IRS Extends Moratorium on Tax Shelter Enforcement

By Paul Bonner December 28, 2009

IRS Commissioner Doug Shulman announced in a letter to Sen. Chuck Grassley, R-Iowa, that the IRS is extending until March 1, 2010, a moratorium on collection enforcement of the IRC § 6707A penalty for failure to disclose tax shelters and other reportable transactions.

Shulman first announced the moratorium July 6 in response to congressional concerns that the penalty amounts—$100,000 for individuals and $200,000 for other taxpayers—in many instances far exceed the tax benefit of the targeted transactions. The moratorium, which applies to cases in which the annual tax benefit from the transaction is less than the otherwise applicable penalty, initially ran until Sept. 30, 2009, which Shulman said would give Congress time to amend the statute. Shulman later extended the moratorium to Dec. 31, 2009.

On Nov. 16, 2009, Rep. John Lewis, D-Ga., introduced the Small Business Penalty Relief Act of 2009, HR 4068. An identical bill, S. 2771, was introduced in the Senate by Sen. Max Baucus, D-Mont.

The bills would limit the penalty for listed transactions to the lesser of the current statutory amounts or 75% of the tax benefit shown on the return as a result of the transaction. Listed transactions would carry a minimum penalty of $5,000 for individuals and $10,000 for other taxpayers. The 75%-of-tax-benefit limit would also apply to other reportable transactions, for which the maximum penalty would be the current statutory penalty amounts under section 6707A(b)(1) of $10,000 for individuals or $50,000 for other taxpayers (with no minimum penalty amounts). The bills would apply to penalties assessed after Dec. 31, 2006.

Both bills were still in committee as Congress adjourned last week.

In a letter last week to Shulman and Treasury Secretary Timothy Geithner, Grassley protested what he said was the IRS’ continuing to place liens on small businesses despite the moratorium, and he threatened in a press release to block nominations of Treasury officials until the issue was resolved.

Shulman responded on Dec. 23, further extending the moratorium.  He also said that earlier in December, the IRS stopped filing new lien notices where the amount due was solely related to a section 6707A penalty and would refrain from placing such liens through the latest extension period. Grassley’s office has told the The Washington Post that he will allow the Treasury nominations to go forward.

Tax Vox’s Lump of Coal Award: The Worst Tax Ideas of 2009

by Howard Gleckman

As 2009 draws to an icy conclusion, Tax Vox is pleased to announce its Third Annual Lump of Coal Award for the worst tax ideas of the year. So many choices. So little time.

10.  The Roth Rollover. Let’s see, allowing people to turn their tax-deferred retirement savings into fully tax-free investments starting on Jan. 1 will be a long-term fiscal catastrophe. And in the short run, the up-front taxes people must pay to roll into a Roth could depress the stock market and damage the shaky recovery. What’s not to like?

9. The Bo-Tax and the Tanning Bed Tariff. This is what happens when you need money and won’t talk seriously about revenues.

8. Obama’s Middle-Class. This is a rerun from last year, but it is too good to leave out. The President thinks we will somehow reduce the deficit and fix the tax code without raising taxes by a dime for those poor souls making a quarter million dollars-a-year or less. Unfortunately, that’s 95 percent of us. Can’t wait to see how he does it.

7. Taxing the Rich. Why not let a handful of wealthy taxpayers finance all your new ideas. So let’s drive the top rate north of 45 percent, even though no one will really pay it. On the other hand, except for Barbra Streisand and those other Hollywood types, they are mostly Republicans anyway.

6. The Estate Tax. Now you see it. Now you don’t. Wait, there it is again. So what if nobody has any idea how to do estate planning anymore. On the other hand, Congress has had only eight years to fix this mess.

4. California. It claims to be the fifth largest economy in the world but can’t pass a serious budget, and can’t govern itself. It is the poster child for dysfunctional state governments and fiscal crises everywhere

3. The homebuyer credit. Congress started the year by giving away $8,000 in subsidies to “first-time” homebuyers, as many as 74,000 of whom, it turned out, never quite got around to buying a house. Then, it extended the boondoggle to current owners who buy up. Bottom line: People who were already going to buy will get billions of dollars in government subsides. But you gotta make those real estate agents happy.

2. The Obama Tax Reform Panel. Not only will it fail to propose an improved tax code, it missed its own deadline. Nothing beats being both disappointing and late. “After the holidays,” the Obama people say. Does anybody care?

1. And the winner is, of course, the HAPPY Act. We’ve got a $1.5 trillion deficit and a Republican congressman named Thaddeus McCotter wants a $3,500 deduction for the cost of caring for our pets. Why? Because we love them.

Family Finance: Be cautious when lending to family

Date: 12/18/2009 3:22 PM

EILEEN AJ CONNELLY AP
Personal Finance Writer

NEW YORK (AP)

Get it in writing.

That’s the No. 1 recommendation from financial professionals about lending money to a relative.

Yet as more people who are unemployed or face losing their homes seek help, most people who make loans to family members skip that important step. The result is family loans often don’t get paid back, and hard feelings can damage relationships.

“There’s an old saying with a family loan,” said Donald W. Patrick, a certified financial planner with Patrick, MacLeod & Cranman in Atlanta. “Consider it a gift.”

It doesn’t have to be that way.

Documenting a loan can be done simply and at low cost. Spelling out the terms makes the arrangement businesslike, and can help avoid emotional and financial issues that may arise if the money isn’t repaid.

“If everybody put everything in writing, it would work more often,” said Mitchell Kraus, a certified financial planner with Capital Intelligence Associates, Los Angeles.

Some people think that a formal agreement isn’t needed if the loan is between close relatives. But whether the borrower is your child or a third cousin twice-removed, professionals warn against depending on trust alone. And try to keep emotions out of it.

Advisers also counsel not to lend money you can’t afford to give away. Older parents frequently use savings they need for future living expenses to lend to their kids.

“We see the emotion when the kids aren’t paying back and the parents are really feeling a financial pinch,” said Sally Hurme of AARP.

Reasons to lend

Unemployment is at 10 percent, and 35 percent of Americans say the financial situation in their households is “poor,” a recent Associated Press

Stuart Rohatiner, CPA, JD

-GfK poll found. Home foreclosures remain epidemic and banks are still tight with lending.

“There’s no doubt about it. It’s bad out there,” said Patrick. His clients, who tend to be wealthy, are reporting more requests for loans from family, usually their children. Planners say the reasons for the requests run the gamut from debt consolidation to medical expenses to preventing foreclosure.

And if the family lender charges interest, the loan could be more profitable than putting the money in a certificate of deposit or even many bonds.

Deborah Danielson, owner of Danielson Financial Group in Las Vegas, has clients who financed a $140,000 mortgage for their son. They are charging just 4 percent interest — lower than he would have gotten at any bank, yet more than the money was earning parked in CDs.

To structure it as a business arrangement, the couple had a mortgage company draw up the documents and hire a company to collect the payments. Their son sends his payment to the collector, along with a $6 fee for processing. At year end, the company will send statements to both parties for tax purposes.

Danielson said the arrangement made everyone more comfortable, since the son is dealing with a company instead of writing a check to his parents.

How to set up a loan

The loan documentation, at the very least, should state the amount, duration, interest rate, payment size, and any late penalties. It may seem like overkill, but making the terms clear ensures that everyone knows what is expected.

“If you don’t pay your mortgage or you don’t pay your MasterCard, they penalize you or they take your credit away,” said Stuart Rohatiner, senior tax manager with Gerson, Preston, Robinson & Co., a Miami accounting firm. “With a parent or a relative, there’s too much emotion involved.”

There can be tax implications for loans among family members if no interest is charged, or if the interest rate is very low. Typically, the Internal Revenue Service expects lenders to charge the “applicable federal rate,” published monthly by the agency. The rates also vary with the length of the loan: currently a loan of three to nine years, for example, must carry a rate of at least 2.61 percent.

If no interest is charged, the loan could be considered a gift. In that case, the lender would have to pay gift tax on any amount over $13,000.

Prepared lending forms are available at some office supply stores and online. Forms can also be found at LendingKarma.com, where users can set up e-mail payment reminders for borrowers. Payments can also be entered and tracked on the site.

Some peer-to-peer lending sites, like VirginMoney.com and Prosper.com, facilitate the loan, acting as a middleman between lender and borrower to collect and distribute payments.

More complicated or large loans may best be handled by a financial planner or an attorney. For mortgages, it’s smart to run a credit check and to verify income like a bank would, said Dale Siegel, an attorney with Circle Mortgage Group in Harrison, N.Y. and author of “The New Rules for Mortgages.” ”From step one, after everybody understands how this is going to work.”

Copyright 2009 The Associated Press.

IRS Studying ‘Protocols’ for Joint Audits With Other Countries Share Business

By Ryan J. Donmoyer Dec. 10 (Bloomberg) —

The U.S. Internal Revenue Service is working with tax-collection agencies in other countries on how to conduct joint audits of multinational corporations, Commissioner Douglas Shulman said. “We are in the very early stages of looking at these protocols,” Shulman said today at a conference in Washington co-sponsored by the IRS and George Washington University. Shulman had said in June he was discussing the idea with officials in other nations. Joint audits would be part of a global effort to crack down on cross-border tax evasion, spurred in the last year by tax- evasion cases involving banks in Liechtenstein and Switzerland. Barry Shott, deputy IRS commissioner in charge of international tax issues, said joint audits probably would be conducted by a special agency set up by the U.S. and other countries in 2004 to share information about tax shelters. “It’s new,” Shott said regarding the joint audit program. “I think you’re going to see more of it.” The special agency, the Joint International Tax Shelter Information Center, has offices in Washington and London. Members include the U.S., the U.K., Canada, Australia and Japan. China and South Korea participate as observers. The agency has been used in limited cases to track individuals and companies suspected of flouting tax laws. Shulman said he has expanded the agency’s scope to encourage the exchange of information about a broader range of tax-avoidance techniques. To contact the reporter on this story: Ryan J. Donmoyer at e-mail rdonmoyer@bloomberg.net

More Tax Chores for the Wealthy at Year-End

Wealth Matters

By PAUL SULLIVAN
Published: December 11, 2009

At the end of every year, there is a basic list of things wealthy people should do to put their financial houses in order. But this year, that house may be a lot messier than in years past, given the wild swings in wealth in the last 12 months and the various government programs and proposals that can change the calculus.

Sam Petrucci of Credit Suisse Private Bank says a popular tactic has been a special annuity trust to give money to an heir tax-free.

The biggest question — the one that overshadows all of the others and is still unresolved — is what will happen to the estate tax next year. While the House of Representatives has voted to make permanent the current 45 percent tax rate on all estates above $3.5 million, the Senate has yet to take up the bill. And it is not clear if it will have time to do so this year.

The uncertainty gives wealthy investors much to consider in the next few weeks. To address these concerns, I intend to discuss here what you should do before the end of the year and use the next column to look at what you should do at the beginning of 2010.

NOW OR THEN?

The mantra for year-end tax planning is usually “accelerate deductions, delay income.”

The reason is simple: to lower your tax bill in that year. But with the prospect of higher taxes on the wealthy by 2011 at the latest, the advice now is the opposite: accelerate income now and delay deductions until after taxes rise, when they could be more valuable.

“Many people are resigned that income taxes are going to rise,” said Janine Racanelli, managing director and head of the Advice Lab at J. P. Morgan Private Bank. “People are being tactical as the picture is becoming clearer.”

What is certain is the income tax for the top earners is going to be 39.6 percent in 2011, up from 35 percent now.

Yet there are other variables, Ms. Racanelli said, that could drive tax rates even higher, like surcharges on those who make more than $250,000 a year and other taxes to pay for the health care legislation.

Some of the popular types of income being accelerated are stock options, distributions from retirement accounts for people over 59 ½ and payments from deferred compensation plans. Ms. Racanelli added that business owners were looking particularly closely at paying themselves dividends from their company. Their fear is that the tax on these qualified dividends may rise to the income tax rate, from the current 15 percent.

CAPITAL GAINS DECISIONS

Also unknown is what will happen to the long-term capital gains tax rate. Many advisers suspect it will rise to 20 percent, from 15 percent, by 2011. As a result, some investors are weighing whether to sell securities now and pay the lower capital gains tax.

Stephen Horan, head of private wealth at the CFA Institute, said it might not make sense to rush to sell, even if the rate went up. He has run calculations on the impact of an increase and said that if your investment horizon was 10 years, you needed to earn just 2 percent more per year to make up for a five percentage point increase in the capital gains tax.

“It’s better to keep your money than give it to the government,” he said.

Mr. Horan said investors could actually do even better by avoiding the higher short-term capital gains tax. That rate is 35 percent and is applied to investments held for less than 12 months. Over 10 years, investors could earn 15 percent more on their money by avoiding short-term capital gains, he said.

Of course, these taxes are paid only on gains. Most investors still have substantial losses left from 2008. If losses outweigh gains, people can deduct $3,000 from their taxes each year until that loss is used up.

SHORT-TERM TRUST

For the wealthy, this was the year of the GRAT, for grantor retained annuity trust. Sam Petrucci, a director in the wealth planning group at Credit Suisse Private Bank, said he arranged more of these trusts this year than at any time in the previous decade.

GRATs are a fairly simple way to transfer money to an heir tax-free. A person puts a sum in the trust that will be paid back to him over a fixed period of time. The heir receives any appreciation in the trust above a “hurdle rate” — the interest the Internal Revenue Service requires to be paid to the person who set up the trust.

The reasons for the increased attention in these trusts were twofold: the hurdle rates were low all year, as were the prices of some securities. Mr. Petrucci said that someone who put $10 million into a two-year GRAT with the December hurdle rate of 3.2 percent, assuming an 8 percent return, would pay himself two payments of roughly $5.2 million and pass $760,000 to heirs free of gift tax.

But it was the prospect of Congressional action that really touched off the interest in setting up short-duration GRATs before the end of the year, Mr. Petrucci said. One proposal would require a GRAT to be at least 10 years long. If the person setting it up died in that time, the money would revert to the estate. The second proposal would require the person setting up the trust to pay a gift tax on 10 percent of what he puts in. Currently, a person can “zero out the GRAT,” which means he pays himself back the full amount and nothing is taxed.

CHARITABLE EXPIRATION

The next Wealth Matters column will discuss the pros and cons of converting your pretax retirement account into a post-tax Roth Individual Retirement Account in 2010. Meanwhile, there is one I.R.A. provision that will expire this year unless Congress extends it. It is the charitable rollover provision, which allows someone to donate $100,000 directly from his or her retirement account to a public charity. The person doing this has to be over 70 ½ and the money has to be transferred directly from the I.R.A.

Jere Doyle, wealth strategist at Bank of New York Mellon, said the donor would not get a tax deduction, which he would get if he donated the money directly. But he would get the benefit of not having to pay ordinary income tax on that amount. The transfer also counts toward the minimum distribution from a retirement account, which the I.R.S. suspended for 2009 but may reinstate next year. “It’s a good way to clean out your I.R.A.,” he said.

HOUSING ISSUES

Two property-related benefits also need to be considered. The Mortgage Forgiveness Debt Relief Act was scheduled to expire at the end of the year, but it has been extended until 2012. Normally, a person has to pay ordinary income tax on the part of a mortgage the bank forgives. Under this law, up to $2 million will continue to be forgiven tax-free on a person’s primary residence.

The second issue is conservation easements. The wealthy use these to give part of their property to a local conservancy and get a tax break. Mr. Doyle said this is probably the last year that people can deduct an easement worth up to 50 percent of their adjusted gross income.

Tax Burdens, Around the World: You Think Your Taxes are High? Read This!

The Organization for Economic Cooperation and Development today released new data on tax burdens in its 30 member countries. Across the organization, overall tax revenue totaled an estimated 35.2 percent of gross domestic product in 2008, down half a percentage point from 2007. The organization expects that tax burdens will fall further in 2009.

Denmark had the highest total tax revenue as a percentage of G.D.P., at 48.3 percent, followed by Sweden at 47.1 percent. Turkey and Mexico had the smallest tax burdens, at 23.5 percent and 21.1 percent, respectively.

In the United States, tax revenues represented 26.9 percent of total output last year.

Fed Chairman Bernanke: Frequently Asked Questions

From Fed Chairman Ben Bernanke: Frequently Asked Questions. Dr. Bernanke discusses four questions:

1. Where is the economy headed?
2. What has the Federal Reserve been doing to support the economy and the financial system?
3. Will the Federal Reserve’s actions lead to higher inflation down the road?
4. How can we avoid a similar crisis in the future?

On inflation, Bernanke says he expects “inflation to remain subdued for some time.” On the economy:

Where Is the Economy Headed?
… Recently we have seen some pickup in economic activity, reflecting, in part, the waning of some forces that had been restraining the economy during the preceding several quarters. The collapse of final demand that accelerated in the latter part of 2008 left many firms with excessive inventories of unsold goods, which in turn led them to cut production and employment aggressively. This phenomenon was especially evident in the motor vehicle industry, where automakers, a number of whom were facing severe financial pressures, temporarily suspended production at many plants. By the middle of this year, however, inventories had been sufficiently reduced to encourage firms in a wide range of industries to begin increasing output again, contributing to the recent upturn in the nation’s gross domestic product (GDP).

Although the working down of inventories has encouraged production, a sustainable recovery requires renewed growth in final sales. It is encouraging that we have begun to see some evidence of stronger demand for homes and consumer goods and services. In the housing sector, sales of new and existing homes have moved up appreciably over the course of this year, and prices have firmed a bit. Meanwhile, the inventory of unsold new homes has been shrinking. Reflecting these developments, homebuilders have somewhat increased the rate of new construction–a marked change from the steep declines that have characterized the past few years.

Consumer spending also has been rising since midyear. Part of this increase reflected a temporary surge in auto purchases that resulted from the “cash for clunkers” program, but spending in categories other than motor vehicles has increased as well. In the business sector, outlays for new equipment and software are showing tentative signs of stabilizing, and improving economic conditions abroad have buoyed the demand for U.S. exports.

Though we have begun to see some improvement in economic activity, we still have some way to go before we can be assured that the recovery will be self-sustaining. Also at issue is whether the recovery will be strong enough to create the large number of jobs that will be needed to materially bring down the unemployment rate. Economic forecasts are subject to great uncertainty, but my best guess at this point is that we will continue to see modest economic growth next year–sufficient to bring down the unemployment rate, but at a pace slower than we would like.

A number of factors support the view that the recovery will continue next year. Importantly, financial conditions continue to improve: Corporations are having relatively little difficulty raising funds in the bond and stock markets, stock prices and other asset values have recovered significantly from their lows, and a variety of indicators suggest that fears of systemic collapse have receded substantially. Monetary and fiscal policies are supportive. And I have already mentioned what appear to be improving conditions in housing, consumer expenditure, business investment, and global economic activity.

On the other hand, the economy confronts some formidable headwinds that seem likely to keep the pace of expansion moderate. Despite the general improvement in financial conditions, credit remains tight for many borrowers, particularly bank-dependent borrowers such as households and small businesses. And the job market, though no longer contracting at the pace we saw in 2008 and earlier this year, remains weak. Household spending is unlikely to grow rapidly when people remain worried about job security and have limited access to credit.

Inflation is affected by a number of crosscurrents. High rates of resource slack are contributing to a slowing in underlying wage and price trends, and longer-run inflation expectations are stable. Commodities prices have risen lately, likely reflecting the pickup in global economic activity and the depreciation of the dollar. Although we will continue to monitor inflation closely, on net it appears likely to remain subdued for some time.

Stuck in the Middle with our International Tax System

by Rosanne Altshuler

President Obama took aim at multinational corporations last May at a press conference on international tax policy. I’ll leave out the details here, lest I put you to sleep or explode your brain. Let’s just say that the current system is a mess that drastically needs fundamental reform.

Economists describe two contrasting “pure” approaches to taxing the income U.S. companies earn abroad. A “worldwide” approach would apply our domestic tax rules to all income (with a foreign tax credit to protect against double-taxation). In theory, that system would tax U.S. business income the same, whether it’s earned at home or overseas, so firms shouldn’t care where they invest. In contrast, under a “territorial” or “dividend exemption” system, the U.S. wouldn’t tax active business income earned overseas; American firms would pay only the taxes of the country where they earn income, just like any non-U.S. business operating there. In theory, that puts U.S. businesses that invest abroad on equal tax footing with foreign firms.

Which system do we use? We’re stuck in the middle and it’s not pretty. A 2005 Joint Committee on Taxation Report labeled the current system a “paradox of defects” and recommended that the U.S. adopt a dividend exemption system. The 2005 President’s Advisory Panel on Federal Tax Reform came to the same conclusions. Its November 2005 report said that the current system “likely distorts economic decisions to a greater extent and is more complex than a system that simply exempts active foreign business income from U.S. tax.”

In 2006, Harry Grubert of the U.S. Department of Treasury and I carefully studied three different systems for taxing the cross-border income of U.S. multinational corporations: the current hybrid system, which combines worldwide and dividend- exemption systems; a “burden neutral” variant of a worldwide system that increases the tax base by taxing all foreign source income currently but lowers the rate to keep the burden on foreign source income the same; and a dividend-exemption system. We concluded that either fundamental reform delivers a better system than the current one and recommended the “burden neutral” worldwide system over dividend exemption.

President Obama has proposed several incremental reforms to cut back on deferral—the current policy of taxing foreign earnings only when U.S. corporations bring them home.  If he’s simply looking for revenue, however, the president would do better to move in the other direction. In recent blogs, Bob Williams and I have been examining the revenue and spending options in the new CBO Budget Options report. CBO includes a dividend exemption option—indefinite deferral—that would raise $76.2 over ten years. That’s $11 billion more than the CBO option of ending deferral entirely!  Again, I’ll spare you the details. But you know a tax system is broken when not taxing a form of income raises more money than taxing it today. We definitely need serious, principled, international tax reform.

So what’s the bottom line? We’re in a mess. We’re stuck between two inconsistent systems with no obvious way to get out. We need reform and we need revenue. The two aren’t necessarily incompatible but change will be hard. Many firms benefit from the status quo — the worst of all worlds is the best of all worlds for them. Whatever we do, there will be losers everywhere.