Bankruptcy Debtor’s Income Tax Liabilities Held Not Dischargeable

Bankruptcy Debtor’s Income Tax Liabilities Held Not Dischargeable

Few issues are more misunderstood than the interplay between the taxing authorities and the bankruptcy court.  Congress is no help here because the language of the Bankruptcy Code is second only to the Internal Revenue Code in obtuseness.  These Codes give the most gifted lawyers fits in attempting to decipher them. 

 

Income tax obligations that are too new are not dischargeable while older taxes can be.  The theory seems to be that the Internal Revenue Service should get a fair chance to collect income taxes before losing that ability entirely to bankruptcy. 

11 U.S.C. 1328(a)(2) excepts from discharge the kind of debt specified in 11 U.S.C. 507(a)(8)(C) (withholding taxes) or 11 U.S.C. 523(a) (all other taxes), including specifically 11 U.S.C. 523(a)(1)(B) debt. 11 U.S.C. 523 (a)(1)(B)(ii) denies discharge of taxes for which a late return was filed after two years before the date of the filing of the bankruptcy petition.  Via 11 U.S.C. 507(a)(8)(A)(i), taxes for which a return is last due including extensions after three years before the date of the filing of the bankruptcy petition are not discharged. Via 11 U.S.C. 507(a)(8)(A)(ii), taxes assessed within 240 days before the date of the filing of the bankruptcy petition are also not discharged.  If any of these three are met, there is no discharge.

In In re Ollie-Barnes, 114 AFTR 2d ¶ 2014-5413 (Bktcy Ct 11/06/2014) the bankruptcy court ruled that the filing date was less than two years from the late tax return filing and therefore  the taxes were not dischargeable.  One of the issues in Ollie-Barnes was whether her prior bankruptcies tolled the two year period.  The bankruptcy court held that the earlier bankruptcy filings tolled the running of the two year period and therefore the two year period had not expired and thus the taxes were not discharged.

Moral of the case: when dealing with taxes and bankruptcy, engaging counsel familiar with the interplay between taxes and bankruptcy is key.

U.S. Tax Court upholds $10,000 penalty against a PRIVATE foundation who filed a return late

In Grace Foundation v. Comm., T.C. Memo 2014-229, the U.S. Tax Court sustained an Internal Revenue Service levy of a $10,000 penalty on a private foundation.  The Tax Court rejected all of the foundation’s arguments that there were errors in the IRS's conduct of the taxpayer's collection due process (CDP) hearing.  First, the Tax Court made clear that a private foundation which is not exempt from tax must comply with the same return filing requirements as organizations described in Code Sec. 501(c)(3) which are exempt from tax under Code Sec. 501(a). (Code Sec. 6033(d)) and that Code Sec. 6652(c)(1)(A) imposes a penalty for failing to file Form 990 in a timely manner.

Lesson learned #1:  The Internal Revenue Service will impose penalties for failure to timely file returns on private foundations and the Tax Court will uphold these penalties. 

Lesson learned #2:  All taxpayers, even private foundations, should have proper advice and counsel of their filing obligations so these issues do not occur. 

 

 

Richard Weber, the Chief of I.R.S. - Criminal Investigation issues statement regarding no longer seizing structured funds of otherwise legal source activity.

Richard Weber, the Chief of I.R.S. - Criminal Investigation issues statement regarding no longer seizing structured funds of otherwise licit activity.  This means that 31 U.S.C. 5324 will only be applied on a forward going basis to structuring of non-legal sourced funds.  This does not change the affect the government’s ability to audit and recommend criminal prosecution where structuring is a part of avoiding reporting for income tax purposes.

Here is the full statement:

After a thorough review of our structuring cases over the last year and in order to provide consistency throughout the country (between our field offices and the U.S. attorney offices) regarding our policies, I.R.S.-C.I. [Criminal Investigation] will no longer pursue the seizure and forfeiture of funds associated solely with “legal source” structuring cases unless there are exceptional circumstances justifying the seizure and forfeiture and the case has been approved at the director of field operations (D.F.O.) level. While the act of structuring — whether the funds are from a legal or illegal source — is against the law, I.R.S.-C.I. special agents will use this act as an indicator that further illegal activity may be occurring. This policy update will ensure that C.I. continues to focus our limited investigative resources on identifying and investigating violations within our jurisdiction that closely align with C.I.'s mission and key priorities. The policy involving seizure and forfeiture in “illegal source” structuring cases will remain the same.

 

A merger of two family-owned companies may result in taxable gifts

In Cavallaro, v. Comm., T.C. Memo 2014-189 (2014), the Tax Court determined that a merger of one co. owned by the parents and the other co. owned by their sons, resulted in a taxable gift from parents to sons. The ruling was based upon the Tax Court determining the parents' company to have been undervalued. Background. Code Sec. §2501(a) imposes the gift tax on any transfer of property by gift regardless of the form of the gift transaction. Any time that property is transferred for less than full and adequate consideration, the excess value is considered a gift. (Code §2512) Taxable gifts include "sales, exchanges and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor." (Treas. Reg. §25.2512-8) Conclusion: Any type of transaction can be a deemed gift. This is especially so when there are transactions involving family members. Be sure to be vigilant in any transactions that could contain any type of gifting element so that the gift tax consequences, if any, can be ascertained and proper planning done to consider non-gift alternative transactions.

Internal Revenue Service is committed to whistleblower program

Internal Revenue Service is committed to whistleblower program IRS Deputy Commissioner John Dalrymple issued a memo providing procedures and goals for the IRS whistleblower program while IRS Commissioner John Koskinen issued a statement that he is also committed to increasing the reach of the program. Commissioner Koskinen's statement stated that over the last three fiscal years, more than $186 million in awards have been paid, on collection of more than $1 billion based on whistleblower information. Background. I.R.C. §7623(a), gives the IRS discretion to pay awards to whistleblowers between 15% to 30% of the "collected proceeds" resulting from an action based on information provided by the whistleblower. There is also the authority to pay up to 10% where the information provided by the whistleblower is “less substantial.” On Aug. 7, 2014, the Treasury issued final regulations on the whistleblower program. The Dalrymple memo makes three points: debriefing whistleblowers, protecting the identity of whistleblowers, and timeliness. There will typically be a debriefing interview with the whistleblower unless it is deemed unnecessary. The whistleblower’s identity and even the existence of a whistleblower from the taxpayer. Even the examiners will not know the identity or existence of the whistleblower. The Internal Revenue Service is also promising more timeliness: claims received should be initially evaluated by the Whistleblower Office within 90 days; review should be completed within 90 days of receipt, and whistleblowers should be notified of an award decision within 90 days.

There is no Bankruptcy Protection from Inherited IRAs

There is no Bankruptcy Protection from Inherited IRAs The U.S. Supreme Court in Clark v. Rameker, 134 S. Ct. 2242, 113 A.F.T.R.2d 2014-2308, 59 Bankr. Ct. Dec. 159 (6/12/2014) has held that inherited IRAs do not qualify for a bankruptcy exemption, and therefore are not protected from creditors in bankruptcy. Many of us know that assets in an IRA are protected from creditors both under most state laws and in Bankruptcy. Pursuant to 11 U.S.C. 522(b)(3)(C), a debtor may exempt amounts that are both (1) "retirement funds," and (2) exempt from income tax under one of several specified Internal Revenue Code provisions, including Code Sec. 408, which exempts IRAs. In the Clark case, the daughter of an IRA account holder held an inherited IRA which allows her to keep the assets in the IRA and only take the assets out annually over her life expectancy. They then filed for bankruptcy and sought to keep the inherited IRA from the creditors. There had been a split amongst the circuits: the Seventh and Fifth Circuits were contradictory so the Supreme Court resolved the controversy by unanimous decision (Justice Sotomayor writing for the unanimous court) in favor of the creditors. She stated that the "text and purpose" of the Bankruptcy Code provided that funds held in inherited IRAs are not "retirement funds" for purposes of the Bankruptcy Code §522(b)(3)(C) exemption. Left open by the Court is the query of whether assets in a spousal rollover IRA would be factually distinct or might also be subject to creditors. Recommendation: A trust for the benefit of the beneficiary – rather than naming the beneficiary outright - may avoid the result that the Clarks had in this case.

NEW OFFSHORE VOLUNTARY DISCLOSURE PROGRAM (OVDP) RULES GO INTO EFFECT

NEW OFFSHORE VOLUNTARY DISCLOSURE PROGRAM (OVDP) RULES GO INTO EFFECT We have been hearing rumors that the Treasury Department was going to be amending the OVDP program. Yesterday they did amend the program. Briefly, for people that have not yet filed for OVDP, the 27.5% penalty that is currently available will go up to 50% for filings on or after July 1 for offshore accounts at foreign financial institutions that have indicated that they will be complying. Thus anyone with accounts overseas should strongly consider acting quickly and in June. For people that have already filed, there are tweaks in the program that may make it beneficial to elect the new program. Thus, if you are currently in the program, it would behoove you to analyze whether such an election would prove beneficial to you. Here is the link to the new program: irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised

Commissioner of Internal Revenue Service talks of amending the Offshore Voluntary Disclosure Program (“OVDP”)

Commissioner of Internal Revenue Service talks of amending the Offshore Voluntary Disclosure Program (“OVDP”) IRS Commissioner John Koskinen has stated that the Internal Revenue Service "has also sought to encourage taxpayers to come into compliance voluntarily." Koskinen stated that the various OVDPs, ranging from the 2009 version and then the 2011 and now the current 2012 version have led to more than 43,000 voluntary disclosures from person paying over $6 billion in a combination of back taxes, interest, and penalties. Koskinen urged though that, while these three programs have been very successful, the IRS may amend the program "to accomplish even more." He said that the agency is "considering whether our voluntary programs have been too focused on those willfully evading their tax obligations and are not accommodating enough to others who don't necessarily need protection from criminal prosecution because their compliance failures have been of the non-willful variety." Those who have lived abroad for many years may be distinguished from U.S. resident taxpayers who were willfully hiding their investments overseas and stated that "[w]e expect we will have much more to say on these program enhancements in the very near future." The National Taxpayer Advocate has previously criticized the three OVDPs as prescribing a "one-size-fits-all" approach. The NTA states that the stiff penalty may be unfair since it fails to draw any distinction between those who willfully vs. inadvertently fail to report foreign accounts. Stay tuned for further developments when they occur.

Israel and U.S. Reach Substantive Agreement

Israel and U.S. Reach Substantive Agreement Today, May 1, 2014, the Treasury Department announced that the U.S. has reached an intergovernmental agreement (IGA) with Israel to implement the Foreign Account Tax Compliance Act (FATCA). A Treasury spokeswoman announced that Israel and the U.S. had reached a Model 1 IGA in substance. FATCA, which was enacted in 2010, requires foreign financial institutions (FFI) to report accounts owned by U.S. persons to the Internal Revenue Service or face a 30 percent withholding tax in certain cases on their U.S. source income. These IGAs permit FFIs to give information about these accounts to their own governments, which then would share the data with the IRS. Model 1 agreements call for reciprocal information exchanges between nations. For those U.S. persons who have not disclosed their assets in Israel (or any other foreign country for that matter) the window is closing to do so while still avoiding prosecution. I urge you to consider entering into the offshore voluntary disclosure program (OVDP).

Feuding brothers

When brothers feud, they can split up their corporation in two and go their separate ways in a tax free exchange.

In a recent private letter ruling (PLR 201411012), the IRS ruled that no gain or loss would be recognized on division of corporation by feuding siblings.  This is a carefully laid out plan needing to qualify under a plethora of carefully planned criteria to qualify the transaction for non-recognition treatment of the split off.  Under the scenario painted by the taxpayers to the Internal Revenue Service, each corporation will operate one of the two businesses currently being run by the existing company.

By way of background, the Code provides nonrecognition treatment for reorganizations listed in Code Sec. 368(a). Under Sec. 368(a)(1)(D), a so called type "D" reorganization, a transfer of all or part of the assets of one corporation to another corporation qualifies if: (i) immediately after the transfer, the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the transferee corporation; and (ii) stock or securities of the corporation to which the assets are transferred are, under the plan, distributed in a transaction which qualifies under Sec. 354, 355, or  356.

The IRS ruled that the split will qualify for tax-free treatment and specifically ruled that the transaction qualified as a “D” reorganization, neither corporation nor shareholder will recognize any gain, the basis in all assets of both corporations are maintained and the holding periods are tacked on from the prior corporation and the earnings and profits, if any, will be allocated between the two companies under Sec. 312(h) and Reg. §1.312-10(a).

Be aware that there are numerous pitfalls in trying a “D” reorganization.  Among other items, IRS expressed no opinion regarding whether the Split-Off: (i) satisfied the business purpose requirement of Reg. §1.355-2(b)); (ii) was used principally as a device for the distribution of the earnings and profits of either company; or (iii) was part of a plan (or a series of related transactions) pursuant to which one or more persons will acquire directly or indirectly stock representing a 50% or greater interest in either company under Code Sec. 355(e) and Reg. § 1.355-7 .

FBAR Filing

Today is April 16, 2014 and the 2013 filing season is now behind us.  Some of us filed on time and others are on extension until October 15.  So all of us have temporarily forgotten about our tax filings for a while.  But there is another filing deadline creeping up on June 30.  That is the deadline for reporting foreign accounts aggregating at least $10,000.  For many years, filing an information return to report foreign accounts was done on a paper return called a TD F 90-22.1.  This form no longer exists.  Now that form can only be filed electronically.  It is form 114 and it is filed with the Financial Crimes Enforcement Network (FinCEN) of the Treasury Department.  Get started at http://bsaefiling.fincen.treas.gov.  Happy filing.

Tax Court Rules on an IRA Prohibited Transactions Case

Tax Court Rules on an IRA Prohibited Transactions Case:

In Ellis v Comm., T.C. Memo. 2013-245 (T.C. Memo 2013), the United States Tax Court ruled that funding an IRA with the taxpayer’s used car business was a prohibited transaction.  The Court determined that by paying himself a salary and pay rent to an entity owned by his immediate family was prohibited under Section 4975 of the I.R.C.   The Court ruled that it was not a prohibited transaction when the taxpayer first caused the IRA to invest in the business since the business did not have owners at the time.  But when the taxpayer became a fiduciary by virtue of the IRA holding more than 50% of the ownership interest in the business, the Court ruled that the company then became a disqualified person.  When he paid himself salary, this was a prohibited transaction also.  Thus, the IRA was deemed to have distributed the entire account subjecting the whole to income tax and a 10% additional tax on early distributions.

Prior to ever having an IRA invest in any business, be sure to consult your tax advisor as disastrous results could result as evidenced by the Ellis case above.

U.S. and Canada sign Tax Avoidance Agreement

U.S. and Canada sign Tax Avoidance Agreement

The list of countries signing deals with the United States has grown to twenty-two (22) now that Canada and the United States have signed a tax-information sharing agreement to crack down on tax avoidance by U.S. taxpayers.

The intergovernmental agreement (“IGA”) prevents Canada from having to hand over information to the Internal Revenue Service under FATCA and instead, Revenue Canada collects information from Canada’s banks and share it with the IRS under an existing bilateral tax treaty.  FATCA  was signed in 2010 and was originally scheduled to take effect on January 1, 2013. But in 2011, the effective date was moved to January 1, 2014 and then moved forward again to July 1, 2014.

The IGA exempts some smaller financial institutions and certain Canadian registered savings plans.

While it is estimated that there

about 1,000,000 citizens of the U.S. residing in Canada, it is unclear how many U.S. Citizens would be affected by the IGA.

Banks are scheduled to commence collecting information in July and Revenue Canada will commence reporting to the IRS in 2015.

 

Per IRS: Married same sex couples are married but unwed same sex couples are not

 

In June, the United States Supreme Court in U.S. v. Windsor, 111 AFTR 2d 2013-2385, struck down section 3 of the Defense of Marriage Act (DOMA).  As such, the Internal Revenue Service determined that married same-sex couples are married for federal tax purposes. However, the IRS's website continues unequivocally that same sex (and opposite sex) individuals who are in registered domestic partnerships, civil unions, or other similar relationships that are not considered marriages under State law are not considered as married for federal tax purposes.  Thus, those couples are not permitted to file federal tax returns using a married filing jointly or married filing separately status.

All other Code provisions that only apply to married taxpayers similarly do not apply to registered domestic partners. They are simply not married for federal tax purposes.

Also, if the partner is dependent, he cannot be claimed as a dependent because he is not one of the specified related individuals in Code Sec. 152(c) or Code Sec. 152(d) that qualifies the taxpayer to file as head of household.  

Domestic partners who reside in community property states and who are subject to their State's community property laws are also addressed by the Internal Revenue Service website.  Registered domestic partners must each report their own separate income plus half the combined community income earned by the partners.