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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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Expatriate Tax Advice: What Are the Filing Requirements for U.S. Expats?

What U.S. Expats Need to Know About IRS Filing Requirements
expatriate tax advice

Many expatriates have questions about how to handle their taxes while living abroad. There are many things to consider such as: Do I have to file U.S. income tax return? What about state taxes? And what if any income taxes can I deduct? 

The U.S. tax code can be complicated and confusing for expatriates. It is always best to consult an experienced tax attorney to reduce your tax burden and to also help you understand your rights and responsibilities.

It is important to understand that no matter where you live in the world, as a United States Citizen or a Permanent Legal Resident you are required to file an annual return with the Internal Revenue Service (IRS) if you meet the minimum income requirements. In 2014, the minimum income requirement for a single person less than 65 years of age was $10,150. A married couple both under 65, filing jointly, faced a minimum income requirement of $20,300. The United States does have treaties with several countries that may reduce the total amount you owe.

When it comes to U.S. state tax returns each state sets its own rules. The rules can be complicated and it is best to consult a professional when it comes to filing state returns. States like California, New Mexico, Virginia, and South Carolina have very strict rules when it comes to filing state returns after moving abroad.

Filing Requirements for U.S. Expats

Another area of confusion for expatriates is whether their income might qualify for the Foreign Earned Income Exclusion (FEIE). The IRS qualifies you as eligible for the Foreign Earned Income Exclusion (FEIE) if you fall into one of three categories:

  1. You are citizen of the US who qualifies as a bona fide resident of another country for a period of time containing one entire tax year.
  2. You are a resident alien of the US whose home country has an income tax treaty with the US. Additionally, you must be a bona fide resident of another country for a period of time containing one entire tax year.
  3. You are a citizen or resident alien of the US whose physical absence from the US constitutes a minimum of 330 days out of any 365.

There may also be deductions for any taxes you have paid to your country of residence.

As with any matter involving the U.S. Tax Code there are many pitfalls to trying to figure out what you can legally deduct from your income and how you can minimize your risks of an audit. It is best to consult an experienced tax attorney before filing your taxes. A consultation will help reduce your risk of mistakes on your tax returns and avoid costly audits.

 

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Publication 519: What You Need to Know

What You Need to Know About IRS Publication 519

publication-519-tax-status-irs U.S. Tax guide for AliensPublication 519 is provided by the Internal Revenue Service (IRS) to assist in tax preparation for both resident and non-resident aliens. Among other things Publication 519 helps you to determine whether you are a resident, non-resident alien or if you fall under both classifications; what income may be subject to tax; how income of aliens is taxed; and where, when and how you should file your income tax forms.

Your first step, for tax purposes, should be to determine if you are a resident or non-resident alien. If you qualify as both resident and non-resident in the same year, you have what is referred to as dual status. If you are married, you may also have a choice of treating your non-resident spouse as a resident alien. Your status is determined by either the “Green Card” test or the “Substantial Presence” test. However, even if you do not meet the requirements of either test you may be able to choose to be treated as a United States resident for part of the year.

After you have determined your residency status, your next step is to determine what income is subject to taxes. As a Resident alien, income is generally subject to tax treatment in the same manner as a U.S. citizen. Non-resident aliens are generally subject to U.S. taxes only on income earned from U.S. sources. However, not all income from U.S. sources is subject to income tax.

How Your Income is Taxed

Tax Resolution Firms and tax preparers should also seek counsel with a qualified tax lawyer.Resident and non-resident aliens are taxed in different ways. Resident aliens are generally taxed in much the same way as U.S. citizens.

What this means is that the residents alien’s worldwide income is subject to U.S. tax and must be reported on his/her tax return. The same graduated tax rates that apply to U.S. citizens will apply to a resident alien.

Income for a non-resident alien will be divided into two categories:

  1. Income that is effectively connected to a United States trade or business; and
  2. income that is not effectively connected to a United States trade or business.

The difference between the two categories will be the rate in which the income is taxed. The effectively connected income is subject to the same graduated rates discussed above. The non-effectively connected income is taxed at a flat 30% rate.

As you can see, Publication 519 is a complicated document that also refers to several other IRS publications. When it comes to figuring out which tax status is right for you and which, if any, income is subject to U.S. taxes it is best to consult an experienced tax lawyer.

An experienced tax lawyer can help you to minimize your taxes and reduce the risk of costly audits. They will also help you wade through the complexities of the U.S. tax code.

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Form 8938: The Statement of Specified Foreign Financial Assets

form-8938-statement-of-specIn an effort to curb tax dodging by United States citizens with foreign assets, Congress passed The Hiring Incentives to Restore Employment Act.

The act imposes a new reporting requirement for foreign financial assets, in addition to the requirement of filing an FBAR.

The new law applies to specified persons with specified foreign financial assets which satisfy the reporting threshold.

Internal Revenue Code Section 6038D now requires individuals to report interests in specified foreign financial assets (SFFAs) when filing their federal income tax returns for tax years beginning after March 18, 2010, using Form 8938, Statement of Specified Foreign Financial Assets.

 

SFFAs include, among other things, interests in:

  • Foreign bank and financial accounts;
  • Foreign trusts and foreign estates;
  • Stock issued by foreign corporations;
  • Foreign partnerships;
  • Notes, bonds, debentures, or other debt issued by a foreign person;
  • Interest rate swaps, currency swaps, and other similar agreements with a foreign counterparty; and
  • Certain foreign derivatives.

Those with $50,000 in aggregate value of specified foreign financial assets during the tax year are required to filed form 8938; however the IRS is authorized to set higher amounts. The regulations in tax code provide two sets of thresholds for United States Taxpayers as follows:

Taxpayers living in the United States:

  • For single taxpayers and married taxpayers filing separately: $50,000 on the last day of the year or $75,000 anytime during the year; and
  • For married taxpayers filing jointly: $100,000 on the last day of the year or $150,000 anytime during the year.

Taxpayers living abroad:

  • For single taxpayers and married taxpayers filing separately: $200,000 on the last day of the year or $300,000 anytime during the year; and
  • For married taxpayers filing jointly: $400,000 on the last day of the year or $600,000 anytime during the year.

The value of foreign assets is its fair market value. The IRS is clear that “an appraisal by a third party is not necessary to estimate the maximum fair market value during the year.” Instead the maximum value of the interest is the fair market value of the interest on the last day of the tax year. Failure to properly assess foreign assets and file Form 8938 subjects the tax payer to a civil penalty of $10,000 and an additional penalty of $10,000 for every 30 days the failure to file continues after the initial 90 days, up to a maximum penalty of $50,000. Further penalties may be assessed for underpayment of fraud. The statute of limitations for failure to report income from a foreign financial assess whose value exceeds $5,000 is six years.

As always, please consult with your tax professional and seek legal advice from a lawyer specializing in tax law and foreign taxable transactions before making any decisions regarding the reporting or lack of reporting of foreign assets.