It’s Time to Panic!

September 20th, 2022

Today is September 20th. Three weeks from Monday is October 17, 2022. That’s the deadline for individual taxpayers on extension to file their tax returns (unless you’re in a federal disaster area). If you have yet to send your paperwork to your tax professional it’s past the time to do so. Yes, it’s time to panic!

If your return is simple and straightforward, stop procrastinating and get it done and filed. If your return has any sort of complexities, you must start working on it now. Your tax professional needs time to get it done correctly. You need to turn in that paperwork post haste. If you’ve procrastinated, stop, sit down, and get it done–NOW.

Every tax professional I’ve spoken to this year is buried.  Indeed, it may already be too late for your return to be timely filed with many tax professionals. For example, our official deadline was September 15th. We’re not horribly behind, but I can state that if one of our clients procrastinates beyond this weekend there will be issues.  And I can guarantee if you drop off your paperwork with us on October 10th your return is almost certainly not going to be timely filed.

If you file late, it’s as if you never filed your extension. So sit down and get everything done now! Of course, if you like paying a 25% penalty, continue procrastinating.  After all, tax professionals are far less busy after the October deadline.

The Trouble With Identity Protection Verification Notices

September 16th, 2022

The IRS sends two types of Identity Protection Verification Letters: LTR 4883C and LTR 5071C.  If you receive a LTR 4883C, you must call the IRS’s Identity Protection unit so that your return is processed.  If you receive a LTR 5071C, you can generally respond online and have your return processed.

There are three main problems with the verification notices:

  1. Reaching a human at the IRS is extremely difficult;
  2. Tax professionals generally cannot call on your behalf if you receive one of these notices (we can be on the call with you, but the IRS wants the taxpayer to be on the line);
  3. The IRS is not following up with taxpayers who don’t respond to the notices.

Today, I’m going to look at the third issue: the lack of follow-up.  Here’s a real world example.

A client, call him John Smith, filed his 2021 tax return in May.  He owed the IRS $5,000 in tax and paid that and the appropriate amount of interest.  It was the first time Mr. Smith had ever filed a return after April 15th–and there was no extension.  The IRS assessed the late filing and late payment penalties.  Mr. Smith believed he qualified for First Time Abatement and signed an IRS Power of Attorney form allowing me to request the abatement.  I called the IRS to request the abatement (on my 10th try to reach the IRS today via the Practitioner Priority Service, I got through).  The helpful IRS agent asked me if Mr. Smith had filed his 2019 return.  I said he had (I had a copy of it).  She did some digging, and discovered that the IRS had sent an Identity Protection Letter that Mr. Smith never responded to, and his return was sitting in limbo.  Another copy of the letter is going out in the mail to Mr. Smith, so his 2019 return should soon be processed.  Once that happens, we’ll be able to request the abatement for 2021.

Mr. Smith told me he was stunned by what I wrote; he claims he never received the IRS letter.  Unfortunately, the mail isn’t perfect and it is quite possible that he didn’t receive it.  (Indeed, today a different client told me one of his past due returns had finally been processed and there’s a balance due.  I ran an Account Transcript; in theory, the IRS sent notices to him and me in March showing the balance due.  Neither of us received a notice.  But I digress….)

Let’s consider an alternative reality where three or four months after the initial Identity Protection Unit notice is sent a follow-up notice is sent (if the return remains unprocessed).  There’s a better likelihood of the taxpayer responding and getting the return processed–the goal of all involved.  And the cost of this programming change and sending the letter should be minimal.

Unfortunately, that isn’t the reality we live in today.  Instead, there’s no follow-up and it was only by accident that we discovered the issue.  If my client had timely filed his 2021 tax return, we still wouldn’t know about this issue.  IRS: It’s time to start following up on these notices.

Are NFTs Subject to Sales and Other State and Local Taxes?

August 31st, 2022

Let’s say you’re Ralph, and you create a series of Non-Fungible Tokens (NFTs).  You begin selling these NFTs, and each sells for the equivalent of $100,000.  Of course, that income is subject to income tax (it’s an accession to wealth, and clearly income to Ralph).  Is it subject to sales tax?

Some states’ sales taxes cover digital (electronic) items; other states’ sales taxes do not.  There are even some states, such as Oregon, that do not have sales tax and other states, such as Florida, that exempt sales of digital items from sales tax.  But let’s say Ralph resides in Pennsylvania and he sells an NFT to Linda; she also resides in Pennsylvania.  Let’s further assume that Ralph is in the business of selling NFTs.  Does he (a) need to register with Pennsylvania as a retailer for sales tax purposes, and (b) does he need to collect sales tax?

The answer is yes, he does.  The Pennsylvania Department of Revenue released a new sales tax booklet that addressed this issue.  Under Pennsylvania law, “…[S]ales and use tax applies to any transfer of a digital product where the purchaser pays a consideration, unless that transfer is otherwise exempt.”  NFTs are specifically noted as taxable.  That means that Ralph must register as a retailer and collect and remit sales tax.  This income is, because Ralph is in business, also subject to local Earned Income Tax.

Let’s change the facts slightly.  Ralph resides in Oregon, a state without sales tax, and sells an NFT to Linda, a Pennsylvania resident.  Believe it or not, Ralph may still have to register for sales tax in Pennsylvania.  Under the Wayfair Supreme Court decision, out-of-state sellers are, in some circumstances, required to register for sales tax in other states (if they meet minimum threshold requirements).  Let’s further assume that Ralph doesn’t meet that threshold.  In that case, Linda owes use tax (the equivalent of sales tax when sales tax isn’t charged) to Pennsylvania and must include it on her individual tax return.

Pennsylvania isn’t alone in releasing guidance.  Washington state released interim guidance noting that NFTs would be subject to both sales tax and the state’s Business & Occupations Tax.  I strongly suspect NFTs are subject to sales tax in other states, too.

If you’re selling or purchasing NFTs, or you are a company facilitating the sales of NFTs, you should speak with your tax professional regarding handling sales and use tax issues.

Student Loan Forgiveness: Should You File or Wait?

August 25th, 2022

With President Biden’s announcement of forgiving student loans, there are some obvious questions:

  1. Will this be taxed by the IRS?
  2. Will this be taxed by the states with income taxes?
  3. Will this be upheld by the courts?
  4. When will there be guidance on this?
  5. When should impacted taxpayers file?

We have answers to some of these questions, but definitely not all.  First, this will not be taxed federally.  This is quite clear based on the American Rescue Plan Act.  Indeed, issuers are not supposed to send Form 1099-C’s to those with forgiven loans.  However, some states do not conform to the Internal Revenue Code of today.  Thus, on the state level this will be taxable income in some (but not all) states.  Jared Walczak of the Tax Foundation noted that this could be taxed in Arkansas, Connecticut, Hawaii, Idaho, Illinois, Iowa, Kentucky, Massachusetts, Minnesota, Mississippi, New Jersey, Pennsylvania, South Carolina, Virginia, West Virginia, and Wisconsin.  (I haven’t done the research for every state, but it sure looks like a taxable event for Pennsylvania and New York.)

But the big question is one I cannot answer: Will this be upheld by the courts?  I’m not an attorney, but it’s a certainty this will be litigated.  I have my doubts as to this being upheld (the “major questions doctrine” from West Virginia v EPA is a–sorry for the pun–major issue here), and no one will know until the cases are resolved.  I absolutely could see one Court of Appeals ruling in favor of allowing it while another imposes a national injunction.  I expect the Supreme Court to be the arbiter of this, and probably not for several weeks.

As to when there will be guidance: soon.  I would expect it within ten days, but this is just an educated guess on my part.  I actually expect it sooner than ten days, but you never know about Washington.

Finally, the question.  “Russ, I have student loans.  I’m on extension.  Should I file?”  That’s an it depends question.  If your return is set, and there are no tax planning opportunities for the return (you’re single and/or you cannot contribute to retirement plans for 2021), the tax you owe and the income you have will not change; whether you qualify or not is set.  Thus, you can file–whether or not you’re above the income threshold.

The individuals who should wait for guidance are those who still have tax planning opportunities for 2021 (and who are impacted by this).  Generally, those are the self-employed (who can still contribute to retirement accounts such as SEP IRAs) and married couples (who can choose between filing separate and joint).  Of course, if your income is far above the threshold no matter how you file and/or contribute to retirement plans, filing now or after the guidance is released won’t change your eligibility for forgiveness.  It’s only those who might qualify by doing something that should wait.

 

UPDATE: I originally listed New Jersey as a state that I thought where forgiveness would be taxed; however, the Tax Foundation released a new list without New Jersey.  They’re spending a lot more time on the research on this than I am.  Do note that until official guidelines come out, all any of us are doing is speculating.  The official state pronouncements (and those are in the future) will govern.

If You Haven’t Filed Your 2019 and/or 2020 Tax Returns, You Have One Month to Do So and Avoid Late Filing Penalties

August 24th, 2022

Earlier today, the IRS announced extremely broad penalty relief for 2019 and 2020 late-filed tax returns.  Here’s the beginning of the IRS’s press release:

To help struggling taxpayers affected by the COVID-19 pandemic, the Internal Revenue Service today issued Notice 2022-36, which provides penalty relief to most people and businesses who file certain 2019 or 2020 returns late.

The IRS is also taking an additional step to help those who paid these penalties already. Nearly 1.6 million taxpayers will automatically receive more than $1.2 billion in refunds or credits. Many of these payments will be completed by the end of September.

Besides providing relief to both individuals and businesses impacted by the pandemic, this step is designed to allow the IRS to focus its resources on processing backlogged tax returns and taxpayer correspondence to help return to normal operations for the 2023 filing season.

“Throughout the pandemic, the IRS has worked hard to support the nation and provide relief to people in many different ways,” said IRS Commissioner Chuck Rettig. “The penalty relief issued today is yet another way the agency is supporting people during this unprecedented time. This penalty relief will be automatic for people or businesses who qualify; there’s no need to call.”

The relief applies to the failure to file penalty. The penalty is typically assessed at a rate of 5% per month and up to 25% of the unpaid tax when a federal income tax return is filed late. This relief applies to forms in both the Form 1040 and 1120 series, as well as others listed in Notice 2022-36, posted today on IRS.gov.

The returns impacted by this include:

  • Form 1040 (Individual Income Tax Returns)
  • Form 1041 (Trust/Estate Tax Returns)
  • Form 1120 (C-Corporation Tax Returns)
  • Form 1120-S (S-Corporation Tax Returns)
  • Form 1065 (Partnership Tax Returns)
  • Some foreign information returns, such as Forms 5471 and 3520

Let’s say you haven’t filed your 2020 tax return.  You’re being given a golden opportunity to avoid a 25% penalty.  You will still owe the late payment penalty (0.5% of the tax due per month late) and interest, but these pale in comparison to the late filing penalty.  If I were an impacted taxpayer, I would immediately contact a tax professional to get the return filed!  Most tax professionals are extremely busy (especially with the extension deadlines approaching), but things will only be worse in two weeks.

If you did file one of these returns and late and were assessed a penalty, you should receive your refund by the end of September.

On Exchanging Cryptocurrency for Casino Chips (or Cash)

August 22nd, 2022

The high stakes poker world works a little differently than you might think.  Most of the players frequenting these games know each other, and borrowing money from one another is common.  Another common occurrence is the exchanging of cryptocurrency for casino chips.  Let’s look at an example.

Russ, a professional poker player, is playing high stakes, and he’s not having a good day.  He needs another $100,000 to stay in the game.  He asks Alice (another professional poker player), can I send you $100,000 of Bitcoin for $100,000 of casino chips?  (Alice knows that Russ will send her the cryptocurrency.)  Russ logs into his online wallet, transfers the Bitcoin to Alice’s address (her Bitcoin wallet), and Alice hands Russ $100,000 of casino chips.  All is well, right?

Not exactly.  Sure, Alice received $100,000 worth of Bitcoin for $100,000 of casino chips but she now might be guilty of money laundering.  At minimum, a currency transaction report (CTR) might be required.

The anti-money laundering laws are complex, and I’m not an attorney.  But the basic idea is that exchanging one kind of cash-valued item for something considered to be cash requires knowing your customer and following the rules and regulations set by FINCEN (the Financial Crimes Enforcement Network) under the Bank Secrecy Act and the Patriot Act (and there are others, including state laws).  If you regularly take in cash (or a cash equivalent) and are exchanging it for something else (or vice versa), you may fall under the definition of non-bank financial institution.  And a single transaction (like the one above) may make someone guilty of money laundering.

So let’s say you’re playing high stakes poker, and someone wants to exchange some Bitcoin for casino chips.  Should you do this exchange (knowing you will get the cryptocurrency)?  My advice is that because of the anti-money laundering laws you should not.

IRS: Let’s Spend $5 (At Least) to Disallow $0.11

August 21st, 2022

When you file an amended return, you’re actually making a claim for refund.  Tax professionals have been filing (for their clients) amended payroll tax returns (Form 941) to obtain the Economic Recovery Credit (ERC).  I’ve done two (so far), and have a few more to go.  Another tax professional filed one claiming a $19,746.61 refund.  The IRS partially disallowed it, so a five-page letter was sent.

The disallowance? 11ȼ.  No, you didn’t misread it: eleven cents.

Why, IRS, are you doing this? This is the literal example of penny-wise and pound-foolish.  I wish I could tell you why this is happening, but….

Square Pegs and Round Holes: Tornado Cash, Anti-Money Laundering, and Crypto

August 17th, 2022

On August 8th, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) went after virtual currency “mixer” Tornado Cash.  Tornado Cash was sanctioned, and as the Treasury’s press release notes,

As a result of today’s action, all property and interests in property of the entity above, Tornado Cash, that is in the United States or in the possession or control of U.S. persons is blocked and must be reported to OFAC. In addition, any entities that are owned, directly or indirectly, 50 percent or more by one or more blocked persons are also blocked. All transactions by U.S. persons or within (or transiting) the United States that involve any property or interests in property of designated or otherwise blocked persons are prohibited unless authorized by a general or specific license issued by OFAC, or exempt. These prohibitions include the making of any contribution or provision of funds, goods, or services by, to, or for the benefit of any blocked person and the receipt of any contribution or provision of funds, goods, or services from any such person.

Before I get into the meat of this post, let me explain what a mixer is.  The idea of a mixing service is to literally mix “good” cryptocurrency with “bad” cryptocurrency so that no one knows if you have bad cryptocurrency.  Tornado Cash allegedly took in Ethereum (ETH) from people who just wanted to anonymize their transactions (which is not illegal) and from others who were criminals or state actors such as North Korea, mixed it all together, and it became very difficult (if not impossible) to tell good crypto from bad crypto.

What is the legal basis of Treasury’s sanctions? Anti-money laundering laws.  Let’s go back to the days of the mafia.  Assume you have $500 million of tainted cash you’d love to invest (and have turned into “good” cash).  In John Grisham’s The Firm the mafia used a tax law firm to money launder the funds in the Caribbean (with about 25% of each ‘shipment’ lost to bribes and corruption).  Today, moving such cash around to be legal is tougher than ever as most countries exchange information with each other.  The laws that prohibit this date from this time (and are part of the Bank Secrecy Act and the later Patriot Act).

That takes us to cryptocurrency. The Financial Crimes Enforcement Network (FINCEN) ruled that cryptocurrency is a type of currency and is subject to the anti-money laundering laws.  This means firms anywhere in the world who deal with Americans must have anti-money laundering law practices for cryptocurrency.  Similar laws exist in most of the world.

But isn’t cryptocurrency anonymous?  No, it’s pseudonymous.  The blockchain is permanent, so if you can figure out someone’s address you can trace people.

Not only was Tornado Cash sanctioned, a developer of the software was arrested in the Netherlands.  Now, I am not an attorney (and I am not in the Netherlands), but I was told by an individual who is familiar with the Netherlands’ anti-money laundering laws that they are similar to those of the US, only tougher.  But how can writing software (or ‘code’) be illegal?

I suspect the issue isn’t the writing of the software; rather, it’s allowing the software to be used and being active in the website allowing the mixing.  Let’s say I write software to allow Bitcoin to be mixed.  I post the software on an open-source forum.  That’s probably not illegal.  But what if I now actively market this product, don’t do anything to comply with anti-money laundering laws even though I don’t take any profits from the mixing: Have I committed a crime?  Almost certainly I have (probably multiple felonies).

That’s the problem cryptocurrency advocates face: the real world is intruding, and anti-money laundering laws are part of the real world.  Here, cryptocurrency is a square peg and the round holes are the anti-money laundering laws.  While I do see headlines stating, “Coin Center prepares legal challenge to Treasury’s Tornado Cash sanctions,” I highly doubt any such challenges will be successful.  FINCEN’s pronouncement that cryptocurrency is a currency for anti-money laundering law purposes seems reasonable (and almost certain to pass Chevron muster), and there’s nothing unconstitutional with the anti-money laundering laws.

But, Russ, won’t that will lead to cryptocurrency being centralized?  Won’t this just defeat the purpose of cryptocurrency and it will just become (more or less) another form of currency–just digital and online?  Yes, that’s the likely result.  This may not please the Libertarian cryptocurrency advocates but I don’t see anti-money laundering laws being overturned during my lifetime.   It appears the freewheeling age of cryptocurrency is ending sooner rather than later.

Answering to a Higher Authority

August 10th, 2022

Robert Brockman, the 2020 Tax Offender of the Year, passed away last weekend.  Mr. Brockman was facing a 39-count indictment for tax fraud and related charges; his trial was set for this coming February.  Mr. Brockman’s attorneys argued that he was incompetent to stand trial due to dementia; however, the judge had ruled him competent.  The criminal case is now moot—Mr. Brockman is answering to a higher authority; the civil case will continue against his estate (the IRS attempting to obtain back taxes, penalties, and interest).

My condolences to his family.

Do IRS Employees Know the Postmark Rule?

July 22nd, 2022

So what’s the postmark rule?  The IRS notes this on their website:

Your return is considered filed on time if the envelope is properly addressed, has enough postage, is postmarked, and is deposited in the mail by the due date. If you file electronically, the date and time in your time zone when your return is transmitted controls whether your return is filed timely.

Of course, the IRS website doesn’t govern; the Tax Code and regulations promulgated under the Code do.  And here the IRS website exactly matches the law under IRC Section 7502 and 26 CFR § 301.7502-1.  So why aren’t IRS employees aware of this rule?  Let me first explain why I’m asking.

We normally file business return extensions electronically.  However, every year there are a few that must be paper-filed (mailed to the IRS).  On March 11th we mailed an extension for an S-Corporation (call it Acme).  The IRS had yet to process Acme’s S-Corporation election paperwork; when I attempted to e-file the extension, it failed.  So we mailed it certified mail, return receipt to the IRS on March 11th; it was received at the IRS in Ogden, Utah on March 17th.  This past week, Acme received a letter from the IRS stating we cannot accept your extension because it was filed after the deadline.

The owner of Acme was, of course, upset with me until he saw that I did file the extension timely; eventually the extension will end up being valid.  But (a) I had to waste time on a conversation with the owner of Acme, (b) the IRS wasted time and money in sending out the notice, and (c) will waste additional time removing the penalty and noting the extension was timely filed.

And I’m not alone in having clients impacted by this.  On Twitter, another tax professional noted he’s been receiving a “steady stream” of notices denying extensions for business returns.  Why has this happened?

I can only think of two reasons: either the IRS is separating envelopes from extensions (so that the IRS employee processing the mailed extension has no idea when it was mailed and only knows the receipt date) or the IRS employee processing the extensions aren’t aware of the rule.  Neither of these reasons is acceptable, but it appears that’s the reality today.

What does this mean for taxpayers?  First, you must use certified mail, return receipt requested in sending anything to the IRS (or any other tax agency) by mail.  Yes, my envelope mailed on March 11th from Las Vegas should have made it to Ogden by the 15th (it’s about a 6 1/2 hour drive from my office) but it didn’t.  Because I have proof of the postmark there won’t be any issues (in the long run).  Had I not mailed it certified mail, there would be no proof.  Given current IRS practices, this is essential.  Second, where possible e-file.  With electronic filing, there’s absolute proof of the date and time of filing.