Tuesday, March 27, 2012
We are visiting state taxation today. Our trip this time will take us to New Jersey, and it will highlight how tax law can simultaneously arrive at a technically correct but bumble-headed conclusion.
Let’s say you manufacture parts in New Jersey. Would you expect to file and pay state income tax to New Jersey?
That one is easy - of course. You are doing business there – in the meaningful sense of the phrase. You have a building, you have employees. You park your car out front. You visit Chipotle for lunch. You are there.
Let’s make this more challenging. You do not manufacture parts. You do not manufacture anything. You develop software. Your offices are in Rockville, Maryland. You do not have offices in New Jersey. You do not park your car in New Jersey or visit their Chipotle for lunch. You are not there. You have an employee who moves to New Jersey. You like her. You keep her on board.
Like a Jim Croce song, you have a name. Your name is Telebright.
Let’s have her work from her new home. She begins her workday at 9:00 a.m. by checking with her project manager, who is based in Boston. She receives daily work assignments. When done, she uploads her work and sends it to you. She is expected to work 40 hours a week. She could live on the moon, for what location matters to her work.
She does not solicit customers. She does not have sales responsibility. She does not refresh products, or stock shelves, or install, or service. She does not supervise employees. She does not have management authority. You do not even reimburse for her office-in-home. She travels twice a year to Maryland. By the way, you do not pay for the travel – rather she pays for those trips out of her own pocket.
You – being enlightened – take New Jersey withholding taxes out of her paycheck so that she has no rude April 15th surprise.
New Jersey surfaces, somewhat like the mutant alligator in a bad Sci-Fi network movie. New Jersey says that you are doing business in the state, and it wants you to … (wait on it) … pay corporate income taxes!
The case goes before the New Jersey Tax Court. The court cites the New Jersey statute:
Every domestic or foreign corporation which is not hereafter exempted shall pay an annual franchise tax for each tax year, as hereafter provided … for the privilege of doing business , [or] employing or owning capital or property … in this state.”
The Court then reflects philosophically:
The term ‘doing business’ is used in a comprehensive sense and includes all activities which occupy the time or labor of men for profit.”
It rolls up its sleeves and grittily reviews the law (N.J.A.C. 18:7-1.9(b)):
Whether a foreign corporation is doing business in New Jersey is determined by the factors in each case. Consideration is given to such factors as:
(4) The employment in New Jersey of agents, officers and employees.”
Oh, oh. This is going to go wrong, isn’t it? Or is it possible the court will recognize that a lone employee in the state hardly amounts to a corporate beachhead? Here is the Court:
There is no one, single controlling factor nor is there a bright line standard that determines whether a foreign corporation’s in-state activities meet the Director’s regulatory requirements for doing business. Rather, it is only by close scrutiny of all the facts of the case, taken as a whole, that a final determination can be made. ”
It then digs in like a free agent seeking a new sports contract and drives for the bright line.
It cannot be disputed that plaintiff satisfies factor 4 … by employing Ms. … in New Jersey.”
[Telebright] agreed to permit Ms. … regularly to perform her duties at her New Jersey home.”
This consistent contact with New Jersey was not sporadic, occasional or intermittent.”
But the Court pauses. Will it realize that you are being a good sport for even keeping her employed after the move? Will it acknowledge that this is not a 19th century economy, when a county seat could not be more than a day’s travel for any resident of the county? It hesitates:
“While it is true that [Telebright] has never maintained an office in New Jersey, nor solicited business here ….”
No! Not now Tax Court of New Jersey! You are so close!
The Court shakes it off:
… [its] daily contact with the State through its employee is sufficient to trigger application of the CBT Act.”
The mere fact that Ms. … is the only … employee in this State does not change the court’s decision.”
Yes, the court determined that Telebright was responsible for New Jersey corporate tax because it permitted an employee to work from her home in New Jersey.
Why does this upset me?
One reason is that reasoning like this would have me filing taxes with India if I hired an on-line bookkeeper there.
Another reason is that I have read court decisions like this for more than two decades now. After a while it is like watching WWE wrestling – there really isn’t much suspense about who is going to win. There was a time when a state at least tried to develop coherent doctrines and workable principles. In recent years however state tax has become more like a hijacking on a Sopranos episode.
Another reason is this is an employee-hostile decision.
I have a friend and client, for example, who lives in Kentucky and commutes to California. Yes, you read that right. He works a week here in Kentucky and a week near San Francisco. He is situated well enough at the company that he floated the idea of having an “office” here. The company turned him down. Why? Because they do not have a footprint in Kentucky and his “office” could create one. So he commutes every other week to California. I suspect he may be their only Kentucky-resident employee.
If you were Telebright, what would you do? Would you not permit your employee to work from home, never mind the reasons? Would you even keep her as an employee?
Who gains here? Tony … er, Trenton gets a few dollars from its next mark … er, taxpayer. Who loses? For now, the company loses. In the future, the loser will be the next employee who wants to work from a New Jersey residence for an out-of-state company whose tax advisor has read Telebright.
Wednesday, March 21, 2012
Another one of the tax resolution chains is going out of business. The newest one is TaxMasters, whose commercials featured a red-headed and -bearded fellow. That fellow was Patrick Cox, the CEO. TaxMasters had battled the attorneys general of Texas and Minnesota for fraudulent practices. I am reading that Texas had accused them of not commencing work for their clients until TaxMasters was fully-paid. So much for deadlines. Did you know that they were publicly-traded?
They follow on the heels of JK Harris, which was based out of South Carolina and filed for bankruptcy last October. JK Harris had been battling the attorneys general of Texas, West Virginia and Missouri.
Before JK Harris was Roni “Tax Lady” Deutch, who was sued by California, forfeited her law license and closed shop. She had done an “Arthur Andersen” and shredded documents. Nice.
I work tax representation, and I am not particularly surprised by the fate of these companies. They were working a specific area of representation – collections. Why? Many taxpayers first take the matter seriously only when the IRS sends them a letter indicating intent to lien or levy.
I cannot begin to tell you how many times I have heard the refrain “What are they going to do to me? Put me in jail?” No, they will not put you in jail unless you crossed the line into criminal tax. They will take your stuff, however. We presently have a revenue officer here in Cincinnati who seems quite determined to take a client’s house, for example. At that moment those late-night commercials promising pennies-on-the-dollar sound appealing and one is willing to suspend disbelief. Don’t. If it were true I would have reduced my own taxes to pennies-on-the-dollar.
How can tax representation fit into a publicly-traded company? I am at a loss. There is no way I could do what I do being constantly worried about quarterly earnings and stock performance. Hey, sometimes it takes a client forever to assemble paperwork, or an examiner is unreasonable, or every issue goes to Appeals, or we spend time fending off an overly-aggressive revenue officer. We are not profitable on that engagement. It is part of practice. We do not rock the house every time.
My advice? If you are in a collection situation, find a local practitioner who works tax representation. Please stay away from those national tax warehouses. Ask yourself: who is paying for this airtime? You know better.
Sunday, March 18, 2012
The IRS this past Wednesday issued proposed regulations requiring taxpayers with employer identification numbers (EINs) to update them periodically with the IRS.
EINs are issued to businesses, trusts and estates.
What the IRS is concerned about is listing nominees on the original EIN application as officers, partners and what not. The nominee’s authority to act and represent thereafter expires, sometimes as soon as the EIN is received, thus obscuring the true ownership of the entity.
The IRS will be revising its application form – the SS-4 – to identify when a nominee or agent is obtaining an EIN for a principal. The IRS will refer to such nominee as a “responsible party.”
The IRS also states that it will provide further rules on updating EINs – such as forms and frequency - in the future.
Saturday, March 17, 2012
Harry Reid introduced an amendment to a transportation bill before the Senate. The provision allows the Secretary of State to deny or revoke a passport if you owe taxes. Here is the language:
SEC. 7345. REVOCATION OR DENIAL OF PASSPORT IN CASE OF CERTAIN TAX DELINQUENCIES.
(a) IN GENERAL.
If the Secretary receives certification by the Commissioner of Internal Revenue that any individual has a seriously delinquent tax debt in an amount in excess of $50,000, the Secretary shall transmit such certification to the Secretary of State for action with respect to denial, revocation, or limitation of a passport pursuant to section 4 of the Act entitled ‘An Act to regulate the issue and validity of passports, and for other purposes’, approved July 3, 1926 (22 U.S.C. 211a et seq.), commonly known as the ‘Passport Act of 1926’.
Would you believe this nonsense PASSED the Senate? It now goes to the House, which hopefully has more common sense. The current transportation authorization expires at the end of March, so I suppose something will pass.
Do these people scare you – even a little bit?
Friday, March 16, 2012
I am starting to like Nina Olson, the National Taxpayer Advocate.
I have been negative on the IRS program called the Offshore Voluntary Disclosure Program (OVDI). This was the government reaction to the UBS and offshore bank account scandals. That however was tax fraud committed by the extraordinarily wealthy. My background has been the Foreign Service and expat community, primarily because my wife is the daughter of a (retired) Foreign Service officer. These are rather ordinary folk who just happen to live overseas.
Tax advisors who work this area know that the IRS pulled a bait-and-switch a year ago - on March, 2011 - with taxpayers trying to comply with the freshly-resurrected foreign reporting requirements. The FBAR has, for example, been out there since at least the early 70s, but at no time did Treasury want to confiscate 50% or more of your highest account balance for not filing a one-page form. The IRS was waist-deep with 2009 OVDI and had previously encouraged taxpayers to enter the program with lures of reduced penalties for non-willful violations.
EXAMPLE: You have expatriated to Costa Rica. You have next-to-no ties in the United States and pay little attention to tax developments here. You have even learned to like soccer (but why?). The requirement to file an FBAR comes as quite the surprise to you. You first thought it absurd that such reporting would apply to the most ordinary of taxpayers. Surely that is for rich people only. You have to qualify as non-willful, right?
Then last March the IRS trotted-out a memo directive that it would not consider non-willfulness, reasonable cause, or the mitigation guidelines in applying the offshore penalty. Let me phrase that a different way: the IRS instructed its examiners to assume that the violation was willful unless the taxpayer could prove that it was not. Would you further believe that, at first, the memo was kept secret?
Huh? Are you kidding? O.J. Simpson received more “benefit of the doubt” than the IRS was willing to provide.
Then in August Nina Olson issued a Taxpayer Advocate Directive ordering IRS division commissioners to revoke this position and direct examiners to live up to their own promises to thousands of affected taxpayers. The IRS division commissioners blew her off.
Tax Analysts now reports that the main IRS commissioner – Douglas Shulman – has no intention of responding to Nina Olson on this matter. To aggravate the matter, there is a statutory requirement that the IRS commissioner respond to the Taxpayer Advocate within 90 days. Do laws mean nothing to this crowd?
Is this a specialized tax area? Yes. Does it have greater import? I believe it does. It does because the tax attorney and tax CPA community – people such as me – pay attention, and this behavior diminishes confidence in the IRS and any trust in its word. The consequences are subtle, injurious and lasting. And for what purpose? To extract a penalty from someone whose only crime was not paying attention to increasingly obscure and inane U.S. tax law?
Thursday, March 15, 2012
Here is another one of those tax cases where you wonder how it got so far. Let’s set this up:
(1) say that you are self-employed, and
(2) you lost money, so you have a net operating loss carryover; and
(3) you fail to file a later year tax return, and
(4) the IRS prepares one for you, and
(5) you owe a lot of tax, and
(6) you ignore matters until you receive the statutory notice of deficiency, and
(7) you clue the IRS that you have an NOL carryover, which reduces but does not eliminate your tax, and
(8) the IRS still wants some tax (both income and self-employment) from you, and
(9) you disagree because the you think the NOL reduced both your taxable income and self-employment income, and
(10) the IRS wants to know where in the tax code it says you can do that.
To understand what is happening here, think of your income tax and your self-employment tax as side-by-side railroad tracks. You use the same numbers to calculate how much is subject to income tax and to employment tax, but there comes a point where the tracks diverge. In our situation, that point is the net operating loss. There is no question you get a deduction for the NOL on your income taxes, but what is the answer for your self-employment taxes? Remember: different tracks = different trains.
Did I mention that you are an accountant?
So you are now preparing for the Tax Court. While preparing you come across this sharp rock from the tax code:
1402(a) Net Earnings from Self-Employment – The term “net earnings from self-employment” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed…; except that….
(4) the deduction for net operating losses provided in section 172 shall not be allowed.
Oh no. Now what do you do? Well, our taxpayer (Joseph DeCrescenzo v Commissioner T.C. Memo 2012-51) comes up with a two-pronged attack:
(1) Argue that the IRS cannot raise the issue because they did not raise the issue in the notice of deficiency. The problem with this is … that they did by including the NOL in the notice.
(2) And even if the IRS did, it was not binding on you because you suffer from acute anxiety disorder.
You can probably guess that this did not turn out well for the taxpayer. It cost him over $70,000 in penalties (late filing, late payment and etc.) alone.
It would have been much cheaper to have hired a competent tax CPA.
Wednesday, March 14, 2012
He is known for an NFL playoff game in 2004. The Eagles were playing Green Bay. It was fourth quarter. The Eagles were trailing with 1:12 remaining, 4th down and 26 yards to go for a first down. NFL fans call this a “long shot.” He ran a slant, the Green Bay Cover 2 defense broke down, and Donovan McNabb connected with him for a 26-yard play. The play set up a David Akers field goal, which led to overtime, which led to a win for the Eagles.
The player? Freddie Mitchell, a wide receiver.
Why are we talking about him? Because he is likely to go to jail for tax fraud.
Freddie associated himself with two people – Jamie Russ-Walls and her husband, Richard Walls. Jamie fancied herself a tax expert. For a period between 2009 and 2010, Freddie used his football contacts to lure unsuspecting athletes to Jamie, who promised them all kinds of tax refunds because she was – well, a tax expert! She and her husband prepared returns claiming refunds between $170,000 and $1.9 million. They were not deterred by things like actual W-2s. No sir. They would forge W-2s to get the refunds they promised. If not a W-2, they would manufacture a Schedule C (self-employed) to show business losses.
Freddie was the face. His job was to recruit clients.
The three had agreed to share any tax refunds they received.
These three were geniuses. What could possibly go wrong?
Freddie recruited an athlete we will call A.G. Freddie had A.G. pay $100,000 as a down payment for his 2008 tax return and 2006 and 2007 amended returns.
OBSERVATION: I have never seen a $100,000 individual income tax return. I have seen yachts with professional crews, mansions in Wyoming, airplanes, overseas residences, FLPs, rolling GRATS, skip trusts, charitable leads and a number of other high-end tax planning vehicles, but I have never seen a $100,000 individual income tax return.
Freddie and crew prepared a tax refund claim for $1,968,288.
A.G. was not the only client. The indictment cites five other tax returns claiming refunds over $2.2 million.
Tuesday, March 13, 2012
Sheldon Kay, deputy chief of IRS Appeals, stated during a February webcast that the case inventory for IRS Appeals reached 148, 000 for fiscal 2011. This is the highest it has ever been. To be fair, Appeals case closures were also at a record level, but not enough to gain ground.
A tax CPA working representation will be quite familiar with Appeals. The normal process is that a taxpayer is selected for examination, i.e. the “audit.” The audit can be through the mail, which is called a correspondence audit. The audit can be at the IRS offices, in which case you go to them. A third type is when they come to you, also called the “field” audit. You are working with a revenue agent. If you disagree you can appeal the agent’s adjustments to the agent’s supervisor, also called the “group manager.”
If you have no settlement there, you are bound for Appeals.
The cases in Appeals fall into two types: collection and exam. What we described above is exam. A collections case has normally gone through exam, and now the IRS is pressing for money. Congress gave taxpayers more protection from IRS collections in 1998 with the IRS Reform and Restructuring Act. Collections have now become half or more of the cases in Appeals.
Back to Sheldon Kay. He explained that the situation has been aggravated by IRS budget constraints. We have seen that here in Cincinnati, as the Appeals office is becoming a ghost town. It is not just the budget, though. Some long-term IRS careerists have also been retiring, reflecting incentives to retire as well as the demographic march of the Baby Boom generation.
There is also another reason. Practitioners comment among themselves that exam is experiencing a brain drain. I agree that a new hire cannot replace the experience and judgment of a career examiner. In the past, the group manager provided some continuity and savvy, but today it is possible that group manager has been there only slightly longer than the examiner. The “system” is – too often – just not working.
Whether responding to examination or collection frustrations, practitioners are taking their clients to Appeals. The frustration may be because of IRS budgetary constraints, inexperienced personnel, excessive automated collection practices, unrealistic Congressional demands or other reasons. Practitioners are seeking the more experienced personnel available in Appeals.
Monday, March 12, 2012
The IRS last week expanded its relief provisions for financially distressed taxpayers. Effective immediately, the IRS will abate its failure- to-pay penalties for 2011 taxpayers, as long as all taxes are paid by October 15, 2015. To qualify for this relief, you have to be:
· A W-2 employee and unemployed for at least 30 consecutive days in 2011 or during the 3 ½ months ending April 15,2012, or
· Self-employed and experiencing a contraction of at least 25% in 2011 business income.
The IRS was very quick to point out that this abatement is for the failure- to-pay penalty only. You still have to file a return by April 15, 2012.
NOTE: There are two “big” penalties when you do not file a return. The first is the failure-to-file penalty. The second is the failure-to-pay. Most tax advisors will counsel you to always file, even if you cannot pay. The failure-to-file penalty is 5% a month, ten times the failure-to-pay penalty of 1/2% a month.
There is a new form to request the abatement (Form 1127-A). The relief is also limited to incomes of $100,000 if you are single and $200,000 if you are married.
The other thing the IRS did is to double the income limitation for a streamlined installment agreement. The streamlined is a payment plan with the IRS. You now qualify if your assessed taxes are $50,000 or less. This is an increase from $25,000, which itself had recently been raised from $10,000. The advantage to the streamlined is that you do not have to provide financial information to the IRS.
The payment term for the streamlined was also increased – from five years to six.
Friday, March 2, 2012
This is a bit specialized, but if you have a foreign bank account it applies to you.
You may recall that you are required to file Form 90-22.1 “Report of Foreign Bank and Financial Accounts” (more commonly called the “F-Bar”) if you keep over $10,000 in a foreign bank account. It doesn’t have to be a secret Swiss account. A Canadian account will do it, for example. We have clients with Mexican real estate that also have bank accounts requiring FBARs.
You were previously required to file that form electronically starting in 2012. Chances are that meant you were going to use a tax preparer, if you were not using one already.
That electronic filing requirement has been delayed one year – until June 30, 2013.