Sunday, February 25, 2018
Let’s say that a couple divorces. The divorce decree stipulates that liability for previous federal taxes will be split 50:50. They had always filed jointly The IRS audits one or more of those earlier years and assesses additional taxes.
Question: what is each spouse’s liability?
Your first thought might be 50:50, as that is what the divorce decree says.
Our protagonists this time would find out.
Mae Asad and Sam Akel filed joint returns for 2008 and 2009. The IRS audited those years, looking at rental losses. They disallowed the losses and assessed over $30,000 in taxes and penalties.
Mae filed for innocent spouse.
Later Sam filed for innocent spouse.
NOTE: Filing for innocent spouse status means that a spouse (probably an ex-spouse, but I had a client who was still married) has been assessed taxes for which he/she does not believe he/she is responsible. The classic case is the stay-at-home spouse, the other self-employed spouse, and the stay-at-home has no participation in or knowledge of the other’s business. Think Carmela Soprano.
The IRS bounced both requests for innocent spouse.
Both ex-spouses filed with the Tax Court.
Before the hearing, the IRS conceded that Mae was responsible for 28% of the 2008 tax and 41% of the 2009 tax. Sam of course was responsible for the balance.
Seems to me that Sam might not like this deal.
I do not know how, but Mae agreed to a 50:50 split. She did not have to, mind you.
The courts have been consistent that a divorce decree is not binding on the IRS, as the IRS is not party to the divorce. A joint return means that both spouses are liable, and the IRS can go after one … or both, to the extent the IRS desires. The decree may provide for a former spouse to seek restitution against the other, but it has no impact on the IRS.
The Court accepted the IRS previous concession to Mae of 28% and 41%. It did not have to observe the divorce decree and it did not.
Then the Court reviewed the penalties of over $5,000.
But there had been a fatal flaw,
You see, Mae and Sam had filed pro se with the Tax Court. Pro se means one is going in without professional representation (not exactly correct, but close enough). It happens with small tax cases. The paperwork to get to Court and the procedural rules once there are more lenient for small cases.
Sam and Mae had not included the penalty in their petition to the Court.
The Court did not have authority to review the penalties.
But it did provide us a clear example of the downside to representing oneself pro se.
Sunday, February 18, 2018
We have spoken in the past about clients I would not accept: one with an earned income credit, for example. The tax Code requires me to go all social worker, obtaining and reviewing documents to have reasonable confidence that there is a child and said child lives in given household. There are penalties if I do not.
Did you know that I can be penalized for not signing a tax return as a paid professional? Yep, it is in Section 6694 for the home gamers.
I saw a penalty recently under Section 6701. That one is a rare bird.
The 6701 penalty can reach someone who is not a preparer but who “aids,” “assists” or “advises” with respect to information, knowing that it will be used in a material tax situation.
Here is an example: you gift majority control of your (previously) wholly-owned business to your kids. This would require a valuation, which in turn requires a valuation expert. That expert is probably not preparing the gift tax return, but the preparer of the gift tax return is relying – and heavily – on his/her work.
The penalty is $1,000 for each incident. Pray that you are not advising a corporation, as then it goes to $10,000 per incident.
The IRS recently trotted out Section 6701 in Chief Counsel Advice (CCA) 201805001. Think of a CCA as an IRS attorney advising an IRS employee on what to do.
The situation here involved a “tax-consultant engineer” who analyzed a taxpayer’s assets to determine the classification of property for depreciation purposes.
In the trade, we call this type of work “cost segregation.”
If you have enough money tied-up in certain types of depreciable assets, a “cost seg” may be a very good idea.
What drives the cost seg is an abnormally-long tax life for commercial property: usually 39 years. It is a tax fiction, divorced from any economic analysis to build or not build or from a bank decision to lend or not lend.
The grail is to “carve out” some of that 39-year property into something that can be depreciated faster. There is room. The parking lot and landscaping, for example, can be depreciated over 15 years. Upgraded wiring to run equipment can be depreciated with the equipment. The additional plumbing at a dentist’s office? Yep, that gets faster depreciation.
But it probably requires a cost seg. Realistically, an accountant can do only so much. A cost seg really needs an engineer.
The engineer in this CCA must have left the plot, as the IRS was nearly out-of-its-mind over his classification into five-year property. The word they used was “egregious.”
Unfortunately, we are not told what he “egregiously” misclassified.
We are however told that he is getting the Section 6701 chop.
What is the math on this penalty?
Well, his misclassification affected five years of individual returns. The penalty would be 5 times $1,000 or $5,000 for each individual client. Hopefully this was a one-off, as $5 grand should be enough to get his attention.
Can you imagine if it had been a corporation?
Sunday, February 11, 2018
Let’s talk about miscellaneous itemized deductions - likely for the last time.
These are the deductions at the bottom of the form when you itemize, and you probably itemize if you own a house and have a mortgage. Common miscellaneous deductions include investment management fees (if someone, such as Simply Money, manages your savings) and employee business expenses.
These are the “bad” expenses that are deductible only to the extent they exceed 2% of your income (AGI), because … well, because the government wants more of your money.
I am reading a case concerning a bodyguard and his employee business expenses.
His name is Rick Colbert and he retired after 30 years from the Long Beach, California Police Department. He gigged-up with Screen International Security Service Ltd (SISS) in Beverly Hills. They assigned him celebrities. He chauffeured them, deflected paparazzi, installed and monitored security devices, patrolled their estates, performed access point control and responded to distress calls.
SISS had a reimbursement policy. It did not cover everything, but it did cover a lot. Colbert did not seek any reimbursement.
He filed his 2013 tax return and reported SISS income of $25,546.
He then deducted employee business expenses of $23,965.
COMMENT: One can tell he is not in it for the money.
Those numbers are out-of-whack, and the IRS audited him. Like the IRS we know and love, they bounced all of his employee business expenses, arguing that he had not substantiated anything.
On to Tax Court they went.
The Court went through the list of expenses:
(1) $211,154 for a pistol and target practice.
Looks legit, said the Court.
(2) $86 for earbuds
To avoid annoying celebrities.
The Court grinned. OK.
(3) $1,711 for clothing and dry cleaning
Nope said the Court.
We have talked about this before. If you can wear the clothing about town and day-to-day, there is no deduction. It is just another personal expense, unless our protagonist wanted to dress up like “Macho Man" Randy Savage.
(4) $1,609 for a gym membership, weight loss pills and other stuff.
Uhh, no, said the Court, as these are the very definition of “personal, living, or family expenses.”
(5) Office in Home
This would have been nice, be he did not use space “exclusively” for the office, which is a requirement. This would hurt a send time when the Court got to his …
(6) iPad and printer
Computers are like cars when it comes to a tax deduction: you have to keep records to document business use. The reason you never hear about this requirement is because of a significant exception – if you keep the computer in an office you can skip the records requirement.
When Colbert lost his office-in-home, he picked-up a record-keeping requirement. He lost a deduction for his iPad, printer and supplies.
(7) $5,003 for his cellphone
It did not help that his internet and television were buried in the bill.
The Court disallowed his cellphone, which amazes me. Seems to me he could have gone through his bills and highlighted what was business-related.
He won some (primarily his mileage) but lost most.
And his case is now among the last of its kind.
The new tax bill does away with employee business expenses, beginning in 2018. There is NO DEDUCTION this year.
If you have significant employee business expenses, you really, really need to arrange a reimbursement plan with your employer. Your employer can deduct them, even though you cannot. Why the difference?
Because, to your employer, they are just “business expenses.”
Saturday, February 3, 2018
I had forgotten about the conversation.
About a couple of years ago I received a call from a nonclient concerning tax issues for his charity. I normally try to help, at least with general tax issues. I rarely, if ever, help with specific tax advice. That advice is tailored to a given person or situation and should occur in a professional – and compensated – relationship.
Some accountants will not even take the call. I get their point. Tax season, for example, is notorious for nonclient phone calls saying “I just have a quick question.” Sure. Get a Masters degree, practice for 30 years and you will have your answer, Grasshopper.
This phone-call fellow was thinking about drawing payroll from a charity he had founded. It had to do with housing, and he was thinking of contributing additional rental properties he owned personally. However, those rentals provided him some sweet cash flow, and he was looking at ways to retain some of that flow once the properties were in the charity.
Got it. A little benevolence. A little self-interest. Happens all the time.
What about drawing management fees for … you know, managing the properties for the charity.
Someone has to. A charity cannot do so itself because, well, it doesn’t have a body.
Now the hard facts: the charity did not have an independent Board or compensation committee. He was reluctant to form one, as he might not be able to control the outcome. There was no pretense of a comparative compensation or fee study. He arrived at his number because he needed X-amount of money to live on.
Cue the sounds of warning sirens going off.
This is not a likely client for me. I have no problem being aggressive – in fact, I may be more aggressive than the client - but we must agree to play within the lines. Play fudge and smudge and you can find another advisor. We are not making a mutual suicide pact here.
Let’s talk about “excess benefits” and nonprofits.
The concept is simple: the assets of a nonprofit must be used to advance the charitable mission and not for the benefit of organization insiders. If the IRS catches you doing this, there is a 25% penalty. Technically the IRS calls it an “excise tax,” but we know a penalty when we see one. Fail to correct the problem in a timely fashion and the penalty goes to 200%.
That is one of the harshest penalties in the Code.
Generally speaking, an excess benefit requires two things:
(1) Someone in a position to exercise substantial influence over the charity. The term is “disqualified,” and quickly expands to others related to, or companies owned by, such people.
(2) The charity transfers property (probably cash, of course) to a disqualified person without fair value in exchange.
The second one clearly reaches someone who is paid $250,000 for doing nothing but opening the mail, but it would also reach a below-market-interest-rate loan to a disqualified person.
And the second one can become ninja-level sneaky:
When the organization makes a payment to a disqualified for services, it must contemporaneously document its intent to treat such payment as consideration for services. The easiest way to do that is by an employment contract with the issuance of a Form W-2, but there can be other ways.
Fail to do that and it is almost certain that you have an excess benefit, even if the disqualified person is truly working there and even if the payment is reasonable. Think of it as “per se”: it just is.
Yet it happens all the time. How do people get around that “automatic” problem?
There is a safe-harbor in the Code.
(1) An independent Board approves the payment in advance.
(2) Prior to approval, the Board does comparative analysis and finds the amount reasonable, based on independent data.
(3) All the while the Board must document its decision-making process. It could hire an English or History graduate to write everything down, I suppose.
Follow the rules and you can hire a disqualified.
Don’t follow the rules and you are poking the bear.
I thought my caller did not have a prayer.
Would I look into it, he asked.
Cheeky, I thought.
As I said, I forgot about the call, the caller and the “would I look into it.”
What made me think about this was a recent Tax Court decision. It involves someone who had previously organized the Association for Honest Attorneys (AHA). She had gotten it 501(c)(3) status and continued on as chief executive officer.
From its 990 series I can tell AHA is quite small.
Here is a blip from their website:
However, our C.E.O. has 40+ years experience, education and observation of the legal system, holds a B.S. and M.S. Degree in Administration of Justice from Wichita State University, and has helped take ten cases to the United States Supreme Court.
I do not know what a Masters in Administration of Justice is about, but it sounds like she has chops. She should be able to figure out the ins-and-outs of penalties and excess benefits.
She used the charity’s money for the following from 2010 through 2012:
- A&A Auto Salvage
- Derby Quick Lube
- Westar Energy
- T&S Tree Service
- Gene’s Stump Grinding Service
- an animal clinic
- St John’s Military School (her son’s tuition)
- The exhumation and DNA testing of her father’s remains
The Tax Court went through the exercise: she used charity money for personal purposes; she never reported the money as income; there was no pretense of the safe harbor.
She was on the hook for both the 25% and 200% excise tax.
How did she expect to get away with this?
I suspect she was playing the audit lottery. If she was not caught then there was no foul, or so she reasoned. That is more latitude than I have. As a tax professional, I am not permitted to consider the audit lottery when deciding whether to take or not take a tax position.
The case is Farr v Commissioner, T.C. Memo 2018-2 for the home gamers.