Tag: IRS

Taxpayer Attempts To Claim A Unilateral Settlement With IRS

In his letter enclosing his $1,396 check, taxpayer asserted unilaterally that “we are now concluded on this tax return issue” and that he would not “have any more issues with IRS” regarding 2006. But there can be no settlement unless there is mutual assent to its terms, which taxpayer has not shown. To demonstrate assent by the IRS, taxpayer must do more than show that the IRS cashed his check. No compromise was implied by “the government’s acceptance and cashing” of taxpayer’s check.

Once assessed, a disputed tax liability may be compromised by the IRS under Code section 7122. Taxpayer was free to propose an offer-in-compromise during the proceeding by submitting Form 656, Offer in Compromise, together with supporting financial information. But he declined to request a collection alternative of any sort, insisting instead that he had no liability for 2006 whatsoever.

Taxpayer’s argument is meritless. A disputed tax liability may be settled by agreement between taxpayer and the IRS. A settlement of a case pending in Court is a contract that “may be reached through offer and acceptance made by letter, or even in the absence of” a written instrument. Taxpayer did not settle his 2006 tax liability with IRS counsel. Rather, his case was tried in Court and he lost.

Even if the IRS employee were thought to have made a settlement offer, no settlement of any kind is binding on the IRS unless it is duly authorized and properly memorialized, as “This Court has repeatedly declined to enforce a settlement agreement when the person entering into the agreement on behalf of the Commissioner lacked the authority to bind the” IRS. Taxpayer has supplied no reason to believe that his IRS correspondent had the requisite settlement authority.

Taxpayer relied solely on its unilateral statement that the issues were all resolved. It did not follow any of the procedures available to it. In short, taxpayer had proffered no plausible evidence of a settlement. Thus, the court held for the IRS.

Morris R. Saunders, msaunders@lgattorneys.com.

Following Corporate Formalities are Really that Important?

Recently a dissolved corporation found out the hard way that corporate formalities do indeed matter to the IRS.

Urgent Care Nurses Registry, Inc. (Urgent Care) was incorporated in California on July 21, 2005, and was assigned a taxpayer identification number by the California Franchise Tax Board (board). On Aug. 1, 2008, the board suspended Urgent Care’s corporate charter pursuant to section 23301 of the Suspension and Revivor article of the California Revenue and Taxation Code, and on July 26, 2016, the California secretary of state certified that Urgent Care’s “powers, rights and privileges remain suspended.”

Urgent Care filed some income and employment tax returns for 2009 through 2013 but enclosed no payments. It failed to file other returns, and IRS prepared substitutes for returns and assessed all of the taxes in question plus a penalty for failing to file Forms W-2, Wage and Tax Statement. In January of 2015, IRS sent Urgent Care a Final Notice of Intent to Levy and Notice of Your Right to a Hearing.

On Sept. 28, 2015, Urgent Care timely sought review in the Tax Court. On July 28, 2016, IRS filed a motion to dismiss for lack of jurisdiction, contending that the petition was not filed by a party with capacity to sue. The Court directed Urgent Care to respond to the motion to dismiss on or before Sept. 2, 2016, which it failed to do.

The Tax Court granted IRS’s motion to dismiss for lack of jurisdiction on the ground that Urgent Care lacked legal capacity to prosecute the case.

The Court said that since Urgent Care’s corporate powers were suspended in 2008, and there was no indication that it has since received a certificate or revivor or become current on its California tax obligations, it lacked the capacity to sue.

Is your corporation in good standing and are its books and records up to date? Shouldn’t they be?

If you have any questions or would like to discuss this article or any other legal concern you have, please contact:

Morris Saunders at:

msaunders@lgattorneys.com or at 312-368-0100.

Taxpayer Held Liable For Withholding Tax Penalty After Agent Embezzles The Funds

Plaintiff was the owner of a corporation which was the owner-operator of five McDonald’s restaurant franchises. Plaintiff paid certain withholding penalties assessed against him and sought to recover penalties and related interest paid to IRS for the corporation’s alleged failure to make Federal tax deposits and pay taxes regarding its payroll taxes.

Plaintiff alleged that beginning “some 30 years ago,” the corporation engaged an outside payroll service to process all aspects of the corporation’s payroll, including the issuance of paychecks to the corporation’s employees, the withholding of federal and state taxes from these paychecks, the preparation of employment tax returns, and the depositing of withheld taxes with the IRS. The corporation would electronically transfer the funds necessary for payroll and associated taxes from its bank account to a third party payroll service. Plaintiff claimed that it “reasonably relied upon the outside payroll service and the clearinghouse bank to discharge their duties to remit withheld employment taxes to the IRS,” but instead, “the payroll service and/or the bank absconded with the timely submitted Federal Tax Deposits, which were not remitted to the IRS, resulting in the imposition upon Plaintiff of penalties and interest.

Plaintiff claimed that it learned that its payroll tax deposits to the IRS and had been embezzled, perhaps by the bank or the payroll service. It was later informed by representatives of the U.S. Treasury Inspector General’s Office that the bank was the subject of a Federal grand jury investigation. Plaintiff alleged that:

Through no fault of Plaintiff, unscrupulous third parties illegally diverted the EFTs intended for the payment of Plaintiff’s payroll taxes to their own purposes and failed to tender such amounts to the IRS. Plaintiff reasonably relied on [the payroll service] to tender its tax deposits to the IRS and exercised reasonable business care and prudence in so doing. An employer, like Plaintiff, is entitled to rely on a professional payroll tax service, such as [payroll service], to deposit payroll taxes from the employer’s sufficient available funds with a federal-authorized depositary, like [the bank], and to thereby discharge the employer’s obligations under the Internal Revenue Code and related Treasury Regulations to pay over withheld payroll taxes.

The Court held that, “at the heart of this action is plaintiff’s contention that its good faith delegation-to a third-party agent-of the responsibility to pay taxes in a timely manner may constitute “reasonable cause.” The Court concluded, as many other courts with similar facts have concluded, “a taxpayer may not avoid the adverse consequences of the failure of its agent to perform the taxpayer’s responsibility to timely file and pay federal taxes.”

If you have any questions regarding withholding tax liability, please contact:

Morris Saunders at:

msaunders@lgattorneys.com or (312) 368-0100.

If You Sell Stock In Your Start-Up Business Can You Exclude the Gain From Income?

You started your business and it grew beyond your wildest dreams. Now, a potential purchaser has approached you to acquire your business. Your first thought after, “I’m going to be rich!”, is “How much of my money will the IRS want from me?”

If your stock qualifies as “qualified small business stock” (QSBS) then that big payoff could escape income tax. Prior to 2015, Internal Revenue Code Section 1202 provided a tax free benefit in certain situations for stock acquired after September 27, 2010, but before 2015. The “Protecting Americans from Tax Hikes Act of 2015” (PATH Act) restored the QSBS provisions for stock acquired in 2015 and thereafter.

Now, subject to certain limits, you may exclude from gross income 100% of any gain realized on the sale or exchange of QSBS held for more than five years. Also, the excluded portion of the gain from eligible QSBS is not treated as an alternative minimum tax preference item.

Stock qualifies as QSBS only if it meets all of the following tests:

  1. it must be stock originally issued after Aug. 10, 1993;
  2. as of the date the stock was issued, the corporation was a domestic C corporation with total gross assets of $50 million or less (a) at all times after Aug. 9, 1993 and before the stock was issued, and (b) immediately after the stock was issued;
  3. in general, you must have acquired the stock from the corporation, either in exchange for money or other property or as pay for services to the corporation; and,
  4. during substantially all the time you held the stock:  the corporation was a C corporation; at least 80% (by value) of the corporation’s assets are used in the active conduct of one or more qualified businesses; and the corporation was not a foreign corporation, or certain other types of companies.

A qualified business cannot be: a business involving services performed in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or a business whose principal asset is the reputation or skill of one or more employees; a banking, insurance, financing, leasing, investing, or similar business; a farming business (including the raising or harvesting of trees); a business involving the production of products for which percentage depletion can be claimed; or a business of operating a hotel, motel, restaurant, or similar business.

For each tax year, the amount of gain eligible for the exclusion is limited to the greater of: $10 million ($5 million for married persons filing separately), or 10 times your total adjusted basis in QSBS of the corporation disposed of by you in the tax year.

The above is a brief synopsis of the rules regarding QSBS. If you’d like to discuss these rules or any other business issue you might have, please contact:

Morris R. Saunders at:

msaunders@lgattorneys.com or (312)368-0100

IRS Announces Attack on Family Business Transfers

On August 2, 2016, the U.S. Department of the Treasury announced a new regulatory proposal to “close a tax loophole that certain taxpayers have long used to understate the fair market value of their assets for estate and gift tax purposes.”

It is common for wealthy taxpayers and their advisors to use certain tax planning tools to take into account “discounts” for such things as lack of marketability and minority interests to effectively lower the taxable value of their transferred assets. These planning tools have been, until now, approved by the IRS and the courts. By taking advantage of these tactics, certain taxpayers or their estates owning closely held businesses or other entities can end up paying less in estate or gift taxes. Treasury’s action will significantly reduce the ability of these taxpayers and their estates to use such techniques solely for the purpose of lowering their estate and gift taxes. These proposed regulations are subject to a 90-day public comment period. The regulations themselves will not go into effect until the comments are carefully considered and then 30 days after the regulations are finalized.

If you were planning to make transfers of closely held business interests, you should consider whether it is appropriate to expedite making those transfers ahead of the effective date of the proposed regulations.

If you have any questions, please contact:

Morris R. Saunders at:

(312) 368-0100 or msaunders@lgattorneys.com.

Is It a Hobby or a Business and What Does the IRS Think?

A taxpayer may deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” But if the activity giving rise to the expenses “is not engaged in for profit,” these activities are not considered a “trade or business” and are commonly referred to as “hobbies”. Hobby expenses may only be deducted from hobby profits and not from any other income that the taxpayer may have.

In 2014 the Tax Court held that a taxpayer had deducted the expenses of his horse-racing enterprise on his federal income tax returns for 2005 and 2006 erroneously because the enterprise was a hobby rather than a business. The court assessed tax deficiencies.  But it also ruled that the business had ceased to be a hobby, and had become a bona fide business, in 2007. He challenged the assessments for 2005 and 2006.

The Tax Court’s ruling that the horse-racing enterprise was a hobby in 2005 and 2006 but became a business in 2007 and remained so in 2008, and every year thereafter (the IRS failed to challenge any deductions for any year after 2008) was held by the Seventh Circuit Court of Appeals to be “untenable; it amounts to saying that a business’s start-up costs are not deductible business expenses-that every business starts as a hobby and becomes a business only when it achieves a certain level of profitability.”

The Seventh Circuit then cited what it felt to be a “goofy regulation” (Treas.Reg. § 1.183-2) and addressed the various factors used to determine whether an activity is engaged in for profit:

(1)  Manner in which the taxpayer carries on the activity.
(2)  The expertise of the taxpayer or his advisors.
(3)  The time and effort expended by the taxpayer in carrying on the activity.
(4)  Expectation that assets used in activity may appreciate in value.
(5)  The success of the taxpayer in carrying on other similar or dissimilar activities.
(6)  The taxpayer’s history of income or losses with respect to the activity.
(7)  The amount of occasional profits, if any, which are earned.
(8)  The financial status of the taxpayer.
(9)  Elements of personal pleasure or recreation.

The Court went on to note, “a business will not be turned into a hobby merely because the owner finds it pleasurable; suffering has never been made a prerequisite to deductibility. Success in business is largely obtained by pleasurable interest therein.”

This case recognizes that every start-up business is not a hobby just because there is no profit at the beginning. Here that Tax Court seemed to take the position that the taxpayer started in the horse racing business as a hobby and then turned it into a business. The Appellate Court rejected this and held for the taxpayer.

If you have any questions regarding start-up businesses, please contact:

Morris R. Saunders at:

(312) 368-0100 or msaunders@lgattorneys.com

Shareholder Loans to Family Business–Are They Really Loans?

June Shaw agreed to advance up to $1 Million to her family’s company, SRG, pursuant to an unsecured revolving line of credit note.  June Shaw advanced $808,475 to SRG pursuant to the Note.  SRG began facing financial difficulties but June kept making advances under the Note.  In 2009, her brother Kenneth Shaw, president of SRG, advised June that the company could not repay her.  June listed the amount as a bad debt on her tax return.  The IRS denied the deduction and was upheld by the Tax Court.

On appeal, the Ninth Circuit upheld the Tax Court’s ruling.  It held that the advance was not a bona fide debt that arose from a debtor-creditor arrangement.  “Notably her behavior was not consistent with that of a traditional lender; she continued to advance money to SRG despite its unstable finances and the company’s failure to repay any interest or principal.”

If you are intending to treat advances to your closely held company as loans, it is important that you act like a “real” creditor and document and treat the advance as a loan.  A real creditor would require a note to document the loan, would stay aware of the company’s finances and ability to repay the debt, would require regular payments and depending on the amount loaned, would require collateral security.  If you fail to follow the formalities of a “real” lender-borrower relationship, you may find that your advance is not afforded the same tax treatment as a bona fide loan.

If you have any questions about family loans to family or other closely-held businesses or any other aspect of family businesses, please contact:

Morris R. Saunders at:

msaunders@lgattorneys.com or 312-368-0100.

Are You Personally Responsible for the Payment of Withholding Taxes?

The Court of Appeals recently upheld the IRS’s determination that two officers of a corporation were responsible for the payment of withholding taxes that were not paid by the corporation. The IRS may find personal liability attaches to responsible persons who act willfully in not paying trust fund taxes to the IRS.

Schiffmann was the company’s president and CEO. He also served as a director and owned stock in the company. As such, he was deeply involved in the day-to-day management of the company; his functions included the power to hire and fire, the development of fundraising strategies, and the formulation of a retention and compensation plan for the company’s workforce. Furthermore, he was a signatory on the company’s bank accounts, and regularly signed checks. In November of 2005 the board adopted a resolution specifically authorizing him to sign financial and contractual obligations up to $100,000 without a second signature. Schiffmann was found to have acted willfully because — after becoming aware that the trust fund taxes were not being paid — he did not pay them. Instead, he allowed the company to use unencumbered funds to pay other creditors. Given Schiffmann’s position and authority, no more was required to support a finding of willfulness.  In August 2005, the company hired Cummings as a financial consultant. Cummings became the CFO on October 25, 2005, and as such had check signing authority and was generally responsible for the company’s financial well-being.  On November 18, 2005, the company board of directors (which then consisted of at least four members) met to discuss, among other things, the outstanding trust fund tax liabilities.   Following the meeting in which the board gave him the power to sign checks and contractual obligations up to $75,000, he exercised that power to pay rent and operational expenses. The company’s tax liabilities went begging. So viewed, Cummings acted willfully because he voluntarily, consciously, and intentionally preferred other creditors to the United States.

They nonetheless signed checks to pay other creditors, but did not pay the government. The funds backing these checks came primarily from cash infusions raised by Schiffmann and the company’s board chairman. Matters went downhill from there: the trust fund tax arrearage was not paid, new trust fund taxes accumulated, the company’s financial decline continued, and the board fired Schiffmann and Cummings in June of 2006.

The court considered each corporate officer’s status, duties, and authority.  The inquiry focused on the “function of an individual in the employer’s business, not the level of the office held.” The criteria that typically inform the determination include whether the person is an officer and/or director; whether the person owns shares or otherwise has an equity interest in the company; whether the person participates actively in day-to-day management of the company; whether the person has authority to hire and fire; whether the person “makes decisions regarding which, when, and in what order outstanding debts or taxes will be paid”; whether the person exercises significant superintendence over bank accounts and disbursement records; and whether the person is endowed with check-signing authority. Though this list is not meant to be exhaustive and no one factor is dispositive, debt prioritization, control over bank accounts, and check-signing authority are at the “heart of the matter” because they “identify most readily the person who could have paid the taxes, but chose not to do so.”

If you have any questions in this area, please contact:

Morris R. Saunders at:

msaunders@lgattorneys.com or 312-368-0100.

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