IRS CHASING DOWN ‘QUIET DISCLOSURES’

In a recent report, the General Accounting Office (GAO) encourages the IRS to do more to uncover and pursue taxpayers who made quiet disclosures in regard to their non-U.S. accounts.

In recent years, the IRS has encouraged taxpayers with non-U.S. accounts and non-U.S. entities to enter into its Offshore Voluntary Disclosure Initiative programs if they had previously not reported the income from and/or the existence of those accounts and entities. When applicable, the OVDI programs avoid criminal exposure for the prior nonreporting. It also reduces the penalty exposure of the taxpayer, although significant penalties (based on the highest balance or value of the offshore accounts or assets) can still apply. The OVDI programs also provide a method of filing disclosure returns without penalty if all income taxes relating to income from the reportable assets had been properly paid when due.

In lieu of entering an OVDI program or otherwise filing in accordance with the program, some taxpayers have opted to file amended or initial returns for prior years reporting their non-U.S. accounts and companies. Such so-called "quiet disclosures" were often undertaken to attempt to correct the prior reporting deficiencies in this new era of enhanced enforcement activity, while avoiding having to pay the OVDI program penalties. Undoubtedly, many such taxpayers sought to fly under the radar - they would correct their prior underreporting but hopefully not be examined and thus avoid reporting penalties.

The GAO report notes that there are substantially more amended filings for prior years that likely relate to offshore reporting than people entering into the OVDI program. Thus, the GAO suspects there are a large number of taxpayers who made quiet disclosures.

The report also notes that the IRS has already reviewed at least several thousand amended returns based on its criteria to find suspect filings, and had found several hundred quiet disclosures. The report notes that:

An IRS official told us that the tax returns that were identified as part of a quiet disclosure will be examined and that cases already examined had penalties assessed. Because they were quiet disclosures, the official said the taxpayers did not receive the reduced offshore penalty.

The IRS offshore initiative office did indicate to the GAO that it had no current plans to conduct efforts as to uncovering quiet disclosures. The GAO report encourages the IRS to do some further research, employing some of the research methodologies used by the GAO to uncover more quiet disclosures.

The GAO also encouraged the IRS to conduct further efforts to determine the extent that taxpayers that are making their first time foreign reporting may have underreported non-U.S. accounts in prior years which they are not reporting currently. Unlike taxpayers who make a quiet disclosure and thus correct prior filing deficiencies, the GAO is concerned that some taxpayers who are making first time disclosures may have had their accounts in prior years but are only now starting to report - there is a good chance that such taxpayers may have unpaid taxes, interest and penalties relating to prior years. The GAO advises that the IRS can easily find suspect situations simply by asking when the newly reported filers opened the accounts they are now starting to report.

In summary, the GAO report advises us that the IRS has undertaken some reviews to uncover and audit taxpayers who made quiet disclosures. While not presently doing further research in this area, based on GAO prompting, further IRS research may be undertaken in this regard. Further, the report may stir greater IRS interest in reviewing the circumstances of first-time disclosures to determine if prior tax obligations may have been avoided.

GAO Report to Congressional Requesters (March 2013), OFFSHORE TAX EVASION: IRS Has Collected Billions of Dollars, but May be Missing Continued Evasion

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UNUSUAL RESULTS IN OFFSHORE ACCOUNT CASE

79 year-old Mary Estelle Curran received good new when she was sentenced for criminal tax evasion and failing to file reports of foreign bank accounts on UBS Swiss accounts she inherited from her husband.

The good news was that the judge awarded no jail time and only probation, and then immediately revoked the probation. The bad news was that Ms. Curran entered into an agreement to pay a fine of $21 million dollars (half of the highest balance of the offshore accounts).

Even more unusual than the immediate revocation of probation and the very large penalty were the comments of the judge, who called the situation "tragic" and note that the government "should have used a little more discretion." The judge further urged Ms. Curran to seek a pardon from the President.

You can read more about the sentencing here and read the settlement agreement here.

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BAD PLANNING IN FOREIGN ASSET PROTECTION TRUST SCENARIO

Foreign asset protection trusts are often established by U.S. persons to shield their assets from creditors. Typically, assets transferred to the trust can be paid to or applied for the benefit of the U.S. grantor(s) and their family members only in the discretion of the trustee. The trustee is typically a trust company situated in the foreign jurisdiction. So that the grantor has some measure of control over the situation, the grantor typically has power to remove and replace the trustee. Thus, if the trustee is uncooperative, the grantor has the ability to try to find and install a more cooperative one.

In a recent South Florida case, the U.S. government is a creditor of a deceased husband and his wife. The wife is a discretionary beneficiary of non-U.S. trusts, and she has the power to change trustees. The IRS has a lien on the trust assets – however, since the assets are situated outside of the U.S. with a non-U.S. trustee, the U.S. courts have no jurisdiction over the foreign trustee.

The bad planning in this situation is that the wife has the power to appoint a trustee situated anywhere in the world (including in the U.S.). Thus, the court is now ordering her to exercise that power to remove the current trustee and replace it with a U.S. trustee. Once that is done, the trustee will be within the jurisdictional reach of the court, and the assets of the trust will be reachable.

A better plan would have been to limit replacement trustees to those situated in the jurisdiction of the trust, or at least to jurisdictions outside of the U.S. Further, taxpayers should not engage in transfers that put assets beyond the reach of the IRS – such activities can result in criminal liability.

U.S. v. Grant, 2013 WL 1729380 (S.D.Fla., April 22, 2013)

APPLICABLE FEDERAL RATES–MAY 2013

 

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IS THE IRS READING EMAILS WITH A SEARCH WARRANT?

Last week, the ACLU created a stir when it suggested that the IRS may be reading taxpayers’ emails without obtaining a search warrant. Read more about that from the ACLU here. At least at some point in time in the past, according to the IRS’ 2009 “Search Warrant Handbook,” the IRS believed that the Fourth Amendment protections against unreasonable searches and seizures did not apply to email messages stored on a server.

Under the federal Electronic Communications Privacy Act, email stored on an email provider’s server can be obtained without a warrant if it has been on the server for more than 180 days or has been opened. However, the Sixth Circuit Court of Appeals in U.S. v. Warshak in 2010 requires a probable cause warrant before compelling email providers to turn over messages.

However, the head of the IRS told a Senate finance committee yesterday (April 16) that the agency does require a warrant before requesting emails from an internet provider. However, the ACLU still indicates there are open questions, such as whether the IRS only seeks a warrant for emails under 180 days old, whether it acts differently when it is in jurisdictions outside of those in the Sixth Circuit Court of Appeals, and whether it seeks a warrant for other electronic communications such as text messages and private massages on social media sites such as Facebook and Twitter.

PART-TIME LANDLORDS THAT WORK FULL TIME WILL HAVE A HARD TIME QUALIFYING AS REAL ESTATE PROFESSIONALS

Taxpayers that own rental real estate property will often want to qualify as “real estate professionals” under Section 469 (the “passive loss rules”). If they do that, their losses from their real estate activities can be used to offset other income beyond the $25,000 that is allowed – otherwise, they can only apply those losses against passive activity income.

Normally, a taxpayer will need to show that he or she spent at least 750 hours in the year on rental activities to qualify as a real estate professional for this purpose. However, there is a second requirement that must be met, which will make the real estate professional label difficult to obtain for taxpayers who also work other jobs, as demonstrated in a recent Tax Court case.

In Hassanipour, T.C. Memo 2013-88, Mr. Hassanipour owned 28 rental units in California. With that number of units, it should have been easy to show the 750 hours requirement was met. However, the passive loss rules also require that more than one-half of the personal services performed in trades or businesses by the taxpayer during the year are performed in real property trades or businesses in which the taxpayer materially participates. Since Mr. Hassanipour also worked a full time job outside of the real estate professional, he thus would have also had to show that he worked more than the 1500-1600 hours or so that he worked at his other job. This obviously is a much higher burden, and Mr. Hassanipour was unable to satisfy the court that he worked that level of time in both his regular job and in his real estate business. This burden will also make it difficult for others working full-time jobs to qualify as real estate professionals.

Taxpayers who can meet the hours requirements should keep contemporaneous time records to be able to prove it if questioned. Further, unlike Mr. Hassanipour, they should NOT present to the court evidence of contemporaneous time records on a paper calendar that bears a copyright date on it that is AFTER the years it was supposedly being used to track.

Hassanipour, T.C. Memo 2013-88

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SO MUCH FOR "PERMANENT" - TRANSFER TAX RATES AND EXEMPTIONS ARE BACK IN PLAY

Late last year, Congress and the President agreed to "permanent" transfer tax revisions that set the unified credit equivalent exemption at $5.25 million in 2013, indexed it for inflation, and set the maximum rate at 40%. At long last, the moving target of exemption and rate changes that have varied annually since 2001 was dead and buried.

Not for long, however. President Obama's budget proposal has reopened the issue. It calls for a $3.5 million exemption, without indexing for inflation. It would also move the maximum rate up to $45%. These changes would take place in 2018, which would again likely rekindle gift tax planning in 2017 before the old rates and exemptions expire.

This of course is only a proposal. Nonetheless, the four month period of "permanence" has reached its end.

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TAXPAYERS WAIT TOO LONG FOR ASSIGNMENT

If a taxpayer owns appreciated property and transferors it to another, and that successor owner sells the property, the gain from the sale is reportable by the successor owner, not the donor. However, if the gift occurs too close to the sale date, the assignment of income doctrine will attribute the gain back the transferor. A recent cases demonstrates what “too close” means.

In the case, the transferred assets were member interests in LLCs that owned stock in a closely held corporation. In early 2000, the stockholders of the company retained an investment banking firm to sell the business. On November 16, 2000, Agilent Technologies made a bid to purchase all of the stock. On November 21, 2000, the board of directors of the corporation agreed to the offer, subject to certain conditions. On November 24, 2000, the board gave its final approval. A formal Agreement and Plan of Merger was entered into on that day. Trading in the stock was restricted by those agreements, pending closing. Also on November 24, 2000, the owners of the LLC sold their shares to 3 Cayman Island corporations in exchange for annuities. Presumably, based on rules in effect in 2000, it was intended that the gains from sale would be taxed on a deferred basis (but this is not certain). The sale of shares to Agilent was publicly announced on November 27, and the Agilent sale closed on January 8, 2001.

The transfers of the LLC interests occurred too late to avoid the assignment of income doctrine, ruled the District Court of the Virgin Islands. Thus, the gains from the sale of the stock of the closely held company to Agilent were taxable to the original LLC owners.

The court relied heavily on Ferguson v. Comm'r, 174 F.3d 997, 1003 [83 AFTR 2d 99-1775] (9th Cir. 1999). In that case, a transfer occurred too late to shift the incidence of taxation when the subsequent sale was “practically certain to proceed” and not a remote hypothetical possibility, and it was “quite unlikely” that the anticipated sale would not occur. In this case, all sale approvals had been obtained, and the owners were contractually bound to sell. Thus there was “no real risk” that the sale transaction would not occur.

Gail Vento LLC v. U.S., 111 AFTR 2d 2013-XXXX, (DC VI), 03/28/2013

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GRANDFATHERED BUY-SELL AGREEMENTS

Code §2703 severely restricts the ability of a buy-sell agreement to control estate tax values in a closely held entity. A recent private letter ruling reminds us that older agreements are not subject to Code §2703.

More particularly, agreements entered into before October 8, 1990, and that are not “substantially modified” after that date are not subject to Code §2703. Apparently, there are still a few of these older agreements out there.

The private letter ruling recognized that the older agreement was not subject to Code §2703.  The ruling also sought confirmation that certain changes being made now to the agreement are not substantial modifications that will subject it to Code §2703.  Treas. Regs. §25.2703-1(c) provides guidance on what is a substantial modification for this purpose.

One modification to the agreement was to extend the repayment term. The IRS viewed this as only a de minimis change to the quality, value, or timing of the rights of a party to the agreement because the agreement requires payment of a reasonable rate of interest.

The other modification was a clarification that the “prime rate” used in the agreement is a rate that is to be adjusted semiannually. This change was not a substantial modification because the regulations provide a substantial modification does not include a modification that results in an option price that more closely approximates the fair market value. Here, an adjustable interest rate should result in payments that more closely approximate fair market value.

Note that agreements that are not subject to Code §2703 still must meet the requirements of  Treas.Reg. § 20.2031-2(h), Rev. Rul. 59-60, 1959-1 CB 237, and applicable case law before the purchase price provided therein will control for federal estate tax valuation purposes.

Private Letter Ruling 201313001

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