In addition to our Estate Planning, Probate, Business Law, Asset Protection and Captive practices, we are tax attorneys with offices in North Carolina and Virginia and represent taxpayers nationwide and abroad. We help taxpayers with a variety of tax issues, including, but not limited to:
- Understanding IRS Notices
- Negotiating Offers in Compromise
- Defending tax audits
- Negotiating penalty abatements and waivers
- Defend against civil penalties and tax fraud
- Defend against Trust Fund Recovery Penalties (Form 4180)
- Represent taxpayers before IRS Appeals (Form 12153) and US Tax Court
- Handle withdrawals and releases of IRS tax liens and IRS tax levies
- Prepare/negotiate Innocent Spouse claims (Form 8857)
- Prepare/negotiate Injured Spouse claims (Form 8379)
- Ensure Foreign Tax compliance
- Foreign Bank Account Reporting (Filing FBARs)
- File delinquent IRS Form 8938, 1040 Statement of Foreign Accounts
- Defend against FBAR penalties
- Help with Unfiled Tax Returns
- Respond to IRS Notices of Deficiency (CP3219N Notice)
- Assist with State tax audits, sales and use tax problems and State income tax issues
On November 2, 2020, IRS SB/SE Deputy Commissioner, Darren Guillot, said the goals of the new IRS “Taxpayer Relief Initiative” are three-fold:
First, the IRS wants to do everything it can under existing rules for immediate, broad-based relief from unpaid liabilities resulting from COVID-19 issues, including those affected by IRS mail processing and correspondence delays. Second, the IRS seeks to remove bureaucratic barriers and expand flexibilities to all taxpayers whose financial condition has been affected by COVID-19. And third, the IRS will make sure it has adequate resources available to work complex cases or address egregious non-compliance. And it will work to uphold the laws and help ensure fairness in the tax system.
Here are highlights from the New Taxpayer Relief Initiatives currently being offered:
- Extending from 120 days to 180 days, the short-term payment plan timeframe for taxpayers who qualify for a short-term payment plan option;
- Automatically adding new tax liabilities to an existing Installment Agreement for individuals and out-of-business taxpayers rather than default the Installment Agreement;
- Permitting individual taxpayers who only owe taxes for tax year 2019, and who for 2019 owe no more than $250,000, to enter into an Installment Agreement without the IRS filing a Notice of Federal Tax Lien;
- Allowing individual taxpayers to secure a non-streamlined Installment Agreement for past due tax liabilities owed of up to $250,000 without providing any financial statement or substantiation ( i.e., no Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals is required), provided: (i) the case has not been assigned to a revenue officer ( i.e., the case must still be in the Automated Collection System (“ACS”)), and (ii) the monthly payment proposal is sufficient to full pay the liability within the remaining CSED (collection statute expiration date); 
- Allowing qualified taxpayers with an existing Direct Debit Installment Agreement to use the Online Payment Agreement (“OPA”) system to propose a lower monthly payment amount, and also to change their monthly payment due date;
- Providing relief from penalties by considering requests for penalty abatement on grounds of reasonable cause for the failure to file, failure to pay, and failure to deposit penalties, as well as first time abatement relief; and
- Offering flexibility to taxpayers who are temporarily unable to meet the payment terms of their previously accepted Offer-in-Compromise.
The new IRS Taxpayer Relief Initiative is a valuable tool against enforced IRS collections. If we can assist you in taking advantage of this important opportunity, please do not hesitate to contact us.
The IRS Fresh Start Initiative, or Fresh Start program, is almost 10 years old. It focuses primarily on collection policies and procedures and offers a variety of flexible payment options, streamlined payment and penalty abatement procedures and flexibility in withdrawing IRS tax liens. It includes streamlined procedures for accepting Offers in Compromise, establishing automatic installment agreements, allowing for first-time penalty abatements, and more lenient lien releases. If you meet the criteria and you’re struggling to manage your tax debt, the IRS Fresh Start Initiative is something to take advantage of.
Not all IRS installment agreements or IRS payment plans are treated equally. There are various types of “guaranteed” and “streamlined” payment plans with the IRS. A “guaranteed” installment agreement is available if you owe $10,000 or less and it is easy to apply online. You must have a previous compliance history, have filed all past-due tax returns, not used an installment agreement plan within the previous five years, and must pay the tax amount due within three years or less. If you meet these criteria, your installment agreement is “guaranteed”.
For tax debts up to $50,000, you may be eligible for a “streamlined” installment agreement. The biggest difference with “streamlined” installment agreements is that they offer a longer payment term, up to 72 months or six years.
If you owe over $50,000, your installment agreement options become a little bit more difficult to obtain. You must submit financials to the IRS so they can determine the proper installment agreement terms. This is where your negotiation becomes more difficult and it is advisable that you seek professional legal assistance.
Finally, there is an opportunity for a “Partial Pay” installment agreement. This is basically a “tiered” approach to paying your tax debt over time. It involves paying less on the front end and increasing tiered payments in later years. The IRS CSED becomes particularly important in “partial pay” in installment plans. The “partial pay” installment option requires careful negotiation and it is advisable that you seek professional legal assistance. “Currently Not Collectible” is also an option if you cannot currently pay your tax debt at all. Also, expect the IRS to file a federal tax lien to guarantee its debt collection and protect its interests.
We have all heard of the Offer in Compromise program, where the taxpayer pays less than he or she owes in full settlement of their tax debt. There are three different types of Offers in Compromise. One is “Doubt as to Liability”, which involves a situation where there is doubt as to whether the taxpayer is liable for the underlying tax liability. The most common Offer in Compromise is “Doubt as to Collectability”. This type of Offer in Compromise is by far the most common; however, there is a third type. It is called an “Effective Tax Administration” Offer in Compromise. This is a situation where a taxpayer may have the means to full-pay the tax debt, but compelling public policy or equity considerations provide a basis for accepting less than the full amount of tax owed. A situation where, due to exceptional circumstances, collecting the tax in-full would undermine the public’s confidence that the tax laws are being administered in a fair and equitable manner.
For example, despite the ability to full-pay, a bedridden elderly grandmother living primarily off Social Security and a modest retirement pension may be a good candidate for an “Effective Tax Administration” Offer in Compromise. Her retirement pension could pay the tax owed, but it would be inequitable to expect her to deplete her modest pension to pay the tax in-full. In this situation, the IRS might find that there are compelling reasons and an inherent inequity to make her pay the tax liability in-full – given her life circumstances. This is by far the most delicate Offer in Compromise negotiation. It can be very difficult to convince the IRS that public policy and compelling equity factors exist. It sometimes involves using technical analysis, like life expectancy actuarial tables and economic forecasts.
If you are under investigation for, or have been assessed, a civil penalty for your company’s nonpayment of employment tax, you know how devastating the Trust Fund Recovery Penalty can be. If the IRS determines you are a “Responsible Person” for the nonpayment of employment tax, you will be assessed a Trust Fund Recovery Penalty under IRC 6672. The penalty is assessed against any person required to collect, account for, and pay over employment taxes held in trust for the benefit of the IRS. You must have “willfully” failed to perform those duties. The penalty is equal to the total amount of employment or excise tax evaded, not collected, or not accounted for and paid over.
The Trust Fund Recovery Penalty, or 6672 penalty, is a matter of status, duty, and authority. It can apply to officers or employees of a corporation, partners or employees of a partnership, corporate directors or shareholders, employees of a sole proprietorship, limited liability company (LLC) members, managers or employees, and others.
There are multiple factors in determining “responsibility”, including: the ability to exercise independent judgment over financial affairs of the business, owning stock or membership interests in the business, the authority to sign checks, and many other “responsibility” factors.
The IRS must also establish “willfulness” however. Willfulness means intentional, deliberate, voluntary, reckless, knowing acts, as opposed to accidental. No evil intent or bad motive is required. To show willfulness, the IRS generally must demonstrate that a Responsible Person was aware, or should have been aware, of the outstanding taxes and either intentionally disregarded the law or was plainly indifferent to its requirements. The defense of the Trust Fund Recovery Penalty is a delicate noneegotiation, often times involving legal research and witness preparation. An inadvertent admission can easily destroy a defense.
Notices of Deficiency (CP3219N Notice), as explained by the IRS: With Notice of Deficiencies, the IRS has calculated your tax, penalty and interest based on wages and other income reported to it by employers, financial institutions and others. The CP3219N is a Notice of Deficiency (90-day letter). Once you receive your notice, you have 90 days from the date of the Notice to file a Petition with the U.S. Tax Court, if you want to challenge the tax we proposed. The 90 days is a hard deadline. If you fail to respond, the tax, penalty and interest become final with no ability to re-challenge. Filing a Tax Court petition is your key to the door of the U.S. Tax Court.
CAP Requests generally apply to challenging the actual collection action taken (lien, levy, seizure) only, not to the underlying penalty associated with the collection action. In contrast, with CDP Requests, you can also argue against the underlying penalty using, for example, a reasonable cause waiver argument. CAP Requests are filed on Form 9423. CAP Hearing Requests are available much sooner than CDP Hearing Requests because you do not have to wait to receive a “Final Notice” before requesting a CAP Hearing. There are several important characteristics of CAP Hearing Requests to be aware of: CAP does not stop all IRS collection action in its tracks like CDP Hearing Requests; the statute of limitations continues to click in a CAP scenario (statute of limitations is not tolled); CAP Hearings are processed much sooner that CDPs; if you request a CAP Hearing, you cannot then later request a CDP Hearing (in effect, by requesting CAP, you are giving up your CDP Hearing rights; and finally, CAP findings, if favorable or not, are binding on you and the IRS – there are no further remedies, like review by the Tax Court (until CAP, there is no higher level of review).
With CDP Hearing Requests the protections are firmer. All collection stops in its tracks once a CDP Hearing Request is filed – but it also tolls the running of the statute of limitations. In CDP hearings, unlike CAP, you can challenge all penalties and liabilities and offer a variety of solutions: you can challenge the enforced collection action against you, you can request waiver of penalties, and you can offer alternative collection methods (installment agreements or Offers in Compromise). However, CDP rights do not mature until after you have received a Final Notice from the IRS (of proposed collection action). If you miss the 30-day deadline to file your CDP Hearing (30 days from the Final Notice), you can still file for an “Equivalent Hearing”; note, the IRS treats all late-filed CDP Hearings Requests as Equivalent Hearings. The key difference between a timely-filed CDP Hearing Request and an Equivalent Hearing is that the former’s administrative ruling can be challenged at the Tax Court, while the latter’s administrative ruling cannot. There are reasons why it is advantageous to file for an Equivalent Hearing over a CDP however, for example, the statute of limitations continues to run with Equivalent Hearing Requests.
Whether you file a CAP Hearing Request, CDP Hearing Request, or even an intentionally-defective Equivalent Hearing Request, it is entirely dependent upon your specific facts and circumstances and the overall strategy of your case. If you have questions about what is the best course of action, you should seek professional assistance in making that decision.
The intersection of Collection Due Process (or CDP) Hearings and the Tax Court is of paramount importance. The interplay between these two functions cannot be ignored. One of the most important aspects is the “preservation” of issues or legal arguments.
You should know a little bit about the IRS Independent Office of Appeals. IRS Appeals is part of the Department of Treasury, but it is an impartial body that reviews proposed IRS actions outside of the normal collection division chain of command. That means, IRS Appeals acts independent from a pure tax collection motive. Their job is to independently review IRS actions and determine whether it is procedurally correct and within the bounds of the law. If it is not, then they have discretion to unwind the IRS action or remand it for further consideration. It is a quasi-judicial role that conducts administrative hearings, and they have real meaningful power. Anytime the IRS proposes to take some enforced collection action against you, like a levy, garnishment, or the filing of a federal tax lien, you have a statutory right to have that proposed action reviewed by IRS Appeals. There are important deadlines to meet however so make sure you know them. If you miss the deadline to file an Appeal, your options for recourse are severely limited. In fact, by missing an opportunity to go to Appeals you can be prevented from arguing your “liability” on the merits later. The point – take your first opportunity to go to IRS Appeals.
But what happens if you disagree with an IRS Appeals determination? In many cases, you then have the right to go to United States Tax Court. But you must first understand what to do at IRS Appeals so that you can have your case fully considered at the Tax Court -- if you end up there. The answer might not be as easy as you think.
There is a legal concept called issue preclusion and it’s important in the IRS Appeals and Tax Court contexts. In seeking Tax Court review of a Determination by IRS Appeals, you can only ask the Court to consider an issue, including a challenge to the underlying tax liability, that was properly raised in your CDP hearing. An issue is properly raised if you request consideration of your issue at the Appeals Hearing and you meaningfully participate. That is, you actually present evidence on your behalf. So, if you do not raise an issue at IRS Appeals or you do not fully participate or present your case at IRS Appeals you are prevented from later arguing that issue at the Tax Court. This is issue preclusion. You cannot wait until the Tax Court to bring up new arguments.
This is one reason why your Administrative Record at IRS Appeals is so important. One of your goals at IRS Appeals should be to “fill” the Administrative Record with ALL pertinent and relevant evidence on your behalf. What does that mean? The Regulations tell us that the Administrative Record for purposes of Tax Court review is the full case file, including but not limited to – internal notes made by the Appeals officer concerning any oral communications with you, any memoranda created by the Appeals Officer, any materials relied upon by the Appeals Officer in making the determination. All of this constitutes the Administrative Record in which the Tax Court will review in determining whether the Appeals determination was founded or unfounded.
So, your job is to fill the Administrative Record will all relevant documentary evidence. It is good practice to request a Freedom of Information Act Request (FOIA) immediately after you file your Request for an Appeals Hearing (if your case was with a Revenue Officer previously). This will help you identify what issues to focus on at IRS Appeals. That is true, but you should also request a FOIA post-Appeal. You need the Appeals Officer’s internal workpapers, so you better understand the case against you and can make better arguments before the Tax Court. FIOA will give you the right clues. You may also request your “case file”, which should include internal notes of the Agent too, under Internal Revenue Code Section 6103(e). You can make your Section 6103 requests in writing or verbally – in writing is the preferred method.
But while at Appeals, leave nothing out. You are not penalized for submitting too much relevant information. You should submit everything relevant to your case. That building of the Administrative Record will serve you well at Tax Court. The worst thing you can do is not document your arguments at Appeals or not fully participate. And do not miss deadlines for requests from information; request an extension of time if you need one.
To overturn an Appeals determination, the Tax Court must find that IRS Appeals abused its discretion; that the Appeals determination was arbitrary, capricious, or without sound basis in fact or law. And the Tax Court cannot find in your favor without a full Administrative Record stacked with all your evidence. As you can see, IRS Appeals is – in effect -- Tax Court preparation.
So, bring up all issues and document each and every one at IRS Appeals. Issue preclusion is a powerful legal precept that can be used against you. It is important that you know the rules of the game. The rules say that you must raise your issue at IRS Appeals and you must meaningfully participate at Appeals before your issue can be then reviewed and considered the Tax Court. Stack the Administrative Record and do not forget issue preclusion or you may lose important opportunities to make legal arguments – no matter how right your argument might be.
The non-filing of tax returns is a serious matter. In fact, it is a federal crime not to file a tax return when you have a legal obligation to do so. Below are just a few important considerations:
- With unfiled tax returns, the statute of limitations to audit (3 years) and for collections (10 years) never starts to tick. In effect, with unfiled tax returns, there is no statute of limitations to audit and collect. You must affirmatively sign and file a tax return to start the statute of limitations clock.
- If you have many years of unfiled tax returns, the question of how many years back should you file is a difficult question to answer. There is no one-size-fits-all answer. The answer is on a case-by-case basis. Non-compliant taxpayers should be careful to discuss the factors that led up to the non-compliance with counsel so a strategy can be put into place that best protects the taxpayer from criminal prosecution and civil fraud penalties. It is not an easy question to answer; there are many landmines to navigate.
- Unfiled tax returns with balances carry the following associated penalties: Failure-to-file penalties; Failure-to-pay penalties, combined with the failure-to-file penalty can reach a maximum of 47.5%; Fraudulent failure-to-file penalties triple the normal failure-to-file penalty, which can increase it to the maximum penalty of 75%; and Information returns for foreign accounts, gifts, entities and assets have special penalties that can be significant, depending upon the information return in question and the facts for non-reporting.
- First Time Penalty Abatement relief and reasonable cause defenses are available to abate some penalties.
- If you have not filed tax returns for many years, Substitute for Returns (SFRs) are likely to be assessed. These are returns created by the IRS for non-filers based upon information the agency receives from third-parties, like employers and bank, with forms such as 1099s, W2’s, and other third-party reporting of information returns. Importantly, with your SFR, the IRS does not determine favorable deductions, exemptions and credits, thus it maximizes the tax you will owe.
There are new important changes to IRS Form 8857, Request for Innocent Spouse Relief, last updated in 2014. Some changes to be aware of:
- A new bullet point advises taxpayers of the “Administrative File Rule” -- the rule that the Tax Court, upon its review, will only consider information submitted by the taxpayer as part of its administrative claim or file, prior to the Tax Court action. Be sure to fill the administrative record with all pertinent information before getting to the Tax Court. This is critical; leave nothing out.
- In the 2014 version, taxpayers were asked about their involvement the family finances. There were a series of Yes or No questions that left little room for nuances that could not be explained by a simple Yes or No answers. Now, the new form eliminates the check boxes and replaces them with a series of “open ended” questions, allowing for nuances to be better and more fully explained.
- Practice Point. The IRS takes very seriously situations where “abuse” is present. It can be a very important factor in your favor. Be aware that the IRS’s definition of abuse, including financial abuse, is much broader than state law definitions of it.
When you file a joint tax return, both you and your spouse are jointly and individually responsible for any tax, interest, and penalties due. However, in some instances you can be relieved of your responsibility if your spouse (or former spouse) improperly reported items on the tax return or omitted them entirely (without your knowledge). To start the process, you need to file an IRS Form 8857, Request for Innocent Spouse Relief. The Form will ask you a series of questions including your marital status, your level of education, whether you are a victim of spousal abuse or domestic violence, and whether you have any mental or physical health problems. You will need to explain your involvement with the household finances and the preparation of the tax returns in question. It will also ask you a series of questions about yours and your spouse’s lifestyle choices, your expenditures on automobiles and jewelry for example. Finally, you will be asked about your current financial situation. Innocent Spouse Relief is a facts and circumstances examination. It is important that you describe the circumstances specifically and clearly. For more information, see: IRS Innocent Spouse.
Understanding the Innocent Spouse legal landscape is important in deciding whether your facts and circumstances warrant relief from a joint tax lability with your spouse or ex-spouse. Here are some important considerations:
Innocent Spouse Relief Qualifications
To qualify for Innocent Spouse Relief, you must meet ALL of the following five requirements:
- A joint return was filed for the year in which relief is requested;
- There is an understatement of tax, not attributable to you;
- You did not know and had no reason to know (knowledge) of the understatement of tax at the time the tax return was signed;
- Considering all the facts and circumstances, it would be inequitable (unfair) to hold you liable for the understatement of tax;
- Your request is made within two years from the date of the first collection activity, unless an exception applies.
Actual and Constructive Knowledge
The critical question is whether you knew or had reason to know of the understatement of tax at the time the tax return was signed. Under this requirement, you must establish: (1) a lack of actual knowledge (did not know), or (2) a lack of constructive knowledge (had no reason to know). If you are a victim of spousal abuse, special rules apply.
Facts and Circumstances
The following factors, in part, are used to determine whether a reasonable person in similar circumstances would have known of the understated tax:
- Yours and your spouse’s financial situation;
- Your educational background and business experience;
- Whether you failed to inquire, at or before the time the return was filed, about items on the return, or omitted from the return, that a reasonable person would inquire about;
- Whether the tax item in question was unlike your previous tax year filings; it was unusual.
Considerations in determining whether it is unfair to hold you liable for the tax:
- Whether you received a significant economic benefit;
- Your education and experience level;
- Your level of involvement in household finances;
- Abandonment by your spouse;
- Your health at the time the return was signed;
- Your health at the time relief is requested;
- Any economic hardship you are experiencing;
- Any alleged abuse;
- Financial control of your spouse;
- Deceit by your spouse.
The IRS takes very seriously Innocent Spouse Claims. They do not easily relieve a taxpayer of his or her obligation to pay taxes due. However, if it would be unfair to hold you, the taxpayer, liable for the tax
due under your particular facts and circumstances, then yes, the IRS can be empathic to your situation – and provide you relief. Consider the above factors as you contemplate your Innocent Spouse Claim.
Foreign Bank Account Reporting, or FBARs, have been a priority for the IRS for over 10 years. It requires certain U.S. Persons to disclose their foreign bank accounts if those accounts meet certain threshold requirements. The disclosures must occur annually and be filed electronically. The penalties for nondisclosures are harsh. They are $10,000 per account* (not disclosed), or go as high as $100,000 if the nondisclosures were willful. *(there is current litigation on per account penalty assessments)
The IRS is very serious about FBAR enforcement. It is not an area of tax law to be taken lightly. In fact, the IRS takes it so seriously that each year there are high profile criminal cases resulting from FBAR violations. The IRS even developed an Offshore Voluntary Disclosure Program (“OVDP”). Under it, a taxpayer may voluntarily come-forward, after a period of noncompliance, and may be relieved of penalties associated with his or her nondisclosures. The OVDP program was in place for about 10 years and was very successful. Nearly 50,000 taxpayers came forward voluntarily and the IRS netted over $10B in tax dollars. FBAR compliance continues to be an area of focus for the IRS.
Typically, but not always, a taxpayer – having an FBAR obligation – will also have an obligation to file an IRS Form 8938 with his or her Form 1040. The foreign bank account thresholds are different but a failure to disclosure is just as serious as FBAR violations.
In recent and past IRS guidance, the IRS has made clear its treatment of cryptocurrency as “property”, and not true currency. This has significant tax consequences for taxpayers engaging in cryptocurrency transactions. It means that taxpayers must now track their adjusted “basis” and calculate their gains and losses, just as they would any other stock transaction. It also means that taxpayers receiving cryptocurrency for services performed now have reportable income, just as Schedule C taxpayers have reportable income.
Taxpayers using cryptocurrency to purchase products may also have a capital gain or loss depending on the fair market value of the product received (and your basis in the cryptocurrency exchanged for that product). Tracking adjusted “basis” with multiple transactions across multiple exchanges can be overly burdensome, especially with exchanges that do not third-party report your transactional activities (you must do it yourself). Tax reporting of cryptocurrency transactions is now very difficult. The IRS also ramped up its cryptocurrency task forces to assist in compliance and enforcement efforts; taxpayers and crypto users should be prepared to face IRS scrutiny.
Cryptocurrency and Estate Planning are not normally used in the same sentence. But given the popularity of cryptocurrency, it is becoming necessary to account for digital assets within estate planning documents. There are several key reasons why “traditional” estate planning documents fail to adequately address cryptocurrencies. It is a new asset class and old “boilerplate” language just doesn’t capture the nuances of cryptocurrency.
The biggest failing is the drafting itself. Assuming the Trustee or Executor (“Fiduciary”) even knows of the existence of the Decedent’s cryptocurrency, he or she must be able to access it and administer it. Estate planning documents should explicitly permit Fiduciaries to “access” the Decedent’s digital devices, such as laptops, cell phones and digital storage devices. These devices may have information about cryptocurrencies owned by the Decedent at death. Even if the Fiduciary has access to “private” keys, without the properly drafted permissions a search through digital devices, online platforms and even the “use” of the private keys may violate federal or state privacy laws, terms of service agreements, or computer fraud and data protection laws. Digital permission clauses should be drafted with precision.
Another drafting concern involves competent administration. Many corporate Fiduciaries may not administer cryptocurrency and may not have the ability to be a custodian. To prevent responsibilities from falling into the lap of an inept Fiduciary, “carve-outs”, or bifurcation, are important drafting considerations. For example, a corporate Fiduciary may be designated to administer the Trust generally; but a drafter might carve-out authority for a “Special” Trustee to administer cryptocurrency investment decisions and digital storage. The same could be true inside Trusts that do not utilize corporate Fiduciaries. The key is to bifurcate competent Fiduciaries to handle specific tasks. One to manage general administration and another, “Special” Fiduciary, to handle digital duties – one who is preferably digitally savvy.
Yet another drafting concern involves Fiduciary limitations. Cryptocurrencies are generally volatile, and many investors take “hold” positions despite that volatility. Because of this, a well-drafted Trust should indemnify Fiduciaries and release them from any duty to diversify investments. If not, non-diversification may run afoul of the Uniform Prudent Investor Act. Failure to draft around it may result in a Fiduciary administrating the Trust inconsistent with the Grantor’s desires – out of fear of legal exposure. Another idea is to draft a provision granting the Fiduciary the authority to retain (or “hold”).
Successor Trusteeship is also problematic and quite frankly, dangerous. It is not good practice to pass cryptocurrency from one “former” Fiduciary to a new “Successor” Fiduciary in soft wallets or on exchanges. This is because once the “former” Fiduciary knows the private keys, he or she can, if accessed, fully use the cryptocurrency and fears of theft arise. If a theft were to occur, there is no backing by a centralized authority to help rectify a loss. In a sense, it is just hard cash. One solution is to pass down the cryptocurrency – from one Fiduciary to the other – through “cold” storage.
On the cold storage device, Fiduciaries can create multiple wallets with different passphrases. Upon a change in Fiduciaries, the “Successor” Fiduciary can create an empty wallet and transfer the cryptocurrency to it with a new passphrase wallet. This is a way to transfer ownership from a “Former” Fiduciary to a “Successor” Fiduciary without the “Former” Fiduciary retaining the passcode and full access to the cryptocurrency. In effect, there is a changing of wallets with different passphrases to protect the cryptocurrency and the private keys. A memorandum memorializing the transfer of the cold storage device is also advisable – just as one might memorialize the transfer of a work of art.
Finally, all the above presupposes “knowledge” of the cryptocurrency’s existence. It is advisable to alert Fiduciaries now that crypto assets are owned. It is possible for a Fiduciary to discover ownership – for example, cryptocurrency apps on a cell phone – but it is much more difficult. There is no centralized bank to send as inquiry to. Plus, disclosure of ownership alone is not enough. A Fiduciary must know where to find the private keys. Without the private key, transferability, management, and true ownership of the crypto assets is not possible. This is where choosing a trusted person to act as a “digital” Fiduciary is critically important. It is akin to giving someone the code to your safe.
Some other practice points:
When funding an Irrevocable Trust with cryptocurrency, it is important to prepare a contemporaneous memorandum recording the transfer. That memorandum should record amounts, dates, times, digital transaction codes and FMV. It should also ensure that the Donor has not retained any control over the transferred cryptocurrency – for example, allowing only the Fiduciary access to the cold storage device and private keys. The memorandum is important because – to date – there is no authoritative guidance on funding Trusts with cryptocurrency, nor any direction on how such transfers should be memorialized for tax and asset protection purposes. The memorandum should be signed and dated with two witnesses present.
When gifting crypto assets, best practice includes getting an appraisal of the FMV of the cryptocurrency being gifted and executing a contemporaneous memorandum that includes details of the gift. In fact, two memorandums are recommended. One is prepared by the Donor. His or her memorandum might include the date and time of the transfer, digital transaction codes, the Donor’s basis in the gift, the FMV of the gift at the time of the transfer and the recipient’s information. The second memorandum should be a memorandum of acceptance of the gift by the Donee. The import is to evidence the Donor’s intent to give up control or dominion over the cryptocurrency and to identify that the gift is complete. If the gift is being made to a charitable organization, ensure the gift meets the requirements of IRC § 170(f) (to it qualify for an income tax charitable deduction).
These are just a few practice points and drafting considerations when dealing with crypto assets. Drafters should not assume dealing with cryptocurrency is just like dealing with other financial assets inside an estate plan. They simply are not. It is an entirely new asset class with distinct characteristics much different than other financial assets. Competent estate planning drafting should accommodate those differences.
The U.S. Department of Justice recently published its Cryptocurrency Enforcement Framework report describing its view of the types of threats cryptocurrencies pose, the tools the government will use to confront those threats, and some of the challenges with cryptocurrency enforcement. Here is a listing of some of the federal statutes that may be used in the cryptocurrency world:
- Wire Fraud – scheme to defraud by electronic means
- Money Laundering – scheme to conceal the origin of funds used for criminal activities
- Bank Secrecy Act – most commonly, failure to conduct “Know Your Customer” due diligence, which is a failure to implement proper anti-money laundering procedures
- Operating an Unlicensed Money Service Business – where a company fails to comply with the registration, licensing, and regulatory requirements for engaging in the money transmission services business
- Securities and Commodities Fraud – knowingly executing, or attempting to execute, a scheme to defraud any person in connection with any commodity or any option on a commodity for future delivery
- Tax Evasion – willful attempt to evade or defeat any tax imposed by the Internal Revenue Code
In addition to the Department of Justice, here are a list of government agencies who may also investigate and prosecute cryptocurrency crimes:
- FinCEN, Financial Crimes Enforcement Network, U.S. Department of the Treasury
- OFAC, Office of Foreign Assets Control (OFAC), U.S. Department of the Treasury
- OCC, Office of the Comptroller of the Currency (OCC), U.S. Department of the Treasury
- SEC, Securities and Exchange Commission
- CFTC, The Commodity Futures Trading Commission
- IRS, Internal Revenue Service
- Other state agencies and international consortiums
The enforcement arm of the U.S. Government is far-reaching. And given the new crypto focus, we can anticipate enforcement activity now and for years to come.
In a recent 2020 FBAR case (United States v. Horowitz), the Fourth Circuit adopted the Third Circuit’s “objective standard” of recklessness in FBAR penalty cases. That means that the taxpayer’s “subjective” belief or intent, right or wrong, will not carry the day in court. Rather, to impose the FBAR penalty for Willful Conduct, the IRS has the burden to show that the taxpayer violated an objective standard of recklessness. And the FBAR penalties for Willful Conduct are steep – the greater of $100,000 or 50% of the balance in the undisclosed account(s) at the time of the violation. A taxpayer commits an “objective” reckless violation of the FBAR statute by “engaging in conduct … entailing an unjustifiably high risk of harm that is either known or so obvious that it should have been known.” The inquiry can be boiled down to: what the taxpayer (1) clearly ought to have known, and (2) should the taxpayer have known that there was a grave risk that an accurate FBAR was not being filed and (3) was the taxpayer in a position to find out for certain very easily. Other factors play significant roles – for example, did the taxpayer sign a personal income tax return 1040 and answer “no” to the foreign bank accounts question on Schedule B of the 1040? If so, this simple answer (“no”) has been held to be Willful Conduct. Taxpayers need to understand that there is a wide range of factors than can weigh in favor of Willful Conduct. Be certain to seek professional help if you find yourself out of FBAR compliance.
To overcome an IRS challenge, a taxpayer must be prepared to demonstrate to the IRS that he or she is a bona fide Puerto Rican resident and was present in Puerto Rico for at least 183 days during the taxable year. The determination of whether a taxpayer is a bona fide resident is analyzed via 11 factors. Those 11 factors are:
- Intention of the taxpayer
- Establishment of his home temporarily in the foreign country for an indefinite period
- Participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment
- Physical presence in the foreign country consistent with his employment
- Nature, extent and reasons for temporary absences from his temporary foreign home
- Assumption of economic burdens and payment of taxes to the foreign country
- Status of resident contrasted to that of transient or sojourner
- Treatment accorded his income tax status by his employer
- Marital status and residence of his family
- Nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time
- Good faith in making his trip abroad; whether for purpose of tax evasion
IRC Section 937 was amended to provide greater clarity as to determining bona fide residence of U.S. possessions. Specifically, an individual is a bona fide resident of a U.S. possession if 1) such person is present in the possession for at least 183 days during the year, 2) such person does not have a tax home outside the possession during the year, and 3) such person does not have a closer connection to the United States or a foreign country than to the possession. A taxpayer availing him or herself of the tax benefits of PR Act 60 are well served to ensure these factors are satisfactorily satisfied.
In this short article I will discuss Crypto Asset Protection LLCs. As cryptocurrency becomes more prevalent, more mainstream, we need to start treating it like a true asset on our balance sheets. Lenders and even the IRS are now inquiring about your crypto assets. From a lending perspective, banks want to know your liquidity in crypto as a cash asset. And the IRS wants to know for compliance reasons and also as a means to collect unpaid taxes from you. In fact, on IRS Form 433A, a taxpayer’s Financial Statement, there is a specific and separate section dedicated to crypt assets. It appears along aside bank account information and asks you to list all the virtual currency you own or in which you have a financial interest. So why is this importance outside the lending and tax context?
It is important because crypto assets are now on the asset radar. They are now a balance sheet line item. And do you know “who” else would want to know about your crypto assets? Creditors. If you were held personally liable for a car accident for example and sued for a million dollars and that million dollars was reduced to a judgement against you personally, the creditor – now knowing the liquidity of crypto – could seek to seize your crypto in satisfaction of its debt. It is no longer some esoteric, misunderstood asset. To creditors, it is a good as cash. And they now know to look for it.
This is why you need to start thinking about ways to protect your crypto from creditor attack. One vehicle is a Crypto Asset Protection LLC. LLCs build a wall around your assets and “can be” used in the case of virtual assets. For example, let’s suppose you own real estate inside a Single Member LLC. The real estate is titled in the LLC name and you think it is therefore protected from your outside personal creditors. Because a personal judgement would come in your name only, you think the creditor could not reach your real estate titled in the Single Member LLC name. If you think this, in this example, you are mistaken.
Single Member LLCs have – basically – no asset protection. A creditor could foreclose on your Single Interest in the LLC and take your real estate. The same is not true however of Multi-Member LLCs. With Multi-Member LLCs, the outside creditor is limited in his remedies. He cannot foreclose on your LLC interest and take what’s inside it. He can only receive a Charging Order against your interest in the LLC. A Charging Order is the creditor’s lone remedy. And there are ways to make that Charging Order less valuable and frustrate would-be creditors.
So how does this apply to crypto? For crypto held in cold storage, like on a Trezor device for example, there is no account number to title in the LLC name. However, you can contribute your private keys to the LLC. It is no different – in my view – than contributing other property to the LLC – like a piece of valuable fine art or a stock certificate. The private keys are what’s valuable. If you’re in the crypto space, you know well the saying – “not your keys, not your crypto”. Here, we contribute the private keys to the LLC. That creates a shield between your personal creditors and your crypto. But you need two additional things.
First, you need Multi-Member status. Remember, Single Member LLCs do not work. That additional member can hold a small membership interest, say 1%, and can be a spouse, another family member, or if that’s not an option, the other member can even be another LLC or a Trust. That type of advanced planning is beyond the scope of this article, but it is a viable option. You can even intertwine estate planning with a Crypto Asset Protection LLC; using a Trust to hold crypto is another workable solution. And secondly, you need proper documentation. This is an absolute must. You need contemporaneous record of your transfer of your private keys to the LLC, to include transfer documentation, information about the blockchain, transactional codes, hashes and date stamps. It is the only way to thwart an allegation that your Crypto Asset Protection LLC is a sham structure. I strongly advise working with counsel on how to prepare the proper legally binding documentation evidencing your transfer of your crypto and private keys. Without it, I dare say – you may lose your crypto.
I wrote this short article because crypto is now more mainstream, and we need to start thinking about its exposure to mainstream problems and how to protect it within existing models – like LLCs. At Webb & Morton, we understand digital assets and asset protection. If we can assist in protecting your crypto assets, please do not hesitate to contact us.
If you find yourself in an FBAR penalty situation, it is not a pleasant place to be. I thought this short article was important because there is a present disagreement as to how the FBAR penalty is imposed on non-willful noncompliant taxpayers. To recap FBAR for a moment, US taxpayers are required to file annual FBARs if their foreign bank accounts meet certain thresholds. You have an FBAR filing obligation if the aggregate balance of your foreign accounts at any time throughout the tax year was greater than $10,000. And the failure to file FBAR penalty regimes are harsh. For non-willful failures to file, the penalty is $10,000 per violation. For willful failures to file, the penalty is an amount equal to the greater of $100,000 or 50% of account balances.
The present disagreement concerns the non-willful penalty and whether the $10,000 penalty is $10,000 per foreign bank account or $10,000 per each FBAR “Form” not timely filed – that is, $10,000 for each year the FBAR was due. There is a dramatic difference b/w the two interpretations and dramatic differences can occur. For obvious reasons, the IRS currently believes that the per account penalty application applies, while taxpayers and practitioners, like me, think the non-willful penalty should be imposed per FBAR “Form” due, not per account.
Let's look at some examples.
This is from a real case just last year. The IRS asserted non-willful penalties against Mr. Bittner for 5 years (5 FBARs). Because Mr. Bittner had hundreds of accounts (272), the penalties assessed against him per account total $2.7 Million dollars. And remember, this is for non-willful behavior; and non-willful is defined as negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. Does $2.7 Million sound like a fair penalty for a mistake and good faith?
Applying the non-willful penalty per the FBAR “Form” not timely filed or per year produces a much fairer result or $50,000. That’s over a 2.6M difference. In Bittner, the IRS said per account applies. The IRS looked at the statute and Regs and makes a “relationship” argument. That is, each and every separate “relationship” with the foreign bank, or each account “relationship” matters. The District court in that case disagreed, however.
Before we get to the court’s ruling, lets look at another possible result under the IRS’s theory. Here, you see another inequitable result for the same behavior, non-willful behavior by two similarly situation taxpayers. Both Joe and Jane have $1 Million dollars in their foreign bank accounts; Jane, however, spreads her risk over 10 accounts. For simply holding more accounts, Jane’s penalty is $100,000, while Joe’s is $20,000. Jane’s penalty is 5 times higher than Joe’s; it is the same penalty application -- for the same non-willful behavior -- yet it yields far different results.
But let’s see what happens when you compare non-willful penalties vs. willful penalties.
What if Joe and Jane both had the same number of foreign accounts, say 20 each. And Joe had aggregate account balances of $180,000 and Jane $100,000. But Joe was a bad actor and was hit with the higher willful penalty of an amount equal to the greater of $100k or 50% of account balances; then Joe’s penalty then is $100,000. Jane was only negligent in her behavior or made a good faith mistake and was assessed a non-willful penalty of $10,000 per violation. On the IRS’s theory, then Jane’s non-willful penalty is $200,000 (20 times $10,000), while Joe’s penalty is only $100,000. Therefore, Jane’s non-willful penalty is double that of Joe’s willful penalty. You can play with the numbers and produce similar results that makes little sense from a penalty policy perspective.
The better rule is that the non-willful FBAR penalty is per FBAR “FORM”, per year, and not per account. Going to back to Mr. Bittner, a District Court in Texas agreed with the taxpayer. It held that the non-willful FBAR penalty relates to each FBAR “Form” not timely filed rather than each foreign account. The Court found, in part, that the IRS’s interpretation could not reasonably be read into the controlling statute, and that Congress’s omission of “per account” language from the non-willful statute was intentional and that the IRS’s reasoning leads to absurd outcomes – like the ones discussed here.
This is the second case in the last year holding in favor of taxpayers. Unfortunately, the IRS has not budged. To date, they have not changed their guidance on this issue. Even though it makes little sense to treat Joes and Jane’s non-willful conduct with different results; and it makes no sense that Joe’s willful penalty is less than Jane’s non-willful penalty.
2021 should be a firecracker year concerning this issue. In the meantime, noncompliant taxpayers are well-served to plan around FBAR penalties or if necessary, mount a strong defense against them. At Webb & Morton, we have many years of experience with FBAR compliance and FBAR penalty defense. If we can be of assistance to you, please do not hesitate to contact us.
The Department of Treasury is again sharpening its sword upon crypto. In January 2021, the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) issued Notice 2020-2. The Notice states that FinCEN intends to amend its Regulations concerning the reporting of foreign financial accounts to include virtual currency as a type of reportable account. In simple terms, this means FinCEN may soon require crypto users to file annual Reports of Foreign Bank and Financial Accounts (FBARs) for crypto held on foreign exchanges. The effects of such an amendment are expansive. A mere paragraph long, the Notice carries several implications that affect crypto owners – well beyond a simple FBAR report.
Presently, cryptocurrency accounts are not reportable accounts within the meaning of the FBAR Regulations. Should a change occur, crypto owners – already burdened by heightened IRS focus – would then be required to report annually the highest aggregate balances of their crypto accounts to FinCEN. This requirement is in addition to the crypto disclosure question on IRS Form 1040, Individual Income Tax Return. Along with disclosing the highest aggregate balance, the crypto owner must also disclosure the custodian of the crypto, its location, and the crypto account number (or some other identifier). Privacy is slowly eroding. Assuming the reporting rules stay the same, the crypto accounts would be reported on FinCEN Form 114 and filed electronically by April 15th of the following applicable year (like tax returns).
But not all crypto accounts would be reportable. The FBAR filing requirement only applies to foreign accounts whose balances exceed $10,000 (in the aggregate) for the tax year. So, if two accounts have a combined account balance greater than $10,000 at any one time, then both accounts are reportable. For example, if one holds $4,000 of ADA and another $7,000 of BTC on a non-US exchange, both holdings are reportable because, in the aggregate, they exceed $10,000. Therefore, crypto owners should carefully track the fair market values of their crypto accounts throughout the year in a volatile market. What is worth $5,000 today could exceed the $10,000 threshold in a short time.
And failure to disclose a reportable account is a fool’s errand. FBAR penalties are draconian. For “non-willful” failures to file FBARs, the penalty is $10,000 per failure. The courts are currently in flux over whether that $10,000 is per account per year, or just per FBAR due. The IRS – predictably – takes the former view. If the $10,000 penalty is per account per year, it is easy to see how FBAR penalties can easily exceed the actual balances of the accounts themselves. That is, a taxpayer could pay more in FBAR penalties than the worth of their accounts. And for “willful” noncompliance, the penalties teeter on unconscionability. They prescribe a civil penalty for willfully failing to file an FBAR of up to the greater of $100,000 or 50% of the balance in the account at the time of the violation. Willful violations include both knowing and reckless nondisclosures.
There is yet another requirement birthed from the possible changes in the FBAR Regulation. At the bottom of Schedule B of the Form 1040, there is a series of foreign bank account questions. Presumably, if crypto accounts fall within the new FBAR Regulations, then an FBAR-reporting taxpayer would also need to answer the Schedule B questions in the affirmative. And answering in the negative is not a good choice. Untruthfully answering “no” to the Schedule B foreign bank account questions is considered “willful” behavior in the eyes of the IRS. And importantly, unlike the FBAR rules, there is no account value threshold with the Schedule B questions. Voluntary foreign bank account disclosures do not begin and end with the filing of an annual FBAR. If applicable, the taxpayer must also answer the Schedule B foreign bank account questions truthfully.
Regrettably, the work does not stop there. If crypto accounts are deemed reportable accounts under the FBAR Regulations, then they are naturally reportable accounts under IRS Form 8938. If U.S. taxpayers have a financial interest in specified foreign financial assets and meet certain account balance thresholds, they must also file a Form 8938 with their Form 1040 Individual Income Tax Return. Form 8938 is an attachment to the Form 1040. The same foreign bank accounts reportable under the FBAR Regulations are currently the same types of accounts reportable on Form 8938. In effect, the FBAR disclosures bleed over to the Form 8938. The reporting thresholds are different, however. To be reportable, for unmarried taxpayers, the foreign bank account balances must exceed $50,000 on the last day of the tax year, or if more than $75,000 at any time during the year, to implicate Form 8938. The thresholds are higher for Married Filing Jointly taxpayers. And akin to FBAR, the penalties are heavy-handed. There is a $10,000 penalty for failure to disclose on Form 8938 and an additional $10,000 for each 30 days of non-filing after the IRS notices the taxpayer of a failure to disclose, for a potential maximum penalty of $60,000. Criminal penalties may also apply. Effectively, FBAR and Form 8938 are two peas in a pod and a crypto owner may need to report on both Forms. For a good comparison of FBAR and Form 8938, see here.
In all of this, there may be a ray of good news. I previously argued for a crypto income tax amnesty program, and this may be a case where amnesty emerges. Currently, there are several voluntary disclosure procedures for failures to file FBARs. Presumably, if crypto accounts are the types of accounts now reportable under the FBAR Regulations, then the same amnesty procedures should apply to crypto accounts as well. Unless the new Regulations carve an exception, crypto accounts may fall within those types of accounts available to participate in the Offshore Voluntary Disclosure Procedures. And importantly, the Procedures capture “both” penalties for nondisclosure and the penalties for the nonreporting of income. It is an amnesty program that covers both.
For example, let’s assume the new FBAR Regulations go in effect in 2021. A crypto owner named Joe fails to report capital gains on his crypto in tax years 2021, 2022 and 2023. In each year, Joe also fails to file FBARs on his crypto accounts. Then, in 2024, Joe wants to come clean. Presumably, Joe can then participate in the FBAR voluntary disclosure procedures and capture both his failure to file his FBARs as well as his failure to report his crypto capital gains. While Joe must pay a 5% Miscellaneous penalty under voluntary disclosure procedures, he can avoid the $10,000 “non-willful” penalty for each year and avoid any additional penalties associated with his nonreporting of crypto income, including the 20% accuracy-related penalty and civil fraud penalties. It may be a backdoor into crypto income tax amnesty.
What started as an innocuous one paragraph Notice, Notice 2020-2 carries broad implications. It is not uncommon for a tax reporting requirement to touch one or more tax forms, like here. Crypto owners are well served to understand the breadth of the Tax Code. A misstep in one area is likely a misstep in another.
Whether Non-Fungible Tokens (NFTs) are taxable depends upon how you came into possession of the NFT. If you purchased the NFT using dollars or fiat, then no, there is no taxable event because you just purchased property. But if you previously held cryptocurrency and then used that cryptocurrency to purchase youjr NFT, then yes, you have a taxable event. When you use your cryptocurrency to purchase the new NFT you have an exchange of property. If your previously held cryptocurrency appreciated in value, then – at the exchange – you have a capital gain (or loss) and your new basis in the NFT is its purchase price. If you purchased cryptocurrency for the sole purpose of buying the NFT, then you likely have little or no gain or loss because the amount of time between your cryptocurrency purchase and the exchange of value (buying the NFT) is so slight. That is, only a nominal change in Fair Market Value is expected. So, whether purchasing an NFT is taxable depends upon “how” and “when” you purchased it.
We all know The Bill of Rights: Congress shall make no law abridging the freedom of speech and so on. But there is another kind of federal Bill of Rights, first introduced in 2014. It is the “Taxpayer” Bill of Rights or also known as TABOR. Yes, these rights really exist, and what they are might surprise you.
Like “The” Bill of Rights, there are ten. The Right to Be Informed, The Right to Quality Service, The Right to Pay No More than the Correct Amount of Tax, The Right to Challenge the IRS’s Position and Be Heard, The Right to Appeal an IRS Decision in an Independent Forum, The Right to Finality, The Right to Privacy, The Right to Confidentiality, The Right to Retain Representation, and The Right to a Fair and Just Tax System. There are some semblances to the “The” Bill of Rights, like the right to privacy over our affairs and the right to representation. But differently, TABOR gives taxpayers a real voice within the IRS.
TABOR are not shallow ideals; rather, they are law. Because of the efforts of former National Taxpayer Advocate, Nina Olson, TABOR was codified and became law in 2016. Now, the IRS instructs its personnel (Collection Officers and Auditors) that they have an ongoing responsibility to ensure all taxpayer rights are protected and observed throughout their dealings with taxpayers. And TABOR touches some of the most common (and stressful) IRS interactions.
With IRS Examinations, TABOR is present throughout. Examiners must now advise taxpayers of all their rights under TABOR at the initial audit interview. All examination papers must be concise and easy to understand. Examiners should consider unilaterally – even if unprompted – whether a taxpayer qualifies for penalty relief. And in more contemporary fashion, because of the Right to Privacy, IRS personnel are not permitted to log in to any social media sites while conducting official research. Taxpayers can thank TABOR for these protections.
With IRS Collections, TABOR again lends a hand. In fact, some of the protections may surprise you. A taxpayer has the right to make an audio recording of in-person IRS interviews, and taxpayers may request transfers of their cases to other IRS offices. At all times during IRS Collections, a taxpayer – thanks to TABOR – has a right to stop the proceeding and contact the Taxpayer Advocate Service at any time they are experiencing hardship. And IRS Revenue Officers cannot silent TABOR; rather, they are directed to clearly explain the IRS Appeals process to taxpayers and answer any questions regarding their right to appeal IRS collection actions. Finally, if a taxpayer is unlawfully bullied into a corner, he or she can always contact The Treasury Inspector General for Tax Administration and make a TIGTA referral for IRS misconduct.
TABOR opened many doors for taxpayers and IRS personnel, on the whole, respect those rights. But taxpayers are well-served to know their rights and exercise them where appropriate. TABOR is not just fluff. Make it part of your tax vocabulary and your IRS journey may be a bit more pleasant.
The filing of a Federal Tax Lien is a disruptive event in a taxpayer’s life. It can affect your credit, cause hardship with employment and make it difficult to sell your property to third-parties. But under certain circumstances, a taxpayer may request a withdrawal of a Federal Tax Lien. First, it is important to understand that a Withdrawal of a Federal Tax Lien differs from a Certificate of Release of Federal Tax Lien. They are not interchangeable and cannot be used for one another. A Withdrawal only removes the effect of the Federal Tax Lien whereas the Certificate of Release releases both the lien and extinguishes fully its legal effect. To request a withdrawal, a taxpayer generally files a Form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien. By statute, the IRS has the authority to withdraw a Federal Tax Lien under the following conditions:
- The filing of the Notice of Federal Tax Lien (NFTL) was premature.
- The taxpayer entered into an installment agreement (under certain conditions, discussed below).
- Withdrawal of the Federal Tax Lien will facilitate the collection of the tax liability.
- By consent of the National Taxpayer Advocate, the withdrawal would be in the best interests of the taxpayer and the Government.
Withdrawal using a Direct Debit Installment Agreement.
When certain conditions are met, a taxpayer may request Withdrawal of a Federal Tax Lien while in compliance with the terms of a “direct debit” installment agreement. A taxpayer may qualify for a withdrawal if:
- The aggregate unpaid balance of tax assessments are $25,000 or less at the time of the request.
- The total tax liability will be paid in-full in 60 months or the agreement will be fully paid prior to the Collection Statute Expiration Date (meet the statue of limitations for collections).
- The taxpayer must request the Withdrawal in writing, preferably using Form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien.
- The taxpayer is in compliance with other filing and payment requirements.
- The installment agreement is active, current and at least three consecutive electronic payments (generally received on a monthly basis) have been processed. Also, there have been no defaults in payment under this, or any previous, installment agreements.
- The taxpayer did not previously have a Withdrawal of Federal Tax Lien.
Withdrawal That Facilitates Collection.
A Withdrawal facilitates collection if withdrawing the Federal Tax Lien will result, either immediately or in the future, in a greater amount being collected by the IRS than had the Federal Tax Lien been maintained. To determine if Withdrawal of the Federal Tax Lien will facilitate collection of the tax liability, the IRS will consider all relevant case factors. One example provided in the Internal Revenue Manual is as follows:
A taxpayer has been making installment payments for the past year and has two years of payments remaining. The taxpayer is a salesman and needs to purchase a new automobile in order to continue to generate the income that is being used to make the installment payments. The taxpayer verifies that he cannot obtain a new car loan or a lease because of the Federal Tax Lien. The Federal Tax Lien may be withdrawn, with the provision that it will be filed again in case of default, because doing so will facilitate collection of the tax liability.
All requests for Withdrawal of the Notice of Federal Tax Lien must be in writing. Preferably, taxpayers should use Form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien; however, any written request that contains the necessary information may be used. Note: A faxed request qualifies as a written request. Written requests for Withdrawal must contain the following information: taxpayer’s name and current address; taxpayer’s identification number; a copy of the Federal Tax Lien affecting the property; a statement explaining the basis for the Withdrawal request; and authorization for disclosure of information to creditors, credit reporting agencies and financial institutions.
If you have a Notice of Federal Tax Lien filed against you, you have options, not all is lost. If we can be of assistance, please do not hesitate to contact us.
Remember 3 things: (1) the IRS statute of limitations for the collection of tax is 10 years; (2) the IRS statute of limitations can be extended for a number of reasons; and (3) the IRS statute of limitations “clock” never starts to “tick” if you never file a tax return; with unfiled tax returns, there is no statute of limitations. The 10-year statute of limitations begins on the “assessment” date, or typically the date you file a tax return. The IRS calls this date the “CSED” date or the “Collection Statute Expiration Date”.
There are many ways the 10-year CSED can be extended (beyond 10 years). Think of it this way – anytime some “event” prohibits the IRS from collecting tax for a given period of time, then the statute of limitations is extended for that time period and added to the back-end (plus, generally 30 days extra). Here are a few examples: filing bankruptcy, the IRS files a lawsuit against you, a timely-filed Collection Due Process (CDP) Appeals hearing request, anytime your tax case is in IRS Appeals, while your Offer in Compromise is pending, filing an IRS Innocent Spouse Claim and more.
The 10-year statute of limitations is not extended while you are in an installment agreement and current with it. The statute of limitations is extended while your installment agreement request is pending and for 30 days immediately following a rejection or a termination of an installment agreement.
This list is not meant to be exhaustive but should give you an idea of how statute of limitations work.
Can I dispute IRS penalties?
Yes, the IRS may waive penalties on the following grounds:
- Reasonable Cause;
- Administrative Waiver; or
- Statutory Exception.
What do the different grounds mean?
Reasonable Cause can mean a number of things:
- You exercised ordinary business care and prudence but were nonetheless unable to file or pay on time;
- You had matters beyond your control that left you unable to file or to determine the amount of deposit or tax due;
- You didn't receive the necessary financial information;
- You didn’t know you needed to file a tax return even though you made efforts to find out;
- You had a death in your immediate family;
- You or a member of your immediate family suffered a serious illness that kept you from handling your financial matters;
- You lost your tax documents in a fire or some other disaster.
This list is not exhaustive, but it gives you an idea of some the situations the IRS will consider. Other situations may also qualify for reasonable cause relief, however. The crux of any inquiry is: you did what any reasonable taxpayer would do, but because of some event or circumstances beyond your control you were unable to comply. If your situation fits that scenario, then you ask for a penalty abatement and be sure to request it in writing.
An Administrative Waiver is basically the IRS offering you a one-time forgiveness. First-time abatement procedure is just one example. The IRS may remove penalties under its First-Time Abatement policy if:
- You have no penalties for the 3 tax years prior to the tax year in which you received a penalty;
- You are filing compliant; and
- You have paid, or arranged to pay, any tax due (you are paying compliant).
Less common, but another example of an administrative waiver involves a taxpayer’s reliance on advice from the IRS. If you received incorrect verbal advice from the IRS, you may qualify for administrative relief of penalties. If you received incorrect written advice from the IRS, you may qualify for a statutory exception to the failure to file and/or the failure to pay penalties. If you feel you were charged a penalty because of erroneous written advice you received from the IRS, you would typically file a Form 843, Claim for Refund and Request for Abatement, to request penalty relief based on incorrect written advice from the IRS.
What if the IRS denies my Penalty Abatement Request?
You generally have appeals rights with penalty waiver denials and can request a conference or hearing before the IRS Office of Appeals. You typically have 30 days from the date of the penalty rejection letter to file your request for an appeal. IRS Appeals has greater latitude and wider discretion in granting penalty abatements. If you have grounds, you should always appeal a penalty denial to IRS Appeals.
How much are IRS penalties?
IRS penalties are high. Here is an overview of the penalty regime: IRS Penalties.
Simply put, I will initially give you the “typical” lawyer answer – “it depends…”. The statute of limitations for IRS audits varies depending on the nature of the tax issue. It is important to remember that the statute of limitations does not begin to “tick” until after a tax return has been filed.
So, remember, there is – in effect – no statute of limitations on an unfiled tax return (or a tax return filed fraudulently). In regard to an unfiled tax return or a fraudulent tax return, it can be audited at any time: three years or ten years or any period of time.
With filed returns, the basic rule is that the IRS can audit for 3 years after you file your return or the due date of the tax return, the later of those two dates. For example, if you filed early on say, February 15, the 3-year statute of limitations begins to “tick” on April 15 – the due date of the tax return (not the earlier filing date). So, you do not shorten the statute of limitations by filing early. If you filed late however, say November 15 (7-months late after April 15), the statute of limitation begins to “tick” on November 15 – the date you filed your tax return late.
But there are exceptions that give the IRS 6 years or longer to initiate a audit. For example, the IRS can audit for up to 6 years if you omitted more than 25% of your income. This 25% rule can apply to tax basis too – if an erroneous basis is used to underreport your income tax. The IRS also gets 6 years to audit if you omitted more than $5,000 of foreign income.
Also, if you omit a required IRS Form within your tax return, the statute of limitation remains open as to that omitted Form. Suspected criminality can also extend the statute of limitation to 6 years.
The proper application of the statute of limitations for audits “depends” on the facts and circumstances surrounding your particular situation. There is no hard and fast rule that applies to ALL situations.
The National Taxpayer Advocate Service (TAS) recently presented its 2020 Annual Report to Congress. Each year, the National Taxpayer Advocate give a report to Congress discussing various aspects of taxpayer rights and the effective and fair administration of the tax laws. The TAS 2020 Annual Report to Congress Executive Summary can be found here. TAS also released the National Taxpayer Advocate 2021 Purple Book. In it, it presents a concise summary of 66 legislative recommendations that it believes will strengthen taxpayer rights and improve tax administration. It can be found here.
Internal IRS records and your internal IRS case file can be critical to your tax defense. The IRS Revenue Agent’s or Examiner’s internal memorandum, workpapers or internal notes can give you the right clues as to the real issues in your case. You can obtain those records through a FOIA request; but you may also make an IRC 6103(e) request, either verbally or in writing. See IRC 6103(e).
The Taxpayer Advocate Service (TAS) will intervene on the behalf of taxpayers in certain situations. It is important to understand the criteria to gain TAS’s assistance. TAS is an independent organization within the Department of Treasury that helps taxpayers resolve problems with the IRS and recommends changes to prevent future problems. But your situation must meet their acceptance criteria.
The acceptance criteria fall into four main categories:
- Economic Burden: a situation where some IRS action or inaction has caused or will cause negative financial consequences or have a long-term adverse impact on the taxpayer. Economic burden can be broken down to four scenarios: (1) the taxpayer is experiencing economic harm or is about to suffer economic harm; (2) the taxpayer is facing an immediate threat of adverse action; (3) the taxpayer will incur significant costs if relief is not granted (including fees for professional representation); and (4) the taxpayer will suffer irreparable injury or long-term adverse impact if relief is not granted.
- Systemic Burden: where an IRS process, system, or procedure has failed to operate as intended, and as a result the IRS has failed to timely respond to or resolve a taxpayer issue. It can broken down into three main categories: (1) the taxpayer has experienced a delay of more than 30 days to resolve a tax account problem; (2) the taxpayer has not received a response or resolution to the problem or inquiry by the date promised; and (3) a system or procedure has either failed to operate as intended, or failed to resolve the taxpayer’s problem or dispute within the IRS.
- Best Interests of Taxpayer: cases to ensure that taxpayers receive fair and equitable treatment and that their rights as taxpayers are protected. That is, the manner in which the tax laws are being administered raises considerations of equity or has impaired or will impair the taxpayer’s rights.
- Public Policy: acceptance of cases into TAS under this category are on a case-by-case basis, where there’s a unique set of circumstances warranting assistance to certain taxpayers. It is a case where TAS determines compelling public policy warrants assistance to an individual or group of taxpayers.
At the center of all activities within TAS are the Taxpayer Bill of Rights. Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. Those fundamental rights include:
The Right to Be Informed
The Right to Quality Service
The Right to Pay No More than the Correct Amount of Tax
The Right to Challenge the IRS’s Position and Be Heard
The Right to Appeal an IRS Decision in an Independent Forum
The Right to Finality
The Right to Privacy
The Right to Confidentiality
The Right to Retain Representation
The Right to a Fair and Just Tax System
There are certain IRS requirements when closing your Corporation. It does not matter how long your business operated – from a few months to many years. Here is a list of the most required IRS Forms and Schedules when closing your operations.
- Your Corporate Income Tax Returns – 1120 or 1120-S, including Schedule D, capital gains or losses
- Make sure you selected the “Final Return” box at the top of the Corporate Income Tax Form
- If you adopted a resolution or plan to dissolve the corporation or liquidate its stock, you must file IRS Form 966, Corporate Dissolution or Liquidation
- If you sell your Corporation, you may need to file IRS Form 8594, Asset Acquisition Statement
- All outstanding employment tax returns, 941s (Quarterly Employment Tax Returns) and 940s (Annual Federal Unemployment (FUTA) Tax Return)
- For Form 941s, file it for the calendar quarter in which you made your final wage payments and enter the date final wages were paid on line 17
- On your final Form 941, you must attach a statement naming the person keeping the payroll records and the address where those records will be kept
- Be sure and make your final federal tax deposits for your employees or you could be liable for the Trust Fund Recovery Penalty if you are a person responsible for making such deposits
- For Form 940s, file for the calendar year in which final wages were paid and check the Box “d.” in the “Type of Return” section to show that it is the final form
- If you sell or exchange property used in their business, you must file an IRS Form 4797, Sales of Business Property
- You also need to file an IRS Form 4797 if your use of certain business property, Section 179 or listed property, drops to 50% or less
- Furnish your employees with their final W-2s and transmit them to the Social Security Administration; failure to do so could subject you to stiff non-reporting penalties
- If your employees received tips, an IRS Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, is required to report final tip income and allocated tips
- If your Corporation provides employees with a pension or benefit plan, you need to file a final IRS Form 5500, Annual Return/Report of Employee Benefit Plan
- If you paid contract workers (exceeding $600 in payments) during the calendar year in which you go out of business, you must file an IRS Form 1099-NEC, Nonemployee Compensation
There are still other good practice points to follow: the IRS recommends that business owners should keep all records of employment taxes for at least four years; and that businesses should keep records relating to property until the period of limitations expires for the year in which they dispose of the property in a taxable disposition.
Finally, remember that once the IRS has assigned you an EIN to your Corporation, it becomes the “permanent” EIN for that business. To close your business account, Corporations need to send the IRS a Letter that includes (1) the complete legal name of their business, (2) the EIN, (3) the business address, (4) the reason they wish to close their account and (5), if you have it, a copy of the notice that the IRS issued with the initial EIN assignment. The letter should be written to the IRS at: Internal Revenue Service, Cincinnati, Ohio 45999
As you can see, there is must to do in addition to closing your doors. This checklist provides you a path to full compliance when shutting down your corporate operations.
This short article discusses the importance of asset protection. It is very basic but gives you an idea of why asset protection is important. It does not capture the intricacies of asset protection planning; however, it does show you why it is important and what it does.
At the most basic level, a good asset protection plan provides you three things. One, outside-in protection. Two, inside-out protection. And three, peace of mind. You have worked hard to build your company and your assets, both personal and business. Without asset protection, all of your assets are at risk, comingled and exposed to one libelous event. However, if you structure your company properly you can isolate the triggering events.
If you had a properly formed LLC for example, with a properly drafted LLC Operating Agreement, should a libelous event occur in your personal life (outside the LLC), the outside personal creditor would be prevented from foreclosing on your membership interests and company assets inside the LLC. This is “outside-in” protection. However, this relies specifically on proper drafting of the LLC Operating Agreement. A poorly drafted Operating Agreement can destroy asset protection entirely. But if you follow proper company formalities and carefully draft an LLC Operating Agreement, with the proper language and protections, you can achieve “outside-in” protection.
The inverse is also true with “inside-out” protection. A properly formed LLC with the right LLC Operating Agreement can prevent a libelous event inside the company from reaching your personal assets outside it. This is “inside-out” protection. I cannot stress enough the importance of internal company documents, whether that be the LLC’s Operating Agreement or a corporate Shareholder’s Agreement. And you must also follow all company formalities, including things like drafting Bylaws, company minutes and annual meetings. Without proper formalities, an argument could be made that your asset protection structure is merely a sham and you never intended to treat the company separate and distinct from yourself. Establishing true separateness is a tenant of good asset protection planning.
From the beginning, it is imperative that you follow all company formalities and pay close attention to your Operating Agreement or Shareholder’s Agreement. Often times, boilerplate language will not suffice. You should make an investment of time and money on the front end to ensure you have the protection on the back end. If we can be of assistance in forming your company, drafting the proper internal company documents or assisting you with company business matters as they arise, please do not hesitate to contact us.
There are many considerations in choosing the proper company “form” for your new or existing business. But it is important that you first understand the basics of company formation. Below is an overview of the most common company formation options available to you.
Proprietorship. This is owned by a single individual. There are no formalities or “corporate governance” issues. Income is reported on Schedule C of the Form 1040 – the U.S. Internal Revenue Service (IRS) tax form – and there is no separate “entity” filing. The major – and significant – drawback is that the proprietor is personally liable for contracts and torts (i.e., liabilities) of the business.
Partnership. This is owned by two or more persons who own a business conducted for profit. Formalities may be required, depending upon the form of the partnership. Partnerships file a copy of Schedule K-1 (Form 1065) with the IRS to report a partner’s share of the partnership’s income, deductions, credits, etc. Generally, partnerships do not pay tax at the entity level. The exception is if the partnership makes a “check-the-box” election to be treated as a C corporation for tax purposes. Unless otherwise agreed, typically all partners are equal owners and have an equal voice in management, and ordinary matters are decided by majority vote. Also, unless otherwise agreed, acts outside the ordinary course of business require a unanimous vote. As in a proprietorship, no formalities are required, although a partnership agreement is strongly recommended.
Limited Partnership (LP). This involves one or more general partners who manage the business and have unlimited liability, and one or more limited partners who have no voice in management but enjoy limited liability. Generally, the limited partnership must file a certificate of limited partnership with the state, and each state has different requirements for drafting and filing. General partners are liable for contracts and torts of the business, but limited partners are not liable. The structure may encourage investment into more risky ventures where the management team is experienced and is perceived to have “skin in the game”, given the unlimited personal liability. Examples include hedge funds, some real estate deals (hotels, office buildings, shopping centers), tax minimization vehicles (movie or record deals, some oil and gas), and family offices (when used as an estate planning tool).
Limited Liability Partnership (LLP). This is a general partnership (above) that has elected limited liability status for its partners. An LLP structure protects the partners against personal liability arising from contracts or torts made after the date of filing. Examples include national accounting firms, large law firms, and other professional firms.
Limited Liability Limited Partnership (LLLP). This is a limited partnership (above) that has elected limited liability status for its general partners. It is not available in all states, but, where permitted, generally this requires a simple filing with the state. Like the LLP (above), the structure protects partners against personal liability arising from contracts made after the date of filing. Examples include existing limited partnerships that desire to protect the general partners from personal liability (for liabilities incurred following the date of conversion) and a family LP.
Limited Liability Company (LLC). This is not a “partnership”, but, like partnerships, typically LLCs pass through the income to the member and do not pay tax at the entity level. LLCs are the response of states to the rigidity of the U.S. Internal Revenue Code regarding the taxation of corporations. The structure allows owners and investors to enjoy limited liability without the complexities of a corporate taxation structure. Generally, the entity is organized by filing articles of organization with the state. Unlike the corporation (below), which has comprehensive rules codified in statutes regarding corporate governance, generally LLCs create their own management scheme, although the governing statutes do provide certain default rules. The primary tool for doing so is the operating agreement. Owners of the LLC are referred to as members rather than stockholders, as in the corporation context. Often LLCs are governed by managers. The members may serve as managers directly (a “member-managed” LLC) or appoint others to serve as the managers (a “manager-managed” LCC). The default rule is that action may be taken if authorized by those members holding a majority of the LLC's interests in profits.
Corporation. This is what one may think of as the traditional corporate form. The owners of a regular corporation are stockholders. The stockholders elect the board of directors, which manages, or oversees the management of, the business and affairs of the entity. The board of directors, in turn, appoints the officers to manage the day-to-day operations of the entity. The general principle is that decisions are made by the board of directors as the elected representatives of the stockholders. The exception is for certain extraordinary acts that require a vote of the stockholders, such as for a merger, a sale of assets, or an amendment of the charter. In contrast to a regular corporation, a “close corporation” may elect to have no board of directors, and typically certain extraordinary acts require the unanimous or two-thirds vote of all stockholders. In terms of taxation, the corporation may elect to be treated as an “S corporation”, which protects the corporation from being taxed at the entity level and, like an LLC or partnership, permits the income to pass through to the stockholder for tax reporting. An S corporation, however, is subject to certain restrictions. For example, the entity must have 100 or fewer stockholders, all stockholders generally must be individuals or certain trusts (and not corporate entities), and there may be only one class of stock. Importantly for foreigners, the structure does not permit non-U.S. ownership. By contrast, a “C corporation” – like the LLC (above) – has no limit on the number of stockholders, no limit on the classes of stock, and no limit on the types of stockholders. But, unlike the LLC, the entity is subject to double taxation, meaning that income is taxed at the corporate level at the then-prevailing corporate tax rate and again when dividends (payments) are issued to the stockholders.
Adapted from, “Choice of Entity Basics and Other Suggestions for Your New U.S. Business”, Alexander W. Koff, Lexology accessed June 7, 2021
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