Another Year of Tax Return Identity Theft

Tax Return Identity Theft is a by-product of the IRS’s incessant desire to go electronic.  By not requiring a physicial signature, they are accepting returns on the honor system that someone, somewhere, has an authentic signature in their file.  Thieves know this, and are ripping off the Treasury blind.

How big a problem?  The IRS has 650,000 identity theft cases in its inventory, according to Nina Olsen, National Taxpayer Advocate.  The average refund theft is $3,000.  That $2 billion dollars only represents the cases in inventory.  The actual figure is estimated to be 5 times that…annually.

We spoke on this before, on numerous occasions actually, back when we knew of only a handful of cases.  It’s now a financial epidemic.  And it gets worse…

Our advice, as recently as yesterday morning on WWLP TV-22, was to file early.  The best defense is a strong offense.  Beat the thieves to the punch.  Well, believe it or not, Congress and the IRS have made that impossible.  The “fiscal cliff” negotiations of two weeks ago forced the IRS to change about 30 tax forms, which means that returns involving those forms (including depreciation, Form 4562), will not be ready until late February or early March.

Yup, so much for filing early.  Tax return identity thieves do not need these forms.  Heck, they are lying on the return anyways, as if they are going to care about due diligence and protocol?  So Nina Olsen’s big PR fiasco may just be getting warmed up.

The American Public has GOT to get more diligent.  Do NOT provide your personal information to anybody, for example, a car dealership (requiring financing) unless you are satisfied with their recording keeping and privacy security.  No satisfaction, do not buy from them.  Since you may not be able to file early, you MUST get more diligent in other ways.  The IRS Taxpayer Advocate has basically said they don’t have the ability to help if you have been a victim.  We have no defense in this battle, other than our own due diligence, and it costs the Treasury more than any war we have ever waged.

Looking for a preparer?  Stay away from “tax shops” that close after tax season.  Who are you going to talk to if you become a victim, if your tax preparer closes until next year, presuming they ever come back?  It’s scary to think the level of trust placed on fly by night operations.   Buyer beware, at its best.

As we told TV-22, when looking for a preparer, do the following:

1)  Do NOT do business with a preparer that charges a fee but will not sign your return.

2)  Do NOT do business with a preparer that charges based upon a percentage of the refund.  Just the appearance of that is bad, and the IRS is actively looking for these preparers.

3)  Use a CPA or an attorney (we are quickly learning in many cases they cost less than the national brands.  I personally see many returns prepared by H&R Block that are at least 25% higher than our fee structure, and I am an attorney at law AND a CPA!).

4)  Finally, ask how the preparer protects your personal information.  Visit the office, ask about security.  An inner city shop, on a street level plaza, with preparers working behind plate glass windows, does NOT pass the security smell test.  Alarm system, recorded video with siren audio, a secure file room, panic features, etc., passes the test.

In short, no one is looking out for you.  With tax return identity theft, you are literally on your own.  And Washington and the IRS are totally to blame.  The best advice is to stay diligent with your personal information and get your return filed as early as possible.  Good luck.

 

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Accounting Today Article

I was asked by the Editorial Staff of Accounting Today if I could put an article together on the use of Form 8275, Disclosure Statement, and its protective use for preparers and taxpayers alike.

It is our pleasure to include the article here in “A Tax Blog”.

This was a very difficult piece to write, and I was never entirely comfortable, although some of my “tax gurus” reviewed it and gracefully approved.   It’s a complex area, and very hard to put into plain language as the use of Form 8275 encompasses various penalty code sections and Circular 230 (which governs practice before the IRS).  I found it very hard to write without citing the law and including all the disclaimer caveats one normally reads in such an article.  But, I think we covered it fairly well in a plain language tone.

Getting to the substance, fear comes with this uncertainty.  Frankly I don’t trust the IRS to use the rules governing paid preparers objectively or fairly.  As competent and ethical preparers we know the type of situation where a paid preparer has violated the rules of Circular 230.  But we don’t know how the decision is made within the confines of the IRS.  Preparer penalties are determined by local office personnel. 

Here’s a hypothetical example.  A taxpayer is examined in a civil case, and the tax preparer, who is also the representative, is told by the IRS examiner that the examiner wants to interview the taxpayer.  While most representatives “cave” on this issue and allow the interview (presumably to stay in the “good graces” of the IRS – tantamount to client “treason” in my opinion), a prudent practitioner may simply produce IRC Section 7521, which states pretty clearly that the taxpayer can have his or her representative act in their place for the interview.  It’s the law.  In general, that means the questions would be reduced to writing, and the representative and taxpayer together will later respond in writing to those questions.

Local IRS offices don’t like this, and the interview issue usually ends in disagreement between representative and examiner.  The examiner may even bring in his or her group manager to discuss with the representative.  If the representative (with the law clearly on his or her side) sticks to his position, that position will prevail.  The law is the law. 

However, there was the inevitable “tension” during the exchange, and this is human nature.  Now, if there is a change on the tax return that results in a proposed assessment, where will the IRS draw the line on preparer penalties?  Will the IRS “search” for a reason to assess preparer penalties on this tax preparer because he zealously represented the taxpayer, without prejudice, and was successful in an argument during the course of the examination?  Will the examining agent, and/or group manager, retaliate by assessing preparer penalties, because of a competent but “zealous” preparer?

While I totally support preparer penalties, we as objective, ethical tax representatives know a violation when we see it.  I’ve read many, many articles on “dirty” preparers and it sickens me, as it damages the profession.  But they are obvious, and fail the smell test.

However, I hope, but I’m not hopeful, that the IRS can respect the consistent application of preparer penalties pursuant to IRC 6694, and not cross the line from a punitive tool for bad practitioners, to a “sword” used to retaliate against quality practitioners who zealously represent their clients, with passion and without prejudice.  And this is why I believe Form 8275 is such an important document.  If used properly, disclosing uncertain but well thought out tax positions can protect prepares from such a “sword.” 

http://www.accountingtoday.com/news/irs-penalties-form-8275-64062-1.html

 

 

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What is the MA Governor thinking?

On Tuesday, August 7th, Massachusetts Governor Deval Patrick vetoed a section of a jobs bill that would have helped the Massachusetts economy.

First, I live in Connecticut, so this has no effect on me.  But I do have many business clients in Massachusetts, and the Commonwealth really doesn’t have a clue how to energize an economy.   At least the Executive Branch doesn’t.

One provision, vetoed by the Governor, would have changed the corporate estimated tax payment structure from 40% (1st Qtr), 25% (2nd and 3rd Qtrs), and 10% (4th Qtr), to four equal payments of 25%.  This would have been a welcome change, as having businesses pay 40% of their income tax in the first quarter of the year, is a real impediment to growth.  Plus, the Commonwealth still gets their money in full, just in more rational and fair proportions.  This would be similar to the U.S. Treasury, which requires four equal payments, and the rule for Massachusetts individuals.  What was the Governor thinking?

Many businesses are busiest in the fall and early winter.  Think Christmas for retailers and restaurants, for example.  Yet they must pay most of their state tax in the first quarter, and 65% by June 15th?  That just doesn’t seem right, yet it’s the law.

But it gets better.  The bill also had a provision to give a $456 tax credit to newly created corporations for the first three years.  This is equal to the minimum excise tax, obviously.  This was a brilliant idea by the Statehouse (and they aren’t noted for brilliant ideas), as small businesses, newly created, need the most help.  Once they are on their feet, after three years, this credit is gone.  This was a silly veto, frankly.  It takes no money out of the Commonwealth’s budget.  It’s “new” corporations.  You know, corporations that haven’t been formed yet.  How can a credit to an entity that doesn’t exist yet affect the state budget?

In short, the Massachusetts Governor had the opportunity to extend a hand to small business and basically slapped the hand of reason away.  He may be a great Governor, and his pros may vastly outweigh his cons as an executive, but I must admit, I am not seeing it from my lounge chair in Connecticut, and I’m not seeing it with this veto.

However, fight back!   Ascertain whether S Corporation status works for you.  In general, no more corporate income taxes, as the taxes are paid personally, in quarterly equal installments!!  Thus, any small business can veto Governor Patrick’s veto by electing S status.  Check with your advisor first of course, as S Corporation status may not work for everyone (believe it or not).

Can’t help with the vetoed tax credit.  But the Commonwealth sure tanked a great opportunity to embrace new business.  Again.

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Fisheries and Wildlife…..and MA Taxes

We stated at the outset that this Blog was only to be used as a “think tank” for sharing ideas related to tax practice and procedure.  And we hope a glance of our prior posts are true to that.

So, why are we going to discuss the Massachusetts Division of Fisheries and Wildlife, and its agency, Natural Heritage, in a tax blog?

Well, because the fact pattern is relevant to tax practice and procedure.

Laws exist in the event land is affected by endangered species.  In a nutshell, Massachusetts General Law 131A basically states that if a plant or animal is designated a “Significant Habitat,” then 1) Public hearings and notices are required, 2) Notice to land owners is required, 3) Recording in the registry of deeds if required, and 4) Landowners are compensated for a just taking related to the foregoing.

And typical with many IRS and state tax statutes, “The Secretary may promulgate regulations necessary to administer the law (or words to that effect).”

However the argument here, having read the Springfield Republican’s series on the subject in their July 29 through 31 publications with great interest, relates to the Massachusetts Division of Fisheries and Wildlife (specifically Natural Heritage), promulgating a regulation that contains language far beyond what is in M.G.L. 131A.  Specifically, they created a new designation, called “Priority Habitat.”  This new designation DOES NOT require 1) Public hearings and notices, 2) Notice to landowners, 3) Recording in the registry of deeds, and 4) Compensation.

It appears that, with this regulation in effect, landowners have been required to donate or restrict land, or frankly, pay money to or at the direction of Natural Heritage in order for landowners to further their intentions with their property (in this particular case, build a home).

Any tax practitioner can see that this would be a catastrophe had the Internal Revenue Service or the Commonwealth of Massachusetts Department of Revenue worked in this manner, creating regulations that were literally “about face” from statutory intent.  We are aware of situations where the Internal Revenue Service certainly pushed its luck, but we’re not aware of a circumvention of the law similar to the actions of Natural Heritage as reported in the Springfield Republican story.

By the way, has anyone treated a payment to Natural Heritage, pursuant to this fact scenario, on a tax return?  There doesn’t appear to be donative intent, for charitable contribution purposes.  Perhaps only in Massachusetts has it become ordinary and necessary as a business expense, although one can’t help but see “bribe or kickback” under IRC §162 in the notes of an aggressive and ambitious IRS examiner.  This is an interesting theoretical discussion for another time.

The Commonwealth of Massachusetts, following the United States Constitutional outline, has its own three branches of government; the executive, legislative and judicial.  The legislative branch makes the laws, the executive branch enforces the laws, and the judicial branch interprets the laws.  If the executive branch makes and enforces laws, we basically violate our Constitution, both at the Federal and Massachusetts level.  We negate one entire branch of government, the branch that makes laws.  And “we are a government of laws, not of men,” recalling Boston native John Adams.  So if we circumvent the body that makes the laws, and we are a government of laws….I don’t know what we become, but we sure would be putting a lot of control in very few people.

This particular regulation, by Massachusetts Fisheries and Wildlife, and led by Natural Heritage, is the biggest diversion from statutory intent that I have ever witnessed professionally.  The regulations don’t further the intent of the statute in any way whatsoever, and in fact, create significant “new law.”  A new designation was created, “Priority Habitat” via the regulations, and that designation has been used exclusively by the Division of Fisheries and Wildlife, sidestepping all aspects of due process as expressed by the statute.  If upheld, that would render the Massachusetts Statehouse a useless puppet legislatively, with the real power of Government residing in the executive branch, which can use administrative agencies to create its own laws as it deems necessary.  That means the tax code could be next.  Not exactly what the Founding Fathers had in mind.

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WWLP TV22 Interviews

Our office was kindly asked by WWLP TV-22, our local NBC affiliate, for our thoughts on two important tax issues of the day.  The first related to Identity theft and the ease of getting personal data directly from the Social Security Administration with respect to deceased citizens, and the second focused on the pros and cons of extending the Bush tax cuts.

For those so bored that this may actually be interesting, here are the links to the stories direct to WWLP’s website.  Thank you to Raven and Nicole, and all our friends at TV22 for your continued confidence on using our office as a resource.

Identity Theft and Social Security Administration:

http://www.wwlp.com/dpp/news/local/hampden/death-master-file

 

Bush Tax Cuts:

 http://www.wwlp.com/dpp/news/local/hampden/debate-over-bush-tax-cuts

 

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Identity Theft is Bad, but Free Identity Giveaways?

The IRS doesn’t have a clue how to deal with the identity theft issue.

How do I know this?  Read on….

On April 16th, 2012, I went home and retrieved our mail from the mailbox.  Included was a letter from the Internal Revenue Service.

Opening the letter, it was obvious it wasn’t for me, as it was addressed to someone unknown to me, and further, the last four digits of the individual’s social security number were also unknown to me, or any member of my family.  But it was clearly addressed to my home.  It is important to note that in the correspondence, the IRS only provided the last four digits of this individual’s social security number.

Reading on, the letter indicated that this person’s refund was being delayed, as the IRS wanted to perform a “more thorough review.”  Frankly, it appeared to be tax return identity theft, as it was clearly addressed to my home, and further, the IRS obviously suspected something, as refunds are normally just issued without delay.  Taking it a step further, the name appeared to be Hispanic, and members of the tax community should already be aware that residents of the island of Puerto Rico are prime targets for tax return identity theft of late.

I wrote to the IRS, attaching the letter.  The goal was to 1) notify the IRS of the incorrect address, and 2) warn the IRS that as a result of the clear use of my home address, this may be a case of tax return identity theft.  As we reported earlier, this is now a multi-billion dollar “industry.”

Usually, when writing the IRS, they will respond with a courtesy letter, which basically says “Thank you for your correspondence, and we will get back to you within 45 days” or words to that effect.  In fact, I did receive that communication.  The only problem is, it was still addressed to the unknown individual.  I am the one who wrote them!

But that isn’t the bad part.

The bad part is, the “we’ll get back to you” letter referred to above also had the entire social security number of the individual in question.  This is an incredible breach of the identity of an individual, who more likely than not, in my opinion, has already been a victim of identity theft!

To rephrase.  I believed an individual may have been subject to identity theft.  As such, I followed up and notified the IRS, who “thanked” me by providing me the full social security number of the person who I believe was the victim!  In a nutshell, that is what transpired.

I put a package together to Commissioner Shulman, in the hopes that the IRS can address an astonishing security weakness in their correspondence system.  Interestingly, I did receive a letter from the Commissioner’s office, which indicated that someone would be contacting me to discuss the matter.  I am looking forward to that.

Maybe, just maybe, our “little office that could” is helping to close a potential breach of security at the Internal Revenue Service.  We’ll keep you posted.

The entire chronology, with sensitive information omitted, can be seen below.

Commissioner Shulman Package

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Personal Plea to the IRS!!!

Whenever we get a new client that has multiple years of unfiled federal and state tax returns, we always, 1) get a power of attorney (Form 2848 – the new one!), and 2) contact the tax practitioner’s hotline and obtain what is known as “wage and income” information.

Wage and income information is important because in many cases, the client may have forgotten an item of income and you may find it by cross-referencing with the IRS transcript of wage and income information.  In other cases it may be the only information available, and with the client’s approval that the IRS data is all he or she is aware of, a return could be filed with that information.

Usually, the practitioner’s hotline will result in getting the necessary wage and income information via facsimile pretty quickly, and from there you can proceed to prepare the delinquent returns.

But there is one little weakness with the computer system of the Internal Revenue Service.  They forget one very important item.  Oh sure, gross wages is included, along with federal withholding, social security wages and social security withholding.  Heck, even the name, address and employer identification number of the employer is listed…

But what is NOT listed is the state wages and state withholding.  After all these years that function has yet to be fixed.  As a practitioner, how can we possibly help a client get into compliance with their respective states if we don’t have that data?  And how can the IRS spot check state taxes paid on Schedule A if this information is excluded from their system?  The IRS gets it when employers file their W-2’s.  They have it right in their hands, and neglect to include it into the system.  The IRS was our only hope, as the thought of getting wage and income information from the Commonwealth of Massachusetts, outside of a MA Freedom of Information Act (assuming that works), isn’t worth the effort of discussion.

“Mr. Shulman (IRS commissioner) if you are reading this, PLEASE fix the IRS wage and income transcript system to include state wages and withholding.”

Please??

 

 

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Follow Up to MA Earned Income Tax Credit Audits

We blogged back in February how the IRS is using MA Department of Revenue resources to conduct audits of tax returns that have taken the earned income credit (EIC).  In that post, we shared some of our experience and advice as to how to try to control the audit process.  If you lose at the MA level, the IRS will follow up with their bill (significantly larger).  Primary targets are those returns that also have a Schedule C included in the return.

This post is a follow up.  The more we think about it, the more one thing becomes quite clear.  For purposes of Massachusetts, perhaps the EIC simply isn’t worth it.  If a Taxpayer needs to go through six months of a MA DOR exam (and a six month stay at our warm, fuzzy facilities at Guantanamo Bay may be easier), We think we are ready and willing to suggest that Taxpayers with a Schedule C and the EIC for Federal purposes should seriously consider not taking the EIC on their MA return.

Why?  Because it appears there is a very, very large chance of being selected for a very intrusive examination.  And for what – $300 to $400?  The professional fees could be ten times that!  Going it alone will cost at least the same amount in aggravation and lost sleep, to say nothing of venturing into an examination setting with no experience.  And then, if you lose, you lose the Federal EIC as well (which could be in the thousands of dollars).

So, to follow up on our post of February 14, 2012, we are prepared to suggest that Massachusetts Taxpayers with both Schedule C and the EIC consider NOT taking the EIC on their MA return.

 

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THE IRS AND INVENTORY, FROM BEGINNING TO END (no pun!)

Inventory is always an interesting subject in the context of an IRS audit.  We have dealt with it on numerous occasions to the point where I think it’s worth the blogging effort.

For an accrual basis taxpayer that maintains an inventory of items to sell in the ordinary course of business, this post is applicable to those who must maintain inventory on their books for tax purposes.  In other words, for purposes of this post we are disregarding the IRC exceptions to maintaining inventory.

In the context of an IRS examination, revenue agents search fairly diligently to either establish an inventory at year end (if inventory hasn’t been kept), or boost it higher.  Either way, the adjustment is (debits to the window, I think) to increase inventory and conversely to decrease purchases expense, thus resulting in higher income.  I am writing this post primarily because on a number of occasions, we were surprised to get the case and be the first to raise a challenge to this type of inventory adjustment.  Thus we hope this information is useful to a preparer representing a client out there, somewhere.

I experienced this for the first time years ago when I was representing a used car dealer under examination.  The IRS performed this analysis, which was very straightforward in that it’s pretty easy to review a used car sales book (which must be kept by law), and track the date of purchase and date of sale.  As such, it’s even easier to then figure out what cars were purchased and remained unsold at year end.  And in this case an understatement of inventory was found and the report of examination changes, Form 4549, was issued reporting the discrepancy.  Ok.

But it occurred to me.  “Wait a minute!  What about the beginning inventory?  Shouldn’t the methods used be consistent?”  I mentioned this to the examiner, who replied, “Well if you want to go through that trouble…”  Huh?  Are you kidding?  A $150,000 adjustment, resulting in $50,000 of additional tax, penalties and interest, and the question is whether or not I want to go through the “trouble?”  Well, we went through the trouble, which as stated above was pretty easy, and that went a long way to making the examination more palatable…and fair.

Over the years I have seen more and more of this, with the IRS giving no attention to the beginning inventory, and fighting vehemently against allowing a re-evaluation of it, the idea being, “Hey, your client got away with deducting those purchases in earlier years (barred by the statute of limitations), and we’ll be damned if they are going to get those deductions, and then double dip by calling it back into inventory at the beginning of year, diminishing our audit adjustment.”

Now we having something we can work with.

First, it’s a pleasure to tell the IRS to “call their congressman” for a change, if they don’t like the tax law.  The statute of limitations is generally three years, and that is the law.  If it was five years, we’d oblige.  But it’s not, and that statute is pretty much out of our control.  It’s the law.  If an older year cannot be audited, so be it (but admittedly, I do understand their reasoning!).

Second, IRC §471 says in part, “inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting income.  The case law appears to interpret that to mean that beginning and ending inventory should be done using the same method, if you want an honest bottom line in any given year.  Isn’t that what it’s all about, an honest bottom line?  I like John Wanamaker Philadelphia Inc. v. U.S., Primo Pants Co. v. Commissioner, Superior Coach of Florida v. Commissioner, and Wayne Bolt & Nut Co. v. Commissioner.  There are other cases as well where the court believed that beginning and ending inventory should be consistent in their application.

Bottom line, if there has been an adjustment by the IRS to the ending inventory, look at mitigating the effects by re-evaluating beginning inventory using the same method, then fight tooth and nail to show that the change to beginning inventory must be utilized to arrive at a “clear reflection of income.”  I have found that, fairly regularly, inventory levels for stable companies stay pretty constant (make sure first!).  But I think the IRS is pretty fair on the issue when confronted with the case law.  If not, disagree and take it to appeals.

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Tax Masters Goes Bankrupt

We issued a post on December 19th, after reading a notice from the Massachusetts Taxpayer Advocate, on the wisdom of using so called “National Tax Representatives.”  The notice indicated that they tend to take large retainers, and do absolutely nothing in return.

We fielded a question at our public presentation at Western New England University on November 5, 2010, issuing the same skepticism.  In fact, I believe we had two “horror” stories at that time, with respect taxpayers being “duped” by these companies.

Well, it appears it may have caught up with Tax Masters, the tax resolution company that declared banktuptcy yesterday.  Incidentally, 37% of their spending budget was in advertising.  They also had some state attorney generals hot on their trail also.

A black eye on the profession, but perhaps the end of yet another financial bilking scheme.

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