Thursday, April 23, 2020

Paycheck Protection Program Loan: Tax Implications

The CARES Act created the Paycheck Protection Program (“PPP”). Under the program, small businesses can take a loan to cover expenses to help get through the COVID-19 pandemic. The funding for the loan quickly ran out leaving many struggling business without the help they desperately need. A second round of funding is on the way, but it is also not likely to be enough considering how fast prior funding was exhausted. Small businesses lucky enough to obtain a PPP loan may now be asking questions about the tax implications.

The CARES Act allows forgiveness of the debt when certain requirements are satisfied. Full details on forgiveness criteria have not yet been released. The Small Business Administration states additional guidance is forthcoming. Here is what has been said by Treasury so far:

You will owe money when your loan is due if you use the loan amount for anything other than payroll costs, mortgage interest, rent, and utilities payments over the 8 weeks after getting the loan. Due to likely high subscription, it is anticipated that not more than 25% of the forgiven amount may be for non-payroll costs. The eight week period begins to run on the first date the lender makes a disbursement to the lender.

The first tax question that comes to mind is will the forgiven amount of the loan be taxed as income? Internal Revenue Code section 61(a)(11) generally requires forgiven debt to be treated as income. It is commonly referred to as “cancellation of indebtedness income” or CODI. The good news for PPP borrowers is that Section 1106 of the CARES Act specifically excludes the forgiven PPP loan amount from taxation. No cancellation of indebtedness income is recognized on forgiveness of a PPP loan. All good, right?

Here is where it gets interesting!

Can expenses paid with forgiven loan funds be deducted? The answer appears to be no. Expenses paid from income exempt from tax cannot be deducted. Simply from the long-standing principles of tax symmetry, there would be an unintended double benefit if a taxpayer did not have to include an item in income and at the same time be allowed to deduct related expenses. I doubt this is what was intended when the CARES Act was passed, but in the haste to pass relief, this detail was overlooked.

Internal Revenue Code Section 265(a)(1) states no deduction shall be allowed:

for any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this subtitle, or any amount otherwise allowable under section 212 (relating to expenses for production of income) which is allocable to interest (whether or not any amount of such interest is received or accrued) wholly exempt from the taxes imposed by this subtitle.

There are a number of court cases that reach the same result when analyzing expenses attributable to tax exempt income.

The intent of the statute in providing loans under the Paycheck Protection Program is to help small businesses through an extraordinarily difficult financial time without tax implications. Allowing forgiveness of the loan amount used for specified purposes without imposing tax for CODI does exactly that. However, the benefit is negated if the expenses paid with the loan are non-deductible. This seems to be an unintended consequence of rushing the legislation through. For now, we will have to wait and see if Congress takes steps to correct this. If there is no fix, some PPP borrowers will be caught off-guard at tax time when they find out they can’t take a deduction for some of their normal business expenses.

Sunday, April 12, 2020

State of IRS Operations Amid COVID-19 Pandemic

The IRS issued an evacuation order on March 30, 2020, to minimize the spread of COVID-19 and protect both its employees and the public. The IRS provided an update on its operations in IR-2020-68. The IRS is still on the job and adapting to the current situation along with the rest of us.

The notice encourages taxpayers to use electronic options. It will help the IRS continue to carry out its mission and aid the agency in maintaining its efforts at social distancing. It will also help to minimize backlogs.

Things taxpayers can and should do electronically include:

• Filing tax returns;
• Obtain transcripts;
• Check status of a refund;
• Make tax payments;
• Establish installment agreements in some cases;
• Apply for an EIN; and
• Check the status of amended tax returns.

Taxpayers cannot yet check the status of economic impact payments online. However, a new registration tool was announced that will allow non-filers to register to receive the payment. Is this a tax trap for a non-compliant taxpayer? A blog on that topic by Steve Mopsick can be found here. A second tool is expected to be released next week that allows taxpayers to check the status of their economic impact payment.

All taxpayer assistance centers remain closed and customer service is limited. Processing paper tax returns is also limited. Delinquent tax returns should still be filed as required. They will be posted retroactive to the date received helping to minimize late filing penalties even if processing is delayed.

I have spoken with contacts at the IRS. Despite the evacuation order and shuttered assistance centers, the IRS is carrying on with much of its normal work. Many revenue officers, revenue agents, and appeals officers are still on the job working remotely. The IRS continues to work audits, field collection cases, and appeals. It is working to issue economic impact payments, itself a massive undertaking.

The IRS is issuing guidance to taxpayers and tax practitioners daily on how the new Federal relief legislation will be implemented. It is addressing a large number of issues. Among them administering economic impact payments, launching new tools, new tax credits, deferral of tax payments, deferral of filing deadlines, how those deferrals relate to other deadlines like certain retirement contributions, changes to NOL rules, collection procedures, disseminating information to the public, and the list goes on. This all requires large scale coordination and implementation of procedures at a pace the government is not accustomed. We all know the federal government, IRS included, is not known for speed and efficiency. A little patience with the agency is due in this extraordinary time as we are truly all in this together.

Tuesday, April 7, 2020

Installment Agreements in the Time of COVID-19

The IRS is responding to the Coronavirus (COVID-19) pandemic in many different ways. The IRS specifically addressed installment agreements in Notice IR 2020-59.

For those with an existing installment agreement, the requirement to make monthly payments is suspended for the period April 1, 2020 through July 15, 2020. The IRS will not default installment agreements during that time. The IRS recently announced also that direct debit agreements will continue to be processed, with payments debited from accounts as scheduled. Taxpayers will need to proactively contact their bank to stop payments if they are unable to continue.

For taxpayers that do not have an installment agreement and need to establish one, the options for doing so depend on the status of the case. Revenue Officers have been able to work remotely for many years and are continuing to do so. Taxpayers should continue to work with their Revenue Officer to establish an agreement. For those taxpayers whose cases are being worked in a service center, the only option with the IRS service centers being closed to prevent the spread of COVID-19 is to set up the agreement online. However, not all taxpayers are eligible to set-up an agreement online. Taxpayers are eligible to set up an installment agreement online if:

• They owe $50,000 or less in combined tax, penalties and interest, and
filed all required returns for long term agreements; or
• They owe less than $100,000 in combined tax, penalties and interest and can pay in full in less than 120 day.

A large number of taxpayers are left in limbo since their case is not assigned to a Revenue Officer, and they don’t meet the eligibility requirements to set-up an installment agreement online. The IRS should significantly expand the criteria for setting up an installment agreement online, but that issue is a blog for another day.

Those taxpayers unable to set up an installment agreement and who have an ability to make payments in any amount toward their tax liability should make voluntary payments until such time as the case is either assigned to a Revenue Officer, or the service centers resume full operation. Rest assured, the IRS will resume full operation in the very near future.

There is no doubt many who suspended their installment payments during this period will be financially unable to resume payments due to furloughs, layoffs, or a decline in business. If payments are not resumed, the IRS will eventually catch-up with the case and terminate the agreement. The IRS automated system will issue a notification to the taxpayer and then set aside the agreement as defaulted. This does not automatically mean that a taxpayer is shut out of the installment agreement process. Taxpayers can renegotiate an installment agreement. Most cases will require the preparation and presentation of a new financial statement to show a change in circumstance, and a diminished ability to pay.

In some instances, an installment agreement may not be the appropriate resolution due to diminished finances. Careful consideration should be given to filing an offer in compromise to settle the tax liability for less than the owed,
Another alternative to consider is “currently not collectible status” enabling the taxpayer to defer payment of tax while a financial hardship exists.

Friday, April 3, 2020

COVID-19 Response and Relief Resources

As Americans join together to defeat COVID-19, governments at all levels have shown us an unprecedented response. At the Federal level, laws are being passed in rapid succession, regulations are being prepared, and agencies are working tirelessly to implement new laws and temporary relief measures, all while working remotely, shutting posts of duty, and government workers being subject to potentially contracting the highly contagious coronavirus themselves.

The acts which Congress has already passed affect every business, man, woman, and child in the United States. In some cases the Congress has added significant provisions to the Internal Revenue Service. Others are in the realm of labor law. Shown below are some resources on the many developments in response to COVID-19. It is a work in progress. New information is coming out daily and we will be frequently updating a list of resources, to include our own commentary and analysis. It will be made available under resources at www.mopsicktaxlaw.com. Check often for updates.

Federal Legislation Related to Coronavirus Response

• Families First Coronavirus Response Act (FFCRA)

FFRCA responds to the COVID-19 outbreak by providing paid sick leave, tax credits, and free COVID-19 testing;
expanding food assistance and unemployment benefits; and increasing Medicaid funding.

• Coronavirus Aid, Relief, and Economic Security Act (CARES Act)

The CARES Act provides emergency assistance and health care response for individuals, families, and businesses
affected by the coronavirus pandemic.

• Coronavirus Preparedness and Response Supplemental Appropriations Act (CPRSA Act):

CPRSA provides $8.3 billion in emergency funding for federal agencies to respond to COVID-19

IRS Issued Notices and Announcements Relating to Coronavirus Relief Measures

IR-2020-62, IRS: Employee Retention Credit available for many businesses financially impacted by COVID-19
gov/newsroom/economic-impact-payments-what-you-need-to-know">IR 2020-61, Economic impact payments: What you need to know
IR-2020-59, IRS unveils new People First Initiative; COVID-19 effort temporarily adjusts, suspends key compliance program
IR-2020-58, Tax Day now July 15: Treasury, IRS extend filing deadline and federal tax payments regardless of amount
IR-2020-57, Treasury, IRS and Labor announce plan to implement Coronavirus-related paid leave for workers and tax credits
for small and midsize businesses to swiftly recover the cost of providing Coronavirus-related leave
• Treasury News Release: Treasury and IRS Issue Guidance on Deferring Tax Payments Due to COVID-19 Outbreak
IR-2020-54, IRS: High-deductible health plans can cover coronavirus costs
IR-2020-64, IRS issues warning about Coronavirus-related scams; watch out for schemes tied
Notice 2020-22, Relief from Penalty for Failure to Deposit Employment Taxes
• IRS Internal Memo, IRS to allow email, images of signatures and digital signature: New COVID-19 Protocols
• IRS Evacuation Order: IRS Order to Employees: Evacuate Your Post of Duty

IRS FAQs

Filing and Payment Deadline Extension
Employee Retention Credit Under the CARES Act

U.S. Treasury

Assistance For Small Businesses, Paycheck Protection Loans

U.S. Department of Labor

• Coronavirus Resources page: www.dol.gov/coronavirus
• Families First Coronavirus Relief Act: Employer Paid Leave Requirements: https://www.dol.gov/agencies/whd/pandemic/ffcra-employer-paid-leave

Monday, March 27, 2017

Summa Holdings – IRS Pushed Back on Substance Over Form Doctrine

Domestic International Sales Corporations (DISC) allow deferral of federal income tax on certain income from exports. A DISC is often nothing more than a corporate shell formed to take advantage of a federal tax loophole. I’ll save the technical aspects for another day. Suffice it to say the DISC loophole was created for the purpose of incentivizing companies to export goods and using a DISC can result in significant tax savings. A Roth IRA is a common form of retirement savings vehicle. A taxpayer does not deduct contributions to a Roth IRA, but can take out contributions, including all gains from investment, tax free in retirement. When the tax benefits of a DISC are combined with the tax benefits of a Roth IRA the result is huge tax savings. It is unlikely Congress considered this result when passing legislation in 1997 to create Roth IRAs. Nevertheless, the law as it is written is clear, at least according to the Court of Appeals for the Sixth Circuit.

In Summa Holdings, Inc. v. Commissioner, (“Summa”) the IRS takes issue with two taxpayers who used the combination of a DISC and Roth IRAs to avoid taxation of income. The taxpayers set up two Roth IRAs. One Roth IRA for each taxpayer. They immediately made a contribution, within prescribed limits, and used the funds contributed to purchase shares of a DISC. A holding company was then formed which purchased the DISC shares back from the Roth IRAs, but the holding company itself was also owned by the Roth IRAs, 50 percent each. By funneling income through this structure into the Roth IRAs, each of the two Roth IRAs accumulated more than three million dollars, achieving major tax savings. The Roth IRAs grew by a combined 1.4 million dollars in one year alone.

The IRS, as you can imagine, did not like this tax savings scheme.

The IRS sought to recast the funds funneled into the Roth IRAs through this structure as dividends to the individual shareholders of Summa Holdings. The result of the IRS’s proposed recast would have been a large amount of tax, an excise tax penalty, accuracy related penalty, and interest on the tax and penalties. The IRS presented its argument based on the doctrine of substance over form. In simple terms, under this doctrine, the form of a transaction is ignored for the true substance of the transaction. The economic reality of a transaction is analyzed to determine whether or not the transaction meets legal requirements imposed by the Tax Code. The idea is to achieve a clear reflection of income on a tax return, or set of tax returns, by setting aside transactions that have no economic purpose other than tax avoidance. The concept of substance over form is captured exceptionally well by Judge Sterrett in the Tax Court case John D. Gray, 56 T.C. 1032 in which he writes “Once the fog of [a transaction] is blown away by the fresh air of economic reality the substance of the transactions is clearly visible.” Although the case was decided in 1972, it is still relevant.

The IRS’s point in Summa was that the structure the taxpayers set-up had no economic substance, except to avoid tax. On that point the IRS is correct. The Tax Court initially went along with the IRS’s argument and application of substance over form. There is no doubt substance over form has its place in tax law. Congress believes it does as well since the judicially created doctrine has been adopted in the Internal Revenue Code, but in this case the Court of Appeals for the Sixth Circuit said not so fast:

How can citizens comply with what they cannot see? And how can anyone assess the tax collector’s exercise of power in that setting? The Internal Revenue Code improves matters in one sense, as it is accessible to everyone with the time and patience to pour over its provisions. In today’s case, however, the Commissioner of the Internal Revenue Service denied relief to a set of taxpayers who complied in full with the printed and accessible words of the tax laws.

The Court of Appeals flatly rejects the IRS’s argument and reversed the Tax Court. It holds that the law allows the taxpayers to do exactly what they did and scolds the IRS:

It’s one thing to permit the Commissioner to recharacterize the economic substance of a transaction- to honor the fiscal realities of what taxpayers have done over the form in which they have done it. But it’s quite another to permit the Commissioner to recharacterize the meaning of statutes- to ignore their form, their words, in favor of his perception of their substance.

The Court goes on to state:

Each word of the of the “substance-over-form doctrine,’” at least as the Commissioner has used it here, should give pause. If the government can undo transactions that the terms of the Code expressly authorize, it’s fair to ask what the point of making these terms accessible to the taxpayer and binding on the tax collector is. “Form” is "substance” when it comes to law. The words of the law (its form) determine content (its substance). How odd, then, to permit the tax collector to reverse the sequence-to allow him to determine the substance of a law and to make it govern “over” the written form of the law – and to call it a “doctrine” no less.

These are strong words used by the Court. Because the taxpayers used a legislatively approved mechanism to legally reduce tax, there is no basis for the Commissioner to change the application of the law, by arguing in esoteric terms, that what is plainly allowed under the law is somehow forbidden. While not expressly stated, the Court of Appeal seems to be reminding the IRS of a basic tenet of the U.S. Constitution, separation of powers. The IRS cannot legislate through the courts by arguing substance over form because it doesn’t like the result of proper application of the law. I guess the IRS forgot about that.

There is no question the substance over form doctrine has its place in tax jurisprudence. I, for one, think the IRS’s use of the doctrine is at times an overreach. The irony… Unfortunately, the courts tend to go along. It’s refreshing to see the IRS pushed back in persuasive terms in the Summa case. I wonder if it will mark a scaling back of the IRS’s use substance over form doctrine as a sword. Or, will the IRS in its arrogance persist? Probably the latter.

Thursday, February 16, 2017

Owe An IRS Tax Debt? You May Soon Be Contacted By A Private Collection Agency!

The IRS will soon begin using private collection agencies (PCA) to collect delinquent tax debts. The IRS has not yet announced a specific date, but said it will begin using PCAs as early as the spring of this year.

This is not the first time the IRS will try using PCAs. An independent study on cost effectiveness of using PCAs was conducted in 2009 that led to the IRS discontinuing use of PCAs. IRS Commissioner at the time, Doug Shulman, concluded based on the study that the IRS is more effective than the PCAs. Nevertheless, FAST Act was passed in December of 2015 and mandates the IRS to begin contracting with PCAs for help collecting on certain tax debts.

The relevant section of the FAST Act is incorporated in the Internal Revenue Code (IRC) at section 6306. The FAST Act also included in the new law which mandates the IRS to certify certain tax delinquencies to the State Department for passport revocation. You can find my blog on that topic here.

IRC Section 6306 states in part “notwithstanding any other provision of law, the Secretary shall enter into one or more qualified tax collection contracts for the collection of all outstanding inactive tax receivables.” Basically, this means the tax debts that the IRS is no longer actively trying to collect will be referred to a PCA.

What criteria will the IRS use to determine cases that will be referred to a PCA?

Three specifically designated types of cases will meet the criteria for referral:

1. At any time after assessment, the Internal Revenue Service removes a case from active inventory because of lack of
resources or inability to locate the taxpayer;
2. More than one-third of the applicable statute of limitation has lapsed and the case has not been assigned to an IRS
employee; or
3. For a case assigned to an IRS employee for collection, more than 365 days have passed without interaction with the
taxpayer or a third party in furtherance of collecting delinquent tax.

There are also designated categories of cases that are not eligible for referral to a PCA:

1. A case with a pending or active offer in compromise or installment agreement;
2. A case classified as innocent spouse;
3. Deceased taxpayers;
4. Minor taxpayers;
5. Taxpayers serving in a combat zone; and
6. Victims of tax-related identity theft.

The IRS will provide the taxpayer and the taxpayer’s representative notice of assignment of the case to a PCA. The PCA will then send a second notice and begin trying to collect on the tax debt.

Who are the Private Collection Agencies?

So far, The IRS has entered in to contracts with four companies:

1. ConServe based in Fairport, New York;
2. Pioneer based in Horseheads, New York;
3. Performant Recovery based in Livermore California; and
4. CBE Group based in Cedar Falls, Iowa.

What can the private collection agencies do?

A private collection agency does not have the power of the IRS. The IRS can issue liens and levies, and summon records in its effort to collect on a delinquent tax debt. A private debt collector has none of those powers. A private debt collector must also adhere to the Fair Debt Collection Practices Act. Fair tax collection practices set forth in Internal Revenue Code section 6304 are also applicable limitations on PCAs. They can do no more than try to track down a taxpayer, send letters and make calls. They are prohibited from contacting third parties. There is no authority to file liens or issue levies. They cannot file a lawsuit to reduce a tax debt to judgment or foreclose on a tax lien. Their effectiveness rests solely in their persistence to collect a buck.

PCAs can collect financial information from a taxpayer, but only for the purpose of transmitting that information to the IRS. They can also negotiate installment agreements for agreements of less than 60 months that will result in full payment of the tax debt. However, the IRS reserves the right to approve or deny any installment agreement. According to IRS announcement 2006-63, all installment agreements on debts over $25,000 or covering a period of more than 36 months must be approved by the IRS. The IRS will likely continue following that framework.

What to do if your case is assigned to a private debt collector?

Assignment to a PCA may interfere with efforts to resolve a tax debt. In that case, a request should be made to refer the case back to the IRS in order to work out a resolution. In other cases, it may be advantageous to work with the PCA directly. A tax professional can help evaluate all available options.

There are many on-going scams targeting taxpayers and practitioners. A concern with the IRS’s use of PCAs is that it will be more difficult to distinguish between legitimate contacts and scammers. It is important to be vigilant to avoid falling victim to a tax scam. Taxpayers suspecting a scam or dealing with misconduct by a PCA employee can make a report by calling the TIGTA hotline 1-800-366-4484 or visiting the TIGTA website.

Friday, February 3, 2017

Examination Collectibility Consideration: Another Example of IRS Inefficiency

I recently read a very interesting report issued by the Treasury Inspector General for Tax Administration (TIGTA) on the topic of the IRS Examination function failing to consider the collectibility of potential assessments. Collectiblity is simply the likelihood the IRS will ever actually collect any tax following an assessment. The report is titled “Examination Collectibility Procedures Need to be Clarified and Applied Consistently.” It is a stinging criticism of IRS inefficiency. The full report can be found here. It’s worth a read.

It is rare for the IRS during an audit to consider whether or not any additional tax assessed at the conclusion of an audit can actually be collected. It’s even more unusual for the IRS Examination function to actually discuss collectability with the taxpayer or their representative. This is contrary to established policy and procedure. The Internal Revenue Manual states “Examiners are expected to consider the collectability during the pre-contact phase as a factor in determining whether to survey the return or limit the scope and depth of examination. Collectibility may also become a factor for consideration during the course of the examination.”

The IRS is failing to follow its own policy to consider collectability determinations in Examination in a majority of cases. The result is an extremely poor use of resources. TIGTA provides the example that in a five year period, the IRS Collection function received over 700,000 tax delinquent account (TDA) cases per year, all of which originated with an exam assessment. A TDA case is a case where the taxpayer owes a seriously delinquent tax debt. The number 700,000 represents nearly 10% of all TDA cases.

The IRS has cried foul about budget cuts over the last few years. Commissioner Koskinen stated a while back the IRS will simply do less with less in light of the on-going budget reductions. This comment was well publicized. I thought that comment was a clear example of poor leadership. Instead of striving to do better with resources available, he just threw his hands up like it was okay to do a crappy job for the U.S. taxpayer.

Examples like the IRS Examination function not following policy to consider collectibilty only solidifies my opinion that the IRS does not really need more money to do its job. They need to use the resources they do have to the fullest. Clearly they are not doing that! In this example, the Examination function simply plows forward to complete assessments of tax that will never be collected. It is completely unproductive work. Once a tax assessment is complete, how many IRS employees does it then take to sort through 700,000 TDA cases per year that land in the lap of the Collection function? A lot! All those employees require a desk or cubicle, chair, computer, etc. Administering these cases requires letters to taxpayers; so there is paper, ink, printing, postage, customer service demands in the form of taking phone calls, processing financial statements from taxpayers, etc., etc. It all adds up to a mind boggling amount of wasted money.

If the IRS corrected just this one example of its failure to follow policy and thereby work more efficiently and effectively, it could save many millions of dollars a year. TIGTA says “If examiners do not follow the IRM procedures to consider and evaluate collectability while working their cases, there is a higher risk of uncollectible assessments and inefficient use of both Examination and Collection functions’ limited resources.”

In other words, a lot of IRS employees are paid for work that does nothing productive. According to the report, “all of the cases that [TIGTA] reviewed were sent to the Collection function. Both Examination and Collection function resources were spent developing the assessment and pursuing collection, but ultimately all of the cases were closed without the taxpayer making any subsequent payments to the IRS.” TIGTA estimates that IRS Revenue Officers spent more than 22,000 hours (yes, twenty-two-thousand hours, that translates to over 10 years of 40 hour work weeks) working on cases where Examination failed to consider collectability. Every one of those cases was closed by Collection without any payment from taxpayers. Ouch!

If the IRS only followed its own policy and procedure, not only would it save a lot of tax dollars, it would almost certainly produce more revenue by turning its attention to focus on more productive work – work that might actually produce payment of some taxes. There are many very good people that work at the IRS who have little to no control over issues like this. Addressing systemic problems takes sound and strong leadership at the highest level, and that is truly lacking at the IRS.