Tax Relief Blog

TIGTA study finds modest audit rate increase for C corps but marked increase for passthroughs ( S Corps)

Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008095

A recently released TIGTA (Treasury Inspector General for Tax Administration) report reveals that despite a slight uptick in FY 2007, IRS audits of corporations have declined dramatically over the last ten years. However, audits of S corporation and partnership returns increased substantially over the same period.

TIGTA's findings for business entities. The new TIGTA report examined IRS statistical data and found the following audit trends for business:

• The number of corporate income tax returns examined (excluding returns for foreign corporations and S corporations) increased by just over 4% in FY 2007, after dropping by 1% in FY 2006. However, the number of examinations dropped by almost 45% since FY 1998, from 53,648 (1 of every 48 returns filed) to 29,664 (1 of every 75 returns filed). TIGTA notes that the 13% drop in the number of corporate income tax returns filed during the same 10-year period may have impacted the exam coverage rate. For FY 2007, the number of corporate tax returns examined with assets of less than $10 million grew by slightly over 12%, the number of corporate tax returns examined with assets of $10 million and greater decreased by almost 9%, and exams of those with assets of $250 million and greater decreased by almost 20%. Overall, however, the exam rate is much higher for large corporations than for those with assets of less than $10 million.
• The number of S corporation exams declined by 75% from FYs 1998 to 2004, but increased by almost 176% from FYs 2004 to 2007; the increase in FY 2007 alone was slightly over 26%. Since FY 2004, however, the number of S corporation returns filed has increased by 16%. TIGTA notes that the increase in exam coverage can be partly attributed to an IRS research project studying the compliance of S corporations.
• The number of partnership returns examined increased by 25% in FY 2007 and has increased by almost 141% since the 10-year low experienced in FY 2001. The number of returns filed increased by about 42% between FYs 2001 and 2007. About 1 of every 408 returns filed was examined in FY 2001. This increased to 1 of every 241 for FY 2008.

For more details on TIGTA's Report on audit rates and related IRS activities, click on this link: Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008095.

For S Corp and C Corp audit representation CLICK HERE

TIGTA issues statutory review of IRS compliance with legal guidelines when issuing levies [ Audit Report No. 2008-30-097 ]:

During the process of issuing levies, IRS has been complying with legal guidelines regarding proper notification and the protection of taxpayer rights, the Treasury Inspector General for Tax Administration (TIGTA) reported in a recent audit.

The agency is required to notify taxpayers a minimum of 30 calendar days before initiating any levy action to give taxpayers the chance to appeal the proposed levy. Since prior audits found that IRS had implemented tighter controls related to systemically generated levies, the latest annual audit on the subject focused on the issuance of manual levies.

Auditors looked at 30 Integrated Collection System and 30 Automated Collection System manual levies issued between July 1, 2006, and June 30, 2007. Analysis of these levies "showed revenue officers and customer service representatives continued to properly inform taxpayers of their rights at least 30 calendar days prior to issuing the levies," TIGTA said.

The audit can be found at

http://treas.gov/tigta/auditreports/2008reports/200830097fr.pdf

Houses passes legislation that would make sure certain government contractors pay employment taxes - Foreign shell companies payroll tax problems

Mike Habib, EA
myIRSTaxRelief.com

The House of Representatives has passed legislation [H.R. 5719, Sec. 18, 4/15/08] proposed by Representatives Brad Ellsworth (D-Ind.) and Rahm Emanuel (D-Ill.) that seeks to end the practice of U.S. government contractors setting up shell companies in foreign jurisdictions to avoid paying payroll taxes. Under current law, US companies are required to pay Social Security and Medicare taxes for their American workers overseas. But some firms have been able to get around that requirement by hiring workers through offshore shell companies or foreign subsidiaries.

The legislation would amend the Internal Revenue Code and the Social Security Act to treat foreign subsidiaries of U.S. companies performing services under contract with the U.S. government as American employers for Social Security and Medicare tax purposes. The legislation would require any foreign company that is at least 50% owned by a U.S. federal contractor to pay payroll taxes for its American employees.

The bill was inspired by recent news that defense contractor KBR Inc. had avoided paying Social Security and Medicare taxes by creating shell companies in the Cayman Islands. A similar provision is being sponsored in the Senate by Senators John Kerry (D-Mass.) and Barack Obama (D-Ill.).

District court allows $60 million of income to be offset by Son-of-Boss shelter

Sala v. U.S. (DC Co 4/22/08) 101 AFTR 2d ¶ 2008720

Mike Habib, EA
myIRSTaxRelief.com A district court has allowed an individual to offset $60 million of compensation income with losses from a Son-of-Boss transaction.

Facts. Carlos E. Sala had income in 2000 of more than $60 million. However, he claimed a tax loss that essentially nullified his tax burden. Sala achieved the loss through his involvement in a foreign currency options investment transaction known as Deerhurst. He claimed that the $60 million loss resulted from a series of steps that made use of an S corporation (Solid Currencies, Inc.) and an investment in a partnership (Deerhurst Investors, GP). These steps were orchestrated under a then-existing tax rule that disregarded short options as liabilities for purposes of establishing partnership basis. Under this rule, liabilities created by short options were considered too contingent to affect a partner's basis in the partnership.

IRS challenged this transaction, which is commonly known as a Son-of-Boss shelter, on various grounds. The district court faced these key issues:

(1) whether the transactions creating Sala's 2000 tax loss were sham transactions;
(2) whether Sala had a profit motive for entering into the transactions creating his 2000 tax loss;
(3) whether the transactions creating Sala's 2000 tax loss, as executed, allowed the tax loss; and
(4) whether any allowable tax loss was rendered retroactively disallowed by Reg. § 1.752-6.

Background. On June 24, 2003, IRS issued temporary and proposed regs which expanded the definition of liability under Code Sec. 752 to include "any fixed or contingent obligation to make payment without regard to whether the obligation is otherwise taken into account for purposes of the Internal Revenue Code." This particular change, which was a part of broader regulatory changes in this area, was adopted as final Reg. § 1.752-1(a)(4)(ii) in May 2005. However, IRS made the reg retroactively effective for all assumptions of "liabilities" (as newly defined) by partnerships occurring after Oct. 18, '99, and before June 24, 2003. It did so through Reg. § 1.752-6 (also issued as a temporary reg), which requires a partner to reduce his basis in his partnership interest by the amount of any contingent obligation, assumed by the partnership between Oct. 18, '99, and June 24, 2003.

When it issued the temporary reg on June 24, 2003, IRS noted in an accompanying Treasury release that it had previously said in Notice 2000-44, 2000-2 CB 255, that Son of Boss transactions don't work.

District court sustains the shelter. The district court reached these pro-taxpayer conclusions:

(1) Sala's participation in the Deerhurst Program possessed a reasonable possibility of profits beyond the tax benefits, was entered into for a business purpose other than tax avoidance, and was motivated by a desire for profits above and beyond the tax benefits sought.

(2) Sala's basis in Solid Currencies was approximately $69 millionand Solid Currencies' basis in Deerhurst GP was an identical amount;

Observation: Sala transferred 24 foreign currency options to Solid Currencies and then to Deerhurst GP. The court said Solid Currencies' basis in Deerhurst GP was increased by the value of the long options, $60,987,867, but was not offset by the $60,259,569 cost of the short options. Accordingly, Solid Currencies' claimed basis in Deerhurst GP was approximately $69 millionthe value of the cash plus the long options.

(3) the 24 options contracts contributed by Sala to Solid Currencies and by Solid Currencies to Deerhurst GP were separate financial instruments.

(4) Solid Currencies received property upon the liquidation of Deerhurst GP.

Observation: Upon liquidation of Deerhurst GP, Solid Currencies received a portion of Deerhurst GP's liquidated assets equal to the proportionate size of Solid Currencies' basis. Solid Currencies received approximately $8 million in cash and two foreign currency contracts. The foreign currency contracts were considered to be "property." The value of the foreign exchange contracts distributed to Solid Currencies, therefore, was approximately $61 million$69 million (Solid Currencies' original basis in Deerhurst GP) less the $8 million in cash. When Solid Currencies sold the foreign currency contracts, its loss was equal to the $61 million dollar value of the contracts, offset by any profit received from their sale.

(5) IRS exceeded its authority when issuing Reg. § 1.752-6(b)(2); and
(6) IRS exceeded its authority when making that reg retroactive.

Accordingly, Sala prevailed in using the Son-of-Boss transaction to offset about $60 million of income.

Observation: It remains to be seen whether IRS will appeal this case. But it has previously won a number of Son-of-Boss cases. In one winning case for IRS, the Seventh Circuit upheld the retroactive reg (see Cemco Investors, LLC v. U.S., CA 7, 101 AFTR 2d ¶2008-452).

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Payments made by retailer in connection with sales promotion weren't taxable - PLR 200816027

Mike Habib, EA

myIRSTaxRelief.com

The IRS has privately ruled that payments made by a retailer in connection with a sales promotion were nontaxable purchase price adjustments and they weren't subject to reporting or withholding.

Facts. Taxpayer, which owns retail stores, advertised Promotion on Date 1. Under its terms and conditions, customers would be entitled to a payment of Amount if:

• they purchased qualifying merchandise from Taxpayer during the period beginning Date 1 and ending Date 2,
• they took delivery of the merchandise on or before Date 3,
• Event occurred, and
• they submitted claims for the payment on or before Date 4.

Amount could not be greater than the price that the customers paid to purchase the qualifying merchandise.
There was no fee to participate in Promotion. The prices charged by Taxpayer for all items of qualifying merchandise sold during the promotional period were Taxpayer's customary retail prices, which were subject to any generally applicable coupons, discounts, or special pricing arrangements. Taxpayer did not specially increase or decrease the prices of any items of qualifying merchandise for the promotional period.

On Date 5, Event occurred, and customers who satisfied Promotion's terms and conditions became entitled to a payment of Amount.

Payments are nontaxable. Subject to exceptions, gross income includes all income from whatever source derived. (Code Sec. 61) The concept of gross income encompasses accessions to wealth, clearly realized, over which taxpayers have complete dominion.

Purchase price adjustments are one exception to the broad definition of gross income. Generally, when a payment is made by a seller to a customer as an inducement to purchase property, the payment does not constitute income but instead is an adjustment to the cost or purchase price of acquiring the property. (Rev Rul 76-96, 1976-1 CB 23) The payment is, in effect, a means by which the buyer and seller reach an agreed upon price.

The IRS noted that Promotion was intended to induce customers to purchase qualifying merchandise during the period beginning Date 1 and ending Date 2. Taxpayer allowed only the customers who purchased qualifying merchandise and satisfied Promotion's terms and conditions to receive a payment of the Amount. The Amount could not be greater than the price that the customers paid to purchase the qualifying merchandise. Accordingly, IRS concluded that each payment represented a reduction in the purchase price that the customer paid for the qualifying merchandise with respect to which the payment was made, and was not includible in the recipient's gross income.

No reporting or withholding. Code Sec. 6041(a) provides generally that all persons engaged in a trade or business that pay another person $600 or more in any tax year of fixed or determinable income in the course of that trade or business must file an information return setting forth the amount of the payment and the recipient of the payment.

A payor is generally not required to make a return under Code Sec. 6041 for payments that are not includible in the recipient's income, and a payor is not required to make a return if the payor does not have a basis to determine the amount of a payment that is required to be included in the recipient's gross income.

Thus, IRS concluded that Taxpayer didn't have a reporting requirement under Code Sec. 6041 as to the recipients for the Promotion payments made by it.

For like reasons, IRS also concluded that Taxpayer did not have any withholding obligation under Code Sec. 1441(a), Code Sec. 1442(a) or Code Sec. 3406(a) with respect to the payments made in connection with Promotion.

Enhanced tax breaks make it an especially good time to buy business autos

Mike Habib, EA
myIRSTaxRelief.com Thanks to economic woes in general and financial trouble for auto manufacturers in particular, it's a good time to shop for a new vehicle, if you can afford to do so. Thanks to bonus first year depreciation deductions under the Economic Stimulus Act of 2008, it's an even better time to buy if the vehicle is going to be used for business. This Practice Alert takes a close look at the enhanced first year write-offs that are available to new business autos, light trucks or vans that are placed in service this year.

Bonus depreciation basics. In general, for property placed in service after Dec. 31, 2007, in tax years ending after that date, taxpayers get an additional depreciation deduction in the placed-in-service year equal to 50% of the adjusted basis of "qualified property." (Code Sec. 168(k)(1)) This is property that meets all of these conditions:

• It is property falling within one of four statutory categories, the most important of which is property to which MACRS applies with a recovery period of 20 years or less. (Code Sec. 168(k)(2)(A))
• The original use of the property commences with the taxpayer after Dec. 31, 2007. Original use is the first use to which the property is put, whether or not that use corresponds to the taxpayer's use of the property. (Code Sec. 168(k)(2)(A))
• The property is acquired by the taxpayer (a) after Dec. 31, 2007, and before Jan. 1, 2009, but only if no binding written contract for the acquisition is in effect before Jan. 1, 2008, or (b) pursuant to a binding written contract which was entered into after Dec. 31, 2007, and before Jan. 1, 2009. (Code Sec. 168(k)(2)(A)(iii))
• The property is placed in service after Dec. 31, 2007, and before Jan. 1, 2009 (the placed-in-service date is extended for one year for certain property with a recovery period of ten years or longer and certain transportation property). (Code Sec. 168(k)(2)(B), Code Sec. 168(k)(2)(C))

If all of the Code Sec. 168(k) requirements are met, bonus first-year depreciation automatically applies to qualified property, unless the taxpayer "elects out" under Code Sec. 168(k)(2)(C)(iii).

Under pre-Stimulus Act regs that taxpayers may rely on pending further guidance, the bonus depreciation allowance is found by multiplying the qualifying property's unadjusted depreciable basis by 50%. (Reg. § 1.168(k)-1(d)(1)(A)) The unadjusted depreciable basis is basis for gain or loss purposes, before depreciation, amortization, or depletion, less a number of adjustments, including a reduction in basis for personal use (i.e., use other than for trade or business or investment purposes), and a reduction for any portion of the property expensed under Code Sec. 179. (Reg. § 1.168(k)-1(a)(2)(iii))

To calculate regular depreciation allowances for qualifying property, the taxpayer first subtracts the bonus first year depreciation amount from the unadjusted depreciable basis of the asset. (Code Sec. 168(k)(1)(B), Reg. § 1.168(k)-1(d)(2))

Depreciating luxury autos. Purchased autos and other vehicles used in a trade or business normally are depreciated over five years using 200% declining balance depreciation, with a built-in switch to straight line. (Code Sec. 168(b)(1); Code Sec. 168(e)(3)(B)) Because the depreciation rules generally treat property as placed in service in the midpoint of the placed-in-service year (Code Sec. 168(d)(1)), yielding only half of the otherwise allowable depreciation for the placed-in-service year, the actual depreciation period is six years. The regular depreciation percentages (if the half-year convention applies) are:

• 20% for the first year;
• 32% for the second;
• 19.2% for the third year;
• 11.52% for each of the fourth and fifth years; and
• 5.76% for the sixth year.

However, the deduction normally obtained by applying the above depreciation rules (and the Code Sec. 179 expensing rules) to autos, light trucks and vans, is limited by the so-called "luxury auto dollar caps" of Code Sec. 280F. Thus, the maximum annual depreciation/expensing deduction for a business auto is the lesser of the otherwise allowable depreciation/expensing allowance or the applicable luxury-auto dollar cap.

For vehicles acquired and placed in service in 2008 that are not eligible for bonus depreciation (e.g., they are bought used, or the taxpayer elects out of bonus depreciation for five-year property), the dollar caps for: (1) autos (not trucks or vans) are $2,960 for the placed in service year, $4,800 for the second tax year, $2,850 for the third tax year; and $1,775 for each succeeding year; and (2) for light trucks or vans (passenger autos built on a truck chassis, including minivans and sport-utility vehicles (SUVs) built on a truck chassis) are: $3,160 for the placed in service year, $5,100 for the second tax year, $3,050 for the third tax year; and $1,875 for each succeeding year.

Boosted write-off for business autos, and light trucks or vans. Under the Stimulus Act, for vehicles that otherwise are qualified property under Code Sec. 168(k) (assuming the taxpayer doesn't elect out of bonus depreciation for 5-year property), the regular first-year luxury auto caps are boosted by $8,000 to $10,960 for autos, and to $11,160 for light trucks or vans.

Calculating first-year depreciation deduction. Where expensing isn't claimed, the first-year dollar-cap for a new passenger auto, truck or van that is qualified property under Code Sec. 168(k) and is acquired and placed in service in 2008, is determined as follows:

(1) Multiply the vehicle's depreciable basis by its business/investment use in the placed-in-service year.
(2) Multiply Line (1) result by 50%.
(3) Subtract Line (2) from Line (1).
(4) Multiply Line (3) result by 20% (assuming the half-year convention applies).
(5) Add Line (4) result to Line (2) result.
(6) Multiply the appropriate first-year dollar cap ($10,960 for autos, $11,160 for light trucks or vans) by the business/investment use percentage.

(7) The lesser of Line (5) or Line (6) is the total first-year depreciation allowance for the vehicle.
Illustration 1: On Jan. 10, 2008, a business bought and placed in service a new $35,000 auto and uses it 100% for business. It does not expense any part of the auto's cost, and the half-year depreciation convention applies. The 2008 depreciation deduction for the auto is computed as follows:

(1) $35,000 × 100% business use = $35,000.
(2) $35,000 × .50 = $17,500 bonus depreciation.
(3) $35,000 − $17,500 = $17,500 remaining basis.
(4) $17,500 × .20 first year depreciation allowance = $3,500.
(5) $17,500 + $3,500 = $21,000.
(6) $10,960 × 1.0 = $10,960.
(7) Lesser of $21,000 or $10,960 = $10,960 regular first year depreciation.

Caution: The combined special depreciation allowance and regular first-year depreciation deduction for lower-priced vehicles may be less than the maximum first-year depreciation allowance.

Illustration 2: The facts are the same as in the first illustration, except that the new auto costs $18,000. The 2008 depreciation deduction for the auto is computed as follows:

(1) $18,000 × 100% business use = $18,000.
(2) $18,000 × .50 = $9,000 bonus depreciation.
(3) $18,000 − $9,000 = $9,000 remaining basis.
(4) $9,000 × .20 first-year depreciation allowance = $1,800.
(5) $9,000 + $1,800 = $10,800.
(6) $10,960 × 1.0 = $10,960.
(7) Lesser of $10,800 or $10,960 = $10,800 regular first year depreciation.

Hidden danger for company owned vehicles. A vehicle is qualified property eligible for bonus first year depreciation only if it is used more than 50% in a qualified business use. (Reg. § 1.168(k)-1(b)(2)(ii)(A)(2)) In general, this isn't a problem for company owned autos so long as employee personal use is properly treated as compensation income under the fringe benefit rules. In this case, personal use is treated as qualified business use. ( Reg. § 1.280F-6(d)(2) ; Instructions for Form 4562 (2007), p. 9) However, a vehicle bought new in 2008 and provided to a 5% company owner (or a related person) will not be eligible for bonus first year depreciation unless it is actually used more than 50% for business driving. (Code Sec. 280F(d)(6)(C)) Thus, companies tempted by the prospect of larger first year writeoffs to buy new vehicles this year for their 5% owners should do so only if their business mileage on the car will exceed 50% of total mileage. Keep in mind, too, that depreciation recapture applies if qualified business use in the placed in service year exceeds 50% of total use but declines below that level in subsequent years. The 50% bonus first-year depreciation allowance for a passenger auto that qualifies under Code Sec. 168(k) is taken into account in computing recaptured depreciation. (Code Sec. 168(k)(2)(F)(ii))

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Tax Court properly denied separate filer equitable innocent spouse relief - Christensen, (CA 9 4/21/2008) 101 AFTR 2d ¶ 2008-705

Mike Habib, EA

MyIRSTaxRelief.com

The Ninth Circuit has affirmed the Tax Court's dismissal of a taxpayer's claim for equitable innocent spouse relief under Code Sec. 6015(f). The Ninth Circuit agreed with the Tax Court's finding that relief under Code Sec. 6015(f) is available only to spouses who file a joint return. In this case, the taxpayer filed separately and thus was not entitled to innocent spouse relief.

Background. Each spouse is jointly and severally liable for the tax, interest, and penalties (other than the civil fraud penalty) arising from a joint return. Relief from joint and several liability is available: (1) under the regular innocent spouse rules; (2) in the case of spouses who are no longer married, are legally separated, or live apart, under the separate liability election rules; and (3) where relief is not available under (1) or (2), under IRS's power to grant equitable relief. (Code Sec. 6015)

On Sept. 14, 2004, Christensen filed a request with IRS for relief from tax liabilities assessed against him for tax years '89 through '92. He did not file jointly for those years but said that the tax deficiencies resulted from improper income reporting within his wife's check-cashing business. Christensen argued that the deficiencies should not be attributed to him, given his lack of involvement in the business. He sought relief from the liabilities as an innocent spouse under Code Sec. 6015 , or, alternatively, for relief under community property laws.

IRS denied his request for innocent spouse relief and for relief under Code Sec. 66, which relieves community property liability under some circumstances. Christensen petitioned for review before the Tax Court, which granted summary judgment for IRS on the Code Sec. 6015 claim after finding that such relief is available only to joint filers. The Tax Court dismissed Christensen's claims under Code Sec. 66(c) and the predecessor innocent spouse provision of former Code Sec. 6013(e) for lack of jurisdiction. Christensen filed a timely appeal seeking review of his request for equitable relief under Code Sec. 6015(f) for tax years '89 and '90.

Jurisdictional question. While IRS didn't question the Tax Court's jurisdiction, the Ninth Circuit said it had to consider the issue, which it felt was murky in this case. The Tax Relief and Health Care Act of 2006 amended Code Sec. 6015 to provide that the Tax Court may review claims for equitable innocent spouse relief and to suspend the running of the period of limitations while such claims are pending. This change was effective for requests for equitable relief with respect to liability for taxes that were unpaid or after the enactment date (Dec. 20, 2006).

The Ninth Circuit noted that, under the change, the Tax Court would have had express jurisdiction over Christensen's Code Sec. 6015(f) claim as of Dec. 20, 2006. However, the Tax Court entered its order on Jan. 10, 2006. The Appeals Court said that where a new statutory provision confers jurisdiction while an action is pending, it normally applies the new rule regardless of whether the court below had jurisdiction when the suit was filed or judgment was entered. Accordingly, it concluded that the Tax Court had jurisdiction to review the Code Sec. 6015(f) claim.

Joint return required for relief. Christensen argued that Code Sec. 6015(f) is available to spouses who face joint liability under community property laws but do not file a joint return. The Ninth Circuit agreed that, unlike Code Sec. 6015(b) and Code Sec. 6015(c), the language of Code Sec. 6015(f) does not explicitly require the filing of a joint tax return as a procedural requirement for relief. However, it stressed that the language in Code Sec. 6015(e) and Code Sec. 6015(h) implies a joint return requirement for Code Sec. 6015(f). For example, Code Sec. 6015(e) directs the Tax Court to "establish rules which provide the individual filing a joint return but not making the election under subsection (b) or (c) or the request for equitable relief under subsection (f) with adequate notice and an opportunity to become a party..." (Code Sec. 6015(e)(4)) Similarly, Code Sec. 6015(h) refers to the non-petitioning spouse in a Code Sec. 6015(f) claim, to whom notice must be sent, as "the other individual filing the joint return." The Ninth Circuit said that this language indicates that Congress anticipated a joint return where a spouse petitions for relief under Code Sec. 6015(f). Accordingly, the Appeals Court sustained the Tax Court's dismissal of the case.

Qualified joint venture's rental real estate income isn't subject to self-employment tax - Chief Counsel Advice 200816030

Mike Habib, EA
myIRSTaxRelief.com In Chief Counsel Advice (CCA), IRS has concluded that the qualified joint venture election under Code Sec. 761(f) doesn't cause self-employment tax to be imposed on income from a rental real estate business that would otherwise be excluded. Dividends and capital gains are similarly excluded. The qualified joint venture election, which was recently added by the Small Business and Work Opportunity Act of 2007 (Small Business Act), allows eligible married co-owners to avoid filing partnership returns and both spouses to receive credit for social security and Medicare coverage purposes.

Background on qualified joint ventures. The Small Business Act provision generally allows a qualified joint venture whose only members are a husband and wife filing a joint return not to be treated as a partnership for Federal tax purposes. (Code Sec. 761(f)) A qualified joint venture is a joint venture involving the conduct of a trade or business, if:

(1) the only members of the joint venture are a husband and wife,
(2) both spouses materially participate in the trade or business, and
(3) both spouses elect to have the provision apply. (Code Sec. 761(f)(2))

The meaning of material participation is the same as under the passive activity loss rules in Code Sec. 469(h) and its regs.

Where the election is made, all items of income, gain, loss, deduction, and credit are divided between the spouses according to their respective interests in the venture, and each spouse takes into account his or her respective share of these items as if they were attributable to a trade or business conducted by the spouse as a sole proprietor.

Background on self-employment tax. A tax is generally imposed on an individual's self-employment income (i.e., on his net earnings from self-employment) with certain adjustments. (Code Sec. 1401, Code Sec. 1402(b)) Net earnings from self-employment generally includes an individual's gross income from a trade or business, plus his distributive share of income or loss from a partnership in which he is a member. An exception provides that rental income from real estate is excluded from net earnings from self-employment, unless the rental income is received in the course of a trade or business as a real estate dealer. (Code Sec. 1402(a)(1)) Similarly, dividend income and gain or loss from sale or exchange of a capital asset are excluded from net earnings from self-employment. (Code Sec. 1402(a)(2), Code Sec. 1402(a)(3))

Code Sec. 1402(a)(17), added by the Small Business Act, provides that "notwithstanding the preceding provisions of this subsection,"each spouse's share of income or loss from a qualified joint venture is taken into account under the Code Sec. 761(f) qualified joint venture rules in determining the spouse's net earnings from self-employment. IRS has indicated that an electing husband and wife must each file with their joint income tax return a separate Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) or Schedule F (Form 1040), Profit of Loss From Farming, and a separate Schedule SE (Form 1040), Self- Employment Tax, as applicable (see Newsstand e-mail 3/21/08 or Federal Taxes Weekly Alert 03/27/2008). While the general instructions for the 2007 Form 1040 don't address the issue, the instructions for the 2007 Schedule E informs electing spouses that for a rental real estate business each spouse must report his or her share of this income on their respective Schedules C and not on Schedules E.

IRS examiners have questioned whether the spouses' qualified joint venture election for a rental real estate business doesn't convert income derived from business, which would otherwise be excluded, into net earnings from self-employment.

Effect of spousal joint venture election on self-employment tax. The CCA concludes that in the case of a husband and wife who make the qualified joint venture election for a rental real estate business, each spouse has a share of the qualified joint venture income, and each spouse may exclude his or her respective share of the qualified joint venture income from net earnings from self-employment under the Code Sec. 1402(a)(1) exclusion.

Generally, an individual who has income from a rental real estate business won't be subject to self-employment tax on the income because it's excluded from net earnings from self-employment under Code Sec. 1402(a)(1). He'll report the income on a Schedule E (Form 1040) and carry over the amounts to his individual return (e.g., Form 1040), but not include the amounts on Schedule SE (Form 1040) in calculating self-employment tax.

The CCA reasons that the legislative history of Code Sec. 761(f) suggests that any income earned by a qualified joint venture is reported for all federal tax purposes using the same forms as if each spouse were a sole proprietor who earns that income. The phrase "not withstanding the preceding provisions of this subsection," in Code Sec. 1402(a)(17) taken together with the rest of Code Sec. 1402 and Code Sec. 761(f) 's legislative history directs that none of the preceding subsections in Code Sec. 1402 are to alter that allocation between spouses. To read this phrase as nullifying the application of all the exclusions from net earnings from self-employment would trigger dramatic changes in the application of the self-employment tax to spouses electing qualified joint venture treatment. This was clearly not intended. The purpose of Code Sec. 761(f) wasn't to convert income that would otherwise be excluded from net earnings from self-employment altogether into income that is subject to self-employment tax.

Dividends and capital gain aren't subject to self-employment tax. The CCA similarly concludes that its reasoning applies to dividends and capital gains earned by a qualified joint venture. This income, otherwise excluded from net earnings from self-employment, is also excluded from self-employment tax for a qualified joint venture.

TIGTA audit reviews effectiveness of IRS processing of Heavy Highway Vehicle Use Tax Return [Audit Report No. 2008-40-089]: The

IRS should encourage more states to participate in its Alternative Proof of Payment Program for the collection of the Heavy Highway Vehicle Use Tax (also known as the Heavy Vehicle Use Tax), the Treasury Inspector General for Tax Administration (TIGTA) said in a recent audit.

The tax is a federal highway use tax paid annually on vehicles with a taxable gross weight of 55,000 or more pounds, designed to carry a load over public highways, and expected to be used more than 5,000 miles (more than 7,500 miles for agricultural uses). Typically, after a taxpayer files Form 2290 (Heavy Highway Vehicle Use Tax Return) and pays the tax, IRS stamps the Schedule of Heavy Highway Vehicles (Schedule I) of the form to show payment was received and returns it to the taxpayer for use as proof of payment for vehicle registration.

The Alternative Proof of Payment Program is based on an agreement between IRS and a state department of motor vehicles that allows taxpayers to simultaneously file Form 2290, pay the tax, and register their vehicles.

The program has been in place for 10 years but only 11 states participate, TIGTA noted. "Although guidelines for the program authorize a state department of motor vehicles to accept Forms 2290 with related payments to register vehicles, the IRS has not regularly pursued expansion of this program," TIGTA said. The audit is located at

http://treas.gov/tigta/auditreports/2008reports/200840089fr.pdf If you ar ea truck driver and need help resolving your tax problem CLICK HERE.

The IRS OKs deferral of income from intellectual property payments

Mike Habib, EA

myIRSTaxRelief.com

The IRS has privately ruled that a taxpayer could defer reporting income from intellectual property payments until the tax year following the tax year of receipt of the payments under a revenue procedure governing advance payments.

Background. Under the accrual basis method of accounting, income is reported when: (1) all events have occurred which establish the right of the taxpayer to receive the income; and (2) the amount can be determined with reasonable accuracy. (Reg. § 1.451-1(a)) All the events that fix the right to receive income occur when the first of the following events happens:

• the required performance takes place;
• payment is due; or
• payment is made. (Rev Rul 84-31, 1984-1 CB 127)

Certain taxpayers may use the deferral method described in Rev Proc 2004-34, 2004-22 IRB 991, Sec. 5.02(1)(a). A taxpayer using the deferral method must include an advance payment in gross income in the tax year of receipt to the extent recognized in revenues in its applicable financial statement in that year, and include the remaining amount of the advance payment in gross income in the next succeeding tax year.

A payment received by a taxpayer for the use (including by license or lease) of intellectual property, such as patents and similar intangible property rights, is an advance payment if including the payment in gross income for the tax year of receipt is a permissible method of accounting for federal income tax purposes (without regard to Rev Proc 2004-34) and the payment is recognized by the taxpayer (in whole or in part) in revenues in its applicable financial statement for a subsequent tax year. (Rev Proc 2004-34, Sec. 4.01(3))

A taxpayer may adopt any permissible method of accounting for advance payments for the first tax year in which the taxpayer receives advance payments. (Rev Proc 2004-34, Sec. 8.01)

Facts. Taxpayer is engaged in Business. Before Date 1, Taxpayer owned or controlled certain intellectual property (the IP), including patents and know-how, related to Product. Taxpayer and Company entered into an agreement as of Date 1 (the Agreement), under which Taxpayer granted Company an exclusive license to develop, use, offer for sale, sell, sublicense and otherwise commercialize any products for human use containing Product that are made by a process covered by the IP (licensed products). The license granted to Company was co-exclusive with Taxpayer so that Taxpayer could exercise its rights and perform its obligations under the Agreement. Under the Agreement, Taxpayer and Company will collaborate in developing, marketing, and obtaining regulatory approval for, licensed products. They agreed how they would share the costs of development of the initial licensed product for Indication X and Indication Y.

In consideration for entering into the Agreement Company is obligated to: (1) pay Taxpayer a nonrefundable initial license fee (the Fee) in Year I; (2) make payments to Taxpayer if and when certain milestones in the development of the IP are met (the Milestone Payments); and (3) if licensed products are commercialized, make payments of royalties to Taxpayer based on the level of sales of the product (the royalty payments).

The Milestone Payments are solely for the use of the IP and compensate Taxpayer for the increased value of the IP as it progresses through each stage of development, testing, and regulation. No part of the Milestone Payments is compensation for services.

Taxpayer has a certified audited financial statement, accompanied by the report of an independent CPA, which is used for credit purposes, reporting to shareholders, and other substantial non-tax purposes, and is an applicable financial statement as defined in Rev Proc 2004-34, Sec. 4.06(2). Taxpayer anticipates that it will recognize the Fee in revenues in the applicable financial statement over Period 1, rather than in the year of receipt. Taxpayer received no advance payments, as defined in Rev Proc 2004-34, Sec. 4.01, before Year 1. Taxpayer anticipates that current financial reporting rules will require it to recognize the Milestone Payments in income in the tax year of receipt, but will include the Milestone Payments in income in its applicable financial statement in a subsequent tax year to the extent financial reporting rules permit.

Deferral OK'd. Based on the language of the Agreement and Taxpayer's representations, IRS concluded that the Fee and the Milestone Payments are payments for the use of intellectual property and are advance payments within the meaning of Rev Proc 2004-34, Sec. 4.01, to the extent the Taxpayer recognizes the payments in its applicable financial statement for a tax year following the tax year of receipt. Therefore, IRS concluded that, under Rev Proc 2004-34, Sec. 5.02, it is a proper method of accounting for Taxpayer to defer to the next succeeding tax year following the year of receipt the inclusion in gross income of the Fee and each Milestone Payment to the extent that they are recognized by Taxpayer (in whole or in part) in revenues in its applicable financial statement for a tax year subsequent to the tax year of receipt. Because Year 1 is the first tax year in which Taxpayer receives an advance payment, Taxpayer may adopt the deferral method of Rev Proc 2004-34, Sec. 5.02 in Year 1, under Rev Proc 2004-34, Sec. 8.01.

Grantor's power to substitute trust property didn't trigger inclusion in estate - Rev Rul 2008-22, 2008-16 IRB 796

Mike Habib, EA
myIRSTaxRelief.com A new revenue ruling concludes that the corpus of an irrevocable trust that a grantor created during life is not includible in his gross estate under Code Sec. 2036 or Code Sec. 2038 on account of the grantor having retained the power, exercisable in a nonfiduciary capacity, to acquire property held by the trust by substituting other property of equivalent value.

Observation: This ruling is good news for anyone who wants to set up a defective grantor trust - a trust intentionally structured so that the grantor, rather than the trust or its beneficiaries, will be taxed on the trust's income without the trust being included in the grantor's estate. Under Code Sec. 675(4), a grantor's power to substitute property causes trust income to be taxed to the grantor and is commonly used to create a defective grantor trust. The new ruling gives this technique a big boost by making it clear that such a power of substitution won't cause inclusion in the grantors' estate.

Background. Under Code Sec. 2036, a decedent's gross estate includes transfers under which he retained the possession or enjoyment of, or the right to the income from, the transferred property. The decedent need not have a legally enforceable right, but there must be an agreement, either expressed or implied, that the decedent will retain the benefit. Under Code Sec. 2038 , a decedent's gross estate includes a lifetime transfer if the enjoyment of the transferred property was subject at his death to any change through the exercise by him of a power to alter, amend, revoke or terminate. This includes any power affecting the time or manner of enjoyment of property or its income. Inclusion is not required under Code Sec. 2036 or Code Sec. 2038 if the transfer was a bona fide sale for full and adequate consideration.

Facts. In Year 1, Danny, a U.S. citizen, established and funded an irrevocable inter vivos trust (Trust) for the benefit of his descendants. Danny is barred from serving as Trustee. Danny has the power, exercisable at any time, to acquire any property held in Trust by substituting other property of equivalent value. The power is exercisable by Danny in a nonfiduciary capacity, without the approval or consent of any person acting in a fiduciary capacity. To exercise the power of substitution, he must certify in writing that the substituted property and the trust property for which it is substituted are of equivalent value.

Under local law, Trustee has a fiduciary obligation to ensure that the properties being exchanged are of equivalent value. If a trust has two or more beneficiaries, under local law, the trustee must act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. Further, under local law and without restriction in the trust instrument, Trustee has the discretionary power to acquire, invest, reinvest, exchange, sell, convey, control, divide, partition, and manage the trust property in accordance with the standards provided by law.

Danny dies in Year 2.
Inclusion not required. IRS noted that, under the posited facts, the trust instrument expressly prohibits Danny from serving as trustee and states that his power to substitute assets of equivalent value is held in a nonfiduciary capacity. IRS thus noted that Danny is not subject to the rigorous standards attendant to a power held in a fiduciary capacity. However, the ruling went on to observe that the assets Danny transfers into the trust must be equivalent in value to the ones he receives in exchange. In addition, Trustee has a fiduciary obligation to ensure that the assets exchanged are of equivalent value. As a result, Danny cannot exercise the power to substitute assets in a manner that will reduce the value of the trust corpus or increase his net worth. Further, in view of Trustee's ability to reinvest the assets and his duty of impartiality regarding the trust beneficiaries, Trustee must prevent any shifting of benefits between or among the beneficiaries that could otherwise result from a substitution of property by Danny. Under these circumstances, the ruling concluded that Danny's retained power will not cause the value of the trust corpus to be included in his gross estate under Code Sec. 2036 or Code Sec. 2038.

For fiduciary and estate tax problem help CONTACT US HERE

Offsets in Senate Finance's farm bill include Schedule F loss limits, optional self-employment tax, and information reporting

Mike Habib, EA

MyIRSTaxRelief.com

On April 18, the Senate Finance Committee conferees on the farm bill announced $2.4 billion of reforms/offsets - "double the reforms in the House or Senate bills alone" - that could be used to fully offset the farm bill. These reforms/offsets (along with a slight decrease in the ethanol tax credit) would include:

• Preventing the use of farm losses as a tax shelter. This provision would address the use of complex farming operations to reduce taxable income by limiting the amount of Schedule F (agricultural) losses that can be use to reduce non-agricultural business income. Agricultural losses would be limited to $200,000, if the taxpayer receives any Farm Bill commodity payments. A farmer's or rancher's ability to use agricultural losses against their agricultural gains wouldn't be limited.
• Allowing farmers to pay additional self-employment taxes to qualify for Social Security. This provision would modify the farm optional method so that farmers and ranchers can pay more in optional self-employment taxes (and so be eligible for Social Security benefits). Qualifying for Social Security benefits can be difficult for self-employed farmers and ranchers because they don't always have a steady stream of income. When there are no earnings, no Social Security taxes are paid and no quarters are accrued. The payment thresholds in the farm optional methods, in which farmers and ranchers can voluntarily pay Social Security taxes in order to earn quarters (and so receive Social Security benefits), are outdated and no longer allow farmers and ranchers to earn enough Social Security credits per year.

Ensuring that farmers know their tax obligations. The provision would requires the Commodity Credit Corporation (CCC) to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he repays a CCC market assistance loan. As a result, income that is subject to information reporting would be less likely to be underreported to IRS.

In addition to the above, Senate conferees are committed to $600 million more in agriculture tax-related reforms to complete the package.

In response to word that House conferees would score any temporary tax provision as if it were permanent, Senate Finance Committee Ranking Member Chuck Grassley (R-IA) complained that this imposed a double standard because none of the 5-year spending proposals were considered as if they were permanent. In particular, Grassley noted that this approach overlooked that the largest agricultural tax revenue raiser, a reduction in the ethanol credit, is temporary, expiring at the end of 2010 (roughly the same period as some of the temporary tax relief provisions in the bill). Grassley objected that if the House was going to look at the agricultural tax package over ten years, then the same test should be applied on the spending side.

IRS proposed regs would update federal tax lien priority provisions for holders of security interests

Preamble to Prop Reg 04/16/2008, Prop Reg § 301.6323(b)-1, Prop Reg § 301.6323(c)-2, Prop Reg § 301.6323(f)-1, Prop Reg § 301.6323(g)-1

Mike Habib, EA

myIRSTaxRelief.com

IRS has issued proposed regs on the priority of federal tax liens against certain persons under Code Sec. 6323 - purchasers, holders of security interests, mechanic's lienors, and judgment lien creditors. The proposed regs, which would be effective when finalized, would incorporate changes made in the IRS Restructuring and Reform Act of '98 (RRA) and make various other updates. They would also reflect that a notice of federal tax lien (NFTL) would be extinguished if it contains a certificate of release and isn't timely refiled. The proposed regs would also clarify IRS's authority to file NFTLs electronically.

Background. The holder of a security interest (including a mortgagee or pledgee) is protected against a general tax lien if, before IRS files notice of lien, the security interest is in existence, even if it came into existence after the tax lien arose. For this purpose, the holder of a security interest, is protected against the tax lien even if the holder had actual knowledge of the tax lien before acquiring the interest. (Code Sec. 6323(a))

Since '76, there have been numerous amendments to Code Sec. 6323 that have not been reflected in the existing regs, including changes made by the RRA and the Revenue Act of '78. In addition, there have also been several changes to IRS practice that aren't reflected in the existing regs.

Proposed regs. The proposed regs would update the existing regs to indicate that:

• a purchaser of property in a casual sale is protected against a filed tax lien if the sale price is less than $1,000 (i.e., reflecting the Code Sec. 6323(b)(4) limit). For 2008, this $1,000 limit, as indexed for inflation, is $1,320. (Prop Reg § 301.6323(b)-1(d)(1))
• a holder of a mechanic lien is protected against a filed tax lien with respect to residential property in an amount not more than $5,000 (i.e., reflecting the Code Sec. 6323(b)(7) limit). For 2008, this $5,000 limit, as indexed for inflation, is $6,600. (Prop Reg § 301.6323(b)-1(g)(1))
• household goods (fuel, provisions, furniture and personal effects in a taxpayer's household, etc.) are exempt from levy to the extent they don't exceed $6,250 in value (i.e., reflecting the Code Sec. 6334(a)(2) limit). For 2008, this $6,250 limit, as indexed for inflation, is $7,900. (Prop Reg § 301.6323(b)-1(d)(3))

The proposed regs would clarify that a NFTL (Form 668) may be filed either in paper form or electronically, and specifically define transmission by fax and e-mail as electronic, as opposed to paper, filings. The proposed regs would reflect the IRS's authority to file NFTLs electronically in all situations and would allow IRS to work with local jurisdictions to receive electronically-filed NFTLs if they have the capacity to do so without obtaining the state's permission. (Prop Reg § 301.6323(f)-1(d)(2))

The proposed regs would provide that, with regard to an NFTL that includes a certificate of release, failure to timely refile the NFTL in any jurisdiction where it was originally filed would extinguish the lien, and that when an NFTL is filed in more than one jurisdiction, certificates of revocation as well as new NFTLs would have to be filed in all the jurisdictions for the lien to be reinstated. (Prop Reg § 301.6323(g)-1(a))

The proposed regs would indicate that there is generally a 10-year period (reflecting the period in Code Sec. 6502) for instituting a proceeding in court or serving a levy to collect a properly assessed tax. (Prop Reg § 301.6323(g)-1)

The proposed regs would also amend the examples in the existing regs under Code Sec. 6323(c), Code Sec. 6323(g), and Code Sec. 6323(h) to reflect that a notice of federal tax lien isn't treated as meeting the filing requirements until it is both filed and indexed in the office designated by the state (in the case of real property located in a state where a deed is not valid against a purchaser until the filing of such deed has been entered and recorded in the public index). (Prop Reg § 301.6323(c)-2(d), Ex. 1, Ex. 4)

The proposed regs would also remove Reg. § 301.6323(b)-1(j) because it is misleading and unnecessary in light of changes to Code Sec. 6323(b)(10) which made the reference to "passbook accounts" obsolete. Code Sec. 6323(b)(10) currently protects from a federal tax lien certain institutions holding deposit-secured loans, to the extent of any loan made without actual notice or knowledge of the federal tax lien.

IRS Oversight Board Annual Report 2007 is now available - see more details below Mike Habib, EA
myIRSTaxRelief.com As you can see from the report below, the IRS places " enforcement of their tax audit activity. The IRS must strive to achieve the standard of "great" performance and settle for nothing less, the IRS Oversight Board said in its latest annual report. The board called for "breakthrough" agency performances in four areas - taxpayer service, enforcement, human capital and information technology. For example, to enhance customer service, IRS must continually assess taxpayer needs and implement education and outreach services tailored to the needs of specific taxpayer groups, the board said. IRS also must apply the results of its research efforts to improve its enforcement activity. In addition, the agency must address the loss of unique skills and institutional knowledge that results from the normal retirement rate of some 4,000 employees annually. "The board has challenged the IRS to rise to an unprecedented level of performance in all parts of its mission," said Paul Cherecwich, chairman of the board. "It will not be easy and there are no givens. But the board firmly believes that today's IRS is up to the task and the end results will be worth the journey and the hard work." The annual report can be found at http://www.ustreas.gov/irsob/reports/2008/IRSOB_Annual-Report_2007.pdf

You missed the tax deadline April 15th, so now what?

Mike Habib, EA

myIRSTaxRelief.com

Although the IRS has received a record number of returns this year, there are still thousands of people who did not file tax returns on April 15^th. The reasons for this are numerous, but the IRS research shows that often people do not file in years that their status changes, for instance the death of a spouse or a divorce. Emotional or financial hardship reasons may also cause a person not to file. And then there are some folks who have simply procrastinated. Whatever your reason is, if you did not file your taxes by April 15th, you should stop putting it off and file your tax returns as soon as possible - even if you are late.

Sure, if you file late, you might be missing out on the economic stimulus tax refund check, but the reasons for filing are more compelling, and often less painful than ignoring your obligation.

Here are some things you should consider:

1. You could lose 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.
2. You won't receive your Earned Income Tax Credit (EITC). Even if you are not otherwise required to file a tax return, you must file in order to receive this credit. The Earned Income Tax Credit (EITC) sometimes called the Earned Income Credit (EIC), is a refundable federal income tax credit for low-income working individuals and families. Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. When the EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. To qualify, taxpayers must meet certain requirements and file a tax return, even if they did not earn enough money to be obligated to file a tax return. The EITC has no effect on certain welfare benefits. In most cases, EITC payments will not be used to determine eligibility for Medicaid, Supplemental Security Income (SSI), food stamps, low-income housing or most Temporary Assistance for Needy Families (TANF) payments.
3. A statute of limitations applies to refunds and credits. 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 overpayment of estimated or withholding taxes, to other tax years that are underpaid. It is also worth noting that the statute of limitations for the IRS to assess and collect any outstanding balance does not begin until a return has been filed. Or put another way, there is no statute of limitations for assessing and collecting the tax if no return has been filed.
4. A "Failure to File" penalty may be assessed when you miss the tax filing deadline; the sooner you file, the more likely you are to be able to negotiate or decrease this penalty.

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.

I personally specialize in helping individuals and businesses who are unable to fully pay their taxes, either back taxes, or due to current or late filing. If you can not pay your taxes, do not let this prevent you from filing as tax settlement options may be available. For more details contact us as quick as possible.

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
If you are experiencing tax collection issues, CLICK HERE FOR HELP.
If you received a tax audit letter, CLICK HERE FOR HELP.

No refund suit is allowed in the absence of a timely claim filed with IRS

U.S. v. Clintwood Elkorn Mining Co., (S Ct 4/15/2008) 101 AFTR 2d ¶ 2008696

Mike Habib, EA
myIRSTaxRelief.com

The Supreme Court, reversing the Court of Appeals for the Federal Circuit, has held that the plain language of Code Sec. 7422(a) and Code Sec. 6511 requires a taxpayer seeking a refund of a tax assessed in violation of the Export Clause of the U.S. Constitution, just as for any other unlawfully assessed tax, to file a timely administrative refund claim with IRS before bringing suit against the Government.

Background. A manufacturers excise tax is imposed on coal mined from underground or surface mines located in the U.S. and sold or used by the producer. (Code Sec. 4121) In '98, a district court (Ranger Fuel Corp v. U.S., (DC VA 1998) 83 AFTR 2d 99-375) held that the coal excise tax is unconstitutional to the extent it applies to exported coal based on the blanket prohibition imposed by the Export Clause of the U.S. Constitution and IRS acquiesced, in effect, in that decision by issuing guidance (Notice 2000-28, 2000-1 CB 1116) on how to claim a refund for coal excise tax imposed on exported coal.

A taxpayer must file a refund claim with IRS before starting a suit for refund (or credit). (Code Sec. 7422(a))
A taxpayer must file a claim for credit or refund of an overpayment within three years from the time the relevant return is filed, or two years from the time the tax is paid, whichever period expires later. (Code Sec. 6511(a)) No credit or refund is allowed if a claim is not filed within these time limits. (Code Sec. 6511(b))

Facts. The taxpayers, three coal companies, had all paid taxes on coal exports under Code Sec. 4121 since as early as '78. After Code Sec. 4121 was held unconstitutional as applied to coal exports, the companies timely filed administrative claims for refund of coal taxes they had paid in '97 through '99. IRS refunded those taxes, with interest.

The companies also filed suit in the Court of Federal Claims seeking a refund of $1,065,936 in taxes paid between '94 and '96. They did not file any claim for those taxes with IRS. The Supreme Court noted that any such claim would of course have been denied, given the limits set forth in Code Sec. 6511. Notwithstanding the failure of the companies to file timely administrative refund claims, the Court of Federal Claims allowed the companies to pursue their suit directly under the Export Clause. Jurisdiction rested on the Tucker Act, 28 USCS 1491(a)(1), and the companies limited their claim to taxes paid within that statute's 6-year limitations period. The Court of Federal Claims did not, however, allow the companies to recover interest on the taxes. (Andalex Resources, Inc. v. U.S., (2002 Ct Fed C) 90 AFTR 2d 2002-7393) The Court of Appeals for the Federal Circuit allowed the refund and also allowed interest. (Clintwood Elkhorn Mining Co v. U.S., (2007, CA Fed Cir) 99 AFTR 2d 2007-613)

Supreme Court reverses. The Supreme Court observed that the Code provides that taxpayers seeking a refund of taxes unlawfully assessed must comply with its tax refund procedures. Under those procedures, a taxpayer must file an administrative claim with IRS before filing suit against the Government. Such a claim must be filed within three years of the filing of a return or two years of payment of the tax, whichever is later.

The Supreme Court noted that the Tucker Act is more forgivingit allows claims to be brought against the U.S. within six years of the challenged conduct.

The question before the Court was whether a taxpayer suing for a refund of taxes collected in violation of the Export Clause of the Constitution could proceed under the Tucker Act, when the suit does not meet the time limits for refund actions in the Code. In a unanimous opinion, the Court said the answer is no.

The Court based its decision on the plain language of the pertinent Code provisions. The Court stressed that Code Sec. 7422(a) provides that no suit shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected until a claim for refund or credit has been duly filed with IRS. The Court said that the companies did not file a refund claim with IRS for the '94 through '96 taxes. Thus, they may bring no suit in any court to recover the taxes.

The Supreme Court further noted that the time limits for administrative refund claims apply to any tax imposed by the Code (Code Sec. 6511(a)) and that the Code provides that no refund shall be allowed after the expiration of those time limits. (Code Sec. 6511(b)) This language clearly covered the companies' claim for refund of taxes imposed by Code Sec. 4121.

The companies nonetheless argued that their claims were exempt from the Code provisions' broad sweep because the claims derived from the Export Clause of the Constitution. The Supreme Court said that there is no basis for treating taxes collected in violation of that Clause differently from taxes challenged on other grounds. Because the companies acknowledged that their claims were subject to the Tucker Act's time bar, the question was not whether their refund claim could be limited, but rather which limitation applied. Their argument that, despite explicit and expansive statutory language, the Code's refund scheme did not apply to their case as a matter of statutory interpretation was without merit. Accordingly, the Supreme Court reversed the Federal Circuit and denied the claim.

Observation: If a taxpayer believes that a tax is unlawful, it should file a refund claim. If IRS denies the claim, the taxpayer can then challenge the tax in court. A taxpayer who does not intend to challenge a tax that it feels is unlawful should nonetheless file a protective refund claim if it is aware that another taxpayer is challenging the tax. The protective claim may serve to allow the taxpayer to recover the tax if the other taxpayer subsequently prevails in its suit against IRS.

IRS acquiesces to TLC Leasing - explains meals deduction limit in employee leasing setting Rev Rul 2008-23, 2008-18 IRB

TRUCKER TAX RELIEF & TRUCKER TAX PROBLEM RESOLUTION

Mike Habib, EA

myIRSTaxRelief.com

IRS has acquiesced to the Eighth Circuit's holding in Transport Labor/Contract Leasing (TLC Leasing) that a company leasing truck drivers to client companies wasn't subject to the Code Sec. 274(n) deduction limit on meal reimbursements it made to drivers because it substantiated these expenses to the clients. Instead, the Eight Circuit said the client companies were subject to the limitation because they ultimately bore the expenses. The ruling clarifies IRS's stance on reimbursed meal expenses involving leasing companies by way of three examples.

Observation: The new ruling isn't limited to leased truckers. Its conclusions may be applied to any situation where leased employees are reimbursed for expenses subject to the Code Sec. 274(n) deduction limit.

Background. Business-related meals such as those incurred while away from home overnight on business generally are subject to the Code Sec. 274(n) 50% deduction limit for meal and entertainment expenses. Under Code Sec. 274(n)(3), for tax years beginning in 2008 or thereafter, an 80% deduction limit applies to certain transportation workers, such as interstate truck operators and interstate bus drivers under Department of Transportation regulations. Under Code Sec. 274(e)(3)(B) and Code Sec. 274(n)(2)(A), the Code Sec. 274(n) deduction limit doesn't apply to a taxpayer who incurs an expense on behalf of a person other than an employer under a reimbursement or other expense allowance arrangement with the other person, if the taxpayer accounts for the expense to the other person, and the payment is not treated as compensation. This requires the taxpayer to substantiate each element of the expense to the person for whom he incurs the expense (time, place, business purpose and amount). Here, the Code Sec. 274(n) limit applies to the person for whom the expense was incurred.

Reg. § 1.274-2(f)(2)(iv)(a) provides that for Code Sec. 274 purposes, a reimbursement or other expense allowance arrangement is defined as it is under Code Sec. 62(a)(2)(A), i.e., an arrangement that shows the business connection of the expense, substantiates it, and provides for a return of excess reimbursements.

M&IE (meals and incidental expenses) incurred while traveling away from home on business are treated as an expense for food and beverages and are subject to the Code Sec. 274(n) limit. An employee who is reimbursed for M&IE may follow simplified substantiation procedures (time, place and business purpose).

In 2004, the Tax Court held in TLC Leasing that a company that leased truck drivers to independent trucking companies was the common-law employer of each driver-employee and, as a result, per diems paid by the leasing company to cover amounts spent by the drivers for food and beverages while traveling away from home were subject to the Code Sec. 274(n) deduction limit on meals. In the decision, client trucking companies submitted reports to TLC for each payroll period showing the gross wages and per diem amounts for each driver-employee. TLC made the appropriate payments to each driver-employee and sent the client company an invoice showing total expenses for all the driver-employees leased to the client.

The Tax Court's holding reached the result IRS had urged (but did so for different reasons).
In 2006, the Eighth Circuit reversed the Tax Court and held on the facts that the Code Sec. 274(n) limit did not apply to TLC because it was not the party that ultimately bore the per diem expenses. [See Federal Taxes Weekly Alert 08/31/2006] Instead, the limit applied to the client companies, who actually bore the per diem expense under the reimbursement arrangement between the parties. The appellate court concluded that status as a common law employer is not dispositive in the Code Sec. 274(n) analysis, but did not explicitly reject that status as a relevant factor.

IRS acquiescence. In Rev Rul 2008-23, IRS acquiesces in the result in TLC and agrees with the Eighth Circuit's opinion that the Code Sec. 274(n) deduction limit should apply to the party that ultimately bears the per diem expenses. However, IRS says it does not agree with the opinion to the extent that it could be read to imply that status as a common law employer is relevant to the Code Sec. 274(n) analysis.

Observation: The new ruling is much more than an unconventional vehicle for an acquiescence. It also formulates IRS's approach to situations where a reimbursed expense is substantiated and submitted to one party who in turn passes on the cost to someone else. The ruling also clarifies when IRS will and will not treat an M&IE (or a meals expense only) as substantiated to a third party. In TLC, there was no formal substantiation of the truckers' meal expenses in the generally accepted sense.

Substantiating to third party. The ruling establishes IRS's position where (1) an employee (or independent contractor) adequately substantiates a M&IE expense to an initial payor (i.e., a company like TLC) that initially makes the reimbursement, and (2) the initial payor in connection with its performance of services for a third party, is reimbursed under a reimbursement or other expense allowance arrangement with a third party. In this instance, IRS rules that if the initial payor accounts to the third party in the same manner that the employee (or independent contractor) accounted for the expenses to the initial payor, then the initial payor satisfies Code Sec. 274(e)(3)(B) and the third party bears the expenses and is subject to the Code Sec. 274(n) deduction limit on the expenses.

IRS illustrates this principle, and what it will treat as adequate substantiation to the third party, with three examples, all dealing with these common facts:

• Leasing Company (LC) leases its employee truck drivers to Client under a contract that provides that LC will calculate Client's periodic payments to cover LC's expenses (driver wages, payments of M&IE to drivers under a reimbursement arrangement between LC and the drivers, and other expenses) plus a profit. The M&IE are incurred while drivers travel overnight away from home on business. All reimbursements paid to Driver are paid under a "reimbursement or other expense allowance arrangement," within the meaning of Code Sec. 274(e)(3) between LC and each driver. Neither LC nor Client deducts the M&IE amounts as compensation on its originally filed income tax return, and neither of them treat the M&IE amounts as wages for withholding purposes.
• The employee leasing contract does not address which party reimburses the drivers' M&IE for purposes of applying the Code Sec. 274(n) deduction limit.
• Driver adequately accounts for his M&IE expenses to LC.
• Either LC or Client may be Driver's employer under the usual common law rules.

Illustration1: After Driver accounts to LC for M&IE, LC calculates his wages and any M&IE payments that may be due, and sends Client a billing invoice for a periodic payment due. The invoice does not itemize the M&IE reimbursement, but immediately after LC pays Driver, it sends Client a statement indicating the amount paid to Driver as a M&IE reimbursement. LC also accounts for the M&IE amount by delivering to Client a copy of the substantiation that Driver had originally submitted to LC. Client accepts the substantiation and acknowledges that the portion of its periodic payment equal to the amount that LC paid to reimburse Driver's M&IE is paid under a reimbursement arrangement with LC and is subject to the Code Sec. 274(n) deduction limit.

Illustration2: The facts are the same as in the first illustration except that Driver accounts for his M&IE to Client who in turn sends the paperwork to LC, which (a) calculates Driver's wages and any M&IE reimbursements that may be due, and (b) sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. After Client makes the invoice payment, LC pays both Driver's wages and M&IE reimbursement, and sends Client a statement indicating the amount paid to Driver as an M&IE reimbursement, and referring to the substantiation Client had received from Driver and had submitted (via a copy) to LC.

Results. In both illustrations (1) and (2), IRS concludes that LC meets the requirements of Code Sec. 274(e)(3) because (1) LC can prove that it has established a reimbursement or other expense allowance arrangement with Client, and (2) LC accounts to Client by (in the first illustration) delivering a copy of the substantiation that Driver had provided to LC or (in the second illustration) referring to the substantiation Driver originally submitted to Client. LC is not subject to Code Sec. 274(n) deduction limit and, instead, Client bears the expense of the M&IE, and is subject to the Code Sec. 274(n) for the M&IE, regardless of whether LC or Client is Driver's employer under the usual common law rules.

If the initial payor does not properly substantiate the M&IE expenses to the third party payor, then the initial payor will be treated as bearing the expenses and will be subject to the Code Sec. 274(n) deduction limit.

Illustration3: After calculating Driver's wages and any M&IE payments that may be due, LC sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. Client pays LC the lump-sum periodic payment, and then LC pays both Driver's wages and M&IE reimbursement.

Result. Because LC provides Client with only a lump-sum, non-itemized billing invoice, and does not account to Client or have a reimbursement or other expense allowance arrangement with Client, LC bears the expense of the M&IE and it is subject to the Code Sec. 274(n) deduction limit on Driver's M&IE, regardless of whether LC or Client is Driver's employer under the usual common law rules. Even if LC had provided an itemized invoice to Client designating part of the payment as an M&IE reimbursement. LC still does not satisfy Code Sec. 274(e)(3)(B) because it didn't adequately account to Client and didn't have a reimbursement or other expense allowance arrangement with Client.

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IRS Begins Focus on Foreign Athletes and Entertainers

The IRS recently launched an Issue Management Team focused

on improving U.S. income reporting and tax payment compliance by foreign athletes and entertainers who work in the United States. The initial focus is on those engaged in tennis, golf and music. These individuals and those associated with arranging their appearances in the U.S. and managing their financial affairs are typically high income individuals. Because of this, it is important to ensure proper tax reporting and payment.

IRS is using a three pronged approach for this initiative:

• improving the availability of information and guidance needed to help this group comply with income reporting and tax payment requirements
• providing IRS enforcement personnel with information they need to identify and work compliance issues frequently encountered with this population and
• conducting direct compliance and enforcement activity.

Artists and Athletes (Income Code 20)

Because many tax treaties contain a provision for pay to artists and athletes, a separate category is assigned these payments for withholding purposes. This category may include payments made for performances by public entertainers (such as theater, motion picture, radio, or television artists, or musicians), athletes, or other persons as defined by the applicable treaty article.

Note: As a general rule the tax treaty article dealing with artists and athletes must be applied before the articles on independent personal services and dependent personal services are applied to the income of the artists and the athletes.

As a general rule Form W-8ECI may not be used to exempt withholding on a payment for personal services provided by a foreign individual. In addition, special rules apply to artists and athletes who have formed partnerships or corporations as the beneficial owners of the income accruing to them. Refer to Withholding Exemption on Effectively Connected Income for more information.

Withholding Rate

You must withhold tax at a 30% rate on payments to artists and athletes for services performed as independent contractors. Refer to pay for independent Personal Services for more information. You must withhold tax at graduated rates on payments to artists and athletes for services performed as employees. Refer to pay for dependent Personal Services for more information. However, in any situation where the nature of the relationship between the payor of the income and the artist or athlete is not ascertainable, you should withhold at a rate of 30%.

Payments to a U.S. Agent of a Foreign Person

Caution should be taken when payments are made to a U.S. agent of a foreign person. Withholding agents who have knowledge that the payee is an agent of a foreign person must treat the payment as made to a foreign person. An exception is made for a payee who is a "financial institution".

Treasury Regulation 1.1441-1(b)(2)(ii) effective for payments made after December 31, 2000 Follows:

§1.1441-1. Requirement for the deduction and withholding of tax on payments to foreign persons.

(b)(2)(ii) Payments to a U.S. agent of a foreign person. A withholding agent making a payment to a U.S. person (other than to a U.S. branch that is treated as a U.S. person pursuant to paragraph (b)(2)(iv) of this section) and who has actual knowledge that the U.S. person receives the payment as an agent of a foreign person must treat the payment as made to the foreign person. However, the withholding agent may treat the payment as made to the U.S. person if the U.S. person is a financial institution and the withholding agent has no reason to believe that the financial institution will not comply with its obligation to withhold . . .

Central Withholding Agreements

Nonresident alien entertainers or athletes performing or participating in athletic events in the United States may be able to enter into a withholding agreement with the IRS for reduced withholding provided certain requirements are met. Under no circumstances will a withholding agreement reduce taxes withheld to less than the alien's anticipated income tax liability.

Nonresident alien entertainers or athletes requesting a central withholding agreement must provide the following information.

1. A list of the names and addresses of the nonresident aliens to be covered by the agreement.
2. Copies of all contracts that the aliens or their agents and representatives have entered into regarding the time period and performances or events to be covered by the agreement including, but not limited to, contracts with:
1. Employers, agents, and promoters,
2. Exhibition halls,
3. Persons providing lodging, transportation, and advertising, and
4. Accompanying personnel, such as band members or trainers.
3. An itinerary of dates and locations of all events or performances scheduled during the period to be covered by the agreement.
4. A proposed budget containing itemized estimates of all gross income and expenses for the period covered by the agreement, including any documents to support these estimates.
5. The name, address, and telephone number of the person the IRS should contact if additional information or documentation is needed.

The name, address, and employer identification number of the agent or agents who will be the central withholding agents for the aliens and who will enter into a contract with the IRS. A central withholding agent ordinarily receives contract payments, keeps books of account for the aliens covered by the agreement, and pays expenses (including tax liabilities) for the aliens during the period covered by the agreement.

When the IRS approves the request, the Associate Chief Counsel (International) will prepare a withholding agreement. The agreement must be signed by each withholding agent, each nonresident alien covered by the agreement, and the Commissioner or his delegate.

Generally, each withholding agent must agree to withhold income tax from payments made to the nonresident alien; to pay over the withheld tax to the U.S. Treasury on the dates and in the amounts specified in the agreement; and to have the IRS apply the payments of withheld tax to the withholding agent's Form 1042 account. Each withholding agent will have to file Form 1042 and Form 1042-S for each tax year in which income is paid to a nonresident alien covered by the withholding agreement. The IRS will credit the withheld tax payments, posted to the withholding agent's Form 1042 account, in accordance with the Form 1042-S. Each nonresident alien covered by the withholding agreement must agree to file Form 1040NR or, if he or she qualifies, Form 1040NR-EZ.

A request for a central withholding agreement should be sent to the address shown in the discussion found at Central Withholding Agreements at least 90 days before the agreement is to take effect.

Refer to Revenue Procedure 89-47, C.B. 1989-2, 598 for more information.

Tax Treaties

Under many tax treaties, compensation paid to artists, entertainers, or athletes for services performed in the United States is exempt from U.S. income tax only when the services are performed during a limited period of temporary presence in the United States and the pay is within limits provided in the tax treaty that applies (Refer to Table 2 of Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities (PDF)).

Employees and independent contractors may claim an exemption from withholding under a tax treaty by filing Form 8233 (PDF). Often, however, you will have to withhold at the statutory rates on the total payments to the artist, entertainer or athlete. This is because the exemption may be based upon factors that cannot be determined until after the end of the year.

References/Related Topics

• Withholding on Specific Income

Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.

Failure to follow IRS procedure prevented use of longer NOL carryback

Tualatin Valley Builders Supply, Inc. v. U.S. 101 AFTR 2d ¶ 2008688

Mike Habib, EA

myIRSTaxRelief.com

The Ninth Circuit, affirming a district court, has held that a taxpayer could not use the special 5-year carryback period that applied for net operating losses arising in tax year 2001 because the taxpayer did not follow IRS procedures for choosing that carryback period.

Dispute over 5-year carryback period. Tualatin Valley Builders Supply, Inc. (Tualatin), now dissolved, was seeking a refund of $366,043 of corporate income taxes assessed and collected from it for '96, plus interest. It filed a claim for refund of the '96 taxes with IRS in 2004. After IRS denied the claim and Tualatin lost administrative appeals, Tualatin went to district court.

Before the district court, Tualatin said it was entitled to claim an NOL carryback from its tax year ending Mar. 31, 2001, to its tax year ending Dec. 31, '96. IRS argued that Tualatin lost the opportunity to use the 5-year carryback period because it didn't timely elect to claim it.

Underlying facts. Tualatin timely filed its 2001 Form 1120 on Oct. 15, 2001 after getting an extension. At that time, it elected to utilize the 2-year carryback period for its NOL under Code Sec. 172(b)(1)(A). This election entitled Tualatin to choose between either amending its return for the year to which the NOL was being carried back in accordance with Code Sec. 6511, or filing for a tentative carryback adjustment for its NOL under Code Sec. 6411(a) . It chose to file for a tentative carryback adjustment. IRS granted the tentative carryback application and Tualatin received what is colloquially referred to as a "quickie refund" for the carryback of the 2001 NOL to '99.

Subsequent law change. Subsequently, in March 2002 [see Federal Taxes Weekly Alert 3/14/2002], Congress, in the Job Creation and Worker Assistance Act of 2002 (JCWAA), changed the law to provide an elective 5-year carryback period for NOLs arising in tax years ending in 2001 or 2002. (Code Sec. 172(b)(1)(H)) In mid-2002, IRS issued Rev Proc 2002-40, 2002-1 CB 1096, which addressed how a taxpayer who had already filed tax returns for 2001 or 2002 and had already elected a strategy for NOL carrybacks, could take advantage of the new March 2002 law (see Federal Taxes Weekly Alert 5/30/2002).

Specifically, Rev Proc 2002-40, Sec. 5.01 stated that a taxpayer (such as Tualatin) who had previously filed an application for a tentative carryback adjustment (whether or not IRS had acted upon it) or an amended return using a 2-year carryback period for an NOL incurred in a tax year ending in 2001 or 2002, and that did not elect to forgo the 5-year carryback period under Code Sec. 172(j), could use the 5-year carryback provided under Code Sec. 172(b)(1)(H) by following the procedures of Rev Proc 2002-40, Sec. 7 on or before Oct. 31, 2002.

Rev Proc 2002-40, Sec. 7 provided that corporations seeking to choose the 5-year carryback period had to file either a Form 1139, Corporation Application for Tentative Refund, or Form 1120X, Amended U.S. Corporation Income Tax Return. Rev Proc 2002-40, Sec. 5 explicitly required one of these two forms to be filed by Oct. 31, 2002 in order for a taxpayer to elect the 5-year carryback.

Action taken after deadline expired. IRS released Rev Proc 2002-40 on May 23, 2002 and published it in the Internal Revenue Bulletin on June 10, 2002. Tualatin attempted to amend its filing to take advantage of the new 5-year carryback by filing an amended return (Form 1120X) for the '96 tax year, on Jan. 7, 2003, over two months after the Oct. 31, 2002, deadline for such amendments established by Rev Proc 2002-40, Sec. 5. Because Tualatin acted after this deadline expired, IRS sought to have the case dismissed.

District court sided with IRS. The district court sided with IRS after pointing out that Code Sec. 172(j) provided that the election was to be made in such manner as IRS may prescribe and was to be made by the due date (including extensions of time) for filing the taxpayer's return for the tax year of the NOL. It also provided that the election, once made for any tax year, was irrevocable for that year. The court said that this language clearly gave IRS the explicit authority to determine how and when the election was to be made and that IRS exercised this authority by publishing Rev Proc 2002-40 . The instructions prescribed by IRS established the deadline of Oct. 31, 2002, for electing the five-year carryback. Rev Proc 2002-40 made it clear that unless the taxpayer followed the procedures of Rev Proc 2002-40, Sec. 7, the taxpayer would be considered to have made an election under Code Sec. 172(j) to forgo the 5-year carryback period in favor of the 2-year carryback period.

Ninth Circuit affirms. Before the Ninth Circuit, Tualatin argued that neither Code Sec. 172(j) nor a Congressional Letter to IRS on the intent concerning the carryback provision, directed IRS to issue rules specifically related to a taxpayer that filed an application for tentative adjustment under the 2-year carryback rule and then sought to apply the 5-year net operating loss carryback rule. The Ninth Circuit said that Congress authorized IRS, both generally and specifically, to promulgate rules implementing the new five-year carryback period. IRS did so in Rev Proc 2002-40 , which established an Oct. 31, 2002, deadline for taxpayers in Tualatin's position. The Ninth Circuit said that this deadline was consistent with the text of the statute and the authority Congress conferred on IRS. Moreover, Congress implicitly ratified Rev Proc 2002-40 when it made technical changes to the 5-year carryback provision in the Working Families Tax Relief Act of 2004 while leaving Rev Proc 2002-40 untouched.

The Court also held that because Rev Proc 2002-40 did not prohibit a taxpayer from filing a claim for refund in the absence of compliance, it neither shortened the period for filing a claim for refund or credit under Code Sec. 6511(d)(2)(A) nor conflicted with Code Sec. 6511(d)(2)(B)(i), which mandates that a refund from a carryback be allowed even if otherwise prevented by operation of law. Accordingly, it agreed with the district court that Tualatin's refund claim for '96 was untimely.

IRS rules that withholding exceptions for employees in foreign country don't apply - Chief Counsel Advice 200814010

Mike Habib, EA

myIRSTaxRelief.com

In Chief Counsel Advice (CCA), IRS has held that a U.S. employer had to withhold on wages it paid to employees working in a foreign country. The withholding exception under Code Sec. 3401(a)(8)(A)(ii) (dealing with foreign countries that require wage withholding) didn't apply. This conclusion wasn't altered by the employer's proposed arrangement that attempted to comply with both the U.S. and foreign country's withholding laws. The CCA also held that neither this nor another exception applicable to the Code Sec. 911 foreign earned income and housing cost exclusions applied to the foreign employees who were aliens. The CCA was issued even though the taxpayer withdrew its ruling request after being notified of IRS's intent to rule adversely.

Background. For income tax withholding purposes, "wages" doesn't include remuneration paid for services performed for an employer (other than the U.S. or a U.S. agency) by a U.S. citizen if, at the time of payment, it's reasonable to believe that the remuneration will be excluded from gross income under the Code Sec. 911 foreign earned income and foreign housing exclusions. Such payments are subject to withholding only to the extent that they are expected to exceed these exclusions. (Code Sec. 3401(a)(8)(A)(i)) Under another exception, "wages" don't include remuneration paid for services performed for an employer by a U.S. citizen if, at the time of payment, the employer is required by the law of the foreign country or U.S. possession to withhold income tax on the remuneration. (Code Sec. 3401(a)(8)(A)(ii))

In Rev Rul 79-392, 1979-2 CB 360, IRS ruled that a U.S. company wasn't required to withhold federal income tax on remuneration paid to its U.S. employees who serve as consultants to a foreign company and perform all services within the foreign country, where, under an agreement with the company, the foreign country assesses the income tax imposed by its law on the consultants on a direct collection basis.

Facts. X, a U.S. limited liability corporation, employed a number of U.S. citizens and U.S. resident aliens in a foreign country (foreign employees). Under the foreign country's tax procedures, its income tax (salaries tax) was remitted to its tax authority using a program of provisional tax payments submitted by individual employees.

X had been advised by counsel that payroll deductions that were not specifically permitted under the foreign country law were prohibited, except where a government official gave his express approval. X wasn't aware of any occasion where a government official gave such approval. This withholding prohibition didn't apply to amounts paid at the employer's discretion, and so the deduction of U.S. income tax withholding from discretionary bonuses paid to the foreign employees wasn't prohibited.

To comply with both the U.S. and foreign country's laws on withholding, X plans to adopt a proposed approach in which X would enter into an agreement with the foreign country tax authority to obtain an acknowledgment that X was the foreign employee's agent in connection with the purchase of tax reserve certificates (TRCs) on behalf of the foreign employee. The TRCs would be automatically redeemed by the foreign country tax authority on a first-in-first-out basis to settle any outstanding foreign country tax liabilities for each foreign employee. The foreign country tax authority would automatically redeem the TRCs (purchased on behalf of the specific foreign employee) to pay that foreign employee's foreign country tax liability on the tax due date. X believed that it would be replicating a tax withholding system by deducting approximately 16% of the foreign employee's gross compensation to purchase TRCs in the same amount for the foreign employee's foreign country TRC account to satisfy applicable foreign country tax.

Conclusions. The CCA ruled that because the foreign country didn't require income tax withholding on the wages of X's foreign employees, remuneration paid to them didn't qualify for the exception under Code Sec. 3401(a)(8)(A)(ii), regardless of whether X entered into its proposed approach. IRS rejected X's comparison of its approach to that in Rev Rul 79-392. Under the facts in Rev Rul 79-392, the company was required under the law of the foreign country to withhold income tax on the remuneration paid to the consultants. However, in X's case, the foreign country law doesn't require withholding from the remuneration paid to X's employees. Rather, the foreign country prohibits withholding on wages (as wages is defined for this purpose under foreign country law) unless there is an agreement between the employer and employee approved by the foreign country tax authority. Thus, the two situations deal with different facts, and Rev Rul 79-392 doesn't support X's proposed approach.

X's funding of the TRCs through the proposed approach wouldn't require X to withhold foreign country income tax from the wages of the foreign employees for purposes of the Code Sec. 3401(a)(8)(A)(ii) exception. Furthermore, IRS was unaware of any amendment to X's proposed approach that would require X to withhold the foreign country income tax from X's foreign employees' wages under Code Sec. 3401(a)(8)(A)(ii), in light of X's representation that the foreign country law provided that no withholding of foreign country income tax was required from employees' wages.

The CCA also ruled that neither the exception in Code Sec. 3401(a)(8)(A)(i) or the one in Code Sec. 3401(a)(8)(A)(ii) applied to remuneration for services performed by individuals who were aliens (whether a resident alien or a nonresident alien). Thus, these exceptions couldn't apply to an X employee who is an alien individual.

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Foreclosure Prevention Act of 2008 - S

enate passes housing stimulus bill

Mike Habib, EA
myIRSTaxRelief.com

On Apr. 10, the Senate by a vote of 84 to 12 approved H.R. 3221, the "Foreclosure Prevention Act of 2008," the Senate housing stimulus bill. Before final passage of the bill, the Senate approved an amendment offered by Senator John Ensign (R-NV) that would extend various clean energy production incentives.

Key provisions in the bill would:

(1) Extend the net operating loss (NOL) carryback for losses incurred in tax years 2008 and 2009 from the two year carryback permitted currently to four years (back to 2004 and 2005, respectively) to aid homebuilders and other businesses hit hardest by the economic slump. Taxpayers would be given the choice of (a) electing the longer NOL carryback, or (b) claiming the larger expensing allowance and bonus first year depreciation authorized by the Economic Stimulus Act of 2008.

(2) Modernize the tax rules for real estate investment trusts (REITs) to provide them with flexibility to reflect recent changes in real estate markets.

(3) Allow businesses unable to benefit from bonus depreciation due to extended periods in a loss position to receive refunds of alternative minimum and research and development credits when they make investments.

(4) Create a new standard deduction for property taxes paid by nonitemizers. The deduction, available only for tax years beginning in 2008, would be $500 for single filers and $1,000 for joint filers. This relief would not be available if the rate of tax for all residential real property taxes in the jurisdiction is increased after Apr. 2, 2008, and before Jan. 1, 2009.

(5) Create a tax credit for taxpayers who buy foreclosed single-family homes and use them as their principal residences. The credit would be: available for the purchase of only one home; up to $7,000 of the cost of the home; claimed ratably over two tax years; and available for purchases made within a one year period beginning after the date of enactment. Eligible single-family homes would be those upon which foreclosure has been filed under state law, and that: (a) are new, previously unoccupied residences for which a building permit was issued and construction began before Sept. 1, 2007; or (b) were occupied as a residence by a mortgagor for at least one year before the foreclosure filing.

(6) Allows victims of Hurricanes Katrina and Rita to adjust casualty loss deductions taken in addition to grant payments to cover uninsured losses caused by the hurricanes. The provision would allow the use of amended income tax returns to take into account receipt of certain hurricane-related casualty loss grants by disallowing previously taken casualty loss deductions. The provisions also would waive the deadline on the construction of GO Zone property which is eligible for bonus depreciation.

(7) Increase the overall allocation to mortgage revenue bonds by an additional $933 million.


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Memo explains how state property tax credits are taxed and reported - Chief Counsel Advice 200814022

Mike Habib, EA

myIRSTaxRelief.com

In Chief Counsel Advice, IRS has explained the proper federal income tax treatment of certain state property tax credits and the extent to which the state must provide information reports about the credits to IRS under Code Sec. 6041 or Code Sec. 6050E.

Background on tax benefit rule. In general, a taxpayer who receives a refund of state taxes previously deducted on a prior year's federal income tax return must include the refund in gross income in the year received to the extent of any federal income tax benefit, unless all or part of the income is excluded under Code Sec. 111. A taxpayer who receives a refund of state taxes that were not previously deducted on a prior year's federal income tax return is not required to include the refund in gross income in the year received. (Rev Rul 93-75, 1993-2 CB 63)

Facts. State X real property taxes are imposed on a calendar year period and become due Date 1 of the following year. Taxpayers receive a discount if they pay their real property taxes by Date 3.

State X mobile home taxes are imposed on a calendar year period and become due Date 2 of the same year. Taxpayers receive a discount if they pay their mobile home taxes by Date 3.

State Statute A provides for a homestead income tax credit for individuals during Year 1 and Year 2. The credit is equal to 10% of the real property taxes or mobile home taxes that were levied against an individual's homestead, became due during the tax year, and were paid anytime before filing the income tax return claiming the credit (including a timely filed amended return). If the credit exceeds an individual's state income tax liability, the taxpayer can carry forward the unused credit for up to five years. Alternatively, he can request that the state tax commissioner issue a certificate for the unused portion of the credit. The certificate can be used against any of the taxpayer's real property tax or mobile home tax liabilities that become due during the tax year following the year for which the taxpayer claimed the credit. The counties in State X will treat the receipt of a certificate as a payment when it is transferred to them. The counties will have the authority to implement a system that applies the certificate to the following year's liability or (at the county's option) also permits a cash refund if a taxpayer has already paid the real property tax or mobile home tax liability that becomes due during the income tax taxable year following the year for which the taxpayer claimed the credit. This election to carry forward or receive a certificate is irrevocable.

State Statute B provides for a commercial property income tax credit for individuals and corporations during tax years Year 1 and Year 2. The amount of the credit is equal to 10% of the real property taxes or mobile home taxes that were levied against a taxpayer's commercial property, became due during the tax year, and were paid anytime before filing the income tax return claiming the credit (including a timely filed amended return). If the credit exceeds a taxpayer's income tax liability, the taxpayer can carry forward the unused credit for up to five years but there is no option to receive a certificate for the unused portion of the State Statute B credit.

Federal taxable income is used as a starting point in calculating State X income tax for corporations as well as individuals, and there is no add back if a taxpayer claims the Statute A or B credit and takes a deduction on the federal return for real property taxes or mobile home taxes paid or accrued. Consequently, the State Statute B credit is in addition to a deduction for state income tax purposes.

Proper tax treatment of State Statute A credit. The CCA concluded that the following general tax treatment applies when the State Statute A credit exceeds an individual's state income tax liability:

• the credit carryforward should be treated as a reduction in the taxpayer's state income tax liability in the carryforward years and
• the use of a certificate to timely satisfy a real property tax or mobile home tax liability should be treated as a reduction in the taxpayer's real property tax or mobile home tax liability.

Each of these reductions affects the amount deductible under Code Sec. 164(a). Additionally, in a county that permits a refund if a taxpayer has already paid the real property tax or mobile home tax liability that becomes due during the tax year following the year for which the taxpayer claimed the credit, such a refund would be subject to the general rules concerning the tax benefit rule, as discussed above, for taxpayers using the cash method who receive the refund in a year after the real property tax or mobile home tax liability was paid. If the real property tax or mobile home tax refund occurs during the same tax year those taxes were paid, the refund reduces the amount otherwise deductible under Code Sec. 164 by a taxpayer using the cash method.

Proper tax treatment of State Statute B credit. The CCA observed that the State Statute B credit can affect only a taxpayer's state income tax liability for the year the credit is claimed or for a carryforward year. Accordingly, this credit should be treated as a reduction in a taxpayer's state income tax liability. This affects the amount deductible under Code Sec. 164(a)(3).

Information reporting. Code Sec. 6050E requires information reporting for state and local income tax refunds. Form 1099-G is used for this purpose. The CCA said that, in the case of State Statute A, if a taxpayer uses the credit against his state income tax liability for the year the credit is claimed, and receives a refund of state income tax for that year, the amount of the refund must be reported by the state refund officer on Form 1099-G. A copy of the Form 1099-G must be sent to the taxpayer. (Code Sec. 6050E(b)) However, the refund officer need not furnish this statement to the taxpayer if the refund officer verifies that the taxpayer did not claim itemized deductions for federal income tax purposes. (Reg. § 1.6050E-1(k))

If the credit is carried forward and applied to reduce state income tax liability in subsequent years, any state income tax refunds in those subsequent years will be subject to Code Sec. 6050E reporting.

The use of a certificate to pay, reduce or obtain a refund of real property or mobile home tax is outside of Code Sec. 6050E, as it is not a state income tax refund. Instead, any information reporting for a certificate would be based on Code Sec. 6041, which requires information reporting for payments of $600 or more made in the course of a trade or business for rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income. If the refund is reportable under Code Sec. 6041, the amount reported would be shown on a Form 1099-MISC, in box 3 "Other income."

Reg. § 1.6041-1(b)(1) and Reg. § 1.6041-1(i) provide that payments made by a state or a political subdivision are subject to this reporting requirement. Payments are only reportable under Code Sec. 6041 to the extent they constitute fixed or determinable income. Under Reg. § 1.6041-1(c), income is fixed when it is to be paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained. A taxpayer's use of a certificate to timely satisfy real property or mobile home tax is treated as a reduction in the tax liability and not as income. Therefore, there is no required reporting under Code Sec. 6041 as there is no fixed or determinable income. If, however, the county permits a refund based on the application of the certificate, there may be income if the taxpayer previously deducted these taxes, based on the tax benefit rule. In that case, the refund must be reported on Form 1099-MISC to the extent it is income. The county does not have a reporting obligation if it cannot determine the amount that is fixed or determinable income.

In the case of State Statute B, a taxpayer can only use the credit to reduce its state income tax liability for the year the credit is claimed or a carryforward year. Any state income tax refund received by individual taxpayers must be reported on Form 1099-G, under Code Sec. 6050E, regardless of whether all or part of the refund does not constitute income. Code Sec. 6050E does not apply to state income tax refunds issued to corporations.

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IRS wrongfully revoked DLC's tax-exempt status

Democratic Leadership Council, Inc. v. U.S., 101 AFTR 2d ¶ 2008-661

Mike Habib, EA

myIRSTaxRelief.com

A district court has held that IRS violated its own regs when it retroactively revoked the tax exempt status of the Democratic Leadership Council (DLC) as a Code Sec. 501(c)(4) social welfare organization.

Facts. In '85, several prominent Democrats, including then-Governor Bill Clinton, formed the DLC. Specifically, on Nov. 8, '85, the DLC filed its Form 1024 application with IRS for tax-exempt status as a "social-welfare" organization under Code Sec. 501(c)(4). The application included the DLC's Articles of Incorporation. It further explained that the DLC was organized by certain elected officials and others who were concerned with the formulation of national policy and with the direction of policy debate within the Democratic Party.

The application stated that "the organization was conceived as an active forum for the development of fresh policy options and approaches which could spark and advance public debate." To further this purpose, the application stated, the DLC intended to: create task forces; hold town meetings and issue forums with business, labor, civic, student, and other audiences; hold policy meetings; contract for studies; initiate public-affairs programs (including press conferences, meetings with editorial boards, and press releases); and host fund-raising receptions.

The application also represented that the DLC would "not intervene in campaigns on behalf of any public candidate," nor "seek to influence voter perceptions indirectly, such as by establishing voting records or other ratings of candidates."

On Feb. 7, '86, based on the DLC's application for exempt status, IRS recognized the DLC as a tax-exempt organization under Code Sec. 501(c)(4).

In 2002, IRS revoked the DLC's tax-exempt status for the years '97, '98, and '99, concluding that the DLC rendered an impermissible level of private benefit during those yearsnamely, support to Democratic officials.

The DLC paid approximately $20,000 in total taxes and interest for those years, but filed a suit for a refund.
IRS didn't revoke the DLC's tax-exempt status for any time period since tax year '99. Accordingly, since that time, the DLC has filed each year as a tax-exempt, Code Sec. 501(c)(4) organization.

Parties's arguments. Under Reg. § 601.201(n)(6), the revocation or modification of a determination letter or ruling recognizing exemption may be retroactive if the organization omitted or misstated a material fact, operated in a manner materially different from that originally represented, or engaged in a prohibited transaction of the type described in the regs. The DLC contended that it was entitled to summary judgment because (1) it qualified as a Code Sec. 501(c)(4) organization during the years at issue and (2), even if it did not so qualify, IRS improperly revoked the DLC's Code Sec. 501(c)(4) status retroactively in violation of Reg. § 601.201(n)(6) because the DLC did not omit or misstate a material fact, or operate in a manner materially different from that originally represented.

IRS countered that it was entitled to summary judgment because (1) the DLC did not qualify as a Code Sec. 501(c)(4) organization during the years in issue; and (2) the retroactive revocation of Code Sec. 501(c)(4) status was permissible because the cited reg does not apply in refund suits and, in any event, IRS complied with the reg.

Wrongful revocation. The district court acknowledged that there could be legitimate questions as to whether the DLC was entitled to Code Sec. 501(c)(4) status. However, it held that because the DLC did not omit or misstate a material fact in its '85 application for that status or operate in a manner materially different from that originally represented when the IRS granted it that status, IRS violated its regs when it retroactively revoked the DLC's tax-exempt status. Accordingly, the court granted summary judgment to the DLC and ordered a refund of the taxes the DLC paid for the years in question.

Kickback Income Tax Fraud - Ballard finally prevails in reversal by Eleventh Circuit

Ballard, (CA 11 4/7/2008) 101 AFTR 2d ¶ 2008-659

Mike Habib, EA

myIRSTaxRelief.com

In the latest chapter of a case with a long and storied history, the Eleventh Circuit rejected the Tax Court's findings that a taxpayer fraudulently failed to pay tax on kickback income. Instead, the Eleventh Circuit sent the case back to Tax Court directing it to adopt the original Special Trial Judge's Report as the Tax Court's opinion.

Observation: That was good news for the taxpayer because the Special Trial Judge found that the taxpayer did not sell his influence for kickbacks and hence did not fraudulently underreport his income.

Background in brief. Claude Ballard, Burton W. Kanter, and Robert Lisle received multiple notices of deficiency going back several years. Specifically, IRS charged that, during the '70's and '80's, Ballard and Lisle, real estate executives at the Prudential Life Insurance Company of America, had an arrangement with Kanter, a tax lawyer and business entrepreneur, under which people seeking to do business with Prudential made payments to corporations controlled by Kanter. IRS said that those payments were then distributed to Kanter, Ballard, and Lisle, or to entities they controlled but were not reported by Ballard, Kanter, and Lisle on their individual tax returns. The taxpayers went to Tax Court where their cases were consolidated and assigned to Special Trial Judge (STJ) Couvillion. His findings were given to Tax Court Judge Dawson, who found that Ballard, Kanter, and Lisle had acted with intent to deceive IRS, and held them liable for underpaid taxes and substantial fraud penalties. In so ruling, Judge Dawson purported to collaborate with Judge Couvillion and adopt the findings contained in the report submitted by Judge Couvillion.

The taxpayers came to believe that the document titled "Opinion of the Special Trial Judge" was not in fact a reproduction of Judge Couvillion's report. A declaration by Kanter's attorney attested to conversations with two Tax Court judges who said that Judge Couvillion had concluded that Ballard, Kanter, and Lisle did not owe taxes with respect to payments made by certain individuals seeking to do business with Prudential, and that the fraud penalty was not applicable.

The taxpayers filed motions in Tax Court to get the underlying special report released but the Tax Court refused to do so. They appealed to their respective Circuits Courts of Appeal (Fifth, Seventh and Eleventh Circuits) and lost. Having rejected the taxpayers' objection to the absence of the special trial judge's report from the record on appeal, the Seventh and Eleventh Circuits proceeded to the merits of the Tax Court's final decision and affirmed that decision in principal part.

The Supreme Court agreed that no statute authorizes, and the then-applicable text of Rule 183 (governing two-tier proceedings in which a STJ hears the case but the Tax Court itself renders the final decision) did not warrant, concealment of the special trial judge's report. It thus reversed the holdings of the Seventh and Eleventh Circuit Courts of Appeal that disclosure was not required and directed those Courts to conduct further proceedings in accordance with its decision.

In response to the Supreme Court's holding, the Tax Court amended Rule 183 to provide a procedure for service on the parties of a Special Trial Judge's recommended findings of fact and conclusions of law and the filing of objections and responses.

Subsequently, the Seventh Circuit remanded the Kanter cases to the Tax Court "for further proceedings consistent with the Supreme Court's decision ...." The Eleventh Circuit then remanded the cases to the Tax Court, directing, among other items, that: (1) the collaborative report and opinion of the Tax Court be stricken; (2) the original report of the STJ be reinstated; and (3) the matter be assigned to a regular Tax Court Judge who had no involvement in the preparation of the collaborative report. The Eleventh Circuit directed that: (1) the Tax Court to proceed to review the matter giving due regard to the credibility determinations of the special trial judge and presuming correct fact findings of the trial judge; and (2) Special Trial Judge Couvillion's findings of fact are to be presumed correct "unless manifestly unreasonable." Finally, the Fifth Circuit directed the Tax Court to reexamine its findings consistent with the Eleventh Circuit's instructions.

In Estate of Burton W. Kanter, deceased, Joshua S Kanter, Executor, et al, TC Memo 2007-21, a mammoth 457-page decision dealing with 23 different issues, the Tax Court, in an opinion by Judge Haines, by and large sustained IRS's positions. Moreover, in two instances, the Tax Court rejected as "manifestly unreasonable" the STJ report's acceptance of the taxpayers' testimony. There were, however, three exceptions in which the taxpayer prevailed (dealing with an '86 interest expense deduction, an '80 business expense deduction, and an '83 charitable contribution), and a finding in one instance that an adjustment was overlooked. Ballard appealed to the Eleventh Circuit.

Eleventh Circuit reversal. The essential question before the Eleventh Circuit was whether Judge Haines (the Tax Court judge in the 2007 decision) gave due regard to the fact findings of the STJ. For reasons explained in considerable detail in its opinion, the Eleventh Circuit held that Judge Haines did not.

The Appeals Court concluded that the STJ's findings of fact and credibility determinations were supported by the record and that his finding that Ballard was not responsible for a deficiency and had not committed fraud were not manifestly unreasonable. The Eleventh Circuit concluded that, in finding otherwise, Judge Haines did not presume the STJ's findings to be correct or give his credibility determinations their due deference, as required by Tax Court Rule 183. Rather, Judge Haines conducted a nearly de novo review of the facts in violation of Rule 183 and the Eleventh Circuit's prior instructions.

The Eleventh Circuit did acknowledge that this case was a close call. It noted that had Judge Haines been the original trial judge, his rulings would probably be entitled to an affirmance. However, he was not the trial judge and did not see or hear the witnesses. The STJ did and found them credible. Accordingly, the Appeals Court sent the case back to the Tax Court with instructions to vacate Judge Haines' opinion and enter an order approving and adopting the STJ's original report as the opinion of the Tax Court.

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The most important IRS Tax Development in Q1 2008

Mike Habib, EA

myIRSTaxRelief.com

While the Economic Stimulus Act of 2008 was the most significant development in the first quarter of 2008, many other tax developments may affect you, your family, and your livelihood. The new law changes and other key developments are summarized below. Please contact us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Economic Stimulus Act. On Feb. 13, President Bush signed the "Economic Stimulus Act of 2008" (Stimulus Act) into law. The centerpiece of the Stimulus Act, which was designed to bolster the sagging economy, was a provision that puts extra cash into the hands of most Americans. Most will receive a rebate check in 2008 from the IRS based on the filing status and income stated on their 2007 return (which is filed in 2008). Some will get a tax credit in 2009 when they file their returns for tax year 2008, and still others (depending largely on income in tax years 2007 and 2008) may receive a combination of a rebate check in 2008 and an income tax credit in 2009. To receive the cash rebate, taxpayers, including many who wouldn't ordinarily have to file a return, must file a return for tax year 2007. Key provisions in the Stimulus Act include:

• Most taxpayers are to receive cash rebate payments, which typically will equal the amount of tax liability on the 2007 return, up to a maximum amount of $600 for individuals ($1,200 for taxpayers who file a joint return) and a minimum of $300 for individuals ($600 for taxpayers who file a joint return). There is also an additional $300 for each qualifying child. The rebates are reduced by 5% of adjusted gross income (AGI) in excess of $75,000 for individuals and $150,000 for those who are married and file jointly. Those individuals who have little or no tax liability may also qualify for a minimum payment of $300 ($600 if filing a joint return) if they file a tax return that reflects $3,000 or more in qualifying income (which includes Social Security benefits, railroad retirement benefits, and certain disability or survivors' benefits from the Veterans Administration).
• Expensingis made much more attractive. The amount that a taxpayer could otherwise expense, $128,000, has been increased to $250,000 for tax years that begin in 2008. And, the $510,000 overall investment limit (beyond which there's a phaseout of current expensing) has been increased to $800,000.
• In addition to the usual depreciation allowed for business property, taxpayers may take an extra "bonus" depreciation deduction for the first year certain property is placed in service. A bonus first-year depreciation deduction of 50% of adjusted basis is allowed for qualified property (most new personal property and software) acquired and placed in service after Dec. 31, 2007, and before Jan. 1, 2009. (The liberalized rules for writing off business autos are covered below.)
  

Zero tax on long-term capital gain and dividend income. Beginning this year and continuing through 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate (last year, a 5% rate applied to such income). This low rate has an impact not only on lower-bracket individuals but also, surprisingly, on some whose top dollars are taxed well in excess of 15%. The amount of income taxed at 0% depends on the interplay between an individual's filing status, his taxable income, and how much of that taxable income consists of long-term capital gain and qualifying dividend income.

$1 million deduction limit. Generally, a publicly held corporation's deduction for compensation paid during a tax year to its chief executive officer or any of its four highest paid officers is limited to $1 million. The IRS has formally ruled that compensation paid to an executive is not excepted from this limit as qualified performance-based compensation if the plan or contract under which it's paid also provides for payment to the executive on: (1) termination without cause or for the executive's resignation for good reason or (2) voluntary retirement. In a concession to taxpayers, the IRS will only apply this new interpretation of the rules prospectively.

Quicker deduction for payroll tax on bonuses and vacation pay. The IRS has allowed employers who use the accrual method of accounting and incur payroll taxes (Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax) to take a deduction for bonuses and vacation pay in an earlier year than the year in which the amounts are paid in many cases. The IRS now allows these employers to use the recurring item accounting exception. In general, under this exception taxpayers may be able to currently deduct certain recurring liabilities that they pay on or before the earlier of when they must file their returns (including extensions), or the 15th day of the ninth calendar month after the close of the tax year.

Lifetime payouts to nonspouse IRA beneficiary. In a private letter ruling, the IRS has allowed a nonspouse beneficiary of an individual retirement account (IRA) to salvage lifetime payouts even though she failed an essential rule requiring distributions to begin by the end of the year following that of the IRA owner's death. Generally, where an IRA owner dies before he must start taking annual required minimum distributions, the IRA must be distributed to a nonspouse beneficiary either within five years of his death, or over the life or life expectancy of the designated beneficiary. To qualify for the latter alternative, the distributions must begin no later than one year after the deceased owner's death. However, the IRS allowed the beneficiary, who made up her missed annual required minimum distributions and paid a penalty excise tax, to avoid the tough five-year payout rule. This was an extremely favorable result for the taxpayer, allowing her to avoid quickly depleting the IRA (and by so doing, having to likely pay more taxes, sooner). The ruling illustrates the hazards of not receiving expert tax advice when dealing with post-death IRA distributions.

Trust's investment advice fees. The Supreme Court has held that investment advisory fees paid by a trust were deductible only to the extent that they exceeded 2% of the trust's adjusted gross income (AGI). Thus, such expenses didn't qualify for the exception to the 2% of AGI limit in the tax law for costs paid or incurred in connection with the administration of a trust or estate that wouldn't have been incurred if the property weren't held in the trust or estate. However, for the sake of administrative convenience, the IRS has provided that, for tax years beginning before Jan. 1, 2008, nongrantor trusts and estates will not have to "unbundle" a fiduciary fee (i.e., separate the fee into components that are subject to the deduction limit and those that aren't). As a result, for 2007 tax years, affected taxpayers can deduct the full amount of a bundled fiduciary fee without regard to the 2% floor.

Luxury auto depreciation limits for 2008. Under special "luxury automobile" rules, a taxpayer's otherwise available depreciation deduction for business autos, light trucks, and minivans is subject to additional limits, which operate to extend depreciation beyond its regular period. The IRS has released the inflation-adjusted depreciation limits for business autos, light trucks and vans (including minivans) placed in service in 2008e.g., $10,960 for autos first place in service in 2008; $11,160 for light trucks or vans first place in service in 2008.

Chances of being audited. The IRS has issued its annual data book, which provides statistical data on its fiscal year 2007 activities, including how many tax returns it examines (audits), and what categories of returns it focuses its resources on. Out of a total of 135 million individual returns filed in calendar year 2006, about 1,384,563 individual income tax returns (1.0%) were audited during fiscal year 2007, slightly more than those examined in the prior year. Of the 1.5 million individual farm returns that showed gross receipts from farming (Schedule F), only 5,705 (0.4%) were audited in 2007. For returns with total positive income 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 of $1 million or more, the audit rate was 9.3%. The audit rate for corporations with less than $10 million of assets was 0.9% (up from 0.8% in the prior year); and for corporations with $10 million or more of assets, it was 16.8% (down from 18.6%). The audit rate for S corporations was 0.5% (up from 0.38% for the prior year); and for partnerships it was 0.4% (up from 0.36%).

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Avoiding IRS Tax Penalties and the Tax Gap

Mike Habib, EA
myIRSTaxRelief.com

IRS -- The Internal Revenue Code imposes many different kinds of penalties, ranging from civil fines to imprisonment for criminal tax evasion.

If you do not file your return and pay your tax by the due date, you may have to pay a penalty. You may also have to pay a penalty if you substantially understate your tax, understate a reportable transaction, file an erroneous claim for refund or credit, or file a frivolous tax submission. If you provide fraudulent information on your return, you may have to pay a civil fraud penalty.

Penalties are generally payable upon notice and demand. Penalties are generally assessed, collected and paid in the same manner as taxes. The notice will contain the name of the penalty, the applicable code section, and how the penalty was computed (or information on how to obtain the computation if not included).

This fact sheet is the 22nd in the Tax Gap series. It provides additional guidance to taxpayers regarding civil penalties and the consequences for understating income and overstating expenses.

Estimated Tax-Related Penalties

Employees have taxes withheld from their paychecks by their employer. When you have income that is not subject to withholding you may have to make estimated tax payments during the year.

This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes, and awards. You also may have to pay estimated tax if the amount being withheld from your salary, pension, or other income is not enough to pay your tax liability.

Estimated tax payments are used to pay income tax and self-employment tax, as well as other taxes and amounts reported on your tax return. If you do not pay enough through withholding or estimated tax payments, you may have to pay a penalty. If you do not pay enough by the due date of each payment period you may be charged a penalty even if you are due a refund when you file your tax return.

Penalties for filing or paying taxes late

The most common penalties are for filing late or paying taxes late.

Filing late: If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually 5 percent for each month or part of a month that a return is late, but not more than 25 percent. The penalty is based on the tax not paid by the due date (without regard to extensions).

If you file your return more than 60 days after the due date, the minimum penalty is $100 or, if less, 100 percent of the tax on your return.

Paying tax late: You will have to pay a failure-to-pay penalty of ½ of 1 percent (0.5 percent) of your unpaid taxes for each month, or part of a month, after the due date that the tax is not paid. This penalty does not apply during the automatic six-month extension of time to file period if you paid at least 90 percent of your actual tax liability on or before the original due date of your return and pay the balance when you file the return.

The failure-to-pay penalty rate increases to a full 1 percent per month for any tax that remains unpaid the day after a demand for immediate payment is issued, or 10 days after notice of intent to levy certain assets is issued.

For taxpayers who filed on time, the failure-to-pay penalty rate is reduced to ¼ of 1 percent (0.25 percent) per month during any month in which the taxpayer has a valid installment agreement in force.

Combined penalties: For any month both the penalty for filing late and the penalty for paying late apply, the penalty for filing late is reduced by the penalty for paying late for that month, unless the minimum penalty for filing late is charged.

Accuracy Related Penalties

The two most common accuracy related penalties are the "substantial understatement" penalty and the "negligence or disregard of the rules or regulations" penalty. These penalties are calculated as a flat 20 percent of the net understatement of tax.

Penalty for substantial understatement

You understate your tax if the tax shown on your return is less than the correct tax. The understatement is substantial if it is more than the larger of 10 percent of the correct tax or $5,000 for individuals. For corporations, the understatement is considered substantial if the tax shown on your return exceeds the lesser of 10 percent (or if greater, $10,000) or $10,000,000.

You may avoid the substantial understatement penalty if you have substantial authority for your tax treatment of the item or through adequate disclosure. To avoid the substantial understatement penalty by adequate disclosure, you must properly disclose the position on the tax return and there must at least be a reasonable basis for the position.

To properly disclose the position, complete and attach IRS Form 8275 to your tax return and disclose all relevant facts. A reasonable basis is one that has approximately 10 percent or greater chance of success if challenged. This means that the position must be more than just arguable. There must be some authority supporting the position.

Penalty for negligence and disregard of the rules and regulations

"Negligence" includes (but is not limited to) any failure to:

* make a reasonable attempt to comply with the internal revenue laws

* exercise ordinary and reasonable care in preparation of a tax return or

* keep adequate books and records or to substantiate items properly

This penalty may be asserted if you carelessly, recklessly or intentionally disregard IRS rules and regulations - by taking a position on your return with little or no effort to determine whether the position is correct or knowingly taking a position that is incorrect. You will not have to pay a negligence penalty if there was a reasonable cause for a position you took and you acted in good faith.

Civil Fraud penalty

If there is any underpayment of tax on your return due to fraud, a penalty of 75 percent of the underpayment due to fraud will be added to your tax. The fraud penalty on a joint return does not apply to a spouse unless some part of the underpayment is due to the fraud of that spouse.

Negligence or ignorance of the law does not constitute fraud.

Typically, IRS examiners who find strong evidence of fraud will refer the case to the Internal Revenue Service Criminal Investigation Division for possible criminal prosecution. Keep in mind that both civil sanctions and criminal prosecution may be imposed.

Frivolous Tax Return penalty

You may have to pay a penalty of $5,000 if you file a frivolous tax return or other frivolous submissions. If you jointly file a frivolous tax return with your spouse, both you and your spouse each may have to pay a penalty of $5,000. A frivolous tax return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax you reported is substantially incorrect.

You will have to pay the penalty if you filed this kind of return or submission based on a frivolous position or a desire to delay or interfere with the administration of federal tax laws. This includes altering or striking out the preprinted language above the space provided for your signature.

This penalty is added to any other penalty provided by law.

Penalty for bounced checks

If you write a check to pay your taxes and the check bounces, the IRS may impose a penalty. The penalty is either 2 percent of the amount of the check - unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less.

The bottom line is that you must report all your income, file your return and pay your tax by the due date to avoid interest and penalty charges.

For more information about IRS notices and bills, refer to Publication 594 (PDF), Understanding the Collection Process. More information about penalty and interest charges is contained in Chapter 1, Filing Information, of Publication 17, Your Federal Income Tax.

If you are an individual or a business and been assessed by the IRS tax penalties and wish to abate these penalties, contact us as quick as possible.

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 detail donee's filing requirements for qualified intellectual property contributions
T.D. 9392, 04/04/2008; Reg. § 1.6050L-2

Mike Habib, EA

MyIRSTaxRelief.com
IRS has issued final regs explaining the information return requirements for donees receiving net income from qualified intellectual property contributions made after June 3, 2004.

Background. A taxpayer's deduction for the donation of "qualified intellectual property" - patents, certain copyrights, trademarks, trade names, trade secrets, know-how, certain software, and similar property, other than property contributed to for the use of a private foundationis limited to the donor's basis, if that is less than the property's fair market value at the time of the initial contribution. (Code Sec. 170(e)(1)(B)) Subject to limitations, the donor can take an additional deduction in the year of contribution and in succeeding years based on a sliding-scale percentage (from 100% to 10% depending on the year after the initial contribution) of the "qualified donee income" that the charitable donee receives or accrues from that contributed property. (Code Sec. 170(m)(1)) An additional deduction in any year is allowed only to the extent that the aggregate of the specified percentages of qualified donee income exceeds the initial deduction claimed by the donor for the intellectual property itself. (Code Sec. 170(m)(2))

A donee of qualified intellectual property who is notified by the donor that he intends to take the additional charitable deduction for "qualified donee income" must: (1) file an information return (Form 8899, Notice of Income from Donated Intellectual Property) for each of the donee's tax years showing the amount of any qualified donee income and (2) furnish the donee with a copy of the return. (Code Sec. 6050L)

In May of 2005, IRS issued temporary and proposed regs explaining how donees file this information return. These regs were generally effective for qualified intellectual property contributions made after June 3, 2004, but included several transition rules.

Final regs on donee's filing obligation. The final regs adopts the provision in the temporary and proposed regs with only minor changes. The final regs do not include the transition rules in the temporary and proposed regs, which are no longer necessary.

Under the final regs, if a charitable organization, other than a private foundation that doesn't qualify as a 50% charity, receives or accrues net income during a tax year from a qualified intellectual property contribution, it must make an annual information return at the time and on the form prescribed by IRS. A donee isn't required to file an information return if:

• the property isn't qualified intellectual property defined in Code Sec. 170(m)(8) (e.g., property for which the donor doesn't provide the required notice to the donee);
• the qualified intellectual property produced no net income for the donee's tax year;
• the qualified intellectual property contribution is for a tax year beginning after the expiration of the legal life of the donated qualified intellectual property; or
• the tax year begins more than 10 years after the date of the qualified intellectual property contribution. (Reg. § 1.6050L-2(a))

The information return must include:

• The donee's name, address, tax year, and employer identification number (EIN);
• The donor's name, address, and taxpayer identification number;
• A description of the qualified intellectual property in sufficient detail to identify the property received by the donee;
• The date of the contribution to the donee;
• The amount of donee's net income for the tax year that is properly allocable to the qualified intellectual property (determined without the Code Sec. 170(m) limitations that would exclude income not reported to the donee, income received ten years after the initial contribution, and income beyond the legal life of the qualified intellectual property); and
• Other information specified by the form or its instructions. (Reg. § 1.6050L-2(b))

The donee generally must file the information return (with a copy furnished to the donor) on or before the last day of the first full month following the close of the donee's tax year to which net income from the qualified intellectual property is properly allocable. (Reg. § 1.6050L-2(c), Reg. § 1.6050L-2(d)(2))

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Estate and Gift Tax Relief - Joint Committee Staff examines options for reforming transfer taxes

Mike Habib, EA
MyIRSTaxRelief.com

The Staff of the Joint Committee on Taxation has released JCX-23-08, Taxation Of Wealth Transfers Within A Family: A Discussion Of Selected Areas For Possible Reform. This document, which was prepared in conjunction with an Apr. 3, 2008 hearing conducted by the Senate Finance Committee, explains the estate and gift tax system's current state of flux and explores ways to reform it. The full-text document can be viewed at http://www.house.gov/jct/x-23-08.pdf.

Observation: Estate planning has become unduly difficult in the face of uncertainty posed by the current regime, which calls for a one-year repeal of estate tax followed by a return to harsher rules. While it is a fairly good bet that estate tax won't be permanently repealed, it seems certain that some types of changes will be implemented even before 2010. For example, there is a pretty good chance that a fully unified system will be restored with a higher exemption level.

Background. As noted in JCX-23-08, the Federal estate and gift tax rules are in a state of flux. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the estate tax and the gift tax are partially unified: a single tax rate schedule applies under the estate tax and the gift tax, but after 2003 the exemption amounts differ. The highest rate of estate and gift tax has decreased in steps from 55% in 2001 to 45% in 2007 through 2009. The estate tax exemption amount is increasing in several steps from $1 million in 2002 to $3.5 million in 2009. The gift tax exemption amount has remained at $1 million. The credit against Federal estate tax liability for State estate and inheritance taxes was phased down from 2002 through 2004 and replaced by a deduction starting in 2005.

For 2010, the estate tax is repealed, but the gift tax remains in effect with an exemption of $1 million and a maximum rate of 35%. In 2010, property transferred at death generally has the same basis in the hands of the heir as it had in the hands of the decedent (that is, a carryover basis). By contrast, under the estate tax that apply currently, the heir's basis generally equals the property's fair market value (FMV) at the time of the decedent's death.

Estate tax repeal lasts only for one year. In 2011, the estate and gift tax rules are scheduled to be the same as those that would have been in effect without enactment of EGTRRA. Under pre-EGTRRA law, the estate and gift tax was fully unified: a single rate schedule and exemption amount applied to gifts made during life and to transfers at death. Consequently, unless the rules are changed, starting in 2011 the estate and gift tax exemption amount will be $1 million, and the highest estate and gift tax rate will be 55%. The credit for State estate and inheritance taxes will return, and property acquired from a decedent will take an FMV rather than a carryover basis.

Possible areas of reform. Against this backdrop of changing estate and gift tax laws, Congress is exploring ways of reforming transfer taxes. The Senate Finance Committee is holding a series of public hearings to examine the current system and possible changes to, or replacements of, it. A Nov. 14, 2007 hearing addressed broad design issues such as rates, exemption amounts, and the treatment of farms and family businesses. A hearing on Mar. 12, 2008 studied alternatives to the present estate and gift tax system. JCX-23-08 was prepared in connection with the hearing conducted on Apr. 3, 2008, which included a discussion of possible reforms to the existing Federal estate and gift tax rules.

JCX-23-08 is divided into two parts. The first part examines the present partially unified credit and possible reforms to it. The second part looks at liquidity to pay estate tax when estates consist largely of farms or other businesses.

Unified credit. Under present law in effect through 2009 and after 2010, a unified credit is available with respect to taxable transfers by gift and at death. The unified credit offsets tax computed at the lowest estate and gift tax rates. Before 2004, the estate and gift taxes were fully unified, such that a single graduated rate schedule and a single effective exemption amount of the unified credit applied for purposes of determining the tax on cumulative taxable transfers made by a taxpayer during his or her lifetime and at death. For years 2004 through 2009, the gift tax and the estate tax continue to be determined using a single graduated rate schedule, but the effective exemption amount allowed for estate tax purposes is increased above the effective exemption amount allowed for gift tax purposes. Therefore, under present law for the years 2004 through 2009, estate and gift taxes are not fully unified because the estate and gift tax effective exemption amounts differ.

One possible reform to present law's partially unified credit would be to make the credit fully unified. Under this approach, a common rate schedule and a single exemption amount would apply to gifts made during life and transfers at death. It has been argued that this would simplify planning and that the current credit distorts behavior by encouraging taxpayers to hold onto property until they die to take advantage of the higher exemption amount under the estate tax.

JCX-23-08 notes that the extent to which making this change would counteract the gift tax's role in preventing income tax avoidance is unknown. In the absence of a tax on gifts, income tax liability may be reduced when high-income individuals make gifts to lower-income individuals. A fully unified credit also could encourage gifts over bequests. Also, a gift tax is not imposed on funds used to pay the gift tax while an estate tax is imposed on funds used to pay the estate tax. This difference in treatment causes the effective rate of tax on gifts to be lower than the effective rate of tax on bequests, which, in turn, could favor giving over making bequests.

A second possible reform to the unified credit, which would result in portability, would allow a surviving spouse to benefit from the unused exemption amount of the first spouse to die. As for a fully unified credit, a principal argument for portability for an unused exemption is that this approach would simplify wealth transfer tax planning. Portability, however, raises concerns about IRS's ability to administer the transfer tax rules. Certain design features, such as the treatment of multiple marriages, also may create difficulties.

Estate liquidity. The second part of JCX-23-08 discusses liquidity to pay estate tax when estates consist largely of farms or other businesses. A particular concern has been that if the value of an estate is largely attributable to a farm or other business, heirs may be forced to sell to pay the tax.

Specifically, the second part of JCX-23-08 describes three provisions intended to mitigate the effect of the estate tax on farms and other family-owned active businesses.

• Code Sec. 2032A permits real property to be valued for estate tax purposes at its current-use value (for example, as a farm) rather than at a higher market value (for example, the price that could be received in a sale to a developer).
• Code Sec. 6166 allows payment of estate tax attributable to certain family businesses to be deferred for five years and then made in installments over the succeeding ten years.
• Code Sec. 2057 (terminated after 2003 but scheduled to be in effect after 2010) grants a deduction from the value of the gross estate for the value of certain family-owned business interests.

The discussion then evaluates criticisms of those provisions. In addition, to help assess the extent to which the estate tax creates cash flow problems for family businesses, the discussion presents data showing relative liquidities of estates with farms and other closely held businesses and certain characteristics of estates for which benefits have been claimed under Code Sec. 2032A, Code Sec. 6166, or former Code Sec. 2057. The data suggest that many estates that are comprised largely of farms or other closely held businesses have enough liquid assets to satisfy estate tax liabilities. Nonetheless, JCX-23-08 notes that the decreased liquidity attributable to payment of estate tax may impair a business's ability to function and grow.

Appendix with earlier proposals. JCX-23-08 includes an appendix that reprints previous Joint Committee on Taxation staff options for reforms of certain estate, gift, and generation-skipping transfer tax rules including a proposal to limit perpetual dynasty trusts, one to limit various transfer tax discounts, and another to limit the ability to use Crummey powers to exempt property from gift tax.

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District court holds that stipends paid to medical residents were exempt from FICA

Regents of the University of Minnesota v. U.S. (DC MN 4/1/2008) 101 AFTR 2d ¶ 2008-647

Mike Habib, EA
myIRSTaxRelief.com

A district court has held that stipends paid by the Regents of the University of Minnesota to medical residents were exempt from FICA under the Code Sec. 3121(b)(10) student exception. The court followed the district court's previous holding in Mayo Foundation, which invalidated IRS regs that would have disqualified medical residents for the student exception.

Observation: The case has important ramifications for the many teaching hospitals and their residents.
Caution: The decision doesn't affect the income tax aspects of medical residents' stipends. It is well settled that they are not excludible.

FICA background. Code Sec. 3121(b)(10) exempts from FICA service performed in the employ of a school, college, or university "if such service is performed by a student who is regularly enrolled and regularly attending classes at" such an institution. In 2003, in determining that residents in graduate-level medical programs were students entitled to the student FICA exception, a Minnesota district court held, in U.S. v. Mayo Foundation for Medical Education & Research, (2003, DC MN) 92 AFTR 2d 2003-5774, that the residents satisfied these requirements and their wages were not subject to FICA.

In response, late in 2004, IRS amended the regs in this area. The regs now provide that an institution is a school, college, or university only if its primary function is formal instruction; it has a regular faculty and curriculum; and it has a regularly enrolled student body. (Reg. § 31.3121(b)(10)-2(c)) An employee is a student only if the services he or she provides are incidental to the course of study, and if the educational aspect of the relationship predominates over the service aspect. Moreover, an employee whose normal work schedule is 40 hours or more per week is considered a full-time employee and therefore services performed by that individual are not incidental to the course of study. (Reg. § 31.3121(b)(10)-2(d))

In 2007, a district court in Minnesota, finding that the 2004 regs were invalid, held that stipends paid by the Mayo Foundation to medical residents were exempt from FICA under the Code Sec. 3121(b)(10) student exception. (Mayo Foundation for Medical Education and Research v. U.S., (DC MN 8/3/2007) 100 AFTR 2d 2007-5449

Facts. Regents of the University of Minnesota (University) operates graduate medical education programs for medical residents and fellows (collectively, residents). A medical resident is an individual who has earned a medical degree and is participating in a residency program for additional medical training in a specialty field, such as internal medicine or surgery. University entered into affiliation agreements with certain hospitals in Minnesota for the purpose of providing educational experiences to the residents. University paid a stipend to the residents to provide a minimum level of financial support during their enrollment.

Under the affiliation agreements, University had responsibility for the general educational experience of the residents, including: (1) determining educational goals; (2) establishing prerequisite criteria for placement; (3) determining completion of assignments; (4) evaluating the residents' performance; and (5) selecting and appointing staff members at the affiliated hospital to the faculty of the University for the purpose of training the residents. Staff physicians appointed to the University faculty had the responsibility for teaching, supervising, and evaluating the performance of residents.

University initially paid FICA taxes on the residents' stipends, but then sought a refund based on the residents qualifying for the FICA student exception.

Student exemption applies to residency stipends. In a summary judgment motion, the district court found that stipends paid by University to medical residents were exempt from FICA under Code Sec. 3121(b)(10). Relying on the previous district court's determination that the regs were invalid, the district court determined if University qualified for the FICA student exclusion by analyzing whether the residents were: (1) "employed" by University; and (2) "students" who "regularly attended classes."

The district court found that the residents' services were performed in the "employ" of University. The physicians involved in University's residency program held faculty appointments and acted as University's agent in the administration of the program. Residents learned how to care for patients under the supervision and control of the University-faculty physicians.

However, the court found the residents, who paid tuition which was deducted from the residents' paychecks, were clearly enrolled at University. The court rejected IRS's contention that residents were not students who regularly attended classes, but were physicians who worked in hospitals. The educational aspect of University's residency program necessarily included learning how to safely care for patients. Thus, the principal classroom for residents had to be the clinical setting because they learned by caring for patients in a medical specialty under the supervision of a University-faculty member.

The district court similarly rejected IRS's claim that the residents' services were not "incident to and for the purpose of pursuing a course of study" because the hospitals paid the residents to work long hours taking care of patients and the residents provided patient-care services when education was minimal or nonexistent. Instead, the court concluded that the primary purpose of University's residency program was educational. It found that residents spent the majority of their time learning how to care for patients under the watchful eye of a faculty physician.

Observation: The only Appellate Court to say that medical residents may qualify for the student FICA exception has been the Eleventh Circuit in a decision which involved years before the 2004 regs went into effect. (U.S. v. Mount Sinai, (CA 11 05/18/2007) 99 AFTR 2d 2007-983 ) The Eighth Circuit Court of Appeals, to which Regents of the University of Minnesota would be appealable, in analyzing a parallel Social Security regulation, found that a case-by-case approach was required to determine whether particular services qualified for the student exemption. (Minnesota v. Apfel, (CA 8 1998) 151 F.3d 742, 747-48)

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New, changed and expired provisions affect 2008 individual estimated tax

Mike Habib, EA
MyIRSTaxRelief.com

Apr. 15, 2008 is the due date for affected calendar year taxpayers to make their first installment of 2008 estimated tax. There aren't any drastic changes in the estimated tax rules themselves for 2008. However, there are a number of new, changed and expiring provisions that will affect some individuals' estimated tax computations for 2008. This article provides a brief overview of the estimated tax rules for individuals and looks at the changes that may impact 2008 estimated taxes.

Who needs to pay estimated tax. Individuals who have income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony, etc.) must pay estimated tax or face a penalty. In addition, taxpayers who do not elect voluntary withholding on unemployment compensation and the taxable part of social security payments also may have to pay estimated tax on those items or face a penalty. (Code Sec. 6654)

When and how much to pay. For 2008 estimated tax, in general, a taxpayer must pay 25% of a "required annual payment" by Apr. 15, 2008, June 16, 2008, Sept. 15, 2008 and Jan. 15, 2009 to avoid an underpayment penalty. (Code Sec. 6654(c))

The required annual payment for most taxpayers is the lower of 90% of the tax shown on the 2008 return or 100% of the tax shown on the 2007 return even if filed late ("prior year exception"). However, a taxpayer (other than a farmer or fisherman) whose adjusted gross income on his 2007 return is over $150,000 (over $75,000 if married filing separately) must pay the lower of 90% of his 2008 tax or 110% of his 2007 tax. The prior year exception does not apply for a taxpayer who did not file a 2007 return or filed a 2007 return that did not cover 12 months. (Code Sec. 6654(d))

Other exceptions to penalty. There's no underpayment penalty if the tax shown on the return (after withholding) is less than $1,000. Estimated tax does not have to be paid for 2008 if the taxpayer was a U.S. citizen or resident alien for all of 2007 and had no tax liability for the full 12-month 2007 tax year. (Code Sec. 6654(e))

Annualized method. A taxpayer who, after Mar. 31, 2008, has a large change in income, deductions, additional taxes, or credits that requires him to start making estimated tax payments should use the annualized income installment method. While the due dates will not change, the payment amounts will vary based on the taxpayer's income, deductions, additional taxes, and credits for the months ending before each payment due date. As a result, this method may allow the taxpayer to skip or lower the amount due for one or more payments. A taxpayer who uses the annualized method should be sure to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with his 2008 tax return, to indicate to IRS how he has computed his payments, even if no penalty is owed. (Code Sec. 6654(d)(2))

Farmers and fishermen. Special estimated tax rules apply to farmers and fishermen.
New items for 2008. A taxpayer should use his 2007 return as a starting point for figuring his 2008 estimated tax. He should determine whether he will benefit by any of the following new provisions:

• Forgiveness of mortgage debt. For debt discharged on or after Jan. 1, 2007 and before Jan. 1, 2010, taxpayers generally may exclude up to $2 million of mortgage debt forgiveness on their principal residence.
  

Observation: This technically is not new for 2008 as it also applied for 2007. Presumably, IRS included it as a new item on Form 1040ES for 2007.

• Tax relief for volunteer responders. An income tax exclusion applies for qualified state or local tax benefits (such as reduction or rebate of state or local income or property tax) and qualified reimbursement payments (up to $360 a year) granted to members of qualified volunteer emergency response organizations (e.g., state or local organizations whose members provide volunteer firefighting or emergency medical services). The exclusion applies for the 2008 through 2010 tax years.
  
• Homesale exclusion liberalized for surviving spouse. Before a late 2007 law change, the up-to-$500,000 exclusion was available only if a husband and wife filed a joint return for the year of sale. Thus, if the home was sold in a year after the year of a spouse's deathit allows a surviving spouse to qualify for the up-to-$500,000 exclusion if the sale occurs not later than 2 years after the spouse's death, provided the requirements for the $500,000 exclusion were met immediately before the spouse's death and the survivor has not remarried as of the date of the sale.
  
• Capital gain tax rate reduced. As discussed in greater detail in Federal Taxes Weekly Alert 1/17/2008, beginning this year and continuing through at least 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate (last year, a 5% rate applied to such income).
• Kiddie tax broadened. For 2008 (technically for tax years beginning after May 17, 2007), a 2006 tax law expanded the kiddie tax to apply to children age 18, and children over age 18 but under age 24 who are full-time studentsif their earned income doesn't exceed one-half of the amount of their support.

Observation: The 2006 tax law did not change the kiddie tax rules for children who are under age 18. Rather, it expanded the kiddie tax to apply where:

... the child turns age 18, or turns age 19-23 if a full-time student, before the close of the tax year;
... the child's earned income for the tax year doesn't exceed one-half of his or her support;
... the child has more than the inflation-adjusted prescribed amount of unearned income (i.e., $1,800 for 2008);
... the child has at least one living parent at the close of the tax year; and
... the child doesn't file a joint return for the tax year. [See Federal Taxes Weekly Alert 6/7/2007 for details]

• Itemized deduction phaseout reduced. A higher-income taxpayer's itemized deductions (other than those for medical expenses, investment interest, nonbusiness casualty and theft losses, and gambling losses) are reduced if his adjusted gross income (AGI) exceeds an inflation-adjusted amount. His itemized deductions generally are reduced by the lesser of (1) 3% of the excess of adjusted gross income over the applicable amount, or (2) 80% of the itemized deductions otherwise allowable for the tax year. For 2008, the phaseout begins at $159,950 of AGI ($79,975 for marrieds filing separately). However, under a 2001 tax law change that applies for the first time in 2008, a taxpayer will lose only 1/3 of the amount he would otherwise lose under the regular reduction computation. [See Federal Taxes Weekly Alert 1/14/2008 for details]
• Personal exemption phaseout reduced. The personal exemption amount of a taxpayer whose AGI exceeds an inflation-indexed threshold amount is reduced by an applicable percentage. This applicable percentage is 2% for each $2,500 (or fraction thereof) by which the AGI of a taxpayer (other than a married taxpayer filing separately) exceeds the appropriate threshold amount. For married persons filing separately, the applicable percentage is 2% for each $1,250 (or fraction of that amount) by which his AGI exceeds the threshold amount. The applicable percentage can't exceed 100%. The inflation-adjusted threshold amounts for 2008 are $239,950 (joint returns and surviving spouses), $199,950 (head of household), $159,950 (unmarried individuals), and $119,975 (married persons filing separately). However, under a 2001 law change that applies for the first time in 2008, a taxpayer will lose only 1/3 of the amount he would otherwise lose under the regular phase-out computation.
  
• Mortgage insurance deduction extended. Mortgage insurance premiums continue to be deductible after 2007. Originally, this deduction was available only for 2007. It now applies through 2010.
  

Changed provisions. In calculating 2008 estimated tax, individuals also should consider the following changed provisions:

• Increased standard deductions. The basic and additional standard amounts have increased for most categories of taxpayers for 2008.
  
• IRA deduction. An taxpayer may be able to take an IRA deduction if covered by a retirement plan and the taxpayer's 2007 modified AGI is less than $63,000 ($105,00 if married filing jointly or qualifying widow(er)).
  
• IRA contribution limit increased. In general, an individual who isn't an active participant in certain employer-sponsored retirement plans, and whose spouse isn't an active participant, may make an annual deductible cash contribution to an IRA up to the lesser of: (1) $5,000 (increased from $4,000 for 2007), plus an additional $1,000 for those age 50 or older, or (2) 100% of the compensation that's includible in his gross income for that year. If the individual (or his spouse) is an active plan participant, the deduction phases out over a specified dollar range of MAGI.
• Standard mileage rates. The 2008 mileage rates for a taxpayer's use of his vehicle are 50 1/2¢ per business mile, 19¢ per mile to get medical care or make a job related move, and 14¢ per mile for charitable use (the latter figure is unchanged).
  
• Tax breaks for adoption. The maximum adoption credit has increased to $11,650, as has the maximum adoption exclusion.
  
• Earned income credit. The maximum credit is higher, and the AGI-based phaseout figures are revised.
  
• Savers credit. The income limits have increased for the retirement savers credit.
  

Expired tax benefits. The following tax changes for 2008 involve tax provisions that expired at the end of 2007 but may be reinstated by Congress.

• Credits reduced by AMT calculation. Personal tax credits (other than the adoption credit, the child tax credit and the credit for elective deferrals and IRA contributions) can't exceed the excess of regular tax liability over tentative minimum tax.

Observation: This credit limit may reduce a taxpayer's personal credits even if he has no AMT liability.

• Decreased AMT exemption amount. In 2008, the AMT exemption amount will decrease to $33,750 for unmarried individuals, $45,000 for marrieds filing jointly or qualifying surviving spouses, and $22,500 for marrieds filing separately. For 2007, the AMT exemption amounts were $44,350, $66,250, and $33,125, respectively.

Observation: Although there's a high probability that Congress will once again "patch" the AMT problem, taxpayers must nonetheless make their estimated tax payments as if this relief will not materialize.

• Educator expenses. The above-the-line deduction for educator expenses doesn't apply for post-2007 tax years.
• Tuition and fees deduction. The above-the-line deduction for higher-education expenses isn't available for tax years beginning after 2007.
• D.C. first-time homebuyer credit. This credit does not apply to homes purchased after 2007.
• Option to claim state & local sales tax as itemized deduction instead of deducting state & local income tax. This option is no longer available for tax years beginning after 2007.
• Tax-free distributions from IRAs for charitable purposes. The special rule for IRA distributions to charities has expired. Under this rule, which applied for distributions in tax years beginning in 2006 and 2007, an exclusion from gross income, not to exceed $100,000, is allowed for otherwise taxable IRA distributions by taxpayers age 70 1/2 and older from a traditional or Roth IRA that are qualified charitable distributions.
• Election to include nontaxable combat pay as earned income for purposes of the earned income tax credit. For tax years beginning after 2007, taxpayers no longer may elect to treat combat pay as earned income for purposes of the earned income credit.
• Penalty-free withdrawals for individuals called to active duty. A provision giving early withdrawal penalty relief for active duty reservists has expired. Under this rule, the Code Sec. 72(t) 10% early withdrawal penalty tax does not apply to a distribution from an IRA (or attributable to elective deferrals under a Code Sec. 401(k) plan, Code Sec. 403(b) annuity, or certain similar arrangements) that's (1) made to reservists ordered or called to active duty after Sept. 11, 2001, and before Dec. 31, 2007, for a period of more than 179 days or for an indefinite period, and (2) made during the period beginning on the date of the order or call to duty and ending at the close of the active duty period.
• Credit for nonbusiness energy property. For property placed in service after 2007, a taxpayer can no longer claim a lifetime nonrefundable credit of up to $500 for making qualifying energy saving improvements to his home (only $200 for qualifying window expenditures).
• Research credit. The research credit does not apply for amounts paid or incurred after 2007.
• Indian employment credit. The Indian employment credit does not apply for tax years beginning after 2007.

Observation: The changed and expired items described above are those that IRS mentions in the instructions to Form 1040ES for 2008. There are many other items that have changed for 2008 as a result of inflation adjustments.


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Retired insurance agents' renewal commissions didn't qualify for FICA special timing rule

Mike Habib, EA
myIRSTaxRelief.com

Chief Counsel Advice 200813042

In a Chief Counsel Advice (CCA), IRS has ruled that because renewal commissions paid to its retired employees were subject to a substantial risk of forfeiture as of the insurance agents' retirement dates, an insurance company couldn't take those amounts into account on the employees' retirement dates under the special FICA timing rule for nonqualified deferred compensation under Code Sec. 3121(v)(2) . As a result, IRS denied the refund claimed by the insurance company, which had been withholding and paying FICA taxes on the renewal commissions at the time that they were actually paid.

Background. Any amount deferred under a nonqualified deferred compensation plan is taken into account for purposes of the Federal Insurance Contribution Act (FICA) tax as of the later of:

• when the services are performed; or
• when there is no substantial risk of forfeiture of the rights to the amount. (Code Sec. 3121(v)(2)(A))

Observation: This is so-called "special timing rule" in contrast to the general timing rule (which provides that wages are taken into account for FICA purposes when they are actually or constructively paid).

Observation: In many cases, the application of the special timing rule will reduce FICA taxes from what they would have been under the actual or constructive payment rule. The Old Age, Survivors and Disability Insurance (OASDI) portion of FICA tax is assessed against a limited amount of compensation, called the taxable wage base. Consequently, deferred compensation will effectively escape the OASDI portion of FICA taxation to the extent it is taken into account in early years (e.g., when the service is rendered) in which an individual's compensation subject to FICA exceeds the taxable wage base. If the nonqualified deferred compensation is taken into account for FICA purposes when paid, and this occurs after the individual has retired, it's more likely to be subject to the OASDI portion of FICA taxation, especially since income from a qualified retirement plan isn't subject to FICA taxation.

Under Reg. § 31.3121(v)(2)-1(e)(4)(ii)(A), for FICA purposes, a taxpayer can take into account an amount deferred under a nonaccount balance plan (i.e., generally plans other than ones in which employees receive amounts based solely on balances in their individual accounts) that isn't reasonably ascertainable, if that amount is no longer subject to a substantial risk of forfeiture.

Facts. Under Insurance Company's compensation plan, an employee received a renewal commission only if: (1) the agent was either an active sales agent or his services had been terminated because of retirement, disability, or death; and (2) the insurance policy was in force on the anniversary date of the policy and the customer paid the renewal premiums. Insurance Company represented that renewal commission rates couldn't be reduced after the sale of the policy, i.e., they weren't subject to unilateral reduction or elimination by Insurance Company.

Insurance Company filed refund claims, asserting that it shouldn't have withheld and paid FICA tax on the renewal commissions at the time it paid the renewal commissions to its retired agents. It argued that its compensation plan gave the agents the right to future renewal commissions because all required services had been performed as of the date of retirement. Accordingly, it argued, under Code Sec. 3121(v)(2), it could treat the renewal commissions that it may eventually pay a retired agent as subject to FICA tax on the retirement date of the agent.

Based on Reg. § 31.3121(v)(2)-1(e)(4)(ii)(A), Insurance Company contended that it could retroactively aggregate the renewal commissions from all insurance policies sold by a retired agent and assign a fair market value at the date of retirement based on the discounted value of the entire stream of renewal commission payments the agent was expected to receive, subject to true up at the resolution date. (In fact, for the years at issue, Insurance Company used the actual renewal commission payment data to retroactively determine the value of renewal commissions as of the date of the agent's retirement, rather than applying a methodology in order to estimate the fair market value on the date of retirement.)

No refund allowed. In the CCA, as an initial matter, IRS concluded that the insurance agents' rights to renewal commissions were paid under a nonqualified deferred compensation plan for purposes of Code Sec. 3121(v)(2). However, IRS further ruled that the renewal commissions were subject to a substantial risk of forfeiture on the dates the agents retired. Insurance Company only paid renewal commissions if the customer renewed the underlying insurance policy and paid the renewal premiums. As a result, the commission was subject to a substantial risk of forfeiture until the policy was renewed, and the customer paid the related renewal premiums on the policy. The renewal and premium payment was a condition related to the compensatory purpose of the transfer of the right to the renewal commission, and an agent forfeited the right to any renewal commission if the customer didn't renew the policy or pay the premium. Accordingly, the CCA advised denying the refund that Insurance Company claimed based on the erroneous assumption that it could use the Code Sec. 3121(v)(2) special timing rule.

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Truckers Tax Relief - Are you a truck driver with tax problems?

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

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Don't compromise on your representation! We represent truckers and truck drivers 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 truckers and truck drivers 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