Michael Cohen Takes Fifth, But Don’t Try It On Your Taxes

President Trump’s lawyer Michael Cohen is in hot water after his home and office were searched. The feds want details, and took the unusual step of searching a lawyer’s office despite claims of privilege. Mr. Cohen says he will take the Fifth. If you have serious tax issues, can you take the Fifth on your taxes?  In Lee v. United States, Theodore Lee argued that he couldn’t file his 2006 tax return because it would incriminate him. After all, he claimed, when his tax return was due, he was deep in an audit with the IRS over returns he had filed for 1999 through 2005. He was fearful that the IRS would prosecute him, so he took the Fifth. The court rejected his claim. The Fifth Amendment does grant a privilege against self-incrimination. However, that doesn’t mean you can just refuse to file taxes.

US President Donald Trump’s personal lawyer Michael Cohen(C) leaves the US Courthouse in New York on April 26, 2018. – US President Donald Trump acknowledged on Thursday that his personal lawyer, Michael Cohen, represented him in a ‘deal’ involving porn star Stormy Daniels. Trump had previously denied knowledge of a $130,000 payment Cohen made to Daniels that she claims was to prevent her from talking about their alleged 2006 affair.Trump, in a wide-ranging telephone interview with ‘Fox and Friends,’ admitted for the first time that Cohen represented him in a ‘deal’ with Daniels, who has filed a lawsuit seeking to have the ‘hush agreement’ negotiated by Cohen thrown out. (Photo by HECTOR RETAMAL/AFP/Getty Images)

The mere act of filing an annual income tax return has little real and appreciable tendency to incriminate the filer, said the court. In fact, merely invoking the Fifth in a tax case can invite penalties or get the IRS looking more harshly at you. You have to file tax returns, and you have to report your income. Way back in 1927, the Supreme Court considered a man who refused to file a tax return, claiming that to do so would incriminate him. In U.S. v. Sullivan, the Supreme Court said that it was too bad if disclosing illegal income opened him up to prosecution.

Even a criminal must file tax returns and pay taxes. And you have to do it accurately. What if the IRS asks you questions you are afraid to answer? Answering IRS questions in an audit or investigation can be nerve-wracking. Do not speak up without your lawyer present, and ask your lawyer what to is fair to discuss. But claiming Fifth Amendment protection in taxes cases can be a mistake. The issue can also come up with books and records. You have to keep them to fulfill your tax filing obligations. You even have to keep bank account records for accounts outside the U.S. Undisclosed offshore bank accounts can qualify as money laundering.

So, if the IRS asks you if you have any foreign bank accounts, can you take the Fifth? You can, but it probably won’t help. Even if you claim the Fifth, the IRS can hand you an “information document request” to produce your records. If you refuse, the IRS will issue a summons. Then, if you refuse to answer that, the IRS will take you to court, which will probably order you to comply. But, doesn’t your constitutional right to take the Fifth trump the IRS? After all, even in court, you can say, “I refuse to answer on the grounds that I may incriminate myself.”

Does this work with taxes and the IRS? Not always. Ironically, you can refuse to talk, but you cannot refuse to produce most documents. Your own private papers are personal records. If they might incriminate you, they are protected by the Fifth Amendment. But the Required Records doctrine says you must hand over some documents no matter how incriminating they are. The government requires you to keep certain records, and the government has a right to inspect them. The IRS and prosecutors have exploited this rule.

It can mean that pleading the Fifth in response to a subpoena for foreign account records can cause even more trouble than claiming it on your tax returns. Required records are those where the reporting has a regulatory purpose, where a person must customarily keep the records the record-keeping scheme requires him to keep, and the records have public aspects. In the case of foreign bank records, the courts uniformly deny Fifth Amendment protection. Numerous courts have all given the IRS a free pass, ruling that no Fifth Amendment protection applies.

Despite repeated requests, the U.S. Supreme Court has been unwilling to hear this issue. So, is it likely that the Fifth Amendment will be much help on your taxes? Not really. In most cases, a tax audit is civil and there is little risk that it will become otherwise. Still, a majority of criminal tax cases come directly out of civil tax cases. The IRS civil auditors ‘refer’ a case to the IRS Criminal Investigation Division. The IRS civil auditor will not tell you this is occurring, so the first time you hear about it, your case may have gone from bad to worse.

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Despite Michael Cohen Raid, How To Get Attorney Client Privilege For Your Taxes

The government searched the office and home of President Trump’s attorney, Michael Cohen, catapulting attorney client privilege into the daily news. We still do not know exactly what evidence prosecutors are seeking, although Stormy Daniels payment details are surely one area of interest. It is a rare treat for investigators to comb through files in a normally off-limits attorney’s office. Exactly how that combing is being done, how it should be done and by whom, is also a big debate. Michael Cohen made a bid to have his people make the first cut of what was privileged, but that attempt was rejected. It is not clear if prosecutors on the case are reviewing the materials, or if an independent privilege team is doing so.

In a Monday, April 16, 2018, file photo, Michael Cohen, President Donald Trump’s personal attorney, center, leaves federal court, in New York. (AP Photo/Mary Altaffer, File)

The latter would involve additional protections for the materials, since some surely are privileged. The exception being discussed that might render some materials fair game is the crime-fraud exception. There is no privilege if the client’s communication was made with the intention of committing or covering up a crime or fraud. But who decides is another big question. The exception applies if the client was in the process of committing or intended to commit a crime or fraudulent act, and the client communicated with the lawyer with the intent to further the crime or fraud, or to cover it up.

Many Americans may face legal issues over their taxes, and it is one area where they may encounter attorney client privilege. Everyone over a minimum income threshold must file a federal income tax return each year. In most states, you must file a state income tax return too. And if you are in business, you have tax returns for business entities too, and probably payroll taxes. And like it or not, you must sign all of them under penalties of perjury. Altering the penalties of perjury statement or refusing to sign renders the return invalid. It does not even count to start the IRS statute of limitations (usually three or six years). Plus, if during an audit you lie to the IRS, it is an entirely separate crime. See 26 U.S.C. § 7206. In fact, many of the most serious criminal tax cases involve bad moves during the audit. If you lie or to create fake documents in the course of an audit, you compound your problems.

As you reflect on these sobering issues, consider attorney client privilege. Thanks to attorney client privilege, if you tell your lawyer that you hid money offshore, the IRS cannot make your lawyer talk. The IRS generally cannot even make your lawyer produce documents. When it comes to taxes, lawyers and accountants are not the same. Accountants do not have attorney client privilege. If you make statements or provide documents to your accountant, he or she can be compelled to divulge them no matter how incriminating they may be. There is a “tax preparation” privilege in Section 7525(a)(1) of the tax code, but it does not apply to criminal tax cases so is of little value.

In sensitive civil or criminal tax matters, the answer is the Kovel letter, named after United States v. Kovel. This case stands for the proposition that you can get attorney client privilege with your accountant by having your lawyer hire the accountant. In effect, the accountant is doing your tax accounting and return preparation but reporting as a subcontractor to your lawyer. Properly executed, it imports attorney-client privilege to the accountant’s work and communications. The Kovel arrangement generally works well. It can be less effective with client-accountant relationships that pre-date the Kovel letter, but even there it can help. However, some IRS lawsuits have eroded some parts of the privilege.

For example, in United States v. Richey, the Ninth Circuit refused to protect an appraisal that a taxpayer, lawyer and accountant were trying to keep from the IRS. There have been some other attacks too. In United States v. Hatfield, the court forced disclosure of discussions between the lawyer and accountant. But this is rare, Kovel is still good law and the practice remains widespread. For clients with complex or sensitive tax situation, adding a Kovel letter can provide some additional comfort and control.

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Amend Your Tax Return Right After Filing? Be Careful

You just filed your taxes, so why would you amend? Maybe you realized you made a careless mistake, forgot your check or W-2, or left off income from a Form 1099 you found in the bottom of a drawer. Whatever the situation, it is not too early to amend. But should you? It depends. Math errors are not a reason to file an amended return, since the IRS will correct math errors on your return. The IRS may process your return without them. You normally also do not need to amend if you discover that you omitted a Form W-2, forgot to attach schedules, or made similar mistakes. The IRS will request them if needed. So don’t assume that a mistake means you must amend. 

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One key factor is timing and your intent when you filed. If you are evaluating whether to amend, ask yourself whether the return you filed was accurate to your best knowledge when you filed it. If it was, you are probably not legally required to file an amendment. You might want to amend, but you probably do not have to amend. Next, ask if you can correct it without amending. You usually can’t correct a tax return without amending it. But there’s an exception for some mistakes up until the normal due date–or your extended due date if you went on extension.

If you file a ‘superseding’ return before the due date of the original return (including extensions), it can take the place of the originally filed return. In effect, the “errors” of the first original return didn’t happen. It can be used to make an election that cannot be made on an amended return, or to make certain other changes. But be careful with this unusual procedure. You might confuse the IRS and end up having a dispute about which of the “original” returns is valid, and whether an amended return actually functions as a superseding one. Apart from this odd exception, you can generally only fix mistakes by amending your return.

If you find you made a mistake, receive revised Forms 1099 or K-1, etc., the IRS says you should amend. But you are not actually required to file an amended return. If you do, though, you can’t make only corrections that get you money back, but not those that increase your tax liability. Every tax return–including amended ones–are filed under penalties of perjury. So be accurate and complete. If you are going to amend, you do it by filing a Form 1040X within three years from the date you filed your original return, or within two years from the date you paid the tax, whichever is later.

You must use Form 1040X whether you previously filed Form 1040, 1040A or 1040EZ. Amended returns are only filed on paper, so even if you filed your original return electronically, you amend on paper. If you are amending more than one tax return, prepare a separate 1040X for each return. If you file an amended return asking for considerable money back, the IRS may review the situation even more carefully. As an alternative, you can apply all or part of your refund to your current year’s tax. Normally the IRS has three years to audit a tax return.

You might assume that filing an amended tax return would restart the three-year statute of limitations. Surprisingly, it doesn’t. In fact, 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 has only 60 days after it receives the amended return to make an assessment. This narrow window can present planning opportunities. Some people amend a return just before the statute of limitations expires. If your amended return shows you owe more tax than on your original return, you will owe additional interest and probably penalties too. Interest is charged on any tax not paid by the due date of the original return, without regard to extensions. The IRS will compute the interest and send you a bill if you don’t include it. If the IRS thinks you owe penalties it will send you a notice, which you can either pay or contest.

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On Tax Day, Report Offshore Accounts Too

April 17 this year is tax filing day, but it is also the due date for FBARs to report foreign accounts. The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a reminder of the due date for filing FinCEN Form 114, Report of Foreign Bank and Financial Accounts(FBAR), to report foreign financial accounts held in 2017. For over a decade, the IRS has made a major push for Americans to report their offshore income and assets. It can sometimes feel like the IRS does not want to you have anything anywhere that is not 100% American.

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Actually, you are free to have it, but you had better report it. Much of the hullabaloo about offshore assets started when the IRS went after Swiss banking. Americans are required to report their worldwide income. There have been many criminal cases, and a vastly larger number of civil ones about this issue. Large numbers of taxpayers in the last decade have stepped forward in one of several IRS disclosure programs.

After getting bruised in court battles with the IRS, in 2009, UBS paid $780 million to settle charges that it helped wealthy Americans evade taxes. Other Swiss banks followed suit. The episode triggered thousands of voluntary disclosures to the IRS, and changed bank secrecy forever. Eventually, the Swiss Parliament passed a measure enabling banks to hand over client identities to American authorities without violating Swiss bank-secrecy laws. Then, in 2010, the U.S. passed FATCA, the Foreign Account Tax Compliance Act.

Most people are surprised to learn that FBARs—also now called FinCEN Form 114, Report of Foreign Bank and Financial Accounts, have existed since 1970. They are filed with FinCEN, the Financial Crimes Enforcement Network, part of the Treasury Department. That itself is a little scary. FinCEN regulations say you must file if you have a financial interest in, or signature authority over, foreign financial accounts with a total value exceeding $10,000 during the previous calendar year. The due date this year is April 17, but if you extend your tax return due date, your extension extends your FBAR due date too.

In the meantime, don’t forget about FATCA, which spans the globe with a network of reporting that is unparalleled in the world. America is requiring foreign banks and governments to hand over secret bank data about depositors. Non-U.S. banks and financial institutions around the world must reveal American account details or risk big penalties. Offshore banks that do not hand over Americans are withholding at 30% on most transactions. Non-compliant institutions are frozen out of U.S. markets, so there is little choice but to comply. FATCA cuts off companies from access to critical U.S. financial markets if they fail to pass along American data. More than 100 nations have agreed to the law. Countries must agree to the law or face dire repercussions.

For years, the IRS has been warning offshore account holders to disclose before it’s too late. Then just this year, the IRS announced that it would end the Offshore Voluntary Disclosure Program on September 28, 2018. Those who are still exposed might want to give it a second look. After all, under FATCA, banks everywhere want to know if you are compliant with the IRS. The IRS’s long-running Offshore Voluntary Disclosure Program (OVDP remains the safest program, with amnesty even for willful acts. But for those with the right facts, the IRS Streamlined program is simpler and less costly. 

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Claiming Bitcoin 1031 Exchanges On Your 2017 Taxes

You might think the biggest tax debate about bitcoin and other crypto is whether you should report it, or whether the IRS will catch people who don’t. Actually, there’s no longer much debate about these topics. Everyone seems to know that you should report, and that the IRS is after those who do not. The IRS is tracking with software, and the IRS Summons of Coinbase is already bearing fruit with account files for the IRS. In fact, the biggest crypto tax debate still seems to be about 1031, the tax code provision that allows some like-kind exchanges. Everyone knows that 1031 currently only applies to exchanges of real estate. The Trump tax law passed right around Christmas 2017 means that for 2018, you can forget arguing that swaps of one crypto for another are tax free. But there is debate about the past. 

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If you are about to file your tax return, should you claim 1031 treatment for 2017 crypto transactions? If you are cleaning up past tax reporting before the IRS finds you, you might have the same issue for 2016 or even 2015. Claiming 1031 treatment for crypto trades for the past turns out to be a nuanced subject. Until the Trump tax bill killed it, depending on how aggressive you were, and how you could orchestrate it, you could try swapping one digital currency for another. A 1031 or like-kind exchange is a swap of one business or investment asset for another, but most swaps are taxable. Section 1031 is an exception to the rule that swaps are fully taxable. If you qualify, your tax basis stays the same, so your investment continues to grow tax-deferred. If you qualify, there is no limit on how many times or how frequently you can do a 1031.

Real estate investors do this all the time. Despite a profit on each swap, they avoid tax until they sell for cash years later, paying only one tax, ideally as a long-term capital gain. Whether 1031 (before 2018) applied to cryptocurrency is debatable. Some exchanges of personal property (say a painting or a private plane) have qualified. But exchanges of corporate stock or partnership interests never did. Classically, an exchange involves a simple swap of one property for another between two people. But the majority of exchanges are not simultaneous, but are delayed or “Starker” exchanges (named for the tax case that allowed them). In a delayed exchange, you need a middleman who holds the cash after you “sell” your property and uses it to “buy” the replacement property.

The intermediary must meet a number of requirements. That’s one reason delayed exchanges of cryptocurrency may not qualify. There are also two timing rules you must observe in a delayed exchange. Once the sale of your property occurs, the intermediary will receive the cash. Then, within 45 days of the sale of your property, you must designate replacement property in writing to the intermediary, specifying the property you want to acquire. The second timing rule in a delayed exchange relates to closing. You must close on the new property within 180 days of the sale of the old. These two time periods run concurrently. You start counting when the sale of your property closes.

Many holders of cryptocurrency probably can say they are holding their cryptocurrency for investment. The tougher hurdle is whether they swapped for property of like-kind. Section 1031 does not apply to trades of stocks or bonds, and the IRS could rely on this rule to disqualify any cross-species trade of cryptocurrency. However, different types of cryptocurrency are arguably like different types of gold coins. If a swap of one type of gold coin for another qualifies, why not swaps of cryptocurrency? The IRS may argue that swapping Ripple for Bitcoin is really more like swapping silver for gold, or vice versa. Silver for gold would be taxable, so the IRS may say that a swap of cryptocurrency should be taxable too.

Some of this may turns on the size of your gains, and how much of a chance are you willing to take. But one big issue is the mechanics of tax reporting. You need to claim Section 1031 treatment to say you met the rules. It might seem tempting not to report swaps of cryptocurrency at all. But for those trying to use 1031, failing to report is a mistake, in my view. If you want to see what to report, check out IRS Form 8824.

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As Tax Day Looms, 6 Month Extension Has Big Benefits

Tax returns are usually due April 15, but this year you’ll get an extra two days, until April 17th. Those extra few extra days might help, but they may not matter to many. Instead of rushing to file your taxes, you can go on an automatic six-month extension. You need to pay what you owe even if you go on extension. The extension is to file your return, not to pay. Some people fine tune their payment, while others do only a rough estimate. Just remember that if you owe more when you later file your return, you’ll have to settle up then. But even though you have to pay now, there can be good reasons to take the extension.

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If you do succumb to the allure of an extra six months, it is wroth considering whether you increase your odds of audit or decrease them. Few deadlines are more dreaded than the annual rush to April 15th (well, 17th this year). You may not want to delay it. You may even feel guilty if you take advantage of an automatic six-month reprieve. There’s no shame in an extension, and millions are processed every year. Everyone can get six extra months by filing (electronically or by mail) a tiny form that doesn’t even require a signature.

Here are some reasons to consider an extension. Going on extension encourages reflection. Use the time to gather records, consider reporting alternatives, and get professional advice. Remember, tax returns are filed under penalties of perjury. File accurately so you don’t have to amend later. Amended returns often come about because people rush. Although there are times you may want or need to amend, use amended returns sparingly. Amended returns are much more likely to be scrutinized. File once correctly, so you don’t have to do it again.

The extension is automatic. The IRS doesn’t have to approve the extension, and there is no discretion involved. You just get the extra six months, period. Extensions used to be four months, with two additional months only if you had a good reason. Now, automatic extensions are six months. Again, the extension is to file, not to pay. Make your payment and use the time to make your return accurate and complete.

Going on extension also allows for corrected Forms 1099 and K-1. You may be waiting for Forms K-1, gathering documents or seeking professional advice. If there are debatable points on your return, such as whether a litigation recovery is ordinary or capital, get some professional advice. But even if you have all your forms and are ready, what if you receive a K-1 or 1099 after you file? The earlier you file, the greater the risk you will receive corrections. Going on extension makes it less likely that you will be surprised by a tardy corrected K-1 or 1099. You may as well file once and file correctly.

Some people say that going on extension increases audit risk, while some people say the opposite. But there is no hard evidence to support either theory. Still, it is worth saying this again: there is no increased audit risk to going on extension. And given all the advantages of an extension, one can argue that an extension may help reduce audits.

All taxpayers worry about IRS audit risk. Opinions vary, and there are many theories about what triggers an audit. However, it is unlikely that going on extension increases IRS audit riskThe IRS releases data about audit rates based on income levels and types of tax returns. They do not release data about whether going on extension increases or decreases your chances. So, go on extension if you need the time. To extend, you can submit a Form 4868, ask your return preparer, use commercial software, or do it yourself electronically. For more guidance, IRS tax topic 304 explains extensions of time to file your tax return.

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Dear IRS, I Don’t Actually Own That Bitcoin

It’s tax time, and crypto gains can be painful, especially if you lost money after a taxable event but still have to pay the higher taxes. Taxes are an annual job, and the IRS says that bitcoin and other cryptocurrency is property for federal tax purposes. Just about any transfer can trigger taxes. Currently, a crypto for crypto exchange cannot qualify as a tax-free 1031 exchange. Transfers are treated as sales for tax purposes, even when you are buying something with your bitcoin. The fact that crypto is property might prompt you to consider the concept of ownership. Wouldn’t it be nice if some looming tax problem turned out not to be yours, but instead, someone else’s?

Ethereum, Bitcoin and Ripple coins (physical). (Photo by Ulrich Baumgarten via Getty Images)

If you are holding crypto for someone else, is it really yours, or does it belong to the person on whose behalf you are holding it? Put another way, if there are taxes to pay, and you are holding the crypto for the benefit of someone else, who has to pay the taxes? You might think the answer would be 100% clear, but it may not be. First, start with the proposition that federal income tax liability is generally allocated based on ownership under local law. See Lipsitz v. Commissioner, 220 F.2d 871, 873 (4th Cir. 1955).

The issues can be intensely factual. Who has to pay can turn on who has control over and benefits and burdens of the property. The same thing can happen with bank accounts. There may be one nominal owner, but the money might effectively be held in trust for someone else. Who has to pay tax on the interest may not be so clear. Local law ownership and beneficial ownership are not always the same. The IRS can try to tax the beneficial owner of an account, regardless of that person’s rights to the funds under prevailing local law.

The IRS and the courts often look beyond local law to impose taxes on the party who is the beneficial owner. In Chu v. Commissioner, T.C. Memo. 1996-549, a man was subject to income tax as the beneficial owner of a bank account, even though he was not the owner of the account under local law. Conversely, if you are just holding something as an agent, you shouldn’t be taxed. As one tax case put it, if someone “holds legal title to property as an agent, then for tax purposes the principal and not the [agent] is the owner.” See Montgomery v. Commissioner, T.C. Memo. 1989-295 (citing Commissioner v. Bollinger, 485 U.S. 340 (1988)).

A nominal owner is not the owner for federal income tax purposes. In general, income should be taxed to the principal, even if the agent is a joint signatory. In Bollinger, 485 U.S. at 349, the Supreme Court said that “the law attributes tax consequences of property held by a genuine agent to the principal”. The Court enunciated a three-part agency safe harbor. Under it, you won’t be treated as the owner for tax purposes if:

  • A written agency agreement is entered into with the agent contemporaneously with the acquisition of the asset;
  • The agent functions exclusively as an agent with respect to the asset at all times; and
  • The agent is held out as merely an agent in all dealings with third-parties relating to the asset.

What if you don’t meet all three conditions? The Tax Court has said that these Bollinger factors are non-exclusive. See Advance Homes, Inc. v. Commissioner, T.C. Memo. 1990-302. Even an oral agency agreement might suffice, although if you’re in a tax fight, you surely want to have it in writing. Assuming a true agency, the agent should not face taxes on income over which he has no control and no beneficial right. The Tax Court has defined beneficial ownership as the “freedom to dispose of the accounts’ funds at will.” See Chu, T.C. Memo. 1996-549. Courts may weigh factors including: (1) which party enjoys the economic benefit of the property; (2) which party has possession and control; and (3) the intent of the parties.

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