This week the IRS published five "Dirty Dozen" list warnings. Each year, the IRS highlights various tax scams. This education helps taxpayers avoid tax trouble by using only the proper tax filing strategies.
The five scams on the "Dirty Dozen" list are frivolous arguments, hiding assets offshore, padding deductions, falsifying income to claim tax credits and micro-captive insurance transactions.
- Frivolous Arguments - Each year promoters of frivolous tax claims lead many taxpayers astray. The taxpayers claim zero income tax on dubious theories -- there is no duty to pay tax on religious or moral grounds, only federal employees must pay tax or only overseas income is taxable. IRS Commissioner John Koskinen stated, "Taxpayers should steer clear of tax-avoidance arguments and the unscrupulous promoters of such schemes. Taxpayers tangled up in these scams end up paying back taxes and often stiff penalties as well."
- Hiding Assets Offshore - American taxpayers may maintain bank accounts abroad, but they must disclose the account and pay applicable taxes on income. The Foreign Account Tax Compliance Act (FATCA) requires reporting of these bank accounts. The IRS has worked with foreign banks to encourage disclosure. Koskinen reports, "Offshore compliance remains a top IRS priority. We have collected $10 billion in back taxes in recent years with 100,000 taxpayers making use of our voluntary disclosure programs. The IRS receives more foreign account information each year, making it harder to hide income offshore. I urge taxpayers with international tax issues to come forward and get right with the system."
- Padding Deductions - Some taxpayers "fudge" or falsely claim extra deductions, expenses or credits. IRS software is updated each year to test for probable errors in reporting. If you are caught, the penalties may include 20% of the disallowed amount, $5,000 for a frivolous return, underpayment penalties and interest. It is best to use tax software to ensure you have an accurate return.
- False Income to Claim Tax Credits - If you use fraudulent documents to claim false income, the additional wages or self-employment income may increase your refundable credit. Some fraudulent tax preparers create improper reporting forms to do this. The IRS urges you to be careful to select a reputable tax preparer. You may find the information on www.irs.gov/chooseataxpro helpful in selecting a reputable tax preparer.
- Micro-Captive Insurance - Life insurance plans qualify for multiple tax benefits. Some taxpayers create "captive" insurance companies that are owned by the insured person. These can be qualified, but promoters may abuse them. The micro-captive insurance company may lack the appropriate attributes of a large insurance organization. In Notice 2016-66 (1 Nov 2016), the IRS classified some micro-captive insurance organizations as "Transactions of Interest." These micro-captive insurance companies are subject to specific IRS reporting obligations.
Border Adjustable Tax Debate Continues
Chairman of the House Ways and Means Committee Kevin Brady (R-TX) and Speaker of the House Paul Ryan (R-WI) are industriously drafting a comprehensive tax reform bill. Their plan is to reduce personal tax rates to 33% and corporate tax rates to 20%. The large rate reductions are dependent upon finding tax revenue in another area. A substantial source of tax revenue is expected to be a "border adjustable tax." This tax would produce substantial revenue because there would be a new tax on imports while exports would be tax-free.
Speaker Ryan stated on February 16, "We are doing tax reform. Tax reform is going to happen. You know why tax reform is going to happen? Because it has to happen. America has the worst tax code in the industrialized world. It is killing economic growth. It is driving companies to become foreign companies."
Because the tax on imports will affect retailers and other importers, there is opposition to a new tax on imports. Senators from states with companies who are importers are opposing the tax. Sen. Tim Scott (R-SC) stated that he is concerned there will be higher prices for consumer items. He met with companies involved in retail sales on February 15 and they expressed unhappiness over a dramatic increase in their tax burden.
Sen. Tom Cotton (R-AR) said on February 15, "It is estimated that this one change alone would produce something like $100 billion a year in additional tax revenue. That is a lot of money and someone's got to pay for it, and I'll tell you exactly who's going to pay: working Americans who have been struggling for decades."
Both Scott and Cotton represent states that are home to companies with substantial imports who face significant tax increases.
On February 15, President Donald Trump met with CEO's of Target, Best Buy, Gap, Walgreens and other major companies. They officially reported a "productive conversation" over the new tax. However, the National Retail Federation CEO Matt Shay called the border adjustable tax "radical and far-fetched." He suggested that the tax should be dropped.
Both Brady and Ryan hope to retain the border adjustable tax. They need a very substantial amount of revenue if they are going to reduce rates and allow expensing of assets. While this is a major upcoming battle, the opponents of the border adjustable tax will need to find some other comparable source of revenue if the tax is to be dropped.
Estate Penalty Abatement
In Estate of Esther M. Hake et al. v. United States;
No. 1:15-cv-01382 (10 Feb 2017), a U.S. District Court abated a late filing penalty. The executor reasonably relied on incorrect advice from counsel.
Decedent Esther M. Hake died October 2, 2011. Sons Ricky and Randy Hake were executors.
Five surviving children were in a major dispute over the estate. Business attorney and long-time family advisor Douglas P. France was selected as the estate attorney. His associate Jennifer Galloway completed the estate filings.
On June 21, 2012, Galloway filed IRS Form 4768 and obtained a six month filing extension and a one year tax payment extension. The estate paid $900,000 in tax on Feb. 12, 2013. They erroneously waited one year, rather than six months, to file the estate tax return on July 2, 2013.
The IRS assessed a late-filing penalty of $197,868.26 with interest of $17,202.44. Because the $900,000 payment was approximately $100,000 over the tax eventually due, there was a net balance due of $106,543.73.
The court observed that an executor may obtain a six month filing extension under Reg. 20.6081-1(b) and a twelve month payment extension under Reg. 20.6161-1(a)(1). The late filing penalty applies unless "it is shown that such failure is due to reasonable cause and not due to willful neglect."
In the unique circumstances of this case, the estate made a timely payment of estate taxes with an overpayment of approximately $100,000. While counsel did erroneously believe, and advise that, the filing date was also deferred for one year, the executor was clearly attempting to comply with the law. Therefore the penalty was abated.
Applicable Federal Rate of 2.4% for March -- Rev. Rul. 2017-7; 2017-10 IRB 1 (17 Feb 2017)
The IRS has announced the Applicable Federal Rate (AFR) for March of 2017. The AFR under Section 7520 for the month of March will be 2.4%. The rates for February of 2.6% or January of 2.4% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2017, pooled income funds in existence less than three tax years must use a 1.2% deemed rate of return. Federal rates are available by clicking here