Posted on 01/17/2012
A DISCUSSION OF TAX RETURNS AND ISSUES
SURROUNDING TAX RETURN PREPARATION
By Robert S. Steinberg, Attorney, CPA, CVA
January 17, 2012
It is paradoxical that as tax law becomes more complex to frustrate loopholes, that very complexity creates the opportunity for more loopholes. It is perverse that the loopholes are employed by few, while everyone must deal with the complexity aimed at them. Despite government efforts the tax gap (estimate of tax owed but not paid) somehow widened between 2001 and 2006, the last measured period, to $385 billion, 14.5% of taxes owed (Wall Street Journal 1/7/12). In his book “Why the Law is So Perverse, Leo Katz, provides a humorous example of how human beings find ways around rules. The example is paraphrased by Jonathan V. Last in his article “Illogical but Not Unjust,” (Wall Street Journal 12/13/2011):
Mr. Katz imagines children waiting in line to see a movie when Suzy arrives to find her friend Amanda already in line. Amanda is happy to let Suzy cut in line behind her, but the other children in line object to this (According to playground law line-cutting requires the consent of the party who will be immediately behind the cutter.) The other children are happy to let Suzy cut in front of Amanda, but Amanda is not. So Suzy proposes that she cut in from of Amanda, but later allow Amanda to cut in front of her, thus using two front-cuts to achieve the singe back-cut that playground law justly forbids.
Some courts in holding that communications imparted for tax return preparation are not protected by the attorney-client privilege have called tax return preparation a mere scrivener’s function. I am sure that no judge so holding has ever tried to prepare a modern-day federal income tax return. In fact, every entry on a tax return is an interpretation of some provision of tax law codified in the Internal Revenue Code. These interpretations of law, however, involve and often combine both legal and computational determinations. Most returns are prepared by non-lawyers and most CPAs who are often very capable return preparers know when to team-up with a tax lawyer if questions cross into the legal domain. I recently spoke before the Miami-Dade CPAs on the subject, “Where Tax Accounting Ends and Tax Law Begins.”
TAX RETURNS FOR 2011
Abraham Lincoln said, “The best thing about the future is that is comes only one day at a time.” I suppose the best thing about a tax return is the knowledge when you file that it is not again due for a whole year.
The tax system gets kicked around in
How likely is compromise? The end of 2011 saw a mad Congressional scuffle before agreement was reached for a mere two month extension of the purported economic stimulus payroll tax cut. An Op Ed in The Wall Street Journal noted (“Want Growth? Try Stable Tax Policy, John B. Taylor, 12/21/11) that the payroll tax cut was only one of 84 tax provisions expiring in 2011 and that such rapid-fire change makes the tax system unpredictable. But, expiring provisions are not the whole sad story. There are many complexities and headaches new and old to deal with for 2011 tax filings. Some are:
The above paragraphs only touch on these changes each of which deserves an expanded article. It is well that this year we have two extra days to file, tax returns being due on Tuesday, April 17, 2012, thanks to the D.C. Emancipation Day holiday being observed on Monday, April 16.
KEEPING OUT OF TROUBLE
It easier to keep out of trouble, than it is to get out of trouble. Yet, many tax payers and preparers are quite cavalier about how serious a document is the ordinary tax return. When I mention criminal tax matters, the stock response is: “I’ve never had a client who was investigated for or charged with a tax crime.” This anecdotal assessment, on one level, is true; only the very few unfortunates are subjected to the honor. The rub is that those targeted for investigation are put on the rack and subjected to a very expensive and painful experience, even if not ultimately indicted. Even the more ordinary civil tax audit is expensive and emotionally fretful to endure. The response is not wholly irrational of those, who, upon receiving an envelope in the mail from IRS, mentally transpose “IRS” into “I’m Really Scared!” A criminal tax investigation is like a Hurricane, not likely to happen but very destructive when it does. A civil tax audit is more likely but still hits you with tropical storm force. Thus, respect your tax return and attend thoughtfully and cautiously to its filing. Don’t allow self-assessment (initially the taxpayers determines how much tax is owed) on your tax return to become self delusion. Remember, I’ve never had a problem can suddenly and quite unexpectedly become, “Houston, we have a problem.”
WHY BE CONCERNED ABOUT SIGNING YOUR TAX RETURN?
This obtuse document, this complex and vexing tax return, this intimidating Form 1040 - we sign under the following declaration:
“Under penalties of perjury, I declare that I have examined this return, including accompanying schedules and statements, and to the best of my knowledge and belief, it is true, correct and complete.”
Your tax return is one of the rarest of documents, one calling for a signature and expressly stating that a knowingly false statement will be treated as perjury. The information in your tax return is akin to providing testimony under oath. Your tax return is a disclosure and reporting document. Some behave like it is a document filed in an adversarial proceeding but that is an inaccurate expression. Filing your tax return may lead to an adversarial proceeding but it is not in and of itself an adversarial filing. Thus, your return preparer is not merely an advocate but has a parallel duty not to frustrate or subvert the integrity of the tax system. The filer is bound by the above declaration, ethical rules of tax practice, and other civil and criminal sanctions for abusing the system by negligently or willfully under-reporting income or overstating deductions and credits.
The federal criminal statues embody that concept. Specifically, as to the tax return declaration, 26 USC Section 7206, provides, in part:
Any person who –
(1) willfully makes and subscribes any return … which contains or is verified by a written declaration that it is made under penalties of perjury, and which he does not believe to be true and correct as to every material matter…shall be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000…, or imprisoned not more than 3 years, or both, together with the costs of prosecution.
Despite possible severe sanctions, author Herman Wouk wrote: “income tax returns are the most imaginative fiction being written today.” Here in South Florida, the genre seems popular. Civil and criminal tax sanctions raise high the price one may pay for attempting to illegally best the IRS.
All taxpayers are individually responsible for the tax on their separate taxable income. Filing a joint return requires an affirmative election indicated by signing the return with the intent to file jointly. Filing jointly generally results in a lower tax than if each spouse filed separately. Filing a joint return, however, renders each spouse both individually and jointly liable to IRS for the entire tax liability reported on the tax return or later determined by audit. This joint and several liability on a joint return may be avoided only if a spouse qualifies for the very restrictive so called “innocent spouse” relief. A spouse may choose file a separate return reporting only his or her own income, deductions, tax-credits and withholding. A spouse individually may not be required to file at all. Thus, each filer should sign a joint return only if he or she is certain that the return is accurate, and he or she intends to file a joint return and thereby assume all of the benefits and burdens of the joint return election.
Caveat: Joint filers can use Form 8888, Allocation of Refund (Including Savings Bond Purchases), to direct IRS to split their direct deposit refund into two accounts. IRS has announced that if processing of a 2011 return is delayed, for any reason, the refund will not be split but deposited into the first account listed on Form 8888. Divorced or divorcing couples who often use this form should make sure the court order or agreement regarding the refund covers this eventuality.
YOUR TAX RETURN PREPARER
Almost anyone can prepare a tax return for hire although all tax return preparers are now required to register with IRS and obtain an identification number (PTIN). The levels of education and competency of preparers varies considerably. Tax attorneys, CPAs and Enrolled Agents are usually the most competent. The IRS has unwisely chosen to call those authorized to prepare tax returns but not in the above three categories “Registered Tax Return Preparers,” a title that may mislead unwary filers believing such preparers are comparable to the more competent preparers.
NOT FILING A TAX RETURN
Some avoid the frustration altogether by simply not filing a tax return. This ostrich technique of sticking one’s head in the sand to avoid a problem does not work, however. Not washing the dishes right away leaves them sticky and harder to clean up later. Neglectfully failing to file a return carried a civil penalty of 5% per month (maximum 25%). Willfully failing to file a return, known to be due, is a misdemeanor, not a felony like filing a false return. But, it can be elevated to the felony level of tax evasion if accompanied by other acts of deception such as using nominee entities to hide assets and income, etc. Moreover, IRS has become more skilled at locating non-filers. Because failing to file can be treated by IRS as a crime or civil tax matter, non-filers are wise to come back into the system with the assistance of a capable tax lawyer.
The IRS has just announced a third Offshore Voluntary Disclosure Program offering the certainty of no criminal charges for those hiding unreported offshore financial accounts. This announcement comes amidst a brouhaha with the National Taxpayer Advocate who has accused IRS of bait and switch tactics regarding the 2009 Offshore Voluntary Disclosure Initiative. One seeking admission into this program should engage an attorney to oversee the process (See Volume 5, No. 2). It is a risky enterprise for one to simply file delinquent tax returns, offshore bank account or not, using a trusted tax return preparer. The filing may not be viewed as a Voluntary Disclosure. The tax return preparer lacks attorney-client privilege and broader confidentiality protections that are granted to lawyers and which can protect communications and information not included in the returns. Also, a non-lawyer preparer is not trained to determine whether the facts and circumstances are such that returns may be safely filed without the filer being indicted for admitting his or her crime; or, whether other protective measures must be employed to bring the delinquent filer into compliance with the law. Not filing a tax return when due can have collateral consequences, as well, including:
If IRS discovers your non-filing and you fail to respond to requests to file, IRS will prepare a substitute return for you based on the information in its computer. This will often result in a higher tax assessment than you would owe on a return prepared from complete information because it will omit tax basis of assets sold and deductions and credits. A substitute return does not relieve one from the duty to file a return reporting income not included in the substitute return (e.g., income not reported on a Form 1099).
HOW LONG TO SAVE YOU TAX RETURN AND DATA
Keep your tax return forever. It is not that bulky in most cases and contains information that may become relevant to later tax issues. Your tax back up data, however, may generally be discarded after six years have elapsed following the filing of your return or the filing due date if later. Absent fraud, six years is generally the maximum period within which IRS can assess additional tax, although the usual period is within three years of the filing or due date, if later. Some documents should be kept longer. Examples are:
2. Documentation for expenses comprising a net operating loss carryover: for six years following the year in which you utilize the net operating loss.
Noted criminal defense attorney Michael Louis Minnis in his article “Cross-Examination of the Government Witness,” (The Tax Lawyer, Vol. 64, No 1, Fall 2010, p. 125, 134) says, “If the (Internal Revenue) Code were to have life breathed into it and sit on the (witness) stand, it might break down in tears under cross-examination and proclaim, ‘Nobody understands me!’” Yet we must deal with the monster and file our tax returns.
Treat your tax preparation and tax return filing as serious matters. Employ a competent and ethical return preparer. If your return preparer is a non-lawyer, make certain that he or she knows where tax accounting ends and tax law begins that he or she not end up as a government witness testifying against you in a criminal tax fraud trial or jeopardize legal rights about which non-lawyers are unfamiliar. Areas where one should involve a tax lawyer include when contacted by an IRS special agent, when filing seriously delinquent or amended tax returns involving large amounts, when requesting Innocent Spouse relief or a Collection Due Process Hearing about an IRS tax collection matter or when deciding how to appeal an IRS audit result (i.e., filing a protest with IRS Appeals Division, petitioning the U.S. Tax Court or paying the tax and filing a refund claim), when federal tax law depends on state law interpretations, and, when considering an item in a tax return to be filed that involves a controversial tax matter, requiring an analysis of tax law and litigated cases, and/or required or protective disclosures. These are some matters that have legal consequences on choice of forum, statute of limitations, avoidance of severe penalties or the ability to discharge a tax liability in bankruptcy, none of which are within the normal scope of a non-lawyer’s training or experience.
© 2012 by Robert S. Steinberg, Esquire
All rights reserved.