Collections and Hutzpah

 

An old partner of mine would have called it “hutzpah.”

The case is ridiculous, but it does give us a chance to review the tolling of the statute of limitations.

Let’s start:

·      The IRS has – barring unusual circumstances – only so much time to collect taxes from you. This period is 10 years from the date of assessment. A key concept here is that the date of assessment is not necessarily the date you filed, and that one tax year can have more than one ten-year period running concurrently (think an IRS audit a couple of years after you filed).

·      The 10 years can be interrupted (the fifty-cent word is “tolled”) for certain things, such as filing for an offer in compromise. This means that that 10-year statute can stretch to much longer than 10 years in the real world.

Let’s look at the Ward case.

The IRS determined the Wards had underreported income by $197 grand for 1996 and $209 grand for 1997. The Wards took the matter to Tax Court and lost.

The 1996 tax was assessed in November 2002.

COMMENT: Plus ten years puts one at November 2012.

The 1997 tax was assessed in December 2002.

COMMENT: Plus ten years means December 2012.

Alright, how in the world does one get to 2022 with these dates and facts?

Let’s look at the following:

(1)  Offer in compromise dated 12/27/2002

(2)  Due process hearing requested 7/15/2003

(3)  Offer in compromise dated 3/15/2004

(4)  Offer in compromise dated 12/4/2008

(5)  Due process hearing requested 12/16/2011

(6)  Offer in compromise dated 3/6/2014

(7)  Offer in compromise dated 9/23/2015

Five offers? This has the signature of tax protest and will likely go poorly with the Court.

Each offer tolls the statute. The IRS has up to two years to resolve an offer, and it is not uncommon for an offer to take a year or more to resolve. The statute is tolled while an offer is being considered. Just reviewing the dates quickly, the Wards added at almost seven years to the statute.   

Then we have the due process hearings.

A CDP is a Collections hearing and generally means that the IRS wants you to pay more tax than you think you can pay. The hearing allows one to propose a payment alternative – think a smaller monthly payment than the IRS wants. The statute is tolled during CDP, and the IRS tacks-on another 30 days to boot after the determination.

I see that just one of the CDPs added over a year and a half to the statute.

Add all the seven tolling events and the statute had tolled until the summer of 2021.

Yep, the tax years were open, and the IRS could pursue collection.

Let’s go back.

Remember I said that the Tax Court had decided the matter?

Two of the offers were to contest the tax liability.

Let’s give some background about offers.

There are three types of offers:

(1) You argue that you do not owe the tax (or at least as much). This is a "liability” offer.

(2) You argue that you cannot pay the amount due in full. Think of a “pennies on the dollar” late-night commercial and you get the drift. This is a “collectability” offer.

(3)  You argue that fair and effective and fair tax administration requires acceptance of an offer. This third type is rare. I have never done one in practice, although we presently have a client where I intend to request one. The facts are extraordinary, though, and involve financial malfeasance while the client was a minor.

A key point is that a liability offer is off the table once the Tax Court has decided. The Wards’ first and fourth offers were liability offers and were therefore invalid.

Still, the offers tolled the statute.

So, the Wards played a wild card: they argued that the IRS considered two invalid offers in order to toll the statute. The IRS was playing a cynical game to buy time, and the Wards should not be punished for the IRS’ egregious behavior.

Hutzpah!

The Court shut them down immediately:

It was Defendants who primarily benefited from these delays. While the offers remained pending, the IRS could not collect payment on the underlying assessments…. [By] filing so many offers, [Defendants] successfully blocked collections for years.”

The statute tolled. The Wards owed. The Court had little patience with people who knew just enough to muck-up the tax collection process for the better part of two decades.

Our case this time was United States of America v Walter and Virginia Ward, USDC AK, Case 3:21-cv-0056, July 6, 2022.

An Attorney Learns Passthrough Taxation

 

I have worked with a number of brilliant attorneys over the years. It takes quite a bit for a tax attorney to awe me, but it has happened.

But that law degree by itself does not mean that one has mastered a subject area, much less that one is brilliant.

Let’s discuss a case involving an attorney.

Lateesa Ward graduated from law school in 1991. She went the big firm route for a while, but by 2006 she opened her own firm. For the years at issue, the firm was just her and another person.

She elected S corporation status.

We have discussed S status before. There is something referred to as “passthrough” taxation. The idea is that a business – an S corporation, a partnership, an LLC – skips paying its own tax. Rather the tax-causing numbers are pushed-out to the owners – shareholders, partners, members – who then include those numbers on their personal return and pay the taxes thereon personally.

Why would a rational human being do that?

Sometimes it makes sense. A lot of sense, in fact.

I will give you one example. Say that you have a regular corporation, one that the tax nerds call a “C.” Say that there is real estate in there that has appreciated insanely. It wouldn’t hurt your feelings to sell the real estate and pocket the money. There is a problem, though. If the real estate is inside a “C,” the gain will be taxed to the corporation upon sale.

That’s OK, you reason. You knew taxes were coming.

When you take the money out of the corporation, you pay taxes again.

Huh?

If you think about, what I just described is commonly referred to as a “dividend.”

That second round of income taxes hurts, unless one is a publicly-traded leviathan like Apple or Amazon. More accurately, it hurts even then, but ownership is so diluted that it is unlikely to greatly impact any one owner.

Scale down from the behemoths and that second round of tax probably locks-in the asset inside the C corporation. Not exactly an efficient use of resources, methinks.

Enter the passthrough.

With some exceptions (there are always exceptions), the passthrough allows one – and only one – round of tax when you sell the real estate.

Back to Lateesa.

In 2011 the S corporation deducted salary to her of $62,388.

She reported no salary on her personal return.,

In 2012 the S deducted salary to her of $73,448.

She reported salary of $47,171.

In 2011 her share (which was 100%, of course) of the firm’s profits was $1,373.

She reported that.

Then she reported the numbers again as though she was self-employed.

She reported the numbers twice, it seems.

The IRS could not figure out what she was doing, so they came in and audited several years.

There was the usual back-and-forth with documenting expenses, as well as quibbling over travel and related expenses. Standard stuff, but it can hurt if one is not keeping adequate records.

I was curious why she left her salary off her personal return. I have a salary. Maybe she knew something that has escaped me, and I too can run down my personal taxes.

She explained that only some of the officer compensation was salary or wages.

Go on.

The rest of the compensation was a distribution of “earnings and profits.” She continued that an S corporation shareholder is allowed to receive tax-free distributions to the extent she has basis.

Oh my. Missed the boat. Missed the harbor. Nowhere near water.  Never heard of water.

What we are talking about is a tax deduction, not a distribution. The S corporation took a tax deduction for salary paid her. To restore balance to the Force, she has to personally report the salary as income. One side has a deduction; the other side has income. Put them together and they net to zero. The Force is again in balance.

Here is the Court:

Ward also took an eccentric approach to the compensation that she paid herself as the firm’s officer.”

It did not turn out well for Ms. Ward. Remember that there are withholdings and employer-side payroll taxes required on salary and wages, and the IRS was already looking at other issues on those tax returns. This audit got messy.

There was no awe here.

Our case this time was Lateesa Ward v Commissioner and Ward & Ward Company v Commissioner, T.C. Memo 2021-32.