Warren Buffett Gives $3.6 Billion To Charity, How To Supersize Your Donations Too

The news that Warren Buffett is donating a whopping $3.6 Billion of his Berkshire Hathaway stock to charity means he has surpassed the $3.4 billion gift he gave last year. Buffett is the world’s fourth richest man, with an $88.6 billion net worth thanks to his success with Berkshire Hathaway. His $3.4 billion and now $3.6 billion pledges fulfill part of his promise to donate over 99% of his fortune to charity. So far, he has given roughly 45% of his stock to five foundations as part of the Giving Pledge he made in 2006. Big recipients are the Bill and Melinda Gates’ Foundation, the Susan Thompson Buffett Foundation, the Sherwood Foundation, the Howard G. Buffett Foundation and the NoVo Foundation.  The Bill and Melinda Gates Foundation is the world’s largest private charitable foundation, having given over $50 billion in grants. As for the mechanics of Buffett’s gifts, he is converting 11,250 of Class A Berkshire shares into 16,875,000 of Class B shares, worth roughly $3.6 billion.

Warren Buffett, Chairman and CEO of Berkshire Hathaway, smiles as he plays bridge following the annual Berkshire Hathaway shareholders meeting in Omaha, Neb., Sunday, May 5, 2019. (AP Photo/Nati Harnik) photocredit: ASSOCIATED PRESS

When Mr. Buffett makes these outsized gifts, he does not make them in cash. The famously savvy CEO of Berkshire Hathaway does it in stock, of course. Why donate stock rather than cash? When someone donates stock, the donor gets a charitable contribution deduction based on the fair market value of the stock. Value and basis are different things, which can mean enormous tax advantages. By donating the shares at their market value, Mr. Buffett gets credit for the appreciation in the shares. The fair market value of the stock is his donation, but he does not have to pay income tax on his gain as if he sold it. Thus, donating appreciated stock is far better than selling the stock, paying tax on the gain, and donating the cash.

Giving appreciated property is the kind of wise tax planning you would expect from Mr. Buffett. Mr. Buffett is not alone. Facebook CEO Mark Zuckerberg has done the same thing, as have many other wealthy individuals. By donating the stock, the donor avoids paying tax on the gain. The donee organization can hold or sell the stock. But since it is a tax-qualified charity, if it sells the stock it pays no tax regardless of how big the gain. Big donations yield big tax benefits, but pay attention to the details. You can only take a deduction for up to 50% of your adjusted gross income for most charitable contributions (30% in some cases).

Observe other basic rules too. If your donations entitle you to merchandise, goods or services, you can only deduct the amount exceeding the fair market value of the benefits you received. If you pay $500 for a charity dinner ticket but receive a dinner worth $100, you can deduct $400, not the full $500. Another basic rule is to make sure the donee organization is qualified. You cannot deduct contributions to individuals, political organizations or candidates. The IRS maintains a list of all charities. To check whether particular organizations are on the IRS list, click here.

Mr. Buffett has famously said that he believes his own income tax rate should be higher than it is. However, he has also proven to be careful and tax-savvy investor, planning transactions efficiently so that he pays as little as possible. Like a long-term investment that pays off, perhaps there’s something satisfying in arranging a deal that is tax-efficient and that benefits charity. It’s unlikely that any of us will make it to Warren Buffett‘s level, but even on a smaller scale, properly planned charitable contributions can be tax efficient, and do good works too.

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Five Key IRS Rules How Lawsuit Settlements Are Taxed

Many plaintiffs win or settle a lawsuit and are surprised they have to pay taxes. Some don’t realize it until tax time the following year when IRS Forms 1099 arrive in the mail. A little tax planning, especially before you settle, goes a long way. It’s even more important now with higher taxes on lawsuit settlements under the recently passed tax reform law. Many plaintiffs are taxed on their attorney fees too, even if their lawyer takes 40% off the top. In a $100,000 case, that means paying tax on $100,000, even if $40,000 goes to the lawyer. The new law generally does not impact physical injury cases with no punitive damages. It also should not impact plaintiffs suing their employers, although there are new wrinkles in sexual harassment cases. Here are five rules to know.

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1. Taxes depend on the “origin of the claim.” Taxes are based on the origin of your claim. If you get laid off at work and sue seeking wages, you’ll be taxed as wages, and probably some pay on a Form 1099 for emotional distress. But if you sue for damage to your condo by a negligent building contractor, your damages may not be income. You may be able to treat the recovery as a reduction in your purchase price of the condo. The rules are full of exceptions and nuances, so be careful, how settlement awards are taxed, especially post-tax reform.

2. Recoveries for physical injuries and physical sickness are tax-free, but symptoms of emotional distress are not physical. If you sue for physical injuries, damages are tax-free. Before 1996, all “personal” damages were tax-free, so emotional distress and defamation produced tax-free recoveries. But since 1996, your injury must be “physical.” If you sue for intentional infliction of emotional distress, your recovery is taxed. Physical symptoms of emotional distress (like headaches and stomachaches) is taxed, but physical injuries or sickness is not. The rules can make some tax cases chicken or egg, with many judgment calls. If in an employment dispute you receive $50,000 extra because your employer gave you an ulcer, is an ulcer physical, or merely a symptom of emotional distress? Many plaintiffs take aggressive positions on their tax returns, but that can be a losing battle if the defendant issues an IRS Form 1099 for the entire settlement. Haggling over tax details before you sign and settle is best.

3. Allocating damages can save taxes. Most legal disputes involve multiple issues. You might claim that the defendant kept your laptop, frittered away your trust fund, underpaid you, failed to reimburse you for a business trip, or other items. Even if your dispute relates to one course of conduct, there’s a good chance the total settlement involves several types of consideration. It is best for plaintiff and defendant to agree on tax treatment. Such agreements aren’t binding on the IRS or the courts in later tax disputes, but they are usually not ignored by the IRS.

4. Attorney fees are a tax trap. If you are the plaintiff and use a contingent fee lawyer, you’ll usually be treated (for tax purposes) as receiving 100% of the money recovered by you and your attorney, even if the defendant pays your lawyer directly his contingent fee cut. If your case is fully nontaxable (say an auto accident in which you’re injured), that shouldn’t cause any tax problems. But if your recovery is taxable, watch out. Say you settle a suit for intentional infliction of emotional distress against your neighbor for $100,000, and your lawyer keeps $40,000. You might think you’d have $60,000 of income. Instead, you’ll have $100,000 of income. In 2005, the U.S. Supreme Court held in Commissioner v. Banks, that plaintiffs generally have income equal to 100% of their recoveries. even if their lawyers take a share.

How about deducting the legal fees? In 2004, Congress enacted an above the line deduction for legal fees in employment claims and certain whistleblower claims. That deduction still remains, but outside these two areas, there’s big trouble. in the big tax bill passed at the end of 2017, there’s a new tax on litigation settlements, no deduction for legal fees. No tax deduction for legal fees comes as a bizarre and unpleasant surprise. Tax advice early, before the case settles and the settlement agreement is signed, is essential.  

5. Punitive damages and interest are always taxable. If you are injured in a car crash and get $50,000 in compensatory damages and $5 million in punitive damages, the former is tax-free. The $5 million is fully taxable, and you can have trouble deducting your attorney fees! The same occurs with interest. You might receive a tax-free settlement or judgment, but pre-judgment or post-judgment interest is always taxable (and can produce attorney fee problems). That can make it attractive to settle your case rather than have it go to judgment. For a crazy example how these tax rules can whittle after-tax amounts to nothing, check out how IRS taxes kill plaintiff’s $289M Monsanto weedkiller verdict.

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How Lawsuit Structured Settlements Work

Unless you’ve been involved in a lawsuit, you may not know about structured settlements. You may have heard of them on late night TV. “It’s your money,” some TV ads will exclaim. “Cash in your structured settlement and use your money now!” These TV ads are from factoring companies that buy up lawsuit structured settlements, but how do you get one in  the first place? If you are a successful plaintiff in a lawsuit, your contact with structure settlements may be personal. You may have received one, be evaluating one now, or have considered one but opted for cash. Even if you already have a structure, you may not know how they operate and why they’re set up in the way they are. Structured settlements are mostly about taxes. If you are injured in a car accident and receive a $300,000 settlement from the other driver or insurer, it’s tax free, which is one of the rules how settlements are taxed. When you invest the $300,000, your investment earnings are taxable. If you receive a structured settlement instead of the $300,000 cash, you’ll get payments over a term of years or your lifetime (however you choose), and each payment is fully tax free. Thus, a structure converts your after-tax earnings into a tax free return.

calculator and hammer of a judge on the money dollar banknote. Taxes, not payment, court, law. The Mosques. tax evasion photocredit: Getty

Structured settlement brokers (a special type of insurance agent) consult as a case approaches settlement. Brokers are paid standardized commissions by the life insurance company that issues the annuity. Brokers can run many financial projections based on a term of years, payments over your life, over your joint life with your spouse, etc.  You can even call for no payments for say 10 or 15 years, with payments starting thereafter as a way to fund your retirement. Structured settlements are very flexible. Provided that you consider these issues before signing a settlement agreement in your case, you can structure as much or as little as you want and take the rest in cash. They have to be set up properly, and you can’t own the annuity policy or the tax benefits won’t work. Rather than paying the cash to you or your lawyer, the defendant will send the money for the structure to a life insurance company’s subsidiary called an “assignment company.”  The assignment company will buy the annuity from its parent life insurance company, and the assignment company will hold the policy and pay you each month as the contract requires.

Special provisions in the tax code allow this structure.  Apart from special benefits to insurance companies, the arrangement allows you to be a mere recipient of the periodic payments over time.  Even though you’re guaranteed to receive each payment, the tax code doesn’t treat you as owning anything except an expectation of each payment. Structured settlements are tax efficient and can have asset protection and spendthrift advantages too.  Like other tax deferral ideas, their results are more impressive the longer their term and the slower they pay out.  They aren’t for everyone, and you shouldn’t structure every nickel you receive.  Once they are set up, they generally can’t be changed. The “cash it in and get your money!” crowd advertising on TV are factoring companies that buy structures at a discount from accident victims who need the cash now.  Most states require a court hearing before they can buy a structure.

Finally, the same concept is used in non-tax free settlements (like a contract dispute). These have been around for more than a decade, and are common in taxable cases like employment settlements. The idea is to stretch out the payments even though each installment will be taxable when paid. Couldn’t you just have the defendant pay the money in installments? Sure, but most plaintiffs don’t want to rely on a defendant and want a reliable third party to pay them, growing the pot in the process. In 2008, the IRS issued a key ruling spurring these damage structures. There is even more interest in these now, given the harsher ways that legal settlements are taxed after the 2017 tax reform.

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Wrongful Life And Wrongful Birth Damages, Taxable or Tax-Free?

As medicine, science, and the law continue to develop, lawsuits for wrongful birth and wrongful life are increasingly being recognized. Wrongful birth actions are brought by parents to recover for the birth of an unhealthy child. The parents’ right to recover is based on the defendant’s negligent deprivation of their right to not conceive the child, or to prevent the child’s birth. In contrast, wrongful life actions are brought by the child but parallel a wrongful birth cause of action. Both kinds of cases generally involve medical evidence and damage studies that focus on the life-care needs of a disabled or ill child. States vary in whether they allowing either or both kinds of cases, but if a parent or child sues and recovers a settlement or judgment, is it taxable?

a hammer of a judge, American dollar bills on the background of a wooden table. corruption, arrest, court. photocredit: Getty

Damages for personal physical injuries (like an auto accident or slip and fall case) are tax-free. So are damages for physical sickness. But punitive damages and interest are taxable, as are damages for emotional distress. Up until 1996, just about anything qualified as tax free personal injury damages, including emotional distress, defamation or invasion of privacy. In 1996, the tax code was changed so only recoveries for personal physical injuries or physical sickness qualify. Unfortunately, the IRS is notoriously tough on what is physical. Traditionally, it means injuries you can see like bruises or broken bones. How do wrongful life and wrongful birth damages stack up to this standard? For a wrongful life claim, a plaintiff child’s personal physical injury or physical sickness may be clear, and damages are usually assessed based on the additional medical and special needs of the child.

That arguably goes a long way toward the tax-free standard. With both types of cases, pay attention to the particular language in the settlement agreement. Ideally, consider these issues before the settlement documents are finalized. In wrongful birth cases, the defendant’s actions take away the parent’s right to make an informed decision on whether to carry a fetus to term. In that sense, the defendant caused the birth, and thereby caused the physical injury or disability. Except for the defendant’s negligence, the child’s medical condition would not have had the opportunity to manifest itself, with the resulting medical and life-care expenses.

It may not matter to the tax treatment whether it is the child or the parents who receive the damages. The IRS has repeatedly suggested that the nature of the damages is more important that who is receiving them. For example, survivors or bystanders may receive damages for someone else’s injuries or death, but they may still be entitled to tax-free treatment. The legislative history of the tax code section says that all non-punitive damages that flow from a physical harm can be excluded, regardless of whether the recipient of the damages is actually the injured party.

With wrongful life or wrongful birth damages, the funds are meant to pay for the stress of caring for an ill or disabled child and the attendant costs. The parents are receiving the funds, but they are really receiving them on account of the injuries to or special needs of the child. It is conceivable that the IRS could classify these damages as emotional distress recoveries. However, using strong tax language in settlement agreements may keep the issue from arising. Stressing the nature of the damages and the medical failures in question should help. So, too, should statements that the settlement payment is being made on account of medical expenses, physical injuries, physical sickness, and emotional distress they caused.

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Avoid California & Other State Taxes With Supreme Court Trust Ruling?

In North Carolina Dept. of Revenue v. Kimberley, the U.S. Supreme Court unanimously ruled that a state could not tax an out of state resident on trust income without minimum contacts. If you live in a high tax state (in California, rates top out at 13.3%!) you might be slapping an out of state trust together to stockpile income and assets in Nevada, Delaware, etc. But will it work? You could avoid California taxes by moving, of course, as many do shortly before a major income event. You might be selling a company, settling a lawsuit, or about to sell a mountain of Bitcoin. Done carefully and with the right kind of income, a tax-motivated move can cut the sting of high state taxes. Of course, even moving to avoid state taxes can be tough to orchestrate, and states can audit and push back. A newer and still largely untested approach involves setting up a new type of trust in Nevada or Delaware. A ‘NING’ is a Nevada Incomplete Gift Non-Grantor Trust. A ‘DING’ is its Delaware sibling. There is even a ‘WING,’ in Wyoming. The usual grantor trust for estate planning doesn’t help, since the grantor must include the trust income on his own tax return.

Credit: Shutterstock

With a Nevada or Delaware Incomplete Gift Non-Grantor Trusts, the donor makes an incomplete gift to the trust, and the trust has an independent trustee. The idea is to keep the grantor involved but not as the owner. New York State changed its law to make the grantor taxable no matter what, but the jury is still out on these trusts in California and other states. Some marketers of NING and DING trusts offer them as alternatives or adjuncts to a physical move. The idea is for the income and gain in the NING or DING trust not to be taxed until distributed, when the distributees will hopefully no longer be in the high tax state. The trustee must not be a resident of the high tax state. Tax-deferred compounding can yield impressive results, even if only state tax is being sidestepped. Parents frequently fund irrevocable trusts for children, and may not want the trust to make distributions for years, removing future appreciation from parent’s estates.

For tax purposes, most trusts are considered taxable where the trustee is situated. For NING and DING trusts, a common answer is an institutional trust company. Trust investment and distribution committees should also not be residents. The facts, documents, and details matter, and states like California may well push back. However, doesn’t the Supreme Court’s North Carolina Dept. of Revenue v. Kimberley case help?The Court ruled that North Carolina’s tax statute asserting jurisdiction on a foreign trust based solely on the residence of a beneficiary was too broad. But it is still constitutional for a state to taxed based on the residence of the trustee or cite of trust administration. Plus, who forms the trust matters. In the North Carolina case, the trust was formed by the taxpayer’s father, and he was a resident of New York. The taxpayer (the daughter) was not the trustee and had no control over the trust. Plus, she didn’t even receive any distributions from the trust in the years involved in the case. That made it a pretty compelling case for the Supreme Court to tell North Carolina it just couldn’t tax her.

In contrast, many NING/DING trusts are formed by the person in the high tax state trying to avoid state tax, a person in California, for example. And then there’s the distribution question, as some NING/DING trusts do anticipate that the settlor might receive distributions. The administration can be touchy too, as some NING/DING trusts include the settlor/beneficiary as a member of a distribution committee that exercises control over trust distributions. Depending on the facts of the NING/DING trust, therefore, the Supreme Court’s ruling seems pretty limited. In fact, the case is limited to the handful of states that use beneficiary residence as the sole factor for determining the state’s taxing jurisdiction. The Court says its ruling should not impact states that consider beneficiary residence as only one of several factors for determining their jurisdiction to tax. Interestingly, California is one of five states identified in the case that establishes jurisdiction based entirely on the beneficiary’s residence. Even here, though, the opinion carves out California’s tax statute as an issue to resolve at a later date. California law only allows the state to assert jurisdiction based solely on the beneficiary residence when the beneficiary’s interest is not contingent (such as not subject to the discretion of a trustee). The North Carolina case involved a trustee who had discretion to control distributions, or to not make distributions at all. Thus, the Court saved for later the question whether a beneficiary’s residence alone is sufficient when a beneficiary’s interest is not contingent.

In that sense, the true holding of the North Carolina case seems pretty narrow.  It says that a state cannot assert jurisdiction over a trust based solely on the residency of the beneficiaries, when the beneficiaries have contingent interests. As the Court states: “[W]e address only the circumstances in which a beneficiary receives no trust income, has no right to demand that income, and is uncertain necessarily to receive a specific share of that income.  Settlors who create trusts in the future will have to weigh the potential tax benefits of such an arrangement against the costs to the trust beneficiaries of lesser control over trust assets.” So will your NING/DING trust work to shield you and your beneficiaries from state tax? Some people even blend federal and state tax strategies, perhaps so a legal settlement is tax free or tax deferred. Creative trusts can be worth trying on the right facts, but you need to be careful. After all, you don’t want to be low-hanging fruit for the high tax state to attack.

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Litigation Finance Transactions Face Taxes, So Be Careful

Lawyers and clients often need cash. There is also the element of risk. Lawyers and clients may want to lay off some of the risk of a case on someone else, and the litigation finance industry generally offers non-recourse money. Lawyers may seek funding, the clients alone may seek it, or each may get some, depending on how the deal is structured. But one of the most consistent questions is how taxes will be handled, and that depends on the documents. Financing documents vary materially, so one can’t answer the tax questions without reviewing them. Fundamentally, is this a loan? Is it a sale of a portion of the claim, or of a portion of the fees?

Hammer judge against background of large amount of dollars photocredit: Getty

These may sound like simple questions, but they can be difficult to answer. Notably, attorney fees can be taxed in surprising ways, especially under the new tax law. Thus, the client may have a tax impact even if the lawyer alone is getting funding.  You can ask the litigation finance company about taxes, but they are generally not in the business of providing tax advice. The primary choice is loan vs. sale, but from there it gets more complicated. With a loan, you receive loan proceeds which are not taxable because you have to pay them back. A loan has the advantage of deferring any tax on the receipt of the initial funding.

However, there can be tax downsides later. Some litigation financing documents are written as sales. Sales are taxable, so the normal rule would be that the lawyer or client must pay tax when the sale is made on the up-front money. Getting money that will be immediately halved by taxes is very different from getting loan money that you can fully deploy without taxes. It can be nice to defer the tax problems until later. Running out some numbers and timing under loan vs. sale scenarios can be helpful. But apart from sales and loans, some funders are willing to use an unusual structure called a prepaid forward contract. It is a sale, so you might assume you have to report the up-front money (the sale proceeds) immediately as income.  However, this is a sale contract with an unclear final sales price, usually because the formula for payment depends heavily on the time when the case proceeds come in.

When you sign the documents and receive the money, you have entered a contract to sell a portion of your case (if you are the client) or a portion of your contingent fee (if you are the lawyer) when the lawsuit is resolved. The contract calls for a future sale, so it is called a forward contract.  You are contracting to sell now, but the sale does not close until the case is resolved. For the contract to qualify, it must have certain required elements specified by the IRS. If you qualify, you generally should not have to report the up-front payment you receive from the litigation funder until the conclusion of the case. A loan arrangement is easiest to document, and some lawyers and clients prefer it. However, many litigation funders do not like loans.

Some documents are not even clear whether they are a loan or a sale. The prepaid forward contract has the advantage of no immediate tax on the upfront payment, just like a loan. However, good documentation is critical. Whatever structure is used, it is important for lawyers and clients to consider taxes. You do not want to receive taxable money, pay a litigation finance company a steep return, and find that you cannot deduct a big payment or offset it against your recovery.  It pays to be careful and to run some examples on the numbers.

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Uber Tax Audit By IRS & Abroad Is Big, But Not Over Driver Employment Taxes

Uber went public recently, but its shares have since dropped in price. The company has losses, and they could get bigger. Uber’s recent SEC filing says the IRS is auditing the company’s 2013 and 2014 tax returns. Plus, Uber is under audit by state and foreign tax authorities, apparently due to the company’s transfer pricing positions. That basically involves how costs and income are allocated among different locations. The whole world isn’t involved, but it is a nice subset of countries. Uber’s 2010 through 2019 tax years are still open in the U.S., Brazil, Netherlands, Mexico, United Kingdom, Australia, Singapore, and India. Uber says it believes adequate amounts have been set aside for any additional tax liability that might turn out to be due. However, given the number of years that are open, and the number of matters being examined, Uber cannot estimate the size of the potential hit. Uber expects the gross amount of unrecognized tax benefits to be reduced within the next twelve months by at least $141 million. For most people, that would be serious money. Here’s what Uber said:

Melbourne, Australia – March 17 2019: Uber car service. Uber transportation network company offers services of vehicle ride sharing and food delivery. The company has operations in 785 metropolitan areas worldwide. Photocredit: Getty

The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. The Company is currently under a federal income tax examination by the Internal Revenue Service (“IRS”) for tax years 2013 and 2014. The Company is also under examination by various state and foreign tax authorities. The Company believes that adequate amounts have been reserved in these jurisdictions. To the extent the Company has tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by federal, state or foreign tax authorities to the extent utilized in a future period. For the Company’s major tax jurisdictions, the tax years 2010 through 2019 remain open; the major tax jurisdictions are U.S., Brazil, Netherlands, Mexico, United Kingdom, Australia, Singapore, and India.

Although the timing of the resolution and/or closure of audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining subject to examination and the number of matters being examined, the Company is unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. The Company does expect the gross amount of unrecognized tax benefits to be reduced within the next twelve months by at least $141 million, which is related to ongoing matters with tax authorities regarding the Company’s transfer pricing positions.

There is more in Uber’s filing, even mentioning the rules about company ownership changes and Section 382 of the Internal Revenue Code. However, so far, Uber does not anticipate its tax attributes being limited now under that rule. How will all the tax issues shake out for Uber? It is way too early to tell. Uber started rides in 2010, and its foreign tax issues go back all the way. Even if you ignore the foreign countries and only consider the IRS audit, it seems hard to imagine that it will not be protracted. Most IRS audits take significant time, and a company of the size and complexity of Uber is not likely to be an exception. Of course, the foreign tax audits are unlikely to be quick either.

What is one issue that has been the subject of litigation, strikes and proposed legislation and more, but appears not to be covered by the audits? The independent contractor v. employee status of drivers. Indeed, when it comes to taxes, liability, benefits and more, the worker status of drivers could be the biggest issue of them all. It could be the Uber issue of all Uber issues. On that point, Uber may have distanced itself from the claims and the lawsuits. Uber, Lyft and other companies have fought hard to keep drivers as independent contractors, not employees. But lawsuits and laws could change that, and tax audits might raise the specter of this issue too. So far, Uber has managed to avoid serious financial hits from this biggest of all tax issues. But as more more tax authorities are poking around, the more it is at least conceivable that this issue could come up. Stay tuned.

 

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IRS Slaps 100% Penalty On All ‘Responsible’ For Company Taxes

For anyone with employees, paying employment taxes is inevitable. You withhold taxes from employee pay, and send the money to the IRS. The taxes are withheld from wages and are supposed to be promptly paid to the government. This is trust fund money that belongs to the government, and no matter how good a reason the employer has for using the money for something else, the IRS is strict. If you are in business, it can be tempting to figure that you have to keep the rent paid and supplies ordered, and that the IRS won’t miss the payroll tax money if you just divert it temporarily. You never want to become delinquent in paying taxes, especially employment taxes. The IRS is vigorous in going after these payroll taxes.

Stamp IRS audit and accounting documents. photocredit: Getty

No matter how good the reason for using the money to keep the business afloat, the practice is dangerous. It is one reason that in cases where the IRS catches the problem early, the IRS will encourage use of a payroll service. If the payroll service automatically takes out and remits all the payroll taxes, the business won’t have the discretion to divert the money, even briefly. When a tax shortfall occurs, the IRS will usually make personal assessments against all responsible persons who have ownership in or signature authority over the company and its payables. The IRS can assess a Trust Fund Recovery Assessment, also known as a 100-percent penalty, against every “responsible person” under Section 6672(a).

You can be liable even if have no knowledge the IRS is not being paid. If you’re a responsible person the IRS can pursue you personally for payroll taxes if the company fails to pay. The 100% penalty equals the taxes not collected. The penalty can be assessed against multiple responsible persons, allowing IRS to pursue them all to see who coughs up the money first. “Responsible” means officers, directors, and anyone who makes decisions about who to pay or has check signing authority.

When multiple owners and signatories all face tax bills, they generally do their best to direct the IRS to someone else. Factual nuances matter in this kind of mud-wrestling, but so do legal maneuvering and just plain savvy. One responsible person may get stuck, while another may pay nothing. Meanwhile, the government will still try to collect from the company that withheld on the wages. And those IRS collection efforts can be serious.

The IRS can move to collect, too, including via a levy on your bank accounts. But before a levy can be issued the IRS must provide notice and an opportunity for an administrative Collection Due Process hearing. A Collection Due Process hearing is only available for certain serious IRS collection notices. Among other things, it allows you the opportunity to ask for an installment agreement, an offer in compromise or another collection alternative. There are special rules in the case of a predecessor employer. That is, this procedural safeguard won’t apply if you are a predecessor employer. Here’s what the IRS evaluates to determine if one business is a predecessor of another:

• Does it have substantially the same owners and officers?
• Are the same individuals actively involved in running the business, regardless of whether they are officially listed as the owners/shareholders/officers?
• If the taxpayer’s owners or shareholders are different, is there evidence they acquired the business in an arm’s-length transaction for fair market value?
• Does the business provide substantially the same products, services, or functions as the prior business?
• Does the business have substantially the same customers as the prior business?
• Does the business have substantially the same assets as the prior business?
• Does the business have the same location/telephone number/fax number, etc. as the prior business? See IRC Section 6330(h).
• A business won’t be treated as a predecessor if there was a genuine change in control and ownership, as where the business was acquired in an arm’s-length transaction for fair market value, where the previous owners have ceased all involvement.The IRS’s guidance lists examples of predecessor status and explains how to determine if a business requesting a Collection Due Process hearing for employment taxes is a “predecessor.”  There’s no right to a Collection Due Process hearing to resolve the employment tax liabilities if you already had your chance.

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Taxes Slash $2 Billion Roundup Weedkiller Verdict To $27.5 Million

Another Roundup verdict is in, and once again, bizarre new tax rules make the IRS the biggest winner. This time, a Northern California jury found that Monsanto failed to warn users that Roundup was dangerous, awarding Alva and Alberta Pilliod $55 million in compensatory damages and a whopping $2 billion in punitive damages. Alva and Alberta Pilliod used Roundup on their San Francisco Bay Area property for 35 years. They were both diagnosed with non-Hodgkin lymphoma, but are currently in remission. This is the largest jury award in the U.S. so far this year, and the eighth-largest ever in a product-defect claim, according to Bloomberg. Last year, jurors gave $289 million to a man they say got cancer from Monsanto’s Roundup. That verdict was later reduced, and is on appeal. In early 2019, jurors awarded Edwin Hardeman $200,000 for economic losses, $5 million for past and future pain and suffering, and $75 million in punitive damages. Bayer has said it would appeal the jury award. Monsanto faces over 13,400 claims, and is fighting hard. But even if Monsanto pays up, new tax rules could swallow up many of the verdicts plaintiffs might be hoping to collect. 

(AP Photo/Haven Daley, File) Photocredit: Associated Press

President Trump’s tax bill passed in late 2017 imposes a new tax on litigation settlements in the form of no deduction for legal fees. Amazingly, many legal fees can no longer be deducted. That means many plaintiffs must pay taxes even on monies their attorneys collect. Of course, the attorneys must also pay tax on the same money. Here’s the bizarre tax math. The Pilliods were awarded approximately $55 million in compensatory damages and $2 billion in punitive damages. Their combined legal fees and costs might total as much as 50%. If so, they would get to keep half, or $27.5 million of the $55 million compensatory award. Since it is for their claimed non-Hodgkin’s lymphoma, that part for physical injuries should not be taxed. Of the $2 billion punitive award, $1 billion could go to legal fees and costs, with $1 billion to the Pilliods. So before taxes, the plaintiff’s could take home $1,027,500,000. The case will be appealed, so no money will be paid for quite a while. Even so, it’s worth reviewing the math to see how this could come out.

So what about after taxes? The $2 billion in punitive damages are fully taxable, with no deduction for the legal fees to their lawyer. Between federal taxes of 37% and California taxes of up to 13.3%, the Pilliods could lose about 50% to the IRS and California’s Franchise Tax Board. That could make their after-tax (and after legal fee) haul from a $2.55 billion verdict only about $27.5 million. Does that seem fair? $27.5 million isn’t pocket change, but it is a shocking result. So is being taxed on money you do not receive. The bizarre result comes from the Trump tax law, which kills tax deductions like Roundup for many legal fees. Notably, compensatory damages for physical injuries or physical sickness are still tax-free, but what injuries are “physical” can be a chicken or egg issue.

When punitive damages or interest enter the picture, many plaintiffs cannot deduct their legal fees. It can mean being taxed on their gross recoveries, even if the lawyer is paid first. According to a 2005 U.S. Supreme Court tax case, if you are the plaintiff with a contingent fee lawyer, the IRS treats you as receiving 100% of the settlement or judgement, even if the defendant pays your lawyer directly. If your case is fully nontaxable, that causes no tax problems. But if your recovery is taxable, all or in part, you could be taxed on more money that you actually collect. Up until the end of 2017, you could claim a tax deduction for your legal fees. In 2018 and after, there may be no deduction for these legal fees. Fortunately, not all lawyers’ fees face this terrible tax treatment.

If the lawsuit concerns a plaintiffs’ trade or business, the legal fees are a business expense. If the case involves claims against the plaintiff’s employer or certain whistleblower claims, those legal fees are also still deductible. But in other cases, plaintiffs are out of luck unless they are awfully creative. In some cases, there may be ways to circumvent these tax rules, but you’ll need sophisticated tax help to do it. Advice on the taxation of damage awards before the case settles is best if you hope to avoid a terrible tax result.

via Robert W. Wood http://bit.ly/2HqPk9c

Trump’s Billion In Tax Losses And IRS Statute Of Limitations

New reports suggest that President Trump claimed a whopping $1.17 billion in tax losses between 1985 and 1994. The New York Times says much of the data for this finding came from IRS transcripts. IRS transcripts list certain key reporting data under a taxpayer’s taxpayer identification number. Even so, it is hard to see how transcripts could reveal the kind of sweeping picture being painted. Yet the President has not exactly disputed the accusations, instead suggesting in Twitter posts that these were just real estate techniques for tax purposes and that the Times report was fake news. Meanwhile, of course, Democrats are using this latest reveal about the President’s taxes, deal acumen and wealth to once again call for an urgent look-see at Trump’s elusive tax returns. Representative Bill Pascrell Jr., D-NJ, said this about the latest revelations about President Trump:

President Trump holds a chart as he speaks at a rally in Panama City Beach, Fla., Wednesday, May 8, 2019. (AP Photo/Gerald Herbert) photocredit: ASSOCIATED PRESS

Trump was perhaps the worst businessman in the world. His entire campaign was a lie. He didn’t pay taxes for years and lost over $1 billion — how is that possible? How did he keep getting more money and where on earth was it all going? We need to know now.

It seems unlikely that President Trump or his administration will hand over the returns anytime soon, whether or not the President’s storied audit has finally been completed. Yet it does make one wonder just how many tax returns could be examined, and how far back is fair game in an audit. If the New York Times reports are accurate, could the IRS go back to audit those 1985 through 1994 tax years? It is hard to see how. IRS audit exposure is usually finite, and tax lawyers and accountants routinely monitor it. They watch the calendar until the returns are clear of audit. The IRS normally has three years to audit, which may make you wonder how President Trump could have so many years under review. In some circumstances–including where you under-report your income by more than 25%–the IRS is allowed to go back six years.

Omitting more than 25% of his income was probably not the President’s problem, which means he probably consented to extending the IRS’s normal three years. Why would anyone give the IRS more time? The IRS often asks, and usually you should grant IRS more audit time. If you say “no” or ignore an IRS request, the IRS assesses extra taxes based on whatever information the IRS has. Usually that will put you at a disadvantage. President Trump may be perennially under audit as he has suggested. But after three or six years, aren’t most people completely out of the woods? Maybe, but in some cases, the IRS statute of limitations never runs. Examples are where you don’t file a return, don’t sign your return, or alter its normal penalties of perjury language. There’s also no time limit on fraud. 

Another set of rules governs amended tax returns, although they normally don’t restart the three-year clock. If your amended return shows an increase in tax, and you submit the amended return within 60 days before the three-year statute runs, the IRS only has 60 days after it receives the amended return to make an assessment. An amended tax return that does not report a net increase in tax does not trigger an extension of the statute of limitations. Statute of limitation issues come up frequently with partnerships, LLCs and S corporations, and Trump probably has many such entities. The partners or shareholders pay tax, but the return is filed by the entity. Untangling audit issues for an entity and its partners or shareholders can be complex. For offshore accounts, you also usually have six years of exposure to IRS audits. If you have an offshore company, it can trigger an IRS Form 5471. Failing to file it means penalties, generally $10,000 per form, even if no tax is due. And if you omit this tax form, it allows the IRS to audit you forever.

Finally, there are also situations where the statute of limitations is on hold. Certain types of IRS summonses can stop the three or six years from running, even if you have no notice of it. The IRS statute of limitations can also be on hold when you are outside the U.S., or if you commit certain continuing violations that tie years together. Some of the President Trump’s critics might suggest that there is some way the IRS could go back to 1985, or even 1994. But as a practical matter, it is very hard to imagine the IRS making such an argument, or winning if it did.

via Robert W. Wood http://bit.ly/2VTHi24