Can You Tell When You Are Being Audited?

 I am looking at a Tax Court pro se decision.

Pro se means that the taxpayer represents himself or herself.

Technically, that is explanation insufficient. I, for example, could represent someone in Tax Court and it would still be considered to be pro se.

I tend to shudder at pro se cases, because too often it is a case of someone not knowing what they don’t know. And – once you are that far into the tax system – you had better be up-to-speed with tax law as well as tax procedure. Either can trip you up.

There is a cancer surgeon who inherited an IRA in 2013. He took distributions in both 2014 and 2015 – distributions totaling over $508 thousand - but he researched and came to the conclusion that the distributions were not income.

COMMENT:  How did he get there? The first thing that comes to mind is that these were Roth IRAs, but that was not the case. He argued instead that the IRAs included nondeductible contributions, and those nondeductible amounts were not taxable income coming out.

The reference here is to nondeductible IRAs, the cousin to Roth IRAs. These bad boys would be almost extinct except for their use in backdoor Roth conversions. Still, the doctor was wrong: it is EXTREMELY unlikely that a nondeductible IRA would be fully nontaxable. The reason is that only the contributions are nontaxable; any earnings on the contribution would be taxable. I suppose that one could have a completely nontaxable distribution, but that would mean the nondeductible IRA had no - none, nada, zippo - earnings over its existence. That would be among the worst investments ever.

The IRS computerized matching program kicked-in, as the IRA distributions would have triggered issuance of a 1099. The IRS caught 2014. The doctor disagreed he had income. The IRS machinery ground-on and resulted in the issuance of a 90-day letter (also known as a Statutory Notice of Deficiency) for 2014. The purpose of the SNOD is to reduce a proposed tax assessment to an actual assessment, and it is nothing to snicker about. The doctor had the option to appeal to the Tax Court, which he did.

Practice can be described as doing what is not taught in school, so the story took an unusual twist. The doctor was contacted by a revenue agent for a real and actual audit of his 2014 tax return. The agent however was looking at issues other than the IRA, and the doctor did not mention that the IRS Automated Under Reporting unit was looking at 2014. The agent continued blithely on, not knowing about the AUR and eventually expanding his audit to 2015.

QUESTION: Why didn’t the doctor tell the agent about AUR? I would have tried to consolidate the exams myself.

The doctor was dealing with AUR over matching. They wanted money for 2014.

The doctor was also dealing with a living, breathing agent about 2014. The agent wanted money, but that money was from areas other than the IRA.

The doctor took both SNODs to Tax Court.

He argument was straightforward – he invoked the tax equivalent of double jeopardy: Section 7605(b):

         (b) Restrictions on examination of taxpayer

No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer’s books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.

If there was double jeopardy, the doctor clearly wanted the revenue agent’s proposed assessment, as it did not include the IRA.

Did the doctor have an argument?

This Code section has an interesting history. It goes back to the 1920s, at a time when only the wealthy were subject to income tax and there were no computers, 1099s and what-not. Matching was not even a fevered dream. What did exist, however, was the potential for human abuse and repetitive examinations to beat someone into submission. The progenitor of our Section 7605(b) came into existence as an early version of taxpayer protection and rights.

What the Tax Court focused on was whether there were two “examination(s) or investigations.” If the answer was yes, the Court would have to continue to the next question: was the additional examination “unnecessary?”

The Court did not need to continue to the second question, as technically there were not two examinations. You see, the matching program is driven by 1099s and other reporting forms. The AUR unit is not “auditing” in the traditional sense; it is instead trying to reconcile what a taxpayer reported to what an independent party reported.  

Additionally, the only thing AUR is looking at is income.  AUR is not concerned with deductions. Its review does not rise to the level of an examination as AUR is intentionally ignoring all the deductions on one’s return.

But I get it: it does not feel that way to the person interacting with the AUR unit. And there definitely is no real-world difference when AUR wants additional money from you.

But there is a technical difference.  

The doctor saw two examinations. I suspect most people would agree. However, the doctor technically had one examination. He was not in double jeopardy. Section 7605(b) did not apply.

Our case this time was Richard Essner v Commissioner, TC Memo 2020-23.

Pay Me In Bitcoin

 

He plays right guard for the Carolina Panthers and had a great quote about cryptocurrency:

         "Pay me in Bitcoin.”

We are talking about Russell Okung.

I believe he earned about $13 million for the 2020/2021 season, so he can move a lot of Bitcoin.

And Bitcoin had quite the run in 2020, moving from approximately $7,200 in January to $30,000 by year-end. The payment platform company Square added Bitcoin as an investment, and PayPal started a new service allowing its users to buy, hold and sell Bitcoin through their PayPal account.

Then there is, as always, the near inexplicable behavior of some people. In October, John McAfee (yes, John of McAfee computer security products) was arraigned for tax fraud. He was charged with, among other things, not reporting income for his work promoting cryptocurrencies.

The IRS is paying more attention.

We have existing guidance that the IRS views cryptos – which include Bitcoin and Ethereum – as property and not currency. While this might sound like an arcane topic for a business school seminar, it does have day-day-day consequences. If you buy something for $11 and pay with a $20 bill, there is likely no tax consequence.  A crypto is not currency, however. Pay for that $11 purchase using your Bitcoin and the IRS sees the trading of property.

What does that mean?

Taxwise you sold crypto for $11. You next have to determine your cost (that is, “basis”) in the crypto. If less than $11, you have a capital gain. If more than $11, you have a capital loss. The gain or loss could be long-term if you held the crypto for more than one year; otherwise, it would be a short-term gain or loss.

Assume that you have frequent transactions in crypto. How are you to determine your basis and holding period every time you pay with crypto?

You had better buy software to do this, or use a wallet that tracks it for you. Otherwise you could have a tax mess on your hands at the end of the year.

You can, by the way, also have ordinary taxable income (rather than capital gain) from cryptos. How? Say that you do consulting work for someone and they pay you in crypto.  You have gig income; gig income is ordinary income; that crypto is ordinary income to you.

By the way, mining Bitcoin is also ordinary income.

The IRS had a question about cryptos on a schedule in prior years, but for 2020 it is moving the following question to the top of Form 1040 page 1:

At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The IRS moved the question to make it prominent, of course, but there is another reason. Remember that you are signing that tax return “to the best of your knowledge and belief” and “under penalties of perjury.” The IRS is raising the stakes for not reporting.

Expect more computer matching. Expect more notices.   

Even Treasury is upping its game.

There is a form that one files with the Treasury if one owns or has authority over $10,000 or more in a foreign bank or other financial account. We tax veterans remember it as the FBAR (Foreign Bank and Financial Accounts) report, but the name has since been revised to FinCen 114 (Financial Crimes Enforcement Network). Here is Treasury telling us that we will soon be reporting cryptos on their form:

Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define a foreign account holding virtual currency as a type of reportable account. (See 31 CFR 1010.350(c)).  For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it is a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency).    However, FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 CFR 1010.350.

This area is moving in one direction – more reporting. There is currently some inconsistency in how cryptocurrency exchanges report to the IRS (Form 1099-B versus 1099-K versus 1099-MISC). I expect the IRS to lean harder – and soon - on standardizing this reporting. This genie is out of the bottle.

Foreign Investment In U.S. Rental Real Estate

We have spoken about Congress’ and the IRS’ increasing reliance on penalties.

Here is one from the new Taxpayer First Act of 2019:

The minimum penalty for filing a return more than 60 days later will now be no less than the lesser of:

·        $330 or

·        100% of the amount required to be shown on the tax return.

The previous marker was $205, adjusted for inflation.

Thanks for saving the republic from near-certain extinction there, Congress.

There is another one that has caught my attention, as it impacts my practice.

By happenstance I represent a fair number of foreign nationals who own rental real estate in the U.S.

Why would a foreign national want to own rental real estate in Georgetown, KY, Lebanon, OH or Arlington, TN?

I don’t get it, truthfully, but then I am not a landlord by disposition. I certainly am not a long-distance landlord.

There is a common structure to these arrangements. The foreign national sets up an U.S.-based LLC, and the LLC buys and operates the rentals. Practitioners do not often use corporations for this purpose.

There is a very nasty tax trap here.

There is special reporting for a foreign corporation doing business in the United States. As a flip to that coin, there is also special reporting for a U.S. corporation that is 25%-or-more owned by nonresidents. We are referring to Form 5472, and it is used to highlight “reportable transactions,” with no dollar minimum.

“Reportable transactions” sounds scary. I suppose we are looking for laundering of illicit money or something similar, right?

Here is an example of a “reportable transaction”:

·        borrowing money

Here is another:

·        paying interest on borrowed money

Yep, we are going full CSI on that bad boy.

Let’s play with definitions and drag down a few unattentive tax practitioners, why don’t we?

An LLC with one owner can be considered to be the same as its owner for tax purposes.

Say that Emilio from Argentina sets up an Ohio LLC.  He is the only owner. The LLC goes on to buy rental properties in Cincinnati and Columbus.

For federal income tax purposes, the LLC is disregarded and Emilio is deemed to own the properties individually.

For purposes of information reporting, however, the IRS wants you to treat Emilio’s single-member LLC as a corporation.

A “corporation” that is more-than-25% owned by a nonresident.

Meaning that you have a Form 5472 filing requirement.

What happens if the tax practitioner doesn’t catch this wordplay?

An automatic penalty of $10,000 for not filing that 5472.

Granted, the practitioner will fight the penalty. What choice is there?

Let’s up the ante.

Buried in the new tax law for 2018 (that is, the Tax Cuts and Jobs Act), Congress increased the minimum penalty from $10,000 to $25,000.

So a foreign national buys a rental house or two in name-a-city, and somehow he/she is on par with an Alibaba or Banco Santander?

The IRS automatically charges the penalty if the form is filed late. The practitioner would have to provide reasonable cause to have the penalty abated.  

Remember next that the IRS does not consider an accountant’s error to be necessarily provide reasonable cause, and you can anticipate how this story may not turn out well.

Owing A Million Dollar Penalty

What caught my attention was the size of the penalty.

The story involves Letantia Russell, a dermatologist from California who has been in the professional literature way too much over too many years. The story started with her attorneys reorganizing her medical practice into a three-tiered structure and concealing ownership through use of nominees. Then there was the offshore bank account.

Let’s talk about that offshore account.

Back when I came out of school, one had to report foreign accounts above a certain dollar balance. The form was called the “TD 90-22.1.” I remember accountants who had never heard of it. It just wasn’t a thing.

The requirement hasn’t changed, but the times have.

If you have an overseas bank account, you are supposed to disclose it. The IRS has a question on Schedule B (where you report interest and dividends) whether you have a foreign bank account. If you answer yes, you are required to file that TD 90-22.1. The form does not go to the IRS; it instead goes to the Treasury Department. Mind you, the IRS is part of Treasury, but there are arcane rules about information sharing between government agencies and whatnot. Send to Treasury: good. Send to IRS: bad.

The rules were fairly straightforward: bank account, balance over $10 grand, own or able to sign on the account, required to file. There was no rocket science here.

Don’t play games with account types, either. A checking account is the same as a savings account which is the same as a money market and so on. Leave that hair-splitting stuff to the lawyers.

About a decade or so ago, the government decided to pursue people who were hiding money overseas. Think the traditional Swiss bank account, where the banker would risk jail rather than provide information on the ownership of an account. That Swiss quirk developed before the Second World War and was in response to the unstable Third Republic of France and Weimar government of Germany. Monies were moving fast and furious to Switzerland, and Swiss bankers made it a criminal offense to break a strict confidentiality requirement.

Thurston Howell III joked about it on Gilligan’s Island.

Travel forward to the aughts and the UBS scandal and the U.S. government was not laughing.

Swiss banks eventually agreed to disclose.

The IRS thundered that those who had … ahem, “underreported” … their foreign income in the past might want to clean-up their affairs.

The government dusted-off that old 90-22.1 and gave it a new name: FinCen 114 Report of Foreign Bank and Financial Accounts.

The IRS was still miffed about that government-agency-sharing thing, so it came up with its own form: Form 8938 Statement of Foreign Financial Assets.

So you had to report that bank account to Treasury on the FinCen and to the IRS on Form 8938.  Trust me, even the accountants were trying to understand that curveball.

Resistance is futile, roared the IRS.

Many practitioners, me included, believed then and now that the IRS went fishing with dynamite. The IRS seemed unwilling to distinguish someone who inherited his/her mom’s bank account in India from a gazillionaire hedge-fund manager who knew exactly what he/she was doing when hiding the money overseas.

And you always have … those people.

Letantia Russell is one of those people.

The penalties can hurt. Fail to fail by mistake and the penalty begins at $10,000. Willfully fail to file and the penalty can be the greater of

·      $100,000 or

·      ½ the balance in the account

Letantia dew a $1.2 million penalty on her 2006 tax return. I normally sympathize with the taxpayer, but I do not here. One has to be a taxpayer before we can have that conversation.

It went to District Court. It then went to Appeals, where her attorneys lobbed every possible objection, including the unfortunate trade of Jimmy Garappolo from the New England Patriots to the San Francisco 49ers.

It was to no avail. She gets to pay a penalty that would make a nice retirement account for many of us.

How Do You Really Know If You Filed A Tax Return?

Here is what caught my attention:

The Internal Revenue Service … determined a deficiency of $541,552 in petitioner’s 2012 Federal income tax and an accuracy-related penalty of $107,995.”

This is the Whitsett case. She is a doctor and specializes in blood transfusions. Way back in 1982 she and her husband bought 4,000 shares of Immucor, Inc stock for $11,000. She kept it after the divorce.

Fast forward to 2011 and someone agreed to acquire Immucor for $27 per share.

She had almost 20 years for the stock to split and split again; she now owned 63,594 shares.

By my math 63,594 times $27 = $1,717,038.

How I wish I had those problems.

Come tax time she takes the paperwork to her accountant, whom she had used for decades. She showed him paperwork accompanying her $1.17 million check, captioned “Corporate Action Advice.” It said that …

·      The “payment date” was August 19, 2011

·      The “tax year” was 2012

·      The sale was “processed” on January, 2012

I have no idea what this “action advice” was trying to say. As a tax CPA, I report someone’s financial life to the IRS one year at a time. It is critical to me to know whether this sale took place in 2011 or 2012. Whoever wrote this “advice” must have been crazed or did not command the language.

COMMENT: If I were the CPA, I would be on the phone to shareholder services. Or I would ask you to call. Either way, we are investigating.

QUESTION: There is one more thing that could help with determining the tax year. Can you guess what it is?

Dr W’s accountant takes a look at the paperwork and decides that 2011 is the proper year to report the gain.

The accountant was also under the impression that she had been reinvesting dividends. He does a calculation (totaling $628,437), adds it to $11,000 and determines that her “basis” in the stock was $639,437.

And her gain is $1,077,601 (1,717,038 – 639,437).

He extends her return and has her send an extension payment of $154,776.

The return was extended until October 15, 2012. For some reason, he did not finish it on time. Instead he finished it in February, 2013. He sent Dr W a copy of her return as well as a letter explaining that he had “filed the return electronically.”

Happens all the time.

COMMENT: Except that a step is missing. Do you know what it is?

There was $5,393 due, and the Dr sent a check.

All done, right?

Nope.

The Dr gets a Form 1099-B reporting the sale of the stock in 2012.

COMMENT: Now he has to amend her 2011 to remove the sale.

The accountant reviewed the paperwork and decided that nothing needed to be reported in 2012, as she had reported the sale the year before. As if to provide an exclamation point, he did not even show the sale on her 2012 return with zero gain, if only to avoid tripping the IRS computers. He was pretty certain about his game. 

COMMENT: This is not done. Even if I was absolutely convinced that the 1099 was in error, I would report it on your return and then find a way to back it out. The IRS simply matches A to B; in the event of a mismatch, the IRS computers send out an automatic notice. The notice does not pass human eyeballs until you respond (or eventually, should you fail to respond).

Late in 2013 the IRS sent the Dr a notice asking where her 2011 return was. They were showing a credit of $165,562 but no return.

For some reason the Dr sent another check for $5,393. Why? Who knows.

She asked him about that 2011 return. He assured her that he filed it electronically.

COMMENT: If the IRS is asking, you did not file. You may have thought you did, but you are not going to win this fight. Send them a copy. Some practitioners even include a legend such as “Information Only – Previously Filed.” You can attach a note to this effect. No one is going to read the note and – more likely than not – you will receive a notice for late filing, but there is no harm.

Her accountant was so sure, however, that he sent the IRS nothing. Not a letter. Not a call. Nothing. What could possibly go wrong?

By October, 2014 the IRS sent the Dr a notice for big-time taxes due for 2012. Remember that - according to the IRS - she sold that stock in 2012.

In February 2015, the accountant backed down and admitted that the sale should have been reported in 2012. He also blew the calculation of her stock basis by adding $628,437 for reinvestments. Turns out that she had not reinvested. He promised to amend the 2011 and 2012 returns.

He amended nothing.

Finally – and fed up – she hired an attorney.

On April 10, 2015, the attorney amended the 2011 return, removing the sale of stock. 

QUESTION: Do you recognize the significance of the date: April 10, 2015?

Without the stock sale, she had a gigantic overpayment for 2011, which the attorney applied to 2012 and the stock sale.

The case, by the way, was not about the story we have just told. No sir. The case was because the IRS wanted gigantic penalties from Dr W.

Huh?

From their perspective, she refused to file a 2011 return, even after being reminded.

And – on top of that – she left out a big stock sale on her 2012 return.

If that was all you knew, she would look pretty bad.

From her side, the IRS looks like a bully. She reported the stock gain and paid the tax A YEAR EARLY.

Granted, the paperwork was a disaster, but the money was there before its time. If anything, the IRS should pay interest for banking her money.

The Tax Court fortunately reversed the penalties against Dr W. They felt she had acted with “reasonable cause” and “in good faith.” She relied on a long-standing tax advisor. He went off the rails, but how was she to know?

Remember that the penalty was over a hundred grand.

Back to our questions:

(1) The accountant should have questioned why he did not have a Form 1099-B for 2011. Anything can happen and paperwork gets lost, but the lack of one made me curious immediately.

(2) The accountant is not allowed to release her return without written permission from Dr W. Why? Because it not his return, that is why. He should have requested her to sign an authorization and mail it back to him before filing anything.

(3) The significance of the date is the statute of limitations. The original due date for a 2011 return was April 15, 2012. Add three years and make it April 15, 2015. If she wanted to get her 2011 refund (and she did), she had to get her amended return in by April 15, 2015. She made it by 5 days.

I am not sure what happened with the accountant. Was there a foul-up with his software? Did he attempt to electronically file but not recognize that the attempt failed? Why did he ignore a Form 1099, knowing that those things are chum-in-the-water for the IRS? Why did he not recognize that the statute of limitations was closing on a hundred-and-fifty grand?

And why not just send another copy of the return to the IRS and be done with it?

A Tax Shelter In The Making

Have you ever heard of a “captive” insurance company?

They have become quite cachet. They have also drawn the IRS’ attention, as people are using these things for reasons other than insurance and risk management.

Let’s walk through this.  

Let’s say that you and I found a company manufacturing sat-nav athletic shoes

COMMENT: Sat-nav meaning satellite navigation. That’s right: you know you want a pair. More than one.

We make a million of them, and we have back orders for millions more. We are on the cover of Inc. magazine, meet Jim Cramer and get called to the White House to compliment us for employing America again.

Sweet.

Then tax time.

We owe humongous taxes.

Not sweet.

Our tax advisor (I am retired by then) mentions a captive.

LET’S EXPLAIN THIS: The idea here is that we have an insurable risk. Rather than just buying a policy from whoever-is-advertising-during-a-sports-event, we set up our own (small) insurance company. Granted, we are never going to rival the big boys, but it is enough for our needs. If we can leap through selected hoops, we might also get a tax break from the arrangement.

What risks do you and I have to insure?

What is one of those shoes blows out or the satellite-navigation system shorts and electrocutes someone? What if it picks up contact from an alien civilization – or an honest political journalist? We could get sued.

Granted, that is what insurance is for. The advisor says to purchase a policy from one of the big boys with a $1.2 million deductible. We then set up our own insurance company – our “captive” – to cover that $1.2 million.

We are self-insuring.

There is an election in the tax Code (Section 831(b) for the incorrigible) that waives the income tax on the first $1.2 million of premiums to the captive. It does pay tax on its investment income, but that is nickels-to-dollars.

You see that I did not pick the $1.2 million at random.

Can this get even better?

Submitted for your consideration: the You & Me ET Athletic Shoe Company will deduct the $1.2 million as “Insurance Expense” on its business return.

We skip paying tax on $1.2 million AND we deduct it on our tax return?

Easy, partner. We can still be sued. We would go through that $1.2 million in a heartbeat.

Is there a way to MacGyver this?

Got it. Three ways come quickly to mind, in fact:

(1) Let’s make the captive insurance duplicative. We buy a main policy with a reputable insurance company. We then buy a similar – but redundant -  policy from the captive.  We don’t need the captive, truthfully, as Nationwide or Allstate would provide the real insurance. We do get to stuff away $1.2 million, however – per year. We would let it compound. Then we would go swimming in our money, like Scrooge McDuck from the Huey, Dewey and Louie comics.

(2) A variation on (1) is to make the policy language so amorphous and impenetrable that it is nearly impossible to tell whether the captive is insuring whatever it is we would submit a claim for. That would make the captive’s decision to pay discretionary, and we would discrete to not pay.

(3) We could insure crazy stuff. Let’s insure for blizzards in San Diego, for example. 

a.    Alright, we will need an office in San Diego to make this look legitimate. I volunteer to move there. For the team, of course.

The tax advisor has an idea how to push this even further. The captive does not need to have the same owners as the You & Me ET Athletic Shoe Company. Let’s make our kids the shareholders of the captive. As our captive starts hoarding piles of cash, we are simultaneously doing some gifting and estate tax planning with our kids.

Heck, we can probably also put something in there for the grandkids.

To be fair, we have climbed too far out on this limb. These things have quite serious and beneficial uses in the economy. Think agriculture and farmers. There are instances where the only insurance farmers can get is whatever they can figure-out on their own. Perhaps several farms come together to pool risks and costs. This is what Section 831(b) was meant to address, and it is a reason why captives are heavily supported by rural state Senators.

In fact, the senators from Wisconsin, Indiana and Iowa were recently able to increase that $1.2 million to $2.2 million, beginning in 2017.

Then you have those who ruin it for the rest of us. Like the dentist who captived his dental office against terrorist attack.

That nonsense is going to attract the wrong kind of attention.

Sure enough, the IRS stepped in. It wants to look at these things. In November, 2016 the IRS gave notice that (some of) these captive structures are “transactions of interest.” That lingo means that – if you have one – you must file a disclosure (using Form 8886 Reportable Transaction Disclosure Statement) with the IRS by May 1, 2017.

If this describes you, this deadline is only a few months away. Make sure that your attorney and CPA are on this.

Mind you, there will be penalties for not filing these 8886s.

That is how the IRS looks at things. It is good to be king.

The IRS is not saying that captives are bad. Not at all. What it is saying is that some people are using captives for other than their intended purpose. The IRS has a very particular set of skills, skills it has acquired over a very long career. Skills that make the IRS a nightmare for people like this. If these people stop, that will be the end of it. If they do not stop, the IRS will look for them, they will find them, and they will ….

Ahem. Got carried away there.

When this is over, we can reasonably anticipate the IRS to say that certain Section 831(b) structures and uses are OK, while others are … unclear. The IRS will then upgrade the unclear structures and uses to “reportable” or “listed” status, triggering additional tax return disclosures and potential eye-watering penalties.

In the old days, listed transactions were called “tax shelters,” so that will be nothing to fool with.

Proposal to Report IRS Debt to Credit Bureaus

The General Accounting Office has released a report titled “Federal Tax Debts: Factors for Considering a Proposal to Report Tax Debts to Credit Bureaus.”

Seems self-explanatory.

The report was provided to Sen. Max Baucus (D-Montana), chairman of the Senate Finance Committee, and Sen. Charles Grassley (R-Iowa), ranking Republican on the Senate Judiciary Committee. At the end of 2011 the IRS was carrying an inventory of $373 billion in receivables: $258 from individuals and $115 from businesses. Under current policy the IRS cannot directly report these debts to credit bureaus, although it does provide indirect clues by filing tax liens to secure its debts. The liens become part of the private record, which can in turn be picked up by credit bureaus and included in their data bases. There are firms that troll these records to solicit IRS representation, as a number of our clients can attest. There is one outfit in California that seems quite aggressive, as I have seen their form letters with regularity.

Credit reporting is not yet IRS policy, but the GAO report does indicate that the Senate tax committee is looking seriously at this matter. As Congress considers ways to address runaway deficits, it seems a viable proposal to raise revenue.

Are there issues here? Of course.  Many employers are using credit reports as part of their hiring process, and they are also being increasingly used in housing (think renting) decisions. These credit reports have real-life consequences.

On the flip side, reporting may encourage recalcitrant taxpayers to resolve their IRS issues sooner rather than later.

I am not sure I am comfortable with this proposal. I have worked IRS representation for many years, and while my experience with the IRS has been generally positive, I also have my share of war stories. I have arrived at agreement at examination, only to have exam reverse its decision and force me into Appeals. I have had the IRS battle me on a research credit, where the business owner is a professor at the University of Cincinnati and is commercializing his research. I have a client in Florida with two daughters. He is divorced, and his wife pays child support. We are battling the IRS because they do not want to believe that the two girls live with him. This affects his filing status (head of household), as well as his child credit ($1,000 for each girl). It would seem an easy case, as the girls’ mother lives in northern Kentucky. The girls are in Florida, for goodness sake.

Remember: these are people who can afford to hire me.

Of the $373 billion, $60 billion was in dispute or already in installment plans. $110 billion has been classified as uncollectible (I have several clients included in that total). That leaves about $200 billion that could be brought into the system, I suppose. The distribution curve of the debt is pretty much what one would expect. Well over half the taxpayers owe small dollars - less than $5,000.  The big dollars are concentrated in a much smaller group of taxpayers: debts over $5,000 add-up to $310 billion of the $373 billion total.

Still, how much of this is contestable IRS debt but the taxpayer cannot afford a tax pro?

The New 1099 For Credit Card Reporting

It’s been over a year since we talked about the new IRS Form 1099-K. This was part of the Housing Assistance Act of 2008, and it was to – at least partially - “offset” the cost of the first homebuyer’s credit.

This is Congress passing laws, mind you, so the reporting did not apply until sales made on or after January 1, 2011. This means you may be receiving this new 1099 during the 2012 tax filing season.

Let’s talk about the “why” for this form.

Say that you are a vendor on eBay or Amazon. It used to be that eBay or Amazon did not have to send you a tax reporting form. Why would they? They did not pay you; rather, a number of buyers using eBay or Amazon paid you. Let’s use another example. Let’s say that you use PayPal or Google Checkout on your website. As a third party payment network, they did not have to report the transaction. Why would they? They did not pay you; they just processed the transaction whereby some else paid you.

This caught the attention of a Congress that has all but gone through our sofa cushions for the next thing to tax.

So, let’s say that you are selling stuff on eBay or otherwise accepting payment through PayPal. Will you receive a 1099-K? It depends. If you have sales of less than $20,000 a year or fewer than 200 transactions per year, then 1099-K reporting will not be necessary.

The look and feel of Form 1099-K is very similar to Form 1099-INT used by banks to report interest and Form 1099-DIV used to report dividends.

Are we are expecting problems with the new 1099-Ks? Oh yes. The 1099-K will include sales tax and shipping charges, for example. The 1099-K will report the gross amount of payment card and third-party network payments, so one has to be careful with the reporting of refunds. The IRS is already talking about segregating receipts on different lines of the tax forms so that they can match to the 1099-Ks. When you consider that the IRS has a computer-matching program that generates notices without the intercession of human eyes, this may well be a disaster waiting to happen.

Be Careful With Foreign Tax Information Returns

Today we filed an extension for a client company with a foreign subsidiary. I was recently reading a Chief Counsel’s Advice concerning the same type of tax return that our client will be filing in a few months.

There is an additional form to file when one owns a foreign corporation. That is Form 5471 “Information Return of U.S Persons with Respect to Certain Foreign Corporations.” The common ownership threshold for filing is 10 percent. There is a twist in which an officer or director has a responsibility to file, even if the officer or director owns no shares directly, as long as a US citizen owns at least 10 percent.

Frankly, this is a confusing return. There are four types of “filers,” and each has to fill-out – or not fill-out- certain sections of the return. One may have to provide an income statement for the foreign company, for example, or track its earnings and profits.

The 2010 HIRE Act amended the tax Code (Section 6501(c )(8)) so that the statute of limitations for an income tax return to which an international “information return“ relates does not start until the information return is filed.

What does this mean? Well, Form 5471 is considered an “information return.” This means that it has numbers on it, but there is no line that says “tax due.” There is a similar form (Form 8865) for foreign partnerships and another (Form 3520) for foreign trusts.

So you own (enough of) a foreign corporation to file Form 5471. The accountant doesn’t think about it and files the corporate return without it.  The IRS in CCA 201104041 clarified that the statute of limitations on the corporate return does not begin to run until the Form 5471 is filed.

The client referred to above is new to the firm. One of the reasons that they switched firms? Their former CPA had not been filing Forms 5471.

If you remember, there are also penalties for not filing foreign information returns, including Form 5471. That however is for another blog post.