I am a huge NFL fan. It is, without a doubt, my favorite sport.
Did you hear about Fuzzy Thurston’s tax problems?
Who is Fuzzy? His actual name is Fred Thurston. He played with the Green Packers from 1959 to 1967. He played guard in the first two Super Bowls under Vince Lombardi.
He was considered a tough football player and part of the famed “Power Sweep.” When asked how he prepared for the bitter cold of the Ice Bowl on December 31, 1966 at Lambeau Field against the Dallas Cowboys, he replied “About 10 vodkas.”
After football he became a restaurateur. He and partners, including Max McGee, opened a restaurant named Left Guard in Menasha, Wisconsin and eventually had six locations throughout Wisconsin. Fuzzy played left guard – hence the name of the restaurant.
The trouble arose with employment taxes. Somewhere between 1978 and 1980 the Janesville restaurant failed to remit payroll taxes withheld from employees. We have spoken of withholding before. These penalties are some of the toughest in the IRS arsenal. It makes sense, if you remember that these are withheld taxes. The money belongs to the employees, and the employer is merely a conduit for remittance to the Treasury. When the employer fails to remit, it not only deprives the Treasury but it has also robbed from its employees.
So Fuzzy had a withholding problem. The tax action goes against the company and the responsible persons at the company. As a partner, Fuzzy must have had enough authority to be considered a responsible person. So were his partners. His partners paid-off their actions, but Fuzzy fought his. The initial judgment against him in 1984 was approximately $190,000.
Fuzzy continued to fight. His liability, with interest and penalties for more than 25 years, is a little more than $1.7 million. The IRS is selling off his football paraphernalia, including his 1960 Packers helmet, two 1960 footballs signed by Packers players and Vince Lombardi, his NFL championship rings from 1958, 1961, 1962 and 1965, and Fuzzy’s Super Bowl II ring. The IRS is searching for his Super Bowl I ring also, but it hasn’t turned up.
It’s an unfortunate story, but I have to point out that Fuzzy either dug in his heels unreasonably or otherwise received horrendous tax advice. Perhaps he felt that his partners stole from him and that he wasn’t responsible. Fine, but a quick education from his accountant might have included the concept of surrogate liability, and that as a partner in the restaurant he had triggered that liability. At that point it was not a matter of right or wrong, but rather a matter of emergency room decision-making. Stop the bleed, clot the wound, stabilize the patient, live to fight another day. I have to believe he could have come up with $190,000 in 1984. He could then have sued his partners, if it made him feel better. But he was not going to win the responsible person action against him with the IRS.
Monday, June 27, 2011
Your Accountant Makes the Mistake. Do You Owe Penalties?
If your accountant omits some of your income on your personal income tax return, is it fair that you should be penalized by the IRS?
Generally speaking, reliance on a tax preparer is “reasonable cause” to request penalty mitigation from the IRS. Generally, but not always.
Enter Stephen Woodsum (SW). SW has a bachelors degree from Yale and a masters from Northwestern. He was a founding director of Summit Partners, a private equity firm.
In 1998 SW entered a transaction described as a “ten year total return limited partnership linked swap.” This transaction involved Bankers Trust Company and Deutsche Bank and included a reference to paying interest at the “LIBOR rate” upon the “notional amount” of the “reference fund.”
Note: Financially unsavvy people do not use these words.
So, the swap was to expire in 2008 – ten years. SW was unhappy with the performance of the swap and ended it in 2006. He received at that time a Form 1099 reporting the $3.4 million Deutsche Bank paid him and another 1099 for $60,291 of interest income.
SW gave all of his tax documents to his accountant. There were over 160 such documents. SW must have had a good year, as the $3.4 million was not the largest number on his tax return. It would however had been the third largest capital gain had the $3.4 million in proceeds been reported.
The accountant prepared the return, including the interest but excluding the $3.4 million. Some accountant. SW and his wife met with the accountant on October 15, the day the return was due. They had to go over the federal return and 27 state income tax returns. The federal return alone was 115 pages.
Mr. and Mrs. Woodsum did not notice that the accountant had left out the $3.4 million.
The IRS did notice, of course, and wanted the tax and interest, as well as penalties.
Mr. Woodsum felt he did not have to pay penalties because… well, he relied on his accountant. I agree with SW.
The court made an interesting comment. It observed that courts have previously mitigated the penalties, but it continued …
No actual evidence supports that characterization? I would have gotten a statement from the accountant clarifying that the accountant was provided but failed to include the 1099 on my return.
The court seemed unwilling to give SW as much latitude because of his financial sophistication. The court goes on…
I have had clients who did the same as Mr. Woodsum. It did not occur to me that they were conducting an unreasonable review. They provided all documents, answered all questions, met with me and complained about the amount I told them they owed. These are wealthy people. This is not you or I, where the absence of our salary would be immediately noticeable on our return. Mr. Woodsum reported approximately $33 million of income on his return. Note that the sale was not even the largest number on a schedule to Mr. Woodsum’s return.
The court upheld the penalties.
Perhaps this is what happens when a private equity manager gets into a complex financial transaction with names like “ten year total return limited partnership linked swap.” This court was not willing to bend much on the reporting of a “Wall Street” transaction that requires a tax seminar to understand.
The penalties were over $100 thousand.
I wonder whether Mr. Woodsum is suing his accountant for malpractice.
Generally speaking, reliance on a tax preparer is “reasonable cause” to request penalty mitigation from the IRS. Generally, but not always.
Enter Stephen Woodsum (SW). SW has a bachelors degree from Yale and a masters from Northwestern. He was a founding director of Summit Partners, a private equity firm.
Note: Mr. Woodsum is financially savvy.
Note: Financially unsavvy people do not use these words.
So, the swap was to expire in 2008 – ten years. SW was unhappy with the performance of the swap and ended it in 2006. He received at that time a Form 1099 reporting the $3.4 million Deutsche Bank paid him and another 1099 for $60,291 of interest income.
SW gave all of his tax documents to his accountant. There were over 160 such documents. SW must have had a good year, as the $3.4 million was not the largest number on his tax return. It would however had been the third largest capital gain had the $3.4 million in proceeds been reported.
The accountant prepared the return, including the interest but excluding the $3.4 million. Some accountant. SW and his wife met with the accountant on October 15, the day the return was due. They had to go over the federal return and 27 state income tax returns. The federal return alone was 115 pages.
Mr. and Mrs. Woodsum did not notice that the accountant had left out the $3.4 million.
The IRS did notice, of course, and wanted the tax and interest, as well as penalties.
Mr. Woodsum felt he did not have to pay penalties because… well, he relied on his accountant. I agree with SW.
The court made an interesting comment. It observed that courts have previously mitigated the penalties, but it continued …
It may be (and petitioners seem to expect the Court to assume) that the omission was the result of the C.P.A.'s oversight of one Form 1099 amid 160 such forms, but no actual evidence supports that characterization. The omission is unexplained, and since petitioners have the burden to prove reasonable cause and good faith, this evidentiary gap works against their defense.”
The court seemed unwilling to give SW as much latitude because of his financial sophistication. The court goes on…
Mr. Woodsum, however, makes no showing of a review reasonable under the circumstances. He personally ordered the termination that gave rise to the income; he received a Form 1099-MISC reporting that income; that amount should have shown up on Schedule D as a distinct item; but it was omitted. The parties stipulated that petitioners' “review” of the defective return was of an unknown duration and that it consisted of the preparer turning the pages of the return and discussing various items. Petitioners understated their income by $3.4 million—an amount that was substantial not only in absolute terms but also in relative terms (i.e., it equaled about 10 percent of petitioners' adjusted gross income). A review undertaken to “make sure all income items are included” (in the words of Magill)—or even a review undertaken only to make sure that the major income items had been included—should, absent a reasonable explanation to the contrary, have revealed an omission so straightforward and substantial.”
The court upheld the penalties.
Perhaps this is what happens when a private equity manager gets into a complex financial transaction with names like “ten year total return limited partnership linked swap.” This court was not willing to bend much on the reporting of a “Wall Street” transaction that requires a tax seminar to understand.
The penalties were over $100 thousand.
I wonder whether Mr. Woodsum is suing his accountant for malpractice.
Thursday, June 23, 2011
There Are New Deductible Mileage Rates
The IRS has revised the deductible mileage rates for the second half of 2011.
The new and old rates are as follows:
NEW OLD
Business mileage 55.5 cents/mi 51 cents/mi
Medical or moving 23 cents/mi 19 cents/mi
Charitable mileage 14 cents/mi 14 cents/mi
The charitable mileage rate did not change because that rate is set by statute and not regulation. It requires Congress to change the charitable mileage rate.
The new and old rates are as follows:
NEW OLD
Business mileage 55.5 cents/mi 51 cents/mi
Medical or moving 23 cents/mi 19 cents/mi
Charitable mileage 14 cents/mi 14 cents/mi
The charitable mileage rate did not change because that rate is set by statute and not regulation. It requires Congress to change the charitable mileage rate.
Tuesday, June 21, 2011
The IRS Sues Over Conservation Easements
It has been several years since I visited Washington D.C. I saw a bit of tax news recently that got me thinking about it. Several years ago I was involved in the planning of a conservation easement in D.C. As Washington has 26 historic districts, this was not that unusual. Our client was renovating residential property, and the easement was for the building façade. We normally associate an easement with access to real property, but it can also be a legally enforceable right to preserve real property. In my case, what was being preserved was the outside of the building, which was of historical interest in a neighborhood of historical consequence. You could say that they were donating the right for future generations to look at the building.
The tax advantage? Quite simple: if you follow the rules you can obtain a charitable contribution for the easement. The deduction is (theoretically) the decrease in property value attributable to the grant of the easement. Memory tells me that a reasonable range for a facade is 10 to 14 percent of the building’s value, which is not insignificant.
This area is fraught with danger. An appraisal – or appraisals – is mandatory. The easement will be transferred to a government or charitable organization, so an attorney is required. You may have to obtain the mortgage lender’s agreement to subordinate their right to that of the government or charity receiving the easement.
The IRS challenged some of these donations early on. In some cases, the IRS argued that the donation was zero, although the IRS took considerable punishment in the courts for this position (Akers and Symington, for example).
I was reading Janet Novak’s article in Forbes where she stated that the Justice Department filed a lawsuit to enjoin the Trust for Architectural Easements from certain practices the IRS considers improper. The lawsuit demands that the Trust turn over the names of approximately 800 property owners in Baltimore, New York City and Boston who have claimed this type of deduction. The IRS has already identified more than 300 taxpayers for audit.
The IRS has been concerned with these easements because of their potential for abuse. In some cases, taxpayers have claimed deductions approaching 50% of the property’s value. In others the charity buys the property, places the easement and then sells it to the taxpayer – at a reduced price. The taxpayer makes two checks out – one to purchase the property and the other as a “donation.” He/she of course deducts the second check on his/her return.
The IRS has taken fire from practitioners who argue that it is over-zealous and not regarding Congress’ intent to encourage these easements. I admit that I felt that way at first. It was easy to see a heavy-handed IRS. Consider the following quote from the court in Symington, for example:
"We are hard pressed to imagine a prospective purchaser of a 60-plus acre parcel of land who would not have considered the restrictions of such an open-space easement in determining his offering price. The fact that a purchaser of Friendship Farm would have been precluded from even giving away part of his land if he ever so desired, for example, to his children, or, along the same lines, precluded from ever building an additional home on his property, would certainly have affected the purchase price he would have been willing to pay."
However, I am at a loss why I would structure a transaction requiring the charity to buy the real property and for my client to subsequently write two checks. I wouldn’t. I don’t see it how it reflects normal commercial terms. It feels oily, at least to me. The IRS may have valid grounds for this action.
The tax advantage? Quite simple: if you follow the rules you can obtain a charitable contribution for the easement. The deduction is (theoretically) the decrease in property value attributable to the grant of the easement. Memory tells me that a reasonable range for a facade is 10 to 14 percent of the building’s value, which is not insignificant.
This area is fraught with danger. An appraisal – or appraisals – is mandatory. The easement will be transferred to a government or charitable organization, so an attorney is required. You may have to obtain the mortgage lender’s agreement to subordinate their right to that of the government or charity receiving the easement.
The IRS challenged some of these donations early on. In some cases, the IRS argued that the donation was zero, although the IRS took considerable punishment in the courts for this position (Akers and Symington, for example).
I was reading Janet Novak’s article in Forbes where she stated that the Justice Department filed a lawsuit to enjoin the Trust for Architectural Easements from certain practices the IRS considers improper. The lawsuit demands that the Trust turn over the names of approximately 800 property owners in Baltimore, New York City and Boston who have claimed this type of deduction. The IRS has already identified more than 300 taxpayers for audit.
The IRS has been concerned with these easements because of their potential for abuse. In some cases, taxpayers have claimed deductions approaching 50% of the property’s value. In others the charity buys the property, places the easement and then sells it to the taxpayer – at a reduced price. The taxpayer makes two checks out – one to purchase the property and the other as a “donation.” He/she of course deducts the second check on his/her return.
The IRS has taken fire from practitioners who argue that it is over-zealous and not regarding Congress’ intent to encourage these easements. I admit that I felt that way at first. It was easy to see a heavy-handed IRS. Consider the following quote from the court in Symington, for example:
"We are hard pressed to imagine a prospective purchaser of a 60-plus acre parcel of land who would not have considered the restrictions of such an open-space easement in determining his offering price. The fact that a purchaser of Friendship Farm would have been precluded from even giving away part of his land if he ever so desired, for example, to his children, or, along the same lines, precluded from ever building an additional home on his property, would certainly have affected the purchase price he would have been willing to pay."
However, I am at a loss why I would structure a transaction requiring the charity to buy the real property and for my client to subsequently write two checks. I wouldn’t. I don’t see it how it reflects normal commercial terms. It feels oily, at least to me. The IRS may have valid grounds for this action.
Possible Change in the FUTA Payroll Tax
Beginning July 1, there may be a change in your FUTA payroll tax rate.
The FUTA tax is 6.2%, although the IRS allows a credit of 5.4% if you pay your state unemployment taxes on time. This makes for a net tax rate of 0.8%. FUTA applies to the first $7,000 of wages per employee. There has been a “temporary” surcharge of 0.2% since the 1970s, and that 0.2% is set to expire June 30, 2011. If the surcharge expires, the 5.4% state credit will nonetheless remain the same, making the net cost to the employer 0.6%.
Please be aware that a proposal in the President’s 2012 budget would make the 0.2% surcharge permanent. There is an alternate budget proposal that would increase the FUTA wage base from $7,000 to $15,000 per employee.
Should the FUTA surcharge expire, it will add to an already confusing year for payroll taxes. Remember that for 2011 employers are paying Social Security taxes of 6.2% while employees are paying 4.2%.
We at Kruse and Crawford are monitoring this issue and will available to answer any questions as June 30, 2011 approaches.
The FUTA tax is 6.2%, although the IRS allows a credit of 5.4% if you pay your state unemployment taxes on time. This makes for a net tax rate of 0.8%. FUTA applies to the first $7,000 of wages per employee. There has been a “temporary” surcharge of 0.2% since the 1970s, and that 0.2% is set to expire June 30, 2011. If the surcharge expires, the 5.4% state credit will nonetheless remain the same, making the net cost to the employer 0.6%.
Please be aware that a proposal in the President’s 2012 budget would make the 0.2% surcharge permanent. There is an alternate budget proposal that would increase the FUTA wage base from $7,000 to $15,000 per employee.
Should the FUTA surcharge expire, it will add to an already confusing year for payroll taxes. Remember that for 2011 employers are paying Social Security taxes of 6.2% while employees are paying 4.2%.
We at Kruse and Crawford are monitoring this issue and will available to answer any questions as June 30, 2011 approaches.
June 30th and the FBAR
If you have a foreign bank account, either personally or through work, please remember that you may have to report the account(s) to Treasury by the end of this month. This report is called the Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1, and is usually referred to as the FBAR. If the value of the account(s) exceeds $10,000 at any time, then anticipate that you have to file.
Where the FBAR may get tricky is when one has a signature authority over a foreign account at work. Say for example that your company regularly travels to or has a location in Poland. It is very possible that there will be a Polish account, if for no other reason than for administrative ease. Say that you have authority to sign on that account, although you have no ownership over the account. The company owns the account, not you. Is an FBAR still required?
In the past many an accountant would have said no, but the rules are changing. Believe it or not, the situation described may require an FBAR, although it may also qualify for transitional relief. You do not want to mess with FBAR penalties, as they are quite severe and – in some cases – out of proportion to the money in the account. Treasury is convinced that considerable money is hidden offshore and is having much less patience with such matters.
Where the FBAR may get tricky is when one has a signature authority over a foreign account at work. Say for example that your company regularly travels to or has a location in Poland. It is very possible that there will be a Polish account, if for no other reason than for administrative ease. Say that you have authority to sign on that account, although you have no ownership over the account. The company owns the account, not you. Is an FBAR still required?
In the past many an accountant would have said no, but the rules are changing. Believe it or not, the situation described may require an FBAR, although it may also qualify for transitional relief. You do not want to mess with FBAR penalties, as they are quite severe and – in some cases – out of proportion to the money in the account. Treasury is convinced that considerable money is hidden offshore and is having much less patience with such matters.
Hiring Your Child
If you own a business, would it make sense to hire your child? There are different facets to this question, and the one we will discuss today are the tax consequences.
Income Taxes
You can pay your child up to $5,800 without either of you incurring an income tax liability. As long as the wages are reasonable for the work performed, the wages are deductible to your business and taxable to your child. The child’s standard deduction of $5,800 can reduce the child’s taxable income to zero, effectively sheltering the wages.
Is the “kiddie tax” a consideration? The answer is no, as the kiddie tax applies to the transfer of passive income, such as interest and dividends. The income we are discussing is earned income, and the kiddie tax does not penalize earned income.
How much can you save? Well, that depends on your tax rate. If you are in the 35% tax bracket, then you are saving $2,030 in federal income taxes alone ($5,800 times 35%). This amount may be less if there is social security or you as employer have to pay federal unemployment tax. What are the rules for those taxes?
Social Security Tax
The social security consequence will vary depending on the age of the child and whether you are self-employed.
The first requirement is that the child must be under the age of 18.
If you are self employed (which is to say, you are unincorporated and file a Schedule C), you do not have to withhold or pay FICA taxes on a child under the age of 18. If you are under the FICA limit for 2011, this may be an immediate tax savings of 14.13% (15.3% times .9235). If you are over, then the FICA savings reduce to 2.68% (2.9% times .9235).
If you are incorporated, then there are no social security savings, as a different rule applies.
What if you are a partner in a partnership (or a member in an LLC)? If the only partners (or members) are the parents, then you do not have to withhold or pay FICA. Otherwise the corporate rule applies.
Federal Unemployment Tax
The same rule as for FICA applies here, with one exception. If the child works for your unincorporated business, or in a partnership (or LLC) where you and your spouse are the only partners (or members), then the wages will not be subject to FUTA. Otherwise, FUTA will apply.
The exception is the age cutoff. For FUTA, the child must be under age 21.
Income Tax Withholding
Usually, an employee who had no income tax liability for the prior year and expects none for the current year can claim exempt status and have no federal income tax withholding. There is a different rule for children who can be claimed as dependents on their parents’ return. That child cannot claim exempt status if his/her income will exceed $950 AND include more than $300 of interest, dividends and passive income of that nature.
Mind you, it is possible that you will get back the withholding when your child files his/her individual income tax return.
Income Taxes
You can pay your child up to $5,800 without either of you incurring an income tax liability. As long as the wages are reasonable for the work performed, the wages are deductible to your business and taxable to your child. The child’s standard deduction of $5,800 can reduce the child’s taxable income to zero, effectively sheltering the wages.
Is the “kiddie tax” a consideration? The answer is no, as the kiddie tax applies to the transfer of passive income, such as interest and dividends. The income we are discussing is earned income, and the kiddie tax does not penalize earned income.
How much can you save? Well, that depends on your tax rate. If you are in the 35% tax bracket, then you are saving $2,030 in federal income taxes alone ($5,800 times 35%). This amount may be less if there is social security or you as employer have to pay federal unemployment tax. What are the rules for those taxes?
Social Security Tax
The social security consequence will vary depending on the age of the child and whether you are self-employed.
The first requirement is that the child must be under the age of 18.
If you are self employed (which is to say, you are unincorporated and file a Schedule C), you do not have to withhold or pay FICA taxes on a child under the age of 18. If you are under the FICA limit for 2011, this may be an immediate tax savings of 14.13% (15.3% times .9235). If you are over, then the FICA savings reduce to 2.68% (2.9% times .9235).
If you are incorporated, then there are no social security savings, as a different rule applies.
What if you are a partner in a partnership (or a member in an LLC)? If the only partners (or members) are the parents, then you do not have to withhold or pay FICA. Otherwise the corporate rule applies.
Federal Unemployment Tax
The same rule as for FICA applies here, with one exception. If the child works for your unincorporated business, or in a partnership (or LLC) where you and your spouse are the only partners (or members), then the wages will not be subject to FUTA. Otherwise, FUTA will apply.
The exception is the age cutoff. For FUTA, the child must be under age 21.
Income Tax Withholding
Usually, an employee who had no income tax liability for the prior year and expects none for the current year can claim exempt status and have no federal income tax withholding. There is a different rule for children who can be claimed as dependents on their parents’ return. That child cannot claim exempt status if his/her income will exceed $950 AND include more than $300 of interest, dividends and passive income of that nature.
Mind you, it is possible that you will get back the withholding when your child files his/her individual income tax return.
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