FEDERAL TAX ALERT PAGE 1 OCTOBER 2008

NEWS ITEMSPresidential Candi-dates’ tax Plans

GaO saYs tOUGH rUles FOr Paid Pre-Parers WOrK

taxPaYers Can Fix lOss OF stiMUlUs PaYMent On 2008 retUrn

relYinG On taxPaYer inFOrMatiOn Can Be risKY

sPeCial Presidential eleCtiOn issUeThis month we have a guest author for the Federal Tax Alert, Lucia Smeal, a prac-ticing lawyer and Accounting Professor at Georgia State University in Atlanta, Georgia.

In this issue, Lucia Smeal gives us insight into how the Presidential election may affect the Tax Code by taking a detailed look at the tax plat-forms of the two major candi-dates. For contrast, Smeal has included information on the most visible third-party candidate, Bob Barr, a former U.S. Attorney and Republican Congressman from Georgia, who is running as the national Libertarian candidate.

If you want to contact Lucia to offer any comments or suggestions for future issues, she can be reached by e-mail at lnsmeal@comcast.net.

aBOUt tHe aUtHOr.Smeal received her B.A. with Honors from the University of Georgia and her Juris Doctor degree from the Columbus School of Law, Catholic Univer-sity, in Washington, D.C. After law school, she worked as a tax legislative analyst for Congres-sional Research Service at the Library of Congress, then at the Washington, D.C. tax firm of Silverstein & Mullins. Smeal later joined Tax Analysts, a noted tax policy think-tank and legal publisher, where she was a member of the Capitol Periodical Press Corps, editor of Tax Notes Today, and later served as Chief Oper-

ating Officer of electronic publishing, Executive Vice President, and assistant corpo-rate counsel.

Smeal’s many publishing activities include Editor, Tax Notes Today; Contributing Editor, S Corporations service, published by Prentice-Hall/RIA; Contributing Editor, Tax Management Portfolios; Editor, Washington Tax Review, published by Tax Manage-ment; Contributing Writer, US Digest of Public General Bills and Resolutions and Thomas, the US House Legislative Infor-mation System.

Presidential Candidates’ tax PlansThe new President will barely be finished unpacking his boxes at the White House when he will be required to send his first comprehensive Federal budget proposal to Congress in early February 2009. And with that proposal will most certainly be a major new tax plan. In preparation, the presidential candidates each have crafted a set of far-reaching tax proposals which reflect their own version of fiscal “change” and economic recovery measures.

When discussing their tax plans, the candidates tend to emphasize who will benefit rather than how the rules will be changed. But the devil is in the details, as they say, so let’s look at the specifics of each candidate’s plan. To understand their positions, you need a quick summary of President Bush’s tax cuts. The Bush tax rates, set to expire in 2011, are shown below in the first column under “Individual Provisions.” Many of the candidates’ positions key off the sitting President’s current tax framework.

continued on pg. 2

Tax LaW UpdaTE

Breaking News—As the Federal Tax Alert went to press, Congress had just passed the bank bailout bill, the Emergency Economic Stabi-lization Act of 2008, and the tax extenders and alternative minimum tax (AMT) relief legislation, all in one bill, H.R. 1424. Over 100 tax provisions were added to the bailout bill, primarily by the Senate, including AMT relief, tax relief for disaster areas in the Midwest, Texas and Louisiana, a huge package of renewable energy incentives, and exten-sions of numerous tax breaks expiring at the end of this year, such as the R&D credit. The President is expected to sign the bill.

The tax law changes in the bailout bill will be explained in a forthcoming issue of the Federal Tax Alert. Watch this space!

NEWS ITEMS PAGE 1

TAX LAW UPDATE PAGE 1

IRS ACTION NEWS PAGE 3

ETHICS CORNER PAGE 8

COntentsNews Items .......................... 1Tax Law Update .................. 1IRS Action News ................ 3Tax Court Decisions .......... 6Other Court Opinions ....... 7Ethics Corner ...................... 8Quotes ................................. 8

inserts2008 NSTP Fall UpdateMake Room for EducationFire Sales

A PUBLICATION OF THE NATIONAL SOCIETY OF TAX PROFESSIONALS OCTOBER 2008A PUBLICATION OF THE NATIONAL SOCIETY OF TAX PROFESSIONALS OCTOBER 2008

FEDERAL TAX ALERT PAGE 2 OCTOBER 2008 FEDERAL TAX ALERT PAGE 3 OCTOBER 2008

PRESIDENTIAL TAX PLAN MATRIX

Tax Provisions Republican: McCain-Palin Democrat: Obama-Biden

INDIVIDUAL PROVISIONS:TAX RATES

BUSH TAX CUTS:

Individual tax rates –10%, 15%, 25%, 28%, 33%, and 35% (through 2010).

Long-term Capital Gains Rate – 15% for taxpayers in the 25% or higher bracket; 5% for lower brackets.

Dividend rate – 15% for taxpayers in the 25% or higher bracket; 0% for taxpayers in lower brackets.

Make the Bush tax cuts permanent by extending current individual rates indefinitely.

Keep the existing long-term capital gains rate of 15%.

Keep the existing dividend rate of 15%.

Extend the Bush tax rates only for those earning under $250,000 per year.

Raise the long-term capital gains rate to 20% for those earning $250,000 or more. Eliminate all capital gains taxes on start-up and small busi-nesses.

Raise the dividend tax rate to 20% for those making $250,000 or more.

DEPENDENTS Double the personal exemption for dependents from $3500 to $7000.

Expand the child and dependent care credit to make it refundable;

Allow low-income families a 50% credit for childcare expenses.

HEALTH INSURANCE Give taxpayers a $2500 refundable credit ($5000 for married couples) for health insurance costs; the credit could be elected instead of deductible employer plans.

WORKING FAMILIES “Making Work Pay” credit of up to $500 per working person or $1000 per family for those with incomes up to $150,000;

Expand earned income tax credit (EITC).

SENIORS Eliminate all income taxes on senior citizens making less than $50,000 per year.

HOMEOWNERS “Universal Mortgage Credit” of 10% for nonitemizers.

AMT Phase-out the alternative minimum tax.

FILING SIMPLIFICATION Allow taxpayers to stay on the current system or to elect a new system that has only 2 rates and a generous standard deduction.

Filing simplification plan giving taxpayers the option of using pre-filled out forms which would be generated using income information from banks and employers. (Estimated to save $2 billion in preparer fees!)

TUITION Refundable $4000 credit for tuition.

SAVERS Expand and make the Savers Credit refundable for families making less than $75,000. Credit would be 50% of the first $1000 in savings.

BUSINESS PROVISIONS:CORPORATE TAX RATE Reduce the corporate tax rate from 35% to 25%.

RESEARCH AND DEVEL-OPMENT CREDIT

Establish a permanent R&D credit equal to 10% of the wages spent on research and development.

Make the existing R&D tax credit permanent.

OTHER BUSINESS PROVI-SIONS

Allow first year expensing of equipment and tech-nology investments. Ban new cell phone taxes. Ban internet taxes.

Provide tax incentives for universal Broadband coverage.End tax breaks for companies that send jobs overseas. (no details given by Obama campaign) More stringent enforcement of tax shelter and tax haven laws (no details given by Obama campaign).

ENERGY $5000 tax credit for purchasers of a zero-emissions vehicle under a new Clean Car Challenge for car companies.

Allow renewable energy credits until those sources become competitive.

Gas tax holiday (proposed for last summer)

$1000 Emergency Energy Rebate to families paid for with a Windfall Profits Tax on oil prices exceeding $80 per barrel.

Extend the Production Tax Credit for renewable energy sources.

liminate special tax breaks for the oil and gas industry.

ESTATE TAX Permanently reduce the estate tax rate to 15% and increase the exemption to $10 million

Freeze the top estate tax rate at 45% and allow an exemption of $3.5 million.

CONGRESSIONAL TAX CHANGES

Require a 3/5 majority in each House of Congress to raise taxes.

Enforce the current PAYGO rules in Congress which require new spending or new tax breaks to be offset with either cuts to other programs or tax increases.

FEDERAL TAX ALERT PAGE 2 OCTOBER 2008 FEDERAL TAX ALERT PAGE 3 OCTOBER 2008

liBertarian Candidates tax Plan — BOB Barr and WaYne allYn rOOtLibertarian presidential candidate Bob Barr’s position is that it is impossible to compre-hend the U.S. Tax Code and that taxpayers expend “billions of hours” trying to comply. Barr promotes a three-point plan to reform the tax code and the U.S. budget:

(1) Barr’s brand of tax reform starts with repealing the 16th Amendment to the U.S. Constitution, which enabled the federal government to impose an income tax on its citizens. (This Amendment was put in place in 1913.)(2) Next, Barr would cut government spending drastically to reduce the need for federal taxes. (3) Finally, with the stage set for a reduced government budget, Barr would put in place some type of consumption tax, such as the Fair Tax promoted by Rep. John Linder (R-Ga.) and Atlanta radio talk show host Neal Boortz. This tax would completely replace the federal income tax, payroll taxes and the estate and gift taxes.

Barr adds that there may be even better alternatives for tax reform that have not yet been proposed, so he would consider all ideas to replace the current system. Before a complete overhaul is undertaken, however, he would start by drastically reducing the existing income tax and replacing it with a flat tax, reducing corporate income taxes and the capital gains tax, and eliminating the estate and gift taxes. It is Barr’s position that all of these taxes must be reduced and eventually completely eliminated.

Research Tip: If you want to read the text of the 2008 Fair Tax bill, H.R. 25, you can locate a free copy on the Library of Congress’ website. It’s a fun read. It repeals most of the existing tax Code. Here’s how to locate the text:1) Go to the website http://thomas.loc.gov

(no www needed!)2) Enter “hr 25” in the Search box under

the heading “Legislation in Current Congress.”

3) Click on the Radio button for “Bill Number” as shown below.

Word/Phrase Bill Number4) Click the SEARCH box to retrieve the

bill.Happy Reading!

country. With 1.56 million individual tax filers in Oregon, this equals over $390 million more in income taxes paid in Oregon. GAO observed that these results point to the fact that Oregon’s licensing laws may lead to more accurate tax returns, although GAO concedes that the Oregon results are not conclusive.

Conclusion. Currently, no federal registra-tion, education, or testing requirements apply to all paid preparers before they can prepare federal tax returns. Thus, GAO recommends that Congress consider adopting nationwide rules for federal tax preparers similar to the strict Oregon paid preparer regime to dramatically increase federal revenues in a cost effective manner.

Observation. This may be a cost effec-tive way for the government to increase tax revenues, but the costs to return preparers and their clients could greatly increase.

From the “Government Employment Without the Benefits” Department—GaO saYs tOUGH rUles FOr Paid PreParers WOrKThe Government Accountability Office (GAO) has just said what all tax collectors wanted to hear—more regulation of tax return preparers translates into “increased tax return accuracy.” What does this mean? It means more tax money coming into government coffers with paid preparers doing all of the work. GAO recently examined Oregon’s and California’s relatively strict preparer rules. State Preparer Rules.

California paid preparers who are not attor-neys, CPAs, enrolled agents (or employed by one of these types of tax practitioners) must complete 60 hours of qualifying education, obtain a surety bond, register with the Cali-fornia Tax Education Council (CTEC), and pay a fee to become a CTEC Registered Tax Preparer (CRTP). They also must complete 20 hours of continuing education and reregister in each subsequent year. Paid preparers who fail to register can be fined up to $5,000.

Oregon has a two-tiered licensing program. Oregon requires new paid preparers to complete 80 hours of qualifying education, pass a state-administered examination, register, and pay a fee to be initially certified as a Licensed Tax Preparer (LTP). Additionally, they must complete 30 hours of continuing education and pay a fee to reregister in each subsequent year. Oregon also requires that all LTPs work under the supervision of a Licensed Tax Consultant, CPA, or attorney. To become an LTC, a preparer must meet specific work experience requirements and pass a second, more advanced examination. Oregon can impose fines of up to $5,000 per return for unlicensed tax return preparation and for certain misconduct on the part of LTPs and LTCs. The Oregon tests have low passing rates -- 54 percent for the LTP examination and 30 percent for the LTC examination.

Maryland enacted legislation in May 2008 to regulate paid preparers, and at least three other states have pending legislation to regu-late paid preparers.Increased Taxes.

According to GAO’s analysis of the data, Oregon returns were more likely to be accu-rate compared to the rest of the country. For example, the average Oregon return required about $250 less of a change in tax liability than the average return in the rest of the

NOTICETAX HOTLINE

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Technical Tax advice provided by NSTP Hotline staff is based upon specific information conveyed by the member. Members should take special care in relying upon recommendations and opinions that reflect the understanding of the Hotline staff member. NSTP and the Hotline staff are not responsible for misapplication of information given. Members are resposible for the utimate verifi-cation and application of any information provided by NSTP.

The Federal Tax Alert is published 10 times a year by the National Society of Tax Professionals.Mailing address: The Federal Tax Alert, 10818 NE Coxley Dr. Ste. A, Vancouver, WA 98662. Telephone: 800-367-8130.

Opinions expressed in The Federal Tax Alert are those of the editors and contributors.Guest Editor: Lucia Smeal; Technical Editor: Ronald Larson; Subscription Services: Glyness Scott;

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NOTE FROM THE BOARDThe NSTP Executive Director, Beanna Whitlock, has tendered her resignation effective September 22, 2008.She has asked that we express her appreciation to the NSTP member-ship for allowing her to serve them over the past two and a half years.NSTP wishes to thank Beanna for her dedication to improving the services offered to NSTP members.NSTP Board of Directors assures each member that NSTP continues “In Service to the Profession.”

FEDERAL TAX ALERT PAGE 4 OCTOBER 2008 FEDERAL TAX ALERT PAGE 5 OCTOBER 2008

before the credit is paid back, all installments come due in the year of sale or conversion to another use. That means the entire amount must be repaid on a single year’s tax return.

Hint. Taxpayers who claim the credit may want to increase their withholding or esti-mated payments to cover the yearly additions to tax they face during the repayment period.

irs exPands rUles FOr treatinG CHild as dePendent OF BOtH ParentsIn the August/September 2008 issue, we explained the new regulations on the custo-dial and noncustodial parents’ rights to claim a child as a dependent and discussed the new procedures under the regulations for filing Form 8332, Release of Claim to Exemption for Child of Divorced or Sepa-rated Parents.

Now, in a move that is sure to lessen the friction between divorced spouses, IRS has said that it will automatically treat a child as a dependent of both parents whether or not the custodial parent consents. Under a recent Revenue Procedure, a child of divorced parents will now be treated as a dependent of both parents for purposes of the following key deductions and exclusions including:

exclusion for employer-provided medical •expense reimbursementsexclusion of employer-provided coverage •under accident and health plansexclusion for qualified employee discounts •deduction for medical expenses •exclusion for distributions from Archer •Medical Savings Accounts (MSAs) and Health Savings Accounts

This treatment only will apply if the taxpayer-parents are divorced, legally sepa-rated under a court order, or live apart at all times during the last 6 months of the calendar year. The child must receive over one-half of his or her support during the calendar year from the parents and must be in the custody of one or both parents for more than half of the calendar year. Finally, the child must be a “qualifying child” or “qualifying relative” of one of child’s parents based on their family connection to the parent or based on their being a member of a parent’s household under the general dependency rules.

Observation: Before the 2004 change, chil-dren of divorced or separated parents were treated as dependents of both parents for purposes of these deductions and exclusions whether or not a parent released the claim to the exemption. In the 2004 and 2005 tax bills, in an attempt to clean up and standardize the dependency rules, Congress retreated from this position and put IRS in the middle of these controversies by requiring proof that

The IRS has already issued 90 percent of the economic stimulus payments but expects to issue more through December 2008. Taxpayers can track the status of their payments on www.irs.gov, under the link to “When Will You Get Your Stimulus Payment?”

Practice Tip: People who do not file a 2007 tax return by October 15th can still get the payment when they file next year’s return (2008 tax year) as a “Recovery Rebate Credit.” However, if they wait until they file their 2008 return, the payments will be based on their 2008 income and personal situations rather than their 2007 status. Thus, higher income or losing a depen-dent could result in a reduced payment!

First-tiMe HOMeBUYers tax Credit exPlained BY irsTaxpayers who qualify should start planning now to take the new homebuyers’ tax credit allowed under the recently enacted Housing bill. IRS advises that the credit is available for a limited time only—for home purchases made between April 8, 2008 and July 1, 2009. And there is a catch. It operates like an interest-free loan, so those taking the credit eventually will have to pay it back. Here’s a quick review of the rules:

Credit is 10% of the purchase price of •the home, with a maximum for $3750 for individuals and $7500 for married couples filing jointly.Principal residence only—no vacation •homes or rental properties.Available only for first-time home- •buyers or those who have not owned a home in the past three years. Phased out for modified AGI between •$150,000-$170,000 for married joint filers and $75,000-$95,000 for indi-viduals.

Repayment. The credit must be repaid over fifteen years. Within two years of taking the credit, one-fifteenth of the credit amount (or $500 each year for a $7500 credit) must be included as an addition to tax on a taxpayer’s 2010 return. This is not an addition to taxable income, but an actual increase in the tax owed for the year. The timing works this way. Repayment begins the second tax year after the year the credit is claimed. So if the credit is claimed in 2008, the repayment begins in 2010. If the credit is claimed in 2009, the repayment begins in 2011.

Procedure. The credit is claimed on new IRS Form 5405, which will be available later this year on the www.irs.gov website. Note that taxpayers purchasing a home in 2008 can claim the credit on their 2009 return or can file an amended return for 2008.

Ouch! If the taxpayer stops using the home as a principal residence or sells the home

IRS aCTION NEWS

taxPaYers Can Fix lOss OF stiMUlUs PaYMent On 2008 retUrnMany taxpayers have made simple errors on their 2007 returns that are delaying stimulus payments. In a recent news release, IRS identified the most common mistakes and misconceptions:

Filing more than one return. • Some taxpayers are filing both a paper and an electronic return in an effort to speed up the process, but this only slows it down. When IRS receives two returns, payments are delayed. It takes IRS up to 12 weeks to process the paper returns.Listing monthly instead of annual •income. Taxpayers should list their annual amount of qualifying income. Qualifying annual income includes at least $3000 in earned income, combat pay, or benefits from Social Security, Veterans Affairs and Railroad Retirement. Small tax liability reduces payment •amount. Some taxpayers who have little or no tax liability may get a smaller stim-ulus check than they expected. The law provides for a minimum of $300 and a maximum of $600 for individuals OR an amount equal to a taxpayer’s tax liability, whichever is less. If people have no tax liability, but have at least $3000 in quali-fying income, they will be eligible for the minimum $300 stimulus payment.Amending 2007 returns won’t fix •stimulus error. In general, if taxpayers make a mistake which results in no stimulus payment, filing an amended return will not result in an adjustment of the payment amount this year. Rather, such taxpayers will have another chance to claim the full payment when they file their 2008 tax returns in 2009. Only low-income individuals and recipients of Social Security, railroad retirement or certain veteran’s benefits who filed their original returns before IRS issued guidance for their situation will be able to get a stimulus payment based on a 2007 amended return.Wrong address. • A number of payments are going to old addresses and are thus being returned to the IRS. If taxpayers move after filing for the stimulus checks, they must make some provision for having their mail forwarded by the U.S. Postal Service or they must file a Form 8822 Change of Address notice with the IRS immediately.

FEDERAL TAX ALERT PAGE 4 OCTOBER 2008 FEDERAL TAX ALERT PAGE 5 OCTOBER 2008

one parent had released the exemption to the other parent before the noncustodial parent could take advantage of certain employer-provided fringe benefits or the medical deduction for their children. This must have been too much for IRS to police, so IRS has gone back to allowing both parents to claim these benefits for their children.

rUles FOr COnVertinG a nOn-rOtH ira annUnitY tO a rOtH ira Under the Code, a taxpayer whose modified adjusted gross income for a year does not exceed $100,000 (and who, if married, files jointly) may convert an amount held in a non-Roth IRA to a Roth IRA without paying an extra penalty tax. Because traditional IRAs are established with before tax income, when converting to a Roth, the taxpayer is taxed on the value of the non-Roth IRA being converted.

Conversions take many forms, but usually are done by a rollover where either the taxpayer gets a distribution and then puts it in another account or the trustees of the two plans transfer the taxpayer’s funds directly from one account to another. A third possi-bility is that the non-Roth IRA is redesig-nated as a Roth IRA.

In the case of a conversion involving prop-erty, the conversion amount generally is the fair market value of the property on the date of distribution. The final regulations address how to value distributions from a retirement annuity contract when it is being converted to a Roth. The valuation rules were changed in the final regulations to set the distribution amount as the surrendered cash value of the annuity. This change is a simplification from the valuation methods proposed in the initial regulations.

Observation: Through 2009, taxpayers must have modified adjusted gross income of less than $100,000 to rollover traditional IRAs into Roths without paying a penalty. They also must file jointly, if married, to perform this type of rollover. For tax years beginning after 2009, the income limit goes away and so does the filing status require-ment. Thus, although taxpayers will be taxed on the rollover amount, they will be able to permanently avoid tax on the earnings which accumulate in the Roth IRA. Taxpayers with in a lower tax bracket from the bad economy should definitely consider a Roth conversion since their taxable income from the change will be taxed at a lower marginal rate.

irs WHistleBlOWer PrOGraM BOOMinGIRS Whistleblower Office Director Stephen Whitlock has announced that the whistle-blower claims have risen dramatically in 2008, with upwards of 900 claims so far

this year. IRS believes the increase is due to the fact that possible rewards are higher than they were under the old law. Now, for cases in which the taxes, penalties, interest and other amounts in dispute exceed $2 million, the IRS will pay 15 to 30 percent of the amount collected to the whistleblower. If the case deals with an individual, the taxpayer who gets turned in by the infor-mant must have annual gross income of more than $200,000. If these qualifications are not met, whistleblowers can still get an award maxing out at 15 percent of the amount collected up to $10 million.

Procedure. Claims for awards must be filed on Form 211 Application for Reward for Original Information.

Key Point: Most new claims come from disgruntled spouses, business partners, or key employees, according to IRS. So tell your clients to keep the peace at work and at home!

taxPaYers in relieF areas MaY MaKe eleCtiOn FOr HiGHer WriteOFFsThe Economic Stimulus Act of 2008 put in place new rules on expensing deduction for business assets similar to the bonus deprecia-tion rules for the Gulf Opportunity Zone and Kansas disaster areas. The Economic Stimulus Act increased the dollar limits for Sec. 179 expensing from $128,000 to $250,000 per year. It also increased the phase-out amount from $250,000 to $800,000 in yearly investment. The phase-out amount is designed to target the relief to small businesses with a limited amount of investments—now $800,000. If taxpayers spend more than this amount on new, depreciable property, they lose the deduction. The law also allows 50% additional first year depreciation. These changes are effective for tax year 2008. (Neither amount is adjusted for inflation.)

The good news for taxpayers in the GO Zones or Kansas Relief Areas is that they essentially get to double-dip on depreciation deductions. They can take advantage of both the existing tax relief measures and the new increased limits under the Economic Stimulus bill. This can result in these taxpayers having up to $350,000 in expending write-offs with a $1,400,000 limit on equipment purchases for 2008.

IRS also cautions that since the expensing limits change from 2008 to 2009 and beyond, a problem can arise when a partner’s or S Corpo-ration shareholder’s tax year does not coincide with the partnership or S Corporation’s. When this happens, a partner or S Corporation share-holder’s expensing deduction can be delayed until the entity’s tax year.

Practice Tip: Note that IRS will allow taxpayers without its consent to make an expensing elec-tion by filing an amended return.

FisHinG inCOMe Can Be aVeraGed OVer tHree YearsThe IRS has issued regulations on how to average fishing income when computing tax liability The farm income averaging concept was extended to fishing businesses by the American Jobs Creation Act of 2004. The new rules define taxpayers engaged in commercial fishing as those who harvest fish for sale, barter or trade. Taxpayers running a fishing business now can elect to reduce their current tax liability by treating all or a portion of the taxable year’s fishing income as if one-third of it had been earned in each of the prior three taxable years.

irs delaYs VOUCHer rUle FOr eMPlOYee’s eleCtrOniC transit Passes

IRS is delaying for two years the effec-tive date of a 2006 ruling which requires vouchers for employer-provided transporta-tion benefits. The reason for the delay is that mass transit systems around the nation have not been able to develop the technology to generate acceptable vouchers from the use of electronic transportation cards. These cards, provided as an excludable fringe benefit by some employers, allow taxpayers free or reduced price transportation on subways, busses, ferries and multi-passenger commuting vehicles. Considering the price of gas, these transportation benefits will be used more and more as Americans turn toward public transportation. The delay in the voucher rule is until January 1, 2010.

irs UPdates aUtOMatiC COnsent PrOCess FOr aCCOUntinG MetHOd CHanGes

In a massive 200+ page Revenue Procedure, IRS tells taxpayers how to obtain automatic consent to change accounting methods for a huge list of specific items contained in the Appendix to the ruling.

To obtain consent, the taxpayer must file a Form 3115, Application for a Change in Accounting Method, during the taxable year in which the taxpayer wants to make the change. Under the new procedure, the taxpayer may be able to file a written statement in lieu of Form 3115 to get an automatic change. Significant changes to the existing proce-dures include:

separate five-year limitations for change • of the entire accounting method versus change of accounting only for a specific item.final year of a trade or business limita- •tions are determined without regard to whether accounting method adjust-ments are positive or negative.A designated automatic accounting •method change number is assigned to

FEDERAL TAX ALERT PAGE 6 OCTOBER 2008 FEDERAL TAX ALERT PAGE 7 OCTOBER 2008

dennis WilsOn v. COMMissiOner t.C. sUMMarY OPiniOn 2008-114Issue: Whether payments received by an individual from a company he partially owns are repayments for a loan or compensation for services. Facts: Taxpayer first filed a 2004 Form 1040, which included a Schedule C reporting that he had a sole proprietorship that had received $27,573 of gross receipts during 2004 and net profit of the same amount. Taxpayer did not report any self-employment tax for the net profit he had received. His company, Enduroglas, had reported the income on a Form 1099-MISC as $27,573.67 of nonem-ployee compensation during 2004.

The IRS issued a notice of deficiency to Taxpayer based on his nonpayment of self-employment taxes on the net profit. Taxpayer then had Enduroglas issue him a “Corrected” 2004 Form 1099-MISC stating that Enduro-glas had not paid him any nonemployee compensation during 2004. Taxpayer filed an amended return containing this explana-tion, “The 1099 the taxpayer received for $27,574.00 was incorrect and should have not been issued. A corrected one was sent in and the amount is $0.” Taxpayer asserts that the 1099 was issued in error because Enduroglas owed him nearly $50,000 in loans, and the $27,573.67 should have been a repayment of loan instead of compensation. Analysis and Conclusion: The Tax Court found that during 2004 the taxpayer and 10 other individuals were the owners of Enduroglas and that the taxpayer rendered significant services to the company with the understanding that he would be paid for those services. The Court noted that the tax law concerning the characterization of a payment as compensation is clear. Whether or not amounts are paid as compensation depends on the intent of the payor at the time the payment was made. Enduroglas paid the $27,754 to the taxpayer in return for services, intending that the payment be characterized as compensation. Only later did the taxpayer attempt to recharacterize the payment as a repayment of debt. Therefore, the Court held that the taxpayer was liable for the self-employment tax that applies to that payment.

lUCianO FernandeZ v. COMMissiOner t.C. MeMOrandUM 2008-210Issue: Should IRS consider local standards for living expenses or the actual living expenses of the taxpayer when evaluating collection potential for an Offer in Compromise.Facts: Taxpayer, a Florida resident, filed an Offer in Compromise which started

each type of change in the Appendix.The voluminous Appendix lists the specific

changes to which the new procedures apply. A sampling is set forth below.

Advances made by lawyers on behalf of —clients—instead of treating as deductions, treating as loans. —Timber grower fertilization costs. —Impermissible to permissible method of —depreciation or amortization.Expensing reforestation expenditures. —Computer software costs. —Method changes for state franchise taxes. —

Practice Tip: You may want to scan through the Appendix to this revenue procedure to see if a particular item of importance to your clients is listed. It is available as Revenue Procedure 2008-52 on the www.irs.gov website. Click on the Tax Professionals tab, in the left box, click on “Code, Regs & Guid-ance.” Click “Other Guidance” at the top of the page and enter “2008-52” in the right box for “Individual IRB articles.”

Tax COURT dECISIONS

KanOKWan sMitH v. COMMisiOner t.C. sUMMarY OPiniOn 2008-125Issue: Whether an individual married in a reli-gious ceremony only can claim deductions and child tax credit for a partner’s children. Facts: Taxpayer Smith and her partner, Mr. Little, lived together beginning in November 2001. During 2005, they cohabited in Alaska. While in Alaska, Smith and Little were married in a religious ceremony, but they did not obtain a marriage license from the local government. The couple held themselves out as husband and wife. Three children of Little’s lived with the couple. The children were 10, 8, and 7 years old in 2005. Mr. Little’s children had no contact with their biological mother and the children regarded the taxpayer as their mother. Taxpayer provided the sole support for their family during 2005 while Little (and his three children) attended a religious and language school in Yemen.

Taxpayer filed her 2005 Form 1040, U.S. Individual Income Tax Return, claiming head of household status, dependency exemption deductions, child tax credits, additional child tax credits, and child or dependent care credits.

The IRS denied Smith’s dependency exemption deductions, additional child tax credits, child or dependent care credits, and head of household filing status, determining an $8,134 adjustment.Analysis and Conclusion. The Court first noted that marital status is determined by state

law for federal income tax purposes. Because Alaska law does not recognize common law marriages, Smith and Little were not married for Federal income tax purposes. Smith was not related to Little’s children by blood, she had not legally adopted the children, and they were not her eligible foster children in 2005. The only way she would have been entitled to the claimed deductions and credits was if the children were Smith’s stepsons or stepdaugh-ters. Since there was no valid marriage, Little’s children were not the taxpayer’s stepsons or stepdaughters so dependent status was denied by the Court.

Note: Tell your clients, the taxpayer always has burden of proof for dependency exemptions.

MOUssa i. KOUrOUMa v. COMMissiOner t.C. sUMMarY OPiniOn 2008-120Issue: Whether the taxpayer is entitled to deduct expenses incurred for developing elec-tricity prediction software where the activity never earned any substantial revenue. Facts: From 2002 through 2007, Taxpayer, an electrical engineer, worked full time as an analyst/trader for a company which purchases and sells electrical power. During his employment, he obtained a business license for a company named Excelix, through which he started to market software he developed which could be used to predict the future price of electricity. Excelix did not generate any revenues in 2002. Excelix gener-ated $750 of revenues, from one customer, in 2003, but none in 2004. Nor did the company have any employees. Taxpayer’s business was ultimately unsuccessful, generating $5 million of unpaid liabilities and/or losses by the time of trial. Taxpayer reported his 2003 income and also took an array of business deductions on Schedule C in 2003 and 2004. Taxpayer also did not keep contemporaneous or methodical records of any kind with respect to his Excelix activity.Analysis and Conclusion: The Tax Court concluded that because the taxpayer did not earn revenue, maintain adequate records, or hire employees or consultants, he did not prove that the Excelix venture was a bona fide business activity. To be engaged in a trade or business, an individual taxpayer must be involved in the activity with conti-nuity, regularity, and the primary purpose of deriving a profit. The Court found that the activity generated substantial losses while only earning $750 over several years. Thus, the Court found that the activity was not a business engaged in for profit; there-fore, it upheld the IRS’s denial of losses as well as accuracy related penalties against the taxpayer.

FEDERAL TAX ALERT PAGE 6 OCTOBER 2008 FEDERAL TAX ALERT PAGE 7 OCTOBER 2008

evidence in the record was the computer listing, which did not indicate client addresses, locations, or distances. Also, the taxpayer did not have a representative from New York Life corroborate the listing, and he did not call his tax preparer, clients, or anyone else to testify on his behalf. The Court thus concluded that the taxpayer did not adequately substantiate his business expenses, and there was not a reasonable basis for his estimates. Thus, he was not entitled to the deductions.

OTHER COURT OpINIONS

United states v. rOOseVelt KYle, et. al. nO. 3:07-CV-02187 Us dist. Ct., sOUtHern dist. OF CaliFOrniaIssue: Permanent injunction necessary to stop fraudulent return preparation. Facts: Kyle, who resided in San Diego, California, has prepared tax returns for hire since 1983, with the exception of 2006 when he was in federal prison for willfully failing to file federal income tax returns. Kyle operated his tax preparation business using several entities or names, including Century One Resorts, COA Financial Group, LLC, and Eagle Financial Services, LLC. Kyle stopped personally signing returns in 2004, but Kyle still interviewed customers and prepared returns which were later signed by others. Kyle and his businesses prepared and filed approximately 1,500 returns per year since 2000. The returns prepared by Kyle understated his customers’ tax liabilities, most commonly by fabricating or inflating deductions on IRS Form 1040 Schedule A, “Itemized Deductions,” and Schedule C, “Profit or Loss from Business.” Analysis and Conclusion: The Court found that Kyle stopped signing the returns to thwart IRS efforts to detect his illegal conduct. The Court also was persuaded that Kyle’s fraudulent return preparation was directly responsible for his customers filing federal income tax returns that understated their federal income tax liabilities. As a result, Kyle’s clients claimed large income tax refunds to which they were not entitled. The fraudulent items included:

Inflated or Bogus Schedule A Employee Business Expenses

Inflated or Bogus Charitable Contribu-tions, donations to churches and good will without documentation

Schedule C Business Expenses such as exces-sive business travel expenses and work clothes

an evaluation by the IRS Appeals Office of Taxpayer’s reasonable collection potential. The IRS found the collection potential to be $205,220 on the basis of the information the Taxpayer provided. The reasonable collec-tion potential was calculated based upon current national and local allowance sched-ules instead of Taxpayer’s own figures. The Appeals officer allowed $1450 for Taxpayer’s monthly housing and utility expenses on the basis of the local standard amount for South Florida of $1,291, which was less than peti-tioner’s claimed amount of $3,678. Taxpayer argued that local standard was unreasonable based on his actual Florida living expenses. Because the reasonable collection potential was significantly greater than Taxpayer’s offer-in-compromise, the IRS Appeals officer did not recommend acceptance of the offer. Later, IRS issued a notice of liens against Taxpayer for his outstanding income tax liabilities.Analysis and Conclusion: The Tax Court, in upholding the liens, found that the IRS Appeals Officer did not abuse his discre-tion in using the standard IRS guidelines in determining the taxpayer’s total monthly living expenses. The Court concluded that the use of the IRS’s published national and local allowances as guidelines for basic living expenses was an appropriate method to determine a taxpayer’s monthly expenses and was authorized by the Code, regulations, and Internal Revenue Manual. The Court noted that the Appeals officer had consid-ered and adjusted the financial information based on the taxpayer’s figures and had come up with a figure already slightly higher than the published standards.

JinGYUn Qi v. COMMissiOner t.C. MeMOrandUM 2008-200Issue: Whether the taxpayer relied in good faith upon CPA preparer when she failed to report income from gambling winnings; whether accuracy-related penalties were appropriate. Facts: Taxpayer and her husband filed a joint Federal income tax return for 2004 which was prepared by a certified public accountant named John T. Tsai. On that return, Taxpayer failed to report all of her gambling income, dividends, and interest income. IRS imposed an accuracy-related penalty for the underreporting. Taxpayer was a California resident. Taxpayer disputed the deficiency and penalty based on the fact that she had used gambling losses against some gambling income on the return and on the basis that she had a CPA prepare the return. Analysis and Conclusion: The Tax Court found that the taxpayer’s reliance on her CPA was unfounded and was not in good faith because she had failed to give the CPA the necessary

information to properly fill out the return. The Court reasoned that although the CPA was a competent professional who had sufficient expertise to justify reliance, the taxpayer had not supplied her CPA with necessary and accurate information. The Court noted that the taxpayer had a duty to examine her return to ensure that all income items were included.

Hassan s. niYiteGYeKa v. COMMissiOner t.C. sUMMarY OPiniOn 2008-129 Issue: Whether insurance salesman’s esti-mates of unreimbursed automobile, travel, and other business expenses were properly substantiated. Facts: Taxpayer worked for five or six different employers over several years. His principal employer was the New York Life Insurance Co. where he was a “salesperson in training.” He did not receive a salary but earned his income entirely through commissions. Taxpayer lived in Brooklyn and commuted via subway to an office in Manhattan that New York Life designated. His sales territory included Manhattan and the surrounding areas. He generated about 80 percent of his business by calling on prospective clients. He worked days, nights, and weekends, traveling as far as the outlying parts of Queens, New Jersey, and Connecticut to meet with clients. He often drove his own car, stayed in hotels, and paid for meals. New York Life did not reimburse Taxpayer for his expenses.

A return preparation firm prepared his tax filings He provided some receipts to the preparer, but because he did not maintain a log book, and did not have totals for the business expenses he paid, the preparer and Taxpayer had to estimate the amount of the expenses. His estimates were backed up by a computer listing on plain paper that detailed dates and client names. There was nothing about the listing that indicated it came from New York Life, except Taxpayer’s testimony. Taxpayer claimed a total of $15,500 in unre-imbursed employee business expenses as a miscellaneous deduction on Schedule A, including automobile expenses using the standard mileage rate, travel expenses for overnight trips, and other expenses such as meals near home. IRS disallowed the entire amount of the deductions. Analysis and Conclusion: The Tax Court held that the taxpayer had not properly substantiated his automobile, travel, and meal expenses. The Court relied on the Code language which requires stricter substantiation by making taxpayers provide adequate records or sufficient other evidence establishing the amount, time, place, and business purpose of the expense to corroborate the taxpayers’ statements. The Court noted that the only

FEDERAL TAX ALERT PAGE 8 OCTOBER 2008

Observation: These IRS comments suggest that the Service intends to impose the penalty only in the most obvious and egre-gious circumstances. Let’s hope this is the case. We will be closely covering all develop-ments in this area and hope to hear from our membership regarding their personal expe-riences with the imposition of the return preparer penalty.

relYinG On taxPaYer inFOrMatiOn Can Be risKYMany of the Tax Court decisions and other Court opinions stated above raise ethical questions regarding the responsibility of the tax professional regarding the accuracy of work product and the level of culpability when preparing an inaccurate tax return. Circular 230, § 10.34 pro vides that a tax preparer generally may rely in good faith without verification upon information furnished by the client, but this section specifically provides that:

The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.

All tax professionals must be careful to assure that inaccurate filings are avoided; otherwise, the tax professional could be sanctioned by the Office of Professional Responsibility of IRS.

Click Here — Tax Research for Your PracticeThere are many websites that give you links to free sources of tax informa-tion, but none as useful as the “Tax and Accounting Sites Directory” found at http://www.taxsites.com. This directory is a comprehensive index of tax and accounting resources. With 4000 different links, it functions as a great starting point for your web-based tax research. In addition to federal, state, and inter-national government sites, it provides access to a broad range of information such as news, publishers, professional associations, tax firms, and tax discus-sion groups. It also has quick links to IRS information and useful tools, such as tax calculators. The directories are in alphabetical order by category. So, if you click on “State and Local Tax” on the Main Directory Page, you will get 4-5 subcategories which are then organized in alphabetical order.

Failing to Sign Returns and to Provide Preparer Identification Numbers

Because Kyle’s misconduct was “continual or repeated” the Court found that a narrower injunction prohibiting only the specific conduct would not be sufficient to prevent Kyle from his fraudulent behavior in the future. Therefore, the Court enjoined him from preparing returns altogether.Order Requirements: The Court ordered Kyle to contact all of his customers within 21 days after the date of the Order. He was required to inform those persons of the Court’s findings, the possibility of the impo-sition of penalties against him, the possibility that the government may seek to assess and collect any federal income taxes, interest, and penalties against them, and that he was permanently enjoined from preparing any returns in the future. Also within 21 days from the date of the Court’s order, Kyle had to give the government a complete list of persons (including names, address, phone numbers, and social security numbers) for whom he prepared or assisted in the prepa-ration of a federal income tax returns.

ETHICS CORNER

irs tries tO reassUre PraCtitiOners On Final PreParer PenaltY reGUlatiOnsAt several recent public appearances, including an IRS hearing on the preparer penalty regu-lations and an American Bar Association conference, high-level IRS officials tried to reassure nervous practitioners that the final return preparer penalty regulations will be imposed fairly and reasonably. Practitioners are most concerned with the preparer’s responsibility to check up on his or her client’s facts. Gone are the days when one could take the taxpayer’s word for something and put it on the return. At one forum, Deborah Butler, IRS Associate Chief Counsel, stated, “Preparers must make appropriate inquiries into the existence of facts and cannot gloss over fishy information…” Just how much due diligence a return preparer will have to do to check taxpayer facts and conclusions is unclear at this point. IRS insists it will be workable.

IRS agents will not be able to unilaterally impose a preparer penalty. The agent will have to go through a review process with supervi-sors before any penalty is imposed on a return preparer. Finally, IRS has indicated that it is focusing on tax return positions that are clearly out of line, not the close calls.

Here’s an example of an expanded listing for State Rate information.

State and Local TaxRates and Data

Sales Tax Rates ...Sales Tax Clear-•inghouseState Payroll Taxes Information •...Symmetry SoftwareState Tax and Finance Data •...Census BureauState Tax Rates and Structure  ...•Federation of Tax AdministratorsState Tax Tables  ...Urban-•Brookings Tax Policy CenterTax Bites ...Tax Foundation•Taxes/Budget Data ...Stateline.org•

www.nstp.orgService to the Tax Profession

QUOTES“Both the McCain and Obama campaigns have tried to keep pace with the political issues of the day – largely by responding with proposals for new programs and regulations that could reach deeper and deeper into taxpayers’ pockets.

Demian Brady, Senior Policy Analyst for National Taxpayers Union Foundation

“There is one difference between a tax collector and a taxidermist—the taxidermist leaves the hide.

Mortimer Caplin, former IRS Commis-sioner and founder of Caplin & Drysdale

“And as the economy starts to recover, we’re going to take those mortgages and we’re going to resell them into the market or we’re going to hold them until they’re paid off. In either instance, it is very likely that the taxpayers’ dollars will be recovered, that there will be no loss here to the taxpayer.”

Senate Budget Committee ranking minority member Judd Gregg, R-N.H., on bailout bill.

“Because the government would be purchasing troubled assets and selling them once the market recovers, it is likely that many of the assets would go up in value over time. Ultimately, we expect that much – if not all – of the tax dollars we invest will be paid back.”

President Bush on bailout plan.

“They have larded the bailout legislation with tax breaks.”

Libertarian Presidential Candidate Bob Barr on the bailout bill.

Did you miss the Special Topic Workshop in Williamsburg, VA this summer? Paul LaMonaca, CPA, MST and NSTP Educational Director, taught Details of Form 1040 - Schedules A, B and D and the Forms that support them.

The 2008 Special Topic Workshop topics included:

Determining How, When and Why an Item is deductible on Schedule A: —— Medical Cost - When and How to deduct —— Which Taxes are deductible and Why —— Mortgage and Investment Interest issues —— Those pesky Miscellaneous Deductions, etc.

Reporting requirements and issues of: —— Municipal Bond Interest —— Nominee transactions —— Accrued interest —— U.S. Savings Bonds —— Education Exclusion issues —— Qualified vs. Nonqualified Dividends, Etc.

Schedule D - Capital transactions including: —— Basis and the return of capitol —— Ordering rules —— Unused losses —— § 1250 unrecaptured depreciation issues —— Installment sale issues —— Reporting and the differing rates in 2008-2010 —— Related party sales —— § 1244 stock transactions —— Worthless Securities —— Wash sales, Etc. —— Etc.

In DVD format, Paul comes to you with the answer to your questions.

Receive the full 12 hour text material and DVD’s referencing the material to the applicable DVD. Pop the DVD in your computer (DVD ROM Drive Required) or DVD player and view Beanna at your leisure or use this wonderful reference tool.

Cost: $185 for Members (plus $4 S&H), $220 for Non-Members (plus $4 S&H), includes material and DVD set. 8 CE credits available through examination for an additional $35.

NSTP Member Price (DVD ONLY) - $185 Non-Member Price (DVD ONLY) - $220NSTP Member Price (DVD + 8 CE Credits) - $220 None-Member Price (DVD + 8 CE Credits) - $255

2008 Special Topic Workshop DVDs!

Service to the Tax Profession

2008 Regional Conference - Limited Liability Companies - The Good, The Bad and The Ugly DVDs!

Did you miss the Regional Conference this summer? Beanna Whitlock taught Limited Liability Companies - The Good, The Bad and The Ugly.

Examine the versatility of the LLC, when it is the right organization of choice. Discover the limitations of the LLC and why it might not meet your client’s needs. Learn the pitfalls of creating an LLC and why this entity may create problems for your client. Instructor: Beanna J. Whitlock, EA CSAIn DVD format, Beanna comes to you with the answer to your questions.

Receive the full 4 hour text material and 2 DVD’s referencing the material to the applicable DVD. Pop the DVD in your computer (DVD ROM Drive Required) or DVD player and view Beanna at your leisure or use this wonderful reference tool.

Cost: $100 for Members (plus $4 S&H), $135 for Non-Members (plus $4 S&H), includes material and 4 DVD set. 8 CE credits available through examination for an additional $35.NSTP Member Price (DVD ONLY) - $100 Non-Member Price (DVD ONLY) - $135NSTP Member Price (DVD + 8 CE Credits) - $135 None-Member Price (DVD + 8 CE Credits) - $170

2008 Regional Conference - Real Estate Transactions DVDs!

Did you miss the Regional Conference this summer? Paul LaMonaca, NSTP’s premier instructor taught Real Estate Transactions.

In this challenging economic time discover the proper tax treatment of some of the most pesky real estate transactions for your client. Subjects include:

Instructor: Paul LaMonaca, CPA, MST, NSTP Education DirectorIn DVD format, Paul comes to you with the answer to your questions.

Receive the full 8 hour text material and 4 DVD’s referencing the material to the applicable DVD. Pop the DVD in your computer (DVD ROM Drive Required) or DVD player and view Paul at your leisure or use this wonderful reference tool.

Cost: $150 for Members (plus $4 S&H), $185 for Non-Members (plus $4 S&H), includes material and 4 DVD set. 8 CE credits available through examination for an additional $35.NSTP Member Price (DVD ONLY) - $150 Non-Member Price (DVD ONLY) - $185NSTP Member Price (DVD + 8 CE Credits) - $185 None-Member Price (DVD + 8 CE Credits) - $220

Acquisitions •

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Carry forward Issues •

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Distributions •

Filing Requirements •

Form 1040 Effects •

Form K-1 Presentation •

Like-Kind Exchanges •

Ownership Issues •

Passive Activity Loss Issues •

§ 1250 Unrecaptured Depreciation Issues •

Much, Much More •

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2007 s Corp nRP audit & successful iRs negotiations sales Price $15.00

2004 introduction to LLC’s sale Price $25.00Special Topic Workshop

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A N N O U N C I N G

THE ARRIVAL OFNSTP EDUCATION – DVD STYLE

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2008Williamsburg special topic seminarBook and dVd set – 12 hours $185Details of form 1040 – Schedules A,B and D and the forms that support them.

2008 Regional Conference – Real estatetransactions – Book and dVd set8 hours $150

2008Limited Liability Companies – LLC’sBook and dVd set4 hours $100

Forensic accounting for the taxand accounting Professional $50

Form 1099 vs. W-2 employeea guide to understanding $50

The a B C’s of schedule C $50

All courses have self-study questions available for CPE credit.Additional fees apply.

For additional information and to order your educational materials, call nstP today at 800-367-8130.

If you missed the Williamsburg Special Topic Workshop or 2008 Regional Conference and regretted it, now the seminars come to you in the convenience of your home or office.

Questions? Call the nstP Hotline. nstP members have the best of both worlds – education when and how you want it and your questions answered by qualified tax professionals.

Education is the key!

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Make Room for Education!

Service to the Tax Profession