FEDERAL TAX ALERTNEWS ITEMSAMERICAN RED CROSS APPOINTS NEW PRESIDENT AND CEO— FORMER IRS COMMISSIONER, MARK W. EVERSONThe American Red Cross Board of Governors has unanimously approved Mark W. Everson, currently serving as Commissioner of Internal Revenue, to become the next president and CEO of the Red Cross, effective May 29, 2007. The vote was taken at a regularly scheduled meeting of the full Board.

"On behalf of the entire Board, the Red Cross is delighted to welcome such a capable and compassion-ate leader whose proven experience and leadership skills will bring valuable expertise to better prepare the American Red Cross to prevent, prepare and respond to the nation's critical needs," said Bonnie McElveen-Hunter, Chairman of the Red Cross. "We know Mark will bring new energy and drive terrific results when his tenure officially begins in May."

"It is an honor and a privilege to become part of such a vital and enduring humanitarian service or-ganization. The Red Cross reaches out to those in need in communities across the nation and around the world," said Everson. "I look forward to working with the outstanding volunteers, staff and Board during this defining period in the history of the Red Cross."

SURVEY SHOWS TAX ATTITUDESMost people file their tax returns elec-tronically because it is convenient; despite lingering concerns about the security of their most sensitive financial information according to a new Associated Press poll.

Half of the people surveyed reported using a professional tax preparer to file their returns, a quarter use a software program,

15 percent do the returns the old-fashioned way with pen and paper and 8 percent ask a friend or family member for help, according to the survey conducted by Ipsos, an inter-national polling firm.

And almost half complain that their taxes are unfair.

"When I look at my paycheck and see how much goes out, it makes me sick," said Kimberly Hahn, a nurse from Bloomington, Indiana. "It is like you are paying to charity without deciding where it is going."

54 percent of tax filers say their returns are sent electronically and that number is rapidly growing. Most say e-filing is "very convenient" but people are less convinced it is very safe.

More than six in 10 who were polled in early April said they already had filed their taxes. The average time spent in preparing their returns was just more than eight hours. Only about one in ten admitted to being a procrastinator who would barely make the filing deadline.

Those expecting refunds were much more likely to have filed their returns early.

Two-thirds of those polled expected to get a refund back. The most popular use of tax refunds is to pay off bills or to pay down debt, followed by saving the money or investing it.

More than half of those polled, 53 %, said they think their taxes are fair, according to the poll of 1,000 adults. It had a margin of sampling error of plus or minus 3 percentage points.

Middle-income earners were more likely to feel the taxes they pay are fair than those with high incomes and those with low incomes, who were about evenly split on the question.

UNPAID TAXES TOUGHTO RECOVERJudging from his tax returns, Dinh Kim Huynh was not getting rich in the manicure business. In 2000 Huynh and his wife claimed taxable

CONTENTSFrom the Editor . . . . . . . . . . . . 2IRS Action News . . . . . . . . . . . 4Tax Law Update . . . . . . . . . . . . 7Inside Washington. . . . . . . . . . 8 FYI . . . . . . . . . . . . . . . . . . . . . . 9Tax Court Decisions. . . . . . . . 10Et Cetera . . . . . . . . . . . . . . . . 11Book Review. . . . . . . . . . . . . . 12Tax Rep Roundtable. . . . . . . . 12Ethics Corner. . . . . . . . . . . . . 13Members Ask . . . . . . . . . . . . . 15Quotes of the Month . . . . . . . 16

INSERTS■ Regional Conferences■ Special Topics Workshop■ May Membership Madness

A PUBLICATION OF THE NATIONAL SOCIETY OF TAX PROFESSIONALS MAY 2007

MISTAKE MEANS TAX CHEAT CAN KEEP$100 MILLION

NEWS ITEMS PAGE 3

EVERYONE HATES THE AMT TAX BUT…

TAX LAW UPDATE PAGE 8

RAINBOW TAX SERVICE v. COMMISSIONER

TAX COURT DECISIONS PAGE 10

STEALING FROM IRS? CONVICT SAYSIT IS EASY

ETHICS CORNER PAGE 14

LEGISLATIVE AND GOVERNMENT RELATIONS UPDATE

MEMBERS ASK PAGE 15

THE FEDERAL TAX ALERT – MAY 20072

The Federal Tax Alert is published 10 times a year by the National Society of Tax Professionals. Subscription rate is $200 a year; single copy $20.Mailing address: The Federal Tax Alert, 10818 NE Coxley Dr. Ste. A, Vancouver, WA 98662. Telephone: 800-367-8130.

Opinions expressed in The Federal Tax Alert are those of the editors and contributors.Staff-Executive Editor: Beanna Whitlock; Proof Editor: Ronald Larson; Subscription Services: Glyness Scott;

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

income of just $7,578 from their two nail salons in Southern Maryland, so little that they qualified for a tax credit for the working poor. Their tax bill was $195.

But like millions of American business owners who trade primarily in cash, Huynh was not altogether honest with the Internal Revenue Service. When IRS agents poked around, they discovered four cars in Haynh's name, including a $77,000 Mercedes; receipts for diamonds and Rolexes in a closet at his Waldorf, Maryland home; and a videotape of Huynh flashing a five-caret ring during the purchase of yet another vehicle at a local Honda dealership, court records show.

Huynh, 57, appears to be an especially bold contributor to the tax gap, the difference between what Americans owe the federal government and what they actually pay. By the most recent estimate, the tax gap is $345 billion. Unreported business income accounts for nearly a third of that amount. According to IRS data, U.S. shopkeepers, mechanics, farmers and landlords will

pay less than half the taxes they owe on the returns they file on April 15th.

The tax gap is becoming a popular target in Washington. Narrowing the gap would require potentially invasive new reporting requirements and ramped-up IRS audits that would inconvenience honest taxpayers and businesses even as they detect cheaters.

Some ideas under discussion include: Forcing credit card companies to report the flow of funds to individual businesses, from the corner dry cleaner to online auctioneers who use eBay. Require stock brokers to report the purchase price when people sell stock. And create tax-withholding arrange-ments in industries that use independent contractors, such as hair salons, travel agencies and constructions sites.

The U.S. Chamber of Commerce and other business groups say many of the proposals would burden law-abiding citizens while doing little to tackle the most significant component of the tax gap, small operators who deal directly with the public and are paid primarily in cash.

Nina F. Olson, the IRS's national taxpayer advocate, acknowledges that

reducing the gap would be painful for the innocent as well as the guilty.

For the past four decades, voluntary compliance with U.S. tax laws has held relatively steady, varying from 81 to 84 percent, according to the Government Accountability Office. But the gap's size in dollars has grown with the economy, jumping from about $95 billion 15 years ago to nearly four times that today.

In 1985, taxpayers were told to name dependents on whom they wanted to claim deductions and list their Social Security numbers. 5 million- plus children left the dependent roles. What were 5 million children worth to the IRS? About $5 billion.

Congress believes that the IRS can squeeze as much as $100 billion a year out of tax cheats. "But not quickly and not easily," said former IRS Commissioner Charles Rossotti. "And not without doing things people may not be willing to accept."

The IRS, of course, has a history of doing things people are not happy to accept. For years, the agency's chief tool for assessing the tax gap was a vast system of random examinations derided as "audits from hell." The surveys last conducted in 1988, were discontinued in the mid-1990's after grass-roots anger flared over taxes and aggressive IRS enforcement. The 1988 survey remains the most recent source of detailed information about the tax-paying behavior of corporations.

In 2001, the IRS introduced a new compliance tool called the National Research Program, NRP. The first

NOTICETAX HOTLINENEW HOTLINE NUMBER!

3 Days a WeekMonday, Wednesday, Friday

9 – 2 PST

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DIRECT LINE360-695-0556

NEW Website Password: taxlaw(use lowercase only)

Technical Tax advice provided by NSTP Hotline staff is based upon specific information conveyed by the member. Members should take special care in relying upon recommendations and opinions that reflect the understanding of the Hotline staff member. NSTP and the Hotline staff are not responsible for misapplication of information given. Members are responsible for the ultimate verifi-cation and application of any information provided by NSTP.

FROM THE EDITOR April 1, 2007 marked a very important anniversary for me. I have now had the privilege

of being the Executive Director of NSTP for one year.

I am very appreciative to the NSTP Board of Directors for giving me this opportunity

and I am incredibly grateful to the NSTP membership who have so warmly welcomed

me and embraced new ideas and initiatives. I must credit the success of this year to

an outstanding staff, Mr. Steve, Brandi and Glyness who do everything they do with a

genuine commitment to NSTP and its members.

NSTP is the best partner a tax professional can have!

You have responded to every survey, opportunity to comment and your efforts

have raised the visibility of NSTP at the IRS, with the IRS Oversight Board and with

Congress. NSTP members have much to say and now people are listening. Many

of you have embraced the electronic Federal Tax Alert the web board and regularly

visit the redesigned www.nstp.org for all your tax needs. This tax season more of our

members used the Hotline than at any other time in our history.

NSTP members all over the country are being active with their IRS Liaison

Groups and regularly report their activity to NSTP in order that the information can be

broadcast to other NSTP members in the area. I am overwhelmed at the generous

nature of the membership. The volunteer spirit of this society is catching!

For the first time in many years, the membership renewal rate is outstanding! This is

only the start of what NSTP can do. We exist to be of Service to the Tax Profession, it

is our mission and it is at the forefront of everything we do.

Fasten your seatbelts, the road ahead may be challenging but for those who have

chosen to be in the business of tax we have the right "stuff" to be successful!

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

MAY 2007 – THE FEDERAL TAX ALERT3

round focused on 46,000 individual taxpayers, including 21,000 sole proprietors with business income. Those results, combined with a re-estimate of the 1988 corporate data, make up the government's current understanding of the tax gap.

Agency officials say some under-reporting is unintentional, though no one knows how much. Another portion may be caused by unscrupu-lous tax preparers, an emerging focus of concern.

The IRS has resisted efforts to regulate tax preparers, but Olson said lawmakers are considering the idea.

Of course, some cheating tax preparers act at the behest of cheating taxpayers. The IRS has con-sistently found that cheating is con-centrated where there is opportunity, meaning no paper trail. Wage earners whose taxes are withheld and whose income appears on W-2 statements tend to understate their tax bill by 1.2 percent. But sole proprietors, farmers, renters and "informal suppliers" such as sidewalk vendors and housekeep-ers pay just 46 percent of the taxes they owe, according to IRS research.

The courts are full of examples of unreported business income. Justthis year:

Konstantions "Gus" Stamoulis and three of his children pleaded guilty to skimming hundreds of thousands of dollars off daily receipts at a restaurant four blocks from the White House. Stamoulis was sentenced to two years probation.Mike Hogan Jr., was indicted on charges of concealing income from a mattress shop, a restaurant and two other West Texas establishments, in part by depositing nearly $400,000 in bank accounts he allegedly opened in the names of his sister-in-law and ex-wife.Joseph Francis, creator of the "Girls Gone Wild" videos, was recently indicted on charges that his companies claimed more than $20 million in phony business expense, using offshore bank accounts to conceal income.

Then there was Huynh, the nail salon owner. Prosecutors say Huyhn's taxable income in 2000 was $273,000, 36 times what he reported. The IRS will not say how it caught him. His attorney suspects a snitch, but IRS officials say that is rare. Cases like Huynh's typically start with a red flag during a routine tax review.

Last year, Huynh pled guilty and began serving 18 months in prison. His wife is to be sentenced later this

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month. So far, they have been ordered to pay $365,000 in back taxes.

Audits alone cannot close the tax gap. "We would have to have every other person in America working for Internal Revenue," said Steve Burgess, a director of IRS examina-tions. "Nobody wants that."

MISTAKE MEANS TAX CHEATCAN KEEP $100 MILLION Poorly written Justice Department documents cost the federal government more than $100 million in what was supposed to have been the crowing moment of the biggest tax prosecution ever.

Walter Anderson, the telecommu-nications entrepreneur who admitted hiding hundreds of millions of dollars from the IRS and District of Columbia tax collectors, was sentenced to nine years in prison and ordered to repay about $23 million to the city.

But U.S. District Judge Paul Friedman said he could not order Anderson to repay the federal government $100 million to $175 million because the Justice Depart-ment's binding plea agreement with Anderson listed the wrong statute.

Friedman said he could have worked around that problem by ordering Anderson to repay the money as part of his probation. But, prosecutors omitted any discussion of probation, a common element of plea deals, from Anderson's paperwork.

"I have come to the conclusion, very reluctantly, that I have no authority to order restitution," Friedman said. "I hope the government will appeal me."

Channing Phillips, a spokesman for the U.S. attorney's office, which prosecuted the case in cooperation with Justice Department headquar-ters, said the government would bring civil charges against Anderson.

That will require a new round of litigation in a court that does not wield the threat of more jail time. Prosecutors have said Anderson has money stashed away in accounts around the world, a claim Anderson denied in court.

He appeared humbled but not overly apologetic at the hearing. He took responsibility for his actions but said he never intended to defraudthe government.

Anderson told the judge that his millions in unpaid taxes were not funding an opulent lifestyle. He often used jets but for business or charity, he said, and usually he flew business class, not first class, and sometimes even coach.

"For every time I ate in a nice restaurant, I also grabbed a doughnut or a burger in an airport," he said. "I

could have wasted millions. I could have taken a limo everywhere."

Friedman was not persuaded. He sentenced Anderson near the high end of his sentencing range.

Anderson started a long-distance telecommunications business in the 1980's as the industry was being deregulated. When his first company, Mid-Atlantic-Telecom, merged with another company in 1992, Anderson formed corporations in the British Virgin Islands to hide the income, prosecutors said.

Authorities said Anderson used other offshore corporations to disguise his ownership in other telecommunications companies that earned more than $450 million between 1995 and 1999. He allegedly did not file federal income tax returns from 1987 to 1993.

With credit for the two years he has been jailed, he will have to serve seven years in prison and will be eligible for release in less than six years.

Among the taxes allegedly owed to the District of Columbia are use taxes, equivalent to sales taxes, on art, jewelry and wine. The indictment alleges that Anderson bought a painting by Salvador Dali and several paintings by Rene Magritte, an 18-karat gold bracelet and more than $47,000 in fine wines, and then had them, shipped to a Virginia address to avoid Washington taxes.

ILLEGAL IMMIGRANTS FILING TAXES MORE THAN EVERCarlos Diaz broke the law when he crossed the border and took a job as an office janitor. But he is not about to break another by failing to pay his income tax.

"I've been talking to other people who have done it, and I want to follow the law," said Dias, an undocumented worker from Guatemala.

On April 17, 2007 millions of illegal immigrants found themselves collaborating with one federal agency, the Internal Revenue Service, while trying to avoid another, Immigration and Customs Enforcement.

They hope a track record of on-time payments will aid their citizenship applications, but critics who favor tougher enforcement of federal immigration rules say it is absurd for the government to work with people it should be tracking down and deporting. It legitimizes the presence of immigrants who are here illegally, critics say, and sends a mixed message about the country's interest in enforcing its own rules.

"The word schizophrenic comes to mind," said Marti Dinerstein, president of Immigration Mattes, a

THE FEDERAL TAX ALERT – MAY 20074

research firm that advocates tighter immigration enforcement. "There is something fundamentally wrong about this."

The IRS created a nine-digit Individual Tax Identification Number in 1996 for foreigners who do not have Social Security numbers but need an identifying number to file taxes in the U.S. But it is increasingly used by undocumented workers to file taxes, apply for credit, get bank accounts or even buy a home.

The IRS issued 1.5 million ITINs in 2006, a 30 percent increase from the previous year. All tolled, the tax liability of ITIN filers between 1996 and 2003 was $50 billion. The agency has no way to track how many were immigrants, but it is widely believed most people using ITINS are in the United States illegally.

One number hints at the number of illegal immigrants having income taxes deducted from their paychecks.

In 2004, the IRS got 7.9 million W-2s with names that didn't match a Social Security Number. More than half were from California, Texas, Florida and Illinois, states with large immigrant populations, leading experts to believe they likely represent the wages of illegal immigrants. Even immigrants who use ITINs to file taxes are forced to make up a Social Security Number when they get a job.

Critics like Dinerstein believe the process makes room for law violators and in some cases might endanger the country by allowing them to operate more freely.

"That's why people who are living here illegally rushed to get ITINS like they are chocolate candy," said Dinerstein. "It is a national security issue."

IRS spokeswoman Nancy Mathis said the ID numbers are issued strictly to track a tax return's progress through the system, noting the tax code says nothing about whether foreigners filing taxes are here legally or not.

WHERE DO MY INCOMETAX DOLLARS GO?You worked hard for that money you just sent off to the IRS. So like many tax filers you are probably asking yourself; Just where, exactly, does my money go when the government gets its hands on it? Let us see who gets what.

If a taxpayer has trouble balancing their checkbook, imagine trying to keep track of where $2.7 trillion goes every year. Even with armies of government accountants and auditors, it is hard to know with certainty exactly where your income taxes end up. But you can get

some idea from the government's accounting of where it went last year.

For the complete details you can check the latest estimates from the official budget on the Government Printing Office Website, where you will find the government's finances sliced and diced by agency, department, function and source, with historical data back to the 1949s and beyond.

What you will find is a lot of big numbers. So to give you some sense of proportion, here is roughly how the federal budget compares to your budget and mine.

We will assume you make $52,000 a year or $1,000 a week which is about the median household income in the U.S. The real number was $46,326 in 2005.

Last year, the three biggest federal budget items were Social Security, health care and defense spending, each of which ate up about $200 of your $1,000 weekly paycheck.

Even though you may not have health insurance, about $219.40 of every $1,000 of your taxes went to pay for health care last year. On an annual salary of $52,000, that works out to $11,408.80 a year. The biggest chunk of that, $124.20 per thousand, went to pay for Medicare, which provides health coverage for people age 65 and older. The rest, $95.20, went for Medicaid, which covers low-income families and individuals, and state ad-ministered health coverage for children.

While most households are having a hard time setting aside a few dollars a month for their IRAs, your government is busy stashing away retirement cash for a rainy day; some $206.60 of the weekly paycheck went to the Social Security fund, most which is officially "off budget."

Next up is military spending. This includes a variety of defense costs, including salaries for the troops at $48.00; operating and maintenance costs of $76.70, "procurement" of $33.80 and research, development, test and evaluation of all those things you bought $25.80. Throw in $12.00 or so for things like "atomic energy defense activities" and housing the troops, and you paid $196.50 to keep the world safe, or $10,218 for the year.

Unfortunately, Uncle Sam, like many Americans, has been living beyond his means and spending more than he takes in. To make up the difference, the Treasury steps up by selling more debt, roughly the same as you or me using our credit cards. And like most credit card users, Uncle Sam is not paying back that debt; he is just making the minimum monthly payment. So interest on the

Treasury's credit card eats up $122.20 of Uncle Sam's $1,000 paycheck. That bill is cut by $36.80, thanks to the interest that the government pays itself for Treasury debt that it keeps "off-budget." Your net interest payment amounts to $85.30.

There is also a line in Uncle Sam's budget for $132.70 for "income security" which includes things like unemployment insurance, $12.70, food and nutrition programs, $20.30, and housing assistance, $14.40. Also tucked into this line item is the cost of retirement for federal workers, $37.00.

IRS ACTION NEWSIRS GRANTS SIX-MONTH FILING, PAYMENT EXTENSION FOLLOWING VIRGINIA TECH SHOOTINGThe Internal Revenue Service has granted a six-month tax filing and payment extension to those affected by the shootings at Virginia Tech, in Blacksburg, VA. This relief applies to the victims, their families, emergency responders and university students and employees.

The relief announced allows taxpayers affected by the events at Virginia Tech to have until October 15, 2007 to file and make payments associated with their 2006 individual tax returns due April 17. No filing and payment penalties will be due for those who qualify for this extension as long as the returns are filed and payments are made by October 15, 2007.

In order to claim this relief, taxpayers need to call the IRS at 1-866-562-5227 and identify themselves to the IRS before they file and or make payment.

EVEN IRS DREADED TAXTIME THIS YEARThe deadline to file has come and gone. For taxpayers filing their own returns, estimates project that 3.18 billion hours were spent figuring out and filing their tax returns. That is 24.2 hours per taxpayer.

The National Taxpayers Union, an advocacy group, came up with its estimate of 3.18 billion hours for individual compliance based on an IRS report on forms submitted. The group did not have an estimate for past years, but the Tax Foundation, using similar means of calculation said the figure for the previous year was 2.8 billion hours.

The figures are much higher if you count businesses such as General Electric Co., which may have set a

MAY 2007 – THE FEDERAL TAX ALERT5

record last year by filing a return that, had it been printed on paper, would have totaled more than 24,000 pages.

The NTU calculated that the average taxpayer spent 24.2 hours in record keeping, boning up on tax law and preparing their 2006 returns. With some 60 percent of people now using paid preparers, the group said the average cost of paying taxes is $207.

Corporations spent an estimated $156.5 billion working on their taxes, nearly half the $354 billion in corporate income taxes the U.S. collected last year.

"This spring you have people spending more on tax preparation than our government is spending on higher education," said Sen. Ron Wyden, Ore., who is sponsoring a tax simplification bill with a one-page 1040 form for most taxpayers. "It should not have to be bureaucratic water torture to fill out all these forms," Wyden said.

Despite the obstacles, most Americansmake an honest effort to pay their taxes on time. Internal Revenue Service Commissioner Mark Everson said the agency expects to process 136 million returns this year. As of April 7, IRS had received 88.1 million returns. For most, the effort is rewarded: As of April 7 the IRS had issued 73.6 million refunds totaling $174 billion. The average refund was $2,366.

So far, the IRS said, 61 million returns had been filed electroni-cally, up 6.2 percent from last year. Of those, 44 million came from tax professionals and 17 million from people using software on their home computers. The IRS reports that the web site, http://www.irs.gov/, had received 111 million visits from people seeking help or information.

Things were tough for the IRSas well. Commissioner Everson told a Senate committee in April that the agency was anticipating "the most difficult filing season in a numberof years."

Congress late last year complicated matters when it failed to revive, until after the IRS had gone to print with its forms for the 2006 filing season, expired tax breaks for college tuition, teacher expenses and state taxes.

The IRS has also had difficulty making taxpayers aware that they were entitled to a one-time tax refund, worth $30 to $60 in most cases, for a long-distance phone tax that was eliminated last year. Almost one-third of returns coming in to IRS have not sought the rebate, and there have been scattered problems with taxpayers and unscrupulous preparers claiming refunds of thousands of dollars.

Commissioner Everson said there had been only "minimal interest" in a new program allowing taxpayers to deposit refunds in separate accounts. Another new program of contracting out debt retrieval to private collection agencies continues to be closely scrutinized by critics in Congress.

The IRS also is under pressure from Congress to narrow the tax gap, the difference between taxes owed and taxes paid. The IRS estimates that amount at $290 billion a year. About 84 percent of taxpayers voluntarily comply with the law on what they owe. Raising that by just one percentage point "will yield an additional $25 billion each year to pay for priorities like children's health care and energy independence," said Senate Finance Committee Chairman Max Baucus, Mont.

Commissioner Everson said enforcement revenue was up from $34 billion in fiscal 2002 to almost $49 billion last year. Most taxpayers had a less than 1 percent chance of getting audited last year, but the rate rises to 6.3 percent for millionaires and 35.3 percent for the largest corporations.

FORUM LETS TAXPAYERSTURN TABLES ON IRSTaxpayers were given the chance to turn the tables on the Internal Revenue Service, responding to the agency's request for an audit of its services.

The forum, one of three nationwide this year, allowed taxpayers to complain, suggest changes and quiz the nation's top advocate for taxpayers on everything from phone menus to identity theft.

Taxpayer concerns ranged widely. One woman spoke of waiting 40 minutes on the phone for an IRS agent to help her with a simple question. A man asked why the IRS does not provide computer software so taxpayers can submit returns online for free. "I filed for years online and had to pay my fee to an online company, "said Bill Riley, 37, of Council Bluffs, Iowa. "I don't understand why the IRS cannot do it."

Nina E. Olson, the national taxpayer advocate, who moderated the forum, told Riley she had asked Congress for years to ask the agency to develop the software.

About 60 people came to the forum at the University of Nebraska Alumni Center, complaining about taxes for farmers and small businesses, identity theft and even paying taxes at all. The forum was organized by the Taxpayer Advocacy Panel, a federally funded organization of 100 people that monitors IRS policies and procedures,

with representative in each state and the District of Columbia.

Similar forums were held in New York City and in Phoenix. The three cities were based upon demographics. The forum held in New York focused on low-income taxpayers. Omaha's meeting was generally for small business taxpayers and the Phoenix meeting spotlighted the elderly.

IRS COMPLETES TAXPAYER ASSISTANCE BLUEPRINTThe Internal Revenue Service has announced it has submitted to Congress the completed Taxpayer Assistance Blueprint. The Blueprint is the joint response of the IRS, the IRS Oversight Board and the National Taxpayer Advocate to a congressional mandate for the development of a five-year plan for the delivery of taxpayer service.

The Blueprint represents the most extensive IRS research ever conducted into the needs, preferences and behaviors of taxpayers and partners who assist them in complying with the tax laws, such as volunteer and paid tax return preparers. This research formed the foundation for the strategic plan for taxpayer service outlined in the Blueprint. The plan includes a variety of specific rec-ommendations for improving IRS services for taxpayers and partners. Improving taxpayer service is an important part of a comprehensive strategy to reduce the "tax gap" by helping taxpayers understand and meet their tax obligations.

To address congressional and stakeholder interests, the Blueprint was designed to:

Establish a taxpayer and partner baseline of needs, preferences and behaviors;Create a transparent process for making service-related resources and operational decisions;Develop a framework to improve service delivery; andDefine both short-term performance and long-term business goals and metrics to assess service value.

"It is critical that the IRS understand what services taxpayers needs and their preferences for receiving them," IRS Oversight Board Chairman Paul B. Jones said. "The Taxpayer Assistance Blueprint is based on extensive research and provides a strategic five-year plan to help the IRS make the most out of its investments in taxpayer services."

The Blueprint offers recommenda-tions to expand, simplify, standardize and automate services, and to improve and expand technology in-

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THE FEDERAL TAX ALERT – MAY 20076

frastructure. It includes recommen-dations for increasing education and outreach to taxpayers, partners and IRS employees, and incorporating feedback from these stakeholders into future service decisions.

IRS E-FILE FOR BUSINESS TOPSONE MILLION RETURNSThe Internal Revenue Service has announced that more than one million business taxpayers have electronically filed tax returns this year. Corporate e-filed returns have increased by nearly 50 percent over this period last year.

Corporations with assets of $10 million or more that file at least 240 returns (including W-2's, 1099's and others) are now included in the mandate to e-file. The deadline for most corporate filers was March 15, 2007.

On the day of the deadline, IRS systems successfully processed more than 200,000 business returns, of which more than 50,000 were returns of corporations. Over 400,000 corporate taxpayers have e-filed their returns so far this year. Corporate returns can be thousands of pages.

More than 4,700 of the nation's largest corporations, those with at least $50 million in assets, filed electronic returns by the due date. Nearly 6,400 of the newly mandated smaller corporations did so.

Corporations that operate on the calendar year can request an extension to file until September 15 and many elect to do so. This year, 634,000 taxpayers used e-file to file Form 7004 to request an extension.

Non-corporate business filers are also using e-file. Close to 185,000 businesses electronically filed their partnership returns this year. Partner-ships are required to file a Schedule K-1 for every partner. The IRS has received more than 1.1 million e-filed K-1s so far this year, above and beyond the million returns.

In addition, the IRS received 847 million electronically filed information returns, W-2s, W-4s, 1099s, 1098s, etc., last year, more than 80 percent of the total 1.2 billion information returns.

NEARLY HALF OF TAXPAYERSSEEK IRS HELPAround 41 percent of taxpayer households contacted the Internal Revenue Service at least once over the past two years seeking help, says a survey commissioned by the IRS Oversight Board.

The most common reasons for contacting the IRS; seeking help with tax law questions or returns, requesting forms and resolving disputes or errors.

The study, conducted by Roper Public Affairs found that 22 percent telephoned the IRS, 3 percent visited an IRS office, 25 percent visited the IRS Web site, 4 percent sent the tax agency an e-mail and 6 percent a letter. Some taxpayers contacted the IRS multiple ways.

While most taxpayers said they would prefer service from a person rather than an automated system, about half those who visited an IRS center or called during the past two years said they would be willing to consider using an online alternative to resolve their tax matter.

More than 80 percent said IRS service was better than or equal to service from other government agencies. But many also said the IRS was not doing enough to make the tax system fair.

Among other findings:92 percent were confident in their ability to solve their financial problems in their everyday life.17 percent wish they had better English reading and writing skills.73 percent did not feel secure sharing personal financial information over the Internet, even with a government agency.14 percent worried that people will take advantage of them when they get help with filing their taxes.94 percent felt it was theircivic duty to pay their fair shareof taxes.

The study, conducted this spring, consisted of a telephone survey of a random sample of 1,000 taxpayer households.

UNPAID U.S. TAXES HIT$2,680 PER HOUSEHOLDThink of the uses of 300 billion, the annual gap between what taxpayers owe and what they pay.

It would more than cover the federal deficit for a year.

It would pay for the $125 billion that Congress has agreed to spend on Hurricane Katrina relief, with enough left for three years worth of federal education programs.

Such are the dreams of lawmakers pressing the Internal Revenue Service to get more aggressive about reducing what is known through Washington as "the tax gap."

IRS WARNS OF PHONY E-MAILS CLAIMING TO COME FROM IRSThe Internal Revenue Service has alerted taxpayers about Internet scams in which fraudulent e-mails are sent that appear to be from the IRS.

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The e-mails direct the consumer to a Web link that requests personal and financial information, such as Social Security, bank account or credit card numbers. The practice of tricking victims into revealing private personal and financial information over the Internet is known as "phishing" for information.

The IRS does not send out unsolicited e-mails or ask for detailed personal and financial information. Additionally, the IRS never asks people for the PIN numbers, passwords or similar secret access information for their credit card, bank or other financial accounts.

Last year, the IRS established an electronic mail box, phishing@irs.gov. to receive copies of possibly fraudulent emails involving misuse of the IRS name, logo or Web site for investigation. Since the establishment of the mail box, the IRS has received more than 17,700 e-mails from taxpayers reporting more than 240 separate phishing incidents.

Recently, the IRS has become aware of commercial Internet sites that bear a striking resemblance to the real IRS site or that contain some form of the IRS name in their address but with a .com, .net, .org or other designation in the address instead of .gov. The IRS urges consumers not to be misled into thinking such sites are the genuine IRS Web site or have some connection to the real IRS.

IRS SEEKS NOMINATIONS FOR ADVISORY COMMITTEESThe Internal Revenue Service is requesting membership nominations for the Information Reporting Program Advisory Committee—IRPAC. The appointment is for a 3-year term.

The deadline for submitting appli-cations is May 31, 2007.

Application packages are available on the Tax Professional's Page on the IRS Web site at irs.gov. Questions about the nomination process can be sent to "public_liaison@irs.gov.

Established in 1991, IRPAC provides recommendations to IRS leadership on a wide range of information reporting and admin-istration issues. The committee presents a report to the commis-sioner of the IRS each year at a public meeting in the fall.

Interested parties may nominate themselves or a qualified person for membership. All nominees must complete an application and federal tax check waiver form. In addition, FBI background checks using finger-prints and, if applicable, practitioner checks are required of all nominees.

MAY 2007 – THE FEDERAL TAX ALERT7

JENKENS & GILCHRISTADMITS IT IS SUBJECT TO$76 MILLION IRS PENALTYThe Internal Revenue Service has announced that it has reached a settlement with the law firm of Jenkens & Gilchrist, which agreed that it is subject to a penalty of $76 million. The penalty stems from the firm's promotion of abusive and fraudulent tax shelters and violation of the tax law concerning tax shelter registration and maintenance and turnover to the IRS of tax shelter investor lists.

The firm aggressively marketed potentially abusive tax shelters to high-net-worth individuals. Some of the packages marketed to these individuals included listed transac-tions such as COBRA, Currency Options Bring Reward Alternatives, BEST, Shot Option/Basis Enhancing Securities Transaction, BLISS, Basis Leveraged Investment Swap Spreads, OPS, Option Partnership Strategy, BEDS, Basis Enhancing Derivatives Structure and BOSS, Bond & Option Sale Strategy.

The agency estimates that 1,400 investors are affected by the firm's advice and will owe interest and penalties on their underpayment of tax. Jenkins & Gilchrist, which was once a 600-lawyer national firm, is in the process of winding down its legal practice and business affairs. The national law firm of Jenkens & Gilchrist is composed of a corporation in Dallas, Texas, a corporation in Chicago, Illinois, a partnership in Los Angeles, California and a partnership in New York City.

IRS NABS PHONE TAX ABUSERSIN SEVEN CITIESIRS criminal investigators have conducted raids in seven cities to shut down tax preparation businesses suspected of abusing a one-time telephone tax refund.

The Internal Revenue Service, in a statement said some tax-return preparers are requesting thousands of dollars of refunds for clients despite IRS pronouncements that the tax break should be in the $30 to $60 range.

In Atlanta, Georgia, Dallas, Tyler and Athens, Texas, Riverside, California, Miami, Florida and Baton Rouge, Louisiana agents temporarily closed businesses, seizing computers and documents to be used as evidence.

The tax agency said that IRS auditors also are visiting tax preparers across the nation who are seeking questionable telephone tax refunds. The agency is advising taxpayers to stay away from preparers making exaggerated claims about refunds.

In several instances, it said, taxpayers have put in for a refund of $30,000, while others are requesting refunds for the entire amount of the taxpayer's phone bill, rather than just the 3 percent long-distance tax.

The government stopped collecting the long-distance excise tax last August, and has authorized a refund of tax collected on service billed during the period from March 2003 to July 2006.

The IRS has urged taxpayers to request a standard refund amount, requiring no documentation and ranging from $30 to $60, depending on exemptions claimed. Those basing refunds on actual taxes paid must have documentation available if the IRS questions the claim.

TAX-AUDIT RISK RISESWITH YOUR INCOMEYour chances of being audited are pretty good if you are wealthy. They are not bad if you are not.

About 1 in 16 taxpayers with income of $1 million and higher was audited last year, a 33 percent increase from the previous year.

"If you are earning that kind of money and we notice a problem, you are going to hear from us," IRS Commissioner Mark W. Everson said in a statement on the agency's enforcement figures for the 2006 fiscal year.

But it is not just those in the financial stratosphere who face increased IRS scrutiny.

Audits of taxpayers with incomes above $100,000 were up 18 percent from 2005, the highest figure in more than a decade. Audits of certain businesses, especially "S" corpora-tions and partnerships, increased by 34 percent, though audits of larger corporations, with assets over $10 million, were down slightly.

Overall, audits of individual taxpayers were up by 6 percent in 2006; total individual returns audited were 1.3 million, for an average individual audit risk of about 1 in 100.

Not every audit means a "field" audit, a face-to-face meeting with an IRS agent. Some are correspon-dence audits, essentially a letter from the IRS to clear up discrepancies or apparent inaccuracies.

More serious tax issues involve un-derreporting income and overstating deductions, exemptions and credits. For that reason, a tax return with a large number of deductions may be flagged for audit.

Celebrities have also been known to attract the IRS' attention. Late last year, actor Wesley Snipes pleaded innocent to federal charges that he failed to file

tax returns and that he falsely claimed millions of dollars in refunds.

Taxpayers have the right to appeal IRS findings and, if the dispute cannot be settled, to take their case to the Taxpayer Advocate Service, which is part of the IRS but operates independently and will help taxpayers resolve problems.

The IRS can also work out payment plans for those who owe unpaid taxes, interest or penalties.

Congress set three years as the deadline, or statute of limitations, during which the IRS can go back and make additional tax assessments. But that time can be extended if the IRS suspects serious underreport-ing of income. There is no statute of limitations for failure to file a return or when tax fraud is suspected.

If the case reaches actual prosecution, there is this sobering fact: The IRS reports it had a conviction rate last year of 91.5 percent.

TAX LAW UPDATELISTED PROPERTY LIMITSFOR 2007 ANNOUNCEDInternal Revenue Code §280F provides ceilings on the amount of deprecia-tion and §179 the amount that can be claimed on passenger automobiles, light duty trucks and vans.

Limitations are applied to the tax payer's business use of the vehicle in thepercentage of business use applicable.

§280F limits for passenger automobiles first placed in service during the calendar year 2007 that are neither trucks nor vans:

Year 1 $3,060Year 2 $4,900Year 3 $2,850Year 4 & after $1,775

§290F limits for trucks and vans first placed in service during the calendar year 2007 have not changed from 2006 and are:

Year 1 $3,260Year 2 $5,200Year 3 $3,050Year 4 & after $1,875

§280F limits for electric automobiles first placed in service during the calendar year 2007 will have the same limits apply as passenger automobiles since the special depreciation limits for electric automobiles expired on January 1, 2007.

This information as well as two lease inclusion tables can be found at www.irs.gov under Internal Revenue Bulletin 07-30.

THE FEDERAL TAX ALERT – MAY 20078

YOUR TAX BILL MAYBE ON THE RISEIf taxes are "the price we pay for civi-lization" our payments should help make America the Athens of the21st century

Unfortunately, the price we pay for civilization will need to rise sharply in the near future. Whatever you paid this year, get ready to pay lots more.

The newest estimates come from two economists, Jagadeesh Gokhale and Kent Smetters at the Cato Institute and Wharton School, respectively.

Writing in the March/April issue of the Financial Analysts Journal, Gokhale and Smetters update their earlier generational accounting work. Since 2003 things have gotten worse, not better. Their work shows:

Our government has promised $63,675 trillion more in benefits than it will collect in taxes."If the federal government confiscated all the land in the United States along with all of its improvements—buildings, highways, plants and equipment, and other durable assets built on it—and sold them at auction to foreign investors, it would still fall more than $20 trillion short in present value of the monies required to satisfy its future budget."The true federal deficit is not the $200 billion-odd a year discussed in newspapers but nearly 10 times more, $2.4 trillion.That without Social Security and Medicare, we would be running a surplus. The entire problem is the $72.9 trillion unfunded liabilities of Social Securityand Medicare.Complete elimination of all military spending, forever, would cover only about one-half of the unfunded liabilitiesof Medicare.Paying for the promised benefits would require an immediate new 14.4 percent tax on all payroll. A tax increase that large probably would not be collectible. Work would go underground.The vast majority of the problem can be traced to a single program, Medicare. Its unfunded liabilities are 8.5 times as large as the unfunded liabilities of Social Security.

If you think Gokhale and Smetters belong to the Chicken Little School of Economics, the two economists compare their estimates with figures from the trustees for Social Security and Medicare. The trustees' estimates are $10.9 trillion higher.

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To put these figures in perspective, the total output of the U.S. economy is now about $12.5 trillion. The Federal Reserve recently estimated the net worth of all U.S. consumers is $55.6 trillion.

UPDATES ON S1591—U.S. TROOPS READINESS, VETERANS' HEALTH AND IRAQ ACCOUNTABILITY ACTLate March saw the adoption of the Kennedy amendment to the act which was also inclusive of a second-degree Grassley-Baucus amendment providing additional tax incentives for small businesses, along with various offsets. Provisions include:

Depreciation and Cost Recovery provisions.Tax relief for rural out-migration counties.Extension of GO Zone Small Business Expensing.Deductibility of interest expense on indebtedness incurred by an acquiring business trust to acquire S corporation stock.Expansion of kiddie tax.Tax gap proposals.Repeal suspension of certain deficiency interest.Other tax administration and enforcement provisions.

As with all tax related legislation, look to NSTP to keep tax professionals informed.

EVERYONE HATES THE AMT,BUT FIX WILL BE COSTLYEveryone agrees that something needs to be done to "fix" the alternative minimum tax. But there is little agreement on how to go about it.

This year, some 3.7 million Americans learned the hard way that they are subject to the AMT, a stealth tax increase that forces many to prepare their returns twice and pay the rate that hits them hardest. And unless the tax law is changed, some 23 million, 17 percent of all filers, will be subject to the AMT when they file in 2008. Many taxpayers are in for a nasty surprise.

The majority of middle-income taxpayers have never heard of the AMT and are unaware that it may apply to them. Worse, there is no simple formula for determining whether the tax applies to you, because eligibility depends heavily on how many exemptions, credits or deductions you claim under the regular system. The only way to know for sure is to complete a 16-line worksheet, read 10 pages of instruc-tions and fill in a 55-line form. If you do not check and it turns out you owe the tax, you can expect a bill for

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the difference plus a penalty for not paying up. Last year, the average AMT filer owed $6,800 in extra taxes.

So it is no wonder that politicians of both parties are vowing to provide AMT relief. But fixing the problem turns out to be much more difficult that just eliminating it. That is because scrapping AMT also means eliminating a "stealth tax" windfall that Congress and the White House have already factored into their budget forecasts.

By some estimates, eliminating the AMT would cost the government some $1 trillion over 10 years, money that would have to be made up with further spending cuts or tax increases.

Debate over the AMT is also snarled in the wider discussion of the tax cuts, which are set to expire in 2010. Ironically, those cuts had the effect of accelerating the problem because rates under the AMT system were not cut, lowering taxes under the regular tax system and pushing more people into the higher AMT rates.

One solution that has gotten widespread support is the so-called "tax gap," representing taxes owed but not paid. Roughly $300 billion a year goes uncollected for a variety of reasons.

Some have suggested hiring more IRS workers to go after those who are not paying, but it is not clear just how much money better enforcement would generate.

"While it is easy for the IRS to estimate this as the shortfall, they have not shown us how to go after it," said Rep. Charles Rangel, NY, who chairs the House Ways and Means Committee. "But the tax gap will be on the agenda, no question about it," he said.

Skeptics of the proposal to use the tax gap to pay for eliminating the AMT also worry that a new system devised to improve compliance could end up burdening honest taxpayers with yet another layer of paperwork.

INSIDE WASHINGTONRETIREMENT BENEFITSGIVEN EXTRA YEARFewer benefits, more taxes and some accounting magic will buy an extra year of life for Social Security and Medicare, trustees of the govern-ment's two largest benefit programs have announced.

The oncoming crush of 78 million retiring baby boomers still will crash the Medicare trust fund by 2019 and the Social Security trust fund by 2041 unless Congress and the White

MAY 2007 – THE FEDERAL TAX ALERT9

House can agree on a way to save the programs officials said.

For the first time, Medicare hit a trigger that requires President Bush to send the House and Senate legislation to deal with Medicare's funding problems with his 2009 budget.

The Medicare funding warning is triggered any time two consecutive trustees' reports conclude that the amount of general revenue needed to finance Medicare will top 45 percent of the program's outlays. The trustees first made that determination last year.

Although Congress must consider the proposals, it is not required toact on them.

As in past reports, the trustees warned that the financial situation facing Medicare is more dire than Social Security because of the rapid increase in health care costs.

In their annual report on the health of the government's two biggest benefit programs, the trustees said that slight reductions in projected benefit payouts and slightly higher tax collections had extended the date that Medicare is projected to be depleted by a year.

Technical changes like using more recent information on disability rates for men caused the change for Social Security from 2040 to 2041.

Both programs will be in trouble soon, with the baby boomers about to enter the system. The first baby boomers begin retiring next year, accelerating benefit payments while reducing the number of workers paying in.

"Without change, rising costs will drive government spending to un-precedented levels, consume nearly all projected federal revenues and threaten America's future prosperity," Treasury Secretary Henry Paulson said.

2017, just a decade from now, is the year that Social Security will begin paying out more in benefits than it collects in payroll taxes.

For Medicare, benefit payouts are expected to start exceeding tax collections this year.

FYITHE ECONOMY BOOMS BUTMOST PAYCHECKS DO NOTBy most economic measure, 2006 was a great year. Despite rising interest rates, high oil prices and the sharpest housing downturn in 15 years, inflation was low, productivity rose steadily, corporate profits reached a 40-year high, the stock market soared and the unemployment rate dropped to 4.6%, the lowest level in more than five years. Strong hiring in service

businesses like education, health care, finance, travel and entertainment more than offset big job losses in the auto and housing sectors.

Many Americans feel that govern-ment statistics do not match their daily experience. Most Americans do not see the long economic boom reflected in their paychecks. For many Americans, being employed no longer means being free of financial insecurity.

One reason is that employee benefits have been steadily shrinking. Only 18% of private-sector workers now have a traditional pension plan and 40% have no retirement plan of any kind at work. A majority of baby boomers, Americans born between 1946 and 1964, say they expect to continue working after they reach retirement age.

The cost of health care keeps rising faster than wages or inflation. Fewer employers offer health coverage and fewer employees can afford to buy it. The upshot: Almost 47 million Americans now are uninsured, and most of them are in families with at least one full-time worker. Only 47% of parents in families earning less than $40,000 a year are offered health insurance at work.

The Bureau of Labor Statistics reports the following sampling of jobs and their median weekly pay nationwide:

Petroleum engineer $1,891Veterinarian $1,160Computer programmer $ 1130Firefighter $ 898Occupational therapist $ 882Clergy $ 774Social worker $ 706Corrections officer $ 610Dietitian $ 555Taxi driver $ 461Bartender $ 342Telemarketer $ 303Dishwasher $ 245Child-care worker $ 228

Reported as "hottest jobs" for college graduates:

Forensic accountant—Combines accounting, auditing and investi-gative skills. $30,000—$150,000 Logistics manager—Plan, implement and control flow of goods or services. $35,000—$118,000Corporate librarian—More companies need specialists to manage information. $37,000—$93,000Emerging media specialist—Managers in web content and online marketing need commu-nication skills and tech savvy. $26,500—$100,000

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Physical therapist—Aging baby boomers will drive the increasing need.$34,600—$74,000Information security—Workers plan, implement and support network security. $47,000—$122,000

The "hottest jobs" with no college degree required include:

Sales representatives—High turnover and new products equal demand. $42,000—$114,000Translators—The need is expected to grow 26% by 2014. $43,000—$100,000Dental hygienists—An estimated 68,000 new jobs are predicted by 2014. $45,000—$85,000Registered nurses—An aging population ensures demand for years to come. $48,000—$74,000Insurance adjusters—These jobs are not easily outsourced or replaced by technology. $34,000—$75,000Transportation workers—Rail and trucking companies cannot meet the demand. $28,000—$53,000Athletic trainers—A growth business, due to the spread of health clubs. $23,000—$35,000Auto technicians—Today's computerized engines require specialized training. $27,000—$40,000Legal secretaries—Experts predict 47,000 new openings by 2014. $35,900—$60,000

MAKE CERTAIN NAME ANDSS RECORDS MATCH UPIt is important to regularly check your records to make certain the name and number on your Social Security card matches up with the name and number you are using elsewhere. If you do not, it could cost you time, money and effort to resolve.

Your Social Security number and the name on your Social Security card are often used by companies and government agencies as a way to check your identity. If anything is amiss, you could have a problem. This is especially true for people who recently have changed their names, such as new brides or adopted children.

The Internal Revenue Service also checks your return against your Social Security records. If your name and number do not match up it could mean a delay or trouble with the IRS,

It is also important for your voter registration records. Do not go to the polls only to discover that you do not

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THE FEDERAL TAX ALERT – MAY 200710

have permission to vote because of a mismatch.

You will also have problems if you cannot renew your driver's license due to a name and Social Security number mismatch with your state's Department or Bureau of Motor Vehicles.

In addition, make sure your employer and human resources department are using the correct name and Social Security number. Not only could it be a red flag to your employer when your identity does not match, it could affect your future Social Security benefits.

If your earnings are not reported to Social Security under your correct name and number, you may not get the earnings credits you are due. That could translate to lower benefit payments in your future. Such earnings discrepancies can be corrected, but it can cause an inconve-nient delay when you file for benefits.

There are many reasons why your identity records should match those of Social Security. Make certain any time you deal with a company or government agency that they have your correct name and Social Security number as it appears on your Social Security card.

TAX COURT DECISIONSRAINBOW TAX SERVICE V. COMMISSIONER128 T.C. NO. 5MARCH 8, 2007Non-CPA deemed in practice of accounting for C corporation Personal Service Corporation Designation.

Rainbow Tax Service employed individuals to provide tax return preparation and bookkeeping services. The taxpayer calculated its tax liability for tax years ending June 30, 2002 and 2003 using the graduated corporate income tax rate set forth in Sections 11(b)(1) of the Internal Revenue Code. Donna Rodgers and the Estate of Steve Rodgers own 100% of the stock of Rainbow Tax Service.

Respondent, IRS, determineddeficiencies of $11,903 and $5,003,respectively.

The issue for the court's decision is whether petitioner's tax return preparation and bookkeeping services are to be treated as accounting services. If so, petitioner will be treated as a qualified personal service corporation under section 448(d)(2) and will be subject to the flat 35-percent tax rate set forth in section 11(b)(2).

In 1978, Rainbow Tax Service was established as a C corporation in the State of Nevada. Operations consisted of providing tax return preparation and bookkeeping services.

Over the years, the number of clients increased as well as the number of employees increased to perform tax return preparation and bookkeeping services. Multiple locations were established.

During the years at issue, Rainbow Tax Service prepared Federal and State individual, corporate, partnership, gift and estate tax returns. Bookkeeping services performed by Rainbow Tax Service generally consisted of the preparation, from client records, of profit and loss statements and various other reports and forms relating to client Federal payroll taxes, State unemployment taxes and sales taxes.

Rainbow Tax Service is not a public accounting firm and none of the employees perform services that require the distinction of being a Certified Public Accountant, CPA.

For the years at issue, all employees of Rainbow Tax Service spent all of their work-related time performing tax return preparation and bookkeeping services with related administrative and support services.

All tax returns of Rainbow Tax Service were timely filed and taxes timely paid.

On April 14, 2005, IRS issued a notice of deficiency treating Rainbow Tax Service as a qualified personal service corporation subject to the flat 35-percent tax rate.

For the court's consideration:A corporation is to be treated as a qualified personal service corporation if substantially all of the corporation's activities involve the performance of services in the fields of "health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting".

If 95 percent of the corporation's stock is owned by, among others, individual employees performing covered services for the corporation, the ownership test.

Substantially all of a corporation's activities will be treated as covered services only if in the aggregate the corporation's employees spend 95 percent or more of their time in performing covered services.

Section 448(d)(2), the regulations hereunder, and court opinion generally do not define accounting services. However in section 1.448-IT(e)(5)(vii), Example 1(i), Temporary Income Tax Regs., 52 Fed. Reg. 22770 (June 16,

1987), the preparation of tax returns and audit and financial statements are treated as accounting services.

Rainbow Tax Service concedes that, if tax return preparation and bookkeeping services constitute accounting services, by virtue of the ownership of Rainbow Tax Service stock, the above ownership test has been satisfied.

Rainbow Tax Service argues that, for purposes of section 448(d)(2)(A), tax return preparation and bookkeeping services do not constitute accounting services, that Rainbow Tax Service therefore does not meet the above function test and that Rainbow Tax Service should not be treated as a qualified personal service corporation.

Rainbow Tax Service argues that under Nevada law, accounting services can be performed only by CPAs and that because Rainbow Tax Service is not a CPA firm, does not employ CPAs and does not perform services which are restricted under Nevada Law to CPAs, Rainbow Tax Service should not be treated as performing accounting services.

The court disagreed with the "overly restrictive" definition of accounting services.

The court noted that Rainbow Tax Service fails to appreciate the distinction between "public accounting" and "accounting". Public accounting, which generally consists of the preparation and/or audit of financial statements, and generally requires a CPA license, represents a branch of accounting, not the entire realm of accounting.

Further, section 448(d)(2) requires only that the services be in the "field of accounting" and is not limited to public accounting. Historically, tax return preparation and bookkeeping services are regarded as within the field of accounting.

Accounting has been defined as:

The process of recording transactions in the financial records of a business and peri-odically extracting, sorting, and summarizing the recorded transac-tions to produce a set of financial records. (Black's Law Dictionary)

The court further commented that "tax return preparation services are to be treated as accounting services although they noted that under Nevada statutory law "public accounting" includes "the preparation of tax returns."

The court noted that a defining characteristic of our Federal income tax system is the reporting of financial transactions within "annual accounting

MAY 2007 – THE FEDERAL TAX ALERT11

periods." Tax Professionals and the Internal Revenue Code itself generally regard the process of determining in which annual accounting period revenues and expenditures are to be recognized as tax accounting.

A significant aspect of Rainbow Tax Service's tax return preparation services consists of assisting clients in properly recognizing and reporting revenue and expenditures in the appropriate tax year or, in other words, performing tax accounting services.

We conclude that Rainbow Tax Service tax return preparation services, for purposes of section 448(d)(2), constitute services within the field of accounting.

Bookkeeping, which section 448 and the regulations hereunder do not address, has been defined elsewhere as:

A branch of accounting that deals with the systematic classification, recording, and summarizing of business and financial transactions in books of account. (Webster's Third New International Dictionary)

Not only does bookkeeping constitute a "branch" of accounting, but our system of double entry bookkeeping under girds modern financial accounting.

The court therefore sustains the IRS determination that tax return preparation and bookkeeping services constitute and are to be treated as services in the field of accounting. Accordingly, for the 2 years at issue, Rainbow Tax Service is to be treated as a qualified personal service corporation taxed at the flat 35-percent rate.

Mrs. Rodgers, an Enrolled Agent, is considering appeal based upon the impact of this decision on tax profes-sionals. She represented Rainbow Tax Service in this matter before the Internal Revenue Service and the courts.

First reported in an e-mail to the NSTP membership in March, 2007, many members asked for a full account of the court's decision.

The case only affects C corporations. S cor-porations remain unaffected by the personal service corporation designation. However, the greater issue is that the court has now defined the "practice of accounting" for taxation purposes without regard to definitions of "accounting" in state statutes or the "practice of accounting" as governed by State Boards of Accountancy.

C corporations affected by this decision should seek relief from the Qualified Personal Service Corporation flat rate of 35 percent by either payment of wages in lieu of net corporate income or making an S election to have the corporation taxed as an S corporation.

Plan to attend an NSTP Regional Conference where NSTP Director of Education, Paul LaMonaca, will be addressing this issue and all related S corporation issues in his 8 hour "All

you ever wanted to know about S corporations but were afraid to ask" class.

ET CETERA2007 BOOM TOWNSInc. Magazine recently published the 10 Top Cities for 2007. In ranked order they include:

St. George, UtahYuma, ArizonaPrescott, ArizonaFort Myers, FloridaMcAllen, TexasNaples, FloridaLas Vegas, NevadaSarasota-Bradenton-Venice, FloridaMorgantown, W. VirginiaBend, Oregon

Boom Towns are evaluated by bothjob and economic growth. To compile the rankings, Inc. examined job-growth data supplied by the Bureau of Labor Statistics.

A LIFESAVER FOR THESELF-EMPLOYEDMusic-store owner Scott Hillie was concerned for his 11 year-old son last year when he fell at the school playground and was taken by ambulance to the hospital. Unlike many self-employed people, Hillie was not worrying about how he was going to pay the medical bills.

Every month, $500 is automatically deducted from Hillie's account to go to HSA Bank. From that account he pays a premium for a family health plan with a high deductible, while the remainder awaits spending on medical needs and grows from year to year if there is anything left at the end of the year.

While Americans and the medical community have been a little slow to take up the idea of a health savings account, or HSA, as a way to control medical costs, flexibility and tax-friendly changes to how HSAs work are getting people's attention.

There are about 10 million people enrolled in so-called "consumer-driven health plans," and about 6 million of those are health savings accounts. The U.S. Treasury Department estimates that 25 million to 30 million people will be enrolled in an HSA by 2010.

Laws passed late last year allow an individual to contribute up to $2,850 a year to an HSA and to allow a family to contribute up to $5,650.

Although that is up only slightly from last year's allowance of $2,700 per individual and $5,450 per family it comes with the advantage of being

1.2.3.4.5.6.7.8.

9.10.

fully tax-deductible. In previous years, only the amount of the health plan deductible could be written off.

Deposits can be spread out throughout the year; but taxpayers also can take advantage of fully funding an HSA before the original filing date of their tax return.

HSAs mean more out-of-pocket expenses than traditional insurance because of the high deductible; but for those without coverage, putting any amount toward tax-free health savings is still better than no coverage.

NEW ENGLAND HAS THIRD HIGHEST TAX BURDEN IN U.S.New England is the third most heavily taxed region in the nation, and residents will pay an estimated 11.3 percent of their income in state and local taxes this year, behind only the Mideast and Great Lakes Region, an independent study reported.

Massachusetts ranks 28th nationwide, with residents paying an estimated 10.6 of their income this year to fund state and local operations and services. The state, the region's largest economy, was once referred to as Taxachusetts because of its painful tax burden, according to the Washington-based Tax Foundation, a nonpartisan research group.

New Hampshire is the second least-taxed state, with residents shelling out 8 percent of their income in state and local taxes, according to the report.

Vermont and Maine have the highest and second-highest tax burden, with residents paying 14.1 percent and 14 percent respectively, the report says.

Connecticut ranks eighth, with residents paying 12.2 percent of their income to fund state and local operations.

Rhode Island ranks fourth nationwide and its residents will pay 12.7 percent in state and local taxes this year.

Moderate tax burden in Massachu-setts teams with the low burden in New Hampshire to prevent New England from being an especially high-tax region, despite the huge tax burdens in the four smaller states of Vermont, Maine, Rhode Island and Connecticut.

State and local taxes will consume a record-setting 11 percent of the nation's income this year.

HOUSING SLUMP PINCHESSTATES IN POCKETBOOKState tax revenues around the country are growing far more slowly this year and in some cases falling below projections, a result of the housing market slowdown that has curbed voracious spending on real estate, building materials, furniture and other items.

THE FEDERAL TAX ALERT – MAY 200712

Nowhere is the downturn more apparent than in Florida, where tax revenue is projected to drop this year for the first time since the energy crisis of the 1970s.

But other states, especially those where housing prices soared in recent years, are also seeing their collections slow, especially in the sales and real estate transfer tax categories. While the economy remains generally strong and it is too early to predict whether the housing slump will have long-term effects, some states will have to adjust their wish lists.

For example, New Jersey could face a $2.5 billion shortfall by mid-2008, Governor Jon S. Corzine has said, and may lease its turnpike or its lottery to a private company to raise money. In California, where income tax receipts in January were $1 billion less than forecast, a nonpartisan legislative analyst has urged budget cuts and warned that the state could have about $2 billion less in revenue this year and next than Governor Arnold Schwarzenegger has projected.

New home sales nationally fell in February to the lowest rate in seven years and homeowners who tapped into plentiful home equity and spent extravagantly during the real estate boom have started to cut back.

Chris McCarty, survey research director at the Bureau of Economic and Business Research at the University of Florida, said it would be foolish to "underestimate the effect that the inability to extract equity from homes is going to have."

In one hint of how much Floridians were relying on property wealth during the real estate boom, 16 percent of new car purchases here were being made with home equity loans in 2006, compared with 7 percent nationally, according to CNW Marketing Research, an automotive research firm in Bandon, Oregon. In California, the percentage was even higher at 30 percent.

During the last few years, families in much of the country have relied on the cash from mortgage refinancing made possible by rising house values, low interest rates and a bevy of creative new loans, to make up for stagnant wages. From 2001 to 2005, even as the economy was growing at a healthy clip over all, the pay of most workers failed to keep pace with inflation. Now the housing slowdown is making it more difficult to take equity out of a house, and an improved job market is finally causing wages to rise.

Arizona, California, Florida and Nevada, the chief beneficiaries of

the housing rush, are also expectedto suffer disproportionately fromthe slump.

Maryland's real estate transfer tax revenue has tumbled by 22 percent this fiscal year, suggesting that fewer homes are being sold, prices have fallen or both. Connecticut's real estate transfer tax revenue, which state budget analysis predicted would fall by 3.5 percent, is down by 13.3 percent so far.

Some states have defied the trend, chiefly among them New York, where the housing market has been bolstered by sales in Manhattan. The prices and number of apartments selling in Manhattan rose in the first three months of this year, according to data released last week by several of New York City's largest real estate brokerages.

Some economists fear the situation will worsen as credit standards tighten and more recipients of subprime loans, typically people with bad credit, who obtained such loans easily during the housing boom, default on their payments.

Alan Greenspan, the former Federal Reserve chairman who has expressed worries about the housing market, has said he believes there is a one-in-three chance the economy will slip into recession in 2007.

Even without a recession, a growing national movement to reduce local property taxes could leave local governments short of the amount they need to provide services at a time when home values are falling.

BOOK REVIEWDNA LEADERSHIP THROUGH GOAL-DRIVEN MANAGEMENTBy James R. Ball, $29.95The Goals Institute, Inc.Reston, VA www.goalsinstitute.com

The task of a 21st-century leader is to move people from where they are to where they have never been, by getting individuals to become more than they thought they could become and to accomplish more than they thought possible.

James Bell has written a ground-breaking book outlining a new leadership model, two proprietary methods, and fifty-nine success strategies.

He writes, "Most people are intelligent, but only some are successful and the best-kept secret is that successful organizations and people find and follow methods for everything they do.

Apply a few ideas and you will see immediate results. Study and apply the concepts completely and you will substantially increase your lifetime accomplishments and the growth and profits of your business.

If you are seeking a better approach for building your company and for pursuing business and personal goals with greater results, here it is.

TAX REP ROUNDTABLEIMRS—MONTHLY OVERVIEWThe IRS Stakeholder Liaison function has established the Issue Management Resolution System, IMRS, a streamlined and structured process that facilitates stakeholder issue iden-tification, resolution and feedback.

IMRS captures, develops, resolves and responds to significant national and local stakeholder issues. When stakeholder organizations notify the IRS of concerns about IRS policies, practices and procedures, Stakeholder Liaison researches the issues to bring about resolution.

Recently Closed Issues:IMRS 07-0000496Address Change for Form 1040ESThe mailing address for Form 1040ES payments for Pennsylvania and Kentucky taxpayers will change for the 3rd and 4th quarter payments.

Response: Correct address information will appear on irs.gov on 7/1/07. Currently the Cincinnati lockbox serves both Philadelphia and Fresno. After June the St. Louis lockbox will serve Pennsylvania and Kentucky taxpayers. Payments sent to Cincinnati after June will not be forwarded to St. Louis. They will be processed in Cincinnati. Unprocess-able payments, returns, etc., will be date-stamped with the applicable IRS Receiving Date Stamp and forwarded to the Fresno Service Center. Timely received payments will be considered timely and processed timely regardless of which lockbox bank processing site receives the payment.

IMRS 06-0000232Erroneous CP2000 NoticesState Tax Refund and AMTTaxpayers are erroneously receiving CP2000 notices informing them that they did not include their state tax refund as income when the taxpayer was subject to AMT in the prior year.

Response: The issue was elevated to IRS for Tax Year 2004 Automated Under Reporter (AUR) cases. As a result, the proper procedures have

MAY 2007 – THE FEDERAL TAX ALERT13

been reinforced with tax examiners and for Tax Year 2005 we were able to systemically eliminate the situation.

IMRS 06-0000307Listed TransactionsThe Listed Transactions Webpage on irs.gov has been redesigned. The new page can be found at http://www.irs.gov/businesses/corporations/article/0..id=120633.00.html.

IMRS 07-0000479Continuing Education CreditsAICPA will not grant continuing education credits for the IRS' presen-tations on Circular 230.

Response: Currently there is no agreement between the AICPA and IRS that qualifies the IRS Circular 230 presentations as Ethics training for CPE credit.

NSTP will be presenting part I of the Circular 230 presentation at the 2007 IRS Tax Forums. CPA members of NSTP should take special note that while both the NSTP presentation and that of the Office of Professional Responsibil-ity will qualify for Ethics presentations before OPR they will not qualify for AICPA credit

IMRS 07-0000387Enrolled Agent ExamInformation about the scoring and results of the Enrolled Agent Examination will be posted to the Thomson Prometric web site. Visit www.prometric.com/irs to review.

NSTP RECEIVES ISSUERESOLVE FROM IRSThe IRS Office of National Public Liaison and NSTP's assigned staff member, Michael Singleton, responded to our inquiry of where on www.irs could a tax professional access a list of "task specific" campuses. Our request was for a single location of access. Mike reports:

Thank you for your request and your thoughtful suggestions. I explored several ideas for how to make this information readily available to tax professionals. Many of the resources I considered are not approved for external use. However, I spoke with our SB/SE Stakeholder Liaison staff and learned that they had a similar project well underway. They reviewed your suggestions and made some modifications to their new web page to include information on innocent and injured spouse issues. They are working to add contact information for insolvency issues as well.

I truly appreciate the time you took to work with our field liaison to ensure we all understood your suggestions properly and could build

them into the new web page. The page is now live and can be found at the following URL:

http://www.irs.gov/businesses/smal-larticle/0..id=158633.00.html.

It can also easily be reached by clicking on the "Where to File" buttons on the left of most of our irs.gov screens.

The additional issue NSTP brought forward was who should be contacted when there were problems with IMFs, Individual Master Files, or BMFs, Business Master Files. After discussions with subject matter experts at IRS, it was determined that Practitioner Priority Services would best handle any such issues.

NSTP gratefully acknowledges the assistance of the Office of National Public Liaison, Director Candice Cromling, Cynthia Vanderpool and Michael Singleton in the resolve of issues brought by our membership.

IRS OFFERS SEVERALTAX PAYMENT OPTIONSThe Internal Revenue Service reminds taxpayers to file their tax returns timely and to pay as much as possible to avoid or minimize any accrued penalties and interest. Payment options include:

Request an Extension of Time to Pay—Based on the circum-stances, a taxpayer could qualify for an extension of time to pay. The IRS is willing to allow extensions of time to pay in order to assist in tax debt repayment. A taxpayer can request an extension from 30 to 120 days depending on the specific situation. Taxpayers qualifying for an extension of time to pay of 30 to 120 days generally will pay less in penalties and interest than if the debt were repaid through an installment agreement. Taxpayers can request an extension of time to pay using the Online Payment Agreement option available on the IRS's Web site at irs.gov.Apply for an Installment Agreement—The IRS may allow taxpayers to pay any remaining balance in monthly install-ments through an installment agreement. Taxpayers who owe $25,000 or less may apply for a payment plan electroni-cally, using the Online Payment Agreement application. Alter-natively, taxpayers may attach a Form 9465, Installment Agreement Request, to the front of their tax return. Taxpayers must show the amount of their proposed monthly payment and

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the date they wish to make their payment each month. The IRS charges $105 fee for setting up an installment agreement. The fee is reduced to $52 for those who establish a direct debit installment agreement and $43 for those with an income below a certain level. Taxpayers are required to pay interest plus a late payment penalty on the unpaid taxes for each month or part of a month, after the due date that the tax is not paid. A taxpayer who does not file the return by the due date, including extensions, may have to pay a failure-to-file penalty.Pay by Credit Card—Taxpayers can charge taxes on their American Express, MasterCard, Visa or Discover cards. To pay by credit card, taxpayers should contact one of the service providers at its telephone number or Web site listed below and follow the instructions. The service providers charge a convenience fee based on the amount of tax the taxpayer is paying. Taxpayers should not add the convenience fee to their tax payment.

Link2Gov Corporation: 888-PAY-1040(888-729-1040), www.pay1040.comOfficial Payments Corporation: 800-2PAY-TAX (8990272-9829), www.official-payments.com

ETHICS CORNERJUSTICE DEPARTMENT SUESTAX-PROTESTING CHARITYThe U.S. Justice Department is suing the founder of a charitable organiza-tion for allegedly peddling a national tax-fraud scheme that it says has cost the government $21 million.

The government charges in its lawsuit filed in April that Robert L. Schulz of Queensbury, NY used the charity, the We the People Foundation for Constitutional Education, to falsely sell donors that they could legally avoid having federal income taxes withhold from their paychecks.

Schulz, a high-profile tax protestor, denies any wrongdoing and maintains that the foundation simply educates people about the U.S. Until the government responds to the foundation's petition challenging its legal authority to collect income taxes. Until the government responds to the founda-

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2.

THE FEDERAL TAX ALERT – MAY 200714

tion's petition challenging its legal authority to collect income taxes and the authority of the Internal Revenue Service to withhold them from people's paychecks, Schulz said he and his followers should not have to give it any money.

"We have a First Amendment right to withhold our taxes if the government does not respond to our grievances," he said.

Schulz also maintained that the Justice Department lawsuit is invalid because he does not sell the information on his Web site, he gives it away. The foundation requests a donation for the material.

Donations to the foundation, which have totaled some $2 million since 2000, have helped it pay for civic education, legal advocacy, and activism efforts in support of its beliefs.

Because the foundation is a charity, the donations are tax-deductible for donors who pay income taxes.

Some experts say they are puzzled that the foundation, listed as a legitimate charity by the IRS, has not lost its tax-exempt status.

As is its policy, the IRS declined comment on a specific case. In general, organizations can qualify for nonprofit status if they show their mission is educational.

Schulz and the foundation have been leading player in the anti-tax movement. We the People has sponsored meetings of tax protesters and paid for full-page newspaper ad-vertisements, including a 2001 ad in USA Today that proclaimed "Congress has yet to pass a law that requires most Americans to file a tax return or pay income tax."

After the USA Today ads ran, an outraged Congress held hearings on tax protesters, and the federal government stepped up its enforcement efforts.

Since then, life has become more difficult for tax protesters. The Justice Department has obtained more than 230 injunctions since 2001 to stop promoters of tax-fraud schemes.

The Internal Revenue Service says the arguments made by tax protesters are frivolous and has posted a rebuttal of the latest anti-tax claims on its Web site.

In recent years, the tax agency has successfully prosecuted people who have promoted schemes to escape taxes or who have boasted publicly of their ability to avoid making income-tax payments, including Irwin Schiff, Lynne Meredith, Larken-Rose and Richard Simkanin. All are in jail. The IRS is continuing to pursue criminal investigations of others.

The Internet has created a new type of tax protestor. In the past, people

withheld their tax payments as an act of civil disobedience, for example, against the Vietnam War. They knew and accepted jail or fines as the conse-quences of their behavior.

By contrast, the new protesters are in it for themselves. They want the benefits of withholding funds from government without any of the negative consequences. They are not practicing civil disobedience; they are following a cult-like belief system made up of absurd pseudo-legal theories and wild-eyed conspiracy tales.

Schulz, a former environmental engineer, said he gets no personal benefit from his crusade. According to the 2005 Form 990 tax filing for the foundation, which received $240,000 in donations that year, he collects no salary for his efforts.

Schulz says it is the principle that matters. "The Constitution does not defend itself," he said.

But he adds that his fight against the federal government has not been easy or pleasant. "The IRS can turn anybody's life upside down," he said.

U.S. ASKS FEDERAL COURT TO BAR DALLAS MAN FROM PREPARING TAX RETURNS FOR OTHERSThe United States has sued a Dallas, Texas man, seeking to bar him from preparing federal income tax returns for other. According to the govern-ment's civil injunction complaint, Farai Mushaninga, who operates FW Hawk Services and FW Hawk Taxes in Dallas, prepared federal income tax returns claiming fraudulent fuel tax credits, a scam that the complaint says is a serious enforcement problem for the IRS.

The government's complaint alleges that Mushaninga fraudu-lently prepared a return for one customer, a cashier, claiming that she bought 19,050 gallons of gasoline for business-related purposes. The suit notes that for such a claim to be accurate, the cashier, whose total income for the year was $392, would have had to spend approximately $41,910 for gasoline that year, nearly 110 times her total income, and would have to have driven approximately 381,000 miles during the year, an average of 1,084 miles each day, seven days a week.

The government complaint alleges that Mushaninga has prepared at least 1,207 returns since 2006 and the IRS has identified over $900,000 in fraudulent fuel tax credits on Mushaninga-prepared returns.

The Justice Department encourages anyone who has information about suspected tax fraud to report it to the IRS Web site at http://www.irs.gov and

click on the links "Contact IRS" and "How Do You Report Suspected Tax Fraud Activity."

STEALING FROM THE IRS? CONVICT SAYS IT IS "EASY"A man serving prison time for fraud recently told Congress that using stolen identities to apply for tax refunds was "an easy way to make money quickly."

"The system in my eyes is inviting criminals like me to steal from the IRS, banks, et cetera," Evangelos Dimitros Soukas said in testimony before the Senate Finance Committee.

Soukas, 28, serving nearly eight years in prison for defrauding the government, banks and individuals of $1.1 million, said he was puzzled why the Internal Revenue Service does not require PIN numbers or use of a mother's maiden name when filing electronically or seeking information.

The Commissioner of the IRS told the panel that stopping identity thieves is not simple, but the senators were not mollified.

In a heated exchange, Finance Committee Chairman Max Baucus, Montana, asked IRS Commissioner Mark Everson why he did not carry out Soukas' suggestions. Turning to Soukas, Baucus said his criminal acts were "not a mark of your accom-plishment. It is a mark of the govern-ment's failure to protect taxpayers."

Senator Charles Grassley, Iowa, faulted the IRS, saying it was "not reaching out to help the taxpayers who fall victim, but is instead interrogating them as though they were the crooks."

Everson said he would study new electronic safeguards but cautioned that there was a trade-off between adding new protections and efforts to make taxpaying more consumer friendly. "If you stop everything that you think is questionable, then you will be damaging the interests of many legitimate taxpayers," he said.

Soukas' testimony took place only after a U.S. district judge rejected a Justice Department argument that the committee had no right to ask a federal judge to order a federal prisoner to appear before the legislative body.

Soukas said he was a "criminal already on the run from the FBI" in 2000 when he came across an Internet ad for quick tax refunds. Using his mother's W-2 form, he said it took several hours to design a legitimate-appearing tax return. He said he received a refund of $3,614 within days after applying for a refund antic-ipation loan through a tax preparer.

The next year he made $43,600 by using stolen identity information,

MAY 2007 – THE FEDERAL TAX ALERT15

keeping each refund request under $5,000. One mistake, apparently undetected by the IRS, was having the refunds under different names all deposited in his checking account.

MEMBERS ASKCLIENT'S ASK—HOW DID FEDERAL INCOME TAX BEGIN?In the nation's early history, very few taxes were imposed in the U.S. to run the government. From 1791 until 1802, the Government collected internal taxes on alcohol, carriages, sugar, tobacco, auctioned-off property, corporate bonds, and slaves.

Then, in order to pay off the debts that were incurred from the War of 1812, sales taxes were imposed on gold, silverware, jewelry, and watches. Congress did away with these taxations. And the Government was supported by collecting tariffs from imports brought into the country.

Congress then passed the nation's first income tax law in 1862 to support the Civil War effort. It was a forerunner of the modern income tax in that it was based on a progressive scale, much like what is used today. The lowest tax rate was a flat 3% and it applied to people who earned anywhere between $600 and $10,000 a year. The next highest tax rate was 5% and it was levied on any income amount that exceeded $10,000. For people who earned a higher dollar amount, the rates were increased accordingly. Additional sales and excise taxes were added, and an "inheritance" tax also made its debut.

The Act of 1862 was also the beginning of the Internal Revenue Service called the office of the Commis-sioner of Internal Revenue. The Commis-sioner was given the power to assess, levy and collect taxes and the right to enforce the tax laws through seizure of property and income and through prosecution. His powers and authority remain very much the same today.

Rates were changed when the Government instituted the Internal Revenue Act of June 30, 1864. The people who earned between $600—$5,000 paid 5% while the people who earned over $5,000+ paid 10% of their incomes. This tax change was needed in order to generate additional revenue to fund the Civil War. Now, every taxpayer had to submit a list of their income as well as a list of any taxable property they might have to the tax assessor before the first Monday in May. And, fines were

imposed on people who failed to abide by the tax laws.

Internal revenue collections reached their highest point in the nation's 90-year history of more than $310 million in 1866, an amount not reached again until 1911.

In 1872, Congress did away with the imposed income tax once again. Instead of taxing people's incomes, Congress once again looked towards the taxation of goods, tobacco and alcohol, for revenue. It had a short-lived revival in 1894 and 1895.

Questioning the validity of the taxes imposed during the Civil War times; lead the U.S. Supreme Court to finally hand down a ruling in 1895, which said that the income tax was unconstitutional because the taxes were not collected proportionately among the states. To correct this situation, the 16th Amendment to the Constitution was ratified on February 25, 1913. Now, income taxes were a permanent part of the United States economy, and Congress could tax incomes however they saw fit.

In 1918, annual internal revenue collections for the first time passed the billion-dollar mark, rising to $5.4 billion by 1920. With the advent of World War II, employment increased, and so did tax collections to $7.3 billion. The withholding tax on wages was introduced in 1943 and was in-strumental in increasing the number of taxpayers to 60 million and tax collections to $43 billion by 1945.

Congress enacted the largest tax cut in U.S. history in 1981, approxi-mately $750 billion over six years. The tax reduction, however, was partially offset by two tax acts, in 1982 an 1984, which attempted to raise approximately $265 billion.

The Tax Reform Act of 1986, one of the most far-reaching reforms of the U.S. tax system since the adoption of the income tax, was an attempt to remain revenue neutral. The act called for a $120 billion increase in business taxation and a corresponding decrease in individual taxation over a five-year period. Following were what seemed to bea yearly tradition of new tax acts that began in 1986.

Over the years, there have been several grass root efforts by Americans who believe that the idea of a mandatory income tax and the Sixteenth Amendment are unconsti-tutional. At least one group claimsto have proof that the amendmentwas not even ratified because at least eleven states did not vote on it. The main goal of these groups is to getthe amendment declared legallynull and void.

Tax Timeline1813 The Revenue Act; taxes were imposed when and as needed.

Pre-1862 U.S. government operations funded through collected import duties and sold public lands.

July 1, 1862 Congress formed Office of Commissioner of Internal Revenue to meet fiscal demands of the Civil War. (After the war, tax efforts declined.)

1913 16th constitutional Amendment introduced our first Income Tax.

(World War I; heavy fiscal demands: Increase tax efforts.)

1916-1951 New tax legislation enacted every year.

1939 U.S. Tax Laws first codified as an integral part of the U.S. Code—IRC 1939.

1954 U.S. tax code amended and becomes IRC 1954.

1986 Code completely revamped—IRC 1986 U.S. Code, Title 26, Internal Revenue Code of 1986.

1997 Taxpayer Relief Act—new beneficial rules to offset education costs.

2001 Economic Growth and Tax Relief Reconciliation Act—began phased in changes with sunset provisions causing the new tax laws to terminate in 2011 and launched a series of enactments of annual legislative changes which bring us to 2007.

LEGISLATIVE AND GOVERNMENT RELATIONS UPDATEMay, 2006NSTP's Executive Director represented NSTP members at the Treasury hearing in Washington DC. One issue affecting NSTP membership, the ability of return preparers to represent the taxpayer at the initial examination, was a focus of testimony. While Treasury has made no announcement, discussions with the Office of Profes-sional Responsibility indicate that no change will be made to the current provision and tax professionals can continue to represent the clients for whom they have prepared the return at the initial examination.

Summer, 2006NSTP presents Circular 230—The Basics at six IRS Nationwide Tax Forums and participates as a panelist on the Office of Professional Respon-sibility presentation at the Forums.

THE FEDERAL TAX ALERT – MAY 200716

NSTP takes the "lead" on issues of Ethical and Professional Conduct.

Not only was the Circular 230 pre-sentation by NSTP ranked #1 by forum attendees but NSTP was requested to assist OPR in the development and presentation of a jointly-sponsored Circular 230 presentation for the 2007 IRS Nationwide Tax Forums.

November, 2006Dr. Bill Stevenson, NSTP Member—NY and Executive Director meet with Senate Finance Committee staff over S832, Regulation of Return Preparers.

NSTP Executive Director contacts Acting Director of OPR, Steve Whitlock, regarding improper notifi-cation of taxpayers about credentials of Enrolled Agents as their repre-sentatives. NSTP demands affected Enrolled Agents be notified and letters of apology be sent to taxpayers and Enrolled Agents regarding the IRS error. IRS agrees.

February, 2007Executive Director responds to Small Business Administration with comments regarding licensing of return preparers and the potential in-terruption of small business activities engaged in by tax professionals.

March, 2007Executive Director appears before IRS Oversight Board regarding issues of the Tax Gap. Comments included the value of Tax Professionals to voluntary compliance and recommended changes to Form 1098 requiring the reporting of address for interest and real estate tax reporting. NSTP announced planned program for presenting "The Real World of Taxes", currently in development, where NSTP members would have tools to teach "taxes" to high school and middle school students as well as students of English as a second language. With the considerable assistance of Dr. Bill Stevenson, NSTP launched support of the "Compact", an agreement between the tax professional community and IRS on how issues for taxpayers should be solved based upon the premise of mutual respect.

April, 2007With resignation of Mark W. Everson as Commissioner of the Internal Revenue Service, NSTP immediately established contact with Acting Commissioner, Kevin Brown. NSTP meeting with Commissioner Everson postponed until personnel assignments established at IRS.

NSTP Board President, Laurie Conner Jarrett, and NSTP Executive Director met with Senate Finance Committee Staff for Senator Baucus

and Senator Grassley regarding issues involving the proposed legislation to regulate tax return preparers. NSTP's Board President and Executive Director reflected on the value of "experience" and the need for "grand-fathering" provisions. In addition, NSTP asked for consider-ation for time-lines and implementa-tion procedures that would facilitate any testing procedure. NSTP also requested that as a professional organization, NSTP be allowed to administer the examination. All suggestions were noted by the Committee Staff.

April 26, 2007Senate Bill 1219 Introduced—"Taxpayer Protection and Assistance Act of 2007"

The bill calls for a full testing and registration of tax return preparers with an exemption from testing for CPAs, Enrolled Agents and Attorneys. Those tested by state boards would also be exempted. Implementation is set for 1 year from enactment. The test appears to be focused on the Earned Income Tax Credit and Ethics and Professional Conduct.

Other parts of the legislation address the use of the initials EA, with or without the periods and regulation of the Refund Anticipation Loan as well as Low-Income Taxpayer Clinic provisions.

The bill was introduced in the Senate by Senator Jeff Bingaman, New Mexico. The House of Representatives has already passed its version of the Taxpayer Protection Act—H.R. 1677. It should be noted that the House legislation contains no provision to regulate tax return preparers.

NSTP will continue to monitor this and all legislation that affects our members. Conversa-tions have already taken place with the Office of Professional Responsibility and the IRS Oversight Board. As with all initial legislation, hearings will be held, test-imony received and modifications made before final legislation is put for vote.

QUOTES OF THE MONTH"Without change, rising costs will drive government spending to unprec-edented levels."

Treasury Secretary Henry Paulson

"The pay gap is not going to disappear just through educational achievements."

Catherine Hill, Director of ResearchUniversity Women Educational Fdn.

"Taxes are the last thing the Virginia Tech family should be worried about at this time. Our hearts go out to the people affected by this tragic event."

Mark W. Everson, IRS Commissioner

"People who sell tax scams are asking for trouble for themselves and their customers who participate in them."

Eileen J. O'ConnorAssistant Attorney General—Justice

"In my eyes, it doesn't take an Einstein to file false tax claims. It is actually pretty easy."

Evangelos Soukas, convicted taxfelon, testifying before the SenateFinance Committee

"I do think it is important to send a message in a case like this. It is about as serious as it gets."

Paul Friedman, U.S. District JudgeWalter Anderson trial judge

NEXT ISSUE(JUNE 2007)

☛ TAX SEASON “HOTLINE” ISSUES—MOST FREQUENTLY ASKED QUESTIONS

WWW.NSTP.ORGSERVICE TO THE TAX

PROFESSION

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Top winner is announcedand especially honored at

Annual Meeting in Atlanta.(you don’t have to be present to win!)

Proud Member of the National Society of Tax Professionals

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May is

Madness Month!Membership

New memberships in May qualify.

“Referred by” on the membership application

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All new memberships qualify.

Members referring new members qualify

for prizes based upon number of

memberships obtained.

One membership referral gets you a prize.

More get you more and bigger prizes.

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

12 hours of continuing professional education (CPE).

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

NSTP 2007REGIONAL CONFERENCES

at the IRS Nationwide Forums

www.nstp.orgService to the Tax Profession

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

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

as well as the fi nances and status of programs.

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

Continues on back…

Location Dates Place

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

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

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

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

Schedule:

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

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

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

Instructor: Paul LaMonaca, CPA, MST OR

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

Instructor: Beanna J. Whitlock, EA CSA

Special invitationfrom Board President

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

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

Laurie Conner Jarrett,NSTP Board President

www.nstp.orgService to the Tax Profession

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Business name. If no separate business name, leave blank.

C

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If you started or acquired this business during 2006, check here

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24

Car and truck expenses (see

page C-4)

9

24a

11

Travela

Commissions and fees

10

12

Depletion

2

Deductible meals andentertainment (see page C-6)

b

Depreciation and section 179

expense deduction (not

included in Part III) (see

page C-4)

13

Employee benefit programs

other than on line 19) 14

25

15

Utilities25

nsurance (other than health)

26

Wages (less employment credits)

26

terest:

16a

rtgage (paid to banks, etc.)

Other expenses (from line 48 on

page 2)

27

16b

er

17

al and professionalces

18

Office expense

18

19

Pension and profit-sharing plans

19

Rent or lease (see page C-5):

20

20a

Vehicles, machinery, and equipment

ab Other business property

20b

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

31

All investment is at risk.

32a

Some investment is notat risk.

32b

Schedule C (Form 1040) 2006

ction Act Notice, see page C-8 of the instructions.

(1)Cash

(2)Accrual

(3)Other (specify) �

Business address (including suite or room no.) �

City, town or post office, state, and ZIP code

Cat. No. 11334P

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

s for business use of your home. Attach Form 8829

2930

�

Part I

Part II

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

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

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

you must go to line 32.a loss, check the box that describes your investment in this activity (see page C-6).

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

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

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

�

Contract labor (see page C-4)

1

24b

06

3

3

3

3

3

4

4

4

u

r

r

o

Topic:Meeting the Challenges of the 1040 Schedule C

When:June 28-29, 2007

“The Last Thursday and Friday in June.”

Where:Williamsburg, VA

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

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

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

Instructor:Paul LaMonaca, CPA, MST

Cost To AttendThe cost for the 12 hour seminar is

$195 for members$245 for non-members

Day 1 is 8 hoursDay 2 is 4 hours

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

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

online at www.nstp.org.

2007 NSTP Special Topic Workshop

www.nstp.orgService to the Tax Profession