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

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:

1. 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.

2. 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.

3. 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.

4. 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.

April 18th, 2007 | No Comments »

Disgruntled Ex-Spouses or Just Good Tax Procedure?

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. Kovitch v. Commissioner, 128 T.C. 9 (2007), 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.

The Kovitch’s were divorced. The IRS then issued a notice of deficiency to both spouses. Only Ms. Kovitch filed a petition in the U.S. Tax Court. Ms. Kovitch only sought innocent spouse relief, she did not challenge the underlying tax assessment. 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 U.S. Tax Court was whether the bankruptcy automatic stay would preclude the 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 can’t help but wonder 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 lucky coincidence….

April 4th, 2007 | No Comments »

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

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….

April 2nd, 2007 | No Comments »

IRS Says When a Grape is No Longer a Grape

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 business operations. This could provide the taxpayer with the ability to choose what items it wanted to capitalize or deduct and when….

March 31st, 2007 | No Comments »

Yet Another Lottery-Related Tax Question

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.

March 30th, 2007 | No Comments »

Does Anyone Really Win the Lottery?

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.

March 28th, 2007 | No Comments »

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

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.

March 20th, 2007 | No Comments »