Archive for the ‘ Tax Litigation ’ Category

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.

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.

There are hundreds of strategies for handling IRS issues. But not all strategies are as effective as others.

A car-repair owner got audited and brought his tax-return preparer (Jim) to handle the audit. The preparer said to give the IRS as little information as possible . “The IRS won’t want to go to trial, and they’ll cave in at the last minute,” he said. But something didn’t seem right to the car-repair owner. Perhaps it was the approaching trial date, the lack of apparent concern on the IRS side or (most likely) the way the IRS threw Jim, the return preparer, out of the meeting when Jim became too confrontational. Whatever the reason, the tax-payer called me.

I explained why Jim’s advice was off-base: the law requires that taxpayers prove their expenses; the IRS does not disprove expenses. Unless there is a receipt and a valid reason for an expense, the IRS – and the Tax Court – will not allow it. Trial for an IRS attorney litigating expenses is a walk in the park; the IRS does not ‘cave’ in these situations, no matter how aggressive or obnoxious your accountant or tax attorney is.

I also told the taxpayer a bit more about ‘Jim’. I had handled a case against him when I was an IRS attorney and he obstructed that case to the point where I needed to tell the taxpayer to fire him. Jim was a disbarred attorney from another state. His advice routinely lost his clients’ cases, while costing them thousands of dollars.

I worked to get the best outcome for the car repairman, despite a poorly-prepared return. Jim had included many unsubstantiated expenses. My client ended up owing, but the audit ended more quickly and the final bill was lower than if Jim had continued stonewalling the IRS.

When it comes to expense substantiation, it’s always best to provide information, documentation, and answer questions quickly. Any advisor who tells you otherwise is simply wrong. Check credentials: a valid law license or an up-to-date CPA license won’t guarantee a good result, but they do indicate some level of responsibility.

To the IRS, Every Tax Period Stands on Its Own

I received a call recently from someone already represented by a tax attorney, but who wanted my opinion on whether there was anything his attorney could have done to avoid the following, very unfortunate situation.  John Barrett owed a bunch of employment taxes on his own. He tried to make arrangements to pay them, and made good use of the Collection Due Process provisions in the Tax Code: he filed four cases against the IRS in the Tax Court to challenge the way the IRS was trying to collect almost $85,000. He settled those cases with an agreement that the IRS would place these liabilities “in a Currently Not Collectible status due to the petitioner’s financial hardship.” This is a good result, because it means that the IRS will go away and not try to collect these liabilities.

Unfortunately Barrett had other liabilities: he and his wife Carol owed $10,000 in joint income taxes for the 2002 and 2009 tax years. The IRS tried to levy on their bank accounts, so together the Barretts filed another Collection Due Process case (Tax Court case 1576-12L). They claimed that the legal doctrine of “res judicata” (“the thing has been decided”) required the IRS to make the joint income tax liabilities non-collectible too. After all, if financial hardship prevented John Barrett from paying the $85,000 in back employment taxes, that same hardship ought to extend to the $10,000 in income tax owed. When the IRS asked for financial documentation to determine collection alternatives, the Barretts produced only the signed settlement agreements from John’s employment tax cases.

The IRS disagreed that it had decided that the income tax liabilities were non-collectible, and so did the Tax Court (T.C. Memo. 2013-256). “A well-established principle is that the Commissioner [IRS] may challenge in a succeeding year what was accepted in a previous year,” according to Judge Cohen. End result: the IRS gets to levy on any accounts it finds belonging to John and Carol, and it doesn’t need to find the liabilities non-collectible.

The result is tragic, because the Barretts probably could have gotten their joint income tax liabilities into non-collectible status by providing the same documentation that John produced to find the $85,000 non-collectible. The appeals officer considering their situation had already proposed an installment agreement of $340 a month, and offered to do more for them if they provided a financial statement (Form 433A). Had I represented the Barretts, I would have had them complete the Form 433A and provided all requested documentation, while also sending the information from John’s employment tax collection effort to show how the IRS had dealt with the same taxpayer on a different liability. In truth, they may have the chance to do that now, but the IRS will have the legal right to reject their offers to pay on their terms.

The moral of this case: cooperate with the collection officer. If he asks for specific documentation, show it to him. The argument that the IRS had already considered his situation and reached a decision does not hold water, because the IRS treats each individual tax liability as a separate item – each year, each type of tax – as a separate item.

Statutes of Limitation, the IRS, and the FTB

A potential client called me last week for help in dealing with the IRS.

It seems he owed a lot of taxes for tax years from 1992 to 1996. Had he filed the returns on time? Yes. Had he filed bankruptcy in the meantime? No. Had he filed an offer in compromise? No. Has he heard anything from the IRS in the last three years? No, but he thought that was because he had moved and not written to the IRS collection department to tell them about the move. Has he filed a tax return from his new address? Yes.

I told him not to worry, that he probably didn’t owe the taxes anymore because it took more than 10 years for the IRS to collect those taxes. And it occurred to me that I should explain how statutes of limitation can work to the taxpayer’s advantage.

Audit and Assessment – Three Years IRS, Four Years FTB

The IRS has a three-year limitation period on assessment from the time of the return’s filing. That means that if three years pass from the time you, the taxpayer, filed your return, the IRS can no longer audit you for that tax year.

Sounds simple, right? But when did you actually “file the return?” Let’s take a return for the 2011 tax year. If you filed it before April 15, 2012, the law says that the return was filed on April 15. If you had an extension until October 15 and filed the return on September 1, the limitation period starts on October 15.

If you filed the return late, the law says that it was filed on the day the IRS received it.

In California, the Franchise Tax Board generally enjoys more liberal state laws than the federal IRS. The FTB has four years to assess more taxes on a filed return.

There is a big difference between how the IRS and the FTB go about “assessing” a tax, and how their audit procedures work. For the IRS, assessment occurs at the end of the audit process. Thus, the IRS generally tries to reach potential audit targets within a one-to-two-year window after the return is filed. If the three-year clock has been ticking for two years and ten months, and you haven’t heard from the IRS, you are unlikely to get audited for that year – although there are relatively uncommon exceptions. The IRS has to start its audit soon enough that it can complete the process and issue a Statutory Notice of Deficiency more than four months before the end of the limitation period, for reasons that are too complicated to mention here.

The relatively uncommon exceptions? The IRS gets six years to audit you if it can show a large understatement of income, and if it can show that your return is fraudulent, it can open the audit and assess at any time; there is no statute of limitations on a fraudulent return.

The FTB, on the other hand, assesses the increased tax as soon as it smells a problem. Like a deputized posse member who shoots first and asks questions later, the FTB starts its process with a Notice of Proposed Assessment; this counts as the “assessment” for purposes of the statute of limitations. This notice can be mailed on the last day of the four-year clock, and it’s still effective.

If the taxpayer gets audited by the IRS and agrees to a higher assessment, the taxpayer has a duty to inform the FTB within six months. The FTB then has two years to make its assessment. If the taxpayer doesn’t make the six-month deadline, there is no limitation period – the FTB has an infinite amount of time to make the assessment.

These assessment clocks can be tolled (and often are) by agreement between the taxpayer and the taxing authority. Sometimes this is a good idea, especially if the taxpayer just needs a bit more time to gather records to show to the auditor. Sometimes it’s a bad idea, if the tax authority’s case is not very strong.

Obviously, the laws strongly favor the taxing authorities: our legislatures want to make sure that people do not get out of taxes owed by skillful procedural. And while the FTB’s laws sound even more tilted against the taxpayer, there is a counterbalance: the FTB is generally less effective at opening and closing audits, and investigating a taxpayer’s affairs, than the IRS. “Generally,” of course, doesn’t mean that it can’t be extraordinarily effective if it wants to be.

Collection – Ten Years IRS, Twenty Years FTB

Once the assessment is made, the taxing authority then has to try to collect it. The IRS has 10 years. The date that the collection authority ends is called the “CSED” (Collection Statute Expiration Date). The ten-year clock can be tolled by any of several events: bankruptcy, offer in compromise, or collection due process hearing. Installment agreements do not toll the collection period.

For the FTB, the statutory period is 20 years. Installment agreements, bankruptcy, military service, presence in a disaster area, and child support collection actions all toll the statutory period.

While I have counseled taxpayers at the end of the IRS’s 10-year period, I have never counseled anyone at the end of the 20-year period. The main reason is that the statute of limitations is less than 20 years old: prior to July 1, 2006, there was no statute of limitations on collection actions for income tax in California. No one has yet had their California tax liability extinguished by operation of time.

Period before Dischargeability in Bankruptcy – Three-year, Two-year, 240-day Rules

Taxpayers may discharge their liabilities in bankruptcy. However, the law requires the taxing authorities to have a chance to collect those liabilities before the taxpayer can discharge them. Thus, 11 USC Sec. 507(a)(8) and 523(a) work together to create several rules, familiar to most bankruptcy attorneys: in order for a tax liability to be discharged, it must come from a return last due more than three years before the bankruptcy filing (this is October 15 if the taxpayer got an extension), actually filed more than two years before the bankruptcy filing, and the tax on that return must have been assessed more than 240 days prior to the bankruptcy filing (this becomes relevant in an audit situation). These periods may be tolled by bankruptcy, collection due process hearings, and offers in compromise.

Because these rules are set by federal bankruptcy law, not federal and state taxation law, they are identical for the IRS and the FTB. But there is yet a wrinkle between the two: the 240-day rule operates slightly differently for the FTB than for the IRS.

The “assessment date” for the IRS is straightforward: it is the date appearing on the transcript, the date that the tax return was received, the taxpayer agreed to an increased assessment, or the date that a Tax Court decision became final. For the FTB, it is the date that the assessment proposed in the Notice of Proposed Assessment becomes “final.” While the NOPA serves as the assessment date for all kinds of clocks (including the inter-agency agreement determining priority of liens), it does not serve as the starting period for the 240-day rule. Rather, the 240-day clock starts 60 days after the NOPA, thus effectively giving the FTB a 300-day period before dischargeability is allowed.

Debtor’s often have Notices of Federal Tax Liens outstanding at the time they file bankruptcy. How are these handled?

First, a properly-noticed lien survives bankruptcy. It continues to attach to any property owned at the time of the bankruptcy. It does not attach to any property acquired after the petition date.

1. Lien on real property. If the bankrupt debtor owns a house and the IRS has filed a Notice of Federal Tax Lien against the debtor’s real property (in the county records), the IRS will generally keep that notice in place after bankruptcy. The house may be underwater and the IRS lien thus worthless, but if the house appreciates in value, the IRS is entitled to the new value.
If, however, the debtor acquires a new piece of land after filing bankruptcy and discharging his taxes, the IRS lien won’t attach to the new piece of land.

2. Personal property. If there is a Notice of Federal Tax Lien filed against personal property, it attaches to everything the debtor owns on the day of the bankruptcy petition. Once the debtor discharges the underlying tax, the IRS still has the right to seize all your personal assets (even those exempted) to satisfy its lien, but it just won’t. Imagine: you, as a debtor, file for bankruptcy, go through the entire process, get your debts including your tax debts discharged, and then they send the Asset Recovery Team to your house to seize your car and sofas – for which it could get how much at auction? Also, the lien doesn’t attach to newly-acquired property, so it would need to investigate whether the bracelet it proposes to seize and sell came from Aunt Tammy as a birthday gift after the bankruptcy petition was filed. The IRS long ago figured out that the PR and legal problems here are huge, so they’ll go ahead and release the lien.

Whittling a Tax Debt Down from $513,000 to $30,000!

“Impossible,” you’re probably thinking. But it’s not. Here’s why.

My client knew he had $200,000 in tax debt, only $30,000 of which was income tax debt; the remaining $170,000 was for back payroll taxes from a pizza shop he’d owned a decade earlier.

The first issue to address was whether he should file a Chapter 7 or 13 bankruptcy. I advised against a Chapter 7 (liquidation) because my client had almost no tangible assets and thus the IRS would not file a Proof of Claim (for taxes owed) since there would be no way for the agency to get money out of my client. We would miss any chance to find out exactly how much the IRS thought he owed, and contest that amount.

In a Chapter 13 bankruptcy, all creditors step forward to assert what they are owed, and the debtor proposes a plan in which the creditors are paid off over five years. Some debts (secured and priority claims) must be paid in full; other debts (general unsecured, like credit card or stale tax debt) must be paid according to the debtor’s means. If we filed a Chapter 13 for my client, then the IRS would most certainly file a Proof of Claim for the $200,000 it believed the agency was owed since the back taxes could be paid (partially) from my client’s wages over the next 5 years. And, once the IRS filed a Proof of Claim in the Chapter 13, we could contest the amount.

The second issue was the unexpected curve ball the IRS threw at us: in its Proof of Claim in my client’s Chapter 13, the IRS asserted not the $200,000 tax debt we were expecting, but rather $513,000! Huh? The agency was trying to stick my client for $313,000 in payroll trust fund taxes (the taxes withheld by employers for their employees to fulfill Social Security, Medicare and other tax obligations – this is different from payroll taxes which are the employer’s obligations on Social Security and Medicare for their employees) owed to IRS by a non-profit entity in which my client had worked at the VP of Finance years earlier. His reaction to this unwelcomed news? “That’s crazy! I had nothing to do with the payment of withholding taxes in my job there!”

Indeed, the third issue that arose in this case was whether my client was a “responsible person” who had “willfully” failed to withhold and pay withheld payroll taxes on behalf of the non-profit organization’s employees. My knowledge strongly suggested he did not meet the IRS’s “responsible person” criteria: my client did not have check signatory privileges, nor did he have the discretion to choose to pay another creditor over the IRS. (The IRS views non-payment of trust payroll – the taxes withheld from employee’s paychecks – as almost criminal: it will treat as a thief any agent of an organization who had the power to withhold employee wages and the discretion to choose which creditors of the organization to pay – the so-called “responsible person” who failed to pay the withheld wages to the government.) Obviously, we objected to the IRS’s claim that my client was responsible person. Unsurprisingly, after interviewing my client and doing a search of the documents at the non-profit organization, the IRS agreed that my client was not a “responsible person” for the $313,000 of owed trust fund payroll taxes at the non-profit he’d worked at. Whew – unexpected curveball successfully addressed.

Now on to the original $200,000 tax debt, $170,000 of which was outstanding FICA and FUTA tax owed by the debtor’s pizza shop. The pizza shop was never incorporated, so the client owed the payroll tax as an employer. The IRS never took the extra step of assessing the debtor as a responsible person for any portion of this tax, and the statute of limitations has passed, so it can no longer find him personally liable for the trust fund portion of the payroll tax. This is an important distinction: the payroll tax is dischargeable in bankruptcy, the trust fund tax is not; here, the debtor was able to put the payroll tax into the bucket of dischargeable taxes, saving himself $170,000.

The final tab: only the $30,000 in income taxes. That’s right: we went from $200,000 owed to the IRS, to $513,000 owed, to a final outcome of $30,000 owed! That $30,000 by the way, will be paid out over five years in my client’s Chapter 13 bankruptcy – or $6,000 annually which breaks down to $500 a month. I know. I didn’t hope for, or believe in, such a positive outcome at the beginning of this case either. But, the outcome of this case reaffirmed three claims I often make to my clients or potential clients on tax matters.

First, the IRS is not infallible: it makes mistakes and will admit to them when challenged. Second, it is not difficult to challenge the IRS. If the agency does not have good evidence to back up its claims against you, it will fold because it is an agency with limited resources and it will concentrate its money and manpower on more promising cases. It’s also a conservative litigator: with the law so heavily on its side, it tends to give taxpayers the benefit of the doubt in close factual situations. If your facts are good, the agency will often back down even when it sees a reasonable chance it could prevail. But note: if you’re just trying to shirk taxes you legitimately owe, then no amount of legal mumbo-jumbo will get you off the hook. Third, the cost-benefit analysis of hiring good legal counsel on tax issues is often a no-brainer. In this case, my fee to the client was around $10,000. For that amount, my client saved $483,000. While this was an unusually positive result, the amount you can save by hiring an experienced tax attorney often is very disproportionate to what you can save in debt to the IRS. Lesson? At least speak to a tax attorney before you concede to the IRS. Good, ethical attorneys will be honest with you about whether you have a good reason to contest an IRS judgment.

Tax Court Case–Gaggero v. Comissioner

Here is a rather recondite discussion of true sales and capital gains on those sales.  I am barred from commenting on the background of the case because of disclosure laws.