VAT Flap

If you find yourself stuck at another boring dinner party and desperately seek some new topic which will get the attention of all in attendance just mention the federal VAT tax. Whether in lowly New Jersey, or in the stratosphere of Washington DC, federal lawmakers are being teased by the prospect of scrapping the entire Internal Revenue Code in favor of a federal consumption tax. Just imagine the income, estate gift and FICA taxes would all evaporate with a stroke of the pen. April 15 would be remembered only for the sinking of the Titanic and not the day that Americans suffered through the annual task of filing federal income tax returns. The Internal Revenue Service itself could perhaps be cut to a 10th of its size saving oodles on the federal payroll, perhaps to be used for more worth while pursuits. So what is this thing called VAT? From to time  I have referred to it simply as a sales tax. This short changes the idea. From the buyer's perspective, VAT in fact looks a lot like a sales tax, which is paid upon the purchase of listed items. However, from the seller's point of view and the tax collection authorities, it is not all that simple. Take a peak at what Wikipedia has to say about VAT tax:

A value added tax (VAT) is a form of consumption tax. From the perspective of the buyer, it is a tax on the purchase price. From that of the seller, it is a tax only on the value added to a product, material, or service, from an accounting point of view, by this stage of its manufacture or distribution. The manufacturer remits to the government the difference between these two amounts, and retains the rest for themselves to offset the taxes they had previously paid on the inputs.
The value added to a product by or with a business is the sale price charged to its customer, minus the cost of materials and other taxable inputs. A VAT is like a sales tax in that ultimately only the end consumer is taxed. It differs from the sales tax in that, with the latter, the tax is collected and remitted to the government only once, at the point of purchase by the end consumer. With the VAT, collections, remittances to the government, and credits for taxes already paid occur each time a business in the supply chain purchases products.

A true sales tax lets a buyer potentially worm out of paying the tax by claiming that he is not in fact the ultimate consumer. Sellers are required to obtain certificates affirming that fact, but what is it to him? With a VAT tax the seller has his own head and money in the game:

Value added taxes were introduced in part because they create stronger incentives to collect than a sales tax does. Both types of consumption tax create an incentive by end consumers to avoid or evade the tax, but the sales tax offers the buyer a mechanism to avoid or evade the tax—persuade the seller that the buyer is not really an end consumer, and therefore the seller is not legally required to collect it. Therefore, the burden of determining whether the buyer's motivation is to consume or re-sell is on the seller, and the seller has no direct economic incentive to collect it. The VAT approach gives sellers a direct financial stake in collecting the tax and eliminates a decision needing to be made by the seller about whether the buyer is or is not an end consumer.

So there you have it a short tutorial on VAT tax. Since Congress doesn't seem to be able to do much of anything these days some congressmen with time on their hands have actually put together a proposal called the Fair Tax. It is in essence a federal VAT. The tax rate would be 29.9%. Tax rebates would be provided to some taxpayers and some asset purchases would be exempt. Of course there are critics who say such a VAT tax would simply not raise sufficient revenue as the current system. But the reason may also be in our political system that it would be difficult for congressmen and senators to slip in as many exemptions for pet taxpayer contributors if such a simplified method of taxation were to be adopted. The current Internal Revenue Code is simply riddled with special interests. In fairness, the current tax code does raise substantial revenue, but it is also used for economic and social tinkering, and it is there where a VAT tax may not fill the bill.

The IRS Audit Lottery

Face it, the odds of winning the lottery, power ball or whatever it may be called are probably only slightly less then being hit by lightning on an absolutely clear winter evening. Twice. The odds of winning the IRS lottery are better. But not as good as you may think. Tax returns are not selected by random. Au contraire. The IRS does its best to use its limited resources laser like to select those returns which most likely present compliance issues. As computers become ever more sophisticated the process becomes more fine tuned. For the most part, audit selection is based upon the entries on the return. In a well kept IRS secret, a formula exists which when pumped into the IRS computers spits out tax returns which should at least be reviewed by a human and possibly further examined by the IRS examination division. Now as to the odds themselves: there are about 140 million individual income tax returns filed annually about 1.5 million are audited. That is approximately 1.1%. Most of these audits are conducted by correspondence. That is, lucky winners get mail from the IRS requesting explanation and verification of tax return entries. For business returns showing total gross receipts of $100,000-$200,000 approximately 4% are audited and for those returns with receipts of $200,000 or more 3.8% get to chat with IRS. For lucky winners with total positive income of 1 million or more, the rate may be as high as 12.5%. In all categories for recent years IRS claims that audit rates have increased slightly. How does one avoid winning this lottery? Recognize that the deductions, credits and allowances claimed on a tax return are actually compared to income and that the IRS formula also considers the likelihood of being able to survive on the amount of net reported income. IRS does also conduct special audit projects to identify non filers and problem cases and the agency may respond to hate mail from disgruntled spouses, employees and such. IRS has also gotten rather good at matching those pesky forms 1099 that are sent to taxpayers every year by all manner of income sources. Brokerage houses for example will be letting IRS know not only the gross sale proceeds of stock sold but also the tax basis or cost that is used to figure the taxable gain on the transaction.

Italian tax authorities have shifted their attention away from tax return numbers on their forms and toward finding out what Italians spend and then comparing that to their filed tax return. How did Mario have the lira to get that Maserati on the paltry income reported on his not so buono Italian tax return? As computers, iPhones, iPads and such track a taxpayer’s every purchase and preference, hiding from IRS or the Italian tax people for that matter, may become very difficult indeed.

Sequester and Weight Gain

  I have managed to gain 5 pounds. Don't give me this business about it to being the result of the holidays or cavorting in cafés in Miami Beach. While some of that may be true, my recent weight gain is much more serious. It is the fault of those damn Republicans in Congress. I have done the research. You may be comforted to know that your expanding middle may be the result of a minor bout with depression. Scientists say that in this part of the country the simple loss of sunshine can bring it about. Those who know me realize that I can hardly claim that defense. But there is something to this depression stuff. If you have been diligent in reading these tax blurbs of mine from this blog you know that the end of last year brought about the fiscal cliff scare. Congressman then batting around their party’s ideology certainly cost me a few pounds. But as that issue appeared to get resolved and just when it seemed weight loss was in the cards for me the new March 1 “sequester” darkened my bathroom scale. The New York Times stated that "House Republicans are resolutely opposing new tax increases to head off $85 billion in across-the-board spending reductions all but ensuring the cuts will go into force March 1 and probably remain in place for months, if not longer". This raises the potential of widespread disruption in government services and even military operations in the weeks and months ahead. There you have it. Depressing news and five extra pounds and counting. As the GOP continues to resist tax increases, my pants will no longer fit. By the way, there is a threat that the entire government will have to close down on March 1 although Congress appears ready to extend that deadline until September 30, the end of the fiscal year. The sequester cuts will be both arbitrary and deep to defense and domestic programs and to borrow a term from our own now beloved NJ governor “stupid”. Why not just call this silly sequester off if for no other reason so people like me can shed a pound or two.

Tax Crimes and Littering?

Where should tax crimes fall in the spectrum of criminal activity? In “Alice's Restaurant” a ‘60’s Vietnam protest movie, Arlo Guthrie tells the story of his avoiding the draft by having been arrested for littering in Vermont. The military was unwilling to take him into the Army knowing he had such a sordid past. In one famous scene, Guthrie is shunned by other inductees waiting psychoanalysis for their past criminal actions when they learn his only crime is littering. They welcome him back however, when he reveals a further charge of disorderly conduct. Now the people at the Immigration and Naturalization Service are permitted to deport aliens under United States Code Section 1227 if they have been convicted of an “aggravated felony”. That seems sensible. I can picture all types of terrible crimes that would fit that definition. But in Kawashima vs. Holder, the United States Supreme Court had to confront the important issue of whether filing a false income tax return with the Internal Revenue Service is such an “aggravated felony” as to require deportation of two natives and citizens of Japan who have been lawful permanent residents of the United States since 1984.The taxpayers went through hearings within INS and through the courts. After an exhaustive study of what the term aggravated felony means in the INS law, the Supreme Court in a 6 to 3 decision determined that such a tax crime was in fact an aggravated felony which can result in deportation. Lawyers should note that tax evasion is sometimes called the piggyback crime, at least by me, because it can be added to most financial crimes where income has been gained. The Internal Revenue Code makes income taxable from any source legal or not. So the thief is pursued by the police as well as by IRS agents. The mere non filing of returns can also result in a charge of tax evasion and taxpayers so situated should consider taking advantage of the IRS’ voluntary disclosure policy.

Who Are the IRS Agents?

No one likes contact from the IRS.  Which IRS agent is planning to visit? All IRS agents are not the same. It helps to understand the essential differences and what it means to the taxpayer or an attorney representing his client's interests.

The IRS Revenue Agent

 The most common contact will be the Revenue Agent. This person works in the examination branch. He often holds a CPA certificate or at least a solid background in accounting. Trained by IRS in substantive tax matters, he is the soldier in the trenches in the exam division of IRS. He will use predetermined audit guidelines to check tax compliance. Revenue agents are known for being thorough, documenting each step in the audit process. They will be fact centered and have sufficient knowledge of the tax laws or the backup to discover it, if need be, assistance being provided by IRS lawyers called Area Council.

Revenue agents will request information from the taxpayer and will issue information document requests (IDR) for information setting forth due dates to move the audit forward. Revenue agents like all IRS agents can issue administrative summons to obtain both testimony and documents from less than forthcoming taxpayers. This administrative action is not self enforcing and requires district court action brought by the Internal Revenue Service to enforce the demands made in the summons.

The IRS Revenue Officer

Possibly the most difficult and dangerous job at IRS is that of the IRS revenue officer. When we hear of IRS agents killed in the line of duty it is often from this unarmed tax agent’s ranks. He is the IRS collection expert in the field assigned to local IRS offices with a likely background in finance or perhaps a former business owner himself. He is primarily charged with collecting back taxes that are owed. His demand to tax debtors is simple: When are you going to pay the taxes you owe?

Revenue officers are also assigned taxpayer delinquent accounts where the taxpayer is a non-filer. This is the IRS civil attempt to obtain tax returns from the taxpayer. In all cases, revenue officers will check for current filing status and request that any open tax returns be filed directly with them.

Like revenue agents, revenue officers may issue administrative summons for information and like their examination brethren, if need be, they can make referrals to the criminal investigation division (CID) for possible criminal violations disclosed or suspected along the way.

The IRS Special Agent.

No practitioner or taxpayer should ever confuse the IRS special agent with either the revenue agent or revenue officer. The special agent has but one role in tax administration and that is to determine whether a criminal violation of the Internal Revenue Code has occurred. These violations may be found in Internal Revenue Code. section 7201 and following, the most popular of which is tax evasion and the filing of false and fraudulent tax returns. Special agents may have backgrounds in law enforcement and are the only IRS personnel authorized to carry guns. They take their work very seriously and are extremely good at it. IRS conviction and incarceration rates border on 100% in most criminal tax cases owing to the thoroughness of the special agent investigation. No lawyer or accountant unfamiliar with the work of the special agent should endanger his client by taking representation for a CID investigation which may go on typically 2 to 4 years. The statute of limitations for criminal violations is generally six years. Taxpayers who insist on representing themselves are simply arranging for “a vacation in New England” at a federal penitentiary.

IRS agents will identify themselves and Special Agents will display an unmistakable gold badge. Taxpayers and lawyers are well advised to appreciate the difference in the work they do for IRS.                                                               

TMD, Esq.

The IRS Dirty Dozen Tax Scams

 Every year, the Internal Revenue Service announces its “Dirty Dozen” ranking of tax scams. While the Service says many of these arise during the year, there is a scheme peak during tax filing season. IRS warns that “scam artists will tempt people in person, online and by e-mail with misleading promises about lost refunds and free money”. I am sure as a lawyer you have received notification from a Nigerian bank which desperately needs to wire transfer huge sums of money to your attorney trust account. All that is asked in return is the account and routing numbers to get in the game. Needless to say, this is not the most sophisticated scam in the world.

So here goes the rest from the most to least significant tax scams:

The winner, which has made the list for the last several years, is none other than identity theft. IRS sees identity thieves filing what appear to be legitimate tax returns requesting fraudulent refunds. In this case, IRS will notify a taxpayer that more than one return was filed in the taxpayer's name. That notice may be the first tip-off that the individual has been victimized. According to IRS in 2011 it stopped more than $1.4 billion of taxpayer refunds going into the wrong hands due to identity theft. IRS maintains a special identity theft page on its website IRS.gov/identity theft.

According to IRS, tax return preparer fraud comes in second on the list as tax return preparers have been known to skim off their clients’ refunds, charge inflated fees and attract new clients by promising guaranteed or extravagant refunds. In 2012 every preparer must have a preparer tax identification number which is entered on the tax return he or she prepares. Taxpayers should be alert to preparers who do not provide a copy of the tax return or charge a percentage of the refund amount as a preparation fee or add bogus forms to the tax return never before filed.

Rounding out the trifecta is Phishing. Here fake emails and websites request both personal and financial  information. IRS urges taxpayers to report any such contact to pfishing@irs.gov. There are a few fake IRS websites that truly look like the real McCoy.

Coming in just behind the leaders is hiding income offshore. The IRS is wising up to this technique which involves offshore banks, brokerage accounts, debit and credit cards or wire transfers to access funds. Taxpayers involved in undisclosed or illegal offshore accounts face both civil penalties and criminal prosecution. IRS does maintain come-clean disclosure rules. See IRS.gov for any current version.

In fifth position sweeping up the rear, is free money from the IRS or rebates from Social Security. You have to love this one. Among the pile of mostly useless e-mails all of us receive every day is often an urgent message that IRS is holding your money. IRS says scammers here prey on low income individuals and the elderly.The“elderly”now includes most of my friends.

False income and expenses. While once considered being the next Milton Bradley board game, the IRS does take a dim view of claiming deductions and expenses to which you are not entitled. Popular scam deductions and credits include the earned income tax credit, which by virtue of Congressional magic can result in a refund even when no tax payments have even been made.

Frivolous arguments. Now that is a catchy phrase. The IRS maintains a list of arguments it considers to be frivolous, which are unreasonable and outlandish claims to avoid paying the taxes owed. Take a look at the IRS website for help here.

Falsely claiming zero wages. Here the taxpayer is urged to file a substitute form W-2 or a corrected form 1099, thereby throwing the IRS computers into a tizzy and sending refunds out of nowhere.

Abuse of charitable organizations and deductions. IRS continues to examine intentional abuse of 501(c)(3) organizations using highly overvalued contributions by donors.

Disguised corporate ownership. In this scam third parties are used to request employer identification numbers and create corporations that obscure true ownership of a business. The new business may be used to claim false deductions and facilitate money laundering and other financial crimes.

The improper use of trusts. Promoters here urge taxpayers to transfer assets into trusts promising the reduction of income tax, deductions for otherwise personal expenses as well as reduced estate or gift taxes. According to IRS there has been an increase in the improper use of private annuity trust and foreign trusts.

There you have it. Happy Tax Season.

What's the Big Deal About Employees?

 A rose is a rose is a rose; and an employee is an employee is an employee. You may recognize the first part, as an Elizabethan sonnet, the second may not be as familiar. Why do employers go to extremes to avoid having workers called employees? The answer is straightforward. It is simply a lot cheaper. The employer is not only relieved of the burden of having to withhold taxes from the employee’s wages but gone is his responsibility to pay his portion of the Social Security and Medicare tax, which many view as making payments into the abyss. Additionally, savings may be had by keeping these workers out of pension plans, medical benefits and other perks available to employees. The case of the law firm of Donald Cave is illustrative. In that case, a law firm treated its associates and law clerks as independent contractors. The firm sent these workers forms 1099 -MISC. The firm of course claimed that it did not have sufficient control over their work to have these workers called employees. The Fifth Circuit affirmed the Tax Court holding that the law firm exercised sufficient control over the attorneys to show an employer-employee relationship because of the firms ability to affect the course of litigation by its decisions regarding the funding of litigation, work assessments, and working conditions. The firm provided offices, office equipment, secretarial support, business cards, letterhead, access to its law library and legal research services. As to the law clerk involved, the court found that Cave exercised complete control over the assignment of his work for the firm. The law clerk did work for other lawyers and other law firms. However, the Fifth Circuit said that providing services to multiple employers does not necessitate treatment as an independent contractor. When all was said and done, the firm was liable for employment taxes and penalties.Walking the tightrope between employee and independent contractor status is not easy. It helps to have a formal contract setting forth the worker's status but the ultimate test will be to what extent is the worker controlled by the employer. The IRS is on to this issue and will not hesitate to seek taxes and penalties from employers caught in the game of mischaracterizing employees.