How do you decide if an Offer In Compromise is a good way to resolve your IRS debt?

Posted on by katemley

In the past couple of years, the IRS has dramatically changed its formula for calculating the amount a taxpayer must pay to settle a tax debt.  Fundamentally, the changes were favorable for the taxpayer and the IRS appears to better understand that acceptance of an Offer in Compromise likely results in collection of more tax dollars than simply continuing to enforce collection efforts through levies and lien filings.  However, the movement towards a more favorable calculation by the IRS of the taxpayer’s ability to pay, and thus the taxpayer’s reasonable collection potential, has actually been further adjusted in a manner that removes some of the initial excitement about formula changes to Offer calculations.

The basis of acceptance of most Offers in Compromise is doubt as to collectability.  Basically, the IRS performs an analysis of a taxpayer’s financial situation and if the taxpayer’s ability to pay is less than the amount they owe, then the taxpayer could theoretically qualify for an Offer in Compromise settlement.  The ability to pay analysis consists of the calculation of both a taxpayer’s equity in assets and “future income potential.”

A taxpayer’s future income potential for a settlement is typically calculated by performing a monthly financial analysis in which the IRS compares gross earnings to allowable expenses to determine if there is any excess monthly income remaining from which the taxpayer could pay the IRS.  If so, this excess income was historically multiplied by a factor – either 48 or 60, to determine the future income potential portion of a settlement Offer.  The taxpayer would be allowed to multiply the excess monthly income by 48 if the Offer was for a lump sum settlement, and 60 if the payments were to be made over a couple of years.

Recently, a favorable adjustment was made to the multiplier.  Rather than asking the taxpayer to multiply excess income over expenses by 48 for a lump sum Offer, the IRS dramatically adjusted this number down to 12!  And, rather than multiplying by 60 for a short term payment Offer over up to a couple of years, the multiplier was altered to 24! 

This seemed almost too good to be true. And in part, it was. The IRS clarified, through the adoption of guidance in its Internal Revenue Manual, that even if a taxpayer calculates that he or she qualifies under the new formula, the taxpayer will not qualify for a settlement Offer if the IRS could collect the entire debt through establishment of an Installment Agreement over the statutory period of collections, unless there are special circumstances.

What this means is that at the time of analyzing a taxpayer’s situation, it is important to be aware that even though the formula indicates a taxpayer would qualify for a settlement, if the monthly excess income over expenses would retire the debt under the statute of limitations, then the taxpayer is wasting time submitting an Offer.  Furthermore, the taxpayer will be putting the statute of limitations for collection on hold while the defective Offer is under review, and for a period of time after rejection.

Here’s a simple example of how this would work.  Assume a taxpayer owes $50,000 in tax debt.  If the taxpayer just filed the return, the IRS will have 10 years, or 120 months to collect the debt, with exceptions for extensions of time – such as when an Offer is filed. If the taxpayer has no equity in assets, but a financial analysis shows an ability to pay $1,000 a month, the taxpayer might think a lump sum Offer would be a good way to put the debt to rest forever.  Under the lump sum analysis, the future income potential would be $1,000 x 12 or $12,000.  With no equity in assets, this is less than the tax debt and would make this look viable.  Even the short term Offer looks good as the future income potential would be $1,000 x 24 or $24,000.  The settlement would be paid over 24 months, or $1,000 per month.

The reality in the above example is that the Offer will be rejected, absent special circumstances, because the monthly future income potential of $1,000 multiplied by the life of the collection statute exceeds the tax debt as follows: $1,000 x 120 months (or 10 years as the return was just filed) = $120,000.  The exception to this is if special circumstances exist as disclosed on submission of the Offer.  Generally, special circumstances would include creation of economic hardship, or alternatively, compelling public policy or equity factors, such as health concerns or age, could tip the analysis in favor of settlement, in spite of the above.

Fundamentally, and especially because of the fact that the statute of limitations is placed on hold during a lengthy analysis period (several months), a taxpayer has to be careful to review their particular situation so that submission of an Offer in Compromise doesn’t do more harm than good.  If you would like assistance with your tax matter, or the tax situation of a client, please don’t hesitate to contact us.

Final Regulations Issued for Use of Truncated Taxpayer Identification Numbers

Posted on by katemley

New IRS Regulations Aim to Fight Identity Theft Through Use of Truncated Taxpayer Identification Numbers

This week, in an effort to safeguard taxpayers from identity theft, the IRS issued its final regulations regarding the use of Truncated Tax Identification Numbers or (TTINs). The final regulations, published on July 15, are amendments to the Income Tax Regulations and Procedure and Administration Regulations, which allow the tax filer to truncate a payee’s identification number on certain documents. The Service states that the amendments are specifically targeted at reducing the risk of identity theft, which can stem from the use of an employee’s entire identification number on documents.

A “Truncated” identification number simply takes an existing nine-digit identification number and replaces the first five numbers with either asterisks or “X”s so that only the last four digits remain. (i.e. A tax identification number of 99-9999999 would become XX-XXX9999). Because a TTIN is merely a method of masking taxpayer identification numbers that already exist, use of a TTIN does not require the Service to issue any new identification numbers or expend any funds for the taxpayer to be able to use a TTIN. The new regulations allow for TTIN to be used for a taxpayer’s social security number (SSN), IRS individual taxpayer identification number (ITIN), IRS adoption taxpayer identification number (ATIN), or employer identification number (EIN) on payee statements and certain other documents.

Before issuing their final regulations, the IRS ran a pilot program, which allowed certain qualified filers to truncate an individual’s payee identification number on a paper payee statements for Forms 1098, 1099, and 5498. This program ran from 2009 to 2010. In 2011 the IRS extended the pilot program for two more years and modified it by removing Form 1098-C from the list of eligible documents.

In January of 2013, the US Treasury and the IRS issued proposed regulations, in response to the growing threat of identity theft and associated tax fraud. The proposed regulations largely mirrored the pilot program, with TTINs permitted on electronic payee statements in addition to paper statements.

The final regulations became effective on July 15, 2014 and permit the use of TTINs “on any federal tax-related payee statement or other document required to be furnished to another person….” TTINs may not be used (1) on any return or statement filed with, or furnished to, the IRS, (2) where prohibited by statute, regulation, or other guidance by the IRS, or (3) where a SSN, ITIN, ATIN, or EIN is specifically required. Further a TTIN cannot be used by an individual to truncate their own identification number on any statement or other document that they give to another person. This includes an employer’s EIN on a W-2 or Wage and Tax Statement that they might give to an employee, and also an individual’s identification number on either a W-9 or Request for Taxpayer Number and Certification. 

If you have questions about the use of TTINs, please contact our office.

Estate Planning and Charitable Intentions

Posted on by katemley

For many reasons, people are making a greater effort to make sure that their estate plan has an effect on both their own family, and a variety of charities.  The New York Times recently ran a piece entitled In Estate Planning, Family Isn’t Always First by Caitlin Kelly that said as much.  While many still aren’t making an effort to put together estate plans for the efficient administration of asset transfer at death, many, many more are at a higher rate than in years past.

It is mere speculation to think that charities have done a better job educating the populace about the benefits of giving to their organization during and after the recession.  Or, perhaps the advent of tools like Donor Advised Funds such as those offered by Fidelity, T. Rowe Price and Vanguard, have changed the giving landscape.  Regardless, clients seem to be interested in either creating a legacy or benefiting many of the same organizations they worked with closely during life, through their estate plan.

Both the client and the estate planner should have an in depth discussion about who the client is ultimately trying to benefit.  It is critically important for the estate planner to make a proper determination about the ultimate beneficiary of the client’s estate plan.  This is true if the client has a long history of giving to a particular organization, or even if the client decides that an organization is worthy of receiving their assets at death, but has never directly given to that organization.

For the sake of explanation, take this example.  If a client indicates that he or she wishes to benefit the United Way, problems could arise if the estate plan merely transfers assets at death to “United Way.”  Did the client intend to benefit the global organization, or a local chapter of the United Way?  While the answer to this question might seem obvious if the client had a long history of involvement with her local chapter of the United Way organization, it may not be obvious if she deemed them to have a worthwhile purpose that she planned to benefit with a bequest from her estate, even though she did not benefit the organization during life.

A general goal of estate planning is to inject efficiencies into the process of asset distribution at death.  Lack of clarity regarding charitable intent can make estate administration grossly inefficient.  If the Executor of the estate, or Trustee of the client’s Trust is unsure of the exact beneficiary of the estate, he or she may have to seek guidance to properly abide by their fiduciary duty under the law to properly administer the estate.  That fiduciary duty could result in request for Court interpretation of the Last Will or Trust, an inefficient process, to say the least.  The Court process could be both time consuming, and costly to all involved.

It is certainly possible to reduce the likelihood of confusion during estate planning.  A good estate plan drafter should do some homework.  Information from the client should be gathered to find out more about the organization that is to be the recipient of the client’s estate distribution.  There are times when the organization may simply not be a viable recipient of the estate bequest.  While many charitable organizations do great things, some of them are tenuously in existence, at best.  Perhaps one individual effectively runs the charity and if something happened to that person, the entity would shut down.  If this is the case, the estate planner should draft accordingly to allow the Trustee some flexibility. Perhaps the Trustee distributes assets to an alternative organization in existence at death.  Or the bequest lapses if the organization no longer exists.  All of this information can be included in the plan.

To prevent the type of confusion illustrated above in the United Way example, the estate planner should clarify the client’s wishes and investigate the organizational structure of each charity.  It could be that there is one umbrella organization where all funds are directed, but noted as benefitting a particular geographical division of the organization.  Some entities are really an amalgam of multiple regional charities that are loosely held together and merely market together without having a structural entity controlling them. 

Upon investigation, the estate planner should be able to learn how to properly draft the charitable bequest.  That bequest should include the proper legal name of the entity and its Federal Tax Identification number.   It may be helpful to the Executor or Trustee to also include a current address and phone number in the beneficiary designation.  The planner should also include directions regarding what happens if the organization either no longer exists or if it has been acquired or absorbed into a successor organization.  All of these events are very possible, especially when the plan preparation is removed by many years from the date of death.

If you have questions about how you can properly plan for charitable distributions at death, or any other estate planning questions, please contact our office.

Professional Assistance With Long-Term Tax Delinquencies Can Be Key To A Turn Around

Posted on by katemley

If you have experienced a continuing struggle with handling your ongoing employment and income tax filings and payments, you may be facing the stark reality that managing these obligations is getting more and more difficult.  Some businesses have operated off the premise that the federal and state government will perpetually respond to their tax problems in a certain way.  That response by the government, through a series of notices, delayed responses, and payment plans, is changing faster than ever.  This is especially true at the state level.  Businesses should not make what was once predictability of tax collections by the government a part of how they manage their ongoing business expenses.

While the government may not upgrade their technologies as quickly as the private sector, the actions being taken are making a difference in closing the Tax Gap. This is true at the federal level and even more so at the State level.  As Bloomberg Business Week reports, states are taking much more aggressive action to capture lost sources of tax revenue.  States are using better resources of data collection along with other enforcement tools to prevent businesses, large and small, from operating in a non-compliant tax status.

From a business perspective, the stark reality is that there are some businesses on the fringe of existence that may simply be forced to cease operations as the tax collection activity described here intensifies.  It’s my opinion that this is not necessary.  Rather, if these businesses spend less time juggling some of these obligations and direct their time towards the expertise they have related to their primary business function, their likelihood of success is much greater.  We have seen the most success for clients who have long-term tax delinquencies when that client acquires proper legal and accounting assistance.  For a long-term problem, a long term solution is necessary. 

Certified Public Accountants and other tax return specialists can provide a level of service that is invaluable to any business.  Assistance from a tax lawyer can be an important tool which allows for a delinquent taxpayer to create a long term plan for tax debt resolution which is then executed upon by the taxpayer, its accountant and lawyer.  Most clients find that the support of professionals that can readily provide expert guidance on stressful tax matters are invaluable.  The relief provided to the business owner typically gives them the breathing room they finally need from a stressful situation to focus on the reason they entered their business to begin with.  It is highly rewarding for the tax lawyer and accounting professional to observe this process.  No business operation will ultimately succeed with the passion of its owners for the services or products it provides. 

As a tax lawyer I have observed that the combination of a Certified Public Accountant or other tax return professional with the guidance of a tax lawyer is a highly beneficial combination for a delinquent business taxpayer.  The reality is that the Certified Public Accountant or tax return professional likely has all the expertise to resolve these issues, but due to the reality of the tax season, that person lacks the time to provide the level of assistance demanded from a Revenue Officer or other collection agent.  Without the obligations of providing return preparation services for clients, I have found the ongoing demands of dealing with delinquent tax matters for clients to be manageable. 

Ideally, the long term is a viable business with a plan to manage ongoing tax obligations while addressing delinquencies in a manner that does not effectively shut down the business.  Once that plan is in place, the taxpayer’s Certified Public Accountant or return preparation professional can provide services to manage current tax filing and payment obligations.  Should the government return for review of the client’s ability to address the tax delinquencies, the tax lawyer can return to representation to assist with that issue. 

As a business owner with a long term delinquency a critical perspective to have when acquiring professional assistance is that there is no “quick fix.”  A multi-year problem will likely take many months, if not years, to resolve.  But it can, and does, happen.  Feel free to contact us to discuss these issues if you have them.

Income Tax Consequences of Terminating a Whole Life Insurance Policy

Posted on by katemley

The United States Tax Court just handed down a decision in Black v. Commissioner of Internal Revenue, T.C. Memo 2014-27, that explains what the income tax consequences are when this situation occurs.  In the opinion, the taxpayer had been the owner of a whole life insurance policy for over twenty years.  The policy had both cash value and loan features.  The policy allowed the taxpayer to borrow up to the cash value of the policy.  Loans from the policy would accrue interest and if the policy holder did not pay the interest then it would be capitalized as part of the overall debt against the policy.

The taxpayer had the right to surrender the policy at any time and receive a distribution of the cash value less any outstanding debt, which could include capitalized interest.  If the loans against the policy exceeded the cash value, the policy would terminate.  In this case, the taxpayer invested $86,663 in the life insurance policy, his total premiums paid for the policy.  Prior to the termination the total the taxpayer had borrowed from the policy was $103,548, however with capitalized interest over time the total debt on the policy was $196,230. The policy proceeds retired the policy debt at termination.

The taxpayers in this case were issued a 1099-R showing a gross distribution of $196,230 and a taxable amount of $109,567.  The non-taxable difference of $86,663 was the taxpayers’ investment in the policy – premiums paid. None of the information was included on the taxpayers’ return.  The taxpayers eventually amended their return and included as income the amount of $16,885 which represented the difference between the loan principal amount borrowed of $103,548 and the amount of premiums paid of $86,663.  Ultimately, the IRS disagreed with the taxpayers’ representation of the tax consequences of the life insurance policy termination.

The primary issue in the case then centered around whether or not the capitalized interest from the outstanding policy loans should be included in income. The Court explained that the money borrowed from the policy was a true loan with the policy used as collateral.  There were no income tax consequences on distribution of loan proceeds from the insurance company to the taxpayers.  Further, the Court explained that this is true of any loan as the taxpayers’ were obligated to re-pay the insurance company the debt owed.

The Court explained that when a policy is terminated then the loan is treated as if the proceeds were paid out to the taxpayers and the taxpayers then retired the outstanding loan by paying it back to the insurance company. The Internal Revenue Code provides that proceeds paid from an insurance company, when not part of an annuity, are generally taxable income for payments in excess of the total investment.  The insurance policy at issue treated the capitalized interest as principal on the loan. Therefore, when the policy is terminated, the loan, including capitalized interest, is charged against the proceeds and the remainder is income. This outcome makes sense or else the return on investment inside of the policy would never be taxed.

The taxpayers ended up with a large tax bill and a tough pill to swallow.  Ultimately, the result is logical in the context of capturing deferred income tax consequences.  Clearly, it would have been beneficial for the taxpayers to have consulted with counsel prior to preparing their tax return in order to avoid an unwelcome tax bill, penalties and interest.

Should you have transactions that you are unsure of when it comes to their income tax consequences, feel free to contact our office.  If you find yourself in receipt of an adjustment to your tax return based on exam action that you disagree with, or an assessment has been made and you have simply decided you were incorrect in your analysis, call us, we can help.

Brand Protection through Trademarking for your Brand

Posted on by katemley

Many producers spend a lot of time creating a marketable image for their products through innovative images, label designs and catch phrases.  As a producer you hope to stand out based on the sensation of taste.  However, to get the consumer to the point of enjoying what you have created, it is likely that you will need to convey your craft through images, designs and marketing tools that create a brand which represents your hard work – namely the wine, beer or distilled spirit that is the ultimate product you sell.

Since your brand image will represent the beverage you create, and ultimately your business, it is important to make sure that it is protected.  In some ways protecting your actual product is a bit easier than protecting your brand because you have the ability to set up procedures that are only known internally for production of your beverage.  Your graphic design, logo, or tagline is intentionally placed into public view.  As a matter of fact, you want it in front of as many people as possible! 

As you become more successful, there is a higher likelihood that an individual or business will seek to “borrow” some of your hard work to create their own success.  However, what you have created as your brand image is actually an intellectual property right that is protected under the law of the U.S. and many foreign countries.  When someone else uses this property without proper permission, which usually comes in the form of a license, they are basically stealing from you and subjecting themselves to liability.

In order to protect your brand, you need to properly register your trademark.  So, what is a trademark?  The U.S. government describes a trademark as a word, phrase, symbol, or design, or a combination of these, that identifies and distinguishes the sources of goods of one party from those of others.

Many may be surprised to learn that a trademark interest is not created when you register with the federal government.  The trademark is established by using the mark in commerce.  The longer that you use it, the stronger your claim to it becomes. However, if you are looking to establish the highest level of protection, then your goal should be to register the mark with the United States Patent and Trademark Office (USPTO). This registration will do the following:

  • Create a legal presumption of your ownership of the mark and your exclusive right to use the mark nationwide on or in connection with the goods/services listed in the registration;
  • Put the public on notice of your claim of ownership of the mark;
  • Place a listing in the USPTO’s online databases;
  • Provide the ability to record the U.S. registration with the U.S. Customs and Border Protection Service to prevent importation of infringing foreign goods;
  • Provide you with the right to use the federal registration symbol “®”;
  • Create the ability to bring an action concerning the mark in federal court; and
  • Create the use of the U.S. registration as a basis to obtain registration in foreign countries.

You will want to begin the process of registering your mark as soon as you know what your mark is and how you want to use it.  It is not necessary for you to be using the mark in commerce at the time you begin the registration process.  As long as you know that you will be using the mark in commerce in the next few years, you will be able to take priority over any other person or entity that files after you, even if your basis for the mark is an intent, rather than actual use in commerce.

It is also important to work through your brand protection issues early because you may be infringing on the intellectual property rights of another business.  Proper registration of a trademark with the USPTO should start with a trademark search to determine if there are any immediate conflicts with your preferred mark.  The USPTO will only register unique marks.  The examining attorneys at the trademark office will not allow for registration unless your mark is unique.  Therefore, it is important to perform a search before submitting your request in case there is an immediate, identifiable conflict.

If in fact there is a conflict, it may still be possible to utilize the mark.  One of two things could happen.  Either you perceive a conflict and proceed to register your mark in the hopes it will be deemed unique and registered. Or, you approach the owner of the mark with a proposition to either purchase the mark from them if they no longer wish to use it, or you could purchase a license from them to use the mark in some manner while paying them a fee to do so.  Should you be able to purchase the mark from them, then you will want to properly record your “Assignment” of trademark with the USPTO.  There is a process for this and it will allow you to become the proper owner of the mark.

When you apply for your mark, it will be necessary for you to determine what good you are trademarking, as each good represents a separate mark. The USPTO will allow you to register one type of good, based on a description from the International Schedule of Classes of Goods and Services, for one fee.  However, the specific item of goods must be listed.  So, for example, you may want your logo to be a registered mark and use it on both your beverage container and also on an item of clothing – these would technically be two separate marks that carry two registration fees.  However, there is the possibility of listing multiple items of goods to be covered in any one class that will have a single fee.  So, if you intend to sell merchandise in your tasting room with your logo and that merchandise falls within the same class – such as shirts and ball caps do for clothing, then you will simply have one trademark to register.  It will be necessary to carefully describe the goods in which you intend to place your mark.

It should be refreshing to know that your business has the opportunity to grow and develop a recognizable brand image that can be protected in the marketplace.  It would be our pleasure to answer any questions you may have about trademarks, or assist you with proper protection of your brand. 

Why do I have to owe over $10,000 to get help with my IRS tax debt?

Posted on by katemley

Everyone has seen on television, or heard on the radio, advertisments for assistance with owing the IRS back taxes.  Turn on the TV late at night to watch reruns of your favorite show and you’re bound to see at least one. But they all have that caveat, saying that you must owe the IRS over $10,000 for them to help you, but why?

The fact of the matter is that you don’t need to owe a certain amount to have representation to assist with your tax debt – at least not from our firm.  If you listen to the television or radio you would think that there is no way to help someone who owes less than this amount.  Most of the businesses that advertise in this way are looking to submit a settlement proposal, known as an Offer in Compromise, to the IRS on your behalf.  This may or may not be possible, but generally that is the only service these businesses provide.  What they know is that due to the manner in which the IRS settles debt, it is nearly impossible to settle a small tax debt.  However, here are several situations that our office sees frequently where taxpayers have a small tax debt, but still need help sorting through their options to come into compliance:

  • Sometimes a client may owe the government a small amount, but has unfiled returns and is preparing to file bankruptcy to discharge health care debt or other obligations.  The bankruptcy code requires the taxpayer to file their last three returns in order to qualify for the bankruptcy.  After filing, the client anticipates owing more.  Perhaps that is a small amount or a large amount.  Regardless, this client needs help with those taxes because they will not be discharged in the bankruptcy.
  • A client may owe a small amount based on a return filed by the government – known as a Substitute for Return (SFR).  However, the client will owe much more later when a proper return is filed.  This can happen when a client is self-employed and receives a few 1099’s that comprise a small amount of the taxpayer’s overall revenue.  Once the return is properly completed, there may be a different picture.
  • Sometimes a client owes tax debt that their spouse created and it is simply unfair for them to be held responsible for the debt.  That client may want to be relieved from the obligation – no matter how small – through the Innocent Spouse Relief process.  Alternatively, a spouse may be harmed because his or her refund was offset to their spouses tax debt.  In this instance, this client may need assistance filing an Injured Spouse claim.
  • A client may have a few thousand dollar tax debt created by automated Exam at the IRS, but if the client merely pays it or sets up a payment agreement to resolve the balance, the taxpayer may be setting himself or herself up for problems with future tax return positions.  If your expense or other deduction is valid and the IRS disallowed it, it may be worth fighting to substantiate it so you do not create a record showing you agreed with the claim or deduction being disallowed.  Therefore, your representative could make arguments to assist in your exam and protect your position for later.
  • Some clients owe less than $10,000 and are interested in relieving themselves from the burdens of a tax lien.  It is now possible to establish a Direct Debit Installment Agreement and apply for a withdrawal of the tax lien.  There are specific procedures for this doing this must be met to qualify, but it is possible.  As a matter of fact, it is now possible to accomplish this if you owe up to $25,000.
  • A client may owe a small tax debt which was originally much larger and triggered the filing of a tax lien.  Though the debt is paid down, it is preventing the sale of a piece of real estate because there is not enough equity to retire the tax debt at closing.  These clients need assistance with a request to Discharge Property from Federal Tax Lien.  This will clear title to the property and allow for the closing, even though the entire tax debt is not being paid off in full.
  • Some of our clients only owe a couple of thousand dollars, but have many years of unfiled tax returns and anticipate owing much more.  A settlement proposal, Offer in Compromise, may be appropriate.  However, it is impossible to know if that is the case until the taxpayer knows the total owed and a financial analysis is performed which includes a review of income, expenses and equity in assets.
  • A client may need assistance when a wage levy is in place, but the balance on their total tax debt is not larger than $10,000.   In those instance, it is very likely that the taxpayer can be moved to a voluntary payment agreement if all returns are filed.  Even if all returns are not filed, substantiation to the IRS of income and expenses could likely result in a partial levy release to relieve the client of some, or all of the wage levy.
  • If any of the above is similar to your situation, or you have some other tax problem, we will be happy to help you, regardless of the size of your debt.  Just give us a call.

Anticipating a shortfall on your 2013 tax return?

Posted on by katemley

Haven’t seen your CPA since you filed your tax return in early 2013?  Paid the minimum in estimated taxes to avoid being penalized by the IRS? Made approximately the same amount of money in 2012 as 2013? You may have a problem – a tax debt problem. Don’t panic, review all your options before taking drastic action to pay that tax bill.

So what happened? A lot. 2013 brings with it many tax increases for those in higher income tax brackets.  Individuals earning over $250,000 and couples earning over $300,000 will start to lose their itemized deductions. Individuals earning over $400,000 and couples over $450,000 hit the new 39.6% top marginal tax rate.  Additionally, they are subjected to the 3.8% medicare surtax on investment income.  Finally, they lose the personal exemption of $3,900 this year.  These quickly add up.  Capital gains rates have taken a “bump” too for those earning more than $400,000 as a single person and over $450,000 as a couple, from 15% to 20%. 

These new changes may cause some to be surprised when they pick up their tax returns.  Taxpayers who have owed little or none before may find themselves in a situation where they don’t have liquid cash to simply write a check the U.S. Treasury. If you don’t have the cash, the last thing you want to do is take action that increases your 2014 tax bill.  In other words, you wouldn’t want to take an early withdrawal from your IRA or 401(k).  These withdrawals could cause you to incur both taxes and penalties. Further, you want to avoid a cash out of non-retirement assets that drive up your capital gains taxes or cause you to incur other ordinary income tax consequences. 

Perhaps you have access to a line of credit to pay your taxes – either secured or unsecured – such as a home equity loan or line of credit through a bank card. These could carry hefty closing costs if you are trying to establish them for the purpose of accessing cash to pay the taxes. And, home equity loans on average carry a 6% interest rate at this time.  Other lines of credit could carry interest rates in the double digits. A problem with using the line of credit, especially if you don’t have it established, is that it could take time to obtain the cash.  Delay in paying the tax bill could cause further penalties and interest.

One option that you can consider, if you need time, is asking the IRS for a “full pay delay.” It is not uncommon for the IRS to place a 120 day hold on collection action while you acquire funds.  Another option is to establish a payment agreement directly with the IRS.  In many cases, the payment agreement can be established without full financial disclosure and without the filing of a tax lien.  The interest rate at the IRS is actually pretty low, currently about 3%.  Additionally, penalties for failure to full pay your tax bill will accrue.  Regardless, this is another viable option that may very well be your cheapest overall option.

When analyzing this type of situation, regardless of what option the taxpayer chooses to resolve the debt, the taxpayer must plan for 2014 current taxes.  This will be necessary to avoid a similar shortfall like the one in 2013.  So, from a cash-flow perspective, the taxpayer will have to balance some mechanism to retire the 2013 taxes while not creating a new balance for 2014. 

If a taxpayer has a $25,000 shortfall for 2013, that will likely also be the case for 2014.  As such, an increase of greater than $2,000 per month in estimated taxes will be required to close the gap.  This type of foresight is necessary when looking at options to deal with the 2013 debt.

If you would like more assistance with resolving your 2013 tax balances and planning for 2014, please don’t hesitate to contact our office.

How Estate Tax Exemption Portability Provides Relief

Posted on by katemley

Over the past decade the effective estate tax exemption has risen from $600,000 to $5.340 million for 2014.  Of course, there is an unlimited marital deduction that allows one to transfer as many assets as is desired to their surviving spouse at death.  That actually created a problem, which created common estate tax planning needs.  The problem was that each spouse had an exemption, but if all assets passed to the surviving spouse at death under the unlimited marital deduction, then the effective exemption of the first spouse to die would be unused and lost.

A common planning technique used by estate planning lawyers for years was to create a “family trust,” also called a “credit shelter trust.”  Assets would be split between spouses so that outright transfer to the surviving spouse would be avoided.  Then assets owned by the first spouse to die would be transferred to a trust for the benefit of the surviving spouse.  The surviving spouse would not have unfettered access to the funds in this trust, however the funds could be used for the health, education, maintenance and support of the surviving spouse.  This was just enough of a limitation to avoid triggering the use of the unlimited marital deduction.  As such, the exemption of the first to die’s estate would be used, rather than lost.  The effect was to basically double the amount of assets shielded from the estate tax.  Additionally, assets held in the credit shelter trust could grow, and even though they might eventually exceed the exemption amount before distribution after the surviving spouse’s death, they would never be subjected to estate tax at that time.

The above was historically very valid planning.  As the estate tax exemption rose from $600,000 to $1.5 million to $3.5 million and now going to $5.34 million, estate planners found it unnecessary to utilize the credit shelter trust technique as often.  If the exemption was $3.5 million and the total estate was $2.0 million, and the clients were elderly, it wouldn’t be worthwhile to separate assets and establish a credit shelter trust as the exemption of even one spouse would adequately shelter the entire estates of both spouses at the survivor’s death.

Even though the exemption rose, many estate plans have not been reviewed to see if the credit shelter technique is necessary.  Further, many practitioners were very hesitant to assume that the exemption would remain as high as it is now.  With the adoption of the American Taxpayer Relief Act of 2012 (the “Act”), we have stability on the exemption amount and it is tied to an inflation adjustment so it will not take an act of Congress to increase it.

Of even greater importance is that the Act adopted “portability” of the exemption between spouses.  Portability is probably one of the most efficient tax tools created in many years, though there is some room for improvement.  The basic concept is that portability allows the surviving spouse to use the deceased spouse’s unused exemption.  It is now no longer necessary to create a credit shelter trust because you can access the first spouse to die’s exemption by timely filing an estate tax return.  This is the only downside, you may have to file a return simply for the sake of portability.  Nevertheless, this is a simpler and cheaper tool than separating assets and administering a trust for the benefit of the survivor’s life.  Ideally, the government would create an easier way to elect portability than filing an estate tax return.  

From a planning perspective, our office is taking advantage of the opportunity to remove the credit shelter provisions from our client’s estate plans.  This allows for a consolidation of assets.  One objective we always have when preparing an estate plan is to seek to reduce the burden of administration at the death of the first spouse.  There is little reason in many cases to preserve the complex credit shelter provisions of an estate plan and the ongoing administration of that plan until the death of the surviving spouse.  A proactive plan is necessary as it is not possible to “un-do” the credit shelter provision after the first spouse dies.  If you have one of these plans, or have a client that has one of these plans, feel free to contact our office for a review to determine if it is possible to amend your documents to streamline estate administration for the surviving spouse and family.

Trust Fund Recovery Penalties

Posted on by katemley

Certain situations can place an individual at risk of personal assessment for business related taxes, including employment taxes and withheld income taxes.  Congress created the Trust Fund Recovery Penalty to discourage misuse of employee’s tax dollars.  An employer is technically expected to set aside income taxes along with Social Security and Medicare taxes in trust for the benefit of the government.  Ultimately, the employer also pays Social Security and Medicare taxes and submits all taxes to the IRS with the employment tax return.  A willful failure to collect or pay over the taxes by a responsible person could result in an assessment of the Trust Fund Recovery Penalty. This penalty equals 100% of the unpaid income tax withheld, plus the employees withheld Social Security and Medicare taxes.

 If the business owner is the individual assessed with this penalty, it is important to note that the penalty is a separate assessment from the employment tax of the business.   Legally, the IRS could collect both, but as a matter of policy the IRS does not. However, it is entirely possible for the IRS to collect on both debts at the same time, requiring the individual and the business each to come into some form of compliance with a payment agreement or other arrangement.  The IRS policy merely means that the IRS will not collect more than the total employment tax owed by the business.

 In order for the government to assess this penalty, it must substantiate that a person is both responsible for collecting and paying over the taxes withheld to the government and that the person responsible willfully failed to collect or pay these taxes.

 When examining a delinquent business taxpayer, the IRS will look for any and all responsible parties – their analysis does not necessarily focus on a single individual.  A responsible person is a person, or group of people, who has the duty to perform and the power to direct the collecting, accounting, and paying of trust fund taxes. This person may be:

  • an officer or an employee of a corporation, or limited liability company
  • a member or employee of a partnership
  • a corporate director or shareholder
  • a limited liability company manager or member
  • a member of a board of trustees of a nonprofit organization
  • another person with authority and control over funds to direct their disbursement, or
  • another corporation or third party payer

As this list indicates, it is not simply the owner of the business that is at risk for assessment.

 The IRS describes responsibility as a matter of status, duty, and authority. A determination of responsibility is dependent on the facts and circumstances of each case. A responsible person has:

  • A duty to perform
  • Power to direct the act of collecting trust fund taxes
  • Accountability for and authority to pay trust fund taxes
  • Authority to determine which creditors will or will not be paid

The United States Tax Court has ruled that a person can still be held responsible even if he or she has delegated a duty to someone else.  And the Court has ruled that a person may be responsible even though he did not know that the withheld taxes were not being paid over to the government.

 There are certain factors that the Courts have looked at as indicators that a person is likely a responsible person. Here are some examples:

  • Holding the position of an officer or member of the board of directors
  • Having a substantial ownership interest in the business
  • Having the authority to hire and fire employees
  • Managing the day-to-day operations of the business
  • Deciding how to disburse funds and pay creditors
  • Possessing the authority to sign checks or authorize payments on behalf of the business.

Just because a person is responsible, doesn’t mean that they can be assessed.  It is necessary to show that the person acted willfully in failing to collect or pay over the trust fund taxes.  Several Courts have ruled that willfulness does not require a criminal or other bad motive. Rather, the Courts have indicated that a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees is enough to be deemed willful for this purpose.  A responsible person acting with a reckless disregard of a known or obvious risk that trust fund taxes may not be remitted to the Government will be deemed willful.  Merely acting negligently however is not enough to meet the required standard of acting willful.

 If you are put in the position of potentially being assessed with a trust fund recovery penalty, you should be aware that the proposal to assess you does come with appeal rights.  If the IRS employee proposing assessment believes you are responsible and acted willfully, you may administratively appeal this proposal to the Appeals Division of the IRS for review. During the appeals hearing, you have an opportunity to show why you were either not responsible or not willful.

 If you lose on appeal, or do not appeal the proposed assessment, the liability is assessed and the IRS will proceed with collection of this debt no differently than any other personal liability.

 If you are undergoing evaluation as a proposed responsible person for assessment of a Trust Fund Recovery Penalty, or if you need assistance with the Appeal of a proposed penalty or avoidance of collection action for an assessment of a trust fund penalty, do not hesitate to contact our office for further assistance.