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The Tax Discharge Timeline for Bankruptcy

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October 17, 2014


By: Dan Gibson, CPA

 

Gibson_New(1)There is a common misconception that all income tax debt is dischargeable in bankruptcy. In fact, you can discharge your back federal, state, and local income tax debt in Chapter 7, Chapter 13, and Chapter 11 if certain criteria are met. That’s where determining which back tax debt is dischargeable can be a little complex.

The 3-Year, 2-Year, and 240-Day Rules

The Bankruptcy code sets out specific time periods that determine if you can discharge your taxes, often called the 3-year, 2-year, and 240-day rules (or the 3-2-240 rules). Under these rules, you can discharge taxes that came due 3 years before filing for bankruptcy, as long as it has been at least 2 years since you filed the tax forms and 240 days since the taxes were assessed. These rules are often misunderstood. However, the important thing to understand is that you must meet the requirements of all three rules to discharge your taxes.

The 3-Year Rule: This rule states that to discharge your back income taxes, they must become due at least three years before you file for bankruptcy. Typically, your federal and most state income taxes become due on or around April 15 of each year. In most cases, it is simply a matter of adding three years to this due date to determine the earliest date you can file for bankruptcy and still discharge your taxes.

Example: Joe’s 2008 federal income taxes are due on April 15, 2009. If Joe owes taxes for that year and wants to discharge them, the earliest he can file for bankruptcy is April 15, 2012 (April 15, 2009, plus 3 years).

The 2-Year Rule: Under the 2-year rule, your income tax returns must have been filed at least two years before filing your bankruptcy petition. This requirement allows you to discharge your taxes, even if you filed your tax forms late, as long as you file them at least two years before filing for bankruptcy.

Example: Jill’s 2008 income taxes were due on April 15, 2009. However, she did not get around to filing her tax forms until June 1, 2010. If Jill wants to discharge her 2009 taxes, she cannot file for bankruptcy until June 1, 2012 (two years from the date she filed her taxes AND more than three years from the date the taxes were due).

What if you did not file? If you did not file an income tax return in a given tax year, any taxes assessed by the IRS for that year are not dischargeable. If the tax debt is significant, you might be advised to go ahead and file the tax forms, then wait to file for bankruptcy.

The 240-Day Rule: Taxes must be assessed at least 240 days before you file for bankruptcy under this rule. As a practical matter, the date of assessment is typically on or near the date you filed your income tax form (assuming the IRS and you agree on the amount of taxes owed). However, if you file a correction or a change results from an IRS audit, the assessment date may be substantially later.
 
Example: Jill files her 2008 taxes on time on April 15, 2009. The IRS audits Jill’s taxes and finds that Jill made a mistake. She actually owes a few hundred dollars more than shown on her original tax form. The IRS assesses the new amount on March 1, 2011. To discharge these taxes, Jill will have to wait until October 27, 2011 to file for bankruptcy (240 days from the IRS’s new assessment).

If back taxes are an issue, it may be necessary to order an IRS “account transcript” for the tax years in question. The account transcript typically includes the assessment date. You can order an account transcript from the IRS over the phone or online, or using IRS Form 4506T. 
 
Other actions can add additional time to some or all of the 3-2-240 time requirements, including (a) making an offer in compromise, (b) having filed for bankruptcy previously, or (3) obtaining a taxpayer assistance order.  However, simply entering into a payment arrangement with the IRS does not toll the statute of limitations.

If you have any questions on this issue or any other bankruptcy matters, please do not hesitate to contact your tax or bankruptcy professional.

If you want to learn more about this topic and other issues when working with the IRS, please join Tim Schuster and myself in a one hour webinar titled  “Dealing with the IRS: What You Need to Know”  October 23  at Noon E.T.  - See more

New ACA Draft Forms Released

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September 19, 2014

By Dan Gibson, CPA


Gibson_New(1)The IRS has released preliminary, unofficial drafts of forms that the Affordable Care Act (ACA) compels employers, plan administrators and employees to file to certify coverages offered and provided to employees in 2015. These forms are:


Form 1095-A (Health Insurance Marketplace Statement) – Form 1095-A is filed by the ACA Exchange to the IRS and to those who enrolled in coverage through the Exchange. This will be used by enrollees in preparing Form 8962(see below).

Form 1095-B (Health Coverage) – This will be filed by health insurance issuers and employers that sponsor self-insured health plans that provide individuals with “minimum essential coverage” to report to the IRS and to enrollees information concerning the type and period of coverage offered for the purposes of administering the ACA’s individual shared responsibility provisions.

Form 1095-C (Employer-Provided Health Insurance Offer and Coverage) – Large employers will file Form 1095-C to provide information to the IRS and to employees about the type of health coverage offered to their employees for purposes of the large employer “pay or play” mandate. The form provides information on the coverage provided, and on to whom and when the coverage was offered. The IRS will use Form 1095-C to determine whether the employer owes payments under the employer shared responsibility provisions.

As part of an effort to streamline the reporting process, applicable large employers that sponsor self-funded health plans are to report the information required of them for both the individual (1095-B) and employer mandates (1095-C) on a single combined form using Form 1095-C.

Form 8962 (“Premium Tax Credit”) – Using information from Form 1095-A, subsidized exchange purchasers will file Form 8962 with Form 1040 to determine the amount of premium tax credits they should be reporting on their Form 1040. If they took advanced credits (reduction of insurance premiums purchased on Exchange), this form will calculate whether they need to take additional credits on their Form 1040 (because not enough advanced credit was taken) or pay back amounts for taking more advanced credits than should have been taken.

Form 8965 (“Health Coverage Exemptions”) – Individual mandate exemptions are claimed on Form 8965. This form is prepared by taxpayers and will be filed with Form 1040.

The IRS release suggests that further mandate enforcement delays are not under consideration.  Though the official forms and instructions for their use will not be available for months, this early look should help employers and their benefit administration partners assess the significant administrative burdens to come.

And yes, it is true: A draft of the 2014 Form 1040 reveals that the individual mandate has been covered by way of a query on Line 61.

You Didn't File a 1099?

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September 9, 2014

 

By Dan Gibson, CPA


Gibson_NewHere is the scenario: You paid your subcontractors, but did not send them a Form 1099 for the payments. You’re being audited; the IRS requests verification and provides the auditor with copies of your checks verifying the payment. No problem, right? But the IRS auditor says you cannot deduct an expense if you did not send out Form 1099. 

But you paid the expense, and can prove it.

Huh? Is this possible? It seems so unfair.

It is not possible, and it’s wrong. The IRS auditor is confusing two separate rules. Here are the steps to overcome the issue:

Rule 1: Prove that the expense was a necessary part of your business, and that you paid it.

Section 162 of the Internal Revenue Code allows a deduction for ordinary and necessary business expenses that are paid or incurred during a year. In the case of subcontractors, you would need to prove to the IRS auditor that the work performed was done in the ordinary course of your business and was necessary to it, then prove that you paid the contractor.  A check to the contractor proves the payment (it is best if the check has a notation in the memo portion, notated along the lines of “labor for Smith job,” but that’s not absolutely necessary, just good practice for the future).

Rule 2:  Send a Form 1099 to the IRS so they can check that your contractor reported the payment on his tax return. 

Rule 1 is about your ability to prove your expense; Rule 2 is about the IRS tax enforcement to your contractors. They are both important, but they are two different things. Remember, proving an expense under tax code Section 162 does not require the sending of a Form 1099. Section 6041 of the Internal Revenue Code requires a business that pays more than $600 to a subcontractor providing services to send the IRS a Form 1099-MISC reporting the amount paid.

The IRS wants to know how much your subcontractor was paid, and whether your subcontractor reported the income on his tax return. The IRS takes the Form 1099 you send them, and makes a computer match to your contractor’s tax return. If the income was not reported, or if a tax return was not filed, the IRS could write to your subcontractor to collect the taxes not paid on the income. This is an essential tool to enforce compliance with our tax laws, but it is not in any way tied to your entitlement to write-off the expense on your tax return.

Not following Rule 2 has its own result for you: Under Section 6721 of the Internal Revenue Code, the IRS can charge you with a monetary penalty for every person for whom you did not send a Form 1099. This is pretty important for the IRS, so IRS auditors like to wrap it into Rule 1. That’s incorrect  – you can comply with the deduction requirements and be entitled to the deduction.

What to do if your IRS auditor will not budge

You have rights if you disagree with an IRS auditor. An IRS auditor not allowing a business expense that can be verified for which a 1099 was not issued is a definite source of disagreement. Initially, ask to speak to the auditor’s supervisor if you can’t resolve this with him or her.

If you aren’t satisfied, you have a legal right to appeal. That includes decisions of IRS auditors. Your rights include requesting an administrative hearing with an IRS appeals officer, who is separate from audit and will take a fresh and impartial view of your case. Most IRS appeals officers understand the difference between proving an expense (Rule 1) and not issuing Form 1099 (Rule 2).

Hopefully, it won’t come to this, but you also have the right to file a petition to U.S. Tax Court and have an independent judge – who is not affiliated with the IRS in any way – review your case. You can testify to the judge, tell her your story, and present your evidence. The IRS would need proof that you did not pay your subcontractors. Without this, not issuing the 1099 is not a defense for the IRS. It is the auditor’s opinion, an opinion which is subject to appeal, trial and being overturned.

Look at it this way:  If you issued a Form 1099 to your subcontractors but have no records to prove you paid the expenses, the IRS would not allow you the expense. 

Are They Really Independent Contractors?

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September 3, 2014

By Dan Gibson, CPA

Gibson_New(1)This is a drum worth beating, especially in light of the upcoming employer mandates from the Affordable Care Act that are scheduled to go online in 2015. You can bet that enforcement in this area of the law by the IRS will increase in the upcoming years.

Employers may be tempted to classify workers as independent contractors/freelancers as opposed to full-time employees. Doing so eliminates the cost of company benefits such as vacation, sick pay, health insurance and retirement funding. It also eliminates the employer’s matching share of Social Security and Medicare payroll taxes, not to mention saving on unemployment taxes and worker’s compensation insurance.

However, traveling down this road requires the utmost of caution. Just designating and then paying a worker like an independent contractor does not necessarily make him one. And if you are subsequently challenged on that classification by the IRS or your state taxing authority and lose, you’ll probably have to pay back all those savings plus penalties and interest. The company’s retirement plan could also be in jeopardy of losing its qualifying status if workers who should have been eligible to participate were excluded from the plan.

The line between independent contractor and employee is not always clear; the following are some guidelines that can be used in making the determination.

The three primary characteristics the IRS uses to determine the relationship between businesses and workers are: Behavioral Control, Financial Control and the Type of Relationship. 

  • Behavioral Control – Relates to facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means. 
  • Financial Control – Relates to facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job. 
  • Type of Relationship – Relates to how the workers and the business owner perceive their relationship.  If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees. If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

Here are some additional factors to consider when making a determination: 

  • Sole Employer – An independent contractor is in business for him or herself and generally will have additional clients for whom services are provided. If you are the only client and he or she is not actively pursuing work from others, then it becomes an indicator favoring employee status. 
  • Work Schedule – Independent contractors generally set their own work schedule. Requiring the worker to maintain regularly scheduled work hours is an indicator of employee status. 
  • Materials & Supplies – Independent contractors generally provide their own materials and equipment and invoice their clients for labor and materials. If you provide all of the material and supplies, that is another indicator of employee status. 
  • Work Location – Another indicator of employee status is when a worker performs services only at your work location and does not maintain an office or facilities elsewhere. 
  • Assistance – If the independent contractors uses your employees to assist in his work and does not have employees of his own, this may indicate a lack of independent contractor status.


Lastly, if you want a fighting chance in your classification battle with the IRS or your state authorities, please ensure that you are in compliance with Form 1099 filings.   If 1099s are not properly filed for unincorporated independent contractors providing $600 or more in services, your position will not have much traction.

What you need to know before moving anything to the “CLOUD”.

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August 27, 2014

 

“The Cloud”.  You see it everywhere.  Everyone wants to be there.  People tell you that you need to be there.  But what is it?  Why is everyone talking about it?  What does it mean for your business?  What is a Public Cloud, a Private Cloud, a Hybrid Cloud?  If you are trying to understand all this before you move there, you are not alone.  Learn what is behind “The Cloud”, who the major players are, why you should consider moving there (or not), and more importantly, what you need to know before you choose your Cloud partners.  
What “The Cloud” really is

  • Why you should (or should not) consider moving anything there
  • What problems “The Cloud” will solve (or create) for you
  • What improvements/advantages does it offer
  • Who are the major Cloud vendors, why, and what they offer
  • What SaaS and multi-tenancy mean for you
  • What are Public, Private, and Hybrid Clouds
  • What are Virtual Desktops, Virtual Servers, Published Applications
  • What is the future of the PC, the tablet, the smartphone
  • What does all this mean for your existing technology investment
  • The emergent issues re: Privacy, Security, Reliability, Performance, Disaster Recovery
  • Why studies show a significant level of dissatisfaction with “The Cloud”
  • What are the hidden costs, unforeseen issues, problems
  • All the questions that you must ask before moving anything to “The Cloud” to ensure success

If the issues above have peaked your interest, consider joining me and Bill Blum of Alpine Business Systems, Inc. on September 23, 2014 for a webinar that will broadcast between Noon and 1PM Eastern.   Stay tune for event registration early September on our event page.

What Are My Chances of Being Audited?

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August 5, 2015

 

By Daniel Gibson, CPA
 
Gibson_New(1)This is probably one of the most frequently asked questions by taxpayers.  Your chances of getting audited depend on many factors.  Do you have only wage, interest, and capital gain income and take the standard deduction?  Your chances are probably less.  If you take a large charitable contribution deduction, have a Schedule C, or own rental property, then your chances are likely to be higher.  The same is true for business returns.

However, based upon new data from the IRS, the matrix for tax examinations over the past ten years has evolved.  From 2011 to 2013, the number and percentage of audited returns has decreased pretty much across the board.  For individuals with income of $200,000 or more, the number of audits did increase between 2012 and 2013, but the percentage of returns audited decreased.  On the other hand for that group, the number of correspondence audits decreased, but the number of field audits increased.  A field audit can be far more intrusive than a correspondence audit, which in some cases may be limited to a specific item such as charitable contributions. 

You should keep in mind that 2013 was the year of sequestration.  That put a crimp in many of the IRS programs.  Future comparisons could show an increase in the audit rate -- or not -- if Congress cuts the IRS's budget as the House is trying to do. 

While the numbers are interesting and give an idea of your overall chances of getting audited in a particular category, the IRS is more likely to pick your return because of a particular triggering item.  A trigger could be charitable contributions materially in excess of the average for returns at your income level, or claiming a substantial deduction for property contributions.  Property contributions beyond a certain amount require an appraisal, which are frequently challenged by the IRS.  There are a host of others. 

And while the IRS may be auditing a fewer percentage of returns, they're also auditing smarter.  They're focusing on issues more likely to produce results for the government.  States are also getting smarter; using computers to analyze data and entering into share agreements with the federal government.  You could escape an IRS audit only to be trapped by your home state, or a state in which you do business. 

Of course, none of the percentages matter if your return is picked.  Just understand that playing the audit lottery has become more dangerous.  If the IRS can assess the accuracy-related penalty, it will.  That'll add 20% to your tax assessment.  Interest and late-filing penalty assessments will also increase the total and it can add up quickly. 

Best advice?  If any government agents contact you, call a tax professional.

How to Deal with the IRS If You Are a Closely-Held Business

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July 31, 2014

By Daniel Gibson, CPA

 
Gibson_NewIf you have ever squared off with a Revenue Officer or Revenue Agent, you know how difficult it can be to resolve your tax issues.  Often our actions bring out the worst in a Revenue Officer or Agent.  Here are just a few points to keep in mind when things get “hot” with the IRS.
 
Keep in Touch with the IRS
If you're behind on taxes and want to stay in business, one crucial thing to remember is to keep in touch with the IRS.  The agency might leave you alone for a while, but you can bank on the IRS coming back around again -- probably at a most inopportune time.  Consequences for ignoring the IRS can be dire -- penalties and interest increase, easily doubling what you owe, and you may even lose your business!  The IRS’ collection power is enormous.  The IRS can seize assets and effectively close down operations.
 
Provide Information to the IRS
For the most part, you should be cooperative and provide financial information to IRS when requested to do so.  You’ll probably want your accounting firm to review it before passing this information along.   However, when you feel the IRS is getting too intrusive, don’t hesitate to push back.  If the IRS wants it bad enough, they’ll issue a summons that will require you to come forth with the information.  At that point, you’ll definitely want to seek tax counsel before complying with the summons.
 
IRS Threats Are Usually Worse Than IRS Actions
Unless the issue relates to large unpaid payroll tax liabilities, the IRS is normally not interested in shutting down a business.  This can be somewhat comforting and allow you to continue working through the tax debt problems with the IRS.
 
Ask for a Payment Plan and/or Discount
In most cases, the IRS will allow taxpayers to enter into a monthly installment plan.  However, remember that penalties and interest will continue to accumulate on the balance, even if you enter into a plan.  With an explanation that fits into the IRS’ definition of reasonable cause, penalties can be reduced or eliminated.  However, accumulated interest and accumulating interest are usually non-negotiable.
 
Offer a Compromise
Requesting an offer-in-compromise is a lengthy, formal process in which the business fills out an IRS form, provides detailed information about its precarious financial situation, and requests that the IRS accept only a portion of what the business owes.  If the IRS believes that it is unlikely to collect more in the future -- so that accepting less now is in its best interest -- it will likely accept your offer in compromise.  Just remember, it has to be in the IRS’s best interest, not yours.
 
"Uncollectible" Status
If your business' financial situation is truly in the tank, you can request "uncollectible" status.  If the IRS agrees, it will leave you alone for a certain period of time.  However, they’ll periodically revisit your situation in the future.   You will still owe the tax and penalties (and interest will accumulate), but the IRS will not engage in collection efforts against you during the time you are in this status.
 
Consider Bankruptcy
Most people don’t care for the ‘B’ word, but you need to be ready to use it if your circumstances warrant it.  Rules are complicated, so engage a bankruptcy attorney long before you declare bankruptcy.
 
Guns and Badges
If you ever get a visit from IRS Special Agents who show you a badge and are carrying guns, politely ask them for their cards and tell them your attorney will get back to them shortly.  Never speak to them, provide them with information or allow them to roam around your business without the advice of legal counsel.  These agents are from the criminal investigation division of the IRS.  Their mission is to put taxpayers in jail.

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