IRS Bad Debt Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

How many of you all have ever loaned money or property through your business and have not been paid back? Have you ever loaned money or property to a friend and have not been paid back? Did you all know you can deduct either on your business or personal tax return a bad debt either as a business bad debt under IRS Section 166(a) and 166(b) or a nonbusiness bad debt under IRS Section 166(d)? However, the Government looks closely at your bad debts perhaps years later disallowing all your deductions in and IRS Bad Debt Audit. So if you loaned out some money or property that you want to deduct in 2015 as a bad debt, stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to keep those bad debt deductions from being disallowed years later during and IRS Bad Debt Audit.

Bad Debts are not so bad when you get to write them off on your tax return. But what if you get audited as did Fred Cooper in Cooper v IRS US Tax Court (2015). The facts are simple:  Cooper liked to make large sporadic loans to friends and business acquaintances. One of these loans was for almost $1M to Wolper Construction commencing in 2005 and due to be paid back in 2007. Wolper filed Chapter 11 in 2008 and eventually Chapter 7 in 2009. On advice of professional tax advisors Cooper amended his 2008 tax return in 2010 and deducted $750,000 bad debt deduction against ordinary income. The IRS audited years later in 2013 and disallowed the entire bad debt deduction for 2008.  Cooper appealed to US Tax Court in Cooper vs IRS TC Memo 2015-191.

Judge Buch notes that Section 166 allows taxpayers to deduct any debt that becomes worthless within the taxable year. To be entitled to the deduction the taxpayer must show a bona fide debt based on a debtor-creditor relationship citing IRS Regulation 1.166-1(c). Business debts and nonbusiness debts are treated differently under Section 166.  Nonbusiness debts are defined as debts not connected in connection with a trade or business. Unlike Business Bad Debts that are deducted directly against income, nonbusiness bad debts are short term capital losses with a maximum deduction of $3000 per year if there are no offsetting capital gains. Whether or not the debt is business or nonbusiness is a question of fact citing Rollins v Commissioner 276 F.2d 368 (4th Cir 1960). The business bad debt must be “proximately related” to the conduct of the trade or business, citing Litwin v US 983 F.2d 997 (10th Cir 1993).

Cooper argued before the Court that he was in the business of lending and therefore the deduction was a business bad debt. The Government argued otherwise citing that the facts do not support Cooper’s argument. The Court agreed with the IRS finding that there were five facts that showed Cooper was not a lender: 1. Cooper made only 12 loans over a six year period from 2005-2010. 2. Cooper only would lend money to friends and acquaintances. 3. Cooper did not use formal lending practices with no credit checks or collateral verification and there were no written promissory notes for 7 of the 12 loans. 4. Cooper did not publicly hold himself out to be a lender and 5. Cooper did not keep adequate contemporaneous business records. Many of the records given to the Court were constructed after the fact and were not considered credible.

The Court then went on to find that the nonbusiness bad debt was not wholly worthless in the year Cooper claimed the deduction in 2008. Cooper unfortunately was unable to show identifiable events to the Court that formed the basis of Cooper abandoning any hope of recovery citing Aston v Commissioner 109 US Tax Court 400 (1997). The facts unique to Cooper showed Cooper never claimed the debt to the US Bankruptcy Court, that Cooper listed the loan on his personal financial statement in 2009 as an asset, and that Cooper never sent Wolper a form 1099-C, cancellation of debt, nor was the IRS ever sent the 1096 form reporting the cancellation of the debt to Wolper. The Court therefore concluded that based on the facts, Cooper’s nonbusiness bad debt was not wholly worthless and therefore the deduction could not be sustained. IRS wins Cooper loses.

Our next case, Shaw v IRS US Tax Court (2013)  also has simple facts. June Shaw had a large capital gain of over $1M in 2009 from the sale of an apartment building in 2008. In the same year as this gain, the facts show that in 2009 June Shaw loaned on a very short term basis over $800K to a company owned by her brother Kenneth Shaw. June Shaw was unable to get her loan paid back by her brother Kenneth in 2009 so she deducted this $800K as a capital loss bad debt against the $1M capital gain.  The IRS audited years later and disallowed the entire bad debt deduction claiming there was no bona fide worthless bad debt to deduct. June Shaw appealed to US Tax Court in Shaw v IRS Tax Court 2013-170.

Judge Lauber opines that Section 166(a)(1) allows a deduction for any bona fide debt that becomes worthless within the taxable year. A bona fide debt is a debt that arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed sum of money, citing Section 1.166-1(c) of the IRS regulations. Transactions between family are subject to special extra scrutiny citing Caligiuri v Commissioner 549 F.2d 1155(8th Cir 1977). The Court observed that June Shaw provided no evidence that she checked out the credit worthiness of the company nor that she request assets be given to collateralize the loan. The facts showed further that June Shaw extended an unsecured line of credit that no third party lender would have approved. Finally that Court noted that June Shaw made no serious effort to obtain repayment nor did she send a letter demanding payment.  Finally she never filed a law suit against the company. The Court easily concluded that the loan was not a bona fide loan and therefore not deductible under Section 166.  IRS Wins June Shaw loses.

So how can you best create the facts you need to deduct a bad debt and sustain the deduction under Section 166 during an IRS bad debt audit years later?  First, before you lend anyone any money or property make sure you have a written legal promissory note with real terms of repayment.  Check their credit scores and make sure you get collateral on the loan.  Obtain financials and a PFS from the borrower, just like a bank would ask for.  Second, if you think the debt is going bad, retain a collection company to collect the debt and consider bringing legal action.  About a year later if all else fails, then and only then can you claim on a tax return that you are deducting a bona fide bad debt that is wholly worthless and noncollectable.  Finally, have your tax attorney attest to the steps you have taken to collect the debt and insert her contemporaneous statement into your tax return before you file.  You will be glad you protected your bad debt deduction from Government adverse action when the IRS come knocking on your door years later to commence an IRS Bad Debt Audit.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

IRS Legal Fees Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

If any of you have incurred legal fees in 2015 perhaps you should consider a Legal Fees Tax Deduction?  You are entitled to deduct civil or even criminal legal fees under Section 162(a) paid to an attorney in connection with your business. You can also deduct legal fees paid to an attorney as a miscellaneous itemized deduction under Section 67 if you bring legal action against your employer. Finally, you can deduct legal fees under Section 212 if you paid an attorney in connection with the production or collection of income or the maintenance of property held for the production of income. But the Government is aggressively reviewing your legal fee deductions in many cases years later during an IRS Legal Fees Audit, hoping to disallow much of your legal fees deductions.  So stay with us here on TaxView with Chris Moss CPA Tax Attorney where you will learn how to deduct legal fees in 2015 by protecting those deductions with bullet proof evidence you will need years later to successfully defend your deductions during an IRS Legal Fees Audit.

The first and most important evidence you need is contemporaneously prepared legal invoices by your attorney detailing the kind of legal work you paid for as Parker Company found out in Parker v IRS US Tax Court (2012). The Parker business claimed $630,000 in legal fees paid to attorneys in 2003 in relation to the arbitration and the shareholder derivative suit. The IRS audited six years later in 2009 and disallowed all legal fees. Parker appealed to US Tax Court in Parker v IRS US Tax Court (2012) arguing the legal fees were ordinary and necessary trade or business expenses to defend shareholder derivative suits. However, the Court concluded that Parker could not substantiate most of the claimed legal fees. A ledger and two cancelled checks provided by Parker was not good enough.  The Court allowed only $55K and disallowed $575,000.  IRS Wins Parker Loses.

In addition to having the proper contemporaneously prepared legal invoices, make sure you know what IRS Code Section you are able to legally deduct your legal fees as Gary Lee Colvin found out in Colvin v US Tax Court (2004).  Colvin paid an attorney in connection with State Court litigation against his primary residence homeowners association and paid the same attorney to sue his former employer to recover lost wages, however the attorney he paid never provided detailed invoices showing the kind of legal work he was paid for. Colvin deducted one total legal fee on his Schedule C business in 1997 and 1998. The IRS audited and disallowed all legal fees arguing that the legal fees were not ordinary and necessary business expenses and there was insufficient legal invoices to sustain the deduction. Colvin appealed to US Tax Court in Colvin v IRS US Tax Court (2004) arguing the legal fees were deductible under Section 212 to protect the production and collection of income. Special Trial Judge Dean easily finds for the Government noting that Colvin may not under Section 212 deduct legal fees that are personal expenses to protect his primary home as per Section 1.212-1(h). The Court concedes that legal fees to sue his former employer for lost wages would have been deductible but because there were no contemporaneously prepared legal invoices documented the nature of the legal work performed no deduction could be allowed.  IRS wins Colvin loses.

Our next case Chaplin v IRS US Tax Court (2007), involves a professional fiduciary Philip Chaplin who worked for Rice Heard & Bigelow Inc (Rice) and was elected to the Board of Directors of Rice in 1987.  Chaplin acted as a fiduciary for clients from 1988-1994, was provided a Rice credit card and was paid as an employee of Rice as per his employment agreement. Unfortunately Rice terminated Chaplin in 1994 and eventually in 1997 Chaplin filed suit against Rice alleging breach of contract and wrongful termination.  The case settled in 2002 and Chaplin was paid $1.5M.  Chaplin deducted legal fees on his 2001 tax return as an offset to the $1.5M.  In 2005 the IRS audited Chaplin’s 2001 tax return and denied his legal fee deduction claiming that the legal fees were not deductible from adjusted gross income as business legal fees but rather unreimbursed employee expense legal fees under Code Section 67 to be deducted as miscellaneous itemized deductions subject to the 2% floor limitation.  Chaplin appealed to US Tax Court in Chaplin v IRS US Tax Court (2007)Judge Haines easily finds for the Government concluding that Chaplin was clearly an employee not an independent contractor.  IRS Wins Chaplin loses.

Our next case Brenner v IRS US Tax Court (2001) introduces us to Andrew Brenner employee of Nomura Securities from 1987 to his termination in May of 1996.  Brenner sued Nomura and eventually settled in 1998 for $1.9M. In 1997, Brenner deducted $215,354 worth of legal fees as a miscellaneous itemized deduction under Section 67. But in 1999 he filed an amended return  on advice of his accountants claiming his legal fees were part of his company corporate plan under IRS Section 62 and Regulations 1.62, which allowed that his legal fees be directly deducted as an offset to his $1.9 settlement income.  The IRS audited and disallowed the adjusted the legal fees back to what they were on his original return claiming that Nomura was Brenner’s employer.  Brenner appealed to US Tax Court in Brenner v IRS US Tax Court (2001)and Judge Halpern easily found for the Government because no lawyer’s bill was ever submitted to Nomura, and no itemization of specific bills or invoices was ever substantiated under Section 162-2(e)(3). Because Brenner did not provide the required documents  to comply with Section 1.62-(2)(e)(3), Brenner’s only recourse was to deduct the legal fees under Section 67 as a miscellaneous itemized unreimbursed employee business expense on Schedule A of the original return as filed.  IRS Wins Brenner Loses.

Our final case is Butler v IRS US Tax Court (1997).  The facts are simple.  Butler purchased a farm in California and became involved with various law suits over water rights to protect and defend the title to his farm.  Butler deducted his legal fees in 1991 1992 and 1993 under Section 162.  The IRS audited disallowing all legal fees claiming the farm was not engaged in for profit within the meaning of Section 183, and therefore not deductible or in the alternative under Section 263 the legal fees were capital in nature to protect the title to the property and were also not deductible.  Butler appealed to US Tax Court in Butler v IRS US Tax Court (1997).  Butler claimed that at the legal fees where business expenses under Section 162 or in the alternative itemized deductions under Section 212 to protect is investment in the farm.   Judge Gerger finds easily for the Government because Butler did not work the farm full time and that Butler lacked a profit motive.  Therefore under Section 183 no legal fees could be deducted either under Section 162 or in the alternativeSection 212.  IRS Wins Butler loses.

As you can see, the US Tax Court does not allow legal fees to be deducted on your tax return unless you have well document legal invoices, a business connection under Section 162, unreimbursed employer expense under Section 67, or a clearly set up contemporaneous set of facts and evidence to prove the legal fees you paid  to an attorney protected  your income producing investment under Section 212.  So how can you win an IRS Legal Fee Audit?  First make sure you legal invoices are all specific enough to connect the legal service provided to the appropriate Code Section eitherCode Section 162, Section 67 or Section 212.  Second make sure you retain a tax attorney to create contemporaneous documentation to insert into your tax return before you file to make sure the Government has disclosure of under what Section of the IRS Code you are claiming your legal fee deduction. Finally obtain from your trial attorney before you pay them their opinion on whether or not their legal fee is tax deductible.  If they don’t know, perhaps they can retain a tax attorney to give her opinion prior to commencing litigation.  You will be glad you did years later when the Government comes knocking on your door to commence an IRS Legal Fee Audit.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

by Chris Moss CPA

IRS Clergy Parsonage Allowance

Welcome to TaxView with Chris Moss CPA Tax Attorney

The Clergy Tax Free Parsonage Allowance Exclusion under IRS Section 107(1) and 107(2) which has provided tax free rental exclusions to the preachers of the Gospel for almost 100 years has been saved by the 7th Circuit Court of Appealsin a dramatic reversal of Judge Barbara Crabb’s November 21, 2013 ruling in Wisconsin Federal District Court.  So if you are a minister or preacher of the Gospel and are planning to take advantage of the Parsonage Exclusion in 2015, stay tuned to TaxView with Chris Moss CPA Tax Attorney to hear about the exciting conclusion of the 7th Circuit’s November 13, 2014 Opinion in Freedom From Religion vs Jacob Lew, Sec of the Treasury and John Koskinen, Commissioner of the IRS, on Appeal from No.11-cv-06260 Freedom From Religion, Gaylor, and Barker vs Jacob Lew Secretary of the US Treasury (2013) Barbara B Crabb, Wisconsin District Judge presiding.

Recapping from a previous TaxView, Tax Free Housing Allowance for Clergy, by Chris Moss CPA Tax Attorney, let’s first look at what Section 107 is all about. Simply stated if you are a preacher of the Gospel you get to exclude from your income the fair rental value of the home or what the church pays you for the home, whichever is less. Section 107(1)excludes the value of your housing provided by the Church. Section 107(2) excludes direct cash compensation paid to the preacher for housing that the preacher pays for. 

Further regulations added requirements that the Allowance be officially approved by the Vestry or similar church Board.  See IRS Ministers’ Compensation and IRS topic 417. Various tax court rulings, including US Tax Court Driscoll v IRS imply that Congress had viewed the relationship between a Church and its ministers in a similar manner as they viewed the relationship between an Employer and its Employees. Congress reasons that if Employees were exempted on housing provided for the convenience of their employer, then why not have the Clergy exempt on similar housing allowance income when they would travel to a new Church to preach the Gospel. Interestingly, while the US Tax Court has ruled for or against the clergy over the years for abuse of the Exclusion, the Court has never before challenged Section 107 on Constitutional grounds that is until now.

Judge Crabb’s Opinion argues that her invalidation of the Allowance on Constitutional grounds does not mean that the US Government is powerless to enact tax exemptions that benefit religion. Indeed Judge Crabb concludes that Congress can enact legislation for granting the Exclusion that would be based on secular rather than religious grounds.  Unfortunately until Congress acts Judge Crabb opines, the Allowance is an unconstitutional violation of the separation of Church and State as found in the US Constitution.

However the 7th Circuit Judges Flaum, Rovner and Hamilton reversed Crabb in a most dramatic ruling, not deciding the case on the merits but rather on procedural grounds.  Judge Joel Flaum gave his Opinion that the Plaintiffs, Freedom From Religion, Gaylor and Barker, “lacked standing” before the Federal Court system to challenge Code Section 107(2).  The Court did not therefore reach the issue of the Constitutionally of the parsonage exemption.

The facts upon which this reversal were based were relatively simple in that Freedom From Religion’s co-Presidents Annie Gaylor and Dan Barker received a portion of their salary in the form of a housing allowance which was taxable to Gaylor and Barker.  Gaylor, Barker and Freedom From Religion brought suit in the Western District of Wisconsin claiming that Section 107 violated their First Amendment rights because it had given a tax benefit to preachers of the Gospel but not to them. The District Court agreed with Gaylor and Baker and ruled Section 107 unconstitutional. The Secretary of the Treasury and the IRS appealed to the 7th Circuit arguing that Gaylor and Barker did not have standing to bring the suit.

Gaylor and Barker argued before the 7th Circuit as they successfully argued before the District Court that they did indeed had standing because they were denied a tax exemption for their own employer provided housing allowance that was conditioned on them preaching the Gospel which of course they didn’t do.  The 7th Circuit reversed the District Court concluding that Barker and Gaylor were never denied the parsonage exemption because they never asked for it.

The 7th Circuit reasoned that without a request by Barker and Gaylor there could be no denial.  And absent any personal denial of the tax benefit, Gaylor and Barker’s claim amounted to nothing more than a generalized grievance about107(2)’s unconstitutionality, which does not support standing before the Federal Court system.  Citing Lujan v Defenders of Wildlife 504 US 555 (1992),   the Court agreed argued that a Plaintiff raising only a generally available grievance about government does not state a Constitutional Article III case or controversy.

But Gaylor and Barker argued further that they are in fact similarly situated to preachers of the Gospel receiving the107(2) exemption because they too receive a housing allowance from the company they work for.  The only reason they argue that they cannot take advantage of 107(2) is that they are not ministers of the Gospel but executives who are employed by Freedom From Religion. The 7th Circuit rejected this reasoning because there was still no injury to Gaylor and Barker since they had never tried to take advantage of 107(2).  The preachers of the Gospel actual had claimed the exemption, but Gaylor and Barker did not.  Being similarly situated is simply not enough to give standing opines Judge Flaum.

Finally, Gaylor and Barker argue as they did successfully before the District Court that for the 7th Circuit to require Gaylor and Barker to “claim the exemption” and wait for the IRS to deny their claim would serve no useful purpose and only delay the inevitable outcome in the case citing:  Freedom from Religion Foundation, Inc. v. Lew, 983 F. Supp. 2d 1051, 1055–56 (W.D. Wis. 2013).  The 7th Circuit however disagreed with District Court concluding that the US Constitution does not allow Federal Courts to hear suits filed by plaintiffs who lack standing, and standing is absent here with Gaylor and Barker because they have not been personally denied the parsonage allowance.  Finally, because the Plaintiffs did not have standing to challenge the parsonage exemption, the 7th Circuit, remanded the case back to Judge Grabb instructing her to dismiss the complaint for lack of jurisdiction,.

So what does this mean for all you Preachers of the Gospel out there? Since there has not yet been an Appeals Court ruling on the merits of this case, you can be sure there will be further attempts by Freedom From Religion type organizations to have the Parsonage Exemption ruled unconstituational.   Until then, please have your tax attorney continue to exclude your parsonage allowances from your taxable income under IRS Code 107 with written contemporaneous explanations included in your personal tax return before your file with reference to the ongoing Constitutional issues.  Finally as these cases ultimately wind their way up to US Supreme Court for a final Constitutional determination enjoy the tax free benefit under IRS Code Section 107(1) and 107(2) in my view you so rightfully deserve as  preachers of the Gospel.  God bless you all. Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Many large public businesses have their corporate operations legally headquartered offshore.  For example Apple, General Electric, Pfizer, IBM, and Merck have offshore operations legally sheltering billions of dollars from US income taxation.   However, if any of you individuals or small business owners out there are ever approached with a too good to be true personal tax savings arrangement that involves offshore investing or business operations that result in you personally saving taxes on your From 1040 get a second opinion before you invest in and activate such a scheme.  Once the scheme is discovered by the Government action is immediate and devastating to the promoter of the shelter.  Unfortunately in many cases you the taxpayer/victim are accused of tax fraud as well resulting in severe civil fraud penalties in addition to all the additional income tax you owe.  So if you have money offshore right now or are thinking about a plan that purportedly legally allows you to send money offshore, please stay with us here on TaxView with Chris Moss CPA Tax Attorney to give you a fair warning that such schemes lead nowhere but to large civil fraud penalties and in some cases criminal Government tax investigations.

Big and small business have always been able to operate abroad and save taxes.  But owners of closely held businesses are not legally able to take advantage of these provisions.  In fact Americans are taxed on worldwide income regardless of whether or not the funds are deposited to a foreign bank in a tax free haven. Unfortunately there are many taxpayers out there who don’t know that these schemes are illegal, like Stanley and Ruth Alexander who were in US Tax Court over this very issue in Alexander vs IRS T.C. Memo 2013-203.

The facts are very complex in this 71 page Opinion.  Dr Alexander, a plastic surgeon, used offshore tax strategy to lease back his medical services to his professional Ohio practice.  Alexander met attorney Reiserer from Seattle who reviewed offshore employment leasing with Alexander.  There were numerous doctors who were well versed through seminars in the Bahamas about this strategy. Reiserer and a CPA Kritt “structured, implemented and managed” the offshore strategy for tax year 1996-2003 for Alexander.  In 2003 the IRS initiated a criminal investigation of Kritt.  Kritt was charged with criminal tax evasion, but Kritt was found not guilty by jury of any criminal misconduct.

As a result of the Kritt criminal investigation, Alexander and hundreds of other doctors were audited by the IRS for years 2000-2002 and were accused of substantial understatement of income and tax fraud.  Alexander appealed to US Tax Court in Alexander vs IRS US Tax Court (2013).  Alexander claimed the offshore strategy was to create retirement for his family.  The Government argued that the motivation was avoidance of tax as there was no meaningful economic substance to the strategy.  Judge Goeke on Page 45 of the Opinion opines Alexander relied on Krit and Riserer and Alexander had limited ability to understand the tax law.  As the case unfolds the Court seems to have sympathy for Alexander who “placed a great deal of reliance on Kritt”.  The Court concludes that Alexander did not possess the education that would allow him to know he should have reported additional income”. Page 50.  IRS loses on tax fraud, but IRS wins on understatement.

Our next case involves Dr Child in Child vs IRS T.C. Memo 2010-58.   The facts are relatively simple.  Dennis Evanson designed organized and promoted schemes to shelter income from taxation.  He was ultimately convicted of Federal income tax evasion by a jury in 2008.  All of Evanson’s tax evasion schemes used sham transactions to transfer clients’ untaxed income to offshore entities that Evanson created and controlled.  The funds were typically returned to his clients disguised as disbursements from fictitious loans to avoid taxation.

Dr Child was a highly compensated radiologist who met Evanson at a party.  Evanson helped Child and hundreds of over doctors create a tax evasion scheme which allowed a fictitious offshore insurance company to providing insurance coverage for Child. Premiums were paid and deducted on Child’s tax returns from 1997-2003.  The IRS audited not only disallowing over $280K of deductions but  claimed Child was guilty of tax fraud as the whole scheme was nothing but a tax avoidance sham transaction lacking any economic substance. Child appealed to US Tax Court in Child vs IRS US Tax Court (2010). Judge Kroupa concluded that indeed Child fraudulently intended to evade taxes and this was liable for additional fraud penalties under Section 6663 of the IRS Code which increases the penalty by 75% of the tax owed. IRS wins and Child loses on fraud under IRS Code Section 6663.

If you lose on Fraud you owe additional 75% of the tax owed, a lot of money for most of us.  So why did Child lose on Fraud but not Alexander?   The law says you commit tax fraud if “badges of fraud” are present:  you have inadequate records, you participate in the promoter’s scheme to mislead the Government, you give implausible explanations of behavior to conceal the fraud, you file false documents, and you fail to respond to subpoenas.  Finally you don’t cooperate with the Government. Judge Kroupa in Child argued that “most of the badges of fraud upon which this Court relies were present in Child”. Page 23.   Judge Goeke didn’t feel that way with Alexander and so Alexander did not have to pay the 75% fraud penalty.

In conclusion, if you are a small business owner who attends a seminar on offshore investing schemes, simply say no.  There is no legal tax strategy for individuals and small business owners to keep their offshore earnings from being reported on their personal tax return Form 1040.  Unless you are willing to give up your US Citizenship and leave the country there is simply no legal way to avoid paying personal income taxes by keeping your earnings offshore.  Work within the system to change the tax to perhaps a flat tax or national sales tax, but say no to offshore tax schemes.  You will be happy you did when the IRS comes knocking on your door for an offshore tax audit.

Thank you joining us on TaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView.

Kindest regards

Chris Moss CPA Tax Attorney

IRS Crummey Gift Tax Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Do you all own a family business and want to start the process of transferring ownership to your children without getting hit with large gift and estate taxes? 
Best practice suggests you consider gifting to your minor children, or if you are the older children, have your parents or grandparents gift to you a Crummey Trust membership through your Family Limited Liability Company. The “Crummey” Trust”, named for Crummey 397 F.2d 82 (9th Cir 1968­) is a great way to get tax deductions, have your children receive annual Family LLC memberships, reduce your estate tax and have the family work together in a unified and protected Estate Plan. But danger lies ahead during an IRS Estate tax audit after you die or an IRS Gift tax audit before you die claiming if you died the gifts were not irrevocable, or while you are still living that the Trust should be subject to gift tax by disallowing the tax free exclusions. Either way you lose unless you are structured correctly. So if you are interested in winning for you your family, stay with us here on TaxView with Chris Moss CPA Tax Attorney to learn how to fight back during an IRS Crummey Trust audit so you can win, save taxes, and keep your assets in the family business safe and protected from harm for many generations to come.

Current gift tax law allows exemption for a Husband and Wife to gift tax free $28,000 to a Crummey Trust owning a membership in the Family LLC to each child in 2015. Named after taxpayer Crummey, the Crummey Trust accumulates the $28,000 tax free exemption year after year in a protected irrevocable trust by giving your children the right to demand immediate distribution of exemption. This is exactly what Crummey did in 
Crummey vs IRS 397 F.2d 82 (9th Cir 1968).

The facts are simple.  Husband and Wife Crummey each gave in 1962 their 4 minor children $3000, the exemption at that time, or $12,000 total to an irrevocable trust.  The IRS audited and disallowed the Trust claiming that the gifts to minors were nothing more than disguised future interests disallowed under then IRS Section 2503(b).  Crummey appealed first to US Tax Court and next to the US Court of Appeals for the 9th Circuit 397 F.2d 82 (9th Cir 1968).

District Judge Byrne frames the key issued presented as whether or not a present interest was given by the Crummey’s to their minor children so as to qualify for the exclusion under 2503(b).  The Court looked to California law to determine if the children had the right to demand distributions from the Trustee. The Government said if the children can’t sue under California law they can’t demand the trust assets under California law.  The Crummey’s said if the children can own property under California law they can indeed demand the trust assets under California law.

The Court took particular interest in George W Perkins 27 T.C. 601 (1956) where the Court said that where the parents were capable of asking the Trustee for the assets on behalf of the minor children in order for the children to have the “right to enjoy” the assets and there was no showing that the demand for funds from the children via the parents could be resisted under State law, then the gift was a present interest.  The Court in my view did not clearly have an easy answer, but in the end ruled that under Perkins, the “right to enjoy” test is preferable.  Crummey win IRS loses.

Where is Crummey trending in 2015? Let’s take you all as an example:   In 2015 you and your wife irrevocably gift $28,000 to each of your 3 children ages 5, 7 and 9 and give at this level for 5 more years.  If structured through a Crummey Trust your gifts would be $84,000 per year or $420,000 after 5 years all tax free.  Further suppose your $28,000 irrevocable gift to each child was an LLC membership interest.  With a 35% discount applied to each membership gift for lack of marketability your tax free gifts to 3 children for 5 years would be $630,000.

The Mikel family set up this kind of trust in 2007 with one exception:  The Trustee had final and conclusive power to assist the children with “Life Changing Events”, like reasonable wedding costs, the cost to purchase a primary residence, or costs of starting a new trade or business.  Finally the Trustee had power over the children’s expenses in connection with their health, education, maintenance and support.  The IRS audited Mikel and disallowed the gifts to his children claiming they never were gifted a “present interest in the property” that is an unrestricted right to immediately use the gifts, citing Regulations 2503-3(a) and 2503-3(b) particularly in light of the special “Life Changing Event” powers granted to the trustee.  Mikel appealed to the US Tax Court Mikel v IRS, US Tax Court (2015).

Mikel argued and surprisingly IRS conceded that each of the children received a timely and effective notice of their right to withdraw the maximum annual exclusion.   Both the Government and Mikel further agreed that the trust declaration stated unequivocally that upon receipt of a timely made withdrawal demand, “the Trustees would have to immediately distribute to the children the property allocable to them.” The IRS finally also conceded that the declaration put forth by Mikel in the Crummey Trust did in fact afford each beneficiary an unconditional right of withdrawal.

However the Government not to be outdone, argued vigorously that the children did not receive a present interest in the trust income and corpus because their rights of withdrawal were not legally enforceable in practical terms.  That is the children’s right of withdrawal was “legally enforceable” only if the children could go before New York State Court to enforce their rights and that such an action by the children was not likely to happen considering the special powers for life changing events granted to the Trustee.

Judge Lauber’s thoughtful Opinion acknowledges that the Mikel trust was indeed a Crummey Trust citing Crummey v Commissioner 397 F.2d 82 (9th Cir 1968) with a substantially similar demand clause providing that whenever an addition was made to the trust, the children or their guardian could demand immediate withdrawal of an amount equivalent to the maximum annual exclusion as required by Section 2503(b). The Court further noted that even though the IRS expressed its general agreement with Crummey citing Estate of Cristofani v IRS 97 Tax Court 74 (1991) it appeared to the Court that the Government was challenging Crummey power only when the withdrawal rights are not in substance what they purport to be in form.  Judge Lauber nevertheless opined that the Government’s claim that the withdrawal right of Mikel children was illusory was flawed.  The Court went on to conclude that the Mikel children under New York law could seek justice to enforce the provisions of the Crummey Trust regardless of the special powers of the Trustee for “Life Changing Events”.  The Court therefore found that under New York law withdrawal demands by the beneficiaries could be in fact legally enforced citing Crummey. Mikel wins, IRS loses.

What does this mean for all families with a small business who want to gift Crummey assets to their young children to take advantage of the $28,000 per year gift tax exclusion?  First, create your Family LLC with your wife as your partner each donating your share of the family business into the Family LLC.  Second, for each subsequent year gift your children Family LLC discounted membership interests to the maximum exclusion $28,000 in 2015 through a Crummey Trust.  Third, make sure your Tax Attorney gives the children the absolute right and power under State Law to withdraw their interests.  Fourth, by the time your children are in their late teens and early 20s you should have successfully used the Annual Exemption and the Lifetime Exclusion to perhaps have your Family LLC owned by a Spousal Lifetime Access Trust (SLAT) with your wife as Trustee and Beneficiary and your children as successor beneficiaries  to further protect your tax free transfer from not only an IRS Estate Tax Audit, but to protect in a spend thrift clause from potential creditors as well.  Finally have your tax attorney prepare for you a written opinion that she will file your tax returns and represent you when and if the IRS should audit disallowing your Crummey Trust.  Include your Crummey Trust in your tax returns as a contemporaneously prepared PDF file before you file your returns.   Rest assured your Estate Plan is safe, secure and protected from IRS audit many years later.

Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView.

Kindest regards,

Chris Moss CPA Tax Attorney

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Domestic Asset Protection Trusts (DAPTs) and Spousal Lifetime Access Trust (SLATs) appear to be best practice in 2015 for Asset Protection and Estate Tax Reduction. The SLAT, which is nothing more than a DAPT for a family allows your Husband Grantor Settlor to appoint you his Wife as both Trustee and Beneficiary with your children appointed as successor Beneficiaries. If your SLAT becomes a member of the Family Business LLC you have an ideal estate tax reduction, asset protection, and additional annual income tax savings all created in an almost “too good to be true” legal tax structure and foundation. Are in fact DAPTs and SLATs too good to be true? Some feel the IRS is just waiting, patiently I may add, until you die to audit your estate and disallow the entire SLAT arguing before the US Tax Court that the SLAT corpus never legally left the Estate. So if you are interested in setting up a SLAT, stay tuned to TaxView with Chris Moss CPA Tax Attorney to find out how to take advantage of these new Domestic Asset Protection Trusts without losing your advantage during an IRS SLAT Audit soon to be coming your way.

So what is a SLAT?  A SLAT is an irrevocable DAPT established uniquely for a married couple, in many cases with children who ultimately become successor beneficiaries under newly enacted Sweet 16 State Protection Trust laws that allow the SLAT Husband Settlor Grantor to irrevocably gift his assets to his Wife, Trustee and Beneficiary with all lifetime distributions being made according to “ascertainable standard” as per IRS Code Section 2514, and IRS Code Section 2041 and Sweet 16 State laws, relating solely to the health, education, support or maintenance of in the case of a SLAT, your wife, both Beneficiary and Trustee. As Grantor Settlor you must make absolutely certain that you do not retain a life estate of any kind whatsoever in the Trust Corpus or Income Distributions in violation of IRS Code 2036.  If you flawlessly insert a Spendthrift Clause in the Trust documents exactly according to State Law, and then finally appoint a non-family member Trust Protector or Co-Trustee you have what some would consider a “too good to be true” Estate plan.

The “too good to be true” folks out there may very well remember that prior to 1997, State Court Common Law for over 100 years held that these kind of Domestic Asset Protection Trusts were unenforceable and void against public policy.  Yet one State legislature after another have in the last 20 years codified Trust Fund laws making legal what the Courts in Equity have prohibited.  These DAPT and SLAT friendly 16 States (Sweet 16) Alaska, Colorado, Delaware, Hawaii, Missouri, Mississippi, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming are the only States in my view that you can safely create a DAPT or SLAT with some reasonable assurance that creditors could not reach your SLAT assets.

So what steps can you take to prove the “too good to be true” folks wrong.  First keep your DAPT or SLAT within the “Sweet 16” as Sessions should have done in Rush Univ Med Center v. Sessions, N.E. 2d , 2012 IL 112906, 2012 WL 4127261 (Ill, Sept. 20, 2012) (Rush U).  The facts in Rush are rather simple.  Sessions established a DAPT which irrevocably pledged $1.5M to Rush.  Rush commenced construction in reliance on the pledge.  Sessions however was diagnosed with cancer that he blamed on Rush for failure to diagnose.  He wrote Rush out of his Will before he died in effect voiding the $1.5M gift.  Rush sued the Sessions estate in Rush v Sessions claiming the estate was liable for the $1.5.  Lower Courts grappled with conflicts between the Common law in Equity and the Illinois Fraudulent Transfer Act with the Appeals Court eventually ruling for Sessions.  However, the Illinois Supreme Court reversed noting that Sessions created a DAPT for his own benefit and used the “spendthrift clause” to protect the assets from Rush, a legal creditor.  Justice Thomas further opined that regardless of state statute supporting Sessions, justice and fairness require that Illinois common  law in equity void the “spendthrift clause” of Sessions DAPT and allow Rush to pierce the DAPT and collect their debt.  Rush wins, Estate of Sessions loses.

If you are fortunate enough to live within the Sweet 16 how should you structure the SLAT so that when the IRS audits your SLAT your SLAT will survive intact and protected?  Historically the US Tax Court has looked to States for guidance on whether or not an irrevocable trust is a valid transfer not subject to estate tax of the Settlor Grantor.  For example inOutwin v IRS 76 T.C. 153 (1981), Outwin created various irrevocable trusts under Massachusetts law with Outwin being the sole Beneficiary during his lifetime with family friends as trustees.  The IRS audited and claimed gift taxes were not paid on what the IRS claimed was an irrevocable transfer out of Outwins’s estate. Outwin appealed to US Tax Court inOutwin v IRS 76 T.C. 153 (1981) arguing that he never lost control over the trust because he was the “sole Beneficiary” of the fund assets and therefore no legal gift had been transferred.

Judge Dawson goes further asking whether Outwin’s trusts could be subjected to the claims of the settlor’s creditors under Massachusetts law. Citing Ware v Gulda 331 Mass. 68, 117 N.E.2d 137 (1954) the Court finds that under Massachusetts law Outwin’s trust fails to relinquish dominion and control for gift tax purposes if creditors can reach the trust assets. Concluding there is a strong public policy in Massachusetts common law against persons placing property in trust for their own benefit while at the same time insulating such property from the claims of creditors the Court finds for Outwin.   IRS loses, Outwin, wins.

So in conclusion, to make your SLAT bullet proof against an IRS SLAT Audit, first, make sure you retain a tax attorney who knows his Sweet 16 SLAT law and knows it well. Have that same tax attorney file all tax returns.  Second,  have your tax attorney structure the SLAT so that you Settlor Grantor Husband appoint your wife as Trustee and as a primary Beneficiary receiving beneficial ascertainable standard distributions for her health education support or maintenance in accordance with IRS Code Section 2041(a)(2), (b1) and (b)(2) making sure you Husband Grantor Settlor are not in violation of IRS Code Section 2036 by not retaining a life estate in the Trust corpus or income. Third make sure your SLAT is absolutely protected from Creditors by inserting exact word for word language of the Spendthrift provisions of your State’s Domestic Asset Protection Trust laws.  Finally, Appoint a non-family member Trust Protector or independent Co-Trustee to give you that extra added protection when the IRS comes on over soon after you are gone.  If you stayed married for the duration, on the day of your passing, you can rest in peace knowing your Wife and children are protected from a very likely IRS SLAT Audit coming your way, with your family Business and Estate bulletproofed in a safe and protected SLAT tax strategy and structure for many years to come.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

IRS Charitable Remainder Unitrust CRUT Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Are you planning on a large gift to charity after you die? The Charitable Remainder Unitrust (CRUT) and the Charitable Remainder Annuity Trust (CRAT) as per IRS Code 664 are great tax strategies for charitable giving. The CRUT for example allows you to take an immediate charitable deduction on your income tax return, deferring the actual donation of the remainder of the trust until after your death, but at the same time allowing for you to live off the income of the trust while you are alive. Sounds too good to be true? It’s true, but unfortunately  the IRS  seems to be thinking otherwise, waiting perhaps patiently I might add, until you die only to commence a CRUT Audit with disastrous results for for your children and other heirs at the conclusion of the CRUT Audit.  So if you have already established a CRUT or are thinking about setting up a CRUT stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to bullet proof your CRUT and related tax returns from adverse Government audit action when the IRS CRUT audit team arrives shortly after you have passed.

While the Joint Committee on Taxation has always favored charitable giving deductions, Congress strictly limits the deductibility of the Charitable Remainder of your CRUT on your personal tax return to the present value of the CRUT remainder using a current qualified appraisal, as defined in § 1.170A-13(c)(3), from a qualified appraiser, as defined in § 1.170A-13(c)(5). Section 664(d)(2)(D) requires that the valued remainder be at least 10% of the property’s net fair value on the date of contribution.  After the initial appraisal year IRS Regulations 1.664.1, and 1.664.3 generally with some exceptions allows you to pay to yourself annually not less than 5% of the net fair value of the trust corpus.  Sounds pretty easy, but as Arthur Schaefer’s Estate found out in Schaefer v IRS US Tax Court (2015) there are IRS traps surrounding CRUTS after you die which could make you turn over in the grave.

On February 21, 2006 Schaefer created a CRUT with a slight variation, an exception to the general rule as per Section 664(d)(3)(A). The exception allowed Schaefer to distribute only the trust income for the year but limited by a fixed percentage. Trusts created under this exception are called Net Income Charitable Remainder Unitrusts (NICRUTs). Additionally, 664(d)(3)(B) allowed Schaefer to distribute to himself the current trust income in excess of the fixed percentage to the extent that the aggregate amounts distributed in prior years were less than the aggregate of the fixed percentage amounts for those prior years. Trusts using this provision are Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs) and this is the trust Mr. Schaefer created.

Sure enough after Schaefer died, and after the Estate tax return Form 706 was filed, the IRS came knocking on Schaefer’s Estate door and indeed audited and disallowed the NIMCRUT charitable deduction in its entirety because the trusts did not meet the requirements of Section 664(d)(2)(D) in that the value of each remainder interest be at least 10% of the net fair value of the property on the date of contribution claiming Schaefer used an incorrect valuation method.  Schaefer’s appealed to Tax Court in Schaefer v IRS US Tax Court (7/28/2015).

Judge Buch opined that while the legislative history is rather unclear on this matter, nevertheless Congress gave the IRS the power to issue administrative guidance on the subject of valuing a remainder interest in a NIMCRUT citing Rev. Rul. 72-395, sec. 7.01 superseded by Internal Revenue Bulletin:  2005-34, which includes all the relevant Revenue Procedures including Rev Proc 2005-52, 2005-53 and 2005-54 requiring the remainder interest of a NIMCRUT to be valued using the fixed percentage stated in the trust instrument, regardless of the fact that distributions are limited to trust income. The Court observes that Schaefer was using a rate that was less than stated in the trust instrument. When the Court converted the Schaefer rate to the fixed rate required by IRS regulations the Schaefer NIMCRUT remainder fell below the 10% threshold thereby terminating the entire NIMCRUT. IRS wins Schaefer loses.

A second IRS trap, as Joseph Mohamed found out, is the requirements for a “qualified appraisal” in Mohamed v IRS US Tax Court (2012). Mohamed set up a CRUT in 2003 worth millions with the remainder to go to the Shriners Hospitals for Children.  Mohamed filed his tax returns along with Form 8283 claiming millions of dollars of charity deductions. The IRS noticed this almost immediately and commenced a CRUT audit.  It turns out that Mohamed self-appraised his donations, albeit on the low side, but nevertheless, in violation of IRS regulations requiring a qualified appraisal by a qualified appraiser. Mohammed retained a qualified appraiser, while the audit was ongoing, to perform a qualified appraisal and even though the remainder asset value appraised higher than Mohamed’s charitable tax deduction, the appraisal was performed simply too late to do any good. The IRS invalidated the entire CRUT and disallowed the millions of deductions that Mohamed had claimed as a charity deduction.  Mohamed appealed to US Tax Court in Mohamed v IRS US Tax Court (2012).

The Court reluctantly ruled for the Government in that Mohamed did not comply with IRS regulations. Judge Holmes sadly opines that this result is harsh–a complete denial of charitable deductions to a couple that did not overvalue, and may well have undervalued, their contributions–all reported on forms that even to the Court’s eyes seemed likely to mislead someone who didn’t read the instructions. But the problems of bad appraisals of property was so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions, and we cannot in a single sympathetic case undermine those rules. IRS wins Mohamed loses.

What does this mean for all of us who want to set up CRUT’s?  First, make sure you get a qualified appraiser to do a contemporaneously performed qualified appraisal of the remainder interest property that you are currently deducting as a charitable donation on Sch A of your Form 1040. Complete Form 8283 and attach the appraisal to the tax return in a PDF file at the time you file your tax return. Second, hire the best tax attorney you can find to give you a written opinion that your CRUT, CRAT, NICRUT or NIMCRUT complies with IRS Code 264 and IRS Revenue bulletin 2005-34 including Revenue Procedure 2005-52, 2005-53 and 2005-54.  Give that legal opinion to your children to hold on to as there is a good chance the IRS is out there patiently waiting for your passing. Finally, introduce your children to your tax attorney so they know what to expect after your pass. There is a good chance your Estate be subject to an IRS CRUT audit after your passing, and at least you can rest in peace knowing that your tax returns will survive with your Estate protected and safe from harm’s way.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

Make sure to join us next time on TaxView when we will take closer look at where Domestic Asset Protection Trusts DAPTs and Spousal Lifetime Access Trusts SLATs are trending in 2015.

Kindest regards,

Chris Moss CPA Tax Attorney

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Did you know if you are working and living abroad you can exclude from taxation your foreign income under IRS Section 911(a)? You just have to pass one of two tests: The Bona Fide Residence Test or the Physical Presence Test.  If youqualify under one of these two tests then you are good….that is, until the IRS comes to see you and commences aForeign Income Exclusion Audit. So if you are abroad, or plan to be, and are going to be earning income there, stay tuned to TaxView with Chris Moss CPA Tax Attorney to see what tax traps the Government has waiting for you when the IRSForeign Income Exclusion Audit team comes knocking on your door.  Before you leave town learn how to create the facts and evidence you need to fight back an IRS Foreign Income Exclusion Audit….and win….on TaxView with Chris Moss CPA Tax Attorney.

Americans earning income abroad have since 1926 been allowed to exclude from taxable income under 911(a) but only if they were a “bona fide non-resident” of the United States for at least a year.  To qualify as a “bona fide non-resident” though you also need to establish a residence in the foreign country which is not always the same as your permanent home or domicile and for IRS purposes you must make a valid and timely election under Regulations 1.911-7(a)(2).  This is easier said than done as Ms. McDonald found out in a just released decision from US Tax Court this week in Nancy McDonald vs IRS US Tax Court August 25, 2015 which illustrates how important it is to make a valid and timely election to take advantage of the foreign exclusion.

The facts are relatively complex in that McDonald was living abroad and did not file a tax return in 2009.  The IRS prepared a substitute tax return and then issued a notice of deficiency.  McDonald the filed the 2009 return two years late claiming foreign earned income exclusion.  The IRS audited and disallowed the exclusion claiming McDonald failed to make a valid election under 1.911-7(a)(2). McDonald appealed to US Tax Court in McDonald v IRS US Tax Court (8/25/2015) claiming she made a valid election or in the alternative the election requirements were unreasonable and not specifically authorized by law.

The Court notes the IRS promulgated regulations, even though Congressional law is silent on when and how to make the election.  You can chose from four alternative timing methods to make the election three of which involve Form 2555: 1. Attach From 2555 to your income tax return timely filed 2. Attach Form 2555 with your return filed by amendment. 3. AttachForm 2555 with your the original return filed within one year after the due date and 4. Attach Form 2555 with your return filed after the deadline provided that you owe no federal tax including the exclusion and file Form 2555 before the IRS catches you OR in lieu of Form 2555 print on the top of the tax return “filed pursuant to Section 1.911-7(a)(2)(i)(D).

McDonald argues that if she had simply included on the top of the first page the required statement she would have made a valid election and owe no tax, in effect, that her omission of this statement should be excused because only the regulations, not Congressional law make this a requirement and that the requirements are unreasonable.  Judge Gustafson opines “…it is true that the Code Section 911(d)(9) makes no mention of the timing of the election but rather provides the Secretary shall prescribe such procedures…” The Court therefore concludes that the regulation provides taxpayers with four alternative methods by which they can timely elect the exclusion. The fact that the Secretary could have chosen longer periods within which to permit the election is of no consequence, because the alternative methods with four varying periods are reasonable.  IRS Wins McDonald Loses.

So now that you have made a valid election, as Hermine Dinger found out, you must work for a foreign company or government that has no connection with an American company or business or US Military or US Military Agency.  Hermine Dinger thought she was able to exclude the income earned from ADD, the German authority of the Minister of Internal Affairs that administered payroll for civilian employees of the US Army.   The IRS audited and disallowed her exclusion.   Dinger appealed to US Tax Court in Dinger v IRS US Tax Court (8/ 6/ 2015) claiming she was paid by a German Government office.  The Court easily found for the Government finding that Dinger worked for the United States even though the ultimate source of her income was foreign.

Our final case illustrates how difficult it is to qualify living abroad under Section 911(a), as Joe Evans found out in Evans v IRS US Tax Court (1/20/2015).  Evans worked in Russia in the oil industry and filed tax returns from 2007-2010 prepared by Bradley Borden, a tax professional, claiming that his tax home was Russia.  The IRS audited all 4 years disallowing the foreign earned income exclusion claiming Evans was not a bona fide Russian resident. Evans appealed to US Tax Court in Evans v IRS US Tax Court (1/20/2015)

The Court notes that Section 911(d)(3) carves an exception out in that if a person has a home or an “abode” within the United States during his foreign residency Evans cannot establish that his tax home is in a foreign country, citing Jones v Commissioner 927 F.2d 489 (5th Cir. 1991).   Evans had invariably some connections with the foreign country in which he works, but if his ties to the United States are stronger, we have held that his “abode” remains in the United States citingHarrington v Commissioner 93. T.C. 297 (1989).  Unfortunately for Evans, he still was registered to vote in his home state of Louisiana, possess a Louisiana Driver’s license and had a Louisiana bank account.

Judge Lauber easily finds for the Government showing that Congress limited the benefits of Section 911(d)(3) to discourage folks from incurring duplicative costs of maintaining distinct US and foreign households citing again Jones v Commissioner 927 F.2d 489 (5th Cir. 1991).   IRS wins Evans loses.

In conclusion, if you are planning to work abroad and want to take advantage of Section 911(a) Foreign Income Exclusion, first, before you leave the United States make sure you retain the services of a tax attorney to plan out your tax strategy so that you not only legally elect the exclusion, but you have the contemporaneous evidence created to insert into your next tax return before you leave the country so that the Government will have on record your election.  Second, if in the very likely event you get audited by the IRS retain that same tax attorney to defend you so she can apply the law to your unique set of facts and circumstances that she helped create for you years earlier. Finally sit back and relax wherever you are in the world as you win your IRS Foreign Income Exclusion Audit with a bullet proof protected tax return.

Thank you for joining us on TaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView.

Kindest regards

Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

All business owners at one time or another have had to make a choice between classifying a new worker as an employee or an independent contractor.  For most part in the 20th century these choices were easy to make. But in the 21st century a unique worker has begun to emerge that is somewhere between an employee and an independent contractor, the “Gig Worker” or what some may call the Gigs. While Judge Edward Chen O’Conner v Uber 3:13-cv-03826 ruled against the existence of Gigs, the California Uber case is far from over. Whatever the ultimate outcome in Uber, in my view Gigs are here to stay. What or who are the Gigs and how will they be evaluated during an IRS audit of your business? Stay with us here on TaxView with Chris Moss CPA Tax Attorney to see where Gig law is trending in the 21st century and what you need to do now to protect yourself from an IRS Gig Worker Audit.

So what is Gig and who are the Gigs?  It all started with Uber.  Not only are there now Gig Uber Drivers but Uber like Medicine Gigs called “healers”.  In the last few years we are being invaded and inundated by Gigs.  Unfortunately US tax law has not caught up with the rapid rise of Gigs, who in my view are simply independent contractors being directed by cell phone apps by you all out there to fulfill an immediate need, either providing a service, product or both.

Just so you know, Gig was coined in the early 20th century as slang for a paying musical engagement.  The Urban dictionary now defines Gig as a job that could now apply to contract work in the IT and computer field or any temporary or incidental employment.  However, the Gig has traveled or “Ubered” way beyond even Urban Dictionary’s definition.

In order to best define a Gig and understand the tax law of Gigs or lack thereof, let’s take a look at the 20th century worker.  These folks, our parents and grandparents all worked in a 9-5 job as their primary source of income.  Taxes were withheld and their work was reviewed by the “boss” at a company office.  Independents back in those days were according to the current IRS web site the tradesmen and professionals who earned income from many customers, clients, and patients, such as Doctors, Lawyers, and other self-employed contractors.

In my view Gigs are legally somewhere in the middle between Employees and Independent Contractors.  Gigs come to life when you all click on an Uber app and electronically signal or page a Gig driver to come to your location and drive you from Point A to Point B.  The Gig driver is star rated by the public and develops a “branding” based on those ratings.  Over a few months, each Gig develops a unique brand or “good will” based on their star ratings from folks around the world who have used their services. The legal status of Gig drivers, could be compared to the legal status of Gig Nurses, Gig Landscapers, Gig Fitness Trainers, Gig Pilots, and Gig Dog sitters to name a few.  The fact that Uber supplies the App to us to find us the Gig driver, or HEAL supplies the App to find us the Nurse healer, is not the point.  The point is Uber, HEAL, and all the other service Apps simply put the buyer and seller of the service together electronically, kind of like EBay does. The world wide customer base of the individual Gig “controls” how successful the Gig will be, just like EBay sellers are controlled by their star world wide ratings.

Would anyone claim sellers on EBay are employees of EBay?   The similar question was presented to Judge Chen inO’Conner v Uber 3:13-cv-03826, where the the the Court is grappling with whether Gig drivers found via the Uber app are employees. Unfortunately, because Congress and the Courts have been caught off guard by the rise of the Gigs, the Government during an IRS Gig Worker Audit may be unable to find that middle ground in existing tax law to allow you the business owner to have a no change audit.  So listen up on TaxView with Chris Moss CPA Tax Attorney as you learn how whether or not you win comes down to one simple word: “control”.

The key issues in existing law is “control” over the worker, as in Jones v IRS US Tax Court 2014.   Facts are simple enough.  Jones an attorney hired Tarri’s Business Service (TBS) as an independent contractor owned by his wife Mrs. Jones.  They filed separate tax returns. The IRS audited and claimed TBS was really a disguised employee of Jones and should be classified as an employee.  Judge Goeke easily finds Jones for because Jones did not control the details of TBS work schedule, thereby making TBS an independent contractor.  In other words, Jones did not “control” TBS.  Jones wins, IRS loses.

The facts are just as simple in Central Motorplex v IRS US Tax Court (2014). Central Motorplex (CM) engaged in buying, repairing and selling used autos. Mr. Smith was contracted to pick up and deliver license plates and title certificate as an independent contactor.  The IRS audited and claimed Smith was an employee.  Judge Lauber easily found for the Government because CM assigned Smith tasks, supervised his performance and set his compensation.  In other words, CM was in “control” of Smith. IRS wins, CM Loses.

So what does this all mean for all of us out there who might be paying for Gig services?  While Judge Edward Chen opines in his Order of March 11, 2015 “…it is conceivable that the legislature would enact rules particular to the new so-called “sharing economy..,” the IRS, Congress and the Courts, have yet to recognize the legal significance of the 21st century Gig worker.  So first, for now, our best practice perhaps is to have your tax attorney create standard “Gig Contracts” showing you have absolutely no control over the Gigs.  The easiest way to do this is to allow your Gig to receive public ratings so the public  controls the Gig not your business.  Second, include the Gig Contract in a PDF file attached to your business tax return so that if you are audited years later you will have a document in the tax return supporting your Gig strategy. Finally have your tax attorney standing by with the contemporaneously created documentation, so that when the IRS Gig Worker Audit comes your way you can be confident you will win and save taxes.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

Welcome to TaxView with Chris Moss CPA Tax Attorney

Most of you know the IRS has a 3 years from the date you file your tax return to commence and complete an audit of your tax return and assess you additional tax owed to the Government.   What you might not be aware of is that the Government due to budget cuts now routinely asks you to extend the three year “statute of limitations” to give the IRS more time to complete the audit.  If the IRS asks you to sign Form 872, Consent to Extend the Statute, what should you do?   If you do sign Form 872 you keep the period to assess the tax longer than required by the 3 year statute of limitations.  But if you don’t sign Form 872 the IRS in most cases immediately assesses you a tax and issues you  a 90 day Notice of Deficiency propelling the case into US Tax Court and into the hands of a high priced tax attorney. So if you are not sure what you would do, stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out just how to handle a Government request to extend the statue of limitations in a way that best protects your family and saves you taxes.

IRS Code 6501 prohibits the IRS from “assessing a tax” on your income after your tax return has been filed for 3 years.  This three year statute of limitations enacted in 1918 has worked well for almost 100 years.  But recently agents have told me that due to Federal budget cuts reducing staff the IRS has insufficient time to complete your audit in an expeditious manner within the 3 year period.  So taxpayers are now routinely asked to consent to extend the 3 year statute on Form 872.   Further complications arise as a result of agents trying to comply with a very complex set of internal rules as per this IRS audit manual yet at the same time trying as best they can to finish up a taxpayer audit prior to the expiration of the 3 year window.

In order to best ascertain whether or not to extend the 3 year statute of limitations best practice is to review with your tax attorney how your audit is going.   If you have deductions that cannot be easily and timely documented, but nevertheless know you can at some point provide the necessary documentation the Government has asked for, and you believe the IRS agent is going to need more time to complete your audit examination, you would perhaps want to extend the statute to give the agent time to finish up and give you a no change audit.  On the other hand, if you have given the agent sufficient documentation to support your deductions and the audit is taking a long time to complete through no fault of your own, then you would not extend the statute as long as your tax attorney who prepared and filed your tax return could cost effectively litigate the case in US Tax Court.

Furthermore, for those of you being audited who might have underreported income, there should begin a series of confidential attorney-client privileged discussions with your tax attorney on whether or not you should agree to sign a statute extender on Form 872.  That is because as Williamson’s Estate found out in Williams v IRS US Tax Court (1996) there are exceptions to the 3 year statute, and of particular relevance to Judge Korner is Code Section 6501 (e) which extends the statute 3 more years to 6 years if there is an undisclosed 25% understatement of gross income on your tax return.  Citing Colony v Commissioner 357 US 28 (1958)  the Supreme Court said “Congress manifested no broader purpose than to give the Commissioner an additional 2 (now 3) years in cases where because of a taxpayer’s omission to report some taxable income, the IRS is at a special disadvantage.”  In Williams, the tax return did in fact disclose the understatement so Williams wins IRS loses.

But for other taxpayers who by accident or intention, there is a 25% understatement of gross income that has not yet been discovered by the ongoing IRS audit, best practice in this case might suggest for you not to sign Form 872 and allow the case go to US Tax Court as quickly as possible in the hope to have the audit end sooner than later.  This could have been the case in Connell v IRS US Tax Court (2004).

The facts in the Connell case are very simple.  Thomas and Sara Anne Connell had four small trusts which they used to underreport income on their personal return. This scheme was discovered by the IRS Criminal investigation division.  While a recommendation to prosecute was made by Criminal division, for reasons not known to the US Tax Court no criminal action was ever undertaken.  The IRS then issued Notices of Deficiency which were issued more than 3 but less than 6 years after the returns were filed.  Connell appealed to US Tax Court in Connell v IRS US Tax Court (2004) claiming they failed to report additional income, but they adequately disclosed this by filing the bogus trusts. 

Judge Gale easily brushes aside the Connell argument and rules for the Government citing Reuter v IRS US Tax Court (1985)  requiring that the actual tax returns themselves have to disclose the understatement not some other return or document.  In Reuter there was undisclosed S Corporation distributions.  In Connell it was the trusts.  In both cases the actual 1040 personal tax returns did not disclose the omitted income.  As Reuter points out “the legislative history of the 1954 changes made to section 6501(e)(1)(A) does not suggest looking beyond the face of the return to determine disclosure of an omitted item of income.  So in Connell as in Reuter, IRS wins, Connell loses.

Further complicating understatement of income issues are the growing popularity of larger partnerships as underscored in a recent 2014 report from the US Government Accountability Office to the Senate Committee on Homeland Security.  The report claims the IRS finds it very difficult to audit all these entities within the 3 year statute even if fully staffed with no budget cuts.  What happens if you should file your personal tax return with a K1 that as a result of an audit at the partnership level puts you at risk of a substantial understatement?  If you get audited personally should you agree to sign Form 872 even though you know you might have substantially overstated your basis on various sales from complex partnerships you have an ownership interest in causing you to have a substantial 25% understatement of income?

In fact, this very question was addressed by a divided US Supreme Court in,  US v Home Concrete and Supply LLC, US Supreme Court  566 US_____(2012) affirming 634 F 3d 249.   The facts in Concrete were simple, but existing Federal law as applied to these facts was anything but simple. Here are the facts:  Partnership tax shelters generated losses to Home Concrete.  The losses were a result of an overstated basis which in turn caused a substantial understatement of income.  The question presented to the Supreme Court was whether a basis overstatement on sold property can trigger the 6 year statute under 6501(e) and US Treasury regulation 301.6501(e )(1)(A).  The majority opinion given by Justice Breyer ruled that based on the facts in this case, Congress did not intend to make basis overstatement the same as substantial understatement of “gross”  income subject to the 6 year statute of limitations, thereby in effect overruling the US Treasury regulation.  The reason given by Justice Breyer: “taken literally, “omit” limits the statute’s scope to situations in which specific receipts or accruals of income are left out of the computation of gross income; to inflate the basis, however, is not to “omit” a specific item, not even of profit.”

But Justice Kennedy, Ginsburg, Sotomayor and Kagan strongly dissented arguing that “there is a serious difficulty to insisting, as the Court does today, that an ambiguous provision must continue to be read the same way even after it has been reenacted with additional language suggesting Congress would permit a different interpretation. Agencies with the responsibility and expertise necessary to administer ongoing regulatory schemes should have the latitude and discretion to implement their interpretation of provisions reenacted in a new statutory framework.”   

So what can you do if the IRS asks you to sign Form 872?  Perhaps  you could do the same thing Home Concrete and their tax attorney did when they saw a gray area of the law:  You just might decide not to sign Form 872 and have your tax attorney take the case to US Tax Court and perhaps as did Home Concrete achieve ultimate victory in the US Supreme Court.  So first and foremost if you are asked by the Government to sign Form 872 retain the services of a tax attorney, hopefully the same tax attorney who prepared, filed and handled the audit of  your tax return in the first place, before you make a decision whether to sign Form 872 or not.  Second, make sure you always contemporaneously prepare the documents and records needed to support your tax return in the unlikely event of an IRS audit, and include summary documents in the tax return you file to create the facts and records you need to win an audit.  With a good set of records supporting your tax positions you will hopefully finish up the audit with no adjustments.  Finally, if the audit takes too much time, whether due to Government budget cuts, or for lack of records, make sure you have your tax attorney standing by to help you answer the soon to be asked question by your IRS agent:  Would you please sign Form 872 to extend the statute of limitations on your audit?  If the IRS asks you to sign Form 872, Consent to Extend the Statute, what would you do?  Whether you win or lose may depend on how you answer this question.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney.

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Chris Moss CPA Tax Attorney