Vince Nardone: Tax and Controversy

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

IRS Cans Private Collectors of Federal Tax Liabilities

IRS has announced that after an extensive review of the private debt collection program, including its cost effectiveness, IRS will not renew its contracts with two private debt collection agencies.  See the news release attached below in IR 2009-19.  This is great news for taxpayers.  Although I recognize that some taxpayers may have horror stories to tell about dealing with an IRS revenue officer.  In most instances, they are very professional.  Now, that does not mean they are going to give the taxpayer a break, but they generally do a good job of looking at the collection alternatives.  I would certainly rather work with the IRS then some private company or attorney.  

The whole idea of having some private debt collector collect for the IRS has always left a bad taste in my mouth.  I practice in Ohio and the Ohio Department of Taxation and the Ohio Attorney General's Office contracts with third party attorneys, who simply actas debt collectors and they financially benefit from each transaction that they collect on.  The is certainly a conflict of interest.  In addition, many of the attorneys, also called special counsel, have a certain political affiliation (i.e., same as the Ohio Attorney General), which never mixes well with legal work.  All and all, it is a very poor system in Ohio when it comes to collection work.  Thus, I am happy that the IRS has canned the idea for now and will not follow in Ohio's footsteps.  

The bad news, however, that came out of the news release is that the IRS intends to hire another 1,000 revenue officers in the next year.  See the attached notice from the IRS. 

Download Debt Collection - No more private

IRS Reminds Taxpayers of Installment Agreement On-line Options

On February 18, 2009, the Internal Revenue Service issued a notice reminding taxpayers of their on-line options for installment agreements.  I have found, however, that this service is not very user friendly and many times the Internal Revenue Service ultimately requires you to mail in information.  I believe the more efficient way to handle the installment agreement process is to either: (i) have the case transferred to the local office where the taxpayer resides or (ii) contact the Internal Revenue Service by telephone and actually speak to a person. 

See the attached notice.

Download Installment Agreement

Offer-in-Compromise - You must file your returns

No matter how many times we tell the client, many taxpayers fail to follow through with the express conditions of the Internal Revenue Service's collection alternatives.  In Trout, (2008) 131 TC No. 16, the taxpayer entered in an Offer-in-Compromise ("OIC") with the Service.  For those of you who do not know, an OIC is simply a settlement with the Service to pay less than the full amount due.  Although it sounds simple, many taxpayers do not qualify because of the rigid requirements of the OIC and the fact that the Service does not like the OIC program.  But, it is amazing how many times taxpayers, who are initially successful with entering in an agreement with the Service, fail to follow the Service's express conditions of the agreement.

In this case, the Service agreed to accept the taxpayer's OIC if, among other things, the taxpayer filed timely tax returns for the five years following the acceptance of the offer.  Yet, the taxpayer failed to file the returns on time.  Rather than correct the error immediately and plead to the Service's discretion for leniency, the taxpayer continued the delinquency and then attempted to come up with some creative (but baseless) legal arguments in challenging the Service's revocation of the offer.  This is one of those cases where you scratch your head and wonder why such a case should be litigated.  The fact is the Service accepted the taxpayer's offer on the express condition, among others, that he must file his returns on time.  Yet, he failed to do so and the Service revoked the OIC.  Sounds easy enough for me.  But yet, it was litigated.

See the case attached.  Download OIC - Breach

Innocent Spouse Relief - Fraudulent Income of Spouse

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

 

In Yakubic, TC Summary Opinion 2008-74, the Tax Court held that it was an abuse of discretion when the Service failed to grant a taxpayer relief for failing to report his ex-wife’s income that she fraudulently obtained.  In 2003, the taxpayer’s wife worked as a paralegal, and embezzled funds from her employer.  She also wrote out bad checks on the couple’s joint bank account and forged checks belonging to the taxpayer’s stepfather.  Later that year, she was caught, sentenced to prison, and ordered to pay restitution to her employer and the taxpayer’s stepfather.  In 2004, while his wife was in prison, the taxpayer filed a joint tax return for 2003.  Although he knew that his wife worked in 2003, and he knew she obtained money through dishonest means, he did not report the additional income.  After filing the original return, he received a W-2 form from his wife’s employer and failed to amend the return to reflect the income.  Due to his understatements, the couple qualified for an earned income credit and the Service issued a refund for $5,017.

 

In May 2005, the Service detected the taxpayer’s understatements and sent him a notice of deficiency indicating an increase in the couple’s tax liability along with a penalty for not reporting all of their income.  A few months later, the taxpayer divorced his wife.  Then in December of that same year, the taxpayer filed a Form 8857 Request for Innocent Spouse Relief.  The Service denied his request, and the taxpayer filed a petition with the Tax Court.

           

            Generally, under the Code, taxpayers filing joint Federal Income tax returns are jointly and severally liable for taxes due. Section 6013(d)(3).  A taxpayer, however, may obtain relief from joint and several liability if he qualifies under any of the exceptions listed in Sections 6015 (b) (c) or (f) of the Code.  The taxpayer seeking relief bears the burden of proof. Rule 142 (a).

 

            In this case, the taxpayer failed to qualify for relief under either Section 6015(b) or (c).  Both of these exceptions require that the taxpayer not know or have reason to know of the understatements of income at the time of filing.  Here the taxpayer knew he was understating their income when filing their return.  He knew his wife worked in 2003, and he knew his wife was convicted for embezzling money, but he did not report either of those monies as income.  The taxpayer, nevertheless, obtained relief under the last exception listed in Section 6015(f).

 

            Under Section 6015(f), a taxpayer must first satisfy seven conditions before a court will even consider giving the taxpayer relief.  The seven conditions are that the requesting spouse (1) filed a joint return; (2) does not qualify for relief under section 6015(b) or (c); (3) applied for relief no later than 2 years since the first collection activity; (4) did not transfer assets as part of a fraudulent scheme; (5) did not get assets transferred to him by the non-requesting spouse; (6) did not file the returns with a fraudulent intent; and (7) is seeking relief attributable to an item of the non-requesting spouse.  In the present case, the taxpayer satisfied all seven conditions.

           

            After determining that the taxpayer satisfies all seven conditions, the court must then weigh eight non-exclusive factors to determine whether it would be inequitable to hold the taxpayer liable for all or part of the deficiency.  These factors are: (1) the taxpayer is separated or divorced from the non-requesting spouse; (2) the taxpayer will suffer economic hardship without relief; (3) the taxpayer did not know or have reason to know of the deficiency; (3) the non-requesting spouse had a legal obligation to pay the liability; (4) the taxpayer did not receive significant benefit from the item giving rise to the deficiency; (5) the taxpayer has made a good faith effort to comply with tax laws in subsequent years; (6) the taxpayer was abused by the non-requesting spouse; and (8) the taxpayer was in poor physical or mental condition when signing the return or requesting relief.  In the present case, factor (3) weighed against the taxpayer because he knew he was understating their income at the time of filing.  In general, factor (3) weighs heavily against granting relief.  That factor, however, may be outweighed by the other factors weighing in favor for relief.  In the present case, the Tax Court found that factors (1), (2), and (4) weighed in favor for relief and were sufficiently compelling to outweigh factor (3).  The taxpayer was divorced, he would have suffered economic hardship in paying the tax liability, and he did not obtain any significant benefit from the refund check.  He instead used the check to pay their outstanding debts, restitution on bad checks his wife wrote out, and his wife’s children’s Christmas presents.  The rest of the factors were neutral.  Therefore, the Court found that it would be inequitable to deny the taxpayer relief.

 

Internal Revenue Service Can Levy Guaranteed Payments of LLC Member -

Written by Guest Author: Pilar Honer:

In CCA 2008366002, the Service Chief Counsel’s Office determined that the Service could levy upon payments owed by an LLC to its member at the time of levy.  The CCA, however, left open the question as to whether contingent fees qualify as salary and wages for purposes of serving a continuing levy upon them.  In this instance, the taxpayer, a personal injury attorney, organized his law practice as a Limited Liability Company (LLC).  The LLC entered into contingent fee agreements with the clients.  After successful litigation, the LLC collected a percentage of the recovery and after paying overhead costs, paid the taxpayer for his services rendered.

Since the taxpayer’s practice was set up as a LLC, the Service had a harder time obtaining a levy upon the taxpayer’s assets.  First, even though the taxpayer was the only owner/member of the LLC, the Service could not place a levy on the LLC’s assets. Unless there is evidence of an alter-ego relationship, the Service cannot reach the actual assets of the LLC to satisfy the personal debts of a single owner.  Second, the Service could have placed a levy on the taxpayer’s interest in the LLC; however, there were no other owners/market to buy this interest.  Therefore, the only potential asset for the Service was the income the taxpayer received from the LLC.

Under the Code, the Service may use two methods to enforce a lien. It can either bring a foreclosure action pursuant to I.R.C. §7403, or it can levy on the taxpayer’s property pursuant to I.R.C. §6331.  A levy reaches only to “property possessed and obligations existing at the time of the levy.” Hemmen, 51 F.3d 883 (9th Cir. 1995).  Reg. Reg. 301.6331-1(a)  interprets the “present obligation” as “[l]evy may be made by serving a notice of levy on any person in possession of, or obligated with respect to, property or rights to property subject to levy.... Except as provided in §301.6331-1(b)(1) with regard to a levy on salary or wages, a levy extends only to property possessed and obligations which exist at the time of the levy. Obligations exist when the liability of the obligor is fixed and determinable although the rights to receive payment thereof may be deferred until a later date.....” 

Therefore, the first question was “what ‘rights to property’ does a member of an LLC have?”  According to state law, an LLC’s member has a “right to property” in being repaid his capital contribution and share in the profits and other assets, unless otherwise stated in the operating agreement.  This right, however, must be fixed and determinable at the time of levy for the LLC to be obligated to turn it over to the Service. Courts hold that “when events which give rise to the obligation have occurred and the amount of the obligation is capable of being determined in the future it is ‘fixed and determinable’.”  Hemmen, 51 F.3d at 890.  Therefore, although the taxpayer worked on a contingency fee arrangement, the LLC’s obligation to the taxpayer was fixed and determinable with respect to legal services rendered prior to the notice of levy.  Hence, the Service was successful in obtaining fees that the LLC owed to the taxpayer, but only with respect to those owed at the time of levy. 

The Service then sought to place a levy upon the taxpayer’s future right to payments from the LLC.  Generally, a levy extends only to property possessed and an obligation existing at the time the levy is made.  There is, however, an exception with respect to salary and wages. I.R.C. §6331(a).  Section 6331(e) provides that the effect of a levy on salary or wages payable to or received by a taxpayer will be continuous from the date the levy is first made until the levy is released under Section 6343.  Section 6331(e) does not specify the types of remuneration that are covered by the terms “salary or wages.”  The CCA discussed a more recent district court opinion that held that amounts paid and payable to a member of a law firm, organized as a partnership, were subject to a continuing levy.   

In that case, the district court held that since the partnership made payments to the delinquent taxpayer/partner on a regular basis they were wages for purpose of the code. Moskowitz, Passman & Edelman, 100 AFTR 2d 2007-6358 (DC N.Y., 2007).  There the delinquent taxpayer handled all of the books for the law firm and regularly wrote checks out to himself from the partnership’s bank account.  The taxpayer argued that those checks were not salary or wages because they were as he testified a “draw or an advance or a loan against what is ultimately converted to income at the end of the year.”  The district court disagreed and held that since the remuneration was paid on a recurring basis, his self-payments were wages.  In applying this holding from Moskowitz to CCA 200836002, the Chief Counsel’s Office was concerned that the irregular payments received by the taxpayer from the contingent fee awards would not qualify as wages.  Therefore, the CCA required the Service to obtain more information in order to make that determination, leaving open the question as to whether contingent fees qualify as wages or salary.

Comment by Vince Nardone:

I found the CCA very interesting; specifically on issue that the Service cannot simply attach the assets of an LLC when the Service is a creditor of one of the LLC’s members.  I receive questions many times from other lawyers concerned about the LLC’s assets when the Service is pursuing a member for his personal income tax liabilities.  In many instances, I am representing the individual and the other lawyer is representing the LLC.  I try to explain the fact that the Service cannot simply attach the LLC’s assets.  But, invariably there is always an attorney that questions that position without sound reasoning for doing so.

Download levy_llc.pdf

Discharging Taxes in Bankruptcy Thwarted by Claims/Evidence of Willful Attempt to Evade or Defeat Tax - Tax Liabilities and Collection Alternatives

In a recent Eleventh Circuit decision (Zimmerman v. IRS, CA 11, 101 AFTR 2d ¶2008-390 ), the Court affirmed the bankruptcy court’s decision that a Chapter 7 debtor/CPA's decades-old tax debts were subject to 11 USCS 523(a)(1)(C) 's discharge exception and therefore not dischargeable. The record showed that taxpayer engaged in numerous and willful attempts to evade tax. According to the Court, examples of affirmative act evidence included that the taxpayer repeatedly failed to pay known tax obligations even while supporting lavish lifestyle, which included oceanfront living and luxury cars; and engaged in substantial asset transfers for no consideration to long-time girlfriend and family. In addition, the Court stated that willfulness was shown by facts of his education/profession and that he engaged in foregoing transfers and other acts to defeat collection of taxes that he knew were due and owing.

This case highlights the government’s best tool in combating a taxpayer’s ability to discharge old tax debts in bankruptcy. But, the fact remains that if you meet the bankruptcy provisions for discharging taxes, discharging your taxes remains a good collection alternative. (See my outline below on discharging taxes in bankruptcy) And, the government’s burden is not easily met to establish the "willful attempt to evade tax" exception. Read the entire Zimmerman v. IRS, CA 11, 101 AFTR 2d ¶2008-390 opinion below. 

Download discharging_taxes_in_bankruptcy.PDF

Outline on discharging taxes in bankruptcy is attached below.

Download outline_bankruptcy.PDF

Collection Due Process Hearing appealed, Taxpayer Successful (I think).

In this case, an auto dealership was granted a second remanded CDP hearing on IRS's administrative determination to proceed with liens for its employment tax deficiencies and penalties: The appeals officer erred in original hearing insofar as failing to properly consider taxpayer's underlying liabilities disputes and argument that penalties should be abated on basis of bank errors in EFTPS transactions. Although taxpayer wasn't entitled to abatement on basis of certain other theories it was advancing, it was entitled to be heard on bank error/EFTPS transaction error theory. So, officer was ordered to give that issue proper consideration on remand. Officer was also ordered to consider effect of IRS's earlier failure to properly apply certain agreed payments and adjustments. And, while he had been correct insofar as determining that taxpayer had not submitted necessary information to support any collection alternative during original hearing, officer was required to re-consider same in light of foregoing issues and to conduct renewed balancing analysis. See Don Johnson Motors v. U.S., DC TX, 101 AFTR 2d ¶2008-335 attached. 

Now, this case highlights that in some instances appeals officers make mistakes in these cases, but the question I have is: Is it worth appealing and maybe it is. Because what you do not hear about is what happens when the case is remanded.  That is, most of these cases are procedural errors and once it is remanded to the appeals officer you are likely to find that the appeals officer corrects the procedural error and the end-result is the same. That is, the taxpayer loses. What is more important is working with the appeals officer at the appeals so that the taxpayer can obtain a satisfactory result without having to pursue litigation, which in most instances is cost prohibitive—although I recognize that you may obtain that one appeals officer that is simply not going to work with you.

This case also provides a good discussion on reasonable cause and the abatement of certain penalties.

Download 1373689.PDF

Utilizing Bankruptcy to Reduce an Individual’s Outstanding Tax Debts

Utilizing Bankruptcy to Reduce an Individual’s Outstanding Tax Debts[1]

I. Introduction[2].

A. Introduction. Bankruptcy is a commonly overlooked tool of a tax practitioner when attempting to resolve his client’s tax liabilities. In fact, a taxpayer’s filing of a petition in bankruptcy may result in the elimination or significant reduction in taxes owed to federal, state, and local taxing authorities. It can also be used as leverage when negotiating offer-in-compromises and installment agreements with the IRS, as well as with state and local taxing authorities.