Tax Evasion Twist

One way to avoid a tax evasion conviction is to show that the underlying tax is not owed. The recent United States v. Kayser case provides a slightly different twist on this defense.

The court sets out the following facts:

From November 1998 to May 2000, A2Z USA, Inc. employed Kayser first as a salesperson and later as a vice president for its Internet-based shopping mall. A2Z compensated Kayser as an independent contractor and paid him a commission by checks made out to his name. In July 1999, Kayser incorporated Aspen Ventures Inc. to receive A2Z income and take business deductions related to that income.

After failing to file timely tax returns for 1998 through 2000, Kayser ultimately filed his delinquent individual and corporate tax returns for those years in August 2001. Kayser was subsequently indicted on two counts of attempted income tax evasion (for 1999 and 2000).…

The government claimed that Kayser had structured his individual and Aspen Ventures’ corporate returns for 1999 and 2000 to evade the payment of taxes on his A2Z activities.

The court noted that:

For the year 1999 (count 1), the government contended that Kayser received $104,000 of A2Z income that should have been reported on his individual return, but Kayser improperly reported this income on Aspen Ventures’ corporate return. For the year 2000 (count 2), the government showed that Kayser failed to report his A2Z income on either his individual or Aspen Ventures’ corporate return. However, Kayser did report $49,026 in deductible business expenses on Aspen Ventures’ 2000 return. These deductions were composed of automobile expenses, office expenses, utilities, travel and entertainment expenses, and rents.

Kayser raised the defense that the government could not prove that there was a tax deficiency because:

the A2Z income he failed to report on his individual return in 2000 should be offset by the $ 49,026 in business deductions he improperly reported on Aspen Ventures’ corporate returns in 2000 and carried back to 1999.

At the IRS attorney’s request, the district court refused to instruct the jury as to this defense, because Kayser should not be able to reclassify the tax deductions contrary to how he reported them on his tax returns.

The Second Circuit Court of Appeals reversed the district court’s ruling because “the requested jury instruction was supported by law and had sufficient foundation in the evidence.”

In a strongly worded dissenting opinion, Circuit Judge Kozinski stated that the taxpayer should be:

stuck with the way he reported [the tax deductions] at the time — which was as corporate deductions. To let him now go back and treat the deductions as applicable to his personal income allows for precisely the kind of heads-I-win, tails-the-government-loses scenario that [a prior court case] sought to foreclose…. The majority thus eviscerates the evidentiary standard for proposed jury instructions by forcing a district court to give an instruction that’s only supported by generalities and hypothetical possibilities. I must part company with my colleagues in both of these precarious endeavors.

June 4th, 2007 | No Comments »

Payroll Taxes: The Single Member LLC Owner (Again)

Many taxpayers do not understand the implications of operating a business as a LLC when it comes to payroll tax liabilities. Apparently even some accounting firms do not fully understand this concept.

The recent McNamee v. Dept. of Treasury case involves a six-person accounting firm that was operated as a single member LLC. The accounting firm failed to pay $64,736.18 in payroll taxes for tax years 2000 and 2001. The LLC ceased operations in March 2002. The IRS disregarded the LLC and imposed tax liens on the sole member’s personal property.

The accounting firm owner contested the government’s ability to disregard the entity, arguing that state law prevented the IRS from reaching the owner’s personal assets and that the federal regulations were invalid. The district court and the Second Circuit Court of Appeals rejected the accountants arguments.

Single member LLCs provide very little creditor protection for the owner’s personal assets, especially when the federal government is the creditor and the debt is a payroll tax debt (or possibly when the owner files or is forced into bankruptcy).

The accounting firm in this case could have prevented the IRS from pursuing the owner’s personal assets by simply having a nominal business partner (possibly a having a corporation that was also owned by the sole LLC owner owning a 1% membership interest in the LLC) or possibly by electing to have the LLC treated as a corporation for federal tax purposes.

With that said, the single member LLC might be sufficient to protect the LLC’s assets from the single member owner’s liabilities. An IRS Internal Legal Memorandum prepared by an IRS tax attorney specified that the IRS could not levy on the assets of a single-member LLC to satisfy a tax liability of the LLC’s sole owner solely because the LLC was disregarded for federal tax purposes (See, ILM 199930013, Apr. 18, 1999).

If this is correct, then the interesting question is whether, applying the court’s logic that the payroll tax is a personal liability of the single member LLC owner, the accounting firm could have left the owner’s assets inside of the LLC thereby leaving the assets beyond the reach of the IRS….

May 31st, 2007 | No Comments »

Real Estate Purchase Price Reduction

Sometimes it is the simple transactions that are overlooked. 

In the typical real estate sale, a person selling a piece of real estate will generally agree to pay a commission to their real estate agent.  The real estate agent will then pay a portion of this commission to a second real estate agent who produces a ready, able and willing buyer (the buyer’s agent).  At the real estate closing, the buyer’s agent will usually pay or credit the buyer with a portion of the commission that the buyer’s agent received. 

The IRS recently confirmed that the payment or credit in this common transaction is treated as a purchase price reduction and not as taxable income.  As a result, the buyer does not have to report the income on his or her tax return and the buyer’s real estate agent does not have to send the buyer a Form 1099 to report the transaction. 

I have noticed that IRS examiners do not fully understand this issue, as I have never had one IRS auditor even inquire about this issue.  I can’t help but wonder if IRS auditors might start looking for this, given the IRS recent push to crackdown on taxpayers who inflate the cost basis of their stock portfolio holdings to minimize their income taxes associated with their traditional stock sales. 

May 30th, 2007 | No Comments »

Doctrine of Substantial Compliance

Taxpayers often ask the government and the courts to overlook failure to comply with legal technicalities by making doctrine of substantial compliance arguments.

The doctrine of substantial compliance is a legal theory that essentially says that one party should not forfeit his or her rights if he or she attempts to comply with the law, but he or she does not fully comply with all of the technicalities of the law.

The doctrine of substantial compliance has been invoked in by individuals in a great number of legal matters, from bankruptcy cases (the bankruptcy code has a specific provision for this) to employee benefits and real estate construction defect cases.

The doctrine of substantial compliance comes into play with tax matters where taxpayers argue that they met a tax filing requirement by providing all pertinent information with their tax returns. In other words, taxpayers use the doctrine to overcome deficiencies in their filed tax forms.

The IRS usually rejects these types of arguments. For example, the IRS recently rejected a taxpayer’s request to pay its estate tax in installments due to the taxpayer failing to timely file the tax election form based on the doctrine of substantial compliance. The IRS decision noted that “the provisions leave no room for a reasonable cause exception for an untimely return.”

Given the number of these types of court cases (many of which do not actually use the term “doctrine of substantial compliance”), perhaps it is time for Congress to add a provision in the tax code that addresses the doctrine of substantial compliance.

May 28th, 2007 | No Comments »

2007 Tax Planning Figures

2007 Tax Planning Figures There are a number of key figures that taxpayers must know in order to properly plan to minimize their 2007 federal income tax liabilities. Here is a list of a few such figures:

1. Income Tax Rates.

   • Married Filing Jointly:

   Over	But Not Over	Pay	+% on Excess	Of the Amount Over
   $0	$15,650	$0	10	$0
   15,650	63,700	1,565.00	15	15,650
   63,700	128,500	8,772.50	25	63,700
   128,500	198,850	24,972.50	28	128,500
   195,850	349,700	43,380.50	33	195,850
   349,700		94,601.00	35	349,700

   • Single Taxpayer

   Over	But Not Over	Pay	+% on Excess	Of the Amount Over
   $0	$7,825	$0	10	$0
   7,825	31,850	782,50	15	7,825
   31,850	77,100	4,386.25	25	31,850
   31,850	77,100	4,386.25	28	77,100
   160,850	349,700	39,148.75	33	160,850
   349,700		101,469.25	35	349,700

   • Head of Household:

   Over	But Not Over	Pay	+% on Excess	Of the Amount Over
   $0	$11,200	$0	10	$0
   11,200	42,650	1,120.00	15	11,200
   42,650	110,100	5,837.50	25	42,650
   110,100	178,350	22,700.00	28	110,100
   178,350	349,700	41,810.00	33	178,350
   349,700		98,355.50	35	349,700

2. Standard Deductions:

   • Married/Joint $10,700
   • Single 5,350
   • Head of Household $7,850
   • Dependents $850

3. Personal & Dependency Exemptions:

   $3,400, phased out at:

   • Married/joint $234,600
   • Single 156,400
   • Head of Household 195,500
   • Married/Separate 117,300

4. Capital Gains & Losses:

   	10% & 15% Tax Brackets	25% or Higher Tax Brackets
   Short-Term	Ordinary rate	Ordinary rate
   Long-Term	5%	15%

5. Alternative Minimum Tax:

   AMT Income	Tax (%)
   Up to $175,000	26%
   Over $175,000	28%

6. Tax Credit for Dependent Children:

   2007	Modified Adj. Gross Income	Tax Credit for Each Child Under 17
   Married/Joint	$0 - $110,000	$1,000
   Individual	0 - 75,000	1,000

May 24th, 2007 | No Comments »

Paying Employment Taxes

The IRS Office of Chief Counsel remids taxpayers that they need to specifically designate how payments made to the IRS are to be applied — or else the IRS will decide how to apply taxpayer payments.

The IRS will, pursuant to Revenue Procedure 2002-26, apply voluntary taxpayer payments as the taxpayer designates when he or she makes the payment to the IRS. In cases where the payment is not voluntary (i.e., it occurs via an IRS wage levy) or the taxpayer fails to designate where the IRS is to apply the payment, the IRS will apply the payment “”in the order of priority that the Service determines will serve its best interest.”

With federal income taxes, this usually means that the IRS will apply the tax payment to the tax and tax period that has the shortest IRS tax collection statute (AKA CSED or collection statute expiration date). Where trust fund recovery penalties are involved, the IRS will generally apply the payments “first to the non-trust fund portion of tax, then to assessed lien fees and collection costs, then assessed penalties, then assessed interest, then accrued penalties and accrued interest, and then finally to the trust fund portion of the tax.”

In the later scenario, the IRS is able to maximize the trust fund recovery penalty because the penalty is imposed retroactively on the amount of tax that is outstanding at the time that the penalty is assessed. Thus, if the penalty is not assessed before the taxpayer pays off the older tax periods, then the IRS will have lost the penalty amounts and interest that would have accrued on the prior tax years.

May 23rd, 2007 | No Comments »

Tax and Divorce Planning

Taxpayers often seek tax advice as a means of adding insult to injury in divorce proceedings. Private Letter Ruling 200720007 provides yet another example of how taxpayers can go about doing this.

The ex-wife requested this ruling from the IRS. More specifically, the wife requested a ruling that the payments she received were not “alimony.” “Alimony” payments are generally taxable income to the recipient (in this case, the ex-wife) and tax deductible by the payor (in this case, the ex-husband).

The code sets out several requirements for payments to qualify as “alimony,” including:

1. such payment is received by, or on behalf of, a spouse under a divorce or separation instrument;
2. the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income under section 71 and not allowable as a deduction under section 215;
3. in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee and payor are not members of the same household at the time such payment is made; and
4. there is no liability to make such payment for any period after the death of the payee and no liability to make any payment as a substitute for such payments after the death of the payee.

Payments must meet all of these elements to qualify as “alimony” for federal income tax purposes.

The divorce agreement in this case stated that the amounts paid were to qualify as “alimony” for federal income tax purposes, but the divorce agreement failed to specify that the payments were to terminate upon the death of the payee. The question then is, are the payments “alimony” if the agreement fails to address this “death of the payee” issue?

As the IRS ruling sets out, where the agreement is silent on this issue, it is necessary to look to state law to see if the state law specifies that the requirement to make “alimony” payments terminates upon the death of the payee. The state law in this case (the name of which state was not listed), did not specify that “alimony” payments were to terminate upon the payee’s death. As a result, the payments did not qualify as “alimony” for tax purposes, despite the express provision in the divorce decree.

I wonder if the wife and wife’s tax counsel had this result in mind when they failed to include a provision in the divorce agreement for the “alimony” payments to end upon the wife’s death? If so, the tax planning saved the wife from having to report and pay income taxes on the “alimony” payments and it precluded the husband from being able to deduct the payments.

May 22nd, 2007 | No Comments »