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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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OK, perhaps I was a bit harsh yesterday when I compared life as a CPA to serving hard time. For fear that I may have dissuaded any impressionable readers from pursuing a potentially rewarding career in the field, allow me to highlight some of the advantages to becoming an accountant, starting with the undeniable fact that  — much like midget wrestlers and left-handed relief pitchers — accountants will always be in demand.    

If you don’t believe me, check out this list of the 6 Jobs to Watch in 2012,  on which accounting is firmly entrenched at #1. Take that, computer systems analysts!

Accountants are in especially high demand in April. But throughout the year, large firms require the assistance of public accountants to prepare, analyze, and verify financial documents. The Labor Department projects that more than 279,000 accounting positions will become available between 2008 and 2018.

As gratifying as that ranking may be, the accounting industry still has a bit of a “public perception” problem to overcome before it will ever be embraced for reasons other than its consistent demand. CPAs, it has long been my contention, are subject to more scorn and ridicule than any other profession in America, save for perhaps male nurses. We’re seen as Bob Cratchitt-types; complete with pale skin, thick glasses, and a healthy fear of our own shadow, conventional and tedious to the core, with the only thing less impressive than our sense of humor our aerobic capacity. While some may argue that this stereotype is too firmly entrenched in the collective conscience of the American public to ever be undone, I’d beg to differ.

As with most stereotypes, the one of the “geeky accountant” can be shattered simply through closer inspection. Throughout history, CPAs have run the gamut of the coolness meter. Consider these examples:

Clearly, being an accountant is not mutually exclusive with being a badass, regardless of popular opinion. There’s no reason you can’t crunch numbers, train for an Ironman, interpret the tax code, and lay down some hot licks on your guitar all in the same day. And while that race car driver gig you’ve always day-dreamed about might play better with the ladies, good luck finding a race car driver with a solid 401(k).

Of course, you could always just be a race car driver AND a CPA, like WS+B’s very own Rebecca Machinga:

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Yesterday was the unofficial start of “busy season” in the accounting world, which is every bit as depressing as it sounds. For the next few months we’ll be confined to our cubicles and deprived of sunlight and sound nutrition for days at a time; surviving only by adopting a singular focus on doing whatever it takes to make it until April 17th arrives to return our freedom. If busy season sounds a lot like a prison sentence, it’s because it is, only without all the free weights and shower shivvings.   

But if we’re gonna’ do it, we may as well do it right. To that end, throughout the next few months I’ll  touch on some commonly encountered tax compliance issues that are often misunderstood or misapplied. Today’s lesson: determining the deductible amount of mortgage interest when a taxpayer has total mortgage debt that exceeds the statutory limitations.

First, a primer on the limitations:

Since 1986, I.R.C. § 163(h)(3) has allowed a deduction for qualified residence interest for up to $1,000,000 of acquisition indebtedness and $100,000 of home equity indebtedness. Prior to amendment, the Code generally permitted a deduction for qualified residence interest on debt that did not exceed the basis of the residence and the cost of improvements.

Questions have surrounded the continued relevancy of temporary regulations that were issued prior to the 1986 amendments. The IRS recently answered these questions  — albeit 25 years late — in Chief Counsel Memo 201201017. The memo holds the following:

  • A taxpayer may use any reasonable method, including the exact method and simplified method provided for in the temporary regulations, to determine the amount deductible as qualified residence interest when total debt exceeds the statutory limitations.
  • Regardless of which method is used, a taxpayer may allocate any interest in excess of the limited amounts in accordance with the use of the proceeds under the interest tracing rules. Thus, if the excess proceeds are traced to use in a rental activity, the interest can be deducted on Schedule E; if they were used to purchase investments, the interest may be deductible on Sch. A as investment interest, and so on…

If those bullets make perfect sense to you, lovely. If not, read on, as a detailed explanation and illustration follows.

The Temporary Regulations

The outdated temporary regulations[i] provided two methods for determining a taxpayer’s qualified residence interest when debt exceeded the applicable limitation: the simplified method and the exact method. Citing the legislative history of I.R.C. § 163, the IRS held in CCM 201201017 that a taxpayer can also use any reasonable method to allocate debt in excess of the $1,100,000 limitation. An example of any reasonable method would be the method used in the worksheet found in Publication 936.

Simplified Method

Under the simplified method, interest on all debts is multiplied by the following fraction to determine the maximum deductible amount  :  $1,100,000/ the sum of the average balances of all secured debts.[ii]

To illustrate, assume you owned a home secured by the following debts: First mortgage: $900,000; Home equity line: $300,000; Second mortgage: $150,000.

Assume the home equity line was used for personal expenses and the second mortgage was used entirely in your rental real estate business. If the total interest expense on all three mortgages for 2011 was $80,000, using the simplified method the maximum amount of interest deductible on Schedule A as qualified residence interest would be: $80,000 * $1,100,000/$1,350,000 = $65,185.

Under the temporary regulations, if you used the simplified method you were required to treat interest on all excess debt as nondeductible personal interest. Thus, you would not be permitted to deduct any of the remaining interest in excess of the $65,185 computed above, even though the proceeds of the second mortgage were used in a rental activity. In perhaps the most important piece of CCM 20120107, however, the IRS ruled that a taxpayer using the simplified method can, in fact, apply the interest tracing rules to any interest expense in excess of the limited amount.

Exact Method

Under the exact method, the amount of qualified residence interest is determined on a debt-by-debt basis by comparing the applicable debt limit for the debt to the average balance of each debt. The applicable debt limit is an amount that is equal to the $1,000,000 limit on qualified residence debt reduced by the average balance of each debt that was previously secured by the qualified residence.

If the average balance of the debt does not exceed the limitation for that debt, all the interest on that debt is qualified residence interest. If the average balance of the debt exceeds the limitation, the amount of qualified residence interest is determined by multiplying the interest with respect to the debt by a fraction, the numerator of which is the applicable debt limit for that debt and the denominator of which is the average balance of the debt.

Applying the same facts as above, the applicable debt limit for the $900,000 first mortgage would be $1,000,000, and the entire interest expense related to the debt would be deductible. The applicable debt limit for the $250,000 debt would be $100,000 ($1,000,000 – $900,000), and 10/25 of the interest expense would be deductible as qualified residence interest. The interest on an additional $100,000 of the $250,000 debt would be deductible as home equity interest. Lastly, the applicable debt limit for the second mortgage of $150,000 would be $0, as the entire $1,000,000 limitation has been used.

Under the exact method, a taxpayer is also permitted to treat interest on debt that exceeds the limitations according to the use of the debt proceeds under the interest tracing rule. Thus, though the interest on the remaining home equity line of $50,000 would not be deductible — as it was used for personal expenses — the interest on the $150,000 second mortgage would be deductible as trade or business interest under the interest tracing rules.


[i] Treas. Reg. § Section 1.163-10T

[ii] Prior to the amendment, this numerator was the adjusted purchase price of the residence.

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Ed note: If you received an email earlier today, please disregard. I had a case of premature publication. It’s embarassing, but it happens, and I’m not ashamed to admit it.

In response to increased scrutiny regarding the effective tax rate paid on his substantial income, Republican Presidential candidate Mitt Romney released his tax returns late last night. Yours truly was given an opportunity to review the returns immediately upon their release for Bloomberg and provide comment. You can read that article here, but in the interest of keeping this blog self-contained, the most revealing items included in Romney’s 2010 individual tax return are discussed below:

  •  His real name is Willard? I’d go with Mitt, too.
  • Romney paid $3,000,000 of federal tax on $21,600,000 of gross income, for an effective rate of 13.9%. While this is sure to draw ire from the 99-percenters, it is 100% legal, and is largely attributable to two things:
  1. Romney’s $18,000,000 of alternative minimum taxable income (he paid a small amount of AMT)  consisted of $15,500,000 of income eligible for the preferential tax rate of 15%. In specific, $3.3M of Romney’s $4.7M of dividend income was eligible to be taxed at this lower rate, a break that was added to the Code with the Bush tax cuts. In the absence of the Bush legislation, Romney’s entire $4.7M of dividends would have been taxed at the maximum ordinary income rate, currently 35%. In addition, Romney’s also recognized $12.2M of long-term capital gains, which similarly benefitted from the Bush cuts. The gains are currently taxed at 15% rather than the 25 or 28 percent rates that existed previously.
  2. As expected, Romney benefits greatly from the current treatment of “carried interest” as provided for under administrative rulings issued by the IRS. In short, a carried interest is a partnership interest granted to a partner — typically a money manager in a private equity firm — in only the future profits of the partnership in exchange for managing the money of the private equity firm, choosing its investments, divestitures, etc… Under Rev. Procs. 93-27 and 2001-43, the granting of a pure profits interest is not a taxable event; thus, when Romney receives a profits interest in a private equity firm, it is not taxed as compensation (or capital gain), and the future income of the private equity partnership that is allocated to him — typically long-term capital gains — is eligible for the preferential 15% rates.

The reason carried interests have come under attack — particularly from the Obama administration — is obvious. On the surface, the amounts allocated to the managing partner certainly appear to be compensation for services; thus, according to critics, they should be taxed at ordinary income rates rather than capital gain. While this law may change in the future, it is important to note that Romney is completely correct in treating the amount of income allocated to him from his carried interests — $7,000,000 of the total $12,200,000 of capital gain according to his campaign — as LTCG rather than compensation.

  • Of Romney’s $3,000,000 of charitable contributions, half were made in cash to the Church of Latter Day Saints (which would appear to be part of Romney’s tithing requirement), and half made in stock to Romney’s private foundation, the Tyler Foundation.
  • How bad were things in 2009 if even Mitt Romney had a $4,000,000 capital loss carryforward to 2010?

All in all, there as nothing shocking about Romney’s tax returns. Yes he paid only 13.7% of his income to the IRS in federal tax, but such is life under the current tax regime when the overwhelming majority of your income is earned in the form of long-term capital gains and qualified dividends. Critics, however, are sure to focus on four things:

  1. The effective rate. Again, for right or wrong, Romney paid only 13.7% of his income in tax, but he did so legally and in total compliance with the current rules.
  2. The pure size of the numbers. Even for a Presidential candidate, $20M of AGI is a lof to income, which may not be particularly well received in this time of the Occupy Wall Street movement, cries of economic inequality, and other opening salvos of class warfare.
  3. Romney received a $1.6M tax refund in 2010. Now you and I know that tax refunds are purely a function of your tax liability compared to the estimated payments you’ve made, but the public is likely to find it hard to swallow that someone with $20M of income received a refund exponentially larger than most people’s income for the year. Again, it’s not the right reaction, but it’s likely to occur.
  4. Prior to the release of his returns, Romney admitted to a 15% effective rate, stating that he did generate some ordinary income from speaking fees, but “not much.” It turns out “not much” was in excess of $500,000, a sum most would be more than happy to accept for a few hours of speaking. This could position Romney as “out of touch” with the average American, an angle many of his critics and opponents may embrace.

Additional coverage:

The Washington Post

The NY Times

CBS News

Wall Street Journal

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From Reuters:  N.J. Governor Chris Christie would like to see all state income tax brackets cut by 10%.

Christie, saying that New Jersey competes with neighboring New York and Connecticut for jobs, noted that both states have raised income taxes on the wealthy. New York’s top rate is 8.82 percent and Connecticut’s highest rate is 6.7 percent, both below New Jersey’s current 8.97 percent rate.

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I’ve never been what one would call a skilled prognosticator. In the past year alone, I told anyone who would listen that Bin Laden would never be caught, Cam Newton would be a bust and the Kardashian-Humphries union would be a long and happy one, complete with a litter of vapid, talentless children. Wrong on all counts.

Unfortunately, as a CPA — and in light of the uncertain political and economic climate we find ourselves in — clients often look to me to foretell the changes that may impact their tax liabilities in the future, a role I’ve never been entirely comfortable with in light of my putrid track record.

While I may be loathe to predict this country’s tax future, luckily others aren’t so cowardly. Laura Saunders over at the Wall Street Journal recently asked some two dozen tax experts to predict what the tax rates will look like come 2013.

Of particular note:

  • The top individual tax rate will remain at 35%, though some experts see it climbing to 40%.
  • The long term capital gains rate will stay at 15%, with a few experts predicting a 20% rate.

Now, those predictions aren’t overly novel, but then again, what did you expect? CPAs are not risk-takers. 

Well, except for this group. They’re cleary nuts. Dance like that on the wrong subway car, and you’re just begging to get shivved.  

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From the estate and trust world comes this post from WS+B partner Hal Terr, who reminds us that estate tax returns are under heavy scrtunity, so record keeping and adequate substantiation of all expenses are a must.

When reading this case you can only imagine the presiding judge listening to the evidence and proclaiming in his best John McEnroe “You cannot be serious!”

The executrix was the mother of the decedent. When the decedent was injured in 1992 his mother took care of him; he lived in her house, she fed and clothed him and paid his bills. She did this, according to the facts of the case, “without expectation of repayment.” The expenses for his care were paid in cash and no records were kept substantiating the amounts paid.

When the son passed away in 2006, as executrix the mother gathered the information and provided it to her attorney for the preparation of the federal estate tax return, but kept no records of the work performed by her or her attorney.  As such, there was also no substantiation of the amounts paid for executor’s commissions or attorney fees.

The federal estate tax return contained (or failed to contain) the following items at issue:

  • Two life insurance policies, the ownership of which were disputed, were omitted from the return;
  • A note owned by the decedent was not included as an asset of the estate;
  • Deductions for executor commissions of $87,000 and attorney fees of $94,000 were reflected on the return;
  • A deduction was taken for a charitable contribution of $142,000; and
  • The estate reflected a debt of $175,000 owed to the mother by the decedent to repay her for the expenses she incurred in his care.

Life Insurance Policies

The executrix claimed that two life insurance policies were actually owned by her and not the decedent.  She claimed the record of the insurance companies was a mistake of the agent and produced copies of checks of the payments of premiums by her.   However, the executrix could not produce any documents concerning the ownership of the policy or testimony of the agent.  The Tax Court found the two life insurance policies were included in the taxable estate as it was more likely she paid the premiums on behalf of her son as she paid other expenses for him while he was alive.

Inclusion of the Note

The executrix argued that the note had no value since a January 2005 brokerage statement did not indicate a value and that the issuer “went broke”. The Tax Court found that although the value of the note was not readily ascertainable, it was unlikely that it was worthless since the company’s stock was valued at $19.05 per share.   As such, the note should have been included in the taxable estate for the face value of $10,000.

Estate Deductions

Under IRC Section 2053(a)(2), amounts deductible as administration expenses on the estate tax return are limited to those actually and necessarily incurred.   The Tax Court found that because the executrix had not substantiated the claimed deductions and had not maintained required records, the executrix had to prove the statutory notice issued by the IRS was incorrect. The Tax Court was not persuaded that the amounts claimed by the executrix for commissions or attorney’s fees were reasonable or that they had been actually and necessarily incurred.  

Charitable Contribution

Under IRC Section 2035, an estate is allowed a charitable contribution for amounts transferred to a qualified charitable organization if made during the decedent’s lifetime or by Will.   However, the decedent did not have a Will, and the amounts paid to charity were made after the son’s death.   As such, the Tax Court disallowed the charitable deduction.

Note Due to Mother

IRC Section 2053(a)(3) provides that a claim against an estate can be deducted if the claims “when founded on a promise or agreement were contracted bona fide and for an adequate and full consideration in money or money’s worth”. 

The mother claimed her son owed her $165,000 plus interest for the care she provided during his lifetime.   The mother did not keep records for the amounts she provided on the behalf of her son and in her testimony stated “I’m trying to get it from his estate” which suggested to the Tax Court the debt was not valid and enforceable during the son’s lifetime. The son had adequate investments in his brokerage account which suggested that the debt owed to his mother could have been paid if the son recognized the debt as valid. The Tax Court was not convinced the debt was real and did not allow the deduction.

What can be learned from this case:   The executrix was assisted by the attorney who had prepared the estate tax return but was not admitted to practice before the Tax Court.   It should go without saying that if one is due before the Tax Court, one should make sure their counsel is actually allowed to help.  As Sean Connery says in the movie “Untouchables”  you don’t bring a knife to a gunfight.

Given the increases in the federal estate exemption, fewer federal estate tax returns will be filed and those that are actually filed will be scrutinized.   As such, executors should make sure they have adequate documentation to support the assets and deductions claimed on the estate tax return in the event of examination.

FujishimaMemo.TCM.WPD

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