April 08, 2016

IRS Whistleblower Rewards Program; Statistics and Recent News

The tax attorneys at Nardone Limited in Columbus, Ohio, continuously monitor the latest development in the Internal Revenue Service’s efforts to identify and pursue taxpayers, who the IRS believes have failed to report or pay taxes owed to the IRS. The IRS Whistleblower Program provides an incentive to people to come forward and identify other taxpayers, including individuals and businesses that have failed to pay the tax that they owe.  The IRS uses this Whistleblower Program to further its efforts to identify and ferret out taxpayers it believes are committing wrongdoings regarding the failure to report and pay their tax liabilities. If the IRS ultimately uses the information provided by the whistleblower, the IRS may award up to 30 percent of the additional tax, penalty and other amounts the IRS collects. In a previous article, “IRS Whistleblower Rewards Program,” we discussed the two types of award programs available to whistleblowers. This article will discuss the latest IRS statistics involving these two types of awards, as well as, recent news on the latest large IRS whistleblower award.

Whistleblower Statistics

Since 2007, the Whistleblower Office has paid awards in the amount of $403,804,331 based on collected proceeds in the amount of $3,050,441,676. Fiscal Year (“FY”) 2015 was a successful year for the Whistleblower Program. A total of 99 awards were made to whistleblowers, totaling more than $103 million before sequestration. While the total amount of claims received in 2015 were down 17% from those submitted in 2014, the total amount of claims closed increased by 27%.

In FY 2015, the Whistleblower Office closed 10,615 claims. Claims received in FY 2015 an FY 2014 accounted for 79% of closures in FY 2015. The four most common factors for closures, identified by the IRS were: (i) rejected claims with either a non-specific, non-credible, or speculative allegations; (ii) the information was already known to the IRS, lack of resources, or due to a survey; (iii) the issues were below the threshold for IRS action; or (iv) the closure fell into the “other” category.

The following chart represents amounts collected and awards paid under both Section 7623(a) and (b) for Fiscal Years 2013 to 2015.

 

FY 2013

FY 2014

FY 2015

Total Claims Related to Paid Awards

130

240

204

Total Number of Awards Paid

133

101

99

Collections Over $2 Million

6

9

11

Total Amount of Awards Paid

$54,054,587

$52,281,628

$103,486,677

Amounts Collected

$343,674,315

$309,990,568

$501,317,481

Awards Paid as a Percentage of Amounts Collected

15.7%

16.9%

20.6%

Recent News

In one of the latest large whistleblower awards, the IRS awarded a whistleblower $11.6 million. Although the whistleblower chose to remain anonymous, he allowed his attorney to disclose certain facts about the case. According to the whistleblower’s attorney, the whistleblower was a corporation officer who resigned. The whistleblower’s claim involved “a number of very wealthy individuals whom the business helped evade tax.”

The whistleblower’s attorney explained that the road to an award is long, difficult, and uncertain. The whistleblower must provide conclusive evidence of cheating to the IRS, with names, dates, and other relevant information. Further, the attorney stated that the IRS is particularly interested in “one-off, ‘bespoke’ tax shelters” that it might have a hard time detecting, and secret off-shore accounts, especially in Hong Kong, Singapore and Panama. The IRS is also interested in corporate cases that extend over several years. This is because if the statute of limitations expires for one year, the IRS still can pursue taxes for other years.

It is strongly advisable for anyone who wants to file for a whistleblower award to seek help from an attorney who specializes in tax whistleblower cases. Often the attorneys’ fees, which are deductible from the award, come to 30% to 40% of the total amount. Further, large awards typically take about seven years from start to finish. This is partially due to the fact that the IRS will not make a payment to the whistleblower until the taxpayer’s deadline to appeal the case has passed. Even if the whistleblower is able to get through the process and receives an award, the IRS will withhold taxes from the award amount.

Contact Nardone Limited

Nardone Limited frequently represents individuals and businesses in federal and state tax controversy matters. To the extent that you have questions regarding whistleblower claims or defenses, you should contact one of the experienced tax attorneys at Nardone Limited to learn more about the IRS Whistleblower Program.

March 24, 2016

Offers-In-Compromise Under our Current Administration

Our Columbus tax attorneys routinely provide guidance to taxpayers and businesses regarding how to utilize the Internal Revenue Service’s collection alternatives to manage their federal tax liabilities. If an individual taxpayer or a business is contacted by an IRS Revenue Officer, it is extremely important to be aware of, and fully understand, the various collection alternatives that are available to settle federal tax liabilities.

There are instances where paying the tax liability in full is not an option for the taxpayer. In this instance, there are various collection alternatives available to taxpayers and businesses that will help reduce, or completely eliminate, tax liabilities that arise as the result of, among other things, an IRS audit or examination. These collection alternatives include, but are not limited to: (i) offer-in-compromise, (ii) installment agreements, (iii) currently-not-collectible status, (iv) discharging taxes in bankruptcy, and (v) challenging the underlying tax liability. As part of the collection process and working with the IRS, there are times when we obtain new information that is helpful to taxpayers and tax professionals in determining which collection alternative may be the most viable option for a particular taxpayer.  This short blurb discusses that information.

How long does an Offer-in-Compromise take to Process?

As we learned and confirmed, the current administration’s failure to fund the Internal Revenue Service to the levels necessary to operate effectively and efficiently continues to have a negative impact on taxpayers as well as tax professionals. We recently spoke with the Internal Revenue Service regarding an offer-in-compromise that we were handling for a client. We are now being told that offers that were submitted in January/February 2015 have just recently been given attention and assigned to an offer specialist. That is over a year since they were submitted. This is a significant hardship for taxpayers. And to be clear, we do not point fingers at the Internal Revenue Service or in any way blame the Internal Revenue Service for the lack of timeliness or the hardship. Rather, we blame the current president and his administration for its continued failure to properly fund the one revenue source that the government has, taxes.

As we have been told by the IRS, offers-in-compromise that are below $100,000 are getting worked more quickly and likely will be worked within six to nine months of submission. But, for offers-in-compromise that exceed $100,000, it is very likely that those will not be worked until nine months or later after that offer-in-compromise is submitted. Thus, we have numerous offers-in-compromise that are out there that have not even been assigned to an offer specialist, and will not be for some time.

Is an Offer-in-Compromise right for you?

In many instances, an offer-in-compromise is an excellent resolution to your federal tax liabilities when confronted by an IRS Revenue Officer. But, it is very important to be aware of what to expect throughout every step in the offer-in-compromise process. The tax attorneys in Columbus, Ohio regularly represent individuals and businesses in a variety of federal tax matters, including the collection alternatives described in this article. If you or your business have been contacted by an IRS Revenue Officer, or you are struggling with federal tax liabilities, we encourage you to contact one of our tax attorneys today. We have vast experience representing clients before the Internal Revenue Service, and we would be happy to thoroughly review your case to determine what options and alternatives are available to you.

February 12, 2016

IRS Whistleblower Rewards Program; How Protected is Taxpayer Information and Whistleblower Identity?

The tax attorneys at Nardone Law Group in Columbus, Ohio continuously monitor the latest developments in the Internal Revenue Service’s efforts to identify and pursue taxpayers who the IRS believes have failed to report or pay taxes owed to the IRS. The IRS uses the Whistleblower Program to further its efforts to identify and ferret out taxpayers it believes are committing wrongdoings regarding the failure to report and pay their tax liabilities.  In a previous article, “IRS Whistleblower Rewards Program; Eligibility and Information Considered,” we discussed the requirements necessary for the IRS to accept a whistleblower submission and the types of whistleblowers eligible to claim an award. If the IRS ultimately uses the information provided by the whistleblower, the IRS may award the whistleblower up to 30 percent of the additional tax, penalty, and other amounts the IRS collects. But, given the sensitivity of the information being exposed, federal law provides rules that protect the interests of both the taxpayer and the whistleblower.

Protection of Taxpayer Information

Since the whistleblower has the right to appeal an award determination for a claim submitted under I.R.C. §7623(b), a meaningful right to appeal requires disclosure to the whistleblower of the basis for the award determination. This will often include taxpayer information that is protected from disclosure under I.R.C. §6103(a). For this reason the IRS uses confidentiality agreements as a way to protect confidential taxpayer return information disclosed during the course of an administrative proceeding. When the whistleblower signs, dates, and returns the confidentiality agreement, the Whistleblower Office will provide the whistleblower with a detailed award report and an opportunity to review the documents supporting the report. 26 C.F.R. 301.7623-3. In reviewing the document, however, the Whistleblower Office will supervise the whistleblower’s review of the information and the whistleblower is not permitted to make copies of any of the documents or other information. 

Despite the IRS’ commitment to protecting taxpayer information, the law does not provide an effective sanction if the whistleblower discloses taxpayer information in violation of the confidentiality agreement and I.R.C. §6103(h). Also, the whistleblower may, against the wishes of the taxpayer, disclose the identity of the taxpayer in a Tax Court or other judicial proceeding. But, a revision to Tax Court Rule 345 requires that taxpayer information be masked in documents filed with the Court. But, release of information during discovery in Tax Court proceedings, however, is not addressed in the new rules and has brought a new set of concerns. This issue with discovery has been highlighted in a recent Tax Court decision.

In Whistleblower One 10683W, et al, (2015), 145 TC No. 8, the Tax Court granted a group of whistleblowers’ motion to compel production of certain discovery requests relevant to the IRS’ denial of an award based on information they provided. The Court rejected the IRS’ argument that the information was outside of the administrative record, and stated that the IRS could not unilaterally decide what constitutes that record.

In this case the whistleblowers filed a claim in 2006 informing the IRS of a tax evasion scheme carried out by Target. The IRS declined to make an award to the whistleblowers, and the whistleblowers appealed. The whistleblowers alleged that the information they provided resulted in the IRS’s investigation. In the course of the appeal, the whistleblowers sought information as to who reviewed the information they provided the IRS’ investigation into Target, the publishing of the legal memorandum that was issued for general distribution during the investigation, the IRS’ investigation into the sham debt obligation, and the amount of collected proceeds. The IRS objected on the grounds that the information requested was not contained within the “Whistleblower Office’s case file,” meaning that it fell outside the “administrative record” and was beyond the scope of discovery.

The Court held that the information sought by the whistleblowers was relevant, in that it would prove whether any of the proceeds collected from Target were attributable to the information they provided. Further, the Tax Court stated that the IRS’ argument that the information was outside of the “administrative record” was an insufficient basis for denying the discovery request. The Court granted the whistleblowers’ motion, however, it included several rules and restrictions governing such disclosure and the use of the information in light of the confidentiality concerns and I.R.C §6103.

Whistleblower Protection

As a matter of policy and under I.R.C. §6103, the IRS has committed to protect whistleblower identity. The IRS has implemented a multilevel review process to ensure that the identities of whistleblowers are disclosed only after careful consideration. The IRS has indicated that it will continue to do its best to prevent disclosure and to provide the whistleblower with notification prior to a disclosure. But, under some circumstances, such as when the whistleblower is an essential witness in a judicial proceeding, it may not be possible to pursue the investigation or examination without revealing the whistleblower’s identity. If a whistleblower’s identity is revealed, the law does not provide the whistleblower with protection.

Unlike other laws that encourage whistleblowers to report information to the government, I.R.C. §7623 does not protect the whistleblower from retaliation. When the whistleblower is an employee of the taxpayer, retaliation can take the form of a job-related action. In other cases, whistleblowers may face threats of physical harm or damage to economic interests. In these situations, whistleblowers may have recourse under state law, but Federal law does not provide a remedy.

Contact Nardone Law Group

Nardone Law Group represents individuals and businesses in federal and state tax issues, including both representation and defense against whistleblower claims. If you have information on an individual or business that has failed to report or pay taxes it owes to the IRS, or you are being investigated or prosecuted by the IRS, you should contact one of the experienced tax attorneys at Nardone Law Group to learn more about the Whistleblower Program. We will thoroughly review your case to determine what options and alternatives are available.

February 09, 2016

Quick Service Restaurants: What Owners Should Know About Sales Tax

The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise individuals and businesses on state and federal tax issues, including those involving the Ohio Department of Taxation. When faced with a sales tax audit, appeal or other litigation, many owners of quick service restaurants (“QSR”) find themselves in unfamiliar territory. Strict compliance with sales tax laws can be challenging for restaurant owners because understanding the distinction between what is taxable and nontaxable is sometimes difficult. In addition to this confusion, the restaurant staff at the cash registers may not be adequately trained to differentiate between taxable and non-taxable sales, or they may apply the law on an inconsistent basis. Despite this difficulty, if the restaurant owner fails to collect the tax on taxable transactions, he or she is personally liable for the amount of tax owed. For this reason it is important for owners of QSR to understand the applicable laws regarding the sale of food and beverages and how to avoid non-compliance.

Applicable Laws for QSR Owners

Under Ohio law, sales tax is imposed on each retail sale made in this state. R.C. § 5739.02. Therefore, all retail sales of food are presumed to be taxable, unless the vendor establishes that the sale is exempt. In Ohio vendors have a duty to collect and remit the applicable state and local sales tax. R.C. § 5739.03. Sales tax is a “trust” tax, meaning that the vendor is collecting and holding the sales tax in trust for the taxpayer (i.e., the customer that pays the tax). Because sales tax is a trust tax, the individual owners, officers and those responsible for tax filings are held personally responsible for non-collection or non-remittance. R.C. § 5739.13. The taxability of sales made in QSR is largely dependent on where the food or beverage is to be consumed.

  • On Premises v. Off Premises Consumption

Food consumed on premises (dine-in) in Ohio is always taxable. R.C. § 5739.01. But, food sold for consumption off the premises (take-out) is not taxable. R.C. § 5739.02(B)(2). Ohio law defines premises as, “ . . . any real property or portion thereof upon which any person engages in selling tangible personal property at retail or making retail sales and also includes any real property or portion thereof designated for, or devoted to, use in conjunction with the business engaged in by such persons.” R.C.§ 5739.01(K). “On premises” includes food court seating, regardless of whether the restaurant owner owns the chairs and tables where the customers sit.

  • Which Foods and Beverages are Taxable?

What constitutes food is important because food consumed off the premises is not subject to Ohio sales tax. “Food” means substances, whether in liquid, concentrated, solid, frozen, dried, or dehydrated form, that are sold for ingestion or chewing by humans and are consumed for their taste or nutritional value. Food however, does not include alcoholic beverages, dietary supplements, soft drinks, or tobacco. R.C. § 5739.01(EEE)(1).

Soft drinks are not considered food and are always taxable regardless of where they are consumed. Soft drinks are nonalcoholic beverages that contain natural or artificial sweeteners or contain fifty percent or less of pure fruit or vegetable juice. R.C. § 5739.01(EEE)(2)(c). Beverages that are unsweetened (e.g. black coffee or tea), contain dairy, dairy substitutes, or contain more than fifty percent of fruit or vegetable juice are considered “food.”

How to Stay Compliant

When the Ohio Department of Taxation conducts a sales tax audit on a QSR, the legal presumption is that all food will be consumed on premises and is therefore subject to sales tax, unless the vendor establishes that the sale is exempt.  A QSR may be selected for audit for a variety of reasons including: (i) filing history; (ii) observed or reported non-compliance; and (iii) data analytics. Factors include: (i) unusually low ratio of taxable to gross sales; (ii) a test buy or witnessed event indicating non-compliance with sales tax law; or (iii) anomalies when compared with peer group sales reported for that type of business structure.

There are, however, preemptive measures QSR owners can take to achieve sales tax compliance and avoid owing the Ohio Department of Taxation for sales that should have been taxed. This includes:

  • Providing adequate training and monitoring of employees;
  • Asking the question, “for here or to go” to determine if the sale is exempt;
  • Verifying that your point-of-sale system (POS) is programed to charge tax on all taxable items;
  • Considering programing the POS to make “taxable” the default for every item purchased at the counter, with an override for take-out food; and
  • Ensuring that sales at the drive-through window can be segregated.

In addition to these preemptive measures, vendors may enter into a prearranged agreement with the Ohio Department of Taxation. R.C. § 5739.05. This arrangement allows sales tax to be remitted to the State of Ohio based on a set percentage of taxable gross sales. The taxable percentage is based on a test check agreed to by the tax commission and the vendor or any other method agreed upon by the tax commissioner and the vendor.

Contact Nardone Law Group

If you are the owner of a QSR and you are facing a sales tax audit by the Ohio Department of Taxation, or you would like further advice on how to stay compliant regarding your sales tax, you should contact Nardone Law Group. We have experience representing owners of restaurants in sales tax audits, examination, and litigation with the Ohio Department of Taxation. Contact us today for a consultation.

January 06, 2016

IRS Whistleblower Rewards Program; Eligibility and Information Considered

The tax attorneys at Nardone Law Group in Columbus, Ohio, continuously monitor the latest developments in the Internal Revenue Service’s efforts to identify and pursue taxpayers, who the IRS believes have failed to report or pay taxes owed to the IRS. The IRS uses this Whistleblower Program to further its efforts to identify and ferret out taxpayers it believes are committing wrongdoings regarding the failure to report and pay their tax liabilities. If the IRS ultimately uses the information provided by the whistleblower, the IRS may award the whistleblower up to 30 percent of the additional tax, penalty and other amounts the IRS collects. In a previous article, “IRS Whistleblower Rewards Program,” we discussed the two types of award programs available to whistleblowers. This article will supplement our prior article by expanding the discussion to include information on who is an eligible whistleblower claimant and what type of information the IRS looks for when it reviews a whistleblower submission.

Am I an Eligible Claimant?

While the Internal Revenue Code does not specifically exclude any whistleblower from filing a claim for an award, awards under I.R.C §7623(b) are limited to individuals. Moreover, I.R.C. §7623(b)(3) requires the Whistleblower Office to deny an award to a whistleblower convicted of a crime arising from the whistleblower’s role in planning and initiating the actions that led to the underpayment of tax or violation of the internal revenue laws. Furthermore, an individual who is otherwise required to disclose information or precluded from disclosing information by federal law or regulation is not eligible to claim an award for providing such information.

What Does the IRS Look for in a Submission?

A threshold requirement for an award under I.R.C. §7623 is that the information must lead to judicial or administrative action and the audit or investigation must result in the collection of proceeds. When a whistleblower submits a claim, an analyst in the Whistleblower Office will consider the information and decide whether the case is worth pursuing. Furthermore, the Whistleblower Office will determine if the information received is specific and credible. This includes identifying a person and describing and documenting the facts that support the whistleblower’s belief that the person owes taxes or violated the tax laws. This does not mean, however, that a whistleblower must identify a taxpayer by name. The whistleblower just needs to include enough identifying information that the IRS and the Whistleblower Office will be able to identify a taxpayer. The more identifying information that a whistleblower includes in the submission, the more likely it is that the submission will be considered.

If the IRS uses the information provided by the whistleblower, the Whistleblower Office must determine if the IRS proceeded based upon the information provided by the whistleblower. This occurs when the information substantially contributes to the underlying action. As an example, a whistleblower’s information substantially contributes to the underlying action if it leads to: (i) an examination; (ii) an expansion of an issue already being examined; (iii) an expansion to the examination to another year; or (iv) an additional adjustment. Information that just merely supports information obtained independently by the IRS, however, does not substantially contribute to the underlying action.

Contact Nardone Law Group

Nardone Law Group frequently represents individuals and businesses in federal and state tax issues, including both representation and defense against whistleblower claims. If you have information on an individual or business that has failed to report or pay taxes it owes to the IRS, or you are being investigated or prosecuted by the IRS, you should contact one of the experienced tax attorneys at Nardone Law Group to learn more about the Whistleblower Program. We will thoroughly review your case to determine what options and alternatives are available.

December 18, 2015

Personal Liability for Sales Tax: Penalties and Interest an Owner May Suffer

The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise individuals and businesses on state and federal tax issues, including those involving the Ohio Department of Taxation. When faced with a sales tax audit, appeal, or other litigation, many owners of bars and restaurants find themselves in unfamiliar territory. It is not uncommon for these owners to end up owing additional sales tax, interest, and penalties as a result of the audit, despite doing their best to maintain adequate records of their sales. Ohio law permits the Department of Taxation to hold responsible parties/individuals personally liable for the underlying sales tax due, plus any additional penalties. In many cases, the additional sales tax and penalties could have been avoided by maintaining adequate records. In a prior article, we discussed preemptive actions bar and restaurant owners can take to counter inflated liability. If care is taken to keep adequate records, it could decrease the likelihood of the bar or restaurant owner’s personal liability.

Personal Liability

Sales tax is considered a trust-fund tax, meaning that it is collected from the customer by the vendor, and is held in trust until remitted to the state. For this reason, under Ohio law, a responsible party can be held personally liable for failure to collect or remit sales tax. Not only is the responsible party liable for the underlying sales tax obligation, they are also liable for the penalties and additional charges that come with the non-payment or late payment. A responsible party may include any of the business’ employees having control or supervision of or charged with the responsibility of filing returns and making payments, or any of its officers, members, managers or trustees who are responsible for the execution of the business trust’s financial responsibilities. R.C. § 5739.33.

Additional Penalties and Interest

In addition to the sale tax that is owed, the responsible party may have to pay additional charges and penalties associated with the non-payment or late payment. In the case of an assessment against a person who fails to collect and remit the required sales tax, up to 50 percent of the amount assessed may be owed as a penalty. R.C. § 5739.133(A)(1) and (2). An additional charge of fifty dollars or 10 percent of the tax required to be paid, whichever is greater, may be levied on every tax return not filed on time or when the tax liability is not paid in full. R.C. § 5751.06(A).  Interest will also start to accrue on the unpaid tax beginning from the day the tax was required to be paid until the tax is paid or until the day an assessment is issued, whichever occurs first. R.C. § 5739.132(A).

For example, if the taxpayer owes $100,000 in sales tax, the Ohio Department of Taxation could issue a penalty of $50,000, for the non-payment. Further, let’s say the taxpayer owes $5,000 for one return period, but failed to file the return on time. The Ohio Department of Taxation will issue an additional charge of fifty dollars or 10% of the tax to be paid, whichever is higher. Here, since 10% of $5,000 is greater than fifty dollars, the department will issue an additional charge of $500 to the taxpayer for the period in which the return was not filed on time. The department of taxation can issue this additional charge on all return periods for which the sales tax was not paid on time. If the bar or restaurant owner has consistently failed to file returns or has consistently filed late sales tax returns, they may be facing significant additional charges and penalties.

However, the taxpayer may appeal the additional charges and penalties. For this reason it is important to seek the help of an experienced tax attorney if you are a bar or restaurant owner facing a sales tax audit. If you have failed to file timely returns, or have failed to remit all sales tax that is due, and are worried that you may be personally liable for the underlying sales tax obligations of your business, you should contact the tax attorneys at Nardone Law Group. Our attorneys have vast experience representing bars and restaurants in sales tax audits, examinations, and litigation with the Ohio Department of Taxation. We will thoroughly review your case and advise you of preemptive steps to avoid the risk of being held personally liable for your business’ debts. Contact us today for a consultation.

December 08, 2015

IRS Collection Alternatives with the Ohio Society of CPAs

We would like to thank the Ohio Society of CPAs for giving us the opportunity to speak at the 2015 Mega Tax Conference on December 7, 2015. A great crowd joined Vince Nardone for a discussion regarding tax planning and IRS collection alternatives impacting our small businesses. This discussion included more information on the offer in compromise, bankruptcy as a collection alternative, various installment agreements, and more. From the assessment process to the collection process, it is important that all business owners understand the rules and regulations that the Internal Revenue Service will follow. We encourage all readers to become familiar with your collection alternatives in an attempt to minimize the Internal Revenue Service's impact on your business. We would like to thank those that attended the presentation and the Ohio Society of CPAs for hosting a wonderful event.

December 04, 2015

Failing to Submit or Submitting Fraudulent Information on Late Tax Returns May Preclude a Taxpayer from Discharging Debt

The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise individual taxpayers and businesses on how to utilize the Internal Revenue Service’s collection alternatives to manage their federal tax liabilities. If taxpayers are contacted by an IRS revenue officer, it is important to understand that there are various collection alternatives available to resolve federal tax liabilities. Some collection alternatives include: (i) offer-in-compromise; (ii) installment agreements; (iii) currently not collectible status; (iv) discharging taxes in bankruptcy; and (v) challenging the underlying tax liability. It is important to also be aware of circumstances where one of the collection alternatives may not be available. As an example, a taxpayer may lose the option to discharge taxes in bankruptcy if the IRS prepares a substitute return on the taxpayer’s behalf. In our prior article, “Effect of Substitute Returns on Discharge of Debt,” we discussed the criteria for a section 6020(a) substitute return and its effect on the taxpayer’s discharge of debt. The IRS files a 6020(a) return in cooperation with the taxpayer. But, when a taxpayer submits either no information or fraudulent information, the IRS prepares the substitute return under section 6020(b), without the cooperation of the taxpayer. Thus, taxpayer’s should be aware that substitute returns filed under section 6020(b) may negatively affect their ability to discharge debt in bankruptcy.

Substitute Returns Prepared by the IRS

The Bankruptcy Code requires that a return be filed before taxes can be discharged. But, if a taxpayer fails to make and file a return, the IRS may prepare a return for the taxpayer under the following situations:

  1. If the taxpayer discloses all information necessary for the preparation of the return the IRS will prepare a return under section 6020(a); or
  2. If the taxpayer has failed to make and file a return, or has filed a false or fraudulent return, the IRS can prepare a return on the basis of the knowledge and information it can obtain through testimony or other means under section 6020(b).

Section 6020(b) is a collection device that the IRS can use to assess and collect unpaid taxes. While Section 6020(b) returns are good for all legal purposes, the Bankruptcy Code specifically states that returns filed under 6020(b) are non-dischargeable regardless of whether the taxpayer later files a return; however, additional amounts reported on returns filed after an assessment on a substitute return are potentially subject to discharge. The following bankruptcy court decision uses 11 U.S.C. § 523, which states that a “return” does not include a return made pursuant to section 6020(b), in conjunction with the test established in Beard v. Commissioner to determine whether the taxpayer’s late filing qualified as a return for purposes of discharging debt.  

Taxpayer’s Overdue Filing Reporting Additional Liability was Dischargeable

In the case of In re: Biggers, the Sixth Circuit held that the taxpayer’s liabilities for 2001, 2003, and 2004 were non-dischargeable because: 1) the returns were filed after the IRS had already assessed the federal tax; 2) the returns revealed less tax than the amount assessed by the IRS; and 3) the returns served no tax purpose. The 2002 returns, however, revealed an amount due in excess of the tax assessed by the IRS. The court held that the 2002 return served a tax purpose to the extent that it reported an additional tax liability. The IRS conceded that the excess was dischargeable, although the remainder of the 2002 tax liability was not.

As previously stated, for taxes to be discharged a return must be filed. The court in Beard established a test to determine what qualifies as a return. The court held that for a Form 1040 to qualify as a return: 1) it must purport to be a return; 2) it must be executed under penalty of perjury; 3) it must contain sufficient data to allow calculation of tax; and 4) it must represent and honest and reasonable attempt to satisfy the requirements of the tax law.

In this case the IRS argued that the taxpayer’s late filings satisfied the first three elements of the Beard test, and the only issue was whether the late filing represented “an honest and reasonable attempt to satisfy the requirements of the tax law.” The court then cited United States v. Hindenlang, a Sixth Circuit case, which held that Form 1040 is not a return if it no longer serves any tax purpose or has any effect under the Internal Revenue Code. Further, a return filled too late to have any effect at all under the Internal Revenue Code cannot constitute “an honest and reasonable attempt to satisfy the requirements of the tax law.”

Here the taxpayer’s forms for 2001, 2003, and 2004 all reported a lower liability than the amount originally assessed by the IRS, and therefore served no purpose. However, the tax form from 2002 reported an additional $15,088 in tax liability. Thus, the 2002 tax form served a purpose under the Internal Revenue Code to the extent that it reported additional liability and was therefore subject to discharge.

Contact Nardone Law Group

Nardone Law Group frequently represents individuals and businesses in federal tax matters, including collection alternatives, such as discharging taxes in bankruptcy. If you or your business have been contacted by an IRS revenue officer, or are struggling with tax liabilities, you should contact one of our tax attorneys today. Nardone Law Group’s tax lawyers have vast experience representing clients before the IRS. We will thoroughly review your case to determine what options and alternatives are available to you.

November 30, 2015

Nardone Law Group's Tax Attorneys Agree with the Inspector General Regarding IRS Examination Procedures

The tax attorneys at Nardone Law Group in Columbus, Ohio routinely defend individual taxpayers and businesses in Internal Revenue Service’s audits and examinations. The IRS has broad authority and tools available to examine individual and business tax returns. In fact, the IRS has recently taken steps to implement its high-income and high-wealth strategy. This high-income and high-wealth strategy simply means that the IRS intends to audit and examine more high-income taxpayers than ever before.  Thus, not only did the top one-percenters already pay over 40% of the taxes in this great country, the IRS and the current defunct administration wants the high-income taxpayers to pay more. Yet, this same administration has failed to provide the IRS with the necessary resources to do so. And, in many instances, this administration has stripped the IRS from its ability to do so.  These issues were highlighted in the Treasury Inspector General for Tax Administration’s September 18, 2015 Report, titled Improvements are Needed in Resource Allocation and Management Controls for Audits of High-Income Taxpayers.

As detailed in the table below, although the IRS initially increased its audit coverage of high-income taxpayers, the percentage of high-income taxpayers audited dropped in most income levels from fiscal year 2010 to fiscal year 2014.  See the chart below. Thus, not surprising from this administration, one hand of the government announces broad and sweeping changes to its audit and exam functions of high-income taxpayers, while the other hand removes the IRS’ ability to follow through with the broad and sweeping changes, by un-funding the IRS and stripping it of its ability to audit and examine taxpayers effectively. See the report below:

Percentage of High-Income Tax Return Audits by Adjusted Gross Income During Fiscal Years 2010, 2013, and 2014

Chart 1

What is also not surprising is that the audit coverage of filed individual high-income tax returns completed in fiscal year 2014 reveals that the IRS provides increased audit coverage as the percentage of each total positive income range as the high-income taxpayer’s total positive income increases.  See the chart below:

Audit Coverage of Filed Individual High-Income Tax Returns Completed in Fiscal Years 2014 by TPI Level

Chart 2

Although at first glance, the chart and the IRS strategy seems to make sense.  You increase the percentage of audits based upon the amount of income earned.  The understanding there is that the returns become more complex as income earned increases, which justifies a higher percentage.  But, what the chart reveals is that the IRS conducted 66-percent more audits of taxpayers earning less than $600,000, in comparison to those taxpayers earning in excess of $600,000. Again, it really makes no sense.  If the IRS is going to audit or examine more high income earning taxpayers, with little resources to do so, then it should focus on those in excess of $600,000. As an example, the IRS only examined 6,309 taxpayers that made over $5,000,000. Yet, the IRS examined 62,159 returns of taxpayers making between $200,000 and less than $400,000. Where do you think more complexity exists, and where do you think more changes would potentially occur? Certainly, there would be more changes in those returns of taxpayers making more than $5,000,000. Yet, the IRS spends its limited resources on tax returns that likely have very little changes. See the Treasury Inspector General for Tax Administration’s September 18, 2015 Report.

Contact Nardone Law Group

If the IRS, Ohio Department of Taxation, or other taxing authority has contacted you or your business to be audited or examined, do not go at it alone. You should contact the tax attorneys at Nardone Law Group. We have vast experience representing individuals and businesses in IRS audits, exams, appeals, United States Tax Court, and other courts. Contact us today for a consultation.

November 13, 2015

Sales Tax Audits of Bars: Sufficient Documentation to Avoid Inaccurate Mark-Ups

The tax attorneys at Nardone Law Group in Columbus, Ohio, routinely advise individuals and businesses on state and federal tax issues, including those involving the Ohio Department of Taxation (the “Department”). When faced with a sales tax audit, appeal, or other litigation, many owners of bars and restaurants find themselves in unfamiliar territory. Throughout this article, we will discuss why it is important for bar and restaurant owners to understand the methods used by the Department to perform sales tax audits, and why we would encourage them to take proactive steps to avoid an assessment, or overassessment, of sales tax due.

Direct Audit Method

During a direct sales tax audit, the Department will seek to obtain the taxpayer’s primary sales records directly from the taxpayer, including the taxpayer’s sales receipts and reports generated by its point of sale (POS) system, and the taxpayer’s invoices reflecting all inventory purchased by the taxpayer during the audit period.  If the taxpayer is able to produce its primary sales records, then the Department will typically perform a “test-check” of the records by comparing the taxpayer’s purchase invoices to its sales receipts for a sample portion of the audit period.  The Department will perform the “test-check” to verify whether the inventory purchased by the Taxpayer during the sample period coincides with the taxpayer’s sales during that same period. This analysis assumes that the taxpayer sold all inventory purchased during the sample period.  If the purchases and sales match-up during the test-check period, then the Department will typically determine that all taxable sales are accounted for.

The Department will then compare the taxpayer’s actual taxable sales (as determined from the taxpayer’s primary sales records) to its sales tax reports filed with the Department, to ensure that all taxable sales were reported, and that all sales tax was collected and remitted.  If there are no discrepancies, then the Department will generally complete the audit with no determination of liability. Many times, however, bars and restaurants fail to properly maintain their primary sales records, or there is a large discrepancy between the taxpayer’s purchase invoices and its sales records for the sample period. In order to avoid the Department using an indirect approach to estimate sales tax liability, it is important for bars and restaurants in particular to keep detailed reports due to the cash basis on which many liquor establishments operate. If the taxpayer’s primary sales records are inaccurate or incomplete, then the Department will use an indirect audit method to estimate the taxpayer’s taxable sales and sales tax liability.

Indirect Audit Method

If the Department concludes, after the test-check, that the taxpayer’s sales records do not match-up with its purchase records, then the Department will use an indirect method to estimate the taxpayer’s taxable sales. In the event the taxpayer has not maintained all of its purchase invoices during the audit period, this indirect method will often involve the Department gathering such information, typically in summary form, directly from beverage distributors. The Department will use this information to compute a mark-up, taxable sales, and related sales tax, rather than calculating sales tax based on actual sales records. The Department uses this approach to estimate the sales tax owed by the taxpayer during the audit period, and then compares that number to the sales tax that was reported and remitted to the Department by the taxpayer, in order to determine the taxpayer’s assessed liability.

In the bar and restaurant industry, the Department will typically use a unit-volume method in order to calculate the “mark-up” of purchased inventory. In addition to obtaining the purchase records directly from the distributors, the Department will also obtain a drink list, pricing information, and other relevant information from the taxpayer. In the absence of supportable information provided by the taxpayer, it will then make assumptions regarding things like the number of drinks that can be poured from a bottle, and standard drink size (e.g., 1.5 ounces for a mixed drink, 6.3 ounces for a glass of wine, etc.).  The Department will use this information to compute a weighted average mark-up, and then multiply the mark-up by purchased inventory to arrive at an estimated taxable sales figure for the audit period.

Problems for the bar owners arise when they are unable to provide the auditor with accurate information regarding drink size, pricing, and drink specials or promotions. Again, in the absence of this information, the auditor may make numerous assumptions regarding the number of drinks that can be poured from a bottle, drink sizes, spillage, and breakage. The most important factors in the unit volume method are the unit price and drink size. Inaccurate assumptions by the auditor or information from the taxpayer can significantly impact the audit results. However, the mark-up method may only be used when there is support that the taxpayer’s records are inadequate. Further, there are proactive steps a bar owner can take in order to avoid the mark-up method and achieve the most accurate reflection of their taxable sales.    

How to Keep Adequate and Complete Records to Avoid Inaccurate Mark-Ups

An honest and conscientious taxpayer who maintains required records has a right to expect that those records will be used in a complete audit.  For this reason it is important for bar or restaurant owners to track and document things such as losses due to breakage, theft, or spillage, pricing, drink specials, and serving size, and to also employ ways to reduce inventory losses.

1. Track and Document Breakage. Losses of inventory in the bar and restaurant industry may include spillage (typically over-pouring), spoilage (i.e., bottles with a bad seal), pilferage (loss due to employee or customer theft), breakage (i.e., broken bottles), and loss due to complementary drinks from the bar tender. Accounting for these losses is necessary because Ohio law contains no required allowance for losses due to spillage, breakage, or pilferage. The presumption is that all alcoholic beverages purchased from a distributor will be resold to the customer. The taxpayer bears the burden of demonstrating what happened to its inventory. If the taxpayer is able to provide specific documentation, such as daily summaries documenting inventory lost to breakage or spillage, and detailing the size, brand, and type of lost inventory, then the auditor will be more inclined to accept this as documentation supporting the loss. In addition to tracking and documenting inventory losses, bar and restaurant owners can use various tactics, such as placing video cameras to identify, count and correct the effect of such acts.

 2. Document Prices. As previously stated, pricing is critical when using the unit volume method to calculate estimated mark-ups and estimated gross sales. During the audit, the taxpayer should ensure that pricing and estimated mark-ups are adjusted and calculated to reflect all distinct happy hour, seasonal, and promotional pricing in effect during each separate month, quarter or year.  The taxpayer should be able to provide evidence for the special pricing, as well as evidence as to the length of time over which the specials were offered. Otherwise, the auditor may use current regular sales pricing mark-ups against past periods for which much lower pricing was in place, resulting in an overstated assessment of additional sales tax due. 

 3. Document Serving Size. If the taxpayer does not provide accurate serving size information, the assumed mark-up will likely be overstated. To avoid this, the bar or restaurant owner should be able to provide the auditor with evidence of distinct serving sizes, and to the extent that the bar uses larger or distinct glass sizes, it should provide evidence of that as well. Absent credible evidence of serving size, the auditor may calculate the estimated mark-up on the assumption that all bars use 1.5 ounces of liquor in all mixed drinks, and that 12 ounces of beer and 5 ounces of wine is being poured per drink.

 4. Hire Independent Auditors. Bar owners should also consider hiring independent auditors to conduct unannounced audits of their sales.. If these audits are done prior to a state audit, the results of these detailed reports can be used as compelling evidence to contradict the assumptions made by the auditor with regard to breakage, pricing, or mark-ups.

 5. Invest in a Sophisticated Cash Register. Bar owners should invest in a relatively sophisticated cash register or point of sale system, and inventory tracking software, that is able to provide detailed sales reports and track items like complimentary sales and loss of inventory.

 6. Train Employees. Bar owners should properly train their employees on proper drink sizes to avoid the over-pouring of drinks, to implement procedures to avoid loss of inventory due to breakage and spillage, and to properly document such losses of inventory.  In some instances, it may be beneficial to hire a third-party consultant to provide a training session to bartenders or servers.  

7. Keep Records and Reports for at least Four Years. The statute of limitations in Ohio, for which the state can audit a taxpayer and assess for unpaid tax, is four years. For this reason, all primary sales reports and records, including sales receipts, purchase invoices, inventory records, and documentation of inventory losses should be maintained for at least four years.

Contact Nardone Law Group

If you are the owner of a bar or restaurant and you are facing a sales tax audit by the Ohio Department of Taxation, or you would like further advice on ways to keep adequate and complete records to avoid inaccurate mark-ups, you should contact Nardone Law Group. We have vast experience representing bars and restaurants in sales tax audits, examinations, and litigation with the Ohio Department of Taxation. Contact us today for a consultation.

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