May 2011 Archives

May 31, 2011
Posted by Michael Brooks

IRS Waives 60 Day IRA Rollover Requirement in Four Separate Scenarios

On May 27, 2011, the IRS, in four separate private letter rulings, "blessed" four fact patterns where it elected to waive the 60 day rollover requirement. Keep in mind, private letter rulings are directed only to the taxpayer who requested the ruling, and may not be used or cited as precedent (although as a practical matter practitioners use private letter rulings regularly as important guidance).

Backgound

Under IRC Section 408(d), an individual may rollover (and thereby avoid tax) a distribution from an IRA into an eligible retirement plan for the distributee's benefit within 60 days after the distribution. The term "eligible retirement plan" includes qualified pension, profit-sharing, stock bonus, and annuity plans, tax-deferred annuities under IRC Section 403(b), and eligible deferred compensation plans maintained by state and local governments and their agencies and instrumentalities. IRC Section 408(d) further gives the IRS the right to waive the 60 day requirement where events occur which are "beyond the reasonable control of the individual". In Revenue Procedure 2003-16, the IRS stated it will consider all relevant facts and circumstances in deciding when to waive the 60-day rollover requirement, including: (1) errors committed by a financial institution; (2) inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error; (3) the use of the amount distributed (for example, in the case of payment by check, whether the check was cashed); and (4) the time elapsed since the distribution occurred.

Four Separate Private Letter Rulings Allow a Waiver to the 60 Day Requirement

In each scenario described below, although well past the original 60 day rollover deadline, the IRS granted the taxpayer 60 days from the issuance of the ruling to properly contribute the amounts into an eligible retirement plan:

PLR 201121033- Financial advisor disregarded taxpayer instructions and improperly deposited amounts into a non-IRA account.

PLR 201121034- Financial advisor inadvertently set up an IRA for the benefit of the wrong person.

PLR 201121035- Involves a complicated fact pattern where a taxpayer failed to give proper rollover instructions within the 60 day period due to his deteriorating mental condition (he subsequently committed suicide) because of stress brought on by the weakening economy.

PLR 201121036- Financial advisor disregarded taxpayer instructions and improperly deposited amounts into a non-IRA account.

May 26, 2011
Posted by Michael Brooks

CPA Changes Return After Taxpayer Signs It; IRS Nullifies Return

In Program Manager Technical Advice 2011-013, the IRS determined that a tax return that was altered by a CPA without the taxpayer's knowledge was a "nullity" because the amount of the claimed chartible deduction was unknown and unverified by the taxpayer. In the stated facts, a CPA provided his client a copy of his return which was signed by the taxpayer. However, subsequent to the client signing the return, the CPA changed the return by increasing the amount of charitable contributions.

Background

The general test for establishing a valid return was outlined in Beard v. Com., 58 AFTR 2d 86-5290 , where the Sixth Circuit, affirming the Tax Court, held that for a document to constitute a valid return, it must:
• contain sufficient data to calculate tax liability;
• purport to be a return;
• be an honest attempt to satisfy the requirements of the tax law; and;
• be executed under penalty of perjury.

Conclusion

Since the signed and verified return was not the document that was sent to the IRS, and the taxpayer was not aware of the amended charitable contribution amount added in by the CPA, the taxpayer did not execute his return under penalty of perjury. Thus, the signature requirement was not met, and the document did not constitute a return. The IRS determined that since the fraudulently altered return was a nullity, the affected taxpayer is treated as if no return has been filed. Therefore, the taxpayer whose return was fraudulently altered shouldn't file a Form 1040X. Instead, the taxpayer should file an accurate Form 1040. Finally, the IRS noted that since no return was filed, no accuracy-related or civil fraud penalties could be imposed against the taxpayer. However, criminal fraud penalties under could potentially apply.

May 24, 2011
Posted by Michael Brooks

2010 California New Home Homebuyers, There's Still Time to Claim Your Credit

Background: California's "New Home / First-Time Buyer" tax credits are available for taxpayers who purchased a qualified principal residence on or after May 1, 2010, and before January 1, 2011. Additionally, these tax credits are available for taxpayers who purchase a qualified principal residence on or after December 31, 2010, and before August 1, 2011, pursuant to an enforceable contract executed on or before December 31, 2010. Both credits are limited to the lesser of 5 percent of the purchase price or $10,000 for a qualified principal residence. Taxpayers must apply the total tax credit in equal amounts over 3 successive tax years (maximum of $3,333 per year) beginning with the tax year in which the home is purchased. Note, however, the total amount of allocated tax credit for all taxpayers may not exceed $100 million for the New Home Credit and $100 million for the First-Time Buyer Credit.

New Home Credit: A qualified principal residence, for purposes of the New Home Credit, must:
Be a single family residence, either detached or attached. This can be a single family residence, a condominium, a unit in a cooperative project, a house boat, a manufactured home, or a mobile home. A home constructed by the taxpayer is not eligible since the home has not been "purchased."
Have never been occupied. Sellers must certify that the home has never been occupied in order for a taxpayer to receive an allocation of the credit.
Be eligible for the California property tax homeowner's exemption.
Be occupied by the taxpayer as their principal residence for a minimum of 2 years immediately following the purchase.

Update: As of March 24, 2011, the First-Time Buyer Credit was fully allocated. However, the California Franchise Tax Board (FTB) has issued an update on the New Home Credit. As of May 17, 2011, the FTB has numerous reservation requests and applications, but has not yet received sufficient applications to allocate the full $100 million. Claimants should continue using the 2010 forms for homes purchased pursuant to an enforceable contract in 2010, but closing in 2011. Taxpayers who applied for the New Home Credit for a purchase that closed escrow in 2010 and have not yet received a determination from the FTB, may either: get an extension to file their tax returns (to avoid penalties and interest, compute and pay any balance due as if their application will not be approved) or file now, but do not claim the credit (if their application is approved, they may then file an amended return).

May 23, 2011
Posted by Howard Sanger

Fiduciary Liability For Unpaid Taxes -- Part I

1. MUST AN EXECUTOR FILE A DECEDENT'S FINAL INCOME TAX RETURNS?
Let's say you act as an executor for a decedent who died in 2011. The decedent died before filing his 2010 personal income tax return. Must you, as executor, file the decedent's 2010 personal income tax returns? Answer: Yes. IRC §6012(b)(1) provides that if a decedent dies before filing his personal income tax return, the responsibility to file the income tax return falls upon his "executor, administrator, or other person charged with the property of such decedent."

2. MUST AN EXECUTOR FILE A DECEDENT'S GIFT TAX RETURNS?
Let's say you act as an executor for a decedent who died in 2011. The decedent died before filing his 2010 gift tax return for gifts made in 2010. Must you, as executor, file the decedent's gift tax returns? Answer: Yes. Treasury Regulation §25.6019-1(g) places the responsibility for filing the decedent's gift tax return on the executor or administrator.

3. MUST AN EXECUTOR PAY THE DECEDENT'S PRE-DEATH TAXES?
Must the executor also arrange for the payment of the decedent's pre-death income and gift taxes? Answer: Yes. California Probate Code § 11420(a) sets out the priority of payments an executor must make. California Probate Code § 11420(a) provides that debts of the United States or California have preference and the executor must pay such debts first. In the case of the gift tax, Treasury Regulation §25.2502-2 makes the executor responsible to arrange for payment of the gift tax.

May 18, 2011
Posted by Michael Brooks

The Latest Tax Court Pronouncement on Employee vs. Independent Contractor

In Donald T. Robinson (TC Memo 2011-99), the Tax Court ruled that a full-time college professor at University A, who also taught classes and prepared curricula for University B, should have been classified by University B as an independent contractor, and not an employee.
IRC Section 3121(d)(2) defines "employee", for employment tax purposes, as "any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee." But what does that mean? Factors considered by courts in determining whether an individual is an employee or independent contractor include:
(1) the degree of control exercised by the principal;
(2) which party invests in the work facilities used by the worker;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship;
(7) whether the worker is paid by the job or by the time;
(8) the relationship the parties believed they were creating; and
(9) the provision of employee benefits.
The Tax Court concluded that the professor was an independent contractor. Why? Because University B exercised little control over the professor's work. Also, the professor did not have an office at University B; the professor was free to market his services to other businesses; and University B did not provide the professor any employee benefits.
This is a good opportunity to remind ourselves of the relevance of the employee versus independent contractor distinction in the employment tax setting. Subject to a base limit, the compensation of every employee is subject to FICA taxes (commonly called social security taxes). Further, IRC Section 3102(a) requires employers to withhold FICA taxes from an employee's pay. If the employer fails to withhold the tax, it is still liable for payment of the tax. In addition, the employer must also pay a matching FICA tax equal to the employee portion of the tax. Lastly, a federal unemployment tax (FUTA ) is assessed on employers on all "wages" paid in a calendar quarter, although frequently employers never actually pay federal unemployment taxes due to credits they receive for payment of state unemployment taxes. An independent contractor (or self-employed person), on the other hand, pays for his or her own social security in the form of self-employment taxes (SECA). A self-employed person pays an amount equal to the employee portion plus the employer portion of employment taxes.
The IRS frequently targets employers for the FICA taxes of workers the employer classifies as independent contractors but the IRS believes are truly employees. The lesson for employers seeking to avoid this problem: review the factors listed above, treat your workers in the most independent contractor-like fashion possible, and always consult your attorney!

May 17, 2011
Posted by Michael Brooks

Can I Avoid the 6 Year Tax Assessment Statute By Filing a More Accurate Amended Return?

In a recently issued Chief Counsel Advice (CCA 201118020), the IRS addressed the issue of whether a taxpayer who omits over 25% of gross income on the original tax return, but then files an amended return showing additional income (putting the omission, if any, below 25%) within 3 years, precludes the IRS from assessing the income tax liability over the original 6 year statute of limitation period.
Before addressing CCA 201118020, we should remind ourselves of the general statutes of limitation governing the assessment of tax liability. Under IRC Section 6501(a) , a valid assessment of income tax liability generally may not be made more than 3 years after the later of: (a) the date the tax return was filed or (b) the due date of the tax return. However, under IRC Section 6501(e) , a severe 6-year limitations period applies when a taxpayer non-fraudulently omits from gross income an amount that is greater than 25% of the amount of gross income stated in the return.
In CCA 201008020, the Chief Counsel addressed a scenario where a taxpayer omitted greater than 25% of the amount of gross income stated in the return, subjecting him to the 6 year statute; but within the first 3 years thereafter the taxpayer amended his return so that he had no longer omitted greater than 25% of the gross income. Should the original 6 year IRC Section 6501(e) statue still apply, or is the 3 year IRC Section 6501(a) statute now applicable? The answer is, unfortunately, the 6 year statute continues to apply. The CCA concludes that the filing of an amended return showing additional income doesn't preclude the IRS from applying IRC Section 6501(e)'s 6-year period. However, the CCA emphasized that the IRS should assess additional tax and issue deficiency notices within IRC Section 6501(a)'s 3-year period whenever possible, even if it determines that the 6-year period applies.

May 17, 2011
Posted by Michael Brooks

Ninth Circuit Reminds Us To Be Careful With Transfers To Family Limited Partnerships

Why do individuals wish to transfer assets to family limited partnerships? The answer is simple: if the assets are held by the family limited partnership, then they're not held in the estate (i.e, less amounts subject to the estate tax). IRC Section 2036 provides generally that an individual's gross estate includes property the decedent transferred during his life if he retained for life the possession or enjoyment of the property, or the right to the income from the property. But no inclusion is required if the transfer was a bona fide sale for an adequate and full consideration in money or money's worth. And further, the transferee (the family limited partnership) must be respected as legitimate. The family limited partnership must be run as a legitimate business, with annual meetings, regularly maintained books and records, and active business activities.
In Estate of Erma v. Jorgensen ((2011, CA9) 107 AFTR 2d ¶ 2011-793 ), a decedent transferred marketable securities to her family limited partnership which held passive investments only and did not maintain books and records. Further, while still alive, the decedent wrote personal checks from the family limited partnership accounts. Before the US Tax Court, the estate claimed that the transfers of securities were bona fide sales for full and adequate consideration (the family limited partnership interest), and that they should not be included in her estate under IRC Section 2036. The Tax Court disagreed, and the Ninth Circuit affirmed the decision of the Tax Court (citing it appeared the amounts transferred to the family limited partnership could be accessed for the personal needs of the decedent at any time).
The key lesson, as noted by the Ninth Circuit: transfers to family limited partnerships are subject to heightened scrutiny; careful planning and attention to detail are a must.

May 6, 2011
Posted by Michael Brooks

Update on Form 8939

As discussed in previous entries, the IRS recently released a draft Form 8939, for decedents who died in 2010 and wish to elect no estate tax (which comes with no basis step-up in assets). We think that only estates of very wealthy 2010 decedents will likely wish to file a Form 8939. But where is the final Form 8939? How can we file it if it does not exist? On March 31, 2011, the IRS issued the following statement: "Form 8939 is not due on April 18, 2011, and should not be filed with the final Form 1040 of persons who died in 2010. New guidance that announces the form due date will be issued at a later date and Form 8939 will be released soon after guidance is issued." While that provided some relief for practitioners left completely in the dark about how to file a nonexistent Form 8938 by the filing deadline, it still leaves us all waiting for the final Form 8939. We don't have much more to add, except that we are all...still waiting.