IRS increases audit efforts relating to withholding and other information reporting

The IRS has announced a new nationwide Compliance Initiative Project (“CIP") to address noncompliance by "non-traditional" withholding agents (i.e., non-financial institutions). A CIP is an examination of specific taxpayers within a group, using internal and external data to identify potential areas of noncompliance within the group, for the purpose of correcting the noncompliance. The IRS decided to undertake this initiative based on information uncovered during its administration of the Voluntary Compliance Program (VCP) that was available to withholding agents with respect to the payment, withholding, and reporting of certain taxes due on payments to foreign persons (see prior Inbound Newsalerts, dated October 1, 2004 and March 9, 2005). The VCP originally was available for submissions made on or before December 31, 2005. The filing date was later extended to March 31, 2006.

Although the compliance program primarily was developed to address problems experienced by financial institutions in reporting payments to foreign account holders, the IRS realized there was noncompliance with withholding rules by non-financial institutions based on submissions under the VCP program by these non-traditional withholding agents. IRS Computer Audit Specialists and International Examiners are being trained to conduct more directed “surgical audits” of taxpayers with the highest audit potential. Examiners will be analyzing information reported on Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations), Form 5472 (Information Return of a 25% Foreign-Owned U.S. Corporation), and withholding agents’ accounts payable records to identify payments to foreign persons.

The Audits:
According to the IRS, the audits will be a three-step process:
Step One: Determine payments to foreign vendors.
Step Two: Examine amounts paid by expense types that may generate reporting or withholding responsibilities.
Step Three: Determine U.S. source vs. foreign source income.

Companies that conduct business with foreign entities and that make payments of both U.S. and non-U.S. source income may wish to discuss withholding requirements with their accounts payable departments.

Observations:
This initiative could be significant for U.S. entities that make payments of certain kinds of income to foreign persons but that may not be familiar with the complex withholding regulations under sections 1441 and 1442. This will affect U.S. withholding agents making payments of fixed or determinable annual or periodical income such as interest, dividends, royalties, and payments for services performed in the United States to foreign persons.

Information provided by our international resource.

Ryan L. Losi, CPA, REALTOR
Business Development Manager
Piascik & Associates, P.C.
4470 Cox Road, Suite 250
Glen Allen, VA 23060
Direct: (804) 228-4179
Main: (804) 527-1815
Facsimile: (804) 527-1816
E-mail: rlosi@piascik.com

California LLC Update

There has been a flurry of activity in California regarding LLCs since the beginning of the year. In this update we will try to sum up the three biggest issues.

The LLC Fee being ruled unconstitutional,
Foreign LLCs requirement to pay the $800 LLC tax and
Series LLCs in California.


LLC Fee is Unconstitutional

First of all let’s make sure we all understand that California has two charges that it imposes on LLCs. It imposes an LLC fee and an LLC minimum tax. The LLC minimum tax is the $800 LLCs must pay if they are registered in California. The LLC fee is an amount in addition to the $800 based on the gross receipts of the LLC (many LLCs do not have high enough gross receipts to be required to pay this fee). It is this additional fee that was ruled unconstitutional. If your LLC only paid the $800 minimum this case does not affect you.

In the case of Northwest Energy Services, LLC v. FTB the San Francisco Superior Court ruled that fee was not actually a fee but a tax and as a tax it violates both the Due Process Clause and the Commerce Clause of the US Constitution.

Northwest was an LLC organized in the state of Washington that registered to do business in California with the California Secretary of State. This was sufficient to trigger the LLC fee under R&TC §17942, which, according to the FTB, is computed on total worldwide income without apportionment. The court held that, because the fee is not apportioned, it is unconstitutional. However, since Northwest did not do business in California, the decision is not ideal for determining the outcome for other LLCs that have paid the fee.

While the court ruled that the fee violates the Commerce Clause and the Due Process Clause of the U.S. Constitution, and the Due Process Clause of the California Constitution, it is not clear whether the statute itself is invalid or whether the statute will stand if the fee is calculated using an apportionment method. If the latter, the Northwest decision will only affect multi-state LLCs — those with income both within and without California. If the statute is ruled invalid it will affect all LLCs that pay (and have paid) the fee.

Although the outcome of the Northwest case was a clear victory for one taxpayer, the effect on the LLC fee for other taxpayers is unclear. For now, the decision does not apply to other taxpayers. The FTB must continue to enforce the LLC fee until a Court of Appeal or higher court declares it unconstitutional. This means that, for LLCs that filed protective claims, the waiting game is on. If the FTB does not appeal Northwest, the decision will apply only to Northwest, LLC, and you will have no recourse other than to file in superior court or wait for another taxpayer to file suit.

If the FTB appeals Northwest, there are a number of possible outcomes. First, the appeals court could overturn the lower court’s decision and side with the FTB. Second, it could side with the lower court but even that entails multiple possible outcomes.
• The court could rule that the entire statute (R&TC §17942) is unconstitutional. In that case, the result would be that no LLC, whether operating interstate or solely within California, would be required to pay the fee and the FTB would be forced to act on refund claims.
• The court could find that the unconstitutional provisions are severable from the rest of the statute. For example, they could find that the statute is valid generally in that it does not preclude a requirement for apportionment. In that case, the decision would apply only to LLCs doing business in multiple states.

Since it is possible that the decision may affect all LLCs that paid the fee, you should file a protective claim for refund of the entire amount of those fees for all years open under the statute of limitations.

Cautions: Please observe the following:
• Northwest addressed the constitutionality of the annual LLC fee only, not the $800 annual tax levied under R&TC §17941.
• The decision does not affect LLCs that have elected to be taxed as corporations because they do not pay the annual fee under R&TC §17942.
• You must continue to pay the LLC fee without apportionment; and you must pay the fee before filing the claim (see below).

If your LLC has paid this fee in prior years please contact our office to file a protective claim of refund. This will put your LLC on record as to have filed for a refund before the statute of limitations runs out and will preserve your right to claim a refund if the Appeals Court upholds this ruling.

Foreign LLCs

California law requires foreign LLCs (LLCs not organized in California) to register with the Office of the California Secretary of State (SOS) before entering into any intrastate business in California. The SOS may not deny recognition of an LLC because the laws of the LLC’s home state or foreign country differ from California’s laws, except in the case of professional service LLCs, which are not allowed to register as LLCs in California (Corp. Code §§17451, 17452).

For California taxation purposes, a foreign LLC must use a “doing business” test instead of the “transacting intrastate business” test that is used for determining registration requirements. “Doing business” means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit” (R&TC §§17941, 23101).

In a member-managed LLC, every member of an LLC is an agent of the LLC for conducting the usual business of the LLC, unless the articles of organization or operating agreement restrict the scope of the agent’s authority (Corp. Code §17157). A non-member may become an agent through precedent authorization or ratification by the LLC’s member-managers (Civil Code § 2307). It is therefore presumed by the FTB that California LLC managers are conducting LLC business while in California.

It is not clear whether a California resident who is a non-managing member of a foreign LLC with no managing members in California forces the entity to meet the “doing business” test.

So what all this means is that if an LLC has a member manager that is a California resident the LLC is assumed to be doing business in California and must register and pay the $800 tax. To avoid this, the member manger must travel outside of California to conduct business for the LLC. The member manager should keep meticulous logs of the business conducted and where the business was conducted. They should also be prepared to substantiate the travel with hotel, airline and or gas receipts. In addition the LLC should have its bookkeeping and tax returns prepared outside of California and its bank account should be outside of the state as well.

Another option is to have a person outside of California be the LLC manager and leave any California members as non-managing members. This option is based on our interpretation of the FTB’s ruling that LLC managers are agents of the LLC and therefore are conducting the business of the LLC. Non-manger members are not engaged in the business of the LLC and therefore would not lead to the assumption that their residency in California automatically assumes that the LLC is doing business in California. As said earlier this is based on our interpretation and to this point in time we are not aware of any rulings or guidance from the FTB as to how they would treat this situation, so caution should be used in determining whether or not to use this option.

To some of us taking steps to avoid the extra $800 per year LLC tax may be more of a nuisance than the $800 itself and it is just easier to register and pay the $800 to California. But what if you have several LLCs outside of California? Now we are not just talking about $800 but maybe 5, 10 or more times $800. An additional $8,000 (if you had 10 LLCs) may turn your entire investment strategy upside down. An option for this is to create a holding company LLC outside of California in which you are the member manager. This LLC would be registered in California as a foreign LLC and pay the annual $800 tax. All of your other non-California LLCs would be owned and managed but this new holding company LLC. It is our opinion that this structure would only require one $800 payment to California, however as with the non-manger member strategy we discussed earlier; to this point in time we are not aware of any rulings or guidance from the FTB as to how they would treat this situation, so caution should be used in determining whether or not to use this option

There is one safe and proven option for avoiding all of this and that is to leave California!

Series LLCs
It is standard practice to put assets into separate LLCs to isolate potential liability. This can be an expensive proposition entailing multiple administrative costs and, in California, multiple annual taxes and multiple total-income fees.

Many advisors are now recommending the “Series LLC” as a means of accomplishing many of the same objectives with a single round of administrative costs and taxes. The question is, does it work to eliminate multiple taxes and fees in California?

Series LLCs are now allowed in Iowa, Illinois, Nevada, Oklahoma, and Delaware. However, the Delaware law was the first and is the best known.

A Series LLC is one that places its assets in separate “series,” which function like separate businesses and are, in fact, required to keep separate books and records (Delaware Limited Liability Company Act §18-215). In addition, each series can operate different kinds of businesses and have different managers, members, and ownership percentages. A series can make distributions to its own members without regard to members of the LLC’s other series. Most importantly, the law provides that the debts and obligations of one series are enforceable against that series only.

A Delaware LLC is required to register with the SOS prior to doing business in California. Generally, the California courts will apply California law to all disputes regarding the entity except for those regarding internal governance. Under California Corporations Code §17450(a), “The laws of the state or foreign country under which a foreign limited liability company is organized shall govern its organization and internal affairs and the liability and authority of its managers and members.” As such, the separate treatment of series LLCs will apply in California for purposes of internal governance.

However, that doesn’t mean that the series laws will apply for creditors, claimants, and other California third parties who have not agreed to be bound by those laws. In fact, some legal commentators believe that the series laws would have little chance of working even for California tenants who sign a lease agreement stating that they must respect the series limitations given California’s heavy consumer- and tenant-protection laws.

So it appears that in California a series LLC will not provide separation of assets but instead the courts will more than likely open up the entire LLC to satisfy a judgment. If that was not bad enough wait until you see how the FTB will treat a Series LLC.

According to the FTB, each series is considered a separate LLC that must file its own FTB Form 568, and pay a separate LLC annual tax and fee if it is registered or doing business in California. The FTB compares the series LLCs to the separate series of a single trust, which have been regarded as separate taxpayers as found in National Securities Series-Industrial Stock Series v. Commissioner (13 TC 884) and Revenue Ruling 55-416.

It is our opinion that Series LLCs are only good in the state in which they were organized; and certainly not in California and not for California residents that may, as discussed earlier, need to register their foreign LLC in California. Someday California may adopt its own Series LLC law and at that time we may change our opinion.

Please note that the opinions and options mentioned are our best guess as to what the FTB might do and as such should not be relied upon solely in determining what actions if any should be taken in your individual circumstances. Our opinions are not intended be by legal opinions. Our purpose is only to make you aware of these issues and as always we suggest you consult your attorney as to how this may or may not apply to you. If you have any questions on this information or would like discuss this in more detail on how to proceed under your specific circumstances please contact our office.
Tel: 623-209-0012
Fax: 623-537-9184
13933 W. Grand Avenue, #302, Surprise, Arizona 85374

100% write-offs

Recent federal legislation [section 179] allows certain classes of assets to be fully depreciated in 1 year. They include personal property such as office furniture, computers, etc. Up to $108,000 can be written off in 1 year!

This cap is linked to the amount of qualifying property being purchased, and reduces as the total exceeds $430,000. Not normally an issue for small businesses >grin<.

In 2010 that deduction limit is expected to fall back to pre-legislation values of $25,000, so this is still a good planning tool for financial forecasting and revenue modeling.

Typically you'll want your deductions applied to higher taxed income whenever possible. So if you can wipe out employment taxes [15.3%] as well as income taxes [say 25%] that would be better than just creating a Net Operating Loss. As always, consult with your tax professional to make sure that your plans maximize the benefits that you will receive.

oops - the dragonflies are out again - I'll see if I can catch one this time.

Until later then, Smokey says bye.

Want to set up a Corp or LLC in the USA?

If you want to start a business in the USA, it is relatively simple. IF you are living here and are a citizen or a resident alien. If not, then the normal hoops can become major stumbling blocks. Contact gary @ yourentitysolution dot com for help in resolving company formation issues. At this time we do not need either an EIN or ITIN for the federal government (according to extensive conversations with the IRS).

California Real Estate Crash?

The Norris Group released this update recently and it paints a uncertain or even negative future for real estate in the near to mid-term. Bruce Norris has invested a lot of time and money in this forecast and his last major report forecast the big boom in California very accurately - so this deserves more than a casual glance.

The summary is that Investor and second home purchases are around 47% of all of the homes bought over the past year. That's up from the normal 10% [yikes].

Historical Housing Median Prices
. . . . . . . 2004 . . 2005 . . 2006
January . . $404,460 $485,700 $540,000
February. . $391,550 $470,920 $535,480
March . . . $428,060 $496,550 $561,350
April . . . $452,270 $509,630
May . . . . $463,690 $522,900
June . . . $468,620 $543,120
July . . . $462,140 $540,900
August . . $473,360 $568,730
September . $463,620 $543,980
October . . $459,800 $538,770
November . $471,980 $548,680
December . $474,280 $548,430


The California real estate market is heavily dependent upon two things: The continuation of cheaper than market payments when people buy real estate and the mental outlook that real estate is still the “hot ticket” investment. Without the positive outlook, there’s no way a many of us will be signing up for the 50 year “easy payment” plan.

California foreclosures headline April 10, 2006, PRNewswire

“Los Angeles Foreclosures increase dramatically; 63% from 2005 to 2006” “The rising foreclosures are due to the ‘Average Joe’ buying a house he cannot afford because of inflated
home prices. Then, with interest rates rising, he cannot pay for the mortgage. Many of the homeowners used ‘aggressive financing to buy homes they could not afford.’” – Serdar Bankaci, President of Default Research, Inc.

California LLC Franchise Tax is Unconstitutional

Court holds that part of the California LLC Franchise Tax is Unconstitutional
A San Francisco Superior Court dealt the Franchise Tax Board a blow last week when it ruled that a major portion of the California Franchise Tax violates both the Commerce Clause and Due Process Clauses under the United States Constitution. The case is almost guaranteed to be appealed given the magnitude of the decision.

The issue boiled down to whether the franchise tax imposed on LLCs under one or two major sections of the LLC act was a tax or a fee. If it is a fee, then the franchise tax would stand. If it was a tax, then the U.S. Constitution would kick in and certain rules would apply to protect the LLCs from being unfairly taxed.

The Impact of the Franchise Tax
According to the Court documents, the California Legislature added two revenue generating provisions in 1994 as part of the LLC Act to offset tax revenues that would be lost if companies operated as LLCs as opposed to Corporations. One provisons imposed an $800 minimum tax while the second imposed a levy based on the revenues of the LLC. The second provison was as issue.

Why does it matter if it is a tax or a fee?

In a nutshell, fees are imposed to fund a regulatory program - to cover the costs, if you will - or provide compensation for services and benefits received by the government while taxes raise revenue for typical governmental services (they are compulsory). Thus, a fee is incurred voluntarily to receive a benefit (i.e. you pay the Secretary of State a fee to receive the benefits of being an LLC) while a tax is compulsory (i.e. you pay just for being an LLC). Taxes, being compulsory, have more protections for taxpayers as they are imposed without choice.
The reason this is a big deal is because the Court held that the Secretary of State was collecting the fees relating to the LLC Act and that the proceeds generated by the Levy at issue EXCEEDED the ENTIRE budget of the Secretary of State in all years after 1999. Keep in mind that LLCs are only a small portion of what the Secretary of State's responsibilities.

So what if it is a tax?

If it is a tax, then the Due Process and Commerce Clause create a duty on the State to make sure the tax is applied to activities with a substantial nexus to the taxing state, that they be fairly apportioned (you should not get taxed by two states on the same dollar), that the tax does not interfere with interstate commerce and that it be related to the services provided by the state. The Court held that the tax was not fairly apportioned. The plaintiff in the case, a Washington State LLC registered to do business in California, was given a full refund plus interest as the levy could not "constitutionally" be applied to plaintiff.

Future Impact?
We will have to wait and see the fallout of the decision, but it does raise interesting issues for businesses, specifically, LLCs doing business in California. First, how do you preserve your right to refund if the statute is indeed struck down? Second, what impact will this decision have on the $800 minimum tax imposed?

For the first question, a taxpayer could preserve their rights to a refund by filing a protective claim. This tolls the statute of limitations until the case works its way through the appeal process. It is generally accomplished by stating on the face of the return that you are seeking a protective claim for refund based on (insert the case name). In this case, it would be "Protective Claim for Refund Based on the Outcome of Northwest Energetic Services, LLC." Have your preparer attach a statement and cite the case (case number CGC-05-437721). Use a professional.

As for the second question - only time will tell. We will have to wait and see how the legislature and other courts react to the decision.

Scam 12, “No Gain” Deduction

Filers attempt to eliminate their entire adjusted gross income (AGI) by deducting it on Schedule A. The filer lists his or her AGI under the Schedule A section labeled “Other Miscellaneous Deductions” and attaches a statement to the return that refers to court documents and includes the words “No Gain Realized.”

Scam 11, Employment Tax Evasion

The IRS has seen a number of illegal schemes that instruct employers not to withhold federal income tax or other employment taxes from wages paid to their employees. Such advice is based on an incorrect interpretation of Section 861 and other parts of the tax law and has been refuted in court. Lately, the IRS has seen an increase in activity in the area of “double-dip” parking and medical reimbursement issues. In recent years, the courts have issued injunctions against more than a dozen persons ordering them to stop promoting the scheme. During fiscal 2005, more than 50 individuals were sentenced to an average of 30 months in prison for employment tax evasion. Employer participants can also be held responsible for back payments of employment taxes, plus penalties and interest. It is worth noting that employees who have nothing withheld from their wages are still responsible for payment of their personal taxes.

Scam 10, Offshore Transactions

Despite a crackdown by the IRS and state tax agencies, individuals continue to try to avoid U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance to do so. The IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions. During fiscal 2005, 68 individuals were convicted on charges of promotion and use of abusive tax schemes designed to evade taxes.

Scam 9, Abuse of Charitable Organizations and Deductions

The IRS has observed increased use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur, for example, when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. A “contribution” of a historic facade easement to a tax-exempt conservation organization is another example. In many cases, local historic preservation laws already prohibit alteration of the home’s facade, making the contributed easement superfluous. Even if the facade could be altered, the deduction claimed for the easement contribution may far exceed the easement’s impact on the value of the property.

Scam 8, Credit Counseling Agencies

Taxpayers should be careful with credit counseling organizations that claim they can fix credit ratings, push debt payment plans or impose high set-up fees or monthly service charges that may add to existing debt. The IRS Tax Exempt and Government Entities Division is in the process of revoking the tax-exempt status of numerous credit counseling organizations that operated under the guise of educating financially distressed consumers with debt problems while charging debtors large fees and providing little or no counseling.

Scam 7, Return Preparer Fraud

Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers derive financial gain by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” And remember, no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others. During fiscal year 2005, more than 110 tax return preparers were convicted of tax crimes.

Scam 6, It's against the law; constitution; yada, yada

Promoters have been known to make the following outlandish claims: the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

Scam 5, Illegal Use of Trusts

For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits, and the IRS is actively examining these arrangements. There are currently more than 200 active investigations underway and three dozen injunctions have been obtained against promoters since 2001. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust.

Scam 3, Phishing.

Phishing is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for new loans in their names. These Internet-based criminals pose as representatives of a financial institution and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. Sometimes scammers pose as the IRS itself. In recent months, some taxpayers have received e-mails that appear to come from the IRS. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. In a variation of this scheme, criminals have used e-mail to announce to unsuspecting taxpayers they are “under audit” and could make things right by divulging selected private financial information.

Taxpayers should take note: The IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it.

Scam 2 Form 843 Tax Abatement

This scam, also new to the Dirty Dozen, rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83––Property Transferred in Connection with Performance of Service."

Scams 1 & 4, Zero Wages and Zero Return

In this scam, new to the Dirty Dozen, a taxpayer attaches to his or her return either a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 that shows zero or little wages or other income. The taxpayer may include a statement indicating the taxpayer is rebutting information submitted to the IRS by the payer.

An explanation on the Form 4852 may cite "statutory language behind IRC 3401 and 3121" or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation. The Form 4852 or 1099 is usually attached to a “Zero Return.”

Promoters instruct taxpayers to enter all zeros on their federal income tax filings. In a twist on this scheme, filers enter zero income, report their withholding and then write “nunc pro tunc”–– Latin for “now for then”––on the return. They often also do this with amended returns in the hope the IRS will disregard the original return in which they reported wages and other income.

How to Report Suspected Tax Fraud Activity

Suspected tax fraud can be reported to the IRS using IRS Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov, or through the U.S. Mail by calling 1-800-829-3676. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential. The person may also be entitled to a reward.

Tax scams for 2006

IRS Announces “Dirty Dozen” Tax Scams for 2006
WASHINGTON — The Internal Revenue Service today issued the 2006 “Dirty Dozen”––its latest annual tally of some of the most notorious tax scams––along with an alert to taxpayers this filing season to watch out for schemes that promise to reduce or eliminate taxes.
Two new schemes have worked their way onto the list in 2006. In recent months IRS personnel have noted the emergence of the two scams––“zero wages” and “Form 843 tax abatement”–– in which filers use IRS forms to claim that their tax bills have been wrongly inflated.
Also high on the list in 2006 is “phishing,” a favorite ploy of identity thieves. Over the past few years, the IRS has observed criminals working through the Internet, posing even as representatives of the IRS itself, with the goal of tricking unsuspecting taxpayers into revealing private information that can be used to steal from their financial accounts.
Several of the usual suspects from last year remain on the list. The IRS, for example, continues to see schemes designed to exploit charitable organizations. Some taxpayers, meanwhile, still use frivolous arguments to claim they do not owe taxes, despite the fact such reasoning has been thrown out of court time and again.
“When it comes to taxes, everyone has to pay their fair share,” IRS Commissioner Mark W. Everson said. “I urge taxpayers not to be taken in by hucksters who promise to lower or eliminate taxes. Getting caught up in the Dirty Dozen or similar schemes can lead to big headaches.”
Namely, involvement with tax schemes can lead to imprisonment and fines. The IRS pursues and shuts down promoters of these and numerous other scams. Anyone pulled into these schemes can also face repayment of taxes plus interest and penalties.
The IRS urges people to avoid these common schemes:
1. Zero Wages. In this scam, new to the Dirty Dozen, a taxpayer attaches to his or her return either a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 that shows zero or little wages or other income. The taxpayer may include a statement indicating the taxpayer is rebutting information submitted to the IRS by the payer.
An explanation on the Form 4852 may cite "statutory language behind IRC 3401 and 3121" or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation. The Form 4852 or 1099 is usually attached to a “Zero Return.” (See number four below.)
2. Form 843 Tax Abatement. This scam, also new to the Dirty Dozen, rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83––Property Transferred in Connection with Performance of Service."
3. Phishing. Phishing is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for new loans in their names. These Internet-based criminals pose as representatives of a financial institution and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. Sometimes scammers pose as the IRS itself. In recent months, some taxpayers have received e-mails that appear to come from the IRS. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. In a variation of this scheme, criminals have used e-mail to announce to unsuspecting taxpayers they are “under audit” and could make things right by divulging selected private financial information. Taxpayers should take note: The IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it.
4. Zero Return. Promoters instruct taxpayers to enter all zeros on their federal income tax filings. In a twist on this scheme, filers enter zero income, report their withholding and then write “nunc pro tunc”–– Latin for “now for then”––on the return. They often also do this with amended returns in the hope the IRS will disregard the original return in which they reported wages and other income.
5. Trust Misuse. For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits, and the IRS is actively examining these arrangements. There are currently more than 200 active investigations underway and three dozen injunctions have been obtained against promoters since 2001. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust.
6. Frivolous Arguments. Promoters have been known to make the following outlandish claims: the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.
7. Return Preparer Fraud. Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers derive financial gain by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” And remember, no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others. During fiscal year 2005, more than 110 tax return preparers were convicted of tax crimes.
8. Credit Counseling Agencies. Taxpayers should be careful with credit counseling organizations that claim they can fix credit ratings, push debt payment plans or impose high set-up fees or monthly service charges that may add to existing debt. The IRS Tax Exempt and Government Entities Division is in the process of revoking the tax-exempt status of numerous credit counseling organizations that operated under the guise of educating financially distressed consumers with debt problems while charging debtors large fees and providing little or no counseling.
9. Abuse of Charitable Organizations and Deductions. The IRS has observed increased use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur, for example, when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. A “contribution” of a historic facade easement to a tax-exempt conservation organization is another example. In many cases, local historic preservation laws already prohibit alteration of the home’s facade, making the contributed easement superfluous. Even if the facade could be altered, the deduction claimed for the easement contribution may far exceed the easement’s impact on the value of the property.
10. Offshore Transactions. Despite a crackdown by the IRS and state tax agencies, individuals continue to try to avoid U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance to do so. The IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions. During fiscal 2005, 68 individuals were convicted on charges of promotion and use of abusive tax schemes designed to evade taxes.
11. Employment Tax Evasion. The IRS has seen a number of illegal schemes that instruct employers not to withhold federal income tax or other employment taxes from wages paid to their employees. Such advice is based on an incorrect interpretation of Section 861 and other parts of the tax law and has been refuted in court. Lately, the IRS has seen an increase in activity in the area of “double-dip” parking and medical reimbursement issues. In recent years, the courts have issued injunctions against more than a dozen persons ordering them to stop promoting the scheme. During fiscal 2005, more than 50 individuals were sentenced to an average of 30 months in prison for employment tax evasion. Employer participants can also be held responsible for back payments of employment taxes, plus penalties and interest. It is worth noting that employees who have nothing withheld from their wages are still responsible for payment of their personal taxes.
12. “No Gain” Deduction. Filers attempt to eliminate their entire adjusted gross income (AGI) by deducting it on Schedule A. The filer lists his or her AGI under the Schedule A section labeled “Other Miscellaneous Deductions” and attaches a statement to the return that refers to court documents and includes the words “No Gain Realized.”
Two Fall off the List
Two noteworthy scams have dropped off the “Dirty Dozen” this year: “claim of right” and “corporation sole.” IRS personnel have noticed less activity in these scams over the past year following court cases against a number of promoters.
How to Report Suspected Tax Fraud Activity
Suspected tax fraud can be reported to the IRS using IRS Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov, or through the U.S. Mail by calling 1-800-829-3676. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential. The person may also be entitled to a reward.

Consumer Bankruptcy Filings for 2005 Are Highest on Record

BURLINGAME, CA -- Lundquist Consulting, Inc., released it's findings that in 2005 consumer bankruptcy filings numbered over 2 million, up 31.6 percent from 2004, representing the highest number of filings on record. The dramatic surge in filings coincided with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S. 256), which was enacted on October 17, 2005.

Consumer bankruptcy filings for 2005 were 2,043,535, up from 1,552,967 in 2004. On an annualized basis, 1 in every 53 households filed bankruptcy. (Household numbers are based on 2005 estimates by the US Census.) Chapter 7 consumer filings, providing consumers with the greatest relief of their debts, increased 47.2 percent in 2005. Chapter 13 consumer filings, requiring consumers to repay a part of their debts, declined 7.9 percent.

Chris Lundquist, Founder of Lundquist Consulting, Inc., has over 15 years of experience in the bankruptcy industry, publishing high quality statistics and performing qualitative and quantitative studies on the subject. Lundquist Consulting statistics are quoted in research papers and media articles as well as used by government entities for policy planning and legislative support papers. Regarding the increase in 2005 filings, Mr. Lundquist stated, "The number of consumers seeking relief of their debts through bankruptcy was at an all time high in 2005, however, since the new law went into effect on October 17, relatively few consumers have used the new bankruptcy system. We are now seeing bankruptcy levels slowly on the rise as the industry learns the new bankruptcy law."

The total number of filings since the enactment of the legislation, on October 17, through December 31 was just over 38,000, representing fewer than 2.0 percent of all 2005 filings. Low filing numbers since the law's enactment can be correlated to the fact that many consumers filed earlier than they might have otherwise to take advantage of the old bankruptcy law. Since the enactment, the proportion of consumers filing Chapter 13 as compared to Chapter 7 has increased. Nearly 60 percent of all filings since October 17th have been filed as Chapter 13, as compared to about 30 percent historically under the old law. The new law requires consumers to be subjected to a "means test," requiring them to file Chapter 13 unless they meet certain debt and income requirements.

Growth in Consumer Bankruptcy Filings by Region (in percent)
Region 2005 : 2004
South (West) 26.8 : -0.1
South (East) 17.6 : -6.8
Pacific 34.3 : -10.6
Northeast 36.8 : -0.8
North Central (West) 42.4 : -2.8
North Central (East) 43.2 : -1.7
Mountain 32.3 : -0.6

All regions showed a significant increase in growth of filings for 2005.

The South (East) showed the smallest growth in filings at 17.6 percent, whereas the greatest increase was seen in the North Central (East) at 43.2 percent.

The rise in filings in North Central (East) was driven by Ohio, which increased 51.7 percent in 2005 and was ranked the second highest state in filing volume at 135,142.

The largest number of filings was found in California at 164,856, a growth of 35.9 percent from 2004.

The lowest filing growth was seen in South Carolina at 1.2 percent.

Smokey asks "If you're not helping people in the pre-foreclosure stage yet, now would be a great time to start."

California turns up the heat on small businesses

This is an update on a previous comment.

The California Franchise Tax Board is stepping up surveillance in response to pressure from the state's elected officials in Sacramento.

Check with your tax professional for details.

Smokey thinks that if you live in California, then the FTB wants you to register every company you own EVEN IF IT IS SOLELY DOING BUSINESS IN ANOTHER STATE. That way, the FTB can be sure that they can collect the $800+ every year as well as make sure that they can tax you on any income you make - from anywhere.

Don't forget - you need a good business reason to incorporate in a specific state. And avoiding taxes is not a good business reason.

The following is a copy of our previous post...

According to a recent article in the LA Times, California businesses are incorporating in Nevada, where there is no income tax. State officials call it fraud and vow a crackdown.“Forget complicated wire transfers to the Cayman Islands or secret Swiss deposit boxes. Californians who want to hide their money from tax authorities are increasingly opting for a simpler alternative: socking it away just over the state line. No need for savvy accountants or high-priced lawyers. Seminars, web casts and radio advertisements bray that it's easy to slash a California tax bill — or eliminate it altogether — by creating a corporation in Nevada, where there is no income tax on businesses or individuals. Set one up online with a few keystrokes and a $395 credit card payment! For a little extra, a Nevada mailing address, telephone number and bank account can be added. Promoters peddling the packages call it good tax planning. California officials call it something else: tax fraud. They say the cash-strapped state's coffers are being drained as even some of the smallest California businesses shift their profits into hastily created corporate shells in the Silver State.”“We want to catch this scam before it gets out of hand," said state Controller Steve Westly. "We think it will cost the state tens of millions of dollars if this continues.”Here is the full story.At Your Entity Solution, we don’t think that a Nevada Corporation is necessarily the only, or even the best answer to setting up a legitimate company structure that addresses your need to manage your tax burden and protect your assets from unwanted liability.Don’t forget – if it seems too good to be true, it usually is.Bye for now, time for a nap.Smokey Says - don’t take any rancid tuna.