Palm Springs Tax and Trust Lawyers

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!).

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.

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.

Background
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.

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.

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.

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.

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!

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.

How you ever won a big jackpot at the casino? Well, if that jackpot was worth at least $1,200, you know that along with your winnings, the casino will issue you a W-2G, which notifies the IRS of your big payday. You might not care about that, except that most of us don't walk away from the casino right after winning the big jackpot. Typically, we play a little more, and maybe even by the end of the day have more losses than winnings, or certainly less winnings than the $1,200+ of which the IRS now has notice. The Internal Revenue Code allows a taxpayer to deduct gambling losses from gambling winnings on an annual basis. But Internal Revenue Code requires a taxpayer to prove his or her gambling losses. How do you prove gambling losses? The IRS has traditionally accepted a daily log or journal kept by the taxpayer detailing the gambling activity of the day. But how many people really keep a daily journal on their gambling activities?

We have a suggestion: get a casino issued "players card" and use it every time you play the slots. Not only do you earn points towards casino freebies, by using the card you allow the casino to electronically track your gambling winnings and losses. This should serve as excellent evidence when proving your gambling losses to the IRS.