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12 Days of Tax Planning

 

 

The 12 days of tax planning countdown- for web

In a recent case, an appeals court upheld the Tax Court’s decision that a bookie’s plea agreement on criminal charges does not bar a civil action for unpaid taxes.

Gary Kaplan operated an illegal sports booking business called BetOnSports. The majority of Kaplan’s booking business was located in the Caribbean islands and Costa Rica for most of the 1990s.

Right before the company went public in July 2004, Kaplan engaged in several transactions and stock transfers that allowed him to set up two trust funds worth $98 million dollars. These trusts were referred to as the “Bird Trusts,” and the money was located somewhere off the coast of France.

Kaplan was the sole grantor of the Bird Trusts. As the grantor of the trusts, Kaplan was responsible for paying income taxes on the earnings of the trusts. Kaplan neglected to pay federal income tax or capital gains tax for the trusts for either 2004 or 2005.

In 2006, Kaplan was indicted by a federal grand jury for operating an illegal bookmaking operation within the United States. Kaplan ended up making a plea deal with the government. In exchange for accepting reduced charges, Kaplan agreed to allow the federal government to take civil action against him regarding the two years at issue.

During a change-of-plea hearing in 2009, Kaplan was questioned about the provision in his original plea agreement that dealt with the right of the government to pursue a civil tax matter against him for the 2004 and 2005 tax years. Kaplan assured the judge that he understood the difference between a civil court matter and a criminal court matter. He insisted that he was aware of the ramifications of the plea deal.

After the change of plea hearing, the court accepted the plea offer and sentenced him to 51 months in jail and ordered him to forfeit $43.65 million to the United States.

Sometime in 2012, the IRS commissioner issued a notice of deficiency for failure to file and pay taxes for 2004 and 2005. Kaplan was also liable for interest and various penalties. The taxes, penalties and interest totaled almost $25.5 million for 2004 and a little over $11 million for 2005.

Kaplan challenged the IRS at the district court level and lost. He brought his appeal to the U.S. Court of Appeals for the 8th Circuit.

Kaplan raised three issues in his appeal:

1. The statute of limitations had run on the commissioner’s ability to assess the unpaid taxes.

2. His 2009 plea agreement barred the claim.

3. Judicial estoppel barred the commissioner’s determination.

The appeals court rejected all three of these issues.

The statute of limitations does not start to run until an income tax return is actually filed by the taxpayer. Because the taxpayer did not file a tax return for 2004 and 2005, the statute of limitations has not run on those tax years. So Gary Kaplan lost on this issue.

The 2009 plea agreement was unambiguous as to the government’s ability to bring a civil action against Gary Kaplan. In addition, during the 2009 change-of-plea hearing, the court referenced answers given by Gary Kaplan that clearly demonstrated that he understood the government had the ability to bring a civil tax proceeding against him.

On the issue of judicial estoppel, Kaplan felt that, because the government did not object to his Presentence Report, it was prevented from bringing a civil tax proceeding against him. In his report, Gary Kaplan did not list any tax liabilities for 2004 and 2005. There were a number of reasons that Kaplan lost this issue, including that the numbers contained in the report were compiled and put together by Kaplan himself, not the IRS. (Gary Kaplan v. Commissioner, U.S. Court of Appeals, Eighth Circuit, 14-2342, July 29, 2015) ■

©2015 CPAmerica International

Under the Affordable Care Act, large employers are required to file information returns with the IRS and provide statements to full-time employees.

You are a large employer if you employed, on average, 50 full-time equivalent employees or more during 2014. You must include employees of other members of any companies under common control.

A full-time employee is someone who works an average of 120 hours per month for purposes of determining large employer status.

If you are a large employer, you need to track the following information in 2015 so you can meet the reporting requirements of early 2016:

1. Whether you offered full-time employees and their dependents minimum essential coverage that meets the minimum value requirements and is affordable.

2. Whether your employees enrolled in the self-insured minimum essential coverage you offered.

It’s necessary to track the above information so you can meet the following reporting requirements mandated by the Affordable Care Act:

  1. Form 1095-C, Employer-Provided Health Insurance Offer and Coverage – Large employers are required to provide this form to all of their full-time employees by Jan. 31, 2016. This form contains basic information about both the employee and the employer. It also provides information about the insurance coverage offered the employee during 2015 and the employee’s share of the premium cost.
  2. Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns and Form 1095-C. Large employers are required to submit a copy of all of the Forms 1095-C issued to all of their full-time employees along with Forms 1094-C. The Form 1094-C is a type of summary sheet for the individual Form 1095-C. The 1094-C also requires some additional information disclosures regarding total number of employees, the full-time employee count and various eligibility information. These forms need to be submitted to the IRS by Feb. 29, 2016, or March 31, 2016, if filed electronically.

To be able to fill out the Forms 1095-C and 1094-C in a timely and efficient manner, large employers need to start tracking their full-time employee and insurance information for 2015 now. ■

©2015 CPAmerica International

When starting a new business, a wise first step is to seek the advice of your CPA.

Some things you might want to consider before starting the business:

  1. Business Structure – Determining the business structure should be the first decision that you make. The basic choices are sole proprietorship, corporation, limited liability company or partnership. There are two different types of corporations: C corporation and S corporation. A limited liability company defaults to being taxed as a partnership – or a sole proprietorship in the case of a single member LLC – but may elect to be taxed as either a C or an S Corporation. The type of entity you select determines what forms you will need to file with the IRS and when you will need to file them.
  2. Business Taxes – The four basic types of business taxes are payroll, income, self-employment and excise. The business structure you choose affects which taxes you will be subject to. The income tax could be either corporate income tax or individual income tax – again depending on the business structure.
  3. Employer Identification Number –You are required to have an employer identification  number if you have payroll or if you choose the corporate or partnership form of business structure. Apply for your EIN through the IRS.
  4. Accounting Method – An accounting method is a set of rules that you use to determine when to report income and expenses. The three methods available are cash, accrual and hybrid. Most taxpayers will choose the cash-basis method of accounting unless they are required to select another method. You are required to use the accrual method when your average gross receipts exceed $5 million computed over a three-year period of time.
  5. Employee Health Care – The Small Business Health Care Tax Credit is available to businesses that employ fewer than 25 employees who work full-time, or a combination of full-time and part-time, and purchase insurance through the Exchange. The maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities. The employer shared responsibility provisions of the Affordable Care Act affect employers employing at least 50 full-time equivalent employees.

Learn the tax basics of starting a business on IRS.gov at the Small Business and Self-Employed Tax Center. ■

©2015 CPAmerica International

 

Most people are probably familiar with the general tax rule about hobbies: You can deduct expenses only to the extent that you have income from the hobby.

This rule applies to individuals, S corporations, partnerships, estates and trusts.

There is a certain pecking order in deducting these expenses:

  1. Deductions a taxpayer can claim whether or not they are incurred with a hobby. Some examples are taxes and interest. These expenses are allowed even if they exceed hobby income.
  2. Deductions not resulting in an adjustment to the property’s basis. These are the hobby’s operating-type expenses. An example is supplies. These expenses are allowed to the extent that the gross income from the hobby exceeds the deductions under No. 1.
  3. Deductions resulting in an adjustment to the basis of property. Depreciation and amortization deductions are allowed but only to the extent that gross income from the hobby exceeds deductions under both No. 1 and No. 2.

The income from the hobby activity is picked up on line 21 on page 1 of the Form 1040 return. This income is not subject to self-employment tax but is subject to federal income tax.

No. 1 deductions are Schedule A-type itemized deductions not subject to the 2-percent-of-adjusted-gross-income limitation. To take advantage of these deductions, you must itemize your deductions.

Nos. 2 and 3 deductions are Schedule A-type itemized deductions, but they are subject to the 2-percent-of-AGI limitation. To take advantage of these deductions, you must itemize your deductions. But even if you itemize your deductions, a portion of the expense deduction is lost because of the 2 percent rule.

Hobbies are considered to be activities engaged in without a profit motive. Whether an activity is engaged in for profit is determined by a facts-and-circumstances test.

Here are a couple of general rules:

© 2015 CPAmerica International

 

The U.S. Tax Court settled a case in July between a landlord and a tenant who wasn’t paying rent – and the court came down on the side of the tenant.

John E. Burgess owned a piece of land that he rented to Dennis Mineni. The land was used as an overflow parking lot for Mineni’s business, Atwater Flea Market. The two men had a handshake agreement that required Mineni to pay Burgess $2,000 (later reduced to $1,500) a month for the use of the land.

Burgess failed to file income tax returns for the years 1999 through 2007. The IRS assessed taxes for each unfiled year, and the total amount was almost $5 million.

Because of the assessment, Burgess was considered a delinquent taxpayer. This designation allows the IRS to place a levy upon a taxpayer’s property or rights to property.

Burgess brought up tax-protestor-type arguments, claiming that he is not a federal citizen and therefore is not subject to the jurisdiction of any federal institution or law, including but not limited to Congress, the IRS and the Social Security Administration.

Burgess felt that he did not owe any federal income tax and that the levy placed against him was invalid.

Mineni’s business was required by law to report the rent payments made to Burgess on IRS Form 1099. A copy of the Form 1099 was sent to Burgess and another copy was submitted to the IRS as required. The IRS became aware of Burgess’s income through the Form 1099.

The IRS sent a notice of levy to Atwater Flea Market, which was now incorporated and renamed Franklynn Properties, Inc. Through payments made by his business, Mineni honored the notice of levy by paying his monthly rent payment directly to the IRS instead of Burgess.

Over a 21-month period, Franklynn Properties, Inc., paid $31,500 to the IRS.

Under Internal Revenue Code Section 6332, anyone in possession of property, or rights to property, that belongs to a delinquent taxpayer upon whom a levy has been made must surrender to the IRS the property or rights to the property. Failure to honor the levy may result in personal liability.

The person who surrenders the property or rights to the property to the IRS will be discharged from any obligation or liability to the delinquent taxpayer. Immunity under IRC Section 6332 has been interpreted generously to protect people who honor levies.

The U.S. government requested and received summary judgment on the grounds that Mineni is immune from suit for his surrender of rental payments, owed to Burgess, to the IRS under an IRS levy.

So Mineni was not required to reimburse Burgess for the rent payments that were sent to the IRS. In fact, he is to continue making the rent payments directly to the IRS until such time as the levy is found invalid or stopped (John E. Burgess, Plaintiff, v. Dennis Mineni, Defendant/Dennis Mineni, Counterclaim-Plaintiff, v. John E. Burgess, United States of America, Counterclaim-Defendants, U.S. District Court, Eastern District of California, 2015-2 U.S.T.C., July 20, 2015).

©2015 CPAmerica International

 

The U.S. Tax Court recently upheld the IRS’s frivolous return position, costing a taxpayer $10,000 in fines.

Mark A. Lovely failed to file tax returns for 2005, even though he admitted that he had received compensation from Tradewinds Airline, Inc., and Triad International Maintenance Corp. He claimed the compensation did not constitute “wages” and therefore it was not taxable income.

Each of Lovely’s employers issued to him a Form W-2 Wage and Tax Statement. Because the IRS receives a copy of every W-2, the agency knew that Lovely had earned income and a requirement to file a tax return.

Using this information, the IRS prepared a substitute return for Lovely and assessed income tax, penalties and additions to tax.

In July 2009, Lovely prepared a Form 1040X, Amended U.S. Individual Income Tax Return. He claimed that he had no income for the tax year at issue, which was 2005. He in fact had $29,500 worth of taxable compensation for that year. He requested that the federal income tax amount of $1,475.37, which had been withheld from his wages, be refunded to him.

In September 2012, Lovely followed a similar procedure. This time he filed a 1040X requesting a refund of $781.51.

The IRS determined that both Forms 1040X submitted by Lovely had constituted frivolous returns and assessed a $5,000 fine for each one submitted.

In a collection due process hearing with the IRS, Lovely contested the $10,000 in fines assessed by the IRS for his having submitted frivolous returns. He claimed he did not receive a statutory notice of deficiency and did not have a proper opportunity to dispute the fines.

Both of the issues raised by Lovely are defenses to the existence of the amount of the tax liability according to the Internal Revenue Code. The tax liability in this case was the $10,000 in fines.

The IRS brought up some prior court cases that supported the position that issuing a statutory notice of deficiency and allowing the taxpayer an opportunity to dispute the tax are not required when the taxpayer’s original position on the 1040X is frivolous.

Lovely agreed that he had received compensation for his services but contended that it was not taxable income because he didn’t work for the federal government. The court ruled that his tax-protestor-type arguments in support of his position were frivolous.

Taking all of the facts and circumstances of the case into account, the Tax Court ruled in favor of the IRS and upheld the $10,000 in fines (Mark A. Lovely v. Commissioner, T.C. Memo 2015-135, July 27, 2015). ■

©2015 CPAmerica International

 

Qualified education expenses under the American Opportunity Tax Credit are basically tuition, fees and course materials.

The tuition must be paid to an eligible educational institution. An “eligible educational institution” is generally any accredited public, nonprofit or proprietary (private) college, university, vocational school or other postsecondary institution.

Student activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. Student health fees are not included as part of this expense. They are considered a medical expense.

Course materials include books, equipment and supplies. You do not have to purchase these items directly from the school to include them. Books included in the credit are the textbooks needed for the course. Supplies include highlighters, pens, pencils, etc. An example of equipment is a laptop computer.

If you do not purchase your course materials from the university bookstore, those qualified education expense items will not be included on the Form 1098-T that you receive from the university. You will need to enter these expenses – in addition to the expenses listed on the Form 1098-T – when preparing your income tax returns.

Qualified education expenses never include personal expenses. Room and board, insurance, medical expenses, transportation and similar personal, living or family expenses are examples of personal expenses.

The amount of qualified education expenses is reduced by the amount of a qualified scholarship, which is excluded from gross income, as well as tax-free fellowship grants, the tax-free part of employer education assistance and veterans’ educational assistance. The amount of the scholarship will be provided to you on Form 1098-T. ■

©2015 CPAmerica International

from the IRS

 

If you have something called qualified dividend income, it receives special tax treatment.

Qualified dividend income is defined as dividends received during the tax year from a domestic corporation or a qualified foreign corporation. It is taxed at the lower preferential capital gains tax rates.

A domestic corporation is a corporation incorporated within the United States. A qualified foreign corporation is a corporation incorporated in a possession of the United States or a corporation eligible for benefits of a comprehensive income tax treaty with the United States that the secretary of the Internal Revenue Service determines is satisfactory.

In contrast, ordinary dividends are fully includable in gross income. An ordinary dividend is any distribution made by a corporation to its shareholders whether in money or property. The amount of the dividend is the amount of cash received plus the fair market value of any property received, if applicable.

You pay tax on ordinary dividends at your ordinary income tax rates. Your tax bracket determines the rate of income tax that you pay. There are currently seven ordinary income tax rates or brackets.

However, if the corporation’s dividends meet the criteria for qualified dividend income treatment, the lower preferential tax rates apply, as shown in the table below:

Ordinary Income Tax Rate                        Qualified Dividend Rate

10%                                                                     0%

15%                                                                     0%

25%                                                                   15%

28%                                                                   15%

33%                                                                  15%

35%                                                                  15%

39.6%                                                              20%

These rates are applicable for individuals, estates and trusts.

Investments in tax-deferred retirement vehicles such as a regular IRAs, 401(k)s and deferred annuities do not receive any benefit from the preferential rate reduction.

Distributions from these accounts are taxed at ordinary income tax rates even if the funds represent dividends paid on the stocks held in these accounts.

There is a 60-day holding period requirement to qualify for the preferential qualified dividends rate. You have to hold a stock at least 60 days within a 121-day period, which begins 60 days before the ex-dividend date and ends 60 days after.

The ex-dividend date is the day after the date of record, which is the date on which all shareholders who own a particular stock will receive a dividend for that period of time.

Obviously, following the rules and qualifying for the preferential qualified dividends rate can result in a substantial tax savings. ■

©2015 CPAmerica International

Courts

 

Ordinary and necessary business expenses are not deductible when a trade or business consists of trafficking in controlled substances prohibited by federal law, under a recent decision by the 9th U.S. Circuit Court of Appeals.

Martin Olive owns a business called the Vapor Room, located in San Francisco, Calif.

He appealed the Tax Court’s decision to disallow the deduction of all of his business expenses for 2004 and 2005. The Vapor Room had $236,502 of business expenses in 2004 and $417,569 of business expenses in 2005.

The Internal Revenue Code (IRC) defines “gross income” and allows a business to deduct from its gross income all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on the business. The difference between the two items is the business’s net income.

The IRC also has some exceptions to what is deductible as an ordinary and necessary business expense. One exception is IRC Section 280E, which disallows the amount paid or incurred during the taxable year for the purpose of carrying on any trade or business consisting of trafficking in controlled substances.

The test for determining whether an activity constitutes a trade of business is whether the activity was entered into with the dominant hope and intent of realizing a profit.

The Tax Court in applying the profit test determined that the only business activity that was engaged in by the Vapor Room was the sale of medical marijuana. Medical marijuana, while legal to sell in the state of California, is still considered to be a controlled substance for federal government purposes.

The Tax Court found that the only income-generating activity in which the Vapor Room engaged was its sale of medical marijuana. Marijuana was the only item for which the Vapor Room charged a fee.

It offered other services and amenities for which it did not charge a fee. For example, it provided vaporizers, food, drink, yoga, games, movies and counseling. The business offered the free items hoping to lure in customers to its dispensary to buy its medical marijuana.

Because marijuana is a controlled substance, IRC Section 280E disallows the deduction of any expenses related to this activity.

Thus, the appeals court affirmed the Tax Court’s decision to deny the Vapor Room a deduction for what it had considered the ordinary and necessary business expense associated with its operation (Martin Olive v. Commissioner, U.S. Court of Appeals, Ninth Circuit, No. 13-70510, July 9, 2015). ■

©2015 CPAmerica International





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