May 14, 2012
Posted by Sanger & Manes, LLP

How Do I Sell My House, Buy Another, and Not Pay Tax?...Let's See Some Examples:

Let's do some basic (and not so basic) 1031 examples. Again, before we start, remember that in addition to a rising real estate market (no sure thing the last few years, although in the Palm Springs area we might finally be turning the corner), in order to qualify for 1031 you need property either: held for (a) investment or (b) productive use in a trade or business.
Also remember vacation homes are unlikely to qualify as either: held for (a) investment or (b) productive use in a trade or business, unless the owner or the owner's family uses the vacation house not more than 14 days a year. A property used as rental property will qualify for Section 1031 because the IRS deems rental properties as held for productive use in a trade or business.

Basic 1031 Examples

Here's a basic example (1): Tom purchases a Palm Desert house in 2001 for $500k. Tom sells it in 2006 for $1,000,000. Shortly thereafter in 2006, Tom purchases an Indian Wells home for $1,000.000. In 2012, Tom sells the Indian Wells home for $1,250,000. Assuming the Section 1031 requirements met, Tom's taxable income in 2006 is $0, and Tom's taxable income in 2012 is $750,000.

When the taxpayer receives cash in the transaction, the taxpayer must recognize gain (at least to the extent of the cash received).

Basic example (2):
Tom exchanges real estate held for investment (i.e., the general rule is he or his family uses it not more than 2 weeks a year), which he purchased in 2000 for $500,000 which now (in 2012) has a fair market value of $800,000, for other real estate (to be held for productive use in a trade or business) worth $600,000, and $200,000 in cash. The gain from the transaction is $300,000 (Tom bought a property for $500,000 and is now exchanging it for a new property worth $600,000 plus $200,000 in cash), but the $300,000 gain is only recognized to the extent of the cash received: $200,000. Tom must recognize $200,000 in 2012 when he engages in the exchange.

And let's do one more example (with a little more complexity, including two assets transferred (only one of which qualifies under 1031)), plus the question of what is the basis in the new property:

Basic example (3): In 2007, Tom transfers real estate he used exclusively as a rental property which he purchased in 2002 for $1,000,000 in exchange for other real estate (to be held as rental property) which has a fair market value of $900,000, an automobile which has a fair market value of $200,000, and $150,000 in cash. Tom realizes a gain of $250,000 (bought property in 2002 for $1,000,000 and sold it in 2007 for property plus a car plus cash all worth $1,250,000). Tom must recognize (ie pay tax on) the entire $250,000 gain because he received items other than another real property (the car plus the cash) worth a total of $350,000. The basis of the new rental property received in exchange is the basis of the transferred real estate ($1,000,000) decreased by the amount of money received ($150,000) and increased in the amount of gain that was recognized ($250,000), which results in a basis for the property received of $1,100,000. This basis of $1,100,000 is allocated between the automobile and the real estate received by Tom. The basis of the automobile must remain its fair market value at the date of the exchange- $200,000, with the basis of the real estate received being the remainder: $900,000. So at the end of the transaction, the basis in new property is only $900,000 ($100,000 less than the basis in the old property).

April 14, 2012
Posted by Sanger & Manes, LLP

How Do I Sell My House, Buy Another, and Not Pay Tax?

We're taking a break from speaking about the FBAR amnesty program (we will return to this topic shortly), but were going to continue to parallel (for now) our Canadian Snowbird Blog. So the topic at hand is how do I sell my house (we're assuming the house has gone up in value), buy a new house, and not pay tax? Let's assume, for the sake of discussion, that I sell a La Quinta home which has appreciated in value by $500,000 since I bought the house in 1997.

Question #1- Can I sell the house in La Quinta (for $500k more than he bought it for) and buy the Palm Desert replacement property without paying any US tax?
The general answer is yes. Internal Revenue Code Section 1031allows me to exchange, tax free, US real property for other US real property, if several requirements are met.

Question #2- What are the general requirements for a Section 1031 exchange?
In order for me the taxpayer to exchange real property for other real property, and not pay tax:
A) The Property must be exchanged for "like-kind" property. "Like-kind" simply means that real property must be exchanged for real property. But Section 1031 also mandates both the relinquished property and the replacement property must be held for productive use in a trade or business or for investment. Thus, I cannot exchange into or out of my own personal residence, because that is not deemed held for productive use in a trade or business or for investment. Vacation homes may qualify if they are rented out to unrelated persons, or held primarily for investment rather than personal use. For example, in the 2007 case of Moore v. CIR, the Tax Court held that an exchange of vacation homes did not qualify for nonrecognition under § 1031(a)(1) because neither home was held for investment: "the mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence." Subsequent to the Moore case, the IRS issued Rev. Proc. 2008-16, which provides vacation properties may qualify for a 1031 if:
(a) The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange; and
(b) Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange,
(i) The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and
(ii) The period of the taxpayer's personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.
In addition, the replacement property must meet the same requirements for the two years after the exchange (i.e., must be rented out and not used too much for personal use). So if I have a vacation home for (primarily) personal use, I will have a difficult time taking advantage of Section1031 tax free exchange treatment.
B) It's not as simple as selling my property one day (let's assume for a gain), and buying a replacement property down the road, and not paying tax on the gain. First, the replacement property must be identified not later than 45 days after the sale of the first property. What does it mean to indentify a property? You identify a property in writing, giving the writing to an independent party (a qualified intermediary). Second, the replacement property must be received not later than 180 days after the sale.
We'll pick it up here in our next post, reviewing some examples of how the tax treatment works....

February 16, 2012
Posted by Sanger & Manes, LLP

US Tax Residents- Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program, But It's Tricky (Part II)

We're speaking about US citizens or residents (and US tax residents can be citizens of any country who happen to stay in the US too long in a given year, this could be citizens from any country outside of the US who may visit Palm Springs, or Rancho Mirage or Palm Desert long enough for a given year that they are deemed a US tax resident; we are also speaking of citizens of foreign countries who are US green card holders). US citizens and residents must declare to the Department of Treasury their foreign bank accounts (provided they have over $10,000 in aggregate foreign bank accounts/ assets...not a high bar). They must file these information returns (called "FBARs") by June 30 of each year. Many US citizens and tax residents (particularly those who are current or former citizens of another country) are unaware of the FBAR requirement, which was enacted in 2003. That is why the IRS amnesty programs can be so valuable. In 2012, the IRS is again offering a FBAR amnesty program. This is the third such amnesty program. There is no guarantee there will be a fourth.

Structure of the IRS Amnesty Program
Although the IRS has yet to provide (much) specific guidance on the 2012 amnesty program, it will almost certainly follow the framework provided in the 2011 program. So it makes sense to review generally the 2011 program (the "OVDI Program"). Taxpayers who made voluntary disclosures under the 2011 OVDI Program could expect the following penalties/payments:

Path One- the No Questions Asked Path requires the taxpayer to pay 27.5% (for the 2012 program...under the 2011 OVDI Program it was only 25%) of the highest aggregate overseas account balance in the highest year. So if the aggregate overseas account balance in the highest year (when the individual did not file a FBAR) was $2,000,000 (and by the way, when we say highest aggregate overseas account balance we are including the value of overseas assets- such as a house- plus the value of overseas accounts), the individual is volunteering to pay a penalty to the IRS of $550,000 (27.5% x $2,000,000), plus the unpaid income tax (if any), plus penalties for failure to file or pay income tax (if any). So, under Path One, the easy/no risk path, the individual with undeclared overseas accounts (and assets) of $2,000,000 must pay a penalty of $550,000 at an absolute minimum...THIS IS A STIFF AMNESTY PENATLY!!!

Path Two- Opt Out of the 27.5% No Questions Asked Penalty, and Ask the IRS for a Lesser Penalty Path Ahh, this sounds better. Let's ask for a lower penalty than the 27.5% general amnesty penalty (which required a payment of at least $550,000 for a $2,000,000 overseas aggregate account balance above). But here's the catch: you can ask the IRS for a lesser penalty, and they might agree (and the individual might end up owing almost nothing to the IRS)...on the other hand, under Path Two, if the IRS doesn't agree, they can take every penny of your overseas aggregate account balances!!! Quite a gamble under Path Two.

More on the Path Two, and the decision making process which an individual must undertake when deciding between Path One and Two (or not taking part in the amnesty program at all) Part III of this series coming up.

February 6, 2012
Posted by Sanger & Manes, LLP

US Tax Residents- Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program, But It's Tricky (Part I)

In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative ("OVDI"). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents must file a "FBAR" (a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

2012 Program Will Likely Be Similar to the 2011 Program

Although the IRS has yet to provide details, it's a fairly safe assumption that the 2012 will look very similar to the 2011 OVDI Program. So, for taxpayers who went through the 2011 OVDI Program, what were the penalties?

Non-Willful Failure to File a FBAR

The general penalty for a "non-willful" failure to file a FBAR for a given year is $10,000 per year.

Willful Failure to File a FBAR
A willful failure to file a FBAR is far more significant. In the case of a willful failure to file a FBAR, the penalty can be as high as 50% of the aggregate balance of the overseas account(s) per year. This is steep. Let's look at this example published last year by the IRS in their 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers (Q&A 8):

We start with an account balance in 2002 or $1,000,000

Year Interest Income Account Balance
2003 $50,000 $1,050,000
2004 $50,000 $1,100,000
2005 $50,000 $1,150,000
2006 $50,000 $1,200,000
2007 $50,000 $1,250,000
2008 $50,000 $1,300,000
2009 $50,000 $1,350,000
2010 $50,000 $1,400,000

If the taxpayers didn't come forward, when the IRS discovered their offshore activities, and the IRS deemed the failure to file "willful", they would face up to $4,543,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayers would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution.

The civil liabilities outside the 2011 Offshore Voluntary Disclosure Initiative potentially include:

FBAR penalties totaling up to $4,375,000 for willful failures to file complete and correct FBARs (2004 - $550,000, 2005 - $575,000, 2006 - $600,000, 2007 - $625,000, 2008 - $650,000, and 2009 - $675,000, and 2010 - $700,000),

So, if the IRS deemed the failure to file a FBAR was willful in this case, the IRS could impose a penalty of $4,543,000, even though the taxpayer's account was only as high as $1,400,000 (i.e., the penalty is 3 times higher than the highest overseas aggregate account value)!!!

We discuss what constitutes a willful failure to file, and what the 2012 amnesty program offers taxpayers, in future posts. But the key take-away for US citizen/residents with foreign bank accounts is: you better participate in the 2012 amnesty program, because the possible penalties for not filing FBARs are huge.

December 28, 2011
Posted by Sanger & Manes, LLP

California Taxpayers: Failed to File a Gift Tax Return for a Property Transfer to a NonSpouse Relative From 2005-2010? The State of California is About to Tell the IRS All About It

A district court has now granted the IRS permission to issue a summons to the State of California Board of Equalization, as part of a gift tax enforcement initiative to detect transfers of real property between nonspouse relatives that weren't reported on gift tax returns. California now joins Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin, as states where the state governments must turn over records about property transfers to the IRS. If you transferred property to nonspouse relatives and did not complete the appropriate gift tax return, the State of California may be on the verge of telling the IRS all about you.

Gift Tax Background
Intra-family transfers of property are extremely common. Remember that in 2011, decedents can exclude up to $5 million of their estate before having to pay estate tax on the remainder. Likewise, in 2011 individuals can "gift" up to $5 million and not pay a tax on the gift amount (the Internal Revenue Code therefore "unifies" the estate tax and the gift tax.) However, any individual who makes gifts to any one donee during a calendar year above the $13,000 annual exclusion must file a gift tax return (an IRS Form 709). A return must be filed even if no tax is payable (due to the $5 million lifetime exclusion).

When the IRS issues a Summons to the State of California, what Information can it Gather about You?
With a summons served upon the state of California, the IRS can uncover transfers of real property to nonspouse family members. How? Property transfers in California generally constitute a "change in ownership" so that the county assessor may reassess a property for property tax purposes. Absent a change in ownership, the state may only increase a California property owner's taxes by 2% per year. In order to claim an exclusion from the change in ownership reassessment rule, California taxpayers must file Forms BOE-58-AH (Claim for Reassessment Exclusion for Transfer Between Parent and Child) or BOE-58-G (Claim for Reassessment Exclusion for Transfer Between Grandparent and Grandchild). These forms are filed with the local county assessor's office. California property owners are generally very diligent about completing these forms, because they do not want their property reassessed for fear of considerably higher property taxes. The state of California maintains a statewide database of the information garnered from these forms. And now the IRS has access to the Forms BOE-58-AH and BOE-58-G filed by California transferors of property (to relatives) seeking to avoid a reassessment of the property.

California tells the IRS of the Property Transfer, now the IRS is Looking for The Transferor's Form 709
The rest is relatively simple. The state of California allows the IRS to review the Forms BOE-58-AH and BOE-58-G, and the IRS simply follows up by seeing whether that individual completed a Form 709 (and paid gift taxes, if appropriate). IRS survey results concluded that at least 50% and up to 90% of individuals who transferred property to nonspouse family members failed to file a Form 709.

California residents- if you transferred property since 2005 to a nonspouse family member, and you should have filed a Form 709 and didn't (and didn't pay the appropriate gift tax, if any), go file it now. Because there is a very good chance the IRS is going to find this out anyway, and the penalties of their discovering your lack of compliance will be much worse if you have not already rectified the situation.

December 23, 2011
Posted by Sanger & Manes, LLP

Tax Court: Professional Gamblers Can Deduct More on Their Tax Return Than Recreational Gamblers

Visitors to the Coachella Valley often spend some time at our local casinos: such as the SPA Casino in Palm Springs or the Agua Caliente Casino in Rancho Mirage. When the gambler has a single win of at least $1,200, the casino is required by law to issue the big winner a W-2G, which notifies the IRS of the win (great, thanks a lot casino). The Internal Revenue Code does allow a taxpayer to deduct gambling losses from gambling winnings (but not below zero) on an annual basis, but as we've discussed before, proving gambling losses can be difficult. After all, unlike the big win, the casino never notifies the IRS when the gambler has a big loss. The IRS has traditionally accepted a daily log or journal kept by the taxpayer detailing the gambling activity of the day as proof of gambling losses, but how realistic is keeping a daily journal? In our high-tech modern era, the best evidence a taxpayer can use to show the IRS that he or she was, in fact, a big loser (and not a big winner) is the casino issued "players card". The card allows the casino to electronically track the individual's gambling winnings and losses. This serves as excellent evidence when proving gambling losses to the IRS. So gamblers, always get and use the casino issued player's card, because the day might easily come when you need to prove your gambling losses to the IRS.

Special Rules For Deductions of "Professional Gamblers"

As discussed above, the Internal Revenue Code permits individuals to deduct gambling losses to the extent of gambling winnings (but not below zero). But here we're talking about gambling loses (i.e., wagering losses). What about expenses incurred in gambling? Can an individual who gambles for a living deduct gambling expenses just like a regular business expense (the rest of us seem to be able to deduct our business expenses)? If so, does the amount of gambling winnings have any bearing on the amount of expenses the professional gambler may deduct?

The US Tax Court addressed theses issues in the recent case of Mayo v. Commissioner, 136 TC 81 (2011). In that case, the taxpayer in question was in the business of "gambling on horse races"(i.e., a professional gambler). Although a facts and circumstances test, a professional gambler is generally one who gambles for profit, and not for recreation. The taxpayer in the case had substantial losses from the gambling on races, but the taxpayer also had significant expenses associated with the gambling activity. Such "business" expenses included meals, telephone costs, horse racing periodicals and admission fees into the horse racing grounds. If the taxpayer were allowed to deduct his total gambling losses and expenses, the total deduction would, in fact, exceed his total gambling winnings on the year.

The Tax Court held that these amounts may be deducted by the professional gambler. So gamblers with heavy losses and expenses are far better off classifying themselves as professional gamblers than recreational gamblers. This categorization permits the individual to deduct gambling losses (up to the amount of gambling winnings, as with any gambler), and expenses associated with gambling (below the gambling winnings threshold...fantastic!).

September 30, 2011
Posted by Sanger & Manes, LLP

IRS Announces New Amnesty Program For Employers Who Have Improperly Classified Employees as Independent Contractors

In Announcement 2011-64, the IRS developed a new program to permit employer/ taxpayers to voluntarily reclassify workers as employees for employment tax purposes. And the penalty for compliance: a mere 10% of the employment tax liability that would have been due for the last year (plus the promise to the classify the individuals as employees going forward)!

Recall the importance of how an employer classifies its workers. 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.

Who's an employee and who's an independent contractor? It comes down to a review of factors, including:

(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.

To be eligible for the program, called the Voluntary Classification Settlement Program ("VCSP"), an employer must: (1) consistently have treated the workers in the past as nonemployees; (2) have filed all required Forms 1099 for the workers for the previous three years; and (3) not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers. No interest or penalties will be due (there will be the 10% employment tax liability for the previous year), and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. The IRS retains discretion whether to accept a taxpayer's application under the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS.

July 13, 2011
Posted by Sanger & Manes, LLP

Tax Court Says Downturn in the Economy is an Acceptable Reason For Penalty Abatement on Failure to Deposit Employment Taxes? No Kidding.

On July 5, 2011, in the case of Custom Stairs & Trim, LTD., v. Commissioner (TC Memo 2011-155), the US Tax Court addressed the issue of what circumstances constitute "reasonable cause" for the purpose of abating a penalty for an employer's failure to deposit employment taxes in a timely manner. Does a downturn in the economy constitute reasonable cause? Some may find the result surprising.

Federal law requires employers to withhold taxes from its employees' paychecks. Each time the employee pays wages, it must withhold - or take out of its employees' paychecks - certain amounts for federal income tax, social security tax, and Medicare tax (these taxes are termed "employment taxes"). Further, an employer must file a quarterly Form 941 reporting the wages it paid to its employees for the previous quarter. The IRS Form 941 includes totals for: (a) the number of employees and total pay for the period being reported; (b) amounts withheld from the pay of employees for the period; (c) taxable Social Security and Medicare wages for the period; and (d) calculation of total Social Security and Medicare wages. The form requires a calculation of the total taxes and the total deposits (from the employer to the government) made during the period. Beginning January 1, 2011, an employer deposits all depository taxes (such as the employment tax) electronically by electronic funds transfers.

IRC Section 6656 imposes penalties on late deposits of the employment tax (of 2 to 15% on the amount of tax, depending on the lateness of the deposit). Under IRC Section 6656(a) and Rev Proc. 2001-58, however, the IRS may abate the penalty if it determines there exists "reasonable cause" to do so.

Does a Downturn in the Economy Constitute "Reasonable Cause"?
In Custom Stairs & Trim, LTD., v. Commissioner, the employer failed to make certain employment tax deposits. As a consequence, the IRS imposed a penalty under IRC Section 6656- Failure to Make Deposit of Taxes. The issue before the US Tax Court was whether the company's failure to make the deposit of taxes was attributable to reasonable cause, so that the penalties should be abated. As a reason for failing to make the deposit for the 2nd quarter of 2008, the company cited the effects of the economic recession. It noted it had been forced during this time to lay off employees, eliminate vacations and reduce employee benefits. The company stated it simply did not have enough money to deposit the taxes for that quarter and meet its other crucial operating expenses. The company did deposit taxes during that time it owed for a previous quarter for which it was in arrears. The IRS responded, in turn, that it never constitutes reasonable cause (for the purposes of abating penalties) to pay other creditors before the IRS.

In its decision, the Tax Court noted that in the 2nd, 3rd, 7th and 9th circuits (the 9th circuit is California's circuit) the courts have opined that financial hardship, under certain circumstances, can constitute reasonable cause. The Tax Court stated reasonable cause will be found if the taxpayer "exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship." In determining whether the taxpayer exercised ordinary business care and prudence, "consideration will be given to all the facts and circumstances of the taxpayer's financial situation, including the amount and nature of the taxpayer's expenditures in light of the income. Primary factors in determining whether a taxpayer exercised ordinary business care are: (1) the taxpayer's favoring other creditors over the Government, (2) a history of failing to make deposits, (3) the taxpayer's financial decisions, and (4) the taxpayer's willingness to decrease expenses and personnel."

Because the company did actually make deposits during the 2008 quarter (albeit, for amounts due from prior periods, and not the actual amounts due for the 2nd quarter of 2008) the Tax Court reasoned the company was not paying other obligations instead of its obligation to the IRS. That fact coupled with the economic downturn (including proof that the company cut benefits and payroll and was attempting to sell some of its real property) satisfied the Tax Court, which ruled that the company exercised ordinary business care, and that the IRS must abate the company's penalties for failure to deposit the employment taxes for the second quarter of 2008.

Include your author as one of the surprised.

July 7, 2011
Posted by Sanger & Manes, LLP

Tax Court Decision Offers a Refresher on Definition of Chronically Ill Individual for Deducting Long-Term Care Expenses

On July 7, 2011, the US Tax Court, in Estate of Lillian Baral (137 T.C. No. 1), the Tax Court offered a good refresher on the fundamentals of deducting long-term medical costs for those who qualify as "chronically ill".

The opinion walks through a series of particular and critical definitions for this process.

The general rule of deductibility, provided under IRC Section 213, is that certain expenses paid during the taxable year for the medical care of the taxpayer or a dependent that are not compensated for by insurance or otherwise may be deducted to the extent that the expenses exceed 7.5 percent of the taxpayer's adjusted gross income.

"Medical Care", under IRC Section 213, includes amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, and amounts paid for qualified long-term care services.

"Qualified long-term care services", under IRC 7702B, means necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, and rehabilitative services and maintenance or personal care services required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.

A "chronically ill individual" means any individual who has been certified by a licensed health care practitioner as meeting one of three tests: (1) being unable to perform at least two of six specified activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of at least 90 days due to a loss of functional capacity ("the ADL level of disability"); (2) having a level of disability similar to the ADL level of disability as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services ("the similar level of disability"); or (iii) requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment ("cognitive impairment").

Finally "licensed health care practitioner" is a physician, registered professional nurse, licensed social worker, or other individual who meets requirements that may be prescribed by IRS

In this particular case, while the doctor specified in his evaluation that the patient required assistance for daily living, he did not specify which activities (amongst the categories of eating, toileting, transferring, bathing, dressing, and continence) the patient could not accomplish on her own. The Tax Court did, however, refer to a doctor's report which stated that the patient suffered from dementia, and therefore would not take her medication regularly without supervision. Therefore, the patient qualified under the 3rd test of chronically ill individual, as she required substantial supervision to protect herself from threats to her health and safety due to severe cognitive impairment. As such, the amounts paid to the caregivers were deductible by the patient as amounts paid for qualified long-term care services under IRC Section 213.

One important final note, under IRC Section 7702B, an individual who otherwise qualifies as chronically ill will not qualify unless during the preceding 12 month period the licensed health care practitioner certifies the individual meets the requirements. In Estate of Lillian Baral, although the court refers to the doctor's notes from 3 years ago regarding the patient's not properly taking her medication, the court does note that in the last 12 months the doctor's evaluation states that the patient required supervision because of her memory deficit and therefore needed supervision for her health and safety. Hence, the 12 month certification requirement was satisfied.

July 1, 2011
Posted by Sanger & Manes, LLP

Taxpayer Advocate Service Issues Mid-Year Report With a Focus on IRS Fairness to the Taxpayer

On June 29, 2011, National Taxpayer Advocate Nina E. Olson released a report to Congress that identifies several issues the Taxpayer Advocate Service plans to address during the coming fiscal year. The Taxpayer Advocate Service is an independent office within the Internal Revenue Service. It is under the supervision and direction of the Taxpayer Advocate who is appointed by and reports directly to the Commissioner of Internal Revenue. The Taxpayer Advocate Service identifies systemic problems that exist within the Internal Revenue Service and, to the extent possible, propose changes in the administrative practices which may be appropriate to mitigate such problems.

The 2011 mid-year report expresses particular concern about the impact of IRS budget cuts on taxpayer service and tax compliance. The National Taxpayer Advocate has previously suggested that the IRS generally be exempt from budget caps or reductions.

With respect to IRS collection practices, the report praises several recent changes the IRS has announced, including making lien withdrawals available to taxpayers in a wider range of cases. However, the report expresses continuing concern about the IRS's practice of automatically filing tax liens based on a dollar threshold instead of basing lien-filing decisions on an analysis of the taxpayer's financial situation. The National Taxpayer Advocate believes that such an analysis "should balance the need to protect the government's interests in the taxpayer's assets with a corresponding concern for the financial harm the lien will create for that taxpayer." In situations where the IRS has determined a taxpayer is suffering an economic hardship or possesses no significant assets, the filing of a lien is unlikely to further tax collection but will further damage a taxpayer's credit rating.

In addition, The Taxpayer Advocate Service announced it planned to focus on the following areas in the upcoming year:

Tax Reform and Tax Complexity. The Taxpayer Advocate Service will continue to engage the public in a discussion about fundamental tax simplification. The Taxpayer Advocate Service has established an electronic suggestion box to solicit comments from taxpayers on tax simplification.

Earned Income Tax Credit Improvements. Taxpayers frequently face difficulty in substantiating their Earned Income Credit claims to the satisfaction of the IRS, notably by proving that a qualified child lived with the taxpayer for more than half the year and bears the requisite familial relationship. The Taxpayer Advocate Service wishes to aid taxpayers in making their substantiation problems easier to prove.

Tax-Related Identity Theft. The IRS continues to experience difficulties in expeditiously resolving tax identity theft-related cases, which continue to increase. The Taxpayer Advocate Service will continue to work with the IRS to mitigate identity theft problems, improve identity theft case processing, and follow up on previous recommendations in this area.

Innocent Spouse Relief. The IRC currently contains "innocent spouse" rules designed to shield individuals from responsibility for joint tax liabilities generally attributable to their spouse (or former spouse) in appropriate cases. However, equitable relief for otherwise eligible taxpayers is barred if an "innocent spouse" request is not filed within two years from the date of the first IRS collection action. The two-year rule can lead to poor and unfair results for true innocent spouses. The Taxpayer Advocate Service looks forward to working with the IRS to improve this rule.

June 28, 2011
Posted by Sanger & Manes, LLP

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 ( 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

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.

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 1, 2011
Posted by Howard Sanger

Fiduciary Liability For Unpaid Taxes -- Part II


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.


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.

May 31, 2011
Posted by Sanger & Manes, LLP

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).


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 Sanger & Manes, LLP

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.


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.


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.