“Willful” Fail to File FBAR Defined in a California District Court Case

“Willful” Fail to File FBAR Defined in a California District Court Case In U.S. v. Bohanec, 2016 WL 7167869, 118 AFTR 2d ¶ 2016-5537(DC CA 12/8/2016), a district court in California determined that a taxpayers' failure to timely file a Foreign Bank and Financial Accounts Report (“FBAR”) was willful. U.S. citizens with accounts outside the U.S. must disclose those accounts on an FBAR by June 30 of the year following if the amount is at least $10,000. 31 U.S.C. 5314. In Bohanec, the taxpayers stopped employing a bookkeeper or keeping any books after opening a foreign bank account. They made several misstatements under penalty of perjury when they applied (and were rejected) from participating in the Offshore Voluntary Disclosure Program (“OVDP”). The facts in Bohanec showed that the taxpayers were very deceptive and when they filed their OVDP, they did not even disclose all of their foreign accounts - leaving out accounts in Mexico and Austria while only disclosing the Swiss accounts at UBS. They also claimed the funds were all from income duly reported and on which taxes were paid but that was also untruthful. The reason the term “wilfully” is so important is that if the failure is not willful, the penalty is “only” $10,000 but if the failure to disclose is considered “willful,” the penalty goes up to the greater of $100,000 or 50% of the highest account value for the year! Bohanac ruled that “willful” does not only include knowing failure to disclose but also reckless violations of the filing requirements.

Imposition of Attorney’s Fees Unavailable For Undue Influence Absent a Fiduciary Duty

Imposition of Attorney’s Fees Unavailable For Undue Influence Absent a Fiduciary Duty New Jersey applies the American Rule when it comes to attorney fees. The American Rule states that each party to litigation pays its own fees. There are certain exceptions outlined by New Jersey Court rules and a few judicially mandated exceptions as well where fee shifting is appropriate. The most well known judicial exception is the imposition of fee shifting for a successful litigation for attorney malpractice. Saffer v. Willoughby, 143 N.J. 256 (1996) The New Jersey Supreme Court in Estate of Folcher, 224 N.J. 496 (2016) has recently proclaimed in a 5-1 decision (Justice Fernandez-Vina did not participate) that an award of reimbursement of attorney fees is not permitted against a tortfeasor who commits the pernicious tort of undue influence but is not a fiduciary. In re Niles Trust, 176 N.J. 282 (2003) had held that an award of attorney’s fees is available against a fiduciary who commits undue influence. Folcher refused to extend the Niles fee shifting to persons who are not fiduciaries. Folcher relied heavily on the American Rule in reaching its result. “New Jersey is an ‘American Rule’ jurisdiction meaning we have a strong public policy against shifting counsel fees from one party to another.” Folcher at 506-07. While the Folcher court was certain to point out that the tortfeasor was particularly perfidious in that case with very strong proofs of undue influence, it still refused to extend the attorney fee award in that case. Rather, the Supreme Court remanded the case back to the trial court to determine whether punitive damages should have been awarded. The sole dissenter, Justice Albin, felt that the award of attorney fees was appropriate but he was the only one willing to extend the attorney fee shifting to undue influence committed by someone who was not a fiduciary.

Stolen Income is Still Taxable Income

Stolen Income is Still Taxable Income The Tax Court in Swartz v. Comm., Docket No. 3583-10 (10/17/16) has just entered an order holding that a taxpayer's criminal conviction for theft of $12.5 million from his employer precludes him from arguing that he did not receive such income. The rule of law preventing him from arguing that he did not receive the income is called collateral estoppel. Under the doctrine of collateral estoppel, any issue litigated in a prior legal proceeding is conclusive of the same issue. Code Sec. 61(a) provides that all income including illicit income such as embezzlement, larceny, false pretenses, extortion, or any other types of theft unless there is restitution paid in the same year as the theft. In this case, the Taxpayer, Mark Swartz was a CFO who participated in his company’s Key Employee Loan Program (KELP) for its executive officers. He took a “loan” that was unauthorized in one year and did not pay it back until a later year. Mr. Swartz was convicted of larceny and conspiracy with respect to the $12.5 million. The Tax Court ruled that collateral estoppel applied and that Mr. Swartz's conviction for stealing $12.5 million precludes him from arguing that he didn't have $12.5 million in unreported taxable income. The Court did not address the issue of the tax effects of the later repayment as that issue was not before the court.

Offshore Account Holders Cannot Sue to Enter into More Lax Disclosure Program

Offshore Account Holders Cannot Sue to Enter into More Lax Disclosure Program The District Court in the District of Columbia in the case of Maze v. Internal Revenue Service, Civ. Action No. 2015-1806 (7/25/16) held that taxpayers cannot sue the Internal Revenue Service to be permitted to enter a more favorable program than the one for which they initially applied. Background: The taxpayers failed to report foreign accounts so they entered into the voluntary OVDP (Offshore Voluntary Disclosure Program) which enabled them to come forward without risk of prosecution and pay a fine. The Internal Revenue Service later came out with a simpler and less expensive program called the SFCP or Streamlined Filing Compliance Procedures. While SFCP has different requirements, the taxpayers felt that they would have met those criteria and have been eligible for a much lower penalty – 5% instead of 27.5%. The problem is that the SFCP became available only after the taxpayers already filed and were accepted under the OVDP program. Decision: The Court in Maze determined that the Internal Revenue Service has the authority to set its programs and their parameters and deadlines as it sees fit. Therefore the D.C. Court was unwilling to require the I.R.S. to accept the taxpayers into the easier program. The taxpayers argued for the relief, but the Court ruled that the Anti-Injunction Act found in 26 U.S.C. 7421 prevented the taxpayers from the relief it sought. Moral of the story: Timing is often everything. But now, both programs (OVDP and SFCP) are available and should be carefully considered with counsel before choosing the program to enter.

“BLAME THE LAWYER” NO EXCUSE TO AVOID PENALTIES FOR LATE ESTATE TAX FILING

“BLAME THE LAWYER” NO EXCUSE TO AVOID PENALTIES FOR LATE ESTATE TAX FILING The Court of Appeals for the Sixth Circuit, in Specht v. U.S., 118 AFTR 2d ¶ 2016-5243 (6th Cir. 09/22/2016) has just held that where the attorney for an estate failed to perform numerous duties with respect to the estate, including timely filing the estate tax return, and told the unsophisticated executor that the attorney had received all necessary extensions, the estate did not meet the reasonable cause/not willful neglect standard for avoiding late filing and late payment penalties where the executor had evidence that the attorney was lying. Background. The I.R.C. provides for mandatory penalties for the failure to timely file a return (I.R.C. §6651(a)(1)) and failure to timely pay a tax (Code §6651(a)(2)). But, these penalties are not owed if the taxpayer can establish reasonable cause for the failure and that the failure was not due to willful neglect. (I.R.C. §6651(a)(1), and §6651(a)(2)). In order to meet the reasonable cause exception, Treas. Reg. §301.6651-1(c)(1) requires that a taxpayer show that while he used ordinary care, he nevertheless was unable to file the return within the prescribed time. Previously the U.S. Supreme Court held that reliance on an attorney is normally insufficient to avoid penalties. Boyle, 55 AFTR 2d 85-153555 AFTR 2d 85-1535 (1985), In Boyle, the Supreme Court, held that Congress had charged the executor with an unambiguous, precisely defined duty to file the estate return within nine months and the fact that an attorney, as the executor's agent, was expected to attend to the matter, did not relieve the principal of his duty to comply with the statute. Under Boyle, to meet the reasonable cause exception, the taxpayer bore a heavy burden of proving both that there was reasonable cause and that the failure to timely file did not result from willful neglect. While reliance on a lawyer was common, that reliance couldn't function as a substitute for compliance with an unambiguous statute. In Specht, the Decedent died on Dec. 30, 2008 but her attorney of 50 years in estate planning, and unbeknownst to Specht, was privately battling brain cancer. No federal estate tax return was filed on or before Sept. 30, 2009, nor was an extension sought. And, no federal estate tax payment was made on or before Sept. 30, 2009. But Specht received four notices from the probate court warning her that her attorney was failing to perform her duties and that the Estate had missed probate deadlines. Since the executor knew there was a problem with her lawyer, she was found to have been neglectful. The 6th Circuit held that the relevant question was whether the executor, not the attorney, was reasonable in missing the deadline. In this case the executors blindly relied on an attorney's representations that the filing would be completed on time, and as a result the deadline was missed. The Sixth Circuit reinforced the strict, bright-line rule of Boyle where it concluded that, although the company had exercised ordinary business care and prudence, it also had to demonstrate that it was "rendered unable to meet its responsibilities despite the exercise of such care and prudence". That is, the failure to pay must result from circumstances beyond the taxpayer's control (e.g. postal delays, illness), not simply the taxpayer's reliance on an agent employed by the taxpayer. Specht's reliance on an unreliable agent was her downfall. Therefore pick your attorneys carefully and learn the deadlines and oversee their compliance like a hawk to avoid decisions such as Boyle and now Specht.

Recent Tax Court decision finds against the abuse defense in an innocent spouse case

Recent Tax Court decision finds against the abuse defense in an innocent spouse case. In a recent Tax Court decision, it was determined that a person claiming innocent spouse relief based upon abuse by her husband failed. The case, Hardin v. Comm. , T.C.M. #684-14, T.C. Memo 2016-141 (7/26/16) stands for the proposition that a taxpayer claiming innocent spouse relief must prove abuse and the Tax Court Judge Chiechi ruled that the burden was not sustained. The alleged abuser and abused both testified before the Tax Court and Judge Chiechi felt that the abused’s testimony was not credible. Moral: Threatened abuse can form the basis of an innocent spouse defense but the facts showing the abuse must be credible.

No loss deduction available for retaining wall collapse

No loss deduction available for retaining wall collapse Few laws make as little sense as tax law. In another example of a quirky tax law, the case of Alphonso v. Comm., T.C. Memo 2016-130 (TC Memo 2016) exposes a most peculiar tax law. This quirk in the law says that a sudden collapse of a building or in this case a retaining wall is deductible but an undetected deterioration followed by a collapse is not deductible. The Tax Court in Alphonso found that the taxpayer failed to show that the damage from a collapsed retaining wall was a deductible casualty loss and not a nondeductible loss caused by gradual deterioration. The IRS disallowed the casualty loss deduction stating that the collapse of the retaining wall was a result of gradual weakening, and therefore didn't constitute a casualty loss under Code Sec. 165(c)(3). The Tax court concluded that the collapse of the retaining wall in question wasn't a casualty within the meaning of Code Sec. 165(c)(3). The taxpayer wasn't entitled to claim any loss with respect to that collapse. Under Code Secs. 165(a) and (c)(3), a taxpayer may deduct losses if such losses arise from fire, storm, shipwreck, or other casualty. Prior rulings have stated that the term "casualty" refers to an identifiable event of a sudden, unexpected, or unusual nature. See Rev. Rul. 76-134 and suddenness is an essential element of a casualty. See Rev. Rul. 61-216,and Rev. Rul. 72-592. The rulings further describe that to be considered as sudden, the event must be one that is swift and precipitous and not gradual or progressive. Rev. Rul. 72-592. And on point is I.R.S. Pub. 17 which states that progressive deterioration of property through a steadily operating cause is not a casualty loss. In this case, Christina Alphonso owned stock in Castle Village a cooperative housing corporation that owned land and buildings located in upper Manhattan. The retaining wall suddenly collapsed causing substantial damage. The taxpayer then claimed a casualty loss. The U.S. Tax Court found that the taxpayer failed to carry her burden of proof of showing that the cause of the collapse of the retaining wall was excessive rainfall. The Court further found that although the rainfall may have been a contributing factor to the particular time at which the retaining wall collapsed, they did not cause that collapse. The cause of the collapse was progressive deterioration in and around that wall that had begun at least 20 years before that collapse occurred. The case boiled down to a battle of the expert witnesses over the cause and the court found the Government’s witness more compelling.

Tax Court determines Emotional distress damages taxable since not derived from physical injury

Tax Court determines Emotional distress damages taxable since not derived from physical injury In Barbato v. Comm., TC Memo 2016-23, the U.S. Tax Court determined that a taxpayer who was awarded damages by the Equal Employment Opportunity Commission for her emotional distress for discrimination against her constituted taxable income. The court ruled that she did not meet Code §104(a)(2) requirements for excluding damage awards from gross income. §104(a)(2) excludes damages received for personal physical injury or physical sickness from gross income. Because emotional distress is not considered a physical injury or physical sickness, taxpayers must include damages they receive for emotional distress in their gross income unless the damages are paid for medical care attributable to the emotional distress. §104(a). Only "damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under Code Sec. 104(a)(2)." See also Treas. Reg. §1.104-1(c)) In Barbato, the taxpayer had been a U.S. Postal Service (USPS) letter carrier who incurred injuries to her neck and back in a job related car accident. Her physical limitations required her to switch from a letter carrier to an office position at the USPS. She was eventually reassigned to carrying mail but her old position caused her to have more pain. When she complained, she was discriminated against. As a result, she claimed severe stress and emotional difficulties as a result and was awarded $70,000 by the EEOC for the emotional distress caused by the discrimination. The administrative Judge ruled that she suffered from depression, anxiety, sleep problems, and post-traumatic stress disorder, and that the conditions were caused by and/or exacerbated by the actions which were found to be discriminatory. The Tax Court found that the damages did not fit within the exclusion provided in §104(a)(2) and thus were taxable. The Tax Court said that the EEOC decision was clear that the damages USPS paid to the taxpayer were for emotional distress attributable to discrimination. The $70,000 in damages for emotional distress was "proximately caused by the discrimination" of USPS' employees and not for emotional distress attributable to a physical injury or physical sickness. The decision clearly stated that the taxpayer’s "significant physical distress and pain" "were exacerbated by non-discriminatory actions."

NO CLOTHING DEDUCTION FOR WEARING RALPH LAUREN CLOTHING

NO CLOTHING DEDUCTION FOR WEARING RALPH LAUREN CLOTHING In Barnes, TC Memo 2016-79 (Apr. 27, 2016), the Tax Court has held that a salesman for Ralph Lauren who was required to wear Ralph Lauren branded clothing at work could not deduct the cost of the clothing for federal income tax purposes as unreimbursed employee expenses. Since the Tax Court found that the clothing was clearly suitable for regular use, the Court denied the deduction and imposed penalties on the salesman as well. By way of background, pursuant to I.R.C. Sec. 262, a taxpayer generally cannot deduct personal, living, or family expenses. But, I.R.C. Sec. 162(a), does permit a deduction for all ordinary and necessary expenses paid or incurred in carrying on any activity that constitutes a trade or business, which may include the trade or business of being an employee. Primuth v. Comm., 54 T.C. 374, 377 (1970). Clothing expenses are generally nondeductible expenses under Code Sec. 262 even though the clothing is worn by the taxpayer in connection with his trade or business, unless: (1) the clothing is required or essential in the taxpayer's employment; (2) the clothing is not suitable for general or personal wear; and (3) the clothing is not so worn. Hynes v. Comm., 74 T.C. 1266, 1290 (1980) There was also a 20% accuracy-related penalty applied pursuant to I.R.C. Sec. 6662(a) since there was an underpayment of tax attributable to negligence, disregard of rules or regulations. The Court found there was no reasonable cause for the understatement so the exemption from the penalty under I.R.C. 6664(c)(1) did not apply. The Tax Court ruled that it has consistently applied the 3-part test for clothing deductibility and that Ralph Lauren clothing clearly fails the test.

Whistleblowers Do Not Get Paid For FBAR Civil Penalties

Whistleblowers Do Not Get Paid For FBAR Civil Penalties In a recent case entitled: Whistleblower 22716-13W, 146 T.C. No. 6 (2016), the Tax Court determined that the $2 million nondiscretionary award threshold under I.R.C. Section 7623(b)(5)(B) is not met when turning someone in for failing to file a Foreign Bank Account Report (FBAR) (Form TD F 90-22.1) under 31 U.S.C. Section 5321(a). The amounts owed pursuant to 31 U.S.C. Section 5321(a) are not to be included because they are not taxes in the I.R.C. In Whistleblower 22716-13W, the petitioner sought an award and filed Form 211, Application for Award for Original Information with the Whistleblower Office of the IRS. The taxpayer that was turned in pled guilty and paid an FBAR civil penalty on his Swiss Bank accounts. But the Tax Court ruled that a whistleblower is only eligible for a nondiscretionary award under Section 7623(b) “if the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed” $2 million (Section 7623(b)(5)(B)). Since FBAR civil penalties are imposed and collected under a different Title of the U.S. Code (31 U.S.C. section 5321) they do not constitute “additional amounts” for purposes of ascertaining whether the $2 million threshold has been met. The court did, in fact, concede that the statute would offer stronger incentives to whistleblowers if FBAR civil penalties were included like tax liabilities for purposes of whistleblower award eligibility under Section 7623(b)(5)(B). The court ruled though that it was up to Congress to determine eligibility for the award, not the Court.

Law firm operating as a C Corporation hit with non-deductible salaries and dividend treatment and penalties when zeroing out income to its shareholders as salary bonus.

Law firm operating as a C Corporation hit with non-deductible salaries and dividend treatment and penalties when zeroing out income to its shareholders as salary bonus. In, Brinks Gilson & Lione PC, TC Memo 2016-20TC Memo 2016-20, the U.S. Tax Court upheld the IRS's imposition of underpayments resulting from the law firm's mischaracterization of dividends paid to its shareholder-attorneys as deductible compensation for services and also imposed accuracy-related penalties against the firm for the mischaracterization. The Tax Court held that the firm lacked substantial authority for its position and failed to establish reasonable cause for the underpayments. I.R.C. Sec. 6662 imposes an accuracy-related penalty if any part of an underpayment of tax required to be shown on a return is due to negligence or disregard of rules or regulations, or a substantial understatement of tax. An "understatement" pursuant to I.R.C. Sec. 6662(d)(2)(A) is defined as the excess of the tax required to be shown on the return over the amount shown on the return as filed. In the case of a corporation, an understatement is substantial if, it exceeds 10% of the tax required to be shown. The penalty is reduced or eliminated if the taxpayer had substantial authority for the position. I.R.C. Sec. 6662(d)(2)(B)(i). Also, pursuant to I.R.C. Sec. 6664(c)(1), no penalty is imposed pursuant to I.R.C. Sec. 6662 with respect to any portion of an underpayment if it is shown that there was reasonable cause for the underpayment and the taxpayer acted in good faith. In the Brinks case, the law firm had about 85 non-shareholder attorneys, and about 65 shareholder attorneys. The law firm filed its returns showing all amounts paid to the shareholder-attorneys as deductible employee compensation. After negotiations, the parties conceded the tax but left the penalty issue for the court to resolve. The firm argued that it had substantial authority for deducting the money it paid to its shareholder-attorneys; and it relied on a reputable accounting firm to prepare its returns for the years in issue, and had reasonable cause to deduct those amounts and acted in good faith in doing so. But the Court held that the amounts paid to the shareholder-attorneys do not qualify as deductible compensation to the extent that the payments are funded by earnings attributable to the services of nonshareholder employees or by the use of the corporation's intangible assets or other capital. Those earnings constitute nondeductible dividends. Pediatric Surgical Associates v. Comm., T.C. Memo 2001-81 (TCM 2001) and Mulcahy, Pauritsch, Salvador & Co v. C.I.R., 680 F.3d 867 (7th Cir. 2012). Therefore, the penalty was upheld. A corporation's payment of salaries to shareholder-employees in amounts that leave insufficient funds available to provide an adequate return to the shareholders on their invested capital indicates that a portion of the "salaries" is properly characterized as distributions of earnings and thus - dividends. The court ruled that investors in such a situation would expect a return on their investment. Finally, the Tax Court ruled that the law firm did not act with reasonable cause and good faith. The law firm did not provide the accounting firm with accurate information. Conclusion: When operating as a C Corporation, a client must be diligent with their accountants to avoid the imposition of penalties.

New Innocent Spouse Proposed Regulations Issued

New Innocent Spouse Proposed Regulations Issued The IRS proposed regulations on innocent spouse relief under Code Sec. 6015 was just released on Wednesday, January 6, 2016 at Federal Register 134219-08. Of particular significance are the following: 1. Guidance is given on the application of res judicata in innocent spouse cases. Res judicata – as applied here - would prevent a spouse from seeking innocent spouse relief when such relief was at issue in a prior court proceeding or the requesting spouse meaningfully participated in a prior proceeding in which innocent spouse relief could have been raised. The proposed regulations provide guidance on “meaningful participation.” The proposed regulations provide a nonexclusive list of considerations in making a facts and circumstances determination of whether the requesting spouse “meaningfully” participated in such prior proceeding. Also, the Proposed Regulation exempts the application of the above rule if the requesting spouse establishes that he or she performed the acts due to abuse by the other spouse or the other spouse maintained control over the requesting spouse, and the requesting spouse did not challenge the other spouse because of fear of retaliation. 2. A definition of “underpayment or unpaid tax” as found in Code Sec. 6015(f) is provided. It states that “unpaid tax” and “underpayment” have the same meaning. Thus, the “underpayment” is the balance shown as due on the return less the amount of tax paid with the return on or before the due date for payment (without considering any extension of time to pay). The “unpaid tax” is calculated after applying any credits for withholding, estimated tax payments, payments made when requesting an extension, and other credits. 3. Guidance is given on credits and refunds in innocent spouse cases, explain how to determine the amounts of credits and refunds that may be available. The Proposed Regulations also provide for allocation of refunds in certain cases. 4. Clarification is provided for credits and refunds in equitable relief cases to make clear that credits and refunds of tax are available in deficiency cases as well as in underpayment cases.