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Off-Balance Sheet: Is the Tax Code Written in Code?

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The IRS has distilled the definition of a collapsible corporation down into one, easy-to-understand, bite-size piece of information.

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Relax, it's only money. Here in the 'Ville we like to keep things smart, but we also love to laugh. All work and no play...you know how it goes. With that in mind we give you The "Off-Balance Sheet," a place where Minyans can experience humorous takes on the world of finance, personal stories from our Professors and Minyans and all the other stuff that makes life worth living. So take a break from the flickering ticks and dive in.


The Office of Management and Budget estimates Americans will spend 6.4 billion hours and $265 billion this year complying with the obligations of a tax code that now contains more than 66,000 pages of rules and regulations. Businesses complain that the burden of compliance is even more onerous.

Now, I'm no CPA. But it seems to me that all the bellyaching about the complexities of our tax system is coming from a coddled few that are unwilling-or unable-to deal with life's little curveballs. All the desperate cries of, "Simplify! Simplify!" are-to me, at least- getting a bit tiresome.


A guy who likely thinks taxes are "too complex"

Take a look at this passage (reprinted verbatim from IRS guidelines) pertaining to collapsible corporations:

For purposes of subsection (a)(1), a corporation shall not be considered to be a collapsible corporation with respect to any sale or exchange of stock of the corporation by a shareholder, if, at the time of such sale or exchange, the sum of - (A) the net unrealized appreciation in subsection (e) assets of the corporation (as defined in paragraph (5)(A)), plus (B) if the shareholder owns more than 5 percent in value of the outstanding stock of the corporation the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the shareholder owned more than 20 percent in value of such stock, plus (C) if the shareholder owns more than 20 percent in value of the outstanding stock of the corporation and owns, or at any time during the preceding 3-year period owned, more than 20 percent in value of the outstanding stock of any other corporation more than 70 percent in value of the assets of which are, or were at any time during which such shareholder owned during such 3-year period more than 20 percent in value of the outstanding stock, assets similar or related in service or use to assets comprising more than 70 percent in value of the assets of the corporation, the net unrealized appreciation in assets of the corporation (other than assets described in subparagraph (A)) which would be subsection (e) assets under clauses (i) and (iii) of paragraph (5)(A) if the determination whether the property, in the hands of such shareholder, would be property gain from the sale or exchange of which would under any provision of this chapter be considered in whole or in part as ordinary income, were made - (i) by treating any sale or exchange by such shareholder of stock in such other corporation within the preceding 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the assets of such other corporation, and (ii) by treating any liquidating sale or exchange of property by such other corporation within such 3-year period (but only if at the time of such sale or exchange the shareholder owned more than 20 percent in value of the outstanding stock in such other corporation) as a sale or exchange by such shareholder of his proportionate share of the property sold or exchanged, does not exceed an amount equal to 15 percent of the net worth of the corporation.

How can anyone complain about this being complex? Look closely-the entire regulation is only one sentence long. The IRS has distilled the definition of a collapsible corporation down into one, easy-to-understand, bite-size piece of information.

But, suppose you don't have a collapsible corporation. Perhaps you're lucky enough to be a peanut farmer-not only are you entitled to government subsidies, but the IRS makes it simpler than ever to take advantage of them:

If you are an eligible peanut quota holder, your contract entitles you to receive one of the following payment options.

  • Five equal annual payments of 11 cents per pound of peanut quota during the period 2002 through 2006.
  • A single lump sum payment in any one of the five years.


Your taxable gain or loss is the total amount received for your quota reduced by any amount treated as interest (discussed later), over your adjusted basis. The gain or loss is capital or ordinary depending on how you used the quota. See Capital or ordinary gain or loss, later.

Report the entire gain on your income tax return for the tax year if you:

  • Receive a lump sum payment or
  • Elect not to use the installment method.


The adjusted basis of your quota is determined differently depending on how you obtained the quota.

  • The basis of a quota derived from an original grant by the federal government of an acreage allotment is zero.
  • The basis of a purchased quota is the purchase price.
  • The basis of a quota derived from a purchased acreage allotment is the purchase price.
  • The basis of an inherited quota is generally the fair market value of the quota at the time of the decedent's death.


If not previously allocated, the total basis of a quota (or acreage allotment) and land obtained at the same time must be properly allocated between the two assets.

You are required to reduce the basis of your peanut quota by the following amounts.

  • Deductions you took for amortization, depletion, or depreciation.
  • Amounts you previously deducted as a loss because of a reduction in the number of pounds of peanuts allowable under the quota.
  • The entire cost of a purchased quota or acreage allotment you deducted in an earlier year (which reduces your basis to zero).


You must reduce your peanut quota buyout program payment by the amount treated as interest, which is reportable as ordinary income. If payments total $3,000 or less, your total quota buyout program payment does not include any amount treated as interest and you are not required to reduce the total payment you receive.

In all other cases, a portion of each payment may be treated as interest for federal tax purposes. You may be required to reduce your total quota buyout program payment before you calculate your gain or loss. For more information, see Notice 2002-67 on page 715 of Internal Revenue Bulletin 2002-42. This bulletin is available at
www.irs.gov/pub/irs-irbs/irb02-42.pdf.

You may use the installment method to report a gain if you receive at least one payment after the close of your tax year. Under the installment method, a portion of the gain is taken into account in each year in which a payment is received. See chapter 10 for more information.

Whether your gain or loss is ordinary or capital depends on how you used the quota.

If you used the quota in the trade or business of farming and you held it for more than one year, you report the transaction as a section 1231 transaction on Form 4797.

If you held the quota for investment purposes, any gain or loss is capital gain or loss. The same result also applies if you held the quota for the production of income, though not connected with a trade or business.

If you previously deducted any of the following items, some or all of the capital gain must be recharacterized and reported as ordinary income. Any resulting capital gain is taxed as ordinary income up to the amount previously deducted.

  • The cost of acquiring a quota.
  • Amounts for amortization, depletion, or depreciation.
  • Amounts to reflect a reduction in the quota pounds.


You should include the ordinary income on your return for the tax year even if you use the installment method to report the remainder of the gain.

The peanut quota buyout payments are not self-employment income.

The gain or loss resulting from the quota payments does not qualify for income averaging. A peanut quota is considered an interest in land. Income averaging is not available for gain or loss arising from the sale or other disposition of land.

The buyout of the peanut quota is not an involuntary conversion.

A peanut quota is considered an interest in land, so the USDA will generally report the total amount you receive under a contract on Form 1099-S, Proceeds From Real Estate Transactions, if the amount is $600 or more. The USDA will generally report any portion of a payment treated as interest of $600 or more to you on Form 1099-INT, Interest Income, for the year in which the payment is made.

For more information on the taxation of peanut quota buyout program payments, see Notice 2002-67.


Peanut farmers: enjoying some of the simplest tax rules around


For another perspective on tax simplification, I once again turned to Minyanville's own Kevin Depew:

Justin, if one were to ask my opinion on the matter of taxation in the United States of America and claimed them to be byzantine and convoluted, I would have no choice but to be forced to disagree by virtue of the fact that the intricacies involved with monetary collection by the Internal Revenue Service is quite a task and to keep the system operational, we must not kowtow to external forces conspiring to "simplify" what is a perfectly simple arrangement to begin with.

So, what you're saying is, you think the tax code is fine the way it is.

Well, that's an extremely tortuous way of paraphrasing my take on the matter under discussion here, but I suppose you could define my position as one that is not dissimilar to what just spouted forth from your oral cavity-a thought that was first formulated in the cerebral cortex, after which it was processed and turned into actual speech by your diaphragm forcing air from the lungs into the trachea to produce sound-of course, involving the excitation of the vocal chords by periodic pulses of air created by the glottis.

Meaning, you don't think the U.S. tax code is too complex.

My answer to your inquiry is as follows: my belief is that we are entering an age in which corporations are feeling myriad pressures to cut costs and increase productivity, thus feeling stretched in many areas-one being IRS compliance. Special interests, such as the corporate lobby, do not look kindly upon any change in the tax code that will complicate the issue for them come tax time-which could be January, February, March, April, May, June, July, August, September, October, November, or December, depending on when the company's fiscal year begins and ends. Therefore, I hasten to say that no, I do not believe the U.S. tax code is overly complex.

Okay, I…I think I've got a handle on where you stand. Can you add any other insight into the issue?

No.

Really?

Boy, you really know how to talk circles around a guy.

Wait, I was just asking if you-

What, are you trying to intentionally confuse me or something?

Of course not. I was simply giving you an opportuni-

Look, I didn't just fall off the turnip truck. Let's cut out the "I'm from the big city and my manner of speaking is really dense and impressive" bit.

Okay…I wasn't-

The time has come for me to bid your acquaintance adieu. Fare thee well, my good man. May we meet again sometime in the not-terribly-distant future.

Alright, so what you mean to say is-

Later.

No positions in stocks mentioned.
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