June 2011 Archives

June 28, 2011
Posted by Michael Brooks

Be Careful About Your Charity of Choice- the IRS is Cracking Down on Nonprofits For Failing to File Form 990

In June 2011 the IRS announced that 275,000 nonprofit groups (around 18% of all nonprofits in the US) lost their tax-exempt status for failing to file the Form 990. The IRS Form 990 is the tax document that tax-exempt nonprofit organizations file each year with the IRS. The Form 990 (or (Form 990-N, 990-EZ, or 990-PF) allows the IRS and the public to evaluate nonprofits and how they operate.

Up until 2006, nonprofits with annual revenues under $25,000 generally did not have to file these informational returns. Generally speaking theses organizations didn't have much income and didn't pay large salaries. But under 2006 legislation, the rules changed. Now, even small nonprofits must file an informational return. And if they have failed to do so for three consecutive years (and plenty have failed), the IRS has now revoked their exemptions. The deadline for compliance was May 17, 2010. And sure enough, the IRS has now notified hundreds of thousands of small nonprofits (and the public via the IRS website) that their tax-exempt status was revoked.

The nonprofit sector is often overlooked in discussions of a state or the country's economy. But it's important to remember that this sector includes churches and many academic institutions and major foundations, as well as the familiar social-service agencies. In addition, they employ a significant amount of employees throughout the United Sates.

The non-compliant non-profits are now liable for paying taxes on any future revenue, and donations are no longer tax-deductible (DONORS NEED TO MAKE SURE THEIR NON-PROFIT OF CHOICE HAS NOT BEEN STRIPPED OF ITS TAX-EXEMPT STATUS). The complete "Automatic Revocation of Exemption List" for the state of California includes more than 33,000 organization names and addresses. It can be found on the IRS website (www.irs.gov). Locally, in Palm Desert for example, dozens of nonprofit groups lost their tax-exempt status.

The IRS recently released IRS Notice 2011-43, which provides transitional relief to small organizations which lost their tax-exempt status because they failed to file a Form 990 (or Form 990-N) for three consecutive years. The process for applying for retroactive reinstatement is similar to the application process for new organizations. Organizations that qualify for the transitional relief program are eligible for a reduced application fee. Further, Notice 2011-43 provides relief for organizations that have had their tax-exempt status automatically revoked but that do not qualify for small organization program. This is a welcome development because until now, there has been no clear process or procedure to request retroactive reinstatement. To qualify for retroactive reinstatement, such organizations must demonstrate that there was reasonable cause for failing to file a return or notice over the entire three year period.

In any event, now even small charities must go through the somewhat complicated and arduous process of become visible to the US government. The IRS is now watching.

June 22, 2011
Posted by Howard Sanger

Fiduciary Liablity For Unpaid Taxes -- Part III

6. WHEN CAN AN EXECUTOR BE PERSONALLY LIABLE TO THE IRS FOR A DECEDENT'S UNPAID TAXES?
Answer: The government can hold the executor personally liable for taxes the decedent owed to the IRS where because the executor pays creditors and beneficiaries, the estate lacks the funds to full-pay the IRS. Example: A decedent has unpaid taxes of $12. The decedent's estate has $10 in total assets. The executor distributes $3 to the estate beneficiary, and then pays the remaining $7 to the IRS. The law requires the executor to pay claims owed to the United States before paying most of the other of the decedent's debts. For purposes of the law, "debts" includes distributions to beneficiaries. Because the executor blundered when he distributed $3 to the beneficiary before paying/applying all $10 of estate assets to the IRS on account of the $12 of unpaid taxes, the executor is PERSONAL LIABLE to the IRS. In our example, the executor is personally liable for the amount of $3 (the amount he paid to the beneficiaries instead of paying the IRS). Note that the executor is not liable for the $5 of taxes remaining unpaid after (i.e. $12 owed the IRS minus the $7 of estate assets paid to the IRS), because the estate only had $10 from the outset, so the government could not expect the executor to pay more than $10. Since the estate had $10, and paid $7 to the IRS, the executor is personally responsible to pay $3 to the IRS. You will find the law at Section 3713 of title 31 of US Code (note §3713 is not an Internal Revenue Code section). There exist two important caveats to the general rule of an executor's personal liability, discussed in our next post.

7. IF THE ESTATE HAD SUFFICIENT ASSETS TO PAY ALL IRS TAXES, BUT BECAUSE THE ESTATE ASSETS' VALUE PLUMMETED AND THE TAXES COULD NOT BE PAID, IS THE EXECUTOR PERSONALLY LIABLE?
Answer: No. Example: A decedent has unpaid taxes of $12. When the decedent died, the assets were worth, $20. The economy suffered a depression and the estate assets dropped in value to $7. The executor pays the $7 to the IRS, leaving $5 of unpaid taxes. The executor is not personally liable to the IRS for the $5 because the law (§3713) only imposes personal liability where the executor paid other creditors or made beneficiary distributions which left the estate with insufficient funds to pay the entire $12 of taxes.

June 9, 2011
Posted by Michael Brooks

Canadian Snowbird Issues II- How Does A Foreign Citizen Become Subject To US Tax?

We are continuing with our series on how the US taxes non-US citizens who visit the US regularly. In the Palm Springs area for instance, we frequently see Canadians who maintain a local property for a good chunk of the winter months. For those Canadian citizens who are not lawful US residents, and do not have a green card, they must stay mindful of the amount of days actually spent in the US. An individual who establishes a "substantial presence" in the United States can make him or herself subject to US tax on their worldwide income (i.e., a potential tax on income of a foreign citizen which otherwise has no connection to the United States). An individual has a substantial presence in the US if the individual is present in the US at least 31 days during the current year and at least 183 days for the three-year period ending on the last day of the current year, using a weighted average approach. The mechanics of this test were discussed in Part I of this series. Even if an individual establishes a substantial presence in the US in a given year, that person can still avoid being subject to US tax by declaring a "closer connection" to a tax home in another country. To accomplish this, the foreign citizen individual must file a Form 8840 with the IRS (the "Closer Connection Exception Statement").

Even if the individual meets the substantial presence test, the individual can be treated as a nonresident alien (and not pay US tax on their worldwide income) if the individual:
1) is present in the United States for less than 183 days during the year;
2) maintains a tax home in a foreign country during the year, and
3) has a closer connection during the year to the tax home in the foreign country.

Tax Home The tax home of an individual is first and foremost the location of his regular place of business, employment or post of duty regardless of where the individual maintains his family home. If the individual is not engaged in any business, the visitor's tax home is his regular place of abode.

Closer Connection A frequent visitor to the US will be considered to have a closer connection to another tax home (e.g., Canada) if he maintains more "significant contacts" with the other country and not with the US. Other factors considered in making the closer connection determination include the location of the individual's main residence, where the person's family resides, personal belongings, routine banking activities and organizations to which he belongs.

An individual is not eligible for the closer connection exemption if any of the following apply:

1) The individual was present in the United States 183 days or more in the most recent calendar year.
2) The individual was a lawful permanent resident of the United States (a green card holder).
3) The individual has applied for, or taken other affirmative steps to apply for, a green card; or have an application pending to change your status to that of a lawful permanent resident of the United States.

The Closer Connection exemption is available only to those individuals who file the Form 8840 Closer Connection Exception Statement by June 15 for the previous calendar year. Again, the purpose of the Form 8840 is to demonstrate to the IRS that although an individual spent too much time in the United States so as to pass the "substantial presence" test, he or she should be exempt from US tax on their worldwide income because the person has a closer connection to a country other than the US. Part IV Form 8840 asks a series of questions designed test the closer connection assertion. The form asks questions such as: (a) where is your family located; (b) where is your automobile located and registered; (c) where is your driver's license issues, etc. These questions are likely easily answered favorably for the Canadian citizen who truly is merely a regular visitor to the US, but might have stayed a little too long.

June 6, 2011
Posted by Michael Brooks

Canadian Snowbird Issues I- How Does A Foreign Citizen Become Subject to US Tax?

Next, we start a series directed at snowbirds generally, specifically with an eye towards our Palm Springs/ Coachella Valley visitors who hail from Canada.

The United States taxes its citizens and residents on income they earn anywhere in the world ("worldwide income"). Non-US citizen or residents are only taxed in the US on income which is "effectively-connected" to a United States trade or business or on non-effectively-connected business income which is deemed to come from a "US source." Does this mean Canadian citizens who are deemed US residents will pay tax twice on the same income (once in Canada and once in the US)? Not necessarily. Canadian citizens resident in the US will generally receive a credit on their Canadian taxes for taxes paid in the US, but not always (so double tax is possible). If you are a Canadian citizen who is merely a frequently visitor to the area, you must be careful not to inadvertently be deemed a US resident.

Individuals who are not citizens of the US may be considered US residents for tax purposes (and therefore taxed on their worldwide income) if any of the following tests are met:

1) The individual has a green card;

2) The individual becomes a lawful permanent resident of the US; or,

3) The individual has a "substantial presence" in the US.

The substantial presence test is the test of which many frequent visitors to the US must be aware. An individual has a substantial presence in the US if the individual is present in the US at least 31 days during the current year and at least 183 days for the three-year period ending on the last day of the current year using a weighted average approach (the weighted average approach works as follows: the number of days spent in the US in the current year are given full weight; the number of days spent in the US in the last year are multiplied by 1/3; and the number of days spent in the US two years ago are multiplied by 1/6....add up the total for the three years and if it equals or exceeds 183 days, the nonresident alien has a substantial presence in the US. For example, an individual who spent exactly 124 days in the US this year and the previous two years would have a total of 187 days under the substantial presence test:

This Year: 124 x 1= 124

Last Year: 124 x 1/3= 42

2 Yrs Ago: 124 x 1/6= 21

Total= 187 days. Substantial presence test of 183 days exceeded...this person could be deemed a US resident, subject to tax in the US on their worldwide income).

Even if an individual satisfies the substantial presence test in a particular year, the individual can still avoid being considered a US resident if the individual is present in the US on fewer than 183 days in the current year, and the individual has a tax home in a foreign country to which the individual has a closer connection than to the United States (e.g., Canada). But for those who pass the substantial presence text and hope to avoid US taxes by declaring a closer connection to another country, that individual must file an IRS Form 8840.

More on this process to follow in Part II.

June 1, 2011
Posted by Howard Sanger

Fiduciary Liability For Unpaid Taxes -- Part II

4. CAN A PERSON BE RESPONSIBLE TO PAY THE DECEDENT'S UNPAID TAXES IF THE PERSON IS NOT THE COURT APPOINTED EXECUTOR?

Answer: Yes. IRC §2203 defines "executor" as the duly appointed executor or administrator, or if none has been appointed, then any person in actual or constructive possession of any property of the decedent.

5. IS THE EXECUTOR PERSONAL LIABLE FOR THE UNPAID TAXES OF THE DECEDENT?

Answer: Except is explained in Part III to-be-published next week, the answer is "no". The executor is not personally responsible for the decedent's unpaid taxes. The executor's duty to pay the decedent's taxes is in his representative capacity, using the decedent's estate assets, and not the executor's personal assets. Thus, if the decedent's unpaid taxes total $12, and the estate assets total $10, and the executor pays the $10 to the IRS, the executor in his personal capacity is not liable for the $2 of unpaid taxes; the executor's personal assets are not liable for the $2 of the decedent's unpaid taxes. However, a foolish or ill-advised executor could find himself personally liable and his personal assets taken by the IRS by a non-IRC provision: §3713 of 31 U.S. Code. See also Cal. Rev & Tax Code §19516.