Monthly Archive: September 2014

Death Gift Estate Tax For Beginners

Welcome to TaxView, with Chris Moss CPA

Death tax is a fact of life, or death, as the case may be, and death taxes have been taxing estates for thousands of years. Euphemistically referred to as “estate tax”, the tax is assessed when assets are transferred to your beneficiaries on that special day of your departure over the tax free IRS allowed exemption. Despite the fact that Congress likes to adjust this exemption from time to time, if your tax attorney “guessed” right as to what the tax free exemption will be when you die, your estate pays no tax, if she guessed wrong….well your kids just might have to sell the farm to pay the estate tax. Best practice is to gift to your Family Limited Liability Company (LLC) up to the IRS annual 2014 exclusion of $14,000 per person ($28,000 if married) which reduces by the same the amount of the value of your estate. Sounds easy, but beware of the IRS tax traps waiting for the unwary beginner. So you had better stay with us on TaxView with Chris Moss CPA for an exciting journey to the beginner’s world of estate and gift tax planning so you can keep your assets legally safe from taxation for many generations to come.

First, if you don’t yet have a Family LLC I recommend you first read my article on the Family LLC as well as read my article on Family LLC Discounts. You can make up to $28,000(married) in 2014 tax free gifts a year to each of your children. If you are married and have two children age 10 by the time they are both 20 each will have $280,000 worth of membership in your family LLC. In addition to the annual gift exclusion of $28,000, you can also make lifetime gifts of $5M ($10M married) but these gifts require the filing of a gift tax return with the IRS. Any gifts over the $10 Million are taxable, either as gifts if you are alive or as estate tax if you are dead. Because Congress frequently changes these exemptions and exclusions, best practice requires annual review of your estate plan by your tax attorney to make sure your unique plan complies with current law. Sounds simple but not really. In addition to ever changing exclusion and exemptions amounts, there are many death traps awaiting you as you create the family LLC.

The first trap we are going to cover today is released with a trap question: When is a gift not a gift? To answer this question we head on over to US Tax Court to listen in on a 2013 Tax Court case Estate of Sommers v IRS. Sommers was a successful physician who owned a valuable collection of art. Sommers retained the services of a B&T Tax Attorney who advised Sommers in 2001 to get the art appraised, create an LLC as owner of the art and gift LLC units to his three nieces, Wendy Julie and Mary up to the maximum allowed exemption ($675K at that time) to avoid Sommers of having to pay gift tax. However, after the appraisal came in over the exemption and gift tax was owed, the nieces paid the gift tax themselves to avoid any breach of the agreement and more importantly to reflect that the parties carried out the original intent of the agreement that Sommers pay no gift tax.

Fast forward a few years and Sommers (or perhaps other relatives of Sommers) changed their minds about gifting the art to Wendy, July and Mary, but the nieces refused to give the art back to Sommers. After Sommers died, his executor sued the nieces for the art in various State court actions claiming that the gift agreement was illegally altered when the appraisal came in over the allowed exemption. Even though the estate eventually lost in state court, it’s legal executor nevertheless included the value of the art as part of the estate tax return on Form 706. The IRS rejected this return noting that Form 709 a US Gift tax return had been filed years earlier in 2001 for these same works of art. Sommers estate appealed to US Tax Court. Estate of Sommers vs IRS. Judge Halpern sided with the IRS noting that Sommers did not retain the power to “alter, amend, revoke or terminate those gifts within the meaning of IRS Section 2038 and therefore, the gifts were valid and had to be removed from Summers estate. IRS (and nieces) win, Estate of Sommers and other relatives lose.

The second trap we are going to look at today is found in the Operating Agreement of the LLC as highlighted in the US Tax case of Hackl v IRS. Hackl was a successful executive with Herff Jones Inc. in Georgia. Upon his retirement in 1995 he started a tree farming business with his wife in both Georgia and Florida. Treeco LLC was created with both Mr and Mrs Hackl owning 50% each. The LLC operating agreement designated Hackl as the initial manager to serve for life and had very restrictive buy sell provisions. One such restrictive provision required each new member to get Hackl’s permission before they could sell their membership, even if the sale was between brothers and sisters. Shortly thereafter, Hackl gifted various membership interests in Treeco to each of his eight (8) children and spouses and timely filed gift tax returns to the IRS claiming the gifts qualified for the annual exclusion under IRS Code 2053(b). The IRS audited the 1996 gift tax return in 2000 and disallowed the exclusions claiming the gifts were future interest gifts and had no present value. Hackl appealed to US Tax Court in 2002 Hackl v IRS claiming the gifts were in fact gifts and had real substantial present value. Judge Nims points out that for Hackl to win his children must have an unrestricted right to the immediate use possession or enjoyment of the property or the income from property within the meaning of IRS Section 2503(b). The Court agreed with the IRS that due to the severe operating agreement restrictions the children never received a “present” interest in the LLC memberships they received. IRS wins, Hackl Loses.

What does that mean for all of us? If you are planning to gift the current $28,000 (married) annual exclusion to your children through your Family LLC make sure you and your tax attorney create an operating agreement for the children that can withstand Government scrutiny regarding “present interest” in the event of an IRS audit. Second, if you are gifting large gifts over the $28,000 annual exclusion either less than or in excess of the current $10M exemption (married) make sure you file all gift tax returns and pay any gift tax you owe to make sure the gift cannot be revoked or amended by other not so happy relatives after your death. Finally, develop a long range estate and gift tax plan with your tax attorney so that when your final day comes you can keep your assets legally safe from estate taxation to assist your children and preserve your wealth for many generations to come. Thank you for joining us on TaxView with Chris Moss CPA.

Kindest regards and see you next time,
Chris Moss CPA

Temporary vs Permanent Tax Deductions

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Have any of you purchased a vehicle in late December to receive that coveted tax deduction that year? If you answered yes, you were able to receive “temporary tax deduction.” (TTD) That is to say you accelerated a tax deduction into the current tax year to save taxes immediately. However, the tax savings you thought you had was unfortunately just an illusion in the big tax picture of the IRS Code. That is because as you saved taxes in year one, you did not necessarily save taxes in year two, unless you somehow were able to convert the TTD to a “permanent tax deduction. “(PTD) That is to say instead of saving taxes just one year, you would be saving taxes every year. How cool would that be? So if you are interested in learning more about how to convert TTDs to PTDs, stay with us on TaxView with Chris Moss CPA as we delve into the bizarre world of temporary vs permanent tax differences to create PTD tax strategies to permanently save you taxes and to create wealth for you and your family.

So what exactly is a TTD? If you all want to see how one taxpayer behaved at year end to receive a fleeting TTD, let’s review together Michael and Mary Brown’s timing saga in a US Tax court case recently decided in December of 2013. Brown vs IRS Brown is a successful insurance agent who purchased a Bombardier Aircraft (Challenger) to visit his clients on December 31, 2003. Brown deducted almost $11M in depreciation on the Challenger in his 2003 tax return. The IRS audited Brown for that year and disallowed the deduction on the grounds that the Challenger was not in service until 2004. The Brown’s appealed to US Tax Court Brown vs IRS. Judge Holmes takes off immediately to the issue of “timing”. The IRS says the Challenger is deductible in 2004 and Brown says 2003. Ultimately the question presented to the Court was whether or not Brown put in use the Challenger in 2003. The Court ultimately concluded that Brown did not put the Challenger “in use” until 2004. IRS wins and Brown loses.

Now that we understand the simple TTD, let’s travel out of the world of timing differences to a better more secure place, the world of PTDs more much complex and much more rewarding. For most American taxpayer’s the easiest way to create PTDs is through a 5-10 year long range financial plan. Our first example is about a family who has decided their passion is real estate. They have annual conversion of TTDs through the use of leverage and the acquisition of commercial and residential property. For a husband wife both working two jobs earning $200K with two children ages 8, and 11 that could mean a 5-10 year financial plan with the goal of creating as many PTDs as legally possible. One spouse would need to cut back on hours at his or her full time job and head up newly created Family LLC which would purchase one property with each succeeding year leveraging the appreciation on preceding properties. As you purchase and then improve each property for potential sale you meet regularly with your tax attorney to bullet proof against an IRS material participation attack to your Family LLC. Please review Chris Moss CPA material participation article. Each property is deductible in accordance with IRS regulated TTDs but taken together in the 5-10 year financial plan, you have successfully converted TTDS to PTDs. If you acquire the right property in the right location for the right price you have not only created PTDS and saved taxes, but substantially increased your net worth. In other words PTDs create wealth.

Continuing with the same family, once the Family LLC is set up, TTDs constantly become converted to PTDs. In your financial plan transportation perhaps should be as important as the actual purchase and sale of real estate. For example, if you purchase or lease a Bombardier Challenger, if you have a 5-10 year financial plan, it really does not matter which year you get the deduction. Because in your 5-10 year financial plan you have already determined that either you or your spouse is going to visit real estate you own, and real estate you want to purchase with perhaps someday your son or daughter piloting the plane. Again if you purchase or lease a small fleet of company owned cars and trucks, TTDs are constantly being converted to PTDs as you continually trade in older for newer models. This could be said of your office equipment and furniture as well as your office headquarters and possibly satellite offices around the country. Which leads us to al startling observations: As your business grows TTD to PTD accelerates exponentially, creating tax deductions and substantially increasing your net worth. Indeed, PTDs create wealth.

Let’s look at yet another family in another example with a very different 5-10 year financial plan. Our second family is a young couple with no children, and both husband and wife are working jobs earning $150K annually. This taxpayer’s 5-10 year financial plan focuses on purchasing a territory in their location for a franchise type of business. They are not sure whether to own a fast food franchise like a McDonalds or perhaps a less known franchise selling yogurt, or perhaps they will create their unique storefront business that could franchise out to others someday. In this example you are concerned about losing income if one of you quits your full time position. Your financial planner custom creates your financial plan so that both of you continue to work your current jobs in years one, two and three, allowing you the flexibility to start-up your franchise at night and on weekends. Since your 5-10 year financial plan calls for losses the first few years, you make sure your tax attorney bullet proofs you all against hobby loss attacks by the IRS. Please review Chris Moss CPA hobby loss article. Your PTDs in this unique 5-10 year plan would be focused on trademarks, copyrights and brand promotion. You would be converting TTDs to PTDS related to “branding” including advertising, marketing, and public relations. As you can see in this unique 5-10 year financial plan you are creating your net worth by development of a “brand” or the creation of good will. Goodwill is just as valuable an asset as real estate and can create a viable brand to sell goods and services in the community and around the nation creating wealth for you and your family just as valuable as wealth created by real estate.

So what is your 5-10 year financial plan to convert TTDs to PTDs? Don’t’ have one? It’s not too late to start. Seek out a qualified financial planner and create your 5-10 year financial plan. Round out your team with a good insurance agent, banker and Tax Attorney to protect you from the IRS traps and road mines that await you as you move forward with your financial plan. Finally, create your own path to fit your own unique family’s goals to guide you to a better American dream of financial independence and the creation of wealth for you and your family. There has never been a better time to convert TTDs to PTDs. Perhaps I will see you next time at the Mercedes dealer last week in December for that easy TTD. Better yet would be to know you are working those PTDs for your family to save taxes and create wealth. Thanks for joining us on TaxView with Chris Moss CPA.

Submitted by Chris Moss CPA

IRS Doomsday Levy

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Just the thought of a “levy” gives me the absolute feeling of impending doom. However, an IRS levy adds additional and painfully real fear of immediate economic loss to any law abiding American taxpayer. What is an IRS levy? According to the IRS website a levy is a legal seizure of your property to satisfy a tax debt. If you think this could never happen to you, think again. What about a payroll tax debt, or perhaps a nasty divorce or partnership dissolution suit targets you as owing tax to the IRS. Or perhaps a business you were involved with that has filed bankruptcy had you listed as an officer owing tax to the IRS. In all these cases I would hope your family tax attorney would have been busy filing petitions on the merits with the US Tax Court to defend you and your family and protect your hard earned assets. But you somehow let events overtake you and now find yourself with a final “levy notice” from the IRS also referred to as a Doomsday Levy. What can you do? You have one last line of defense in this battle. So stay with us here on TaxView with Chris Moss CPA to better understand how you can minimize the damage to your family and your financial assets if an IRS Doomsday Levy ever shows up on your doorstep.

Have your heard certified letters usually bring you bad news? The IRS issued “Final Notice of Intent to Levy” oftentimes referred to as the “Doomsday Levy” is usually sent certified by the Government, but also can be delivered by a special agent in person direct to your front doorstep. Regardless how you receive the Levy notice, if the amount of the Levy is relatively large enough to cause you severe economic hardship, I recommend you retain the best tax attorney you can afford. While the IRS website is an excellent source of information on how the IRS levies you and explains your rights to appeal within the IRS and then eventually to US Tax Court, you are simply no match for the brutally effective Collection Division of the US Treasury if you should, as thousands before, lose to the IRS in Court.

Once you have your team assembled best practice in my view is to appeal within 30 days of the date on the levy notice to the IRS appeals division and submit your “offer in compromise” If you read my article on offer in compromise you know that this offer is a very viable alternative to being levied and can in many cases be a “win-win” for both you and the Government. However, your offer must be reasonable enough to be accepted by the Government. In order to better understand how reasonable is reasonable let’s take a look at some very interesting US Tax Court cases.

In Lloyd v IRS 2008-15 taxpayer Lloyd a 70 year old practicing attorney was assessed income tax after an IRS audit for years 1990 through 2002. What makes this case so interesting is that Lloyd never disputed the tax owed, but he also never paid the tax owed. After receiving a notice to levy in 2006, Lloyd’s tax attorney requested a hearing with the IRS Appeals Office to discuss an offer in compromise. Lloyd offered a 7 year payment plan for a total of $139,707 to compromise $264,457 owed. The IRS determined that Lloyd’s “reasonable collection potential” RCP was almost $1.5 Million easily allowing Lloyd to pay much more than $139,707 if not the whole amount due. After months and months if not years of delays, phone calls, meetings and correspondence by both sides no agreement could be reached. The IRS gave Lloyd 30 days to appeal to US Tax Court which indeed he did in 2008 US Tax Court Lloyd v IRS . Judge Chiechi immediately notes early on in this 63 page Opinion that Lloyd could not challenge the tax owed, but only challenge whether or not Appeals abused its discretion by not accepting Lloyds RCP calculations. The Court concluded that Appeals “on the record before us” did not abuse its discretion. IRS wins Lloyd loses.

Next case is Crosswhite vs IRS just decided two weeks ago. Crosswhite owed 2003 Form 941 payroll taxes from a business he owned. He retained a tax attorney to put forth an offer in compromise to the IRS in 2004. Crosswhite’s tax attorney was still working this case with the IRS all the way to January of 2007. Eventually in June of 2009 the IRS sent the dreaded Doomsday Levy to Crosswhite. Legal counsel executed Form 12153 “request for due process hearing” before IRS appeals. The IRS determined Crosswhite had RCP of $82,948. Crosswhite only offered $7,200. The IRS countered with a revised RCP of $68,847. Crosswhite eventually offered $25,000. The Government issued a notice of determination sustaining the levy. Crosswhite appealed to US Tax Court in Crosswhite vs IRS 2014-179.

Judge Paris points out that the IRS analysis of RCP for Crosswhite only included net equity but not future income computations. Therefore the Court was unable to conclude whether or not it was an abuse of discretion for Appeals to proceed with the levy. The Court remanded the case back down to the Appeals office for further consideration and suggested that Crosswhite offer a revised new collection alternative. Hopefully now that Crosswhite has been given a second chance his tax attorney will work this out with Appeals.

What does all this mean for us? First, don’t ever ignore IRS notices and bills. Ignoring IRS notices and correspondence endangers your business and family making a Doomsday Levy attack very possible in your own backyard. Second, retain a tax attorney early in the battle to minimize injury and protect your assets. Just so you know, if you try to hide assets while all this is going on the IRS will invoke the power of Code Section 6331(d)(3) that “collection of the tax was in jeopardy” and proceed immediately against you to protect the Government’s best interest with such financial force your assets will not know what hit them. Finally, if you do get the dreaded Doomsday Levy, don’t rely on the US Tax Court to save you. As we saw in Lloyd and Crosswhite, Doomsday Levy US Tax Court proceedings rarely have happy endings. Your best chance to minimize the damage if an armed Doomsday Levy is racing your way, is to have your tax attorney proceed quickly and quietly to IRS Appeals, work out an offer in compromise, and neutralize and unarm that Doomsday Levy before it ever hits its target.

Thanks for joining us on TaxView with Chris Moss CPA.

Kindest regards
Chris Moss CPA

Substitute Tax Return

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What is a substitute tax return? No your identity has not been stolen and a false return filed by the perpetrator. In fact, a substitute tax return is what the Government has the authority to file for you when you don’t file your tax return on time. Yes, isn’t that nice of the IRS to file your income tax return for you, and better yet, all at no charge! But wait a minute. Before you all start calling me asking how to get the government to file this free substitute tax return for you, let me make clear that a substitute return is not the real deal, it is more like a knock off return. You all know what knock offs are, those fake replicas of an authentic brand of luxury goods or service, often times not worth purchasing even at any price due to lack of quality and poor workmanship. The same holds true for a substitute tax returns, usually poorly prepared by the IRS and in worse cases substantially inaccurate, not reflective of your true net income and tax owed and unfortunately presenting you with a very large tax bill with even larger interest and penalties that is simply in many cases not correct. So if you have an outstanding tax return that has not yet been filed, or perhaps a few such returns, or if you are in any way just curious, then stay with us on TaxView with Chris Moss CPA to find out how you can get hit with a substitute knock off return and what you need to do to “return” the return back to sender where it belongs.

According to the Government’s own IRS website, the IRS warns us all: “…If you fail to file, we may file a substitute return for you. This return might not give you credit for deductions and exemptions you may be entitled to receive. We will send you a Notice of Deficiency proposing a tax assessment. You will have 90 days to file your past due tax return or file a petition in Tax Court. If you do neither, we will proceed with our proposed assessment….” Seems fair enough. In my view you get a pretty good deal. Either file or go to Tax Court. Although not everything with the IRS is quite what it seems to be especially when you go through the bizarre world of US Tax Court case law.

Gloria Spurlock did not file her tax returns for 1995 96 and 97 and in fact did go to US Tax Court in Spurlock v IRS 118 TC No 9 (2002). Judge Ruwe points out that under IRS Code Section 6020(b)(1), the Government has the authority to execute a return “If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return”. IRS wins Gloria loses. Sandra Stern also didn’t file a tax return and decided to go to Tax Court, Sandra Stern vs IRS TC 2002-212. Judge Beghe says: “…the above-quoted language of section 6020(b) makes clear that the Commissioner is not charged with preparing a perfectly accurate return. The Commissioner is required only to do the best he can with the information available to him, in the absence of a return prepared and filed by the taxpayer…” IRS wins Sandra loses.

The next case is even more interesting: Sam Kornhauser, a practicing attorney no less, didn’t file his 2007 tax return nor did he file one for 2008. The IRS prepared a substitute 2008 return and sent him the 90 day letter. Within the 90 day period Kornhauser signed a tax return and submitted it to the IRS for processing. However, the IRS did not process the return. Kornhauser appealed to US Tax Court, Kornhauser v IRS 2013-230. Judge Haines’ Opinion allowed into evidence Kornhauser’s “income” but not his deductions. Surprise, Surprise. Judge Haines says: “…It seems Kornhauser disputes the tax liability because the substitute return failed to take into account certain “deductions and credits”. Kornhauser’s only evidence to support his deductions and credits was his testimony as well as documents and records contained in exhibits…” Unfortunately for Kornhauser the Court did not feel the evidence Kornhauser presented to the Court or even his own sworn testimony to be credible. The Court concluded “….we find Kornhauser’s testimony to be self-serving and uncorroborated and do not accept it”. IRS wins Kornhauser loses.

In conclusion, there are certainly going to be times in your life that your tax return is going to be filed late, even years after the deadline, perhaps for reasons beyond your control. A death in the family, divorce, loss of job, natural weather disaster to name a few. So make sure you tax attorney communicates with the IRS that your return is running late and keep in constant touch with the Government until your return is eventually filed. In my view best practice in cases like this requires proper, regular, and effective written and verbal communication with the IRS to allow for cooperation not confrontation, and assistance not interference. Finally, for whatever reason, if you choose not to file your tax return without communicating to the IRS via your tax attorney, expect the IRS to file a substitute tax return for you. If you try to contest the substitute tax return in US Tax Court I bet you a Lobster dinner at the Palm that the Government wins every time. Happy tax return filings and remember, there is no substitute. Thanks for joining Chris Moss CPA on TaxView

Kindest regards
Chris Moss CPA

Section 1031 Reverse Tax Free Exchange

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What is a reverse 1031? No it is not a football game plan. Commonly known as a reverse exchange or a reverse Section 1031 tax free exchange, this very trendy tax savings variation on the traditional Starker exchange has roared back to life. If you read my article on 1031 Exchanges you are somewhat familiar with tax free exchange investment strategy. We are now going to take a look at this same tax free strategy but in reverse. As an example, the Smiths give you 30 days advance notice before their hotel in Carmel CA property officially lists for 10M. Your spouse loves that hotel and you both have talked about retiring there. You are certain you could clear 10M if you sell those three rental properties you own. You arrange to meet your tax attorney to get her to structure the deal. Unfortunately she has some bad news. She says “Even if you could sell your property within the next thirty days, depreciation recapture turns your already low basis into negative territory causing at least $5M of your 10M sales price to go to the IRS in taxes.” But your tax attorney has some good news too: a tax free and reverse section 1031 exchange, could save you 5M in taxes. Interested in how this is possible? Stay with us on TaxView with Chris Moss CPA to see how a reverse Section 1031 tax free exchange can save you taxes and help to preserve your wealth.

Just to refresh your memory, a traditional easy 1031 starts out with a sale of your investment called the “relinquished” property. A qualified intermediary (QI) escrows the proceeds. Not all QIs are qualified as experts in their field. Make sure your QI is a member of the Federation of Exchange Accomodators. After you choose a QI you trust you must identity within 45 days an investment you want to buy called the “replacement” property. Within 180 days your QI purchases the replacement property and then transfers ownership to you. All gain on the sale of your first property is deferred and adjusted into the basis of the replacement property. In theory the gain could be deferred forever unless Congress changes the rules. It’s that simple.

Now let’s tackle the reverse 1031 play. The IRS has give us a safety in a safe harbor provided by Rev Proc 2000-37 and a related IRS Bulletin 2000-40. (Page 308-310), Before this Rev Proc there was surprisingly little guidance from the US Tax Court on how to play this field. There was just one tax court case that I found which is the poster case for how not to handle a reverse exchange play. DECLEENE vs IRS 115 T.C. No. 34 US Tax Court.

The facts of the case are relatively simple, Decleene operated a trucking business since 1977 and leased the building on McDonald Street land Decleene owned. In 1992, Decleene purchased Lawrence Drive land with his intent to eventually house his trucking business on that land. In 1993 P sold the McDonald Street and Lawrence Drive land to Western Lime and Cement (WLC) in exchange for WLC constructing a building on Lawrence Drive and then conveying back Lawrence drive to Decleene. On their 1993 tax return, the Decleene’s disclosed a tax free exchange with WLC as a taxable sale of the Lawrence land (boot) and a like kind exchange of McDonald for improved Lawrence with no gain or loss reported to the IRS. The IRS audited the 1993 tax return indicating that the Lawrence property had never really been “sold” to WLC by Decleene. The Decleene’s appealed to US Tax Court Decleen vs IRS.

Judge Beghe points out that Decleene purchased the replacement property directly with WLC, without the participation of a third-party exchange facilitator or qualified intermediary (QI) a year or more before he relinquished the McDonald property. In the following year Decleene transferred title to Lawrence subject to an “exchange agreement’ again not to a QI but directly to WLC. The Court concludes that “in foregoing the use of a third party QI Decleene created an inherently ambiguous situation. The reality of the subject transactions as we see them is a taxable sale of the McDonald Street property to WLC. Petitioner’s prior quitclaim transfer to WLC of title to the unimproved Lawrence Drive property, which petitioners try to persuade us was petitioner’s taxable sale, amounted to nothing more than a parking transaction by petitioner with WLC. In substance, petitioner never disposed of the Lawrence Drive property and remained its owner during the 3-month construction period because the transfer of title to WLC never divested petitioner of beneficial ownership. IRS wins, Decleene loses.

What does all this mean if you spot a deal of a lifetime that you want to purchase now and pay for it with tax free money from a future sale of property you presently own? It is clear form Decleene that you must use a QI if you want to survive an IRS audit. In fact, you should assemble the following team you trust: commercial real estate agent, tax attorney, and QI either in person or by conference call to map out the reverse 1031 exchange tax strategy that fits your unique situation. Furthermore, if you intend to pay off a mortgage on the relinquished property or incur new debt on the replacement property be aware that not all lenders understand complex reverse 1031 exchanges, so add to your team an experienced 1031 banker as well. Finally, have your tax attorney fully disclose to the government the nature of the reverse exchange in an attachment to your income tax return. Ask your attorney to put in writing that your unique reverse exchange complies with the safe harbor provided by Rev Proc 2000-37 and that she will be there to defend you in the likely event of an IRS audit years later.

In conclusion, if you correctly execute, a 1031 reverse exchange in compliance with Rev Proc 2000-37 and fully disclose your tax strategy in your tax return before filing, you will have bullet proofed your return from IRS audit years later, and assisted your family in preserving wealth, savings taxes, and achieving your financial goals. Happy 1031 Exchanges to all.

Thank you for joining us on TaxView with Chris Moss CPA.

Kindest regards
Chris Moss CPA

Portfolio vs Passive Loss Rules

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If you have investment gains to offset business losses this year, you may be in store for a direct head on collision with the IRS and the Tax Reform Act of 1986. The journey to disaster starts off innocently enough. You sell some stocks for a $10M gain to purchase a small retail shopping center for the same price. You think about structuring the deal so that the losses from the first year of operations at the shopping center could offset your capital gains from the sale of stocks. You never bothered to retain a tax attorney to create a tax plan because as you see it you have a no brainer zero tax due. You believe that a buy and sell for $10 Million equals a full and complete offset come April 15 2015; but perhaps not so fast says TaxView, because the offset is in great danger. There are land mines ahead that seem to explode at the worse possible moment with an IRS audit. If you are interested in how the IRS could dramatically change even your best tax plan for offsetting gains and losses, stay with us on TaxView with Chris Moss CPA to see how the Tax Reform Act of 1986 makes your no brainer into a brain strainer and a tax disaster for you the unfortunate taxpayer victim of the creation of Section 469 and the Passive Loss rules.

To get a better idea of the catastrophe ahead, first let’s all take a short trip back to the source of confusion to Washington DC. Fasten up your tax plan as we turn back the clock landing us right in the middle of the center table at the downtwon Palm. Dan Rostenkowski (House Ways Means) and Bob Packwood (Senate Finance) have gotten together to finalize some last minute provisions of the 1986 Act. Legendary Tommy Jacomo spots us immediately with a great table. We hear Rosti roar over the boisterous dinner crowd to Bob: You personally have quite a large portfolio in stocks and bonds. Would you really consider interest and dividends “positive” income? Rosti, you know I don’t like that word “positive” taken in this context. Besides, we can’t really tell the average American taxpayer that the wealthy making dividends and interest are working as hard as they are with “positive income”. Let’s just go with this term “Portfolio”. It bridges the gap between those darn “passive” tax shelters and the American W2 worker. I say we treat these items like positive income similar to a salary but call it “portfolio”. In other words we tell America that their stocks and bonds are…well like working 40 hours a week for them as their “portfolio”. Bob, you have got to be kidding, that is really dumb, really stupid… but you know, comparing portfolio to W2 earnings is so ridiculously outrageous it might just work. See Joint Committee on Taxation, page 209-213 which eventually morphed into IRS Code Section 469 Passive Loss Rules.

Agree or disagree with how my imaginary conversation might have unfolded that night, the fact is that Section 469 prohibits the offset of “portfolio” gains or losses and “passive” gains all losses. In order to see the bizarre consequences of how these two types of gains and losses can interact, let’s head over to US Tax Court just a five minute cab ride from the Palm over to Capitol Hill to survey a 2000 case More v IRS 115 T.C. No 9 More was an independent managing underwriter as part of a syndicate for Lloyds of London. In order to be accepted by Lloyds More had to demonstrate his ability to cover potential losses of his syndicate usually by posted a letter of credit. In 1988, More transferred his personal stock portfolio to a brokerage account at Bank Julius Baer (BJB), a London-based bank. During 1992 and 1993, petitioner underwrote £500,000 of Lloyd’s premiums which were secured by a letter of credit from BJB in the amount of £150,000. The policies written by More did in fact incur losses and More cashed in his stocks at a large gain to cover those losses as required by his letter of credit. More reported his losses and gains on his tax returns so that each offset the other. The IRS audited Moore, and disallowed all the losses, arguing “portfolio” income could not be offset against “passive” income. Moore appealed to US Tax Court.

Judge Vasquez in More writes a very short 16 page jam-packed with Section 469 Opinion. The Court then confirmed that Congress enacted passive loss regulations “to curb expansion of tax sheltering”. Judge Vasquez further noted that IRS regulation 469-2T makes an exception to the general rules regarding disposition of More’s stocks at a gain. Specifically, gross income derived in the ordinary course of a trade or business includes “income from investments made in the ordinary course of a trade or business of furnishing insurance or annuity contracts or reinsuring risks underwritten by insurance companies” The Court notices that More’s attorney, Louis B. Jack, did not refute or address this at all and was silent on the reason why More acquired the stock. If More could have shown that he primarily created this portfolio as a way to get into the insurance business and not as an investment More wins IRS loses. Unfortunately for More, no evidence was presented to the Court on when his investments in stocks turned primarily to assist More in keeping his job at Lloyds. I don’t know about you all, but it seemed More’s transfer to a brokerage account back in 1988 was primarily to show sufficient assets so he could work at Lloyds. Nevertheless, since More did not refute the Government’s argument leaving the Court no choice but to hold that More’s stocks were primarily created for investment and not for the convenience of Lloyds. Government wins, More loses.

What does this rather obscure Tax Court case and the provisions within Section 469 tell us working taxpayers regarding passive loss rules that create “portfolio income” and “passive income”? Anyone out there who wants to offset losses from one activity against gains of another: Be warned, the IRS is actively and aggressively audited these kinds of offsets, particularly any losses that offset W2 income or Investment Portfolio Income, or any gains that offset passive losses. Prior to filing your tax return with any offsets from different sources of gains and losses, review with your tax attorney the ramifications of Section 469, with particularly emphasis on what kind of offsets you have. If you have “portfolio” and “passive” losses or gains pay particular attention to whether or not the Section 369 allows those offsets. Finally have your tax advisors insert into your tax return detailed evidence of your tax strategy explaining how these offsets were created, what provision of Section 469 controls, and how your tax strategy is being implemented. For example if your tax strategy involves long range estate planning, make sure you disclose this in the tax return before filing. Better you should support and bullet proof your tax strategy now than to have to wait 4 years for the Government to do it for you during an IRS income tax return audit.

May your losses and gains offset wisely. Thanks for joining Chris Moss CPA on TaxView

Kindest regards,
Chris Moss CPA

Unreimbursed Volunteer Expense

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Do you volunteer for a nonprofit organization which is exempt from paying income tax? For example, have you driven for Meals On Wheels, or perhaps you have dropped off some household goods to the local Salvation Army, hosted a student in your home, or headed up an usher team at Church? All of these activities most likely have legitimate tax deductions hidden from view of most American taxpayers due to the complexity of the IRS Code. I believe many of you involved with charitable organizations, whether it be the United Way, the American Cancer Society, or the Leukemia and Lymphoma Society, just to name a few, overlook a wonderful tax deduction explained in IRS Code Section 170(a) called Unreimbursed Volunteer Expense (UVE). I wager many of you have UVE which you are not deducting on your tax returns. Interested in learning more about this deduction and how you can save income tax this year? Stay with us on TaxView as we better understand the nature and history of UVE.

Taxpayers have been deducting cash and property donations to charities for almost 100 years. However, there is an obscure IRS regulation 26 CFR 1.170A-1(g), “contributions of services” that seems to generate many controversial US Tax Court case Opinions as to what constitutes UVE. We start with an easy case, so get ready for our journey to Washington DC where we can catch the opening arguments in Van Dusen vs IRS. VanDusen of Oakland California was an attorney who loved cats. As a volunteer for Fix Our Ferals VanDusen trapped feral cats, had them neutered, obtained vaccinations and necessary medical treatments, housed them while they recuperated, and released them back into the wild. She also provided long-term foster care to cats in her home. VanDusen deducted all the unreimbursed expense for this volunteered activity on her 2004 income tax return. The IRS audited her 2004 tax return and disallowed all her deductions, arguing that VanDusen was an independent cat rescue worker whose services were unrelated to Fix Our Ferals and did not benefit the organization. Proceeding Pro-Se VanDusen appealed to US Tax Court. Van Dusen vs IRS.

Judge Morrison’s Opinion recognizes that VanDusen is entitled to a charitable-contribution deduction only if her expenses were, in the words of section 1.170A–1(g), ‘‘expenditures made incident to the rendition of services’’ to Fix Our Ferals. The Court noted that in determining whether a taxpayer has provided the requisite service, courts consider the strength of the taxpayer’s affiliation with the organization, the organization’s ability to initiate or request services from the taxpayer, the organization’s supervision over the taxpayer’s work, and the taxpayer’s accountability to the organization citing Smith v. IRS and Saltzman v. IRS.

Travis Smith attended nondenominational company of Christians called an “assembly” at Cuyahoga Falls, Ohio. Smith deducted on his 1967 and 1968 tax returns the costs of trips to the rural areas of Western and Northwestern Newfoundland each year since 1964 to carry out evangelistic activities as a minister of his church. The IRS audited and disallowed all deductions claiming Smith had either taken these trips as vacation, or more probably and primarily that the trips did not directly benefit the local Ohio church economically, religiously, or otherwise. Smith appealed to US Tax Court. Smith vs IRS Judge Featherston noted that one of the basic functions of Smith’s church is evangelism — spreading the faith through preaching, teaching, and personal persuasion. As a member of his local assembly, Smith was taught that it was his duty to do missionary work of the kind he performed, and he responded to that teaching by doing it. Smith wins IRS loses.

Not to be outdone by Smith, the Government pursued Saltzman during 1966. Salztman served without pay as the leader of the Harvard-Radcliffe Hillel Folk Dance Group. He taught folk dancing and related subject matter to a group which met once a week, 3 to 4 hours at a time. During 1966, Saltzman took four trips on which he led members of the Hillel group to folk dance festivals and conventions, at which these group members performed exhibitions as part of the convention. The IRS audited Salztman and disallowed all his expenses. Saltzman appealed to US Tax Court Saltzman v IRS. Salztman argued based on Rev. Rul. 55-4, 1955-1 C.B. 291, and Rev. Rul. 56-509, 1956-2 C.B. 129, that his expenses of his trips to Pittsburgh and Europe qualify for deduction under these rulings. Rev. Rul. 55-4 holds that a taxpayer who renders gratuitous service to a charitable organization may deduct certain unreimbursed traveling expenses incurred while away from home “in connection with the affairs of the association and at its direction.” Judge Simpson easily found for the IRS as Salztman offered no evidence that he was under the direction of the Hillel Folk Dance Group. IRS wins, Salztman loses.

Heading back to VanDusen, the Court noted that Van Dusen has demonstrated a strong connection with Fix Our Ferals. She was a regular Fix Our Ferals volunteer who performed substantial services for the organization in 2004 and clearly had the required “connection” necessary for the deduction to prevail in US Tax Court. Van Dusen wins, IRS loses.

In conclusion, the key to winning in an IRS audit for UVE is to prove that your activity has a strong enough “connection” to the exempt organization to prevail in Court. What this means is that if you are chief usher in your Church and travel with your usher team to various other cities and churches on training missions, and you want to deduct the cost of this trip on your tax return, make sure you establish the required “connection” with your home Church. Finally consult with your tax attorney to make sure you fully disclose to the Government the “connection” established. Get emails in writing from the Vestry commissioning your trip and include those documents in your tax return before filing. You will then have bullet proof UVE deductions when and if you are audited many years later by the IRS. Hope to see you again soon on TaxView with Chris Moss CPA.

Kindest regards,
Chris Moss, CPA