Texas Tax Talk

Texas Tax Talk

New Guidance From IRS On At-Risk Rules For LLC Member Guarantees

Posted in Tax Planning

The IRS recently released a chief counsel memorandum AM2014-003 on LLC Member Guarantees of LLC Debt and “Qualified Nonrecourse Financing.”  These memorandums are very helpful because they provide the IRS’ interpretation of complicated issues.  These memorandums do not have the force and effect of law – thus a taxpayer is not bound by them.  However, it is wise to thoroughly consider them.

The at-risk rules are complicated, but in a nutshell, these rules serve to limit the amount of losses that a business can deduct if it suffers losses.  The losses are limited to the amount the taxpayer is economically or actually at risk for the investment.

This situation normally arises where a company has taken a loan to fund its operations.  Some loans cause the taxpayer to be economically at-risk, like a ”recourse” loan.  Others do not, like a “nonrecourse” or “guaranteed” loan.

Limited liability companies have some peculiarities due to state law rules.  Generally, in the case of an LLC, all members have limited liability with respect to LLC debt.

In the absence of any co-guarantors or other similar arrangements, an LLC member who guarantees LLC debt becomes personally liable for the guaranteed debt.   If called upon to pay under the guarantee, the guaranteeing member may seek recourse only against the LLC’s assets, if any.

The IRS holds in its Memorandum that:

Therefore, in the case of an LLC treated as a partnership or disregarded entity for federal tax purposes, we conclude that an LLC member is at risk with respect to LLC debt guaranteed by such member without regard to whether the LLC member waives any right to subrogation, reimbursement, or indemnification against the LLC, but only to the extent that,

(1) the guaranteeing member has no right of contribution or reimbursement from persons other than the LLC,

(2) the guaranteeing member is not otherwise protected against loss within the meaning of § 465(b)(4) with respect to the guaranteed amounts, and

(3) the guarantee is bona fide and enforceable by creditors of the LLC under local law.

Oftentimes, when an LLC is created to carry on a business not much thought is put into tax consequences.  It is important to consider the at-risk rules.  Failure to consider will result in a less advantageous result when tax time comes.

IRS Makes Bitcoins a Tax Headache

Posted in Tax Planning

The IRS just published Notice 2014-21 which explains the IRS’ vision on how general tax principals apply to “virtual currency” transactions like Bitcoin.

If you’re not familiar with Bitcoin, it’s a currency that isn’t issued by a central government. And just to be clear, there isn’t an actual “coin” associated with it either. The currency is created by very powerful computers.

Ok, back to the IRS news. While this is just the IRS’ interpretation of the law – failure to follow it could result in penalties if your contrary opinion ends up being wrong.

The jist of the Notice is that Bitcoin is a capital asset and not currency.

Here is a simple example:

Day One: You purchase one Bitcoin for $600

Day Two: On day two your Bitcoin increased in value to $650.  You then decide to use your Bitcoin to purchase a flight to Europe.

If you would have used cash this would not be a taxable event.  But under the IRS’ ruling you now have a short-term capital gain of $50 ($650 amount realized less your cost basis of $600).  You will also have to send a check to the IRS for about $20 if you are in the highest tax bracket.

Bitcoin will certainly complicate your taxes and cause you to have to keep careful records.

From a policy standpoint, the government thinks that Bitcoin is a favorite tool for tax evasion and other illegal activities (and they are probably right).  This Notice is a clear disincentive from the government to use Bitcoin.

First Lady of Tax Fraud

Posted in Criminal Tax

The IRS just issued its Criminal Investigation Annual Report.  Budget constraints caused the staffing of Special Agents to drop to the lowest numbers in recent history, but 2013 included a 12.5 percent increase in investigations initiated and a nearly 18 percent gain in prosecution recommendations.

Specifically, CI initiated 5,314 cases and recommended 4,364 cases for prosecution.  Clearly the IRS is on the move.

The report also mentioned some of the big “wins” for the government.

One that caught my eye was the case involving Rashia Wilson – the self-proclaimed “First Lady of Tax Fraud.”

The Department Of Justice press release stated that from at least April 2009 through their arrests in September 2012, Rashia Wilson and her co-conspirator, Maurice J. Larry, engaged in a scheme to defraud the Internal Revenue Service by negotiating fraudulently obtained tax refunds. They did so by receiving U.S. Treasury checks and prepaid debit cards that were loaded with proceeds derived from filing false and fraudulent federal income tax returns in other persons’ names, without those persons’ permission or knowledge.

Wilson and Larry filed these false and fraudulent federal income tax returns from multiple locations, including Wilson’s residence and hotels in the Tampa area. Wilson, Larry, and others then used these fraudulently obtained tax refunds to make hundreds of thousands of dollars worth of retail purchases, to purchase money orders, and to withdraw cash.

Ms. Wilson was not shy about her crimes.  She lived an opulent lifestyle with a $90,000 Audi (bought with a money order) and a $30,000 birthday party for her one-year-old child.

She apparently also posted her exploits on Facebook with this picture and a post saying “I’m Rashia, the queen of IRS tax fraud. … I’m a millionaire for the record. So if you think that indicting me will be easy, it won’t. I promise you. I won’t do no time, dumb b—”

Ms. Wilson did not get away with it and is now spending 21 years in federal prison.

Once you start bribing – I guess it is hard to stop

Posted in Uncategorized

News came out last week that chiropractor Stephen Jacobs of Lowell, MA is in hot water with the feds.  Dr. Jacobs allegedly paid an IRS auditor $5,000 in cash to ignore two deductions he improperly took on this 2011 income tax form.

These deductions, allegedly, were in fact payments Jacobs made to two different women because he touched them inappropriately during medical treatments during 2011 and 2012.

Mr. Jacobs was charged under 18 U.S.C. 201 (bribery of public officials).

Interestingly, the improper deductions were for two payments of $5,000 to the women – so a total of $10,000.  The highest tax rate in this time frame was 35%.  So he was looking at an additional $3,500 in tax.  This was less than what he paid the IRS agent!

Obviously, Dr. Jacobs was not thinking very clearly.  Sometimes it is better just to take your medicine.

Now he is looking at a prison sentence of up to 15 years and a fine of $15,000. Additionally, he is probably looking at losing his license to practice as a chiropractor.

But if the allegations of “inappropriate touching” are true, then it is for the best.

There are also other laws that Mr. Jacobs probably violated – like IRC Section 7212 (attempt to interfere with the administration of tax laws).

Whenever you have a matter before the IRS or any governmental organization it is vital to get competent help.  People like Dr. Jacobs get themselves into trouble unnecessarily by being pennywise and pound foolish.

Gentleman’s Club Owner Hit With Fraud Penalty

Posted in Criminal Tax

A new Tax Court decision just came out – Potter v. Commissioner, TC Memo 2014-18.  The case involved a “gentleman’s club” owner in Michigan.

In December 2006 IRS special agents engaged in an undercover investigation of Potter’s Pub, posing as buyers interested in acquiring the business. John Potter assured the agents that Potter’s Pub was much more profitable than it appeared (note – great admission of fraud).

Mr. Potter explained that he deposited in the corporate account only enough of the business revenues to cover its expenses and that he wired the balance of its revenues to his personal bank account in Florida.  The wire transfers were structured in amounts less than $10,000 to avoid reporting obligations by the bank to the IRS.

In reality, Mr. Potter told the agents that Potter’s Pub grossed more than $1 million annually and he took home between $400,000 and $520,000 each year.  Mr. Potter showed the agents clandestine sales ledgers for 2003 and 2004 that supported the gross receipts he claimed.

Not surprisingly, Mr. Potter is now a convicted felon a was sentenced to 18 months in prison.  His crime was filing false tax returns. 

As is the normal course of business for the IRS – after it got its “pound of flesh” – the IRS now wants to hit him with the fraud penalty. 

Section 6663(a) of the Internal Revenue Code imposes a 75% penalty on any underpayment of tax that is due to fraud.  Ouch!

In order to establish fraud, courts look at circumstances that may indicate fraud which are known in the tax world as “badges of fraud”:

  1.  understating income
  2.  maintaining inadequate records
  3.  giving implausible or inconsistent explanations of behavior
  4.  concealing income or assets
  5. failing to cooperate with tax authorities
  6.  engaging in illegal activities
  7.  providing incomplete or misleading information to one’s tax preparer
  8.  lack of credibility of the taxpayer’s testimony
  9.  filing false documents, including false income tax returns
  10. failing to file tax returns; and
  11.  dealing in cash

Unfortunately for Mr. Potter he had little defense to the penalty.  His behavior will likely haunt him for many years to come.

Crowdfunding and Taxes in Kickstarter: Everybody Wants Their Share

Posted in Tax Planning

The Crowdfunding movement has moved from an internet e-commerce buzz word to an actual viable way for everyone from the smallest of artists to high profile actors to get funding for a project that otherwise wouldn’t happen.  (For example $5.7 million to make a Veronica Mars movie http://www.kickstarter.com/projects/559914737/the-veronica-mars-movie-project).   The concept is simple: creators pitch a product to the public, and whoever likes the product pools together funds to support the creator.

Crowdfunding websites have proliferated over the last decade, starting with ArtistShare (2001) and followed later by sites such as EquityNet (2005), Pledgie (2006), Sellaband (2006), IndieGoGo (2008), GiveForward (2008), Kickstarter (2009), RocketHub (2009), Fundly (2009), GoFundMe (2010), Appsplit (2010), Microventures (2010), and Fundageek (2011). These websites helped companies and individuals worldwide raise $1.47 billion in 2011 and $2.66 billion in 2012 (from which $1.6 billion was raised in North America). In 2012 there were more than 1 million individual campaigns globally.

To many, a crowdfunding project through a website like Kickstarter might seem like an uncomplicated way to bring their dream to reality.  But, unfortunately, Uncle Sam, Kickstarter, and your state taxing authority won’t let you take the entirety of the money your project was funded without getting their share. I’m going to run down how $50,000 from a funded project to create a new board game would be spent.

For this example, your benefit levels are $5 – No benefits other than “thank you” acknowledgements and $30 for one copy of the board game.  You state that the board game will be sold for $50 when it hopefully starts getting produced at a larger scale after the kickstarter.

 Gross Project Funds Raised:  $50,000 ($8,000 at the $5 level, $42,000 from 1,400 board game orders)

 1.      Kickstarter and Credit Card Processing Fees (9%):  Kickstarter takes a 5% fee off the top, and Amazon.com (which processes the credit card payments) takes 3-5%.  We’ll split the difference and call it 4% for credit card fees for a total of 9%.

  2.     Cost of Goods Sold – Content Costs (42%):  This is the actual cost to produce whatever funding benefits you are giving to the backers.  Let’s say once you factor in all other costs to produce, these cost about $15 a game ($21,000 total).

 3.     Sales Tax (3.5%):   We’ll do this scenario in Texas.  You produce the board games in Texas and make exactly half of your sales to Texas residents.  You will need to register for a sales tax permit and collect sales tax on all sales to Texas residents (but not the out of state residents).  If you did not collect the tax on the pledge in addition to the $30 (or state that sales tax is included), you will owe tax on the full $30.  (700 * $30 * 0.0825=$1732.50)

  4.     Personal Income Tax (11.2%):  If you did not create a legal entity for the kickstarter project, all of the income and expenses from this project will be reported as a Schedule C business on your individual tax return.  The first question is, how much of the $50,000 should be considered gross income.  It is clear that the $42,000 for the board games, should be gross income. Backers received a project for less than the fair market value so there is no gift.  “Where consideration in the form of substantial privileges or benefits is received in connection with payments by patrons of fund-raising activities, there is a presumption that the payments are not gifts.”  Rev. Rul. 86-63.  However you may be able to argue that the $8,000 from the backers who received nothing was a gift.  A gift is a transfer that (1) is voluntary, and (2) is motivated by a “detached and disinterested generosity.”   Commissioner v. Duberstein, 363 U.S. 278, 285 (1960).

 You will be able to deduct the Kickstarter and credit card processing fees, content costs, and the sales tax from your gross income of $42,000.  This would leave you with a net income of about $15,000.  The surprising thing is how high the tax rate is on this remaining amount.  You will owe self-employment tax (15.3%) on the net income amount, as well as your ordinary income tax rate on the amount (less a deduction for half of the self employment tax you paid).  For a person in the 25% tax bracket, this would be about $5,600 in self employment and income taxes.  If you live in a state with state income tax, this percentage will be even higher

 What’s Left? About $17,000 – 34% of the Original Amount.

 The thing we haven’t accounted for is how much of your time you put into this.  For those artists whose project is truly a labor of love, the bottom line won’t matter as much. But for artists that work on a project like a full time job and need the bottom line to pay bills, what’s left may not make ends meet.

Special thanks to guest blogger Austin Carlson for this post.

How to Choose a Tax Return Preparer? Watch out for Fraud

Posted in Tax Planning

It is tax season and it is time to think about getting your taxes done.  This time of year is filled with angst for most people.

The IRS every year posts its “Dirty Dozen Tax Scams” – one of particular interest now that we are entering tax season for 2013 tax returns is tax return preparer fraud.

The IRS claims that 60% of taxpayers will use tax professionals in the preparation of their returns.  In my view, getting the help of a competent preparer is very important.  I always caution people against preparing their own returns.  I very much appreciate “do-it-yourselfers” – it is very satisfying to be able to handle your own problems and not have to get help.

Unfortunately, the government has made the filing of a return incredibly burdensome and complicated. The fact that the tax code is complicated is not news to anyone.  Getting competent and trustworthy help is very valuable.

Take tax credits, for instance.  There are tax credits for:

  • just earning an income (Section 32)
  • having a child (Section 24)
  • becoming disabled (Section 22)
  • buying a car (Sections 30, 30B, 30D)
  • getting health insurance (Section 35)
  • buying a house (Section 36)
  • going to school (Section 25A)
Additionally, the number of business-related credits stretches for about 250 pages in very small print in my version of the Internal Revenue Code. When it comes to these tax credits – there has been and will continue to be a large amount of preparer fraud. When looking at your return be certain to look at page two of the 1040 – from approximately line 47 through 53.  Make sure you understand what credits are being claimed.  The US Tax Court has been prone to use the “too good to be true” maxim when analyzing cases.   If you have a child tax credit and you don’t have a child – you have a problem. The IRS also has a list of tips on how to choose your preparer.  All of them are good:
  1. Check the preparer’s qualifications.  All paid tax return preparers are required to have a Preparer Tax Identification Number. In addition to making sure they have a PTIN, ask if the preparer belongs to a professional organization and attends continuing education classes.
  2. Check on the preparer’s history.  Check with the Better Business Bureau to see if the preparer has a questionable history. Also check for any disciplinary actions and for the status of their licenses. For certified public accountants, check with the state boards of accountancy. For attorneys, check with the state bar associations. For enrolled agents, check with the IRS Office of Enrollment.
  3. Ask about service fees.  Avoid preparers who base their fee on a percentage of your refund or those who claim they can obtain larger refunds than other preparers can. Also, always make sure any refund due is sent to you or deposited into an account in your name. Taxpayers should not deposit their refund into a preparer’s bank account.
  4. Ask to e-file your return.  Make sure your preparer offers IRS e-file. Any paid preparer who prepares and files more than 10 returns for clients must file the returns electronically, unless the client opts to file a paper return. IRS has safely and securely processed more than one billion individual tax returns since the debut of electronic filing in 1990.
  5. Make sure the preparer is accessible.  Make sure you will be able to contact the tax preparer after you file your return, even after the April 15 due date. This may be helpful in the event questions arise about your tax return.
  6. Provide records and receipts.  Reputable preparers will request to see your records and receipts. They will ask you questions to determine your total income and your qualifications for deductions, credits and other items. Do not use a preparer who is willing to e-file your return by using your last pay stub before you receive your Form W-2. This is against IRS e-file rules.
  7. Never sign a blank return.  Avoid tax preparers that ask you to sign a blank tax form.
  8. Review the entire return before signing.  Before you sign your tax return, review it and ask questions. Make sure you understand everything and are comfortable with the accuracy of the return before you sign it.
  9. Make sure the preparer signs and includes their PTIN.  A paid preparer must sign the return and include their PTIN as required by law. The preparer must also give you a copy of the return.
  10. Report abusive tax preparers to the IRS. You can report abusive tax preparers and suspected tax fraud to the IRS on Form 14157, Complaint: Tax Return Preparer. If you suspect a return preparer filed or altered a return without your consent, you should also file Form 14157-A, Return Preparer Fraud or Misconduct Affidavit.   

Tax Exemption for Ministers Unconstitutional?

Posted in Tax Planning, Tax Practice

The Western District of Wisconsin recently issued a decision that makes the parsonage exemption unconstitutional as a violation of the Establishment Clause of the US Constitution.

This ruling is controversial and hotly opposed by many.  

The parsonage exemption is found at IRC Section 107, and allows a “minister of the gospel” to exclude 1) the rental value of a home furnished to him as part of his compensation, or 2) the rental allowance paid to him as compensation to the extent used for housing and to the extent it does not exceed the fair rental valued of the home.

The Court’s problem with the parsonage exemption is: “… it violates the well-established principle under the First Amendment that ‘[a]bsent the most unusual circumstances, one’s religion ought not affect one’s legal rights or duties or benefits.’”

Here the Court thinks that ministers have preferential treatment over others.  The Court quoted the Texas Monthly v. Bullock case related to a sales tax preference: “Every tax exemption constitutes a subsidy that affects nonqualifying taxpayers, forcing them to become indirect and vicarious ‘donors.’”

Undoubtedly, this case will be appealed.  It will be interesting to watch what the courts decide.

 

Qualified Domestic Relations Orders: Little-Known Issues Involving Dividend Pass-Through Elections And Same-Sex Spouses

Posted in Uncategorized

Special thanks to guest author Jason Luter for this post.

As most family law practitioners are aware, ERISA and the Internal Revenue Code (“IRC”) do not permit a participant in a retirement plan to assign or alienate his/her interest in that plan to another person.  These rules are intended to ensure that the participant’s retirement benefits are actually available to provide the participant with financial support during his/her retirement.  However, a Qualified Domestic Relations Order (“QDRO”) affords one of the limited exceptions to these anti-alienation rules, and allows a participant’s interest in a retirement plan to be lawfully assigned to an alternate payee, such as a spouse, former spouse, child or other dependent of the participant.

Dividend Pass-Through Elections

As a general rule, a QDRO gives the alternate payee the right to receive all or a portion of the participant’s benefits under an employer-sponsored retirement plan.  So, the QDRO can only give an alternate payee rights that the retirement plan actually permits.  For example, if a 45 year old participant in a pension plan gets divorced and a QDRO awards 50% of a his/her pension plan benefits to his/her former spouse, but the pension plan does not permit any distributions until age 60, then the former spouse must wait 15 years before receiving any benefits.  However, some retirement plans contain special features, like the option for a participant to make a dividend pass-through election, which can be of great value in divorce negotiations.  Under certain retirement plans, a participant may elect to personally receive dividends paid by the employer on company stock attributable to the participant’s shares in the company’s stock fund within the retirement plan.  If the participant has made such an election, then a QDRO can assign to an alternate payee the right to receive some or all of those dividend payments, unless the plan provisions prohibit it.  If the participant has not made such an election, then the parties may wish to discuss having the participant make the election prior to drafting the QDRO.

As an example, consider the situation where an alternate payee (e.g., the wife in a divorce), needs post-divorce income in an amount exceeding what she can earn through employment.  Assuming that her spouse owns company stock within his retirement plan, and the plan allows for dividend pass-through elections, then assignment of a portion of the husband’s retirement plan via QDRO can create an opportunity for dividend payments to be received by the wife which may lessen the need to consider contractual alimony or spousal maintenance.

Same-Sex Spouses Are Now Eligible QDRO Alternate Payees

Effective September 16, 2013, a “spouse” includes a person of the same sex if the participant is lawfully married to such individual under state law, based on the state in which the marriage ceremony occurs or occurred – not where the individuals reside.  Thus, if a same-sex couple was lawfully married in a state that recognizes same-sex marriage (e.g., Massachusetts), but reside in a state that does not recognize same-sex marriage (e.g., Texas), a QDRO can still name the same-sex spouse or same-sex former spouse as an alternate payee.  Note, however, that this only applies to “marriage” – i.e., couples (whether same-sex or opposite-sex) who have entered into a civil union, domestic partnership, or similar relationship recognized under state law do not qualify as “spouses” for QDRO purposes.

 

Expansion of IRS Innocent Spouse Relief

Posted in Tax Court, Tax Planning, Tax Practice

On September 13th the IRS issued a new revenue procedure that significantly changes equitable innocent spouse relief.  I wrote an article that was published Tuesday in the Texas Bar Association’s Texas Tax Lawyer .

I have excerpted part of the article which discusses the significant changes.

Change #1: Greater deference is given to the presence of abuse than Rev. Proc. 2003-61. Existence of abuse can outweigh or negate other factors. Change #2: Request for equitable relief can be filed any time before the collection statute runs out. Previously, the rule was that relief had to be requested within 2 years of collection action. This change actually happened in 2011 (IRS Notice 2011-70). Change #3: Threshold conditions previously required that the income tax liability must be attributable to the non-requesting spouse. New exception exists if the item stems from the nonrequesting spouse’s fraud and thus gave rise to the understatements of tax. Change #4: Streamlined determinations now apply to understatements of tax, underpayments of tax and claims for equitable relief under IRC § 66(c). Change #5: No one factor or majority of factors controls a determination – it all depends on the facts and circumstances. Change #6: Standards for economic hardship are revised. A lack of economic hardship will now be viewed as a neutral factor. Change #7: A finding of actual knowledge of an item giving rise to an understatement will no longer be weighed more heavily than other factors. Abuse or financial control by nonrequesting spouse causing fear of retaliation will result in the knowledge factor to weigh in favor of relief. Change #8: Similar to change #7 above, in a situation where the spouse had knowledge that nonrequesting spouse would not pay liability within a reasonably prompt time frame, the existence of abuse or financial control causing a fear of retaliation will cause this factor to weigh in favor of relief. Change #9: IRS clarifies that the legal obligation of the requesting spouse is a consideration (not just whether the non-requesting spouse has an obligation to make payment to the IRS). Change #10: The significant benefit factor will not weigh against relief if the nonrequesting spouse abused or maintained financial control over the nonrequesting spouse and the nonrequesting spouse made the decisions about living a more lavish lifestyle. Change #11: Subsequent compliance with income tax laws will now weigh in favor of relief, instead of just being viewed as a neutral factor. Change #12: Refunds are now available in deficiency cases for payments made other than through an installment agreement.