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.
Friday, March 17, 2006
Thursday, February 09, 2006
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.
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.
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.
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.
Thursday, January 12, 2006
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."
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."
Wednesday, January 11, 2006
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.
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.
Thursday, December 22, 2005
Reasons NOT to invest in Real Estate
From a good friend, Dolf deRoos says,
"As the holiday season rounds the corner and you think about all the money you’ve spent on gifts this year, the last thing on your mind is spending even MORE money on an investment property. (If you did find one now, however, maybe next year for the holidays you could buy that sporty little BMW you had your eye on - as a gift for your significant other, of course!).
There are plenty of reasons not to invest, and we've heard them all, from "it’s the holidays" to "I’ll never find the great deals Dolf finds." But these are not valid reasons; they are just excuses. Dolf’s colleague, John Baen has provided us with some excuses why people do not invest. Here are the top five:
5. My Rich Aunt Gertrude is bound to leave me something in her will.
4. I can cash in those Coca-Cola collector’s bottles when it’s time to retire.
3. I am going to marry rich, so why make my own money?
2. I am bound to win the lottery someday, as I play every week!
We are not saying that these things won't happen, but your chances are only about .005%. If you think you are part of the .005%, stop reading this email and please buy US a lottery ticket.
And the number one reason not to invest in real estate is:
1. The interest rates are rising and the bubble is going to burst
Now, even though you’ve been hearing about the rising interest rates and the cooling market, this is actually beneficial in many ways to real estate investors, as explained in our recent report "How to Bubble Proof your RE Investments". Rising interest rates are useful to you as an investor because rising interest rates go hand-in-hand with inflation and appreciation. In other words, it helps to raise the value of a property. The amount you owe on the property will stay the same but the value of the property will have risen, resulting in an increase in equity.
That's all for tonight - gotta go check under the bushes for some presents.
Smokey
"As the holiday season rounds the corner and you think about all the money you’ve spent on gifts this year, the last thing on your mind is spending even MORE money on an investment property. (If you did find one now, however, maybe next year for the holidays you could buy that sporty little BMW you had your eye on - as a gift for your significant other, of course!).
There are plenty of reasons not to invest, and we've heard them all, from "it’s the holidays" to "I’ll never find the great deals Dolf finds." But these are not valid reasons; they are just excuses. Dolf’s colleague, John Baen has provided us with some excuses why people do not invest. Here are the top five:
5. My Rich Aunt Gertrude is bound to leave me something in her will.
4. I can cash in those Coca-Cola collector’s bottles when it’s time to retire.
3. I am going to marry rich, so why make my own money?
2. I am bound to win the lottery someday, as I play every week!
We are not saying that these things won't happen, but your chances are only about .005%. If you think you are part of the .005%, stop reading this email and please buy US a lottery ticket.
And the number one reason not to invest in real estate is:
1. The interest rates are rising and the bubble is going to burst
Now, even though you’ve been hearing about the rising interest rates and the cooling market, this is actually beneficial in many ways to real estate investors, as explained in our recent report "How to Bubble Proof your RE Investments". Rising interest rates are useful to you as an investor because rising interest rates go hand-in-hand with inflation and appreciation. In other words, it helps to raise the value of a property. The amount you owe on the property will stay the same but the value of the property will have risen, resulting in an increase in equity.
That's all for tonight - gotta go check under the bushes for some presents.
Smokey
Saturday, December 17, 2005
Fix and Flip
Well, here goes. As opposed to "buy and hold" rental properties, "fix and flips" need a different strategy.
Why? Rental generates passive income (no 15.3% self-employment taxes), while the short term capital gains that result from a flip can be termed earned or active income by the IRS. That adds the 15.3% employment taxes (ouch!) on top of the ordinary income taxes that you will pay.
Our alternative strategy focuses on reducing that 15.3% bite.
Definition:
1. A General Partner earns active income and holds all of the liability for a transaction.
2. A Limited Partner earns passive income and has no control or liability for a transaction (think shareholders)
Creative use of these facts provide the basis for a great strategy, and also let you selectively embrace the much maligned "Dealer Status".
Bye for now - more holiday shopping to do,
Smokey
Why? Rental generates passive income (no 15.3% self-employment taxes), while the short term capital gains that result from a flip can be termed earned or active income by the IRS. That adds the 15.3% employment taxes (ouch!) on top of the ordinary income taxes that you will pay.
Our alternative strategy focuses on reducing that 15.3% bite.
Definition:
1. A General Partner earns active income and holds all of the liability for a transaction.
2. A Limited Partner earns passive income and has no control or liability for a transaction (think shareholders)
Creative use of these facts provide the basis for a great strategy, and also let you selectively embrace the much maligned "Dealer Status".
Bye for now - more holiday shopping to do,
Smokey
Monday, December 12, 2005
What's a Professional?
Occasionally, the IRS uses phrases that have meanings that can be confused with popular usage. This is one of them.
A Real Estate Professional would be a Broker or a Realtor®, correct? Well, no.
It turns out that you don't need to be a Realtor® or anything like it. All you need to do is spend more time in real estate related activities than any other job, and at least 750 hours / year. So the real question is "What are real estate related activities?"
According to the IRS, a qualified real estate activity is any activity in which you “develop, redevelop, construct, reconstruct, acquire, convert, rent, operate, manage, lease or sell” real estate.
Details of these kinds of activities are illustrated in many places including Smokey's place.
This status has some incredible tax advantages, the most important of which is the ability to take unlimited paper losses on your real estate investments.
People who not meet the definition of a Real Estate Professional (according to the IRS rule) are limited to claiming a maximum of $25,000 losses per year and only if they make less than $100,000 per year. If you qualify, then you may be in a position to dramatically lower the amount of your taxes.
Some people can legally reduce their taxes all the way to ZERO!
A Real Estate Professional would be a Broker or a Realtor®, correct? Well, no.
It turns out that you don't need to be a Realtor® or anything like it. All you need to do is spend more time in real estate related activities than any other job, and at least 750 hours / year. So the real question is "What are real estate related activities?"
According to the IRS, a qualified real estate activity is any activity in which you “develop, redevelop, construct, reconstruct, acquire, convert, rent, operate, manage, lease or sell” real estate.
Details of these kinds of activities are illustrated in many places including Smokey's place.
This status has some incredible tax advantages, the most important of which is the ability to take unlimited paper losses on your real estate investments.
People who not meet the definition of a Real Estate Professional (according to the IRS rule) are limited to claiming a maximum of $25,000 losses per year and only if they make less than $100,000 per year. If you qualify, then you may be in a position to dramatically lower the amount of your taxes.
Some people can legally reduce their taxes all the way to ZERO!
Wednesday, December 07, 2005
LLCs and Rental Properties
Setting up an LLC (or other entity) provides you with the liability protection afforded by the law. Great!
But you bought the house in your own name, so you are still liable!!!
All you have to do is transfer the title from your own name into that of your LLC. Sounds simple doesn't it. In practice, it's not that complicated either. Take your deed or title that you got from the lawyer or title company at closing, and take your corporate minutes book to the county recorder's office and ask the clerk to help you transfer the title from your name(s) into the name of your LLC (or whatever). There is usually a fee involved (typically less than $30.00) for the paperwork.
And yes, before you ask, you need to go to the county where your property is located. If your LLC was established before you purchased the property, you should ask the lawyer or title company if they will do an "accomodation" at closing and do that transfer for you. If not, some people do offer a service so that you don't have to travel from your home to some far away place just to transfer the property (unless of course it happens to be somewhere warm in the winter).
Hope that helps. Now it's time to see how many ornaments I can knock off of the tree - yipee!
Smokey
But you bought the house in your own name, so you are still liable!!!
All you have to do is transfer the title from your own name into that of your LLC. Sounds simple doesn't it. In practice, it's not that complicated either. Take your deed or title that you got from the lawyer or title company at closing, and take your corporate minutes book to the county recorder's office and ask the clerk to help you transfer the title from your name(s) into the name of your LLC (or whatever). There is usually a fee involved (typically less than $30.00) for the paperwork.
And yes, before you ask, you need to go to the county where your property is located. If your LLC was established before you purchased the property, you should ask the lawyer or title company if they will do an "accomodation" at closing and do that transfer for you. If not, some people do offer a service so that you don't have to travel from your home to some far away place just to transfer the property (unless of course it happens to be somewhere warm in the winter).
Hope that helps. Now it's time to see how many ornaments I can knock off of the tree - yipee!
Smokey
Tuesday, November 22, 2005
Canadian transfer taxes
Thanks to one of Smokey's friends, we have a useful tool for all of you investor types.
"Hi Smokey - You have a great blog and I appreciate your focus on Canadian real estate and our market. Here is a tool that I use to calculate land transfer taxes when closing deals for my clients.
Canadian real estate calculator
All the best from Toronto, Kelly"
"Hi Smokey - You have a great blog and I appreciate your focus on Canadian real estate and our market. Here is a tool that I use to calculate land transfer taxes when closing deals for my clients.
Canadian real estate calculator
All the best from Toronto, Kelly"
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