Taxable Talk

The IRS announced today a "clarification" of the rules for self-employed health insurance deductions for S Corporations. This is bad news overall, and especially bad news for California S Corporations.

The self-employed health insurance deduction allows sole proprietorships, partnerships, LLCs (those treated as partnerships or as disregarded entities) to deduct their health insurance premiums "above the line;" that is, an adjustment to AGI rather than as an itemized deduction subject to a 7.5% limitation on AGI. This is a large tax savings for the self-employed.

The IRS announcement indicates that for S Corporations to be eligible for this deduction, the policy must be in the name of the corporation. But if you do this, the health insurance premiums will be included as compensation on your W-2 (although they are exempt from FICA and medicare).

Additionally, many states, including California, do not allow single-employee corporations of any kind to obtain health insurance. This ruling means that California single-member S Corporations (a single individual is the employee and owner) are generally ineligible for this deduction.

For example, my health insurance premiums run about $5,000 annually. If I were impacted by this ruling and were in the 25% tax bracket, my federal tax bill just went up $1,250.

If you're impacted by this ruling I urge you to write your Representatives and Senators. I'm certain this is not what Congress intended when they enacted this deduction.

Forbes magazine recently presented its annual comparison of taxes in the US to the world. So where does the US rank? More or less, in the middle.

Of course, that depends on what state you reside in. The comparison looked at two US states: New York (a relatively high tax state) and Texas (with no personal state income tax). New York ranks 115.7 on Forbes' misery index; Texas is at 94.6.

As far as the rest of the world, leading the way in low taxes is the United Arab Emirates at 18.0 (not surprising, given their oil). The worst place for taxes? France, at 166.8.

And you thought that the Treaty of Paris (signed on December 10, 1898) ended the Spanish-American War. No! It ended today, May 25, 2006, when the Department of the Treasury announced that they will no longer fight for enforcement of the 3% telephone excise tax used to fund the Spanish-American War.

Refunds of tax for long-distance service paid over the past three years will be given as part of your 2006 tax returns filed in 2007. As to what documentation (if any) is required, this has not been announced. (From a tax preparers' viewpoint, I hope that preparers aren't the ones who will have to check that individuals requesting refunds meet the requirements....)

Additionally, the press release and the news stories do not reference mobile telephone service (e.g. cellular). However, the IRS notice does, stating,

"These cases [on the telephone excise tax] hold that a telephonic communication for which there is a toll charge that varies with elapsed transmission time and not distance (time-only service) is not taxable toll telephone service as defined in § 4252(b)(1) of the Internal Revenue Code. As a result, amounts paid for time-only service are not subject to the tax imposed by § 4251. Accordingly, the government will no longer litigate this issue and Notice 2005-79, 2005-46 I.R.B. 952, which states otherwise, is revoked."

So cellular phone service and long-distance service should be free of the excise tax.

Until the IRS and the Department of the Treasury announce the procedure for refunds, keep your old phone bills! The Treasury Department estimates that refunds will total $15 billion.

Links: Reuters News Story, Roth Tax Updates, and TaxProf Blog

Proposition 82, the Mandatory Preschool/Tax Increase/Help Las Vegas, Phoenix, and Denver Initiative, still leads in the polls. However, the last statewide poll was released over a month ago.

Unfortunately for all Californians, the primary election on June 6th is dominated by the Democratic primary for Governor. With no major draw for Republicans, it's very likely that this initiative, which would likely continue California's downward march among states to do business, will pass.

Interestingly enough Dan Weintraub (of the Sacramento Bee) noted that a measure buried in the Governator's budget would provide preschool to the most needy at a fraction of the cost of Proposition 82. Now, excuse my sarcasm, but do Democrats support a lean program, targeted to those who need it, or a new bureaucracy, with a program to match?

Dan Weintraub's Column (registration required)
Text of Proposition 82

I'm not a soccer fan. But if you are, the World Cup begins in just a couple of weeks. One of the favorites (based on what I've read) is Italy. But a scandal is clouding the picture.

International football (soccer, for us Americans) president Sepp Blatter was quoted in the Italian newspaper Corriere della Sera as saying, "This is madness. How is it possible that Italian soccer has stooped so low? This is the greatest scandal in the history of soccer."

So what happened? Allegations include rigging matches through corrupt referees, kidnapping a referee and two linesmen, wiretaps that show some of the alleged offenses, betting by players, embezzlement (through using public funds to chauffeur some of the ringleaders), and, of course, tax evasion. Another Italian newspaper, La Repubblica, said that Italian officials were investigating whether millions of Euros have been stashed at the Vatican Bank. The transcript of allegations runs over 1,000 pages.

Agenzia Giornalistica Italia reports that player transfers have led to tax fraud based on omissions of at least 70 million Euros. Three publicly traded soccer teams have seen their shares fall by 50% since the scandal broke.

For Italian soccer fans, this scandal, code named "Off Side" and dubbed by the Italian media "Operation Clean Feet," is the equivalent of the Black Sox scandal of 1919. It will be interesting to see the impact on the Italian World Cup team, and what charges (if any) are actually filed.

Links: AGI Story, The Australian (much more readable than AGI)

That's not a typo in the subject of this post. The tax bill that was signed last week by President Bush is titled "The Tax Increase Prevention and Reconciliation Act of 2005." Apparently Congress didn't look at a calendar....

Here are the good points of the bill, such as they are:

1. AMT Relief, but just for one year. The bill increases the AMT exemption to $62,500 for Married Filing Jointly and $42,500 for single filers for 2006. However, yet another tax bill will need to be passed in 2007 to further extend AMT relief or millions of taxpayers will find themselves in AMT hell.

That's the long list, in my view, of the good points. Now, here are the probable good points of the bill...but these could change, as they're all in the future:

2. Dividend and Capital Gains Cuts Extended. This bill extends the dividend and capital gains tax cuts (these were scheduled to expire in 2008) until 2010. Note that nothing prevents Congress from extinguishing this extension next year.

3. Roth IRA Conversions. In 2010 anyone will be able to convert a regular IRA into a Roth IRA. Regular IRAs give taxpayers a tax deduction today but distributions (upon retirement) are taxable. Roth IRAs do not give a tax deduction today but the proceeds (in retirement) are tax-free. The tax owed for these conversion must be paid in 2011 and 2012. It's quite possible that this new tax break could itself be broken by Congress between now and 2009.

Now let's examine the negative points of the bill.

4. Offers in Compromise. Do you want to make an Offer in Compromise (OIC) with the IRS? You had better do it very soon—you have until July 15th to make an OIC without making a 20% OIC deposit. If your OIC is rejected by the IRS you will lose that deposit. I doubt we'll see many OICs after July 15th.

5. Kiddee Tax Increase. If you're wealthy, one tax strategy is to shift income to your children. The kiddee tax used to end at age 14...but the new bill extends it until age 18.

6. Expatriate Tax Increase. While the new bill does increase the Foreign Earned Income Exclusion (to $82,400), it greatly reduces the housing allowance for Americans living abroad. Additionally, the tax rate for investment income of expatriates is increased dramatically. The International Herald Tribune has an excellent story on this.

7. Changes to Section 199. If you're a manufacturer (or a business that qualifies for this deduction), the Section 199 Deduction is now limited to 50% of W-2 earnings.

What's not in the bill? Plenty. Tuition deduction, educators deduction, estate tax...the list is endless. A second bill is likely to emerge from Congress this Fall.

California's sales tax rules, enforced by the Board of Equalization are far too complicated. Then throw in political shenanigans and you get...a lawsuit.

San Francisco International Airport is located just south of the City by the Bay in San Mateo County. United Airlines has a major hub at SFO. This sounds like a sales tax boon for San Mateo County.

Except for a law that relocates the sale from the airport to an office building in Oakland, in Alameda County. The Governator signed a bill that will eliminate this "quirk" in 2008. San Mateo County decided they couldn't wait that long.

Did I mention that Oakland gives a kickback of $0.65 to United for every dollar of sales tax collected? But as Aero-News notes, the Legislature believes the deal is currently legal.

Given the backlog in California's courts, the case will likely not be decided for a couple of years.

News Stories: Aero-News Net, San Francisco Business Journal

There was lots of activity this week among scofflaws and other tax cheats. First, the operators of a Middle-Eastern restaurant have been accused of skimming $16 million in cash from La Shish restaurants and sending the money to Lebanon. One of the owners is in custody; the other has apparently fled to Lebanon.

From Cleveland comes the story of a sportscaster who didn't pay between $12,000 and $30,000 in taxes. Bruce Drennan is the former voice of the Cleveland Indians. Mr. Drennan apparently debated the betting line on his radio talkshow, and then bet on the games. He apparently was a successful gambler...but he forgot to claim his winnings on his tax returns. Oops. He is also alleged to have been running a bookmaking ring. The Cleveland Plain Dealer has a full summary of the case here.

Mr. Drennan has pled guilty, and under a plea agreement will serve five months in prison and then five months under house arrest. Mr. Drennan, quoted by the AP, stated, "I am not being punished because I bet on games and lost...I am being punished because I bet on games and won, and did not declare those winnings to the IRS, and that's a crime, and I pled guilty to the that crime. It's wrong, and I'm sorry, and I'm going to pay the price for that."

Contrast Mr. Drennan, who admitted his wrongs, to our next lucky winner, Richard Hatch. As I noted a few days ago, Mr. Hatch was sentenced to over four years in prison. Survivor: Victorville is coming soon!

But our biggest loser comes from Washington state. David Carroll Stephenson was sentenced to eight years for conspiring to defraud the U.S. and for not filing three years of tax returns. Additionally, he must pay $8.5 million in restitution. Mr. Stephenson was behind "pure equity trusts." These trusts weren't worth the paper they were printed on, and were devised just to avoid taxes. My usual rule of thumb applies: If it sounds too good to be true, it probably is.

The always vexing question of whether or not a gambler is a professional or an amateur was looked at this week by the Minnesota Supreme Court. In Busch v. Commissioner of Revenue (A05-656), Estelle Busch fought the Minnesota Department of Revenue's ruling that she was an amateur and had to pay Minnesota's Alternative Minimum Tax (AMT) on her gambling winnings.

The facts of the case were not in dispute. Estelle Busch, a retiree, began playing slot machines at an Indian casino in Minnesota. She enjoyed herself, but lost. She played more and more, from 40 to 60 hours per week. Initially, she filed as an amateur, putting her winnings as Other Income (line 21 of her federal return) and her losses as an itemized deduction on Schedule A of her federal return.

In 2001, she decided that she met the standard of being a professional, and filed a Schedule C. She was not able to take her losses as a deduction against other income on her return; however, she was able to net out her income so she essentially reported $0 as the "net income" from her business.

The IRS apparently never audited her. (The record is not completely clear on this.) However, the Minnesota Department of Revenue did, and the Commissioner of Revenue fought her in Minnesota Tax Court. Minnesota has a very strict AMT. Minnesota AMT denies most deductions and forces a gambler to pay tax on the gross winnings rather than the net winnings. This is quite different from the federal AMT. Although in certain situations gambling winnings could conceivably cause a taxpayer to fall into the federal AMT, gambling losses are deductible on the federal AMT. The Commissioner won in Minnesota Tax Court, and Ms. Busch appealed to the Minnesota Supreme Court.

The Minnesota Supreme Court looked at four issues: (1) Was Minnesota prohibited from challenging the business vs. hobby status by the actions (or inactions) of the IRS; (2) Did the Groetzinger decision apply to Ms. Busch; and (3) Did Ms. Busch have a reasonable expectation of profit?

The first issue is a collateral estoppel argument. Is Minnesota precluded from acting because the IRS hasn't acted? The court ruled that Minnesota can have a different ruling than the federal government, if the laws and circumstances justify it.

On the second issue, the Groetzinger decision states:

"[I]f one’s gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned. Respondent Groetzinger satisfied that test in 1978. Constant and large-scale effort on his part was made. Skill was required and was applied. He did what he did for a livelihood, though with a less-than-successful result. This was not a hobby or a passing fancy or an occasional bet for amusement."

Ms. Busch was certainly gambling on a full-time basis. But did she have an expectation of profit?

Here, the fact that she kept scrupulous records aided her case immensely. That, and the fact that she did win a jackpot now and then helped out.

Still, the Commissioner argued that it was impossible for anyone to be a professional slots player because "it's impossible to win." (As a side note, there are slot machines in some casinos that are either beatable (100% payback with perfect play), or are so close to beatable that perfect play combined with slot club rewards can lead to a positive expectation. That was likely not the case where Ms. Busch gambled.) The court noted,

"[W]e disagree with the tax court’s conclusion that a reasonable expectation of profit is required for a given activity to qualify as a trade or business. We conclude that it is often too difficult and uncertain for courts to decide, from the safe position of hindsight, which business activities had a reasonable expectation of profit and which did not. Furthermore, if trade or business tax incentives hinged upon a court’s determination of whether an activity had a “realistic” expectation of profit, valuable innovation in our entrepreneurial society could be chilled. We conclude that the taxpayer’s expectation of profit from a given activity need not always be reasonable for the activity to qualify as a trade or business."

So Ms. Busch wins the big gamble, fighting the Minnesota Department of Revenue, avoids AMT, and will be able to pursue her slot play as a business.

Churches don't generally pay income tax. They're non profits in the true sense of the word.

So why not create your own church? Take your salary, send it directly to the church (say, the Church of Russ), name yourself minister, and before you can say "Let us pray," there goes all of your tax troubles!

Hint: It had better be a real church.

Second Hint: If you take a vow of poverty, make sure you do so.

Or you could find yourself in trouble. Like the Incline Village, NV man who allegedly formed the "International Academy of Lymphology," assigning all of his income to the "church," and then obtaining tax refunds of $100,000 and not reporting income of $500,000. He faces three felony counts of false claims and three counts of tax evasion.

News Story: Las Vegas Sun

Last night I drove home from Las Vegas and the CSEA's SuperSeminar (well worth it, as usual; I'll have more on the seminars later). As you head out of the high desert from Barstow on Interstate 15, you pass a sign that says, "Victorville Federal Correctional Complex." There's a chance that our favorite Survivor contestant may soon be taking up residence there (or a Club Fed location near you).

Richard Hatch, who will be a charter member of the Bozo Tax Offender Hall of Fame, was sentenced to 51 months in prison. That was more time than expected. Although Hatch told the court before sentencing, "I believe I’ve been completely truthful and completely forthcoming throughout the entire process," Judge Ernest Torres didn't see it that way. "There’s no nice way to say it: Mr. Hatch lied," Judge Torres remarked. And that led directly to his sentencing.

So, finally, the Richard Hatch story is over. The moral? If you win a prize with 300 million witnesses, you had better declare it on your tax return.

For the next several days, I'll be at the CSEA's annual SuperSeminar; thus, updates will be infrequent at best. We'll return next Wednesday or Thursday with more news and some information from what has in the past been an excellent seminar. Until then, take a look at some of the other tax bloggers listed in the blogroll on the right.

Happy Mother's Day, too!

Perhaps the Governator reads Taxable Talk (though I doubt it). In any case, Governor Schwarzenegger will propose tomorrow to:

1. Use $1.6 billion of the new revenues to retire debt;
   
2. Use $1.6 billion for the reserve account;
   
3. Use $2 billion to compensate schools for money "taken" over the past two years; and
   
4. Spend $400 million on disaster preparedness.
   

Of course, who know what the Democratically controlled legislature will do, and how active the Governator's red pencil (line item veto) will have to be. Don't be shocked if he needs multiple red pencils this year.

Meanwhile, speculation is that Google is the major cause of the extra revenue. Not through taxes on Google itself; rather, through taxes on the sale of stock by Google insiders. cnet believes that it could amount to 10% of the tax revenue, $450 million.

News Stories: Governor's Budget Plans (Scripps-Howard); Google/cnet

You'd think that if you're a psychic you'd be able to just will your way to violence—you wouldn't have to throw any punches.

Sadly, our tax evading psychic apparently threw plenty of punches at his wife. David Guardino of Cary, NC has been free pending his tax evasion trial (which he also apparently didn't see coming). Joe Kristan has more on our not-so-pyschic psychic.

Republican negotiators in Congress sent tax legislation out of conference committee. The highlights of this generally lackluster legislation:

- AMT Relief extended, with a new higher exclusion of $62,550 for 2006;

- 15% capital gains rate extended for two more years, through 2010;

- Section 179 depreciation at $100,000 extended to 2010, from 2008;

- Roth IRA conversions allowed for everyone. This, as Joe Kristan correctly notes, increases tax revenues today, but drastically impacts tax revenues in a few years. Roth IRAs are not tax deductible today. However, when you retire and starth withdrawing the funds, they are tax-free;

- The Section 199 Production Deduction (the deduction from hell) has been toughened. The deduction will now be limited to 50% of W-2 wages; and

- Mandatory payments for Offers in Compromise (OIC) of 20% of the OIC. This will discourage OICs.

There's plenty more, but it's mostly arcane stuff. There's a lot of budget shenanigans. As Joe Kristan noted, corporate estimated tax payments are definitely being played around with:

"The 2006 estimated tax payment installments due in July, August or September (third quarter, for calendar year taxpayers) will be 105% of the amount otherwise due for the quarter. The same installment in 2012 will be 106.25% of the amount otherwise due; in 2013, the magic number will be 100.75% of the amount otherwise due.

-In 2010, 20.5% of the third quarter installment due September 15 will be payable October 1; in 2011, 27.5% of the third quarter installment is payable in October.

The government has a September 30 fiscal year, and these rules obviously shuffle income among the fiscal years to meet some arcane budget rule, at least on paper and in a laughably phony manner."

Of course, the whole procedure is that way. Many of the delayed tax increases will never see the light of day. They're only in the legislation so that it meets the $70 billion tax cut limitation; if the tax cut were larger than that, the bill would be subject to a fillibuster in the Senate. It cannot be fillibustered.

For more information:
Text of the Bill (HR 4297);
Los Angeles Times News Story;
Roth Tax Updates Post;
and TaxProf Roundup on the legislation.

Back in the 1996 tax year, Leonard Gittinger, an attorney, didn't pay his taxes. He argued that wages weren't income. If you've been reading this blog, you know that argument is a typical tax protester argument, and is baseless. The Tax Court rejected his argument then, and the 5th Circuit also rejected his first appeal, noting it was "completely and utterly frivolous."

Well, Mr. Gittinger also didn't file tax returns for 1997 through 2001, and he filed yet another Tax Court case. Unfortunately, both Tax Court cases aren't available online. However, he also lost his second case. We do know, from reading his appeal of that decision, that he had 19 typical tax protester arguments. As the Appeals Court noted, only one of his 19 items merited comment: "“Whether the allegations in the petition and . . . instant proceeding are ‘frivolous and groundless?’” The answer is yes."

The Appeals Court noted that Mr. Gittinger should have learned his lesson the first time. As a reminder of the frivolous nature of the appeal (and, frankly, of the whole case), he was also ordered to pay a $6,000 sanction. "A
party who continues to advance long-defunct arguments invites sanctions." Tello v. Comm’r, 410 F.3d 743, 744 (5th Cir. 2005)

Case: Gittinger v. Commissioner, 04-611118 (5th Circuit)

My thanks to Decision of the Day for their link to this case.

Today the Tax Court looked at a §1031 Exchange case. The question before the court was whether a partnership (Peabody) could exchange gold mines for coal mines. The problem: the coal mines were encumbered with supply contracts that sent the coal to electric utilities. Does the encumbrances constitute "boot" that causes tax to be due?

Under a §1031 Exchange, like property is exchanged for like property. The exchanger avoids capital gains tax. Like property need not be exactly the same property. You can exchange a rental house for a rental duplex, for example. (There significant restrictions to &1031 exchanges; make sure you talk to your own tax advisor about your situation.)

When cash gets involved in the transaction, it's considered "boot." Boot is taxable. The IRS argued that the contracts weren't real property, but were the equivalent of cash or personal property received along with like-kind property. (There's no question that you can, in a § 1031 exchange, exchange one mine for another mine, even if each mines different substances, assuming the other provisions of § 1031 are followed.)

The court had to determine, (1) are supply contracts considered real property and, thus, can be part of a § 1031 exchange (the IRS argued that they are contracts to sell personal property); (2) are the servitudes created by the supply contracts real property; and (3) are the supply contracts boot or not?

The court noted that like-kind doesn't mean exactly the same kind:

In determining whether the like-kind requirement of section 1031 had been met, we found it significant in Koch v. Commissioner, 71 T.C. at 65, that section 1031(a) refers to property of a like, not an identical, kind. The required comparison of the old and new exchanged properties, we reasoned, should be directed to whether the taxpayer, in making the exchange, has used its property to acquire a new kind of asset or has merely exchanged its property for an asset of like nature or character.

The court did note that not all real property exchanges are like-kind exchanges, though.

The idea behind a § 1031 exchange is that the taxpayer is exchanging one piece of property for another, and that his original investment has not been sold or liquidated. The court noted,

It is true Peabody is obligated to mine and supply coal to meet the operating needs of power stations and that Peabody is prohibited from impairing the contracted-for supply by selling coal to other buyers. In our view those contract obligations and restrictions constitute a distinction in the grade or quality of the old and new mining properties rather than a difference in their kind or class. The new coal mine property is of a like nature or character to the gold mining property Peabody exchanged. By exchanging the gold mining property for the coal mining property subject to the supply contracts, Peabody is essentially continuing the original investment which remains fully unliquidated.

The court concluded, "In the light of that holding and because the supply contracts cannot be separated from Peabody’s ownership of the Lee Ranch mine coal reserves, it follows that those contracts are not taxable as other property or boot under section 1031(b)."

So Peabody is allowed to turn gold into coal, tax-free.

Case: Peabody Natural Resources Company v. Commissioner, 126 T.C. No. 14

In April, Californians sent $11.3 billion in personal income tax payments to the state, $4 billion more than predicted in January, according to the Department of Finance. So, what should be done with this money?

The California Constitution requires a balanced budget, so there's no such thing as deficits or surpluses—at least on paper. The reality is a bit different, of course. For the last few years, the state has borrowed funds from a variety of sources in order to balance the books. Funds tapped included payments to local governments, funds for education, and emergency funds.

H.D. Palmer, a spokesman for the Department of Finance, notes what happened the last time California had an unexpected surplus. "When the dot-com boom went spectacularly bust and those one-time revenues disappeared, that increased the structural deficit that we are still working to close."

It even appears that Democrats in the state legislature know that California has fiscal issues. "We as Democrats need to be careful and focus on getting ourselves out of this hole so we don't have a permanent structural deficit," said Wes Chesbro (D-Arcata).

So will the money go to reducing the structural deficit and paying back the debt/borrowed funds, or will the Democrats in the legislature attempt to spend the money? The budget is supposed to be approved by June 30th (a deadline that's rarely met), so we should have some idea on this soon.

News Story: Contra Costa Times

...the state would probably be run much more efficiently than it is today. Their methods, though, might leave something to be desired.

However, the methods employed by Governor Jon Corzine leave a lot to be desired. Corzine wants to increase New Jersey's sales tax rate by 16.67% (from 6% to 7%), and add a $1,424/month "bed tax" on hospitals. Certainly, it's creative, but as Professor Maule notes this fee tax would just be passed on to users of hospitals. Health insurance premiums would rise, and hospitals will suffer. It's likely that the number of available hospital beds would shrink. It is basic economics.

Luckily for residents of the "Garden State," even his Democratic colleagues in the New Jersey Legislature aren't happy with his proposals. The Newark Star-Ledger quotes Assemblywoman Joan Quigley as stating, "[this tax money would go into] a black hole...We are taxing hospitals to pay for roads and jails."

Given the political climate in New Jersey (corruption and a very dysfunctional electorate) I won't be surprised if Governor Corzine's budget is implemented.

News Stories: Philadelphia Inquirer, Newark Star-Ledger

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

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

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

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

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

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

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

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

Case: Garwood Irrigation Corp. v. Commissioner