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June 9, 2009

Federal Headlines

IRS E-Administration Director Labels Recent Filing Season "Very Successful"; Advancing E-file Study Moves to Phase 2

 

The IRS had a very "successful filing season" and experienced "significant growth in e-filing," reported David Williams, director, Electronic Tax Administration and Refundable Credits, IRS. Speaking at the 2009 IRS Software Developers Conference in Arlington, Va., on June 8, Williams was generally upbeat over progress made on e-filing as the IRS continues to make progress toward the 80-percent e-file goal set by Congress.

Online Filing Increases

 

Williams reported that there was a 20-percent growth rate in online filing. He attributed the increase to taxpayers becoming "more comfortable interacting electronically" as well as the "elimination of separate e-filing charges."

 

The IRS also experienced a growth in online PIN returns, which, Williams revealed, caused a rise in call volume at the IRS because taxpayers were trying to get their adjusted gross income (AGI) so they could file electronically. Nevertheless, the IRS did not see a decline in e-filing because of this change.

Free File Usage Drops

 

Williams also reported that the IRS saw a "significant" drop in Free File usage, "despite improvements in the program" and Free File's availability to approximately 100 million taxpayers. Williams theorized that the decline may have been caused by the tax software industry's offer of free products and significant marketing of those products during the filing season. Williams also commented that, with Free File agreements ending in 2009, the IRS will be looking at ways to renegotiate those agreements.

Healthcare Proposals Effect on Tax Administration

 

Williams revealed that with the Tax Code's continuing and increasing importance to Congress for serving as "a place to go to enact what used to be spending provisions," the IRS continues to be concerned with how to effectively "administer things that are coming to us, which is mostly refundable credits." He expects that, with healthcare high on Congress's agenda, the IRS and Congress will be examining how to administer the Tax Code's health-care provisions.

Advancing E-file Study

 

The IRS Advancing E-file Study is a major effort to collect and analyze all substantial data on the IRS e-file program in order to help the IRS validate and launch future studies, research, and other activities to meet the congressionally set goal of an 80-percent e-file rate. The IRS has completed Phase 1 of the study, which contains various options for e-filing and to increase e-filing by taxpayers. The Phase 1 study is available online.

 

Williams said that he plans to internally circulate a draft of the study's second phase within the next month seeking input on the filing options set forth in the draft. Williams could not commit to a public release date of the draft.

 

By H. Goehausen, CCH News Staff

IRS Failed to Prove Tax Shelter Exception to Tax Practitioner Privilege Applied (Countryside Limited Partnership, TC)

 

Related entities taxed as partnerships for federal income tax purposes did not have to provide the IRS with meeting minutes and handwritten notes recording communications with their federally authorized tax practitioner (FATP) about various partnership redemptions. Generally, Code Sec. 7525 provides a limited privilege to communications regarding tax advice between a taxpayer and any FATP. An exception exists, however, for written communications promoting any tax shelter.

 

In this case, the meeting minutes did not met the exception to the FATP privilege because the IRS failed to prove that they involved the "promotion" of a tax shelter. The FATP had a long and close relationship with the taxpayers, preparing returns, assisting with tax planning, responding to Federal and State tax officials on their behalf. Advising the taxpayer's with the tax aspects of the redemptions was a regular part of his practice. Moreover, the FATP's employer received no additional fees for any potential savings from the transactions. It was paid for the FATP's advice regarding the transactions as it was for any other service provided by the FATP outside of preparing returns. The written communication promoting tax shelters exception is not meant to adversely affect routine relationships such as the one that existed between the FATP and the taxpayers.

 

The IRS was also not entitled to the handwritten notes taken by one of the taxpayer's partners recording confidential communications with the FATP regarding tax advice received while discussing the partnership redemptions. The notes did not constitute a "written communication" under the exception to the FATP privilege as they were not communicated to anyone but merely were a record of the points of the discussion.

 

Related decision at 95 TCM 1006, Dec. 57,304(M), TC Memo. 2008-3.

Countryside Limited Partnership, 132 TC No. 17, Dec. 57,846

Other References:

 

Code Sec. 7525

 

CCH Reference - 2009FED ¶42,816F.25

 

Tax Research Consultant

 

CCH Reference - TRC IRS: 21,404

Corporation Entitled to Bad-Debt Deduction; Denied NOL and Partially Denied Owner's Legal Defense Expense Deductions (HIE Holdings, Inc., TCM)

 

A corporation wholly owned by an individual was denied deductions for claimed net operating losses, allowed claimed bad-debt deductions, partially denied a deduction for professional fees incurred for the benefit of the owner, and the owner was subject to tax on any of the fees for which the deductions were denied. The corporation was involved in many retail and vending businesses, including the sale of coffee and cigarettes. The owner was charged with and convicted of several counts of tax evasion, the defense of which was paid for by the corporation.

 

The corporation was not entitled to a deduction for net operating losses under Code Sec. 172 for state tobacco tax refunds it claimed to have accounted for prematurely. The corporation presented no credible evidence that the refunds were ever actually received, as state tax filings did not indicate any offsets or overpayments of taxes. Further, the theory upon which the corporation claimed to be entitled to the refund was not valid under the laws of the state.

 

The corporation was entitled to a bad-debt deduction under Code Sec. 166 for amounts owed by the mistress of the corporation's owner. The corporation claimed that the owner transferred assets from the corporation to the mistress to hold in trust to pay to the owner's ex-wife in satisfaction of a divorce settlement. However, the corporation failed to provide credible evidence establishing that this event even occurred and, if it had occurred, that a valid creditor/debtor relationship was established. Nonetheless, the corporation's claim to a bad-debt deduction was upheld because a state court entered a judgment requiring the mistress to pay money to the corporation, and a creditor/debtor relationship was thereby established. In the proceedings for the mistress's bankruptcy petition, the debt was settled for a lesser amount, and the corporation was entitled to a deduction under Code Sec. 166 for the difference.

 

The corporation was entitled to deductions, as trade or business expenses under Code Sec. 162, for some of the professional fees incurred by a wholly owned subsidiary corporation in the legal defense of the owner. The corporation was entitled to claim deductions for expenses paid by the subsidiary because the subsidiary understood that it would be reimbursed for the expenses by the corporation, so the corporation was the actual payor of the expenses. Several of the expenses claimed to be incurred as professional fees (specifically, legal fees) were properly disallowed as deductions because the corporation either failed to properly substantiate the expenses or the expenses were incurred solely for the benefit of the corporation's president and sole shareholder. Expenses were found to be solely for the benefit of the individual if the expenses either did not benefit both the individual and the corporation due to the individual's importance to the corporation or if the legal expenses did not arise out of the individual's role with the corporation.

 

Any professional expenses paid for the benefit of the corporation's owner and president that were not deductible by the corporation as trade or business expenses constituted constructive dividends to the owner under Code Sec. 301, and he was subject to ordinary tax on the amount of the covered expenses up to the amount of accumulated earnings and profits held by the corporation under Code Sec. 316. Any amounts determined to be dividends in excess of the corporation's earning and profits were taxed as long-term capital gain.

 

The corporation was liable for an addition to tax under Code Sec. 6651 for a failure to timely file a return.

 

Related cases at 2008-1 USTC ¶50,206; and 2009-1 USTC ¶50,289.

HIE Holdings, Inc., TC Memo. 2009-130, Dec. 57,847(M)

Other References:

 

Code Sec. 162

 

CCH Reference - 2009FED ¶8520.588

 

CCH Reference - 2009FED ¶8526.4462

 

Code Sec. 166

 

CCH Reference - 2009FED ¶10,650.12

 

CCH Reference - 2009FED ¶10,650.515

 

Code Sec. 172

 

CCH Reference - 2009FED ¶12,014.3095

 

CCH Reference - 2009FED ¶12,014.311

 

CCH Reference - 2009FED ¶12,014.411

 

Code Sec. 316

 

CCH Reference - 2009FED ¶15,704.22

 

Code Sec. 6651

 

CCH Reference - 2009FED ¶39,475.23

 

Tax Research Consultant

 

CCH Reference - TRC CCORP: 6,308

 

CCH Reference - TRC BUSEXP: 18,052.10

 

CCH Reference - TRC BUSEXP: 45,100

 

CCH Reference - TRC BUSEXP: 48,050

 

CCH Reference - TRC BUSEXP: 48,300

 

CCH Reference - TRC PENALTY: 3,052

 

State Headlines

All States --Multiple Taxes: FTA Passes Resolutions, Receives Bleak Revenue Forecasts at Annual Meeting

 

The states' fiscal situation dominated presentations as the Federation of Tax Administrators (FTA) held its 77th annual meeting in Denver, May 31-June 3, 2009. In other developments, the FTA approved several resolutions, received updates on nexus developments and the Streamlined Sales Tax (SST) effort, and elected Cindi Holmstrom, Director of the Washington State Department of Revenue, as its new president.

 
Resolutions Approved

 

During its business meeting, the FTA passed six resolutions by voice vote. Among the states represented at the meeting, Missouri and Texas abstained from all the votes. Other abstentions are noted.

 

-- The FTA continues to offer its support to the SST effort. Alaska and New York abstained.

 

-- The FTA supports federal legislation authorizing SST member states to require remote sellers with sales above a reasonable threshold to collect tax. Alaska, Georgia, Montana, and New York abstained.

 

-- The FTA encourages uniform action by states as the preferred solution to issues that prompt federal preemption proposals. The resolution provides a set of criteria that will be used by the FTA in evaluating proposed federal legislation that would preempt state taxing authority. Hawaii voted against this resolution. Colorado and Montana abstained.

 

-- The FTA supports expanding the federal tax offset program to include income tax debts owed by all taxpayers, not just state residents. (TAXDAY, 2009/05/11, S.2)

 

-- The FTA believes that any legislation extending or enacting a federal estate tax should include a credit for estate taxes paid to a state.

 

-- The FTA supports coordinated state action as the appropriate solution to concerns over taxation and withholding of wages earned in multiple states and opposes action on federal legislation until these state efforts are exhausted. Alaska, New York, and Montana abstained. (TAXDAY, 2009/04/29, S.1)

 

A representative of Montana read a statement explaining that the state's vote to abstain on the two preemption resolutions, rather than to vote no, was because of the drafters' willingness to accept some of Montana's suggestions. Its vote was not a recognition of any authority of the FTA to speak for Montana on issues related to federal preemption of state authority. The willingness to accept federal preemption as a last resort undermines the argument against congressional authority to preempt, according to Montana.

 
Fiscal Situation Foreshadows Tax Increases

 

The federal stimulus funds being provided to the states are both a blessing and a curse, according to KPMG's Harley Duncan. While the funds relieve some of the immediate burden on the states, that relief may delay for a couple years a "necessary reckoning" involving essential changes to state spending and revenue policies. Meanwhile, Duncan expects that among the steps states will take to avoid additional revenue losses will be continued decoupling from the cancellation of debt income (CODI) deferral that was contained in the federal recovery package.

 

Nick Johnson, Center on Budget and Policy Priorities (CBPP), agreed with Duncan that the federal stimulus funds bought states time to make hard decisions on spending and taxes. The CBPP projects states will have a $350 billion budget gap over the period July 1, 2009-December 31, 2011, and that the federal stimulus funds will fill approximately 40% of that gap. Johnson said that further federal stimulus legislation to benefit the states is unlikely and state tax increases should be expected.

 

A state shortfall of at least $230 billion for fiscal years 2009-2011 was foreseen by Scott Pattison, National Association of State Budget Officers. He said that all 50 states are now in recession, including the formerly resilient resource-rich states. Pattison expects GDP growth to resume in the nation by the fourth quarter of 2009 or the first quarter of 2010. However, he also expects there to be significant declines in state rainy-day fund balances and believes there will be strong pressure on states to raise taxes to make up for continuing budget shortfalls.

 

Eugene Steurle, Peter G. Peterson Foundation, believes the nation is entering an era of fundamental restructuring, and predicted that revenue-raising measures will dominate the debate going forward.

 
Opinions Offered on Future of Tax Systems

 

The effect of technological change and innovation on tax systems was discussed by Dr. Kishore Swaminathan, Accenture. Among the trends he discerns are cloud computing (the use of Web-based software and computing capacity) and the use of mobile devices to perform transactions. These trends challenge traditional methods of tracking, collecting, and remitting taxes, according to Swaminathan, while offering opportunities for creative solutions to these same challenges.

 

Dr. Charles McLure, Hoover Institution, discussed the merits of various tax systems, including different versions of a value-added tax (VAT) and a national retail sales tax. He believes that the United States needs to adopt a VAT, after the end of the current recession, in order to raise sufficient revenue to deal with federal deficits and fund new initiatives focusing on health care, education, and energy independence. McLure recommends a credit-method VAT (similar to the European model) at the federal level, with an integrated sales tax for the states. Coordinating state sales taxes with a federal VAT would, in his opinion, reduce state taxation of business inputs, increase the taxation of services, and improve administration. There are, however, significant political obstacles to overcome before these goals can be achieved, he said.

 
MTC Developments Reviewed

 

Developments at the Multistate Tax Commission (MTC) were described by Executive Director Joe Huddleston. The organization has seen a dramatic increase in the volume of disclosure activity through its National Nexus Program, he said, prompting the MTC to begin work on an online application process. In other action, the Executive Committee has directed the staff of the Uniformity Committee to examine the issue of nonresident wage withholding. Also, the MTC has entered into a memorandum of understanding with 23 states that allows the MTC to receive federal taxpayer information and share MTC joint audit results with the IRS.

 

Huddleston said the Uniform Law Commission (ULC) has encountered "roadblocks" in its attempts to revise the Uniform Division of Income for Tax Purposes Act (UDITPA). (TAXDAY, 2009/05/29, S.1) However, he pledged the MTC "will not back away from its responsibilities" related to UDITPA. The MTC "stands ready to move forward" to address key issues along with interested states and taxpayers, if the ULC chooses not to proceed, Huddleston said.

 
SST Developments Discussed

 

Scott Peterson, Executive Director of the SST Governing Board, discussed a recent report prepared for the board that estimates states may lose $11.4 billion in uncollected sales and use taxes on electronic commerce in 2012, and an additional $6.8 billion in losses on non-electronic, remote sales (mail order) in business-to-consumer transactions. (TAXDAY, 2009/04/15, S.1) Peterson said that state economists are preparing a report for release soon that estimates losses of $5 billion on business-to-business non-electronic remote sales during the same time frame.

 

Peterson said that 1,163 sellers have registered under the SST system as of May 1, 2009. Of these, 133 are using a certified service provider and 29 use a certified automated system. Ohio, Tennessee, Utah, and Wisconsin are the only member states in which the amnesty mandated by the SST Agreement is still available to registrants. Peterson said that sellers often contact him wanting to register under the SST system and take advantage of the existing amnesties, but expressing concern about liability they may have in the other member states that are no longer offering amnesty. He advises these sellers that they may be able to take advantage of voluntary disclosure agreement (VDA) programs in these states or the MTC National Nexus Program. Peterson added that, given the number of such inquiries he receives, he is going to ask the Governing Board to explore the possibility of a joint SST registration/VDA program.

 

Federal legislation to give SST member states authority to mandate collection by remote sellers will be introduced as soon as the National Retail Federation and the Governing Board can agree on a definition of "reasonable vendor compensation," according to Peterson.

 
Sales Tax Nexus Issues Addressed

 

Robert Plattner, New York State Department of Taxation and Finance, said that 30-40 remote sellers had registered to collect in New York as a result of its nexus-presumption legislation, commonly referred to as the Amazon law. The state has collected $50-70 million in additional revenue on these remote sales. Plattner said that he was surprised the SST group originally did not seem to see the connection between New York's action and the group's goals, and by the suggestion that New York was not being a "good team player." He said negative comments from groups like the National Conference of State Legislatures had suggested New York was "running amok" and was an example of why the SST was needed. Plattner said the New York law may help the SST effort by giving businesses an incentive "not to drive too hard a bargain." However, he admitted that, if more states follow New York's lead, the SST effort may lose its momentum.

 

In other comments, Plattner said that the attempt by Massachusetts to require a tire seller to collect Massachusetts tax on sales of tires in New Hampshire to Massachusetts residents appeared to be a "clear overreach" by Massachusetts, which did not have sufficient nexus with the transaction. (TAXDAY, 2008/06/18, S.15) The case is on appeal to the Massachusetts Supreme Judicial Court, which is expected to rule later this summer. Stanley Arnold of Rath, Young & Pignatelli commented that, under the SST Agreement, which Massachusetts is likely to join soon, these sales clearly would have been sourced to New Hampshire.

 

Plattner and Phil Horwitz, Colorado Department of Revenue, discussed the Dell cases out of Connecticut, Louisiana, and New Mexico and the extent to which a third-party contractor's post-sales activities in a state can create substantial nexus for an out-of-state seller. (TAXDAY, 2008/06/09, S.12) They agreed that decisions in similar cases are likely to turn on the degree of control the seller exercises over the in-state contractor.

 
Economic Nexus Debated

 

The states seem to be moving inevitably to an economic nexus standard, according to a panel consisting of Marilyn Wethekam, Horwood, Marcus & Berk; Brian Fliflet, Illinois Department of Revenue; Phil Horwitz, Colorado Department of Revenue; and the FTA's Matt Tomalis. Wethekam said that, in the absence of guidance from the U.S. Supreme Court, it is difficult to predict what amount of economic presence is sufficient for nexus. Fliflet responded that such guidance exists in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). Horwitz suggested that, if states adopt the MTC's factor-presence nexus standard, it might encourage the high court to accept review since it would give the Court a clear standard on which to base its ruling. Wethekam and Horwitz agreed that states that use an economic nexus standard in determining who is subject to their tax should, if they are to be consistent, employ that standard for throwback purposes as well.

 
Taxpayer Privacy Concerns Aired

 

Admitting that he was trying to "provoke" participants, Jeff Friedman, with Sutherland, discussed potential conflicts between taxpayer privacy concerns and states' desire for information, and between taxpayers' wish for guidance and states' reluctance to provide advice that can be used for planning purposes. Friedman said that taxpayers increasingly are turning to Freedom of Information Act (FOIA) requests in frustration at states' refusal to disclose positions on topics such as nexus standards and how cost-of-performance sourcing is applied. Meanwhile, taxpayers object to providing some information, such as that sought on the MTC's proposed "51-state spreadsheet" and the California amnesty requirement to identify the basis of payments. Friedman questioned the usefulness of such information and said taxpayers worry they are providing states with an "audit checklist" when they supply such data. He also commented that some states have not shown the same restraint as the Internal Revenue Service (IRS) in requesting FIN 48 workpapers and that some "people are scared as to what the future holds." Friedman also touched on courts' reluctance to accord confidential treatment to taxpayer information that is disclosed in litigation, and he concluded that he suspects information sharing among the states is likely to increase.

 
Tips on Reducing Tensions Offered

 

In an annual ritual, a panel of taxpayers and administrators discussed ways to reduce tensions in their interactions. Charles Collins, ADP Taxware, stressed that "communication and professionalism" are key. Douglas Ewald, Nebraska Department of Revenue, added that "attitude" is important, and said that he asks taxpayers to improve his understanding of what is important to them. "Consistency and respect" were the factors emphasized by Roxanne Huber, Colorado Department of Revenue. John Chavez, Financial Management Services, said he worries that revenue shortfalls will generate tensions on both the taxpayer and tax-agency side. He stressed that it is important for taxpayers to distinguish among states and recognize that some have good policies, while others do not.

Federation of Tax Administrators Annual Meeting, Denver, May 31-June 3, 2009

 

Kansas --Sales and Use Tax: Department of Revenue Denied Judgment in Integrated Plant Theory Case

 

The Kansas State Court of Tax Appeals denied the Kansas Department of Revenue summary judgment in an action filed by a taxpayer seeking a sales tax refund under the integrated plant theory exemption for machinery and equipment (and associated repair and replacement parts) used in Kansas as an integral or essential part of an integrated production operation by a manufacturing or processing plant or facility. The taxpayer argued that the exemption applied with respect to repair and replacement parts for loaders and haulers that it used in its concrete manufacturing operation. The taxpayer quarried limestone on its property and used the loaders and haulers to move the limestone to its adjacent property where it crushed it and manufactured it into concrete. The department contended in its motion for summary judgment that the exemption did not apply because the excavation activities were distinct from the manufacturing activities.

 

The court noted that the exemption statute includes within an "integrated production operation" preproduction operations to handle, store, and treat raw materials. In addition, the exemption statute states that machinery and equipment is considered used as an integral or essential part of an integrated production operation when used to receive, transport, convey, handle, treat, or store raw materials in preparation of placement on the production line. Based on the evidence, the court declined to find as a matter of law that the loaders and haulers were not used as part of an integrated production operation.

 

The court found that the term "manufacturing or processing plant or facility" means a single fixed location owned or controlled by a manufacturing or processing business that consists of one or more structures or buildings in a contiguous area where integrated production operations are conducted to manufacture tangible personal property for ultimate sale at retail. Because the evidence showed that the quarry and cement manufacturing operations were conducted on adjacent property owned by the taxpayer and not on a right-of-way or easement located on land not owned by the taxpayer, the court declined to find as a matter of law that the loaders and haulers were not primarily used by and at the taxpayer's "plant." In addition, it was irrelevant in determining the boundaries of the "plant" that the loaders and haulers might have performed extraction-related activities on a portion of the grounds where no additional processing (such as the crushing of the limestone) occurred. As a result, the court denied the department's summary judgment motion. However, the court did not enter judgment in favor of the taxpayer, as the department's motion did not address all of the exemption's statutory requirements and the taxpayer still had the burden of proving that the exemption applied.

 

Subscribers can view the order denying the department's motion for summary judgment.

 

In the Matter of the Appeal of LaFarge Midwest/Martin Tractor Co., Inc., Kansas State Court of Tax Appeals, No. 2006-8532-DT, June 4, 2009

 

New Jersey --Multiple Taxes: Certain Voluntary Disclosure Agreements to Be Honored

 

For purposes of the state's Voluntary Disclosure Program, which is a means for taxpayers who realize that their activity creates nexus for New Jersey state tax purposes to come forward and file the appropriate tax return(s), registration materials, and pay outstanding tax obligations, the New Jersey Division of Taxation will honor the terms and conditions of the Voluntary Disclosure Agreements (VDAs) that were negotiated prior to May 4, 2009, as long as fully executed by June 15, 2009. Thereafter, the agreements will be considered null and void and subject to the new terms and conditions detailed in this revised notice. As of the conclusion of the 2009 Tax Amnesty Program on June 15, 2009, the terms and conditions of new VDAs will be modified to be more stringent. The opportunity and benefits provided by the 2009 Tax Amnesty Program will not be improved upon by a VDA.

 

By coming forward prior to being contacted by the division, the taxpayer will be permitted certain favorable terms and conditions offered under the Voluntary Disclosure Program, including anonymity pending an agreement. However, as a consequence of the 2009 Tax Amnesty program, the general look-back period no longer will be four years (three prior years and the current year), but will be seven years (six prior years and the current year).

 

To be eligible for the Voluntary Disclosure Program, there must have been no previous contact with the taxpayer by the division or any of its agents. Furthermore, the taxpayer must be willing to pay all outstanding tax liabilities that are included in the agreement and file the prior year returns within a 60 days. No deferred payment plans will be permitted. Since each request is considered on a case-by-case basis, the division may require additional information in order to evaluate the situation.

 

The Voluntary Disclosure Program is not available to resident taxpayers for gross income tax purposes; taxpayers who are registered for the taxes they wish to come forward regarding; any taxpayer currently under any criminal investigation; any taxpayer who has received a nexus survey or any taxpayer who otherwise has been previously contacted regarding their activities in New Jersey.

 

A taxpayer who wishes to proceed with a VDA must submit a written proposal detailing all New Jersey business activity. This proposal should include the commencement date of the activity and the tax(es) to be filed. All taxes administered by the division are eligible, but the most common include corporation, sales and use, litter, personal income and withholding taxes.

 

For approved agreements, the division will waive the late filing penalties and criminal penalties relating to the tax returns and periods subject to the agreement. An unabateable penalty of 5% will be imposed for failure to take advantage of the Tax Amnesty Program ending on June 15, 2009. In addition, the 5% late payment penalty will be imposed in all instances. Statutory interest will be assessed and calculated at the prime rate plus 3% for the tax returns and periods included in the agreement. As an alternative, the division is willing to enter into negotiations leading to a specific closing agreement with a taxpayer who is prepared to come forward with full disclosure of all pertinent information.

 

The press release regarding the program can be viewed at http://www.state.nj.us/treasury/taxation/voldisc.shtml.

Press Release, State of New Jersey Department of the Treasury, Division of Taxation, June 5, 2009

 
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