I often hear those with federal tax debts state: “I am worry-free because all I own is my home which is an exempt homestead.” I tell them to start worrying. Other creditors lack the powers given by Congress to IRS. IRS can reach your homestead to satisfy an individual tax debt even if the home is titled as tenants by the entireties and your spouse did not sign the tax return. IRS can reach your retirement assets protected in many states against most other creditors. IRS can also wipe out your bank account simply by sending a letter (Notice of Levy) to the bank and garnish your wages without a court order. In a flash the account or wages disappear. Recently, IRS Chief Counsel advised that IRS can levy on an interest in non qualified or incentive stock options even when the non-qualified stock option plan restricts transferability and the ISO plan is non-assignable under ERISSA. Although taxpayers have certain limited collection due process rights, it is often wiser to borrow to pay off IRS and deal with creditors who must first obtain a judgment in order to involuntarily collect from you.
COMPLEXITY OF TAX CODE
I recently participated in an American Bar Association telephone conference with Nina Olsen, the National Taxpayer Advocate. Her biggest complaint about the tax system is its complexity. She says taxpayers spend about 7.6 billion hours per year complying with the tax law. Since 2001, there have been more than 3,250 changes to the tax code. In 2008 alone, there were 500 changes. The number of words in the code, estimated at 2.1 million, has more than tripled since 1975. 25 volumes of tax regulations now take up 9 feet of library shelf space. Some of the more vexing areas of needless complexity involve the Alternative Minimum Tax, over 100 phase out rules for various tax benefits and approximately 130 distinct civil tax penalties. That, despite Congress having passed Tax Reform Acts in 1969, 1976, 1986 and 1998, a Tax Reduction Act in 1975, a Tax Reduction and Simplification Act in 1977, a Tax Equity Act in 1982, and Tax Relief Acts in 1997, 2001 and 2003. I think we would all welcome a break from all of the reform, simplification and equity.
SMALL BUSINESS TAX AUDITS
A recent study reported that small businesses with under $10 million in sales were audited 41% more often in 2007 than larger businesses and those with under $50 million in sales were audited 29% more often. Tax audits are time consuming expensive projects often leading to tax deficiencies and civil or sometimes criminal penalties. With proper proactive guidance and careful tax return preparation, however, a small business can substantially diminish the likelihood and severity of an audit.
OFFSHORE BANK ACCOUNT VOLUNTARY DISCLOSURES
In Volume 3, Number 4 “Come in From the Cold” I discussed offshore bank accounts and the IRS Voluntary Disclosure program. IRS has posted Frequently Asked Questions and Answers on its website regarding the program. The FAQ and prior announcements make clear:
1. This is not an amnesty program. The disclosure is a mitigating factor in the IRS decision process of whether to recommend prosecution of a tax crime. That being said a truly voluntary and honest disclosure almost always results in no prosecution being recommended. A tax lawyer with privilege and not a CPA should debrief the account owner to determine if he or she will qualify under the program.
2. IRS wants you to make a “noisy disclosure” by contacting the local CID office and not by filing amended returns quietly with the service center. IRS wants an opportunity to question account owners about promoters who advised them or helped them open the account. Thus, IRS has stated it will not view quiet disclosures as a voluntary disclosure qualifying for the reduced civil penalty scheme discussed in my earlier issue. That would make filing amended returns on your own far more expensive unless there are “reasonable cause” circumstances present for not having timely filed the foreign bank account reports. It might also subject you to criminal sanctions although the Department of Justice having the final say on criminal tax prosecutions does not view quiet disclosures as less voluntary than noisy disclosures.
3. Taxpayers who have a legal excuse for not having timely filed a FBAR are not tax criminals and should not use the noisy disclosure process. Once again a tax lawyer with privilege should vet the taxpayer’s reporting and income history to determine whether the non-filing was due to reasonable cause, willful or wanton neglect under the civil penalty statute and/or willful under the criminal statute.
4. IRS will not assess civil penalties on Taxpayer’s who file a delinquent FBAR with an attached explanation for an account on which all income has previously been reported. Once again a tax lawyer should vet the account owner to ascertain that the funds creating the account originated from a legal non-taxable source, that all income on the account, has, in fact, been reported, and, that there are no other accounts or factors that would render the account owner less than innocent. A CPA without privilege should not conduct this interview.
STANFORD PONZI SCHEME
In Volume 3, Number 5, “Madoff and other Ponzi Schemes Present Tricky Tax Issues” I discussed the tax rules for deducting losses from fraudulent investment scams. On June 21, 2009 Texas financier Allen Stanford was indicted and charged with running a $7 billion fraudulent phony CD scam. Thus, under Revenue Procedure 2009-20, Section 4.04, the year of discovery and for taking a theft loss will be 2009, the year in which the indictment was filed. Recouping the maximum tax refunds from Ponzi scheme losses involves choosing among alternative remedies which should be done with the help of a tax lawyer.
ROTH IRA CONVERSIONS
In 2010 only Roth IRA conversions will be permissible without regard to one’s adjusted gross income (not permitted for those with AGI over $100,000 in 2009). If you have converted a traditional IRA during 2009 to a Roth IRA and now find that your income will exceed $100,000 for the year, you can reverse the rollover and re-convert the account in 2010. If the attempted 2009 conversion was a qualified rollover (trustee to trustee or made within 60 days) there will be no tax or penalty in 2009. When you convert in 2010, the conversion income (then value of the IRA account assuming all deductible contributions) is spread evenly over 2011 and 2012. Conversions generally are useful only when one is financially able to pay the up front tax from funds other than the converted traditional IRA account. Roth IRAs offer greater flexibility for those nearing retirement and are most beneficial when one’s tax rate will be higher during retirement or, at least, is not expected to substantially diminish. Bear in mind that you are prepaying the tax on future benefits which become somewhat speculative when retirement is distant. Also, computer models contain assumptions that may differ from your specific situation.