Tax Watch: IRS taking showbiz approach to education

The Internal Revenue Service has caused a lot of taxpayers to tear their hair out, so it’s fitting that its new monthly forum was designed by the same company that won praise last spring with its launch of a hair-coloring product.

The target audience of “Tax Talk Today,” which went live last week, is the nation’s 700,000 tax practitioners. It will be broadcast over the Internet, by satellite and by video conferencing, and will be available on videocassettes. The show’s centerpiece will be a 60-minute round table each month.

The round tables will be led by a revolving panel of tax experts from the Big Five accounting firms, the nation’s top law and business schools, associations and, of course, the IRS.

“Tax Talk Today” is interactive, allowing tax practitioners to ask panelists questions via e-mail, telephone and fax.

There will also be news features, puzzles, tips and short tax news segments.

The media presentation company that designed the forum helped launch Clairol Hydrience to kudos and awards from the advertising community last year.

IRS would tighten standards on shelters

* The Treasury Department recently released proposed rules (Reg-111835-99) that, if approved, would tighten standards under Circular 230 for tax-shelter opinions.

“Abusive tax shelters are the most serious compliance problem in the U.S. tax system,” departing Treasury Secretary Lawrence H. Summers declared in a press release that also included a summary of the new rules.

The proposed measures, he said, would “deter the purveyance of these shelters, protect the integrity of our tax system and ultimately reduce the tax burdens of honest taxpayers.”

According to the press release, the new rules would strengthen the standards regarding factual due diligence and legal analysis, and prohibit certain contingent-fee arrangements. The rules would also require that practitioners who have responsibility for a firm’s tax practice take reasonable steps to put in place adequate procedures to ensure compliance with the Circular 230 standards.

The proposed rules would also authorize the IRS to issue a public reprimand or censure in cases warranting a sanction less severe than suspension or disbarment.

Stricter rules set

for taxpayer reps

* The IRS has proposed long-awaited modifications to Circular 230, the regulations governing the practice of lawyers, certified public accountants, enrolled agents, enrolled actuaries and others who are authorized to represent taxpayers before the tax agency.

The changes address a practitioner’s responsibilities, including: assisting or receiving assistance from disbarred or suspended persons, practicing with former government employees, contingent-fee arrangements, confidentiality and conflicts of interest.

The modifications also address the return of a client’s records even if a fee dispute exists, restrictions on negotiation of a taxpayer’s check, solicitations, sanctions and response to document requests even if the practitioner or client doesn’t control the documents.

The rules also change the standards governing tax-shelter opinions, concentrating on opinions used by third parties to market tax shelters and the so-called “more likely than not” shelter opinions. The modified rule proposals will be effective on the date that final regulations are published in the Federal Register.

The IRS has scheduled a public hearing for May 2. The agency must receive comments and requests to speak no later than April 12.

Cite: Reg-111835-99, 66 Fed. Reg. 3276

IRS eyes efficiency

in audit process

* The IRS is reportedly preparing to study its audit process, with the goal of re-engineering examinations to make the system more effective and efficient. In the meantime, the IRS will be stepping up its audit coverage, especially for trusts, partnerships and higher-end taxpayers.

The IRS has already begun to increase audits in the areas of underreporting, non-filing and abusive trusts.

Meanwhile, the IRS, which currently doesn’t match information reported by taxpayers with information on partnership Schedule K-1s, believes that up to 20% of income covered by K-1s may be underreported, at least according to Joseph Kehoe, commissioner of the IRS’ small-and-midsize-business/self-employed division.

In 1999, according to Mr. Kehoe, the audit coverage rate was a dismal 0.025% of returns. “We are almost non-existent anymore,” Mr. Kehoe says, referring to the IRS’ audit presence. “We are almost invisible.”

In 1999, the IRS spent 24% of its examination resources auditing taxpayers that account for only 4% of revenues, Mr. Kehoe says. Such an allocation by a private-sector company would be considered an outrageous waste, he says. That is one reason why the IRS is redirecting its examination of resources to K-1 matching, trusts and high-end taxpayers.

Mr. Kehoe also says that the audit process now takes 20% longer than before implementation of the Internal Revenue Service Restructuring and Reform Act of 1998.

The process is longer, he says, because the IRS needed to add 33 documentation steps. Fortunately, the agency believes the process can and should be streamlined, he says.

Small businesses wrongly paid AMT

* More than 2,000 businesses that appeared to have qualified as small corporations may have erroneously paid more than $25 million in alternative-minimum tax in 1998, according to a final report issued by the U.S. Treasury’s inspector general for tax administration.

The Treasury unit reviewed provisions affecting the IRS’ processing of corporate tax returns and identified four as needing attention: the research tax credit, the work-opportunity credit, the welfare-to-work credit and the AMT exemption for small corporations.

The finding was based on the number of taxpayers affected, expected revenue impact, sensitivity to the issue and its complexity.

The unit then identified corporate income tax returns for 1998 that were affected by those provisions and conducted computer analysis of data on those returns. It sampled and reviewed the returns to determine whether the taxpayers filed them correctly and whether the IRS processed them correctly.

“The IRS properly processed most corporate tax returns affected by three of the four legislative provisions that we reviewed,” according to the unit. “Generally, taxpayers properly applied the law to their particular tax situations for these provisions.”

But some taxpayers “may have experienced problems with preparing tax returns that qualified for the small-corporation exemption from the alternative-minimum tax,” the unit found. The Taxpayer Relief Act of 1997 provided an exemption from the AMT for qualified small-business corporations for tax years beginning after Dec. 31, 1997.

The Treasury unit identified 2,343 returns for 1998 on which the AMT had been paid but where the corporations appeared to meet the code’s gross-receipts criteria for small corporations.

Based on a sample of 150 of those returns, the inspector general estimated that, despite being exempted from the AMT by the Taxpayer Relief Act of 1997, 93% of the 2,343 small corporations paid more than $25 million in AMT.

“Many taxpayers and their tax professionals may have overlooked their qualification for the small-corporation exemption from the alternative-minimum tax,” the report says.

“Without significant manual effort, the IRS could not identify these errors. As a result, these taxpayers were not informed of their errors and, accordingly, are likely to repeat them.”

Cite: TIGTA report, Ref. No. 2001-30-019

Equity options get additional rules

* The IRS has proposed rules addressing the eligibility for qualified-cover-call treatment of exchange-traded equity options with flexible terms, over-the-counter options and standardized options with terms longer than one year.

Under the proposed regulations, equity options with flexible terms may be treated as QCC options as long as they satisfy the general rules for QCC treatment, are not for a term longer than one year and meet other requirements.

In addition, an equity option with standardized terms must be outstanding for the underlying equity. The proposed regulations provide that the benchmarks will be the same as those for an equity option, with standardized terms on the same stock having the same applicable stock price.

The proposed regulations also make an OTC option eligible for QCC treatment as long as it is entered into with a person registered with the Securities and Exchange Commission as a broker-dealer or alternative trading system and meets the same requirements for QCC treatment that apply to equity options with flexible terms.

Those regulations create a one-year term limit that applies to equity options with standardized terms.

Cite: Reg-115560-99, 66 Fed. Reg. 4751

New rules offered for straddle deals

* The IRS recently issued proposed regulations that provide guidance for the capitalization of interest and carrying charges that apply to straddle transactions.

The regulations generally address these issues: the definition of personal property in Section 263, Capital Expenditures; the type of payments that are subject to the capitalization rules; and the operation of the capitalization rules.

Also addressed are the circumstances under which an issuer’s obligation under a debt instrument can be considered to be a position in actively traded personal property and, therefore, part of a straddle.

Cite: Reg-105801-00, 66 Fed. Reg. 4755

Contracts of deed held to be sales

* The U.S. Tax Court has ruled that a couple’s real estate contracts for deed amounted to complete sales for tax purposes.

Furthermore, the court ruled that the gains that resulted from those contracts had to be included in the couple’s gross income for the year in which they were signed.

Laura Keith owned Greenville Insurance Agency, formed as a potential tax-saving vehicle to sell real estate via contracts for deed.

Under the contracts, the buyers obtained possession, assumed responsibility for taxes, insurance and maintenance, and they were obliged to make monthly payments, with interest, toward the purchase price.

After full payment, the buyers would receive a warranty deed. If the buyers defaulted, the contracts could be voided and Greenville would retain all amounts received under those contracts as liquidated damages.

Laura and her husband, James, reported the gain attributable to the contracts for deed in the year in which full payment was received and title was transferred. Only interest payments had been included in their income previously.

Gain on any property sales was to be computed by reducing the total sale price by the Keiths’ adjusted basis in the properties.

The IRS determined deficiencies in the Keiths’ 1993 through 1995 returns, finding that their accrual method of accounting for sales was improper and failed to clearly reflect their income.

The Keiths argued that the contracts were merely voidable, executory agreements and did not result in a completed sale.

In other words, according to the Keiths, there was no disposition of the properties for tax purposes and no realization of gain until the final payment was actually received and titles transferred.

Senior Tax Court Judge Arthur L. Nims III, noting that a transfer of legal title is not a prerequisite for a completed sale under tax rules, found that the contracts for deed were sufficient under Georgia law to confer the benefits and burdens of ownership on the buyers.

The court further held that under state law, the contracts for deed would be construed as passing an equitable ownership to the buyers at the time they were signed, leaving Greenville with a security interest.

Thus, the income attributable to the disposition must be recognized and reported during the year in which the contract was signed.

In arriving at its decision, the court said that it would no longer follow its earlier holding on the issues in another court case that was reversed two years later by the 6th U.S. Circuit Court of Appeals.

The Tax Court concluded that Greenville was an accrual-method business.

As such, it was required to report gains from the completed sales during the years in which the contracts for deed were signed.

Cite: James W. Keith, et ux., v. Commissioner, 115 T.C. No. 42

Procedure clarified on cash accounting

* In Revenue Procedure 2001-10, the IRS has clarified that prior guidance allowing small businesses to use the cash method of accounting does not apply to tax shelters.

That revenue procedure modifies and supersedes Revenue Procedure 2000-22.

Under the guidance, a taxpayer qualifies for the cash method of accounting if, for each tax year ending on or after Dec. 17, 1998, the taxpayer’s average annual gross receipts for the three-year period ending with the applicable prior tax year are not in excess of $1 million.

To change to the cash method, an eligible taxpayer generally must follow the automatic change-in-accounting-method provisions of yet another revenue procedure, 99-49.

And, as mentioned, tax shelters are not eligible.