The IRS Audit Blog

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Ten Things to Know About 1031 Exchanges

Real estate swaps grow popular, but traps are many. Beware new rules on vacation homes.

The Go-Go’s – Vacation

Question: An opposing lawyer is proposing to use Black-Scholes valuation on 4,565 of stock options?

The stock is COP Connocophillips stock that has increased from $42 per share in 12/2004 to $67 per share today. He states that the fair market value of the stock options will equal the option spread (the difference betweeen the fair market value of the stock option at exercise less the exercise price) E.G. (Transfers of compensatory stock options to related persons audit technique guide) (IRS 02-2003)

These shares will be sold in next two years.

Opinion??

Fred

Answer: This is definitely the minimum theoretical value. The Black-Scholes equation will give you a value that is probably at least equal to this value. In fact if these options can be exercised at any time they will have a value which could be higher (but may not be) than the stock price minus the strike price. This will come from the COx-Ross-Rubenstein binomial model. But this is a detail that may not be totally relevant.

I guess as he is the opposing lawyer, you probably want to find a way he could be wrong. Maybe you are a guy who is going thru a divorce and the assets are being split up?

Well, if you have to hold the options until the expiration date, it may be hard to find an argument. But if you are strapped for cash and are able to exercise the options early, you might argue that you could be forced to exercise the options “irrationally”. This notion of “rational exercise” along with the notion of “risk neutral valuation” are assumptions that are made if the Black-Scholes model is to be assumed to be correct. Risk neutral valuation is OK for a bank but doesn;t realy apply to an individual. Tell your lawyer to pick up a book by John Hull called “Options, Futures and Other Derivatives (6th Edition)” – in there will be stated the exact assumptions for the Black Scholes equation to be applicable. Right or wrong, he can probably find some argument to say that one of the assumptions is not applicable in your case. Good luck!

Question: Do you think the government should force you to make energy saving improvements to your home?

Consider this…. if Cap and Trade is implemented and you decide you want to sell your home, would you be happy to have a government inspector do an energy audit of your house and then force you to spend the money to upgrade your house before it can be sold?

Wouldn’t you think that upgrades ought to be the buyer’s choice after they own?
Would you approve of energy saving tax credits instead of forcing a person to do this stuff? Often, people who sell homes are not in the best of financial circumstances, especially nowadays. I think of the elderly who are trying to downsize and how little income they might have.
What other alternatives can you think of to making laws like this? Or, do you think this is just fine?
You are right, some energy improvements do have tax credits, but not all and there are several restrictions involved.

Answer: By government do you mean the people living in mansions and flying around in jets? The ones that know every trick in the book to avoid taxes? Well maybe if they practiced what they preach…
Cap and Trade is a scam!

Aronstein Skirts Tax ‘Nightmare’ as Commodities Bet Returns 50%

Jan. 21 (Bloomberg) — Michael Aronstein made too much money betting on commodities last year. The 56-year-old manager of the $102.4 million Marketfield Fund predicted the collapse of commodity prices in 2008, then reversed course in the first quarter of last year, putting one- fourth of the fund’s assets in commodities such as palladium and zinc.

Sci-Tech Today: Tax credits and nanotech to make solar energy more affordable

Question: IRS Audit for Amended Return?

I have a small business (restaurant).

My 2005 tax returns were totally off. Gross sales and COGS were off 110% ($50K to110K and 26K to 55K), and lots of deductions were not included. This is a family business and my brother did the returns and totally screwed up. The old 2005 return paid the IRS $350. With the amended returns, I’m going to be paying them $1300. The amended return numbers are pretty similar to my past returns.

I’m really paranoid because I’m afraid this might trigger an audit

Answer: You will be paying them $950 more with the amendment and they may want some interest. That is likely the last you hear about it. If you can support the numbers on the amendment why worry about an audit. In most cases if you are not trying to do something wrong an audit is no big deal other than the time it take to prepare.

Nett: New tax rules now in effect may affect your preparations

There weren’t any big, sweeping changes in the federal tax law for this year, but there were a few tweaks here and there – things to have in mind when you meet with your tax preparer about your 2009 Form 1040, and things to know, or at least think about, as you do business in 2010.