IRS Charitable Deduction Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

All taxpayers at one time or another have made tax deductible charitable donations under IRS Code 170.  But would your charitable deduction hold up during an IRS Charitable Deduction Audit?   While Façade Easements were recently the focus of IRS Charitable Deduction Audits, the IRS in addition to disallowing Façade Easements deductions still routinely disallows your normal cash and noncash donations during an IRS Charitable Deductions Audit. In fact, the IRS is just as likely to commence a regular and routine IRS Charitable Deductions Audit against you in many cases years after you file your tax return.  So if you have made a donation to your favorite charity and plan on deducting these donations on your 2015 income tax return in accordance with IRS Code 170, stay tuned to TaxView with Chris Moss CPA Tax Attorney to learn how to comply with Government regulations for legal record keeping of cash and non-cash charity donations, and see where IRS Charitable Deductions Audits are trending in 2016 so you can make sure you don’t lose an IRS Charitable Deduction Audit headed your way soon.

Regarding noncash donations to Purple Heart, Goodwill, Salvation Army and other similar organizations, the IRS seems to be just waiting to disallow all these deductions during an IRS Charitable Deduction Audit just as they did to Kenneth and Susan Kunkel in Kunkel v IRS US Tax Court 2015.  The Kunkels deducted on their 2011 Sch A tax return noncash charity donations of $37,315 comprised of household items, books, clothing, furniture, and toys donated to the Lutheran Church, Goodwill Industries, Purple Heart, and Vietnam Veterans.   The Government not only disallowed the whole deduction in an IRS Charitable Deduction Audit claiming the Kunkels had lack of substantiation but also hit the Kunkels with an accuracy related penalty plus interest. The Kunkels fought back appealing to US Tax Court in Kunkel v IRS US Tax Court 2015.  Indeed the Kunkels produced for the Court the receipts given to them by the various organizations and in my view very detailed spreadsheets of exactly what they had contributed but unfortunately this wasn’t good enough to overrule an IRS Charitable Deduction Audit.

Judge Lauber of the US Tax Court observed that Section 170 indeed allows the Kunkels to deduct their charity contribution, cash or noncash, made within the taxable year to a charitable organization.  However charity cash or noncash deductions are allowed only if the Kunkels can satisfy statutory and regulatory requirements of 170(a)(1) andRegulation 1.170A-13.   Whether cash or noncash, if you make donation over $250 you must obtain a contemporaneous written acknowledgement from the charity.  For a noncash donation that exceeds $500 then you are subject to even more rigorous substantiation requirements, and finally if the noncash donation is higher than $5000 you are subject to highest substantiation requirement including a qualified appraisal which must be included in the tax return prior to filing.

The Court also noted that similar items of property must be aggregated in determining whether the noncash gift exceeds the $500 and the $5000 thresholds as per Section 170(f)(11)(F).  While clothing, jewelry, furniture, electronic equipment, household appliances or kitchenware are considered separate categories the Government in an IRS Charitable Deduction Audit in many cases aggregates as much of your donation as they can into one category so that they can push you into the next more rigorous substantiation threshold.   Unfortunately for the Kunkels the Court aggregated their donations in 2011 to add up to $21,920 for clothing, $8000 for books, which subjected them to the $5000 threshold.  The rest of the donations were aggregated over the $500 category threshold. There was little that the Kunkels could do to dispute these groupings because their tax return lacked contemporaneous evidence within the tax return itself.

The Court went on to list the requirements of any contribution (cash or noncash) over $250.  There must be a “contemporaneous written acknowledgment of the contribution by the charitable organization citing Weyts v IRS T.C.Memo 2003-68.  The charity also must give you a description of any property other than cash, and whether or not you received any goods or services back from the charity.  If you did receive some sort of goods or services back from the charity, then the charity must provide you a good faith estimate of the value of those goods and services.  Finally and most importantly the evidence that you receive in form of documentation from the charity must be “contemporaneous”.  In other words the facts will have to show perhaps later that you had all your documentation in your possession by the date you filed your tax return.

For noncash donations, the documented facts are a much difficult to gather contemporaneously but nevertheless essential to you winning an IRS Charitable Deduction Audit.  As an example, Goodwill, Purple Heart and Salvation Army usually pick up clothes and other household goods direct from your doorstep, in many cases when you are not at home leaving a receipt hanging on your door handle.  While the Court acknowledged that at times it might be difficult to obtain the required documentation, when property is left at a charity’s unattended drop site, the Court nevertheless placed on Kunkel the burden of obtaining the necessary documentation prior to them filing their tax return.

The Court then went on to address noncash contributions exceeding $500.  Citing Gaerttner v IRS  TC Memo 2012-43Judge Lauber opined that the records Kunkel should have obtained  prior to filling their tax return were at minimum: 1. The date the Kunkels  acquired the property and how they acquired the property, 2. A description of the property, 3. The Cost of the property, 4, the Fair market value of the property at the date of contribution and  5, the method the Kunkels used in determining fair market value as per Section 170(f)(11)(B) and Regulation 1.170(A)-13(b)(2)(ii)(C) and (D).

The Court was not without compassion for the Kunkels charitable intent, and conceded that “no doubt the Kunkels did donate some property to charity in 2011.” But the Court concluded that the IRS Code imposes a series of increasingly rigorous substantiation requirements for larger gifts, especially when the consist of household property rather than cash and that the documentation required by law was simply not present in the Kunkels 2011 tax return that they filed with the Government.  Indeed, the Court also found the Kunkels negligent in filing a tax return without supporting documentation and hit them with a substantial Section 6662(a) penalty plus interest.  IRS wins, Kunkels lose.

So how can you win an IRS Charitable Deduction Audit if you have noncash donations in excess of $500? First, have your tax attorney include in your tax return the facts and evidence you need to win an IRS Charitable Deduction Audit.  Best practice for larger noncash donations would be insert the required documentation into tax return itself prior to filing to prove that the evidence was contemporaneously created. Second, do not make the donation if the charity cannot give you the IRS required information. If you don’t have the facts on your side simply don’t take the deduction.  Not only are you not going to win the audit without the facts and evidence contemporaneously documented in your tax return, but you will also get hit with a substantial negligence penalty plus interest. Finally, if the charity cannot give you the required documentation simply consider donating to another similar charity which perhaps can provide you the required government documentation to sustain an IRS Charitable Deduction Audit.  After you file your tax return with the required facts and evidence you can then sit back and relax, knowing that when the IRS Charitable Deduction Audit commences, perhaps years later, you are going to win big.

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

See you next time on TaxView.

Kindest regards and happy New Year 2016 from Chris Moss CPA Tax Attorney

IRS Mortgage Interest Audit

IRS Mortgage Interest Audit

Chris Moss CPA Tax Attorney

November 25, 2015

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Just about all of us at one point or another have deducted mortgage interest as an itemized deduction allowed under IRS Code Section 163 on Schedule A of your Form 1040 tax return. IRS Publication 936 and IRS Regulations 1.163 allow a married couple or single individual to deduct interest paid on debt no greater than $1.1M or $550K each filing separately. That is until Charles Sophy and Bruce Voss two unmarried joint owners of a home decided to file a tax return claiming $1.1 Million each or $2.2 Million total. So if you are not married and jointly own a home stay with us here on TaxView withChris Moss CPA Tax Attorney to find out how in 2015 it appears that you are now able to deduct interest paid on $2.2 Million and learn how to protect that deduction from an almost certain IRS Mortgage Interest Audit perhaps many years later.

In 2002 Charles Sophy and Bruce Voss purchased a house in Beverly Hills California as joint tenants financed by $2.2 Million in debt. They filed a federal income tax return in 2006 and 2007 with all interest on over $2M in debt deducted onSchedule A of their personal 1040 Tax return.  The IRS commenced an IRS Mortgage Interest Audit and disallowed all interest on debt over $1.1M. Sophy and Bruce appealed to US Tax Court in Sophy v IRS US Tax Court (2012).

Sophy and Voss argued to the Court that Section 163 limitations were applied per taxpayer with respect to co-owners who are not married and therefore they should be allowed interest on debt up to $2.2M.  The Government argued that whether married or unmarried you still live in one house and get to use only one $1.1M limitation. Judge Cohen therefore had to decide whether or not the statutory limitation of Section 163 was properly applied on a per-residence or per-taxpayer basis where residence co-owners were as in the case of Sophy and Voss not married.

The Court reviewed the legislative history of Section 163 and concluded that because married couples filing separate returns had to split the exemption in half, so should unmarried couples.  Sophy and Voss countered that Congress intended to create a special rule for married couples, the marriage penalty if you will, which should not apply to unmarried couples. Congress was silent on unmarried couples and therefore the marriage penalty should not apply to them. The Court ultimately found for the Government concluding that that nothing in the legislative history of Section 163 suggests that Congress had any other intention than to view mortgage debt on a per-residence basis.  Therefore the per-taxpayer basis used by Sophy and Voss was overruled by the Court with a win for the IRS.

Sophy and Voss then appealed to the US Court of Appeals for the 9^th Circuit in Pasadena California filing on August 7, 2015, in Voss c. Commissioner 796 F.3d 1051 (9th Cir. 2015).  An Amici Curiae brief was filed by Shannon Minter and Christopher Stoll of the National Center for Lesbian Rights and Sophy and Voss were represented by Sideman & Bancroft LLP of San Francisco and Hone Maxwell LLP of San Francisco. The Government was represented by Assistant Attorney Generals Keneally, Cohen and Schumann from the US Dept. of Justice Tax Division in Washington DC

Sophy and Voss continued to argue that the US Tax Court should be overruled because Section 163 debt limits apply to unmarried co-owners on a per-taxpayer basis.  Circuit Judge Jay Bybee acknowledges that Section 163 is specific with respect to a married couple but notes the IRS Code does not specify whether in the case of residence co-owners who are not married the debt is limited per residence or per taxpayer.  The gap in the Code is the source of the present controversy Judge Bybee opines.

The Court argues that because Voss and Sophy were unmarried they were required to file separate single tax returns not joint or married filing separately returns.  Knowing that married couples file as one person, either jointly or separately, Congress on many other occasions has provided half-sized deductions for married couples filing separately including a capital gain limitation of $3000 for married, $1500 for married filing separately.

If Congress, the Court reasons, wanted to go further and ensure that two or more unmarried taxpayers were treated as a single taxpayer for purposes of Section 163, then Congress could have done that with specific language in the Code. The Court gave as an example Section 36 of the Code the First Time Homebuyer credit where unlike the mortgage debt interest limitation in Section 163, First Time Homebuyer credit Section 36 says “Married filing separately each can take $4000 of the total $8000 credit AND if two or more individuals who are not married purchase a principal residence, the amount of the credit can not exceed $8000”. The Court concluded that a per-taxpayer reading of the statute debt limit provisions is most consistent with Section 163 and Treasury regulation 1.163 as a whole. The Court therefore reversedSophy v IRS US Tax Court (2012) and remanded back to the US Tax Court the job of determining in a manner consistent with the 9^th Circuit Opinion the proper amount of qualified residence interest under Section 163. Voss Sophy win, IRS loses.

But there’s more: Circuit Judge Ikuta writes a blistering dissenting Opinion claiming that the majority opinion allows unmarried taxpayers who buy expensive residences to deduct twice the amount of interest than married spouses would be allowed to deduct. The Dissent shows how over the years the IRS has promulgated numerous regulations and rulings showing how exactly unmarried taxpayers who jointly own a home can apportion the interest on the $1.1 M debt limitation of Section 163. Voss and Sophy’ s approach should be rejected because due respect and deference should be given the US Treasury interpretation of the statute citing Christensen v Harris 529 US 576 (2000). The Dissent called the Majority “an absurd” marriage penalty with the better solution being to defer to the IRS reasonable interpretation of the statute. Therefore Judge Ikuta concluded in his Dissent that he would affirm the US Tax Court below.

What does all this mean to any of you purchasing a home with debt of over $1.1M? First, in my view, even if you don’t live in the 9^th Circuit, if you are unmarried in 2015 and co-own a home together with a larger mortgage than $1.1M make sure you consult with a tax attorney before you file your 2015 income tax return.  It sure looks at least for now until the other Circuits chime in that you will have a good chance of supporting an interest deduction on debt of up to $2.2 million.  Second, have your tax attorney include in your tax return Voss c. Commissioner 796 F.3d 1051 (9th Cir. 2015) to support your position. Finally until Congress amends Section 163 and the other Circuits chime in, you should expect an IRS Mortgage Interest Audit within perhaps years after you file your tax return. With proper preparation and planning you will have an excellent chance to win an IRS Mortgage Interest Audit as did Voss and Sophy. Thank you for joining us onTaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView

Happy Thanksgiving 2015 from

Chris Moss CPA Tax Attorney

IRS Legal Fees Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

If any of you have incurred legal fees in 2015 perhaps you should consider a Legal Fees Tax Deduction?  You are entitled to deduct civil or even criminal legal fees under Section 162(a) paid to an attorney in connection with your business. You can also deduct legal fees paid to an attorney as a miscellaneous itemized deduction under Section 67 if you bring legal action against your employer. Finally, you can deduct legal fees under Section 212 if you paid an attorney in connection with the production or collection of income or the maintenance of property held for the production of income. But the Government is aggressively reviewing your legal fee deductions in many cases years later during an IRS Legal Fees Audit, hoping to disallow much of your legal fees deductions.  So stay with us here on TaxView with Chris Moss CPA Tax Attorney where you will learn how to deduct legal fees in 2015 by protecting those deductions with bullet proof evidence you will need years later to successfully defend your deductions during an IRS Legal Fees Audit.

The first and most important evidence you need is contemporaneously prepared legal invoices by your attorney detailing the kind of legal work you paid for as Parker Company found out in Parker v IRS US Tax Court (2012). The Parker business claimed $630,000 in legal fees paid to attorneys in 2003 in relation to the arbitration and the shareholder derivative suit. The IRS audited six years later in 2009 and disallowed all legal fees. Parker appealed to US Tax Court in Parker v IRS US Tax Court (2012) arguing the legal fees were ordinary and necessary trade or business expenses to defend shareholder derivative suits. However, the Court concluded that Parker could not substantiate most of the claimed legal fees. A ledger and two cancelled checks provided by Parker was not good enough.  The Court allowed only $55K and disallowed $575,000.  IRS Wins Parker Loses.

In addition to having the proper contemporaneously prepared legal invoices, make sure you know what IRS Code Section you are able to legally deduct your legal fees as Gary Lee Colvin found out in Colvin v US Tax Court (2004).  Colvin paid an attorney in connection with State Court litigation against his primary residence homeowners association and paid the same attorney to sue his former employer to recover lost wages, however the attorney he paid never provided detailed invoices showing the kind of legal work he was paid for. Colvin deducted one total legal fee on his Schedule C business in 1997 and 1998. The IRS audited and disallowed all legal fees arguing that the legal fees were not ordinary and necessary business expenses and there was insufficient legal invoices to sustain the deduction. Colvin appealed to US Tax Court in Colvin v IRS US Tax Court (2004) arguing the legal fees were deductible under Section 212 to protect the production and collection of income. Special Trial Judge Dean easily finds for the Government noting that Colvin may not under Section 212 deduct legal fees that are personal expenses to protect his primary home as per Section 1.212-1(h). The Court concedes that legal fees to sue his former employer for lost wages would have been deductible but because there were no contemporaneously prepared legal invoices documented the nature of the legal work performed no deduction could be allowed.  IRS wins Colvin loses.

Our next case Chaplin v IRS US Tax Court (2007), involves a professional fiduciary Philip Chaplin who worked for Rice Heard & Bigelow Inc (Rice) and was elected to the Board of Directors of Rice in 1987.  Chaplin acted as a fiduciary for clients from 1988-1994, was provided a Rice credit card and was paid as an employee of Rice as per his employment agreement. Unfortunately Rice terminated Chaplin in 1994 and eventually in 1997 Chaplin filed suit against Rice alleging breach of contract and wrongful termination.  The case settled in 2002 and Chaplin was paid $1.5M.  Chaplin deducted legal fees on his 2001 tax return as an offset to the $1.5M.  In 2005 the IRS audited Chaplin’s 2001 tax return and denied his legal fee deduction claiming that the legal fees were not deductible from adjusted gross income as business legal fees but rather unreimbursed employee expense legal fees under Code Section 67 to be deducted as miscellaneous itemized deductions subject to the 2% floor limitation.  Chaplin appealed to US Tax Court in Chaplin v IRS US Tax Court (2007)Judge Haines easily finds for the Government concluding that Chaplin was clearly an employee not an independent contractor.  IRS Wins Chaplin loses.

Our next case Brenner v IRS US Tax Court (2001) introduces us to Andrew Brenner employee of Nomura Securities from 1987 to his termination in May of 1996.  Brenner sued Nomura and eventually settled in 1998 for $1.9M. In 1997, Brenner deducted $215,354 worth of legal fees as a miscellaneous itemized deduction under Section 67. But in 1999 he filed an amended return  on advice of his accountants claiming his legal fees were part of his company corporate plan under IRS Section 62 and Regulations 1.62, which allowed that his legal fees be directly deducted as an offset to his $1.9 settlement income.  The IRS audited and disallowed the adjusted the legal fees back to what they were on his original return claiming that Nomura was Brenner’s employer.  Brenner appealed to US Tax Court in Brenner v IRS US Tax Court (2001)and Judge Halpern easily found for the Government because no lawyer’s bill was ever submitted to Nomura, and no itemization of specific bills or invoices was ever substantiated under Section 162-2(e)(3). Because Brenner did not provide the required documents  to comply with Section 1.62-(2)(e)(3), Brenner’s only recourse was to deduct the legal fees under Section 67 as a miscellaneous itemized unreimbursed employee business expense on Schedule A of the original return as filed.  IRS Wins Brenner Loses.

Our final case is Butler v IRS US Tax Court (1997).  The facts are simple.  Butler purchased a farm in California and became involved with various law suits over water rights to protect and defend the title to his farm.  Butler deducted his legal fees in 1991 1992 and 1993 under Section 162.  The IRS audited disallowing all legal fees claiming the farm was not engaged in for profit within the meaning of Section 183, and therefore not deductible or in the alternative under Section 263 the legal fees were capital in nature to protect the title to the property and were also not deductible.  Butler appealed to US Tax Court in Butler v IRS US Tax Court (1997).  Butler claimed that at the legal fees where business expenses under Section 162 or in the alternative itemized deductions under Section 212 to protect is investment in the farm.   Judge Gerger finds easily for the Government because Butler did not work the farm full time and that Butler lacked a profit motive.  Therefore under Section 183 no legal fees could be deducted either under Section 162 or in the alternativeSection 212.  IRS Wins Butler loses.

As you can see, the US Tax Court does not allow legal fees to be deducted on your tax return unless you have well document legal invoices, a business connection under Section 162, unreimbursed employer expense under Section 67, or a clearly set up contemporaneous set of facts and evidence to prove the legal fees you paid  to an attorney protected  your income producing investment under Section 212.  So how can you win an IRS Legal Fee Audit?  First make sure you legal invoices are all specific enough to connect the legal service provided to the appropriate Code Section eitherCode Section 162, Section 67 or Section 212.  Second make sure you retain a tax attorney to create contemporaneous documentation to insert into your tax return before you file to make sure the Government has disclosure of under what Section of the IRS Code you are claiming your legal fee deduction. Finally obtain from your trial attorney before you pay them their opinion on whether or not their legal fee is tax deductible.  If they don’t know, perhaps they can retain a tax attorney to give her opinion prior to commencing litigation.  You will be glad you did years later when the Government comes knocking on your door to commence an IRS Legal Fee Audit.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

IRS Bad Debt Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

How many of you all have ever loaned money or property through your business and have not been paid back?  Have you ever loaned money or property to a friend and have not been paid back? Did you all know you can deduct either on your business or personal tax return a bad debt either as a business bad debt under IRS Section 166(a) and 166(b) or a nonbusiness bad debt under IRS Section 166(d)?  However, the Government looks closely at your bad debts perhaps years later disallowing all your deductions in and IRS Bad Debt Audit. So if you loaned out some money or property that you want to deduct in 2015 as a bad debt, stay with us here on TaxView with Chris Moss CPA Tax Attorney to find out how to keep those bad debt deductions from being disallowed years later during and IRS Bad Debt Audit.

Bad Debts are not so bad when you get to write them off on your tax return.  But what if you get audited as did Fred Cooper in Cooper v IRS US Tax Court (2015).  The facts are simple:  Cooper liked to make large sporadic loans to friends and business acquaintances. One of these loans was for almost $1M to Wolper Construction commencing in 2005 and due to be paid back in 2007.   Wolper filed Chapter 11 in 2008 and eventually Chapter 7  in 2009.  On advice of professional tax advisors Cooper amended his 2008 tax return in 2010 and deducted $750,000 bad debt deduction against ordinary income.  The IRS audited years later in 2013 and disallowed the entire bad debt deduction for 2008.  Cooper appealed to US Tax Court in Cooper vs IRS TC Memo 2015-191.

Judge Buch notes that Section 166 allows taxpayers to deduct any debt that becomes worthless within the taxable year.  To be entitled to the deduction the taxpayer must show a bona fide debt based on a debtor-creditor relationship citing IRS Regulation 1.166-1(c). Business debts and nonbusiness debts are treated differently under Section 166.  Nonbusiness debts are defined as debts not connected in connection with a trade or business.  Unlike Business Bad Debts that are deducted directly against income, nonbusiness bad debts are short term capital losses with a maximum deduction of $3000 per year if there are no offsetting capital gains.  Whether or not the debt is business or nonbusiness is a question of fact citing Rollins v Commissioner 276 F.2d 368 (4^th Cir 1960).  The business bad debt must be “proximately related” to the conduct of the trade or business, citing Litwin v US 983 F.2d 997 (10^th Cir 1993).

Cooper argued before the Court that he was in the business of lending and therefore the deduction was a business bad debt.  The Government argued otherwise citing that the facts do not support Cooper’s argument.  The Court agreed with the IRS finding that there were five facts that showed Cooper was not a lender:  1. Cooper made only 12 loans over a six year period from 2005-2010. 2. Cooper only would lend money to friends and acquaintances. 3. Cooper did not use formal lending practices with no credit checks or collateral verification and there were no written promissory notes for 7 of the 12 loans. 4. Cooper did not publicly hold himself out to be a lender and 5. Cooper did not keep adequate contemporaneous business records.  Many of the records given to the Court were constructed after the fact and were not considered credible.

The Court then went on to find that the nonbusiness bad debt was not wholly worthless in the year Cooper claimed the deduction in 2008.  Cooper unfortunately was unable to show identifiable events to the Court that formed the basis of Cooper abandoning any hope of recovery citing Aston v Commissioner 109 US Tax Court 400 (1997).  The facts unique to Cooper showed Cooper never claimed the debt to the US Bankruptcy Court, that Cooper listed the loan on his personal financial statement in 2009 as an asset, and that Cooper never sent Wolper a form 1099-C, cancellation of debt,  nor was the IRS ever sent the 1096 form reporting the cancellation of the debt to Wolper.  The Court therefore concluded that based on the facts, Cooper’s nonbusiness bad debt was not wholly worthless and therefore the deduction could not be sustained.  IRS wins Cooper loses.

Our next case, Shaw v IRS US Tax Court (2013)  also has simple facts. June Shaw had a large capital gain of over $1M in 2009 from the sale of an apartment building in 2008. In the same year as this gain, the facts show that in 2009 June Shaw loaned on a very short term basis over $800K to a company owned by her brother Kenneth Shaw.  June Shaw was unable to get her loan paid back by her brother Kenneth in 2009 so she deducted this $800K as a capital loss bad debt against the $1M capital gain.  The IRS audited years later and disallowed the entire bad debt deduction claiming there was no bona fide worthless bad debt to deduct. June Shaw appealed to US Tax Court in Shaw v IRS Tax Court 2013-170.

Judge Lauber opines that Section 166(a)(1) allows a deduction for any bona fide debt that becomes worthless within the taxable year. A bona fide debt is a debt that arises from a debtor-creditor relationship based on a valid and enforceable obligation to pay a fixed sum of money, citing Section 1.166-1(c) of the IRS regulations.  Transactions between family are subject to special extra scrutiny citing Caligiuri v Commissioner 549 F.2d 1155(8^th Cir 1977). The Court observed that June Shaw provided no evidence that she checked out the credit worthiness of the company nor that she request assets be given to collateralize the loan. The facts showed further that June Shaw extended an unsecured line of credit that no third party lender would have approved.  Finally that Court noted that June Shaw made no serious effort to obtain repayment nor did she send a letter demanding payment.  Finally she never filed a law suit against the company. The Court easily concluded that the loan was not a bona fide loan and therefore not deductible under Section 166.  IRS Wins June Shaw loses.

So how can you best create the facts you need to deduct a bad debt and sustain the deduction under Section 166 during an IRS bad debt audit years later?  First, before you lend anyone any money or property make sure you have a written legal promissory note with real terms of repayment.  Check their credit scores and make sure you get collateral on the loan.  Obtain financials and a PFS from the borrower, just like a bank would ask for.  Second, if you think the debt is going bad, retain a collection company to collect the debt and consider bringing legal action.  About a year later if all else fails, then and only then can you claim on a tax return that you are deducting a bona fide bad debt that is wholly worthless and noncollectable.  Finally, have your tax attorney attest to the steps you have taken to collect the debt and insert her contemporaneous statement into your tax return before you file.  You will be glad you protected your bad debt deduction from Government adverse action when the IRS come knocking on your door years later to commence an IRS Bad Debt Audit.

Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

Preachers of the Gospel Parsonage Exclusion

November 14, 2015

by Chris Moss CPA

Chris Moss CPA Tax Attorney

IRS Clergy Parsonage Allowance Exclusion

Welcome to TaxView with Chris Moss CPA Tax Attorney

The Clergy Tax Free Parsonage Allowance Exclusion under IRS Section 107(1) and 107(2) which has provided tax free rental exclusions to the preachers of the Gospel for almost 100 years has been saved by the 7^th Circuit Court of Appeals in a dramatic reversal of Judge Barbara Crabb’s November 21, 2013 ruling in Wisconsin Federal District Court.  So if you are a minister or preacher of the Gospel and are planning to take advantage of the Parsonage Exclusion in 2015, stay tuned to TaxView with Chris Moss CPA Tax Attorney to hear about the exciting conclusion of the 7^th Circuit’s November 13, 2014 Opinion in Freedom From Religion vs Jacob Lew, Sec of the Treasury and John Koskinen, Commissioner of the IRS, on Appeal from No.11-cv-06260 Freedom From Religion, Gaylor, and Barker vs Jacob Lew Secretary of the US Treasury (2013) Barbara B Crabb, Wisconsin District Judge presiding.

Recapping from a previous TaxView, Tax Free Housing Allowance for Clergy, by Chris Moss CPA Tax Attorney, let’s first look at what Section 107 is all about. Simply stated if you are a preacher of the Gospel you get to exclude from your income the fair rental value of the home or what the church pays you for the home, whichever is less. Section 107(1)excludes the value of your housing provided by the Church. Section 107(2) excludes direct cash compensation paid to the preacher for housing that the preacher pays for. Further regulations added requirements that the Allowance be officially approved by the Vestry or similar church Board.IRS Ministers’ Compensation and IRS topic 417. Various tax court rulings, including US Tax Court Driscoll v IRS imply that Congress had viewed the relationship between a Church and its ministers in a similar manner as they viewed the relationship between an Employer and its Employees. Congress reasons that if Employees were exempted on housing provided for the convenience of their employer, then why not have the Clergy exempt on similar housing allowance income when they would travel to a new Church to preach the Gospel. Interestingly, while the US Tax Court has ruled for or against the clergy over the years for abuse of the Exclusion, the Court has never before challenged Section 107 on Constitutional grounds that is until now.

See 

Judge Crabb’s Opinion argues that her invalidation of the Allowance on Constitutional grounds does not mean that the US Government is powerless to enact tax exemptions that benefit religion. Indeed Judge Crabb concludes that Congress can enact legislation for granting the Exclusion that would be based on secular rather than religious grounds.  Unfortunately until Congress acts Judge Crabb opines, the Allowance is an unconstitutional violation of the separation of Church and State as found in the US Constitution.

However the 7^th Circuit Judges Flaum, Rovner and Hamilton reversed Crabb in a most dramatic ruling, not deciding the case on the merits but rather on procedural grounds.  Judge Joel Flaum gave his Opinion that the Plaintiffs, Freedom From Religion, Gaylor and Barker, “lacked standing” before the Federal Court system to challenge Code Section 107(2).  The Court did not therefore reach the issue of the Constitutionally of the parsonage exemption.

The facts upon which this reversal were based were relatively simple in that Freedom From Religion’s co-Presidents Annie Gaylor and Dan Barker received a portion of their salary in the form of a housing allowance which was taxable to Gaylor and Barker.  Gaylor, Barker and Freedom From Religion brought suit in the Western District of Wisconsin claiming that Section 107 violated their First Amendment rights because it had given a tax benefit to preachers of the Gospel but not to them. The District Court agreed with Gaylor and Baker and ruled Section 107 unconstitutional. The Secretary of the Treasury and the IRS appealed to the 7^th Circuit arguing that Gaylor and Barker did not have standing to bring the suit.

Gaylor and Barker argued before the 7^th Circuit as they successfully argued before the District Court that they did indeed had standing because they were denied a tax exemption for their own employer provided housing allowance that was conditioned on them preaching the Gospel which of course they didn’t do.  The 7^th Circuit reversed the District Court concluding that Barker and Gaylor were never denied the parsonage exemption because they never asked for it.

The 7^th Circuit reasoned that without a request by Barker and Gaylor there could be no denial.  And absent any personal denial of the tax benefit, Gaylor and Barker’s claim amounted to nothing more than a generalized grievance about107(2)’s unconstitutionality, which does not support standing before the Federal Court system.  Citing Lujan v Defenders of Wildlife 504 US 555 (1992),   the Court agreed argued that a Plaintiff raising only a generally available grievance about government does not state a Constitutional Article III case or controversy.

But Gaylor and Barker argued further that they are in fact similarly situated to preachers of the Gospel receiving the107(2) exemption because they too receive a housing allowance from the company they work for.  The only reason they argue that they cannot take advantage of 107(2) is that they are not ministers of the Gospel but executives who are employed by Freedom From Religion. The 7^th Circuit rejected this reasoning because there was still no injury to Gaylor and Barker since they had never tried to take advantage of 107(2).  The preachers of the Gospel actual had claimed the exemption, but Gaylor and Barker did not.  Being similarly situated is simply not enough to give standing opines Judge Flaum.

Finally, Gaylor and Barker argue as they did successfully before the District Court that for the 7th Circuit to require Gaylor and Barker to “claim the exemption” and wait for the IRS to deny their claim would serve no useful purpose and only delay the inevitable outcome in the case citing:  Freedom from Religion Foundation, Inc. v. Lew, 983 F. Supp. 2d 1051, 1055–56 (W.D. Wis. 2013).  The 7^th Circuit however disagreed with District Court concluding that the US Constitution does not allow Federal Courts to hear suits filed by plaintiffs who lack standing, and standing is absent here with Gaylor and Barker because they have not been personally denied the parsonage allowance.  Finally, because the Plaintiffs did not have standing to challenge the parsonage exemption, the 7th Circuit, remanded the case back to Judge Grabb instructing her to dismiss the complaint for lack of jurisdiction,.

So what does this mean for all you Preachers of the Gospel out there? Since there has not yet been an Appeals Court ruling on the merits of this case, you can be sure there will be further attempts by Freedom From Religion type organizations to have the Parsonage Exemption ruled unconstituational.   Until then, please have your tax attorney continue to exclude your parsonage allowances from your taxable income under IRS Code 107 with written contemporaneous explanations included in your personal tax return before your file with reference to the ongoing Constitutional issues.  Finally as these cases ultimately wind their way up to US Supreme Court for a final Constitutional determination enjoy the tax free benefit in my view you so rightfully deserve as  preachers of the Gospel.  God bless you all. Thanks for joining us on TaxView with Chris Moss CPA Tax Attorney

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney

Offshore Tax Evasion

Offshore Tax Evasion

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Many large public businesses have their corporate operations legally headquartered offshore.  For example Apple, General Electric, Pfizer, IBM, and Merck have offshore operations legally sheltering billions of dollars from US income taxation.   However, if any of you individuals or small business owners out there are ever approached with a too good to be true personal tax savings arrangement that involves offshore investing or business operations that result in you personally saving taxes on your From 1040 get a second opinion before you invest in and activate such a scheme.  Once the scheme is discovered by the Government action is immediate and devastating to the promoter of the shelter.  Unfortunately in many cases you the taxpayer/victim are accused of tax fraud as well resulting in severe civil fraud penalties in addition to all the additional income tax you owe.  So if you have money offshore right now or are thinking about a plan that purportedly legally allows you to send money offshore, please stay with us here on TaxView with Chris Moss CPA Tax Attorney to give you a fair warning that such schemes lead nowhere but to large civil fraud penalties and in some cases criminal Government tax investigations.

Big and small business have always been able to operate abroad and save taxes.  But owners of closely held businesses are not legally able to take advantage of these provisions.  In fact Americans are taxed on worldwide income regardless of whether or not the funds are deposited to a foreign bank in a tax free haven. Unfortunately there are many taxpayers out there who don’t know that these schemes are illegal, like Stanley and Ruth Alexander who were in US Tax Court over this very issue in Alexander vs IRS T.C. Memo 2013-203.

The facts are very complex in this 71 page Opinion.  Dr Alexander, a plastic surgeon, used offshore tax strategy to lease back his medical services to his professional Ohio practice.  Alexander met attorney Reiserer from Seattle who reviewed offshore employment leasing with Alexander.  There were numerous doctors who were well versed through seminars in the Bahamas about this strategy. Reiserer and a CPA Kritt “structured, implemented and managed” the offshore strategy for tax year 1996-2003 for Alexander.  In 2003 the IRS initiated a criminal investigation of Kritt.  Kritt was charged with criminal tax evasion, but Kritt was found not guilty by jury of any criminal misconduct.

As a result of the Kritt criminal investigation, Alexander and hundreds of other doctors were audited by the IRS for years 2000-2002 and were accused of substantial understatement of income and tax fraud.  Alexander appealed to US Tax Court in Alexander vs IRS US Tax Court (2013).  Alexander claimed the offshore strategy was to create retirement for his family.  The Government argued that the motivation was avoidance of tax as there was no meaningful economic substance to the strategy.  Judge Goeke on Page 45 of the Opinion opines Alexander relied on Krit and Riserer and Alexander had limited ability to understand the tax law.  As the case unfolds the Court seems to have sympathy for Alexander who “placed a great deal of reliance on Kritt”.  The Court concludes that Alexander did not possess the education that would allow him to know he should have reported additional income”. Page 50.  IRS loses on tax fraud, but IRS wins on understatement.

Our next case involves Dr Child in Child vs IRS T.C. Memo 2010-58.   The facts are relatively simple.  Dennis Evanson designed organized and promoted schemes to shelter income from taxation.  He was ultimately convicted of Federal income tax evasion by a jury in 2008.  All of Evanson’s tax evasion schemes used sham transactions to transfer clients’ untaxed income to offshore entities that Evanson created and controlled.  The funds were typically returned to his clients disguised as disbursements from fictitious loans to avoid taxation.

Dr Child was a highly compensated radiologist who met Evanson at a party.  Evanson helped Child and hundreds of over doctors create a tax evasion scheme which allowed a fictitious offshore insurance company to providing insurance coverage for Child. Premiums were paid and deducted on Child’s tax returns from 1997-2003.  The IRS audited not only disallowing over $280K of deductions but  claimed Child was guilty of tax fraud as the whole scheme was nothing but a tax avoidance sham transaction lacking any economic substance. Child appealed to US Tax Court in Child vs IRS US Tax Court (2010). Judge Kroupa concluded that indeed Child fraudulently intended to evade taxes and this was liable for additional fraud penalties under Section 6663 of the IRS Code which increases the penalty by 75% of the tax owed. IRS wins and Child loses on fraud under IRS Code Section 6663.

If you lose on Fraud you owe additional 75% of the tax owed, a lot of money for most of us.  So why did Child lose on Fraud but not Alexander?   The law says you commit tax fraud if “badges of fraud” are present:  you have inadequate records, you participate in the promoter’s scheme to mislead the Government, you give implausible explanations of behavior to conceal the fraud, you file false documents, and you fail to respond to subpoenas.  Finally you don’t cooperate with the Government. Judge Kroupa in Child argued that “most of the badges of fraud upon which this Court relies were present in Child”. Page 23.   Judge Goeke didn’t feel that way with Alexander and so Alexander did not have to pay the 75% fraud penalty.

In conclusion, if you are a small business owner who attends a seminar on offshore investing schemes, simply say no.  There is no legal tax strategy for individuals and small business owners to keep their offshore earnings from being reported on their personal tax return Form 1040.  Unless you are willing to give up your US Citizenship and leave the country there is simply no legal way to avoid paying personal income taxes by keeping your earnings offshore.  Work within the system to change the tax to perhaps a flat tax or national sales tax, but say no to offshore tax schemes.  You will be happy you did when the IRS comes knocking on your door for an offshore tax audit.

Thank you joining us on TaxView with Chris Moss CPA Tax Attorney.

See you next time on TaxView.

Kindest regards

Chris Moss CPA Tax Attorney

IRS Innocent Spouse Relief Audit

by Chris Moss CPA

Welcome to TaxView with Chris Moss CPA Tax Attorney

Have any of you wives out there perhaps sometimes not quite understood the tax strategy your husband has used to prepare your income tax return?   Any husbands out there traveling so much for work that your wife pays all the bills and files all tax returns?  If any of these situations apply to you, then you can see why innocent Spouse Relief allowed by IRS Code Section 6015(a)(1) is probably one of most litigated of all tax strategies particularly when couples split up and divorce.  In fact, chances are the IRS may just be waiting, patiently I might add, to begin a Whipsaw Innocent Spouse Audit soon after your Divorce decree is finalized. So for all you couples out there, happily married or soon to be divorced, stay tuned to TaxView with Chris Moss CPA Tax Attorney as we journey through real life Innocent Spouse Court cases to discover the best tax strategy for you to win an IRS Innocent Spouse Audit and keep your assets safe and protected from long reach of the IRS Innocent Spouse Audit agents.

Innocent Spouse Relief is litigated in US Tax Court more than just about any other tax strategy.  There were 5 cases in 2015 alone including Willie and Sandra Scott decided last month in September 2015.  In Scott vs IRS US Tax Court 2015-180, the facts are simple except that in this case both husband and wife stayed married.  Husband was in charge of the finances and was responsible for filing the 2008 and 2009 tax returns.  His wife played no role at all in filing the tax return except she gave her husband information on her two businesses for him to include in the tax return he prepared.  The IRS audited and in addition to other minor adjustments against the husband’s businesses disallowed over $200,000 of expenses for wife’s businesses.

Wife did not dispute the tax she owed when she appealed to US Tax Court, but instead, claimed the resulting tax liability should not be joint and several to her because she did not have any involvement with preparation of the tax return. Judge Goeke states that Section 6015(b) provides that a taxpayer will be relieved of liability for an understatement of tax if: (1) a joint return was filed for the taxable year in question; (2) there is an understatement of tax attributable to erroneous items of the nonrequesting spouse; (3) the taxpayer requesting relief “did not know, and had no reason to know, that there was such understatement” when he or she signed the return; (4) taking into account all of the facts and circumstances, it would be inequitable to hold the taxpayer liable for the deficiency attributable to such understatement; and (5) the taxpayer elects to have section 6015(b) apply within two years of the initial collection action.The Court further determined that of all these factors, the key and most important factor was whether the wife “had a reason to know” of the understatement.  The Court of Appeals for the Eleventh Circuit, has held that a spouse has reason to know of a substantial understatement if a reasonably prudent taxpayer in her position could be expected to know that the return contained the substantial understatement. See Kistner v. Commissioner, 18 F.3d 1521 (11th Cir. 1994), rev’g T.C. Memo. 1991-463; Stevens v. Commissioner, 872 F.2d 1499 (11th Cir. 1989).

The Court then reviewed the four factor inquiry that has generally been used in deciding the question of whether a spouse asking for innocent relief has “reason to know” 1. Level of Education, 2. Involvement in family finances, 3. Routine vs lavish expenditures and 4. Deceit by the other spouse. Citing Butler v. Commissioner, 114 T.C. 276, 284 (2000). The Court noted that Wife had a college education and should have had knowledge of income tax owed relating to her own business.  The Court concluded that Wife had in fact “reason to know” of the understatement.  IRS Wins Wife loses Husband wins.   However, the Court also concluded that Wife would have relief from husband’s business tax adjustments, since she had “no reason to know” of her husband’s business.  Wife wins, IRS loses, and Husband has a partial loss.

Unlike the Scotts who stayed married, most of these innocent spouse cases end in tragic Whipsaw divorce as didDemeter v Demeter v IRS in US Tax Court 2014-238 decided November 24, 2014.  The facts are simple: Husband and wife filed tax returns for 2004 2005 and 2006 prepared by tax attorney Ron Mulchi.  Wife signed returns in 2007 having never met or talked with Mulchi.  Taxes were not paid by husband due to his business failing and wife first became aware of this when she started receiving levy notices from IRS.  Both husband and wife filed bankruptcy in 2008 and later divorced in 2009.  Wife filed for Innocent Spouse Relief in 2011 and the IRS was about to grant relief, but her ex-husband filed an appeal in Demeter v Demeter v IRS in US Tax Court 2014-238  as an “Intervenor” opposing in this Whipsaw case relief to his ex-wife.  With the Government conceding to the Ex-Wife, Judge Vasquez eventually ruled in favor of the Ex-wife, finding that she filed for innocent spouse relief after the divorce, during a personal economic hardship, and that her ex-husband agreed as part of the divorce settlement agreement to pay the back taxes, thereby giving the ex-wife “no reason to know” that her ex-husband, the Intervenor, would not pay the tax.  Ex-wife and Government win, Intervenor Ex-husband loses.

Our final case involves a husband fighting for innocent spouse relief in Richard vs IRS vs Ellis Intervenor US Tax Court 2011-144 decided on June 27, 2011.  The facts are fairly simple in that Husband and Wife filed a joint return in 2004 with the bulk of the taxable income attributed to the wife.  Not reported on this tax return was an early distribution from the wife’s retirement account.  The couple divorced in 2006.  Shortly after the divorce, the IRS audited their joint 2004 return and increased the tax due by the failure to report the retirement income distribution.  In 2007 ex-husband filed for innocent spouse relief for the early retirement distribution.  Now here comes the Whipsaw:  The ex-wife intervened claiming the ex-husband very well knew that they did not report the early retirement distribution on their 2004 tax return.  Chief Judge Colvin ultimately finds for the Ex-husband because he credibly testified that he was unaware of his Ex-wife Intervenor’s early distribution. This is in spite of the ex-wife Intervenor testifying that ex-husband and she discussed the early retirement distribution before and after she requested the funds.  Perhaps Judge Colvin heard “she said” but believed “he said” as ex-husband appears to have been more credible than ex-wife to the Court. Ex-husband wins, IRS loses, and Ex-wife loses.

So what does this all mean for anyone out there who wants to file for innocent spouse relief?  First and foremost, figure out whether or not you benefited from your husband’s tax error, mistake or in some cases civil or criminal fraud. If you did not, and are separating from your spouse, make sure your divorce attorney includes Innocent Spouse Relief language in the settlement agreement. Also, if you are the ex-husband be prepared for your ex-wife to intervene to US Tax Court denying much of what you are claiming creating the tragic Whipsaw.  Second, hire a tax attorney who can effectively gather sufficient evidence to prove to the Court that you had “no reason to know” of the tax liability you are claiming relief from.  Perhaps if you are the ex-wife, you had “no reason to know” because you traveled a lot working out of town, or didn’t have the educational background to understand, or perhaps just didn’t get the whole truth from your now ex-husband. In other words, if your tax attorney sufficiently gathers from you the evidence needed to win, provided your testimony is credible, you will in fact win the IRS Innocent Spouse Relief Audit, Whipsaw your Ex-spouse, and at the same time keep your assets safe and protected from the long reach of IRS Innocent Spouse Relief Audit agents.

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

See you next time on TaxView

Kindest regards

Chris Moss CPA Tax Attorney