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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.
 
 
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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. 
 
 
To listen, click on the Play button below.  Blog transcript follows.
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 4.10.4.6. 

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.
 
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Murray Singerman, JD, LLM

Author

Self-dubbed "Tax Knight," Murray Singerman writes in defense of the "humble citizen," often beaten down by the IRS and state taxing authorities.  Enjoy his short ruminations about the ever-changing area of tax controversy law.  Written with accountants in mind, Murray offers useful info and a chuckle to make your day a bit more enjoyable.

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