Vince Nardone: Tax and Controversy

PRACTICING DUE DILIGENCE AND PROFESSIONAL RESPONSIBILITY

Guest Author: Ryan K. Carnes, Columbus, Ohio

On June 19, 2009, Director of the Office of Professional Responsibility (“OPR”) Karen L. Hawkins filed a complaint against Florida-based Certified Public Accountant Tim W. Kaskey pursuant to 31 U.S.C. Sec. 330 and 31 C.F.R. Secs. 10.60 and 10.91. The complaint alleged that Kaskey engaged in “disreputable conduct” as defined by 31 C.F.R. Sec. 10.51. (“disreputable conduct” generally includes “any conduct that is violative of the ordinary standards of professional obligation and honor”). Specifically, Kaskey failed to file his Federal individual income tax returns for five consecutive years, the years of 2001 through 2005. Additionally, Kaskey was charged with failing to exercise due diligence in determining the correctness of the representations he made to the Internal Revenue Service (“IRS”) concerning the tax matters of a corporation and its husband and wife shareholders.

Kaskey never filed an answer to the complaint. Furthermore, he neither requested an extension of time, nor did he provide the court with a reason for his failure to respond. Kaskey’s failure to respond constituted an admission of the allegations of the complaint and a waiver of hearing. Accordingly, United States Administrative Law Judge William B. Moran entered a default judgment and ordered Kaskey disbarred from practice before the IRS.   

On May 28, 2010 the Appellate Authority upheld Judge Moran’s decision to disbar Kaskey. On appeal, Kaskey stated that his failure to file his individual income tax returns was due to an ongoing medical condition. The only evidence of a condition provided by Kaskey, other than his statement, was a copy of a prescription. Additionally, throughout the period in which he failed to file his individual income tax returns, Kaskey prepared many returns for other taxpayers. In relation to Director Hawkins due diligence claim concerning corporation and its husband and wife shareholders, Kaskey argued that his clients misrepresented their income to him. In response, Appellate Authority Ronald D. Pinsky stated that “it was inconceivable that [the individual taxpayers] could pay their living expenses based upon the income reported on their returns.”    

 

“Practitioners who think OPR isn’t serious about due diligence should take heed,” added OPR Director Hawkins. “Practitioners may not ignore the implications of information already known, and must make reasonable inquiries if the information furnished by a client appears to be incorrect, inconsistent, or incomplete.”

 

This OPR decision also emphasizes the importance of tax practitioners taking their jobs seriously and ensuring they thoroughly examine their client’s factual circumstances and complete their necessary due diligence before making representations to the IRS. In addition, tax practitioners need to follow their own advice, if we tell our clients to file their returns on time, we certainly should be doing the same thing.

See the attached for more details.  Download OPR v. Kaskey Download OPR v. Kaskey - appeal

APPLICATION OF ACCURACY RELATED PENALTIES

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

In Multi Pak Corporation v. Commissioner, T.C. Memo 2010-139, the tax court upheld the deductions taken by Multi Pak, Corp. (the “Taxpayer”) in relation to its officer compensation for the 2002 tax year. For the 2003 tax year, the tax court held that the Taxpayer could deduct only a portion of the officer compensation that the Taxpayer had reported. Thus, for the 2003 tax year, there was tax liability and a basis to impose an accuracy related penalty. The tax court, however, held that the Taxpayer acted reasonable and in good faith by relying on the advice of its accountant and did not impose an accuracy related penalty.

 

Code Sections 6662(a) and (b)(1) impose a 20-percent accuracy-related penalty on the portion of underpayment that is due to negligence or intentional disregard of rules or regulations. Thus, there has to be a tax liability to have an accuracy related penalty.  And, the amount of accuracy related penalty depends on the amount of tax liability attributable to the negligence or international disregard of the rules or regulations. Negligence includes a failure to attempt reasonably to comply with the Code. Disregard includes a careless, reckless, or intentional disregard of the rules or regulation.  Code Section 6662(c). Code Section 6664 (c) provides an exception to this penalty if the taxpayer had reasonable cause and acted in good faith for the underpayment of tax.  Reasonable cause is defined as the exercise of ordinary business care and prudence. U.S. v. Boyle, 469 U.S. 241 (1985).Depending on the facts and circumstances, a taxpayer’s reliance on the advice of a tax professional advice may be sufficient to show reasonable cause and good faith. Treasury Regulation § 1.6664-4(C).

 

Here, because there was no tax liability for the 2002 tax year, there was no basis for the accuracy related penalty. For the 2003 tax year, however, there was a tax liability and a basis for an accuracy related penalty. But, the Taxpayer had relied on the advice of its accountant in determining what was reasonable compensation and the Taxpayer’s reliance was reasonable and it acted in good faith. The Taxpayer’s accountant was a certified public accountant independent of the Taxpayer. Prior to the 2003 tax year, the accountant had prepared the Taxpayer’s return for approximately 38 years and regularly advised the Taxpayer on the reasonableness of its officer compensation. Thus, the tax court held that, pursuant to Code Section 6664(c), the accuracy related penalty did not apply.

 

This case demonstrates two important points. First, if the taxpayer is successful in obtaining relief for the underlying tax liability, the related accuracy related penalty should not be imposed. Second, if the taxpayer relies on the advice of a tax professional then, depending on the circumstances, the taxpayer may have a strong defense against the imposition of penalties.  These principles also apply to failure file and pay penalties under Code Section 6651.

Download Multi-Pak Corp. v. Commissioner

Cancellation of Indebtedness Income

We hear a lot today about debtors being subject to cancellation of indebtedness income, sometimes referred to as discharge of indebtedness, which I will refer to as COD income.  What you also hear about is debtors complaining that it is unfair.  But, in fact, it is not unfair.  Rather, it is necessary, and what the debtors and their advisors should be looking at is whether there are any exclusions available to the debtor to avoid the income legitimately, and stop worrying about what is fair or unfair.

So, why is it necessary and fair to subject debtors to COD income.  Well, when a borrower receives money in a loan transaction, such as purchasing a home, the borrower does not have to include that money in income.  As a fundamental principle of tax, borrowed monies are excluded from gross income because the obligation to repay borrowed monies offsets the economic increment even though borrowed funds increase a taxpayer's assets.  But, when the obligation is later discharged without requiring the borrower to pay it back, the borrower has realized an accession to wealth.  Again, the receipt of the proceeds of a loan is not income because the receipt is offset by an obligation to repay the borrowed monies.  If the obligation to repay is then eliminated, the borrower realizes an accession to wealth that should be included in gross income (i.e., the COD income).   Under basic tax theory, that is absolutely fair and not requiring them to include it in income is where it would be unfair as a matter of principle.

What debtors and their advisors should be focusing on is what theories under common law and statute, allow the the debtors to avoid the income.  As an example, a debtor that is insolvent immediately before the discharge will likely be able to exclude a portion of the amount discharged from income, both under common law and statute. Debtors and their advisors should seek out competent tax advisors to assist with this analysis.

REMINDER REGARDING IRS’ RECORD RETENTION GUIDELINES

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

 

Code Section 6001 of the Internal Revenue Code and its regulations provides for most of the IRS’ rules regarding record retention. The IRS recognizes that records include not only paper files, but also computerized data.  And, during these times of ever changing technology, the IRS has issued revenue procedures that businesses must follow in keeping certain computerized data. A business’s failure to comply with these guidelines can result in penalties being assessed and can be detrimental to businesses during an audit. 

 

Revenue Procedure 98-25 provides that Code Section 6001 requirements, which apply to hard-copy books and records, also apply to machine-sensible books and records maintained within an Automatic Data Processing (ADP) system. And, Revenue Procedure 98-25 sets forth the Service’s expectations regarding these items. The ADP consists of an accounting or financial system that processes the taxpayer’s transactions, records, or data. Machine sensible data is data in an electronic format intended for use by a computer.

 

Revenue Procedure 98-25 provides that taxpayers’ machine sensible records must support and verify the entries made on returns and determine the correct tax liability, and they must reconcile with the taxpayer’s books and records. It also provides that taxpayers may create files solely for the IRS's use. But, the taxpayer must be able to establish the relationship between the files created and the original Data Base Management System (DBMS) records. This Revenue Procedure also provides a procedure for taxpayers to identify machine sensible records that taxpayers believe do not have to be maintained and obtain permission to not maintain them. Revenue Procedure 98-25, however, does not relieve a taxpayer from retaining the hardcopy of the records that are created or received in the ordinary course of business. But, Revenue Procedure 97-22 does allow taxpayers to transfer their hardcopy records or computerized records to an adequate electronic storage media.   It also allows taxpayers to destroy original hard copy books and records and delete original computerized records so long as the Revenue Procedure’s guidelines are followed. Machine sensible records, however, are still required to be maintained. 

 

For more information see the attached Revenue Procedures 98-25 and 97-22.

Download Revenue procedures

 

Gifts of Partnership Interests Did Not Qualify for the Annual Gift Tax Exclusion

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

 

 

In Walter M. Price v. Commissioner, TC Memo 2010-2, the Tax Court held that gifts of partnership interests were not eligible for the annual gift tax exclusion because they were gifts of future interests. The court characterized the gifts of partnership interests as gifts of future interests because those interests were subject to various restrictions that prevented the donees from having the present right to the use, possession, or enjoyment of those interests. 

 

Under the Internal Revenue Code (the “Code”), donors of gifts can take advantage of an annual gift tax exclusion of $13,000 (as indexed for 2010) per donee so long as the gift is that of a present interest.  See Code § 2503(b).  For a gift to qualify as a present interest, the donor must confer upon the donee an unrestricted and noncontingent right to the immediate right to the use, possession, or enjoyment of the property or income from the property, such that the donee derives a present and substantial economic benefit from the property. See Treas. Reg. § 25.2503-3(a) and (b); Hackl v. Commissioner, 118 T.C. 279, 293 (2002).

 

In Walter, the partnership agreement had various restrictions that prevented the children donees from deriving a present and substantial economic benefit from the partnership interests gifted by their parents.  The two major restrictions that the court focused on were: (i) the inability to sell the partnership interest to third parties without the consent of all partners; and (ii) distributions of income from the partnership being subject to the discretion of the general partner.  Thus, the donees were unable to presently realize a substantial financial or economic benefit from the partnership interests and the court held they were gifts of future interests not eligible for the gift tax exclusion.

 

When forming a limited liability company or a partnership, if one anticipates gifting these interests, it is important to plan ahead to allow the owners to take advantage of the annual gift tax exclusion. For example, there could be fewer restrictions given in the partnership or operating agreement to allow the donees to have a present and unrestricted right to use, possession, or enjoyment of these interests.  This, however, may come with a price of having less control over the ownership and sale of these interests.  Another idea would be to have a provision in the agreement similar to that of a Crummey power in a trust, which would allow the donee a limited right to demand the income or principal from the business.

 

Attached please find Walter M. Price v. Commissioner, TC Memo 2010-2. Download Walter vs. Commissioner

Internal Revenue Service Announces New Format for Notices

Tax Attorney Vince Nardone discusses a recent Internal Revenue Service release:

Have you previously received an IRS notice that was dated two weeks after the date your received it?  Have you ever received an IRS notice that references a subject matter that does not pertain to you as a taxpayer or simply does not make any sense at all?  My point here is that the IRS has a lot of room for improvement when it comes to their notices.  Well, in Internal Revenue Service news release 2010-3, the IRS has announced new a format for certain notices.  I am skeptical at this point that there will be much improvement.  But, I hope for us tax professionals and our clients that I am wrong and hope that the revised notices are a step in the right direction.  See the newest notices by clicking on the link below or by copying and pasting the link into your web browser.  Also, the complete copy of the IRS news release is attached as a pdf for you to review.

http://www.irs.gov/individuals/article/0,,id=96199,00.html

Download Temp - IRS news release for new notice format

New Rules in Place for Paid Tax-Return Preparers - IRS Announces

Vince Nardone of Nardone Law Group, LLC discusses the IRS’ recent news release 2010-1, dealing with paid tax-return preparers. 

According to IR 2010-1, the Internal Revenue Service kicked off the 2010 tax filing season today by issuing the results of a landmark six-month study that proposes new registration, testing and continuing education of tax return preparers. See the attached study in pdf format.  According to the IRS, with more than 80 percent of American households using a tax preparer or tax software to help them prepare and file their taxes, higher standards for the tax preparer community will significantly enhance protections and service for taxpayers, increase confidence in the tax system and result in greater compliance with tax laws over the long term.

To bring immediate help to taxpayers this filing season, the IRS also announced a sweeping new effort to reach tax return preparers with enforcement and education. As part of the outreach effort, the IRS is providing tips to taxpayers to ensure they are working with a reputable tax return preparer.

The IRS goes on to say that based on the results of the Return Preparer Review, the IRS recommended a number of steps that it plans to implement for future filing seasons, including:

· Requiring all paid tax return preparers who must sign a federal tax return to register with the IRS and obtain a preparer tax identification number (PTIN). These preparers will be subject to a limited tax compliance check to ensure they have filed federal personal, employment and business tax returns and that the tax due on those returns has been paid.

· Requiring competency tests for all paid tax return preparers except attorneys, certified public accountants (CPAs) and enrolled agents who are active and in good standing with their respective licensing agencies.

· Requiring ongoing continuing professional education for all paid tax return preparers except attorneys, CPAs, enrolled agents and others who are already subject to continuing education requirements.

· Extending the ethical rules found in Treasury Department Circular 230 -- which currently only apply to attorneys, CPAs and enrolled agents who practice before the IRS -- to all paid preparers. This expansion would allow the IRS to suspend or otherwise discipline tax return preparers who engage in unethical or disreputable conduct.

The registering and testing of tax return preparers has been on the radar screen of the IRS for some time.  It will be interesting to see the impact it has on the tax return preparer community, and the potential influx of cases into the IRS Office of Professional Responsibility.

Download Tax Return Preparer Study - IRS

NOL Carry Back Rules in the Worker, Homeownership, and Business Assistance Act of 2009

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

The ''Worker, Homeownership, and Business Assistance Act of 2009'' (the “Act”), signed into law on Nov. 6, 2009 as P.L. 111-92  now expands the 5-year carryback's availability to include most businesses, not just eligible small businesses (ESBs), and extends the 5-year carryback of net operating losses (“NOL”) to 2009 NOLs.  The Act also provides greater flexibility to ESBs who made elections pursuant to the American Recovery and Reinvestment Act of 2009 (the “2009 Recovery Act”), which  allowed only ESBs to elect to carry back NOLs from tax year 2008 for up to 5 years.

In general, NOLs may be carried back two years and forward 20 years. The Act now allows most businesses to increase the carryback period for applicable NOLs from 2 to 3, 4, or 5 years. See Code Sec. 172(b)(1)(H)(i)(I).  The Act imposes a 50-percent income limitation on NOL offsets in the fifth preceding tax year. But, this limitation does not apply to ESB’s that elected to carry back 2008 NOLs under the 2009 Recovery Act; however, the limitation will apply if those businesses have 2009 NOLs.  Also, the election may be made for only one tax year. See Code Sec. 172(b)(1)(H)(iii)(I).  But, again an ESB that made an election pursuant to the 2009 Recovery Act may make an election for 2 tax years instead of just 1. See Code Sec. 172(b)(1)(H)(v)(I). Finally, the Act affects the alternative minimum tax (AMT) by suspending the 90-percent income limitation on the use of NOLs for determining AMT for an extended carryback year.

For further details see the attached Worker, Homeownership, and Business Assistance Act of 2009 H.R. 3548.Download HR 3548

The Internal Revenue Service Enforcement Statistics for the 2009 Fiscal year

Tax Lawyer Vince Nardone discusses recent publication of the Internal Revenue Service’s enforcement statistics.

Based on a limited review of the IRS 2009 fiscal year enforcement statistics, the IRS's enforcement actions in fiscal year 2009 increased significantly over 2008.  But, the enforcement revenue collected shows a significant decline from the previous two years, according to information previously released by the IRS.  This is no surprise of course.  Based on the current economic climate, you would expect the IRS activity to increase but less money to come in because of the money simply not being available.  That is, the Taxpayer simply do not have any money.

As to the specific statistics, in fiscal year 2009, IRS levies totaled 3,478,181, liens totaled 965,618, and seizures totaled 581. In fiscal year 2008, there were 2,631,038 levies, 768,168 liens, and 610 seizures. The IRS also garnered $48.9 billion through enforcement actions in fiscal year 2009—with $26.9 billion through collection, $17.4 billion through examination, and $4.6 billion through document matching. In fiscal year 2008, the agency collected a total of $56.4 billion and, in fiscal year 2007, the amount collected was $59.2 billion. As to exams, for those with income between $200,000 and $999,999, 2.89% of returns were examined.  For those earning $1 million or more, 6.42% of returns were examined.  A total of 9,951,648 business returns (small and large corporation returns, and Subchapter S and partnership pass through returns) were filed and 58,144 were examined for a coverage rate of 0.58%.  The coverage rate for corporations with assets under $10 million was 0.85%, for corporations with assets of at least $10 million it was 14.55%, for Subchapter S corporations (Form 1120-S) it was 0.40%, and for partnership returns (Form 1065) it was 0.38%.

Please see the attached statistics for more information.

Download Collection Enforcement Results - Fiscal year 2009

Update on Estate Taxes

Guest Author Pilar Puerto discusses Estate Taxes:

 

On December 3, 2009, the house approved H.R. 4154, which would make the current estate, gift, and generation skipping transfer (GST) tax laws permanent.  As background, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estatetax was scheduled to be gradually phased out by increasing the applicable exemption amount each year up to $3.5 million in 2009 and then repealing in 2010. It is now the end of 2009 and unless Congress passes another act, in 2011 the estate tax provisions will revert to pre-2001 law. This would mean decreasing the unified credit exemption amount for estate tax purposes from the current $3.5 million to $1 million. But, lately there has been much debate and action in Congress for the passing of an estate tax bill.  And, up to this point there has been much speculation and uncertainty as to what the estate tax laws would look like.  But, now with the house’s approval of H.R. 4154 we have a better picture of what the future holds.

 

H.R. 4154 would make permanent the current unified credit effective exemption amount of $3.5 million for estate tax purposes to apply to estates of decedents dying during 2010 and later years. As to gift taxes, the unified credit effective exemption amount would remain at $1 million. And, the highest estateand gift tax rate would be 45%. The GST tax exemption would equal the unified credit effective exemption amount for estate tax purposes and be determined using the highest estate and gift tax rate. 

Considering the high exemption amounts, H.R. 4154 would make it so that only a small percentage of Americans need to worry about paying federal estate tax.  In general, estates are only subject to federal estate tax if they exceed the applicable exclusion amount. For example, under 2009 law only if a decedent’s taxable estate is over $3.5 million—after taking into consideration the unlimited marital deduction—will the decedent’s estate be subject to federal estate tax. Since H.R. 4154 would maintain the applicable exemption amount at $3.5 million, only the most fortunate of Americans need to be concerned about the estate tax.

 

There have been discussions among policy makers, however, on the effects that the estate tax may have on small family businesses, in particular farms.  The argument among these policy makers is that since most of the value of these family businesses is held in illiquid assets, these businesses would be forced to liquidate vital assets just to pay the federal estate tax. But, these concerns are not applicable to most family businesses. A recent report by the Congressional Research Service (CRS) shows that only a small fraction of estates with small or family business interests have paid the estate tax—about 3.5% for businesses in general, and 5% for farmers, compared to 2% for all estates.  CRS also reports that less than ½ of 1% of family-owned businesses that are subject to the estate tax “do not have readily available resources to pay the tax.” Therefore, even if there is a considerable burden on small businesses, this burden only applies to small percentage of these businesses. (RL33070 - Estate Taxes and Family Businesses: Economic Issues)

In sum, it looks like the future will continue to be the same as it is today.  That is, we will have high unified credit exemption amounts that will in turn exclude most estates from having to pay estate tax.  In turn, many will not need to worry about utilizing complicated devices in their estate plan for purposes minimizing the impact of the estate tax on their estates.

See the CRS study attached and the bill.Download Estate Tax - December 2009

Download Legislation - CRS Report

Internal Revenue Service, Office of Professional Responsibility Announces Recent Disciplinary Action

On December 18, 2009, the Internal Revenue Service, Office of Professional Responsibility (OPR), announced recent disciplinary sanctions involving attorneys, certified public accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents, and appraisers.  These individuals are subject to the regulations governing practice before the Internal Revenue Service, which are set out in Title 31, Code of Federal Regulations, Part 10, and which are published in pamphlet form as Treasury Department Circular No. 230. The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations.

I have attached the actual announcement below.  Each and every time these announcements come out they should be a reminder to tax professionals that we must not cross the line.  We as tax professionals owe a duty to both our clients and the government to ensure that we follow the law.  I am certainly not suggesting that we advocate for less tax favorable positions, or give in to certain Internal Revenue Service positions that seem unreasonable or simply not supported by the law.  Rather, I follow the rule that we must interpret and apply the law in a reasonable and good faith manner that allows for the most tax efficient position a taxpayer may take, while avoiding any potential of civil tax penalties.  Over the years, unfortunately, there are certain professionals that simply go too far.

See the announcement below. Download December 2009 - OPR announcement's

PRACTICING DUE DILIGENCE AND PROFESSIONAL RESPONSIBILITY

Guest Author: Ryan K. Carnes, Columbus, Ohio

On June 19, 2009, Director of the Office of Professional Responsibility (“OPR”) Karen L. Hawkins filed a complaint against Florida-based Certified Public Accountant Tim W. Kaskey pursuant to 31 U.S.C. Sec. 330 and 31 C.F.R. Secs. 10.60 and 10.91. The complaint alleged that Kaskey engaged in “disreputable conduct” as defined by 31 C.F.R. Sec. 10.51. (“disreputable conduct” generally includes “any conduct that is violative of the ordinary standards of professional obligation and honor”). Specifically, Kaskey failed to file his Federal individual income tax returns for five consecutive years, the years of 2001 through 2005. Additionally, Kaskey was charged with failing to exercise due diligence in determining the correctness of the representations he made to the Internal Revenue Service (“IRS”) concerning the tax matters of a corporation and its husband and wife shareholders.

Kaskey never filed an answer to the complaint. Furthermore, he neither requested an extension of time, nor did he provide the court with a reason for his failure to respond. Kaskey’s failure to respond constituted an admission of the allegations of the complaint and a waiver of hearing. Accordingly, United States Administrative Law Judge William B. Moran entered a default judgment and ordered Kaskey disbarred from practice before the IRS.   

On May 28, 2010 the Appellate Authority upheld Judge Moran’s decision to disbar Kaskey. On appeal, Kaskey stated that his failure to file his individual income tax returns was due to an ongoing medical condition. The only evidence of a condition provided by Kaskey, other than his statement, was a copy of a prescription. Additionally, throughout the period in which he failed to file his individual income tax returns, Kaskey prepared many returns for other taxpayers. In relation to Director Hawkins due diligence claim concerning corporation and its husband and wife shareholders, Kaskey argued that his clients misrepresented their income to him. In response, Appellate Authority Ronald D. Pinsky stated that “it was inconceivable that [the individual taxpayers] could pay their living expenses based upon the income reported on their returns.”    

 

“Practitioners who think OPR isn’t serious about due diligence should take heed,” added OPR Director Hawkins. “Practitioners may not ignore the implications of information already known, and must make reasonable inquiries if the information furnished by a client appears to be incorrect, inconsistent, or incomplete.”

 

This OPR decision also emphasizes the importance of tax practitioners taking their jobs seriously and ensuring they thoroughly examine their client’s factual circumstances and complete their necessary due diligence before making representations to the IRS. In addition, tax practitioners need to follow their own advice, if we tell our clients to file their returns on time, we certainly should be doing the same thing.

See the attached for more details.  Download OPR v. Kaskey Download OPR v. Kaskey - appeal

APPLICATION OF ACCURACY RELATED PENALTIES

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

In Multi Pak Corporation v. Commissioner, T.C. Memo 2010-139, the tax court upheld the deductions taken by Multi Pak, Corp. (the “Taxpayer”) in relation to its officer compensation for the 2002 tax year. For the 2003 tax year, the tax court held that the Taxpayer could deduct only a portion of the officer compensation that the Taxpayer had reported. Thus, for the 2003 tax year, there was tax liability and a basis to impose an accuracy related penalty. The tax court, however, held that the Taxpayer acted reasonable and in good faith by relying on the advice of its accountant and did not impose an accuracy related penalty.

 

Code Sections 6662(a) and (b)(1) impose a 20-percent accuracy-related penalty on the portion of underpayment that is due to negligence or intentional disregard of rules or regulations. Thus, there has to be a tax liability to have an accuracy related penalty.  And, the amount of accuracy related penalty depends on the amount of tax liability attributable to the negligence or international disregard of the rules or regulations. Negligence includes a failure to attempt reasonably to comply with the Code. Disregard includes a careless, reckless, or intentional disregard of the rules or regulation.  Code Section 6662(c). Code Section 6664 (c) provides an exception to this penalty if the taxpayer had reasonable cause and acted in good faith for the underpayment of tax.  Reasonable cause is defined as the exercise of ordinary business care and prudence. U.S. v. Boyle, 469 U.S. 241 (1985).Depending on the facts and circumstances, a taxpayer’s reliance on the advice of a tax professional advice may be sufficient to show reasonable cause and good faith. Treasury Regulation § 1.6664-4(C).

 

Here, because there was no tax liability for the 2002 tax year, there was no basis for the accuracy related penalty. For the 2003 tax year, however, there was a tax liability and a basis for an accuracy related penalty. But, the Taxpayer had relied on the advice of its accountant in determining what was reasonable compensation and the Taxpayer’s reliance was reasonable and it acted in good faith. The Taxpayer’s accountant was a certified public accountant independent of the Taxpayer. Prior to the 2003 tax year, the accountant had prepared the Taxpayer’s return for approximately 38 years and regularly advised the Taxpayer on the reasonableness of its officer compensation. Thus, the tax court held that, pursuant to Code Section 6664(c), the accuracy related penalty did not apply.

 

This case demonstrates two important points. First, if the taxpayer is successful in obtaining relief for the underlying tax liability, the related accuracy related penalty should not be imposed. Second, if the taxpayer relies on the advice of a tax professional then, depending on the circumstances, the taxpayer may have a strong defense against the imposition of penalties.  These principles also apply to failure file and pay penalties under Code Section 6651.

Download Multi-Pak Corp. v. Commissioner

Cancellation of Indebtedness Income

We hear a lot today about debtors being subject to cancellation of indebtedness income, sometimes referred to as discharge of indebtedness, which I will refer to as COD income.  What you also hear about is debtors complaining that it is unfair.  But, in fact, it is not unfair.  Rather, it is necessary, and what the debtors and their advisors should be looking at is whether there are any exclusions available to the debtor to avoid the income legitimately, and stop worrying about what is fair or unfair.

So, why is it necessary and fair to subject debtors to COD income.  Well, when a borrower receives money in a loan transaction, such as purchasing a home, the borrower does not have to include that money in income.  As a fundamental principle of tax, borrowed monies are excluded from gross income because the obligation to repay borrowed monies offsets the economic increment even though borrowed funds increase a taxpayer's assets.  But, when the obligation is later discharged without requiring the borrower to pay it back, the borrower has realized an accession to wealth.  Again, the receipt of the proceeds of a loan is not income because the receipt is offset by an obligation to repay the borrowed monies.  If the obligation to repay is then eliminated, the borrower realizes an accession to wealth that should be included in gross income (i.e., the COD income).   Under basic tax theory, that is absolutely fair and not requiring them to include it in income is where it would be unfair as a matter of principle.

What debtors and their advisors should be focusing on is what theories under common law and statute, allow the the debtors to avoid the income.  As an example, a debtor that is insolvent immediately before the discharge will likely be able to exclude a portion of the amount discharged from income, both under common law and statute. Debtors and their advisors should seek out competent tax advisors to assist with this analysis.

REMINDER REGARDING IRS’ RECORD RETENTION GUIDELINES

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

 

Code Section 6001 of the Internal Revenue Code and its regulations provides for most of the IRS’ rules regarding record retention. The IRS recognizes that records include not only paper files, but also computerized data.  And, during these times of ever changing technology, the IRS has issued revenue procedures that businesses must follow in keeping certain computerized data. A business’s failure to comply with these guidelines can result in penalties being assessed and can be detrimental to businesses during an audit. 

 

Revenue Procedure 98-25 provides that Code Section 6001 requirements, which apply to hard-copy books and records, also apply to machine-sensible books and records maintained within an Automatic Data Processing (ADP) system. And, Revenue Procedure 98-25 sets forth the Service’s expectations regarding these items. The ADP consists of an accounting or financial system that processes the taxpayer’s transactions, records, or data. Machine sensible data is data in an electronic format intended for use by a computer.

 

Revenue Procedure 98-25 provides that taxpayers’ machine sensible records must support and verify the entries made on returns and determine the correct tax liability, and they must reconcile with the taxpayer’s books and records. It also provides that taxpayers may create files solely for the IRS's use. But, the taxpayer must be able to establish the relationship between the files created and the original Data Base Management System (DBMS) records. This Revenue Procedure also provides a procedure for taxpayers to identify machine sensible records that taxpayers believe do not have to be maintained and obtain permission to not maintain them. Revenue Procedure 98-25, however, does not relieve a taxpayer from retaining the hardcopy of the records that are created or received in the ordinary course of business. But, Revenue Procedure 97-22 does allow taxpayers to transfer their hardcopy records or computerized records to an adequate electronic storage media.   It also allows taxpayers to destroy original hard copy books and records and delete original computerized records so long as the Revenue Procedure’s guidelines are followed. Machine sensible records, however, are still required to be maintained. 

 

For more information see the attached Revenue Procedures 98-25 and 97-22.

Download Revenue procedures

 

Gifts of Partnership Interests Did Not Qualify for the Annual Gift Tax Exclusion

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

 

 

In Walter M. Price v. Commissioner, TC Memo 2010-2, the Tax Court held that gifts of partnership interests were not eligible for the annual gift tax exclusion because they were gifts of future interests. The court characterized the gifts of partnership interests as gifts of future interests because those interests were subject to various restrictions that prevented the donees from having the present right to the use, possession, or enjoyment of those interests. 

 

Under the Internal Revenue Code (the “Code”), donors of gifts can take advantage of an annual gift tax exclusion of $13,000 (as indexed for 2010) per donee so long as the gift is that of a present interest.  See Code § 2503(b).  For a gift to qualify as a present interest, the donor must confer upon the donee an unrestricted and noncontingent right to the immediate right to the use, possession, or enjoyment of the property or income from the property, such that the donee derives a present and substantial economic benefit from the property. See Treas. Reg. § 25.2503-3(a) and (b); Hackl v. Commissioner, 118 T.C. 279, 293 (2002).

 

In Walter, the partnership agreement had various restrictions that prevented the children donees from deriving a present and substantial economic benefit from the partnership interests gifted by their parents.  The two major restrictions that the court focused on were: (i) the inability to sell the partnership interest to third parties without the consent of all partners; and (ii) distributions of income from the partnership being subject to the discretion of the general partner.  Thus, the donees were unable to presently realize a substantial financial or economic benefit from the partnership interests and the court held they were gifts of future interests not eligible for the gift tax exclusion.

 

When forming a limited liability company or a partnership, if one anticipates gifting these interests, it is important to plan ahead to allow the owners to take advantage of the annual gift tax exclusion. For example, there could be fewer restrictions given in the partnership or operating agreement to allow the donees to have a present and unrestricted right to use, possession, or enjoyment of these interests.  This, however, may come with a price of having less control over the ownership and sale of these interests.  Another idea would be to have a provision in the agreement similar to that of a Crummey power in a trust, which would allow the donee a limited right to demand the income or principal from the business.

 

Attached please find Walter M. Price v. Commissioner, TC Memo 2010-2. Download Walter vs. Commissioner

Internal Revenue Service Announces New Format for Notices

Tax Attorney Vince Nardone discusses a recent Internal Revenue Service release:

Have you previously received an IRS notice that was dated two weeks after the date your received it?  Have you ever received an IRS notice that references a subject matter that does not pertain to you as a taxpayer or simply does not make any sense at all?  My point here is that the IRS has a lot of room for improvement when it comes to their notices.  Well, in Internal Revenue Service news release 2010-3, the IRS has announced new a format for certain notices.  I am skeptical at this point that there will be much improvement.  But, I hope for us tax professionals and our clients that I am wrong and hope that the revised notices are a step in the right direction.  See the newest notices by clicking on the link below or by copying and pasting the link into your web browser.  Also, the complete copy of the IRS news release is attached as a pdf for you to review.

http://www.irs.gov/individuals/article/0,,id=96199,00.html

Download Temp - IRS news release for new notice format

New Rules in Place for Paid Tax-Return Preparers - IRS Announces

Vince Nardone of Nardone Law Group, LLC discusses the IRS’ recent news release 2010-1, dealing with paid tax-return preparers. 

According to IR 2010-1, the Internal Revenue Service kicked off the 2010 tax filing season today by issuing the results of a landmark six-month study that proposes new registration, testing and continuing education of tax return preparers. See the attached study in pdf format.  According to the IRS, with more than 80 percent of American households using a tax preparer or tax software to help them prepare and file their taxes, higher standards for the tax preparer community will significantly enhance protections and service for taxpayers, increase confidence in the tax system and result in greater compliance with tax laws over the long term.

To bring immediate help to taxpayers this filing season, the IRS also announced a sweeping new effort to reach tax return preparers with enforcement and education. As part of the outreach effort, the IRS is providing tips to taxpayers to ensure they are working with a reputable tax return preparer.

The IRS goes on to say that based on the results of the Return Preparer Review, the IRS recommended a number of steps that it plans to implement for future filing seasons, including:

· Requiring all paid tax return preparers who must sign a federal tax return to register with the IRS and obtain a preparer tax identification number (PTIN). These preparers will be subject to a limited tax compliance check to ensure they have filed federal personal, employment and business tax returns and that the tax due on those returns has been paid.

· Requiring competency tests for all paid tax return preparers except attorneys, certified public accountants (CPAs) and enrolled agents who are active and in good standing with their respective licensing agencies.

· Requiring ongoing continuing professional education for all paid tax return preparers except attorneys, CPAs, enrolled agents and others who are already subject to continuing education requirements.

· Extending the ethical rules found in Treasury Department Circular 230 -- which currently only apply to attorneys, CPAs and enrolled agents who practice before the IRS -- to all paid preparers. This expansion would allow the IRS to suspend or otherwise discipline tax return preparers who engage in unethical or disreputable conduct.

The registering and testing of tax return preparers has been on the radar screen of the IRS for some time.  It will be interesting to see the impact it has on the tax return preparer community, and the potential influx of cases into the IRS Office of Professional Responsibility.

Download Tax Return Preparer Study - IRS

NOL Carry Back Rules in the Worker, Homeownership, and Business Assistance Act of 2009

Guest Author: M. Pilar Puerto, Esq., Columbus, Ohio

The ''Worker, Homeownership, and Business Assistance Act of 2009'' (the “Act”), signed into law on Nov. 6, 2009 as P.L. 111-92  now expands the 5-year carryback's availability to include most businesses, not just eligible small businesses (ESBs), and extends the 5-year carryback of net operating losses (“NOL”) to 2009 NOLs.  The Act also provides greater flexibility to ESBs who made elections pursuant to the American Recovery and Reinvestment Act of 2009 (the “2009 Recovery Act”), which  allowed only ESBs to elect to carry back NOLs from tax year 2008 for up to 5 years.

In general, NOLs may be carried back two years and forward 20 years. The Act now allows most businesses to increase the carryback period for applicable NOLs from 2 to 3, 4, or 5 years. See Code Sec. 172(b)(1)(H)(i)(I).  The Act imposes a 50-percent income limitation on NOL offsets in the fifth preceding tax year. But, this limitation does not apply to ESB’s that elected to carry back 2008 NOLs under the 2009 Recovery Act; however, the limitation will apply if those businesses have 2009 NOLs.  Also, the election may be made for only one tax year. See Code Sec. 172(b)(1)(H)(iii)(I).  But, again an ESB that made an election pursuant to the 2009 Recovery Act may make an election for 2 tax years instead of just 1. See Code Sec. 172(b)(1)(H)(v)(I). Finally, the Act affects the alternative minimum tax (AMT) by suspending the 90-percent income limitation on the use of NOLs for determining AMT for an extended carryback year.

For further details see the attached Worker, Homeownership, and Business Assistance Act of 2009 H.R. 3548.Download HR 3548

The Internal Revenue Service Enforcement Statistics for the 2009 Fiscal year

Tax Lawyer Vince Nardone discusses recent publication of the Internal Revenue Service’s enforcement statistics.

Based on a limited review of the IRS 2009 fiscal year enforcement statistics, the IRS's enforcement actions in fiscal year 2009 increased significantly over 2008.  But, the enforcement revenue collected shows a significant decline from the previous two years, according to information previously released by the IRS.  This is no surprise of course.  Based on the current economic climate, you would expect the IRS activity to increase but less money to come in because of the money simply not being available.  That is, the Taxpayer simply do not have any money.

As to the specific statistics, in fiscal year 2009, IRS levies totaled 3,478,181, liens totaled 965,618, and seizures totaled 581. In fiscal year 2008, there were 2,631,038 levies, 768,168 liens, and 610 seizures. The IRS also garnered $48.9 billion through enforcement actions in fiscal year 2009—with $26.9 billion through collection, $17.4 billion through examination, and $4.6 billion through document matching. In fiscal year 2008, the agency collected a total of $56.4 billion and, in fiscal year 2007, the amount collected was $59.2 billion. As to exams, for those with income between $200,000 and $999,999, 2.89% of returns were examined.  For those earning $1 million or more, 6.42% of returns were examined.  A total of 9,951,648 business returns (small and large corporation returns, and Subchapter S and partnership pass through returns) were filed and 58,144 were examined for a coverage rate of 0.58%.  The coverage rate for corporations with assets under $10 million was 0.85%, for corporations with assets of at least $10 million it was 14.55%, for Subchapter S corporations (Form 1120-S) it was 0.40%, and for partnership returns (Form 1065) it was 0.38%.

Please see the attached statistics for more information.

Download Collection Enforcement Results - Fiscal year 2009

Update on Estate Taxes

Guest Author Pilar Puerto discusses Estate Taxes:

 

On December 3, 2009, the house approved H.R. 4154, which would make the current estate, gift, and generation skipping transfer (GST) tax laws permanent.  As background, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estatetax was scheduled to be gradually phased out by increasing the applicable exemption amount each year up to $3.5 million in 2009 and then repealing in 2010. It is now the end of 2009 and unless Congress passes another act, in 2011 the estate tax provisions will revert to pre-2001 law. This would mean decreasing the unified credit exemption amount for estate tax purposes from the current $3.5 million to $1 million. But, lately there has been much debate and action in Congress for the passing of an estate tax bill.  And, up to this point there has been much speculation and uncertainty as to what the estate tax laws would look like.  But, now with the house’s approval of H.R. 4154 we have a better picture of what the future holds.

 

H.R. 4154 would make permanent the current unified credit effective exemption amount of $3.5 million for estate tax purposes to apply to estates of decedents dying during 2010 and later years. As to gift taxes, the unified credit effective exemption amount would remain at $1 million. And, the highest estateand gift tax rate would be 45%. The GST tax exemption would equal the unified credit effective exemption amount for estate tax purposes and be determined using the highest estate and gift tax rate. 

Considering the high exemption amounts, H.R. 4154 would make it so that only a small percentage of Americans need to worry about paying federal estate tax.  In general, estates are only subject to federal estate tax if they exceed the applicable exclusion amount. For example, under 2009 law only if a decedent’s taxable estate is over $3.5 million—after taking into consideration the unlimited marital deduction—will the decedent’s estate be subject to federal estate tax. Since H.R. 4154 would maintain the applicable exemption amount at $3.5 million, only the most fortunate of Americans need to be concerned about the estate tax.

 

There have been discussions among policy makers, however, on the effects that the estate tax may have on small family businesses, in particular farms.  The argument among these policy makers is that since most of the value of these family businesses is held in illiquid assets, these businesses would be forced to liquidate vital assets just to pay the federal estate tax. But, these concerns are not applicable to most family businesses. A recent report by the Congressional Research Service (CRS) shows that only a small fraction of estates with small or family business interests have paid the estate tax—about 3.5% for businesses in general, and 5% for farmers, compared to 2% for all estates.  CRS also reports that less than ½ of 1% of family-owned businesses that are subject to the estate tax “do not have readily available resources to pay the tax.” Therefore, even if there is a considerable burden on small businesses, this burden only applies to small percentage of these businesses. (RL33070 - Estate Taxes and Family Businesses: Economic Issues)

In sum, it looks like the future will continue to be the same as it is today.  That is, we will have high unified credit exemption amounts that will in turn exclude most estates from having to pay estate tax.  In turn, many will not need to worry about utilizing complicated devices in their estate plan for purposes minimizing the impact of the estate tax on their estates.

See the CRS study attached and the bill.Download Estate Tax - December 2009

Download Legislation - CRS Report

Internal Revenue Service, Office of Professional Responsibility Announces Recent Disciplinary Action

On December 18, 2009, the Internal Revenue Service, Office of Professional Responsibility (OPR), announced recent disciplinary sanctions involving attorneys, certified public accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents, and appraisers.  These individuals are subject to the regulations governing practice before the Internal Revenue Service, which are set out in Title 31, Code of Federal Regulations, Part 10, and which are published in pamphlet form as Treasury Department Circular No. 230. The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations.

I have attached the actual announcement below.  Each and every time these announcements come out they should be a reminder to tax professionals that we must not cross the line.  We as tax professionals owe a duty to both our clients and the government to ensure that we follow the law.  I am certainly not suggesting that we advocate for less tax favorable positions, or give in to certain Internal Revenue Service positions that seem unreasonable or simply not supported by the law.  Rather, I follow the rule that we must interpret and apply the law in a reasonable and good faith manner that allows for the most tax efficient position a taxpayer may take, while avoiding any potential of civil tax penalties.  Over the years, unfortunately, there are certain professionals that simply go too far.

See the announcement below. Download December 2009 - OPR announcement's