Friday, April 29, 2011

United States and Panama Reach Agreement to Exchange Tax Information

The U.S. Department of the Treasury has announced the entry into force of the 2010 Tax Information Exchange Agreement (TIEA) with Panama. The TIEA allows both countries to seek information pertaining to taxes in both civil and criminal matters for tax years beginning after Nov. 29, 2007. The pact is applicable to all federal taxes in the U.S., including federal employment taxes. The agreement defines “criminal tax matters” as tax matters involving intentional conduct which is liable to prosecution under the criminal laws of the requesting jurisdiction [2010 Panama-U.S. Tax Information Exchange Agreement; U.S. Treasury Press Release, Treasury: U.S.-Panama Tax Information Exchange Agreement Now In Effect, 4/18/11; Panama/U.S. Joint Declaration, 11/30/10].

Appellate Court Upholds Imposition of FICA Tax on Northern Mariana Islands Nonresident Workers

The U.S. Court of Appeals for the Federal Circuit has ruled that temporary work performed by Chinese nationals in the Commonwealth of the Northern Mariana Islands (CNMI) was subject to FICA tax. The decision upholds a U.S. Court of Federal Claims decision from Sept. 22, 2009 on this issue [Zhang v. United States, CA Fed Cir, 107 AFTR 2d ¶2011-688, 4/6/11].

The facts. Five Chinese citizens were employed as temporary contract workers in the CNMI. The workers and one of the employers filed a complaint seeking a refund of FICA taxes paid to the U.S. between 2004 and 2007. They claimed that FICA taxes were not due on wages paid to noncitizens and nonresidents of the CNMI.

The law. Code Sec. 3121(b) defines employment for FICA tax purposes as “any service, of whatever nature, performed by an employee for the person employing him, irrespective of the citizenship or residence of either within the United States.” Code Sec. 3121(e)(2) defines the term “United States” when used in a geographical sense to include Puerto Rico, the Virgin Islands, Guam, and American Samoa. The U.S. government argued that the CNMI is considered a part of the United States (“within the United States”) under Code Sec. 3121(b), due to its relationship with Guam in the 1976 “Covenant to Establish a Commonwealth of the Northern Mariana Islands in Political Union with the U.S.” (the Covenant). The plaintiffs argued that work performed in the CNMI was not “within the United States.”

The ruling. The appellate court ruled that the workers and the employer were subject to FICA tax on the work performed in the CNMI. With respect to the employer, the court noted that, absent congressional amendment, it was undisputed that Section 606(b) of the Covenant imposed FICA taxes on employers in the CNMI.

While the appellate court agreed with the plaintiffs that the CNMI is not explicitly included in the definition of “United States” under Code Sec. 3121(e)(2), it pointed out that Section 606(b) of the Covenant states that “those laws of the United States which impose excise and self-employment taxes to support or which provide benefits from the United States Social Security System will ... become applicable to the Northern Mariana Islands as they apply to Guam” (see 48 USC 1801). Even though the Internal Revenue Code does not define the term “excise,” the court said that it was reasonable to conclude, based on the dictionary definition of the term, that it included FICA taxes. The appellate court noted that federal courts have given a broad interpretation to the term “excise” and it has included both the employee and employer portion of FICA taxes.

USCIS Accepting H-1B Visa Petitions for Fiscal Year 2012

The U.S. Citizenship and Immigration Services (USCIS) began accepting H-1B visa petitions on April 1 for fiscal year 2012 (Oct. 1, 2011 to Sept. 30, 2012) [USCIS News Release, 4/8/11].

The H-1B visa is used by U.S. employers to hire foreign workers in areas of specialized knowledge or technical expertise, such as scientists, engineers, or computer professionals. U.S. employers that apply for the visa must prove that there are no qualified U.S. workers that could fill the position, and must ensure that the H-1B visa holders are paid the same as their U.S. counterparts.

There is a congressionally mandated annual cap of 65,000 for H-1B visas, plus a 20,000 cap for workers with a U.S. master's degree or higher. As of April 8, USCIS had received 5,900 H-1B petitions counting against the 65,000 cap, and approximately 4,500 petitions counting against the 20,000 cap. Petitions filed by employers who are exempt from the cap, as well as petitions filed on behalf of current H-1B workers who have been previously counted against the cap in the past six years, will not count against the fiscal year 2012 cap.

Earlier this year, USCIS announced that it has received a sufficient number of H-1B visa petitions to reach the congressionally mandated cap of 65,000 for fiscal year 2011.

Employment Tax Scam Continues to Make IRS “Dirty Dozen” List

The IRS's annual list of “dirty dozen” tax scams continues to include an employment tax scam known as “zero wages” [IR 2011-39].

This tax scam has appeared on the dirty dozen list since 2006. It involves filing a phony wage- or income-related informational return to replace a legitimate information return 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 may also 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. The IRS is advising taxpayers to resist any temptation to participate in any of the variations of this scheme. Participants in the scheme may be subject to a $5,000 penalty. Taxpayers report suspected tax fraud to the IRS on Form 3949-A, Information Referral.

In addition, the IRS has seen several situations in which scam artists have filed false or misleading returns to claim refunds to which they were not entitled. In one variation of this scheme, a taxpayer sought a refund by fabricating an information return and falsely claiming the corresponding amount as withholding. The IRS takes refund fraud seriously, and has programs to aggressively combat and stop the vast majority of incorrect refunds.

Q&A Corner

The following question was asked to the IRS during its April 7 payroll industry conference call:

Q. We're a South Carolina employer who expects to pay an interest surcharge on our 2011 South Carolina unemployment tax returns to help the State pay the interest on its federal unemployment insurance loans. Can we claim the surcharge as a credit on our 2011 annual federal unemployment tax (FUTA) return (Form 940)?

A. The IRS did not have a definitive answer to this question; however, it appears, based on a review of federal law and the Form 940 instructions, that the employer will not be able to include the surcharge in the credit computation.

Background. Employers pay FUTA tax at a 6.2% rate on the first $7,000 of covered wages paid to each employee during a calendar year. However, Code Sec. 3302(a) provides employers with a 5.4% credit against the FUTA tax rate for amounts paid to a state unemployment insurance fund by January 31 of the subsequent year. The credit is permitted only for the amount of state unemployment contributions (taxes) required for the taxable year, and can be taken only if state unemployment taxes have been paid by the due date of the Form 940.

Page 3 of the 2010 Form 940 instructions notes that state unemployment insurance contributions do not include “special administrative taxes.” It would appear that the South Carolina interest surcharge would be classified as a “special administrative tax,” and, therefore, the surcharge would not be included in the 5.4% credit computation.

There is a worksheet on page 8 of the 2010 Form 940 instructions that certain employers must use to compute the credit. The IRS advises employers to have their state unemployment tax rate and the amount of their taxable state unemployment wages available before completing the worksheet. The interest surcharge is not a factor in determining either an employer's state unemployment tax rate or its taxable state unemployment wages, so it appears unlikely that the surcharge can be included in the credit computation.

Social Security Administration No Longer Mailing Out Earnings Statements to Workers

The Social Security Administration (SSA) has announced that it is no longer mailing out annual earnings statements to workers. The statements show how much workers have paid into the Social Security system and how much they are scheduled to receive in retirement benefits. The SSA said that the decision was made “in light of the current budget situation.” It advises workers to estimate their retirement benefits using the “Retirement Estimator” on its website. Workers may use the “Retirement Estimator” if they have enough Social Security credits to qualify for retirement benefits and are not: (1) currently receiving Social Security benefits on their own Social Security record; (2) age 62 or older and receiving benefits on another Social Security record; or (3) eligible for a pension based on work not covered by Social Security.

Published reports say that the SSA is working on providing the annual earnings statements electronically, possibly by the end of the year [Social Security Online, Social Security Statement, Information Regarding the Social Security Statement].

IRS Believes that Typical Information Reporting Penalties Will Apply to Employers Not Complying with W-2 Health Care Rules

On the April 7 payroll industry conference call, Scott Mezistrano from IRS Employment Tax discussed recent IRS guidance in Notice 2011-28, 2011-16 IRB 656, on the W-2 reporting rules for employer-sponsored health insurance coverage.

Beginning with 2012 W-2s (filed in 2013), most employers will be required to report the cost of employer-sponsored health insurance coverage on Form W-2 (see Code Sec. 6051(a)(14)). During the conference call, the IRS was asked what would be the ramifications for an employer if it failed to report this information on Form W-2. Mezistrano noted that penalties are not discussed in Notice 2011-28, 2011-16 IRB 656; however, this new reporting requirement is now part of the general IRS W-2 reporting requirements in federal law, and, therefore, Mezistrano believed that an employer who failed to comply with the requirement would be subject to the same information reporting penalties that otherwise apply to Form W-2.

Mezistrano said that employers would need to file a Form W-2c if the health care information on Form W-2 was reported incorrectly.

Mezistrano also noted that an employer would not be subject to the health care W-2 reporting requirements with respect to employees who terminate employment before the end of the year and who request to receive their W-2 before the usual January 31 deadline (see Notice 2011-28, 2011-16 IRB 656, Q&A-6).

Mezistrano pointed out that Notice 2011-28, 2011-16 IRB 656, is interim guidance. The IRS is accepting comments for 90 days on all aspects of the interim guidance and the reporting requirements.

President Obama Signs Repeal of 1099 Corporate Information Reporting Requirements into Law

President Obama has signed the “Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayment Act of 2011” (H.R. 4) into law. The Act repeals new corporate Form 1099 information reporting requirements that were scheduled to go into effect in 2012. Businesses had raised concerns about the expense and effort required to comply with the new information reporting requirements. At the signing, President Obama said, “I was pleased to take another step to relieve unnecessary burdens on small businesses by signing H.R. 4 into law.”

Under current law, payments to corporations, except those made for medical or health care services, are not required to be reported on an information return.

IRS Extends Pilot Program that Allows Truncation of Social Security Numbers on Information Returns

The IRS has extended the pilot program that allows filers of information returns to truncate an individual payee's Social Security number or other nine-digit identifying number on paper payee statements if the filers meet certain requirements [Notice 2011-38, 2011-20 IRB].

The pilot program was in effect in the 2009 and 2010 calendar years. Notice 2011-38, 2011-20 IRB, extends the program through calendar years 2011 and 2012, as the IRS would like more time to evaluate the effectiveness of the program.

The pilot program only applies to paper payee statements in the Form 1098 series (mortgage interest), Form 1099 series (various payments, including, for example, miscellaneous income), and Form 5498 series (IRA and other items). Substitute and composite substitute statements (within the meaning of Reg. § 301.6722-1(a)(1)) that meet the requirements in the notice are also included in the pilot program. The pilot program is not available for any information return filed with the IRS, any payee statement furnished electronically, or any payee statement that is not in the Form 1098 series, Form 1099 series, or Form 5498 series. Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, is no longer included in the pilot program. Truncation of payee employer identification numbers (EINs) or filer identifying numbers is not permitted.

Requirements for truncation. A filer must satisfy the following requirements to be authorized to truncate identifying numbers for individuals on paper payee statements:

1. The identifying number must be a Social Security number, IRS individual taxpayer identification number, or IRS adoption taxpayer identification number;

2. It must be truncated by replacing the first five digits of the nine-digit number with asterisks or Xs (for example, the Social Security number 123-45-6789 could appear on the paper payee statement as XXX-XX-6789); and

3. It must appear on a paper payee statement (including substitute and composite substitute statements) in the Form 1098 series (other than Form 1098-C), Form 1099 series, or Form 5498 series.

The IRS will treat filers who meet the above requirements as having satisfied any requirement in Treasury and IRS guidance, whether in a regulation, form, or form instructions, to include a payee's identifying number on a payee statement.

The IRS notes that it has authorized truncation for the 2011 and 2012 calendar years, even though the 2011 Form 1099 instructions say that the program has expired.

The IRS hopes that the pilot program will reduce the risk of identity theft.

DOL Amends FLSA Regulations

The Department of Labor (DOL) has amended Fair Labor Standards Act (FLSA) and Portal-to-Portal Act regulations that are out of date because of subsequent legislation or court decisions. The revisions conform the regulations to FLSA amendments passed in 1974, 1977, 1996, 1997, 1998, 1999, 2000, and 2007, and Portal Act amendments passed in 1996. The amended regulations are effective May 5, 2011 [76 FR 18831-18860, 04/05/2011].

The following changes are included in the amended regulations:

Tipped employees. The FLSA allows employers to credit tips received by certain “tipped employees” against the minimum wage rate. Federal law defines a “tipped employee” as “any employee engaged in an occupation in which he customarily and regularly receives more than $30 a month in tips.” 29 USC 203(m) requires an employer to provide advance notice to its employees that it is claiming the tip credit.

Federal regulation 29 CFR 531.59 has been amended to note that the notice should include the following information: (1) the amount of the cash wage that is to be paid to the tipped employee; (2) the amount by which the employee's wages are being increased on account of the tip credit (the credit can't exceed the value of the tips actually received by the employee); (3) that all tips received by the tipped employee must be retained by the employee except for tips received in a valid tip pooling arrangement; and (4) that the tip credit will not apply to any employee who has not been informed of these requirements.

The regs do not say that the above notice must be provided to employees in writing; however, the DOL notes that employers may wish to do so, since a physical document with all of the required information would permit employers to document that they have met the notification requirements in 29 USC 203(m) and federal regulations. If an employer fails to notify employees that part of their tips will be credited toward the minimum wage, the employer will be barred from taking a credit for the tips and could owe back pay.

29 USC 203(m) allows tip pooling “among employees who customarily and regularly receive tips.” Federal regulation 29 CFR 531.54 has been amended to note that 29 USC 203(m) does not impose a maximum tip pooling contribution percentage.

Exclusion of certain stock options from regular rate of pay calculations. Under 29 USC 207(e)(8), income derived from certain employer-provided grants or rights provided pursuant to a stock option, stock appreciation right, or bona fide employee stock purchase program, are not included in the computation of an employee's regular rate of pay for overtime purposes. Federal regulation 29 CFR 778.200(a)(8) has been added to conform the regulations to federal law.

Youth opportunity wage. Federal law ( 29 USC 206(g)) provides that new hires under 20 years of age may be paid $4.25 per hour for the first 90 calendar days after the date of hire. Federal regulation 29 CFR 786.300 has been updated to conform to the federal law.

SSA Sending Out No-Match Letters to Employers

The Social Security Administration (SSA) has resumed sending employers a letter called the “Decentralized Correspondence” (DECOR) notice. The notice informs employers that it could not process a Form W-2 because it does not have an employee's Social Security number (SSN) or name, or the SSN or name submitted does not match information in the SSA's earnings records [SSA Program Operations Manual System, Employer Reports - Wage Reports, Id No. RM01105 TN 06, 4/6/11].

There are a number of reasons why reported earnings information may not agree with SSA records. These include typographical errors, unreported name changes, inaccurate or incomplete employer records, or misuse of an SSN. In these cases, the SSA places the earnings information in the Earnings Suspense File (ESF) instead of posting the earnings to a worker's record. The SSA attempts to resolve items placed in the ESF by sending DECOR notices to employees, employers, and self-employed workers to inform them that a reported name or SSN does not match the SSA's records.

The SSA did not send employer DECOR notices for the 2007 through 2009 tax years because of litigation on a proposed Department of Homeland Security (DHS) regulation that involved a related correspondence process. The DHS later rescinded the proposed regulation, and the SSA is now sending out DECOR notices for the 2010 tax year. The SSA will not send out the DECOR notices that it held for the 2007 through 2009 tax years.

Employers will be asked to check their records to determine if the information provided to the SSA matches those records. If they still currently employ the employee, they may be instructed to ask the employee to provide his or her SSN card to verify that they accurately reported both the employee's name and SSN. If employers prepare a Form W-2c, they will be instructed to send it with a covering Form W-3c transmittal to the SSA with no supporting documents attached. Employers will be encouraged to call the SSA toll-free number at (800) 772-6270 if they have any questions regarding the SSNs listed on the DECOR notice.

If the employer and the employee are unable to resolve the issue based on reviewing the SSN and name, employers will be instructed to tell the employee to contact a local Social Security office to resolve the discrepancy. Employers should give the employee a reasonable amount of time to rectify the situation. It may take up to two weeks, and sometimes longer, to get a new or replacement Social Security card.

If the employer is unable to resolve the no-match with the employee (e.g., the employee is unable to provide a valid SSN or may no longer work for the employer), the SSA will advise the employer to document efforts made to obtain the corrected information. The documentation should be retained in accordance with federal recordkeeping requirements. Employers will be encouraged to use the SSA's online Social Security Number Verification Service (SSNVS) to minimize future mismatches.

EDCOR letters. The SSA has discontinued sending out “Code V” educational correspondence (EDCOR) letters to employers. These letters had been sent to employers if their wage reports included more than a certain number of employee names and SSNs that the SSA could not match to its records.

States Taking Action to Build Up Their Unemployment Trust Funds

As of April 18, 2011, thirty-two states and the Virgin Islands have borrowed money from the federal government to help keep their unemployment insurance (UI) trust funds solvent. The loans total over $48 billion. The federal government is going to begin charging interest on these loans sometime this year unless legislation is enacted that waives the interest charges. In addition, UI trust funds are also being depleted due to large unemployment benefit payouts. Recently, a number of states have proposed or enacted legislation to improve the solvency of their trust funds. The legislation includes provisions that raise unemployment tax rates, impose tax surcharges, and reduce eligibility for unemployment benefits. The following is a summary of recent developments.

Arizona. Arizona has enacted legislation that imposes a special assessment on employers in 2011 and 2012 to help the State pay the interest on its federal unemployment loans [L. 2011, H2619].

Arkansas. Arkansas has enacted legislation that reduces the maximum unemployment benefit period from 26 weeks to 25 weeks [L. 2011, S593].

Connecticut. The Connecticut Department of Labor (DOL) has announced that, beginning in August, it will be imposing its first annual special assessment on employers to pay the interest due to the federal government on UI loans [DOL Employer Information Notice, December 2010].

Hawaii. Recent legislation increased the 2011 employment and training fund assessment on employers to reimburse Hawaii for interest it must pay on federal loans. Unlike in previous years, employers assigned the minimum (0.0%) or maximum (5.4%) unemployment tax rate are not exempt from this assessment [L. 2011, H1077].

Illinois. Illinois has enacted legislation that increases the maximum cap on the 2012 taxable wage base from $12,960 to $13,560. The legislation also reduces the maximum period to receive unemployment benefits from 26 weeks to 25 weeks, beginning in 2012 [L. 2011, H1030].

Indiana. Recent legislation includes a provision that requires employers to pay a surcharge if Indiana is required to pay interest on federal unemployment loans. The legislation also limits eligibility for unemployment benefits and changes the way that benefits are calculated, beginning in 2012 [L. 2011, H1450].

Massachusetts. The unemployment health insurance contribution tax rate for employers in business for at least five years has increased to 0.36% of wages (previously, 0.24%) [L. 2011, S8].

Michigan. New legislation reduces the maximum period for receiving unemployment benefits from 26 to 20 weeks, effective with new claims filed after Jan. 14, 2012 [L. 2011, H4408].

Missouri. Employers will be subject to an additional assessment to pay for interest on federal loans to the Missouri unemployment trust fund. The Missouri Division of Employment Security (DES) will notify each employer of its share of the interest assessment with the mailing of the 2011 second quarter contribution and wage reports. Missouri has also enacted legislation that reduces the maximum period for receiving unemployment benefits from 26 weeks to 20 weeks [DES website, Unemployment Insurance Tax, Unemployment Trust Fund-Interest Payments on Federal Loan; L. 2011, H163].

New Hampshire. The 1.0% emergency surcharge rate remains in effect for all four quarters in 2011. Negative-rated employers continue to pay a 1.5% inverse rate surcharge for all four quarters in 2011 [New Hampshire Department of Employment Security, Special Notices, 1/3/11].

New Mexico. New legislation, effective July 1, 2011, reduces the number of dependents for whom an individual may claim a $25 dependency unemployment benefit from four to two [L. 2011, H59].

South Carolina. Employers that have been assigned a 5.4% base unemployment tax rate are no longer exempt from the administrative contingency fund tax [L. 2011, H3286].

Proposed Legislation

The following states have introduced legislation that would improve the solvency of their unemployment trust funds.

Florida. The Florida legislature is considering a bill that would reduce the maximum period for receiving unemployment benefits from 26 to 20 weeks, beginning in August. The maximum unemployment benefit period would be further reduced to as low as 12 weeks if the state unemployment rate declines [L. 2011, H7005].

New Jersey. Governor Christie supports a reduction in the maximum weekly unemployment benefit from $600 to $550 [Governor Christie Press Release, 2/25/10].

7 Innovative Tax Reform Proposals

By Joy Taylor, Assistant Editor, The Kiplinger Tax Letter

Tax reform is a lot like the weather. There’s plenty of talk about revamping the tax code, but very little seems to get accomplished. However, in the past few months, both chambers of Congress have held hearings on tax overhaul. And, just this month, President Obama and Paul Ryan, Chairman of the House Budget Committee, each introduced deficit reduction proposals that include tax reform ideas.

There is widespread agreement that the current tax code is too complex (for instance, almost 4,500 changes have been made to the tax code in the last ten years) and provides large subsidies for activities that lawmakers and lobbyists want to favor, such as home ownership, and that the top corporate income tax rate is high relative to other countries around the world.

But there is no consensus on how to fix what ails it. Remember, any reform creates both winners and losers, and the losers will squawk long and hard about losing cherished tax breaks.

As part of the discussion, lawmakers and policy wonks have proposed a number of alternatives for revamping the tax system. Take a look at some of the ideas and our assessment of their chances.

Flat Tax

This proposal calls for a single flat rate tax on income for all taxpayers. Wages, retirement plan distributions and unemployment compensation would be taxed at 17%...19% in the first two tax years. Social Security, interest, dividends and capital gains would be tax exempt.

Taxpayers would get large standard deductions: $30,320 for couples, $19,350 for heads of household and $15,160 for individuals, plus an additional standard deduction of $6,530 for each dependent. Itemized deductions would disappear. Business income, including that of corporations, would also be taxed at 17% (19% in the first two years). The alternative minimum tax and estate and gift tax would be repealed.

Backers of the flat tax cite its simplicity: A single low rate on income and very few deductions. Filing could be as easy as filling out a postcard.

Critics say the flat tax is regressive since all taxpayers, no matter their income, are taxed at the same rate. They also doubt a 17% or 19% tax rate would bring in as much revenue as the current income tax. If a higher tax rate is needed, it would be hard to win public support for the plan.

Chances of passage: Low, unless the tax rate can be kept below 20%.

Changing the Mix by Reducing Tax Breaks and Lowering the Rate

Many tax reform advocates want to keep the current income-based system, but make it less complex, reduce tax rates and collapse tax brackets, and curb many big-ticket tax breaks.

For example, the National Commission on Fiscal Responsibility and Reform set forth the following illustrative plan:

• Collapse the six tax brackets, which currently range from 10% to 35%, into three…12%, 22% and 28%

• Permanently repeal the alternative minimum tax

• End preferential treatment of capital gains and dividends; tax such income at the same rates as salaries

• Retain the earned income and child credits

• Eliminate all itemized deductions; all taxpayers would claim the standard deduction

• Allow a 12% tax credit for charitable donations that exceed 2% of adjusted gross income and a 12% credit for home mortgage interest (on mortgages up to $500,000)

• Eliminate or significantly reduce most other tax expenditures

And for corporate taxes, the Commission provides an illustration with a single 28% tax rate, while eliminating most corporate tax expenditures, including the 9% domestic production deduction.

Other like-minded reform ideas that have received significant attention include the proposals set forth in Representative Ryan’s Fiscal Year 2012 Budget Resolution (25% top individual tax rate and 25% flat corporate rate) and the “Bipartisan Tax Fairness and Simplification Act of 2011” proposed by Senators Ron Wyden and Daniel Coats (three individual tax rates…15%, 25% and 35%...and a single corporate rate of 24%).

Chances of passage: Good, but probably not until 2013. Similar reforms that culminated in the Tax Reform Act of 1986 took two years to come to fruition.

Taxpayer Choice: Pick Flat Tax Forever Or the Status Quo

A handful of House Republicans introduced a bill to give individual and corporate taxpayers a choice: They can stick with the current income tax system, warts and all, or irrevocably elect the flat tax.

Proponents expect most taxpayers to elect the 17% (19% in the first two years) flat tax option since it’s simpler and most would pay a reduced rate of tax.

However, giving taxpayers a choice to elect their poison could also benefit those who believe their federal tax liability would be lower under the current tax system than under a flat tax and who can tolerate the complexity of the tax code. Critics point out that this proposal would bring in far less revenue than the current tax system and would cause deficits to soar.

Chances of passage: Close to zero with the current large deficit.

National Sales Tax

The “Fair Tax” is a national sales tax backed by some Republicans, about half of which are tea partiers, in the House and Senate. Much of the tax code would be scrapped, including both corporate and individual income taxes, estate and gift taxes and payroll taxes.

Instead, a 29.9% sales tax collected only at the retail level would be imposed on the sales of goods and services. Retailers would collect the tax and pass it on to the government.

Although fair tax proponents say the rate is 23%, the tax is actually 23% of the item’s total price, including the tax. When the tax is stated as an add-on percentage to the item’s retail price, like a typical state sales tax paid at the register, the rate is just a hair less than 30%.

Only limited exemptions would be allowed. The tax wouldn’t apply to assets purchased for business or investment use. Tax rebates would be provided, including a stipend for each family equal to 23% of the federal poverty level. Proponents tout the simplicity of the plan. Critics say it’s regressive and the rate is too low to generate necessary federal revenues.

Chances of passage: A real long shot.

Value Added Tax (VAT)

A value added tax (or VAT) is a consumption tax similar to a national sales tax. However, instead of a tax imposed once at the retail level, a smaller rate of tax is imposed each time a product or service is sold or value is added. Take the example of manufactured goods. A tax is applied when the manufacturer sells the goods to a wholesaler and again when the wholesaler passes them on to a retailer.

If a VAT is imposed, the price of goods is expected to rise because the cost would include the built-in tax paid by the seller. That would lead to increased inflation. Representative Ryan has given a nod to a VAT-type approach. Last year, he proposed to repeal the corporate income tax and replace it with an 8.5% tax on business consumption, although he doesn’t propose a VAT in his most recent tax plan.

Chances of passage: Poor.

Adding a National Sales Tax

Some tax reform proponents favor retaining the income-based tax system and supplementing it with a consumption tax, similar to the approach used by many other industrialized countries. This could be tempting to tax writers as a means of raising additional revenue to reduce the deficit.

As part of its tax reform plan, the Debt Reduction Task Force of the Bipartisan Policy Center proposed a supplemental 6.5% national sales tax on goods and services as an additional source of revenue to reduce the federal deficit. This wouldn’t replace the income tax (which would be modified under the plan), but would instead supplement federal revenues.

Businesses would pay tax on their sales, but receive credits for taxes that their suppliers pay when they purchase materials and capital goods from other firms. Final consumers will also pay the tax, but they wouldn’t be able to claim any credits on their purchases.

Chances of passage: Not as remote as you might think, with the federal government awash in a sea of red ink.

Repeal First, Come Up with Something Better Later

This proposal is for those who don’t like the current income tax system, but haven’t yet settled on a better alternative.

The 40-plus Republican co-sponsors of the Tax Code Termination Act want to end our current federal tax system (with the exception of payroll taxes) by December 31, 2015, and use the intervening time to find something else that works.

They don’t yet have a replacement tax proposal, but they know what they want from a new federal tax system:

• Fairness and simplicity
• Low tax rate
• Tax relief for working Americans
• Protection of taxpayer rights and reduction of IRS abuses
• No bias against savings or investment
• Promotion of economic growth and job creation
• No penalty on marriage or families

Chances of passage: Nil. Repealing the tax code without a replacement is putting the cart before the horse.

Thursday, April 28, 2011

Real Estate Professionals and Home Office Deduction

The home office deduction is an area that trips up many real estate professionals. Many real estate professionals have a desk at the real estate office they work out of, but many times, the real estate professional prefers to work out of their home because it is easier for the real estate professional. The IRS does not care whether you work out of your home or the real estate office. However, if you have a desk at a real estate office, you are NOT ELIGIBLE to take the home office deduction on your personal income tax return (Schedule C).

In most cases, individuals who are employed in the real estate industry are not allowed to take the home office deduction on their personal income tax returns (on Schedule C). The reason for this is because most real estate offices provide a desk at the office location for the real estate professional, whether or not the real estate professional uses the desk that is provided for them.

It is better for the real estate professional to file an amended tax return, correcting the error (by removing the home office deduction) and paying the additional tax due, than to take the risk of an IRS audit and the IRS finding the error. If the IRS finds the error, the IRS will hit you with additional tax, fines and penalties, and possible criminal prosecution. The IRS could look at prior tax returns (for "closed years" - returns that are more than 3 years old). If this happens, you will definitely find yourself in some serious financial trouble (paying additional taxes, huge fines and penalties, as well as possible criminal prosecution and jail time).

If you are uncertain about your tax returns, or if you would like to have me review your tax return (for any year going back to 1992), please contact me privately.

IRS Expands Rules on Deductible Home-Equity Debt

By ALISTAIR M. NEVIUS - Journal of Accountancy

In Revenue Ruling 2010-25, the IRS ruled that a taxpayer can deduct as qualified residence interest up to $1.1 million of the debt securing the purchase of a taxpayer’s principal residence.

While personal interest is nondeductible, qualified residence interest, which includes both interest on acquisition indebtedness and home-equity indebtedness, is generally deductible. IRC § 163(h)(3)(B) provides that the total amount treated as acquisition indebtedness cannot exceed $1 million for any period ($500,000 for a married individual filing separately), and any indebtedness in excess of $1 million is not acquisition indebtedness. Section 163(h)(3)(C) provides that home-equity indebtedness for any period cannot exceed $100,000 ($50,000 for a married individual filing separately).

Home-equity indebtedness is indebtedness other than acquisition indebtedness secured by the taxpayer’s principal or secondary residence, to the extent the aggregate amount of the debt does not exceed the excess of the fair market value of the residence over the amount of acquisition indebtedness.

Revenue Ruling 2010-25 discusses a factual scenario in which an unmarried individual purchases a principal residence for $1.5 million with a cash down payment of $300,000 and a bank loan of $1.2 million secured by the residence. The taxpayer pays interest that accrues on the indebtedness, and there is no other debt outstanding that is secured by the principal residence. The ruling concludes that the taxpayer may deduct the interest paid on the first $1 million of the original loan balance because it is considered acquisition indebtedness, but, under the ruling, the taxpayer may also deduct the interest paid on $100,000 of the remaining debt of $200,000 because the first $100,000 loan amount in excess of home acquisition indebtedness is considered home-equity indebtedness. Any interest on the remaining indebtedness of $100,000 is considered nondeductible personal interest under section 163(h)(1) because it cannot be traced to any source other than the personal residence, which has already reached its limits.


The IRS provided much-needed clarification by issuing Revenue Ruling 2010-25, in which it states that it will not follow earlier Tax Court decisions (Pau, TC Memo 1997-43; and Catalano, TC Memo, 2000-82), which had held that indebtedness incurred to acquire, construct or substantially improve a taxpayer’s residence could qualify only as acquisition indebtedness. The IRS disagrees with the Tax Court’s holding in Pau that taxpayers must demonstrate that debt treated as home-equity indebtedness “was not incurred in acquiring, constructing, or substantially improving their residence.”

As the IRS explained, the definition of home-equity indebtedness in IRC § 163(h)(3)(C) contains no such restrictions, and, as a result, the IRS will determine home-equity indebtedness consistent with the provisions of Revenue Ruling 2010-25, notwithstanding the decisions in Pau and Catalano. Indebtedness incurred by a taxpayer to acquire, construct or substantially improve a qualified residence can constitute home-equity indebtedness to the extent it exceeds $1 million (subject to the applicable dollar and fair market value limitations imposed on home-equity indebtedness).

For a detailed discussion of the issues in this area, see “Interest on Home-Equity Indebtedness,” by Assimina D. Kiouressis in the May 2011 issue of The Tax Adviser.

—Alistair M. Nevius, editor-in-chief
The Tax Adviser

Wednesday, April 27, 2011

Several Senators Call For Changing Time Limit For Seeking Innocent Spouse Equitable Relief

Three senators have called on IRS to modify a provision in Rev Proc 2000-15, 2000-1 CB 447 and Rev Proc 2003-61, 2003-2 CB 296 regarding the deadline for filing for “innocent spouse” relief from joint tax liability. (April 18 letter to IRS Commissioner Douglas Shulman) In their letter to Commissioner Shulman, Senate Finance Committee Chairman Max Baucus (D-MT), and Senators Sherrod Brown (D-OH) and Tom Harkin (D-IA), stressed that the intent of Congress in first addressing the issue of innocent spouse relief was to “make it easier” for affected individuals to obtain such relief. “In addition to granting relief under two specific circumstances, the new innocent spouse rules allowed the IRS to grant “equitable relief” if, considering all the facts and circumstances, it would be inequitable to hold a spouse liable for a joint deficiency or unpaid tax arising from a joint return,” the letter said. “The IRS Restructuring and Reform Act did not set a time limit within which taxpayers must request equitable relief, thereby implying that taxpayers may request equitable relief at any time during the 10-year collection statute of limitations,” the letter continued. Nevertheless, IRS guidance established a deadline for filing for equitable relief claims of two years from the date of IRS's first collection activity. “The two-year limitation on claims for equitable relief prevents innocent spouses from receiving the relief they deserve,” the senators wrote. “In many cases, the two-year limitation serves to deny equitable relief to the very taxpayers the law was designed to reach, such as innocent spouses unaware of IRS collection activities because of intimidation or deception on the part of the joint filer,” the senators noted. The letter can be found at

TIGTA Expresses Concerns Regarding Poor Controls Over All Refundable Tax Credits

An audit of the First-Time Homebuyer Credit has led the Treasury Inspector General for Tax Administration (TIGTA) to the conclusion that improved controls are needed over all refundable tax credits. (Audit Report No. 2011-41-035) The credit was available to taxpayers who purchased a home in 2008, 2009, or 2010. “Fraudulent and erroneous Homebuyer Credits totaling millions of dollars in refunds were issued, revealing a need for not only stronger controls over claims for the Homebuyer Credit, but also for strengthening controls over all refundable credits,” TIGTA said. The audit took note of IRS's efforts to bolster controls regarding the First-Time Homebuyer Credit, including the use of filters to identify questionable claims for the credit before they are processed. Legislation granting IRS math error authority was also helpful, the audit said. However, control weaknesses discovered in the latest audit, as well as in two previous audits, “allowed potentially erroneous refunds of more than $513 million to be received by taxpayers who most likely did not qualify” for the credit, the audit said. TIGTA recommended that IRS require taxpayers to supply documentation to support eligibility for all refundable tax credits. In addition, “to the extent feasible, the IRS should also ensure that the processing of refundable credits provided for in late legislation be initiated only after sufficient controls can be implemented to protect the government from erroneous and fraudulent claims for the credits,” TIGTA said. The audit is available at

IRS Phone Forum To Discuss Issues Related To Single And Multiemployer Pension Plans

Funding standards that apply to single and multiemployer pension plans will be the focus of the next IRS phone forum that is scheduled for April 28 at 2 p.m. (ET). As described by IRS, the presentation will address rules under the Pension Protection Act, funding relief and relevant agency guidance, and key practical issues. Additional information, including registration details, can be found at,,id=218995,00.html.

IRS Selection of Vendors for Return Preparer Testing and Fingerprinting Programs

The Internal Revenue Service has selected Prometric, Inc. as the vendor to administer a new competency examination and fingerprinting program for certain paid tax return preparers. The IRS has also selected Daon Trusted Identity Services as a vendor to offer fingerprinting services.

The testing and suitability checks are two components of the second phase of increased IRS oversight of federal tax return preparers, as outlined in the Return Preparer Review issued on Jan. 4, 2010. Mandatory registration and issuance of Preparer Tax Identification Numbers (PTINs) was the first phase which began in Sept. 2010.

The testing vendor will administer the testing program. The vendor will be responsible for conducting a job analysis using subject matter experts from both the IRS and preparer community to ascertain the capabilities and necessary knowledge for return preparers. Once a test plan is approved, the IRS will make test specifications available to assist individuals in preparation for the examination. The IRS will have final approval of all test questions.

The fingerprinting vendor will assist the IRS in evaluating the background and suitability of certain PTIN applicants, but the IRS will make all determinations regarding suitability issues.

IRS Identified Tax Preparers Who Applied For PTINs And Failed To Disclose Criminal Tax Convictions

In connection with its new tax preparer oversight program, IRS announced on April 25 that it has identified 19 tax preparers who applied for preparer tax identification numbers (PTINs) and failed to disclose a criminal tax conviction on their application or have been permanently enjoined from preparing tax returns. (IR 2011-47) These individuals were sent letters from IRS proposing revocation of their PTINs, and they now have 20 days to respond and provide documentation showing why their PTINs should not be revoked. According to the news release, IRS's efforts to prevent tax preparers with criminal tax convictions or permanent injunctions from preparing tax returns reflect “just one of several recent moves to improve the quality and oversight of the tax preparation industry.”

Disaster Victims In Oklahoma And More Disaster Victims In North Carolina Qualify For Tax Relief

IRS has announced on its website that victims of severe storms, tornadoes and straight-line winds on April 14, 2011 in counties in Oklahoma that are designated as federal disaster areas qualifying for individual assistance have more time to make tax payments and file returns. In addition, more victims of severe storms, tornadoes and flooding on April 16, 2011 in counties of North Carolina have more time to make tax payments and file returns if they are affected taxpayers in counties that have been designated as federal disaster areas qualifying for individual assistance. Certain other time-sensitive acts also are postponed. This article summarizes the relief that's available and will be updated to include any new disaster area designations and extended filing and deposit dates for areas affected by storms, floods and other disasters in 2011.

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;

... 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 deposit delayed date (specified by county, below), provided the taxpayer made these deposits by the deposit delayed date.

Affected areas and dates for storms, floods and other disasters in 2011 that are federal disaster areas qualifying for individual assistance, as published on IRS's website, are carried below.

Observation: Effective for disasters declared in tax years beginning after Dec. 31, 2007, the term “federally declared disaster” replaced the previously used “presidential disaster area” term (see Code Sec. 1033(h)(3), as amended by Sec. 706(d)(1), Div. C, P.L. 110-343). The new term is substantially the same as the definition of “presidentially declared disaster” under former law. (T.D. 9443, 01/4/2009)

North Carolina: The following are federal disaster areas qualifying for individual assistance on account of severe storms, tornadoes and flooding on Apr. 16, 2011: Bertie, Bladen, Craven, Cumberland, Currituck, Greene, Halifax, Harnett, Hertford, Hoke, Johnston, Lee, Onslow, Pitt, Robeson, Sampson, Wake and Wilson counties.

For these North Carolina counties, the onset date of the disaster was Apr. 16, 2011, the extended date is June 30, 2011 (which includes the April 18 deadline for filing 2010 individual income tax returns, making income tax payments and making 2010 contributions to an individual retirement account (IRA)). The deposit delayed date is May 2, 2011.

Oklahoma: The following is the federal disaster area qualifying for individual assistance on account of severe storms, tornadoes and straight-line winds on Apr. 14, 2011: Atoka County.

For this Oklahoma county, the onset date of the disaster was Apr. 14, 2011, the extended date is June 30, 2011 (which includes the April 18 deadline for filing 2010 individual income tax returns, making income tax payments and making 2010 contributions to an individual retirement account (IRA)). The deposit delayed date is Apr. 29, 2011.

References: For postponement of tax deadlines due to disasters, see FTC 2d/FIN ¶S-8500; United States Tax Reporter ¶75,08A4; TaxDesk ¶570,306; TG ¶1944.

Supreme Court Won't Review Case Denying Basis For Capital Contributions To S Corporations

Nathel, (CA 2 06/02/2010) 105 AFTR 2d 2010-2699 cert denied 04/25/2011

Last year, the Court of Appeals for the Second Circuit, affirming the Tax Court, held that shareholders' capital contributions to S corporations did not constitute income to the entities and did not restore or increase their tax basis in their loans to the S corporations. Subsequently, the shareholders asked the Supreme Court to review the case but it has now declined to do so.

Background. Generally, under Code Sec. 1367 a shareholder's tax basis in the stock in, and in the loans to, an S corporation are adjusted to reflect the shareholder's share of income, losses, deductions, and credits of the S corporation, as calculated under Code Sec. 1366(a)(1). Under Code Sec. 1367(a)(1), a shareholder's tax basis in his S corporation stock is increased by, among other things, the shareholder's share of the S corporation's income items (including tax-exempt income).

Under Code Sec. 1367(a)(2), a shareholder's tax basis in his S corporation stock is decreased (but not below zero) by, among other things, the shareholder's share of losses and deductions. If a shareholder's tax basis in his S corporation stock is reduced to zero by his share of the losses of the S corporation, any further share of the S corporation's losses decreases, but not below zero, the shareholder's tax basis in outstanding loans the shareholder has made to the S corporation. (Code Sec. 1367(b)(2)(A), Reg. §1.1367-2(b)(1)) If the shareholder's basis in debt was so reduced, any net increase in basis in a subsequent tax year is first applied to restore the shareholder's basis in debt before it is applied to restore the shareholder's basis in stock. (Code Sec. 1367(b)(2)(B))

Observation: As a result of these rules, a shareholder's tax basis in loans the shareholder has made to an S corporation may be lower than their face amount or zero because of downward adjustments in such basis caused by losses of the S corporation that are passed through to the shareholder.

Facts. In calculating ordinary income relating to $1,622,050 in loan payments received from two S corporations, for purposes of Code Sec. 1366(a)(1), shareholder brothers Ira and Sheldon Nathel treated $1,437,248 in capital contributions that they had made to the S corporations as income to the entities (excludable under Code Sec. 118) that under Code Sec. 1367(b)(2)(B) restored or increased their tax basis in the loans that they had previously made to the S corporations. The brothers then used the restored or increased tax basis in these loans to offset ordinary income that otherwise would have been reportable by them on their receipt from the S corporations of the $1,622,050 loan payments.

On audit, IRS determined that the $1,437,248 capital contributions couldn't be treated as restoring or increasing the brother's tax basis in their loans to the S corporations. Rather, the contributions increased their basis in their S stock, resulting in additional ordinary income being charged to them on receipt of the S corporation loan payments.

The Tax Court held that for purposes of Code Sec. 1366(a)(1), the $1,437,248 capital contributions to the S corporations did not constitute income to the S corporations and that under Code Sec. 1367(b)(2)(B), these capital contributions did not restore or increase the brother's tax basis in their loans to the S corporations. Reg. §1.118-1 specifically provides that capital contributions do not constitute income to an S corporation. Nor, the Court found, were the capital contributions tax exempt income.

The Court reasoned that by attempting to treat their capital contributions to the S corporations as income to the S corporations, Ira and Sheldon in effect sought to undermine three cardinal and longstanding principles of the tax law: (1) that a shareholder's contributions to the capital of a corporation increase the basis of the shareholder's stock in the corporation; (2) that equity (i.e., a shareholder's contribution to the capital of a corporation) and debt (i.e., a shareholder's loan to the corporation) are distinguishable and are treated differently by both the Code and the courts; and (3) that contributions to the capital of a corporation do not constitute income to the corporation.

Appeals Court decision. Before the Second Circuit, the brothers argued that capital contributions constitute “items of income (including tax-exempt income)” for purposes of Code Sec. 1366(a)(1)(A). The Court observed that they made this argument even though Code Sec. 118(a) provides that gross income does not include capital contributions. The Court said that it knew of no case that has decided whether capital contributions constitute income items under Code Sec. 1366(a)(1)(A). However, cases addressing the scope of income under Code Sec. 61(a) and the Sixteenth Amendment indicate that capital contributions traditionally have not been considered income. Therefore, the Court said, they should not be considered “items of income” under Code Sec. 1366(a)(1)(A).

The brothers argued that capital contributions should be regarded as items of tax-exempt income. According to them, there would be no reason to exclude capital contributions from gross income as Code Sec. 118(a) does if they were not already included in gross income under Code Sec. 61(a). The Court rejected this view. It stressed that capital contributions traditionally have not been included in gross income in the first instance. The fact that Code Sec. 118(a) explicitly excludes them does not transform them into “items of income” for purposes of Code Sec. 1366(a)(1)(A). The legislative history showed that Congress did not consider capital contributions to be generally includible in gross income when it created the exclusion. Accordingly, the Second Circuit affirmed the judgment of the Tax Court.

Case now over. The Supreme Court has now declined to review the case. Accordingly, the decision of the Second Circuit stands.

References: For how S corporation shareholders are taxed, see FTC 2d/FIN ¶D-1761 et seq.; United States Tax Reporter ¶13,664; TaxDesk ¶614,701; TG ¶4771.

Tax Court Again Holds Basis Overstatement Didn't Trigger 6-Year Limitations Period

Carpenter Family Investments, LLC, (2011) 136 TC No. 17

The Tax Court has held on summary judgment that a notice of final partnership administrative adjustment (FPAA) issued to a limited liability company (LLC) after the expiration of the general 3-year limitations period on assessment was untimely, and again rejected IRS's argument to apply the extended 6-year period on the grounds of the LLC's basis overstatement. In so holding, the Court acknowledged that IRS had since issued final regs to the contrary, and considered the effect of the recent Mayo decision on the level of deference to which they are entitled, but nonetheless reaffirmed its prior conclusion based on Ninth Circuit and Supreme Court precedent.

Background. Under the TEFRA partnership audit rules, the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount that relates to an adjustment to a partnership item) generally is to be determined at the partnership level. (Code Sec. 6221) If IRS decides to adjust any “partnership items,” it must notify the individual partners through an FPAA. (Code Sec. 6226) Various Code provisions define the limitations on assessments made with respect to FPAA adjustments, and the tolling of those periods (see, e.g., Code Sec. 6229, Code Sec. 6501)

Code Sec. 6501(a) generally provides that a valid assessment of income tax liability may not be made more than 3 years after the later of the date the tax return was filed or the due date of the tax return. However, under Code Sec. 6501(e), a 6-year period of limitations applies when a taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return.

Procedural history. In Intermountain Insurance Service of Vail, LLC, TC Memo 2010-195, which involved a partnership that engaged in several basis-increasing transactions that IRS determined were improper and ineffective for tax purposes, the Tax Court followed its earlier decision in Bakersfield Energy Partners, LP, et al., (2007) 128 TC 207 and granted Intermountain summary judgment because IRS's partnership item adjustments were made after the general 3-year period of limitations for assessing tax had expired. IRS asked the Tax Court to overrule its decision in Bakersfield and find that the 6-year limitations period applied in this situation, but the Court declined to do so.

Less than a month after the initial Intermountain decision, IRS issued temporary regs that provided that an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission from gross income for purposes of Code Sec. 6229(c)(2) and Code Sec. 6501(e)(1)(A). (Reg. §301.6229(c)(2)-1T, Reg. §301.6501(e)-1T) The “Effective/applicability date” provisions of the temporary regs provided that “The rules of this section apply to taxable years with respect to which the applicable period for assessing tax did not expire before September 24, 2009.” (Reg. §301.6229(c)(2)-1T(b), Reg. §301.6501(e)-1T(b)) Bolstered by the temporary regs, IRS asked the Tax Court to vacate and reconsider it previous Intermountain decision, but it declined to do so, instead concluding that IRS's interpretation of the temporary regs' effective date and date of applicability was erroneous and inconsistent with the regs.

In December of 2010, IRS issued final regs under which an understated amount of gross income resulting from an overstatement of unrecovered cost or other basis constitutes an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items. The Court of Appeals for the Fourth and Fifth Circuits and the Tax Court have rejected the regs. On the other hand, the Federal Circuit has upheld them and the Seventh Circuit has viewed them favorably.

In Mayo Foundation for Medical Education and Research, et al. v. U.S. (S Ct 1/11/2011) 107 AFTR 2d 2011-341, the Supreme Court stated that interpretive IRS regs are entitled to heightened Chevron deference. In general, under Chevron, a regulation that is reasonable and not contrary to the “unambiguously expressed intent of Congress” will be given controlling weight.

Facts. Carpenter Capital Management, LLC, is an LLC classified as a partnership for tax purposes, and it serves as the tax matters partner (TMP) for Carpenter Family Investments, LLC (Partnership).

During its 2000 taxable year, Partnership sold shares of stock of American Tower Corp. (ATC), a publicly traded corporation listed on the New York Stock Exchange, for total proceeds of $29,608,861 (the stock sale). On or before Oct. 15, 2001, Partnership timely filed Form 1065, U.S. Return of Partnership Income, for its taxable year ending Dec. 31, 2000. On this information return, it reported gross proceeds of $29,608,861, an adjusted tax basis of $23,285,745, and gain of $6,323,116 from the stock sale. On or before Oct. 15, 2001, the partners timely filed a joint income tax return on Form 1040, U.S. Individual Income Tax Return, for calendar year 2000, reporting all of the $6,323,116 gain from the stock sale.

On Apr. 10, 2007, the TMP sent IRS a Form 872-P, Consent to Extend the Time to Assess Tax Attributable to Partnership Items, executed on behalf of Partnership. Also on Apr. 10, 2007, the partners sent IRS an executed Form 872-I, Consent to Extend the Time to Assess Tax As Well As Tax Attributable to Items of a Partnership. IRS issued an FPAA to the TMP on Oct. 2, 2008, for thePpartnership's taxable year ending Dec. 31, 2000.

In the FPAA, IRS alleged that “the partnership exploited a complex series of basis-inflating tax avoidance transactions (a variant of the Son-of-BOSS shelter described in Notice 2000-44, 2000-2 CB 255) beginning in December 1999.” IRS asserted that, as a result of the artificial step-up in basis in the ATC stock, the partnership's total net long-term gains in 2000 were significantly understated.

Parties' arguments. The TMP moved for summary judgment, arguing that the FPAA was untimely issued after the 3-year limitations period in Code Sec. 6501 expired and that the consents to extend the limitations period were invalid because they weren't executed within the 3-year period. However, IRS claimed that under Reg. §301.6229(c)(2)-1T and Reg. §301.6501(e)-1T, the 6-year limitations period applied, and the FPAA was timely issued thereunder.

Conclusion. The Tax Court, acknowledging that IRS's regs have since been finalized and that the Supreme Court's decision in Mayo states that Treasury regs are entitled to Chevron deference, nonetheless reaffirmed the holding of its earlier Intermountain decision.

The Court looked to precedent of the Ninth Circuit, to which an appeal of this case would lie, and noted that the Ninth Circuit affirmed the Tax Court's decision in Bakersfield. (Bakersfield Energy Partners v. Comm. (CA 9 6/17/2009)) Further, the Ninth Circuit rejected the argument that the Supreme Court's decision in Colony, Inc. v. Com., (S Ct 1958) 1 AFTR 2d 1894, which held that the extended period of limitations applies to situations where specific income receipts have been “left out” in the computation of gross income and not to something put in and overstated, was limited to the sale of goods and services in a trade or business. The Tax Court observed that the Fourth and Fifth Circuits also reached similar post-Mayo conclusions. Ultimately, the Tax Court stood by its earlier decision and concluded that Colony isn't limited to a trade or business and thus controls the Court's interpretation of Code Sec. 6501(e)(1)(A).

The Court then turned to the regs and noted that, under National Cable & Telecomm. Ass'n v. Brand X Internet Servs., (2005) 545 U.S. 967, a court's prior interpretation of a statute can override an agency's contrary interpretation if the prior judicial construction “follows from the unambiguous terms of the statute.”

The Court determined that, even if IRS intended to repudiate the Supreme Court's holding in Colony, it failed to unequivocally do so. Unless and until it does, that decision remains binding, and IRS's discretion in interpreting Code Sec. 6501(e)(1)(A) remains limited. Thus, in accord with the Ninth Circuit's holding in Bakersfield, and the Supreme Court's holding in Colony, the Tax Court held that a basis overstatement does not constitute a gross omission for Code Sec. 6501(e) purposes. The FPAA was accordingly untimely.

Observation: There were also two concurring opinions filed with this decision. One emphasized that prior decisions on this subject have been decided based on the unambiguous terms of Code Sec. 6501(e)(1)(A), and that such provided sufficient grounds for granting summary judgment in favor of the taxpayer in this case without the need to even address the regs. The second stated simply that there was “no compelling reason for this Court to abandon its precedents in this case” since the Ninth Circuit had previously affirmed the Court's Bakersfield decision, albeit before the issuance of the final regs.

References: For the 6-year assessment period, see FTC 2d/FIN ¶T-4201; United States Tax Reporter ¶65,014.15; TaxDesk ¶838,016; TG ¶70538.

Estate Couldn't Recover Costs Of Winning Charitable Deduction From Will Settlement

Estate of Antonio J. Palumbo, (DC PA 03/09/2011) 107 AFTR 2d ¶2011-750

A district court has declined to award an estate attorney fees and other costs of winning a dispute with IRS over the deductibility of a settlement. Specifically, the court previously held that the estate was entitled to an estate tax charitable deduction as a result of a settlement between the decedent's son and a charity. The court denied the costs because it found that IRS's position was substantially justified.

Underlying decision. Antonio J. Palumbo died on Dec. 16, 2002. In '74, he had created the A.J. and Sigismunda Palumbo Charitable Trust (the Charitable Trust).

Mr. Palumbo executed various wills and trust instruments with testamentary provisions during his lifetime. At the time of his death, his will executed on July 6, '99, together with its three codicils was in effect. The first paragraph stated that taxes were to be paid out of the residuary estate. The third paragraph of the will identified and defined the Charitable Trust, naming it as a remainder beneficiary in several places throughout the will and the three codicils. However, there was no express residuary provision in the will due to a scrivener's error on the part of Mr. Palumbo's attorney. Earlier iterations of the will had a residuary provision.

As a result of the lack of a residuary provision, Mr. Palumbo's son claimed that as the sole intestate heir, he alone was entitled to the residuary estate. However, the Charitable Trust claimed that it was entitled to the residuary estate because the missing residuary clause was due to scrivener's error. The parties reached a settlement under which the Charitable Trust received a portion of the residuary estate amounting to $11,721,141 and Mr. Palumbo's son received $5,600,000 and real property.

After entering into the agreement, the estate filed a claim for a federal estate tax charitable deduction in the amount of $11,721,141. IRS disallowed the charitable deduction, finding that the transfer had been made by Mr. Palumbo's son via a settlement agreement, and not by Mr. Palumbo through his '99 will.

The estate then sued in district court, which held in favor of the estate. Based on the evidence presented, the court determined that the failure of the '99 will to provide for a residuary estate was not by design of the testator but due to human error on the part of his attorney. As such, it found that the estate was entitled to a $11,721,141 charitable deduction.

Background. Under Code Sec. 7430, taxpayers who prevail against the U.S. in court (or at the administrative level) may be awarded reasonable litigation and administrative costs (including the costs of recovering the award). Recovery of such costs is subject to limitations—the taxpayer must have exhausted administrative remedies, must not have unreasonably protracted the proceedings, and must meet financial eligibility requirements. In addition, a taxpayer will not be treated as a prevailing party where IRS proves its position in the proceeding was substantially justified. Code Sec. 7430 requires a party seeking attorney's fees and costs from the government to meet the requirements set forth in 28 USC 2412(d)(2)(B), which bars an estate with a net worth of over $2 million from recovering costs.

Parties' arguments. The estate sought an award of attorneys' fees and costs as the prevailing party under Code Sec. 7430. IRS argued that an award of attorneys fees and other costs was improper for these reasons:

... The estate had a net worth of over $2 million.

... IRS's position was substantially justified throughout the litigation.

... The estate failed to submit evidence justifying the fees sought.

The estate acknowledged that its net worth exceeded $2 million but said that this did not bar recovery because the Charitable Trust was the real party in interest. It advanced arguments as to why IRS's position wasn't substantially justified and said it submitted ample evidence detailing its costs.

Court finds substantial justification issue controlling. The court said it did not need not to reach the question of net worth, and more specifically, who is the real party in interest in terms of determining net worth, because it found that IRS was substantially justified in its position. Similarly, that finding made it unnecessary for the court to ascertain the reasonableness of the fees and costs sought to be awarded.

The court observed that, under Code Sec. 7430(c)(4)(B)(ii), the government's position is presumed not to be substantially justified if IRS did not follow its applicable published guidance in the administrative proceeding. Also, the court noted that Code Sec. 7430(c)(4)(B)(ii) directs a court, in determining whether the government's position was substantially justified, to take into account whether the government lost in courts of appeal for other circuits on substantially similar issues.

The estate seized on these two provisions to claim that IRS's position was not substantially justified. It pointed to rulings and cases that it claimed IRS did not follow, including Rev Rul 89-31, 89-1 CB 277. However, the court examined the cited rulings and cases and found that they were factually distinguishable. The key difference in most instances was that the estate in the current case was not a designated residuary beneficiary under the '99 will. Accordingly, the court found that IRS's position was substantially justified and thus declined to award costs.

References: For recovery of litigation costs, see FTC 2d/FIN ¶U-1240; United States Tax Reporter ¶74,304; TG ¶71405.

White House Suggests Timeline To Finalize Regulatory Review Plans In Accord With EO

Executive Office of the President, “Memorandum for the Heads of Executive Departments and Agencies”

In a memorandum, the White House has issued a suggested timeline for agencies to follow in finalizing their preliminary plans to retrospectively review existing regs in accord with Executive Order (EO) 13563, “Improving Regulation and Regulatory Review.” Such plans must be submitted to the Office of Information and Regulatory Affairs by May 18, and should be finalized within 80 days after they are released.

Background. President Obama signed EO 13563, “Improving Regulation and Regulatory Review,” on Jan. 18, 2011. The EO contained a number of principles and requirements relating to regs with an eye towards enhanced public participation, improved integration and innovation, increased flexibility, scientific integrity, and retrospective analysis of existing rules. These principles included being aware of the costs and benefits of a reg; making the regulatory process more transparent and including public participation; coordinating and simplifying regs to reduce costs and promote certainty; and guiding regs by “objective scientific evidence.”

Section 6 of EO 13563 also requires agencies to submit a preliminary plan within 120 days (i.e., by May 18, 2011) outlining how it will conduct periodic reviews of its existing regs to determine whether any such regs ought to be modified, expanded, streamlined, or repealed.

Observation: On March 29, the Treasury Department released and sought comments on its preliminary plan to retroactively review its regs in accord with EO 13563.

Suggested timeline. The memorandum sets out a series of steps that agencies are encouraged to follow after the initial 120-day period.

... Immediately after May 18. Agencies should make their preliminary plans available to the public within a reasonable period (not to exceed two weeks) after May 18.

... Days 1 through 30 after preliminary plans are released. Agencies should use the first 30 days after releasing their plans to engage in such public consultation via public meetings, Federal Register notices, social media, or other kinds of outreach.

... Days 31 through 60. Agencies should revise their plans in ways that are responsive to the public input received.

... Days 61 through 80. Agencies should finalize their plans within 80 days after releasing their preliminary plans. The final plans should be made available to the public and can be published on

... After finalization. In accord with the goals of the EO, agencies should write and design future regs in a manner intended to facilitate evaluation of their consequences and promote retrospective analyses. To the extent consistent with law, agencies should consider how best to promote empirical testing of the effects of rules both in advance and retrospectively. Additionally, agencies' plans should also be periodically reviewed and updated.

New Procedures In The Works For Reportable Transaction Penalty

Large Business and International Division Memo LB&I-20-0211-001

A Memo from IRS's Large Business and International Division reveals that IRS is in the process of changing procedures for the reportable transaction penalty, which was eased and otherwise modified by the Small Business Jobs Act of 2010 (SBJA). As explained below, revenue agents are directed to take or forgo certain actions until the final procedures are released.

Background. Code Sec. 6707A imposes a penalty on any person who fails to include on any return or statement any information regarding a “reportable transaction” which is required to be included with the return or statement. Under pre-SBJA law, the penalty applied regardless of whether the transaction resulted in a tax understatement.

Under pre-SBJA law, the penalty for failure to report reportable transactions was $10,000 in the case of a natural person and $50,000 for others ($100,000 and $200,000 respectively for listed transactions).

For penalties assessed after Dec. 31, 2006, the SBJA completely replaced the Code Sec. 6707A penalty structure. Except as provided below, the amount of the penalty with respect to any reportable transaction is 75% of the decrease in tax shown on the return as a result of the transaction (or which would have resulted from the transaction if it were respected for federal tax purposes). (Code Sec. 6707A(b)(1))

The amount of the penalty for any reportable transaction for any tax year can't exceed:

1. for a listed transaction, $200,000 ($100,000 in the case of a natural person); and

2. for any other reportable transaction, $50,000 ($10,000 in the case of a natural person). (Code Sec. 6707A(b)(2))

The SBJA also established a minimum penalty for a failure to disclose a reportable or listed transaction. The amount of the penalty for any transaction for any tax year can't be less than $5,000 for a natural person and $10,000 for any other person. (Code Sec. 6707A(b)(3))

RIA recommendation: Since the Act's changes are retroactive (i.e., they are effective for penalties assessed after Dec. 31, 2006), taxpayers who have already paid a Code Sec. 6707A penalty should consider filing a refund claim.

Changed procedures in the works. The Memo notes that procedures are being developed to centralize processing of closed cases (i.e., calculation of new penalty amounts, processing of partial abatements, and notices to impacted taxpayers). It stresses that revised case processing procedures for open and future cases will be developed.

The Memo instructs Revenue Agents to not issue a 30-day letter or process any assessments until further notice. In addition, until procedures are finalized, Revenue Agents are told to:

... contact their Technical Advisor immediately if a statute of limitations on a case will expire within the next 2 months, and the transaction is coordinated through an Issue Management Team (e.g., Code Sec. 412(i), Code Sec. 419A, Abusive Roth IRA).

... continue to develop facts related to the application of the Code Sec. 6707A penalty.

... attempt to calculate the revised penalty; and

... seek assistance from Issue Management Team Technical Advisors and Counsel regarding calculation of the Code Sec. 6707A penalty.

References: For the Code Sec. 6707A penalty, see FTC 2d/FIN ¶V-2282 et seq.; United States Tax Reporter ¶67,07A4; TG ¶71811.

Transactions To Divide Businesses Upheld As Tax-Free Recapitalizations And Spin-Offs

PLR 201116001

In a private letter ruling (PLR), IRS has held that a series of proposed transactions by three related corporations in order to separate two lines of business will be treated as tax-free recapitalizations and spin-offs. Accordingly, no gain or loss will be recognized by any of the corporations or their shareholders as a result of the transactions.

Background. A Type E reorganization is a recapitalization or change in the capital structure of a single corporation. (Code Sec. 368(a)(1)(E)) A recapitalization may be achieved through an exchange of stock for stock, bonds for bonds, stock for bonds, or bonds for stock.

A corporate division may be accomplished on a tax-free basis in the form of a spin-off, i.e., a pro rata distribution of a controlled corporation's stock to the distributing corporation's shareholders without requiring the shareholders to surrender any of their distributing corporation stock. A number of requirements must be satisfied in order to qualify for tax-free treatment. (Code Sec. 355)

Facts. Parent, a State A corporation formed in Year 1, is the common parent of an affiliated group of corporations that files a consolidated federal income tax return. Parent is a holding company with one class of stock outstanding. The stock of Parent is owned by a number of shareholders, two of which (Shareholders 1 and 2) own more than 5%.

Sub, a corporation from State B, is a wholly-owned subsidiary of Parent and a member of Parent's group. Sub has been engaged in Business A for an undisclosed number of years.

Controlled, a State A corporation, was a member of Parent's group until Date 1. Controlled has been engaged in Business B since Year 2. Controlled currently has outstanding one class of voting common stock (Class A) and one of class of nonvoting common stock (Class B).

Sub acquired Controlled in Year 3 and owned all of its issued and outstanding stock until Date 1, when Shareholder 3 paid an undisclosed amount to Controlled for the issuance of a number of shares of voting stock. Shareholder also made a payment to Sub for a 3-year option to acquire additional shares in Controlled.

Sub, Shareholder 3, and Controlled entered into a stockholders' agreement as of Date 1 that currently remains in effect. The agreement provides that Controlled's board of directors be comprised of a number of members who are designated by Sub, a number of members who are designated by Shareholder 3, and a number of whom must serve as an executive officer of Controlled and be reasonably acceptable to Sub and Shareholder 3. The agreement was subsequently amended to increase the exercise price of Shareholder 3's option and provide that, if the option expires unexercised on Date 4, Controlled would issue shares of nonparticipating preferred stock to Sub. The option was not exercised, entitling Sub to be issued preferred stock.

On Date 2, Controlled issued a number of shares of Class B stock to certain of its current and former employees. This stock may be converted by Controlled into shares of voting common stock upon a shareholder vote and may be redeemed at any time for fair market value (FMV). On Date 5, Controlled issued additional Class B shares to certain employees, and it repurchased shares from an employee who left the company on Date 6.

The senior managements of Parent, Sub, and Controlled have concluded that a separation of Businesses A and B would enhance the successful operation of both businesses, citing among other reasons the fundamental differences between the two businesses and the lack of synergies from their combination. Notably, separating the businesses would allow each to pursue tailored growth strategies, allow Controlled to improve the terms of the contracts with current suppliers and possibly provide access to new suppliers, allow Controlled to tailor compensation programs and issue equity-based compensation to its employees, and promote efficiency.

Proposed transactions. Parent, Sub, and Controlled propose engaging in the following transactions in order to separate Businesses A and B:

1. Controlled will redeem all of the Preferred Stock, or distribute such stock together with the Class A stock in Step (5).

2. Controlled's charter will be amended to: (i) provide each share of nonvoting common stock with a vote, including for the election of directors (Recapitalization 1); (ii) expand the board of directors, with Sub appointing the additional directors and replacing the Controlled directors that are also officers or directors of Sub; and (iii) create a new class of stock (Class C) with special voting rights for which Shareholder 3 will exchange its Class A stock (Recapitalization 2).

3. Through a stock split, recapitalize all of the outstanding Class A Stock, Class B Stock and Class C Stock to increase the total number of shares of each class to a number determined appropriate (Recapitalization 3).

4. Sub, Shareholder, and Controlled will amend the stockholders' agreement to eliminate Shareholder 3's current rights to designate directors.

5. Sub will distribute to Parent (i) all of its Class A Stock representing at least 80% of the voting power of Controlled's outstanding stock, and (ii) to the extent not previously redeemed or settled, all of its outstanding preferred stock, representing 100% of the only nonvoting class of Controlled's outstanding stock (the Class A stock together with any preferred stock distributed—collectively, “Controlled stock”) (“Spin-Off 1”).

6. Sub will distribute all of its Controlled stock to the shareholders of Parent on a pro rata basis (“Spin-Off 2”). Neither Sub nor Parent will retain any Controlled Stock following the Spin-Offs.

7. Immediately following the Spin-Offs, the stockholders' agreement will be further amended to add Shareholder 1 as a party with respect to certain provisions and remove Sub. Also, following the Spin-Offs, the board of Controlled might (but is under no obligation to do so) propose a shareholder vote to convert the Class A, B, and C stock into a single class of common stock, or propose to convert the Class B stock into Class A stock.

Various representations were made in association with each of the transactions.

Favorable rulings. The PLR concluded that Recapitalizations 1, 2, and 3 will each be treated as a reorganization within the meaning of Code Sec. 368(a)(1)(E), with no gain or loss recognized respectively by the Class B Shareholders, by Shareholder 3, or by Sub, Shareholder 3, or the Class B shareholders as a result. (Code Sec. 368(a)(1)(E); Code Sec. 354(a)(1))

IRS further held that no gain or loss will be recognized by Parent or Sub upon their respective receipt and distribution of the shares of Controlled stock as a result of Spin-Off 1, and no gain or loss will be recognized by Parent shareholders or Sub upon their respective receipt and distribution of shares of Controlled Stock as a result of Spin-Off 2. (Code Sec. 355(a)(1); Code Sec. 355(c))

The aggregate basis of the Controlled Stock and the Parent stock in the hands of Parent's shareholders will be the same as the basis in the Parent stock held immediately prior to Spin-Off 2, allocated in proportion to the FMVs of the Controlled stock and the Parent stock. (Code Sec. 358(a)(1); Code Sec. 358(b); Reg. §1.358-2(a)(2)) The holding period of the Controlled stock received by Parent's shareholders in Spin-Off 2 will include the holding period of the Parent stock with regard to which Spin-Off 2 will be made, provided that such stock is held as a capital asset on the date of Spin-Off 2. (Code Sec. 1223(1))

References: For recapitalizations, see FTC 2d/FIN ¶F-3000; United States Tax Reporter ¶3564.05; TaxDesk ¶235,001; TG ¶5163. For spin-offs, see FTC 2d/FIN ¶F-4600; United States Tax Reporter ¶3554; TaxDesk ¶235,601; TG ¶5168.

TIGTA: IRS Is Warning Taxpayers of Its Intent to Issue Levies

WASHINGTON – The Internal Revenue Service (IRS) is following its statutory requirement of providing taxpayers with advance notice of its intent to issue levies, according to a new report publicly released today by the Treasury Inspector General for Tax Administration (TIGTA).

When taxpayers do not pay delinquent taxes, the IRS has the authority to work directly with financial institutions and other third parties to seize taxpayers’ assets. This action is commonly referred to as a “levy.”

The IRS Restructuring and Reform Act of 1998 (RRA 98) requires the IRS to notify taxpayers at least 30 calendar days before initiating any levy action to give taxpayers an opportunity to formally appeal the proposed levy.

TIGTA is required by RRA 98 to conduct an annual review of whether the IRS is notifying taxpayers prior to issuing levies.

TIGTA reviewed 30 systemically generated levies identified through the Automated Collection System and the Integrated Collection System and determined that systemic controls were effective to ensure the taxpayers were given notice of their appeal rights at least 30 calendar days prior to the issuance of the levies.

In addition, TIGTA identified 60 manual levies issued by employees on those same systems and determined that all the taxpayers were given notice of their appeal rights at least 30 calendar days prior to issuance of the levies.

“Protecting the rights of taxpayers is a very important responsibility of the IRS,” said J. Russell George, the Treasury Inspector General for Tax Administration. “The IRS is to be commended for its continued compliance with this important statutory requirement,” he added.

TIGTA did not make any recommendations in this report. A draft of the report was provided to the IRS for review and comment. The IRS had no comments on the report.

To view the report, including the scope and methodology, go to:

Tuesday, April 26, 2011

IRS Begins Enforcement of New Return Preparer Rules

WASHINGTON — The Internal Revenue Service is taking steps to stop tax preparers with criminal tax convictions or permanent injunctions from preparing tax returns. This is just one of several recent moves to improve the quality and oversight of the tax preparation industry.

More than 700,000 tax preparers nationwide have registered with the IRS and obtained Preparer Tax Identification Numbers (PTINs). This nine-digit number must be used by paid tax return preparers on all returns or claims for refund. Paid preparers must renew their PTINs annually to legally prepare tax returns.

“We owe it to all taxpayers and the many honest tax return preparers to remove the relatively small number of bad actors from the tax preparation industry,” said Doug Shulman, IRS Commissioner. “Just one unscrupulous tax return preparer can cause a lot of financial damage to both taxpayers and the tax system.”

By comparing the new PTINs with a database managed by the IRS’ Office of Professional Responsibility, the IRS was able to identify 19 tax preparers who applied for PTINs and either failed to disclose a criminal tax conviction or have been permanently enjoined from preparing tax returns. A permanent injunction is a court order used by the Department of Justice to stop a preparer who repeatedly prepares erroneous or fraudulent federal tax returns.

The IRS has sent letters to all 19 individuals proposing revocation of their PTINs. Preparers facing revocation have 20 days to file a written response and provide supporting documentation as to why their PTIN should not be revoked.

With the end of the tax filing season, the IRS also will initiate a review of tax returns that were prepared by a preparer who used an identifying number other than a PTIN, did not use any identifying number, or did not sign tax returns they prepared. The agency will send notices to those preparers who used improper identifying numbers. The IRS is also piloting methods to help identify returns that appear to be professionally prepared but are unsigned by the preparer.

“Hundreds of thousands of tax return preparers, the vast majority, play by the rules every filing season. The IRS is committed to ensuring they have a level playing field,” Shulman said. “Compliance with regulations that require the signing of a tax return by a paid preparer and use of the PTIN is central to our enforcement effort.”

The IRS is still registering approximately 2,000 preparers a week. Anyone who prepares for compensation all or substantially all of any federal return or claim for refund must register for a PTIN and pay a $64.25 annual fee.

The PTIN registration is the first step in a multi-year effort by the IRS to provide standards for and oversight of the tax preparation industry. Starting this fall, certain paid preparers will be required to pass a new competency test. The IRS will also conduct background checks on certain paid preparers. Additionally, expected to start in 2012, certain paid preparers must have 15 hours of continuing education annually.

Certified public accountants, attorneys and enrolled agents are exempt from the competency testing and continuing education requirements because of similar professional standards already applicable to those groups. Supervised employees of these exempt groups also are generally exempt.

For more information see the PTIN registration page on this website.

Americans depend more on federal aid than ever

By Dennis Cauchon, USA TODAY

Americans depended more on government assistance in 2010 than at any other time in the nation's history, a USA TODAY analysis of federal data finds. The trend shows few signs of easing, even though the economic recovery is nearly 2 years old.

A record 18.3% of the nation's total personal income was a payment from the government for Social Security, Medicare, food stamps, unemployment benefits and other programs in 2010. Wages accounted for the lowest share of income — 51.0% — since the government began keeping track in 1929.

The income data show how fragile and government-dependent the recovery is after a recession that officially ended in June 2009.

The wage decline has continued this year. Wages slipped to another historic low of 50.5% of personal income in February. Another government effort — the Social Security payroll tax cut — has lifted income in 2011. The temporary tax cut puts more money in workers' pockets and counts as an income boost, even when wages stay the same. From 1980 to 2000, government aid was roughly constant at 12.5%. The sharp increase since then — especially since the start of 2008 — reflects several changes: the expansion of health care and federal programs generally, the aging population and lingering economic problems.

Total benefit payments are holding steady so far this year at a $2.3 trillion annual rate. A drop in unemployment benefits has been offset by rises in retirement and health care programs.

NEW YORKERS: Lead pack in government benefits

Americans got an average of $7,427 in benefits each in 2010, up from an inflation-adjusted $4,763 in 2000 and $3,686 in 1990. The federal government pays about 90% of the benefits.

"What's frightening is the Baby Boomers haven't really started to retire," says University of Michigan economist Donald Grimes of the 77 million people born from 1946 through 1964 whose oldest wave turns 65 this year. "That's when the cost of Medicare will start to explode."

Accounting for 80% of safety-net spending in 2010: Social Security, Medicare (health insurance for seniors), Medicaid (health insurance for the poor) and unemployment insurance.

IRS Office of Professional Responsibility Prevails on Appeal Against CPA

IR-2011-48, April 25, 2011

WASHINGTON — The Internal Revenue Service’s Office of Professional Responsibility (OPR) recently prevailed in an agency appeal against a Florida certified public accountant, who challenged the length of the expedited suspension sought by OPR, after he pled guilty to a tax misdemeanor, according to the published Decision on Appeal.

Lawrence Legel, a Ft. Lauderdale practitioner who was represented by counsel, voluntarily waived his right to a trial in Federal District Court and pled guilty to a violation of section 7203 for assisting with a client’s efforts to hide income from the IRS. When OPR initiated an expedited proceeding to indefinitely suspend him, Legel recanted his admission of guilt, alleging prosecutorial misconduct and coercion by his criminal defense attorney.

In a subsequent administrative hearing on the suspension, rejecting OPR’s recommendation of a 36 month suspension, Administrative Law Judge Susan Biro, imposed a suspension of 24 months and calculated the start date for the suspension from the date Legel was placed on probation in the criminal proceeding. Legel’s probation commenced one year before OPR took action to suspend him from practice before the IRS. OPR appealed both the length and commencement date of the suspension.

On March 31, the Treasury Appellate Authority (TAA) ruled that 36 months was the appropriate suspension period under the circumstances, and that the correct date from which to calculate the period of suspension is the date on which OPR imposed its suspension under the expedited procedure provisions of Circular 230.

According to the published Decision on Appeal, the Appellate Authority reviewed the administrative law judge’s analysis of aggravating and mitigating factors, agreeing with some and disagreeing with others. Seriously aggravating factors were “ Legel’s lack of concern with telling the truth in sworn testimony in the [criminal proceeding] and in his testimony in the disciplinary proceeding, and his lack of remorse…both weigh very heavily against suitability [to practice before the IRS],” according to the Appellate Authority.

“The Appellate Authority makes it clear in his decision that he considers a conviction of knowingly and willfully assisting in the failure of another to pay income tax to be a very serious charge that strikes at the heart of the agency’s mission and is directly contrary to the duties of one who practices before the IRS,” said OPR Director Karen L. Hawkins. “Convicted practitioners can expect OPR to continue its aggressive use of the expedited suspension procedures in Circular 230 to quickly and efficiently remove them from practice for the taxpaying public’s protection.”