IRS

IRS: The Nice Guys Once Again

About two weeks before the wildfires struck northern California, my wife and I spent a few days in Napa Valley.  We went to a stunning estate to celebrate the perfect nuptial ceremony featuring a beautiful bride.  There aren’t many places more gorgeous than California wine country.  My friends there tell me that still is true, despite the fires.  However, a lot of folks have lost their homes and their jobs.  People are helping.  Also, the IRS is doing its part.

Yesterday, the IRS released Notice 2017-70 that provides guidance on the treatment of leave-based donation programs to aid victims of the California wildfires.

Under a leave-based program, employees elect to forgo vacation, sick or personal leave and the employer makes contributions of such forgone amounts to a charitable organization that, in this case, helps victims of the 2017 California wildfires.  There are some tough questions about taxation of such programs, when one looks at underlying law and authorities.  One could certainly project all kinds of adverse tax results of people trying to do good deeds.

If the IRS were to stick to the letter of the law, a lot of money intended for victims might go into the coffers of the Treasury, instead of to the charities helping the victims.  But, the IRS is turning away from a strict interpretation and, without citing any authority (of which there is probably none), outlines for the employees and employers a best-case scenario.  It is simply the case of the Federal government, through the IRS, doing the right thing; forget about the rules.

This is not the first time that the IRS has performed a kind act.  Over the last several years I have observed a number of these types of pronouncements and actions that aided victims of all sorts by loosening the strictures of tax law.  For example, in the aftermath of the recent hurricanes, the IRS extended many deadlines for filing returns and paying taxes; it set up and manned hotlines to help victims and tax preparers serving those victims.

Most of my dealings with the IRS are ministerial.  However, some of my dealings are respectfully adversarial.  The IRS interprets the law to be sure that my clients pay no less than they should and I am interpreting the law to be sure that my clients pay no more than they should.  Sometimes, the twain do not easily intersect.

Today, though, my hat’s off to the IRS.  Well done, Revenuers.

VKM

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IRS

National Taxpayer Advocate’s 2016 Annual Report to Congress – Some Key Takeaways

Every year, by law, the National Taxpayer Advocate, “an independent voice for the taxpayer within the IRS,” issues a report to Congress.  For 15 years, the National Taxpayer Advocate has been Nina E. Olson.  She knows her stuff.

Issued last week, the 2016 report is about 965 pages, give or take a page or two.  The executive summary alone is 95 pages long.  The IRS ignores the National Taxpayer Advocate at its peril.  The new Congress and the new President would be wise to heed her advice, too.

The 2016 report includes a lot of good ideas, observations, complaints, and suggestions.  I may come back to some additional items in future blogs.  In this blog I focus on three “foundational themes” that she identifies as core to improving the IRS and its operations.

  1. “Simplify the Internal Revenue Code Now.” Of course, the IRS does not write the tax laws; Congress does.  Nevertheless, the IRS’ job revolves around this massive, complicated and confusing document.  Olson points out that the Internal Revenue Code consists of four million words.  She estimates that taxpayers spend six billion hours in order to meet filing requirements. (Based on the way the number is calculated, that may include some or all of tax preparers’ time.  She admits that it’s a rough estimate.)
  1. “The IRS needs to talk to the taxpayer. IRS must present a human side to the agency to foster and keep voluntary compliance.”  While self-service assistance has its beneficial attributes, she points out that behavioral science studies confirm the human voice is quite soothing to someone who is stressed and anxious.  Indeed, she cites a number of behavioral science lessons that may be applicable to taxpayer compliance.
  1. There is a “need for establishing minimum standards of and testing for competency of Federal tax return preparers.” She is not worried about CPAs, attorneys, and enrolled agents.  However, there are a lot of tax return shops that don’t have any real proficiency standards and sometimes have no scruples.  Consider the guy standing on the side of the road at the strip shopping center dressed as the Statue of Liberty; when somebody parks and walks into his storefront, he takes off his costume and prepares a tax return.  It might be good to check his credentials.

VKM

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IRS

Happy New Year 2017! A Little Gift

 

I was cleaning out my “blog topic” file this morning and readying for the new year.  I found a note that I should send this link to my friends and readers.

The IRS website is full of helpful information, if you can navigate to it.  Take a look at “A-Z Index for Business” at  www.irs.gov/businesses/small-businesses-self-employed/a-z-index-for-business. There are probably more than 500 topics that are just a click away.

If you have time, you might send the IRS a suggestion for topics that would fall under “X”, “Y”, or “Z”, which are without topics at this time.

Happy New Year!

VKM

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IRS, Tax Court

Don’t Tell My Clients About This Case

I always tell my clients to keep good records.  Often, I tell them again and again annoyingly.  It is my experience, and I daresay the experience of most other tax practitioners, that a taxpayer’s failure to keep good  books and records will almost always result in a bad experience, if the taxpayer has to tangle with the IRS.  Well, I said almost always.

Mr. Singer owned an S corporation of which the primary business was servicing, repairing, and modifying recreational vehicles.  The corporation also sold Kraftmaid cabinets used in the construction of homes.

Mr. Singer relocated his business from Florida to Colorado in 1999. After a slow start, Mr. Singer’s operations grew quickly.  He needed money to fund the business’s growth.  He established a home equity line of credit; he refinanced his home; he borrowed money from his mother and her boyfriend.  In total, from his own funds or from funds that he borrowed personally, he injected $646,443 into his corporation.

The corporation recorded the advances as loans from shareholder on its general ledger and Form 1120S, U.S. Income Tax Return for an S Corporation.  However, there were no promissory notes between Mr. Singer and the corporation, there was no interest charged, and there were no maturity dates.

It is no surprise what happened to the business in 2008.  Most money spent on recreational vehicles is discretionary and revenues dried up during the Great Recession.  Mr. Singer had to scramble. He moved his business back to Florida.  He borrowed more money from his mother and her boyfriend.  He paid personal bills out of the corporation’s bank account.  The corporation treated those bill payments as repayments of the shareholder loans.  He was taking no other compensation payments from the business.

In a recent case before the Tax Court, the IRS wanted to classify the payments from Mr. Singer to the corporation as contributions to capital and the corporate payments of Mr. Singer’s bills as wages to Mr. Singer.  As a result of those  classifications, the IRS wanted to collect employment taxes from the corporation.

The court cited thirteen factors to consider in classifying funds flowing between a closely held corporation and its owner.   Then, the court pretty much ignored the factors.  To my surprise, the court said that, up until the Great Recession ravaged his business, the advances by Mr. Singer were loans.  After that, the advances were contributions to the corporation’s capital.  The court further ruled that all the payments of the personal expenses by the corporation were repayments of the loans.

I would tell you that, without proper documentation of a loan, almost always the IRS will win the argument that arose in this case.  That’s almost always.

VKM

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IRS

The Gig Economy – Another Problem for the IRS

Today, the IRS released on its website a “Sharing Economy Tax Center” (“SETC”).  The IRS cautions therein that if you receive income from a sharing economy activity, you’ve got income that should be reported on your tax return and that may result in taxable income, after taking into account allowable deductions and exemptions.  The SETC also discusses a number of tax topics that may affect someone participating in the sharing economy.  The IRS goes on to emphasize that income received from gig activity is income, whether or not you get an information form of which the IRS gets a copy.  The 1099 series and the W-2 form are examples of those information forms.   Why is the IRS addressing this issue now?  Because pretty sizable dollars are at stake.

Fortune published an article on May 24, 2016 entitled “The Gig Economy Could Cost the IRS Billions of Tax Dollars.”  The article cited a recent study estimating that more than two-thirds of the 2.5 million people who earned money from gig economy jobs in 2014 don’t earn enough to have their income reported to the IRS.

The article points out that this reporting gap is exacerbated  by the fact that beginning in 2008, a Form 1099-K has been used as the information statement filed with the IRS to report credit card payments.  The likes of Airbnb, Lyft, and Etsy don’t have to file Form 1099-K for persons who receive credit card and third party network payments (such as PayPal), unless the independent contractor driver, home/room renter, or seller during the year received more than $20,000 or entered into more than 200 transactions.  Most sharing economy participants fall below those limits.  At the time of the article, many sharing economy companies argued that 1099-K was the only information reporting form they had to file for their giggers.

The article rightly did not include Uber in that list.  According to its website, Uber sends to drivers Forms 1099-MISC if the driver earned more than $600 and a 1099-K if the driver earned more than $20,000 or had more than 200 transactions.

What’s the impact on the U.S. Treasury?  Probably a lot of money, but not enough to move the needle on the overall Federal budget.  Suppose that subject two-thirds of 2.5 million people were non-reporters,  earned income of $10,000 each,  had no expenses to deduct and would have paid 30% in income and self-employment tax (the latter tax not always applicable).  I calculate the amount of tax not paid to be about $5 billion.  However, if properly documented deductions and exemptions are considered, that tax number probably would be significantly lower.

So we are looking at less than 1% of the nation’s annual approximately $450-plus billion “tax gap” – taxes not collected because of taxpayer noncompliance.  Oh well, as the late Senator Everett Dirksen is said to have said:  “A billion here, a billion there, pretty soon, you’re talking real money.”

VKM

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IRS

Aw, the IRS has a heart

Today, the IRS issued Announcement 2016-25:  Tax Treatment of Payments made on Behalf of or Reimbursements Received by Residents Affected by the Southern California Gas Company Natural Gas Leak.

Let’s refresh our memories.  The Aliso Canyon gas leak (also called the Porter Ranch gas blowout) was a massive gas leak from a well that was part of the second-largest gas storage facility of its kind in the U.S.  SoCal said it first discovered the leak on October 23, 2015.  The residents of the nearby and tony Porter Ranch neighborhood (on the northern edge of Los Angeles) say it happened before then.  Even before that day, people were getting headaches, nosebleeds, eye infections, ear and throat infections, and vomiting.  Stopping the leak was hard.  Closing the well took several attempts and until February 18, 2016, when state officials announced that the leak was permanently plugged.  The damage to the atmosphere caused by the methane emitted from the leak was measurable and significant.  One estimate was, at its peak, the leak was emitting 1.6 million pounds per day of methane gas.  That is equivalent to the methane gas emitted by 2.2 million cows per day.  That’s a lot of flatulence and burping!

Pursuant to administrative edict and court orders, SoCal is required to pay on behalf of or reimburse affected residents for certain and extensive relocation and cleaning expenses incurred in the relevant time period.   Examples of expenses include:  hotel expenses, meal reimbursements, mileage reimbursements, pet boarding fees, expenses of staying with friends or family, expenses of renting another home and incidental expenses related thereto, and cleaning of affected homes and vehicles.  The list goes on.

In this announcement, the IRS addresses the question of the taxability of these expenses paid on behalf of or as reimbursements to affected area residents.  The IRS said that existing guidance does not specifically address these questions.  Without citing any authority, the IRS says that it will not assert that an affected area resident must include these payments or reimbursements in gross income.

That’s really nice.  I know.  I’ve researched this topic extensively.

I had an oil and gas client that was the operator of a well that blew out.  The well was close to a housing development.  People had to move out and do so in a hurry.  They had all kinds of expenses that were caused by the blowout that were similar to the ones cited above.  Some were pretty unique.  It was spring when the blowout occurred; the oil company had to buy prom dresses for the high school girls who could not get back into their homes before the party.

One of the questions that arose was whether or not the oil company had to issue Forms 1099-MISC to the victims of the blowout for the alternate living expenses and damages.  A second question that related to the first was whether or not the payments were taxable to the victims.

We determined that, for the most part, the various types of payments were taxable or at least arguably taxable, if we had no additional information available from the payee.  Those payments that were taxable were reportable on Forms 1099-MISC.  Arguably, payments that were possibly not taxable might not have to be reported on Forms 1099-MISC. (Are those enough hedges for you?)  Why does reporting on Form 1099-MISC matter?  If you are the recipient of a 1099-MISC, most likely the IRS computers will try to match the information from this form with what is on your income tax return.  If the computer cannot identify that amount of income on your tax return, at a minimum, you may have some burdensome correspondence with the IRS.  You might also owe some tax.

The IRS is right that existing guidance is not definitive.  But, in this case, it seems that the IRS decided to err on the side of the angels.  Because the IRS says that such payments are not taxable, it is fairly easy to argue that they don’t belong on a 1099-MISC.  With its decision to gloss over arguments that some of the payments are income, the IRS is assisting the many victims of one of the largest gas leaks ever recorded.

So, the next time you see an IRS agent, give him/her a pat on the back and say thank you on behalf of the gas leak victims in Porter Ranch.

VKM

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IRS

Caught Twixt a Rock and a Hard Place: The IRS and Hobby Losses

I’ve blogged about hobby losses a few times.   Section 183 of the Internal Revenue Code generally disallows business tax deductions for activities “not engaged in for profit” – hobbies.  The regulations under Section 183 provide a nonexclusive list of nine factors used to analyze a taxpayer’s profit objective with respect to an activity.  In the last month or so, two authorities have weighed in on the IRS’ and, in one case, the Tax Court’s handling of hobby losses.

The Treasury Inspector General for Tax Administration (“TIGTA”) is, in substance, the Treasury’s internal auditor of the IRS.  TIGTA issued a report on April 12, 2016, that criticized the IRS for not using its supposedly vast (if somewhat defective)  “big data” skills to identify high-income individual returns (defined as reporting wages of at least $100,000) that had multiple years’ of losses reported on Schedule C, Profit or Loss From Business.   Basically, TIGTA urged the IRS to go after taxpayers who must, in its opinion, be hobbyists, citing the 687,382 taxpayers who in tax year 2013 reported over $7.1 billion in losses from Schedule C businesses that also reported losses in the previous three tax years.   I paraphrase the IRS’ response:  “We’ll jump right on it.”

Within a month of the IRS receiving this guidance, the Seventh Circuit Court of Appeals applied some good ol’ Midwestern logic in issuing a blistering rebuke of the Tax Court’s and the IRS’ treatment of the losses from a horse breeding operation as hobby losses in Roberts v. Commissioner.

In 1999 Mr. Roberts bought two horses, for $1,000 each, and netted that year $18,000 of profit.  He was hooked and, the best I can tell, never made a profit again.  The Tax Court considered 2004 and 2005 losses and ruled them to be nondeductible.  The IRS said that in 2006 through 2008 (the last year in the record of this case), Mr. Roberts had a horse breeding business that produced business losses and was not a hobby.  Thus, the Tax Court did not rule on those years.

To say that the Seventh Circuit was critical of the Tax Court’s decision is an overwhelming understatement.  I excerpt just a few of its observations:

“The Tax Court’s finding that his purchase and improvements were irrelevant to the issue of profit motive until he began using the new facilities is unsupported and an offense to common sense.”

“We mustn’t be too hard on the Tax Court.  It felt itself imprisoned by a goofy regulation.”

“The court careens from profit motive to pleasure motive and back.  All that emerges from the opinion and the record . . . is that Roberts enjoys his new career [in horse racing].”

“It may have been a fun business, but fun doesn’t convert a business to a hobby.  If it did, Facebook would be a hobby, Microsoft and Apple would be hobbies, Amazon would be a hobby, etc., ad infinitum.”

So, what are my takeaways?

  • The IRS will probably be more aggressive of its auditing returns with Schedule C losses.
  • Don’t report a business you enjoy on Schedule C, particularly if it has losses.
  • Relocate to Illinois, Indiana, or Wisconsin if your Schedule C has losses.

VKM

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