Spotting The Skip Tax - Part One

I was reviewing something this week we may not have discussed before. Mind you, there is a reason we haven’t: it is a high-rent problem, not easy to understand or likely to ever apply to us normals. If you work or advise in this area (as attorney, CPA, trustee or so on), however, it can wreck you if you miss it.

Let’s talk a bit about the generation skipping tax. It sometimes abbreviated “GST,” and I generally refer to it as the “skip.”

Why does this thing even exist?

It has to do with gift and estate taxes.

You know the gift tax: you are allowed to make annual gifts up to a certain amount per donee before having to report the gifts to the IRS. Even then, you are spotted an allowance for lifetime gifts. While there may be paperwork, you do not actually pay gift tax until you exhaust that lifetime allowance.

You know the estate tax: die with enough assets and you may have a death tax. Once again, there is an allowance, and no tax is due until you exceed that allowance. The 2024 lifetime exemption is $13.6 million per person, so you can be wealthy and still avoid this tax.

As I said, we are discussing high-end tax problems.

Then there is the third in this group of taxes: the generation skipping tax. It is there as a backstop. Without it, gift and estate taxes would lose a significant amount of their bite.

Why Does the Skip Exist?

Let go through an example.

When does the estate tax apply (setting aside that super-high lifetime exemption for this discussion)?

It applies when (a) someone with a certain level of assets (b) dies.

How would a planner work with this?

Here is an idea: what if one transfers assets to something that itself cannot die? Without a second death, the estate tax is not triggered again.

What cannot die, without going all Lovecraftian?

How about a corporation?

Or – more likely – a trust?

When Does The Skip Apply?

It applies when someone transfers assets to a skip person.

Let’s keep this understandable and not go through every exception or exception to the exception.

A skip person is someone two or more generations below the transferor.

          EXAMPLE:

·       A transfer to my kid would not be a skip.

·       A transfer to my grandchild would be a skip.

What Constitutes a Transfer?

There are two main types:

·       I simply transfer assets to my grandchild. Perhaps she finishes her medical degree, and I buy and deed her first house.

·       I transfer assets through a trust.

The first type is called a direct skip. Those are relatively easy to spot, trigger the skip immediately and require a tax filing.

You already know the form on which the skip is reported: the gift tax return itself (Form 709). The form has additional sections when the skip tax applies.

          EXAMPLE:

·       I give my son a hundred grand. This is over the annual dollar limit, so a gift tax return is required. My son is not a skip person, so I need not concern myself with the skip tax sections of Form 709.

·       I give my grandson a hundred grand. This is over the annual limit, so a gift tax return is required. My grandson is also a skip person, so I need to complete the skip tax sections of Form 709.

What Is the Second Type of Transfer?

Use a trust.

Here is an example:

• Create a trust in a state that has relaxed its rule against perpetuities (RAP).

a.     This rule comes from English common law, and its intent was to limit how long a person can control the ownership and transfer of property after his/her death.

• Fund the trust at the settlor’s death.

a.     If that someone is Jeff Bezos or Elon Musk, there could be some serious money involved here.

•   The settlor’s children receive distributions from the trust. When they die, the settlor’s grandchildren take their place.

• When the grandchildren die, the great grandchildren take their place, and so on.

What we described above BTW is a dynasty trust.

The key here is - before the skip tax entered the Code in the 1970s - the then-existing gift and estate tax rules would NOT pull that trust back onto anyone’s estate return for another round of taxation.

Congress was not amused.

And you can see why a skip is defined as two generations below the transferor. Congress wanted a bite into that apple every generation, if possible.

How Does Skipping Through A Trust Work?

There are two main ways: 

EXAMPLE ONE: Say the trust has a mix of skip and nonskip beneficiaries, say children (nonskip) and grandchildren (skip). The IRS chills, because the trust might yet be includable in the taxable estate of a nonskip person. Say the last nonskip person dies (leaving only skips as beneficiaries) AND nothing is includable in an estate return somewhere. Yeah, no: this will trigger the skip tax. To make things confusing, the skip refers to this as a “termination,” even though nothing has actually terminated.   

EXAMPLE TWO: The trust again has a mix of skip and nonskip beneficiaries. This just like the preceding, except we will not kill-off the nonskip beneficiary. Instead, the trust simply distributes to a skip or skips (say the grandchildren or great-grandchildren). This triggers the skip tax and is easier to identify and understand.

If Skipping Through A Trust, When Is the Tax Due?

Look at Example One above. This could be years – or decades – after the creation of the trust.  

The trustee is supposed to recognize that there has been a skip “termination” of the trust. The trustee would file the (Form 709) tax return, and the trust would pay the skip tax.

And – yes – in the real world it is a problem. What if the trustee (or attorney or CPA) misses the termination as a taxable event?

Malpractice, that’s what. An insurance company will probably be involved.

What About Example Two?

This is a backstop to the first type of transfer. In the second type there is still a nonskip beneficiary, meaning that the trust has not “terminated” for skip purposes. The trust distributes, but the distribution goes to a skip.

Say the trust distributes a 1965 Shelby Mustang GT350 R.

First, nice.

Second, the skip tax is paid by the beneficiary receiving the distribution. The trust does not pay this one.

Third, the trustee may want to warn the beneficiary that he/she owes skip tax on a car worth at least $3.5 million.

Fourth, realistically the trust is going to pay, whether upfront or as a reimbursement to the beneficiary. The tax paid is itself subject to the skip tax if it comes out of the trust.

How Much Is the Skip Tax?

Right now, it is 40 percent.

It changes with changes to the gift and estate tax rates.

That 1965 Shelby GT 350R comes with a skip tax of at least $1.4 million. It takes a lot of green to ride mean.

How Do You Plan for This Tax?

The skip is very much a function of using trusts in estate planning.

Trust taxation can be oddball on its own.

Introduce skip tax and you can go near hallucinatory.

This is a good spot for us to break.

We will return next post to continue our skip talk.

Embezzlement And A Payroll Tax Penalty

It has been about a month since I last posted.

To (re)introduce myself, I am a practicing tax CPA. I like to think practice allows a certain reality check on topics we discuss here. I am hesitant to discuss topics I do not work with or have not worked with for a long time. On the other hand, I can be acerbic while bloviating within my wheelhouse. I have strong opinions, for example, with IRS administration of “reasonable cause” relief for certain penalties. Here is one: work someone 80, 90 or more hours per week, deprive him/her of adequate rest, maintain the stress meter at redline, and ... stuff ... just ... happens. Maybe - if we had a government union to drag high achievers down to the level of the common spongers - then stuff would stop happening.

The downside is that this blog is maintained by a practicing CPA, and we just finished busy season.

Let’s ease back into it.

Let’s talk about the big boy penalty - the BBP.

There are penalties when someone fails to remit withheld payroll taxes to the IRS. It makes sense when you think about it. Your employer withholds 6.2% of your gross paycheck for social security and another 1.45% for Medicare. Your employer is also withholding federal income tax. All that is your money - your employer is acting only as a go-between - and not remitting the tax to the IRS is tantamount to stealing from you. And from the IRS.

I have seen it many times over the years. Sometimes still do. Not grievous stuff like Madoff, but nonetheless happening when a business is laboring.

I get it: the business is doing the best it can. I am not saying it is right, but growing up includes acknowledging that a lot of things are not right.

The BBP is a 100% penalty on the withheld employee taxes.

You read that right: 100 percent.

It applies if you are a “responsible person.” That makes sense to me if you are the big cheese at the Provolone factory, but the IRS has been known to consider ordinary Joe’s – somebody stuck at a miserable job for a needed paycheck before another job allows an escape – to be responsible persons. A common thread is that someone has the authority to write checks, meaning the person can decide where the money (however limited) goes. Sounds great in a classroom, but it can lead to stupid in the real world.

Let’s look at Rodney Taylor.

He has degrees in political science, speech, and theater. He is multilingual. He has worked domestically and internationally. He now owns a management company called Taylor & Co.

He says that he suffers from a limited learning disability, one involving mathematics.

Couldn’t tell, but I believe him.

Over the years he delegated much of his financial stuff to professionals such as Robert Gard, his CPA.

OK.

Gard embezzled between one and two million dollars from Taylor. Some of those monies were earmarked as payroll tax deposits.

Gard had a heart attack during a meeting when his fraud was unearthed. It appears that Taylor is a good sort, as Gard survived and attributed his survival to actions Taylor immediately took in response to the heart attack.

And next we read about the lawsuits. And the insurance companies. And banks. And insurance reimbursements. You know the storyline.

While all of this was happening, Taylor paid himself a $77 thousand bonus.

STOP! Pay it back. Immediately. Not Kidding.

Taylor transferred funds from the company’s bank account to a new something he was launching.

DID YOU NOT HEAR STOP???

You know the IRS had a BBP issue here.

Taylor argued that he could not be a responsible person, as he was embezzled. He had difficulties with mathematical concepts. He hired people to do stuff.

I do not know who was advising Taylor - if anyone - but he lost the plot.

• Taylor owed the IRS.
• Taylor was CEO, hired and fired, controlled the financial affairs of the company, and made the decision to sue Gard. He couldn’t be any more responsible if he tried.
• Meanwhile, Taylor diverted money to himself while still owing the IRS.

The IRS gets snarky when you prioritize yourself when you still owe back payroll taxes.

Bam! Big boy penalty.

Yeah, and rain is wet.

Sometimes it … is … just … obvious.

Our case this time was Taylor v Commissioner, T.C. Memo 2024-33.

The IRS Changes An In - Person Visit Policy

 

This afternoon I was reading the following:

As part of a larger transformation effort, the Internal Revenue Service today announced a major policy change that will end most unannounced visits to taxpayers by agency revenue officers to reduce public confusion and enhance overall safety measures for taxpayers and employees.”

One can spend a lifetime and never interact with a Revenue Officer. We are more familiar with Revenue Agents, who examine or audit tax returns and filings. Revenue Officers, on the other hand, are more specialized: they collect money.

I deal with ROs often enough, but – then again – consider what I do. I rarely meet with one in person, though. The last time I met an RO was one late afternoon at northern Galactic Command. I was the only person in the office, until I realized that I was not. I encountered someone who claimed to be an RO, which I immediately and expressly disbelieved. He presented identification, which gave me pause. He then asked about a specific client, giving me grounds to believe him. The IRS could not contact a taxpayer, so the next step was to contact the last preparer associated with that taxpayer.

I was – BTW – not amused.

I wonder if the above IRS policy change has something to do with an event that occurred recently in Marion, Ohio. The following is cited from a recent House Judiciary Committee letter to IRS Commissioner Danny Werfel:

On April 25, 2023, an IRS agent—who identified himself as 'Bill Haus' with the IRS’s Criminal Division—visited the home of a taxpayer in Marion, Ohio. Agent 'Haus' informed the taxpayer he was at her home to discuss issues concerning an estate for which the taxpayer was the fiduciary. After Agent 'Haus' shared details about the estate only the IRS would know, the taxpayer let him in. Agent 'Haus' told the taxpayer that she did not properly complete the filings for the estate and that she owed the IRS 'a substantial amount.' Prior to the visit, however, the taxpayer had not received any notice from the IRS of an outstanding balance on the estate.
 
"During the visit, the taxpayer told Agent 'Haus' that the estate was resolved in January 2023, and provided him with proof that she had paid all taxes for the decedent's estate. At this point, Agent 'Haus' revealed that the true purpose of his visit was not due to any issue with the decedent’s estate, but rather because the decedent allegedly had several delinquent tax return filings. Agent 'Haus' provided several documents to the taxpayer for her to fill out, which included sensitive information about the decedent.
 
"The taxpayer called her attorney who immediately and repeatedly asked Agent 'Haus' to leave the taxpayer's home. Agent 'Haus' responded aggressively, insisting: 'I am an IRS agent, I can be at and go into anyone's house at any time I want to be.' Before finally leaving the taxpayer’s property, Agent 'Haus' said he would mail paperwork to the taxpayer, and threatened that she had one week to satisfy the remaining balance or he would freeze all her assets and put a lean [sic] on her house.
 
"On May 4, 2023, the taxpayer spoke with the supervisor of Agent 'Haus,' who clarified nothing was owed on the estate. The supervisor even admitted to the taxpayer that 'things never should have gotten this far.' On May 5, 2023, however, the taxpayer received a letter from the IRS— the first and only written notice the taxpayer received of the decedent’s delinquent tax filings—addressed to the decedent, which stated the decedent was delinquent on several 1040 filings. On May 15, 2023, the taxpayer spoke again with supervisor of Agent 'Haus,' who told the taxpayer to disregard the May 5 letter because nothing was due. On May 30, 2023, the taxpayer received a letter from the IRS that the case had been closed.”

Yeah, someone needs to be fired.

The IRS did point out the following in today’s release:

For IRS revenue officers, these unannounced visits to homes and businesses presented risks.

No doubt, especially for those who think they can go into “anyone’s house at any time.”

What will the IRS do instead?

In place of the unannounced visits, revenue officers will instead make contact with taxpayers through an appointment letter, known as a 725-B, and schedule a follow-up meeting. This will help taxpayers feel more prepared when it is time to meet.

Taxpayers whose cases are assigned to a revenue officer will now be able to schedule face-to-face meetings at a set place and time, with the necessary information and documents in hand to reach resolution of their cases more quickly and eliminate the burden of multiple future meetings.

There will be situations where the IRS simply must appear in person, of course:

The IRS noted there will still be extremely limited situations where unannounced visits will occur. These rare instances include service of summonses and subpoenas; and also sensitive enforcement activities involving seizure of assets, especially those at risk of being placed beyond the reach of the government.

These situations should be a fraction of the number under the previous policy, however.

No Job Is Worth This Penalty

A few years ago someone asked me to “run their payroll.” This particular place had enough issues to fuel multiple seasons of Game of Thrones, among the least of which was an inability or unwillingness to pay their payroll on time.  It was just a matter of time until someone reported them to a government agency. I was to timely process the payroll, transfer funds, make tax deposits and so on.

My answer?

Not a chance.

I have no problem processing a payroll. The one thing I will not do however is involve myself with making payroll tax deposits.

Why?

There is an IRS penalty out there called the “responsible person” penalty, which we have previously referred to as the “big boy” penalty. This is gallows humor, and you want nothing to do with this boy. The IRS becomes very grim when one withholds payroll taxes and fails to remit them to the government. They consider it theft. The IRS roots around to learn who in the company had control over cash – that is, who decides who to pay, who can sign checks, that type of thing. If that person is you, you may be a “responsible person,” meaning that you are also liable for the payroll taxes. The IRS can chase the company, it can chase you, it can chase both of you. You have stepped into someone else’s problem.

Where have I seen this? Mostly it stems from severe cash flow pressures, such as after the 2008 business crash. My last responsible person penalty client was a contractor on the Kentucky side of Cincinnati. What made it frightening was the IRS interviewing the controller/office manager in addition to the owners. Why? Because, once in a blue moon, she would write a check, mostly if there was no one else available to sign. That woman was understandably terrified.

I am reading a District Court decision coming out of Virginia. From 1990 to 2000 Brenda Horne was the office manager for a medical practice. Her duties included:

·       Billing customers

·       Collecting accounts receivable

·       Making bank deposits

·       Writing checks

·       Preparing, signing and filing payroll tax returns

·       Decisions about hiring, firing and employee compensation

The company stopped making payroll tax deposits in 2006.  Brenda continued writing and signing checks to everyone but the IRS.

The IRS came in. The company owed over $2.8 million in back payroll taxes.

And now, so does Ms. Horne.

Perhaps she was part of this. Perhaps she was under-informed and went along in order to keep her job. She wouldn’t be the first. The fatal fact? That she could decide who to pay, who not to pay, and could sign checks accordingly. The IRS did not get paid, and they held her responsible.

Granted, the owners of the company are responsible long before an office manager is, but that is not the way the IRS approaches this. The IRS is happy to have several responsible persons. That increases the odds of collecting from someone. Theoretically, she could sue the medical practice and its owners for restitution if the IRS compelled her to pay. Considering that the company did not – or could not – pay the taxes when due, I am skeptical that it could pay Brenda Horne now.

It does not matter what she was paid for being an office manager. It cannot approach $2.8 million.

And the company’s loyalty to her?

She got fired at the end of 2010.

Can The IRS Collect From You After 31 Years?

What were you doing 31 years ago? 

Me? I was living in South Florida. I probably had a nice tan. 

Let’s return to tax talk: do you think that the IRS can chase you down after 31 years?

One wouldn’t think so. There is a three-year statute of limitations on assessment, which generally means that the IRS has three years to audit you. If there is tax due, the IRS will then “assess” the tax, which means that they post the tax due to your master account. They have ten years (after assessment) to lien, levy or otherwise collect from you. The ten years is the statute of limitations on collection.  

NOTE: You can see there are two statutes at play: one on assessment and another on collection. The two can – and frequently – overlap, so that many times the effective statute of limitations is ten years.

There are specialized situations where tax representation involves exhausting the ten-year period. I had a client from Florida, for example, who inherited a nasty tax problem from her deceased husband.  Exhausting the collection period was part of our strategy.

Let’s talk about Beeler, which the Tax Court decided last month. 

There used to be a company called Equidyne Management, Inc, which failed to remit payroll taxes thirty-one years ago. That would be 1982.

Skipping out on payroll taxes is a bad idea. Somebody will not only be responsible for the taxes, interest and penalties but also for a 100 percent penalty to boot. This is the “responsible person” penalty, and this is one case where you do not want to be responsible.

NOTE: We have previously called this the “big-boy” penalty. It is one of the most gruesome penalties in the tax Code, as it imposes personal liability for a business debt.

Equidyne had three responsible persons: Beeler, Ross and Liebmann.

Ross filed for bankruptcy almost right away – in 1983. During his bankruptcy, he sent $80,860 as part of a “global settlement” with the IRS. “Global” means that he was paying off various taxes, not just the responsible person penalty.

Per the statute of limitations, the IRS had three years to assess. Right on schedule, in 1985 the IRS assessed the responsible person penalty against the three Equidyne officers. It could not assess against the company, as Equidyne itself had gone out of business.

Beeler lawyers up and contests the penalty. 

OBSERVATION: Litigation will “toll” the statute. This means that the ten-year period is suspended until the toll comes off.

The litigation is not resolved until 1995 - 10 years later. Beeler loses.   

Beeler contacts the IRS in 1997. The IRS fails to list the big boy penalty on his transcript.  

In 2001 the IRS releases liens on Beeler’s properties in New York and Sarasota. 

Even better, the IRS makes entry in Beeler’s master account that the statute of limitations on collections had expired.

Beeler wonders what is going on. More likely, Beeler’s tax CPA wonders what is going on. What the IRS did could be correct. The trust fund penalty is “joint and several.” The IRS could go against any of the three officers, but it does not have to go against the three proportionally. If the IRS had collected from one of the other two officers, then Beeler would be off the hook. The IRS cannot collect the penalty more than once, regardless of the number of responsible persons. 

In 2005 an IRS employee reviewing Beeler’s account notices that a “pending” code had been entered into the master file when Beeler litigated in 1986. This is standard procedure, and it indicates the “tolling” of the account. Problem is that the IRS failed to remove the code when the litigation ended in 1995. 

The IRS corrects the file. The judgment against Beeler is recorded. 

NOTE: One way to override the collection period is for the IRS to obtain a judgment, which requires the IRS to go to Court. Beeler was considerate enough to do this on his own power. 

Beeler is hopping mad. Wouldn’t you be? He sues the IRS - again. He has two arguments:

(1) The lien release discharged his trust fund obligation.

COMMENT: It did not. The lien secures a debt; it does not pay a debt. Relinquishment of a lien has nothing to do with the enforceability of the underlying debt.

(2) The big-boy penalty had been satisfied by payment.

COMMENT: This caught the Appeals Court’s attention, especially since the file went back to when some of the judges were probably entering law school. The Appeals Court sent the case back to the Tax Court to look into this matter.

The Tax Court determined the following:

(1)  Equidyne never paid anything.

(2)  Liebmann never paid anything.

(3)  Beeler never paid anything.

(4)  Ross paid $80,860 as part of a global settlement.

Beeler argues that Ross paid another $64,000. The Court finds record of a $64,000 but it believes that this was a bookkeeping entry reflecting a transfer among bankruptcy trustees and not a payment to the IRS.

But there was an IRS entry for $60,773. There was some dispute as to what it meant, as decades have gone by. The Court concluded that the IRS was correcting a prior entry, that this was not cash received and therefore not the $64,000 payment Beeler wanted.

Since there is no better information, the Court assumes that all of the $80,860 was paid toward the responsible person penalty and reduces Beeler’s liability accordingly. But Beeler is still on the hook for the balance.

Let us speculate. What if Beeler had not litigated the big-boy penalty? There would have been no judgment, and the statute of limitations would have eventually expired. Would the IRS have let that happen? Who knows? Sometimes the IRS will send a 90-day notice (called a “SNOD”) to get the case into Tax Court before the statute expires. You know what the IRS wants, of course: it wants the Court to transmute the assessment into a judgment. The IRS does not always send a SNOD, though. Perhaps it decides the likelihood of payment is low, or the amount due is inconsequential, or maybe the file just gets lost in the system. 

If he could go back, I wonder if Beeler would have litigated the penalty. It is the reason he is still on the hook, thirty- one years later.

Can Your Accountant Owe Your Payroll Taxes?

You own an accounting firm. A potential client is willing to pay you $4,900 month to do their accounting, including payroll. You will be writing checks and paying vendors, including deposits with the IRS.

Are you interested?

What can go wrong, you ask. Since this is a tax blog, you can anticipate that someone is going to step on the IRS’ or state tax agency’s tail, but that does not means that someone is automatically wrong. A significant part of my practice is representation, for example, which usually entails arguing that my client is right.

Buddy and Barry are brothers and together own an accounting firm. There is a North Carolina entrepreneur (Erwin) who owns or operated at least 60 restaurants. He has a new deal to start a Golden Corral franchise, which he does under the name GCAD. There will eventually be five franchises under GCAD. 

The restaurants start to lag. There is negative cash flow of approximately $2 million. Understandably, GCAD has difficulty paying its creditors. Erwin hires a new business manager (Pintner), who knows Buddy and Barry.  They are hired to handle the accounting and taxes for GCAD.

Buddy and Barry obtain data by accessing the restaurant computers remotely. After running payroll, they send the checks to Pintner for distribution to employees. GCAD allows them direct access to the bank account to remit withholdings. They do not need further authorization to make payroll tax deposits.

They are also responsible for paying vendors, but that process is a bit different. Initially they send checks for signature, but eventually they are given a signature stamp.

By the way, remember that they too are a vendor of GCAD. They are paid $4,900 a month.

The brothers are aware of the cash stress. They inform GCAD and Erwin that there is not enough money to pay everybody.

Erwin learns that the brothers had failed to remit payroll taxes. He and another partner fund a capital call, sending the brothers $150,000 with the following instructions:

“that absolutely under no circumstances whatsoever were [you] to be late with any taxes.”

That did not seem to take, and GCAD is again late with payroll taxes.

Business does not improve. Erwin obtains release from one of the leases. GCAD goes three more quarters without remitting payroll taxes. Erwin and his partners make another capital call.

Erwin eventually fires Buddy and Barry. He moves the accounting to North Carolina, and GCAD gets current with its payroll taxes. GCAD however does not pay its back taxes. It can’t. It needs all the money it has to remain in business.

GCAD finally folds.

Uncle Sam shows up, and he wants his payroll taxes. Erwin pays some, then immediately countersues to get the monies back. The IRS starts swinging, suing Erwin and Pintner and Buddy and Barry.

Erwin lawyers up. Pintner lawyers up. The brothers do not. They show up in court “pro se,” which means they are representing themselves. I consider that decision to be suicidal.

Why suicidal? The IRS considers the brothers a “responsible person,” and the IRS has a point. The brothers did have quite a bit of discretion over who was paid with the limited cash available. The IRS argues that it gets paid first, a point they are now emphasizing by going after Erwin and Pintner and the brothers for trust fund penalties. This is the “big boy” penalty, and it is 100 percent of the withholding taxes.

How did it turn out? Read the court’s verdict for yourself:

... the Light Brothers are jointly and severally indebted to the United States for the unpaid withholding taxes assessed against them, plus the applicable interest accruing according to law.”

The tab?  Try $325,734.

The monthly $4,900 fee was sweet, but not enough to cover the penalty.

Could representation have saved the brothers? I am speculating at this point, but I do not believe so. The brothers took on too many of the trappings of a corporate officer. The IRS would be harsh on their control over the checking account, for example. The IRS takes priority when it comes to payroll withholdings, and it reserves the right to disregard other vendors – even if not paying other vendors would put one out of business. The brothers paid other vendors (including themselves) before paying the IRS.  They walked directly into the IRS crosshairs.