Archive for the ‘ Lawyering ’ Category

Is it true that there is no law requiring payment of income tax?

My tenure as an IRS attorney caused me to think deeply about taxes, courts, and government. And it helped me see how I can help individuals who face the tax system.

There are people – common in the San Fernando Valley – who believe that the government does not have the right to collect taxes. At the IRS offices, we called them “constitutionally challenged.” We weren’t allowed to call them “tax protestors.” A common assertion they made: there is no law that requires them to pay income tax. Oh, they’ll say that the 16th Amendment wasn’t properly ratified because Ohio wasn’t a state in 1916, or that the term “person” in I.R.C. § 6012 isn’t defined, therefore doesn’t include them, or that receiving “cash” isn’t “income.” Debating them made me think about the IRS’s mission. It also made me think about what a mentally healthy person does.

Someone recently showed me a case involving a bankruptcy debtor who filed Uniform Commercial Code Financing Statements against federal employees because he didn’t like the way the federal employees were doing their jobs. It brought me back five years, to a case where the taxpayer didn’t like the IRS collecting taxes from him, and didn’t like that I was helping the IRS collect taxes from him. He filed a UCC-1 financing statement against me in the amount of $41 million (or was it billion?). I wasn’t alone; the statement also named 10 other IRS personnel and a Tax Court judge. It’s a good thing I had already gotten a home loan.

That particular taxpayer had used a novel argument against the IRS: he was not only a “natural-born, 13th Amendment citizen,” but also a “U.S. Vessel.” As such, he had a prior lien against his earnings under the Tax Court’s maritime jurisdiction that trumped the federal government’s contractual right to payment from him.

This argument, of course, was not seaworthy, and the judge did not even dignify it with comment beyond the word “frivolous.” (The IRS has identified a host of other arguments that are “frivolous;” the kindest word I can use is “creative.”)

My sometime-vessel taxpayer left the bounds of mental health when he adopted an extravagantly unrealistic statement: “I am a U.S. vessel.” Yes, there are legal fictions (corporations are persons), but they are few and widely-accepted.

More importantly: the taxpayer made a grave mistake when he said that the government had a contractual right to taxes.

Attorneys and the general public must be clear about this. There is nothing “contractual” about taxes. Taxation is extortion. It is only legal because all three branches of the government, which controls the legitimate use of power and violence, say it is legal. Regardless of its morality and justice, the income tax exists. It’s mentally healthy to recognize this and deal with it, rather than claiming that some tortured loophole rescues me from its obligations.

Because I know the way the IRS works, and the workings of the income tax, I can help most people live with and, sometimes, even defeat the IRS. But not if that person also thinks he’s a boat.

It happens to the best of us

My mother-in-law, Margret, is in a nursing home. She knows who she is, but not much more than that. My wife does her taxes every year. And it’s usually pretty simple to do, because Margret’s income is fixed: some social security, some pension money from Mercedes-Benz, where her husband had worked for 40 years. I have to believe that our family prepares a good tax return.

But the IRS doesn’t believe that. Our house received some correspondence, a “CP2000” letter, saying that Margret had not reported a payment of $49,490 (in addition to her normal pension) from Mercedes on her 2012 tax return. Mercedes had apparently sent the IRS a Form 1099-R showing a distribution in this amount on February 28, 2012.

Whipped into a frenzy of righteousness, and knowing exactly how to deal with this after more than 15 years of experience with the IRS, I went into action. I sent a letter to the Fresno Service Center saying that the IRS was wrong, that Margret did not receive this money, and asking that the IRS provide both a copy of the 1099-R and any other evidence showing the receipt of this income.

The IRS surprised me. It answered by issuing a statutory notice of deficiency (SND). This letter means that the IRS is done with the taxpayer, and has determined that the taxpayer owes the money. The only recourse for the taxpayer is to bring the issue before the Tax Court, where the taxpayer usually has to prove the IRS is wrong.

It is very hard to prove a negative. Here, however, there is a wrinkle for the IRS: IRC § 6201(d) puts the burden of proof on the IRS when it is relying on an information return. Put simply, the IRS must find other evidence of the payment than the Form 1099-R. The taxpayer does not have to prove that she didn’t get the money; that would be impossible.

The SND surprised me because the IRS knows it cannot assess this tax unless Mercedes-Benz sends it some further information.

It occurs to me that most relatively well-educated individuals would not know what to do in this situation. The IRS probably collects a great deal of tax it isn’t actually owed by sending out these kinds of letters. Here, the tax is approximately $13,000; I can see a lot of people giving up and just agreeing with it because they don’t know how to fight it.

If you get a similar notice, call me. I can help you make sense of this and walk you through the process. I will help you analyze whether it makes sense to hire me: for a $13,000 tax bill, it may not.

Portuguese Water Dog

I sometimes run into conflict with clients who are so angry they want to use me primarily for revenge, even if their case would have a better outcome if we approached the adversary calmly and with a reasoned strategy designed to get them the best financial outcome. Instead, these clients want me to employ any tactic that will punish and pummel their adversaries. In short, these clients want me to be their legal pit bull, conveying all the rage and frustration they’ve built up over their matter.

Their desire for revenge is almost always justifiable, but hiring an attorney to “get even,” or to be a mouthpiece for a client’s frustration is a bad strategy for dealing with the IRS. Moreover, the pit bull approach is not my style. I’m more of a legal Portuguese Water Dog– slow to get ruffled, stately and somewhat refined. Legal Ports are more effective than legal pit bulls: they get attention not because the adversary is afraid of them but rather because the adversary cannot ignore the elegance and beauty of the Water Dog’s legal reasoning. The Portuguese Water Dog conducts himself with dignity and quiet persuasion; the legal pit bull’s snarling is sloppy and off-putting.

Let me illustrate with a recent example. A client of mine faces a terrible finding from the IRS: $500,000 in income adjustments over 3 years that translate into an additional $200,000 in tax, interest and penalties. He wants me to fight on absolutely every little issue. I try to educate him about picking our battles strategically: some of his deductions won’t be sustained in the audit, or later in the appeals and tax court process. I have a good sense of how IRS auditors work, and why they work the way they do. Presumably, my client has hired me, in part, because of my decade as an attorney for the IRS. There are excellent reasons for us to concede on some of the issues in my client’s case right way; contesting them will both hurt our credibility and lead the auditor to other issues that we don’t want opened. I try to convey that to my client. “I don’t care: fight’ em!” he insists. The client is mad. He wants revenge. I’ve been hired to be his legal pit bull.

Unfortunately, the IRS is one of the least revenge-worthy institutions that exist. Government functionaries show up to do their job at varying levels of competence. They have procedures for every situation. Case law says that tax courts should assume that any government functionary is incompetent, so an IRS employee’s failure to “snap to” does not hurt the government’s legal position. A pit bull does not work well against the government. In fact, when I was at the IRS, I was greatly amused by a taxpayer who fought the IRS’s right to audit him, spent $100,000 in legal fees to thwart our attempts to look at his records, and ended up having to show us everything we had asked for a year earlier anyway.

When facing the IRS, aggression doesn’t work and revenge is meaningless. Do you think a 30-year veteran auditor cares if you fight on every item of the audit? It’s much better to choose battles that can be won in the audit or on appeal, and be quietly and calmly persistent with the IRS and tax courts. In short, the stately, legal Portuguese Water Dog gets much more effective results than the angry, legal pit bull. Please, do us both a favor: if you want a pit bull, go elsewhere. I’m not your dog – er, — man.

Should legal losers pay the winners’ attorney fees?

My clients were nurses at a local hospital, immigrants from a third-world country.  They worked hard and bought a house.  One day, a fellow told them that their house had been built by a contractor without a license.  The fellow said that the house was therefore substandard, and he handed them an attorney’s card.  They contacted the opportunistic, aggressive attorney, started a lawsuit against the contractor, and lost.

Did I say they lost?  It was so much more than just losing.  They not only failed to get a judgment in their favor, a recovery of a few thousand dollars to compensate them for the lower value of the house, but the contractor countersued for attorney’s fees under the sales contract, and got a $1 million verdict.  The nurses’ attorney had been a bulldog, someone who refused to give up, and the builder had to pay a fortune to its attorneys to prevail.

Once the nurses’ wages began to be garnished, they contacted me.  I filed a bankruptcy to discharge this debt (they owed just about nothing else).  The builder didn’t like this, and sued them in bankruptcy court, claiming the $1 million attorney fee debt was nondischargeable.  The builder said that the nurses had engaged in “malicious prosecution,” and that this was a malicious tort under section 523(a)(6) of the bankruptcy code.

The debtors now have to pull together several tens of thousands of dollars to pay me to fight this dischargeability action.  They may lose just because they can’t afford to pay me for the full defense.  At the same time, I see some good ways to end this in their favor, and I am confident that they can prevail and discharge this debt: it wasn’t malicious prosecution.

I enjoy cases like this: tough legal issues, and the need to handle things economically.  I can’t run up a million dollars in legal fees here.

But this does reflect disturbing issues in the legal system.  We allow contingency fee arrangements to encourage attorneys to fight for people with few resources.  When we hire an attorney, we want him to fight for us as hard as he can.  Here, that fight backfired on the nurses: they now owe $1 million.  When people ask for a “loser pays” system, is this what they want?

When someone can’t pay their bills, we want them to be able to discharge them and start over, unless the bills are for specified kinds of debt: student loans, recent taxes, fraud, domestic support, malicious torts.  Debtors don’t have much money, and can’t fight creditors when the creditors chase them into the sanctuary of bankruptcy.  These cases often get resolved in very unsatisfactory ways: payments made by poor people to get rid of a claim that may have little merit.

Nothing left to lose and loving it

I had a client come to me a few years ago to file bankruptcy.  He owned two office buildings with mortgages totaling more than the buildings’ values. They were going to be foreclosed, triggering personal guarantees, and the client would owe millions of dollars to the lender.  If he somehow got out of the personal guarantees, he would owe hundreds of thousands of dollars of tax on the imputed income from canceling his debt.

My client was 75 years old and suffering from Parkinson’s Disease. He had $100,000 in a bank account, and was living off of his social security checks – $10,000 per year.  Though he was married, his prenuptial agreement said the money and income were his separate property.

I advised him against filing bankruptcy.  “Give the money to your wife,” I said, “in return for her promise to feed and shelter you for the rest of your life. The social security income will be exempt from attachment in California; you are effectively judgment-proof.  And you won’t owe tax, because cancelation of debt isn’t income when you are insolvent.”

He followed that advice.  The wife spent the money caring for him; the foreclosures still haven’t occurred, so there is no judgment against him yet.

I saw him recently.  He said he had never felt happier in his life – not when he was a physics professor, nor when he was raking in money as a commercial landlord in good times.  He was surrounded and cared for by people he loved, had no worries about losing anything, and was satisfied with the life he had led.

I’m in a different place.  I work hard to provide my clients the best in service and expertise.  I have bills to pay, mouths to feed, obligations to others.  I enjoy it; I feel a satisfaction in achieving goals and being recognized by my peers.

In looking at this client, however, I felt more than the usual amount of satisfaction.  I did nothing superhuman; the work wasn’t particularly demanding.  But I made a difference in his life, a difference for the better, and I feel deeply satisfied about that.  Such experiences make my work very rewarding.

What happens when I meet the trustee?

Every bankruptcy case has a Meeting of Creditors, often called the “341 meeting.”  It occurs about 30 to 45 days after the petition is filed.  My clients often tell me that they are scared of the meeting: will they need to explain why they filed bankruptcy?  What if they say the wrong thing?  What if the trustee decides not to approve their bankruptcy?

The hearing takes place in front of the trustee.  It’s in a separate office from the courthouse.  In chapter 7 cases, trustees spend the whole day questioning debtors, who wait and watch the other debtors.  When it’s well-run, the 341 meeting lasts about five minutes; a debtor can expect to be at the office for an hour, waiting for his case to be called.

Some trustees require a debtor to complete a questionnaire, others don’t.  All trustees require the debtor to read a pamphlet with information on the bankruptcy process.

Each debtor has to produce identification (driver’s license, passport, military id) and proof of social security number (original card is best, but an original W-2 or health insurance card with the entire number will work).  The trustee’s assistant verifies the numbers and identification.

The debtor is put under oath, and the trustee records the proceedings.  So it’s natural to be a bit nervous about it.  The trustee has a standard patter of questions:   Are you who you say you are?  Did you intend to file bankruptcy?  Is that your signature on the petition?  Does your petition list everyone you owe and everything you own?  Are there any mistakes on it?  Did you read the green pamphlet? Check out this list of questions Here’s a more complete list of questions from another district.

If the trustee is interested in any particular item on the petition, he’ll ask questions about it.  But because he has dozens if not hundreds of other debtors to question that day, he doesn’t want to spend much time on a single person.

My advice to debtors facing a 341 hearing: listen to the trustee’s question, answer only the question asked, and tell the truth when doing so.

The meeting usually goes very easily, and my clients tend to wonder what they were so worried about before the meeting.

Why I try not to do loan modifications

The following commentary is from Hale Antico, a local bankruptcy attorney colleague:

Bank of America’s mortgage servicing unit systematically lied to homeowners, fraudulently denied loan modifications, and paid their staff bonuses for deliberately pushing people into foreclosure: Yes, these allegations were suspected by any homeowner who ever had to deal with the bank to try to get a loan modification – but now they come from six former employees and one contractor, whose sworn statements were added last week to a civil lawsuit filed in federal court in Massachusetts.

“Bank of America’s practice is to string homeowners along with no apparent intention of providing the permanent loan modifications it promises,” said Erika Brown, one of the former employees. The damning evidence would spur a series of criminal investigations of BofA executives, if we still had a rule of law in this country for Wall Street banks.

The government’s Home Affordable Modification Program (HAMP), which gave banks cash incentives to modify loans under certain standards, was supposed to streamline the process and help up to 4 million struggling homeowners (to date, active permanent modifications number about 870,000). In reality, Bank of America used it as a tool, say these former employees, to squeeze as much money as possible out of struggling borrowers before eventually foreclosing on them. Borrowers were supposed to make three trial payments before the loan modification became permanent; in actuality, many borrowers would make payments for a year or more, only to find themselves rejected for a permanent modification, and then owing the difference between the trial modification and their original payment. Former Treasury Secretary Timothy Geithner famously described HAMP as a means to “foam the runway” for the banks, spreading out foreclosures so banks could more readily absorb them.

Pigs Get Fat, and Hogs Get Slaughtered

That’s a great saying, and it applies well to pre-bankruptcy planning.  It is perfectly acceptable to move assets around before a bankruptcy, within reason.  It’s a little like the difference between tax avoidance and tax evasion: there are legal limits to avoiding taxes, and there are legal limits to avoiding your creditors.  Stay within those limits, and you’re being pretty smart.  Eric Busby, Houston bankruptcy lawyer, explains it a bit more.

Bankruptcy isn’t a “get out of jail free” card

Here’s a great little loophole being closed. Get your car impounded, file bankruptcy, get your car back, dismiss the case. Easy! Until the FBI comes knocking on your door.

Lesson: Bankruptcy may seem like a free lunch.  It isn’t. There are benefits and burdens to it.  File with a reputable lawyer who knows what he is doing.

Trader Joe’s

My client had been an executive with an ad agency.  He had put a daughter through college, then lost his retirement nest egg in the real estate crash.  He now lives with his wife in a rental in the Valley.  Stretched beyond his means, he was having his wages garnished because of a credit card judgment entered against him a year earlier.

He came by my office to sign his bankruptcy petition.  He made the appointment, then called to say he was running 15 minutes late.  When he showed up, he was a bit out of breath.  He explained that he had just walked there, because he had given up his car.  I don’t have an office that one just walks to – it took him a half hour to trek the two miles from his previous appointment.

I asked about his life.  He works at Trader Joe’s for $11.50 an hour.  I said I was always impressed at the workers at Trader Joe’s – many are tattooed, some of them look pretty rough, but they are invariably kind and helpful, and appear to be pretty competent.

His eyes lit up.  “I just love working at Trader Joe’s,” he said.  He talked about his best friend at the store – a former marine in his 30s with tattoos up and down his arms. “I’d never have anything to do with him in any other situation, but we got along great and accomplished some pretty big jobs together,” he said.

He said he would love to keep working at Trader Joe’s because it’s so much fun.  But people are calling him now for consulting on advertising projects, at pay rates of $50 an hour and up.  He’ll do that, but he’ll always miss Trader Joe’s.

After he was done, I had no more appointments, so was going to go home.  I offered him a ride to the nearest bus stop; he gladly took it.

What does it take to be happy?  David Allen talks about a former Navy aircraft carrier captain who went to work at UPS as a delivery man, and a corporate CFO who became a duck at Disneyland.  All these people – my client, the former high-powered execs – found meaning in relatively low-level stress-free jobs.  I’m honored to know people like this, and humbled that I can help them out.

My calling isn’t nearly so stress-free, but I find great meaning in it as well.