Non-Profit No More

The IRS can sometimes take a hardline with taxpayers. For example, the IRS often takes a hard line with taxpayers in instances where the taxpayer is a non-profit and it fails to timely file a tax return. In these cases the IRS will has the power to revoke the taxpayer’s non-profit status, but in many cases the IRS does not have to exercise this power.

The IRS often cites to the US v. Boyles case, which the IRS interprets as saying that there is no excuse (ever) for filing a late tax return. The case doesn’t actually say that, rather, it says that absent “reasonable cause,” there is no excuse for missing a tax filing deadline. There have been cases that interpret the Boyles opinion that watter it down even more — cases which are ignored by the IRS.

Code Section 6652(c) makes this issue much more extreme for non-profits. This section sets out a $20 per day fine for non-profits for each day that any one tax return is not filed, with a $10,000 maximum fine. The section goes on to specify that the $20 fine is $100 per day and the cap is $50,000 for non-profits that have gross receipts of $1,000,000 or more. The use of the term gross receipts is unfortunate, because many non-profits have gross receipts of more than $1,000,000 but they may only have a few dollars of income after distributions and expenses are accounted for.

Think about it. A non-profit — which is probably staffed by volunteers — misses a filing deadline. The non-profit doesn’t notice that the filing deadline was missed. The non-profit did have gross revenues in excess of $1,000,000 for the year, but it only had $10 of net income for the particular year.

The IRS does not notify the non-profit of the missed deadline for, say, two, five, ten, or more years (usually becuase the IRS is slow or it mails notices to the wrong address or taxpayer or the mail is not delivered to the taxpayer). The non-profit could now be subject to a $50,000 tax penalty and the IRS can revoke the non-profit’s tax exempt status.

The IRS will then use the threat of taking away the non-profit’s tax exempt status as leverage to politely “encourage” the non-profit to pay the $50,000 fine. This is a very common scenario (see, e.g., IRS Ruling 200720027 for an instance when it appears that the IRS actually sent some notice to the non-profit).

And what can the non-profit do to contest the penalty? They can hire a tax attorney to contest the penalty via the Appeals Office. What is the taxpayer to do when the Appeals Office misinterprets the Boyles case to uphold the penalty? Well, they will have to pursue the claim in Federal District Court — but wait, it’s a non-profit with only $10 of net income. It can’t even afford the court filing fee, so it has lost its case before the case has even started.

And if the non-profit cannot pay the $50,000 fine to the IRS, then the IRS usually doesn’t have to bother taking away the non-profits tax exmpt status — becuase it simply uses its tax collection powers to take the non-profit’s assets — shutting down the non-profit outright.
I can’t help but doubt that this is what Congress had in mind when it added Section 6652(c) to the code.

May 21st, 2007 | No Comments »

Taxation of Employee Donated Sick Leave

Employees often want to donate paid sick-leave time to deserving co-workers who find themselves in a pinch. The IRS recently released another ruling that identifies a few of the planning considerations in donating sick-leave to co-workers.

The federal tax consequences of donating paid sick-leave depends on whether the donation is made through the employer or directly from the employee and whether the recipient employee or a third party actually receive the payment.

As the recent IRS ruling sets out, where employees forfeit paid sick-leave to the employer and the employer credits the recipient employee with the donated sick-leave, the payments will only be considered taxable income to the recipient employee (for both federal income and employment taxes). This tax treatment only applies where the transfer is made pursuant to an “employer-sponsored medical leave sharing arrangement” or a “qualified employer-sponsored major disaster leave-sharing plan.”

Each of these plans has a few specific requirements. For example, as the recent IRS ruling notes, the later type of plan only covers transfers of paid sick leave that are made pursuant to a Presidential-declared disaster. Payments associated with a major disaster that is not made pursuant to a Presidential-declared disaster do not qualify.

While not addressed in the IRS rulings, presumably donations made pursuant to these plans will not trigger a gift tax liability for the donating employee.

Absent one of these arrangements or plans, the “assignment of income” doctrine specifies that the donating taxpayer is subject to both federal income and employment taxes on sick-leave that is donated to recipient employees. The donating employee could also incur a gift tax liability for the transfer.

This would be similar to the scenario where the donating employee simply wrote a check to the recipient employee; however, the donating employee may be able to avoid a gift tax on a direct transfer if they make the payment directly to a hospital or medical provider (and the payment is applied to qualified medical expenses).

An even better option might be to create a separate non-profit entity to handle these types of donations. With the non-profit, employees might be able to offset their income tax obligation with a charitable deduction (assuming that they do not run into an alternative minimum tax situation and/or their itemized deductions are not phased out due to the amount of their adjusted gross income) and there would probably be no gift tax consequences.

This option could have the added benefit of avoiding the restrictions imposed by the “medical leave sharing arrangement” and “major disaster leave-sharing plan” and the qualified medical expense limitation for the gift tax exclusion.

May 19th, 2007 | No Comments »

Taxpayer Anctics: Taxpayer Convictions

Taxpayers often make mistakes. It happens. But there are some times when you just have to ask “what was the taxpayer thinking?”

Take the recent United States v. Baucom (and combined United States v. Davis) case. Taxpayers Martin Louis Baucom and Patrick Grant Davis were convicted of conspiracy to defraud the United States and willful failure to file tax returns.

After being indicted the taxpayers were given the opportunity to hire a competent tax attorney. The taxpayers sent “questionnaires” to potential tax attorneys in an effort to hire tax counsel. The court informed the taxpayers that this was not an appropriate means for obtaining a tax attorney and it gave the taxpayers additional time to obtain tax counsel.

The taxpayers then asked the court to allow their non-attorney friend to represent them in their criminal tax matter. The taxpayers’ request – which was sent to the judge, who was also an attorney – stated:

Defendant . . . has little confidence in the legal profession . . . . Defendant is aware of a few attorneys he trusts, but their multi-thousand dollar fees are out of the question . . . . He does NOT trust just any attorney out of a grab-bag whom the government is willing to furnish; neither would this defendant be satisfied with such an “attorney’s” concept of the Constitution of the United States after the average attorney, full of law-school brainwashing, thinks that the Constitution is what the judges say it is, rather than what the Constitution itself, says it is.

The court admonished the taxpayers for “continuing to send questionnaires to potential attorneys after having been advised that this was not an effective means of obtaining counsel” and the court gave the taxpayers additional time to find a tax attorney.

The taxpayers responded by filing:

a document entitled “AFFIDAVIT & DECLARATION OF CONTINUED EFFORTS TO SEEK COMPETENT COUNSEL.” The document contained numerous citations of Washington State cases and procedural rules. Among other things, Davis asserted that “[t]his court has NO authority to appoint me counsel over my objections”; “I can and will sue any Attorney for ineffective assistance of counsel who is appointed to my case over my objections”; and that “I can and will sue the person who picked my attorney and appointed him to me over my objections if said attorney loses my case.”

Fifteen months after the indictments, the court finally said that the taxpayers had had sufficient time to obtain a tax attorney, they refused to do so, and, therefore, the criminal trial would proceed with the taxpayers representing themselves. The trial commenced and the taxpayers were convicted. The court sentenced Baucom to fifteen months imprisonment. The court considered Davis’ charitable works in imposing a light four years probation (conditioned on the service of 12 months of house arrest). The taxpayers appealed the convictions and they lost.

Notwithstanding the antics of the taxpayers, here is the interesting part of the case. The lower court judge refused to include the amount of the state taxes that the taxpayers failed to pay in determining the taxpayers federal sentence. The lower court judge said:

I don’t think I have the . . . jurisdiction to sentence this man for [a] violation of North Carolina law. I mean, it’s inconceivable to me that a federal judge would be sitting up here and saying you violated North Carolina law and I’m putting you in jail for it. It’s just–what happened to the whole notion of federalism? I don’t think I have the power to do that. And if I do, if I have discretion, I decline to exercise the discretion to do that. It’s not fair and I ain’t gonna. Y’all can all go to Richmond and they can tell some other judge what to do.

On appeal, the IRS attorneys argued that the judge did have this power and he should have exercised the power. The Fourth Circuit Court of Appeals agreed with the IRS.

The Fourth Circuit Court stated:

We also think that the sentences imposed by the district court fail to reflect the seriousness of the offense and do not provide just punishment… Appellants failed to file taxes of any sort for twelve years before they were apprehended. Moreover, as the Government notes, neither Appellant began paying taxes until 2004, after his conviction. Finally, we note with respect to Davis’ sentence that we are troubled by the heavy reliance of the district court on Davis’ charitable works.

The appeals court affirmed the convictions, vacated the sentences, and remanded the cases to the lower courts to impose higher sentences.

May 17th, 2007 | No Comments »

IRS Tax Attorney Office Reorganizes

It appears that the IRS Office of Chief Counsel is doing some housecleaning (this office consists of tax attorneys who handle most of the civil tax court matters for the IRS).

IRS Office of Chief Counsel Notice CC-2007-012 specifies that the Procedure and Administration Section of the Office of Chief Counsel subsidiary legal divisions have been reorganized into seven new branches.

The notice lists these branches and their subject matter as:

Branches 1 and 2

Subject areas: Returns, information returns, withholding, statutes of limitations, interest, penalties, sanctions, ethics, practice before the IRS, Circular 230, innocent spouse, electronic tax administration, powers of attorney.

Branches 3 and 4

Subject areas: Payment, assessment, collection, liens, levies, collection due process, period of limitations on collections, trust fund recovery penalty, jeopardy and termination assessments, refunds, erroneous refunds, joint committee.

Branch 5

Subject Areas: Bankruptcy, installment agreements, offers in compromise, receiverships, closing agreements, attorney fees, low income tax clinics, user fees.

Branches 6 and 7

Subject Areas: Court procedure, confidentiality of return information, privacy act, FOIA, summonses, burden of proof, disaster relief, combat zone, examinations, informants, arbitration, mediation and alternative dispute resolution, Appeals, rules of evidence, mitigation and equitable doctrines, discover, Fed/State issues, judicial doctrines, privileges, Religious Freedom Restoration Act, Right to Financial Privacy Act.

The Notice goes on to provide new contact information for each branch. Taxpayers should take note of this new contact information, as contacting IRS tax attorneys directly is probably the most overlooked avenue for addressing the more challenging procedural tax issues.

May 16th, 2007 | No Comments »

City of Chicago Takes Church Property For Un-Owed Taxes

The recent Beth-El All Nations Church case shows just how far state and local tax collectors will go to collect taxes - even when the taxes are not owed.

Here are the facts set out by the court:

An employee of the City of Chicago mistakenly addressed a notice to Beth-El All Nations Church at 1534 East 63rd Street, instead of Beth-El’s true address, 1534 West 63rd Street. The notice was pretty important: it advised the Church of its right to redeem title to the 63rd Street property after the parcel was sold for delinquent taxes. Despite the misaddressed notice, the City acquired a tax deed to the 63rd Street property in 1998. Finally, after Beth-El’s failed attempts to challenge the tax deed through state postjudgment proceedings, the City sought to oust Beth-El from the property in 2006.

The opinion goes on to explain that:

The Church was not, however, deemed to be tax-exempt during the period from 1986 to 1995, and so real estate taxes, totaling over $ 100,000, were assessed by Cook County against the property. Because of the delinquent taxes, the property was sold at a “scavenger sale,” a sale authorized by Illinois law for properties that have been tax delinquent for more than two years, if annual forfeiture sales have not satisfied the delinquency.

After quite a bit of legal wrangling, the Church persuaded the District Court to issue an injunction to prevent the City of Chicago from taking control of the Church property. The District Court stated “In this country, even a church is entitled to its day in court. That did not happen in this case.”

The Seventh Circuit Court of Appeals disagreed and overturned the lower court’s injunction. The Seventh Circuit Court noted that the Church property was tax exempt and there were no taxes owing, but the federal court was not the proper forum and since the Church did not raise the proper argument in its state court wranglings the federal court injunction was not proper.

The end result: the City of Chicago will probably obtain possession of the Church property for taxes that were not owed.

May 15th, 2007 | No Comments »

Florida Department of Revenue Harasses Taxpayer

Some states have a very poor record with regard to collecting taxes via legal means. The State of Florida is one of those states. In the recent In re: Omine case the Eleventh Circuit Court of Appeals details the Florida Department of Revenue’s illegal collection activities.

The Omine opinion states that:

Gregg and Michele Omine filed for Chapter 13 bankruptcy protection in 2001. The Florida DOR then filed a proof of claim seeking to recover public assistance money Hawaii paid to Gregg Omine’s former wife and children, who resided there. This Hawaii debt was included among those to be paid in the Omines’ Chapter 13 plan. The Omines filed a motion for contempt and sanctions, contending that the Florida DOR had continued debt-collection efforts after the filing of the bankruptcy petition, in violation of the automatic stay. The Omines withdrew the motion in January 2002 after the Florida DOR assured them that no further actions would be taken against them, but that assurance proved illusory.

The court opinion goes on to say:

The following year, Gregg Omine’s employer received a letter from the Florida DOR directing the employer to garnish Omine’s wages in connection with the Hawaii debt. n1 After counsel for both sides conferred, the Florida DOR agreed to cease this garnishment, but then, a week later, Omine received a letter threatening him with various penalties if he failed to pay the Hawaii debt. Again, after the parties’ counsel conferred, the collection efforts were halted, albeit only temporarily.

and

The Florida DOR soon directed Omine’s employer to begin garnishing Omine’s wages again to pay the Hawaii debt, and counsel for each side again conferred and resolved to halt the collection effort. A few days later the Omines received a notice that their 2002 tax refund had been offset against the Hawaii debt. The Omines then filed a motion for sanctions that alleged the Florida DOR repeatedly violated the automatic stay.

The bankruptcy judge discharged the remainder of the Hawaii debt and awarded the Omines $1,000 in actual damages, plus $1,600 in attorney’s fees and costs. This monetary award, in my opinion, is very low given the State of Florida’s intentional and repeat violations of our laws. It sounds as if the Florida Department of Revenue has forgotten that its job is to administer our tax laws, not break them.

May 14th, 2007 | No Comments »

Prepayment: to Deduct in Year 1 or Year 2?

Say you hire someone to provide a service to you in year one, the service is to be provided to you over a twelve month period, and you prepay the person for this yet to be provided service. When can you claim a deduction for this prepayment? The IRS Office of Chief Counsel recently said that accrual method taxpayers cannot deduct any portion in year one.

Accrual method taxpayers are generally entitled to a deduction when “all events” with respect to the liability have occurred and the amount of the liability is relatively certain. “All events” occur with regard to service contracts when the services are performed. There are two exceptions to this general rule, namely the taxpayer can deduct the expense if the services will likely be rendered in three and one half months or, if the payment is a recurring payment, if the services will be provided by September 15th.

The question then is can you deduct a portion of the expense for the three or nine month periods in the first year if the services will be rendered over a period that is beyond these time periods? In other words, must all services be rendered before these periods in order for taxpayers to deduct the prepayment expense?

According to the IRS, yes, all services must be rendered before these periods or else taxpayers cannot deduct the expense. The IRS attorneys held that the time periods are strict.

So if taxpayers want to claim a deduction in year one for a prepayment on a service agreement, taxpayers must structure the governing legal contract to fit within these time periods. Of course, the same rules apply (in reverse) for taxpayers who receive prepayments pursuant to a service agreement and who want to delay recognizing the income and paying tax on the income….

May 13th, 2007 | No Comments »