Taking Tax Advice From Friends

 

I received a text message one night this past week.

I was researching living trusts on the internet. It sounds like it might work for my situation.

I had two immediate reactions:

First, excellent. I am a fan of doing your own research and understanding what an expert is recommending.

Second - and maybe more important – use the expert.

The problem with DIY tax research is that you may not know what you do not know. Granted, in many cases it might not matter as much (hey, can I deduct the mileage for my gig income?), but in other cases it might matter a lot.

Let’s talk about the Horowitz case from 2019.

Peter Horowitz was an anesthesiologist. Susan Horowitz was a PhD working as a public health analyst for the U.S. Department of Health of Human Services.

In 1984 they moved to Saudi Arabia. They lived mostly on Susan’s income while banking most of Peter’s salary.

They used U.S.-based accountants, so they knew to (and filed) federal taxes on their Saudi earnings.

One thing about a bank account in Saudi Arabia: it does not pay interest. After a couple of years, the Horowitzes got tired of that and opened a Swiss bank account. They were also concerned about untangling the Saudi account when the Saudi gig played out.

Makes sense.

The Horowitzes did not tell the U.S accountants about the Swiss account. This meant that they did not report the interest income nor did they report the existence of the foreign account to the Treasury or IRS.

Why?

Their friends in Saudi Arabia told them that they did not have to pay U.S. tax on interest earned on the Swiss account.

In 2001 they moved back to the U.S. That Swiss account had grown to $1.6 million. Peter called the bank every year or two to keep an eye on the account.

COMMENT:  I would too.

Fast forward to 2008, the year that UBS got in trouble with the (non)reporting on Swiss bank accounts. UBS notified the Horowitzes that they would be closing the account. Peter traveled to Switzerland and moved the funds to another bank. Susan travelled the next year to add her name to that account.

Peter opened a “numbered” account, which meant that a number rather than a name identified the account. He also requested the new bank to not send correspondence (termed “hold mail” - something the IRS did not like).

Why?

The bank explained:

… these services allowed U.S. citizens to eliminate the paper trail associated with undeclared assets and income they held … in Switzerland.”

This is going downhill.

In 2009 Peter started reading about IRS enforcement on foreign bank accounts. He and Susan decided to consult a tax attorney.

The Swiss account was now worth nearly $2 million.

They learned that they were supposed to – all along – have been reporting that account.

 In 2010 they closed the Swiss account, repatriated the funds and applied for a voluntary Treasury disclosure program.

Good idea.

They filed amended returns for the interest income, as well as filing FBARs disclosing the existence of the foreign account.

The interest income was not inconsequential: they sent the IRS more than $100 grand in back taxes.

Got it. It was going to hurt, so they might as well rip the band-aid.

In 2012 they opted out of the voluntary disclosure program (OVDP).

COMMENT:  The default ODVP penalty was 27.5%. I suspect - but do not know for certain - that they were hoping for a better penalty result during the audit process. Considering the Swiss account had neared $2 million, the penalty alone would have been around a half-million dollars.

In 2014 the IRS sent notices. The Horowitzes, their accountants and the IRS conferred but failed to reach an agreement.

The penalties now became an issue. The base FBAR penalty is $10 grand per instance. The IRS however saw the Horowitzes behavior as willful, meaning they wanted enhanced penalties. To muddy the waters further, the law had changed. What used to be a maximum $100 grand penalty was now the greater of $100 grand or 50% of the account.

COMMENT: You may also know the FBAR by its current name: FinCEN Form 114.

The Horowitzes protested. Their behavior was not willful, and - even if it was - the old penalty (maxed at $100 grand) should apply.

The Court was short on the willfulness issue.

The court acknowledged that the couple ‘insis[ed] that neither of them had actual knowledge on the FBAR requirement.’ But, relying on United States v. Williams …., it reasoned that willfulness in the civil context ‘covered not only knowing violations… but reckless ones as well’.”

In particular, the court pointed to the fact that the tax returns signed by the Horowitzes ‘included a question of whether they had foreign bank accounts, followed by a cross-reference’ to the FBAR filing requirement. It also found significant that, by their own account, the Horowitzes had ‘discussed their tax liabilities for their foreign accounts with their friends’ but failed to ‘have the same conversation with the accountants they entrusted with their taxes for years’.”

The Horowitzes appealed.

They argued that they messed up, but that mistake was not willful. The enhanced penalties should not apply.

The IRS countered: “willfulness” in this context includes recklessness, which standard was met by:    

The Horowitzes never asking their tax preparer whether they had to report the Swiss bank accounts,

The Horowitzes asking their friends about international tax matters demonstrated their awareness of potential issues,

The Horowitzes knew to report their Saudi earnings and U.S.-based interest income from domestic banks, and

The Horowitzes signed their tax returns without reviewing them with any care.

Here is the Court:

… their only explanation for not disclosing foreign interest income related to some unspecified conversations they had with friends in Saudi Arabia in the late 1980s. Yet, if the question of whether they had to pay taxes on foreign interest income was significant enough to discuss with their friends, they were reckless in failing to discuss the same question with their accountant at any point over the next 20 years.”

Taking all of these circumstances together, the record indisputably establishes not only that the Horowitzes ‘clearly ought to have known’ that they were failing to satisfy their obligation to disclose their Swiss accounts, but also that they were in a ‘position to find out for certain very easily’.”

How much are we talking about across the years?

Including interest and penalties, it was close to $1 million.

Our case this time was Horowitz v US, No. 19-1280 (4^th Cir. 2020)

Trump Savings Accounts

 

I was reading someone somewhere complaining about Michael and Susan Dell’s recent donation of $6.25 billion. 

The bitter are always with us, unfortunately. 

But it gives us a chance to talk about the new Trump savings accounts. I see that we even have a new tax form to (possibly) bulk-up our 2025 Form 1040 return.

What are they?

The Trump accounts are a twist on an IRA.

What is the twist?

One does not need earned income to contribute to a Trump account.

Anything else?

Trump accounts cease to be Trump accounts when the beneficiary turns age 18. These things are intentionally designed for infants, children and young adults who (likely) have not started working.

How are infants and children going to know how to open this account?

They do not need to. Their parent (more precisely, the person who can claim them on a tax return) will do so for them.

How will the parent/person do this?

Two ways:

·      There is a new tax form (Form 4547 - get it?)

·      There will be a new tax portal (trumpaccounts.gov) 

 

Will this account be with the government itself?

The Treasury will create the account with a “designated financial agent.” No, I do not know what that means. I do see where one can thereafter move the account - say to Fidelity, Schwab or Vanguard (as examples) - should one wish.

How do you know one can move the account?

Because I was looking at an ad from one of the investment companies.

What about free money?

Children born between January 1, 2025, and December 31, 2028 will be eligible for a $1,000 seed contribution from the Treasury. There are requirements, such as a social security number, of course.

This period (2025 to 2028) BTW is called the “pilot program.”

What if the family makes too much money?

The “too much money” thing does not apply to the $1,000.

What is the July 4, 2026 date I have read about?

None of the government’ $1,000 seeding will occur before July 4, 2026.

What if you were born before 2025?

You still qualify to establish a Trump account, as long as you are under the age of 18 at the end of the year. You won’t get that $1,000, though.

Big deal. Why all this hullabaloo for $1,000?

One can put more than a $1,000 into the account.

The annual limit is $5 grand, and the $1 grand seed money does not count toward the $5 grand.

An employer can also put in $2.5 grand annually, but that $2.5 counts toward the overall $5 grand.

Who can contribute?

Parents of course, but also grandparents, other family members, and friends.

And Michael and Susan Dell.

Who qualifies for the Michael and Susan Dell Donation?

The $250 Dell donation reaches children age 10 and under but not eligible for the $1,000 Treasury seed contribution.

There is also an income test, although the test is by zip code and not household. The test is $150,000 or less of median income. Note that a child may qualify even if living in a wealthy household, if the median (not average) income for the zip code is $150,000 or less. The reverse is also true, of course.

What if I cannot put in $5 grand every year?

Put in what you can. Skip a year. Do not make the perfect the enemy of the possible.

Is there a tax deduction for this?

In general: no. Think of it as a Roth contribution.

I am uncertain about the employer ($2.5 grand) contribution, though. Generally, such expenses are deductible by an employer. I however expect that it will also be taxable to the employee, meaning that someone somewhere is paying tax.

Is there another way to get money into the account?

Yes. There is the usual stuff, such as rolling an account from one investment company to another.

The one that intrigues me is a contribution from a 501(c)(3) tax exempt. There is no explicit limit on these contributions, other than the overall (c)(3) requirement to benefit broad categories of beneficiaries and not just the select fortunates.

This, BTW, was the Dell contribution we referred to above: a $6.25 billion donation to contribute $250 each to 25 million children age 10 and under.

What if my parent/person fails to open an account?

Supposedly, the Treasury will open one if the child otherwise qualifies.

You think so?

Consider me cynical at the moment.

How is this thing taxed?

It is not: think IRA.

When can the child get to the money?

Figure that the child cannot until he/she turns age 18. If he/she can, something terrible has happened.

What about after age 17?

Then the Trump account gets wonky.

Supposedly this thing becomes a “regular” IRA account.

OK, but it would be a “regular” IRA account with nondeductible contributions in it. In tax lingo, we call this a “nondeductible” IRA, which has greatly lost favor since people have had access to Roth IRAs. Distributions from a Roth are (generally) tax-free. Distributions from a nondeductible are partially tax-free. There is even a tax form (Form 8606) for nondeductibles to track the numbers between taxable and nontaxable.

Inside wonk: you would not believe how difficult it can be to get (some) tax preparation software to run an IRA distribution through Form 8606 to calculate the taxable portion. I have seen more than one staff accountant give up in frustration.

I suppose Congress may further clarify/change the rules for this age-18 flip. I would like to see the flip go to full-Roth and not to this nondeductible-IRA yahtzee, but we will see.

A positive, though: since it flips to a “regular” IRA, you can make annual IRA contributions to it, if you wish. You will need earned income, of course.

Are there penalties for distributions?

You are not supposed to access IRA monies before age 59 ½. If you do, the distributions (adjusting for that wonky nondeductible IRA arithmetic) will be taxable.

In addition to income tax and unless for several permitted purposes (first house, higher education, adoption expenses and so on), there will also be a 10% penalty.

What does CTG think?

You can tell Trump accounts took water during passage of the One Big Beautiful Bill. There is stuff to both like and dislike.

Me? In general, I like.

Let’s say that you can put away $1,000 per year for 18 years. Add the government’s $1,000 seed. Assume market rate of returns, low investment fees and the money remaining untouched (remember: it is not taxed while within the IRA) for 40 to 50 years.

What an incredible gift and legacy to a grandchild.