The IRS Meets An Actuary

I think it was November or December of last year that I met with a client. He was “behind” on his taxes, and he now wanted to do the right thing and catch up.  He passed me a Form 1099, which he described as bogus. It had his name and social security number, but he swore he did not know the payor or provide any services for them.

Could be. Mistakes happen all the time.

I am reviewing the Tax Court summary opinion in Furnish v Commissioner. It is not a technically difficult case – the “summary” part tells you that – but it made me think of my client.

Furnish is an actuary.

QUESTION: Do you know what an actuary does? These guys/gals bring math, statistics and financial modeling to bear in measuring and predicting uncertain outcomes. They may work for insurance companies, for pension plans, for banks and investment firms. Think of them as the Sheldon Coopers of the business world.

Furnish had bought life insurance policies back when. He used policy dividends to buy additional coverage over the years, and he thereafter used policy loans to pay premiums on some or all of the policies. If you use loans to pay premiums for long enough, the policy will eventually burnout. This means it runs out of money. The insurance company will then shut down the policy. It happens with some frequency.

This happened to Furnish. The insurance company then sent him a Form 1099 saying that he had $49,255 as taxable income from the burnout.

         QUESTION: How can you have income from a burnout?

ANSWER: There are three pieces to the answer: (1) you have written checks for the policy over the years. The total amount of checks is your “basis” in the policy; (2) you have loans on the policy; (3) the policy has built-up “cash value” over the years. When the policy burns out, the cash value is used to pay off the loans. If that cash value exceeds your basis, you have income. “Phantom” income perhaps, but still income.

Furnish doesn’t buy into the $49,255 at all. He contacts the insurance company and requests files and records back to the beginning of time. The insurance company had a problem, as those old files were nonelectronic and not easily retrieved.

The insurance company wants nothing to do with this guy. Their letters to him went something like “We are right. Why do you keep bothering us?”

Ah, but they were dealing with an actuary.

Furnish sends the IRS two tax returns: one reporting the $49,255 and one not reporting and explanations for each. I presume he did not have professional advice to handle it in this manner, but so be it. The IRS of course accepts the one with the $49,255 reported in income.

PAUSE: I’ll give you a moment to get over your shock.

The IRS wanted their money. Furnish tells the IRS that the insurance company was full of bunkum and the 1099 was incorrect. The IRS tells Furnish to have the insurance company correct their paperwork. Until then, the IRS wanted their money. Eventually Furnish took the matter to the Taxpayer Advocate.

No dice with the Advocate and the matter went before a Tax Court judge. At play is Code Section 6201(d), which reads:

           

In any court proceeding, if a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return field with the Secretary *** by a third party and the taxpayer has fully cooperated with the Secretary (including providing, within a reasonable period of time, access to and inspection of all witnesses, information, and documents within the control of the taxpayer as reasonably requested by the Secretary),  the Secretary shall have the burden of producing reasonable and probative information concerning such deficiency in addition to such information return.”

Furnish argued that he met the requirements of Section 6201(d). The IRS argued that he had not; that he raised the issue too late in the proceedings; that he showed only minor calculation issues; and that Furnish had bad breath. The only evidence the IRS presented was a declaration by an insurance company employee, agreeing that Furnish did in fact have bad breath.

The Court decided that Furnish had raised enough doubt whether the Form 1099 income could be materially incorrect, and that Furnish had interacted reasonably in providing information and otherwise responding to the IRS. Furnish had met the requirements of Section 6201(d), and the burden of proof shifted to the IRS.

The IRS, having presenting no additional evidence beyond a Form 1099 and a letter from the insurance company, lost. They did not meet the burden of proof.

CONCLUSION: Some commentators consider this decision an outlier, and the judge has taken criticism in the literature. My experience is for the IRS to require the taxpayer to have the issuer either void or amend the disputed information form. Makes sense, in truth. Many times the issuer will, but then there are those hard-luck cases. Furnish gives practitioners an option to consider.

If A Tax Credit Falls In The Woods And No One Hears It ...

I am looking at a proposed rule for the Section 45R credit for small employers that offer health insurance.  The IRS says I have until November 25 to respond with comments.

Let’s talk about nonsense that tax practitioners have to work with.

This credit was added as an inducement for smaller employers to provide health insurance while waiting for the balance of the ObamaCare scaffolding to be erected.

As credits go, it was cumbersome to calculate and – by many reports – quite ineffective.  Many practitioners consider the credit to be such a joke they will not even bother to calculate it. Why? The professional fee to calculate the credit could be more than the credit itself.

The restrictions on the credit eviscerated almost any benefit it could provide.

(1) The credit applied to firms less than 25 employees. However, its sweet spot was ten employees, and the credit began to phase-out in excess of that number.  That eleventh employee would cost you when calculating the credit.

(2) The credit phased-out when average payroll exceeds $50,000. It sweet spot was $25,000 or less, and the credit began to phase-out in excess of that number.  Many of us were quizzical on the $25,000 strike, as average American household income is approximately twice that amount. Maybe Congress was dividing the average household income between two spouses. Who knows.

(3) Owners and their families were excluded from the credit. For many small businesses, the owner and family are a significant portion, if not the majority, of the work force. Congress had already imposed the 10/25 and $25,000/$50,000 rules, so was it necessary to also have an “off with the owners’ heads” rule? 

COMMENT: Someone please explain to Congress that excluding owners from a tax incentive is not incentivizing.

(4) There was a cumbersome calculation of “full-time equivalents” that may have tested the limited accounting resources of many small employers.

(5) The employer had to pay at least 50% of the premiums for all employees to qualify for the credit. This may be the least onerous requirement.

The credit – when finally calculated – was 35% of the health insurance premiums remaining after excluding the owners and running the two phase-outs.

… and the company had to reduce its tax deduction for health insurance by that 35%.

The credit will still be available in 2014, and it has been expanded from 35% to 50%. However the credit can only be used two more times, so if an employer uses the credit in 2014 and 2015, that employer has exhausted its maximum Section 45R mandated remaining number-of-years. Why? Who knows.

In addition, the employer has to obtain its insurance through the Small Business Health Options Program (SHOP).

NOTE: SHOP is the company-sponsored health insurance Exchange and is the counterpart to the individual health insurance Exchange.

The credit will not be available if the employer provides insurance through other means, such as through an insurance agent.

COMMENT: Think about that for a moment. Why is the credit unavailable if one purchases insurance for one’s employees through an insurance agent, a professional one may have used and relied upon for years? How does this requirement have the employees’ best interest at heart? I am at a loss to see any business reason for this. I immediately see a political-hack reason for excluding health insurance that is not sitting on a government website, however.

Let’s go though some recent headlines as we step through the looking glass:

• SHOP was to be accessible starting October 1, as were individual policies. 
• The SHOP website is accessible through HealthCare.gov, or it would be assuming the thing ever works.
• The Obama administration said in 2011 that SHOP would allow small employers to offer a choice of qualified health plans to their employees, akin to larger businesses. This “choice option” was to be available in January 2014. Administration officials have said they would delay the “choice option” until 2015 in the 33 states where the federal government runs the exchanges. This means employers would have only one plan to choose from for 2014.

COMMENT: Think about that “choice.” Yep, small businesses will be lining up to buy this thing.

• The Obama administration announced on September 26 that the opening of SHOP would be delayed a month, until November 1.
• On Tuesday, October 29, 2013, Marilyn Tavenner, the Head of the Center for Medicare & Medicaid Services, said the SHOPS would be functional “at the end of November.”

COMMENT: That is how Steve Jobs expanded Apple – by demanding “functional.” Shoot for the stars there, government bureaucrat.

• Businesses seeking coverage effective January 1, 2014 must enroll by December 15. Remember Ms. Tavenner’s comment about the “end of November.” This means that small could have as little as 15 days to enroll in SHOP.

In the Administration’s defense, the SHOP can admit employees throughout the year, so its January 1 start is not as critical as the individual Marketplace.

What is on the other side of the looking glass?

• A cumbersome credit calculation …
• That will expire after two more uses …
• For health insurance a small business may not be able to buy, resulting in  …
• A tax credit that approaches a work of fiction.

The bottom line is that the credit was almost useless before, and it is more useless now.

I guess that is my comment.

Beany Baby Billionaire Caught With Secret Swiss Bank Account

I cannot understand people who go to great lengths to underreport income. I am not talking about tax planning – perhaps even aggressive tax planning – to reduce one’s tax under the law. Some actions are so routine one may not even see them as tax planning, such as moving from a higher-tax state (say Ohio) to a lower-tax state (say Florida or Nevada). 

What I am talking about is flat-out tax evasion. We have now crossed a line. The Supreme Court has acknowledged that no one is under compulsion to pay more tax than necessary, but likewise all are under compulsion to pay the appropriate tax.

Enter Ty Warner. He was responsible for the “beanie babies” from the 1990s and is the 100% owner of TY Inc and other business interests. There must be a LOT of money in beanie babies, as Forbes has ranked him as the 209th wealthiest American, with a net worth estimated at $2.6 billion.

He opens a secret bank account with UBS in 1996. In 2002 he transfers over $93 million from there to another Swiss Bank. He obfuscates the ownership of the account by tagging it with the name “Molani Foundation.” The UBS account threw off $3.2 million in income for 2002.  This income is not reported to the accountants and is not included on his tax return. Mind you, he had already reported $49.1 million on his income tax return.

QUESTION: Is it possible to have so much income that one forgets some of his/her income?

You can pretty much guess that there was no FBAR filed. How could there be? There apparently was no "foreign" account, at least to Warner.

Fast forward the conversation and UBS gets dragged into the IRS and Justice Department hunt for secret Swiss bank accounts.

Oh, oh, Warner realizes the jig is up. He tries to enter the IRS Offshore Voluntary Disclosure Program, but he was denied entry. A likely reason is that the IRS had already identified him as owner of one or more unreported accounts.

Now he has a serious problem. Could there be tax fraud? I cannot say. I can say that I recall sitting across a conference table from a client who could not tell you (or me) if his tax return – showing $33 million in gross income – included all his income for the year. Is it possible that $3.2 million got lost in Warner’s reported income of $49.1 million? It is possible, but the other actions – like fudging the name of the Swiss account or not telling the accountants – look bad.

What Warner did run into face-first is the FBAR reporting. This is the filing for foreign accounts over $10 thousand. It is mailed separately from the tax return, and it is due July 1. For decades no one paid much attention to these reports, but in the aughts the IRS decided that there was money to be found. They began the crackdown on foreign bank accounts, starting with UBS - eventually ensnaring Ty Warner. The penalties for an FBAR are confiscatorily insane, as the government somehow justifies that they can take up to half of whatever is in the account. For multiple years. Reflect for a moment that the government is saying that – should they press beyond two years - they can take from you more than you have – or ever had – in the account.

This has nothing to do with the earnings from the account. For example, for 2002 Warner’s secret account generated approximately $3.2 million in income. Did the government want taxes on the $3.2 million, which would be about $1 million? Nope. Did they want all of that $3.2 million? Nope.

What they wanted was one-half of the highest balance in the account. What was that amount for Warner? Try $53.6 million.

Warner doesn’t pay taxes on $3.2 million. Let’s be generous and say that it was $3.2 million for several years. It now costs him $53.6 million to cash-out?

Set aside whether this is confiscatory. I cannot understand why Warner –or anyone - would even go there. Let’s be honest: would he even have noticed the taxes had he correctly reported the $3.2 million to begin with? 

Happy Halloween

Suit Against Subsidies Could Derail ObamaCare

Did you hear about the court decision in Halbig, et al v Sebelius? The suit was brought by six businesses against the employer mandate under ObamaCare. The federal District Judge, Paul Friedman, refused a preliminary injunction against the government, but he did say the case would be decided on an expedited basis.  That court joins Pruitt v. Sebelius, a case from Oklahoma. There is yet another suit to be heard by month-end in Richmond, Virginia.

What is going on?

They are suing over the employer penalty under ObamaCare - the $2,000 or $3,000 penalty, depending upon whether the employer offers insurance and whether the insurance meets politically correct criteria. The employer penalty triggers when an employee qualifies for a subsidy on the public exchange (the “Marketplace”). One qualifies if one’s income is below 400% of the federal poverty line and meets other criteria. The employer would then be required to subsidize some of the cost through that $2,000/$3,000 penalty.

What does it take to qualify for an individual subsidy?

Let’s do something that Congress apparently did not do when this passed this law: let’s read it:

Let’s start with Section 1311(b):

          Sec 1311(b) AMERICAN HEALTH BENEFIT EXCHANGES.—

(1) IN GENERAL.—Each State shall, not later than January 1, 2014, establish an American Health Benefit Exchange (referred to in this title as an ‘‘Exchange’’) for the State that…

We read that each state is to establish an Exchange.

What if the state fails to establish an Exchange?

         

Sec 1321 (c) FAILURE TO ESTABLISH EXCHANGE OR IMPLEMENT REQUIREMENTS.

(1) IN GENERAL.—If—

(A) a State is not an electing State under subsection (b); or

(B) the Secretary determines, on or before January 1, 2013, that an electing State—

(i) will not have any required Exchange operational by January 1, 2014; or

(ii) has not taken the actions the Secretary determines necessary to implement—

(I) the other requirements set forth in the standards under subsection (a); or

(II) the requirements set forth in subtitles A and C and the amendments made by such subtitles;

the Secretary shall (directly or through agreement with a not for profit entity) establish and operate such Exchange within the State and the Secretary shall take such actions as are necessary to implement such other requirements.

We read that the Secretary will establish the Exchange.

How does an individual get to a subsidy?

SEC. 1401. REFUNDABLE TAX CREDIT PROVIDING PREMIUM ASSISTANCE FOR COVERAGE UNDER A QUALIFIED HEALTH PLAN.

(a) IN GENERAL.—Subpart C of part IV of subchapter A of chapter 1 of the Internal Revenue Code of 1986 (relating to refundable credits) is amended by inserting after section 36A the following new section:

SEC. 36B. REFUNDABLE CREDIT FOR COVERAGE UNDER A QUALIFIED

HEALTH PLAN.

(a) IN GENERAL.—In the case of an applicable taxpayer, there shall be allowed as a credit against the tax imposed by this subtitle for any taxable year an amount equal to the premium assistance credit amount of the taxpayer for the taxable year.

(b) PREMIUM ASSISTANCE CREDIT AMOUNT.—For purposes of this section—

(1) IN GENERAL.—The term ‘premium assistance credit amount’ means, with respect to any taxable year, the sum of the premium assistance amounts determined under paragraph (2) with respect to all coverage months of the taxpayer occurring during the taxable year.

‘‘(2) PREMIUM ASSISTANCE AMOUNT.—The premium assistance amount determined under this subsection with respect to any coverage month is the amount equal to the lesser of

(A)   the monthly premiums for such month for 1 or more qualified health plans offered in the individual market within a State which cover the taxpayer, the taxpayer’s spouse, or any dependent (as defined in section 152) of the taxpayer and which were enrolled in through an Exchange established by the State under 1311 of the Patient Protection and Affordable Care Act, or

(B)    the excess (if any) of— ‘‘(i) the adjusted monthly premium for such month for the applicable second lowest cost silver plan with respect to the taxpayer, over ‘‘(ii) an amount equal to 1/12 of the product of the applicable percentage and the taxpayer’s household income for the taxable year

Whoa. If the nuns taught me how to read English, I see that the taxpayer has to be enrolled in an Exchange pursuant to Section 1311. Section 1311 requires “each state” to do something, otherwise Section 1321 kicks in.

Question: What if a state does nothing (thereby removing Section 1311) and the federal government steps in under Section 1321. Would someone in that state be receiving a subsidy as defined under Section 1401 or not?

Can the federal government be a “state?”

Let’s look at Section 1304(d):

Sec 1304(d) STATE.—In this title, the term ‘‘State’’ means each of the 50 States and the District of Columbia.

Looks like the answer is “no.”

Considering that there are approximately three dozen states that did not set-up their own Exchange, how does the federal government propose to get an employer to pay that $2,000/$3,000 penalty despite the language in Sections 1401 and 1311?

The IRS comes to the rescue by proposing the following Regulation:

         

a taxpayer is eligible for the credit for a taxable year if . . . the taxpayer or a member of the taxpayer’s family (1) is enrolled in one or more qualified health plans through an Exchange established under section 1311 or 1321 of the Affordable Care Act . . .”

         

Good grief! Well, one thing about Tony is that he could always count on Paulie and Christopher to back him up.

Does law mean nothing to this crowd? Perhaps the law is flawed, perhaps it was poorly drafted, but it still law. How many times have I read about unintended consequences of the alternative minimum tax or about some poor taxpayer being hung out to dry because he/she did not get that “special” piece of paper the IRS wanted in order to substantiate a transaction?  How did the IRS invariably defend its position? By arguing that the law is the law and that Congress should remedy any inequity.  

In a swell of self-importance, the Administration and its enablers refuse to accept that the same law that applies to you or me also applies to them. Instead they argue that:

         

(1) Justice Roberts decided that the penalties are a tax. The Anti-Injunction Act precludes plaintiffs from challenging the imposition of a tax before it is actually assessed.

(2) The plaintiffs lack standing due to the speculative nature of any claimed injuries.

(3) Following the White House announcement of the one-year delay of the employer mandate, the court should also delay its consideration.

(4) The language around subsidies represents but one of the ACA’s many drafting errors.

(5) Congress clearly intended to have tax credits available in all the states.

Let me get this straight: their argument is that Tony did not clearly intend for me to defend myself until after I was shot, because before then any self-defense would be speculative and contingent on the actions of someone for whom English is a second language. 

Really?

Let us review history to understand how we got into this mess. The House had a bill. The Senate had a bill. The bills were different. The Senate wanted to force the states to absorb the Exchanges, but it ran into a problem with Pritz v United States (1997):

[T]he Federal Government may not compel the states to implement, by legislation or executive action, federal regulatory programs.’’

The Senate instead added a provision for federally established exchanges as a backup option for states that refused to set up exchanges.

Remember that bill could not obtain bipartisan support, and it was passed on a Saturday night at late hour, after the Louisiana Purchase, the Cornhusker Kickback and who-knows-what-else. The Democrats had lost their Senate 60-vote majority in January 2010, meaning they could not override the expected filibuster.  To push the bill through the Senate, Reid forced a reconciliation vote - a tactic normally reserved to limit debate on budget bills. This tactic however did not allow for a normal Senate-House joint committee process to reconcile burrs in the law. How could it? It was designed for budget and debt ceiling items, not for something like this.

Let’s see what happens in Halbig and Pruitt. Judge Paul Friedman hopes to have his opinion out by February.