How Overdue Taxes Can Jeopardize Passports

In a fresh 2018 Notice 2018–01, the IRS has provided new details about tax debts that can impact your ability to travel. The IRS is required by law to notify the State Department once your tax debt is certified as ‘seriously delinquent.’ After that, the State Department will generally deny issuing or renewing a passport. The State Department can even revoke a passport already in use. The law was enacted back in 2015, but the IRS and State Department are only now implementing the rules.


Notably, the rules are not limited to criminal tax cases, or even where the IRS thinks you are trying to escape a tax debt. The basics are in Section 7345 of the tax code, and the IRS has details on its website. The IRS first notifies the State Department, then the State Department generally will not issue or renew your passport. However, this only applies to a seriously delinquent tax debt, more than $50,000. Even so, that $50,000 includes penalties and interest. A $20,000 tax debt can grow to $50,000 including penalties and interest.

The latest details from the IRS involve what you can do if you face this situation. The IRS says that taxpayers notified that certification of their seriously delinquent tax debt has been transmitted to the State Department should consider: (1) paying the taxes in full; (2)r entering into an installment agreement with the IRS; or (3) making an offer in compromise. The certification is serious. If a certified taxpayer applies for a passport, the State Department, in general, will provide the applicant with 90 days to resolve the tax delinquency before denying the passport application. If a taxpayer needs their passport to travel within those 90 days, the taxpayer must contact the IRS and resolve the matter within 45 days from the date of application, so that the IRS has adequate time to notify the State Department.

Can certifications be undone? Generally, the sole remedy for a taxpayer who believes that a certification is erroneous, or that the IRS incorrectly failed to reverse a certification (because the tax debt is fully satisfied or ceases to be seriously delinquent), is to file a civil action in court. The taxpayer cannot go to IRS Appeals to challenge the certification or the IRS decision not to reverse a certification. However, the taxpayer may contact the phone number in the IRS Notice CP508C to request reversal of the certification if the taxpayer believes that the certification is erroneous.

Procedure is important. Before a tax debt gets to this stage, the IRS usually sends multiple notices, so you should respond, and keep protesting. If you receive an IRS Notice of Proposed Deficiency or Examination Report, prepare a protest before the deadline. Normally a protest will land you in the IRS Appeals Office, where you have another chance to resolve it. If you fail to protest, or you can’t resolve your case at IRS Appeals, you probably will receive a Notice of Deficiency. Then, you have 90 days to respond, by filing in the U.S. Tax Court. A tax debt does not become final if you keep your tax dispute going.

If despite all this, you get a certification that your tax debt is ‘seriously delinquent,’ contact the phone number listed on the IRS Notice. One of the main ways to keep your passport would be striking a deal with the IRS. It is often not too difficult to get an installment agreement with the IRS to pay your tax debt over time. If you sign one, stick to its terms. Even if your debt is huge, the IRS doesn’t call it ‘seriously delinquent’ if you are paying the installments on time. There are many taxpayer protections when it comes to IRS collections. If you make a timely request for a collection due process hearing in connection with a levy to collect the debt, you might buy time to work out a deal with the IRS.

via The Tax Lawyer


Contingent Fee Lawyers Dodge Bullet In Tax Reform

Many lawyers assume that if they pay for a deposition transcript, a court reporter, or travel expenses for a hearing, they can immediately deduct these costs as business expenses on their taxes. The same for expert witness fees. These seem like business expenses for lawyers. However, the IRS looks at who really bears the impact of these expenses and when, and that often means delayed deductions. On that point, it looked as if contingent fee lawyers in California and the rest of the Ninth Circuit were going to be hurt by the recently passed massive federal tax bill. For years, contingent fee lawyers in the Ninth Circuit had an easier time when it came to tax deductions for client costs. In the huge year-end tax reform bill, Congress was expected to conform the rules in favor of the IRS. But as happens in the sausage-making of tax reform, something happened at the last minute. The provision was not included in the final version of the bill. That means lawyers in the Ninth Circuit still have the benefit of a more favorable tax rule.

US President Donald Trump speaks after signing a tax reform bill in the Oval Office of the White House December 22, 2017 in Washington, DC. (Photo credit: BRENDAN SMIALOWSKI/AFP/Getty Images)

Business expenses have to be ordinary and necessary to be tax deductible. But the IRS has always had the view that lawyers cannot deduct these costs if the lawyers effectively might get reimbursed for the costs later, at the conclusion of the case. Under most contingent fee agreements, the client pays nothing (not even costs) unless there is a recovery.  Under some fee agreements, costs are subtracted from the client’s share. In others, costs are taken off the top, before the client and lawyer split the remainder.

In the meantime, someone has to pay the costs up front as they are incurred. Usually, that is the lawyer. When lawyers pay these costs, they want to write them off, but the IRS has battled to prevent these deductions. The IRS general rule is that contingent fee lawyers who pay costs for clients are making loans to the client. You can’t deduct loans. That means paying the costs currently, but not deducting them on your taxes until what could be many years later when the case finally resolves. Only at that point could you write them off.

There was—and still is—a way out in California, and throughout the Ninth Circuit, thanks to a tax case called Boccardo v. Commissioner, 56 F.3d 1016 (9th Cir. 1995). The Ninth Circuit held that attorneys could currently deduct costs if they had a gross fee contract. A gross fee contract involves the attorney receiving a percentage of the gross recovery, with costs paid by the attorney taken solely out of the attorney’s percentage. Any other type of fee agreement is a loan of the costs. Some lawyers in California and other states in the Ninth Circuit go to great pains to make sure they qualify. Some lawyers are less careful, but still hope they get some protection from Boccardo. The IRS has long been unhappy over this issue. In fact, the IRS issued a Field Service Advice, 1997 FSA 442 (basically a memo to IRS personnel) stating that it would not follow Boccardo except in the Ninth Circuit.

But the IRS has long wanted uniform tax treatment. The IRS wanted Congress to bring the Ninth Circuit contingent fee lawyers into compliance with everyone else. But the fact that the tax bill did not include the IRS fix means lawyers in California can still have gross fee contracts if they want. That gives lawyers in the Ninth Circuit a choice. With the survival of the gross fee agreement in the Ninth Circuit, should lawyers adopt them? That is not solely a tax question. It involves some economics and perhaps even marketing. And it can impact lawyer take-home pay. But the tax reform bill didn’t eliminate the choice.

via The Tax Lawyer

$10K State Tax Deduction Cap Prompts Bold Moves To Skirt California Taxes

Federal tax reform passed at year-end, but not everyone is happy. There could be lawsuits and work-arounds by states trying to blunt the impact of some of the provisions. One of the biggest changes—and perhaps most distressing to taxpayers in high tax states is the cap on state income and property tax deductions. In California, we are used to writing off high California taxes. When you pay 13.3%, a write-off with the IRS helps. Since a $10,000 limit doesn’t go very far in the Golden State, you have to hand it to California for creativity. If passed, the pending Protect California Taxpayers Act will take a creative spin on tax deductions. Since the federal tax law caps deductions at $10,000, how about making them “charitable contributions?” 


The pending bill would provide for that, though whether the IRS would buy it is not yet clear. After all, wouldn’t you expect the IRS and FTB to attack taxpayers that try an end run like this? You might think so, but perhaps it will be different if state law provides a call-it-something-else workaround. It’s a curious turn of events, with California sounding a little like a tax-dodger. Some Californians are not waiting around for the state legislature. Some are moving out of the state, or at least thinking about it, even if New Yorker Millionaires love NYC too much to leave if taxes go up.

For Californians, this is not a new phenomenon. For decades, tax lawyers in the golden state meet clients with wanderlust, often right before a big income event. Wandering taxpayers might be about to sell or take a company public or settle a big lawsuit. They might be about to sell highly appreciated Bitcoin. Whatever the circumstance, state taxes can play a big part. Moving doesn’t always work, if it isn’t done soon enough or done properly. And moving won’t help if you are selling something that is inherently always taxed by California, such as a sale of California real estate.

But for many, a move done carefully, and with the right kind of income, can cut the sting of California’s high 13.3% state tax. Apart from physical moves, another approach—that will probably be considered by more people in 2018—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,’ from Wyoming. Let’s say you can’t move, so you wonder if a trust in another state might sidestep California taxes.

Living trusts are great for avoiding probate on death, but they don’t help for income tax purposes. You are still taxed on income from trust assets on your individual income tax return. With a Nevada or Delaware Incomplete Gift Non-Grantor Trust, the donor makes an incomplete gift—with strings attached—to the trust. The trustee must not be a resident of California. NING and DING trusts started with wealthy New Yorkers trying to sidestep New York taxes on certain assets. But New York changed the law to make the grantor taxable no matter what. California has not done that, but California’s Franchise Tax Board says it is studying the issue. It is possible that California tax authorities will pursue these trusts in audits and tax controversies.

But some people are giving it the old college try. Some marketers of NING and DING trusts offer them as alternatives or adjuncts to a physical move. The idea is for income and gain in the NING or DING trust not to be taxed by California until it is distributed. At that point, the distributees will hopefully no longer be residing in California. California taxes all income at up to 13.3%, and there is no lower rate for long term capital gain. Tax-deferred compounding can yield impressive results, even if only state income tax is being sidestepped.

Parents frequently fund irrevocable trusts for children, and may not want the trust to make distributions for many years. The parents might also remove future appreciation of trust assets from their estates. Since most trusts are taxable where the trustee is situated, one common answer is an institutional trust company in Delaware or South Dakota, where there is no state income tax. For trust investment and distribution committees, committee members should also not be residents of California. Outside of New York, the jury is still out on NING and DING trusts. The facts, documents, and details matter. But if one is careful, willing to bear some risk, and there is sufficient money at stake, the calculated risks may make sense.

via The Tax Lawyer

Ironically, Weinstein Tax On Sexual Harassment Settlements May Hurt Plaintiffs Too

Harvey Weinstein, Kevin Spacey, Bill O’Reilly, and many other figures in the business and entertainment world have been accused of serious acts of sexual harassment. As the #MeToo movement gained strength, many people seem shocked that settlements and legal fees are nearly always tax deductible by businesses. So the recently passed tax bill includes a Harvey Weinstein tax that denies deductions in confidential sexual harassment or abuse settlements. Notably, this “no deduction” rule applies to the lawyers’ fees, as well as the settlement payments. New Section 162(q) of the tax code provides:

In this March 2, 2014 photo, Harvey Weinstein arrives at the Oscars in Los Angeles. The recent sexual harassment and assault allegations against Weinstein set off a wave of charges against other men and led to an obscure provision in the Senate tax cut bill. (Photo by Jordan Strauss/Invision/AP)

(q) PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE. — No deduction shall be allowed under this chapter for — (1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney’s fees related to such a settlement or payment.”

Most legal settlement agreements have some type of confidentiality or nondisclosure provision. However, some commentators have suggested that the IRS might read the law as a denial of a tax deduction for legal fees related to sexual harassment or abuse, even without a nondisclosure agreement. That would hurt plaintiffs. Even worse, could legal fees paid by the plaintiff in a sexual harassment case be covered if there is a confidentiality provision? It surely was not intended, but the wording could cover plaintiff’s legal fees too.

That isn’t the only tax worry either. Plaintiffs who use contingent fee lawyers are treated for tax purposes as receiving 100%, of if their lawyer takes 40% off the top. So ruled the U.S. Supreme Court in Commissioner v. Banks, 543 U.S. 426 (2005). That means the plaintiff must figure a way to deduct the 40 percent fee. In 2004, Congress provided an above the line deduction for legal fees in employment cases. Since then, plaintiffs in employment cases have been taxed on their net recoveries, not their gross.

Surely Congress would not want a sexual harassment victim to pay tax on 100 percent of her recovery when 40 percent goes to her lawyer! But we do not yet know how this will be read by the IRS. Before the 2004 change, many employment plaintiffs had to be content a below the line deduction, which face limitations. But with higher standard deductions, the law eliminates these deductions. Thus, for the sexual harassment plaintiff, the choice may be an above the line deduction or nothing. Outside of employment cases, plaintiffs who do not qualify for an above the line deduction for legal fees may now pay tax on 100 percent of their recoveries, not merely on their post-legal fee net. Only employment and certain whistleblower claims are covered by the above the line deduction.

It is also worrisome to ask if any mention of sexual harassment claims trigger the Weinstein provision? If it does, will it bar any tax deduction, even if the sexual harassment part of the case is minor? Plaintiff and defendant may want to agree on a particular tax allocation, attempting to head off the application of the Weinstein tax. In a $1M settlement over numerous claims, could one allocate $10,000 to sexual harassment? This figure may or may not be appropriate on the facts. However, legal settlements are routinely divvied up between claims. There could be good reasons for the parties to address such allocations now.

The IRS is never bound by an allocation in a settlement agreement. But the IRS often respects them, and we may start seeing explicit sexual harassment allocations. We may see them where sexual harassment was the primary impetus of the case, and where the claims are primarily about something else. Suppose that the parties allocate $50,000 of a $1M settlement to sexual harassment. That amounts to 5 percent of the gross settlement. If $400,000 is for legal fees, 5 percent of those fees ($20,000) should presumably be allocated to sexual harassment too. Perhaps a complete release might state that the parties agree that no portion of the settlement is allocable to sexual harassment?

These are big and worrisome tax changes, and they may complicate already difficult settlement discussions. For many types of cases involving significant recoveries and significant attorney fees, the lack of a miscellaneous itemized deduction could be catastrophic. There may be new efforts, therefore, to explore the boundaries of the Supreme Court’s 2005 holding in Banks. The Court alluded to various contexts in which this general 100 percent gross income rule might not apply. We should expect taxpayers to more aggressively try to avoid being tagged with gross income on their legal fees. It is a troubling new tax world, and it could well hurt plaintiffs materially.

via The Tax Lawyer

Loophole Allows Tax-Free Bitcoin Exchanges Into 2018

After December 31, 2017, it is clear that only real estate can be the subject of a tax-free 1031 exchange. A 1031 exchange is a swap of one like kind business or investment asset for another. The IRS treats most swaps are taxable as sales, so 1031 is an exception to the normal rule. The IRS says cryptocurrency is property not currency. So, many investors assumed that meant you could swap them tax-free under section 1031. But whether 1031 applied to cryptocurrency until year end is debatable. Some tax advisers say no, while others yes, provided that you did it all carefully.


That ‘carefully’ part turned out to be important. Some crypto investors bought and sold without trying to improve the “exchange” optics. Whichever side of this debate you are on, the massive tax bill that was just passed limits 1031 exchanges to real estate. Yet even that new tax law is having a curious impact among crypto investors, who want to keep debating. Sure, the law now says 1031 is only for real estate. But does that change in the law strengthen or weaken the argument that 1031 can apply to crypto deals done in say 2016 or 2017?

Some say the fact that Congress changed the law (prospectively) makes it clear that before the change in the law, crypto swaps were OK. Others say the reverse. It is not clear what the IRS will say. What’s more, there are at least some indications that there’s a last ditch effort to do crypto deals before the end of 2017, including some that might be extended into 2018. The new law (saying 1031 is only for real estate) goes into effect for deals after December 31, 2017.

However, the law says that, “[A]n exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.” What this means is that (if 1031 does apply to crypto swaps), it still does through the end of 2017. But is that enough time? For a direct two party swap, it may be. And what about extending into 2018? It might go something like this.

Suppose that you want to trade Bitcoin for Ethereum. Assume that your tax adviser is convinced that such a cross-species swap is OK under 1031, until the end of 2017. But, instead of selling your Bitcoin, say you buy the Ethereum first, though a qualified intermediary.
Once you do that, you could have up to 45 days to designate the property the intermediary will acquire for you. Then after that, you should have another 135 days (for a total of up to 180 days from your original purchase transaction) to actually have your intermediary get the other leg of the “exchange” closed.

You could call this a reverse exchange, because it involves buying before selling. Assuming that 1031 applies to a direct Bitcoin for (say) Ethereum swap, this kind of year-end reverse exchange arguably should to. Of course, you would still want to observe the formalities, actually have an intermediary, and actually have documents (such as an ‘exchange agreement’) that spells out all the particulars.

When it comes right down to it, one reason many investors might fail to meet 1031’s requirements may not be that their deal involved crypto, but rather that they just sold their crypto (taxable), and bought something else. If you were doing that with real estate, that would not work either. One can always make arguments, of course. But if you are arguing for 1031 treatment, you might expect the IRS to focus on documents, mechanics, and reporting. Bottom line? Some crypto investors are probably already searching for other ways to try to diversify without paying all the taxes. Stay tuned.

via The Tax Lawyer

Bitcoin Sellers Cut Taxes By Moving Before Sale

Bitcoin has captured the hearts and wallets of techies everywhere, and the returns have been positively heady. But taxes can be painful too. At the start of the crypto craze, it seemed anonymous. But now, the IRS is getting Coinbase customer data. It now seems practically mainstream, with futures and institutional investors. And on the subject of taxes, many a Bitcoin millionaire may be thinking like their forefathers did with appreciated stock. In general, shares of stocks are considered intangible assets for tax purposes. One effect of that rule is that, for tax purposes, you can take them with you when you move. If you live in California and sell your stocks and bonds, they are sourced to California where you reside for tax purposes.

(Photo credit: PIERRE TEYSSOT/AFP/Getty Images)

However, if you move to Nevada or Texas before you sell, your sale should be sourced to Nevada or Texas. Since California has a 13.3% income tax, and no tax break at all for capital gain, paying tax in California would be painful. Nevada, Texas, Florida, Washington, South Dakota, Alaska and Wyoming have no state income tax. So it may be worth thinking about the total tax hit. The IRS has said that Bitcoin property, and it sure seems intangible. It seems hard to imagine that the IRS or state tax authorities would view it as different from a share of stock that travels with you when you move.

Moving has its own rules. You have to really do it, and it has to be permanent, not a visit. At the federal level, the capital gain rate is 20% for higher income taxpayers. Add the 3.8% net investment tax under Obamacare, and you have 23.8%. California taxes long term capital gain as ordinary income, so Californian’s pay up to 13.3%. By paying 23.8% plus 13.3%, Californians are paying more on capital gain than virtually anyone else in the world. California’s tough Franchise Tax Board (FTB) polices the line between residents and non-residents, and it does so rigorously. As with other high tax states, California is likely to probe how and when you stopped being a resident.

A California resident is anyone in the state for other than a temporary or transitory purpose. It also includes anyone domiciled in California who is outside the state for a temporary or transitory purpose. So, if it looks as though you are exiting to sell and then will come back, the state may say you effectively never left. The burden is on you to show that you are not a Californian. If you are in California for more than 9 months, you are presumed to be a resident. Check out FTB Publication 1031. On the other hand, if your job requires you to be outside the state, it usually takes 18 months to be presumed no longer a resident.

Your domicile is your true, fixed permanent home, the place where you intend to return even when you’re gone. It should be no surprise that former Californians often become residents of no-tax states like Texas. The IRS reports that between 2013 and 2014, over 250,000 California residents moved away. More than 10% went to Texas alone. Some people get the travel itch right before cashing in shares, a public offering, or settling litigation. Some people have unrealistic expectations about establishing residency in a new state. They may have a hard time distancing themselves from California, and may not plan on California tax authorities chasing them.

You can have only one domicile, and objective facts can bear on your intent. Start with where you own a home. Where your spouse and children reside counts, as does the location where your children attend school. Your days inside and outside the state are important, as is the purpose of your travels. Where you have bank accounts and belong to social, religious, professional and other organizations is also relevant. Voter registration, vehicle registration and driver’s licenses count. Where you are employed is key. You may be a California resident even if you travel extensively and are rarely in the state. Where you own or operate businesses is relevant, as is the relative income and time you devote to them.

California, like the IRS, gets unlimited time to audit if you never file an income tax return. You might claim that you are no longer a resident and claim that you have no California filing obligation. But the FTB may disagree and can audit you forever unless you file a return. That can make it smart to file a non-resident tax return, just reporting your California-source income as a non-resident.

via The Tax Lawyer

California Taxes Already Prompt Moving Then Selling, No Deduction Could Mean Exodus

Writing off state income taxes is second nature to most high income Californians. One can say the same about a number of other high tax states, including New York, Connecticut, and others. Tens of millions of Americans claim this tax deduction, writing off their state and local taxes to reduce their federal income tax. However, state income tax deductions are itemized deductions. Thus, they are subject to numerous limits and phase-outs. And state income taxes are not deductible at all in computing the dreaded alternative minimum tax (AMT).

In that sense, the mere fact that you can write them off doesn’t actually mean you get any particular benefit. Some high income Californians might be surprised to find that they actually get no benefit at all from their state tax deduction. Still, losing something that you are used to claiming is hard, and California taxes are very high. California taxes income at rates up to a whopping 13.3% on top of IRS rates. To make matters even worse, California does not distinguish between ordinary income and capital gain. Thus, even before the pending tax bill passes, even while California taxes are still a write-off, they already seem to invite investors and business people to move away. 


Many people want to make money in California, but to move elsewhere before it is taxed by the Golden State. Year after year, no state has a bigger and more persistent group of would-be tax fugitives than California. Some people worry that the outflow will be much worse under GOP proposals. Both the House and the Senate tax bills would eliminate the state income tax deduction. To an even greater degree, therefore, some people could rethink where they want to live. Some aggressive taxpayers may try to skip California taxes without moving by 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,’ from Wyoming.

Let’s say you can’t move quite yet, so you wonder if a trust in another state might work. The usual grantor trust you form for estate planning doesn’t help, since the grantor must include the income on his own return. An emerging answer for the adventurous is a Nevada or Delaware Incomplete Gift Non-Grantor Trusts. The donor makes an incomplete gift—with strings attached—to the trust, and the trust has an independent trustee in another state. The idea is to keep the grantor involved, but not technically as the owner.

New York State has changed the law to make the grantor taxable no matter what. California’s Franchise Tax Board is studying the issue. Some sellers hold significant assets and move states before they sell. A cleaner plan is an outright move, and some of those may happen if the tax bill passes in its current form. It has been true for many years that some Californians flee the state before a major income event. But, many leavers have unrealistic expectations about establishing residency elsewhere, and have a hard time distancing themselves from California.

The burden is on you to show that you are not a Californian. You can have only one domicile, and it depends on your intent. Start with where you own a home. If you own several, compare size and value. Where your spouse and children reside counts, as does the location where your children attend school. Days inside and outside the state are important, as is the purpose of your travels. Where do you have bank accounts and belong to social, religious, professional and other organizations? Voter registration, vehicle registration and driver’s licenses count. Where you are employed is key. You may be a California resident even if you travel extensively and are rarely in the state. If you leave California, sell your residence or rent it out on a long-term lease. Like other high tax states, California is likely to probe how and when you stopped being a resident.

via The Tax Lawyer