View Article in Tax News & Comment — October 2012
RECENT IRS DEVELOPMENTS – OCTOBER 2012
Over 50 million Americans are now filing tax returns showing no income tax liability. This represents approximately 35 percent of all personal income tax returns filed. A family of four would typically owe no tax until income exceeded $51,000. This phenomenon illustrates the use tax expenditures, rather than governmental expenditures, to further social objectives.
Utilizing the Internal Revenue Code to achieve societal objectives appears defensible on a philosophical as well as practical basis, since Congress and the President ultimately legislate the appropriate tax laws. The more difficult task, like identifying elusive muon particles in physics, is deciding whether the tax expenditure or the revenue expenditure, as the case may be, is itself “fair.”
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National Taxpayer Advocate Nina Olson recently issued a report detailing the issues on which the IRS will focus during the fiscal 2013 tax year. IR-2012-66. The Taxpayer Advocate is required by federal law to issue two reports annually directly to the House Ways and Means Committee and to the Senate Finance Committee without prior review by the IRS, the Treasury, the IRS Oversight Board, or the Office of Management and Budget.
In the June 2012 Report, Ms. Olson expressed particular concern that “the continual enactment of significant tax law and extender provisions late in the year has led to IRS delays in handling millions of taxpayers’ returns and caused many taxpayer to underclaim benefits because they did not know what the law was.” Ms. Olsen added that “the 2013 filing season is already at risk.” Among the provisions that expired in 2011 were (i) the AMT “patch””; (ii) the deduction for state and local sales taxes; (iii) the deduction for mortgage insurance premiums; and (iv) the provision allowing taxpayers over 70½« to tax-free withdrawals from IRA accounts to take charitable contributions.Provisions set to expire in 2012 include (i) the Bush tax cuts; (ii) reduced rates on long term capital gains and dividends; (iii) certain marriage relief provisions; (iv) certain aspects of the child tax credit; (v) the earned income tax credit; (vi) the adoption credit; and (vii) the moratoria on the phase outs of itemized deductions and personal exemptions.
The Report cited the vast increase in tax-identity theft, which increased 72 percent in tax year 2011. Where the IRS seeks to verify wage and withholding information, it is required to make a final determination within 11 weeks or release the claimed refund. By reason of budget limitations, the Service has placed “hard freezes” on cases it cannot process within 11 weeks. The Report states that the IRS has “little incentive to prioritize a case once a hard freeze has been imposed, resulting in harm to honest taxpayers.” The Report addresses Taxpayer Assistance Orders (TAOs) and Taxpayer Assistance Directives (TADs), which authorize the Advocate to direct the IRS to either take action or refrain taking action in a particular case in order to protect taxpayer rights. The Advocate alleges that over the past year the IRS has “ignored and sought to limit the Advocate’s authority to issue TADs.” The Report states that the Advocate intends to focus on these additional issues in 2013: (i) the increased use of automated audit procedures which curtail taxpayer interaction with IRS employees; (ii) the impact of “draconian” penalties frequently imposed on taxpayers with offshore accounts, many of whom were not engaged in tax evasion; (iii) assessing the application of the IRS “fresh start” initiative, which allows struggling taxpayers to remain in compliance based upon their ability to pay;” and (iv) improving coordination between the IRS and other government agencies to protect taxpayer rights.
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The IRS has announced that its Offshore Voluntary Disclosure Program (OVDP) has yielded in excess of $5 billion, and has released new details regarding the program. In tightening the eligibility requirements, IRS Commissioner Shulman noted that “[p]eople are finding it tougher and tougher to keep their assets hidden in offshore accounts.” Details regarding eligibility issues are addressed in a new set of questions and answers which relate to the latest version of the OVDP, announced in January of 2012. IR-2012-64. The IRS extended OVPD following strong taxpayer interest in programs commenced in 2009 and 2011.
The IRS also took action to foreclose a perceived loophole: Under existing law if the taxpayer challenges the disclosure of tax information in a foreign court, the taxpayer must advise the Department of Justice of the appeal. Under new IRS policy, if the taxpayer fails to advise Justice of the appeal, the taxpayer will no longer qualify for OVDP. The IRS also put taxpayers on notice that their eligibility for OVDP could be terminated once the U.S. government has taken action with respect to their specific financial institution.
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The IRS inspector general J. Russell George acknowledged that the IRS may issue as much as
$21 billion in fraudulent tax refunds in the next five years. The problem, which he describes as growing “exponentially,” is being perpetrated brazenly, since ““[o]nce the money is out the door, it is impossible to get it back.” In one case, a single Chicago address generated 765 tax returns showing more than $900,000 in tax refunds. The scam is most prevalent in Miami and Tampa. Mr. George believes that the IRS more resourcefully utilize the information which it has, and should seek other information which could be available to it.
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According to the quarterly report issued by the Treasury, 189 persons renounced U.S. citizenship in the last quarter. Almost half of the list consists of taxpayers of Chinese origin. It has been suggested that the high rate of Chinese expatriation could be due to the fact that the highest marginal income tax rate in Hong Kong is 15 percent, and that Hong Kong imposes no capital gains tax and, unlike the U.S., does not tax foreign earnings unless repatriated. Interestingly, high net worth Chinese disproportionally choose the United States when deciding where to emigrate. The principle in U.S. international taxation of imposing tax on all income of U.S. taxpayers, regardless of source, may be a significant factor in the decision of many U.S. taxpayers to renounce U.S. citizenship.
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The New York Attorney General, Eric Schneiderman, has begun an investigation into private equity firms, including Bain, with respect to whether those firms used abusive tax strategies to reduce partners’ income taxes. The principal issue involves the propriety of converting management fees, normally taxed as ordinary income, into investment income reported as capital gains. The Service has identified the area as one of “possible noncompliance,” but thus far has taken no action. There appears to be no consensus among tax professionals as to whether the practice is legitimate.
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The IRS has announced tax relief to those affected by Hurricane Isaac in Louisiana and Mississippi. Various tax filing and payment deadlines occurring after August 26th will be extended until January 11, 2013. The relief includes individuals and businesses on extension until October 15th.