Posts Tagged ‘ceo’

Every guy has a friend like my buddy Todd, who despite being an otherwise normally functioning adult, thinks it’s an indictment on his manhood to admit that he’s really into a girl.  

The thing is, he’s not fooling anyone. He’s been dating this same girl exclusively for the last nine months. He’s met her family. She’s met his. They go camping together, skiing together, make fondue together, all the adorable crap that defines the traditional boyfriend-girlfriend relationship.   

Only Todd refuses to refer to this girl as his “girlfriend.” Won’t do it. Even though everyone they come into contact with walks away certain that she is just that, he won’t concede it to his friends, lest a level of permanency attach to their relationship and jeopardize his self-aggrandizing “ladies man” persona.

Ridiculous, right? We’ll that’s exactly the same silly posturing Congress has engaged in for the last fifty years by refusing to make certain tax provisions permanent, instead enacting them with arbitrary deadlines and routinely allowing them to expire before retroactively extending them again and again and again.

Take, for example, the R&D credit. According to Congress, the credit is a “temporary” provision, but it’s been in the Code for 30 years! Every few years, the credit expires — as it did most recently on December 31, 2011 — and taxpayers and practitioners alike are left to put their faith in their pattern recognition skills and trust that Congress will again retroactively reinstate Section 41. Based on the history of these extenders, we can be confident it will get done, but we can never really be certain, and it makes tax planning needlessly complicated.

So why does Congress go through this song and dance every few years? It’s simple really: when the national budget is determined, any tax provisions that are set to “expire” at the beginning of the year are left out, typically yielding a much smaller budget deficit than what would otherwise appear. I wish I were making that up.  

Luckily, Montana Senator Max Baucus is taking up our cause, calling for a long-term solution that would end the uncertainty caused by the frequent renewal required for more than 50 tax provisions.

Until that day comes however, we’re left doing the annual year-end will-they-or-won’t-they bit. As for this year, according to MSNBC, our best chance at seeing expired provisions — including the R&D creidt — extended in the near future is if Congress is willing to tack the extenders package onto the proposed extension of the payroll tax cut, which is set to expire at the end of February.

Whether it happens remains to be seen, but in the interim, it can be awfully awkward extolling the virtues of an R&D study to a client when the statute permitting the credit technically no longer exists.

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When it comes to conjuring badass imagery, international airspace will always live in the shadow of its cousin, international waters. To wit:

International airspace = miniature bags of Rold Gold pretzels and insufferable Sandra Bullock films.

International waters = pirate ships and legalized monkey knife-fights.

Winner: International waters.

Both areas, however, are equally troublesome to the tax law. Consider the case of Andrea Ready (Ready). Ready was a dual citizen of the U.S. and U.K. who resided in France. Ready was employed as a flight attendant for United, where she regularly worked international flights.

On her 2006 and 2007 U.S. tax returns, Ready properly reported her wages earned from United.[i] Attached to each return, however, was From 2555-EZ, Foreign Earned Income Exclusion, claiming that all of Ready’s wages during those years represented foreign earned income excludable from gross income under I.R.C. § 911.

By way of background, I.R.C. §  911(a) permits a qualifying individual to elect to exclude “foreign earned income” from taxable income. Foreign earned income is defined as income received by a qualifying individual from sources within a foreign country which constitutes earned income attributable to services performed.[ii] Earned income is from sources within a foreign country only if it is attributable to services performed by the individual within a foreign country or countries.”[iii].

The IRS argued that the wages earned by Ready on flights in the U.S. and in international airspace did not constitute foreign earned income, as they were not earned in France or another foreign country, and thus were not eligible for exclusion from her taxable income.

While the Tax Court quickly agreed with the IRS with regards to Ready’s services performed within the U.S., the court had to dig a little deeper before reaching the conclusion that income earned in international airspace is not earned in a foreign country. Luckily, they’d already covered this seemingly obscure issue:

In Rogers v. Commissioner, T.C. Memo. 2009-111, 97 T.C.M. 1573, we concluded that income earned by a flight attendant while in international airspace was not foreign earned income and had to be included in the taxpayer’s gross income. The taxpayer in Rogers, like petitioner, was a U.S. citizen residing abroad and working as a flight attendant for United. In holding that the taxpayer in Rogers could not exclude income earned while in international airspace, we reasoned that income earned in international airspace was akin to income earned in international waters. We see no cause for disturbing our holding in Rogers, and we rely upon its reasoning to hold that petitioner may not exclude income earned in international airspace under section 911.

The lesson? There’s nothing new under the sun, or apparently, in the U.S. Tax Court.  

[i] Even though Ready was a resident of France, I.R.C. § 1 imposes an income tax on the taxable income of every individual who is a citizen of the United States, regardless of where they call home.

[ii] I.R.C. § 911(d)(1)(A).

[iii] Treas. Reg. §1.911-3(a).

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The awesomeness of the internet cannot be overstated. It’s not just a place for admiring vintage pornography and slandering people anonymously, it’s also a place where we can go to engage in wild speculation about topics on which we have little to no information. It’s a beautiful thing: we can make baseless predictions on whether Peyton Manning will retire,  pontificate on whether Sarah Palin’s had some work done, or devote a poll to questioning Daniel Tosh’s sexuality, and do it all without fear of reprisal.  

Such is the foundation for this Wall Street Journal article, which attempts to take the sting out of the political firestorm surrounding Mitt Romney’s much-publicized 13.9% effective tax rate for 2010 by using Romney’s 2010 tax return to “back into” an estimated effective rate for 2009 of 19%; a rate that would likely be more palatable to the American voter.

In fairness, the analysis in the article is well thought-out, and probably pretty darn accurate. Unfortunately, that doesn’t make the task of guessing someone’s effective tax rate any less an exercise in futility.

Their theory goes like this:

  • On their 2010 return, the Romney’s made estimated payments totaling only $1,369,000 before $3,250,000 was paid with extension. Since no underpayment of estimated tax penalty was assessed under I.R.C. § 6654 upon the filing of the return, the estimated payments were enough to “safe harbor” the Romney’s 2010 estimated tax based on 110% of their 2009 tax. This would put their 2009 tax liability at $1,240,000.
  • In 2010, the Romney’s $17,000,000 of capital gains were partially offset by a $5,000,000 capital loss carryforward. This would mean that the Romney’s had no net capital gain in 2009, but rather a $3,000 capital loss, the maximum allowable under I.R.C. §  1211.
  • Removing the capital gain from the Romney’s 2010 return and assuming items like interest, dividends, and speaking fees remained relatively constant from 2009 to 2010,  the article puts their 2009 AGI at approximately $6,500,000.
  • Dividing the federal tax bill of $1,2400,000 by the assumed AGI of $6,500,000, the article concludes that the Romney’s effective rate in 2009 was 19%, a much more reasonable number for a man of such prodigious wealth.

The shortcoming of the article is not in its methodology, but rather in the meaningfulness of its conclusion. What is to be accomplished by pegging Romney’s tax rate at 19%? Truth be told, Romney’s widely reported 2010 effective rate of 13.9% isn’t even particularly meaningful – since it fails to take into consideration the corporate level tax paid by many of Romney’s investments, making his real effective rate likely considerably higher — so why go through the exercise of guessing at Romney’s 2009 rate?

To illustrate, what if Romney’s 2009 AGI was $8,000,000 or $5,000,000 rather than the $6,400,000 posited in the article, a totally reasonable margin for error. This would put Romney’s effective rate at 15.5% or 23% rather than 19%. Would it matter? It’s hard to imagine a  4% reduction in a tax someone paid three years ago costing them votes, just as its equally unlikely that a 4% increase in the same tax rate would calm concerns of financial inequity. 

From my perspective, investing this much guesswork in Romney’s 2009 tax picture can only reinforce two things we should have already known: 

1. Romney’s effective tax rate — like most Americans — varies from year to year.

2.  The stock market really, really tanked in 2008 and 2009 for a private equity kingpin like Mitt Romney to have a net capital loss.  

Perhaps this comment left on the Wall Street Journal website reacting to the article said it best, and using much more modern vernacular to boot:

“OMG, who cares…..”

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While Eli and the gang ready themselves for Sunday’s game, team ownership is preparing to fight it out in court over a $1,500,000 property tax bill East Rutherford says the team owes.

At the root of the issue is whether the team’s new training facility — which was built with private funds as part of the construction of Met Life Stadium — should enjoy the same tax-exempt status as the old state-owned Giants Stadium.

The team argues that the current training facility is grandfathered under the previous, tax-exempt arrangement:

“The new stadium replaced the old stadium. The Giants had a practice facility here and offices here. Now they have a practice facility and offices. Nothing has changed.”

From the county’s perspective, however, the Giants gave up the right to its property tax exemption when it borrowed $650,000 of private money to construct its current facility. As Mayor James Cassella put it,  “It’s an office building…Why should someone who owns an office building, built by a private company, not pay taxes?”

Of course, if the Giants have too much pride to lay down on Sunday, they could also try and cover their tax bill by laying $150 bucks at 10,000 to 1 that they’ll win by more than 29 but less then 33 points. It could happen, right?  Right????

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Managing the tax law is no different than installing hardwood, baking a casserole[i], or concocting an email that bilks the unwary by posing as the deposed prince of Nigeria: the devil is in the details. 

Take, for example, the case of Francis[ii] and Maureen Foster.[iii] A well-intentioned couple, they believed they had met the statutory requirements of a straight-forward tax provision, but by mishandling some subtle non-tax housekeeping, they cost themselves $8,000.  

In February 2006, the Foster’s put their home of 30 years on the market, though the property didn’t sell until June of 2007. During the 16 months between the initial listing and the subsequent sale, the Foster’s made several damaging administrative missteps:

  • They moved in with Mrs.. Foster’s parents, but failed to pay rent or any portion of the utilities.    
  • Mrs. Foster renewed her driver’s license at the old address, rather than at her parent’s address.
  • They used the old address on their 2005 tax return.  
  • During 2006 and 2007, the Fosters continued to visit the old home, where they maintained all utilities services, requently stayed overnight, and received mail.
  • On a 2007 rental application, the Foster’s again listed the address of the old home as their primary residence.

In July 2009, the Foster’s purchased a new home and claimed the $8,000 first-time homebuyer’s credit on their tax return. The IRS disallowed the credit in full, arguing that the Foster’s failed to qualify as first-time homebuyers.

The Service based its position on  I.R.C. § 36(c)(1), which defines a “first-time homebuyer” as any individual having no present ownership interest in a principal residence for three years prior to the date of purchase of a principal residence. The IRS argued that since the Foster’s hadn’t sold their previous primary residence until June 2007, a date only 2 years prior to the purchase of the new home, they failed to qualify for the credit.

The Fosters, to the contrary, argued that the ceased using the old home as a principal residence in February 2006 when they listed it for sale, and thus qualified for the credit as three years had passed prior to their purchase of the new home.

The Tax Court sided with the IRS, citing the damaging facts and circumstances bulleted above as evidence that the Foster’s continued to use their old home as their primary residence even after they moved out and until it was sold in 2007.

The takeaway lesson, quite obviously, is that paying attention to detail could have preserved the credit for the Fosters. Had they taken the steps necessary to distance themselves from their old home — by paying rent to Mrs. Foster’s parents, switching the address used for their licenses, tax returns, mail service, and rental applications to their temporary home and by cutting off any non-essential utilities and ceasing visitation at their old home  —  the Foster’s would likely be $8,000 wealthier today.

[i] Or so I’m told.

[ii] Note, the court did not indicate whether Francis Foster preferred to be called “Psycho.”

[iii] Foster v. Commissioner, 138 T.C. 4 (1.30.12)

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On Wednesday, we posted a quick tutorial on how to determine the deductible amount of mortgage interest when total mortgage debt exceeds the statutory limits. While we briefly mentioned that any interest in excess of the allowable amount was subject to the interest tracing rules, we failed to expand further on this concept.

Lucky for us, on Thursday the Tax Court explained the interest tracing principles beautifully, providing a ready-made supplement to our previous post.[i] 

Robert Brooks (Brooks) worked for Dain Rauscher (Dain) as a stock broker. As part of his compensation, Dain lent him more than $500,000, which Brooks promised to repay, including accrued interest. Dain, however, promised to forgive the loan, including the accrued interest, if Brooks remained a Dain employee.[ii]

In 2003 Dain forgave the entire loan and included $650,342 ($506,300 in principal and $144,042 of accrued interest) on Brooks’ 2003 Form W-2. Brooks recognized the income on his 2003 tax return, but upon a subsequent IRS audit, he changed his position and argued that the accrued interest of $144,042 should not have been included in income.

The basis for Brooks’ argument lay in I.R.C. § 108(e)(2). In general, I.R.C. § 61 requires all cancellation of indebtedness (COD)income — including cancellation of any accrued but unpaid interest — to be included in income of the debtor. An exception to this general rule is found in I.R.C. § 108(e)(2), however, which provides that a debtor will not realize COD income to the extent payment of the liability would’ve given rise to a deduction.

Thus, the determination of whether Brooks could exclude the forgiven interest depends entirely on whether it would have been deductible on Brooks 2003 tax return had he actually paid it: if it would have been, Brooks could exclude the income; if it would not have been deductible, then the forgiven interest must be included in Brooks’ taxable income.

To determine the deductibility of the interest, the interest tracing rules must be applied. These rules generally allocate interest expense based on the use of the debt proceeds. Stated in another manner, Brooks was required to prove what the money borrowed from Dain was used for; if it was used in a trade or business, to generate investment income, or for the production of income under I.R.C. § 212; the underlying interest would be deductible as business interest, investment interest, or I.R.C. § 212 interest, respectively. To the contrary,if the proceeds were used for personal purposes, any interest would be non-deductible personal interest.[iii]

Brooks argued that the loan proceeds were used to purchase shares of stock, and thus the underlying interest should be deductible as investment interest. The Tax Court disagreed, for two reasons:

1. Brooks did not provide adequate support for how the borrowed funds were used. The only proof he provided was to point to the long list of stock transactions he attached to his 2003 return, which the court held was not sufficient to “trace” the use of the funds.[iv]

2. Even if the use of the funds could be traced to the purchase of stock, the interest would be investment interest, which is subject to limitation. Investment interest is only deductible to the extent a taxpayer has “net investment income,” defined as investment income less related expenses. Because Brooks had no net investment income in 2003, no investment interest would have been deductible by Brooks even if paid in 2003. Since payment of the interest would not have given rise to a deduction, I.R.C. § 108(e)(2) would not apply, and Brooks would be required to include the forgiven interest in income.

[i] Brooks v. Commissioner, T.C. Memo 2012-25.

[ii] The real issue here, as recognized by the Tax Court, was whether the loan should have been treated as compensation to income to Brooks when it was made in 1998. Since neither parties argued that the loan proceeds were compensation in 1998, the Tax Court “looked the other way” on the matter.

[iii] I.R.C. § 163(h)(1).

[iv] Brooks should have presented bank account statements and brokerage account records to show the flow of funds from Dain to Brooks to the purchase of stock.

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Here at Double Taxation, we tend to highlight the lighter side of the Tax Court, with topics ranging from the application of the hobby loss rules to drag racing to trophy wife-related theft losses to charitable contributions for crazy cat ladies.

But tax trials are serious business; and if you’d like to stay out of the court room, it’s helpful to know the most frequently litigated issues.  To that end, the IRS Taxpayer Advocate’s annual report has you covered:

Most Frequently Litigated Tax Issues: June 1, 2010 – May 31, 2011
1. Summons Enforcement 132
2. Trade or Business Expenses 107
3. Collection Due Process 89
4. Failure to File and Estimated Tax Penalties 74
5. Gross income 62
6. Accuracy Related Penalties 55
7. Civil Actions to Enforce Federal Tax Liens or to Subject Property to Payment of Tax 48
8. Joint and Several Liability 44
9. Frivolous Issues Penalty 44
10. Charitable Deductions 27
1,045. Medical Expense Deductions for Visits to Prostitutes 1

So how does one leverage that information to increase their chances of a Tax Court victory? Dean Zerbe over at Forbes offers some advice:

Trade or business expenses.  For individuals the problem continues to be having good books and records to support the deduction of expenses – especially for travel and entertainment expenses.  

A number of cases in this area also get into the question of whether the taxpayer is deducting expenses (and claiming losses) for a legitimate “for profit” activity.  As a general rule, I’ve found the IRS takes a dim view of businesses that involve animals – horse training, cat raising, etc.  If you aren’t making a profit in your animal business, be ready for an IRS letter, particularly if you are claiming a loss from the activity and deducting as a business expense your subscription to “Cat Fancy” or “Horse and Hound” magazines, as well as the cost of kitty litter, oats, etc.  Don’t be surprised if the IRS deems your animal fancy a hobby.

Gross income – What counts as income.  Damage awards top the list here.  While payments due to physical injury or sickness are not subject to tax, other damage payments are (ex. payments for emotional distress).  The effort to avoid this issue should start by having a tax attorney involved with the final settlement agreement.  Always a big help if you ensure that a settlement makes clear what the payments are for.

Charitable Deductions.  This is a new one for the list of litigated issues.   Congress and the IRS have cracked hard on taxpayers taking an expansive view of the value of certain charitable deductions. If you think your Yugo that goes only in reverse is worth 20k as an antique – think again.  Good valuation is the key to success – and keeping your feet on the ground in what you claim especially in areas such as conservation easements.

Zerbe saves his best advice for last; recommending how to make nice with the IRS before things ever escalate to the point of litigation:

Of course the best way to win in court is never to end up there in the first place.  So if you’re audited, first, when the IRS is knocking on your door – this is not the time to be a spendthrift – get your tax professional involved early in the process as positioning is everything.  Second, listen closely and understand fully the IRS’ concerns. Third, provide the IRS documentation and legal support justifying your positions and addressing the IRS issues.  Fourth, exercise your rights for review at IRS appeals and mediation. Finally, I am a big believer that you need to be on offense when dealing with an IRS audit. 

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