FEDERAL TAX ALERTNEWS ITEMSNSTP MEMbERS PARTiciPATE iN ANNuAL MEETiNg AND ELEcT MEMbERS To ThE boARD oF DiREcToRSOn August 20, 2006 NSTP members met in Las Vegas to conduct NSTP business and to elect three members to the Board of Directors.

The new members, elected to serve a 3-year term, include:

Ron LarsonDorothy LeamonRick Snowden

These members will join Directors serving the second year of a three-year term:

Laurie Conner Jarrett, Board PresidentPaul LaMonaca, Board Vice PresidentGreta Barncord, Board TreasurerJim Oliver, Director

The NSTP leadership is dedicated to serving NSTP and its members.

ELEcTRoNic FEDERAL TAX PAyMENT SySTEM ciTED iN NEw E-MAiL ScAMThe IRS is warning taxpayers to be on the lookout for a new e-mail scam that uses the Treasury Department's Electronic Federal Tax payment System (EFTPS) as a hook to lure individuals into disclosing their personal information. More than six million taxpayers use EFTPS allowing business and individuals to pay their taxes online or by telephone.

The fraudulent e-mail claims someone has enrolled the taxpayer's credit card in EFTPS and has tried to pay taxes with it. The e-mail also claims there have been fraud attempts involving the taxpayer's bank

account. The e-mail claims money was lost and remaining funds are blocked. Recipients are asked to click on a link that will help them recover their funds, but the subsequent site asks for personal information that the thieves could use to steal the taxpayer's identity.

Many of these scams originate outside of the U.S. and this is the first of such scams to use the EFTPS system.

Taxpayers should be told that the IRS does not send out unsolicited e-mails asking for personal information.

FED KEEPS KEy RATE STEADy AT 5.25%The longest sustained campaign of interest-rate hikes in Federal Reserve history has ended breaking a string of 17 consecutive increases. The Fed policymakers believe the economy is slowing sharply and may continue to slow in coming months quelling an upsurge in inflation.

Since June 2004, when the rate was at a four-decade low of 1 percent, the policy-setting Federal Open Market Committee has lifted it 17 times by one-quarter of a percentage point at each of its meetings. The rate, which is 5.25 percent, indirectly affects many other interest rates.

TAX REvENuE SoAKS uP A PART oF ThE DEFiciTThe federal deficit appears on track to register less than $300 billion for the budget year ending September 30, as surging tax revenues continue to signal significant improvement over White House estimates released last February, though only modest gains over last year.

The nonpartisan Congressional Budget Office, which makes estimates for lawmakers, said that the deficit for the first three-quarters of fiscal 2006 came in $41 billion less than the

coNTENTSFrom the Editor . . . . . . . . . . . . 2IRS Action News . . . . . . . . . . . 4Tax Law Update . . . . . . . . . . . . 6Inside Washington. . . . . . . . . . 9FYI . . . . . . . . . . . . . . . . . . . . . . 9Tax Court Decisions. . . . . . . . 11Et Cetera . . . . . . . . . . . . . . . . 12Tax Rep Roundtable. . . . . . . . 13Book Review. . . . . . . . . . . . . . 14Ethics Corner. . . . . . . . . . . . . 14Members Ask . . . . . . . . . . . . . 15Quotes of the Month . . . . . . . 16

iNSERTS■ Penalties Insert■ Fall Tax Update

Seminar Schedule■ Pension Protection Act■ Calendar■ TaxWorks Insert

A PublicAtion of the nAtionAl Society of tAx ProfeSSionAlS AuGuSt/SePtember 2006

DEbATiNg RETiREMENT? coNSiDER youR oPTioNS

NEWS ITEMS PAGE 3

2006 iRS NATioNwiDE TAX FoRuM bREAKS ALL REcoRDS

IRS ACTION NEWS PAGE 4

SENATE FiNANcE coMMiTTEE REPoRTS S. 832

TAX LAW UPDATE PAGE 6

NEw FEATuRE SEcTioNTAX REP ROUNDTABLE PAGE 13

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 20062

The Federal Tax Alert is published 10 times a year by the National Society of Tax Professionals. Subscription rate is $200 a year; single copy $20. Mailing address: The Federal Tax Alert, 10818 NE Coxley Dr. Ste. A, Vancouver, WA 98662. Telephone: 800-367-8130. Opinions expressed in The Federal Tax Alert are those of the editors and contributors. Staff-Executive Editor: Beanna Whitlock; Production: Melissa Bowden; Subscription Services: Glyness Scott; Printer: Sunset Printing, Inc., Portland, Oregon.

red ink recorded for the same period in 2005.

The 2005 deficit registered $318 billion. It would take major erosion in the fiscal picture in the final three months of the budget year for the deficit to exceed $300 billion.

Tax collections are surging at a 13 percent growth rate, reflecting par-ticularly strong growth in taxes paid on corporate profits and income taxes paid by wealthier people and small businessmen and businesswomen who pay taxes quarterly instead of having them withheld by employers.

why KEEPiNg ThE PENNy No LoNgER MAKES SENSEBecause of the soaring price of zinc, it now costs nearly a penny-and-a-half to produce a penny. If the U. S. Mint were a for-profit business, the next step would be pretty automatic. It would shut down penny production or quickly reduce the penny's cost by changing its content. The Mint, however, has the luxury of considering what is best for the country as a whole in making such a momentous decision.

Economists of all political stripes have concluded it is time to get rid of the penny even if the Mint could make it at zero cost. The rising value

of our time has turned a penny from a useful coin into a nuisance. When people start leaving a monetary unit at the cash register for the next customer, the unit is too small to be useful. However, groups such as Americans for Common Cents worry that customers will be ripped off if Congress kills the penny. In a penny-free world, sellers would round your bill to the nearest nickel. Cash purchases totaling $9.98 or $9.99, for example, would be rounded up to $10 while those equaling $10.01 or $10.02 would be rounded down to $10.

The bottom line is that it is not just the Mint that is losing money on pennies. The Federal Reserve, banks, retailers and customers lose millions more because of the costs of toting around and handling these nearly worthless coins. Time is money, and conservative estimates of the value of our time lost using pennies exceed $300 million per year.

SociAL SEcuRiTy wiNDFALL ELiMiNATioN PRoviSioNYour Social Security retirement or disability benefits may be reduced if you work for an employer who does not withhold Social Security taxes from your salary, such as a government agency or an employer

in another country. The "windfall elimination provision" affects how the amount of your retirement or disability benefits is calculated if you receive a pension from work where Social Security taxes were not taken out of your pay. A modified formula is used to calculate your benefit amount, resulting in a lower Social Security benefit.

Your Social Security benefits are reduced because Social Security benefits were intended to replace only a percentage of a worker's pre-retirement earnings. The way Social Security benefit amounts are figured, lower-paid workers get a higher return than highly paid workers. For example, lower paid workers could get a Social Security benefit that equals about 55 percent of their pre-retirement earnings. The average replacement rate for highly paid workers is about 25 percent.

Before 1983, people who worked in jobs not covered by Social Security received benefits that were computed as if they were long-term, low-wage workers. They received the advantage of a higher percentage of benefits in addition to their other pension. Congress passed the windfall elimination provision to eliminate this advantage.

Social Security benefits are based on the worker's average monthly earnings adjusted for inflation. This is a complex formula. Average earnings are separated into three amounts and then multiplied by various factors. Example: A worker who turns 62 in 2006, the first $656 of average monthly earnings is multiplied by 90 percent; the

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FROM THE EDITOR What an incredible privilege it has been to meet with NSTP members at each of the Regional Conferences and IRS Nationwide Tax Forums. You have graciously shared your knowledge and experience with me and, without question, I have observed, first hand, what your membership in NSTP means to you.

It has been thrilling to teach at the Regional Conferences and to share the stage with the incomparable Paul LaMonaca, NSTP's Director of Education. The NSTP membership should make plans now to attend one of the Fall Update Classes by going to the NSTP.ORG website, under Education, and schedule a Fall Update Class near you.

The Web Board is active on NSTP.ORG and NSTP members are communicat-ing about tax issues, IRS problems and office management. It is so easy to register; post and receive messages that I can even do it!

NSTP has several new "partners" on the MEMBERS ONLY site, offering special offers and discounts to members.

Check out the REFERENCES site for addresses to all State Taxing Authorities as well as IRS locations for various filings.

All sites are designed to make NSTP.ORG your one stop shop for EDUCATION, RESOURCES and INFORMATION.

An incredible "thank you" to Mr. Steve, NSTP's Director of Technical Services, for his outstanding contribution to the web site..

NSTP members deserve the best and the BEST is yet to come because…"Members Matter!"

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

AUGUST/SEpTEmbER 2006 – THE FEDERAL TAX ALERT3

next $3,299 by 32 percent; and the remainder by 15 percent.

The 90 percent factor is reduced in the modified formula and phased in for workers who reached age 62 or became disabled between 1986 and 1989. For those who reach 72 or who become disabled in 1990 or later, the 90 percent factor is reduced to 40 percent.

There are exceptions to this rule. Example: The 90 percent factor is not reduced if you have 30 or more years of "substantial" earnings in a job where you paid Social Security taxes.

To see the maximum amount your benefit could be reduced, visit www.socialsecurity.gov.

The windfall elimination provision does not apply to survivors benefits. It also does not apply if:

You are a federal worker first hired after December 31, 1983;You were employed on December 31, 1983, by a non-profit orga-nization that did not withhold Social Security taxes from your pay at first, but then began withholding Social Security taxes from your pay;Your only pension is based on railroad employment;The only work you did where you did not pay Social Security taxes was before 1957; orYou have 30 or more years of substantial earnings under Social Security.

If you receive a relatively low pension, you are protected. The reduction in your Social Security benefit cannot be more than one-half of that part of your pension based on your earnings after 1956 from which Social Security taxes were not deducted.

PEBES statements, issued by the Social Security Administration, now include the following:

"If you will receive a non-covered pension, your benefit estimate is WRONG!" The disclaimer goes on to read:

If estimate is $590 or greater, subtract $328.

If estimate is $589 or less, multiply by 4 and divide by 9, then drop the cents.

The amount of reduction can never be more than half the amount of your public pension.

ThiNKiNg oF RETiRiNg? coNSiDER youR oPTioNSAs you approach the age when you can receive Social Security retirement benefits, you have options to consider and decisions to make. Before making your retirement decision you should consider all the options.

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There are important questions you need to ask yourself. At what age do you want to begin receiving benefits? Do you want to stop working and receive benefits? Do you want to work and receive benefits at the same time? Or do you want to work beyond your full retirement age and delay receiving benefits?

When you continue working beyond full retirement age, your benefit may increase because of your additional earnings. If you delay receiving benefits, your benefit will increase because of the special credits you will receive for delaying your retirement. This increased benefit could be important to you later in your life. It also could increase the future benefit amounts your family and survivors could receive.

Each person's retirement situation is different. It depends on circum-stances such as health, financial needs and obligations, family respon-sibilities, amount of income from work and other sources. It also may depend on the amount of your Social Security benefits.

Option 1.Retiring at Full Retirement Age. To retire, you must have earned 40 credits.

Year of Full Retirement Birth Age

1937 or earlier 651938 65 and 2 months1939 65 and 4 months1940 65 and 6 months1941 65 and 8 months1942 65 and 10 months1943-1954 661955 66 and 2 months1956 66 and 4 months1957 66 and 6 months1958 66 and 8 months1959 66 and 10 months1960 or later 67

*Refer to the previous year if you were born on January 1.

Option 2.Retiring Early. If you have earned 40 credits, you can start receiving Social Security benefits at 62 or at any month between 62 and full retirement age. However, your benefits will be permanently reduced based on the number of months you receive benefits before you reach full retirement age. If you retire before your full retirement age of 65, your benefits will be reduced:

20 percent at age 62;13 1/3 percent at age 63; or6 2/3 percent at ate 64.If your full retirement age is 66,

they will be reduced:

25 percent at age 62;20 percent at age 63;13 1/3 percent at age 63;6 2/3 percent at age 65.

Option 3.Receiving Retirement Benefits While You Work. You can work while receiving monthly benefits. It could mean a higher benefit that can be important to you later in your life and increase the future benefits your family and survivors could receive. Social Security will review your record each year to see whether the additional earnings will increase your monthly benefit. If there is an increase, they will send you a notice of your new benefit amount. Earnings in or after the month you reach full retirement age will not reduce your Social Security benefits. However, if you receive benefits before reaching your full retirement age, your benefit amount will be reduced.

In the year you reach full retirement age, $1 in benefits will be deducted for each $3 you earn above the annual limit ($33,240 in 2006) until the month you reach full retirement age. After that, your benefits will not be reduced, no matter how much you earn.In the years before you reach full retirement age, $1 in benefits will be deducted for each $2 you earn above the limit ($12,480 in 2006).

If you lose benefits because of work, your benefit will be increased later to account for the months you did not receive a benefit before reaching full retirement age.

OptiOn 4.Delaying Retirement. You may decide to continue working beyond your full retirement age without choosing to receive benefits. If so, your benefit will be increased by a certain percentage for each month you do not receive benefits between your full retirement age and age 70. The following table illustrates the rate your benefits increase if you delay retiring: Year of Birth Yearly Increase Rate 1935 -1936 6.0% 1937-1938 6.5% 1939-1940 7.0% 1941-1942 7.5% 1943 or later 8.0%It is best to contact Social Security three months before the month in which you want to file for retirement benefits to discuss the options that are available to you. In some cases, your choice of retirement month

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THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 2006�

could mean additional benefits for you and your family.

Even if you do not plan to receive benefits because you will continue working, you should sign up for Medicare three months before reaching age 65 regardless of when you reach full retirement age.

Apply for Retirement Benefits on the internet at www.socialsecurity.gov/planners or by calling 1-800-772-1213 between 7 am and 7 pm, Monday through Friday.

IRS ACTION NEWS2006 iRS NATioNwiDE TAX FoRuMS bREAK ALL REcoRDSIn combination, the six IRS Forums of 2006 attracted well over 17,000 tax professionals with the largest attended Forum being Las Vegas. The wide-range of educational offerings, including the Education Menu and the Circular 230 presented by NSTP were popular with the audiences. The focus of the Forums has changed from being about electronic filing to being about IRS partnering with the tax professional community. The Forums always present an outstanding opportunity for NSTP to reconnect with members and to introduce tax professionals to NSTP.

Members providing assistance in the NSTP booth this year included Madonna Bailey, Rick Snowden, Floyd Thomas, Laurie Conner Jarrett, Greta Barncord, Kristina Rice, Marilyn Melendez Olmsted, Dorothy Leamon, Karen Caudle, Debbie Hogan, Paul LaMonaca, Keith Huebel along with John Haugner and Chris Foley of Target Insurance.

Tremendous appreciation is given to these NSTP members and partners of NSTP.

Well done!

iRS hEADquARTERS buiLDiNg REMAiNS cLoSED; TAX oPERATioNS coNTiNuEThe IRS Headquarters Building at 1111 Constitution Avenue, NW in Washington is likely to remain closed for the foreseeable future.

The building sustained extensive damage to the infrastructure, office furniture and supplies.

The subbasement was submerged in more than 20 feet of water. The subbasement holds all of the building's electrical and maintenance equipment such as electrical trans-formers, electrical switchgears, and chillers. Although these systems

require closer inspection, they appear to be 95 percent damaged or destroyed.

The basement was flooded with five feet of water. The fitness center, food service canteens, offices, systems furniture, carpet, ceiling tiles, computer equipment and vehicles garaged in the building were all destroyed.

While an assessment of total damage has not been compiled, costs are expected to run in the tens of millions of dollars.

Repairs to the headquarters building will not impact the IRS's service and enforcement operations. All IRS business units have extensive business resumption plans that have been executed. The 2,400 employees who work at the headquarters building are being relocated to the other 12 buildings IRS occupies in the metro area or into temporary space, and some will telecommute as appropriate.

DATA PRoTEcTioN AT ThE iRSSince January 1, 2006 more than 65.7 million Americans, 23 per cent of the population, nearly one in four, have had their personal information lost or stolen.

The Office of Privacy and Information Protection within the Internal Revenue Service works to protect personally identifiable information (PII). The office was created as a result of the need for an enterprise-wide approach to data protection and includes three distinct program areas: Identity Management, Safeguards and Privacy. The Office focuses on enabling taxpayer and employee confidence by ensuring the right people see the right data in the right places for the right reasons.

PII is a specific type of sensitive but unclassified information including the personal data of taxpayers and also the personal information of employees, contractors, applicants and visitors to the IRS. Examples include:

Names;Social Security numbers;Date of birth;Other numbers or information that alone or in combination with other data can identify an individual.

The IRS privacy principles provide guidance for employees working with PII because:

Protecting Taxpayer privacy is a public trust.Personal information will only be collected if it is necessary

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for tax administration or other legally authorized purposes.Information will be used only for the purpose for which it was collected, or as specifically authorized by law.Information will be collected, to the greatest extent practicable, directly from individuals to whom it relates. Information that is collected from third parties will be verified for accuracy with the subject, whenever possible, before final action is taken.All IRS employees share in the responsibility for protecting the privacy of individuals whose information they have access to: taxpayers, employees, and visitors to IRS web sites.

Privacy is NOT an option but a sound business decision. E-file addresses privacy concerns and instills confidence in tax administration, encouraging both compliance and modernization efforts. Based upon the 66,609,000 e-filed returns in 2005, the cost savings of $143,209,350 in processing was generated by the cost difference of $2.71 for a paper return vs. the cost of an e-filed return of 56 cents.

The Office of privacy can be contacted at 202-927-5170 or www.irs.gov/privacy. E-mail: privacy@irs.gov.

iRS whiSTLEbLowER PRogRAM To iNcREASEIn June 2006, a Treasury Department audit examined the workings of the Internal Revenue Service's "Informant's Reward Program". The IRS said that it would implement the report's recommendations. The result will be more centralized control and consistent administration of the program. In addition, the IRS will make information about the reward program more accessible in order to encourage additional claims.

Treasury found that examina-tions initiated based on informant's data is more effective and efficient in identifying taxes than returns selected using the IRS' primary method for selecting returns for examination. This Treasury audit conclusion is consistent with a 1999 IRS report that showed the total cost of collection under the reward program was 4 cents for each additional dollar collected, while the cost of other enforcement programs was 10 cents on the dollar.

It is unknown how much tax is unreported, but the IRS estimates that the "tax gap" is around $300 billion annually. Most of this is believed to

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be for self-employed individuals who deal in cash, and whose income is not reported on Forms 1099. Because of concerns over increased budget deficits, pressure is mounting to close this tax gap. Better use of informants is one way of doing this.

The IRS receives information about potential tax violations in the mail, over the telephone at 800-829-0433 or from visits to IRS walk-in offices. The program guidance is contained in the Internal Revenue Manual, Section 25.2 accessible from www.irs.gov. Generally, an IRS employee will take the information by completing Form 3949. In order for the IRS to take your complaint seriously, you will need specific information such as the wrongdoer's social security number, bank accounts used, assets involved, and copies of the accounting books and records.

In order for a reward to be con-sidered, the informant will need to com-plete Form 211, Application for Reward for Original Information. Information regarding the reward program is contained in Publication 633.

The IRS has authority under IRC section 7623 to make payments for assistance:

Detecting underpayments of tax, and

Detecting and bringing to trial and punishment of persons guilty of violating the Internal Revenue laws.

Rewards are paid as a percentage of the taxes, fines and penalties, but not interest, collected based on the relationship of the informant's information to the recovery, as follows:

15% for information that directly leads to a monetary recovery.10% for information that indirectly leads to a monetary recovery.1% of information which led to an examination, but which had no direct relationship to the amount collected.

Potential rewards of less than $100 are not paid regardless of the quality of the information provided. The maximum reward is $2 million.

For Fiscal 2005, $7.6 million was paid from the whistleblower program. Based on the taxes and penalties collected, the overall average reward was 10.9 percent and the average individual reward was around $24,000. For the Treasury's audit sample it took over 7 1/2 years on average for the informant's to be paid.

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2006 ENRoLLED AgENT EXAM NEwSPoints of Interest - From the IRS Nationwide Tax Forums

The Special Enrollment Exam will now be offered at approxi-mately 300 Thomson Prometric testing centers worldwide.The new exams will be taken at computer terminals.There will be three parts to the Exam; Individuals, Businesses, Representation Practice and Procedures.Each part of the Exam will consist of 100 questions and each part will be 3.5 hours in length.Candidates will not be required to take all parts in one sitting.Exam production involved extensive participation from the Enrolled Agent Community.Carry over policy is determined by the Internal Revenue Service.In 2006 SEE exams will only be offered in the United States, Canada, and London.Registration for the exam began July 7th, 2006.The first test window will be October 5th, 2006 to December 1st, 2006.Visit www.prometric.com or http://www.irs.gov/ for more information.

TEMPoRARy PRocEDuRES FoR cERTAiN EXPEDiTED RuLiNg REquESTSBecause of the flooding and temporary closure of the main Internal Revenue Service headquar-ters building in Washington, D. C., a special procedure for processing requests for certain expedited letter rulings for reorganizations and section 355 distributions has been established.

Rather than faxing a copy of the requests to (202) 622-7707 as described in Revenue Procedures 2005-68 and 2006-1, taxpayers or their representatives should call the office of the Associate Chief Counsel (Corporate) at 202-283-7930 and ask to speak to an attorney regarding the temporary procedures for submitting these ruling requests.

The Internal Revenue Service established a pilot program for processing requests for letter rulings for reorganizations and section 355 distributions on an expedited basis, provided certain requirements are met.

News Release, IR-2006-103 states the temporary address for courier delivery of these requests,

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which are typically hand delivered, is: IRS, 940 L'Enfant Plaza, Fifth Floor, Washington, D.C. 20024. All requests that are not hand delivered should continue to be sent to the Post Office Box specified in the revenue procedures.

iRS woRKERS couLD gET uNoFFiciAL AccESS To DATAIRS employees could begin unauthor-ized access to confidential taxpayer information because many of their supervisors are not checking on them, a new government audit reported on July 26, 2006.

On average, 42% of IRS supervisors sampled in the audit certified that they had reviewed security reports showing whether their staffers gained access to taxpayer information without authorization.

This certification rate ranged from a low of 15% for IRS supervisors in Austin, TX to a high of 75% for their Brookhaven, NY counter-parts, according to the audit by the Treasury Inspector General for Tax Administration (TIGTA).

Underscoring the potential danger, auditors reported that they found a clear violation of data safeguards designed to prevent unauthorized access to taxpayer information during a site visit to one unidentified IRS location.

Auditors also said the IRS paid a government contractor $2.4 million for the data security system in 2002, even though it did not completely meet the agency's requirements. The IRS did not renew the contract last year because the contractor was unable to develop an anticipated upgrade.

Auditors recommended that the IRS emphasize the importance of reviewing data security reports and hold managers accountable. They also recommended that the agency hire a new contractor quickly to upgrade the security system. The IRS agreed with most of the recommendations.

Nonetheless, the audit results prompted criticism from Senator Max Baucus, D-MT, the ranking minority member on the Senate Finance Committee. "With recent reports of security breaches at the VA and the Social Security Administration, it is unbelievable that IRS is not doing what it takes to keep information safe in-house," Baucus said.

iRS iSSuES SPRiNg 2006 STATiSTicS oF iNcoME buLLETiNThe Internal Revenue Service has announced the release of the Spring 2006 issue of the Statistics of Income

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 20066

Bulleting which takes a detailed look at individual noncash charitable con-tributions.

The Spring Bulletin also includes information about high-income individual income tax returns for Tax Year 2003, S corporation returns for Tax Year 2003, split-interest trusts for Filing Year 2004, controlled foreign corporations (CFCs) for Tax Year 2002, and the accumulation and distribution of Individual Retirement Arrangements (IRAs) for Tax Years 2001-2002.

Additionally, the report contains the following information:

For Tax Year 2003, individuals reported noncash donations valued at $36.9 billion on Form 8283, Noncash Charitable Con-tribution. The largest number of donations reported on Form 8283 was for clothing, represent-ing 48 percent of all donations.A total of nearly 3.3 million S corporation returns were filed for Tax Year 2003, an increase of 5.9 percent from Tax Year 2002.For Tax Year 2002, individual income taxpayers contributed approximately $42.3 billion to IRAs. This represented an 18.3 percent increase over the contributions for 2001. In addition, $204.4 billion came into IRAs during 2002 as rollovers, usually from employer-sponsored plans such as 401(k) plans. These rollovers represented an 8.8 percent increase over rollovers for 2001.

Additionally, the report includes individual income tax return statistics by state for returns filed for Tax Year 2004. Statistics are also presented on tax collections, including excise taxes by type and refunds for recent years.

E-FiLE AvAiLAbLE ThRough ocTobER 16The Internal Revenue Service reminds tax professionals who previously filed an extension of time to file tax returns for their clients that they can electronically file their returns until October 16, 2006.

Last year, nearly 1.8 million taxpayers filed electronically after the April deadline. This year, through April 21 alone, 70 million tax returns were e-filed. 20 million were from home computers.

The extension granted extra time for filing the tax return only, not for paying any taxes due. Taxpayers will owe interest on any past due tax and may be subject to a late payment penalty if payment was not made by the original due date of the return.

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This year, the original due date for most taxpayers was April 17.

The IRS is encouraging taxpayers to contact their tax professional in order to e-file their taxes.

ATTRibuTED TiP iNcoME PRogRAM (ATiP)The Internal Revenue Service has released formal guidance on ATIP, Attributed Tip Income Program, which expands the existing IRS tip reporting and education program. Employers in the food and beverage industry will be offered the ATIP to simplify enrollment requirements encouraging the reporting of tips on Federal Income Tax Returns.

This pilot program for food and beverage employers begins a three year pilot on January 1, 2007.

Benefits to employers and employees are similar to existing tip reporting initiatives however; the new ATIP program does not require employers to meet with the IRS to determine tip rates or their eligibility. No agreement is required with the IRS for the employer to participate. As with other tip agreements with the IRS, participation is voluntary.

An employer who participates in ATIP will not be subject to an "employer-only" IRC 3121(q) examination during the period the employer participates in ATIP. Employers will elect to participate in ATIP by checking the designated box on Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips.

An employee who participates is not required to keep a daily tip log or other tip record. Employees who participate in ATIP will sign an agreement with their employer to have the tip income computed under the program and have tips reported as wages on their W-2.

General requirements for participation in ATIP:

The employer annually elects to participate in ATIP using prescribed methodology for reporting tips by filing Form 8027 and checks the ATIP par-ticipation box.Simplified filing is provided for small establishments not required to file Form 8027.The employer's establishment must have at least 20 percent of gross receipts as charged receipts that reflect a charged tip.At least 75 percent of tipped employees must agree to participate in the program.Employer reports attributed tips on Employees' Form W-

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2 and pays taxes using the formula tip rate. The formula tip rate is the charged tip rate minus two percent (the two percent takes into account a lower cash tip rate).The charged tip rate is calculated on information from the establishment's Form 8027.

TAX LAW UPDATESENATE FiNANcE coMMiTTEE REPoRTS S. 832On June 28, 2006, the Senate Finance Committee reported out Senate Bill 832 by incorporating it into Senate Bill 1321, the Telephone Excise Tax bill.

S. 832 would require all non-Circular 230 paid tax preparers to register with the IRS and take a new national examination in order to continue in practice as well as maintain continuing professional education requirements.

While this legislation is of concern to our profession, notice should be taken that there is no correspond-ing legislation in the House of Rep-resentatives and in order for this legislation to move forward it would require a companion House Bill or be unopposed in committee by the House of Representatives. The Speaker of the House of Representatives has indicated the Bill has no interest in the House.

The NSTP Executive Director and Dr. Wm. Stevenson, NSTP member from NY, met with Senate Finance Committee staff on August 15th, 2006, via a telephone conference, expressing NSTP member concerns regarding the proposed legislation and the need for a grandfather provision. Highly doubtful a grandfather provision would be included in the legislation, Senate staffers say the legislation includes great flexibility in time for Treasury to implement once the legislation is actually passed and signed into law.

NSTP continues to be a part of any Congressional consideration. We will keep you informed on this important legislation!

iRS couLD SEE 2006 buDgET EXTENDED AS NuMERouS iSSuES iMPEDE 2007 biLLCongress might not be able to clear the Internal Revenue Service's fiscal year 2007 budget on time, according to lawmakers and staffers.

The House took just two days to consider the annual spending bill for

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IRS programs included in H. R. 5576, but in years past the Senate has spent up to a week on the measure. Given the amount of issues the Senate must address it will probably take much longer this year.

Federal agencies that have not had their budgets signed into law by the October 1 start of the fiscal year must operate under a Continuing Resolution, which generally funds programs at a prorated level of the expiring year's budget.

The administration requested $10.73 billion, including new user fees, for the IRS for fiscal 2007, which would represent a 1.4 percent increase compared to the $10.54 billion enacted for fiscal 2006. The House-passed bill would provide the agency with $10.48 billion for fiscal 2007.

Adding to the pressure to complete work on the measure are expected massive costs that will be associated with repairing and rebuilding the IRS's flooded headquarters.

PRESiDENT SigNS PENSioN biLLPresident Bush agrees that the Pension Protection Act, H. R. 4, is on target for sound pension plan reform, signing it into law on August 18, 2006. The legislation passed the Senate earlier this month with a 95 to 5 vote allowing employers to put more money into pension plans during the good times, building a surplus that can supplement the lean years. Included in the legislation is an incentive giving tax-free individual retirement account contributions. Congress may not be entirely finished with the Pension Protection Act already proposing technical corrections to the law to be acted upon later this year.

Specific provisions of the Pension Protection Act include:

Defense contractors that do the bulk of their business with the government and generate more than $5 billion a year in sales to the Pentagon are given a three-year grace period before new pension funding rules kick in.

During that period the Cost Accounting Standards Board, an independent, legis-latively established panel that determines accounting practices for government contracts, would set new rules for recovering pension costs from those contracts.

The rationale is that defense contractors have costs that are programmed in over a

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long period of time and do not have the flexibility like other industries, to cover a sudden spike in pension costs if their plans are underfunded.

Among the companies likely to be affected are BAE Systems, General Dynamics Corp., Lockheed Martin, Northrop Gumman Corp. and Raytheon.Airlines in bankruptcy proceeding that have frozen their pension plans, meaning participants get no new benefits, get an extra 10 years to meet their funding obligations, above the seven years given to other pension managers.

This applies specifically to Northwest Airlines Corp. and Delta Air Lines. The two airlines with active defined-benefit plans, American Airlines and Continental Airlines, Inc., also are liable for a less generous break if they choose not to freeze their plans; they will get 10 years after the new funding rules go into effect in 2008 to meet their obligations.Gate Gourmet, a major airline caterer with a defined-benefit plan is also eligible for the airline exemptions.Greyhound Lines, Inc. froze its plan in 1983, and the vast majority of its remaining partici-pants are former drivers who are now retired and elderly. Conse-quently, the bus line succeeded in getting language allowing it to use mortality tables that its actuaries deem more appropriate to determine pension obligations.Smithfield Foods won a reprieve in restoring fiscal integrity to the failing pension plans of recently acquired companies. The argument was that Smithfield, in opting not to dump those plans on the government, should not be penalized by having to immediately meet the bill's re-quirements of increased contri-butions for underfunded plans.

The goal of the legislation is to reinforce the employer-based pension system which is the retirement lifeblood of some 44 million Americans.

TAX cREDiTS To ShRiNK oN hybRiDSEnvironmentally concerned car buyers will see some federal tax breaks for energy-efficient hybrids start shrinking this fall.

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Toyota Motor Corp. has hit the production limit of 60,000 on vehicles eligible for a special tax credit designed to encourage more buyers to choose gas-electric hybrids.

This means the tax credits for Toyota and Lexus hybrids will be cut in half for drivers who purchase their vehicles beginning in October. The $3,150 credit for the popular Toyota Prius, the largest hybrid tax credit available, would shrink to $1,575. Six months later beginning April 2007, the tax credits will shrink to one-quarter of their original value. They will disappear by October 2007.

Taxpayers could still claim a full tax credit for purchasing hybrids made by other manufacturers, such as Honda Motor Co., Ford Motor Co, and General Motors Corp., until those man-ufacturers trigger the credit limits or the tax break expires in 2011.

EMPLoyER cASh iNcENTivES FoR hybRiDS ARE TAXAbLE.To encourage their employees to purchase environmentally-friendly hybrid cars, several companies reportedly are offering "rebates" or cash incentives to their employees in select areas to offset the purchase price of these vehicles. Just like other forms of compensation, these cash incentives are taxable compensation.

Employers should include the cash incentive amounts in employees' com-pensation reported on year-end Form W-2 earnings statements. The cash incentives also are subject to income tax withholding and employment tax. The tax code provides for an exclusion from income for employee discounts only if the employer produces the product and certain other require-ments are met.

The tax code already includes incentives for the purchase of hybrid cars. The Alternative Motor Vehicle Credit for hybrid vehicles applies to vehicles purchased on or after January 1, 2006 and it may be as much as $3,400 for those who purchase the most fuel-efficient vehicles.

SEvERAL gM vEhicLES cERTiFiED FoR ALTERNATivE vEhicLE TAX cREDiTThe Internal Revenue Service has acknowledged the certification by General Motors Corporation that several of its 2006 and 2007 vehicles qualify for the Alternative Motor Vehicle Credit created by the Energy Policy Act of 2005. The tax credit for hybrid vehicles applies to new vehicles placed in service on or after January 1, 2006.

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 20068

The hybrid vehicle certifications recently acknowledged by the IRS and their credit amounts are:

GMC Sierra (4WD) hybrid pickup truck Model Year 2006 $650.00GMC Sierra (4WD) hybrid pickup truck Model Year 2007 $650.00Chevrolet Silverado (4WD) hybrid pickup truck - Model Year 2006 $650.00Chevrolet Silverado (4WD) hybrid pickup truck - Model Year 2007 $650.00GMC Sierra (2WD) hybrid pickup truck Model Year 2006 $250.00GMC Sierra (2WD) hybrid pickup truck Model Year 2007 $250.00Chevrolet Silverado (2WD) hybrid pickup truck - Model Year 2006 $250.00Chevrolet Silverado (2WD) hybrid pick up truck - Model Year 2007 $250.00

Starting in 2006, this tax credit replaces the tax deduction of $2,000, which was previously allowed for taxpayers who purchased a new hybrid vehicle before December 31, 2005, for the clean-burning fuel deduction. The tax credit requires a different certification. Many currently available hybrid vehicles may qualify for this new tax credit.

Taxpayers seeking the credit may want to buy early since the full credit is only available for a limited quantity of vehicles sold by a manufacturer to retail dealers. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.

For a complete listing of all qualified hybrid vehicles visit www.irs.gov.

gM'S 2007 SATuRN vuE gREEN LiNE cERTiFiED FoR ThE NEw ENERgy TAX cREDiTThe Internal Revenue Service has acknowledged the certification by General Motors Corp. that its 2007 Saturn Vue Green Line vehicle qualifies for the Alternative Motor Vehicle Credit created by the Energy Policy Act of 2005. This certification is under IRS Notice 2006-9. The tax credit for hybrid vehicles applies to new vehicles placed in service on or after January 1, 2006.

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The credit amount for the hybrid vehicle certification of the Saturn Vue Green Line Model Year 2007 is $650.

NEw LAw REvAMPS iRS oFFER iN coMPRoMiSE PRogRAM; 20 PERcENT uP-FRoNT PAyMENT REquiRED iN MANy cASESUnder a new federal law, taxpayers submitting new offers in compromise must make a 20 percent nonrefund-able, up-front payment in many cases.

The recently-enacted Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) made major changes to the offer in compromise (OIC) program, tightening the rules for lump-sum offers and period-payment offers. These changes became effective for all offers received by the IRS starting July 16, 2006.

An offer in compromise is an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt. The IRS has the authority to settle, or "compromise," federal tax liabilities by accepting less than full payment in certain circumstances.

Under the new law, taxpayers submitting requests for lump-sum OICs must include a payment equal to 20 percent of the offer amount. The payment is nonrefundable and will not be returned if the OIC request is later rejected. A lump-sum OIC means any offer of payments made in five or fewer installments.

Taxpayers submitting requests for periodic-payment OICs must include the first proposed installment payment with their application. A periodic payment OIC is any offer of payments made in six or more install-ments. The taxpayer is required to pay additional installments while the offer is being evaluated by the IRS. All installment payments are nonre-fundable.

Under the new law, taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability qualify for a waiver of the new partial payment requirements.

If the IRS cannot make a deter-mination on an OIC within two years, then the offer will be deemed accepted. If a liability included in the offer amount is disputed in any court proceeding, that time period is omitted from calculating the two-year timeframe.

OIC requests are submitted using Form 656, Offer in Compromise. The form provides detailed instruc-tions for completing an offer and includes all of the necessary financial forms. When submitting Form 656, taxpayers must include an application fee of $150 unless they qualify for the

low-income exemption or are filing a doubt-as-to-liability offer.

A new version of Form 656, revised to reflect the new law, will be posted on www.irs.gov. In the meantime, taxpayers may continue to use the 2004 revision of the form.

guiDANcE iSSuED– DoMESTic PRoDucTioN AcTiviTy DEDucTioNFinal Regulations have been released under Section 199 for the domestic production activity deduction. Rev. Proc. 2006-22 provides methods for calculating W-2 wages for purposes of Sec. 199 deduction for income at-tributable to domestic production activities to 50 percent of the W-2 wages of the taxpayer for the taxable year.

PRESiDENT buSh SigNS biLL EXTENDiNg To PARTNERS STATE TAX EXEMPTioN oN RETiREMENT iNcoMEPresident Bush, on August 3, 2006, signed H. R. 4019 into law, expanding to nonresident retired partners the exemption given to nonresident retired employees from state taxation of retirement income.

H. R. 4019 clarifies the original intent of a 1996 law, Public Law No. 104-95, that prohibits states from taxing nonresident employees' retirement income. The 1996 law eliminated state taxation of nonresident retirement income received from qualified retirement plans, simplified employee pensions, annuity contracts, individual retirement plans, eligible deferred-compensation plans, governmental plans, or other retirement plans or trusts that provided benefits as a series of "substantially equal periodic payments."

The bill was introduced in 2005 to deflect action that the state of New York had taken to tax nonresident partners' retirement income. The state had said partners were not included in the tax exemption created by Public Law No 104-95.

H. R. 4019 also clarifies that adjustments in the retirement amounts that are set in advance in a predetermined formula or adjustments to reflect the cost of living would not cause the plan to fail. It is retroactive to 1996.

ELEcTRoNic FiLiNg oF FoRM 5500 REquiRED by DEPARTMENT oF LAboRElectronic filing requirements for Form 5500 will begin on or after January 1, 2008.

AUGUST/SEpTEmbER 2006 – THE FEDERAL TAX ALERT9

The Employee Benefits Security Administration, Internal Revenue Service and Pension Benefit Guaranty Corporation have proposed changes to Form 5500 to facilitate the compatibil-ity for electronic processing.

Among the proposed changes to Form 5500 is the inclusion of a new short form for small plans whose assets are held in easy-to-value investments with regulated financial institutions. Other proposed changes are to increase the transparency of plan-related fees and expenses, improved information on the funding of defined benefit plans and realignment of the reporting rules of IRC Sec. 403(b) in order to be more compatible with the reporting rules of IRC Sec. 401(k). Additionally, the new system customized the information required to the type of plan involved in the Form 5500 filing.

hEALTh iNSuRANcE covERAgE–S coRPoRATioNSHealth insurance coverage for share-holders owning more than 2 percent of the S corporation is not a tax-free fringe benefit. Instead, sharehold-ers report coverage as additional compensation and then deduct their premiums as an adjustment to gross income on their personal returns.

However, the IRS has warned that the policy must be purchased by the corporation and not by the shareholder individually, according to IRS Headliner Volume 163, May 15, 2006. This is even if state law prohibits a one-shareholder S corporation from purchasing health insurance coverage in the corporate name. Sole proprietors can deduct health coverage as an above-the-line deduction even if purchased in their name and not in the name of the business (IRS Chief Counsel Advice 200524001).

The S corporation must purchase the health care policy and reports the premiums as compensation to the shareholder. The S corporation deducts the compensation and reports this on Form W-2 to the shareholder. The shareholder then reports the compensation as income, but claims the above-the-line deduction to create a wash. The W-2 compensa-tion for this health insurance is not subject to FICA or Medicare for the S corporation shareholder/employee.

If a shareholder purchases coverage in his or her own name, the premiums are deductible only as an itemized medical expense (to the extent medical costs exceed 7.5 percent of adjusted gross income).

Appreciation is extended to NSTP member, Holly Carlin, Park City, Utah, for her concern expressed for tax professionals attempting to understand this provision of the Code.

INSIDE WASHINGTONNATioNAL TAXPAyER ADvocATE RELEASES REPoRT To coNgRESS; iDENTiFiES PRioRiTy iSSuES FoR uPcoMiNg yEAR.National Taxpayer Advocate, Nina E. Olson, delivered a report to Congress identifying the priority issues the Office of the Taxpayer Advocate will address in the coming fiscal year. These issues include the rules governing the use or disclosure of tax return information by return preparers, a recently imposed requirement that taxpayers submitting lump-sum offers in compromise make a down payment of 20 percent of the amount of the offer, IRS guidelines in evaluating "non hardship effective tax adminis-tration" offers, and the importance of safeguarding taxpayer rights as the IRS rolls out its private debt collection initiative.

The Advocate's report, which is required by law, notes that the IRS is under significant pressure both to reduce the tax gap and to maintain and improve taxpayer service. The report commends the IRS for adopting a more strategic approach to these objectives. "I am concerned, however, that the IRS is approaching its taxpayer service and enforcement initiatives on almost entirely separate tracks," Olson writes. "In the IRS today, enforcement employee's work on enforcement initiatives and taxpayer service employee's work on taxpayer service initiatives, and never the twain shall meet."

FARM PRogRAM PAyS $1.3 biLLioN To PEoPLE who Do NoT FARMEven though Donald R. Matthews put his sprawling new residence in the heart of rice country, he is no farmer. He is a 62-year-old asphalt contractor who wanted to build a dream house for his wife of 40 years.

Under a federal agriculture program approved by Congress, his 18-acre suburban lot receives about $1,300 in annual "direct payments," because years ago the land was used to grow rice.

Matthews is not alone. Nationwide, the federal government has paid at

least $1.3 billion in subsidies for rice and other crops since 2000 to individuals who do no farming at all.

The checks were intended 10 years ago as a first step toward eventually eliminating costly, decades-old farm subsidies. Instead, the payments have grown into an even larger subsidy that benefits millionaire landowners, foreign speculators and absentee landlords, as well as farmers.

Most of the money goes to real farmers who grow crops on their land, but they are under no obligation to grow the crop being subsidized. They can switch to a different crop or raise cattle or even grow a stand of timber and still get the government payments. The cash comes with so few restrictions that subdivision developers who buy farmland advertise that homeowners can collect farm subsidies on their new back yards.

The payments now account for nearly half of the nation's expanding agricultural subsidy. What began in the 1930s as a limited safety net for working farmers has swollen into a far-flung infrastructure of en-titlements that has cost $172 billion over the past decade. In 2005 alone, when pretax farm profits were at a near-record $72 billion, the federal government handed out more than $25 billion in aid, almost 50 percent more than the amount it pays to families receiving welfare.

FYINSTP ATTENDS bi-MoNThLy iRS LiAiSoN MEETiNgThe July meeting held by the Office of National Public Liaison for the IRS opened with information regarding the recent flooding of the main headquarters building of IRS in Washington DC. It was noted that the building would not be reoccupied until some time in 2007 and that IRS employees had been distributed in various sites including the IRS facility in New Carrollton.

The Director, Office of Privacy and Information Protection, presented information concerning loss of taxpayer privacy, citing since January 1, 2006 almost 25 percent of the U. S. population has been impacted by a loss of personal information at some level. Since the Veteran's Ad-ministration data loss, the Office of Management and Budget has been providing guidelines and check lists that include how to function: encryption issues, lap top use and paper flow. Privacy and theft of information is a developing area.

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 200610

Government agencies and the people involved realize that they can not do things the way they have been done in the past. The technology of the 21st Century is requiring everyone to look at our professional lives differently and be prepared to change the way we are doing business.

Elizabeth Boyd, Marketing & Brand manager, Electronic Tax Administration reported that the ELECTRONIC IRS is more than just e-file. On line you can Google and type: What is the Electronic IRS and you will be taken to the home page which lists all the electronic options available to taxpayers, businesses, tax professionals and others.

Pam Walker, Chief, Individual Maser File Policy & Procedures Branch, discussed the new refund initiative that is in place for the next filing season. Taxpayers will now be able to direct their refunds to three different accounts on a yet to be released Form 8888. Ordering rules, if the requested refund amount was changed by he IRS, either increase or decrease, the change would first go to the lowest account listed on the form and then to the second account and then to the first account. A direct deposit of a refund can be made to any bank account and not just to the person receiving the refund. Offsets to refunds not initiated by IRS, such as student loans, etc., are taken from the first account with the lowest routing number.

Janice Hedemann, Director of Research reported that the estimates of the cost of tax preparation included in the IRS tax booklet to taxpayers would be published in the Federal Register.Dr. William (Bill) Stevenson, NSTP Member - NY

iRS AND SSA ANNouNcE FouR chANgES To ELEcTRoNic FiLiNg1. New Batch Provider Software for Tax Professionals Available from EFTPSTax professionals that prepare and pay federal taxes for clients or multiple Taxpayer Identification Numbers (TIN), have a secure, easy and convenient way to make up to 1,000 payments in one transmis-sion using the newly updated Batch Provider Software from the Electronic Federal Tax Payment System (EFTPS).

The latest version of the popular free software contains many enhance-ments designed to make paying easier:

Send up to 1,000 enrollments and 5,000 payments in one transmission;

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Use memorized transaction capability where the last transaction is automatically displayed for each EIN/SSN;Make individual debits to a Master Account or clients' account (or use both);Send clients a Taxpayer Inquiry PIN so they can look at their accounts online;Synchronize enrollments and payment history between the software and the EFTPS database in real-time;Import/export enrollments and payments; andCreate customized reports.

2. Social Security Requires Elec- tronic Filing Beginning with Tax Year 2006 W-2s.If your company now files W-2s with Social Security on diskette you will be required to file electroni-cally starting in tax year 2006 (W-2s due in calendar year 2007), as Social Security will no longer accept diskettes. Similarly, as of tax year 2005, Social Security no longer accepts W-2s filed on magnetic tape and cartridge.

Companies that file on magnetic tape, cartridge or diskette format their reports according to Social Security's Magnetic Media Reporting and Electronic Filing format (MMREF). Filing electronically uses the same MMREF format, so re-programming is not necessary. All you need to do is follow your same year-end process, up to the point where you would copy the W-2 report onto a tape, cartridge or diskette and mail it to Social Security.

Instead, you will log onto the Social Security Web site and upload the file. It is that simple. For security purposes, you will need to register first for a PIN and password.

3. Electronic Data Exchange (EDI) and Proprietary Formats for Elec-tronically Filed Forms 940 and 941 to be discontinued.The Internal Revenue Service recently announced plans to discontinue the acceptance of electronically filed Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return and Form 941, Employer's Quarterly Federal Tax Return, that are transmitted in the EDI and Proprietary formats. Partici-pants currently using the EDI and Proprietary formats can transmit Form 941 for the 3rd Quarter until November 13, 2006. After that time, the IRS will no longer accept e-file transmissions in these formats.

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Decline in use of these formats, combined with increasing costs to maintain these formats, prompted this decision. This decision is also necessary as part of the IRS' efforts to provide a more modernized and efficient method of receiving Form 940/941 returns.

The IRS will continue to support the Employment Tax e-file System which utilized the Extensible Markup Language (XML) standard for the transmission of Forms 940/941. The Employment Tax e-file System provides greater flexibility for filing Forms 940/941 electronically.

4. IRS to Eliminate 31/2-inch Diskettes.Effective January 1, 2007, the Internal Revenue Service Enterprise Computing Center in Martinsburg, West Virginia will no longer accept information returns filed on 3 1/2-inch diskettes.

Filers are encouraged to file elec-tronically on the internet using the FIRE (Filing Information Returns Electronically) system at http://fire.irs.gov. Some advantages of filing electronically are:

Paperless Form 4804 is not required;Secure Socket Layer - 128-bit encryption;More attempts than magnetic media filing to replace bad files within a specific time frame before imposing penalties;Better customer service due to on-line availability of transmit-ter's files for research purposes;Extendable due dates for elec-tronically filed Forms 1098, 1099 and W-2G;Longer period to test electronic files; andAvailable results available within 1-2 workdays regarding the acceptability of the data transmitted.

Additional information on the electronic filing of information returns can be found in Publication 1220, Specifications for Filing Forms 1098, 1099, 5498 and W-2G electroni-cally or magnetically or call 866-455-7438 with questions.

w-2 oNLiNE: AN ELEcTRoNic FiLiNg oPTioN FoR SMALL buSiNESSAn electronic filing option is now available for small businesses. It is a secure internet service that allows you to prepare and submit up to 20 W-2s at a time.

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All you need is a:Personal computer with internet access and a printer;Copy of Adobe Acrobat loaded on your personal computer; andWeb browser set up to accept a "cookie" and capable of "128-bit encryption".

Follow four simple steps to file:Go to: www.socialsecurity.gov/employer and click on "Business Services Online."To get a Personal Identification Number (PIN) and password, click on registration and follow the instructions.Click on "Login" and give your PIN and password.Create W-2s under the heading "Create W-2s Online" on the next screen.

In using Social Security Business Services Online, Social Security advises:

You will have more time to spend on your business. Electronic filers have until March 31 to file, a full month later than other filers;Freedom from paper, forms, typewriters;Electronic receipts you can use as proof that you filed on time;W-2s for your employees and your records; andTracking of your W-2 report as it is processed.

Business Services Online is available the first week of January through the last day of March.

Receive more information about filing W-2s online by calling 1-800-772-6270.

TAX COURT DECISIONSbyER AND AKSENovA v. coMMiSSioNER T.c. SuMMARy oPiNioN 2006-125 AuguST 2, 2006Statutory Employee assertion, disal-lowance of expense and IRC Section 6662(a) accuracy related penalty.

A tax deficiency of $11,746 for the tax year of 2000 is determined along with an accuracy-related penalty under IRC 6662(a) of $2,298.

Issues for decision: 1) Whether, for the year at issue, Byer was a statutory employee as a full-time life insurance salesman, 2) whether Byer is entitled to deductions for disallowed trade or business expenses incurred in connection with the insurance activity and 3) whether Byer and Aksenova

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are liable for the IRC Section 6662 (a) accuracy-related penalty.

Byer is an attorney who was previously employed as an auditor by the IRS from 1987 to 1999. During 2000, Byer was engaged in an income-producing activity with Corben Financial Services selling insurance, primarily life insurance.

For 2000, Byer and Aksenova filed a joint tax return reporting gross income from Corben Financial Services of $61,100 and a net income of $18,278 after expenses. No self-employment tax was included on the return.

Byer asserted that he was not self-employed but rather an employee of Corben and was not subject to the self-employment tax. The Court found under IRC 3121 (d) (3)(B), section 31.3121(d)-1(d)(3)(ii), Employment Tax Regs., defines a "full-time life insurance salesman as:

An individual whose entire or principal business activity is devoted to the solicitation of life insurance or annuity contracts, or both, primarily for one life insurance company is a full-time life insurance salesman.

Byer named at least six different insurance companies from which he placed insurance for clients during the trial.

On Schedule C, expenses of Car and Truck expense, Meals and Enter-tainment, Repairs and Maintenance, Travel and Legal and Professional as well as Other expenses were disallowed by IRS.

Byer offered, at trial, envelopes of receipts which he stated were sufficient to substantiate the deductions.

The Court found Byer to be a self-employed insurance salesman subject to self-employment tax. Ad-ditionally, citing that Byer, being a former IRS auditor, knew the require-ments of record keeping and the Court disallowed all the Schedule C deductions. Again citing that Byer is an attorney with a specialized degree in tax law who was employed as an auditor by the IRS for several years and that with his education, knowledge and experience, the Court disallowed the request for reasonable cause and applied the 20 percent accuracy-related penalty.

buLLocK v. coMMiSSioNER T. c. MEMo 2006-139 JuLy 5, 2006Taxpayer files Tax Court Petition to delay, fined $7,500 by Court.

A tax deficiency of $6,896 plus additions to tax of $2,230 for tax year

2002 was determined based upon Bullock's failure to file a Federal Income Tax Return from wages earned from Delta Air Lines.

This was the third case in which Bullock petitioned the Tax Court. It was also the third time that Bullock did not appear at the trial.

Citing IRC Section 6673(a)(a) authorizing the Tax Court to require a taxpayer to pay to the United States a penalty not in excess of $25,000 whenever it appears that proceedings have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position in such proceeding is frivolous or groundless, pursuant to section 6673, the Court nevertheless will take this opportunity to admonish Bullock that the Court will consider imposing such a penalty should she return to the Court and advance similar arguments in the future.

Bullock had been on notice since at least 2001 that her arguments concerning her income and her liability for income tax were frivolous.

The Court concluded that it is apparent that Bullock's tactics in filing petitions in Court are primarily for delay and that she intends to pursue only frivolous arguments.

The Court found that a motion for judgment by default will be granted. The decision will include an award of a penalty to the United States in the amount of $7,500 under section 6673.

bRANDoN v. coMMiSSioNER T. c. SuMMARy oPiNioN 2006-98 JuLy 5, 2006Taxpayer's loss of dependency exemption, head of household status, earned income tax credit and child care credit.

At issue; a tax deficiency of $3,677 for taxable year 2003.

During taxable year 2003, Brandon lived in various locations including not only New Jersey but Florida and Brooklyn, New York. Brandon was single throughout the taxable year of 2003.

In either late 2002 or early 2003, a fire destroyed an apartment building where Brandon's sister resided with her three minor children. After the fire, the eldest child came to live with Brandon at his home in Newark, New Jersey. During this time, Brandon assisted his nephew by providing food and shelter and on some occasions, financial aid. While neither of the nephew's parents provided any support some financial assistance was provided by Brandon's mother

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 200612

and grandmother for the support of the nephew.

Brandon's wage income in 2003 was $16,878. Filing his 2003 U. S. Individual Federal Income Tax Return, Brandon claimed his nephew for the dependency exemption, earned income tax credit and child credit. Additionally he filed with head of household status.

The Court noted that the burden of proof shall be upon the petitioner; however in certain circumstances if the taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the proper tax liability, section 7491 places the burden of proof on the Commissioner.

the COurt fOund as fOllOws:Dependency Exemption - Brandon has not kept records of how much he spent on the nephew, nor could he reconstruct for the Court a dollar amount of total support provided for his nephew. Petitioner also testified at trial that other family members, including his mother and grandmother, provided financial support for the nephew, although he could not offer an accounting for these funds. Because petitioner failed to establish the total amount of support from all sources, the Court is unable to conclude that petitioner provided more than one-half of the total support for the nephew and therefore the Court sustained the respondent on the issue.

Head-of-Household - The Court already held that petitioner is not entitled to the dependency exemption deduction pursuant to section 151 with respect to the nephew. It follows; accordingly, that petitioner is not entitled to head of household filing status. Therefore, the Court sustains respondent's determination with respect to this issue.

Earned Income Credit - Although the Court finds petitioner's testimony credible that the nephew did reside at his residence in Newark, New Jersey, for a period of time in 2003, petitioner did not offer into evidence any documentation or any testimony to establish that such period was more than one-half of the year.

Child Tax Credit - The Court had already held that petitioner is not entitled to the dependency exemption deduction under section 151 for the nephew. Accordingly, the nephew is not considered a "qualifying child" within the meaning of section 24(c).

The Court overwhelming sustained the respondent's determination in the case.

ET CETERATiPS To iMPRovE youR cREDiT ScoREFreddie Mac and the three major credit bureaus; Equifax, Experian and TransUnion offer the following tips on improving your credit rating:

Pay bills on time.If you miss a payment, get current and stay current.Know that paying off a collection account does not remove it from your credit report. Most negative information stays on your credit report for 7 1/2 years but bankruptcy stays on your report for 10 years.If you have trouble paying your bills, contact your creditors or see a legitimate credit counselor. Your creditors may be willing to settle, negotiate a payment plan, or lower your interest rate.Keep balances low on credit cards. Lenders prefer to see no more than 30 percent of your available credit used at one time.Do not have too many credit cards. Three is considered a good number and do not max them out.Pay off debt. Do not move it around.Do not close unused cards as a short-term strategy to raise your credit score. Lenders like to see some available credit.Do not open a lot of accounts too rapidly.Know that it is alright to request and check your own credit report.Rate shop for a loan within 30 days since all inquires count as one within that time frame.Keep a permanent address if possible. Lenders like stability. If you have moved around a lot or change jobs often, lenders might think you are a credit risk.

FiNANciNg coLLEgE 101Funding college is one of the largest expenses for many families. Even students who apply early for financial aid often are still scrambling to find enough money to cover college expenses. U. S. Families will need $36 billion, after using financial aid awards and personal savings, to fund college costs in 2006, according to SimpleTuition Inc., which tracks private student loan rates.

Students can find unclaimed schol-arships now by calling local donors, service groups and associations. The

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most desirable scholarships to apply for are local and regional scholar-ships because there is less competition for the dollars.

Other last-minute tips include:Do not try to fund all expenses upfront.Tap home equity, which may be tax-deductible, before borrowing from retirement accounts.Crunch budget to cut enter-tainment and other non-basic expenses, including insurance premiums, to free up income.Have student work on or near campus, where salaries tend to be higher, to cover some costs.Check for employee tuition assistance programs.Set up a monthly payment plan at the university.Start at a community college, which typically charges half the tuition of a four-year public institution.

how To wRiTE A buSiNESS PLANMany small business owners put off writing a formal business plan. However a smart business plan can be a real asset. The following six points, written up, will form a good basis for a business plan:

Be Clear on Your Purpose. Sounding simple, this directive often has business owners at a loss for words. Craft an executive summary that is clear and concise. The mission statement of the business as well as the value of the business should be descriptive when conveyed to a bank or investor.Calculate the Return on Investment. Investors want to know how they will profit from their investment including what variables will affect the projected numbers positively or negatively.Size Up the Competition. Small business owners rarely back away from a fight although when they put together a business plan they have a tendency to shy away from rivals. If you sell your competition short it may indicate that you do not fully understand the market place. Include a few pages of information in your business plan which identifies your competition and the plans to position the business in a positive, competitive manner. Focus on trends and areas of the market in which you can capitalize and where the competition is lacking.

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Get Help. Reach out to trustworthy advisors to provide you feedback on your business plan. The more input from smart people, the better. Think Large. Portray your idea in grand scale. Do not be shy. After laying the ground-work for the business project over-whelming success based upon a foundation of research and sound business principles.Display your Enthusiasm. Investors look for intellectual honesty and if they read a business plan that is exciting and financially sound they will make the determination that investing in your small business will equally be exciting and Financially sound.

ShouLD KiDS bE LEFT FoRTuNES, oR bE LEFT ouT?Actor and playwright Stephen Lang remembers when at 7 or 8 years old he asked his father to buy him a toy submachine gun.

The request was not extravagant. His father, Eugene Lang, was on the way to becoming a multimillionaire as the founder of patenting firm Refac Technology Development. But rather than buy Stephen the toy, Eugene suggested they donate what it would cost to charity if it went to a boys' home.

The gesture made an impression to this day and he does not seem to mind that his 87-year old father intends to leave most of his wealth to charity.

When Warren Buffett pledged $31 billion to the Bill & Melinda Gates Foundation in June 2006 he rekindled a debate among the rich over inheritance: whether it is better to limit what you pass on and not spoil your heirs or let them inherit the wealth and build on it.

Actors Joan Crawford and Marlon Brando wielded their money like a weapon from the grave, leaving some of their children nothing at all. Lang and Buffet are among those who say they chose to pass on modest amounts out of concern for their children's future.

PLAN FuNERAL Now To hAvE ThE FiNAL woRDThe average cost of a funeral is $6,500 but some can go up to $20,000

"Planning your own funeral eases the burden for families," says Robert Biggins, president of the National Funeral Directors Association.

A federal law known as the Funeral Rule is designed to protect consumers from unscrupulous

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funeral home operators. The law includes the following:

A funeral home must provide you with an itemized price list of its products and services including fees for professional services, transportation and care costs as well as obituary notices.If state or local law requires you to buy a particular service, the funeral provider must disclose it on the price list, along with a reference to the law.When you visit a funeral home, the director is required to show you a list of caskets the company sells, along with descriptions and prices, before showing you the caskets. If you buy your casket from somewhere else, the funeral home cannot refuse to provide services.If you want a direct cremation, which means there will be no visitation or viewing, the funeral home cannot require you to buy a casket.Funeral homes are barred from requiring embalming if you plan to be buried or cremated shortly after death. Except in certain cases, embalming is not required by law and funeral homes must disclose that fact to potential customers.

Many funeral homes allow individuals to pay in advance for their funerals. These prepaid plans appeal to people who prefer not to burden their families with funeral costs. These plans are not covered by federal law and state regulation is not uniform.

Once you have decided on your final arrangements, write a letter of instruction for your survivors. Include in the instructions what type of service or memorial you desire.

TAX REP ROUNDTABLETax Rep Roundtable is a new feature in the Federal Tax Alert specifically for tax professionals who represent taxpayers before the Internal Revenue Service.

iNTEgRATED coLLEcTioN SySTEMIntegrated Collection System (ICS) logs are available for up to three years after the case has been closed on the ICS. They are maintained on the ICS active database for six months after the case is closed. After six months, the case history is moved to the ICS archive database and two and

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one-half years later it will be deleted from the archive. The ICS case history is accessible through a freedom of information (FOIA) request.

FoRMS �33F AND �33A– uTiLiTy EXPENSESWhen practitioners or taxpayers call ACS, Automated Collection System, with completed Forms 433F, Collection/Information Statement ACS, or 433A, Collection Information Statement for Wage Earners and Self-Employed Individuals, the ACS assistor requests a breakdown of the utility expenses such as gas, electric, water. This is requested even though both Forms 433 ask for a combined figure for utilities. In some instances, ACS requests the practitioner or taxpayer to call back with the breakdown. This creates frustration and additional burden for the caller. This resulted from a 2005 ACS update that changed the assistor's screen prompts to include asking for separate amounts for each type of utility.

chEcK-ThE-boX DESigNATioN Tax professionals have complained the third party designation should be extended to no fewer than 24 months to allow for resolution of potential CP 2000 notices by their clients. Notices are usually received after the 12-month period and the tax professional felt the subject matter is appropriate for the third party designee.

The IRS will not extend third party designations from 12 to 24 months. The original intent of allowing 12 months was that it be used during the initial processing of the return. After a year, the likelihood is that outstanding matters would involve audit or collection activities rather than processing issues. The IRS does not want to put their employees in a position where they might erroneously allow designees to practice before the IRS based upon these authorizations. CP2000 notices are sent with a taxpayer response page included. That page has an area to authorize someone, in addition to the taxpayer, to discuss and give information pertaining to proposed changes to the IRS notice.

ESTiMATED TAX PAyMENTS–hiSToRy AvAiLAbiLiTy oN iRS.gov.This option is currently available only to taxpayers enrolled in EFTPS. Taxpayers get 16 months worth of payment history when they make their tax payments elec-tronically through EFTPS. The IRS

THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 20061�

is conducting a feasibility study of providing tax return and tax account information, including payments, for viewing on-line via irs.gov. The new option should be available for all taxpayers in the 2008/2009 timeframe.

iRS LAuNchES oNLiNE PAyMENT AgREEMENT APPLicATioNTax professionals are helping to launch a new system that will allow many individuals who owe delinquent federal taxes to apply online for a payment agreement.

The IRS is implementing the new Online Payment Agreement (OPA) application through national part-nerships with he tax professional community. Members of tax profes-sional organizations are using OPA to apply for payment agreements for clients who owe taxes. This application will eliminate the need to write or call the IRS toll-free number for assistance. When fully implanted, OPA will provide an easier way for taxpayers on their own or with the help of tax professionals to voluntarily resolve tax liabilities.

"This new system reduces taxpayer burden by providing the convenience of online service during extended hours and on weekends," said IRS Commissioner Mark W. Everson. "Taxpayers can set up an agreement and arrange for payment options including automatic payments through direct debit or payroll deduction."

The IRS estimates that 90 percent of taxpayers who qualify for a payment agreement will be able to obtain one through OPA once the application is available to the general public later this year.

The link to the new OPA application is not available on www.irs.gov. However it is accessible at https://sa.www4.irs.gov/irfor/IRServlet?app=EIA&type-POA.

This link is direct to the POA page bypassing the introductory pages. The Power of Attorney is required to have all balance due tax periods covered by the Form 2848. Addition-ally, all required tax returns must be filed. In order to access OPA, the caller ID number from the IRS notice will be required.

iRS SMALL buSiNESS AND SELF-EMPLoyED hoLDS coLLEcTioNS MEETiNgIRS representatives from the Small Business and Self-Employed operating division recently held a compliance teleconference with tax profession-

als. Discussion centered on Field Collection Policies.

Since RRA 98, collection has been down by greater than 20 percent. In 2005, changes in collection policy as well as procedures and training have increased current collection activity to pre RRA 98 levels.If the taxpayer has a representa-tive, evidenced by a Form 2848 on file with IRS, the Revenue Officer is obligated to attempt to call the Power of Attorney. If the deficiency is for a period of time that the POA does not have authority, the RO is to try and contact the tax professional and notify them of the issue. However the RO is not required to contact the POA over such a matter.IRM 5 - Collection Policy 5.1.10.3 requires a "face to face" meeting with the taxpayer, citing the taxpayer can resolve issues when the Power of Attorney cannot. Recognizing the POA often does not want the taxpayer to meet with IRS, meeting with the POA may be sufficient for IRS. However in the case of the Trust Fund Recovery Penalty, the IRS will require a meeting with the taxpayer.The IRS requests and recommends tax professionals meet with the Manager before filing a Collection Due Process hearing request.Regarding the procedure of "bypassing" a Power of Attorney, the IRS stated that the procedure would be implemented when deadlines set were not repeatedly met by the representative.

BOOK REVIEWSo, Who DieD anD Left You in Charge?!John C. Haugner, Jr. S. 15 W. 37060 Willow Springs Drive Dousman, WI 53118 $47.00 including shipping

A time-saving guide created to hold the data you will need to close out an Estate, forms to guide you on your journey plus a few dozen helpful hints to simplify and shorten the process.

Finding the information requested by this guide will save you much "waiting around time" where the whole process of getting the estate settled can be delayed while you

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petition to find a duplicate of some required form or title.

This guide is an excellent resource for the tax professional and can serve as an appreciation gift to your clients.

ETHICS CORNERENRoN'S LAy DiES oF hEART ATTAcKKenneth L. Lay, who catapulted Enron Corp. into the ranks of the nation's largest companies only to be convicted of fraud after its collapse, died after suffering what a family spokeswoman said was a heart attach at a rental property in Old Snowmass, Colorado.

Lay, 64, faced the prospect of spending the rest of his life in prison after a Houston jury found him guilty of conspiring to inflate the energy company's stock price and misleading investors and employees who lost billions of dollars in its 2001 bankruptcy.

Lay's death all but ensures that defense lawyers will seek to throw out his criminal conviction and casts serious doubt on the ability of the government and investors to recover money from the Lay estate. Lay's death complicates prosecutors' request for a $43.5 million money judgment against him because it is not clear whether the government can seek restitution against someone who has died.

Exactly how much money is in the Lay family coffers remains as much in dispute as the man's legacy? Earlier this year, Lay testified during six sometimes -combative days that his personal debts had mounted to nearly $100 million in his final year at Enron. He told the jury that he and Linda, his second wife of two dozen years, had sold lavish properties in Aspen, Colorado and Galveston, Texas but were still $250,000 in the hole.

LAy'S DEATh couLD PRovE EvEN MoRE coSTLy To JEFFREy SKiLLiNgFederal prosecutors want former Enron Corp. CEO Jeffrey Skilling to turn over nearly $183 million for helping perpetuate one of the biggest business frauds in U. S. history, his alleged share and that of his late co-defendant company founder Kenneth Lay.

The government originally had split that amount between the two former corporate titans, who were convicted in May 2006 of charges including fraud and conspiracy at the close of a four-month trial.

AUGUST/SEpTEmbER 2006 – THE FEDERAL TAX ALERT15

Prosecutor's say that with his conspiracy conviction, Skilling is "liable for all the proceeds attribut-able to all co-conspirators, indicted or unindicted, including Lay."

ciRcuLAR 230 AND ThE EThicS oF ThE TAX PRoFESSioNALAt the 2006 IRS Nationwide Tax Forums, the following scenarios were presented in panel format. On day two of the Forum, NSTP was represented on the panel by the Executive Director along with members from the AICPA and AAA/CPA.

The scenarios are composed of facts that have come to the attention of the Office of Professional Responsibility.

Scenario #1 - Tax ComplianceAndrew, a Circular 230 sole practitio-ner, had sufficient income to trigger a filing requirement for the years in question. For 5 years, Andrew failed to file his personal income tax returns on time. When contacted by the Office of Professional Responsibility, Andrew responded by stating that he never intended to defraud the IRS by pointing out that his returns always showed a refund. Andrew also offered as a mitigating factor the fact that his clients' were always filed timely and all stood up to audits.

Andrew also had compliance issues with his Quarterly Federal Tax Return (Form 941) for several quarters. He failed to timely file his 941 and had balances due and owing.

Circular 230 - Section 10.51 (f) - Willfully failing to make a Federal tax return in violation of the revenue laws of the United States.

faCtOrs tO COnsider:1040 issues: A refund does not relieve the practitioner from the duty to file timely all tax returns. Willfulness does not require proof of any motive other than an intentional violation of a known legal duty. The practitioner knew of his legal duty to file his tax returns on time but did not meet his legal requirement and established a pattern of filing late returns.

941 issues: The OPR views compliance and monies owing on 941's very seriously.

Scenario # 2 - Conflicts of InterestA practitioner has prepared the corporate and personal returns for the owners of a corporation for several years. The owners are a married couple who filed joint returns since they became the practitioner's client several years ago. As with previous years, the practitioner met with both the husband and the wife to go over their tax

information. During the meeting, they informed the practitioner that they are in the process of getting a divorce but that they agree on how their taxes should be filed, and that they would both like him to continue representing them individually.

CirCular 230 issues:Conflict of InterestDue Diligence

faCtOrs tO COnsider:Does the divorce present an actual conflict of interest situation or is there a potential for a conflict of interest? What is proper due diligence in this situation and how is the divorce going to affect his ability to prepare the corporate and the personal returns for the past year and future tax years? Do they have any children? Who is going to be involved in the corporation? The current conflict rules allow the clients to waive the conflict if the practitioner informs the clients of the conflict and the client gives informed consent, confirmed in writing. Under the proposed rules, the practitioner is required to obtain the consents in writing "at the time the existence of the conflict of interest is know by the practitioner." Under the proposed rules, the practitioner is required to obtain the consents in writing prior to representing clients with conflicts of interest. If the parties do not agree to the waiver, the practitioner should consider withdrawing representation from all returns.

Scenario # 3 - Disreputable ConductRevenue Agent Jay request support for a certain deduction taken on a taxpayer's return. Bob, a Circular 230 practitioner representing the taxpayer, submits a series of confusing and complex schedule to Jay. Jay still does not understand how the deduction was calculated and he asks Bob to explain the calculation further in a face-to-face meeting.

During the meeting, Bob states repeatedly and in a loud voice that Jay is "an idiot" and should be removed from the case.During the meeting, Bob states that his client will sue the IRS for damages based on the way the IRS has treated the client in this matter.During the meeting, Bob tells Jay that if Jay does not approve the deduction Bob will file a section 1203 complaint against Jay and Jay will lose his job. This is not the first time that

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Bob has used this tactic with IRS personnel and Bob knows he has no real basis for such a complaint.After the meeting, Bob contacts Jay's supervisor to complain that Jay is incompetent and Bob demands that a different Revenue Agent be assigned to the case. Subsequently, Bob refuses to respond to Jay's telephone calls or requests for more information.

CirCular 230 issues:False or misleading informationAbusive languageUnreasonable delayThreats or coercion.

faCtOrs tO COnsider:Have Bob and Jay worked together on any prior cases?Does Bob have a history of abusive behavior with IRS personnel?Did Bob go through proper channels to make his complaints known?

The Office of Professional Responsibil-ity will consider all facts of the case before taking any action against Bob.

MEMBERS ASKhow To SuRvivE AN iRS AuDiTWhat happens when the IRS wants more from your taxpayer than just a tax return?

If your client receives notification of an IRS office audit, knowing what to do next can be the difference in whether or not you and your client survive the IRS exam.

Number 1– Do not ignore the IRS notice. Normally the taxpayer is given thirty days to respond to an IRS audit notice. Failure to respond to the notice could result in IRS automati-cally adjusting the tax liability.

Number 2– Read the audit notice carefully and understand what items on the tax return are being questioned. The notice will identify items the Revenue Agent is requesting be brought to the audit. This document is called an IDR, Information Document Request, Form 4564.

Number 3– Only bring the required documents to the audit. Revenue Agents are not interested in other issues, usually, unless you bring them up. Use adding machine tapes to

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THE FEDERAL TAX ALERT – AUGUST/SEpTEmbER 200616

provide totals of items reflected on the tax return.

Number 4– Come prepared to the audit. Having thoroughly reviewed the tax return for the year in question, be ready to answer questions the Revenue Agent will address.

Number 5– If you find the Revenue Agent (auditor) is unreasonable and you and the Revenue Agent cannot reach an agreement, ask to speak to the Revenue Agent's supervisor in order to calmly explain the situation and ask for the Manager's assistance. It is their job, however, be aware, the Manager does have the authority to expand the scope of the audit.

To avoid an IRS audit, consider the following:

Be careful with deductions. A favorite target of the IRS is the home office deduction. In order to qualify for a home office deduction, your office needs to be your "principal place of business" and used "regularly and exclusively" for business.Where you live vs. your income. A red flag for audit is when you live in a very high-income area but only claim that you earn $20,000 in income. Also, if your income is much lower than last year's taxable income, the IRS will wonder where you are hiding the money and will want to investigate.Avoid inconsistencies. If there are inconsistencies in return year reporting, the IRS computers will catch them. Also, make certain you report the same information on your federal taxes that you filed on your state returns.File neat, mathematically correct returns.Report all your income. While some people are tempted to be dishonest and will ask you your opinion of their chances of audit on a tax return, Circular 230 Federal Code of Regulations guides us to respond, "It is not about an audit game, it is about the filing of a complete and accurate tax return."

Avoid Tax Return Preparer Fraud Return Preparer Fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. Preparers may also

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manipulate income figures to obtain fraudulent tax credits, such as the Earned Income Tax Credit.

In some situations, the taxpayer may not have knowledge of the false expense, deductions, exemptions and/or credits shown on their tax returns. However, when the IRS detects the false return, the taxpayer must pay the additional taxes and interest and may be subject to penalties and criminal prosecution.

The IRS Criminal Investigation Return Preparer Program (RPP) focuses on enhancing compliance on the return-preparer community by engaging in enforcement actions and/or asserting appropriate civil penalties against unscrupulous or incompetent return preparers.

The IRS offers the following suggestions to taxpayers when choosing a return preparer:

Avoid tax preparers who claim they can obtain larger refunds than other preparers.Avoid preparers who base their fee on a percentage of the amount of the refund.Use a reputable tax professional that signs your tax return and provides you with a copy for your records.Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed.Review your return before you sign it and ask questions on entries you do not understand.No matter who prepares your tax return, you are ultimately responsible for all of the information on your tax return.Never sign a blank tax form.Do you know anyone who has used the tax professional?Were they satisfied with the service they received?

As tax evasion is a risky crime, a felony, punishable by 5 years im-prisonment and a $250,000 fine, taxpayers hearing claims from preparers offering larger refunds than other preparers are encouraged to check it out with a trusted tax pro-fessional or the IRS before getting involved.

QUOTES OF THE MONTH"Wealthy parents should leave their children with enough money to do

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anything they want but not so much that they are doomed to do nothing at all."

Warren Buffett

"As a result, employees may be browsing their spouses' or other employees' tax information with little chance of detection,"

Treasury Inspector General (report)

"IRS audit rates are far below the historical highs, but the individual rates rose from 0.77% in 2004 to 0.93% in 2005. These figures include all kinds of audits, letters, in person and field."

Barbara Haas, NC NSTP Member

"The dream I lived became the American nightmare".

Ken Lay, Enron Founder

"The building will be closed for an extended period of time, and we will reoccupy it only when it is safe to do so."

Mark W. Everson, IRS Commissioner

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