Archive for Appeals & Audit Resolution

Trafficking under IRC § 280E

February 9, 2013 Appeals & Audit Resolution, Asset Classification, Business Expense, Cash Transaction, COGS, IRS Mediation, Marijuana, Net Operating Loss, NOL, Tax Abuse, Tax Court, Tax Guidance & Preparation, Tax Problems & Requests

The Internal Revenue Code is a complex beast.  In the lunacy of it all I’ve been asked to define ‘trafficking’ as it relates to 26 USC § 280E – Expenditures in connection with the illegal sale of drugs which states as follows:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

As I understand the Controlled Substance Act the word trafficking is more often than not used in conjunction with the word ‘illicit’ as in nefarious or illegal.  This begs the very question as to whether the cultivating, possessing and distributing of marijuana in a state (Colorado) where the substance is fully legal under state law rises to the threshold of trafficking as it is used in the Controlled Substances Act.

Naturally the laws of interstate commerce should in my opinion generally prevail.  If however marijuana does not cross state borders then in my humble layman’s opinion the federal government in theory under our constitution has no basis for intervention.  Of course you will always find the pundits from the other side pontificating the evils of the drug as they swirl down their martinis and pop their pills but let’s not get into name calling.

When it comes to the IRS, the Service is obligated to enforce the letter of the federal law.  Marijuana is federally illegal and if taxpayers are in the business of cultivating it and distributing it for profit or otherwise then the argument goes they are by the letter of the federal law guilty of ‘trafficking’ in a controlled substance regardless of state law.

Presently and with all due respect the IRS seems to be lacking a standard of enforcement over dispensaries, cultivators and bakeries in these regards.  The recent court case of Olive v. Commissioner seems to make the efficacy of a dispensary’s income tax return achieve an allowable threshold when Cost of Goods sold are allowed as offsets to gross receipts but general business expenses are disallowed. This attempt at a standard is overtly far reaching in that the intent of IRC 280E as it pertains to the Controlled Substances Act was to curtail illicit activity.  If the activity is not illicit by state law then moving it around inside that state’s border should by default be transportation not trafficking.

It is my personal opinion that moving a fully legal product inside a state border is NOT ILLICIT NOR IS IT TRAFFICKING. If the substance is fully legal by state law than possessing it, cultivating it and even distributing it in no way reaches the threshold of ‘illicit activity’.

Until further tax court cases help iron out a standard I believe a reasonable solution is to narrowly define ‘trafficking’ under IRC 280E as a transaction where marijuana dispensary employee ‘X’ hands a product containing marijuana to a customer and the customer in turn hands employee ‘X’ money for the marijuana product.  In this limited time and space a transaction happens that could be argued to be perceived as trafficking and as such the expenses associated with that limited transaction should perhaps not be deductible under 280E of the Internal Revenue Code.

When trafficking is narrowly defined all other costs should by default in theory become legitimate business expenses be they general and administrative or cost of goods sold. This is just one simple man’s opinion and the Service presently has a vastly different opinion.  There is a middle ground somewhere and it appears the courts will have to find it for us. Because like it or not this is a growth industry. Tread lightly.  Stay tuned…

 

Pursuant to the requirements related to practice before the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of:  Avoiding penalties imposed under the United States Internal Revenue Code, or Promoting or recommending to another person any tax-related matter

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IRS Restrictions on Contacting Taxpayers

October 1, 2012 Appeals & Audit Resolution, Audit Reconsideration, Audit Technique Guide, IRS Appeal, IRS Audit, IRS Collections, IRS Criminal Enforcement, IRS Enforcement, IRS Examination, IRS Mediation, Tax Abuse, Tax Guidance & Preparation, Tax Relief, Taxpayer Advocate, TIGTA

I’ve worked with many good people inside the IRS on a wide variety of cases. So please do not get me wrong I’m not bashing ALL IRS employees. However like any big bloated bureaucracy I’ve also worked with some real shit heads inside the IRS who take their orders to advocate on behalf of the US government a little too seriously. When indeed government bureaucrats should be focused on getting maters resolved some use their vested authority to wreak havoc on good people’s lives using what I refer to as procedural maneuvers.

One such example is when IRS Revenue Officers can negatively impact the ability of taxpayers to obtain appropriate and effective representation during collection investigations.  According to the Treasury Inspector General for Tax Administration (TIGTA) “IRS employees are required to stop an interview if the taxpayer requests to consult with a representative and may not bypass a representative without supervisory approval.” Evidently this is not happening as provided for by law in that “between October 2010 and September 2011, TIGTA’s Office of Investigations closed 19 direct contact complaints involving IRS employees, of which eight were disciplined or counseled for their actions by IRS management officials.” AKA – a slap on the wrist.

The IRS’s compliance with Internal Revenue Code Sections 7521(b)(2) and (c) is in my opinion woefully inadequate. The audit report I reference goes on to state that “in the sample of 73 cases, TIGTA found that 14 revenue officers deviated from procedures by: 1) contacting the taxpayer directly, instead of the authorized representative, on the initial or subsequent contact in the collection investigation, 2) not sending copies of taxpayer correspondence to the authorized representative, or 3) not allowing enough time for the taxpayer to obtain a representative.” The report in question clearly states “IRS personnel are intentionally disregarding the direct contact provisions of the Internal Revenue Code.”

As such if you are under investigation you need to know your rights. You also need to keep in mind that IRS employees are specifically trained to create the perception that they are ‘helping’ you ‘achieve compliance’ when indeed they are compiling evidence to portray you as a delinquent or even a criminal. Check out the report yourself here ->

http://www.treas.gov/tigta/auditreports/2012reports/201230089fr.html.

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Ex Parte Communication and IRS Appeals – Rev. Proc. 2012-18

July 17, 2012 Appeals & Audit Resolution, IRS Appeal

Ex parte communication is oral or written communication that takes place between any IRS Appeals employees such as Appeals Officers, Settlement Officers, Appeals Team Case Leaders, Appeals Tax Computation Specialists and employees of other IRS functions without the taxpayer’s representative being given an opportunity to participate in the communication.

IRS Rev. Proc. 2012-18 updates the rules relating to this type of communication. The new rules I am told are designed to accommodate the overall interests of tax administration, while preserving operational features that are vital to Appeals’ case resolution processes within the structure of the IRS. It does not adopt the formal ex parte procedures that would apply in a judicial proceeding. Either way these new rules are worth looking at if you are considering an IRS Appeal.

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US Treasury SS-8 Determination of Worker Status for Purposes of Federal Employment Tax

June 4, 2012 Appeals & Audit Resolution, Audit Reconsideration, Business Expense, Employee Business Expense, Employment Tax, FICA, Payroll Tax Problems, Self Employ, Small Business, Sub-chapter S, Tax Guidance & Preparation, United States Treasury

In my dealings with the US Treasury Department regarding worker classification disputes I have learned that although in reality there may be shades of gray distinguishing between what constitutes an employee and what constitutes an independent contractor the US Treasury has some very specific positions.  Here are four that will hopefully help you make the correct determination and avoid future problems:

1. A relationship between an employer and an employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to what is to be done, but also how it is to be done.  It is not necessary that the employer actually direct or control the individual, it is sufficient that the employer merely has the right to do so. The designation of a worker as an agent, sub-contractor or independent contractor is irrelevant if the relationship of employer and employee exists.  The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed.

2. A worker who is required to comply with another person’s instructions about when, where and how he or she is to work is ordinarily an employee.  This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions.  Some employees may work without receiving instructions because they are highly proficient and conscientious workers or because the duties are so simple or familiar to them.  Furthermore, instructions, that show how to reach the desired results, may have been oral and given only once at the beginning of the relationship.

3. Lack of significant investment by a person in facilities or equipment used in performing services for another indicates dependence on the employer and, accordingly, the existence of an employer-employee relationship.  The term “significant investment” does not include tools, instruments, and clothing commonly provided by employees in their trade; nor does it include education, experience or training.

4. A person who can realize a profit or suffer a loss as a result of his or her services is generally an independent contractor, while the person who cannot is an employee.  “Profit or loss” implies the use of capital by a person in an independent business of his or her own.  The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and, thus, does not constitute a sufficient economic risk to support treatment as an independent contractor. If a worker loses payment from the firm’s customer for poor work, the firm shares the risk of such loss. Control of the firm over the worker would be necessary in order to reduce the risk of financial loss to the firm. The opportunity for higher earnings or of gain or loss from a commission arrangement is not considered profit or loss.

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Updated Rules Issued for IRS Communications with Appeals Office – Rev. Proc. 2012-18

May 2, 2012 Appeals & Audit Resolution, IRS Appeal

The IRS Office of Appeals resolves more than 100,000 tax cases each year. Employees staffed in this function are trained to resolve disputes taking into consideration the hazards of litigation as well as the benefits of efficient tax administration. They are not necessarily trained to advocate on behalf of the United States Government’s best interest as they are to resolve and close files. To that end the Internal Revenue Service updated existing rules on permissible communications between the Office of Appeals staff and pretty much all other parts of the IRS. The updated rules are in Revenue Procedure 2012-18.

The previous rules were issued in October 2000 so it was time that they were revisited. The new rules address ex parte communications, which are communications between the Office of Appeals and other parts of the IRS that take place without the taxpayer or the taxpayer’s representative being given an opportunity to participate in the communication.

“These rules implement a provision in the IRS Restructuring and Reform Act of 1998, aimed at ensuring that the Office of Appeals remains an independent and flexible vehicle for settling audit and collection-related disputes between taxpayers and the IRS. A part of IRS, but independent of the agency’s compliance functions, Appeals serves as one of the checks and balances built into the U.S. system of tax administration.”

In one key change IRS Appeals will no longer participate on issue management teams (IMT) but can be briefed by IMTs, as long as the discussion remains generic rather than case specific. IMTs include representatives from various IRS components, typically Compliance and Counsel, and the IMT meetings usually involve general discussions of how to handle technical issues or procedural matters.

Additionally when there is a breach of the ex parte communication rules, Appeals employees will now ask the affected taxpayer or their representative for input on the appropriate remedy and the appropriate remedy will be determined by a senior management official. The IRS Office of Appeals resolves more than 100,000 tax cases each year.

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Dwelling Unit vs. Primary Residence

October 10, 2011 Appeals & Audit Resolution, IRS Appeal, IRS Audit, IRS Enforcement, IRS Examination, Rental Real Estate, Tax Guidance & Preparation, Tax Problems & Requests, Uncertain Tax Position

Many taxpayers have both a dwelling unit and a principal place of residence.  Understanding the difference between the two is important for a wide variety of reasons.  The file that landed on my desk today involves such a matter.  The taxpayer has a dwelling unit in Texas (where there is no state income tax) and a principal place of residence in Colorado (where there is a state income tax).  Because the tax payer was afforded bad advice by his previous tax return preparer he now finds himself in quite a mess that requires filing amended tax returns going back 3 tax years.  If you are fortunate enough to have both a primary residence and a dwelling unit, make sure that you understand the difference between the two AND properly list your PRIMARY RESIDENCE on your tax returns.

Under Reg. §1.280A-1, a dwelling unit includes a house, apartment, condominium, mobile home, boat or similar property that provides basic living accommodations, such as sleeping space, toilet and cooking facilities. However IRS Reg. §1.121-1(b) states that if a taxpayer alternates between two properties, using each as a residence for successive periods of time, the property that the taxpayer uses the majority of the time during the year ordinarily will be considered the taxpayer’s principal residence.

If you are unsure and state law doesn’t provide clarity on residency requirements the general rule of thumb when dealing with the IRS is to count and document the number of nights spent in each location throughout the duration of the tax year (365 nights total). Which ever location the most nights were spent at can generally speaking for the most part be represented as your principal place of residence.

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Communicating with the IRS Requires Organized + Detailed Note Taking

October 4, 2011 Appeals & Audit Resolution, Basis, IRS Appeal, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, Tax Court, Tax Guidance & Preparation, Tax Problems & Requests

When you call the IRS I suggest doing it as early in the work day as possible to minimize wait time.  Have a pen and pad of paper in hand and ideally be sitting in front of a computer.  Write your questions down in advance of picking up the phone and be calm yet alert. Be sure to record on the top of your notes the date and time of the call.

THE VERY FIRST QUESTIONS YOU ALWAYS WANT ANSWERED:

1. Who are you talking to?

2. How is their name spelled?

3. What is their IRS identification number?

Be polite when asking but do know that the person you are talking to is obligated to provide you this minimal information. This is also particularly important because sometimes when defending against allegations it may prove beneficial to request that the actual taped phone conversation be reviewed for accuracy and without this above information the IRS will simply not comply.  When the IRS provides documented misinformation they can and sometimes do create a basis for you to seek relief from their allegations.

Remember the person on the other end of the phone is obligated and trained (usually very well) to advocate on behalf of the US government. And this person is skilled at using what I refer to as phone tactics in pursuit of their obligations to their employer which manifests itself in a variety of ways and can cause you to experience a variety of emotions if you let it. Take solace in knowing that politeness and calmness usually prevail.

In the US Tax Court Case Stephen Meeh v. Commissioner - TC Memo 2009-18, the Court noted that the IRS settlement officer had a history of being unavailable and misrepresenting or failing to record the taxpayers’ efforts to contact the officer. The Court was of the opinion that both the tax payer and the IRS are partially at fault, but because the IRS records were so “badly muddled,” the appropriate action was to honor the taxpayers’ request for an installment plan.

Lesson here is to take better notes than your opponent because more often than not it distills down to who ever has the more precise and organized documentation gets a ruling more in their favor, unless of course their is an overt violation of the code.

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Burden of Proof

September 30, 2011 Appeals & Audit Resolution, Cancelled Debt, IRS Appeal, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, IRS Levy, IRS Lien, IRS Mediation, IRS Penalties, IRS Penalty and Interest Abatement

The IRS as many of you are painfully aware is often looked upon as accusing first without due process requiring the tax payer to shoulder the burden of proof in regards to his or her innocence relevant to the Internal Revenue Code.  In other words there is no such concept as ‘innocent until proven guilty’ when it comes to IRS audits.  Systematically the IRS conducts correspondence exams routinely requiring tax payers to defend themselves.  That is how the United States Treasury rolls, deal with it. Shifting the burden of proof back onto the IRS is almost always an effective means of navigating through the process in route to a favorable resolution. How does one do that?

Under §6201(d) the taxpayer can shift the burden of proof to the IRS if he or she asserts a reasonable dispute with respect to the income reported on an information return like say for example a 1099-C Cancellation of Debt.

According to §7491(a) (1) the burden of proof is switched from the taxpayer’s responsibility to the IRS if the taxpayer submits
factual evidence contrary to the information return.

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IRS Expanding Audits to Unrelated Tax Years and Tax Matters

September 29, 2011 Appeals & Audit Resolution, Audit Reconsideration, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, IRS Mediation

According to the Treasury Inspector General for Tax Administration (TIGTA) the IRS needs to expand audits to other tax years and tax matters when large dollar amounts are involved in a preexisting audit making it all the more important to know exactly what you are doing when communicating with the IRS. A couple of general rules of conduct are in order.  First you want to create the perception that you are working to help the Revenue Agent or Officer ‘close’ your file which is manifested in timely responses and general communication.  Second you want to answer the SPECIFIC QUESTION ASKED and nothing more.  If the Revenue Officer or Agent asks you what time it is, don’t tell them how to build a watch. This only invites opportunity for further inquiry and probing.

Here’s what the TIGTA Report concluded verbatim and how the IRS responded:

“TIGTA identified three factors that likely contributed to our concerns with expanding audits. First, the IRS strives to keep its audit inventories free of old tax year returns. As a result, tax compliance officers seldom expand an audit to a taxpayer’s prior year return. Second, case file documentation does not indicate that tax compliance officers are taking full advantage of the IRS’s internal sources of information when conducting required filing checks. Third, the IRS’s performance feedback mechanisms are not always taken advantage of to hold tax compliance officers accountable for the quality of their filing checks.

TIGTA recommended that the Director, Exam Policy, Small Business/Self-Employed Division, provide: 1) detailed examples to tax compliance officers on when it would be appropriate to expand audits to prior and/or subsequent year returns, 2) information to tax compliance officers that focuses on using the IRS’s automated information systems to enhance the quality of required filing checks, and 3) additional guidance to first-line managers to improve the feedback provided to tax compliance officers on the quality of required filing checks.

In their response to the report, IRS officials agreed with the recommendations and plan to: 1) provide examples in internal publications that show when it is appropriate to expand audits, 2) conduct a workshop on using IRS automated systems, and 3) improve the feedback provided to tax compliance officers on the quality of their filings checks. Although IRS officials agreed with all three recommendations, they did not agree with the potential monetary benefits associated with the recommendations.

To view the report, including the scope, methodology, and full IRS response, go to:

http://www.treas.gov/tigta/auditreports/2011reports/201130084fr.html.

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Trends in IRS Collection and Enforcement

August 18, 2011 Appeals & Audit Resolution, IRS Audit, IRS Collections, IRS Enforcement, IRS Examination, IRS Mediation, IRS Penalties, Tax Abuse, Tax Fraud

According to a report filed by the Treasury Inspector General for Tax Administration there has been a 19 % increase of enforcement personnel serving in the Collection and Examination function of the IRS since Fiscal Year 2006. Whereas on average overall IRS staffing increased 4 percent during this same period, from 103,811 employees in Fiscal Year 2006 to 107,622 employees at the end of Fiscal Year 2010.  So yes there appears to be a concerted effort to dedicate disproportionate resources to the collection and examination functions inside the IRS.

The Examination function’s recent increase in revenue agents and tax compliance officers resulted in the most tax returns examined over the past five years. The number of tax returns examined increased across the board for individual, corporate, and S Corporation tax returns in Fiscal Year 2010, while the number of partnership examinations decreased. As a direct result of this the number of delinquent tax accounts closed by full payment increased as did the amount collected on delinquent accounts. However, the IRS Collection function received more delinquent accounts than it closed, gross accounts receivable increased, and the number of tax delinquency investigations closed with the filing of a delinquent tax return decreased. In addition, while the number of taxpayers with delinquent accounts and delinquent returns in the Queue decreased, it was offset by an increase in the number of these cases that were shelved or surveyed.

Bottom line is that the situation is going to get worse before it gets better in my humble opinion.  Take heed and file/pay your taxes on time to avoid complications. No recommendations were made to the IRS based on this report. To view the report, including the scope and methodology, go to:

http://www.treas.gov/tigta/auditreports/2011reports/201130071fr.html.

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