Category: Taxes: Because We’re The Little People

TurboTax Jockey Tim Geithner Says Tax Increases Won’t Hurt Small Businesses a Bit

The top individual tax rate is scheduled to jump to 39.6% on January 1, 2011. To those of us who do private business tax returns for a living, one effect is obvious: this will raise the tax rate on LLC and S corporation income.

But now Treasury Secretary Tim Geithner says that all my small business clientsthy rich law partners and CEOs (my emphasis):

Ninety-seven percent of small businesses in this country would not pay a penny more due to letting these upper-income tax rates expire.

Now some have argued that even if only a few percent of small business owners make over $250,000, these few make up a vast amount of supposedly small business income.

This argument apparently counts anyone who receives any type of partnership or business income as if they were a small business.

By this standard, every partner in a major law firm and every principal in a major financial institution would count as a separate small business. A CEO who has board fees or speech fees would also count as a small business owner under this overly broad definition.

Well yes, Timmy, “some” have argued for that “overly broad definition” — your friends who say 97% of small businesses won’t be affected by the scheduled tax increase. A 2009 report by the Center on Budget and Policy Priorities is a source of the talking point that only a tiny fraction of businesses will be affected by the expiration of the tax increase. They define a small business 1040 as:

…any tax unit that receives any income (or loss) from a sole proprietorship, farm proprietorship, partnership, S corporation, or rental income.

So while a CEO who has board fees will count as a separate small business — as will President Obama, for that matter — so will every taxpayer that has a schedule C, schedule E or Schedule F. Your office Mary Kay girl or Shacklee dealer counts as a small business. Everybody who moonlights and reports their income is a small business. Everybody who rents out a duplex or vacation home counts, as does every taxpayer who holds, even briefly, an interest in a publicly-traded oil and gas partnership.

So how much small business economic activity will be hit by the increase in the top rate? A lot more than 3%. The center-left Tax Policy Center estimates that 44.3% of taxable income of these “small businesses” will be hit with next year’s scheduled tax increase (hat tip: Howard Gleckman). That seems low, if anything, based on what I see in practice.

It’s the successful, growing and profitable S corporations and partnerships that push their owners into the top tax brackets. Growing businesses typically distribute only enough income to owners to cover taxes — either by inclination or by agreements with lenders. Their remaining earnings go into growing the business or paying off the bank. If you increase their taxes, it either reduces growth and hiring or their ability to service their debt — neither of which does much for the economy.

When Tim Geithner says that the only people who will get hit by his tax increase are rich lawyers and director fee millionaires, it may tell us something about his social world. It tells us nothing about how the tax increase will hit business owners.

Land Yachts and the Tax Law: Four Tips to Avoid “At-Risk” Pitfalls

If there’s one thing the economy offers to businesses nowadays, it’s opportunities to lose money. As unpleasant as that is, it at least will reduce your taxes, right?

Maybe.

Even tax loss parties have their poopers, and the “At-risk rules” of Code Sec. 465 are as poopy as can be. Drafted to fight the first generation of retail tax shelters in the 1970s, these rules have faded into obscurity, but remain available for annoyingly competent IRS agents to wield against your loss deductions. The rules are supposed to defer losses when it’s really the lender on the hook for them, rather than the nominal owner of the money-losing activity. The losses carry forward to offset future income on the activity, or gain on a sale someday.


These rules pooped all over the tax loss of CTI Leasing, an LLC owned by Kieth Roberts, an Indiana man, to lease trucks to his trucking company. He loanded the LLC $425,000 to buy a “Vantare H3-45 Super S2” RV. The Tax Court says “Vantare RVs are custom-built, fully furnished, luxury coach RVs known for their ‘yacht quality fit and finish.'”

The leasing business cranked out tax losses. The IRS disallowed $425,000 of them on the grounds that the $425,000 loan didn’t give the LLC owner “at-risk” basis in his leasing activity. The Tax Court said the taxpayer failed to show that the land yacht was used in the truck leasing business or was owned by it, so the $425,000 wasn’t “at-risk” in the leasing activity.

Not every business can afford a nice land yacht, but they all can lose money. Some pointers to help keep you from trippng over the at-risk rules:

• If your loan is “non-recourse” — if you don’t pay, all the lender can do is repossess the property — that’s an at-risk rule red flag.

• Limited partners and LLC members are likely to face at-risk issues; the whole point of a “limited liability company” is to limit owner liability, after all.

• Be careful of loans from related parties. If you borrow from the wrong person, the tax law will treat the loan as not “at-risk,” even if you borrow from a business partner who might leave you under an end-zone somewhere if you don’t pay up.

• If you are in the real-estate business, “qualified” non-recourse debt – generally third-party commercial loans – are O.K. under the at-risk rules.

If you trip over the at-risk rules, your losses may not be gone forever. Form 6198 tracks your deferred losses, and you can lose them if your activity generates income someday.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Patch This or: How to Learn to Stop Worrying and Love the Alternative Minimum Tax

Congress has been twisting itself into knots to pass 70-odd special interest “expiring provisions” this spring, though without success. These provisions that have come within one or two votes of being extended one more time are almost all special-interest provisons, providing tax breaks or direct cash subsidies to folks like biodiesel producers and race-track operators.

Meanwhile, the grandaddy of all expiring provisions goes largely unmentioned. Without new legislation, 24 million additional taxpayers will pay alternative minimum tax this year. That will happen because the AMT exemption for joint returns will fall from $70,950 to $45,000, and from $46,700 to $33,750 for single filers.


The AMT is a shadow tax system with fewer deductions and credits and a different rate schedule; it only applies when it gives a higher tax than the “regular” income tax. The reduction of regular tax rates in 2001 brought the regular and AMT brackets much closer, threatening to bring millions of voters into the AMT system. Congress has been passing “patches” to raise the AMT exemption for a year or two at a time since 2001 to avoid that. The last “patch” expired at the end of 2009.

An unpatched AMT would hit hardest taxpayers in the $100,000-$500,000 income range. Congress doesn’t want to anger that many potential campaign contributors. But where will Congress find the $68 billion or so of income that the AMT is budgeted to raise next year without a patch? The six month unemployment extension failed yesterday in the Senate because it would have increased the deficit by $34 billion.

So what will happen? Presumably an AMT patch will pass to appease voters as the election approaches, deficits be damned. Still, that’s not certain, especially in the current political environment.

So what can taxpayers do? They should start by projecting their tax for 2010. If you have one, your tax preparer is likely to have software to enable you to run the projection. If you use home tax software, it may also include a tax projection feature. Otherwise, you will have to use a 2009 copy of Form 6251, but using the reduced 2010 exemption amounts. Then you should fiddle with some items that affect AMT:

• The timing of your state and local tax payments.
• The timing of your miscellaneous itemized deductions.
• The timing of your capital gains, including capital losses.

Don’t be surprised if you find you have alternative minimum tax no matter what you do, especially if you live in a high-tax state. Then call your Congresscritter and ask for your patch.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Franken’s Monster: State Taxes for the Traveling Employee

He’s good enough, he’s smart enough, and doggone it, the state revenue departments loved Al Franken — once he paid $70,000 in back taxes.

Like many celebrities, Mr. Franken took his act on the road, making a good living on gigs in various states. Unlike many celebrities, Franken ran for office, subjecting his tax life to unnatural scrutiny. It turned out that he hadn’t filed taxes in every state wher

$70,000 of back taxes paid to 17 states later, Mr. Franken squeaked into the U.S. Senate by the narrowest of margins.


Franken has a lot of company in going from state to state without paying all of his taxes (he also has a lot of company in dumping on his accountant to weasel out of the blame). It’s a lot of work, and a lot of expense, for a traveling worker to pay taxes in every state. Every state has its own tax rules, and preparing all those returns isn’t cheap. Unfortunately, current law can make you taxable in a state with as little as one day of work.

State taxes are a compliance nighmare for glamour professions like sports, entertainment, construction and auditing. That’s why the Multistate Tax Commission is working on model legislation that would exempt workers from state taxes if they work in a state for less than 20 days in a year. That is, unless they work in sports, entertainment or construction (perhaps the only known instance where auditors aren’t abused worse than other professionals). A bill going nowhere in Congress, the Mobile Workforce State Income Tax Fairness and Simplification Act, would would create a 30-day threshold, but similarly screw entertainers and athletes, but not construction workers.

This raises the obvious question: why do they want to screw the athletes and entertainers? Presumably the states all want to pick Taylor Swift’s pocket (understandably), but for every Taylor Swift there are hundreds of struggling young musicians trying to scrape by and make a name for themselves. Yet the tax law, in all its majesty, requires the same level of tax compliance for millionairess Taylor Swift and the wonderful, but surely less prosperous, Carrie Rodriguez.

Small businesses used to be able to blow off states they only visited for a brief time. That’s becoming a bad bet. Better and cheaper data mining software makes it easier each year for state revenuers to sniff out temporary presence. If there is any publicity for your visit, you leave a Google trail. If you don’t file in a state, the statute of limitations never runs there, and you can build up a painful multi-year liability. If they catch you after the statute of limitations for your home state runs out, you lose your credit on the home state return for taxes paid in the other state — meaning you pay tax on the same income in two states.

So what do you do if you are a small business? Pay attention to which states you are doing business in. Don’t assume they just won’t notice you. Discuss things with your tax preparer. If you have sinned, most states will work out a deal through your preparer to only collect for a few years, and maybe waive penalties, if you come forward before they catch you. And remember that if you live in a high tax state, like California, New York or Iowa, you should be able to get an offsetting refund on your home state return for non-resident state taxes on an amended return for open years.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Tax Court: Don’t Bet Your Bass on Those Hobby Losses

One of the promised benefits of feminism was that both men and women would reap benefits from allowing women to achieve their potential in the workforce. And for Mr. Steve Lowe, it absolutely worked that way.

The Tax Court gives a hint at Mrs. Lowe’s achieved potential:

During the years at issue petitioner wife (Mrs. Lowe) worked full time as a “controller” for Fry Steel Co., where she has worked for over 38 years. She earned $177,219 and $184,181 in 2005 and 2006, respectively, with an additional $12,000 per year for taking notes at the board of directors meetings.

And how did that work out for Mr. Lowe?

In 2005 Mr. Lowe fits run by either American Bass, FLW Strem Series, or Western Outdoor News (WON) and reported gross income on petitioners’ Schedule C of $4,241. In 2006 Mr. Lowe fished in 15 tournaments run by those same organizations and reported $10,932 of gross income. The entry fees ranged from $280 to $825 with an additional $325 for a “coangler” amateur in FLW events.

Yes, Mrs. Lowe’s empowerment enabled her to hold down a fulfilling and well-paid job, freeing her husband to follow his dreams – to go fishing every day.

The only thing that could possibly be better than fishing every day while your wife brings home a nice paycheck is to get a tax deduction for fishing every day while your wife brings home a nice paycheck. And Mr. Lowe gave it a try, deducting $49,067 of fishing expenses in 2005. Unfortunately, he hooked a snag.

The tax law disallows losses from activities “not engaged in for profit” – the so-called “hobby loss” rules. The Tax Court summed it up (my emphasis):

Mrs. Lowe earned substantial income from her job at Fry Steel Co., and the losses from Mr. Lowe’s fishing activity resulted in substantial tax benefits. During the years at issue Mrs. Lowe earned an average of about $180,000 a year from her job, and petitioners were able to deduct an average of about $41,000 per year on their joint Federal income tax returns due to Mr. Lowe’s fishing activity losses. Mr. Lowe was not employed before the fishing activity and was able to pursue this activity because of Mrs. Lowe’s substantial income. We also note that Mr. Lowe fished for recreation and pleasure long before commencing his competitive bass fishing activity. He clearly enjoyed that activity and likely would have incurred significant fishing costs yearly for personal pleasure had he not conducted his claimed business activity.

The case illustrates some hobby loss red flags:

• The activity loses money and shows no sign of doing otherwise – It’s fishing, for heavens’s sake.

• The losses offset significant other income – If you would be getting the earned income credit otherwise, the IRS doesn’t invoke the hobby loss rules.

• The activity is fun – If your money-losing business can be perceived as fun – like fishing, say, or playing slots – it’s that much harder to convince the IRS that you’re really in it for profit. Remember, though, that even miserable activities (like selling Amway or writing blog posts) can run afoul of the hobby loss rules.

So Mr. Lowe lost his deductions. The Tax Court waived penalties, though, and Mr. Lowe, as far as we know, still can fish every day while his wife works. Millions of red-blooded men would take that deal, even without tax deductions.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Lazarus Was a Piker or: How the Extenders Bill Resurrects Bad Tax Provisions Year After Year

The Book of John says that Lazarus emerged from his tomb four days after his death. While impressive, Lazarus has nothing on the Section 41 Research Activities Tax Credit. While Lazarus is credited with only one extension, the Research Credit, first enacted in 1981 as a temporary measure, it has been extended at least 12 times — several times after it had expired.

If it’s such a wonderful tool for our economy, as its beneficiaries always say, and if it isy isn’t it just made permanent? There are two main reasons, one only slightly less cynical than the other.


First, the credit costs the government a lot of revenue. The one-year extension in H.R. 4213, the current “extender” bill, is scored as a $6.6 billion revenue-loser. By extending it only a year at a time, the Congresscritters disguise the real cost of the credit, which they have no intention of allowing to expire. Remember this phony accounting the next time some corporate shmoe trembles while Henry Waxman berates his accounting methods.

Even more cynical: it forces the lobbyists for the credit to pay tribute to their Congressional patrons every year to keep their pet corporate welfare provisions alive. A former Congressional staffer explains (my emphasis):

I never understood the “why” about expiring tax provisions until one very late night markup of the “extenders bill” several years ago while I was working for the Ways and Means Committee. Bleary-eyed, one of usually twinkly-eyed members plopped down in a chair next to me in back of the dais–just to take a little rest away from his member’s seat. I asked him “why do we have to do this every year?…why can’t we just pass these things permanently?”

His eyes suddenly twinkled again, as he looked at me with a combination of amusement and disbelief. He said: “Are you kidding me?… We couldn’t do that!… Why, I’d lose all my friends!…Who would come visit me and say kind things to me and do nice things for me then, if they didn’t have to come back every year to ask for these tax provisions?!!”

The research credit is just one of 70 or so “temporary” provisions included in this year’s omnibus “extender” bill. Other tax breaks critical to the continued robust functioning of the economy include the Indian employment tax credit, the special short depreciation life for qualified leasehold and restaurant improvements, subsidies for biodiesel, and the all-important “7-year recovery period for certain motorsports complexes.”

To “pay for” these “temporary” provisions, Congress each year reaches deeper into its bag of tricks for permanent tax increases. The chumps this year: private equity, hedge funds, and small professional corporations. When these things “expire” a year later, this year’s victims will continue to pay their higher tax without Congress having to pass another bill; they will be forgotten while Congress is busy looking for its next revenue fix. And like any junkie, it will give up the addiction only when it’s impossible to score.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

S Corp Shareholders Are Going to Have Basis Issues at Year End – Four Things for Them to Keep in Mind

When somebody repays a loan, that’s not income to the lender, is it? It can be when a shareholder loans money to an S corporation. New York businessmen Ira and Sheldon Nathel learned that the hard way in court this week. Ira and Sheldon each owned shares in food distributors that were set up as S corporations. When you own an S corporation you may deduct corporate losses on your 1040, but only if you have basis in your S corporation stock or in loans you have made to the corporation (guarantees of corporate debt don’t work).

Yes, there’s a catch. When you take S corporation losses, they reduce your basis — first in your stock, then in your loans. Subsequent income, including tax-exempt income, restores your basis in your debt andr. If you repay a loan with reduced basis, you have taxable income to the extent the repayment exceeds your basis.


At the end of 2000, IRA and Sheldon each loaned $649,775 to one of their S corporations. That enabled them to take losses of $537,228 or so, leaving them with $112,547 in remaining loan basis. That would have been fine if they had waited patiently until S corporation income had restored their basis. Their patience ran out in February 2001, when they repaid the loan in full.

They may have had second thoughts. In August 2001 Ira and Sheldon each made a capital contribution to the S corporation — $537,228, coincidentally. They then took a novel position on their 2001 tax returns. The Second Circuit Court of Appeals takes up the story:

In calculating their 2001 taxes, the Nathels treated their capital contributions… as constituting “tax-exempt income” to the corporations for the purposes of § 1366(a)(1)(A). Therefore, because the Nathels’ bases in their stock previously had been reduced to zero and because their bases in the loans they made to the corporations were also reduced, the Nathels used their capital contributions to restore their bases in the loans pursuant to § 1367(b)(2)(B). Without such an increase in their bases, the petitioners would have been taxed on the ordinary income that would have resulted from the corporations’ repayment of the petitioners’ loans in amounts above the petitioners’ previously reduced bases.

The IRS didn’t buy the idea that a capital contribution was some sort of income. They said a capital contribution increases capital, not debt, and is allocable to stock basis. That meant $537,228 in ordinary taxable income. Unfortunately for Ira and Sheldon, the Tax Court, and now the Second Circuit, continue to recognize the capital/income distinction that has been around for approximately forever.

The economy being what it is (still crappy), lots of S corporation shareholder are going to have basis problems at year end. They should keep a few points in mind:

• Basis is necessary to deduct losses, but it isn’t sufficient – Your basis has to be “at-risk” and you have to clear the maze of the “passive loss” rules.

• Use caution when repaying loans – When you make a year-end loan to your S corporation to enable you to deduct losses, repaying the loan will trigger taxable income until the loan basis is restored by subsequent S corporation income.

• “Open account” loans can be tricky – Regulations split “open account” debt into separate “loans” when the loan amounts exceed $25,000. That means fluctuating open account balances during the tax year can lead to taxable income, even if the balance ends up higher at year end than it was at the start of the year.

• Related party issues – It’s dangerous to borrow from one S corporation you control and loan the funds to another one. The IRS likes to attack such loans as lacking substance.

So Ira and Sheldon get to write some big checks to the IRS. They have the consolation of having $537,228 more basis in their stock, to offset other income somewhere, somehow, someday.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Doing Penance for John Edwards’ Sins: Provision Could Hit “Skilled” S Corp Owners

Long before John Edwards became known as a well-coiffed skirt-chasing weasel, he was a well-coiffed successful trial lawyer. He was successful enough to afford good tax advice, so he conducted his law practice in an S corporation.

Back in the old days, professional practices were conducted as sole proprietorships or general partnerships, reportable as self-employment income, subject to the 15.3% self-employment tax up to the FICA base (currently $106,800), and to the 2.9% Medicare portion of the tax to infinity.


When state laws allowed professionals to incorporate, attorneys and accountants quickly noticed that income on S corporation K-1s is not subject to self-employment tax. This makes S corporations a popular way to run a professional practice. The professionals take a “reasonable” salary out of the business (subject to employer and employee FICA and Medicare tax) – enough to not raise IRS eyebrows – and take the rest out as S corporation distributions with no employment tax.

John Edwards did well by this. His law practice generated millions dollars of K-1 earnings in excess of his salary, saving him hundreds of thousands of dollars in payroll and self-employment tax.

Now that he has been reduced to a wealthy target of mockery, Congress is ready to crack down on the John Edwards S corporation tax shelter. The annual “extenders” bill has a provision – almost as absurd as Edwards love life – that will hit professional S corporation K-1 income with self-employment tax. The SE tax will apply when the “principal asset” of the S corporation is the “reputation and skill” of three or fewer professionals – defined for this purpose as “services in the fields of health, law, lobbying, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, investment advice or management, or brokerage services.”

Congress doesn’t muss its hair worrying about how taxpayers in multi-owner S corporations are supposed to figure out whether its “principal asset” is the “reputation and skill” of three or fewer owners. However it works, this provision is too late to hurt John Edwards — his reputation isn’t much of an asset anymore.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Don’t Get Too Anxious to Stuff Just Anything into Your IRA

Individual Retirement Accounts are a taxpayer’s dream, with constraints. The income they earn isn’t taxed until you distribute it; with a Roth IRA, it may never be taxed. It’s only natural for taxpayers to stuff anything they can that might generate income into an IRA.

That can be a terrible mistake.


Not everything is tax free in an IRA. Interest, dividends, capital gains – that stuff is fine. But beyond that things can get ugly.

Most problems arise when taxpayers try to use their IRAs to finance business ventures. Because IRAs are shirttail relatives of qualified pension and profit sharing plans, many pension plan rules, like those for prohibited transactions, bedevil IRAs, with taxes that can exceed 100%.

When an IRA owns an interest in a “passthrough” entity – usually a partnership, because most S corporations can’t have IRA shareholders – another complication arises. The tax law frowns on tax-exempt competition for taxable business. The frown takes the form of the “unrelated business income tax,” or UBIT. The UBIT hits otherwise tax-exempt entities with an income tax on their “unrelated business income.”

If an IRA owns an interest in a partnership (most LLCs are taxed as partnerships) that operates a trade or business, the IRA’s LLC income may be subject to UBIT, which applies at corporate tax rates. UBIT can also apply to an IRA if it owns an interest in mortgaged rental real estate. Some IRAs even run into UBIT by investing in publicly-traded energy partnerships, like Buckeye Partners, LP. Many states also have unrelated business income taxes.

The partnership is required to break out unrelated business taxable income and report it to the IRA. The IRA in turn must provide a tax identification number to the partnership to make it easier for the IRS to follow the UBIT to the IRA.

When an IRA is subject to UBIT, it can cause some awkward moments between the IRA investor and the trustee. Most IRA trustees want nothing to do with filing Form 990-T, the UBIT return. Of course the IRA owner doesn’t like the idea either, but it needs to be done. Having income tax in an IRA is especially ugly when it’s a Roth IRA, which normally would otherwise be tax-exempt forever, inside and out.

The threshold for filing a 990-T is “gross income” of $1,000 or more. Gross income is normally higher than taxable income – it is the IRA’s share of gross receipts less cost of goods sold, not reduced for any other expenses.

So be careful what you stuff into your IRA. Just because you can put something in there doesn’t mean you should.

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

One Diligent CPA Forced the IRS to Use a ‘Staggering’ Amount of Resources

Sure, NYU has produced lots of fancy-pants tax lawyers. And many high-powered big-school tax accountants haunt the cubicles of the Final Four accounting firms. But if driving the IRS to distraction is a mark of tax distinction, an obscure Kansas City attorney/CPA, formerly of Grant Thornton and Coopers and Lybrand, is a true tax all-star.


Or was. A federal judge this week made it inconvenient for GT alum Allen R. Davison to pursue his tax practice by enjoining him from marketing some of his most creative ideas:

Davison is hereby enjoined from organizing, establishing, promoting, selling, offering for sale or helping to organize, establish, promote, se any tax plan, as addressed herein, involving sham parallel C management companies, sham 412(i) plans, sham flock contracts or any other illegal tax scheme, plan, or device, even if not specifically addressed herein. Additionally, Davison shall not organize, establish, promote, sell, offer for sale or assist in any financial or tax related arrangement without submitting in writing to an IRS designee, a detailed plan explaining the financial or tax arrangement and all steps necessary for the arrangement to be legal under the tax code.

That would all be rather inconvenient for a practitioner. Why are the feds so down on Mr. Davison? From the injunction order:

Davison’s numerous, complex, ever-changing, tax-fraud schemes and his deliberate efforts to disguise his true involvement in the promotion of these tax-fraud schemes have required the IRS to expend a “staggering” amount of resources on discovering and combating these schemes. If this outlay of resources continues – and it almost certainly will continue in the absence of an injunction barring Davison from offering tax advice without significant restraint, then these resources will not be available to service honest tax paying Americans. Nor will these resources be available to investigate other promoters of tax-fraud schemes.

What were these “schemes”? Some of them used “management fees” to shift income from taxable businesses to sham S corporations owned by tax-exempt ESOPs or Roth IRAs. Others involved improper pension plans. But good old Midwestern farm ingenuity was behind what may be his most creative plan:

Davison drafts purported flock contracts for his clients. (Tr. 398:21-399:4). He argues that by executing these agreements, his clients become farmers, who are eligible to claim deductions for the cost of purchasing a flock of layer hens during the tax year in which that cost is incurred, pursuant to Revenue Ruling 60-191. (Tr. 412:10-20; PX 165). That revenue ruling provides “that farmers employing the cash method of accounting may deduct the cost of baby chicks and egg laying hens in the year of payment therefor, provided such method is consistently followed and clearly reflects income.”

The judge found that Mr. Davison has an overly-inclusive view of what “farming” means. The judge said that a guy with dirty boots who actually fed and raised chicks might be a farmer, but a “self-employed insurance salesman,” for example, who loaned money to a real farmer, did not.

There are many fascinating threads here, but let’s just hit three for now:

• Mr. Davison began selling many of these ideas while working for Grant Thornton, and according to the court order, marketed them through a network of CPA firms set up by GT alums. Networking pays!

• The elaborate system of preparer registration, testing and continuing education that IRS Commissioner Shulman is ramming through will spend enormous resources making honest and competent preparers jump through hoops; they would have done nothing to stop Mr. Davison. Shulman’s plan will spend money on driving honest preparers crazy with paperwork rather than chasing scammers.

• The cash-basis chicken flock technique that is outrageous for an insurance salesman is hunky-dory when done by a wealthy farmer. Because America Needs Farmers!

Joe Kristan is a shareholder of Roth & Company, P.C. in Des Moines, Iowa, author of the Tax Update Blog and Going Concern contributor. You can see all of his posts for GC here.

Closely-Held Corporations May Want to Take a Bullet Over the Pending Dividend Tax Hike

As a role model, Andrew Jackson has serious shortcomings, not least his penchant for genocide. But some of his policies are back in vogue, like the casual destruction of the national banking system. Taxpayers may be choosing to be like Andy in another way before the end of t had the bad fortune to get crossways with Charles Dickinson, one of the best pistol shots in Tennessee, when dueling was still fashionable. He met his antagonist across the state line in Kentucky, where duels were legal. Jackson was serious about this one, so he decided to take all the time he needed to do Dickinson in. Given Dickinson’s marksmanship, that meant accepting a bullet. Sure enough, Dickinson’s shot hit home:

The bullet struck him in the chest, where it shattered two ribs and settled in to stay, festering, for the next 39 years. Slowly he lifted his left arm and placed it across his coat front, teeth clenched. “Great God! Have I missed him?” cried Dickinson. Dismayed, he stepped back a pace and was ordered to return to stand on his mark.

Blood ran into our hero’s shoes. He raised his pistol and took aim. The hammer stuck at half cock. Coolly he drew it back, aimed again, and fired. Dickinson fell, the bullet having passed clear through him, and died shortly afterward.

Taxpayers owning C corporation stock might also want to take a bullet, figuratively speaking, this year. That’s because the tax rate on dividends will either leap or soar in 2011.

The increase in the dividend rate is a consequence of the scheduled expiration of the 2001 Bush tax cuts after this year. Prior to the Bush administration, dividends were taxed as ordinary income. As dividends are distributions of corporate income already taxed at a corporate rate as high as 35%, that meant a combined rate of 57.75%. The Bush tax cuts tied the dividend rate to the capital gain rate, now 15%.

When the Bush tax cuts expire, the capital gain rate is set to return to 20%. But without Congressional action, dividends will again be taxed as ordinary income. Given the size of the deficit, the poisonous election-year political atmosphere, and that the President promised to hold the dividend rate to 20%, it’s likely that dividends will be taxed as ordinary income in 2011. That would means a 164% increase the top dividend rate.

But wait, there’s more! Starting in 2013, Obamacare will tack another 3.8% to the top rate on investment income, resulting in a top dividend rate of of 43.4%, making the total tax increase over 189%.

This makes it tempting to take the bullet – a big 2010 dividend out of a closely-held C corporation. It will be especially attractive for shareholders who lack the ability to suck out corporate cash using the usual tricks of shareholder bonuses or rent payments.

Yes, it means taking a bullet. Taking dividends out of closely-held corporations breaks the rules of the C corporation tax planning crib book. Taxpayers go to elaborate lengths to avoid taking income before they have to. But a 189% tax increase might be enough to make some taxpayers take the bullet, like Andy, for the greater good.

When a Tax Time Bomb Goes Off: Repurcussions Await Some Small Nonprofits

At the end of the day on Monday, May 17, hundreds of thousands of little tax-exempt organizations will to turn into taxable little pumpkins. Under a provision of the Pension Protection Act of 2006, tax-exempt organizations that had been small enough to fall below IRS filing thresholds were required to start filing information reports. The law automatically revokes the exempt status of organizations that fail to file for three straight years. The deadline for that third year is May 17 for calendar-year filers.

Of course many of these organizations are inactive or defunct, but many aren’t. That means thousands of volunteer garden club, school parent organization and social club volunteer treasurers will unwittingly find themselves in charge of filing tax returns for their newly-taxable little corporations.


If you are an exempt organization treasurer or board member, you should find out right now whether your organization has filed. If your organization normally takes in less than $25,000 per year, the filing is a very simple on-line process, mostly just asking for identifying information. Bigger outfits will have to file a version of Form 990. If you need extra time, you can get a three-month extension on Form 8868. Some organizations, mostly governments and religious entities, are exempt from the filing and revocation rules.

But what will happen when these outfits lose their exempt status? They can ask for it back retroactively by filing Form 1023 or Form 1024 and paying a fee from $250 to $800. But many of these outfits will have no idea that they have lost their exempt status. What happens to them?

Most will become taxable C corporations or, in some cases, a taxable trust – depending on how they are set up. They will have income – for example, from contributions or dues – and they will be subject to normal Form 1120 filing requirements. If they fail to file, the normal kind and gentle penalties will accrue. Nobody really knows what the IRS will do about all of these little unwitting scofflaws.

And for what? Senator Charles Grassley explained back when the bill was passed in 2006:

The pension bill includes a good package of charitable giving incentives and loophole closers. It makes sense to tighten areas of abuse while increasing incentives for charitable giving. Americans are very generous with their donations. They deserve to know that their money helps the needy, not the greedy. Some individuals are creative about exploiting non-profits’ tax-exempt status for personal gain, and Congress has to be just as smart about shutting down abuse.

So take that, you greedy, abusive volunteer booster club treasurers! @ChuckGrassley has your number.