Recently in Dealing with the IRS Category

May 18, 2011

IRS Hangs Tough on IRA 60-Day Rollover Deadline

In a recent private letter ruling (PLR 201118025), IRS got pretty tough with a taxpayer whose IRA rollover took a bit longer than the permissible 60 days.

IRS sometimes offers a bit of leniency in these cases. Rev Proc 2003-16 outlines the situations in which leniency might be appropriate, and notes "The Service will issue a ruling waiving the 60-day rollover requirement in cases where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster or other events beyond the reasonable control of the taxpayer." But not so in this case.

Here, the taxpayer and his siblings wanted to help their elderly mother purchase (for cash) a new residence, necessitated by her mobility limitations which made it unsafe for her to remain in her two-story residence. So, the taxpayer took a distribution from his IRA and applied the funds toward a new residence for his mother who then secured a reverse mortgage to generate the funds to repay the taxpayer and his siblings.

Despite assurances from the bank (that the mortgage process would be completed in time to enable the taxpayer to meet his 60-day rollover requirement) delays ensued and the taxpayer missed the deadline. He pled mercy -- claiming that his failure to timely complete the rollover was due to "numerous and unreasonable processing delays" which "were beyond his control."

But IRS concluded that the taxpayer had not presented any evidence as to how any of the factors outlined in Rev Proc 2003-16 affected his ability to timely complete the rollover. Those factors include:

  1. Errors committed by a financial institution;
  2. Inability to complete a rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error;
  3. The use of the amount distributed; and
  4. The time elapsed since the distribution occurred.

IRS' position in this case was that none of the above applied -- the taxpayer's IRA funds were simply used to make a short-term loan to Mom. Period.

Bottom line -- push the 60-day time limit at your own peril.

April 13, 2011

Tax Dodgers and Whistleblower Ethics

A curious section of the Internal Revenue Code allows the IRS to pay money to people who blow the whistle on persons who fail to pay taxes owed. Particularly curious when the whistleblower may be the tax dodger's own accountant!

The amount of the reward is determined by the IRS' "Whistleblower Office," and depends on the extent to which the whistleblower "substantially contributed" to the administrative or judicial action the IRS brings based on the information. All relevant factors, including the value of the information furnished in relation to the facts developed by an investigation of the violation are taken into account in determining the amount of the reward.

Section 7623 allows the Secretary to pay an "informant award" of at least 15 percent, but not more than 30 percent of the amount collected if the taxes, penalties, interest and other amounts in dispute exceed $2 million. If the case deals with an individual, his or her annual gross income must be more than $200,000. If the whistleblower disagrees with the outcome of the claim, he or she can appeal to the Tax Court.

There is also an award program for other whistleblowers -- generally those who do not meet the dollar thresholds mentioned above. Awards in the smaller cases are discretionary and the informant cannot dispute the outcome of the claim in Tax Court.

Recently, the IRS paid $4.5 million to an accountant who "blew the whistle" on his employer, and found something like $20 million for the government. Sounds like a "win-win," but the notion of Uncle Sam encouraging advisors to turn in their employers and clients is unsettling to say the least. Most of us consider our first obligation to provide honest, reputable advocacy to all of our good and valued clients, and not to function as government cops, policing the collection of revenue.

But if you're so inclined, consider IRS Form 211: Application for Award for Original Information.

March 23, 2011

Odds of an Audit: Interesting IRS Stats

So you're thinking about playing the old "audit lottery," and wonder what the stats show regarding your chances of getting caught, and what the consequences might be.

Check out the IRS 2010 Data Book (Publication 55B) which is supposed to be printed by mid April. The info there covers IRS fiscal year 2010, and covers not only tax audit rates, but other items, such as the categories of returns which interest the IRS most, and collections efforts.

In terms of the overall changes of being audited, only about 1.1% of all individual returns filed in the fiscal year were audited -- up from 1.0% in the prior year. And only 21.7% of the individual audits were actually conducted by revenue agent folk. The other 78.3% were correspondence audits.

Here are some key stats regarding individual audits (other than audits of taxpayers claiming the earned income tax credit):

  • Business returns (other than farmers) showing total gross receipts of $100,000 to $200,000: 4.7% audited
  • Business returns showing total gross receipts of $200,000 or more: 3.3% audited
  • Farmers (Schedule F filers): 0.4% audited
  • Individuals with adjusted gross income (AGI) between $100,000 and $200,000: 0.71% audited
  • Individuals with AGI between $200,000 and $500,000: 1.92% audited
  • Individuals with $1 to $5 million AGI: 6.67% audited

As for corporations (other than those filing Form 1120S), 1.4% were snagged for audit overall. But small corporations with assets of $1 to $5 million experienced a 1.7% audit rate.

Some more interesting stats: the total number of individual returns actually filed dropped 2% from the year before. When times are bad, the number of filers drops off. Nonetheless, IRS continues to find a way to penalize very many filers -- the top three penalties in percentage terms were 57.3% for failure to pay, 27.3% for underpayment of estimated taxes, and 13% for filing taxes late.

And beyond the common civil penalties, the stats show that crime doesn't pay -- IRS initiated 4,706 criminal investigations in 2010, and of those convicted, 81.5% were incarcerated - up from 81.2% the year before.

Learn how to stay off the IRS radar -- and get tips on what to do if you are audited -- in Nolo's articles How to Reduce the Chance of an Audit and Top 10 Tips for Surviving an Audit.

February 15, 2011

Are Punitive Damages Excludable From Income?

You've got to hand it to the Greenbergs. It was a nice try, attempting to read between the lines of the Internal Revenue Code in an effort to justify excluding a punitive damages award from their income tax return.

Unfortunately, they couldn't convince the Tax Court. In a recent decision, the Court not only slapped the Greenbergs down in affirming a tax deficiency of over $1 million, but further hammered the folks in sanctioning the IRS imposed accuracy-related penalty, because the taxpayers had neither substantial authority, nor reasonable cause underlying their posture on the damage award. (The decision is Gary L. Greenberg, et ux. v. Commissioner, TC Memo 2011-18.)

Seems Mr. Greenberg, owner of a disability income policy, became disabled, thus precipitating a claim. The insurer paid some benefits, but not as much as Greenberg thought was proper, so he sued, alleging breach of contract and insurance bad faith. And, by golly, he won a damage award which included $2.4 million of punitive damages, which the taxpayers excluded from their return, justifying the exclusion on the basis of Internal Revenue Code Section 104(a)(3). (Learn more from Nolo: I won a lawsuit; do I have to pay tax on my damage award?)

Unfortunately that section only permits exclusion of "amounts received through accident or health insurance.....for personal injuries or sickness...." which "amounts" Mr. Greenberg liberally interpreted to include the punitive damages.

But the Court wasn't buying it, noting that, "In general, exclusions from income are narrowly construed," and with specific reference to IRC Section 104, that the Supreme Court had clearly spoken in the O'Gilvie case, to the effect that punitive damages received in a suit for personal injuries are not received "on account of" the personal injuries, themselves, but rather in connection with assessing a form of punishment on the offending party. Bottom line: punitive damages are taxable.

Attempting a novel twist on words, the Greenbergs also claimed that the punitive damages they received were not punitive, but "bad faith damages" (whatever that means), and that "damage awards that serve both to compensate and punish are excludable."

Perhaps the Greenbergs would have gotten farther had they found some citation in the published authority for this position, which they apparently did not.

One last point, of course, should be notation of the fact that the current application of IRC 104 only pertains to exclusion of compensatory damages "on account of personal physical injuries or physical sickness."

Pain and suffering just won't cut it.