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How Does the IRS Treat Federal Agencies Who Owe Employment Taxes?

October 3, 2012

By George W. Connelly

Previous Blawg articles have cautioned my readers about the problems they can face if they do not take care of their Federal employment taxes, ranging from collection action against their business, to the trust fund recovery penalty being asserted against individuals determined to be “responsible officers.”  Since Federal agencies are also required to pay employment taxes for their employees, it is only fair to wonder if the IRS is dealing as harshly with them.  The answer warrants a letter to your Congressman.

On September 5, 2012, the Treasury Inspector General For Tax Administration (TIGTA) issued a report to follow up one prepared in August 2007, when TIGTA found that there were serious weaknesses in the Federal Agency Delinquency Program’s efforts to identify and address the causes for delinquencies in filings and payments.  TIGTA found that the corrective action the IRS took in response to that prior report did not fully address the previously identified weaknesses, and particularly those involving delinquent tax accounts. TIGTA  analyzed 132 aged Federal agency delinquent tax accounts from December 2008, and found that as of December 31, 2011, 40—totaling approximately $2.6 million—were still open after three years, and that collection action had been suspended for 34 of those 40 accounts, totaling $2.4 million.

TIGTA noted that the IRS does not have the same set of tools available when the taxpayer is another Federal agency.  For instance, Federal agencies are not authorized to pay interest and penalties for late filed returns or underpaid employment taxes.  Also, various IRS policies—policies!—do not allow enforcement actions to be taken against Federal agencies with delinquent tax accounts.  These apparently prevent filing of a Notice of Tax Lien, sending a Final Notice of Intent to Levy, or assessing the trust fund penalty against responsible officers, let alone seizure of property.  Of the 132 aged delinquent tax accounts for 68 Federal agencies in December 2008, TIGTA found that 36% had their collection statutes expire—the collection statute is ten years from the time of assessment!—and thus prevented the IRS from ever collecting those amounts.  40 accounts were open and unresolved after three years and in 85% of those, collection action had been suspended by the IRS.

There’s an old saying:  “What’s good for the goose is sauce for the gander.”  There is simply no reason why our hard-earned tax dollars should go to paying interest and penalties incurred by Federal agencies which should be setting a standard for compliance with employment taxes.  However, if the trust fund recovery penalty could be asserted against the persons in those agencies who are not performing their jobs, we would see a different response from them.  Moreover, we would not have to worry about the IRS wasting resources on chasing the few dollars it does collect from them.

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What Will The IRS Do If You Don’t Prepare An Income Tax Return?

September 28, 2012

By George W. Connelly

Well for starters, it won’t be very happy!  Beyond that, the IRS has several avenues it can pursue.

In extreme situations, such as where a taxpayer owes a considerable sum of money and has not filed for several years, the IRS may consider pursuing criminal liability under I.R.C. § 7203, which makes it a misdemeanor to “willfully” fail to file a Federal Income Tax Return.  This is rarely applied unless a pattern of three consecutive non-filing years are present, but potentially any single willful failure to file could result in this prosecution.  There is a six year statue of limitations, which begins to run on the day each tax return is due, so that the IRS has plenty of time to conduct an investigation.

Above and beyond the criminal liabilities, there can be civil liability for taxes, interest and penalties.  The presence of a criminal investigation is not a prerequisite to such a civil proceeding, nor is it barred in the event a criminal prosecution is pursued.  In fact, most non-filer situations are pursued civily.

The IRS is authorized by I.R.C. § 6020(b) to prepare a return for a taxpayer in the event one is not filed.  The information used could be the subject of information returns—Forms 1099 and W-2; formal examination of the taxpayer’s records; and in some cases even situations where the IRS relies upon information from prior years’ tax returns.

The taxpayer should be aware that the IRS seldom does this in isolation.  It is normal for the IRS to send a letter to the taxpayer stating that its records show that no tax return has been filed, and asking the taxpayer to send a copy if one was in fact filed, but alternatively to file one as soon as possible.  When the taxpayer does not respond, the IRSeither conducts an examiantion or simply handles it by correspondence.  In the absence of a formal agreement by the taxpayer to what the liability and its components are, the IRS cannot simply “assess” the liability.  It will issue a Notice of Deficiency outlining the details of its adjustments and computations.

One serious handicap in cases where taxpayers do not participate in either the correspondence or personal audits is that the IRS is undoubtedly not going to allow any deductions, since none are proven, and will treat any receipts reflected on a Form 1099 or 1099 substitute as ordinary income.  In many cases, such items from brokerage houses include gross receipts from the disposition of securities or other assets, but do not reflect the taxpayer’s basis, holding period, or other information which might affect the amount taxable, and the proper tax treatment.

On top of the foregoing, there are penalties based upon late filing in and of itself.  I.R.C. § 6651(a)(1) provides for a penalty running at the rate of 5% for each month or part of a month that a return is delinquent, maxing out at 25% of the underpayment of tax.  However, if the IRS concludes that the failure to file the return was fraudulent, I.R.C. § 6651(h) provides for an enhanced penalty of 75% of the underpayment.

As busy as we all are, it is important to take whatever steps are possible to get your tax returns filed on time, and to understand that if you fail to do so, it is only a matter of time before the IRS arrives and proceeds as we have described.

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What Can The IRS Do If You Go Out Of Business?

September 20, 2012

By George W. Connelly

Obviously, there will be “nothing” to do unless the business owes taxes or has not filed all its tax returns.  These comments are prompted by the fact is that the IRS has just issued a Manual Administration Supplement No. 855 to instruct its employees about how to proceed in the case of insolvency proceedings.

If the company files bankruptcy, the IRS will file a Proof of Claim and, depending upon the nature of its claim—is a Federal Tax Lien filed?are the taxes assessed?—it will proceed to pursue its rights based on its priority relative to other creditors.  If the proceeding is instead a receivership, assignment for the benefit of creditors, corporate disolution, or insolvent decedents estate, the IRS will likewise file a Proof of Claim, but note that each has a “fiduciary” that acquires the property of the debtor or decedent which then becomes the property of the insolvent estate, and the fiduciary has the responsibility of administering and distributing the property, including payments to creditors.  If the company does not initiate a proceeding, the IRS will try to contact the owner.

In these situations, if other creditors are paid ahead of the Internal Revenue Service, there is a Federal Priority Statute, 31 U.S.C. § 3713, which provides that a fiduciary could become personally liable if it pays other claimants ahead of the IRS.  In addition, the IRS may assert “transferee liability” against persons who receive property from insolvent estatesor companies if federal taxes are not paid.

If the business is a sole proprietorship, the IRS will doubtless pursue any assets of the owner.  Likewise, if it is a partnership, the IRS will pursue the assets of the partnership, as well as consider potential exposure of the general and limited partners.  If the business is a corporation, liability generally extends only to the extent of corporate assets, except for situations where transfers have been made voluntarily to the shareholders without adequate consideration.

In all these situations, there is the specter of further personal liability for those involved in the business.  If the unpaid liabilities include employment taxes, the IRS can pursue “responsible officers” pursuant to I.R.C. § 6672.  Under I.R.C. § 7501, above and beyond employment taxes, a person required to collect or withhold any Internal Revenue tax from any other person and pay it over to the Internal Revenue Service will similarly be treated as the holder of a “trust fund” in favor of the United States, which can be assessed and collected in the same manner as the underlying taxes themselves.

The important lesson is simply that the end of a business does not mean the end of liability to the IRS or the IRS’ interest in that business.  It is important to consult with a knowledgeable tax advisor if it appears your business is going under to make sure you are aware of all possible ramifications, and your own exposure to personal liability in these situations.

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Is the IRS Going Easier on Taxpayers with Foreign Accounts?

July 11, 2012

By George W. Connelly

Noooo!  But the IRS does seem to be getting more rational in a couple of respects.

On May 18, an IRS Associate Area Counsel for Philadelphia explained that the IRS may send warning letters in lieu of asserting penalties for failure to file a Form TD F 90-22.1, also known as an FBAR.  This will occur in situations where the IRS concludes a letter would be “sufficient to bring the individual into compliance.”  The speaker indicated that the IRS Office of Chief Counsel reviews every proposed FBAR penalty to ensure “that adequate facts exist to support the proposed assessment.”  The largest penalties apply to persons who willfully violate FBAR requirements, and go as high as 50% of the value of the unreported account.  When applying the willfulness penalty, the speaker indicated that the IRS looks for circumstantial evidence that the taxpayer had knowledge of a filing obligation – such as a prior warning letter or penalties.  If a person who conducts all his banking in the U.S. suddenly decides to open an account in a foreign country, the IRS will be interested in the reasons for opening the account.  The IRS will also take into account whether the account is “inherited” and how the taxpayer treated other inherited accounts.

On June 28, 2012, the IRS issued IR 2012-65, and announced new procedures for U.S. and dual citizens who live abroad and fail to file tax returns and FBARS.  The Notice was issued because the IRS became aware that many U.S. taxpayers living abroad failed to timely file U.S. federal income tax returns or FBARS, and have only recently become aware of their filing requirements and want to comply.  The new procedures will allow taxpayers who are “low compliance risks” to get current with their tax requirements without facing penalties or additional enforcement action.  These are individuals who have “simple tax returns” and owe $1,500 or less in tax for any of the covered years.  The new procedure is also intended to resolve issues related to certain foreign retirement plans, such as those under the Canadian Registered Retirement Savings Plan system, where tax treaties allow for income deferral under U.S. tax law in the event of a timely election. Under the new procedures, the taxpayers will be required to file delinquent returns along with appropriate related information returns for the past three years, plus delinquent FBARSs for the past sis year.  Taxpayers who present “higher compliance risk” will be subject to more thorough review and potentially an audit, perhaps beyond the three years. These provisions are effective September 1, 2012.

Finally, the IRS issued e-mailed technical advice on April 27, 2012 to the effect that the penalty under I.R.C. § 6038D for failure to disclose information on foreign assets is not subject to the “deficiency procedures” and is simply assessable.  That means that the IRS need not issue a Notice of Deficiency to the taxpayer before assessing these penalties, and that the taxpayer cannot take them to the United States Tax Court.  This means that, once such a penalty is assessed, a taxpayer is expected to pay the penalty (and any interest) in full before filing a claim for refund or pursuing the matter in United States District Court or the Court of Federal claims.  The advice did not address whether the taxpayer would have an opportunity to protest the penalty before it is assessed or collection activity begins.

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Under Water on Your Home Mortgage? Talk to Your Tax Advisor Before You Take Action!

April 10, 2012

By George W. Connelly

Recently, the IRS issued “Tax Tip 2012-39″ regarding important issues concerning mortgage debt forgiveness.  While anyone capable of reading this Blawg is capable of pulling that up from the IRS website and reading it, no action should be undertaken without making sure your tax professional has covered the positives and negatives of doing so.

Right now, a lot of people are “under water” on their home mortgage, and faced with possible foreclosure, short sale, or other transactions in which their mortgage debt is partly or entirely “forgiven” during this tax year.  There are several things to be wary of.  For starters, any time a debt is forgiven, it is presumed to result in taxable income.  However, there is a statute known as the Mortgage Forgiveness Debt Relief Act of 2007 that may permit the exclusion of up to $2,000,000 of debt forgiven on a personal residence.  (For a married person filing separately, the limit is $1,000,000).  This can take place through a mortgage restructuring as well as a debt forgiven in a foreclosure or short sale.  The only “qualified debt” involves monies used to buy, build or substantially improve the principal residence and be secured by that residence.  This includes refinancing for the purpose of substantially improving the principal residence.  A taxpayer seeking to qualify for this relief must fill out and file a Form 982 with the Federal Income Tax Return for the year in question.

Second, not all debt qualifies.  Proceeds of financing used for other purposes, such as paying off credit card debt, will not qualify.  Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for this relief provision.  However, some other tax relief provision – such as being insolvent both before and after the debt forgiveness – may be applicable, and these circumstances are covered on Form 982.

Next, if a debt is reduced or eliminated, a taxpayer is supposed to receive a year end statement, Form 1099-C, Cancellation of Debt, from the lender.  This form is supposed to show the amount of debt forgiven and the fair market value of the property foreclosed.  If you receive this form, examine it closely, because it is filed with the Internal Revenue Service and that agency will assume its contents are correct.  If it containsany incorrect information, notify the lender in writing immediately – pay especially close attention to the amount of debt forgiven in Box 2, as well as the value listed for the property in Box 7.  That notification should be in writing and this writer recommends that you send it certified mail with return receipt requested.

Finally, do not “attempt all this in your own home.”  Better to have a tax professional guide you through the process than to take the chance of a costly mistake.

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Don’t Be A Victim Of One Of The IRS “Dirty Dozen Tax Scams” For 2012

March 22, 2012

By George W. Connelly

In February, the IRS published its annual “Dirty Dozen” listing of tax scams to caution taxpayers about problems they may face in this filing season.  They range from self-inflicted—too good to be true—to situations where third parties prey upon the unsuspecting.

Several are fairly common and familiar, ranging from reporting income that was not earned in order to maximize refundable credit, claiming excessive fuel tax credits, or simply claiming deductions one did not incur.  So are the time-worn tax protester arguments that have been thrown out by the courts.  There are, however, several that are new and equally dangerous.

The first involves identity theft – where someone files a return with your name and social security number in order to obtain a fraudulent refund.  This writer can tell you from the experience of his clients that these things are happening at an alarming rate and, quite frankly, that the IRS has not made a really firm respose to the cases he has seen, notwithstanding its claims to have a “robust screening process” in place.  This problem has been the subject of many newspaper articles, and anyone who believes personal information has been stolen – such as where you receive a letter from the IRS that your return was previously processed – needs to visit the IRS Special Identity Theft page at www.irs.gov/identitytheft.

Second, there are an increasing number of “PHISHING” scams – unsolicited emails or fake websites that pose as IRS sites in order to lure victims to provide personal and financial information.  Any unsolicited email claiming to be from the IRS or an organization linked to the IRS should be reported to phishing@irs.gov.  The IRS does not initiate contacts with taxpayer by email or request personal or financial information in this fashion.

A third problem involves tax return preparer fraud.  There are some “bad apples” out there, and it is important to make sure that your tax return preparer operates on the up-and-up.  For 2012, every paid preparer needs to have a Preparer Tax Identification Number (“PTIN”), and enter it on the return being prepared.  If your preparer does not enter one on the return, or does not also sign it, beware!

A fourth problem area involves attempts to hide income offshore, which have received a great deal of publicity due to the IRS Offshore Voluntary Disclosure Programs.  This can include foreign accounts, nominee entities, credit cards issued by foreign banks, and a multitude of other approaches.  While there may be legitimate reasons for maintaining financial accounts abroad, taxpayers have to be mindful of the many reporting requirements that need to be fulfilled, because the penalties for failing to do so – even in legitimate situations – are severe.  The IRS is working on information exchange programs with virtually every foreign country, so that these accounts are being “discovered” every day.  If you have or need to open any sort of foreign financial account, talk to your tax advisor abour your reporting obligations.

Finally, there are situations where corporations are created to obscure the true ownership of a business,and trusts are promoted to disguise asset transfers.  There are legitimate uses of both, but promises that income can be reduced, deductions of personal expenses can be permitted, or estate and gift taxes can be reduced, must be viewed with great suspicion.  Again, have any such plan reviewed by an experienced tax professional before you proceed.

As long as we have a federal income tax, there are going to be scams to deal with.  Don’t be a victim in 2012!

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If The Job Offer Includes A Loan From The Employer, Talk To Your Tax Adviser Before Accepting!

February 27, 2012

By George W. Connelly

It is not uncommon for sought-after job seekers to receive what appears to be an offer that is too good to be true:  in addition to a good compensation and benefits package, the employer proposes to make a loan to the applicant, and to forgive the entire amount if the person stays employed for a particular term—such as five years.  Sometimes the game plan is not in writing, and is left to “wink wink, nudge nudge” in terms of the likelihood that the loan will be forgiven if the person stays employed that length of time.

These arrangements are not in any way “illegal,” but as Robert and Elizabeth Brooks learned in the United States Tax Court this year, in TC Memo 2012-25, there are some significant tax problems that could arise from this arrangement.

At the outset, there is a question about whether the arrangement is really a “loan” when there is an intent to forgive in the first place.  A loan is a transaction where one person borrows money from the other, with the agreement that it will be repaid, and the lender expects repayment.  They are easily reduced to writing, bear interest, and are treated as loans by both parties.  Those facts alone, however, will not necessarily make the transaction a loan.

As Judge Mark Holmes pointed out in the Brooks case, such advances have in various contexts been treated as income at the outset because the Court concluded that the intent of the transaction was not a loan, but rather an attempt to induce the person to provide personal services, and the obligation to repay was conditional—only if the applicant quits or was fired for cause within five years.  In that situation, the “loan” could be treated as income in the year it is advanced.

In the case of Mr. and Mrs. Brooks, the Court was confronted with the tax year in which the loan was actually forgiven, and Judge Holmes noted that the Internal Revenue Code normally treats forgiveness of debt as income, since the borrower who does not have to pay it back has received an economic benefit.  This discharge of indebtedness income includes both the forgiven loan principal and the accrued interest.

In these situations, the old adage that “If it looks too good to be true, it probably is,” isn’t necessarily the point.  Rather, before one enters into a transaction like this, it is critical that the prospective employee pin down as closely as possible what the real intentions are, and then review them with a tax adviser.  A lot of trouble can be avoided if these steps are taken at the outset, rather than after the IRS comes in and questions the transaction.

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Where Does the IRS Get Off Telling You How to Run Your Business?

November 22, 2011

By George W. Connelly

When the IRS audits a tax return involving a business, its agents invariably get involved in questions of recordkeeping and how transactions are conducted and recorded.  All too often, an IRS Examiner will suggest that a taxpayer’s records are not “adequate,” or that in some fashion the taxpayer is not operating in “a businesslike manner.”  This most often occurs in situations where the taxpayer is attempting to operate a ranch and has incurred losses, or claims that shareholder advances to the company should be recognized as bona fide loans rather than an investment of capital. (more…)

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Will “Starving the Beast” Mean the End of the Taxpayer Advocate’s Office?

November 10, 2011

By George W. Connelly

Your writer has been dealing with tax disputes for over 40 years, and believes that the two most important developments for taxpayers were the passage of the 1998 IRS Restructuring and Reform Act, and the creation of the Taxpayer Advocate Service (“TAS,” formerly known as the “Problem Resolution Office” and the “Ombudsman”).  The Advocate created to assist taxpayers where, for lack of a better term, the system simply was not working properly, and for most of its existence has done a wonderful job.

Well, that organization’s health now appears to be in peril.  (more…)

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How Do You Know the IRS Received What You Sent?

November 3, 2011

By George W. Connelly

In any given year, a person is likely to send one or more of a fairly standard variety of items to the IRS. Tax returns, payments, responses to inquiries, and claims for refund are the most frequent but certainly not an exhaustive list. I’ve even known of some people who have sent “thank you notes” to IRS employees who seem to have gone above and beyond the call of duty to assist them. That said, how do you know the IRS actually received what you sent? This is not an idle question, as the IRS’ failure to timely receive some of those items can result in serious problems for a taxpayer, ranging from penalties to significant expenditures of time and money to get a problem fixed. So let’s look at the ways things are sent. (more…)

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