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Case Where Texas Ranchers Were Victorious in IRS Appeal

Dallas Appeals Officer Reverses IRS Decision
Allows Business Expenses and Ranching Losses for 2011 & 2012 and Abates the 20% Accuracy Related Penalty

If you have been contacted by the IRS concerning your business expenses and the losses reflected on your Federal income tax returns, you should contact a competent tax attorneyBack in 2014, I represented a Texas couple in connection with an Appeal from an IRS decision disallowing the Taxpayers’ business expenses and losses associated with the Taxpayers’ ranching operations for the tax years 2011 and 2012 as well as the assessment of the I.R.C. § 6662(a) 20% accuracy related penalty.

The client names have been changed due to confidentiality. The Appeal was successful and resulted in the allowance of 100% of the Taxpayers’ business expenses and losses associated with their ranching operations for the relevant tax years, as well as the abatement of the 20% accuracy related penalty. The Appeal resulted in a total tax savings of approximately $300,000.

The Facts of the Case

Kenneth Johnson* and Pamela Johnson* (the Taxpayers) are residents of the State of Texas with their principal place of domicile located in Brownwood. Mr. Johnson comes from a long line of ranchers and farmers. His grandfather came to Texas in a covered wagon and started raising cotton and cattle. The family tradition continued with his father and uncle and subsequently with Mr. Johnson.

In July 2001 the Taxpayers purchased, a 100 acre property located in Brownwood, Texas. The original property consisted of a 2,650 square foot home, barns, sheds, stock tanks, as well as corrals and a cattle chute. In November of 2002, the Taxpayers purchased the adjoining 120 acres. The Taxpayers subsequently leased an additional 403 Acres. The leased property has three stock tanks, is cross fenced and has corrals for working livestock. All of the foregoing was acquired with the intent of establishing a viable ranching operation, consistent with Mr. Johnson’s rich family history in ranching.

Beginning in 2010 and continuing through 2012, Central Texas experienced a severe drought. Farmers and Ranchers in this area saw their earthen tanks as well as rivers and creeks dry up. In order to survive many ranchers and farmers had to haul water to their livestock. In addition, due to the lack of rainfall, ranchers, including the Johnson’s, were forced to purchase more hay and feed to try and make it through the drought. Ultimately, many ranchers, including the Taxpayers, were forced to mitigate their losses by selling off their livestock. As a result of the drought, ranchers were faced with a shortage of breeding stock available for sale, which in turn, resulted in higher livestock prices. Consequently, ranchers required additional time in order to replenish their herds.

In addition to the Taxpayers’ ranching operations, Mr. Johnson* was employed full-time in the oil and gas industry. The Taxpayer and his wife also owned and operated several other enterprises including a sales and marketing and mud logging business and also owned several rental properties. For the Tax Years 2011 and 2012, the Taxpayers self-prepared and filed their joint Federal income tax returns. For the tax years 2011 and 2012, the Johnson’s Federal income tax returns reflected ranching losses in the amount of $342,326 and $483,705 respectively.

In June of 2013 the Taxpayers’ 2011 and 2012 Federal income tax returns were selected by the IRS for examination. The Johnson’s were not represented during the IRS examination which resulted in the IRS disallowing 100% of the Schedule F (Farming) business expenses and the ranching losses sustained during the years in question. In addition, the IRS assessed the I.R.C. § 6662(a) 20% accuracy related penalty. The predicate for the IRS assessment was based upon the principle that a taxpayer may not deduct expenses and losses associated therewith, where a legitimate business purpose and profit motive is absent. The IRS assessed $102,697 and $145,112 in additional income tax for the respective tax years 2011 and 2012. In addition, the IRS assessed the 20% accuracy related penalty in the amount of $23,963.00 and $29,022.00 for the two years in question.

The IRS auditor provided the Johnson’s with Form 4549 (Income Tax Examination Changes) outlining the proposed changes. Thereafter, the Taxpayers contacted and retained the services of Kathryn J. Earnhardt, a local certified public accountant, for purposes of filing a written request for reconsideration to the Income Tax Examination Changes with the IRS. Ms. Earnhardt’s filed the request for reconsideration, but the IRS determined that it would not alter Form 4549. The IRS response consisted of Letter 692 (Request for Consideration of Additional Findings) and Form 886-A (Explanation of Items).

Mr. and Mrs. Johnson* thereafter contacted me and retained my services to represent the Taxpayers in connection with filing an Appeal with respect to the IRS assessments for 2011 and 2012. The issues presented for Appeal included the disallowance of the Schedule F business expenses, the disallowance of the losses from the Taxpayers’ ranching operations for the years 2011 and 2012 and the assessment of the I.R.C. § 6662(a) 20% accuracy related penalty.

In January 2014, my office prepared and filed a Protest Letter and Form 12203 (Request for Appeals Review) on behalf of the Johnson’s with the IRS Appeals office in Dallas, Texas. A conference was subsequently scheduled with the Appeals office in Dallas for March of 2014.I attended the conference together with the Johnson’s. We met with Mr. Robert Warfield, an attorney with IRS Appeals. During the conference, we discussed the issues presented and the Johnson’s provided credible testimony concerning profit motive in their ranching operations, as well as the circumstances related to the draught. At the conclusion of the conference Mr. Warfield informed the Taxpayers that they were entitled to 100% of the business expenses and ranching losses reflected on Schedule F for the tax years 2011 and 2012 and that those adjustments would be made to the Taxpayers’ account. In addition, Mr. Warfield also informed the Taxpayers that the 20% accuracy related penalty would be abated.

The experience gained from this case is as follows: If you started a business within the last five years and have continued to sustain losses, there is a risk that your returns will be selected for examination and subject to the IRS disallowing the both the business expenses as well as any losses. A self-employed Taxpayer needs to be able to establish that the business is viable as a going concern, and that a clear profit motive exists. Since no two cases are alike, it is important to have credible evidence regarding income patterns in your industry and that your expenses are in line based upon your income. If you have been contacted by the IRS concerning your business expenses and the losses reflected on your Federal income tax returns, you should contact a competent tax attorney to discuss the specific facts of your case, industry profit and loss statistics and the options available to you.

* The clients’ names have been changed for purposes of preserving the privacy of attorney client privilege. The facts of the tax law case are the same.

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New Jersey Couple Avoids FBAR Penalty and Instead Receives Warning Letter

The following is an actual FBAR case handled by the Law Office of Anthony N. Verni. My Princeton New Jersey office was successful in securing a waiver of the proposed FBAR penalties for these two taxpayers.

FBAR statute of limitations can incur FBAR penalties by the IRS, here is a prior experience with a New Jersey coupleMr.and Mrs. Beránek (a.k.a. the “taxpayers”) are Czechoslovakia nationals.* The taxpayer as well as his spouse are retired and in their early seventies. The Beránek’s came to the United States in 1997 as Permanent Legal Residents and became naturalized citizens in 2004. Since their immigration to the U.S., Mr. and Mrs. Beránek have lived in Freehold, New Jersey.

The taxpayers maintained an account with UBS in Switzerland (the “UBS Account”), which was established in 1962. The taxpayers would routinely deposit their earnings from their employment as electrical engineers into the UBS Account. In addition to the UBS Account,Mrs. Beránek opened and maintained a joint account with her non-resident alien sister, Catalina in Zvolen Slovakia at Credit Suisse (the “Credit Suisse Account”).

In 1996 the Beránek’s sold their personal residence in Prague and liquidated a number of investments totaling $1,350,000. The proceeds were used to open a Brokerage Account with Raymond James in Newark, New Jersey. The taxpayers also owned a commercial rental property located in Prague until October of 2005, when the property was sold for $700,000. The proceeds from the sale were deposited into the UBS Account and remain there to date.

The taxpayers’ federal income tax returns were prepared by a local CPA near Howell, New Jersey, by the name of Sam Patel.** Each year the taxpayers would meet with Mr. Patel’s assistance and would provide her with copies of the Composite Form 1099 they received from Raymond James.

The CPA was unfamiliar with the FBAR filing requirements, and further, did not understand the concept that U.S. Taxpayers are taxed on their worldwide income. Consequently, Mr. Patel failed to prepare and file FBAR reports, failed to report the interest income earned on those accounts and failed to report the income and expenses from the rental property on the taxpayers’ income tax returns. In addition, Mr. Patel also failed to report the sale of the property in 2005 on the taxpayers 2005 tax returns.

In 2010 the taxpayers were notified that their 2005-2007 federal income tax returns were selected by the IRS for examination. The taxpayers retained an Upper Montclair, New Jersey CPA, who was competent in the area of IRS examinations, but he too was unfamiliar with the reporting requirements for foreign financial accounts.

As part of the examination process the IRS auditor asked the taxpayers about the existence of any foreign financial accounts and whether the taxpayers had any foreign source income.

In response to the IRS agent’s questions, the taxpayers disclosed that they had two foreign financial accounts and that interest income was earned on these two accounts. In addition, the taxpayers told the IRS that they received rental income from the commercial rental property in Prague, but sold the property in 2005. As a result of the taxpayers’ disclosures, the scope of the examination was expanded to include the tax years 2008 and 2009.

At the conclusion of the examination, the IRS advised the taxpayers that an additional income tax in the amount of $2,822 for the years 2005-2009 would be proposed. The agent also told the taxpayers that he was recommending a negligence FBAR penalty in the amount of $100,000, representing a $10,000 penalty for each account for each of the five years.

The taxpayers then retained my office in Princeton NJ for purposes of bringing them into compliance with the IRS and pursuing an abatement of the proposed negligence FBAR penalties.

During my initial meeting with the Beránek’s, I was not able to discern that the taxpayers were unaware of the FBAR reporting requirements nor were they aware of their obligation to report their worldwide income for Federal income tax purposes.

The taxpayers also informed me that neither Mr. Patel nor his assistance ever asked the Beránek’s whether they had any interest in any foreign financial account or whether the taxpayers received any income from foreign sources. Based upon the foregoing, I determined that reasonable cause existed and that an abatement of the proposed FBAR penalties should be pursued.

I contacted Mr. Patel and secured the taxpayers’ complete file. I was also able to secure an affidavit from the Mr. Patel wherein he acknowledged being unfamiliar with the FBAR filing requirements and also admitted that he was not aware that U.S. Taxpayers must report their worldwide income for federal income tax purposes.

I contacted the IRS agent’s supervisor and explained the situation. We agreed that the taxpayers would submit amended income tax returns for 2005-2009 and also prepare and file delinquent FBARS for the same years. We further agreed that we would revisit the FBAR penalties proposed by the agent once the taxpayers brought their filings current.

We amended the taxpayers’2005-2009 Federal Income Tax Returns. We also prepared and filed FBAR reports for 2005-2009.

The amended returns, together with the taxpayers’ remittance in the amount of $2,822 were delivered the IRA agent. We also provided the agent with, copies of the filed FBARS, a letter brief, outlining the relevant facts supporting our abatement request and Mr. Patel’s affidavit.

Following his review of the documents submitted and supervisor review, the examining agent advised me that he would be withdrawing his recommendation for the imposition of the FBAR penalties and would instead recommend that a warning letter be issued to the taxpayers. Several weeks later the taxpayers received a warning letter (Letter 3800) from the IRS and the case was closed.

Anthony N. Verni is an attorney and certified public accountant with over 20 years of experience.His practice is focused on representing expatriates and other U.S. Taxpayers, who have failed to report their worldwide income and/or failed to meet the FBAR reporting and other U.S. financial reporting requirements. Mr. Verni services clients in the Tri-tate area, South Florida, as well as client residing outside of the United States. In addition, Mr. Verni represents clients in domestic tax matters including examinations, appeals as well as taxpayers with un-filed income tax returns.

*The clients’ names have been changed for purposes of preserving the attorney client privilege. The facts of the case, however, are the facts from the actual case.

**The CPA name and location is fictitious, based upon a confidentiality agreement.

©2017 Anthony N. Verni, Attorney at Law, CPA

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Taxation of Professional Athletes & Entertainers – Are You At Risk?

An athlete running, thinking about the reporting of taxes to the irsThe Risks of Professional Athlete and Entertainer Taxation

Global sports and entertainment have created many new opportunities as well as challenges for those individuals, who are multi-jurisdictional earners.  The IRS has taken a keen interest in cross border sports and entertainment in the context of U.S. tax enforcement. This scrutiny has been expanded to include directors, producers, technicians, managers, promoters as well as others.

Recognizing that professional athletes and entertainers  are globally mobile  and have unlimited earning capacity, the IRS  formed a task force charged  with the  responsibility of improving federal tax compliance among high income athletes and entertainers, through taxpayer awareness and increased enhanced enforcement efforts.

Other countries are likewise interested in professional athletes and entertainers, who earn income while performing services in venues outside of the U.S. Recent global tax enforcement initiatives signal that athletes and entertainers who evade taxes within and without the United States will be vigorously pursued. Specifically, the standards contained in FATCA and the Common Reporting Standards will facilitate the mutual exchange of information, transparency and the detection of those who are determined to evade paying their fair share of income taxes to the United States and its global partners.

In determining whether a professional athlete or entertainer is subject to U.S. income tax, the IRS will always key in on whether the athlete or entertainer is a resident for federal income tax purposes. The IRS will also look at how the income is characterized, whether the athlete or entertainer made use of a shell company or other device to avoid paying U.S. tax and whether the individual unreasonably relied upon a tax treaty or income allocation.A map of the world where U.S. expatirates live outside the United States but are still required to pay foreign income tax to the IRS

A U.S. tax resident is subject to U.S. income tax on his or her worldwide income.

As such, whether an athlete or entertainer is a resident for U.S. income tax purposes is the critical starting point.  Generally, U.S. citizens and permanent resident aliens are considered U.S. tax residents and subject to federal income tax on their worldwide income.

In certain circumstances even a non-resident can be considered a U.S. tax resident if the individual spends the requisite number of days in the United States. A non-resident who is physically present in the United State for 183 days or more during a calendar year is considered a U.S. tax resident. A non-resident can also meet the physical presence test under a formula. If an individual is present in the United States for less than 183 days during a single tax year he or she may nevertheless be considered a U.S. tax resident in that year if the individual spends at least 31 days in the United States in the current year and, by application of a certain carryover formula, where the number of days in the United States in the current year plus the number of days from the prior two years equals 183 days or more.

Finally, a non-resident, who files and signs a joint tax return with a U.S. citizen or legal permanent resident, may also, be subject to federal income tax based upon his or her worldwide income.

Residency for federal tax purposes is significant to the IRS for the following reasons:

      1. Athletes and entertainers, who are considered tax residents of the United States, are subject to U.S. income tax on their worldwide income. As such, the IRS is particularly interested in determining whether the athlete or entertainer received income from foreign sources, and if so, whether that income was properly reflected on the individual’s U.S. tax return.
      2. Foreign athletes and entertainers, who are considered non-residents for U.S. tax purposes, are only subject to U.S. income taxon compensation received for services rendered in the United States, as well as royalties, rents from investments in U.S. real property, dividends, interest, and income derived from U.S. business operations. The IRS will focus on these individuals to determine if the foreign athlete or entertainer is reporting his or her U.S. source income. The IRS will also scrutinize the number of days a foreign athlete or entertainer spends in the United States for purposes of determining whether the individual meets the physical presence test.The unintended consequences of a non-resident athlete or entertainer, who is present for 183 days or otherwise meets the physical presence test under the formula, can be financially devastating.

Many professional athletes and entertainers may not be aware of their U.S. filing and reporting obligations if they are represented by a tax professional that is unfamiliar with cross border tax reporting.  Too often, athletes and entertainers rely upon professional agents and management companies for direction in selecting legal, accounting and tax professionals to assist them with their financial affairs.  Relying upon a professional agent or management company in the selection of a tax professional is inherently suspect and should be avoided at all costs.  The simple reason for this is lack of independence. Moreover, while a recommended tax professional may have a general understanding of U.S. taxation, the individual may not be familiar with the mechanics of taxation in a multi-jurisdictional context.

Similarly, athletes and entertainers who rely upon friends or family in vetting and selecting a tax professional may eventually find themselves at odds with the Internal Revenue Service. An athlete or entertainer may also continue to use his or her existing tax professional out of loyalty, due to a personal relationship or based upon the assumption that the tax professional has the requisite experience, skill and knowledge related to cross border earners. However well intended, these methods for selecting a tax professional can result in adverse tax consequences.

A an athlete or entertainer, who fails to comply with his or her U.S. Tax and filing obligations can be subject to civil and criminal penalties. In cases where the athlete or entertainer has engaged in a systematic pattern of non-compliance, the individual may be subject to criminal prosecution, imprisonment and heavy fines. The IRS is particularly interested in the prosecution of famous athletes and entertainers, since the IRS considers high profile prosecutions a strong deterrent to potential tax cheats.

Running afoul of the U.S. tax laws may also result in loss of work visas and deportation of green card holders and individuals in the United States on visas. In addition, where the IRS has assessed income tax, an athlete or entertainer may not be permitted to leave the United States until federal tax liability is satisfied.

If you are a professional athlete or entertainer, you should speak with a tax attorney. Even athletes or entertainers who are currently in high school or college and anticipate signing a lucrative contract, it would be wise to speak with a tax attorney for purposes of evaluating the tax implications.

A final word of caution unrelated to the topic of taxation. Never permit an agent, accountant, attorney or financial manager to manage your financial affairs or have access to your assets.  The investment, reporting and custody functions should always remain segregated as a safeguard against potential misappropriation of assets or making ill-advised investments. Any appearance of a conflict of interest should be a red flag. If a financial advisor, attorney or accountant suggests an investment, you should always get an independent attorney opinion prior to parting with your hard earned money.  Just ask Hall of Famer, Scotty Pippen or superstar singer Rihanna.

© 2016 Anthony N. Verni, Attorney at Law, Certified Public Accountant

November 12, 2016

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Tax Controversy: What to Do When You Get An Audit Letter

tax controversy | auditThe phrase “tax controversy” is used in the legal profession to define tax disputes that originate between the IRS or a state tax agency and a Taxpayer, usually, but not always, originating from an audit.

Legal services offered as part of a typical tax controversy matter can include assistance with audits, appeals, and Tax Court litigation as well as negotiated settlements.

While the odds of getting audited are lower than 1%, there is still a chance that the IRS will serve you with an audit letter, particularly where tax issues are flagged on the Taxpayer’s return. So what do you do when you receive an audit letter and are facing a tax controversy?

  1. Ask “Why me?

The IRS may know exactly why you’ve been targeted, but just because you receive a tax audit letter does not automatically mean you are guilty of tax evasion or some other tax related crime.

Many times people are audited because the IRS doesn’t have enough information about them and is merely seeking clarification. In other case, a Taxpayer maybe selected randomly. With most Taxpayers, the IRS has access to all their information, like their total wages and how much mortgage interest they paid. However, returns filed by self-employed people and the wealthy tend to have a lot more self-reported items that the IRS may question.

Review your return to ensure it is accurate and only provide the information the IRS specifically asks for to avoid broadening the scope of the audit to other years.

  1. Get Your Ducks in a Row

Once you have reviewed your return and determined, with the help of a tax controversy specialist, the necessary information the IRS is seeking, begin compiling that information.

The IRS can audit you for taxes up to three years, so it is important to save documentation of your business or personal expenses as they relate to your taxes. For example, if you are being audited because you wrote off 100% of your car usage as a business expense, get your mileage log and other evidence that the car was used only for business purposes all in one place.

  1. Be Efficient in Your Response

The most surefire way to avoid the negative ramifications of a full blow audit is compliance. This doesn’t mean you roll over and give in to the IRS. Instead it means that you seek a qualified tax attorney to assist you in preparing the documents and information the IRS is seeking and conduct due diligence to ensure that you are complying with their requests. Once you have done your due diligence, respond to the IRS promptly and courteously

As the adage goes, ignorance is bliss, but in the case of an IRS audit, ignoring the letter will only make things worse. The IRS will give you a certain deadline to respond, make sure to meet this deadline in order to avoid larger consequences like civil penalties or possibly criminal action.

If you have a tax controversy, either related to your personal or business, please see the help of a qualified tax attorney to guide you through the process of dealing with the IRS.
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FBAR Failure Leads Connecticut Executive to Plead Guilty to $8.4 Million Tax Evasion

Prosecutors announced Jan. 20 that a Connecticut business executive has pleaded guilty to willfully failing to report offshore bank accounts to the IRS.

Tax Evasion, Offshore Account filing taxes with the IRSAs part of his plea, which was entered Jan. 16 2015 before Magistrate Judge Debra Freeman of the U.S. District Court for the Southern District of New York, George Landegger of Ridgefield, Conn., agreed to pay a civil penalty of more than $4.2 million and more than $71,000 in back taxes.

According to the charges in a criminal information, Landegger maintained undeclared accounts at an unidentified Swiss bank based in Zurich from at least the early 2000s until 2010. His undeclared assets reached a high value of over $8.4 million in that period.

If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds, the Bank Secrecy Act may require you to report the account yearly to the Department of Treasury by electronically filing a Financial Crimes Enforcement Network (FinCEN) 114, Report of Foreign Bank and Financial Accounts (FBAR).

According to prosecutors, a representative of the Swiss bank referred Landegger to a Zurich-based attorney, Edgar Paltzer, to form a sham entity to hold his undeclared accounts. In April 2009, Landegger met with the bank representative and another individual to discuss the future of his undeclared accounts in light of the news about a U.S. investigation into hidden accounts at another Swiss bank, UBS AG, according to the charges.

At the meeting, prosecutors said, Landegger affirmatively rejected the possibility of disclosing his undeclared accounts to the IRS through its Offshore Voluntary Disclosure Program or otherwise. Instead, he shifted the assets out of Switzerland into a new, declared account in Canada and an account kept by another person in Hong Kong.

“The benefits of citizenship or residency in the United States come with certain obligations, including, as George Landegger well knew, the legal requirement to report foreign bank accounts,” U.S. Attorney Preet Bharara said. “He will now pay for his illegal conduct.”