Wednesday, June 24, 2009

Long-term tax advice not "promotion" of tax shelters

Note taking while talking with your Federally Authorized Tax Practitioner (FATP) is still confidential, as long as your FATP is giving advice and not “promoting” a tax shelter.

In a case addressing the confidentiality of notes taken during meetings with a tax professional regarding the tax consequences of certain business transactions, the Tax Court recently decided that the limited privilege of Section 7525(b) of the Internal Revenue Code does not apply to personal notes because they are not written communications given to someone else:

“The notes were not communicated to anyone. Therefore, they do not constitute a written communication that can satisfy that element of the section 7525(b) exception. The FATP privilege accorded to the notes is not subject to the exception in section 7525(b.)”

However, the Tax Court decided that they were privileged anyway because they were not promotions of a tax shelter. The long time relationship between the FATP and the taxpayer weighed against the argument that the FATP was “promoting” a tax shelter and in favor of the argument that the FATP was providing tax privileged tax advice. Noting differences among District Courts in defining the meaning of the term “promotion” in section 7525(b), it turned to the legislative history for guidance. It noted that the conferees of the House and Senate committee stated:

“The Conferees do not understand the promotion of tax shelters to be part of the routine relationship between a tax practitioner and a client. Accordingly, the Conferees do not anticipate that the tax shelter limitation will adversely affect such routine relationships.”

Following this guideline, the Tax Court ruled that the communications from the FATP to his client remained privileged because they were not “promotion” of a tax shelter. The factors it noted were that the FATP:

“has had a long, close relationship with the Winn organization, preparing returns, assisting with tax planning when asked, answering questions when asked, and responding to notices and inquiries from Federal and State tax officials. His advice with respect to the partnership redemptions and associated transactions under review in these cases was furnished (as was similar advice with respect to similar transactions) as part of a long-standing, ongoing, and, hence, routine relationship with the Winn organization.”

Monday, June 22, 2009

Valuing a conservation easement

If you are in the mood to get a tax deduction for donating a conservation easement, (or any real estate for that matter) valuation is a substantial concern. The Tax Court just issued a decision that outlines in great detail how it looks at valuation in cases where there isn't comparable sales data:

Kiva Dunes Conservation v. Commissioner

It's a good look into how the Tax Court evaluates the valuation opinion of experts.

Tuesday, April 7, 2009

Lurking unfiled 941 returns?

Business owners who have employees should be filing their quarterly 941 returns in a timely fashion. Of course, they should be paying the tax withholding as well. Perhaps that goes without saying, but I’ve received a few calls lately regarding unfiled 941 returns from small businesses.

First off, the penalties for failing to file these returns are substantial. There is the failure-to-file penalty of 5% of the tax due for each month or part of the month it wasn’t reporting (up to 25% maximum). If you receive a penalty notice, you may be able to provide a reasonable cause, but reasonable cause is not the fact that you spent the money on something else (it’s called a “trust” fund for a reason).

The IRS can, and does, seize business assets, close bank accounts, and garnish accounts receivables to get what is owed.

Even more ominous is the 100% “Trust Fund Penalty”, which is applied to any “Responsible Person” such as owners, officers, or check-signers. This is personal liability, the corporate shield will not protect from the IRS’s collection activities.

Finally, of course, there is the potential for criminal prosecution for failure to file. Section 7203 of the Internal Revenue Code states:

Any person required under this title to pay any estimated tax or tax, or required by this title or by regulations made under authority thereof to make a return, keep any records, or supply any information, who willfully fails to pay such estimated tax or tax, make such return, keep such records, or supply such information, at the time or times required by law or regulations, shall, in addition to other penalties provided by law, be guilty of a misdemeanor and, upon conviction thereof, shall be fined not more than $25,000 ($100,000 in the case of a corporation), or imprisoned not more than 1 year, or both . . . .

Indeed the IRS takes failing to file the 941 return and failing to pay withholding tax to be a serious thing.

The simple advice: if you are cash-strapped, do not, under any circumstances, use employee withholdings for anything else but to pay the IRS. It is better, in the long run, to default on your rent or on your business loan than to default with the IRS.

And, if you haven’t filed, you should file the return as soon as possible to avoid the possibility of criminal prosecution. Consult with a tax professional soon so as to arrange with the IRS to an agreement to not prosecute and enter into a payment arrangement.

Friday, April 3, 2009

Policy Paper

I finally got around to getting my musings on the Morality of Taxation on the internet.

Monday, November 10, 2008

Section 382, tax breaks for bailed out banks, and changing tax law by memo

A remarkable Washington Post story on how long-standing tax policy was changed by administrative notice hit the wires last Sunday.

It’s not every day that a popular press story deals with an obscure section of the tax code. But these aren’t regular times. Amit R. Paley does a good job explaining how, in the heat of financial chaos and the clamoring to do something, a tax policy of some 22 years was quietly reversed by a mere memo published by the Treasury Department.

In a nutshell, Congress passed Section 382 in the 1980s to attack certain kinds of tax shelters. The code had allowed corporations to buy companies that had a “net operating loss” or “built in loss” and then apply that loss to their books to reduce taxable income. The loss companies had no real value except for the tax benefit. Section 382 drastically limited the types and amounts of loss that the buying company could write off.

Although many business-oriented economists and tax policy experts (certainly not all) argued that the rule was too heavy-handed, Congress steadfastly refused to change it. This is consistent with Congress’s general power to set tax and fiscal policy.

Until Treasury, in the heat of the financial meltdown, decided to do away with it by an administrative notice.

The notice essentially does away with the limitations for institutions that participate in the “Capital Purchase Program (CPP) implemented by Treasury under the authority of the “Emergency Economic Stabilization Act of 2008 (aka Bailout Bill). The idea was to ease the tax consequences of bank mergers. The Washington Post article points out:

The Treasury notice suddenly made it much more attractive to acquire distressed banks, and Wells Fargo, which had been an earlier suitor for Wachovia, made a new and ultimately successful play to take it over.

But, apparently, Congress was surprised and not happy about what has come to be called “the Wells Fargo Ruling.” According to the article, estimates of the hit to federal revenue range from $105 billion to $140 billion.

Some commentators are very surprised as well. From the article:

"Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no," said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. "They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks."

Reading the Notice, I can see why he said this. It is only 2 ½ pages long. The memo is written in technical terms that are incomprehensible to anyone not familiar with the operations of Section 382. However, under the “Background” header is a paragraph that insouciantly states the authority for the action:

Section 101(c)(5) of the Act provides that the Secretary is authorized to issue such regulations and other guidance as may be necessary or appropriate to carry out the purposes of the Act. Section 382(m) of the Code provides that the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of sections 382 and 383.

Parse that a little. The first sentence says that “the Act” (aka Bailout Bill) gives the Treasury Secretary authority to issue regulations for the purpose of carrying out “the Act” (aka Bailout Bill). OK, nothing very controversial about that.

The next sentence says something similar about Section 382 of “the Code” (in Treasury lingo, this means the “Tax Code”). The Treasury Secretary is authorized to issue regulations “to carry out the purposes of section 382. . . .”

The problem is obvious. The “purposes of section 382” has nothing to do with the Bailout Bill. The purpose of 382 is to stop a certain kind of tax shelter.

And, as far as I know, the Bailout Bill did not grant the Treasury Secretary authority to amend the Tax Code. The Bailout Bill did deal with the tax code in three separate areas: capital gains, executive compensation, and help for homeowners. It does not give the Treasury Secretary authority to amend the Tax Code. (The Bailout Bill is a mere 451 pages long, maybe you can find something in there I have missed, but I doubt it.)

Yet the Secretary of Treasury did amend the tax code because, apparently, it seemed like a good idea. Certainly the merging banks are getting a huge break. And maybe it is a good idea, but this sort of sweeping change to tax policy, under cover of administrative ruling and in the heat of confusion, is decidedly unusual and ominous.

BTW, don't expect this change in the law to benefit any small companies that might want to buy out other struggling companies. It's only for the big kids, the "too big to fail finance companies," who have been able to sell their smoldering and nearly worthless instruments to the government.

Monday, November 3, 2008

Tax Plans are not patentable

One of the weirder discussions in the tax world has been the question of whether a fancy tax plan, devised by lawyers and accountants, could be patentable. Stories abounded regarding whether such authors (inventors?) could sue other practitioners for patent infringement for using similar strategies. It was all potentially lucrative for those holding patent rights.

The idea was based on a view that certain business ideas are patentable. However, that view has taken a serious hit in the Federal Circuit Court of Appeals.

As background, 35 U.S.C. 101 states that a "new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof" are patentable. The Supreme Court has held that the scope of the statute is very broad, but that "laws of nature, natural phenomena, and abstract ideas" are not patentable.

However, in 1998, State Street Bank & Trust Co. v. Signature Financial Group, Inc. 149 F.3d 1369, opened the door to allowing the patenting of business processes. This led to the idea that tax planning processes could be patentable as well.

But State Street has been overruled. In the Bilski case, just decided, the Court of Appeals held that a method of hedging risk in the field of commodities trading is not patentable. In essence, the method was too abstract:

We hold that the Applicants' process as claimed does not transform any article to a different state or thing. Purported transformations or manipulations simply of public or private legal obligations or relationships, business risks, or other such abstractions cannot meet the test because they are not physical objects or substances, and they are not representative of physical objects or substances.

This language seems to effectively prevent any sort of legal strategy from being patented.