As the War of The Ring, brought the long ignored hobbits and their pleasant Shire to the center of the concerns of Middle-earth, the Tax Cuts and Jobs Act brings forth from obscurity a band of otherwise meek and mostly happy and content modest creatures. That would be the small band of geeks, in every tax practice of more than moderate size, who actually look things up and read extensively. They dress poorly, lack executive presence, associate with people they like rather than referral sources and prefer board games to golf. Like hobbits, they can “survive rough handling by grief, foe, or weather” (and managing partners and executive committees) in a way that astonishes those who do not know them well. And this is their hour.
Only the eldest of them can remember their last moment in the sun – 1987 – when it began to sink in that the Tax Reform Act of 1986 made everything that everybody knew about tax planning wrong and the only people who weren’t surprised were the hobbits, who treasured their copies of the 1984 Tax Reform, For Fairness, Simplicity, And Economic Growth (Volume 1 and Volume 2).
In honor of this magic moment in the lives of tax geeks, I have decided that Reilly’s Laws of Tax Planning, long relegated to my alternative blog has become Forbes worthy (FW). There are seventeen laws, which seems like a lot compared to the Ten Commandments or Wilson’s Fourteen Points, but it is nothing compared to the Ferengi Rules of Acquisition . I was thinking a couple might not be FW, but I’m going to give you all of them, with modified explanations.
Reilly’s Laws Of Tax Planning
This is my restatement of the Cohan Rule. At Joseph B Cohan and associates, young staff accountants thought the rule was named for our eponymous founder, who still came into the office from time to time, or his son Herb who was our managing partner. Actually it is named for George M Cohan who appealed a Board of Tax Appeals decision to the Second Circuit. The 1930 decision noted
In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees, and, as he naively adds dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. ……
Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent.
The reason this is the prime directive rather than one of the laws is that even though I use it as a kind of motto, it only occurred for me to include it here recently and it is too significant to be the seventeenth law.
Legislation on various topics has eroded the Cohan rule (See the 16th law), but it still has life in it. TCJA will bring the law to life as you and your planner concoct the narrative that shows that your business, all indications to the contrary notwithstanding, is not a business involving:
performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees
1. It is what it is. Deal with it.
This law originates with a response I used to have to less experienced staff and sometimes clients when one of them would say about a particular tax rule “That doesn’t make sense”. My response was “That’s not a requirement”. In light of TCJA, you should note that anything you read that does not send you to primary sources like the thousand-plus pages of statute and Committee explanations was probably written by somebody who doesn’t know what they are writing about. The more prestigious their source is, the more likely that you are getting third-hand information.
2. Sometimes it’s better to just pay the taxes.
When you are trying to save money on something, there is only so far you should go. Sometimes schemes to save taxes are not consistent with other goals. Code Section 1031, one of the handiest items in my bag of tricks is a good illustration.
Imagine someone has had their real estate ship come in and they have sold a property with negligible basis for $5,000,000. An alternative to having $4,000,000 in after-tax dollars to do with as you please is to exchange into a Walgreens. Then you have a property with a long lease that yields a cap rate in the 5% vicinity. On a per square foot basis, it is worth maybe $2,500,000. You need to ask yourself if what you had was $4,000,000, would you buy what is, in effect, a Walgreens bond with some downside protection. If not, it is better to pay the taxes.
In light of TCJA, there will be things that you can do to qualify your business for the 20% Qualified Business Deduction. They are not things that you “should” do. They are things that you might consider. Don’t let the tax-saving tail wave the economic dog.
3. Any clever idea that pops into your head probably has (or will have) a corresponding rule that makes it not work.
Tax planning, particularly at the more ethereal level is something of an arms race between clever people coming up with cute ideas and legislators and regulators cleaning up behind them or sometimes anticipating their villainy. When something pops into your head, there is a good chance that yours is not the first head into which it has popped. I have added the “or will have”, because TCJA has not yet been fleshed out. The decrepit state of the Internal Revenue Service might make for an anything-goes atmosphere for a while.
4. Execution isn’t everything but it’s a lot.
I derived this law mainly from reading cases, but also from some real-life experience. One batch of cases where it shows up a lot is family limited partnerships. The ones that get blown up usually have people showing no respect for the entities that they established. A classic remark in one of the cases was by one of the partners saying “I just could not wrap my head around the fact that it was not my money”.Accountants have a delusion that they can fix all the problems with journal entries. When it goes to court, journal entries mean nothing.
If a structure calls for different entities, they should all be actually formed and each should execute its own transactions.
5. A tax plan that ignores SALT or AMT is not much of a tax plan.
I changed the order on this one because SALT – state and local income tax- has risen in importance under the Tax Cuts and Jobs Act and AMT – alternative minimum tax – will affect fewer people. Not all states tie their codes to the Internal Revenue Code so there will be more state-federal differences. And with the federal deduction for state and local taxes sharply limited, their net cost is greater.
SALT practitioners are the least understood and least respected tax professionals. They are the last to be called in and they usually are the bearers of bad news. Some of the clever moves to exploit the 20% Qualified Business Income deduction will have bad SALT implications that will not be recognized until too late. SALT people will probably rise to greater prominence as the implications of TCJA sink in.
6. Don’t do the math in your head.
Tax law is full of thresholds and phase-outs and other complications, so that when somebody tells you that it is easy that you just can take X% of Y and Z% of A and you have your answer, they may be right most of the time, but their answer will be wrong often enough that you don’t want to do it. Serious planning requires running a plan through an actual return and being sensitive to various interactions and oh yeah – see the fifth law.
7. Read the instructions.
I have cleaned this one up to make it Forbes worthy. Instructions to forms are not authority, but they usually reference it pretty well. Putting numbers where they belong makes you look more compliant which is almost if not more important than actually being compliant. When returns were done by hand, people would ignore this rule more often than they should have. Now the practice has gone by the boards almost entirely. Staff accountants will just try to figure out what field to use or box to check. Particularly in complex areas, always read the instructions.
8. Both before and after thinking outside the box, take a good look inside the box.
Sometimes, the simple straight-forward most obvious answer turns out to be the optimal answer. Don’t rule out that possibility in your desire to be creative.
9. Tell the preparer what the plan is.
There is a huge gap between very sophisticated tax planners and people who actually prepare returns. It is not unusual for a plan to be passed from the planner to the principal and then to the preparer. In the partnership area, the preparer is sometimes not provided with a copy of the partnership agreement and might not read it or understand it if it is available. Many thousands of dollars in high priced legal work can be made naught of by a beleaguered staff accountant hounded by a manager who is driven by realization concerns.
10. Once the tax is more than you can pay it might not matter how much more.
The IRS knows that it cannot get blood from a stone and Congress in the nineties put in substantial due process requirements that restrain the IRS from taking collection actions. If you find yourself in such deep water that even in the best-case scenario you still drown, arguing about the correct amount of tax is an academic exercise. You need to start working with people who specialize in collections. You should not expect your regular tax advisers to understand the nuances of collections. Sometimes the right move for minimizing tax is the wrong move for collections. Filing a joint return is an example of that.
11. Pigs get fed. Hogs get slaughtered.
It can be a good idea to be a little aggressive in your tax planning but don’t get carried away.
12. Any new business concept will be pitched as a tax dodge.
Tax savings can seem like free money. Anything that seems like free money will attract scoundrels. Be wary of pitches that seem to rely heavily on tax concerns.
13. When an idea makes you think of a Seinfeld episode, it is not going to end well.
If an idea seems complicated and implausible. Think about what Kramer would do. If Kramer would try it, you shouldn’t.”
14. If something is a listed transaction, just don’t do it.
Really there are plenty of good tax planning things you can do without doing the things the IRS has specifically told you are not so good. Here is the list in case you are curious.
15. If somebody calls you up to talk about your unpaid federal taxes, just hang up.
When you get that call there are two possibilities. One is that it is a scammer. The other is that it is one of the collection agencies that have been foisted on the IRS by Congress. Clearly hanging up on the first is the right thing to do, even though I would probably try to amuse myself by stringing them along. In the latter case, it requires a bit more discussion.
I am assuming that you know that you had a deficiency, but haven’t heard anything in a long time. The IRS can do a lot of nasty things to you to collect the taxes you owe. Drain your bank account, take your stuff, file liens that louse up your credit rating. Before they can do that they have to send you a notice that suggests you might want to file Form 12153 to request a hearing. That is where you or your representative get to play “Let’s make a deal”. The results can be appealed to Tax Court.
All those nasty things the IRS can do. The collection agency can’t do any of them. And while the collection agency has your file, neither can the IRS. Also, the collection agency has less deal-making flexibility and unlike the IRS they get paid on a percentage basis. There is a ten-year statute of limitations on collections, and it keeps ticking while the collection agency has your file. Let them hand it back to the IRS and maybe it will get lost.
And if you want to be a good citizen and pay up, it is better for the country if you pay up after your file goes back to IRS. Interest rates are not that onerous and you probably have already maxed out penalties.
16. Being right without substantiation can be as bad as being wrong.
Sometimes the Cohan rule will bail you out, but there are many areas where lack of substantiation is fatal – more than de minimis charitable contributions and meals are examples of that. And substantiation is better than the Cohan rule. Revenue Agents are accountants and carefully cross-reference receipts with ticked and tied schedules will buy you a lot of credibility.
17. Don’t cut your deadlines close and use the US Mail with proof of mailing.
Some deadlines – Tax Court petitions for example – are very strict and others have mild but still annoying consequences for missing. Make believe that the deadline is ten days before the actual deadline. And always use US Mail if a physical document has to be sent. Other services are acceptable, but US Mail is a sure thing. And go to the counter and get everything stamped by an actual person.
After over a year I am finally adding a law.
18. Honest Objective Trumps Realistic Expectation – One of the problems with my laws since they are largely drawn from case law is that they lean a little negative. This one is positive. It is directed toward Section 183 (Hobby Loss) and it encourages practitioners to support their clients in claiming losses even when you personally think the prospects of ultimate profitability are slim,
My analysis of case law in the 183 area teaches that of the nine factors in the regs, the only one that matters is the first – carrying on in a businesslike manner. Coach your client to keep separate accounts and accurate books and records and to have a real business plan that they continually revise in the light of experience, but otherwise, be bold and take those losses.
source article: https://yourtaxmatterspartner.com/laws-of-tax-planning/