Husband Can't Sign Joint Return For Allegedly Insane WifeFebruary 15, 2017
In Moss, TC Memo 2017-30TC Memo 2017-30 (2017), the Tax Court held that a husband who alleged that his wife's mental illness led her to the delusion that she was a victim of the "Madoff fraud" could not file a return over her objection as a married filing joint status taxpayer. Since the husband had no signed power of attorney, he was barred from claiming that he filed a valid joint return with his wife as her agent. The wife had refused to sign the joint return and she filed her own return as married filing separately.
I.R.C. § 6012(b)(2), provides that when a person cannot make a return due to incapacity, "the return of such individual shall be made by a duly authorized agent, his committee, guardian, fiduciary or other person charged with the care of the person or property of such individual". Treas. Reg. § 1.6012-(a)(5) provides reasons a person may be unable to make a return include disease, illness, or continuous absence from the U.S.
Reg. § 1.6013-1(a)(2) provides that a return for a disabled person must be accompanied by the following even when there is a spouse signing:
IRS Form 2848 (Power of Attorney and Declaration of Representative), or, a power of attorney authorizing the agent to represent the taxpayer in making, executing, or filing the return;
A statement signed by the spouse who is signing the return confirming that the incapacitated spouse consents to the signing of the return; or
3. A request for permission from, and determination made by, the appropriate IRS district director that good cause exists for permitting an agent to submit the return. (Reg. § 1.6012-1(a)(5))
In this case, Mr. Moss filed the return and attached to it a letter stating that his wife was seriously mentally ill, that IRS should disregard all information she sent, and that the return included her income for 2008 as well as his. He did not attach any power of attorney that would authorize him to act on behalf of his wife.
While Mrs. Moss was hospitalized in 2005 and 2006and was delusional, Mr. Moss never sought official status as a conservator, holder of a power of attorney, or guardian of his wife. Since Mrs. Moss never submitted to IRS any consent for Mr. Moss to file the return for her and instead insisted on filing a separate return, his jointly filed return was rejected by the I.R.S. and the Tax Court.
The Court stated that a person's previous commitment to a hospital and a spouse's assertion of mental illness were not sufficient to invalidate an individual's right to file his or her own return. Furthermore, since he did not qualify as his wife's agent and had no power of attorney or Form 2848 and did not file a statement confirming that she consented to the signing of the return, the return was properly rejected. The court did note that in certain circumstances, a joint return may be found, even without a spouse's signature, but only if there is other evidence that the husband and wife intended to file a joint return which in this case was lacking.
Conclusion, when dealing with a taxpayer who may lack capacity, be sure to obtain a valid power of attorney or other proof of authority to sign on such person’s behalf to avoid litigation with the Internal Revenue Service.
“Willful” Fail to File FBAR Defined in a California District Court CaseDecember 16, 2016
In U.S. v. Bohanec, 2016 WL 7167869, 118 AFTR 2d ¶ 2016-5537(DC CA 12/8/2016), a district court in California determined that a taxpayers' failure to timely file a Foreign Bank and Financial Accounts Report (“FBAR”) was willful. U.S. citizens with accounts outside the U.S. must disclose those accounts on an FBAR by June 30 of the year following if the amount is at least $10,000. 31 U.S.C. 5314. In Bohanec, the taxpayers stopped employing a bookkeeper or keeping any books after opening a foreign bank account. They made several misstatements under penalty of perjury when they applied (and were rejected) from participating in the Offshore Voluntary Disclosure Program (“OVDP”).
The facts in Bohanec showed that the taxpayers were very deceptive and when they filed their OVDP, they did not even disclose all of their foreign accounts - leaving out accounts in Mexico and Austria while only disclosing the Swiss accounts at UBS. They also claimed the funds were all from income duly reported and on which taxes were paid but that was also untruthful.
The reason the term “wilfully” is so important is that if the failure is not willful, the penalty is “only” $10,000 but if the failure to disclose is considered “willful,” the penalty goes up to the greater of $100,000 or 50% of the highest account value for the year!
Bohanac ruled that “willful” does not only include knowing failure to disclose but also reckless violations of the filing requirements.
Imposition of Attorney’s Fees Unavailable For Undue Influence Absent a Fiduciary DutyNovember 30, 2016
New Jersey applies the American Rule when it comes to attorney fees. The American Rule states that each party to litigation pays its own fees. There are certain exceptions outlined by New Jersey Court rules and a few judicially mandated exceptions as well where fee shifting is appropriate. The most well known judicial exception is the imposition of fee shifting for a successful litigation for attorney malpractice. Saffer v. Willoughby, 143 N.J. 256 (1996)
The New Jersey Supreme Court in Estate of Folcher, 224 N.J. 496 (2016) has recently proclaimed in a 5-1 decision (Justice Fernandez-Vina did not participate) that an award of reimbursement of attorney fees is not permitted against a tortfeasor who commits the pernicious tort of undue influence but is not a fiduciary. In re Niles Trust, 176 N.J. 282 (2003) had held that an award of attorney’s fees is available against a fiduciary who commits undue influence. Folcher refused to extend the Niles fee shifting to persons who are not fiduciaries. Folcher relied heavily on the American Rule in reaching its result. “New Jersey is an ‘American Rule’ jurisdiction meaning we have a strong public policy against shifting counsel fees from one party to another.” Folcher at 506-07.
While the Folcher court was certain to point out that the tortfeasor was particularly perfidious in that case with very strong proofs of undue influence, it still refused to extend the attorney fee award in that case. Rather, the Supreme Court remanded the case back to the trial court to determine whether punitive damages should have been awarded. The sole dissenter, Justice Albin, felt that the award of attorney fees was appropriate but he was the only one willing to extend the attorney fee shifting to undue influence committed by someone who was not a fiduciary.
Stolen Income is Still Taxable IncomeOctober 24, 2016
The Tax Court in Swartz v. Comm., Docket No. 3583-10 (10/17/16) has just entered an order holding that a taxpayer's criminal conviction for theft of $12.5 million from his employer precludes him from arguing that he did not receive such income. The rule of law preventing him from arguing that he did not receive the income is called collateral estoppel. Under the doctrine of collateral estoppel, any issue litigated in a prior legal proceeding is conclusive of the same issue.
Code Sec. 61(a) provides that all income including illicit income such as embezzlement, larceny, false pretenses, extortion, or any other types of theft unless there is restitution paid in the same year as the theft. In this case, the Taxpayer, Mark Swartz was a CFO who participated in his company’s Key Employee Loan Program (KELP) for its executive officers. He took a “loan” that was unauthorized in one year and did not pay it back until a later year. Mr. Swartz was convicted of larceny and conspiracy with respect to the $12.5 million.
The Tax Court ruled that collateral estoppel applied and that Mr. Swartz's conviction for stealing $12.5 million precludes him from arguing that he didn't have $12.5 million in unreported taxable income. The Court did not address the issue of the tax effects of the later repayment as that issue was not before the court.
Offshore Account Holders Cannot Sue to Enter into More Lax Disclosure ProgramOctober 17, 2016
The District Court in the District of Columbia in the case of Maze v. Internal Revenue Service, Civ. Action No. 2015-1806 (7/25/16) held that taxpayers cannot sue the Internal Revenue Service to be permitted to enter a more favorable program than the one for which they initially applied.
Background: The taxpayers failed to report foreign accounts so they entered into the voluntary OVDP (Offshore Voluntary Disclosure Program) which enabled them to come forward without risk of prosecution and pay a fine. The Internal Revenue Service later came out with a simpler and less expensive program called the SFCP or Streamlined Filing Compliance Procedures. While SFCP has different requirements, the taxpayers felt that they would have met those criteria and have been eligible for a much lower penalty – 5% instead of 27.5%. The problem is that the SFCP became available only after the taxpayers already filed and were accepted under the OVDP program.
Decision: The Court in Maze determined that the Internal Revenue Service has the authority to set its programs and their parameters and deadlines as it sees fit. Therefore the D.C. Court was unwilling to require the I.R.S. to accept the taxpayers into the easier program. The taxpayers argued for the relief, but the Court ruled that the Anti-Injunction Act found in 26 U.S.C. 7421 prevented the taxpayers from the relief it sought.
Moral of the story: Timing is often everything. But now, both programs (OVDP and SFCP) are available and should be carefully considered with counsel before choosing the program to enter.
“Blame The Lawyer” No Excuse To Avoid Penalties For Late Estate Tax FilingSeptember 27, 2016
The Court of Appeals for the Sixth Circuit, in Specht v. U.S., 118 AFTR 2d ¶ 2016-5243 (6th Cir.09/22/2016) has just held that where the attorney for an estate failed to perform numerous duties with respect to the estate, including timely filing the estate tax return, and told the unsophisticated executor that the attorney had received all necessary extensions, the estate did not meet the reasonable cause/not willful neglect standard for avoiding late filing and late payment penalties where the executor had evidence that the attorney was lying.
Background. The I.R.C. provides for mandatory penalties for the failure to timely file a return (I.R.C. §6651(a)(1)) and failure to timely pay a tax (Code §6651(a)(2)). But, these penalties are not owed if the taxpayer can establish reasonable cause for the failure and that the failure was not due to willful neglect. (I.R.C. §6651(a)(1), and §6651(a)(2)). In order to meet the reasonable cause exception, Treas. Reg. §301.6651-1(c)(1) requires that a taxpayer show that while he used ordinary care, he nevertheless was unable to file the return within the prescribed time.
Previously the U.S. Supreme Court held that reliance on an attorney is normally insufficient to avoid penalties. Boyle, 55 AFTR 2d 85-153555 AFTR 2d 85-1535 (1985), In Boyle, the Supreme Court, held that Congress had charged the executor with an unambiguous, precisely defined duty to file the estate return within nine months and the fact that an attorney, as the executor's agent, was expected to attend to the matter, did not relieve the principal of his duty to comply with the statute. Under Boyle, to meet the reasonable cause exception, the taxpayer bore a heavy burden of proving both that there was reasonable cause and that the failure to timely file did not result from willful neglect. While reliance on a lawyer was common, that reliance couldn't function as a substitute for compliance with an unambiguous statute.
In Specht, the Decedent died on Dec. 30, 2008 but her attorney of 50 years in estate planning, and unbeknownst to Specht, was privately battling brain cancer. No federal estate tax return was filed on or before Sept. 30, 2009, nor was an extension sought. And, no federal estate tax payment was made on or before Sept. 30, 2009. But Specht received four notices from the probate court warning her that her attorney was failing to perform her duties and that the Estate had missed probate deadlines.
Since the executor knew there was a problem with her lawyer, she was found to have been neglectful. The 6th Circuit held that the relevant question was whether the executor, not the attorney, was reasonable in missing the deadline. In this case the executors blindly relied on an attorney's representations that the filing would be completed on time, and as a result the deadline was missed. The Sixth Circuit reinforced the strict, bright-line rule of Boyle where it concluded that, although the company had exercised ordinary business care and prudence, it also had to demonstrate that it was "rendered unable to meet its responsibilities despite the exercise of such care and prudence". That is, the failure to pay must result from circumstances beyond the taxpayer's control (e.g. postal delays, illness), not simply the taxpayer's reliance on an agent employed by the taxpayer.
Specht's reliance on an unreliable agent was her downfall. Therefore pick your attorneys carefully and learn the deadlines and oversee their compliance like a hawk to avoid decisions such as Boyle and now Specht.
Recent Tax Court Decision Finds Against the Abuse Defense in an Innocent Spouse CaseAugust 8, 2016
In a recent Tax Court decision, it was determined that a person claiming innocent spouse relief based upon abuse by her husband failed. The case, Hardin v. Comm., T.C.M. #684-14, T.C. Memo 2016-141 (7/26/16) stands for the proposition that a taxpayer claiming innocent spouse relief must prove abuse and the Tax Court Judge Chiechi ruled that the burden was not sustained. The alleged abuser and abused both testified before the Tax Court and Judge Chiechi felt that the abused’s testimony was not credible.
Moral: Threatened abuse can form the basis of an innocent spouse defense but the facts showing the abuse must be credible.
No Loss Deduction Available For Retaining Wall CollapseJuly 22, 2016
Few laws make as little sense as tax law. In another example of a quirky tax law, the case of Alphonso v. Comm., T.C. Memo 2016-130 (TC Memo 2016)exposesa most peculiar tax law. This quirk in the law says that a sudden collapse of a building or in this case a retaining wall is deductible but an undetected deterioration followed by a collapse is not deductible.
The Tax Court in Alphonso found that the taxpayer failed to show that the damage from a collapsed retaining wall was a deductible casualty loss and not a nondeductible loss caused by gradual deterioration. The IRS disallowed the casualty loss deduction stating that the collapse of the retaining wall was a result of gradual weakening, and therefore didn't constitute a casualty loss under Code Sec. 165(c)(3). The Tax court concluded that the collapse of the retaining wall in question wasn't a casualty within the meaning of Code Sec. 165(c)(3). The taxpayer wasn't entitled to claim any loss with respect to that collapse.
Under Code Secs. 165(a) and (c)(3), a taxpayer may deduct losses if such losses arise from fire, storm, shipwreck, or other casualty. Prior rulings have stated that the term "casualty" refers to an identifiable event of a sudden, unexpected, or unusual nature. See Rev. Rul. 76-134 and suddenness is an essential element of a casualty. See Rev. Rul. 61-216, and Rev. Rul. 72-592. The rulings further describe that to be considered as sudden, the event must be one that is swift and precipitous and not gradual or progressive. Rev. Rul. 72-592. And on point is I.R.S. Pub. 17 which states that progressive deterioration of property through a steadily operating cause is not a casualty loss.
In this case, Christina Alphonso owned stock in Castle Village a cooperative housing corporation that owned land and buildings located in upper Manhattan. The retaining wall suddenly collapsed causing substantial damage. The taxpayer then claimed a casualty loss.
The U.S. Tax Court found that the taxpayer failed to carry her burden of proof of showing that the cause of the collapse of the retaining wall was excessive rainfall. The Court further found that although the rainfall may have been a contributing factor to the particular time at which the retaining wall collapsed, they did not cause that collapse. The cause of the collapse was progressive deterioration in and around that wall that had begun at least 20 years before that collapse occurred.
The case boiled down to a battle of the expert witnesses over the cause and the court found the Government’s witness more compelling.
Innocent SpouseMay 31, 2016
In the recent case of Hiramaneck v. Comm., (Tax Court May 10, 2016), the U.S. Tax Court was faced with two spouses successively seeking to be granted innocent spouse relief for the same deficiency. The ploy did not work. In the earlier case, the wife was granted relief because it was determined the return was signed under duress of the husband. In the earlier case, the husband was allowed to participate in that decision as an intervenor. Because the Court allowed husband to participate in the trial in that case, he is bound by the doctrine of collateral estoppel. Under collateral estoppel, the husband is bound by the Court's determination that she signed the 2006 return under duress. Held, further, because the return under duress was not a joint return, he has no claim for relief under I.R.C. sec. 6015 for that year. Thus, the Commissioner's motion for judgment on the pleadings was granted.
UPDATE: Extension for Federal Form 8971 to June 30, 2016!May 13, 2016
IRS Notice 2016-27 provided for a further extension: Executors and other persons required to file or furnish a statement under section 6035(a)(1) or (a)(2) before June 30, 2016, need not do so until June 30, 2016.
No Clothing Deduction For Wearing Ralph Lauren ClothingMay 10, 2016
In Barnes, T.C. Memo 2016-79 (Apr. 27, 2016), the Tax Court has held that a salesman for Ralph Lauren who was required to wear Ralph Lauren branded clothing at work could not deduct the cost of the clothing for federal income tax purposes as unreimbursed employee expenses. Since the Tax Court found that the clothing was clearly suitable for regular use, the Court denied the deduction and imposed penalties on the salesman as well.
By way of background, pursuant to I.R.C. Sec. 262, a taxpayer generally cannot deduct personal, living, or family expenses. But, I.R.C. Sec. 162(a), does permit a deduction for all ordinary and necessary expenses paid or incurred in carrying on any activity that constitutes a trade or business, which may include the trade or business of being an employee. Primuth v. Comm., 54 T.C. 374, 377 (1970). Clothing expenses are generally nondeductible expenses under Code Sec. 262 even though the clothing is worn by the taxpayer in connection with his trade or business, unless: (1) the clothing is required or essential in the taxpayer's employment; (2) the clothing is not suitable for general or personal wear; and (3) the clothing is not so worn. Hynes v. Comm., 74 T.C. 1266, 1290 (1980)
There was also a 20% accuracy-related penalty applied pursuant to I.R.C. Sec. 6662(a) since there was an underpayment of tax attributable to negligence, disregard of rules or regulations. The Court found there was no reasonable cause for the understatement so the exemption from the penalty under I.R.C. 6664(c)(1) did not apply. The Tax Court ruled that it has consistently applied the 3-part test for clothing deductibility and that Ralph Lauren clothing clearly fails the test.
Whistleblowers Do Not Get Paid For FBAR Civil PenaltiesMay 9, 2016
In a recent case entitled: Whistleblower 22716-13W, 146 T.C. No. 6 (2016), the Tax Court determined that the $2 million nondiscretionary award threshold under I.R.C. Section 7623(b)(5)(B) is not met when turning someone in for failing to file a Foreign Bank Account Report (FBAR) (Form TD F 90-22.1) under 31 U.S.C. Section 5321(a). The amounts owed pursuant to 31 U.S.C. Section 5321(a) are not to be included because they are not taxes in the I.R.C.
In Whistleblower 22716-13W, the petitioner sought an award and filed Form 211, Application for Award for Original Information with the Whistleblower Office of the IRS. The taxpayer that was turned in pled guilty and paid an FBAR civil penalty on his Swiss Bank accounts.
But the Tax Court ruled that a whistleblower is only eligible for a nondiscretionary award under Section 7623(b) “if the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed” $2 million (Section 7623(b)(5)(B)). Since FBAR civil penalties are imposed and collected under a different Title of the U.S. Code (31 U.S.C. section 5321) they do not constitute “additional amounts” for purposes of ascertaining whether the $2 million threshold has been met.
The court did, in fact, concede that the statute would offer stronger incentives to whistleblowers if FBAR civil penalties were included like tax liabilities for purposes of whistleblower award eligibility under Section 7623(b)(5)(B). The court ruled though that it was up to Congress to determine eligibility for the award, not the Court.
Tax Court Determines Emotional Distress Damages Taxable Since Not Derived from Physical InjuryFebruary 22, 2016
In Barbato v. Comm., TC Memo 2016-23, the U.S. Tax Court determined that a taxpayer who was awarded damages by the Equal Employment Opportunity Commission for her emotional distress for discrimination against her constituted taxable income. The court ruled that she did not meet Code §104(a)(2) requirements for excluding damage awards from gross income.
§104(a)(2) excludes damages received for personal physical injury or physical sickness from gross income. Because emotional distress is not considered a physical injury or physical sickness, taxpayers must include damages they receive for emotional distress in their gross income unless the damages are paid for medical care attributable to the emotional distress. §104(a). Only "damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under Code Sec. 104(a)(2)." See also Treas. Reg. §1.104-1(c))
In Barbato, the taxpayer had been a U.S. Postal Service (USPS) letter carrier who incurred injuries to her neck and back in a job related car accident. Her physical limitations required her to switch from a letter carrier to an office position at the USPS.
She was eventually reassigned to carrying mail but her old position caused her to have more pain. When she complained, she was discriminated against. As a result, she claimed severe stress and emotional difficulties as a result and was awarded $70,000 by the EEOC for the emotional distress caused by the discrimination. The administrative Judge ruled that she suffered from depression, anxiety, sleep problems, and post-traumatic stress disorder, and that the conditions were caused by and/or exacerbated by the actions which were found to be discriminatory.
The Tax Court found that the damages did not fit within the exclusion provided in §104(a)(2) and thus were taxable. The Tax Court said that the EEOC decision was clear that the damages USPS paid to the taxpayer were for emotional distress attributable to discrimination. The $70,000 in damages for emotional distress was "proximately caused by the discrimination" of USPS' employees and not for emotional distress attributable to a physical injury or physical sickness. The decision clearly stated that the taxpayer’s "significant physical distress and pain" "were exacerbated by non-discriminatory actions."
Wife Cannot Stop I.R.S. Collection Of Husband's Tax Through Its Liens On Community PropertyFebruary 18, 2016
A District Court in Washington in Smith v. C.I.R., 117 AFTR 2d ¶ 2016-412 (DC WA 2/8/2016) found against the wife who argued that the IRS should not be permitted to foreclose a Federal Tax Lien on the couple's community property to pay taxes owed solely by the husband.
Unpaid taxes act as a lien on a taxpayer's property. Code §6321. The I.R.S. may sue to enforce its lien or to subject the taxpayer's property to payment of tax in any case where there has been a refusal or neglect to pay any tax, or to discharge any liability in connection with the tax. Code §7403(a). In Smith, Mr. Smith incurred tax liabilities for unpaid taxes and he failed to pay them so the I.R.S. filed suit to foreclose its liens on the couple's home, which was community property.
Mrs. Smith’s arguments to prevent the foreclosure were all rejected: First, she argued that IRS had no right to satisfy Mr. Smith's debt with Mrs. Smith's share of the home, which was community property, because Washington's community debt doctrine did not apply. The District Court, applying Washington State law, stated that "community real estate shall be subject to liens of judgments recovered for community debts." Washington case law provides that all debt incurred by either spouse during marriage is presumptively community debt, a general presumption only overcome by clear and convincing evidence to the contrary.
She also argued that the lien should not be enforced because she should have been sent a notice of deficiency. The District Court rejected that argument explaining that the IRS is only required to issue a notice of deficiency to the individual who owes the tax.
Couples should know that the Internal Revenue Service can and does foreclose liens against one taxpayer even when property is held as husband and wife and only one spouse owes the tax.
UPDATE: Extension for Federal Form 8971 to March 31, 2016!February 12, 2016
Extension! According to IRS Notice 2016-19, the due date for statements required under IRC Section 6035, which was February 29, 2016, shall be extended to March 31, 2016.
IRS Recommendation. The IRS has provided the extension so that executors and such other persons may have the opportunity to review the proposed regulations to be issued under IRC §§ 1014(f) and 6035 prior to preparing a Form 8971 and any Schedule A. The IRS expects to issue the proposed regulations very shortly. In the meantime, the IRS recommends that executors and other such persons wait until the issuance of such proposed regulations before beginning to prepare the statements required by IRC §§ 6035(a)(1) and (2).
Background. On July 31, 2015, the President of the United States signed H.R. 3236 into law, and IRC §§ 1014(f) and 6035 were enacted. Section 6035 imposes new reporting requirements with regard to the value of property included in a decedent’s gross estate for federal estate tax purposes. Briefly, statements must be filed with the IRS and furnished to beneficiaries. In Notice 2015-57, the IRS postponed the due date of the statements required by § 6035 to be filed/furnished before Feb. 29, 2016 to Feb. 29, 2016. This applied to executors of estates of decedents (and to other persons who are required under § 6018(a) or (b) to file a return) if a Federal Form 706 was filed after July 31, 2015.
Section 6035(a)(3)(A). This section provides that each statement required to be furnished under § 6035(a)(1) or (a)(2) shall be furnished at such time as the Secretary may prescribe, but in no case at a time later than the earlier of (i) the date which is 30 days after the date on which the return under § 6018 was required to be filed (including extensions, if any) or (ii) the date which is 30 days after the date such return is filed. Failure to furnish these statements may result in penalties under §§ 6721 and 6722.
Law Firm Operating as a C Corporation Hit With Non-Deductible Salaries and Dividend Treatment and Penalties When Zeroing Out Income to its Shareholders as Salary BonusFebruary 12, 2016
In, Brinks Gilson & Lione PC, TC Memo 2016-20TC Memo 2016-20, the U.S. Tax Court upheld the IRS's imposition of underpayments resulting from the law firm's mischaracterization of dividends paid to its shareholder-attorneys as deductible compensation for services and also imposed accuracy-related penalties against the firm for the mischaracterization. The Tax Court held that the firm lacked substantial authority for its position and failed to establish reasonable cause for the underpayments.
I.R.C. Sec. 6662 imposes an accuracy-related penalty if any part of an underpayment of tax required to be shown on a return is due to negligence or disregard of rules or regulations, or a substantial understatement of tax. An "understatement" pursuant to I.R.C. Sec. 6662(d)(2)(A) is defined as the excess of the tax required to be shown on the return over the amount shown on the return as filed. In the case of a corporation, an understatement is substantial if, it exceeds 10% of the tax required to be shown. The penalty is reduced or eliminated if the taxpayer had substantial authority for the position. I.R.C. Sec. 6662(d)(2)(B)(i). Also, pursuant to I.R.C. Sec. 6664(c)(1), no penalty is imposed pursuant to I.R.C. Sec. 6662 with respect to any portion of an underpayment if it is shown that there was reasonable cause for the underpayment and the taxpayer acted in good faith.
In the Brinks case, the law firm had about 85 non-shareholder attorneys, and about 65 shareholder attorneys. The law firm filed its returns showing all amounts paid to the shareholder-attorneys as deductible employee compensation. After negotiations, the parties conceded the tax but left the penalty issue for the court to resolve. The firm argued that it had substantial authority for deducting the money it paid to its shareholder-attorneys; and it relied on a reputable accounting firm to prepare its returns for the years in issue, and had reasonable cause to deduct those amounts and acted in good faith in doing so.
But the Court held that the amounts paid to the shareholder-attorneys do not qualify as deductible compensation to the extent that the payments are funded by earnings attributable to the services of nonshareholder employees or by the use of the corporation's intangible assets or other capital. Those earnings constitute nondeductible dividends. Pediatric Surgical Associates v. Comm., T.C. Memo 2001-81 (TCM 2001) and Mulcahy, Pauritsch, Salvador & Co v. C.I.R., 680 F.3d 867 (7th Cir. 2012).
Therefore, the penalty was upheld. A corporation's payment of salaries to shareholder-employees in amounts that leave insufficient funds available to provide an adequate return to the shareholders on their invested capital indicates that a portion of the "salaries" is properly characterized as distributions of earnings and thus - dividends. The court ruled that investors in such a situation would expect a return on their investment. Finally, the Tax Court ruled that the law firm did not act with reasonable cause and good faith. The law firm did not provide the accounting firm with accurate information.
Conclusion: When operating as a C Corporation, a client must be diligent with their accountants to avoid the imposition of penalties.
Caution: IRS Final Form 8971 Has Been Issued! New Estate Basis Reporting Rules (IRC Section 6035)February 11, 2016
Reporting Basis on Form 8971. On July 31, 2015, the President of the United States signed H.R. 3236 into law, and IRC §§ 1014(f) and 6035 were enacted. Section 6035 imposes new reporting requirements with regard to the value of property included in a decedent’s gross estate for federal estate tax purposes. Briefly, statements must be filed with the IRS and furnished to beneficiaries. In Notice 2015-57, the IRS postponed the due date of the statements required by § 6035 to be filed/furnished before February 29, 2016 to February 29, 2016. This applies to executors of estates of decedents (and to other persons who are required under § 6018(a) or (b) to file a return) if a Federal Form 706 is filed after July 31, 2015. [Note: Who is required to file/furnish such statements is not yet clear. For example, must an executor who filed a federal estate tax return for the sole purpose of making a portability election file/furnish such statements?]
Section 6035(a)(3)(A). This section provides that each statement required to be furnished under § 6035(a)(1) or (a)(2) shall be furnished at such time as the Secretary may prescribe, but in no case at a time later than the earlier of (i) the date which is 30 days after the date on which the return under § 6018 was required to be filed (including extensions, if any) or (ii) the date which is 30 days after the date such return is filed. Failure to furnish these statements may result in penalties under §§ 6721 and 6722.
Observation: If an executor filed a Federal Form 706 after July 31, 2015, then such executor probably needs to file/furnish statements by February 29, 2016.
MORE INFORMATION TO COME!
New Innocent Spouse Proposed Regulations IssuedJanuary 8, 2016
The IRS proposed regulations on innocent spouse relief under Code Sec. 6015 was just released on Wednesday, January 6, 2016 at Federal Register 134219-08. Of particular significance are the following:
- Guidance is given on the application of res judicata in innocent spouse cases. Res judicata – as applied here - would prevent a spouse from seeking innocent spouse relief when such relief was at issue in a prior court proceeding or the requesting spouse meaningfully participated in a prior proceeding in which innocent spouse relief could have been raised. The proposed regulations provide guidance on “meaningful participation.” The proposed regulations provide a nonexclusive list of considerations in making a facts and circumstances determination of whether the requesting spouse “meaningfully” participated in such prior proceeding. Also, the Proposed Regulation exempts the application of the above rule if the requesting spouse establishes that he or she performed the acts due to abuse by the other spouse or the other spouse maintained control over the requesting spouse, and the requesting spouse did not challenge the other spouse because of fear of retaliation.
- A definition of “underpayment or unpaid tax” as found in Code Sec. 6015(f) is provided. It states that “unpaid tax” and “underpayment” have the same meaning. Thus, the “underpayment” is the balance shown as due on the return less the amount of tax paid with the return on or before the due date for payment (without considering any extension of time to pay). The “unpaid tax” is calculated after applying any credits for withholding, estimated tax payments, payments made when requesting an extension, and other credits.
- Guidance is given on credits and refunds in innocent spouse cases, explain how to determine the amounts of credits and refunds that may be available. The Proposed Regulations also provide for allocation of refunds in certain cases.
- Clarification is provided for credits and refunds in equitable relief cases to make clear that credits and refunds of tax are available in deficiency cases as well as in underpayment cases.
Estate Litigation – Father Held Not to Have Abandoned Son and Therefore Entitled to a Share of His Deceased Son’s EstateDecember 14, 2015
A father, who had very little contact with his child for nine years prior to the child's death, was not deemed to have "abandoned" him or "willfully forsaken" him. Thus he was not barred from a share of the child's estate. The case was one of first impression in New Jersey and the New Jersey Appellate Division in In the Matter of the Estate of Michael Fisher II, __ N.J. Super. __, 2015 WL 8484786 (N.J. App. Div. 2015) reversed the lower court’s ruling which had determined that the father had, in fact, abandoned his son and was therefore excluded from sharing the son’s estate.
There were facts that pointed toward abandonment such as, the father moved away, was late with child support payments and failed to attend court-ordered counseling in order to have his visitation rights reinstated. However, the Appellate Court held that these facts alone were insufficient to declare abandonment of the child. At issue were essentially the proceeds from a wrongful death lawsuit against the child’s cardiologist who allowed him to play hockey though he had a congenital heart defect. But the court required that the father “clearly manifested a settled purpose to permanently forego all parental duties and relinquish all parental claims to the child. That purpose was not demonstrated here."
N.J.S.A. 3B:5-4.1 states that one can be held to have given up parental rights when he "abandoned" or was "willfully forsaking the decedent." The standard applied required was that “through his or her unambiguous and intentional conduct, has clearly manifested a settled purpose to permanently forego all parental duties and relinquish all parental claims to the child,”
Since the father paid $37,000 in child support, had one face-to-face meeting and had exchanged some messages on Facebook, those facts precluded a finding of abandonment.
IRS Explains Deductibility of Business Donations to Entities Where Percentage of Sales Promotion are DonatedOctober 30, 2015
The Internal Revenue Service just issued Chief Counsel Advice 201543013 (“CCA”) which discusses deductibility of payments to charities and non-charities where a business advertises that it will give a certain percentage of its sales to organizations devoted to a particular cause, such as environmental conservation or eradicating hunger.
The CCA addresses not only charities described in Code §170 but also non-Code §170(c) organizations, and even for-profit entities with a social mission included in their corporate bylaws. But specifically rejected was recipients engaged in political activity. A question not answered explicitly was who gets the donation, the customer who bought the product at full price leading the business to pay the charity, or the business itself? While the CCA does not answer the question, it does not appear that the funds are donated by the customers.
Normally, a business expense deduction is not permitted for contributions to charities. But under this plan which is directly related to the taxpayer's business and is made with a "reasonable expectation of financial return commensurate with" the amount transferred, the payment is deductible as a business expense rather than a charitable contribution under Code §162(b) and Treas. Regs. §1.162-15(a) and §1.170A-2(c)(5)). Under the percentage of sales plan, the Taxpayer appears to have acted with the reasonable belief that it would enhance and increase its business.
The CCA went on to permit as a business deduction the payments to organizations not described in Code §170. The CCA reiterated for that type of organization that Taxpayer had a reasonable expectation of commensurate financial return from the donations it is making through the promotion.
The only exception is for donations to lobbying organizations under Code §162(e)(1). No business expense deduction is allowed for amounts paid in connection with influencing legislation or participation or intervention in any political campaign on behalf of, or in opposition to, any candidate for public office.
Conclusion: Donating a percentage of sales to charity leads to the business being entitled to a deduction for the payment to charity as a business expense.
Autism Spectrum Disorder No Excuse For Late Filing and Payment Penalty AbatementOctober 26, 2015
In Poppe v. Comm., TCM 2015-205 (2015), the taxpayer’s autism spectrum disorder (“ASD”) was held not to constitute reasonable cause for failure to file and pay. The Taxpayer was an active day trader. He argued that he had reasonable cause for failing to timely file his return because, as a result of his ASD, he became "despondent" from all of the money he had lost and could not organize himself to timely file a tax return. The Tax Court in its memorandum decision rejected that argument. First, the Court did provide that reasonable cause may exist if a taxpayer's or a family member's illness or incapacity prevents the taxpayer from filing his or her tax return. But the Tax Court went further to state that if the taxpayer is able to continue his or her business affairs despite the illness or incapacity, the excuse will not be sustained.
In Poppe, the Taxpayer’s mental condition did not prevent him from engaging in activities that required a high degree of concentration and ability to analyze and organize information. Poppe's work station as a day trader was equipped with six monitors showing the status of his trades. He was able to collect, analyze, and organize information on which to base his trades. Thus, the Court reasoned, if he could attend to his affairs despite his ASD, he could file and pay his taxes timely.
The Court did not state that ASD is no excuse generally. But under the facts and circumstances in Poppe, the Court would not sustain the excuse. Had the Taxpayer been so overcome by his ASD that he could not attend to his business affairs, the ASD would have provided reasonable cause for penalty abatement.
Senior Freeze on Property Tax Increases New Jersey Property Tax Reimbursement Program Could you be eligible for a reimbursement check?October 13, 2015
Senior citizens and disabled New Jersey residents may be eligible to apply for the Property Tax Reimbursement program (commonly known as “Senior Freeze”). This program reimburses eligible senior citizens and disabled persons for property tax increases on their principal residence.
To be eligible for 2014 Senior Freeze, the individual must meet all of the following requirements:
- The individual’s total annual income (combined if the individual was married or in a civil union and lived in the same home) did not exceed $84,289 in year 2013 and did not exceed $70,000 in year 2014.
- The income requirement takes into account all income that the individual received during the year, with exceptions. A list of these exceptions can be found on the NJ Treasury Dept. website: www.state.nj.us/treasury/taxation/ptr/income.shtml.
- The individual (or his/her spouse/civil union partner) were either (i) age 65 or older as of Dec. 31, 2013, or (ii) receiving Social Security disability benefits as of Dec. 31, 2013 and Dec. 31, 2014;
- The individual lived in New Jersey continuously since Dec. 31, 2003 or earlier;
- The individual owned and lived in his/her current home since Dec. 31, 2010 or earlier;
- The individual paid the full amount of the property taxes due on his/her home for year 2013 by June 1, 2014 and for year 2014 by June 1, 2015; and
- The application must be completed and filed prior to Oct. 15, 2015. Generally, the filing deadline is June 1st, but for the 2014 Senior Freeze the filing deadline was extended until Oct. 15th.
How to Apply
If You Are Applying for the First Time or You Filed an Application for the 2013 Senior Freeze & Was Denied Due to Ineligibility – Use Form PTR-1
A Form PTR-1 should be used if (1) the individual meets the above eligibility requirements and has never previously applied for the Senior Freeze, or (2) the individual filed an application for the 2013 Senior Freeze but was denied due to ineligibility.
If You Filed an Application for the 2013 Senior Freeze & Met the Eligibility Requirements – Use Form PTR-2
A Form PTR-2 should be used if the individual filed an application for the 2013 Senior Freeze and met all of the eligibility requirements. Form PTR-2 is a personalized application and is not available online. If the individual does not receive a Form PTR-2 in the mail, a call to the Senior Freeze Hotline (1-800-882-6597) can be made to request the form and to obtain further information.
Note: The original income limit for the 2014 Senior Freeze was $85,553 but was changed to $70,000 due to the amount appropriated for the program in the State Budget for FY 2016. If you have already applied based on the $85,553 limit and you do not qualify under the $70,000, you will not receive a reimbursement but you will have established eligibility for future years with your applications.
The Senior Freeze is a good program to keep in mind for clients, friends, or yourself who could be eligible or who may soon be eligible. According to a New Jersey Department of the Treasury Press Release, last year over 172,000 senior and disabled New Jersey residents received Senior Freeze checks that averaged almost $1,200 per recipient. For more information, visit www.state.nj.us/treasury/taxation/ptr to read more about the program and contact an attorney regarding the current laws.
If you would like to speak to an attorney about tax or estate planning and/or you have any questions regarding this Memorandum, please do not hesitate to contact any member of the Brach Eichler estate planning team: Stuart M. Gladstone (973.403.3109 or email@example.com); David J. Ritter (973.403.3117 or firstname.lastname@example.org); Susan K. Dromsky-Reed (973.403.3146 or email@example.com) or Jay J. Freireich (973.364.5206 or firstname.lastname@example.org).
Attorney Advertising: This publication is designed to provide Brach Eichler, L.L.C. clients and contacts with information they can use to more effectively manage their businesses. The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authored it are rendering legal or other professional advice or opinions on specific facts or matters. Brach Eichler, L.L.C. assumes no liability in connection with the use of this publication.
IRS Determines Year Taxpayer Had Theft Loss From Ponzi SchemeAugust 7, 2015
The IRS Chief Counsel’s office released a legal memorandum - ILM 201511018 - which sets forth the proper year a taxpayer can claim a theft loss deduction when victim of a Ponzi scheme.
I.R.C. §165(a) permits a deduction for losses sustained during the tax year (and not compensated by insurance or otherwise). A loss arising from criminal fraud or embezzlement in a transaction entered into for profit is a theft loss, not a capital loss, under §165.
Pursuant to §165(e) any loss arising from a theft is deemed sustained in the tax year a taxpayer discovers the loss. But the Regulations state that if, in the year of discovery, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss for which reimbursement may be received is sustained until the tax year in which it can be ascertained with reasonable certainty whether or not the reimbursement will be received. Whether a reasonable prospect of recovery exists is a question of fact to be determined upon examination of all facts and circumstances. Treas. Reg. §1.165-8(a)(2) and 1.165-1(d).
Rev. Proc. 2009-20 provides a safe harbor under these schemes for the timing and amount of the theft loss in Ponzi schemes which are defined as a fraudulent arrangement in which a party (the lead figure) receives cash or property from investors; purports to earn income for the investors; reports income amounts to the investors that are partially or wholly fictitious; makes payments, if any, of purported income or principal to some investors from amounts that other investors invested in the fraudulent arrangement; and appropriates some or all of the investors' cash or property.
Where the lead figure is indicted, Rev. Proc. 2009-20 states that a taxpayer's discovery year is the tax year of the investor in which the indictment, information, or complaint is filed. And if the lead figure died, then Rev. Proc. 2011-58 provides the discovery year as the later of the civil claim becoming public, a receiver appointed or funds frozen or the death of the lead figure.
In ILM 201511018, the Internal Revenue Service determined that the year of discovery was the year when: (1) the civil complaint was filed by the Agency that alleged facts that comprise substantially all of the elements of a specified fraudulent arrangement conducted by the lead figures; (2) one of the lead figures died before being criminally charged; and (3) a receiver was appointed with respect to the arrangement.
While these Ponzi schemes are becoming all too frequent, at least the Government is easing the path for taking the loss as a deductible theft.
District Court Affirms FBAR Penalties but Disallows FBAR Late Payment Penalty and InterestAugust 4, 2015
In Moore v U.S., 2015 WL4508688, 116 AFTR 2d ¶ 2015-5094 (W.D. Wa. 7/24/2015), a district court found that the Taxpayer did not provide an adequate explanation for not imposing FBAR penalties, so those penalties were affirmed. But, the Court also found that tacking on additional late payment penalties was excessive. As a result, the court disallowed IRS's assessment of interest and late payment penalties with respect to the original FBAR penalties and treated the FBAR penalty as if it were assessed on the date of the judgment imposing the penalties.
Background. The Bank Secrecy Act (BSA) provides that the Treasury Department has the authority to collect information from U.S. persons who have financial interests in or signature authority over financial accounts maintained with financial institutions located outside of the U.S. Taxpayers are required to file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR) if the values of the foreign financial accounts (“FFA”) exceed $10,000.
For non-willful violations, the maximum civil penalty is $10,000 per failure. (31 CFR 5321(5)(b)(i)) However, no penalty is imposed if the violation was due to reasonable cause. (For willful violations, in addition to possible criminal penalties, the maximum civil penalty is the greater of $100,000 or 50% of the FFA per year)
In Moore, the Court affirmed the imposition of the non-willful penalties of $10,000 per year for four years since the IRS demonstrated that its decision to assess FBAR penalties of $10,000 for each year for four years was not arbitrary, not capricious, and not an abuse of its discretion. However, the IRS's conduct in seeking further late payment penalties and interest on those FBAR penalties, was determined to be arbitrary since the IRS disclosed no adequate basis for its decision to assess the penalties until the litigation forced its hand. The IRS had even promised not to assess penalties in an earlier communication until an internal appeal was exhausted. Thus any late fee or interest that IRS attempted to tack on to the FBAR penalties was void. The government had to treat the FBAR penalties as if they were first assessed on the date of the court's order.
In addressing FBAR penalties, taxpayers are well served to consult with tax counsel prior to making disclosures.
Third Circuit Holds That the IRS Can Compel Production of Foreign Bank Records Over a Fifth Amendment AssertionJuly 22, 2015
The Court of Appeals for the Third Circuit in U.S. v. Chabot, 2015 WL 4385279 (3rd Cir. 2015) affirmed a New Jersey District Court decision and held that the "required records" exception to the Fifth Amendment privilege against self-incrimination applies to allow the IRS to enforce a summons of foreign bank account records..
Background 31 CFR 1014.420 requires a taxpayer to file a Report of Foreign Bank and Financial Accounts (“FBAR”) to report financial accounts in foreign countries where the aggregate of such accounts exceeds $10,000. The Fifth Amendment states that "[no] person... shall be compelled in any criminal case to be a witness against himself." An individual may claim this privilege if compelled to produce self-incriminating, "testimonial communications." The act of producing documents may trigger the Fifth Amendment privilege. Fisher v. U.S., 425 U.S. 391 (1976). But there is an exception to the 5th Amendment called the “required records exception.” This exception states that when records are required to be maintained for a legitimate purpose, the 5th amendment does not apply to such records.
In Shapiro v. U.S., 335 U.S. 1 (1948), the Supreme Court held that the Fifth Amendment privilege is not abrogated by requiring that taxpayers maintain records as long as the records closely served the purpose of a valid, civil regulation. As set forth in Grosso v. U.S., 390 U.S. 62 (1968), three prongs must be met to fall within the required records exception: (1) the reporting or recordkeeping scheme must have an essentially regulatory purpose; (2) a person must customarily keep the records that the scheme requires him to keep; and (3) the records must have "public aspects."
The Chabot case. IRS issued summonses to Mr. and Mrs. Chabot requesting documents required to be maintained under 31 CFR 1014.420. The Chabots refused claiming the 5th Amendment privilege. The New Jersey District Court ruled that the summonses were proper under the required records exception and the Third Circuit just affirmed. The Third Circuit analyzed the three Grosso prongs and determined all three were met.
Conclusion For anyone still holding assets abroad without disclosing them, be aware that the IRS may obtain the records through summons enforcement. As such, such taxpayers should consult counsel and strongly consider entering into either the offshore voluntary disclosure program or the streamlined program.
Innocent Spouse Taxpayer Recovers Litigation Costs by Making a “Qualified Offer” and Then Prevailing in CourtJuly 20, 2015
The Court of Appeals for the Ninth Circuit, reversed the Tax Court in Knudsen v. C.I.R., 116 AFTR 2d ¶2015-5051 (9th Cir. 2015) finding that Taxpayer was a prevailing party eligible to recover reasonable litigation costs. The Ninth Circuit determined that she was entitled to an award of costs as a "qualified offer" because she offered to settle her tax liability, the offer was not acted upon and her ultimate liability was zero.
Innocent spouse (equitable relief) - background
Each spouse is liable jointly and severally for the tax, interest, and most penalties when they file a joint return. Code §6015(f) permits equitable relief to a requesting spouse if, taking into account all of the facts and circumstances, it is inequitable to hold the requesting spouse liable.
Litigation costs - background. Under Code §7430, taxpayers who prevail against the U.S. in court may be awarded reasonable litigation and administrative costs unless the IRS's position is substantially justified (Code §7430(c)(4)(B)), or the taxpayer fails to substantiate his claim for reasonable litigation costs. But a taxpayer may also make a qualified offer (“QO”) under Code §7430(g)(1) to settle a tax controversy. If that offer is rejected by the IRS and the amount of the QO is greater than the taxpayer's ultimate liability, will be treated as a prevailing party. Using the QO, the taxpayer's qualification as a prevailing party does not depend on whether IRS's position was substantially justified or whether the taxpayer substantially prevailed in the proceeding.
Ninth Circuit reverses. The Ninth Circuit Court found that its decision to grant costs to the taxpayer was consistent with the purpose of the QO, that is: to encourage settlements by imposing costs on the party who was unwilling to settle.
Conclusion. The use of the QO tool is one that all tax practitioners should have in their arsenal to use to even the playing field when sometimes it seems the Government has endless funds to fight the taxpayer.
Victim of a "Pump and Dump" Scheme Not Entitled to Theft Loss Deduction for Losses IncurredJune 25, 2015
In a recent decision: Greenberger v. U.S., 115 AFTR 2d ¶2015-844 (D. Oh. 6/19/15). The District Court of Ohio ruled that a taxpayer was only entitled to a capital loss on the loss from the sale of stock rather than a theft loss as the taxpayer claimed. The taxpayer was the victim of a “pump and dump.” “Pump and dump” is a scheme whereby schemers “pump” up the value of shares through fictitious or fraudulent sales, then “dump” their shares at the inflated prices leaving the public with worthless shares. The taxpayer in Greenberger was one such victim. Yet, the Ohio District court ruled consistent with an Internal Revenue Service Notice. In Notice 2004-27, 2004-1 CB 782, the Internal Revenue Service stated that theft losses for declines in stock value resulting from corporate misconduct where the stock was purchased on an open market and not from the officers who may have made misrepresentations were to be disallowed. The Internal Revenue Service, in that Notice, said such losses due to corporate misconduct may only qualify as capital losses.
I.R.C. Sec. 165(c)(3) allows individual taxpayers to deduct from their taxable income losses arising from theft crimes such as "larceny, embezzlement, and robbery." Treas. Reg. §1.165-8(d)) amplifies this stating: To deduct a theft loss, a taxpayer must show that the loss resulted from a taking of property that is illegal under the law of the state where it occurred, and that the taking was done with criminal intent. (Rev Rul 72-112, 1972-1 CB 60). In many cases, this requires that the perpetrator have specific intent to deprive the victim of his property, which in turn requires a degree of privity (i.e., close connection or relationship) between the perpetrator and the victim. Even though the court said the executives of the company committed a "theft offense," the court ruled that the fact that the taxpayer bought his shares on the open market meant that there was no direct transfer of funds to the culprits, and thus the taxpayer was ineligible for a theft loss deduction.
The case was decided under Ohio law so a case similar to this in another state may be decided differently.
Estate Tax Closing Letters Issued Only Upon RequestJune 18, 2015
The Internal Revenue Service has just announced that, estate tax closing letters will be issued only upon request by the taxpayer for estate tax returns filed on or after June 1, 2015. It also clarified the circumstances under which it will issue closing letters for estate tax returns filed prior to June 1, 2015. Prior to the recent pronouncement, the Internal Revenue Service would issue an estate tax closing letter indicating the return is accepted as filed or send an audit notice within four to six months of filing. It is often prudent for an estate executor to wait for the closing letter before distributing the majority of the estate.On its website, the I.R.S. asks that estate tax filers wait at least four months after filing the return to request the closing letter.
Lawsuit Settlement Payments Not Deductible For Income Tax Purposes After Claiming Same as a Deduction For Estate Tax PurposesJune 15, 2015
In a recent decision by the Eleventh Circuit Court of Appeals, Batchelor-Robjohns v. United States, No. 14-10742, 2015 WL 3514674 (11th Cir. June 5, 2015), the Court denied an income tax deduction for an estate that already took an estate tax deduction for lawsuit settlement payments.
The Estate had filed suit concerning $41 million in payments it made to settle various lawsuits against the Estate. The Estate deducted the payments from its gross estate for estate tax purposes as claims against the estate pursuant to I.R.C. §2053(a)(3). The estate and Internal Revenue Service agreed that this deduction was proper, and the estate tax liability was not at issue before the district court. However, after taking the estate tax deduction, the Estate also claimed an $8.3 million credit on its income tax return for the settlement payments. The district court rejected the Estate's claim, finding that I.R.C. §642(g) barred the Estate from claiming both an estate tax deduction under § 2053 and an income tax deduction for the same payment. The Eleventh Circuit agreed. The government maintained that the Estate cannot use the $41 million repayment to reduce both its estate and income tax obligations, and instead may only deduct the payments from either one tax or the other. The Eleventh Circuit agreed.
The Estate argued on appeal, as it did in the district court, that sections 162 and 212 provide the basis for permitting the “double deduction” of the settlement payments at issue because the payments arise out of the Decedent’s business activities in selling his corporate assets, and thus are ordinary and necessary business expenses. The Eleventh Circuit disagreed.
The Eleventh Circuit’s analysis focused on the I.R.C. provisions relating to overlapping estate and income tax deductions. I.R.C. §642(g), entitled “Disallowance of double deductions,” generally prevents an estate from claiming both an estate tax deduction under I.R.C. §2053 and an income tax deduction for the same payment. The statute provides: Amounts allowable under §2053 or §2054 as a deduction in computing the taxable estate of a decedent shall not be allowed as a deduction ... in computing the taxable income of the estate or of any other person, unless there is filed ... a statement that the amounts have not been allowed as deductions under §2053 or §2054 and a waiver of the right to have such amounts allowed at any time as deductions under §2053 or §2054.
I.R.C. §642(g) contains an exception, however, for “income in respect of decedents.” A double deduction is permitted for “taxes, interest, business expenses, and other items accrued at the date of a decedent's death” that fall within § 2053(a)(3) as claims against the estate, as long as they are also allowable under §691(b). See 26 C.F.R. § 1.642(g)–2. Section 691(b), in turn, provides that a decedent's estate may claim both deductions if the expense falls within one of six statutes: sections 162, 163, 164, 212, 611, or 27.
When there are claims that could potentially be available as a deduction for federal estate tax, federal income tax, or both, competent counsel should be consulted to determine how best to take available deductions to minimize estate and/or income tax liability.
U.S. Flight Attendants Living Abroad Owe Tax When Flying Over the U.S. or International AirspaceJune 12, 2015
The D.C. Circuit in Rogers v. C.I.R., 115 AFTR 2d 2015-1534 (D.C. Cir., 2015), has just affirmed the Tax Court's decision that a flight attendant providing services in or over the United States. and international waters could not use the foreign earned income exclusion under Code Sec. 911.
Background: U.S. Citizens and U.S. Residents must pay tax on their worldwide income unless there is an exclusion that applies. Code Sec. 911 provides an exclusion for U.S. persons residing outside the U.S. and earning “earned income” to exclude same up to a limit. The limit is $80,000 plus inflation adjustment. The adjustment brings the maximum foreign earned income exclusion to $100,800. The taxpayer in Rogers did not earn more than that amount but the Internal Revenue Service determined that some of her earnings were attributable to time flown in and over the U.S. and some while flying over international waters. The portion of her earnings in the U.S. or over international waters was determined not to qualify as foreign earned income and both the Tax Court and the D,C. Circuit agreed with the Commissioner’s interpretation. The Circuit Court relied on the Regulation found at Treas. Reg. 1.911-3(a) which provides “earned income is from sources within a foreign country if it is attributable to services performed by an individual in a foreign country or countries.”
Treas. Reg. 1.911-2(h) defines foreign country to include territorial waters of and airspace over the foreign country. But income earned over waters not subject to any foreign country's jurisdiction is not income earned in a foreign country. Thus, the Courts sided with the regulations.
Flight attendants, pilots, ship crew members etc. must consider the Rogers ruling and keep logs of earnings in foreign countries versus the U.S. and international waters and report the income from those areas without claiming the foreign earned income exclusion on those earnings.
House Ways and Means Committee Votes to Repeal the Estate and GST TaxesApril 1, 2015
By a vote of 22 to 10, the House Ways & Means Committee (“W&M”) on March 25, 2015, voted to pass H.R. 1105, the “Death Tax Repeal Act of 2015.”
Currently the Estate Tax is imposed on estates valued at $5,430,000 (the basic exclusion amount) or higher for taxpayers dying in 2015. There is also a Generation Skipping Tax (“GST”) which is imposed on either outright transfers or transfers in trust to beneficiaries more than one generation below the transferor's generation. Both the estate and GST taxes are imposed at 40% (I.R.C. Sec. 2001(c)) of the amount in excess of the basic exclusion amount. The tax is based upon a unified system so that lifetime taxable gifts are added to transfers at death.
The Republican dominated W&M has proposed estate tax repeal. The Death Tax Repeal Act of 2015 – if enacted - would repeal the estate and GST tax for estates of decedents dying, and generation-skipping transfers made, on or after the date of enactment.
While the Estate and GST taxes would be eliminated, the proposed bill would retain the gift tax with its current tax rate of 35%. The lifetime gift tax exemption amount ($5,430,000 for 2015) under the proposed bill would remain the same as under present law and the gift tax annual exclusion ($14,000 for 2015) would continue to apply. The proposed bill does not change the basis rules for income tax purposes. Thus the basis of assets acquired by gift would retain its current basis while assets acquired from a decedent would obtain a stepped up basis - the fair market value of the asset on the date of death or on the alternate valuation date (the earlier of six months after the decedent's death or the date the property was sold or distributed by the estate).
Should this bill make it through the House of Representatives and Senate, the likelihood that it will be signed by the President is remote. President Obama has indicated (through The President's Budget for Fiscal Year 2016 issued earlier this year) that not only does he want to retain the estate and GST taxes, but believes the current threshold for imposing the taxes ($5,430,000) is too high and wants to tax estates and skips starting at $3,500,000. Stay tuned as the path that this bill might take strongly affects estate planning. For those readers in states that impose an estate tax, this bill, if enacted, may have an effect on the state tax as well but states looking for estate tax revenue may choose to decouple their laws from the federal laws (if they have not done so already). As this author is in New Jersey, I can state that the New Jersey State Estate Tax has remained since 2001 at the same number: there is a tax on estates in excess of $675,000. Thus, estate planning at this time must be done very carefully by an estate planner familiar with the laws of the state and federal governments to weave through the morass of laws.
Final Regs Issued on $1 million pay limitMarch 31, 2015
The Internal Revenue Service has issued final regulations on I.R.C. §162(m) in Treas. Reg. §1.162-27. These regulations make clear what was permitted under temporary regulations (with certain modifications) and now yields more certainty in the area of planning executive pay by public companies.
Background. I.R.C. §162 allows a deduction for trade or business expenses. I.R.C. §162(m) limits the deduction that a public corporation may take for payment of compensation to the principal officer and three highest paid employees to $1 million. However, pay that is performance based is exempt if certain criteria are met. I.R.C. §162(m)(4)(C) and Treas. Reg. §1.162-27(e)(2))
We now have permanent regulations further defining the terms and issues. A discussion of the rules is beyond the scope of a blog. Suffice it to say that anyone seeking to be paid more than $1 million ought to have competent legal advice and any company seeking to pay more than $1,000,000 ought to have competent legal advice.