Tax Watch: IRS helps taxpayers recoup 'gratuity' benefits

Both provisions were retroactive, so some qualifying taxpayers must file amended returns to claim these tax breaks. The IRS is asking them to write "Military Family Tax Relief Act" in red at the top of such returns in order to help speed processing. The new law doubled to $12,000 the benefit paid to survivors of deceased armed forces members, made the entire amount tax-free and made the changes effective for deaths occurring after Sept. 10, 2001. Previously, only $3,000 was tax-free. Recipients who already have paid tax on benefits received for deaths after the effective date may file an amended return on Form 1040X, reducing their adjusted gross income by the $3,000 they had reported as taxable. Those who receive such "gratuity" benefits in 2003 and future years won't have to report them on their tax returns. Taxpayers may also exclude a gain on a home sale, provided they have owned and used the home as a principal residence for two of the five years before the sale. A reduced maximum exclusion may apply to those who satisfy part of the two-year rule. Military personnel often retain ownership of a home while away on duty but eventually sell it without returning to live in it, sometimes failing the use test completely. The new law will allow those on qualified extended duty in the U.S. armed services or foreign service to suspend this five-year test period for up to 10 years of such duty time. A taxpayer is on qualified extended duty when at a duty station that is at least 50 miles from the residence sold, or when residing under orders in government housing, for more than 90 days or for an indefinite period. (IR-2003-132)

Contested-liability trust use `listed'

* The Department of the Treasury and the IRS have issued guidance to prevent the use of trusts to accelerate deductions for liabilities that a taxpayer is contesting. The use of a trust to accelerate improperly deductions under the Section 461 rules for determining the year of deduction is now a so-called listed transaction. A taxpayer using a trust for that purpose will have to disclose it to the IRS, and an adviser promoting its use will be required to keep a list of taxpayers. These final, temporary and proposed regulations relate to the transfer of money or other property to provide for the satisfaction of a contested liability. The rules clarify that the transfer of a taxpayer's indebtedness, or promise to provide services or property in the future, isn't a transfer to provide for the satisfaction of an asserted liability. What's more, the temporary regulations clarify that a taxpayer's transfer of money or other property to a trust, escrow account or court to provide for the satisfaction of a contested workers' compensation, tort or other payment liability generally doesn't satisfy the economic performance requirement of the tax law. Rather, economic performance occurs when payment is made to the claimant. In Notice 2003-77, the IRS designates certain transactions that use contested-liability trusts to accelerate deductions as listed transactions under the tax-shelter disclosure, registration and list maintenance requirements. (T.D. 9095, REG-136890-02)

Learning the books of teachers' union

* The IRS is auditing the nation's largest teachers' union, scrutinizing an organization that works energetically to elect candidates but files tax returns reporting zero political expenditures from member dues. The National Education Association promised to cooperate, but its president, Reg Weaver, says the union "will not be silenced" by the audit or the conservative law firm that requested it. "It will be a complete, thorough audit," says NEA spokeswoman Kathleen Lyons. "The IRS has not singled out any particular aspect of our activities." The Washington-based NEA has tax-exempt status as a union but must report "direct and indirect" political expenses on its tax returns. Some of those expenses could be considered taxable by the IRS. The agency defines a political expense as "one intended to influence the selection, nomination, election or appointment of anyone to a federal, state or local public office." The New York-based Associated Press, which first reported on the NEA's tax returns three years ago, has reviewed the NEA's filings from tax years 1993 through 1999 and hundreds of pages of internal NEA documents. The records show that the 2.7 million-member union spent millions of dollars to help elect pro-education candidates, produce political training guides and gather teachers' voting records. Both Mr. Weaver and Ms. Lyons predict that the NEA will be exonerated, contending that the IRS found no problems when it audited the association's 1993 tax return. The IRS is prohibited by law from publicly discussing audits of specific taxpayers. Listed-transaction list gets an update * The IRS recently released an updated list of transactions that have been determined by the IRS to be so-called listed transactions. This notice restates the basic list of listed transactions in Notice 2001-51, and updates the list by adding transactions identified as listed transactions in notices and other guidance released subsequent to Aug. 2, 2001. Transactions that are the same as, or substantially similar to, transactions listed in the notice have been determined by the IRS to be tax avoidance transactions and are listed transactions. As a result, taxpayers may need to disclose their participation in these listed transactions as prescribed, and promoters (or other persons responsible for registering tax shelter transactions) may need to register these transactions. Cite: IRS Notice 2003-49

Lodge can't pull off pull tab exemption

* In a recently issued technical advisory, the IRS has determined that the purchase of pull tabs sold by a tax-exempt fraternal lodge is a wager and not tax exempt. The lodge apparently purchases pull tabs in series of less than 2,500 from the manufacturers. Under the lodge's operations, winners are identified and prizes are awarded at a gaming session. The lodge doesn't carry over pull tabs to its next session. The lodge argued that because wagers are placed, winners are determined, and prizes are awarded in the presence of all people placing wagers, its pull tab games are exempt from the tax law's definition of wagers. The IRS, however, concluded that because the winners are actually determined when a series is manufactured, and therefore are predetermined outside the presence of any persons placing wagers in a game, the purchase of the pull tabs is subject to the Section 4401 tax on wagers. Cite: Technical Advice Memorandum 200337007

Preparer granted a second trial

* The 9th U.S. Circuit Court of Appeals, reversing a denial of a motion to suppress evidence and vacate a conviction, remanded a tax return preparer's case to district court for a new trial. The appeals court also said that the IRS' search warrant was too broad. Alfred Bridges operated a tax consulting business, Associated Tax Consultants, which advised clients not to pay taxes and to declare themselves non-resident aliens. Agents from the IRS' criminal-investigation division launched an investigation into ATC. Mr. Bridges allegedly told undercover Treasury agents that they could avoid paying taxes if they declared that they were non-resident aliens. In 2000, under a search warrant, Treasury agents seized the Billings, Mont., company's computers, correspondence, files and videos. Mr. Bridges requested a copy of the application for search warrant and requested a return of the items seized. A U.S. District Court denied Mr. Bridges' requests, and he appealed. A grand jury indicted him, and the appellate court dismissed the indictment. In 2000, Mr. Bridges moved to suppress the items seized from ATC's offices and to have his property returned. In 2001, a jury returned a verdict for the government, convicting Mr. Bridges. Circuit Judge Dorothy W. Nelson reversed the denial of Mr. Bridges' motion to suppress. The court concluded that the IRS special agent's affidavit was sufficient to show probable cause but that the scope of the warrant was overly broad and didn't state what items were targeted for search or what the criminal activity was. The court, concluding that the warrant failed to say what criminal activity was being investigated, rejected the argument that the warrant was valid because ATC's cooperation was permeated with fraud. The court noted that the IRS' warrant contained no objective limitations to guide agents in searching. It vacated Mr. Bridges' conviction and remanded for a new trial. Cite: United States v. Alfred G. Bridges, 9th Circuit