Use of Tax Fraud Resources

The government has limited resources available to detect and prosecute tax fraud. This raises the question of whether it is a better to use our limited government resources to pursue taxpayers whose conduct barely amounts to tax fraud or if it is better to use government resources to pursue taxpayers who are blatantly committing tax fraud?

The United States v. Turturro case provides a good example of the blatant tax fraud type of case. The Turturro case is similar to other cases where one or more prisoners submit false tax returns with the hope of obtaining federal income tax refund checks from the US Treasury.

According to the court:

Turturro mailed the names and social security numbers to his wife, who prepared the returns, mailed them to the IRS, and received and cashed the refund checks. Turturro instructed his wife where to send the refund money after it arrived and how to look for bankrupt companies to use on the W-2 forms. When his wife withdrew from the scheme, Turturro recruited another woman to prepare the returns in her place.

As taxpayers become more and more sophisticated - especially as technology and the internet help disseminate information - this sophistication of this type of blatant tax fraud will no doubt increase.

For example, where the prior prisoner tax fraud cases involved prisoner tax information, the Turturro case involved bankrupt corporation tax information, and in the future it might involve deceased taxpayers [using information culled from the local probate records], small corporations that were sold to third parties via asset sales and not as stock sales [culled from state corporate filing records], or even international corporations [possibly those that have ceased doing business in the US].

This type of blatant tax fraud is more visible to the public and, theoretically, easier to detect and secure convictions for. Although, it is unlikely that these public convictions will deter taxpayers who are thinking about committing less blatant tax fraud from committing tax fraud.

This type of blatant tax fraud probably costs [in terms of tax revenues] the government much less than lesser conduct that barely rises to the level of tax fraud — such as sophisticated corporate tax planning and tax reporting.

June 18th, 2007 | No Comments »

Court Says No Fraud, So IRS Finds Friendlier Court

Say you are convicted of a tax crime and the criminal judge finds that your conduct has not risen to the level of tax fraud. Should a civil court later say that this same conduct does in fact rise to the level of tax fraud? In Maciel v. Commissioner, the Ninth Circuit Court of Appeals says that the second court can make this contradictory finding that the same conduct amounted to tax fraud.

Maciel understated his income of several of his tax returns and the understatement was discovered by the IRS during a routine tax audit. The IRS charged Maciel with two counts of tax evasion and then reduced the charges to two courts of willfully filing a false tax return.

Macel entered into a plea agreement with the Department of Justice. During the hearing, the government made this very convincing argument: “there appeared to be ‘some intent on [Maciel’s] part to do something.’”

The judge explained that:

I think on balance I am satisfied that the intent here was not primarily to avoid payment of tax. I think the intent may well have been to divert corporate money to personal use which is not a good thing and certainly is not something that the Court should countenance and particularly since it did have a consequence in terms of the accuracy of Mr. Maciel’s tax returns. But I don’t think that the conduct looked at in its totality suggests that the reason Mr. Maciel diverted the money was to avoid paying money to the Internal Revenue Service.

Maciel was sentenced to three months of home detention.

The IRS then sent Maciel a Notice of Deficiency (in 2000) showing that he owed $300,000 in back taxes for 1990-92 and nearly $250,000 in civil fraud penalties. Maciel petitioned the tax court and argued that the IRS could not impose a fraud penalty when the prior court said that he did not commit fraud and, absent fraud, the time period that the IRS had to assess the additional tax had expired.

The tax court rejected Maciel’s arguments, noting that Maciel had done the following evil acts:

Maciel regularly commingled funds among his various businesses, engaged in large unexplained cash transactions, mislabeled certain transactions as loans, failed to report any earnings from certain unincorporated business ventures, failed to keep adequate business records, and failed to inform his accountants and bookkeeper of his activities.

Marciel raised the same arguments before the Second Circuit Court of Appeals and it affirmed the tax court decision. The second circuit stated:

It is apparent that the government had virtually no incentive to litigate the fraud issue at sentencing [in the criminal trial]. In some cases, the government’s obligation to seek a sentence consonant with a criminal defendant’s culpability will be incentive enough to ensure that relevant issues are litigated vigorously.

In other words, if Marciel’s tax liability would have been larger then the IRS would be precluded from having a second court find that he committed fraud, even though the first court said that he didn’t commit fraud.

June 11th, 2007 | No Comments »

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 calculate 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 »