Good - But Not Good Enough 07/25/2011
To hear an audio recording of the blog, click on the Play button (>) below. Transcript follows.
Tax professionals – accountants, enrolled agents, and lawyers – are no different than any other person. When they make a small mistake, they move on, confident that the error can be rectified without serious consequence. Getting it right 99 percent of the time is a pretty admirable record…most people would say.
But here's what you get if 99 percent is good enough:
· No phone service for 15 minutes each day.
· 1.7 million pieces of first-class mail lost each day.
· 35,000 newborn babies dropped by doctors or nurses each year
· 200,000 people getting the wrong drug prescriptions each year
· 2 million people dying from food poisoning each year.
Along the same lines, when it comes to taxes, making a small mistake can have disastrous consequences, as it did for Denise Ciotti, a Maryland taxpayer, who found herself stuck with more than $500,000 of tax, interest, and penalties after her accountant's “small” mistake.
Ciotti's train wreck occurred where bankruptcy and state tax law intersect. Ciotti filed a Chapter 7 bankruptcy in 2007, seeking to discharge tax debts. Among the debts on her bankruptcy petition, Ciotti listed tax liabilities owed Maryland for 1992 through 1996.
Ciotti’s State tax liabilities stemmed from an IRS audit adjustment. Under Maryland tax law (Md. Code Ann., Tax-Gen. § 13-409(b)), Ciotti was required to report the IRS audit changes to the Comptroller, because Maryland income is based upon the federal adjusted gross income. Ciotti and her accountant failed to report the changes to the Comptroller. Even so, the State learned of the IRS adjustment to Ciotti’s return through an interstate information sharing program. Based on the IRS’ shared information, the Comptroller adjusted her taxes, increasing them to a whopping $500,000, once penalties and interest were added.
Forced into bankruptcy, Ciotti sought protection from the Compliance division of the State and a fresh start. The State, however, had other plans for Ciotti, dragging her through litigation which lasted for two years and eventually reached the United State Court of Appeals for the 4th Circuit.
The State argued that Ciotti's taxes could not be discharged under the Bankrutpcy Code (11 USC 503(a)(1)(B)), which provides that a Chapter 7 discharge does not apply to a tax if a return or equivalent report or notice required from the taxpayer is not filed. The State argued that Ciotti had an obligation to comply with the State law and report to the Comptroller the IRS changes resulting in the tax increase. Because Ciotti failed to do so, her taxes could not be discharged, argued the State. Ciotti argued her taxes should be discharged, because the IRS shared the audit adjustment with the State, meeting, in her opinion, the requirement to provide an “equivalent report or notice.”
After winding its way through the Bankruptcy courts and the United States District Court, the Court of Appeals for the 4th Circuit agreed with the State. The Court of Appeals held that Ciotti's failure to report the IRS audit adjustment to the Comptroller prevented her taxes from being discharged.
Ciotti, or perhaps, more accurately, Ciotti's accountant made a small mistake. Perhaps Ciotti's accountant was unaware of the Maryland law requiring a taxpayer to report IRS audit changes; perhaps the accountant knew and forgot.
Getting it right 99 percent of the time is pretty good, but sometimes, that errant 1 percent is just enough to ruin a client's life.
To hear an audio recording of the blog, click on the Play button (>) below. Transcript follows.
Good tax policy says that the broadest expanse of our citizenry should pay their fair share of taxes. Bad tax policy enforces the idea of a shared burden in a heavy-handed manner.
A wide variety of professionals – including architects, barbers, electricians, engineers, lawyers, even accountants – have found themselves unable to work when the State refuses to renew their professional license, because they owe State unpaid back taxes.
Delinquent taxpayers run face first into the tough provisions of the Business and Occupations Article (Sec. 1-204), which requires the offices issuing licenses to verify through the Comptroller that the applicant has paid his taxes or provided payment “in a manner satisfactory to the unit responsible for collection.” (MD Code Bus. Occ. & Prof. § 1-204).
Many of these people cannot pay their taxes because of unemployment, a failed business, divorce, illness, or death. They make mistakes along the way and need a fresh start, something the State is reluctant to help with.
The Collection Division of the Comptroller, the unit responsible for determining what constitutes a “satisfactory” manner, typically demands 25 percent down and the rest of the liability paid off in 12 months to reinstate a professional license. For many people, this demand is insurmountable. Some exceptions have been made, but for the most part, the Collection Division utters “no” more than it says “yes”.
Whether due to the State’s fiscal shortfall or outrage over the idea that some people are not paying their fair share, the Comptroller has convinced the legislature to broaden the reach of this law. As of June 1, 2011, the Department of Motor Vehicles will not renew a driver’s license or a vehicle registration if a taxpayer has unpaid liabilities or is not in an approved payment plan. (MD Code Transp. § 13-406).
One client, who just found a job as a truck driver after a long period of unemployment, has a new baby, and no savings. He threw up his hands when the Collection division demanded 10 percent of what he owed, more than $2,000, and an installment agreement stretching over 99 months to renew his driver’s license. Without allowing reasonable terms, the Comptroller will force this taxpayer, and others like him, to violate our State’s driving laws just to get to work or go food shopping.
The Collection Division should follow the lead of the IRS and its good tax policy, which fosters the idea of a “fresh start” by enforcing collection action only when taxpayers have more money available than what would be needed for a reasonable standard of living. People like the client mentioned above who deal with the IRS would not have to come up with $2,000 down to enter into a payment arrangement. The IRS might even declare them uncollectible, giving strapped taxpayers the hope of returning to tax compliance without the heavy hand of the IRS weighing them down.
Driving people to violate State laws by taking away their driver’s license cannot be considered good tax policy.
6000 Audit Disasters 05/19/2011
To hear an audio recording of the blog, click on the Play button (>) below. Transcript follows.
Faced with a recession that won’t seem to go away, small companies are employing a strategy that reaps huge benefits, clearing $50,000 to $100,000 of net profit without having to develop a new product or win new customers. To a small business owner, that can mean the difference between more years of sweat equity or the start of a profitable business.
These small companies have embraced the aggressive strategy of laying-off workers and then hiring them back as independent contractors. Engaging an independent contractor instead of an employee brings huge savings. Companies save on FICA and FUTA taxes, Maryland unemployment taxes, Maryland worker’s compensation insurance, benefits, and overtime pay. In addition, companies have more protection from negligence or damages caused by independent contractors.
The risks, however, are huge.
Over the next two years, the Internal Revenue Service will steam roll over 6,000 randomly selected businesses, auditing them to determine whether they have misclassified employees as independent contractors. As Maryland tax attorneys, we solve tax problems for companies throughout the Baltimore and metropolitan DC area. We’ve learned there’s nothing more shocking for a client than being hit with a bill for taxes, interest, and penalties that result from misclassifying employees. Because the audits often include several years, it’s not unusual to see a tax bill for hundreds of thousands of dollars – often the death toll for a small business.
Before rolling the dice and taking the risk, small business owners should consult with a tax lawyer to provide guidance through the morass of applicable law. In Maryland, companies are subject to federal tax law – the 20-Factor classification test and the section 530 Safe Harbor rules – the Maryland Code and COMAR, and federal and state common law.
For those unlucky enough to be among the 6,000 businesses selected by the IRS, solid legal representation during and after the audit can lead to a victory. Even if the IRS finds that misclassification occurred, the IRS Classification Settlement Program offers a cost-efficient resolution, often for 10-cents on the dollar and a pledge to be bound by the proper classification moving forward.
The Wolf In Sheep's Clothing 04/15/2011
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When it comes to taxes, there’s nothing more disappointing than tearing open your IRS refund letter and instead of finding a check, you are presented with a bill for several thousand dollars. Surprise – you forgot to claim income, which the IRS picked up when the company or person who paid you sent in a Form 1099 listing your additional income.
To be truthful, there is something more disappointing. When the tax bill comes, it turns out you are being charged with someone else’s income. The IRS seizes your refund and demands more taxes from you by adding another person’s income to your tax return. As an example, you may have really earned $50,000, but once the IRS gets done adjusting your return, your income rises to $80,000 and you owe another $8,000 in tax after penalties and interest are added.
In our digital age, identity thieves ply their trade by selling names and social security numbers to illegal immigrants anxious to find work. With forged documents, illegal immigrants impersonate American citizens working at menial jobs across the country. Employers, who are unaware or choose to be unaware, pay wages and report earnings to the IRS for impostors using stolen identities, unwittingly adding income to unsuspecting taxpayer victims.
There are no easy fixes to this type of tax problem. Recently, our STS Tax Law attorneys resolved an identity theft case using old-fashioned evidence. Our client filed the proper form, the Form 14039, Identity Theft Affidavit, with the IRS, where it languished for six months. In the interim, our client’s 2009 refund was seized to pay the bogus “additional” taxes she owed for tax years 2006 through 2008.
Once we got involved, we filed a Form 911, Request for Taxpayer Advocate Assistance, documenting at length why our client could not have been the person who earned the wages listed on the employer’s Form W2. When the Taxpayer Advocate representative insisted our client must have performed the work and “forgotten” about it, we had to prove her wrong.
By aggressively pursuing the employer’s human resources department, we discovered the imposter’s manager at a Washington, D.C. hotel. We arranged a meeting between the manager and our client. The manager, who oversaw the imposter for three years, attested he had never seen our client before. This affidavit convinced the Taxpayer Advocate and achieved success, ensuring the abatement of the additional taxes and the return of our client’s refund.
When it comes to identity theft, beware. The IRS is a lackluster shepherd at best, unable to tell a wolf in sheep’s clothing from the rest of the flock.
Tax Controversy Magic 03/15/2011
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Latest government statistics for Delinquent Collection Activities show the IRS rejects more than three of every four Offers in Compromise. The IRS accepted only 11,000 of 52,000 of Offers in Compromise submitted in 2009. Even though the government is strapped for funds, the IRS accepted a mere 21 percent of people trying to get back into the system.
To get the IRS to agree to an Offer in Compromise, the taxpayer must offer an amount that “reasonably reflects collection potential.” (IRM 188.8.131.52.3). Translated that means an Offer in Compromise must contain the minimum amount of the taxpayer’s equity in his or her assets plus an amount based upon “Future Income.”
“Future Income” is one of the trouble spots where many Offers fail. The “Future Income” calculation creates an “asset” based upon the taxpayer’s ability to make monthly payments after necessary living expenses are deducted. Extra monthly income, that is “extra” as defined by the IRS, is multiplied by either 48 or 60 months, depending on Offer payment terms.
Assume for a moment that a contractor has no real assets, but after necessary living expenses are deducted has $400 extra each month. The minimum Offer amount could be as high as $24,000. Based upon regulations, the IRS takes the $400 and multiplies by as much as 60 months. What seemed like a promising situation now seems doomed.
Here’s where tax law becomes magic. With detailed knowledge of the Internal Revenue Manual regulations on Offers in Compromise, a dogged attitude to fix tax problems, and a questioning mind, a tax attorney can make the $24,000 Future Income asset disappear.
Let’s assume that the contractor hauls a lot of material and refuse each month for work. Were he to hire a hauler, the contractor would incur costs of $400 monthly. Right now, as we draft our Offer, the contractor uses his twelve year-old pickup to haul, a beat up truck worth about a $1,000.
By selling the pickup truck and offering the $1,000 for the Offer, the contractor can claim the expected costs of delivery as a business expense. (See IRM 184.108.40.206.1). With the contractor expected to have higher monthly hauling costs of $400, he no longer has any Future Income. Our minimum Offer amount has now plummeted by $23,000 to $1,000.
Now you see it; now you don’t. Of course, one problem remains – how will the contractor haul his materials and refuse? There are some secrets a magician can never reveal.
To listen, click Play below. Blog transcript follows.
Bestowed by the “Kindler, Gentler,” IRS, the “Streamlined Installment Agreement” promised to help taxpayers who owe less than $25,000 quickly reach a resolution of back tax debt. Hidden in its benevolent promise, though, is a trap of quicksand, waiting to sink those who dial the IRS’ toll free telephone number and sign up.
Under regulations updated in August, 2010, the Streamlined Installment Agreement allows taxpayers to enter into an extended payment arrangement without submitting financial information. So long as the taxpayer owes less than $25,000 and has filed outstanding tax returns, your friendly IRS employee must grant a payment plan if the taxes owed can be paid off in less than 60 months or before the statute of limitations for collection expires. The name for this extended payment arrangement, “Streamlined Installment Agreement,” derives from the elimination of the requirement to review financial information or obtain managerial approval.
So what could be dangerous about an easier, quicker way to set up a payment plan? How could the opportunity to negotiate with the IRS and not have to expose financial information about a bank account or current employer be considered a quicksand trap?
The answer is simple. Many taxpayers jump at the chance to set up a payment plan without having a clear understanding of their finances. Faced with high interest and penalties and afraid of the IRS, they often pick a monthly payment that breaks their budget. “Let’s see. I owe $20,000? Hmmm…I’ll pay that off in forty months with a $500 monthly payment. No problem,” they think.
It’s not that easy though. On an annual income of $50,000, a mortgage, two car payments, and supporting two children, finding the $500 each month becomes more and more challenging. Before long, the taxpayer defaults on the Installment Agreement.
Eliminating the requirement to review financial information has removed an important reality check that made many installment agreements successful over the long haul. Without the review of an experienced tax representative, many of these new installment agreements are destined to fail, placing the taxpayer in worse danger of enforced collection.
While optimism is a positive character trait, too much optimism can sink you. An unknown author once said: “Don’t be too optimistic. The light at the end of the tunnel may be another train.”
Could this “unknown author” have been a taxpayer staring into the blinding light of a monthly IRS payment too high to pay? Or a taxpayer lying in the wreck of a derailed Streamlined Installment Agreement? Perhaps “Kindler and Gentler” isn’t always better.
IRS: Dangerous Hitchhiker 01/15/2011
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Almost daily the media reminds us that small business drives the American economy. The IRS is listening and with increasing zeal has hitched a ride on the small business engine.
Latest statistics show that the IRS Examination Division – the army of feared auditors – focuses on small business owners with positive incomes between $100,000 and $200,000. Many of our neighbors fall into this category. Even with a limited number of revenue agents to conduct audits, in 2009 the IRS targeted almost 40,000 small business owners. Of those, 88% ended up with increased tax assessments between $23,000 and $32,000. For someone living on $150,000, for example, that’s a big chunk to come up with. Add penalties and interest and the number often rises to as much as $50,000. Could you come up with a third of your annual income for quick payment to the IRS?
If you’ve ever faced off against an enthusiastic revenue agent, you know it’s wise to bring a pair of sunglasses to shield against the glint in the eye of the hunter. Focused on the trapped taxpayer sitting in the cross-hairs, IRS auditors love to blast away using the feared indirect methods of assessment to raise the small business person’s taxes.
The Internal Revenue Manual defines indirect methods as “…the use of circumstantial evidence to determine the tax liability based on omitted income, overstated expenses, or both.” IRM 220.127.116.11.
Circumstantial evidence. Just think about it. As the fictional but wise Sherlock Holmes taught:
“Circumstantial evidence is a very tricky thing…It may seem to point very straight to one thing, but if you shift your own point of view a little, you may find it pointing in an equally uncompromising manner to something entirely different."
Here’s an example of one indirect method used when the taxpayer doesn’t deposit a lot of cash and doesn’t volunteer cash outlays.
The indirect Markup Method invents an estimated income based on the use of percentages or ratios considered typical for the business under examination. The revenue agent analyzes sales and/or cost of sales and the application of an appropriate percentage of mark up to arrive at the taxpayer’s Gross Receipts. The revenue agent determines sales, cost of sales, gross profit or even net profit.
We all know that there is no such thing as the “typical” business. Statistics may give an idea but cannot deliver the truth. With a bit of imagination, the over-zealous revenue agent can get a joy ride on the back of the small business owner.
Small business owners: your mother was right when she told you to never pick up hitchhikers – especially when they’re wearing an IRS badge.
Don't Kill Builder Bob! 12/26/2010
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At the rate the government is spending its way out of this nagging, resilient recession, the Administration and Congress have been forced to find inventive ways to fill the Treasury’s coffers. One of those quick fund raising initiatives involves clamping down on the classification of workers as employees and not subcontractors.
One legislative proposal involves HR 5107 and S. 3254, the Employee Misclassification Prevention Act. In plain English, what used to be an expensive mistake now becomes a crime. If this bill is passed, misclassifying workers could lead to fines of up to $5,000 per employee. In addition to facing a huge fine, employers will shoulder the burden of increased record keeping and more bookkeeping costs.
When it comes to classifying employees, we’ve been through the 1978 Safe Harbor Section 530 rules, the 20-Factor test of Revenue Ruling 87-41, and most recently, the three category common-law rules determining control and independence that appear on the IRS website.
Each decade, it seems, the government promulgates more regulations and promises clarification. Our clients, however, end up flummoxed and we withhold a litany of verbal abuse as a stone-faced IRS auditor waves the magic “20-Factor” wand or recites “the control and independence” incantation and turns our 1099s into W2s, even though we know the audited workers are subcontractors and not employees.
No matter what clarification the IRS offers, employers are stuck with risky decisions. As the IRS admits on its webpage:
"There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another." (http://www.irs.gov/businesses/small/article/0,,id=99921,00.html)
Because there is no “magic” or “set number of factors” to determine proper classification, this latest legislation, which aims to stem abuse of misclassification, will end up penalizing honest entrepreneurs trying to stay in business and make a living.
When these issues surface, I’m reminded of my client, Builder Bob (not his real identity). When the IRS reclassified all of his subcontractors as employers, Builder Bob was ready to close his doors. The FICA and unemployment taxes on his annual $1 million subcontractor fees would come to roughly $85,000, his take home salary. Fortunately, in Appeals, thorough lawyering prevailed and the IRS auditor was forced to eat crow. Builder Bob lived to see another day. But how many honest firms will go under because of aggressive IRS auditors? How many businesses will be undercut when they’re not fortunate enough to prevail in Appeals? How many dollars will be spent in litigation which would be better spent growing our economy?
Tax Resolution Irony! 11/16/2010
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How could we live without "irony?" Irony brings a smile to our faces and reassures our sense of right and wrong. Irony is the incongruity between what is expected to be and what actually is.
A cardiologist who's overweight, has high blood pressure, and never exercises...and ends up with a heart attack - that's irony. Wikileaks founder, Julian Assange, who sues over the leak of his medical records and police file - that's irony. The office colleague who always procrastinates and then complains when no one shows up on time to his meeting - that's irony.
Here's Tax Resolution Irony: In July 2010, "nationally recognized" (read instead as PR firm self-puffery) attorney Roni Deutch of California, aka the "Tax Lady," issued a news article warning consumers about dishonest tactics used by some tax relief companies to take advantage of taxpayers dealing with IRS back tax problems.
Remember what Gomer Pyle used to say: "Surprise, Surprise!" Less than one month later, the California Attorney General filed a $34 million lawsuit against Deutch and accused her firm of misleading consumers by falsely promising to reduce tax debts to the IRS. The Attorney General alleged that the firm takes large, up-front payments with little or no help in reducing tax bills.
Deutch allegedly spends $3 million a year on advertising, using false testimonies from clients who claim her firm saved them thousands of dollars in tax debts. Three clients who appear in one advertisement still owe the IRS the full amount of their taxes plus interest and penalties, alleged the Attorney General. As part of their sales tactics, the Attorney General said that telephone representatives claim a 99 percent success rate in dealing with the IRS. In reality, the firm reduces only 10 percent of its clients' tax bills. (To read the Complaint, click here.)
Moral of this ironic story: ethical tax attorneys lawyer the old-fashioned way, one client at a time. There are no shortcuts when it comes to delivering quality legal services.
Roni Deutch 'Tax Irony Lady'
What will she be selling next?
"Wanna buy the Brooklyn Bridge?"