property given up; realized gain

If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.

Beware of schemes

Taxpayers should be wary of individuals promoting improper use of like-kind exchanges. Typically they are not tax professionals. Sales pitches may encourage taxpayers to exchange non-qualifying vacation or second homes. Many promoters of like-kind exchanges refer to them as "tax-free" exchanges not "tax-deferred" exchanges. Taxpayers may also be advised to claim an exchange despite the fact that they have taken possession of cash proceeds from the sale.

Consult a tax professional or refer to IRS publications for additional assistance with IRC Section 1031 Like-Kind Exchanges.

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

Starting March 2008, casinos and other sponsors of poker tournaments will be required to report most winnings to winners and the Internal Revenue Service, according to the IRS.

Mike Habib, EA
myIRSTaxRelief.com

The new requirement, which went into effect on March 4, 2008, was contained in guidance released Sept. 4 by the Treasury Department and the IRS. The guidance is designed to clear up confusion about the tax reporting rules that apply to poker tournaments. In recent years, some casinos and players have been confused over whether poker tournament sponsors who hold the money for participants in a poker tournament are required to report the winnings to the IRS and withhold tax on the winnings.

For tournaments completed during 2007 and before March 4, 2008, casinos and other sponsors of poker tournaments will not be required to report the winnings to the IRS or withhold tax on the winnings. But beginning March 4, 2008, the IRS will require all tournament sponsors to report tournament winnings of more than $5,000, usually on an IRS Form W-2G.

Tournament sponsors who comply with this reporting requirement will not need to withhold federal income tax at the end of a tournament. If any tournament sponsor does not report the tournament winnings, the IRS will enforce the reporting requirement and also require the sponsor to pay any tax that should have been withheld from the winner if the withholding requirement had been asserted. The withholding amount is normally 25 percent of any amounts that should have been reported.

So that tournament sponsors can comply with this requirement, tournament winners must provide their taxpayer identification number, usually a social security number, to the tournament sponsor. If a winner fails to provide this identification number, the tournament sponsor must withhold federal income tax at the rate of 28 percent.

The IRS reminds tournament winners that, by law, they must report all their winnings on their federal income tax returns. This rule applies regardless of the amount and regardless of whether the winner receives a Form W-2G or any other reporting form. This is true for 2007 and earlier years, and will continue to be the case after the new reporting requirement goes into effect.

Don't compromise on your representation, we're licensed to represent taxpayers in all 50 states.

Examination and Compliance Check Processes For Exempt Organizations

Mike Habib, EA
myIRSTaxRelief.com

The Internal Revenue Service has a variety of tools at its disposal to make certain that tax-exempt organizations comply with federal law designed to ensure they are entitled to any tax exemption they may claim.

The responsibility for administering these procedures belongs to the Exempt Organizations (EO) function, which is part of the IRS's Tax Exempt and Government Entities (TE/GE) Operating Division.

Examinations vs. Compliance Checks

A review of a tax exempt organization falls into two broad categories: compliance checks and examinations.

The IRS conducts examinations, also known as audits, which are authorized under Section 7602 of the Internal Revenue Code. An examination is a review of a taxpayer's books and records to determine tax liability, and may involve the questioning of third parties. For exempt organizations, an examination also determines an organization's qualification for tax-exempt status.

EO conducts two different types of examinations: correspondence and field examinations.

A compliance check is a review to determine whether an organization is adhering to recordkeeping and information reporting requirements and is not an examination since it does not directly relate to determining a tax liability for any particular period.

Correspondence Examinations

Correspondence examinations are limited in scope and focus on only one or two items on a return. An EO specialist typically conducts the examination through letters and phone calls with the organization's officers or representatives.

If the issues become complex, or if the organization does not respond to a letter or call, EO may require the officers or representatives to bring records to an IRS office. EO may also convert a correspondence examination into a field examination.

Field Examinations

A field examination is one conducted by a revenue agent at the organization's place of business. Generally, these audits are the most comprehensive. There are two distinct types of EO field examinations - EO Team Examination Program (TEP) and EO General Program.

* EO TEP examinations are field examinations of large, complex organizations that may require a team of specialized revenue agents, as well as coordination between IRS functions and other governmental agencies. They are often conducted using coordinated team examination approaches and procedures.
* EO General Program examinations are typically performed by individual revenue agents. They usually do not require a team of specialists.

A field examination usually begins when the revenue agent notifies the organization that its return has been selected for examination. This initial contact is by telephone or by letter to schedule an initial appointment. The organization receives Publication 1, Your Rights as a Taxpayer, with the appointment letter.

In the appointment contact, the revenue agent will typically request the following documents to begin the audit:

1. Governing instruments (articles of incorporation, charter or constitution, including all amendments; and bylaws, including all amendments),
2. Pamphlets, brochures, and other printed literature describing the organization's activities,
3. Copies of the organization's Forms 990 for the years before and after the year under examination,
4. For the year under examination (at a minimum):
5. Minutes of meetings of the board of directors and standing committees or councils,
6. All books and records of assets, liabilities, receipts and disbursements,
* Auditor's report, if any,
* Copies of other federal tax returns filed and any related workpapers (Form 990-T for taxable income, Form 1120-POL for political activity, etc.),
* Copies of employment tax returns and any related workpapers (Forms W-2, W-3, 941, 1096, 1099).

(Note: Many of these records may also be required for a correspondence examination.)

During an opening conference with the organization's officers or representatives, the revenue agent explains the audit plan and the reason the organization has been selected for examination. The revenue agent usually conducts a comprehensive interview and tours the organization's facilities to gain a basic understanding of the organization's purposes and activities.

The examination of a tax-exempt organization is multifaceted and includes a review of its operation and activities to verify the existence of an exempt purpose, as well as a review of financial records. The length of the examination will depend upon a variety of factors, such as the size of the organization, the complexity of its activities and the issues that may arise during the examination. Some audits can be completed in just a few days; others can last for a year or more.

A field examination typically concludes with a closing conference. The revenue agent will discuss the audit with the organization's representatives, and if necessary, furnish a report explaining proposed adjustments to the organization's returns or exempt status. If the revenue agent and the organization's representatives disagree on the findings, the organization may request a meeting with the revenue agent's manager to discuss the disagreement. If the manager cannot resolve the differences, the organization may pursue its case through the IRS appeals process. For additional information on the appeals process, see Publication 892, EO Appeal Procedures for Unagreed Issues.

Compliance Checks

Exempt Organizations also maintains an active compliance check program. EO specialists conduct the checks by corresponding with or telephoning exempt organization representatives. A specialist may inquire about an item on a return, determine if specific reporting requirements have been met or whether an organization's activities are consistent with its stated tax-exempt purpose.

An officer or representative of an exempt organization may refuse to participate in a compliance check without penalty. However, EO has the option of opening a formal examination, whether or not the organization agrees to participate in a compliance check.

At the beginning of a compliance check, the specialist will inform the officer or director that the review is a compliance check and not an examination. The specialist will not ask to examine any books or records or ask questions regarding tax liabilities. The specialist may ask whether the organization understands or has questions about filing obligations for required forms. The specialist may also ask questions about the organization's activities. If, during a compliance check, the specialist decides an examination is appropriate, he or she will notify the organization that EO is commencing an examination before asking questions related to tax liability.

Because a compliance check only reviews whether an organization is adhering to record keeping and information reporting requirements or whether an organization's activities are consistent with its stated tax-exempt purpose and is not an examination, it is possible to have more than one compliance check for a tax year if facts and circumstances warrant. For more information, see Publication 4386, Compliance Checks.

Selecting Organizations for Examination or Compliance Checks

EO strives to ensure consistency and fairness in its examination and compliance check processes. In its annual Implementing Guidelines, which are available on the IRS website at www.irs.gov/eo, EO describes its proposed examination and compliance check activities for the year.

EO designs and implements comprehensive projects to address issues that carry the most non-compliance risk. To determine which organizations should be targeted, experienced specialists analyze information from Forms 990 and other sources. This analysis will usually result in the selection of a group of returns for examination or compliance check.

EO also reviews media reports and receives complaints from the general public and Congress about potential non-compliance by exempt organizations. After confirming the information, and when appropriate, these organizations may be selected for examination or to receive a compliance check. For details on how EO handles complaints about exempt organizations, see Fact Sheet 2008-13.

Regardless of the process used to select returns, EO does not presume that an organization is violating the tax laws before it begins the examination or sends a compliance check letter.

Help Yourself by Filing Past-Due Tax Returns

Mike Habib, EA
myIRSTaxRelief.com

Most citizens voluntarily file their tax returns and pay their taxes. Most people explain it by saying they want to pay their fair share. Others file to get a refund, claim a credit or avoid breaking the law.

There are times when normally law-abiding citizens fail to file. Why? IRS research shows that sometimes people don't file in years their filing status changes, such as due to the death of a spouse or divorce. Emotional or financial reasons may cause a person to not file. Or it could simply be due to procrastination.

Unfortunately, failing to file a return creates additional problems. This is the 20th fact sheet in the Tax Gap series and will help taxpayers better understand the importance of filing past-due returns.

Your need to file is largely determined by your age, filing status and gross income. You can determine whether you needed to file in a prior year by checking the "Do You Have to File" section in the instructions of the Form 1040 for the year in question.
Why file a tax return?

Taxpayers are required by law to file an income tax return for any year in which a filing requirement exists.

There are numerous practical reasons to file tax returns. Important programs like federal aid to higher education require applicants to submit copies of tax returns to qualify for loans. Lending institutions also may require copies of filed returns for buying a home or financing a business.

And the filing of tax returns can have a tremendous impact on your future. A person's lifetime earnings as reported to the IRS and the Social Security Administration are the basis for Social Security retirement and disability benefits as well as Medicare. Reported income is also the source for state benefits such as unemployment compensation and industrial insurance.
What happens if you do not file?

Not filing a federal tax return can be costly -- whether you end up owing more or missing out on a refund. The IRS may also impose a wide range of civil and criminal sanctions on persons who fail to file returns.

If you owe tax and your return was not filed by the due date, including extensions, you may be subject to the failure to file penalty, unless you have reasonable cause for not filing. If you did not pay your tax in full by the due date for the return, not including extensions of time to file, you also may be subject to the failure to pay penalty, unless you have reasonable cause for your failure to pay. Additionally, interest is charged on taxes not paid by the due date; even if you have an extension of time to file. Interest is also charged on penalties.

The IRS continues to identify people who have a filing requirement but have failed to file a return.

By law the IRS may file a substitute return for you if you do not voluntarily file. A series of letters is first sent explaining the possible action IRS may take as part of the Substitute for Return Program.

If you do not file a return or otherwise indicate disagreement such as by requesting to exercise your appeal rights, the IRS will file a basic return for you. An IRS-prepared return will not include any of your additional exemptions or expenses. The IRS will compute the tax liability and send you a bill for the tax that will also include interest and penalties.

If a substitute return has already been filed for you by the IRS, you should still file your own return to claim any additional items. The IRS will generally adjust your account to reflect the corrected figures.

What are the consequences of not filing a tax return?

Here are some things to consider:

* Failure to file penalty. If you owe taxes, a delay in filing may result in a "failure to file" penalty, also known as the "late filing" penalty, and interest charges. The longer you delay, the larger these charges grow. It may result in penalty and interest charges that could increase your tax bill by 25 percent or more.

* Losing your refund. There is no penalty for failure to file if you are due a refund. However, you cannot obtain a refund without filing a tax return. If you wait too long to file, you may risk losing the refund altogether. In cases where a return is not filed, the law provides most taxpayers with a three-year window of opportunity for claiming a refund.

* EITC. Individuals who are entitled to the Earned Income Tax Credit must file their return to claim the credit even if they are not otherwise required to file. The return must be filed within three years of the due date in order to receive the credit.

* Statute of limitation. After the expiration of the refund statute, not only does the law prevent the issuance of a refund check, it also prevents the application of any credits, including overpayments of estimated or withholding taxes, to other tax years that are underpaid.On the other hand, the statute of limitations for IRS to assess and collect any outstanding balances does not start until a return has been filed.In other words, there is no statute of limitations for assessing and collecting the tax if no return has been filed.

What should you do?

Regardless of your reason for not filing, file your tax return as soon as possible. You can contact a tax professional or the IRS for help with filing delinquent returns.

If you are unable to fully pay any tax due on the late returns, do not let this prevent you from filing as payment options may be available. For more details, ask your tax professional or an IRS representative.

Filing tax returns and paying the correct amount of tax is good citizenship. Conscientiously discharging this duty contributes to our nation's well being and provides peace of mind. And failing to file returns can jeopardize a family's financial security and future.

For more information on how to file a tax return for a prior year, visit our website at http://www.myirstaxrelief.com/irs-tax-help-services.html

Guidance on timing of PPA-related amendments for calculating plan cash-outs starting in 2008

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued guidance, in question and answer format, that addresses the timing of plan amendments made to comply with Sec. 302 of the Pension Protection Act of 2006 (PPA 2006, P.L. 109-280, Sec. 302), which changed the statutory assumptions that must be used beginning in 2008 for calculating the present value of plan cash-outs.

Background. For purposes of the Code Sec. 417(e)(3) cash-out requirements under the minimum survivor annuity rules, the present value of plan benefits cannot be less than the present value calculated by using the "applicable mortality table" and the "applicable interest rate" (collectively, the "statutory assumptions"). PPA Sec. 302 changed the definitions of those statutory assumptions, effective for plan years beginning on or after Jan. 1, 2008.

For plan years beginning before Jan. 1, 2008:

o the "applicable interest rate" was, generally, the annual rate of interest on 30-year Treasury securities (the "pre-PPA '06 applicable interest rate"); and
o the "applicable mortality table" was the mortality table prescribed by IRS, based on the prevailing commissioners' standard table used to determine group reserves for group annuity contracts issued on the date as of which the present value was determined (the "pre-PPA '06 applicable mortality table").

For plan years beginning on or after Jan. 1, 2008:

o the "applicable interest rate" is the adjusted first, second, and third segment rates applied under rules similar to the rules under Code Sec. 430(h)(2)(C) for the month before the date of the distribution, or such other time as IRS regs prescribe, determined without regard to the Code Sec. 430(h)(2)(D)(i) 24-month averaging, with a transition rule that phases in the use of the segment rates over five years (the "post-PPA '06 applicable interest rate"); and
o the "applicable mortality table" is a mortality table, modified as appropriate by IRS, based on the mortality table specified for the plan year under Code Sec. 430(h)(3)(A) (without regard to subparagraph (C) or (D)), the "post-PPA '06 applicable mortality table." There is no transition rule for the applicable mortality table.

Although PPA Sec. 302 is effective for plan years beginning on or after Jan. 1, 2008 (the "PPA Sec. 302 effective date"), PPA Sec. 1107 permits a plan sponsor to delay adopting plan amendments under statutory provisions of the PPA (or under any regulation issued under the PPA) until the last day of the first plan year beginning on or after Jan. 1, 2009 (Jan. 1, 2011, for governmental plans). IRS has now issued guidance that addresses specific questions related to the timing of plan amendments made to comply with the requirements of PPA Sec. 302, while taking into account the delayed amendment period provided under PPA Sec. 1107.

Guidance on timing of plan amendments. If, after the PPA Sec. 302 effective date, a plan is amended during the period provided in PPA Sec. 1107, to provide that the amount payable under an optional form of benefit is calculated as the more favorable to participants of the amount calculated by using either (1) the pre-PPA '06 statutory assumptions, or (2) the post-PPA '06 statutory assumptions, the plan won't fail to satisfy the requirement that a qualified joint and survivor annuity (QJSA) for a married participant be at least as valuable as any other form of benefit payable under the plan at the same time. IRS cautioned, however, that this special treatment permitting use of the pre-PPA '06 statutory assumptions applies only through the end of the period described in PPA Sec. 1107. (Notice 2008-30, Q&A-16)

If a plan is amended as described in Q&A-16 (above), but provides that benefits cease to be calculated by using the pre-PPA '06 statutory assumptions after a specified period, relief under PPA Sec. 1107, as described in Rev Rul 2007-67, 2007-48 IRB (see Federal Taxes Weekly Alert 11/08/2007), generally applies to the amendment.

In general, relief under PPA Sec. 1107 applies to an amendment that provides the more favorable to participants of an amount calculated by using either (1) the pre-PPA '06 statutory assumptions, or (2) the post-PPA '06 statutory assumptions, even if the pre-PPA '06 statutory assumptions apply only for a specified period of time (as long as the amendment is adopted during the period provided in PPA Sec. 1107). However, for a particular plan provision, relief under PPA Sec. 1107 applies only to the first plan amendment that implements the post-PPA '06 statutory assumptions for the provision, and any later amendment for the provision will not be treated as adopted "pursuant to" statutory provisions under PPA '06, as required for relief under PPA Sec. 1107.

For purposes of determining whether an amendment that implements the post-PPA '06 statutory assumptions for a particular plan provision is the first such amendment, amendments adopted on or before June 30, 2008, are disregarded. Thus, if a plan amendment is adopted that provides that the amount payable under an optional form of benefit is calculated in the manner described in Q&A-16, and the plan is later amended (during the period provided in PPA Sec. 1107) so that the amount payable is calculated without reference to the pre-PPA '06 statutory assumptions, then the relief under PPA Sec. 1107 will apply to the later amendment only if the initial amendment was adopted on or before June 30, 2008. (Notice 2008-30, Q&A-17)

The relief under PPA Sec. 1107, as described in Rev Rul 2007-67 and Notice 2008-30, applies to a plan amendment that replaces a plan reference to the pre-PPA '06 statutory assumptions with a reference to the post-PPA '06 statutory assumptions, without regard to whether PPA Sec. 302 requires that amendment.

IRS provided the following example to illustrate how this rule applies to a plan that is subject to the Code Sec. 401(a)(11) qualified survivor annuity rules. If a plan calculates the amount of an optional form of benefit that is not subject to the Code Sec. 417(e)(3) minimum present value requirements by reference to the pre-PPA '06 statutory assumptions, and the plan is amended pursuant to an amendment adopted during the period established in PPA Sec. 1107 so that the plan calculates the amount of the optional form of benefit by reference to the post-PPA '06 statutory assumptions, then the plan will not fail to satisfy the Code Sec. 411(d)(6) anti-cutback rules by reason of the amendment. (Notice 2008-30, Q&A-18)

IRS explains how to correct a failure to follow retirement plan terms
Retirement News for Employers

Mike Habib, EA

In its Retirement News for Employers, IRS has explained how to correct the common retirement plan mistake of failing to follow the plan terms in its operation. IRS clarified when a plan amendment can be used to correct this mistake via the Employee Plans Compliance Resolution System's (EPCRS) Self-Correction Program (SCP).

In general, the failure to follow the plan's terms may be corrected by:

(1) the plan fixing what was done in the plan's operation by correcting the mistake to match the plan's terms; or
(2) the employer retroactively amending the plan so that the plan's provisions match the way the plan was operated.

Generally, SCP is only available if correction is made using the first approach, said IRS. However, SCP may be used to correct an operational failure by amending the plan to match the terms of the plan to the plan's prior operations for only the three operational failures listed in Rev Proc 2006-27, 2006-22 IRB 945, Appendix B, Sec 2.07 (see RIA Pension and Benefits Week Newsletter 5/15/2006). According to IRS, those three operational failures are:

o Maximum compensation ( Code Sec. 401(a)(17) ) failures. A defined contribution plan that allocates contributions or forfeitures based on a participant's compensation that exceeds the Code Sec. 401(a)(17) limit may be corrected by amending the plan. The affected participant's allocation rate, after taking into account only compensation up to the Code Sec. 401(a)(17) limit, must be recalculated, and extra amounts must also be contributed to the other employees.
o Hardship distribution and plan loan failures. The operational failure of making hardship distributions or plan loans to employees under a plan that does not allow them may be corrected by retroactively amending the plan to provide for the hardship distributions or plan loans that were already given. The retroactive plan amendment is permissible provided that: the plan loans or hardship distributions were mostly made to individuals who were not highly compensated employees; loans were made according to the limits in Code Sec. 72(p); and for a 401(k) plan, hardship distributions complied with the Code Sec. 401(k) rules relating to hardship distributions.
o Early inclusion of otherwise eligible employee failures. The operational failure of including an otherwise eligible employee in the plan too early may be corrected by retroactively amending the plan. This would apply to an employee who either (i) has not completed the plan's minimum age or service requirements, or (ii) has completed the plan's minimum age or service requirements, but became a participant in the plan earlier than the plan entry date. The amendment, permitting the ineligible employee's inclusion, serves to reflect the plan's actual operations. To be entitled to make this retroactive amendment, employees affected by the amendment should be mainly nonhighly compensated employees.

A plan that corrects a failure using SCP must submit, within the plan's remedial amendment period described in Rev Proc 2007-44, a determination letter application on the corrective amendments, identifying the amendments separately in the application.

The failure to operate the plan in accordance with its terms can be prevented by ensuring that all of the parties involved with plan administration are familiar with the plan's terms, said IRS. Also, periodic plan reviews should be performed.

Mike Habib, EA
myIRSTaxRelief.com