Final regs include new process for reporting employment tax adjustments and refund claims T.D. 9405, 06/30/2008, Reg. § 31.6011(a)-1, Reg. § 31.6011(a)-4, Reg. § 31.6011(a)-5, Reg. § 31.6205-1, Reg. § 31.6302-1, Reg. § 31.6402(a)-1, Reg. § 31.6413(a)-1, Reg. § 31.6403(a)-2

Mike Habib, EA

IRS has issued final regs on employment tax adjustments and refund claims, effective Jan. 1, 2009. The final regs modify the process for making interest-free adjustments for both underpayments and overpayments of Federal Insurance Contributions Act (FICA) and Railroad Retirement Tax Act (RRTA) taxes and Federal income tax withholding (ITW).

Background on interest-free adjustments and refunds. While generally interest must be paid to IRS on any tax underpayment and to a taxpayer on any tax overpayment, an exception applies to employment taxes. Where an incorrect amount of tax under Code Sec. 3101 (employee FICA tax), Code Sec. 3111 (employer FICA tax), Code Sec. 3201 (employee RRTA tax), Code Sec. 3221 (employer RRTA tax), or Code Sec. 3402 (ITW) is reported to IRS for any payment of wages or compensation, Code Sec. 6205(a) and Code Sec. 6413(a) allow employers to make interest-free adjustments for underpayments and overpayments, respectively.

Under the prior Code Sec. 6205(a) regs, if a return is filed and less than the correct amount of employee or employer portions of FICA or RRTA tax is reported and paid, the employer adjusts the underpayment (a) by reporting the additional amount due as an adjustment on a current return, or (b) by reporting such additional amount on a supplemental return. For overpayments of employment taxes, Code Sec. 6413(b) allows a refund claim to be filed when an interest-free adjustment cannot be made. Under the prior Code Sec. 6413 regs, IRS allows taxpayers to choose between filing a claim for refund and making an interest-free adjustment to correct an overpayment of employment taxes.

Late in 2007, IRS issued proposed regs on employment tax adjustments and refund claims (see Federal Taxes Weekly Alert 01/03/2008). The proposed regs have now been adopted with only minor changes.

Revised adjusted return process. The final regs are issued in connection with IRS's development of new forms to report adjustments to employment taxes which will replace the existing process of reporting adjustments on regularly filed employment tax returns. The regs are part of IRS's effort to reduce taxpayer burdens by allowing employers to make employment tax adjustments on a separately filed form as soon as an error is ascertained, rather than as a line adjustment on the regularly filed employment tax return. The new adjusted return will not affect the liability reported on the current return. Under the regs, the forms used to accept an assessment of employment taxes after an examination (Form 2504, Agreement and Collection of Additional Tax and Acceptance of Overassessment (Excise or Employment Tax), and Form 2504-WC, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment in Worker Classification Cases (Employment Tax)) constitute adjusted returns. (Reg. § 31.6205-1)

Interest-free adjustments. The final Code Sec. 6205 regs set out the procedures for making interest-free adjustments for underpayments of employment taxes. If a return is filed and less than the correct amount of employee or employer FICA or RRTA tax is reported, and the employer discovers the error after filing the return, the employer adjusts the resulting underpayment of tax by reporting the additional amount due on an adjusted return for the return period in which the wages or compensation was paid. The adjustment must be made by the due date of the return for the return period in which the error is ascertained, and the amount of the underpayment must be paid by the time the adjustment is made, or interest will begin to accrue from that date. An underpayment adjustment can only be made within the period of limitations for assessment. For underpayments of ITW where the incorrect amount was withheld, subject to limited exceptions, an adjustment can only be made for errors ascertained during the calendar year in which the wages were paid. (Reg. § 31.6205-1(b)(2))

The final regs also provide for interest-free adjustments of underpayments of FICA tax, RRTA tax, and ITW under certain circumstances where the underpayment arises because the employer failed to file an original return or failed to report and pay the correct type of tax. (Reg. § 31.6205-1(b)(3), Reg. § 31.6205-1(c)(3))

The final Code Sec. 6413(a) regs set out the procedures for making interest-free adjustments for overpayments of employment taxes. If an employer ascertains an overpayment error within the applicable period of limitations on credit or refund, it's required to repay or reimburse its employees the amount of overcollected employee FICA or RRTA tax before the expiration of that period. However, the requirement to repay or reimburse doesn't apply to the extent that taxes weren't withheld from the employee or if, after reasonable efforts, the employer cannot locate the employee. In such a case, the employer can make an adjustment for only the employer share of FICA or RRTA tax. An interest-free adjustment for an overpayment cannot be made once a claim for refund has been filed. (Reg. § 31.6413(a)-1)

Once an employer repays or reimburses an employee to the extent required, the employer may report both the employee and employer portions of FICA or RRTA tax as an overpayment on an adjusted return. The employer must certify on the adjusted return that it has repaid or reimbursed its employees to the extent required.

Under the final regs, the reporting of the overpayment constitutes an interest-free adjustment if the overpayment is reported on an adjusted return filed before the 90th day prior to expiration of the period of limitations on credit or refund. Similar rules apply for making interest-free adjustments for ITW overpayments, except that an interest-free adjustment can only be made if the employer ascertains the error and repays or reimburses its employees within the same calendar year that the wages were paid and reports the adjustment on an adjusted return. (Reg. § 31.6413(a)-2)

No repayment or reimbursement for interest-free adjustments of overpayments. Unlike in the proposed reg, in the final regs the employer isn't required to repay or reimburse the employee or to adjust the overpayment by the due date of the return for the return period following the return period in which the error is ascertained. (Reg. § 31.6402-2(a)(1)) After reconsideration, IRS determined there was insufficient reason to impose a timing restriction other than the period of limitations on credit or refund of taxes. (T.D. 9405, 06/30/2008)

Deposits, payments, and credits. An employer making an interest-free adjustment must pay the amount of the adjustment by the time it files an adjusted return. The timely payment satisfies the employer's deposit obligations for the adjustment. (Reg. § 31.6302-1(c)(7)) In determining the amount of accumulated taxes in an agricultural employer's lookback period (which determines the employer's deposit schedule), adjustments to tax liability made under the filing of adjusted returns or refund claims aren't taken into account; new agricultural employers are treated as having employment tax liabilities of zero for any lookback period before the date the employer started or acquired its business. (Reg. § 31.6302-1(g)(4))

If the underpayment amount isn't paid when the adjusted return is filed, interest begins to accrue as of the date the adjusted return is filed. (Reg. § 31.6205-1(b)(2))

The adjusted overpayment amount will be applied as a credit toward payment of the employer's liability for the calendar quarter (or calendar year for annual returns being adjusted) in which the adjusted return is filed, unless IRS notifies the employer that the credit will be applied to a different return period or that the employer isn't entitled to the adjustment under applicable laws or procedures. (Reg. § 31.6413(a)-2(b)(2))

Refunds for overpayments. As in the prior regs, instead of making an interest-free adjustment for an overpayment, employers can file a claim for refund for the amount of the overpayment. Furthermore, if an employer can't make an interest-free adjustment for an overpayment because the period of limitations for claiming a credit or refund for the overpayment will expire within 90 days or because IRS has otherwise notified the employer that it's not entitled to the adjustment, the employer can recover the overpayment only by filing a claim for refund. (Reg. § 31.6413(a)-2(d))

An employer can file a claim for refund of an overpayment of FICA or RRTA tax, but must certify that it has repaid or reimbursed the employee's share of FICA or RRTA tax to the employee or has secured the employee's written consent to allowance of the refund or credit. However, the employer isn't required to repay or reimburse the employee or obtain the written consent of the employee to the extent that the overpayment doesn't include taxes withheld from the employee or, after reasonable efforts, the employer cannot locate the employee or the employee, once contacted, will not provide the requested consent. (Reg. § 31.6402(a)-2(a)) The final regs under Code Sec. 6414 set out similar procedures for filing a claim for refund of overpaid ITW, except that an employer can't file a claim for refund of an overpayment of ITW for an amount the employer deducted or withheld from an employee. (Reg. § 31.6414-1(a))

IRS intends to issue guidance to provide examples of how the final regs apply in different factual scenarios. (T.D. 9405, 06/30/2008)

Gain from selling carbon dioxide allowances didn't generate foreign personal holding company income PLR 200825009

Mike Habib, EA

IRS has privately ruled that gain from the sale of surplus carbon dioxide allowances didn't constitute foreign personal holding company income (FPHCI) under Code Sec. 954(c). It concluded that the emissions allowances were excepted because they were intangible property used in the controlled foreign corporations' trade or business.

Facts. Taxpayer indirectly owns through a chain of foreign subsidiaries an unspecified percentage of the vote and value of Corporation A. The remaining interest is owned by unrelated parties. Corporation A engages in Industry M in Country A, where it is organized.

Taxpayer also indirectly owns 100% of the vote and value of Partnership B, a Country B entity that is treated as a controlled foreign partnership under Code Sec. 6038(e) . An unspecified percentage of Partnership B is directly owned by Corporation C, a controlled foreign corporation (CFC) of Taxpayer, organized in Country A. The remaining interest of Partnership B is directly owned by a domestic subsidiary corporation of Taxpayer. Partnership B engages in Industry M and other industries in Country B.

Countries A and B are members of the European Union (EU), which has developed the Emissions Trading Scheme (ETS) to regulate the emissions of carbon dioxide or its equivalent within certain industries, including Industry M. Beginning on Jan. 1, 2008, the ETS was expanded to include regulation of 5 other greenhouse gases. Corporation A and Partnership B are subject to the ETS.

Under the ETS, member states may emit specified amounts, measured in units, of the regulated greenhouse gases. The emissions capacity of each member state is represented by an allocation of allowances to it. Corporation A and Partnership B received carbon dioxide allowances from Country A and Country B, respectively, in Year 1 and Year 2. A business must surrender its allocated allowances for any year to the relevant authority in amounts equal to its emissions for the year. To the extent the measured emissions of a business exceed its allowances, a fine is imposed. However, to the extent a business has excess allowances, it may sell any surplus to another person. Corporation A and Partnership B had surplus allowances in Year 1 and Year 2, which were sold to unrelated purchasers.

Carbon dioxide allowances are traded over the counter and on exchanges such as the European Climate Exchange, the European Energy Exchange and Nordpool.

Background. Under Code Sec. 951(a), a U.S. shareholder of a CFC must include in gross income its pro-rata share of the CFC's subpart F income for the tax year.

A U.S. shareholder is any U.S. person (as defined in Code Sec. 957(c)) who owns (under Code Sec. 958) 10% or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. (Code Sec. 951(b))

A CFC is any foreign corporation if more than 50% of the total combined voting power of all classes of its stock or more than 50% of the total value of its stock is owned by U.S. shareholders on any day during the tax year of such foreign corporation. (Code Sec. 957(a))

Subpart F income includes foreign base company income. (Code Sec. 952(a))
Under Reg. § 1.952-1(g)(1), a CFC's distributive share of any item of income of a partnership is income that falls within a category of subpart F income, as defined in Code Sec. 952(a), to the extent the item of income would have been income in such category if received by the CFC directly.

Code Sec. 954(a) defines four categories of foreign base company income, including FPHCI.
Code Sec. 954(c)(1)(C) provides, in part, that FPHCI includes the excess of gains over losses from transactions in any commodity. Commodity, for this purpose, includes tangible personal property of a kind that is actively traded or with respect to which contractual interests are actively traded. (Reg. § 1.954-2(f)(2)(i)) There are, however, exceptions. For example, net commodities gain that is included in FPHC income for subpart F purposes does not include active business gains or losses from the sale of commodities, if substantially all of the CFC's commodities are property described in Code Sec. 1221(a)(1) (inventory), Code Sec. 1221(a)(2) (property used in a trade or business subject to depreciation), or Code Sec. 1221(a)(8) (supplies used or consumed by the CFC in its trade or business). (Code Sec. 954(c)(1)(C)(ii))

Code Sec. 954(c)(1)(B)(iii) provides that FPHCI includes the excess of gains over losses from the sale of property which does not give rise to any income. However, under Reg. § 1.954-2(e)(3)(iii), property that does not give rise to income excludes intangible property (under Code Sec. 936(h)(3)(B)) to the extent used or held for use in the CFC's trade or business.

Reg. § 1.954-2(a)(5) provides special rules for calculating FPHCI applicable to distributive shares of partnership income. Under Reg. § 1.954-2(a)(5)(ii)(A), the exclusion provided by Reg. § 1.954-2(e)(3) applies only if such exception would have applied to exclude the income from FPHCI if the CFC had earned the income directly, determined by taking into account only the activities of, and property owned by, the partnership and not the separate activities or property of the CFC or any other person.

Code Sec. 936(h)(3)(B)(iv) and Code Sec. 936(h)(3)(B)(vi) include in the definition of intangible property any franchise, license, or contract, or any similar item, which has substantial value independent of the services of any individual.

Reg. § 1.954-2(a)(2) provides coordination rules for overlapping categories under the FPHCI provisions. Under those rules, gain or loss from commodities transactions under Code Sec. 954(c)(1)(C) take priority over gain under Code Sec. 954(c)(1)(B).

Analysis. IRS said it was currently studying the question of whether carbon dioxide allowances should be viewed as commodities for purposes of Code Sec. 954(c)(1)(C). However, it stated that, solely for purposes of PLR 200825009, IRS believes it is appropriate at this point to analyze carbon dioxide allowances as property that does not give rise to income under Code Sec. 954(c)(1)(B)(iii). No inference is intended as to whether the allowances are properly considered commodities for purposes of Code Sec. 954 or any other Code section.

The ruling noted that Reg. § 1.954-2(e)(3)(iv) provides that intangible property is excluded from FPHCI to the extent used or held for use in the CFC's trade or business. But this is applied to CFC partners by taking into account only the activities of the partnership.

In this case, possession of carbon dioxide allowances is necessary to operate in Industry M. Because each allowance permits the holder to engage in a business activity otherwise unlawful, without penalty, the allocation of an allowance by a member state is the granting of an intangible property right to each business to emit carbon dioxide to a set limit. The value of the allowance is independent of the performance of services by any individual. Thus, for purposes of Code Sec. 954(c)(1)(B), the allowances are intangible property under Code Sec. 936(h)(3)(B). However, to qualify for the exclusion of Reg. § 1.954-2(e)(3)(iv), the intangible property of Corporation A and Partnership B must be used or held for use in Corporation A and Partnership B's trade or business.

Based on the facts presented, IRS concluded that Corporation A and Partnership B held the carbon dioxide allowances to offset emissions resulting from the operation of their businesses in Industry M. Thus, Corporation A and Partnership B held the emissions allowances for use in their trade or business. Therefore, the allowances are intangible property held for use in a trade or business within the meaning of Reg. § 1.954-2(e)(3)(iv) and gain from their sale is properly excluded from the definition of FPHCI found in Code Sec. 954(c)(1)(B)(iii) by Corporation A and Corporation C.

Bottom line. Gain from the sale of surplus carbon dioxide allowances by Corporation A and Partnership B does not constitute FPHCI within the meaning of Code Sec. 954(c) to Corporation A or Corporation C.

House Subcommittee Passes IRS Funding Bill

The House Appropriations Financial Services Subcommittee this week passed a bill that would appropriate $11.4 billion to IRS for FY 2009.

The bill would grant IRS budget authority to spend $5.1 billion on enforcement, $2.2 on taxpayer services, and $3.8 billion on operations.

The total is about $40 million more than the president's request for the agency. The bill will next be considered by the full House Appropriations Committee before it goes to the House floor.

Closing the Tax Gap: An estimated $290 billion in taxes owed go unpaid every year. The IRS Oversight Board noted in a recent report that "the tax gap is an injustice to compliant taxpayers who ultimately are bearing the financial burden of those who do not pay what they owe, whether intentionally or not." • Enforcement: $5.1 billion, $337 million above 2008 and matching the President's request, to catch tax cheats through audits, collection efforts, and technology improvements.

---- As you can see from the above, over $5,000,000,000 (Five Billion), allocated for IRS enforcement. Enforcement will encompass aggressive collection efforts for collecting back taxes, and additional tax audits to ensure compliance and catch tax cheats.

So, if you owe the IRS, contact us today to resolve your tax matter. Don't let the IRS punish you, you could settle your tax debt for less than you owe.

Business Provisions of the Economic Stimulus Act of 2008

Mike Habib, EA

The Economic Stimulus Act of 2008 contains two provisions that provide tax benefits for businesses. The first provision increases the limit up to which a business can expense property purchased and placed in service during its 2008 tax year. The second provision provides an additional 50 percent special depreciation allowance for property acquired and placed in service during calendar year 2008.

Unlike the economic stimulus payments that millions of individuals have already received, the tax benefits for businesses are not automatic; businesses must act to take advantage of the new provisions by purchasing qualifying property.

The Joint Committee on Taxation estimates that businesses stand to lower their 2008 tax bills by roughly $45 billion as a result of the two business provisions in the Economic Stimulus Act of 2008; these provisions accelerate into 2008 the tax benefits that otherwise would not have been available until future years.

The following are some details about these two key tax benefits:

Section 179 Expensing

• In general, section 179 provides that, instead of depreciating property, a business with a sufficiently small amount of annual property purchases may choose to expense the cost of the property. For taxable years beginning in 2008, the Economic Stimulus Act increased the section 179 expensing limit allowing more property to be currently expensed.
• The Economic Stimulus Act increased the maximum section 179 expense deduction to $250,000 for qualified section 179 property that is placed in service in tax years that begin in 2008. This is a 95 percent increase from the previous limitation of $128,000.
• The Economic Stimulus Act also increased the total amount of qualifying property a taxpayer may purchase before the section 179 expensing limit begins to be reduced. Under the new law, the $250,000 deduction amount is reduced only when a business acquires more than $800,000 of qualifying property. Prior to changes made by the Economic Stimulus Act, the reduction began when a business acquired more than $510,000 of qualifying property.
• The new law does not alter the section 179 expense limit for sport utility vehicles, which remains at $25,000.
• More than 4.5 million small businesses claimed the section 179 expense deduction for tax year 2005, the most recent year for which this information is available. These businesses placed almost $44 billion of section 179 property in service in 2005 and claimed related deductions of approximately $41 billion (data derived from Depreciation and Amortization forms filed with Forms 1040).

Special Depreciation Allowance

• The Economic Stimulus Act also provided a 50 percent special depreciation allowance for property acquired and placed in service during 2008. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years. It is an annual allowance for the wear and tear, deterioration or obsolescence of the property.
• Under the new law, a taxpayer is entitled to depreciate 50 percent of the adjusted basis (after subtracting any section 179 deduction taken on that property) of qualified property during the year the property is placed in service. For example, if the taxpayer purchased and placed in service in 2008 a single piece of property at a cost of $450,000 that qualified for section 179 expensing and the 50 percent special depreciation allowance, $250,000 of the cost could be immediately expensed (under section 179 ) and the remaining $200,000 of adjusted basis would be available for the 50 percent special depreciation allowance. The taxpayer would also be permitted to take regular depreciation on the remaining $100,000 of adjusted basis during that year. This is similar to the special depreciation allowance that was previously available for certain property placed in service generally before Jan. 1, 2005 , often referred to as "bonus depreciation."
• The types of property that qualify for the 50 percent special depreciation allowance are section 168 property with a recovery period of 20 years or less, off-the-shelf computer software, water utility property and qualified leasehold improvement property.
• To qualify for the 50 percent special depreciation allowance, a taxpayer must meet all of the following tests:
• The taxpayer must have acquired the property after December 31, 2007 , and before Jan. 1, 2009 . If a binding contract to acquire the property existed before Jan. 1, 2008 , the property does not qualify for the special depreciation allowance.
• The property must be placed in service before Jan. 1, 2009 (before Jan. 1, 2010 , for certain transportation property and certain property with a long productions period).
• The original use of the property must begin with the taxpayer after Dec. 31, 2007 . In other words, the property must be "new" property.
• Prior to the enactment of the Economic Stimulus Act the total depreciation amount (including the section 179 deduction) a business could deduct for a passenger automobile was $2,960. The Economic Stimulus Act increased this limitation by $8,000. Therefore, the maximum limit is increased to $10,960 for automobiles for which the special bonus depreciation allowance is claimed.
• Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the section 179 deduction) a business could deduct for a truck or van used in a business and first placed in service in 2008 was $3,160. The Economic Stimulus Act increased this limitation by $8,000. The new maximum limit is increased to $11,160 for trucks and vans for which the special bonus depreciation is claimed.

More disaster victims in Indiana, Iowa and Wisconsin qualify for tax relief IRS website [http://www.irs.gov/newsroom/article/0,,id=108362,00.html]

Mike Habib, EA

IRS has announced on its website that additional counties in Indiana, Iowa and Wisconsin have been declared disaster areas on account of recent severe storms, tornadoes and flooding. As a result, more victims of the disaster have additional time to make tax payments and file returns. Certain other time-sensitive acts also are postponed.

Who gets relief. Only taxpayers considered to be affected taxpayers are eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts. Affected taxpayers are those listed in Reg. § 301.7508A-1(d)(1) and thus include:

• any individual whose principal residence, and any business entity whose principal place of business, is located in the counties designated as disaster areas;
• any individual who is a relief worker assisting in a covered disaster area, regardless of whether he is affiliated with recognized government or philanthropic organizations;
• any individual whose principal residence, and any business entity whose principal place of business, is not located in a covered disaster area, but whose records necessary to meet a filing or payment deadline are maintained in a covered disaster area, or whose tax professional/practitioner is located in a covered disaster area;
• any estate or trust that has tax records necessary to meet a filing or payment deadline in a covered disaster area; and
• any spouse of an affected taxpayer, solely with regard to a joint return of the husband and wife.

What may be postponed. Under Code Sec. 7508A, IRS gives affected taxpayers until the extended date (specified by county, below) to file most tax returns (including individual, estate, trust, partnership, C corporation, and S corporation income tax returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date falling on or after the onset date of the disaster (specified by county, below), and on or before the extended date.

IRS also gives affected taxpayers until the extended date to perform other time-sensitive actions described in Reg. § 301.7508A-1(c)(1) and Rev Proc 2007-56, 2007-34 IRB 388, that are due to be performed on or after the onset date of the disaster, and on or before the extended date. This relief also includes the filing of Form 5500 series returns, in the way described in Rev Proc 2007-56, Sec. 8. Additionally, the relief described in Rev Proc 2007-56, Sec. 17, relating to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 or 5498 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. IRS, however, will abate penalties for failure to make timely employment and excise deposits, due on or after the onset date of the disaster, and on or before the information return delayed date (specified by county, below), provided the taxpayer made these deposits by the information return delayed date.

IRS will waive the failure to deposit penalties for employment and excise deposits due on or after the onset date of the disaster, and on or before the deposit delayed date (specified by county, below , as long as the deposits were made by the deposit delayed date.

Affected counties and dates for storms, floods and other disasters in 2008 are as follows:
Arkansas: The following are presidential disaster areas qualifying for individual assistance: Arkansas, Benton, Cleburne, Conway, Crittenden, Grant, Lonoke, Mississippi, Phillips, Pulaski, Saline and Van Buren counties.

For these Arkansas counties, the onset date of the disaster was May 2, 2008, the extended date is July 21, 2008, the information return delayed date was May 19, 2008, and the deposit delayed date was May 19, 2008.

Colorado: The following are presidential disaster areas qualifying for individual assistance: Larimer and Weld counties.

For these Colorado counties, the onset date of the disaster was May 22, 2008, the extended date is July 25, 2008, the information return delayed date was June 6, 2008, and the deposit delayed date was June 6, 2008.

Georgia: The following are presidential disaster areas qualifying for individual assistance: Bibb, Carroll, Douglas, Emanuel, Jefferson, Jenkins, Johnson, Laurens, McIntosh and Twiggs counties.

For these Georgia counties, the onset date of the disaster was May 11, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Iowa: The following are presidential disaster areas qualifying for individual assistance: Adams, Allamakee, Benton, Black Hawk, Bremer, Buchanan, Butler, Cedar, Cerro Gordo, Chicksaw, Clayton, Crawford, Delaware, Des Moines, Fayette, Floyd, Freemont, Hardin, Harrison, Jasper, Johnson, Jones, Linn, Louisa, Mahaska, Marion, Mills, Monona, Muscatine, Page, Polk, Story, Tama, Union, Warren and Winneshiek counties.

For these Iowa counties, the onset date of the disaster is May 25, 2008, the extended date is July 28, 2008, the information return delayed date was June 9, 2008, and the deposit delayed date was June 9, 2008.

Indiana: The following are presidential disaster areas qualifying for individual assistance: Adams, Bartholomew, Brown, Clay, Daviess, Dearborn, Decaturm Greene, Hamilton, Hancock, Henry, Jackson, Jennings, Johnson, Knox, Marion, Monroe, Morgan, Owen, Parke, Putnam, Randolph, Rush, Shelby, Sullivan, Vermillion, Vigo and Wayne counties.

For these Indiana counties, the onset date of the disaster was May 30, 2008, the extended date is Aug. 7, 2008, the information return delayed date was June 16, 2008, and the deposit delayed date was June 16, 2008.

Maine: The following are presidential disaster areas qualifying for individual assistance: Aroostook and Penobscot counties.

For these Maine counties, the onset date of the disaster was April 28, the extended date is July 8, the information return delayed date was May 13, 2008, and the deposit delayed date was May 13, 2008.

Missouri: The following are presidential disaster areas qualifying for individual assistance: Barry, Jasper and Newton counties.

For these Missouri counties, the onset date of the disaster was May 10, 2008, the extended date is July 22, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Mississippi: The following are presidential disaster areas qualifying for individual assistance: Bolivar, Warren, Washington and Wilkinson counties.

For these Mississippi counties, the onset date of the disaster was March 20, 2008, the extended date is July 7, 2008, the information return delayed date was April 4, 2008, and the deposit delayed date was April 4, 2008.

Oklahoma: The following are presidential disaster areas qualifying for individual assistance: Craig, Latimer, Ottawa and Pittsburg counties.

For these Oklahoma counties, the onset date of the disaster was May 10, 2008, the extended date is July 14, 2008, the information return delayed date was May 27, 2008, and the deposit delayed date was May 27, 2008.

Wisconsin: The following are presidential disaster areas qualifying for individual assistance: Crawford, Columbia, Dodge, Green, Sauk, Milwaukee, Racine, Richland, Vernon, Washington, Waukesha and Winnebago counties.

For these Wisconsin counties, the onset date of the disaster was June 5, 2008, the extended date is Aug. 13, 2008, the information return delayed date is June 20, 2008, and the deposit delayed date is June 20, 2008.

Claiming disaster loss on previous year's return. A taxpayer that sustains a loss attributable to a disaster occurring in a Presidential disaster area may elect to deduct that loss on his return for the tax year immediately preceding the tax year in which the disaster occurred. (Code Sec. 165(i)) Generally, a taxpayer must make this election by filing a return, an amended return, or a refund claim on or before the later of (i) the due date of his income tax return (determined without regard to any filing extension) for the tax year in which the disaster actually occurred, or (ii) the due date of his tax return (determined with regard to any filing extension) for the immediately preceding tax year. The election is irrevocable 90 days after it is made. (Reg. § 1.165-11(e)) Because of the new disaster area designation, taxpayers in affected counties designated as disaster areas in 2008 can elect to claim a 2008 disaster loss on their 2007 returns, instead of on their 2008 returns.

Observation: Claiming the disaster loss for the year before the loss occurred saves taxes immediately, without having to wait until the end of the year in which the loss was sustained. In some cases, the deduction may result in a net operating loss, which could result in a refund from an earlier year to which it is carried. On the other hand, deducting the loss in the year the loss actually occurred may result in bigger tax savings if the taxpayer is in a higher bracket in that year.

Regs crack down on tax avoidance repatriations of CFC earnings
Preamble to TD 9402, 06/23/2008; Reg. § 1.956-1T; Preamble to Prop Reg 06/23/2008; Prop Reg § 1.956-1

IRS has issued temporary and proposed regs to determine the basis of certain U.S. property acquired by a controlled foreign corporation (CFC) in certain nonrecognition transactions that are intended to repatriate earnings and profits of the CFC without income inclusion by the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Background. IRS is aware that certain taxpayers are engaging in certain nonrecognition transactions in which a CFC acquires certain U.S. property (within the meaning of Code Sec. 956(c)) without resulting in an income inclusion to the U.S. shareholders of the CFC under Code Sec. 951(a)(1)(B).

Illustration: USP, a domestic corporation and the common parent of an affiliated group that files a consolidated tax return, owns 100% of the outstanding stock of US1 and US2, both domestic corporations that join USP in the filing of a consolidated tax return. US1 owns 100% of the stock of CFC, a controlled foreign corporation. US2 issues $100 million of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash. USP takes the position that: (i) US2's transfer of its stock to CFC in exchange for $10 million of CFC stock and $90 million cash is an exchange to which Code Sec. 351 applies; (ii) US2 recognizes no gain on the receipt of $10 million of CFC stock and $90 million cash in exchange for its stock under Code Sec. 1032(a) ; (iii) CFC recognizes no gain on the issuance of its stock to US2 under Code Sec. 1032(a) ; (iv) CFC's basis in the US2 stock is zero under Code Sec. 362(a) ; and (v) US1 and US2 do not and will not have an income inclusion under Code Sec. 951(a)(1)(B) as a result of CFC holding the US2 stock (which constitutes U.S. property under Code Sec. 956(c) ). (Preamble to TD 9402, 06/23/2008)

IRS believes these transactions raise significant policy concerns because the transactions may have the effect of repatriating earnings and profits of a CFC without a corresponding dividend inclusion, or an income inclusion under Code Sec. 951(a)(1)(B) by reason of the CFC's investment in U.S. property.

Code Sec. 956 was enacted to require an income inclusion by U.S. shareholders of a CFC that invests certain earnings and profits in U.S. property on the ground that the investment is substantially the equivalent of a dividend being paid to them.

Under Code Sec. 951(a)(1)(B), each U.S. shareholder (as defined in Code Sec. 951(b)) of a CFC (as defined in Code Sec. 957(a)) must include in its gross income for its tax year in which or with which the tax year of the CFC ends, the amount determined under Code Sec. 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under Code Sec. 959(a)(2)).

Regs under Code Sec. 367(b) prevent the repatriation of a U.S. person's share of earnings and profits of a foreign corporation through what would otherwise be a nonrecognition transaction.

Under Code Sec. 362(a), for property acquired by a corporation in connection with a Code Sec. 351 transaction (relating to transfer of property to corporation controlled by transferor), the basis is the same as it would be in the hands of the transferor, increased by the amount of any gain recognized to the transferor on the transfer.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032)

Temporary regs. When a CFC acquires stock or obligations of a domestic issuing corporation, that constitute U.S. property under Code Sec. 956(c), from such corporation pursuant to an exchange in which the CFC's basis in the property is determined under Code Sec. 362(a), the temporary regs apply. As a result, solely for Code Sec. 956 purposes, the temporary regs cause the CFC's basis in the property to be no less than the fair market value of the property transferred by the CFC in exchange for the property. For this purpose, "property" has the meaning set forth in Code Sec. 317(a), but includes any liability assumed by the CFC in connection with the exchange notwithstanding Code Sec. 357(a). (Reg. § 1.956-1T(e)(6))

The temporary regs also apply when property whose basis is determined under the regs is transferred to a related person (related person transferee), or by a related person transferee to another related person, pursuant to an exchange in which the related person transferee's basis in the property is determined, in whole or in part, by reference to the transferor's basis in the property. This rule is intended to prevent taxpayers from attempting to avoid the general rule of the temporary regs by subsequently transferring the property to a related person in another nonrecognition transaction. (Reg. § 1.956-1T(e)(6))

Basis determined under the temporary regs applies only for purposes of determining the amount of U.S. property acquired or held by a CFC under Code Sec. 956 , and accordingly the amount of a U.S. shareholder's income inclusion under Code Sec. 951(a)(1)(B) with respect to the CFC. (Reg. § 1.956-1T(e)(6))

The temporary regs apply only to determine the basis of U.S. property acquired by a CFC pursuant to an exchange that is within their scope. All other basis determinations are made under the rules in Reg. § 1.956-1(e)(1)(4). (Preamble to Prop Reg 06/23/2008)

Illustration: Applying the facts from Illustration (1), the results are as follow under the temporary regs. The US2 stock acquired by CFC in the exchange constitutes U.S. property under Reg. § 1.956-1T(e)(6)(ii) because CFC acquires the US2 stock from US2, the issuing corporation. Therefore, because CFC's basis in the US2 stock is determined under Code Sec. 362(a), then for purposes of Code Sec. 956, CFC's basis in the US2 stock is, under Reg. § 1.956-1T(e)(6)(iii) no less than $90 million, the fair market value of the property exchanged by CFC for the US2 stock (the $10 million of CFC stock issued in the exchange does not constitute property for purposes of Reg. § 1.956-1T(e)(6)(iii)). Under Reg. § 1.956-1T(e)(6)(iv), for purposes of Reg. § 1.956-2(d)(1)(i)(a), CFC is treated as acquiring its basis of no less than $90 million in the US2 stock at the time of its transfer of property to US2 in exchange for the US2 stock. The result would be the same if, instead of CFC transferring $90 million of cash to US2 in the exchange, CFC assumes a $90 million liability of US2. Reg. § 1.956-1T(e)(6)(vi), Example 1.

Effective date. The temporary regs apply to U.S. property acquired in exchanges occurring on or after June 24, 2008. No inference is intended as to the basis of U.S. property acquired by a CFC pursuant to a comparable transaction occurring before that date. IRS may, where appropriate, challenge such pre-June 24 transactions under applicable provisions or judicial doctrines. (Reg. § 1.956-1T(f), Preamble to TD 9402, 06/23/2008)

Observation: IRS's increase in the business standard mileage rate is undoubtedly a result of recent pressure brought to bear on IRS to take action to relieve taxpayers suffering from skyrocketing gas prices (see Newsstand e-mail 6/18/08). On June 11, 2008, Senator Norm Coleman (R-MN) sent a letter to IRS Commissioner Shulman, requesting that IRS increase the 2008 standard mileage rates to better reflect the high cost of travel. Coleman noted that in the past, in 2005, IRS raised the standard mileage rates for the last four months of the year, rather than waiting until year-end, due to a large increase in gas prices. Earlier, on June 6, 2008, National Treasury Employees Union (NTEU) President Colleen Kelley also wrote to Commissioner Shulman, on behalf of federal government employees, asking him to consider making a mid-year adjustment to the 2008 standard mileage rates.

Observation: The plight of taxpayers suffering from ever increasing gas prices has not been ignored by legislators. On May 19, 2008, Sen. Charles Schumer (D-NY) introduced a bill in the Senate, S. 3032, the "Reimburse Our American Drivers (ROAD) Act of 2008," that would temporarily increase the standard mileage rate to 70¢ per mile on travel for business, medical, and moving expense-related purposes. Federal employees would also be allowed to use this rate. The rate would be in effect during all of 2008. The legislation has been referred to the Senate Finance Committee for consideration.

Observation: As the gas prices at the pump continue to rise at a record breaking pace, it is questionable whether the additional 8¢ per mile will provide significant relief to taxpayers, or turn out to be a matter of too little too late.

Background. The mileage allowance deduction replaces separate deductions for lease payments (or depreciation if the car is purchased), maintenance, repairs, tires, gas, oil, insurance and license and registration fees. The taxpayer may, however, still claim separate deductions for parking fees and tolls connected to business driving. (Rev Proc 2007-70, Sec. 5.04) IRS generally adjusts the standard mileage rate annually, based on a yearly study of the fixed and variable costs of operating an automobile.

Employers that require employees to supply their own autos may reimburse them at a rate that doesn't exceed the business mileage allowance for employment-connected business mileage, whether the autos are owned or leased. (Rev Proc 2007-70, Sec. 9.01) Additionally, an employee's personal use of lower-priced company autos may be valued at the optional mileage allowance if the conditions specified in Reg. § 1.61-21(e)(1) are met.

A separate rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction. (Rev Proc 2007-70, Sec. 7.02) The mileage rate for driving an auto for charitable use (14¢ per mile) is a statutory rate that's not adjusted for inflation. (Rev Proc 2007-70, Sec. 7.01)

When the new rates are effective. The revised standard mileage rates in Ann. 2008-63 apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2008, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2008; and (2) with respect to transportation expenses paid or incurred by the employee on or after July 1, 2008.

However, the standard mileage rates in Rev Proc 2007-70, 2007-50 IRB 1162, continue to apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes before July 1, 2008, and to mileage allowances paid: (1) to an employee before July 1, 2008, or (2) with respect to transportation expenses paid or incurred by the employee before July 1, 2008. All other provisions of Rev Proc 2007-70 remain in effect. (Ann. 2008-63)

Mike Habib, EA

Many Tax Relief and Tax Negotiation firms advertise on TV claiming that they can settle your tax debt for "pennies on the dollar". Now, you, as a taxpayer must be informed of what options you have and should research these firms at the Better Business Bureau www.BBB.org

Here is our Customer BEWARE REPORT on certain Tax Negotiation Companies that advertise on TV claiming "pennies on the dollar" tax settlements.

Customer...Beware!

How To Keep From Getting Ripped Off?

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

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

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

So, what should you do?

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

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

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

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

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

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

Recap of recent state employment tax laws, developments, and changes taking effect in July

Several states and localities are making employment tax changes that take effect in July. In addition, several new employment tax laws and developments have occurred recently. Here are some of the highlights from the following states:

Alabama
Unemployment. Effective for benefit years beginning after July 5, 2008, a claimant must serve a one-week waiting period prior to receiving unemployment benefits. The maximum weekly benefit will also increase from $235 to $255 [L. 2008, H427].

California
Employment Taxes. A state of emergency was declared on June 12th in the following counties: Sacramento, San Joaquin, Stanislaus, Merced, Madera, Fresno, Kings, Tulare, and Kern, due to the drought. Affected employers may request up to a 60-day extension of time to file their state payroll reports and deposit state payroll taxes with the Employment Development Department (EDD). All requests will be evaluated on a case-by-case basis. For further information, contact the Taxpayer Assistance Center at (888) 745-3886 [EDD Announcement, 6/13/2008].

Wage and Hour. The California Court of Appeal has ruled that an employee who received a premium holiday pay rate for work performed on Labor Day, and who worked 12 hours on Labor Day and 60 hours during the week, was only entitled to overtime based on her regular pay rate. The employer is entitled to credit the time-and-a-half premium pay on holidays against otherwise earned overtime [ Advanced-Tech Security Services, Inc. v. Superior Court, Cal. Ct. App., Second App. Dist., Division Five, Dkt. No. B205186, 6/3/08].

Colorado
Unemployment. The Colorado Department of Labor & Employment (DLE) reminds employers to review adjustments to their account on line 15 of Form UITR-1, Unemployment Insurance Tax Report (Tax Report), before determining their tax payment for the quarter [DLE UI Quarterly News, 2nd Quarter 2008].

Connecticut
Employment Taxes. The state is setting up a joint task force on worker misclassification issues (i.e., employee vs. independent contractor) [L. 2008, H5113].

Unemployment. New registration requirements go into effect for professional employer organizations (PEOs), beginning in 2009 [L. 2008, H5113].

Wage Payment. Effective Oct 1, 2008, wage deductions are permitted for contributions that are attributable to automatic enrollment in IRC §401(k), 403(b), 408, 408A, or 457 retirement plans [L. 2008, S157].

District of Columbia
Time Off. Effective Nov. 13, 2008, all Washington, D.C. employers must provide paid leave for illness and absences associated with domestic violence, sexual abuse, or stalking of employees or their family members [D.C. Register, Vol. 55, No. 21, 005886, 5/23/08; DC Law 17-152, 5/13/08].

Idaho
Wage and Hour. Effective July 1, state employees who do not qualify for the executive exemption under Idaho law, or the administrative or professional exemption under federal law, and state employees not designated as exempt under any other complete exemption in federal law, are eligible for overtime compensation.

Illinois
Wage and Hour. The minimum wage rate will increase from $7.50 per hour to $7.75 per hour on July 1.
Iowa
Wage and Hour. Effective July 1, the following enterprises are exempt from Iowa minimum wage rules, regardless of whether sales are $300,000 or more: (1) enterprises engaged in the business of laundering, cleaning, or repairing clothing or fabrics; (2) enterprises engaged in construction or reconstruction; (3) hospitals and schools; and (4) public agencies.

Indiana
Wage Payment. A federal court has ruled that store managers who were no longer employed by a company were not entitled to unpaid bonuses, since one contingency for receiving the bonuses was continued employment. The bonuses did not qualify as wages under either Indiana wage payment or wage claim statutes because of the contingency [ Harney v. Speedway SuperAmerica, LLC, CA7, Dkt. No. 07-3488, 5/30/2008].

Withholding. Indiana law requires the withholding of adjusted gross income tax and local option income tax from a pension distribution, if the payee requests withholding. The withholding request must be made in writing and should include the payee's Indiana county of residence [Indiana Information Bulletin IT13, 06/01/2008].

Kansas
Withholding. Effective July 1, employers with an annual total withholding tax liability of over $45,000 (before July 1, over $100,000) may be required to remit taxes by electronic funds transfer [Kan. Stat. Ann. §75-5151, as amended by L. 2007, H2434, §13].

Unemployment. Wage reports, contributions returns, and payments due after June 30, 2008, must be filed electronically by employers with 250 or more employees, and third-party administrators with 250 or more client employees.

Kentucky
Wage and Hour. The minimum wage rate will increase from $5.85 per hour to $6.55 per hour on July 1.
Massachusetts
Wage and Hour. Effective July 13th, treble damages will be awarded for all wage and hour violations, even if there was no "willful misconduct" by the employer.

Maryland
Time Off. The Flexible Leave Act amends the state's family leave provisions, effective Oct. 1, 2008. The provision will apply to employers with 15 or more employees working in the state. Employers will not only be able to allow employees to take "leave with pay" for the birth or adoption of a child, but also to care for a spouse, child, or parent. "Leave with pay" includes sick leave, vacation time, and compensatory time. In cases where an employee earns more than one type of leave, the employee may elect the type and amount of paid leave to be used [L. 2008, H40].

Minnesota
Withholding. Effective beginning after Dec. 31, 2008, payments to independent contractors are subject to state backup withholding if they are subject to federal backup withholding. Previous legislation that required third-party bulk filers to withhold from independent contractors was deleted before the provision took effect [L. 2007, H3149].

Mississippi
New Hire Reporting. Beginning in July, certain employers, third-party employers, contractors, and subcontractors will be required to register and use the federal Department of Homeland Security E-Verify program for all new hires. Required compliance is phased in through July 2011, based on the number of employees.

Michigan
Wage and Hour. The minimum wage rate will increase from $7.15 per hour to $7.40 per hour on July 1.
Montana
Unemployment. Effective July 1, the administrative fund tax for governmental experience-rated employers is 0.09% of total wages.

Nevada
Employment Taxes. The Nevada Tax Commission has approved a tax amnesty program that calls for waiving interest and penalty on certain tax liabilities, including the modified business tax (on payroll). The program is scheduled to start on July 1, 2008, and end on Sept. 30, 2008. To be eligible for amnesty, a business or taxpayer must be in full compliance with state law and pay the entire tax due by the end of the amnesty period. The Nevada Department of Taxation is in the preliminary stages of developing specific guidelines and requirements for the program [ Nevada Press Release, 6/2/08].

Unemployment. Effective July 1, all unemployment tax payments of $10,000 or more (including interest and penalties) must be remitted electronically.

Wage and Hour. Effective July 1, the state minimum wage will increase to $5.85 per hour for employees who receive qualified health benefits, and to $6.85 per hour for all other employees.

New Jersey
Withholding. Employees are allowed to exclude certain employer-provided commuter transportation benefits from their taxable gross income, up to a maximum amount that is adjusted annually for inflation. The maximum amount for 2008 is $1,440, up from $1,410 for 2007. Amounts in excess of $1,440 must be included in an employee's gross wages on Form W-2 or other written statement [Div. Tax. Notice of Employee Commuter Transportation Benefit Limits, 06/02/2008].

Oklahoma
Withholding. A federal district court has suspended the enforcement of a statute that required contractors to withhold from workers who could not produce federal documents showing that they were authorized alien labor. The court found the Oklahoma law to be an attempt to regulate behavior, not to impose a new tax. The injunction continues until the merits of the case are finally decided [Chamber of Commerce of the U.S.A. v. Henry, DC OK, Dkt. No. CIV-8-109-C, 6/4/2008].

The governor has signed into law a tax amnesty bill. A taxpayer will be entitled to a waiver of penalty, interest, and other collection fees due on eligible taxes (including withholding taxes), if the taxpayer voluntarily files delinquent tax returns and pays the taxes due during the compliance initiative. The program is scheduled to take place from Sept. 15 until Nov. 14, 2008 [L. 2007, S2034 (c.395), §1].

Oregon
Time Off. The state Supreme Court has ruled that while employers are required to provide minimum rest breaks as per Or. Admin. R. § 839-020-0050(1)(b) , violations do not give rise to a wage claim for additional wages [Gafur v. Legacy Good Samaritan Hosp. & Med. Ctr., Or. Sup. Ct., Dkt. No. SC055175, 5/15/08].

Pennsylvania
Withholding. Effective July 1 through Dec. 31, 2008, Philadelphia tax rates are reduced to 3.98% for residents and 3.5392% for nonresidents. The tax rate that should be used is the rate in effect on the date that the taxable compensation is actually paid to the employee. For example, wage tax on a paycheck dated July 1, 2008, for wages paid for the period from June 16 to June 30, 2008, should be withheld at the rate in effect as of July 1, 2008 [Philadelphia Bill No. 080161, 05/22/2008; Important Notice: Wage Tax Rate Reduction, Philadelphia Dept. of Rev., 06/04/2008].

South Carolina
New Hire Reporting. New legislation requires all employers to verify the employment eligibility of new hires beginning as early as Jan. 1, 2009 [L. 2008, H4400].

Withholding. Effective June 4, 2008, withholding agents must withhold 7% state income tax on compensation paid to an individual that was reported on Form 1099, if the individual: (1) fails to provide a taxpayer identification or Social Security number; (2) fails to provide a correct taxpayer identification or Social Security number; or (3) provides an IRS-issued taxpayer identification number issued for nonresident aliens. There are exceptions to this rule [S.C. Code Ann. §12-8-595, as amended by L. 2008, H4400].

Texas
Unemployment. The state has begun mailing checks to experience-rated employers eligible to receive the surplus tax credit [TWC Tax Department Tip of the Month, June 2008].

Vermont
Withholding. Effective July 1, the state may grant EFT filers up to six additional days for payment (prior to that, four additional days).

Virginia
Withholding. The Virginia Supreme Court has ruled that the requirement in Va. Code Ann. § 58.1-1815 to "truthfully account for and pay over such tax" is violated by one who willfully fails either to "account for" or "pay over" the tax. Therefore, a criminal penalty could be assessed against a person who failed to pay his withholding tax obligation, even though he had truthfully accounted for the obligation [Gibson v. Cmwth. of Virginia, Va. Sup. Ct., Dkt. No. 072023, 6/6/2008 ].

West Virginia
Withholding. A business registration certificate may be revoked for repeated, willful refusal to remit state withholding taxes when due [West Virginia Administrative Decision 08-052 F, 06/08/2008].

Wage and Hour. The minimum wage rate will increase from $6.55 per hour to $7.25 per hour on July 1.
Wisconsin
Withholding. Wisconsin will follow federal rules that require "disregarded entities" to pay their own employment taxes and file their own employment tax reports, beginning with wages paid in 2009. As an "employer," a disregarded entity must obtain a Wisconsin employer identification number [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

The state has issued a tax release that clarifies the circumstances under which "public speaking services" are subject to Wisconsin's nonresident entertainer prepayment law [Wisconsin Dept. Rev. Tax Bulletin 156, 04/01/2008].

Wyoming
Unemployment. Effective July 1, 2007, employers were required to submit "Wyoming Employee Wage Listings" as part of their quarterly reporting responsibilities. Beginning in 2009, the state may increase an employer's tax rate by a 2% penalty rate if the employer has failed to submit the wage listing [Wy. Quarterly Connection, 1st Qtr. 2008].

IRS urged to increase standard mileage reimbursement rates

Several requests have been made to the IRS in recent days to increase its standard mileage rates.
The standard mileage rate for use of a car (including vans, pickups, and panel trucks) is currently 50.5 cents per mile for business-related travel, and 19 cents per mile for medical or moving expense-related travel. Employers paying a mileage allowance in excess of the standard rate must report the excess on Form W-2. The IRS generally adjusts the standard mileage rates annually, based on a yearly study of the fixed and variable costs of operating an automobile.

On May 19, 2008, Sen. Charles Schumer (D-NY) introduced a bill in the Senate called the "Reimburse Our American Drivers (ROAD) Act of 2008," that would temporarily increase the standard mileage rate to 70 cents per mile on travel for business, medical, and moving expense-related purposes. Federal employees would also be allowed to use this rate. The rate would be in effect during all of 2008. The legislation has been referred to the Senate Finance Committee for consideration [S. 3032, 5/19/2008].

On June 6, 2008, National Treasury Employees Union (NTEU) President Colleen Kelley wrote a letter to IRS Commissioner Douglas Shulman, on behalf of federal government employees, asking him to consider making a mid-year adjustment to the 2008 standard mileage rates. Kelley noted that taxpayers would receive relief much sooner if there was direct IRS action to increase the standard mileage rate, rather than waiting for the merits of a rate increase to be debated in Congress [NTEU Letter to IRS, 6/6/2008].

On June 11, 2008, Senator Norm Coleman (R-Minn.) sent a letter to Commissioner Shulman, requesting that the IRS increase the 2008 standard mileage rates to better reflect the high cost of travel. Coleman noted that in 2005, the IRS raised the standard mileage rates for the last four months of the year, rather than waiting until year-end, due to a large increase in gas prices [Coleman Letter to IRS Commissioner, 6/10/08].

Appeals Court overturns oil company's large claim of right refund
Texaco v. U.S. (CA 9 6/13/2008) 101 AFTR 2d ¶ 2008889

The Court of Appeals for the Ninth Circuit has reversed a district court award of an over $100 million refund claim to a large oil company, which had sought claim of right relief under Code Sec. 1341(a) because it was required to pay out pursuant to a settlement agreement sums that it had previously included in its gross income. The district court agreed with the taxpayer and ordered the government to pay the refund. The Ninth Circuit has now reversed, finding that the inventory exception in Code Sec. 1341(b)(2) barred the taxpayer from using Code Sec. 1341(a).

Background. Under the claim of right doctrine, income received without restrictionmust be reported in the year received, even if there's a possibility it may have to be repaid in a later year. If it is repaid, the repayment is deductible in the year paid. However, various factors may prevent the taxpayer from receiving enough benefit from the deduction to offset the tax paid on the receipt of the income.

Code Sec. 1341 provides relief to taxpayers who received income in one year under the claim of right rule and were required to make refunds in another year at a time when the tax benefits of the repayment were less than the tax paid in the earlier year. It corrects the inequity by a reduction in the tax for the year in which the repayment is made. In essence, the amount of the tax reduction is equal to the amount the taxpayer would have saved if he had never received the income and never made the repayment, except for the loss of interest or other compensation for the use of his money.

For a claim of right relief to apply: (1) an "item" must have been "included in gross income for a prior taxable year (or years)," (2) "because it appeared that the taxpayer had an unrestricted right to such item," (3) a "deduction" must be "allowable for the taxable year," (4) "because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item," and (5) "the amount of such deduction" must exceed $3,000. (Code Sec. 1341(a))

Under the inventory exception, Code Sec. 1341(a) does not apply to any deduction allowable with respect to an item that was included in gross income by reason of the sale or other disposition of stock in trade (or other property of a kind which would properly have been included in the inventory of the taxpayer if on hand at the close of the prior tax year) or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. (Code Sec. 1341(b)(2))

Facts. Texaco was engaged in an integrated petroleum business. Between '73 and '81, it sold crude petroleum and refined petroleum products at prices that exceeded the price ceilings set by federal price regulations. Texaco included these overcharges as gross income on its corporate tax returns for the years '73 through '81. The Department of Energy (DOE) took various administrative actions against Texaco which eventually resulted in a consent degree requiring Texaco to pay $1,250,000,000 plus interest. Texaco made the payments and deducted the settlement amount on its federal income tax returns as ordinary and necessary business expenses. In February 2001, Texaco filed Refund Claims for the years '88, '90, '91, and '92, claiming that the tax benefit of the ordinary and necessary business expense deductions should have been calculated in accordance with Code Sec. 1341(a). IRS denied the refund claims on the ground that the Code Sec. 1341(b)(2) inventory exception rendered Code Sec. 1341(a) inapplicable.

In January 2004, Texaco filed a complaint against the U.S. in the District Court for the Northern District of California. On cross-motions for summary judgment, the district court determined that Code Sec. 1341(b)(2) did not preclude Texaco from seeking tax treatment under Code Sec. 1341(a), reasoning that the statute was ambiguous and sources outside the text of the statute supported Texaco's argument that Code Sec. 1341(b)(2) only prohibited the use of Code Sec. 1341(a) computation for "sales returns, allowances and similar items."

Failed argument. Texaco argued that there is a "syntactical" ambiguity in Code Sec. 1341(b)(2), and that the phrase "by reason of the sale or other disposition of [inventory]" modifies the phrase "deduction allowable with respect to an item which was included in gross income" in such a way that "the question that must be answered is whether the deduction in the current year is allowable "by reason of the sale or other disposition of [inventory]." It then argued that "by reason of the sale or other disposition of [inventory]" should be limited to "sales returns, allowances, and similar items."

The Ninth Circuit said that, even if such a construction were grammatically possible, it would not be reasonable. First, Code Sec. 1341(a) clearly states that its general rule applies when "an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item." Accordingly, the Court said that there is no reason to interpret "included in gross income" in Code Sec. 1341(b)(2) as referring to anything other than the prior tax year or years. Moreover, the proposed interpretation would eviscerate Code Sec. 1341(b)(2) because a Code Sec. 1341(a) deduction is always based on calculations arising from a prior tax year and not on whether an item was included in gross income in the current year.

Second, the Court stressed that there is nothing in the statute that limits the definition of "sale or other disposition of stock in trade" to "sales returns, allowances, and similar items." Texaco argued that such a limitation arises from Reg. § 1.1341-1(f). The Ninth Circuit, however, held that this reg does not limit Code Sec. 1341(b). It said that the reg says no more than that "sales returns and allowances and similar items" are examples of situations where the inventory exception applies; they do not delimit the exception.

Third, the Court said that Texaco's proposed interpretation of Code Sec. 1341(b) would reduce the final sentence of the section to surplusage. The final sentence of Code Sec. 1341(b)(2) provides that the bar to using a Code Sec. 1341(a) computation in the first sentence does not apply "if the deduction arises out of refunds or repayments made by a regulated public utility," if required by a government agency, a court, or "made in settlement of litigation or under threat or imminence of litigation." The Court observed that, although it may not be impossible for a public utility's refund or repayment to be based on "sales returns, allowances, and similar items," it defies logic to believe that Congress in enacting the final sentence of Code Sec. 1341(b)(2) was concerned with only such a refund or repayment.

Why the company car is still a valued fringe benefit for company owners and key employees

A company car has long been an extremely popular "perk" or fringe benefit for company owners and key employees of medium sized or small enterprises. As this article demonstrates, this benefit yields substantial nontax as well as tax benefits for the owner or employee, as well as tax deductions for the employer.

To illustrate the benefits of the company auto, let's assume that Mr. Smith, the owner-employee of Widget, Inc., expects to drive an auto 8,500 miles a year for business (e.g., to visit customers, check on local suppliers and distributors), and 7,000 for personal driving (e.g., commuting and weekend trips; his family owns other cars used for other personal mileage). That's roughly 55% business and 45% personal usage. We'll assume Widget's having a good year and Smith wants to project a successful image to his business contacts, so Widget buys or leases a new $50,000 auto for his business/personal use.

The unique benefits that flow from the arrangement are as follows:

• Smith's cost for personal use of the vehicle will be equal to the tax he pays on the fringe benefit value of his 45% personal mileage. By contrast, if Smith bought or leased the auto himself to be able to drive those personal miles, he'd have to use after-tax dollars to fund the entire purchase or lease cost of the car.
• Assuming Smith's personal use is properly treated as fringe benefit income, Widget treats the car for tax purposes much the same way it would any other business asset, subject to severe depreciation deduction restrictions if the auto is purchased (somewhat mitigated by a bonus first-year writeoff if the auto is bought new and placed in service this year), and relatively mild deduction restrictions if the auto is leased. Out of pocket expenses associated with the car (insurance, oil and gas, maintenance, etc.) are completely deductible, including the portion that relates to Smith's personal use. If Widget finances the car, all of the interest it pays on the loan would be deductible as a business expense. By contrast, if Smith bought or leased the auto himself, he could only claim deductions for the business use portion of the otherwise allowable depreciation amount (or lease expense) and out of pocket expenses of running the car. And if he financed the car, the interest payments would be nondeductible under Code Sec. 163(h)(2)(A) (unless he used a home equity line of credit).
• As a final benefit to Smith, the purchase or lease of the vehicle by Widget will have no effect on his credit rating.

Observation: It's important to note that providing an auto for an owner's or employee's personal and business use (or solely personal use) will not be free of complications and paperwork. Personal use will have to be tracked and valued under the fringe benefit rules and treated as compensation income.

Tax Consequences of Personal Use

The value of an employee's personal use of a company auto is a taxable fringe benefit treated as noncash compensation paid to the employee (our references to the employee are references to both an employee-owner or a regular employee). It is included in his or her income unless excluded under the Code. (Reg. § 1.61-21(a)) Such personal driving has the following tax consequences:

• For the employer: Although it furnishes a noncash fringe benefit to an employee that must be treated as compensation, the employer may deduct only the costs it incurs in providing the auto to its employee, not the auto's value to the employee. It may claim a depreciation deduction if it owns the auto or a deduction for leasing costs if it rents the auto. (Reg. § 1.162-25T(a)) Because the value of personal use of an auto is treated as compensation income, the employer must pay FICA taxes (i.e., for old age, survivors, and disability insurance (OASDI), and hospital insurance (HI)) on that value. However, the OASDI component of FICA taxes is payable on the value of personal use only to the extent the employee's other compensation does not exceed the OASDI wage base ($102,000 for 2008). The value also is subject to federal income tax withholding unless the employer elects not to withhold federal income tax. (Code Sec. 3402(s)(1); Ann. 85-113, 1985-31 IRB 31, 4)
• For the employee: The personal use value appears on the employee's Form W-2 and is treated as salary on his Form 1040. FICA taxes must be withheld from the employee's pay on the value (but only on the HI part of the FICA taxes if he's already over the OASDI wage base).

As a general rule, the personal use of any vehicle results in compensation income. (Reg. § 1.61-21(a), Reg. § 1.61-21(b)(1)) However, mileage on an employer-provided auto is a nontaxable working condition fringe benefit to the extent that it is (1) employment related business mileage, and (2) substantiated to the employer (see below). The exclusion applies whether the employee is equipped with an upscale auto or an economy model. (Reg. § 1.132-5(a)(1), Reg. § 1.132-5(b)(1), Reg. § 1.132-5(c)(1))

Valuing Personal Use With the FMV Method

The value of any fringe benefit supplied to an employee generally is its FMV. In the auto context, the FMV is the amount an individual would have to payto lease an auto comparable to the one supplied by the employer, for a comparable period of time. (Reg. § 1.61-21(b)(4)) If the employer leases the auto supplied to the employee, it cannot use its lease cost as FMV. (Reg. § 1.61-21(b)(2))

Observation: The dealer that sold or leased the auto to the employer should be able to supply a statement of the auto's FMV leasing cost.

Once FMV has been established, the employer then multiplies it by the ratio of the employee's personal mileage on the car to total mileage. The result is charged to the employee as noncash compensation due to personal use of the auto. (Reg. § 1.61-21(b)(1), Reg. § 1.132-5(b)(1)(i)) The employer also must charge the employee with compensation income equal to the FMV of other employer-paid costs for goods or services relating to personal use (e.g., gas, maintenance, insurance).

Illustration: Continuing with our example of Widget, Inc., and Mr. Smith, an owner-employee, we'll assume Widget buys or leases a new $50,000 auto for him in January of 2008. The lease runs for three years. Widget also insures the auto and pays for maintenance. We'll assume that the lease would cost Smith $7,500 a year and the insurance and maintenance would cost $3,000. For 2008, Smith's employment-related business use of the auto is 55%, and his personal use is 45%.

Result. Under the general FMV personal use valuation method, Smith would be charged with $4,725 of compensation income in 2008 due to his personal use ($7,500 plus $3,000, times 45%). At a 35% effective tax rate, that ends up costing Smith only $1,653.75 ($4,725 × 35%). If Smith also charges all gas costs on a company credit card, and doesn't reimburse the employer for fuel consumed during personal driving, he would also have compensation income equal to 45% of total gas costs for 2008.

Valuing Personal Use With the Table-Value Method

Instead of using the general FMV method, employers have the choice of using one of three optional methods: the table value method (also know as the annual lease value method), the cents-per-mile method, or the commuting value method. (Reg. § 1.61-21(b)(1)) However, as a practical matter, because of the many restrictions placed on the cents-per-mile and commuting value methods, the table-value method is the only optional method that is effectively available for owners or key employees.

To apply the table value method, the first step is to determine the FMV of the auto as of the first date on which the auto is made available for the personal use of any employee of the employer. (Reg. § 1.61-21(d)(2)(i)(A))

As a general rule, an auto's FMV for purposes of determining annual lease value is the amount an individual would pay locally to purchase a comparably equipped auto. (Reg. § 1.61-21(d)(5)(i)) However, the employer can avail itself of the following safe-harbor valuation methods:

• For an auto owned by the employer, the safe harbor value (for non-auto manufacturers) is the employer's cost of buying it (including sales tax, title and other expenses attributable to the purchase), provided the purchase is made at arm's length. (Reg. § 1.61-21(d)(5)(ii)(A))
• The safe harbor value of an auto leased by the employer is either: (1) the manufacturer's suggested retail price less 8% (including sales tax, title and other purchase expenses) (Reg. § 1.61-21(d)(5)(ii)(C)), or (2) the retail value of the auto as reported in a nationally recognized publication that regularly reports new or used auto retail values, whichever is applicable (reported retail price). For the auto in question, the reported retail price must be reasonable. Pricing sources consist of publications and electronic data bases. (Reg. § 1.61-21(d)(5)(ii)(C)) Alternatively, where the employer leases the vehicle, it may use the manufacturer's invoice price (including options) plus 4% as a safe harbor estimate of FMV for all purposes under Reg. § 1.61-21(d)(5)(ii). (Notice 89-110, 1989-2 CB 447)

Once FMV is found, locate the dollar range in column (1) of the table below which corresponds to that FMV. The corresponding amount in column (2) is the auto's annual lease value. (Reg. § 1.61-21(d)(2)(i)(B)) Finally, multiply the annual lease value by the ratio of the employee's annual personal mileage of the auto to total annual mileage (employment-connected business driving plus personal driving). (Reg. § 1.132-5(b)(1)(i); Reg. § 31.3501(a)-1T, Q&A-7)

Annual Lease Value Table for Automobiles (Reg. § 1.61-21(d)(2)(iii))

Annual Lease
Automobile Fair Market Value Value
-------------------------------------------------------
$0-999 ................................... $ 600
1,000-1,999 .............................. $ 850
2,000-2,999 .............................. $ 1,100
3,000-3,999 .............................. $ 1,350
4,000-4,999 .............................. $ 1,600
5,000-5,999 .............................. $ 1,850
6,000-6,999 .............................. $ 2,100
7,000-7,999 .............................. $ 2,350
8,000-8,999 .............................. $ 2,600
9,000-9,999 .............................. $ 2,850
10,000-10,999 ............................ $ 3,100
11,000-11,999 ............................ $ 3,350
12,000-12,999 ............................ $ 3,600
13,000-13,999 ............................ $ 3,850
14,000-14,999 ............................ $ 4,100
15,000-15,999 ............................ $ 4,350
16,000-16,999 ............................ $ 4,600
17,000-17,999 ............................ $ 4,850
18,000-18,999 ............................ $ 5,100
19,000-19,999 ............................ $ 5,350
20,000-20,999 ............................ $ 5,600
21,000-21,999 ............................ $ 5,850
22,000-22,999 ............................ $ 6,100
23,000-23,999 ............................ $ 6,350
24,000-24,999 ............................ $ 6,600
25,000-25,999 ............................ $ 6,850
26,000-26,999 ............................ $ 7,250
28,000-29,999 ............................ $ 7,750
30,000-31,999 ............................ $ 8,250
32,000-33,999 ............................ $ 8,750
34,000-35,999 ............................ $ 9,250
36,000-37,999 ............................ $ 9,750
38,000-39,999 ............................ $10,250
40,000-41,999 ............................ $10,750
42,000-43,999 ............................ $11,250
44,000-45,999 ............................ $11,750
46,000-47,999 ............................ $12,250
48,000-49,999 ............................ $12,750
50,000-51,999 ............................ $13,250
52,000-53,999 ............................ $13,750
54,000-55,999 ............................ $14,250
56,000-57,999 ............................ $14,750
58,000-59,999 ............................ $15,250
For automobiles with a FMV greater than $59,999, the annual lease value is: (.25 × FMV) + $500. (Reg. § 1.61-21(d)(2)(iii))

The annual lease value method takes into account the FMV of insuring and maintaining the auto. The amount shown in the table can't be reduced by the FMV of any service included in the lease value, but not supplied by the employer. (Reg. § 1.61-21(d)(3)) For example, there is no reduction if the employee must pay his or her own insurance costs. The FMV of any other service supplied with the automust be added to the table lease value. (Reg. § 1.61-21(b)(5), Reg. § 1.61-21(d)(3)(i))

Illustration: Continuing with our example of Widget, Inc., suppose it supplied Mr. Smith, its owner-employee, with a new $50,000 auto on Jan. 1 of this year, and he uses it 55% for business driving and 45% for personal driving.

Under the table lease value method, Smith would have $5,962.50 of noncash compensation for the year due to his personal use of the auto ($13,250 annual lease value per table times 45%).

Observation: Special table value rules apply if the lease starts in the middle of the year or the auto is only made available for part of the year. Additionally, the table values are based on a four-year term.

The table value method does not take into account the FMV of fuel provided to the employee by the employer, whether in kind, via a reimbursement arrangement, or via direct charging of the cost of fuel to the employer. Therefore, where an employer provides fuel to an employee, its FMV is an additional fringe benefit to the employee and must be included in gross income (except for the gas used for employment-connected business driving). (Reg. § 1.61-21(d)(3)(ii)(A)) The FMV of fuel provided in kind by an employer may be determined based on all the facts and circumstances. Alternatively, but only for fuel provided in kind for miles driven within the U.S., Canada, or Mexico, fuel may be valued at 5.5¢ per mile for all miles driven by the employee. (Reg. § 1.61-21(d)(3)(ii)(B))

Observation: With gas hovering at over $4 a gallon in many areas, having personal mileage fuel valued at 5.5¢ per mile is an incredible bargain. As a practical matter, however, this rule is usable only if the employer maintains a gas pump on its premises (e.g., it has a fleet of cars or trucks).

Where an employer provides an employee with fuel by means of a reimbursement arrangement, or by allowing the cost of the fuel to be charged directly to it, the FMV of the fuel is the amount of the actual reimbursement or the amount charged, if the fuel is bought at arm's length. (Reg. § 1.61-21(d)(3)(ii)(C))

Pros and cons of valuation methods. The chief virtue of the general FMV valuation method is that the current arm's length cost of leasing a car (and insuring it) may be less than the valuation produced by the annual lease value method, which is based on a table that has not changed since it was first issued in temporary regs in '85. (TD 8063, 1986-1 CB 10) On the minus side, however, the FMV method may mean more "legwork" for the employer (i.e., in establishing the arm's length value of the auto's use) and can be a cumbersome method for an employer that maintains more than a few cars. The method also may be costly for the employee if he is given the use of an auto for a relatively short period of time (e.g., he's give the use of an auto that the company leases for only two years).

The annual lease value method's chief virtue is simplicity. An employer that uses this method can find the value of any employee's personal mileage on any auto by using a universal table that includes insurance and maintenance costs. On the minus side, however, the annual lease value method may bear little if any resemblance to actual lease values. Thus, this method may produce more taxable compensation income for employees than the FMV method.

Consistency Rules for Personal Use Valuation Methods

An employer is not required to use the same valuation method for all its autos. For example, it may use the FMV method for one auto and the annual lease value method for another. (Reg. § 1.61-21(c)(2)(ii)) However, once an employer chooses a valuation method for a particular auto, it is generally locked into that method for that auto. In other words, the election is binding for all later periods that the auto is made available to any employee. (Reg. § 1.61-21(d)(7)(ii), Reg. § 1.61-21(e)(5)(ii))

An employer is treated as having made the choice to use a particular valuation method when it values personal use with that method for income, employment tax, and reporting purposes. (Reg. § 1.61-21(c)(3)(i)) In general, the election to use the annual lease value or mileage rate method must be made for the first day on which the auto is made available to an employee. (Reg. § 1.61-21(d)(7)(i), Reg. § 1.61-21(e)(5)(i))

For income tax purposes, a company owner or employee may always use the general fair market valuation method to value an employer-provided benefit, even if the employer uses the table value method. (Reg. § 1.61-21(c)(2)(ii))

Caution: An employee tempted to use the general FMV method because it produces a lower valuation than the employer's use of the table value method should keep in mind that he or she will have to attach a statement to his return reconciling the amount included in income with the amount reported on his Form W-2.

In general, in the context of our discussion geared to a small or medium-sized firm, an owner or employee will use the annual lease value method to value his personal use of an employer-provided auto only if the employer uses that method. (Reg. § 1.61-21(c)(2)(ii))

Recordkeeping Requirements

Whether the general FMV or table value method is chosen, the only way to distinguish between employment-related business driving (which is excluded as a nontaxable working fringe benefit if properly substantiated) and personal driving (which is a taxable fringe benefit) is on the basis of mileage. (Reg. § 1.132-5(b))

Recommendation: Employees must keep a diary or similar record with detailed entries for employment-connected business usage of the auto (time, place, mileage, business purpose). These entries are needed to establish the non-taxable working condition fringe benefit portion of employees' usage. Employees also should enter beginning and ending odometer readings for the period of time involved. Total mileage less employment-connected business mileage will yield personal mileage, the value of which must be treated as taxable fringe benefit compensation income.

Business Auto Deductions for the Employer

If all personal use of the auto by an owner or employee (or a member of his or her family) is properly treated as fringe benefit compensation income, the auto will be treated as if it were 100% used for business. That means the employer may deduct all of its operating expenses (e.g., oil, gas, maintenance and repairs) and also may claim all of the otherwise allowable depreciation deductions or lease deductions. Rationale: Where personal use is treated as fringe benefit compensation income, the employer may deduct all of the otherwise allowable costs incurred in supplying that benefit. (Reg. § 1.162-25T; Reg. § 1.274-5T(e)(2))

Because of the so-called "luxury auto" deduction limits of Code Sec. 280F , however, employers will have to grapple with severe restrictions on depreciation and expensing deductions if the company auto is purchased (unless the vehicle is a heavy SUV, defined below), and relatively mild restrictions if it is leased (and no restrictions at all if the vehicle is a heavy SUV).

Purchased autos: The otherwise-allowable depreciation and Code Sec. 179 expensing deductions for a new business auto bought and placed in service in 2008 are limited to $10,960 for the placed-in-service year, $4,800 for the second tax year, $2,850 for the third, and $1,775 for each succeeding year. For new light trucks or vans (passenger autos built on a truck chassis, including minivans and sport utility vehicles (SUVs) built on a truck chassis) bought and placed in service in 2008, the limits are $11,160 for the placed-in-service year, $5,100 for the second tax year, $3,050 for the third, and $1,875 for each succeeding year. (Rev Proc 2008-22, 2008-12 IRB)

Caution: If the vehicle is used by a more-than-5% company owner, the above first-year limitsapply only if business use exceeds 50% of total use. If it doesn't (or if the auto is bought used or the employer elects not to use bonus first year depreciation for autos and other 5-year assets), first-year depreciation will be limited to only $2,960 if the vehicle is an auto, and $3,160 if it's a light truck or van. (Code Sec. 168(k)(2)(D))

These rules are relaxed considerably if the company owned vehicle is a heavy SUV, one with a gross vehicle weight rating (GVWR) of over 6,000 pounds. Because such vehicles fall outside of the Code Sec. 280F(d)(5) definition of a passenger auto, the strict annual depreciation deduction limits don't apply. As a result, the employer may:

• expense up to $25,000 of the cost of the heavy SUV under Code Sec. 179(b)(6);
• claim bonus first year depreciation under the Economic Stimulus Act of 2008 of its cost as reduced by any expensing claimed (this is available only if the vehicle is bought new and placed in service in 2008); and
• write off what's left of the cost of the vehicle, after subtracting the expensed amount and the bonus first year depreciation amount, under the normal depreciation rules applicable to 5-year property.

Caution: If the heavy SUV is used by a more-than-5% company owner, the above generous rules apply only if business use exceeds 50% of total use. If it doesn't, the vehicle isn't eligible for expensing, bonus first-year depreciation won't be available, and a slower (straight line) form of depreciation must be used to recover the cost of the vehicle. (Code Sec. 168(k)(2)(D), Code Sec. 280F(b)(1), Code Sec. 280F(d)(1))

Leased autos: A business that leases an auto for its owner or key employee may deduct the full lease payment, assuming personal use is properly treated as compensation income. However, unless the auto is modestly priced (e.g., for leases signed in 2008, it has a FMV under $18,500 if an auto, or under $19,000 if a light truck or van), the business must include a certain amount in income during each year of the lease. (Code Sec. 280F(c)) This income inclusion amount varies with the initial FMV of the leased auto, the lease term and the year of the lease, and is adjusted for inflation each year. Tables 5 and 6 of Rev Proc 2008-22, 2008-12 IRB, Sec. 4.03, carry the income inclusion tables for passenger autos, and light trucks and vans with a lease term beginning in 2008.

Observation: These addback amounts are relatively modest, even for higher-priced autos. For example, if a $50,000 auto is leased on Jan. 1, 2008 for a three-year term, the income inclusion amount would be $177 for 2008, $388 for 2009, and $575 for 2010.

Mileage rate method of deducting auto expenses: For the sake of completeness, it should be noted that instead of deducting actual business-related out-of-pocket expenses plus depreciation, an eligible business may deduct business-connected expenses of leased or purchased autos (including vans, pickups and panel trucks) by way of the standard mileage rate. This method yields a fixed deduction for each business mile traveled, regardless of actual expenses, cost of the auto, or its age. Assuming personal use is properly valued and treated as compensation income, even personal mileage would count as business mileage. The mileage rate, which is adjusted for inflation annually, is equal to 50.5¢ for each business mile traveled during 2008. The mileage rate deduction method is available only if a number of restrictions are met. For example, it's not available if the auto was written off in a previous year using accelerated depreciation, or if the business owns or leases five or more autos and uses them simultaneously. (Rev Proc 2007-70, 2007-50 IRB 1162)

A deduction computed under the standard mileage rate is in lieu of all operating and fixed costs of the automobile allocable to business purposes. Such items as depreciation (or lease costs), maintenance and repairs, tires, gasoline (including all taxes on the gasoline), oil, insurance and registration fees are included in operating and fixed costs. (Rev Proc 2007-70, 2007-50 IRB 1162, Sec. 5.03) However, the taxpayer may separately deduct parking fees and tolls attributable to business use of the auto. (Rev Proc 2007-70, 2007-50 IRB 1162, Sec. 5.04)

Observation: As a practical matter, the mileage rate method isn't an attractive writeoff for the company auto used by the owner or a key employee, because it's likely to be much smaller than the deductions that can be claimed by writing off actual out-of-pocket expenses and depreciation or lease costs.

Conclusion

The company auto still weighs in as a champion fringe benefit for the company owner or key employee. It can provide company owners or key employees with the use of a status-enhancing auto at a low tax cost while generating tax deductions for the company.

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IRS may prepare substitute returns in worker classification cases
Chief Counsel Advice 200822026

A Chief Counsel Advice (CCA) has concluded that, in employment tax cases where worker classification issues are present, revenue officers have authority under Code Sec. 6020(b) to prepare employment tax returns, but the requirements of Code Sec. 7436 must be met before assessment.

Background. Where there is an actual controversy involving a determination by IRS that one or more individuals performing services for the taxpayer are employees as part of an examination, Code Sec. 7436 gives the Tax Court jurisdiction to determine certain "worker classification issues" (i.e., the proper amount of the additions to tax, additional amounts, and penalties that relate to the employment tax with respect to determinations of worker classification and whether the taxpayer is entitled to relief under § 530 of the Revenue Act of 1978). To meet Code Sec. 7436 's requirements, certain procedures must be followed before assessment of employment taxes. They are spelled out in Notice 2002-5, 2002-1 CB 320. For example, Notice 2002-5 provides generally that a taxpayer will first receive a "30-day" letter listing the proposed employment tax adjustments to be made and describing the taxpayer's right either to agree to the proposed adjustments or to protest the proposed adjustments to the IRS's Appeals function (Appeals) within 30 days of the date of the letter.

If the taxpayer does not respond to the "30-day" letter by agreeing to the proposed adjustments or by filing a protest to Appeals, the taxpayer will receive a Notice of Determination of Worker Classification (NDWC). The taxpayer may also receive the NDWC if the taxpayer files a protest with Appeals and the worker classification issues are not settled in Appeals. As indicated in Notice 2002-5, under Code Sec. 7436(d)(1), the mailing of the NDWC suspends the period of limitations for assessment of taxes attributable to the worker classification issues for the 90-day period during which the taxpayer can bring suit and precludes IRS from assessing the taxes identified in the NDWC before the expiration of the 90-day period during which the taxpayer may file a timely Tax Court petition.

If IRS erroneously makes an assessment of taxes attributable to the worker classification issues without first either issuing a NDWC or obtaining a waiver of restrictions on assessment from the taxpayer, the taxpayer is entitled to an automatic abatement of the assessment. However, under Notice 2002-5, once any procedural defects are corrected, IRS may reassess the employment taxes to the same extent as if the abated assessment had not occurred.

The amount of any tax imposed by the Code is to be assessed within 3 years after the return was filed, subject to certain specified exceptions. (Code Sec. 6501(a))

Under Code Sec. 6020(b), if a taxpayer fails to file a return when required, IRS may prepare a return based on its own knowledge and on information it obtains through testimony or other means. The failure-to-pay penalty under Code Sec. 6651(a)(2) applies to the amount of tax shown on the return, including, under Code Sec. 6651(g)(2) , any amount shown on a substitute return prepared by IRS. Absent the existence of a return under Code Sec. 6020(b), the Code Sec. 6651(a)(2) penalty doesn't apply to a nonfiler. [For discussion of recently issued regs on substitute returns, see Federal Taxes Weekly Alert 02/14/2008]

Facts. The Chief Counsel was asked to review a memorandum which addressed the issue of whether a revenue officer has authority under Code Sec. 6020(b) to prepare employment tax returns on behalf of taxpayers who fail to file such returns in a case in which worker classification issues are present and where the revenue officer did not refer the case to the Employment Tax Program as required under the Internal Revenue Manual (IRM).

For the years at issue, the taxpayer took the position that certain workers were independent contractors for federal tax purposes. However, for prior years, the taxpayer had treated the workers as employees. After reviewing the facts of the case, the revenue officer determined that the workers should have been treated as employees and prepared Substitute for Returns (SFRs) under Code Sec. 6020(b).

The taxpayer objected to the preparation of the SFRs and requested an appeal. The appeals officer concluded that the worker classification issue was undeveloped and that "the revenue officer did not have the authority to prepare Forms 941 under Code Sec. 6020(b) procedures because the IRM requires the issue to be referred to the Employment Tax Program," and recommended the government concede the case.

Analysis. The CCA observed that the taxpayer failed to file an employment tax return and did not submit evidence to establish that no employment tax return was due. The revenue officer determined that some of the taxpayer's workers were employees and that an employment tax return should have been filed. The revenue officer prepared returns under Code Sec. 6020(b).

The CCA said that, because the revenue officer failed to meet Code Sec. 7436 's requirements, an assessment of employment taxes based on the Code Sec. 6020(b) return prepared by him is improper. However, the CCA said that the facts do not indicate that the government is required to concede the case. The CCA said that, under Notice 2002-5 , once the procedural defects are corrected and Code Sec. 7436 's requirements are met, employment taxes may be assessed.

IRS Announces 'Dirty Dozen' Tax Scams for 2008

Phishing Scams, Fuel Tax Credits, Frivolous Arguments, Hiding Income Offshore Top the 2008 Tax Scams

WASHINGTON -- The Internal Revenue Service today issued its 2008 list of the 12 most egregious tax schemes and scams, highlighted by Internet phishing scams and several frivolous tax arguments.

Topping this year's list of scams is phishing, which encompasses numerous Internet-based ploys to steal financial information from taxpayers. New to the "Dirty Dozen" this year is a scheme, which IRS auditors discovered, that relates to unreasonable and/or excessive fuel tax credit claims.

"Taxpayers should be wary of scams and promises to avoid paying taxes that seem too good to be true," Acting IRS Commissioner Linda Stiff said. "There is no secret formula that can eliminate a person's tax obligations. People should be wary of anyone peddling any of these scams."

Tax schemes can lead to problems for both scam artists and taxpayers. Tax return preparers and promoters also risk significant penalties, interest and possible criminal prosecution.

The IRS urges taxpayers to avoid these common schemes:

1. Phishing

Phishing is a tactic used by Internet-based thieves to trick unsuspecting victims into revealing personal information they can then use to access the victims' financial accounts. These criminals use the information obtained to empty the victims' bank accounts, run up credit card charges and apply for loans or credit in the victims' names. Phishing scams often take the form of an e-mail that appears to come from a legitimate source. Some scam e-mails falsely claim to come from the IRS. To date, taxpayers have forwarded more than 33,000 of these scam e-mails, reflecting more than 1,500 different schemes, to the IRS. The IRS never uses e-mail to contact taxpayers about their tax issues. Taxpayers who receive unsolicited e-mail that claims to be from the IRS can forward the message to a special electronic mailbox, phishing@irs.gov, using instructions contained in an article titled "How to Protect Yourself from Suspicious E-Mails or Phishing Schemes." Remember: the only official IRS Web site is located at www.irs.gov.

2. Scams Related to the Economic Stimulus Payment

Some scam artists are trying to trick individuals into revealing personal financial information that can be used to access their financial accounts by making promises relating to the economic stimulus payment, often called a "rebate." To obtain the payment, eligible individuals in most cases will not have to do anything more than file a 2007 federal tax return. But some criminals posing as IRS representatives are trying to trick taxpayers into revealing their personal financial information by falsely telling them they must provide information to get a payment. For instance, a potential victim is told by phone or e-mail that he or she is eligible for a rebate but must provide a bank account number (or similar information) to get the payment. If the target is unwilling, the victim is then told that he cannot receive the rebate unless the information is provided. Individuals should remember that the only way to get a stimulus payment is to file a 2007 tax return. The IRS urges taxpayers to be extra-vigilant. The IRS will not contact taxpayers by phone or e-mail about their stimulus payment.

3. Frivolous Arguments

Promoters of frivolous schemes encourage people to make unreasonable and unfounded claims to avoid paying the taxes they owe. Most recently, the IRS expanded its list of frivolous legal positions that taxpayers should stay away from. Taxpayers who file a tax return or make a submission based on one of these positions on the list are subject to a $5,000 penalty. The most recent update of the list of frivolous positions includes: misinterpretation of the 9th Amendment to the U.S. Constitution regarding objections to military spending, erroneous claims that taxes are owed only by persons with a fiduciary relationship to the United States, a nonexistent "Mariner's Tax Deduction" related to invalid deductions for meals and the misuse of the fuel tax credit (see below). The complete list of frivolous arguments is on the IRS Web site at IRS.gov.

4. Fuel Tax Credit Scams

The IRS is receiving claims for the fuel tax credit that are unreasonable. Some taxpayers, such as farmers who use fuel for off-highway business purposes, may be eligible for the fuel tax credit. But some individuals are claiming the tax credit for nontaxable uses of fuel when their occupation or income level makes the claim unreasonable. Fraud involving the fuel tax credit was recently added to the list of frivolous tax claims, potentially subjecting those who improperly claim the credit to a $5,000 penalty.

5. Hiding Income Offshore

Individuals continue to try to avoid paying U.S.taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore debit cards, credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance plans. The IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions.

6. Abusive Retirement Plans

The IRS continues to uncover abuses in retirement plan arrangements, including Roth Individual Retirement Arrangements (IRAs). The IRS is looking for transactions that taxpayers are using to avoid the limitations on contributions to Roth IRAs. Taxpayers should be wary of advisers who encourage them to shift appreciated assets into Roth IRAs or companies owned by their Roth IRAs at less than fair market value. In one variation of the scheme, a promoter has the taxpayer move a highly appreciated asset into a Roth IRA at cost value, which is below annual contribution limits even though the fair market value far exceeds the amount allowed.

7. Zero Wages

Filing a phony wage- or income-related information return to replace a legitimate information return has been used as an illegal method to lower the amount of taxes owed. Typically, a Form 4852 (Substitute Form W-2) or a "corrected" Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer also may submit a statement rebutting wages and taxes reported by a payer to the IRS. Sometimes fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any of the variations of this scheme.

8. False Claims for Refund and Requests for Abatement

This scam involves a request for abatement of previously assessed tax using Form 843, "Claim for Refund and Request for Abatement." Many individuals who try this have not previously filed tax returns. The tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses Form 843 to list reasons for the request. Often, one of the reasons given is "Failed to properly compute and/or calculate Section 83-Property Transferred in Connection with Performance of Service."

9. Return Preparer Fraud

Dishonest tax return preparers can cause many problems for taxpayers who fall victim to their schemes. These scam artists make their money by skimming a portion of their clients' refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Some preparers promote the filing of fraudulent claims for refunds on items such as fuel tax credits to recover taxes paid in prior years. Taxpayers should choose carefully when hiring a tax preparer, especially one who promises something that seems too good to be true.

10. Diguised Corporate Ownership

Some people are going as far as forming domestic shell corporations in certain states for the purpose of disguising the ownership of a business or financial activity. Once formed, these anonymous entities can be used to facilitate underreporting of income, non-filing of tax returns, engaging in listed transactions, money laundering, financial crimes and even terrorist financing. The IRS is working with state authorities to identify these entities and to bring the owners of these entities into compliance.

11. Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust.

12. Abuse of Charitable Organizations and Deductions

The IRS continues to observe the misuse of tax-exempt organizations. Misuse includes arrangements to improperly shield income or assets from taxation, attempts by donors to maintain control over donated assets or income from donated property and overvaluation of contributed property. In addition, IRS examiners are seeing an upturn in instances where taxpayers try to disguise private tuition payments as contributions to charitable or religious organizations.

IRS Watches Scams That Fall Off the List

While the IRS has seen a decline in the occurrence of some of these scams, other problems, such as abuse of the American Indian Employment Credit and misuse of structured entity credits, continue to be areas of concern. The absence of a particular scheme from the Dirty Dozen should not be taken as an indication that the IRS is unaware of it or not taking steps to counter it.

How to Report Suspected Tax Fraud Activity

Suspected tax fraud can be reported to the IRS using IRS Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential.

Whistleblowers also could provide allegations of fraud to the IRS and may be eligible for a reward by filing Form 211, Application for Award for Original Information, and following the procedures outlined in Notice 2008-4, Claims Submitted to the IRS Whistleblower Office under Section 7623.

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IRS Media Relations Office Washington, D.C. IR-2008-41, March 13, 2008

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Tax provisions directly affecting farmers in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted "Heartland, Habitat, Harvest, and Horticulture Act of 2008" (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act that directly affect farmers:

• Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
• The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
• A new deduction is allowed for endangered species recovery expenses incurred after 2008.
• A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
• The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
• A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
• Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
• Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
• The amount of farming losses (other than those losses arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
• For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
• The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.
  

Limitation on farming losses in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted "Heartland, Habitat, Harvest, and Horticulture Act of 2008" (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. Those incentives are paid for, in part, by a new limitation on farming losses for certain taxpayers. In essence, the new law limits agricultural losses that can be claimed to the greater of $300,000 ($150,000 for a married person filing separately) or the net farm income for the previous five years if the taxpayer receives any 2008 Farm Act commodity payments or Commodity Credit Corporation loans. Here is a closer look at this new limitation.

Except for passive activity rules in Code Sec. 469, the amount of farming losses that a taxpayer may claim is not limited under pre-2008 Farm Act law. The new provision, which is effective for tax years beginning after December 31, 2009, alters that situation by limiting the amount of farming losses that a taxpayer, other than a C corporation, may use to offset non-farm business income. The limitation amount is the greater of $300,000 ($150,000 in the case of a married person filing a separate return) or the total net farm income the taxpayer has received over the last five years. For example, assume a taxpayer has $300,000 of net farm income and $700,000 of non-farm income in 2010, and $1 million of net farm income in each tax year 2011 to 2014. In 2015, he incurs a $7 million farming loss. Under the new provision, his farming loss in 2015 is limited to the greater of (1) $300,000 or (2) $4.3 million (total net farm income for the prior five tax years). The $4.3 million of the farming loss allowed in 2015 may be carried back to the prior five tax years.

Losses that are limited in a particular year may be carried forward to subsequent years.
For partnerships and S corporations, the limit is applied at the partner or shareholder level. Farming losses arising by reason of fire, storm, or other casualty, or by reason of disease or drought, are disregarded for purposes of calculating the new limitation.

This provision only applies to eligible taxpayers who receive any direct or counter-cyclical payments under title I of the 2008 Farm Act (or any payment elected in lieu of any such payment), or any Commodity Credit Corporation loan. For purposes of this provision, the definition of "farming business" is broadened to include the processing of commodities, without regard to whether such activity is incidental, by a taxpayer otherwise engaged in a farming business with respect to such commodities.

Agricultural chemicals security tax credit created by the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted "Heartland, Habitat, Harvest, and Horticulture Act of 2008" (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. One fairly specialized new incentive addresses the need to safely secure agricultural chemicals. Agricultural chemicals and pesticides purchased for legitimate uses are increasingly vulnerable to theft because of the drug trade and national security threats. Some agricultural businesses may pay tens of thousands of dollars on new measures to secure their storage sites. In recognition of this, the 2008 Farm Act creates a new credit to help agricultural businesses afford the increasing expenses of protecting agricultural chemicals and pesticides.

The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.

I hope this information is helpful. If you would like more details about this or any other aspect of the new law, please do not hesitate to contact us.

Overview of the tax changes in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted "Heartland, Habitat, Harvest, and Horticulture Act of 2008" (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act:

• Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
• The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
• A new deduction is allowed for endangered species recovery expenses incurred after 2008.
• There is a one-year cut in the tax rate for a corporation's qualified timber gain. For tax years ending after May 22, 2008 and beginning on or before May 22, 2009, a 15% alternative tax applies on the portion of a corporation's taxable income that consists of qualified timber gain (or, if less, the net capital gain) for a tax year. In addition the rules for REITs (real estate investment trusts) holding timber property are liberalized temporarily.
• A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
• The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
• A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
• Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
• For property placed in service after 2008 and before 2014, all racehorses are classified as three-year property for depreciation purposes, regardless of their age.
• Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
• The amount of farming losses (other than those arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
• For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
• The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.
• For large corporations (those with assets of at least $1 billion), estimated tax payments due in July, August, and September of 2012 are increased by 7.75% of the payment otherwise due, and the next required payment is reduced accordingly.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Tax relief for Peace Corps volunteers and employees in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted "Heroes Earnings Assistance and Relief Tax Act of 2008" (the 2008 Heroes Act) contains a wide-ranging package of tax cuts for military personnel and veterans. In addition, a provision in the 2008 Heroes Act will potentially enable more Peace Corps employees and volunteers to qualify for the homesale exclusion on the sale of their principal home. Here are the details of the new provision affecting Peace Corps volunteers.

An individual taxpayer may exclude up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a principal residence. To be eligible for the exclusion, the taxpayer must have owned and used the residence as a principal residence for at least two of the five years ending on the sale or exchange. A taxpayer who fails to meet these requirements by reason of a change of place of employment, health, or, to the extent provided under regulations, unforeseen circumstances is able to exclude an amount equal to the fraction of the $250,000/$500,000 that is equal to the fraction of the two years that the ownership and use requirements are met.

There are special rules relating to members of the uniformed services, members of the Foreign Service of the United States, and employees of the intelligence community that allow for an option to suspend the five-year test period for ownership and use during any period these individuals or their spouses serve on qualified official extended duty. This means that they may be able to meet the two-year use test even if, because of their service, they did not actually live in the home for at least the required two years during the five-year period ending on the date of sale. The five-year period can't be extended by more than ten years.

Under the 2008 Heroes Act, a new rule is created for Peace Corps volunteers and certain employees similar to the rules that already apply to the uniformed services, Foreign Service, and intelligence community. Under this new rule, which is effective for tax years beginning after December 31, 2007, an individual may elect to suspend for a maximum of ten years the five-year test period for ownership and use during certain periods that the employee or volunteer is serving outside the U.S.. If the election is made, the five-year period ending on the date of the sale or exchange of a principal residence does not include the period up to ten years during which the taxpayer or the taxpayer's spouse is serving as a Peace Corp volunteer or employee.

For example, let's say that Betty bought and moved into a home in 2002. She lived in it as her main home for two and one-half years. For the next four years, she did not live in it because she was serving outside the United States as a Peace Corps volunteer. She then sells the home at a gain in 2008. To meet the use test, Betty chooses to suspend the five-year test period for the four years she was serving in the Peace Corps. This means she can disregard those four years. Therefore, Betty's five-year test period consists of the five years before she went on qualified official extended duty in the Peace Corps. She meets the ownership and use test because she owned and lived in the home for two and one-half years during the testing period.

I hope this information is helpful. If you would like more details about this provision or any other aspect of the new law, please do not hesitate to contact us.

Pension plan benefits for military personnel in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted "Heroes Earnings Assistance and Relief Tax Act of 2008" (the 2008 Heroes Act) provides several important pension plan benefits for military personnel. Specifically, the Act makes the following pension plan liberalizations for members of the military and their families:

• Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
• Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
• Permits a military death gratuity or amount received under the Servicemembers' Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.
  

Other military tax benefits in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted "Heroes Earnings Assistance and Relief Tax Act of 2008" (the 2008 Heroes Act) contains a wide-ranging package of tax cuts for military personnel and veterans. While many of the military tax benefits are pension plan-related, several important changes are not. Specifically, the 2008 Heroes Act makes the following nonpension-related liberalizations for members of the military and their families:

• Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
• Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law this benefit was only available for tax years ending before 2008).
• Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law this exception only applied for bonds issued before 2008).
• Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations. This provision is important because length-of-service-based military retirement benefits are included in income but veterans' benefits based on a service-connected disability are excluded. Where individuals receive includible retirement benefits and are later retroactively determined to be eligible for service-connected disability benefits, the retirement benefits attributable to the disability are retroactively excluded. Under pre-2008 Heroes Tax Act law, individuals may claim a refund of the tax paid on the retroactively excluded benefits, subject to the statute of limitations on filing a refund claim (generally, the claim must be filed within three years of the filing of the tax return or within two years of the payment of the tax, whichever expires later). Effective for claims filed after the enactment date, the Act extends the time period for filing a refund claim. For a determination after the enactment date, the period is extended until one year after the date of the disability determination (if later than the time periods allowed under current law). The change applies to any tax year which begins five years before the date of the determination or thereafter. For a determination after 2000, and on or before the enactment date, the refund period is extended until one year after the enactment date (if later than the time periods allowed under current law).
• Modifies the rules regarding differential pay. Some employers voluntarily agree to continue paying the compensation that service members would otherwise have received from the employer during their active duty. Under pre-2008 Heroes Act law, such "differential pay" isn't wages for federal income tax withholding purposes but under the new law is subject to withholding, effective for amounts paid after 2008. Additionally, effective for tax years beginning after 2008, differential pay will have to be treated as compensation for retirement plan purposes, and will qualify as compensation for purposes of the IRA contribution rules.
• Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
• Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
• Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).

Please keep in mind that this is only a summary of these changes in the new law. If you would like more details about these provisions or any other aspect of the new law, please do not hesitate to contact us.

Overview of tax changes in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted "Heroes Earnings Assistance and Relief Tax Act of 2008" (the 2008 Heroes Act) provides targeted tax relief for military members and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty. Here's a summary of the tax provisions in the Act:

New relief provisions. The 2008 Heroes Act makes the following liberalizations for members of the military and their families:

• Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
• Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law, this benefit was only available for tax years ending before 2008).
• Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law, this exception only applied for bonds issued before 2008).
• Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
• Includes differential wages paid by an employer to an employee who becomes active duty military in the calculation of wages for retirement plan and IRA purposes, effective for years beginning after 2008. Differential pay is also made subject to federal income tax withholding, effective for amounts paid after 2008.
• Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations.
• Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
• Permits a military death gratuity or amount received under the Servicemembers' Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.
• Entitles Peace Corps volunteers and certain employees to a similar tolling of the homesale exclusion ownership and use period that already applies to members of the uniformed services, Foreign Service, and intelligence community. The Act also makes permanent the special homesale exclusion rules for certain employees of the intelligence community and repeals the requirement that those employees move overseas in order to qualify for special treatment.
• Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
• Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
• Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).
• Retroactively clarifies that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.

Revenue raising provisions. To offset the cost of the new tax breaks (and the cost of various SSI liberalizations for the military), the Act:

• Tightens the expatriation rules. U.S. citizens and long-term U.S. residents are subject to tax on their worldwide income. Taxpayers can avoid taxes by renouncing their U.S. citizenship or terminating their residence. The Act tightens the expatriation rules to ensure that certain high net-worth taxpayers can't renounce their U.S. citizenship or terminate their U.S. residency in order to avoid U.S. taxes. Under this provision, high net-worth individuals are treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residency. Gain is recognized to the extent that the aggregate gain recognized exceeds $600,000 (which will be adjusted for cost of living in the future). The provision, which applies for those who relinquish U.S. citizenship or terminate their U.S. residency on or after the enactment date, is estimated to raise $411 million over 10 years.
• Treats foreign subsidiaries of U.S. companies performing services under a U.S. government contract as American employers for employment tax purposes. Under the new law, the domestic parent is jointly liable for employment taxes imposed on the foreign subsidiary. The new provision applies to services performed in calendar months beginning more than 30 days after the enactment date and is estimated to raise $846 million over ten years.
• Increases the minimum penalty for a failure to file an individual tax return within 60 days of the due date to the lesser of $135 (up from $100) or 100 percent of the amount of tax required to be shown on the return, effective for tax returns required to be filed after 2008. The provision is estimated to raise $296 million over ten years.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Temporary regs curb abuses in triangular reorganizations involving foreign corporations

T.D. 9400, 05/23/2008, Reg. § 1.367(a)-3T, Reg. § 1.367(b)-14T, Preamble to Prop Reg 05/23/2008

IRS has issued temporary (along with final and proposed regs) under Code Sec. 367(b) to curb abusive triangular reorganizations involving foreign corporationssometimes referred to as "Killer B" transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48, and their text serves as the text of the proposed regs.

Statutory background. A U.S. person's transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354, Code Sec. 356, or Code Sec. 361 exchanges, generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent's stock provided by it to its subsidiaryunder a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent's stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target's stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent's stock that it exchanges for the target's stock in a reverse triangular merger. (Code Sec. 361)

A corporation's distribution of property to its shareholder with respect to its stock is included in the shareholder's gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation's current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation's stock, and any amount of the distribution in excess of the shareholder's basis is treated as gain from the sale or exchange of the corporation's stock. (Code Sec. 301(c)(2), Code Sec. 301(c))

Background on prior IRS notices. In Notice 2006-85, 2006-41 IRB 677, IRS announced that it would issue regs under Code Sec. 367(b) to curb abuses where triangular reorganizations involving foreign corporations had the effect of repatriating the subsidiary's foreign earnings to the parent without a corresponding dividend to the parent that would be subject to U.S. income tax (see Federal Taxes Weekly Alert 09/28/2006). The regs would treat the transfer of property from the parent to the subsidiary as a distribution of property under Code Sec. 301(c). IRS later issued Notice 2007-48, 2007-25 IRB 1428, to amplify and broaden the reach of Notice 2006-85 to cover transactions where the subsidiary acquires stock of its parent from a person unrelated to its parent, such as from the public on the open market (see Federal Taxes Weekly Alert 06/07/2007).

IRS has now issue final, temporary and proposed regs under Code Sec. 367(b) to address these other transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48 , and their text serves as the text of the proposed regs. The final regs revise an existing final reg and add a cross-reference.

Temporary regs. IRS has issued temporary regs that apply to triangular reorganizations where P or S (or both) is foreign and, in connection with the reorganization, S acquires, in exchange for property, all or a portion of the P stock that is used to acquire T's stock or assets. The "in connection with" standard is a broad standard that includes any transaction related to the reorganization even if the transaction is not part of the plan of reorganization. For example, the temporary regs apply to a triangular reorganization regardless of whether P controls S (under Code Sec. 368(c)) when S acquires the P stock that is used in the reorganization. (Reg. § 1.367(b)-14T(a)(1))

The temporary regs make adjustments for P and S that have the effect of a distribution of property from S to P under Code Sec. 301. The amount of the deemed distribution is equal to the amount of money plus the fair market value of other property that S used to acquire P stock. For this purpose, "property" has the meaning in Code Sec. 317(a) , but includes any liability assumed by S in exchange for the P stock (notwithstanding Code Sec. 357(a)) and any S stock used by S to acquire the P stock from a person other than P. To the extent S buys P stock from a person other than P, immediately after taking into account the deemed distribution to P, P is deemed to contribute to S the property deemed distributed to P. (Reg. § 1.367(b)-14T(b)(1))

The deemed distribution is treated as a transaction separate from, and occurring immediately before, the triangular reorganization. Thus, P is not be treated as receiving the property from S in exchange for P stock, and the transfer of P stock in the triangular reorganization is subject to the generally applicable provisions, e.g., Reg. § 1.1032-2. (Reg. § 1.367(b)-14T(b)(2)) The deemed distribution is treated as a distribution for all purposes of the Code. (Reg. § 1.367(b)-14T(c)(1)) Similarly, a deemed contribution of property is treated as a contribution of property for all purposes of the Code. For example, appropriate adjustments to P's basis in the S stock and other affected items must be made according to applicable Code provisions. (Reg. § 1.367(b)-14T(c)(2))

Ordering rules generally require the deemed distribution and, in cases where S buys P stock from a person other than P, the deemed contribution to be taken into account before the transfers undertaken under the triangular reorganization. If P controls S (under Code Sec. 368(c)) at the time of the purchase, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately before the purchase. If P doesn't control S (under Code Sec. 368(c) ) at the time that S purchases the P stock, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately after P acquires control of S. Thus, in a transaction where S purchases the P stock from a person other than P, after taking into account the adjustments made under these temporary regs, S's purchase and transfer of P stock under the triangular reorganization are taken into account under generally applicable Code provisions, such as Code Sec. 304, Code Sec. 354, Code Sec. 356, Code Sec. 358, and Code Sec. 368. (Reg. § 1.367(b)-14T(b)(3))

Under the temporary regs, appropriate adjustments are made if in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of the regs. (Reg. § 1.367(b)-14T(d)) For example, if S is a newly formed corporation and, in connection with the reorganization, P contributes to S another corporation with positive earnings and profits (S2) to facilitate S's purchase of the P stock or to facilitate the repayment of an obligation incurred by S to purchase the P stock, then, under the temporary regs, the earnings and profits of S may be deemed to include S2's earnings and profits. (T.D. 9400, 05/23/2008)

Effective date. For rules addressing transactions described in Notice 2006-85, the temporary regs are generally applicable to transactions occurring on or after Sept. 22, 2006. For rules addressing transactions described in Notice 2007-48, the temporary regs are generally applicable to transactions occurring on or after May 31, 2007. Other reg rules are generally applicable to transactions occurring on or after May 23, 2008. Limited transition relief applies. (Reg. § 1.367(b)-14T(e))

IRS expands advance pricing agreement procedures to include other issues relevant to transfer pricing

Rev Proc 2008-31, 2008-23 IRB

In a Revenue Procedure, IRS has expanded the procedures under which taxpayers secure an advance pricing agreement (APA) to include additional types of issues that may be resolved in the APA process.

Background. An APA generally combines a voluntary agreement between a taxpayer and IRS on an appropriate transfer pricing methodology (TPM) for covered transactions with an agreement between the U.S. and one or more foreign tax authorities that the TPM is correct. This kind of bilateral APA assures the taxpayer that the income from the transactions will not be subject to double taxation by the U.S. and the foreign tax authority. IRS and taxpayers also may execute unilateral APAs, which are agreements establishing an approved transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and IRS, but does not prevent foreign tax bodies from taking different positions. If a transaction covered by a unilateral APA is subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding, provided there is an applicable income tax treaty in force with the other country. The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee.

IRS has now updated Rev Proc 2006-9, 2006-2 IRB 278, which contains the procedures for applying for an APA.

Updated procedures. In Rev Proc 2008-31, IRS modifies the procedures in Rev Proc 2006-9 to state that the APA program also provides a process by which IRS and taxpayers may resolve other issues than transfer pricing arising under certain income tax treaties, the Code, or the regs for which transfer pricing principles may be relevant. For example, these issues would include: attribution of profits to a permanent establishment under an income tax treaty, determining the amount of income effectively connected with the conduct by the taxpayer of a trade or business within the U.S., and determining the amounts of income derived from sources partly within and partly without the U.S., as well as related subsidiary issues.

House-passed Heroes Act would provide tax relief to military members & their families

On May 20, by a vote of 403-0 the House of Representatives unanimously approved H.R. 6081, the "Heroes Earnings Assistance and Relief Tax Act of 2008." The bill, dubbed the HEART Act by its sponsors, is very similar to the version of H.R. 3997 (the "Heroes Earnings Assistance and Tax Relief Act of 2007") that was passed by the House of Representatives in the waning days of 2007 but failed to pass the Senate. The bill would provide targeted tax relief for members of the military and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty.

Caution: Several of the HEART Act relief provisions would create significant compliance and plan amendment challenges for tax qualified retirement plans and their sponsors.

The press staff for Speaker of the House Nancy Pelosi (D-CA) has said that H.R. 6081 is the "final agreement with the Senate that is expected to be sent to the President by Memorial Day."

Here's a roundup of the tax provisions in the HEART Act:

• Clarify that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
• Make permanent the ability to treat combat pay as earned income for purposes of the earned income tax credit.
• Make permanent and modify provisions relating to qualified mortgage bonds used to finance residences for veterans.
• Modify the Uniformed Services Employment and Re-employment Rights Act (USERRA) to allow the day before the date of death to be treated as the date the employee returned to work for purposes of triggering payment of benefits under a qualified plan. The bill would also permit an employer to make certain contributions to a qualified pension plan on behalf of an employee who is killed or become disabled in combat. These changes would apply to deaths and disabilities occurring after 2006.
• Treat differential wages paid by an employer to an employee who goes on active military duty as wages for withholding, retirement plan, and IRA purposes. The wage withholding change would apply for remuneration paid after 2008; the other changes would apply for years beginning after 2008.
• Provide small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty. The credit would apply for amounts paid after the enactment date and before 2010.
• Extend the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs (DVA) disability determinations, effective for claims for credits or refunds filed after the enactment date.
• Make permanent expiring rules that permit active duty reservists to make penalty-free withdrawals from retirement plans.
• Make permanent an expiring provision authorizing the Social Security Administration (SSA) to disclose tax return information to the DVA for purposes of determining eligibility for certain veteran's programs.
• Permit recipients of military death benefit gratuities to make tax-free rollovers of amounts received to a Roth IRA or a Coverdell Education Savings Account. In general, this provision would apply for payments made on account of deaths from injuries occurring after the enactment date, but such rollovers would be permitted for amounts received with respect to deaths from injury occurring after Oct. 6, 2001 and before the enactment date, if the rollover is completed no later than one year after the enactment date.
• Effective for tax years beginning after 2007, liberalize the home sale exclusion rules for Peace Corps volunteers by making them similar to the rules that apply to those in the military, the foreign service, and the intelligence community. The bill also would make permanent the special home-sale exclusion rules for certain employees of the intelligence community, and for sales or exchanges after the enactment date, repeal the requirement that such employees move overseas in order to qualify for special treatment.
• Effective for payments made before, on, or after the enactment date, provide an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
• For distributions made after the enactment date, allow members of the reserves who are called to active duty to withdraw amounts held in a Flexible Spending Account (FSA) without penalty.
• Retroactively clarify that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Debt Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.
• Tighten the expatriation rules to ensure that certain high net-worth taxpayers can't renounce their U.S. citizenship or terminate their U.S. residency in order to avoid U.S. taxes. High-net-worth individuals would be treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residency. Gain would be recognized to the extent that the aggregate gain recognized exceeds $600,000 (which would be adjusted for cost of living in the future). The provision would apply for those who relinquish U.S. citizenship or terminate their U.S. residency on or after the enactment date.
• For services performed in calendar months beginning more than 30 days after the enactment date, treat foreign subsidiaries of U.S. companies performing services under a U.S. government contract as American employers for employment tax purposes. The domestic parent would be jointly liable for employment taxes imposed on the foreign subsidiary.
• Effective for tax returns required to be filed after 2008, increase the general penalty for failure to file tax returns within 60 days of the due date to the lesser of $135 or 100% of the amount required to be shown on the return.
• Extend current law's excise tax for failure to comply with the mental health parity requirements for benefits for services furnished on or after the enactment date through Dec. 31, 2008.

IRS focusing efforts on four employment tax initiatives

American Payroll Association 26th Annual Congress May 13-17 (Austin, TX)

John Tuzynski, IRS Chief, Employment Tax Operations, told attendees at APA's 26th Annual Congress that the IRS is focusing its efforts on the following four key employment tax initiatives: (1) worker classification, (2) tip reporting compensation, (3) officer compensation, and (4) fringe benefits.

Worker classification. Approximately 30% of IRS audits focus on the employee vs. independent contractor issue. The IRS may further review a personal income tax return which, over a period of several years, has only included 1099-source income.

Tip reporting. The IRS is looking for voluntary compliance in this area. Tuzynski believes some employers in the food and beverage industry may not be aware of the Attributed Tip Income Program (ATIP). ATIP provides benefits to employers and employees similar to those offered under other tip reporting agreements, including protection from audits. However, ATIP does not require employers to meet with the IRS to determine tip rates or eligibility.

Officer compensation. There are many S corporations with significant distributable income that report very little officer compensation, even though the officer provided key services to the corporation. These corporations may not be paying their fair share of employment taxes.

Fringe benefits. The IRS continues to target improper employee tool and equipment expense reimbursement plans.

New initiative. The IRS does not currently follow up on notices that it sends to employers asking them to begin backup withholding on employees with mismatches between their name and taxpayer identification number. Tuzynski said that the IRS will soon have a new initiative in this area.

Levy couldn't force early distribution of taxpayer's state retirement account Chief Counsel Advice 200819001

In Chief Counsel Advice (CCA), IRS has concluded that it can't, after serving a notice of levy on a state retirement fund, exercise the taxpayer's right to suspend her membership in the fund in order to obtain an immediate distribution of her assets in the fund when she hasn't yet reached retirement age.

Facts. Married taxpayers, who we'll call Betty and Bob, have an unpaid joint income tax liability. Betty is 50 years old and not currently receiving benefits from a state retirement fund with which she has an account. Although she no longer works for the state, she has obtained other employment and is not retired. Under the terms of the retirement fund, she may elect to suspend membership in the retirement fund and receive a distribution of all assets in her account. If she doesn't elect, when she reaches retirement age, she'll be eligible to receive her retirement benefits from the account.

IRS served a notice of levy on the state retirement fund in order to collect Betty's assets in the fund. The fund will not distribute the assets unless Betty elects to suspend membership in the fund. The IRS revenue officer asks whether IRS can "elect" on Betty's behalf to suspend her membership in the fund.

Background. Under Code Sec. 6331(a), IRS can levy on all property and rights to property of a taxpayer on which there is a federal tax lien in order to collect delinquent taxes. Only property that is specifically enumerated in Code Sec. 6334(a) is exempt from levy, and funds in a state retirement fund aren't so enumerated.

Can force immediate distribution. The CCA concluded that IRS can't exercise Betty's right to suspend membership in the retirement fund in order to obtain an immediate distribution of her assets in the fund when she hasn't yet reached retirement age. IRS can levy on a retirement plan even if a participant has no immediate right to receive benefits. But, the fund is not obligated to turn over any assets under the levy until the taxpayer reaches the age in which she is eligible for retirement benefits under the plan or she voluntarily suspends her membership in the plan.

The CCA reasoned that while IRS's levy attaches to Bob and Betty's interest in the state retirement fund, it only extends to property rights and obligations that exist at the time of the levy. (Reg. § 301.6331-1(a)) Obligations exist for purposes of a levy when the liability of the obligor is fixed and determinable, even though the right to receive payment is deferred until a later date. Thus, even if Betty isn't currently receiving benefits from the retirement fund, if a present right to a future payment exists, the levy reaches that present right. (Rev Rul 55-210, 1955-1 CB 544)

On service of a notice of levy, IRS steps into the shoes of the taxpayer and acquires whatever rights to the property she had possessed before the notice of levy. As a result, the levy only reaches property rights that exist at the time of the levy. Although IRS's levy reaches Betty's future right to retirement benefits when she reaches retirement age, it doesn't entitle IRS to compel suspension of her membership in the fund. The state retirement fund would only have to honor the levy when the benefits become payable to the taxpayer under the terms of the retirement fund.

As an alternative to a levy, the CCA concluded that IRS may bring a lien foreclosure suit under Code Sec. 7403, i.e., an action in federal district court, to reach the funds. Lien foreclosure suits are typically brought where a third-party's rights are involved so that the courts can resolve all parties' rights to the property and force a sale. Because the administrative levy in this situation would not immediately entitle IRS to any assets, the CCA viewed a lien foreclosure suit as appropriate.

Observation: IRS enforces its tax lienby one of two methods: sale of seized property; or suit to enforce the lien. If IRS sues before it seizes a taxpayer's property, it can still avail itself of the seizure power later. Bringing suit doesn't foreclose that right. The ultimate end of either method is to sell the liened property for the tax debt. When IRS sues to enforce a lien, it is actually bringing a suit to foreclose its right in the property.