Thursday, July 29, 2010

More To The Story Than Meets The Eye

Pendergraft v. U.S. was decided on July 22, 2010. PPC's description of the case is: Mortgage Refinance Proceeds: Taxpayers filed an amended return based in part on their claim that the IRS incorrectly characterized a $35,103 bank deposit from a mortgage refinance as taxable income. The IRS denied the claim because: "You did not document that your share of the loan proceeds were deposited into the accounts considered in determining gross receipts. Rather it appears that your share of the loan proceeds were deposited into one of the accounts not provided to the examining agent which she requested." After noting that funds received from a mortgage refinance are not taxable, the Court of Federal Claims concluded that taxpayers produced sufficient evidence (a letter from Kanaly Trust Company) establishing that they received a check for $35,103 representing one-half of the mortgage refinancing proceeds. Pendergraft v. U.S. , 106 AFTR 2d 2010-XXXX (Ct. Fed. Claims).

I thought this would be an interesting case to read in full. How could the IRS argue that loan proceeds are taxable income? Is this a matter of an IRS correspondence case where the IRS agent added up all bank deposits and the taxpayer explained the additional deposit amount was due to a refinance and the IRS did not understand the explanation? Is this a case where the IRS is ignorant? Is this a case where the IRS tries to extract money from the taxpayer? Or is there more to the story?

There IS more to the story. The case states: The Government highlights the fact that since 1997 Plaintiffs have “created a series of illegal trusts that they believed would enable them to avoid all income taxes.” Gov't Opp. & Cross Mot. at 5. This is not the first time the IRS has had to re-examine Plaintiffs' tax returns. Id. In fact, Plaintiffs filed Form 1040EZ returns between 1998 and 2001 reporting zero taxable income, even though they had received substantial income. Id.; see also NHUSS Trust v. Comm'r, 90 T.C.M. (CCH) 374 [TC Memo 2005-236] (2005) (holding Plaintiffs in the case at bar liable for negligence penalties that arose as a result of the underpayment of taxes in 1999 and 2000). The instant refund claim is a continuation of Plaintiffs' “brazen” “tax-avoidance scheme.” Gov't Opp. & Cross Mot. at 5; see also id. at 6–13 (characterizing Plaintiffs' previous “[s]ham [t]rust [s]tructure and 2005 Tax Court [l]itigation,” and questioning Plaintiffs' 2001 tax return).

Originally the taxpayers filed a joint zero-taxable income return Form 1040EZ for the tax year 2001, then they filed a revised joint tax return claiming an adjusted gross income of $310,701. And then they filed another 1040X.

While the proceeds of a loan refinance are not taxable, is it any surprise that the IRS was suspicious?

And the moral of the case? A brief description of a case, no matter how carefully written and edited, does not tell the whole story. And, many times, we need the truth, the whole truth, and nothing but the truth.


In the words of Sesame Street’s Kermit the frog, “It’s not easy being green.” At least that is what a lot of business leaders around the world are discovering. Finding leaders who understand environmental and sustainability issues is difficult and the absence of these leadership skills is probably one of the greatest challenges facing countries wanting to make the move to a low carbon economy.

Whether you believe that going green is necessary or not you have to ask yourself; are our current business models sustainable? How long will it be until we run out of oil or the polar ice caps melt if we don’t reduce our carbon emissions? In order to implement the changes that may be necessary we need leaders with the appropriate leadership skills. There is an organization in the UK, “Business in the Community,” along with several other groups that are developing a best practices guide for sustainable leadership for a wide-range of employees including senior managers, middle managers, customer-facing staff and the general workforce. They have described these key leadership skills as “the ability to develop a long term vision of how the organization will contribute to a sustainable economy, the ability to inspire a broad range of people internally and externally and the ability to work collaboratively with different stakeholders.”

Going green is already having an impact on accounting and tax practices in the US as evidenced by the green initiatives included in some of the 2009 tax acts passed by Congress. If you would like to learn more about these green tax initiatives just click on the following link to a four hour self-study course titled “Going Green Under the New Tax Law.”

Going green and being green may be just as difficult for us as it is for Kermit the Frog but it may be inevitable. What do you think?

Thursday, July 22, 2010


The curtain is rising on Act One of the new IRS play, which will add rules on preparer behavior. The first stage is simple: we must all register with the IRS.

Proposed §300.9 establishes a $50 user fee to apply for or renew a PTIN. The $50 user fee is based on an annual PTIN renewal period, and the procedures for renewing a PTIN will be provided in other guidance, including forms and instructions. The user fee is nonrefundable regardless of whether the applicant receives a PTIN. PTINs were previously issued to tax return preparers solely for the convenience of the tax return preparers, providing an alternative to using the tax return preparers' social security numbers. Requiring registration through the use of PTINs will enable the IRS to better collect and track data on tax return preparers. This data will allow the IRS to track the number of persons who prepare returns, track the qualifications of those who prepare returns, track the number of returns each person prepares, and more easily locate and review returns prepared by a tax return preparer when instances of misconduct are detected.

A public hearing has been scheduled for Tuesday, August 24, 2010. This is a comment period that we can all participate in.

The statute itself is very simple:

Par. 11. Section 300.9 is added to read as follows:

§300.9 Fee for obtaining a preparer tax identification number.

(a) Applicability. This section applies to the application for and renewal of a preparer tax identification number pursuant to 26 CFR 1.6109-2(d).

(b) Fee. The fee to apply for or renew a preparer tax identification number is $50 per year, which is the cost to the government for processing the application for a preparer tax identification number and does not include any fees charged by the vendor.

(c) Person liable for the fee. The individual liable for the application or renewal fee is the individual applying for and renewing a preparer tax identification number from the IRS.

(d) Effective/applicability date. This section will be applicable on the date of publication of a Treasury decision adopting these rules as final regulations in the Federal Register.

Your thoughts? Remember, the comment period is still open. Let the IRS know your thoughts.

And remember, this is only Act One. We'll keep you posted as matters progress.

Wednesday, July 14, 2010

The Ever Elusive Materiality

Just what is materiality and why is it so elusive? It is somewhat like pass interference; difficult to describe, but I know it when I see it. Materiality is elusive partly because it requires the use of professional judgment to determine it. Your professional judgment is not always the same as mine, so is my determination of materiality better than yours; certainly not. When using your professional judgment in determining materiality, the number you arrive at will depend upon which variables you choose when making your estimate. Materiality is measured in several different ways, such as:

· in relation to something else (financial statements, account balance, compliance requirement)
· by size or as a percentage of something
· a threshold or cutoff point

Also materiality is not a constant. It changes from one entity to another or from one year to another. So how do the standard setting bodies define materiality? Here are the definitions from the Financial Accounting Standards Board (FASB), the Securities and Exchange Commission (SEC) and the International Accounting Standards Board (IASB):

FASB – US GAAP – “…the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.”

SEC – uses the same information the courts do in interpreting the federal securities laws. The Supreme Court has held that a fact is material if there is...”a substantial likelihood that the…fact would have been viewed by the reasonable investor as having significantly altered the”total mix” of information made available.”

IASB – International GAAP – “Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cutoff point rather than being a primary qualitative characteristic which information must have if it is to be useful.”

Based on these definitions then can we say that materiality is calculated by applying multiple variables to unknown conditions to arrive at the magical number; “materiality?” Well at least it is a logical approach to determining this threshold or cut off point but after all isn’t the most important part of this equation your professional judgment? What do you think?

Love and Marriage

The United States District Court, District of Massachusetts, issued a decision on July 8, 2010 on Nancy Gill & Marcelle Letourneau, et al., v. Office of Personnel Management. The case has a very important tax issue. And that issue is, who exactly can file under the married filing status.

The case presents a challenge to the constitutionality of Section 3 of the Defense of Marriage Act (DOMA). The seven same-sex couples contend that they have been denied certain federal marriage-based benefits that are available to similarly-situated heterosexual couples, in violation of the equal protection principles in the Due Process Clause of the Fifth Amendment.

The court agrees with the couples that there is an irrational prejudice which prevents the same sex couples the same rights as heterosexual couples. The court states:

In the wake of DOMA, it is only sexual orientation that differentiates a married couple entitled to federal marriage-based benefits from one not so entitled. And this court can conceive of no way in which such a difference might be relevant to the provision of the benefits at issue. By premising eligibility for these benefits on marital status in the first instance, the federal government signals to this court that the relevant distinction to be drawn is between married individuals and unmarried individuals. To further divide the class of married individuals into those with spouses of the same sex and those with spouses of the opposite sex is to create a distinction without meaning. And where, as here, “there is no reason to believe that the disadvantaged class is different, in relevant respects” from a similarly situated class, this court may conclude that it is only irrational prejudice that motivates the challenged classification. As irrational prejudice plainly never constitutes a legitimate government interest, this court must hold that Section 3 of
DOMA as applied to Plaintiffs violates the equal protection principles embodied in the Fifth Amendment to the United States Constitution.

As such, the court holds that the couples would file as married under Internal Revenue Code 7703(a)(1) and be entitled to the married rates, whether filing jointly or separately.

If you have any same sex couples, this is an important case to read and understand. I don't expect this to be the last development in this issue, do you?

Thursday, July 8, 2010


Now I can see why everyone wants a piece of the action; first the FASB and now the ASB. Have you heard of The Clarity Project? It is a multi-year effort undertaken by the Auditing Standards Board (ASB) to reformat and redraft all of the existing U.S. auditing standards for nonpublic companies while converging them with the International Standards on Auditing (ISAs).

I personally think that the codification of the FASB standards was extremely beneficial since it combined more than 20 different sources of GAAP into one logical and orderly system. The benefits from the Clarity Project probably won’t be quite as dramatic as the FASB Codification because the auditing standards had already been codified but there will be benefits from the project. Those benefits will come from the goals of the project. The goals are to:
  • Establish objectives for each of the standards and define the auditor’s obligations related to the objectives.
  • Make structural and drafting improvements to the standards so they’re easier to read and understand.
  • Include, in the explanatory material of the standards, special considerations related to audits of both governmental entities and small entities.
  • Converge with the ISAs or clearly establish reasons for divergence from those standards.

Unless there is a practical need for issuing a standard earlier, all of the revised standards will be issued on the same date. The revised standards will be effective for periods ending on or after December 15, 2012, with early application prohibited. The previous effective date of December 15, 2010 was changed by the ASB in May of this year in order to allow more time for finalization of the standards as well as to give more time for training and updating of firm methodologies.

Similar to the FASB Codification project, you can expect an entirely new body of authoritative U.S. auditing literature for nonpublic companies starting in 2013. I think this revision of the auditing standards codification will be a significant step in improving the usability of the standards and in bringing the U.S. more in line with the international audit community. What do you think?

Thursday, July 1, 2010


Misleading headlines really irritate me, but I must admit they usually get me to read the article or at least enough of it to know that I have been had. For example the headline “Supreme Court Rules PCAOB Unconstitutional.” Wow now you really have my attention. So the PCAOB has been declared unconstitutional. What does this mean for oversight of the accounting profession? Will the PCAOB be disbanded?

As I began to read the articles I immediately became confused. Confusing me is never very difficult. The article went on to say that by a vote of 5 to 4 the court had ruled that the PCAOB violated the Constitution’s separation of powers principle because their board members are not appointed by the president, but rather by the Securities and Exchange Commission with consultation with the Federal Reserve chairman and the Secretary of the Treasury. I guess that what really started me scratching my head was a few paragraphs further into the article there was a quote from the chairman of the PCAOB saying that he was pleased with the decision. Now I am really confused. Why would the chairman of an organization that has just been declared unconstitutional be happy about that decision?

As always the devil is in the detail. What the court had actually ruled was that the Board’s existence does NOT violate the separation of powers, but the method by which board members can be removed does violate the constitution. Previously the SEC could only remove PCAOB board members for good cause. So with this ruling the SEC will now be able to remove board members “at will” and not just for good cause. All of the other operations and activities of the PCAOB will remain intact.

So the next time you have someone ask you if you heard what was in the paper you might want to take it with a grain of salt until you have a chance to check it out for yourself. What do you think?