Obtaining a Claim for Refund from the IRS or Ohio Department of Taxation

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As a tax attorney in Columbus, Ohio, I routinely assist businesses with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and state tax agencies. As part of that representation, I try to keep individuals and businesses informed about new information and guidance provided by the IRS and the Ohio Department of Taxation (the “ODT”), as well as taxpayer rights. This article will detail the timeframe that an individual Taxpayer has to claim a refund.

Overview

For individual taxpayers, a tax refund commonly comes from overpayments made by their employer via W-2 withholdings. To the extent that these withholdings exceed the tax liability assessed by the IRS or another tax agency, the taxpayer is due a refund.  Overpayments may also occur when an error is discovered that results in a lower tax liability. This can be found by the taxpayer (in which case the taxpayer should file an amended return), or it can be discovered by the IRS or another tax agency (in which case the taxpayer should review the notice provided by the agency to determine the next step).

Refunds per the IRS

For individual taxpayers filing a federal tax return (the Form 1040), the limits on refunds are described in the Internal Revenue Code, Section 6511(a) and 6511(b). In general:

Refunds must be claimed within 3 years from the time the return was filed, or 2 years from the time the tax was paid, whichever is later.

Additionally, even if the above rule is followed, refunds can only be claimed on payments within the last three years of when the return was filed. For purposes of this calculation, taxes paid via an employer’s W-2 withholdings are considered paid as of the due date of the return.

In effect, an individual taxpayer will only be permitted a tax refund on payments made through their W-2 withholdings if the return is filed within three years of the filing due date, including extensions. In the case of amended returns resulting in a lower tax liability, a taxpayer has three years from when their return was filed to submit a corrected return to be eligible for a refund.

Refunds per the State of Ohio

For individual taxpayers filing a state tax return (the Ohio IT 1040), the limits on refunds are described in the Ohio Revised Code, Section 5747.10 and 5747.11. In general:

Refunds must be claimed within four years of the date of payment to be eligible for a refund. For the purposes of this rule, taxes paid via an employer’s W-2 withholdings are considered paid as of the due date of the return.

Even if outside the four-year limit, if the adjustment is due to changes made by the IRS (meaning outside of the taxpayer’s control), the taxpayer is granted 60 days from the IRS’s notice to file an amended return with the State and obtain a refund. Note that this limitation only applies to the portion of the return amended by the IRS and does not allow refund balances that have previously expired to once again become refundable.

This stresses the importance of filing timely tax returns, especially when the Taxpayer is due a refund. Please note that rules will differ when considering other tax forms as well as taxes filed in other states.  If you have any questions or would like more information, contact me at vnardone@nardonelimited.com and I would certainly be happy to discuss.

September 10, 2019

FBAR Penalty and Impact of Taxpayer’s Failure to Disclosure Foreign Assets and IRS’s Assessment of Penalties

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As a criminal and civil tax attorney, I like to report on and advise taxpayers about U.S. tax reporting requirements and obligations regarding foreign and domestic financial accounts and the importance of reporting previously undisclosed accounts or income. Although the reporting and enforcement involving the Internal Revenue Service (“IRS”) and taxpayers has been highlighted for over a decade now, the failure to report continues—subjecting taxpayers to significant penalties.  As discussed below, a recent federal district court, Schwarzbaum (DC Fl 8/23/2019), rejected an individual's claim that FBAR penalties assessed against him should be set aside because they were assessed after the limitations period expired.

Background

If a taxpayer has a financial interest in, or signature authority over, a foreign financial account, a taxpayer may be required to report the account to the IRS. It is important to understand that those who fail to meet the IRS’s requirements could face criminal or civil penalties.  Generally, U.S. persons who maintain a financial account in a foreign country—foreign financial account—must file a Report of Foreign Bank and Financial Accounts (FBAR) with the Treasury's Financial Crimes Enforcement (FinCEN) division. An FBAR is required for all foreign financial accounts a taxpayer maintained that had a balance exceeding $10,000 at any time during the previous calendar year. Under Title 31 USC § 3521(a)(5)(A), a taxpayer’s willful failure to file an FBAR may result in a significant penalty. And, as the Schwarzbaum court pointed out below, an FBAR penalty may be assessed at any time before the end of the 6-year period beginning on the date of the transaction with respect to which the penalty was assessed.

Facts in Schwarzbaum Case

As I understand it, between 2006 and 2009, the taxpayer, Isac Schwarzbaum, maintained several foreign financial accounts. According to the case reporting, the taxpayer failed to file FBARs for his accounts in Switzerland.  See the link for the actual case from the district court. In 2011, the taxpayer submitted an Offshore Voluntary Disclosure request, attempting to avail himself of the Offshore Voluntary Disclosure Initiative (OVDI). As part of his participation in the OVDI, the taxpayer signed an extension of the limitations period to assess and collect taxes and penalties related to his 2006-2009 returns.  The taxpayer then opted out of OVDI and underwent full examinations of his returns.

Nardone Comment: From my perspective, opting out was probably the first major mistake for the taxpayer. But, without knowing all the facts and circumstances, or the motivations of the taxpayer, there may have been very good reasoning for opting out at the time. So, it is hard to say.

As part of the examination, the IRS asserted a willful FBAR penalty against the taxpayer, which is not unusual in a case where a taxpayer opts out and puts the IRS through additional hoops and forces the government to continue to work the case. Thus, no one should be surprised that that the IRS took this position and assessed the penalty. Either way, the FBAR penalties (for tax years 2006-2009) were assessed in September 2016.

The taxpayer argued that the FBAR penalty assessments were time-barred. The IRS argued that the taxpayer voluntarily signed a consent to extend the limitations period to assess and collect taxes related to his 2006-2009 returns.  The Schwarzbaum court held that the taxpayer’s argument that the FBAR penalties assessed against him were time-barred was meritless. The court found that it was taxpayer’s burden to show that his voluntary agreement to extend the limitations period to assess FBAR penalties was invalid since that was the taxpayer’s affirmative defense. According to the court, the taxpayer failed to point to any legal authority to support his argument that the agreement he signed was invalid.  The Schwarzbaum court further highlighted that a taxpayer—who fails to press a point by supporting it with pertinent authority or by showing why it is sound despite a lack of supporting authority or in the face of contrary authority—forfeits the point. (Melford v Kahane & Assocs., (DC FL 2019) 371 F Supp 3d 1116)

Nardone Comment: In November 2018, the IRS replaced the OVDI with an updated voluntary disclosure program. If you would like more information on UVDP, see our previous blog article.

Conclusion

We strongly encourage our clients to be compliant with any and all U.S. reporting requirements relating to their foreign or domestic financial accounts, even if they have not done so in the past. The IRS offers options to non-compliant taxpayers when it comes to disclosing unreported financial accounts or income. But, taxpayers must be diligent when it comes to communicating with the IRS. That is why it is important to seek help from an attorney who has vast experience representing taxpayers before the IRS. Ultimately, if you have undisclosed foreign financial accounts, or would simply like more information regarding your filing obligation, contact me at vnardone@nardonelimited.com and I would certainly be happy to discuss.

 

August 27, 2019

Taxpayer Rights: Appealing IRS Decisions

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and state tax agencies. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS, as well as taxpayer rights. This article is the first of a series highlighting a taxpayer’s right to appeal IRS actions to the Office of Appeals (“Appeals”).

Overview

The IRS accepts most of the returns taxpayers file. But, other returns are selected for examination or audited by the IRS to determine whether a taxpayer accurately reported income, expenses, deductions, and credits (the “Examination”). Pending the outcome of an Examination, a taxpayer that disagrees with the outcome of an Examination can challenge the outcome at Appeals.

Appeals is an independent organization within the IRS that helps taxpayers resolve tax disputes through an informal, administrative process. A taxpayer can appeal several types of tax disputes to Appeals, including proposed adjustments, actions, penalties, interest, trust fund recovery penalties, liens, levies, and offers in compromise. Taxpayers today expect more options for resolving tax disputes, and Appeals is one of the options the IRS provides.

Appeals is a form of alternative dispute resolution and strives to resolve tax disputes in a fair way that is impartial and cost-efficient for both the taxpayer and the IRS. The role of Appeals is to make an independent review of a tax dispute, considering the positions of both the taxpayer and the IRS. Before discussing Appeals any further, we will first review the Examination process.

The Examination Process

The IRS selects a return for Examination in one of two ways. The first way is to identify returns that may contain incorrect amounts by using a computer program. The computer program selects the returns based on information returns (i.e., Forms 1099, W-2, etc.) received by the IRS.  The second way is by using information received from IRS compliance projects that indicate that a taxpayer’s return may contain incorrect amounts. Once a return is selected for review, the IRS conducts the Examination either by mail or in person. It should be noted that nearly eighty percent of Examinations are conducted by mail.

Taxpayer Notification

If the Examination is conducted by mail, the taxpayer receives a letter from the IRS requesting additional information about certain income, expense, deduction, and credit items claimed on the return. If the Examination is conducted in person, the IRS informs the taxpayer that the taxpayer’s return is under exam and requests any additional information needed from the taxpayer. Once the taxpayer gathers the information, the time and location of the Examination is scheduled. In-person Examinations take place at the taxpayer’s home or place of business, the taxpayer’s representative’s place of business, or an IRS field office.

The Examination

During the Examination, an IRS examiner (the “Examiner”) reviews the additional information provided by the taxpayer. Throughout the process, the Examiner works with the taxpayer to ensure that the taxpayer provides all documentation necessary to allow the Examiner to accurately perform the Examination. Then, the Examiner compares the additional information provided by the taxpayer with the income, expense, deduction, and credit items with the income, expense, deduction, and credit items from the return under Examination. The Examiner then makes a determination.

Examination Results

After comparing the information provided by the taxpayer to the return under Examination, the Examiner will either accept the return as filed or propose changes to the return. If the IRS accepts the return as filed, the taxpayer receives a letter stating that there are no proposed changes and the matter is closed. If the IRS does not accept the return as filed, the Examiner prepares a report explaining the positions of the IRS and the taxpayer (the “Report”). The IRS sends the Report along with a letter, known as a thirty-day letter, and an agreement form to the taxpayer informing the taxpayer of the IRS decision and proposed changes (the “Correspondence”). The taxpayer then has thirty days from the Correspondence to either agree or disagree with the proposed changes.

If the taxpayer agrees with the proposed changes, the taxpayer signs the agreement form and pays the additional tax assessed, as well as any interest and applicable penalties. Or, if the taxpayer is entitled to a refund, the taxpayer receives a refund, along with interest. If the taxpayer disagrees with the proposed changes, the taxpayer does not sign the agreement form and must follow the guidance provided in the Correspondence to appeal the IRS decision to Appeals.

The Appeals Process

Appeals is the only level of appeal within the IRS. The mission of Appeals is “to resolve tax controversies, without litigation, on a basis which is fair and impartial to both the government and the taxpayer, and in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the IRS.” The taxpayer initiates the appeals process by requesting a conference (the “Conference”) with an Appeals officer (the “Appeals Officer”).

Requesting a Conference

Taxpayers with total proposed changes in tax, interest, and penalties of $25,000 or less for each tax period at issue can make a “small case request.” The small case request allows the taxpayer to appeal the decision by sending a brief written statement to the IRS requesting a Conference.

A taxpayer is required to file a formal protest to the IRS requesting a Conference if: the total amount of tax, penalties, and interest is more than $25,000; the case involves a partnership or S corporation, regardless of the amount at issue; the case involves an employee plan or exempt organization, regardless of the amount at issue; and all other cases. Once the IRS receives the taxpayer’s request for Conference, the Examiner forwards the taxpayer’s case to Appeals. Appeals then contacts the taxpayer to schedule the Conference. The Conference can be by phone or in person.

The Conference

It is the objective of Appeals to resolve the differences between the IRS and a taxpayer during the Conference. The taxpayer may be required to file a formal written protest letter at this time, which makes it all the more important that the taxpayer retain an experienced professional.

The IRS assigns the taxpayer’s case to an Appeals Officer that takes an independent review of the strengths and weaknesses of the respective IRS and taxpayer positions (the “Review”). The Review is conducted in an informal manner and often involves open dialog between the Appeals Officer and the taxpayer. The Review also gives the taxpayer an opportunity to provide significant new information unavailable or not considered during the initial Examination. If the taxpayer does provide new information, the Appeals Officer works as a liaison to provide the new information to the IRS examiner for additional review and consideration. After the Appeals Officer completes the Review, the Appeals Officer decides whether a proposed adjustment or action outlined in the Correspondence is sustained, modified, or eliminated. Although the appeals process is described as informal, all parties are expected to conduct themselves in an organized and professional manner.

Contact Nardone Limited

Appeals provides an impartial and cost-efficient means for taxpayers to resolve Examination tax disputes with the IRS. Although the appeals process is described as informal, it is important that the taxpayer retains the necessary experienced professionals for additional guidance. Working with the right professionals allows the taxpayer to get the most out of the Examination and appeals process. The right professionals have relationships with Appeals Officers and understand the information and arguments that Appeals needs to make a fair and informed decision. The tax attorneys at Nardone Limited have this understanding and are prepared to discuss your tax dispute matters with the IRS.  Contact Nardone Limited today.

August 09, 2019

The IRS Gets Audited: Results from the TIGTA Report

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “Service”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article highlights a report on a recent audit of the Service’s Large Business and International Division (“LB&I”) performed by the Treasury Inspector General for Tax Administration (“TIGTA”) (the “Audit”).

The Audit

The Service uses taxpayer penalties to enhance voluntary compliance by demonstrating fairness to compliant taxpayers and penalizing noncompliant taxpayers. The Service’s examination program is made up of three operating divisions: LB&I, which is responsible for the tax compliance of partnerships, S and C corporations with assets of $10 million or more, and individuals with high wealth or with international tax implications; the Small Business/Self-Employed Division (“SBSE”), which examines other businesses with assets less than $10 million; and the Wage and Investment Division (“WI”), which examines taxpayers who claimed certain refundable credits. A Service examiner (the “Examiner”) is primarily responsible for determining a taxpayer’s correct tax liability through the examinations the Examiner conducts. An Examiner is also responsible for considering any applicable penalties associated with an examination and is required to document and explain each proposed penalty. This includes accuracy-related penalties.

The Service reported that the gross underreported income tax for large corporations, for tax years 2008 through 2010, averaged $28 billion annually. This creates substantial challenges for LB&I Examiners, especially as it relates to accuracy-related penalties. TIGTA conducted the Audit from August 2017 through December 2018. The Audit acted as a performance review of the imposition of accuracy-related penalties by LB&I, as well as an analysis of the percentage of penalties sustained by the Service’s Office of Appeals (the “Appeals Office”). The Audit reviewed the imposition of accuracy-related penalties and Appeals Office practices for tax years 2015 through 2017 (the “Audit Period”).

The Results

The TIGTA report outlines the Audit findings in three main categories that demonstrate the Service’s and LB&I’s areas in need of improvements:

Accuracy-Related Penalties Are Infrequently Proposed by LB&I
and Often Reduced or Eliminated by the Appeals Office

During the Audit Period, LB&I reviewed 6,709 business tax returns. Of these returns, Examiners proposed accuracy-related penalties on 519 returns in the amount of $1.8 billion. Taxpayers appealed 308 of the 519 returns, which amounted to $1.5 billion in penalties. By December 2018, the Appeals Office reviewed 195 of the 308 returns, and eliminated or reduced penalties worth $765 million on 183 of the returns.

The Audit pulled an additional 4,600 business tax returns from examinations that resulted in additional tax assessments in excess of $10,000. These additional assessments totaled $14.4 billion. Of these 4,600 returns, Examiners proposed accuracy-related penalties on 295—or six percent. By comparison, the SBSE examined 22,370 business tax returns from examinations that resulted in additional tax assessments in excess of $10,000. Of those 22,370 returns, Examiners proposed accuracy-related penalties on 5,634 of the 22,370 returns—or twenty-five percent. TIGTA highlighted this as a significant discrepancy between LB&I and SBSE examination practices.

Examiners Did Not Always Consider or Justify Accuracy-Related
Penalties and Supervisors Were Not Always Involved in Penalty
Development and Approval

It is the responsibility of the Examiner to identify the appropriate penalties, determine whether to propose the penalties, and accurately calculate the penalties as they relate to a specific examination. Examiners are also responsible for documenting the considerations, reasoning, and computations for all penalties proposed on a return.

The Audit pulled a stratified sample of 50 closed LB&I examinations containing accuracy-related penalties, as well as a stratified sample of 50 closed LB&I examinations with additional tax assessments greater than $10,000 but without accuracy-related penalties.

A review of the 50 closed examinations that did not contain accuracy-related penalties showed that Examiners did not even consider accuracy-related penalties for twenty percent of the examinations. And, in the examinations where Examiners considered accuracy-related penalties, twenty percent of the exams failed to provide sufficient documentation on the considerations, reasoning, and computations related to penalties assessed on the returns.

A review of all 100 closed LB&I examinations pulled indicated that in sixty-six percent of the examinations, the Examiner’s supervisor either did not approve the proposed penalties or was entirely not involved in the proposal of penalties. The Examiner-supervisor relationship is an important part of the Service’s Examination procedures, however, the Audit revealed glaring issues related to this relationship within LB&I.

Many Closed Examination Paper Case Files Were Missing or Incomplete

The Audit also reviewed a sample of 90 closed LB&I examination paper case files to determine their completeness. To do so, TIGTA requested 90 random paper case files from the Service’s Integrated Data Retrieval System (“IDRS”) according to standard Service procedures. Not only did TIGTA experience longer than expected processing times in receiving the case files, but TIGTA also discovered several instances of incompleteness. Of the requested files, IDRS provides partial files for twenty-seven percent of the files and could not retrieve six percent of the requested files.

The Recommendations

Based on the Audit’s results, the TIGTA report offered the following recommendations to the Service and LB&I for improving the issues described above:

  1. Conduct a study to understand why Examiners’ proposed tax assessments and accuracy-related penalties are not being sustained by the Appeals Office and whether Examiners consider all relevant facts and circumstances prior to proposing tax adjustments and accuracy-related penalties.
  2. Ensure Examiners and their supervisors are properly trained to consider accuracy-related penalties for each examination, follow the proper procedures for documenting penalty consideration and development, and follow the Service’s requirements for supervisor involvement in each examination.
  3. Revise the Internal Revenue Manual to indicate which Examiners are responsible for penalty development and documentation and provide more specific requirements as to a supervisor’s involvement in approving penalty decisions.
  4. Ensure adequate quality review systems are in place that can accurately determine whether Examiners properly consider penalties, provide adequate support for such penalties, involve managements throughout the examination processes, and obtain all necessary approvals.
  5. Use the Service’s internal process improvement team to evaluate the procedures for closing, shipping, and storing paper examination case files.

Overall, the Service was generally receptive of the recommendations provided by TIGTA and agreed that several changes needed to be made to correct the issues and concerns addressed in the TIGTA report.

Nardone Limited Comment: Going forward, taxpayers filing returns within the purview of LB&I examination should take great caution to ensure the accuracy of the returns. With the results and recommendations that came out of the TIGTA report, taxpayers can expect greater scrutiny from Examiners and their supervisors. We expect to see a rise in accuracy-related penalties assessed to LB&I returns going forward. We recommend that taxpayers contact experienced professionals regarding all accuracy-related concerns on a return before filing. Getting it right the first time has never been more important. We also expect to see changes made at the appeals level. The TIGTA report highlighted the trend occurring at the Appeals Office whereby penalties appealed to the Appeals Office were being severely reduced or even eliminated in almost every case brought to appeals. We anticipate this to stop and expect the Appeals Office to increase its scrutiny at all levels of the appeals review process. If you are assessed an accuracy-related penalty, or any penalty for that matter, it is important that you retain the appropriate professional advisors who will take a more detailed approach when submitting your cases to Appeals.

Conclusion

If you are assessed similar proposed assessments or accuracy-related penalties on your business or personal income tax return, it is important to work with a qualified tax professional to review those assessments or penalties and your opportunities for appeal. The tax and business attorneys at Nardone Limited are experienced in federal, state, and local tax controversies, including examinations by the SBSE and LB&I. If you believe the Service wrongfully proposed an assessment or penalty, or are under examination by a taxing authority, our firm can assist you.  Contact Nardone Limited today.

The full report is available at: https://www.treasury.gov/tigta/auditreports/2019reports/201930036fr.pdf

July 19, 2019

IRS Overrules Common-Law Mailbox Rule in the Ninth Circuit

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation in tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service (“IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys advise clients on recent developments in the law. In a recent Ninth Circuit case, the court reminds us why it is important to properly document and follow-up with the IRS when it comes to time sensitive filings.  

Mailbox Rule May No Longer Be a
Defense for Certain Taxpayers

In Baldwin v. United States, a recent Ninth Circuit case, the taxpayers asserted that they timely mailed an amended return in 2011. The IRS, however, never received the original amended return. But, in 2013 the IRS received a new copy of the amended return from the taxpayers. When the IRS received the return in 2013 it noted that the postmark date was after the statutory deadline for filing a refund claim. Thus, the IRS denied the taxpayers’ refund on the grounds that it was not timely filed. The taxpayers, however, argued that under the common law mailbox rule there is a rebuttable presumption that the document was delivered to the IRS before the deadline.  

Under the common law mailbox rule, proof of proper mailing creates a rebuttable presumption that the document was physically delivered to the addressee. But, Internal Revenue Code Section 7502 was enacted to codify the mailbox rule. Section 7502 provides that if a document is postmarked before, and is received by the IRS after the due date of the required filing payment, then the date of the postmark is treated as of the date that the document was filed with the IRS. Section 7502 further provides that, if a document sent by registered mail, certified mail, or with a designated private delivery service, then the document will be presumed to have been delivered on the registration date. Ultimately, the court held that the taxpayer’s refund claim was not timely filed because the IRS never received the taxpayer’s original refund claim and the original claim was not sent by registered mail, certified mail, or a designated private delivery service.

Nardone Limited Comment: Although electronic filings are making Internal Revenue Code Section 7502 less relevant when it comes to filing returns, there are many reasons why taxpayers and tax return preparers will continue to file hard copy returns.  Thus, it is important to fully understand and comply with Internal Revenue Code Section 7502.  As we typically advise our clients and the tax return preparers that we work with, it is important to document all stages of the mailing. That is, in addition to filing the return by certified mail or by a third-party commercial delivery service, such as Federal Express, we also want to make sure that we maintain a copy of the outside of the envelope to confirm that it was properly addressed, we want to maintain a complete copy of all the contents of the mailing, and then we want to confirm delivery. Part of confirming delivery may include making sure that we track down the green card and maintain the green card with the certified mailing with postmark. Or, that may simply require us to go online to confirm delivery by Federal Express, UPS, United States Postal Service, etc. That entire mailing should then be maintained together with the contents of the mailing so that if there is ever a question, we have that maintained. And, importantly, all of those documents should be scanned and saved together electronically. Over time, the postmark, as an example, fades. Thus, if we need to document that we have a proper and timely postmark, if all we have is the faded postmark that we can no longer read, we may have a problem. If we maintain it electronically, it will not fade. 

Conclusion

In light of the Baldwin case, taxpayers should ensure that the professionals they hire are experienced in dealing with the IRS on a routine basis. Taxpayer’s need to ensure their filings and payments, in response to an IRS examination, are timely to avoid penalties. In addition, the Baldwin case highlights the importance of sending filings and correspondences to the IRS via registered mail, certified mail, or by private delivery service when you are handling a time sensitive matter. It is best practice to follow-up with the IRS to ensure that it received any filing or correspondence in response to an IRS exam. It is equally important to document that your filing was delivered, and that the IRS confirmed receipt. Carefully documenting your mailings to the IRS will help to refute any claims by the IRS that it did not timely receive your filing. If you have any questions or concerns regarding responding to the IRS, call Nardone Limited today at 614-223-0123.

 

June 05, 2019

5 Common Tax Scams and How to Avoid Them

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “Service”) and state tax authorities. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the Service and other tax authorities.

The 2019 Service “Dirty Dozen” Tax Scams

Each year, right before tax-filing season, the Service releases what it calls the annual “Dirty Dozen” list of tax scams that taxpayers, tax professionals, and other professionals working with financial information need to watch out for. Although scamming activity peaks during tax-filing season, this year’s Dirty Dozen list includes five scams that taxpayers can encounter at any time during the year. This article gives you background on those five scams and provides you with some tips to help prevent you from falling victim.

Scam 1: Micro-Captive Insurance Entities

Captive insurance entities found their way into the Dirty Dozen for the fifth consecutive year. Specifically, the Service is focusing-in on micro-captives. The Service’s increased focus to curb micro-captive tax abuse is best evidenced by the nearly 500 docketed cases in Tax Court and numerous Service examinations that involve micro-captives. Unlike many of the other Dirty Dozen, micro-captives are different in that the taxpayer knowingly gets involved. However, in many cases the decision to create a micro-captive is based on misinformation and the taxpayer is unaware of the potential consequences. So, what is a micro-captive?

Micro-captives are small, self-owned, non-life insurance entities governed under § 831(b) and offer taxpayers a tax-effective way to self-insure. To qualify as a micro-captive, the entity’s annual net premiums cannot exceed $2,300,000, among other requirements. The taxpayer creates the micro-captive to provide insurance coverage against future potential claims, without losing access to the premiums paid or the investment income generated by the micro-captive’s investments.

Borrowing an example from a Journal of Accountancy article, assume that you are a doctor paying $500,000 per year for malpractice insurance. The annual premiums that you pay go to a third-party insurance provider and are deductible as an ordinary and necessary business expense under § 162. However, once you pay the premiums, you lose access to that money and any future claims against you go through the third-party insurance provider. If you operate a claim-free practice, then you will likely view these premiums payments as a waste of capital potential. Enter the concept of the micro-captive.

The micro-captive allows you to establish a self-owned insurance entity. You continue to pay premiums, but now the premiums are paid to the micro-captive rather than the third-party insurance provider. You are still entitled to take a § 162, however, you now have access to the premium payments and any investment income generated by the micro-captive. When you retire, the micro-captive is liquidated, and you receive any remaining funds from the micro-captive. These funds are taxed at the favorable long-term capital gains rates. The potential upside of micro-captives is obvious, but the risk of abuse is a serious concern of the Service.

Business with high insurance costs are the likely candidates to fall into the micro-captive trap. Taxpayers should remain leery of propositions by promoters or other advisors recommending that a business create a micro-captive. Many times, this is where the abuse begins. Once created, taxpayers find themselves paying premiums to insure against irrelevant risks not previously considered. The additional premium payments lead to larger § 162 deductions, but portions of these deductions do not meet the necessary and ordinary expense standard if the risk is irrelevant. Also, giving the taxpayer direct access to the premium payments creates other concerns. Direct access may result in a taxpayer using the micro-captive reserves for purposes other than coverage for future potential liabilities. Specifically, the Service is concerned about circular lending where the taxpayer over loans the premium payments to themselves and then is unable to pay a claim. The Services is also aware of micro-captives being used to defer the taxation of income for the income to be taxed at the capital gains rate, versus the less favorable individual income tax rates.

In Notice 2016-66, the Service identifies as the “traits” that it identifies with abusive micro-captives. The first trait is that the insurance covers an “esoteric, implausible risk.”  The Service warns that a taxpayer must be able to demonstrate that the risk insured against is plausible considering the line of business. The second trait is that the coverage does not match the business’s risks or insurance needs. The Service requires that the risks and premiums are correlated. The third trait is that the contracts governing the insurance coverage are “vague, ambiguous, or illusory.” The Service advises that the premium payments must be broken-down, and the actual risks covered must be clearly described. Finally, the coverage and premium must make sense considering the market. The micro-captive premiums must make economic business sense compared to what the costs for similar coverage that the taxpayer could receive from a third-party commercial insurer.

Not all micro-captives are abusive, but the Service’s increased scrutiny requires that taxpayers seriously consider their intentions before getting involved. The safe bet is to avoid the micro-captive trap all together. But, if you decided to get involved, make sure that you engage the proper advisors to review the potential risks.

Scam 2: Emails and Websites That
Are Phishing for Trouble
      

Phishing is a scam tactic where scammers use fraudulent emails or websites to steal your personal information. These emails and websites appear to come from reputable sources claiming to need additional personal information in order to help you resolve a financial matter. However, the intent behind these requests is far more sinister. With phishing, scammers often only need you to click a link in the email or enter basic information on their website in order to steal valuable information. The simplest of actions, such as clicking a link, gives the scammer instant access to not only your personal information, but also anyone else’s personal information stored on that computer or network.

Whenever you receive an unsolicited email requesting personal information, it is necessary to take a closer look at the request itself, the email’s content, and the sender’s email address. Just this simple step can help prevent most phishing attacks. An email from a legitimate taxing authority will almost always end in “dot gov.” Many scammers try to take advantage of the fact that most unsuspecting people will overlook a similar, but inaccurate email address. For example, a scammer might send an email from an email address that ends in “@irs.com.”

If you receive an unsolicited email or come across a suspicious website requesting your personal information, you should use great caution. You can learn more by going to the Report Phishing and Online Scams page at IRS.gov.

Scam 3: Beware of Phony Calls

You should also be aware of unexpected and aggressive phone calls coming from scammers claiming to work for the Service or a state tax authority. Scammers make these unsolicited calls or leave voicemails claiming to be government officials and request your immediate action to prevent further penalty. The scammer can sometimes even “spoof” their call ID so that the call looks like it is coming from a legitimate source. The scammer will also usually use false titles or identification numbers. During these calls, the scammer aggressively orders you to make an immediate payment on an alleged tax liability and will request that you pay by a money wire transfer, prepaid debit card, or even gift card. Do not be surprised if scammers even threaten to have local authorities come and arrest you if you do not make an immediate payment. These types of scams have cost over 14,700 victims more than $72 million since 2013.

You should know that the Service or a state tax authority will never do the following: call and demand an immediate payment using a specific payment method (you will usually receive a bill or notice in the mail first); threaten to have local authorities arrest you if you do not immediately pay the tax; demand a tax payment without giving you an opportunity to question or appeal the amount owed; or ask for your debit or credit card number over the phone. If you receive an unsolicited phone call, you should hang up and then contact the purported agency on your own to determine whether the liability exists.

Scam 4: Always Be on The Lookout for Identity Theft

Identity thieves are constantly developing new methods to steal your personal information. While certain scammers send sophisticated emails or impersonate others over the phone, identity thieves often do nothing more than wait for you to make a mistake regarding your own personal information. Identity thieves look for instances where you leave unprotected access to your Social Security number, bank account information, or usernames and passwords out in the open. Identity thieves will go to great means looking for your information, ranging from digging through trash cans to find confidential documents to finding sophisticated ways to access your personal computers and networks.

It is important that you properly dispose of unneeded financial documents, debit and credit cards, unused checks, and other personal documents. You should always use a personal shredding machine or attend an annual “shred it day” event. You should also be careful where you keep your important information such as Social Security cards, prior tax returns, and other similar documents. These documents contain enough information to allow an identity thief to make a quick run on your bank accounts.

The Service recommends that taxpayers and businesses use security software with firewall and antivirus protection software. Computers containing files with sensitive information should always be password protected. Be sure to use encrypted files or a secured share cite any time that you need to send sensitive information over the internet.

Scam 5: Do Not Donate to Fake Charities

Sometimes it is easiest for scammers to take advantage of your willingness to help others. Scammers do this by creating fake charities that they then use to steal your money and other personal information. These fake charities often use names that are similar or are familiar to well-known organizations. A rise in charity scams typically occur at year-end when taxpayers are more willing to help others during the holiday season while also receiving the benefit of a last-minute tax deduction. The Service warns that you should also be weary of these scams after a significant natural disaster or other devastating event.

The Service recommends using the Tax Exempt Organization Search on its website to confirm whether a particular charity is valid and tax-deductible. There are also reputable private directories, such as GuideStar, that allow you to search for a specific charity to gauge its legitimacy. Keep in mind that a legitimate charity will always provide you with their Employer Identification Number, which you can also use to verify the charity. You should never give personal financial information to anyone who solicits a charitable contribution. For security and tax record purposes, the Service recommends making contributions via check, credit card, or other methods that provide documentation of the donation, rather than giving cash donations.

Contact Nardone Limited

If you are considering creating a micro-captive or if you receive an unsolicited request for personal information related to a tax issue, you should contact the appropriate professionals before taking any further action. The tax professionals at Nardone Limited are willing and able to help you determine the legitimacy of any tax planning decisions and tax communications. We can work with you to ensure that you keep clean of the Dirty Dozen. Contact Nardone Limited today.

May 28, 2019

Disclosing Foreign Financial Accounts: Updates and Filing Requirements

Foreign-Bank-and-Financial-Accounts-FBAR

Nardone Limited’s tax attorneys advise taxpayers about U.S. tax reporting requirements and obligations regarding foreign and domestic financial accounts and the importance of reporting previously undisclosed accounts or income. For example, if a taxpayer has a financial interest in, or signature authority over, a foreign financial account, the taxpayer may be required to report the account to the Internal Revenue Service (“IRS”). Those who fail to meet the IRS’ requirements could face criminal or civil penalties.  Fortunately, the IRS offers certain programs to those who have failed to disclose their foreign financial accounts that allows the taxpayer to voluntarily disclose offshore accounts and resolve any tax and penalty obligations.

Report of Foreign Bank and
Financial Accounts Filing Deadline   

Every year, United States citizens and resident aliens, including those with dual citizenship, who have certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds, must report those assets to the Treasury Department by electronically filing a FinCen Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”). On April 4, 2019, the IRS published a news release reminding taxpayers of the requirements for disclosing foreign financial accounts. The deadline for filing the FBAR is the same as the deadline for filing a federal income tax return. Thus, the 2018 FBAR should have been filed electronically by April 15, 2019. But, the Financial Crimes Enforcement Network (“FinCEN”) grants those taxpayers who have missed the April 15th deadline, an automatic extension until October 15, 2019. The FBAR form is only available through the BSA E-Filing System website.

Generally, the requirement to file the FBAR applies to anyone who had an interest in, or signature or other authority, over a foreign financial account whose aggregate value exceeded $10,000 at any time during 2018. In its news release, the IRS encouraged taxpayers to check if the filing requirements apply to them, since the threshold amount is relatively small. If you have missed the automatic extension date, the IRS allows taxpayers to file a delinquent FBAR, as long as the taxpayer is not under civil examination or criminal investigation by the IRS, and the taxpayer has not already been contacted by the IRS.  But, for those taxpayers who have undisclosed foreign assets which span several years, the IRS offers two programs that allow taxpayers to become compliant and avoid significant civil or criminal penalties.

Streamlined Filing Compliance Procedures

The Streamlined Filing Compliance Procedures (“SFCP”) were first offered in 2012 as a way to provide taxpayers with a streamlined procedure for filing amended or delinquent returns, however, since 2012 the IRS has expanded and modified the program to accommodate more taxpayers. But, the SFCP is only available to individual taxpayers, and estates of individual taxpayers, who certify that their failure to report foreign financial assets and pay all tax due on those assets, was not due to willful conduct. This applies to taxpayers applying for the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is a result of a good faith misunderstanding of the requirements of law. As mentioned above, if the IRS has already initiated a civil or criminal examination of the taxpayer’s returns, regardless if the examination relates to the undisclosed foreign account, the taxpayer is not eligible to use the SFCP. If a taxpayer is unsure whether their conduct was due to willful or non-willful behavior, it may be wise for the taxpayer to participate in the Updated Voluntary Disclosure Practice (“UVDP”) to avoid criminal liability or significant monetary penalties.

Nardone Limited Comment: If you are unsure whether your non-compliance is due to willful or non-willful behavior, it is important that you contact an attorney who is experienced in communicating with the IRS. For more information on the SFCP, or what the government considers to be willful behavior, see our previous blog article.

The Updated Voluntary Disclosure Practice

After the IRS ended the Offshore Voluntary Disclosure Program (“OVDP”) in September of 2018, it established the UVDP. Unlike the SFCP, the UVDP was created for taxpayers with exposure to potential criminal liability and substantial civil penalties—due to a willful failure—a way to come into compliance with the law. The UVDP applies to both domestic and offshore matters disclosed after September 28, 2018. While the UVDP does not guarantee that the taxpayer will be free from criminal prosecution, a voluntary disclosure may result in the IRS not recommending criminal prosecution. Under the new program, willful penalties will be the greater of $100,000 or 50% of the amount in the account at the time of the violation, and for cases involving willful violation over multiple years, examiners may recommend a penalty for each year the FBAR violation was willful.

Under the UVDP, a disclosure is considered voluntary when the taxpayer shows a willingness to cooperate. When speaking with the IRS about the taxpayer’s non-compliance, it is imperative that the taxpayer answer truthfully, timely, and completely. The taxpayer must show a willingness to cooperate, or the IRS will not consider the disclosure to be voluntary. As part of that cooperation, the IRS expects that voluntary disclosures be resolved by agreement with full payment of all taxes, interest, and penalties for the disclosure period. I.R.M. 9.5.11.9.4. If a taxpayer fails to cooperate, the examiner may request that Criminal Investigation (“CI”) revoke the preliminary acceptance. Thus, it is important that taxpayers ensure that they are timely replying to the IRS and that they are making arrangements, in advance, to pay off their delinquent taxes.   

Nardone Limited Comment: If you would like more information on UVDP, see our previous blog article.

Conclusion

We strongly encourage our clients to be compliant with any and all U.S. reporting requirements relating to their foreign or domestic financial accounts, even if they have not done so in the past. The IRS offers options to non-compliant taxpayers when it comes to disclosing unreported financial accounts or income. But, taxpayers must be diligent when it comes to communicating with the IRS. That is why it is important to seek help from an attorney who has vast experience representing taxpayers before the IRS. Ultimately, if you have undisclosed foreign financial accounts, or would simply like more information regarding your filing obligation, contact us today.

April 23, 2019

IRS Provides Update on Voluntary Disclosure Process

IRS

Nardone Limited’s tax attorneys advise taxpayers about U.S. tax reporting requirements and obligations regarding foreign and domestic financial accounts and the importance of reporting previously undisclosed accounts or income. For example, if a taxpayer has a financial interest in, or signature authority over, a foreign financial account, the taxpayer may be required to report the account annually by electronically filing a FinCen Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”). If a taxpayer fails to follow the Internal Revenue Service (“IRS”) reporting requirements, such as filing the FBAR, and the failure is due to willful behavior, the taxpayer could face potential criminal liability or substantial civil penalties. The IRS, however, has historically offered taxpayers a way to potentially avoid criminal liability by voluntarily disclosing the taxpayer’s willful non-compliance.

Background

On March 26, 2009, the IRS announced its first Offshore Voluntary Disclosure Program (“OVDP”), which offered taxpayers who had undisclosed foreign accounts a pathway to compliance with U.S. tax law. The OVDP was originally created for taxpayers with exposure to potential criminal liability and substantial civil penalties due to a willful failure to report foreign financial assets and to pay the tax due on those assets. The first OVDP ran through October 15, 2009. The IRS then announced a second OVDP, which ran through September 9, 2011. On January 9, 2012, the IRS reopened the OVDP, which remained in effect until September 28, 2018. While the OVDP is no longer in effect, the IRS established a new voluntary disclosure procedure, which may provide non-compliant taxpayers relief from criminal liability.  

Nardone Limited Comment: It should be noted that the Streamlined Filing Compliance Procedures (“SFCP”) are still available for taxpayers whose behavior is not due to willful non-compliance. If you are unsure whether your non-compliance is due to willful or non-willful behavior, it is important that you contact an attorney who is experienced in communicating with the IRS. For more information on the SFCP, or what the government considers to be willful behavior, see our previous blog article.

The Updated Voluntary Disclosure Practice

On November 20, 2018 the IRS released a memorandum to taxpayers, detailing the new process for voluntarily disclosing violations due to willful behavior. The new program titled the “Updated Voluntary Disclosure Practice” (“UVDP”), applies to both domestic and offshore matters, whereas the OVDP only applied to undisclosed offshore accounts. The purpose of the UVDP is to provide taxpayers—who are concerned that their conduct is willful or fraudulent—a way to come into compliance with the law and avoid potential criminal prosecution. The IRS set out the following procedures regarding the UVDP.

The IRS has indicated that Criminal Investigation (“CI”) will screen all voluntary disclosure requests to determine whether the taxpayer is eligible to make a voluntary disclosure. To be eligible to make a voluntary disclosure, taxpayers are required to submit a preclearance request on Form 14457. The form must be submitted to CI via fax or mail. If CI accepts the taxpayer’s preclearance, the taxpayer must promptly submit to CI all required voluntary disclosure documents using Form 14457. This form requires the taxpayer to submit information related to the taxpayer’s non-compliance. If CI accepts the taxpayer’s voluntary disclosure, it will send a preliminary acceptance letter to the taxpayer. CI will then send the letter and attachments to the IRS’ Large Business & International (“LB&I”) division in Austin, Texas for case preparation before examination. Once received by LB&I, the IRS will not require the taxpayer to submit any additional information or documentation to the Austin unit. The LB&I Austin unit then forwards cases for case building and field assignment to the appropriate Business Operating Division and Exam function for civil examination. Examiners within LB&I will develop the case, use appropriate information gathering tools, and determine the taxpayer’s liability and applicable penalties.

When speaking with the IRS about the taxpayer’s non-compliance, it is imperative that the taxpayer answer truthfully, timely, and completely. The taxpayer must show a willingness to cooperate, or the IRS will not consider the disclosure to be voluntary. As part of that cooperation, the IRS expects that voluntary disclosures be resolved by agreement with full payment of all taxes, interest, and penalties for the disclosure period. I.R.M. 9.5.11.9.4. If a taxpayer fails to cooperate, the examiner may request that CI revoke the preliminary acceptance. Thus, it is important that taxpayers ensure that they are timely replying to the IRS and that they are making arrangements, in advance, to pay off their delinquent taxes.   

Conclusion

We strongly encourage our clients to be compliant with any and all U.S. reporting requirements relating to their foreign or domestic financial accounts, even if they have not done so in the past. The IRS offers options to non-compliant taxpayers when it comes to disclosing unreported financial accounts or income. But, taxpayers must be diligent when it comes to communicating with the IRS. That is why it is important to seek help from an attorney who has vast experience representing taxpayers before the IRS. Ultimately, if you are concerned that your failure to report income or pay tax is due to willful conduct, we encourage you to contact Nardone Limited at 614-223-0123 to discuss your options.  

April 03, 2019

IRS Concludes Free Employee Meals are Not Excludable under IRC Section 119

Employee_food

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists businesses with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article will discuss the recently published Technical Advice Memorandum (“TAM”) which analyzes whether free meals provided by an employer to its employees is excludable under IRC 119.

IRC Section 119 and the Convenience of the Employer Test

On January 18, 2019, the IRS released a TAM informing business owners that free meals to employees under IRC Section 119 are not excludable under the “convenience of the employer” test if the employer cannot show a substantial non-compensatory business reason for the free meal. TAM 2019030171. Generally, an employee’s gross income includes certain fringe benefits such as gym memberships and prizes. But, under IRC Section 119(a), meals and lodging furnished to an employee by or on behalf of their employer for the convenience of the employer is excluded from the employees income if (i) the meals are furnished on the business premises, or (ii) in the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment. Whether meals are furnished for the convenience of the employer is a question of fact to be determined based on the facts and circumstances of each case. Further, free meals provided by an employer to its employees are considered furnished for the convenience of the employer if such meals are furnished for a “substantial non-compensatory business reason.” The regulations have identified the following substantial non-compensatory business reasons: (i) the employer’s business requires that the employee be restricted to a short meal period during which the employee could not be expected to eat elsewhere; (ii) the employee must be available for emergency calls during the meal period; or (iii) the employee could not otherwise secure proper meals within a reasonable meal period. Additionally, free snacks provided to employers are excludable as de minimis fringes.

Analyzing the Facts

In the case presented before the IRS, the employer provided meals, without charge, to all employees, contractors, and visitors. In one area, meals were eaten at seating in or near the snack areas, or at the employee’s desks. The employer also had a cafeteria where meals were consumed. In addition to meals, the employer provided unlimited snacks and drinks. The reasons the employer had for providing these free meals were: (i) to foster collaboration and innovation; (ii) to protect the employer’s confidential and proprietary information; (iii) to protect the employees due to unsafe conditions surrounding the business premises; (iv) to provide healthy eating options for employees to improve employee health; (v) because the employees cannot secure a meal within a reasonable meal period; (vi) because demands of the employees job functions allow them to only take a short break; and (vii) to provide meal so that employees are available to handle emergencies that regularly occur.

In analyzing the facts of the case, the TAM stated that it did not doubt the legitimacy of the of the employer’s reasons listed above, but the fact that these reasons are legitimate does not quality them as substantial non-compensatory business reasons. In particular, several items were for the benefit of the employee and not the employer. Further, the TAM noted that these goals did not have specific policies to implement them. According to the TAM, policies are necessary to connect a business goal to the business necessity for furnishing meals to employees in order to achieve that goal. But, it is not enough for a policy to exist, the employer must actually enforce the policy and demonstrate how the policy relates to the furnishing of meals to employees. Finally, the TAM concluded that the value of snacks provided by employers to it employees is excludable from gross income as a de minimis fringe benefit, because the value of the portions consumed by each employee are hard to quantify and given the low value of each snack portion it would be administratively impracticable.

The TAM, however, does not address situations where the employer provides occasional meals to employees, such as food provided at company parties, or pizza lunches. Fortunately, the IRS has covered these situations in IRS Publication 15-B (the “Publication”). According to the Publication, you can generally exclude from the employee’s wages, the value of de minimis meals employers provide to employees. Further, per the Publication, meals furnished to employees for recreational or social activities, are 100% deductible, provided they are primarily for the entire company and not weighted towards top owners or highly compensated employees.

Contact Nardone Limited

If your business provides free meals to employees, you should consider how the TAM may affect you and your employees. Ensuring that you have policies that address the reason for the free meals and that you are prepared to demonstrate how the policy relates to the free meals are things your business should be considering. If you or your business need help navigating the tax laws regarding employee benefits or need help creating employment policies, it is important that you seek guidance from a legal professional experienced in tax matters.

Nardone Limited represents employers with federal tax issues and provides guidance regarding changes and shifts to tax laws. If you are unsure how the TAM will affect you or your business, you should contact an experienced tax attorney. Nardone Limited’s tax attorneys and professionals are experienced in representing businesses regarding federal tax issues.

 


1You can find the full TAM here.

March 25, 2019

Real or Personal Property? It Makes a Tax Difference

Dissolution_business2

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation (the “Department”). As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the Department.

Introduction

Taxpayers and businesses with business real estate often hire contractors to construct and fabricate buildings and other structures on their property to use for business operations. Sometimes a business constructs an entire building to contain and protect their business operations. Other times a business constructs smaller projects described as improvements to already existing property or projects that allow the business to expand into a new business venture.

To the unsuspecting business owner, these projects result in property that the business owner, and many others, would categorize as real property. But, according to the Department’s assessments and Ohio case law, this is not always the case.

Each year the Department assesses Ohio business owners use tax on projects like those described above. This is because the Department classifies the resulting property from a project as tangible personal property, rather than real property. This distinction might not seem important at first, but this classification can present serious sales and use tax implications for the taxpayer.

Ohio Sales and Use Tax Generally

Sales tax is levied on all sales transactions unless otherwise excluded. A sale includes any transaction by which title or possession in an item of tangible personal property is transferred. A sale also includes a transaction where an item of tangible personal property is installed, unless the transaction is otherwise excluded for sales tax purposes. A sale does not include a transaction established under a construction contract to construct or fabricate real property.

Use tax is levied on the consumption of tangible personal property or the benefit realized in the state on any service provided. An exception exists for the acquisition of tangible personal property that is already subject to sales tax, in which case use tax is not assessed. Generally, for construction projects, it is assumed that the builder pays any necessary sales tax upon purchasing the construction materials. However, use tax would be assessed on the value of any materials used that were not assessed sales tax when purchased.

Order of Analysis

So, how is a taxpayer supposed to determine whether a project should be taxed as real or personal property? Ohio law provides three distinct categories for property: real property; personal property; and business fixtures.

Through case law, the Ohio Supreme Court provides the following guidelines to determine whether property is real property, personal property, or a business fixture under Ohio Revised Code sections 5701.02 and 5701.03:

  1. Determine whether the property is defined as real property under § 5701.02;
  2. If the property does not meet the definition of real property under § 5701.02, then the property is personal property;
  3. If the property is defined as real property under § 5701.02, then the property is real property unless defined as a business fixture under § 5701.03;
  4. If the property is defined as a business fixture under § 5701.03, then the property is personal property.

Real property includes the land and all buildings, structures, improvements, and fixtures of whatever kind on the land. Ohio law defines buildings, structures, improvements, and fixtures as follows:

  1. A building is any fabrication or construction consisting of foundations, walls, columns, girders, beams, floors, and a roof that is intended as a habitation or shelter for people, animals, or tangible personal property.
  2. Fixtures are any items of tangible personal property that are permanently attached or affixed to the land or to a building, structure, or improvement for the primary benefit of the real property, rather than a business conducted on the property.
  3. Improvements are any permanent additions, enlargements, or alterations to a building or structure that would be considered part of the building or structure had they been completed during the initial construction process.
  4. Structures are permanent fabrications or constructions, other than a building, that are attached or affixed to the land and increases or enhances the utilization or enjoyment of the land.

At the end of the day, real property is distinguished from other types of property in that fact that the primary intent of real property is to benefit the realty and the taxpayer’s use of the land.

Personal Property and Business Fixtures under § 5701.03

Personal property includes every tangible item that is the subject of ownership, including business fixtures, but does not constitute real property. This definition acts as a catchall category of property.

A business fixture, as referenced above, is an item of tangible personal property that is permanently attached or fixed to the land, building, structure, or improvement for the primary benefit of a business conducted on the premises. Unlike real property, the primary intent of real property is to benefit a business. A business fixture also includes any portion of the building, structure, or improvement that is specially designed, constructed, and used for a business conducted in the building, structure, or improvement.

Even with these statutory definitions, many taxpayers are left to determine whether a project is a structure, which is real property, or a business fixture, which is tangible personal property.

Structures or Business Fixtures

At the core of any determination is whether the project increases or enhances the utilization or enjoyment of the land, or whether the project primarily benefits a business conducted on the premises. The Ohio General Assembly and Ohio Supreme Court state that the decisive test is whether the property at issue is devoted primarily to the business conducted on the premises, or whether the property is devoted primarily to the use of the land upon which the business is conducted.

The Department makes these determinations on a case by case basis depending on the facts and circumstances surrounding the project.

Conclusion

Whether you received a similar assessment from the Department or are considering a similar project at your place of business, it is important to work with a qualified tax professional to review the tax implications of the project. The tax and business attorneys at Nardone Limited are experienced in Ohio tax law and have the necessary abilities to scrutinize your project to determine the appropriate classification. If you believe the Department wrongfully assessed use tax on your project, our firm can help you appeal the assessment.  Contact us today for a consultation.

 

 

 

 

February 22, 2019

Section 199A: The New Small Business Tax Break—Part III

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As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article is the third in a series of articles exploring what some tax professionals describe as the best small business tax break of the last half-century—the Section 199A Qualified Business Income Deduction (the “Deduction”).

Brief Reintroduction

Our last article on Section 199A introduced the concept of a specified service trade or business (“SSTB”), which we said is not a qualified trade or business (“QTOB”) for Section 199A purposes. At first pass, the statutory language suggests that SSTB-classification disqualifies a trade or business from the Deduction; however, there is an exception (the “Exception”).i Before we discuss the Exception, we should revisit the definition of an SSTB.

SSTB Defined

For purposes of Section 199A, an SSTB is any trade or business that involves the performance of services in one of the following fields: health; law; accounting; actuarial science; performing arts; consulting; athletics; financial services; brokerage services; investing and investing management; trading; dealing; or a business where the principal asset is the reputation or skill of one or more of its owners or employees.ii Although the Code is broad, the Regulations provide more specific examples of jobs within these fields that do, and do not, fall in SSTB purview.

Calculating the Deduction for an SSTB

The Deduction for qualified business income (“QBI”) from an SSTB is subject to a “phase-out” (the “Phase-out”) once a taxpayer’s taxable income exceeds $157,500 for single filers and $315,000 for joint filers (the “Threshold”).iii

Similar to a QTOB, a taxpayer with QBI from an SSTB enjoys a full 20 percent deduction is their taxable income is less than or equal to the Threshold. But, unlike a QTOB, the Deduction for an SSTB is eliminated once a taxpayer’s taxable income exceeds $207,500 for single filers and $415,000 for joint filers.  The gray area between $157,500 to $207,500 and $315,000 to $415,000 for single and joint filers, respectively, is where the Phase-out occurs.

Calculating the Phase-out

Mechanically speaking, the Phase-out is better described as a “phasing-in” of the “wage/investment” limitation for a QTOB (the “Limitation”) described in our previous article. If you recall, the Limitation is a function of QBI, W-2 wages, and the unadjusted basis in qualified property associated with a trade or business. For an SSTB, these three variables are “phased-out” of the Deduction calculation as a percentage (described in the next paragraph) of their actual values used in the QTOB calculation. Meaning, the QBI, W-2 wages, and unadjusted basis in qualified property values used in the SSTB calculation are less than those used in the QTOB calculation. This difference in value results in a difference in the Deduction between QTOBs and SSTBs.

The percentage described above is equal to 100 percent minus a percentage calculated by the difference between taxable income and the Threshold, divided by either $50,000 for single filers or $100,000 for joint filers (the “Phase-Out Percentage”). The Phase-Out Percentage cannot be less than zero, which results in the complete phase-out of the Deduction once taxable income hits $207,500or single filers and $415,000 for joint filers. The Phase-Out Percentage is then multiplied against the QBI, W-2 wages, and qualified property amounts associated with the SSTB, reducing their values.

Finishing the Deduction Calculation

Once the Phase-On Percentage is applied, the Deduction calculation for an SSTB is lockstep with that of a QTOB. But, because the SSTB calculation QBI, W-2 wages, and qualified property values are a percentage of those used for the QTOB calculation, the SSTB Deduction is smaller. The following are the final steps for the Deduction calculation; however, they are no different than those described in the previous article.

When taxable income exceeds the Threshold, the Limitation is the lesser of: (i) 20 percent of QBI from an SSTB, or (ii) the greater of: (a) 50 percent of W-2 wages from an SSTB, or (b) 25 percent of W-2 wages from an SSTB, plus 2.5 percent of the unadjusted basis in qualified property associated with an SSTB. 

The percentage of phase-in is the difference between a taxpayer’s taxable income and the Threshold, over either $50,000 for single filers or $100,000 for joint filers (the “Phase-In Percentage”). The Phase-In Percentage is used to determine the reduction amount used against the 20 percent of QBI deduction starting point.

The Phase-In Percentage is multiplied against the difference between: (i) 20 percent of QBI and (ii) the Limitation. This figure represents the phase-in of the Limitation, or the amount by which the 20 percent of QBI starting point is reduced to determine the Deduction amount.

Businesses Related to an SSTB

Many taxpayers with SSTB enterprises operate under an organizational structure that keeps their operational entity separate from their real estate entity and sometimes even a management entity. For example, it is not uncommon that an accountant, attorney, dentist, or doctor will conduct their business using two entities. The first entity contains the primary operations of the firm or practice. And, the second entity contains the real property in which the first entity operates.

Under the Section 199A Regulations, when a trade or business provides property or services to an SSTB, and there is a 50 percent or more common ownershipiv between the two trades or businesses, the portion of the trade or business providing property or service to the SSTB is treated as an SSTB.v Thus, the Deduction for either entity is subject to the SSTB Phase-Out limitations even though the entity providing the property or services is otherwise considered a QTOB.

Example: Doctor, a dentist, operates his dental practice using three different entities: Clinic LLC, which holds the clinical operations of the practice; Real Estate LLC, which holds the office building used by the practice; and Management LLC, which holds the non-clinical operations of the practice.  Doctor is the 100 percent owner of all three entities. 

On their own, the activities of Real Estate LLC and Management LLC qualify them as QTOBs, which would subject them to the lesser restrictive Deduction limitations for QTOBs. Clinic LLC is an SSTB because it holds the operations of a trade or business in the health field, which would subject it to the more restrictive Deduction limitations for SSTBs. However, because Real Estate LLC and Management LLC provide property or services to Clinic LLC, with which they share over 50 percent common ownership, all three entities are considered SSTBs.

Therefore, Doctor is unable to take the Deduction for any QBI generated by the three entities once Doctor’s taxable income exceeds $207,500 (if filing single) or $415,000 (if filing joint). Doctor would remain eligible for the Deduction if Doctor’s taxable income falls below these thresholds.

Conclusion

There is a common theme across these first three Section 199A articles—the Deduction is complex.  We now see that the Deduction, in the case of an SSTB, requires an additional level of calculations.  There is also additional analysis required to determine if or when the trade or businesses ancillary to a taxpayer’s SSTB are required to be included as an SSTB even though they would otherwise qualify as a QTOB.  Therefore, it is important that taxpayers work with experienced tax law professionals who understand Section 199A from a legal perspective.  The tax and business attorneys at Nardone Limited have this understanding and are prepared to discuss your Section 199A planning today.

 


i I.R.C. § 199A(d)(3).

ii Reg. § 1.199A-5(b)(1).

iii I.R.C. § 199A(d)(3)(A).

iv Common ownership means a direct or indirect ownership by related parties within the meaning of Sections 267(b) or 707(b). Reg. § 1.199A-5(c)(2)(ii).

v Reg. § 1.199A-5(c)(2)(i).

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