Archive by Author

Mar 16

I am starting to like Nina Olson, the National Taxpayer Advocate.

I have been negative on the IRS program called the Offshore Voluntary Disclosure Program (OVDI).  This was the government reaction to the UBS and offshore bank account scandals. That however was tax fraud committed by the extraordinarily wealthy.  My background has been the Foreign Service and expat community, primarily because my wife is the daughter of a (retired) Foreign Service officer. These are rather ordinary folk who just happen to live overseas.

Tax advisors who work this area know that the IRS pulled a bait-and-switch a year ago – on March, 2011 – with taxpayers trying to comply with the freshly-resurrected foreign reporting requirements.  The FBAR has, for example, been out there since at least the early 70s, but at no time did Treasury want to confiscate 50% or more of your highest account balance for not filing a one-page form. The IRS was waist-deep with 2009 OVDI and had previously encouraged taxpayers to enter the program with lures of reduced penalties for non-willful violations.

EXAMPLE:  You have expatriated to Costa Rica. You have next-to-no ties in the United States and pay little attention to tax developments here. You have even learned to like soccer (but why?). The requirement to file an FBAR comes as quite the surprise to you. You first thought it absurd that such reporting would apply to the most ordinary of taxpayers. Surely that is for rich people only. You have to qualify as non-willful, right?

Then last March the IRS trotted-out a memo directive that it would not consider non-willfulness, reasonable cause, or the mitigation guidelines in applying the offshore penalty. Let me phrase that a different way: the IRS instructed its examiners to assume that the violation was willful unless the taxpayer could prove that it was not. Would you further believe that, at first, the memo was kept secret?

Huh? Are you kidding? O.J. Simpson received more “benefit of the doubt” than the IRS was willing to provide.

Then in August Nina Olson issued a Taxpayer Advocate Directive ordering IRS division commissioners to revoke this position and direct examiners to live up to their own promises to thousands of affected taxpayers.  The IRS division commissioners blew her off.

What?

Tax Analysts now reports that the main IRS commissioner – Douglas Shulman – has no intention of responding to Nina Olson on this matter. To aggravate the matter, there is a statutory requirement that the IRS commissioner respond to the Taxpayer Advocate within 90 days.  Do laws mean nothing to this crowd?

Is this a specialized tax area? Yes. Does it have greater import? I believe it does. It does because the tax attorney and tax CPA community – people such as me – pay attention, and this behavior diminishes confidence in the IRS and any trust in its word. The consequences are subtle, injurious and lasting. And for what purpose? To extract a penalty from someone whose only crime was not paying attention to increasingly obscure and inane U.S. tax law?

Mar 14

He is known for an NFL playoff game in 2004. The Eagles were playing Green Bay. It was fourth quarter. The Eagles were trailing with 1:12 remaining, 4th down and 26 yards to go for a first down.  NFL fans call this a “long shot.” He ran a slant, the Green Bay Cover 2 defense broke down, and Donovan McNabb connected with him for a 26-yard play. The play set up a David Akers field goal, which led to overtime, which led to a win for the Eagles.

The player?  Freddie Mitchell, a wide receiver.

Why are we talking about him? Because he is likely to go to jail for tax fraud.

Freddie associated himself with two people – Jamie Russ-Walls and her husband, Richard Walls. Jamie fancied herself a tax expert. For a period between 2009 and 2010, Freddie used his football contacts to lure unsuspecting athletes to Jamie, who promised them all kinds of tax refunds because she was – well, a tax expert! She and her husband prepared returns claiming refunds between $170,000 and $1.9 million. They were not deterred by things like actual W-2s. No sir. They would forge W-2s to get the refunds they promised. If not a W-2, they would manufacture a Schedule C (self-employed) to show business losses.

Freddie was the face. His job was to recruit clients.

The three had agreed to share any tax refunds they received.

These three were geniuses. What could possibly go wrong?

Freddie recruited an athlete we will call A.G. Freddie had A.G. pay $100,000 as a down payment for his 2008 tax return and 2006 and 2007 amended returns.

OBSERVATION: I have never seen a $100,000 individual income tax return. I have seen yachts with professional crews, mansions in Wyoming, airplanes, overseas residences, FLPs, rolling GRATS, skip trusts, charitable leads and a number of other high-end tax planning vehicles, but I have never seen a $100,000 individual income tax return.

Freddie and crew prepared a tax refund claim for $1,968,288.

A.G. was not the only client. The indictment cites five other tax returns claiming refunds over $2.2 million.

This will not turn out well for Freddie. There will be no “4th and 26” this time.

Mar 13

Sheldon Kay, deputy chief of IRS Appeals, stated during a February webcast that the case inventory for IRS Appeals reached 148, 000 for fiscal 2011. This is the highest it has ever been. To be fair, Appeals case closures were also at a record level, but not enough to gain ground.

A tax CPA working representation will be quite familiar with Appeals. The normal process is that a taxpayer is selected for examination, i.e. the “audit.” The audit can be through the mail, which is called a correspondence audit. The audit can be at the IRS offices, in which case you go to them. A third type is when they come to you, also called the “field” audit. You are working with a revenue agent. If you disagree you can appeal the agent’s adjustments to the agent’s supervisor, also called the “group manager.”

If you have no settlement there, you are bound for Appeals.

The cases in Appeals fall into two types: collection and exam. What we described above is exam. A collections case has normally gone through exam, and now the IRS is pressing for money. Congress gave taxpayers more protection from IRS collections in 1998 with the IRS Reform and Restructuring Act. Collections have now become half or more of the cases in Appeals.

Back to Sheldon Kay. He explained that the situation has been aggravated by IRS budget constraints. We have seen that here in Cincinnati, as the Appeals office is becoming a ghost town. It is not just the budget, though. Some long-term IRS careerists have also been retiring, reflecting incentives to retire as well as the demographic march of the Baby Boom generation.

There is also another reason. Practitioners comment among themselves that exam is experiencing a brain drain. I agree that a new hire cannot replace the experience and judgment of a career examiner. In the past, the group manager provided some continuity and savvy, but today it is possible that group manager has been there only slightly longer than the examiner.  The “system” is – too often – just not working.

Whether responding to examination or collection frustrations, practitioners are taking their clients to Appeals. The frustration may be because of IRS budgetary constraints, inexperienced personnel, excessive automated collection practices, unrealistic Congressional demands or other reasons. Practitioners are seeking the more experienced personnel available in Appeals.

Mar 12

The IRS last week expanded its relief provisions for financially distressed taxpayers. Effective immediately, the IRS will abate its failure- to-pay penalties for 2011 taxpayers, as long as all taxes are paid by October 15, 2015. To qualify for this relief, you have to be:

  • A W-2 employee and unemployed for at least 30 consecutive days in 2011 or during the 3 ½ months ending April 15,2012, or
  • Self-employed and experiencing a contraction of at least 25% in 2011 business income.

The IRS was very quick to point out that this abatement is for the failure- to-pay penalty only. You still have to file a return by April 15, 2012.

NOTE: There are two “big” penalties when you do not file a return. The first is the failure-to-file penalty. The second is the failure-to-pay. Most tax advisors will counsel you to always file, even if you cannot pay. The failure-to-file penalty is 5% a month, ten times the failure-to-pay penalty of 1/2% a month.

There is a new form to request the abatement (Form 1127-A). The relief is also limited to incomes of $100,000 if you are single and $200,000 if you are married.

The other thing the IRS did is to double the income limitation for a streamlined installment agreement. The streamlined is a payment plan with the IRS. You now qualify if your assessed taxes are $50,000 or less. This is an increase from $25,000, which itself had recently been raised from $10,000. The advantage to the streamlined is that you do not have to provide financial information to the IRS.

The payment term for the streamlined was also increased – from five years to six.

Mar 02

This is a bit specialized, but if you have a foreign bank account it applies to you.

You may recall that you are required to file Form 90-22.1 “Report of Foreign Bank and Financial Accounts” (more commonly called the “F-Bar”) if you keep over $10,000 in a foreign bank account. It doesn’t have to be a secret Swiss account. A Canadian account will do it, for example. We have clients with Mexican real estate that also have bank accounts requiring FBARs.

You were previously required to file that form electronically starting in 2012. Chances are that meant you were going to use a tax preparer, if you were not using one already.

That electronic filing requirement has been delayed one year – until June 30, 2013.

Feb 29

Here is another one of those tax cases where you wonder how it got so far. Let’s set this up:

(1)    say that you are self-employed, and

(2)    you lost money, so you have a net operating loss carryover; and

(3)    you fail to file a later year tax return, and

(4)    the IRS prepares one for you, and

(5)    you owe a lot of tax, and

(6)    you ignore matters until you receive the statutory notice of deficiency, and

(7)    you clue the IRS that you have an NOL carryover, which reduces but does not eliminate your tax, and

(8)    the IRS still wants some tax (both income and self-employment) from you, and

(9)    you disagree because the you think the NOL reduced both your taxable income and self-employment income, and

(10) the IRS wants to know where in the tax code it says you can do that.

To understand what is happening here, think of your income tax and your self-employment tax as side-by-side railroad tracks. You use the same numbers to calculate how much is subject to income tax and to employment tax, but there comes a point where the tracks diverge. In our situation, that point is the net operating loss. There is no question you get a deduction for the NOL on your income taxes, but what is the answer for your self-employment taxes? Remember: different tracks = different trains.

Did I mention that you are an accountant?

So you are now preparing for the Tax Court. While preparing you come across this sharp rock from the tax code:

1402(a) Net Earnings from Self-Employment – The term “net earnings from self-employment” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed…; except that….

(4) the deduction for net operating losses provided in section 172 shall not be allowed.

Oh no. Now what do you do? Well, our taxpayer (Joseph DeCrescenzo v Commissioner T.C. Memo 2012-51) comes up with a two-pronged attack:

(1) Argue that the IRS cannot raise the issue because they did not raise the issue in the notice of deficiency. The problem with this is … that they did by including the NOL in the notice.

(2) And even if the IRS did, it was not binding on you because you suffer from acute anxiety disorder.

You can probably guess that this did not turn out well for the taxpayer. It cost him over $70,000 in penalties (late filing, late payment and etc.) alone.

It would have been much cheaper to have hired a competent tax CPA.

Feb 27

On February 2, 2012 the IRS published proposed Regulations concerning QLACs – qualified longevity annuity contracts. These contracts would be purchased by and held within your 401(k), 403(b), 457 and IRA accounts.

NOTE: Roths however are not permitted to own a QLAC. Can you guess why? (The answer is below).

Longevity annuities provide life annuity payments, typically starting at age 80 or 85. In many cases, the life annuity is the only benefit the contract provides. As such, these are specialized contracts to aid against outliving your savings. The IRS requires certain bells and whistles before deeming them “qualified” to be owned inside your retirement account.

Why would someone put an annuity inside a retirement account? The IRS has given us at least one very good reason.

You can delay the minimum distribution rules (MRD) on a QLAC. Yes, you read that correctly. Normally, you have to begin taking distributions in the year you reach age 70 ½. A QLAC allows you to defer distributions until and no later than the month following your 85th birthday.   

How will the minimum distribution rules work with a QLAC? You may remember that the normal rule for an MRD is to divide the retirement account balance by an IRS-provided factor for your age. The IRS is allowing you to exclude the QLAC from the balance in the retirement account.

EXAMPLE: If your account is worth $850,000, of which $95, 0000 is a QLAC, you will compute your MRD on $755,000 ($850,000 – $95,000).

The proposed regulations provide that the only QLAC benefit permitted after death is a life annuity. If the contract provides an annuity for a term certain or for a refund of premiums, it will not qualify as a QLAC.

There are restrictions; this is the tax code, after all. Premiums you pay for a QLAC are limited to the lesser of $100,000 or 25% of your retirement account. Bad things happen if you exceed this, so do not exceed the limit.

ANSWER: So why are Roths not permitted to own QLACs? Simple. Roths have no minimum distribution requirement.

Feb 21

If you are wondering whether the IRS is taking longer to process and issue refunds, you are correct. This has been aggravated by a glitch in the “Where’s My Refund?” tool on the IRS website. The glitch occurs when you file your return electronically, wait a few days and then go to “Where’s My Refund,” which tells you that the IRS is not aware of your return. This is unnerving, of course. It is also incorrect.

What has occurred is that the IRS is tweaking its filters to counter identity fraud. Each year the IRS revises the Electronic Fraud Detection System (EFDS) to reflect fraud patterns detected the previous filing season. Last year, for example, over one million returns were flagged. The returns then go to personnel for review, and therein is the problem. There are not enough people to review the returns.  The ideal time for identity theft is early in the filing season, as the thief is trying to beat you to your refund. The IRS therefore has its fraud filters at their highest setting early in the season.

The IRS has released the customary “we are working on it” statement. It has also reinforced its commitment to getting refunds out within 21 days or less.

Feb 16

The President delivered his proposed budget for fiscal year 2013 this Monday. The budget included as one of its five tax “reform” principles the following:

  • Simplify the Internal Revenue Code

Sounds good. Here are some proposed tax “simplifications”:

  • Provide a temporary 10% tax credit for new jobs and wage increases
  • Provide additional tax credits for investment in advanced energy manufacturing
  • Provide tax credit for energy-efficient commercial building property expenditures
  • Reform and extend Build America Bonds
  • Provide for automatic enrollment in IRAs, including a small-employer tax credit
  • Expand the earned income tax credit for larger families
  • Expand the child and dependent care tax credit
  • Provide tax incentives for locating jobs and business activity in the United States
  • Provide new manufacturing communities tax credit
  • Target the domestic production deduction to domestic manufacturing activities
  • Provide a tax credit for the production of advanced technology vehicles
  • Provide a tax credit for medium- and heavy-duty alternative-fuel commercial vehicles
  • Modify certain energy incentives
  • Eliminate capital gains taxation on investments in small business stock
  • Expand the tax credit provided to qualified small employers for nonelective contributions to employee health insurance
  • Extend and modify the new markets tax credit
  • Designate growth zones
  • Provide tax incentives for transportation infrastructure
  • Modify tax-exempt bonds for Indian tribal governments
  • Allow current refundings of state and local governmental bonds
  • Reform and expand the low-income housing tax credit
  • Defer deduction of interest expense related to deferred income of foreign subsidiaries
  • Determine the foreign tax credit on a pooling basis
  • Tax currently excess returns associated with transfers of intangibles offshore
  • Limit shifting of income through intangible property transfers
  • Disallow the deduction for nontaxed reinsurance premiums paid to affiliates
  • Limit earnings stripping by expatriated entities
  • Modify tax rules for dual capacity taxpayers
  • Tax gain from the sale of a partnership interest on a lookthrough basis
  • Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment
  • Extend Sec. 338(h)(16) to certain asset acquisitions
  • Remove foreign taxes from a Sec. 902 corporation’s foreign tax pool when earnings are eliminated
  • Require a certified taxpayer identification number (TIN) from contractors and allow withholding if the contractor does not provide a TIN
  • Require e-filing by any entity that must file Schedule M-3
  • Authorize Treasury to require additional information to be included in Form 5500, Annual Return/Report of Employee Benefit Plan
  • Allow the IRS to require prospective reclassification of misclassified workers
  • Extend the statute of limitation where a state adjustment affects federal tax liability
  • Require taxpayers who prepare their returns electronically but file their returns on paper to print a 2D bar code
  • Impose a penalty on failure to comply with electronic filing requirements

Don’t worry too much about this. The Senate hasn’t passed a budget in years.

Feb 15

Congress is looking to take away a planning option for IRAs as it seeks more money to fund its spending.

The proposal was snuck into the Highway Investment, Job Creation and Economic Growth Act of 2012. The bill was heard by the Senate Finance Committee, and Chairman Max Baucus (D., Mont.) recommended a provision curtailing the use of “stretch” IRAs.

What is a “stretch” IRA? Say you leave your IRA, or part of your IRA, to your son and daughter. Upon your passing, they take over (separate) IRA accounts. They cannot wait until 70 ½ to begin distributions, as these are inherited IRAs. They have to begin distributions by December 31 of the year following your death, but they are allowed to reset the distribution period to their own life expectancy. This allows the opportunity to have the IRA compound – or “stretch” – over their much longer life expectancy.

Truthfully, the numbers can be astounding. Consider a 78 year-old grandfather passing a $100,000 IRA to his granddaughter, who, upon her passing, transfers the remaining stretch IRA to her son or daughter. This wealth compounding is a reason financial planners like to work with stretch IRAs.

It is of course unpalatable to allow one to decide how to distribute the monies in his/her IRA, so Sen. Baucus has stepped-in to decide this matter for you. Under his proposal, most nonspouse inheritors would have to withdraw the entire amount from the traditional IRA over a period of five years. There would be exceptions for beneficiaries who are disabled, chronically ill, a minor, or a beneficiary no more than 10 years younger than the IRA owner.

Roth IRAs would remain unchanged. Nonspouse beneficiaries must begin distributions from the Roth by December 31 of the year after inheriting, but they can draw these out over their own expected life expectancies.

Why are people concerned? Here is a statistic: approximately 40% of the stock market is tied-up in 401(k)s, 403(b)s, IRAs and similar vehicles. It is an attractive target.