Sunday, March 9, 2014
We have picked up two or three nonfiler clients this season. By itself, this does not overly concern me, although there are nasty tax traps concerning refunds and overpayments for nonfiled years. Did you know, for example, that – if you go long enough without filing – the IRS will not refund your overpayment? Nonetheless, one files, pays tax due with the IRS and carries on.
Then there is a subcategory of nonfilers that could be referred to as protestors. I have little patience for those. I recently picked up a corporate tax audit client, and it is proving to be a very difficult examination. There are several reasons, but I believe a key reason is that one of the owners may be walking this line.
I am looking at a Tax Court case decided last month: Waltner v Commissioner. This is a protestor case, and it is a bit unusual. In general, courts have given protestors short patience. This time the court took the time to go through the arguments and address them one by one.
Have you hear about Peter Hendrickson? He is a protestor himself, and he wrote a book titled Cracking the Code. It appears that Waltner studied Hendrickson closely, as the techniques he used follow the book’s recommendations.
The case concerns Mr. Waltner’s 2008 individual tax return, in which he reported zero wages, an IRA distribution, a student loan interest deduction and home mortgage interest. All in all, it came down to zero tax liability, which is understandable when you report zero wages.
Mind you, he received three W-2s, but Waltner submitted Forms 4852 (Substitute for Form W-2), reporting zero wages but showing income tax withheld. He also received a Form 1099-B (Proceeds from Broker), but crossed-out proceeds of $5,000 and inserted zero. He then wrote the following text:
This correcting Form 1099-B is submitted to rebut a document known to have been submitted by the party identified above as “Payer” and “Broker” which erroneously alleged a payment to the party identified above as …. of “gross proceeds” in connection with a “trade or business.” Under the penalty of perjury, I declare that I have examined this statement and to the best of my knowledge and belief, it is true, correct and complete.”
The IRS was having none of this and sent a letter requesting a corrected return. The IRS otherwise was going to assess a frivolous submission penalty of $5,000.
He didn’t. They did. Then they issued a notice of intent to levy.
Waltner requested a Collection Due Process hearing, submitting a 49-page brief.
COMMENT: Trust me, 49 pages is impressive.
So the Appeals officer got to read the following:
· Waltner was not “an officer, employee or elected official of the United States”
· He was “never an officer of a corporation”
· He “did not receive Wages from any source”
· He "did not work for or receive any pay from an Employer or American employer”
· He “was not engaged in Employment”
· He “was not an Employee”
· He “was not engaged in Self-employment”
· He “was not a citizen or resident of the District of Columbia or any territory or possession of the United States”
· He “was never incorporated in Washington, D.C. or worked for any company who incorporated in Washington, D.C.”
· He “was not a governmental unit or agency or instrumentality thereof, or a United States Person”
In addition to not understanding the rules for capitalization in the English language, he appears to be flying the tax protestor flag.
The Appeals officer warned him about frivolous arguments. Waltner did not back down. The IRS assessed him. Waltner then filed with the Tax Court.
It took months to go before the Court, during which time the two parties filed 24 motions, resulting in the Court issuing 22 orders. The maneuverings defy belief:
· The IRS moved for admissions, meaning they wanted to know Waltner’s reasoning for the substitute W-2s. The Court, being a good sport, issued a 39-page order reviewing 44 requests for admissions and 83 supplemental requests.
· Waltner responded with boilerplate language but not otherwise addressing the issues under discovery.
· The IRS responded with a 993-page request for admissions.
· Waltner filed a motion for protective order delaying discovery.
· The IRS filed an objection. The Court accepted some and dismissed some.
· Less than a month later Waltner filed a motion to compel stipulation. The motion was filed under an arcane procedure known as Rule 9(f).
· The IRS responded, so the motion was discharged.
· The IRS filed a motion to compel responses to interrogatories, which the Court granted.
· Waltner filed a motion for reconsideration, which the Court denied.
· Waltner sought an extension to respond to the interrogatories, which the Court granted.
· Waltner never responded to the interrogatories. Instead he paid the $5,000 fine.
· Waltner filed to have the IRS answer interrogatories, to which the IRS filed objection.
· The IRS responded to the interrogatories. The Court found some acceptable and others not.
· The IRS filed for supplemental information from Waltner.
· Waltner filed a motion for reconsideration.
Do you see the game being played here? Rather than provide arguments, Waltner is neck-deep in Tax Court procedural minutiae. No wonder the Courts hate protest cases.
When all is said and done, Waltner lost and the IRS requested the Court to apply a $25,000 Section 6673 penalty.
The Court instead went on the discuss Cracking the Code, noting how Waltner’s arguments and techniques mirror the book. Here are some gems, for example:
· The federal government has legislative authority over only the District of Columbia and U.S. territories.
· The Revenue Act of 1862 imposed a 3% tax only on federal employees.
· Federal direct taxes which affect citizens of the several states must be apportioned (a position which predates the 16th Amendmnet).
· Remuneration for work is not profit and is therefore not taxable.
You get the idea.
The court could have assessed a $25,000 penalty for wasting its time, but it decided instead to impose a $2,500 penalty, adding:
Mr. Waltner has other matters pending in this Court in which he is asserting arguments similar to those presented in this case, and he has now been cautioned in both an order and this opinion. We hope that he will heed the warning.”
The Court is allowing Waltner to back down, although I am not optimistic that he will.
There are any number of reasons for not filing. There can be illness, death, emotional collapse, for example. The IRS will mitigate if not abate penalties in many cases. Protest is not one of them. This is a bad street late on a dark night, and nothing good will be found there.
Saturday, March 1, 2014
We prepare payroll for our clients. We do not handle money, mind you, but we do the calculations, observe the deposit schedules and prepare the tax returns. ADP and Paychex do the same thing, but in much larger volume.
Have you ever wondered who is responsible for penalties if these payroll taxes are not prepared correctly: you or me (that is, the provider)? Let’s ramp this up a notch: what if you remit monies trusting the provider to make the deposits … and they don’t? Think about this for a second. Would the IRS really expect you to make the deposit again? After all, you are out the monies remitted to the provider. And, if they did, would the IRS add insult to injury by applying penalties?
Chances are the answer is yes (to the first) and no (to the second).
Let’s review the buzzwords in this area and then let’s discuss a horror story.
Technically there are three types of payroll providers:
(1) Payroll Service Providers (PSP)
a. A PSP prepares the payroll tax returns but the client signs and files the paperwork. This is what we do. Under this arrangement, you remain the employer in the eyes of the IRS.
(2) Reporting Agent (RA)
a. RA’s prepare and file the paperwork. It is a slight difference, granted, and again you remain the employer in the eyes of the IRS.
(3) Professional Employer Organization (PEO)
a. PEO’s are more difficult to pin down.
i. PEO’s perform the range of human resource functions: tax filings and administration, benefit design and ERISA, compliance with federal and state workplace regulations, disciplinary actions, unemployment, disability and workers compensation.
b. It gets tricky on who is the “employer” in this instance. You are paying the PEO as a virtual outsourcing of your personnel and payroll departments. Odds are – for example – that the PEO is issuing W-2s in its name and identification number. Again, odds are that employee benefits – health and other – are also provided under their name.
i. That sets up the question: who is the employer – you or the PEO?
c. The tax law is not as clear as it could be.
i. There is a way for the PEO to be the “employer”, but certain requirements must be met and paperwork has to be filed to notify the IRS.
d. PEO’s commonly use an indemnity provision requiring them to reimburse you in the event of liability attributable to their failure to collect or remit taxes.
i. An indemnity provision – by itself – is not enough to have the IRS consider the PEO to be the employer.
ii. This means that – if all that happens is an indemnity provision - you remain the employer, and the IRS can act against you for penalties and undeposited taxes.
What can go wrong?
I am looking at an FBI release dated February 21, 2014. There is a court in San Antonio that is sending three individuals to jail for participating in what the FBI describes as “the largest real dollar loss fraud and tax related case ever prosecuted in the Western District of Texas.” At the core of this case were PEOs.
· John Bean, owner of Synergy Personnel and an officer with several other San Antonio and Austin PEOs, was sentenced to six years in prison and order to repay more than $120 million in restitution.
· Pat Mire, owner and manager of several San Antonio PEOs (including one with John Bean) was sentenced to three years in prison and order to repay $10 million.
· Mike Solis, an executive at several San Antonio PEOs, was sentenced to two years in prison.
· John Walker II owned and managed several San Antonio PEOs. He was sentenced to five years of probation and ordered to repay $450,000.
They had an unusual – but track-proven way - of dealing with the pesky payroll taxes they collected from clients and were supposed to remit to the government: they didn’t. Needless to say, they were extraordinarily profitable. They admitted that between 2002 and 2008 they stole more than $133 million from clients.
That is Nimitz-class payroll taxes, and someone is going to pony up. If you were a client of these PEOs, you would not want the IRS to come knocking, expecting you remit payroll taxes after you already paid these guys to do the same. You would be paying twice.
The technical lexicon is that you want the PEO to be the “Section 3401” employer. The concept doesn’t apply to a PSP or RA, as their functions are limited. A PEO, on the other hand, performs so many of the employer functions that they practically “are” the employer. You want to be certain that the IRS agrees with that, though, by acknowledging the PEO as the “Section 3401” employer.
BTW, will the IRS go after the San Antonio employers? Truthfully, I cannot tell. I hope that the PEOs involved were the Section 3401 employers. Even if they weren’t, this case is so egregious that I would like to believe the IRS would make exceptional accommodation for the employers affected.
Update as of 3/10/14: Last Friday I had an IRS employment tax specialist in the office. Yes, she is auditing one of our clients (sigh). We spoke about the San Antonio PEO fraud and whether the IRS would accept 3401 status for the underlying employers.
She believes the IRS will act against the underlying employers and not even pause for any 3401 argument. Her observation: "it is a risk you take when you hire a PEO."