We are taking a look at an Interest Charge – Domestic International Sales Corporation (IC-DISC).
As you can guess, this has to do with a company which exports. I remember the DISC as providing a tax deferral, but it has another tax feature that we like as much or more.
Here is quick breakdown of how the IC-DISC would work:
(1) There is an exporting company (ExCo)
(2) ExCo (or its owners) set up a second company (DISC) and elect to be treated as an IC-DISC.
(3) ExCo pays DISC a commission
(4) DISC pays no tax on the commission (up to a point) as long as 95% of its activities and assets are export-related.
NOTE: Do you see what is happening? DISC pays no tax on the commission. ExCo deducts the commission and reduces its tax.
(5) DISC may pay dividends to its shareholders.
(6) If DISC does not pay dividends, there will a charge to the shareholders. The charge will vary depending on whether the shareholders are individuals or a corporation. Individuals will pay interest (hence “Interest Charge – DISC”). There is a different tax treatment for corporations.
The DISC can be a “paper” company. That is, it does not have to perform any substantial economic functions. It does not have to have employees or office space, for example. Pretty much the only thing it has to do is keep its own books and records, which an accounting department can do. You incorporate, print some new stationary and continue doing what you were doing before. How much easier can this be?
There are of course limits on how to calculate the commission; otherwise you would have a product selling for $50 with a thousand dollar commission tacked onto it. The commission is 4% of the qualified export receipts or 50% of ExCo’s taxable income, whichever is greater.
The DISC can defer $10 million in commissions EVERY year. There is even a way to increase this limit.
The tax deferral is sweet, but Rick and I like the dividend treatment as much or more. We expect the DISC to be an S corporation, and its shareholders to be the same as those for ExCo. We can also see a wealth transfer opportunity here by having the younger generation as the owners of the DISC, while mom and dad (or grandmom and granddad) still own ExCo. We are thinking of having the DISC distribute every year. Under this scenario there is no deferral. We want to move money out of the main company (ExCo), which would otherwise be taxed at the maximum rate, and push it to DISC, whose dividends are taxable at 15 percent. This would be an immediate 20% tax savings.
Tuesday, June 21, 2011
The Collection Due Process Hearing
A client recently faxed me a Notice of Intent to Levy. His tax case is relatively simple, as we are not debating the amount of tax. Rather, he is in a position where he cannot pay-off his tax due. This requires a payment plan, which can blow up if the taxpayer misses a payment. He is self-employed with erratic income, so he is at ongoing risk of blowing up his payment plan. He unfortunately believes – or has believed – that we can reactivate a payment plan whenever he feels like missing a payment, but I believe we impressed upon him that this is not the case. The IRS becomes weary, and frankly so do we.
I thought this a good time to talk about the Collection Due Process hearing.
Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.
What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.
You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.
An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.
I thought this a good time to talk about the Collection Due Process hearing.
Once you receive a Notice of Federal Tax Lien (NFTL) or Intent to Levy, you have 30 days to request a CDP hearing. If so, the levy action will be suspended for the duration of the hearing. IRS Appeals conducts the hearing. The taxpayer can appeal a CDP hearing, if so inclined.
What happens if you miss the 30 days? Not all is lost. You can request an Equivalent Hearing as long as you file within one year of the NFTL or levy notice. The difference is that you cannot appeal an Equivalent Hearing.
You have to file a form (Form 12153) and state a reason for the hearing. In our case, we will request a collection alternative, such as an installment agreement. Our client does not qualify for an offer in compromise, which is another valid reason. Other reasons include requests to release or subordinate a lien, request for innocent spouse and a dispute over the amount of unpaid taxes. An important reason in today’s economy is financial hardship, which can include heavy medical bills, unemployment, and taxpayer’s reliance on social security or unemployment benefits.
An unfortunate note is that – even if the IRS accepts the collection alternative – interest and penalties will continue to accrue.
Losing Bankruptcy Protection On Your IRA
You probably know that monies in your IRA are protected from bankruptcy. No one intends to go there, but it’s nice to know that you have that safeguard.
What do you have to do to void that protection?
Enter Ernest Willis and his IRAs (Willis v Menotte).
Willis opened a self-directed IRA with Merrill Lynch in March, 1993. On December 20, 1993 he withdrew $700,000to help him with a real estate transaction. On February 22, 1994 he put the $700,000 back in the IRA.
NOTE: Let’s count the days… 12 + 31 +22 = 65 days. You may remember that you can withdraw money from your IRA and not have it count as a distribution IF you replace it within 60 days. Looks like Willis missed his count.
In January, 1997 Willis had problems with the stock market. He had to put money into his brokerage account (I presume he was on margin), so he wrote checks back and forth between his IRA and the brokerage account. The settlement takes a few days, so he could keep the brokerage account afloat by swapping checks. Since he was replacing the IRA monies within 60 days, he did not have a distribution.
Somewhere in here Willis partially rolled-over his Merrill Lynch account to AmTrust and Fidelity.
In February, 2007 Willis filed for bankruptcy. The creditor wanted his IRA. Willis said NO NO and NO. The IRA is protected by Bankruptcy Code Section 522(b) (4) (A). “Go away” says Willis.
The bankruptcy court takes a look at the IRA transactions. An IRA is not allowed to participate in certain transactions (called “prohibited transactions”) with its fiduciary. Guess what? If you direct a self-directed IRA, you are a “fiduciary.” Willis tapped into his IRA and did not replace the money within 60 days. The 60 days is not a suggestion; it is the statute. He didn’t make it. He put the money back in there, but this was not horseshoes. This was a prohibited transaction.
The court was also not too amused with the check swapping scheme and his brokerage account. The court observed that this had the effect of a loan between Willis and his IRA. An IRA cannot loan money, and it especially cannot loan money to its fiduciary. This was a prohibited transaction.
The bankruptcy court held against Willis. He appealed to the district court. That court sustained. Willis next appealed to the Eleventh Circuit, and the circuit court has just sustained the district court. Willis has lost.
How much money was in these IRAs? The Merrill Lynch account alone was over $1.2 million.
I have known clients to “borrow” from their IRA, and I especially remember one doing this while Rick and I worked together at another firm a few years ago. I remember counting down and sweating the 60 days. This was a sensitive client, and – if it blew up – I was going to take massive damage. Willis unfortunately did not keep it to 60 days. He must have been strapped, because he wound up borrowing from friends and family. He put the money back into the IRA, but he had missed the window. The later episode with the check swapping was just icing on the cake.
The court pointed out that once the IRA was tainted, the taint followed the partial rolls to the other two IRAs. His three IRAs were unprotected and could be actioned by his bankruptcy creditors.
Willis thought he was clever. He got schooled, and the tuition was expensive.
What do you have to do to void that protection?
Enter Ernest Willis and his IRAs (Willis v Menotte).
Willis opened a self-directed IRA with Merrill Lynch in March, 1993. On December 20, 1993 he withdrew $700,000to help him with a real estate transaction. On February 22, 1994 he put the $700,000 back in the IRA.
NOTE: Let’s count the days… 12 + 31 +22 = 65 days. You may remember that you can withdraw money from your IRA and not have it count as a distribution IF you replace it within 60 days. Looks like Willis missed his count.
In January, 1997 Willis had problems with the stock market. He had to put money into his brokerage account (I presume he was on margin), so he wrote checks back and forth between his IRA and the brokerage account. The settlement takes a few days, so he could keep the brokerage account afloat by swapping checks. Since he was replacing the IRA monies within 60 days, he did not have a distribution.
Somewhere in here Willis partially rolled-over his Merrill Lynch account to AmTrust and Fidelity.
In February, 2007 Willis filed for bankruptcy. The creditor wanted his IRA. Willis said NO NO and NO. The IRA is protected by Bankruptcy Code Section 522(b) (4) (A). “Go away” says Willis.
The bankruptcy court takes a look at the IRA transactions. An IRA is not allowed to participate in certain transactions (called “prohibited transactions”) with its fiduciary. Guess what? If you direct a self-directed IRA, you are a “fiduciary.” Willis tapped into his IRA and did not replace the money within 60 days. The 60 days is not a suggestion; it is the statute. He didn’t make it. He put the money back in there, but this was not horseshoes. This was a prohibited transaction.
The court was also not too amused with the check swapping scheme and his brokerage account. The court observed that this had the effect of a loan between Willis and his IRA. An IRA cannot loan money, and it especially cannot loan money to its fiduciary. This was a prohibited transaction.
The bankruptcy court held against Willis. He appealed to the district court. That court sustained. Willis next appealed to the Eleventh Circuit, and the circuit court has just sustained the district court. Willis has lost.
How much money was in these IRAs? The Merrill Lynch account alone was over $1.2 million.
I have known clients to “borrow” from their IRA, and I especially remember one doing this while Rick and I worked together at another firm a few years ago. I remember counting down and sweating the 60 days. This was a sensitive client, and – if it blew up – I was going to take massive damage. Willis unfortunately did not keep it to 60 days. He must have been strapped, because he wound up borrowing from friends and family. He put the money back into the IRA, but he had missed the window. The later episode with the check swapping was just icing on the cake.
The court pointed out that once the IRA was tainted, the taint followed the partial rolls to the other two IRAs. His three IRAs were unprotected and could be actioned by his bankruptcy creditors.
Willis thought he was clever. He got schooled, and the tuition was expensive.
Another Warning on Deducting Auto Expenses
There is a very recent case concerning tax deductions for business use of a vehicle that I am considering as mandatory reading for many of our clients.
The pattern is repetitive. Either the business provides the car or the employee uses his/her car for business and is not reimbursed. Tax time we ask the following questions: what is your mileage? What do you have as documentation to support that mileage? We review the danger associated with this tax deduction (the IRS will disallow it if you cannot back it up), to which it seems most of the clients roll their eyes and go “yea, yea.”
Well, Jessica Solomon just got schooled. It’s a shame, too, as it sounds like Jessica was trying to do the right thing, but she just didn’t know what that meant. Let’s look at Jessica Solomon v Commissioner.
Jessica Solomon moved from Illinois to Missouri in 2006. First, let me say that I went to the University of Missouri, so I approve of her move. Second, she started work as a commission-only salesperson for seven months – June through December. She was peddling office supplies. Every day she started the morning at the company office in St Louis, and at the end of the day she finished with an evening meeting there. She only made $3,307 in commissions. Considering that she was reimbursed for NOTHING, it sounds to me like this was a waste of her time.
She kept a log in her car. At the start of the day she wrote down her mileage, and at the end she noted her mileage. Unfortunately, there was no other information, such as the towns, prospects or customers she was visiting. It was bare-boned, but it was something.
At the end of the year she went to H&R Block. They deducted her business expenses, including 18,741 business miles.
In January, 2009 the IRS issued a statutory notice disallowing all her mileage and employee expenses for 2006. Jessica, bless her heart, went to Tax Court representing herself (this is called “pro se”). It did not go well for Jessica.
Unfortunately, the court was right. Let’ go through this…
* It is an axiom in tax practice that deductions are a matter of legislative grace. This is fancy way of saying that there is no deduction just because you really, really want there to be one.
* If a taxpayer presents credible evidence on a factual issue concerning tax liability, Code Section 7491(a) shifts the burden of proof to the IRS.
* If Section 7491(a) kicks in, the IRS (or Court) may even estimate the amount of expenses, if the supporting documentation is poor or even nonexistent.
* There are some expenses where the burden of proof does not shift under Section 7491(a).
* A car is one of those expenses. Car expenses are addressed under Section 274(n).
* Section 274(n) says that no deductions are allowed with respect to listed property (think a car) unless very specific documentation requirements are met:
** The amount
** The time and place
** The business purpose
** The taxpayer’s relationship with the persons involved
The Court looked at her log. The court had several problems;
(1) The log noted only the beginning and ending mileage for each day
(2) The log included a 27 mile commute
(3) The log may have included personal trips
So far, I could have worked with this. I would ask Jessica for a Day Runner or some other record of who she visited, where and etc. In fact, had she submitted contact reports to the company, I would ask the company to provide copies for her tax audit. I need corroborating evidence. The evidence does not have to be on the same sheet of paper. In truth, it need not even had been created at the time, although that would of course carry more weight.
Unfortunately Jessica could not do this. Here is the Court:
Petitioner did not present any evidence at trial, such as appointment books, calendars, or maps of her sales territories, to corroborate the bare information contained in the mileage log…”
But the court KNEW that she had to use her car – right? Surely the Court would spot her something.
Although we do not doubt that petitioner used her Chevrolet Cavalier for business between June and December, 2006, we have no choice but to deny in full petitioner’s deduction for mileage expenses. For reasons discussed …, petitioner’s mileage log does not satisfy the adequate records requirement of Section 274(d).”
No mileage deduction for Jessica.
As I said, perhaps this case should be mandatory reading for many of our clients.
The pattern is repetitive. Either the business provides the car or the employee uses his/her car for business and is not reimbursed. Tax time we ask the following questions: what is your mileage? What do you have as documentation to support that mileage? We review the danger associated with this tax deduction (the IRS will disallow it if you cannot back it up), to which it seems most of the clients roll their eyes and go “yea, yea.”
Well, Jessica Solomon just got schooled. It’s a shame, too, as it sounds like Jessica was trying to do the right thing, but she just didn’t know what that meant. Let’s look at Jessica Solomon v Commissioner.
Jessica Solomon moved from Illinois to Missouri in 2006. First, let me say that I went to the University of Missouri, so I approve of her move. Second, she started work as a commission-only salesperson for seven months – June through December. She was peddling office supplies. Every day she started the morning at the company office in St Louis, and at the end of the day she finished with an evening meeting there. She only made $3,307 in commissions. Considering that she was reimbursed for NOTHING, it sounds to me like this was a waste of her time.
She kept a log in her car. At the start of the day she wrote down her mileage, and at the end she noted her mileage. Unfortunately, there was no other information, such as the towns, prospects or customers she was visiting. It was bare-boned, but it was something.
At the end of the year she went to H&R Block. They deducted her business expenses, including 18,741 business miles.
In January, 2009 the IRS issued a statutory notice disallowing all her mileage and employee expenses for 2006. Jessica, bless her heart, went to Tax Court representing herself (this is called “pro se”). It did not go well for Jessica.
Unfortunately, the court was right. Let’ go through this…
* It is an axiom in tax practice that deductions are a matter of legislative grace. This is fancy way of saying that there is no deduction just because you really, really want there to be one.
* If a taxpayer presents credible evidence on a factual issue concerning tax liability, Code Section 7491(a) shifts the burden of proof to the IRS.
* If Section 7491(a) kicks in, the IRS (or Court) may even estimate the amount of expenses, if the supporting documentation is poor or even nonexistent.
* There are some expenses where the burden of proof does not shift under Section 7491(a).
* A car is one of those expenses. Car expenses are addressed under Section 274(n).
* Section 274(n) says that no deductions are allowed with respect to listed property (think a car) unless very specific documentation requirements are met:
** The amount
** The time and place
** The business purpose
** The taxpayer’s relationship with the persons involved
The Court looked at her log. The court had several problems;
(1) The log noted only the beginning and ending mileage for each day
(2) The log included a 27 mile commute
(3) The log may have included personal trips
So far, I could have worked with this. I would ask Jessica for a Day Runner or some other record of who she visited, where and etc. In fact, had she submitted contact reports to the company, I would ask the company to provide copies for her tax audit. I need corroborating evidence. The evidence does not have to be on the same sheet of paper. In truth, it need not even had been created at the time, although that would of course carry more weight.
Unfortunately Jessica could not do this. Here is the Court:
Petitioner did not present any evidence at trial, such as appointment books, calendars, or maps of her sales territories, to corroborate the bare information contained in the mileage log…”
But the court KNEW that she had to use her car – right? Surely the Court would spot her something.
Although we do not doubt that petitioner used her Chevrolet Cavalier for business between June and December, 2006, we have no choice but to deny in full petitioner’s deduction for mileage expenses. For reasons discussed …, petitioner’s mileage log does not satisfy the adequate records requirement of Section 274(d).”
No mileage deduction for Jessica.
As I said, perhaps this case should be mandatory reading for many of our clients.
Signing Up for Social Security?
Those applying for social security beginning Monday, May 2, will have to select an electronic payment option – either direct deposit or a debit card. The debit card can be reloaded every month. One has to be careful, though, as fees will apply. For example, there is a $1.50 charge for transferring from the card to a checking or savings account.
If you are already receiving social security, then you have two more years – until March, 2013 - to make this decision.
If you are already receiving social security, then you have two more years – until March, 2013 - to make this decision.
Will Bankruptcy Protect Against An IRS Lien on Your IRA
It happened this busy season. As you may know, we do our share – and then some – of tax representation work. I would say that, despite our size, we do as much representation work as many firms in Cincinnati.
So what happened? A client wanted to know whether the IRS could lien her IRA.
Do you know the answer?
I’ll give it to you momentarily
I was looking at a tax case called Miles v Commissioner. Corrie Miles ran up past due taxes. The IRS filed liens for 1997 and 1998 which attached to her IRA.
Note: Under Section 6321 if a taxpayer fails to pay a liability after notice and demand, the IRS can file a lien on taxpayer’s property and rights to property.
If it goes to the next step, the IRS is allowed under Section 6331 to seize and sell the property (unless it is exempt) subject to a federal tax lien.
Corrie Miles filed for bankruptcy in 2003. Her 1996, 1997 and 1998 taxes were discharged.
Remember: Taxes more than three years old can be discharged.
Can the IRS go against her IRA?
What is your answer? Did Corrie keep her IRA?
This case went through Appeals and the Supreme Court has just refused to give it cert. But it did go that high up the chain. The IRS won. Why? Although Corrie went through bankruptcy, the IRS had a priority position going in to bankruptcy. The bankruptcy will not wipe out the lien. The IRS could proceed against Corrie’s IRA to the tune of $142,000 – the balance in the IRA before she went into bankruptcy.
So what happened? A client wanted to know whether the IRS could lien her IRA.
Do you know the answer?
I’ll give it to you momentarily
I was looking at a tax case called Miles v Commissioner. Corrie Miles ran up past due taxes. The IRS filed liens for 1997 and 1998 which attached to her IRA.
Note: Under Section 6321 if a taxpayer fails to pay a liability after notice and demand, the IRS can file a lien on taxpayer’s property and rights to property.
If it goes to the next step, the IRS is allowed under Section 6331 to seize and sell the property (unless it is exempt) subject to a federal tax lien.
Corrie Miles filed for bankruptcy in 2003. Her 1996, 1997 and 1998 taxes were discharged.
Remember: Taxes more than three years old can be discharged.
Can the IRS go against her IRA?
What is your answer? Did Corrie keep her IRA?
This case went through Appeals and the Supreme Court has just refused to give it cert. But it did go that high up the chain. The IRS won. Why? Although Corrie went through bankruptcy, the IRS had a priority position going in to bankruptcy. The bankruptcy will not wipe out the lien. The IRS could proceed against Corrie’s IRA to the tune of $142,000 – the balance in the IRA before she went into bankruptcy.
Congress Speaks Up on Innocent Spouse Tax Relief
I am glad to see that Congress is addressing the IRS’s position concerning innocent spouse and litigated in Cathy Marie Lantz v. Commissioner.
Here is a summary of the issue:
There are three “types” of innocent spouse claims. Let’s refer to them by the Code subsections they are presented under: (b), (c) and (f). Type (b) is the classic innocent spouse: the erroneous items belong to one spouse; the other spouse did not know or have reason to know. Type (c) is for divorced spouses and allows each spouse to determine his/her liability as if the spouse had filed a separate return.
Type (f) is more of an expansive innocent spouse rule. It was passed years after the original provisions (it was passed in 1998), and it seeks to provide an opportunity for spouses who cannot meet the (sometimes technical) requirements of (b) and (c).
What (b) and (c) have in common is that the spouse has to file the innocent spouse claim within two years of contact by the IRS. What happens, though, if the one spouse is not told by the other spouse of the contact? Could happen. Some would say it will happen. Say further that two years go by. The spouse then learns of the problem and tries to pursue innocent spouse relief under (f). Does the two year rule apply to an (f) filing?
Interestingly, Congress did not include a two year rule in (f), a point which many practitioners, including myself, interpret to mean that Congress did not mean to include a two year rule in (f). Seems straightforward. The law was in place; Congress was aware of the law and chose not to include the two year requirement.
The IRS does not agree. The IRS argues that Congress delegated authority to it to write administrative Regulations for (f), and that, after consulting with Carnac the Magnificent, it believes that Congress intended for there to be a two-year requirement under (f). Congress just forgot to write it in to the law.
There was a case last year,Cathy Marie Lantz v. Commissioner, which unfortunately agreed with the IRS. To be fair, there is a technical argument, and the argument can be persuasive. Unfortunately, it does not pass the “common sense” test.
Congress has now chimed in and 49 Representatives — including all the Democrats who sit on the tax-writing House Ways and Means Committee — have told the IRS Commissioner that the IRS had “violated the spirit of the original law” in limiting relief to two years. Three Democratic senators — Max Baucus of Montana, the chairman of the Finance Committee; Tom Harkin of Iowa; and Sherrod Brown of Ohio — have sounded the same theme.
The national IRS taxpayer advocate - Nina Olson – has also asked for the two year limit to be extended or revoked.
Let’s hope something comes of this.
Here is a summary of the issue:
There are three “types” of innocent spouse claims. Let’s refer to them by the Code subsections they are presented under: (b), (c) and (f). Type (b) is the classic innocent spouse: the erroneous items belong to one spouse; the other spouse did not know or have reason to know. Type (c) is for divorced spouses and allows each spouse to determine his/her liability as if the spouse had filed a separate return.
Type (f) is more of an expansive innocent spouse rule. It was passed years after the original provisions (it was passed in 1998), and it seeks to provide an opportunity for spouses who cannot meet the (sometimes technical) requirements of (b) and (c).
What (b) and (c) have in common is that the spouse has to file the innocent spouse claim within two years of contact by the IRS. What happens, though, if the one spouse is not told by the other spouse of the contact? Could happen. Some would say it will happen. Say further that two years go by. The spouse then learns of the problem and tries to pursue innocent spouse relief under (f). Does the two year rule apply to an (f) filing?
Interestingly, Congress did not include a two year rule in (f), a point which many practitioners, including myself, interpret to mean that Congress did not mean to include a two year rule in (f). Seems straightforward. The law was in place; Congress was aware of the law and chose not to include the two year requirement.
The IRS does not agree. The IRS argues that Congress delegated authority to it to write administrative Regulations for (f), and that, after consulting with Carnac the Magnificent, it believes that Congress intended for there to be a two-year requirement under (f). Congress just forgot to write it in to the law.
There was a case last year,Cathy Marie Lantz v. Commissioner, which unfortunately agreed with the IRS. To be fair, there is a technical argument, and the argument can be persuasive. Unfortunately, it does not pass the “common sense” test.
Congress has now chimed in and 49 Representatives — including all the Democrats who sit on the tax-writing House Ways and Means Committee — have told the IRS Commissioner that the IRS had “violated the spirit of the original law” in limiting relief to two years. Three Democratic senators — Max Baucus of Montana, the chairman of the Finance Committee; Tom Harkin of Iowa; and Sherrod Brown of Ohio — have sounded the same theme.
The national IRS taxpayer advocate - Nina Olson – has also asked for the two year limit to be extended or revoked.
Let’s hope something comes of this.
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