Patti Spencer Talks to Fox News on Art Valuation

 

What is the value of a piece of art that cannot be sold? In the case of "Canyon" by artist Robert Rauschenberg, the IRS claims it is worth $65 million. They also want to tax the heirs who now own the artwork over $29 million.  

Last week I had the privilege of appearing on Fox News to discuss the dilemma that taxpayers can face when estate planning basics are overlooked. Click on the image below to watch.

Patti Spencer on Fox News 

Patti Spencer on Fox News


Fair Market Value and Estate Planning

All personal and business assets are subject to an estate tax based on fair market value at the date of death. In this case, deceased art owner Ileana Sonnabend knew that the Canyon artwork she held could not be sold because it prominently features a bald eagle. She had acquired a special permit to continue owning the artwork, but failed to transfer it out of her estate through a charitable donation prior to her death.

Read the New York Times Coverage

Here is an excerpt from a New York Times article on the story.  

Because the work, a sculptural combine, includes a stuffed bald eagle, a bird under federal protection, the heirs would be committing a felony if they ever tried to sell it. So their appraisers have valued the work at zero.

But the Internal Revenue Service takes a different view. It has appraised "Canyon" at $65 million and is demanding that the owners pay $29.2 million in taxes.

"It's hard for me to see how this could be valued this way because it's illegal to sell it," said Patti S. Spencer, a lawyer who specializes in trusts and estates but has no role in the case.

 

The family is now challenging the judgment in tax court and its lawyers are negotiating with the I.R.S. in the hope of finding a resolution.


Read the full New York Times story:
Art's Sale Value? Zero. The Tax Bill? $29 Million.

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Understanding Income Tax Rate Lingo

 

With the November elections approaching, there is much political talk (I could call it something else, but I am writing for a family newspaper) about the income tax. Candidates and commentators throw around revenue projections, tax rates, and statistics like so much confetti. I am not sure they know what they are talking about, but I want to make sure you do. Here are definitions of some commonly used terms.

Average Tax Rate - The rate a taxpayer would be taxed at if taxing was done at a constant rate, instead of progressively. It is calculated by dividing the total tax paid by income.

For example, the first two tax brackets for single persons in 2011 are 10% for everything up to $8,500, then 15% for everything between $8,500 and $34,500. Adjusted Gross Income (AGI) is the number at the bottom of page one and top of page two of the 1040 form. Taxable income is AGI minus deductions and exemptions. If taxable income is $20,000, then the tax is $850 (10% of the first $8,500) plus $1,875 (15% of the next $12,500) for a total of $2,750. What is the average rate? The total tax of $2,750 is divided by total taxable income of $20,000 which gives an average tax rate of 13.75%.

While this example is clear, it is not at all clear what number should be used here as "income." Is it the AGI? Is it taxable income, which would drive the Average Tax Rate up? Is it adjusted gross income plus tax-exempt interest, non-taxable social security, and other non-taxable items which would drive the Average Tax Rate down? What is total tax? Intuition dictates it is the tax due on the 1040, but some analysts add all other taxes paid (see the Debbie Bosanek example below), driving the Average Tax Rate up. When commentators and politicians throw average tax rates around, it is impossible to know if they are comparing apples to oranges because the calculation of the average rate is not made consistently. Beware.

 Effective Tax Rate - This term is not used consistently. Some use it to mean exactly the same this as Average Tax Rate. Others use it to describe the amount of tax a taxpayer pays when all other government tax offsets or payments are applied, divided by total income. For example, the Congressional Budget Office refers to an effective federal tax rate on individuals which includes all benefits received including things like health care and food stamps, and all four of the major federal taxes - individual and corporate income taxes, payroll taxes (social security medicare, etc.) and excise taxes (like cigarette tax).

 Marginal Tax Rate -- The amount of tax paid on an additional dollar of income. The marginal tax rate for an individual will increase as income rises and higher brackets are passed into. In the above example, lets assume taxpayer made $12,000. What is his marginal rate? He has passed through the $8,500 bracket and the next $3,500 of income is taxes at 15%. If he makes another $1 of income, it will be taxed at 15%. The taxpayer’s marginal rate is 15%.

Have you heard people saying they don’t want to be in a higher tax bracket because they will pay more tax? This statement is based on a misunderstanding.
 

Lets look back at our example taxpayer. If he makes $20,000, his marginal rate is 15% and he is in the 15% bracket. It is important to understand that just because he is in the 15% bracket, that does not mean that all of his income is taxed at 15%. It just means that the next dollar earned will be taxed at that rate. Going in to a higher tax bracket does not raise the tax on all of the income below that bracket. Moving into a higher tax bracket is usually not a "big deal" although many folks talk about it as if it is a tax disaster. It is a complete myth that going into a higher tax bracket costs you money. A progressive tax system only imposes the highest rates of tax on the incremental dollars over the top of the last bracket.

There has been much talk about the Buffett rule. Warren Buffet pointed out that his secretary, Debbie Bosanek, pays a higher rate than he does. ABC reported Bosanek’s tax rate as 35.8% in payroll and income taxes (higher than even the top income tax rate), while Buffet’s is 17.4%. They are talking about the average rate, that is, total tax divided by total income. We don’t know the details but we can surmise that most of Buffet’s income comes from capital gains and qualified dividends, both taxed at a maximum rate of 15% while the secretary’s income is taxed at ordinary income tax rate and his numbers include her payroll taxes, both employee and employer. There are lots of other factors, too, like charitable deductions, that we really can’t quantify without seeing the actual tax returns.

Last Monday, the Senate blocked a vote on the Fair Share tax - referred to as the Buffet rule. The Fair Share tax would have required people with income offer $2 million to pay at least 30% in income tax. It didn’t pass and spawned a whole raft of articles, talk shows, and blog posts - all throwing around average, effective, and marginal rate lingo - often incorrectly.

The Bush tax cuts expire at the end of this year. You can expect to hear a lot about brackets, rates, and income from the lame-duck Congress in the seven weeks between the November 6 election and the end of the year. What will be the state of the economy and who will win control of the House, Senate and White House? No predictions here. My crystal ball is broken.

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No More Patents on Tax Strategies

A patent is an exclusive right granted by the government to an inventor for a limited period of time in exchange for public disclosure of the invention. A patent application must include one or more claims defining the invention which must be novel and non-obvious. The exclusive right that is given with the granting of a patent is the right to prevent others from making, using, selling, or distributing the patented invention without permission or a license.Error! Hyperlink reference not valid. In general, the right to exclusivity is granted for 20 years.

The policy behind the system of granting patents is to 1) encourage inventions; 2) provide for disclosure of the invention to the public; 3) provide an incentive to invest the time, energy, and money to experiment and then to produce and market the invention; and 4) to improve upon earlier patents.

 

Relatively new on the scene is the tax patent. A tax patent is a business method patent that discloses and claims a system or method for reducing or deferring taxes. They are also known as "tax planning patents", "tax strategy patents", and "tax shelter patents". In 1998, the Circuit Court of Appeals held in State St. Bank & Trust v. Signature Fin. Group that tax strategies were patentable. Since 1998, 160 patents on tax strategies have been granted. Patents have been granted on charitable giving techniques, real estate transactions, retirement planning and stock options among others.

 

The granting of tax patents has been a controversial subject. Opponents to tax patents say that they are "government-issued barbed wire" that prevents some taxpayers from getting equal treatment under the tax law. These would be the taxpayers who can’t use certain tax strategies because the strategies have been granted exclusively to the patent holders.

 

The American Institute of Certified Public Accountants (AICPA) has been very critical of tax patents. Their position is that no one should have a monopoly over any part of the tax code and all Americans should be free to use any legally permissible means to comply with the law. Taxpayers should not be required to pay royalties or be subject to litigation for patent infringement just for paying their taxes.

 

The AICPA says that tax patents 1) limit the ability of taxpayers to fully utilize interpretations of tax law intended by Congress; 2) cause some taxpayers to pay more tax than Congress intended and may cause other taxpayers to pay more tax than others similarly situated; 3) complicate the provision of tax advice by professionals; 4) hinder compliance by taxpayers; 5) mislead taxpayers into believing that a patented strategy is valid under the tax law; and 6) preclude tax professionals from challenging the validity of tax strategy patents.

 

The idea of patenting tax planning techniques has caused much consternation. At a meeting of the American Bar Association, an estate planning technique using a Grantor Retained Annuity Trust (GRAT) to hold stock options was discussed. Many of the attendees received letters subsequently stating that the method under discussion had been patented - the Stock Option Grantor Retained Annuity Trust patent (“SOGRAT”) - and that taxpayers who had set up such an entity would have to pay a royalty or face suits for patent infringement.

 

Many of the attendees thought the technique was obvious, and many had frequently set up GRATs with various assets including stock options. With the advent of tax patents, before recommending any strategy does the lawyer have to do due diligence and search to see if the strategy was patented so as not to inadvertently violate the patent and subject himself and his client to liability for patent infringement?

 

In September 2011, President Barack Obama signed legislation passed by the U.S. Congress that effectively prohibits the granting of tax patents in general. The Leahy-Smith America Invents Act stops the granting of patents on tax strategies. Under the new law any “strategy for reducing, avoiding, or deferring tax liability” is deemed to be “prior art” under patent law, and, therefore not patentable. Existing tax patents were not affected by the new law and remain intact. However, tax patents in pending applications were deemed prior art under the new law and nonpatentable..

 

Since there are still existing tax patents, tax advisors and practitioners should know what techniques have been patented so as not to violate any patents thereby subjecting their clients and themselves to liability.

 

The Act specifically does not stop the granting of patents to tax preparation software and other software, and explicitly excludes the patenting of any “method, apparatus, technology, computer program product, or system, that is used solely for preparing a tax or information return or other tax filing” or that is “used solely for financial management, to the extent that it is severable from any tax strategy or does not limit the use of any tax strategy by any taxpayer or tax advisor.”

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Going Once, Going Twice

The Department of Justice, the Internal Revenue Service, and Congress have all identified "offshore tax evasion" as a primary enforcement target. The success of the enforcement effort so far has energized government efforts in these cases.

If you are an American taxpayer with an offshore account that you thought was secret, you have very little time to bring it into compliance. We are now in the second amnesty for unreported foreign income. The first amnesty was in 2009. In February 2011, the IRS announced a second amnesty for taxpayers with unreported foreign assets. It is called the 2011 Offshore Voluntary Disclosure Initiative - OVDI. The objective is to bring taxpayers who have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with U. S. tax laws.

This is the last amnesty. You will not get another chance. If you have unreported foreign accounts and/or unreported foreign income, after August 31, 2011 you will no longer be able to come forward under the amnesty. There is not much time left. The disclosure and its related amended return filings and payment of taxes, interest and penalty must be completed before August 31, 2011. Once the IRS gets your name from other sources, it is too late.

Foreign banks have boots (wingtips) on the ground in the U.S. selling accounts and services. The U.S. is threatening to expel them if the foreign banks resist cooperating with the IRS. This new "cooperation" is why there will not be a third amnesty program and why the second is less generous than the first.

Taxpayers are strongly advised to bring unreported foreign income and accounts into tax compliance to avoid discovery by the IRS, higher penalties, and criminal prosecution.

If you have unreported foreign income in any amount (there are no exceptions, a small amount of unreported income is still a violation) you have three choices:

(1) Do nothing and hope you don’t get caught. I definitely do not recommend this. The government now has TIEs (Tax Information Exchange Agreements), MLATs (Mutual Legal Assistance Treaties), John Doe summonses (like those used against UBS in Switzerland and HSBC in India) and a vast collection of information from the more than 20,000 voluntary disclosures already made. The new Foreign Account Tax Compliance Act (FATCA) also creates new reporting requirements for U.S. taxpayers and foreign financial institutions. If you do nothing, keep this in mind: "He who places head in sand, will get kicked in the butt.’

(2) Make a "quiet disclosure." Some U.S. taxpayers with undeclared foreign accounts are hoping to "sneak through" by amending their returns and paying taxes on unreported income from foreign accounts. This is what is referred to as a "quiet disclosure". This is not recommended. The IRS has made it clear that these returns have a high chance of being audited. It is also well known that so-called quiet disclosures have resulted in criminal prosecutions. The IRS is targeting amended tax returns reporting increases in income. Even though tax returns are amended and taxes paid, foreign account holders will still face penalties and criminal charges.

There are other problems with a "quiet disclosure". It only addresses payment of taxes and interest, not penalties. It does not address the issue of failure to file the Report of Foreign Bank and Financial Accounts (FBAR) disclosing the foreign account. If the foreign account was in the name of a foreign trust, then an IRS Form 3520 was probably due also.

(3) The third choice, and the recommended course, is for a taxpayer with noncompliant foreign accounts to enter the Offshore Voluntary Disclosure Initiative - OVDI. In order to participate in the 2011 OVDI, taxpayers must resolve any non-compliance within an eight year period, from 2003-2010. All filings and payments must be complete by August 31, 2011.

Taxpayers have to pay: 1) income tax deficiencies during the eight year period 2003-2010; 2) interest on the deficiencies; 3) a 25% penalty on the highest aggregate balance held within foreign accounts during the eight year period. For smaller foreign holdings not exceeding $75,000, the penalty will be reduced to 12.5%. ; 4) accuracy-related penalties of 20% of the back taxes; and 5) if applicable, 25% of back taxes for failure to timely file a return or pay tax shown on a filed return.

Taxpayers who participate in the OVDI will generally avoid 1) criminal prosecution; 2) civil and criminal penalties for failure to file FBARs; and 3) any taxes, interest, and penalties prior to 2003.

While the OVDI fines and penalties are significant, they pale compared to the consequences of an IRS criminal prosecution and imposition of all penalties for non-reporting.

If you are entering the OVDI or planning a quiet disclosure it is a very serious matter with potentially life altering repercussions. Don’t rely on the internet for your advice. Make sure you get a competent tax lawyer with experience in the amnesty program.

Making an Offer in Compromise to the IRS

An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles the taxpayer’s tax liabilities for less than the full amount owed. Don’t get too excited - it is not that easy. Unless there are special circumstances, an offer in compromise will not be accepted if the IRS believes that the taxpayer can pay the liability in full either as a lump sum or through a payment agreement.

In most cases, the IRS will not accept an OIC unless the amount offered by the taxpayer is equal to or greater than the reasonable collection potential (RCP). The RCP is how the IRS measures the taxpayer’s ability to pay and includes the value that can be realized from the taxpayer’s assets, such as real property, automobiles, bank accounts, and other property. The RCP also includes anticipated future income, less certain amounts allowed for basic living expenses.

There are three grounds for acceptance of an OIC: 1) doubt as to collectibility, 2) doubt as to liability, and 3) effective tax administration.

Doubt as to collectibility applies when it appears unlikely that the taxpayer can pay all that is due within the statutory period for collection. Doubt as to liability exists when there is legitimate doubt about the correctness of the assessment. The examining agent may have made a mistake, or there could be an argument over interpretation, or perhaps the taxpayer has come up with new evidence. Effective tax administration exists when the taxpayer can demonstrate that the collection of the tax would create an economic hardship or would be unfair or inequitable.

 

Don’t think that an OIC is a way to make a deal with the IRS to split the difference. It’s not that kind of compromise. It is based on a formula to determine what the taxpayer can pay from what they owe and what they earn (the reasonable collection potential). Offers less than that amount are typically not accepted. The rules for application of the formula are very complicated. The taxpayer must present a complete financial picture to the IRS, detailing assets and liabilities, income and expenses.

An OIC is not for everyone. It actually prevents taxpayers from disputing the underlying liability at appeals or in tax court. Negotiating an installment plan that is a realistic payment plan may be a better alternative for the taxpayer. An installment plan works much like any installment loan. Those who are struggling financially catch up on their tax debt by making smaller payments over a period of time. While this may translate to paying more in total (because of interest rates and penalty charges), it's often a workable alternative.

An OIC is a lengthy and time-consuming process. Only about 15% of applicants actually reduce their debt through the OIC program. Because the filing and process are complex, it is highly recommended that you get professional advice in preparing and negotiating the offer. You need a tax attorney, a CPA, or an Enrolled Agent. Make sure you find someone with experience in IRS collection matters. A professional can help maximize the possibility that the OIC is accepted and the tax debt is minimized.

Beware of scams where promoters claim that tax debts can be settled for "pennies on the dollar." You’ve probably seen them on late-night TV. These scammers collect high fees and then don’t deliver on the promise - because they can’t in most cases. Some preparers collect fees but then fill out and file a form but provide no backup documentation and do not negotiate with the IRS. This is a waste of time and money. If the advertising refers to a "tax settlement specialist", run the other way.

An OIC is made on Form 656. There is a $150 application fee that must accompany the form. You cannot file an OIC if you are in bankruptcy. A taxpayer filing a lump-sum offer must pay 20 percent of the offer amount with the application. A lump-sum offer means any offer of payments made in five or fewer installments. A taxpayer filing a periodic-payment offer must pay the first proposed installment payment with the application and pay additional installments while the IRS is evaluating the offer. A periodic-payment offer means any offer of payments made in six or more installments.
 

 

 

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2011 Voluntary Disclosure for Foreign Accounts

 

In February 2011, the IRS announced a second voluntary disclosure program for taxpayers with unreported foreign assets. It is called the 2011 Offshore Voluntary Disclosure Initiative - OVDI. The objective is to bring taxpayers who have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with U. S. tax laws.

In announcing the 2011 OVDI, IRS Commissioner Douglas H. Shulman stated, "The situation will just get worse in the months ahead for those hiding assets and income offshore. The new disclosure program is the last, best chance for people to get back into the system. It gives people a chance to come in before we find them."

In 2009 the IRS offered a similar amnesty program for taxpayers not reporting income from foreign accounts. That program brought in 15,000 disclosures prior to its October 15, 2009 deadline.

It is not illegal to have a foreign account. What is illegal is 1) failing to disclose the accounts and 2) failing to report the income and pay income tax on income earned on the foreign assets. In addition to disclosing the existence of the accounts on your 1040 and reporting the income, Foreign Bank Account Reports ("FBARs") must be filed by any U.S. taxpayer who has signatory or other authority over a foreign account or accounts that have a combined value of more than $10,000 at any time during the calendar year.

In order to participate in the new 2011 OVDI, taxpayers must resolve any non-compliance within an eight year period, from 2003-2010. The deadline is August 31, 2011.

Taxpayers will have to pay: 1) income tax deficiencies during the eight year period; 2) interest on the deficiencies; 3) a 25% penalty on the highest aggregate balance held within foreign accounts during the eight year period; 4) accuracy-related penalties of 20% of the back taxes; and 5) if applicable, 25% of back taxes for failure to timely file a return or pay tax shown on a filed return.

For smaller holdings of not more than $75,000, the penalty will be reduced to 12.5%. The rate could be reduced to 5% if the taxpayer did not know he or she was a U.S. citizen (mostly children born in the U.S. to foreign parents and now living in the foreign jurisdiction) or if the account was inherited.

Taxpayers who participate in the OVDI will generally avoid 1) criminal prosecution; 2) civil and criminal penalties for failure to file a Report of Foreign Bank and Financial Accounts (FBARs); and 3) any taxes, interest, and penalties prior to 2003. The IRS policy on voluntary disclosures is that when a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.

If the IRS has initiated an examination, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities, the taxpayer will not be eligible to participate in the 2011 OVDI. Taxpayers under criminal investigation are also ineligible. Disclosures involving illegal source income will not be accepted.

Some taxpayers have attempted so-called ‘quiet’ disclosures by filing amended returns and paying additional taxes and interest. The IRS is currently reviewing amended returns that show an increase in income and selecting returns for audit. Individuals who are singled out for audit are not eligible to participate in the OVDI. Individuals who have filed quietly and have not yet been audited may make an application to participate in the OVDI.

Possible criminal charges related to tax returns include tax evasion, filing a false return and failure to file an income tax return. Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties.

A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

Warning for Tax Professionals:

It is the IRS position that it is a violation of Circular 230 to represent a taxpayer on a prospective basis if such taxpayer has noncompliance that the taxpayer elects not to resolve through a voluntary disclosure: "[a] practitioner whose client declines to make full disclosure of the existence of, or any taxable income from, a foreign financial account, may not prepare a current or future income tax return for that taxpayer without being in violation of Circular 230."

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Jackson Hewitt vs. H&R Block

On January 31, 2010, Jackson Hewitt Tax Service filed a lawsuit against H&R Block (Jackson Hewitt Inc. v. H&R Block Tax Services LLC) to stop a new advertising campaign. The complaint is that H&R Block’s "Second Look" marketing campaign is deceiving customers and diverting business away from Jackson Hewitt. They claim that H&R Block has been disparaging Jackson Hewitt’s reputation and goodwill in the marketplace. The lawsuit also claims that H&R Block misleads customers about refund anticipation loans (RALs). The lawsuit is Jackson Hewitt Inc v. H&R Block Tax Services LLC, U.S. District Court, Southern District of New York, No. 11-00641.

H&R Block’s ad campaign claims it found errors in 2 out of 3 returns prepared by other commercial tax preparers when the returns were reviewed by Block. The reviews in question are H&R Block's "Second Look Review" service. For $29, Block will review returns prepared by other companies, to see if anyone missed anything. Jackson Hewitt in the complaint states: "H&R Block's 2 out of 3 claim necessarily implies the false claim that two out of three Jackson Hewitt customers who are entitled to refunds have been short-changed due to Jackson Hewitt errors or incompetence."

Interestingly, the Block TV ad campaign never mentions Jackson Hewitt in the script- it refers to "other commercial preparers." However, there is a "fine print" disclaimer on the ad which refers to Block’s review of Jackson Hewitt prepared returns. The complaint alleges that Block has run print advertisements that say, "We found errors in 2 out of 3 Jackson Hewitt Tax Returns."

H&R Block is about five times bigger than Jackson Hewitt, which is the second largest commercial tax preparer. Jackson Hewitt said it prepared 2.53 million U.S. tax returns in 2010. H&R Block prepared 20.1 million U.S. returns in its 2010 fiscal year. H&R Block is based in Kansas City, Missouri, and Jackson Hewitt in Parsippany, New Jersey.

Speculation is that the H&R Block ad campaign is in response to their being prevented from giving out RALs. This highly profitable short term loan offered by many commercial tax return preparers has been criticized by many because of high fees and interest rates.

Taxpayers who get RALs often pay charges for the application, e-filing and a range of other costs, in addition to the bank's finance charge. This can all add up to the equivalent of an interest rate in excess of 100% and sometimes multiples of that, according to the National Consumer Law Center. The Center reported that a $3,300 RAL carries a rate of about 72% when fees and charges are added up.

In December 2010, federal banking regulators Office of the Comptroller of the Currency informed HSBC Holdings Plc., H&R Block’s principal lender, that it must stop offering RALs.

The FDIC, which governs the bank funding Jackson Hewitt’s RALs, hasn’t made the same determination. This looks like a windfall for Jackson Hewitt whose RAL program is still going strong. Despite the government’s and financial advisors’ criticism of RALs, the public apparently still likes them. Hewitt was positioned to pick up lots of business from Block since Hewitt could offer RALs and Block couldn’t.

Block, in an attempt to aggressively market its services, began a new ad campaign. The campaign focuses on the Second Look Service. Taxpayers are urged to bring in their 2007, 2008 and 2009 returns. These returns can be amended if errors are found, and Block claims 2 out of 3 reviews result in refunds.

Jackson Hewitt’s complaint says: "H&R Block’s failure to offer a program comparable to Jackson Hewitt’s RALs has proven to be a significant disappointment to H&R Block’s prospective 2011 customers, with the result that H&R Block saw itself facing significant competitive disadvantage in competing with Jackson Hewitt as the peak tax return season approached. . . H&R Block’s response was to launch a massive promotional campaign based on false and misleading statements, designed to ‘trash’ both Jackson Hewitt and its RAL service."

Since they can’t offer RALs, H&R Block has some alternative products available for this filing season, including the Emerald card - you receive your refund on a prepaid MasterCard, and a Refund Anticipation Check (RAC) - Block gets your refund, deducts its fee and possibly your tax preparation fees and gives you either a check or a direct deposit. These are not loans. Block claims you get your refund in 8 to 15 days if you use one of these products.

This year the IRS says it expects more than 70% of returns to be filed electronically. Taxpayers can expect to get refunds in 7 to 10 days after filing. Let’s see - which is better 7 to 10 days or 8 to 15 days. Be careful out there.

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Is the Internal Revenue Code Too Complex To Be Constitutional?

Jack Hough writes for SmartMoney:

"Douglas Shulman says he uses a hired tax preparer because the U.S. tax code is so complex. That's a bad sign. He's the I.R.S. commissioner."

Read more: Tax System: Too Complex To Be Constitutional? - SmartMoney.com

"Consider the following two sentences from different sources:

1. "[A] statute which either forbids or requires the doing of an act in terms so vague that men of common intelligence must necessarily guess at its meaning and differ as to its application, violates the first essential of due process of law."

2. For purposes of paragraph (3), an organization described in paragraph (2) shall be deemed to include an organization described in section 501(c)(4), (5), or (6) which would be described in paragraph (2) if it were an organization described in section 501(c)(3).

The first sentence comes from a 1926 Supreme Court decision that helped establish the right of citizens to known what laws mean. The second comes from the tax code."

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They Call It a Tax Cut, Part 2

The biggest changes from the 2010 Tax Relief Act that became law on December 17, 2010 were outlined in last week’s column: extension of the Bush individual and capital gains tax cuts for two years, a one-year payroll tax cut, a top federal estate tax rate of 35% and a $5 million exemption for the estate, gift, and generation-skipping tax. But wait, there’s more:

 

Adoption and Childcare Provisions

Taxpayers who adopt children can receive a tax credit for qualified adoption expenses. A taxpayer may also exclude from income adoption expenses paid by an employer. The credit and the exclusion from income were both previously raised to $10,000 (both for non-special needs adoptions and special needs adoptions and subject to inflation) and would have expired in 2011, but they are now extended through 2012.

The Patient Protection and Affordable Care Act (PPACA) passed in March 2010 increased the credit and exclusion by another $1,000 to $13,170 for 2010 and 2011 and the new act made the credit refundable for 2010 and 2011.

Existing law provided employers with a credit equal to 25% of qualified expenses for acquiring, constructing, rehabilitating or expanding property which is used for a child care facility. There is an additional 10% credit for child care resource and referral services. The credit is capped at $150,000. The new law extends the credit through 2012.

 

Expensing Versus Depreciation under Section 179

 

Under prior law, a taxpayer may elect to deduct the cost of certain property placed in service for the year rather than depreciate those costs over time. The 2010 Small Business Jobs Act increased the dollar and investment limits for the maximum amount that can be deducted as an expense to $500,000 and $2 million, respectively, for 2010 and 2011. The 2010 Tax Relief Act provides for a $125,000 dollar limit and a $500,000 investment limit for 2012.

Energy-efficient new homes credit. The new law extends the credit for manufacturers of energy-efficient residential homes purchased before January 1, 2012.

Energy-efficient appliances. The new law extends through 2011 and modifies standards for the credit for US-based manufacturers of energy-efficient clothes washers, dishwashers and refrigerators.

Energy-efficient existing homes. The bill extends through 2011 the credit for energy-efficient improvements to existing homes, reinstating the credit as it existed before passage of the American Recovery and Reinvestment Act. Standards for property credit eligibility are updated to reflect improvements in energy efficiency.

 

Refund and tax credit disregard for means-tested programs.

 

The expiring law provided that the refundable components of the Earned Income Tax Credit and the Child Tax Credit do not make households ineligible for means-tested benefit programs. The new law extends these exclusions from income for purposes of means-tested programs through 2012.

Barring a technical correction, the requirement that GRATS be for a minimum term of ten years was not included. A GRAT is a special grantor trust that people use to transfer assets that are expected to increase greatly in value in a short period of time. To the extent that the appreciation outpaces inflation, leverage is gained in transferring the assets via trust at the end of a two year term. The donor gets the original funding back in an annuity plus two years of normal interest as it exists at the time of transfer, and the beneficiaries get the rest. The shorter the term of the trust, the better the leverage.

Also not included was "portability" of the Generation Skipping Transfer Tax (GSTT) exemption. Taxable transfers to beneficiaries two or more generations younger than the donor get not only the gift (or estate) tax burden, but also a second tax slice taken at the highest estate tax rate, which will be 35%. This is a heavy tax burden on such a transfer, but everyone has an exclusion amount (free pass, so to speak) of whatever is the current Estate tax exclusion amount. The Estate Tax exemption is now "portable", with the surviving spouse being eligible to use the deceased spouse’s unused exclusion amount. But, there is no such portability for the Generation Skipping Transfer Tax. If there will be a large transfer to second-generation beneficiaries in an estate plan, either directly or just in case the first generation doesn’t survive their parents, pre-death estate planning is the only way to use both parents’ full GSTT exclusion.

 

 

What Was Not in the Bill

Energy Credits

Education Incentives

Coverdell Accounts are tax-exempt savings accounts for paying education expenses of a beneficiary. The allowable contribution had been raised from $500 to $2,000 and elementary and secondary education expenses were included in 2001. Those changes will now be continued through 2012.

Exclusion of up to $5,250 from income and employment taxation for employer-provided education assistance is extended through 2012.

Student loan interest deduction up to $2,500 per year is allowed. The 2001 law eliminated the 60-month limit on deductions and raised the phase-out income range beginning at $55,000 AGI (the bottom number on page one of your 1040) for single filers and $110,000 for joint filers. These 2001 improvements are continued through 2012.

The American Opportunity tax credit is available for up to $2,500 of the cost of tuition and related expenses that are actually paid. All of the first $2,000 may be taken as a credit, and 25% of the next $2,000 may be taken. Phase out of the credit begins at an AGI of $80,000 for single filers, $160,000 for joint filers. This credit is now extended through 2012.

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They Call It a Tax Cut, Part 1

The new tax legislation passed by the House, December 15, and the Senate, December 16, (not to mention signed by the President) is referred to as a tax cut. That’s a misnomer. In fact, the legislation keeps taxes where they are. It prevents taxes from increasing. But a cut? No, not exactly.

Here are some highlights:

Estate and Gift Tax

 

In 2009, each person had an exclusion amount of $3.5 million they could pass on to their heirs free of federal estate tax and the tax rate on amounts over $3,500,000 was 45%. In 2010 there was no estate tax. With the new legislation, each person has a $5 million exemption, and the tax rate on amounts over $5 million is 35%. If the first spouse to die does not use all of his or her exempt amount, the unused exemption can be added on to the surviving spouse’s exempt amount. This feature is called "portability."

 

Before anyone starts figuring out how to chain together five or six deceased spouses’ excess exclusion amounts, know this. A surviving spouse may only use the excess exemption amount of his or her last spouse to die. Consider Herman’s Hermit’s ditty about a man named Henry marrying the widow next door who had married seven previous Henrys. If Henry VII just passed away, and the fair widow had $4 million in excess exclusion amount from Henry VI, that $4 million is gone with the death of Henry VII, to be replaced, with the excess amount, if any, from Henry VII. Also consider that if Henry VII’s Executor refuses to elect to assign the excess amount to the fair widow, she gets no excess amount from Henry VII and Henry VI’s excess exclusion amount is still eliminated.

The changes are retroactive to the beginning of 2010, and carryover basis is repealed. However, for estates of 2010 decedents; executors will have an election. They may choose to have the law apply as it was in 2010 without the change made by this legislation. In general, executors of 2010 estates larger than $ 5 million will have to decide whether to pay no estate tax and use carryover basis, or to pay estate tax and get a basis step-up. There is an extension of time to make the election, pay estate tax and file returns of 9 months after enactment. The extension also applies to ancillary planning matters such as disclaimers.
 

In the new law, the gift tax and the estate tax are "re-unified." The gift tax exemption is $5 million, the same as the estate tax exemption. (There is one $ 5 million exemption which can be used for making life-time gifts or for death-time transfers.) In 2010, the gift tax exemption was $1 million. The annual exclusion from the gift tax for present interest gifts remains at $13,000 per donee.

Generation-Skipping Transfer Tax

The Generation Skipping Transfer Tax (GSTT) is levied on transfers to recipients two or more generations below the donor. The exempt amount for the GSTT is the same as the Estate Tax at the time of the transfer, so for the next two years it will be $5 million. While the estate tax exemption is "portable", the GSTT exemption is not.

Income Tax

•   The lowest bracket, 10%, is continued through 2012, rather than reverting to the 15% level. The 10% bracket applies to individuals making up to $8,500 and couples making up to $17,000.

•   The 25%, 28%, 33% and 35% brackets would have increased 3%, but now they’ll remain through 2012.

•   Phasing out of the personal exemption for those with higher adjusted gross income (AGI, the number at the bottom of page one of the 1040) was repealed for 2010 and now will continue to be repealed for two more years.

•   Phasing out of itemized deductions for those with higher AGI was repealed for 2010 and now will continue to be repealed for two more years.

•   The Alternative Minimum Tax (AMT) threshold for 2011 is $48,450 for single filers and $74,450 for joint filers.

•   Long term capital gains and dividends have been taxed at 0% for those in the 15% tax bracket and at 15% for those above that bracket. This favorable treatment is extended for two more years.

•   Child care credit for low income earners with children under 17 had been raised from $500 to $1,000. This increase is extended through 2012.

•   The marriage penalty relief for the standard deduction, the 15% tax bracket and the Earned Income Tax Credit (EITC) has been extended through 2012.

•   The dependent care credit for those with children under 13 and disabled dependents is $3,000 for one child and $6,000 for two children, and those levels have been extended through 2012.

•   EITC for families with three or more children is 45% of the couple’s first $12,570 of AGI, with a phase-out that begins at a higher amount. The new law extends the three child credit and raises the phase out point somewhat through 2012. The two-child credit remains unchanged.

•   Above-the-line deductions for teachers for $250 for school supplies was renewed for 2010 and 2011.

•   Itemized deductions for state and local general sales taxes in lieu of itemized deductions for state and local government income taxes was renewed through 2011.

•   Tax free charitable contributions directly from IRAs up to $100,000 per taxpayer per tax year was extended through 2011. Due to the late passage of the bill, such transfers made in January 2011 may be treated as made in 2010 if the taxpayer so elects.

•   The unemployment insurance section provides a one-year extension of the federal unemployment insurance benefits

 

•   Employee-paid payroll taxes are reduced. The rate for 2011 had been 6.2% of all wages earned up to $106,800 and 12.4% for self-employed individuals. The new law reduces these rates two percentage points; 4.2% for social security and 10.4% for self-employed individuals. This change is for 2011 only.

•   Additional provisions of the "tax cut" will be highlighted in next week’s entry.

Unemployment Insurance and Payroll Taxes

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Pennsylvania Legislature Passes Trusts and Estates Legislation

Soon we will have some much needed changes to Pennsylvania’s Probate, Estates and Fiduciaries Code which will clarify rights of inheritance when a divorce is pending, interpret funding clauses dependent on the federal estate tax, and curtail some abuses prevalent in the use of powers of attorney.

As of October 14, 2010, Senate Bill 53 had been approved by both the Pennsylvania House and the Senate and had been sent to the governor for his signature. The governor is expected to sign it in due course. Here are a few of the provisions:

 Formula Clauses for Federal Estate Tax

As has been discussed in this column before, estate plans that contain "formula clauses" that divide the decedent’s estate into two parts based on the amount of the exemption from the federal estate tax ran aground this year. There is no federal estate tax in 2010, so the question arises: how to interpret these formula clauses? I recommended to my clients that they amend their plans to answer this question because it very fundamentally determines "who gets what." If you did not do that, the legislature will now answer it for you, and here is their answer: a will, trust, or other instrument for a decedent who dies after December 31, 2009 and before January 1, 2011, that contains a formula clause will be "rebuttably presumed to be interpreted pursuant to the Federal Estate Tax and Generation-Skipping Transfer Tax laws applicable to estate of decedent dying on December 31, 2009." In other words, the formula will be interpreted under the federal estate tax as it existed in 2009. There is an exception: the rule of the new law does not apply (1) if the will, trust or other instrument was executed after December 31, 2009 or indicates that a different rule should apply, or (2) there is a federal estate tax or generation-skipping tax that applies to the decedent who dies in 2010 (which would take some fast action by Congress or else a very controversial and probably unconstitutional retroactive application of an estate tax or generation skipping tax).

 Agent Under a Power of Attorney

With regard to the agent’s power to engage in insurance transactions, the law is amended to provide that an agent or a named beneficiary of a life insurance policy "shall be liable, as equity and justice require, to the extent that a beneficiary designation made by the agent is inconsistent with the known or probable intent of the principal." In other words, the agent cannot name himself as beneficiary if that is not the principal’s intent. This is aimed at situations such as when an agent under a power of attorney changes a beneficiary designation to him or herself.

A similar provision is made for an agent’s change of beneficiaries on a retirement plan. Further, an agent cannot designate himself a beneficiary of a retirement plan unless the agent is the spouse, child, grandchild, parent, brother or sister of the principal.

Death while Divorce is Pending

Prior PA law provided that a spouse who for one year or more before death has willfully neglected or refused to support the spouse, or who for one year or more has deserted the spouse, shall have no right to claim a share of the deceased spouse’s estate.

The Omnibus Amendment would add that a surviving spouse shall have no right or interest in the estate of the deceased spouse if the spouse died domiciled in Pennsylvania during the course of divorce proceedings, no decree of divorce has been entered, and grounds have been established.

Similarly, wills are modified not only by a divorce but also by a pending divorce where grounds have been established. The surviving spouse in a pending divorce is deemed to have predeceased when the will is interpreted.

A pending divorce where the grounds have been established will also void a beneficiary designation of a life insurance policy, annuity contract, pension or profit-sharing plan.

Uniform Trust Act

Various technical corrections and clarifications are made to the Uniform Trust Act. These changes will be most helpful to practitioners as they work with the new law which requires notice to trust beneficiaries and provides for ways to modify trusts by agreement.

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Would you Blow the Whistle on a Tax Cheat?

The IRS estimates that U.S. taxpayers under report and underpay about $400 billion in taxes each and every year. The IRS operates a Whistle blower Program where the agency will give monetary awards to individuals who provide information that results in the collection of significant un-reported tax dollars.

The IRS Whistleblower Office was established by the Tax Relief and Health Care Act of 2006. There were ways to turn in alleged tax cheats before that, but since 2006 there are specific procedures. Now, if the IRS uses information provided by the whistleblower; it can award the whistle blower up to 30% of the additional tax, penalty and other amounts it collects.

The information must be specific and credible, and it must result in the actual collection of taxes, penalties and interest from the noncompliant taxpayer. The information must be detailed. They are not interested in speculation and unsubstantiated accusations about your ex-husband or former employer.

There are two types of awards for whistleblowers: (1) If collected taxes, penalties and interest exceed $2 million, the IRS will pay at least 15 but not more than 30%. This is the major change in the program that was made by the 2006 law. These awards are no longer discretionary. The new law says that the whistleblower shall receive 15 to 30% of the collected proceeds. The IRS’s determination on this award is appealable by the whistleblower. If the taxpayer is an individual, his or her gross income must exceed $200,000. (2) If tax is less than $2 million or the alleged cheat’s annual income is less than $200,000, there are also awards. These can be up to a maximum of 15%, and the IRS’s determination is not appealable.

If you decide to submit information, use IRS Form 211, Application for Award for Original Information. You must provide specific and credible information regarding the taxpayer that you believe has failed to comply with tax laws and that will lead to the collection of unpaid taxes. Attach all supporting documentation (for example, books and records) to substantiate the claim. If documents or supporting evidence are not in your possession, you must describe these documents and their location. You must also describe how the information which forms the basis of the claim came to your attention, including the date(s) on which this information was acquired, and a complete description of your relationship to the taxpayer. The IRS emphasizes that under no circumstance do they expect or condone illegal actions taken to secure documents or supporting evidence.

If you chose to file Form 211, the process could take several years. There must be an audit or investigation resulting in the collection of proceeds. The taxpayer’s appeal rights must be expired and all sums collected before any award is paid to the whistleblower.

A person who reports under the IRS Whistleblower Act does not have the right to prosecute it. A whistleblower cannot compel the IRS to investigate a claim nor may a whistleblower file a private cause of action if the IRS declines to pursue an investigation.

Will the alleged tax cheat know you turned them in? The IRS will protect the identity of the whistleblower to the fullest extent permitted by the law (whatever that is). If the whistleblower is an essential witness in a judicial proceeding, it may not be possible to pursue the investigation or examination without revealing the whistleblower’s identity. The IRS will inform the whistleblower before deciding whether to proceed in such cases.

Offshore accounts are an increasing priority for the IRS and the Whistleblower Program has helped in uncovering these situations. As reported by Janet Novack and William P. Barrett for Forbes, "In June 2007, Bradley C. Birkenfeld–motivated in large part, he now acknowledges, by the new reward law–came to U.S. officials with documents in hand and laid out how his former employer, UBS AG, helped wealthy Americans hide money offshore. So far the investigation he triggered has produced a $780 million payment to the U.S. government from UBS, Switzerland’s largest bank; an unprecedented agreement by the Swiss to finger 4,450 U.S. taxpayers with secret UBS accounts; and criminal investigations of more than 150 American UBS clients."

However, Birkenfeld tried to conceal his own involvement in the fraud and was prosecuted for a felony for his participation. His prosecution has been roundly criticized. Here is the lesson: If you’re going to blow the whistle, you must "tell all" truthfully. Whistleblowers willing to tell the full truth can usually obtain any protection needed.

The fact the Birkenfeld was prosecuted is not a bar to his award. He is still eligible for the "bounty."

 

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Make Gifts in 2010 - It's a Bargain!

Much ink has been spilled on the subject of our President and Congress’s failure to address the federal estate tax in a coherent way. Last year there was a $3.5 million exemption. This year there is no federal estate tax at all. And it looks like there is a good chance there will be an estate tax with a $1 million exemption in 2011.

It’s bizarre. Billionaire George Steinbrenner died in 2010, and his heirs will pay no estate tax at all. If your neighbor who is worth $1 .5 million dies in 2011, his estate will pay the federal government $210,000 in estate tax. Insane.

But it is what it is. Yet in this mess there is an opportunity.

While there is no estate tax in 2010, there is a gift tax. Its lifetime exemption is $1 million and rate is 35% - which is the lowest rate since the 1930's. This $1 million exemption is in addition to the annual exclusion, which is a free pass of $13,000 per year per donee. Wealthy people are looking at making taxable gifts in 2010.

They are considering paying a 35% gift tax now, because next year the top rate will rise to 55%. That’s a huge increase in the rate. That’s not all. The value of many assets is currently depressed. Stocks, real estate, and interests in businesses are at low market values in the struggle to weather the recession (Is it really over?). Making gifts of these assets now gets them through the transfer tax system at a low value. Any future appreciation will not be subject to gift or estate tax.

When there are steep declines in the market, most folks are understandably concerned about the shrinking value of their assets. The natural urge is to hold them closer. If you are in taxable estate territory - over $1 million in 2011, you need to ask yourself if you really need to hold it all so very close. Wouldn’t it be better to take advantage of low valuation and low rates to pass more property to your beneficiaries?

It gets better. If the donor is making gifts to grandchildren or to a trust for the benefit of grandchildren, there is a major advantage. Usually large gifts to grandchild (or more remote descendants) are subject to an additional tax called the Generation-Skipping Transfer Tax (GSTT). The GSTT applies in addition to the Gift Tax and Estate Tax but in 2010, just like the Estate Tax, there is no Generation-Skipping Tax!If a single donor makes $3,013,000 million gift to one grandchild or a generation-skipping trust, in 2010, there is only a gift tax, and that at the rate of 35% over the $1 million exemption. The 2010 gift tax, after taking the $13,000 annual exclusion for gifts, would be $700,000.

Here is an example.

Contrast that with a gift in 2011, or with a death in 2011. The generation skipping tax after the $13,000 annual exclusion for generation skipping transfers, and the $1,340,000 GST exemption in 2011, would be $912,900. That generation skipping tax is added to the amount of the gift for a total gift of $3,912,900. The gift tax on that amount is $1,447,095. Add to that the $912,900 generation skipping tax, and the total tax due for the gift comes to $2,359, 995. Yikes! Compare that to this years total of $700,000 and you will see why it is such a bargain.

If you are attracted by this planning opportunity, start making plans now. Be cautious, and make sure that you know what Congress is up to this month, but be prepared to act. To take advantage of this opportunity, gifts must be made before year end and a large gift requires careful planning. It shouldn’t be rushed into at the end of the year.

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Beware of Tax Relief Scams

They appear on late night television and on the internet promising to reduce your tax debt, remove tax liens, and settle your unpaid taxes, interest and penalties for pennies on the dollar. Do you really believe you can pay a fee to a tax relief company and reduce your $50,000 tax bill to $2,000?

Apparently a lot of people do believe that. The California Attorney General is suing TV’s Tax Lady, Roni Deutch, for $34 million.

Attorney General Jerry Brown announced the suit last Monday saying "Tax Lady Roni Deutch…promises to significantly reduce [clients’] IRS tax debts, but instead preys on their vulnerability, taking large up-front payments but providing little or no help in lowering their tax bills."

Brown alleges that Roni Deutch regularly violates state law by making false promises about her ability to resolve disputes with the IRS. He says that Deutch overstates her advertised television claims of winning 99% of her tax battles with the IRS while in reality she reduces the amount of money her clients owe in taxes in just 10% of the cases. Most of her clients quit or are terminated by her firm and are denied refunds after her staff bills them for work that wasn't performed, the lawsuit said.

The attorney general's office says hundreds of Deutch's clients have filed complaints. In addition to not lowering their debts, consumers says she also refused to refund fees of as much as $4,700 that her firm charged.

The complaint filed against her alleges that she engaged in a scheme to swindle taxpayers, including senior citizens and disabled, who cannot afford to pay their tax debt by enticing them to engage her firm to negotiate a resolution of their tax debt with the IRS. She promises to lower the amount the clients owe the IRS, eliminate interest and penalties, establish a low monthly payment plan, or prevent the IRS from collecting on the tax debt altogether. According to the complaint, she also falsely represents that she is able to immediately stop IRS collection actions such as levies and wage garnishments.

Deutch has faced similar allegations before. In December 2006, she settled a lawsuit filed by New York City's Department of Consumer Affairs that alleged she misled consumers with her advertising. She agreed to pay $300,000, including $100,000 in fines and $200,000 in restitution to consumers.

A recent MSNBC article cautioned taxpayers against falling for tax resolution promises that sound too good to be true. According to the article, "Instead of describing the long odds [of winning a tax settlement], many tax debt settlement companies sweet talk clients. Then they take large up-front payments — prices start at $3,000 and climb fast from there – but do little or nothing to help with the tax problem."

Most people are frightened when they are in trouble with the IRS. They may have a bill that is larger than anything they ever owed and they are scared stiff. Put yourself in their shoes. There you are, watching late night TV, unable to sleep because you are so worried about your tax problem, and an angry female attorney comes on and tells you she will fight the IRS for you and win! If you call the toll free number, you reach a salesperson whose job it is to get a large up front payment from you on your credit card.

Many tax relief companies make outlandish promises about reducing their tax bill to taxpayers, collect a large fee up front, and then never do anything. They may tell the taxpayer later that they don’t qualify for relief and suggest they call the IRS themselves for a payment plan.

If you are already in debt because of unpaid taxes, you don’t need to pay a big fee for nothing to one of these outfits.

Finding competent help can be challenging. You need to do your homework, and ask lots of questions. Find out about the firm - how long it’s been in business, what kind of complaints have been lodged against it? How many tax attorneys do they have on staff? Ask for references.

If the firm offers you a guarantee. Just say "no thanks" and run away. Nobody can guarantee anything. Does the firm want all its fee up front? If they do, run away. Some money upfront as a retainer is reasonable.

Do they give you a high pressure sales pitch? If they are pushing that hard, that's a warning sign to stay away. In many cases when you get a sales pitch, you are talking with a salesperson, not a tax attorney or tax resolution specialist who can help you.

In general, when considering hiring any company or person to represent you, look for statements that seem too good to be true, claims of some kind of special advantage, or creating a fear that only they can solve. Be careful out there.

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The Turbo Tax Defense

Remember when Treasury Secretary Timothy Geithner ran into trouble because he hadn’t paid his self-employment tax? There was quite a political stir because it meant a tax-evader would be in charge of the IRS.

Geithner had worked at the International Monetary Fund from 2001 to 2004. During those four years, he paid no social security or Medicare taxes. American citizens who are IMF employees don't have FICA and Medicare tax withheld from the paychecks because it is an international agency. They are considered to be self-employed and are supposed to treat the income as "self-employment" earnings, paying both employer and employee payroll taxes on the income.

The IRS audited Geithner in 2006 and discovered the problem for his 2003 and 2004 returns. Geithner paid just under $17,000 at the time, and the IRS waived any possible penalties. A three-year statute of limitations precluded the IRS from auditing the 2001 and 2002 tax returns. Geithner didn’t volunteer to look over 2001 and 2002 returns even though they contained the same mistake as the 2003 and 2004 returns. The additional amounts for 2001 and 2002 ($25,000) were discovered by the Obama vetting team and Geithner promptly paid up.

Mr. Geithner testified before Congress that he self-prepared his returns using Turbo Tax and that the error was a careless mistake. He paid his over-due social security taxes without penalty, and went on to become the Secretary of the Treasury. Did you ever wonder if it would work for the rest of us?

On June 21, 2010, the U.S. Tax Court handed down a decision in the case of another IMF employee, David Cameron Parker. Mr. Parker also failed to pay self-employment tax, used Turbo Tax to self-prepare his tax returns, and due to that fact argued that he had reasonable cause and acted with good faith with regard to the underpayment. Mr. Parker initiated contact with the IRS and voluntarily came forward with the problem, requesting a waiver of penalties. (He wasn’t caught in an audit.)

From May 25, 2005 through 2006, Mr. Parker earned gross annual compensation of approximately $175,000 while working for the IMF. On his 2005 return, Mr. Parker reported a tax liability of $20,212, which was about $12,000 less than what he actually owed. He asserted that he believed Turbo Tax included the self-employment tax in the tax he owed. He claimed that he called TurboTax and specifically asked "an expert" if self-employment taxes were included. He claimed the "expert" said they were included.

The Court did not believe such a conversation took place, since there were no self-employment taxes shown on the return. As for acting in "good faith" by initiating contact with the IRS regarding the underpayment, good faith must be shown before and during the act of filing. No later acts are included in the "good faith" definition. The IRS refused to waive penalties and the Tax Court backed up the IRS. Here is an excerpt from the opinion, Parker v. Commissioner, T.C. Summ. Op. 2010-78 (June 21, 2010):

"We shall address briefly petitioner's contention that the IRS granted "favorable treatment" in a case involving U.S. Secretary of the Treasury Timothy Geithner, which petitioner described as "incredibly similar" to the instant case. According to petitioner, "there should not be different, or favorable rules for the well-connected". The record in this case does not establish any facts relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner. In any event, those facts would be irrelevant to our resolution of the issue presented here. Regardless of the facts and circumstances relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner, petitioner is required to establish on the basis of the facts and circumstances that are established by the record in his own case that there was reasonable cause for, and that he acted in good faith with respect to, the underpayment for each of his taxable years 2005 and 2006 that is attributable to his failure to report self-employment tax."

Similarly situated taxpayers should be treated similarly. The Tax Court was not necessarily wrong in the Parker case. There are other cases holding that reliance on tax preparation software is not enough to escape penalties. The problem is that Geithner should have had to pay the penalty as well.

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Pennsylvania Tax Amnesty

 

 

 

"Amnesty

(from the Greek amnestia, oblivion) is a legislative or executive act by which a state restores those who may have been guilty of an offense against it to the positions of innocent people. It includes more than pardon, in as much as it obliterates all legal remembrance of the offense. The word has the same root as amnesia."

 

 

 

                                                                                                                          – Wikipedia

The Pennsylvania legislature has authorized a tax amnesty period from April 26 to June 18, 2010. During this limited, 54-day time frame, the Pennsylvania Department of Revenue will waive 100% of penalties and half of the interest for anyone who pays his or her delinquent state taxes.

Any PA taxes delinquent as of June 30, 2009, and any non-filed PA returns overdue as of June 30, 2009, are eligible for tax amnesty. Individuals and businesses are included.

All taxes administered by the PA Department of Revenue are eligible for the tax amnesty program. There are many state taxes. Here are a few: Personal Income Tax, Inheritance Tax, Capital Stock Tax, Sales and Use Tax, Corporate Net Income Tax. The tax amnesty does not include Unemployment Compensation because it is administered by the PA Department of Labor and Industry. The program does not apply to any tax administered by another state, the federal government or Internal Revenue Service.

To obtain tax amnesty, you must do the following between April 26 and June 18, 2010:

 

 

 

 

file an amnesty return online with the PA Department of Revenue (taxpayers will only be able to apply online; no paper application will be available);

file tax returns for periods for which returns were not filed, or file amended returns for all underreported tax; and

pay all delinquent taxes plus 50 percent of the interest due with the amnesty return that is filed.

 

 

 

 

No extensions to file or to pay are available. Penalty and interest paid before the tax amnesty program begins are non-refundable.

If you are reporting and paying taxes which are completely unknown to the Department – meaning you have not registered, filed or paid the state taxes, nor have you been contacted by the department about the taxes - you could qualify for a limited filing period. In this case, only undisclosed tax delinquencies dating back to July 1, 2004, will be required to be filed and paid under the amnesty program.

If you are reporting and paying taxes which are known to the department, you must file tax returns or amended returns for all tax periods and pay all taxes due to the department.

Taxpayers with known delinquencies will receive notices from the DOR informing them about the amnesty program. The notice will include a Personal Identification Number (PIN) to be used in the application process. For delinquencies that the department does not know about, taxpayers will have to register and get a PIN online in order to file.
 

A business or individual currently under criminal investigation for violation of a tax law, or named as a defendant in a criminal complaint alleging a violation of a PA tax law is not eligible to participate in the amnesty.

After the amnesty period closes, a 5% non-participation penalty will be imposed on all un-paid tax, penalty and interest not paid in full during the amnesty period. Existing deferred payment plans, active appeals and entities in bankruptcy will not be assessed the additional 5% penalty.

In addition, if within two years after the end of the program a taxpayer that is granted amnesty becomes delinquent for certain periods in payment of any taxes that are due or in the filing of any required returns, the Department of Revenue may assess and collect all penalties and interest waived through the amnesty program.

You only get one shot at Pennsylvania tax amnesty. If another Amnesty Program is held in the future, a taxpayer participating in the 2010 Amnesty Program will be prohibited from participating in future Amnesty Programs.

The amnesty is projected to generate an additional $190 million for the state to help offset spending in the fiscal year that began July 1, 2009. Last year New Jersey had a hugely successful amnesty program which collected $725 million in six weeks.

Pennsylvania’s last tax amnesty was 14 years ago. The 1995-96 amnesty waived penalties but required full payment of taxes and interest. This year’s amnesty is better. It will waive penalties and 50% of the interest. The extra incentive for taxpayers previously unknown to state officials to come forward is that they will not be held responsible for taxes due before July 2004. The theory is that they will have to supply the department with the information it needs to tax them in the future.

While there is no question that tax amnesties work, it can provide a negative incentive to tax payers. As Kail Padgitt of The Tax Foundation in Washington D.C. says a tax amnesty is essentially "rewarding people that have not paid their taxes and have been out of compliance. So really what it does is it provides a perverse incentive to not pay your taxes."

 

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Innocent Spouses Can File for Tax Relief

 “For Better, For Worse; For Richer, For Poorer”

You’ve heard of the “marriage penalty” -- two people married to each other with the same income as two single people pay more taxes. Let me tell you about another “marriage penalty.”

If you file a joint return with your spouse and there is a problem and tax, penalties and interest are due, both spouses are liable individually and jointly, and the IRS may collect the owed tax from either spouse regardless of whose income, understatement or fraud was involved.

Most married couples file a joint income tax return because this gives a lower tax than filing two returns as married filing separate. (Although still not as little as two unmarried persons with the same income). The general rule for a joint return is that both taxpayers will be responsible for any taxes, interest, and penalties owed, even if only one spouse was earning the income. Married couples are not required to file a joint return. In fact, filing a joint return is an election. Since it almost always results in a lower combined tax than if each spouse files separate returns, it is routinely and almost automatically elected by married couples. If you file separately, you and your spouse can change your mind and file a joint return within three years after your original return's due date. The converse is not true. If you file jointly, you can't switch back to separate filing (unless there is enough time to do this before the due date for the return) even if your spouse agrees and wants the same thing. When you elect to file and sign a joint income tax return, you consent to joint and several liability.

Joint liability means that both spouses are liable. Several liability means that each spouse is liable for the entire amount The IRS may collect from either spouse. They may collect the tax however they think will be fastest and easiest.

Beware: even if you file separately, you can be liable for tax on your spouse's income if you live in a community property state. When you are married, all income becomes community property income and one-half belongs to each spouse. The IRS can take ½ of your paycheck to pay an old tax bill for your spouse. In any state, the IRS can collect your spouse's taxes from you if your spouse transferred assets to you in an attempt to evade taxes. Relief provisions are not available in this case because both spouses participate in a scheme to evade taxes.

Divorce does not terminate joint liability. Let’s say you were married to Spouse # 1 for 5 years and filed joint returns. You get divorced, and after a few years, marry Spouse #2. It turns out that Spouse #1 had significantly understated his income on one of those joint income tax returns. You get a notice form the IRS that you owe $10,000 in tax, interest and penalties. Unless you can qualify for one of the relief provisions described below, you have to pay the $10,000 because you signed a joint return. Often, as part of a divorce decree or marital property settlement, the spouses will make agreements about who is to pay income taxes. These agreements are not binding on the IRS. The IRS was not a party to the agreement. You can use the agreement to collect from your spouse (if he or she has anything), but the agreement is no bar to collection from you by the IRS. Chances are, if the IRS is coming after you for the tax, it’s because your ex-spouse has no assets, and the tax is noncollectable from the ex-spouse, by you or by the IRS. Before 1998, the only relief available for a spouse in this situation was if she qualified as an “innocent spouse.”

There were many rules and technicalities and this status was hard to demonstrate. In 1998, Congress amended the Internal Revenue Code to provide other mechanisms to allow you to avoid paying taxes that should have been paid by a spouse or former spouse. There are three forms of relief:  1) one is am improved version of the innocent spouse rules, 2) another has more lenient provisions, but is only available if you are no longer married or are separated from your spouse, and 3) the third form of relief is an equitable remedy that applies if it would be unfair to collect the tax from you and you didn’t qualify under 1) or 2). The 1998 new and improved version of the innocent spouse rules require that an innocent spouse must meet the following conditions to qualify: “(1) a joint return understated taxes because of erroneous claims by the requesting party's spouse, such as unreported or under reported income, or unjustified deductions or credits; (2) when the return was signed, the innocent spouse did not know or have reason to know that there was an understatement of tax. If the spouse knew, or should have known, that there was an understatement, but did not know by what amount, partial relief may be given; and (3) in light of all of the surrounding circumstances, it would be unfair to hold the requesting party liable for the understatement of tax.”

Requests for relief under any one of these three provisions is made on Form 8857, Request for Innocent Spouse Relief. Separation of liability is an allocation between the spouses of unpaid liabilities resulting from the understatement of taxes owed. Either 1) the parties filing the joint return are no longer married or are legally separated, or 2) the joint filers were not members of the same household at any time during the 12-month period before the relief is sought. If spouses transferred assets between themselves to avoid tax, this relief does not apply. If the spouse had actual knowledge of the other spouse's erroneous items on a joint return, this relief is also not available. For those situations where the innocent spouse rule or separation of liability does not apply, a third possibility of equitable relief is there. If there has been no fraud and it is “unfair” to hold the spouse seeking relief liable, the IRS can still grant relief. Various factors are considered such as separation or divorce, economic hardship, whether or not there was knowledge of the items causing the understated tax, or whether the spouse seeking relief received a significant benefit from that understatement. Don’t depend on these rules. Even these do not always provide relief. The bottom line is, if you think something is wrong with your tax return, don’t sign it. If your spouse won't file a correct return, file a separate return with married filing separately status. It may mean paying more tax in the short run, but signing a false tax return can mean paying a lot more tax in the long run.

Maybe the marriage ceremony should go like this: "You have the right to remain silent, anything you say may be held against you, you have the right to have an attorney present. You may kiss the bride."

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Getting divorced? Should you file Joint or Separate Returns?

Your marital status on December 31 determines your filing status for the entire preceding year. If you are still married on December 31, you have a choice. You can file jointly with your soon-to-be ex-spouse or file using married filing separately status. You might qualify to file as Head of Household even though you are still married if you have been living apart for the last 6 months of the year.

Unfortunately, using married filing separately status is not very favorable from a tax viewpoint. A joint return usually results in a lower overall tax liability.

If you file a joint return, as far as the IRS is concerned, both you and your spouse are liable for the whole amount of tax due regardless of what any agreement between the spouses states and regardless of who earned the money. This can obviously be a problem. For example, if your self-employed husband has not paid his taxes and you file a joint return with him, the IRS can collect 100% of the tax from you. It does not matter what you have agreed with him, or whether or not you earned the money - filing a joint return produces joint liability. If you are concerned that your spouse might have unreported income or be claiming improper deductions, your best route may be to forego any joint tax return savings and file separately.

There is an exception to joint liability if you can prove you were an "innocent spouse." Let’s say your husband failed to report some of his income. If you didn’t know and had no reason to know about a tax understatement, then you may not be liable. If you know that he is not reporting accurately and you sign the joint return, you are liable.

If your return shows a refund but you owe arrearages in child or spousal support payments, or student loans, all or part of your refund may be used to pay the past-due amount. If you file a joint return and your spouse owes some of these debts, you can prevent your share of a tax refund on a joint return from being applied to a debt owed by your spouse by attaching a completed Form 8379, "Injured Spouse Claim and Allocation", to your return. Also, write "Injured Spouse" in the upper left corner of Form 1040.

If you choose to file separate returns, each spouse reports his or her own income, exemptions, deductions and credits. You each report your own withholding tax from W-2's. If you and your spouse made estimated tax payments, they may be divided in whatever way you and your spouse agree. If there is no agreement, the IRS will divide them proportionately based on your two respective tax liabilities. If you paid the estimates, some may be credited to your spouse.

The advantage of filing separately is that each spouse is responsible only for the tax due shown on his or her own return. Unfortunately, separate returns often result in overall higher taxes for the couple. If one of you itemizes deductions, the other spouse will not qualify for the standard deduction and, therefore, must also itemize deductions on his/her tax return. If you file separately, you cannot take the credit for child and dependent care expenses, and IRA deductions are reduced.

If you agree to file jointly in order to save overall taxes, you and your spouse can execute an agreement on how to share any tax savings generated by filing a joint return.

If you file separately, you can change your mind, go back and amend to joint returns any time within 3 years of the due date. You cannot go the other way. If you file jointly, you cannot amend to file a separate return.

The Madoff Tax Advantage

OK so you lost a fortune with Madoff, at least you get a tax write-off.

Steve Dubner explains it in this New York Times article - click here.

See also Prof. Paul Caron's Post:

Tax Law to Provide Bailout to Madoff's Victims

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The Season for Business Gifts

In general, any payment, whether called a gift or not, to an employee is taxable income to the employee.

Gifts of nominal value, such as a holiday turkey, are treated as de minimis fringe benefits. A gift to an employee is de minimis if the value is nominal, accounting for the item would be administratively impractical, the gift is provided infrequently, and the gift is made for the purpose of promoting health or goodwill to the employees. There is no set dollar limit, but in one particular instance a gift with a value over $100 was treated as taxable income. A de minimis employee gift is deductible as a non-wage business expense by the employer.

Regulations give these examples of gifts that qualify for de minimis treatment: birthday or holiday gifts of property (not cash) with a "low fair market value", gifts such as books or flowers under special circumstances (e.g., outstanding performance), traditional awards (such as a gold watch) upon retirement after lengthy service for an employer, and an occasional cocktail party, group meal or picnic for employees and their guests, or occasionally giving out theater or sporting event tickets.

If you give your employees cash, gift certificates or other similar items that can be converted to cash, the value of these gifts is considered additional wages or salary, regardless of the amount.

Reasonable costs of giving a holiday party for employees are fully deductible. There is no requirement to discuss business before, during, or after the event. To be fully deductible, the party must be primarily for the benefit of employees and not limited only to top executives.

When a business makes gifts to others, whether they be customers, vendors, or referral sources, other rules apply. A business may deduct up to $25 in gifts given to each recipient during any given year. Items clearly of an advertising nature such as promotional items do not count as long as the item costs $4 or less. Many companies give things like pens, frisbees, and key chains under this rule. Incidental expenses for the costs of engraving, wrapping, and mailing the gifts are also allowed as a deduction. A husband and wife are considered to be one taxpayer, so only $25 in total gifts to the two of them can be deducted.

The limit is not on the value of the gift that can be given. The limit is on how much of the cost of the gift the business can deduct. You may give a client a gift worth $100 - but you may only deduct $25.

What if you give your clients tickets to a concert or a football game? Is it a gift, or is it entertainment? If it’s a gift, only $25 is deductible. If it’s entertainment, 50% of the cost is deductible.

If you give a customer tickets to a theater performance or sporting event and you do not go with the customer to the performance or event, the IRS gives you a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is to your advantage

If you go to the event with the client, then it's a business entertainment expense. That means no $25 limit, but you only get to deduct 50% of the total cost. You must treat the cost of the tickets as an entertainment expense. You cannot choose, in this case, to treat the cost of the tickets as a gift expense.

If you give a customer packaged food or beverages that you intend the customer to use at a later date, it is treated as a gift.

Keep accurate records of all business gift expenses, recording the date, the name of the business associate, and the cost of the gift. Make sure you can show receipts.

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Obama and McCain on the Estate Tax

2010 is the year for Throwing Momma from the Train.  In 2009 the estate tax exemption is $3.5 million.  In 2011 the estate tax exemption goes way down to $1 million.  In between?  In 2010 there is no estate tax at all.

Obviously, something has to be done.

The Urban-Brookings Tax Policy Center has published a report entitled Back from the Grave: Revenue and Distributional Effects of Reforming the Federal Estate Tax. (Blogging credit to North Carolina Estate Planning Blog.)

An outline of the presidential candidates' and other recent proposals for reform is contained in Table 11 on page 20.

Obama's proposal is an exemption of $3.5 million and a 45% rate.

McCain's proposal is an exemption of $5 million and a 15% rate.

Last March Wealth-Counsel, LLC began a contest.  They announced they would give $10,000 to the first estate planning attorney who submits the most accurate prediction that is closest to the actual result enacted by Congress and signed into law.  What did I predict?  $3.5 million and 45%.  Wonder if I was first?

 

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