TIGTA Report – IRS Needs Better Strategy for Obamacare Medical Device Tax

A new report released today by the Treasury Inspector General for Tax Administration (TIGTA) says that the IRS needs to improve its strategy for ensuring accurate reporting and payment of the Medical Device Excise Tax that is included in the Affordable Care Act.

Apart from all the tax credits and other tax law changes included in the ACA, the most controversial one is perhaps the Medical Device Excise Tax.

This is an excise tax of 2.3 percent of the sales price for medical devices sold starting from January 1, 2013.

Manufacturers, producers and importers of medical device goods are now responsible for collecting the tax and filing Form 720 as their quarterly federal excise tax return.

Estimated revenues from this tax were pegged at $20 billion for the period from fiscal year 2015 to 2019.

TIGTA’s review found the number of forms 720 filed and the amount of revenue reported were much lower than expected.

TIGTA’s analysis of 5,107 forms 720 that were processed for the first half of 2013 identified discrepancies totaling almost $117.8 million compared to what the IRS toted up from the forms.

TIGTA says the IRS is trying to come up with a compliance strategy for this tax, but the agency is apparently still unable to identify the medical device manufacturers registered with the Food and Drug Administration who need to file Form 720 and pay the medical device excise tax.

“While the IRS has taken steps to educate medical device manufacturers of the medical device excise tax during implementation, it faces challenges to definitively identify manufacturers subject to the medical device excise tax reporting and payment requirements,” said J. Russell George, Treasury Inspector General for Tax Administration.

As if identifying the companies that need to pay the tax wasn’t hard enough, the agency went ahead and stiffed $706,753 out of businesses through 219 failure-to-deposit penalties for the first six months of 2013, which was supposed to be a designated penalty relief period.

The IRS then backtracked on 133 of these penalty assessments, but left the others stand. When TIGTA notified the IRS about the remaining 86 penalty assessments, they were also reversed and the IRS wrote them apology letters.

TIGTA included several recommendations in the report for the IRS, including that the agency continue refining its compliance strategy for identifying noncompliant manufacturers, establish a process for verifying the tax amount for paper-filed Forms 720, and initiate correspondence with taxpayers for obtaining missing taxable sales or tax amounts.

The IRS agrees with TIGTA’s recommendations, and is planning to develop alternative strategies for identifying the medical device makers and ensuring compliance and payment of the medical device excise tax.

Read the full TIGTA report – Download (pdf)

Photo credit - will1ill/flickr

Senate Moves Towards Agreement on Inversion Tax Law

The U.S. Senate is moving towards a bipartisan agreement that would allow passage of a tax law to close the loopholes that allow corporate inversions.

Sen. Ron Wyden, chairman of the Senate Finance Committee, is reported to be negotiating over bipartisan legislation that could be introduced as early as next month.

Sen. Wyden is said to be working on the inversion tax law with Sen. Orrin Hatch, who is the ranking minority member on the committee.

Sen. Wyden has also consulted on the issue with Sen. Chuck Schumer, who just released his own proposal for dealing with companies who move their official headquarters registration overseas while leaving the rest of their operations in the U.S. intact.

According to Sen. Schumer’s proposal, the deductible interest for companies who opt for inversions would be reduced from 50 percent to 25 percent. The proposal would additionally limit these companies’ ability to carry forward deductions to future years, and would require them to seek IRS approval for transactions between the foreign and domestic parts of the company.

This would put a stop to the foreign part of the company lending money to the domestic part, which could then claim a deduction on the interest.

Sen. Schumer’s proposal is one of several such proposals floating around that would place severe restrictions on the net benefits available to a company that merges with a smaller overseas company and shifts its headquarters to the other company’s overseas address in order to save on their U.S. tax bill.

Sen. Carl Levin has introduced a proposal that would require the foreign company to own at least 50 percent of the merged entity in order to be considered as a foreign company that could avoid U.S. taxes, as opposed to the existing 20 percent.

But most of the proposed bills are considered to be overly restrictive by the business lobby and have no bipartisan support and little chance of getting through the Senate, and absolutely no chance of being approved by the House.

That makes Sen. Wyden’s intent to proceed with bipartisan legislation the only realistic solution being proposed at the moment. It may be quite watered down at the end of the day, but it should still be enough to make inversions less beneficial and a lot more expensive and burdensome to push through.

The key question now is how soon it can be passed by the Senate and then approved by the House. Treasury Sec. Jacob Lew is already on record as saying that Congress should consider approving a stop-gap arrangement to stop inversions that would be retroactively applicable for inversions going back to May 2014.

This could be another sticking point in the negotiations. If they don’t plan on making it retroactive, there will be a rush towards the exits to complete inversions before the law becomes applicable, and it would then be more of a stable door being closed after the horse has bolted to more tax-friendly pastures.

Photo credit - Allison Harger/Flickr

US Expats in Canada Sue Canadian Govt Over FATCA

FATCA is one of the most far reaching tax laws to be passed in recent years and implemented with a global impact that could end up changing the entire world’s taxation system.

It’s definitely a very powerful and effective tool for the IRS to collect taxes on the overseas assets and income of U.S. citizens parked in opaque banking systems such as those in Switzerland.

On the other hand, it’s a pain in the neck for countries like Canada which don’t have anything to hide other than a large numbers of U.S. expats with dual citizenship.  

Canada has more than a million residents who are also U.S. citizens, and their FATCA inter-governmental agreement with the U.S. that forces banks to share these residents’ banking information is causing a lot of angst north of the border.

The five largest banks in Canada have been forced to spend around $687 million to ensure FATCA compliance.

It’s causing a large number of varied problems to Canadians holding dual citizenship, and has led to a flood of people renouncing their U.S. citizenship rather than face IRS scrutiny.

In a bid to get the Canadian Government to back off from the agreement, a group called the Alliance for the Defence of Canadian Sovereignty is backing a lawsuit filed against the Government of Canada by plaintiffs Virginia Hillis, 68 and Gwendolyn Louise Deegan, 52.

They claim that the FATCA agreement the government has entered into with the U.S. is in violation of the Canadian Constitution and violates their rights under the Charter Of Rights And Freedoms.

Both plaintiffs were born in the U.S. but have lived in Canada since childhood. They have never worked or filed taxes in the U.S., and neither of them holds a U.S. passport.

The organization explains the issue nicely and in detail on their website, but many of the people they represent aren’t quite as diplomatic.

Here’s what one retiree from Alberta is quoted as saying - “I CHOSE to be a Canadian. I CHOSE to raise my family in Canada. I detest having myself or my children, born and raised in Canada, being referred to as ‘a US citizen residing in Canada’ or ‘a US taxpayer residing in Canada’… Is the Canadian Charter of Rights and Freedoms a worthless rag that we have been lulled into believing protects ALL Canadians?”

The lawsuit filed in the Federal Court of Canada in Vancouver (docket number F173614) earlier this week is costing the Alliance a huge amount of money. They need to raise and spend $400,000 CAD over the next year to pay for the legal costs just for getting the case through this first court.

This doesn’t include their organizational costs and the future expenses associated with the likely appeals process in the Federal Court of Appeal and then the Supreme Court of Canada.  

Photo credit – adcs-adsc.ca

Utah Resident Robert Redford Takes NY Double Taxation to Court

The Sundance Kid as a tax outlaw? Robert Redford is taking on New York State over a constitutional issue of double taxation related to the sale of the Sundance Channel in 2005.

Redford, an Utah resident, has filed suit in the Albany County Supreme Court against the New York State Department of Taxation and Finance.

According to Courthouse News, New York is seeking to recover $1,568,470 from Robert Redford, which includes $845,066 in taxes and $727,404 in interest.

In 2005, Robert Redford wholly owned Sundance T.V., which had an 85.5 percent stake in Sundance Television Limited, an S Corporation. Sundance Television Limited in turn owned a 20 percent stake in the Sundance Channel LLC.

Of these three entities, only the Sundance Channel LLC is headquartered in New York and has operations in the state.

Neither Sundance T.V. nor Sundance Television Limited has an office in New York State. They don’t directly employ anyone in the state, and have no payroll, property or receipts that can be labeled as being part of a trade or business within New York State.

In 2005, in Sundance Television Limited sold a part of its stake in Sundance Channel LLC to an unrelated third party.

Being an S Corporation, the gain from the sale was passed through to the owners, which included Robert Redford through Sundance T.V.  Redford declared the gain and paid tax on it Utah.

In 2008, the remaining stake in the channel was again sold to Cablevision’s Rainbow Media, and once again the gain was reported as income not sourced from New York and therefore not subject to NY state income tax.

This time, the NY State Department of Taxation actually reviewed the transaction and accepted Redford’s filing position in his NY state tax filings that the gain from the sale was not subject to NY state tax.

But now in May 2014, the Department notified Redford about his unpaid tax liability of $845,066 for the 2005 sale, topped off with $727,404 in interest.

On July 30, Redford filed suit against the assessment. In the complaint, he notes it is a question of law, and claims the assessment of personal income tax on a non-resident for gains from the sale of an ownership interest in an LLC is not consistent with the constitution of New York State.

Although one could sympathize for New York losing out on the tax to Utah, this ultimately boils down to double taxation. If he’s already paid state income tax in Utah on the gains for both the 2005 and 2008 deals, the courts should be able to favor the plaintiff and grant the declaratory judgment Redford is seeking that clears him of the tax liability.

Photo credit -  Castles, Capes & Clones/Flickr

Walgreens Blinks First – No Tax Inversion in Alliance Boots Deal

Walgreen Company (NYSE:WAG) has dropped the plan to include a tax inversion in their merger with European drugstore chain Alliance Boots GmbH.

Had they gone ahead with the inversion, the registered headquarters of the new merged entity would have been in Switzerland, which would have reduced Walgreen Co’s tax bill over the next five years by around $4 billion.

However, the public outcry and the intense pressure from Congress, the President and the media forced Walgreens to back off.

The company will announce today that the merger will be completed without the inversion. Back in 2012, Walgreens bought a 45 percent equity stake in Alliance Boots for about $6.7 billion, and has an option to acquire the remaining 55 percent next year before Aug 2015.

Under the terms of the original deal finalized in 2012, Walgreens would have had to pony up around $16 billion for the full acquisition of Alliance Boots.

The deal, minus the inversion, is worth considerably less to Walgreens. It still makes Walgreen Co the world’s biggest pharmaceutical wholesale firm that will be truly global with its headquarters and more than 8,190 drugstores in the U.S., and significant operations across the pond in Europe.

Alliance Boots has a presence in more than 25 countries, and has pharmacy-led health and beauty retail businesses in nine countries. The company operates more than 3,100 health and beauty retail stores, 605 optical practices and around 390 hearing-care practices.

Alliance Boots’ pharmaceutical wholesale businesses delivers over 4.6 billion units each year to more than 170,000 pharmacies, doctors, health centers and hospitals in 20 countries.

The Walgreen tax inversion saga may be over and done with, but the federal government is already on a roll now.

Congress is considering changes to the tax law that would close the loop hole and make it impossible to shift your headquarters overseas on paper while continuing to run your business as before in and from the U.S.

Meanwhile, the Treasury and IRS are considering going ahead with changes without waiting for Congress.

One possibility is to section 7874 of the Internal Revenue Code. This section was added to the code under the American Jobs Creation Act of 2004.

Section 7874 obviously hasn’t been able to prevent inversions, but the law does empower the IRS and Treasury to write regulations that will be able to “to prevent the avoidance of the purposes.”

This power has actually been exercised more than once since then, so they could in theory write their own ticket to implement a de-facto ban on inversions, which would be in force until Congress gets its act together.  

Photo credit – house.gov

CHIPRA Tobacco Tax Law Fail

What can you say about a tax hike on tobacco that not only reduces tax revenue by billions of dollars, but also pushes smokers towards cheaper tobacco products that are more harmful?

This massive tobacco tax law fail was the Children’s Health Insurance Program Reauthorization Act (CHIPRA) of 2009.

According to a study report released by the U.S. Government Accountability Office (GAO) at a hearing before the Senate Finance Committee, CHIPRA forced tobacco product manufacturers into tax avoidance by shifting to lower-priced and less regulated products.

CHIPRA increased federal tobacco taxes, but also managed to create a disparity by making pipe tobacco less expensive that manufactured cigarettes and roll-your-own tobacco. Secondly, the law also taxed large cigars less as compared to small cigars and manufactured cigarettes.

Before CHIPRA, the federal tax was the same for pipe and roll-your-own tobacco. After 2009, the tax hike made roll-your-own tobacco $21.95 more expensive per pound than pipe tobacco.

So manufacturers started using packaging gimmicky to label roll-your-own tobacco as pipe tobacco, and small cigars were made marginally heavier through use of additives to make them fit the legal definition of large cigars.

The tax code defines small cigars as weighing three pounds or less per thousand cigars. As you can see in the image above, small cigars and the technically large cigar look to be about the same size.

These tax avoidance methods reduced federal tobacco revenue by somewhere in between $2.6 to $3.7 billion for the period from April 2009 to Feb 2014.

The report clearly show why this happened – “From fiscal year 2008, the last year before CHIPRA, to fiscal year 2013, annual sales of domestic and imported pipe tobacco increased from about 5.2 million pounds to 43.7 million pounds, while sales of domestic and imported roll-your-own tobacco declined from about 21.3 million pounds to 3.8 million pounds. Over the same period, annual sales of domestic and imported large cigars increased from about 5.8 billion sticks to 12.4 billion sticks, while sales of domestic and imported small cigars declined from about 5.7 billion sticks to 0.7 billion sticks.”

The negative impact on the health of smokers was even worse. The problem is that many FDA regulations that apply to factory made cigarettes and roll-your-own tobacco do not apply to pipe tobacco and cigars.

So cigarette-sized cigars and tobacco with a pipe label can be sold in candy flavors and misleading descriptors such as mild and light. These practices were banned for factory-made cigarettes because it’s easier to get youth addicted to flavored tobacco products.

But now CHIPRA is undoing decades of painstaking gains against the tobacco lobby, and has in the process managed to reduce federal tax revenue by $2.6 billion or more.    

Read the full GAO report on their CHIPRA study – Download (pdf)

 Photo credit – senate.gov

A Personal Inversion to Avoid State Taxes?

Corporate inversions are all the rage at the moment, what with Congressional hearings and the President weighing in on schemes by American corporations looking to relocate overseas on paper to save on taxes, while still continuing to operate and be headquartered in the United States.

Blame it all on Pfizer, which earned itself a whole lot of unwanted attention due incessant and futile attempts at a takeover of AstraZeneca PLC so that the merged entity could technically be a European company and could save huge sums in U.S. taxes.

Inversion, which was until recently a mind-numbingly boring technique known only to corporate tax strategists, is now getting star billing on the Daily Show and the Colbert Report.

So it’s no big surprise that the pitchforks are now looking for more evil corporate witches. Cue for a focus on “personal inversion.”

Personal inversion is the individual version of corporate inversion – as in how you can avoid state taxes by keeping your wealth in states that have low or no personal income tax while living in a state that has high income tax rates.

This has been previously covered in detail, but at that time it was just a boring old tax strategy that went by names such as DING and NING.

Now it’s a big deal because it’s a personal inversion, which is no doubt a whole lot more unpatriotic and sinister-sounding thing than a DING.

DING here is a Delaware Incomplete Gift Non-Grantor Trust, which holds your assets in a sort of limbo which ensures that you avoid both the state tax on it in your home state if you kept the assets in your name and the federal gift tax that would kick in if you gave away the assets altogether.   

NING is the Nevada Incomplete Gift Non-Grantor Trust. Obviously it only works in certain states that facilitate establishment of these trusts and do not tax the income in the trusts.  

There are billions in assets tucked away in such trusts that do not get taxed, while the people who originally owned the assets continue to live and get rich in states like New York.

Recent IRS rulings approving several NINGs have kept this technique alive and quite handy for wealthy citizens of high-tax states to avoid state income taxes.

But with all the hype over corporate inversions, some of the blowback is bound to make personal inversions difficult going forward.

Forbes already has an article labeling use of DING and NING as personal inversions. How long before we see a Congressional hearing on personal inversions?   

Photo credit – house.gov

Tax Expert Grandpa Forces California to Take Back Grandkid’s $6 Tax Refund

Hugh Sprunt, a retired CPA and tax expert for an international accounting firm, is in the news for strong-arming California State into taking back a $6 tax refund the State issued erroneously to his two-year granddaughter.

Sprunt had been building up a savings account for little Rosa, and during this tax season, the interest income and dividend in the account exceeded $1,000. That means Rosa was required to file state and federal returns for the first time in her life.

According to the San Jose Mercury News, Sprunt used TurboTax tax software to do the tax returns for his granddaughter as a dependent on her parents’ returns. The software showed that Rosa did not owe any federal taxes, and neither did the IRS owe her a refund.

But TurboTax did show that Rosa was supposed to pay $6 in state taxes. So Sprunt filed the returns and mailed the $6 check, and that should have taken care of little Rosa’s tax issues for the year.

But then, the California Franchise Tax Board unexpectedly sent Rosa a $6 refund. Thinking that maybe he had made a mistake, Sprunt went through everything all over again. He found nothing wrong in the paperwork or the software, which still showed that Rosa was supposed to pay $6 to the State of California.

So he called the Tax Board, and his call stirred up quite a bit of action. After many consultations with supervisors, the rep on the phone finally admitted that they had screwed up.

The government’s software had given Rosa an exemption as a single filer, which she was not entitled to as a dependent on her parents’ returns.    

The rep told Sprunt this was the most patriotic call he had ever taken, and demanded that little Rosa hand over the $6 she owed the State.

The Franchise Tax Board then checked their records to make sure that kids all over the Golden State were not spending tax refunds they had gotten by mistake.

Turns out this was an isolated case because Rosa’s paper return was bent and could not be scanned. A manual operator had then made a mistake while punching it in.

Photo credit - efile989

How Banks and Hedge Funds Used Basket Options to Avoid Billions in Taxes

The U.S. Senate Permanent Subcommittee on Investigations held a hearing on tax avoidance by banks and hedge funds working together using basket options.

The concept is pretty simple, and was perfectly legal and commonplace until recently, when the IRS started challenging it.

Banks offer hedge funds basket options whose values fluctuate based on the performance of the underlying securities.

Hedge funds could then buy and sell stocks within the basket without subjecting the transactions to taxation as a short-term gain because it was technically owned by the bank.

The hedge funds only had to pay taxes on long-term gains, if and when they actually exercised their options.

This arrangement makes a huge difference because of the difference in the tax rates for short-term capital gains and long-term gains.   

Senator Carl Levin, who chairs the Senate Permanent Subcommittee on Investigations, said in his opening statement that “This structure worked well for the banks, which earned hundreds of millions of dollars in fees. It worked well for the hedge funds, which made billions of dollars in profits. But it didn’t work for average taxpayers, who had to shoulder the tax burden these hedge funds shrugged off with the aid of the banks.”

The hearing was focused on the basket options developed and sold by Deutsche Bank AG and Barclays Bank PLC to more than a dozen hedge funds.

These two banks together sold 199 basket options to hedge funds, which then made use of the arrangement to make more than $100 billion in trades.

One of the hedge funds singled out for attention in the hearing was Renaissance Technologies LLC aka RenTec, which used the basket options to rack up 100,000 trades per day on average, or about 30 million per year.

Around 60 options sold by the two banks to a RenTec fund called the Medallion fund, which generated profits of around $34.2 billion for investors, who saved $6.8 billion in taxes on these profits by avoiding taxes on short-term gains.

RenTec computers would send the order to the bank, which would then execute the trade. RenTec’s investment in a stock would often end in seconds or minutes, and was made to appear as a mere recommendation rather than being an actual trade.

Renaissance claims it was well within the law in doing this, and noted that it was the same as trading securities held by a brokerage.

However, the IRS challenged it and both banks have since discontinued the practice. Renaissance is currently engaged in a dispute with the IRS over the tax treatment of the trades that were conducted from within basket options.

Photo credit – senate.gov

National Taxpayer Advocate’s FY2015 Objectives Report to Congress

The National Taxpayer Advocate had a hugely successful 2014, not least because the battered IRS has been actively seeking out ways to improve its image and soften the rough edges.

The announcement last month of the adoption of Taxpayer Bill of Rights by the IRS was a big win after a five-year campaign, but NTA Nina E. Olson is now focusing on other priorities, as outlined in the NTA’s FY2015 Objectives Report submitted to Congress last week.

The focus is now on tax preparer issues and the agency’s funding gap. To be more specific, these are areas of focus for FY 2015:-

- Implementation of the Taxpayer Bill of Rights;

- Preparer Standards and Helping Victims of Return Preparer Fraud;

- Tax Exempt Status Applications;

- IRS Funding Gap and TAS Technology; and

- Statutory Violations During Government Shutdown.

The section of the report on tax preparer standards discusses the recently announced voluntary continuing education (CE) program for unenrolled preparers as an interim solution while Congress considers giving the IRS the authority to establish a mandatory training and certification program for tax prepapers.

The NTA report stresses the need for competency testing to be an essential part of the voluntary education program, because its absence limits the program’s value and could mislead taxpayers during the 2015 filing season.

The report also takes the IRS to task for ignoring the legal authority granted to the agency to assist victims of prepaper fraud.

The NTA notes that the IRS has received four separate legal opinions on this issue since 2000 from its own Office of Chief Counsel, but has chosen to ignore things such as issuing refunds to victims of preparer fraud.

It has been 14 years since the first legal opinion was provided, but the IRS has still not developed procedures to fully unwind the harm done to the victims.

One section of the report is meant to wake up Congress to the impact of the IRs funding gap. One of the victims is the Taxpayer Advocate Service itself, which was informed earlier this year that their Taxpayer Advocate Service Integrated System (TASIS) could not be funded for the rest of this year.

TAS has been developing TASIS for a decade, and scrapping their funding is going to waste a huge amount of work that has already been done and will significantly diminish TAS’ capabilities.

Read the full NTA FY2015 Objectives Report to Congress – Download (pdf)

Photo credit – taxpayeradvocate.irs.gov