Tax practice

More than two thirds of consumers participating in a survey by the National Retail Federation and CNN/Money expect to receive a tax refund this year -- and are ready to spend it. The NRF found that just one out seven respondents plans to wait until April to file this year, in anticipation of their refunds. The Internal Revenue Service reports that the average tax refund this year will be $2,259. Half of those expecting IRS largesse will use the refund to pay down debt, while others indicated that they plan to use part of their monies for such things as vacations or major purchases. In a gender breakdown, the NRF said that women were almost twice as likely as men to use portions of their refund for a major purchase.

The first study of taxpayer compliance since 1988 shows that the vast majority of American taxpayers pay their taxes on time and accurately, but that the nation still has a significant tax gap, according to the Internal Revenue Service. The National Research Program, launched in 2001, randomly selected about 46,000 returns for review and examination from 2001 to 2004. The return selection process included an oversampling of high-income returns to enable IRS researchers to draw valid conclusions about important sub-categories of taxpayers. The preliminary findings show that the gross tax gap -- the difference between what taxpayers should pay and what they actually pay on a timely basis -- exceeds $300 billion per year. IRS enforcement activities, coupled with late payments, recover about $55 billion of the tax gap, leaving a net tax gap of between $257 billion and $298 billion. The study found that underreporting of income is the largest component of the tax gap, accounting for more than 80 percent of the total, with non-filing and underpayment at about 10 percent each. Individual income tax is the single largest source of the annual tax gap, accounting for about two-thirds of the total. For individual underreporting, more than 80 percent comes from understated income, not overstated deductions, and most of the understated income comes from business activities, not wages or investment income. IRS Commissioner Mark W. Everson said that the study confirms two key points involving tax enforcement and simplification. "The IRS needs to enforce the law so that when Americans pay their taxes, they are confident that neighbors and business competitors are doing the same," Everson said. "At the same time, this research underscores [President George W. Bush's] call for tax reform. Complexity obscures understanding. Complexity in the tax code compromises both the service and enforcement missions of the IRS." "Those who try to follow the law but cannot understand their tax obligations may make inadvertent errors or ultimately throw up their hands and say, 'Why bother?' Meanwhile, individuals who seek to pay less than what they owe often hide behind the tax code's complexity in order to escape detection by the IRS and pay less than their fare share," Everson added.

A ruling by the Tax Court has underscored the way in which the alternative minimum tax penalizes holders of incentive stock options when the stock loses value after the option is exercised. Ronald Speltz thought that his employer was doing him a favor by issuing him ISOs to augment his salary, which was less than $100,000 a year. Instead, the ISOs triggered a tax nightmare when he exercised them before the tech bubble burst, leaving him with nearly worthless stock but with an unexpected tax bill of nearly $225,000. Although Speltz and his wife borrowed $134,000 to help pay state and federal taxes, and offered the cash value of his life insurance policy as a compromise for the remainder, the Internal Revenue Service rejected his offer. The Tax Court agreed. Even though the offer-in-compromise provisions include a compromise to promote effective tax administration -- explained by the regs to cover situations "where collection in full could be achieved but would cause economic hardship" -- the court found that the Speltz's had sufficient income to meet "basic living expenses" and therefore didn't qualify. The court said that it sympathized with the situation, but it is up to Congress, not the courts or the IRS, to come up with a solution.

More people have used Free File so far this year than for all of last year, according to the latest figures from the Internal Revenue Service. As of March 16, 3.55 million tax returns have gone through Free File, up 44 percent compared to the same time last year and exceeding last year's total of 3.51 million. Now in its third year, Free File is a partnership between the IRS and a consortium of tax software manufacturers. Electronic filing continues to surge, with e-filed returns running 7 percent ahead of last year. Of the 67 million returns filed as of March 18, 68 percent were e-filed. While this percentage will decline as April 15 approaches, the IRS said it expects that for the first time more than half of all individual tax returns will be electronically filed this year.

Taxpayers participating in "Son of Boss" tax shelter settlements have so far paid in more than $3.2 billion, a figure that should top $3.5 billion when the project concludes in the coming months, according to the Internal Revenue Service. Son of Boss, an offshoot of an earlier shelter called Boss ("bond and option sales strategy") was an abusive transaction aggressively marketed in the late 1990s and 2000 primarily to wealthy individuals. Both the Boss and Son of Boss shelters were structured using derivatives, noted Selva Ozelli, CPA, an international tax attorney with RIA. "Derivatives were used because of their uncertain tax treatment, limited financial statement disclosure and uncertainty regarding their valuation," she said. The settlement initiative required taxpayers to concede 100 percent of the claimed tax losses and pay a penalty of either 10 percent or 20 percent, unless they previous disclosed the transactions to the IRS. "This was a particularly bad shelter, and we're glad so many chose to get right with the government," said IRS Commissioner Mark W. Everson. "Despite the tough terms we offered, two-thirds of Son of Boss participants have come forward and paid up." Thus far, nearly 1,200 Son of Boss taxpayers have settled with the IRS. Typical settlements were about $1 million, while 18 taxpayers forked over $20 million apiece, and one paid a whopping $100 million. Based on disclosures that the IRS has received from promoter investigations and from investor lists from Justice Department litigation, the agency determined that over 1,800 people participated in Son of Boss. "For those who didn't come forward, we know who they are," Everson said. "We are going after them."

The IRS has released Rev. Proc. 2005-13, which details the limitations on depreciation deductions for owners of passenger automobiles first placed in service during calendar year 2005. Special tables of limitations on depreciation deductions are also provided for trucks and vans, and for passenger automobiles designed to be propelled primarily by electricity and built by an original equipment manufacturer (electric automobiles). In addition, the revenue procedure details the amounts to be included in income by lessees of passenger automobiles first leased during calendar year 2005, including a separate table of inclusion amounts for lessees of trucks and vans, and a separate table for lessees of electric automobiles.

The Internal Revenue Service has expanded the number of tax professionals who can use its suite of e-Services incentive products. Effective immediately, tax professionals who e-file any combination of five or more accepted individual and business tax returns in a calendar year can use these e-Services products: disclosure authorization, electronic account resolution and transcript delivery. These three products increase tax filing efficiency and save time and resources for tax practitioners. When launched in the summer of 2004, the e-Services incentive products were reserved for those who e-filed 100 or more individual returns. "These services make it easier for taxpayers to deal with the IRS and obtain information to help their clients," said IRS Commissioner Mark W. Everson. Other e-Services products available to all tax professionals include: e-Services registration, preparer tax identification numbers, IRS e-file applications, and taxpayer identification number matching.

"Where's My Refund?" -- the Internet-based service to check on federal income tax refunds -- now offers a way to trace refund checks and update flawed mailing addresses. The enhancements allow taxpayers to start a trace for lost or missing refund checks and notify the Internal Revenue Service of an address change when a refund check goes undelivered. "This new feature lets taxpayers take quick and easy steps to track down a lost refund," said IRS Commissioner Mark W. Everson. "It can reduce headaches for nearly 88,000 taxpayers who wind up with undelivered refund checks each year." Taxpayers securely access their personal refund information through www.irs.gov, and enter their Social Security number, filing status and the exact amount of their refund. These shared secrets -- data known only to the taxpayer and the IRS - verify that the person is authorized to access the account and make it possible to avoid delays in tracing refunds and changing an address.

The President's Advisory Panel on Federal Tax Reform will hold its fifth meeting on March 23 in New Orleans. The focus will be on additional perspectives about the fairness of the tax code and how the tax system affects families. The first panel will discuss, "What Is Fairness and How Can it Be Measured?" Panel members include Bob Greenstein, founder and executive director of the Center on Budget and Policy Priorities, and William W. Beach, director of the Center for Data Analysis of The Heritage Foundation. The topic for the second panel is "Low-Income Taxpayers." Its members include Hilary Hoynes, professor of economics at the University of California at Davis: Mark Moreau, co-director of Southeast Louisiana Legal Services; and David Marzahl, executive director of the Center for Economic Progress. The third panel, "Tax Treatment of Families," will include presentations by Eugene Steuerle, senior fellow at the Urban Institute; Mark Pauly, a professor at the Wharton School of the University of Pennsylvania; and James Alm, a professor at the Andrew Young School of Public Policy of Georgia State University.

The Internal Revenue Service has clarified in Rev. Rul. 2005-11 that interest paid on a loan that is refinanced more than once will retain its status as qualified housing interest, to the extent that the amount of the loan is not increased. That interest is deductible for alternative minimum tax purposes. Any other interest on amounts borrowed that are not used to acquire, construct or substantially improve any property that was a principal residence or qualified residence may not be deducted for AMT purposes, the service said. Revised instructions to Form 6251, which include a worksheet to help taxpayers determine the correct home mortgage interest adjustment, will be posted on the IRS Web site, www.irs.gov

Electronic filing continues to show a strong increase, with e-filed tax returns running more than 6 percent ahead of last year, according to the Internal Revenue Service. Out of 61 million returns filed as of March 11, 42.7 million, or nearly 70 percent, were e-filed -- up from 65 percent the previous year. While this percentage is expected decline as April 15 approaches, the IRS expects for the first time to have more than half of all individual tax returns filed electronically. Out of tax returns e-filed so far, the biggest increase is among those who prepare their own returns on a home computer -- 10.6 million returns, up more than 14 percent over results from the same period last year. The jump in computer use coincides with another strong year from the Free File program. The IRS and a consortium of tax software manufacturers offer free services through Free File, which is available at www.irs.gov. More than 3.33 million returns came in through Free File through March 9, which is a 44 percent increase from 2.32 million returns for the same period last year.

Internal Revenue Service Commissioner Mark W. Everson praised the agency's improvement in taxpayer service and its renewed emphasis on enforcement of the tax laws. In a speech at the National Press Club, Everson noted that the playing field is no longer tilted toward tax evaders, with only the amount of tax owed at risk. "Now they might have to pay the entire tax, interest and a stiff penalty," he said. "A taxpayer might have to wrestle with questions like, 'How much am I going to have to pay the lawyers and expert witnesses to litigate this thing?' And going to court is a public matter. Damage to one's reputation is a potential factor." Everson said that as the tax reform process unfolds, he doesn't expect to offer support for, or to oppose, any particular policy options. However, he offered these pointers to consider when reforming the code: _ Construct a tax system that recognizes the dynamic of an evolving economy; _ Assess policy options for their potential impact on attitudes towards compliance; _ Any new system should be administratively feasible; _ When looking at policy options, don't compare a sub-optimized existing system to a perfect, theoretical system; and, _ Recognize that transition to a new code must be properly planned and managed, or it may take decades to recover.

In an effort to minimize disputes regarding whether a truck body satisfies the weight-based exclusion provided in Section 4051(a)(2), the Internal Revenue Service, in Rev. Proc. 2005-19, has established four truck body safe harbors. Section 4051(a)(2) provides an exclusion from the tax imposed by Section 4051(a)(1) for truck chassis and bodies suitable for use with a vehicle that has a gross vehicle weight of 33,000 pounds or less. Similarly, Section 4051(a)(3) provides an exclusion for truck trailer and semi-trailer chassis and bodies suitable for use with a trailer or semi-trailer that has a GVW of 26,000 pounds or less. The IRS announced that it will not challenge a seller's determination that any of the following classifications of truck body types meet the "suitable for use" standard and sales thereof are excluded from the retail excise tax pursuant to Section 4051(a)(2): 1. Platform truck bodies 21 feet or less in length; 2. Dry freight and refrigerated truck van bodies 24 feet or less in length; 3. Dump truck bodies with load capacities of eight cubic yards or less; or 4. Refuse packer truck bodies with load capacities of 20 cubic yards or less. Other body types may also still satisfy the "suitable for use" standard if the seller can establish that, pursuant to Reg. 145.4051-1(a)(4), the truck body has practical and commercial fitness for use with a vehicle having a GVW of 33,000 pounds or less. Rev. Proc. 2005-19 is effective for sales on or after April 4, 2005. In the case of sales before April 4, 2005, the IRS won't challenge sellers who take positions consistent with the revenue procedure's safe harbors.

The Taxpayer Advocacy Panel recommended that tax preparers adhere to a basic standard of competence, with the responsibility of certifying and registering all tax preparers delegated to the various national tax associations. The VITA exam given by the Volunteer Income Tax Assistance Program would be the basic testing mechanism, and current preparers would be grandfathered into the program through an application, subject to approval by the Internal Revenue Service. TAP, a volunteer group that works to improve customer service and satisfaction at the Internal Revenue Service, made the recommendation as part of its annual report to the Treasury Department. Other recommendations made by the panel include eliminating the option to apply for refund anticipation loans through the IRS FreeFile Web site; informing taxpayers if all or a significant portion of their return will be outsourced to a location outside the United States; and clarifying that the earnings of newspaper carriers under age 18 are not subject to self-employment tax.

The Internal Revenue Service Oversight Board released a report requesting an additional $11.6 billion in funding for fiscal year 2006, a 9 percent increase over the Bush administration's recommendation. President Bush is required to submit the board's request, without revision, to Congress along with his own request. "One of the board's roles is to provide a private sector perspective," observed board chairman Raymond T. Wagner Jr. "And from this vantage point, it makes perfect sense to make the additional investments in enforcement that will pay for themselves many times over. The IRS and administration estimates show that every dollar invested in enforcement generates four dollars in increased revenues." The board estimated that an additional $435 million for enforcement would result in $1.74 billion in additional tax revenue. The board also called for additional funding toward maintaining and improving customer service and supporting the Business Systems Modernization program, which is replacing the agency's antiquated computer system. In its report, the board stated that its recommendations are backed by taxpayers. Those surveyed in its annual tax compliance survey called for additional funding for the IRS -- 62 percent favored more funding for enforcement and 64 percent favored more taxpayer assistance.

The Internal Revenue Service has taken the offensive against frivolous arguments that taxpayers should avoid when filing their tax returns. "Every filing season, thousands of taxpayers hear groundless theories suggesting that they don't have to pay taxes or file returns," said IRS Commissioner Mark W. Everson. "We want people to know the truth about these frivolous arguments: They don't work." Just-issued IRS Notice 2005-30 describes 23 frivolous arguments that taxpayers should avoid when filing their returns. Five revenue rulings issued in conjunction with the notice address specific frivolous claims often made to the IRS. These include arguments that the income tax is unconstitutional, that taxes may be withheld as a protest against government programs, and arguments that taxpayers may obtain a refund of all Social Security taxes paid by waiving their right to Social Security benefits. The revenue rulings emphasize the adverse consequences to taxpayers who fail to file or fail to pay taxes based on an erroneous belief in any of these frivolous arguments. In addition to tax and interest, taxpayers who file frivolous income tax returns face a $500 penalty, and may be subject to civil penalties of 20 or 75 percent of the underpaid tax. Those who pursue frivolous tax cases in the courts may face an additional penalty of up to $25,000. "The courts have consistently rejected these arguments and imposed substantial penalties on those taking these unsupportable positions," said IRS chief counsel Donald L. Korb. "Those potentially tempted by these schemes need to realize that they carry a heavy price for both the taxpayers and the promoters."

-- The IRS is providing limited transition relief for certain partnerships and other pass-through entities. Section 470 of the American Jobs Creation Act of 2004 generally bars a deduction for "tax-exempt use losses" on "tax-exempt use property," where there are leases of property in sale-in, lease-out transactions involving tax-exempt entities. It is generally applicable to leases entered into after March 12, 2004. In Notice 2005-29, the IRS indicated that it would not apply Section 470 to partnerships or other pass-through entities for taxable years beginning before Jan. 1, 2005, for property treated as tax-exempt use property solely because of the application of Section 168(h)(6). Section 168(h)(6) provides that if any property that isn't otherwise "tax-exempt use property" under Section 168(h) is owned by a partnership that has both a tax-exempt entity and a person who isn't a tax-exempt entity as partners, and any allocation to the tax-exempt entity of partnership items isn't a qualified allocation, an amount equal to the tax-exempt entity's proportionate share of the property generally is treated as tax-exempt use property.

The Bush administration budget for fiscal year 2006 would make permanent the tax cuts passed in 2001 and 2003, close loopholes, and consolidate the many existing retirement plans into one, but it would leave fixing the alternative minimum tax to be considered by the tax reform panel named in January.The proposed budget includes a refundable income tax credit for the cost of health insurance purchased by individuals under age 65, and an additional $500 million for Internal Revenue Service enforcement measures.

If a principal residence is considered the ultimate personal tax shelter for some, then the vacation home is fast approaching a close second for many more.The recent run-up in the market value - and popularity - of second homes has helped solidify their place as a sound investment. The tax advantages make it even more worthwhile: mortgage and real estate tax deductions, rental exclusions and expense offsets on an annual basis, followed by ultimate disposition at primarily capital gains rates - or better, now that the rules are more clear for use of the personal residence exclusion and like-kind exchange deferral, singularly or in tandem.

IRS DENIES PRE-EXISTING SILO BENEFITS: The Internal Revenue Service has designated "sale-in/lease-out" or "Silo" arrangements as abusive tax avoidance transactions.Silo arrangements are designed to exploit the tax law by shifting tax benefits from a tax-indifferent party that cannot use them to a taxpayer that can. Taxpayers entering into Silo arrangements cannot claim tax benefits as the purported owners of property subject to the lease, because they do not acquire tax ownership of the property.