Blog - Archives for July, 2011.



IRS eliminates high-low substantiation method

Posted On: Mon 25th Jul, 2011 at 11:06am

The Internal Revenue Service announced that it is doing away with the high-low method for substantiating certain travel expenses. The method was designed to be a simplified substantiation method for employers who pay a per diem allowance instead of reimbursing actual travel expenses, but when the IRS asked for comments on whether it was still needed, it received none.

IRS Attorneys Audit Technique Guide

Posted On: Mon 25th Jul, 2011 at 10:49am

IRS recently released a comprehensive Attorneys Audit Technique Guide (ATG) for auditors to use in reviewing returns of attorneys. It pinpoints the problem areas that IRS agents are instructed to probe for, explains in detail how attorney audits should be conducted, and lists the types of documents that should be requested and examined. 

Following is an overview of some of the key areas agents are instructed to examine when reviewing an attorney's return. 

Unreported income. Generally, attorneys deposit settlement and award proceeds to their trust accounts. Settlement and award checks are usually made out to both the attorney and the client. After depositing the funds to their trust accounts, attorneys must distribute the proceeds. Frequently, the attorney will draw a portion of these funds to cover their fees and case costs, i.e., when a case is taken on a contingency basis. IRS tells auditors it is important for them to determine if fees were included in income at the proper time. Some attorneys may cash fee payment checks or deposit them directly into personal or investment accounts. If they determined taxable income by totaling deposits made into the general operating accounts, these fees are omitted from income. Inspecting the endorsements on checks written to or on behalf of the attorney from trust accounts is one important auditing procedure. These checks are income or expense reimbursements. Auditors are also told to pay special attention to all checks that either are deposited into accounts other than the general operating account or are cashed. 

Deferral of income. After a case has been settled, an attorney may attempt to defer earned income by allowing fees to remain in the trust account until the next year. Once the settlement is received, the attorney's fee is both determinable and available and therefore should be included in income. The ATG says that an effective audit step is to analyze the source of funds remaining in the trust account at year-end, particularly if there is a large ending balance. 

Noncash payments instead of fees for services rendered. Auditors are told that examination of the client ledger cards will many times lead to the discovery of noncash payments. Also, verifying the basis of newer assets, such as partnership interests or stock, may reveal that they were noncash payments for services. ATG examples: An attorney may borrow a large sum of money from a corporate client and then pay it off by performing legal services. The loan is shown on the attorney's books, but not the income resulting from the relief of the debt. When no loan repayments were noted, the lender was contacted, and it confirmed the loan and the credits against the outstanding balance posted when the attorney rendered legal services. As another example, an attorney who sets up partnerships or corporations may accept an interest in the formed entity as payment for legal services rendered. 

Bartering, namely the exchange of legal services for other services, is another source of noncash income. Auditors are told that an effective audit tool would be to compare the attorney's work schedule with his claimed fees. If the attorney's workload has not decreased, but claimed fees from one or more clients has, that may indicate he is performing services in exchange for noncash payments. These variations should be noted and questioned as deemed appropriate, says the ATG. 
Constructive receipt. Income earned under the constructive receipt doctrine is an exception to the general rule that cash basis taxpayers must have actual receipt of income before it is taxable. Income is constructively received if it is subject to the demand of a taxpayer and there are no substantial limitations or conditions on the right to receive it. The ATG cites the example of a criminal defense attorney acting as a public defender who was paid an hourly rate plus any costs incurred. He had to submit a billing statement to the county government on a monthly basis to receive payment. At the end of the year a Form 1099 was issued to the attorney for the income that was actually paid. To defer income, the attorney did not bill the county for services rendered for the second half of the year. Since billings were submitted only for the first half of the year, the attorney's gross income was considerably understated. 

Advanced client costs. Attorneys who take cases on a contingency fee basis commonly pay litigation expenses on behalf of clients and recover the costs out of the settlement or award. These attorneys generally use a cash basis of accounting and may deduct those expenses when paid, and include the recovered costs in income when received. The ATG says this causes a distortion of income since it can take years to resolve these cases. It concludes that courts have determined that costs paid on behalf of a client are loans for tax purposes, and are not deductible as a current cost of conducting business. The costs are the client's and not the attorney's since there is an expectation of reimbursement. However, a bad debt deduction may be taken in the year that any costs are determined to be uncollectible. The ATG advises auditors to raise this issue if the amount of deducted client costs is “material.” 

By contrast, the ATG says cash-method attorneys are generally allowed a current deduction for client reimbursed costs which are allocated to normal operating expenses (for example, secretarial costs or copying costs). These are general office type expenses which would reasonably be incurred even if not charged to a particular client. Of course, if a current deduction is taken, any subsequent reimbursement from the client would be treated as income in the year of reimbursement under the Code Sec. 111 tax benefit rule. 

The ATG notes that taxpayers and their representatives have argued that if advanced costs are to be treated as loans, then the recovery of these loans shouldn't create taxable income. In Canelo, (1969) 53 TC 217, the Tax Court held that an “erroneous deduction exception” applied to the tax benefit rule and determined that the tax benefit rule could only be used in cases in which a proper deduction was originally taken. The ATG points out that there are several Actions on Decision which address this issue and that many circuit courts have rejected the Tax Court's “erroneous deduction exception.” 
Other issues. The ATG for attorneys covers a host of other issues, including the following: 

• Whether an attorney has misclassified employees as independent contractors. 

• Whether the attorney has properly issued Forms 1099 to independent contractors for payments made to them out of an attorney's trust fund. The ATG notes that it is possible for a taxpayer to present copies of Forms 1099 to an agent without ever filing them with IRS or providing copies to the payees, and explains how agents can find out if IRS has received the forms. It also notes that 1099s are required to be filed for payments to recipients of lawsuit settlements or awards unless specifically exempt from tax under Code Sec. 104 . 

• Whether the attorney has filed Form 8300 where required. Generally, each person engaged in a trade or business who, in the course of that trade or business, receives more than $10,000 in cash in one transaction or in two or more related transactions, must file Form 8300. 

Reporting Credit Card Activity on Business Tax Returns

Posted On: Fri 15th Jul, 2011 at 09:55am

If you accept credit cards for payment in your business your service provider will be sending you a Form 1099-K for you to report this activity on your business return for tax years after 2010. While the return forms are not yet completed, the IRS has posted a draft of form 1099-K and the appropriate instructions. 

On the business return, you will be required to report the total transaction amount? from Form 1099-K on one line, sales not reported on the 1099-K on a second line, and returns and "cash back" on a third line. Make sure you're prepared to handle the new requirements

An Overview of the IRS's 2011 Offshore Voluntary Disclosure Initiative.

Posted On: Tue 12th Jul, 2011 at 12:16pm

In February 2011, the IRS announced the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI). The initiative is designed to bring unreported offshore money back into the U.S. tax system by providing an incentive to U.S. taxpayers with undisclosed offshore accounts to file delinquent informational reports and satisfy their outstanding tax obligations. Taxpayers who are accepted into the 2011 OVDI can avail themselves of the reduced penalties offered under the program, while also avoiding criminal investigation and prosecution. Admission into the 2011 OVDI, however, is predicated on the taxpayer not only providing all requested information and tax remittances by the 8/31/11 deadline, but also on providing those items to the IRS before the IRS otherwise learns of the existence of the previously undisclosed account from other sources. (C.J. O"Reilly, 13 Business Entities, No. 3, 20 (May/June 2011).) 

IRS has broad view of willful violations under FBAR

Posted On: Tue 12th Jul, 2011 at 12:15pm

As the Internal Revenue Service steps up enforcement of the Report of Foreign Bank and Financial Accounts, it is adopting a very narrow view of what constitutes "innocent" violations, writes Robert W. Wood. A willful violation of the law could include a conscious effort to avoid learning about the relevant regulations. Learn more about FBAR, the Foreign Account Tax Compliance Act and the resources available to you on Forbes/The Tax Lawyer Blog(7/6)     

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