I.R.C. Section 108(a)(1)(B), insolvency exception. In Vincent C. Hamilton and Stephanie Hamilton v. Comm’r, T.C. Memo 2018-62, filed May 8, 2018, the Tax Court explores a common exception to inclusion of discharge of indebtedness in gross income. Gross income generally includes discharge of indebtedness – I.R.C. section 61(a)(12). Section 108(a)(1)(B) excludes income from the discharge of indebtedness from gross income if the discharge occurs when the taxpayer is insolvent. Insolvency is measured by comparing the excess of the taxpayer’s liabilities over the fair market value of the taxpayer’s assets immediately before discharge. Taxpayers borrowed money in order to finance their son’s education. The husband ultimately injured his back and became permanently disabled. The student loan provider discharged over $158,000 in student loan debt. Husband then exhibited poor money management skills and his wife took over their finances. To protect their assets, she transferred $323,000 into their son’s savings account. She had the password and permission from her son to transfer money. She did this regularly during the year at issue to pay bills from her joint account with her husband. When filing the return, their accountant advised they were insolvent and claimed as much on the return. He had not included the value of the savings account in the son’s name. In this case, the sole issue is whether or not a bank account of taxpayers’ son should be included in their asset calculation. In this case, the taxpayers failed to prove that their son was not their nominee because they continued to enjoy the benefits of the funds they transferred to their son’s savings account. There was no evidence that the son paid any consideration for the funds transferred to his savings account by the taxpayers. As such, the funds were included as assets of the taxpayers, and the taxpayers were no longer insolvent.
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I.R.C. Section 7345. If a taxpayer has “seriously delinquent tax debt,” the IRS will certify that debt to the State Department for action. The State Department will generally not issue a passport to a taxpayer after receiving certification from the IRS. Further, the State Department may revoke a taxpayer’s passport on certification from the IRS. “Seriously delinquent tax debt” is defined as a tax debt currently in excess of $51,000 (this is inflation adjusted), for which a notice of federal tax lien has been issued and all administrative remedies under I.R.C. section 6320 have lapsed or been exhausted, or a levy has been issued. Some tax debts are not included, even if they meet the above criteria. This includes tax debt that is being paid timely on an IRS approved installment agreement, is being paid timely with an accepted Offer in Compromise, is pending a timely requested Collection Due Process hearing regarding a levy, or for which collection is suspended because of an application for innocent spouse relief. Additionally, a passport won’t be at risk under the program if the taxpayer is in bankruptcy, identified by the IRS as a victim of identity theft, if the taxpayer’s account is in currently not collectible, if the taxpayer resides in a federally declared disaster area, if the taxpayer has a pending request for an installment agreement, if the taxpayer has a pending Offer in Compromise, or if the taxpayer has an IRS accepted adjustment that will satisfy the debt in full. Before denying a passport, the State Department will hold the application for 90 days to allow the taxpayer to resolve any erroneous certification issues, make a full payment of the tax debt, or enter a payment arrangement with the IRS.
This is a hard fought case on a narrow issue that ultimately went in favor of the IRS. The Tax Court in Scott T. Blackburn v. Comm’r, 150 T.C. No. 9, filed April 9, 2018, was asked to review the verification of compliance rule of I.R.C. section 6751(b), as required by sections 6330(c)(1) and (3)(A). The Appeals officer must “obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met.” Sec. 6330(c)(1). The Petitioner did not argue or contest the liability issue relating to assessment of the Trust Fund Recovery Penalty against him. The Revenue Officer in this instance has recommended assessment and said assessment was approved by the Revenue Officer’s manager using Form 4183. The name of the manager was listed on the form, but no signature was present. The taxpayer argued that in creating section 6751(b), Congress could not have meant to require a meaningless, supervisory “rubber stamped” signature. Petitioner asked the IRS many times to provide some evidence that the supervisor’s review was meaningful. Petitioner relies on the Internal Revenue Manual to suggest an argument that the signature of a supervisor in support of a penalty is not in itself a sufficient showing to comply with section 6751(b). The Court indicated that caselaw review applying these code sections has only required the officer to review the administrative steps taken before assessment of the underlying liability. To impose the requirement of a substantive review on the officer would allow the taxpayer to avoid the limitations of pursuing the underlying liability in a review under section 6330 and apply a level of detail in the verification process that has never been previously required, the Court explained.
In Connie L. Minton a.k.a. Connie L. Keeney v. Comm’r, T.C. Memo 2018-15, filed February 5, 2018, the Tax Court was asked to review an IRS Appeals’ decision denying innocent spouse relief based on equitable relief. In this case, taxpayer made application for relief after divorce. The return in question reflected income from a 401(k) withdrawal taxpayer instituted at the request of her former spouse – for the purpose of investing in a business venture that failed. Additionally, the spouse’s income from his business, along with a small amount of interest income was reported on the return. The Appeals officer indicated that the taxpayer’s request for relief failed because the tax was attributed to her income. Thus, it did not meet the threshold condition for relief. The Tax Court reviewed this decision and discussed the exceptions to the attribution rule. Those exceptions include: a) attribution due solely to the operation of community property law, b) nominal ownership, c) misappropriation of funds, d) abuse before the return was filed that affects the requesting spouse’s ability to challenge the treatment of items on the return or question payment of any balance due, and e) fraud committed by the nonrequesting spouse that is the reason for the erroneous item. Ultimately, the Court indicated that the taxpayer did not meet any of the exceptions and failed the threshold conditions as to her 401(k) withdrawal. The Tax Court, however, disagreed with Appeals in that they concluded the liability attributed to the nonrequesting spouse’s business income should not be attributed to the taxpayer because her involvement in the business was nominal only. This is a good discussion of some exceptions to the income attribution rule, not regularly reviewed by the Court.
IRS institutes Early Interaction Initiative for Employment Tax matters
It is expected that the IRS will be instituting swifter action against employers that are falling behind on their Federal Tax Deposits (FTD’s) for employment taxes. Those taxpayers who have had interaction with a field Revenue Officer are likely hearing from those Revenue Officers more quickly if they fall behind on their required deposits. However, the IRS announced in December 2015 that it is instituting efforts to identify employers who appear to be falling behind on their tax payments – apparently even before their employment tax return is being filed.
The IRS has indicated that their identification efforts will result in letters, automated phone messages, and other communications which could include a visit from a field Revenue Officer. The IRS has indicated that this effort will reduce the likelihood of the problem becoming uncontrollable. Many taxpayers simply do not realize how steep the penalties can be for failure to properly make tax deposits, pay employment taxes timely, or failure to file timely returns. Further, it is unlikely that most taxpayers understand the personal liability that can be assessed from unpaid employment taxes. A liability that is not dischargeable in bankruptcy.
While the education efforts are beneficial, certainly there is an enforcement aspect of this activity by the IRS. The IRS readily admits that two-thirds of federal taxes are collected through the payroll tax system. With a reduced budget, this activity makes good sense for the IRS. However, it is most likely going to be most burdensome for small businesses.
No doubt early action is best. If you know you have been falling behind on your payroll tax obligations and need assistance planning before you hear from the taxing authorities, feel free to call.
8th Circuit Ruling Affects Characterization of Payments from Conservation Reserve Program:
The US Court of Appeals for the 8th Circuit recently handed down a decision in Morehouse v. C.I.R, (8th Cir. Oct. 10, 2014), which decided whether or not payments received under the Department of Agriculture’s Conservation Reserve Program (CRP) should be included as income from self-employment on a taxpayer’s return.
In this case, the taxpayer inherited 1223 acres of land in 1994, located on three different properties in South Dakota (503 acres in Grant County, 320 acres in Roberts County, and 400 acres in Day County). All of the land was tillable cropland with exception of a gravel pit on the Grant County property and 129 acres on the Roberts County property that the taxpayer’s father placed under the CRP program. The taxpayer never farmed any of the land.
In 1997, the taxpayer enrolled the remaining acreage of the Roberts County property and the tillable land in Grant County in the CRP program. The primary purpose of the CRP program is to reduce soil erosion and improve soil conditions on highly erodible cropland by limiting the taxpayer’s use of the property. Therefore, by enrolling in the program, the taxpayer entered into a contractual obligation with the Commodity Credit Corporation (CCC) requiring him to implement conservation plans for the properties in the program. These plans required the taxpayer to establish and maintain certain types of grass or vegetative cover on the land and engage in periodic weed and pest control. As compensation for implementing the conservation plans, the taxpayer was reimbursed for a portion of his costs and was paid an “annual rental payment.”
In both 2006 and 2007, the taxpayer received CRP payments of $37,872. The taxpayer included the CRP payments on his return in both years as a rental payment received from real estate. As a result, on October 14, 2010 the IRS sent the taxpayer a notice of deficiency stating that the CRP payments should have been reported as self-employment income on a Schedule F, Profit or Loss from Farming. The taxpayer petitioned the Tax Court for review of this determination, claiming that the CRP payments were rentals from real estate under 26 U.S.C. §1402(a)(1), and therefore should be excluded from his net earnings from self-employment. However, the Tax Court sustained the service’s conclusion that the CRP payments constituted self-employment income reasoning that because the payments were proceeds from the taxpayer’s own use of the land they did not constitute rental payments.
On appeal, the primary issue centered on whether or not CRP payments should be categorized as “net earnings from self-employment.” In deciding this question, the Appeals Court first looked at types of payments that would generally be classified as self-employment income. The Court explained that self-employment income consists of the gross income derived from the taxpayer’s trade or business. Or in other words, the trade or business must give rise to the income before it can be included as self-employment income.
Contrary to the Tax Court’s opinion, the Appeals Court found that the CRP payments did not derive from the taxpayer’s activities on the land because the only reason the taxpayer engaged in any activities such as tilling and seeding on the land was because it was required by the CRP contracts. The Appeals Court further determined that because the contracts reserved a right of entry for the government onto the CRP property for purposes of inspection, that the government was “using” the land as much as if not more than the taxpayer. Therefore, the CRP payments were given to the taxpayer in consideration for this right to use and occupy the taxpayer’s property.
Next the Court looked at how similar payments to taxpayers have been categorized in the past. In doing so, the Court looked to Rev. Ruling 60-32, 1960-1 C.B. 23 (1960) concerning the CRP’s predecessor, the Soil Bank Act. In this ruling the IRS concluded that soil bank payments to people who did not operate or materially participate in a farming operation were to be viewed as rental income, not self-employment income. However, the ruling further stated that soil bank payments made to farmers were self-employment income. Although this precedent was not controlling, the Court decided that given the significant overlap in the CRP and Soil Bank programs, and because it reflects a longstanding and reasonable interpretation of the Agency’s regulations, the revenue ruling was persuasive. Therefore, the Court decided to follow the Soil Bank Program distinction between payments to farmers and non-farmers in concluding that CRP payments to the taxpayer in this case were rental income because he was not engaged in farming operations. Looking forward it appears that at least in the 8th Circuit, taxpayers who receive payments from the CRP program will be able to include the income as rental income rather than self-employment income on their tax return, if they are not operating farming activities on the land.
If you have any questions about how this ruling might affect the characterization of your CRP payments, please feel free to contact our office.
Missouri Legislature Overrides Vetoes on Taxpayer Friendly Bills: An Overview of Senate Bills 829 & 727
This past week the Missouri Legislature voted to override the governor’s veto on several bills including Senate Bill 829 regarding the burden of proof in taxpayer liability cases, and Senate Bill 727 regarding sales taxes for farmer’s markets. Both of these bills are effective retroactively beginning August 28, 2014.
Senate Bill 829 repeals and replaces section 136.300 of the Missouri Revised Statutes, amending the burden of proof requirements in taxpayer liability cases. Although Senate Bill 829 was signed by both the house and senate earlier this year, it was vetoed by Governor Jay Nixon on June 11. While the governor’s veto was in place, the Department of Revenue (DOR) only had the burden of proof in tax liability disputes if the taxpayer met certain threshold requirements. Such requirements included whether (1) the taxpayer was a partnership, corporation, or trust, (2) the taxpayer’s net worth did not exceed $7 million and (3) the taxpayer had less than 500 employees.
On September 10 the legislature overturned the governor’s veto, enacting Senate Bill 829. The bill replaces the threshold requirements mentioned above, and places the burden of proof on the DOR with respect to any factual issue relevant to ascertaining the liability of the taxpayer as long as the taxpayer has (1) produced evidence that shows that there is a reasonable dispute with respect to the issue and (2) has adequate records of its transactions and provides the DOR reasonable access to the records. Now because the burden of proof is on DOR, they have to prove liability for claims stating that a taxpayer owes additional taxes (this act includes issues regarding the applicability of an exemption but excludes issues regarding the applicability of any tax credit). In addition, by placing the burden of proof on DOR, the bill mirrors current Internal Revenue Service procedure concerning federal tax liability. Overall the bill is favorable to the taxpayer and creates consistency between the state and federal tax liability procedures.
Senate Bill 727 amends Chapters 144 and 208 of the Missouri Revised Statutes by adding three new sections, the first of which, section 144.527, is related to sales taxes at farmer’s markets.
Section 144.527, specifically exempts “all sales of farm products sold at farmer’s markets” from sales and use taxes as defined in Chapter 144. In addition, the section states that in order to qualify as a “farmer’s market,” the individual farmer, group of farmers, nonprofit, or cooperative must (1) consistently occupy a given site throughout the season, (2) operate as a “common marketplace” for farmers to sell farm products directly to consumers, and (3) be a marketplace where the sole intent and purpose of the farmers is to generate a portion of their household income. While section 144.527 limits farmer’s markets to the “sale of farm products,” it defines “farm products” very broadly so as to encompass almost any type of food that one might find at a farmer’s market (including baked goods made with farm products). However, the term “farm products” would exclude any third party goods or other non-farm product goods that a farmer may want to sell. Lastly, the exemption does not apply to persons or entities with total annual sales of $25,000 or more from farmer’s markets participating in the tax exempt program.
If you have any questions regarding how these bills may affect your tax matter or farmer’s market, please feel free to contact our office.
Tags: Wealth Management, Missouri, Tax Controversy, Department of Revenue, Farmer’s Markets, Tax Delinquency, Tax Collections, Tax Planning, Legislation, Tax Debt, Delinquent Taxes, Vetoes, SNAP., Tax Liability, Sales Tax