FEDERAL TAX ALERTNEWS ITEMSNATIONAL ECONOMY IS LOOKING SLUGGISHWeighed down by the housing slump, the economy in 2007 is expected to log its most sluggish growth in five years. But that showing should not cause businesses to really clamp down on hiring, economic forecasters say.

A forecast released in mid-May by the National Association for Business Economics puts the growth of the gross domestic product at 2.2 percent for this year. The rate was 2.7 percent in the group's previous survey in February.

If the latest prediction proves correct, the growth rate would be the weakest since 2002. Back then, the fragile economy was emerging from a recession and grew by just 1.6 percent.

The main culprit is the sour housing market. It fell into a slump last year after the five-year boom. Nearly half of the forecasters think the market will not reach its bottom until this winter or later.

Even so, the employment climate should continue to weather the fallout from the housing slump.

Forecasters predict the unemploy-ment rate for 2007 will match last year's rate of 4.6 percent, a six-year low.

For the most part, employers have shown a decent appetite to hire even as the economy as measured by the Gross Domestic Product has lost momentum.

GDP is the value of all goods and services produced within the UnitedStates. It is considered the best barometerof the country's economic standing.

For next year, the forecasters believe the economy will grow by 2.9 percent somewhat more sluggish and lower than the earlier forecast of 3 percent.

The unemployment rate would edge up to 4.8 percent next year according to the survey of 48 forecasters that was conductedApril 19 through May 8.

More than half of the forecasters said there was at least a 25.6 percent chance of a recession starting within the next year. Earlier this year, former Federal Reserve Chief, Alan Greenspan, put the odds of a recession at one in three.

On the inflation front, the forecasters predicted consumer prices would rise by 2.5 percent this year, compared with the February forecast of 1.9 percent. The more bearish outlook is attributed to rising prices for gasoline and other energy products.

Gasoline climbed to $3.10 a gallon nationwide in the middle of May, com-pared with $2.97 at the end of April.

The Federal Reserve is predicting that inflation will moderate as the economy cools.

On May 9, the Federal Reserve Board held interest rates steady, extending a nearly yearlong period of stability that has positives for savers and borrowers at 5.25 percent.

The forecasters predicted that rate would not budge for the rest of this year.

UNCLE SAM SETSREVENUE RECORDFederal revenue collections hit an all-time high in April, contributing to a further improvement in the budget deficit for the year.

Releasing its monthly budget report, the Treasury Department said through the first seven months of this budget year, the deficit totaled $89.8 billion, significantly below the $184.1 billion imbalance run up during the first seven months of the 2006 budget year.

So far this year, tax revenue totals $1.505 trillion, an increase of 11.3 percent over the same period last year. That figure includes $383.6 billion collected in April, the largest monthly tax collection on record.

For the first seven months of this budget year, which began October 1, revenue collections and government spending are at all-time highs. The spending total of $1.585 was up at a

CONTENTSFrom the Editor . . . . . . . . . . . . 2IRS Action News . . . . . . . . . . . 3Tax Law Update . . . . . . . . . . . . 5Inside Washington. . . . . . . . . . 6 FYI . . . . . . . . . . . . . . . . . . . . . . 8Tax Court Decisions. . . . . . . . 10Et Cetera . . . . . . . . . . . . . . . . 11Tax Rep Roundtable. . . . . . . . 12Ethics Corner. . . . . . . . . . . . . 13Members Ask . . . . . . . . . . . . . 15Quotes of the Month . . . . . . . 16

INSERTS

■ Regional Conferences■ Special Topics Workshop■ CCH Offer

A PUBLICATION OF THE NATIONAL SOCIETY OF TAX PROFESSIONALS JUNE 2007

WHISTLEBLOWER LAW SCORES EARLY SUCCESS

IRS ACTION NEWS PAGE 3

TAXPAYER REP CHECKLIST FOR DEALING WITH NON-FILERS

TAX REP ROUNDTABLE PAGE 13

“PROPOSED” SMALL BUSINESS INCENTIVES

INSIDE WASHINGTON PAGE 8

WHY NOW IS THE PERFECT TIME TO DOA 1031 EXCHANGE

FYI PAGE 8

DO NOT BE FOOLED BY IRS LOOK-A-LIKE SITES

IRS ACTION NEWS PAGE 4

THE FEDERAL TAX ALERT – JUNE 20072

The Federal Tax Alert is published 10 times a year by the National Society of Tax Professionals. Subscription rate is $200 a year; single copy $20.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.Staff-Executive Editor: Beanna Whitlock; Proof Editor: Ronald Larson; Subscription Services: Glyness Scott;

Production: Melissa Bowden Printer: Sunset Printing, Inc., Portland, Oregon.

slower pace of 3.2 percent from the previous year.

The difference in the growth of collections and spending is the reason for a narrowing deficit.

The Congressional Budget Office said it expects the deficit for all of 2007 to total $150 billion to $200 billion. That would be a significant improvement from last year's deficit of $248.2 billion which has been the lowest imbalance in four years.

The administration's budget sent to Congress in February projects the deficit will be eliminated by 2012 even if the President achieves his goal of getting the tax cuts made permanent. They are due to expire in 2010.

S&P 500 HITS LATESTWALL STREET MILESTONEWall Street reached another milestone during a muted session on May 21 when the Standard & Poor's 500 index briefly passed its record close of 1,527.46 for the first time in more than seven years.

The S&P 500, considered by market professionals the best indicator of stock performance, surpassed the mark shortly after noon following news of a fresh round of take-over deals.

The broad market index has lagged the Dow Jones industrial average in recovering from Wall Street's prolonged slump earlier this decade.

The S&P 500 rose as high as 1,529.87, and then edged back to 1,525.10 up 2.35 as cautious investors locked in some profits after weeks of gains. The advance was driven by buying in nontechnology sectors such as energy, materials, industrials and financials, S&P data showed. It is still well below its all-time trading high of 1,552.87 set March 24, 2000, the same day the index reached its record close.

In early 2000, all the major stock market indicators reached record highs, only to be dragged down by the end of the dot.com boom, recession, the 2001 terror attacks and a series of corporate scandals including the collapse of Enron.

The S&P 500 fell to a low of 776.76 in October 2002 at the depths of a three-year bear market on Wall Street.

The market recovered slowly, but it was not until last October that the more widely recognized Dow Jones industrial average surpassed its own previous closing high of 11,722.98.

The Dow has gone on to barrel past 13,000 as Wall Street rallies

on a mixture of take-over news, respectable earnings and hopes for an interest rate cut.

Meanwhile, crude oil soared $1.33 to $66.27 a barrel on the New York Mercantile Exchange.

TAX FLAP SNARESAIRPORT VENDORA high-profile vendor with numerous businesses at Hartsfield-Jackson In-ternational Airport was forced to pay more than $600,000 in back taxes and penalties after state officials discovered his company was collecting sales taxes and not turning them over to the state.

The discovery last year led to a tense confrontation between the state and the city-approved vendor. At one point state revenue agents got permission from federal security officials to seize the vendor's airport property. The vendor, Oliver Lee, says the episode was a massive misun-derstanding between his company, National Concessions Management LLC, and overzealous tax collectors. Lee said he paid his back taxes and penalties as soon as he learned of the problem. The state disputes the timing of the payment but agreed Lee has now met his state tax obligations.

Information obtained by The Atlanta Journal-Constitution through the state's Open Records Act show the state placed a lien against Lee's company for $753,705 in back taxes and penalties on April 3, 2006. Lee eventually paid the state $485,595 to cover his back taxes and a penalty

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 responsible for the ultimate verifi-cation and application of any information provided by NSTP.

NOTICETAX HOTLINENEW HOTLINE NUMBER!

3 Days a Week

Monday, Wednesday, Friday 9 – 2 PST 10 – 3 MST 11 – 4 CST 12 – 5 EST

FROM THE EDITOR Returning from the NSTP Board of Director's meeting in Alexandria, VA, I am enthused and encouraged at the decisions made by the Board of Director's on behalf of NSTP.

Plans are moving forward for the NSTP Annual Meeting in Atlanta, GA on July 15, 2007 where members will have the opportunity hear Ed Pittock from the Society of Certified Senior Advisors talk about the change to our practice which will occur as America ages. Additionally, IRS Director of Electronic Services, David Williams, will address the membership on what is next not only in E-services but issues regarding EITC and the Telephone Excise Tax Credit. He will also address changes at the IRS. Then, the real fun begins! Social time with food and drink will be followed by the first NSTP Town Hall Meeting. There is no election this year which provides time for the NSTP membership to discuss issues of importance to NSTP and how NSTP can meet the changing needs of the Tax Professional Community. Members in attendance will also receive a “special gift” from NSTP.

Once again, I am privileged to be with you this summer at all the Regional Conferences and the IRS Nationwide Tax Forums. It is always my great pleasure to meet, reacquaint and learn from you. I've always learned a great deal from Tax Profes-sionals and learning from NSTP members means I have learned from the BEST!

Many members are stepping forward to get “involved” with NSTP, claiming NSTP as their professional organization of choice. NSTP welcomes new members and holds our long-time members with great appreciation for their loyalty. The BEST is yet to come for NSTP. Being a tax professional is not easy and NSTP is the best partner a tax profes-sional can have.

BeannaBeanna J. Whitlock, EA CSAEditorSan Antonio, Texasbeanna@whitlocktax.com

DIRECT LINE

360-695-0556

NEW Website Password: taxlaw

(use lowercase only)

JUNE 2007 – THE FEDERAL TAX ALERT3

of about $142,000, which included interest. “My recollection is that things might have gotten crossed in the mail,” Lee said. “They called us about it and we said we had paid. They said, “You have not paid! So we had to gather up checks and the like and go out there.”

Revenue officials, however, dispute Lee's version of the events.

“There was a misunderstanding all right. He had the taxpayers' money in his bank account,” said state Revenue Commissioner Bart Graham.

The department began to look at Lee's Hartsfield operation, and those of other vendors, after the liquor license of an airport business Lee operated in Savannah was pulled for tax nonpayment, officials said. “With the amount of money he owed, and the amount of evasion he had engaged in, we considered him a jeopardy situation, so we applied that lien to him,” Graham said.

More than 85 million passengers a year pass through Atlanta's Harts-field-Jackson, providing a lucrative market for vendors who owed back taxes totaling more than $1 million total; most of those cases were settled without liens being filed and are not open to public review.

Lee said an employee improperly computed the company's Georgia sales taxes owed on its Hartsfield-Jackson operations, turning over to the state only about 10 percent of what the company actually owed. That employee is no longer with his company, he said.

Airport officials said National Concessions Management operates 11 stores at Hartsfield-Jackson, including two Great Sports stores, four Atlanta News and Gifts outlets and one Friedman's Shoes, and that Lee's company is a “disadvantaged business enterprise” partner with four Brookstone stores throughout the airport. Only two companies had liens placed against them as a result of the state Revenue Department's review. Liens were issued against Lee's company and against Franklin and Wilson Airport Concessions, which is co-owned by David Franklin, the ex-husband of Atlanta Mayor Shirley Franklin. Franklin's company declared bankruptcy two weeks after the state placed a $176,000 lien against his company in August 2006, and the state has not been able to collect the $120,000 in state taxes he owes.

The incident began when the Revenue Department suspended the liquor license for the Budweiser Brewhouse at the Savannah airport, a business which Lee operated through his company and a third party. The

reason listed was “failure to comply with state tax laws” and “individual income tax.” Lee said he is no longer affiliated with that business.

Hartsfield-Jackson officials said Lee's tax problems are between him and the state. “As far as we know, they have met all their obligations to us,” airport spokesman Herschel Grangent said of Lee's businesses. The airport, like most other government entities with private businesses on their premises, do not conduct yearly compliance checks to make sure those businesses are turning over the taxes they collect. However, airport officials say they should. It should not be an unreason-able standard to maintain if you are going to do business with a captive market like you have at the airport.

IRS ACTION NEWSWHISTLEBLOWER LAW SCORES EARLY SUCCESSThe Internal Revenue Service recently received important tips from informants hoping to cash in on a law offering sharply higher rewards in cases involving large amounts of tax cheating and other violations.

Since the law was enacted in December, the IRS has received about 20 reward claims, some involving hundreds of millions of dollars. Under the law, informants generally may collect as much as 30% of whatever the IRS eventually collects, including penalties and interest.

Congressional advocates hope the new law will help the IRS collect signif-icantly larger amounts of back taxes.

Among the lawyers who recently have filed reward claims on behalf of whistleblowers is Bryan C. Skarlatos, a partner at the New York law firm of Kostelanetz & Fink LLP. Mr. Skarlatos says he has filed three separate claims in just the past few months. Two came from individuals alleging large tax underpayments by two separate companies. The other came from an individual at an investment firm, alleging that a publicly traded company underpaid its taxes by more than $350 million over several years.

Although the law is relatively new, it is attracting attention. Many lawyers attended a panel discussion on the subject at a recent meeting of the American Bar Association Tax Section in Washington. Some lawyers predict many more reward claims will be filed in coming months as more people learn about the law's details.

The law generally sets a reward floor of 15% and a cap of 30% of the

collected proceeds, including penalties and interest. Smaller rewards may be handed out in certain circumstances, such as if a reward is principally based on public information, including a court case or the media. Congress limited the new program to tips involving large amounts of money. The law applies to someone with information involving a business or, in the case of an individual, someone whose gross income exceeds $200,000 for any year in question. Whatever the case, the taxes, penalties and interest in dispute must exceed $2 million. Also the information must be submitted as a statement “under penalties of perjury.”

To file a claim under the law, use IRS Form 211, available on the IRS web site at www.irs.gov. Provide as much information as you can about the alleged tax noncompliance.

Informants can still file smaller claims but they will be limited to the old law, under which the reward typically cannot exceed 15% of the amount recovered. The reward ceiling generally has been $10 million in recent years, although that ceiling and the percentage may be increased under special agreements.

Another big change: Under the old law, the IRS typically would not pay a reward to tipsters who “substan-tially” participated in the wrongdoing they reported. The new law allows the IRS to pay rewards to people who were involved but only under certain circumstances. For example, tipsters involved with planning and initiating wrongdoing now may get reduced rewards, but they would get nothing if convicted for planning and initiating.

If considering filing a claim, be as specific as possible. The most important thing a prospective whistle-blower can do is to develop the facts with as much detail as possible and to provide supporting documents whenever possible. The key is to make an airtight case. Basically, you want to do the legwork for the IRS.

Over the past few decades, only about 8% of all claims have resulted in rewards, according to IRS data. The IRS is not allowed by law to pay a reward until it actually collects the money and that often takes many years.

IRS RELEASES FILING FACTSElectronic filing continues to grow in popularity. E-file grew 8.9% from 2006 to 2007 with 70.5 million returns e-filed in 2006 and 76.8 e-filed in 2007.

Through May 4, 2007, the IRS has received nearly 128 million individual income tax returns, up 2.9% from the

THE FEDERAL TAX ALERT – JUNE 20074

prior year. It had processed almost 114.1 million returns, up 3.2%

The IRS approved 96.3 million refunds, up 3.9%. Total refunds were $217.07 billion, up 6.6%.

A BUSINESS OR JUST A HOBBY?The Internal Revenue Service is stepping up efforts to prevent taxpayers from deducting losses on activities that are not genuine businesses run to make a profit. The problem: it is not so easy to tell a budding business from a hobby.

Officials say new research shows taxpayer errors in this area are costing the government billions of dollars a year in unpaid taxes. Thus, auditors are “on the lookout” for people trying to deduct losses from hobbies. To underscore the agency's concern, the IRS recently issued a fact sheet aimed at “making sure that taxpayers know and abide by the rules.”

The fact sheet summarizes the law, which allows taxpayers to deduct “ordinary and necessary” expenses involved in a trade or business. Generally, an activity qualifies as a business if it is carried on “with the reasonable expectation of earning a profit,” the IRS says. What makes this rule so important is that if an activity is not truly designed to make a profit, you cannot use losses from it to offset other income. This rule applies to individuals, partnerships, estates, trusts and S-corporations.

However, the IRS's interpretation does not always prevail, as a recent court case illustrates. In a decision that is attracting close attention among lawyers and accountants, the U. S. Tax Court recently ruled in favor of Tracey L. Topping, a Florida woman who deducted net losses from her equestrian activities, which she said were part of her plan to develop a profitable interior-design business.

The decision is especially important because many people run more than one business, and there can be important connections between each of those businesses, as in Ms. Topping's case. Moreover, the case underscores the importance of keeping good records and putting together “a compelling business strategy,” says David Aughtry, an Atlanta lawyer at Chamberlain, Hrdlicka, White, Williams & Martin, who represented Ms. Topping.

But how are you supposed to figure out whether your activity qualifies as a genuine for-profit business? That can be exceptionally tricky. The IRS says you should consider several factors, such as: Does the time and effort put into the activity indicate you intend to make a profit? Do you

and your advisers have the knowledge needed to carry on the activity as a successful business?

Another factor is whether you have made a profit in the past. The IRS says it “presumes” an activity is indeed carried on for profit if you have made a profit during at least three of the past five tax years, including the current year. The rule is different, at least two of the past seven years, for activities that consist primarily of breeding, showing, training or racing horses.

The Topping case is especially interesting because Ms. Topping's lawyers persuaded the Tax Court that her equestrian and related activities were part of her strategy to build a design business and that the combination was conducted for profit.

Judge Joseph Goeke agreed with Ms. Topping's assertion that her plan was to use her prominence in the equestrian world to build an interior-design business involving homes and high-end horse barns. He also concluded that the expenses associated with her equestrian activities were “ordinary, necessary and reasonable in amount.”

The judge sided with Ms. Topping even though the IRS cited a few other cases in which the Tax Court had ruled that a taxpayer's multiple activities could not be lumped together. For example, the court refused to combine a taxpayer's farming/polo activity and his real-estate law practice, despite the taxpayer's argument that one reason he began playing polo was to meet clients for his law firm.

Judge Goeke said those cases were not analogous to the Topping situation. The judge agreed there was a “close organizational and economic relationship” between the equestrian and design ventures.

The IRS declined to comment on whether it plans to appeal the decision.Wall Street Journal

DO NOT BE FOOLED BY IRS LOOK-A-LIKE SITESThe Internet can be an unforgiving place. Make one small mistake typing in the address of the web site you want to visit and you could end up someplace completely different.

The Internal Revenue Service is warning that some sites are apparently using similar addresses and a look similar to the official IRS site—www.irs.gov—to confuse taxpayers.

In a warning, the tax collection agency said it has noted the prolifera-tion of Internet sites that contain some form of the Internal Revenue Service name or IRS acronym with a “.com,”

“.net,” “.org,” or other designation in the address instead of “.gov.”

Since many of these sites also bear a striking resemblance to the real IRS site, taxpayers may be misled into thinking that the site they have accessed is indeed the official IRS government site. These sites are not the official IRS web site and have no connection to the official IRS site or to the IRS.

Because “.com,” “.net,” and “.org” are such common parts of Internet addresses, taxpayers may automatically or inadvertently type these extensions, instead of “.gov,” into the address line of their web browser when trying to find the genuine IRS web site.

Following recent concerns that Internet sites may be causing confusion among taxpayers, the IRS said it is working with the Treasury Inspector General for Tax Administration on this matter. TIGTA has authority to review issues protecting the integrity of tax administration, including imperson-ation of the IRS. The IRS said TIGTA is committed to ensuring that taxpayers are not misled.

Although the IRS web site offers interactive features, the tax or private financial information that these features ask the taxpayer for is extremely limited. The IRS reminds consumers who access unfamiliar sites, or sites they have never dealt with before, that they should never reveal any personal or financial information such as credit, bank account or PIN numbers without verifying the validity of the site.

The IRS also reminds consumers to be alert to an on-going internet scam in which consumers receive an e-mail informing them of a federal tax refund. The e-mail, which claims to be from the IRS, directs the consumer to a link, often a web site resembling the IRS web site that requests personal and financial information, such as Social Security number and credit card information.

The scheme is an attempt to trick the e-mail recipients into disclosing their personal and financial data.The practice is called “phishing”for information

The information fraudulently obtained is then used to steal the taxpayer's identity and financial assets. Generally, identity thieves use someone's personal data to steal his or her financial accounts, run up charges on the victim's existing credit cards, apply for new loans, credit cards, services or benefits in the victim's name and even file fraudulent tax returns.

Taxpayers who receive an unsolicited e-mail purporting to be

JUNE 2007 – THE FEDERAL TAX ALERT5

from the IRS should never click on any links in the message, open any attachments or provide any personal or financial information to the sender.

IRS OFFERS NEW PUBLICATION 4588 FOR GREEN CARD HOLDERSIRS Publication 4588, Basic Tax Guide for Green Card Holders, addresses the tax issues of resident aliens—Green Card Holders.

A resident alien is a lawful permanent resident of the United States and is taxed as a United States citizen for income tax purposes. Green Card Holders are taxed on worldwide income. Publication 4588 provides answers to various questions a resident alien may have regarding their tax obligations to the United States.

Publication 4588 can be obtained by going to www.irs.gov.

TAX LAW UPDATESTATE AND FEDERALE-FILE MANDATESStates continue to issue mandatory requirements for electronic filing of tax returns. If you prepare returns in any of the states listed, you should be aware of the state's e-file requirements.

AlabamaTax professionals who prepare 250 or more Alabama individual income tax returns for the taxable year that began on January 1, 2004; prepare 100 or more returns using tax preparation software for the taxable year that begins on January 1, 2005; and prepare more than 50 returns for the taxable year that begins on January 1, 2006, are required to e-file all of their individual returns.

CaliforniaCalifornia law requires tax profes-sionals who prepare more than 100 California individual income tax returns annually and prepare one or more using tax preparation software to e-file all personal income tax returns.

ConnecticutEffective January 1, 2006 preparers, who prepared 200 or more Connecticut Income tax returns, are required to elec-tronically file all eligible Connecticut income tax returns using the Federal/State Electronic Filing program.

MassachusettsPaid tax professionals must, under certain conditions, electronically file all Corporate, S Corp and Partnership returns and corporate extensions.

The State of Massachusetts requires personal income tax extensions with zero payment or with payments of $5,000 or more to be filed and paid, if applicable, electronically.

MichiganPaid tax professionals must electroni-cally file all Single Business Tax—SBT forms.

Tax preparation businesses who prepare 200 or more Michigan Individual returns must e-file all Michigan Individual returns prepared at all of their business locations.

MinnesotaPaid tax professionals who prepare 100+ Individual Minnesota returns must e-file all individual returns. Returns that would otherwise meet the requirements of the mandate are subject to a penalty if paper filed.

New JerseyPaid tax professionals who filed 200 or more New Jersey Resident Income Tax Returns must use one of New Jersey's three electronic filing services to electronically file all New Jersey Resident Income Tax Returns for their clients.

New Jersey partnership returns with 10 or more partners must be filed electronically.

New YorkFor calendar year 2007, the e-file man-date will apply to individual personal income tax returns and extensions.

Tax professionals must e-file begin-ning on January 1, 2007, if they:

Prepared more than 200 New • York State original tax returns for tax year 2005 in calendar year 2006, andUsed tax preparation software to • prepare one or more New York State authorized personal income tax returns for tax year 2006 in calendar year 2007, orWere subject to the mandate • during calendar year 2006.

Once subject to the e-file mandate, the tax profesional must continue to e-file for all clients' authorized personal income tax returns and extensions in all future years regardless of the number of returns and extensions filed.

Form IT-800, Opt-Out Record for Tax Practitioners, can be used if a client does not want to e-file, or if you have other reasonable cause not to e-file a return.

OklahomaA tax professional who prepared more than 50 Oklahoma income tax returns for the prior year must file all

Oklahoma income tax returns prepared for the current tax year electronically. This section will not apply to a return upon which the taxpayer has indicated that the taxpayer did not want the return filed by electronic means.

UtahBeginning with the tax year 2005 return filing period, if a preparer or multiple preparers affiliated together in the same establishment, prepared 101 or more returns in the prior calendar year, they must submit all Utah Individual tax returns electroni-cally or using 2-D bar code technology. Exceptions apply for taxpayers who elect to opt out of electronic filing or using 2-D technology, and for undue hardship on the preparer in conforming to this mandate.

VirginiaIf a tax professional prepares 200 or more Virginia individual income tax returns, you must file all acceptable Virginia individual income tax returns, via electronic filing or software that produces 2-D bar codes in accordance with Virginia specifications.

West VirginiaFor tax year 2006, West Virginia requires tax professionals who prepared 100 or more 2005 West Virginia income tax returns to file all 2006 West Virginia personal income tax returns electronically using the Federal/State Electronic Filing Program.

WisconsinPaid tax professionals who prepared 100 or more Wisconsin Individual returns must e-file all Wisconsin Individual returns.

Federal UpdateCorporations with total assets of $10 million or more and filing at least 250 returns, including income tax, excise tax, employment tax, and information returns, during a calendar year are required to electronically file their 1120/1120S income tax returns for tax years ending on or afterDecember 31, 2005.

Certain tax-exempt organizations with total assets of $10 million or more and filing at least 250 returns, including income tax, excise tax, employment tax, and information returns, during a calendar year are required to electroni-cally file their 2005 annual exempt or-ganization tax year returns due in 2006. If an organization has 245 employees, it must file Form 990 or Form 990-PF electronically, because each Form W-2 and quarterly Form 941 is considered a separate return; therefore, the organiza-tion files a total of 250 returns.

THE FEDERAL TAX ALERT – JUNE 20076

Section 1224 of the Taxpayer Relief Act of 1997 requires partnerships with more than 100 partners to file their return electronically for taxable years ending on or after December 31, 2000.

KENTUCKY COURT RULINGIn a decision that may have far reaching implications for the municipal bond market, the Kentucky Court of Appeals ruled that it is un-constitutional for the state to tax interest received by its residents from tax-free bonds issued by other states and political subdivisions.

The state is expected to appeal the decision to the Kentucky Supreme Court. If upheld, the ruling will likely encourage similar challenges to taxation in other states that tax out-of-state issues.

The case was brought against the Kentucky Department of Revenue in 2003 by Mr. and Mrs. George Davis. The appeals court found Kentucky's taxation system “clearly” uncon-stitutional because it allows more favorable tax treatment to in-state bonds than it does for “extraterritori-ally issued” bonds.

The Kentucky ruling also paves the way for the plaintiffs to seek class-action certification. This could make the state potentially responsible for refunding tax payments, not only to the Davis's, but also to other Kentucky taxpayers who join the lawsuit.

If the lawsuit is ultimately successful, it could have a major impact on the municipal bond market. Existing tax policy causes most municipal bond investors to purchase bonds issued in their state of residence in order to avoid state taxes. A dramatic change in investor preference could significantly change municipal finance throughout the country.

Tax-free bond investors and revenue officials from other states will be following this case very closely.

College savings plans and other state programs could be significantly affected.

If the Supreme Court decides to review Davis V. Kentucky and sides with the state appeals court ruling that it is unconstitutional to tax out-of-state bonds while not taxing those issued in state, the same reasoning could be applied to 529 plans and could wipe out the state tax advantages that many states offer.

Established under Section 529 of the Internal Revenue Code, college savings plans allow adults to save money in special accounts that will be free from federal income tax when used to pay for the “qualified higher-education expenses” of their children and other beneficiaries. Many states try to lure assets to their in-state programs by

offering residents a deduction on personal income tax returns for con-tributions to these plans.

The municipal market has been waiting for weeks to see whether the Kentucky Supreme Court will take up the case. At least 38 states refrain from taxing bonds issued in-state.

Update: On May 22, 2007 the Kentucky Supreme Court passed up an opportunity to review this case.

INSIDE WASHINGTONALTERNATIVE MINIMUM TAXThe number of taxpayers expected to pay AMT is estimated to jump from 4 million to a whopping 25 million in 2007. With little chance of a tax law change in the near future, it might be time to revisit tax-related strategies for clients.

The AMT is an alternative way of calculating taxes, and you may need to explain the basics to a growing number of clients. Introduced in 1969, it was intended to target a handful of high-income households that were eligible for so many tax benefits that they wound up paying no income tax under the tax code at that time. Over the years, the AMT has crept up on middle-class taxpayers and now seems to penalize a growing group for which it was not intended.

In general, taxpayers with household incomes between $150,000 and $500,000 are most likely to be subject to the AMT, but those with lower incomes may be liable as well. Taxpayers increase their potential for AMT liability by taking a lot of deductions, exemptions and credits on regular income tax returns. That is because many of these tax-lowering strategies, while allowable on regular tax returns, are not permitted when calculating AMT liability. As a result, AMT liability is very likely to be higher than regular tax liability, and that is when the AMT kicks in.

Part of the reason that AMT is affecting more and more people is that, unlike the regular income tax, the AMT is not indexed for inflation. The accumulating effect of inflation is a key source of growing AMT coverage. The expanding reach of the AMT may mean more than simply higher tax liability for many. Not only must taxpayers complete the regular income tax returns, but more of them will need to complete the AMT forms, whose definitions of taxable income, deductible expenses and exemptions differ from those of the regular

income tax. The required calculations increase both the complexity and time required to comply with tax laws.

Taxpayers' potential liability for the AMT complicates many of their decisions beyond the tax forms themselves, including in what year to place earned income and when to claim or avoid deductions.

To address the problem, Congress has enacted a series of temporary patches over the years, which have boosted the thresholds for a year or two at a time. The problem lawmakers face is that the AMT is part of the official budget projections and is expected to generate hundreds of billions of dollars of revenue in the coming years. To change the rules around the AMT would mean drastically changing the government's projection of tax revenue.

According to new Treasury Department estimates, undercurrent tax laws:

4 million tax returns were • subject to AMT in 200625 million will be affected in 2007• 28 million will pay AMT in 2008•

TEMPORARY FIX LIKELY FOR INCOME-TAX TRAP: AMTThe safest prediction anyone can make is that Congress will decide something this year about the alternative minimum tax.

It has to. At stake are tens of millions of household budgets.

The 2006 patch to protect middle-class taxpayers has expired. It kept all but 4 million taxpayers from paying the dreaded income-tax trap that strips away nearly all deductions.

Congress is left with three choices:1. Do nothing and blindside an

estimated 20 million more taxpayers, some with incomes down to $50,000, with the AMT's brutal 26 percent or 28 percent tax brackets. When snagged by the AMT, a family must pay an average of $3,600 more in taxes.

2. Add another one-or-two year patch to protect middle-class taxpayers.

3. Permanently fix the AMT with a high-income cutoff point. That would fulfill the tax's original purpose in 1969, to keep the ultra-wealthy from escaping taxes through loopholes and deductions.

The most likely scenario is No. 2.The AMT is a parallel income

tax that never has been indexed to inflation. Its income limit gradually has crept down to the middle class. Those taxpayers must calculate their income taxes two ways, one with deductions and one without, and then pay the higher amount.

JUNE 2007 – THE FEDERAL TAX ALERT7

Hurt the most would be families with children. Harmed even more would be taxpayers in high-tax states because state and local taxes cannot be deducted.

Congress has been reluctant to fix the AMT permanently because the legislative body has become addicted to the growing revenues.

The U. S. House Ways and Means Committee seeks a permanent fix. The panel will hold more hearings before its bill emerges, but it will look something like this:

Families with incomes below $250,000 a year would be exempt from the AMT, which accounts for 96 percent of taxpayers. The AMT tax burden would be lowered for families with income between $250,000 and $500,000.

Families making more than $500,000 would pay higher AMT bills to make up the revenues lost by exemptions and reductions for lower-income families.

The details of how much more the wealthy families would pay have not been revealed, but a couple of think tanks have calculated the hike would amount to 5 percent to 13 percent higher. Example: A family making more than $1 million a year that would have to pay an extra $52,000 on average.

REDUCING THE “TAXGAP” IS PRODUCINGCONTROVERSIAL IDEASIf everyone paid the taxes they truly owed, tax rates for everyone could go down.

Congress is looking at the “tax gap” with growing seriousness, especially since the Internal Revenue Service believes that the federal income tax gap between what taxpayers owe and what they pay is an estimated $290 billion a year.

This amount could offset losses when certain parts of the federal income tax code are simplified, such as reforming the alternative minimum tax that many in Congress believe harms too many middle-class families.

Hiring a bigger army of IRS auditors would be expensive and likely would not close the gap enough to please Congress.

Some of the other ideas to close the tax gap are controversial, though, to say the least. Consider these:

Requiring banks to withhold on • the taxable portions of interest payments on deposits.Requiring taxable portions on • cash dividend payments on stock shares to be withheld.

Requiring brokerages to • maintain more information on the purchase of investments, called the basis, to provide more evidence when it comes to determining capital gains as investments are sold.Instituting higher penalties on • tax preparers who handle family tax returns.Banning some cash payments • and requiring more electronic payments.

Some of these ideas are not new. A bill to withhold from bank interest payments, for example, was stopped by the banking industry years ago.

Many other ideas are floating around Washington, but new ideas are needed. That is why the National Conference on the Tax Gap, scheduled for June 22-23 likely will advance the agenda more than any other recent event.

Members of Congress, IRS leaders, staff members of congressional tax-writing committees, U. S. Treasury officials and leading tax lawyers and accountants are expected to attend.

The conference will be staged right where the action is, on Capitol Hill in a U. S. House office building. It likely will create a wave of news articles and proposed legislation.

The conference as well as congres-sional deliberations, must answer many questions before favoring any new moves. Who would new policies hurt, and who would benefit? Which ones are practical?

A big consideration is the costly paperwork and procedural costs likely to be imposed on businesses. Businesses, especially small firms will complain that their tax-collecting roles will be intensified.

Since much of the tax gap can be traced to underreported incomes at small businesses and from the self-employed, small companies may be forced into more paperwork.

Another looming concern is placing additional burdens on honest taxpayers. The U. S. Treasury estimates that 85 percent of federal income taxpayers pay all of their owed taxes on time. More record keeping and form filing will not be welcomed by honest taxpayers.

Some of the proposals actually would reduce revenues. Instead of paying share dividends in cash, corpo-rations likely would switch, as many already do, to paying dividends in shares, which are not taxed, to avoid the ugly appearance of withholding.

So far, the tax-gap solutions on the table now do not make many people happy. The June conference could make a difference.

SENATOR'S TWO SLIP-UPS SHOW DIFFICULTY OF CLOSING TAX GAPMax Baucus, the Senate Finance Committee chairman, is trying to get Americans to pay more of the taxes they owe on time. But the Montana Senator himself may be Exhibit A for why that goal is so elusive.

Twice in recent years, Mr. Baucus has made mistakes on local property taxes that led to late payments and fines. The senator's tax history shows just how difficult it is to narrow the so-called tax gap, the estimated $290 billion a year taxpayers owe the federal government but have not paid, because even taxpayers who say they intend to pay in full sometimes make mistakes.

Mr. Baucus has given new prominence to the tax gap. It seems an easy way to collect the new revenue Congress has promised to find to cover new spending without the difficult choice of raising tax rates. Last year, 84% of taxpayers filed their taxes correctly and on time, according to the Internal Revenue Service. “This nation should commit itself to achieving the goal, before the decade is out, of having at least nine out of 10 taxpayers comply with the law,” Mr. Baucus said at a Senate hearing in mid-April.

But as a taxpayer, Mr. Baucus shows it is not so simple. Part of the gap is caused by people who pur-posefully avoid paying taxes and presumably could be caught with stepped-up enforcement. But much of the shortfall is thought to result from confusion and honest mistakes. A recent IRS report noted that many tax delinquents underpay because they “must deal with tax law complexity, extensive record keeping, and regulatory requirements.”

In Mr. Baucus's case, it was local property taxes in Washington, D. C. and Montana that tripped him up. He underpaid his property-tax bill on his $1.4 million Georgetown house from 2003 to 2005 because of a computer error by city tax collectors, according to property records. Tax assessors incorrectly gave Mr. Baucus a credit on his property-tax bill that should only apply to those who claim their property as their primary residence. Mr. Baucus's main residence is in Montana.

When the city realized the mistake, Mr. Baucus was given 30 days to pay $5,625.72 in back taxes, according to tax officials. Mr. Baucus paid the bill but not until a few weeks after the deadline. That cost him $538.86 in penalties and interest.

In Helena, Montana, Mr. Baucus paid a small penalty in 2002 for paying his property-tax bill a few

THE FEDERAL TAX ALERT – JUNE 20078

weeks late due to a misunderstand-ing involving his brother. Mr. Baucus bought the house he grew up in from his brother in 2002, and the two agreed to split the tax payments, according to the senator's spokesman.

But there was some confusion about who was responsible for the first payment of $1,650. As a result, the bill was paid a few weeks late. Mr. Baucus was charged $60.36 in penalties and interest, which the brother split.

“It was an honest mistake, due to how complicated the agreement is,” said Mr. Kaiser, the Baucus spokesman.

“PROPOSED” SMALL BUSINESS TAX INCENTIVESThe Senate Finance Committee and the members of the House Ways and Means Committee have agreed on a series of small business tax relief measures totaling $4.84 billion which will be met with full offset.

A summary of the tax provisions and offsets would:

Small Business Tax Relief ProvisionsExtend Work Opportunity Tax • Credit for 3-1/2 years with disabled veterans and outward migration provisions.Increase the expensing limit of • Code Section 179 to $125,000 and the phase-out to $500,000 and extend through 2008 the 179 for Go Zone businesses.Extend enhanced credit • treatment for 2 additional years through 2010 and modify the carryover allocation and Federally subsidized rules for certain low income housing credit building for GO Zone Low Income Housing.Treat certain qualified Go • Zone repairs or reconstruc-tion as “qualified rehabili-tation” for purposes of the mortgage revenue bond and Gulf Opportunity Zone bond rules. Allow employers to receive full • tip credit despite increase in Federal minimum wage.Allow an unincorporated • business owned jointly by a married couple to file as a sole proprietorship instead of a partnership.Allow Work Opportunity Tax • Credit and the tip credit to be taken under Alternative Minimum Tax.Include several changes to the• S Corp rules.

These proposals represent a budget increase of $4.844 billion.

OffsetsReduce the amount of credits • taxpayers claim under the FICA/tip tax credit as a result of increase in the minimum wage.Modify the rule that the IRS • must stop charging interest and filing related penalties if the IRS fails to notify the taxpayer about a deficiency within 18 months after the taxpayer filed the return. This is an extension to 36 months.Eliminate the requirement that • the IRS hold a collection due process hearing before issuing a levy on delinquent employment taxes so these trust fund taxes are not allowed to pyramid. Taxpayers are still afforded CDP hearings once every two years.Extend permanently IRS user • fees.Raise the $750 threshold to • $1,250 and the $15 fee to $25. In general, the penalty remains at 2% of the check amount.Expand preparer penalties to all • types of tax returns and increase the amounts of the penalties also.Create a new penalty on claims • for refund that are filed without any reasonable basis.Raise the age from under-18 to • under-19, under-24 if a student, at which a child's unearned income in excess of $1,700 is taxed at the parent's rate. This would discourages the practice of transferring investments to one's child for the purpose of avoiding higher tax rates.

These proposals represent a budget decrease of $4.899 billion.

Many of these proposals require consideration for taxpayers as they are planning for 2007. Example: The so-called “Kiddie Tax” proposal increases the age threshold in the Kiddie Tax from under-18 to under-19 and under-24 if a student. If a child under the age limits has unearned income in excess of $1,700, the excess is taxed at the parent's rate. This provision was originally added to the Small Business Tax Relief Act of 2007 to discourage the practice of transferring investment assets to a child for the purpose of avoiding the parents' higher tax rates. The new rules would apply retroactively to all investment income that occurred after December 31, 2006.

Although prospects for passage of the current legislation are uncertain, you should factor into your tax planning recommendations any potential changes to the Kiddie Tax provision. Such a change in the

law would generate $1.4 billion in revenue for the federal government, thereby attracting significant support in Congress.

In late May, Congress passed the bill and it sits on the President's desk for signature as the Federal Tax Alert goes to press.

FYIWHY NOW IS THE PERFECT TIME TO DO A 1031 EXCHANGEBetween 2000 and 2004, the residential real estate markets grew at a phenomenal pace. Most investors can look at the value of their real estate investments today, as compared to 5-6 years ago, and notice that the values of their homes, vacation residences and investment properties have more than doubled during that time span. Unfortunately, real estate prices over the past 8-12 months have been marching to the beat of a different drummer. In fact, for almost a year now, the real estate market has been wobbling or even backsliding a bit.

Investors are understandably nervous. They want to protect and lock-in the gains achieved so far but they do not want to write the IRS a check for 20-30% of their gains if they were to cash-out of the market. Thankfully, Code Section 1031 can provide them the opportunity to lock-in their gains without writing a check to the IRS, while moving their funds into a more conservative, defensive investment.

Why 1031 now? Enough time has elapsed since we have seen a truly hot real estate market where the investor can feel confident that the high double-digit gains he or she experienced during the prior 4-5 years are not soon to return. At the same time, commercial property values have been enjoying a measure of consistency and stability not seen in the residential real estate market.

While the residential market is cooling, the commercial market is heating up. According to David Lereah, chief economist for the National Association of Realtors, the fundamen-tals of the commercial market are solid. “Vacancy rates are declining in all of the major commercial sectors, and rents are rising at healthy rates,” he said. Office vacancies are at the lowest level since 2001. By the end of this year, office vacancy rates are projected to drop once again, while office rents are expected to rise 5% in 2006.

In addition to the commercial office market, the apartment and multi-family rental market is continuing to tighten, with vacancy rates forecast to drop to an average of 4.5 percent

JUNE 2007 – THE FEDERAL TAX ALERT9

this year from 5.2 percent in 2005. Average rents for multi-family properties are projected to increase by 5.3 percent during 2006.

The contact of the shaky residential housing market consisting of vacation homes, condos and speculative con-struction projects, with the consis-tently solid fundamentals and glowing economic outlook for the commercial real estate markets, make right now the perfect time for the investor to re-balance his real estate portfolio. Savvy investors are taking their housing market gains off the table, and rolling these gains over into the commercial sector. And savvy investors do not pay unnecessary taxes.

The concept is that the same strategies that work for stocks and securities through the Dow Jones and NASDAQ's boom and bust cycles, will work for real estate investments during real estate's boom and bus cycles.

At the end of a bull market in stocks, investors move from high-risk, growth stocks that have clearly reached their peaks, into conserva-tive, defensive, dividend-paying stocks or even bonds in order to protect the built-in gains that the investors racked up while the market was soaring. In that same vein, the strategies that worked for real estate prices are wobbling or beginning to ebb.

NSTP has entered into a new partnership with Bayview 1031, a 1031 Exchange Facilitator. View more about Bayview 1031 at nstp.org—Members Only Section.

UNCLE SAM WANTS YOUTO PAY YOUR TAXESDefense Department staffers know the importance of funding.

After all, where would they be without it?

But maybe they need a primer on where that funding comes from. It comes from taxes.

David Chu, a top official with the Pentagon, rebuked Defense Department civilians for having the worst delinquency rate for paying federal income taxes among federal agencies, according to esaminer.com.

“As federal employees we have a special obligation to help foster public confidence in our government by serving as model taxpayers,” Chu said in a memo obtained by the online newspaper.

At least one employee, who asked to remain anonymous, was not amused. “The Defense Department's civilians are decisively engaged in the war,” the worker said. “They are helping our combatants carry a heavy load and do not need reminders to meet their obligations.” Facts say they do!

DISPEL RETIREMENTURBAN LEGENDUrban legends are seldom examined stories that circulate as fact. In reality, they are untrue. The sewers of New York are not filled with alligators. A frog will jump out of a pot of water on a stove.

The most common urban legend in personal finance is a rule of thumb: the retirement income replacement rate. It says that most people will need 70 percent to 85 percent of the income they earn immediately before retirement when they retire. So if you are earning $50,000 at age 65, you will need $40,000 in your first year of retirement.

This is nonsense. In fact, if you are married, had and educated children, financed the purchase of a home or paid off student loans, odds are that 70 percent to 85 percent rule does not apply to you.

One immediate consequence of having a lower replacement rate is the amount of money needed to add to Social Security benefits to sustain our standard of living in retirement is smaller. That is fortunate because most people have smaller nest eggs than they are told they should have.

The fundamental problem with the retirement income replacement rate idea is that it uses income immediately before retirement to measure our retirement needs. It ignores our standard of living during the 40 or 45 preceding years. Basically, it ignores our entire adult lives.

It ignores all the decisions we make that reduce our standard of living when younger. It ignores getting married, buying a house, having children and educating them. It ignores mortgages that have been paid off, tuition checks that have been cashed; and special help to ailing parents. It ignores the major realities of daily living.

These are pretty major omisisions.The following are five reasons why

the conventionally used replacement rate is misleading:

1. Debt service. We carry different amounts of debt at different times. When young, the amount can be quite large. Every dollar spent on debt service is a dollar not available to spend on consumption. A young couple may spend 20 percent of their gross income on a home mortgage and another 10 percent on car payments. That is 30 percent of income that will not need to be replaced when the mortgage is paid off and buying new cars is no longer a thrill.

2. Raising and educating children. We adore our children but, with any

luck, they are off the payroll by the time we retire. Some cut it closer than others, of course, but all those expenses from disposable diapers to college tuition, are dollars that we have never had to sustain our personal standard of living.

3. New spending in retirement. Both of those adult standard of living reducers could be followed by increases in retirement. One that comes to mind is rapidly escalating, Medicare Part B premiums. It also could be the expense of living so long nursing home care is needed, etc.

4. Eventual widowhood. Short of perishing together in a romantic accident, we can be virtually certain that one partner will outlive the other. In typical marriages, women will survive their husbands by about six years. As a consequence, part of future spending will reflect the lower expenses of a single-person household.

5. Spending principal. The replace-ment rate assumes we never spend principal. In fact, most people do. Some do out of necessity. Some do it by choice. Either way, spending principal works to sustain consumption.

We should be encouraged and encourage our clients. We still need to save for retirement but it is not “Mission Impossible.”

Scott Burns

RETIREMENT, ACTIVE-ADULT COMMUNITIESWelcome to what developers hope is the new face of housing for maturing baby boomers. Active-adult communities are by now an old idea, but developers have been puzzling over how to make them appeal to boomers. They think they have finally found the magic formula: location-specific, “resort style” communities like Trilogy. They are often far from the Sun Belt and are built to evoke the lifestyle associated with their sur-roundings in California wine country, Colorado ski country, or even the outskirts of Chicago or Washington, DC. These communities aim to give boomers even more convenience, luxury, and fun than they thought they wanted in their later years by offering yoga, walking trails, high-speed computer access, guest speakers, day spas, chic cafes, and wine bars, all at their doorsteps.

Active-adult communities have been around since the 1960s, when Del Webb began building them in Arizona. With a few thousand identical homes built around golf courses, he reinvented retirement by giving old folks permission to be active; indulge them and have fun.

THE FEDERAL TAX ALERT – JUNE 200710

A few years ago, adult-commu-nity builders began to worry that boomers would not gravitate to their homes at all. In response, they began branching out of the Sun Belt to urban and suburban communities where they had never built before. According to J. D. Power & Associates, Phoenix is still the top destination for people buying into 55-and-over communities, but less than a fifth of recent buyers in a fall 2006 survey chose that area. The other top markets for active-adult communities were Chicago, “Inland Empire,” southeast of Los Angeles, Las Vegas, Philadelphia and Washington, D.C.

Recipes for retiring include these top ingredients for baby boomers:

38% Lower cost of living• 38% Near family• 38% Access to quality healthcare• 37% Better climate• 36% Near a river, lake or other • body of water24% Near the beach• 20% Access to recreational • activities18% Near cultural activities• like museums

All boomers rate being near family as important but the most desired char-acteristics vary by income level:

Under $50,000—Lower cost of • living$50,000 to $99,000—Better • climate$100,000 or more—Access to • quality healthcare

SENIOR DEBT ON THE RISEThe percentage of American families with heads age 55 or older with debt reached a startling 61 percent in 2004, almost 5 percentage points higher than in 2001, according to the Employee Benefit Research Institute. And families with a head age 75 or older with debt increased dramati-cally to 40 percent in 2004, up from 29 percent in 2001. Housing debt is a contributing factor for seniors. Families with a head age 55 or older with housing debt have increased steadily from 24 percent in 1992 to 36 percent in 2004.

NEW LONG TERM CAREPOLICIES LIFT ASSET LIMITSResidents of four states can now purchase long-term care insurance that allows them to qualify for Medicaid even if their assets are relatively high. And 21 other states have enacted legislation to authorize such plans.

Under the program, which was created under the Deficit Reduction

Act of 2005, individual states set standards for the policies and companies sell them to consumers. Once the LTC insurance is used up, the participant can qualify for Medicaid and keep assets equal to the amount of benefits received under the LTC policy.

Normally, individuals on Medicaid cannot have more than $2,000 in assets. But with the new policies, an individual who has exhausted an LTC policy that had provided $200,000 in benefits would be allowed to keep $202,000 in assets and still qualify for Medicaid coverage of long-term care.

Policies are currently available in California, Connecticut, Indiana and New York. The 21 states that have enacted legislation to authorize such plans are: Arkansas, Colorado, Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Maryland, Massachu-setts, Michigan, Missouri, Montana, Nebraska, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, Virginia and Washington.

TAX COURT DECISIONSBARBARA A. TRIMBLE-GEE V. COMMISSIONERT.C. SUMMARY OPINION 2007-68MAY 1, 2007Are expenses business related and is taxpayer liable for accuracy-related penalties?

In 2001 and 2002, petitioner was employed full-time by the Internal Revenue Service as an examination group manager. Petitioner also operated a cleaning business on weekends and holidays.

During the years at issue, petitioner owned a Plymouth Voyager. In July 2001, petitioner also purchased a Chevrolet Astor Van for a total of $25,379 after rebate. Petitioner used the vehicles to bring equipment to the houses and businesses she cleaned, as well as for personal use.

On her 2001 and 2002 Federal income tax returns, petitioner reported the income and expenses of the cleaning business on Schedules C, Profit or Loss From Business. On her 2001 Schedule C, petitioner reported gross income of $5,745 and expenses of $28,026. On her 2002 Schedule C, petitioner reported gross income of $2,377 and expenses of $28,045.

In January 2006, respondent issued petitioner a notice of deficiency. For the taxable year 2001, the notice disallowed claimed deductions for $16,815 of depreciation and section 179 expense; $4,031 of car and truck

expense; and $323 of interest expense. For the taxable year 2002, the notice disallowed claimed deductions for $2,977 of depreciation and section 179 expenses; $10,390 of car and truck expense; $1,302 of meals and entertain-ment expense; $329 of travel expense; $898 of wage expense; and $5,202 of “remaining expenses.” which consisted of items such as rent, supplies, and utilities expenses. Respondent also determined a penalty pursuant to section 6662(a) for each year.

A taxpayer who carries on a trade or business generally may deduct ordinary and necessary expenses paid or incurred in connection with the operation of the business. The IRS does not dispute that the cleaning business qualifies as a trade or business for Federal income tax purposes. The sole question is whether or not the expenses were ordinary and necessary.

For 2001, the petitioner made an election under section 179 to expense a portion of the cost of the Astro Van claiming a deduction of $17,886 representing a business usage of 63.88 percent. Records to substanti-ate such use came from a document entitled “Weekly Expenses” with ab-breviations for travel with no noted mileage or business purpose. Addi-tionally no indication was made as to which vehicle was used for the travel. When asked about her approximate 500-mile round trip to one location, the Petitioner said she was trying to get a large contract in that city in order to move her business location. She could provide no details about her efforts to acquire such a contact. IRS allowed 35% usage of the Astro Van. Accordingly, she is not entitled to make the section 179 election.

Section 274(d) imposes strict sub-stantiation requirements for listed property, travel, entertainment, and meal expenses. To obtain a deduction for such expenses, a taxpayer must substantiate by adequate records or sufficient evidence to corroborate the taxpayer's own testimony the amount of the expense, the time and place of the use, the business purpose of the use, and, in the case of entertain-ment, the business relationship to the taxpayer of each person entertained.

With respect to the claimed deduc-tions for travel, entertainment, and meal expenses, petitioner introduced a number of receipts and other records. However, none established the business purpose of the expense.

With respect to the claimed deductions for car and truck expense, listed property generally includes passenger automobiles and any other property used as a means of tran-

JUNE 2007 – THE FEDERAL TAX ALERT11

spiration. In general, a passenger automobile includes any truck or van that is 6,000 pounds “gross vehicle weight” or less. The IRC does not define the term “gross vehicle weight”. The term “gross vehicle weight rating” is similarly defined as “the value specified by the manufacturer as the loaded weight of a single vehicle.” The 2001 Astro Van has a gross vehicle Weight rating of 5,950 pounds.

For 2001, petitioner claimed a $5,459 deduction for car and truck expenses and respondent allowed $1,428, disallowing the remaining $4,031. For 2002, petitioner claimed $11,430 for car and truck expense with respondent allowing $1,040 and disallowing the remaining $10,390.

Other expenses disallowed included interest, wage and other items which were disallowed due to petitioner either failing to establish that the expenses were incurred and paid or that they were incurred in connection with the cleaning business.

The Court found with the Respondent on the additional assessment of tax as well as the 20% underpayment of tax attributable to negligence or disregard of rules or regulations for the taxpayers failure to substantiate the disallowed deductions and maintain records. The Court found such failure to be especially egregious considering that she worked for the Internal Revenue Service during the years at issue.

LAURENCE L. GRABOWSKI V. COMMISSIONERT.C. SUMMARY OPINION 2007-74MAY 17, 2007Are expenses ordinary and necessary business expenses and is taxpayer liable for the accuracy related penalty.

During 1998, petitioner and his brother, Patrick Grabowski, operated several businesses including a property management company, a trailer park, and two motels. Petitioner was responsible for the onsite management of the businesses while Patrick paid the expenses and maintained the books and records.

Petitioner, on his 1998 Federal income tax return, reported losses relating to the businesses. On April 25, 2005, respondent issued petitioner a notice of deficiency relating to 1998. Respondent determined that petitioner did not substantiate the losses relating to the businesses and was liable for the section 6662(a) accuracy-related penalty.

Petitioner contends that the losses relating to the motels and trailer park are deductible pursuant to section 162 as ordinary and necessary expenses paid or incurred during the

taxable year in carrying on a trade or business. Petitioner must maintain sufficient records to substantiate the amounts of the deductions. Sec. 6001; sec. 1.6001-1(a) of the Regulations. Petitioner did not produce evidence to substantiate the losses claimed.

Petitioner did not produce evidence to substantiate the issues claimed. Accordingly, the Court sustained the IRS determination.

Section 6662(a) imposes a penalty equal to 20 percent of the amount of any underpayment attributable to various factors including negligence or a substantial understatement of income tax. Negligence includes any failure to make a reasonable attempt to comply with the law or maintain adequate books and records. An under-statement is substantial if it exceeds the greater of $5,000 or 10 percent of the tax required to be shown on the return. Respondent bears the burden of proof relating to the penalty.

Respondent established that petitioner erroneously reported income resulting in a $25,643 understatement of tax relating to 1998. Section 6664(c)(1), however, provides that no penalty shall be imposed if a taxpayer dem-onstrates that there was reasonable cause for the underpayment and the taxpayer acted in good faith. The de-termination of whether a taxpayer acted with reasonable cause and in good faith depends upon the facts and circumstances. Sec. 1.6664-4(b)(1) of the Income Tax Regulations.

Petitioner contends that he was unable to substantiate the losses because Patrick refused to provide the businesses' records. On August 16, 2002, the Superior Court of California, County of Orange, issued an order requiring Patrick to provide petitioner with the business records. Patrick did not comply with the California Court's order. On February 26, 2007, Patrick evaded service of a subpoena for the 1998 records and did not provide petitioner with access to such records. Petitioner has earnestly and diligently attempted to obtain the requisite documentation. Thus, he has demonstrated reasonable cause for his failure to substantiate the losses and has acted in good faith.

Accordingly, petitioner is not liable for the section 6662(a) accuracy-re-lated penalty.

ET CETERASOCIAL SECURITY DIRECT DEPOSIT CHANGES ARE EASYTO DO ONLINESocial Security advises that any beneficiary who is thinking about

opening a new bank account or changing banks and who may need to change the direct deposit of benefit payments should just go online to make the process quicker and easier.

First, you will need to get a password from Social Security. You can get a password by applying online at www.socialsecurity.gov or by calling Social Security at 800-772-1213. Once you have your password, you can do business with Social Security with total confidence in the security of your transaction. Of course, you also can change direct deposit services by using their automated phone service at 800-772-1213.

You also can fill out a direct deposit sign-up form available from the Social Security web site and take it to your financial institution or Social Security office. Your bank or credit union also can help you complete the change. You can use any of these methods to set up direct deposit for the first time.

Social Security also recommends that you wait until deposits actually are going to your new bank savings and loan or credit union before you close your old account.

It is important for Social Security to have your correct home address, even if you are having your Social Security benefits deposited directly into a banking account so that they can contact you about other Social Security matters, such as when they mail you your Form 1099 each year.

You also can change your home address and/or telephone number over the Internet on the Social Security web site. You can use your password to change your address online or by answering a series of specific questions whose answers have to match the information in its records.

FINANCIAL PLANNERS OFFERED ONLINE RESOURCESThe Social Security Administration provides information to financial planners regarding the various Social Security programs and Medicare and is a valuable resource in helping clients plan for retirement or other life events. Offering planning tools for:

Retirement• Disability• Survivors• Medicare•

Choose a benefit calculator to estimate potential benefit amounts using different retirement dates and levels of future earnings. The calculators will show retirement benefits as well as disability and survivor benefit amounts in case of disability or death.

Benefit amounts can be affected by a number of different factors. If you

THE FEDERAL TAX ALERT – JUNE 200712

already have a benefit estimate, use more charts and calculators to find out how different situations affect Social Security benefits.

The Social Security Statement is a concise, easy-to-read personal record of the earnings on which a worker has paid Social Security taxes during his or her working years and a summary of the estimated benefits he or she and his or her family may receive as a result of those earnings.

Social Security also provides related information on:

Marriage, divorce and name • changesReport of death• Identity theft and your Social • Security numberNew or replacement Social • Security cardNew Social Security numbers for • domestic violence victimsHow work affects your benefits• The taxation of Social Security • benefitsThe Windfall Elimination • ProvisionGovernment Pension Offset•

To access the Financial Planners Resource page go to www.socialsecu-rity.gov/financialplanners/.

Information provided by NSTP Member, Dr. Bill Stevenson, NY

BIG COMPANIES MOVE TOPLANS LIKE 401(K)SThe nation's largest companies continue to move away from traditional pension plans, with more than four in 10 now offering new workers only defined con-tribution accounts such as 401(k)s.

Of the nation's 100 largest companies, just 31 offered traditional pension plans in 2006, according to a study by the Watson Wyatt Worldwide human resources consulting and management firm. That is down from 35 in 2005 and only about a third of the 89 that offered traditional pensions in 1985, the study indicated.

As of last year, 42 of the companies had moved to defined contribution plans, like 401(k) accounts, which require employees to play a major role in funding their retirement savings. That is up from 37 in 2005 and 10 in 1985, the study showed.

The rest, 27 companies, were using so-called hybrid defined-benefit plans, such as cash-balance plans. These pension programs offer a guaranteed benefit like a traditional pension, but generally provide longtime workers with less in accrued benefits than traditional plans. That was down from 28 in 2006 but up significantly from the single plan offered in 1985.

Watson Wyatt, which is head-quartered in Arlington, VA, expects further growth in the hybrid plans, especially after recent legislative changes and legal decisions have taken some of the uncertainty out of the programs.

Last summer, a federal appeals court reversed a lower court's finding that International Business Machine Corporation's cash-balance pension plan discriminated against older workers. The Supreme Court in January refused to review the case.

TAX REP ROUNDTABLEIRS ACCEPTS MORE TAX PAYMENTS VIA CREDIT CARDThe IRS recently expanded the types of payments individuals and businesses can pay by phone or Internet with their credit cards.

Beginning this year, you can use your credit card to pay Trust Fund Recovery Penalty liabilities and the balance due on certain employment tax returns, including installment agreement payments on those liabilities.

INFORMATION MANAGEMENT RESOURCE SYSTEM—IMRSCLOSED ISSUESIMRS 05-0000064IRS Restructuring CausingTaxpayer Burden

Issue: Taxpayers and their rep-resentatives are having problems locating an address for sending non-return related forms.

Response: IRS has developed and launched website “Where to Send Non-Return Forms Applications and Payments” on irs.gov. Site includes information on topics such as offer in compromise, liens, installment agreements, innocent and injured spouse, application for ITIN and other information. This site can be found by going to irs.gov and entering “Where to File” in the search field.

NSTP led the request that IRS addressthis issue.

IMRS 07-0000383Balance Due Notices

Issue: Preparers advise that balance due notices are being generated when the return is e-filed and a check is mailed shortly afterwards.

Response: Because the electronically filed return posts more quickly than a payment via paper check, this is a difficult systemic issue to resolve. The IRS has several controls in place to prevent this from happening during

the peak filing season, but there are related issues that prevent year-round implementation. If tax is the only item owed, the taxpayer or tax professional can avoid this problem by using an electronic funds withdrawal. However, if penalty and interest are due the EFW does not permit payment of the penalty and interest so there will still be a notice issued for those amounts. Beginning in processing year 2008, a scheduled enhancement to EFW will enable taxpayers to make penalty and interest payments.

Rick Oelerich, NSTP Member- Iowa first brought this issue to NSTP regarding a corporate taxpayer and the failure of IRS to recognize a timely paper payment when the return was filed electronically. A subsequent notice with penalty and interest was issued resulting in the necessity that Rick represented his client before the IRS in order that the penalty and interest be abated .for absolutely no reason.

IMRS 07-0000470Split Refunds, Payment for Tax Preparation Services

Issue: Practitioners request the option of designating a portion of their client's refund to pay for tax preparation services.

Response: At this time, split refunds are only available between two and three accounts with financial institutions and are not available for taxpayers to direct part of their refund into their tax professional's checking or savings account to pay for tax preparation fees.

IMRS 07-0000390Penalty and Interest Calculator

Issue: Practitioners request a penalty and interest calculator be placed on irs.gov.

Response: Due to the nature and complexity of interest computations, a calculation tool for federal returns could only provide an estimated computation and could not take into consideration the various tax law provisions that may be applicable. Therefore, at this time there is no plan to provide an interest calculation application via irs.gov.

TAXPAYER REPRESENTATIVESNEED TO BE AWAREAn NSTP member recently encountered an IRS auditor who had on his business card the letters “CPA” after his name. The member checked with his State Board of Accountancy to find no record of this auditor ever being licensed by his state.

Reports of IRS personnel in Michigan indicate claims of being an attorney when the State Bar Association has no record of the individual.

JUNE 2007 – THE FEDERAL TAX ALERT13

While IRS employees do not have to be Certified Public Accountants or Attorneys, if they claim to be they must meet state requirements. Tax profes-sionals should ask for business cards from IRS employees and if there is a designation, verify it with the state.

TAXPAYER REPRESENTATIVE CHECKLIST—DEALING WITHA NON-FILER

Determine a workable approach • to dealing with all aspects of the taxpayer's non-filing.Obtain copies of last-filed• tax returns.Determine if ASFR assessments • have been implemented by IRS.If tax returns require preparation, • address the issue to determine the level of compliance.Work with the taxpayer to • acquire all required documents utilizing third party documents accessible through IRS.Request a transcript on the • taxpayer from IRS.Make immediate contact with the • Revenue Officer if one has been assigned to the case.Have the taxpayer prepare Form • 433 A and if applicable B in draft form.Consider filing status and inform • the taxpayer or taxpayers of issues regarding such.Look for “reasonable cause” for • penalty abatement or waver.Prepare Form 843, Claim for • Refund if applicable.Collection alternatives should be • reviewed with the taxpayer.When appropriate, make referral • to a bankruptcy attorney may be in order.Respond promptly and appropri-• ately to any IRS correspondence or requests.Keep journal of activities related • to the case including contact with client, IRS and third parties.Ensure client is and remains • current with filing and payment responsibilities.Keep taxpayer aware of progress • with IRS.Get a retainer and do not allow • your client to fall behind in payments to cover your services.

ETHICS CORNERJUSTICE DEPARTMENTAND INTERNAL REVENUESERVICE HIGHLIGHT TAX ENFORCEMENT RESULTSThe Department of Justice and the Internal Revenue Service have

announced highlights of their work during the past year to defend and enforce federal tax laws.

Since 2001, the Justice Depart-ment's Tax Division has brought to justice hundreds of people who evaded their federal taxes or otherwise violated the internal revenue laws. The division has obtained hundreds of civil injunctions to stop the promotion of tax scams and the preparation of false and fraudulent tax returns, and has criminally prosecuted numerous tax fraud scheme promoters.

To curb the marketing of tax shelters to corporations and individuals, the Justice Department's Tax Division has helped the IRS to identify and pursue nearly every customer who engaged in certain abusive tax shelter transactions, while at the same time pursuing the profes-sionals who designed, facilitated, or accommodated the underlying tax shelter transactions.

“Taxes are how we pay for what we ask our government to do for us. People who pay what the law requires deserve the assurance that those who do not and those who promote or facilitate tax evasion, will not get away with it,” said Eileen J. O'Connor, Assistant Attorney General for the Tax Division. “The Tax Division is using all available law enforcement tools to identify and punish tax offenders and to recover tax revenues.”

“The vast majority of Americans pay their taxes honestly and accurately,” said IRS Commissioner Mark W. Everson. “We enforce the law because people deserve to know their neighbors and competitors are doing the same.”

The Tax Division continues to bring civil injunction suits to stop tax preparers who habitually prepare bogus tax returns. In response to the government's efforts, courts across the country have barred tax preparers from preparing inaccurate returns.

Since January 2001, the Justice Department has sought and obtained injunctions against more than three dozen tax return preparers, including 18 since January 2006. It expects to obtain many more injunctions throughout the year. The United States recently has obtained injunctions that barred the following schemes by tax preparers:

Filing tax returns that falsely • report “zero income”;Claiming that only income from • a foreign source is taxable, using a spurious interpretation of Section 861 of the Internal Revenue Code;Claiming personal living • expenses as business expenses;

Preparing amended tax returns • to claim tax refunds without customers' knowledge or consent; andAsserting that casino gaming • proceeds paid to Native Americans are exempt from federal income tax.

The Department of Justice also has obtained injunctions against employers who fail to withhold, account for, and pay over employment and withholding taxes and against return preparers who prepare related false returns.

During fiscal year 2006, the Justice Department's Tax Division authorized prosecutions of nearly 1,200 defendants for tax crimes, an increase of more than 34 percent over the number authorized for prosecution in 2001. The Tax Division's criminal enforcement priorities include investi-gating schemes that involve:

Using trusts or other entities• to conceal control over income and assets;Shifting assets and income to • hidden offshore accounts;Making false statements to the • IRS in order to claim tax refunds;Selling and promoting fraudulent • tax avoidance schemes;Using frivolous justifications for • not filing truthful tax returns;Failing to withhold, report and • pay payroll and income taxes;Failing to report income on indi-• vidual and corporate returns; and Failing to file tax returns.•

Since April 2006, the Justice Department and the IRS has vigorously pursued the promoters of tax fraud schemes to stop their activity and to warn would-be promoters that promoting tax fraud schemes leads nowhere but to a federal court injunction or to a long stay in jail.

Since January 2001, the Justice Department has sought and obtained injunctions against nearly 200 promoters of tax fraud schemes, including 66 since January 2006. These injunctions have stopped promoters from selling tax evasion schemes on the internet, at seminars, or through other means. The tax-scam promoters the government has sought to enjoin have cost the U. S. Treasury an estimated $2.5 billion, and have had an estimated 500,000 customers. Among the government's results in this area are:

In May 2006, David Carroll • Stephenson was sentenced to eight years in prison in connection with his promotion of a tax evasion scheme using “pure equity trust” organizations.

THE FEDERAL TAX ALERT – JUNE 200714

In June 2006, a federal judge • sentenced five defendants, Dennis Poseley (seven years), David Trepas (five years), Patria Ensign (18 months), Rachel McElhinney (16 months), and Keith Priest (18 months), to prison terms for their respective roles in promoting a tax evasion scheme that used offshore trusts and bank accounts.On June 22, 2006, District Judge • Elizabeth Kovachevich issued an injunction permanently barring Douglas Rosile, a former Certified Public Accountant whose clients included Wesley Snipes, from preparing federal income tax returns for others and from promoting a frivolous tax argument based on Section 861 of the Internal Revenue Code. Among the documents the government filed in court was a return submitted to the IRS on behalf of Snipes claiming a bogus $7.3 million tax refund.In November 2006, a federal • judge sentenced Milton H. Baxley 11 to 18 months in prison and fined him $10,000 for contempt of court. On August 9, a jury convicted Basley on two counts of violating an injunction order barring him from promoting a tax fraud scheme.In December 2006, a federal • judge sentenced Thomas Miller to nearly four years in prison for conspiring to defraud the United States in connection with a “pure trust” tax fraud scheme. Miller operated Freedom Education Center, a business in California that sold anti-tax literature and helped people create bogus trusts.

During the past year, the Justice Department and the IRS have continued their vigorous enforcement efforts against promoters and facilita-tors of abusive tax shelters. Abusive shelters for large corporations and high-income individuals have cost the U. S. Treasury billions annually, according to Treasury Department estimates. The Tax Division also has had great success in federal court defending the U. S. Treasury against tax shelter-related claims of large companies and individual investors. The Tax Division is currently litigating approximately 86 tax shelter cases or groups of cases, including 47 separate cases involving the Son of BOSS tax shelter. Among the successes during the past year in this area are the following:

In December 2006, Utah • businessman Chandler S. Moisen

pleaded guilty to conspiracy and wire fraud in connection with a criminal probe of tax shelters promoted by a group of KPMG, LLP executives.In January 2007, Steven Michael • Acosta, a former KPMG manager, pleaded guilty to four felony tax charges in connection with is involvement in KPMG's promotion of tax shelter transactions.The Supreme Court let stand • the decision of the U. S. Court of Appeals for the 6th Circuit that the COLI (corporate -owned life insurance) program The Dow Chemical Company used to claim more than $33 million of tax deductions was an economic sham.The Supreme Court also let • stand the decision of the U. S. Court of Appeals for the Federal Circuit that the IRS was right to disallow the $375 million loss Coltec Industries claimed for its “contingent liability” tax shelter.The U. S. Court of Appeals for • the 2nd Circuit held that the IRS properly disallowed the losses General Electric Capital Corporation claimed for its par-ticipation in an equipment leasing tax shelter, resulting in $62 million in additional income taxes.The U. S. District Court for the • Middle District of North Carolina granted summary judgment for the United States in the first Lease In-Lease Out (LILO) tax shelter to go to court. BB&T Corporation v. United States.The U. S Court of Appeals for • the Federal Circuit ruled for the United States on an issue raised by tax shelter participants in several tax shelter refund suits in A. D. Global Fund, LLC b. United States. The court ruled that the statute of limitations on the return of a person who participates in a tax shelter partnership does not expire at least before the statute of limitations on the partnership's return does.

The government brings both its civil and its criminal tools to bear in the fight against tax fraud. An ongoing tax scam causes continued harm to the federal Treasury and it leaves participants owing taxes, interest, and often, penalties. The government does not wait until a criminal case has been developed to take action to stop the scam. Rather, the Justice Department brings civil injunction suits to stop both the promotion of tax scams and the preparation of false or fraudulent returns. Addition-

ally, in appropriate cases, the Justice Department brings criminal charges against the promoters, preparers, and scam participants to punish them for their unlawful conduct.

JUSTICE DEPARTMENT SUES TO BLOCK ALLEGED SHAM-TRUST COSTING TREASURY AN ESTIMATED $31 MILLIONThe Justice Department announced in March that it sued two Las Vegas-based promoters of an alleged sham-trust tax scheme that the complaint alleges has caused an estimated $31 million in loses to the federal treasury. The suit alleges that Reinhold Sommerstedt and Daniel Young of Las Vegas sold sham-trust packages to customers for as much as $14,500 and helped their customers hide their income from the IRS in Caribbean bank accounts. The defendants' customers allegedly used phony loans and gifts to repatriate their money while concealing their income from the IRS.

Also named in the suite are Lynn Lakers, a Boulder City, Nevada tax-return preparer who allegedly prepared false tax returns for the phony trust used in the scheme, and Stephen Nestor of Boise, Idaho, a former IRS revenue officer who allegedly signed tax returns on behalf of the bogus trusts.

TAX FRAUD COMPLAINT UNSEALED AGAINST FOUNDER OF ANDERSON ARK & ASSOCIATESThe founder of a nationwide abusive tax shelter promotion scheme has been charged with conspiring to defraud the United States by organizing a group of accountants who used a variety of shell corpora-tions, trusts and partnerships to operate tax shelter schemes they sold to their clients, the Department of Justice's Tax Division has announced.

Keith E. Anderson, founder of Anderson Ark and Associates was charged in a criminal complaint which was unsealed today in Seattle.

The complaint alleges that from 1998 through 2001, Anderson Art and Associates obtained more than $30 million in illegal tax refunds for between 1,500 and 2,000 clients and received approximately $50 million in fees and other funds from the clients.

The complaint further alleges that Anderson Ark & Associates' accounts prepared tax returns that claimed large tax deductions for fraudulent “loans” and “consulting expenses.” In reality, the complaint alleges, the funds were not spent as claimed, but instead were wired to Costa Rica so that Anderson Ark & Associates'

JUNE 2007 – THE FEDERAL TAX ALERT15

clients could later withdraw them with a debit card.

The tax charges against Anderson are in addition to an indictment returned in the Eastern District of California on May 3, 2001, charging Anderson and several other defendants with conspiring to commit money laundering through Costa Rica.

Anderson, who had been a fugitive from justice, was apprehended in Costa Rica on February 9, 2002, and is awaiting extradition to the United States.

COURT SHUTS DOWN 'WAREHOUSE BANK'A federal court in Seattle has shut down a nationwide “warehouse banking” scheme. Promoters falsely tell customers they could legally hide their income, assets, and identities from the Internal Revenue Service, according to the Justice Department.

The warehouse bank, known as Olympic Business Systems (OBS), is operated by Des Moines, Washington resident, Robert Arant.

The government contended that Olympic deposited almost $28 million of customer funds into accounts that OBS maintained in its own name at commercial banks. Olympic allegedly used the funds to pay customers' bills and expenses while promising to leave no paper trail.

The court's order held that Arant “is or should be aware that courts have repeatedly held that warehouse banks are tax evasion schemes.”

A California federal court in 2004 permanently closed a similar warehouse bank. In 2005 a federal court in Oregon sentenced operators of a warehouse bank to prison, after their criminal convictions.

Since 2001, the Justice Department has obtained injunctions againstmore than 235 tax preparers and tax-fraud promoters.

MEMBERS ASKNSTP “HOTLINE” TAXSEASON QUESTIONSDuring Tax Season the NSTP “Hotline” assistors took hundreds of telephone calls from NSTP members assisting them with their questions, concerns and issues. Over the next several months the Federal Tax Alert will address some of the more frequently asked questions in order that we all become better educated in these areas. In order to be inclusive of issues related to a specific subject the questions addressed will be generic in nature. This month's question:

How do I know what education benefits are available to my taxpayer?

The ABCs of Education—Part I.

Education benefits:Certain tax benefits can apply to qualified education expense.They include:

The Hope credit;1. The lifetime learning credit;2. Deduction of student loan 3. interest;Receive tax-free treatment of a 4. canceled student loan;Receive tax-free student loan 5. repayment assistance;Deduct tuition and fees for 6. education;Establish and contribute to a 7. Coverdell education savings account (ESA), which features tax-free earningsParticipate in a qualified tuition 8. program (QTP), which features tax-free earnings.Take early distributions 9. from any type of individual retirement arrangement (IRA) for education costs without paying the 10% additional tax on early distributions.Cash in savings bonds for 10. education costs without having to pay tax on the interest.Receive tax-free educational 11. benefits from your employer; andTake a business deduction for 12. work-related education.

TAX-FREE SCHOLARSHIPS AND FELLOWSHIPSA scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies.

The student may be either an un-dergraduate or a graduate.

A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.

CANDIDATE FOR DEGREE.You are a candidate for a degree if you:

Attend a primary or secondary • school or are pursuing a degree at a college or university, orAttend an accredited educational • institution that is authorizedto provide:

A program that is acceptable • for full credit toward a bachelor's or higher degree orA program of training to pre-• pare students for gainful employment in a recognized occupation.

ELIGIBLE EDUCATION INSTITUTIONAn eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students

in attendance at the place where it carries on its education activities.

QUALIFIED EDUCATION EXPENSESFor purposes of tax-free scholarships and fellowships, these are expenses for:

Tuition and fees required to enroll at or attend an eligible educational institution, and

Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.

EXCEPTIONSYou do not have to include in income the part of any scholarship or fellowship that represents payment for teaching, research or other services if you receive the amount under:

The National Health Service • Corps Scholarship Program;The Armed Forces Health • Professions Scholarship and Financial Assistance Program and you:Are a candidate for a degree • at an eligible educational institution, andUse that part of the scholarship • for fellowship to pay qualified education expenses.

REPORTING SCHOLARSHIPSAND FELLOWSHIPSWhether you must report your scholarship or fellowship depends on whether you must file a return and whether any part of your scholarship or fellowship is taxable.

If your only income is a completely tax-free scholarship or fellowship, you do not have to file a tax return and no reporting is necessary.

If all or part of your scholarship or fellowship is taxable and you are required to file a tax return, report the taxable amount as follows:

For 2006:1040EZ Line 1, enter SCH1040A Line 7, enter SCH1040 Line 7, enter SCH

Even if no W-2 is issued, Schedule SE should be completed if earnings are $400 or more.

HOPE CREDITThe Hope Credit of up to $1,650 for qualified education expenses can be paid for each eligible student.

LIFE-TIME LEARNING CREDITThe Life-time Learning Credit of up to$2,000 per tax return for qualified edu-cation expenses can be taken each year.

THE FEDERAL TAX ALERT – JUNE 200716

CLAIMING THE CREDITWHO CAN CLAIM THE CREDIT?

Generally, you can claim the Hope credit if all three of the following re-quirements are met.

You pay qualified education 1. expenses of higher education.You pay the education expenses 2. for an eligible student.The eligible student is either 3. yourself, your spouse or a dependent for which you claim an exemption on your tax return.

For each student, you can elect for any year only one of the credits. For example, if you elect to take the Hope credit for a child you cannot, for that same child, also claim the lifetime learning credit for the same year.

If you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year, you can choose to claim either credit, but not both.

You can claim the Hope credit for one student and the Life-time Learning credit for another student in the same year.

Qualified education expenses paid by a dependent for which you claim an exemption, or by a third party for that dependent, are considered paid by you.

WHO CANNOT CLAIM THE CREDIT?You cannot claim the Hope credit or Life-time Learning credit for 2006 if any of the following apply:

Your filing status is married 1. filing separately.You are listed as a dependent 2. in the Exemptions section on another person's tax return, such as your parents' return.Your modified adjusted gross 3. income, MAGI, is $55,000 or more ($110,000 or more in the case of a joint return).You, or your spouse, were a 4. nonresident alien for any part of the year and the nonresident alien did not elect to be treated as a resident alien for tax purposes.You can only claim the one, 5. either the Hope credit or the Lifetime Learning credit for the same student in any given year.

EXPENSES THAT DO NOT QUALIFYQualified education expenses do not include amounts paid for:

Insurance;1. Medical expenses, including 2. student health fees;Room and board;3. Transportation, or4. Similar personal, living, or 5. family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.

Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify.

Some eligible educational institu-tions combine all of their fees for an academic period into one amount. If you do not receive or do not have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses contact the institution.

WHO IS AN ELIGIBLE STUDENT?HOPE CREDIT

To claim the Hope credit, the student for whom you pay qualified education expenses must be an eligible student, meeting all of the following requirements:

The student did not have expenses that were used to figure a Hope credit in any 2 earlier tax years.

The student had not completed the first 2 years of postsecondary education, generally, the freshman and sophomore years of college.

For at least one academic period beginning in the tax year the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.

The student was free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of the year.

RECAPTURE OF THE CREDITIf after the tax return claiming the credit is filed, you or someone else receives tax-free educational assistance for, or a refund of, an expense you used to figure a Hope or a Life-time learning credit on that return, you may have to repay all or part of the credit.

You must refigure your credit as if the assistance or refund was received in the year the credit was taken. Subtract the amount of the refigured credit from the amount of the credit you claim. The result is the amount you must repay.

QUOTES OF THE MONTH“If you make any money, the government shoves you in the creek once a year with it in your pockets, and all that doesn't get wet you can keep.”

Will Rogers

“I like to pay taxes. It is purchasing civilization.”

Oliver Wendell Holmes

“We do not have a trillion-dollar debt because we have not taxed enough. We have a trillion-dollar debt because we spend too much.”

Ronald Reagan

“Today it takes more brains and effort to make out the income tax form than it does to make the income.”

Alfred E. Neuman

“I am proud to be paying taxes in the United States. The only thing is I could be just as proud for half of the money.”

Arthur Godfrey

“The income tax created more criminals than any other single act of government.”

Barry Goldwater

“It would be a hard government that should tax its people one-tenth part of their income.”

Benjamin Franklin

NEXT ISSUE(JULY 2007)

☛ MORE “ANSWERS”

ON EDUCATION

FROM THE NSTP

“HOTLINE”

WWW.NSTP.ORGSERVICE TO THE TAX

PROFESSION

Call 1-877-393-2874, option 2 or visit CCHGroup.com/SiteBuilder for a FREE 30-day test drive.

This trial requires no payment, risk, or obligation and no need to cancel.

Be one of the fi rst 50 customers to purchase Site Builder before July 9, 2007 and receive a one-year

subscription to CCH Tax Guide for FREE. (Use media code NSTP1)

ProSystem fx® Site Builder helps you expand your practice onto the Internet so you can effortlessly build stronger relationships with your clients. With a professional presence on the Internet, your fi rm can:

Become a resource for online fi nancial content and tools Make your website a destination point for clients and prospects with CCH eContent. With content from the tax experts at CCH, your website will feature informative and insightful articles, useful calculators and important tax alerts.

Add any of the following modules to make your website even more powerful:

Enhance your client interactions with the easy-to-use File Share module Integrate the power of the Internet into your workfl ow, securely sharing fi les with clients across the Internet.

“The File Share function on our website has been a great addition to the effi cient functioning of our business. It has taken what used to be a real troublesome project — getting clients’ fi les in-house— and simplifi ed it to the point where, sometimes within 10 minutes or less, the fi les are here and are being downloaded to our network.”

— Mary Wilsey, System AdministratorStulmaker, Kohn & Richardson, LLP

Build your own website in less than 30 minutes.

Build your practice online

Customize website content and appearance

Securely exchange documents with clients

Deliver premium content to clients and prospects

CCH Tax Guide — 500+ pages of straightforward explanations of virtually any tax issue

Business Owner’s Toolkit — 4,600+ news and advice documents for your small-business owner clients

Financial Planning Toolkit — 1,500+ fi nancial planning documents, tools and interactive calculators

Client Life-Cycle Reading Rack — Helpful guides that ensure your clients understand the basics

NSTP Members

SPECIAL

BONUS!

35

36

37

38

39

40

41

42car or truck expense

uctions for line 13 on p

r vehicle for:

YesNo

r line 30.

/

YesNo

YesNo

YesNo

Other (attacory?

Y

OMB No. 1545 007

m Businesse Proprietorship)

ps, joint ventures, etc., must file Form 1065 or 1065 B

Form 1040, 1040NR, or 1041. � See Instructions f

APrincipal business or profession, including produ

Business name. If n

C

E

F

YesNo

GH

, see page C-3 for limit on losses

k h, check h

�

Gross receipts or sales.sales. Caution.

Cauti If this income was reported to you on Form W-2 and the “Statutory

employee” box box on that form was checked, see page C-3 and check here

o

�

1

12

2 Returns and allowances

3

3 Subtract line 2 from line 1

4

4 Cost of goods sold (from line 42 on page 2)

5

Gross profit. Subtract line 4 from line 3

5

6

Other income, including federal and state gasoline or fuel tax credit or refund (see page C-3)

67 Gross income. Add lines 5 and 6

�7

Expenses. Enter expenses for business use of your home only on line 30.

8

21

Repairs and maintenance

21

Advertising

8

22

Supplies (not included in Part III)

22

23

9

Taxes and licenses

23

10

Travel, meals, and entertainment:

24

Car and truck expenses (see

page C-4)

9

24a

11

Travela

Commissions and fees

10

12

Depletion

12

Deductible meals andentertainment (see page C-6)

b

Depreciation and section 179

expense deduction (not

included in Part III) (see

page C-4)

13

13

Employee benefit programs

(other than on line 19) 14

25

15

Utilities25

Insurance (other than health)

26

Wages (less employment credits)

26

Interest:

16a

Mortgage (paid to banks, etc.)

Other expenses (from line 48 on

page 2)

27

16b

Other

17

egal and professionalrvices

18

Office expense

18

19

Pension and profit-sharing plans

19

Rent or lease (see page C-5):

20

20a

Vehicles, machinery, and equipment

ab Other business property

20b

al expenses before expenses for business use of home. Add lines 8 through 27 in columns� 28

31

All investment is at risk.

32a

Some investment is notat risk.

32b

Schedule C (Form 1040) 2006

duction Act Notice, see page C-8 of the instructions.Cat. No. 11334P

ative profit (loss). Subtract line 28 from line 7

nses for business use of your home. Attach Form 8829

2930

�

Part

Part II

27ofit or (loss). Subtract line 30 from line 29.

profit, enter on both Form 1040, line 12, and Schedule SE, line 2, or on Form 1040NR,

(statutory employees, see page C-6). Estates and trusts, enter on Form 1041, line 3.

ss, you must go to line 32.

ve a loss, check the box that describes your investment in this activity (see page C-6).

hecked 32a, enter the loss on both Form 1040, line 12, and Schedule SE, line 2, or on

NR, line 13 (statutory employees, see page C-6). Estates and trusts, enter on Form 1041,

cked 32b, you must attach Form 6198. Your loss may be limited.

�

Contract labor (see page C-4)

11

24b

3

3

3

3

3

4

4

4

u

r

r

o

Topic:Meeting the Challenges of the 1040 Schedule C

When:June 28-29, 2007

“The Last Thursday and Friday in June.”

Where:Williamsburg, VA

Holiday Inn Patriot - New Location3032 Richmond Road (Route 60)

(757)565-2600Room Rate: $79.00 plus taxes

Room rate is good for 3 nights prior and 3 nights after Special Topic Workshop.

Instructor:Paul LaMonaca, CPA, MST

Cost To AttendThe cost for the 12 hour seminar is

$195 for members$245 for non-members

Day 1 is 8 hoursDay 2 is 4 hours

Good News For Members!Bring a non-member and save an additional $15 on your cost!

How To Register:You can register for this seminar by calling 800-367-8130 or

online at www.nstp.org.

2007 NSTP Special Topic Workshop

www.nstp.orgService to the Tax Profession

g product ore. If no separate busine

aave veeve bblblablablaAc

ethethhhhod:od:d:dod:od:dmamamatmatmatmatate ierierierialally participate” in the operation f

If f uyouyouyouyouyoo sstst st sta tarted or acquired this busin

IncomeGross receimployee” b

(1)Cash

(2)Accrual

Business address (

titetee ororo or ororr rorroro rooom no.) �

City, town o

,, stastaaas ttetete,te, aan and ZIP code

t Iation of this busin

ation of this busin

business during 2006, check

business during 2006, check

eipts or salesipts or sales Cbb

crual

uct orr s sssssbusiness s namnamnamnamnamnammeee,e, e, , lealealeavevevevev b

AccAccAccAccccounounnnntitintintintininng mgg mg mg mg mmethethethhhoododdoDDidDidDidDidDididD yoyoyoyoyo youuuu ““mamamIf f yyouyouyouyoyo

dress (s inccclludludludlududududinginginging s ssusuuuiteiteitete oroo

own or pppoosostostostststst oooof ficccccee,e,e, eee stastastasts ttLast Chance!545-0074

1065-B.

AAAtAttAttAttachacchhmentSSSeSeqSeqSeqSequence No. 09

ctions for Schedule C (((FoForForForForForFo m 1m 1m 1mm 11mm 04004004004 )).).)SocSocSocSocccialialialiaialial se sesesesecccucurcurcuritiityity number (SSN)

C-2 of the iinininsnsnsnsstrutrutrutrutrucctictictionsonsonsonsonson )))B Enter code from pages C-8, 9, & 10

�D Employer ID number (EIN), if any

g 2006? If “No,” see

herepecify) �

06

Topic:pTo

D number (EIN), number (EIN),

during 2006?

durinhere

Other (specify)(specify) ��

seeseseseseervir ce (see page C

aaanknk.

l

ness durinness durin

l(3)(3)

OtheOth

ssssss

Don’t Miss Out!

Make plans now to attend one of the four NSTP Regional Conferences to be held in advance of the IRS Nationwide Tax Forums.

12 hours of continuing professional education (CPE).

Member Price: $195, includes lunch on Monday and text materials for the Sunday session, as well as for the Monday track you sign up for.

NSTP 2007REGIONAL CONFERENCES

at the IRS Nationwide Forums

www.nstp.orgService to the Tax Profession

What is the NSTP Annual Meeting?Annually the Members of the National Society of Tax Professionals meet to

discuss matters concerning NSTP. The NSTP Board of Directors and Executive Director will be in attendance to report to the Members the successes of NSTP

as well as the fi nances and status of programs.

For more information or to register visit www.nstp.org or call 1-800-367-8130.

Continues on back…

Location Dates Place

Atlanta, GA July 15-16 Hilton Atlanta 255 Courtland Street NE Atlanta, GA 30303 (800) 445-8667 NSTP Annual Meeting July 15 5:15 pm

Chicago, IL July 29-30 Hilton Chicago 720 South Michigan Avenue Chicago, IL 60605 (800) 445-8667

Las Vegas, NV August 19-20 Rio Hotel and Casino 3700 W. Flamingo Las Vegas, NV 89103 (888) 746-7482

Orlando, FL September 16-17 Disney’s Coronado Springs Resort 1001 West Buena Vista Dr. Lake Buena Vista, FL 32830 (407) 939-1020

Schedule:

Sunday afternoon — 2 hours: S Corp. NRP Audit — Wear the Revenue Agent’s Hat! Examine an S Corp Return from line 1 to completion. 2 hours: Negotiate for What You Want — Successful IRS Negotiations Instructor: Beanna J. Whitlock, EA CSA

Monday — Two Different Tracks — Both 8 hours Track 1: S Corporations — From Start-up to Operation to Liquidation

— All you ever wanted to know about S Corps but were afraid to ask!

Instructor: Paul LaMonaca, CPA, MST OR

Track 2: The Ugly 1040 — Discover the solutions to your most nagging issues by preparing the ugliest 1040 — If the 1040 has a problem, this one does! We will handle it all!

Instructor: Beanna J. Whitlock, EA CSA

Special invitationfrom Board President

The NSTP Board of Directors is pleased to announce the date and time of the Annual Meeting: July 15th, 2007, in Atlanta, Georgia at 5:15 pm. Come to the Regional Conference for the outstanding education. Come to enjoy your fellow NSTP members and let them enjoy YOU! You are especially invited to participate in the fi rst:

NSTP Town Hall MeetingBring your comments, questions and suggestions. Together, let’s make NSTP the tax professional organization in Service to the Tax Profession.

Dorothy Leamon,NSTP Board President

www.nstp.orgService to the Tax Profession