Lewis & Associates IRS and California Tax Law News & Updates

Excluding 1099-C Cancellation of Indebtedness Related to Home Foreclosure from Income

Many of my clients are angry at the way they are being treated by the IRS or based on their perception of the lack of fairness of the tax laws. The most distraught clients are those that receive 1099-C’s or 1099-A’s in the January following the year in which their home has been foreclosed, and realize that they could owe hundreds of thousands of dollars in taxes to the IRS for the cancellation of their debt. Being taxed hundreds of thousands of dollars for losing your home is perhaps the best example of adding insult to injury. Fortunately, many taxpayers can advantage of special exemptions to prevent the recognition of cancellation of income and save themselves a SIGNIFICANT amount of money in taxes.

Being taxed hundreds of thousands of dollars for losing your home is perhaps the best example of adding insult to injury. 

Qualified Principal Residence Indebtedness 

Canceled debt that is qualified principal residence indebtedness can be excluded from income. Debt that counts as qualified principal residence indebtedness includes a mortgage to buy, build, or substantially improve your home. Qualified principal residence indebtedness also includes a loan used to refinance a mortgage that you used to buy, build, or substantially improve your home, but only up to the amount of the principal of the old mortgage prior to refinancing.

I know that many people use part of their mortgage or loan proceeds from refinancing to purchase personal property, such as cars or boats or furniture, or to pay off other debts, such as credit card debits, instead of using the all of the loan proceeds to purchase or remodel or improve their property. These amounts do not count as amounts that you exclude from income as qualified principal residence indebtedness, and these amounts are counted first by the IRS when calculating whether you can take advantage of the Qualified Principal Residence Indebtedness exclusion. This exclusion is further limited in that the maximum amount that you can treat as qualified principal residence indebtedness is $2 million.

There is another exclusion that is more flexible than this exclusion, and can even be used in combination with this exclusion…

Insolvency Exclusion

The insolvency exclusion is a very useful exclusion. Under this exclusion, you can exclude canceled debt from income to the extent that you were insolvent immediately before the cancellation event. This amount is calculated by adding up the fair market value of all of your assets and subtracting this amount from the total of all of your liabilities. The resulting figure is the extent to which you can exclude cancellation of indebtedness income from your income. Since taxpayers usually do not have too many assets by the time their home is being foreclosed on, and since the home is usually the taxpayer’s biggest asset, a taxpayer can often exclude close to the entire amount of their cancellation of indebtedness income from their income.

Conclusion

Don’t be discouraged if you receive a 1099-C in your mailbox in January. Call us, schedule a free 30-minute consultation, and we will see what we can do to help ease or eliminate your possible tax burden.

BOE Returns $16,000 of Illegally Withheld Money Back to Client

A client recently had his bank accounts levied for approximately $32,000. He then entered into an installment payment agreement because he has a good business that should continue to operate. The California Taxpayer’s Bill of Rights explicitly states that the Board of Equalization must give all the money taken from my client’s bank account back if he enters into an installment payment agreement:

(a) Except in any case where the board finds collection of the tax to be in jeopardy, if any property has been levied upon, the property or the proceeds from the sale of the property shall be returned to the taxpayer if the board determines any one of the following:

(1) The levy on the property was not in accordance with the law.

(2) The taxpayer has entered into and is in compliance with an installment payment agreement pursuant to Section 6832 to satisfy the tax liability for which the levy was imposed, unless that or another agreement allows for the levy.

(3) The return of the property will facilitate the collection of the tax liability or will be in the best interest of the state and the taxpayer.

(b) Property returned under paragraphs (1) and (2) of subdivision (a) is subject to the provisions of Section 7096.

However, the local office only returned about half of the money, but he needed all the money to pay his suppliers and run his business. They actually told me that they could keep the money because they are allowed to keep the money. I recited this statute to them until I was blue in the face. Technical amount of time equal to blue in the face is one hour and 12 minutes.

I got in touch with their lawyers, explained the situation and the statute. They informed the local office that they have to return the money. The remaining withheld amount was wired back into my client’s account, and he can now continue to run his business.

If you’re having trouble with Sales & Use Tax, give us a call. We’re happy to help!

The Hows, Whats, and Whys of the Pfizer-AstraZeneca Corporate Inversion

If Pfizer’s $119 billion offer for Astra Zeneca was truly its last offer, then the current furor over the tax loophole that Pfizer was attempting to take advantage of might die down. For a while. If not, then we can expect Senator Carl Levin of Michigan to continue to attempt to craft legislation to defeat this tax loophole. But what is this tax loophole, how does it operate, and why is it so potent at lowering a company’s US tax liabilities?

What is the Tax Loophole that Pfizer Wants to Use?

The tax loophole that Pfizer wants to use is called a corporate inversion transaction. The most simple way to conceive of this transaction is that the corporation reincorporates in a new country with a lower tax rate. The transaction is structured to be tax-free to the corporation and taxable to the shareholders.

In the most extreme examples prior to passage of the Jobs Creation Act of 2004, American companies reincorporated in bona fide tax havens:

Since the bill was passed, it has become tougher to do a tax free corporate inversion. But it is still possible. In the next section I will discuss the mechanics of a corporate inversion.

How the Corporate Inversion Works

In a typical corporate inversion, US parent company directly merges into a foreign company or it creates a foreign subsidiary which it reverse merges into. The first is a tax-free reorganization under IRC 368(a)(1)(B), and the second is a tax-free reorganization under IRC 368(a)(2)(E). This is a standard corporate transaction in domestic mergers and acquisitions.

However, and this is where the Jobs Creation Act of 2004 amendment in IRC 7874(b) comes into play, the new foreign domicile of the company will be ignored and it will be taxed as if it’s a domestic, US corporation if:

  1. the former shareholders of the US corporation own at least 80% of the new foreign corporation by vote or value; and
  2. the expanded affiliate group of the new company does not have substantial business activities in the country of its incorporation compared to the total business activities of the expanded affiliate group.

In the event that the former shareholders of the US corporation own less than 80% but 60% or more of the new foreign corporation, then the foreign corporation is respected as a foreign corporation, but it loses:

  1. Certain tax credits; and
  2. Net operating losses.

This effectively eliminated the possibility of reincorporating into a typical tax haven which tend to be very small islands in which substantial business activities could not occur. However, there are still tax savings to be found by reincorporating from, for example, the US with a 35% nominal tax rate into the UK with a 21% nominal tax rate.

Generally, the corporate inversion will result in the shareholders recognize gain on the transaction equal to difference between the fair market value of the shares received in the new foreign company and the shareholders’ adjusted basis in the shares. IRC 367(a); Treas. Reg. 1.367(a)-3(a).

In the proposed merger of Pfizer and AstraZeneca, Pfizer proposed the creation of a new holding company in the UK which would acquire both Pfizer and AstraZeneca. Under the May 2, 2014, terms Pfizer shareholders would own 73% of the new UK company and AstraZeneca shareholders would own 27% of the new company, which would allow it to pass the 80% test in IRC 7874.

Corporate Inversions Lower Tax Rates and Eliminate Tax on Repatriating Foreign Income

In the press release linked to in the previous paragraph, Pfizer announced that there would be tax benefits to the merger. The New York Times’s DealBook quantified those tax benefits:

By reincorporating in Britain, Pfizer would most likely save about $200 million a year for each percentage point less it pays in taxes, according to Barclays. Pfizer paid a 27.4 percent rate in the United States; AstraZeneca paid about 21.3 percent in Britain. Those six percentage points could turn into an annual windfall of more than $1 billion.

Additionally, US companies are typically subject to tax on their worldwide income. If US companies plan around Subpart F, then they can defer recognition of income from foreign affiliates until that income is repatriated into the US. Other countries, China being the notable exception, operate on an exemption system under which income is taxed only in the country that is the source of the income. This means that if Pfizer is reincorporated in the UK, then it can use its $57 billion in cash sitting in its overseas entities for investment anywhere in the world without having to pay additional tax to the US government.

This article originally posted at the Global Law & Business Perspective.

photo credit: CarbonNYC cc

Reporting Receiving $10,000 in Cash to IRS on Form 8300

If you receive cash payments of $10,000 or more in the course of your business, you must file Form 8300 with the IRS. If you don’t file Form 8300 then you face up to 5 years in federal prison and a fine of up to $250,000, plus a civil penalty of the greater of $25,000 or the amount cash you received. Many businesses are hesitant to file Form 8300 with the IRS because you have to ask your customers for their government ID and you have to ask them for their Social Security Number. But the consequences of not filing are severe. After a few examples, I will briefly explain the law on filing Form 8300.

Examples of Failing to Form 8300

The US DOJ Tax Division’s website is full of press releases about convictions of taxpayers who failed to file Form 8300 for receiving $10,000 in cash from their customers and clients. The people who most often run afoul of failing to file Form 8300 are jewelry dealers, vehicle dealers, and attorneys. A few examples:

Cigarette Boat to Federal Prison

60 year old James Allen McKean owned and operated International Boating Center, Inc. (IBC), in Mabank, Texas. IBC was primarily in the business of selling big, fast, cigarette boats. He sold a boat for $121,112.50, with $2,100 on a credit card and the remainder in cash. McKean did not file a Form 8300 reporting that he had received more than $10,000 in a single transaction. He pled guilty to one count of failing to file Form 8300, and he faced an up to 5 year federal prison term and a fine of $250,000.

Attorney Hoarding Green

62 year old attorney Frank Fabbri of St. Louis, Missouri, represented Edward Trober on charges of possession with intent to distribute 1,000 kilograms of marijuana. Trober had his friends and family send all of his hidden drug proceeds to Fabbri so that Fabbri could turn the money over to the US Attorney’s Office. Fabbri was instructed by the DEA and the IRS CID to fill out Form 8300 for any csh payments he received in excess of $10,000. Fabbri gave the US Attorney’s Office $73,000. On reviewing his records, the US Attorney’s Office determined that $36,000 in cash was given from Trober to Fabbri, and Fabbri did not file a Form 8300. Fabbri pled guilty to failing to file Form 8300, and he was sentenced to 18 months in federal prison and a $40,000 fine.

The Legal Aspects of Form 8300

Form 8300 is a form that is jointly developed and enforced by the IRS and FinCEN. The consequences of not filing Form 8300 are a lengthy stay at a federal prison and a large fine.

Who Must File Form 8300?

Any person who, in their trade or business, receives $10,000 or more in cash in a single transaction or in related transactions must file Form 8300 to report cash paid to them  if the cash paid is:

  1. Over $10,000,
  2. Received as:
    1. One lump sum of over $10,000,
    2. Installment payments that cause the total cash received within 1 year of the initial payment to total more than $10,000, or
    3. Other previously unreportable payments that cause the total cash received within a 12-month period to total more than $10,000,
  3. Received in the course of your trade or business,
  4. Received from the same buyer (or agent), and
  5. Received in a single transaction or in related transactions.

person includes an individual, a company, a corporation, a partnership, an association, a trust, or an estate.

Cash is defined as:

  1. The coins and currency of the United States (and any other country), or
  2. A cashier’s check, bank draft, traveler’s check, or money order you receive, if it has a face amount of $10,000 or less and you receive it in:
    1. A “designated reporting transaction”, or
    2. Any transaction in which you know the payer is trying to avoid the reporting of the transaction on Form 8300.

transaction occurs when:

  • Goods, services, or property are sold;
  • Property is rented;
  • Cash is exchanged for other cash;
  • A contribution is made to a trust or escrow account;
  • A loan is made or repaid; or
  • Cash is converted to a negotiable instrument, such as a check or a bond.

Related transactions are:

  • Transactions that occur between the seller and the buyer within a 24 hour period; and
  • Transactions that the seller knows or has reason to know are part of a series of connected transactions.

designated reporting transaction is the retail sale of any of the following:

  1. A consumer durable, such as an automobile or boat. A consumer durable is property, other than land or buildings, that:
    1. Is suitable for personal use,
    2. Can reasonably be expected to last at least 1 year under ordinary use,
    3. Has a sales price of more than $10,000, and
    4. Can be seen or touched (tangible property).
  2. A collectible (for example, a work of art, rug, antique, metal, gem, stamp, or coin).
  3. Travel or entertainment, if the total sales price of all items sold for the same trip or entertainment event in one transaction (or related transactions) is more than $10,000.

The scenarios under which you may or may not have to file a Form 8300 are virtually innumerable. A single blog post is not sufficient to cover the scope of exceptions and nuances to the rules. I wanted to give you the basics, and then run you through the two main problems of actually filling out the form.

Tricky Form Requirements for Business

While knowing whether you have to fill out a Form 8300 can be tricky business, actually filling out the form is fairly straightforward from the seller’s perspective. However, your customers might have some issues with the questions you ask them while filling out the form.

First, you must ask your customers for whom you must file a Form 8300 for their government issued identifications. This is so you can write down their address.

Second, you must ask your customers for whom you must file a Form 8300 for their Tax Identification Number. If they won’t give it to you, then you either need to turn them away as customers, or you must comply with the reasonable cause provisions of Treasury Regulation section 301.6724-1.

 

Conclusion

The IRS and other federal agencies use undercover agents in sting operations to build these cases against business people, including jewelry stores, car dealerships, and attorneys. If you believe that you’re under investigation for failing to file Form 8300 or if you’d like to develop a compliance program, you can contact our office at (408) 459-8427 or will@lewisllp.com.

photo credit: Unfurled cc

IRS Issues Guidance on Taxation of Bitcoin Mining and Virtual Currency

On March 25, 2014, the IRS issued Notice 2014-21 (pdf) which contains guidance on tax principles applied to virtual currencies including Bitcoin. In an interview with Reuters, I told the reporter that this Notice was very unfair to miners, but the reporter did not elaborate on why I believe that the guidance is unfair to miners. Here is why.

In the Notice, the IRS states that it will treat virtual currency transactions as property transactions. The IRS then poses and answers 16 questions that are designed to provide guidance on how it will treat various transactions. 15 of these questions give standard property transaction taxation treatment to virtual currency transactions. However, question and answer 8 deviate from this treatment:

Q-8: Does a taxpayer who “mines” virtual currency (for example, uses computer 
resources to validate Bitcoin transactions and maintain the public Bitcoin 
transaction ledger) realize gross income upon receipt of the virtual currency 
resulting from those activities?

A-8: Yes, when a taxpayer successfully “mines” virtual currency, the fair market value
of the virtual currency as of the date of receipt is includible in gross income. See
Publication 525, Taxable and Nontaxable Income, for more information on taxable
income.

This means that the IRS has taken the position that a person who mines virtual currency is being paid in virtual currency for the service of mining virtual currency, rather than the person has produced virtual currency, a piece of property, through capital intensive number crunching. What is the process of virtual currency mining?

The way that I conceive of the process of virtual currency mining using the example of Bitcoin is that when a block is discovered a number of Bitcoins is created. The pool that discovers the block retains the Bitcoins, and the pool distributes the Bitcoins according to each members’ contributions to solving the block. So it’s not like you’re getting paid for providing services to someone else. It’s more like you’re creating property, Bitcoins, through capital intensive effort, solving math problems with expensive computers. Mining Bitcoins is similar to using alchemical processes to turn lead into gold, and you’d only be taxed on that once the gold is sold to someone else (and as a professional alchemist you’d be able to deduct your expenses for newt’s eye, cauldrons, and lead). Or, to use a more classic example: mining Bitcoins is like baking bread, and the baker is taxed when he sells the bread (the realization event), not when the bread is baked.

If the IRS says that they are going to tax virtual currency according to the principles of property taxation, then virtual currency miners should only be taxed when there is a realization event and not when they produce a unit of virtual currency.

The scope of this problem is immense. In the past year approximately 1.5 million Bitcoins have been mined. I’m going to estimate an average price per Bitcoin of $300 over the past year. If we assume that all Bitcoin miners are subject to US tax, then that represents $450 million in additional taxable income over the past year without any of the subsequent realization events. At a 25% tax rate, the Department of the Treasury has just raised $112.5 million in tax revenue from the production of something. The tax code doesn’t work this way. The taxation of copper or gold mining does not work this way. I cannot fathom why they decided to do this.

If you’re interested in the taxation of virtual currencies or if you have questions regarding your tax issues, give me a call at (408) 459-8427 or an email at will@lewistaxlaw.com.

William Lewis Interviewed by Reuters on New Bitcoin IRS Tax Notice

Bitcoins

William Lewis was interviewed by Reuters on March 25, 2014, about the recently released IRS tax Notice regarding the taxation of Bitcoin and other virtual currencies.

You can read the article here, and you can read relevant analysis by Brad Polizzano at Taxes in the Back.

Contact Mr. Lewis or our office for more info about your virtual currency questions at (408) 459-8427 or will@lewistaxlaw.com.

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