Finance Tax Time

Offshore financial centers are often used to run tax shelters. They have little or no taxes, and little or no financial regulations. For example, in the British Virgin Islands, corporations can be formed without the public disclosure of the names of the directors or officers of the corporation. Favorite offshore tax havens include colonial relics such as the Cayman Islands (British), the Dutch Antilles and Curacao (Netherlands). Other places are feudal relics like Monaco, Liechentenstein and Andorra in Europe, or other nominally independent small nations from the old British, Dutch and French Empires. Other places historically in the U.S. zone of influence are Panama and the U.S. Virgin Islands.

The leading offshore center is the Cayman Islands, which is now the fifth largest banking center in the world, after New York, London, Tokyo and Hong Kong.

This is the backdrop on looking over legal papers from a court opinion on July 20th 2006. The judge in Texas District court ruled that certain technicalities of the case against the BLIPS tax shelter were wrong. This will have some effects in the case against 8 KPMG Accounting Firm former executives. KPMG itself has already pled guilty and paid a $456 million fine. One gets a feeling how these illegal tax shelter were carried out from these papers. BLIPS stands for Bond Linked Issue Premium Structure. It created a financial structure to make the capital gains tax deductions, through a capital loss. However, this “loss” had been paid at the beginning of the deal as the “premium”, hence the “BLIPS”.

The mechanism was as follows: Two companies in the Isle of Man (UK), St. Croix and another investment firm “Rogue” each borrowed $41.7 million from National Westminster Bank. The loans were for 7 years at fixed interest rates. The loans paid Interest Only, until a balloon payment at the end of the 7 years. St. Croix and Rogue agreed to pay high interest rates of 17.97%, in exchange for a $25 million payment to them from Nat West at the time the loans originated. So St. Croix and Rogue, received at the beginning of the loans a total of $66.7 million. Then the $66.7 million plus $1.5 million from each was put in an interest bearing loan at Nat West.

In addition, St. Croix and Rogue agreed to pay $25 million to NatWest, if they paid off the loan early, which is exactly what they did a couple of weeks later, May 25th, 2000.
To make it a little juicier, the two onshore companies behind the offshore companies had an interest swap deal with NatWest, where they received a floating interest rate, in exchange for the high fixed interest rate. Those under indictment argued that the $25 million that they received upfront was a liability or not. It was money they received, but it was not actually “loaned” to them. Plaintiffs argued that it was not a liability under IRS section 762, because this money was never lent to them. The tax shelters aim to create an illusion of capital losses, and also interest payments, both of which are tax deductible.

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Keep or Toss - And When?

Record Retention

By Teri Kaye, CPA

As a Certified Public Accountant, I work with my clients’ banking and business records all the time. As a mom, I handle my own family’s banking, credit card and other financial records. In both capacities, I have learned how important it is to safely retain financial records. If you have ever applied for a loan or been through a tax examination, you also know the need to have adequate records. But what are adequate records and how long do you need to keep them?

In general, except in cases of fraud or substantial understatements of income, the IRS can only assess additional tax for three years from the date the return was filed, (or, if later, three years after the return was due). For example, if you filed your 2005 personal tax return by its original due date of April 17, 2006, the IRS would have until April 15, 2009 to assess a tax deficiency against you. If you filed your return late, the IRS generally would have three years from the date you filed the return to assess a deficiency.

However, the assessment period is extended to six years if the IRS asserts that more than 25% of gross income is omitted and is indefinite if the IRS asserts fraud on a return. In addition, the assessment period doesn’t begin to run until a return is filed. Therefore, if the IRS claims that you never filed a return for a particular year, it can assess tax for that year at any time (even beyond three or six years), unless you can prove that you did file. Proving that you filed would entail providing a copy of the return and proof of mailing (such as the green “return receipt” from the U.S. Postal Service.

Retaining tax returns (along with their proof of mailing) indefinitely and important records (bank statements, check registers, receipts, expense logs, sales invoices, computer backups, W-2s and 1099s, etc.) for six years after the return is filed should, as a practical matter, be adequate. If you file your returns electronically, be sure to get copies from the company that prepared and/or filed your return; it is required to provide you with a paper copy of the return.

The six year retention rule is extended for assets and transactions that affect more than one tax year. For instance, if you buying real property, or other investments, or obtaining or making loans, the records for the purchase or origination should be kept for six years after the ultimate sale or payoff. In addition, documentation on any improvements or other costs required to be capitalized should also be kept until six years after the sale.

For any business with an employee, keep complete and accurate record of hours worked and hours paid for. Have a written payroll policy that states how employees are to record their time and that they must submit the information to the employer. Include rules for overtime (i.e., does it need to be approved in writing in advance by a supervisor). Keep all these records for three years after the employee has been terminated. For all employment records, including tax returns and timecards, keep these records for at least four years.

In the event you have a transaction generating a loss carry-forward, such as the sale of an investment at a loss, you should keep the records relating to the underlying transaction as proof of the loss, until six years after the loss has been fully utilized or expired. In particular, remember that if you reinvest dividends to buy additional shares of stock, each reinvestment is a separate purchase of stock, and the records of each reinvestment should be kept for at least six years after the return is filed for the year in which the stock is sold.

For Individual Retirement Accounts (IRAs) you should keep records of contributions and distributions, Forms 8606, 5498 and 1099-R until all the money is withdrawn from all the accounts and an additional three years has passed.

When new property takes the basis of old property, records relating to the old property should be kept until six years after the sale of the new property is reported. For example, suppose you bought a car for business use in 1998 and you traded it in on a new car for business use in 2001. If you sold the new car in 2006, your basis in the new car will determine whether you have a tax gain or a tax loss on the sale, and your basis in the new car is determined, at least in part, by your basis in the car you traded in 2001. Accordingly, records relating to your old car should be kept until 2013 (i.e., for six years after your 2006 return is filed in 2007).

If separation or divorce becomes a possibility, be sure you have access to any tax records affecting you that are kept by your spouse. Or better still, make copies of the tax records, since in such situations, relations may become strained and access to the records difficult.

As many of us have learned this year with the various hurricanes, and other disasters, the calculation of the casualty and theft loss deduction is determined in part by your basis in the damaged or stolen property. You need to have records to support that basis, until six years after you file the return claiming the loss deduction.

To safeguard your records against loss from theft, fire or other disaster, you should consider keeping your most important records in a safe deposit box or other safe place outside your home. In addition, consider keeping copies of the most important records in a single, easily accessible location so that you can grab them if you have to leave your home in an emergency.

If records are lost or destroyed, it may be possible to reconstruct some of them. For example, a paid tax return preparer is required by law to retain, for a period of three years, copies of tax returns or a list of taxpayers for whom returns were prepared. Similarly, other professionals who assisted you in a transaction may retain records relating to the transaction. Consider contacting, your banker, investment broker, realtor and attorney for records.

Your state may have different rules so consult your State taxing authority to request information regarding their record retention rules.

Today, with the prevalence of computer scanning equipment and software, it is easier than ever to maintain complete records for years. My firm invested in state of the art scanning, storage and retrieval technology and now instead of having a filling room, we scan our files and clients’ records and store them electronically. This not only satisfies the retention requirements, but also allows easy access. No more looking in cabinet after cabinet or boxes in storage.

Whether you keep hard copies of tax returns, proof of filing and other financial records, or scanned copies, it is important to set a policy about what you will keep, how you will keep it and when you will destroy it (by shredding so your identify and information are protected).

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For many business owners the answer to this quandary is tax preparation software. Fill out a fairly simple interview, click “print” and out comes a completed return that will pass muster with the IRS. The answer to all your problemsor is it?

Can One Software Program Cover All Businesses?

Take a moment to consider the wide range of businesses that exist in the United States. Now cut that number down to those that can be categorized as “Internet businesses”. If you were asked to write a business plan to provide web design services to each of these services, how long would it be? It would be huge and completely useless because each business would have different needs. A Internet business selling flowers would have completely different needs from an online bank which would have different needs from a hosting company and so on. The only way you could create a practical plan for all Internet businesses would be to offer a collection of general services they could all use on their sites. Tax preparation software designers have the same problem.

There are over 15,000 pages in the tax code and over 100,000 pages of regulations interpreting those pages. Changes are made to the tax code ever year, and new regulations are issued constantly. If one were to create a list of questions for every tax deduction and credit detailed in those pages, the list of questions would be the size of a phone book! Yet, tax software programmers have somehow boiled it all down to a simple 30-minute interview process? Common sense should tell you that doesn’t make sense.

As practical matter, tax software programs are designed to make sure that you claim a general set of deductions that are applicable to businesses across all industries. Most programs try to mask this fact by asking you to identify your business before proceeding. For a lark, you might try selecting another industry and then running through the interview process. You will find that the interview process is modified a bit, but you are still being asked the same basic tax deduction questions.

If you are only claiming general business tax deductions, you are paying more than you should in taxes. Ask yourself if you have seen any of the following questions in a tax software program interview:

Q. Do you store business inventory in your house?

Hint: You may be able to claim hundreds or thousands of dollars in deductions.

Q. Did you start a pension plan for your employees?

Hint: You may be able to claim a tax credit for the next three years totaling $1,500.

Q. Do you have a home-based business and a second office?

Hint: You may be able to deduct your commuting expenses each day. Yes, commuting expenses.

Q. Do you have business meetings at your home?

Hint: Did you charge your business for the space?

Q. Should you claim the standard mileage rate for your auto or the actual costs?

Hint: The standard mileage rate may not the best option.

Q. Did you modify your business location to comply with the Americans with Disabilities Act?

Hint: You may be able to claim a tax credit AND tax deduction for tax savings of $20,000 or more.

Q. Did you refinance your home?

Hint: The points you paid on your original mortgage are fully deductible now, not over the length of the loan.

This represents only the tip of the iceberg of available credits and deductions available to you. Just one of these deductions could save you thousands of dollars in taxes. Yet, you are never going to see these questions raised in a tax software program interview. The tax code and regulations are simply too large to be incorporated into a usable software program.

Your business is unique. You face and overcome issues and problems that are unique to your size, financial situation and particular business needs. Don’t short change yourself by limiting your deductions by using tax software programs.

Richard A. Chapo is with http://www.businesstaxrecovery.com - recovery of business taxes through tax help and tax relief. Visit http://www.businesstaxrecovery.com/articles to read more business tax articles.

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