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Showing posts with label asset. Show all posts
Showing posts with label asset. Show all posts

Tuesday, March 5, 2024

IRS Gets Called Out In Offer In Compromise Case

 

I am looking at an offer in compromise (OIC) case.

These cases are almost futile for a taxpayer, as the Tax Court extends broad deference to the IRS in its analysis of and determinations on OICs. To win requires one to show that the IRS acted in bad faith.

COMMENT: I have soured on OICs as the years have gone by. Those commercials for “pennies on the dollar” stir unreasonable expectations and do not help. OICs are designed for people who have experienced a reversal of fortune - illness, unemployment, disability, or whatnot – which affect their ability to pay their taxes. It is not meant for someone who is irresponsible or inexplicably unfettered by decency or the responsibilities of the human condition. Not too long ago, for example, one of the clients wanted us to pursue an OIC, as he has racked up impressive tax debt but has no cash. I refused to be involved. Why? Because his cash is going to construct a $2-plus million dollar home. I am very pro-taxpayer, but this is not that. Were it up to me, we would fire him as a client.

Let’s look at the Whittaker case.

Mr. W is a veteran and was a self-employed personal trainer. Mrs. W worked in a local school district and had a side gig as a mall security guard. They were also very close to retirement.

The Ws owed everybody, it seems: a mortgage, student loans, the IRS, the state of Minnesota and so on.

In 2018 the IRS sent a notice of intent to levy.

The Ws requested a collection due process (CDP) hearing.

COMMENT: The Ws were represented by the University of Minnesota tax clinic, giving students a chance to represent clients before the IRS and courts.

The IRS of course wanted numbers: the Form 433 paperwork detailing income, expenses, assets, debt and so forth.

The Ws owed the IRS approximately $33 grand. The clinic calculated their reasonable collection potential as $1,629. They submitted a 20% payment of $325.80, per the rules, along with their OIC.

In the offer, the Ws stressed that their age and difficult financial situation meant that soon they would have to rely on retirement savings as a source of income rather than as a nest egg. Their house was in disrepair and had an unusual mortgage, meaning that it was extremely unlikely it could be refinanced to free up cash.

The IRS has a unit - the Centralized Offer in Compromise unit – that stepped in next. Someone at the unit calculated the Ws’ RCP as $250,000, which is wildly different from $1,629. The unit spoke with representatives at the clinic about the bad news. The clinic in turn emphasized special circumstances that the Ws brought to the table.  

That impasse transferred the OIC file to Appeals.

It was now March 2020.

Remember what happened in March 2020?

COVID.

The two sides finally spoke in September.

Appeals agreed with an RCP of $250 grand. The Settlement Officer (SO) figured that the Ws could draw retirement monies to pay-off the IRS.

Meanwhile Mr. W had retired and Mrs. W was gigging at the mall only two weekends a month.

The SO was not changing her mind. She figured that Mrs. W must have a pension from the school. She also surmised that Mr. W’s military pension must be $2,253 per month rather than $1,394. How did she know all this? Magic, I guess.

The W’s argued that they could not borrow against the house. They had refinanced it under something called the Home Affordability Refinance Program, which helps homeowners owing more than their house is worth. A ballon payment was due in 2034, and refinancing a house that is underwater is nearly impossible.

This did not concern the SO. She saw an assessed value of $243,000 on the internet, subtracted an $85 thousand mortgage, which left plenty of cash. The W’s pointed out that there was deferred maintenance on the house – a LOT of deferred maintenance. Between the impossible mortgage and the deferred maintenance, the house should be valued – they argued – at zero.

Nope, said the SO. The Ws could access their retirement to pay the tax. They did not have to involve the house, so the mortgage and deferred maintenance was a nonfactor. She then cautioned the W’s not to withdraw retirement monies for any reason other than the IRS. If they did so, she would consider the assets as “dissipated.” That is a bad thing.

Off to Tax Court they went. Remember my comment earlier: low chance of success. What choice did the Ws have? At least they were well represented by the tax clinic.

The Court saw three key issues.

Retirement Account

The W’s led off with a great argument:

 

  

This is Internal Revenue Manual 5.8.5.10, which states that a taxpayer within one year of retirement may have his/her retirement account(s) treated as income rather than as an asset. This is critical, as it means the IRS should not force someone to empty their 401(k) to pay off tax debt.

The SO was unmoved. The IRM says that the IRS “may” but does not say “must.”

Yep, that is the warm and fuzzy we expect from the IRS.

The Court acknowledged:

We see no erroneous view of the law and no clearly erroneous assessment of facts.”

But the Court was not pleased with the IRS:

But there may be a problem for the Commissioner – this reasoning didn’t make it into the notice of determination …”

The “notice of determination” comment is the Court saying the files were sloppy. The IRS must do certain things in a certain order, especially with OICs. Sloppy won’t cut it.

Home Equity

The W’s had offered to provide additional information on the loan terms, the deferred repairs to the house, the unwillingness of the banks to refinance.

The IRS worked from assessed values.

It is like the two were talking past each other.

Here is the Court:

The IRS does need to take problems with possible refinancing a home seriously.”

The Whittakers have a point – there’s nothing in the administrative record that states or even suggests that the examiner at the Unit or the settlement officer during the CDP hearing asked for any information in addition to the appraised value.”

There is no evidence in the record of any consideration of the Whittakers’ arguments on this point.”

Oh, oh.

Here is the first slam:

We therefore find that the settlement officer’s conclusion about the Whittaker’s ability to tap the equity in their home was clearly erroneous on this record. This makes her reliance on that equity in her RCP calculations an abuse of discretion.”

COVID

The W’s had alerted the IRS that Mr. W had completely retired and Mrs. W was working only two weekends a month. The SO disregarded the matter, reasoning that the W’s had enough pension income to compensate.

Which pension, you ask? Would that include the pension the SO unilaterally increased from $1,394 to $2,253 monthly?

The Commissioner now concedes that the settlement officer was mistaken, and that Mr. Whittaker had a military pension of only $1,394 per month.”

Oops.

There was the second slam.

The IRS – perhaps embarrassed – went on to note that the Mall of America opened after being COVID-closed for three months. Speaking of COVID, the lockdown had inspired a nationwide surge in demand for fitness equipment. Say …, wasn’t Mr. W a personal fitness trainer?

The Court erupted:

Upholding the rejection of the Whittakers’ offer because Mrs. Whittaker’s mall job may have resumed or Mr. Whittaker might be able to run a training business using potential clients’ possible pandemic purchases is entirely speculative.”

True that.

The settlement officer ‘did not think that the loss of the Whittaker’s wage income or self-employment income … sufficiently mattered to justify reworking the Offer Worksheet.’”

The Court was getting heated.

The settlement officer’s explicit refusal to rework the worksheet despite the very considerable discrepancy in the calculation before and after the pandemic is a clear error and thus an abuse of discretion.”

The Court remanded the matter back to IRS Appeals with clear instructions to get it right. It explicitly told the IRS to consider the material change in the Ws’ circumstances – changes that happened during the CDP hearing itself - and their ability to pay.

We said earlier “almost futile.” We did not say futile. The Ws won and are headed back to IRS Appeals to revisit the OIC.

Our case this time was Whittaker v Commissioner, T.C. Memo 2023-59.

Sunday, February 18, 2024

The Consistent Basis Rule

 

I was talking to two brothers last week who are in a partnership with their two sisters. The partnership in turn owns undeveloped land, which it sold last year. The topic of the call was the partnership’s basis in the land, considering that land ownership had been divided in two and the partnership sold the property after the death of the two original owners. Oh, and there was a trust in there, just to add flavor to the stew.

Let’s talk about an issue concerning the basis of property inherited from an estate.

Normally basis means the same as cost, but not always. Say for example that you purchased a cabin in western North Carolina 25 years ago. You paid $250 grand for it. You have made no significant improvements to the cabin. At this moment your basis is your cost, which is $250 grand.

Let’s add something: you die. The cabin is worth $750 grand.

The basis in the cabin resets to $750 grand. That means – if your beneficiaries sell it right away – there should be no – or minimal – gain or loss from the sale. This is a case where basis does not equal cost, and practitioners refer to it as the “mark to market,” or just “mark” rule, for inherited assets.

There are, by the way, some assets that do not mark. A key one is retirement assets, such as 401(k)s and IRAs.

A possible first mark for the siblings’ land was in the 1980s.

A possible second mark was in the aughts.

And since the property was divided in half, a given half might not gone through both marks.

There is something in estate tax called the estate tax exemption. This is a threshold, and only decedents’ estates above that threshold are subject to tax. The threshold for 2024 is $13.6 million per person and is twice that if one is married.

That amount is scheduled to come down in 2026 unless Congress changes the law. I figure that the new amount will be about $7 million. And twice that, of course, if one is married.

COMMENT: I am a tax CPA, but I am not losing sleep over personal estate taxes.

However, the exemption thresholds have not always been so high. Here are selected thresholds early in my career: 

Estate Tax

Year

Exclusion

1986

500,000

1987- 1997

600,000

1998

625,000

I would argue that those levels were ridiculously low, as just about anyone who was savings-minded could have been exposed to the estate tax. That is – to me, at least – absurd on its face.

One of our possible marks was in the 1980s, meaning that we could be dealing with that $500,000 or $600,000 estate threshold.

So what?

Look at the following gibberish from the tax Code. It is a bit obscure, even for tax practitioners.

Prop Reg 1.1014-10(c):

               (3) After-discovered or omitted property.

(i)  Return under section 6018 filed. In the event property described in paragraph (b)(1) of this section is discovered after the estate tax return under section 6018 has been filed or otherwise is omitted from that return (after-discovered or omitted property), the final value of that property is determined under section (c)(3)(i)(A) or (B) of this section.

(A) Reporting prior to expiration of period of limitation on assessment. The final value of the after-discovered or omitted property is determined in accordance with paragraph (c)(1) or (2) of this section if the executor, prior to the expiration of the period of limitation on assessment of the tax imposed on the estate by chapter 11, files with the IRS an initial or supplemental estate tax return under section 6018 reporting the property.

(B) No reporting prior to expiration of period of limitation on assessment. If the executor does not report the after-discovered or omitted property on an initial or supplemental Federal estate tax return filed prior to the expiration of the period of limitation on assessment of the tax imposed on the estate by chapter 11, the final value of that unreported property is zero. See Example 3 of paragraph (e) of this section.

(ii) No return under section 6018 filed. If no return described in section 6018 has been filed, and if the inclusion in the decedent's gross estate of the after-discovered or omitted property would have generated or increased the estate's tax liability under chapter 11, the final value, for purposes of section 1014(f), of all property described in paragraph (b) of this section is zero until the final value is determined under paragraph (c)(1) or (2) of this section. Specifically, if the executor files a return pursuant to section 6018(a) or (b) that includes this property or the IRS determines a value for the property, the final value of all property described in paragraph (b) of this section includible in the gross estate then is determined under paragraph (c)(1) or (2) of this section.

This word spill is referred to as the consistent basis rule.

An easy example is leaving an asset (intentionally or not) off the estate tax return.

Now there is a binary question:

Would have including the asset in the estate have caused – or increased – the estate tax?

If No, then no harm, no foul.

If Yes, then the rule starts to hurt.

Let’s remain with an easy example: you were already above the estate exemption threshold, so every additional dollar would have been subject to estate tax.

What is your basis as a beneficiary in that inherited property?

Zero. It would be zero. There is no mark as the asset was not reported on an estate tax return otherwise required to be filed.

If you are in an estate tax situation, the consistent basis rule makes clear the importance of identifying and reporting all assets of your estate. This becomes even more important when your estate is not yet at – but is approaching – the level where a return is required.

At $13.6 million per person, that situation is not going to affect many CPAs.

When the law changes again in a couple of years, it may affect some, but again not too many, CPAs.

But what if Congress returns the estate exemption to something ridiculous – perhaps levels like we saw in the 80s and 90s?

Well, the consistent basis rule could start to bite.

What are the odds?

Well, this past week I was discussing the basis of real estate inherited in the 1980s.

What are the odds?

Sunday, July 5, 2020

Requesting A Payment Plan With Over $7 Million In The Bank


Sometimes I wonder how people get themselves into situations.

Let’s take a look at a recent Tax Court case. It does not break new ground, but it does remind us that – sometimes – you need common sense when dealing with the IRS.

The Strashny’s filed their 2017 tax return on time but did not pay the tax due.
COMMENT: In and of itself, that does not concern me. The penalty for failing to file a tax return is 10 ten times more severe than filing but not paying. If the Strashny’s were my client and had no money, I would have advised the same.
The 2017 return had tax due, including interest, of over $1.1 million.
COMMENT: Where did the money go? I am curious now.
In June, 2018 the IRS assessed the tax along with a failure-to-pay penalty.

In July, 2018 the Strashny’s sent an installment payment request. Because of the amount of money involved, they had to disclose personal financial information (Form 433-A). They wanted to stretch the payments over 72 months.
COMMENT: Standard procedure so far.
Meanwhile the IRS sent out a Notice of Intent to Levy letter (CP90), which seemed to have upset the Strashny’s.

A collection appeal goes before an IRS officer settlement officer (or “SO,” in this context). In April, 2019 she sent a letter requesting a conference in May.
COMMENT: Notice the lapsed time – July, 2018 to April, 2019. Yep, it takes that long. It also explains while the IRS sent that CP90 (Notice of Intent to Levy): they know the process is going to take a while.
The taxpayers sent and the SO received a copy of their 2018 tax return. They showed wages of over $200,000.

OK, so they had cash flow.

All that personal financial information they had sent earlier showed cryptocurrency holdings of over $7 million. Heck, they were even drawing over $19,000 per month on the account.

More cash flow.
COMMENT: Folks, there are technical issues in this case, such as checking or not checking a certain box when requesting a collection hearing. I am a tax nerd, so I get it. However, all that is side noise. Just about anyone is going to look at you skeptically if you cite cash issues when you have $7 million in the bank.
The SO said no to the payment plan.

The Strashny’s petitioned the Tax Court.
COMMENT: Notice that this case does not deal with tax law. It deals, rather, with tax procedure. Procedure established by the IRS to deal with the day-to-day of tax administration. There is a very difficult standard that a taxpayer has to meet in cases like this: the taxpayer has to show that the IRS abused its authority.
The Strashny’s apparently thought that the IRS had to approve their request for a payment plan.

The Court made short work of the matter. It reasoned that the IRS has (with limited exceptions) the right to accept or reject a payment plan. To bring some predictability to the process, the IRS has published criteria for its decision process. For example, economic hardship, ill health, old age and so on are all fair considerations when reviewing a payment plan.

What is not fair consideration is a taxpayer’s refusal to liquidate an asset.

Mind you, we are not talking a house (you have to live somewhere) or a car (you have to get to work). There are criteria for those. We are talking about an investment portfolio worth over $7 million.

The Court agreed with the IRS SO.

So do I.

Was there middle ground? Yes, I think so. Perhaps the Strashny’s could have gotten 12 or 24 months, citing the market swings of cryptocurrency and their concern with initiating a downward price run. Perhaps there was margin on the account, so they had to be mindful of paying off debt as they liquidated positions. Maybe the portfolio was pledged on some other debt – such as business debt – and its rash liquidation would have triggered negative consequences. That approach would have, however, required common sense – and perhaps a drop of empathy for the person on the other side of the table – traits not immediately apparent here.

They got greedy. They got nothing.

Our case this time was Strashny v Commissioner.

Sunday, August 18, 2019

You Sell Your Lottery Winnings


I was looking at a case where someone won the New York State Lottery.

I could have worse issues, methinks.

But there was a tax issue that is worth talking about.

Let’s say you won $17.5 million in the lottery.

You elect to receive it 26 years.

          QUESTION: How is this going to be taxed?

Easy enough: the tax Code considers lottery proceeds to be the same as gambling income. It will be taxed the same as a W-2 or an IRA distribution. You will pay ordinary tax rates. You will probably be maxing the tax rates, truthfully.

Let’s say you collected for three years and then sold the remaining amounts-to-be-received for $7.1 million.

          QUESTION: How is this going to be taxed?

I see what you are doing. You are hoping to get that $7.1 million taxed at a capital gains rate.

You googled the definition of a capital asset and find the following:

            § 1221 Capital asset defined.

(a)  In general.
For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include-
(1)  stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167 , or real property used in his trade or business;
(3) a patent, invention, model or design (whether or not patented), a secret formula or process, a copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, held by-
(A)  a taxpayer whose personal efforts created such property,
(B)  in the case of a letter, memorandum, or similar property, a taxpayer for whom such property was prepared or produced, or
(C)  a taxpayer in whose hands the basis of such property is determined, for purposes of determining gain from a sale or exchange, in whole or part by reference to the basis of such property in the hands of a taxpayer described in subparagraph (A) or (B) ;
(4) accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1) ;
(5) a publication of the United States Government (including the Congressional Record) which is received from the United States Government or any agency thereof, other than by purchase at the price at which it is offered for sale to the public, and which is held by-
(A)  a taxpayer who so received such publication, or
(B)  a taxpayer in whose hands the basis of such publication is determined, for purposes of determining gain from a sale or exchange, in whole or in part by reference to the basis of such publication in the hands of a taxpayer described in subparagraph (A) ;
(6) any commodities derivative financial instrument held by a commodities derivatives dealer, unless-
(A)  it is established to the satisfaction of the Secretary that such instrument has no connection to the activities of such dealer as a dealer, and
(B)  such instrument is clearly identified in such dealer's records as being described in subparagraph (A) before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe);
(7) any hedging transaction which is clearly identified as such before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe); or
(8) supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer.

Did you notice how this Code section is worded: a capital asset is property that is not …?

You don’t see anything there that looks like your lottery, and you are thinking maybe you have a capital asset. The sale of a capital asset gets one to capital gains tax, right?

You call me with your tax insight and planning.

If tax practice were only that easy.

You see, over the years the Courts have developed doctrines to fill-in the gaps in statutory Code language.

We have spoken of several doctrines before. One was the Cohan rule, named after George Cohan, who showed up at a tax audit long on deductions and short on supporting documentation.  The Court nonetheless allowed estimates for many of his expenses, reasoning that the Court knew he had incurred expenses and it would be unreasonable to allow nothing because of inadequate paperwork.

Congress felt that the Cohan rule could lead to abuses when it came to certain expenses such as meals, entertainment and travel. That is how Code section 274(d) came to be: as the anti-Cohan rule for selected expense types. No documentation means no deduction under Sec 274(d).

Back to our capital gains.

Look at the following language:
We do not see here any conversion of a capital investment. The lump sum consideration seems essentially a substitute for what would otherwise be received at a future time as ordinary income."
The substance of what was assigned was the right to receive future income. The substance of what was received was the present value of income which the recipient would otherwise obtain in the future. In short, consideration was paid for the right to receive future income, not for an increase in the value of the income-producing property."

This is from the Commissioner v PG Lake case in 1958.

The Court is describing what has come to be referred to as the “substitute for ordinary income” doctrine.

The easiest example is when you receive money right now for a future payment or series of future payments that would be treated as ordinary income when received.

Like a series of future lottery payments.

Mind you, there are limits on this doctrine. For example, one could argue that the value of a common stock is equal to its expected stream of future cash payments, whether as dividends or in liquidation. When looked at in such light, does that mean that the sale of stock today would be ordinary and not capital gain income?

The tax nerds would argue that it is not the same. You do not have the right to those future dividends until the company declares them, for example. Contrast that to a lottery that someone has already begun collecting. There is nothing left to do in that case but to wait for the mailman to come with your check.

I get the difference.

In our example the taxpayer got to pay ordinary tax rates on her $7.1 million. The Court relied on the “substitute for ordinary income” doctrine and a case from before many of us were born.

Our case this time was Prebola v Commissioner, TC Memo 2006-240.

Sunday, April 7, 2019

You Inherit. Can You Owe Estate Tax?


I came across an estate tax lien case the other day.

It has become unlikely that one will owe estate tax, as the lifetime exclusion has now gone over $11 million. Still, it can and does happen.

The federal estate tax is an odd beast. It is a combination of assets owned or controlled at death, increased by an addback for reportable lifetime gifts. This system is called a “unified” tax, and the intent is to not avoid the estate tax by giving property away to family over the course of a lifetime. In truth, the addback is necessary, as tax planners (including me) would drive an 18-wheeler through the estate tax if the lifetime-gift addback did not exist.

There is a potential trap if the estate tax kicks-in.

Let me give you a scenario, very loosely based on the case.  

Mr Arshem was successful. He created and funded a family limited partnership with real estate, stock and securities. He began a multi-year gifting sequence to his children, each time claiming a generous discount for lack of control and marketability. He had cumulatively gifted away $5 million in this manner.

He passed away early in 2019. He died with an estate of $6 million.

On first pass, $6 million plus $5 million equals $11 million. He is just under the threshold, so he should not have an estate tax issue – right?

Not so fast.

The IRS audits one or more of those gift tax returns. They argue that the discounts were too generous, and the reportable gifts were actually $8 million. The estate disagrees; they go to Court; the estate loses.

Now we have $8 million plus $5 million for $13 million.

There is an estate tax filing requirement.

And estate tax due.

Let’s say that the estate had been probated and closed. There no estate assets remaining.

Who pays the tax?

Look over this little beauty:
§ 6324 Special liens for estate and gift taxes.
(a)  Liens for estate tax.
Except as otherwise provided in subsection (c) -
(1)  Upon gross estate.
Unless the estate tax imposed by chapter 11 is sooner paid in full, or becomes unenforceable by reason of lapse of time, it shall be a lien upon the gross estate of the decedent for 10 years from the date of death, except that such part of the gross estate as is used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof, shall be divested of such lien.
(2)  Liability of transferees and others.
If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees' trust which meets the requirements of section 401(a) ), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent's death, property included in the gross estate under sections 2034 to 2042 , inclusive, to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax.

It is not the easiest of reading.

What (a)(2) means is that the IRS can after the transferees – the children of Mr Arshem in our example. There is also a sneaky twist. Income tax liens have to be recorded; estate tax liens do not. They are referred to as “silent” liens and can create unexpected – and unpleasant – surprises.  You cannot go to the courthouse and research if one exists.

What if Arshem’s children received his assets and thereafter sold them? What happens to the lien?

The children are “transferees.” They are personally liable for the estate tax.
COMMENT: There are procedures to possibly mitigate this consequence, but we will pass on their discussion in this post.
The case is U.S. v Ringling. The moral of the story is – if the estate is large enough to draw the wrath of the federal estate tax – please consult an experienced professional. Think of it as insurance.


Tuesday, December 29, 2015

Talking Expatriation (And A Little Latin)



A friend contacted me recently. He was calling to discuss the tax issues of expatriating. As background, there are two types of expatriation. The first is renouncing citizenship, which he is not considering. The second is simply living outside the United States. One remains an American, but one lives elsewhere.

It is not as easy as it used to be. 

I have, for example, been quite critical of Treasury and IRS behavior when it comes to Americans with foreign bank accounts. If you or I moved overseas, one of the first things we would do is open a bank account. As soon as we did, we would immediately be subject to the same regime as the U.S. government applies to the uber-wealthy suspected of stashing money overseas.  

Some aspects of the regime include:

(1) Having to answer questions on your tax return about the existence of foreign accounts. By the way, lying is a criminal offense, although filing taxes is generally a civic matter.
(2) Having to complete a schedule to your tax return listing your foreign financial and other assets. Move here from a society that has communal family ownership of assets and you have a nightmare on your hands. What constitutes wealthy for purposes of this schedule? Let’s start at $50,000, the price of a (very) nice pickup truck.
(3) Having to file a separate report with the Department of Treasury should you have a foreign bank account with funds in excess of $10,000. The reporting also applies if it is not your account but you nonetheless have authority to sign: think about a foreign employer bank account. It should be fun when you explain to your foreign employer that you are required to provide information on their account to the IRS.
(4) Requiring foreign banks to both obtain and forward to the IRS information about your accounts. Technically the foreign banks have a choice, but fail to make the “correct” decision and the IRS will simply keep 30% of monies otherwise going to them.

To add further insult, all this reporting has some of the harshest penalties in the tax Code. Fail to file a given tax form, for example, and take a $10,000 automatic penalty. Fail to file that report with the Treasury Department and forfeit half of your account to the government.

Now, some of this might be palatable if the government limited its application solely to the bigwigs. You know the kind: owners of companies and hedge fund managers and inherited wealth. But they don’t. There cannot be ten thousand people in the country who have enough money overseas to justify this behavior, so one is left wondering why the need for overreach. It would be less intrusive (at least, to the rest of us 320 million Americans) to just audit these ten thousand people every year. There is precedence: the IRS already does this with the largest of the corporations.

Did you know that – if you fail to provide the above information – the IRS will deem your tax return to be “frivolous?” You will be lumped in there with tax protestors who believe that income tax is voluntary and, if not, it only applies to residents of the District of Columbia.

There is yet another penalty for filing a frivolous return: $5,000. That would be on top of all the other penalties, of course. It’s like a party.

Many practitioners, including me, believe this is one of the reasons why record numbers of Americans overseas are turning-in their citizenship. There are millions of American expats. Perhaps they were in the military or foreign service. Perhaps they travelled, studied, married a foreign national and remained overseas. Perhaps they are “accidental” Americans – born to an American parent but have never themselves been to the United States. Can you imagine them having a bank close their account, or perhaps having a bank refuse to open an account, because it would be too burdensome to provide endless reams of information to a never-sated IRS? Why wouldn’t the banks just ban Americans from opening an account? Unfortunately, that is what is happening.

So I am glad to see the IRS lose a case in this area.

The taxpayer timely filed his 2011 tax return. All parties agreed that he correctly reported his interest and dividend income. What he did not do was list every interest and dividend account in detail and answer the questions on Schedule B (that is, Interest and Dividends) Part III. He invoked his Fifth Amendment privilege against self-incrimination, and he wrote that answering those questions might lead to incriminating evidence against him.


Not good enough. The IRS assessed the penalty. The taxpayer in response requested a Collections Due Process Hearing.

Taxpayer said he had an issue: a valid Fifth Amendment claim. The IRS Appeals officer did not care and upheld the penalty.

Off to Tax Court they went.

And the Court reviewed what constitutes “frivolous” for purpose of the Section 6702 penalty:

(1) The document must purport to be a tax return.
(2) The return must either (i) omit enough information to prevent the IRS from judging it as substantially correct or (ii) it must clearly appear to be substantially incorrect.
(3) Taxpayer’s position must demonstrate a desire to impede IRS administration of the tax Code.

The first test is easy: taxpayer filed a return and intended it to be construed as a tax return.

On to the second.

Taxpayer failed to provide the name of only one payer. All parties agreed that the total was correct, however. The IRS argued that it needed this information so that it may defend the homeland, repair roads and bridges and present an entertaining Super Bowl halftime show. The Court asked one question: why? The IRS was unable to give a cogent reply, so the Court considered the return as filed to be substantially correct.

The IRS was feeling froggy on the third test. You see, the IRS had previously issued a Notice declaring that even mentioning the Fifth Amendment on a tax return was de facto evidence of frivolousness. Faciemus quod volumus [*], thundered the IRS. The return was frivolous.

The Court however went back and read that IRS notice. It brought to the IRS’ attention that it had not said that omitting some information for fear of self-incrimination was frivolous. Rather it had said that omitting “all” financial information was frivolous. You cannot file a return with zeros on every line, for example, and be taken seriously. That however is not what happened here.

The IRS could not make a blanket declaration about mentioning the Fifth Amendment because there was judicial precedence it had to observe.  Previous Courts had determined that a return was non-frivolous if the taxpayer had disclosed enough information (while simultaneously not disclosing so much as to incriminate himself/herself) to allow a Court to conclude that there was a reasonable risk of self-incrimination.

The Court pointed out the following:

(1) The taxpayer provided enough information to constitute an accurate return; and
(2) The taxpayer provided enough information (while holding back enough information) that the Court was able to conclude that he was concerned about filing an FBAR. The questions on Schedule B Part III could easily be cross-checked to an FBAR. Given that willful failure to file a complete and accurate FBAR is a crime, the Court concluded that the taxpayer had a reasonable risk of self-incrimination.

The Court dismissed the penalty.

The case is Youssefzadeh v Commissioner, for the at-home players.

I am of course curious why the taxpayer felt that disclosure would be self-incrimination. Why not just file a complete and accurate FBAR and be done with it? Fair enough, but that is not the issue. One would expect that an agency named the Internal “Revenue” Service would task itself with collecting revenue. In this instance, all revenue was correctly reported and collected. With that backdrop, why did the IRS pursue the matter? That is the issue that concerns me. 

[*] Latin for “we do what we want”