IRS

A Must-Read

Last night I sat down with a captivating page-turner that I just had to finish before I went to bed.  No, not The Hunger Games.   It was The Internal Revenue Service Data Book, 2011 – 84 pages chock-full of tables and footnotes.  It addresses 2010 tax returns and the 2011 IRS fiscal year (“FY”).  It was just published.  I think I secured a first edition .pdf download. Trust me; there is some very interesting information in this book. 

  • The IRS had 91,380 employees at the end of its FY 2011, down from 94,346 at the end of its FY 2010.
  • 77% of 143 million individual returns were filed electronically.
  • What are the chances of being audited?  It depends.
    • Overall, about 1.1% for individuals in FY 2011.
    • If an individual return had adjusted gross income of $500,000 to $1,000,000, it was about five times as likely as the average to be audited.
    • Almost 30% of individual returns with $10,000,000 or more of adjusted gross income were audited.
  • Of the roughly 6.6 million math error notices that the IRS sent out relating to 2010 returns, 49.5% were caused by the Making Work Pay Credit, which was a refundable tax credit based on earned income and was available to taxpayers in 2009 and 2010.
  • Businesses for which income or loss is reported on Form 1040 Schedule C (on returns without the Earned Income Credit) are almost 5 times as likely to be audited as partnership returns.
  • About 70% of audits in FY 2011 were correspondence audits.  That basically means a computer selected your return and is auditing it.  Believe me; IRS people are a lot better to deal with than IRS computers.
  • When you don’t have money to pay your taxes, you can submit an offer-in-compromise (“OIC”) to the IRS.  In FY 2011, 59,000 OICs were received by the IRS and 20,000 were accepted.  I was a bit surprised how high the acceptance rate was.
  • The IRS received over 76 million toll-free assistance calls in FY 2011.  The IRS does not tell you how long the average wait time is to receive assistance.

Those are just a few of the factoids in this year’s Data Book.

Vance

Tax Amnesty

Texas Comptroller Announces Tax Amnesty for Businesses for a Limited Period this Summer

According to the Webster-Merriam dictionary website, amnesty is  ”the act of an authority (as a government) by which pardon is granted to a large group of individuals.”  Amnesty can apply to businesses, too. 

The state of Texas announced on March 15, 2012 its Fresh Start tax amnesty period running from June 12 through August 17, 2012.  This gives businesses a chance to file missing reports or amend previous reports in which they had incorrectly reported a lower tax than was due, pay the tax, and not incur penalties or interest.  Remember:  you must pay the tax – all of it – with the report.

The tax amnesty covers taxes and fees that were originally due before April 1, 2012.  It applies to sales tax, franchise tax and other state or local taxes or fees administered by the Comptroller’s office, except the Public Utility Commission gross receipts assessment.  Thus, for example, it does not apply to property taxes, since they are not administered by the Texas Comptroller’s office.

The amnesty does not apply to underpaid tax returns (tax that was reported but not paid) or to filing periods under audit or investigation, or identified for an audit or investigation. 

The Fresh Start amnesty program is not being offered simply as an act of kindness.  A similar tax amnesty was held in the summer of 2007 and brought in approximately $100 million of unpaid taxes.

This may be a fruitful summer activity, if you need to square up with the Comptroller’s office.  You can find out more about the amnesty program at www.freshstart.texas.gov/.  You will know your are in the right place if the landing page has a funny-looking chicken on it.

Vance

Stock Options, Tax Court

Stock received on option exercise was taxable event even though it became worthless in about six months: OUCH!

Patrick Sheedy worked for People’s Choice Financial Corporation (“PCFC”) from October 2001 through June 2006.  In 2004 he received nonqualified stock options to purchase 271,067.30 shares of PCFC common stock for $0.0221347 per share.  The options expired three months after Sheedy’s termination with his employer.

Sheedy left his employer in June 2006 and exercised most of his options on September 22, 2006, purchasing 250,000 shares that were “restricted securities” if the company went public.  As set forth in the option agreement, the compensation committee of the board of directors set the fair market value of the shares of privately held PCFC on the date of exercise.  The committee determined the value to be $3.00 per share, a price at which shares had changed hands infrequently in the last several months before the sale through an investment adviser who acted as an intermediary for trades of PCFC shares.  Sheedy signed a typical “accredited investor” letter stating that he knew what he was doing and knew about the company’s business and financial condition.

Sheedy paid PCFC a total of $225,278:  $5,534 for the purchase price of the shares and withholding tax of $ 219,744.  In March 2007, PCFC declared bankruptcy.

Let’s summarize.  Sheedy recognized almost $750,000 of ordinary income and was out of pocket almost $250,000 in taxes on stock that was worthless six months later.

Sheedy filed an original return for 2006 reporting the income.  He filed an amended return claiming a theft loss in the amount of the income recognized.  Nice try.

The law is clear, but punitive in the instant case.  The Tax Court got it right.  Sheedy was taxable on the difference between the $3.00 per share purchase price and the purchase price of $0.0221347 per share; no refund for 2006 for Sheedy.

As a consolation prize, the IRS awarded Sheedy a worthless stock loss in the form of a short-term capital loss.  If Sheedy lives an exceptionally long life and his investing acumen does not improve, he’ll recoup his money in 250 years.

Back in the 1980s, I witnessed this same phenomenon strike a number of employees of a client of mine.  These good folks were featured in a Fortune magazine article that trumpeted their sudden wealth when their employer went public and they held very valuable stock following the IPO.  Only a six-month restriction period kept them from being cash rich:  sort of an East Texas and low-tech version of Facebook millionaires.  During that six months the stock tanked.  They could not pay their taxes, even if they sold all their stock.  I and my colleagues from around the country tried to find a solution.  There was no way out.

So, let Sheedy be a cautionary tale if you get a chance to get in on the ground floor through nonqualified stock options.  Be sure that you understand the price you pay and the risks you take for the opportunity.

Vance

Tax Court

Tax Court disallows cost segregation of apartment buildings in AmeriSouth XXXII, Ltd., TC Memo 2012-67, issued in March, 2012.

Cost segregation studies performed on depreciable real estate give taxpayers a basis for depreciating certain components of the properties over much shorter depreciable lives than 27.5 years for residential real property and 39 years for nonresidential real property.  If there is any meaningful interest rate to use to present value the accelerated tax savings, the results of a cost segregation study are quite valuable to taxpayers.  As you might guess, the IRS has some reservations about cost segregation.   It took issue with AmeriSouth, a Dallas-based company, about its cost segregation results on its Garden House Apartments, located in Mesquite, Texas and owned by its partnership AmeriSouth XXXII, Ltd.

From this new case, we are reminded of or learn several things.  First, bad facts make bad law.  Second, pigs get fat and hogs get slaughtered. Third, Tax Court Judge Holmes (or one of his law clerks) is a funny person.

Bad facts make bad law.  AmeriSouth didn’t show up for the trial – definitely a bad fact.  By the time this case was tried, AmeriSouth XXXII had sold the property.   It did not answer court summons and orders.  Its attorneys withdrew.  The court could have dismissed the case entirely, but instead decided the case, deeming any factual matters not contested to be conceded by AmeriSouth.   The court sided with the IRS in almost all of its contentions and held that most components were structural components, integral to an apartment building’s operation and maintenance, and therefore depreciable over the life of the building – 27.5 years.

Pigs get fat and hogs get slaughtered.  At least some commentators have said that the cost segregation study was overly aggressive, even by the normally aggressive standards of cost segregators.  The IRS had plenty to pick on.

I suppose that Judge Holmes had some time on his hands, since he did not have to weigh many factual arguments.  He used that extra time to write quite an entertaining opinion; even a casual reader, let alone a tax nerd like me, would get a number of laughs.  For example, at the beginning of the opinion, Judge Holmes says:  “We are tempted to say [the benefit of shorter depreciable lives] is why AmeriSouth throws in everything but the kitchen sink to support its argument – except it actually throws in a few hundred kitchen sinks, urging us to classify them as “special plumbing,” depreciable over a much shorter period than apartment buildings.”  Well, I thought it was funny.

The upshot of this case is that the IRS has something, if only a memorandum decision, that it can rely on to go after cost segregation studies of apartment buildings.  Be forewarned.

 

Vance

Uncategorized

Introducing Vance Maultsby, CPA

Vance is one of eight owners at Huselton, Morgan & Maultsby, P.C., a full service accounting firm located in the heart of Dallas, Texas.  He started his accounting career at Peat Marwick Mitchell where he made partner and was named National Director of the Petroleum Industry Practice. Following his time at Peat Marwick, Vance held executive corporate finance roles at investment bank Stephens, Inc. and Ernst & Young, LLP. Vance has also served as the CEO of Palex, Inc.

The experience Vance gained in each of these roles has given him an exceptional perspective into the business issues companies face today. We invite you to follow his blog as he offers business insights and explores the latest financial news. For more information on Vance, please click on the “About Vance” link in the toolbar above.