Every so often a client asks me, “Can I fund/purchase/own my business through an IRA.” My general answer is don’t do this! You may be able to do it legally, but there are so many gotchas that it’s rarely worth the aggravation.
A taxpayer tried to own his closely-held C-Corporation through his IRA. The results weren’t pretty. Joe Kristan has the details on what went wrong and the troubles the taxpayer now faces.
Yesterday I wrote about the scandal with tax exempt organizations at the IRS. Basically, “low-level employees” according to Lois Lerner of the IRS independently decided to target tax exempt groups with “Tea Party,” “Conservative,” or “Patriot” in their names. Of course that contradicted former IRS Commissioner Douglas Shulman who testified to Congress that there was no such targeting.
However, the AP is now saying that the targeting began in 2011:
Senior Internal Revenue Service officials knew agents were targeting tea party groups as early as 2011, according to a draft of an inspector general’s report obtained by The Associated Press that seemingly contradicts public statements by the IRS commissioner.
The AP report states that TIGTA (the Treasury Department’s Inspector General for Tax Administration) will be releasing a report this coming week on the issue (the report has been a year in the making). I expect that TIGTA report to get a lot more reading than the tax nerds who usually read TIGTA reports. But I digress….
While it’s unclear if former Commissioner Shulman knew of the targeting, it appears that the IRS Chief Counsel’s office knew. From the AP story:
Among the other revelations, on Aug. 4, 2011, staffers in the IRS’ Rulings and Agreements office “held a meeting with chief counsel so that everyone would have the latest information on the issue.”
When the Washington Post and the Wall Street Journal agree editorially you know you have a problem. Today, the Post editorialized that they were aghast over the revelations.
The IRS insisted emphatically that partisanship had nothing to do with it. However, it seems that groups with “progressive” in their titles did not receive the same scrutiny.
If it was not partisanship, was it incompetence? Stupidity, on a breathtaking scale? At this point, the IRS has lost any standing to determine and report on what exactly happened. Certainly Congress will investigate, as House Majority Leader Eric Cantor (R-Va.) promised.
The Journal editorial is similarly scathing toward the IRS:
Just because you’re paranoid doesn’t mean the IRS isn’t out to get you. We only wish that were a joke…
Republicans were up in arms Friday about the IRS disclosure, and rightly so. We assume they will use their oversight power in the House to find out what happened, and whether these Cincinnati kids were really operating on their own.
Other than the power to prosecute, the taxing authority is the most awesome power the government has. It can ruin people and companies. When wielded for political purposes, it is a violation of the basic contract the American people have with their government. The abuse admitted by Ms. Lerner can’t be dismissed in a casual apology on a casual Friday as no big deal. It’s a very big and bad deal.
I recommend reading both editorials in their entirety.
There are lots of questions that need answering:
– Why were politically conservative groups targeted?
– Who at the IRS condoned these actions?
– Was this truly a spontaneous action by “low-level” employees at the Cincinnati Service Center or was this coordinated by Ms. Lerner or others?
– Was outside pressure (e.g. from the White House) put on the IRS to look at these groups?
I’m sure you may be able to think of others. I also suspect that the timing of the apology by Ms. Lerner has a lot to do with the upcoming TIGTA report.
I try to avoid talking politics in this blog. I happen to be a political conservative, but I would be furious if the IRS targeted groups with the word “Progressive” in their title. This is a huge deal, and with the IRS set to be the enforcement arm of Obamacare, expect Republicans to rightly wonder about it. If President Obama was expecting a budget increase for the IRS, this scandal almost certainly eliminated any chance of that happening.
Last year, tea party and conservative groups complained that the IRS was blocking their ability to become tax-exempt organizations. Some organizations complained that the IRS was asking for lists of donors. Last year, then IRS Commissioner Douglas Shulman denied that any such actions were taken.
It turns out Commissioner Shulman was wrong.
Today, Lois Lerner, Deputy Commissioner of the IRS for Exempt Organizations, noted that actions were taken. From an AP story:
“That was wrong. That was absolutely incorrect, it was insensitive and it was inappropriate. That’s not how we go about selecting cases for further review,” Lerner said at a conference sponsored by the American Bar Association.
“The IRS would like to apologize for that,” she added.
The IRS specifically looked for the words ‘tea party’ and ‘patriot.’ Heaven help the Patriot Tea Party League of Patriotsville, Indiana. (I made that last line up, btw.)
Ms. Lerner stated that the actions were taken by low-level employees at the IRS Cincinnati Service Center. The IRS apologized for this occurring. For some in Congress, the IRS apology is not nearly enough. Senator Mitch McConnell (R-KY) wants a probe into the actions. Congressman Darrell Issa (R-CA), chairman of the House Oversight Committee, promised an investigation:
The fact that Americans were targeted by the IRS because of their political beliefs is unconscionable. The Committee will aggressively follow up on the IG [Inspector General] report and hold responsible officials accountable for this political retaliation.
Another part of this scandal–and it is exactly that, a scandal–is that the news of it coming out was accidental. The Fix on the Washington Post noted,
Lerner said she disclosed the information because someone asked her about it Friday morning — indicating that she had no plans to release the information publicly, despite the confirmed wrongdoing.
Of course, this won’t do any favors for the IRS’s reputation. This won’t help the IRS’s ability to increase its budget, nor will it bring a sense of rerlief to anyone thinking about how the IRS will be overseeing health care under Obamacare.
A question I’m asked every year is how long should I keep my tax returns? And how long should I keep the backup documentation for the returns? The first question is easy to answer; the second one isn’t. (James Maule’s post on this subject reminded me of this issue.)
To start on this determination, we need to look at the statute of limitations. That is generally three years from the due date of the return or date of filing (whichever is later) for federal returns. However, it doubles to six years if there’s a gross understatement of income. For your 2012 taxes timely filed, that would be either April 15, 2016 or April 15, 2019. Most states give their tax agencies an extra year for the statute of limitations, so if you live in a state with state income tax that means four or eight years from the due date of the return or date of filing (whichever is later). So you can ditch the returns after eight years, right?
Wrong. I strongly recommend you keep your tax returns–and proof of filing–forever. There is no statute of limitations if you don’t file your return. A few years ago, one of my clients was accused by a state tax agency of not filing his 1977 state tax return. Yes, 30 years after that return was likely filed the state came to him and said he didn’t file the return. They accused him of owing a couple thousand dollars of tax, and a lot more in interest and penalties. My client did have his federal tax return, and we were able to find enough records to show that he was owed a refund by the state for 1977. (Most likely, the 1977 state return was filed and the state tax agency’s records got messed up.) Had my client kept his state tax return he would have been able to send a copy to the state and saved himself a lot of aggravation and fees.
Well, at least I can shred all my backup documentation after six or eight years, right?
Perhaps. If you don’t have any investments, any items with basis calculations, or any similar items, yes, those items can be disposed of after six or eight years. For example, a sole proprietor’s travel receipts can be shredded at that time. However, there are many receipts and records that need to be kept for far lengthier periods. Let’s look at some examples:
1. You bought a stock in 1992. You sell it in 2014. You claim a capital loss on your shares of the stock. The IRS examines your return and alleges that you didn’t have a loss; rather, you made a large profit. Wouldn’t you like to have proof of your purchase price?
2. You purchase a rental property in 1998. In 2007, you use a Section 1031 exchange to defer the gain on sale of that property (by purchasing another property through a qualified intermediary). In 2013, you use another 1031 exchange. In 2020, you sell the property that you ended up with. You need proof of your basis in the property. That means you will need the HUD Settlement Statement on the purchase and sale of all the properties. If you made improvements to the properties, you need those receipts. Depreciation records will be needed. If in 2002 or 2006 you disposed of the records of the original rental purchase, you may have a problem.
3. You purchase a boat in 2002 for $50,000. You retire in 2013; your taxable income is now quite low (you have nontaxable income from municipal bonds). In 2014, a drunken boater rams and destroys your boat. Unfortunately, you only receive $25,000 from your insurance company. You claim a casualty loss on the damage to your boat for $25,000. The IRS denies the loss in an audit. If you don’t have records showing the purchase price of the boat (your “basis”), the IRS will likely win in Tax Court.
I can go on with similar examples–these three were ones I quickly thought of. If you are certain that a situation like any of these won’t apply to you, shred away! Unfortunately, I suspect most of us have items like these (especially clients of tax professionals). If so, keep those records.
If anyone wonders why I left the Bronze Golden State, yet another survey has come out regarding places to do business. Chief Executive Magazine rated all 50 states from top to bottom. Before focusing on the dismal state of California’s business climate, let’s highlight the top ten states:
1. Texas
2. Florida
3. North Carolina
4. Tennessee
5. Indiana
6. Arizona
7. Virginia
8. South Carolina
9. Nevada
10. Georgia
At the bottom was California:
41. Maryland
42. Pennsylvania
43. Hawaii
44. Michigan
45. Connecticut
46. New Jersey
47. Massachusetts
48. Illinois
49. New York
50. California
Looking at why California ranks where it does, one can see the problems are taxation and regulations. The comments note that the regulations and taxation is unreasonably and “…getting worse, if that is even possible.” Compare these to the comments regarding Texas: “Texas is the clear leader because of taxes and pro-business attitudes.”
Do I expect anything to change in California? No — I think the state will have to hit bottom (be broke) in order for real change to happen.
When are tax returns due? For most individuals, its April 15th. However, if you are outside of the United States on April 15th for purposes of employment or self-employment you get an extra two months (until June 15th) to file your return. There are no penalties but interest is charged. As the IRS states (see the link), you simply attach a statement to the return and no penalties are supposed to be charged. I’ve been preparing returns for expatriates for years and never had any problem with this…until last year (the 2012 tax season for filing calendar year 2011 returns).
For whatever reason, I had several clients who were charged penalties who were outside of the United States on April 17, 2012 (last year’s tax deadline) for employment/self-employment purposes. I checked with my software vendor and they told me that nothing had changed with the software–the notices were attached to the filed returns. I believe them because I had two clients who paper-filed who were charged penalties! In all cases, a statement was attached to the return noting the taxpayer was outside of the US on the tax filing deadline.
In most of these cases, I was able to reverse the penalties with a phone call. However, I have had three clients where I have had to write letters to the IRS. Here’s how one case was resolved.
This client’s return was filed in early June. She took the automatic extension, with a statement attached to her return. She had a small balance due which was paid through electronic debit (with the filing of her return). In mid-July she received a CP14 notice noting that she owed late filing and late payment penalties. I obtained a Power of Attorney and called the IRS. The IRS refused to lift the penalties. I wrote a letter in early August explaining that no penalties should be owed. In mid-September, I received a response from the IRS that they hadn’t resolved the situation. In mid-December, the IRS denied removing the penalties.
We have carefully reviewed your case. However, the information provided did not establish reasonable cause. Thus we are unable to remove your penalties for failure to file and failure to pay.
Did the IRS even read the letter I wrote? I asked for the penalties to be removed based on the out-of-country automatic extension, not for reasonable cause. (And yes, it took the IRS over four months to give an answer to my letter.)
We then appealed the decision. The hearing was held in late March and was the shortest Appeals hearing I’ve ever had. The Appeals Officer stated that we were correct, and that no penalties should be charged. “I can’t remove the interest,” he noted. I told him that was fine–the client does owe the interest. The Appeals Officer told me that he had no idea why this couldn’t have been resolved at the Service Center level or by Service Center Appeals Screening. (All appeals are first screened for obvious cases where the appellant is correct. A few years ago, I filed an appeal on behalf of a client who was charged the late filing penalty when his efile return was rejected on October 15th; he had mailed the return the next day–and mailed it using certified mail, return receipt rejected. The screening staff granted our appeal.)
Well, I may be able to answer the question as to why this couldn’t be resolved at the Service Center. I suspect that staff answering the notices (generally, the automated underreporting unit, or AUR) have problems when it’s not something they’ve encountered before. (I cringe when I have a client who receives a CP2000 notice regarding, say, a W-2G. Most personnel at the IRS rarely see gambling-related tax issues and don’t understand the law.) Most likely, the individuals who reviewed the letters I sent had no idea that there’s an extended deadline when you’re outside of the US on April 15th. Since they didn’t know of it, it couldn’t exist.
Second, the sheer volume of notices being sent out is creating a huge volume of responses. This means the staff handling those responses have been overworked. Given that two-thirds of IRS notices are incorrect (in part or in whole), the IRS is likely getting lots of letters. Overwork leads to errors in responses.
I don’t know if I’ll actually have to go to Appeals on the other two clients whose cases have yet to be resolved. (These are both going through the same IRS Service Center which rejected my first client’s out-of-country extension.) In the end, I’m certain my clients are in the right. But consider the expense to my clients and the expense to the IRS. As Joe Kristan noted last week, the IRS could do a better job in spending the money it has. I would expect that basic training in the deadlines would be given (or at least, knowledge of the rules or a database of where to look).
Unfortunately, I don’t expect things to get better. The problem is that the AUR program is a huge moneymaker for the IRS. Far too many individuals see an IRS notice and blindly pay it. Most of my clients have been reading my newsletter (or this blog) and know the reality of IRS notices and don’t blindly pay IRS notices. Make sure you don’t either.
Having resided in Southern California, I know you can put a lot of miles on your car in that area. One engineering teacher learned the hard way from Tax Court that a written mileage log is essential if you want to deduct your business miles.
The petitioner taught at several schools in Southern California. He was not reimbursed by the schools for his mileage. He claimed 85,491 business miles driven–a deduction of $46,593. The IRS allowed only 4,970 miles. That’s a difference of 80,000 miles and a difference that large led to the case going to trial.
Unfortunately, the petitioner did not keep a contemporaneous written mileage log. The Cohan rule (allowing the Court to estimate an expense) does not apply to automobile expenses.
To meet the heightened substantiation requirements, a taxpayer must substantiate the amount, time of use, and business purpose of the expense. Sec. 274(d); see also sec. 1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985). To substantiate by adequate records, the taxpayer must provide both an account book, a log, or a similar record, as well as documentary evidence, which are together sufficient to establish each element of an expenditure…Documentary evidence includes receipts, paid bills, or similar evidence…To substantiate by sufficient evidence corroborating the taxpayer’s own statement, the taxpayer must establish each element by the taxpayer’s statement and by direct evidence, such as documentary evidence.
Unfortunately, the petitioner didn’t maintain a contemporaneous log.
During his testimony petitioner submitted into evidence a mileage log which was created after the 2008 tax year. Petitioner claimed he drove 88,820 miles related to business travel in 2008. Corroborative evidence used to support a taxpayer’s reconstruction of expenditures “‘must have a high degree of probative value to elevate such [a] statement’ to the level of credibility of a contemporaneous record.”
The question for the Court was whether the testimony of the petitioner was enough to prove the 80,000 miles were for business but not commuting (commuting mileage is never deductible).
We find the mileage summary to be insufficient under section 274(d) because the mileage amounts were not entered at the time the vehicle was used. Petitioner testified that the mileage log he presented at trial was prepared “after [he] was approached by the IRS”. Outside of the syllabi petitioner presented, we are unable to determine for what purpose petitioner was traveling to and from the various schools outside of class time. Petitioner provided no evidence to corroborate entries in the mileage log for random trips to the schools other than testimony that he made various trips to prepare for the semester. We are unable to verify whether these trips were for business or were personal.
The petitioner also attempted to argue that even if the mileage were commuting mileage, these were temporary positions. The problem is that commuting to temporary positions outside of the metropolitan area where you reside can be deducted (this would be a travel expense). Unfortunately, all of the positions were within the Los Angeles metropolitan area.
Petitioner worked and lived in the same metropolitan area, and therefore we find that petitioner’s commuting expenses do not qualify for the exception to the general rule of nondeductibility. We hold that petitioner’s commuting expenses were nondeductible.
If you’re going to deduct mileage, keep a contemporaneous written mileage log. It takes just a few seconds to note your starting and ending mileage, the date, where you went, and the business purpose. It could be the difference in deducting 80,000 business miles.
Case: Daniel-Berhe v. Commissioner, T.C. Summary Opinion 2013-33
One of the most difficult things to explain to a non-tax practitioner is the tax concept of domicile. For most individuals, your domicile is your residence. I reside in Las Vegas, Nevada. It’s my only home. In my case, my domicile and residence are identical (as is the case for most people).
However, some individuals have multiple residences. Take Ken Mauer. Mr. Mauer has a home in Afton, Minnesota (just east of the Twin Cities). He also has a home in Fort Meyers, Florida. They’re both residences, so which is his domicile? If Mr. Mauer’s had residences in Nevada and Florida, this wouldn’t be a big issue (neither state has a state income tax). However, Minnesota has a state income tax so being considered a Florida resident would save Mr. Mauer thousands of dollars in state income tax.
Shock of shocks, Mr. Mauer declare himself a Florida resident and didn’t file Minnesota tax returns for 2003 or 2004. After the Minnesota Department of Revenue objected, he filed a part-year 2003 return. Mr. Mauer was audited by the Department of Revenue and lost. He appealed the decision to the Minnesota Tax Court and lost. He then appealed to the Minnesota Supreme Court. That court upheld the previous decision.
I’m not going to into Minnesota’s 26-factor test, or the factors that led to Mr. Mauer being considered a resident of the Gopher State rather than the Sunshine State. One factor, though, is key: Mr. Mauer spent more time in Minnesota than Florida. Few tax agencies will consider you a resident of the other state if you continue to spend a lot of time in their state. Suffice to say, it you are in such a situation it’s best to cut all ties to your old state…or at least spend 183 days in your new home. In Mr. Mauer’s case, he’s liable for Minnesota state income tax for 2003 and 2004.
Hat Tip: How Appealing