Wednesday, December 11, 2013

Media Appearance Redux

Your humble blogger has made another media appearance, at a Forbes blog (also published in print in Tax Analysts):

The Cold War Is Over, But No One Told the IRS
by Joseph Thorndike

(picture not in original article)
Lawmakers also forgot to repeal a provision of the tax law exempting employees of Communist organizations from having to pay Social Security taxes on their wages. (They are similarly forbidden from collecting Social Security benefits derived from those wages, since wages and benefits are linked for all of us.) ***

As Zhang suggests, “An employer could voluntarily send in a registration form and see how it goes.” But if they’re going to give it a shot, they better move fast. In a sign that lawmakers are finally catching up with current events, the congressional Joint Committee on Taxation has identified both the charity disallowance and the Social Security exemption as examples of “potential deadwood” lurking in the code.

Looks like the Cold War might finally be ending. Let’s hope the IRS gets the word this time.

Tuesday, December 3, 2013

Sales Tax Break for Performance Art, But Only If It Is High Brow

The New York sales tax is imposed on most goods and some services.  NY Tax Law section 1105(f)(1) provides that there is a sales tax on any "admissions charge" for the use of any "place of amusement" in New York, such as sporting events and amusement parks. 

But there are several statutory exceptions not subject to sales tax:
1. race tracks,
2. boxing,
3. sparring or wrestling matches,
4. live circus performances,
5. motion picture theaters,
6. sporting activities in which such patron is to be a participant, such as bowling alleys and swimming pools,
7. dramatic or musical arts performances, defined as a "theatre, opera house, concert hall or other hall or place of assembly for a live dramatic, choreographic or musical performance" in in Tax Law section 1101(d)(1).

An adult "juice bar" near Albany NY, called Nite Moves Gentlemen's Club, styles itself Albany's premiere adult venue.  The establishment is evidently a real juice bar where patrons can order juice beverages while watching exotic dancing.

In the landmark case of 677 New Loudon Corporation v. State of New York Tax Appeals Tribunal [pdf], New York State's highest court concluded that the adult juice bar did provide "dramatic or musical arts performances" that qualified for the sales tax exemption, even though the strippers did provide performances set to music. 

The taxpayer apparently lost because it could not prove that its employees performed in a sufficiently choreographed fashion, and furthermore the taxpayer's expert witness was not credible because he did not have any "personal knowledge or observation of 'private' dances" that happened at the club, which was an incredibly foolish oversight on the part of the expert witness. 

The dissent noted that the legislature probably meant "choreographic" to be synonymous with "dance" and that it was unlikely for the legislature to intend to tax improvised dances.  But the United States Supreme Court declined to review the case.

Perhaps the club should try to fit within one of the other statutory sales tax exceptions, such as "sparring or wresting matches" or "sporting activities in which such patron is to be a participant."

Tuesday, November 12, 2013

Tax Breaks for Astronauts Who Die in Space

To answer the question on the mind of everyone who has ever seen the movies Armageddon or Gravity, there are two excellent tax breaks for (spoiler alert!) astronauts who die in the line of duty.

Internal Revenue Code section 692 provides that such astronauts literally do not have to pay any federal income taxes for two years -- the year of their death in the line of duty and the year before.  It doesn't matter if they made a billion dollars selling gold or bitcoins.  Zero taxes.  If some federal income taxes were withheld from their paycheck, they get that money back from the IRS.

But an even better tax break is that the same astronauts are subject to a top estate tax rate of 20%, rather than the usual top estate tax rate of 40%.  Since the estate tax applies only to those who die with over $5.25 million in assets (in 2013), wealthy multimillionaire astronaut-hopeful Lance Bass can rest assured that his estate tax bill is cut in half if he were to have a fatal accident, thanks to Internal Revenue Code section 2201.

The above tax breaks were enacted in November of 2003 by the Military Family Tax Relief Act, and they apply retroactively to all astronauts who died after December 31, 2002.  The provisions were specifically addressing the seven astronauts (six Americans and one Israeli) who died in the Space Shuttle Columbia disaster of February 1, 2003, at least one of whom presumably had over $1 million in assets (the 2003 estate tax threshold). 

While some pundits (Foreign Policy) may bemoan that Americans are falling behind the Chinese in the technological space race, Americans are still way ahead in the tax policy space race.

Friday, November 8, 2013

Media Appearance

Your humble blogger has made a media appearance on Politico.com:

"Tax oddities live on amid budget impasse"

The U.S. government will give you a tax break for buying college football tickets.
And hunting whales. And if you happen to be a foreign professional golfer. Or a college professor. Or if you get divorced.
...
Other provisions would seem to be obsolete. A Cold War-era law allows communists to avoid paying the Social Security tax (they don’t get benefits either). That came after congressional outrage over reports that a jailed communist had continued to receive Social Security checks, said Libin Zhang, a tax lawyer.

“Obviously, that’s not as big of issue nowadays, but the statutory provision is still there,” he said.

Friday, November 1, 2013

It Is Hard to Bowl as a Business

The income tax is a tax on net income, so tax deductions are allowed for business expenses, such as salaries, rents, and interest (though some liberal commentators complain about businesses deducting their interest expenses paid to a bank). 

In order to prevent people from deducting every type of spending, the tax deduction must be for a business and not for a hobby or not-for-profit activity.

In the landmark case of Phillips v. Commissioner [pdf], the Tax Court concluded the taxpayer's bowling activities were not a for-profit business activity.  As a result, the taxpayer could not deduct his $30,000 of annual bowling expenses against his regular salary from being a full-time postal worker.

The Tax Court found that the taxpayer did not conduct his bowling activity in a business-like manner, did not maintain accurate books and records, and did not attempt to improve the activity's profitability by research or coaching.  While the taxpayer did earn some money initially from bowling tournaments, he did not win any tournament for most of the later years.  It did not help that Mr Phillips derived some "recreational benefit from his bowling activities."

In general, taxpayers who try to deduct expenses from their money-losing businesses should be careful that the business does not look too much like an enjoyable hobby that the taxpayer would continue to do in the absence of a profit, like horse racing or bowling.  Activities that are unlikely to be considered recreational hobbies include drywall construction, sewage plumbing, and preparing tax returns.

Wednesday, October 9, 2013

Tax Break for Puerto Rico Government Debt

State and local government bonds pay interest that are generally exempt from Federal income tax, but the state income tax treatment can vary.  The New York state income tax, for example, exempts only New York bonds, and the state income tax is imposed on bonds issued by other states.

The major exception is Puerto Rico bonds, the interest income from which is exempt from income tax by all US state and local governments.  Puerto Rico bonds accordingly have become very attractive to people who live in states and cities with high state and local taxes, such as New York City (8.82% state income tax + 3.876% local income tax) or California (13.3% state income tax). The result is that the vast majority of state-specific municipal bond funds, ostensibly designed to own only bonds issued by New York or another single state, also own substantial amounts of Puerto Rico bonds.

The state/local tax exemption for Puerto Rico government bonds has been around since 1917, as provided by the Jones-Shafroth Act that also granted US citizenship to Puerto Ricans and established a bill of rights.  The exemption is one of the most stable features of the US income tax rules and is a requirement imposed by federal statute, so states cannot choose to tax Puerto Rico bonds even if they want to.

Unfortunately, the generous tax break for Puerto Rico government debt has caused the Puerto Rico government to go overboard in borrowing money, to the tune of $58 billion.  That equates to $15,700 of debt per Puerto Rican, where the per capita income is around $16,300.  The value of Puerto Rico debt has declined by around 20% in value in the past year, which has more than wiped out the benefit of any tax break for Puerto Rico debt.

Some of Puerto Rico's economic troubles can be attributed to the expiration in 2006 of certain tax credits for businesses that operate in Puerto Rico, under Internal Revenue Code sections 30A and 936. 

Fortunately, the same tax exemption apply to bonds issued by Guam and the US Virgin Islands, which are expected to be much more credit-worthy.  Municipal bond fund managers may have to visit those locations in order to conduct extensive due diligence on the borrowers.

Thursday, October 3, 2013

100th Anniversary of the Federal Income Tax

Today is the 100th anniversary of the federal income tax, which was enacted on October 3, 1913.  The New York Times has more.

The 1913 income tax applied to people who made more than the $3,000 personal exemption (around $71,000 in  today's dollars), and the first 1% rate applied to taxable income of between $0 and $20,000 (around $472,000 today).  The top tax bracket of 7% applied to people with taxable income of over $500,000 (around $12 million today). 

Today, the top tax bracket of 39.6% applies to people with taxable income of over $400,000.

Coincidentally, the Federal Reserve was also created in 1913, with the authority to issue paper money, among other things.

Tuesday, September 24, 2013

Tax Break for Businesses in Antarctica, But Not Employees

Internal Revenue Code section 911(a) allows US taxpayers living in a "foreign country" to earn tax-free up to $97,600 (in 2013) of wages and other earned income.  The US person would only pay the taxes of the country of residence, if any, on the first $97,600 of income.

In the landmark 1968 case of  Martin v. Commissioner, the taxpayer spent around a year working at Byrd Station, Antarctica for the Arctic Institute of North America.  The Tax Court rejected his claim that $7,000 of his wages should be considered tax-free income earned in a foreign country.  The court noted that "the Department of State does not consider the Antarctica region to be under the sovereignty of any government... [and] Antarctica has no territorial waters and that the waters surrounding the Antarctica land area and ice sheets are part of the high seas." 

In a 1993 non-tax case, the Supreme Court concluded that Antarctica is a "foreign country" under the Federal Tort Claims Act.  The Act provides that the US government cannot be sued for claims "arising in a foreign country," so the widow of a carpenter who died in Antarctica on a hike could not sue the US government.

Americans working in Antarctica saw the potential tax planning opportunity, but the lower courts quickly reaffirmed that Antarctica continues to not be a "foreign country" under the Internal Revenue Code, such as in Arnett v. Commissioner in 2007.  One explanation for the inconsistencies is that the taxpayer loses every time.

While American individuals in Antarctica have to pay US taxes as if they were living in the United States, businesses in Antarctica may benefit from a special rule in Internal Revenue Code section 863(d)(2) that could reduce their US tax rates to zero.  Certain special rules (too complex to describe in detail) provide tax benefits to "space or ocean activities," and section 863(d)(2) provides that space and ocean activity "includes any activity conducted in Antarctica."  Restaurants and oil wells in Antarctica are expected to be especially lucrative with the low tax rates.


Tuesday, September 10, 2013

Tax Break for Large Yachts and House Boats

The "home mortgage interest deduction" is one of the most popular tax deductions in the US and costs around $70 billion a year, by allowing taxpayers to deduct the interest they pay on up to $1 million in mortgage loans.  Not as well known is the fact that the deduction is not limited to primary homes and the taxpayer does not have to even live in the home. 

The "home mortgage interest deduction" must be for a "qualified residence," which must be:
1. the taxpayer's primary residence, and
2. one other residence of the taxpayer.

Note that the home mortgage interest deduction is not limited to the taxpayer's first home or main home.   Treas. Reg. 1.163-10T(p)(3)(ii) explains the definition of "residence":
"Whether property is a residence shall be determined based on all the facts and circumstances, including the good faith of the taxpayer.  A residence generally includes a house, condominium, mobile home, boat, or house trailer, that contains sleeping space and toilet and cooking facilities."

 Therefore, a yacht can be a residence, and interest on the yacht is deductible, as long as the yacht has a bed, a toilet, and cooking space, loosely defined.  If the taxpayer has no other residence, interest on up to $1 million of yacht mortgage loans can be deducted.

The regulation then helpfully explains that "[a] residence does not include personal property, such as furniture or a television, that, in accordance with the applicable local law, is not a fixture"  So the yacht owner cannot deduct the credit card interest for buying that big screen TV in the yacht, unless the TV is built into yacht.  

The qualified residence must be used "as a residence."  However, if the residence is not rented at any time during the taxable year, it shall be considered to be used as a residence (even if nobody used it for anything).

Tuesday, September 3, 2013

Using IRA Distributions to Pay Tuition and College Housing

IRAs (Individual Retirement Accounts), 401(k) plans, and other retirement accounts are supposed to be used for retirement purposes, and there is a 10% penalty on early withdrawals to persons younger than 59-and-a-half years old.  For instance, a person who withdraws $500 from a traditional IRA would pay taxes on having $500 of additional taxable income, plus a $50 early withdrawal penalty.

Like many other tax breaks, Congress decided to add a huge number of complicated exceptions to the 10% early distribution penalty.  For example, a "first-time homebuyer" may withdraw up to $10,000 from retirement accounts to buy his or her "first" home, except that a "first-time homebuyer" is defined as someone who has not owned a home in the past two years.

Apparently, helping "first-time homebuyers" sounds a lot better than helping "people who already bought houses but sold or abandoned them 24 months ago," akin to born-again virgins.

A separate exception in Internal Revenue Code section 72(t)(2)(E) provides that IRA distributions can be used to pay for higher education expenses and avoid the 10% early distribution penalty.  Higher education expenses are broadly defined, to include college or graduate school tuition, fees, and room and board, for the taxpayer, a spouse, a child, or a grandchild.  The child or grandchild does not have to be a dependent.  In fact, the IRA distributions do not have to be traced to the higher education expenses and can even be made after the expenses were paid, as long as the distributions are less than the amount of the expenses for the same year.

Even though "higher education expenses" are defined very broadly, the statute imposes an oddly strict limitation at the same time, in that the distributions can only come from IRAs and not from other types of retirement accounts in order to qualify for the education expenses exception.  Congress did not explain its rationale when the exception was created in 1997. Congress at the time was working on "education IRAs," a type of "retirement" account that could be only used for educational expenses (now called Coverdell ESAs), and it decided to throw other IRAs into the pot as well.

In the landmark case of McGovern v. Commissioner, T.C. Summary 2003-137, the under-59-years-old taxpayer received around $28,000 from his employer retirement plan (a Thrift Savings Plan, like a 401(k) plan for federal government employees).  He rolled over part of it tax-free to an IRA, and he used $12,880 to pay for tuition at Villanova law school.

The Tax Court concluded that he had to pay a 10% early withdrawal penalty of $1,288, because the education expenses exception applied only to IRA distributions and not to distributions from other retirement plans.  It did not matter that the taxpayer could have simply rolled over the entire amount tax-free to his IRA, and then used a $12,880 IRA distribution to pay for tuition and qualified under the education expenses exception.  He was liable for the 10% early withdrawal penalty because he paid the law school tuition in one step, instead of pointlessly creating two steps.


Monday, August 26, 2013

Tax Break for American Manufacturing of Gift Baskets

The section 199 "domestic production activities deduction" is a tax break for companies engaged in certain manufacturing and production activities in the United States, such as Detroit car manufacturers and Minnesota iron mining companies.  The tax break reduces the companies' tax rates by around 3%, after some complicated calculations and requirements.  The domestic production activities deduction is often complained about as a tax break for Big Oil, since the oil companies are entitled to the same tax break as other businesses.

In the landmark case of Dean v. Commissioner, 112 AFTR 2d (2013), the District Court for the Central District of California concluded that manufacturing includes the creation of gift baskets.

The case involved Houdini, Inc., a company that designs, assembles, and sells gift baskets.  Its 300 permanent employees and 4,000 seasonal employees select certain items, such as candy or wine, to make a gift basket.  The gift items, and the basket itself, are purchased in bulk from other companies in China and the United States.  Houdini's employees work in an assembly line in California to put the different items in the basket, and they plastic wrap the resulting basket with decorative bows. 

Treasury Regulation 1.199-3(e)(1) provides that manufacturing includes "making [property] by processing, manipulating, refining, or changing the form of an article."  The District Court concluded that Houdini's production process changed "the form of an article" because the assembly of the gift basket was a "complex production process" using assembly line workers and machines.  The company produced a final item (a gift) that was distinct in form and purpose from the individual items inside (groceries).  The company went beyond merely packaging or labeling a product, which by itself would not have counted as manufacturing.  Accordingly, the taxpayers (owners of Houdini, Inc.) were allowed to claim the section 199 domestic production activities deduction. 

In a separate matter, the Internal Revenue Service in field attorney advise memorandum 20133302F concluded that photo labs are engaged in manufacturing and production activities that qualify for the section 199 domestic production activities deduction.  The photo lab, located in a pharmacy, used its own equipment and "raw materials (the photo paper, ink and other chemicals) to produce a different tangible product in form and function -- finished photos or photo books sold to its customers."

Houdini Inc. and pharmacy photo labs may be considered prime examples of the American manufacturing renaissance.

Tuesday, August 20, 2013

Tax Break for Underwriters' Laboratories (UL)

Internal Revenue Code section 501(c)(3) provides a list of organization types that can qualify for non-profit status.  The non-profit has to be organized and operated exclusively for religious, charitable, educational, literary, or scientific purposes.  Or it can be an organization that does "testing for public safety" or works to "the prevention of cruelty to children or animals."

One would normally think that a non-profit organization would be considered "charitable," or at least "educational" or "scientific," if the non-profit tests products for product safety or prevents child or animal cruelty, without the need for the specific statutory language.  The "prevention of cruelty" provision was added to the Internal Revenue Code without explanation in 1918, perhaps at a time when people felt less charitable toward animals and children.

The product safety provision arose after the landmark 1943 case of Underwriters' Laboratories v. Commissioner.  Underwriters' Laboratories (UL) is the organization that provides the UL symbol on nearly all household electric products.  UL charges manufacturers an "ample fee" to test their products, and any approved products receive the UL label of approval.  UL keeps the fee even if the product is not approved.  Though UL was formed by various fire insurance companies, which are the members of UL, the members do not receive any of UL's profits.

The Seventh Circuit Court of Appeals concluded:
This does not sound like charity to us. If it is charity, it began at home. It was not the public interest that prompted the establishment of the petitioner. It was financial gain and business advantage. The primary concern of the petitioner was that of its membership, made up almost entirely of insurance companies, and the manufacturers who paid its ample fees. Whatever benefit inured to the public was only incidental to the primary concern.

 Congress changed the Internal Revenue Code in 1954 to specifically provide that UL and similar public safety testing organizations should be considered non-profits exempt from federal taxation.  However, the provision does not apply to drug testing organizations, because the testing to meet FDA requirements helps primarily the drug manufacturer rather than the general public.

Tuesday, August 6, 2013

Tax Break for Skydiving

The Internal Revenue Code contains several excise taxes on air transportation:
Section 4261(a) imposes a 7.5% excise tax on the amount paid for "domestic" air travel (in the United States or the parts of Canada and Mexico within 225 miles of the US border).
Section 4261(b) imposes a $3 excise tax for each segment of domestic air travel. 
Section 4261(c) imposes a $12 excise tax on international air travel that begins or ends in the United States.
Section 4271 imposes a 6.25% excise tax on the amount paid for the air transportation of freight.

The $3 and $12 are adjusted for inflation, and closer to $4 and $17 now.

Fortunately for the skydiving industry, section 4261(h) provides that none of the above taxes apply to any air transportation exclusively for the purposes of skydiving.  It does not matter whether or not skydiving instructions are provided to any of the passengers, as long as some passengers are diving off the plane.  

The Skydiving Exception was enacted by Congress in the Taxpayer Relief Act of 1997Prior to 1997, the taxation of skydiving flights was mixed, depending on whether the passengers were considered to be paying for commercial travel or for education. 

The use of the term "exclusively" means that an airline like Spirit Airlines cannot bundle a few skydivers with its flights to save on the excise taxes.  But a budding entrepreneur might consider starting a skydiving-only airline to provide some lower-cost tax-free transportation.

Monday, July 29, 2013

Tax Break for Corporate Sponsorship of Non-Profit Sports

Non-profit organizations like the Red Cross and the National Football League are normally exempt form US income taxes, but they must pay taxes on their income from certain commercial activities.  For example, a non-profit that runs a trade journal may be subject to tax on its advertising income.

In two memos from the early 1990s, the Internal Revenue Service concluded that two non-profit organizations that ran college football games should be taxed on sponsorship payments that they received from corporations.  The payments were not charitable gifts, but rather payments in exchange for "well positioned visual images" of the sponsors' names during the games.

Although the memos were heavily redacted, insiders knew that they were talking about the John Hancock Bowl, sponsored by the John Hancock Mutual Life Insurance Company, and the Mobil Cotton Bowl, for which the Mobil Oil corporation paid $1 million to display its logo prominently on the playing field, scoreboards, uniforms, paper cups, and all printed material.  Both Bowl games were organized by non-profit organizations.

The memos set off an incredible firestorm of lobbying from Big Nonprofit.  The IRS quickly retreated from its position with new regulations, and Congress finally resolved the matter in 1997 with new Internal Revenue Code section 513(i), which provides that non-profits are not taxed on receiving "qualified sponsorship payments."

Qualified sponsorship payments are sponsor payments for which the sponsor will not receive any substantial return benefit other than the use or acknowledgement of the sponsor's name. 

The non-profit cannot directly advertise the sponsor's products or services, other than showing the sponsor's name.  So the Mobil Oil corporation cannot sponsor a game advertisement for Mobil Oil gasoline, but it can have the non-profit advertise Mobil Oil generally.  The sponsor's products can be distributed or displayed at the event.  

Thursday, July 25, 2013

Dogwalking Is Subject to Sales Tax

In New York, sales of goods are often subject to the sales tax.  The sales tax is also imposed on certain types of services, one of which is "maintaining, servicing or repairing tangible personal property."

In the landmark advisory opinion TSB-A-00(35)S [pdf], the state Department of Taxation and Finance concluded that dog walking and pet sitting are subject to the New York sales tax.  Dogs and cats are tangible personal property, and the dog walking and pet sitting services are performed to maintain the dogs and cats.  The dog walker or pet sitter in New York City should charge 8.875% sales tax on top of the bill to the pet owner. 

In a blatant example of species discrimination, an exception provides that the sales tax does not apply to services for a guide dog, hearing dog, or service dog, but the tax does apply to therapy rabbits and monkey helpers

The sales tax for maintaining personal property , normally applicable to car mechanics and the like, is found in many states, so the dog walking sales tax potentially has nationwide reach. 

In contrast, young children are probably not considered tangible personal property, at least since the Civil War, so babysitters do not have to charge sales tax for maintaining the children.

Tuesday, July 23, 2013

Tax Break for Social Clubs that Discriminate Based on Religion

Fraternities and social clubs enjoy certain tax exemptions under section 501(c)(7) of the Internal Revenue Code, as "clubs organized for pleasure, recreation, and other nonprofitable purposes."  For example, the membership dues that they receive are not subject to federal income tax.

In 1976, Congress enacted section 501(i), which provided that social clubs could not qualify for tax-exempt status if they discriminated on the basis of race, color, or religion (though gender discrimination is okay).  This provision confirmed the results in the case of McGlotten v. Connally, where an African-American man successfully argued that the local Benevolent and Protective Order of Elks should not qualify for tax-exempt status because its admissions policy discriminated against non-whites.

But four years later in an act to "simplify certain provisions of the Internal Revenue Code," Congress added an exception to allow tax-exempt clubs to discriminate on the basis of religion.  The new exception applies retroactively from 1976.

Congress specifically mentioned that the exception would apply to the Knights of Columbus, the world's largest Catholic fraternal organization, which would continue to be tax-exempt.  its membership is limited to "practical" Catholic men age 18 and older, and "a practical Catholic is one who lives up to the Commandments of God and the Precepts of the Church."



Monday, July 22, 2013

Tax Break for the Freemasons But Not College Fraternities

Non-profit organizations are typically organized as section 501(c)(3) organizations, for religious or charitable purposes, or as section 501(c)(4) organizations, for social welfare.  But there are other categories of non-profit organizations.

Internal Revenue Code section 501(c)(10) provides an exemption from taxes for "Domestic fraternal societies, orders, or associations, operating under the lodge system— (A) the net earnings of which are devoted exclusively to religious, charitable, scientific, literary, educational, and fraternal purposes, and (B) which do not provide for the payment of life, sick, accident, or other benefits."

The exemption was created in 1969 to specifically cover the Masons.

In the 1970s, the Zeta Beta Tau national college fraternity, with around 80 chapters nationwide, claimed that they should also qualify for the tax-exemption under section 501(c)(10).  The fraternity already qualified for partial tax-exemption under the different section 501(c)(7), which applied to social clubs, but social clubs are subject to tax on their investment income.  The fraternity had $1,936 of investment income in 1971 that it claimed were tax-free because it was also a "domestic fraternal society" that operated under a lodge system.

Coincidentally, Zeta Beta Tau is the first Jewish fraternity in the United States. 

In the landmark case of Zeta Beta Tau Fraternity, Inc. v. Commissioner, the Tax Court concluded that the Zeta Beta Tau fraternity did not qualify under section 501(c)(10).

The court admitted that "clearly, like the Masons, Zeta Beta operates under the lodge system and its local chapters engage in some activities that concededly further the charitable and educational goals of the fraternity." The fraternity engaged in public service activities such as providing scholarships, leadership workshops, blood drives, "Easter Seal drives," and an annual dance marathon to raise funds for charity, besides the non-charitable activities of "football weekend" and daily meals at the frat house.

But the Tax Court noted that the real purpose of the Zeta Beta fraternity was to provide housing, board, and social activities for its undergraduate members, which was "fundamentally different from fraternal organizations such as the Masons."  Also, the legislative history demonstrated that section 501(c)(10) was supposed to cover the Masons, not college fraternities.

Thursday, July 18, 2013

Tax Break for Homemakers Saving for Retirement

On July 12, 2013, the United States Senate discovered that it had passed all legislation needed by the American people and it had some free time.  Accordingly, the Senate decided to pass the Kay Bailey Hutchison Spousal IRA Act unanimously.

The Kay Bailey Hutchison Spousal IRA Act says, in its entirety:
The heading of subsection (c) of section 219 of the Internal Revenue Code of 1986 is
amended by striking "Special Rules for Certain Married Individuals'' and inserting "Kay Bailey Hutchison Spousal IRA''.


In other words, the Act changed a heading of a tax code provision to honor former Senator Kay Bailey Hutchison, Republican Senator from Texas from 1993 to 2003, who is very much alive. 

The Joint Committee on Taxation conducted its research and dutifully concluded [PDF] that the "estimated revenue effect" of the legislation is zero. 

Internal Revenue Code section 219(c) is an interesting provision that was originally enacted in 1976, and substantially revised in 1996 due to the efforts of Ms. Hutchinson, governing contributions to Individual Retirement Accounts (IRA).  Normally, a taxpayer's IRA contribution is limited to his or her earned income for that year from wages and self-employment.  Congress believed "that this was unfair to a spouse who receives no compensation but performs valuable household work," so section 219(c) was amended to allow individuals to contribute to an IRA even if they do not have sufficient earned income, as long as their spouses have sufficient earned income.  

Such an IRA is called a "spousal IRA," though there is no difference between those IRAs and other IRAs. 

For example, assume the compensation incomes of H and W for a year are $700 and $50,000, H and W are married filing jointly, and the IRA contribution limit is $6,000 per person per year.  Section 219(c) allows H to contribute $6,000 to his spousal IRA, even though an unmarried H would be able to contribute only $700, up to his earned income.

The only other tax account named after a person is the Roth IRA, named after William Roth, the Senator from Delaware (1971 to 2001) who sponsored its legislation.

It is unclear whether future legislation will name the alimony tax provision (Internal Revenue Code section 71) after Newt Gingrich.

Monday, July 15, 2013

Tax Break for Making a Little Money with Foreign Currencies

Foreign currencies are treated like any other capital asset, and the currency holder generally recognizes capital gain or loss (in dollar terms) when he converts the foreign currency to dollars.  More importantly, if the foreign currency is used to buy something, the currency holder usually recognizes the unrealized gain or loss in the foreign currency at the time of purchase.

For example, let's say that an American traveler converts US$2 into 2 Canadian dollars.  A week later, when that 2 Canadian dollars is worth US$3, he buys a Coke for 2 Canadian dollars.  The American traveler has US$1 of taxable capital gain at the time of the Coke purchase, because he is treated as exchanging an asset purchased with US$2 for an asset worth US$3.  In contrast, if the Canadian dollar had depreciated, the American would have a capital loss, but the loss would be a personal loss not deductible for tax purposes.  

In order to simply matters a little bit, Internal Revenue Code section 988(e) provides an exception for personal transactions in foreign currencies after 1997.

The taxpayer does not have to recognize foreign currency gain if:
1. The gain is due to changes in exchange rates,
2. The transaction is a personal transaction (i.e., not a business or investment transaction, but transactions on a business trip are considered personal transactions), and
3. The gain is $200 or less.

The $200 limit is determined on a per transaction basis, not per year.  There is little guidance on what constitutes a separate transaction for this purpose.

If the $200 limit is exceeded, then the entire gain (including the first $200 of gain) is subject to US tax.  For example, if someone goes to Europe, converts $2,000 to 2,000 euros, spends half the euros, and converts the 1,000 euros left back to $1,300, that taxpayer might have to pay tax on the $300 of short-term capital gain in the transaction, though there would be zero tax if he converted only 600 euros to $780 at the same exchange rate.

Saturday, July 6, 2013

Not a Tax Loophole: California is Part of the United States

Los-Angeles-based Certified Public Accountant Anthony A. Tiongson discovered a sure-fire tax loophole for his Californian clients:

1. Californian residents earn foreign-source income, based on the fact that California is not part of the United States, and
2. Foreign earned income is not subject to US federal tax.*

While the above argument might have worked in certain parts of Texas, Mr. Tiongson was not able to convince the IRS that (the People's Republic of) California is actually a foreign country.  Accordingly, Mr. Tiongson was "disbarred" in 2013 from ever practicing before the IRS and he can no longer file federal tax returns [pdf].

Mr. Tiongson was popular enough to have filed returns for at least 52 California "foreign residents" from 1998 to 2002, but lately he has not received very good Yelp reviews.

The lesson for taxpayers is that they should only use legitimate tax loopholes as described on this blog, such as the ones for going on a business-related cruise and producing the renewable energy resource that is Indian coal.

*This part is also incorrect.  Foreign income of US citizens and residents are still generally subject to US tax, with some exceptions.

Monday, July 1, 2013

Proposed Tax Break for Broadway and Other Theater

The section 181 tax deduction for the entertainment industry is currently available only for movies and the first 44 episodes of TV shows produced in the United States.  It is not available for porn and other types of performance art.

United States Senator Charles E. Schumer (D-NY) knew a problem when he saw it, and he is proposing to extend the tax deduction to Broadway shows and other forms of live theater.

Mr. Schumer's main concern is that, just like the section 181 tax deduction has successfully stopped American movies and TV shows from being made in other countries, a similar tax deduction is necessary to prevent New York City's Broadway shows from moving to other countries.

Without the extended tax deduction, Broadway patrons in the future might discover that they can save some money, while obtaining nearly the same experience, by watching a telecast (or even time-delayed) production of Les Miserables made in Europe or Evita made in Argentina.  Thousands of stagehand jobs making $422,600 a year would be lost.

Mr. Schumer's proposed legislation is called the STAGE Act of 2013, which appears to be a clever acronym like the USA PATRIOT Act.  His press release unfortunately does not disclose what the acronym stands for.

Given Mr. Schumer's concern about keeping entertainment jobs and dollars in America, presumably he will also extend the tax break to pornography production, in order to prevent the off-shoring of that job-creating strategic American industry to Eastern Europe and South America.  The PORNOGRAPHIC ("Putting Our Resources (National) in Our Generous Research and Providing Hospitality Industry and Culture") Act of 2013 will undoubtedly receive a warm and welcomed reception.

Tuesday, June 25, 2013

Tax Breaks for Americans in Naughty Countries Like North Korea

One lesser-known aspect of the Internal Revenue Code is its use in furthering America's foreign policy by denying certain tax benefits to US persons operating in the Axis of Evil and other bad countries.  For vague reasons, the Internal Revenue Code has two separate lists of disapproved countries, and some countries are allowed certain tax benefits but not other benefits. 

For example, the first list penalizes US companies who do business in North Korea by denying them foreign tax credits, but the second list fortunately allows American citizens living and working in North Korea to exclude up to ~$100,000 of their North Korean wages from being taxed by the United States. 

List #1
Albania was on the first list until 1991.
US taxpayers are normally allowed to claim foreign tax credits for paying taxes to foreign countries, except for any countries on a list prescribed by Internal Revenue Code section 901(j).  As a result, American individuals and businesses cannot offset their US tax liability dollar-for-dollar by taxes paid to these countries, though they can still deduct the taxes as a business expense. 

The naughty countries are:
Cuba
Iran
North Korea
Sudan
Syria

Iraq and Libya were most recently removed from the list in 2004.  The list also once included Afghanistan, Albania, Angola, Cambodia, South Africa, Vietnam, and the former South Yemen.

(Though the list began in 1987, poor Albania was the only Warsaw Pact country to ever be on the list.)

The US tax on income earned in the first list's countries cannot be offset by foreign taxes paid to that country, nor by other foreign taxes paid to other countries not on the list.  Furthermore, US persons are subject to US tax on their income from corporate subsidiaries operating in those countries, even though the income might be deferred under normal tax rules.  The result is that the income from those countries is generally subject to US tax no matter what.  Apple's tax-sheltering Irish subsidiary would not have worked as a North Korean subsidiary. 

List #2
An entirely separate list of naughty countries is prescribed by Internal Revenue Code section 911(d)(8).  US citizens and resident aliens who work in foreign countries are normally allowed to receive tax-free up to ~$100,000 of foreign wages and other earned income.  But this "foreign earned income exclusion" is denied if the US person works in a country on the second list.

The second list of naughty countries is:
Cuba

That is all.

Libya and Iraq were the only other countries on the second list, and they were removed from the second list in 2004.

Friday, June 21, 2013

Tax Break for Working Abroad on a Yacht Full-Time

US citizens and resident aliens (such as green card holders) living abroad are subject to US tax on all of their worldwide income.  One relatively well-known exception is the foreign earned income exclusion, which allows a qualifying taxpayer to exclude up to $97,600 (in 2013) of earned income from taxable income.

The requirements for earning the $97,600 (adjusted annually for inflation) tax-free are:
1. The income must be earned income, such as wages or commissions, not a pension or other deferred compensation, and not received as an employee of the US government,
2. The person's principal place of business (his "tax home") is in a foreign country, and
3. during any period of 12 consecutive months, the person is present in a foreign country or countries during at least 330 full days in such period (or alternatively is a "bona fide resident" of a foreign country or countries, which is a complicated topic not discussed in this post).
4. The person does not live in a naughty country, which current includes only Cuba (the list was last updated in 2004 to remove Libya and Iraq). 

If a couple is working abroad, both spouses may exclude up to $97,600 of their separate salaries. 

In the landmark 2007 case of Struck v. Commissioner, the Tax Court concluded that yacht employees could claim the foreign earned income exclusion for their yacht-related salaries when the yachts were operating outside the United States.  

Mr. Myron Struck was employed full-time from 1975 to 2002 as a yacht captain for owners of private yachts.  His wife Thelma was employed on the yachts as a chef and stewardess.  They lived on the yachts, which operated primarily in foreign territorial waters, except when they took around two weeks of vacation in the United States each year.

The Tax Court concluded that the Strucks' tax home / principal place of business was on the yacht, since they did not have a regular office or other business location.  Therefore, they satisfied the requirement that their principal place of business be in a foreign country. 

The Tax Court also concluded that the Strucks spent over 330 days each year in foreign countries.  Notably, the Strucks did not have to spend all of the time in one country; they qualified by spending the 330 days in the territorial waters of multiple countries.  While time spent in international waters generally does not count as time spent in a foreign country, a day of travel in international waters from one foreign country to another foreign country is treated as a day in a foreign country.

Tuesday, June 18, 2013

Mining Bitcoins: A Taxable Event?

Bitcoins is an open source virtual currency that was developed in 2009 by an anonymous programmer.  Unlike dollars and other fiat currencies, bitcoins are not issued by any central government, but are instead "mined" by its users. 

Generally speaking, bitcoin miners download free software to solve complex equations that verify bitcoin transactions. When a miner’s computer solves an equation, the bitcoin network accepts the transactions as valid and creates 25 new bitcoins and awards them to the successful miner.  Around 11 million bitcoins have been mined, and there will be a maximum of 21 million bitcoins in circulation ever. In addition to mining new bitcoins, one can acquire existing bitcoins by purchasing them on third-party exchanges or accepting them as gifts or payments for goods or services.

It is fairly clear that when bitcoins are exchanged into dollars, the user has a taxable event to the extent that he (bitcoin users are 96% male) has gain from the transaction.  Likewise, someone who sells goods or services in exchange for bitcoins are subject to tax, in a manner no different than if he were paid in euros or chickens

A more difficult question is whether the bitcoin miner has taxable income at the moment when he receives the 25 newly mined bitcoins for solving the equations.  The United States Government Accountability Office (GAO), in a May 2013 report entitled Virtual Economics and Currencies [pdf], made the following statement:
 Bill is a bitcoin miner. He successfully mines 25 bitcoins. Bill may have earned taxable income from his mining activities.

The GAO provided no legal rationale for its statement, but it is probably based on the idea that Bill is being compensated for providing a service and that income is generally taxable unless a specific exception applies.  There is also some tax law stating that found treasure is taxable when it is discovered, even if the discoverer never sells the treasure for cash.  Treasury Regulation 1.61-14(a) provides that "Treasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession."

Even if bitcoin mining is a taxable event, the bitcoin miner can deduct an allocable share of his expenses from mining the bitcoins, such as the cost of the mining equipment and the electricity costs.

In comparison, small business miners of minerals generally do not have taxable income until they sell the mined products.  But the IRS will probably not be persuaded that bitcoin mining should be treated like gold mining.

A related issue is the Report of Foreign Bank and Financial Accounts (FBAR), which must be filed by all US persons with over $10,000 at any time during the year in foreign financial accounts, which includes securities accounts and commodities accounts.  If the US person transferred over $10,000 worth of bitcoins to a foreign bitcoin exchange, such as the Magic the Gathering Online Exchange based in Japan (and not an American branch of Mt. Gox), even for a brief moment, the person might have to fill out the FBAR and send it to the Department of the Treasury.  The penalties for not filing the FBAR can be especially severe. 

Thursday, June 13, 2013

Tax Credit for Energy-Efficient Mobile Homes

The Internal Revenue Code provides a tax credit to developers and construction contractors who build energy-efficient residential houses.  A tax credit is also provided to the manufacturers of energy-efficient mobile homes (manufactured homes), which happens to be more generous than the credit for non-mobile homes.

Internal Revenue Code section 45L generally  provides a tax credit of $2,000 for a home with annual heating and cooling costs that is 50% less than a comparable dwelling.*

If a mobile home achieves only a 30% energy savings, the credit is reduced to $1,000. But no credit is allowed for a non-mobile home with 30% energy savings.

The credit is claimed by the seller (the developer or contractor), not the buyer.  The home can be a newly built home, or a substantially reconstructed or renovated home, as long as the home is sold to someone as a residence.  The buyer can use the home as a secondary or vacation residence. 

The credit was originally enacted in 2005 to apply only to homes sold in 2006 and 2007, but it has been extended several times since then, most recently to apply to homes sold through the end of 2013 as part of the urgently needed sequester tax legislation.  It is unclear whether a $2,000 tax credit was necessary to stimulate the sale of new homes (median sales price ~$250,000) during the housing boom.  Congress in 2005 noted that there was no tax credit for the construction of energy-efficient homes, and naturally therefore one should be created.

* Technically, the comparable dwelling has to be constructed in accordance with the standards of chapter 4 of the 2006 International Energy Conservation Code, as such Code (including supplements) is in effect on January 1, 2006, and for which the heating and cooling equipment efficiencies correspond to the minimum allowed under the regulations established by the Department of Energy pursuant to the National Appliance Energy Conservation Act of 1987 and in effect at the time of completion of construction.

Friday, June 7, 2013

Capital Gains Rates in Various European Countries

The chart below, from the Internet, shows the capital gains rates for various European countries in stark contrast.  It ranges from no tax ("pas d'impot") in the Netherlands, to a two tier 22%/26% rate in Germany, to a highly complicated looping flowchart that calculates the rate for France. 

The capital gains rates in the United States are similarly complicated:
1. 15% for long-term capital gains, but 20% for high-income households
2. up to 40% for short-term capital gains
3. 28% for gains on collectibles
4. 25% for certain gains on real estate
5. 0% for certain exempt gains, such as gains from the sale of a principal residence and capital gains for low-income households (but not their collectible gains)
6. 0% or 7% or 14% for gains from the sale of small business stock, depending on when the small business was formed





Tuesday, June 4, 2013

Tax Break for Foreign Art Collectors

Nonresident aliens are subject to the US estate tax on the value of their assets located in the United States when they die.  For example, a nonresident alien decedent who put some cash in an American safety deposit box would be taxed on the value of the funds (Rev. Rul. 55-143).

But fortunately for foreigners who are art collectors, Internal Revenue Code section 2105(c) provides that works of art are not considered be in the United States if such works of art are—  
(1) imported into the United States solely for exhibition purposes,
(2) loaned for such purposes, to a non-profit public gallery or museum, and
(3) on exhibition, or en route to or from exhibition, in such a public gallery or museum, at the time of the death of the owner.

Before 1950, all art located in the United States were subject to the federal estate tax, with a top tax rate of 77%.  Multimillionaire Armenian oil mogul and art collector Calouste Gulbenkian had a number of old master paintings on temporary loan to the National Gallery of Art.  Gulbenkian became increasingly concerned about dying and paying the US estate tax on the loaned works, despite the fact that he was a spry 80-years-young at the time.  He made some phone calls, and the trustee of the National Gallery of Art personally asked Congress to change the estate tax law.

Congress sprang into action and on September 1, 1950, it passed Public Law 81-749, which specifically exempted art works loaned by foreigners to the National Gallery of Art from federal and DC estate taxes.

A few months later, Congress realized that the rule did not have to be so specific to one institution.  In the Revenue Act of 1951, the exemption was expanded to apply to all art loaned by foreigners to any non-profit public gallery or museum.

Gulbenkian died in 1955 with a fortune of between $200 million and $800 million.

Monday, May 20, 2013

Tax Break for Retirees and Widows Moving Back to the United States

Internal Revenue Code section 217 allows all taxpayers to deduct their moving expenses, but only if they are moving for a new job.  As described previously, there are additional moving tax breaks for American moving abroad.

Once the taxpayer has moved abroad, Internal Revenue Code section 217(i) provides even more special tax breaks.  The taxpayer can deduct his moving expenses for moving back to the United States for retirement, notwithstanding the normal requirement that a tax-deductible move has to be for a new job.

The retirement has to be a "bona fide retirement" under which the taxpayer intends to permanently stop working, but it is okay if the taxpayer ultimately resumes gainful full-time employment. 

Furthermore, if someone dies while working abroad, his spouse and dependents can deduct their expenses for moving back to the United States, as long as they move within 6 months of the death. This rule does not apply if someone dies in the United States and their spouse and dependents move afterwards.

In contrast, someone who moves within the United States because of retirement or death of a family member is not allowed to deduct any moving expenses, unless a new job happens to be at the new location.

Monday, April 29, 2013

Tax Break for Moving Abroad for Work

A taxpayer can generally deduct moving expenses if he or she is moving for a new job more than 50 miles away and that lasts more than ten months.  This deduction is a very beneficial "above-the-line" deduction that is unlimited in amount and does not require the taxpayer to itemize deductions.  For most taxpayers, the deductible costs are the costs of travel (including lodging, but not meals) and of moving household items. 

But Internal Revenue Code section 217(h) provides that for a taxpayer who is moving to work outside the United States (a "foreign move"), the deductible costs also include the costs of storing items and of moving items in and out of storage. 

The typical "foreign move" is from the United States to a foreign country, but the tax break is also available for moves within a foreign country, or from one foreign country to another foreign country.  In contrast, a move from a foreign country back to the United States does not count, nor does a move from Georgia to Hawaii in 1987 count (someone unsuccessfully tried that argument).  As a result, someone who moves for a new job within the United States cannot deduct storage costs, while someone abroad can deduct an unlimited amount of such storage costs.

The extra deduction for foreign moves was added by the Tax Treatment Extension Act of 1977, which was a bit of a misnomer since it (a) contained a large number of newly created tax benefits for Americans living abroad and (b) was enacted on November 8, 1978.  At the time, section 217(h) did not draw much attention because very few Americans moved abroad and the moving expenses deduction had a total monetary cap, but those facts have changed.


Monday, April 22, 2013

Tax Loophole for Non-Profit Organizations Running Bingo

A teenager was arrested earlier this year for yelling a fake "bingo" at a Cincinnati bingo hall.  “At first, everybody started moaning and groaning when they thought they’d lost,” Police Sergeant Richard Webster said. “When they realized it wasn’t a real bingo, they started hooting and hollering and yelling and cussing. People take their bingo very seriously.” 

The Internal Revenue Code also takes bingo very seriously.

Tax-exempt 501(c) non-profit organizations are subject to federal income tax if they engage in certain commercial activities (so-called "unrelated trades or businesses").  Internal Revenue Code section 513(f) provides that the term “unrelated trade or business” does not include "any trade or business which consists of conducting bingo games."

Likewise, section 527 organizations are formed to raise funds for political campaigns.  They are allowed to receive tax-free contributions of money, membership dues, political fundraising proceeds, and (naturally) the "proceeds from the conducting of any bingo game."

In order to clear up any confusion about what constitutes "bingo games,"  the statute provides that the term "bingo game" means any "game of bingo," of a type in which usually,
1. the wagers are placed,
2. the winners are determined, and
3. and the distribution of prizes or other property is made, in the presence of all persons placing wagers in such game (i.e., no Internet bingo).

The games cannot violate any State or local law, and the tax-exempt organization must not conduct the games as ordinarily on a commercial basis.

The definition of "bingo" has been a hotbed of litigation by many non-profit organizations.

Waco Lodge No. 166, Benevolent & Protective Order of Elks had to pay federal income tax on its weekly bingo earnings because it could not use the section 513(f) exception, since bingo was illegal under local Texas law.

The Julius M. Israel Lodge of B'nai B'rith No. 2113 learned that its "Instant Bingo" did not count as bingo, because bingo requires the players to "place markets over randomly called numbers in an attempt to form a preselected pattern."  Instant Bingo provided the players with pre-made cards with pre-determined arrangements, and were no different from lotteries.  The Fifth Circuit noted the crucial distinction that: "Instant Bingo involves no random selection of numbers by a caller, nor does it require the player to participate in the game by covering the squares on his card that correspond to randomly drawn numbers."

Dayton, Ohio-based Help the Children, Inc. lost its tax-exempt status because its principal activity was the operation of bingo games (and a soda bar).

The bingo exception was enacted in 1978, but effective retroactively from 1970.  Pup Tent No. 14 Military Order of the Cootie of the United States had paid taxes on its 1971 and 1972 bingo earnings, but it discovered that it was not allowed a refund due to the statute of limitations.  The retroactive effect benefited only the non-profit organizations that were not as law-abiding and who did not pay taxes on their bingo earnings in the first place.

Tuesday, April 16, 2013

Tax Credit for Mine Rescue Training



Internal Revenue Code section 45N provides a lucrative tax credit for American mining companies to train their employees in mine rescue operations.  

The tax credit is equal to 20% of the training costs of the employee, up to $10,000 of credits per employee each year.   

The employee should complete a 20-hour initial training course or a 40-hour refresher course in mine rescue during the year.  Congress did not explain why the "refresher" course has to be longer than the initial training course.

Tax credits are normally provided to encourage taxpayers to do things that they would otherwise be reluctant to do (hire summer teenagers, guard agricultural chemicals, buy homes in 2009-2010).  It is not clear why a special tax credit is necessary for a class in rescue operations, given the bad publicity usually associated with unrescued miners.  The credit is not available to companies operating mines only outside the United States.

The Internal Revenue Code does not contain special tax incentives for checking the brakes on school buses, cleaning aircraft engines, and other safety-related tasks in other industries.

The mine safety tax credit was enacted in late 2006 by the Tax Relief and Health Care Act, by a Congress eager to show that the can do something after the Sago Mine disaster earlier that year.  The credit originally expired after three years, but the credit has been continually extended (most recently through December 31, 2013).

No tax deduction is permitted for the 20% of training costs allowed as a credit.  The remaining 80% of training costs are fully deductible, which provides an even greater tax benefit for training mine employees in rescue operations.  

Monday, April 15, 2013

Tax Credit for Guarding Agricultural Chemicals

The Internal Revenue Code provided a tax credit for certain companies to guard their agricultural chemicals, but this credit expired at the end of 2012.  It is too early to tell whether the failure of the sequester tax legislation to extend this credit will lead to a rash of disasters resulting from unsecured chemicals.

Specifically, the Heartland, Habitat, Harvest, and Horticulture (4-H) Act of 2008 created an "agricultural chemicals security credit" equal to 30% of the cost of certain security expenditures paid between May 22, 2008 and December 31, 2012.

The credit is allowed only to an "eligible agricultural business" engaged in selling agricultural products at retail to farmers and ranchers, or engaged in manufacturing, distributing, or aerially applying agricultural chemicals. It is not allowed to farmers and ranchers in general for securing their own agricultural chemicals. 

The eligible agricultural business is entitled to a tax credit equal to 30% of its expenditures to protect certain agricultural chemicals, including for employee security training and background checks, access controls, perimeter protection with security lighting and other equipment, and implementation of computer security measures.  The expenditures must be used to protect certain hazardous chemicals, pesticides, and fertilizers. 

The maximum credit allowed for each facility is $100,000 over every five years, but each taxpayer may claim up to $2 million of the credits each year for all of the taxpayer's facilities.

Wednesday, April 10, 2013

Tax Credit for Wood-Burning Stoves

Humans have burned wood for warmth for several millennia.  In order for Americans to boldly catch up to the 18th century wood-burning technology of the Amish people, the Internal Revenue Code provides a tax credit of up to $300 for wood-burning stoves used in people's homes. 

Specifically, Internal Revenue Code section 25C provides a tax credit of up to $300 for the purchase of any "energy-efficient building property," which includes "a stove which uses the burning of biomass fuel to heat a dwelling unit located in the United States and used as a residence by the taxpayer, or to heat water for use in such a dwelling unit, and which has a thermal efficiency rating of at least 75 percent."  It is one of several credits for renewable energy used at home, since wood is renewable in the sense that the trees grow back after 30-60 years.

Biomass fuel is any plant-derived fuel, such as trees, wood pellets, and plants (including aquatic plants). In order to deter any smarty-pants who claims that coal is plant-derived, the fuel must be "available on a renewable or recurring basis."

The tax credit does not apply to electric heaters made out of wood in order to look Amish.

The wood-burning stove tax credit originally expired at the end of 2011, but it was extended to apply to property placed in service in 2012 (retroactively) and through the end of 2013 as part of the urgently needed sequester tax legislation.

The section 25C tax credit when enacted in 2005 originally applied only to energy-efficient natural gas boilers, geothermal heaters, air conditioners, etc.  The Emergency Economic Stabilization Act of 2008 expanded the qualifying property to include certain wood-burning stoves purchased through the end of 2009.  Congress encouraged the burning of wood in order to reduce America's reliance on foreign oil and reduce pollution in general, though it is not clear how burning wood is cleaner than burning wood-derived fossil fuels.  The credit has been extended several times since then.

Tuesday, April 2, 2013

Tax Credit for the Renewable Energy of Indian Coal

Internal Revenue Code section 45 provides a tax credit for various renewable energy resources, including wind power, geothermal power, solar power, hydroelectric, biomass, and ... the production of Indian coal.

Specifically, the owner of an "Indian coal production facility" receives a tax credit of $1.50 per ton of "Indian coal" produced from 2006 to 2009, and a credit of over $2 per ton of "Indian coal" produced from 2010 to 2013.  The $1.50 and $2 amounts are further increased for inflation.

The Indian coal renewable energy credit originally expired at the end of 2012, but it was extended through 2013 as part of the urgently needed fiscal cliff legislation enacted on January 2, 2013.

"Indian coal" is defined as coal produced from reserves that were owned by an Indian tribe on the very specific date of June 14, 2005. 

An "Indian coal production facility" is any facility that produced coal before 2009.  The facility's owners, who are entitled to receive the tax credit, are not required to be ethnically Indian, either tribal or subcontinental. The Indian coal must be sold to a buyer unrelated to the facility owner.

Coal owned by Indian individuals are not considered renewable energy and do not qualify for this tax credit, nor does coal merely mined by Indians.

The tax credit for Indian coal was enacted by the Energy Tax Incentives Act of 2005 to originally apply for the seven years from 2006 to 2012.  It was introduced as a separate stand-alone tax credit, but the Conference Committee made it part of the renewable energy tax credits.  Congress did not explain how Indian coal was more renewable than other forms of coal.

For no apparent reason, the Indian coal renewable energy credit may reduce the alternative minimum tax (AMT) for the first four years, but not during the later years. 

Thursday, March 28, 2013

Tax Break for Low-Income Artists and Musicians

The front page of Form 1040 contains a deduction line for "certain business expenses of performance artists."  Many actors and musicians get excited about this tax break until they read the fine print on page 4 of the instructions to Form 2106 (which they do not have to file for this tax break).

The special deduction is only useful for performance artists who receive a W-2 as an employee.
Freelancers and independent contractors (who receive Form 1099s) are always entitled to deduct all business expenses on Schedule C, so they do not need to use this special deduction.

Internal Revenue Code section 62(b) provides that a performance artist-employee may take the special deduction only if:
1) He or she worked as an employee for at least two employers (who each paid the artist $200 or more during the year),
2) The expenses being deducted are more than 10% of the income from performance art, and
3) His or her total adjusted gross income is less than $16,000.

The $16,000 income threshold includes income from all sources, not just the performance art.  If the artist is married, the couple's combined income must be less than $16,000. 

Even if a starving artist qualifies for the deduction, it does not provide a particularly large benefit since people do not pay a lot of federal income taxes when they make less than $16,000 a year, thanks to the standard deduction, the earned income tax credit, the credit for small business low sulfur diesel refining, and other tax benefits.

The $16,000 threshold was fixed when the deduction was added in 1986, when the median household income was around $23,000 and when the median artist income was a little lower, and it has never been adjusted for inflation.

Tuesday, March 26, 2013

Tax Break for Employee Discounts


When an employer gives something for free to its employee, like an apartment or a car, that item is treated as taxable compensation to the employee.  But what about employee discounts?

Internal Revenue Code section 132(c) provides that employee discounts is not taxable compensation, up to a limit:
1. the employer can sell goods at cost to its employees, and
2. the employer can provide services to its employees at up to 20% discount from the regular prices.

The employer must be selling the goods or services to general customers.  For example, a Ford dealership can sell a Ford car at cost to any of its employees without generating taxable income, while a Macy's that sells a car at an employee discount would result in taxable income to the employee-buyer.

Anything above the limit is taxable income to the employee.  The fact that goods can be sold at cost is of great relief to anyone who works in a clothing retailer, where the store markup is usually more than 20%. 

The tax-free benefit does not apply to discounts offered to employees of another company  Thanks to vigorous lobbying from department stores, a special rule provides that a department store can lease counter space to other companies (like cosmetics firms), and those separate companies' employees can receive the department stores' "employee" discounts (and vice versa).

When the fringe benefit rules were added in 1984, the employee discount can be provided to an employee or a retired employee, or their spouses, dependent children, and certain widows.  A very special rule was quickly added in 1986 to provide that parents can also receive employee discounts, but only for an employee in the airline industry. 

Tax-free employee discounts are not limited to retail workers, though they do not apply to real property or investment property.  A company like Boeing could sell its $150 million airplanes to its assembly line workers at cost, if it were so inclined, but more commonly appliance manufacturers sometimes arrange for their employees to get discounts on their products. 

Wednesday, March 20, 2013

Tax Loophole for the Non-Profit Organization that is the National Football League (NFL)

In 2010, the National Football League (NFL) earned $184,299,577 in revenues, on which it paid no income taxes.   Its highest paid employee is Steve Bornstein (Executive Vice President of Media), who earned $12.2 million that year from the NFL and related organizations.  NFL Commissioner Roger Goodell was paid $11.5 million.  Former NFL Commissioner Paul Tagliabue received $1 million in salary and $7.6 million in other compensation, which is not bad for someone who left the job in 2006.

The public has knowledge of the above because the National Football League files a Form 990 (Return of Organization Exempt from Income Tax) every year, just like Harvard University, the New York Public Library, and other tax-exempt organizations.

Internal Revenue Code section 501(c)(6) provides that tax-exempt organizations include "Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual."

It should be noted that amateur football leagues are not covered by the tax-exemption, nor do associations for other sports, but they may qualify for the general tax exemption for charitable and educational organizations under section 501(c)(3).

An individual cannot claim a payment to the NFL as a tax-deductible charitable contribution, which are governed by different rules in section 170, but most payments by the teams to the NFL are deductible as business expenses. 

The NFL obtained tax-exempt status from the IRS in 1942 (the original IRS filing has been lost), but section 501(c)(6) was modified to specifically include all professional football leagues in 1966 by Public Law 89-800 ("An act to suspend the investment credit and the allowance of accelerated depreciation in the case of certain real property").  After the House and the Senate both passed a bill concerning the investment credit and accelerated depreciation, the Conference Committee decided to add an extra provision for professional football leagues.  The Conference Committee was concerned that the NFL's pension plan would otherwise be considered as benefiting a private individual. 

The Conference Committee also helpfully amended the antitrust statute to provide that antitrust laws would not apply to the 1966 merger of the NFL and the AFL, though they might apply to future mergers in football and other professional sports. 

Tax-exempt organizations are generally subject to federal income tax for conducting commercial activities.  The Conference Committee tried to add an exception for the NFL's "income derived from promoting or sponsoring any professional football game if such promotion or sponsorship does not occur more than four times during the taxable year with respect to any team," but that proved even too much for the House and it was not included in the final legislation.

Monday, March 18, 2013

Tax Break for Traveling First Class, by Ship

Christopher Columbus on speed boat.
People traveling by air for business reasons can deduct the costs of their plane tickets, even if (and especially if) the tickets are for first class travel.  When the employer is paying for the tickets, the employer can deduct the costs, and the employee receives a tax-free ticket.  But what about even more luxurious business travel, by cruise ships and oceanliners?

Ocean travel for business purposes is deductible, but Internal Revenue Code section 274(m) imposes an upper limit on the deductible amount, of around $734 per day for fall and winter travel and $624 per day for spring and summer travel.  The maximum allowed deduction is technically defined as twice the daily per diem amount allowed for federal executive branch employees.

For example, let's say that a lawyer traveled by ocean liner from New York to London on business in October of 2012.  The trip took six days.  Her maximum deduction for the travel costs is $4,404 for the business expense (6 x $734). 

This deduction for "luxury water transportation" is solely for traveling from one location to another by ship for business purposes.  If the business purpose for the travel is on the boat itself, like a convention, other limitations apply.