In major news for tax professionals, the United States District Court for the District of Columbia has ruled that recent regulations imposed on tax return preparers are not permissible under current federal statutes. This ruling does not affect professionals such as attorneys, CPAs, or Enrolled Agents who were already regulated under Circular 230. The complete Memorandum Opinion is available here:
Expansion and Temporary Changes
The Internal Revenue Service has recently issued guidance expanding eligibility for taxpayers to qualify for the Voluntary Classification Settlement Program (VCSP). In addition to the expanded qualification guidelines, the IRS is temporarily removing a key requirement for acceptance into the program that could provide many employers with a valuable opportunity to reclassify its workers with very limited federal employment tax liability for prior nonemployee treatment. The temporary relief is associated with taxpayers who have failed to properly issue 1099’s to their workers.
The VCSP has been critical given the aggressive nature of worker reclassification at the state level. Many states are seeking to close the gap on unemployment benefit contributions paid by employers versus unemployment benefit payments paid to workers. As the states have had to borrow from the federal government, they have many times incurred additional costs and interest to do so. Several states have increased program activity associated with the recharacterization of 1099 workers to employees. Of course, the contributions to the state unemployment office for re-characterization may not be terribly burdensome, but recharacterization by the IRS becomes much more likely after a state audit and paying inappropriately withheld income taxes, Social Security and Medicare taxes, may very well be too burdensome for the average small business.
The objective of the IRS as set forth in Announcement 2012-45 is to “facilitate voluntary resolution of worker classification issues and achieve the benefits of increased tax compliance and certainty for taxpayers, workers and the government.” In order to expand the program, the IRS has modified it by adjusting the following items:
1) The IRS will now permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate;
2) Clarified guidance that a member of an affiliated group is not eligible to participate in the program if any member of the affiliated group is under an employment tax audit by the IRS;
3) Clarified that a taxpayer is not eligible to participate in the VCSP if the taxpayer is contesting in court the classification of the class or classes of workers from a previous audit by the IRS or Department of Labor; and
4) Eliminated the requirement that a taxpayer agree to extend the period of limitations on assessment of employment taxes as part of the VCSP closing agreement with the IRS.
IRS Announcement 2012-46 temporarily expands eligibility for the program until June 30, 2013. One of the requirements of the existing program is that all 1099s were to have been properly filed for the previous three years with respect to the workers to be reclassified. Many times, this prohibited the taxpayer from qualifying for the program. As such, the IRS will temporarily eliminate this requirement and allow taxpayers who have not complied with 1099 filing requirements to qualify for the program.
If the taxpayer qualifies but is not compliant with 1099 requirements, the taxpayer will pay a greatly reduced employment tax liability for reclassified workers based on the prior year’s compensation. Additionally, the taxpayer will pay a reduced penalty for unfiled Forms 1099 for the prior three years with respect to the workers being reclassified. There will not be any interest or penalties otherwise calculated.
The potential savings from this program along with the certainty it provides are well worth the effort to explore whether or not the taxpayer qualifies. If you require any assistance with a review or submission of an application for the VCSP please do not hesitate to contact our office.
Any business that has more than one owner has an opportunity to use contract law to create expectations for how the business will operate in the event of major life transitions for its owners. All businesses spend time planning how they will generate revenue to maintain their existence. Most businesses even plan for catastrophe through the purchase of a variety of insurance products that can prevent the failure of the business if certain things occur. Many businesses are missing the chance to address several lifetime events that could dramatically affect the operation of the ongoing business. These events are many times a virtual certainty, such as death or retirement, and therefore taking the time to plan should not be perceived as being overly cautious, but rather simply an exercise in prudent long-term business planning.
Many advisors will suggest that executing a buy-sell agreement to create mechanisms to deal with issues such as death, disability, retirement, bankruptcy, forced buy-out, etc. is best done as soon as the business is formed. This advice certainly has credibility and yet is problematic. It is best to draft at least some form of buy-sell agreement to address as many issues as possible early in business operations. However, this document should not be set aside and forgotten until a triggering event occurs. Rather, it would be most useful to review the agreement once a year in the first several years of business operations. If the business is viable, it will grow rapidly in the first few years and decisions made at the outset of operations may make little sense as the business begins to function at a more complex level. Ideally the agreement will be regularly reviewed by the business owners as long as the business continues to function.
Drafting of a buy-sell agreement is essentially a game of “what if?” Discussions regarding what happens when a partner dies, wants to retire, wants to sell his or her ownership interest to an outside party, becomes disabled and cannot continue to contribute to the business in the same way, gets divorced, or files bankruptcy, can all be addressed in the buy-sell agreement. There are endless options for how to deal with each situation and the partners in the business have the opportunity to come to a consensus of personal preference in the contract.
Probably one of the most powerful aspects of the buy-sell agreement is the ability to address the practical issue of funding. Many authorities will suggest that a buy-sell really only works if the instrument is “funded.” In other words, if a partner is required to sell because of certain triggering events, the other partners or the business itself may or may not be able to acquire lending to fund the transaction. The buy-sell agreement creates the opportunity to address this situation by allowing the parties to draft the ability of the buying partner to utilize the selling partner as the lender. The selling partner may be put in a position, either because the buying partner can’t get financing or simply because the agreement calls for the selling partner to providing the financing, to carry a note for payment of the value of the ownership interest. Depending on the circumstance, the parties may not be able to come to an agreement of this sort at the time of the triggering event. The buy-sell effectively acts as pre-nuptial agreement of sorts in that disagreeing owners have made decisions with “cool heads” at contract drafting time, rather than in the heat of a potentially problematic situation. There is no doubt that this creates a beneficial situation for all concerned.
Other funding options may involve the purchase of life or disability insurance that could provide the cash necessary to fund a buyout based on the triggering events of death or disability. A variety of tax and legal issues are associated with the purchase of these insurance products, but all of these issues can be addressed with legal and accounting counsel at the time of drafting to determine what is in the best interest of all contracting parties.
The buy-sell agreement can also be an opportunity to set a value on the ownership interest at the death of an owner for estate tax purposes. If sales of ownership interest will be to family members at death, there will be heightened scrutiny by the IRS of the valuation placed on the ownership interest. Nevertheless, if planned properly, the valuation portion of the buy-sell agreement can have a beneficial effect for estate tax purposes.
If you require a review of your existing agreement or would like to discuss the drafting of a buy-sell agreement for your business, please don’t hesitate to contact us.
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.
The airwaves are inundated with television and radio ads promising delinquent taxpayers an easy solution to their tax problems: the Offer in Compromise. What these ads fail to disclose is that this program has rigorous guidelines for calculating a proper offer amount, and that in recent years, few offers have been accepted by the Internal Revenue Service. Often, taxpayers believe these slick sales pitches and find themselves no closer to a real resolution after hiring an “offer mill” that does not do the proper analysis to determine a correct offer proposal.
Despite the misleading advertisements of offer mills, the Offer in Compromise is a valid program. Fortunately, the Internal Revenue Service has made changes to the financial analysis required by the program to make it easier for taxpayers to participate in the program and settle their outstanding tax debt. These changes include:
Reducing the calculation for taxpayers’ future income
Previously, the IRS would look at 48 months of future income potential for lump sum offers and 60 months of future income for short-term deferred offers. The “Fresh Start” changes have reduced these timeframes to 12 months and 24 months, respectively. The bottom line is that the calculation of an offer has been reduced substantially. For example, a taxpayer with a monthly “ability to pay” of $500 previously would have this amount multiplied by 48 months as part of a lump sum calculation, totaling $24,000. Now, the same $500 ability to pay is multiplied by 12 for the same offer, totaling $6,000. In this example, this change reduces the required offer amount by $18,000—a substantial difference!
Allowing taxpayers to repay their student loans
One of the most common misconceptions taxpayers may have about the Offer in Compromise program is that the Internal Revenue Service will consider all of a taxpayer’s current expenses. This is simply not true. The IRS only considers necessary and allowable living expenses in the calculation of an offer. Often, this results in the IRS having a very different view of what a taxpayer can afford in the context of an offer! By allowing taxpayers to repay their student loans, the IRS is making a concession that student loans may be necessary and allowable, and these payments can be considered to determine a taxpayer’s future ability to pay.
Allowing taxpayers to pay state and local delinquent taxes
Frequently, when a taxpayer is unable to pay their federal taxes, they are also unable to pay their state taxes as well. Because state and local taxing entities do not halt their collection activities when a federal tax debt is present, coordinating resolutions of multiple tax debts can create unique problems for taxpayers seeking to come into compliance with all levels of government. By allowing taxpayers to pay state and local delinquent taxes when calculating an offer amount, the IRS now considers the difficulty of paying federal, state, and local taxes simultaneously. The result is that many taxpayers requesting an offer with the IRS will see a reduction to the final calculation of their offer.
Expanding the Allowable Living Expense allowance category and amount
Previously, the IRS did not allow for credit card payments or bank fees and charges to be allowed as living expenses in the calculation of an offer amount. Recent changes not only allow for these payments to be claimed, but also expand the “miscellaneous” category of living expenses to further account for these common expenses.
These changes to the Offer in Compromise program will give many delinquent taxpayers new hope for resolving their tax matters in a quick and affordable manner.
When spouses file a tax return together, they are held jointly and severally liable for the tax debt. Each spouse is legally responsible for paying the entire liability, including tax, additions to tax, penalties, and interest. Realizing that this may not be appropriate in all cases, the Internal Revenue Service offers “innocent spouse relief” to help spouses in a variety of situations. There are three different types of relief that fall under the umbrella of “innocent spouse relief”:
- Innocent Spouse Relief – you may obtain this type of relief if you filed a joint tax return and the return understated tax that is attributable solely to your spouse’s erroneous item. These items could be income received by your spouse, but not reported on the return or, the items could be incorrectly reported deductions, credits, or property bases attributed to your spouse. The effect of these items, the understatement of tax, would not appear on the return when you signed it. In other words, there was no tax due, or if there was tax due, the item left out and its effect was not shown on the face of the return. You must prove that at the time you signed the return, you did not know, and had no reason to know, that the tax was understated. Finally, when looking at the situation, you must prove it would be unfair to hold you liable for the understatement of tax.
- The next type of relief is known as “separation of liability” relief. Under this type, the understatement of tax, interest, and penalties is allocated between you and your spouse. In order to qualify for this type of relief you must no longer be married to, or are legally separated from, the spouse with whom you filed a joint return. You qualify under this provision if you are widowed. You must additionally not be a member of the same household as the spouse with whom you filed the joint return during the twelve (12) month period prior to filing your application for relief under this provision.
- It is very common for one spouse to seek relief from liability from a tax obligation clearly stated on the face of the return at the time of filing. If the liability is reflected on the face of the return, and not an understatement, then the only way to qualify for relief is through the third type of relief – “Equitable Relief.” In order to qualify for this type of relief, you must establish that taking into account all facts and circumstances, it would be unfair to hold you liable.
There are many factors relevant to relief under this provision. The IRS will consider if you would suffer economic hardship if relief is not granted. The IRS does factor in who is held liable for the taxes under a divorce decree or other agreement to pay the tax – even though the IRS is not bound by these agreements. The IRS will also look at whether or not you received significant benefit from the underpaid or understated tax and whether you knew or had reason to know about the item causing the understated tax or that the tax due would not be paid.
The IRS explicitly takes domestic violence and abuse into account when evaluating claims for innocent spouse relief, especially under the equitable relief provisions. In her most recent report to Congress, the National Taxpayer Advocate explained that “domestic violence and abuse, including economic abuse, have real consequences for tax administration.” See Annual Report to Congress by National Taxpayer Advocate, Most Serious Problems for more details about this issue. The Taxpayer Advocate indicates that about 16% of applicants for innocent spouse relief report that they are victims of domestic violence and abuse. To its credit, the IRS has revised all of its rules regarding review of innocent spouse applications and has expanded the effect abuse will have in determining if relief will be granted to the requesting spouse. The important fact is that domestic violence and abuse is a factor that is being reviewed in more detail than ever by the IRS in the analysis of a request for innocent spouse relief.
By regulation, the Department of Treasury and the IRS established a two year deadline to request Equitable Relief to encourage prompt resolution of liability determinations. Basically, applications for relief under this provision were denied if active collections had been ongoing for more than two years.
On August 8, 2011, the IRS issued Notice 2011-70. The IRS removed the two year rule pending formal alteration of Treasury Regulations. This action was the result of several court rulings that questioned the validity of the provision.
This action by the IRS is important because a somewhat arbitrary rule has now been disposed of and relief can now be granted to otherwise qualified individuals.
It is particularly interesting to note that the IRS included in Notice 2011-70 that those individuals who were previously denied relief under equitable relief provisions solely because of the two year rule, may re-apply for relief.
If you believe that you should be relieved of joint liability with your spouse or former spouse, on a tax return, please contact us. The likelihood for relief is at its highest point given current IRS rules and regulations on this topic.
Over the last few years, the IRS has made numerous efforts to assist individuals and small businesses that are struggling to meet their tax obligations. The IRS intends to provide taxpayers with a “Fresh Start,” as these initiatives have come to be known. The Fresh Start Program is in the “best interest of both taxpayers and the tax system,” reports IRS Commissioner Doug Shulman. The IRS has issued new guidance for lien filings, lien withdrawals, more flexible installment agreements and an expanded offer in compromise program.
Nina Olson, National Taxpayer Advocate, believes that the program has produced real results. In a recent report to Congress she explained that “components of the ‘Fresh Start’ initiative have produced significant changes in IRS collection actions, which in turn have had positive, meaningful results for many taxpayers.”
Major changes were made by the IRS to its lien filing practice. A federal tax lien gives the IRS a legal claim to a taxpayer’s property for the amount of an upaid tax debt. A lien informs the public that the U.S. government has a claim against all property, and any rights to the property, of a taxpayer. This includes property owned at the time the notice of lien is filed and any property acquired thereafter.
A lien will negatively affect a taxpayer’s credit rating. Therefore, the IRS made a decision to reduce the negative impact on taxpayer’s credit by adjusting the level at which the government generally files liens.
Another aspect of the Fresh Start program is a modification of the lien withdrawal guidelines. The IRS realizes that there are significant effects on taxpayer credit when a taxpayer is under an IRS lien. Lending in these circumstances is either extremely difficult or impossible. The effect of the lien on lending was even more detrimental as lending standards tightened during the economic downturn.
Liens will now be withdrawn upon payment in full of the taxes if the taxpayer requests the withdrawal. The IRS has also internally authorized additional personnel to withdraw liens for taxpayers.
If a taxpayer still owes the government delinquent taxes, it may still be possible to obtain a lien withdrawal. If an individual or small business owes the IRS $25,000 or less in unpaid assessments, the IRS will allow the taxpayer to obtain a lien withdrawal if the taxpayer enters into a Direct Debit Installment Agreement (DDIA). A DDIA is essentially an installment agreement where the IRS is authorized to make automatic debits from a taxpayer’s bank account, rather than waiting for the taxpayer to initiate submission of the payment on their own – for example, mailing a check to the IRS.
Likewise, the IRS will withdraw a lien if the taxpayer is already on an installment agreement and authorizes the government to convert their agreement to a DDIA. Some taxpayers already have a DDIA. In this case, they need to merely ask the IRS to withdraw the lien. The withdrawal will occur if the taxpayer meets the criteria above.
Once the DDIA is established, the IRS verifies that the payments will actually be made through the DDIA, then it withdraws the lien. The IRS will not withdraw the lien at the time the DDIA is established – there is a probationary delay.
At the time the IRS established the guidance above, they also expanded some of their criteria for streamlined installment agreements for businesses. Historically, it was only possible to obtain a streamlined payment agreement for a business that owed less than $10,000. This type of agreement generally avoids full financial disclosure to the government and the involvement of a field officer. Now if the business is willing to establish a DDIA they will qualify for a streamlined agreement if they owe up to $25,000. If a business owner owes more than $25,000 in assessed, they could pay their balance down with a lump sum payment to qualify.
More recent guidance has benefited individual taxpayers. In the past, a taxpayer could establish a payment agreement over a 5 year period and avoid full financial disclosure if the taxpayer owed less than $25,000. This cap has now been increased to $50,000 and payments are allowed over a 6 year period. Not unlike the old agreements, the payment timeframe is shortened if the IRS collection statute is less than 6 years. Additionally, in order to qualify for the above, the taxpayer must enroll in a Direct Debit Installment Agreement. These changes will save the taxpayer a significant amount of money and time.
Finally, the Fresh Start program expanded the Offer in Compromise program. The IRS has historically had a streamlined Offer in Compromise program available to taxpayers with lower incomes and debts below $25,000. The IRS expanded the income cap on this to taxpayers with up to $100,000 in income and IRS debts of up to $50,000.
More recently, the IRS adjusted the analysis of Offers in Compromise in favor of taxpayers. They have provided greater flexibility in determining equity in assets. There is also greater flexibility in determining allowable living expenses and a reduction in the amount of future income that must be included for an acceptable offer.
As the National Taxpayer Advocate explained, these changes by the IRS are significantly affecting how taxpayers are subjected to IRS collection efforts. If you are interested in learning whether or not any of theseprograms could help you, we welcome you to contact our office.