The Mobile Workforce State Income Tax Simplification Act

I was glad to see that Senator Sherrod Brown (D – OH) introduced the Mobile Workforce State Income Tax Simplification Act on August 2, 2012.  The bill is being promoted by the American Institute of CPAs, and a version of the bill passed the House on voice vote May 15^th.

The bill would establish a uniform standard for the withholding of state income taxes on nonresident employees.  It would lessen the burden the current system places on employers and traveling employees. 

Both bills would require nonresidents to work in a state for more than thirty days before becoming subject to a state‘s income tax withholding.

Why is this an issue? Let’s say that you start a consulting firm. Business takes off. You develop a national client base and hire employees. You send your employees throughout the country, sometimes for 4 or 5 days and other times for longer. You meet with me to discuss your tax filing requirements, especially your payroll. You tell me that you have engagements coming up in the following states and ask me how to handle the employee withholding.

               State                                      Exempt from Employer Withholding if …

Arizona                                               60 days or less

California                                            exempt if less than $1,500

Delaware                                             no exception

Georgia                                               23 days or less

Hawaii                                                 60 days or less

Idaho                                                   exempt if less than $1,000

Maine                                                  10 days or less

Maryland                                             exempt if less than $5,000

Massachusetts                                     no exception

Ohio                                                    less than $300 in any quarter

Virginia                                               exempt if less than $7,000

Now seriously, how are we to work with this? Remember that payroll may have some very nasty penalties for just minor errors. Do we simply withhold from day one on all employees in all states? That is the safest way to go, but now you are going to have monthly or quarterly reporting to almost every state in the nation. Perhaps the report says “zero”, but it will still take time to prepare and file. You may have additional end of year considerations, such as submitting W-2s to the state. Why not just shut down the account every time, you ask? That likely will save little to no time overall and may create more problems whenever you try to reactivate an account.

This all takes time. It may be my time, it may be your employee’s time, but you will be paying for this time. You can now see the issue. If you ship an employee into Delaware for 1 1/2 days, do they really expect you to withhold, remit and keep reporting to Delaware until the cows come home? Perhaps this made sense years ago when our parents worked at the factory down the street, but it makes no sense today. It is unreasonable to threaten an employer with payroll taxes (and penalties) because they made the mistake of sending an employee into your state for 3 or 4 days. This is not the Lewis and Clark era.

Will this bill pass Congress? My hunch is that no tax bill will pass Congress until the elections are resolved, and then only a tax extender bill passed at the last hour of the last day. This bill will not pass this Congress, but at least the issue is being discussed and highlighted. Perhaps next time and next Congress.

New Plan for U.S. Expats to Comply With The IRS

There is good tax news for many U.S. expats and dual citizens. Beginning September 1^st, the IRS is starting a new program allowing many expats to catch-up on late tax returns and late FBARs without penalties.

This new program is different from the “Offshore Voluntary Disclosure” programs of the last few years. For one thing, this program is more geared to an average expat. Secondly, and more important to the target audience of the OVD programs, this program does not offer protection from criminal prosecution. That is likely a nonissue to an average expat who has been living and working in a foreign country for several years and has not been trying to hide income or assets from the U.S.

Under this new program, an expat will file 3 years of income tax returns and 6 years of FBARs. This is much better than the 8 years of income tax returns and 8 years of FBARs for OVD program participants.

All returns filed under this program will be reviewed by the IRS, but the IRS will divide the returns into two categories:

Low Risk – These will be simple tax returns, defined as expats living and working in foreign countries, paying foreign taxes, having a limited number of investments and owing U.S. tax of less than $1,500 for each year. Low risk taxpayers will get a pass – they will pay taxes and interest but no penalties.

NOTE: When you consider that the expat will receive a foreign tax credit for taxes paid the resident country, it is very possible that there will be NO U.S. tax.

 Higher Risk – These will be more complicated returns with higher incomes, significant economic activity in the U.S., or returns otherwise evidencing sophisticated tax planning. These returns will not qualify for the program and (likely) will be audited by the IRS. This is NOT the way to go if there is any concern about criminal prosecution. However, it MAY BE the way to go if concern over criminal prosecution is minimal. Why? The wildcard is the penalties. Under OVDP a 27.5% penalty is (virtually) automatic. Under this new program the IRS may waive penalties if one presents reasonable cause for noncompliance.

NOTE: This is one of the biggest complaints about the OVD program and its predecessors: the concept of “reasonable cause” does not apply. The IRS consequently will not mitigate OVD penalties. This may have made sense for multimillionaires at UBS, but it does not make sense for many of the expats swept-up by an outsized IRS dragnet.

The IRS has also announced that the new program will allow resolution of certain tax issues with foreign retirement plans. The IRS got itself into a trap by not recognizing certain foreign plans as the equivalent of a U.S. IRA. This created nasty tax problems, since contributions to such plans would not be deductible (under U.S. tax law) and earnings in such plans would not be tax-deferred (under U.S. tax law). You had the bizarre result of a Canadian IRA that was taxable in the U.S.

QUESTION: If your tax preparer had told you that this was the tax result of your Canadian RSSP, would you have believed him/her? Would you have questioned their competency? Sadly, they would have been right.

The IRS Draws Congressional Attention

The IRS itself has been in the news recently. Whether it is the ham-handed treatment of Section 501(c)(4) political/nonprofit groups or the shadow funding of ObamaCare, the agency has been drawing attention and criticism. Today we are going to talk about two recent studies requested by Charles Boustany (U.S. Rep – LA). He presently serves as the Chairman of the House and Ways Subcommittee on Oversight.

The first report is titled “There Are Billions of Dollars in Undetected Tax Refund Fraud Resulting From Identity Theft.”  It addresses identity theft, which has been the number one consumer complaint with the Federal Trade Commission for 12 consecutive years.

The IRS presently processes returns and issues refunds before receiving the information forms with which to crosscheck. For example, if someone receives his/her Form W-2 and files for a refund in January, the IRS is issuing that refund check before the underlying wage information has been received from the employer, much less integrated into IRS information systems. This weakness has been exploited and has become a virtual cottage industry in certain cities such as Tampa, Florida.

Consider what TIGTA discovered:

·         2,137 returns resulting in $3.3 million in refunds were sent to one address in Lansing, Michigan

·         518 returns resulting in $1.8 million in refunds were sent to one address in Tampa, Florida

·         23,560 refunds totaling more than $16 million were issued to 10 bank accounts;  2,706 tax refunds totaling $7.3 million were issued to a single account

This is real money. TIGTA estimates that the IRS will issue almost $21 billion in identity-theft refunds over the next five years.

TIGTA made several recommendations, including:

·         Taking advantage of the information reporting available to the IRS. Social security benefit information, for example, is available in December - before filing season begins. Whereas this is a fraction of identity fraud, it is a positive step.

·         The IRS uses little of the data from its identity theft cases to develop patterns and trends which could be used to detect and prevent future tax fraud. Examples include whether the return was electronically or paper-filed, how the refund was issued, and, if issued by direct debit, the account number or debit card number receiving the refund.

·         Allow the IRS greater access to the National Directory of New Hires (NDNH). NDNH is a national database of newly-hired employees. It includes an employee’s name and address as well as wage information. By referencing information from prior year tax filings, the IRS could correlate NDNH data to determine whether reported wage reporting and claimed withholding appear fraudulent.

·         Encourage banks and work with federal agencies to ensure that direct deposit refunds are made only to an account in the taxpayer’s name.

·         Limit the number of tax refunds issued via direct deposit to the same bank account or debit card.

NOTE: That recommendation seems obvious.

“Substantial Changes Are Needed to the Individual Taxpayer Identification Number Program to Detect Fraudulent Applications”

The second report is disturbing. IRS employees had contacted Congress directly about supervisor misconduct and potential fraud in a program that reviews and verifies individual taxpayer identification numbers (ITINs). Congress then called in TIGTA to investigate.

We should explain that an ITIN is an Individual Tax Identification Number. ITINs were started in 1996 as tax identification for individuals who may have U.S. tax filing requirements but are not eligible for social security.

How can this happen?

·         Consider a German businessperson who invests in and receives income from a Miami shopping mall

·         Consider a Nigerian graduate student attending the University of Missouri (many) years ago with yours truly

·         Consider my brother-in-law’s wife, who is English and married to a U.S. citizen 

An ITIN will allow one to open a bank account and file tax returns. For example, if one’s spouse is English and one lives in England, the spouse will need an ITIN to file a U.S. income tax return. The children – who possibly have never been to the U.S. – will need ITINs to be claimed as dependents on the U.S. income tax return.

OBSERVATION: This is one of the absurd consequences of the U.S. worldwide income tax regime. A U.S. citizen has to file tax returns, even if he/she has lived outside the U.S. for many years, has a family outside the U.S. and has no immediate plans of repatriating to the U.S.

When one finally obtains a green card, one can transfer work and wage information from the ITIN to the Social Security Administration.

One applies for an ITIN by filing a form (Form W-7) and attaching supporting documents to verify one’s identity and foreign status. A passport will satisfy both the identity and foreign status requirements. The IRS will otherwise accept a combination of documents, including a foreign driver’s license, a foreign birth certificate, a foreign voter’s registration, a visa or other IRS-listed documents. The process usually takes place through the mail, which means that no US-agency employee actually sees the person applying for the ITIN.

Unfortunately, ITINs have been swept-up in political battles. For example, there is fear that the IRS will share this information with Immigration, although the IRS is not permitted by law to do so. This may discourage people from obtaining ITINs, so the argument goes. On the other hand, there are states that will allow one to obtain a driver’s license solely with an ITIN, which seems a perversion of its intended purpose.

TIGTA goes into the IRS to investigate the complaints. Here are some of its findings:

·         IRS management is not concerned with addressing fraudulent applications in the ITIN Operations Department because of the job security that a large inventory of applications to process provides. Management is interested only in the volume of applications that can be processed, regardless of whether they are fraudulent.

·         IRS management has indicated that no function of the IRS, including Criminal Investigation or the Accounts Management Taxpayer Assurance Program, is interested in dealing with ITIN application fraud.

·         IRS management has:

o    Created an environment which discourages tax examiners responsible for reviewing ITIN applications from identifying questionable applications.

o   Eliminated successful processes used to identify questionable ITIN application fraud patterns and schemes.

o   Established processes and procedures that are inadequate to verify each applicant’s identity and foreign status.

Good grief! The IRS disbanded an ITIN team that was having too much success, countered by provided virtually no training to new hires and transfers and put negative evaluations in overly-eager reviewers’ files.

TIGTA made nine recommendations in this report. The IRS agreed with seven and has already announced plans to implement interim changes. One has caused quite the consternation in the immigrant community by requiring copies of original documents with ITIN applications.

OBSERVATION: Let’s be fair here: would you be comfortable sending original copies of anything to the IRS? Assuming you can find that birth certificate from the mother country, how are you going to replace it when the IRS loses the thing?

What Does Insolvency Mean To The IRS?

Shepherd v Commissioner is a pro se case before the Tax Court. “Pro se” means that the taxpayer is representing himself/herself, without a professional. Technically that is not correct, as a taxpayer can go into Tax Court with a professional and still be considered “pro se.” This happens if the professional (say a CPA) has not passed the examination to practice before the Court. The CPA can then “advise” but not “practice,” and the taxpayer is considered “pro se.”

Today we will be talking about cancellation-of-debt income. Tax pros commonly refer to this is “COD” income. For many years I rarely saw a COD issue. In recent years it seems to be endemic. There are two common ways to generate COD: a home is foreclosed or a credit card is settled. If one pays less than the balance of the debt, the remaining balance is considered to be income to the debtor.

How can that be, you may ask. Let’s use an example. Say you go to your bank and borrow $50,000. When the loan is due, you cannot afford to pay in full. The bank agrees to accept $36,000 as full payment on the loan. From the IRS’ perspective, you received and kept a net $14,000. Perhaps you bought a car, went on vacation, or paid for a kid’s college, but you had an accession to wealth. The IRS considers the $14,000 to be income to you.

There are exceptions, and Shepherd involves the “insolvency” exception. This is different from the bankruptcy exception. Granted, in both cases you are likely insolvent, but for the insolvency exception you do not have to file with a bankruptcy court.

Let’s quickly take a look at the wording for insolvency in the tax code:

   108(d)(3) INSOLVENT.— For purposes of this section, the term “insolvent” means the excess of    liabilities over the fair market value of assets. With respect to any discharge, whether or not the taxpayer is insolvent, and the amount by which the taxpayer is insolvent, shall be determined on the basis of the taxpayer's assets and liabilities immediately before the discharge.

An easy way to understand insolvency is the following formula:

·        Add the fair market value of everything you own, then

·        Subtract everything you owe

If the result is negative, you are insolvent. You owe more than you own. You are negative or upside-down. There are special rules for assets such as a pension, but you get the concept.

The IRS says that – if you are insolvent – then COD income not be taxable to you to the extent you are insolvent. Let’s use numbers to help understand this:

·        You own $160,000

·        You owe $175,000

·        Visa forgives $22,000

Your COD income is $22,000 (what Visa forgave).

Your insolvency is $15,000 (175,000 – 160,000).

Therefore $7,000 of your COD income (22,000- 15,000) will be taxable to you. The rest is not taxable.

The tax law requires you to do the calculation of what you own and what you owe as of the date the debt is forgiven. It is not two years later or 18 months before. Remember: this is tax law not a tax suggestion.

Let’s swing over to Shepherd. He and his wife lived in New Jersey and owed Capital One Bank approximately $10,000. In 2008 they settled for approximately $5,500, leaving COD income of $4,500.

The Shepherds claimed insolvency and did not report the $4,500 as 2008 income. The IRS looked into it and found that the key to the insolvency calculation was the value Shepherd attached to two houses.

The first was his beach house. Shepherd received a property assessment of $380,000 for the 2010 tax year. He appealed the assessment, claiming a value closer to $340,000. He presented this as evidence before the Court. The Court had two immediate issues:

·        There is a long-standing tax doctrine that the value of property for local tax purposes is not determinative of fair market value for federal income tax purposes. This is the Gilmartin case, and it clearly established the tax code’s preference for an appraisal over property tax bills.

·        Shepherd did not present to the Court the methodology, procedures or analysis, including comparable sales, for thinking that the value was closer to $340,000. At that point it was just an opinion, and the Court was not bound by his opinion.

The Court pointed out that these events took place two years after the debt forgiveness and said fuhgeddaboudit to Shepherd’s valuation of the beach house.

The second was his principal residence.

·        Shepherd showed the Court a tax bill. The Court duly dismissed that under the Gilmartin doctrine.

·        Shepherd applied for a loan modification in 2011. Chase Home Finance showed a value of $380,000 in a modification letter. The Court wasn’t buying into this, noting that Chase’s letter did not show any analysis or procedures used in arriving at value, such as comparable sales. That is, it was not an appraisal. Oh, and by the way, the letter was three years after the debt discharge.

What is a tax pro’s take? Folks, Shepherd had virtually no leg to stand on. How can one read the tax code stating “immediately before the discharge” and reason that three years later – and after one of the worst housing markets in U.S. history – would constitute “immediately before”? This is simply not reasonable. You are going to lose this if challenged by the IRS. Shepherd’s position is so preposterous that I suspect he was truly “pro se” and did not have a professional, either when he prepared his return or when he was presenting his arguments in Court.

What Is A Quintile?

A quintile is one of five equal groups into which a population can be divided. If the top 20% of taxpayers pay 94% of the income tax, then isn't it fair that they receive 94% of any tax breaks? Isn't it unfair if they don't?

The Olympics As A Tax Haven

As you probably know, the summer Olympics began last week. For a while, east London will be the newest tax haven going.

The basic UK individual income tax rate is 20%, although incomes over 150,000 pounds are taxed at 50%.  The basic corporate tax rate is 24% and a bargain compared to the U.S. corporate rate of 35%.

The UK does have a VAT of 20%, so it is unfair to compare only income taxes.

The “London Olympic Games and Paralympic Games Tax Regulations 2010” exempt the earnings of Olympic athletes and foreign nationals working on Games –related activity, such as judges, journalists and representatives of sports bodies. The Regulations do not exempt construction workers at the sites, nor do they exempt UK residents. The exemption is solely for nonresidents.

The exemption also extends to non-resident companies doing business at the Olympic sites. There has been pressure on companies to forego the tax holiday. Both McDonald’s and Coca Cola have declined the tax break, while General Electric said that all Olympic activities are being done through resident companies and therefore are not eligible for the tax holiday.

What was the reason for this break?

I am unsure about the corporate tax holiday, but the individual tax holiday is easy to understand. The UK’s general tax rule is to tax a proportion of an athlete’s earnings. The proportion is the number of UK appearance days to total annual appearance days. As an example, say a tennis player competes at the Olympics for a week and for 35 days in total during 2012.  The general rule is that 20% of the tennis player’s earnings would be subject to UK tax. That may or may not be fair. The general rule assumes that appearance earnings are proportional.

But it gets worse. The UK will tax both the athlete’s performance and endorsement income. Take someone with significant endorsement income – say Usain Bolt – and this can get expensive. It is the reason Usain Bolt had not previously set foot on a British track since 2009. Golfer Sergio Garcia has admitted to limiting his British appearances because of this tax. It is also the reason that Wembley Stadium lost its bid for the 2010 Football (that is, soccer) Champions League. 

So, HMRC waived the rule and created a temporary tax haven for the Olympic Games.

There has been controversy over the tax holiday, with pressure groups arguing that the holiday was unnecessary if not unjust. Just and unjust are slippery terms, but the general argument is that for-profit activities – whether corporate or athlete – should pay whatever taxes the host country deems to implement. The host country should be able to recoup the cost of its Olympic facilities, for example. Seems reasonable. Tax holidays however have become a factor in the IOC decision process. The unwelcome fact is that east London may not have had the Olympics without the holiday.

Should you be going to England during the first week of August, you may want to consider the Bristol Tax Avoidance Olympics on August 4^th. In the spirit of protest, the events will include:

·        Cooking the books

·        Jumping through the tax loopholes

·        Avoiding the taxman

·        Hide (your profits) and seek

Heh.

The Collections Appeal and Pace

This past Tuesday I submitted financial and other information regarding a collections appeal with an IRS officer in California. We have several clients with unpredictable income streams, and this client is one of them. We are pursuing something called a “manually monitored installment agreement,” which allows for changes in an IRS payment plan as one’s income varies. It can be difficult to obtain. In fact, a revenue officer I often work with informed me that this type of agreement was “above his grade.” That comment struck me as odd and is something I intend to follow-up on.

Back to our client. I was concerned as time was running out, and the client did not seem to register the urgency of the matter. I am working within a compressed time period. To her credit, the IRS officer showed patience and goodwill. She was within her rights to be much stricter with me, but she agreed to move the file and hearing back to Cincinnati. I was greatly relieved, as Rick wanted the file here.

“How much more do they want?” “They have everything.” “What are they going to do if I don’t?” These are all common questions. So much so I should just post the questions and answers on my office wall to save time.   

Today let’s talk about this part of IRS representation: the collections appeal. Let’s also talk about Pace v Commissioner, who got himself into collections appeal and perhaps should have been less confrontational and more forthcoming.

Your entry into the IRS will likely be through Examinations. This step is what we consider the “audit”, although these days the whole matter may be handled through the mail. The IRS is becoming fond of computerized matching, for example, as Congress provides it with ever-more tax reporting for anything that you do. Such is the new audit, I guess.

If you owe money your file will be transferred to Collections. Collections will send you a bill, and you will be working with Collections if you want a payment program, a cannot-collect status or an offer in compromise. The problem with Collections is that they are not really interested in the how-and-whys of you getting there, but they are very interested in getting money from you. They can back this up by garnishing your wages, liening your assets, levying your bank account or terminating your installment plan. Collections appeal exists as a safety valve for these more-aggressive collection actions. It takes your file out of Collections and gives it to an appeals officer. You have a chance to present information – geared to writing the IRS a check, of course – to someone who may be less “eager” to separate you from your last dollar at the earliest possible chance.

Perhaps you are talking to the appeals officer about delaying payments while you look for work, about setting up a payment plan, or having the IRS restart a payment plan they decided to terminate. Understandably, that appeals officer is going to want to know your finances. You will be sending him/her a Form 433-A or B, which is a listing of your assets and your earnings and expenses for (at least) the last three months. He/she will also want copies of bank statements as well as of significant bills, like your mortgage or car payments. You may have to send them a copy of your broker statement, for example, if you have a few dollars invested in the market. None of this is surprising. What if you don’t provide what he/she wants? Well, he/she can stop working with you and throw you back into the Collections pool. For you to do this seems self-defeating, doesn’t it? With that, let’s talk about Pace.

Pace operated a chiropractic business through a corporation (Dauntless). Pace fell behind on his 2006 and 2007 taxes. The IRS sent a Final Notice of Intent to Levy.  Pace did the right thing and requested a collection due process (CDP) hearing to discuss a collection alternative. The appeals officer requested a 433-A and B. During this process the officer learns that Pace is associated with two more entities – Achievement Therapeutic Services LLC (Achievement) and Kenneth D. Pace LLC (KDP). The officer requests a 433-B for them, as well as evidence that they are up-to-date on their tax filings. Pretty routine.

Pace provides none of it. He does have an argument. Whereas he is the registered agent for both, he has derived no income from these two entities, and he does not think producing any information regarding them is appropriate.

NOTE: Me? I think I can still play linebacker for the Bengals this upcoming football season.

The collections appeal hearing takes place.  Tell me, if you were the appeals officer, what would you do?

The appeals officer threw Pace back into Collections for their tender mercies, that is what he did. Pace next goes to Tax Court.

My Take: Pace is bonkers. I would have provided the IRS with copies of tax returns for Achievement and KDP, if tax returns existed. If the entities were dormant, then I would have discussed that fact with the appeals officer and asked what he considered a reasonable next step.  By not doing so, the Tax Court decided that Pace was the one being unreasonable.  Being unreasonable, Pace lost his case.