|
The
Center for Financial, Legal & Tax Planning, Inc. |
|||||||
|
(Sample) If you would like to subscribe to this
publication, please send a check for $75 to The Center. THE TAX REPORT Spring 2005 Vol.
26 No. 3
Bankruptcy In
a bankruptcy case, an Appellate Court decided that taxes were properly
discharged in a bankruptcy. In this case,
the taxpayer’s tax return met the requirements for a tax return. The tax return was disputed in court by the
IRS because it was filed after the taxes were assessed and were a mirror
image of the assessment. Editor’s
Comment: Generally,
income taxes are dischargeable in bankruptcy if it has been more than three
years since the tax return was filed.
Surprisingly, this is a problem for many people who are filing
bankruptcy. Frequently a lot of
individuals’ attitude in the past has been to avoid filing their
returns. This retreatist
strategy does not work for taxes. No
matter how dire your circumstances are, be sure to file a tax return. Not only does it make bankruptcies go
easier, but also the statute of limitations begins to run upon filing of the
return. If the return is not filed,
the taxpayer’s statute of limitations does not start and it is impossible to
file bankruptcy on tax returns which have not been filed. Recently, the bankruptcy laws have
been changed. It is important that
income tax returns be properly and timely filed in all situations, i.e.,
whether or not you are considering bankruptcy.
In a very well known case, the Tax
Court has held that the value of property transferred from a decedent into a
Family Limited Partnership (FLP) is includible in the estate. In the case, the decedent transferred a
substantial amount of wealth into an FLP and made himself a limited partner
while having his attorney in another corporation holding the position of
general manager. The Court ruled that
the entire amount was includible in the estate because the decedent retained
the right to decide to whom the property was designated. The court further held that there was not a
transfer of consideration as the FLP did not give consideration in return to
the decedent in return for the transfer of ownership pf the property. Editor’s
Comment: All
incidents of possession must be given up when transferring property into an
FLP, irrevocable trust, or as a gift in order to have them not included in
your estate. FLP’s
are an economic fiction which taxpayers use to undervalue their estate to the
IRS. As such, taxpayers must use extra
caution in using these planning. If
the taxpayer does not abide by the letter of the law, they risk harsher
scrutiny by the IRS and courts.
The Tax Court has ruled, based on
the fact that an attorney was a statutory employee the firm owed withholding
taxes on his compensation. The attorney
was a big revenue maker for the firm.
To compensate him, the firm treated him as an independent contractor,
wrote large distributions to him, and even recorded some of the amounts as
loans. Furthermore, the company did
not issue him a 1099 form, nor did they treat him as an independent
contractor. The Court found that the
attorney was a statutory employee because not only was the attorney an
officer of the company, but he also performed substantial services for the
firm and was treated as an employee. Editor’s
Comment: Recently
the IRS has been cracking down on abuses concerning whether employers treat
workers as employees or as independent contractors. The reason is clear why the abuse exists. If independent contractor status is used,
no withholding taxes must be paid by the company. The employer gets to use the worker less
expensively than that of an actual employee. In order to be an independent
contractor, the worker must be given a large degree of control over the work
to be performed. In addition, the
employer must treat the worker as an independent owner of a separate
business, it must be reasonable, and issue a Form 1099-MISC to the
worker. If these things are done, the
employer will be eligible for relief under the Internal Revenue Code for the
error. Absent a 1099 and proper
treatment, the employer is not entitled to relief and will face the full
brunt of the Tax Courts’ wrath in these proceedings. When
hiring people, do not be intellectually dishonest with yourself. If you think the worker is an employee,
treat them as such. If you believe
them to be an independent contractor, be careful exercising the
discretion. If you have questions,
contact the professionals at the Center with any of your concerns and the
will assist your decision process.
The
Ninth Circuit Appeals Court has ruled that a decedent was treated as having
paid the gift tax as opposed to the surviving spouse. The decedent’s entire estate was valued
well into the nine figure range. As
part of his estate plan, the taxpayer purchased an insurance policy for his
wife. The policy ended up creating a
large gift tax liability. To pay the
gift tax liability, the tax payer handed his wife a check for the amount of
the gift tax due. She then used the
money to pay the IRS. The court ruled
that the decedent paid the gift tax, which resulted in an inclusion in the
decedent’s estate of the gift tax itself. Editor’s Comment: Generally gifts are includible in a
decedent’s gross estate but the gift tax is not after a three year period
expires. In this situation, the
decedent dies within three years of the transfer of the gift tax money. The application of the tax laws in this
case was appropriate, because the wife acted as a mere conduit, even though
she was not legally obligated to pay the amounts to the IRS. The wife was part an attempt to shift the
risk, but it did not work. When
planning complex estate plans, you had better be dealing with knowledgeable
professionals. My word of advice here
is to start planning estate taxes early and don’t expect everything to go as
planned unless you are getting proper advice.
In the present case, it was obvious that no professional was consulted
as to the proper was to structure the estate.
A
federal district court has decided that a home that is used most does not
qualify it for the home sale exclusion.
In the case, a couple had multiple residences around the Editor’s Comment: In order to qualify for the home sale
exclusion, the taxpayer must use the home for his or her primary residence
for at least 2 of the past 5 years.
Close enough is not good enough.
The regulations point to six factors to determine principal residence
status. What the courts will look to
in these cases is where your tax returns are sent, time spent at the
residence, where the drivers license is registered, etc... Had the
taxpayer and his representative looked closer at their situation, they
probably would have determined in advance which house to sell instead of the
one they did. It is always helpful to
do research before you do any major transaction to manage the tax
liability. The result here was a very
large tax bill that exceeded 42% of the profits.
The
Tax Court has ruled that employers may have a “safe harbor” in independent contractor
/ employee disputes even if the informational returns are not filed on
time. This dispute concerned usage and
payment of medical doctors. The
doctors had been treated as independent contractors as a matter of long
standing procedure with the hospital.
The IRS disputed the hospital’s treatment of the doctors and their use
of a “safe harbor” provision which allows taxpayers some relief if they treat
the employees as independent contractors and file the necessary forms. Both the IRS and hospital agreed that the
doctors were treated as independent contractors, but were in fact
employees. What was is dispute was
whether the late filed forms would disqualify “safe harbor” status for the
hospital. The court ruled it would
not, because even if they are filed late, safe harbor still applies. Editor’s Comment: Once again we face the issue of whether a
worker is an employee of an independent contractor. Here the taxpayer fell within the safe
harbor provisions granted by the Internal Revenue Code. The taxpayer must issue proper
informational returns and treat the worker as an independent contractor. Even though the tax forms were filed late,
apparently the Tax Court was willing to forgive the infraction. However, if you are hiring
individuals and are unsure how they should be classified with employees, now
is the time to get straight with the IRS.
Waiting until an audit will only lead to trouble. Not only will the IRS know you are treating
your employees as independent contractors in the current year, they can look
back up to six years in some cases, assess interest, and assess
penalties. If you are in doubt
regarding your status be sure to call one of the professionals at The Center
for an evaluation.
In
a recent Revenue Ruling, the IRS has concluded that an executor of an estate
has the authority to claim innocent spouse relief even when the claim was not
opened during the life of the spouse.
In this case, a couple claimed a deduction relating to an investment
owned by the husband. The IRS denied
the deduction. The wife then
died. The executor requested relief
under the innocent spouse rule.
Previously, this was disallowed unless the innocent spouse filed for
relief during life. The IRS approved
this action as an expansion of existing law because it falls in line with the
broad authority executors typically have when working on estates. Editor’s Comment: The IRS formerly did not allow claims for
innocent spouse relief unless the claim was made during the life of the
innocent spouse. The IRS is beginning
to allow innocent spouse filings reflecting back on the broad discretion
executors have in handling estates.
The relief will be granted as long as during life, the spouse
satisfied the applicable requirements to gain innocent spouse relief. The ruling may open up additional
possibilities for executors. For
example, a surviving spouse serving as executor could claim innocent spouse
protection for the deceased spouse to protect the estate from creditors. Sometimes it is best not to let your spouse
know everything you do for her own interest.
The
Tax Court has ruled that life insurance proceeds in community property states
are one-half includible in estates of the deceased. In the case, the decedent was a resident of
a community property state and had multiple life insurance policies. The decedent purchased the plans and named himself the only owner of the policies. The court held that one-half would be in
the estate since community property funds were used for the purchase of the
plans. In
a case concurrently released, the Service has set a set of circumstances
would will lead to the life insurance proceeds being one-half included in the
estate. The set of circumstances are
discussed below. Editor’s Comment: Community property law states always have
interesting tax consequences. In the concurrent tax court case, the IRS
stated that when 1) when a community property state resident 2) purchases a
policy on his life 3) during marriage, 4) names himself as owner and 5) does
not transfer the ownership of the policy, then the policy is presumed to be
community property and hence on-half includible in the estate. These states are:
The
IRS has simplified late subchapter S Corporation Election relief. To qualify for relief for failing to file
the elections, the taxpayers must seek relief within 24 months of the
subchapter S election date. However,
the taxpayer must show the failure to file was inadvertent and
reasonable. The entity must not have
filed tax returns for the first year of operation. This ruling should be used as opposed to
obtaining a private letter ruling. Editor’s Comment: Usually electing subchapter S Corporation
status is not a problem as an attorney is consulted and sets the company up
with all necessary forms and files the proper papers. Problems arise when professionals are not
utilized or when the professional is not familiar with S Corporation
status. If a subchapter S Corporation
status is not elected, the default status is a C Corporation. For most, this is highly undesirable
because the income is taxed once at the corporate level and once again at the
shareholder level. Due to this new
procedure, taxpayers who would otherwise be stuck with a C corporation in
this predicament, now have a way to correct this problem if they have not
filed their first tax return.
In
a Chief Counsel Advice, the IRS determined that employee leasing companies,
not clients were subject to the 50% meal deduction limitation. In this situation, the company paid workers
and reimbursed them for their food and beverage expense which was set up as a
per diem expense. Therefore, parts of
the payments were wages and the other part was deemed a reimbursement
expense. There was no evidence of an
arrangement like this in the lease agreement between the lessor
and lessee. The IRS ruled that the lessor was subject to the meal reimbursement limitation,
not the company using and paying for the employees. Editor’s Comment: Generally, when you reimburse an employee
for meal expenses, those expenses are 50% deductible. Under the Internal Revenue Code, the payor of the reimbursement is subject to a 50% limitation
unless that payor can pass the cost to another
party. In a case where the employee
performs services for a person or company other than the employer, the meals
are fully deductible. The fact that
the employees who were reimbursed were performing work for a client company
was exactly the fact that the company needed to fully deduct the
expense. Thus the limitation would
only apply to the lessor, if they paid any meal
expenses to the employees. Typically
many businesses won’t benefit from meal expense exceptions such as this, if
they use a third party service company and hire their employees. This is more common among small companies. If you are not using a third party service
company to hire your employees, you may want to consider the arrangement if
you can receive a benefit such as presented in this advisory.
The
Tax Court has ruled that income paid under noncompete
agreements is generally ordinary income and NOL carrybacks
can not be generated through raising a shareholder’s stock basis. In the case, the taxpayer signed a noncompete agreement when selling his company. The entire agreement was contingent on the
taxpayer treating the income as ordinary income while special allocations
given to other assets that were sold.
The taxpayer also loaned money to his company in order to raise his
stock basis in order to get an NOL carryback. The court ruled both of these were not
proper. Editor’s Comment: The taxpayer lost this case across the
board is surprising that the taxpayer brought this case to court. Generally, income from noncompete
agreements will always be ordinary income.
There are exceptions to the rule that apply in rare
cases when the noncompete is transferred to another
party; which rarely happens. Net operating losses from
subchapter S Corporation activity is also deductible but only to the extent
of the taxpayer’s at risk investment.
The taxpayer’s strategy of increasing his basis through a loan was a
good strategy, but there must be an actual economic outlay. In this case the shareholder made a loan
from the same company. The effect was
merely a paper transaction of no economic effect. The shareholder went about the transaction
entirely wrong. When in this
situation, be sure to have a transaction of actual economic effect.
The
Tax Court has ruled that Substitute for Returns (SFRs)
standing alone and without adequate information are not tax returns for
assessing additions to tax including failure to pay penalties. In the case, the taxpayer was receiving
income from a pension fund. The
pension fund income was doubtlessly taxable.
Instead of filing an honest return, the taxpayer filled a return full
of zeros, sidestepping any honest attempt to file a valid return. The IRS, in the place of the return, filed
an SFR and assessed penalties from it.
The SFR was substantially the same return as the taxpayer’s return in
that it only contained the name and address.
The IRS assessed penalties from the SFR. The Tax Court said this was not a return
for failure to pay penalties and said the IRS could not do this from their
SFR thus stopping the IRS. Editor’s Comment: It is usually never a good thing to have an
SFR filed for you. Always file your
own tax return. If you file your own
tax return, the statute of limitations begins to run and you may find
yourself in less trouble if problems are later discovered with the return or
strategies used in the return. Having
the Internal Revenue Service file a return for you means trouble form the
beginning.
In
a letter ruling, the IRS decided that unemployment falls into one of three
categories for determining whether FICA/FUTA taxes apply. The taxpayer had three plans. One was a lump sum, another regular layoff
benefits, and the third short week benefits.
The IRS stood with its longstanding procedure that Supplemental
Unemployment Benefits (SUBS) are will be free from FICA/FUTA taxes unless
they are paid in a lump sum. The IRS
ruled that the regular benefits were not wages for FICA/FUTA, the lump sum
payments were subject to FICA/FUTA, and short week benefits were not subject
to FICA/FUTA. Editor’s Comment: Believe it or not, there are no statutory
rules in existence to confirm whether supplemental payments are wages for
FICA and FUTA purposes. The IRS is
relying on its long standing practice which it has been following since 1956. This practice has been around since the time
SUB plans emerged. SUB payments must
be directly linked to state unemployment benefits to generally be exempt from
FICA and FUTA payments. Under this
rule, lump sum payments are considered to not be linked to
unemployment. Therefore as a word of
advice, when creating a SUB plan, be sure to follow and tie the payments to
unemployment. Doing so will save
everyone money that would otherwise go towards Social Security and Medicare
taxes. If you would like to subscribe to
this publication, please send a check for $75 to The Center. |
|||||||
|
The Center for
Financial, Legal and Tax Planning, Inc. |
|||||||
|
|
Satellite Office: Longboat Key, FL |
||||||
|
(618) 997-3436 Fax: (618) 997-8370 © Copyright 2005. All rights reserved. |
|||||||
