Tax Watch: Challenge for the challenged misses the mark

The 9th U.S. Circuit Court of Appeals recently dismissed an argument that the tax laws fail to provide equal protection to less educated individuals in an estate tax matter.

In agreeing with the U.S. Tax Court and the Internal Revenue Service, the appellate court upheld the IRS’ imposition of an estate tax liability against an individual who was “educationally handicapped.”

Earl and Mildred Koester drafted wills with advice provided by an attorney. Mildred died and left everything to her husband. When he died, his estate reported a gross estate of $1 million and a $109,000 estate tax liability.

The IRS determined a $45,000 estate tax deficiency in Mr. Koester’s estate tax return but conceded it. The estate argued that the $109,000 liability reported was incorrect and that it had no liability.

The estate argued that Mr. Koester had been deprived of equal protection because lack of education had left the couple unaware of how to avoid estate tax liabilities.

Lawyers for the Koester estate also maintained that the law’s complexity deprived undereducated individuals of equal protection.

The Tax Court found the estate’s argument misguided, and upheld the IRS’ determination of the estate tax liability. The court further held that the Koesters had been free to will their property as they saw fit.

However, the court was unable to determine if the couple had been aware of the provisions that the estate claimed would have reduced their estate taxes.

Cite: Estate of Earl C. Koester, et al., v. Commissioner, T.C. Memo 2002-82, & 9th Circuit

Bermuda minister: We’re no tax haven

* Randolph Horton, acting finance minister for Bermuda, recently defended his country against media accusations that it has encouraged corporate malfeasance by allowing reincorporations there.

“Bermuda does not encourage companies to reincorporate in Bermuda in order to reduce their tax obligations,” Mr. Horton said.

“The handful of companies that left the United States for Bermuda over the last few years did so of their own volition, based on their analysis of the tax code,” he added.

He quoted the general counsel of the U.S. Department of the Treasury as having said: “The incentives to relocate in Bermuda arise out of our own U.S. Tax Code. We are at fault, and it is no fault of Bermuda.”

New certification being mulled

* The national taxpayer advocate in Washington has requested that Congress consider a certification system for tax preparers who aren’t certified public accountants, enrolled agents or attorneys. Certification would require passing a series of tests as well as receiving continuing-education credits.

Make-good payment a deductible expense

* The U.S. Tax Court recently ruled that the compensation paid to a corporation’s founder was, in light of the underpayment in preceding years, reasonable compensation and therefore fully deductible as a legitimate business expense by the corporation.

Devine Brothers Inc., a family-run business, has been in operation since 1918. Richard Devine worked for the company, and by 1961, he owned all of its stock. He oversaw finances, marketing and supervising employees.

The company then had financial problems, released its employees and left Mr. Devine as its sole employee.

He changed the company’s direction and increased its retained earnings to boost its bonding capacity in order to compete in the direct-bid market.

That bonding requirement required 10% of revenue in liquid assets, so the company underpaid Mr. Devine to build those assets. Between 1986 and 1989, he transferred 220 of his 550 company shares to his son.

For 1994, Mr. Devine’s salary was $51,663, and his son’s was $66,987. For 1995, the father’s salary was $260,378, the son’s $112,599. The company also provided Mr. Devine with a retirement plan, health, life and disability insurance, and the use of a vehicle.

Devine Brothers filed a corporate tax return for the year ended Feb. 28, 1995 and claimed a $260,378 deduction for Mr. Devine’s compensation. The IRS disallowed $65,000, and the parties stipulated that the salary fell in the range of salaries of presidents of comparable companies.

Tax Court Judge Mary Ann Cohen ruled that the entire compensation deduction was reasonable and said the IRS had failed to show that the compensation was excessive.

Judge Cohen noted that Mr. Devine had been undercompensated to meet the bonding requirements, and ruled that the bonus had compensated him for that deficiency.

Cite: Devine Brothers Inc. v. Commissioner, T.C. Memo. 2003-15

Issue resolution procedures revised

* The IRS has published revised procedures for the Industry Issue Resolution Program.

Under the revised procedures, business taxpayers, industry associations and other interested parties can submit frequently disputed or burdensome business-tax issues at any time for possible resolution under the program.

In previous years, issues had been submitted by industry associations and others representing both small- and large-business taxpayers.

These submissions have resulted in tax guidance that has affected thousands of taxpayers.

Requests received will be reviewed semiannually, generally after March 31 and Aug. 31 of each year, for inclusion in the program.

To allow time for initial submissions under the program, the March 31 review date was changed to May 15. All requests received by that date will be considered for IIR project selections that are expected to be included in the 2003-2004 Treasury and IRS Guidance Priority List.

For each issue selected for the program, IIR teams consisting of IRS and Treasury Department personnel will meet with taxpayers or other interested parties.

The IRS says this benefits both taxpayers and the agency by saving time and expense that would otherwise be expended on resolving the issue through examinations.

IRS urges patience in home seizures

* In a legal memorandum, the IRS has recommended to its agents that judicial approval be obtained before seizure of an individual’s principal residence is attempted – even in cases where the property is titled in the name of a trust created under an abusive trust scheme.

In a recent instance, an individual created several trusts as part of an abusive trust scheme intended to evade taxes. He then transferred title of his principal residence to one of those trusts.

As part of the standard examination procedure, the IRS assessed the tax against the trust on its return. Thereafter, a revenue officer sought to seize the residential property from the trust.

The IRS noted that while Section 6334 of the tax rules, “Property Exempt From Levy,” requires judicial approval before an individual’s principal residence may be seized, that section contemplates the seizure of properties titled in the name of individuals instead of corporations, partnerships or trusts.

While a strictly technical application of the rule may allow seizure without judicial approval, the IRS explained, doing so would contradict the premise underlying abusive trusts where the trust is considered to be a mere nominee of the individual.