IRS Again Revises its Offshore Voluntary Disclosure Program

The Federal government is continuing to use its power to catch taxpayers who did not report their foreign financial accounts and/or pay income tax on the income derived in those accounts.  The U.S. taxes worldwide income of its citizens and residents and requires the disclosure of certain foreign financial accounts and assets.  The rules for determining who must report and what must be reported are exceedingly complex.  Many taxpayers have been blissfully ignorant of the rules.  The government is using the threat of large penalties to encourage taxpayers to catch up on accounts that haven’t been reported in the past.  In the past these threats have not distinguished between taxpayers who ignorantly omitted their foreign disclosures and taxpayers who have willfully concealed their accounts.  Responding to some criticism of their approach, the IRS has revised some of the rules pertaining to the offshore voluntary compliance program.  See their statement dated June 18, 2014.  There appear to be four programs currently in place as described on the IRS website.  Various financial penalties apply.

1.     The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets.  OVDP is designed to provide to taxpayers with such exposure (1) protection from criminal liability and (2) terms for resolving their civil tax and penalty obligations.  A special rule under this program requires taxpayers to comply with an August 3, 2014 deadline.  This is the date that FBAR non-filers  who have foreign bank accounts with a foreign financial institution that has been publicly identified as being under investigation, or is cooperating with a government investigation.  See the list here.  If such individuals voluntarily come forward by the deadline, their penalty is reduced to 27.5% of the account balance instead of the 50% penalty that will be imposed if they voluntarily come forward after this date.

2.     “Streamlined” filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.  The streamlined procedures are designed to provide to taxpayers in such situations (1) a streamlined procedure for filing amended or delinquent returns and (2) terms for resolving their tax and penalty obligations.  These procedures will be available for an indefinite period until otherwise announced.  The IRS definition of “streamlined” does not mean that a lot of work isn’t necessary to comply with the requirements.

3.     Delinquent FBAR Submission Procedures.  Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1), (2) are not under a civil examination or a criminal investigation by the IRS, and (3) have not already been contacted by the IRS about the delinquent FBARs should file the delinquent FBARs according to the FBAR instructions and include a statement explaining why the FBARs are filed late.

4.     Delinquent International Information Return Submission Procedures.  This program pertains to foreign reporting for forms other than the FBAR.  Taxpayers who do not need to use the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:  (1) have not filed one or more required international information returns, (2) have reasonable cause for not timely filing the information returns, (3) are not under a civil examination or a criminal investigation by the IRS, and (4) have not already been contacted by the IRS about the delinquent information returns should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.  As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.

The IRS states that simply filing amended tax returns to correct past problems won’t protect taxpayers from penalties and possible criminal prosecution.  The IRS wants taxpayers to come in under one of the above programs and pay the financial penalty associated with the program.  This type of threat is not normally associated with amended tax returns filed to correct mistakes, and it shows the attitude of the government towards taxpayers who have not timely reported foreign financial accounts.

U.S. Supreme Court Rules that Inherited IRAs are not Protected from the Claims of Creditors

On June 12, 2014, the U.S. Supreme Court unanimously held in Clark v. Rameker that the protection afforded individual retirement accounts under the Bankruptcy Code is lost once such accounts are inherited.  The reason given is that the account loses its traditional character as “retirement funds.”  While it seems clear that an IRA inherited by a non-spouse is now no longer protected, it is unclear whether the protection is also lost if a spouse inherits the IRA.

The Court concluded that an inherited IRA did not constitute “retirement funds” in the hands of the beneficiary by citing the following limitations imposed on inherited IRAs.  Such limitations do not exist for IRAs that are owned and not inherited.

1.     The beneficiary cannot contribute money into the inherited IRA.

2.     The beneficiary must begin minimum required distributions from the inherited IRA and cannot wait until the beneficiary’s own retirement.

3.     The beneficiary may withdraw the entire inherited IRA balance without an early withdrawal penalty if under age 59 ½.

A spouse beneficiary has the ability to roll over the inherited IRA to his or her own personal IRA, whereas non-spouse beneficiaries are unable to do so.  This fact brings up a few important questions: Will this rollover allow the inherited funds to be protected under the Bankruptcy Act?  Or, will the protection not be permitted because the spouse did not set aside such money him or herself?  We may not know the answer to these questions without future litigation.

IRA owners should now consider naming a discretionary trust as beneficiary.  Giving the trustee discretion on how and when to make distributions to beneficiaries may enhance creditor protection.  The trust must be properly drafted to qualify as a designated beneficiary to avoid unfavorable income tax results upon the IRA owner’s death.

This case deals with Federal bankruptcy law.  State law may nevertheless provide some protection to an inherited IRA.  Individuals with large IRA balances who are concerned about asset protection should consult with their attorney.

2013 Foreign Bank Account Report (FBAR) Must be Electronically Filed by June 30, 2014, Using New FinCEN Form 114 (Form TD F 90-22.1 is Obsolete)

U.S. persons having interests in or signature authority over a foreign financial account must file an annual report with the U.S. government if the maximum value of all foreign accounts exceeds US$10,000 on any day during the calendar year.  A foreign exchange rate is used for conversion purposes.  Conversion rates as of December 31^st should be used and they are published here.

New for 2013 is that the old paper-filed Form TD F 90-22.1 has been replaced by new FinCEN Form 114 which must be electronically filed.  FinCEN stands for Financial Crimes and Enforcement Network.  The foreign bank and financial accounts report, or FBAR, must be filed by June 30, 2014 through the BSA E-Filing System here.  BSA stands for Bank Secrecy Act.  You may file your FBAR by using the services of a third-party upon granting the proper permission.  An attorney, CPA, or enrolled agent may act as an account holder’s representative.

No extension of time is permitted.  Significant penalties exist for late or non-filing.  Such penalties can range from $500 to the greater of $100,000 or 50% of the account balance.  In addition, criminal penalties can range from a fine of up to $500,000 plus 10 years in jail in some situations.  Clearly the US government is serious about forcing FBAR compliance.  You should consult legal counsel if you have serious concerns about any delinquency.

Owners of entities that are required to file an FBAR must also file an FBAR at the owner level if they have more than a 50% direct or indirect ownership interest.  So-called “disregarded entities” for income tax purposes are not disregarded for this purpose and must file the report.  Records of accounts required to be reported on the FBAR should be kept for five years from the due date of the report.

Be sure to also check the appropriate boxes at the bottom of Schedule B, Form 1040, and to include any account earnings in your U.S. income tax return.

For more information, consult the IRS’ online FBAR Reference Guide here.

Tax-Exempt Organization Tax Return Filing Deadline Approaching

Tax-Exempt Organizations using a calendar year are required to file 990-series returns by May 15. However, not all organizations are required to file the same form.  The 990-series includes Forms 990, 990-EZ, 990-N and 990-PF, and are not technically income tax returns but are rather informational returns.  However, private foundations are subject to excise taxes on investment income and all exempt organizations are subject to tax on unrelated business taxable income.  In addition to financial information, organizations must describe their organization’s mission and charitable activities. These forms must be filed annually, and organizations that fail to file for three consecutive years will have their federal tax-exempt status automatically revoked.

Depending on the size and type of your organization different forms are required.  Small tax-exempt organizations with average annual receipts of $50,000 or less may file Form 990-N, also known as an e-postcard.  The 990-N filing is only available online, and asks for some basic information regarding your organization.  Organizations that file Form 990-N are not required to file Form 990 or 990-Z.  However, the 990-N is not allowed an extension, and as such must be filed by May 15 if your organization operates on a calendar year.

Form 990-EZ is a shorter and simpler version of Form 990 that can be used by smaller organizations that have average annual receipts of less than $200,000 and less than $500,000 of assets.  Form 990 is required for all exempt organizations with average annual receipts of $200,000 or more and assets of $500,000 or more.  Private Foundations must file Form 990-PF regardless of the amount of receipts or assets.

The due date for filing Forms 990-EZ, Form 990 and Form 990-PF may be automatically extended 3 months by filing Form 8868.  However, a filing extension does not extend the payment due date if any taxes are owing.  If an additional filing extension is required, page two of Form 8868 may be submitted, but reasonable cause must be given as the second extension request is not automatic.

How Many Income Tax Systems Do We Have?

Now that the 2013 tax filing season is over, it is time to consider just what income taxes you had to pay.  Our income tax system is more complex than what many people believe.  One major reason for the complexity is that a brand new income tax system, created by the Affordable Care Act (Obamacare), came into being in 2013.  So, you might wonder, how many income tax systems do we have?  The answer:  we have four parallel income tax systems.  See below. We pay all four taxes when they apply.  The first three starting from the left are federal taxes and are combined on your federal income tax return.

Each of the tax systems have their own definitions of income, deductions, credits, and tax rates.  They apply when taxpayers have certain types of income or deductions in sufficient amounts.  Taxpayers with similar overall income levels can pay very different amounts of income taxes depending upon the make-up of their income and deductions.

For example, some tax-exempt interest not taxable under the regular tax system or under the net investment income tax (NIIT) system might be taxable by the alternative minimum tax (AMT) system and by your state income tax system.  Another example is that not all itemized deductions allowed for regular tax purposes are deductible under the AMT or NIIT systems, and if your income is too high in Utah, none of your itemized deductions are permitted.

Tax planning is difficult to get right if you don't consider all four of these income tax systems.  Tax planning requires the use of sophisticated software and the analysis must consider at least the current and the subsequent tax year.  Now that your 2013 tax return has been filed, consider how these four parallel tax systems impacted your tax expense, and how you might better arrange your financial affairs to reduce their impact on your 2014 income tax.

Tax Court Limits IRA Rollovers, IRS Grants Transition Relief

The IRS recently issued an announcement that will impact taxpayers’ use of IRA rollovers.  An IRA rollover is technically a receipt of funds from one IRA followed by a contribution to another IRA within the 60-day period beginning the day after the date of receipt.  If the rollover is accomplished within the 60-day period, the receipt of the IRA funds is not taxable.  If the contribution to the second IRA occurs after 60 days, the receipt of the IRA funds is considered a taxable distribution (with a 10% early withdrawal penalty if the owner is younger than 59 ½) and the contribution to the second IRA will generally not be permitted and will be counted as an excess contribution subject to penalties.  A similar result occurs if more than one rollover is made within 12 months.  The 12-month period is measured beginning on the date of receipt. 

The 12 month provision discussed in IRC §408(d)(3) has been interpreted by IRS Publication 590 and Prop. Reg. 1.408-4(b)(4)(ii), which state that the once-every-12 months IRA rollover provision be applied on an IRA-by-IRA basis.  On January 28, 2014, the Tax Court ruled in Bobrow v. Commissioner, T.C. Memo. 2014-21, that the once-every-12 months IRA rollover provision applies at the taxpayer level and not at the IRA level.  This decision greatly disrupts the commonly accepted interpretation of the tax law.  On March 20, 2014, the IRS issued Announcement 2014-15 stating that it will follow the Tax Court’s decision and revise Publication 590 and the regulation.  The announcement grants transition relief applying the former interpretation to IRA rollovers made through December 31, 2014, to give IRA owners and custodians time to change to the new procedure.

A direct transfer by one IRA custodian to another IRA custodian is termed a direct “trustee to trustee” transfer and is not considered a rollover for this purpose.  Therefore, the practical implication of this new ruling is that taxpayers should move IRA funds by arranging for the direct transfer from one institution to another institution, rather than receiving the funds and then depositing the funds within the 60-day period.

New Obama Budget Proposal Includes Old Tax Increases and Some Surprises

Pres. Obama released his fiscal year 2015 budget proposal on March 4, 2014.  Most commentators view the proposal as a political document designed for the elections this fall.  Nevertheless, some tax proposals have a way of finding themselves law in the future and so it is important to be aware of the proposals.

The following tax increases are proposed:

·       Increase IRS funding by 6.3% to increase the number of tax audits.

·       Reduce the tax rate benefit of itemized deductions to 28% (which impacts taxpayers paying tax at the higher 33%, 35%, and 39.6% rates).

·       Implement the so-called “Buffett Rule” to require millionaires to pay no less than a flat 30% tax on income after the deduction of charitable contributions.

·       Prevent individuals from saving additional money in tax-preferred retirement accounts once their accumulated balances exceed roughly $3.2 million per person.

·       Require non-spouse beneficiaries of IRAs and qualified plans and annuities to fully distribute the inherited account by the end of the fifth year.
·       Require Roth IRAs to make lifetime minimum required distributions when the account owner turns age 70 1/2 (currently only Roth 401(k) accounts are required to make lifetime MRDs).

·       Increase the estate, gift, and generation skipping tax (GST) rate from 40% to 45%.

·       Lower the estate tax and GST exemptions from $5.34 million to $3.5 million.

·       Lower the gift tax exemption from $5.34 million to $1.0 million.

·       Require grantor-retained annuity trusts (GRATs) to have a minimum 10-year term and to have a remainder value greater than zero.

·       Eliminate the benefits of sales to “defective” grantor trusts by coordinating the income tax rules with the transfer tax rules.

·       Limit the duration of the exemption from GST tax to 90 years for “dynasty” trusts created after the date of enactment.

·       Eliminate the unlimited number of permitted annual gift tax exclusions for gifts of present interests of $14,000 in favor of a flat $50,000 per donor for all gifts.

·       Require professional service business profits to be subject to Social Security and Medicare taxes regardless of whether the business is conducted through an S corporation, an LLC, or a limited partnership.

·       Repeal the last-in, first-out (LIFO) method of inventory tax accounting.

·       Limit the amount of real estate like-kind exchange gain that can be deferred to $1 million per taxpayer per year after 2014.

·       Tax “carried interests” (partnership or LLC profits interests) as ordinary income instead of long-term capital gain.

·       Eliminate the specific identification method and require the average cost method for identifying the cost basis of stocks purchased after 2014.

Several new tax-cut proposals are proposed:

·       Permanently increase the Section 179 equipment expensing limit from $25,000 to $500,000.

·       Permanently extend the research and experimentation tax credit (expired after 2013).

·       Permanently increase the exclusion for qualified small business stock to 100%, and extend the time for tax free reinvestment from 60 days to 6 months for stock held for more than 3 years.

·       Make the expanded American Opportunity Tax Credit for college costs permanent.  It is currently scheduled to revert to the lower credit amount after 2017.

·       Allow non-spouse beneficiaries of IRAs and qualified plans to rollover the inherited balances within 60 days (presently only spouse beneficiaries can do so).

·       Eliminate required minimum distributions for those who attain age 70 ½ if the IRA balance is $100,000 or less.

·       Establish the MyRA savings bond announced in the state of the union address.