Posted by: | April 15, 2014

U.S. Seeks FBAR Related Forfeiture of $12 Million

U.S. taxpayers with previously undisclosed interests in foreign financial accounts and assets continue to analyze and seek advice regarding the most appropriate methods of coming into compliance with their U.S. filing and reporting obligations. Many are pursuing participation in the current IRS offshore voluntary disclosure program (the OVDP, which began in 2012 – modeled after similar programs in 2009 and 2011).

Taxpayers participating in the ongoing IRS OVDP[i] generally agree to file amended returns and file Report of Foreign Bank and Financial Accounts (FinCEN Form 114, formerly Form TD F 90-22.1), commonly referred to as the “FBAR”, for eight tax years, pay the appropriate taxes and interest together with an accuracy related penalty equivalent to 20 percent of any income tax deficiency and an “FBAR-related” penalty (in lieu of all other potentially applicable penalties associated with a foreign financial account or entity) of 27.5 percent of the highest account value that existed at any time during the prior eight tax years.

The IRS OVDP is ongoing and does not have a stated expiration date but it can be terminated by the IRS at any time either entirely or as to specific classes of taxpayers.

INCOME TAX REPORTING. Citizens and residents of the United States who have income in any one calendar year in excess of a threshold amount (“U.S. taxpayers”) are obligated to file a U.S. Individual Income Tax Return Form 1040 (“Form 1040″), for that calendar year with the IRS. Form 1040 requires U.S taxpayers to report their income from any source, regardless of whether the source of their income is inside or outside the United States.

In addition, on Schedule B of Form 1040, the filer must indicate whether “at any time during [the relevant calendar year]” the filer had “an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account.” If the U.S. taxpayer answers that question in the affirmative, then the U.S. taxpayer must indicate the name of the particular country in which the account is located.

BSA FILING REQUIREMENTS. Under the Bank Secrecy Act, U.S. taxpayers who have a financial interest in, or signature authority over, a financial account in a foreign country with an aggregate value of more than $10,000 at any time during a particular calendar year are required to file an FBAR. The FBAR for any calendar year is required to be filed on or before June 30 of the following calendar year.

In general, the FBAR requires that the U.S. taxpayer filing the form identify the financial institution with which the financial account is held, the type of account (bank, securities or other), the account number, and the maximum value of the account during the calendar year for which the FBAR is being filed.

Taxpayers comply with their U.S. filing requirements by both noting the account on their income tax return and by filing the FBAR. Civil penalties for willful failure to comply with the FBAR reporting requirements of 31 U.S.C. § 5314 can be imposed under 31 U.S.C. § 5321(a) (5). For violations involving the willful failure to report the existence of an interest in a foreign account, the maximum amount of the penalty that may be assessed under Section 5321(a) (5) is the greater of $100,000 or 50 percent of the balance in an unreported foreign account, per year, for up to six tax years.

“Willfulness” generally requires the government prove the failure to file was as a result of a “voluntary, conscious and intentional” act by the taxpayer. Taxpayers should carefully review the recent court decisions in United States v. Williams, No. 10-2230 (4th Cir. 2012) and United States v. McBride, No. 2:09-cv-00378 (D. Utah 2012) on the issue of determining “willfulness” for assertion of the more significant “willful” FBAR penalties (of up to 50% of the account balance, per year).

Although the underlying facts in Williams and McBride were not the best, the courts might not lightly view those with considerable financial resources who fail to inquire about their potential reporting requirements associated with various interests in foreign financial accounts. The IRS Internal Revenue Manual suggests that “willfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.”

An “undeclared account” is a financial account maintained outside the United States and beneficially owned by a U.S. taxpayer, but that is not disclosed to the IRS on Schedule B of Form 1040, Form 8938 or on an FBAR, and any income generated in the account was not reported to the IRS on Form 1040.

U.S.A. vs. CARL R. ZWERNER. On June 11, 2013, the U.S. government filed a Complaint to collect multiple 50% civil FBAR penalties in the aggregate amount of $3,488,609.33 previously assessed against Carl R. Zwerner of Coral Gables, Florida for his alleged failure to timely report his financial interest in a foreign bank account, as required by 31 U.S.C. § 5314 and its implementing regulations[ii]. According to the Zwerner Complaint, from 2004 through 2007, Mr. Zwerner, a U.S. citizen, had a financial interest in an account at ABN AMRO Bank in Switzerland (hereinafter, “the Swiss bank account”).

The Zwerner Complaint alleges that the balance of the Swiss bank account from 2004-2007 was at all times greater than $10,000 and that, as such, on or before June 30 of each succeeding year, Mr. Zwerner was required to file an FBAR reporting his financial interest in the Swiss bank account. Accordingly, the government assessed penalties against Mr. Zwerner under 31 U.S.C. § 5321(a)(5) in the amount of 50% of the balance of his account at the time of the violations for each year, as follows: (a) 2004 – $723,762, assessed on June 21, 2011; (b) 2005 – $745,209, assessed on August 10, 2011; (c) 2006 – $772,838, assessed on August 10, 2011; and (d) 2007 – $845,527 assessed on August 10, 2011.

In Zwerner, the government assessed civil FBAR penalties equivalent to 50% of the highest account balance for each of tax year 2004, 2005, 2006, and 2007, aggregating $3,488,609.33 for an account that appears to have had a high balance of $1,691,054 during the relevant time period!

A Motion for Summary Judgment filed on behalf of the U.S. government is pending in the Zwerner matter. Depending on a decision regarding this Motion, the jury trial in Zwerner is scheduled to commence during the two-week trial period beginning May 19, 2014.

THE EXCESSIVE FINES CLAUSE. To many, pursuing multiple year, maximum 50% penalties following submission of amended returns and delinquent FBARs appears punitive. The Excessive Fines Clause of the Eighth Amendment and relevant Supreme Court case law support a conclusion to the effect that a civil penalty or forfeiture is unconstitutional if the penalty or forfeiture is at least in part “punishment” and such punishment is grossly disproportionate to the conduct which the penalty is designed to punish. The touchstone of the constitutional inquiry under the Excessive Fines Clause is the principle of proportionality – the amount of the penalty must bear some relationship to the gravity of the offense that it is designed to punish.[iii]

U.S.A. vs. APPROXIMATELY $12,000,000 IN UNITED STATES CURRENCY[iv]. In a matter completely unrelated to Zwerner, on April 8, 2014, the U.S. government filed a Complaint seeking forfeiture of $12,234,646.79 in United States Currency (hereafter, the “Defendant Currency”). Just when many though the Zwerner matter set the civil high bar for what might possibly go wrong with respect to an undisclosed interest in a foreign financial account, along comes U.S.A. vs. Approximately $12,000,000 in United States Currency[v] displaying yet another powerful tool in the U.S. governments international enforcement arsenal.

The Defendant Currency was previously held in two accounts at a bank located in Zurich, Switzerland. These Swiss bank accounts were nominally held in the names of entities but the Complaint alleges that the assets in the accounts were, in fact, beneficially owned by U.S. citizens (the “Taxpayer”).

The forfeiture Complaint alleges that from 2003 till sometime in 2013, the Taxpayer and the Taxpayer’s father concealed the existence of the Swiss bank accounts and the income earned in these accounts (the “Undeclared Accounts”) from the IRS and that, accordingly, the Defendant Currency is therefore subject to forfeiture pursuant to Title 18, United States Code, Section 981(a)(1)(A). In February 2014, the Defendant Currency was apparently voluntarily transferred from a Swiss bank to an IRS seized asset account, located in Manhattan, New York. Perhaps the repatriation of these funds into an IRS seized asset account part of some larger overall resolution of a matter involving the Taxpayer? Perhaps not . . . time will tell.

The Complaint alleges that, Edgar Paltzer, an attorney in Switzerland who also operated as a financial intermediary, created various nominee entities under the laws of the British Virgin Islands, Lichtenstein and Panama to assist the Taxpayer and the Taxpayer’s father in ensuring that the Undeclared Accounts at the Swiss banks remained hidden from U.S. authorities.

On or about April 16, 2013, Mr. Paltzer was indicted by a federal grand jury in the Southern District of New York for conspiring to defraud the United States and the IRS, and to commit offenses against the United States – violations of Title 26, United States Code, Sections 7206(1) and 7201.

On or about August 28, 2013, Mr. Paltzer pled guilty to one count of conspiring with certain U.S. taxpayers and others to defraud the IRS of taxes due and owing and to evade file false tax returns. Many believe that Mr. Paltzer is cooperating with the U.S. authorities.

APPLICABLE FORFEITURE STATUTES. Title 18, United States Code, § 981(a)(1)(A) subjects to forfeiture “[a]ny property real or personal involved in a transaction or attempted transaction in violation of . . section 1956, 1957 . . . of this title, or any property traceable to such property.”

Title 18, United States Code, § 1956(a)(2) provides: “Whoever transports, transmits, or transfers, or attempts to transport, transmit, or transfer a monetary instrument or funds from a place in the United States to or through a place outside the United States or to a place in the United States from or through a place outside the United States- (A) with the intent to promote the carrying on of specified unlawful activity; [shall be guilty of money laundering].”

Title 18, United States Code, § 1956(h) provides: “Any person who conspires to commit any offense defined in this section or section 1957 shall be subject to the same penalties as those prescribed for the offense the commission of which was the object of the conspiracy.”

FORFEITURE OF $12,234,646.79 TO THE UNITED STATES. As alleged in the forfeiture Complaint[vi], years ago the Taxpayer transferred funds from inside the United States to Switzerland in order to defraud the IRS of taxes due and owing relating to the funds held in Taxpayer’s undeclared accounts in Switzerland. By reason of the foregoing, the U.S. government alleges that the Defendant Currency – $12,234,646.79 – is subject to forfeiture pursuant to Title 18, United States Code, Section 981(a)(1)(A).

An order approving forfeiture of the $12,234,646.79 to the U.S. government would not preclude the ability of the government to separately and additionally pursue income taxes, penalties and interest under the Internal Revenue Code[vii] nor would it preclude assertion of FBAR penalties for the willful failure to comply with the reporting requirements of 31 U.S.C. §§ 5314 and 5321(a)(5) of up to 50 percent of the balance in the Undeclared Accounts, per year, for up to six tax years. 

THE WAY FORWARD. Time will tell whether the government begins a pattern of pursuing non-compliant U.S. taxpayers using mail and wire fraud related forfeiture statutes. The perception of fairness (or unfairness) in the process can have a significant impact on the decisions of millions of other U.S. taxpayers presently contemplating whether to come into compliance with their filing and reporting requirements.

If every tax evasion case is also deemed to include a mail/wire fraud violation, taxpayers moving funds on or offshore to accomplish the evasion might well be faced with allegations that the transfer was done “with the intent to promote the carrying on of a specified unlawful activity . . .” subjecting the entire proceeds to forfeiture.[viii]

The government will not and can not pursue such actions against everyone. Many factors likely come into play in the exercise of government discretion on which matters to pursue, or not. Given the complexities of the Internal Revenue Code, other relevant statutes and life in general, many of the indiscretions associated with an income tax return or FBAR are anything but willful or intentional and definitely not fraudulent in nature.

Worldwide respect for the integrity of the U.S. system of tax administration depends, at least in part, upon how the government continues to treat those who pursue some type of timely and truthful voluntary compliance with the filing and reporting requirements associated with their foreign financial accounts. A system of tax administration based in large part on voluntary compliance cannot ignore the potential impact associated with the manner in which those who voluntarily comply, even if in a somewhat awkward fashion (but before any contacts by the government), are treated.

The decision whether to participate in the ongoing IRS OVDP as opposed to possibly pursuing some other method of coming into compliance must take into account all relevant facts and circumstances as well as the possibility of expansive IRS discretion to perform examinations over a lengthy period of time outside the OVDP. Long-term residents of the U.S. might be deemed to have a higher degree of knowledge and might be treated differently than long-term non-residents of the U.S.

Certainly, all taxpayers are anything but equally culpable with respect to issues relating to the filing and reporting requirements involving foreign financial accounts. Overall, IRS examinations of taxpayers outside the confines of the OVDP have progressed in a somewhat reasonable manner. The fairness in the resolution often depends on the actual facts involved. However, the government continues to assert that those who are discovered disclosing offshore accounts outside of the OVDP risk more significant civil penalties, depending on the facts and circumstances of their cases.

Those who continue to have undeclared interests in foreign financial accounts and assets should immediately consult experienced, competent professionals. In each situation, the actual facts and circumstances must be carefully reviewed before anyone can determine the appropriate method of coming into compliance with the various filing and reporting requirements associated with offshore financial accounts.

Only one thing is certain, waiting to come into compliance is definitely not a viable option . . . .


[i] See

[ii] See United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, June 11, 2013).

[iii] The standard the Court must use to decide this question is whether the penalties are “grossly disproportional to the gravity of a defendant’s offense.” United States v. Bajakajian, 524 U.S. 321, 333 (1998).

[iv] See U.S. v. Approximately $12,000,000 in United States Currency, 14-CV-2460 (SDNY, April 8, 2014).

[v] Id.

[vi] Id.

[vii] Title 26, United States Code

[viii] But see Department of Justice, Tax Division Directive No. 145 “RESTRAINT, SEIZURE AND FORFEITURE POLICY IN CRIMINAL TAX AND TAX-RELATED INVESTIGATIONS AND PROSECUTIONS” (January 30, 2014), Delegation of Authority, “8. . . . I hereby delegate to the United States Attorney the authority to apply to the district court for an order to restrain and/or seize personal property for forfeiture arising from a criminal tax and/or tax-related investigation or prosecution when said personal property is restrained or seized pursuant to a provision of Title 18, except that: (a) No personal property shall be seized for forfeiture in a tax and/or tax-related investigation if the personal property consists entirely of legal source income and the only criminal activity associated with the personal property is that unpaid taxes remain due and owing on the income.” and Ft. 4 “The forfeiture laws should not be used to seize and forfeit personal property such as wages, salaries, and compensation for services rendered that is lawfully earned and whose only relationship to criminal conduct is the unpaid tax due and owing on the income. Title 18 fraud statutes such as wire fraud and mail fraud cannot be used to convert a traditional Title 26 legal source income tax case into a fraud offense even if the IRS is deemed to be the victim of tax fraud.”

Posted by: | April 12, 2014

JUST RELEASED: Hot Audit Issues for the California FTB !!

The California Franchise Tax Board (FTB) just released the list of “hot” audit issues they are encountering in the process of examining returns filed by California taxpayers. The FTB is responsible for administering two of California’s major tax programs: Personal Income Tax (PIT) and the Corporation Tax. The FTB regularly receives and processes more than 17 million Personal Income Tax (PIT) returns and 1.4 million Business Entity (BE) returns. Over 75 percent of PIT returns are filed electronically.

The FTB employs more than 5,300 permanent and 2,000 seasonal and intermittent employees nationwide. Headquartered in Sacramento, the California FTB office locations include Los Angeles, Oakland, San Diego, San Francisco, San Jose, Santa Ana, Van Nuys, and West Covina. Their out-of-state office locations include Houston, Chicago, and Manhattan.


Some of the most common tax audit issues affecting personal income taxpayers include:

Like-Kind Exchange (IRC Section 1031) – Audits related to IRC Section 1031 continue to assert noncompliance in the following areas:

•Gain computation errors (taxable boot due to debt netting; non-exchange expense items included in the computation).

•Invalid identifications (failing the 3-property 200%:95% tests; not acquiring substantially the same property that was identified; identifying a partial interest and acquiring a higher percentage interest).

•Including the cost of property improvements made after the exchange closed in the exchange (boot) calculation.

•Withdrawing cash out of the proceeds from the relinquished property.

Other State Tax Credit (OSTC) – The FTB uses use third party data to verify tax payments were made to other states and to disallow credits claimed to those states which do not have a reciprocal agreement with California.

Head of Household (HOH) Filing Status – Common errors include:

•The qualifying individual’s income exceeds the gross income test of $3,700.

•Taxpayers who do not meet the requirements to be considered unmarried or considered not an RDP.

Expired Credits -Some of the expired credits disallowed by the FTB include the Ridesharing, Recycling Equipment, Solar Energy, Political Contribution, Employer Ridesharing, and Water Conservation credits.

Employee Business Expenses – The FTB may ask taxpayers claiming unreimbursed employee business expenses to provide documentation to substantiate their employer’s reimbursement policy to determine if their expense is allowable.


Some of the most common tax audit issues affecting pass through entities and related flow through to owners include:

Partnership/LLC Property Dispositions – Issues involving property dispositions reported by partnerships and LLC’s include like-kind exchanges (IRC Section 1031), foreclosures of real estate, and cancellation of debt (COD) income.

Termination of Partnership/LLC – Issues include partnership and LLC liquidations reported by both partnerships and partners.

Transfer of Partnership Interest – Issues include disposition of partnership and LLC interests by the partners/members of partnerships and LLCs. The FTB continues to identify taxpayers who transfer partnership interests between related entities to create a higher basis.

Shareholder/Partner/Owner’s Basis in a Pass-Through Entity – The FTB will verify shareholder’s basis to determine the correct flow-through income, losses, deductions, and credits. The FTB will use the correct basis to determine taxability of distributions, debt repayments, and dispositions.

S Corporation Liquidations – Common S corporation liquidation issues include:

•S corporation taxpayers that do not accelerate the recognition of installment gain for California purposes in the final year.

•S corporation shareholders that do not report the gain recognized under IRC Section 331(a).

•Nonresident shareholders that do not report their share of the gain that was recognized by the S corporation on the sale of intangible assets.

Charitable Deductions for Trusts – The FTB willverify that the amount donated is from the gross income of the trust and is paid pursuant to the terms of the governing instrument.

Charitable Remainder Trusts – The FTB will verify that the trust is operated pursuant to the terms of the governing instrument and that the trust meets statutory requirements. A charitable remainder trust that is not operated correctly may lose its tax-exempt status, and the previously untaxed income may be subject to income tax. In some cases, a disqualified charitable remainder trust will be treated as a grantor trust and the income of the trust will be reported on the grantor’s individual tax return.

Apportionment of Trust Income – A trust will be subject to taxation if the fiduciary is a California resident or a beneficiary whose interest in such trust is noncontingent is a California resident. When trust apportionment of income is within and without California, the FTB will look at how the income is sourced to California and the residency status of the trustee.


Some of the most common tax audit issues affecting corporations include:

Cost of Performance and Sourcing of Intangible Sales – For tax years beginning before January 1, 2011, sales from intangible sales and services are assigned based on the cost of performance. The complex rules of identifying income-producing activities and documentation necessary to do a cost-of-performance analysis may result in incorrect assignment of sales from intangibles and services. For tax years beginning on or after January 1, 2011, taxpayers who elect a single sales factor for apportioning business income to California will use market rules for assigning sales from intangibles and services instead of cost of performance rules.

Sales Factor and Gross Receipts – The FTB continues to see items in the sales factor denominator that do not meet the definition of “gross receipts” or that result in distortion.

Abusive Tax Shelters – The FTB is continuing to identify “abusive tax shelters” in a variety of situations that appear designed to avoid state or federal tax. These types of transactions often involve the creation of entities or deductions without economic substance or a business purpose.

Credits – The FTB will verify that credits, such as Enterprise Zone and Research and Development Credits, are reported correctly. In addition, they will verify that the assignment of credits is properly reported by the assignor and the assignee.

For further information see


Posted by: | March 25, 2014

IRS FBAR OVDP Opt-Out Interview Questions Revealed !

For more than a year, numerous taxpayers with previously undisclosed interests in foreign financial accounts and assets have been seeking participation in the current IRS offshore voluntary disclosure program (the OVDP) which began in 2012, modeled after similar programs in 2009 and 2011.

Taxpayers participating in the OVDP generally agree to file amended returns and file FINCEN Form 114 (formerly Form TD 90-22.1, Report of Foreign Bank and Financial Accounts), FBARs, for eight tax years, pay the appropriate taxes and interest together with a 20% accuracy related penalty and an “FBAR-related” penalty (in lieu of all other potentially applicable penalties associated with a foreign financial account or entity) of 27.5% of the highest account value that existed at any time during the prior eight tax years. The OVDP does not have a stated expiration date but can be terminated by the IRS at any time as to specific classes of taxpayers or as to all taxpayers.

WHETHER TO PARTICIPATE IN THE OVDP. There are various considerations before a taxpayer should determine whether to pursue a voluntary disclosure of prior tax indiscretions through the OVDP or through amending returns or in some other manner. When reviewing the OVDP, many look to whether the taxpayer might be considered a realistic candidate for a criminal prosecution referral by the IRS or prosecution by the Department of Justice? (If so, the determination to participate was relatively quick and easy). Is there a possibility of reducing that prospect by filing amended or delinquent returns and FBARs in lieu of a direct participation in the OVDP?

What would be the potentially applicable penalties upon an examination of such returns and FBARs? Could the government actually carry their burden of demonstrating that the taxpayer “willfully” violated the FBAR filing requirements? Since the OVDP asserts an offshore penalty based on foreign financial accounts and asset valuations, for many with smaller financial account values the aggregate offshore penalty determination, even for multiple years, is actually less outside the OVDP.

OPT OUT CONSIDERATIONS. The IRS has recently afforded those indicating a desire to opt out with the opportunity to provide a “reasonable cause letter” explaining why they should be subjected to some lesser penalty set forth in the OVDP. The decision to opt out must take into account all relevant facts and circumstances as well as the possibility of expansive IRS discretion to perform examinations over a lengthy period of time exceeding the eight tax year period of the OVDP and penalties being asserted for multiple tax years.

Before opting out, taxpayers should carefully review the recent court decisions in United States v. Williams, No. 10-2230 (4th Cir. 2012) and United States v. McBride, No. 2:09-cv-00378 (D. Utah 2012) on the issue of determining “willfulness” for assertion of the more significant FBAR penalties (of up to 50% of the account balance, per year). Although the underlying facts in each case were not the best, the courts might not lightly view those with considerable financial resources who fail to inquire about their potential reporting requirements associated with various interests in foreign financial accounts.

Also note from previous Blogs on this site that there is a case currently pending in the Southern District of Florida – United States v. Carl R. Zwerner, Case # 1:13-cv-22082-CMA (SD Florida, June 11, 2013) – in which the government is pressing forward with the assertion of 50% FBAR penalties for each of four tax years – penalties aggregating $3,488,609.33 (as of June 6, 2013) on a foreign account where the highest value at any time during the relevant time period was $1,691,054.

Presently, there is a Motion for Summary Judgment pending where the government is asserting that: “Zwerner’s recklessness and willful blindness to his reporting obligations are sufficient to establish willfulness as a matter of law. . . . it is immaterial whether Zwerner specifically understood his FBAR reporting requirements. To keep his Swiss bank account a secret he was willing to hide it even from his own CPA, thereby guaranteeing that he would never learn of his reporting obligations. Under the recklessness and willful blindness standards discussed in Williams and McBride, that establishes willfulness as a matter of law. Although Zwerner is correct that the courts in those cases issued their opinions after trial, the facts showing Zwerner’s recklessness are not disputed. A trial here is therefore unnecessary.”

Participants in the OVDP should only consider the possibility of “opting out” of the program if their facts are unique. Having inherited funds in a foreign financial account, without more, might not be considered deserving of some lesser penalty regime by the IRS. Opt out considerations often include the source and amount of funds, how long the account has been maintained, whether there were withdrawals or deposits into the account or the account was moved to another foreign financial institution at some point, whether the taxpayer’s advisors had some degree of knowledge about the account, the sophistication and education of the taxpayer, whether foreign entities were involved as accountholders, etc.

Remaining in the OVDP can be economically oppressive given the penalty structure but it avoids exposure to numerous additional penalties associated with the income tax returns and various required foreign information reports, a detailed examination, and limits the number of tax years at issue while also providing certainty with respect to the avoidance of a referral for criminal tax prosecution.

TAXPAYER INTERVIEW QUESTIONS REVEALED. Numerous taxpayers having previously undisclosed interests in foreign financial accounts have been interviewed by representatives of the IRS as well as many having been interviewed by prosecutors associated with the Tax Division of the Department of Justice investigating various foreign institutions and advisors.

Questions relating to the opening of the account often inquire about who advised and assisted in opening the account; whether the advisor was an internal bank employee or an outside advisor referred by the bank; where the account opening(s) occurred (in the U.S., at the bank, etc.); how often the taxpayer traveled to the foreign institution or their advisor and for what reason; how funds were withdrawn from the account; documents provided by the taxpayer to open the account [i.e. U.S. or foreign passport(s), identification card, etc. - note that it might not be a good fact for a taxpayer having dual passports to open an account with their non-U.S. passport]; whether the taxpayer was asked to sign any documents or forms, including Form W-9; and identification of the advisors and representatives involved at the foreign financial institution and all communications with such individuals.

Additional questions relate to the use of foreign entities to hold title to the account(s). Specifically, why the entity was created (i.e. insurance products, trust, foundation, corporation, annuity, etc.); who formed the entity; who managed the entity; and whether the entity is still in existence. The taxpayer will be asked to disclose all communications with their domestic and foreign advisors, including when, where and in what form the communications took place; who was present and/or participated in the communications; what communications were had with the representative about the IRS OVDP; communications, if any, that occurred regarding bank secrecy, taxation, and/or disclosure of any foreign accounts; and whether letters, postcards or other personal mailings were ever sent or received.

The government will inquire about various services offered by the foreign institution and/or client advisor, including whether the creation of a foreign company, entity or foundation was ever recommended and, if so, for what purpose; was a credit card or debit card linked to the offshore account offered; was there a recommendation to repatriate funds to the U.S. using a foreign relative or entity (purported gifts from non-resident relatives); were there any offers to deliver or accept currency in the U.S.; was there any advice given on how to transport currency into the U.S.; were calling cards or cell phone services ever provided; and whether there were offers to move financial assets to another institution.

Management and administration of the foreign financial account is always of interest to the government. Taxpayers should anticipate questions regarding any instructions received regarding contacting the bank or the representative; instructions or advice received regarding receiving mail from the bank; instructions or advice received regarding taking bank statements or other bank documents from the bank; instructions or advice received regarding withdrawing funds; instructions or advice received regarding the formation of a foreign entity to hold the account and who to contact regarding formation of an appropriate entity.

Deposits and withdrawals to the foreign account can reveal intentions and knowledge of various individuals involved. The government can be expected to inquire about the manner in which deposits and/or withdrawals were made to/from the foreign account(s); the mechanics of how deposits/withdrawals were made; the form in which deposits/withdrawals occurred (i.e. cash, check, wire, travelers’ check, etc.); amounts of each withdrawal/deposit; when such deposits/withdrawals occurred; where such deposits/withdrawals occurred; whether there were there limitations on the amounts that could be deposited/withdrawn; and documents received when a deposit/withdrawal occurred (i.e. receipt, credit memo, debit memo, etc.)?

There will also be inquiries into the documentation received by or shown to the taxpayer regarding their accounts (i.e. account statements, account opening documents, etc.); whether such documents contained names of entities or the financial institution or account numbers; and whether the taxpayer retained the documentation.

Lastly, taxpayers should anticipate the government inquiring as to whether the foreign accounts remain open and if not, where the funds were transferred when the account(s) were closed. Some taxpayers closed accounts and wire transferred the funds directly to a domestic account. Others closed accounts and transferred the funds through various means to other foreign accounts. Further questions often lay within the responses to each of the foregoing questions.

Decisions regarding opting out should be carefully considered depending upon the taxpayers responses to each of the foregoing questions.

Posted by: | March 21, 2014

IRS Internal IDR Training Materials Revealed !

The IRS Large Business & International (LB&I) Division recently issued three recent Directives relating to the issuance and enforcement procedures regarding Information Document Requests (IDRs)(See previous Blog “NEW IRS LB&I Revised IDR Enforcement Process“).[1]

LB&I is generally responsible for examinations of wealthy individuals, closely held entities and partnerships, corporations, and S-corporations with assets greater than $10 million. These entities typically have large numbers of employees, complicated issues involving tax law and accounting principles, and conduct their operations in an expanding global environment.

THE DIRECTIVES. The Directives are commonly referred to as the LB&I Directive on Information Document Requests (IDR Directive); the LB&I Directive on Information Document Requests Enforcement Process (Enforcement Directive); and the LB&I Directive on Updated Guidance for Examiners on Information Document Requests Enforcement Process (Guidance Directive). The Guidance Directive incorporates and supersedes the earlier IDR and Enforcement Directives and provides further clarification of the use of the new IDR processes by LB&I examiners. The IDR Directive, the Enforcement Directive and the Guidance Directive are collectively referred to as the “Directives.”

IRS TRAINING MATERIALS REGARDING THE IDR ENFORCEMENT PROCESS. Every IRS LB&I examiner and specialist have recently been trained with respect to the new Directives. Although the IRS will try to mutually agree on a reasonable time frame for a response to any IDR, the training materials reveal that adherence to rigid timelines will more likely be the rule rather than the exception.

The Training Materials include several enlightening comments:

IDR Enforcement Training – “As the LB&I Commissioner states in the Field Focus Guide, the principles for sound tax administration are accountability, professionalism, discipline, and transparency. It is critical that we demonstrate to the taxpaying public that we adhere to these principles so there is confidence in both the voluntary compliance system and the agency charged with administering the tax law. To this end, we continuously review and assess our examination practices to accomplish these objectives.”

Effective IDR Review – “Let me recap some best practices that you heard in the IDR Process training. The issues should be stated on the IDR and discussed with the taxpayer. We saw that, limiting the IDR to a single issue, identifying questions using numbers and/or letters make it easier for the taxpayer to track and respond to IDRs. Asking specific questions using clear and concise language with terminology used by the taxpayer will help the taxpayer understand what you are asking for. And also writing an effective IDR is not only critical to effective information gathering, it is also important in the event that you need the enforcement process.”

Process Review – “For the IDR process to be effective we need to hold the taxpayer accountable for the agreed to response time and we need to be accountable to provide a response to the taxpayer whether the IDR is complete within an agreed upon and reasonable time frame. When the agreed upon IDR response time frames are not met, we will follow the IDR enforcement process. This process will be used for all LB&I cases. As with any process you should use your professional judgment considering the taxpayer’s history of cooperation and the issues you are working to determine the most efficient way to implement the process.”

Continuous Review and Assessment of the Examination Process – “The information gathering process relies extensively on communication, collaboration and commitments with the taxpayers in planning and executing the Information exchange. There will be a renewed emphasis on securing complete responses within the timeframes to which the taxpayer has agreed.”

Information Availability - “With our examinations being very current, with modem technology such as e-mail, e-fax, electronic media these are just some of the reasons why information is much more readily available. Therefore, if the taxpayer has taken a position on their return there should be documentation available which they relied upon. It follows then, that this information should be available and accessible when requested.”

Delinquency Notice, No Exceptions – “The delinquency notice will be issued regardless of the reasons given by the taxpayer, with no exceptions. Once a response date is set, you cannot reset or extend the date. Regardless of whether they notify you before or at the due date that their response will not be timely and complete, the maximum amount of time that can be granted by a frontline manager is 15 days on the delinquency notice.”

Partial Response –

“QUESTION: How would you handle a situation where you have a historically cooperative taxpayer that completes 90% of an IDR on time? Don’t you think it’s a little harsh to be issuing a Delinquency Notice for the missing items?

RESPONSE: It doesn’t matter what percentage or portion of an IDR is completed, to ensure consistency throughout the process: the only two outcomes of an IDR response are either completed or delinquent.  Any items on the IDR not completed by the due date will be considered delinquent.”

Elevating to Taxpayer Executives –

“QUESTION: “What’s the significance of raising this to the next level of taxpayer management. Isn’t that like going over our contact’s head?

RESPONSE: This is simply to ensure the executive level of the taxpayer is aware of the delay in responding to a request The Pre-Summons Letter ensures that the delay has risen to an appropriate level.”

Due Dates – “Due dates need to be both reasonable and realistic taking into account the complexity of the IDR and your taxpayer’s history. In this example, the information requested already existed and should be readily available. . . It is important that we follow the process and engage management quickly to keep the process moving.”

Communication – “Communication and persistence is key to successfully executing the enforcement process. There is an expectation to establish a response date for ‘each’ IDR. All actions and discussions with the taxpayer should be properly documented so there is a clear record of our attempts to secure the information requested.”

IDRs and Summonses – “An IDR request may be broader than a summons. You may appropriately ask for items in an IDR that you cannot legally obtained by summons[2]. A simple example might be a request for items that the taxpayer may not presently possess and would have to create, such as an organizational chart. Counsel will advise you that you cannot summons an item that doesn’t exist. However, clearly you should still request chart informally if it would assist in the examination. If the taxpayer does not produce the chart, then Counsel may suggest that you summons testimony to ask for the names and positions of employees in order to create your own chart. In this regard, summonsed testimony can serve as the functional equivalent of the item you requested in the IDR, but cannot summons.”

Changing Behavior – “Credibility is the key to changing behavior. We should never say we are considering using a summons, unless we mean it and unless we are prepared to actually issue a summons. Likewise, we should never issue a summons unless we are willing to seek enforcement These IDR enforcement procedures are designed to assure that we will follow-though with the summons process if necessary to complete our examination.”

Set the Date Scenario– “I’ve noticed that you consistently request 60 days or more for many response dates and in many cases you’ve been late on those responses as well. The information requested on this IDR wasn’t overly complicated and we just can’t have every request taking 60 days. Like you, we have limited resources and specific time frames to meet so we need to eliminate the long delays in securing the data.”

Scenario Highlights – “Remember the exam team maintains control of the IDR process. Due dates need to be both reasonable and realistic taking into account the complexity of the IDR taxpayer’s history. In this example, the information requested already existed and should be readily available. You have some flexibility here based on your particular circumstances.  Remember we want to be reasonable but at the same time we need to maintain control of the examination.”

Role of the Taxpayer – “The taxpayers have a responsibility to validate transactions reflected on the return, it would be key for the taxpayer to be proactive and participate in a robust discussion with the IRS Team on the issue identified and the records available to validate the position taken on the return. It is expected that the taxpayer work with the team to determine a “firm” yet reasonable response date on IDRs. In summary, if the parties have worked to identify the appropriate information needed to evaluate the issue identified and have agreed to a firm response time for each IDR, there should be no exception to a timely response. However, if the response is not received, the team will initiate the enforcement process.”

Closing – “This IDR Enforcement process has been created to give LB&I examiners the ability to more consistently manage the flow of information received from taxpayers and conduct their examinations comprehensively with as little delay as possible.”                       

PRACTICE TIPS. Most taxpayers and practitioners maintain a courteous, professional relationship with the IRS during an examination. Information requests are made, discussed, whatever can be readily obtained is provided and a cooperative path forward is discussed for whatever information is not yet provided.

The Directives set forth fairly rigid timeframes in the event an agreement on a response date cannot be agreed upon. In such event, the examiner or specialist will have the sole responsibility of setting a reasonable response date for the IDR.

All discussions regarding IDR responses should be well documented and include the location (foreign or domestic) of the requested documents, availability of key employees, and time frame necessary for a review of potential privileges.

If the taxpayer is unable to agree with a response date set by the examiner, it is imperative that this disagreement be documented and elevated to a Territory Manager. Although some taxpayers fear that doing so might harm their working relationship with their exam teams, such issue elevations are generally expected in a business environment. For large taxpayers, company management should be apprised of the status of IDR requests during the examination.

The LB&I examiner is generally required to issue the IDR within 10 days following issuance of the draft IDR. As such, it is imperative that any perceived difficulties in responding timely should be thoroughly discussed with the examiner. A request for a lengthy response date should not occur with respect to each IDR – agreeing to shorter timeframes with respect to information that might be readily available will lend credibility to requests for longer timeframes for other information.

Any concerns regarding the requested response date should be elevated, in writing, to the exam team manager and possibly beyond. Once the IDR becomes delinquent on either the original due date or any extended date, the mandatory three-step enforcement process must be implemented.

Many, but not all, high wealth individuals maintain a family office providing assistance with investments and coordination with outside professional advisors regarding investments, financial reports, tax return preparation, business operations and the like. However, upon receipt of a notice of examination, such individuals and/or their family office may not be able to readily ascertain the foreign or domestic location of requested information, may have to seek outside representation to coordinate the examination and make determinations regarding potential privileges, etc. In such event, it would seem overly optimistic that information requested near the commencement of an examination being conducted under the new IDR enforcement procedures would be provided in a timely manner. Further, much of the requested information is likely possessed by others who may not feel the pressure to immediately search their files for responsive documents and information.

The new IDR enforcement procedures create an enforcement process that seems to have little patience for unanticipated situations, vacations and real life personal issues that often arise during the course of every examination.

There would seem to be sufficient overall time built in to the process to avoid an actual federal court summons enforcement proceeding since, along the way, taxpayers will presumably be continuing their efforts to locate and provide missing information requested in the IDR.

Meaningful, regular communications and cooperation between the IRS and taxpayers at each stage of an examination is essential. Ensure that every member of the exam team clearly understands exactly what is being requested in the IDRs, who has responsibility for obtaining the requested information, that the IDR is issue-focused and includes a response date is realistic and achievable.

When appropriate . . . elevate, elevate, elevate each concern to upper IRS management. Good night and good luck!



[1] LB&I Directive on Information Document Requests (IDRs) [LB&I-- 04-0613-004 issued on June 18, 2013]; LB&I Directive on Information Document Requests Enforcement Process [LB&I-04-1113-009 issued on November 4, 2013]; and LB&I Directive on Updated Guidance for Examiners on Information Document Requests Enforcement Process [Directive LB&I-04-0214-004 issued on February 28, 2014]. The IDR Enforcement Process became effective on March 3, 2014 although Delinquency Notices could not be issued prior to April 3, 2014.

[2] In U.S. v. Powell, 379 U.S. 48 (1964), the Supreme Court enunciated a four-part test by which the IRS can establish a prima facie case for summons enforcement. Often demonstrated by an affidavit from the IRS examiner who issued the summons, the government can meet its burden by demonstrating: (1) the investigation has a legitimate purpose, (2) the information summoned is relevant to that purpose, (3) the documents sought are not already in the possession of the government and (4) the procedural steps required by the Internal Revenue Code for issuing the summons were followed. Most successful defenses to the summons enforcement relate to claims of privilege.


Posted by: | March 18, 2014

NEW IRS LB&I Revised IDR Enforcement Process

To download a great article regarding “Procedural Challenges to Interest and Penalties in CDP” prepared by our very close friends at the Law Firm of Agostino & Associates in Hackensack, NJ ( ), see the Agostino & Associates Newsletter

The article begins “One of the challenges in collection due process  proceedings is convincing the Internal Revenue Service (“IRS”) to compromise their penalty and interest claims. The purpose of this article is to suggest procedural challenges that are often overlooked by practitioners in Collection Due Process (“CDP”) cases. . . .”

The Agostino & Associates Newsletter has another article of significant  interest to many “Common Forms Associated with International Tax Compliance – Part I.” See

The article begins “We are a nation of immigrants. The 2011 census shows that this fact is especially true in New Jersey. It is unreasonable to assume that taxpayers immigrating here have no business interests outside the United States. Thus, return preparers need to familiarize themselves with the tax forms implicated when taxpayers enter into transactions resulting in money coming into or leaving the United States. . . .”

For further information, contact Frank Agostino at (201) 488-5400.

AGOSTINO & ASSOCIATES, with a national practice located in Hackensack, NJ, specializes in tax and tax controversies (civil and criminal), offers in compromise, voluntary disclosures, tax lien discharges,  innocent spouse determinations, forfeitures, estate planning and probate, contract and contract litigation.  A firm comprised truly great, caring people who want the best for their clients (and they are hosting another absolutely amazing BBQ at their office on June 27 this year – everyone is invited but make sure to rsvp in advance!)

A “real estate professional” may treat rental real estate activities as non-passive if the taxpayer “materially participates” in the rental activities. Taxpayers claiming to be a real estate professional should contemporaneously document their efforts with respect to each real estate activity.

A taxpayer is generally allowed deductions for certain business and profit-seeking investment expenses[1]. However, Code Section 469 disallows a taxpayer’s deductions attributable to a passive activity loss for the taxable year. Section 469(d)(1) defines “passive activity loss” as “the amount (if any) by which — (A) the aggregate losses from all passive activities for the taxable year, exceed (B) the aggregate income from all passive activities for such year.”

REAL ESTATE PROFESSIONAL. Passive activity is defined as any activity “which involves the conduct of any trade or business, and * * * in which the taxpayer does not materially participate.”[2] The Code specifically provides that the term “passive activity” also includes any rental activity[3]. Code Sec. 469(c)(7) then provides an exception from that rule for the rental real estate activity of a taxpayer who is engaged in a real property trade or business (a “real estate professional”).

A taxpayer qualifies as a real estate professional under Code Sec. 469(c)(7)(B)(i) and (ii) if:

(i) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

(ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.[4]

The term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.[5] This list does not include any research or other preparatory activities.

Unless the taxpayer timely elects otherwise, the taxpayer must satisfy the requirement of material participation as applied separately to each rental real estate interest.[6] In the case of a joint return, the foregoing requirements of Code Sec. 469(c)(7)(B)(i) and (ii) are satisfied if and only if either spouse separately satisfies such requirements.[7]

The Treasury Regulations provide that “the extent of an individual’s participation in an activity may be established by any reasonable means.[8]

Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means * * * may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or  narrative summaries.

“BALLPARK GUESSTIMATE” INSUFFICIENT. Although “reasonable means” may be interpreted broadly, “a post event ‘ballpark guesstimate’” will not suffice.[9] In Almquist v. Commissioner, T.C. Memo. 2014-40 (March 10, 2014), Tax Court Judge Wherry sustained an accuracy-related penalty and held that a couple was not entitled to claim losses related to the rental of two real estate properties, finding that the husband didn’t qualify as a real estate professional and the passive activity loss limitation rule of Code Section 469 applied.

To support the taxpayer husband’s material participation, at the beginning of the IRS audit, the taxpayers created a calendar from very brief cryptic notes in the husband’s personal spiral notebook daily records. The calendar was created about a year after the fact, long after the asserted work was completed. No documents or emails supporting the calendar entries were provided to the Tax Court. The calendar entries were only supported by the taxpayers “self-serving testimony.”

Judge Wherry held that the Tax Court was not required to accept such “self-serving testimony” and is not willing to rely on testimony alone to establish the status of the taxpayer husband as having satisfied the material participation requirements necessary to qualify as a “real estate professional.”[10] Without any supporting documentation, the Tax Court held that the calendar created over a year after the work was completed was nothing more than “a post event ‘ballpark guesstimate’”.[11]

Accordingly, the taxpayers’ rental real estate activity was treated as passive and the claimed deductions relating to the passive activity losses was disallowed for the tax year at issue. The disallowed deduction is “treated as a deduction or credit allocable to such activity in the next taxable year.”[12]

ACCURACY-RELATED PENALTY APPLIED. The Tax Court upheld the government’s assertion of a Code Section 6662(a) accuracy-related penalty equal to 20% of the underpayment of tax. The penalty is applicable with respect to adjustments attributable to negligence or, alternatively, because the underpayment is due to a substantial understatement of income tax.[13] Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Code, including any failure to keep adequate books and records or to substantiate items properly.[14] A substantial understatement is an understatement of income tax that exceeds the greater of 10% of the tax required to be shown on the return or $ 5,000.[15]

Reliance on the advice of a tax professional may, but does not necessarily, establish reasonable cause and good faith for the purpose of avoiding a section 6662(a) penalty.[16] To avoid liability for a Code Section 6662(a) penalty on the basis of reliance on a tax professional, a taxpayer must meet the following three requirements: “(1) The adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment.”[17]

The fact that the taxpayers in Almquist had an accountant prepare their returns does not, in and of itself, prove that they acted with reasonable cause and in good faith.[18] Additionally, the tax Court noted that the taxpayers’ failure to properly document their time spent performing rental activities made it impossible for their accountant to have all the accurate information necessary to make an informed tax decision. The accountant relied on the taxpayers for an accurate representation of the amount of hours worked on their rental activity; however, the taxpayers were unable to prove the purported hours worked. Accordingly, the Tax Court concluded that the taxpayers were liable for the Code Section 6662 accuracy-related penalty.

IRS AUDIT TECHNIQUE GUIDE. The IRS is aggressively examining returns claiming status as a “real estate professional.” To assist IRS agents examining the real estate professional issue, the IRS has published an Audit Technique Guide regarding Passive Activity Losses.[19] The ATG provides a summary of court cases, checklists for common issues, various decision trees and references the following common IRS examination techniques:

  • Determine whether the taxpayer materially participates in one or more of the specific real estate trades or businesses identified in Code Sec. 469(c)(7)(B).
  • Determine who is the real estate professional, husband or wife.
  •  Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Treas. Reg. § 1.469-5T(f)(4) to provide proof of services performed and the hours attributable to those services.
  •  Scrutinize other activities the taxpayer is engaged in to determine whether time claimed makes sense.
  • Qualification as a real estate professional is a determination, not an election.
  • During the initial interview, question the taxpayer regarding time spent in all activities (personal, business, civic, family, hobbies, etc).
  • Request and closely examine the taxpayer’s documentation of time utilized for material participation in each activity.
  • Examine time spent by others in the activity. Indicators: commissions, management fees, expenses for cleaning, maintenance, repairs, etc.
  • Question the taxpayer in the initial interview whether an election was made, grouping rental real estate interests as a single activity.
  • Request a copy of the return with the election. Request the original Form 1040, U.S. Individual Income Tax Return, from the IRS Center if doubts exist as to the documents furnished.
  • Review prior and subsequent year’s returns for consistency.
  • Closely scrutinize any passive income on Form 8582 line 1a. If the taxpayer is a real estate professional and did most of the work on the rental, gain on disposition does not belong on Form 8582.
  • Tie down the taxpayer’s day-to-day involvement and specific hours regarding the activity.
  • Request, as soon as possible, a log or other documentation itemizing the nature of the participation and the hours for each type of work claimed during the year.
  • Request a copy of any management or commission agreement. Frequently, there is little left for the taxpayer to do.

[1]  See Internal Revenue Code (Code) Sec. 162 and 212

[2]  Code Sec. 469(c)(1)(A) and (B).

[3]  Code Sec. 469(c)(2).

[4]  Code Sec. 469(c)(7)(B)(i) and (ii).

[5]  Code Sec. 469(c)(7)(B).

[6]  Code Sec. 469(c)(7)(A).

[7]  Code Sec. 469(c)(7)(B).

[8]  Treas. Reg. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).

[9] Moss v. Commissioner, 135 T.C. 365, 369 (2010) (citing Bailey v. Commissioner, T.C. Memo. 2001-296, and Goshorn v. Commissioner, T.C. Memo. 1993-578).

[10] See Tokarski v. Commissioner, 87 T.C. 74, 76-77 (1986); see also Chapman Glen Ltd. v. Commissioner, 140 T.C. __ (slip op. at 45 n.24) (May 28, 2013).

[11] See Moss v. Commissioner, 135 T.C. at 369.

[12] See Code Sec. 469(b).

[13] See Code Sec. 6662(b)(1) and (2).

[14] See Code Sec. 6662(c);  Treas. Reg. Sec. 1.6662-3(b)(1)

[15] See Code Sec. 6662(d); Treas. Reg. Sec. 1.6662-4(b)

[16] Treas. Reg. Sec. 1.6664-4(b)(1); see also United States v. Boyle, 469 U.S. 241, 251 (1985) (reliance on an accountant or attorney as to a matter of tax law may be reasonable); Canal Corp. v. Commissioner, 135 T.C. 199, 218 (2010) (“The right to rely on professional tax advice, however, is not unlimited.”).

[17] Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also Charlotte’s Office Boutique, Inc. v. Commissioner, 425 F.3d 1203, 1212 n.8 (9th Cir. 2005) (quoting with approval the above three-prong test), aff’g 121 T.C. 89 (2003). In addition, the advice must not be based on unreasonable factual or legal assumptions (including assumptions as to future events) and must not unreasonably rely on the representations, statements, findings, or agreements of the taxpayer or any other person. Treas. Reg. Sec. 1.6664-4(c)(1)(ii).

[18] See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99-100.

Posted by: | March 10, 2014

Simplified Option for Home Office Deduction Now Available !

Beginning with tax year 2013 returns (filed in 2014), taxpayers may elect to use a simplified “safe harbor” option when figuring the deduction for business use of their home.

Recognizing that the calculation, allocation, and substantiation of allowable deductions attributable to the use of a portion of the taxpayer’s residence for business purposes can be complex and burdensome for small business owners, the IRS and the Treasury Department have provided an optional safe harbor method to reduce the administrative, recordkeeping, and compliance burdens of determining the allowable deduction for certain business use of a residence under Internal Revenue Code § 280A.

Under this safe harbor method, taxpayers determine their allowable deduction for business use of a residence by multiplying a prescribed rate by the square footage of the portion of the taxpayer’s residence that is used for business purposes.

Note: The simplified option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements of the allowable deduction.

Highlights of the simplified option:

  • Standard deduction of $5 per square foot of home used for business (maximum 300 square feet).
  • Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real estate taxes).
  • No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

Comparison of methods

Simplified Option Regular Method
Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes Same
Allowable square footage of home use for business (not to exceed 300 square feet) Percentage of home used for business
Standard $5 per square foot used to determine home business deduction Actual expenses determined and records maintained
Home-related itemized deductions claimed in full on Schedule A Home-related itemized deductions apportioned between Schedule A and business schedule (Sch. C or Sch. F)
No depreciation deduction Depreciation deduction for portion of home used for business
No recapture of depreciation upon sale of home Recapture of depreciation on gain upon sale of home
Deduction cannot exceed gross income from business use of home less business expenses Same
Amount in excess of gross income limitation may not be carried over Amount in excess of gross income limitation may be carried over
Loss carryover from use of regular method in prior year may not be claimed Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year

Selecting a Method

  • You may choose to use either the simplified method or the regular method for any taxable year.
  • You choose a method by using that method on your timely filed, original federal income tax return for the taxable year.
  • Once you have chosen a method for a taxable year, you cannot later change to the other method for that same year.
  • If you use the simplified method for one year and use the regular method for any subsequent year, you must calculate the depreciation deduction for the subsequent year using the appropriate optional depreciation table. This is true regardless of whether you used an optional depreciation table for the first year the property was used in business.

Full details on the new option can be found in Revenue Procedure 2013-13 available at

The Internal Revenue Service recently released a new YouTube video designed to provide useful tax tips to married same-sex couples[1]. The video is less than two minutes long, is available in English, Spanish and American Sign Language and can be accessed via More than 150 topics covered in various online IRS instructional videos ranging from tips for victims of identity theft to claiming the new simplified home office deduction have been viewed more than seven million times.

Revenue Ruling 2013-17. On June 26, 2013, the United States Supreme Court ruled in Windsor v. United States[2] that Section 3 of the Defense of Marriage Act (DOMA)[3], denying legally married same-sex couples numerous federal protections and responsibilities of marriage, is unconstitutional. Thereafter, the IRS issued Revenue Ruling 2013-17 ruling that same-sex couples, legally married in jurisdictions that recognize their marriages, are now treated as married for federal tax purposes.[4] Under the Revenue Ruling 2013-17, same-sex couples are treated as married for all federal tax purposes, including income and gift and estate taxes. As such, the ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, claiming the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit.

Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by Revenue Ruling 2013-17. However, Revenue Ruling 2013-17 does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law. Legally-married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status.

Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the applicable statute of limitations. Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. As a result, refund claims can still be filed for tax years 2010, 2011 and 2012. Some taxpayers may have special circumstances, such as signing an agreement with the IRS to keep the statute of limitations open, that permit them to file refund claims for tax years 2009 and earlier.

Additionally, employees who purchased same-sex spouse health insurance coverage from their employers on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income.

Updated FAQs. The IRS has also updated its list of frequently asked questions providing tax-related information to individuals of the same sex who are lawfully married (same-sex spouses).[5] Selected FAQs include:

Q1. When are individuals of the same sex lawfully married for federal tax purposes? A1. For federal tax purposes, the IRS looks to state or foreign law to determine whether individuals are married. The IRS has a general rule recognizing a marriage of same-sex spouses that was validly entered into in a domestic or foreign jurisdiction whose laws authorize the marriage of two individuals of the same sex even if the married couple resides in a domestic or foreign jurisdiction that does not recognize the validity of same-sex marriages.

Q2. Can same-sex spouses file federal tax returns using a married filing jointly or married filing separately status? A2. Yes. For tax year 2013 and going forward, same-sex spouses generally must file using a married filing separately or jointly filing status. For tax year 2012 and all prior years, same-sex spouses who file an original tax return on or after Sept. 16, 2013 (the effective date of Rev. Rul. 2013-17), generally must file using a married filing separately or jointly filing status. For tax year 2012, same-sex spouses who filed their tax return before Sept. 16, 2013, may choose (but are not required) to amend their federal tax returns to file using married filing separately or jointly filing status. For tax years 2011 and earlier, same-sex spouses who filed their tax returns timely may choose (but are not required) to amend their federal tax returns to file using married filing separately or jointly filing status provided the period of limitations for amending the return has not expired. A taxpayer generally may file a claim for refund for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. For information on filing an amended return, go to Tax Topic 308, Amended Returns, at

Q3. Can a taxpayer and his or her same-sex spouse file a joint return if they were married in a state that recognizes same-sex marriages but they live in a state that does not recognize their marriage?  A3. Yes. For federal tax purposes, the IRS has a general rule recognizing a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction whose laws authorize the marriage of two individuals of the same sex even if the married couple resides in a domestic or foreign jurisdiction that does not recognize the validity of same-sex marriages. The rules for using a married filing jointly or married filing separately status described in Q&A #2 apply to these married individuals.

Q4. Can a taxpayer’s same-sex spouse be a dependent of the taxpayer? A4. No. A taxpayer’s spouse cannot be a dependent of the taxpayer.

Q5. Can a same-sex spouse file using head of household filing status? A5. A taxpayer who is married cannot file using head of household filing status. However, a married taxpayer may be considered unmarried and may use the head-of-household filing status if the taxpayer lives apart from his or her spouse for the last 6 months of the taxable year and provides more than half the cost of maintaining a household that is the principal place of abode of the taxpayer’s dependent child for more than half of the year. See Publication 501 for more details.

Q6. If same-sex spouses (who file using the married filing separately status) have a child, which parent may claim the child as a dependent? A6. If a child is a qualifying child under section 152(c) of both parents who are spouses (who file using the married filing separate status), either parent, but not both, may claim a dependency deduction for the qualifying child. If both parents claim a dependency deduction for the child on their income tax returns, the IRS will treat the child as the qualifying child of the parent with whom the child resides for the longer period of time during the taxable year. If the child resides with each parent for the same amount of time during the taxable year, the IRS will treat the child as the qualifying child of the parent with the higher adjusted gross income.

Q7. Can a taxpayer who is married to a person of the same sex claim the standard deduction if the taxpayer’s spouse itemized deductions?  A7. No. If a taxpayer’s spouse itemized his or her deductions, the taxpayer cannot claim the standard deduction (section 63(c)(6)(A)).

Q8. If a taxpayer adopts the child of his or her same-sex spouse as a second parent or co-parent, may the taxpayer (“adopting parent”) claim the adoption credit for the qualifying adoption expenses he or she pays or incurs to adopt the child? A8. No. The adopting parent may not claim an adoption credit. A taxpayer may not claim an adoption credit for expenses incurred in adopting the child of the taxpayer’s spouse (section 23).

Q9. Do provisions of the federal tax law such as section 66 (treatment of community income) and section 469(i)(5) ($25,000 offset for passive activity losses for rental real estate activities) apply to same-sex spouses?  A9. Yes. Like other provisions of the federal tax law that apply to married taxpayers, section 66 and section 469(i)(5) apply to same-sex spouses because same-sex spouses are married for all federal tax purposes.

Q10. If an employer provided health coverage for an employee’s same-sex spouse and included the value of that coverage in the employee’s gross income, can the employee file an amended Form 1040 reflecting the employee’s status as a married individual to recover federal income tax paid on the value of the health coverage of the employee’s spouse? A10. Yes, for all years for which the period of limitations for filing a claim for refund is open. Generally, a taxpayer may file a claim for refund for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. If an employer provided health coverage for an employee’s same-sex spouse, the employee may claim a refund of income taxes paid on the value of coverage that would have been excluded from income had the employee’s spouse been recognized as the employee’s legal spouse for tax purposes. This claim for a refund generally would be made through the filing of an amended Form 1040. For information on filing an amended return, go to Tax Topic 308, Amended Returns, at For a discussion regarding refunds of Social Security and Medicare taxes, see Q&A #12 and Q&A #13.

Example. Employer sponsors a group health plan covering eligible employees and their dependents and spouses (including same-sex spouses). Fifty percent of the cost of health coverage elected by employees is paid by Employer. Employee A was married to same-sex Spouse B at all times during 2012. Employee A elected coverage for Spouse B through Employer’s group health plan beginning Jan. 1, 2012. The value of the employer-funded portion of Spouse B’s health coverage was $250 per month.

The amount in Box 1, “Wages, tips, other compensation,” of the 2012 Form W-2 provided by Employer to Employee A included $3,000 ($250 per month x 12 months) of income reflecting the value of employer-funded health coverage provided to Spouse B.  Employee A filed Form 1040 for the 2012 taxable year reflecting the Box 1 amount reported on Form W-2.

Employee A may file an amended Form 1040 for the 2012 taxable year excluding the value of Spouse B’s employer-funded health coverage ($3,000) from gross income.

To review the entire list of 23 FAQs, see

[2] United States v. Windsor, 570 U.S. 2 (2013).

[3] The “Defense of Marriage Act,” or DOMA, was passed in 1996 by Congress and signed into law by President Bill Clinton. The part that was held unconstitutional by the U.S. Supreme Court is “Section 3,” which prevented the federal government from recognizing any marriages between gay or lesbian couples for the purpose of federal laws or programs, even if those couples are considered legally married by their home state. However, individual states do not legally have to acknowledge the relationships of same-sex couples who were married in another state. Only Section Three dealing with federal recognition was ruled unconstitutional.

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