Carl Smith, a tax attorney and frequent contributor to the excellent tax procedure and controversy blog, Procedurally Taxing (“PT”), reported to PT on September 26 from a New York County Lawyers Association seminar entitled “Nontraditional Tax Advocacy,” where Matthew Weir, the Assistant Inspector General of the office of the Treasury Inspector General for Tax Administration (TIGTA) spoke. Among other things, Mr. Weir announced that the IRS had, for lack of sufficient financial resources, suspended its Automated Substitute for Return (ASFR) program.
Internal Revenue Code Section 6020 gives the IRS the authority to make assessments, called “Substitute for Return assessments,” against taxpayers who do not file tax returns. For some taxpayers, this is simple if the IRS has W-2 or 1099 information on file for the taxpayer. Such cases were handled by the Automated SFR function, where the IRS computer would compare W-2 or 1099 infomation against filing records, identify taxpayers with income over the filing threshold but no return on file, and prepare an assessment with the available data.
For years, this ASFR function has been an important component of the Service’s efforts to monitor and enforce filing requirements. But it turns out that while ASFR is good at identifying unfiled returns and making assessments, such assessments go uncollected a third of the time and the amount of such assessments fell in the last filing cycle. Due to continuing budgetary constraints, the IRS is being forced to select which of its enforcement functions continue to receive funding and ASFR was identified as one function that could be cut. Although much of the leg at ASFR was computerized, the deficienciy procedures require taxpayer notification and provide the taxpayer with an opportunity to respond to proposed assessments. While the IRS computer could issue proposed assessments, it could not read and respond to taxpayer correspondence, and there simply isn’t enough money in the budget to pay the employees needed to do so.
“Can you get this tax lien removed from my credit report?” For many years, this has been one of the more common questions we hear from clients and potential clients at Haynes Tax Law. Some are people that have already resolved their tax problems and had the Notice of Federal Tax Lien released, but the credit reporting agencies ( Experian , TransUnion , and Equifax ) have, for many years, continued to report the past existence of a federal tax lien on a consumer’s credit report. But this may be about to change.
A consumer’s credit report is a historical document, provided to potential lenders to assist them in making decisions about a consumer’s credit-worthiness and risk. It contains information about current debts and open accounts, recent credit inquiries, and also a great deal of historical information. Most open accounts also include a payment history for six to twelve months, alerting potential lenders to any history of late or missed payments. Federal tax liens were included for the same reasons – to notify lenders of outstanding balances and a history of unpaid debts. The three credit-reporting agencies usually included a listing of federal and state tax liens, even if the underlying tax liabilities were paid in full or otherwise satisfied, for up to ten years after the liens were released. The process for having such liens expunged from the reports was usually long and unreliable, and involved obtaining a Certificate of Withdrawal from the IRS, having it submitted to the credit-reporting agencies, and then making sure that the Certificate was actually processed by the agencies and the lien removed from the credit report.
In recent years, consumer advocates have begun to fight back against the non-governmental credit-reporting agencies, most notably for the frequency of inaccurate information on many reports, and the difficulty of getting such inaccuracies fixed. It appears that such efforts have born some fruit. As recently reported, the three credit-reporting agencies will be more strict when selecting information for inclusion on a consumer’s credit report. Starting July 1, 2017, they will no longer include any records that do not include the consumer’s name, address, and either Social Security Number or date of birth. Neither the complete Social Security number or taxpayer’s date of birth appear on a Notice of Federal Tax Lien. Such information is also often missing from civil judgments in most jurisdictions in the United States. Some analysts believe that these new standards will result in past federal tax liens and civil judgments being eliminated from consumer credit reports .
Although TransUnion, Equifax, and Experian may be removing such entries from consumer credit reports, there will continue to be companies that gather, compile, and sell such information to potential lenders or others. LexisNexis has already announced that it will continue to make such information available to potential lenders and others. It will then be up to any potential lender if they think that such information, which may exist but will no longer be shown on the credit information they already pay for from the three credit-reporting agencies, is worth an additional subscription to LexisNexis. But for now, the possibility of having any history of federal and state tax liens removed from their credit reports may be of significant assistance to many with past or present tax problems.
In September, the Treasury Inspector General for Tax Administration released a report outlining additional actions needed to ensure taxpayer compliance in the age of bitcoin and other virtual currency. Our tax system relies heavily on taxpayers sel-reporting their taxable transactions and is backstopped by third-party reporting where “information returns” like Forms 1099, W-2, 1098, etc. are issued to the IRS. These information returns provide notice to the IRS of activity that should eventually show up on a taxpayer’s return. The anonymity of virtual currency combined with the lack of a system in place to require reporting of virtual currency transactions to the IRS are a “perfect storm” that could cause substantial amounts of tax revenue to go unreported and undetected.
Although the IRS is undoubtedly aware of the potential problems presented by virtual currency, the report notes that “[n]one of the IRS operating divisions have developed any type of compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currencies. In addition, it does not appear that any of the actions already taken by the IRS to address virtual currency tax noncompliance were coordinated to ensure that the IRS maintains a strategic approach to the tax implications of virtual currencies.” This is clearly a less-than-stellar rating being given to the tax agency for preparing to carry out its function effectively in the modern era.
The report recommends developing a comprehensive strategy to deal with the problem, which is always a good start, but it also advises that the Service add to the information return reporting system a separate requirement that payors identify the amount of virtual currencies used in taxable transactions. This would require anyone issuing a 1099 to another person to separately identify any payments made in virtual currency. But it is unlikely this will be an effective response to the “bitcoin problem” because it relies on the assumption that a payor paying in bitcoin is likely to issue the payee a 1099 to report that transaction, whether they pay in hard or virtual currency.
For now, the report is interesting reading only in that it lays out the existence of a problem presented by rapidly developing technology to our aging tax system. The IRS may not have the nibmleness and technological savvy to respond effectively before significant amounts of tax revenue slip past.
After being disabled more than a year ago due to security issues that led to the theft of confidential taxpayer information, resulting in countless identity theft cases, the IRS has finally announced the relaunch of the online transcript retrieval system called “IRS Get Transcript Online.” The IRS has beefed up the electronic authentication process used in granting taxpayer access to the online system. In order to access the system, users will now have to go through a two-step authentication process in which an email or text message is generated by the system to provide one-time access credentials to the user.
Commissioner John Koskinen said that “[w]e recognize that enhanced security will increase the challenge for taxpayers accessing our on-line services.” In other words, getting access is going to be a pain in the rear end for many people, perhaps similar to the online installment agreement application tool, which only results in successful authentication approximately one out of every ten attempts. In addition, if you previously registered to use the online transcript access tool, you will need to re-register for the new system. Requirements for successfully accessing the new system are available in IRS Fact Sheet 2016-20 .
One of the big “secrets” of tax controversy practice is access to IRS records using the “e-services” portal available to enrolled practitioners, but not available to taxpayers. IRS transcripts provide a wealth of information about taxpayers’ accounts, including balances, a record of IRS actions, a record of taxpayer actions, lists of information returns (Forms W-2, 1099, 1098, etc.) reported to the IRS, and even line-by-line transcripts of tax returns filed by taxpayers. Such information is critical to identifying taxpayer problems, formulating solutions, and for monitoring IRS activity on a case. The ability to access IRS transcripts is critical to empowering taxpayers who have troubles with the IRS. As G.I. Joe said, “knowing is half the battle.” When it comes to IRS problems, getting transcripts is often half the battle.
A recent decision by the Tax Court should serve as a warning to people that own multiple businesses but don’t always “respect the corporate formalities” associated with each business entity. If you own more than one business and sometimes have Company A pay the expenses of Company B, or perhaps task an employee of Company A to do things for Company B, you’re headed for trouble unless your bookkeeping and accounting staff are on top of their game. Read the consolidated case of Key Carpets, Inc. v. Commissioner and Johnson v. Commissioner , decided on 2/25/16. You can also read an excellent write-up of the case by the guys at Procedurally Taxing .
But to save you some time, here’s the moral of the story: Company A must pay its own business expenses in order to take a deduction. If Company A pays one of Company B’s expenses, several things happen and none of them good:
(1) Company A does not get a deduction for the expense, increasing its net profit, thus increasing its federal income tax (if a C corporation) or the owner’s income tax (if a S corporation);
(2) Company B does not get a deduction for the expense because Company B didn’t pay the expense . . . Company A did; and
(3) Owner of Company A is charged with a constructive dividend, which is nondeductible to Company A and taxable to the owner. The transaction is deemed to occur as though Company A distributed the money to Owner, then Owner paid the expense for Company B.
We have seen people get slapped for this many times. To a layperson, the result seems ridiculous and unfair — they will say “but I paid the expense!” However, it is very important to consider who “I” is. The IRS would agree if “I” means the business owner. In the Service’s view, Company A paid a dividend to Owner, and Owner paid the expense, which means Company A isn’t entitled to a deduction for the expense or the dividend, and Owner had additional dividend income he/she didn’t pick up on their individual return. But often the business owner is conflating the term “I” to include herself, and one or more of her businesses! Remember, having a business is like having another child. You would not raid that child’s savings account, investment account, or 529 plan in order to pay your own expenses, right? You cannot do the same thing with your businesses. If Company B is short of funds, you have several options:
(1) have Company A make a loan to Company B, properly documented with a promissory note providing for a commercial rate of interest, then cause Company B to repay that Note in accordance with its terms;
(2) have Company A distribute money to Owner, either as a dividend but preferably as a bonus or salary for which Company A would receive a deduction, then Owner can loan the funds to Company B, again properly documented with a Note and repaid by Company B; or
(3) have Company B approach a commercial lending institution and borrow the funds from a third party, dealing at arm’s length.
These options are more difficult than just having Company A write a check to Company B’s creditor, but if the IRS gets involved, any of these approaches will save you time, taxes, and trouble in the long run. If you read the case above carefully, you’ll have noted that these companies got in trouble by commingling not just funds, but the labor of an employee. An employee of Company A was tasked with doing work for Company B. If you do this, the employee must be hired by BOTH companies and his or her time carefully tracked by the payroll systems for each company. Failure to do so may mean the loss of a substantial deduction by the company that pays him, and an unhappy surprise for the owner.
The IRS has launched its “Early Interaction Initiative,” to quickly identify and intervene with employers that miss a scheduled federal tax deposit. The point of the program is to flag the employer immediately when a deposit is missed, rather than continue to work such cases as the IRS has done for many years — by waiting until the problem has grown to unmanageable size and until there is room in a revenue officer’s inventory to address the case. The old approach often meant years would go by between when the employer started falling behind and when the IRS would begin enforcement efforts. The problem is significant; as the IRS new release points out, “[t]wo-thirds of federal taxes are collected through the payroll tax system.” The IRS will often pay refund claims by employees claiming credit for withholding that the IRS doesn’t succeed in collecting from employers. The result is a “double-whammy” to the Treasury, paying out money they never collected.
In the past, employment tax cases have received the same treatment as other cases: The computer sends notices about the unpaid balances until the total balance gets large enough for the case to be assigned to a revenue officer. But with the continued budget cuts to the IRS, experienced revenue officers are retiring and leaving the Service at an alarming rate. There is now a clear shortage of revenue officers of sufficient grade to work large balance employment tax cases, with the result being that such cases sit unworked, often for years at a time. If the case sits for too long, the IRS will miss out on the limited time they have to assess the Trust Fund Recovery Penalty against persons responsible for the missed deposits. Further, they may miss a significant portion of the ten years they have to collect the unpaid taxes. The new Initiative is designed to reduce the delay between when an employer falls behind and when a revenue officer shows up at the business’ door. But with the staffing and inventory-control problems already wreaking havoc, will it work?
Several years ago, the IRS launched a pilot program to experiment with early intervention. One of the offices that participated was the field office in Fairfax, Virginia. Although higher grade revenue officers expressed approval for the intent of the new program, they also recognized that more time spent reviewing cases that came up under the initiative also meant less time working cases already in their inventory, which meant less effort spent collecting the large balances already owed to the IRS and more time out in the field talking to employers who had only missed a single federal tax deposit. This problem does not appear to have been addressed between the end of the pilot program and the launch of the initiative.
Revenue officers have told us that cases assigned to them under the Initiative are worked like any other case, but they get fast-tracked in the inventory control system so that work begins more quickly. In other words, a small balance-due case resulting from a missed deposit can be given higher priority than an employer who has been behind for years and owes millions of dollars in federal employment taxes. And once the revenue officer begins work on the newer, smaller case, he or she is required to work that case like any other case in their inventory. A higher-grade revenue officer (authorized to work on larger unpaid balance and higher complexity cases) spending their time running around town talking to employers who have been a day late on a relatively small federal tax deposit is a waste of talent and resources, taking them away from working on collecting millions of dollars owed to the IRS. This is likely to contribute to the moral problems already existing in an understaffed, overworked, and politically-maligned organization. But if the Initiative is effective at preventing a multi-million dollar case from being created, then perhaps it is resources well-spent.
Congress has passed, and President Obama has signed, the Fixing America’s Surface Transportation Act (FAST Act) . Title 32 of the bill includes several tax provisions , including Section 32101, which permits the IRS to seek the denial or revocation of a citizen’s passport when that person owes a “seriously delinquent tax debt.” The FAST Act accomplishes this by adding Section 7345 to the Internal Revenue Code. The new Section 7345 authorizes the Secretary of the Treasury to certify to the Secretary of State that a taxpayer has a “seriously delinquent tax debt,” at which point the Secretary of State can deny a passport application by that taxpayer or revoke a passport already issued.
This is new ground in tax enforcement for the IRS. Some states have taken this approach for years. For example, Maryland will often freeze a taxpayer’s driver’s license or vehicle registration, making it impossible to renew them without dealing with the tax problems. Arguably, these can be self-defeating actions if they prevents a taxpayer from going to work and earning the income from which they will pay their Maryland taxes. But such actions have overwhelming success in capturing a taxpayer’s attention. This new federal passport provision is undoubtedly intended to do the same thing. In addition, it will make it harder for taxpayers with serious tax problems to flee the country. However, we think Congress was far more concerned with the first concern — getting a delinquent taxpayer’s attention. Here’s why.
A “seriously delinquent tax debt” is defined as one in excess of $50,000, for which the taxpayer has already been notified of their CDP rights, i.e. a “Final Notice of Intent to Levy” has already been isssued (see our article on CDP hearings ), or a debt on which the IRS has already issued levies. Exceptions exist for balances that are being paid through an installment agreement, for which a CDP hearing is pending, or for which an innocent spouse claim has been filed. With those exceptions, the law’s teeth will sink only into those taxpayers who have been issued many notices and continue to ignore their tax debts. Those that respond by requesting a hearing, requesting innocent spouse relief, or who set up a payment plan and make the required payments, will not be subject to the passport revocation or denial provisions.
There are two other provisions that demonstrate that Congress is trying to whack recalcitrant taxpayers into addressing their tax problems.First, the IRS must notifiy the taxpayer directly of the certification to the Secretary of State. Such taxpayers will get a letter from the IRS saying “we notified the State Department and you’re going to have your passport revoked.” So the taxpayer will clearly know why this is being done. However, if they have already been issued a long series of collection notices and possibly levies, it is unlikely the existence of a federal tax debt in excess of $50,000 will come as a surprise. Second, if the delinquency ceases to be a “seriously delinquent tax debt,” meaning it is reduced to under $50,000 or falls into one of the exceptions, e.g. it is covered by a payment plan, then the certification can be reversed. In other words, “you can have your passport back, just enter into a payment plan for what you owe.”
The IRS Criminal Investigation Division (“CID”) has released its 2015 annual report, which includes information on the number of investigations, prosecutions, targets incarcerated, the impact of budget changes, and areas of focus in the coming year. You can read the entire report here . The report is 47 pages and contains a great deal of information, but we found several items interesting and worth special attention.
1. Cuts to the IRS Budget Have Not Helped CID Accomplish its Mission .
According to CID’s chief, the hiring freeze has caused a staffing shortage. Due to special agents retiring or leaving, the number of active CID special agents has fallen to “their lowest levels since the 1970s.” As a result, CID initiated 444 fewer cases during FY2015 than in FY2014. That resulted in 231 fewer convictions and 176 less prison sentences. The numbers are even worse when compared to FY2013 figures: There were 1,461 fewer investigations in FY2015 than FY2013. If CID’s mission continues to be supporting tax administration and fostering voluntary compliance by enforcing the tax laws, then this dramatic decrease in the volume of cases being worked by CID cannot have a positive impact on our nation’s tax administration.
2. CID Devoted More Available Resources to Identity Theft Cases.
Identity theft fraud was listed first among the 2015 investigative priorities. However, given the overall decrease in investigations of all types, the number of identity theft cases actually fell from 1,063 in 2041 to 776 in 2015. CID special agents worked to prevent false tax refund claims that made use of personal information stolen during data breaches. The report notes that 22 different CID field offices launched “investigations linked to computer intrusions, account takeovers, and data compromises affection tax administration.”
3. Crackdown on “Abusive Preparers.”
We have seen many more tax preparers spending time as involuntary guests of the federal government because they engaged in a widespread practice of increasing the amounts of their clients’ refunds by creating false deductions, false claims for the Earned Income Tax Credit, or helping clients falsify business records or mischaracterize expenditures from small business accounts. This trend is the apparent result of CID making abusive preparer schemes another focuse for enforcement action. The report contains several abstracts of such cases investigated by CID that uncovered massive and widespread fraud by preparers. This should underline several points for lay people looking to choose a return preparer. First, “if it’s too good to be true, it probably is.” If a preparer is advertising their services by promising you the biggest refund you’ve ever received, go somewhere else. Second, “you get what you pay for.” If you are looking for the biggest refund possible for the lowest available fee, you’ll be at much greater risk of having your return prepared by someone other than a competent and reputable accountant.
4. International Investigations
CID continued to be busy in 2015 cracking down on illegal activity moving across international borders, including unreported foreign bank accounts and assets, and also “illegal source” international activity. Most notably, at least one CID special agent was instrumental in taking down “the Dread Pirate Roberts,” Mr. Ross Ulbrecht, the creator of the Silk Road website used to facilitate illegal transactions of all kinds.
When Your Business Owes Employment Taxes – What To Do Immediately
You’ve been running a business for many years. It is your family’s sole source of income. The business has always made enough money to pay its creditors, its taxes, and to support you and the workers. But for whatever reason, it has fallen behind on its federal and state employment taxes. You have continued to pay the rent, the other expenses, and to give the employees their paychecks – you just haven’t made the tax deposits because there “isn’t enough money.” This is a serious problem that could result in your business being shut down, the IRS and state agencies holding you personally liable for what the business didn’t pay, and worse, potential criminal liability resulting in prison time. But there are things you can do to help yourself right now, before the IRS and state show up at your door.
1. Get Back On The Train
Neither the IRS or the state will discuss any sort of arrangement with your business until you have stopped “pyramiding liabilities,” i.e. until you have stopped issuing net paychecks to employees without making the required tax deposits. In fact, the IRS typically requires six months of clean compliance history before they’ll consider any sort of proposal from you. The first step in fixing any problem is to stop making it bigger. It is critical that you realize you are using the IRS and the state as an involuntary lender to subsidize your operations. It is illegal and must cease. For many businesses, the only way to fix the problem and keep it fixed is to turn over payroll processing, payment, and compliance to a third party payroll processor. Our firm recommends Paychex for this. Paychex can process your company’s payroll, issue the paychecks, file the returns, and even make the deposits for you. If you want to talk about pricing and getting your business signed up, call Pam Rossi at Paychex (phone (703) 698-6910 x 27044).
2. Figure Out How Much Can Be Collected From You
The IRS can collect the trust fund portion (the withheld federal income tax and employees’ half of the Social Security and Medicare taxes) from anyone responsible for collecting and paying over such taxes to the government. For more information, see our article on the Trust Fund Recovery Penalty . It is important to quantify your personal exposure to the business’ tax debts and to start making voluntary payments targeted at the unpaid trust fund. Such payments can only be made by paper check – EFTPS does not permit taxpayers to designate such payments between trust fund and non-trust fund. The checks must clearly state the EIN of the business, the form and quarter, and “TRUST FUND ONLY,” e.g. “EIN xx-xxxxxxx, 2015-12 Form 941, TRUST FUND ONLY.” Chances are, the IRS will ignore the designation instructions and post the check incorrectly. But if your check includes these designation instructions, the IRS will have to correct the posting later.
Making voluntary, designated payments to the trust fund portion of the business’ federal employment tax liabilities not only reduces the business’ balance and your own personal exposure, but it demonstrates to the IRS an effort to fix the problem before they have to get involved. That can often go a long way in securing the cooperation and good will of the revenue officer eventually assigned to the case.
Most states have statutes that permit unpaid state withholding taxes to be “converted” against corporate owners or officers. While the IRS can chase “responsible persons” only for the trust fund portion of the unpaid employment taxes, most states can attempt to collect the entire balance owed by your business. In addition, most states are quicker to respond to a problem than the IRS. If you must make voluntary payments or immediately negotiate a payment plan, the state is often a good place to start.
3. Make Some Hard Choices
Often, it is failing businesses that wind up with employment tax problems. There is a downturn in the economy or a particular market and a previously-successful company falls on hard times. In an effort to preserve a failing enterprise, the owners looks for cash anywhere they can find it, and often the tax money becomes the proverbial cookie jar. But every quarter that goes by with the taxes being unpaid brings the business closer to bankruptcy and the owners closer to personal financial ruin. It is often necessary to take a hard look at a business with tax problems and find out if it makes enough money to pay all of its expenses, including the taxes. If it doesn’t, then it should be shut down. The longer it is kept open with the taxes going unpaid, the longer the legacy of a dying company will hang like an albatross around the necks of the owners. Personal liability for federal and state employment taxes cannot be discharged in bankruptcy and merely closing the company will not stop the tax authorities from chasing you personally.
U.S. Department of Justice to Ramp Up Criminal Prosecutions for Willful Failure to Collect and Pay Over Federal Employment Taxes
According to Robert Horwitz , the U.S. Department of Justice, in conjuction with the IRS Criminal Investigation Division, is going to ramp up the rate of criminal prosecutions for willful failure to collect and pay over federal employment taxes under 26 U.S.C. 7202 . Apparently, this area is being stressed by the new Acting Assistant Attorney General for the DOJ Tax Division, our friend Caroline D. Ciraolo. Caroline is one of our favorite people and an incredibly intelligent and able attorney. She was formely with Rosenberg, Martin, Greenburg, in Baltimore, but tasked earlier this year to head up the DOJ Tax Division. The failure of businesses to pay over the withheld taxes from its employees is a double-whammy to the public fisc. First, the government never collects the withheld taxes from the employer, and second, the IRS usually pays the employees’ refunds based on credit for withholding never collected. If your business is significantly behind on its federal payroll taxes and has been for quite some time, your liability may not be limited to a tax bill. There could be handcuffs and substantial fines in your future. You can read more about Mr. Horwitz on his site (he is a former DOJ Tax Division trial attorney and noted practitioner on the west coast).