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A FAMILY LAWYER COULD BE CONSIDERED BY IRS TO HAVE BECOME A TAX RETURN PREPARER

Consider that you have prepared a MSA that includes payments from husband to wife that are to be reduced when one of the minor children attains majority. The MSA does not state that any part of the payment shall be non-taxable to the wife and non-deductible to the husband. The client calls you one April afternoon and asks if under the MSA you drafted for him, he may deduct the all of the payments he has made to the wife in the previous year. You tell him – yes – since the agreement did not expressly make the payments non-taxable or non-deductible. The client deducts all of the payments, is audited and the amount of alimony reduction keyed to the child reaching majority is disallowed as being disguised child support. The client tells the agent that “my divorce lawyer advised me that I could deduct all of the payments.”

Surprise, surprise, surprise! Under amended Section 6694 of the Internal Revenue Code, you literally could be considered a tax return preparer if the amount of alimony deducted represents a substantial portion of the tax return. Section 6694 imposes penalties on those deemed tax return preparers unless the position in the return on which they advised is more likely than not (better than 50 percent likelihood) to be sustained in litigation on the merits. It is not necessary for you to sign the tax return or even see the return or specifically discuss it for you to be considered a tax return preparer. It is only necessary that you are compensated and render advice which is directly relevant to an entry in the return deemed substantial when the underlying events have already occurred. Substantiality is determined by looking at the amount of tax involved in the item and the length and complexity of the item. If the position has less than a 51% likelihood of success the penalty may be avoided with respect to positions having a reasonable basis (something more than merely not frivolous) if the return preparer who was not required to ... Read More »

SPECIAL EDITION: A PRIMER ON THE SUB-PRIME MESS

Like Marvin Gaye, we are now all asking “What’s going on?” This edition will diverge from taxes. Instead, I will summarize:
1. How did we get into this economic hole?
2. Why do we keep digging?
3. Can the hole get so deep that we cannot climb out?
4. What will the federal bail out fix and what may not be fixed by it alone?
5. What have we leaned?
6. Why is the future not bleak for America?
1. How did we get into this economic hole?
Some factors contributing were:
a. All of the players were paid up front - the banker, the mortgage broker and the investment banker all were paid on the front end and therefore had no stake in the performance of the mortgages or securities backed by packages of mortgages.
b. No federal regulatory scheme was present and state regulators fell asleep on the job. The real estate housing market, fueled by home buyer naivety mortgage broker fraud, banker indifference and investment banker greed, spiraled into a frenzy of speculation. The resulting home values greatly exceeded historical appreciation rates and proved illusory. There was no new era of real estate – just another bubble.
c. Investors in mortgage backed securities ignored the complexities of these instruments and the axiom, “the risk assumed is directly proportionate to the rate of return offered.” Mortgages were packaged and repackaged with risk growing with each step removed from the underlying asset. Security rating agencies simply assumed that the large number of mortgages backing each security assured the quality of the group as a hole. They did not consider that most loans were adjustable rate mortgages or that the debt equaled 90% or even 100% of the collateral value at inception, or that no one was regulating the process.


2. Why do we keep digging?
It is not so much that we intentionally keep digging as that we don’t know how to stop? Let’s look at what is happening on Wall Street and on Main Street.
a. Wall Street runs on confide... Read More »

THE SUB-PRIME MESS CONTINUED

BAIL OUT DEVELOPMENTS
1. The Treasury will use $250 billion of the $700 billion congressionally authorized bail out fund to buy preferred stock of commercial banking institutions. Initially, it will take stakes in 8 of the largest banks and Merrill Lynch. Some of these banks do not need financial help from the Treasury but all were pressured to join the plan lest the public perceive banks participating as weak precipitating deposit withdrawals. The other $125 billion will be invested in perhaps hundreds to thousands of healthy banks thru November. The remaining $450 billion of the bail out fund will be used to purchase bad assets from financial institutions as originally conceived. The Treasury retreated from using all of the funds to purchase bad assets because:
a. The Treasury wanted to join a globally more unified front in attacking what clearly had become a world-wide economic crisis. If countries take ad hoc action offering more security, such measures cause unanticipated flights of bank deposits and capital to the perceived to be safer investment locations.
b. Congress took too long to pass the bail out measure and it became clear that it would take even longer to fully implement the complex reverse auction process of buying the bad assets. Market reaction, however, moved at a faster speed.
c. The Treasury came to realize that buying bad assets at current market values would reduce banks’ loan assets more than the cash received thus negatively impacting the seller’s balance sheet and requiring an infusion of capital to meet required capital reserves and collateralized loan requirements (the banks had pledged the bad loans as collateral on lines of credit and bonds). That capital would be next to impossible to procure in this risk-adverse environment. The direct infusion of cash before the bad asset buy-out avoids that potentially exacerbating domino effect.
2. Lowering the Federal Funds rate and Discount rate alone did not unfreeze credit. ... Read More »

TAX HELP IN THE BAIL OUT BILL AND A FEW OTHER YEAR END TAX CONSIDERATIONS

The Emergency Economic Stabilization act of 2008 was signed by President Bush on October 3, 2008. The main focus on the bail-out bill was to stave off further economic panic. These provisions were discussed in earlier editions, “Primer on the Sub-Prime Mess” (Volume 2, No. 3) and “Sub-Prime Mess Continued (Volume 2, No. 4). This edition will discuss only a handful of the more than 300 tax law changes included in the bail out bill and some sundry year-end tax concerns.
MORTGAGE FOREGIVENESS DEBT RELIEF EXTENDED
The Mortgage Forgiveness Debt Relief Act of 2007 (Act) provides tax relief to defaulting homeowners who might otherwise owe income tax on the forgiven portion of their mortgage obligation that was to have expired in 2008 The Act, extended through 2012, makes nontaxable debt forgiven on a qualified principal residence (QPR) with certain limitations as follows:
1. The relief applies to debt forgiven between January 1, 2007 and December 31, 2009.
2. Qualified principal residence is a residence as to each taxpayer meeting the same definition as under Section 121 relating to the home sale exclusion of $250,000 ($500,000 for joint returns).
3. The debt must be secured by a QPR and be either:
a. Acquisition indebtedness up to $2,000,000 ($1,000,000 on a MFS return, or,
b. Home equity indebtedness up to $100,000 ($50,000 on MFS return) to the extent that when added to other QPR debt the total debt does not exceed the FMV of the residence.
4. The amount excluded from income reduces the tax basis of the property immediately.

5. See Volume 2, No. 1 for situations that might require the assistance of a tax lawyer.
ALTERNATIVE MINIMUM TAX
This alternate tax system was added to the tax code to make sure that the very rich pay at east a minimum amount of tax. The AMT has different income inclusion and tax deduction rules, exempts AMT taxable income up to an exemption amount and employs a different tax rates. But, because congress did not index the ... Read More »

THE SUB-PRIME MESS GETS MESSIER

I continue to focus on the financial crisis in lieu of my usual tax commentary because of our mutual concern for this problem.

BAIL OUT CHUTES AND LADDERS
1. The Bail Out now resembles the exciting up and down game for children in which players spin the spinner and move pawns square by square. If a pawn lands on a picture square at the bottom of a ladder, the player climbs up with a good deed while naughty deeds slide players back down for landing on a picture square at the top of a chute. Of course, what square one lands on depends on the chance of the spin. So it is with the bail out, the Fed and Treasury are employing tools for managing the money supply and spending but they can’t always foresee all of the consequences of every move. Thus, the bail out plan continues to be adjusted on the fly. The latest adjustments are:
a. The Treasury is for now abandoning the plan to use the remainder of the $700 million fund to buy bad loans held by financial institutions. Instead, it will directly invest more capital into these entities. The Treasury may also later buy some troubled assets but the program proved too problematic to implement wholesale due to problems in determining the price at which to buy and the dispersed ownership of securitized loan packages.
b. As part of the plan the Treasury is now considering requiring recipient banks to raise an equivalent amount of private capital to qualify for a federal investment. Such a requirement, in effect, lets the market determine which banks are worthy of federal aid. The Treasury was concerned that if it continued to invest unilaterally, it would be the government identifying worthy and unworthy banks and causing more stock market instability and depositor flight from those not selected.
c. Last week, Treasury Secretary Henry Paulson announced that the Treasury will shift its focus from unfreezing institutional lending to helping loosen up consumer credit availability. But, he said, “There are no ea... Read More »