Posts Tagged ‘Net Investment Income Tax’

Tax Court decision cuts 3.8% Obamacare Net Investment Income Tax for many trusts.

Friday, March 28th, 2014 by Joe Kristan

20120511-2The Tax Court reduced 2013 income taxes for a lot of trusts yesterday.  The court ruled that trustees can “materially participate” in rental real estate activities, and by extension in other activities.  If a taxpayer “materially participates” in an activity, it is not subject to the Obamacare 3.8% “Net investment Income Tax” on that activity’s income.

This is a big deal for trusts because they are subject to this tax at a very low income level — starting at $11,950 in 2013.  The IRS has said that it considers it nearly impossible for trusts to materially participate.  Yesterday’s decision flatly rejects the IRS approach.

The IRS had stated its position in a ruling involving an “Electing Small Business Trust,” which is a type of trust that can hold interests in S corporations — and which tend to get hit hard by the NII tax.  The IRS said that a president of the corporation who was also a trustee of the ESBT was participating in the business not “as trustee,” but as a corporation employee — and therefore the trust didn’t materially participate.  The Tax Court disagreed with IRS thinking yesterday:

The IRS argues that because Paul V. Aragona and Frank S. Aragona had minority ownership interests in all of the entities through which the trust operated real-estate holding and real-estate development projects and because they had minority interests in some of the entities through which the trust operated its rental real-estate business, some of these two trustees’ efforts in managing the jointly held entities are attributable to their personal portions of the businesses, not the trust’s portion. Despite two of the trustees’ holding ownership interests, we are convinced that the trust materially participated in the trust’s real-estate operations. First, Frank S. and Paul V. Aragona’s combined ownership interest in each entity was not a majority interest — for no entity did their combined ownership interest exceed 50%. Second, Frank S. and Paul V. Aragona’s combined ownership interest in each entity was never greater than the trust’s ownership interest. Third, Frank S. and Paul V. Aragona’s interests as owners were generally compatible with the trust’s goals — they and the trust wanted the jointly held enterprises to succeed. Fourth, Frank S. and Paul V. Aragona were involved in managing the day-to-day operations of the trust’s various real-estate businesses.

That would seem to put to rest the IRS “as trustees” catch-22.

The Tax Court decision doesn’t make the NII go away for all trusts.  Trusts with only “investment” income, like interest and dividends, are not helped by this decision.  Also, the decision by its terms only covers situations in which the trustee is materially participating in the trust activity; “We need not and do not decide whether the activities of the trust’s non-trustee employees should be disregarded.”  In this respect the Tax Court doesn’t go as far as a Texas U.S. District Court did it the Mattie Carter Trust case, which counted participation of trust employees in determining whether the trust materially participated in an activity.

Still, even with limitations, the case is a big taxpayer win.  It will especially help ESBTs avoid tax on operating income from S corporations when a trustee is also a corporation employee.  Also, while the case doesn’t say that non-trustee employees can give trusts material participation, it doesn’t rule it out, either.  That means bold trusts with employees that manage trust operations may be able to avoid the 3.8% tax, should the Tax Court adopt the Mattie Carter Trust approach.  Future litigation will have to settle the issue.  The IRS is also likely to appeal this case.

An aside: The IRS asserted its usual outrageously-routine 20% “accuracy-related” penalty — and it lost on its underlying argument.  In a just tax system, the IRS would have to write a check to the taxpayer for the amount of the asserted penalties whenever this happens.   The IRS assertion of penalties is far too routine, and should be reserved for cases in which the taxpayer is actually taking a flaky position, or doesn’t bother to substantiate deductions.  When it asserts a penalty and the taxpayer actually wins on the merits, the IRS loses nothing under current law.  Tax Analysts hosted a seminar yesterday on a Taxpayer Bill of Rights.  Any bill worthy of the name would have a “sauce for the gander” rule that would make the IRS — and even IRS employees — as liable as taxpayers are for flaky positions.

Cite:  Frank Aragona Trust et al. v. Commissioner; 142 T.C. No. 9

Related: Self-rental, business sales benefit from new Net Investment Income Tax regulations.

Also: Paul Neiffer, Taxpayer Victory in Frank Aragona Trust Case, on the implications for farm interests held in trust.

A summary of “material participation” rules is below the fold.

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Tax Roundup, 1/8/2014: Instructions for the Net Investment Income Tax! And new foreign account reporting rules.

Wednesday, January 8th, 2014 by Joe Kristan

20140108-1Almost four years after the passage of the Patient Protection and Affordable Care Act, the IRS has issued draft instructions for the act’s “Net Investment Income Tax” form, Form 8960 — which itself has only been issued as a draft so far.  With work already underway on many returns subject to this tax, especially trust returns, the timing is lame.  But this is one aspect of Obamacare that isn’t going to get punted, so we will have to go to war with the forms we have.

The draft instructions provide worksheets for some of the more baroque computations that will be needed to complete the form, including the net loss computation and the allocation of itemized deductions to net investment income.  Still, much of the work will have to be done off-the-forms on preparer worksheets applying the regulations.  Tony Nitti says:

That is my big takeaway from the instructions – there’s no faking it. When we saw that this new, complex area of the law would ultimately be computed on a one-page form, we anticipated that the meat of the computation would be done off-form in worksheets provided by the instructions. And that’s exactly what happened. But that shifts the onus back to us as tax advisors to make sure our inputs are correct, which means we must understand the nuances of the final regulations.

Based on my review of the instructions, it will be virtually impossible for a tax advisor to accurately compute, for example, the Net Gains and Losses worksheet without a solid understanding of the types of gains and losses the final regulations contemplate being included in and excluded from net investment income.

As with the rest of the ACA, what could possibly go wrong?

 

Russ Fox, FBAR Changes for 2014

First, Form TD F 90-22.1 is no more. The FBAR has a new form number, Form 114.

Second, as of last July the FBAR must be electronically filed. The good news is that as of last October, your tax accountant can file the form for you as long as you complete Form 114a.

Also, notes Russ, the filing requirement now kicks in when the balance of all foreign accounts together exceeds $10,000.  It used to be account-by-account.

 

William Perez offers Resources for Preparing Form 1099-MISC for Small Businesses

Kay Bell says it’s Time to get organized for your 2014 tax filing tasks

Paul Neiffer advises us to Decant a Trust – Not Wine.

 

David Brunori on the unwisdom of subjecting business inputs to sales tax:

Indeed, virtually every state tax commission that has studied this issue has concluded that business inputs should be exempt from tax. Why? When you tax business purchases, the tax becomes part of the cost of doing business, and companies try very hard to pass those costs on to consumers. Two bad things then happen. First, consumers unwittingly pay the tax in the form of higher prices. It is a hidden tax and a most cynical way of financing government. Second, consumers often pay sales tax on the tax embedded in the retail price of the goods they purchase. So we are actually taxing a tax. This “cascading” amounts to awful tax policy.

But, as David points out, that doesn’t stop the demagogues:

Several years ago, I had the opportunity to talk to a group of legislators about sales tax policy. I was asked if I had any ideas for reform. I mentioned the common ideas of broadening the base by taxing services and remote sales, and lowering rates. I also said that states should exempt business purchases from the sales tax. One legislator looked at me like I had three heads and asked, “Do you mean letting corporations off the hook for sales taxes?” He asked where the justice was in a system that would make poor working families pay sales tax but let multinational companies go free.

Not all that different from the Iowa Senate’s approach to income taxes.

 

Andrew Lundeen, The Top 1 Percent Pays More in Taxes than the Bottom 90 Percent (Tax Policy Blog):

An interesting piece of information from the chart below is that after the 01/03 Bush tax cuts, often claimed to be a tax cut for the rich, the tax burden of the top 1 percent actually increased significantly.

Top 1 pays more than bottom 90

No matter how much you jack up taxes on the “top 1%,” the same people always will say “the rich” aren’t paying “their fair share” and need to indulge in some “shared sacrifice.”

 

Howard Gleckman, Taxing Bitcoin (TaxVox)

What if bitcoin is a currency for tax purposes, the same as, say a euro? In that case, profits from sales would be taxed as ordinary income, with a top rate of 39.6 percent, though all losses could offset other income.

Either way, the mere act of buying something [with Bitcoins] would likely be a taxable event.

Tax Justice Blog, GE Just Lost a Tax Break – and Congress Will Probably Fix That.  That’s what fixers do.

Jack Townsend, Prosecuting the Banks: Does the U.S. Prefer Foreign Banks to U.S. Banks?

 

TaxProf, The IRS Scandal, Day 244

Programming note: I will be doing a tax update program sponsored by the Institute for Management Accountants over the Iowa Cable Network tomorrow evening at 6:00 p.m.  It’s a chance to get your continuing education for 2014 off to a roaring start.  I figure on talking about an hour, with an emphasis on the new Net Investment Income regulations and other 2013 changes we will see this filing season.  I’ll also cover some of the more interesting cases and rulings of the last year.

In case you were wondering, our friends at Going Concern explain How To Tell if Your Accounting Firm is Really a Car Wash

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Tax Roundup, 12/26/2013: Tax loss harvest time! And: people like you to give them money.

Thursday, December 26th, 2013 by Joe Kristan


harvest
Harvest those tax losses.  
Just as millions of disappointed gift recipients rush the retailers to improve on Santa today, investors can get busy over the next few days trying to make the best of their own disappointments.  They can cash out losses on disappointing investments to shelter their 2013 gains.  Some tips to make sure you do it right:

- You have to take the loss in a taxable account. A loss in an IRA or 401(k) plan doesn’t help you.

- Normally the “trade date” is the effective date for tax purposes, so you can sell a stock as late as December 31 this year and still deduct the loss on your 2009 1040.

- If you have a loss on a short sale, the tax law treats it as closing on the settlement date, not the trade date, so you can’t wait to the last minute to close a short sale to get a deduction.

- You don’t need to overdo it.  You can deduct your capital losses only to the extent of your capital gains, plus $3000.  But if you do overdo it, individual capital losses carry forward indefinitely.

- Harvesting losses helps taxpayers subject to the Obamacare/ACA Net Investment Income Tax to the extent it helps for regular taxes.

- Watch out for the wash sale rules. If you buy the same stock within the 30 days preceding or following the sale of a loss stock, your loss is disallowed. This is true even if you sell from a taxable account and buy in an IRA, according to the IRS.

Come back tomorrow for another 2013 year-end tax tip!

 

Paul Neiffer offers Some Quick Year-End Tax Tips

 

20120906-1Give away money and folks will line up.State tax credit program hits a big bump: It’s out of money, and that’s a good sign,”  reports the Des Moines Business Record:

Economic development officials in Des Moines and other Iowa cities have been told to stop sending requests for a state economic development tax credit. The reason: The fund is tapped out.

Greater Des Moines developers were told during a meeting last week with officials from the Iowa Economic Development Authority and the city of Des Moines that a tax credit program used to provide gap financing for multimillion-dollar developments has reached its $3 million annual cap on the ability to transfer the credits, a key element in financing the projects.

“Transferable” tax credits are actually subsidies. It is economically identical to giving the developers a license to factor the state’s receivables at a small discount.

Local developers, the Greater Des Moines Partnership, and state officials will press the Iowa Legislature to at least raise the $3 million cap and make adjustments that could eliminate the ranking system.

So people who want the state to give them more of our money and the state officials that give away our money want the legislature to make it easier to give away our money. What could go wrong?

 

Speaking of the people giving away our money,  State-owned Honey Creek Resort near Moravia continues to struggle financially.  (thegazette.com, via Gongol) What madness led the government to open a resort?  Maybe the same madness that makes people think the government should be allocating investment capital.

 

tf logoJoseph Henchman, Tax Foundation Wins State Tax Notes Honor, Third Year Running:

For three years running now, we have been honored as most influential in state tax policy by State Tax Notes (subscription req’d). This year, they present it as an unranked list of ten recipients. The list is five state officials, three lawyers, one legislator, and us…

Given the response of the Iowa legislature to my suggestions, I am sure that I rank among the ten least influential in state tax policy.  I wonder if there’s a prize for that?

 

Howard Gleckman,  TheTaxVox 2013 Lump of Coal Award: Wait ‘Til Next Year Edition.  He doesn’t think the Tea Party scandal was more than “merely bungling the job on a bipartisan basis.”  Given the overwhelming attention paid to the right, that’s an unsupported statement.   Mr. Gleckman is a man of the center-left; when it’s your opponents being targeted, it’s easier to conclude that it’s all fair.

 

Tony Nitti, Tax Geek Tuesday: When Structuring The Sale Of Your Business Goes Wrong   Tony addresses the related-party debacle of Fish v. Commissioner, where a Kansas City taxpayer generated $9 million in ordinary income when he thought he was going to have capital gains, because a partial cash-out of his business worked out to be a sale of goodwill to a related party.

Margaret Van Houten,  Do My Estate Planning Documents Need to Have Special Language to Deal with My Digital Assets?  (Davis Brown Tax Law Blog)

Russ Fox, Nominations Due for 2013 Tax Offender of the Year.  Sadly, Russ will have plenty of worthy candidates.

 

TreeTreetreetreetreePeter Reilly offers Kind Christmas Wishes To Those Behind Bars And The Tax Collectors Too  “So when you think treeabout it, you realize that one of the reasons that Jesus was born in Bethlehem was that Joseph and Mary were tax compliant.”

Kay Bell, The Christmas tax story

Jason Dinesen, Greatest Hits: Deducting Mileage from a Home Office   

TaxProf, World Giving Index 2013: U.S. Is #1

Me, What’s new in year-end tax planning, my new post at IowaBiz.com, the Des Moines Business Record’s Business Professionals’ Blog.

Career Corner. How to Choose Between Two Big 4 Offers When You Have No Clue What Either Involves (Going Concern)

 

TaxGrrrl, The True Cost Of Christmas: Santa’s Tax Bill:

Compensation is taxed to the elves as income – but Santa has taxes to pay on their behalf. Payroll taxes – at the employer contribution rate of 7.65% – for the elves work out to $1,890,927.

Santa doesn’t pay income taxes on compensation paid to the elves but he does have to manage their withholding according to any forms W-4 provided to him. Fortunately for Santa, there is no withholding requirement for state taxes in Alaska. 

I would argue the residency issue.  Technically, the North Pole is in the middle of the ocean, and I don’t believe there are territorial claims though.  Of course, with his fearsome legendary powers of retaliation, no IRS agent wanting to be on the “nice” list would mess with him.

 

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Self-rental, business sales benefit from new Net Investment Income Tax regulations.

Friday, December 6th, 2013 by Joe Kristan

The 3.8% Section 1411 Obamacare net investment income tax is absurdly complicated and poorly-designed to start with.  When the Treasury drafted their first set of proposed regulations, they seemed determined to make it even worse.  Taxpayer response was harsh, and the final rules put in place last week fix some of the worst problems in the original rules.

This tax applies to taxpayers with “modified” adjusted gross incomes over threshold levels of $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for other individuals.  It also applies to all top-bracket trusts.  It applies to “net investment income” to the lesser of Net Investment Income or the amount modified AGI exceeds the threshold.  It applies to all trust AGI over the top trust tax bracket amount.

Net Investment Income includes interest, dividend, capital gains, passive K-1 and other business income, royalties, non-qualified annuities, and rents.  It excludes non-passive K-1 income, wages, self-employment income, capital gains on the sale of a partnership or S corporation where the seller is non-passive, and “trade or business” rents for non-passive taxpayers.  A few highlights of the changes in the final regulations:

Self-rental.  The proposed regulations said that taxpayers who rent property to their non-passive trade or business have net investment income from the rents.  The final regulations say self-rental income from property rented to non-passive activities is not subject to the tax.

This is very helpful.  Under the old regulations, there would have been a big incentive for businesses that rent property from their owners to restructure so that they own the rental property.  This is no longer necessary.

Material Participation Rental.  The proposed regulations would have imposed the net investment tax on most rental activity income even where the taxpayer is “non-passive” on the rental.  They required taxpayers to demonstrate that their rental activity rose to the level of a “trade or business,” a vague standard, to avoid the tax.  The new regulations add a safe-harbor where taxpayers who work at least 500 hours in a rental activity are deemed to rise to the level of having a “trade or business.”

Sales of a business.  The proposed regulations required taxpayers selling even a small interest in a partnership or S corporation to identify the inherent gain or loss in each asset owned by the partnership or corporation to determine how much of the gain or loss on the sale was passive, and therefore subject to the tax.

They withdrew that proposal and issued a new proposed regulation that includes a safe-harbor that uses historic K-1 information to compute the portion of a gain of an S corporation or partnership interest to compute the “net investment income” portion.  Absent such a provision, compliance would have been impossible in many or most cases involving a sale of a minority interest.  They should add a de-minimus standard to avoid the computation altogether when non-passive amounts are a trivial portion of the K-1 income.

The tax should still be repealed.  It imposes a whole new fiendishly complex tax on a narrow subset of income.   It violates any standards of good tax policy.  But we have to live with it until Congress and the President come to their senses, and there is no sign of that happening.

Other coverage:

Tony Nitti:

The Definitive Questions And Answers On The New Net Investment Income Tax [Updated For Final Regulations]  

Final Net Investment Income Regulations: Self-Charged Interest, Net Operating Losses, And More

Final Net Investment Income Regulations: Losses From The Sale Of Property Become Much More Valuable 

Final Net Investment Income Regulations: IRS Grants Relief To Real Estate Professionals

 

Paul Neiffer:

Losses Can Offset Investment Income

More Good News on Calculating Invesment Gain

Final Net Investment Income Regs Have Good News For Farmers

(more…)

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Tax Roundup, 12/4/2013: Justice Scalia doesn’t believe in the Tax Fairy. And sure, the IRS can run another tax credit!

Wednesday, December 4th, 2013 by Joe Kristan

 

tax fairyThe Supreme Court wrapped a bow around the IRS victories in the turn-of-the-century tax shelter wars by unanimously ruling that the 40% “gross valuation misstatement” penalty applied to a tax understatement caused by the “COBRA” tax shelter.

COBRA relied on contributing long and short currency options to a partnership, but claiming basis for the long position, and ignoring the liability caused by the short position.  The shelter was cooked up in Paul Daugerdas’ tax shelter lab at now-defunct Jenkens & Gilchrist and marketed by Ernst & Young.  The shelter was designed to generate $43.7 million in tax losses for a cash investment of $3.2 million.

COBRA, like so many other shelters of the era,  was ruled a sham and the losses disallowed, but the Fifth Circuit Court of Appeals ruled that the 40% penalty did not apply.  Other circuits ruled that it did, so the Supreme Court took the case to settle the issue.

Writing for a unanimous court, Justice Scalia disposed of the Fifth Circuit’s position (citations omitted, my emphasis):

     In the alternative, Woods argues that any underpayment of tax in this case would be “attributable,” not to the misstatements of outside basis, but rather to the determination that the partnerships were shams — which he describes as an “independent legal ground.”  That is the rationale that the Fifth and Ninth Circuits have adopted for refusing to apply the valuation-misstatement penalty in cases like this, although both courts have voiced doubts about it.

We reject the argument’s premise: The economic substance determination and the basis misstatement are not “independent” of one another. This is not a case where a valuation misstatement is a mere side effect of a sham transaction. Rather, the overstatement of outside basis was the linchpin of the COBRA tax shelter and the mechanism by which Woods and McCombs sought to reduce their taxable income. As Judge Prado observed, in this type of tax shelter, “the basis misstatement and the transaction’s lack of economic substance are inextricably inter twined,” so “attributing the tax underpayment only to the artificiality of the transaction and not to the basis over valuation is making a false distinction.”  In short, the partners underpaid their taxes because they overstated their outside basis, and they overstated their outside basis because the partnerships were shams. We therefore have no difficulty concluding that any underpayment resulting from the COBRA tax shelter is attributable to the partners’ misrepresentation of outside basis (a valuation misstatement). 

tack shelterI see the basis-shifting shelters of the 1990s as elaborate incantations designed to to get the Tax Fairy to magically wish away tax liabilities.  Like any good witch doctor, the shelter designers relied on lots of elaborate hand-waving and dark magic to do their work, and they collected a lot of cash for their work.  But there is no Tax Fairy.  Justice Scalia has let Tax Fairy believers know that pursuing her is not just futile, but potentially very expensive.

 

Cite: United States v. Woods, Sup. Ct. No. 12-562.

The TaxProf has a roundup and an update.  Stephen Olsen weighs in at Procedurally Taxing.

 

 

Blue Book Blues.   One digression by Justice Scalia in Woods is worth a little extra attention.   From the opinion (citations omitted, my emphasis):

Woods contends, however, that a document known as the “Blue Book” compels a different result…Blue Books are prepared by the staff of the Joint Committee on Taxation as commentaries on recently passed tax laws. They are “written after passage of the legislation and therefore d[o] not inform the decisions of the members of Congress who vot[e] in favor of the [law].” While we have relied on similar documents in the past, …our more recent precedents disapprove of that practice. Of course the Blue Book, like a law review article, may be relevant to the extent it is persuasive.

Back in the early national firm days of my career, one of my bosses was a former national firm lobbyist who was exiled to The Field when a merger with another firm left room in Washington for only one lobbyist in the combined firm.  I remember him telling clients that he could get around unpleasantness in the tax code by arranging for helpful language in the Blue Book.  From what Justice Scalia says, he would have done as well by writing a law review article.

Jack Townsend also noticed this.

 

A new tax credit for the IRS to administer.  What could possibly go wrong?  A lot, as the IRS’s experience with the fraud-ridden refundable credits and ID-theft fraud has shown.  Now a new Treasury Inspector General’s report warns that IRS systems aren’t yet prepared to stop premium tax credit fraud under Obamacare, reports Tax Analysts ($link):

EITC error chart     While the IRS has existing practices to address ACA-related fraud, the agency’s approach is not part of an established fraud mitigation strategy for ACA systems, the report says. The IRS has two systems under development to lessen ACA tax refund fraud risk, but until those systems are completed and tested, “TIGTA remains concerned that the IRS’s existing fraud detection system may not be capable of identifying ACA refund fraud or schemes prior to the issuance of tax return refunds,” it says.

IRS Chief Technology Officer Terence Milholland said in a response included in the report that fraud prevention plans will be put in place as ACA systems are released.

The IRS loses $10 billion annually to Earned Income Tax Credit Fraud alone.  This isn’t reassuring.

 

Paul Neiffer, Losses Can Offset Investment Income:

  1. If you have a net capital loss for the year, the regular tax laws limit this loss to $3,000.  The final regulations allow this up to $3,000 loss to offset other investment income.
  2. If you have a passive loss such as Section 1231 losses, as long as that loss is allowed for regular income tax purposes, you will be allowed to offset that against other investment income.
  3. Finally, if you have a net operating loss carry forward that contains some amount of net investment losses, you will be allowed to use that portion of the NOL to offset other investment income.

A big improvement over the propsed regulations.

 

20120920-3Jason Dinesen,  Same-Sex Marriage, IRAs and After-Tax Basis:

It’s clear that for 2013 and going forward, couples in same-sex marriage will only need to apply “married person” rules to IRAs (and to everything else relating to their taxes).

What’s less clear is what happens with differences between federal and state basis for prior years.

 

Robert D. Flach,  A YEAR END TIP FOR MUTUAL FUND INVESTMENTS.  “If you want to purchase shares in a mutual fund during the fourth quarter of the year, wait until after the capital gain dividend has been issued, and the NAV has dropped, before purchasing the shares.”

 

Janet Novack,  Insurance Agent To Forbes 400 Concedes Understating Taxable Income By $50 Million

David Brunori, Indexing the State Income Tax Brackets Makes Sense (Tax Analysts Blog)

Missouri Rep Paul Curtman (R) wants to index his state’s income tax brackets to inflation. Of all the tax ideas presented this year, this is among the best. Missouri imposes its top rate of 6 percent on all incomes over $9,000. Nine grand was a lot of money in 1931 – and the top tax rate was aimed at the very wealthiest Missourians. But that threshold hasn’t changed since Herbert Hoover was president. 

Or they could just go with one flat rate.

 

TaxProf, The IRS Scandal, Day 209

William McBride, Summary of Baucus Discussion Draft to Reform International Business Taxation (Tax Policy Blog)

Kay Bell, Where do your residential property taxes rank nationally? 

Howard Gleckman,  The Supreme Court Opens The Door to Sales Tax Collections by Online Sellers (TaxVox)

They were too busy fighting the shelter wars to notice.  The Cold War Is Over, but No One Told the IRS  (Joseph Thorndike, Tax Analysts Blog)

Career Corner: A Friendly Reminder to Slobbering Drunks: Be Less Slobbery and Drunk at Your Company Holiday Party (Going Concern)

 

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Tax Roundup, 11/7/2013: Cold comfort on 3.8% Investment Income Tax guidance. And how big a penalty for not buying unavailable insurance?

Thursday, November 7th, 2013 by Joe Kristan

20121120-2Well, that’s reassuring.  Tax Analysts reports ($link) that David Kirk, an IRS official involved in drafting the final rules on the 3.8% Obamacare “Net Investment Income Tax” that took effect January 1, says the rules are still “in flux” with filing season only two months away:

     As for additional NII tax guidance, Kirk said the final regs will contain “overflow valves, breakers” that will allow the IRS to issue subregulatory guidance to address problems that arise, given that opening a new regulatory project “is a very painful and long process.”

“We’re just going to have to roll this out. We’re going to see how these rules work . . . and there’s always fine-tuning,” Kirk said. 

They’ve had over three years to do this, and now “we’re going to see how these rules work”?  Sounds like another recent Obamacare roll-out.  It makes me really excited about the upcoming filing season.

 

Roberton Williams,  How Big is the Penalty if You Don’t Get Health Insurance? (TaxVox)

The basic penalty is $95 in 2014—if you’re unmarried with no dependents and your income is less than $19,500. If your income is higher, you’ll owe more: 1 percent of the amount by which your income exceeds the sum of a single person’s personal exemption and standard deduction in the federal income tax. That’s $10,000 in 2013. But be warned: Income equals adjusted gross income (AGI—that number on the last line on page 1 of your tax return) plus any tax-exempt interest and excluded income earned abroad. If you make $30,000, your penalty will be $200.

Still with me? Good, because it is about to get more confusing.

If you like the penalty you have, you can keep the penalty you have.  Until next year, anyway.

 

Christopher BerginACA + IRS = Perfect Storm (Tax Analysts Blog)

And what lies ahead? The perfect storm: The IRS and the ACA brought together by a hapless Congress that tasked the nation’s tax collector with administering portions of our new healthcare system.

I can see a day coming when a taxpayer gets a letter from her insurance provider canceling her healthcare coverage and then a letter from the IRS informing her that she owes additional taxes under the ACA. Apparently our government thinks that two nightmare bureaucracies must be better for us than one.

You think this is about “us,” friend?

 

200px-Isleys-mrbiggs-eternal.jpg

Ron Isley is a lot better at music than he is at taxes.  He has served time on federal tax charges, and yesterday he lost a Tax Court bid to get his back taxes reduced under an “offer of compromise” he agreed to, but which the IRS rejected before it became final.  The ruling turns on a lot of technicalities involving the rules for accepting compromises in criminal tax cases.

The Tax Court decision wasn’t a total loss, in that they are allowing Mr. Isley to argue against tax levies and to pursue a compromise of his 2009 and 2010 taxes.

Cite: Isley, 141 TC No. 11.

Prior coverage here.

 

Jason Dinesen,  Life After DOMA: Watch Your Withholding 

Annette Nellen, Many tax questions on same-sex federal tax filings

William Perez, The Additional Medicare Tax, Part 4

Tony Nitti,  On Eve Of Twitter IPO, Misguided Senators (Again) Attack Tax Deduction For Stock Option Compensation  Exercising stock options convert corporation income taxed at 35% to individual income taxed at 40.5%, plus payroll taxes.  And yet the congresscritters act like this is some kind of loophole.

 

Russ Fox congratulates The Real Winners of the 2013 World Series of Poker.  It’s not the guys with the cards in their hands.

Now there’s a business plan!  BlackBerry Pins Recovery Hopes On Rumored $1 Billion In Tax Refunds  (TaxGrrrl)

 

potleafpotleafpotleaf20090722-2.jpgWouldn’t you? Colorado Voters Reject $1 Billion Income Tax Increase (Elizabeth Malm, Tax Policy Blog).

But other taxes…  Coloradans agree to a high tax to get high (Kay Bell)

Tax Justice Blog,  Tax Policy Roundup for the 2013 Election

 

 

 

Phil Hodgen’s Exit Tax Book, Chapter 8 – Taxation of Nongrantor Trust Interests

 

The Critical Question.  Is There One ‘Right’ Apportionment Formula? (Cara Griffith, Tax Analysts Blog): 

It could almost be a case in which one state adopted it on the grounds that it would create jobs and increase investment in the state. Then other states followed suit, not because single-sales-factor apportionment produced more accurate results, but because it was perceived as making a state’s tax laws more competitive or business friendly. But while single-sales-factor apportionment may benefit some businesses, it is far from being universally beneficial for taxpayers. In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining — or returning to — the three-factor apportionment method and focus on a less burdensome corporate tax system overall.

Iowa was the first state to adopt single-factor apportionment.  It applies to the highest tax rate in the nation, helping make Iowa’s corporation tax both onerous and useless.  A repeal of the corporation income tax would be the best way of making the corporation tax “less burdensome.”

 

Because they may one day make money?  Why Twitter May Have to Pay Income Taxes One Day (Victor Fleisher, via The TaxProf)

 

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Trusts and material participation: the IRS is just making it up.

Tuesday, April 30th, 2013 by Joe Kristan

20130430-1The Obamacare “Net Investment Income” tax hammers trusts.  The new 3.8% tax affects trusts with taxable income as low as xxx in 2013.  In contrast, it only affects single individuals with Adjusted Gross Income of at least $200,000, and joint filers starting at AGI of $250,000.

“Passive income” is one item subject to the tax.  This means most rental income and business income from pass-through entities, unless the trustee “materially participates” in the business.

The new tax piggybacks off of the old “passive loss” rules for determining whether income is passive.  If a taxpayer has business income or loss, it is passive unless the taxpayer “materially participates” in an activity.   When losses are “passive,” they are only deductible when there is other passive income to offset it, or when the passive business is sold.

So how does a trust participate?  A trust can’t punch a time clock, after all.  The IRS says in newly-released  TAM 201317010 that a trustee’s participation counts as the trust’s participation — and then only if the trustee participates as a trustee.

The TAM involves trusts that own an interest in an S corporation.  The trusts each had a main trustee and a “special trustee” who also happened to be president of the S corporation.  A corporate president normally has no trouble materially participating in corporate business, but the IRS said that wasn’t good enough (my emphasis):

As Special Trustee, A lacked the power to commit Trust A and Trust B to any course of action or control trust property beyond selling or voting the stock of Company X or Company Y. The work performed by A was as an employee of Company Y and not in A‘s role as a fiduciary of Trust A or Trust B and, therefore, does not count for purposes of determining whether Trust A and Trust B materially participated in the trade or business activities of Company X and Company Y under § 469(h).

I think the IRS is wrong here.  They are just making up this requirement that the trustee participate “as a fiduciary.”  If somebody is both a trustee and a corporate employee, how are they to divide the time?  This IRS requirement should be rejected, but it poses a compliance problem until and unless it is overturned.  It creates uncertainty and makes it more difficult for trust businesses to avoid the 3.8% tax.

The TAM also rejects one district court case that allows trustees to count participation of the “employees and agents” as trust participation.  I believe the IRS is correct on that point.

More coverage from Peter Reilly:  Tough IRS Position Means More Trusts Will Get Hit With New ObamaCare 3.8% Tax.    He says “I really have a hard time seeing how you will ever be able to get a trust to be considered to be materially participating in an S
corporation, if this is the logic that is followed.”

A summary of material participation requirements is below the fold.

(more…)

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Tax Roundup, April 29, 2013: Getting ready for the Obamacare Investment Income Tax. And a disturbing lack of faith in OVDI.

Monday, April 29th, 2013 by Joe Kristan

20121120-2Laura Saunders, Are You Ready for the New Investment Tax?, (Wall Street Journal, via The TaxProf):

The tax, which took effect Jan. 1, applies to the “net investment income” of married joint filers who have more than $250,000 of income (or $200,000 for singles). Only investment income—such as dividends, interest and capital gains—above the thresholds is taxed. The rate is a flat 3.8% in addition to other taxes owed.

“Affluent investors who ignore this tax will be in for a total shock next April 15,” says David Lifson, a certified public accountant specializing in tax at Crowe Horwath in New York. Such income is typically not subject to withholding, and people won’t be factoring it into their estimated taxes. Lower-bracket taxpayers who receive a windfall large enough to owe the tax will also be in for a surprise.

This tax is shockingly complex, and it will surprise a lot of taxpayers next April.

Related: Tony Nitti,  Overview Of The New 3.8% Investment Income Tax, Part 1

 

Feds sue over Des Moines utility tax (Des Moines Register).  Des Moines lost a long legal battle over its “utility tax” on electric bills.  Now the federal government is after the city:

Federal prosecutors acting on behalf of the U.S. Department of Veteran Affairs sued the city of Des Moines and Mid­American Energy Co. on Friday, alleging that the city’s longstanding surcharge on gas and electric customers in Des Moines constitutes an illegal tax when levied against Uncle Sam.

 

Trish McIntire,  W-2Gs and CP2000s:

When a taxpayer wins a jackpot, the casino gives them the W-2G for the win at that time. It’s up to the taxpayer to keep the W-2G safe and bring it into me, or their preparer, when their taxes are done. What happens to the W-2G? It gets shoved into a purse or pocket, thrown in the glove compartment or on the desk at home or thrown in the trash by accident.

Robert D. Flach,  THE MORTGAGE INTEREST DEDUCTION:

I support keeping the deduction for acquisition debt mortgage interest on one’s primary personal residence, and the deduction for real estate taxes on the same primary personal residence, not to encourage home ownership, but as a form of “geographical equalization”.

In other words, he wants to help out people who live in places where houses cost more.  I think that’s misguided, as it also encourages people who live in low-cost locales like Des Moines to build palaces with help from the taxman.

 

Russ Fox,  1700 Miles and a 7% Difference.  Joe Mauer of the Minnesota Twins tries to avoid Minnesota residency for low-tax Florida.  It went about as well as this season will for the Florida Marlins (or the Twins, for that matter).

 

Kay Bell,  Smokers are among the latest federal tax targets.  Transferring nicotine addiction from smokers to government.

Jana Luttenegger,  IRS Announces Furlough Days (Davis Brown Tax Law Blog).

Patrick Temple-West,  Obama talks budget with Republicans, and more (Tax Break)

Paul Neiffer,  Don’t Forget Your Retirement Plan.  “I was talking with a new farm client the other day about his estate plan and what struck me the most was not how much farm land value he had accumulated but rather the amount he had tucked away into his retirement plans.”

Peter Reilly,  Fifth Avenue Inspirational Shopping Not Doing Business. Dang.

 

Phil Hodgen,  Note to Concerned Immigrant:

Get some competent advice about how to handle the past years. If the advice is OVDI, then stand up and walk away, swearing the mightiest oaths that a drunken sailor could swear.

Perhaps the Offshore Voluntary Disclosure Initiative has somehow failed to gain the confidence of the tax bar?

Jack Townsend,  More on the GAO Report on IRS Offshore Disclosure Initiatives

 

Trust me, peasant, it’s for your own good.  Former GM Exec Bob Lutz Suggests Higher Gas Taxes Would Help Americans (TaxGrrrl)

The soft bigotry of low expectations.  The Pioneer Press Has Crowned Its Sexiest Accountant(s)  (Going Concern)

 Now he tells us.  Jailed tax cheat’s warning: Just ‘don’t do it’ (TBO.com)

 

 

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The 3.8% question: Is your rental property a “trade or business?”

Monday, January 28th, 2013 by Joe Kristan
Flickr image courtesy John Snape under Creative Commons license

Flickr image courtesy John Snape under Creative Commons license

The IRS isn’t saying.

It matters for real estate operators. The proposed regulations on the Obamacare “Net Investment Income Tax” impose the 3.8% levy on rental income, but not for “material participants” in a rental “trade or business.” Tax Analysts reports ($link) that IRS attorney David Kirk weasels out of saying what “trade or business” means:

“On one end of the [section 469(c)(7)] spectrum, you have the real estate pro that owns one-tenth of lower Manhattan and lives, breathes, and dies by occupancy, building up, renting out,” Kirk said, adding that that individual would be considered to be in the trade or business of renting real estate.

Kirk declined to say whether someone on the other end of the spectrum — the real estate broker who not only lists houses but also owns a couple of townhouses or condos — would be considered to be in the trade or business of renting real estate. “I’m not really comfortable coming out and saying what a trade or business is,” he said.

The term “trade or business” has been defined some under Section 108(a)(1)(D), which allows taxpayers to exclude debt cancellation income if the debt was on “trade or business” real property. The IRS discussed the issue in PLR 9840026 (some citations omitted):

The rental of even a single property may constitute a trade or business under various provisions of the Code. However, the ownership and rental of property does not always constitute a trade or business. The issue of whether the rental of property is a trade or business of a taxpayer is ultimately one of fact in which the scope of a taxpayer’s activities, either personally or through agents, in connection with the property, are so extensive as to rise to the stature of a trade or business. Bauer v. United States, 168 F. Supp. 539, 541 (Ct. Cl. 1958); Schwarcz v. Commissioner, 24 T.C. 733 (1955); See Higgins v. Commissioner, 312 U.S. 212 (1941) (management of taxpayer’s own investment portfolio not a business).

In Rev. Rul. 73-522, 1973-2 C.B. 226, the Service held that rental of real property under a “net lease” does not render the lessor engaged in a trade or business with respect to such property for purposes of section 871 of the Code

It was unwise to make “trade or business” status key to this tax; it makes it difficult for taxpayers to know whether it applies and it encourages taxpayers to be agressive. They should just say that if you achieve non-passive treatment as a real estate professional, you don’t pay the tax.

Related: Real Estate Professional Status – Becoming More Important – Very Hard To Prove (Peter Reilly)

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Tax Roundup, 1/11/2013: No, they aren’t paying attention. And it only gets harder.

Friday, January 11th, 2013 by Joe Kristan

20130113-3Don’t forgive them, because they have no idea what they’re doing.  Last night I taught a session on the Fiscal Cliff tax law and the Obamacare Net Investment Income tax to Iowa chapters of the Institute of Management Accountants over the Iowa Cable Network.  Using the controls to talk to remote classrooms in Marshalltown, Dubuque, Marion and Cedar Falls was a challenge, but a piece of cake compared to working with the tax law.

When they passed the Net Investment Income Tax as part of Obamacare, there were only two concerns for the guilty congresscritters:

- Did it apply only to “the rich,” as defined that day?  and

- Did it raise enough revenue for them to help them pretend that they weren’t raising the deficit?

Nobody who voted for the bill took the time to ask: “should we really set up an all-new tax, unlike anything we have ever done before, requiring all new regulations and recordkeeping requirements, just to collect 3.8% of something?”  And that’s exactly what they did.

If you have any illusions that they have any clue what they are doing, a look at the new bracket schedule for 2013 for single filers should cure you of that:

If taxable income is:                 The tax would be:
--------------------                  ----------
Not over $8,925                       10% of taxable income
Over $8,925 but not                   $892.50 plus 15% of the
  over $36,250                           excess over $8,925
Over $36,250 but not                  $4,991.25 plus 25% of the
  over $87,850                           excess over $36,250
Over $87,850 but not                  $17,891.25 plus 28% of the
  over $183,250                          excess over $87,850
Over $183,250 but not                 $44,603.25 plus 33% of the
  over $398,350                          excess over $183,250
Over $398,350 but not                 $115,586.25 plus 35% of the
  over $400,000                          excess over $398,350
Over $400,000                         $116,163.75 plus 39.6% of the
                                         excess over $400,000

Notice something funky about that 35% bracket?  It covers only $1,650.  While you have to earn $215,100 to get through the 33% bracket, you skip through 35% to 39.6% with only $1,650 of additional income.  Why?  Because the administration wanted to only tax “the rich,” and they decided for that day that “rich” starts at $400,000 income, if you are single.

The only sure cure is to make congresscritters, the President, and the Cabinet prepare their own returns in a live webcast, with a comment bar for viewers to mock them.  It would serve them right if they had to do it a la Robert Flach, with no computer.

 

TaxGrrrl,  Tax Code Hits Nearly 4 Million Words, Taxpayer Advocate Calls It Too Complicated:

What could you do with six billion hours?

Think hard. That’s the equivalent of 8,758 lifetimes. Yes, lifetimes.

It’s also how much time taxpayers spend every year trying to comply with tax filing requirements. That, according to the 2012 annual report as prepared by the National Taxpayer Advocate Nina E. Olson.

It’s not getting easier, either.

Martin Sullivan, Tax Reform Muddle (Tax.com):

Having agreed to tax increases, Republicans are now more insistent than ever that tax reform must be revenue neutral.

The big change is from Democrats– who have become so adamant on the need for tax increases in addition to the $600 billion raised by the fiscal cliff deal, and who realize additional rate hikes are absolutely impossible–are hell-bent on preserving the most politically feasible loophole closers for raising revenue.

It’s a hopeless game.  The deficit is too big to deal with by “loophole closers.”  Behind the push to raise taxes by closing loopholes is a delusion that you can pay for our incontinent government spending just by hitting “the rich” harder.  But the rich guy can’t cover the check.  Either spending comes down or everyone pays a lot more tax.

 

 

Nick Kasprak,  Chart: Effects of Marriage on Income and Payroll Tax Liability (Tax Policy Blog)

 20130111-2

 

Deborah Jacobs, A Married Couple’s Guide To Estate Planning (Forbes, via the TaxProf)

Paul Neiffer, Section 179 Can Create a Farm Loss (In Certain Cases)

Kay Bell,  Top taxpayer problem? Continuing tax code complexity

Christopher Bergin,  Permanent Insanity: “Only in Washington would you find folks who would brag that they did a good thing by making permanent an unfair and indecipherable tax system that wastes billions of dollars to administer.” (Tax.com)

Norton Francis, What the Fiscal Cliff Deal Means for the States (TaxVox):

The good news for states is that American Tax Relief Act of 2012 will  end much of the uncertainty that has plagued the income tax code in recent years. No longer will states have to guess what will happen to many provisions of the federal revenue code that were set to expire. The bad news is some states will lose revenue they were counting on from
scheduled changes in the federal estate tax that won’t happen.

Trish McIntire, Refund Loans

Patrick Temple-West,  Public goals, private interests in ‘Fix the Debt’ campaign, and more

Jack Townsend,  Bank Leumi Signals Cooperation with U.S. on Offshore Accounts.  Israili bank ready to spill the beans on U.S. taxpayers with accounts there.

A Friday Buzz from Robert D. Flach.

The Critical Question:  Shipping Wars’ Token Hot Chick Is a Former Accountant? (Going Concern)

 

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Tax Roundup, 12/6/12: Putting the “net” in investment income. And Bar time! Well, Bar Association school time…

Thursday, December 6th, 2012 by Joe Kristan

I speak this afternoon at the Iowa Bar Association Bloethe Tax SchoolI will be talking about “Affordable Healthcare Act for Pass Through Entities” at 3:40.  The newly-released proposed regulations on the 3.8% net investment income tax and the .9% Medicare tax will star.  If any Tax Update readers are there, please say hello if you get a chance.

 

Putting the “Net” in the net investment income tax.  The Obamacare 3.8% on “net investment income” for higher income taxpayers has a strange feature that is highlighted in the newly-released proposed regulations. The tax applies the tax to “Net” investment income to the extent it increases adjusted gross income — not taxable income — over $200,000 for single taxpayers or $250,000 for joint filers.  “Investment Income” for this tax is a new combination of interest, rents, royalties, non-qualified annuities, capital gains and “passive” business income, as from K-1s.

So what does “net” mean? The proposed rules (Proposed Regs. 1.1411-4(f)) say that you reduce income by deductions “allocable” to the investment income. That includes Schedule A deductions for investment expenses, to the extent they exceed the 2% of AGI floor.  It also includes state income taxes “allocable” to passive K-1 income and other “investment” income (cites removed for clarity):

 In the case of taxes that are deductible… and imposed on both gross income (including net gain)/..and gross income…  the portion of the deduction that is properly allocable… may be determined by taxpayers using any reasonable method. For purposes of the prior sentence, an allocation of the deduction based on the ratio of the amount of a taxpayer’s gross income (subject to the tax) to the amount of the taxpayer’s (total) gross income… is an example of a reasonable method.

So even if a taxpayer gets no benefit from a deduction because of alternative minimum tax, it reduces net investment income.  Nothing in the regulations incorporates AMT.  As long as an itemized deduction is allowed for regular tax, then it reduces investment income.  Taxpayers with AMT liability lose the benefit of their state income tax and miscellaneous deductions for most purposes, but not for this silly tax.

By the same token, if a deduction is disallowed for regular tax — by the 2% floor, the passive loss rules, etc. –it does not reduce net investment income. This makes the GOP proposal for a “cap” on itemized deductions that much worse.

 

Raise rates or limit deductions?  Republican Senator Tom Coburn says that he prefers tax rate increases to the deduction cap proposed by some Republicans.  From The Hill:

“Personally, I know we have to raise revenue; I don’t really care which way we do it,” Coburn said during an appearance on MSNBC. “Actually, I would rather see the rates go up than do it the other way, because it gives us greater chance to reform the tax code and broaden the base in the future.”

While I am a doubter of the “need” to raise revenue — we don’t need to do that if we would spend at not-insane levels — I agree that if you increase taxes, rate increases are the way to go.  It keeps the pain simple and honest.  The deduction cap would be much more disruptive to businesses, as owners of pass-through businesses would lose the deduction for much of their state income tax burden.  It would greatly complicate tax planning and have unpredictable consequences for business owners, charities and the housing market.  It would also be horrible to professional gamblers, whose below-the-line loss deductions would be capped, and to investors with substantial below-the-line investment interest expense.  And all just to pretend there is no tax increase.

Of course I have no faith at all that a GOP compromise on tax rates will lead to serious concessions on spending.  And the spending is the problem.

 

TaxGrrrl,  Key GOP Senator Says Yes To Higher Tax Rates In Compromise

Robert D. Flach is not impressed by our leaders:

The continued unmoveable hard line on “resolving” the “fiscal cliff” taken by the two sides is a clear indication that the idiots in Washington do not give a tinker’s damn about the American public.

He’s right.  It’s never been about us.  It’s about power.

Andrew Lundeen,   Fiscal Cliff: Capital Gains and Dividend Tax Increases Pose Greatest Threat to Economy (Tax Policy Blog)

Patrick Temple-West,   GOP in a difficult political spot in tax fight, and more (Tax Break)

 

Howard Gleckman,  How to Cut the Charitable Deduction Without Reducing Giving (TaxVox)

David Brunori,  Note to Everyone: Business Should Not Pay Sales Tax: (Tax.com)

Only bad things happen when businesses pay sales tax. First, the businesses paying the tax pass the burden on to their customers in the form of higher prices. But the tax is hidden. People do not know they are paying it. Politicians, and perhaps the New York Times, may like that lack of transparency, but it is awful government policy. Second, the higher priced products purchased by consumers are often subject to tax. This gives rise to a tax on a tax. That is awful tax policy.  Finally, taxation of business inputs artificially keeps sales tax rates low. People think the sales tax rate is lower than it actually is.  None of this is good.

It’s always best to not hide the taxes.

Cara Griffith,   New York Times Article Misses the Mark on San Francisco Tax Exemption (Tax.com)

Kay Bell,   Many companies paying dividends early; Be sure to plan for taxes on the income

Jana Luttenegger,  Last Minute Charitable Gifts.  (Davis Brown Tax Law Blog).  If they cap itemized deductions, many folks will wish they had given more this year.  This post has some good ideas.

Tax Trials,  Tax Court: No Penalties for Son of Boss Participants

Trish McIntire,   Education Credits Form Changes

I’m way ahead of the science.   Science Says You Should Have Multiple Large Monitors(Going Concern). Too much is almost enough.

My bare-bones workstation.

 

News you can use:  Timesheet Wars: Non-Billable Codes Are Orwellian Busywork (Going Concern)

 

 

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