Colorado Tax Attorney: Everything Tax Law

Tax Blog URL Has Changed!

2007-05-12T04:43:00.000-06:00

Our blog URL has changed! Please update any references to our blog, which can now be found at: http://www.irstaxtrouble.com/category/tax-blog/ and the RSS feed is now http://www.irstaxtrouble.com/category/tax-blog/rss .

We are sorry for any inconvenience, but our website was long overdue for a makeover....

Tax Overpayments in Bankruptcy

2007-05-10T09:06:00.000-06:00

Taxpayers who owe taxes and who are thinking of filing bankruptcy should be aware of the Ninth Circuit’s recent Nichols v. United States case.

The taxpayers in the Nichols case overpaid their 2001 state and federal tax liability. The court opinion says that:

Sixteen days later, on February 5, 2002, the Debtors filed for bankruptcy. The [Bankruptcy] Trustee demanded that the Debtors turn the deposits over to the Trustee, but this was not done. In February of 2003, the Debtors signed their 2002 federal and state income tax returns and applied the deposits (resulting from the overpayment of their 2001 taxes) to their 2002 tax liabilities.

The Bankruptcy Court held that the overpayment was an asset of the bankruptcy estate; therefore, the taxpayers had to deliver an amount equal to the tax overpayment to the trustee.

The taxpayers appealed the decision, arguing that their inability to get the funds back from the IRS and the irrevocable nature of their election prevents the bankruptcy estate from asserting any right to the funds.

The court rejected the taxpayer’s argument, saying:

As a result of the election, the Debtors were left with a credit with the IRS that provided a dollar-for-dollar tax reduction in the following year. If the Nichols had not elected to prepay their taxes, those funds would have been refunded to them and would likely have been available for the bankruptcy estate when they voluntarily filed for bankruptcy just 16 days later. The fact that the election, once made, was irrevocable, does not change the analysis. In light of the expansive definition of property contained in the Bankruptcy Code and our broad interpretation of "property" …, we hold that this credit toward future taxes constituted estate property at the time the Debtors filed for bankruptcy.

Perhaps the result would have been different if the taxpayers had relinquished any rights in IRS and state tax deposits prior to filing for bankruptcy.

Offer in Compromise: The Coming Storm?

2007-05-09T13:06:00.000-06:00

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) makes substantial changes to the IRS offer in compromise program. Most notably, TIPRA includes a provision in which taxpayer submitted offer in compromises are “deemed” accepted by the IRS.

The offer in compromise or OIC program for compromising tax debts for less than is actually owed. Taxpayers often refer to this program as the process of settling tax debts for pennies on the dollar.

The IRS offer in compromise process is notoriously slow, with the IRS appeals officer not even being assigned to a taxpayer submitted offer in compromise for upwards of six months.

Pursuant to TIPRA, subsection (f) was added to IRC 7122. This subsection indicates that the IRS is deemed to have “accepted” an offer in compromise if the offer in compromise is not withdrawn, returned or rejected within 24 months after the IRS received the offer in compromise. This new law is effective for offer in compromises submitted two months after May 2006. This means that we are one year away from the time when the first “deemed” accepted offer in compromises will start to show up.

Here are some general thoughts about this coming “deemed” offer in compromise scenario:

The offer in compromise process is a bargaining process. Taxpayers often submit an initial offer in compromise and then either amend or submit a new offer in compromise at the instruction of the IRS appeals office. It is not unusual for a taxpayer to submit two or three offer in compromises to the appeals office in this process.

The appeals office, in my experience, has and continues to only continue processing the one final offer in compromise. The others merely disappear. Apparently, the appeals office is not concerned about these other offer in compromises being “deemed” accepted – but it should be.

Also, the courts have said that the offer in compromise is a legal contract that is governed by state contract laws. This means that we will probably see some state law based litigation for these “deemed” offer in compromises. The issues could be very complex. Here are some examples:

If a first offer in compromise is ignored but then a second offer is accepted in the negotiating process, does the first offer then trump the second offer after the 24 month period? What if only the second offer is rejected, does that rejection apply to the first offer? What if there is confusion as to which offer was accepted, rejected, etc.?

What happens if the IRS and/or the taxpayer cannot establish the date on which the offer was received, rejected, withdrawn, or returned? Who has the burden to make that showing and, if it is the taxpayer, how does the taxpayer show that the IRS failed to issue a rejection letter or return the offer to the taxpayer? When is an offer in compromise withdrawn? Is it when the taxpayer calls the appeals office and says “I withdraw my offer in compromise,” when the taxpayer faxes or mails a letter to the IRS saying this, or when the IRS actually receives the fax or letter?

What state law applies if the taxpayer resides in State A at the time the tax obligation arose, moved to State B and negotiated the offer in compromise, moved to State C by the time the offer is “deemed” accepted and the IRS appeals officer is located in State D and the IRS center that received the offer is in State E (Tennessee)?

Also, there are significant federal tax law issues that remain to be resolved.

For example, how does a taxpayer tell the IRS collections function that the tax is not owed and that any future collection activities are illegal? What about getting a lien lifted because the tax debt is no longer enforceable because an offer in compromise was “deemed” accepted?

Taxpayers currently run into this situation where the IRS has let the collections statute expire (i.e., the CSED lapses). Taxpayers who are in this situation have no immediate way of telling the collection branch to stop its illegal collections activities and they have to write letter after letter and just hope that collection activity stops. In most cases the issue is beyond the grasp of IRS employees, who are merely able to read the CSED that shows up on their computer screen and assume that it is THE correct answer.

If collections doesn’t stop, then the taxpayer has to appeal the collection activity after the fact. Is this how “deemed” accepted offers will start showing up in the system? Is that the best way to handle them? Maybe the Advocates Office will start handling these cases?

The IRS has issued Notice 2006-68, which fails to address any of these “deemed” accepted issues. In fact, this Notice raises even more questions.

Even more disturbing, what if every taxpayer decided to start mailing in $1 lump sum offer in compromises every day for the next two years? Would the IRS be able to reject and keep track of each and every one of those offer in compromises?

Sure the taxpayer would have to worry about the new frivolous submission penalty, but that is just a civil penalty and it is only a very nominal amount and taxpayers could withdraw any submission that they were notified by the IRS that it was frivolous, thereby avoiding the penalty on the offer in compromises that the IRS caught.

Of course, I would never recommend something like this to any taxpayer. I merely point out the issue, as there very well could be a storm on the horizon with regard to “deemed” offer in compromises -- a storm that could cost the US Treasury quite a bit of tax revenues.

“We the People Foundation” Loses Court Battle, Wins Publicity

2007-05-08T17:19:00.000-06:00

“We the People Foundation” recently lost yet another tax-related court case, but, perhaps wining in court is not really what the group is after.

According to the court record, We the People have:

engaged since 1999 in "a nationwide effort to get the government to answer specific questions" regarding what plaintiffs view as the Government's "violation of the taxing clauses of the Constitution" and "violation of the war powers, money and 'privacy' clauses of the Constitution."

...

and they contend:

that the President, the Attorney General, the Secretary of the Treasury, the Commissioner of the Internal Revenue Service, and Congress neglected their responsibilities under the First Amendment to respond to plaintiffs' petitions.

As a result, We the People brought suit claiming:

that government officials-by seeking to collect unpaid taxes-have retaliated against plaintiffs' exercise of First Amendment rights.

We the People then asked:

the District Court to enjoin the Internal Revenue Service, the Department of Justice, and other federal agencies from retaliating against plaintiffs' exercise of their constitutional rights (in other words, to prevent the Government from collecting taxes from them).

The district court held that the First Amendment does not provide plaintiffs with the right to receive a government response to or official consideration of their petitions. We the People then appealed this decision, arguing that:

they have a First Amendment right to receive a government response to or official consideration of their petitions. Second, plaintiffs argue that they have the right to withhold payment of their taxes until they receive adequate action on their petitions.

The court of appeals dismissed We the People’s claims. While the group lost the court case, it did get some excellent publicity for its “cause.”

Part 2: One Tax Attorney's Opinion on How the IRS Could Improve

2007-04-20T20:26:00.000-06:00

In the prior blog post I provided a few suggestions for how the IRS could improve. This post was in response from a question posted to me by a fellow Denver tax attorney.

The prior post suggested that the Treasury Inspector General for Tax Administration take a more proactive approach to auditing the IRS, the IRS should provide more and better online tools for tax practitioners, the IRS should be more forthcoming with taxpayer records, and the Taxpayer Advocate Office should play a more active role were intra-agency failures leave taxpayers with no recourse.

Here are some additional suggestions (which are again in no particular order):

The collection due process hearing plays a vital role in our system of tax administration. The collection due process hearing is often the only way taxpayers can prevent the IRS from undertaking illegal collections activities. As important as it is, the collection due process (CDP) process is broken.

The CDP process starts when a taxpayer submits a Form 12153 Collection Due Process Hearing Request. The Internal Revenue Code specifies that the IRS must suspend (most) of its tax collection efforts if the taxpayer submits a timely CDP hearing request.

The main problem with the CDP hearing process is that the IRS does not check the Form 12153 in to its computer system for several weeks or, in some cases, several months. The average time to check in a Form 12153 is about three to four weeks, with an additional one to two weeks for the CDP hearing request to be delivered by the postal system.

During this period of time the IRS collection function, not knowing that a CDP hearing request has been filed, often continues its collections efforts. These efforts are 100% illegal and in many cases the resulting damage cannot be undone after the fact (i.e., taxpayers cannot un-bake the cake).

Yet, the IRS will not permit taxpayers to have a CDP hearing (and its associated benefits) where the taxpayer missed the 30-day deadline for filing the request (for example, where a taxpayer mails in a CDP hearing request one day late). I can’t help but wonder why the IRS takes such a strict approach in these cases when the IRS takes so long to even check taxpayer CDP hearing requests in to its computer system. This is yet another instance where the IRS policy is “do as I say, not as I do.”

I would suggest that the IRS flag each and every taxpayer account on the very day that the IRS receives the CDP hearing request – regardless of whether the CDP hearing request was valid or timely (perhaps technology could provide a solution, such as allowing taxpayers to submit the forms electronically?). That way the IRS collection function would know that it should halt its collections efforts, pending the IRS determination of whether the CDP hearing request is appropriate.

As an alternative, the IRS should adequately staff the CDP hearing request review teams so that it can, in a timely manner, determine whether the CDP hearing request is timely and valid and update its computer accordingly.

I would go even further by setting up an administrative procedure whereby taxpayers can obtain relief and damages should the IRS undertake illegal collection activity after a CDP hearing request was filed (perhaps Congress should add this provision to Sections 6330 and 6320). This is going to become more and more important as the IRS ramps up its tax collections efforts.

As a side note (in support of another suggestion), the IRS takes the position that the 30-day period for taxpayers to submit CDP hearing requests starts to run from the date that the first (lien or levy) notice is sent by the IRS to the taxpayer. So if the IRS sends out a subsequent notice that tells the taxpayer that they have 30-days to request a CDP hearing, the IRS will not honor the second letter – assuming that the letter does not benefit the IRS.

Here is a common fact pattern: the IRS sends a first (lien or levy) notice letter to taxpayer in year one and the IRS sends a second notice letter to the taxpayer in year five. The taxpayer has a copy of the first notice letter, but he or she would not be able to successfully argue that the second letter (and any collection action based on the second letter) is invalid because the IRS had already sent a first notice letter – but why not, if the IRS refuse to honor their second letter when it is convenient for the IRS to do so?

I would suggest that the IRS implement a policy whereby it stands by what it says in its letters in these cases, so that taxpayers are entitled to CDP hearings as set out in second or later letters from the IRS – regardless of whether the IRS letter is not convenient for the IRS (maybe Congress should add something to this effect to the Code as well).

An even better approach would be for Congress to amend the law to specify that the IRS cannot undertake collection activity unless it sends the taxpayer a new notice letter (i.e., that a letter sent five or nine years prior will not do the trick), perhaps the law could provide that the letter has to go out 30-days prior to renewed collection activity….
The “equivalency hearing” provides taxpayers with the ability to get in front of the Appeals Office in cases where the taxpayer missed the 30-day period for filing a CDP hearing request.

Taxpayers cannot appeal equivalency hearing results (as the IRS is always quick to point out) and IRS collection activity is not suspended by requesting such a hearing.

The IRS does not have to grant taxpayers equivalency hearings. In fact, the New Form 12153 specifies that the IRS will ONLY grant taxpayers equivalency hearings if the hearing is requested within one year of the first collection action (This is a new policy that I have found no reference to in anything other than the new Form 12153. Does anyone know how or who was responsible for this? Assuming that there is no authority for this, does this mean that a clerk who designs a IRS form has the power to set IRS policy? Maybe I don’t want to know the answer to the last question.).

IRS employees do not give taxpayers fair consideration in equivalency hearings. In fact, in many cases the IRS uses the equivalency hearing for the sole purpose of gathering additional ammunition to use against the taxpayer. This is unfortunate because all taxpayers who come forward to resolve their tax liabilities should be afforded due consideration.

I would suggest that the IRS implement a policy granting taxpayers CDP hearings, even though it is not required by Congress to do so (technically, such a hearing would not be appealable to court, but the IRS could at least suspend collections activities). I know that this is asking the IRS go to beyond the mere minimum that is required (which it basically never does), but it is the right thing to do.

There are two more suggestions for improvement. Perhaps I will suggest a few more changes in future blog postings.

How Could the IRS Improve: One Tax Attorney's Opinion

2007-04-18T19:09:00.000-06:00

A fellow Denver tax attorney asked me to provide some specific changes that I would make if I found myself in the position of being able to make administrative changes to the IRS. Given two to three seconds to think about it, I was able to come up with around forty such changes.

The other tax attorney apparently wasn’t expecting or didn’t have time for a long and detailed answer (or perhaps he lost interest in the topic), so I thought that I would just list a few of the changes in a blog post (maybe the other tax attorney can read it at his convenience in the future).

Here are a few administrative changes that I think the Treasury Department and IRS should implement:

The Treasury Inspector General for Tax Administration (TIGTA) currently audits and investigates the IRS to “promote economy, efficiency and integrity in the administration of the internal revenue laws.” Published TIGTA audit reports can provide very useful information about various IRS functions that it examines. However, the TIGTA’s audit function is limited in that it almost always investigates the IRS by reviewing past transactions by examining IRS records.

I would suggest that TIGTA develop and actively promote a “mystery shopper” program where TIGTA employees pose as taxpayers who attempt to resolve various IRS tax troubles by contacting and working with the IRS.

This would allow the TIGTA to investigate and report on how the IRS really functions, it would help the IRS weed out “unprofessional” employees, and it might even “encourage” IRS employees to (1) provide high quality service and (2) adhere to IRS policies and our tax laws. As an added benefit, Taxpayers would be able to read TIGTA audit reports to get a real sense of how our IRS employees conduct themselves (be it good or bad news).

In the alternative, I would suggest that the IRS Office of Professional Responsibility take on this role. Similarly, and as a separate suggestion, as I have said before, I think that the IRS Office of Professional Responsibility should promulgate and enforce Circular 230-like ethical rules for IRS employees. Government employees should be held to a high standard, not no standard.
The IRS has recently taken some small steps to provide tax practitioners with online access to IRS records. I would aggressively expand online tools for tax practitioners (and for taxpayers).

For example, all taxpayers must verify their financial information as part of the IRS collection process prior to being able to work with the IRS collection and/or IRS appeals function(s). In most cases, this process consists of the taxpayer or tax practitioner calling the IRS collection and/or appeals function, placing the telephone call with the IRS employee on hold, and submitting a Form 433 (along with the supporting financial records) via facsimile to the IRS employee.

Taxpayers or their representatives then have to wait on hold for the IRS collections and/or appeals function employees to receive the documents and manually enter the information into the computer. The IRS uses the word “verification” to refer to this process. This “verification” process can take more than two hours for some taxpayers (especially if the taxpayer is or owns a business).

In many cases, taxpayers or their representatives will have to call back and start the “verification” process from scratch if any particular information or record is missing. IRS employees often do ask for unusual documentation (in many cases I think that they do this in bad faith just so they can move on to the next case…).

This would not be as much of a problem if IRS employees could simply return phone calls (most ACS collections employees do not have this ability) and/or taxpayers could speak directly with the same IRS employee when the taxpayer calls the IRS back with the additional information or record (this is possible with most IRS appeals and IRS revenue officers, but that presumes that the case is in appeals or has been assigned to the IRS field collection function).

I suggest that a better approach would be to allow tax practitioners (or taxpayers) enter this information into an IRS maintained/hosted website (or even a third party maintained/hosted website). The tax practitioner could even upload and/or fax the documents into the IRS, prior to the IRS contacting the tax practitioner (or taxpayer) to “verify” the information that was uploaded.

This would save the taxpayer and the IRS a considerable amount of time, and it would allow the IRS to handle cases at their convenience (as opposed to when taxpayer and tax practitioner telephone calls come in).

While I am thinking about it, in the alternative, I would suggest that the IRS Form 433 be redesigned to track EXACTLY the computer fields that the IRS employees have to enter. The current Form 433-A does not contain all of the information that IRS employees must enter into the computer to “verify” the taxpayer’s financial information (remember my comment about having to call back and start over if you do not have the necessary information….) and the information that it does include is not listed in the same order (if you want to hear a frustrated IRS employee, all you have to do is send them a Form 433-A with a lot of supporting taxpayer information).

In the alternative to that, the IRS should get rid of the Form 433-A all together. The Form 433-A is used by many IRS functions – such as appeals, the field collection function, etc. There are three other versions of the Form 433 (the Form 433-B, D, and F). The Form 433-F is a much better and more recent form. I would suggest that the Form 433-F be expanded a bit and the other Form 433’s be eliminated.

In the alternative to that, I would suggest that tax practitioners (or taxpayers) not have to “verify” the taxpayer’s financial information with the appeals and/or field collection function if the tax practitioner (or taxpayers) have already (and recently) “verified” their financial information with the automated collection system.

And that only deals with the financial verification process. Don’t get me started about how the IRS could improve the IRS audit and other collection functions by using technology that is used by reasonable and prudent businesses that perform similar functions.
The IRS is pretty good about sending out taxpayer transcripts. However, the IRS is not very forthcoming with other taxpayer records. Taxpayers should not have to submit formal freedom of information requests to obtain their IRS files. If the taxpayer wants their information master file or if the taxpayer wants to see what is in the field function collection file, they should be able to see that information and to obtain copies upon request.

Taxpayers often use the Form 4506-T to request their tax transcripts. The current IRS processing time for a Form 4506-T can range from one month to one year (or to infinity, in some cases). The RAVIS teams that handle these requests are no doubt flooded with transcript requests (Maybe taxpayers could submit their requests online, and, heaven forbid, the IRS could provide the transcripts to taxpayers online or via email). As a side note, the IRS processing time for transcripts requested by taxpayers using the automated telephone system takes about one to three weeks.

I would suggest that the IRS add the ability for taxpayers to request additional documents via the slow Form 4506-T method or via the other existing methods (or again, electronically).

The same issue often limits IRS employees. I continue to encounter IRS employees who are not able to locate files and who are not able to timely access records/information – and IRS employees who (I think, falsely) blame their inability to act on their inability to obtain records.

Lets be honest, how effective can an IRS examiner or collector be if he or she cannot obtain a copy of the taxpayer’s tax return, W2’s, 1099’s, etc. or even IRS records which reflect the contents of these documents?

My suggestion here should be self evident.
The Taxpayer Advocate Office can be very helpful in resolving unresolvable IRS cases. A major problem with the Advocate’s Office is that they will generally not get involved in matters when the matter is assigned to another function – such as the IRS appeals function. In those cases the Advocate will simply say “you need to follow up with Appeals Officer _________.”

This ignores the reality that IRS Appeals Officer __________ may not be able to address the problem. Take the very common situation where the taxpayer is appealing the collection function, but the taxpayer is waiting on the examination function to “assess” a newly filed or amended tax return. IRS Appeals Officer ___________ may be assigned to the case, but he or she will not be able to process the case until the examination function “assesses” the tax.

The current wait time for “assessing” a tax obligation seems to average about thirty days. But there are some instances where the exam function will never “assess” the tax – despite IRS Appeals Officer __________’s request that they do so and despite the taxpayer request that they do so. The Advocates Office will not touch these cases. So what are taxpayers to do in these situations? Unfortunately the answer is “nothing, but send letter after letter and make phone call after phone call to the IRS.”

This same intra-function conflict comes up in a number of common situations. As such, I would suggest that the Advocates Office handle these types of cases.

Well, there are four suggestions. Perhaps I will write about a few more in the next blog post.

Disgruntled Ex-Spouses or Just Good Tax Procedure?

2007-04-04T19:09:00.000-06:00

Divorce is not a very fun topic and divorce often causes people to act in ways that they would not otherwise act. I often encounter taxpayers who want to use the tax aspects of divorce to add insult to injury. Here is a case that very well could be (but may not be) an example of disgruntled ex-spouses who are using the tax system to spite their ex-spouse: Kovitch v. Commissioner.

The Kovitch’s were divorced. The IRS then issued a notice of deficiency to both spouses. Only Ms. Kovitch filed a petition in tax court. Ms. Kovitch only sought innocent spouse relief, she did not challenge the underlying tax. Mr. Kovitch did not file a petition with the tax court. Instead, Mr. Kovitch later opted to intervene in Ms. Kovitch’s tax court proceeding. Mr. Kovitch then filed for Chapter 13 bankruptcy after intervening in the tax court case.

Mr. Kovitch may have done this as a matter of course or Mr. Kovitch may have done this in an effort to preclude Ms. Kovitch from obtaining innocent spouse relief. The question before the tax court was whether the bankruptcy automatic stay would preclude the tax court from determining if wife Kovitch was entitled to innocent spouse relief.

Innocent spouse relief generally can relieve the current or former spouse of liability for a tax, penalties and interest if (1) there was a jointly filed tax return, (2) there is an understatement of tax by the non-innocent spouse, and (3) the innocent spouse can show that he or she did not know or have reason to know of the understatement.

Generally the bankruptcy automatic stay halts all IRS and tax court activities with regard to the taxpayer who files bankruptcy, pending the resolution of the bankruptcy proceeding.

Mr. Kovitch may have thought that he was pulling a fast one, by filing bankruptcy to prevent his ex-wife from obtaining innocent spouse relief; however, it was Ms. Kovitch that pulled the fast one.

The tax court concludes that the bankruptcy automatic stay does not preclude the tax court from determining whether wife Kovitch was entitled to innocent spouse relief. The reasoning is that husband Kovitch will still owe the tax even if wife Kovitch was granted innocent spouse relief, as such the tax court was not determining husband Kovitch’s tax liability and the bankruptcy rules did not halt this type of activity.

The result may have been difficult if Mr. Kovitch filed his own petition contesting the deficiency (and the trials were consolidated) or had Ms. Kovitch opted to contest the deficiency in her tax court petition. I am left wondering if Ms. Kovitch did her homework and knew that she should not contest the tax in addition to requesting innocent spouse relief or if it was just a strange (and lucky) coincidence….

Two Taxpayers Commit Tax Fraud: Should They Get Separate Trials?

2007-04-02T18:28:00.000-06:00

While a taxpayer who commits tax fraud is entitled to a hearing, in United States v. Robbins the question is whether the taxpayer is entitled to a separate hearing.

Lee Robbins founded Robbins & Associates, which was a bookkeeping and tax return preparation business located in Georgia and Oklahoma. Robbins recruited, hired, and trained Gabriel Bonner. Bonner operated the Tulsa office and Robbins operated the Atlanta office; however, Robbins continued to review and e-file the tax returns prepared by Bonner.

Unfortunately, Robbins & Associates had a practice of helping clients minimize their tax payments and maximizing their refunds by falsely characterizing nondeductible personal expenses as deductible business expenses.

Both Robbins and Bonner were indicted for conspiracy to defraud the IRS, Robbins was indicted for fifteen counts of aiding and assisting the preparation and submission of false and fraudulent tax returns, and Bonner was indicted for fifty different counts of aiding and assisting the preparation and submission of false and fraudulent tax returns.

The end result: Bonner was acquitted on all charges and Robbins was found not guilty of conspiracy but guilty of the 15 individual counts.

Robbins filed a pre-trial motion asking for a separate trial, because he felt that he would be prejudiced by being tried with Bonner. The district court denied Robbins’ motion.

The appellate court opinion found that Robbins defense was antagonistic to Bonner’s defense, but not that whether the defenses presented were so antagonistic that they were mutually exclusive, so that the acceptance of one party’s defense would tend to preclude the acquittal of the other, or that the guilt of one defendant tends to establish the innocence of the other.

At trial, Robbins and Bonner each attempted to cast all blame for tax fraud on the other. The court opinion states in part:

Bonner testified that it was … Robbins who “caused all the wrong and illegal tax returns to be filed.” And, according to Robbins, "Bonner’s counsel sought to deliberately undermine Robbins’ defense at trial with every witness so that Bonner appeared only to be someone who was a data clerk.” Robbins also complains that Bonner’s counsel acted as an “additional prosecutor” by identifying himself as a former prosecutor and telling the jury to disbelieve the arguments made by Robbins’ [tax] attorney.

The courts often have to make difficult decisions. On the one hand, Robbins very well could have been prejudiced by having a joint trial with Bonner. I once heard a famous Texas criminal lawyer say that a joint trial will either allow the jury to be swayed by a more sympathetic co-defendant or it will allow a less likeable co-defendant sour the jury (in true Texas trial attorney form, the Texas attorney couched these ideas in terms of the sweet perfume of a beautiful woman and something about throwing a skunk in the jury box...).

On the other hand, combining tax fraud cases can speed the trial along and save the parties the time and expense associated with presenting the same evidence to two different juries.

Given the severity of the consequences in tax fraud cases and the disparate results, I might be more inclined to believe that perhaps Robbins should have been given a separate trial. Then again, Robbins picked recruited and hired his partner in crime, so maybe a joint trial with his partner was warranted....

IRS Says When a Grape is No Longer a Grape

2007-03-31T13:03:00.000-06:00

We all know that (most) wines come from grapes, but many of us might not know exactly when grapes turn into wine for federal income tax purposes. According to the IRS (in Chief Counsel Advice Memorandum 200713023), grapes turn into wine when a taxpayer begins crushing the grapes. This IRS Memorandum highlights a few of the tax planning considerations for businesses that produce and sell their own goods.

In general, taxpayers are not entitled to immediately deduct the cost associated with producing a good. Rather, the taxpayer has to add the associated costs to their tax basis in the good, which permits the taxpayer to claim tax deductions over time or it reduces the amount of taxable gain that the taxpayer will have when they sell the good. Production costs can include everything from direct labor and materials costs to indirect rents, taxes, and other costs.

This is problematic for taxpayers who grow grapes and operate wineries, as it appears that the taxpayer would have to capitalize all of their expenses up until the time that the wine was sold. This would be especially harmful for wineries because the wine making process can take many years.

This Chief Counsel Advice Memorandum says that this is not the case. Instead, the IRS will treat the grape growing and winery functions as separate businesses – even though (1) “the grapes themselves are never subject to a ‘sale or other disposition’ as these terms are customarily used in federal income tax law” and (2) the taxpayer did not operate their business as two separate and distinct businesses.

Of course, the taxpayer could have just separated out their different business functions by operating two or more separate and distinct operations. This could provide the taxpayer with the ability to choose what items it wanted to capitalize or deduct and when....

Yet Another Lottery-Related Tax Question

2007-03-30T13:43:00.000-06:00

Here is yet another lottery-related tax question: Does a state lottery have to withhold tax from lotto winnings if a single taxpayer wins more than one lottery prize from the same lotto ticket where the total winnings exceed $5,000, but the individual winnings do not exceed $5,000?

The IRS recently held that the state would not have to withhold the tax as long as the lotto numbers were different. The IRS reasoned that a lotto ticket that had different winning numbers were not “identical wagers.” Identical wagers are treated as a single wager.

The IRS uses these examples: placing two bets on the same horse in a horse race would be an “identical wager” and it would be treated as only one wager. But, there would be no “identical wager” where one bet was placed with the track and the other bet were placed with an off-track betting establishment. Similarly, there would be no “identical wager” if the bets were placed with the same establishment but one bet was for a trifecta and the other an exacta.

In this case, the IRS said that the lottery numbers would have to be identical for the bet to be an “identical wager.” The state lotto would only have to withhold tax if the winning lottery ticket had the same numbers, because the winnings were treated as different wagers and the individual winnings did not exceed the $5,000 withholding requirement limit.

Does Anyone Really Win the Lottery?

2007-03-28T21:53:00.000-06:00

The Prebola v. Commissioner case serves as a reminder that winning the lottery requires significant tax planning. It also serves as a reminder that absent advanced tax planning, the federal and state governments are the only true lottery winners.

Lottery winnings are treated as income from gambling. As noted in the Prebola case, lottery winnings are accorded ordinary tax treatment, rather than capital gains tax treatment. This means that the federal government can impose a 38%+ tax on significant lottery winnings at the time that the taxpayer receives the winnings. The state and city governments where the taxpayer resides may also impose taxes on the lottery winnings at the time that the taxpayer receives the winnings. These taxes could approach 10%+, as is the case for taxpayers in some cities in Colorado.

If that is not bad enough, both the federal and local governments may impose capital gains taxes on proceeds derived from invested lottery winnings. These taxes could exceed 20%+ of the gains. In addition, the federal and local governments may collect excise and other taxes on items purchased with lottery winnings. These taxes could exceed 10%+ of the cost of the items purchased.

And still, the federal and state governments may impose a tax on gifted or unspent lottery winnings. These taxes could exceed 50%+ of the unspent lottery winnings.

For those keeping tabs, the total tax liability can exceed 100% of the lotto winnings -- which shows who really wins the lottery.

It appears that Prebola did not present any real claims by bringing suit against the IRS, but, given the amount of taxes that she, and other lottery winners, have to pay, one can understand her frustration. Of course, hiring a tax attorney to help restructure her lottery winnings might be a more productive way to vent her frustrations.

IRS Obtains Promissory Note: Can it Collect on the Note?

2007-03-20T21:25:00.000-06:00

In United States v. Spangler, the Eleventh Circuit Court of Appeals upheld a lower court order requiring a taxpayer to transfer a promissory note to the government so that the note payments would be credited towards the amount of the taxpayer’s court ordered tax restitution.

Given that the IRS has a poor track record in collecting taxes from taxpayers via the traditional avenues, this scenario raises the question as to whether the IRS would be able to collect tax payments from third parties via a promissory note.

Generally an individual – be it a taxpayer or the government – steps into the shoes of the person who holds a promissory note and it acquires the rights of that person. If the individual is a taxpayer whose promissory note is seized by the government or turned over to the government via a court proceeding, the analysis then focuses on what rights the individual taxpayer had in the note.

A more precise question is whether the taxpayer who held the note was a “holder in due course.” A “holder in due course” is any person that acquires a negotiable promissory note without knowledge of any claims or defenses associated with the note. The individual who makes payments on a note that is held by a “holder in due course” is generally not justified in refusing to pay the third party due to defenses or claims that he or she may have against the original note holder.

A taxpayer who committed fraud related to the note would probably not qualify as a “holder in due course,” because their fraud would create a claim and defense to payment of the note. Similarly, taxpayers could structure the promissory note so that it is non-negotiable and/or only acquire non-negotiable notes – which would ensure that the government or other parties would might obtain the note would never qualify as a “holder in due course.”

If the taxpayer were not a “holder in due course,” a third party who was subject to the note could raise the defense of fraud, duress or illegality of the transaction in an effort to rescind the note and to recover the instrument or its proceeds. If the note were held by the government, the person making the payments could raise these defenses in order to recover the note proceeds from the government and to rescind the note.

It would be even more interesting if the third party raised a fraud defense, as the government would have to argue that the taxpayer – the same taxpayer that it convicted of tax fraud – did not commit fraud in order for the government to collect on the promissory note. This could create a conflict of interest for the government – one that tax criminals could conceivably, given the right facts, use to overturn their criminal tax fraud sentences.

Does this mean that taxpayers who are facing criminal tax fraud charges can simply transfer assets to a third party in exchange for a promissory note, with the aim of having the third party rescind or void the note and reclaim the note proceeds once the government obtains possession of the note?

The answer is probably not, as the government would likely pursue the third party for fraud as well and/or impose transferee liability upon the third party. The risk is simply too great. Although, this type of case would raise some very interesting issues and the government may find itself running into more of these cases due to the rising number of mortgage foreclosures and the recent increase in private investors purchasing promissory notes.

“Rule of Thumb:” IRS Employees Not Subject to Ethical or Moral Standards

2007-03-16T14:27:00.000-06:00

Unlike tax attorneys, IRS employees are not subject to any ethical or moral standards. Take the case of Wormley v. Department of the Treasury. The Wormley case presents the unusual question as to whether an IRS employee should be fired if she is arrested and convicted of assault for “biting off a portion of her neighbor's thumb during a physical altercation.”

The court opinion sets out the following facts: Patricia Wormley was employed as an IRS tax examining clerk in Philadelphia. Wormely was belligerent with her manager when the manager attempted to discuss Wormley’s training period performance. The IRS discovered that Wormely had been arrested when the IRS was investigating Wormley’s background (apparently after Wormely was already employed with the IRS).

After Wormely was convicted of simple assault, the IRS issued a letter to Wormley indicating that she would be removed from her position due to (1) her attack upon her neighbor, (2) her assault conviction, and (3) her inappropriate behavior toward her manager. The letter also mentioned that Wormley had “three [prior] instances of misbehavior.”

Wormely appealed the IRS determination. The IRS, an administrative law judge, and the Court of Appeals for the Federal Circuit held that “the removal penalty was reasonable considering Ms. Wormley's potential for behaving violently and that her job involved working in close proximity to her co-workers and dealing personally with the general public.”

The Wormely case highlights one of the major problems with the IRS; namely, IRS employees are not held to any ethical or moral standard. Three documented instances of “misbehavior” should be sufficient to warrant termination – absent an arrest for assault or confronting an IRS manager (If there were three documented instances of “misbehavior,” one is left wondering how many instances of “misbehavior” were not documented).

The Taxpayer Bill of Rights is the only body of rules that come close to imposing standards on IRS employees, but these Rights are so basic that they do not really address ethical or moral standards for IRS employees.

Compare this to the lengthy do and do-not standards imposed on tax attorneys via state bar ethics rules, administrative rulings, court cases, and even IRS proclamations.

As the tax practitioner community is well aware, the IRS has been working on Circular 230 and its Office of Professional Responsibility to “strengthen professional standards” for non-IRS employee tax practitioners.

My personal opinion is that the IRS should extend these new “high” Circular 230 standards to its own employees before even beginning to think about extending them to non-IRS tax practitioners. This seems like a logical step if the goal really is to “strengthen professional standards.”

If Wormley were subject to Circular 230, she would probably have found herself before the United States Merit Systems Protection Board much sooner -- perhaps with her first, second or third instance of misconduct.

Until the IRS opts to impose any standards on its employees, non-IRS employee tax attorneys will have to advise their clients that the “rule of thumb” is that IRS employees are not bound by any moral or ethical standards and that, absent extreme circumstances, IRS employees who "misbehave" will not lose their jobs and they will not be subject to any other IRS sanctions.

IRS Incentive to Delay Processing Cases: Extra Tax Penalties & Interest

2007-03-15T21:34:00.000-06:00

I think that most citizens would agree that the IRS should not benefit from failing to do its job in a timely manner. The recent United States v. Ryals case provides an example of how the IRS can benefit from denying taxpayer claims and delaying the collection of taxes.

Ryals owed taxes for tax years 1977 and 1978. The tax court found Ryals liable for these taxes in 1989 and the IRS assessed the taxes at that time. By March 2003 Ryals tax liability had grown (due to tax penalties and interest) from just over $500,000, which was the amount assessed, to just over $1,500,000.

Between 1989 and 2003 Ryals was convicted of a tax crime and he submitted two offers in compromise that were rejected by the IRS. The IRS filed suit against Ryals for the unpaid tax on May 20, 2003. The main question for the court was whether the IRS collection statute had expired.

The court looked at the impact of three Congressional amendments which addressed whether submitting an offer in compromise tolls the IRS collections statute, to conclude that the collections statute expired 19 days AFTER the IRS filed suit against Ryals – which, unfortunately for Ryals, made it possible for the IRS to maintain its tax court case.

Here is a quote from the court’s opinion that I couldn’t resist mentioning: “Whether or not such a construction is at odds with temporary regulations issued, congressional intent, or the initial position of the Government as stated in its motion for summary judgment is irrelevant because the clear words of the statute command this result.” I really like this sentence. It is powerful. There is nothing like a court disregarding IRS-created law, Congress, an IRS attorney, and a taxpayer all in one sentence....

The court did agree with the IRS position that an IRS wage levy by the IRS can in fact continue after an offer in compromise is “pending,” so long as the wage levy was filed prior to the IRS accepting an offer in compromise for consideration. I personally do not agree with this “law,” as it gives IRS employees a strong incentive to delay in accepting offers in compromise for consideration.

Many of us will remember last year’s move by the IRS to consolidate the offer in compromise program by having all offers that are submitted be screened by one IRS office – which was supposed to speed up the offer processing time. This move has not only slowed down the processing of offers in compromise (yes, the IRS is actually getting slower), it also puts the IRS in a very good position to delay processing offers where a wage levy should be filed against taxpayers (the very thing that the IRS chides taxpayers for doing – even though IRS employees do it too).

Under the old IRS procedure for processing offers in compromise, the appeals office would not be able to have direct and impermissible contact with the exam or collections function to determine whether a wage levy was appropriate. Now, the offer processing center probably can have this type of contact as it does not seem to be impermissible ex parte contact (in that the appeals officer or even office that ultimately considers the case is not the one that initially received the offer in compromise for processing).

Cases like this really are unfortunate. Taxpayers should not be penalized by coming forward to make offers to settle their tax liabilities.

Also, taxpayers should demand something more of their chief tax collection agency. Having to argue about 19 days when the IRS had over 20 years to collect this tax has to be embarrassing for IRS administrators and employees (to say the least) and having to live with a tax debt for two decades is unduly burdensome for taxpayers.

There is something wrong with the IRS being rewarded for incompetence by being able to obtain a court judgment for a million dollars worth of penalties and interest that it would not have been entitled to collect had it done its job sooner rather than later.

Section 104 Survives Non-Murphy Constitutional Challenge

2007-03-14T15:59:00.000-06:00

The now famous Murphy decision has left some uncertainties with regard to whether compensation for a personal injuries that are unrelated to lost wages or earnings are taxable. There can be little doubt that the IRS will ask the Supreme Court to settle the issue if the IRS is not successful in the coming Murphy rehearing. Two days ago the Ninth Circuit Court of Appeals issued its opinion in Polone v. Commissioner, solidifying its view that this type of compensation is in fact taxable and upholding Section 104 in light of a different Constitutional challenge.

Polone was a talent agent for United Talent Agency (UTA). UTA fired Polone and its agents allegedly made defamatory statements about Polone’s termination. Polone brought an action against UTA for wrongful termination and defamation. Polone and UTA agreed to settle the claims on May 3, 1996. Four million dollars of the six million dollar settlement was to compensate Polone for UTA’s alleged defamatory statements. The $4 million was to be paid in four biannual installment payments starting on May 3, 1996.

Polone did not report the first payment on his tax return, but he did report the second payment. Polone, believing that none of the installment payments were taxable, then filed an amended tax return seeking a refund of the taxes paid on the second settlement installment payment. The IRS asserted that Polone must report every one of the four payments and tax litigation ensued.

The tax court and the ninth circuit held the last three installment payments were taxable, but the first installment payment was not taxable. The courts concluded that the first payment was not taxable because it was received before the date that Congress amended Section 104 to exempt only payments on account of physical injuries.

Polone was not successful in arguing that the entire amount of the settlement payments was not taxable due to the agreement being finalized prior to Congress amending Section 104, because, according to the Ninth Circuit Court, California law provides that defamation claims are not transferable; therefore, applying Section 1001, the court took the position that Polone was selling his right to sue for defamation (i.e., a chose in action) in incremental sales with each sale being made at the time an installment payment was received.

According to the Ninth Circuit Court, the payments would not have been taxable if Polone entered into a formal agreement eight months prior to the date that the settlement agreement was entered into, because that agreement would have fit in to the grandfather exclusion provision set out in the new amended Section 104.

Polone argued that it was unconstitutional for Congress to enact a tax law that changes the tax consequences for his settlement agreement, because the change only provides a grandfather clause for agreements that were entered into one year or more prior to the enactment of the law (Section 104 was amended effective on August 20, 1996, the grandfather provision exempts agreements in effect as of September 13, 1995, and Polone’s agreement was entered into on May 3, 1996). In other words, Polone argued that Section 104, as amended, amounted to retroactive legislation that violated his Fifth Amendment due process rights.

The Ninth Circuit Court rejected Polone’s Constitutional argument because it held that the last three installment payments did not arise until after Section 104 was amended.

The Ninth Circuit Court of Appeals did not address the direct question of whether Section 104 is Constitutional (as challenged in the Murphy decision) because Polone did not specifically raise that issue; however, the Polone case represents yet another ninth circuit opinion that has held that personal injuries that are unrelated to lost wages or earnings are taxable.

IRS Uses Taxpayer Records to Secure Tax Fraud Conviction

2007-03-12T07:02:00.000-06:00

Taxpayers who are being investigated for tax fraud should be very careful about turning over incriminating records to third parties. The recent Yang v. United States case provides an excellent example of how this can be a problem.

The Yang brothers and their parents were being investigated by the IRS for tax fraud related to the family’s China Buffet Restaurant. You Bin Yang was living with his parents when he called the local police to report that his house was burglarized. The burglars had taken $2,500 from his parents bedroom and a DVD player from You Bin’s bedroom.

During the burglary investigation the local police evidence technician discovered five unsealed notebooks on You Bin’s parents bedroom dresser. Three of the notebooks had a year inscribed on the cover. The evidence technician obtained You Bin’s permission to take the notebooks so that the technician could process them for fingerprints.

You Bin subsequently contacted the police to see if he could pick up the notebooks. The police officer, who knew of the IRS tax fraud investigation, then examined the contents of the notebooks and discovered that they appeared to be the Yang family financial records. They were written in Chinese. The police officer then contacted the IRS Criminal Investigations special agent and the special agent obtained a grand jury subpoena for the copies that the police officer had made (with You Bin’s permission) of the notebooks.

The government translated the notebooks into English and used the notebooks to indict You Bin and his brother for “for conspiracy to commit tax fraud, filing false tax returns, and conspiracy to structure currency transactions for the purpose of evading currency transaction reporting requirements.”

You Bin and his brother filed a motion to suppress the notebook evidence, arguing that the contents were protected under the Fourth Amendment. The district court and the Seventh Circuit Court of Appeals held that the notebooks are not protected by the Fourth Amendment because You Bin and his brother had no expectation of privacy in the copies of the unsealed notebooks that You Bin had turned over to the police.

Based on the Seventh Circuit’s opinion, it appears that You Bin would have prevailed if the notebooks were sealed and if he did not give the local police permission to copy the notebook contents. Of course, the Yang brothers might have avoided prosecution altogether had the taxpayer not turned the records over to the local police in the first place....

IRS Estate Tax Liens Might Not be as Helpful/Harmful as One Would Think

2007-03-11T17:00:00.000-06:00

It can take years (if not decades) to resolve property disputes resulting from a taxpayer’s demise. The IRS uses the general unfiled estate tax lien to protect its interest in a decedent’s assets during this period. The federal estate tax lien is by far the IRS’ primary estate tax collection tool, yet the estate tax lien system is not as efficient as many taxpayers would expect.

The general estate tax lien arises when the estate does not pay an estate tax liability that is due and owing. This tax lien does not have to be filed or perfected in order to be valid and it attaches to all property that is included in the decedent’s gross estate (The general estate tax lien does not attach to property that is outside of the decedent’s gross estate or to assets that are included in the decedent’s gross estate that are expended for court-approved estate expenses).

Very few taxpayers end up with a gross estate that has a large enough value to incur an estate tax liability; however, owners of small (or large) businesses often do have taxable estates due to their business ownership (many wealthy non-business owners tend to hold their investments in business entities for the estate tax savings; entities which do qualify as legitimate businesses).

Congress has provided relief to business owners whose estates (i.e., whose businesses) are not able to immediately pay the full amount of their estate tax liability. Specifically, Congress has provided that executors for business owners can elect to pay the estate’s estate tax liability over a number of years if the primary asset of the estate is an interest in a closely-held business. The IRS imposes a Section 6324A special estate tax lien in these cases.

This type of special estate tax lien is only valid with regard to the specific assets agreed upon by the executor and the IRS, which usually consists of a security interest in the business entity (which, in many cases, is the only substantial estate asset). The special estate tax lien must generally be filed or otherwise perfected to be valid against third parties.

Once a special estate tax lien is filed, there is some uncertainty with regard to whether the general estate tax lien is extinguished. In a footnote in Chief Counsel Advice Memorandum 20070801F the IRS Office of Chief Counsel explains that “The Service’s position is that the general estate tax lien continues to attach all estate property except the property subject to the section 6324A [special estate tax] lien.” This may or may not be correct (The IRS attorneys also admit that this issue has never been directly decided by the courts).

Section 6324A(d)(4) does provide that “If there is a [special estate tax] lien … on any property with respect to any estate, there shall not be any [general estate tax] lien … on such property with respect to the same estate.” This section does not address whether the general estate tax lien survives the filing of a special estate tax lien.

As a practical matter, a filed or perfected special tax lien has the potential to mislead third parties who search the applicable records if the general estate tax lien is not extinguished by the filing of the special estate tax lien. Even though the special estate tax lien identifies the property that the lien attaches to, third parties may assume that the estate has resolved or fully addressed its estate tax obligations via this special estate tax lien and/or that the IRS does not intend to pursue any estate assets other than those listed in the special estate tax lien.

The IRS could easily remedy this situation by filing the general estate tax lien at the time that it files the special tax lien. The IRS should be required to make this additional filing given that it is the party who is in the best position to remedy the situation. The IRS should not be entitled to reap any benefits of an unfiled general estate tax lien if the IRS fails to make this filing.

At some point a taxpayer is going to litigate this tax issue, and there is some chance that the courts may not agree with the IRS’ current position.

This type of estate tax collection issue has not received as much fanfare as estate tax repeal; however, this type of tax collection issue can go a long way in reducing the impact, and ultimately the perceived injustice, of the federal estate tax regime. If opponents of the estate tax cannot secure a full repeal of the federal estate tax, they might be able to modify the tax collection rules to achieve their aims....

The IRS Appeals Office is NOT Independent or Unbiased

2007-03-07T15:11:00.000-07:00

The IRS Appeals Office was created with the aim of providing taxpayers with an impartial and informal forum to have taxpayer and IRS disputes reviewed and tax controversies resolved. This function serves a vital role in our government’s system of administering our tax laws, yet appeals office employees frequently and blatantly violates IRS policies and our tax laws. The IRS’ recent announcement that it does not agree with the Tax Court’s determination in the Moore v. Commissioner case provides an example.

In the Moore case the IRS appeals offer and the IRS appeals offer specialist (the person that reviews offers in compromises that are submitted by taxpayers) had direct communication with two revenue officers – in violation of Section 1001(a) of the Revenue Restructuring Act of 1998. More specifically, the Revenue Officers passed along their belief to the appeals employees that the taxpayer had concealed assets from the IRS, which ultimately led the IRS Appeals Office to reject the taxpayer’s offer in compromise.

Section 1001 was enacted by Congress to prevent IRS appeals office employees from conspiring with the IRS collections employees (i.e., IRS debt collectors) and/or the IRS exam employees (or IRS auditors), to the detriment of the taxpayer. This is the key provision that allows the IRS Appeals Office to claim to provide taxpayers with “independent” and “unbiased” review of cases.

While the IRS has agreed that the IRS appeals office employees acted illegally in the Moore case, the IRS disagrees that the taxpayer in that case is entitled to a second independent appeals hearing. Thus, the IRS is saying the equivalent of “yes our employees got caught committing an illegal act, but our illegal act that harmed the taxpayer should not entitle the taxpayer to a fair review.” This highlights the flawed logic that is embraced by many IRS employees.

The Revenue Restructuring Act also provides that IRS employees employment must be terminated if there is a final adjudication or determination that the IRS employee violated our tax laws. One is left wondering if the IRS employees involved in the Moore case were fired. The reality is that most IRS employees are not fired, despite the law dictating that their employment must be terminated.

In many cases IRS managers will claim that an IRS employee who was caught breaking the law is not to be fired due to there being no official and/or final adjudication that the IRS employee acted illegally – even though there is no doubt that the IRS employee behavior was 100% illegal.

Even then, IRS managers are often the last people who should be making these decisions. In my experience the IRS managers often have a worse track record than their employees (one IRS manager that I met likes to brag to his employees that he used to start every taxpayer audit by asking the taxpayer what time it was and pointing out that he does not wear a watch due to IRS audits taking way too long, in an effort to intimidate taxpayers).

This isn’t to say that there are not good, decent, and honest people working for the IRS. It is to say that these bad apples exist and, in my opinion, the number of bad apples is much greater than the good apples and the bad apples often rule the roost. Unfortunately taxpayers have no way of knowing who they are talking to when they speak to IRS employees. I have often wondered if Congress should require all such complaints against IRS employees be reduced to writing and be made available to the public, so that taxpayers can check to see if their IRS employee is a good or bad apple.

There have been a number of tax practitioners who have questioned whether the IRS Appeals Office is truly an independent forum that provides an opportunity to have an unbiased review for tax controversies. Based on my experience, I would say that the answer is clearly “no” (and that does not take into account the fact that most IRS Appeals Office employees started out working for the IRS collection function, and they have not shed the “my only mission in life is to collect as much in taxes as possible no matter what the tax laws say” mentality).

The IRS Appeals Office’s illegal collusion was discovered by the taxpayer in the Moore case. I would guess that most taxpayers are not that lucky.

IRS Tax Attorneys Disagree With Courts on Tax Restitution

2007-03-03T09:51:00.000-07:00

According to the IRS' tax attorneys, the “The court misconstrued the facts of the case.” That is the conclusion reached by the IRS Office of Chief Counsel in Chief Counsel Notice 2007-008.

The case that the IRS attorney refers to is Creel v. Commissioner. In the Creel case the US Tax Court and Eleventh Circuit Court held that the taxpayer who paid restitution to the government for willfully failing to file tax returns as part of a criminal plea agreement, satisfied his civil tax liability.

What makes the Creel case interesting is that the amount of restitution required by the criminal tax case plea agreement was not sufficient to cover the taxpayers tax liability and the plea agreement included language that specified that the taxpayer was to pay this amount of restitution “plus any applicable penalties and interest” for taxable years involved. It was this later language that gave the taxpayer the ability to argue that he believed that his civil tax liability was satisfied by paying criminal restitution.

The IRS argued that a criminal sentence including restitution for a tax crime does not preclude the IRS from pursuing the taxpayer for the full amount of tax (and penalties and interest), even after the restitution is paid. The court’s disagreed.

The IRS also took the position that the US Attorneys Office does not have the ability to compromise a civil tax liability – an argument that the courts did not address.

As a result, the Department of Justice has revised the U.S. Attorneys’ Manual to include standardized language for use by U.S. Attorneys in restitution orders and in the restitution portion of plea agreements, with the aim of not putting taxpayers in a position to argue that the restitution in their plea agreement will not satisfy or compromise their civil tax liability .

The Chief Counsel Notice advises IRS attorneys that “[i]n factually similar cases arising in other circuits, attorneys should argue that Creel was wrongly decided.”

I agree with the courts on this one. I do not see why taxpayers should have to be subject to the tax collection procedures of two different agencies, when criminal restitution includes the tax and interest. Having to make payments to both the Courts and the IRS Collections Division will only result in confusion and, in many cases, economic hardship for taxpayers.

The law should permit the addition of civil penalties to restitution orders, so that a restitution order for a tax crime can preclude the IRS Collection Division from coming back and trying to collect additional taxes on top of the restitution payments. Or, in the alternative, tax crimes should not entitle the government to restitution payments – allowing the taxpayer to make payment only to the IRS Collection Division.

Referrals/Leads Group is Not a Tax Exempt Entity

2007-03-02T09:16:00.000-07:00

In Private Letter Ruling 200709070 the IRS recently held that Exceptional Organizations, a standard referrals/leads group, did not qualify as a tax exempt “business league.” This ruling presents a good opportunity to review a few of the requirements to qualify as a tax-exempt “business league.”

A “business league” is an association of persons having a common business interest, whose purpose is to promote the common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. Its activities are directed to the improvement of business
conditions of one or more lines of business rather than the performance of particular services for individual persons.

The Treasury Regulations set out the following specific requirements:

1. It must be an association of persons having some common business interest and its purpose must be to promote this common business interest;
2. It must be a membership organization and have a meaningful extent of membership support;
3. It must not be organized for profit;
4. No part of its net earnings may inure to the benefit of any private shareholder or individual;
5. Its activities must be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons;
6. Its primary activity does not consist of performing particular services for individual persons; and
7. Its purpose must not be to engage in a regular business of a kind ordinarily carried on for profit, even if the business is operated on a cooperative basis or produces only sufficient income to be self-sustaining.

According to the IRS, Exceptional Organizations referral group did not qualify as a “business league” because its activities did not improve the business conditions of one or more businesses, its primary activities consisted of providing services for particular persons, and it was engaged in a regular business of a kind ordinary carried on for profit.

The IRS focused on the following facets of this referral/leads group: it restricted its membership to individuals or firms in different trade, businesses, or occupations who do not compete with each other; its primary purpose was to provide exclusive listings (or referrals/leads) to its members; and the group did not do anything to help business conditions outside of helping their own businesses.

So what could the referral/leads group have done different that might have qualified it for not-for-profit status? Perhaps it could have segregated its activities into for-profit and not-for profit activities and operated two separate business enterprises for each activity; perhaps it could have promoted business ethics to members or required its members to promote business ethics outside of the group in an effort to help business conditions outside of helping individual member business; and perhaps it could open multiple chapters so that members from competing trades or businesses could participate while still maintaining the integrity of the referral/leads group.

Courts Should Not Rely on Information from the Wikipedia

2007-02-28T16:54:00.000-07:00

The Wikipedia is a popular internet encyclopedia that is written and edited online by anonymous individuals. As the popularity of the Wikipedia grows, so too does the perception that the Wikipedia provides accurate and reliable information. For instance, the United States Tax Court cited the Wikipedia today in its Ferguson v. Commissioner opinion. As the title of this post indicates, I personally do not think that the tax court – or any other court – should rely on information found in the Wikipedia.

In many cases judges are permitted to take (judicial) notice of facts that are generally known to the public, if the facts are not in dispute and, in some instances, where the facts are readily ascertainable by accurate and reliable sources. Much (if not all) of the information contained in the Wikipedia does not appear to meet these guidelines.

It appears that very little of the information contained in the Wikipedia consists of “facts.” The term “fact” generally refers to a concept that can be proved. Therefore a concept is only a “fact” if it can be verified by a credible outside source. Because the Wikipedia is authored and edited by anonymous individuals who have their own agendas and shortcomings, much of the Wikipedia content cannot be verified by credible outside sources. In many instances, Wikipedia content cannot be verified at all or, if verifiable, the content is incorrect or outdated.

In addition, much of the Wikipedia content is not generally known to the public. The Wikipedia is replete with obscure articles on items that are certainly not known to the general public (If much of the content were generally know to the public, then the content might not need to be included in the Wikipedia in the first place).

Few would refer to the Wikipedia as “accurate and reliable,” since individuals often use the Wikipedia to further their own personal and profit objectives and individuals who write and edit the majority of the Wikipedia articles usually have no specific knowledge of or expertise in the given subject matter (it appears that much of the Wikipedia content is obtained by individuals who illegally copy information from private websites and/or paste together snippets of content from numerous websites – many of which contain in accurate, dated, and obsolete content).

A simple Goolge search – no less accurate I suppose – reveals thousands of complaints of incorrect Wikipedia articles, ranging from Wikipedia articles that falsely indicate that a particular person assassinated JFK to Wikipedia articles that say that someone’s deceased parent was considered a God in several foreign countries.

Because of these shortcomings, it appears that courts may only be able to cite to the Wikipedia for facts that are not in dispute and facts that are so remote that they would not impact the court’s decision. Even then, reliance on this highly suspect material may present problems for the courts.

For example, a court that relies on the Wikipedia for “facts” may give the non-prevailing party a valid excuse to have the courts decision overturned on appeal (perhaps because the Wikipedia “facts” were not admitted into evidence, the party was not given the opportunity to consider and object to the Wikipedia “facts,” or, I presume, in most cases the specific author(s) would not be in court to support their out of court Wikipedia statement of “fact,” or the non-prevailing party may be able to successfully argue that any bias or fallacies evidenced in the Wikipedia article was imputed to the judge who relied on the article). If that is not bad enough, reliance on the Wikipedia by courts may encourage individuals to author and/or edit Wikipedia articles to further their own positions, thereby undermining judicial process.

While other commentators have expressed favorable opinions of courts relying on the Wikipedia, I do not share that opinion.

Health Reimbursement Arrangements: Employer-Provided Medical Coverage

2007-02-25T10:33:00.000-07:00

The business enterprise presents taxpayers with numerous tax planning opportunities. Many of these tax planning opportunities include pulling money out of the entity in a way that benefits both the business and its owners and employees on an after-tax basis. As with employer-provided education benefits, employers may be able to minimize their tax obligations by reimbursing employees for employee medical costs.

A health reimbursement arrangement (HRA, or “health reimbursement account”) is simply a pool of money set aside by an employer to reimburse employee and retired employee medical costs or to pay employee insurance premium costs.

If the HRA is structured right, the funds paid to employees are not taxable to the employee (as confirmed in Private Letter Ruling 200708006) and the costs are deductible by the employer (as an ordinary and necessary business expense).

Unlike Heath Savings Accounts (HSAs), employees are not permitted to contribute to the HRA, the HRA remains with the employer after the employee leaves the company, employees are not required to be covered by (or pay for) an insurance plan, and HRAs are open to employers of all sizes (in contrast to the small business requirement for HSAs). Moreover, HRA employer contributions are not mandatory and HRAs are not necessarily subject to some of the self-dealing and discrimination rules imposed on other tax-favorable arrangements.

In addition to these benefits, HRAs, in theory, motivate employees to remain with the employer. HRAs may also motivate employees not to take excessive sick leave or vacation days, because employers can structure the HRA to contribute an additional amount to the HRA based on unused sick and vacation days. HRAs can also result in substantial savings to the employer and employee as direct payments are often less expensive than insurance premium payments.

HRAs are yet another option available to employers that may allow the employer to expand their business and realize tax savings in the process. Employers should consult with their tax attorney to determine whether a HRA is right for their business.

Tournament Poker Accorded Same Tax Treatment as Live-Action Poker

2007-02-20T19:23:00.000-07:00

Today, in Tschetschot v. Commissioner, the tax court ruled that taxpayers where not entitled to treat tax losses from tournament poker different than tax losses from live-action poker.

In the Tschetschot case the taxpayer had earned $49 thousand dollars from her day job and $11 thousand dollars from gambling. The taxpayer claimed a $29 thousand dollar loss, which offset all of her $11 thousand dollar gambling winnings and part of her $49 thousand dollar income.

On audit, the IRS denied all of the taxpayer’s gambling expenses (before the tax court litigation commenced, the IRS attorney conceded that the taxpayer was entitled to deduct losses in an amount up to her gambling winnings).

The issue before the court was whether tournament poker is a “wagering activity.” The taxpayer argues that tournament poker is not a wagering activity, rather, it is an “entertainment and professional sport.” The taxpayers based their position on the argument that tournament poker is different than regular poker becuase the game only requires an entry fee, the game lasts several days, and the winner is accorded part of the entry fee paid by other contestants. As can be expected, the IRS disagreed.

Since the applicable tax code section and regulations do not define “wagering activity,” the tax court applied the plain meaning of the term “wager” (the court used the Random House College Dictionary this time, instead of the more commonly used Merrim-Webster Dictionary).

The definition of “wager” used by the court was “something risked or staked on an uncertain event” or “a bet.”

In applying the definition of the term “wager,” the tax court concluded that tournament poker was a “wagering activity.” The court reasoned that the context in which the game is played (i.e., as a paid sporting event or in a tournament setting) does not negate that the transaction involves a “bet.” Because there was a “bet” involved, the court held that the taxpayer’s taxable gambling losses were limited to the taxpayer’s gambling winnings (much like the hobby loss rules).

Applying the court’s “bet” analysis it appears that expenses associated with a 100% advertiser-paid poker event would result in the contestant’s expenses being allowed (but limited) to their poker earnings – even though the contestants did not put any money into the endeavor in order to participate -- in tax terms, the contestants would not have any burden or economic risk (but they may have incurred other significant expenses, such as travel and room and board).

Similarly, applying the court's "bet" analysis, it appears that losses associated with a documentary film production that filmed a poker tournament could even be limited becuase they would constitute a "wagering activity."

Another way for determining what is and is not a “wagering activity” might include whether the taxpayer put any money into the game in order to participate and possibly win (i.e., a focus on the first part of the court’s dictionary definition, rather than on the second part).

The court probably did not want to focus on this analysis because it could present a number of tax planning opportunities for taxpayers.

For example, taxpayers could structure these tournaments so that the entry fees are allocated 100% to the administrative fees to carry out the operation (i.e., paying the dealers and for the electricity, rent, etc.) and having the host company put up the funds to pay the winners (in a way to avoid the step-transaction doctrine, possibly by having the host company maintain a continual pool of funds for multiple tournaments) or taxpayers could pool their monies in a partnership and then have the partnership compensate members based on the amount of services that each partner provides (i.e., the partners that last longer or win more hands provide more services and are entitled to get paid more).

Of course, these options would raise a whole host of other tax issues (and tax planning opportunities)....

Automoble Dealerships Present Unique Challenges for the IRS

2007-02-17T10:03:00.000-07:00

Automobile dealerships and other significant cash-based businesses pose a number of problems for the IRS and tax fraud (and, indirectly tax planning) opportunities for taxpayers. Chief Counsel Advice Memorandum 200707001 provides an example of a few of these problems and tax fraud opportunities.

This Advice Memorandum addresses whether payments to the automobile dealer’s bank account by an independent contractor salesman that exceed $10,000 must be reported on Form 8300 (The facts in the Advice Memorandum propose that the independent contractor salesman’s deposit consisted of $6,000 of cash and $4,500 via a cashier’s check).

Form 8300 is the Form designated by the IRS for business owners to report the receipt of cash payments in excess of $10,000. This form makes it possible for the IRS to track substantial cash payments made to cash-based businesses. It is hoped that by being able to track these payments, the IRS will be able to ensure that the payments are reported to the IRS by the taxpayer and that the taxpayer ends up paying tax on the income.

This Advice Memorandum opines that an automobile dealer does not have to report amounts deposited by an independent contractor salesman to the automobile dealer’s bank account, because the governing tax law provision only applies to cash that is received “directly.” Thus, deposits to the automobile dealer’s bank account are not deemed to be received “directly” and, therefore, they are not required to be reported on Form 8300.

Under this ruling, it appears that the salesman could deposit any amount into the automobile dealership’s bank account and the automobile dealership will not have to report its receipt on Form 8300. That leaves open two questions: (1) does the bank have to report the deposit and (2) does the independent contractor have to report the deposit? The Advice Memorandum addresses the first question, but not the second.

The Advice Memorandum concludes that the bank would not have to report the deposit because there was no cash payment in excess of $10,000 (Under the facts, there was only a $6,000 cash payment and a $4,500 cashier’s check payment – which does not qualify as “currency”).

What the Advice Memorandum does not address is whether the independent contractor salesman must report the amounts he received from the person who purchased the vehicle. The answer seems to be “probably not,” because the monies did not belong to the salesman.

The question would be a bit trickier if (1) the cash received exceeded $10,000 and(2)(a) if the independent contractor salesman were really an employee and not an independent contractor and, if so, (b) if the salesman removed enough of the $10,000 cash payment as a commission to himself to reduce the payment below the $10,000 threshold.

In the first hypothetical it appears that the independent contractor may not have to report the payment, as he would merely be a conduit through which the monies pass to the automobile dealer’s bank account. In other words, state law and/or the business contractual arrangement may not afford him sufficient rights in those payments such that the independent contractor “received” the proceeds.

With the second part of the hypothetical it appears that payment to the employee would in fact be “received” by the automobile dealership, which would require the automobile dealership to report the cash receipt.

On the other hand, the answer is much less clear if the employee salesman has the ability to remove his commission prior to turning the proceeds over to the automobile dealership, assuming that the commission were large enough to reduce the cash payment below the $10,000 threshold. This would probably require the business contract between the dealership and the customer to set out what part of any cash payment is going to the dealership and what part is going to the salesman (even then, the IRS would argue that the employee salesman was also really a partner in the automobile dealership, making such payments be deemed received by the automobile dealership).

There is little doubt that automobile dealerships are particularly problematic for the IRS, especially since the number of used car sales is substantial and the money limits associated with most used car sales probably fall just above or under the $10,000 threshold.

Automobile dealerships are also a problem for the IRS as they are in the position to aggressively structure their financial affairs to take full advantage of these opportunities (one only has to think of the third party financing and other loans to start thinking of the possibilities -- such as tax refund loans).

In an era of increased IRS enforcement, I bet we start to see an increasing number of IRS challenges to how automobile dealerships structure their financial affairs. Automoble dealerships should have an experienced tax attorney review their financial arrangements to help ensure that they are compliant with our tax laws.

Traditional Estate Tax Planning Will Now Have to Include Sophisticated Income Tax Planning

2007-02-10T10:49:00.000-07:00

Traditional estate planning focuses on minimizing the impact and addressing the limitations presented by our federal estate and gift regime. Very limited thought is put into the income tax consequences. This can prove to be a costly mistake – especially given the tax law changes that are looming on the horizon.

The estate and gift tax regime applies to property transfers. Estate and gift tax planning often consists of reducing the amount of estate and gift taxes payable so that the maximum amount of wealth and property can pass to lower generations. The issue that many estate planners do not address is whether the estate plan will deliver this wealth and property to the lower generations in a way that will put the lower generation in a position to take advantage of income tax planning opportunities.

The income tax is imposed on “gain” inherent in property. “Gain” is equal to the “amount realized” or sales price less the “tax basis.” “Tax basis” is generally equal to the cost that a person paid to acquire property. For example, one share of Berkshire Hathaway purchased in the early 1970’s would have a tax basis of about a hundred dollars. That same share is valued at approximately $1,000,000 today. Thus, if this stock were sold today it would produce approximately $999,900 in taxable “gain.” If the income tax rate applied to this gain is the current 15% capital gains tax rate, the sale would result in approximately $150,000 in federal income taxes (ignoring any state imposed income tax).

Our tax laws provide taxpayers with a way to avoid this tax. Specifically, our current tax laws provide that persons who inherit property will generally take a “tax basis” equal to the fair market value of the inherited property on the date that the person who bequeathed the property died (or six months thereafter). In the example above, the beneficiary selling the Berkshire Hathaway stock would produce no federal income tax because the taxable gain would be $0, which is the sum of a $1,000,000 sales price less a $1,000,000 stepped up tax basis.

As you can see, the strategy under our current (but soon to change) law is to hold on to low basis property until death, so that the lower generation obtains a stepped-up tax basis. This was most beneficial where the property to be transferred was producing tax benefits to the owner prior to his or her death.

For example, a person who owns rental real estate may have been offsetting the taxable income he or she was receiving from the property by claiming depreciation deductions. If the owner were to sell the real property during his or her lifetime, he or she will have to “recapture” or pay back the taxes on the depreciation amounts that he or she claimed. If the real property owner held on to the property until his or her death, and claimed the full depreciation for the property over time, they would not have to recapture or repay the taxes on the depreciation deduction and the inheritor would still get to step up their tax basis in the inherited property.

This “stepped up tax basis” rule will not apply for inheritances received from persons who die in or after the year 2010. Rather, after 2009 the inheritor will take a tax basis in the property equal to the lower of the tax basis that the dieing taxpayer had or the fair market value of the inherited property on the date that the person who bequeathed the property died.

The executor of the estate (or personal representative) will have the ability to allocate a basis increase up to $1,300,000 (and an additional $3,000,000 for property passing to surviving spouses). This $1,300,000 is an aggregate figure for the entire estate, meaning that the $1,300,000 basis increase is all that can be applied to all property of the estate. In other words, there is no $1,300,000 basis increase for each item of property in the estate.

There are a number of planning opportunities and pitfalls presented by these changes. Today’s estate plans should address these issues. Estate planners can address these issues (1) by taking a fresh look at how property can best titled (joint vs. individual, community property vs. separate property, entity vs. no entity, etc.) and (2) by monitoring (a) assets that are or are becoming low basis high appreciation assets (appreciating vs. depreciating assets, depreciable assets vs. non-depreciable assets) and (b) family changes that will present new planning opportunities over time (marriages, deaths, etc.).

This will require many traditional estate planners to substantially retool their estate forms and to keep up with current income tax planning opportunities. By way of example, estate planners will now have to consider how Section 1031 exchanges – an topic that is traditionally though to be outside of the estate tax planning arena -- may impact their estate plans. This is particularly true given the coming elimination of the stepped up basis rules. Private Letter Ruling 123314-06 provides an excellent look at how Section 1031 issues may creep into traditional estate planning arena.

This ruling addresses whether a taxpayer is entitled to Section 1031 exchanged tax basis treatment for a transfer of one property that was received as a gift from a mother to the taxpayer for another property that is held in trust for the benefit of the mother (and with the taxpayer receiving a remainder interest in the trust).

Both of these properties were initially transferred to the taxpayer’s mother upon the taxpayer’s father’s death. Thus, the father opted to pass one parcel outright to his surviving spouse and he opted to place the other parcel in trust for the benefit of his spouse.

Today’s estate planner views this scenario in light of qualified disclaimer and qualified terminable interest property rules – with an eye primarily on transfer tax minimization. Thinking ahead a few years, this exact scenario will also raise significant income tax issues – such as the 1030 issue addressed in the letter ruling. If that will not be complicated enough, these issues will also bring with them the state income tax planning opportunities and pitfalls as well.

In the past estate planning attorneys often divided estate plans into those that are tax-motivated and those that are not-tax motivated (with non-tax motivated estate plans consisting primarily of a simple will and/or a revocable trust). The "tax" motivation was primarily based on transfer taxes -- not income taxes. Given the new income tax planning opportunities, the old tax-motivated and non-tax motivated schema will have to be tossed aside.

The bottom line is that today’s estate planner will have to build flexibility into their estate plans so that their client’s beneficiaries can take advantage of these types of pure income tax planning opportunities.