An IRS Payment Plan And Tax Evasion

 

Let’s talk today about IRS payment plans. More specifically, let’s talk about common paperwork in requesting a payment plan.

A common one is Form 433-A, and it is used by W-2 workers and self-employeds.

The IRS is trying to figure out how much you earn, own, and owe.

There are questions about whether you (or your spouse) own a business, are a beneficiary of a trust or have gifted property worth more than $10,000 over the last 10 years. Yes, they wanna know stuff.

You will have to list your bank accounts, as well as other investments, real estate and other assets.

You will have to provide an accounting of your monthly income and expenses.

There is also expanded disclosure if you are self-employed (that is, a sole proprietor).

There are other ways to own a business than as a proprietor (for example, a shareholder in a C corporation). The IRS will want to know about that, too.

Part of tax practice is avoiding this series, if possible. For example, if you have personal tax debt of $50,000 or less, you can bypass the 433 series and request a “streamlined” payment plan. You are still entering into a contract with the IRS (you must stay current with your filings, make all payments as required, and so on), but in exchange the IRS lifts some of the paperwork requirements. Sometimes advisors recommend hybrid arrangements (taking out a second mortgage, for example), leaving the IRS debt at $50 grand or less. And sometimes you are simply into the IRS for more than $50 grand, leaving no choice but to run the 433 gauntlet. This can be a rude awakening, as the IRS uses standards for certain expense categories (for example, housing and utilities). You might google that you can request an increase from these standards. You can request; don’t expect to receive, though. Barring significant factors (think care for chronic medical conditions), it is unlikely to happen. Depending on the numbers, you might be forced to downgrade a vehicle or pull the kids from a private school. This is not a friendly loan.  

And you do not want to be … sly … when running the 433 hurdles.

Let’s look at someone who was too clever by half.

Kevin Crandell is a medical doctor. He contracted with two hospitals, one in Mississippi and another in Alabama, for $30 to $40 grand per month.

From 2006 through 2012 he did not file returns or pay taxes.

The IRS started garnishing his wages in 2010.

COMMENT: I find it remarkable that he still did not file or pay even when garnished.

The doctor racked up close to a million dollars in taxes, penalties, and interest.

Somewhere in there he formed a couple of corporations. He used one to receive monies earned as a contractor. The second appeared to serve as asset protection.

He finally hired someone (Blue Tax) to help out with tax returns and attendant debt.

Blue Tax drafted a 433. The first draft showed Crandell’s salary as $17 grand per month (I don’t know where the rest of the money went either). The doctor howled that the number was much too high and should be closer to $12 grand.

Oh, the 433 also left out bank accounts for those two corporations (which he controlled). And a $50,000 gun collection. And the $40 grand he drew from the corporations shortly after submitting a 433 stating that his salary was around $12 grand.

Doc, you have to know when to stop. Lying, and then lying about the lying is called something in tax.

Crandell was indicted for fraud.

That pattern of non-file and non-pay looked bad now. That “creative” 433 also gleamed like a badge of fraud, leaving off income, assets and so on.

Crandell argued that he relied on Blue Tax.

It is a good argument - an excellent argument, in fact - except that he did not fully disclose to Blue Tax. If you want to show reliance on an advisor, you have to … you know … actually rely on the advisor.

Crandell was convicted for tax evasion.

Our case this time was US v Crandell, 2023 PTC 178 (5^th Cir. 2023).

Substantially Disclosing A Gift To The IRS

Take a look at this memorable prose:

         Sec 6501(c) (9) Gift tax on certain gifts not shown on return.

If any gift of property the value of which (or any increase in taxable gifts required under section 2701(d) which) is required to be shown on a return of tax imposed by chapter 12 (without regard to section 2503(b) ), and is not shown on such return, any tax imposed by chapter 12 on such gift may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. The preceding sentence shall not apply to any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item.

I get it: if you never disclose the gift, the IRS can come after you until the end of time. The reverse is what concerns us today: if you disclose the gift “in a manner adequate,” then the IRS does not have until the end of time.

Gift tax cases can be … idiosyncratic, to be diplomatic. All tax is personal, but gift tax can be Addams Family idiosyncratic.

Ronald Schlapfer (RS) was a Swiss-born businessman. He had ties to both Switzerland and the United States. He owned a life insurance policy issued in 2006.The policy in turn owned all the stock in EMG, a Panamanian company previously owned by RS.

It was 2006 and RS was a nonresident of the U.S. He gifted his interest in EMG to his mother, aunt and uncle.

He obtained U.S. citizenship in 2008.

Got it: he gifted before he became subject to U.S. gift tax.

In 2013 – and after obtaining his citizenship – RS decided to play it safe and submitted an offshore voluntary disclosure filing with the IRS. It included a gift tax return for 2006, which informed the IRS of the gift to his family. The return included the following:

“A protective filing is being submitted. On July 6, 2006, taxpayer made a gift of controlled foreign company stock valued at $6,056,686 per U.S. Treasury Regulation 25.2501-1(B). The taxpayer is not subject to U.S. gift tax as he did not intend to reside permanently in the United States until citizenship was obtained in 2008.”

COMMENT: In this situation, a protective filing means that the taxpayer is unsure if a filing is even required but is submitting one, nonetheless. It is an attempt to backstop penalties and other bad things that could happen from a failure to file.

COMMENT: International practice has become increasingly paranoid for many years now. The IRS seems convinced that every UBER driver has unreported foreign accounts, and one’s failure to follow arbitrary and obscure rules are a per se admission of culpability. In this case, for example, there was technical doubt whether the gift was reportable as the transfer of a life insurance policy or as the transfer of a company owned by that policy. Why was there doubt? Well, the IRS itself created it. Rest assured, whichever way you chose the IRS would fall the other way.

The IRS disagreed that the gift occurred in 2006. There was a hitch in the transfer, and the attorney did not resolve the matter until 2007. RS in turn argued that 2007 was but a scrivener’s error. According to well-trod ground, a scrivener’s error is considered administrative, not substantive, and does not mark the actual date of the underlying transaction.

Sometime in here RS agreed to extend the limitations period.

In 2019 the IRS issued the statutory notice of deficiency (SNOD). That is also called a 90-day letter, and it meant that the next step was Tax Court - if RS wanted to further pursue the matter.

Off to Tax Court they went.

RS’ argument was simple: the statute of limitations had expired.

The IRS argued that the gift was not adequately disclosed.

The IRS argued that disclosure requires the following:

·       Description of the property gifted, and any consideration received by the donor.

·       The identity and relationship between the parties.

·       There is additional disclosure for property is transferred in trust.

·       A detailed explanation of how one arrived at the fair market value of the property gifted.

·       Whether one has taken a position contrary to any Regulations or rulings

The IRS was trying to catch RS in the first requirement above: a description of the property gifted.

Was it an insurance policy, ownership in a company, or something else?

Here is the Court:

While Schlapfer may have failed to describe the gift in the correct way, he provided enough information to identify the underlying property that was transferred.”

RS won his case. The IRS had blown the statute of limitations.

Our case this time was Schlapfer v Commissioner, T.C. Memo 2023-65.

IRS Wants Near $9 Million Penalty From A Holocaust Survivor

 

I’ll tell you what caught my eye:

This is a tax case in which the Government alleges that Defendant Walter Schik, a Holocaust survivor, failed to file a foreign bank account reporting form with the Internal Revenue Service …, which now seeks by this action to collect an almost nine-million-dollar civil penalty assessed against him for that failure.”

There are so many things wrong with that sentence.

Let’s talk about Form TD F 90-22.1, also known as the FBAR (“Eff- Bar”). The form existed before I took my first course in accounting years ago, but it has gathered steam and interest when Treasury started to chase overseas bank accounts during the aughts. If one has a foreign account, or has authority over a foreign account, which exceeds $10,000 during the taxable year, one is required to disclose on one’s individual income tax return (on Schedule B) and file Form TD F 9-22.1 with the Treasury.

Up to this point, it is just another form to file. We are drowning in forms, so what is the big deal?

The deal is the penalties for not filing the form. Let’s separate not filing the form because you did not know you had to file from knowing you had to file but deciding not to. That second one is considered “willful” (which makes sense) and can cost you a penalty from $100,000 to 50% of the account balance at the time of violation.

This is VERY expensive money.

The IRS assessed a penalty of almost $9 million against Schik for failure to file an FBAR.

Some background:

·      Mr Schik is a Holocaust survivor.

·      His education was cut short by, how shall we say this …, being in a concentration camp.

·      After the war, he immigrated to the U.S. and became a citizen.

·      After becoming a citizen, he opened a Swiss bank account where he deposited monies recovered from relatives who were slaughtered during the Holocaust.

·      He left the monies in Switzerland as he was fearful that another Holocaust-like event could occur.

·      Schik did not touch or manage the money. That was done by his son and a Swiss money manager.

·      Schik did talk with the money manager occasionally, though.

·      By 2017 one of those Swiss accounts had over $15 million.

·      His accountant never asked Schik if he had overseas bank accounts or explained the recently heightened IRS interest in the area.

I am sympathetic with the accountant. What are the odds of having a client who is a Holocaust survivor and having over $15 million in a Swiss bank account? One could go a career. I have.

The year at issue is 2007. There is a question on the individual tax return whether one has an interest or signature authority over a foreign bank account. Schik’s accountant answered it “No.” Schik did not correct his accountant. More fairly, Schik did not even notice the question.

Wouldn’t you know that Schik’s Swiss money manager got pulled into the UBS investigation?

UBS entered into a deferred prosecution arrangement with the United States. It however had to provide identities of U.S. citizens and residents who were customers of the bank.

At which point Schik submitted a voluntary disclosure to the IRS.

Which the IRS denied.

Without an alternative, Schik submitted a late FBAR.

The IRS then slapped the 50% penalty we are talking about.

Which brings us up to speed.

The penalty requires one’s behavior to be “willful.” Not surprisingly, the word has specific meaning under the law, and the Court evaluated whether Schik’s behavior was willful.

Treasury argued that “willful” means “objectively reckless.”

Got it. Ignoring an issue to an extreme degree is the same as knowing and not caring.

Schik argued that willful means “intentional disregard.”

The difference?

Schik argued that the underlying law was opaque, long-ignored and now quickly – if somewhat capriciously – conscripted into action. He no more intentionally disregarded his tax reporting obligations than he intentionally disregarded the newest developments in cosmological galaxy formation. There was no conspiracy by hundred-year-old Holocaust survivors: he just didn’t know.

And such is tax law. Nine million dollars hangs on the meaning of a word.

The Court noted that other courts – relying on records similar to those available to it - have found willfulness.

Not good for Schik. 

However, the Court was concerned about the many countervailing factors:

·      Schik was nearly 100 years old.

·      Schik had minimal formal education.

·      Schik did not manage the money.

·      Schik did not prepare his own tax returns.

·      Schik had no idea about a disclosure requirement.

·      Schik’s accountant did not explain the disclosure requirement.

·      The question answered “No” was pre-filled by the accountant’s software and did not represent any assertion made by Schik.

The Court denied the IRS summary judgement, noting there was a substantial question of fact.

I agree.

Who will review and clarify the facts?

“The Court believes that the Parties in this case would benefit from mediation. By separate order the Court will refer the Parties to the Southern District of New York’s Mediation Program. … the assigned District Judge … may determine that a case is appropriate for mediation and may order that case to mediation, with or without the consent of the parties.”

Methinks the IRS should just have allowed the voluntary disclosure.  

Was the IRS encouraging compliance, promoting education and providing a ramp to enter/reenter the tax system? Or is this something else, something with the purpose of terrifying the next person?

Our case this time was United States of America v Walter Schik, 20-cv-02211 (MKV)

Do You Have to Disclose That?

I was recently talking with another CPA. He had an issue with an estate income tax return, and he was wondering if a certain deduction was a dead loser. I looked into the issue as much as I could (that busy season thing), and it was not clear to me that the deduction was a loser, much less a dead loser.

He then asked: does he need to disclose if he takes the deduction?

Let’s take a small look into professional tax practice.

There are many areas and times when a tax advisor is not dealing with clear-cut tax law.

Depending upon the particular issue, I as a practitioner have varying levels of responsibility. For some I can take a position if I have a one-in-five (approximately) chance of winning an IRS challenge; for others it is closer to one-in-three.

There are also issues where one has to disclose to the IRS that one took a given position on a return. The concept of one-in-whatever doesn’t apply to these issues. It doesn’t have to be nefarious, however. It may just be a badly drafted Regulation and a taxpayer with enough dollars on the line.

Then there are “those” transactions.

They used to be called tax shelters, but the new term for them is “listed transactions.” There is even a subset of listed transactions that the IRS frowns upon, but not as frowny as listed transactions. Those are called “reportable transactions.”

This is an area of practice that I try to stay away from. I am willing to play aggressive ball, but the game stays within the chalk lines. Making tax law is for the big players – think Apple’s tax department – not for a small CPA firm in Cincinnati.

Staying up on this area is difficult, too. The IRS periodically revises a list of transactions that it is scrutinizing. The IRS then updates its website, and I – as a practitioner – am expected to repeatedly visit said website patiently awaiting said update. Fail to do so and the IRS automatically shifts blame to the practitioner.

No thanks.

I am looking at a case involving a guy who sells onions. His company is an S corporation, which means that he puts the business numbers on his personal return and pays tax on the conglomeration.

His name is Vee.

He got himself into a certain type of employee benefit plan.

A benefit plan provides benefits other than retirement. It could be health, for example, or disability or severance. The tax Code allows a business to prefund (and deduct) these benefits, as long as it follows certain rules. A general concept underlying the rules is risk-taking and cost-sharing – that is, there should be a feel of insurance to the thing.

This is relatively easy to do when you are Toyota or General Mills. Being large certainly makes it easier to work with the law of large numbers.

The rules however are problematic as the business gets smaller. Congress realized this and passed Code Section 419A(f)(6), allowing small employers to join with other small employers – in a minimum group of ten – and obtain tax advantages  otherwise limited to the bigger players.

Then came the promoters peddling these smaller plans. You could offer death and disability benefits to your employees, for example, and shift the risk to an insurance company. A reasonable employer would question the use of life insurance. If the employer needed money to pay benefits, wouldn’t a mutual fund make more sense than an illiquid life insurance policy? Ah, but the life insurance policy allows for inside buildup. You could overfund the policy and have all kinds of cash value. You would just borrow from the cash value – a nontaxable transaction, by the way – to pay the benefits. Isn’t that more efficient than a messy portfolio?

Then there were the games the promoters played to diminish the risk of joining a group with nine others.

Vee got himself into one of these plans.

He funded the thing with life insurance. He later cancelled the plan, keeping the life insurance policy for himself.

The twist on his plan was the use of experience-rated life insurance.

Experience-rated does not pay well with the idea of cost-and-risk sharing. If I am experience rated, then my insurance cost is based on my experience. My insurance company does not look at you or any of the other eight employers in our group. I am not feeling the insurance on this one.

Some of these plans were outrageous. The employer would keep the plan going for a few years, overpay for the insurance, then shut down the plan and pay “value” for the underlying insurance policy. The insurance company would keep the “value” artificially low, so it did not cost the employer much to buy the policy on the way out. Then a year or two later, the cash value would multiply ten, twenty, fifty, who-knows-how-many-fold. This technique was called “springing,” and it was like finding the proverbial pot of gold.

The IRS had previously said that plans similar to Vee’s were listed transactions.

This meant that Vee had to disclose his plan on his tax return.

He did not.

That is an automatic $10,000 penalty. No excuses.

He did it four times, so he was in for $40,000.

He went to Court. His argument was simple: the IRS had not said that his specific plan was one of those abusive plans. The IRS had said “plans similar to,” but what do those words really mean? Do you know what you have forgotten? What is the point of a spice rack? Does anybody really know what time it is?

Yea, the Court felt the same way. The plan was “similar to.” They were having none of it.

He owed $40,000.

He should have disclosed.

Even better, he should have left the whole thing alone.

United States v. Michael F. Schiavo

Let’s look at the matter of Michael Schiavo (United States v. Michael F. Schiavo). He was a bank director in Boston and had invested in a medical device partnership. This partnership had monies overseas. Schiavo decided to tuck the money (approximately $100,000) away and not tell anyone. He did not report the income and certainly did not file the Foreign Bank and Financial Accounts report (FBAR) with the Treasury on or before June 30 every year.

The partnership gave him about $100,000 in Bermuda to play with. He failed to file the FBARs for 2003 through 2008, so he was playing for a while.

He notices what the government was doing with UBS, meets with his advisor and decides to do a “quiet disclosure.” This means that he either amends his income tax return, files the FBAR, or both, without otherwise bringing attention to it. That is, it’s “quiet.”

The IRS had offered an amnesty program for foreign-account taxpayers back in 2009. The advantage was that the government would not prosecute. The downside was that there would be income taxes, penalties and a special 20% penalty for not having reported the monies originally. This program expired in October, 2009. Schiavo decided this was not for him.

The IRS has introduced another amnesty program in 2011, again allowing foreign-account taxpayers to come clean. This time the program covers two more years, and the penalties have been increased to 25% (with some exceptions). The IRS wants to increase the burden to the taxpayer so as not to reward the earlier act of noncompliance.

So Schiavo prepares and files FBARs for 2003 through 2008 but does not participate in the amnesty. That is, he is “quiet.” An IRS special agent then contacts him, whereupon Schiavo amends his income tax return to include the unreported income he just reported to the IRS via the FBAR.

You read this right. He made a quiet disclosure to the IRS but did not amend his income tax return to include the income he had just alerted them to.

The IRS estimates that the taxes at play were about $40,000.

Schiavo was convicted. He now faces a fine and possible jail time.

You are going to take this kind of risk for $40,000 in tax? Are you kidding me? You cannot retire on $40,000. Heck, one can barely send a kid to two years of college for $40,000. What was this guy thinking?