Tax Watch: IRS’ e-filing system suffers from PIN drop

According to the Internal Revenue Service, paperless tax filing is a reality. Now, if they could only get it to work.

Many taxpayers are reportedly encountering problems with the new paper-free e-filing system. About 90% of those individuals who have already asked professionals to prepare and file their tax returns electronically have apparently ended up having to mail in a signed form anyway.

The problems apparently stem from a new system that the IRS launched this year to stamp out the very last piece of paperwork that had kept tax filing from being fully digital – the signature form.

Until this year, most taxpayers who filed electronically also had to sign a form and file it with their tax return preparer or the IRS. Even the IRS is conceding that it was a little silly to tie down e-filers with a paper form.

This year, the IRS has launched a “self-selected” personal identification number process that substitutes for a signature. That PIN, combined with the taxpayer’s Social Security number and some information from last year’s tax return, serves to identify the taxpayer.

Although the IRS predicted electronic tax return filing would jump to at least 42 million this year, from last year’s 35 million, a mysterious glitch has hit the system. According to the IRS, many e-filers have received the response that their PIN selection failed. In that case, taxpayers must file an old-fashioned signature form, 8453-OL.

Surprisingly, filers who aren’t using professional services are having better luck with the new program – about two-thirds have been able to use the PIN process successfully. On the professional-preparer side, the results are dismal: only 12.5% of e-filers using professional help have been able to file using a PIN.

Hedging deals

getting new rules

* The IRS has proposed regulations on the “character” of hedging transactions in order to reflect changes in the law made by the Ticket to Work and Work Incentives Improvement Act of 1999.

Under the proposed regulations, property that is part of a hedging transaction would not be a capital asset. When a short sale or option is part of a hedging transaction, any gain or loss on the short sale or option would be ordinary.

If a transaction falls outside the regulations, gain or loss from the transaction would not be made ordinary by the mere fact that the property is a surrogate for a non-capital asset. After all, the transaction serves as insurance against a business risk, the transaction serves a hedging function, or the transaction serves a similar function or purpose.

Section 988 (foreign currency) transactions would be excluded from those regulations because gain or loss from them is already ordinary.

What’s more, the proposed regulations would provide rules of application designed to ensure that the definition of hedging transactions is applied reasonably to include the most common types of business hedges.

The proposed regulations would also modernize the definition of “hedging transaction” by implementing a risk management standard. A transaction would satisfy the standard if it reduced risk.

A hedge of a single asset or liability would be a managing risk if the hedge reduces the risk attributable to the item or items being hedged and if the hedge is reasonably calculated to reduce the overall risk of the taxpayer’s operations.

Also, if a taxpayer hedges a particular asset or liability, and the hedge is undertaken as part of a program to reduce the overall risk of the taxpayer’s operations, the taxpayer won’t need to show that the hedge reduces its overall risk.

The IRS has scheduled a public hearing for May 16. Written comments and requests to speak at the hearing, along with outlines of topics, are due by April 25.

Cite: Reg. 107047-00

Insurers can shift

on cash advances

* An insurance company may obtain automatic consent from the IRS to its accounting method for cash advances on commissions paid to its agents – at least according to a recently released Revenue Procedure.

That procedure allows an insurance company to change from deducting cash advances on commissions paid to its agents in the year paid to deducting the advances in the year earned.

To qualify for the automatic change, cash advances must be treated as loans. Needless to say, the new procedure details the requirements for treating a cash advance as a loan.

Cite: Revenue Procedure 2001-24, 2001-10 I.R.B., adding to Rev. Proc. 99-49, 1999052 I.R.B. 725

A broker loses

on early bonuses

* To attract new brokers, a securities firm offered a five-year bonus plan. Under the plan, a broker would receive an upfront payment of the bonuses in the form of a loan that was to be paid off with the proceeds of annual bonuses earned during the five years.

If a broker died or became disabled, or employment was terminated other than for cause, the balance of the unpaid loan would be forgiven.

During a tax audit, the IRS and the firm disputed two issues: whether the upfront loan proceeds were immediately taxable to the broker as pay for future services or constituted a bona fide loan; and if the upfront payments were treated as immediately taxable pay to the brokers, whether the firm, as an accrual-method taxpayer, could deduct the upfront payments in the year made.

In a recent letter ruling, the IRS has decided that the upfront bonus payments are not bona fide loans, even though notes are signed, interest is charged and the loans are secured by company stock given to the brokers.

There is no unconditional obligation to repay the loans. Brokers who fulfill the contract over the five years will not be required to repay the loans.

Finally, the loans lack a specific repayment schedule. A broker’s obligation is satisfied by the performance of services rather than cash payments. The IRS rejected the firm’s claim that a broker makes the required cash payment when an earned bonus is paid and applied to the loan.

The broker lacks any control over the bonus as it must be immediately applied to the loan. The fact that the firm gives the broker a bonus check and the broker gives a personal check to pay off the loan is irrelevant: The check swap lacks business and economic purpose and is motivated solely by tax avoidance considerations, according to the IRS.

Although a broker recognizes taxable pay on the receipt of the upfront payments, the firm may not claim an immediate deduction, since they constitute advance payment for services.

Under the economic performance test for accrual-method deductions, liability for the expense is not incurred until a broker performs services.

At that time, a deduction may be claimed for that part of the upfront payment allocable to the performed services.

Cite: Letter Ruling 200040004

Forget that ruling; it’s plain stupid

* In a field service advisory, the IRS has concluded that a taxpayer should not be forced to return to an incorrect method of accounting.

The taxpayer in this situation sells time shares and did not deduct selling expenses, instead capitalizing them. Later, the taxpayer switched accountants and filed an amended return to correct the problem.

The IRS determined that the taxpayer had retroactively changed its method of accounting. Under the rules, the IRS was within its rights to fine the taxpayer for changing its method of accounting and even require it to go back to the earlier, erroneous accounting method.

The IRS concluded, however, that to force the taxpayer to return to an incorrect method of accounting would be abuse of discretion.

Cite: Field Service Advice 200102004

New rules are final on inflated money

* The IRS has issued final regulations specifying when a currency will be considered “hyperinflationary” under Section 988 (foreign currency transactions). The IRS’ new technical document adopts, with modifications, the proposed regulations published Jan. 13, 2000.

The final regulations adopt the changes in the base period to the 36 months ending on the last day of the taxpayer’s current tax year.

In response to a comment, a change reflected in the final regulations provides an exclusion to the revised base period for registered investment companies and real estate investment trusts. The Treasury and the IRS take the position that without the exclusion, the base revision could present an administrative burden for those types of companies.

Cite: T.D. 8914