Author Archive

What Happens If We Abolish the IRS?

November 25, 2013

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?

November 22, 2013

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.

 

Before You Abandon That Underwater House, Read This!

July 24, 2013

By George W. Connelly

The Tax Court recently issued a Summary Opinion, Malonzo v. Commissioner of Internal Revenue, T.C. Summ. Op. 2013-47, involving an individual who was underwater on her mortgage, and who abandoned the property, subsequent to which the mortgage loan was foreclosed.  She took no formal steps to transfer title or provide the lender with notice of her intention to abandon the residence, but just stopped making payments.  The residence was later resold by the lender who sent her a Form 1099-A, Acquisition or Abandonment of Secured Property, reflecting as income the outstanding balance of her mortgage less the amount for which the property was resold.

The IRS determined that she had received a long-term capital gain, based upon the difference between the balance of the mortgage and her adjusted basis in the property.  She, in turn, filed an amended return in which she reported an ordinary loss from the abandonment of the residence equal to roughly the difference between her adjusted basis and the depreciation recaptured from a period in which she rented the home.

The Tax Court concluded that the abandonment of this property and the subsequent foreclosure was a “sale or exchange” under the Internal Revenue Code,” so the gain or loss would be capital.  As such, the Court concluded she was not entitled to an ordinary loss (and fortunately not ordinary gain either!) because the property was subject to a mortgage which was satisfied.  As such, the IRS determination was sustained.

The best lesson to learn here is that before one takes the action taken by Ms. Malonzo, it is worth spending some time with a qualified tax adviser who can explain exactly what the ramifications will be.

How Does IRS Police Its Own Lawyers?

July 15, 2013

By George W. Connelly

The IRS employs many lawyers and employees of the IRS Office of Chief Counsel are its principal legal staff who number 1560, of whom about 550 work in the IRS National Office in Washington, while the balance work in offices around the country.  They provide legal advice to the Commissioner of Internal Revenue and the local IRS offices, and they act as the lawyer for the Commissioner of Internal Revenue in all Tax Court cases.  In addition, some are specially designated to assist United States Attorneys in bankruptcy, summons enforcement and other civil cases.

In 1998, a Chief Counsel’s Professionalism Program was established, to ensure that the office fully complies with Treasury directives, and that all allegations of misconduct are promptly and thoroughly investigated.  All allegations or evidence of an employee’s serious or significant failure to comply with accepted standards must be referred to the Deputy Chief Counsel (Operations), and the most serious matters must be referred to the Office of the Treasury Inspector General for Tax Administration (TIGTA).

The IRS Office of Chief Counsel recently released reports on the subject of professionalism for the years 2009 through 2012, and the findings – which are broken between TIGTA and non-TIGTA cases – are worth noting.

The kinds of TIGTA cases include situations such as an employee lost a government laptop, misused the IDRS system to seek address information about an ex-spouse of the employee’s child, used Office of Chief Counsel letterhead to write a letter to a court on behalf of a personal friend who was being sentenced on tax-related charges, and one who used the Government computer to send emails on a private, non-work related matter which created the impression that they were acting in an official role.  The results of the investigations were as follows:

2008

2009

2010

2011

2012

Cases not substantiated

15

11

18

16

15

Employees separated before reviewcompleted

2 retired

5 resigned

0 retired

0 resigned

0 retired

0 resigned

  7

  0

Substantiated

15

28

15

27

25

Undetermined

  1

  1

  0

  0

  0

               TOTAL

38

40

33

50

40

Of those cases, the nature of the disciplinary action was reported for 2009-2011 as follows:

2009

2010

2011

2012

Counseling

Written-3

Oral-2

Written-1

Oral-8

Written-4

Oral-16

Written-1

Oral-20

Admonishment

  0

  2

  3

  1

Reprimand

  1

  1

  1

  1

Suspension

  1

  2

  3

  0

Removal

  0

  0

  0

  2

Downgrade

  0

  0

  0

  0

               TOTAL

14

27

  7

25

The reports also described the actions in non-TIGTA cases which fell in similar classifications.  The kinds of non-TIGTA cases which arose involved failing to file a proper tax return – overlooking interest income; failure to comply with deadlines imposed by the Tax Court; taking leave without authority; and a verbal altercation in an open office area involving racial terms and profanity.  In 2010, disciplinary action was taken in 97% of such cases, 100% in 2011, and 100% in 2012.

Given all the attention received for the Section 501(c)(4) situation, it is comforting to see that professionalism is not being ignored within the Office of Chief Counsel.  It will be interesting to see how all of the current allegations are dealt with in this framework.

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.

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.

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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