Archive for the ‘Tax Procedure’ category

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

January 16, 2014

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.

Are Quiet Disclosures of Offshore Accounts Becoming Even Riskier?

October 18, 2013

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.

Filing Tax Returns During the Silly Season

October 7, 2013

For my fellow procrastinators whose federal tax returns are on extension, with the October 15th deadline rapidly approaching, perhaps the burning question has crossed your mind, “If I file electronically while the government is shut down, will my return be accepted?”  Yes, I can happily report that a return electronically submitted to the IRS at 3:43 p.m. this day was “accepted for filing” at 4:04 p.m., efficiency approaching a Michael Phelps-like performance. Perhaps the IRS has designed a system that operates better when it is staffed only by computers rather than by people.  Rube Goldberg, eat your heart out.

Filing Your Tax Return

–Phil Karter

Squib Note: The Opera Isn’t Over Yet on FICA Tax Refunds Until The Supreme Court Sings

April 3, 2013

By Phil Karter and John Hackney

In a blog posting earlier this year, we talked about the Sixth Circuit’s decision in United States v. Quality Stores (Civil No. 10-1563, 6th Cir. 2012) affirming a lower court’s decision that supplemental unemployment compensation benefit (SUB) payments are not taxable as wages and are consequently exempt from FICA taxes. The Sixth Circuit’s decision in Quality Stores directly conflicts with the Federal Circuit’s prior decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), which held that such payments were subject to FICA.  For many employers who have filed protective refund claims, the favorable resolution of this conflict could result in meaningful refunds.

Those speculating on whether Quality Stores will be appealed to the Supreme Court, and whether the Supreme Court will grant certiorari, will have to wait a little longer to find out.  The original deadline for filing a petition for certiorari has been extended from April 4th to May 3, 2013.

Although the deadline for the government’s petition has been extended, the April 15, 2013 deadline to file protective refund claims for 2009 (the oldest eligible year) has not.  For employers that haven’t already done so, particularly those located within the Sixth Circuit (Kentucky, Michigan, Ohio and Tennessee), there is still a small amount of time left.

A final word of caution about deadlines:  If a protective FICA tax refund claim is denied, employers have two years from the date of denial to file a tax refund suit or obtain an extension of the two-year period by filing a Form 907.   Given the uncertainty over the final outcome of this issue, it is unclear whether the IRS will summarily deny protective refund claims or wait until the dust settles.  Nonetheless, employers whose refund claims are denied are well advised to keep track of the two-year deadline.  If the Supreme Court accepts certiorari, it may take that long before the final word on the subject is written.

Sixth Circuit Moves The Ball Forward For Companies Seeking FICA Tax Refunds On Supplemental Unemployment Compensation Benefit Payments

January 8, 2013

By Phil Karter and John Hackney

For companies that have implemented employee layoffs in the past several years and made severance payments to terminated employees, the prospect of eligibility for federal tax refunds for any FICA taxes withheld from such payments took another step forward with the Sixth Circuit’s January 4th denial of the government’s petition for rehearing en banc in United States v. Quality Stores (Civil No. 10-1563, 6th Cir. 2012).

The rehearing petition was filed after a government loss in September of last year in which the appellate court affirmed a lower court’s decision that supplemental unemployment compensation benefit (SUB) payments are not taxable as wages and are consequently exempt from FICA taxes. Under section 3402(o)(2) of the Internal Revenue Code, SUB payments are defined as “amounts which are paid to an employee, pursuant to a plan to which the employer is a party, because of an employee’s involuntary separation from employment (whether or not such separation is temporary), resulting directly from a reduction in force, the discontinuance of a plant or operation, or other similar conditions.”

The Sixth Circuit’s decision in Quality Stores directly conflicts with the Federal Circuit’s prior decision in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008), which held that such payments were subject to FICA.  With the denial of the petition for rehearing in Quality Stores, the stage is now set for the government to seek Supreme Court review.  Because the eventual outcome of this conflict has enormous financial implications, a petition for certiorari is reasonably foreseeable.  Such a petition would be due by April 4, 2013.

Although the final word on the issue may not yet be written, for companies located within the Sixth Circuit’s purview (Kentucky, Michigan, Ohio and Tennessee), the taxpayer-friendly Quality Stores decision is currently binding authority which, unless reversed by the Supreme Court, will entitle those who have filed timely refund claims to the refund of FICA taxes paid over on SUB payments. In the rest of the country, Quality Stores is not binding on the IRS.  Nonetheless, the case at least raises the prospect of a taxpayer victory on the issue when the dust finally settles.

Many companies have already filed protective tax refund claims to preserve their rights to receive potentially significant refunds of FICA tax.  For those that haven’t, filing such claims for each open taxable year in which FICA was withheld on SUB payments is an absolute prerequisite to obtain any refunds. There is little cost associated with filing a protective refund claim but the potential benefit could be quite large.  Accordingly, any eligible employers who have not already done so are advised to file their claims as soon as possible for all open years to avoid being barred by the applicable statute of limitations, which typically remains open for the later of three years after the return due date or two years after the date of payment.

A final point about which employers filing refund claims should take note is that under Treas. Reg. § 31.6402(a)-2, a refund claim seeking the refund or credit of an employee’s share of FICA taxes requires the employer to certify either that it has repaid or reimbursed the tax to its employee or that it has secured the employee’s written consent to the filing of the refund claim (except to the extent the taxes were not withheld from the employee).  In Quality Stores, for example, roughly 1,800 of 3,000 former employees consented to the company filing FICA tax refund claims on their behalf.  Consequently, the employer’s refund claim for its own share of FICA taxes exceeded the refund sought for its former employees’ share.

Could The New Economic Substance Statute Apply To End-Of-Year Stock Sales And Repurchases?

December 28, 2012

By Phil Karter

With the looming increase in tax rates on investment income and capital gains in particular, a large number of stock market investors have been selling long-term positions to lock in the 2012 rate, which currently tops out at 15%.  Come January 1,2013, gain on the same sale could be taxed at a rate as high as 23.8%, consisting of a long-term capital gains tax rate of 20% plus a Medicare surtax of 3.8% imposed on joint filers with AGI greater than $250,000 and single filers with AGI greater than $200,000.  (See Internal Revenue Code § 1411).

A question attracting attention as the year draws to a close and the pace of this activity has accelerated has been whether a stock sale undertaken solely to take advantage of the lower 2012 capital gains tax rates might fall within the scope of Code § 7701(o), the relatively new economic substance statute codified as part of the landmark Health Care and Education Reconciliation Act of 2010 (Pub. L. 111-152, 124 Stat. 1029).  Concerns about coming within the scope of this statute are that it might subject the investor to a 20% penalty enacted as part of the new law.  See Code § 6662(b)(6).  The penalty, if applicable, is a “strict liability” one, which means that taxpayers cannot avoid it on grounds of reasonable cause, such as reliance on a tax advisor. (The penalty for a transaction determined to lack economic substance is also increased to a whopping 40% if the transaction is undisclosed.  See Code § 6662(i).  However, as long as a taxpayer reports the transaction on his or her tax return, the 40% penalty should not apply.)

Thankfully, the eleventh hour concerns expressed about this issue should be put to rest for stock investment gain-recognition transactions in 2012.  Even assuming the economic substance statute is conceptually broad enough to ensnare stock sale transactions undertaken to lock in lower capital gains tax rates, the penalty is only applicable to “underpayments.”  Because a long-term capital gain recognized in 2012 does not reduce a taxpayer’s taxable income but rather increases it (unless the gain is offset by otherwise unused capital losses), there is no underpayment against which to apply a penalty.

Now let’s vary the circumstances by introducing a simultaneous buyback of the stock at the time of sale to reestablish the same position.  Does that change anything vis a vis a potential penalty risk?  We still have a gain recognition transaction in 2012, so there is no tax underpayment against which a penalty could apply for this year.  As for the repurchased stock, its cost basis is at the repurchase price, which means that a subsequent sale in a future year will either produce a smaller taxable gain or larger taxable loss than would have occurred had the original share lots with their lower cost basis simply been maintained.  Some have speculated that this could produce a tax underpayment against which the strict liability economic substance penalty might apply in the year of sale.  After all, in defining a transaction that has economic substance, § 7701(o) requires (1) that the transaction change in a “meaningful way” the taxpayer’s economic position apart from federal tax benefits, and (2) that the taxpayer have a non-tax purpose for entering into the transaction.

In theory, a sale and instantaneous repurchase might fail to satisfy both of these tests.  On the other hand, a repurchase transaction that occurs sometime after the sale introduces an element of market risk from stock price fluctuation that should mitigate any penalty risk.  Similarly, a repurchase in a different type of account (e.g., in a tax-deferred account where the original sale was in a taxable account or vice versa) should also put the taxpayer on firmer ground.

So what are the real risks that the IRS might choose some unfortunate taxpayers to assert a strict liability penalty?  It has, after all, been less than forthcoming in providing guidance on what types of plain vanilla transactions, if any, may be viewed as falling within the scope of the new economic substance statute.  Perhaps the best indicator one can draw upon is the title of § 7701(o), “Clarification of Economic Substance Doctrine.”  The codified doctrine has been portrayed as merely a clarification of the economic substance law in effect for transactions entered into before March 30, 2010. Under the pre-codification doctrine, which is derived solely from the common law, there do not appear to be any reported economic substance cases involving a taxpayer’s sale and repurchase transaction that results in accelerated gain recognition. Couple this with the fact that no court has been asked to interpret the breadth of the new economic substance statute since it was passed in 2010, and it is reasonable to believe that the IRS would prefer to choose a different, and presumably more compelling battleground to make its first stand defending the application of Section 7701(o) and the strict liability penalty.

Finally, in the case of a 2012 gain-recognition stock sale and simultaneous repurchase, it cannot be entirely certain that the transaction will even produce a tax savings when all is said and done.  This is because of the difference between the tax rates for long and short term capital gains (which are taxed at ordinary income rates).  Because a new holding period is established for the repurchased stock, it remains possible that the stock, when sold, will produce a short-term capital gain subject to a larger tax burden than might have occurred if if the original long-term position was held into 2013 or beyond.  In the end, the lack of certainty about the ultimate tax effect until the second sale occurs may be taxpayers’ best argument that the sale and repurchase transaction had economic substance after all.

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.

The IRS Can Summons California For Property Transfer Records

December 20, 2011

As noted by Janet Novack at forbes.com, Judge England of the District Court for the Eastern District of California last week issued an order permitting the IRS to serve a “John Doe” summons on the California State Board of Equalization.  The summons seeks the names of residents who transferred property to relatives for little or no considerations.  The IRS hopes that the information it receives will identify individuals who should have, but did not, file Forms 709 – Gift Tax Returns. (more…)


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