Charitable Remainer Annuity Trust – High Value, Low Basis Property for Income Stream

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Philip Falco
Charitable Remainer Annuity Trust – High Value, Low Basis Property for Income Stream

So you are getting older and have been successful in life. Now you own property, perhaps real estate, that has substantially increased in value but has a low adjusted basis. If you were to liquidate that property you would incur a large tax liability.

You want to tap into that value by way of income stream. One solution is to contribute that property to a Charitable Remainer Annuity Trust (CRAT), the CRAT then sells the property tax free and purchases an annuity. But is the receipt of the annuity income tax free (perhaps a single premium immediate annuity SPIA)? That would be too good to be true, unfortunately per Internal Revenue Code 664. Here’s how that breaks down.

What is a Charitable Remainder Annuity Trust – CRAT?

The basic concept of a CRAT involves a grantor’s transfer of property to an irrevocable trust, the terms of which provide for the payment of a specified amount, at least annually, to the grantor or other designated noncharitable beneficiaries for life or another predetermined period of time up to twenty years. I.R.C. § 664(d). What remains in the trust after the expiration of that period (which cannot be less than 10 percent of the initial net fair market value of all property placed in the trust, I.R.C. § 664(d)(1)(D)) must be transferred to one or more qualified charitable organizations or continue to be held in the trust for the benefit of such organizations. In short, unlike an immediate gift to charity, a contribution to
a CRAT blends the philanthropic intentions of a donor with his or her financial needs or the financial needs of others.

As a rule, the grantor recognizes no gain when transferring appreciated property to a CRAT. Moreover,
because CRATs are exempt from income tax, a CRAT can sell appreciated property without itself paying tax on the sale. See I.R.C. § 664(c)(1); Treas. Reg. § 1.664-1(a)(1)(i).

But that does not mean that the grantor or other noncharitable CRAT beneficiaries do not have to pay tax with respect to distributions from the CRAT. “Although a [CRAT] is itself exempt from income tax
and, therefore, pays no tax on any of its taxable income, the annuity . . . payments made to the noncharitable beneficiaries carry out taxable income that is subject to tax at the beneficiary level.” Alpha I, L.P. v. United States, 682 F.3d 1009, 1015 (Fed. Cir. 2012) (stating the rule and citing section 664(b) and (c)(1)). This is so because when property is transferred to a CRAT, the basis of the property in the CRAT’s hands generally is the same as it would be in the hands of the grantor. See I.R.C. § 1015(a) and (b); Treas. Reg. §§ 1.1015-1(a)(1), 1.1015-2(a)(1).

And when the CRAT sells the property, it realizes gain to the extent the amount realized from the sale exceeds its adjusted basis. I.R.C. § 1001; see also Treas. Reg. § 1.664-1(d)(1)(i) (discussing the assignment of income to categories at the CRAT level). Although not taxable to the CRAT, that gain must be tracked and affects the treatment of distributions from the CRAT.30 See, e.g., Treas. Reg. § 1.664-1(d)(1)(viii)
(providing examples illustrating the rules).

Congress has established specific ordering rules that govern the characterization and reporting of annuity amounts distributed by a CRAT to its income beneficiaries. See I.R.C. § 664(b). Under this regime, distributions from a CRAT to income beneficiaries are deemed to have the following character and to be distributed in the following order:
(1) as ordinary income, to the extent of the CRAT’s current and previously undistributed ordinary income;
(2) as capital gain, to the extent of the CRAT’s current and previously undistributed capital gain;
(3) as other income, to the extent of the CRAT’s current and previously undistributed other income; and
(4) as a nontaxable distribution of trust corpus.

CRATs are subject to strict reporting requirements to ensure compliance with the statutory ordering rules. See I.R.C. § 4947(a); Treas. Reg. § 1.664-1(a)(1)(ii). A CRAT must file an annual information return on Form 5227 reflecting its income, deductions, accumulations, and distributions for the year. See I.R.C. § 6011(a); Treas. Reg. § 53.6011-1(d). And it must issue to each income beneficiary a Schedule K–1 properly describing the tax character of all distributions. See I.R.C. § 6034A(a); Treas. Reg. § 1.6034-1(a).

For example, what CRAT earned was ordinary income because the properties the CRATs sold were subject to the rules of section 1245—hence, distributions to grantor would be ordinary income.

Gotcha: IRS Tax Return Proposed Changes CP2000 – Omitted 1099

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Philip Falco
Gotcha: IRS Tax Return Proposed Changes CP2000 – Omitted 1099

We have handled the following situation many times so I figured I would write a post about it. This is very common.

The bad news. Taxpayer receives CP2000 from the IRS, which is IRS’s proposed changes to the 1040 tax return. IRS has a before (shown on return) and after column (as corrected by the IRS). Typically taxpayer has forgotten to include a 1099, such as a 1099-S from the sale of a home, or perhaps a 1099-MISC as to schedule C income.

Taxpayer is scratching his/her head thinking well no tax is owed since the gain from the sale of my home was less than the principal residence tax exclusion of $250,000 or $500,000 for married couples. True but the IRS wants to see the steps.

Also, you might think that the 1099-MISC income was included in schedule C gross income. True but the IRS wants to see the 1099 tied to gros income and reported with the return. In truth, IRS proposed change would double include that 1099 income since it was already included on your schedule C, but the IRS does not know that.

The IRS does not give taxpayers the benefit of the doubt. Taxpayers must apply appropriate tax rules in their return. The IRS assumes worst case scenario when proposing changes, which must then be disproved by the taxpayer. Give us a call to handle this for you.

If you go at it alone, you would have to correct the return and provide the correct documentation to the IRS. If the IRS accepts your corrections, the assessment will be adjusted correctly and you win, or at least set the record straight.

Tax Debt Collection: Statute of Limitations Tolling

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Philip Falco
Tax Debt Collection: Statute of Limitations Tolling

The IRS has a limited amount of time to collect your tax debt. This blog post discusses some of the your actions or reasons why that time period could be extended (tolled). To put it in simple terms, tolling is bad or hurts the taxpayer.

The IRS through the United States Department of Justice can file an action in the United States District Court pursuant to 26 U.S.C. 7401 to reduce your tax debt to judgment on the very last day of the expiration of the statute of limitations. If the action is timely, the statute of limitations is no longer relevant since (assuming a judgment is entered) the tax debt is reduced to judgment. As such, exact calculation of the statute of limitations is critical. Here are some matters that could have extended your period.

Absent events that toll the statute of limitations, 26 U.S.C. § 6502(a) provides a general ten-year collection statute of limitations starting on the date a tax is assessed. The collection statute of limitations is tolled under 26 U.S.C. § 6330(e) anytime there is pending a collection due process hearing under 26 U.S.C. § 6330(a)(3)(B). A taxpayer is entitled to request such a hearing before the IRS levies. See 26 U.S.C. § 6330(e).

The collection statute of limitations is further tolled under 26 U.S.C. § 6330(e) for 90 days after the day on which there is a final determination of a collection due process hearing under 26 U.S.C. § 6330(a)(3)(B).

The collection statute of limitations is also tolled when an offer to enter into an installment agreement is pending between the taxpayer and the IRS. See 26 U.S.C. §§ 6502(a)(2), 6331(i), (k). The collection statute of limitations is tolled for thirty days following the rejection or termination of an installment agreement. See 26 U.S.C. § 6331(i), (k).

So if your installment is pending for a year and then terminated, the statute of limitations would be tolled for a year plus thirty days.

The statute of limitations tolling begins on the day you th taxpayer request an installment agreement even though it could take months for the IRS to accept or reject that request. For example, assume the IRS receives your request on July 20, 2015, to enter into an installment agreement for tax years 2011 and 2012. That request was pending until December 16, 2015 when the IRS granted the installment agreement request for tax years 2011 and 2012. Accordingly, the pending installment agreement request tolled the collection statute of limitations for tax years 2011 and 2012 for at least 149 days (July 20, 2015 to December 16, 2015).

There is some debate over the 90 day period. Under 26 U.S.C. § 6330(e), the statute of limitation period shall not expire “before the 90th day after the day on which there is a final determination in such hearing.” The collection statute of limitations is not further tolled for 90 days but if the final determination is less than 90 days from the date the period expires, then the statute of limitation period is from the 90th day after the date of final determination. See also Reg. § 301.6330-1(g)(3).

related content:

Unpaid taxes – Offers in Compromise

Tax Liens, Tax Levies, Collection Due Process Hearings

If you would like an analysis of your collection period statute of limitations, please contact me (303) 626-7000 phil@coloradolegal.com.

New Entity EIN and Tax Classification

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Philip Falco
New Entity EIN and Tax Classification

This is one of the most important steps that could impact the entire future of your new business. Take your time before applying for an EIN with the Internal Revenue Service. Severe adverse tax consequences could impact the future of your entity.

Name selection. If you choose a name with Corp, or Inc, the default entity will likely be a C Corporation. Taxpayers almost always do not intend on being C Corporations.

If you choose LLC (limited liability company) and you are a sole owner it will most likely default to schedule C on your 1040.

In addition, if you answer questions indicating that you will have payroll, and you very well could, it will trigger the filing of payroll forms typically 940 and 941 with automatic filing dates required, which in turn trigger Colorado state withholding filings, Colorado Department of Labor and Employment, and possibly the Denver Head Tax. In additional, it could trigger worker’s compensation insurance.

Save the letter you get from the IRS CP 575 A for the life of your business.

Tax Tips:

  • Avoid Corp or Inc unless you know exactly what you are doing
  • Be prepared to set up State and local payroll accounts if you have employees
  • Most LLC’s will be on schedule C of your 1040, or form 1065 if you have more than just you as a partner

S Corp Requirements (disproportionate distributions)

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Philip Falco
S Corp Requirements (disproportionate distributions)

S Corporations can only have one class of stock. An argument can be unsuccessfully made that uneven de facto distributions to shareholders would be more than one class of stock. However, so long as the corporate documents call for even distributions all is ok even if uneven distibutions subsequently occur.

The gegal basis for this is found in the regulations: the regulation tells the IRS to focus on shareholder rights under a corporation’s governing documents, not what shareholders actually do. The regulation states that uneven distributions don’t mean that the corporation has more than one class of stock. Treas. Reg. § 1.1361-1(l)(2) (“[A] corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights . . . .”).

Taking a step back, the first rule is that shareholders have to choose to be taxed as an S corporation. Shareholders do so by filling out a Form 2553, Election by a Small Business Corporation, that they file with the IRS. See Treas. Reg. § 1.1362-6(a)(2)(i). Once the IRS approves, the election remains effective indefinitely. § 1362(c); see Mourad v. Commissioner, 121 T.C. 1, 4 (2003), aff’d, 387 F.3d 27 (1st Cir. 2004).

A great many small and medium-sized businesses elect S corporation status because the Code affords them special treatment—income earned by the corporation escapes corporate-level taxation. Mourad, 121 T.C. at 3; see §§ 1363, 1366. That income is instead “passed through” to its shareholders pro rata. See §§ 1363, 1366. But electing to be an S corporation is not enough. The Code has several other requirements. These include having no more than 100 shareholders, having only shareholders who are individuals—or certain trusts or nonprofits—and not having any nonresident alien shareholders. § 1361(b)(1). The parties don’t dispute that Schricker met these requirements.

There’s one other requirement. Section 1361(b)(1)(D) allows a corporation to be an S corporation only if it has no more than one class of stock. What does that mean? Section 1361 doesn’t say, but we know that run-of-the-mill debt isn’t a second class of stock. § 1361(c)(5)(A). And neither are differences in common-stock voting rights. § 1361(c)(4).

The regulation gives us a little more help. It generally treats a corporation as having only one class of stock so long as all the shares confer equal rights to dividends and liquidation proceeds. Treas. Reg. § 1.1361-1(l)(1) (“[A] corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds”).

The regulation also tells us to determine whether stock confers identical rights to distributions and liquidation proceeds based on the corporation’s governing provisions. Id. subpara. (2)(i). These are
documents like a corporate charter, articles of incorporation, and bylaws. Id. The IRS has said it won’t treat any disproportionate distributions made by a corporation as violating the one-class-ofstock requirement if the governing provisions provide for identical rights. Rev. Proc. 2022-19, § 3.02, 2022-41 I.R.B. 282, 286.

As you can see this is a topic that of a Pandora’s Box. Luckily we have some common-sense regulations to pave the way forward, thank you Department of Treasury 🙂

Guilty until Proven Innocent? Tax Court Burden of Proof

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Philip Falco
Guilty until Proven Innocent? Tax Court Burden of Proof

Who has the upper hand in Tax Court, the IRS or the Taxpayer? You decide.

You are considering filing a petition with the United States Tax Court perhaps regarding your Notice of Deficiency post IRS audit. Here are a few rules of play to be aware of.

The IRS’s determinations in a notice of deficiency are generally presumed correct, and taxpayers bear the burden of proving them erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). This puts the main hurdle on the Taxpayer. To put it in common terms, the Taxpayer is presumed guilty, not innocent (these are civil matters, not criminal so this is an analogy). Walking into Tax Court, Taxpayer must prove the IRS’s position is wrong.

All is not hopeless. However, if a taxpayer produces credible evidence with respect to one or more factual issues relevant to the taxpayer’s tax liability, the burden of proof may shift to the IRS as to that issue or issues. § 7491(a)(1). Likewise, the IRS’s determination does not receive a presumption of correctness if the determination is shown to be arbitrary and capricious. Helvering v. Taylor, 293 U.S. 507, 514 (1935); 9 [*9] Cohen v. Commissioner, 266 F.2d 5, 11 (9th Cir. 1959), remanding T.C. Memo. 1957-172. Also, the IRS bears the burden of proving new matters asserted in its answer. See Rule 142(a).

Tax Court proceedings are conducted in accordance with the Federal Rules of Evidence. § 7453; Rule 143(a).

Section 7491(a)(1) provides that if, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the IRS shall have the burden of proof with respect to that issue. See Higbee v. Commissioner, 116 T.C. 438, 440–41 (2001). For the burden to be placed on the IRS under this section, however, the taxpayer must demonstrate that he has: (1) complied with the requirements under the Code to substantiate any item, (2) maintained all records required under the Code, and (3) cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews. See § 7491(a)(2); Higbee, 116 T.C. at 440–41.

CFO and Board Service

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Philip Falco
CFO and Board Service

Chief Financial Officer for your company. Given the dual licensing as a Certified Public Accountant and Attorney, this background and 30 years of business experience is a good fit. Your company could add tremendous value in terms of tax guidance, financial planning, and legal guidance.

For larger companies:

-keeping on track of internal audits

-integrating recommendations into policy

-internal fraud prevention and detection

-Legal exposure prevention.

Smaller companies:

-tax compliance and strategy

-legal compliance

-legal structure

Give us a call to discuss (303) 626-7000

City & County of Denver Taxes

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Philip Falco
City & County of Denver Taxes

So what are these mysterious taxes? Here they are:

Sales Tax – On the purchase price for all sales and purchases of tangible personal property, etc. Return due on or before the twentieth (20 th ) day of each month for sales occurring in the preceding calendar month

Use Tax – There is levied and there shall be collected and paid a tax in the amount stated in this article, by every person exercising the taxable privilege of storing, using, distributing or consuming in the city tangible personal property, or a product or service subject to the provisions of this article, purchased at retail, for said exercise of said privilege, etc. Return due on or before the twentieth (20 th ) day of each month for sales occurring in the preceding calendar month.

Lodger’s Tax –  There is hereby levied and shall be collected and paid a tax by every person exercising the taxable privilege of purchasing lodging, etc. Return due on or before the twentieth (20 th ) day of each month for sales occurring in the preceding calendar month.

Employee Occupational Privilege Tax – There is hereby levied by the city upon and there shall be collected monthly from and paid to the manager by each employee who performs services within the city for any period of time in a calendar month for an employer, an employee’s occupational privilege tax, at the rate of five dollars and seventy-five cents ($5.75) per month for each and every month in which such employee is, for any period of time, so employed. Return due on or before the last day of each month for the taxes required to be remitted for the preceding calendar month.

Business Occupational Privilege Tax – There is hereby levied by the city upon, and there shall be collected monthly from and paid to the manager by, every person engaged in any business, trade, occupation, profession or calling of any kind having a fixed or transitory situs within the city, for any period of time in a calendar month within the city, a business occupational privilege tax in the sum of four dollars ($4.00) per month for the first owner, partner, manager or employee, and the additional sum of four dollars ($4.00) per month for each and every additional owner, partner, manager or employee who performs within the city for any period of time in a calendar month any services or other activities in the operation of such business, trade, occupation, profession or calling within the city. Return due on or before the last day of each month for taxes required to be withheld for the preceding calendar month.

Facilities Development Admissions Tax – “Admission” shall mean the right to an entrance and an occupancy of a seat or an entrance alone, of a person who, for a consideration by whatever name known, including involuntary “contributions,” uses, possesses or has the right to use or possess entrance and occupancy of a seat or an entrance alone to any entertainment, amusement, athletic event, exhibition or other production or assembly staged, produced, convened or held at or on any facility or property owned or leased by the city, including, but not limited to, the following facilities: the Denver Coliseum Complex; the Red Rocks Theatre; Phipps Auditorium; the Denver Performing Arts Complex; the National Western Stock Show Complex; and the Colorado Convention Center. Return due on or before the fifteenth day of each month for sales occurring in the preceding calendar month

Telecommunications Tax – There is levied a tax on the privilege of engaging in the telecommunications business within the city upon each business so engaged one and twelve-hundredths dollars ($1.12) for each account of such business regarding a customer for which local exchange telecommunications are provided by said business within the city. Return due on or before the twentieth (20 th ) day of each calendar month for taxes required to be remitted for the preceding calendar month.

Buyer beware!  Returns required upon sale of business; purchaser subject to lien. (a) Any taxpayer who shall sell out a business or stock of goods or shall quit business shall be required to make out a return as provided in this chapter within ten (10) days after the date the taxpayer sold out the business or stock of goods or quit business, and a successor in business shall be required to withhold sufficient of the purchase money to cover the amount of the tax due and unpaid until such time as the former owner shall produce a receipt from the manager showing that the taxes have been paid or a certificate that no taxes are due. (b) If the purchaser of a business or stock of goods shall fail to withhold the purchase money as provided in subsection (a), and the tax shall be due and unpaid after the ten (10) day period allowed, the purchaser, as well as the taxpayer, shall be personally liable for the payment of the taxes unpaid by the former owner. Likewise, anyone who takes any stock of goods or business fixtures of or used by any employer under lease, title-retaining contract or other contract arrangement, by purchase, foreclosure sale or otherwise, takes same subject to the lien for any delinquent taxes owed by such employer and shall be liable for the payment of all delinquent taxes of such prior owner, not, however, exceeding the value of the property so taken or acquired.

Innocent Spouse Relief Even for the Wealthy

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Philip Falco

If a taxpayer prevails under the provisions of Innocent Spouse Relief, the taxpayer will be freed of that tax-liability shackle. Philip Falco, CPA, Juris Doctor provides you with Tax Tips based on the Ehrmann case and based on his insight and then discusses the requirements for Innocent Spouse Relief.  He discusses a recent tax case drafted by the United States Tax Court, Kathryn D. Ehrmann v. Commissioner of Internal Revenue, T.C. Summary Opinion 2014-96.  This is a very recent case, which is dated September 23, 2013.  This case may not be relied upon as precedent, but it is still telling of the Court’s view on Innocent Spouse Relief cases.

Tax Tips for those entering or exiting marriage (Divorce) as to Innocent Spouse Relief:

  • Consider not paying the tax in dispute,
  • Hire competent tax counsel to draft tax language in divorce decree, stipulation, or settlement agreement,
  • Consider filing your tax return using a different filing status such as separately or head of household (if qualified).
  • Before getting married, hire us to do a tax compliance checkup on your fiancé.  If you are getting married a bit older in life, this actually makes sense since you really would not know a person’s tax history.  Concealment of prior tax history is a common reason for petitions under Innocent Spouse Relief.

Innocent Spouse Relief, Equitable Relief: the catch-all

Generally, married taxpayers who file a joint Federal income tax return are jointly and severally liable for the tax reported or reportable on the return. Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282 (2000). Section 6015, however, allows a spouse to obtain relief from joint and several liability in certain circumstances.

Section 6015(a)(1) provides that a spouse who has made a joint return may elect to seek relief from joint and several liability under subsection (b) (dealing with relief from liability for an understatement of tax with respect to a joint return). Section 6015(a)(2) provides that an eligible spouse may elect to limit that spouse’s liability for any deficiency with respect to a joint return under subsection (c) (dealing with relief from joint and several liability for taxpayers who are no longer married or who are legally separated or no longer living together). If a taxpayer does not qualify for relief under either subsection (b) or (c), the taxpayer may seek equitable relief under subsection (f).

Equitable Innocent Spouse Relief: Requirements

There are seven threshold conditions that a requesting spouse must satisfy to be eligible for relief under section 6015(f):

  1. the requesting spouse filed a joint Federal income tax return for the tax year or years for which relief is sought;
  2. the requesting spouse does not qualify for relief under section 6015(b) or (c);
  3. the claim for relief is timely filed;
  4. no assets were transferred between the spouses as part of a fraudulent scheme;
  5. the nonrequesting spouse did not transfer disqualified assets to the requesting spouse;
  6. the requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and
  7. the liability from which relief is sought is attributable to an item of the nonrequesting spouse.

If a requesting spouse satisfies the threshold conditions of Rev. Proc. 2013-34, sec. 4.01, the Commissioner considers whether the requesting spouse is entitled to a streamlined determination of equitable relief under section 6015(f).  If a requesting spouse is not entitled to a streamlined determination because the requesting spouse does not satisfy all the elements in Rev. Proc. 2013-34, sec. 4.02, the requesting spouse’s request for relief may be considered using the equitable relief factors in Rev. Proc. 2013-34, sec. 4.03.

Under Rev. Proc. 2013-34, sec. 4.03, equitable relief under section 6015(f) may be granted if, taking into account all the facts and circumstances, it would be inequitable to hold the requesting spouse responsible for all or part of the liability. In making the decision, the Commissioner weighs a number of factors, including, but not limited to:

  • Marital status. Whether the requesting spouse is no longer married to the nonrequesting spouse as of the date the Service makes its determination.
  • Economic hardship. Whether the requesting spouse will suffer economic hardship if relief is not granted.
  • Knowledge or reason to know. In the case of an income tax liability that was properly reported but not paid, whether, as of the date the return was filed or the date the requesting spouse reasonably believed the return was filed, the requesting spouse knew or had reason to know that the nonrequesting spouse would not or could not pay the tax liability at that time or within a reasonable
    period of time after the filing of the return.
  • Legal obligation. Whether the requesting spouse or the nonrequesting spouse has a legal obligation to pay the outstanding Federal income tax liability.
  • Significant benefit. Whether the requesting spouse significantly benefitted from the unpaid income tax liability or understatement.
  • Compliance with income tax laws. Whether the requesting
    spouse has made a good faith effort to comply with the income tax
    laws in the taxable years following the taxable year or years to which
    the request for relief relates.
  • Mental or physical health. Whether the requesting spouse was in poor physical or mental health.

“Weighs” is highlighted because not ALL of the factors need be present, which is especially true in the Ehrmann case, as discussed below.

Economic Hardship

Kathryn D. Ehrmann v. Commissioner of Internal Revenue, T.C. Summary Opinion 2014-96, September 23, 2014, sheds light on “economic hardship”.

For purposes of this factor, an economic hardship exists if satisfaction of the tax liability, in whole or in part, will cause the requesting spouse to be unable to pay reasonable basic living expenses. Id. sec. 4.03(2)(b), 2013-43 I.R.B. at 401. The facts and circumstances considered in determining whether the requesting spouse will suffer economic hardship include:

  1. the requesting spouse’s age, employment status and history, ability to earn, and number of dependents;
  2. the amount reasonably necessary for food, clothing, housing, medical expenses, transportation, and current tax payments; and
  3. any extraordinary circumstances such as special education expenses, a medical catastrophe, or a natural disaster.
  4. In addition, consideration is given to the requesting spouse’s current income and expenses and the requesting spouse’s assets.

Ms. Ehrmann, the court found, would not suffer economic hardship if relief were denied based on the following facts:

  1. Ms. Ehrmann sought a refund of money that had already been paid. Thus, her current financial circumstances will not be adversely affected if relief is denied.  TAX TIP: Consider not paying the disputed tax.
  2. Ms. Ehrmann earned significant income from her position as a senior managing director at CB Richard Ellis. On her Form 8857 petitioner estimated that her 2011 salary and bonus would total over $300,000. In her affidavit filed with the Hennepin County District Court, petitioner disclosed that she earned nearly $340,000 in salary and bonuses for 2011. Moreover, nothing in the record suggests that Ms. Ehrmann’s earning potential has declined since then.
  3. Ms. Ehrmann  owned substantial assets, including the Wayzata and Hilton Head residences and a number of luxury vehicles.
  4. Although petitioner had no dependents, her expenses include expenses paid to support her adult children.

In the end, the Court found this factor neutral.  It is pointed out and highlighted that the tax court did not find this factor as weighing against Ms. Ehrmann.

The tax court stated, citing Rev. Proc. 2013-34, sec. 4.03(2)(b), “[t]his factor weighs in favor of relief where the requesting spouse would suffer economic hardship if relief is denied and is neutral where the requesting spouse would not suffer economic hardship if relief is denied.”

Implied by the Rev. Proc. and the tax court is that economic hardship either works in favor of the petitioning taxpayer or is a neutral factor, but NOT a factor weighing against Innocent Spouse Relief.

As such, wealth of the taxpayer seeking Innocent Spouse Relief is NOT weighed against the taxpayer.

Innocent Spouse Relief is available to the rich, which is counter intuitive in my view.

Legal Obligation

For purposes of this factor, a legal obligation is an obligation arising from a divorce decree or other legally binding agreement. Rev. Proc. 2013-34, sec. 4.03(2)(d), 2013-43 I.R.B. at 402. This factor weighs in favor of relief if the nonrequesting spouse has the sole legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement and weighs against relief if the requesting spouse has the sole legal obligation. Id. This factor is neutral if both spouses have a legal obligation to pay pursuant to a divorce decree or agreement or if the divorce decree or agreement is silent as to any obligation to pay the outstanding income tax liability.

In a carefully drafted divorce decree, stipulation, or settlement, an ‘Innocent Spouse’ may successfully plead this factor.  We provide tax counsel to spouses during the process of divorce. In Ehrmann, the decree was drafted in a way that could have been improved.  I won’t shed more light on this issue at this time, but feel free to contact me.  As such, the tax court found this factor neutral.

Tax Form 8857: Innocent Spouse Relief

IRS Pre-Audit Investigations

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Philip Falco

Audit “Flags” – Straight from the Internal Revenue Manual

Large Unusual Questionable Items (LUQs)

The definition of a large, unusual, or questionable item will depend on the examiner’s perception of the return as a whole and the separate items that comprise the return. Some factors to be considered when identifying LUQs are:

  1. Comparative size of the item — an expense item of $6,000.00 with total expenses of $30,000.00 would be a large item; however, if total expenses are $300,000.00, the item would not be generally considered a large item.
  2. Absolute size of the item — despite the comparability factor, size by itself may be significant. For example, a $50,000 item may be significant even though it represents a small percentage of taxable income.
  3. Inherent character of the item — although the amount of an item may be insignificant, the nature of the item may be significant; e.g., airplane expenses claimed on a plumber’s Schedule C.
  4. Evidence of intent to mislead — this may include missing schedules, incomplete schedules, misclassified entries, or obviously incorrect items on the return.
  5. Beneficial effect of the manner in which an item is reported — expenses claimed on a business schedule rather than claimed as an itemized deduction.
  6. Relationship to other items — incomplete transactions identified on the tax return. For example, the taxpayer reported sales of stock but no dividend income.
  7. Whipsaw issues — occur when there is a transaction between two parties and characteristics of the transaction will benefit one party and harm the other. Examples include alimony vs. child support, sale vs. rental/royalty, employee vs. independent contractor, gift vs. income.
  8. Missing items — consideration should be given to items which are not shown on the return but would normally appear on the returns of similar taxpayers. This applies not only to the examination of income, but also to expenses, deductions, etc., that would result in tax changes favorable to the taxpayer.

The foregoing is an excerpt from the Internal Revenue Manual.  These are some of the recommended procedures to IRS Agents when doing background work before a taxpayer is contacted.

The tax return would have been flagged already.  It is now in the hands of the scrutinizing IRS Agent.  These are some of the items the agent will look at closely before contacting the taxpayer.

Click here to read about IRS Audits including IRS letters.

Excerpt from Publication 1, Taxpayer Rights

The process of selecting a return for examination usually begins in one of two ways. First, we use computer programs to identify returns that may have incorrect amounts. These programs may be based on information returns, such as Forms 1099 and W-2, on studies of past examinations, or on certain issues identified by compliance projects. Second, we use information from outside sources that indicates that a return may have incorrect amounts. These sources may include newspapers, public records, and individuals. If we determine that the information is accurate and reliable, we may use it to select a return for examination.

Commercial Real Estate holding entity

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Posted by
Philip Falco

Colorado Corporate entity selection is very important.

Setting off on the correct course at the very beginning is worth the investment.  It can save taxes, owner liability and headaches.

There are various types of entities under Colorado statute Title 7. Colorado was one of the first States to enact a Limited Liability Company (LLC) statute.  In fact, the author’s corporation class studied the Colorado LLC statute in 1993.

A Colorado LLC is the most popular Colorado entity and for good reason.

Its purpose is to provide limited liability to members.  Limited liability has dwindled somewhat by way of Colorado Case Law.  There are measures to take to ensure protection.

What is Limited Liability?  This refers to personal liability of a member for entity liabilities.  Entity liability could include liability from third-party personal injury.

There is the Limited Liability Partnership (LLP).

Under Colorado statute, there are several varieties of LLP.  Historically, an LLP was required to have at least one general partner.  An entity can now chose to be a Limited Liability Limited Partnership (LLLP).

There is the Colorado Corporation.

A Colorado Corporation is formed pursuant to C.R.S. §7-90-101, et. seq.  A great advantage of a corporation is its simplicity.

Taxation

Generally, an entity can be taxed as a partnership, a C-Corp (Double Tax), or an S-Corp (flow through).

A Real Estate holding entity usually would chose partnership taxation because of its flexibility.  Other entities chose S-Corp because S-Corps provide more clarity on payroll, and they do, which is very important for tax compliance.

Under the Check The Box regulations, an entity, such as an LLC, can chose the following tax classifications: C-Corp, S-Corp, Partnership.  Under certain rules, an entity is considered a disregarded entity for tax purposes, in which case, taxation is according to Sole Proprietorship rules.

Partners who are Married.

If there are only two partners and they are married, they might very well be considered a disregarded entity by the IRS.  This could throw a wrench in your tax paradigm, so check with a professional to be sure.

Denver Head Tax a deduction on Colorado State Income Tax Return

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Posted by
Philip Falco
Denver Head Tax a deduction on Colorado State Income Tax Return

We do a host of tax return amendments for clients either as part of OVDP, or simply corrected errors spotted by clients of other CPA’s, c.f.  IRS Pre-Audit Investigations.

As part of our thorough review we noticed that a different accounting office had added back in full the amount of state and local income tax paid by a taxpayer.  Here’s what we gathered based on the tax law.

Colorado State Income Tax return 104 starts with the federal income tax from form 1040.  Pursuant to CRS §39-22-104, certain items are added; that is, taxpayer will pay Colorado State tax on those items even though taxpayer did not pay federal income tax on those items.

One such item is State Income Tax.  State and local income tax is deductible pursuant to IRC §164(a)(3) on a 1040.  It makes sense for Colorado to essentially disallow a deduction for the tax the income of which it is taxing.

Enter local tax, such as the Denver Head Tax. I have good news for you: the Denver Head Tax is deductible on the 1040 and Colorado 104.  It is not added in pursuant to CRS §39-22-104.  The add-in applies only to state income taxes, not local taxes.

 

 

Cryptocurrency Tax Compliance

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Posted by
Philip Falco
Cryptocurrency Tax Compliance

We are now performing tax compliance for taxpayers with Cryptocurrency, the Cryptocurrency net worth of which exceeds 1 million (U.S. convertible).  We are the best at what we do.

Tax year 2017 is a critical tax year for Cryptocurrency.  Getting 2017 correct will provide a foundation for huge gains in later years.  You must seize the moment.

The Internal Revenue Service is focusing on noncompliant taxpayers in this space.  This is evident by the John Doe Summons issued on Coinbase.  As many of us have read, the Internal Revenue Service has obtained information about 14,355 Coinbase account holders.  Coinbase has been ordered to provide the IRS with the taxpayer’s name,etc, for those individuals who have bought, sold, sent, or received more than $20,000.  In addition, the Securities and Exchange Commission is paying attention, which is evident by statements made about Initial Coin Offerings (ICO’s).

The day of tax reckoning is inevitable.  Time is of the essence to properly disclose huge transactions.  Please feel free to call us.  (303) 626-7000.

 

 

 

S.A.L.T. deduction cap of $10,000 effect in Colorado

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Posted by
Philip Falco
S.A.L.T. deduction cap of $10,000 effect in Colorado

The State and local tax (SALT) deduction is limited to $10,000 for tax years beginning 2018.  As such there has been confusion as to whether a taxpayer can prepay 2018 SALT in 2017 and take a full deduction in 2017 thereby avoiding the $10,000 limitation in 2018.  As to Colorado, this has been my experience.

To put this in context, this refers to cash method taxpayers.  Under certain circumstances, cash method taxpayers may prepay liabilities to take a deduction in the year paid as compared with year accrued.  As such, if a Colorado county would not accept payment of a 2018 tax due, then the cash method defeats the prepayment strategy, not the new tax bill.

The cap includes both real estate and income tax.  State income tax cannot be prepaid because of the second to last sentence of the amendment below.  However, real property tax can possibly be prepaid.  Whether the real property tax can be prepaid depends on whether 2018 real property tax has been assessed by that particular county.  Denver has assessed 2018 and it is payable now so Denver could be prepaid.   I checked some other counties and visibility is not clear so call to check with your particular county as to whether the real property tax has been ASSESSED.  If so, and the combined anticipated 2018 SALT (income and property tax) exceeds $10,000), go pay that real estate tax for some tax savings.

It has been my experience in real estate transactions to provide a credit to purchasers for the prior year real estate taxes because they were assessed although not yet due.  This provides further basis to make the case that prepaying 2018 tax is a deduction in 2017.

I have received a case example from a reader of this post.  Taxpayer went to the Arapahoe County Treasurer today, December 29, 2017.  The Treasurer informed taxpayer that Arapahoe considers the tax assessed on May 1, when they value properties.  He promptly paid his 2017 taxes due 2018 and the treasurer gave him a receipt with 2017 printed on it.

Colorado does seem perfectly aligned to prepay your taxes due 2018 in 2017 for a deduction in 2017 to thereby avoid the $10,000 cap in  the new bill.  Of course, there is AMT!

Here’s the text:

SEC. 11042. LIMITATION ON DEDUCTION FOR STATE AND LOCAL, ETC. TAXES. (a) IN GENERAL.-Subsection (b) of section 164 is amended by adding at the end the following new paragraph: ”(6) LIMITATION ON INDIVIDUAL DEDUCTIONS FOR TAXABLE YEARS 2018 THROUGH 2025.-In the case of an individual and a taxable year beginning after December 31, 2017, and before January 1, 2026- ”(A) foreign real property taxes shall not be taken into account under subsection (a)(1), and ”(B) the aggregate amount of taxes taken into account under paragraphs (1), (2), and (3) of subsection (a) and paragraph (5) of this subsection for any taxable year shall not exceed $10,000 ($5,000 in the case of a married individual filing a separate return). The preceding sentence shall not apply to any foreign taxes described in subsection (a)(3) or to any taxes described in paragraph (1) and (2) of subsection (a) which are paid or accrued in carrying on a trade or business or an activity described in section 212. For purposes of subparagraph (B), an amount paid in a taxable year beginning before January 1, 2018, with respect to a State or local income tax imposed for a taxable year beginning after December 31, 2017, shall be treated as paid on the last day of the taxable year for which such tax is so imposed.”.  (b) EFFECTIVE DATE.-The amendment made by this section shall apply to taxable years beginning after December 31, 2016.

Also review the IRS bulletin on this topic: https://www.irs.gov/newsroom/irs-advisory-prepaid-real-property-taxes-may-be-deductible-in-2017-if-assessed-and-paid-in-2017.

What is a “Willful” Failure to Disclose Offshore Bank Account

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Posted by
Philip Falco
What is a “Willful” Failure to Disclose Offshore Bank Account

This is the central question as to whether a taxpayer enters Offshore Voluntary Disclosure or Streamline.  It also fixes potential penalties under 31 U.S.C. §5321.

31 U.S.C. 5314 is the statute that requires reporting of foreign bank accounts.  Pursuant to the statute, reporting is required by the following:

  1. a United States Citizen,
  2. a resident of the United States or
  3. a person in, and doing business in the United States.

Incidentally, the term “person” has broad meaning, which includes corporations.

Pursuant to 31 U.S.C. §5321, the amount of penalty shall not exceed $10,000 unless the case is “willful“.  In cases of willfulness, the maximum penalty increases to the greater of  $100,000 or 50 percent of the account balance.  It is also noteworthy that, pursuant to subsection (d), a criminal penalty may be stacked on top of this civil penalty.

A lot is riding on the meaning of “willful” so let’s turn our focus to it.  If you would like to read what is required of the Secretary of Treasure to prove an FBAR case, click here to read the 7 elements.

Legal standard and Burden of Proof

To affix the civil penalty under 31 U.S.C. §5321 the Secretary of Treasury must establish willfulness by the preponderance of the evidence.  This is a lower standard than beyond a reasonable doubt.  The Burden of Proof is on the United States Government.

Meaning of “Willful”

31 U.S.C. §5321 does not define “willful”.  In United States of America v. McBride, 908 F. Supp. 1186 (D.Utah 2012), The United State District Court analyzed the meaning of “willful” as it is used in 31 U.S.C. §5321.  The Court gave heavy weight to the fact that taxpayer signed the tax return.

Signature alone is sufficient proof of a taxpayer’s knowledge of the instructions contained in the tax return form and in other contexts, the Court stated.  This is an inference of “willful” conduct by mere signature alone. The Court went on to analyze the proposition that signature by itself does not prove knowledge, but knowledge may be inferred from the signature and the signature is prima facie evidence that the signer knows the contents of the return.

In either case, taxpayer’s signature shifts the burden of proof to taxpayer to prove non-willfulness.  The Court held that knowledge of the law, including knowledge of the FBAR, requirements, is imputed to taxpayer, which is sufficient to inform taxpayer of the requirement to file Form TD F 90-22.1.  The Court held that signature alone imputed knowledge to taxpayer of the FBAR requirement.

It is noteworthy that the Court analyzed taxpayer’s credibility in detail.  Taxpayer alleged that he did not know he had a legal duty to file FBAR’s, which is common and understandable assertion.  Rather than just dismiss this argument on the basis of his signature on tax return, the Court found taxpayer not credible because of prior testimonial inconsistencies.

Implicitly, there is a defense that taxpayer did not know of FBAR requirements despite signature on a tax return.  After all a signature is prima facie evidence of willfulness, not the end-all and be-all of willfulness.

In the end, “willfulness” is determined by the facts and circumstances of each case that must be analyzed in the context of that particular time period in question.

 

Panama Papers: The Case for FATCA Global Adoption

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Posted by
Philip Falco
Panama Papers: The Case for FATCA Global Adoption

The disclosure of the Panama Papers promises to cause global unrest as exemplified by the recent protests in Iceland.  As more and more leaders are tied to illicit offshore bank accounts, continued unrest is sure to follow.  FATCA, the Foreign Account Tax Compliance Act, at first appeared to be a time-consuming nuisance for banks is now proving to be a potent weapon of democratic society.

FATCA was implemented to target non-compliant United States taxpayers by forcing banks around the world to report bank balances of U.S. taxpayers to the United States government. U.S. taxpayers of every type must come forward and not only declare foreign accounts but also pay undeclared tax.  It forces all U.S. taxpayers to play by the same rules.  A true democracy cannot be had unless monetary rules are leveled for all involved.

The reportable bank balances are those of United States taxpayers, but not of foreign nationals who have no duty to report under United States laws.  As a result, many of those identified in the Panama Papers were unlikely reportable taxpayers pursuant to FATCA.  Consequently, countries throughout the world would find it prudent to contemplate adopting a FATCA-like disclosure model to maintain peace, disrupt political corruption, and level the monetary playing field.

Keep your sanity during tax season.

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Posted by
Philip Falco
Keep your sanity during tax season.

There are a lot of pressures surrounding our voluntary tax system. There are deadlines and then there is honesty, to name a couple. What, however, is most important is your portrayal of your taxes to the IRS. This is the empowering moment of taxpaying Americans. At this moment you have the liberty to express your capitalist side as a business. You take the liberty to deduct business expenses in that regard while reporting the winnings of your entrepreneurial spirit. Tax is very much a positive vote for your future, so as you disclose and pay your tax, note to yourself that you are investing in your future and your family’s future.

Tax Compliance Check-Up

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Posted by
Philip Falco

For Individuals, Small Businesses, Corporations, Partnerships, and Limited Liability Companies

Tax Compliance Checkup-Up by Philip Falco, Attorney, CPA

We have IRS e-services. We can quickly find out what is not making you or your company tax compliant.

For example, an old unfiled tax return, a quarterly filing, or an IRS Form 940 might not have been filed at some point in time. You might not even know that the IRS has the non-compliance flagged until it is too late.  We can nip this in the bud and get you in 100% compliance.  We also provide tax preparation services so we can actually prepare your unfiled returns for you.

This service can help minimize exposure to an IRS Audit, issues with Unfiled Tax Returns, and Criminal Tax indictment.

Give us a call if you would like us to do a tax check-up for you (303) 626-7000.

Judge Learned Hand on Taxes

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Posted by
Philip Falco

By Philip Falco, Attorney, CPA. In an opinion penned in 1934, Judge Learned Hand endorsed the use of tax planning.  In Helvering v. Gregory, 69 F.2d 809, Judge Learned Hand wrote:

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

To put it another way, there is no patriotic duty to pay more tax than the least tax payable under the tax code. This is the essence of tax planning in a nutshell.

A solid understanding of the tax code is what it takes to navigate to the least tax payable under the tax law.