Archives for March 2022

“At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?”

March 30, 2022 by Frank

Another Signal from IRS that it is focusing on virtual currencies.

New Question on Individual Income Tax Returns

This year’s individual income tax returns have a new question: At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? The taxpayer needs to check either the “Yes” or “No” box. All taxpayers must check one box answering either “Yes” or “No” to the virtual currency question. The question must be answered by all taxpayers, not just taxpayers who engaged in a transaction involving virtual currency in 2021.

Who Can Answer “No”

Taxpayers who merely owned virtual currency at any time in 2021 can check the “No” box when they have not engaged in any transactions involving virtual currency during the year, or their activities were limited to:

Holding virtual currency in their own wallet or account.
Transferring virtual currency between their own wallets or accounts.
Purchasing virtual currency using real currency, including purchases using real currency electronic platforms such as PayPal and Venmo.
Engaging in a combination of holding, transferring, or purchasing virtual currency as described above.

Who Must Answer “Yes”

When taxpayers must check “Yes”
The list below covers the most common transactions in virtual currency that require checking the “Yes” box:

The receipt of virtual currency as payment for goods or services provided;
The receipt or transfer of virtual currency for free (without providing any consideration) that does not qualify as a bona-fide gift;
The receipt of new virtual currency as a result of mining and staking activities;
The receipt of virtual currency as a result of a hard fork;
An exchange of virtual currency for property, goods, or services;
An exchange/trade of virtual currency for another virtual currency;
A sale of virtual currency; and
Any other disposition of a financial interest in virtual currency.

Other Virtual Currency Reporting Requirements

If a taxpayer disposed of any virtual currency that was held as a capital asset through a sale, exchange or transfer, they must check “Yes” and use Form 8949 to figure their capital gain or loss and report it on Schedule D (Form 1040).

If a taxpayer received any virtual currency as compensation for services or disposed of any virtual currency that they held for sale to customers in a trade or business, they must report the income as they would report other income of the same type (for example, W-2 wages on Form 1040, 1040-SR, or 1040-NR, line 1, or inventory or services from Schedule C on Schedule 1).

Tax Tip

If a taxpayer responds with a “No” and is found to have been required to respond with a “Yes”, the IRS can interpret an inadvertent mistake to be intentional act to mislead the IRS. Accordingly, if a taxpayer has any type of virtual currency activity, or is unsure as to how to answer this question, the “safe” approach may be simply to respond with a “Yes”.

If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.

BE SURE TO READ THE DISCLAIMER PAGE: Tax laws, IRS rules and regulations change frequently. Although we hope you’ll find this information helpful, this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher shall not assume liability for any losses, injuries, or damages from the display or use of this information.

About F. Bryan Haarlander, EA, CTRS:

Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.

Rental Property – Need for an LLC?

March 23, 2022 by Frank

Do rental properties need to be placed in an LLC, or is having liability insurance sufficient to hold the property in your personal name?

Background Scenario

Far too often, individuals who purchase, inherit, or are gifted a rental property, or simply convert a residential property used for their personal use to a rental property, report the rental activity on Schedule E of their Form 1040. In other words, they own the rental property in their own name and dismiss having a limited liability company (LLC) own the rental property.

Why Individuals Own Rental Properties in Their Names

One could argue that individuals put the title of their rental properties in their own names because they are ignorant of the liability issues associated with such a move; they wish to avoid the additional costs associated with owning an LLC; or they believe that increasing the liability coverage on their insurance policy will adequately protect them.

While we will discuss all three of the above reasons, the focus of this post will be on the third reason, the misconception about insurance coverage.

Brief Overview of Liability Issues

Owning a rental property is not without risks. A tenant or a customer in a retail operation could have a slip and fall, and sue the owner of the property for negligence. The landlord may have a dispute with a vendor or supplier, and that could result in a lawsuit for breach of contract. There are other ways in which a lawsuit can be the end result. How or why the suit is filed is not our focus. Rather, the focus is on one step that can be taken to limit the landlord’s liability exposure – – – have the rental property owned by an LLC.

If the property is owned directly by the individual, all of the individual’s assets are conceivably at risk. If the property is placed in an LLC, a properly structured LLC should limit the liability to the assets of the LLC and protect the landlord’s personal assets.

We believe that most individuals would agree that it would be best to own the rental property in an LLC. But, why do they own the properties in their individual names?

Additional Costs of an LLC

There is no question that an owner of a rental property will incur additional costs to have the LLC own that property rather than owning the property in their individual name. While not all-inclusive, those costs would include the legal fees associated with the formation of the LLC with the Secretary of State and the writing of an operating agreement, the filing of tax returns and possibly annual returns, bookkeeping costs as the books and records of the LLC must be kept separate from the owner’s individual accounting and tax records, and separate tax return preparation and filing fees to name a few of those additional costs. Initially, those additional costs can run in the thousands of dollars.

If there will be a mortgage on the rental property, the lender will charge the higher commercial interest rates as the LLC is a business entity and not a residential property subject to more attractive rates.

If the owner of the property wishes to transfer ownership from their individual name to the LLC, and that property is located in Pennsylvania, the owner will have to pay the two per cent realty transfer fee. In this scenario, the owner incurs additional costs that can run in the thousands. If there is debt on the rental property, the owner will very likely need to refinance the loan, incur re-financing costs, and be subject to commercial rates.

When faced with the decision of having to spend thousands of dollars to have the rental property in an LLC, the often shortsighted thinking is to quickly dismiss the LLC option and own the rental property in the name of the individual and simply purchase relatively inexpensive additional liability insurance to cover a claim.

The Solution is Not Simply Buying Additional Liability Insurance

Let’s be clear. The first line of defense when a lawsuit is filed is to have adequate liability insurance. Landlords should consult with their insurance broker and determine the adequate amount of liability insurance to carry. If the insurance carrier allows umbrella insurance coverage on the rental property, that is an additional consideration to ponder.

When speaking with the insurance broker, be sure to discuss and thoroughly understand the exclusions from coverage. Far too often, the exclusions in the insurance policy are not read or are quickly dismissed as not important or will never be relevant.

Some possible exclusions are, but not limited to . . .

Toxic mold. Any water leak is susceptible to mold intrusion. If mold develops or is found within the rental property, many policies exclude mold remediation and other environmental hazards. If covered, there is generally a dollar ceiling on that coverage.

Covid-19 pandemic. We just experienced a Covid-19 pandemic. If the rental property is deemed a “sick building,” and the tenants, or contractors engaged to remediate the building fall ill to Covid-19, it is likely that the insurance policy will not cover potential respiratory infection suits.

Vacancies over 30 days. Insurance policies have extended absence exclusions. For example, if your rental property is vacant for say 30 days, and an incident occurs during that vacancy that would normally be covered, is that incident no longer covered due to the extended absence? In addition to normal vacancies after one tenant moves out and the landlord searches for the ideal future tenant, vacancies can occur if a tenant trashes the rental property and it requires extensive rehab work, or is vacant due to the previously mentioned pandemic or environmental hazards.

Reduced rents for services rendered. It is not uncommon for a tenant to barter with a landlord. For example, the tenant agrees to provide some repair or to perform maintenance work in exchange for a reduced rent. State law may treat those tenants performing that work as an unlicensed contractor or as your employee, denying coverage should the tenant incur an injury.

Vicious dog. A tenant ignores the landlord’s rules and regulations and brings a dog into the building and that dog bites another tenant, visitor, or vendor. If that dog is considered a vicious dog by your insurance carrier, those dog bites are not covered.

Related to the above potential insurance policy exclusions, if a claim is filed and since your likely personally guaranteed the loan on the rental property, or if there is insufficient rental income to service the debt on the property, you may have inadvertently exposed your personal assets due to that personal guarantee. Have any of these events caused the fair market value of your rental property to decrease? If the property declines in value, or there any loan provisions related to debt to fair market value ratios that could trigger a personal guarantee?

If the rental property were held in an LLC, your liability exposure may have been limited to the assets within the LLC.

Final Comment

Owning a rental property is not without risk. We believe everyone agrees with that premise. The point we are making is that while the up-front costs of creating an LLC that will hold your rental property may cost a few thousand dollars, in the long run, it may be the most cost efficient way to own rental property.

When entering into a new business venture, in addition to the creation of the business, you also need an exit strategy. What are your future plans for this business? How will you exit from this business enterprise? Perhaps having the rental property in an LLC would better serve you when the property is sold, gifted, or exchanged.

When purchasing a rental property or converting a personal residence to a rental property, consult with a real estate attorney, an asset protection attorney, an insurance broker and an experienced tax professional.

Tip #1

When considering limited liability options and associated costs, you need to look at both the short-term and long-term ramifications of that decision.

Tip #2

To repeat what was stated above, when considering investing in a rental property, consult with a real estate attorney, an asset protection attorney, an insurance broker, and your tax professional. As part of your exit strategy, you may wish to include an estate planning attorney.

About F. Bryan Haarlander, EA, CTRS:

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.

Penalty Enigma-Failure to File a Gift Tax Return

March 16, 2022 by Frank

What happens when a taxpayer fails to file the required gift tax return? How severe are the penalties for failure to file?

Cautionary Note

While we address certain aspects of the requirements to file a gift tax return in this post, our focus in this post is to address the penalty provisions for failure by an individual taxpayer to file a gift tax return.

Some General Gift Tax Return Filing Requirements

Taxpayers use IRS Form 709 to report gifts they make. Per the IRS Form 709 instructions, if you are a citizen or resident of the United States, you generally must file a gift tax return (whether or not any tax is ultimately due). Some general gift tax rules are listed below.

You gave present interests gifts to someone in 2021 totaling more than $15,000 (other than to your spouse). Certain gifts, called future interests, are not subject to the $15,000 annual
exclusion and you must file Form 709 even if the gift was under $15,000.

Spouses may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. You must file a gift tax return to split gifts with your spouse (regardless of their
amount). If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return. Likewise, each spouse must file a gift
tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.
Gifts to charities are generally not considered taxable gifts. There are exceptions, such as when a partial interest is transferred to a charity. IRS Publication 526 is a valuable resource to identify a qualified charity.

Who Is Responsible for Paying the Gift Tax?

This question often arises when the donee (recipient) receives a gift from another individual (the donor). While appreciative of the gift, donees often are aware that a gift tax may be due, and wishing to be in compliance, ask how much in gift tax they must pay. They are pleased to learn that it is the donor who is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

How the Gift Tax Is Computed

The gift tax rates can be found in the IRS Instructions for Form 709 and are not addressed for purposes of this post regarding the penalty provisions.

How are the Penalties for Failure to File a Gift Tax Return and Failure to Pay the Gift Tax Due Computed?

Similar to the computation for failure to file (FTF) an income tax return or failure to pay (FTP) the income tax due, the penalty for FTF a gift tax return and the penalty for FTP the gift tax is based on the amount of tax due.

With respect to an income tax return, the taxpayer generally has a tax liability that is due and the penalty for FTF an income tax return or/and the penalty for FTP the income tax due is based on the unpaid income tax liability.

If those situations where no income tax is due (such as when sufficient income tax withholdings or estimated income tax payments were made), there are no FTF or FTP penalties assessed.

The Gift Tax Exclusions

We briefly mentioned the 2021 annual gift tax exclusion of $15,000. Gifts that don’t exceed $15,000 are not subject to a gift tax. (There is a special exclusion from the gift tax for Sec. 529 college savings plan gifts where the donor is allowed to make 5 years of contributions in one year). In addition to the annual gift tax exclusion, there is also a lifetime exclusion, currently set at $11.7 million (which could be greater if the portability rules come into play for a deceased spouse).

What is the Penalty Enigma?

Since the penalty is based on the amount of gift tax due, there is no gift tax due unless the fair market value of the gift exceeds the annual and lifetime gift tax exclusions. Thus, in most cases where a gift tax return was due and not filed, there is no FTF or FTP penalty because those penalties are based on the amount of the tax due. No tax due – no penalty.

Hypothetical Example Illustrates Non-compliance Dilemma

Bob makes a gift today with a value of $11 million to his only child and files the required Form 709, Gift Tax Return. There is no gift tax due with the filing of his return. For illustration purposes, let’s assume that after claiming the annual and lifetime exclusions, the remainder of this life estate exclusion is an even $700,000. Bob passes away a few years later and leaves $12.7 million to his surviving son. He now has $700,000 of his lifetime exemption remaining, which means that there is a federal estate tax due on the $12 million his son inherits.

Tom, Bob’s brother, has also been financially successful and he too gifted $11 million to his only child. Unlike Bob, Tom did not file a gift tax return. When Tom passes away, he too leaves $12.7 million to his only child. Since no gift tax return had been filed by Tom, the IRS has no record that a prior gift was made and that the lifetime exemption was almost completely used. Will the executor of his estate, which could be his only child, remember that Bob gifted $11 million and only has $700,000 remaining of his lifetime exemption? Is the executor ignorant of the prior gift? Will the executor have selective amnesia?

The problem with how the penalty is computed and the IRS’s apparent inability to track all prior gifts, is that the penalty is hollow as it has no teeth in it to deter a situation like that found with Tom. One could argue that the manner in which the penalty is computed rewards non-compliant taxpayers.

Tax Tip #1

We advise all taxpayers with a sizable estate to consult with an experienced estate tax attorney and their tax professional to plan how to minimize their taxes, whether they be income, gift, or estate taxes.

Tax Tip #2

File all required tax returns, including gift tax returns. While Tom’s not filing the required gift tax return may at first glance appear alluring, it can cause many sleepless nights and could eventually create significant penalties for any taxpayer taking this route. By filing a gift tax return when due, the 3-year statute of limitations begins to run and the taxpayer has closure with respect to the gift transaction. This means that the IRS has 3 years from the date the return was filed to audit it and question the valuation of the gifts made. If it is determined that the fair market value of the gifts was substantially understated (as is sometimes the case when closely held stock is gifted or valuation discounts are used), in addition to FTF and FTP penalties, the IRS could assess a 20% penalty on the understated value for “substantial valuation understatement” or a 40% penalty on the understated value for “gross valuation understatement”.

Two other possible reasons to file a gift tax return on time is that failure to do so, (1) you lose the ability to allocate the general skipping transfer (GST) exemption based on the value of the property on the date of the gift; and (2) you have reflected the date of the gift which is important if a beneficiary of the estate contests who inherits the property of the deceased.

Tax Tip #3

While Congress has historically increased the annual gift tax exemption, the lifetime exemption amount is at the whim of Congress and could possibly be decreased or eliminated. This is why as the tax law changes, it is a good time to meet again with your estate planning attorney and tax professional to update wills, trusts, etc.

About F. Bryan Haarlander, EA, CTRS:

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.

How a $7.00 Penalty Cost a Taxpayer $268,000

March 8, 2022 by Frank

What happened when taxpayers instructed their tax preparer to file an extension of time and to debit their checking account for $1.8 Million to pay the balance due the IRS?

Osterwijk versus the IRS Background

When it came time to file their 2017 Form 1040, the taxpayers expected their longtime preparer to e-file an extension and instruct IRS to apply a payment of about $1.8 million in taxes. The taxpayers made sure they transferred money to their checking account and kept looking to see when the tax payment would hit the account. When the money remained in their checking account past the filing due date, they asked their CPA to double check the status of their payment.

The CPA checks his files and discovers that he failed to file the extension and never instructed the IRS to withdraw the funds to pay for the taxes due.

Failure to File Extension Request Compounded by Poor Tax Advice

The preparer advised the Oosterwijks to immediately file a six-month extension request which would allow them to file their return by October 15. The taxpayer followed the advice of their preparer, mailed in the extension request and a check for $1.8 million.

Upon processing their return, IRS assessed failure to pay penalties (FTP) of about $9,000 for the one month non-payment delinquency period. IRS assessed failure to file (FTP) penalties of about $259,000 for the three month late filing period that ran from the April filing due date to June 29th, the date that Oosterwijks’ CPA e-filed their return on their behalf.

These penalty assessments came as a surprise to the Osterwijks and their CPA. Based on the CPA’s advice, the taxpayers had believed that by paying their taxes, submitting the Extension Request in May, and filing the return before October 15, they would halt the accrual of any FTF penalties beyond the first month.

The problem: An extension to file a return must be made on or before the due date, not afterwards.

Taxpayer Argues that the Penalty be Abated for Reasonable Cause

The taxpayers’ CPA requested penalty relief based on reasonable cause. After all, the taxpayers relied upon the advice of their tax professional. That surely should constitute reasonable cause. The IRS denied the relief.

The CPA appealed administratively on behalf of his clients. The Appeals Officer graciously agreed to abate about 50% of both delinquency penalties. The taxpayers were not happy with the proposed settlement and sent another letter to the IRS raising the issue of reasonable cause due to the failure of their preparer to file the extension and remit the balance due by the April due date of the return.

The taxpayers pay the penalty assessments and sue for a refund claiming that by relying upon the incorrect advice of their tax preparer, they have reasonable cause and the penalties should be abated.

Relying Upon Others to File a Tax Return

The courts have consistently held that reliance on a third party to file a return does not establish reasonable cause because “[i]t requires no special training or effort to ascertain a deadline and make sure that it is met.” The court noted that the Oosterwijks were free to paper file an extension, and in fact they eventually did. Furthermore, the court noted that the taxpayer relied upon their adviser’s advice after the due date of the return. The court, in reaching its decision, also noted that a reasonable cause inquiry looks to the due date, and while the due date (and thus inquiry time) could be extended if the taxpayer timely filed an extension, actions beyond the due date are not determinative.

What is the Relevance of the Aforementioned $7.00 Penalty?

In cases where a Failure to File (FTF) or Failure to Pay (PTP) penalty is assessed, the IRS provides administrative relief to qualifying taxpayers. That relief is called the First Time Abatement (FTA) Policy. One of the conditions for FTA is that the taxpayer’s compliance for the three prior years were free of penalties. If so, the IRS has the discretion to abate the FTF and FTP penalties. In the instant case, the Oosterwijks incurred a $7.00 penalty during the three-year look back period and thus did not qualify for the FTA relief.

The authors wish to thank Leslie Book, Professor of Law at Villanova Law School, for his Feb. 7, 2022 blog posting of this case. For anyone who wishes to know more about this court case and the court rulings regarding reasonable cause, his article makes for an excellent read.

Tax Tip

Carefully select your tax preparer. Whether they are an attorney, CPA, Enrolled Agent, or an unlicensed tax preparer, a college roommate or a family member, the taxpayer is ultimately responsible for his/her tax return which is signed under penalties of perjury as being correct. When you are looking for a tax preparer and your first, and perhaps only question is “How much do you charge?”, you are not doing your due diligence in selecting a tax preparer.

About F. Bryan Haarlander, EA, CTRS:

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.

$12 Million FBAR Penalty

March 1, 2022 by Frank

The Bank Secrecy Act imposes penalties for failure to disclose overseas accounts with balances of more than $10,000 during any day during the tax year– draconian penalties if failure to disclose is found to be willful

What Is the FBAR Filing Requirement?

We have previously reported about the FBAR (Report of Foreign Bank and Financial Accounts) filing requirement and some case studies in our June 15, 2020, January 22, 2019 and April 26, 2016 postings. If you are unfamiliar with the FBAR filing requirements, we recommend that you read the aforementioned posts. Today, we wish to discuss just how costly these penalties for willful failure to disclose can be.

Penalty for Willful Failure to Disclose

The IRS can impose a penalty of up to the greater of $100,000 or 50% if the balance in each undisclosed account at the time of the violation. For taxpayers with multiple accounts and multiple years of willful violations, the maximum willful penalty can be crippling.

Case of United States v Schwarzbaum

Mr. Schwarzbaum had multiple bank accounts: two in Costa Rica and eleven in Switzerland. His CPA, who provided him with incorrect advice, prepared his 2006 return which only listed one of the Costa Rican accounts. Schwarzbaum self-prepared his 2007 return and again only listed one foreign account. He made no FBAR filing in 2008. In 2009, he self-prepared his returns and filed a FBAR that listed his two Costa Rican accounts and one Swiss account. He didn’t file FBARs for his accounts in Switzerland before 2011. In 2011, the taxpayer joined the IRS’s Offshore Voluntary Disclosure Initiative (OVDI). As part of his participation, he signed an extension of the statute of limitations period to assess and collect taxes and penalties related to his 2006 through 2009 returns.

Schwarzbaum then opted out of the OVDI and underwent full examinations of his returns. After the examinations, the IRS decided to assert willful FBAR penalties against him. The FBAR penalties for tax years 2006 through 2009 were assessed in September 2016. The taxpayer argued that the FBAR penalty assessments were time-barred by the statute of limitations. The IRS counter-argued that the taxpayer had voluntarily signed a consent to extend the limitations period to assess and collect taxes related to his 2006 through 2009 returns. The district court held that the taxpayer’s argument that the FBAR penalties were time-barred was meritless as he failed to point to any legal authority to support his argument that the agreement he signed was invalid.

Draconian Penalty

The court found willful violations for tax years 2007 – 2009, not for 2006. The court also picked up on IRS errors in making the assessment computations against Schwarzbaum. Specifically, the court found that the IRS had used maximum account balances self-reported by Schwarzbaum and not the applicable violation dates for the penalty base—i.e., the latter of which should be the amount in the foreign accounts as of the FBAR filing date of June 30. On this basis, the district court found that the penalties were unlawful under the Administrative Procedure Act (the “APA”). The court then imposed new FBAR penalties against Schwarzbaum totaling $12,907,952.

The IRS contended that the willful FBAR penalties should be reduced to $12,555,813, or the amount that the IRS had already assessed against Schwarzbaum for 2007, 2008, and 2009.

Computation of Penalty

The statutory maximum penalty for a willful FBAR violation is the greater of $100,000 or 50% of the balance in the account at the time of the violation. The time of [an FBAR] violation is June 30, the annual FBAR filing deadline. Indeed, the government concedes that the IRS mistakenly calculated Schwarzbaum’s statutory maximum penalties using his foreign accounts’ highest annual balances rather than their June 30 balances. Because the IRS miscalculated Schwarzbaum’s penalties, a remand is in order to allow the IRS to fix the mistake.

Tax Tip #1

Read our prior posts on FBAR as the reporting requirements cover more than just foreign bank accounts.

Tax Tip #2

Don’t tip your big toe in the water to test what the IRS knows about your foreign reportable accounts. The IRS has agreements with most, if not all, foreign governments to report the holdings of U.S. taxpayers to the IRS. As you can see from the Schwarzbaum case, the penalties are very severe. Talk to your tax professional about your foreign accounts (including those held in joint name with another person for the convenience of that person). Most tax professionals have a tax organizer that will ask you about your foreign account holdings. Answer all questions about foreign accounts completely and honestly.

About F. Bryan Haarlander, EA, CTRS:

A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.