Line Items

BY MICHAEL LYNCH

Retired Lawyer Deducts Malpractice Policy

At the time of his retirement, Merlin A. Steger purchased an insurance policy for nonpracticing lawyers. It provided professional liability coverage for any acts, errors or omissions he had committed before he retired. Steger deducted the entire cost of the malpractice policy on schedule C of his tax return that year.

The IRS challenged the deduction. It said the policy was a capital asset and determined Steger, therefore, could deduct only 10% of its cost. Ruling for the taxpayer, the Tax Court held Steger could deduct the entire cost of the policy in the year he retired, regardless of whether or not it qualified as a capital asset. The court based its ruling on the Indopco decision, which stated a capital expenditure is deducted upon the dissolution of an enterprise. ( Commissioner v. Merlin A. Steger et ux., 113 TC no. 18)

Taxpayer Combines Business Losses

Mary Ann Tobin was engaged in two business activities. One resembled a business, but the other appeared to be a hobby. Both ventures, however, generated losses for a number of years. On her tax return, Tobin sought to aggregate the two activities and treat them as one business in order to deduct the losses. The IRS disagreed with her approach, but the Tax Court sided with Tobin.

The court ruled that combining the two businesses for tax purposes was valid because Tobin had managed both businesses as a single activity and reported them as such on schedule F. She also had used the same employees, equipment and land for both ventures. Moreover, both required the planting and harvesting of crops. ( Commissioner v. Mary Ann Tobin, TC Memo 1999-328)

Business Drivers Get Mileage Rate Hike

After decreasing the optional standard mileage rate to 31 cents last spring, the IRS increased it for this year. The service announced the new rate of 32.5 cents per mile in revenue procedure 99-38 (1999-43 IRB). The rate for charitable use of an automobile remains at 14 cents per mile and the rate for using an automobile for medical or moving purposes remains 10 cents per mile.

Employees and the self-employed can use these rates instead of deducting the actual costs—such as depreciation, maintenance and repairs, tires, gasoline, oil, license and registration fees and insurance—of driving their cars. For the first time, the IRS calculated the rates using personal rather than business auto insurance costs. As a result of this change, the 2000 rates are lower than they otherwise might have been.

Court Quashes IRS Summons for Workpapers

The IRS informed a married couple that their federal income tax return was being audited. Since their accountant’s office was close to the revenue agent’s, the couple gave him power of attorney and authorized him to receive and inspect confidential tax information and to act on their behalf before the IRS.

Three years later, the IRS began a criminal investigation of the couple. As part of the inquiry, it issued a summons to the accountant for workpapers, financial statements, journals and other records relating to the couple’s tax return. The couple moved to quash the summons, asserting the Fifth Amendment privilege against self-incrimination.

The district court stated that a taxpayer’s privilege generally ends when he or she voluntarily surrenders documents to a third party. However, the judge granted the couple’s request because they had transferred the documents to the accountant’s office as an accommodation for the IRS agent. ( William Streett et. ux. v. United States, W.D. Va., 8-20-99)

No Gift Tax on Tuition Transfers

The IRS approved a new way for grandparents or terminally ill taxpayers with large estates to presently reduce the size of their estates without having to pay gift taxes (PLR 199941013). IRC section 2503(e) states that transfers directly to an educational institution in payment of another person’s tuition are not subject to gift taxes.

A grandmother recently used this unlimited exclusion rule to her advantage. She prepaid more than $163,000 of her grandchildren’s tuition at a private school. The IRS ruled that the tuition payments were gift-tax-free because the payments were paid directly by her (not through a trust) for specified students in designated years and the payments were nonrefundable.

This new exclusion rule can also be applied to payment or prepayment of someone else’s medical expenses as long as the payments are made directly to the health-care provider.

Court Ordered Return of Refund

A corporate taxpayer’s return was being audited, and the IRS proposed a large adjustment was due. As a result of the adjustment estimate, the taxpayer sent the IRS a check for $6,497,710 and a letter instructing the service to treat the payment as a cash bond. Upon conclusion of the audit, the taxpayer actually owed less than it had reported on the original return. The IRS returned the entire payment plus $1,526,100 in interest.

However, revenue procedure 84-58 (1984-2 CB 501) states no interest is due if a cash bond deposit is later returned to a taxpayer.

Three years later, the IRS realized its error and asked the taxpayer to return the interest. The taxpayer refused and filed a motion to dismiss on the grounds that, under IRC section 6532, the IRS had a two-year statute of limitations to recover erroneously paid refunds. The court denied the taxpayer’s motion. ( United States v. Domino Sugar Corp., DC NY, 9-13-99)

—Michael Lynch, CPA, Esq., professor of tax accounting at Bryant College, Smithfield, Rhode Island.

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