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Must Taxpayers File “Timely” Forms 1099 to Obtain Section 530 Relief? Unexpected Answers from a Recent Worker-Classification Case

April 29, 2013

By Hale Sheppard

When battling the IRS, knowledge is power.  Nowhere is this more true than in worker-classification cases, where the IRS often seems hell-bent on treating all workers as employees, regardless of the facts.  One bright spot for taxpayers under IRS scrutiny is an obscure provision, commonly known as Section 530, that grants taxpayers a brand of “civil immunity” if they meet three criteria.  One requirement is that taxpayers file Forms 1099 (Miscellaneous Income) for all workers considered to be independent contractors.

For over three decades, the IRS has taken the position that Section 530 relief is not available unless taxpayers file their Forms 1099 in a “timely” manner.  One problem with the IRS’s stance is that it has been questioned and contradicted by at least two courts, including the Fifth Circuit Court of Appeals in a recent case called Bruecher Foundation Services, Inc. v. United States.  The bigger problem is that too many taxpayers, unaware of the relevant rules and caselaw, allow themselves to lose worker-classification cases, unnecessarily prolong audits, and/or miss opportunities to seek fee reimbursement from the IRS.  This article, published in the May 2013 issue of TAXES – The Tax Magazine, aims to alleviate these problems by highlighting and analyzing the taxpayer-favorable authorities regarding Section 530 relief and the Form 1099 filing requirement.

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Government Wins Second Willful FBAR Penalty Case: What McBride Really Means to Taxpayers with Unreported Foreign Accounts

April 25, 2013

By Hale Sheppard

Taxpayers with undisclosed foreign accounts wish it were not true, but the reality is that the U.S. government, after a long period of inactivity and ineffectiveness, has taken significant steps over the past few years to identify and punish failures to file Forms TD F 90-22.1 (Report of Foreign Bank and Financial Accounts), or foreign bank account reports (“FBARs”) as they are commonly known.  These steps include enacting legislation obligating foreign institutions to automatically provide the IRS with information about U.S. account holders, paying handsome rewards to whistleblowers, introducing a new information return forcing taxpayers to report their foreign financial assets (including foreign accounts) to the IRS each year, imposing multi-million dollar fines and disclosure duties on foreign banks that collaborate with taxpayers to evade U.S. taxes, extracting valuable data about international tax transgressions from taxpayers participating in the Offshore Voluntary Disclosure Program (“OVDP”), and criminally prosecuting FBAR offenders.  Another step has become apparent in the past few months, i.e., litigation to collect civil penalties for “willful” FBAR violations.  To date, two cases have been decided, both in favor of the U.S. government.  The attached article, “McBride Willfull FBAR Penalty Case Article,” examines the most recent case.  The article was published in the most recent version of the Journal of Taxation (April 2013).

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IRS Introduces Two Unique Remedies for U.S. Persons with Unreported Canadian Retirement Plans and Accounts

February 6, 2013

By Hale Sheppard

Life isn’t fair.  Neither is the IRS’s most recent settlement initiative designed to entice taxpayers to proactively resolve their international tax non-compliance, such as failing to report foreign income, foreign accounts, foreign entities, etc.  In both instances, some people win and some people lose, often with little or no regard to what is equitable.  Among those basking in the benefits of favored status lately are certain Canadians, residing either in the United States or the homeland, who have neglected their tax-related obligations with Uncle Sam.  Indeed, thanks to recent modifications to the offshore voluntary disclosure program (“OVDP”) and the introduction of a special “streamline procedure” for select expatriates, many Canadians are able to resolve their tax transgressions on terms vastly superior to those applicable to the masses.  This is particularly true for persons with specific types of Canadian retirement plans.  The article, “IRS Introduces Two Unique Remedies for U.S. Persons with Unreported Canadian Retirement Plans and Accounts,” which was published in the most recent edition of the International Tax Journal, analyzes the unique options available to Canadians.

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The Moment You Have All Been Waiting For: Payroll Tax Guidance for 2013

January 4, 2013

The IRS released Notice 1036 to assist employer’s with determining the payroll tax consequences of the fiscal cliff.

2013 Withholding Tables. Notice 1036 includes the 2013 Percentage Method Tables for Income Tax Withholding. Employers should implement the 2013 withholding tables as soon as possible, but not later than February 15, 2013. Employers can use the 2012 withholding tables until they implement the 2013 withholding tables.

Social Security Tax. For 2013, the employee tax rate for social security increases to 6.2%. The social security wage base limit increases to $113,700. Employers should implement the 6.2% employee social security tax rate as soon as possible, but not later than February 15, 2013. After implementing the new 6.2% rate, employers should make an adjustment in a subsequent pay period to correct any underwithholding of social security tax as soon as possible, but not later than March 31, 2013. The employer tax rate for social security remains unchanged at 6.2%.

Medicare Tax. The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2012. There is no wage base limit for Medicare tax.

Additional Medicare Tax Withholding. In addition to withholding Medicare tax at 1.45%, employers must withhold a 0.9% Additional Medicare Tax from wages paid to an employee in excess of $200,000 in a calendar year. Employers are required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee and must continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold.

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IRS Finally Collects Civil “Willful” FBAR Penalty in Williams Case – Court Introduces New Lower Standard for Penalizing Taxpayers with Unreported Foreign Accounts

December 7, 2012

By Hale Sheppard

The world of international tax enforcement is changing at a frenetic pace, especially when it comes to the rules about penalizing taxpayers who fail to file Forms TD F 90-22.1 (Report of Foreign Bank and Financial Accounts), or foreign bank account reports (“FBARs”) as they are commonly known.  The latest installment in this area is United States v. Williams, a recent decision by the Fourth Circuit Court of Appeals holding that the taxpayer “willfully” violated his FBAR duties and thus deserved maximum sanctions.  This judicial opinion, already the subject of much criticism by the tax community, raises more questions than answers.  The attached article, called “Third Time’s the Charm:  Government Finally Collects “Willful” FBAR Penalty in Williams Case,” addresses multiple issues triggered by Williams.  The article was published in the December 2012 issue of the Journal of Taxation.

Alarmists might conclude that Williams stands for the proposition that (i) the standard for asserting civil FBAR penalties is willfulness, (ii) in this context, the government can establish willfulness by showing that the taxpayer was merely reckless, (iii) recklessness exists where a taxpayer does not read and understand every aspect of a complex tax return, including all schedules and statements attached to the return (including Schedule B), as well as any separate forms (including the FBAR) alluded to in the schedules, and (iv) the taxpayer’s motive for not filing an FBAR is not relevant.  Pragmatists, on the other hand, might see Williams as an aberration, based on narrow facts, with little precedential value, and with questionable real-world applicability.  Most people likely will fall somewhere in between.  Regardless of the viewpoint, it is undeniable that Williams introduced issues critical to the FBAR debate, many of which remain unresolved.  Taxpayers and their advisors would be wise to follow the evolving issues, as the incidence of FBAR and other international tax enforcement issues will continue to rise in the future.

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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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