Tax research

The Internal Revenue Service has unveiled its annual listing of notorious tax scams, the "Dirty Dozen," reminding taxpayers to be wary of schemes that promise to eliminate taxes or otherwise sound too good to be true. The Dirty Dozen for 2005 includes several new scams that either manipulate laws governing charitable groups, abuse credit counseling services or rely on refuted arguments to claim tax exemptions. The agency also sees the continuing spread of identity theft schemes preying on people through e-mail, the Internet or the phone, sometimes with con artists posing as IRS representatives. The IRS removed four scams from the Dirty Dozen this year: slavery reparations, improper home-based businesses, the Americans with Disabilities Act and EITC dependent sharing. But the IRS cautions that taxpayers should remain wary because old scams can resurface or evolve. The IRS urges people to avoid these common schemes: 1. Trust misuse. Unscrupulous promoters urge taxpayers to transfer assets into trusts, promising reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. 2. Frivolous arguments. Myriad outlandish claims are made, including that the Sixteenth Amendment was never ratified, that wages are not income, and that filing a return is voluntary. 3. Return preparer fraud. Dishonest preparers derive financial gain by skimming a portion of clients' refunds and charging inflated fees for services. 4. Credit counseling agencies. Some of these tax-exempt organizations, which are intended to provide education to low-income customers with debt problems, are charging large fees while providing little or no counseling. 5. "Claim of Right" doctrine. The taxpayer attempts to take a deduction equal to the entire amount of wages, labeling it as a necessary expense for the production of income. 6. "No Gain" deduction. Similar to Claim of Right, filers eliminate their entire adjusted gross income by deducting it on Schedule A. 7. Corporation sole. Participants incorporate under the pretext of being a bishop or overseer of a one-person, phony religious organization, with the idea that this entitles the individual to exemption from federal income taxes as a nonprofit religious organization. 8. Identity theft. Fraudsters send bank customers fictitious correspondence and IRS forms to trick them into disclosing their personal financial data, or use Social Security numbers to file false returns without the clients' knowledge. 9. Abuse of charitable organizations and deductions. A taxpayer moves assets to a tax-exempt organization, but maintains control over the assets, thereby obtaining a deduction without transferring a commensurate benefit to charity. 10. Offshore transactions. Income is illegally hidden in offshore accounts. 11. Zero return. Taxpayers enter all zeros on their return. 12. Employment tax evasion. Failure to withhold income tax or other employment taxes based on an incorrect interpretation of Code Section 861.

The Internal Revenue Service, the Department of Justice and the District of Columbia have announced the arrest and indictment of Walter Anderson, 51, a telecommunications entrepreneur. According to the indictment, Anderson obstructed the IRS and defrauded the District of Columbia by failing to pay well in excess of $200 million in taxes. Anderson was involved in starting up long-distance telecommunications businesses at a time when the industry was just being deregulated. The grand jury charged that in 1992, as Anderson realized that the merger of his first successful company -- Mid-Atlantic Telecom -- with another company would result in substantial taxable earnings, he formed an offshore corporation in the British Virgin Islands to receive and disguise his anticipated income. The company that he formed, Gold & Appel Transfer, was allegedly owned by another BVI company, with a trust company serving as registered agent and sole director. Anderson granted himself an exclusive option to purchase Gold & Appel shares for a nominal sum. Neither the option nor Anderson's name was recorded in public records, while Anderson was able to maintain complete control. Between 1992 and 1996, Anderson further obscured his ownership of Gold & Appel by using an alias and forming another offshore corporation in Panama and a mailbox drop in Amsterdam. During this period, Anderson transferred ownership in three telecommunications companies to his offshore companies so that when appreciated stock was sold, he would not appear to be the taxpayer. The indictment alleges that over a five-year period, Anderson personally earned nearly a half billion dollars through investments in business ventures that he conducted through offshore corporations. If convicted of the charges, Anderson faces up to 80 years in prison. "Average Americans deserve to feel confident that when they pay their taxes, neighbors and competitors are doing the same," said IRS Commissioner Mark W. Everson. "The IRS holds all Americans, including the most wealthy, to the same standards of honesty."

Tax shelters provided by accounting firms or external auditors potentially siphoned an aggregate $129 billion in revenue from U.S. coffers over the period from 1998 to 2003, according to a report from the Government Accountability Office. According to the GAO, some 207 Fortune 500 companies, or about 40 percent of the companies in that category, purchased tax shelters from their auditor or from CPA firms, resulting in a potential revenue loss of $56.6 billion. Meanwhile, tax shelter transactions involving the auditor for 61 Fortune 500 companies sidestepped paying about $3.4 billion in taxes between 1998 and 2003, but as a result of the shelter received $1.8 billion in federal tax benefits. The study, which calculated revenue loss from tax shelters purchased by both Fortune 500 corporations and individuals, was launched at the behest of Sen. Carl Levin, D-Mich., the ranking Democrat on the Senate Permanent Subcommittee on Investigations. The GAO noted, however, that the study included only those transactions known to the Internal Revenue Service, and said that its estimates were imprecise because some of the shelters may not be abusive and some transactions may have been counted more than once. The names of the companies and individuals purchasing tax shelters were not identified.

The Internal Revenue Service has redesigned Form 941, Employer's Quarterly Federal Tax Return. The new, simplified form is intended to help businesses, tax practitioners and payroll companies avoid common errors, and to reduce the burden associated with completing and filing the form. Form 941 is used to report wages, tips and other compensation paid, as well as Social Security, Medicare and income taxes collected. More than 23 million of these forms are filed annually by 6.6 million employers. The redesigned form features an improved layout, plain-language instructions, simplified deposit reporting and paid preparer identification. The form is also scannable, which the IRS expects will reduce transcription errors. "The new 941 is much easier on the eye and much more user-friendly," said Scott Mezistrano, senior manager of government relations for the American Payroll Association. "With the shading, bigger boxes and improved instructions right on the form, you know exactly what you are supposed to report and where to put it. The IRS did a very thorough job of reviewing every line on the 941 and considering how it could be made more clear."

Dr. David Frantz Bradford, a tax economist who proposed the "X tax," a controversial alternative to supplant the Internal Revenue Code, died at his home here. He was 66. The cause of death was burns suffered in a fire at his home earlier this month. Bradford, a professor of economics and public affairs at Princeton, as well as a professor at New York University, had advocated switching to a system that taxed people on their spending levels. His subsequent proposal, the X tax, was a distant relative to a flat tax system, but Bradford's system applied a graduated rate schedule for people in the higher income brackets. A flat tax applies a single rate of tax for all income brackets. Bradford served as deputy assistant secretary of the Treasury for tax policy in the Ford administration, and later was appointed by President George H. W. Bush to the Council of Economic Advisors from 1991 to 1993. He joined the economics department at Princeton in 1966. He also authored "Untangling the Income Tax."

The average combined sales tax rates across the nation hit a record 8.587 percent over 2004, which fueled some 764 tax rate changes, according to the 2004 Sales Tax Rate Report. The report, released by Vertex, a provider of tax technology solutions headquartered here, said that although 237 new rates were established over the course of 2004, the year also saw a record number of decreases, 160, the highest figure since 1996. Other findings included: o- Three states had state rate increases. Arkansas went from 5.125 percent to 6 percent, California went from 6 percent to 6.25 percent, and Virginia went from 3.5 percent to 4 percent. o- Mississippi, Tennessee and Rhode Island have the highest state sales tax rates, at 7 percent. The average sales tax rate is 5.318 percent. o - Wrangell, Alaska, has the highest city sales tax rate, at 7 percent. The average city sales tax rate is 1.583 percent. o- Arab, Ala., was the jurisdiction with the highest combined sales tax rate of 12 percent. The average combined rate is 8.587. The Vertex Sales Tax Rate Report provides a summary of sales tax rate changes at the state, county, city and district levels nationwide. It is available online at www.vertexinc.com.

The Internal Revenue Service issued a reminder to taxpayers and tax preparers that certain returns from Arizona, Connecticut, Utah and Virginia need to be sent to different service centers than last year. For tax year 2004, the changes affect Connecticut and Virginia returns with or without payments, and Arizona and Utah returns with payments. o Connecticut returns without payments should be sent to the IRS in Kansas City, Mo. o Connecticut returns with payments should be sent to the IRS in St. Louis. o Virginia returns without payments should be sent to the IRS in Fresno, Calif. o Arizona, Utah and Virginia payments with payments should be sent to the IRS in San Francisco. The envelopes included in the tax packages of taxpayers filing paper returns have the correct center addresses; taxpayers who do not receive a package should refer to the back cover of the Form 1040, 1040-A or 1040EZ instructions. E-filing taxpayers are unaffected by the changes.

The Internal Revenue Service has announced a settlement initiative for executives and companies that participated in an abusive tax avoidance transaction involving the transfer of stock options or restricted stock to family-controlled entities. Under this scheme, executives, often facilitated by their corporate employers, transferred stock options to family-controlled partnerships and other related entities typically created for the sole purpose of receiving the options and avoiding taxes on compensation income normally taxed to the executive. The tax objective was to defer for up to 30 years taxes on the compensation, and the plan resulted, in many cases, in the corporation deferring a legitimate deduction for the same compensation. "These transactions raise questions not only about compliance with the tax laws, but also, in some instances, about corporate governance and auditor independence," said IRS Commissioner Mark W. Everson. "These deals were done for the personal benefit of executives, often at the expense of shareholders." Corporate executives who engaged in these transactions will have until May 23, 2005, to accept an IRS settlement offer to resolve their tax issues. The offer also extends to corporations that issued the options to executives and directors as part of their compensation. Under the terms of the settlement, participating executives must report 100 percent of the compensation and must pay interest and a 10 percent penalty. This is one-half of the maximum 20 percent applicable penalty. Corporations and executives must also pay appropriate employment taxes. The parties will be allowed to deduct out-of-pocket transaction costs, typically promoter and professional fees. Corporations will be allowed a deduction for the compensation expense reported by the executive. "I commend the IRS for resolving this matter," said Securities and Exchange Commission Chairman William Donaldson. "It is important that leaders in our capital markets avoid inappropriate conflicts of interest such as those described in the IRS's executive stock option initiative. The IRS's settlement initiative is a step forward in the effort to protect the integrity of our capital markets. We will continue to work closely with the IRS and other government agencies to fulfill our mandate." "I appreciate the IRS's effort to flush out the participants in this scheme," said Sen. Chuck Grassley, R-Iowa, the chairman of the Senate Finance Committee. "The agency plays a key role in enforcing a zero-tolerance approach to executive tax evasion. Executives are like other taxpayers. They have a duty to pay every penny they owe, not a penny more or a penny less."

A report by the Treasury Inspector General for Tax Administration absolves the procedures used by the Internal Revenue Service's Tax Exempt and Government Entities Division for reviewing political activities by exempt organizations. While many charities speak out on public issues, the code prohibits Section 501(c)(3) organizations from specific types of political activities. In response to media reports of allegations that the TE/GE Division was examining these types of activities just prior to the 2004 presidential election for politically motivated reasons, the IRS asked the TIGTA to investigate. "This report confirms what we've said all along," said IRS Commissioner Mark W. Everson. "Political considerations played absolutely no part in the inquiries we launched last summer." Everson said that recommendations in the report would be addressed by the IRS and would be in place for future election cycles.

The ambitious goal of having 80 percent of federal tax returns electronically filed by 2007, suggested by Congress in 1998 legislation, may not be out of reach.

Tax prep giant H&R Block has launched a new business employing CPAs to serve the needs of small business owners. After a test of the small business services concept in the Tampa, Phoenix and Atlanta markets, the company, based here, purchased 11 office locations from American Express Tax & Business Services to enter the market.

The 2006 budget reportedly will not address the hot-button issue of revamping or eliminating the controversial alternative minimum tax or other tax reforms, but will allow President George W. Bush's recently appointed tax reform panel to tackle them.According to Tax Analysts, the bipartisan tax reform panel is expected instead to examine tax reform options that will make the code simpler and fairer. The panel is supposed to make recommendations to Treasury Secretary John Snow by July 31.

The National Association for the Advancement of Colored People said that it is refusing to comply with an Internal Revenue Service request for documents that came as part of the agency's investigation into alleged improper political bias on the part of the civil rights group.The IRS is challenging the group's tax-exempt status because, it says, NAACP chairman Julian Bond made politically partisan remarks while speaking at the group's national convention in Philadelphia last July. The civil rights organization was charged in an Oct. 8 IRS document with "distributing statements in opposition of George W. Bush for the presidency."

The Joint Committee on Taxation has suggested over 60 options to close the $311 billion gap between taxes owed and collected. The report, requested by Sen. Chuck Grassley, R-Iowa, chairman of the Committee on Finance, and ranking member Sen. Max Baucus, D-Mont., consists of numerous revenue raisers, in addition to compliance provisions. The largest revenue raiser, to the tune of $164 billion, is a proposal to include in FICA wages salary reduction amounts used to provide benefits under a cafeteria plan or to provide qualified transportation fringe benefits.Proposals affecting individual income tax include a repeal of the exclusion for employer-provided care, making the dependent care credit the exclusive means for receiving tax benefits for dependent care expenses; a modification of the "kiddie tax" by increasing the age of children to which the kiddie tax provisions apply from under 14 to under 18; and a repeal of the deduction for interest on home equity indebtedness.

Tax practitioners preparing 2004 client business and self-employed returns are confronted with a bewildering maze of tax law changes, which in some cases can lead to mistakes.Significant changes affecting 2004 returns include multiple changes to depreciation and expensing, with new limits for sport utility vehicles, passenger automobiles, trucks and vans; bonus depreciation for qualified leasehold property; and newly redesigned Schedule K-1s for partnerships and S corporations.

Turnaround specialist Alvarez & Marsal has expanded its tax advisory unit, adding eight managing directors in several regional locations, and unveiling an office here.

At the inaugural meeting of President Bush's Advisory Panel on Federal Tax Reform, Treasury Secretary John Snow told the panel that, "The tax code is dreadfully murky in its complexity, but its size is clear and easy to see." "More than a million words long, the Internal Revenue Code and regulations has more than doubled in terms of page-length over the past 20 years, and today's 'short' income tax form takes more than 11 hours to prepare -- about the same as the 'long form' did a decade ago," Snow said. Former Senator Connie Mack, who serves as chairman of the panel, said that the group would "take a fresh look at the existing tax code and will formulate options for making the tax system simple, fair and productive." Former Internal Revenue Service Commissioner Fred T. Goldberg Jr., a partner at Skadden, Arps, Slate, Meagher & Flom LLP, presented a history of the income tax, concluding that we currently have "a grotesquely complicated system that distorts the allocation of resources and violates common-sense notions of fairness." Louis Kaplow, a professor of law and economics at Harvard Law School, explained the central concepts of an income tax and a consumption tax. William G. Gale, with the Brookings Institution and co-director of the Urban-Brookings Tax Policy Center, noted that it is a myth that the consumption tax is more effective at taxing the underground economy than the income tax is. He concluded that the income tax is a fair and proven mechanism for raising revenue, consistent with long-term economic growth. "While it could be improved, it should not be scrapped," he said. Stephen J. Entin, president and executive director at the Institute for Research on the 'Economics of Taxation, said that the fairest tax is proportional to income. Since deductions for costs are necessary to measure income properly, and saving is a cost of earning income, he argued, "The best measure of income is consumption. We should tax what we spend." Entin urged a fair, flat and unbiased neutral tax that would treat all savings like pensions and IRAs, end the double taxation of corporate income, and permanently eliminate the "death tax." The panel, charged with submitting a final report to the Treasury by July 31, 2005, will hold its next meeting March 3.

The Multistate Tax Commission, a cadre of some 47 state governments that works with taxpayers to administer tax laws applicable to multistate and multinational enterprises, said that it is conducting a search to replace long-time executive director Dan Bucks, who resigned. Bucks, 59, served with the MTC for 17 years before leaving to become head Montana's state revenue program. In the interim, René Blocker will serve as interim executive director. Under Bucks' leadership, the MTC expanded from 28 to its current roster of 47 states, increased the efficiency of its audit program, and played a key role in the commission's Streamlined Sales Tax Project. Individuals wishing to apply for the post must do so by Feb. 28, 2005. Information about the job is available at http://www.mtc.gov/CNTACTUS/ExecutiveDirectorRecruit.htm.

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. In the American Jobs Creation Act of 2004, Congress enacted limitations on the deductibility of losses from future Silo transactions. In Notice 2005-13, the IRS says that it will challenge the purported tax benefits claimed by taxpayers entering into earlier Silo transactions. It further states that it will consider Silos to be "listed transactions," requiring taxpayers who enter into Silos to disclose their participation to the IRS. In addition, promoters of listed transactions must keep lists of investors and, in certain cases, register those transactions with the IRS. "I appreciate the Treasury Department's effort to shut down these abusive deals," said Sen. Chuck Grassley, R-Iowa, chairman of the Senate Finance Committee. "The department has done a very good job of going after bogus leasing shelters since the Finance Committee exposed them. Today's action complements our new law going after these deals. It reaches back to the deals that otherwise might have gotten away."

Former Senators Connie Mack and John Breaux, chairman and vice-chairman of the President's Advisory Panel on Federal Tax Reform, have scheduled the panel's first meeting for Feb. 16, 2005. Witnesses will be Fred T. Goldberg, a partner at Skadden, Arps, Slate, Meagher & Flom LLP, and a former commissioner of the Internal Revenue Service; Louis Kaplow, a professor of law and economics at Harvard Law School; William G. Gale, co-director of the Urban-Brookings Tax Policy Center; and Stephen J. Entin, president and executive director at the Institute for Research on the Economics of Taxation. Treasury secretary John Snow will also appear before the panel. "The president has tasked our panel with developing reforms to make the tax code simpler, fairer and more growth-oriented," said Senator Mack. "I look forward to the opportunity to hear from Secretary Snow as well as this distinguished group of experts as we begin the process of examining the problem and formulating solutions." "The current tax system is an unfair burden on Americans," added Senator Breaux. "When it takes the average taxpayer 11 hours to fill out the short tax form, something is wrong. This is a unique opportunity to work in a bipartisan effort and find ways to make the tax system serve Americans better." The witnesses will provide the panel with a historical overview of the current tax system and an understanding of how it evolved and where it is today. The panel will also hear background about tax systems. In particular, the witnesses will explain the difference between a tax on income and a tax on consumption, how the different bases impact the overall functioning of the tax system, and the advantages and disadvantages of each one in terms of simplicity, fairness and economic growth.