Quality Stores Day Of Reckoning Draws Near – What Should Employers Be Thinking About?

Posted January 16, 2014 by Phil Karter
Categories: Corporate, Court Cases, Employment Tax, Litigation, Reporting, Tax Procedure

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By Phil Karter

The Quality Stores employment tax refund case was argued before the Supreme Court on January 14, 2014.  An explanation about the issue at stake can be found in prior Taxblawg.net postings.  Although the outcome of the case remains in doubt, the possibility of a taxpayer victory means that employers should start thinking about the need to satisfy an important prerequisite to qualify their claims for refund.

Employment (FICA) taxes have both an employer and an employee component. A taxpayer victory in Quality Stores will enable both employers and terminated employees to recover their respective shares of FICA taxes withheld from the employees’ severance pay.  The obvious question that is likely to arise from an employer’s standpoint is “what incentive do I have to file on behalf of former employees?”

The answer can be found in Treasury Regulation § 31.6402(a)-2(a)(1)(ii), which stipulates that the employer will not be allowed a refund or credit for the employer’s share of withheld taxes “unless the employer has first repaid or reimbursed its employee or has secured the employee’s consent to the allowance of the claim for refund and includes a claim for the refund of such employee tax.”  In other words, merely notifying ex-employees of their rights to claim refunds themselves is inadequate to perfect the employer’s claim to recover its own share of withheld employment taxes. The employer must take affirmative steps on behalf of the terminated employee.

Thankfully, despite the above language about securing consents, the regulation elaborates that the requirement “does not apply to the extent that the taxes were not withheld from the employee or, after the employer makes reasonable efforts to repay or reimburse the employee or secure the employee’s consent, the employer cannot locate the employee or the employee will not provide consent.  Therefore, it is the attempt to secure consents that counts rather than the actual ability to secure such consents. (This same consent procedure also applies to employment tax refund claims arising from the Supreme Court’s ruling in United States v. Windsor, wherein the court struck down the Defense of Marriage Act (DOMA) as unconstitutional.  Prior to that decision, employers were required to withhold and pay over employment taxes for benefits provided to same-sex spouses of employees.)

Up to this point, a majority of employers that have filed protective refund claims have likely not undertaken the effort to obtain employee consents. There are at least two practical reasons for this.  First, the Sixth Circuit’s 2012 favorable decision in Quality Stores came out only about six months before the expiration of the 2009 statute of limitations (assuming the employer’s return was filed without extension). Thus, for employers eligible for refunds of FICA withholding paid over in that year, there wasn’t a good deal of time to accomplish this task.  Without a full solicitation of consents and tabulation of the refunds owed to employees who had responded affirmatively, there would have been no way to calculate the aggregate employee refund and include it on a refund claim.

Additionally, with the final outcome of Quality Stores, and the consequent entitlement to FICA refunds in doubt, it would have been hard for employers to justify the expense of undertaking the consent process when it wasn’t clear the exercise would be worthwhile when all was said and done.

Assuming the Supreme Court affirms Quality Stores, the simple solution for employers that filed protective claims covering only their share of FICA withholding is to file amended claims to add the aggregate employees’ share for those employees who provide their consents.  The procedure for this is set forth right in the instructions for Form 941-X on which the refund claim is made.  The instructions provide, in pertinent part, as follows:

5b.     . . . In certain situations, you may not have repaid or reimbursed your employees or obtained their consents prior to filing a claim, such as in cases where the period of limitations on credit or refund is about to expire. In those situations, file Form 941-X, but do not check a box on line 5. Tell us on line 25 that you have not repaid or reimbursed employees or obtained consents. However, you must certify that you have repaid or reimbursed your employees or obtained consents before the IRS can grant the claim.

 5c.     Check the box on line 5c to certify that your overreported tax is only for the employer share of social security and Medicare taxes. Affected employees did not give you consent to file a claim for refund for the employee share of social security and Medicare taxes, they could not be found, or would not (or could not) give you a statement described on line 5b.

 5d.     Check the box on line 5d to certify that your overreported amount is only for federal income tax, social security tax, Medicare tax, or Additional Medicare Tax that you did not withhold from your employees.

The Form 941-X instructions also provide a sample consent that can be used as a template by employers:

Employee name ____________________

Employer name  ____________________

I give my consent to have my employer (named above) file a claim on my behalf with the IRS requesting $_________ in overcollected social security and Medicare taxes for 20___. I have not claimed a refund of or credit for the overcollected taxes from the IRS, or if I did, that claim has been rejected; and I will not claim a refund or a credit of the amount.

 Employee signature _____________________

Date _________________

The consents are not sent to the IRS but retained by the employer. However, employers should be mindful not only to retain such consents, but also to adequately document their efforts to obtain consents for all qualifying employees, whether or not they are returned.

On a going-forward basis until Quality Stores is decided, employers can ease the burden of having to track down former employees and send out consent forms to qualify their own refund claims by incorporating a consent form along the lines of the template shown above into the paperwork typically involved in the termination process.  Of course, if Quality Stores is decided favorably, employers from that point forward will no longer be obliged to withhold, obviating the need to continue this practice.

What Happens If We Abolish the IRS?

Posted November 25, 2013 by George Connelly, Jr.
Categories: Uncategorized

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By George W. Connelly

Hardly a day goes by when some politician or editorial person doesn’t suggest that we don’t need the IRS or should simply do away with it.  Most of them come in connection with suggestions for changing the tax system to something like a national retail sales tax.  What these people fail to understand, and this writer is not challenging the sincerity of their views, is that without the IRS, our tax gap would explode geometrically.  We call our system a “voluntary” one, but we remain short of “volunteers”: there are simply too many people and businesses who don’t get around to filing tax returns, depositing their taxes, paying with those returns, and sometimes filing false returns.  This circumstance is not limited to income tax:  it is also present for state sales taxes, employment taxes and excise taxes.  As annoying as an IRS audit can be, and as unpleasant as some IRS employees can be to deal with, the reality is that the system does not “enforce itself.”

Those who clamor for an alternative system forget that some agency is going to need to be there to collect it.  Sometimes we hear the suggestion that state agencies can handle a national retail sales tax.  Most of them are undermanned and underfunded as they presently exist, and several states have no sales tax in place to which the federal tax could be surgically attached.  Those of us in the tax profession who deal with the IRS frankly prefer dealing with IRS personnel and the administrative system in place over what we encountered in the state regimes, including this writer’s experience in New York and Texas.

This writer knows that as long as we have a federal tax system, we’re going to have the Internal Revenue Service or some equivalent.  As they say, a rose by any other name … would smell as sweet.  Changing the name of the IRS to something else will not remove the tax man.  No matter what we call him, his job will never change.  Meanwhile, calls for abolishing the IRS simply distract the attention that needs to be placed on making the IRS more effective.

Who Audits TIGTA?

Posted November 22, 2013 by George Connelly, Jr.
Categories: Uncategorized

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By George W. Connelly

The Inspector General for Tax Administration, TIGTA, has been in the news a lot lately. In addition to tracking down misbehaving IRS employees and misbehaving representatives, an important role of this organization seems to be examining every aspect of the operation of the Internal Revenue Service and publishing a critical report about it. Lately, it seems that TIGTA has been publishing an average of two a week, virtually all of which have been critical of the performance of the Internal Revenue Service. Two recent ones, however, deserves some close examination and cause this writer to wonder if TIGTA may not be crossing the line of objectivity.

The first alleges that the IRS is not properly pursuing return preparers who have made mistakes in preparing returns where the earned income tax credit (EITC) has been claimed. Anyone familiar with the EITC knows there are several reasons why this criticism rings hollow. The first is a dirty little secret: EITC is an acronym for “welfare,” and has no place in the Internal Revenue Code. If our executive and legislative branches had any courage at all, they never would have put it there, but they recognize that parts of the American public view welfare as a “four letter word,” so it’s been tucked away in the Internal Revenue Code and dumped on the IRS to administer.

The second reason is well known to anyone who has attempted to navigate the labyrinth of rules relating to the application of the law and eligibility for this credit. It is like a scene out of an old Marks Brothers movie. A well-meaning and professional as most TIGTA agents I have come to know are, I would defy any of them to pass an EITC exam—applying it to several fact situations—without making an error.

The third point very simply is that the IRS does not set its own budget, but rather Congress does, and Congress has simply not allotted enough funds for each and every one of the functions that TIGTA doesn’t seem to think the IRS is doing well enough. The ideal solution—removing the EITC from the Internal Revenue Code, and charging some other agency with properly administering it, seems lost upon TIGTA, and as noted above seems to be an example of criticizing an already overburdened and embattled agency.

The other recent study was to the effect that the IRS is misinterpreting the law in such a manner that it “misses” penalties that should be applied to erroneous refund claims, tax returns, and other matters. Anyone who has represented people before the Internal Revenue Service or prepared returns will find this a mindboggling announcement in light of the fact that penalties seem to be applied during audits for little more than that sake of applying penalties, and unfortunately, judicial opinions about whether the penalty should have been applied in the first place often cannot be reconciled with one another when similar facts appear to be present. The reality exists that many of the penalties are not sustained, and TIGTA does not seem to take that element of the process into account.

Hopefully, TIGTA has not interpreted its role to be critic in residence rather than a source of constructive solutions for addressing the problems which exist in the IRS. It plays an indispensable role as monitor of the IRS, but perhaps it’s falling short when it omits important elements from its reports.

 

Houston – 36th Annual Tax and Business Planning Seminar

Posted October 30, 2013 by _______________
Categories: Uncategorized

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This must-attend seminar will help ensure that you are as ready as the IRS for 2014. Hosted by Best Lawyers-ranked Tier One taxation law firm Chamberlain, Hrdlicka, White, Williams & Aughtry, the event will feature presentations by Patrick Jankowski, CCR, Vice President, Research, Greater Houston Partnership, and more than 14 experts from Chamberlain Hrdlicka’s labor, transactional, planning, and tax controversy practices. Attendees can earn CLE/CPE/CFP credit.

December 5, 2013
Houston Marriott Westchase
Houston, Texas

Click here to register online

Click here for more information

Atlanta – 28th Annual Tax and Business Planning Seminar

Posted October 28, 2013 by _______________
Categories: Uncategorized

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This must-attend seminar will help ensure that you are as ready as the IRS for 2014. Hosted by Best Lawyers-ranked Tier One taxation law firm Chamberlain, Hrdlicka, White, Williams & Aughtry, the event will feature presentations by named shareholder David Aughtry, a former IRS trial attorney and the firm’s leading tax litigator for nearly 30 years, and 15 other experts from Chamberlain Hrdlicka’s labor, transactional, planning and tax controversy practices. Attendees can earn CLE/CPE/CFP credit.

Wednesday, November 13, 2013
Cobb Galleria Centre
Atlanta, Georgia

Click here to register online.

Click here for more information.

Are Quiet Disclosures of Offshore Accounts Becoming Even Riskier?

Posted October 18, 2013 by Phil Karter
Categories: Audit, Individual, International, Reporting, Tax Penalties, Tax Procedure

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By Phil Karter

Is the IRS getting closer to ferreting out “quiet disclosures” by taxpayers who chose that route to address the problem of previously unreported offshore accounts rather than by participating in the Service’s offshore voluntary disclosure program (OVDP)?  That’s the conclusion of an increasing number of tax professionals and if taxpayers in this predicament weren’t already worried, they should be.

A quiet disclosure involves the filing of new or amended tax returns that report offshore income, and FBARs (Report of Foreign Bank and Financial Accounts) that provide other account information regarding the taxpayer’s interest in foreign accounts.  It is a discreet disclosure intended to make a taxpayer compliant with his or her tax reporting responsibilities while avoiding penalties imposed under the IRS’s official voluntary disclosure program.

The IRS has made no secret of its distain for those who choose the quite disclosure route over participation in its voluntary disclosure program.  In its frequently asked questions and answers applicable to the most recent iteration of the OVDP, the Service has cautioned taxpayers that those who have already made quiet disclosures should “be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.”  The IRS has encouraged such taxpayers to “take advantage” of the program before discovery.  The FAQs also note that detection of a quit disclosure also eliminates the possibility of reduced penalty exposure offered under the OVDP. (See FAQs 15 & 16.)

To some, the calculus about whether to participate in the OVDP, follow the quiet disclosure path, or do nothing has been viewed as another form of the audit lottery, albeit one with very high stakes in terms of potential monetary penalties and possibly criminal prosecution.  As virtually everyone should know at this point, offshore account holders can no longer rely on bank secrecy to protect them, so the issue of detecting unreported accounts has become more a question of when, not if. Although a quiet disclosure addresses the unreported account problem, either currently or retroactively, that is not necessarily the end of the story . . . or the risk.

Earlier this year, the Government Accounting Office issued a report in which it noted a dramatic increase in the number of taxpayers reporting offshore accounts, concluding that the trend may reflect attempts to minimize or circumvent taxes, penalties and interest that would be owed if not corrected before detection or even upon participation in the OVDP.  Among other things, the GAO recommended that the IRS explore methodologies to detect and pursue quiet disclosures.  Apparently, the IRS has taken the GAO’s recommendation to heart by working on new ways to identify them.  The effort, according to former Acting IRS Commissioner Steven Miller, was to include “analysis of Forms 8938, Statement of Specified Foreign Financial Assets, to identify specific characteristics of the filing population and to assess filing behaviors indicating potential compliance issues.”

In predicting the effectiveness of this undertaking, it is worth noting that the IRS has a wealth of experience in implementing computer algorithms on a much larger scale to ferret out trends warranting closer scrutiny.  One need look no further than the Services’ Discriminant Function System (DIF), which is used to flag tax returns for possible audit, among the hundreds of millions filed, to appreciate that improved detection of quiet disclosures is well within the IRS’s capabilities.  Therefore, taxpayers who rely on a limited IRS resources justification to ignore the directional trend regarding quiet disclosures are likely to wish they had examined the issue relative to their own personal circumstances a lot more closely. At the very least, given the prevailing wind on this issue, it would be prudent for those who have made quiet disclosures or are contemplating one to revisit the issue with their tax adviser.

Apple’s Double Irish With A Dutch Sandwich Goes Down Easy with SEC

Posted October 9, 2013 by Phil Karter
Categories: Corporate, Economic Substance, International, Legislation, Tax Penalties

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By Phil Karter

Senator Carl Levin (D-Mich.) may have tried to take a bite out of Apple (AAPL) in congressional hearings last May examining the company’s overseas tax structure, calling it “the holy grail of tax avoidance.” However, it appears that more than just Irish eyes are smiling on the company these days, for in the eyes of the SEC, Apple’s efforts to minimize its tax burden are just fine thank you.  See e.g., O’Brian, Chris, “SEC reveals review of Apple’s Irish tax disclosures.” Los Angeles Times, 3 Oct. 2013, LATimes.com, 9 Oct. 2013.

But is that the happy end of the story for Apple and the many other companies such as Google (GOOG), Facebook (FB), Microsoft (MSFT) and Oracle (ORCL) that have replicated the Double Irish structure in one form or another?  Not necessarily given the continuing threat posed by a sweeping application of the economic substance doctrine.  For example, does the creation of foreign subsidiaries for the primary purpose and intent of minimizing tax liabilities meet either or both prongs of the infamous two-prong test examining objective non-tax profitability and subjective non-tax intent?

It very well should if cases like IES v. Comm’r. 253 F. 3d 350 (8th Cir. 2001) and Compaq Computer Corp. v. U.S., 277 F.3d 778 (5th Cir. 2001) continue to represent the state of the economic substance law.  IES’s and Compaq’s transactions were pure tax arbitrage plays whose profitability was derived solely from the monetization of foreign tax credits.  Is anything conceptually different really happening here? Yes, all the fuss over the Double Irish centers around keeping profits abroad beyond the reach of U.S. tax collectors but at bottom, each situation involves ways to reduce ETR and increase after-tax net profits (presumably along with shareholder value) through effective tax structuring.  At this point, the Supreme Court’s pronouncement in Gregory, v. Helvering, 293 U.S. 465 (1935), comes to mind: “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.”

The problem is that there remains considerable uncertainty about the potential reach of the economic substance doctrine based on the plethora of less taxpayer-friendly decisions, particularly recent ones.  Moreover, uncertainty about how and when the ESD could apply – along with the new strict liability penalty under § 6662(b)(6) – has only been heightened by the enactment of a statute, § 7701(o), containing far too many undefined terms.  For example, left open under the codified doctrine are such critical questions as when the doctrine is relevant and what the threshold is for non-tax profits to be substantial relative to tax benefits.

Finally, as reflected by taxpayers’ unsuccessful litigation of leveraged lease (LILO and SILO) transactions, the imprimatur by a government agency blessing the transaction is no assurance that it will thereafter be respected by the IRS.

During his illustrious career, the legendary Steve Jobs was renowned for his prescience.  Such talents would have come in handy in foreseeing the end to this story.  For the legion of companies employing these tax strategies, the hope is for a happy ending rather than a  Tofflerian “Future Shock.”


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