Source: Where Does All the Money Go?
I ended my last blog with a quote attributed to the late Senator Everett Dirksen: “A billion here, a billion there, pretty soon you’re talking real money.”
How about: “a trillion here, a trillion there . . .”?
Relatively quietly, the Inspector General of the U.S. Department of Defense released a report on July 26, 2016, entitled “Army General Fund Adjustments not Adequately Documented or Supported. “
Wow! That’s an understatement!!
The report uses a lot of acronyms, but it boils down to this. The Army made adjusting journal entries to the Army General Fund of $2.8 trillion in the third quarter of 2015 and of $6.5 trillion at yearend. That’s trillions of dollars of AJEs with respect to the Army’s most recent annual budget of less than $200 billion. The Pentagon’s total annual budget is about $600 billion.
The Inspector General says that the AJEs were not adequately supported or documented. The IG goes on to suggest that there is considerable risk that the 2015 financial statements are materially misstated – accounting speak for “you can’t rely on ‘em.”
Congress passed a law requiring that the Army General Fund must achieve “audit readiness” by September 30, 2017. The Army has been working on it. It has had the help of a Big Four accounting firm. The IG speculates that the Army will not be ready for an audit by that time.
I couldn’t help but imagine the following scenario. At the end of an audit, my partners nominate me to approach the client with this proposition: “Well, we are proposing a yearend AJE writing down your accounts receivable by $6,478,376,956,199.87, unless you can convince us that amount is not material to your financial statements.”
Some of the most draconian financial penalties levied by the U.S. Treasury are associated with the Foreign Bank and Financial Accounts Report (“FBAR”). This report is made on FinCEN Form 114 by U.S. persons having a financial interest in or signature authority over foreign financial accounts, if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. Through the year 2015, FBARs were required to be filed by June 30 of the next year, with no possible extensions of time. For returns for tax years beginning after December 31, 2015, the due date for the FBAR will be April 15 of the next year, with a maximum extension for a six-month period ending October 15.
The rules concerning FBAR reporting are complex and confusing. They are made even more confusing by the fact that there is a similar reporting requirement enacted in 2010 by the Foreign Account Tax Compliance Act (“FATCA”) with respect to “specified foreign financial assets” and reported on Form 8938, which is filed with a taxpayer’s income tax return. While similar, the two requirements have marked differences. Some accounts are reported on both forms. Some accounts are reported on Form 8938, but not on the FBAR. Some accounts are reported on the FBAR, but not Form 8938. Sometimes only one of the two forms must be filed. Also, the reporting on Form 8938 continues to evolve.
Did I mention that the rules are confusing? The Ninth Circuit Court of Appeals issued an opinion this week that illustrates the problem. Mr. John C. Hom appealed a Federal District Court’s decision that three accounts that he used to play online poker were financial accounts reportable on the FBAR. Under the regulations in effect at the time under consideration, the key questions in the case were whether the accounts were “bank, securities, or other financial account(s)” and whether those accounts were “in a foreign country.” The Court of Appeals held that one of the accounts (his “FirePay” account) was like a bank account and that the two other accounts primarily were used and could only be used to play poker and, thus, were not financial accounts. The Ninth Circuit said that the online FirePay account was a foreign account because FirePay is located in and regulated by the United Kingdom.
I’ve given a lot of advice about filing of FBARs and Forms 8938 and have spoken on the topic at a tax conference. One can render my voluminous expositions about filing the forms into simply this: when in doubt, fill it out.
Some of my confusion may come from the fact that I am following my spring busy season sleepless pattern. Does the following make any sense to you?
At 3:11 p.m. yesterday I received an “IRS Tax Tips” email entitled: “Corrected: IRS Health Care Tax Tip 2016-45: Don’t Confuse Health Care Forms.”
At 3:13 p.m. yesterday I received an “IRS Tax Tips” email entitled: “IRS Health Care Tax Tip 2016-44: Don’t Confuse Health Care Forms.”
Then, I was intrigued. I disengaged from April 18th deadline work for 10 minutes. I read both versions three times and they appeared to me to be identical. I clicked through all the links on the “incorrect” version and they all took me where they said they would.
Apparently, even the IRS gets confused when communicating about confusing things.
Last week, I was reading headnotes of just-released Tax Court cases and I ran across one that was eerily familiar. Says I to myself: “I have already blogged about this case.” I reviewed my old blogs and found that I had written about a very similar Tax Court case on September 17, 2014. Do people never learn?
Like Patricia Diane Ross in the 2014 Tax Court case, John H. Fisher and Lisa M. Fisher, in the years in question, were busy people. The two attorneys claimed that their three children were legitimately employed in Mrs. Fisher’s legal practice. In 2008, the last of three consecutive years being considered by the Tax Court, the court pointed out that all three offspring were less than nine years old. So, remember, in the first year being considered, all were less than seven years old.
Ms. Fisher said that, since “day care was cost-prohibitive,” she had the children work for her in her office. Ms. Fisher said that they shredded waste, “mailed things,” answered telephones, photocopied documents, greeted clients, and escorted clients to the office library or other waiting areas in the office complex. Ah, yes. If I were looking for legal representation in 2006, I would take great comfort in knowing that Ms. Fisher’s legal assistants averaged no more than six years old.
Ms. Fisher deducted wages on her tax return for her pint-sized administrative staff. However, she did not issue W-2 Forms to them, had no payroll records for them, and made no Federal withholding payments with respect to their “wages.” She said she didn’t have those sorts of bothersome records; she paid them by contributing to their Section 529 college funds and giving them cash, which they found handier than cumbersome checks.
One more thing. When she took them on trips (staff retreats, I guess), such as a trip to Disney World, she deducted the costs of the trip. She purportedly was engaged in the writing of children’s travel guides with a profit motive. You guessed it; she never published a book, hired a literary agent, or offered her books to the public. She said she did sell four (4) books to friends.
Well, I’ll bet you already know what happened: the IRS beat the Fishers like a drum. Also, the Tax Court upheld the accuracy-related penalty assessed by the IRS.
The Fishers must have been playing the audit lottery. They lost. They deserved to lose.
Recently, two Circuit Courts shot down the taxpayers in two cases involving rents and S Corporations.
In the Estate of Stuller, the Seventh Circuit Court of Appeals addressed a Tennessee Walking Horse breeding operation held in an S Corporation. Surprise! The IRS, the District Court, and the Seventh Circuit found that the breeding operation was a hobby. Among other facts not in the favor of the taxpayer was that the operation lost money for 15 of 16 years. It made a whopping $1,500 profit one year. The breeding activity was not conducted in a business-like manner. No real surprise, so far.
The Stullers’ S Corporation rented property from Mr. and Mrs. Stuller, the rents from which apparently they reported as income. After the Stullers were found by the courts to have a non-deductible hobby in the S Corporation, they sought for the courts to hold that they did not have to report as income the rental payments that they received from the hobby-bearing S Corporation. They were rebuffed. The S corporation is separate from the owners. They organized the arrangement and it did not turn out like they wanted. Tough luck. They picked their poison.
In Williams v. Commissioner, the Fifth Circuit addressed a case where an S corporation rented realty to a C corporation. The Williamses owned all of the stock in both companies. Mr. Williams materially participated in the business of the C corporation. The arrangement appeared to be arms’- length and there is no indication that the IRS had a problem with the economics of the deal. The Williamses reported the rental income in the S corporation as passive income, which, conveniently, was offset by losses in other passive activities.
The Williamses got it all wrong. While the “self-rental rule” is a bit obscure, it is aimed squarely at what the Williamses were doing. The IRS, the Tax Court and the Fifth Circuit all agreed that under the self-rental rule, they had to classify the rent income as nonpassive income and their passive losses could not offset the related-party rental income.
In both cases, it appears that the taxpayers tried to be a little bit too clever in structuring their activities for tax purposes. In both cases, they got bad results.
Well, my headline may overstate a little bit the subject matter of a new publication by the Internal Revenue Service. Recently, the IRS issued Publication 15-B, Employer’s Tax Guide to Fringe Benefits. (Click here for full publication). It is a handy summary of fringe benefits, focusing primarily on twenty types of fringe benefits (and variations thereunder) that are wholly, or partially, excluded from the income from most employees. Generally, the “excluded” benefits are exempt from income tax and, in most cases, are exempt from Social Security Tax, Medicare Tax and Federal Unemployment Tax. Table 2-1 on page 6 gives you a concise summary of the primary fringe benefits and the tax treatments.
What fringe benefits, under the appropriate circumstances, might be excluded from the employees’ income? Some of these are pretty well known. Quickly coming to mind are accident and health benefits; health savings accounts; limited moving expense reimbursements: up to $50,000 of group term life insurance; and de minimis benefits, such as holiday parties, low value holiday gifts (other than cash), occasional personal use of the copying machine or printer, and occasional meals (within limits).
Some excludable fringe benefits may not be as obvious or as widely provided, but can be quite valuable to employees. Some examples include educational assistance, adoption assistance, dependent care assistance, athletic facilities, retirement planning assistance, commuting benefits, and employer-provided cell phones.
Other excludable fringe benefits are a bit more employer-type specific, such as lodging on business premises, employee discounts, and no-additional-cost services (think airline and hotel employees).
Some employees are not eligible for all of types of tax free benefits. In many cases of these fringe benefits, “2% shareholders” of S corporations and highly compensated employees are limited in their ability to exclude all or part of many of the fringe benefits. Partners aren’t employees, so they often do not benefit from the exclusions.
Publication 15-B is comprehensive and references many other IRS publications for further guidance. It is a good read for employers. It is also a good read for employees who want to convince their employers to help them turn some of their taxable compensation into tax-free compensation.
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