Larry's Tax Law

As the Chair of the Oregon Tax Institute (OTI), I would like to invite you to the 14^th Annual Oregon Tax Institute scheduled for June 5 & 6 in Portland, Oregon.  We have grown the OTI from a local tax forum into a preeminent tax institute for both tax attorneys and CPAs.  Our topic coverage and faculty this year are fabulous and each one of our speakers is a nationally recognized expert in tax law.  This year’s OTI will be on par with the best tax institutes in the country.      

I hope you will join us in June and I encourage you to sign up for OTI as soon as possible.  Also, please feel free to share this information with your colleagues.

Best,

Larry

On March 18, 2014, the Internal Revenue Service announced that one of its employees had taken home a computer thumb drive containing unencrypted data relating to 20,000 agency workers.  The employee then plugged the thumb drive into an unsecure home computer network.  While the thumb drive did not contain any data relating to persons outside the Internal Revenue Service, it still put 20,000 individuals at risk of theft of identity and/or financial assets.

Commissioner John Koskinen described the data breach as an “isolated event.”  Isolated or not, his statement likely does not give any solace to the 20,000 affected IRS workers.  This data breach may have been narrower in scope than the recent Target Corp. data breach, but it nevertheless illustrates how vulnerable we are to data breaches and potential theft of identity and/or financial assets in this electronic era.

We have to constantly safeguard the personal information we receive from our clients, as well as our own personal information.   Loss of client information could easily lead to liability.

On March 10, 2014, the Internal Revenue Service (“Service”) issued Notice 2014?17 (“Notice”).  The Notice focuses on the tax treatment of per capita distributions made to members of Indian tribes from funds previously held in trust by the Secretary of the Interior and which were derived from interests in trust lands, trust resources and/or trust assets.

The Department of Interior (“DOI”) is responsible for holding these trust funds on behalf of federally-recognized tribes and certain individual Indians who have an interest in trust lands, trust resources, or trust assets.  The Office of Special Trustee within the DOI is tasked with the responsibility of managing these funds.

Prior to 1983, the DOI made per capita distributions of the trust funds directly to the members of the tribes.  In 1983, pursuant to the Per Capita Act, however, tribes were given authority to receive the trust funds and hold them in tribal trust accounts for subsequent per capita distributions to members.  So, now the DOI can distribute the trust funds to the tribes who, in turn, make the per capita distributions to members.

The law appears fairly clear in that per capita distributions of these funds from the DOI to tribal members are excluded from gross income.  The issue, following the enactment of the Per Capita Act, is whether per capita distributions received by members from their tribes are likewise excludable from gross income.

A California couple was recently walking their dog when they noticed a rusty tin container protruding from the soil next to a tree in their garden. Upon investigating the matter, they discovered several tin cans buried in the soil. The cans contained 1,400 gold coins. The coins, which are said to be in mint condition, date back to the 19th century. Experts have placed a preliminary value on the coins of more than $10 million. For obvious reasons, the couple is keeping their identity and the location of their home out of the media.

It appears the couple is legally entitled to retain the treasure trove. A law professor from the University of North Carolina, John Orth, recently told TIME Magazine, because the coins were found on the couple’s own property, they will likely be able to retain them.

Like the winner of a lottery, the California couple will be required to declare their new fortune as gross income for income tax purposes. This is not the first time a person has been faced with good fortune and a corresponding tax bill.

In Cesarini v. U.S., 23 AFTR 2d 69-997 (Northern District of Ohio, 1969), a couple purchased a piano in 1957 for $15. In 1964, while cleaning the piano, they discovered almost $4,500 in U.S. currency.

Following up on my summary of Congressman Dave Camp's discussion draft of the Tax Reform Act of 2014, I had the opportunity to discuss the subject with Colin O'Keefe of LXBN. In the brief interview, I describe some of the proposed tax provisions that will impact individual taxpayers and corporate taxpayers.

On March 3, 2014, the Internal Revenue Service published Announcement 2014-13 (“Announcement”).  The Announcement sets forth the disciplinary actions the Office of Professional Responsibility (“OPR”) recently took against practitioners.

The OPR is responsible for interpreting and applying the Treasury Regulations governing practice before the Internal Revenue Service (commonly known as “Circular 230”).  It has exclusive responsibility for overseeing practitioner conduct and implementing discipline.  For this purpose, practitioners include attorneys, certified public accountants, enrolled agents, enrolled actuaries, appraisers, and all other persons representing taxpayers before the Internal Revenue Service.

In essence, Circular 230 sets forth the “rules of the road” for tax practice before the Service.  Circular 230 cases generally revolve around a practitioner’s fitness to practice.

According to an article published by Kristi Eaton of the Associated Press (“AP”) on February 20, 2014, NBA star Kevin Durant filed a lawsuit against his former accountant, Joel Lynn Elliott, CPA, for alleged mistakes made in the preparation of income tax returns.  As a result of the mistakes, Durant alleges he will have to amend certain income tax returns, pay additional taxes, and possibly be subjected to penalties.

 The lawsuit, filed in California, where CPA Elliott practices accounting, alleges that the accountant made numerous errors in the preparation of Kevin Durant’s income tax returns, including deducting as business expenses the costs of personal travel and the costs of a personal chef.  According to the AP, the complaint provides with respect to the travel expenses:  “In preparing a client’s tax returns, a reasonable prudent accountant would have conducted a basic inquiry and sought documentation to confirm that each travel expense for which a deduction was recorded was truly business related.” 

As a general proposition, if a tax return preparer gives a client incorrect advice about the deductibility of certain expenses or mistakenly includes non-deductible expenses on the client’s tax return, what are the client’s damages? The taxes, the interest on the underpayment of taxes, the penalties and/or the cost to amend the tax return?   If the client ends up engaging a new preparer to amend his or her tax return, and pays the tax, interest on the underpayment of taxes and penalties, it seems logical the preparer could be liable for the cost of amending the returns and the penalties.  The client owes the tax; nothing the preparer did likely changes that conclusion.  Unless the client would have refrained from incurring the non-deductible expenses in the first place had he or she been given a correct recitation of the tax laws, how can the preparer be liable for the tax?   Interest is a bit trickier.  Since the client got the use of the money (from the time the taxes were originally due until actually paid), one can argue the preparer is not liable for the interest.  Assuming the preparer gave incorrect advice or mistakenly included non-deductible expenses on the client’s tax return, he or she will likely be liable for the cost of amending the tax return and the penalties.  Obviously, there may be facts that would cause a court to rule differently.

The Estate of Michael Jackson is battling it out with the IRS in a dispute over the value of the late pop star’s estate.  To borrow the titles from two of Michael Jackson’s hit songs, the Service is alleging the estate is “Bad” in that it substantially understated the value of the decedent’s assets, while the estate is telling the Service that it is wrong and it should simply “Beat It.” 

What is the battle about?  The answer is simple:  Lots of money!  The Service asserts the understatement results in the estate owing taxes of over $500 million more than actually reported on the estate’s tax return, plus almost $200 million in penalties.  If the Service is correct, the State of California will likely have its hand out, asking the estate for a significant amount of additional taxes, plus penalties.

According to the petition filed by the estate in the United States Tax Court, representatives of the estate placed a date of death value on the decedent’s property at a little over $7 million.  The IRS, on the other hand, asserts the value was closer to $1.125 billion dollars.  If the Service is correct, the estate was undervalued by more than 160 times.

House Ways and Means Committee Chairman Dave Camp (R-Michigan) issued a discussion draft of the “Tax Reform Act of 2014” last week.  The proposed legislation spans almost 1,000 pages and contains some interesting provisions, including, without limitation, the following:

Individual Taxpayer Provisions

• • Consolidation and simplification of individual income tax brackets.  The current seven tax brackets would be consolidated into three brackets—namely, a 10% bracket, a 25% bracket and a 35% bracket.  High-income taxpayers would be subject to a phase-out of the tax benefit of the 10% bracket.  In addition, the special rate structure for net capital gains would be repealed.  In its place, non-corporate taxpayers could claim an above-the-line deduction of 40% of adjusted net capital gain.

• • Expand the standard deduction (to $22,000 for joint filers and $11,000 for individuals) and modification of available itemized deductions, including:

• • Repeal of the 2% floor on itemized deductions and the overall limitation on itemized deductions.

• • Reduce the itemized deduction for home mortgage interest to $500,000.

• • Repeal of the deduction for personal casualty losses.

• • Repeal of the deduction for unreimbursed medical expenses.

• • Repeal of the deduction for state and local taxes not paid in connection with business or investment.

• • Simplification of the rules surrounding charitable deductions.

• • Repeal of the exclusion for employee achievement awards.

• • Repeal of the deduction for moving expenses.

• • Reinstating the former provision allowing the cost of over-the-counter medications to be reimbursed through tax-favored health accounts.

• • Consolidation and simplification of tax benefits for higher education.  A single educational tax credit of up to $2,500 annually would be made available that could be used for up to 4 years; however, the current deductions for educational expenses and interest on student loans would be repealed.

• • Elimination of the income limitations on Roth IRAs and prohibiting new contributions to traditional IRAs and non-deductible traditional IRAs—effectively forcing all new IRA contributions to be Roth contributions.

• • Repeal of the exception to the 10% early withdrawal penalty for withdrawals from retirement plans and IRAs used to pay first-time home buyer expenses (capped at $10,000).

• • Elimination of the deduction by the payor for the payment of alimony and elimination of the inclusion in income by the recipient.

• • Repeal of the individual AMT.

• • IRC Section 1031 would be repealed.  Consequently, tax deferral from like-kind exchanges would no longer be permitted.

• • Simplification of rules surrounding in-service distributions, hardship withdrawals and required minimum distributions from retirement plans.

• • Encouraging Roth contributions in 401(k) plans by requiring all 401(k) plans to offer Roth accounts and requiring larger plans to treat all employee contributions as Roth contributions once an employee had contributed one-half of the annual contribution limit.

I Won the Gold Medal in Sochi. Awesome! Do I Owe Taxes on the Value of My Prize? 

As a general rule, in accordance with IRC § 61, the value of any prize or award a taxpayer receives is subject to taxation.  IRC §§ 74 and 117 provide limited exceptions to this general rule.

IRC § 74 specifically excludes from the income of the recipient certain employee achievement awards and certain prizes or awards transferred to charitable organizations prior to receipt.  IRC § 117 specifically excludes from the income of the recipient “qualified scholarship” proceeds.  These exceptions are subject to rigid qualifications. 

The value of prizes and awards which do not come within the parameters of these limited exceptions are subject to taxation.  Consequently, as we know, the winning ticketholder of the lottery is taxed on his or her winnings.  The recipient of the Nobel Prize is subject to taxation on the cash prize he or she receives.  Likewise, the value of the ring received by each of the members of the Seattle Seahawks this year for winning the Super Bowl is subject to taxation.  Also, the value of the rings received by each member of the Miami Heat for winning the NBA championship in 2012 and 2013 is subject to taxation.