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- Written by: Kathleen M. Lach
The decision as to whether to file a joint federal income tax return with one's spouse is not one to be taken lightly. Yet, it is a decision that is frequently made without sufficient consideration, and the consequences can be devastating for the unsuspecting spouse.
Case No.1: John is a self-employed consultant, and in 1991 married Lisa Sudby. By August of 1993, Lisa and John separated, and in October of 1993, Lisa filed for divorce. The divorce was finalized by June of 1994. The couple filed joint federal income tax returns for 1991, 1992, and 1993. John was audited by the IRS. This resulted in adjustments to income for John's business and ultimately adjusted the couple's joint federal income tax obligation. Lisa was jointly and severally liable for the additions to tax and attendant penalties assessed as a result of the audit, with ex-husband John for years 1992 and 1993 since they filed joint returns for those years.
[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]
Case No. 2: Bob is an investment banker. His wife Patty is a stay-at-home mom. Bob’s business involves multimillion-dollar transactions, and his balance sheet reflected deposits or withdrawals in any given day that fluctuated by hundreds of thousands of dollars. Patty has no understanding of or interest in investment banking.
Bob and Patty have filed joint federal income tax returns since they were married. Patty signs the returns each year prior to filing, without review.
In 2001, Bob received notice that the IRS was opening an examination of a transaction he engaged in at the advice of a colleague at the time. Sometime in 2003, the auditor determined that the transaction at issue was a sham. Two of the promoters of the transaction faced prison time. Bob and Patty faced an increase of $1.2 million in tax to their 1998 federal income tax return, plus penalties and interest.
The Internal Revenue Code provides relief from joint and several liability under certain circumstances pursuant to IRC §6015. Section 6015(b) is frequently referred to as the “innocent spouse” provision. Section 6015(c) provides for separation of liability, and takes into consideration the allocable income of each spouse on the jointly filed return. Finally, section 6015(f) provides relief under considerations of fairness or "equity."
Section 6015(b) provides relief for all joint filers who satisfy the five requirements listed in that section. A taxpayer must satisfy all of the requirements of subparagraphs (A) through (E) to be entitled to relief under section 6015(b)(1).1 Section 6015(c) allows a spouse who filed a joint tax return to elect to limit his/her income tax liability for that year to his/her separate liability amount. However, section 6015(c) applies only to taxpayers who are no longer married, are legally separated, or have not lived together over a twelve-month period. A taxpayer may also seek relief under section 6015(f), which authorizes the Service to grant equitable relief from joint and several liability when relief is unavailable under section 6015(b) and (c).
Except for the knowledge requirement of section 6015(c)(3)(C) (the provision disallowing election of separate liability to a spouse with actual knowledge of the item giving rise to the deficiency), the taxpayer bears the burden of proving that he/she has met all the prerequisites for innocent spouse relief.2
1. IRC §6015(b)
IRC §6015(b) lists the conditions that must be satisfied in order for relief to be considered. If each condition is met, the requesting spouse is relieved of the tax liability for that year to the extent the liability is attributable to the understatement.3
The code section also provides for apportionment of relief. If the requesting spouse establishes that he or she did not know about a portion of the understatement, relief may be granted to the extent that the liability is attributable to that portion of the understatement.4 Relief under this code section is available only in audit situations, where as a result of an IRS examination of a return, it determined that there was an "understatement" of tax for the tax year under examination.
2. IRC §6015(c)
IRC § 6015(c) provides relief for taxpayers who are no longer married or who are legally separated or not living together. If relief is available under this section, the individual's liability for any deficiency assessed for the return at issue will not exceed the portion of the deficiency allocable to the individual.5 The requesting spouse has the burden of proof in establishing the portion of any deficiency allocable to him or her.6
Under section 6015(c), the standard to be met is actual knowledge. The determination does not involve the facts as they apply to “constructive” knowledge, or an individual’s “reason to know” in connection with the deficiency.7
3. IRC §6015(f)
Finally, Congress enacted a "last resort" provision to enable relief in situations where section 6015(b) or (c) do not apply. IRC §6015(f) provides for “equitable relief.” Under section 6015(f), relief may be granted if:
(a) Taking into account all the facts and circumstances, it would be inequitable to hold the individual liable for any unpaid tax or any deficiency.
(b) Relief is not available to such individual under subsection (b) or (c).8
Relief under 6015(f) often turns on an analysis of knowledge and hardship, along with significant benefit, factors also considered in the above analysis of section 6015(b).
Where does this leave Lisa and Patty? The initial analysis must focus on the sections of 6015 under which they may qualify for relief. All applicable code sections should be elected on Form 8857. A request is initiated by completing IRS form number 8857, Request for Innocent Spouse Relief, and it was filed with the designated IRS Service Center. If relief is requested under section 6015(a) or (b) it is automatically considered under 6015(f). If relief is requested under 6015(f), it is not automatically considered under either of the other provisions if they are applicable.
Lisa is divorced from John. They have been divorced for more than twelve months. The liability is a result of an understatement of tax. She is eligible to file for relief under IRC §6015(c), as well as 6015(b) and alternatively under 6015(f). The specific facts of Lisa’s case will determine whether she will be granted relief.
Patty is still married to Bob. The liability is due to an understatement of tax. She is eligible to file for relief under IRC § 6015(b), and alternatively under 6015(f). The most significant hurdle for Patty to overcome is that she had no knowledge or reason to know of the understatement of the tax.
This provision is an important consideration for practitioners, particularly practitioners who represent married individuals, to assure that their rights are protected, and that all potential avenues for relief in liability cases are considered.
Kathleen Lach is a Partner in the Tax and Litigation Departments of Arnstein & Lehr LLP. She represents clients before a variety of different tax authorities, including the Internal Revenue Service, the Illinois Department of Revenue, and the Illinois Department of Employment Security.
1. Kling v. Commissioner, T.C. Memo 2001-78 (March 30, 2001).
2. Cheshire v. Commissioner, 2002 WL 200612 (5th Cir.) See also, Reser v. Commissioner, 112 F.3d 1258, 1262-63 (5th Cir.1997).
3. 26 U.S.C. 6015(b)(1)
4. 26 U.S.C. 6015(b)(2)
5. 26 U.S.C. 6015(c)(1)
6. 26 U.S.C. 6015(c)(2)
7. 26 U.S.C. 6015(c)(3)(C); See also, Cheshire v. Commissioner, 115 T.C. 183 (2000), affirmed, 2002 WL 200612 (5th Cir.)
8. 26 U.S.C. 6015(f)
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- Written by: T. Steel Rose, CPA, ACS Editor
Here are three quick tips and tricks to help tax professionals manage, enhance and expand their practice, including IRS and AICPA tax tools and a suggestion on how to apply them.
IRS Tax Tools
Reliable resources to answer common tax questions are worth their weight in gold. Two such tools are the IRS Tax Map and the IRS Interactive Tax Assistant tool. The Tax Map provides tax law information integrated with related tax forms, instructions and publications. The Assistant Tool answers specific scenario questions but does not have 2015 included as this is being written. While both are slow to the point of timing out, they are reliable resources and worthy of a spot in a tax professional’s toolbox.
AICPA Marginal Tax Rate Calculator
Helpful tools are available to enhance the work you already perform. The AICPA provides a Marginal Tax Rate Calculator to show clients and new staff members the effect of deductions and tax credits on the actual tax rate: http://www.360financialliteracy.org/Calculators/Marginal-Tax-Rate-Calculator. Whether clients are in the 15% or 39.6% tax bracket, it helps to show them their effective tax rate of tax decisions, especially before year-end. This calculator is one of several provided by the AICPA at http://www.360financialliteracy.org.
Savers Credit
The marginal calculator is especially useful for seeing the impact of tax credits over deductions, which brings me to a tip to help expand your practice. You can offer to take a look at your client’s parents and adult children’s returns to show them the tax saving potential of the Savers Credit. If the child is over 18 years old and five months out of college this credit can work as an above-the-line deduction and a credit. Code Sec. 25B can potentially save a married couple filing a joint return up to $1,000 when applied to the limit of $2,000 of qualified retirement savings contributions. The 2015 limitations are 50% if the taxpayer’s AGI is below $36,500, 20% if the taxpayer’s AGI is between $36,500 and $39,500, and 10% if the taxpayer’s AGI is between $39,500 and $61,000 (Rev. Proc. 2014-70). Married couples with AGI exceeding $61,000 may not claim the credit. Take a look at form 8800 to determine the aggregate amount of retirement plan distributions that may reduce the credit.
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- Written by: T. Steel Rose, CPA, ACS Editor
A great migration for CPA firm software is beginning again. It’s reminiscent of the first major migration when stand-alone tax software took over the desktop in 1991 revolutionizing professional tax preparation. By 1999 QuickBooks was described as a modern business miracle ushering in the operating system migration to Windows with or without our favorite tax software. A number of vendors decided not to make the technology investment and sold out.
The latest migration has the attention of CPA technologists who have been forecasting the coming of the cloud for the last five years. The cloud is not the only migration; a transition is also occurring which dramatically reduces the cost of tax software. The combination of stronger capability and lower price has created a great migration to affordable tax software. Small firm owners who have used several tax software packages over the years are now considering the cloud for tax prep. After several tax seasons they found their tax software solution acquired by a larger competitor. This provided a more robust tax prep feature set in most cases and, over time, a more robust price tag.
I talked with two CPA firm owners at the 2015 California Accounting & Business Show and Conference in Los Angeles who confirmed they had made the switch to tax software which cost them $1,100 a year versus the $16,000 they were paying annually. Both CPAs confirmed their prior vendor offered substantial discounts to retain them as customers but it was not enough to keep them from making the switch. Both said the support during tax season was a major improvement with the new software. Research revealed 10 more practitioners making the switch.
Concerns about making the change focused on the learning curve. After several staff members grow accustomed to the way the legacy tax prep software package works, they may be loath to making a change. “For 12 complicated returns, I still use my prior package on a per return basis,” one Woodland Hills CPA said.
The rhetoric to move to the cloud is no longer just a paperless promise. Most CPAs absorb that software as a service (SaaS) is another way of saying, “you can never own this software; you can only rent it.” Nevertheless the cloud model is catching on. It would be hard to find a CPA who doesn’t utilize cloud-based payroll. The cool thing about payroll is the evolution of price and services. Heffy Provost, the new vice president of product operations at CCH, recommended attendees of his presentation at the California Accounting Show visit the ZenPayroll exhibit. Provost suggested ZenPayroll commoditized payroll and believes tax prep could also be commoditized. To save you time, ZenPayroll offers very easy to use payroll at half the cost. I was intrigued by ZenPayroll’s price, but not enough to switch to it after seeing the job posting and HR functions in ADP.
While all accounting functions may not move to the cloud because of security, there are advantages of gaining functionality that was once unavailable. AppRiver permits Office 365 Plus use on a per month basis. Gravity Software provides the use of Microsoft Dynamics on a per month cloud delivery method. Early cloud pioneers seem to come from San Diego, take Cloud9 Real Time, and Abacus Data Systems for example. The original incentive was a way to cloud-host the desktop version of QuickBooks before Intuit crafted a desirable cloud-based QuickBooks system of their own. Companies like Gravity and Abacus Data offer robust accounting packages. Abacus Data Systems has battle tested their cloud based accounting and time and billing in law office practice management.
Potential migrations were also predicted at the California Accounting Show by technology futurist Rick Richardson, CPA during his keynote presentation. Richardson said, “by 2020 there will be no more checkbooks or CDs and 25% of payments will be made with ApplePay.”
Richardson spoke about Tableau Software and said it is better than Excel. Any tool better than Excel should be music to an accountant’s ears. Tableau is a tool for Excel which displays data more graphically.
When contemplating migrating to the cloud consider the independent www.technologythisweek.net by Richardson and www.asaresearch.com by J. Carlton Collins, CPA. When it comes to migrating tax prep software and saving $14,900 a year consider the words of the Woodland Hills CPA who said, “What are you waiting for?”
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- Written by: T. Steel Rose, CPA, ACS Editor
The recent 2015 California Accounting & Business Show and Conference featured presentations covering new developments and best practices from leading accounting professionals. One particularly profound presentation was made by Chris Frederikson, CPA of 2020 Group USA and Frederikson-Crawford CPAs about new technology including outsourcing tax returns to increase revenue. Frederiksen has been engaged in public accounting for over 50 years and as CEO of 2020 Group USA has spread his knowledge with seminars and consulting.
Over the course of his presentation, Frederiksen made several points about becoming more efficient as a CPA saying one of the biggest mistakes CPAs make is “not investing in technology.” As an example he described how each desk in his firm uses four monitors. I felt the real game-changing information for many CPAs was about how all of the tax return preparation in his firm is outsourced. Frederiksen mentioned two companies which handle outsourcing: SurePrep and Xpitax.
SurePrep is based out of Irvine, California and Xpitax is out of Braintree, Massachusetts. A third firm, Pransform, is based in Chicago. SurePrep and Xpitax outsource returns to tax preparers in India. Pransform utilizes tax preparers based in Thailand. This outsourcing raises the issue of data security. Pransform’s Chief Operating Officer, Hitendra R. Patil, addressed the subject for Pransform’s solutions stating, “We do not keep any client data on our office servers overseas. We simply securely remote login to our clients' tax software to prepare the returns. In other words, the data always remains with the CPA firms.”
Thomas E. Huckabee, CPA has been in practice for 35 years and outsources returns using Pransform. Based out of San Diego, Huckabee’s specialty includes trusts, and counseling small businesses. Huckabee feels the pressure all tax accountants do because tax returns all come due at the same time.
“Technology helped until 2013, when previous technology applications failed. During tax season 2013 we had to produce returns on a manual basis,” said Huckabee. The system was not working to produce accurate stock transactions, W-2s and 1099s. His clients have a lot of stock transactions, but in 2013 it did not populate correctly. His tax provider suggested solutions but could not correct it. For two years it worked well, but did not in 2013. “The scanning in process was not working. Admin time was spent on Adobe, and our network, and our computers, but it was still not close to accurate,” said Huckabee.
Whether it was the computers, the network, or the software, technology did not solve the problem turning tax season into a nightmare. To solve the problem Huckabee decided to work with humans, rather than just depend on technology. Huckabee asked his IT people to check the systems and security of Pransform. “Most of the accountants are in Thailand,” noted Huckabee. “They work while I sleep.” Each day his CPA firm reviews the returns and gets them ready for delivery.
Huckabee’s firm uses a standardized method to organize and turn source documents into pdfs and deliver them to Pransform. They have limited access to Huckabee’s network for his tax program and QuickBooks to compile the tax return. Pransform provides core proficiencies to produce 1120s, 1065s, 1040s and 1041s and perform QuickBooks work, highlighting open issues in a memo.
“We provide a consent notice to clients to meet IRS requirements,” Huckabee said. “A larger notice for 1040s and a smaller one for business clients explaining we are sending the data off shore. It is a signed consent form.”
“The experience has been only positive,” Huckabee continued. “In 2012 all the admin time produced no results from technology. Communications with Pransform continue to enhance results. The other benefit is I don’t have to train them. I had the best tax season in terms of hours and profitability.”
Huckabee can actually talk to the person working on the return but often does not need to. “We can all go home at 6 p.m., while the Thai accountants begin their work day,” Huckabee reported. When complications did occur, Huckabee noted their response. The 2014 tax season was especially tough because his mother entered hospice. Pransform’s production was not working as well as he hoped and he needed more from them. He called and Pransform responded positively. The result was “more production, more sleep and more money,” Huckabee said.
Huckabee’s advice for other CPAs concerning offshore work is to vet the tax prep outsource vendor and ensure top notch data security. There is a normal reluctance to change, but as Frederiksen advised in his presentation, when a solution is this obvious, “get over it and get on with it.”
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- Written by: Robert E. McKenzie, JD
As the political season enters a fever pitch, some misguided candidates are calling for the abolishment of the IRS. Although the political rhetoric draws applause it ignores one uncontested fact: the U.S. government needs revenue to provide services to the public. Someone has to pay for our national defense, Social Security, Medicare and our highways. In a recent speech John Koskinen, Commissioner of IRS, affirmed that logic by stating, “Somebody has to collect the money and somebody has to make sure when you fill in the small card that you filled in the right numbers. You can call them something other than the I.R.S. if it’ll make you feel better.”1
Whether the U.S. continues its current system or adopts a flat tax or national sales tax, some agency must assure the integrity of returns filed by taxpayers and pursue the non-compliant. Although about 83% of Americans fully comply with the current tax system, 17% of the public chooses not to comply. In the past a vigorous IRS enforcement regime created an environment that has kept the U.S. compliance rate among the highest in the world. One only needs to look to Greece, a country with a corrupt tax enforcement agency and a populace that views compliance with tax laws as voluntary not mandatory, to understand the impact of lax tax regimes. As all the world knows, Greece is on the brink of bankruptcy caused in no small part by the refusal of its populace to pay their taxes. In the current environment where politicians use the IRS as a whipping boy one must project at some point this country may become a failed country like Greece because it chose not to adequately fund its tax agency and enforce its tax laws.
Congress has cut the IRS budget by more than $1 billion dollars over the past five years. That represents a 20% reduction in its budget in inflation-adjusted dollars and seriously imperils our U.S. tax system. The Treasury Inspector General reports less than 40% of taxpayers calling the IRS for advice during the 2015 tax season were able to speak to an IRS representative for tax advice. The IRS has also announced it is only able to answer routine tax questions and not difficult questions. It no longer provides any tax preparation assistance to taxpayers.
In the enforcement area the budget cuts have had direct impact on the number of tax returns audited by the IRS. The 2014 audit rate was about .8% down from over 1% just five years ago. There has also been a 20% reduction in IRS criminal investigations in the last year; and the rate at which the IRS is able to levy assets of taxpayers who chose not to pay their taxes is now at 50% of the rate three years ago. A Washington Post article recently reported the Dallas IRS office could not pursue individual taxpayers owing less than $1 million because of lack of sufficient revenue officer staffing. It should be noted however the IRS continues to pursue taxpayers with smaller tax obligations via its computerized Automated Collection System.
Many commentators have noted the IRS enforcement activities in examinations, collection and criminal enforcement produce $6 for every dollar spent. In other words Congress misguided IRS budget cuts have only served to increase the federal deficit. Tax cheats and scofflaws now have 20% less chance the IRS will discover their non-compliance. Those who choose not to pay their taxes know the IRS is much less likely to levy their wages or bank accounts. Many have noted at the very least the current IRS budget crisis results in a tax cut for the most dishonest Americans while the honest majority must shoulder more of the cost of our society. No one can even project the future cost of the budget cuts as more taxpayers choose to play the audit lottery or simply do not pay their taxes because of lax enforcement.
Once again this year the administration has asked Congress to partially restore the IRS budget to assure our tax system will not suffer the fate of lax tax regimes in other countries. The proposal has been derided by many in Congress. It may be many in Congress are sympathetic to tax cheats. As Mark Twain once said “The only native American criminal class is Congress.” Another great American, John Adams, our second president once said, “In my many years I have come to a conclusion that one useless man is a shame, two is a law firm and three or more is a Congress.” It is time for Congress to suspend its political vendetta against the IRS and provide adequate funding so honest Americans can feel they are not fools for choosing to comply with our tax laws.
Robert E. McKenzie is a tax partner in the firm of Arnstein & Lehr LLP of Chicago.
1. Reported by Alan Rappeport, New York Times, 3-31-15