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Tax Law FAQs

 

  1. What are dividends and how are they taxed?
  2. What is the basis of property acquired by gift?
  3. What is the generation-skipping transfer tax?
  4. Is an early distribution from a retirement plan taxed?
  5. How is the gain or loss on the sale or transfer of a capital asset determined?
  6. What are the tax consequences of the sale of a principle residence?
  7. What are the rules for deducting home office expenses?
  8. Do I have to pay US income tax on money I earned in a foreign country?
  9. What are the reporting requirements for businesses with respect to independent contractors?
  10. Are any taxpayers exempt from paying property taxes?
  11. What is the Alternative Minimum Tax?
  12. Does the IRS Offer Any Assistance to Taxpayers Who Need Help Resolving Tax Problems?
  13. Can I Appeal an IRS Finding?
  14. What Can I Expect from an IRS Audit?
  15. Does a Divorce Raise Any Federal Income Tax Issues?
  16. Are there Criminal Penalties for Violations of the Federal Tax Laws?
  17. What Happens if I Cannot Pay My Taxes?
  18. What are Gift Taxes?
  19. What are Estate Taxes?
  20. Why Should My Business Consult with a Tax Attorney?
  21. What Rights do Taxpayers Have When Dealing with the IRS?
  22. What is an Exempt Organization?

 

Learn More : Taxation

 

What are dividends and how are they taxed?

A dividend is a distribution of cash or property paid by a corporation to a shareholder out of the corporation's current or accumulated earnings and profits. Dividends are included in the shareholder's gross income as ordinary income. A shareholder only has tax liability related to a dividend if there is a distribution of property by a corporation to its shareholders out of its earnings and profits. A mere declaration by the corporation that it has authorized a distribution is not sufficient to trigger a shareholder's tax liability. Dividends are included in gross income of a shareholder when they are actually or constructively received.

 

Dividends are generally taxed as ordinary income. However, qualified dividends are taxed at lower rates. For tax years after 2007, the maximum tax rate on qualified dividends and net capital gain is 0% (reduced from 5%). There is still a 15% maximum tax rate on qualified dividends and net capital gain.

 

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What is the basis of property acquired by gift?

 

The term "basis" generally refers to a taxpayer's capital stake in property, which is used when determining the gain or loss on the sale or exchange of property. Basis is also used to determine the amount of depreciation allowances. Basis is generally the cost of or amount paid for the property.

 

Under section 1015(a) of the Internal Revenue Code (IRC), the recipient of a gift (donee) generally has the same basis in the gift as the basis of the gift giver (donor) or last preceding owner by whom it was not acquired by gift. If this basis, however, after being adjusted for the period before the date of the gift, is more than the fair market value of the gift at the time the property was given away, then the basis for determining loss is the fair market value of the property.

For gifts acquired after September 2, 1958, the basis is the basis under section 1015(a) plus the amount of gift tax paid. This new basis cannot be more than the fair market value at the time of the gift. Under section 1015(d)(6), there is a limit on the amount of gift tax paid for gifts made after December 31, 1976. It limits the increase in basis to the portion of the gift tax paid on the property that is because of the gift's net increase in value.

 

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What is the generation-skipping transfer tax?

 

Chapter 13 of the Internal Revenue Code contains provisions relating to the generation-skipping transfer tax (GST). The rules and regulations relating to the GST are extremely complex. The GST may be imposed on transfers of property to people who are at least two generations below the transferor's generation (for example, a grandparent to a grandchild). Gifts or direct skips to skip persons made on an individual's death may be subject to the GST. A direct skip is a transfer made during an individual's life or on his or her death of an interest in property that is subject to the estate or gift tax and made to a skip person. A skip person is a person of a generation that is two or more generations below the transferor.

 

The GST is determined by using the value of the gift or bequest after subtracting any allocated GST exemption. An individual's GST exemption is equal to the applicable exclusion amount for the year involved. The exemption amount is $2 million in 2007 and 2008 and $3.5 million in 2009.

 

The GST tax rate is high — it is the maximum estate and gift tax rate for the applicable year. The maximum federal estate tax rate, and hence the GST rate, is 45% for the years 2007 through 2009, and then it is repealed in 2010. Thus, in 2010, there is no GST. In 2011, the maximum estate tax rate is scheduled to return to 55%.

 

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Is an early distribution from a retirement plan taxed?

 

There is an additional 10% tax (in addition to income tax) on certain early distributions of retirement plans. The 10% tax is reported on the Form 1040. Early distributions are distributions that an individual receives from a qualified retirement plan or deferred annuity contract before reaching 59 1/2 years old. A qualified retirement plan is:

 

  • A qualified employee plan such as a 401(k) plan
  • A qualified employee annuity plan under section 403(a)
  • A tax–sheltered annuity plan under section 403(b) for employees of tax–exempt organizations or public schools
  • IRAs (other than an education IRA)

 

If an individual takes an early distribution (within the first two years of participation) from a SIMPLE IRA plan, the additional tax is 25%. There are exceptions to the 10% penalty:

 

  • Distributions to a beneficiary or estate on or after a taxpayer's death
  • Distributions made because of a total and permanent disability
  • Distributions made as part of a series of substantially equal periodic payments over the life expectancy of the owner or life expectancies of the owner and the beneficiary
  • Distributions that are equal to or less than deductible medical expenses (expenses that exceed 7.5% of adjusted gross income)
  • Distributions made because of an IRS levy of the plan
  • Distributions to qualified reservists

 

In addition, nontaxable distributions such as distributions that are rolled over to another qualified plan or a distribution of designated Roth contributions are not subject to the additional 10% tax.

 

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How is the gain or loss on the sale or transfer of a capital asset determined?

 

A sale or exchange of a capital asset produces a capital gain or loss. Capital asset is not specifically defined by the Internal Revenue Code. Rather, section 1221 sets forth classes of property that do not qualify as capital assets. Under section 1221, capital assets include all property that is held by a taxpayer, whether or not the property is connected with the taxpayer’s trade or business, except for:

 

  • Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business
  • Depreciable property used in a trade or business or real property used in the taxpayer’s trade or business
  • A copyright; literary, musical, or artistic composition; letter or memorandum; or similar property (if it meets certain listed requirements)
  • Business accounts or notes receivable in the ordinary course of business
  • Certain publications of the US government
  • Commodities derivative financial instruments held by a commodities derivatives dealer (with certain listed requirements)
  • Hedging transactions that are so identified by the close of the day it was acquired, originated or entered into
  • Supplies of a type regularly used or consumed by the taxpayer in the ordinary course of trade or business

 

To determine the gain or loss on a sale or exchange of a capital asset, take the amount realized minus the cost or basis of the property. The amount realized is the amount of cash, property or other assets received in exchange for the item transferred. Generally, the amount realized on the sale of a capital asset is cash, but a taxpayer may receive property in exchange. If the taxpayer receives property, the amount realizes is the fair market value of the property. There are special rules applicable to wash sales, related-party transactions, small business stock and section 1256 straddles, which may affect the amount of gain or loss recognized.

 

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What are the tax consequences of the sale of a principle residence?

 

Generally, a gain on the sale of a principal residence is subject to tax. This tax is calculated by determining the amount realized on the sale (contract price minus selling costs) minus the cost of acquiring the home plus capital improvements to the home. If the home was held for more than one year, the gain is taxed as a long-term capital gain.

There is an exemption from tax for taxpayers who have owned and lived in the home as their primary residence for two of the last five years before the sale. Single taxpayers can exclude up to $250,000 of the gain. Married taxpayers filing a joint return can exclude up to $500,000. This exclusion can be used once every two years. If a taxpayer sells his or her house for a gain and also qualifies for the exclusion, there is no reporting requirement. If a taxpayer sells his or her house for a gain and does not qualify for the exclusion, the taxpayer reports the gain as capital gain on Schedule D of Form 1040. If a taxpayer sells his or her house for a gain and the gain exceeds the exclusion amount, the taxpayer must report the excess gain on Schedule D. A taxpayer cannot deduct a loss on the sale of his or her principle residence.

 

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What are the rules for deducting home office expenses?

 

Taxpayers who work from home for either themselves or an employer may be permitted to deduct expenses related to the business use of the home if certain requirements are met. This is referred to as the home office deduction.

 

Under section 280A of the Internal Revenue Code (IRC), an individual is permitted to deduct expenses related to the business use of his or her home if that part of the home is used exclusively and regularly as a principle place of business for any trade or business; as a place of business that the individual uses in the normal course of his or her trade or business to meet with clients, customers or patients; or if a separate structure on the property is used, it is used in connection with the taxpayer’s trade or business.

 

Regular use requires that the taxpayer use the home office on a regular basis (for example, meeting with clients on a daily basis) rather than only occasionally. Exclusively means that the taxpayer cannot use the office for any other purpose besides business purposes. There is an exception to the exclusive use requirement for areas of a home used to store inventory or for a day care facility.

 

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Do I have to pay US income tax on money I earned in a foreign country?

 

US citizens and residents are taxed on their worldwide income. Even if a US citizen lives outside of the United States, he or she must pay US income tax. US citizens and resident aliens who receive money from foreign sources must report all foreign source income on their US tax returns unless it is exempt. This information must be reported on a US tax return regardless of whether the individual receives a Form W-2, Form 1099 or their foreign equivalents.

 

Foreign source income includes both earned and unearned income such as wages, tips, interest, dividends, capital gains, pensions, rents and royalties. Individuals living outside of the United States may be entitled to an exclusion of up to $85,700 (for the 2007 tax year) of foreign earned income if certain criteria are met. This exclusion does not apply to payments that the US government makes to civilian or military employees who live outside of the United States.

 

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What are the reporting requirements for businesses with respect to independent contractors?

 

Business owners are required to file Form 1099-MISC, Miscellaneous Income, to report payments made to independent contractors of $600 or more during the year for services that the independent contractors performed. This includes any fees, commissions, prizes or awards given to nonemployees. Form 1099-MISC must be filed with the Internal Revenue Service by February 28 of the year following the year in which the payments were made. Because of this filing requirement, it is important for a business owner to request the independent contractor's full name or business name, address and Social Security or taxpayer identification number when hiring the contractor.

 

The Internal Revenue Service will generally cross-reference amounts that a business owner reports as payments to an independent contractor on Form 1099-MISC with the amount of income reported in independent contractor's tax return to ensure that they match. The contractor must report amounts earned as an independent contractor as taxable income, which is subject to the self-employment tax.

 

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Are any taxpayers exempt from paying property taxes?

 

While the rules relating to property and real estate taxes may vary from one state to the next, generally speaking, churches and other religious institutions are exempt from the payment of real estate taxes. Some states also extend this exemption to public property, charitable organizations, cemeteries, hospitals, nonprofit colleges and universities and museums. In some jurisdictions, there are laws that give limited property tax exemptions to widows, veterans and disabled taxpayers. In addition, some states may allow individuals to pay reduced property taxes, based on their income.

 

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What is the Alternative Minimum Tax?

 

The alternative minimum tax (AMT) is basically a separate and parallel tax system from the traditional federal income tax system. The AMT requires individuals to recalculate the amount of tax they owe under a different set of rules by including income that would otherwise be exempt from regular taxation. AMT is a tax that must be paid in addition to, not instead of, regular taxes. Congress created the AMT to prevent wealthy taxpayers from paying a minimal amount of or even no taxes because of various exemptions, deductions and other preferences in the Internal Revenue Code.

 

All taxpayers that are subject to regular tax are also subject to the AMT. All individuals, corporations, trusts and estates are potentially liable for the AMT. Partnerships and S corporations, which are pass-through entities and not subject to regular tax, are not subject to AMT.

 

The AMT is not an alternative to a taxpayer’s regular federal income tax; rather it is an addition to income tax. What is considered income, a deduction or an exemption under the AMT system is different from what qualifies as income, a deduction and an exemption under the regular tax system. Under the AMT system, personal exemptions for individuals, spouses and children are not permitted. Deductions for mortgage interest and/or any state and local taxes paid by the taxpayer are also not permitted. If there is a possibility that a taxpayer owes AMT, that taxpayer must recalculate his or her taxable income as defined under the AMT, apply the alternative tax rates, take into account any applicable credits and compare the potential AMT liability to the regular tax burden.

 

The amount of AMT that a taxpayer owes is the amount, if any, by which AMT liability exceeds regular tax liability. For example, if a taxpayer calculates that he owes $10,000 in taxes under the regular system and the AMT is $10,500, the taxpayer has an AMT liability of $500. Essentially, after calculating the amount of taxes owed under the regular and AMT systems, the taxpayer pays the higher of the two amounts.

 

In recent years, the number of people affected by the AMT has increased dramatically. This increase is due to the fact that, unlike regular income tax, exemptions in the AMT are not adjusted for inflation. In addition, application of tax credits, such as the child credit, has caused many taxpayers to have a lower tax liability under the regular tax system.

It is more likely for married taxpayers filing a joint return to be affected by the AMT then unmarried taxpayers with similar income. There are a few reasons for this. Typically, married couples have more dependents than single taxpayers, and under the AMT these married taxpayers are less able to use exemptions and credits for children than under the regular tax system. In addition, married taxpayers have a larger standard deduction than single taxpayers. Individuals who pay high state and local taxes are also more likely to pay AMT because there is no deduction for these taxes under the AMT system.

 

Congress has enacted temporary increases in the income levels that are exempt from the AMT in the past few years as a way to counter the increasing number of people who are affected by the tax. For the 2007 tax year, the income exemption was increased to $44,350 for a single taxpayer or head of household, $66,250 for married couples filing jointly and $33,125 for married people filing separately. These increases are only in effect for one year. Thus, unless Congress raises the income levels again for the 2008 tax year, the exemptions will be reduced back to $33,750 for single taxpayers, $45,000 for married couples filing a joint return and $22,500 for married people filing separately. If Congress does not raise the exemptions, it is likely that many more people will be subject to the alternative minimum tax.

 

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Does the IRS Offer Any Assistance to Taxpayers Who Need Help Resolving Tax Problems?

 

The Taxpayer Advocate Service is an independent division of the Internal Revenue Service (IRS). The goals of the Taxpayer Advocate Service are to reduce the burdens on taxpayers and protect individual and business taxpayer rights. If a taxpayer has experienced economic harm, needs help solving tax problems that have not been taken care of through normal procedures or believes that an IRS process is not working, he or she can use the Taxpayer Advocate Service. Each state has at least one Advocate who works independently of the IRS office in that state. The Taxpayer Advocate seeks to ensure that taxpayer issues are handled in a prompt and fair manner and identify issues that make things more difficult for taxpayers. Advocates are knowledgeable about the tax system and they listen to taxpayers’ problems, help taxpayers understand how to fix the situation and help taxpayers at every stage until the matter is resolved. The Service is free and confidential.

 

A taxpayer is eligible for assistance from the Taxpayer Advocate Service if:

 

  • The taxpayer is dealing with economic harm or significant costs, such as fees for professional representation
  • The taxpayer has faced a delay of over 30 days to resolve the issue
  • The IRS has failed to provide a response or solution to the taxpayer’s issue by a promised date

 

In addition to helping individual taxpayers and businesses with their problems within the IRS, another role of the Taxpayer Advocate Service is to suggest changes to the IRS’s procedures and rules that will help reduce or eliminate problems. In other words, the Taxpayer Advocate Service seeks to address systemic problems that affect multiple taxpayers; affect local, regional or national groups of taxpayers; relate to IRS policies and procedures; require administrative changes or legislative remedies; or involve protecting taxpayer rights, ensuring fair and equal treatment of taxpayers, reducing or preventing taxpayer burden or providing essential services to taxpayers.

If a taxpayer is experiencing a tax problem that a number of others are also dealing with, the taxpayer can submit the issue to the Taxpayer Advocacy Service for review through the Systemic Advocacy Management System (SAMS). After review, some issues become advocacy projects, which identify and try to develop solutions for problems that affect a large number of taxpayers.

 

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Can I Appeal an IRS Finding?

 

If you do not agree with the findings of the Internal Revenue Service (IRS), you may be able to file an appeal. For example, if after an audit, the IRS concludes that you owe additional taxes, you can appeal this decision. If you do not agree with IRS findings, the first step is to request a meeting with the supervisor of the person who issued the findings. If you still do not agree with the findings after discussing the case with the supervisor, you can appeal the case to the local IRS Appeals Office. The Appeals Office is separate from the IRS division that made the decision with which you disagree.

 

Conferences between taxpayers and Appeals Office representatives are generally informal. You can opt to have a representative such as an attorney, certified public accountant or person who is authorized to practice before the IRS. The conference is not recorded by a court reporter and testimony is not given while under oath. However, any facts you allege must generally be declared to be true under penalty of perjury.

 

If your case involves certain issues, you may need to file a formal written protest or a small case request in addition to requesting an appeals conference. A written protest is required if:

 

  • Your case involves an employee plan or exempt organization;
  • Your case involves a partnership or S corporation; or
  • Your case does not qualify for the small case request procedure or other special appeal process.

 

The Appeals Officer will typically ask you to propose a settlement offer. If it is not accepted, the Appeals Officer will propose his or her own settlement amount to you. If the parties reach a settlement agreement, the Appeals Officer prepares a report detailing the settlement amount, the issues, the evidence presented and the reasons supporting the settlement. You will then receive a bill for the agreed amount.

 

After the conference, the IRS will send you a “30-day letter,” which explains the IRS’s findings and your right to appeal within 30 days. You can then elect to pay any deficiency and then later contest the findings in court; ignore the letter and file a case in court after the IRS sends the “90-day letter;” or protest the 30-day letter and continue administrative proceedings within the Appeals Office with an eye toward settlement.

 

If an agreement is not reached through administrative channels, as noted above, you may be able to take your case to the United States Tax Court, the United States Court of Federal Claims or a United States district court if you meet certain procedural and jurisdictional requirements. The US Tax Court has jurisdiction over disputes relating to whether a taxpayer owes additional income tax, estate tax, gift tax, certain excise taxes and penalties related to those proposed taxes. The IRS will send the taxpayer a notice of deficiency stating the amount it believes the taxpayer owes, and the taxpayer has 90 days to file a petition with the US Tax Court. Claims for refunds can be heard in the US Court of Federal Claims or a US district court after the taxpayer has paid the tax and filed a claim for a refund with the IRS.

 

If you prevail in your dispute with the IRS, you may be able to recover reasonable litigation and administration costs. To recover these costs, you must have exhausted all administrative remedies within the IRS and not unreasonably delayed the proceedings. The recoverable costs may include attorneys’ fees, court costs, reasonable expenses of expert witnesses and reasonable costs of analyses or tests that are needed to prepare the case. A prevailing party is a party that substantially prevailed on the amount in controversy or the most significant tax issue and that meets the net worth requirement. For individuals, net worth cannot be more than $2,000,000 on the date from which costs can be recovered.

 

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What Can I Expect from an IRS Audit?

 

After you file your tax return, the Internal Revenue Service (IRS) checks the return for form and mathematical accuracy and then the Collection Division classifies it according to a system. After classification, the return is passed on to the Examination Division where it is given an initial review to determine whether there will be an office audit, field audit or no audit at all.

 

Office audits can be conducted by correspondence or office interview, with consideration given to your convenience. If there is an office interview, you will be asked to go to the local IRS District Director’s office and bring records and documents that support the information in the tax return.

 

If your case is more complex, a field audit may be used. In these cases, it may be necessary for the IRS officer to go to your home or office to examine books and records. If your return is selected for a field audit, the case will be assigned to an IRS agent who is part of the Examination Division.

 

The Examination Division may also examine tax returns from subsequent years. For example, if your 2005 tax return is selected for an audit, the Examination Division may also extend the audit to cover your 2006 and 2007 returns as well if they were filed before the audit. You can also ask to have the Examination Division examine subsequent returns.

 

You are allowed to represent yourself at the examination, but you can also opt to have representation from an attorney, accountant, agent who is enrolled to practice before the IRS or the person who prepared your tax return. If a joint return that you filed with your spouse is being examined, either one of you or both can attend.

 

You are permitted to record the examination interview. However, your request to make an audio recording must be made in writing at least 10 days prior to the meeting. The IRS is also permitted to record the meeting and must notify you in writing of its intention to do so 10 days before the meeting. You can request a copy of the recording, but you must pay for it.

 

When the examination is done, there are several possible scenarios that could take place. First, it is possible that the IRS will accept the return as it was filed without requiring any changes and close the case. Second, the IRS could assert a deficiency or an amount of additional tax that you owe. If you agree with the proposed changes, you can agree to pay any additional taxes plus interest. Third, the audit may reveal that you are due a refund. If this is the case, you will be paid interest on the refund.

 

If the return is not accepted as is, the IRS will send you a “30-day letter.” You can either accept the proposed changes and pay any deficiency or file a protest and appeal the matter to the IRS Appeals Office.

 

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Does a Divorce Raise Any Federal Income Tax Issues?

 

The first tax issue that a person may want to consider when deciding to divorce is how spousal support payments (also referred to as alimony or separate maintenance payments) are treated for tax purposes. If an individual will be paying spousal support to his or her ex-spouse, the amount of the payments can be deducted when computing adjusted gross income. The payee spouse must include alimony payments in his or her gross income. A payment qualifies as alimony or separate maintenance if:

 

  • The payment is in cash
  • The payment is received by a spouse pursuant to a divorce or written separation agreement
  • The divorce or separation agreement does not designate the payment as not being alimony for tax purposes
  • The payor spouse and payee spouse are not members of the same household after a divorce or legal separation at the time the payment is made
  • The obligation to make payments ends when the payee spouse dies
  • There is front loading of the payments, the excess payments are recaptured in income

 

Other types of payments may be considered alimony so that they are deductible by the payor spouse and included in the income of the payee spouse. Generally, the payment of a mortgage by a payor spouse on the payee spouse’s residence is treated as alimony, unless the payor owns the house. If one spouse pays the medical expenses of the other either directly or to a third party, the payment may be treated as alimony and be deducted by the payor.

 

A divorcing couple that has children might be concerned with how child support payments are treated for tax purposes. A “fixed” child support payment is not deductible by the payor spouse, nor is it included in the income of the payee spouse. If an amount of money is designated as child support in the divorce or separation agreement, then it is a fixed payment.

 

Other tax issues for divorcing parents are which parent can claim an exemption for the child or children and which parent can claim deductions for certain child care expenses. With some exceptions, the parent who has custody for the majority of time during the year is generally considered the custodial parent and can claim an exemption for the child. A taxpayer is entitled to a tax credit of $1000 for each qualifying child. This amount is reduced when the taxpayer’s modified adjusted gross income exceeds certain threshold amounts. A qualifying child means a child who is not over 17 years old, for whom a dependency exemption is permitted and who has a relationship with the taxpayer as set forth in Section 152(c) of the Internal Revenue Code (IRC). Either parent may deduct a child’s medical expenses if they exceed 7.5% of the parent’s adjusted gross income, regardless of which parent provides most of the support for the child. The IRC provides a credit for childcare expenses. A parent who has custody and incurs childcare expenses for a child under the age of 13 can claim this credit.

 

How transfers of property are treated for tax purposes is another concern that a divorcing couple may have. Under Section 1041 of the IRC, when one spouse transfers property to the other spouse, neither the gain nor loss is recognized for tax purposes. This nonrecognition rule applies regardless of whether the transfer was made in contemplation of divorce. If a divorcing couple sells their home and splits the proceeds, the parties must plan so that they do not recognize gain.

 

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Are there Criminal Penalties for Violations of the Federal Tax Laws?

 

A failure to pay taxes or abide by the rules and regulations of the Internal Revenue Service (IRS) can result in serious civil and criminal penalties. Federal income tax crimes are investigated by agents of the IRS’s Criminal Investigation Division. The more common tax crimes are tax evasion; willful failure to collect or pay over tax; failure to file a return; withholding violations; fraud and false statements; aiding and abetting; and fraudulent returns, statements and other documents.

 

Under section 7201 of the Internal Revenue Code (IRC), to establish a case for tax evasion, the government must prove that the taxpayer attempted to evade or defeat a tax or payment of a tax; an additional tax was due and owing; and the taxpayer acted willfully. The government must prove each of these elements beyond a reasonable doubt.

 

Section 7202 of the IRC covers the willful failure to collect or pay over taxes. Under section 7202 any person who is required to collect and pay over taxes (for example, withholding or excise taxes) who willfully fails to do so is guilty of a felony. Penalties include a fine of up to $10,000 or a prison sentence of up to 5 years or both.

 

Failing to file a return is covered by section 7203. Under this section the government must prove beyond a reasonable doubt that the taxpayer was required by law to file a return; that the taxpayer did not file a return within the given time period; and that the failure to file the return was because of a willful omission.

 

Under sections 7204 and 7205, which are rarely used, it is a misdemeanor crime for an employer to file a false or fraudulent W-2 or fail to file a W-2. It is also a misdemeanor for an employer to file a false or fraudulent W-4 or to fail to file a W-4.

 

Section 7206(1) covers the crime of false and fraudulent statements. The elements of this crime are that the defendant made and subscribed a tax return or other document that contains a written declaration that it was made under penalty of perjury when he or she knew it was materially false, and that the defendant acted with a willful, specific intent to violate the law.

 

Under section 7206(2), it is a crime for any person to willfully aid, assist in or advise the preparation or presentation of a tax return, claim or other document that is fraudulent or materially false, regardless of whether or not the individual who is required to present the return or other document is aware of or consents to the falsity or fraud. This section is typically used against people who prepare tax returns.

 

Section 7207 provides a punishment for any person who willfully delivers or discloses any return, statement or other document known to be fraudulent or materially false. This section sets forth that such a person shall be fined no more than $10,000 or be imprisoned for up to one year or both.

 

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What Happens if I Cannot Pay My Taxes?

 

If you are unable to pay your taxes and fail to pay when you file, the Internal Revenue Service (IRS) will send you a bill, which begins the collection process. The bill will set forth how much you owe, including penalties and unpaid interest, and require payment in full. If you cannot pay in full, it is a good idea to pay as much as you can, as any unpaid amount will continue to accrue interest and be subject to a monthly late payment fee. In addition, it is recommended that you contact the IRS and attempt to make payments voluntarily. If you do not do this, the IRS may take certain actions to collect the unpaid taxes, such as: filing a notice of federal tax lien, serving a notice of levy or offsetting a refund to which you are entitled.

 

If you are experiencing a financial hardship and cannot pay anything, the IRS may temporarily stop collection efforts. In addition, if you can establish that paying a tax when due will cause you undue hardship, you can request a statutory extension of time to pay tax for up to 6 months. Undue hardship means substantial financial loss. To obtain this extension, you must file Form 1127 “Application for Extension of Time for Payment of Tax,” along with a list of assets and liabilities and an itemized list of money you received and spent for the three months before you asked for the extension.

 

Taxpayers who cannot pay in full may be able to arrange to pay in monthly installments. However, interest and late payment fees will continue to accrue. If you enter an installment agreement, there are several payment options, including direct deduction from your bank account, payroll deduction from your employer or payment via check or money order.

 

If you do not qualify for an installment payment agreement, you can propose an Offer in Compromise (OIC), which is an agreement between a taxpayer and the IRS that settles the taxpayer’s tax liability for less than what he or she owed. Generally, if you can pay the full amount owed with an installment agreement or other arrangement, you will not be eligible for an OIC.

 

Generally speaking, the IRS will only agree to an OIC if the amount you offer is more than the reasonable collection potential (RCP). The RCP gauges the taxpayer’s ability to pay. It includes the value of the taxpayer’s assets, such as cars, real property and bank accounts, and anticipated future income. There are three bases on which the IRS may accept an OIC: (1) there is doubt as to the taxpayer’s liability; (2) there is doubt that the amount owed by the taxpayer can be collected (i.e. it is doubtful that the taxpayer could pay the full amount); or (3) there is no doubt that the liability is accurate and that the full amount can be collected, but requiring full payment would create economic hardship or would be inequitable based on exceptional circumstances.

 

There is a $150 application fee for an OIC unless the offer is based only on doubt as to liability or you qualify for the low-income exception. You can pay the OIC in a lump sum or in installments. Lump sum is defined as payable in less than 5 installments; while a periodic payment offer is payable in 6 or more installments.

 

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What are Gift Taxes?

 

The federal gift tax applies to any transfer of property by gift. If a person gives property, which includes money or the use of or income from property, without the expectation that he or she will get something of equal or greater value in return, it is a gift. In addition, if an individual sells property for less than its value or makes an interest-free or lower-interest loan, it may be considered a gift. The recipient of the gift does not have to pay a gift tax or income tax on the value of the gift.

 

As a general rule, all gifts are taxable. Of course, there are exceptions to this rule. The following gifts are not taxable gifts:

 

  • Tuition or medical costs paid directly to an education or medical institution on behalf of someone else
  • Gifts to a spouse
  • Gifts to a political organization
  • Gifts to charities
  • Gifts that are not greater than the annual exclusion for the calendar year (except for gifts of future interests)

 

The annual exclusion for 2008 is $12,000, which means that any gift of up to $12,000 is not taxable. The annual exclusion may be periodically increased due to cost-of-living adjustments. Thus, if an individual gave $10,000 to his cousin for her wedding, he will not be taxed. Likewise, if a person gave $11,999 to a friend, she will not be taxed. In addition, if a husband gives $15,000 to his wife, he will not be taxed because, even though the gift exceeds the annual exclusion amount, it is a gift to a spouse, which is excluded from taxation.

 

It is not necessary to file a gift tax return to report gifts of tuition or medical expenses or gifts to political organizations. For example, suppose John Smith paid a friend’s law school tuition of $50,000. Even though the tuition is higher than the exclusion amount, John would not be taxed as long as the tuition was paid directly to the educational institution. In addition, deductible gifts to charities in the form of the entire interest in property or a qualified conservation contribution that is a restriction on the use of real property do not have to be reported. A person must file a gift tax return (using IRS Form 709) if any of the following apply:

 

  • The individual gifts items to at least one person (other than a spouse) that exceed the annual exclusion
  • The individual gives a gift of a future interest to someone (other than a spouse) and the gift cannot be possessed, received or enjoyed until some time in the future
  • A person gives his or her spouse an interest in property that will end with some future event involving his or her spouse
  • A person split a gift with his or her spouse

 

Gift splitting is when a married couple makes a gift to a third party and it is considered as made one-half by the husband and one-half by the wife. Both spouses must agree to split the gift and each can take the annual exclusion for part of the gift. Thus, in 2007 (annual exclusion = $12,000), a married couple can give up to $24,000 without the gift being taxable.

 

The Economic Growth and Tax Relief Reconciliation Act of 2001 significantly changed the federal gift and estate tax systems. The top marginal tax rate applicable to gifts has decreased each year since 2002 to 45% for 2007. It will remain at 45% for 2008 and 2009. The Act also set the highest gift tax rate at 35% for 2010. The provisions set forth in the Act are set to expire at the end of 2010. If Congress does not extend the provisions, the rates will return to pre-Act levels.

 

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What are Estate Taxes?

 

The federal estate tax is a tax on the transfer of property from an individual to his or her beneficiaries at the time of the individual’s death and on other transactions that are determined to be the equivalent of a transfer of property at death. It is sometimes called the death tax.

 

The estate tax is imposed on the decedent’s taxable estate. The taxable estate equals the total value of property transferred at death or considered to be transferred at death (called the gross estate) minus deductions allowed under the Internal Revenue Code. The following types of property are included in the gross estate:

 

  • Property that the decedent owned at the time of his or her death
  • Certain types of gifts made during the decedent’s lifetime within 3 years of death
  • Transfers of property in which the decedent retained a life estate
  • Transfers of property that take effect at death
  • Transfers that are revocable
  • Property that is jointly owned by another and the decedent at the time of his or her death
  • Qualified terminable interest property for which a marital deduction was allowed previously
  • Property that is subject to powers of appointment
  • The decedent’s life insurance
  • Pensions and annuities that have death benefits

Once it has been determined what property is included in the gross estate, the value of that property must be ascertained. The value is generally fair market value. For estate tax purposes, fair market value is defined as the price for which a willing buyer and seller would transfer property, where neither is forced to buy or to sell and both of them have reasonable knowledge of all the relevant facts. Fair market value is normally the value of the property on the date of death. The estate’s executor, however, can select a date other than the date of death to value the gross estate if certain conditions are met. This is called the alternate valuation date.

 

After finalizing the value of the property that is included in the gross estate, the allowable deductions must be determined. Deductions are available for the following:

 

  • Administration expenses
  • Funeral expenses
  • Claims against the estate
  • Unpaid mortgages
  • Theft or casualty losses sustained by the estate during administration if not covered by insurance
  • Charitable transfers
  • The marital deduction (the value of any property that passes from the decedent’s estate to the surviving spouse)
  • Any state or local estate or death taxes paid because of the decedent's death

 

To arrive at the taxable estate, subtract the available deductions from the value of the gross estate.

 

The Economic Growth and Tax Relief Reconciliation Act of 2001 provides for estate tax relief that will expire after December 31, 2010, unless Congress acts to extend it. Under this Act, the maximum estate tax rate was reduced from 50% in 2002 to 45% in the years 2007-2009. For 2010, the estate tax is repealed. In addition, the amount that is exempt from estate taxes has increased under this Act from $1 million in 2002 to $2 million in 2007 and 2008 and up to $3.5 million in 2009.

 

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Why Should My Business Consult with a Tax Attorney?

 

It is important for business owners to stay on top of tax issues. Complying with the tax laws is of the utmost importance and the amount of taxes your business is required to pay may affect your bottom line. An experienced tax attorney can help your business adhere to the requirements of the Internal Revenue Code (IRC) and federal tax regulations.

 

The IRC, Treasury Regulations and other federal tax laws change frequently, and tax attorneys are aware of these changes and how they can affect your business. Generally, amendments to the IRC are made every year. In addition, throughout the year, the Internal Revenue Service (IRS) and Treasury Department issue rulings, regulations and other published guidance interpreting the IRC.

 

Ideally, you should consult with an attorney or other tax professional when you are forming your business. Even your choice of business entity - corporation, partnership or sole proprietorship - will affect the tax liability of your business. Discuss the different possible entities with a tax attorney so you can select one that best suits your business' needs. In addition, having the proper procedures in place at the beginning will help your business deal with tax issues that may arise in the future. For example, your business will need to decide which tax year it will use. An attorney can help your business create a record retention policy so that documents related to income, expenses and potential deductions are kept for a sufficient period of time in case they are needed for a future audit or tax dispute.

 

Another area in which an attorney should be able to assist your business is with clarifying its income-reporting responsibilities. Business income may come in many forms. The IRC refers to gross income, which is defined as all income from whatever source derived and includes compensation for services, interest, royalties, commissions and a number of other things. It is essential that your business know what is considered gross income, so that all of its income is accurately reported. Failure to report income can result in additional taxes, interest and penalties.

 

A tax lawyer can also help your business maximize the available deductions. Taking advantage of all the available deductions will help your business minimize its tax liability. There are a number of deductions available to businesses and an attorney can explain them to you and determine whether they apply to your business.

 

In addition to federal income tax, if your business does business in states other than where it is located, it may have to pay state income tax in those states. Many businesses derive income from doing business outside of the state where they are located. It is as important to be aware of the tax obligations of conducting business outside of your home state, as it is to be aware of your in-state obligations. An attorney can guide you through this potentially confusing area.

 

Business taxation, unlike some other business issues, is an area where there really is almost no room for error. Tax-related mistakes can result in additional taxes, interest and penalties. An audit can be a disruptive and expensive process. Organizing and compiling records before an audit, particularly if the business' record-keeping practices were not up to par can be difficult. An attorney who can explain the examination process and walk you through the steps can help ease your tax worries so you can focus on the business.

 

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What Rights do Taxpayers Have When Dealing with the IRS?

 

Congress has taken a few steps to ensure that taxpayers are protected when dealing with the Internal Revenue Service (IRS). Congress passed a Taxpayer Bill of Rights in 1988 and again in 1996. The provisions of the 1996 legislation include:

 

  • Taxpayer assistance orders, providing relief for taxpayers who might suffer hardship due to an enforcement action
  • Increased right to appeal liens or seizures, either before or after a collection action
  • Greater notice prior to making a levy and issuing summons to a third party
  • Administrative appeal of liens
  • Awards for reasonable costs (administrative and litigation) when the IRS takes unreasonable positions
  • Damages for disclosure of return, failure to properly release lien and unauthorized enforcement actions

 

The 1996 Taxpayer Bill of Rights also created the Taxpayer Advocate Service, an independent organization within the IRS. The Taxpayer Advocate Service works with individuals whose tax problems are not resolved through the normal procedures to ensure that the issues are handled promptly and fairly.

 

In 1998, Congress passed the IRS Restructuring and Reform Act which included the following provisions:

 

  • Burden of proof in civil cases involving tax disputes shifted from taxpayer to the IRS
  • Suspension of penalties and interest if the IRS waits more than 18 months to inform someone that additional taxes are owed
  • Protection from collection actions in certain cases for people whose tax problems were caused without their knowledge by their spouse
  • Expanded powers for the Taxpayer Advocate Service to grant taxpayer assistance orders, halting tax collections in cases of potential hardship
  • Tax relief such as reduction of the long term capital gains holding period; education incentives; principal residence gain exclusions; EIC expansion; new IRAs; and estate and gift provisions
  • Expansion of rights or privileges in the areas of interest calculations for taxes and refunds; liens, levies and seizures; audit criteria; tip reporting; offers in compromise and installment agreements; new "due process" requirements; more inclusive innocent spouse provisions; and third party summonses

 

In dealing with the IRS, a taxpayer also has the following rights:

 

  • The IRS will not disclose information about you to anyone, unless the law authorizes disclosure
  • If the IRS asks for information, a taxpayer has the right to know why, how it will be used and the consequences of nondisclosure
  • If an error or delay of an IRS employee results in a taxpayer being charged interest, the IRS will waive that interest
  • If a taxpayer is entitled to a refund and the IRS takes longer than 45 days from the date the refund claim or return is filed to send you a check, the IRS will generally owe the taxpayer interest
  • If a taxpayer can show that he or she acted reasonably and in good faith or relied on the incorrect advice of the IRS, the IRS will waive penalties when allowed by law
  • A taxpayer is only obligated to pay the correct amount of tax due under the law and no more or no less

 

There are certain rights that taxpayers have with respect to audits as well. Taxpayers have the right to represent themselves at the examination or they can have an attorney, certified public accountant, an agent enrolled to practice before the IRS or the person who prepared their return represent them. A taxpayer is also permitted to make sound recordings of any meetings with the IRS's examination, appeals or collection personnel if he or she notifies the IRS ten days before the meeting. If a taxpayer disagrees with the IRS about his or her tax liability, the taxpayer has a right to ask the Appeals Office to review the case.

 

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What is an Exempt Organization?

 

An exempt organization does not have to pay federal income taxes. A nonprofit organization is not automatically considered an exempt organization. It is exempt from tax only if it meets one of the classifications of organizations outlined by the Internal Revenue Code (IRC). The relevant provisions of the IRC are sections 501(c), 501(d) (religious and apostolic associations), 501(e) (cooperative hospital services organizations), 501(f) (cooperative service organizations or operating educational organizations), 521 (farm cooperatives), 527 (political organizations) and 528 (homeowners’ associations).

 

While the exemption requirements for organizations vary depending on the organization’s nature, all organizations must adhere to the requirement that no part of its net earnings go to private interests, shareholders or beneficiaries of the organization. In addition, exempt organizations still need to file an informational return. The only organizations not required to do so are churches, governmental entities and organizations (other than private foundations) that have gross receipts of less than $25,000.

 

The majority of nonprofit organizations have tax exempt status under section 501(c). There are a number of types of organizations classified under section 501(c) including:

 

  • Charitable, religious, scientific and educational organizations
  • Social and recreational clubs
  • Civic and general welfare organizations
  • Nonprofit cemetery companies
  • War veterans’ organizations
  • Title holding companies
  • Business leagues, chambers of commerce, real estate boards, boards of trade and professional football leagues
  • Fraternal beneficiary societies
  • Labor, agricultural or horticultural organizations
  • Voluntary employee beneficiary associations
  • Credit unions, domestic building and loan associations and cooperative banks
  • Mutual insurance companies
  • Child care organizations

 

Within section 501(c), the most well-known organizations are probably organizations exempt under subsection (3). To be exempt under section 501(c)(3), the charitable organization must:

 

  • Be organized and operated exclusively for one of the following purposes: religious, charitable, scientific, testing for public safety, literary, educational, to foster national or international amateur sports competition or the prevention of cruelty to children or animals
  • Not use net earnings for the benefit of any private shareholder or individual
  • Have no substantial part of its activities be to attempt to influence legislation
  • Not participate in or intervene in any political campaign in support of or in opposition to a candidate for public office

 

To be tax exempt under section 501(c)(3), an organization’s articles must limit its purpose to one or more of the listed exempt purposes and must not expressly give the organization power to engage in activities that do not further that purpose, except insubstantially. In addition, the organization must operate exclusively for one or more of the listed exempt purposes by engaging primarily in activities that accomplish that purpose.

 

Section 501(c)(3) organizations can be either public charities or private foundations. Public charities are generally responsive to the general public rather than a few contributors and include organizations such as schools, churches, hospitals, governmental units, entities engaged in testing for public safety and other publicly supported charitable organizations. Private foundations are subject to strict supervision by the Internal Revenue Service and must pay a tax on net investment income. Generally speaking, contributors to public charities receive more favorable tax treatment than contributors to private foundations.

 

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Learn More: Taxation

 

Tax is a complex area of the law that involves a variety of distinct elements. Taxation involves various levels of government involvement and regulation, from the federal government down to state and local governments. Government entities impose taxes in order to raise the revenue required to pay for government projects and programs. In addition, with the globalization of the economy, tax practitioners must consider potential taxation by foreign governments when advising individual and business clients.

 

The federal government and some states tax the transfer of wealth through estate and gift taxes. An estate tax, also known as a death tax, is imposed on the transfer of property from a deceased person to his or her heirs. For the 2008 tax year, up to $2 million is exempt from the federal estate tax. The federal gift tax applies to any transfer of property by gift. For 2008, there is an exemption of $12,000 so that there is no tax on any gift of less than $12,000.

 

Excise taxes can be imposed by federal, state or local authorities. The federal government alone imposes excise tax on over twenty different types of manufacturing, retail and miscellaneous transactions. Excise taxes cover a wide range of products and activities including diesel fuel, heavy trucks and trailers, sport fishing equipment, bows and arrows and firearms. An excise tax is imposed on manufacturers and producers of tires, gasoline, aviation fuel, coal and certain vaccines.

 

A taxpayer must pay income tax on his or her taxable income. A complex set of rules is applied to determine taxable income. Generally, taxable income is determined by calculating total income minus certain allowable adjustments, deductions and exemptions. Once taxable income is determined, progressive tax rates are applied to calculate the amount of tax due.

 

International tax rules are complex and may affect US citizens and residents that conduct business outside the United States and foreign citizens and nonresident aliens that conduct business within the United States. The United States has entered into tax treaties with a number of foreign countries. While the rules vary depending on the country and the type of income at issue, generally under these treaties, residents of foreign countries are taxed at reduced rates or are even exempt from US income tax on income from sources within the United States.

 

Property (ad valorem) taxes are taxes imposed on the owners of certain types of property. The tax is typically based on the value of that property. Most state and local governments impose an annual property tax on real estate based on the value of the subject property.

 

Sales and use taxes are generally imposed by state and local taxing authorities. A sales tax is collected at the time of sale to a consumer and is based on the cost of the item sold. A use tax is generally a substitute for a sales tax. If an item was not taxed at the time of sale, its use will be taxed when the item is used within the taxing jurisdiction.

 

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