Larry's Tax Law

Treasury issues long-awaited amendments to Circular 230.  On June 9, 2014, Treasury published amendments to Circular 230 that we have been anticipating for the past several months.  It looks like the crazy email disclaimers, just like leisure suits, will be a thing of the past.  Among many changes to Circular 230, the final regulations eliminate or clarify the complex rules for written advice.  Based upon my first read of the regulations, it certainly appears Treasury has been listening to tax practitioners.

Stay tuned, I will be posting a summary of the amended regulations soon.

The Internal Revenue Service (“IRS” or “Service”) has repeatedly stated that, while its crackdown on the failure of taxpayers to report foreign financial accounts has been strong, it is reasonable in the application of the law. At least one taxpayer, Mr. Carl R. Zwerner, would likely debate that pronouncement.

On June 9, 2014, Bloomberg BNA Daily Tax Report (No. 110) revealed that a long and hotly-contested battle between Mr. Zwerner and the United States government has come to an end. This highly-publicized case is frightening. It illustrates that the IRS may not always be reasonable in the application of the foreign financial account reporting (“FBAR”) laws.

Mr. Zwerner, an 87-year old retired specialty-glass importer, is a United States citizen who resides in Coral Gables, Florida. He had a financial account in Switzerland. The account balance never exceeded $1.7 million. It appears the account was opened by Mr. Zwerner during 2004 in the name of a foundation. In 2007, he closed the original account and transferred the account balance to another Swiss account. The new account was opened in the name of yet another foundation. Mr. Zwerner controlled these accounts; he was undisputedly the beneficial owner of the accounts.

On June 11, 2013, the battle commenced when Assistant Attorney General Kathryn Keneally instituted a lawsuit against Mr. Zwerner in the United States District Court for the Southern District of Florida, seeking to collect almost $3.5 million in penalties from him for violating the FBAR rules. The assessment which the government was pursuing against Mr. Zwerner amounted to more than double the highest account balance of his Swiss financial account.

Montgomery v. Commissioner, T.C. Memo. 2013-151 (June 17, 2013) illustrates what appeared to be the obvious – neither a guaranty of the corporation’s debt by a shareholder nor an unpaid judgment against a shareholder for the S corporation’s debt creates basis.

In Montgomery, the taxpayers, Patrick and Patricia Montgomery, claimed a net operating loss on their 2007 joint return, which they carried back to 2005 and 2006.  In the calculation of their net operating loss, they included:  losses UDI Underground, LLC (“UDI”), incurred in 2007 that were passed through to Patricia Montgomery as a 40% member; and losses Utility Design, Inc., an S corporation (“Utility Design”), incurred in 2007 that were passed through to Patrick and Patricia Montgomery as shareholders.

The IRS challenged the amount of the net operating loss for 2007 on two grounds:

• •  First, the IRS asserted Patricia Montgomery did not materially participate in UDI during 2007.

• •  Second, the IRS asserted portions of the losses from Utility Design were disallowed under Section 1366(d)(1).

• •  The IRS asserted Patricia Montgomery’s share of the 2007 losses from UDI were losses from a passive activity.  Specifically, the IRS argued Patricia Montgomery did not materially participate in UDI.

The Tax Court disagreed, holding Patricia Montgomery did materially participate in UDI.  In 2007, Patricia Montgomery handled all of the office functions, managed payroll, prepared documents, met with members of the company and attended business meetings.  Additionally, she continuously worked on company matters and daily discussed the company's business with Patrick Montgomery.  The court ultimately concluded Patricia Montgomery participated in UDI for more than 500 hours during 2007 and her participation was regular, continuous, and substantial.  Thus, Patricia Montgomery’s UDI activity was a non-passive activity.

IRC § 6656(a) provides, in the case of any failure to timely deposit employment taxes, unless the failure is due to “reasonable cause and not due to willful neglect,” a penalty shall be imposed.  The penalty is a percentage of the amount of underpayment.

• • 2% for failures of five (5) days or less;

• • 5% for failures of more than five (5) days, but less than 15 days;

• • 10% for failures of more than 15 days; and

• • 15% for failures beyond the earlier of:  (i) 10 days after receipt of the first delinquency notice under IRC § 6303; or (ii) the day on which notice and demand is made under IRC §§ 6861, 6862 or 6331(a)(last sentence)(jeopardy assessment).

In addition to the “reasonable cause” exception contained in IRC § 6656(a), there are two other means by which taxpayers may avoid the imposition of the penalty.

1.  Secretary has authority under IRC § 6656(c) to waive the penalty if:

• • The failure is inadvertent;

• • The return was timely filed;

• • The failure was the taxpayer’s first deposit obligation or the first deposit obligation after it was require to change the frequency of deposits; and

• • The taxpayer meets the requirements of IRC § 7430(c)(4)(A)(ii) [submits a request within 30 days and comes within certain net worth parameters].

2.  The Secretary has authority under IRC § 6656(d) to waive the penalty if:

• • The taxpayer is a first time depositor; and

• • The amount required to be deposited was inadvertently sent to the Secretary instead of the appropriate government depository.

As the exceptions are limited in application, most taxpayers seeking abatement of the penalty are required to pursue the “reasonable cause” exception.

Acts of dishonesty can cost a tax practitioner his or her ability to practice before the IRS.  Charles M. Edgar (“Edgar”), formerly a licensed CPA and attorney in Massachusetts, recently learned this lesson.

On May 1, 2014, the Service issued a news release (“IR-2014-58”), announcing the disbarment of Edgar.  While the saga of Edgar is long and somewhat convoluted, it illustrates a significant point—failure to act honestly in matters before the IRS constitutes a violation of Circular 230.  It will cost you severely.

Background 

The Secretary of Treasury has express authority to regulate practice before the IRS, including the power to suspend or disbar an individual from practice before the Service for failing to comply with Circular 230.  In such instances, the practitioner must be provided notice and an opportunity for a hearing before an administrative law judge.

Circular 230 grants the Director of the Office of Professional Responsibility authority to bring proceedings to suspend or disbar practitioners from practice before the Service.  Generally, an administrative law judge, not the Office of Professional Responsibility, determines the appropriate sanction, if any, taking into consideration all relevant facts and circumstances.

Circular 230 specifically provides that a practitioner may be sanctioned for giving “false or misleading” information to the Treasury or any officer or employee thereof.  For this purpose, “information” means any facts or statements made in testimony, on federal tax returns, financial statements, and other documents or statements (written or oral).

Circular 230 also provides that a practitioner may be sanctioned if he or she is disbarred or suspended from practice as an attorney, CPA, PA, or actuary.

On April 9, 2014, Oregon Governor John Kitzhaber signed into law House Bill 4138 (“HB 4138”).  Effective June 8, 2014, the methodology by which an “Interstate Broadcaster” apportions its business income for purposes of the Oregon corporate excise tax changes in at least two (2) ways:

           1.        Method of Apportionment.  Prior to June 8, 2014, an Interstate Broadcaster included in the numerator of the “sales factor” gross receipts from broadcasting in the ratio that its audience and subscribers located in Oregon bear to its total audience and subscribers located within and without Oregon.  On or after June 8, 2014, Interstate Broadcasters will no longer use this method of apportionment.  Rather, they will include in the numerator of the “sales factor” only those gross receipts from customers (i.e., advertisers and licensees) that have their commercial domicile in Oregon, or (in the case of individuals) who are residents of Oregon.

            2.        Definition of Interstate Broadcasters.  HB 4138 amends the definition of “Interstate Broadcaster” to include anyone engaging in the for-profit business of broadcasting to persons located within and outside of Oregon.   Prior law referred to broadcasting to subscribers or to an audience.  I am not sure this change to the law is significant other than it reduces the verbiage by four (4) words.

As the Chair of the Oregon Tax Institute (OTI), I would like to invite you to the 14^th Annual Oregon Tax Institute scheduled for June 5 & 6 in Portland, Oregon.  We have grown the OTI from a local tax forum into a preeminent tax institute for both tax attorneys and CPAs.  Our topic coverage and faculty this year are fabulous and each one of our speakers is a nationally recognized expert in tax law.  This year’s OTI will be on par with the best tax institutes in the country.      

I hope you will join us in June and I encourage you to sign up for OTI as soon as possible.  Also, please feel free to share this information with your colleagues.

Best,

Larry

On March 18, 2014, the Internal Revenue Service announced that one of its employees had taken home a computer thumb drive containing unencrypted data relating to 20,000 agency workers.  The employee then plugged the thumb drive into an unsecure home computer network.  While the thumb drive did not contain any data relating to persons outside the Internal Revenue Service, it still put 20,000 individuals at risk of theft of identity and/or financial assets.

Commissioner John Koskinen described the data breach as an “isolated event.”  Isolated or not, his statement likely does not give any solace to the 20,000 affected IRS workers.  This data breach may have been narrower in scope than the recent Target Corp. data breach, but it nevertheless illustrates how vulnerable we are to data breaches and potential theft of identity and/or financial assets in this electronic era.

We have to constantly safeguard the personal information we receive from our clients, as well as our own personal information.   Loss of client information could easily lead to liability.

On March 10, 2014, the Internal Revenue Service (“Service”) issued Notice 2014?17 (“Notice”).  The Notice focuses on the tax treatment of per capita distributions made to members of Indian tribes from funds previously held in trust by the Secretary of the Interior and which were derived from interests in trust lands, trust resources and/or trust assets.

The Department of Interior (“DOI”) is responsible for holding these trust funds on behalf of federally-recognized tribes and certain individual Indians who have an interest in trust lands, trust resources, or trust assets.  The Office of Special Trustee within the DOI is tasked with the responsibility of managing these funds.

Prior to 1983, the DOI made per capita distributions of the trust funds directly to the members of the tribes.  In 1983, pursuant to the Per Capita Act, however, tribes were given authority to receive the trust funds and hold them in tribal trust accounts for subsequent per capita distributions to members.  So, now the DOI can distribute the trust funds to the tribes who, in turn, make the per capita distributions to members.

The law appears fairly clear in that per capita distributions of these funds from the DOI to tribal members are excluded from gross income.  The issue, following the enactment of the Per Capita Act, is whether per capita distributions received by members from their tribes are likewise excludable from gross income.

A California couple was recently walking their dog when they noticed a rusty tin container protruding from the soil next to a tree in their garden. Upon investigating the matter, they discovered several tin cans buried in the soil. The cans contained 1,400 gold coins. The coins, which are said to be in mint condition, date back to the 19th century. Experts have placed a preliminary value on the coins of more than $10 million. For obvious reasons, the couple is keeping their identity and the location of their home out of the media.

It appears the couple is legally entitled to retain the treasure trove. A law professor from the University of North Carolina, John Orth, recently told TIME Magazine, because the coins were found on the couple’s own property, they will likely be able to retain them.

Like the winner of a lottery, the California couple will be required to declare their new fortune as gross income for income tax purposes. This is not the first time a person has been faced with good fortune and a corresponding tax bill.

In Cesarini v. U.S., 23 AFTR 2d 69-997 (Northern District of Ohio, 1969), a couple purchased a piano in 1957 for $15. In 1964, while cleaning the piano, they discovered almost $4,500 in U.S. currency.