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Archive for April 9th, 2011

Courtesy of Businessweek, How to Pay No Taxes, in which the author profiles “Eleven shelters, dodges, and rolls — all perfectly legal — used by America’s Wealthiest People.” 

It’s an interesting read, no doubt, but do note that it’s tempered with “caveat emptors” warning that some of the suggested transactions are currently or have previously been the subject of IRS scrutiny or litigation. 

Of particular interest is #7, “The Friendly Partner.” In this tip, the author extols the virtues of the so-called “leveraged partnership” which he describes as follows:

An investor owns a piece of income-producing real estate worth $100 million. It’s fully depreciated, so the tax basis is zero. That means a potential (and unacceptable) $15 million capital-gains tax.

1. Instead of an outright sale, the owner forms a partnership with a buyer.

2. The owner contributes the real estate to the partnership. The buyer contributes cash or other property.

3. The partnership borrows $95 million from a bank using the property as collateral. (The seller must retain some interest in the partnership, hence the extra $5 million.)

4. The partnership distributes the $95 million in cash to the seller.

Note: The $95 million is viewed as a loan secured by the property contributed by the seller instead of proceeds from a sale. For tax purposes, the seller is not technically a seller, and so any potential tax bill is deferred.

What the author fails to mention, however, is a little case called Canal Corp. v Commissioner, 135 T.C. No. 9 (August 5, 2010). In Canal, the Tax Court blew up a leveraged partnership transaction, resulting not only in the triggering of $524 million in capital gains, but also a rather hefty $36.7 milllion substantial underpayment penalty.

Without getting into too much detail, in Canal, the Tax Court held that even though the “seller,” technically indemnified the other partner’s borrowing on the loan (#3 in the steps above) — which was designed to give the seller basis in the partnership and allow for the tax-free distribution of the cash — the indemnity had no substance and was done simply to avoid the disguised sale rules of Section 707.

For $36.7 million reasons, I’d be rather careful before I entered into a leveraged partnership transaction, regardless of Newsweek’s recommendation.

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Unemployment is up. The stock market is down.

We know these things to be true, but the Statistics of Income Bulletin released today by the IRS — which compares 2009 individual income tax return data to 2008 — really drives home just how much Americans are struggling in the current economic climate. Some high low-lights include:

  • In 2009, 140.5 million tax returns were filed. While I have no empirical evidence to support this, based solely on the way the past month has felt, I”m fairly confident my firm prepares each and every last one of them.
  • Taxable interest was down 24.8 percent from 2008, a reflection that savings have been accessed to pay for living expenses.
  • As further support for this hypothesis, deductible penalties on the early withdrawal of savings increased by 302%!
  • Ordinary dividends were down 25%
  • Capital gains were down a remarkable 46%, while capital gain distributions decreased 89% from 2008 to 2009.
  • Rental income decreased 33.2% as reliable tenants became hard to find, and lessors were forced to lower their rental rates.
  • Taxable unemployment income increased 91.5%! Keep in mind, this is after accounting for the fact that in 2009, the first $2,400 of unemployment income was tax-free.

Not all components of income were down  from 2008 to 2009, however, but that doesn’t mean there was any good news to share. In 2009, taxable pension and annuity income increased by 3.1%, as many American’s were forced to access their retirement funds to weather the storm.

Scary data, certainly. What will be most telling, of course, is how 2010 ends up comparing to 2009.

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