Could I go to Jail?

My client’s shaking, horrified. She lied on her tax return and worries the IRS will find out when they open the audit.  She thinks she’ll end up in handcuffs if she even talks to the IRS.  She won’t.   But the IRS will be happy that she is scared.

Americans filed 137.3 million tax returns in 2015. That same year, the United States convicted just 648 people of tax crimes.  Millions of Americans do things on their returns that they’d be ashamed to have exposed: claim they have no legal obligation to pay tax, fail to pay estimated taxes or withholdings, hide money to keep the IRS from taking it.  There are many more than 648 Americans who could go behind bars for tax violations. Why don’t they?

Because the IRS has many ways to catch and punish tax misconduct before it locks up citizens.  If a taxpayer underreports his annual income tax by more than 10 percent or $5,000, the IRS can automatically assess a 20 percent negligence penalty. If the IRS can prove that a taxpayer lied on their tax return to underpay their tax, it can assess a 75 percent fraud penalty. These assessments either get paid, or become subject to the most stringent collection procedures available at law: wage garnishments, notices of federal tax lien, jeopardy levies. There are lots of negative incentives short of jail time to goad even the most stubborn citizens into properly reporting and paying the correct amount of tax.

The IRS also can and does routinely convict tax cheats of fraud.  The civil statute defining fraud: “If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” IRC § 6663. Case law has fleshed out the elements: an understatement of tax, and knowledge of the understatement at the time the return was signed.

There’s also the criminal statute for tax fraud which prescribes prison or a fine for anyone who “willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof.” IRC § 7201. Case law has defined the elements of criminal fraud almost identically to those of civil fraud. What takes a case from civil into criminal fraud?

According to Assistant US Attorney Robert Conte, who spoke at the California State Bar Tax Section conference in San Diego in October 2016, it’s the “egregiousness” of the conduct. This includes (1) the identity of the taxpayer (federal prosecutors like high-profile people like reality TV stars (http://www.today.com/id/11023392/ns/today-today_entertainment/t/ex-survivor-hatch-found-guilty-tax-evasion/), attorneys (https://www.justice.gov/opa/pr/pittsburgh-tax-attorney-and-owner-iceoplex-convicted-employment-tax-fraud) , and even Tax Court judges (http://www.forbes.com/sites/taxanalysts/2016/04/13/no-deal-for-former-tax-court-judge-kroupa-blame-spiro-agnew/#1c8d1129255a)), (2) the amount of tax loss at issue, (3) how complicated the scheme is, and (4) how the taxpayer acts during audit. While the elements of criminal fraud must be present at the time the taxpayer files the return, Conte said that most cases become criminal because the taxpayer starts to play games with the IRS auditor.

Criminal cases go through a gauntlet of bureaucratic review: once a case becomes criminal, the civil auditor must close the case and turn it over to the IRS’s Criminal Investigation Division (a bunch of auditors with guns). Once the criminal investigation is completed, it is turned over to the Department of Justice. Referral of a criminal case requires approval from three levels of IRS management; prosecution requires approval from two levels of management at the Department of Justice.

The federal government puts a lot of resources into any criminal tax case. It uses these cases as a deterrent: it wants the world to see that it doesn’t lose them. To Bob Conte, the prosecutor, he feels he has not won the case unless the defendant actually goes to jail. He will not even issue a press release if his defendant is convicted but only sentenced to probation.

And that is why my client won’t go to jail: her sins are too trivial and invisible for the federal government use her as a public example of What Not To Do. Chances are, your tax issues are too small to become criminal either. Let’s talk so I can help you reach peace with the government.

IRS Delays Benefit my Clients

The IRS is woefully understaffed: in IRS offices across the country staffing is down 7 to 41% and not one office has seen an increase.

Complicated correspondence is not answered timely, or sometimes at all. I have a large collection of letters from the IRS saying that it received my inquiry some time ago, that it strives to answer inquiries within 45 days, but that it needs another 45 days to respond. But the understaffing and the resultant delays often work to my clients’ advantage. Here’s two examples.

Audit Reconsideration Example. A client’s CPA said she’d handle the client’s audit, but the CPA went out of business mid-audit and didn’t tell my client or the IRS.  The IRS continued with the audit and presented my client with a $50,000 tax bill. My client owes nothing if her expenses are presented correctly, which they weren’t. There’s a process to address this problem: the audit reconsideration which I promptly applied for once my client came to me. It’s now fifteen months later, and we still have not heard back from the IRS. However, collection notices for the $50,000 the IRS thinks it’s due have stop being sent to my client. Indeed, when looking at her account, I see that the IRS has flagged it as “claim pending,” an internal IRS code that prevents its personnel from issuing further collection notices. I have no idea when IRS will finally pick up my client’s file and grant the audit reconsideration. Frustrating but my client isn’t hurt.

Collection Due Process Example. Another client didn’t file tax returns and eventually an IRS collection agent called and said he was preparing and filing returns on her behalf (yes, the IRS can do this). This is always a bad thing because the IRS will make the most conservative guesses on filing status and deductions, so the total tax owed is always higher when the IRS prepares a taxpayer’s return, than when the taxpayer does. At this point my client hired an accountant, who worked up actual tax returns and sent them to the collection agent.

Six months later my client still hadn’t heard about her filed returns, but did start receiving collection notices on IRS-prepared tax returns. My client hired me at this point in the story, and I filed a collection due process hearing since the IRS clearly had not processed the returns she’d send. Collection due process stops the IRS collection, but only when the IRS has sent the last collection notice. It hadn’t, so the collection due process hearing request was denied. Almost exactly a year ago, I sent a request for an audit reconsideration and attached copies of the previously-filed returns and asked that they be processed finally. We still haven’t heard from the IRS. However, after I filed for an audit reconsideration, the IRS added the “claim pending” notation to my client’s account, thus ending all collection processes. We don’t know when or if the IRS will grant an audit reconsideration but, again, my client is not harmed by the delay – only irritated by the IRS’ glacial pace.

In both cases, I could call the IRS to see what’s happening and if there’s any way to speed up the process. However, such a call likely won’t get my clients’ cases unstuck, and it will end up in another bill from me: I have sometimes been on hold with the
IRS for over 6 hours, and the average time I wait is approximately 90 minutes.

Even though interest accrues on my clients’ unpaid liabilities at 4 to 10 percent per year, delay works to their advantage. They are likely to owe a lot less tax in the end than the IRS assessments on the books, and the 10-year collection statute of limitations is running. If the IRS never gets around to opening their files, then the tax assessments will disappear without being collected. If the IRS finally does deal with these situations, the taxpayer will have been able to postpone paying the IRS for a long time.

That’s good for my clients. It’s bad for the country; the tax system is at the heart of how our government functions. Good administration of the tax laws breeds respect for the rule of law in this country.

IRS Tax Debt Ten-Year Clock

Most people don’t know that the IRS stops trying to collect on tax debt after 10 years. This 10-year clock can be valuable to people who owe back taxes from several years ago.

The statute of limitation on collecting tax owed is at 26 U.S.Code § 6502(a)(1): the IRS may start a collection proceeding only within 10 years after the assessment of the tax. The “assessment” date is determined as follows: (1) if the tax return was filed before the due date for that year, then the assessment date is the due date for that year (for example, 2016 tax returns are due by April 17, 2017). Thus, a 2016 return filed on March 13, 2017, will have an assessment date of April 17, 2017. (2) If the tax return is late-filed after the due date for that year, then the assessment date is the date the return arrives at the IRS. The assessment date starts the clock, and the IRS tries to beat the clock by collecting all taxes owed before the 10 years run out.

Four actions will stop the 10-year clock and add to the time the IRS has to collect back taxes. First, filing for bankruptcy protection stops the clock until the bankruptcy court discharges the debt/case. Since it typically takes 4-6 months from the filing to the discharge of a bankruptcy case, a bankruptcy generally adds 4-6 months (and then another 60 days) to the 10-year clock. Second, filing a request with the IRS for a Collection Due Process hearing under 26 U.S. Code § 6330 stops the clock until the hearing occurs; it is currently takes an average of six months to get a hearing result. Third, submitting an Offer in Compromise to the IRS stops the clock until the offer is rejected or accepted, plus 30 days); it currently takes an average of two years to get an IRS decision on an Offer in Compromise. Finally, submitting a request for an installment agreement with the IRS stops the clock from the date the request is submitted until the IRS acts on the request, plus 30 days; it currently takes an average of two months for the IRS approve installment agreements.

Ten years is a long time. I rarely advise clients to try to run out the clock: anyone trying to avoid paying the IRS would need to join the underground economy, and, as a citizen of the United States, I have an interest in seeing to it that my neighbor pays the same tax that I do. But sometimes a client will come to me with a situation where the IRS has just figured out where he is, and there are only nine months left until the Collection Statute Expiration Date (CSED, for those of us in the know). In this situation, I might advise the client to just not contact the IRS, and attempt to get by without putting money in a bank account.

I feel much better about putting clients into installment agreements. Here, the IRS investigates the taxpayer’s financial situation, and agrees to accept a monthly payment in exchange for not levying on the taxpayer. It is a way to reach a truce with a most powerful government agency, an agency that can create chaos in one’s life. Sometimes, the taxpayer’s situation prevents him from paying more than a small token toward his large tax debt. During the time the installment agreement is in effect, the 10-year clock continues to run. When well-managed, this process may allow a portion of a taxpayer’s liability to die a natural death while he is still paying it off.

Note that this article speaks only of the IRS. California income tax is collected by the Franchise Tax Board, under California statutes. Until 2006, the FTB had no statute of limitations on collection; in that year, the legislature passed a law providing for a 20-year collection statute. Rev. & Tax Code § 19255. The statute provides for the FTB to collect a liability for 20 years after the latest tax liability becomes due and payable. Let’s say that 16 years after the assessment, the FTB files a notice of tax lien and charges a $35 lien filing fee. That action, according to the FTB, starts the 20-year clock all over again.

Conclusion: you can sometimes get out of paying federal income tax by being clever, but you can’t get out of the state tax so easily.

What is a Private Letter Ruling (aka PLR)?

Sometimes a taxpayer makes a seemingly minor technical mistake on his return that ends up with large consequences down the line. Shocking, yes, but it’s been known to occur. Good examples of such minor technical mistakes: using a wrong depreciation schedule on a large asset; continuing to report a corporation’s income on Form 1120S after an event that undoes the corporation’s Chapter S election; reporting income on a cash basis when the taxpayer has already elected to report income on an accrual basis.

 

There are ways to undo some of these mistakes, if caught quickly. Others can’t be undone easily.

 

Sometimes a taxpayer does not know how to report a particular transaction, for instance, in a sophisticated call option contract is really an option contract, or a management contract (PLR 2015-47004).

 

In all these cases, it helps to have the IRS commit to a position: “it’s okay to treat the transaction this way.” “Despite bringing in a corporation as a shareholder of the S Corporation (an event that automatically ends a Chapter S corporation election), you can continue to treat the corporation as an S Corporation.” “Assuming you pay these fees and taxes for past years, you may continue to report income on a cash basis.”

 

There is a process for asking for these commitments from the IRS: the Private Letter Ruling (PLR). The procedure for requesting a PLR is more than 100 pages long, and it can be found here.

 

The procedures govern how the request gets to the Internal Revenue Service’s building, how it gets channeled to the correct person (a staff attorney in the National Office, usually a specialist in the particular area of income tax at issue), how long the IRS has to respond (usually six months), and the user fee ($2,000 to $28,000, depending on the issue and the nature and size of the taxpayer).

 

Faucher Law has had a good success record in dealing with Private Letter Rulings. If you need to get out ahead of the IRS on an issue, give us a call.

A Dream Job

A Dream Job

 

I love what I do. Intervening on behalf of my clients in tax audits, or helping people shed crippling debt, allows me to (1) draw on prior professional experience at the IRS and elsewhere, (2) use my detective and people skills in finding and negotiating with the right auditors and revenue officers, and (3) helps me solve people’s problems and move them forward in their lives.  As a small business owner, I also get complete discretion over my time and, of course, full responsibility for all my successes and failures. I’m sure I’ll be doing this for another 20 years, at least.

 

However, every now and then, I daydream about alternative careers. I recently read an article about the razor manufacturer, Gillette, and how it has half a dozen highly-trained men who have a gig testing razors and shaving techniques. http://www.wsj.com/articles/for-cutting-edge-analysis-few-come-closer-than-this-elite-shaving-squad-1460323470  They leave home and stop at Gillette headquarters on their way to work, where they shave. Their daily shave is done according to a strict protocol; they are testing different shaving creams and razors against each other, so every shave has to be done exactly the same way. These guys know about shaving. “Way cool,” I announced to the wife and daughter, both of whom dismissed my excitement with barely-concealed eye-rolling.

 

But I was serious. About a decade ago, I started using shaving soap, rather than canned lather. I like the closer shave, and the soaps generally smell better and feel somehow richer. As I read about the Gillette shavers, I envied that they get to try new soaps and razors on a daily basis. They get to be experts in shaving. Me – I invest in one cake of shaving soap, and it lasts 18 months. Neither my wife nor daughters appreciate how silky smooth I get my face – it’s always too bristly for them, no matter what I do. I suspect at Gillette, the shave scientists get well-deserved praise.

 

Another thing I like about the job is the attention to process. At the IRS, I learned the importance of process: thinking about the steps toward getting a job done. In my law firm, even though each case is different, I always look for the uniform elements so that I can create a check list and get all the steps done.

Tax “Love Gifts”

Churches and ministers receive many tax breaks: churches do not need to withhold social security taxes from their ministers’ pay; churches receive income tax-free; and ministers do not pay tax on the cash value of church-provided housing. But receiving a tax-free salary is not one of the breaks ministers receive.

I have client who’s a minister and is trying to come clean to the IRS after years claiming that he owed no income tax. He has come to his senses and wants to “render unto Caesar what belongs to Caesar,” (Matthew 22:21) and start paying his back taxes but in such a way that the IRS doesn’t take all his income.

To get to this happy result, he and I need to report his ongoing income -not just because it belongs on his tax return, but because we need to show the collection agent how little income the minister collects above what the IRS budgets for living expenses before they beginning levying on everything above that amount.

However, determining my client’s exact income is challenging, primarily because a substantial portion of his income comes from self-described “love gifts,” or cash donations made directly by church members to him personally at the behest of the church’s deacons. In churches where this is a tradition, the congregation is asked not to record the donations or seek a tax deduction, specifically so that the minister may receive the money tax-free.

No matter how generous the intention behind this practice, it’s still illegal. The income tax applies to “all income from whatever source derived,” in the uncompromising words of the Internal Revenue Code. Just because the money showed up in a way that the IRS cannot trace (cash donations) does not mean that it was not income to the minister.

But aren’t gifts excludible from income? Yes, except when an employment relationship exists, such as between a minister and his church, then all payments are assumed to be made within that relationship, and the income must be included on the tax form.

My minister thus will have a tough time getting himself right with the IRS, because the prior “love gifts” are taxable, and because he will need to keep track of all cash he receives in the future. I’d recommend to the church that it make these gifts by check, so that the donors can get a deduction and so that the minister has an easier time keeping records.

In the interim, we can contemplate his parish’s lovely generosity on this Valentine’s Day…

Tax Season is Phishing & Scam Season

I recently received an email solicitation — purporting to be from the IRS — claiming I was eligible for a refund and asking me to click a link to process my return for the refund. Here’s a copy of it.  It is shamelessly not from the IRS: the return email address has nothing to do with our government, and there’s no IRS logo.

This is a good reminder to make sure that you are dealing with the actual government and not a scam artist when you receive communications from the IRS. Here is a link to the IRS website talking about phishing and other scams.

Stay alert out there, people.

My client called in a panic. He was being audited, and the IRS wanted to know why he claimed $2,500 in mileage expense on his Schedule C. My client doesn’t own a Schedule C business. The IRS also questioned my client’s $10,000 loss on his professional stamp collecting – another fictional activity. His tax preparer made these things up. “I didn’t read the return,” the client told me. “I just signed it when the return preparer sent it to me, and then I sent it to the IRS. I appreciated that he got me a $5,000 refund, though; that money sure came in handy.”

The IRS determined that this fellow had understated his taxes by $17,000, leading to a deficiency in income tax of $5,500 and a negligence penalty of $1,100, as well as interest. So much for the refund secured by the tax preparer. “But my return preparer messed this up; he’s the one who lied,” my client asserted. “Am I really responsible for this?”

Yes. Yes, you are. Taxpayers owe the correct amount of tax, regardless of whether it was reported correctly; they can’t shift their own tax responsibility onto the person who prepared the return, no matter how poorly it was prepared, or how little interest a taxpayer takes in looking over the work of a preparer to ensure it is correct – or at least has no screaming falsehoods, exaggerations or omissions. You earned the money, you owe taxes on it – whether it was you who calculated the amount owed, a tax preparer, or the IRS. Moreover, in cases like this, where the tax preparer was deliberately lying, my client will still owe interest on the underpayment. What’s the IRS’s reasoning here?

Paying interest on underreported income doesn’t harm the taxpayer, according to the IRS, since any lender would have charged the taxpayer interest for a loan. And the government considers tax payments made after the April 15th deadline a taxpayer use of government money – thus interest is appropriately charged. In order to treat all taxpayers equally and fairly, Congress has made it extraordinarily difficult to avoid paying interest. As an IRS docket attorney, I found it easier to cut the principal amount of tax owed than to lower the interest required to be paid.

Occasionally, the IRS will waive negligence penalties on underpayment of taxes. Every tax return contains the declaration that the taxpayer has “examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.” And every tax return must be signed. Back to my schoolteacher client: while he’s a non-expert in tax law, he could have reasonably have caught businesses he doesn’t actually have, if he had been paying attention. So, he owed negligence penalties on top of the underpaid taxes and the interest.

Let’s say a preparer’s error was something non-obvious or technical – such as how to report capital gains – and it was the first time a taxpayer was claiming capital gains: if the preparer put them on the wrong line, the IRS would likely not have expected a layperson to have caught this error. After all, it is precisely for such arcane, detailed expertise that most of us hire tax preparers in the first place. I.R.C. § 6664 and associated regulations outline how the negligence penalty can be waived if a professional was used to prepare returns. Broadly, in order to qualify, the taxpayer has to provide all pertinent information to the preparer, the preparer has to be competent, and the taxpayer has to show a good-faith effort to report the proper amount of tax.

Finally, my client wanted to know if he could sue his return preparer. In the U.S., anyone can sue anyone else, at any time, for any reason. But I advised my client that he would not win. That’s because he signed the return saying he examined it and believed it to be correct.

Bottom line? Taxes are the responsibility of the taxpayer, even when you rely on someone else to guide you. If you sign the tax return, expect to answer for what it says.

The IRS Appeals Officer & Process

When a taxpayer disagrees with the IRS auditor’s determination, the IRS assigns the matter to an appeals officer. This is a second, new IRS employee that the taxpayer can negotiate with. Importantly, as a taxpayer deals with successively-higher-level employees in the IRS, the discretion of each employee increases. Appeals officers almost always have more discretion in the kind of allowances they can make to settle a case than auditors do. The next step up in authority over an appeals officer is typically the IRS trial attorney, who defends the IRS’ position if the appeals officer and the taxpayer cannot come to an agreement about the tax return in question, and if the taxpayer decides to sue the IRS.

The IRS has set up the appeals process to be as fair as possible to taxpayers, and to save itself the cost of litigation whenever possible. After all, even the most conscientious and hard-working of auditors makes mistakes. Taxpayers can ask for a review of any auditor decision. Once the auditor issues a final, written report, detailing any changes to the deductions, income and taxes owed in the tax return being audited, the taxpayer can ask that the report (or elements therein) be reconsidered. The appeals officer performing this reconsideration is an IRS civil service employee who has auditing experience, but who has not been previously involved in the particular case. Appeals officers have quasi-judicial power to settle disputed audits. They are not allowed to contact the auditor on the case but rather receive the document file of the taxpayer to review, meet with the taxpayer as necessary to understand the nature of the objections to the auditor’s determination, and adjust those determinations as they think is appropriate.

IRS personnel love their appeals officers and, frankly, so do I. For the IRS, the appeals officers often make the determinations of the IRS more transparent and fair to the taxpayer, thus enhancing the legitimacy of the IRS. Appeals officers settle a vast majority of cases set for trial, thus saving the IRS substantial resources. Finally, the IRS does not like to have public losses, and appeals officers help to filter out the weaker/losing tax cases before they reach the courtroom. I like appeals officers, particularly compared to Auditors, because the appeals officers have more discretion to settle cases and are generally more amenable to finding a mutually-acceptable solution than are auditors.

If you really don’t like the outcome of an audit, don’t be afraid to appeal: with the IRS, at the appeals stage, you can fight “city hall” and often come out ahead.

Account Transcripts: What the IRS Knows About You

Except for what you tell it, the IRS (and for that matter, state tax authorities like the FTB) doesn’t really know very much about you. But it’s worthwhile to find out what it does know about you. The IRS keeps information about taxpayers in transcripts, small files on its central computers. I find it invaluable to get these transcripts when I start to represent a client.

The IRS keeps transcripts of the tax return, the information returns it receives (from Forms W-2 and 1099), and account transcripts (see an example here) showing tax due and payments made. Some of the transcripts, such as tax return transcripts, are available for only three years; account transcripts are available as long as the account is open (meaning there are unresolved/unpaid taxes).

The computerized transcript format has remained almost the same since at least the late 1970s. It has only been in the last decade that transcripts actually use upper and lower-case letters. They display arcane codes, and I need to refer to large textbooks to determine what they mean.

But the transcripts give a wealth of useful information. Did you fail to file a tax return a few years ago, and now you don’t know how much money you made in 2011? A wage and income transcript will show you how much income your sources reported to the IRS. Do you have an S Corporation, and need to know when the corporation made its election? That shows on an account transcript. Is bankruptcy a good option for your unpaid taxes, or should you start a collection due process hearing? Reading the account transcript history will give me a good sense of how to advise you.

I have third ways to get the transcript: first, I can send a power of attorney form to the IRS, and in about two weeks, it may record that form and allow me to access your transcripts online. Second, I can call the IRS’s call center. After about an hour or two on hold, a phone service rep will send me the transcripts by fax. Finally, I can also walk into an IRS office to present the Forms 2848; the IRS will usually generate the transcripts right then.

Once I get the transcripts and read them, the “fun” (or my version of fun) can begin, because then I have a very good idea of exactly what my client’s problem is.