Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.
Friday, December 23, 2016
Tuesday, December 20, 2016
Would You Believe?
It is a
specialized issue, but I am going to write about it anyway.
Why?
Because I
believe this may be the only time I have had this issue, and I have been in
practice for over thirty years. There isn’t a lot in the tax literature either.
As often
happens, I am minding my own business when someone – someone who knows I am a
tax geek – asks:
“Steve, do you know the tax answer to
….”
For future
reference: “Whatever it is - I don’t. By the way, I am leaving the office today
on time and I won’t have time this weekend to research as I am playing golf and
sleeping late.”
You know who
you are, Mr. to-remain-unnamed-and-anonymous-of-course-Brian-the-name-will-never-pass-my-lips.
Here it is:
Can a trust make a charitable donation?
Doesn’t
sound like much, so let’s set-up the issue.
A trust is
generally a three-party arrangement:
· Party of the first part sets up and
funds the trust.
· Party of the second part receives
money from the trust, either now or later.
· Party of the third part administrates
the trust, including writing checks.
The party of
the third part is called the “trustee” or “fiduciary.” This is a unique
relationship, as the trustee is trying to administer according to the wishes of
the party of the first part, who may or may not be deceased. The very concept
of “fiduciary” means that you are putting someone’s interest ahead of yours: in
this case, you are prioritizing the party of the second part, also called the
beneficiary.
There can be
more than one beneficiary, by the way.
There can also
be beneficiaries at different points in time.
For example,
I can set-up a trust with all income to my wife for her lifetime, with whatever
is left over (called the “corpus” or “principal”) going to my daughter.
This sets up
an interesting tension: the interests of the first beneficiary may not coincide
with the interests of the second beneficiary. Consider my example. Whatever my
wife draws upon during her lifetime will leave less for my daughter when her
mom dies. Now, this tension does not exist in the Hamilton family, but you can
see how it could for other families. Take for example a second marriage, especially
one later in life. The “steps” my not have that “we are all one family”
perspective when the dollars start raining.
Back to our
fiduciary: how would you like to be the one who decides where the dollars rain?
That sounds like a headache to me.
How can the
trustmaker make this better?
A
tried-and-true way is to have the party of the first part leave instructions,
standards and explanations of his/her wishes. For example, I can say “my wife
can draw all the income and corpus she wants without having to explain anything
to anybody. If there is anything left over, our daughter can have it. If not,
too bad.”
Pretty
clear, eh?
That is the heart
of the problem with charitable donations by a trust.
Chances are,
some party-of-the-second-part is getting less money at the end of the day
because of that donation. Has to, as the money is not going to a beneficiary.
Which means
the party of the first part had better leave clear instructions as to the who/what/when
of the donation.
Our case
this week is a trust created when Harvey Hubbell died. He died in 1957, so this
trust has been around a while. The trust was to distribute fixed amounts to
certain individuals for life. Harvey felt strongly about it, because - if there
was insufficient income to make the payment – the trustee was authorized to
reach into trust principal to make up the shortfall.
Upon the
last beneficiary to die, the trust had 10 years to wrap up its affairs.
Then there
was this sentence:
All unused income and the remainder of the principal shall be used and distributed, in such proportion as the Trustees deem best, for such purpose or purposes, to be selected by them as the time of such distribution, as will make such uses and distributions exempt from Ohio inheritance and Federal estate taxes and for no other purpose.”
This trust
had been making regular donations for a while. The IRS picked one year – 2009 –
and disallowed a $64,279 donation.
Here is IRC
Sec 642(c):
(c)Deduction for amounts paid or permanently set aside for a charitable purpose
(1)General rule
In the case of an estate or trust (other than a trust meeting the specifications of subpart B), there shall be allowed as a deduction in computing its taxable income (in lieu of the deduction allowed by section 170(a), relating to deduction for charitable, etc., contributions and gifts) any amount of the gross income, without limitation, which pursuant to the terms of the governing instrument is, during the taxable year, paid for a purpose specified in section 170(c) (determined without regard to section 170(c)(2)(A)). If a charitable contribution is paid after the close of such taxable year and on or before the last day of the year following the close of such taxable year, then the trustee or administrator may elect to treat such contribution as paid during such taxable year. The election shall be made at such time and in such manner as the Secretary prescribes by regulations.
The key here is the italicized part:
“which pursuant to the terms of the governing instrument…”
The Code wants to know what the party
of the first part intended, phrased in tax-speak as “pursuant to the terms of
the governing instrument.”
The trustees argued that they could make
donations via the following verbiage:
in such proportion as the Trustees deem best, for such purposes or purposes, to be selected by them as the time of such distribution….”
Problem, said the IRS. That verbiage refers
to a point in time: the time when the trust enters its ten-year wrap-up and not
before then. The trustees had to abide by the governing instrument, and said instrument
did not say they could distribute monies to charity before that time.
The trustees had to think of
something fast.
Here is something: there is a “latent
ambiguity” in the will. That ambiguity allows for the trustees’ discretion on
the charitable donations issue.
Nice argument, trustees. We at CTG are
impressed.
They are referring to a judicial
doctrine that cuts trustees some slack when the following happens:
(1) The terms of the trust are
crystal-clear when read in the light of normal day: when it snows in Cincinnati
during this winter, the trust will ….
(2) However, the terms of the trust can
also be read differently in the light of abnormal day: it did not snow in
Cincinnati during this winter, so the trust will ….
The point is that both readings are
plausible (would you believe “possible?”).
It is just that no one seriously
considered scenario (2) when drafting the document. This is the “latent
ambiguity” in the trust instrument.
Don’t think so, said the Court. That expanded
authority was given the trustees during that ten-year period and not before.
In fact, prior to the ten years the
trustees were to invade principal to meet the annual payouts, if necessary. The
trustmaker was clearly interested that the beneficiaries receive their money
every year. It is very doubtful he intended that any money not go their way.
It was only upon the death of the
last beneficiary that the trustees had some free play.
The Court decided there was no latent
ambiguity. They were pretty comfortable they understood what the trustmaker
wanted. He wanted the beneficiaries to get paid every year.
And the trust lost its charitable
deduction.
For the home gamers, our case this
time was Harvey C. Hubbell Trust v Commissioner.
Labels:
642(c),
ambiguity,
beneficiary,
charitable,
deduct,
donate,
fiduciary,
govern,
Hubbell,
income,
instrument,
IRS,
latent,
tax,
trust,
trustee,
will
Friday, December 16, 2016
Business League: A Different Type Of Tax-Exempt
You may have heard about business leagues.
One very much in the news recently is the National Football
League, which has been considering giving up its tax-exempt status.
In the tax world, exempt entities obtain their exempt status
under Section 501(c). There is then a number, and that number is the “type” of
exempt under discussion. For example, a classic charity like the March of Dimes
would be a 501(c)(3). When we think of tax-exempts, we likely are thinking of
(c)(3)’s, for which contributions are deductible to the donor and nontaxable to
the recipient charity.
The (c)(3) is about as good as it gets.
A business league is a (c)(6). So is a trade association.
Right off the bat, payments to a (c)(6) are not deductible
as contributions. They are, however, deductible as a business expense- which
makes sense as they are business
leagues. You and I probably could not deduct them, but then again you and I are
not businesses.
There are some benefits. For example, a (c)(6) has virtually
no limit on its lobbying authority, other than having to pro-rate the member
dues between that portion which represents lobbying (and not deductible by
anybody) and the balance (deductible as a business expense).
There are requirements to a (c)(6):
(1) There
must be members.
a.
The members must share a common business
interest.
i. Members
can be individuals or businesses.
ii. If
membership is available to all, this requirement has not been met. This makes sense
when you consider that the intent of the (c)(6) is to promote shared interests.
(2) Activities
must be directed to improving business conditions in a line of business.
a.
Think of it as semi-civic: to advance the
general welfare by promoting a line of business rather than just the individual
companies.
b.
This pretty much means that membership must
include competitors.
c.
Sometimes it can be sketchy to judge. For
example, the IRS denied exemption to an organization whose principal activity
was publishing and distributing a directory of member names, addresses and
phone numbers to businesses likely to require their services. The IRS felt this
went too close to advertising and too far from the improvement of general
business conditions.
(3) The
primary activities must be geared to group and not individual interests.
a.
The American Automobile Association, for
example, had its application denied as it was primarily engaged in rendering
services to members and not improving a line of business.
(4) The
main purpose cannot be to run a for-profit business.
a.
This requirement is standard in the
not-for-profit world. You can run a coffee shop, but you cannot be Starbucks.
b.
For example, a Board of Realtors normally
segregates its MLS activities in another – and separate – company. The Board itself
would be a (c)(6), but the MLS is safely tucked away in a for-profit entity –
less it blow-up the (c)(6).
(5) Must
be not-for-profit.
a.
Meaning no dividends to shareholders or distributions
rights if the entity ever liquidates.
b.
BTW – and to clarify – a not-for-profit can show
a profit. Hypothetically it could show a profit every year, although it is
debatable whether it could rock the profit level of Apple or Facebook and keep
its exemption. The idea here is that profits – if any – do not “belong” to
shareholders or investors.
(6) There
must be no private inurement or private benefit to key players or a restricted
group of individuals.
a.
Again, this requirement is standard in the
not-for-profit world.
b.
This issue has been levelled against the NFL. Roger
Goodell (the NFL Commissioner) has been paid over $44 million a year for his
services. It does not require a PhD in linguistics to ask at what point this
compensation level becomes an “inurement” or “benefit” disallowed to a (c)(6).
There is litigation around (4) and (6). The courts have
allowed some business activity and some benefit to the members, as long as
it doesn’t get out of hand. The courts refer to this as “incidental benefit.”
Which can lead to interesting follow-up issues. Take a case
where the organization runs a business (within acceptable limits) and then uses
the profit to subsidize something for its members. Can this amount to private
inurement? The members are – after all - receiving something at a lower cost
than nonmembers.
Let’s take a look at a recent application. I think you know
enough now to anticipate how the IRS decided.
(1) The
(c)(6) members are convenience stores and franchisees of “X.”
(2) Revenues
will be exclusively from member fees.
(3) One-quarter
of member fees will be remitted annually to the national franchisee (that is, the
franchise above “X”)
(4) Member
franchisees will elect the Board.
(5) The
(c)(6) will educate and assist with franchise policies.
(6) The
(c)(6) will facilitate resolution between members and executives of “X.”
How did it go?
The IRS bounced the application.
Why?
We could have stopped at (1). There is no “line of business”
happening here. Members are limited to franchisees of “X.” Granted, “X”
participates in an industry but “X” does not comprise an industry.
The organization tried to clean-up its application after being
rejected but it was too little too late.
The organization was not promoting the industry as a whole.
It rather was promoting the interest of the franchisee-owners.
Nothing wrong with that. You just cannot get a tax exemption
for it.
Labels:
501(c),
association,
Backemeyer,
Basis,
beneficiary,
business,
cost,
death,
decease,
estate,
exempt,
far,
fertilizer,
league,
profit,
seed,
step,
supplies,
trade,
up
Wednesday, December 7, 2016
How To Lose All Of Your Auto Deduction
I am not a fan of dumb.
And I am
reading big dumb.
The IRS
wanted over $22 thousand in taxes and $4,000 in penalties. There were several
issues, but there was one that racked up the money.
What do you
need if you want to claim auto expenses on your tax return?
Answer: some
kind of record, like a log.
There is a
reason for this. It is not random, chaotic or unfathomable.
The reason has two parts:
(1) There was a very famous case decided
in the 1930s concerning George Cohan. George was a playwright, a composer, a
singer, actor, dancer and producer. He was very famous. He was also a terrible
record keeper. Given his day job, he spent a ton of money schmoozing people. He
deducted some of those expenses on his tax return, as he had to wine and dine to
maintain his recognition, connections and earning power. Problem was: he kept
lousy records. One had to – essentially – take his word for the expenses.
The Court, knowing who he was,
thought it believable that he had incurred significant entertainment expenses. The
Court simply estimated what they were and allowed him a deduction.
Ever since, that guesstimate has been
referred to in taxation as the “Cohan rule.”
Problem was: everything can be
abused. What started out as common sense and mitigation for George Cohan became
a loophole for many others.
(2) Congress got a bit miffed about this,
especially when it came to travel, transportation and entertainment expenses.
These expenses can be “soft” to begin with, and the Cohan rule made them
gelatinous. Congress eventually said “enough” and passed Code Section 274(d),
which overrides the Cohan rule for this category of expenses.
BTW, “transportation” is just a fancy
tax-word for mileage.
The tax-tao now is: no records = no
mileage deduction. Forget any Cohan rule.
Now, you do not need to record every
jot and tittle as soon as you get in the car. Records can include your Outlook
calendar, for example. You could extend the appointment by mileage from MapQuest
and (probably) have the IRS consider it adequate. The point is that you created
some record, at or near the time you racked up the mileage, and that record can
be reasonably translated into support for your deduction.
Enter Gary Roy.
He was a consultant in Los Angeles.
He worked out of his home and drove all over the place for business. He must
have made a couple of bucks, as he purchased an Aston Martin Vantage.
This is not a car you see every day.
Chances are the last time you saw an Aston Martin was in a James Bond movie.
You know he deducted that car on his
tax return.
There are multiple issues in the
case, but the one we want to talk about is his car. Roy appeared before the Court and
straight-facedly claimed that he kept a mileage record for the Aston. He
presented a sheet of paper showing mileage at the beginning of the year and
mileage at the end of the year. He helpfully added the description “business
use” so the Court would know what they were looking at.
As far as he was concerned, this was
all the record-keeping he needed, as the car was 100% business use.
I want to be sympathetic, I really
do. I suppose it is possible that he did not understand the rules, but I read
in the decision that he used a tax preparer.
COMMENT: To whom he paid $250. Given that there were complexities in his tax return – the business and a gazillion-dollar car, for goodness’ sake – he really, really should have upgraded on his tax preparer selection.
Roy had no chance. That stretch of
tax highway has a million miles on it, and he missed the pavement completely.
Without the Cohan rule, the Court was
not going to spot him anything. He just got a big zero. That is what Section
274(d) says.
And is what Congress wanted back
when.
Worst case scenario for Mr. Roy.
Thursday, December 1, 2016
Someone Fought Back Against Ohio – And Won
I admit it
will be a challenge to make this topic interesting.
Let’s give
it a shot.
Imagine that
you are an owner of a business. The business is a LLC, meaning that it
“passes-through” its income to its owners, who in turn take their share of the
business income, include it with their own income, and pay tax on the
agglomeration.
You own
79.29% of the business. It has headquarters in Perrysville, Ohio, owns plants
in Texas and California, and does business in all states.
The business
has made a couple of bucks. It has allowed you a life of leisure. You fly-in
for occasional Board meetings in northern Ohio, but you otherwise hire people
to run the business for you. You have golf elsewhere to attend to.
You sold the
business. More specifically, you sold the stock in the business. Your gain was
over $27 million.
Then you
received a notice from Ohio. They congratulated you on your good fortune and …
oh, by the way … would you send them approximately $675,000?
Here is a
key fact: you do not live in Ohio. You are not a resident. You fly in and fly
out for the meetings.
Why does
Ohio think it should receive a vig?
Because the
business did business in Ohio. Some of its sales, its payroll and its assets
were in Ohio.
Cannot argue
with that.
Except “the
business” did not sell anything. It still has its sales, its payroll and its
assets. What you sold were your shares in the business, which is not the same
as the business itself.
Seems to you
that Ohio should test at your level and not at the business level: are you an
Ohio resident? Are you not? Is there yet another way that Ohio can get to you personally?
You bet,
said Ohio. Try this remarkable stretch of the English language on for size:
ORC 5747.212 (B) A taxpayer, directly or indirectly, owning at any time during the three-year period ending on the last day of the taxpayer's taxable year at least twenty per cent of the equity voting rights of a section 5747.212 entity shall apportion any income, including gain or loss, realized from each sale, exchange, or other disposition of a debt or equity interest in that entity as prescribed in this section. For such purposes, in lieu of using the method prescribed by sections 5747.20 and5747.21 of the Revised Code, the investor shall apportion the income using the average of the section 5747.212 entity's apportionment fractions otherwise applicable under section 5733.05, 5733.056, or 5747.21 of the Revised Code for the current and two preceding taxable years. If the section 5747.212 entity was not in business for one or more of those years, each year that the entity was not in business shall be excluded in determining the average.
Ohio is
saying that it will substitute the business apportionment factors (sales,
payroll and property) for yours. It will do this for the immediately preceding
three years, take the average and drag you down with it.
Begone with thy
spurious nonresidency, ye festering cur!
To be fair,
I get it. If the business itself had sold the assets, there is no question that
Ohio would have gotten its share. Why then is it a different result if one
sells shares in the business rather than the underlying assets themselves? That
is just smoke and mirrors, form over substance, putting jelly on bread before
the peanut butter.
Well, for
one reason: because form matters all over the place in the tax Code. Try
claiming a $1,000 charitable deduction without getting a “magic letter” from
the charity; or deducting auto expenses without keeping a mileage log; or
claiming a child as a dependent when you paid everything for the child – but
the divorce agreement says your spouse gets the deduction this year. Yeah, try
arguing smoke and mirrors, form and substance and see how far it gets you.
But it’s not
fair ….
Which can
join the list of everything that is not fair: it’s not fair that Firefly was
cancelled after one season; it’s not fair that there aren’t microwave
fireplaces; it’s not fair that we cannot wear capes at work.
Take a
number.
Our
protagonist had a couple of nickels ($27 million worth, if I recall) to
protest. He paid a portion of the tax and immediately filed a refund claim for
the same amount.
The Ohio tax commissioner denied the claim.
COMMENT: No one could have seen that coming.
The taxpayer
appealed to the Ohio Board of Tax Appeals, which ruled in favor of the Tax
Commissioner.
The taxpayer
then appealed to the Ohio Supreme Court.
He presented
a Due Process argument under the U.S. Constitution.
And the Ohio
Supreme Court decided that Ohio had violated Due Process by conflating our
protagonist with a company he owned shares in. One was a human being. The other
was a piece of paper filed in Columbus.
The taxpayer
won.
But the
Court backed-off immediately, making the following points:
(1) The decision applied only to this
specific taxpayer; one was not to extrapolate the Court’s decision;
(2) The Court night have decided
differently if the taxpayer had enough activity in his own name to find a
“unitary relationship” with the business being sold; and
(3) The statute could still be valid if
applied to another taxpayer with different facts.
Points (1)
and (3) can apply to just about any tax case.
Point (2) is
interesting. The phrase “unitary relationship” simply means that our
protagonist did not do enough in Ohio to take-on the tax aroma of the company
itself. Make him an officer and I suspect you have a different answer. Heck, I
suspect that one Board meeting a year would save him but five would doom him.
Who knows until a Court tells us?
With that you
see tax law in the making.
By the way,
if this is you – or someone you know – you may want to check-out the case for
yourself: Corrigan v Testa. Someone may have a few tax dollars coming
back.
Testa, not Tesla |
Labels:
apportionment,
assets,
business,
Corrigan,
gain,
individual,
nexus,
nonresident,
Ohio,
property,
sale,
stock,
tax
Friday, November 25, 2016
Can A Coffee Shop Be Tax-Exempt?
I have been
spending quite a bit of time over the last few days working on or reviewing
not-for-profit returns.
It may
surprise you, but – with a few exceptions – not-for-profit organizations are
required to file paperwork annually with the IRS.
There is a
reason for this: the tax Code recognizes some organizations as “per se” not-for-profit
– churches are the classic example. Churches do not need to be told by the IRS
that they are tax-exempt; they simply are. A large part of this is church:state
separation, although church programs that begin to look uncannily similar to
for-profit businesses are supposed to file an income tax return (known as Form
990-T) and pay tax.
Then we have
the next tier: the education, charitable, scientific, etc. entities that also
comprise not-for-profits. These are not “per se” and have to apply with the IRS
to have their exempt status recognized. The application is done via either Form
1023 or Form 1024, depending upon the type of exempt status desired.
We talking about
the March of Dimes, Doctors Without Borders or your local high school boosters
club.
One thing
this tier has in common is that they have to explain to the IRS what their
exempt purpose is.
And there
are tax subtleties at play. For example, can your exempt purpose be less than
50% of what you do? What if it is more than 50% but you have a significant (but
less than 50%) non-exempt purpose? What if you start out at a more-than-50%
exempt purpose but – over time – your non-exempt purpose goes over 50%?
This becomes
its own field of specialization. I have met practitioners over the years whose
only practice is tax exempts.
I am looking
at the IRS response to a recent exempt application. I will give you a few facts
and flavor, and let’s see if you can anticipate the IRS decision on the matter.
(1) A minister had an idea for a coffee
shop. The shop would be separate from the church (hence the exempt application).
Being separate however would allow (and maybe encourage) other churches and religious
groups to participate.
(2) The coffee shop would allow believers
and non-believers to interact. There would be religious activities, but the
activities would not be organized by the shop. They would instead be organized
by the patrons. By the way, the shop could also be used for non-religious activities.
One could leave a donation for the use of the space.
(3) There are no similar businesses where
the shop is located, hence it is not taking commercial opportunity from a
profit-seeking business.
(4) The shop affords a gathering space
that is open late, as well as provide safe space for residents to gather.
(5) The shop takes part in a job-skills training
program to help underserved youth by placing them in an actual job for a six-week
internship.
(6) The shop participates in a project
for the children of incarcerated parents. Patrons can share gifts with the
kids, such as for their birthdays and Christmas.
(7) The shop does not want to turn away anyone
for inability to pay. There is a program where a customer can pay for a certain
amount of coffee in advance. When a not-able-to-pay patron enters, he/she is
served from those advance payments.
(8) The shop sells coffee, teas,
smoothies and so forth. There are also baked goods, as well as salads and
desserts.
(9) The shop roasts its own coffee, which
is sourced directly from coffee farmers. This allows the farmers to earn more
than other conventional means of distribution. The coffee is also available for
sale, and there are plans to sell the coffee online in the future
(10)
The
shop uses some volunteers, but its largest expense is (understandably) wages
and related payroll costs.
(11)
The
shop intends to give away its profits - that is, when it finally becomes
profitable.
What do you
think? Would you give this shop exempt status?
Here goes
the IRS:
(1) To be exempt, an organization must be
both organized and operated exclusively for an exempt purpose. The test has two
parts: the paperwork and what is actually going on.
(2) The IRS has defined the word
“exclusively” to mean “primarily.”
(3) Hot on the heels of that definition,
the IRS has also said that non-exempt activities must not be “more than an insubstantial
part” of activities.
OBSERVATION: You can see the evolution of law here. A non-tax specialist would anticipate that an activity is exempt if the exempt activity is 51% or more of all activities. The flip side is that a non-exempt activity should be as much as 49%.
The IRS however states that a non-exempt activity cannot be “more than an insubstantial part” of all activities.
Does “insubstantial” mean as much as 49%?
If not, then the IRS is changing definitions all over the place.
(4) The IRS has previously decided that
the operation of a grocery store to provide on-the-job training to hardcore
unemployed represented two purposes, not one. Each purpose has to be reviewed
to determine whether it is exempt or not.
(a) And now it gets tricky. If the store
is staffed principally by a target group (or volunteers) AND the store is no
larger than reasonably necessary for achieving the exempt purpose, the IRS has
said that the store is exempt.
(b) Conversely, if the store is not
staffed by the target group (or volunteers) or larger than necessary, the IRS has
said that the store is non-exempt.
(5) While the coffee shop intends to
donate its profits, its main activity is the operation of a coffee shop in a
commercial manner.
(6) And that activity is “more than
insubstantial.”
The IRS
rejected the application. The coffee shop will have to pay taxes.
Doesn’t it
matter that they are giving away all profits? Isn’t there a
vow-of-poverty-thing that one can point to?
And there is
a key point about tax law in the world of exempts. Giving away money will not
transform a for-profit activity into a not-for-profit activity. Granted, you
may get a charitable deduction, but you will be taxable. The IRS has been
steadfast on this point for many years. The activity itself has to be exempt, not
just the monies derived from said activity. To phrase it differently, gigantic
donations will not make Microsoft a tax-exempt entity.
The IRS
decided the shop was too similar to a Starbucks or Caribou.
Does the
shop do great work?
Yes.
Is it tax
exempt?
Nope.
Saturday, November 19, 2016
A Mom Taking Care Of A Disabled Child And Payroll Taxes
We have a responsible person payroll tax story to tell.
You may know that I sardonically refer to this penalty as the
“big-boy” penalty. It applies when you have some authority and control over the
deposit of payroll withholding taxes but do not remit them to the IRS. The IRS
views this as theft, and they can be quite unforgiving. The penalty alone is
equal to 100% of the tax; in addition, the IRS will come after you personally,
if necessary.
You do not want this penalty – for any reason.
How do people get into this situation? In many – if not most
cases – it is because the business is failing. There isn’t enough cash, and it is
easier to “delay” paying the IRS rather than a vendor who has you on COD. You
wind up using the IRS as a bank. Now, you might be able to survive this predicament
if we were talking about personal or business income taxes. Introduce payroll –
and payroll withholding – and you have a different answer altogether.
Our story involves Christina Fitzpatrick (Christina). Her
husband made the decision to start a restaurant in Jacksonville with James Stamps
(Stamps). They would be equal partners, and Stamps would run the show.
Fitzpatrick would be the silent wallet.
They formed Dey Corp., Inc to hold the franchise. The
franchise was, of course, the restaurant itself.
Sure enough, shortly after formation and before opening, Stamps
was pulled to Puerto Rico for business. This left Fitzpatrick, who in turn
passed on some of the pre-opening duties to his wife, Christina.
Fortunately, Stamps got back in town before the place opened.
He hired a general manager, a chef and other employees. He then went off to
franchise training school. Meanwhile, the employees wanted to be paid, so Stamps
had Christina contact Paychex and engage their services. They would run the
payroll, cut checks and make the tax deposits.
OBSERVATION:
Let’s call this IRS point (1)
He also had Christina open a business bank account and
include herself as a signatory.
OBSERVATION:
IRS point (2) and (3)
Stamps and the general manager (Chislett) pretty much ran the
place. Whether he was in or out of town, Stamps was in daily contact with
Chislett. Chislett managed, hired and fired, oversaw purchases and so on. He
was also the main contact with Paychex.
Except that …
Paychex started off by delivering paychecks weekly to the
restaurant. There was a problem, though: the restaurant wasn’t open when they
went by. Paychex then starting going to Christina’s house. Chislett told her to
sign and drop-off the paychecks at the restaurant. Chislett could not do it
because it was his day off.
OBSERVATION:
IRS point (4) and (5).
You can anticipate how the story goes from here. The
restaurant lost money. Chislett was spending like a wild man, to the extent
that the vendors put him on COD. Somewhen in there Paychex drew on the bank account
and the check bounced. Paychex stopped making tax deposits for the restaurants
because – well, they were not going to make deposits with rubber checks.
By the way, neither Stamps nor Chislett bothered to tell the
Fitzpatricks that Paychex was no longer making tax deposits.
Sure enough, the IRS Revenue Officer (RO) showed up. She
clued the Fitzpatricks that the restaurant was over two years behind on tax
deposits.
Remember that the restaurant was short on cash. Who could the
IRS chase for its money in its stead? Let
me think ….
The RO decided Christina was a responsible person and
assessed big bucks (approximately $140,000) against her personally.
Off to Tax Court they went.
The Court introduces us to Christina.
·
She
spent her time taking care of her disabled son, who suffered from a rare
metabolic disorder. As a consequence, he had severe autism, cerebral palsy and
limited mobility. He needed assistance for many basic functions, such as eating
and going to the bathroom. He could not be left alone for any significant
amount of time.
·
Taking
care of him took its toll on her. She developed spinal stenosis from constantly
having to lift him. She herself took regular injections and epidurals.
·
She
truly did not have a ton of time to put into her husband’s money-losing
restaurant. At start-up she had a flurry of sorts, but after that she visited
maybe once a week, and that for less than an hour.
·
She
could not hire or fire. She was not the bookkeeper or accountant. She did not
see the bank statements.
She did, unfortunately, sign a few of the checks.
The IRS looks very closely at who has signatory authority on
the bank account. As far as they are concerned, one could write a check to them
as easily as a check to a vendor. Christina appears to be behind the eight
ball.
The Court noted that the IRS was relying heavily on the testimony
of Stamps and Chislett.
The Court did not like them:
Petitioner’s cross-examination of Mr. Stamps and Mr. Chislett revealed that their testimony was unreliable and unbelievable."
That is Court-speak to say they lied.
Mr. Stamps evaded many of the petitioner’s questions during cross-examination by repeatedly responding ‘I don’t remember.’”
Sounds like a possible presidential run in there for Stamps.
The Court was not amused with the IRS Revenue Officer either:
However, we believe that RO Wells did not conduct a thorough investigation. For instance, RO Wells made her determination before she received and reviewed the relevant bank records. She also failed to interview (or summon) Mr. Stamps, the president of the corporation.”
The IRS is supposed to interview all the corporate officers.
Sounds like this RO did not.
The Court continued:
We are in fact puzzled that Mr. Stamps, the president of the corporation and a hands-on owner, an Mr. Chislett, the day-to-day manager, successfully evaded in the administrative phase any personal liability for these TFRPs.”
My, that is curious, considering they RAN the place. The use
of the word “evaded” clarifies what the Court thought of these two.
But there is more required to big-boy pants than just signing
a check. The Court reminded the IRS that a responsible person must have some
control:
The inquiry must focus on actual authority to control, not on trivial duties.”
Here is the hammer:
Notwithstanding petitioner’s signatory authority and her spousal relationship to one of the corporation’s owners, the substance of petitioner’s position was largely ministerial and she lacked actual authority.”
The Court liked Christina. The Court did not like Stamps and
Chislett. They especially did not like the IRS wasting their time. She was a
responsible person they way I am a deep-sea diver because I have previously
been on a boat.
The Court dismissed the case.
But we see several points about this penalty:
(1) The IRS will chase you like Khan
chased Kirk.
(2) Note that the IRS did not chase
Stamps or Chislett. This tells me those two had no money, and the IRS was
chasing the wallet.
(3) Following on the heels of (2), do not
count on the IRS being “fair.” They IRS can cull one person from the herd and
assess the penalty in full. There is no requirement to assess everyone involved
or keep the liability proportional among the responsible parties.
We have a success story, but look at the facts that it took.
Labels:
authority,
control,
employer,
Fitzpatrick,
investor,
IRS,
officer,
own,
payroll,
penalty,
Recovery,
restaurant,
tax,
trust,
wife,
withhold
Subscribe to:
Posts (Atom)