My chronicle of how the IRS and Tax Court affect taxpayers' daily lives.

See below for important disclosures.

Friday, August 20, 2010

Thoughts and Musings

It has been a LONG time since I've posted, so here are just a few random things from today's readings:

From the TaxProf Blog:
The Top 10 Highest State Income Taxes: All Obama Blue States

Forbes, States (And Bill Gates Sr.) Look to Soak the Rich, by Ashlea Ebeling:

1.   Hawaii: 11% (income over $400,000 (couple), $200,000 (single))
2.   Oregon: 11% (income over $500,000 (couple), $250,000 (single))
3.   California: 10.55% (income over $1 million)
4.   Rhode Island: 9.9% (income over $373,650)
5.   Iowa: 8.98% (income over $64,261)
6.   New Jersey 8.97% (income over $500,000)
7.   New York: 8.97% (income over $500,000)
8.   Vermont: 8.95% (income over $373,650)
9.   Maine: 8.5% (income over $39,549 (couple), $19,749 (single))
10. Washington, D.C.: 8.5% (income over $40,000)
From Reuters
The Congressional Budget Office has estimated that the Troubled Asset Relief Program will cost about $66 billion overall, down sharply from an initial estimate of $350 billion. As the price of the program falls, controversy surrounding it appears to fade, according to Reuters. However, lawmakers who voted for the program might face challenges as the election nears.

Thursday, June 3, 2010

Reasonable Compensation in S-Corporations

Watson v. US (DC IA 5/27/2010)

A recent district court case indicates that the courts are siding with the Internal Revenue Service in the area of reasonable compensation.  Mr. David Watson was the president of an accounting firm, Larson, Watson, Bartling and Jeffer.  He owned his portion of LWBJ through a Professional Corporation taxed as an S Corporation (David E. Watson, PC) owned exclusively by Mr. Watson. 

In 2002 and 2003, DEWPC paid Mr. Watson a salary of $24,000 per year, while distributing $118,000 and $221,000 in dividend distributions respectively. 

In February of 2007, the IRS assessed nearly $50,000 in taxes, penalties and interest against DEWPC after it determined that around $305,000 of the dividend distributions should have been wages subject to employment taxes. 

S-Corporations are tax efficient entities where income, losses, deductions, and credits flow through the entity to their respective owners.  Dividend distributions received by the owners are not subject to corporate dividend tax rates (15%) or employment taxes.  Instead, the net taxable income from the company is subject to income tax, regardless of distributions. 

The tax structure of an S-corporation can tempt some owners to avoid paying employment taxes by having officers treat their compensation as cash distributions rather than wages.  The penalty for misclassifying wages is steep - up to 25% for failure to withhold taxes. 

Aaron's Take:  Mr. Watson's salary was unreasonably low, as his $2,000 per month salary was substantially less than his monthly living expenses.  He worked an average of 35 to 45 hours per week for 46 weeks out of the year, bringing his hourly salary to about $10.30 per hour, unreasonably low for any accountant. 

The IRS has issued Fact Sheet 2008-25 listing factors the IRS has considered in determining reasonable compensation, which includes: training and experience, duties and responsibilities, dividend history, timing and method of payment, comparable pay for similar service, and others. 

If you are concerned that your salary may be too low, check and other resources available to your profession. 

Wednesday, May 26, 2010

James C. Bourke, CPA wrote today on the importance of passwords of portable electronics.  In today's world, where Blackberry and iPhones contain confidential client information, it is important to utilize appropriate built-in encryption and password capabilities.

He recommends:
Securing portable devices combines many different techniques. For example, you probably have one or more passwords that need to be entered before accessing data. Be smart and keep these in mind when using and creating passwords:

The Obvious — Create a strong password that you can easily remember and protect it from prying eyes.

Length and Complexity — Use at least 14 characters. The greater the variety of characters in your password, the better. Use the entire keyboard, not just the letters and characters you use or see most often.

Avoid — Dictionary words in any language; words spelled backwards, common misspellings and abbreviations; sequences or repeated characters; using personal information.

Test Your Password — Try Microsoft offers some good guidance on creating strong passwords.
I carry my Blackberry wherever I go, and I do have a password requirement.  I have to enter it dozens of times a day to get at my information, however that is a minor inconvenience compared to protecting my client information.

Thursday, May 13, 2010

Unbelievable story about digital copiers and security.  I hope all tax professionals take note.  (Hat tip to Jorge R., a client who brought this to my attention)

TurboTax as a penalty defense

Taxpayers' 2004 and 2005 joint Form 1040 were prepared using TurboTax. The wife reported expenses for her real estate business as well as unrelated losses on a single Schedule C. Adjustments to this schedule resulted in most of taxpayers' deficiencies and the resulting Section 6662 accuracy-related penalties, and primarily stemmed from the IRS disallowing taxpayers' reported rental losses and recharacterizing the trading losses as capital losses. At trial, the wife argued that they consistently filled out their tax returns using TurboTax and she consistently confused capital gains and losses with ordinary income and expenses. In rejecting taxpayers' misuse of TurboTax, even if unintentional or accidental, as a defense to the penalties, the Tax Court noted that "tax preparation software is only as good as the information one inputs into it." Aileen Yat Muk Lam , TC Memo 2010-82 (Tax Ct.).

Aaron's Take: This is a common argument in penalty abatement, however it rarely rises to the level of Tax Court.  These taxpayers should have quit while they were ahead.  Though, in certain circumstances, you can place the blame for a substantial understatement on your tax preparer, your tax software is not considered a "tax professional" capable of rendering appropriate decisions no your behalf.  Sounds like it would have been a lot cheaper for this couple to hire and Enrolled Agent or CPA.  

Tuesday, May 11, 2010

Tuition tax credit bill is signed by Gov. Brewer

Arizona made minor modifications to the private School Tuition Organization Tax Credit. Unfortunately, the legislature ignored gigantic and glaring loopholes in the program, appointing AzDOR to certify the programs, but provided no funding to do so. The changes, however, will shed light on just how many wealthy people's kids are being sent to private school for free. Well, not really for free, considering these credits raid the state funds in order to provide scholarships for folks who would be going to private school anyway.

Tuition tax credit bill is signed by Gov. Brewer
(Arizona Republic - Valley & State 5/11/10)

Tuesday, March 23, 2010

Aaron was interviewed for a Fox 10 News story on Tax Preparers

Saturday, January 23, 2010

Ex-Spouse is assesed Trust Fund Recovery Penalty

Jeane L. Dintelman, v. United States of America, U.S. District Court, E.D. Arkansas, 2010-1 U.S.T.C.  (Jan. 7, 2010)

A husband and wife incorporated an entity which listed the wife as the President of the company (with the thought that a woman-owned business would be eligible for more contracts), even though she had lmiited responsibilities and duties in the business.  Subsequently the couple split up, even though the wife remained as an employee of the company. 

The finances, handled by the ex-husband, were in shambles, and the company failed to pay their employment taxes.  The IRS has the ability to pierce the corporate veil and assess these taxes to an individual taxpayer if they are deemeed to be a "responsible party."  The ex-wife, who was not involved in the mangagement of the company until its struggles became obvious to her, was still deemed a responsibile party by the courts. 

Aaron's Take:  If you are taking the title of President or CEO of a company, you best be involved intimately in all the activities of the business.  Love and Business are two distinct and separate activities, and you should never sign something just because your spouse tells you to.  My wife sure doesn't!  She even reviews our tax returns, even though she knows I'm "the expert!"

How to find out you're being audited long before an agent shows up!

The IRS has issued Tax Tip 2010-13 reminding taxpayers how to obtain transcripts and copies of previously filed tax returns.  A taxpayer may obtain, for free, tax return transcripts, which are summaries, or account transcripts, which show activiy such as IRS communication, filed extensions, assessment, tax return filing dates, payment informatin, and balances due. 

The transcript may then be used for lending purposes, if the loan requires the individual's tax returns.  The IRS provided transcript will confirm marital status, adjusted gross income, and taxable income.  Taxpayers may request these reports over the phone (800 829-1040) or by filling out form 4506T.  The transcripts shoudl be received between 10 and 30 days from when the IRS receives the request. 

An actual copy of a previously filed tax return may be obtained by filing Form 4506, Request for Copy of Tax Form. A fee of $57 per tax year will be assessed and the request will take much longer (up to 60 days). Copies may be obtained for the current year and the past six years.

Aaron's Take:  The transcript may also give you up to a 6 month head start on preparing for an audit.  Recently, more activity codes have been showing on transcripts which may indicate "return selected for audit."  If caught early enough, you can begin preparing for an audit long before it is ever assigned to a Revenue Agent (auditor). 
Aaron Blau, E.A. is the Vice President of the Central Arizona Chapter of Enrolled Agents and a member of the Government Relations Committee of the National Association of Enrolled Agents. The opinions and ideas expressed here are in no way representative of the official position of the National Association of Enrolled Agents, Arizona Society of Enrolled Agents or the Central Arizona Chapter of Enrolled Agents.

For official comments, please e-mail NAEA Director of Communications at or Arizona Society president

"To ensure compliance with the requirements imposed by the IRS, we inform you that, to the extent this communication (or any attachment) addresses any tax matter, it was not written to be (and may not be) relied upon to (i) avoid tax-related penalties imposed under the Internal Revenue Code, or (ii) promote, market or recommend to another party any transaction or matter addressed herein (or in any such attachment). In addition, nothing herein is intended to convey an expression of an opinion as to the likelihood a tax position would ultimately prevail if challenged by the IRS. This communication is intended solely for the person to whom it is addressed; no one else should rely on the tax advice provided herein. The person to whom this advice is addressed is under no obligation to keep the advice or matters related to the advice confidential."