Taxable Talk

The IRS released its 2006-2007 Priority Guidance Plan earlier this month. There are 264 projects listed. Some of the projects include:

• Regulations to facilitate electronic filing and reduce taxpayer burden [for corporations]. Temporary regulations were published on May 30, 2006.



• Guidance regarding the treatment of incidental health insurance benefits provided under a profit-sharing or stock bonus plan.



• Revenue ruling on taxable health benefits for beneficiaries.



• Guidance on Health Savings Accounts.



• Guidance on political activities by section 501(c)(3) [charitable] organizations.



• Guidance on the treatment of fees incurred in credit card transactions [for financial institutions].



• Revenue procedure under section 3402 regarding the withholding rules applicable to poker tournaments.

It should be noted that just because an item is listed does not mean that the IRS will take action. For example, the revenue procedure for poker tournaments was on the 2005-2006 Guidance Plan and no action was taken. However, when an item appears for two straight years, it's likely that the IRS will eventually release something.

With the college football season beginning this weekend, and with pro football starting just one week later, it's time to root for your favorite team(s). Residents of New Jersey have gotten a head start—the National Conference of State Legislators has found that New Jersey's budget increased the most of any state!

New Jersey's budget increased by $1.9 billion, a five percent increase. New Jersey is now number one in sales tax (tied with three other states), number one in cigarette tax, and number one in property tax. What a trifecta!

On the other hand, some states actually decreased taxes this year: Arizona, Nebraska, Oklahoma, Utah, and Wyoming.

New Jersey, of course, suffered through the budget shutdown crisis in July, and the Garden State's new $30.8 billion budget increased sales tax from 6% to 7%. In an article in the Newark Star-Ledger, New Jersey Senate Minority Leader Leonard Lance is quoted as saying, "Businesses are fleeing New Jersey as well as residents, and it's very discouraging."

There was one bit of good news in the article. New Jersey's gasoline tax (14.5 cents/gallon) is the third lowest in the U.S. Unfortunately, New Jersey has the second worst tax climate for business (according to the Tax Foundation), and until that problem is corrected the Garden State is caught in a perpetual slide.

A fascinating case came out of the Tax Court today. Being late when you file a challenge is never a good idea; in almost all cases, your filing can be thrown out. But what happens if you file too early?

The petitioners in today's case received a notice of lien for 1996 to 2000. Then the petitioners received a notice of levy for tax years 1990 to 1994. The petitioners requested a collection due process hearing (CDP) before the thirty day period before the first day of levy.

In appellate court cases, if you file early, your date of filing is presumed to be the first day of filing (your filing date is "related forward" under Federal Rule of Appellate Procedure 4(a)).

But that wasn't the view of the Tax Court. Instead, it took the statute literally, noting that a request must be made during the 30-day period. The regulations promulgated under the statute use the same terminology: four times the words "during the 30-day period" (or synonyms) are used.

The Court concluded,

Allowing premature CDP requests to be effective, incontrast, would cause prejudice to the Commissioner. The IRS is a bulk-processing organization that sends and receives hundreds of millions of notices and returns each year. If the system is to work, almost all of those notices and returns have to quickly fit into pigeonholes (or their modern-day equivalent, the database field), rather than become the object of contemplation by a IRS clerk charged with finding the right place to put a particular piece of correspondence....We think the Commissioner is right when he argues that allowing a taxpayer to disrupt this sequence with a premature CDP request would be quite likely to cause prejudice.

So if you're going to contest an IRS notice, check the dates carefully. Being early is just as bad as being late.

Case: Andre v. Commissioner, 127 T.C. No. 4

It's been a busy week for the scofflaws.

First up is a dentist from Florence, South Carolina. He is alleged to have added about $1 million in false expenses and loans to his tax returns. If convicted, he faces a maximum fine of $1 million plus 14 years in prison. It's great if you can get away with it....

Meanwhile, another dentist will find himself behind bars. Burton Tucker, of Waynesboro, PA, used offshore trusts to evade about $520,000 in taxes. He'll be making restitution and will spend one year at Club Fed; the government noted that he's cooperating in an ongoing investigation of trusts. It's just been a bad week for dentists, I suppose....

In New jersey, a judge cited that a jeweler has "appalling greed." Licinio Neves, owner of a three-store jewelry chain, will spend up to 6.5 months in Club Fed for his tax evasion, and must make restitution of $470,000. He kept two sets of books, and didn't report the cash sales from his stores in 2001.

Not bad for just a couple of days.

From Joe Kristan's Roth Tax Updates:

Apparently, Respondent believes there is a legal distinction between "Charles David Saunders" the person and "Charles David Saunders" the Living Soul. The Court has been unable to locate any precedent that supports such a distinction.

I imagine that the Respondent lost....

Stock options have been in the news over the past few weeks, for all the wrong reasons. Many corporations have been accused of backdating the options.

Senator Charles Grassley (R-IA), head of the Senate Finance Committee, isn't happy about this. He told Reuters, "If the tax laws are inadequate on stock options backdating, I want to beef them up." Grassley has scheduled a hearing on September 9th to discuss the options mess.

From our vantage point expect tightening of the rules and regulations dealing with stock options, and a likelihood that fewer options will be issued in the future.

News Story: Reuters

Last month we reported on the tax troubles of Australian actor Paul Hogan. Hogan is in trouble over money sheltered in Swiss bank accounts.

The Sydney Morning Herald reports in Thursday's edition that Hogan has hired an American expert in trusts: Scott Michel of Caplin & Drysdale, a Washington firm of attorneys. Mr. Caplin has written many articles dealing with white collar crime in general, and tax evasion specifically.

The Herald article notes that Hogan invested in "honourable trusts" through Phillip Egglishaw. Egglishaw's brochure, according to the Herald, states, "Trusts are typically used to avoid the following forms of taxation: income tax, capital gains tax, death duties, gift taxes, wealth taxes.... The key is 'secrecy'"

Given that Australia's tax laws require residents to declare their worldwide income (as do those in the US), Mr. Caplin may have his work cut out for him. At least the Herald is reporting that Hogan is only looking at civil penalties because of his ignorance of Australian tax law.

News Story: Sydney Morning Herald

Yesterday, the D.C. Circuit ruled that §104(a)(2) of the Internal Revenue Code (Title 26, U.S.C.) is "...unconstitutional insofar as it permits the taxation of an award of damages for mental distress and loss of reputation." This is a monumental decision that if upheld will drastically impact taxes. Interestingly, neither my local newspaper (the Orange County Register) or the Wall Street Journal had a word about this decision.

What This Decision Means In the Short-Term

Clearly, personal injury for mental distress and loss of reputation aren't income under this decision. Given how the court ruled:

The Sixteenth Amendment simply does not authorize the Congress to tax as "incomes" every sort of revenue a taxpayer may receive. As the Supreme Court noted long ago, the "Congress cannot make a thing income which is not so in fact." Burk-Waggoner Oil Ass’n v. Hopkins, 269 U.S. 110, 114 (1925). Indeed, because the "the power to tax involves the power to destroy," McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 431 (1819), it would not be consistent with our constitutional government, and the sanctity of property in our system, merely to rely upon the legislature to decide what constitutes income.

I'd expect tax attorneys to seek out other similar sections in the I.R.C. (like §104(a)(2)) and file claims. Additionally, given the the expiration of the statute of limitations for filing claims and refunds, the IRS will be inundated with these.

Joe Kristan of Roth Tax Updates wrote yesterday that, "this thing is going to trigger lots of refund claims in all sorts of areas starting right now. A great many corporations extend their return, and their 2002 statute of limitations expires September 15. Let the gold rush begin." I agree.

The Impact of This Decision in the Long-Term

Probably none. I'm certain that this decision will either be appealed to the Supreme Court, or that the government will request a rehearing in front of the entire D.C. Circuit (an "en banc" hearing). Orrin Kerr in Volokh says that the Supreme Court would probably take the case. Given that this directly impacts taxation, and would change principles of tax that have been upheld for nearly 100 years, I can't foresee the decision being upheld. But if you had asked me before yesterday the chance that this decision would appear, I would have said zero. So it could happen.

What's Next

As Professor Bainbridge states, "Let...1000 lawsuits bloom. Evey tax nut in the country is probably getting ready to file suit challenging some tax or another using Murphy as a template." This will certainly occur—not just with the nuts, but with intelligent tax attorneys making claims with similar sections of the Code. If I were a tax attorney I'd be researching this right now.

Both Joe Kristan and Marty Lederman believe that even if this Code section is unconstitutional under the 16th Amendment, it is still legal under other areas of the Constitution:

My very rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124). If I'm correct about this, then the tax on the award of damages therefore is constitutional, wholly without regard to whether it is a tax on "income"....

Employment law attorneys will be crafting their cases and settlements in order to take advantage of this decision. They'll be spending quite a bit of time figuring this out.

If you happen to have received a settlement which was taxed based on Section 104(a)(2) of the I.R.C., you should file an amended return seeking a refund based on this decision. You must do so before the statute of limitations expires (for the tax year in question), so contact your professional tax adviser today. You will probably not receive a refund (again, I anticipate this court decision being reversed), but a 0.01% chance of a very large refund makes the decision to file an amended return a no-brainer.

In the end, I think that this decision will be reversed. Still, just the fact that this decision was issued will cause the IRS quite a bit of heartburn. If §104(a)(2) is found unconstitutional, might there not be many other similar sections in the Code that an enterprising tax attorney could challenge? I'm sure the answer is yes (though I have no idea which sections these are).


Links:

TaxProf Blog's Excellent Summary of Blogosphere Reaction

Volokh Conspiracy Article

Roth Tax Updates 8/22

I'm gone for ten days on vacation and return to find that the new news is like an instant replay of the old news. Yet another adult bookstore owner has been indicted on income tax evasion charges.

Jerry Pendergrass owned Metro News, the self described World's Largest Adult Bookstore, and several other adult entertainment entities in Tennessee. Pendergrass allegedly purchased property but didn't record the deed. Then, using the help of two attorneys who have also been indicted, Pendergrass was allegedly able to hide over $300,000 in proceeds from the sale of the property. Pendergrass also allegedly had about $400,000 in phony deductions and had personal expenses paid for by his corporation and not reported as income on his tax returns.

This isn't the first time Pendergrass has been in trouble. Federal tax liens totaling over $565,000 have been filed against him. Pendergrass was convicted in the late 1990s on an obscenity charge, but the conviction was overturned.

News Story: The Chattanoogan

It's time for my annual vacation. I'll be back around the 22nd. If you need a tax fix while I'm gone, check out some of the other blogs listed on the blogroll on the right.

The new Pension Law, which will be signed into law by President Bush next week, will impact areas that have nothing to do with pensions. Joe Kristan at Roth Tax Updates writes how you will need to have a receipt for all of your deductions beginning for 2007. Yesterday Joe noted how the new legislation impacts corporate life insurance.

With Congress, it's not the title of the legislation, it's what's inside that counts.

A chiropractor put his business in a trust. He admits he had no idea of how trusts work and he never performed the duties of a trustee. Given that I'm writing about this, I'm sure you know where this is headed.

Trouble.

And then he started selling his trusts to others. Givers gain, right? He even filed a lien against a client's assets to frustrate the IRS.

The IRS wasn't happy. Given that the government lost about $1 million in tax revenue ($248,000 directly related to the trust scheme), such a reaction was to be expected.

Our chiropractor decided to plead guilty to conspiring to defraud the IRS. He'll spend twenty months in Club Fed thinking about his wayward ways, and also pay a $10,000 fine.

The chiropractor was a licensee of Advanta Strategies and World Contractual Services. The proprietor of Advanta was been sentenced to 54 months in prison last year.

Our usual advice on trusts holds: If it sounds too good to be true, it probably is.

News Story: Salt Lake Tribune

The Tax Court today looked at a case where the government went after a couple who had been convicted of insurance fraud. The problems began in 1998, when the fraud was committed. There was $272,963 in unreported income. As you may remember, illegal income is just as taxable in the U.S. as legal income. However, the Chens, the couple in question, argue that the statute of limitations expired; the spouse argues for innocent spouse relief; and they question the amount of income.

There's a major difficulty when you argue that the statute of limitations prevents prosecution. Under section 6663(a), there must be proof of the fraud, and that the underpayment of tax is due to fraud. Given that the Chens pleaded guilty to fraud, the first hurdle is easily overcome. And the second hurdle is mostly overcome by the plea agreement, where the couple admits "act[ing] with a specific intent to commit fraud." The court also notes the numerous other indications of fraud from the criminal case, including a false insurance claim, concealing information from their tax preparer, and contradictory claims during their testimony. And there's no statute of limitations when a tax underpayment is caused by fraud.

Mrs. Chen doesn't succeed in her innocent spouse claim. She had, in her plea bargain, admitted that she "acted with a specific intent to commit fraud."

So the Chens will need to find another $272,963. For once you say you committed fraud, you have to live with the result.

Tax Court Case: Chen v. Commissioner, T.C. Memo 2006-160

Former Atlanta Mayor Bill Campbell will begin serving his 2 1/2 year sentence on August 21st. Campbell's request to stay free while appealing his sentence was denied last week by Judge Richard Story. Story noted that Campbell "as not shown the existence of a substantial question likely to result in reversal, a new trial, or a reduction in his sentence."

Campbell will serve his sentence at the federal minimum security prison camp in Miami. Campbell, besides prison time, was fined $6,300 and ordered to pay $63,000 in back taxes.

News Story: WISI(AP)

One day, sometime in the future, Congress will complete all their work on appropriation and tax measures before the August recess. But it won't be this year (and it probably won't be for many years).

On Thursday the Senate failed to consider a repeal of the estate tax. Republicans in the House tied a minimum wage increase and various extenders to this bill (including the Research and Development credit). Now the extenders may not happen, which is making the high tech lobby unhappy.

Personally, I expect Congress to pass a version of this legislation...in November, after the election. Neither side wants to give the other any political capital before the election. Yet many of the proposals are too important politically not to get passed.

In other words, business as usual in Washington.

News Story: Wall Street Journal (Pay Link)

If you're a Native American and reside in California on a reservation, you're exempt from California personal income tax. However, you're not exempt from federal income tax. And that's where this story begins.

The Chumash tribe runs a very successful casino near Santa Ynez, north of Santa Barbara. Tribal members receive quite a bit of income each year, and must remit federal income tax. A few years ago the Chumash were approached by Benecorp LLC. Benecorp presented to the Chumash the "CapNet 7 Financial Models." 32 members of the Chumash are alleged to have saved millions in taxes through "sham management fees," according to this story in the Los Angeles Times. The same story notes that in April 2004, outside experts told the Chumash that the program, "is being administered in a way that is not authorized under current IRS laws."

Without knowing the nuts and bolts of the program, it's impossible for me to determine whether the CapNet 7 Financial Model complies with tax laws or not. I did notice when looking at Benecorp's website that the heart of the plan is a trust. The government alleges that the plan, "[created] sham entities and sham transactions." We've seen that in plenty of trust enforcement actions recently. The Chumash officially severed all links to Kenneth Sorenson, one of the two principals behind Benecorp.

The moral is the usual one. Stephen Drake, the other principal of Benecorp, said in a 2004 interview, that Chumash who learned of the program thought it was too good to be true. That just might be the case.

There's nothing at all about tax in this post. You're all forewarned.

Instead, this post focuses on my avocation—writing. My second book has just been released. Written with my good friend Scott Harker, it's called Why You Lose at Poker.

We take the sixteen most common errors in poker, show you how to recognize them, and then how to eliminate them from your game for good.

If you love to play poker but just can't seem to win consistently, this is the book for you!

You can purchase this book today at Amazon.com. It should be available in book stores such as Barnes & Noble in about three weeks.

With an estimated $40 to $70 billion in taxes lost each year because of tax havens, the Senate Homeland Security and Governmental Affairs Committee was naturally quite interested in plugging this hole. Yesterday the panel heard testimony from IRS Commissioner Mark Everson, among others.

The 401-page report issued by the committee The report recommends eight items:

1. U.S. law should presume that offshore trusts and shell corporations are under the control of the Americans directing the use of the assets, when the trusts and shell corporations are located in a jurisdiction designated as a tax haven.

2. U.S. publicly held companies and their insiders should disclose in SEC filings holdings in an offshore trust or corporation.

3. Offshore trust or shell corporations related to a director, officer, or large shareholder of a U.S. publicly traded corporation should treated as an affiliate of that corporation.

4. Require 1099 reporting if a US financial institution opens an account for a foreign trust or shell corporation and determines that the beneficial owner of the account is a
U.S. taxpayer.

5. Loans that are treated as trust distributions under U.S. tax law should be expanded to include loans of real estate and personal property of any kind including artwork, furnishings and jewelry. Receipt of cash or other property from a foreign trust, other than in an exchange for fair market value, should also result in treatment of the U.S. person as a U.S. beneficiary.

6. Require hedge funds to establish anti-money laundering programs and report suspicious transactions to US law enforcement.

7. Enact laws and/or regulations such that taxes on stock option compensation cannot be avoided or deferred by exchanging stock options for other assets of equivalent value such as private annuities.

8. Enact sanctions on tax havens that do not cooperate with US tax enforcement and eliminate US tax benefits for income attributed to those jurisdictions.

Given that both Democrats and Republicans want to reverse this outflow, expect something to pass Congress in the not to distant future.

Hat Tip: TaxProfBlog

New York Times Article
AP Report
Wall Street Journal Article (Paid Subscription Link)