Tax Watch: IRS says no to notional principal contracts

The Internal Revenue Service has alerted taxpayers that it is aware of transactions involving notional principal contracts used to generate tax losses. The IRS warns that no tax benefits from such contracts are allowable.

The transactions involve using the contracts to claim current deductions for periodic payments while waiving the right to receive certain offsetting payments in the future.

A notional principal contract has a term of more than one year, and the taxpayer is required to make periodic payments to the contract principal at regular intervals of one year or less based on a fixed- or floating-rate index. In return, the principal is required to make a single payment at the end of the contract’s term that includes a non-contingent component.

The non-contingent component also may be based on a fixed or floating interest rate. The contingent component may reflect changes in the value of a stock index or currency.

The taxpayer may fund their obligation to make periodic payments in whole or in part by borrowing funds from a lender, who may be the contract principal.

The taxpayer deducts the ratable daily portion of each periodic payment for the tax year to which that portion relates. However, the taxpayer does not accrue income on the non-periodic payment until the year the payment is received. The taxpayer intends to report as capital any gain realized on the termination of the contract.

According to the IRS, the transaction is considered one of the “listed” deals that automatically will be considered an abusive tax shelter required to be registered. The IRS urges taxpayers who have engaged in those transactions to file amended returns.

The transactions also may be subject to the tax-shelter-registration and list-maintenance requirements.

The IRS also has issued Revenue Ruling 2002-30, on the appropriate method for inclusion into income or deduction of a non-periodic payment made pursuant to a notional principal contract where the payment comprises contingent and non-contingent components.

Cite: Notice 2002-35

Low-income clinics eligible for grants

The IRS has announced that it now is accepting grant applications for clinics for low-income taxpayers. Organizations can apply for grants worth up to $100,000 under the program.

The application package is contained in Publication 3319, “Low-Income Taxpayer Clinics, 2003 Grant Application Package,” and must be in the hands of the IRS by July 1. The application package is available on the IRS website, irs.gov, or by calling (800) 829-3676.

New scam targets your bank account

The IRS warns of a fraudulent scheme in which fictitious bank correspondence and IRS forms are used in an attempt to trick taxpayers into disclosing their personal and banking data. The information, the IRS says, is used to assume the taxpayer’s identity and steal bank deposits.

In this scam, a letter purported to be from the taxpayer’s bank states that the “bank” is updating its records to exempt the taxpayer from reporting interest or having tax withheld on interest paid on their bank accounts or other financial dealings. Legally, banks must report interest to the IRS, and taxpayers must include it as income.

Identity thieves can use someone’s personal data to take over his or her financial accounts; run up charges on the victim’s existing credit cards; apply for loans, credit cards, services or benefits in the victim’s name; and file fraudulent tax returns.

People who receive the fraudulent letter and form in the mail should immediately get in touch with their financial institution or the Department of the Treasury’s inspector general for tax administration.

Identity theft is a federal crime under the Identity Theft and Assumption Deterrence Act of 1998. Violations are investigated by federal agencies such as the U.S. Secret Service, the FBI and the Postal Inspection Service, and are prosecuted by the Department of Justice. Using the mail to commit fraud is a federal crime investigated by the Postal Inspection Service.

IRS warns against tax-cutting scheme

The IRS has released a new brochure titled “Home-Based Business Tax Avoidance Schemes – At a Glance.” The schemes described in the document claim to offer tax relief but actually result in illegal tax avoidance.

The promoters of those schemes, according to the IRS, claim that by setting up a bogus home-based business, individual taxpayers can deduct most or all of their personal expenses as business expenses.

The IRS brochure includes some examples of personal expenses that are not deductible but are commonly claimed as business expenses in home-based-business tax-avoidance schemes.

The brochure explains that no matter how convincing the claims in marketing materials for these schemes may appear, non-deductible personal living expenses cannot be transformed into tax-deductible business expenses.

Tax law firmly establishes that a clear business purpose and profit motive must exist to generate and claim allowable business expenses.

The IRS is advising taxpayers who claimed such deductions on past tax returns to file amended returns as soon as possible to limit possible interest and penalties on top of any taxes they might owe.

To find out more about home-based-business tax-avoidance schemes, order IRS Document 01300 (02-2002) by calling (800) 829-2437, or visit irs.gov.

Issue-resolving plan will be permanent

After evaluating the pilot program under its Industry Issue Resolution Program, the IRS has announced that the program should be made permanent. The objective of the pilot program was to provide guidance to resolve frequently disputed tax issues common to a significant number of large or midsize business taxpayers.

The program will be expanded to address issues common to businesses of any size. The large- and mid-size business division and small-business/self-employed division will undertake jointly the operational responsibility. Resolution of contentious issues other than by the examination process is a strategic goal of both divisions.

Taxpayers, as well as industry associations and other groups representing taxpayers, are invited to suggest issues and possible options for resolution. Parties submitting suggestions may be asked to meet with government representatives and to provide additional information.

Foreign annuities get new rules

The IRS has issued final regulations that provide guidance on whether annuity contracts are excluded from the definition of a debt instrument under the original-issue discount provisions.

The rules proposed earlier by the IRS provided guidelines for determining whether annuity contracts issued by foreign insurers were excluded from the definition of a debt instrument.

Those proposed rules provided that annuity contracts issued by foreign insurance companies were to be treated as having been issued by an insurer subject to tax under Subchapter L, if the insurance company is subject to tax under Subchapter L, on income earned on the annuity contract.

According to the examples provided, an annuity contract issued by a foreign insurer without a U.S. trade or business, or without a U.S. permanent establishment under a tax treaty, will not be excluded. If the annuity is purchased from the insurer’s U.S. trade or business, however, the exclusion will apply.

The IRS has adopted the regulations as proposed.

Cite: T.D. 8993

The IRS wants you on taxpayer panel

The IRS invites civic-minded individuals to help improve the nation’s tax agency by applying to be members of the Taxpayer Advocacy Panel. The panel provides a forum for citizens from each state to make suggestions regarding IRS decision-making.

For the first time, the Taxpayer Advocacy Panel will have membership from all 50 states. Previously the panel, formerly called the Citizen Advocacy Panel, was based in four regional locations, with members from only 10 states. The Department of the Treasury, which sponsors the group, recommended expanding the program, which led to the request for applications.

Panel members will:

* Provide opportunities to listen to citizens and make recommendations to the IRS and Treasury Department on customer-service matters.

* Identify and prioritize taxpayer concerns.

* Participate in meetings in which taxpayers are invited to raise issues about their experiences with the IRS.

* Refer taxpayers who contact the panels to the IRS offices best able to address their concerns.

* Report annually to Treasury and the national taxpayer advocate.

To qualify for the panel, applicants must be U.S. citizens and be able to commit about 300 hours a year to the panel. In addition, applicants must be current with their tax obligations and pass a background check.

The application is available at improveirs.org or by calling (866) 602-2223.