Tax Relief Blog

IRS Audit Overview

Pre-audit Analysis

An in-depth pre-audit analysis is essential to conducting a quality examination. IRS Examiners, Revenue Agents, should prepare a comparative analysis of the taxpayer's returns for multiple years to assist in the identification of:

• large, unusual and questionable items,
• missing schedules, statements and/or elections
• inconsistencies between different years, and
• audit potential.

A successful IRS taxpayer audit depends upon what is done before the interview. The IRS examiner should obtain as much information about the taxpayer, be organized, and prepare an interview outline that is tailored to the taxpayer under examination. As preliminary information is gathered, it should be carefully reviewed and documented for the IRS tax audit.

Did you receive an IRS tax audit for your vineyard?

Code Sec. 179 expensing has become a potent tax saver, thanks to current law's $500,000 deduction ceiling. So it should come as no surprise that taxpayers and their advisers are on the lookout for assets that potentially qualify as Code Sec. 179 property eligible for expensing. One such class of property is vineyards and orchards. IRS has published an Audit Techniques Guide (ATG) turning a thumbs down on expensing for such property, but its conclusion appears to be based on prior law. A more recent ATG leaves the door open to a better result. This Practice Alert presents the case for treating vineyards and orchards as Code Sec. 179 property and covers IRS's current "conflicted" guidance as well.

Do you owe back Taxes? Did you receive an audit letter from the IRS?

First, do not to panic. The IRS uses various letters to communicate with taxpayers about IRS back taxes and IRS tax audits. As with most IRS communications, there are strict deadlines associated with these letters that you have to meet. You should seriously review the items that are being challenged and prepare your factual response in a clear way to the IRS. As taxpayer, you can represent yourself, or hire a professional tax representative as a power of attorney to resolve your tax matters. Selecting a tax return for audit does not always suggest that the taxpayer has either made an error or been dishonest. In fact, some audits result in a refund to the taxpayer or acceptance of the return without change.

We represent clients before the IRS to resolve their tax controversies. The tax law is complicated and a professional will be better able to guide you through the audit experience, or to effectively resolve your back tax matter.

Call our reliable tax helpline at 1-877-78-TAXES [1-877-788-2937].

Tax relief services offered such as: wage garnishment release, offer in compromise, negotiated installment agreements, IRS audit representations, 941 payroll tax help, tax resolution service

TIGTA assesses how well IRS Examination function scrutinizes all open tax periods during audits [Audit Report No. 2009-30-034]:

IRS Examination function employees do not always appropriately inspect and examine prior and/or subsequent year tax returns when warranted, the Treasury Inspector General for Tax Administration (TIGTA) said in a new audit.

Auditors reviewed 68 statistical sample cases and found that 13 (or 21%) of the cases warranted scrutiny of additional returns but none were selected for examination. In 26 (or 38%) of the 68 cases, "there was no evidence that examiners inspected either the prior or subsequent year return to identify similar issues to the years under examination or if large, unusual, or questionable items existed that would warrant examination," the audit said. Factors that might be considered include the comparative size of an expense, if the nature of the item is significant, the beneficial effect of the manner in which an item is reported, and missing items on the return.

"When examiners do not make the proper decision to select returns for examination, taxpayers are not provided equitable treatment, and the examination is not as effective for improving taxpayer compliance on future tax returns," TIGTA said.

The audit also found that Compliance function tax examiners are currently unable to assess subsequent year tax returns and select them for audit. As a result, IRS "could be missing an opportunity to conduct examinations more efficiently and consistently from year to year," TIGTA said. This assessment was based on a review of 68 additional cases which revealed that in 31 (or 46%) of those cases the same issues adjusted on the tax year return under examination were present on the subsequent year return.

The audit is available at http://treas.gov/tigta/auditreports/2009reports/200930034fr.pdf.

For IRS tax audit and tax examination expert help, contact Mike Habib, EA at 1-877-78-TAXES or online at www.myirstaxrelief.com

IRS Tax Help

by Mike Habib, EA

UNFILED BACK TAX RETURNS

Do you have back tax returns that are Unfiled? Are you missing the records and forms necessary to file your tax returns? I have the experience and procedures to help you in reconstructing the records necessary to file your back tax returns. The IRS will not allow you to file an offer in compromise or get an installment agreement if you are not current on filing your back tax returns. If you have a refund coming to you and you file more than 3 years past the due date, the IRS will keep the refund. It is important to get your past due returns filed and I can prepare them for you. Get tax help now.

IRS Tax Audit Help

If you have been notified by the IRS that your income tax return has been selected for examination, it is very important that you do not disregard notices. If enough time has passed without cooperation on your part, you will lose any right you have to present your side of the story to explain the income or deductions on your return. We have seen many taxpayers who have ignored IRS requests and ended up paying tax, penalty and interest on overstated income or legitimate deductions.

If you are being audited, we can represent you before IRS and advocate your position to explain and push for every valid deduction possible under audit. If you have received an audit notice, please call us as soon as possible so that we can begin working on your case while it is in the early stage of the audit.

Offer in Compromise - OIC Tax Help

The IRS, the State, and other taxing authorities would allow individual or business taxpayers that cannot fully pay their entire tax liability to settle their tax obligation through the Offer in Compromise Program. This is a great opportunity for the qualified taxpayer to settle their entire tax debt for less than they actually owe. The IRS, the State, and other taxing authorities sets specific rules and guidelines for accepting an Offer in Compromise. When evaluating an Offer in Compromise, the taxpayer's past, current and future financial situation are analyzed before an Offer in Compromise can be accepted. Contact us today to see if you would qualify for an Offer in Compromise, as each individual or business financial situation is different.

Installment Agreement - IA Tax Help

The IRS, the State, and other taxing authorities would allow individual or business taxpayers that cannot fully pay their entire tax liability to settle their tax obligation through an Installment Agreement which allows taxpayers to pay their taxes owed through monthly installment payments. We can negotiate the payment amount and the time frame for the installment agreement on your behalf. When we establish an Installment Agreement for you, it would be a negotiated amount you can afford to pay and live with based on your financial condition. To effectuate an installment agreement, the taxpayer must be compliant by being current with all tax filing requirements before entering into an installment agreement with the IRS, the State or other taxing authority.

Currently Non Collectible - CNC Tax Help

Currently Non Collectible - CNC is accomplished when the IRS holds off an individual or business taxpayer's account from active enforcement collection efforts. There are specific rules and requirements that a taxpayer must meet before a CNC status be accomplished. The IRS would not pursue enforcement collection activity against the taxpayer and possibly the statute of limitations on the entire tax liability will run. CNC is a temporary status and if the taxpayer's financial situation changes, the IRS could start enforcement collection on the delinquent tax account.

Wage Levy / Wage Garnishment / Wage Attachment Tax Help

The IRS, the State and other taxing authorities are actively collecting taxes for the United States Treasury, the State and other localities. If an individual or a business taxpayer can not or refuses to pay their taxes, the IRS, the State and other taxing authority will enforce collection activities through direct contact such as field visits, demand letters, and collection phone calls. The taxpayer should never disregards the demands for delinquent tax payment as the IRS, the State and other taxing authority will be exercising their levy power to collect their delinquent taxes. Wage levy and wage garnishment is enforced to collect the delinquent taxes owed by the taxpayer. Contact us today to negotiate the release of your wage garnishment, and stop your wage levy and save your paycheck.

Bank Levy Release Tax Help

The IRS, the State and other taxing authorities are actively collecting taxes for the United States Treasury, the State and other localities. If an individual or a business taxpayer can not or refuses to pay their taxes, the IRS, the State and other taxing authority will enforce collection activities through direct contact such as field visits, demand letters, and collection phone calls. The taxpayer should never disregards the demands for delinquent tax payment as the IRS, the State and other taxing authority will be exercising their levy power to collect their delinquent taxes. The bank levy is enforced to collect the delinquent taxes owed by the taxpayer. Contact us today to negotiate the release of your bank levy, and save your bank account from being frozen or wiped out.

Payroll Tax Problem Representation Tax Help

We actively represent business taxpayers with payroll tax problems before the IRS and or the State. We help business owners and corporate officers understand and adhere to various payroll tax requirements. Our clients usually never meet or deal with the IRS or the State directly, instead we handle all the payroll tax resolution directly with the IRS and or the State. Delinquent payroll tax is a very serious matter and should be addressed quickly for a favorable resolution as business owners, corporate officers and potentially other employees could be personally liable. Businesses should be current and compliant to reach a final settlement.

Taxpayer Account Review Tax Help

The Taxpayer Account Review service is to help individual and business taxpayers obtain specific balances and information about their tax account with the IRS, the State, or any taxing authority. Most taxpayers receive inaccurate and usually incomplete information from the IRS, the State, or other taxing authority. The Taxpayer Account Review is vital for taxpayers to receive exact and accurate information about their tax account including penalties and interest assessed. We will provide you a detailed account break down for the years in question detailing tax amounts, any credits or payments, and penalties and interest assessed. This is a great tool for root cause analysis to find out what is driving your tax liability

Penalty Abatement Tax Help

For most taxpayers, the accumulated interest and penalties are as much as, or more, than their original tax debt! If this is your situation, we can help by requesting what's called a Penalty Abatement. A penalty abatement works like this: If we can show reasonable cause, the IRS may agree to reduce or even eliminate your penalties altogether. What's reasonable cause? Generally, some kind of hardship beyond your control which prevented you from paying your taxes. It can be as simple as explaining to the IRS that your basement flooded, that you received bad tax advice, or that you or one of your family members suffers from a severe health problem. We can tell you whether you are a candidate for a penalty abatement when you call for your free consultation.

Innocent Spouse Relief Tax Help

An Innocent Spouse is spouse "A" who has become liable for income taxes from a joint return filed with spouse "B" when spouse "B" has caused the income taxes to underpaid by mistake or fraud, and spouse "A" signed the return believing the return to be true and correct. For spouse "A" to be entitled to relief under the Innocent Spouse rules, spouse "A" must be able to prove when signing the returns, he or she did not know or have reason to know that at the time filing, the return either understated income or overstated deductions.

Federal Tax Lien Help

Federal tax liens are a public record stating that you owe federal taxes and are filed in the county you live. Because the tax liens are public records they will show up on your credit report. This often makes it difficult or impossible for a taxpayer to obtain financing, even for an automobile or home. The tax liens need to be reviewed to determine if they are valid. If the tax liens are valid, a strategy must be developed to deal with the IRS tax liabilities.

I focus my tax practice on "Tax Relief Help", as an IRS licensed Enrolled Agent (EA) specializing in solving Tax Problems, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

IRS explains how to claim credit for qualified fuel cell and qualified microturbine property A new Notice carries interim guidance on the terms and conditions that must be met by taxpayers that want to claim the Code Sec. 48 credit for fuel cells and microturbines.

Background. A taxpayer may be eligible to claim (on Form 3468) a number of energy credits, including the following credits added by the Energy Policy Act of 2005 (P.L. 109-58). In each case, the percentage is applied to the basis of eligible energy property placed in service during the year:

• 30% for qualified fuel cell property, (Code Sec. 48(a)(2)(A)(i)(I)) i.e., a fuel cell power plant with a nameplate capacity of at least 0.5 kilowatt of electricity using an electrochemical process, and an electricity only generation efficiency of greater than 30%. The credit can't exceed an amount equal to $500 for each 0.5 kilowatt of capacity. The credit isn't available after 2008. (Code Sec. 48(c))
• 10% for qualified microturbine property, (Code Sec. 48(a)(2)(A)(ii), Code Sec. 48(a)(3)(A)(iv)) i.e., a stationary microturbine powerplant with a nameplate capacity of less than 2,000 kilowatts, and an electricity only generation efficiency of not less than 26% at International Standard Organization conditions. A credit for qualified microturbine property can't exceed $200 for each kilowatt of the property's capacity. The credit is not available after 2008. (Code Sec. 48(c)(2))

No credit is allowed for property unless it is depreciable or amortizable; its construction, reconstruction or erection is completed by the taxpayer or, if acquired by the taxpayer, its original use begins with the taxpayer; and it meets the official quality and performance standards in effect at the time of acquisition. (Code Sec. 48(a)(3))

No credit is allowed for public utility property (Code Sec. 48(a)(3)) (except for certain qualified microturbine property used predominantly in a telephone or telegraph service business (Code Sec. 48(c)(2)(D)), or for property that also qualifies for the rehabilitation credit. (Code Sec. 48(a)(2)) If property is financed in whole or in part by subsidized financing or tax-exempt private activity bonds, the amount taken into account as qualified investment is proportionately reduced. (Code Sec. 48(a)(4))

New guidance. Rev Proc 2008-68 carries detailed guidance on the fuel cell credit and microturbine credit, including the technical conditions that must be met for property to qualify for the credit, how to compute the credit, and the circumstances under which the credit for either type of property is available to a lessor.

Rev Proc 2008-68, Sec. 3.04 refers taxpayers to the following sections of the regs for guidance on the following key definitional terms and conditions:

• whether the original use of property begins with the taxpayer is determined under the principles of Reg. § 1.48-2;
• whether depreciation (or amortization instead of depreciation) is allowable to the taxpayer is determined under the principles of Reg. § 1.48-1(b);
• the he year in which property is placed in service is determined under the principles of Reg. § 1.46-3(d); and
• the basis of property is determined under the principles of Reg. § 1.463-3(a) and Reg. § 1.463-3(c).

Tax problems? Get tax resolution today. We specialize in tax problem resolution and represent taxpayers before any taxing authority.

TIGTA study finds modest audit rate increase for C corps but marked increase for passthroughs ( S Corps)

Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008095

A recently released TIGTA (Treasury Inspector General for Tax Administration) report reveals that despite a slight uptick in FY 2007, IRS audits of corporations have declined dramatically over the last ten years. However, audits of S corporation and partnership returns increased substantially over the same period.

TIGTA's findings for business entities. The new TIGTA report examined IRS statistical data and found the following audit trends for business:

• The number of corporate income tax returns examined (excluding returns for foreign corporations and S corporations) increased by just over 4% in FY 2007, after dropping by 1% in FY 2006. However, the number of examinations dropped by almost 45% since FY 1998, from 53,648 (1 of every 48 returns filed) to 29,664 (1 of every 75 returns filed). TIGTA notes that the 13% drop in the number of corporate income tax returns filed during the same 10-year period may have impacted the exam coverage rate. For FY 2007, the number of corporate tax returns examined with assets of less than $10 million grew by slightly over 12%, the number of corporate tax returns examined with assets of $10 million and greater decreased by almost 9%, and exams of those with assets of $250 million and greater decreased by almost 20%. Overall, however, the exam rate is much higher for large corporations than for those with assets of less than $10 million.
• The number of S corporation exams declined by 75% from FYs 1998 to 2004, but increased by almost 176% from FYs 2004 to 2007; the increase in FY 2007 alone was slightly over 26%. Since FY 2004, however, the number of S corporation returns filed has increased by 16%. TIGTA notes that the increase in exam coverage can be partly attributed to an IRS research project studying the compliance of S corporations.
• The number of partnership returns examined increased by 25% in FY 2007 and has increased by almost 141% since the 10-year low experienced in FY 2001. The number of returns filed increased by about 42% between FYs 2001 and 2007. About 1 of every 408 returns filed was examined in FY 2001. This increased to 1 of every 241 for FY 2008.

For more details on TIGTA's Report on audit rates and related IRS activities, click on this link: Trends in Compliance Activities Through Fiscal Year 2007, TIGTA Reference Number 2008095.

For S Corp and C Corp audit representation CLICK HERE

What are your chances for being audited? IRS's 2007 data book provides some clues


Mike Habib, EA

myIRSTaxRelief.com

IRS has issued its annual data book, which provides statistical data on its fiscal year (FY) 2007 activities. As this article explains, the data book provides valuable information about how many tax returns IRS examines (audits), and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections.

What are the chances of being examined? A total of 1,384,563 individual income tax returns were audited during FY 2007 (Oct. 1, 2006 through Sept. 30, 2007) out of a total of 134.5 million individual returns that were filed in the previous year This works out to 1.0% of all individual returns filed (slightly higher than the 0.97% audit rate for the preceding year).

Of the total number of returns audited, 503,267 (36.5%) were selected on the basis of an earned income tax credit (EITC) claim (down slightly from the 40.3% rate for FY 2006).

Only 22.49% of the audits were conducted by revenue agents, tax compliance officers, and tax examiners; the bulk of the audits (about 77.5%) were correspondence audits. These percentages are about the same as they were in FY 2006.

About 1.5 million individual returns were farm returns that showed gross receipts from farming (Schedule F). Of this group, only 5,705 (0.4%) were audited in 2007.

The no-change rate (returns accepted as filed after examination) was 12% for returns examined by revenue agents, tax compliance officers, or tax examiners, and 16% for correspondence exams.

Here's a roundup of selected audit rates from IRS' latest databook. Because the audit categories aren't organized the same way for individuals as they were for FY 2006, comparisons to the rates for the previous fiscal year aren't possible.

Following are the audit rates for individual nonbusiness returns that didn't claim the earned income tax credit:

• For "selected nonbusiness returns" (includes returns without a Schedule C (nonfarm sole proprietorship), Schedule E (supplemental income and loss), Schedule F (profit or loss from farming), or Form 2106 (employee business expenses), 4%.
• For returns with Schedule E or Form 2106 (excludes returns with a Schedule C, nonfarm sole proprietorship, or Schedule F, profit or loss from farming), 1.2%.
• For nonfarm business returns by size of total gross receipts: under $25,000, 1.3%; $25,000 under $100,000, 2%; $100,000 under $200,000, 6.2%; and $200,000 or more, 1.9%.

For returns with total positive income (TPI) of at least $200,000 and under $1 million, the audit rate was 2% for nonbusiness returns and 2.9% for business returns. For returns with TPI of $1 million or more, the audit rate was 9.3%.

The audit rates for entities were as follows:

• Fiduciary (estate and trust income tax returns), 0.1% (the same as for FY 2006);
• Corporations with less than $10 million of assets, 0.9% (up from 0.8% for FY 2006);
• Corporations with $10 million or more of assets, 16.8% (down from 18.6% for FY 2006);
• S corporations, 0.5% (up from 0.38% for FY 2006);
• Partnerships, 0.4% (up from 0.36% for FY 2006);
• Estate tax returns, 7.7% (down from 9.66% for FY 2006); and
• Gift tax returns, 0.6% (down from 0.77% for FY 2006).

IRS activity on other fronts. Here's a roundup of over valuable information carried in the new IRS Data Book.

Penalties. In fiscal year 2007, IRS assessed 27.3 million civil penalties against individual taxpayers, up from 25.9 million civil penalties assessed in the previous year. Of the FY 2007 assessments, 15.17 million (55%) were for failure to pay, followed by 7.72 million (28.2%) for underpayment of estimated tax. There were 327,822 assessments (1.1%) for "accuracy penalties"assessments of penalties under Code Sec. 6662 for negligence, substantial understatement of income tax, substantial valuation misstatement, substantial overstatement of pension liabilities, and substantial estate or gift tax valuation understatement, and understatement of reportable transactions under Code Sec. 6662A .

On the corporation side, there were a total of 762,718 civil penalty assessments (up from 701,785 for FY 2006), 82.9% for either failure to pay or underpayment of estimated tax.

Offers in compromise. In FY 2007, 46,000 offers in compromise were received by IRS, and 12,000 (26%) were accepted. Over recent years, these numbers have been dropping; in 2006 for example, 59,000 offers in compromise were received by IRS, and 15,000 (25.4%) were accepted.

Criminal cases. IRS initiated 4,211 criminal investigations in FY 2007. There were 2,837 referrals for prosecution and 2,155 convictions. Of those sentenced, 98.5% were incarcerated (a term that includes imprisonment, home confinement, electronic monitoring, or a combination thereof). By way of comparison, in FY 2006, IRS initiated 3,907 criminal investigations, there were 2,720 referrals for prosecution, and 81.7% were incarcerated.

Information returns. IRS received a total of 1.825 billion information returns in FY 2007, including Forms 1098 (mortgage interest, student loan interest, and tuition), 1099 (interest, dividends, etc.), 5498 (individual retirement arrangement and medical savings account), W-2 (wages), W-2 (gambling winnings), and Schedules K-1 (pass-through entities). Of the total, only 3.1% were submitted on paper.

For professional audit representation CLICK HERE

IRS eases rules for partial annuity exchanges

Mike Habib, EA
myIRSTaxRelief.com

In 2003, IRS issued a revenue ruling formally sanctioning partial annuity exchanges as qualifying for tax-free treatment under Code Sec. 1035. At the same time, it issued a notice warning that it would go after taxpayers who use partial exchanges to avoid tax under Code Sec. 72(e)(2). It has adopted the interim guidance as final rules in a new revenue procedures. The final guidance reflects modifications that are mostly pro-taxpayer.

Background. Code Sec. 72(e) governs the federal tax treatment of distributions from an annuity contract that are not received as an annuity. Under Code Sec. 72(e)(2), such amounts generally are taxed on an income-first basis. For this purpose, all annuity contracts issued by the same company to the same policyholder during any calendar year are treated as a single annuity contract. (Code Sec. 72(e)(12)) Code Sec. 72(q)(1) imposes a 10% penalty on withdrawals or surrenders of annuity contracts, unless one of the exceptions in Code Sec. 72(q)(2) applies. No gain or loss is recognized on the exchange of an annuity contract for another annuity contract. (Code Sec. 1035(a))

Partial exchanges. In late '99, IRS acquiesced to a Tax Court decision holding that the direct transfer of a portion of funds from one annuity contract to another qualifies as a nontaxable exchange under Code Sec. 1035. (Conway v. Comm., 111 TC 350 (1998), acq., 1999-2 CB xvi) See Federal Taxes Weekly Alert 12/2/1999)

Rev Rul 2003-76, 2003-2 CB 355 provided additional details on the tax consequences of partial annuity exchanges. Under the facts of that ruling, A owns, and is the obligee under, annuity contract B issued by Company B. A contracts with Company C to issue new annuity contract C. He assigns 60% of the cash surrender value of Contract B to Company C to be used to purchase Contract C. At no time during the transaction does A have access to the cash surrender value of Contract B that is used to purchase Contract C. No other consideration will be paid in this transaction. The terms of Contract B are unchanged by this transaction, and Contract B is not treated as newly issued. The ruling concluded that:

• The direct transfer by A of a portion of the cash surrender value of Contract B to Company C for Contract C is a tax-free exchange under Code Sec. 1035(a)(3).
• After the transaction, under Code Sec. 1035(d)(2), A's basis in Contract C equals 60% of his basis in Contract B immediately before the exchange, and his basis in Contract B equals 40% of his basis in it immediately before the exchange. That's because, basis is allocated ratably based on the percentage of the cash surrender value retained and the percentage transferred to the new contract.
• After the transaction, under Code Sec. 72, A's investment in Contract C equals 60% of his investment in Contract B immediately before the exchange and his investment in Contract B equals 40% percent of his investment in it immediately before the exchange, using the same ratable allocation approach.

IRS's concern about possible abuses. When it issued Rev Rul 2003-76, IRS, in Notice 2003-51, 2003-2 CB 362, expressed concern that some taxpayers may enter into a partial exchange to reduce or avoid the tax that would otherwise be imposed by Code Sec. 72(e)(2).

Illustration: Smith withdraws $100 from an annuity contract with a cash surrender value of $200 and investment in the contract of $80. The entire $100 withdrawal is included in income under Code Sec. 72(e)(2). If, instead, he assigns 50% of the contract's cash surrender value in a partial exchange, and then surrenders either the existing or new contract, only $60 is included in income and $40 is excluded as a return of investment in the contract. (Notice 2003-51, Sec. 3)

At that time, IRS said it was considering whether to issue regs to provide rules for determining when a partial exchange of an annuity contract followed by the surrender of, or distributions from, either the surviving annuity contract or the new annuity contract should be presumed to have been entered into for tax avoidance purposes. Pending the publication of final regs, IRS said it would consider all the facts and circumstances to determine whether a partial exchange and a subsequent withdrawal from, or surrender of, either the surviving annuity contract or the new annuity contract within 24 months of the date on which the partial exchange was completed should be treated as an integrated transaction, and thus whether the two contracts should be viewed as a single contract to determine the tax treatment of a surrender or withdrawal under Code Sec. 72(e). IRS said, if, however, a taxpayer could demonstrate that one of the conditions of Code Sec. 72(q)(2), or any other similar life event, such as a divorce or the loss of employment, occurred between the partial exchange and the surrender or distribution, and that the surrender or distribution was not contemplated at the time of the partial exchange, the taxpayer would not be treated as having entered into the surrender or distribution for tax avoidance purposes.

Final guidance. IRS has determined that it is in the interest of sound tax administration to adopt the provisions of Notice 2003-51 with changes, in the form of a revenue procedure. In doing so, IRS has determined that the 24-month period referred to above should be shortened to 12 months, and the subjective requirement that certain surrenders or distributions not have been "contemplated" at the time of the exchange should be removed.

Observation: The change from 24 to 12 months is favorable for taxpayers who may be contemplating partial exchanges. They will be able to make withdrawals one year after entering into the exchange without concern that IRS may want to try to treat the new and original contracts as one to extract a higher tax cost on the withdrawal.

In addition, IRS has determined it is appropriate to make these clarifications to the rules of Notice 2003-51:

• First, if the direct transfer of a portion of an annuity contract for a second annuity contract does not qualify as a tax-free exchange under Code Sec. 1035 and Rev Proc 2008-24 , it will be treated as a taxable distribution followed by a payment for the second contract.
• Second, the rule treating a transfer as a tax-free exchange if one of the Code Sec. 72(q)(2) conditions is met cannot be satisfied based on a payment described in Code Sec. 72(q)(2)(D) (distribution that is part of a series of substantially equal periodic payments) or Code Sec. 72(q)(2)(I) (distribution under an immediate annuity).
• Third, IRS won't require aggregation under Code Sec. 72(e)(12) or otherwise of two contracts that are the subject of a tax-free exchange under Code Sec. 1035 and Rev Proc 2008-24, Sec. 4.01, even if both contracts were issued by the same insurance company.

Rev Proc 2008-24 applies to the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract, regardless of whether the two annuity contracts are issued by the same or different companies. It doesn't apply to transactions (sometimes referred to as "partial annuitizations") in which the holder of an annuity contract irrevocably elects to apply only a portion of the contract to purchase a stream of annuity payments under the contract, leaving the remainder of the contract to accumulate income on a tax-deferred basis. (Rev Proc 2008-24, Sec. 3)

Effective date. Rev Proc 2008-24 is effective for transfers that are completed on or after June 30, 2008. (Rev Proc 2008-24, Sec. 5)

For IRS tax representation CLICK HERE

For IRS audit representation CLICK HERE

As an IRS licensed Enrolled Agent (EA) specializing in IRS Tax Problem Resolution, I can represent individuals and businesses in all of the following states, counties, and metro cities, Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington D.C.. West Virginia Wisconsin Wyoming. AL AK AZ AR CA CO CT DE DC FL GA HI ID IL IN IA KS KY LA ME MD MA MI MN MS MO MT NE NV NH NJ NM NY NC ND OH OK OR PA RI SC SD TN TX UT VT VA WA WV WI WY New York, Los Angeles, Orange County, Riverside, San Bernardino, San Francisco, Ventura, Lancaster, Palmdale, Santa Barbara, Chicago, Washington D. C., Silicon Valley, Philadelphia, Boston, Detroit, Dallas, Houston, Atlanta, Miami, Seattle, Phoenix, Minneapolis, Cleveland, San Diego, St Louis, Denver, San Juan, Tampa, Pittsburgh, Portland, Cincinnati, Sacramento, Kansas City, Milwaukee, Orlando, Indianapolis, San Antonio, Norfolk & VB, Las Vegas, Columbus, Charlotte, New Orleans, Salt Lake City, Greensboro, Austin, Nashville, Providence, Raleigh, Hartford, Buffalo, Memphis, West Palm Beach, Jacksonville, Rochester, Grand Rapids, Reno, Oklahoma City, Louisville, Richmond, Greenville, Dayton, Fresno, Birmingham, Honolulu, Albany, Tucson, Tulsa, Tempe, Syracuse, Omaha, Albuquerque, Knoxville, El Paso, Bakersfield, Allentown, Harrisburg, Scranton, Toledo, Baton Rouge, Youngstown, Springfield, Sarasota, Little Rock, Orlando, McAllen, Stockton, Charleston, Wichita, Mobile, Columbia, Colorado Springs, Fort Wayne, Daytona Beach, Lakeland, Johnson City, Lexington, Augusta, Melbourne, Lancaster, Chattanooga, Des Moines, Kalamazoo, Lansing, Modesto, Fort Myers, Jackson, Boise, Billings, Madison, Spokane, Montgomery, and Pensacola

Final regs clarify treatment of loss from abandoned securities

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued final regs that provide guidance on the availability and character of a loss deduction from abandoned securities under Code Sec. 165. The regs, which adopt proposed regs issued in 2007, apply to securities abandoned after Mar. 12, 2008.

Background. If any security that is a capital asset becomes worthless during the tax year, the loss is treated as from the sale or exchange of a capital asseton the last day of the tax year. (Code Sec. 165(g)(1)) A security is defined as a share of stock in a corporation; a right to subscribe for or to receive a share of stock in a corporation; or a bond, debenture, note or certificate or other evidence of indebtedness issued by a corporation or government with interest coupons or in registered form. (Code Sec. 165(g)(2)) An exception from this capital loss treatment applies for certain worthless securities in a domestic corporation affiliated with the taxpayer. (Code Sec. 165(g)(3))

IRS had learned that some taxpayers had taken the position that a loss from the abandonment of a security was not subject to the loss characterization rules provided in Code Sec. 165(g). ( Preamble to Prop Reg )

Observation: A number of practitioners had considered the possibility of a taxpayer claiming an ordinary loss for abandoned securities and what hurdles to overcome to justify such treatment. [See Cummings' Corporate Tax Insights on Checkpoint 07/13/2004.

Abandoned securities. The final regs provide that for purposes of applying the Code Sec. 165(g) loss characterization rules, the abandonment of a security establishes its worthlessness to the taxpayer. A loss established by the abandonment of a security that is a capital asset is treated as a loss from the sale or exchange, on the last day of the tax year, of a capital asset, unless the Code Sec. 165(g)(3) exception applies. While a taxpayer doesn't have to relinquish legal title to property in all cases to establish abandonment, the regs require that to abandon a security a taxpayer has to permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. (Reg. § 1.165-5(i))

Abandoned or cancelled debt instruments. Generally, the treatment of a worthless debt is governed by Code Sec. 166. However, there's an exception to this rule under Code Sec. 166(e) where a debt is evidenced by a security as defined in Code Sec. 165(g)(2)(C). In that case, based on what IRS stated in Preamble to Prop Reg, the tax treatment of the debt securities is governed by the final regs.

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Examination and Compliance Check Processes For Exempt Organizations

Mike Habib, EA
myIRSTaxRelief.com

The Internal Revenue Service has a variety of tools at its disposal to make certain that tax-exempt organizations comply with federal law designed to ensure they are entitled to any tax exemption they may claim.

The responsibility for administering these procedures belongs to the Exempt Organizations (EO) function, which is part of the IRS's Tax Exempt and Government Entities (TE/GE) Operating Division.

Examinations vs. Compliance Checks

A review of a tax exempt organization falls into two broad categories: compliance checks and examinations.

The IRS conducts examinations, also known as audits, which are authorized under Section 7602 of the Internal Revenue Code. An examination is a review of a taxpayer's books and records to determine tax liability, and may involve the questioning of third parties. For exempt organizations, an examination also determines an organization's qualification for tax-exempt status.

EO conducts two different types of examinations: correspondence and field examinations.

A compliance check is a review to determine whether an organization is adhering to recordkeeping and information reporting requirements and is not an examination since it does not directly relate to determining a tax liability for any particular period.

Correspondence Examinations

Correspondence examinations are limited in scope and focus on only one or two items on a return. An EO specialist typically conducts the examination through letters and phone calls with the organization's officers or representatives.

If the issues become complex, or if the organization does not respond to a letter or call, EO may require the officers or representatives to bring records to an IRS office. EO may also convert a correspondence examination into a field examination.

Field Examinations

A field examination is one conducted by a revenue agent at the organization's place of business. Generally, these audits are the most comprehensive. There are two distinct types of EO field examinations - EO Team Examination Program (TEP) and EO General Program.

* EO TEP examinations are field examinations of large, complex organizations that may require a team of specialized revenue agents, as well as coordination between IRS functions and other governmental agencies. They are often conducted using coordinated team examination approaches and procedures.
* EO General Program examinations are typically performed by individual revenue agents. They usually do not require a team of specialists.

A field examination usually begins when the revenue agent notifies the organization that its return has been selected for examination. This initial contact is by telephone or by letter to schedule an initial appointment. The organization receives Publication 1, Your Rights as a Taxpayer, with the appointment letter.

In the appointment contact, the revenue agent will typically request the following documents to begin the audit:

1. Governing instruments (articles of incorporation, charter or constitution, including all amendments; and bylaws, including all amendments),
2. Pamphlets, brochures, and other printed literature describing the organization's activities,
3. Copies of the organization's Forms 990 for the years before and after the year under examination,
4. For the year under examination (at a minimum):
5. Minutes of meetings of the board of directors and standing committees or councils,
6. All books and records of assets, liabilities, receipts and disbursements,
* Auditor's report, if any,
* Copies of other federal tax returns filed and any related workpapers (Form 990-T for taxable income, Form 1120-POL for political activity, etc.),
* Copies of employment tax returns and any related workpapers (Forms W-2, W-3, 941, 1096, 1099).

(Note: Many of these records may also be required for a correspondence examination.)

During an opening conference with the organization's officers or representatives, the revenue agent explains the audit plan and the reason the organization has been selected for examination. The revenue agent usually conducts a comprehensive interview and tours the organization's facilities to gain a basic understanding of the organization's purposes and activities.

The examination of a tax-exempt organization is multifaceted and includes a review of its operation and activities to verify the existence of an exempt purpose, as well as a review of financial records. The length of the examination will depend upon a variety of factors, such as the size of the organization, the complexity of its activities and the issues that may arise during the examination. Some audits can be completed in just a few days; others can last for a year or more.

A field examination typically concludes with a closing conference. The revenue agent will discuss the audit with the organization's representatives, and if necessary, furnish a report explaining proposed adjustments to the organization's returns or exempt status. If the revenue agent and the organization's representatives disagree on the findings, the organization may request a meeting with the revenue agent's manager to discuss the disagreement. If the manager cannot resolve the differences, the organization may pursue its case through the IRS appeals process. For additional information on the appeals process, see Publication 892, EO Appeal Procedures for Unagreed Issues.

Compliance Checks

Exempt Organizations also maintains an active compliance check program. EO specialists conduct the checks by corresponding with or telephoning exempt organization representatives. A specialist may inquire about an item on a return, determine if specific reporting requirements have been met or whether an organization's activities are consistent with its stated tax-exempt purpose.

An officer or representative of an exempt organization may refuse to participate in a compliance check without penalty. However, EO has the option of opening a formal examination, whether or not the organization agrees to participate in a compliance check.

At the beginning of a compliance check, the specialist will inform the officer or director that the review is a compliance check and not an examination. The specialist will not ask to examine any books or records or ask questions regarding tax liabilities. The specialist may ask whether the organization understands or has questions about filing obligations for required forms. The specialist may also ask questions about the organization's activities. If, during a compliance check, the specialist decides an examination is appropriate, he or she will notify the organization that EO is commencing an examination before asking questions related to tax liability.

Because a compliance check only reviews whether an organization is adhering to record keeping and information reporting requirements or whether an organization's activities are consistent with its stated tax-exempt purpose and is not an examination, it is possible to have more than one compliance check for a tax year if facts and circumstances warrant. For more information, see Publication 4386, Compliance Checks.

Selecting Organizations for Examination or Compliance Checks

EO strives to ensure consistency and fairness in its examination and compliance check processes. In its annual Implementing Guidelines, which are available on the IRS website at www.irs.gov/eo, EO describes its proposed examination and compliance check activities for the year.

EO designs and implements comprehensive projects to address issues that carry the most non-compliance risk. To determine which organizations should be targeted, experienced specialists analyze information from Forms 990 and other sources. This analysis will usually result in the selection of a group of returns for examination or compliance check.

EO also reviews media reports and receives complaints from the general public and Congress about potential non-compliance by exempt organizations. After confirming the information, and when appropriate, these organizations may be selected for examination or to receive a compliance check. For details on how EO handles complaints about exempt organizations, see Fact Sheet 2008-13.

Regardless of the process used to select returns, EO does not presume that an organization is violating the tax laws before it begins the examination or sends a compliance check letter.

Guidance on timing of PPA-related amendments for calculating plan cash-outs starting in 2008

Mike Habib, EA
myIRSTaxRelief.com

IRS has issued guidance, in question and answer format, that addresses the timing of plan amendments made to comply with Sec. 302 of the Pension Protection Act of 2006 (PPA 2006, P.L. 109-280, Sec. 302), which changed the statutory assumptions that must be used beginning in 2008 for calculating the present value of plan cash-outs.

Background. For purposes of the Code Sec. 417(e)(3) cash-out requirements under the minimum survivor annuity rules, the present value of plan benefits cannot be less than the present value calculated by using the "applicable mortality table" and the "applicable interest rate" (collectively, the "statutory assumptions"). PPA Sec. 302 changed the definitions of those statutory assumptions, effective for plan years beginning on or after Jan. 1, 2008.

For plan years beginning before Jan. 1, 2008:

o the "applicable interest rate" was, generally, the annual rate of interest on 30-year Treasury securities (the "pre-PPA '06 applicable interest rate"); and
o the "applicable mortality table" was the mortality table prescribed by IRS, based on the prevailing commissioners' standard table used to determine group reserves for group annuity contracts issued on the date as of which the present value was determined (the "pre-PPA '06 applicable mortality table").

For plan years beginning on or after Jan. 1, 2008:

o the "applicable interest rate" is the adjusted first, second, and third segment rates applied under rules similar to the rules under Code Sec. 430(h)(2)(C) for the month before the date of the distribution, or such other time as IRS regs prescribe, determined without regard to the Code Sec. 430(h)(2)(D)(i) 24-month averaging, with a transition rule that phases in the use of the segment rates over five years (the "post-PPA '06 applicable interest rate"); and
o the "applicable mortality table" is a mortality table, modified as appropriate by IRS, based on the mortality table specified for the plan year under Code Sec. 430(h)(3)(A) (without regard to subparagraph (C) or (D)), the "post-PPA '06 applicable mortality table." There is no transition rule for the applicable mortality table.

Although PPA Sec. 302 is effective for plan years beginning on or after Jan. 1, 2008 (the "PPA Sec. 302 effective date"), PPA Sec. 1107 permits a plan sponsor to delay adopting plan amendments under statutory provisions of the PPA (or under any regulation issued under the PPA) until the last day of the first plan year beginning on or after Jan. 1, 2009 (Jan. 1, 2011, for governmental plans). IRS has now issued guidance that addresses specific questions related to the timing of plan amendments made to comply with the requirements of PPA Sec. 302, while taking into account the delayed amendment period provided under PPA Sec. 1107.

Guidance on timing of plan amendments. If, after the PPA Sec. 302 effective date, a plan is amended during the period provided in PPA Sec. 1107, to provide that the amount payable under an optional form of benefit is calculated as the more favorable to participants of the amount calculated by using either (1) the pre-PPA '06 statutory assumptions, or (2) the post-PPA '06 statutory assumptions, the plan won't fail to satisfy the requirement that a qualified joint and survivor annuity (QJSA) for a married participant be at least as valuable as any other form of benefit payable under the plan at the same time. IRS cautioned, however, that this special treatment permitting use of the pre-PPA '06 statutory assumptions applies only through the end of the period described in PPA Sec. 1107. (Notice 2008-30, Q&A-16)

If a plan is amended as described in Q&A-16 (above), but provides that benefits cease to be calculated by using the pre-PPA '06 statutory assumptions after a specified period, relief under PPA Sec. 1107, as described in Rev Rul 2007-67, 2007-48 IRB (see Federal Taxes Weekly Alert 11/08/2007), generally applies to the amendment.

In general, relief under PPA Sec. 1107 applies to an amendment that provides the more favorable to participants of an amount calculated by using either (1) the pre-PPA '06 statutory assumptions, or (2) the post-PPA '06 statutory assumptions, even if the pre-PPA '06 statutory assumptions apply only for a specified period of time (as long as the amendment is adopted during the period provided in PPA Sec. 1107). However, for a particular plan provision, relief under PPA Sec. 1107 applies only to the first plan amendment that implements the post-PPA '06 statutory assumptions for the provision, and any later amendment for the provision will not be treated as adopted "pursuant to" statutory provisions under PPA '06, as required for relief under PPA Sec. 1107.

For purposes of determining whether an amendment that implements the post-PPA '06 statutory assumptions for a particular plan provision is the first such amendment, amendments adopted on or before June 30, 2008, are disregarded. Thus, if a plan amendment is adopted that provides that the amount payable under an optional form of benefit is calculated in the manner described in Q&A-16, and the plan is later amended (during the period provided in PPA Sec. 1107) so that the amount payable is calculated without reference to the pre-PPA '06 statutory assumptions, then the relief under PPA Sec. 1107 will apply to the later amendment only if the initial amendment was adopted on or before June 30, 2008. (Notice 2008-30, Q&A-17)

The relief under PPA Sec. 1107, as described in Rev Rul 2007-67 and Notice 2008-30, applies to a plan amendment that replaces a plan reference to the pre-PPA '06 statutory assumptions with a reference to the post-PPA '06 statutory assumptions, without regard to whether PPA Sec. 302 requires that amendment.

IRS provided the following example to illustrate how this rule applies to a plan that is subject to the Code Sec. 401(a)(11) qualified survivor annuity rules. If a plan calculates the amount of an optional form of benefit that is not subject to the Code Sec. 417(e)(3) minimum present value requirements by reference to the pre-PPA '06 statutory assumptions, and the plan is amended pursuant to an amendment adopted during the period established in PPA Sec. 1107 so that the plan calculates the amount of the optional form of benefit by reference to the post-PPA '06 statutory assumptions, then the plan will not fail to satisfy the Code Sec. 411(d)(6) anti-cutback rules by reason of the amendment. (Notice 2008-30, Q&A-18)

Reconstructing Your Records

Mike Habib, EA

Reconstructing records after a disaster may be essential for tax purposes, getting federal assistance or insurance reimbursement. Records that you need to prove your loss may have been damaged or destroyed in a casualty. While it may not be easy, reconstructing your records may be essential for:

* Tax purposes - You may need to reconstruct your records to prove you have a casualty loss and the amount of the loss. To compute your casualty loss, you need to determine: 1) the decrease in value of the property as a result of the casualty and 2) the adjusted basis of the property (usually the cost of the property and improvements). You may deduct the smaller of these two amounts, minus insurance or other reimbursement. See Publication 547 for further information on figuring your casualty loss deduction.

If you repair damage caused by the casualty, or spend money for cleaning up, keep the repair bills and any other records of what was done and how much it cost. You cannot deduct these costs, but you can use them as a measure of the decrease in fair market value caused by the casualty if the repairs are actually made, are not excessive, are necessary to bring the property back to its condition before the casualty, take care of the damage only, and do not cause the property to be worth more than before the casualty.

* Insurance reimbursement.

* Federal Emergency Management Agency (FEMA) and Small Business Administration aid - The more accurately you estimate your loss, the more loan and grant money there may be available to you.

The following tips may help to reconstruct your records to prove loss of personal-use or business property:

Personal Residence/Real Property

* Be sure to take photographs as quickly as possible after the casualty to establish the extent of the damage.

* Contact the title company, escrow company or bank that handled the purchase to obtain copies of escrow papers. Your real estate broker may also be able to help.

* Use the current property tax statement for land vs. building ratios, if available; if not available, get copies from the county assessor's office.

* Check with appraisal companies to locate a library of old multiple listing books. These can be used for "comps" to establish a basis or fair market value.
"Comps" are comparable sales within the same neighborhood.

* Check with your mortgage company for copies of any appraisals or other information they may have about cost or fair market value.

* Tax records - Immediately after the casualty, file Form 4506, Request for Copy of Tax Return, to request copies of the previous four years of income tax returns. To obtain copies of the previous four years of transcripts you may file a Form 4506-T, Request for Transcripts of a Tax Return. Write the appropriate disaster designation, such as "HURRICANE KATRINA," in red letters across the top of the forms to expedite processing and to waive the normal user fee.

o Form 4506, Request for Copy of Tax Return

o Form 4506-T, Request for Transcript of Tax Return

* Insurance Policy - Most policies list the value of the building to establish a base figure for replacement value insurance.

o If you are unsure how to reach your insurance company, check with your state insurance department. http://www.naic.org/state_web_map.htm

* Improvements - Call the contractor(s) to see if records are available. If possible get statements from the contractors verifying their work and cost.

o Get written accounts from friends and relatives who saw your house before and after any improvements. See if any of them have photos taken at get-togethers.

o If a home improvement loan was obtained, obtain paperwork from the institution issuing the loan. The amount of the loan may help establish the cost of the improvements.

* Inherited Property - Check court records for probate values. If a trust or estate existed, contact the attorney who handled the estate or trust.

* No other records are available - Check at the county assessor's office for old records about the property. Look for assessed valued and ask for the percentage of assessment to value at the time of purchase. This is a rough guess, but better than no records at all.

* Vehicles: Kelley's Blue Book, NADA and Edmunds are available on-line and at most libraries. They are good sources for the current fair market value of most vehicles on the road.

* Call the dealer and ask for a copy of the contract. If not available, give the dealer all the facts and details and ask for a comparable price figure.

* Use newspaper ads for the period in which the vehicle was purchased to determine cost basis. Use ads for the period when it was destroyed for fair market value. Be sure to keep copies of the ads.

* If you're still making payments, check with your lien holder.

Personal Property

The number and types of personal property may make it difficult to reconstruct records. One of the best methods is to draw pictures of each room. Draw a floor plan showing where each piece of furniture was placed. Then show pictures of the room looking toward any shelves or tables. These do not have to be professionally drawn, just functional. Take time to draw shelves with memorabilia on them. Do the same with kitchens and bedrooms. Reconstruct what was there, especially furniture that would have held items -- drawers, dressers, shelves. Be sure to include garages, attics and basements.

* Get old catalogs. These catalogs are a great way to establish cost basis and fair market value.

* Check the prices on similar items in your local thrift stores to establish fair market value. Walk through the stores and look at comparable items, especially items such as kitchen gadgets. Look for odds and ends you may have had but forgotten because of infrequent use.

* Use your local "advertiser" as a source for fair market value. Keep copies of the issues handy and copy pages used for specific items to put with your tax records file on the disaster.

* Check local newspaper want ads for similar items. Again keep a copy of any you use for comparison with the tax file.

* If you bought items using a credit card, contact your credit card company.

* Check with your local library for back issues of newspapers. Most libraries keep old issues on microfilm. The sale sections of these back issues may help establish original costs on items such as appliances.

* Go to a used bookstore with a tape measure and the diagram of the destroyed property. Measure several rows of used books and count the number of books per shelf. Add up the prices of those books and determine an average cost per shelf. Then count the number of shelves you had in your home and multiply by the average cost per shelf. This will help determine the value of your books before the loss.

Business Records

* Inventories - Get copies of invoices from suppliers. Whenever possible, the invoices should date back at least one calendar year.

* Income - Get copies of bank statements. The deposits should closely reflect what the sales were for any given time period.

o Obtain copies of last year's federal, state and local tax returns including sales tax reports, payroll tax returns and business licenses (from city or county). These will reflect gross sales for a given time period.

* Furniture and fixtures - Sketch an outline of the inside and outside of the business location. Then start to fill in the details of the sketches. (Inside the building -- what equipment was where; if a store, where were the products/inventory located. Outside the building -- shrubs, parking, signs, awnings, etc.)

o If you purchased an existing business, go back to the broker for a copy of the purchase agreement. This should detail what was acquired.

o If the building was constructed for you, contact the contractor for building plans or the county/city planning commissions for copies of any plans.

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Mike Habib, EA
myIRSTaxRelief.com

Tax Return Preparer Fraud

Since I recently represented an innocent couple who were victims of Tax Return Preparer Fraud, and successfully helped them in their audit, I thought you might be interested in the info below.

Per the IRS:

FS-2008-10, January 2008

Return preparer fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. Preparers may manipulate income figures to fraudulently obtain tax credits, such as the Earned Income Tax Credit.

In some situations, the client, or taxpayer, may not have knowledge of the false expenses, deductions, exemptions and/or credits shown on his or her tax return.

However, when the IRS detects the false return, the taxpayer -- not the return preparer -- must pay the additional taxes and interest and may be subject to penalties.
The IRS Return Preparer Program focuses on enhancing compliance in the return-preparer community by investigating and referring criminal activity by return preparers to the Department of Justice for prosecution and/or asserting appropriate civil penalties against unscrupulous return preparers.

While most preparers provide excellent service to their clients, the IRS urges taxpayers to be very careful when choosing a tax preparer. Taxpayers should be as careful as they would be in choosing a doctor or a lawyer. It is important to know that even if someone else prepares a tax return, it is the taxpayer who is ultimately responsible for all the information on the tax return.

Helpful Hints When Choosing a Return Preparer

* Be cautious of tax preparers who claim they can obtain larger refunds than other preparers.

* Avoid preparers who base their fee on a percentage of the amount of the refund.

* Use a reputable tax professional who signs your tax return and provides you with a copy for your records.

* Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed.

* Review your return before you sign it and ask questions on entries you don't understand.

* No matter who prepares your tax return, you, the taxpayer, are ultimately responsible for all of the information on your tax return. Therefore, never sign a blank tax form.

* Find out the person's credentials. Only attorneys, certified public accountants (CPAs) and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared.

* Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics.

* Ask questions. Do you know anyone who has used the tax professional? Were they satisfied with the service they received?

Reputable preparers will ask to see your receipts and will ask you multiple questions to determine your qualifications for expenses, deductions and other items. By doing so, they are trying to help you avoid penalties, interest or additional taxes that could result from an IRS examination.

Further, tax evasion is a risky crime, a felony, punishable by five years imprisonment and a $250,000 fine.

Criminal Investigation Statistical Information on Return Preparer Fraud
FY2007 FY2006 FY2005
Investigations Initiated 218 197 248
Prosecution Recommendations 196 153 140
Indictments/Informations 131 135 119
Sentenced 123 109 118
Incarceration Rate* 81.3% 89.0% 85.6%
Average Months to Serve 19 18 18

*Incarceration may include prison time, home confinement, electronic monitoring or a combination.

Criminal and Civil Legal Actions

Some return preparers have been convicted of, or have pleaded guilty to, felony charges.

Additionally, the courts have issued more than 255 permanent injunctions against abusive tax scheme promoters and abusive return preparers since 2003. The following case summaries are excerpts from public record documents on file in the court records in the judicial district in which the legal actions were filed.

Miami Return Preparer Sentenced for Telephone Excise Tax Fraud

On Aug. 20, 2007, in Miami, Fla., Equilla McRae, aka Equilla Edwards, aka Equilla Givens, was sentenced to 21 months in prison, followed by three years of supervised release and ordered to perform 250 hours of community service in each of those years of supervised release. In addition, McRae was ordered to pay $179,369 in restitution to the Internal Revenue Service (IRS). In June 2007, McRae pleaded guilty to one count of making and presenting fraudulent federal income tax refund claims to the IRS. According to the indictment, McRae prepared, filed and assisted others in preparing and filing approximately 25 fraudulent income tax returns that resulted in fraudulent tax refund claims, including fraudulent telephone excise tax refund (TETR) credits, of approximately $142,265. The TETR is a one-time credit available on 2006 income tax returns designed to refund previously-collected federal excise taxes on long-distance telephone service paid from March 2003 through June 2006.

Former New York Tax Preparer Sentenced for Tax Fraud and Ordered to Pay $1.2 Million

On June 6, 2007, in White Plains, N.Y., Glen Robins was sentenced to 30 months in prison and ordered to pay $1.2 million in restitution to the Internal Revenue Service for tax fraud conspiracy. Robins, a tax preparer, pleaded guilty in February 2007, admitting that he conspired to falsify expenses on his clients' partnership returns. The fictitious expenses created losses for the partnerships and those losses fraudulently reduced his clients' tax liability. He also admitted that he conspired to take fraudulent deductions for contributions to self-employment retirement plans. In addition, Robins admitted to submitting false tax returns for himself and his own partnerships.

Former Income Tax Preparer Sentenced to 36 Months in Prison

On May 29, 2007, in Shreveport, La., Paulius D. Pitts was sentenced to 36 months in prison, one year of supervised release and ordered to pay $72,193 in restitution to the Internal Revenue Service. Pitts was indicted in August 2006 and charged with 21 counts of making false and fraudulent statements to the IRS. According to court documents, in 2003, while working as a tax return preparer in Shreveport, Pitts prepared numerous false 2003 federal income tax. The false federal income tax returns prepared by Pitts sought refunds totaling $106,309. In January 2007, Pitts pleaded guilty to one count of making false and fraudulent statements.

Former CPA Sentenced to 51 Months in Prison

On May 23, 2007, in Portland, Ore., Harry Nels Kyllo, former certified public accountant (CPA), was sentenced to 51 months in prison to be followed by three years of supervised release. In January 2007, Kyllo pleaded guilty to one count each of mail fraud, tax evasion and impersonation of an IRS employee. Kyllo was a CPA until his license was revoked by the Oregon State Board of Accountancy on September 30, 2003. At the plea hearing, Kyllo admitted that from about 2000 to 2003, he devised a scheme to defraud some of his tax preparation clients, the IRS, and the Oregon Department of Revenue. The IRS and the Oregon Department of Revenue suffered lost tax revenue because of the thefts. Individual victim losses ranged from several thousand dollars up to $390,000.

Texas Tax Preparer Sentenced to 18 Years in Prison

On Feb. 16, 2007, in Austin, Texas, Jonathan Marshall Sr. was sentenced to 18 years in prison and ordered to pay $5,724 for the cost of prosecution for preparing fraudulent tax returns for clients. In addition to the prison term, he was ordered not to prepare or assist in preparing tax returns while in federal prison. Marshall was convicted of 40 tax fraud charges in November 2006. The jury found that from 2000-2005, Marshall placed false dependents and false business income or losses on his clients' tax returns in order to qualify them for larger tax refunds. The majority of his illegal tax scheme involved falsely qualifying his clients for the Earned Income Credit.

Cincinnati Tax Preparer Sentenced for Preparing Fraudulent Tax Returns

On Dec. 1, 2006, in Cincinnati, Ohio, Walter Daulton was sentenced to 46 months in prison followed by one year of supervised release and ordered to pay a $1,500 fine for willfully aiding and assisting in the preparation of federal income tax returns which were false and fraudulent. According to testimony presented at trial, Daulton, a self-described truck tax expert, gave seminars at truck stops and trucking companies and prepared fraudulent income tax returns for truck drivers. On many of his clients' tax returns, he reported numerous fictitious expenses that his clients had neither paid nor incurred. The fictitious expenses included commissions, fees, gifts to charity, tarping and untarping fees, and other business expenses.

Return Prepared Sentenced to 48 Months in Prison for Conspiracy to Defraud the US

On Oct. 19, 2006, in Tucson, Ariz., Luis C. Deguzman Jr. was sentenced to 48 months in prison to be followed by three years of supervised release and ordered to pay $416,965 in restitution to the IRS. On June 14, 2006, Deguzman was found guilty by a federal jury of conspiring to defraud the United States by filing false claims for income tax refunds. Evidence at trial showed that Deguzman told clients he could obtain large income tax refunds to be placed in a trust for the future benefit of their family and a charity of their choice. He claimed to have connections with the IRS which permitted him to gain special approval to use a loophole in the tax code in order to fund a charitable remainder trust for clients. Deguzman prepared the alleged trust documents and the client's tax return. Without the client's knowledge, he inflated the charitable contributions and sometimes added other false deductions. He would sometimes have the entire tax refund sent to accounts he controlled rather than the client's. In the promotion of the fraudulent charitable trust scheme, Deguzman attempted to defraud the IRS of $455,985. Several of Deguzman's clients reported him to the IRS.

Federal Court Orders Halt to Nationwide "Tax Termination" Scheme

On Aug. 9, 2007, a federal court permanently barred Robert L. Schulz of Queensbury, N.Y., and his organizations, We the People Congress and We the People Foundation, from promoting a tax scheme that helped employers and employees improperly stop tax withholding from wages. The court said Schulz "relied on fringe opinions of known tax protestors whose theories have repeatedly been rejected by courts across the country." The court further noted that several of those tax protestors were convicted of tax crimes.

South Carolina Court Bars "Patriot" Group From Promoting Tax Schemes

On July 3, 2007, a federal judge permanently barred Robert Barnwell Clarkson and his so-called "Patriot Network" from promoting tax-fraud schemes. The court detailed Clarkson's efforts to interfere with tax collection, including his instructions to transfer property to nominees and to sue IRS agents who attempt to collect taxes.

Federal Court Bars Georgia Man from Promoting "Absurd" Tax Scheme

On Aug. 31, 2007, a federal court permanently barred Derrick Sanders of Atlanta from promoting a tax fraud scheme involving false claims. According to the complaint, Sanders' customers were advised they were not liable for income tax because they belonged to a purported Native American group, the so-called Yamassee Native American Tribe. The court noted that after it preliminarily enjoined Sanders in 2006 he "refused to back down from his absurd contention that the Yamassee are ... exempt from federal income taxes."

Where Do You Report Suspected Tax Fraud Activity?

If you suspect tax fraud or know of an abusive return preparer, report this activity using IRS Form 3949-A, Information Referral. You can download Form 3949-A from the Web site at IRS.gov or call 1-800-829-3676 to order by mail. Send the completed form, or a letter detailing the alleged fraudulent activity, to Internal Revenue Service, Fresno, CA 93888. Please include specific information about who you are reporting, the activity you are reporting and how you became aware of it, when the alleged violation took place, the amount of money involved and any other information that might be helpful to an investigation. Although you are not required to identify yourself, it is helpful to do so. Your identity can be kept confidential. You may also be entitled to a reward.

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S corporations tax challenges by the IRS and other taxing authorities

Tax Advocate's Report highlights S corporation issues

Despite the fact that Subchapter S corporations are the most common corporate entity (over three million S corporations filing returns in fiscal year 2006), the National Taxpayer Advocate's 2007 Annual Report notes that IRS is still struggling to develop an effective and comprehensive strategy to address noncompliance by S corporations. The Report focuses on some of the challenges in this area, including insufficient data to assess compliance risks and undue taxpayer burden because of the S corporation election process and Schedule K-1 matching errors. In particular, the Report examined the avoidance of employment taxes by means of treating shareholder wages as distributions.

Background. S corporations are incorporated entities with many of the same attributes as traditional C corporations, including limited liability, transferable ownership, and unlimited life. But unlike C corporations, S corporations are generally not subject to income tax. Instead, the business's profit or loss is passed through to the shareholders, who report it on their individual returns. To qualify, a corporation must elect S corporation status and meet a number of requirements. It can have no more than 100 shareholders, and only certain types of taxpayers can be shareholders. It can have only one class of stock.

The Report surmises that the continual growth in S corporation filings--which account for 65% of all corporate returns--may be due in part to the lower individual tax rates available, limited liability, and the perceived opportunity for sole proprietors to avoid self-employment tax.

Compliance data difficulties. IRS stratifies S corporation filings into three separate asset ranges (as compared with the 13 ranges for C corporations). This can make identifying returns with higher compliance risk more difficult, especially when 99% of all S corporation returns report assets of $10 million or less. In fiscal year 2006, an S corporation faced only a 4 in 1000 chance of being audited, compared to 8 in 1000 for C corporations.

The Report notes that IRS increasingly identifies S corporation returns for examination to address abusive tax schemes and avoidance transactions, but identifying compliance risk associated with multi-entity return groups is challenging. (IRS is also developing a high income taxpayer strategy to test the hypothesis that the highest income strata of Forms 1040, Individual Income Tax Return, are using a variety of tax products and entity structures to defer tax liability into future years, convert ordinary income into lower capital gain tax income, or offset income with sham losses.)

When IRS proposes changes to S corporation returns at the conclusion of an examination, it reports each shareholder's distributive share of the change as an adjustment to the individual shareholder's tax return. In addition to certain deficiencies with the audit process, IRS is unable to measure its effectiveness in S corporation examinations because it doesn't track the ultimate tax at the Form 1040 level. IRS records audit results at the S corporation level but never associates them with the tax assessment.

S elections and K-1 filings. Taxpayers elect S corporation status by filing Form 2553, Election by a Small Business Corporation, on or before the 15th day of the third month of the tax year for which the election is to be in effect. If the election isn't timely filed or is incomplete, the S corporation return is converted to a C corporation return when filed. In past years, roughly 14% to 16% of total new S corporation filings were unpostable (i.e., the S corporation election was not approved). Approximately 20% of S corporation returns are unpostable for multiple years because of missing information or IRS processing errors.

S corporations file Schedules K-1 each year to report profit and loss to their shareholders. IRS then matches income and loss information from Schedules K-1 to individual tax returns and generates notices when differences arise. Although returns are screened to eliminate unnecessary notices, the error rate is still high. IRS technicians who work discrepancies have limited accounting and tax training, while S corporation returns contain many complex issues that may go undetected where employees only address flow-through income. Further, since the K-1 matching program is part of the Automated Underreporter (AUR) program unit, which limits human involvement, many taxpayers are unable to reach a trained IRS employee to answer questions concerning mismatched K-1s because the AUR program's level of service is poor and the program has no dedicated line for practitioners.

The Report concludes that IRS needs to focus on reducing taxpayer burden associated with the S corporation election process and the K-1 matching program. Taxpayers and return preparers have identified the S corporation election process as one of the most difficult for eligible small business corporations. While efforts have been made to simplify the S-election process and reduce processing costs, the Report concludes that the best approach to reducing taxpayer burden is to permit the election to be considered timely filed with the first S corporation return. Taxpayers and practitioners need access to knowledgeable IRS employees to deal with the often complex questions regarding S corporation and K-1 matching issues.

Compensation vs. corporate distribution. The earnings of an S corporation are taxed as ordinary income to its shareholders. Unlike partnership or sole proprietor earnings, S corporation earnings are not subject to self-employment tax. This treatment gave rise to a tax planning strategy that recharacterizes shareholder compensation as distributions of profit to avoid payroll taxes. The S corporation owner pays employment taxes on only the portion of profits that he arbitrarily decides is "salary." The S corporation officer or shareholders, who takes no salary or a nominal salary, receives the remaining compensation as tax-free distributions. The corporation saves payroll taxes, and the shareholder pays only income taxes on his share of the corporate profits, avoiding paying Social Security and Medicare taxes.

In tax year 2005, almost one million S corporations with one shareholder paid no officers' compensation. The Report calculates that if all profitable S corporations that reported no officers' compensation had been Schedule C businesses, they would have paid an estimated $4.9 billion in self-employment tax.

The Report notes that the wage-to distribution conversion strategy may reduce the shareholder's future Social Security benefits--an important part of most individuals' retirement income. A taxpayer's Social Security benefits depend on the amount of pre-retirement wages received and social security taxes paid.

Although IRS has repeatedly litigated this issue and has won, taxpayers continue to use it as a tax planning strategy. IRS acknowledges this issue as a special compliance problem, featuring it in corporate classification guidelines for Form 1120S and including a reference to it in its notice of acceptance of S corporation status. IRS continues to audit returns based on this issue and reclassify distributions as wages subject to employment taxes. But establishing a fair and reasonable wage is difficult and time consuming. IRS examiners must consider: the financial condition of the corporation; the time worked by the shareholder; the company's compensation policy for other workers; the salary structure in companies in similar industries; and the return on investment.

Observation: The easiest cases for IRS to litigate and win are those where a sole S corporation owner claims no or negligible salary subject to employment taxes despite the fact that he may serve in key roles in the business, providing management, sales, or service functions, controlling the day to day activities of the company and making decisions affecting its future. The much more difficult and thornier cases are those questioning whether a salary that is not negligible is sufficient, i.e., reasonable.

The Report concludes that actions are needed to reverse the trend of electing S corporation status to avoid Social Security taxes. The employment tax strategy has an economic impact on the tax gap and erodes the Social Security and Medicare tax base. While acknowledging the challenges faced by IRS in dealing with this compliance issue (while reducing taxpayers' burden), the Report concludes that IRS must find the right balance of research, training, outreach, and compliance activities to improve the quality of S corporation work.

S Corporation tax problem? Get professional tax resolution today!

Mike Habib, EA