How are the IRS & Taxes Relevant to My Legal Practice?
How are the IRS & Taxes Relevant to My Legal Practice? Presented by Bryson Law Firm, LLC Random Tax Facts - If you donate your house to the local fire department to burn down for practice, you can deduct the loss as long as you donate the land too! (You cant just donate the house to burn to make room for a new one) - If you rent out space for fewer than 15 days in one year, all related income is tax free. If you rent out the space for greater than 15 days, your income is taxable as rental income - The government imposes an excise tax on arrows, with the money raised going to wildlife restoration - The IRS recently allowed a 100% deduction on private school tuition when a child had an allergy issue at the public school - Theyve also allowed a deduction for
Divorce & Property Settlement Issues The 4 filing options are: 1) Married Filing Joint May save in taxes, but both parties are jointly liable for the entire tax debt Once a Married Filing Joint return is filed, cannot amend to Married Filing Separate after the filing deadline Innocent Spouse is a possible remedy in the situation where a Married Filing Joint tax return was filed and a spouse is being held liable for the other spouses' tax obligations; Innocent Spouse relief includes Separation of Liability and Equitable Relief 2) Married Filing Separate Only the party signing the return is legally obligated by the IRS to pay the tax liability In Louisiana, Community Property laws can interfere with a MFS status, and the IRS can come after assets and/or wages of the non-liable spouse also For IRS Purposes, you are married until Judgment of Divorce is signed, and your marital status is determined as of December 31st each year 3) Head of Household 4) Single
Divorce & Property Settlement Issues Dependent Exemption/Child Tax Credit Qualification: Support Test: the child must have received over half of support from both parents and the child must be in physical custody of one or both parents for more than 50% of the year. Under IRC 152(e): when parents are divorced or legally separated, the parent with primary legal or physical custody of a child is the one entitled to claim the child for tax purposes, though: A non-custodial parent can claim the exemption/credit if the custodial parent signs an IRS Form 8332 (releasing claim to the exemption for that tax year). The Earned Income Credit may only be claimed by the custodial parent, because the child must meet the Residency Test for a qualifying child (child must live with the parent >6 months out of the year) in order for the Divorce & Property Settlement Issues Spousal support- tax deductible by the paying party and is considered income for the recipient.
IRC 71(a) General rule: Gross income includes amounts received as alimony or separate maintenance payments Spousal support can be non-taxable by designating that otherwise qualifying payments are NOT alimony in the divorce judgment or incidental orders, but it must be clear and you must attach a copy of the designating instrument to the return (IRS Publication 504). Child support is NOT deductible by payer, and not taxable to payee. In community property settlements, IRC 1041 states that there is no gain or loss upon the transfer of property from one spouse to another during marriage or as an incident to the divorce. This is the rule if property is transferred within 1 year of the divorce decree, and is presumed if property is transferred within 6 years as long as it is related to the cessation of marriage. This includes the marital residence, stock options, and retirement and pension plans. Legal, accounting, and appraisal expenses associated with a divorce are NOT generally deductible But, legal fees associated with tax advice ARE deductible as a miscellaneous An Attorneys Ethical Obligation to Resolve his Own Tax Issues Louisiana Attorneys have an ethical duty to file and pay their taxes As discussed in Internal Revenue Manual 25.1.7, It is a
criminal act not to file your IRS tax returns. Willful failure to file a tax return is a misdemeanor pursuant to IRC 7203. In cases where an overt act of evasion occurred, willful failure to file may be elevated to a felony under IRC 7201. IRM 184.108.40.206.2 Louisiana Ethics Rule 8.4(b): It is professional misconduct for a lawyer to commit a criminal act especially one that reflects adversely on the lawyers honesty, trustworthiness or fitness as a lawyer in other respects The Louisiana Supreme Court has found that not filing/ not paying taxes can be a violation of Louisiana Ethics Rule 8.4(c): Misconduct, which states that "it is professional misconduct for a lawyer to... c. Engage in conduct involving dishonesty, fraud, deceit, or misrepresentation An Attorneys Ethical Obligation to Resolve his Own Tax Issues In re Wittenbrink, 849 So. 2d 18 (La. 2003): found that "it is beyond dispute... his failure to pay his personal taxes involved elements of dishonesty, fraud, deceit or misrepresentation, in violation of Rule 8.4(c). Although respondent's actions did not occur in the context of the practice of law, his decision to disregard his obligations under federal and state law is an act of dishonesty which falls far below the high standard expected of attorneys admitted to the bar in Louisiana... We have not hesitated to suspend attorneys who have failed to comply with their tax obligations."
A New Orleans attorney running for public office was disqualified from the race for failing to show he filed his tax returns after he declared on the sworn candidacy form he had filed The candidacy form included the following certification pursuant to La. R.S. 18.463(A)(2)(a): If I am a candidate for any office other than United States senator or representative in congress, that for each of the previous five tax years, I have filed my federal and state income tax returns, have filed for an extension of time for filing either my federal or state income tax return or both, or was not required to file either a federal or state income tax return or both IRS Liens & Personal Injury Litigation FAQ: What do I do with Personal Injury proceeds if my client has a tax lien? IRC 6321 gives the government a lien over all property and rights to property of the taxpayer when he does not pay his tax obligations upon demand The IRS also files a public document with the local recording office, the Notice of Federal Tax Lien (IRS Form 668(Y)), to alert creditors and third parties that the government has a legal right to the taxpayers property Generally, a federal tax lien does attach to settlement proceeds, but what weve seen is that for personal injury funds to be used to satisfy an IRS debt, an IRS levy, together
with the IRS tax lien, would need to be filed. A lien is not a levy. A lien secures the governments interest in your property when you dont pay your tax debt. A levy actually takes actual or constructive possession of the property to pay IRS Liens & Personal Injury Litigation IRM 220.127.116.11.3.3 states that "where a taxpayer has instituted suit against a third party for damages in tort or contract, the right of the taxpayer to satisfaction of any judgment obtained may be LEVIED upon. Service of notice of levy upon defendant in most cases will amount to constructive seizure of taxpayer's property rights. US v. Citizens and Southern National Bank, 538 F.2d 1101 (5th Cir. 1976) states that "Section 6321 of the Internal Revenue Code creates a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to a person liable for any tax who has not paid it after demand. Section 6331(a) of the code gives to the Secretary of Treasury or his delegate authority to collect such tax by levy upon all property and rights to property belonging to such person or on which there is a lien provided in this chapter for the payment of such tax. Freeman v. Mayer, 253 F.2d 295 (3rd Cir. 1958) explains that property must be covered by a lien and "accompanied by possession of such property"; to establish the essential possessory relationship, the IRS must notify the debtor that a levy is being made upon that which he owes, or the service of appropriate process upon the debtor purporting to appropriate the debt to the satisfaction of the lien. Simmons Perrine Moyer Bergman, PLC v. Coleman, No. C11-0131, 2013 WL 1080666, at
*4 (N.D. Iowa Mar. 14, 2013): Federal law permits the establishment of a lien in favor of the United States upon all property or rights to property held by persons owing unpaid taxes. 26 U.S.C. 6321. The lien is perfected by filing a notice of assessment. 26 U.S.C. 6322. It is also undisputed that the United States' lien was properly perfected here. See Notice of Levy (docket number 373 at 1330). Therefore, it is clear that the United States has a valid lien against the settlement proceeds now being held by the Clerk of Court. IRS Liens & Personal Injury Litigation What about an ethical obligation under Louisiana Rules of Professional Conduct? Rule 1.3: "A lawyer shall act with reasonable diligence and promptness in representing a client" Rule 2.1: "In representing a client, a lawyer shall exercise independent professional judgment and render candid advice. In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the client's situation" Under Rule 1.15(d) "upon receiving funds or other property in which a client or third person has an interest, a lawyer shall promptly notify the client or third person. For purposes of this rule, the third person's interest shall be one of which the lawyer has actual knowledge, and shall be limited to a statutory lien, [etc]" As an attorney, you have a duty under these rules to explain to your
client the legal consequences that may result if the IRS is not paid, and if there is an IRS tax lien, you may then have an ethical obligation under the Louisiana Rules of Professional Conduct to pay the IRS the funds owed The Taxability of Settlements & Judgments The general rule on taxable income is found in IRC 61 and states that Except as otherwise provided in this subtitle, gross income means all income from whatever source derived Specifically excluded from gross income is damages from physical injuries or physical sickness IRC 104(a)(2)- "... gross income does NOT include...the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness" To determine whether the amount of damages received were on account of personal physical injuries or physical sickness, an Origin of the Claim Test is used. US v. Gilmore, 372 US 39 (1963) What is encompassed under IRC 104(a)(2) damages? Medical expenses are generally tax-free; there is an exception when expenses were taken as a deduction on a prior year's tax return Lost wages, pain and suffering, loss of consortium, and attorney fees so long as they come from a personal injury or physical sickness
The Taxability of Settlements & Judgments What is NOT encompassed under IRC 104(a)(2) damages? A 1996 amendment added to IRC 104(a)(2) that "emotional distress shall NOT be treated as a physical injury or physical sickness." There is an exception here when the emotional distress or mental anguish is related to a physical injury or sickness; Commissioner v. Schleier, 515 US 323 (1995) Compensatory damages not related to personal injury which would have otherwise been fully taxable but for the harm caused by the defendant Punitive damages, even IF paid on account of personal injury or physical sickness; punitive damages are intended to punish the wrongdoer, not compensate the claimant, so they are taxable Interest on judgment/settlement funds; this includes both pre and post judgment interest Other damages that are taxable include those for breach of contract, defamation, discrimination, wrongful termination, ADA, ERISA, lost profits, fraud, breach of duty, negligence, etc.
What about Attorneys Fees? Commissioner v. Banks, 543 U.S. 426 (2005)"As a general rule, when a litigant's recovery constitutes income [NOT personal injury], the litigants income includes the portion of the recovery paid to the attorney as a contingent fee" Legal expenses can be deducted when incurred through attempts to produce or collect taxable income or that you pay in connection with the determination, collection, or refund of any tax There are specific provisions allowing for a deduction of attorney fees in The Taxability of Settlements & Judgments Personal Injury Settlements vs. Judgments Allocating damages can save taxes; even if your dispute relates to one course of conduct, there is a good chance the total settlement amount will involve several categories of damages; it is best for plaintiff and defendant to agree on what is being paid and its tax treatment When the allocation of damages is determined by a judge or jury, the IRS usually does not challenge the character of the classification of damages because of the impartial and objective nature of the determination Settlements out of court should be carefully reviewed for accuracy based on the underlying facts and circumstances, because the IRS can challenge the allocation of damages when circumstances
indicate that the allocations do not reflect the economic substance of the settlement In LeFleur v. Commissioner, TC Memo 1997-312, the Tax Court upheld the reallocation of settlement proceeds performed by the IRS originally designated as emotional distress (non-taxable at the time); the Court stated "we conclude that the petitioner suffered no injury to his health that could be attributed to the actions of defendants, and we are not persuaded that such injury was the basis of any payment to him" Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 LDR License Suspension and Hardship License The Louisiana Department of Revenue offers much fewer options than the IRS typically does Generally, the only option LDR will allow is a 10-20% down, 12-24 month installment agreement Though La. R.S. 47:1603 allows for the waiver of penalties in certain situations and La. R.S. 47:1578(4) allows for an Offer in Compromise in certain situations, these are rarely accepted LDR has the ability to suspend taxpayers Drivers Licenses over unpaid taxes La. R.S. 47:296.2 authorizes the suspension of the Drivers License for an outstanding individual income tax balance of $1000 or more that is final and nonappealable
LDR can also suspend a taxpayers Dept. of Wildlife and Fisheries Hunting and Fishing License over unpaid taxes LDR takes the position that per La. R.S. 47:1581, once a tax assessment is made final, it is imprescriptible (No CSEDS) Effective August 1, 2016, Act 607 of the 2016 Regular Session of the Louisiana Legislature amended/reenacted La. R.S. 32:414(R)(3) and now allows the Department of Public Safety and Corrections, Office of Motor Vehicles (DMV), to issue an economic hardship license to someone whose license has been suspended/not renewed because of unpaid taxes. Per this statute, the DMV can issue this economic hardship license for one year OR until the individual pays or makes arrangements to pay these taxes, whatever occurs first The taxpayer applies for this license at the DMV, not LDR It allows the taxpayer to travel to earn a livelihood or maintain necessities of life ONLY applies to personal Drivers Licenses ONLY applies to personal income tax liabilities Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 LDR License Suspension and Hardship License Until the recent change in law through Act 607, we were faced with the impossible question: how am I supposed to go to work in order to make the money necessary to pay these taxes if I dont have a license to drive to work? We had many clients who lost their jobs or
were unable to apply for/accept certain jobs because of this restriction; even more were scared to drive their children to school or run necessary errands for fear of getting pulled over and cited for driving with a suspended license Now, though the updated law offers some relief to our clients, we still struggle with what will happen after the year is up; if a taxpayer owes a liability theyll never be able to pay, in one year theyll be back to a place where they cannot come up with the down payment and agree to the necessary payment terms and will again have their license suspended, indefinitely according to LDRs interpretation of La. R.S. 47:1581; until LDR decides to grant penalty abatements/offers in compromise more often/consistently, many taxpayers will suffer Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 Solar Tax Credit Before June of 2015, Louisiana Revised Statute 47:6030 allowed a taxpayer to receive a credit of 50% of the cost of an installed solar system up to a $25,000.00 purchase price. This allowed taxpayers who maximized the opportunity to receive a $12,500.00 tax credit This changed on June 19, 2015 when Act 131 amending La. R.S. 47:6030 became effective. Act 131 placed caps on the solar tax credit funding. It also imposed filing requirements on taxpayers, and provided that all credits would be granted on a first-come-first-served
basis No more than $10 million in tax credits shall be granted for returns filed on or after July 1, 2015 to before July 1, 2016 No more than $10 million in tax credits shall be granted for returns filed on or after July 1, 2016 to before July 1, 2017 No more than $5 million in tax credits shall be granted for returns filed on or after July 1, 2017 No credits will be authorized, issued, or granted for systems installed on or after July 1, 2018 Wait for LA Legislature to take corrective action vs. filing their appeals with the Louisiana Board of Tax Appeals: the appeals must be filed within 60 days of the letter received from LDR which formally denied the solar tax credit Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 The Flood and Casualty Losses IRC Section 165 allows individuals to deduct certain Disaster-Area Casualty Losses on their Form 1040 Income Tax Return as they relate to the taxpayers home, household goods, and vehicles (not loss of income/profit) Casualty losses in general are those losses from damage or destruction caused by a sudden, unexpected, and unusual event (such as flooding) To qualify for deductions under the more specific Disaster-Area provisions, the taxpayers residence must be in an area declared by the President as a
disaster area and eligible for federal assistance Generally, the rule regarding casualty loss deductions requires that the taxpayer claim the loss in the year it occurred. However, if the casualty loss is from a federally-declared disaster, the taxpayer CAN choose to deduct the loss for the year immediately preceding the disaster year File a Form 4684 and Schedule A attach it to the Form 1040 Income Tax Return. The IRS advises taxpayers to designate Louisiana, Severe Storms and Flooding on the form in order to expedite processing Calculate the loss under the normal rules for casualty losses= the lesser of either the adjusted basis of property or the decrease in fair market value after the casualty; ensure the $100 and 10% rules on deduction limits are followed: the loss must be reduced by $100 and then further reduced by 10% of AGI Decrease the amount of loss by any insurance payments or certain government payments received or expected to be received Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 The Flood and Retirement Distributions/Loans 401(k)s and similar employer-sponsored retirement plans can make loans and hardship distributions to Louisiana flood victims and members of their Streamlined loan procedures and liberalized hardship distribution rules
Retirement plans can provide this relief to employees and certain members of their families who live or work in the disaster area. To qualify for this relief, hardship withdrawals must be made by Jan. 17, 2017 The six-month ban on 401(k) and 403(b) contributions that normally affects employees who take hardship distributions will not apply Plans will be allowed to make loans or hardship distributions before the plan is formally amended to provide for such features. In addition, the plan can ignore the reasons that normally apply to hardship distributions, thus allowing them, for example, to be used for food and shelter. If a plan requires certain documentation before a distribution is made, the plan can relax this requirement as described in the announcement. Ordinarily, retirement plan loan proceeds are tax-free if they are repaid over a period of five years or less. Under current law, hardship distributions are generally taxable. Also, a 10 percent early-withdrawal tax usually applies. Bryson Law Firm, LLC Year in Review: Additional Noteworthy Tax Resolution Talk Topics in 2016 Oilfield Economy and Lien Relief IRC Section 6321: The IRS has a tax lien against a taxpayer any time the taxpayer has a tax balance assessed against them, has been given notice and demand for payment from the IRS, and has not paid the amount owed within 10 days from the date notice and demand is given. These liens cover all property owned by the taxpayer at the time the lien is issued as well as any after-acquired property
Once a tax lien is filed in the public records where the taxpayers residence is located (IRS Form 668), the lien is effective against third-parties Lien Release: An IRS tax lien will be released from the public records (IRS Form 668(Z) Certificate of Release of Federal Tax Lien) when the liability is fully paid, legally unenforceable, or there is a bond for payment of the tax A Property Discharge removes the lien from a specific piece of property; the IRS will generally issue a lien discharge when the tax liability is partially satisfied with an amount not less than the value of the IRS interest This is generally the case when you are selling a piece of property. After the mortgage and any other encumbrances filed prior to the IRS tax lien are paid, the IRS gets the remainder, though the debt is not fully satisfied, when the IRS interest has no value because the debts senior to the tax lien are greater than the fair market value of the property/sale value of the property, or when selling a home valued at less than the balance owed on the mortgage Lien Subordination: Subordination does not remove the lien, but it allows certain creditors to
move ahead of the IRS priority and facilitate the ability to obtain a loan or mortgage against the property An amount is paid equal to the lien or interest to which the taxpayer is requesting subordination; Example of this would be when a taxpayer refinances their home and uses the equity obtained (after the mortgage and closing costs are paid) to pay the IRS; the lien will still encumber the property, but the new mortgage has priority over the lien The IRS determines that granting the subordination request will increase the amount the IRS realizes and will make collection of the tax liability easier; this is typically the case when refinancing to a lower interest rate allows the taxpayer to may more per month toward the IRS debt
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