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.
Even Minority Shareholders Can Be Hit With Transferee Liability for Unpaid Taxes When the Corporation Does Not Pay the TaxesMarch 26, 2015
The Tax Court in Kardash v. Comm., T.C. Memo 2015-51 (2015) has just held that minority shareholders who are also high-level employees were liable for unpaid taxes as transferees, with respect to some of the monies the taxpayers received from the corporation. I.R.C. Sec. 6901(a) authorizes the IRS to pursue a transferee of property to assess and collect tax owed by the transferor. State law determines the liability, while Sec. 6901 authorizes the enforcement of that liability. In Kardash, taxpayer and another minority owner held less than 10%, and the company’s president, and its board chairman, owned the balance. Kardash was an engineer and was involved in the company's financial affairs. The company paid no income tax despite though it owed more than $120 million, and its majority shareholders siphoned substantially all of the cash out of the company. Kardash received his usual salary, which was not at issue but also "advances" and “dividends,” which were at issue. Pursuant to Sec. 6901, the IRS asserted approximately $5 million that Kardash received from the company in “advances.” In ruling for the Government, the Tax Court, citing several other decisions looked to Florida law to determine whether IRS has an obligation to pursue all reasonable collection efforts against a transferor before proceeding against a transferee. It determined that Florida law does not require a creditor to pursue all reasonable collection efforts against the transferor so the taxpayers could still be held liable. The Kardash Court also noted that the IRS could pursue Kardash without first exhausting collection efforts against the majority shareholders. Under Florida state law and the law of many states, transfers that are not in exchange for reasonable value while a debtor corporation was insolvent at the time of the transfer or became insolvent as a result of the transfer results in transferee liability. Kardash argued that the advances were actually payments of compensation and thus were reasonably equivalent value, i.e., the value of their work. The IRS urged that the advances were loans that the taxpayers never paid back, and, therefore the corporation did not receive reasonable equivalent value. The Court ruled the advances were payments of compensation but that the dividends were not compensation and thus the corporation did not receive equivalent value for the dividends. Therefore, the taxpayers were liable as transferees under Code Sec. 6901(a).
Moral of the story is that anyone receiving funds from an entity that does not pay its taxes can be subject to transferee liability and the recipient of the funds should be sure to document the goods or services provided to the company for which payment is received or risk transferee liability.
Tax Court Rules For Bartender On His Tip Reporting Method Over IRS's Reconstruction MethodMarch 19, 2015
The United States Tax Court held that the actual tip income from a bartender's own records was a better reflection of his income than the Internal Revenue Service’s version based upon reconstructing his tip income.
By way of background, I.R.C. Sec. 6001 and Treas. Reg. Sec. 31.6053-4 require those who earn tips to keep accurate and contemporaneous records of their income. The IRS has the authority to recompute tip income as it determines if the tip earner fails to produce adequate records.
InSabolic v. Comm., TC Memo 2015-32 (T.C.M. 2015), a bartender had a set routine of how he recorded his tips at the end of each shift but IRS claimed that the bartender had underreported his tip income and because his tip logs were recorded in whole numbers; he did not keep track of how much he paid to the bar backs; and the logs did not include all days.
IRS reconstructed the bartender's tip income by determining a “charge tip rate” for each tax year. But, the Court sided with the bartender fully reported his tip income. In the Court’s analysis, it did state that the IRS does have great latitude in adopting a suitable method for reconstructing tip income and its method of recomputing income carries with it a presumption of correctness and therefore, the burden of proof was on the bartender. But the Court sided with the taxpayer on all three challenges: round numbers, payments to bar backs and missing days. In sum, the Court concluded that the bartenders actual records were more accurate than the IRS’s reconstructed method and therefore ruled for the bartender.
Pointer: Many bartenders receive tips that are higher than the Internal Revenue Service method and therefore this case is not helpful. But for those who are not earning tips as high as the IRS method, any tip earner should keep accurate records and fight the IRS if necessary.
Another Estate Tax Repeal Bill Is ProposedMarch 16, 2015
Many Republicans have been urging a repeal of the Federal Estate Tax for years. During the time that we have a democratic president, the chances of such a bill becoming law are remote. In fact, President Obama has set forth his proposal to actually increase the tax by lowering the threshold for an estate to be taxable. The latest bill was sponsored by Rep. Kevin Brady (R-Tx). He introduced H.R. 1105, 114th Cong., 1st Sess. (March 6, 2015), which would repeal the federal estate and GST taxes. The bill already has 32 co-sponsors, and has been referred to the House Committee on Ways and Means.
The upshot of this is that it is unlikely that any changes will occur during this administration but if a Republican takes the white house and the Republicans continue to control both Houses, the possibility of absolute repeal may very well become a reality.
The National Taxpayer Advocate's Office Chimes In On The OVDP Program and How To Fix ItJanuary 16, 2015
The National Taxpayer Advocate (NTA) has just released their annual report to Congress, and it sets forth various problems with the IRS Offshore Voluntary Disclosure Program (OVDP) and suggested fixes. The NTA believes there are flaws in the current program that are not fair and just. One important change suggested would be to allow non-willful taxpayers with closed cases to amend their IRS closing agreement in order to benefit from the recent OVDP changes.
Background: In 2009, the IRS established the OVDP program for taxpayers with undisclosed income from hidden offshore accounts and the I.R.S. traded avoidance of criminal prosecution for a 20% penalty and payment of taxes, interest and penalties going back 6 years. A second OVDP in 2011 allowed taxpayers who did not enter the 2009 program to avoid criminal prosecution for a 25% penalty and payment of taxes, interest and penalties going back 8 years. A third OVDP in 2012 allowed taxpayers who did not enter the 2009 or 2011 program to avoid criminal prosecution for a 27.5% penalty and payment of taxes, interest and penalties going back 8 years. In the middle of 2014, the IRS made available streamlined filing compliance procedures for non-willful taxpayers and such non-willful taxpayers pay only a 5% penalty and payment of taxes, interest and penalties going back 3 years but are provided no guarantee regarding possible prosecution.
The NTA's annual report to Congress states that the new streamlined program is unfair to the non-willful filers who entered into the 2009, 2011 or 2012 programs and received a closing letter after having paid the higher penalties over a longer time frame. The NTA report is asking the I.R.S. to allow taxpayers to amend their IRS closing agreements to benefit from the recent streamlined changes to OVDP. Stay tuned to see if the I.R.S. actually implements the suggestion.
Bankruptcy Debtor's Income Tax Liabilities Held Not DischargeableNovember 14, 2014
Few issues are more misunderstood than the interplay between the taxing authorities and the bankruptcy court. Congress is no help here because the language of the Bankruptcy Code is second only to the Internal Revenue Code in obtuseness. These Codes give the most gifted lawyers fits in attempting to decipher them.
Income tax obligations that are too new are not dischargeable while older taxes can be. The theory seems to be that the Internal Revenue Service should get a fair chance to collect income taxes before losing that ability entirely to bankruptcy. 11 U.S.C. 1328(a)(2) excepts from discharge the kind of debt specified in 11 U.S.C. 507(a)(8)(C) (withholding taxes) or 11 U.S.C. 523(a) (all other taxes), including specifically 11 U.S.C. 523(a)(1)(B) debt. 11 U.S.C. 523 (a)(1)(B)(ii) denies discharge of taxes for which a late return was filed after two years before the date of the filing of the bankruptcy petition. Via 11 U.S.C. 507(a)(8)(A)(i), taxes for which a return is last due including extensions after three years before the date of the filing of the bankruptcy petition are not discharged. Via 11 U.S.C. 507(a)(8)(A)(ii), taxes assessed within 240 days before the date of the filing of the bankruptcy petition are also not discharged. If any of these three are met, there is no discharge.
In In re Ollie-Barnes, 114 AFTR 2d ¶ 2014-5413 (Bktcy Ct 11/06/2014) the bankruptcy court ruled that the filing date was less than two years from the late tax return filing and therefore the taxes were not dischargeable. One of the issues in Ollie-Barnes was whether her prior bankruptcies tolled the two year period. The bankruptcy court held that the earlier bankruptcy filings tolled the running of the two year period and therefore the two year period had not expired and thus the taxes were not discharged.
Moral of the case: when dealing with taxes and bankruptcy, engaging counsel familiar with the interplay between taxes and bankruptcy is key.
U.S. Tax Court Upholds $10,000 Penalty Against a Private Foundation Who Filed a Return LateNovember 13, 2014
In Grace Foundation v. Comm., T.C. Memo 2014-229, the U.S. Tax Court sustained an Internal Revenue Service levy of a $10,000 penalty on a private foundation. The Tax Court rejected all of the foundation’s arguments that there were errors in the IRS's conduct of the taxpayer's collection due process (CDP) hearing. First, the Tax Court made clear that a private foundation which is not exempt from tax must comply with the same return filing requirements as organizations described in Code Sec. 501(c)(3) which are exempt from tax under Code Sec. 501(a). (Code Sec. 6033(d)) and that Code Sec. 6652(c)(1)(A) imposes a penalty for failing to file Form 990 in a timely manner.
Lesson learned #1: The Internal Revenue Service will impose penalties for failure to timely file returns on private foundations and the Tax Court will uphold these penalties.
Lesson learned #2: All taxpayers, even private foundations, should have proper advice and counsel of their filing obligations so these issues do not occur.
StructuringNovember 10, 2014
Richard Weber, the Chief of I.R.S. - Criminal Investigation issues statement regarding no longer seizing structured funds of otherwise licit activity. This means that 31 U.S.C. 5324 will only be applied on a forward going basis to structuring of illicit funds. This does not change the affect the government’s ability to audit and recommend criminal prosecution where structuring is a part of avoiding reporting for income tax purposes.
The full statement is reprinted below:
After a thorough review of our structuring cases over the last year and in order to provide consistency throughout the country (between our field offices and the U.S. attorney offices) regarding our policies, I.R.S.-C.I. [Criminal Investigation] will no longer pursue the seizure and forfeiture of funds associated solely with “legal source” structuring cases unless there are exceptional circumstances justifying the seizure and forfeiture and the case has been approved at the director of field operations (D.F.O.) level. While the act of structuring — whether the funds are from a legal or illegal source — is against the law, I.R.S.-C.I. special agents will use this act as an indicator that further illegal activity may be occurring. This policy update will ensure that C.I. continues to focus our limited investigative resources on identifying and investigating violations within our jurisdiction that closely align with C.I.'s mission and key priorities. The policy involving seizure and forfeiture in “illegal source” structuring cases will remain the same.
A Merger of Two Family-Owned Companies May Result in Taxable GiftsOctober 8, 2014
In Cavallaro, v. Comm., T.C. Memo 2014-189 (2014), the Tax Court determined that a merger of one company owned by the parents and the other company owned by their sons, resulted in a taxable gift from parents to sons. The ruling was based upon the Tax Court determining the parents' company to have been undervalued.
Background. Code Sec. §2501(a) imposes the gift tax on any transfer of property by gift regardless of the form of the gift transaction. Any time that property is transferred for less than full and adequate consideration, the excess value is considered a gift. (Code §2512) Taxable gifts include "sales, exchanges and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor." (Treas. Reg. §25.2512-8)
Conclusion: Any type of transaction can be a deemed gift. This is especially so when there are transactions involving family members. Be sure to be vigilant in any transactions that could contain any type of gifting element so that the gift tax consequences, if any, can be ascertained and proper planning done to consider non-gift alternative transactions.
Internal Revenue Service is Committed to Whistleblower ProgramAugust 25, 2014
IRS Deputy Commissioner John Dalrymple issued a memo providing procedures and goals for the IRS whistleblower program while IRS Commissioner John Koskinen issued a statement that he is also committed to increasing the reach of the program. Commissioner John Koskinen's statement stated that over the last three fiscal years, more than $186 million in awards have been paid, on collection of more than $1 billion based on whistleblower information.
Background. I.R.C. §7623(a), gives the IRS discretion to pay awards to whistleblowers between 15% and 30% of the "collected proceeds" resulting from an action based on information provided by the whistleblower. There is also the authority to pay up to 10% where the information provided by the whistleblower is "less substantial."
On August 7, 2014, the Treasury issued final regulations on the whistleblower program.
The Dalrymple memo makes three points: debriefing whistleblowers, protecting the identity of whistleblowers, and timeliness.
There will typically be a debriefing interview with the whistleblower unless it is deemed unnecessary. The whistleblower's identity and even the existence of a whistleblower will be shielded from the taxpayer. Even the examiners will not know the identity or existence of the whistleblower. The Internal Revenue Service is also promising more timeliness: claims received should be initially evaluated by the Whistleblower Office within 90 days; review should be completed within 90 days of a receipt, and whistleblowers should be notified of an award decision within 90 days.
There is no Bankruptcy Protection from Inherited IRAsJuly 7, 2014
The U.S. Supreme Court in Clark v. Rameker, 134 S. Ct. 2242, 113 A.F.T.R.2d 2014-2308, 59 Bankr. Ct. Dec. 159, (6/12/2014) has held that inherited IRAs do not qualify for a bankruptcy exemption, and therefore are not protected from creditors in bankruptcy.
Many of us know that assets in an IRA are protected from creditors both under most state laws and in Bankruptcy. Pursuant to 11 U.S.C. 522(b)(3)(C), a debtor may exempt amounts that are both (1) "retirement funds," and (2) exempt from income tax under one of several specified Internal Revenue Code provisions, including Code Sec. 408, which exempts IRAs.
In the Clark case, the daughter of an IRA account holder held an inherited IRA which allows her to keep the assets in the IRA and only take the assets out annually over her life expectancy. They then filed for bankruptcy and sought to keep the inherited IRA from the creditors. There had been a split amongst the circuits: the Seventh and Fifth Circuits were contradictory so the Supreme Court resolved the controversy by unanimous decision (Justice Sotomayor writing for the unanimous court) in favor of the creditors.
She stated that the "text and purpose" of the Bankruptcy Code provided that funds held in inherited IRAs are not "retirement funds" for purposes of the Bankruptcy Code §522(b)(3)(C) exemption.
Left open by the Court is the query of whether assets in a spousal rollover IRA would be factually distinct or might also be subject to creditors.
Recommendation: A trust for the benefit of the beneficiary – rather than naming the beneficiary outright - may avoid the result that the Clarks had in this case.
NEW OFFSHORE VOLUNTARY DISCLOSURE PROGRAM (OVDP) RULES GO INTO EFFECTJune 19, 2014
We have been hearing rumors that the Treasury Department was going to be amending the OVDP program. Yesterday they did amend the program. Briefly, for people that have not yet filed for OVDP, the 27.5% penalty that is currently available will go up to 50% for filings on or after July 1 for offshore accounts at foreign financial institutions that have indicated that they will be complying. Thus anyone with accounts overseas should strongly consider acting quickly and in June.
For people that have already filed, there are tweaks in the program that may make it beneficial to elect the new program. Thus, if you are currently in the program, it would behoove you to analyze whether such an election would prove beneficial to you.
Here is the link to the new program:
Commissioner of the Internal Revenue Service Talks of Amending the Offshore Voluntary Disclosure Program ("OVDP)June 5, 2014
IRS Commissioner John Koskinen has stated that the Internal Revenue Service "has also sought to encourage taxpayers to come into compliance voluntarily." Koskinen stated that the various OVDPs, ranging from the 2009 version and then the 2011 and now the current 2012 version have led to more than 43,000 voluntary disclosures from person paying over $6 billion in a combination of back taxes, interest, and penalties.
Koskinen urged though that, while these three programs have been very successful, the IRS may amend the program "to accomplish even more." He said that the agency is "considering whether our voluntary programs have been too focused on those willfully evading their tax obligations and are not accommodating enough to others who don't necessarily need protection from criminal prosecution because their compliance failures have been of the non-willful variety." Those who have lived abroad for many years may be distinguished from U.S. resident taxpayers who were willfully hiding their investments overseas and stated that "[w]e expect we will have much more to say on these program enhancements in the very near future."
The National Taxpayer Advocate has previously criticized the three OVDPs as prescribing a "one-size-fits-all" approach. The NTA states that the stiff penalty may be unfair since it fails to draw any distinction between those who willfully vs. inadvertently fail to report foreign accounts.
Stay tuned for further developments when they occur.
Israel and U.S. Reach Substantive AgreementMay 1, 2014
Today, May 1, 2014, the Treasury Department announced that the U.S. has reached an intergovernmental agreement (IGA) with Israel to implement the Foreign Account Tax Compliance Act (FATCA).
A Treasury spokeswoman announced that Israel and the U.S. had reached a Model 1 IGA in substance.
FATCA, which was enacted in 2010, requires foreign financial institutions (FFI) to report accounts owned by U.S. persons to the Internal Revenue Service or face a 30 percent withholding tax in certain cases on their U.S. source income. These IGAs permit FFIs to give information about these accounts to their own governments, which then would share the data with the IRS. Model 1 agreements call for reciprocal information exchanges between nations.
For those U.S. person who have not disclosed their assets in Israel (or any other foreign country for that matter) the window is closing to do so while still avoiding prosecution. I urge you to consider entering into the offshore voluntary disclosure program (OVDP).
When Brothers Feud, They Can Split Up Their Corporation in Two and Go Their Separate Ways in a Tax Free ExchangeApril 17, 2014
In a recent private letter ruling (PLR 201411012), the IRS ruled that no gain or loss would be recognized on division of corporation by feuding siblings. This is a carefully laid out plan needing to qualify under a plethora of carefully planned criteria to qualify the transaction for non-recognition treatment of the split off. Under the scenario painted by the taxpayers to the Internal Revenue Service, each corporation will operate one of the two businesses currently being run by the existing company.
By way of background, the Code provides non-recognition treatment for reorganizations listed in Code Sec. 368(a). Under Sec. 368(a)(1)(D), a so called type "D" reorganization, a transfer of all or part of the assets of one corporation to another corporation qualifies if (i) immediately after the transfer, the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the transferee corporation; and (ii) stock or securities of the corporation to which the assets are transferred are, under the plan, distributed in a transaction which qualifies under Sec. 354, 355 or 356.
The IRS ruled that the split will qualify for tax-free treatment and specifically ruled that the transaction qualified as a "D" reorganization, neither corporation nor shareholder will recognize any gain, the basis in all assets of both corporations are maintained and the holding periods are taxed on from the prior corporation and the earnings and profits, if any, will be allocated between the two companies under Sec. 312(h) and Reg. §1.312-10(a).
Be aware that there are numerous pitfalls in trying a "D" reorganization. Among other items, IRS expressed no opinion regarding whether the Split-Off: (i) satisfied the business purpose requirement of Reg. §1.355-2(b)); (ii) was used principally as a device for the distribution of the earnings and profits of either company; or (iii) was part of a plan (or series of related transactions) pursuant to which one or more persons will acquire directly or indirectly stock representing a 50% or greater interest in either company and under Code Sec. 355(e) and Reg. § 1.355-7.
FBAR ReportingApril 16, 2014
Today is April 16, 2014 and the 2013 filing season is now behind us. Some of us filed on time and others are on extension until October 15, so all of us have temporarily forgotten about our tax filings for a while. But there is another filing deadline creeping up on June 30. That is the deadline for reporting foreign accounts aggregating at least $10,000. For many years, filing an information return to report foreign accounts was done on a paper return called a TD F 90-22.1. This form no longer exists. Now that form can only be filed electronically. It is form 114 and it is filed with the Financial Crimes Enforcement Network (FinCEN) of the Treasury Department. Get stated at http://bsaefiling.fincen.treas.gov. Happy filing.
Tax Court Rules on an IRA Prohibited Transactions CaseApril 8, 2014
In Ellis v Comm., T.C. Memo. 2013-245 (T.C. Memo 2013), the United States Tax Court ruled that funding an IRA with the taxpayer's used car business was a prohibited transaction. The Court determined that by paying himself a salary and pay rent to an entity owned by his immediate family was prohibited under Section 4975 of the I.R.C. The Court ruled that it was not a prohibited transaction when the taxpayer first caused the IRA to invest in the business since the business did not have owners at the time. But when the taxpayer became a fiduciary by virtue of the IRA holding more than 50% of the ownership interest in the business, the Court ruled that the company then became a disqualified person. When he paid himself salary, this was a prohibited transaction also. Thus, the IRA was deemed to have distributed the entire account subjecting the whole to income tax and a 10% additional tax on early distributions.
Prior to ever having an IRA invest in any business, be sure to consult your tax advisor as disastrous results could result as evidenced by the Ellis case above.
Proposed Legislation Would End NY Estate Tax Savings OpportunityFebruary 18, 2014
As soon as April 1, 2014, New York residents might lose the opportunity to reduce (or even eliminate) their New York estate tax through lifetime gifts!
With the federal estate and gift tax exemption at $5,340,000 for 2014 and increasing in future years as it is indexed with inflation, gifting has been a common method used by New York residents to reduce their future New York estate tax. However, Governor Cuomo has proposed legislation that would prevent that reduction method from being effective. Although the proposed legislation does gradually increase the New York estate tax exemption from $1,000,000 to $5,250,000 over five years and lowers the top tax rate (from 16% to 10%), it would also require that all taxable gifts made after March 31, 2014, shall be included as part of a taxpayer’s gross estate for purposes of calculating the New York estate tax.
Consequently, New York residents making lifetime gifts before April 1, 2014, can benefit from potentially substantial tax savings. Such gifts could be made directly to persons or could be to a trust for the benefit of certain persons. However, no matter the method of the gift, April 1, 2014, is arriving quickly and time is of the essence to make gifts to reduce New York estate tax.
Automatic Extension for Portability Election for Certain Taxpayers Revenue Procedure 2014-18 (eff. as of Jan. 27, 2014)February 7, 2014
The Internal Revenue Service (IRS) has recently provided a procedure under which estates of decedents that died before January 1, 2014, that fall below the dollar threshold for having to file an estate tax return, and that want to elect to make the estate tax portability exclusion can obtain an automatic extension of time to make that election.
The American Taxpayer Relief Act of 2012 established the permanence of the portability of a deceased spouse’s unused federal unified credit to the surviving spouse. However, for the surviving spouse to receive the deceased spousal unused exclusion (also known as DSUE) amount, the executor of the deceased spouse’s estate must meet certain requirements, including filing a Form 706 (U.S. Estate (and Generation-Skipping Transfer) Tax Return) with a computation of the DSUE amount and an election to use the portability. Thus, a portability election is due on the due date of an estate tax return (i.e. 9 months after date of death).
Where an estate is filing an estate tax return only to make a portability election, Treasury Regulation § 301.9100-3 provides that an extension of time would be permitted if the taxpayer established to the IRS’s satisfaction that the taxpayer acted reasonably and in good faith and that the grant of relief will not prejudice the interests of the government.
According to the new Revenue Procedure 2014-18, taxpayers who meet the following requirements will be deemed to meet the above requirements for an extension of time:
1. The taxpayer is the executor of the estate of a decedent who: (a) has a surviving spouse; (b) died after Dec. 31, 2010 and on or before Dec. 31, 2013; and (c) was a U.S. citizen or resident on the date of death.
2. The taxpayer was not required to file an estate tax return under § 6018(a).
3. The taxpayer did not timely file an estate tax return.
4. A person permitted to make the election on behalf of a decedent must file a complete and properly-prepared Form 706 on or before Dec. 31, 2014.
5. The person filing the Form 706 on behalf of the decedent’s estate must state at the top of the Form 706 that the return is “FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A)”.
As the Revenue Procedure references Revenue Ruling 2013-17, which allowed taxpayers in a same sex marriage to file original returns, amended returns, adjusted returns, or claims for credit or refund for a related overpayment of tax, the IRS seems to remind us that this new automatic extension also applies to same sex marriages. Whether a same sex marriage or a traditional marriage, this automatic extension is a notable opportunity for surviving spouses to increase their federal unified credit and pay less estate tax down the road. Who knows – a surviving spouse might win the lottery one day!
U.S. and Canada Sign Tax Avoidance AgreementFebruary 6, 2014
The list of countries signing deals with the United States has grown to twenty-two (22) now that Canada and the United States have signed a tax-information sharing agreement to crack down on tax avoidance by U.S. taxpayers.
The intergovernmental agreement (“IGA”) prevents Canada from having to hand over information to the Internal Revenue Service under FATCA and instead, Revenue Canada collects information from Canada’s banks and share it with the IRS under an existing bilateral tax treaty. FATCA was signed in 2010 and was originally scheduled to take effect on January 1, 2013. But in 2011, the effective date was moved to January 1, 2014 and then moved forward again to July 1, 2014.
The IGA exempts some smaller financial institutions and certain Canadian registered savings plans.
While it is estimated that there are about 1,000,000 citizens of the U.S. residing in Canada, it is unclear how many U.S. Citizens would be affected by the IGA.
Banks are scheduled to commence collecting information in July and Revenue Canada will commence reporting to the IRS in 2015.
Per the U.S. Supreme Court, Every Citizen has Every Right to Save Taxes LegallyDecember 23, 2013
The U.S. Supreme Court decision, that it is every taxpayer’s right to legally save taxes, has been around for one hundred forty years.
“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” United States v. Isham, 84 U.S. 496, 506, 21 L. Ed. 728 (1873); Gregory v. Helvering, 293 U.S. 465, 469, 55 S. Ct. 266, 267 (1935); Superior Oil Co. v. Mississippi, 280 U.S. 390, 395, 396, 50 S. Ct. 169, 74 L. Ed. 504 (1930); Jones v. Helvering, 63 App. D.C. 204, 71 F.2d 214, 217 (D.C. Cir. 1934).
Almost one hundred years ago, the Supreme Court held further that “A taxpayer may resort to any legal methods available to him to diminish the amount of his tax liability.” Bullen v. State of Wisconsin, 240 U.S. 625, 630, 36 S. Ct. 473, 60 L. Ed. 830 (1916). In Iowa Bridge Co. v. Comm., 39 F.2d 777, 781 (8th Cir. 1930), the Eighth Circuit said: ‘In fact, it is held that even thought the transaction is a device to avoid the burden of taxation, or to lessen that burden, it is not for that reason alone illegal.‘
So with this holiday season upon us, keep in mind that it is perfectly legal to choose transactions tax favorably.
Swiss Banks Likely to Cave and Disclose U.S. Accounts to U.S. AuthoritiesDecember 11, 2013
Switzerland's private banks are deciding whether to disavow centuries of secrecy and bow to U.S. pressure to disclose accounts of U.S. persons. The Swiss banks are otherwise going to have to face fines and possible criminal prosecution. Most of the smaller banks are expected to participate but are wrestling with the risk of customer backlash if they concede and disclose customer confidentiality. Back in 2009, Switzerland's largest bank, UBS was fined $780 million and handed over the names of its U.S. customers to avoid facing criminal charges.
If you are a U.S. person with an account in Switzerland and have not properly reported same, you should seriously consider entering the voluntary offshore account program offered by the Internal Revenue Service.
Internal Revenue Service extends deadline for abused innocent spouses to apply for relief from 2 years to 10 yearsDecember 9, 2013
To help victims of domestic violence and others, the Internal Revenue Service has proposed rules to extend from 2 years to 10 years, the amount of time taxpayers can apply for "innocent spouse" relief. Every year approximately 50,000 people apply for innocent spouse relief and some of them are involved in domestic disputes or physical abuse. IRS said it would stop enforcing a two-year deadline to file an innocent spouse relief application in 2011. The recent proposal would make the 10-year deadline permanent in law. The proposed rules also stop the IRS from demanding unpaid taxes while the innocent spouse application is being processed.
Federal District Court in Wisconsin Rules Parsonage Allowance to Clergy is UnconstitutionalNovember 27, 2013
The United States District Court for the District of Wisconsin in Freedom from Religion Foundation, Inc. v. Lew, 112 AFTR 2d 2013-5565 (D. WIs. 2013) has held that the clergy housing parsonage allowance pursuant to Code Sec. 107(2) is unconstitutional.
It issued an injunction ordering the Commissioner of Internal Revenue to stop allowing the exclusion to gross income. The Order is not to take effect until the conclusion of any appeals (sure to be) filed by the Government. FFRF is a non-profit organization that advocates for the separation of church and state that brought the action against the Treasury Department and Internal Revenue Service.
Pursuant to Code Sec. 107, in the case of a minister of the gospel, gross income does not include:
- The rental value of a home furnished to him, or the cost of utilities paid for him, as part of his compensation; or
- The rental allowance paid to him as part of his compensation, to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home, including furnishings and appurtenances such as a garage, plus the cost of utilities.
The Internal Revenue Service has previously ruled in Rev. Rul. 70-549, 1970-2 CB 16 that the parsonage allowance exclusion only applies to a duly ordained, licensed, or commissioned member of the clergy.
The case is legally fascinating on many levels. The suit sought a declaration that the parsonage allowance violates the equal protection clause of the Fifth Amendment and the Establishment Clause of the U.S. Constitution. FFRF had a couple of hurdles to climb.
First, FFRF needed to show it had standing to sue and it successfully accomplished this by claiming that it was - in fact - injured because its owners were denied the exemption that the clergy receives. Second, FFRF needed to show that the parsonage allowance violates the establishment clause. The District Court here agreed with FFRF and relied upon Texas Monthly, Inc. v. Bullock, (Sup Ct 1989) 489 U.S. 1 (1989) which held that a state statute exempting religious writing from sales tax was unconstitutional.
In developing its reasoning, the District Court stated that a reasonable observer would view the parsonage allowance as an endorsement of religion. Stay tuned as this landmark decision will be most certainly appealed through the appellate court and most likely the Supreme Court and Congress may be asked to weigh in and perhaps redraft the parsonage allowance in a way that does not violate the Constitution.
Internal Revenue Service To Get TougherNovember 25, 2013
Most people fear an Internal Revenue Service audit but starting in January, the IRS will start setting strict deadlines for compliance with its Information Document Requests ("IDR").
While those deadlines currently do not exist, for wealthy taxpayers and companies with more than $10 million in assets, the deadlines will apply. Initial IDRs will not be under a strict guideline. But if the initial deadline is not met, then under the new policy, a 49-day clock will start ticking.
After two warnings, a 49-day warning goes into effect. If the information still is not divulged, the agency will go to federal court to seek a summons. This step could expose the audit to the public and pose a risk to investors because the existence of an IRS summons can signal IRS trouble for a company, risking a blow to investor confidence and ultimately the share price.
The compressed timeframes can yield uncertainty and there will be more court cases involving summons enforcement.
Per IRS: Married Same Sex Couples Are Married But Unwed Same Sex Couples Are NotNovember 18, 2013
In June, the United States Supreme Court in U.S. v. Windsor, 111 AFTR 2d 2013-2385, struck down section 3 of the Defense of Marriage Act (DOMA).
As such, the Internal Revenue Service determined that married same-sex couples are married for federal tax purposes. However, the IRS's website continues unequivocally that same sex (and opposite sex) individuals who are in registered domestic partnerships, civil unions, or other similar relationships that are not considered marriages under State law are not considered as married for federal tax purposes. Thus, those couples are not permitted to file federal tax returns using a married filing jointly or married filing separately status.
All other Code provisions that only apply to married taxpayers similarly do not apply to registered domestic partners. They are simply not married for federal tax purposes.
Also, if the partner is dependent, he cannot be claimed as a dependant because he is not one of the specified related individuals in Code Sec. 152(c) or Code Sec. 152(d) that qualifies the taxpayer to file as head of household.
Domestic partners who reside in community property states and who are subject to their State's community property laws are also addressed by the Internal Revenue Service website. Registered domestic partners must each report their own separate income plus half the combined community income earned by the partners.
Internal Revenue Service Aggressively Pursuing U.S. Banks for Ties to Offshore AccountsNovember 14, 2013
The Internal Revenue Service is issuing "John Doe" Summonses on major U.S. based banks.
The IRS uses John Doe summonses to obtain information concerning possible tax fraud by persons whose identities are unknown. Two federal judges from the Southern District of New York have authorized the summonses on five banks (Bank of New York Mellon ("Mellon"), Citibank, JP Morgan Chase Bank ("Chase"), HSBC Bank USA ("HSBC"), and Bank of America ("BOA") requiring them to produce records relating to U.S. taxpayers with offshore accounts.
Judge Kimba Wood authorized the summonses on November 7, requiring Mellon and Citibank to produce information about U.S. taxpayers by holding interests in undisclosed accounts at Zurcher Kantonalbank and its affiliates ("ZKB") in Switzerland. Then on November 12, Judge Richard Berman authorized the summonses requiring Mellon, Citibank, Chase, HSBC and BOA to produce similar information in connection with undisclosed accounts at the Bank of N.T. Butterfield & Son Limited and its affiliates ("Butterfield") in various offshore locations including the Bahamas, Barbados, Cayman Islands, Guernsey, Hong Kong, Malta, Switzerland, and the United Kingdom. The summonses seek records identifying U.S. taxpayers with accounts at ZKB and Butterfield.
According to the Department of Justice ("DOJ"), the IRS Offshore Voluntary Disclosure programs have identified 371 previously undisclosed accounts at ZKB and 81 such accounts at Butterfield. As such, the IRS has reason to believe that other U.S. taxpayers may hold undisclosed accounts at ZKB and Butterfield in violation of federal tax law.
The Offshore Voluntary Disclosure programs have thus been successful in not only getting taxpayers to fess up (without risk of criminal prosecution) but those who have come forward have helped the Internal Revenue Service to understand the process used and thereby find the taxpayers who have not come forward and pursue them more aggressively.
Recent Tax Court Case Outlines Factors in Determining Whether the Commissioner's Determination of a Fraud Penalty Should Be Upheld Against Taxpayer's Omitting IncomeNovember 5, 2013
In McClellan v. Comm., T.C. Memo. 2013-251 (Oct. 31, 2013), Tax Court Judge Laro discussed the nine factors for whether to impose the 75% penalty found in I.R.C. Sec. 6663.
They are referred to as nonexclusive "badges of fraud" from which the Court may infer a taxpayer's fraudulent intent. They are: (1) understanding income, (2) maintaining inadequate records, (3) failing to file tax returns, (4) giving implausible or inconsistent explanations of behavior, (5) concealing assets, (6) failing to cooperate with tax authorities, (7) engaging in illegal activities, (8) attempting to conceal illegal activities, and (9) dealing extensively in cash. Bradford v. Comm., 796 F.2d 303 (9th Cir. 1986). Here, there were six of the nine present: 1, 2, 4, 5, 6 and 9. The court therefore determined that the Commissioner had proven fraud by clear and convincing evidence.
This case highlights how fraud cases are dealt with currently by the Tax Court.
Effect of Government Shutdown on IRSOctober 11, 2013
As a result of the government shutdown, the IRS's operations have been scaled back. However, taxpayers must not also go on hiatus. In fact, taxpayers must continue to meet their tax obligations as usual.
Background on the government shutdown. The House and Senate have failed to pass a spending bill to keep the government funded. Thus, the government was shut down on October 1. The House passed several versions of the spending bill all of which contained provisions that would either delay, reduce or eliminate funding for, or otherwise make changes to Obamacare. Each time, the Senate, rejected the House versions of the bill and repeatedly sent a version without Obamacare changes to the House. This shutdown will continue until Congress can somehow get together and resolve this standoff.
Effect on IRS. The shutdown affects nearly all governmental agencies, including the IRS. The IRS has set forth a list of the following pending the shutdown.
- Continue filing returns and making deposits on time. The filing extension through to October 15, 2013 is still in effect.
- All other tax deadlines remain in effect. White the IRS will accept and process all tax returns with payments. There will be no refunds issued during the shutdown.
- There will be no in-person or live phone assistance, but most automated toll-free telephone systems will remain available. All IRS walk-in taxpayer assistance centers will be closed. The website will remain available, but some of its interactive features may not be available.
- Any appointments with the IRS are cancelled. IRS personnel will reschedule those meetings at a later date.
- Automated notices will continue. IRS won't be working any paper correspondence during the shutdown, but automatic notices will continue to be mailed.
Negotiations on a Tax Information Exchange Agreement Between the U.S. and the Cayman Islands ConcludeAugust 20, 2013
The Cayman authorities have announced that the Cayman Islands and the United States have "concluded negotiations" regarding the Foreign Account Tax Compliance Act (FATCA). The consensus reached a Model 1 Intergovernmental Agreement (IGA) and a new tax information exchange agreement (TIEA). The United States has been putting pressure on foreign governments in its initiative to gather tax dollars from U.S. citizens and permanent residents who have assets overseas but are not reporting the income. Under this pressure, Wayne Panton, the Cayman's minister for financial services said: "as an international financial center that contributes to the efficient functioning of global markets, the initialing and subsequent signing of the IGA and new TIEA with the United States will again demonstrate Cayman's commitment to engage in globally accepted tax and transparency initiatives."
We have all heard of late, the cooperation that has been occurring between the U.S. and the Swiss Government and between the U.S. and the Israeli Government. Any U.S. citizen or resident with assets overseas - whether in Switzerland, Israel, Cayman or anywhere else, that has not been property reporting same, should consider speaking to an attorney to discuss the alternatives.
Appellate Court Affirms the Tax Court That the Period to Petition the Tax Court for Denial of a Collection Due Process Hearing is 30 DaysJuly 29, 2013
In Gray v. Comm., 112 AFTR 2d 2013-5103 (7th Cir. 7/23/2013), the Seventh Circuit Court of Appeals upheld the determination of the Tax Court and found that the Tax Court lacked jurisdiction to review a collection action because more than 30 days had elapsed.
The Seventh Circuit concluded that the Tax Court properly determined that it lacked jurisdiction where the taxpayer failed to comply with the 30-day time limit pursuant to Code Sec. 6330(d)(1). Section 6330(d)(1) is the section providing the Tax Court with jurisdiction to appeal a notice of determination after a collection due process ("CDP") hearing. In Gray, the taxpayer attempted to use the traditional 90-day time limit for challenging a notice of deficiency under Code Sec. 6213(a). But the 7th Circuit found that Sec. 6213 was only applicable to notices of deficiency, not denial of collection due process.
By way of background, taxpayers are entitled to a CDP hearing pursuant to Sec. 6330(b)(1) prior to collection activity taking place. Prior to levying on property, the IRS is required to provide written notice to the taxpayer of the taxpayer's right to a hearing to dispute the collection action. Code Sec. 6330(a). If the taxpayer requests a hearing within 30 days of the notice, an IRS appeals officer (with no prior involvement in the matter) will review the issues that the taxpayer requests. Code Sec. 6330(b) and (c). After the hearing, the IRS will issue a notice of determination, ruling on whether the proposed collection action is justified after considering the taxpayer's objections. Code Sec. 6330 (c)(3). If the taxpayer is not satisfied with the determination, he may within 30 days of such a determination Petition the Tax Court. Code Sec. 6330(d)(1).
Procedurally, in the Gray case, the taxpayer filed to Petition more than 30 days after receiving the notice of determination. Thus, the IRS filed a motion to dismiss for lack of jurisdiction based on filing out of time. While the taxpayer objected to the motion the Tax Court sided with the IRS and the 7th Circuit followed.
Conclusion, when petitioning the Tax Court for review of a determination of a collection due process hearing, be certain to file within the 30 day time period or be barred from further appeals.
John Hom Gets Caught "All In" by Tax CourtJuly 12, 2013
Poker player Jon Hom's bluff was called in a U.S. Tax Court decision: John C. Home v. Comm., T.C. Memo 2013-163 (Tax Ct Memo 2013). Hom had failed to substantiate his gambling losses so his winnings were unreported. He represented himself at trial.
Background: Net gambling winnings are taxable while net gambling losses are not deductible. I.R.C. §165(d). This rule also applies to professional poker players where gambling losses exceed gambling income.
Decision: Hom earned income from various poker tournaments including a $136,695 victory from Grand Sierra Resort & Casino in 2007. Yet he reported net gambling losses in each year. The Court held that he could not substantiate his losses or his expenses and charged him with tax on the winnings. Hom asked the court to let him estimate, but that plan got trumped by the Tax Court because there was no evidence from which to estimate. The court allowed only a few hundred dollars for entry fees. Additionally, the court imposed accuracy related penalties pursuant to I.R.C.§ 6662 of 20% of the underpayment.
Conclusion: Representing yourself in the Tax Court can be disastrous. Gamblers (like all taxpayers) must keep accurate records of their expenses and losses or risk losing the ability to claims the deductions.
Understanding Estate Inheritance Taxes in New JerseyJuly 8, 2013
New Jersey residents should be aware of the Federal Estate Tax, New Jersey Estate Tax and/or other New Jersey Inheritance Tax to pay on death. The federal estate tax of 40 percent is the highest, but that tax kicks in only for estates in excess of $5.25 million indexed for inflation in 2013.
There is also a New Jersey estate tax, which has a lower rate, but kicks in for estates of only $675,000 and up. With proper planning, each spouse can utilize his or her $675,000 exemption amount so that the total a married couple can leave to anyone except a spouse on death is $1.35 million. The tax rate for New Jersey estates is a sliding scale, ranging from 4.8 percent for estates at $675,000, all the way up to 16 percent for estates over $10.1 million.
Planning to reduce New Jersey estate taxes typically involves a trust for the surviving spouse in order to allow utilization of the applicable exclusion amount of both spouses. These trusts are known as either credit shelter trusts, A/B trusts, disclaimer trusts or QTIP trusts. Since New Jersey does not assert a gift tax (though there is a federal gift tax), the gifting of assets before death may result in reduced estate tax.
New Jersey and Maryland are the only two states to impose both an estate tax and an inheritance tax. The New Jersey inheritance tax is a tax on transfers. The tax rate and exemption level depend upon the relationship between the person who receives the assets and the person who passed away. For example, transfers between husbands and wives and parents and children are completely exempt. The beneficiaries, referred to as "Class A," include parents, grandparents, spouses, domestic partners, civil union partners and children. Transfers to certain qualifying charities are also fully exempt. Transfers to beneficiaries in other categories are subject to the inheritance tax. Transfers above $25,000 to Class C beneficiaries are taxed at rates ranging from 11 percent to 16 percent. Class C beneficiaries include siblings and the spouses and civil union partners or children. Transfers to anyone else fall within the Class D category and if the transfer is $500 or more, the entire amount transferred is subject to tax at the rate of 15 percent to 16 percent.
Certain transfers are exempt from the New Jersey inheritance tax even if they are made to a Class C or Class D beneficiary; this includes life insurance that is payable directly to a beneficiary. The inheritance tax acts as a credit against the New Jersey estate tax to avoid double taxation of assets.
Both the New Jersey estate tax and inheritance tax act as liens on the property of the deceased taxpayer. The lien must be released by receiving a tax waiver, which in some cases will involve filing a formal return with the New Jersey Division of Taxation.
Good News for Innocent SpousesJune 10, 2013
The Internal Revenue Service ("Service") has announced that it will not contest the application of a case that went against it: the case of Wilson v. Comm., 111 AFTR 2d 2013-522 (9th Cir. 2013) which had affirmed TC Memo 2010-134. The Service did this is a pronouncement called an Action on Decision - AOD 2013-007, 06/04/2013. This AOD means that the Service will no longer argue in innocent spouse equitable relief cases either that the Tax Court's review is limited by the administrative record developed before trial.
By way of background, Sec. 6015 of the Internal Revenue Code affords relief from joint and several liability on a joint return to certain spouses, including equitable relief under Sec. 6015(f) where other relief provided by Sec. 6015 is not available. Sec. 6015(e)(1) provides that the United States Tax Court has jurisdiction to "determine the relief available" to one who files proper and timely Petition requesting equitable relief. The Service had previously argued in these cases that the scope of the Tax Court's review was limited to determining whether the Service had abused its discretion in denying equitable relief, and should be confined to matters contained in the administrative record. Based upon the AOD, it will no longer argue either of those positions in the Tax Court.
The Tax Court had been rejecting the Service's position in previous cases such as Porter v. Comm., 143 TC 203 (2009), and then Wilson. The Tax Court in Porter I, Porter II and Wilson and then the 9th Circuit in Wilson all ruled against the Service and determined that the Tax Court review of the case was de novo and not confined to the administrative record. So the Courts have stated, and the Service has now conceded, that the Tax Court is not limited to evidence developed in the administrative record and may look to other facts and the Tax Court's ability to grant relief is not dependent on a finding that the IRS abused its discretion in denying relief.
So now if the Service denies innocent spouse relief, instead of having to prove that the Service abused its discretion, a taxpayer must now only show she is entitled to such relief and if facts were not presented to the Service earlier, they may be presented for the first time in the Tax Court. This is a significant victory for innocent spouses who are stonewalled by the Service and may even make the Service kinder and gentler knowing the Tax Court will take a fresh look at the case.
Golfer Birdies in U.S. Tax CourtApril 17, 2013
Sergio Garcia, a golfer who is a citizen of Spain, has won a decision before the U.S. Tax Court over his sponsorship income. The decision will impact many international entertainment and sports personalities who are paid for sponsorships. The Internal Revenue Service had contended that Garcia owed over $1.7 million. The Tax Court ruled largely in Garcia's favor. The case involved different types of sponsorship fees. One type is for sports stars who wear branded apparel or display logos on their apparel. The other is royalties paid for using the images of the personality in advertising.
Image rights are not taxable to foreigners who pay taxes to their home countries, but fees earned for wearing the apparel or displaying logos in the U.S. is taxable in the U.S.
The Tax Court ruled that because Garcia is such a global icon for TaylorMade (owned by Adidas AG, a German company), he earned a 65 percent/35 percent split between non-taxable image rights and taxable service income.
The ruling means international sports and entertainment stars will prefer to write into their contracts larger royalty fees. Such stars might benefit from the ruling, depending on how their home countries tax royalties. Other golfers who are not as iconic have achieved a 50/50 split, so the 65/35 split could be considered a birdie for Garcia. Had he gotten a higher split, one might say he "eagled".
Bankruptcy Does Not Stay Tax Court or Circuit Court Cases in Tenth CircuitApril 2, 2013
For those of you who have a United States Tax Court case pending or under appeal and hoped to receive a stay by filing Bankruptcy, another U.S. Circuit has stated that stratagem does not work. In Schoppe, 111 AFTR 2d 2013-579, WL 1239935 (10th Cir. 2013), the Court of Appeals for the Tenth Circuit has concluded that a taxpayer's filing of a bankruptcy petition does not operate as a stay of his appeal of an adverse Tax Court decision under 11 U.S.C. 362(a)(1). The ruling is based upon the fact that a Tax Court Petition, by its nature, is initiated by the taxpayer rather than against the taxpayer by the Commissioner of Internal Revenue and therefore the automatic stay in Bankruptcy is not in effect. Pursuant to 11 U.S.C. 362(a)(1), a bankruptcy petition operates as a stay of "the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commence of the case under this title." Since a Tax Court is not "against the debtor," the stay is not in effect.
There is a circuit split regarding whether a proceeding is considered initiated by or against a debtor when a debtor files a Tax Court petition. The First, Third, Fifth and Eleventh, Haag v. U.S., 485 F 3d 1 (1st Cir. 2007); Rhone-Poulenc Surfactants and Specialties, LP v. Comm., 249 F.3d 175 (3d Cir. 2001); Freeman v. Comm., 799 F.2d 1091 (5th Cir. 1986); and Roberts v. Comm., 175 F.3d 889 (11th Cir. 1999) have held against the debtor by stating that a debtor does not initiate the proceeding by filing a petition. The Ninth Circuit, is alone however by characterizing the debtor's Tax Court petition as an effective continuation of the assessment procedure commenced by the administrative proceedings of the Internal Revenue Service that stays the taxpayer's appeal. Delpit v. Comm., 18 F.3d 768 (9th Cir. 1994)
Other Circuits have not chimed in, so the issue of the applicability of the stay in Tax Court cases is still unknown in the 2nd, 4th, 6th, 7th and 8th Circuits. Stay tuned.
Supreme Court Hears Two Days of Oral Arguments on the Constitutionality of DOMA in an Estate Tax CaseMarch 29, 2013
The United States Supreme Court, in the estate tax case of Windsor v. U.S., is considering the constitutionality of the Defense of Marriage Act (DOMA). It is a highly anticipated case and is considered such a landmark important case that the Court heard two days or oral argument. The case concerns a surviving same-sex spouse who is seeking an estate tax refund. An estate tax was paid because assets were left to a same sex spouse and the Internal Revenue Code under DOMA requires that no marital deduction is available for the estate. Although DOMA is not generally a tax law, it carries tax consequences for same-sex couples by requiring that they be treated as unmarried for Federal law purposes. The Court's decision may potentially have a major impact on the administration of the IRC.
By way of background, in 1996, Congress exacted, and President Clinton signed DOMA which in Section 3 defines marriage as the "legal union between one man and one woman as husband and wife."
The district court and the Second Circuit Court of Appeals both found in favor of the Taxpayer and ruled the provision of DOMA requiring a man and a woman for a marriage to be unconstitutional.
While waiting to see if the Supreme Court follows the lower Courts, it is generally recommended that same-sex couples in domestic partnerships of civil unions or marriages file protective claims for refund in the event that DOMA in invalidated. The impact of the decision may affect income tax as well so stay tuned for the result of what could be a monumental decision.
There is Still Uncertainty Following "Permanent" Tax Changes by the 2012 ATRAMarch 19, 2013
The American Taxpayer Relief Act of 2012 ("ATRA 2012") made substantial estate, gift and generation skipping changes and these changes are ostensibly permanent. These changes are summarized as follow:
The exemption amount is now $5 million per person, indexed for inflation after 2011. (For transfers in 2013, the exemption is $5.25 million.) The rate of tax is a flat %40 above the exemption. Portability is preserved meaning if the surviving spouse files a timely election on the Estate Tax return of the first spouse to die, the surviving spouse inherits any unused portion of the exemption from the predeceased spouse.
There are still many opportunities for tax reduction including using grantor retained annuity trusts ("GRATs") and discounting through family limited partnerships ("FLP") and family limited liability companies ("FLLCs").
According to a recently issued Congressional Research Service (CRS) report these "permanent" changes may be changed soon. It notes that there are some lingering proposals to crack down on perceived abuses. These changes include:
GRAT reform - A proposal would impose a minimum annuity term of 10 years, disallow any decline in the annuity, and require a non-zero remainder interest.
FLP and FLLC reform - Another proposal would disallow discounts for interests in FLPs and FLLCs. Courts will generally allow estates to reduce the fair market value when assets, including marketable securities, are left in FLPs or FLLCs.
Consistent valuation requirement. Currently, there is no explicit rule requiring the same valuation of fair market value of an estate asset for estate tax purposes versus for purposes of stepped up basis in the hands of the heir. A proposal would require the same value for both purposes.
Limit duration of GST trusts. A proposal would limit the life of a Generation Skipping Trust to 90 years.
Coordination of grantor trust and transfer tax rules. And finally, another proposal would cause inclusion of the assets of a grantor trust in the grantor's estate or cause there to be a gift tax if the grantor ceased being owner.
Conclusion: There are still techniques available to reduce estate, gift and GST taxes, but they may be fleeting so planning now is very important.
Fiscal Cliff Fallout- The New Investment Income TaxJanuary 7, 2013
Much has been said about the level of income at which there would be tax hikes coming out of the fiscal cliff negotiations around year end. We know President Obama had pushed for tax increases for "wealthy" individuals with income over $250,000 annually. The Republicans (who control the House of Representatives) wanted no increase for "wealthy" individuals. We all have read that there was a compromise and the higher tax bracket of 39.6% does not hit until income exceeds $450,000 for married couples filing jointly or $400,000 for unmarried filers. But what appears lost in all of this is the 3.8% increase for wealthy individuals on investment income.
Background: In 2010, Congress passed P.L. 111-152 to become effective 1/1/13. This law imposes a tax on investment income at the rate of 3.8% imposed against married individuals with income over $250,000 annually or unmarried individuals with income over $200,000 annually. The tax is imposed on the following types of income: interest, dividends, annuities, royalties, rents and business income from passive activities and businesses trading financial instruments.
While the increased 4.6% (over the 35% highest bracket) tax on income will not kick-in except for wealthy taxpayers above the $450,000 level (for married individuals), for purposes of the new investment tax, this new tax kicks-in at a much lower income level - $250,000 (for married individuals).
Tax Court Rules Payments to Settle Possible Beneficiary's Claims Against Estate are not Deductible for Estate Tax PurposesDecember 17, 2012
Distributions to beneficiaries are not deductible for Federal Estate Tax purposes while claims for estate expenses are deductible.In Estate of Bates v. Comm'r, T.C. Memo 2012-314 (Tax Ct. 2012), the Tax Court ruled that a decedent's estate could not deduct payments made to a caregiver who was also a named beneficiary under the decedent's instruments. The Tax Court opined that because the payments were made to settles the right to the caregiver's beneficial interests, rather than claims against the estate, they were therefore non-deductible payments.
This issue of whether a claim by a beneficiary is really a distribution or rather a payment of an expense is a fact sensitive question. Proper planning and presentation of appropriate evidence is therefore necessary to attempt to succeed to permit the deduction.
Expiring (Sunsetting) Estate and Gift Tax LawsNovember 13, 2012
Congress will likely battle over tax laws that are set to expire (sunset) by year end. It is likely that we won't know the status of certain estate and gift tax laws until late this year or possibly into next year.
Estate tax: The top rate goes up to 55%. A 5% surtax on the wealthiest of estates phases out the benefit of graduated rates.The unified credit exemption equivalent goes down to $1 million
The Code Sec. 2057 deduction for family-owned businesses is reinstated
The credit against state death taxes reverts
Portability rules: The rules allowing a surviving spouse's estate to use a previously deceased spouse's unused exclusion amount will expire.
Generation skipping transfer (GST) tax: The GST tax is reinstated, with a top rate of 55%, and the GST exemption amount is set at $1 million (plus inflation adjustment).
Gift tax: The top rate increases to 55%.
Installment payment of estate tax: Installment payment rules are modified.
Conclusion: Accordingly planners should plan for both best and worst case scenarios and then settle on a course of action when the legislative picture is clear.
Sole Shareholder Can Receive Employment Agreement Payment on Sale of Business Rather Than Corporation Because Shareholder Sold His Good WillNovember 12, 2012
In H&M, Inc. v. Commissioner, T.C. Memo 2012-290 (2012), the United States Tax Court determined that where a corporation sold its insurance brokerage while its sole shareholder entered into employment with the buyer, the compensation under the employment agreement was not a disguised purchase price payment to the selling corporation. The Tax Court determined that the shareholder's personal ability and other individualistic qualities were not a corporate asset (goodwill) that should be taken into account as part of the purchase price.
By way of background, the sale of a business often involves the transfer of tangible assets. These assets can constitute the goodwill of the business, a corporate asset and the shareholder's agreement not to compete with the buyer, along with an arrangement for the shareholder to provide future services. Two seminal Tax Court cases permit payments to shareholders rather than corporations, thereby precluding double tax treatment. Martin Ice Cream Co v. Comm., 110 T.C. 189 (1998), (personal relationships of a shareholder-employee aren't corporate assets where the employee has no employment contract with the corporation); MacDonald v. Comm., 3 T/C/ 720 (1944) (a corporation did not have any goodwill in the shareholder's ability, business acquaintanceship, and other individualistic qualities).
The Tax Court in H&M held that, in light of the shareholder's personal relationships, his experience in running all facets of an insurance agency and his responsibilities as manager of the bank's insurance agency, the compensation that the bank paid him was reasonable. The employment agreement contained an extensive list of duties that the shareholder was required to perform. Not only was the shareholder an insurance salesman, he also had significant management and bookkeeping responsibilities. He went from working around 40 hours per week before the sale to double that afterward. As such, H&M Court found the case to be akin to MacDonald and Martin Ice Cream Co. The Court specifically found that when customers came to the shareholder's agency, they came to buy from him. It was the shareholder's name and his reputation that brought them there. The Court further found that he had no agreement with H&M at the time of its sale that prevented him from taking his relationships, reputation, and skill elsewhere.
The H&M case provides ammunition to attorneys who structure transactions to avoid double tax on the sale by the selling shareholder entering into an employment agreement with the purchaser.
The IRS Liberalizes Offer In Compromise Terms Under "Fresh Start" Initiative in IR 2012-53October 9, 2012
The IRS has expanded its "Fresh Start" initiative - designed to help struggling taxpayers who owe taxes - by permitting more flexibility in its offer in compromise ("OIC") program. The new rule changes will permit certain taxpayers to solve their tax debts in two years, rather than waiting four or five years as previously required. The future income calculation has been lowered and the allowable living expense allowance category has been expanded. Now, the IRS will permit student loans and state and local delinquent taxes to be an expense allowance.
By way of background Code Section 7122 gave the IRS authority to consider an OIC (an agreement with the IRS that settles the taxpayer's tax liabilities for less than the full amount owed) where: (1) the taxpayer is unable to pay the tax; (2) there is doubt as to the taxpayer's liability for the tax; or (3) a compromise would promote effective tax administration because collection of the full amount of tax would cause economic hardship for the taxpayer, or compelling public policy or equity considerations provide a sufficient basis for compromising the liability. The OIC is filed using IRS Form 656 and Form 433-A and/or Form 433-B and pay the $150 processing fee that generally applies.
In considering an OIC, the IRS analyzes the taxpayer's net income and net assets to make a determination of the taxpayer's reasonable collection potential (RCP).
To come to the RCP, the IRS uses the Allowable Living Expense standards. The IRS has now recognized that many taxpayers are struggling to pay student loan bills and state tax bills, and so it has improved the OIC program to more closely reflect real-world situations.
The new OIC program requires the IRS only look at one year of future income rather than four years for lump sum offers or offers paid in less than 6 months. For offers paid in six to twenty four months, the IRS will look at only two years of future income, rather than five years.
The IRS is even allowing assets that have been dissipated unless the IRS can show the taxpayer sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) after the tax has been assessed or within six months prior to the tax assessment.
Finally, for on-going business, equity in income producing assets will generally be excluded in the RCP calculation.
The OIC program will now be available to substantially more taxpayers, if you think this may be of use to you or someone you know, please have them contact us.
Sometimes Even With Bad Partnership Documents, Estate Tax Discounting May Be PossibleOctober 8, 2012
In a recent 5th Circuit case, Thomas Lane Keller et al. v. U.S., 110 AFTR 2d 2012-5312 (09/25/2012) affirmed the district court and held that even though certain documents were not completed by her death, a decedent capitalized a family limited partnership (FLP) before her death. A refund of over $315 million to the estate was the result. The refund was principally the result of a valuation discount for the FLP interest.
By way of background, assets are often transferred to FLPs in the hope of achieving lack of marketability discounts and lack of control discounts. The discounts can result in substantial estate tax savings and in Keller, huge savings! The area of FLP Law is often hotly contested by the IRS. In Keller, the FLP had been formed but the assets (bonds in this case) had not been transferred on the date of Decedent's death on May 15, 2000. But, under Texas law, the Court ruled that Decedent's intent to transfer bonds info the FLP transformed those bonds into partnership property, even though she never formalized her intent.
Moral or the story - be sure to get competent legal counsel when engaging in transactions of this type.
Executors Themselves Can Be Personally Liable for IRS PenaltiesAugust 20, 2012
In a Chief Counsel Advice (201212020) recently announced, the IRS has set forth the situations whereby an executor can be found to be personally liable for the tax liabilities of an estate and the assets of the estate were already distributed to the estate's beneficiaries. If the executor knew or should have known of the tax when the estate still has assets to pay it, he can be held liable for the tax and penalties. He may also be liable as a transferee if he was also a beneficiary of the estate pursuant to Sec. 6901 of the Internal Revenue Code.
Background - Executor Liability: The United States Code provides that the IRS must be paid tax debts before beneficiaries receive distributions. 31 U.S.C. 3713(b). An Executor who pays an estate debt before paying debts due to the IRS "shall become answerable in his own person and estate" to the extent of the amount paid to preferred creditors. If an Executor can be held personally liable to the extent of the payments that he turned over to creditors other that the IRS. An Executor is only liable if he had notice of the tax debt (or a reasonably prudent person would be on notice) before making a distribution to another creditor.
Background - Transferee Liability: Sec. 6901(a) of the Code provides that the liability of a transferee of a taxpayer's property may be "assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxed with respect to which the liabilities were incurred." The IRS is thus authorized to collect taxes from transferees of Estates that failed to pay taxes.
Ruling: The Chief Counsel advice makes clear that the penalties asserted against the decedent for failure to file the appropriate information returns required for foreign trusts can cause liability to the Executor if he paid out any money or assets to beneficiaries or other creditors.
Lesson: If you become an Executor/administrator of an estate with any foreign holdings or trusts, be certain that all information returns were properly filed and do not distribute to any beneficiaries or even pay other debts, until potential liability for failure by the decedent to properly file all information returns is made.
Senators Are Divided on Estate Tax Reforms for 2013August 8, 2012
A Democratic bill initially drafted would increase the estate tax rate and lower the exemption: On July 17, 2012, Senator Harry Reid (D-Nev.) S. 3393, 112th Cong., 2d Sess. introduced the Middle Class Tax Cut bill, which would: (i) permanently reduce the exclusion amount from $5.12 million to $3.5 million; (ii) permanently raise the highest estate and gift tax rate (and the only GST tax rate) from 35% to 45% and (iii) make clear that there would be no adverse tax effect as a result of making a gift when the applicable exclusion amount was greater than the reduced amount in accordance with the Bill.
But then, the "Middle Tax Cut" bill was amended three days later, and the estate, gift and GST tax provision was eliminated. It is therefore felt that the Democrats will prefer to negotiate any estate tax reform from a position starting at a 55% top estate and gift tax rate (and flat 55% GST tax rate), a $1 million estate and gift tax exemption, and a $1 million GST exemption that is indexed for inflation after 1997. These are the rates and exemptions that will go into effect in 2013 unless Congress enacts changes.
A Republican bill, on the other hand, would retain the 2012 rates and exemptions through 2013: On July 19, 2012, Senator Orrin Hatch (R-Utah) introduced S. 3413, 112th Cong., 2d Sess. which would extend through 2013 the current 35% top estate and gift tax rate and the flat 35% GST rate, and the $5.12 million estate and gift tax exemption and GST exemption.
Tax Debt is Not Discharged in Bankruptcy Where Taxpayer's Late Return is Filed After IRS Already Assessed the TaxJuly 13, 2012
In re Wogoman, --- B.R. ----, 2012 WL 2562323 (10th Cir. BAP (Colo.) 2012)
The United States Bankruptcy Appellate Panel (BAP) for the Tenth Circuit has held that a debtor's Form 1010 filed after IRS has assessed the tax liabilities for the year involved did not qualify as a return, as defined in 11 USC 523(a)(19). As a result, the tax debt relating to this return was excepted from discharge under 11 USC(a)(1)(B)(i).
Background: A Bankruptcy filing can discharge taxes as long as the tax return is filed more than three years prior to the bankruptcy filing. However, where the return was filed late and the Internal Revenue Service already assessed tax based upon no return being filed in that year, the 10th Circuit determined the taxes for such year is not dischargeable in bankruptcy.
Thus, before filing bankruptcy, one should learn whether a late return was filed after an Internal Revenue Service assessment and be guided accordingly.
First Circuit Court of Appeals Finds No Abuse of Discretion in the I.R.S's Rejection of O.I.C.July 6, 2012
The Court of Appeals for the First Circuit, in reversing the Tax Court in Dalton v. C.I.R., --- F. 3d ---, 2012 WL 2334806 (1st CIR. 2012) determined that the Internal Revenue Service did not abuse its discretion in rejecting a taxpayers' offer-in-compromise (OIC). The 1st Circuit based its ruling on the fact that the taxpayers had failed to include in their asset disclosure trust property in which they retained a beneficial interest. Applying a more deferential standard in reviewing the IRS's determinations, the 1st Circuit held that the IRS acted reasonably in determining that the taxpayers were the owners of the property.
Background: An OIC is an agreement between the IRS and a taxpayer that settles the taxpayer's tax debt for less than the full amount owed. Pursuant to Treasury Regulations, OIC's will only be rejected by the IRS when the IRS determines that no basis for compromise is present or that the offer is unacceptable under the IRS's policies and procedures. (Code Sec. 7122(d)(3)(A), Treas. Reg. § 301.7122-1(f)(3))
Facts in Dalton: The IRS sought to collect trust fund recovery penalties from the Daltons but after a collection due process (CDP) hearing, the IRS rejected the Daltons' OIC because it failed to include their asset disclosures a nominee interest in trust property. The IRS determined that the Daltons retained a beneficial interest in the trust property under a nominee ownership theory and rejected their OIC. In Court, the Daltons contended that IRS's determination was an abuse of its discretion because the Daltons did not retain a nominee interest in the trust property after the trust was created, and thus didn't need to include the trust property in their assets for purposes of the OIC.
Tax Court Decision: The United States Tax Court determined that the trust wasn't a nominee of the taxpayers under Maine law so the Tax Court found that IRS had abused its discretion in rejecting the taxpayers' offer because it had premised that rejection on an erroneous view of the law. Dalton v. Comm., 135 TC 393 (2010).
1st Circuit Decision: The First Circuit, reversing the Tax Court's ruling, found that the IRS's nominee determination was reasonable and shouldn't be disturbed. Preliminarily, the First Circuit concluded that the Tax Court had applied the wrong standard of review. The First Circuit held that it was not a court's job to review IRS's CDP determinations afresh. Rather, its job was to decide whether: (1) The IRS's factual and legal determinations were reasonable; and (2) the ultimate outcome of the CDP proceeding constituted an abuse of the IRS's wide discretion.
The Court reasoned that the judicial review must be tailored to the purpose of the CDP process—that is, ensuring that the IRS's determination, whether of fact or of law, were not arbitrary. A court should set aside determinations reached by the IRS during the CDP process only if they were unreasonable in light of the record compiled before the agency. Any more intrusive standard of review would result in the courts inevitably becoming involved on a daily basis with tax enforcement details that judges were neither qualified, nor had the time, to administer. The Court concluded that its analysis was applicable whether an IRS determination reached during the CDP process was based on a purely factual question, or (as here) a mixed question of fact and law.
The 1st Circuit therefore held that the IRS acted within its discretion in refusing to accept the OIC because the evidence before the IRS was ample to justify its conclusion that the Daltons' valuable ownership interest in the property had to be considered when evaluating their OIC.
Import of Decision: The 1st Circuit teaches us two things: First, failure to disclose assets in an asset disclosure can cause the IRS to reject an OIC. Second, the determination by the IRS will rarely be disturbed by the Courts (at least those within the 1st Circuit.)
Tax Court Determines That You May Be Hit With Accuracy Penalties Even When Relying On Tax AdvisersJune 11, 2012
The Tax Court in SAS Investment Partners v. Comm., T.C. Memo 2012-159, has determined that a taxpayer's negligence was subject to the Code Sec. 6662(a) accuracy-related penalties because it failed to show that its reliance on its tax advisers established a reasonable cause and good faith defense. One of the advisors was a promoter who benefited financially from the transaction, and the other wasn't provided full and accurate information. As a general rule, Code Sec. 6662(a) accuracy-related penalty can be avoided under Code Sec. 6664(c)(1), for any portion of an underpayment if the taxpayer shows that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.
In a previous Tax Court case, Neonatology Associates v. Comm., 115 T.C. 43 (2000) aff'd 299 F.3d 221 (3rd Cir. 2002) reliance on the advice of a tax professional will only establish reasonable cause and good faith if the taxpayer claiming reliance on a tax professional proves that: (1) the adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser's judgment.
The Tax Court in SAS found that any reliance the taxpayer placed on the adviser's advice or the attorney opinion letter lacked good faith since the adviser was also the promoter of the transaction.
What we learn from the decision in SAS is that an independent tax adviser with full knowledge of the transaction should be hired in order to avoid the imposition of the accuracy-related penalty.
IRS Has Liberalized the Offer In Compromise Program - the So Called "Fresh Start" InitiativeJune 4, 2012
The Internal Revenue Service has expanded its offer in compromise ("OIC") program with a "Fresh Start" initiative. The initiative is designed to help struggling taxpayers who owe taxes, by offering more flexible terms for their OICs. The initiative allows taxpayers to resolve their tax debts in as little as two years, as opposed to four or five years previously. The IRS has now revised the calculation for the taxpayer's future income and expanded the allowable living expense allowance category amount. IRS will also allow taxpayers to claim as an expense their student loans and state and local delinquent taxes. These changes are now found in the Internal Revenue Manual (IRM) Sec. 5.8.5.
By way of background, pursuant to Code Sec. 7122, the IRS will consider an OIC where: (1) the taxpayer is unable to pay the tax; (2) there is doubt as to the taxpayer's liability for the tax; or (3) a compromise would promote effective tax administration because collection of the full amount of tax would cause economic hardship for the taxpayer, or compelling public policy or equity considerations provide a sufficient basis for compromising the liability. (Treas. Reg. § 301.7122-1(b)) A Taxpayer files Form 656 to make an OIC and typically Form 433-A, Collection Information Statement for Individuals, or Form 433-B, Collection Information Statement for Business. (Treas. Reg. § 301.7122-1(d)(1))
An OIC, if accepted by the IRS, results in an agreement between a taxpayer and the IRS that resolves the taxpayer's tax debt for less than the full amount owed. An OIC is generally not accepted if IRS believes that the liability can be paid in full through a payment agreement or in a lump sum. The IRS will compare the taxpayer's income and assets to determine the taxpayer's reasonable collection potential (RCP). The RCP is arrived at by utilizing the Allowable Living Expense standards. These standard allowances use average expenditures for basic necessities for taxpayers in various regions. The IRS has now recognized that many taxpayers are still struggling to pay their bills, and so has softened its position in the OIC program as follows:
For offers to be paid in five of fewer months, the IRS will now look at only one year or future income, rather than four years. For offers to be paid in six to twenty-four months, the IRS will now look at only two years of future income, rather than five years.
IRS has softened its stance on dissipated assets. The IRM now states that inclusion of dissipated assets in the RCP calculation is no longer applicable except where it can be shown the taxpayer has sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary or other income) after the tax has been assessed or within six months prior to the tax assessment. With the new more liberal rules, more OICs will be accepted.
Tax Court States that Timely Proper Receipts for Charitable Contributions from a Charity are Required for a Donation to be DeductibleJune 1, 2012
The United States Tax Court in Durden v. Commissioner, T.C. Memo. 2012-140 (May 17, 2012), held that an income tax deduction was properly disallowed by the Internal Revenue Service for a charitable contribution, because the charity did not provide a statement that no goods or services were provided in consideration for the contributions. The Tax Court had found that the first acknowledgment received by the taxpayer lacked a statement regarding whether any goods or services were provided in consideration for the contribution, and the second acknowledgment, which included that statement, was not contemporaneous. I.R.C. Sec. 170(f)(8)(A) provides: "No deduction shall be allowed under subsection (a) for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization that meets the requirements of subparagraph (B)." For donations of money, the donee's written acknowledgment must state the amount contributed, indicate whether the donee organization provided any goods or services in consideration for the contribution and provide a description and good faith estimate of the value of any goods or services provided by the donee organization. I.R.C. 170(f)(8)(B) and Treas. Reg. 1.170A-13(f)(2). A written acknowledgment is contemporaneous if it is obtained by the taxpayer on or before the earlier of: (1) the date the taxpayer files the original return for the taxable year of the contribution or (2) the due date (including extensions) for filing the original return for the year. I.R.C. 170(f)(8)(C) and Treas. Reg. 1.170A-13(f)(3). While the taxpayers have argued they substantially complied, the Tax Court would have none of it holding: Petitioners have failed strictly or substantially to comply with the clear substantiation requirements of section 170(f)(8), and their deduction for the charitable contributions in issue for 2007 must be disallowed.
Moral of the story: when making contributions to charities, obtain a statement from the charity indicating whether or not there was value received from the charity and maintain that receipt with your records in case you are audited. This should be obtained before the tax return claiming the deduction is filed.
US Supreme Court Rules in Favor of Taxpayer!May 8, 2012
It is not often that the US Supreme Court hears a tax controversy, and it is even rarer when the Supreme Court sides with the taxpayer. Yet that is precisely what happened last week in Home Concrete & Supply, LLC v. Commissioner of Internal Revenues. There had been a split amongst the Circuit Courts and the United States Tax Court over the applicable statute of limitations for a basis overstatement. By way of background, there were two choices. The normal statute of limitations is three years from the date the return is filed or the date it is due (whichever occurs later). But Code Sec. 6501(e) (1) (A) provides that there is a six-year limitations period for taxpayers who substantially omit income. The questions arose as to which limitations period should apply when a taxpayer overstates his basis over an asset. The Supreme Court ruled that an overstatement of basis is not an omission of income for purposes of the six-year limitations period. The Court decided to follow its earlier decision in Colony from 1958, in which it construed the nearly identical language of Code Sec. 6501(e) (1) (A)'s predecessor statute as referring only to items left out, controlled the outcome of this case.
Now that the conflict is resolved, taxpayers around the country will receive similar treatment and they will know when their returns can be challenged on a basis overstatement issue.
New Jersey Taxing Out-of-State Corporations Even When They Have No Office in the StateMarch 30, 2012
In a March 2, 2012 ruling in a case of first impression in New Jersey, the Appellate Division affirmed a Tax Court decision that out-of-state corporations which have even a single employee living in New Jersey and working from home are deemed to be doing business in New Jersey and must pay the corporate income tax. Telebright Corp., Inc. v. Director, New Jersey Div. of Taxation, 2012 WL 669964 (N.J. Super. A.D. 2012).
Telebright Corporation (the “Corporation”) is a software company incorporated in Delaware and located in Rockville, Maryland. The corporation employed Srisathya Thirumalai (the “employee”), who lived in New Jersey and worked from home, full-time to write software code for use in the corporation’s “ManageRight” web application. She communicated with her project manager by phone and e-mail and uploaded her work onto the corporation’s server. She never did any solicitation or sales work and was not reimbursed for expenses.
In an opinion published on March 24, 2010, Tax Court Judge Patrick DeAlmeida found that the following three of the five factors to determine whether a corporation is doing business in New Jersey were satisfied by the corporation: 1.) the existence of employees in New Jersey; 2.) the nature and extent of the New Jersey activities; and 3.) the continuity and regularity of the corporation’s activities in New Jersey.
Telebright Corp., Inc. v. Director, Div. of Taxation, 25 N.J. Tax 333, 341 (N.J. Tax, 2010).
The corporation appealed the decision and additionally argued that requiring it to pay corporate income taxes in New Jersey would violate the due process and commerce clauses of the U.S. Constitution. However, the Appellate Court affirmed Judge DeAlmeida’s decision and rejected the constitutional claims. 2012 WL 669964 at 5. With respect to the due process clause, the court ruled that the one employee working from home in New Jersey is a sufficient minimum contact with New Jersey for New Jersey to levy an income tax on the corporation. Id., at 3.
With respect to the commerce clause argument, the court ruled that since the employee is producing a portion of the corporation’s product in New Jersey and since the corporation benefits from the protections afforded to the employee by New Jersey law, a sufficient “definite link” or “minimum connection” exists between the corporation and New Jersey for New Jersey to levy an income tax on the corporation. Id., at 4, 5.
This decision will have a large impact on any out-of-state business which has New Jersey employees who work from their homes. If you are involved in such a business, you may want to consider consulting a tax attorney to discuss your legal options for minimizing your business’s taxes.
Clock is Ticking on Estate Planning in 2012February 27, 2012
In estate planning, there is a "use it or lose it" situation which might need to be completed before the end of the year. On December 17, 2010, President Obama, signed the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2020. The Act made significant changes to the estate, gift and generation-skipping tax regimes. It reduced the rats of estate, gift and GST tax to 35% and increased the estate, gift and GST tax exemptions to $5 million.
It also reunified the estate and gift-tax exemptions, where previously they were disparate. These provisions of the Act, will remain in effect only through the end of 2012. The Act is scheduled to sunset. This means that it will no longer be effective and the estate, gift and GST law will revert to the old law, with not nearly the advantages. Unless Congress enacts new legislation prior to then, beginning January of 2013, the law will revert to the laws in effect in 2001, and the top estate, gift and GST tax rates would revert to 55% with an exemption of only $1 million and the GST exemption of $1 million, but the GST would be indexed for inflation.
Accordingly, in order to avail yourselves of the benefits available under to 2010 Act, clients must consider engaging in the planning techniques that are discussed below as soon as possible. These techniques will likely significantly reduce the taxable estate, but only if they are taken advantage of during the period of the applicability of the 2010 Act.
The tool at out disposal this year, but not necessarily after this year, is the ability to make a non-taxable gift of $5 million. This amount is set to sunset back to $1 million.
Gifting can be accomplished through trusts where one is unwilling to divest full authority to the client. Leveraging the full $5 million can be accomplished through the use of LLC's or Family Limited Partnerships. Where the taxpayer wants to gift more than $5 million, this can be done, subject to gift-tax but at the lower 35% rates. The sale to an intentionally defective grantor trust is also an available tool which is recommended in many circumstances. GRATs are also possible under current law.
As a result of these changes, 2012 will be a year that offers particularly fortuitous estate planning opportunities. Accordingly, take action now or perhaps lose this valuable opportunity forever.
IRA Charitable Rollover Expired on Dec. 31, 2011January 9, 2012
Congress did not extend the IRA charitable rollover prior to Dec. 31, 2011, the date on which the rollover expired.
In 2011, taxpayers age 70½ or older could make tax-free charitable gifts of up to $100,000 per year directly from their Individual Retirement Accounts to eligible charities, including colleges, universities and independent schools. I.R.C. 408(d)(8). According to I.R.C. 408(d)(8)(F) that rollover expired at the end of 2011.
Earlier in 2011, Senators Charles Schumer (D-N.Y.) and Olympia Snowe (R-Maine) and U.S. Representatives Wally Herger (R-Calif.) and Earl Blumenauer (D-Ore.) introduced the Public Good IRA Rollover Act of 2011 (S. 557, H.R. 2502). The PGIRA would permanently extend and expand the IRA charitable rollover. As of this writing, the PGIRA has yet to occur. There is still a possibility that a short-term retroactive extension of the IRA charitable rollover will happen in 2012.
In the meantime, a taxpayer can still pull money out of an IRA as taxable income and receive a corresponding deduction for the amount given to the charity (assuming she meets the other criteria for deductibility). Under pre-2012 law, the rollover to charity was neither taxable nor deductible.
New Tax Changes Effective This YearJanuary 5, 2012
Certain important tax changes taking effect in 2012 or the end of 2011 will be highlighted in this post:
Selected business changes taking effect in 2012 and late 2011.
- Reduced bonus depreciation allowance for qualified property. For qualified property acquired and placed in service in 2012, a 50% (down from 100%) bonus first-year depreciation allowance applies under Code Sec. 168(k)
-Reduced expensing. For a tax year beginning in 2012, the Code Sec. 179 expensing election is reduced to $139,000, with a $560,000 investment-based ceiling (down from $500,000/$2 million). For tax years beginning after 2012, it will be further reduced to $25,000 with a $200,000 investment-based ceiling. Additionally for a tax year beginning after 2011, expensing can no longer be claimed for qualified real property.
Selected changes for the tax preparation industry. Largely in connection with IRS's preparer tax identification number (PTIN) requirements - E-file mandate. Beginning in 2012, tax return preparers who expect to file 11 or more individual, estate or trust returns in a calendar year must e-file. Rev. Proc. 2011-25, 2011-17 IRB.
Selected individual income, estate and foreign tax changes taking effect in 2012.
- Reduced alternative minimum tax (AMT) exemption amounts. Absent another AMT “patch,” the AMT exemption amounts for tax years beginning after 2011 revert to the significantly lower “permanent” amounts of $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for marrieds filing separately.
- Protective claims for estate tax refunds. For estates of decedents dying after 2011, a Code Sec. 2053 protective claim for refund of estate tax must be filed by either: (i) attaching one or more completed Schedules PC to the estate's Form 706 at the time the return is filed; or (ii) filing a Form 843 with the IRS office where the Form 706 for the decedent's estate was previously filed, with the notation “Protective Claim for Refund under Section 2053” entered across the top of page 1 of the Form 843. Rev. Proc. 2011-48, 2011-42 IRB 527.
- Reporting foreign assets. Beginning in 2012, U.S. taxpayers who have an interest in certain specified foreign financial assets with an aggregate value exceeding $50,000 must report those assets to IRS on Form 8938, Statement of Specified Foreign Financial Assets, with their tax return.
Expanded information reporting requirements does not take effect.
One highly controversial provision that was originally slated to take effect in 2012 was the expanded information reporting requirements added by the Patient Protection and Affordable Care Act. The PPACAh would have added payments for goods or other property and payments to non-tax-exempt corporations to the list of payments subject to information reporting. These expanded requirements were retroactively repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011.
IRS Has Invited Practitioners to Comment on the Tax Treatment of DecantingJanuary 4, 2012
Decanting is the estate planning practitioner's term for pouring over (decanting, so to speak) the assets of one irrevocable trust to another. Typically this is done when a trust has a provision that no longer is consistent with the desires of the original parties and they wish to make changes to the trust. Since the original trust was irrevocable, the initial trust cannot be amended, so decanting the assets of the first irrevocable trust into a second irrevocable trust is considered. The practice has become so popular that it is now on the radar of the Internal Revenue Service, which is trying to practice out what tax consequences, if any, such decanting should cause.
In I.R.S. Notice 2011-101, 2011-52 IRB, issued on December 27, 2011, the IRS requested that practitioners and any other interested parties provide comments on the income, estate, gift and generation-skipping transfer tax treatment of the transfer of assets from one irrevocable trust to another irrevocable trust. The IRS asked for comments in writing by April 25, 2012.
IRS Issued New Form 8857 Instructions Which Eliminates the 2-Year Filing Period for Equitable Innocent Spouse ReliefOctober 24, 2011
The IRS has now issued new instructions for completing Form 8857, Request for Innocent Spouse Relief. The new instructions explain the newly expanded filing deadline for claiming equitable relief.
By way of background, spouses are generally jointly and severally liable for the tax, interest and penalties (other than the civil fraud penalty) when they file a joint return. But, pursuant to Sec. 6015 of the Internal Revenue Code, relief from the liability can be avoided under any of three conditions: she did not have actual or constructive knowledge of the understatement of tax on a return (6015(b)); she is either no longer married to, or living apart from, the other joint filer and is only liable for her allocable share of any deficiency; (6015(c)); or if ineligible for relief under 6015(b) or 6015(c), where, in view of all the facts and circumstances, it would be inequitable to hold her liable (6015(f)).
Relief under 6015(b) (innocent spouse relief) or 6015(c) (separate liability relief), must be obtained not later than the date that is two years after the date that IRS has begun collection activities with respect to the individual making the election.
The courts and treasury were conflicted for years over whether the two-year period applied to equitable relief under 6015(f), in IR 2011-80 and Notice 2011-70, 2011-32 IRB 135. However, the IRS relief under 6015(f) to submit her request for equitable relief more than two years of IRS's first collection against the requesting spouse with respect to the joint tax liability.
The new instructions to Form 8857 now reflect the elimination of the two-year period for the equitable relief under 6015(f).
The New Estate and Gift Exclusion Amounts Have Just Been Released for 2012October 6, 2011
Unified estate and gift tax exclusion amount- For gifts made and estates of decendents dying in 2012, the basic exclusion amount will be $5,120,000(up from $5,000,000 for gifts made and estates of decendents dying in 2011)
Generation-skipping transfer (GST) tax exemption- The exemption from GST tax will be $5,120,000 for transfers in 2012 (up from $5,000,000 for transfers in 2011).
Gift tax annual exclusion- For gifts made in 2012, the gift tax annual exclusion will be $13,000(same as for gifts made in 2011).
Obama Sets Forth His Deficit Reduction Plan, Which Includes Estate and Gift Tax ChangesOctober 3, 2011
The Obama Administration has proposed a deficit reduction plan in which "The Administration supports the return of the estate tax exemption and rates to 2009 levels." This means that the estate tax applicable exclusion amount would go to $3.5 million (down from $5 million currently) and the gift tax exemption to $1 million (down from $5 million currently), and the top marginal rates would be 45% (up from 35% currently). Portability of a deceased spouse's unused estate tax applicable exclusion amount would remain under the President's proposal.
Fresh Planning Opportunities for Qualified Personal Residence TrustsOctober 24, 2011
Qualified personal residence trusts ("QPRT"s) have been an extremely useful estate planning tool for years. But now in 2011 and 2012, it is a particularly good time for QPRTs. Why? Three reasons:
(1) there is a new gift tax exemption available in the amount of $5M when it was previously only $1M. This allows much more gifting to take place.
(2) there is a potential valuation discount available for an undivided interest in real estate as set forth in Ludwick, TCM 2010-104 which allowed a 17% discount for lack of marketability and lack of control.
(3) the current depressed housing market has made QPRTs a very viable method because the lower the current value, the less the amount of gift tax exemption that needs to be used.
New IRS Notice Eliminates Taxation of Personal Use of Employer Provided Cell PhonesSeptember 23, 2011
When an employer provides its employees with cell phones primarily for business reasons, there is no taxation to the employee on either the business or personal use, and no recordkeeping of usage is required. Similarly, reimbursements by employers of an employee-provided cell phone for business use is not taxed. This notice applies for all tax years beginning with 2010. Notice 2011-72, 2011-38 IRB; IR 2011-93.
The normal rule for an employer providing property to an employee that has both business and personal uses is that no deduction is allowed for the personal, living or family expenses.
Generally an employee is taxed on the personal portion of any property provided to the employee. The IRS has declared, in effect, that the employee's personal use of an employer-provided cell phone is a tax-free de minimis fringe benefit.
The notice does require that there must be substantial reasons relating to the employer's business for providing the phone, other than providing compensation to the employee, in order for the employee not to be taxed. Examples include the need to contact the employee at all times for work-related emergencies, or the need for the employee to be able to speak with clients when he/she is away from the office or to call clients in other time zones after their normal workday is over. However, the notice provides that cell phones provided to promote employee morale or goodwill, to attract prospective employees or to provide additional compensation to employees is not provided primarily for noncompensatory business purposes.
The same rules of non-taxation of employer-supplied cell phones applies for employee reimbursements for their cell phones. However, reimbursements of unusual or excessive expenses or to reimbursements made as a substitute for a portion of the employee's regular wages will remain taxable.
Tax Advantages of Purchasing Property (including Qualified Real Property) for Business Use This YearSeptember 16, 2011
Pursuant to Sections 168 and 179 of the Internal Revenue Code, depreciation deductions and expensing deductions will be more generous in 2011 than in 2012 and beyond. To summarize, for business interested in purchasing new equipment or other business property, this is the year to do so. Now is the time to buy machinery and equipment before the advantages are set to expire. You can lock in accelerated deductions by buying qualifying assets this year, but that property must also be placed in service before year-end. Until the end of the year, in addition to tangible personal property, there is expensing allowed for qualified real property under Section 179(f)(1). This section permits expensing of up to $250,000 this year.
Qualified real property is:
(A) qualified leasehold improvement property described in Section 168(e)(6),
(B) qualified restaurant property described in Section 168(e)(7), and
(C) qualified retail improvement property described in Section 168(e)(8).
See Section 179(f)(2)(C)
In order to qualify as those real property, the property must be depreciable and acquired for use in the active conduct of a trade or business. However, the following types of property are not eligible: used for lodging, used outside the U.S., or used by governmental units, foreign persons or entities, or certain tax-exempt organizations, as well as air conditioning or heating units. Section 179(f)(1)(C).
The 10 Year Statute of Limitation for Collection After Assessment May Be Extended By an Offer in CompromiseAugust 22, 2011
The United States District Court in Nevada case of U.S. v. Booher, 108 AFTR 2d 2011-5113 highlights the fact that the IRS may pursue collection against a taxpayer even though it began after the 10-year time period generally allowed by law. The general rule under Section6502 of the Internal Revenue Code requires the IRS to begin a civil action to collect federal tax within 10 years after assessment or such assessment is released. However, Booher reminds us that under Section 6331(i)(5), the 10 year statute of limitations period is suspended during the time that an offer in compromise (OIC) is pending. In Booher the OICs filed extended the limitation period beyond the general 10 year period. Booher reminds us to obtain transcripts of account for taxpayers to ascertain whether or not the 10 year period has expired before taking action. Such transcripts will show the existence of OICs and the duration of their pendency.
Defined Value Gifts Approved by Ninth CircuitAugust 17, 2011
The U.S. 9th Circuit Court of Appeals in Estate of Petter v. CIR,__ F.3d__, 2011 WL 3332532 (9th Cir. Aug. 4,2011), just affirmed the United States Tax Court, holding that a taxpayer is not liable for transfer tax in a defined value gift scenario. The taxpayer in Petter claimed a charitable deduction for the value of a charity's share of a gift of interests in an LLC, where the gift documents transferred to the donor's children a fixed dollar amount of the interests as finally valued for tax purposes, and gave the balance to charity. The court also held that the taxpayer was entitled to a charitable deduction for the value of the additional assets transferred to charity upon the donees' final determination of the value of the LLC interests.
The affirmance gives planners more assurance that this type of planning opportunity will pass muster with the courts.
Senate Bill Proposes to Eliminate Short Term GRATsAugust 15, 2011
A Senate Bill - S.1286, 112th Cong., 1st Sess. (June 28, 2011) - was introduced by Senator Robert B. Casey (D-Pa.) which would set a minimum term for all grantor retained annuity trusts (GRATs) at 10 years. The bill would also prevent any decreasing annuity payment GRATs during the first 10 years, and would require that the remainder interest have a value greater than zero on the date the trust is created. The bill would make these changes retroactively to all transfers made after December 31, 2010.
Previously, short term GRATs of two years in duration, decreasing term GRATs and so called zero out GRATs were used effectively to save estate taxes.
This bill highlights the fact that we should move diligently to perform estate planning now.
IRS Rescinds Two-Year Limitation Period for Equitable Innocent Spouse ReliefJuly 29, 2011
The IRS in Notice 2011-70, 2011-32 IRB has just rescinded its position on a timeline within which to request equitable innocent spouse relief. It will no longer deny an individual's request for equitable relief under Code Sec. 6015(f) based upon it having been filed more than two years after IRS first acted to collect the liability from the individual. There are also transition rules for pending requests for relief, denied requests and cases in litigation or where the litigation is final.
Background: Each spouse is jointly and severally liable for the tax, interest and penalties stemming from a jointly filed income tax return. Code Sec. 6015(f) allows relief to a requesting spouse if, among other conditions, taking into account all the facts and circumstances, it is inequitable to hold the individual liable.
To be eligible for relief under Code Sec. 6015(b) (innocent spouse relief) or Code Sec. 6015(c) (separate liability relief), the Code explicitly provides that the requesting spouse must elect relief not later than the date that is two years after the date that IRS has begun collection activities with respect to the individual making the election. (Code Sec. 6015(b)(1)(E), Code Sec. 6015(c)(3)(B) ) However, no such limitation is written in Code Sec. 6015(f). The IRS had originally issued a regulation Reg. § 1.6015-5(b)(1) that states that the two-year rule also applies for equitable requests.
The Tax Court had repeatedly invalidated the regulation but the Third, Fourth and Seventh Circuits have rejected the Tax Court's position holding the regulation to be valid.
Until the regulation is formally changed, taxpayers can rely on the IRS notice.
The door is open for existing cases as well as previously denied cases to refile.
If however, payment was already made, no relief will be available.
Innocent spouses rejoice!
Tax Court Sets Value of a Publishing Company Lower than Initially Reported on Estate Tax Return!July 15, 2011
In Estate of Gallagher v. Comm'r, T.C. Memo. 2011-148 (June 28, 2011), the Tax Court set a value for an interest in a publishing company below the amount found on the estate tax return. The Tax Court applied the discounted cash flow method to determine the fair market value of the 15% interest held in a publishing company held by the decedent. The estate tax return had initially valued the decedent's portion of the publishing company at $34.9 million and on audit, the IRS determined the value to be $49.5 million. The estate petitioned to the United States Tax Court and obtained an independent appraisal indicating its value to be only $26.6 million. The Tax Court (Judge James S. Halpern, J.T.C. held the value of the decedent's interest to be $32.6 million (less than on the return), using the discounted cash flow method of valuation. The Court also applied discounts for lack of marketability and lack of control.
The upshot is that when the IRS challenges a valuation, sometimes you end up better off than the value that was placed on the return.
Pending Legal Malpractice Claim Against a Decedent is Disallowed as a Deduction Under the Federal Estate Tax If Claim Amount is UncertainJune 6, 2011
The United States Tax Court has held that a decedent's federal taxable estate for Federal Estate Tax ("FET") purposes may not include, as a deduction, a $30 million potential legal malpractice litigation claim pending against it as of the date of death. Rather, the amount actually paid during the administration of the estate is deductible for the FET. The test is whether the amount due is "reasonably certain" as of the date of death. See (Former) Treas. Reg. 20.2053-1(b)(3) and (Current) Treas. Reg. 20.2053-1(d)(4). In Estate of Saunders, 136 T.C. No. 18 (2011), the conflicting expert reports on the value of the claim as of the date of death, led the Tax Court to conclude that the value of the claim was too uncertain to be deducted based on estimates as of the date of death. Therefore, the court concluded that the deduction was required to be based on the ultimate outcome.
Facts: The taxpayer was an attorney who had a significant claim pending against him which alleged that he was a secret IRS informer against the interest of his client. The complaint requested over $90 million in compensatory damages plus additional punitive damages. After death, a jury returned a verdict in favor of the taxpayer and on appeal, the estate paid only $250,000. Prior to the jury verdict, the estate tax return was filed and a $30 million deduction was claimed for the malpractice claim. The IRS allowed a $1 deduction for the malpractice claim and assessed a $14.4 million deficiency.
Analysis: Code Section 2053(a) permits certain deductions in calculating the taxable estate, including litigation claims against the estate. However, to be deductible, the amount of the claim must be ascertainable with reasonable certainty. The Tax Court stated that it did not consider the subsequent settlement in its discussion of the question of whether the value of the claim was ascertainable with reasonable certainty as of the date of death. Instead, the Tax Court ruled based upon the various reports of the value of the claim. The Tax Court concluded that the claim was not deductible as of the date of death, and only the amount actually paid during the administration of the estate could be deducted in accordance with Prior Reg § 20.2053-1(b)(3). Current Treas. Reg. 20.2053-1(d)(4) would apply to new cases and the current regulation also requires: "A deduction under this paragraph (d)(4) will be allowed to the extent the Commissioner is reasonably satisfied that the amount to be paid is ascertainable with reasonable certainty and will be paid. In making this determination, the Commissioner will take into account events occurring after the date of a decedent's death."
Conclusion: It is important to understand the rules concerning claim deductibility when assessing the effect of potential lawsuits pending against a decedent in preparing the estate tax return and when addressing the concerns that the IRS will pose on audit of such claims.
Corporation Denied Income Tax Deduction for Management Fees Paid to Related EntityJune 1, 2011
A planning technique for individuals with closely-held business is to create a management company to provide services to the primary business. The primary business pays management fees to the management company for the services provided. Internal Revenue Code Section 162 allows for the deduction of the ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. Ordinary means an expense that is a common and accepted practice in the field of business, and necessary means an expense that is appropriate and helpful in carrying on a trade or business.
In Tax Court Memo 2011-105, the tax court denied a deduction from a subchapter S corporation for payment of management fees to a related corporation. In this case, the taxpayer had a corporation manufacturing trailers for recreational vehicles (the “primary corporation”). The corporation elected subchapter S corporate status. The taxpayer was sole shareholder of the primary corporation for the period in question. The taxpayer created a separate subchapter S corporation (the “management corporation”). The primary corporation entered into a management agreement with the management corporation, whereby the management corporation agreed to provide design, personnel and management services to the primary corporation. Millions of dollars were paid by the primary corporation to the management corporation in management fees over a three-year period.
The taxpayer could not provide evidence showing what services were performed by the management company on behalf of the primary corporation to substantiate the payment of the management fees. Thus, the Tax Court determined that the fees were not reasonable and necessary for the services provided.
It is possible for a client to have a primary corporation and a management corporation providing management functions to the primary corporation, and for the primary corporation to pay reasonable management fees for those services. However, the services provided must be ordinary and necessary, and the fees paid for those services must be reasonable and necessary.
Another Case of a Failed Family Limited PartnershipMay 23, 2011
In Estate of Erma v. Jorgensen, the Ninth Circuit Court of Appeals affirmed the Tax Court’s decision to include in the decedent’s gross estate for estate tax purposes the securities transferred by the decedent to two family limited partnerships. In this case, the decedent created two family limited partnerships during her life. She transferred securities to the two partnerships in exchange for interests in the entities. The facts show other family members were given interests in the partnerships as well without making capital contributions or reporting gifts on a timely filed gift tax return. Further, the partnership agreements granted the decedent check writing authority, which she exercised for her own benefit, despite the fact the decedent was not the general partner. Withdrawals were made by the decedent to make gifts to other family members, which were also not reported on gift tax returns. A withdrawal was also made after the decedent’s death to pay estate taxes.
The Tax Court determined and the Ninth Circuit agreed that the underlying assets of the family limited partnerships should be included in the decedent’s gross estate. The court concluded that the transfers of the securities to the partnerships were not bona fide sales for full and adequate consideration. Further, the court concluded there was an implied agreement when the transfers were made that the decedent would retain the economic benefits of the property even though the retained rights were not legally enforceable.
This case demonstrates the need for operating a family limited partnership as an ongoing business entity. The general partner should maintain decision-making authority on behalf of the partnership. Distributions made from the partnership by decision of the general partner should be made according to the terms of the partnership agreement. Allowing a partner to treat the family limited partnership as an open checkbook could result in the failure of the family limited partnership and the inclusion of the underlying assets in the partner’s estate for estate tax purposes.
Tax Court holds that the IRS May Reject a Taxpayer's Offer in Compromise Where He Dissipates Assets Through Day Trading LossesApril 29, 2011
The Tax Court just held in Tucker, TC Memo 2011-67 (Tax Court Memo 2011) , that a taxpayer's day-trading losses while owing taxes constituted the dissipation of assets. Thus, the lost assets were included in his reasonable collection potential ("RCP") analysis.
The procedure of the case went as follows: Tucker owed taxes, the amounts were not in dispute, but he claimed an inability to pay. In connection with the offer, Tucker submitted a Form 656, "Offer in Compromise" (OIC). The OIC was evaluated and IRS notified Tucker that it had determined he could pay the liability in full. Tucker requested a collection due process (CDP) hearing after a lien was filed.
The Appeals Office upheld the filing of the lien, and Tucker appealed to the Tax Court. Tucker sought review in the Tax Court, claiming Appeals abused its discretion in rejecting Tucker's OIC.
The Tax court held that the Service properly included the dissipated assets in its calculation of the taxpayer's RCP. The tax court determined that Tucker's losses from engaging in "the highly speculative and volatile activity of day trading" were not unforeseeable. He had had the cash in hand that would have paid in full the taxes, interest, and penalties that were owing, but chose rather to devote that money to a risky investment. The tax court therefore opined that Tucker's situation was therefore of his own making.
On April 5, 2011, Congress Repeals Expanded 1099 Information Reporting RequirementsThursday, April 21, 2011
The Senate, by a bipartisan 87-12 vote, approved H.R. 4, known as the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011. The Act retroactively repeals the previously enacted expanded Form 1099 information reporting requirements. This legislation was previously passed by the House of Representatives on March 3 by a 314-112 vote, which is now cleared for President Obama's expected signature.
Highlights of the Act include:
Beginning in 2012, recent legislation Patient Protection and Affordable Care Act of 2010 ("PPACA") would have expanded 1099 reporting requirements to all payments for goods or other property. The PPACA also provided that, beginning in 2012, payments to non-tax-exempt corporations -- which had previously been exempt from the reporting requirement -- would be subject to information reporting.
Additionally, for payments made in 2011 and thereafter, the Small Business Jobs Act of 2010 provided that a person receiving rental income from real estate of $600 or more to a service provider (for example, a painter or plumber) in the course of earning rental income would have to provide an information return to the service provider and IRS.
The ACT would retroactively repeal all of these onerous reporting requirements, effectively reverting to the previous reporting requirements.
Obama Administration States Tax Holiday for Corporations that Repatriate Income from Tax Haven Countries is Poor PolicySunday, April 03, 2011
The federal government loses corporate income tax revenue from the shifting of income into low-tax countries, often referred to as tax havens. The revenue losses from this tax planning are hard to estimate, but it has been suggested that the cost of offshore tax abuses may be around $100 billion per year. Pursuant to Section 862 of the Internal Revenue Code ("the Code"), corporations formed in the U.S. are taxable on certain income from outside the U.S. Foreign corporations with U.S. owners, however, can often earn and accumulate certain income without federal tax. For controlled foreign corporations (CFCs), defined in Section 957 of the Code, the non-U.S.-source income may be shielded from U.S. tax until it is actually brought back to the U.S. (i.e., repatriated and distributed to the U.S. owners). Remarkably, the American Jobs Creation Act of 2004 ("AJCA") provided a one year tax special treatment for CFCs to repatriate their income by providing an 85% dividends-received deduction. It has been estimated that approximately $312 billion was repatriated under this provision.
Recently, in a blog post on March 23 titled “Just the Facts: The Costs of a Repatriation Tax Holiday,” the Treasury Assistant Secretary for Tax Policy, Michael Mundaca, stated that there was no evidence that the AJCA repatriation tax holiday increased U.S. investment or jobs, and that it, in fact, cost taxpayers billions of dollars. He wrote that “just five firms got over one-quarter of the tax benefits of the repatriation holiday, and just 15 firms got more than 50 percent of the benefits,” and cited a Congressional Research Service report that found most of the largest beneficiaries actually cut jobs following the tax holiday and used the repatriated funds to repurchase stock and pay dividends.
President Obama Releases Budget Proposals for 2012, Including Permanent Estate and Gift Tax ReformsTuesday, March 01, 2011
On February 14, the Department of Treasury issued its “General Explanations of the Administration's Fiscal Year 2012 Revenue Proposals.” The proposals include the following significant provisions concerning estate, gift, and GST taxes:
The estate, gift and GST rates and exemptions in effect in 2009 would become permanent on January 1, 2013. Thus, the top estate, gift and GST tax rate would increase to 45% (from 35%), the gift tax exclusion would go down to $1 million (from $5 million), and the estate and GST basic exclusion amount would go down to $3.5 million (from $5 million);
The Treasury will be permitted to issue regulations that expand Section 2704(b) of the Code, to ignore certain valuation discounts in valuing partnerships, LLCs, and other entities;
GRATs would be required to have a positive value in the remainder interest in the GRAT, (no "zero out" GRATs) decreasing payment term GRATs would be prohibited and the minimum term of a GRAT would be 10 years;
"Portability" of the deceased spousal unused exclusion amount would become permanent; and finally
The allocation of GST exemption to a transfer would protect that transfer from GST tax for no more than 90 years.
These changes give what may be a once-in-a-lifetime opportunity to enter into short-term GRATs, decreasing term GRATs, family limited partnership or LLC planning with discounting before they are forever barred. These techniques can provide tremendous estate and gift tax savings.
Avoiding Retention of Transferred Real Estate in Taxable EstateFriday, February 18, 2011
Often, clients wish to transfer ownership in real estate to their heirs during life to remove the value of the asset from their taxable estate, but if the transferor retains control or enjoyment of the property, the planned transfer is likely to fail and the value of the transferred asset will remain in the taxable estate. Tax court memo 2011-22 Re Estate of Adelina C. Van serves as a case study of how to avoid inclusion of transferred real estate in the decedent’s estate.
Ms. Van resided in a home with her boyfriend. She negotiated to purchase the home from her boyfriend using funds provided by her daughter and son-in-law. Her daughter and son-in-law paid the entire consideration for the property. Ms. Van continued to live in the property until her death. Ms. Van took title to the property in her own name, but ultimately transferred ownership in the property to her daughter and grandchildren prior to her death. At her death, the estate tax return reported the existence of the residence, but did not list the house as an asset of the estate. The IRS responded with a tax deficiency notice determining the house should have been included as an asset of the estate.
The court first analyzed California law to decide what interest Van held at her death. The estate argued that Van never provided any consideration for the house, and only took title of the house as agent on behalf of her daughter and son-in-law. The court disagreed with the estate, holding that Van not only took title to the residence, but she also lived in the residence rent-free during her lifetime. Thus, Van held an interest in the property under state law during her life.
The court then had to determine if Van’s transfer of title to the house effectively removed the value of the asset from her estate. The court held that even where a decedent has transferred property before death, the value of such property can be included in the estate if the decedent retained a continuing interest in the property. In this case, Van continued to live in the residence rent-free until her death. Therefore, the court held that under IRS Code Section 2036, Van held possession and enjoyment of the house at her death, and the value of the house should be included in her taxable estate.
It is important for clients and estate planning to recognize that any transfers of property require the transferee to give up complete control, possession and enjoyment of the property. In this case, Van could have avoided inclusion of the property in her estate, if she had transferred title and retained no right to possess or enjoy the property for a period of more than three years prior to her death. Living in the house rent-free is an example of Van retaining possession of the property. If Van wanted to continue to use the property, she could have transferred title and then become a true tenant of the property with a valid, negotiated lease with rent determined at fair market. By entering into a formal lease, Van would have transferred the property out of her taxable estate and become a true, legal tenant of the property paying fair market rent to the new owners of the property. Van’s possession and rights in the property would have only extended to her right as a tenant and not as an owner of the property.
Most Recent Challenge to LLC DiscountsJanuary 28, 2011
Any client who uses limited liability companies to transfer wealth must be sure to respect the process of creating and funding the limited liability company (“LLC”) first before transferring ownership of the LLC to her heirs. A recent case decided by the Ninth Circuit Court of Appeals reversed the district court’s grant of summary judgment in favor of the IRS that determined the transfer of ownership of the LLC was actually an indirect gift of the underlying assets of the LLC.
In Linton, William A. v. U.S., (CA 9 January 21, 2011), the Ninth Circuit addressed a transaction by William Linton whereby he transferred wealth to trusts created for his children. In this case, William Linton created an LLC in November 2002. On January 22, 2003, Mr. Linton met with his attorney and executed documents transferring ownership in the LLC to trusts created for his children. The assignments and trust agreements remained undated after the meeting. The funding of the LLC happened on several dates between January 22 and January 31. A few months later, when the attorney was reviewing the corporate minute book of the LLC, the attorney dated the assignments and the trust agreements as of January 22.
A gift tax return was filed reporting the gifts of ownership in the LLC. The LLC was valued as if it was fully funded at the time of the gift. A 47% discount was applied to the LLC ownership interest transferred to the trusts. The IRS argued that no discount should be permitted since Mr. Linton had not made gifts of LLC ownership interest, but instead, made indirect gifts of the property contributed to the LLC. Thus, the issue is: did Mr. Linton fund the LLC first and then transfer ownership in the LLC as a gift allowing the gifted LLC interest to be discounted for lack of marketability and a minority interest; or did Mr. Linton gift ownership interest in an unfunded LLC and then indirectly make a gift to the trusts by funding the LLC, which would be valued at the full value of the assets that funded the LLC?
The Ninth Circuit determined that a gift is complete for federal tax purposes when the donor has parted with dominion and control of the property so that the donor no longer has power to change its disposition. State law dictates when a donor has parted with dominion and control. In this case, Washington state law determines a completed gift when: (1) there is an intention of the donor to give; (2) the subject matter is capable of delivery; (3) there is a delivery; and (4) there is acceptance by the donee. In this case, the Ninth Circuit determined the subject matter was capable of delivery, there was delivery no later than the date of the intent to donate, and acceptance can be presumed since the trustees did not disclaim the gift. The element to be decided was the intent to donate. The fact that the assignments were not dated creates a legal issue as to whether the intent to donate occurred during the meeting or sometime thereafter. Further, the fact that the attorney wrote the date on the assignments is not a sufficient objective manifestation of intent to donate at the time of the writing, or at all. The writing is effective when the donor puts the document beyond retrieval by delivering the document to the donee. The Ninth Circuit held the district court must determine on remand when the intent to donate occurred. Thus, this issue is back to district court for further determination.
Any client or planner using LLC’s or partnerships to transfer wealth can avoid this issue by creating and funding the entity first. The donor should wait a reasonable period of time after funding the entity before making gifts of ownership in the entity to family members. Further, the donor should maintain clear records on the timing of the transfers. Respecting the process of creating and funding the LLC and then transferring ownership in the LLC to heirs will protect discounts to the value of the gift of ownership in the LLC.
Bipartisan Bill Introduced to Repeal the Expanded Form 1099 Reporting RequirementThursday, January 27, 2011
On January 25, Max Baucus, Senate Finance Committee Chairman (D-MT) and Harry Reid, Senate Majority Leader (D-NV) introduced a bill that, if enacted, would repeal the recent Form 1099 reporting requirements for businesses that would have otherwise become effective commencing in 2012. The bill would repeal the expanded requirements for businesses to report payments made for goods and certain services above the existing requirements. The Act being repealed has been widely maligned by businesses that fear the new paperwork requirements would be too cumbersome and too costly to complete the extra 1099 forms.
If this bill does not become law, Sec. 9006 of the recently enacted Patient Protection and Affordable Care Act requires payments for property and goods to also be reported on 1099s. It would also provide that starting in 2012, payments to taxable corporations which had previously been exempt from the Form 1099 reporting requirement, would become subject to the Form 1099 requirement.
This bill comes as a major relief to businesses and, conversely, as a blow to accountants and payment processors who would have enjoyed new business coming from the extra reporting requirements.
Tax Planning Under the New ActFriday, January 21, 2011
President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "Act") into law on December 17, 2010. The Act provides several tax and estate planning opportunities. Keep in mind that the Act sunsets on January 1, 2013, so its opportunities will only last for two years, and some for only one year. Thereafter, the provisions of prior law reappear unless Congress makes more changes. Clients should therefore take advantage of these opportunities while they last.
One important change made by the Act is the unification of the gift, estate and generation-skipping transfer (GST) tax lifetime exemption - all at $5 million per individual or $10 million for a married couple. Another important change is the reduction of the top estate, gift and GST tax rates to 35%.
Since these rates are much lower than the previous rates, which could exceed 55%, for the next two years, clients should consider lifetime transfers during these next two years, 2011 and 2012. For persons who had used up their $1million exemption through gifts prior to 2011, such person can give another $4 million in assets without paying any gift tax (a gift tax return must be filed for the gift). Better yet, the gift can be to grandchildren or to a dynasty trust for the benefit of children and their descendants; not only are estate and gift taxes avoided, but generation skipping taxes are avoided too as long as the total lifetime gifts do not exceed $5 million per donor.
Assuming there are no changes to the tax laws before 2013, the exempt amount for estate and gift tax purposes will revert to $1 million per donor and the GST exemption will revert to $1.3 million per donor. The maximum marginal rate will revert to 55%. This is therefore a tremendous opportunity for gift planning now.
A totally new concept to the estate laws that was introduced for the next two years by the Act is called "portability." Portability permits the use of an unused exempt amount in a predeceasing spouse's estate in the surviving spouse's estate. To achieve portability, an estate tax return must be filed by the estate of the first spouse to die and such estate must elect the portability option. With portability, couples can pass a total of $10 million to the next generation free from federal estate tax regardless of the size of each respective estate. Portability does not apply for purposes of the GST tax.
For estates of decedents dying in 2010, the Act provides beneficial options. Such estates may elect to either subject the estate to the estate tax, with a $5 million exemption amount and a maximum tax rate above that amount of 35%. If such election is made, the Estate also receives a step-up in basis of the decedent's assets from the decedent’s basis to their fair market value on the date of death. Otherwise, the Estate may elect not to pay estate tax at all but receive only the limited basis step-up of up to $1.3 million of the appreciation inherent in the estate, and an additional $3 million of stepped-up basis for assets passing to the surviving spouse. The decision regarding which election to make is based upon a number of factors, including the size of the estate, the amount of estate tax that would be due, the amount of appreciation in the assets and the time frame that the assets would be anticipated to be sold.
The use of discounting through family limited partnerships and family limited liability companies is still not disallowed by the Act though there had been a great deal of speculation that these devices would be legislated out of estate planners’ tool kits. Also Irrevocable Life Insurance Trusts ("ILITs") for multiple generations can be accomplished by leveraging the $5 million exemption for even more spectacular savings. The premiums can be paid with GST exempt dollars so that when the policy matures and pays out, they are received estate, gift, income and GST tax free. Grantor retained annuity trusts (GRATs) with less than a ten-year term and "zeroed-out GRATs" (those with no gift component) were also not legislated out.
New Jersey, like many states, has decoupled its estate tax from the federal estate tax. New Jersey allows only $675,000 of an estate to pass estate tax-free for its estate tax. That leaves a $4,325,000 spread between the amount allowed by the federal exemption and the amount allowed by New Jersey. If not properly planned, the estate may be subjected to a state estate tax on the death of the first spouse, even if the couple desired to defer all taxes until the death of the second spouse.
Congress had various bills pending (but never enacted) that would have eliminated discounts and short term GRATs, but the Act does not do so. The fact that those restrictions were not enacted is yet another reason to act now to revise one’s estate plan.
The time for planning is now.
S Corp Built-In-Gain Period Temporarily ShortenedMonday, January 17, 2011
S corp built-in-gain period temporarily shortened:
For C corporations holding appreciated property, there is a double tax on its sale. First the corporation pays tax on the sale of its appreciated property equal to the difference between the sale price and the property’s basis, multiplied by the corporate tax rate. Then, when the corporation distributes the proceeds to its shareholders as a dividend, the individuals pay a second level of tax on dividends received. To avoid this second level of tax, the C corporation could (if eligible) file an election under Subchapter S and wait ten years and sell the property and only one level of tax on the gain would be paid.
In order to attempt to spur the economy, Congress has temporarily shortened the ten-year built-in-gain holding period. Beginning in 2011, the "Small Business Jobs Act of 2010," the tax title of H.R. 5297, the Small Business Lending Funding Act (P.L. 111-240 ) provided that for S corporation tax years beginning in 2011, no tax is imposed on the net unrecognized built-in gain of an S corporation if the fifth year in the recognition period preceded the 2011 tax year. Code Sec. 1374(d)(7)(B)(ii). Thus, if a corporation converts now to an S corporation, the built-in gain property cannot be sold for 10 years, but if a conversion was done in 2005 or earlier, the built-in-gains tax on S corporations will not apply to the sale and thus the second level of tax can be avoided. For companies that filed S elections in 2005 and earlier, they are now free to sell their appreciated property and only be subject to a single level of tax.
The Hiring Incentives to Restore Employment Act Adds Credit for Hiring New WorkersMonday, January 17, 2011
In an effort to jump start the economy and employment, Congress is providing a credit of up to $1,000 for so-called "retained workers" in 2011 pursuant to Section 102 of the HIRE Act, P.L. 111-147, for any tax year ending after Mar. 18, 2010. A "retained worker" is defined as any qualified individual (as defined for purposes of the employer payroll tax holiday that was in effect for hiring unemployed workers, who makes a proper certification on Form W-11 and began employment with a qualified employer after Feb. 3, 2010, and before Jan. 1, 2011) and
(1) who was employed by the taxpayer on any date during the tax year,
(2) who was employed by the taxpayer for a period of not less than 52 consecutive weeks, and
(3) whose wages (as defined for income tax withholding in Code Sec. 3401(a) ) for that employment during the last 26 weeks of the period (described in item (2) above) equaled at least 80% of the wages for the first 26 weeks of that period. (HIRE Act §102(b))
Make sure to file the Form W-11 to claim this credit for each such worker hired.