ataxingmatter

Overstating basis is an "omission from gross income"--now it's in the regs

The Internal Revenue Service issued a notice of proposed rulemaking (NRPM) and temporary regulations, effective September 24, 2009, defining an "omission from gross income" for purposes of the six-year statute of limitations for assessment of tax.

Those who participated in son-of-boss partnership shelters (described in Notice 2000-44) that claimed a phantom loss generated by an overstated basis claimed that the statute of limitations had run because an overstatement of basis was not an omission from gross income.  (An omission of gross income that exceeds 25% of the income stated on the return gets you into penalty territory.) 

These regs are to clarify the Service's view that an overstatement of basis is an omission of gross income.  As every student in my "baby tax" class knows, gross income includes gains from sales of property.  Gains are determined by subtracting basis from amount realized.  An overstatement of basis thus will trigger an understatement of gain (or even a loss) and hence an omission of that understated amount from gross income.  But courts do odd things in tax cases. As the Service notes in the NPRM:

[T]he United States Court of Appeals for the Ninth Circuit and Federal Circuit recently construed section 6501(e)(1)(A) in cases outside the trade or business context contrary to the interpretation provided in these temporary regulations, holding that an``omission'' does not occur by an overstatement of basis.  Bakersfield Energy Partners v. Commissioner, 568 F.3d 767 (9th Cir.  2009); Salman Ranch Ltd v. United States, 573 F.3d 1362 (Fed. Cir.  2009). The Treasury Department and the Internal Revenue Service  disagree with these courts that the Supreme Court's reading of the  predecessor to section 6501(e) in Colony applies to sections  6501(e)(1)(A) and 6229(c)(2). When Congress enacted the 1954 Internal  Revenue Code, it was aware of the disagreement among the courts that  existed at the time regarding the proper scope of section 275(c) of the  1939 Internal Revenue Code. The changes that Congress enacted as part  of the 1954 Internal Revenue Code predated the Supreme Court's opinion in Colony and were intended to resolve the matter for the future.  Therefore, by amending the Internal Revenue Code, including the  addition of a special definition of ``gross income'' with respect to a trade or business, Congress effectively limited what ultimately became  the holding in Colony, to cases subject to section 275(c) of the 1939  Internal Revenue Code. Moreover, under section 6501(e)(1)(A) of the  1954 Internal Revenue Code, which remains in effect under the 1986  Internal Revenue Code, when outside of the trade or business context,  the definition of ``gross income'' in section 61 applies. In this  regard, the Treasury Department and the Internal Revenue Service agree with the opinions in Home Concrete & Supply, LLC v. United States, 599 F.Supp.2d 678, 690 (E.D.N.C. 2008)(overstatement of basis can  constitute an omission from gross income for purposes of the six-year  period of limitations) and Brandon Ridge Partners v. United States,  2007-2 U.S.T.C. (CCH) ] 50,573, 100  [[Page 49322]]

Health Care Reform or a boondoggle for private insurers?

The Baucus proposal for health care "reform" doesn't include a public option.  And the Senate Finance Committee voted this afternoon-by 15 to 8--to reject the Rockefeller proposal to add a public option "community choice health plan'.  See Hershenson, Senate Panel Rejects Pair of Public Options in Health Plan, NY Times, Sept. 29, 2009.

Kent Conrad, Bill Nelson, Blanche Lincoln, Thomas Carper--those are purported Democrats who voted against Rockefeller's public option.  Conrad and Lincoln voted against both versions put forward today.  They need to think about whom they are serving, because it isn't the ordinary people of this country.  Sure, the Republicans are going to claim that any public option is "socialized medicine".   So what?  Those naysayers want to preserve the status quo system of high prices and low coverage that allows the health industry to reap "rent" profits no matter what the effect on the vast majority of ordinary citizens.  Democrats are supposed to stand for something different--for using government in the service of the people.  They should be out on the stump, explaining to people why public provision of education (public schools, public universities), medicine (medicare, medicaid, and a new public option here), and fire and police protection are not issues of "socialism vs capitalism" but of workable regimes that serve the people versus nonworkable regimes that permit a very few, very large corporate players (and their managers and owners) to hold a near-monopoly over services that ought to be available to everyone at a reasonable price:  this is so because we are a democratic society that believes in government working for the good of all and not just for the good of the wealthy.

I simply don't buy the excuses.  Republicans and Democrats voted for irresponsible tax cuts under Bush and for irresponsible deregulation of financial institutions under Clinton and Bush.  We have the awful result of an economy that serves the wealthy now much better than it serves ordinary Americans, at a cost that will be borne by ordinary Americans in terms of lost job opportunities, lower standard of living, and declines in health care coverage.  I am becoming convinced that this Congress is too beholden to private money to make long-term decisions to benefit the public--whether on climate change or health care reform. 

So where do we go now?  The House needs to stand firm for the public option, and perhaps the Senate itself, not the Finance Committee, will see the light.  We cannot simply mandate coverage--providing a huge boon to private insurers in terms of getting a new captive audience of insureds paying premiums--without also providing a public option that will allow us to move someday, if it proves to work better than private insurance, to a medicare-like system for all.

More on Madoff

When the Bernie Madoff saga became front page news, lots of those who had invested bemoaned their losses.  And certainly there were lots of losses in the multi-billion dollar ponzi scheme.  But as the federal prosecutors' work proceeds, some interesting information--with new tax angles to be considered--has appeared.

It turns out that the government's search of financial records going back to 1979 "shows that investors suffered net losses exceeding $13 billion."   At the same time, "about half of the customers had not lost money because they withdrew more money than they originally invested."  AP, Review Says No Net Loss for Some in Scheme, NY Times (Sept. 23, 2009).

Let's consider those investors who "got back more than they originally invested."   The IRS guidelines permitted Madoff victims to claim 95% of their theft losses--their original investment plus the phantom profits that they paid taxes on minus the SIPC recovery and any other recovery-- for 2008 (in the year of the discovery of the scheme) on the assumption that they wouldn't  have much "reasonable prospect" of recovering the lost amounts.  The rest would be claimed over time. See Kerber, New IRS Rules Offer Relief to Madoff Investors, Boston Globe (Mar. 18, 2009).  The losses could be claimed based on the information about initial investments.  These rules were more favorable than the IRS's former position on reporting ponzi scheme losses, which required taxpayers to wait--often years-- until they had more information about their actual loss.  See Novack, Madoff Victims Get Immediate Tax Relief, Forbes (Mar. 17, 2009) (noting that "the IRS was under considerable pressure to relax those rules," even though they had been upheld in court, after the Madoff scheme came to light).

So if members of this group of about half the victims claimed losses on their 2008 returns but, it turns out, didn't actually have any loss of their original investment (and in fact had at least some real profits among those profits that they paid capital gains-rate taxes on), perhaps they should amend their returns?...  After all, many of those who had already amended their returns to get rid of the phantom income and thus get a refund of the capital-gains-rate taxes paid apparently re-amended their returns to report the income and leave the taxes paid (at capital gains rates) so that they could take advantage of the IRS change of heart about the ability to claim immediate losses in the year the ponzi scheme is discovered for invested amounts and phantom income on which taxes had been paid, reporting the investment theft loss and getting ordinary losses that carry back 3 (or 5) and forward 20 years.  See Tax Girl, Madoff Victims Get a Break (or the one where I say things that get people mad) (Mar. 24, 2009).

(As to taxes paid on what actually turn out to be phantom gains, I still think the rule should be that you could claim a refund of taxes that you had actually paid at capital gains rate on that fictional income, rather than getting to claim an ordinary loss for the fictional income amount on which you paid taxes, since the latter ultimately means you get back at ordinary rates while having paid in at capital gains (lower) rates and should violate the tax benefit doctrine.  Especially when your loss claim is expedited to be allowed even before you know whether you have one or not.....)

Health Care Reform--who gains, who loses

On health reform, the legislative machinery rumbles on.  Going on this week, the Baucus markup of a bill without a real public option, to appease mainly health insurance companies that will get a captive audience of insureds, federal payments for those at the bottom, without giving up their "economic rent" profits, which is one of the main things driving up health costs in this country.

In another corner, Will Ferrell at his best (video sponsored by MoveOn.org).  One might argue that the word for the day is that "no health insurance company should have to lose one cent of their billions in profits just because sick Americans need health care" (to quote Move On's lead in to the video).....

Offshore Account Still Not Reported? IRS Grants A Last Reprieve Against the Severest Penalties

The IRS today announced that it was extending the deadline to Oct. 15 for reporting offshore accounts without incurring criminal prosecution and the severest fine.  See IR-2009-084. 

Before today's reprieve, taxpayers would have had to file by Wednesday (Sept. 23) to reveal their hidden accounts and enjoy the lesser sanction of the administrative voluntary disclosure program.  Under the program, the government limits its remedies to 20% of the peak balance in the account over the last 6 years, and perhaps only 5% if the account has been inactive.  The law permits much more severe sanctions--taxpayers could end up paying 50% of the account balance each year that the report is not filed.  Criminal prosecution is also a possibility in cases of tax fraud.

The release indicates that the Service has received "repeated requests" from tax advisers saying that they need more time to be able to talk with clients and prepare forms:

By extending the deadline for a short period of time, the IRS Iss providing relief for thos taxpayers who had intended to come forward prior to the deadline, but faced logistical and administrative challenges in meeting it.

Bloomberg reports that practitioners are seeing a big influx of interest after the announcement that UBS will give information on more than 4000 additional accounts.

Paul Behling, a partner in a New Haven firm said that "[t]he number of people coming through and talking to me about it has dramatically increased in the last couple of weeks. ... They're concerned they'll be discovered."  Donmoyer, IRS to Extend Leniency for UBS Offshore Disclosers, Bloomberg.com (Sept. 21, 2009).

This appears to be a final deadline.  The Service announced that "there will be no further extensions."  (But note the comment by another practitioner, Lawrence Horn, that the IRS should extend the program through the end of the year.  See Donmoyer story, above.)

So you folks who had sequestered your millions in some corporation set up by UBS in the Caymans or otherwise hidden your income, now's the time to come clean.  Personally, I wouldn't mind at all if you are caught redhanded when the Swiss hand over your account and name to the US and you have to pay a fine of, say, 200% of the amount in the account as well as face criminal prosecution.  You'd make a good "crime doesn't pay" poster boy (or girl).  For it is a crime, you know, to hide your income and evade taxes.  Maybe you could claim you didn't know of your reporting responsibility, but I really would hate to be the defense attorney looking at a jury and hoping to convince them that you really didn't "know" what you were doing when you met with a Swiss banker here under subterfuge and arranged for a fortune and its earnings to be socked away in an island corporation under somebody else's name. ... 

Bloomberg.com notes that UBS declined to comment on the extension. 

More on the Tasck Force on Financial Integrity and Economic Development Conference

The task force statement concluding the conference (blogged yesterday is the keynote speech by Sen. Levin) makes an important connection between problems in achieving appropriate development in poor countries and illicit financial flows facilitiated by the shadow banking system.

The massive flow of illicit money out of developing nations, estimated at some $1 trillion per year, outpaces current levels of foreign aid by a ratio of nearly 10 to 1.  Consisting of tax evasion, tax avoidance, and criminal and corrupt funds, this phenomenon is the most damaging economic condition hurting the global poor.
 
Therefore, the Task Force calls on the G-20 nations to recognize publicly that the flow of illicit money out of poor countries, facilitated by the global shadow financial system, cripples the ability of these countries to work their way out of poverty. Recognizing this linkage is a vital first step in creating the conditions to eradicate poverty in developing countries. The second step is taking action to stop these flows.

Tax evasion isn't just a wealthy person's neat trick of employing spiffy tax advisers to figure out how to hide money offshore and avoid taxes or a corrupt government executive's nifty way of planning ahead to protect himself and his family in retirement.  It's a way of cheating everybody else out of the economic growth and good social programs that those taxes would have made possible.

Task Force on Financial Integrity and Economic Development--Levin Keynote

Michigan's Carl Levin gave the keynote address at the Washington conference of the Task Force on Financial Integrity and Economic Development. (For information on the organization, visit its website at http://www.financialtaskforce.org.  Levin's remarks, and soon a YouTube of the conference, are available here.).  His theme--offshore tax abuse--is described with spy-novel aplumb.

[W]hat's been happening in the offshore tax haven world reads like the stuff of a novel. It involves billions of dollars in hidden assets, secret documents, clandestine meetings, and scheming in cities around the world. It involves conflict among some of the world's richest nations. And in recent months, political events have caused a near earthquake in the offshore world that has shaken the marbled headquarters of some of the world's richest private banks serving some of the world's wealthiest people.

Levin is right-on as to the importance of this effort.  As he says:

Tax evaders reap enormous benefits from civil society - they enjoy the security our military and law enforcement agencies provide; they invest and prosper thanks to the rule of law and sanctity of contract which our regulators and court system enforce; and they build their economic future on the financial, communications, and transportation infrastructure that taxpayers finance. What we ask in return is that all members of society pay that share of their income that they owe, so that governments can continue to protect fundamental rights and provide basic services. If that social contract breaks down and some refuse to pay their share, the effects on civil society are caustic. Ending offshore tax abuse is about more than money; it is about protecting the principles upon which our economic and political systems are built.

Levin  provides a chronology of our progress in ferreting out, and acting to reduce, the offshore tax evasion schemes aided and abetted by multinational enterprises like Enron, KPMG, and the UBS banking conglomerate that the investigative committee thinks has cost the US about $100 billion a year in tax revenues:

• 1991: US banks offering private banking services to foreign heads of states that helped them hide illicit funds

• 2001: use of US banks by small offshore banks to move drug trafficking funds

• 2002: Enron's use of phony offshore transactions to inflate revenues/minimize taxes (440 shell companies in the Caymans, among other entities used)

• 2003: tax scams developed and marketed by major accounting firm KPMG

• 2004: US banking assistance to Augusto Pinochet

• 2006: US taxpayers using tax havens to dodge US taxes

• 2008-9: LGT bank of Lichtenstein and UBS bank of Switzerland using banking secrecy laws to help wealthy US residents conceal assets and evade taxes

Part of the story is the way the US finally was able to start prosecuting some of the most egregious US tax evaders who had hidden their assets in this way.  Two whistleblowers--one at the Lichtenstein bank and one at UBS--sacrificed their normal lives to reveal names and the entrenched and accepted customs of the banks of taking exhaustive steps to get around US laws to "service" wealthy clients' tax evasion wants (secret codes, encrypted computers, pay phones, transfers of money in and out of accounts to block audit trails, secret visits to US clients, counter-surveillance training, smuggling diamonds in tubes of toothpaste).

 

Levin claims that the recent "wins" against Switzerland and Liechtenstein means that the good guys are "on the march" with "more progress in the last year than [in] the previous ten years combined."  The theme is that the OECD model agreement on tax information sharing will essentially end the use of bank secrecy laws for tax evasion. 

( I hope so, though I remain unconvinced, without further changes.  Even if the Swiss expand the exception from "tax fraud" to "tax evasion", it still appears that far too much must be known by the US before it can seek specific account information from the Swiss, when the secrecy of the Swiss information will preevent the US from having enough information to seek more information.  We'll have to see as the facts come out.  Even Levin admitted that:  "the model agreement has traditionally been interpreted as requiring a country to supply information only when a requesting jurisdction has the name of a specific, suspect taxpayer.  Most governments take the psotion that if the requesting jursidction doesn't have the taxpayer's name, no information can be shared, even if the bank secrecy laws make obtaining that taxpayer's name difficult or impossible.  That has to change." (emphasis added).)

 As Levin notes:

Of course, the battle to end offshore tax abuse is far from over. And I am concerned that in our spy story, the good guys may declare victory and relax before the villains are vanquished. We need to take action now to ensure we get a happy ending.

One of the actions recommended seems like a great idea, if countries only have the willpower to do it:

having all G-20 countries adopt rules that require their financial institutions from doing business with an offending bank or jurisdiction-, thus essentially locking them out of the financial system of the G-20 countries.

 Levin urges the passage of the "Stop Tax Haven Abuse Act S 506".  (I've commented on it before.)  Many of the provisions should clearly be passed because they represent workable measures to combat offshre tax abuse, such as taking steps against the banks or jurisdictions, heightening reporting requirements, expanding the statute of limitations so there is more time to track the money, and toughening penalties.  

Levin also argued for the "Incoporation Transparency and Law Enforcement Assistance Act" S 569, which would require reporting of beneficial ownership when corporations and limited liabilities companies are created in the United States.  As he notes, "[t]his corporate secrecy frustrates law enforcement ... and undermines U.S. efforts to persuade offshore jurisdictions to identify the beneficial owners of the companies they form."

 

 

Obama's tax team

Obama has announced his selection for Assistant Secretary of the Treasury for Tax Policy, an important post that serves as the primary liaison between the executive branch and Congress on tax legislation.  His choice is Michael Mundaca, currently an adviser to Secretary Geithner on tax issues.  His career includes working at Ernst & Young, serving in the Clinton Treasury Department, and serving under Bush as Deputy Assistant Secretary for International Tax Affairs. See, e.g., the OECD's bio sketch on Mundaca, available here.  (It describes Mundaca's Ernst & Young work as "focussed on cross-border planning and structuring...and on international legislative and regulatory monitoring and consulting".  The latter likely includes a good bit of lobbying for corporate friendly international regs and laws.)

Rebecca Christie notes in her Bloomberg story on the Mundaca choice:

Mundaca's nomination, which must be confirmed by the Senate, completes Obama's picks for a new tax policy team at the Treasury Department.  The others are Joshua Odintz, who has been a tax lawyer for the Senate Finance Committee; Stephen Shay, a partner with the Boston law firm Ropes & Gray LLP who previously served inthe department; Emily McMahon, currently deputy chief of staff for the congressional Joint Committee on Taxation; Mark Mazur, a former IRS executive; Mark Iwry, another Treasury Department veteran who served as a senior fellow at the Brookings Institution and a lawyer for the firm Sullivan & Cromwell LLP, and George Bostick, a tax benefits lawyer who most recently worked for the firm Sutherland Asbill & Brennan LLP.

Obama's tax policy choices are all upstanding people, I'm sure, and quite competent.  I wish they were all powerful voices for progressive taxation that would help lead us away from the capital-favoring policies of the Clinton and Bush years.

In memory of Sept 2008: bank regulation, anyone?

Last September, Lehman Bros. collapsed, AIG became a ward of the state, and the US woke up to the financial havoc that can be caused by greedy bankers speculating on the financial system with exotic derivatives and no regulation.  After billions in bailouts, it may be that the financial system has survived the disaster.

IN the meantime, the very bankers that caused the systemic problems, and the investors that made hay off of it, continue to benefit.  Bqnker bonuses are intact--soaring again as banks make money by lending very dearly, charging enormous fees for doing almost nothing (credit card banks, especially), and using the bailout monies to make acquisitions giving them even greater market share.

So one would think that the government would now have already stepped in to re-regulate the banks and ensure that we have safeguards in place to prevent the kind of "you lose, I win" speculation that the investment banks engaged in.  But it hasn't happened yet.  Why not?  Is it that the bankers and the bank owners have so much power over elected politicians that they can fail so abysmally yet still get away with bailout dollars and no oversight? 

At least there is one watchdog making recommendations for change that sound reasonable.  The Wall Street Journal reports today on the Bank for International Settlement's study of 20 of the largest banks (unnamed), suggesting that the systemic risk from big banks increases even more than proportionately with their increase in size.  These financial giants, it says "should pay higher taxes to offset their potential threats to the system."  The BIS sees "a clear rationale for having tighter prudential standards for larger institutions."  Natasha Brereton, "BIS Advises Higher Taxes for Big Banks," Wall ST. J. at C1 (Sept. 14, 2009).

Sounds like a start to me.  The US, for example, could impose a surcharge on banks' earnings, for banks that have a certain market share and market capitalization.  That surcharge would result in their paying a higher percentage of their earnings in taxes than they have in the past, when they have managed to have one of the lower effective tax rates.  Along with the surcharge, Congress should remove some of the other special "tax loopholes" that it has enacted to benefit big banks, removing the special tax breaks like the "active financing exception" that permits the big multinational banks to avoid paying current tax on their passive-type income.  (The banks, of course, have lobbied heavily to get Congress to make that "active financing exception" permanent and they aren't exactly eagerly awaiting the creation of a consumer financial products protection agency or a single banking overseer with power to ensure adequate capital and limited risk-taking.  Will Congress have the will to resist the appeal of big campaign contributions from Big Banks?)

Imposing a higher tax rate on big banks, to offset the high costs to the government of an implicit governmental guarantee, would make sense, at least until Congress gathers the will to break up the big banks so that they do not impose such systemic risks.  But it isn't enough.  Congress also needs to institute sharp curbs on derivatives.  Banks should not be permitted to speculate by inventing financial products that do nothing to help companies finance real business.  Derivatives should be reserved for real hedging, and they should be managed through a clearing house with limits on exotic products that primarily allow speculation and even tax evasion.  Congress should also change the rules for sourcing income from derivatives.

But again, banks (and other industries that claim derivatives are essential for hedging) are pushing back.  See Matthew Dalton, "EU Derivatives Proposals Draw Pushback," Wall St. J. at C5 (Sept. 14, 2009) ()noting that the EU proposal to limit th risks that derivatives pose fro the system by requiring standardizedderivatives, traded through a clearing house, has encountered problems from industries who complain that suuch regulation will increase their costs).  Yes, regulation of derivatives may increase costs.  But nonregulation imposed tremendous costs.  Do we really want to go back to "business as normal" pre Sept. 2008?  If we do, banks will continue to trade in risky derivatives, some used as genuine hedges and many not.  There will likely be money made, and the cost will likely be imposed, again, on taxpayers who did not benefit from the boom.  Ultimately, we should strictly regulate derivatives products so that more real money is put into businesses and less money is roaming the markets in speculative play between financial institutions.

A few actions by Congress could make a difference in the future; without it, we can expect the speculative risk-taking, which makes big bucks for bankers and their investors and forces the losses on ordinary taxpayers, to grow again into a dangerous giant.

increasing Income Inequality--CBPP

The Center on Budget and policy Proirities released on Wednesday a report on the increasing concentration of income in the top 1% . See  Feller and Stone, Top 1 Percent of Americans Reaped Two-Thirds of Income Gains in Last Economic Expansion: Income Concentration in 2007 was at Highest Level Since 1928, New Analysis Shows (Sept 9, 2009).  The report is based on the Piketty and Saez analysis of recently released IRS data.

During the period of 2002-2007 when Congress passed a number of tax laws giving extraordinary tax relief to the wealthy, it just so happens that the top one percent garnered two-thirds of the income gains.   The income of the top 1%  grew more than 10 times faster than the income of the bottom 90%.  (The income of the top 1/10th of 1 %, grew even more staggeringly --rising 94% or by an average $3.5 million per household in that group.  The share of income to that group is at its highest level ever--even surpassing the 1928 peak.) A graph that depicts shares of income growth for those two groups (almost everybody --bottom 90% and just the upper crust--top 1%) indicates that the bottom was gaining from 1960 through 1982, but the top acquired a larger proportion of income growth beginning in the 1982-1989 period.  The Bush years look a lot like the 1920s.  Hmmm.

 

Is this concentration less worrisome if we think there is some mobility among classes?  Maybe, but not much.  Not many of the bottom 90% move into the top 1%, and even fewer make it into the top 1/10th of 1%.  And having that kind of resource advantage makes even significant losses (say, from a financial crisis) less likely to create long-lasting harm.  The existence of the wealth disparity (even with some mobility among classes) pervades the way institutions operate.  Influence is still had by the very wealthy, even if there are a few new faces.   The problem with huge disparities of incomes, that is, continues even if there is some mobility in and out of the highest income groups.  It is merely made worsen, of course, when mobility decreases. 

So how should we respond when we learn that our country has experienced a long-term trend towards concentration of enormous wealth in the hands of a few?  I believe we should take steps to redress the situation.  Taxes should be made more progressive--so a surcharge on the wealthiest taxpayers to fund health care reform is a good idea, as is the elimination of the capital gains preference (and in particular the treatment of dividends as net capital gains for individuals).  Benefit programs should be made more progressive--such as the discussion (see Wednesday ataxingmatter) of eliminating the 529 tuition savings plans and putting the revenue cost of that program into funding direct student loans for middle and lower class students.