taxation law services

Innocent Spouse Relief

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In general, a husband and wife are jointly and separately liable for any tax, penalty and interest owed for a year in which they have filed a joint tax return. This means that the IRS can collect the entire amount of tax owed from either spouse alone, regardless of who reported income, or who may have been responsible for errors, omissions, or fraud on a tax return. Joint and several liability thus can potentially result in a situation where substantial amounts of taxes, penalty and interest are owed by one spouse due to the errors, omissions, or fraud committed by the other spouse.

Difficulties involving joint and several liability tend to arise especially when spouses have divorced or separated, and are no longer living together after they have filed a joint tax return. A spouse who is responsible for the errors, omissions, or fraud in a tax return may have an incentive to not cooperate with the former spouse, and may be difficult to even locate. However, due to the fact that a joint return was filed, the IRS could collect the entire amount of tax, penalties, and interest owed from the spouse who was not at fault for the problematic tax return.

In order to provide a remedy for this unjust outcome, in certain circumstances, the IRS allows a spouse, who lacked knowledge of a tax understatement and did not engage in activity giving rise to the understatement, to claim “Innocent Spouse Relief” resulting in full or partial relief from the payments and penalties associated with an understatement of tax made by another spouse.

Legal Test for Innocent Spouse Relief

In order to qualify for Innocent Spouse Relief, all five of the following conditions must be met:

1. A taxpayer must have filed a joint return for a taxable year.

2. On the tax return, there was an understatement of tax attributable to “erroneous items” (see definition below) of a spouse (or former spouse).

3. A taxpayer must establish that when he/she signed the joint return he/she did not know (“actual knowledge”) and “had no reason to know”, that there was an understatement of tax.

4. Taking into account all the facts and circumstances, it would be unfair to hold the taxpayer liable for the deficiency in tax for such taxable year attributable to the tax understatement; and

5. A request for innocent spouse relief will not be granted if the IRS can prove that the taxpayer requesting Innocent Spouse Relief and the taxpayer’s spouse (or former spouse) transferred property to one another as part of a fraudulent scheme. (A fraudulent scheme includes a scheme to defraud the IRS or another third party, such as a creditor, ex-spouse, or business partner.)

Definitions

a) Erroneous Items: an “item” for the Innocent Spouse Relief purposes generally means anything that is required to be reported separately on a tax return or its attachments. There are two types of erroneous items. The first is unreported income, which is any gross income item received by a spouse (or former spouse) that is not reported. The second is an any improper deduction, credit, or property basis claimed by a spouse (or former spouse).

b) Actual Knowledge: if taxpayer requesting Innocent Spouse Relief actually knew about an
erroneous item that belongs to his/her spouse (or former spouse), then the taxpayer will not qualify for Innocent Spouse Relief, and will remain jointly liable for that part of the understatement.

c) Reason To Know: If a reasonable person in similar circumstances would have known of the
understatement, then the taxpayer will not qualify for Innocent Spouse Relief, and will remain jointly liable for that part of the understatement. The IRS will consider a number of facts and circumstances in determining whether a taxpayer had reason to know of an understatement of tax due to an erroneous item, including the taxpayer’s educational background and business experience, the financial situation of both spouses, the nature of the erroneous item and the amount of the erroneous item in relation to other items, the extent of the taxpayer’s participation in the activity that resulted in the erroneous item, whether a reasonable person would have inquired at the time the tax return was signed about the erroneous items, omitted items on the return, and whether the erroneous item represented a departure from a recurring pattern reflected in prior years’ returns.

d) Indications of Unfairness: The IRS will examine a number of factors including, whether the taxpayer’s spouse (or former spouse) deserted him/her, whether the taxpayer and his/her spouse have divorced or separated, whether the taxpayer benefitted from the understatement on the return, and whether the taxpayer received a “significant benefit” (any benefit in excess of normal support), including transfers of property or rights to property, and transfers that are received several years after the year of the understatement.

Types of Innocent Spouse Relief

There are three types of Innocent Spouse Relief available:

1. Full Relief from tax liability (including penalties and interest) for a taxable year to the extent that the liability is attributable to the tax understatement on the joint return. There are certain requirements which must be met in order to qualify.

2. Apportionment of Relief from tax liability (including penalties and interest) for a taxable year. Under this type of innocent spouse relief, the understatement of tax is apportioned between the taxpayer and his/her (or former spouse). In order to meet this type of relief, a taxpayer must show that he or she did not know, and had no reason to know, the extent of understatement on a tax return. If granted, the taxpayer will be relieved of a tax liability to the extent that such liability is attributable to the portion of the understatement that the taxpayer did not know, or did not have reason to know that was in error or omitted.

3. Equitable Relief may be granted if an individual does not meet the requirements for the first two types of relief, but, after taking all the facts and circumstances into consideration, the IRS determines it would be inequitable to hold the taxpayer liable for the unpaid tax.

How Sherayzen Law Office can Assist You

Requesting Innocent Spouse Relief may require legal expertise because of the specificity of the requirements involved, and the necessity of persuading the IRS that you qualify for this relief. Moreover, in some cases, the Tax Code regulations governing the Innocent Spouse Relief process may themselves be challenged in courts. Sherayzen Law Office can help you understand and comply with the required regulations, draft the necessary documents and represent you in your negotiations with the IRS in order to help you limit your tax liability.

Call NOW to discuss your case with an experienced tax attorney!

Internet Sales and Use Taxes: A Growing Concern for Small Businesses and Consumers

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Are you a small business owner who frequently sells goods or services over the Internet, or a consumer who purchases expensive products online? Then you may be responsible for charging sales taxes as a seller, or reporting unpaid use taxes as a consumer under new laws that have been passed by various states. As states look for ways to reduce budget deficits, merchants and consumers should expect to see collection of sales and use taxes become a top priority, and this may require sound tax advice.

Sales and Use Tax Defined

Sales taxes

Sales taxes are state or local taxes based upon a set percentage of the sales price of a product or service. Almost all states have sales taxes, except Alaska, Delaware, Montana, New Hampshire and Oregon. Likewise, most states charge sales tax for Internet purchases made in the state. Certain types of products may be exempt from sales taxes, such as clothing, prescription drugs and some foods and beverages in Minnesota.

Where sales taxes are applicable, merchants who sell via the Internet charge the appropriate sales tax rate for the location of the buyer. For example, a California merchants selling a product to a Minnesota consumer online, would charge the appropriate Minnesota sales tax rate, and then remit the collected tax amount to the state of Minnesota. (Certain exemptions may be applicable in some states depending upon whether the buyer is a consumer or a reseller.)

Use taxes

Use taxes for Internet or mail order purchases, apply when consumers located in a state with a sales tax, purchase goods or services for use in their home state, but are not charged a sales tax (or are taxed at a lower rate than in their home state) by the merchant. In such transactions, the consumer still owes a tax to their home state. Use taxes, unlike sales taxes however, are paid by the consumer. Use taxes that were not paid at the time of sale may be reported on a taxpayer’s state income tax form. Nearly half the states, including California and New York, include a line on individual state income tax forms for taxpayers to voluntarily calculate their use tax liability amount.

Difficulties with Collection of Internet Sales and Use Taxes

A 1992 Supreme Court decision, Quill vs. North Dakota, held that mail order retailers do not need to collect sales taxes unless they have a physical presence in the state of the customer purchasing its product or service. Physical presence may include a store, office, warehouse, or similar facility.

This decision was subsequently applied to exempt Internet retailers that met the requirements. Even though sales taxes are still legally due in circumstances in which an online merchant does not have a physical presence in a customer’s state, such taxes however are rarely reported by customers. Because of the difficulties in tracking online purchases, states often resorted to attempting to collect online sales taxes for expensive items (often requiring licenses to use the good), such as an automobile. In Minnesota, for example, residents are required to pay sales taxes on any online purchases that total $770 over the course of a year.

As many individuals increasingly began using the Internet to purchase goods and services however, states looked for new ways to collect sales taxes. In 2002, 40 states and the District of Columbia joined together to create an initiative called the Streamlined Sales and Use Tax Agreement (SSUTA) to simplify sales tax collection efforts. Although compliance with SSUTA is non-binding, according to recent numbers, nearly 1,200 online retailers now voluntarily collect sales taxes.

Future of Sales and Use Taxes: Collections Likely to Increase

Sales taxes make up the second largest source of state revenue, following individual income taxes. Thus, with many states facing widening budget deficits, the trend is for states to increasingly pursue collection efforts for unpaid sales and use taxes. Recently, state legislatures in New York, North Carolina, and Rhode Island have enacted laws requiring online retailers to collect sales taxes if the retailer operates an ‘affiliate program’ with payments to individuals in return for customer referrals. Similar legislation has been proposed in at least fifteen other states. In Colorado, a new law requires online retailers that run affiliate programs to notify customers of applicable use taxes that must be paid.

The fate of state efforts to increase collection of online sales and use taxes may hinge in part on lawsuits brought by online retailer Amazon.com challenging some of these laws. In challenging the constitutionality of New York’s law, Amazon argued that sending referral payments to its customers through an affiliate program does not constitute a physical presence in a state. Amazon however lost a case in trial court, and has since appealed. Additionally, the company recently filed a lawsuit in federal court challenging North Carolina’s law. States have also filed lawsuits against certain online retailers in an effort to collect unpaid sales taxes and enforce existing state laws.

In addition to the various state laws and pending proposals, federal legislation has been proposed to require most online retailers to collect sales taxes in any states that have joined the Streamlined Sales Tax Project and have passed legislation complying with SSUTA. If the proposed federal legislation eventually becomes law, it would thus override the physical presence requirement. Twenty-three states are members or associate members of this project: Arkansas, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. The proposed law may also allow retailers to retain as an allowance, a small percentage of the sales tax collected, in order to cover reasonable expense for their sales tax collection efforts and tax return filings, as well as other associated costs.

Conclusion

All of the various state and federal legislative initiatives indicate that the states are stepping up their efforts to collect sales and use taxes. This will likely produce an increased complexity of the Internet tax laws with which both, Internet retailers and consumers, will have to comply. Remember, a tax-collection mistake may become very expensive for the involved partes since the unpaid taxes may be subject to penalties and interest.

Sherayzen Law Office can help you navigate this ever-changing tax landscape. Call NOW to discuss your case with an experienced tax attorney!

Preventing the Disaster: Understanding When to File the Report on Foreign Bank and Financial Accounts (FBAR)

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Despite the potentially grave consequences, many U.S. taxpayers are completely unaware of the extensive reporting requirements under the Bank Secrecy Act, particularly of the disclosure of ownership or other interest in or authority over financial accounts in a foreign country by filing the Report of Foreign Bank and Financial Accounts (the “FBAR”). While one can often fault the desire for secrecy on the part of the taxpayers or insufficient diligence of their tax advisors, it seems that the greater part of the blame for this failure should be ascribed to the ever-increasing scope of the reporting requirements (for example, see increasing disclosure requirements and new penalties imposed under Title V of the Hiring Incentives to Restore Employment Act). A person with a foreign account of only $10,500 is unlikely to imagine that he needs to file every year unfamiliar additional paperwork by a date which usually does not coincide with the rest of his tax filings. Nor is this person likely to forward to his tax advisors any information about the account. Given the severe penalties for non-compliance, however, the tax practitioners must be able to alert their clients to the FBAR requirements. This is precisely the purpose of this essay – to clarify for tax attorneys and other tax advisors the situations in which their clients need to file the FBAR. First, I will discuss the definition of “U.S. persons” who may need to file FBARs. Second, I will explain the crucial term “financial accounts.” Then, I will review the procedures for determining the aggregate maximum value of these accounts. I will turn next to the confusing issues of what constitutes a financial interest in or signature and comparable authority over a “financial account.” Finally, I will examine the consequences of failing to file the FBARs.

General Requirements of the FBAR

Pursuant to the Bank Secrecy Act, 31 U.S.C. §5311 et seq., the Department of Treasury (the “DOT”) has established certain recordkeeping and filing requirements for the United States persons with financial interests in or signature authority (and other comparable authority) over financial accounts maintained with financial institutions in foreign countries. If the aggregate balances of such foreign accounts exceed $10,000 at any time during the relevant year, FinCEN Form 114 formerly Form TD F 90-22.1 (the FBAR) must be filed with the DOT. Thus, the FBAR filing is required if four conditions are present:

1). The filer is a U.S. person;
2). There is one or more financial accounts in a foreign country;
3). The aggregate balances of these foreign financial accounts exceed $10,000; and
4). This U.S. person has either a financial interest in or signature authority (or other comparable authority) over these foreign financial accounts.

Definition of “U.S. Person”

Since October of 2008, the definition of a “U.S. person” has been going through a turbulent phase of uncertainty with periodic expansions and retractions. The pre-2008 FBAR instructions (dating back to July of 2000 version) defined the “U.S. person” broadly as: “(1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.”

Two important features of this definition stand out. First, the term “person” is defined to include not only individuals, but also virtually any type of business entity, estate or trust. Even a single-member LLC, which is generally disregarded for tax purposes, may be classified as a U.S. person because it has a separate juridical existence from its owner. A partnership or a corporation created or organized in the United States is considered “domestic” under 26 U.S.C. §7701(a)(4).

Second, the definition of who should be considered as a U.S. resident is interpreted under 26 U.S.C. §7701. Under 26 U.S.C. §7701(b), an individual is a U.S. resident if he meets any of the three bright-line tests: (1) lawful admission for permanent residence to the United States (“green card”); (2) substantial presence in the U.S.: the sum of the number of days on which such individual was present in the United States during the current year and the 2 preceding calendar years (when multiplied by the applicable multiplier determined under the relevant IRS table) equals or exceeds 183 days; and (3) first-year election to be treated as a resident under 26 U.S.C. §7701(b)(4). Thus, the definition of a U.S. resident under the tax rules is much broader than the one used in immigration law.

In October of 2008, the IRS revised the FBAR instructions and further expanded the definition of a “U.S. person” by including the persons “in and doing business in the United States.” This revision caused a widespread confusion among tax professionals. The outburst of comments and questions prompted the IRS to issue Announcements 2009-51 and 2010-16, suspending FBAR filing requirement through June of 2010 (i.e. for calendar years 2008 and 2009) for persons who are not U.S. citizens, U.S. residents, and domestic entities. Instead, the tax professionals were referred back to July of 2000 FBAR definition of a “U.S. person.”

In the meantime, in February of 2010, the IRS published new Proposed FBAR regulations under 31 C.F.R. §103. The proposed rules modify the definition of a “U.S. person” as follows: “a citizen or resident of the United States, or an entity, including but not limited to a corporation, partnership, trust or limited liability company, created, organized, or formed under the laws of the United States, any state, the District of Columbia, the Territories, and Insular Possessions of the United States or the Indian Tribes.” This definition applies even if an entity elected to be disregarded for tax purposes. The determination of a U.S. resident status is to be done according to 26 U.S.C. §7701(b) and regulations thereunder, except the meaning of the “United States”(which is to be defined by 31 U.S.C. 103.11(nn)).

Thus, if the proposed regulations will ultimately be codified in their current form, the definition of the “U.S. person” will be slightly broader than that of the July of 2000, but will represent a major regression from October 2008 definition. Nevertheless, based on even contemporary definition of the “U.S. person,” the IRS has been able to cast a wide net over U.S. taxpayers, trying to force disclosure of as many foreign financial accounts as possible. This trend toward maximizing the scope of disclosure also dominates the definition of what constitutes a foreign financial account – the issue to which I now turn.

Definition of “Foreign Financial Account”

The term “foreign financial accounts” is described expansively and includes any bank, brokerage, securities, securities derivatives and other financial instruments accounts located outside of the United States and its territories. In the instructions to the Form 114, the IRS also includes in this definition savings, demand, deposit, time deposit, debit card, prepaid credit card and any other account maintained with a financial institution or other person engaged in the business of a financial institution. Since October 2008, accounts, such as mutual funds, where the assets are held in a commingled fund and the account owner holds an equity interest in the fund are also considered “financial accounts.” It should be noted that the IRS granted the extension for reporting mutual fund accounts (and certain other filers) for the tax year 2008 and earlier years until June 30, 2010. Individual bonds, notes and stock certificates are not considered as “financial accounts.”

The Proposed Regulations further elaborate the definition of “foreign accounts.” The term includes all “bank, securities, and other financial accounts,” but the understanding of what these terms mean is expanded. The IRS expressly states that, in defining types of the accounts that must be reported on the FBAR, it will focus on the kinds of financial services for which a person maintains an account with a foreign financial institution, irrespective of how long this account is being maintained. The IRS, however, limits itself by stating that “an account is not established simply by conducting transactions such as wiring money or purchasing a money order where no relationship has otherwise been established.”

Outside of this limitation, the Proposed Regulations tend to add the types of accounts that need to be reported on the FBAR. The definition of the “bank account” expressly includes time deposits, such as certificates of deposit accounts that allow an account owner to “deposit funds with a banking institution and redeem the initial amount, along with interest earned after a prescribed period of time.” A “securities account” is defined as “an account maintained with a person in the business of buying, selling, holding, or trading stock or other securities.”

The term “other financial accounts” receives most attention under the Proposed Regulations. The IRS states that, due to the fact that this term covers a broad range of relationships with foreign financial institutions, the new regulations strive to delineate clearly what accounts should be included in the definition. Hence, the Proposed Regulations include in “other financial accounts” the following types of accounts:

“an account with a person that is in the business of accepting deposits as a financial agency; an account that is an insurance policy with a cash value or an annuity policy; an account with a person that acts as a broker or dealer for futures or options transactions in any commodity on or subject to the rules of a commodity exchange or association; or an account with a mutual fund or similar pooled fund which issues shares available to the general public that have a regular net asset value determination and regular redemptions.”

Foreign retirement accounts present an interesting classification problem. The Proposed Regulations state that “participants and beneficiaries in retirement plans under sections 401(a), 403(a) or 403(b) of the Internal Revenue Code as well as owners and beneficiaries of individual
retirement accounts under section 408 of the Internal Revenue Code or Roth IRAs under section 408A of the Internal Revenue Code are not required to file an FBAR with respect to a foreign financial account held by or on behalf of the retirement plan or IRA.” This exception, however, is not extended to the foreign financial accounts. Therefore, it appears that a foreign retirement account that is similar in design to an IRA needs to be disclosed in the FBAR.

The readers must also be aware that other reporting requirements may apply to a foreign retirement account. For example, Canadian Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) should be reported by U.S. residents on Form 8891. In other cases, a foreign retirement plan may be considered as “foreign trust” by the IRS and should be reported on Form 3520.

There are three narrow categories of foreign financial accounts for which the U.S. persons do not have to file the FBAR. First, accounts held in a military banking facility designated by the U.S. government to serve U.S. Government installations located abroad. Second, officers or employees of most banks regulated by the federal government are exempt from filing the FBARs (unless an officer or an employee has personal financial interest in the account). Finally, officers or employees of publicly-traded domestic corporations or privately-owned corporations with assets exceeding $10 million and 500 or more shareholders of record, need not file an FBAR concerning the signature authority (usually acquired by virtue of the officer’s or employee’s position) over a foreign financial account of the corporation (as long as an officer or an employee has no personal financial interest in the account, and he is advised in writing by the chief financial officer of the corporation that the corporation has filed a current report which includes that account).

Aggregate Balance Exceeds $10,000

Despite appearances, the requirement that the aggregate value of all of the foreign financial accounts exceeds $10,000 at any time during a calendar year is not without complications. In order to figure out the account value in a calendar year, one needs to look first at the largest amount of currency and/or monetary instruments that appear on any quarterly or more frequently issued account statement for the relevant year. If the financial institution which manages the account does not issue any periodic account statements, then the maximum account value is the largest amount of currency and/or monetary instruments in the account at any time during the applicable year. If the account consists of stocks or other non-monetary assets, then one only needs to consider fair market value at the end of the relevant year. If, however, the non-monetary assets were withdrawn before the end of the calendar year, then the account value is determined to be the fair market value of the withdrawn assets at the time of the withdrawal.

The maximum value of a foreign financial account must be reported in U.S. dollars on the FBAR. Therefore, a taxpayer needs to convert foreign currency into the corresponding amount of U.S. dollars using the official exchange rate at the end of the relevant calendar year.

A final word of caution on the topic of the account balance. Notice the word “aggregate” – it means that the balances of all of the filer’s foreign financial accounts should be tallied to determine whether the $10,000 threshold is exceeded. For example, if the filer has one foreign bank account of $6,000 and another of $5,000, then he still needs to file the FBAR with the DOT, because the aggregate value of both accounts exceeds the required $10,000.

Financial Interest, Signature Authority, and Other Comparable Authority

The final condition that must be met before the requirement to file the FBAR arises is that the U.S. person has either a financial interest in, or a signature authority or other comparable authority over the relevant foreign financial accounts. In deciding whether the FBAR is required, it is useful to go through all three of these requirements in order.

First, the filer needs to determine whether he has a financial interest in the account. If the account is owned by an individual, the financial interest exists if the filer is the owner of record or has legal title in the financial account, whether the account is maintained for his own benefit or for the benefit of others, including non-U.S. persons. Hence, if the owner of record or holder of legal title is a U.S. person acting as an agent, nominee, or in some other capacity on behalf of another U.S. person, the financial interest in the account exists and this agent or nominee needs to file the FBAR. If a corporation is the owner of record or the holder of legal title in the financial account, a shareholder of a corporation has a financial interest in the account if he owns, directly or indirectly, more than 50 percent of the total value of the shares of stock or has more than 50 percent of the voting power. Where a partnership is the owner of record or the holder of legal title in the financial account, a partner has a financial interest in the financial account if he owns, directly or indirectly, more than 50 percent of the interest in profits or capital. Similar rule applies to any other entity (other than a trust) where a U.S. person owns, directly or indirectly, more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits. Special rules apply to trust and can be found in the Proposed Regulations. Finally, a U.S. person who “causes an entity to be created for a purpose of evading the reporting requirement shall have a financial interest in any bank, securities, or other financial account in a foreign country for which the entity is the owner of record or holder of legal title.”

If there is no financial interest in the foreign financial account, the filer should determine whether he has signature authority over the account. A U.S. person has account signature authority if that person can control the disposition of money or other property in the account by delivery of a document containing his signature to the bank or other person with whom the account is maintained. Notice, once again, that control over the disposition of assets in the account is one of the main factors in deciding whether the FBAR needs to be filed.

It is important to mention that, pursuant to the IRS Announcement 2010-23, persons with signature authority over, but no financial interest in, a foreign financial accounts for which an FBAR would otherwise have been due on June 30, 2010, will now have until June 30, 2011, to report those foreign financial accounts. Combined with IRS Announcement 2009-62, this means that the deadline has been extended for the calendar year 2009 and all prior years.

Finally, even if no financial interest or signature authority exists, the filer has to continue his analysis and determine whether he has “other comparable authority” over the account. This catch-all, ambiguous term is not defined by the IRS. Nevertheless, the instructions to Form 114 generally state that the other comparable authority exists when the filer can exercise power comparable to the signature authority over the account by communication with the bank or other person with whom the account is maintained, either directly or through an agent, or in some other capacity on behalf of the U.S. person.

Penalties

Now that the reader has received an extensive background on the FBAR filing requirements, I would like to discuss some of the penalties that may be imposed as a result of the failure to file the FBAR even though your client was required to do so. In particular, I will focus on three general scenarios describing specific penalties commonly attributed to each of them. The first scenario is where your client willfully failed to file the FBAR, or destroyed or otherwise failed to maintain proper records of account, and the IRS learned about it when it launched an investigation of your client. This is the worst type of scenario which carries substantial penalties. The IRS may impose civil penalties of up to the greater of $100,000, or 50 percent of the value of the account at the time of the violation, as well as criminal penalties of up to $500,000, or 10 years of imprisonment, or both. It should be noted these penalties apply separately to each undisclosed account. Hence, if your client fails to disclose two or more accounts, the penalties are likely to be significantly higher.

Another scenario is where your client negligently and non-willfully failed to file the FBAR, and the IRS learned about it during an investigation of your client. Unlike the first scenario, there are no criminal penalties for non-willful failure to file the FBAR; only civil penalties of up to $10,000 per each violation (unless there is a pattern of negligence which carries additional civil penalties of no more than $50,000 per any violation). Each undisclosed account constitutes a separate violation, and, therefore, the penalties may be significantly higher where your client fails to disclose two or more accounts . In this scenario, your client fares much better, and you may be able to obtain lower penalties by showing of reasonable cause for the failure to file.

The third scenario is where your client non-willfully fails to file the FBAR, accidentally discovers his mistake, and comes to you before the IRS commences its investigation of your client’s finances. This is the most favorable of all scenarios due to the fact that your client may qualify for the benefits of a voluntary disclosure program, despite the fact that the position of the IRS regarding civil penalties for voluntarily filed but delinquent FBARs is uncertain following the October 15, 2009 voluntary disclosure deadline. The best strategy for addressing delinquent FBARs, however, varies depending on the facts and circumstances of the particular case.

A word of caution: this discussion focuses solely on the penalties associated with the failure to file the FBAR. This article does not address the various strategies that may be employed in dealing with the delinquent FBAR filings in the post-October 15, 2009 world, including qualification for the voluntary disclosure program. In certain situations, there may also be other relevant significant tax issues outside of the FBAR realm – the most important of which is non-payment of taxes on undisclosed income by the U.S. taxpayers – which may significantly alter the amount of penalties, interest, and taxes due to the IRS.

Conclusion

Based on the analysis above, it is easy to see now why so many of the U.S. taxpayers fail to file an FBAR when it is required. While the seemingly simple instructions of the FBAR can readily become complex and unpredictable when applied to specific individual circumstances, the main cause of non-filing seems to be simply a failure to recognize that the FBAR report needs to be filed. This problem is exactly what this article is designed to address, and I hope that I have provided the readers with the necessary legal knowledge to conduct a proper legal analysis of relevant circumstances and recognize when the FBAR needs to be filed. This is the crucial first step in preventing regulatory non-compliance and its potentially disastrous consequences for you and your clients.

October 15 Deadline for Extension Filers and Certain Non-Profit Organizations

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If you filed Form 4868 to request a six-month extension to file your tax return, beware that October 15, 2010 is the fast-approaching deadline to file your tax returns. The IRS expects to receive as many as ten million tax returns from such extension filers.

The other important group of filers are small nonprofit organizations at risk of losing their tax-exempt status because they failed to file the required tax returns for the past three tax years (2007, 2008, and 2009). Their one-time chance to preserve their tax-exempt status is to file the appropriate variation of the Form 990 with the IRS.

The IRS has posted on a special page on its website listing the names and last-known addresses of these at-risk organizations, along with guidance about how to come back into compliance. The organizations on the list have return due dates between May 17, 2010 and October 15, 2010, but the IRS has no record that they filed the required returns for any of the past three years.

Click here for more information about this unique one-time relief program.

This essay is provided as a courtesy notice by Sherayzen Law Office, Minnesota tax law firm for businesses and individuals.

Employee vs. Independent Contractor: Common-Law Test in Minnesota

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One of the most crucial distinctions in employment and tax law is one made between employees and independent contractors. The applicability of a whole host of labor and tax provisions hinges on how the worker is classified. In Minnesota, most statutory provisions that deal with these issues (including Minnesota Unemployment Insurance) incorporate in one way or another the common-law test factors adopted by the courts to classify workers. In this essay, I will list and explain each of the five factors for determining whether a worker is an employee or an independent contractor.

Common-Law Test

The common-law test consists of five factors. The two most important factors are: the right to control the means and manner of performance and the right to discharge a worker. The presence of one factor is insufficient to find employment relationship if such factor is countered by other factors. Instead, the courts look at the overall relationship between the parties in order to determine whether a master-servant – this is the so-called “totality of circumstances” approach.

Let us review each of the five factors in more detail.

1. The Right to Control the Means and Manner of Performance

This is one of the two most important factors (right to discharge is another) in the test. If the employer has the right to control how a worker performs his job, then the worker is likely to be classified as an employee. In Minnesota, it is important to distinguish between control over “means and manner” versus control over the “end-product.” In the latter case, the employer control the end result of the worker’s product, not the manner in which the worker was able to achieve this result. Therefore, such control does not evince a master-servant relationship, but, rather, is characteristic of an independent contractor status.

2. The Mode of Payment

The most important issue here is whether the worker is paid on a per job basis or on a basis more akin to an employer-employee relationship (such as payment per hour or fixed salary). Payment based on a job evinces an independent contractor relationship, whereas payment per hour indicates an existence of a master-servant contract.

3. Furnishing of Materials and Tools

An employer-employee relationship is more likely where the employer furnishes all materials and tools necessary for the worker to do his job. On the contrary, if the worker supplies all of his tools and materials, then the court will be inclined to rule that this factor indicates that an independent contractor relationship exists.

4. Control of Premises Where Work Is Performed

Where the services are performed on the premises controlled by the employer, a court may adopt a position that this situation implies that employer exercises control over worker (though, there exceptions). On the other hand, if the worker controls the premises where the work is performed , it is usually indicative that the worker enjoys at least some freedom from the employer’s control. It is important to point out, however, that in some professions where the work is necessarily done outside of the employer’s premises, the worker’s control of the place of work loses its importance.

5. Right of Employer to Hire and Discharge

The right to discharge is the other most important factor in determining whether there is an employer-employee relationship. Where a worker may be terminated by the employer with little notice, without cause, or for failure to follow specified rules or methods, and the employer does not incur any liability as a result of such termination, the court is likely to find that a master-servant relationship exists. On the other hand, if the worker cannot be terminated without the employer being liable for damages (assuming the worker is producing according to his contract specifications), the court is more likely to determine that there is an independent contractor relationship between the parties.

The foregoing is a very simplified overview of the common-law test. The actual analysis may be much more complex, especially when applied to a specific set of facts. Remember, the common-law test emphasizes the “totality of circumstances” approach which is necessarily involves a fact-driven analysis.

Codification of the Common-Law Test

It is also important to emphasize that, in most areas of law, the Minnesota legislature codified the common-law test with significant alterations, adding and deleting various factors. For example, Minnesota Unemployment Insurance administrative rules list more than a dozen factors just to determine whether there is a right to control the means and manner of performance. Moreover, the Rules detail eight factors to consider in addition to the modified common-law test.

Often, the common-law test is modified according to specific circumstances of a relevant industry. For example, the specific factors for the construction and trucking industries will vary significantly from the rules that apply to non-emergency medical transportation, even though the common-law test still constitutes the basis for the divergent rules.

Furthermore, one should remember that several different tests may apply to the same situation depending on the government agency that makes the determination of an employment relationship. For example, the IRS applies a different test than the Minnesota Department of Commerce (the “DOR”), and, in turn, the DOR’s rules differ from the factors adopted by the Minnesota Unemployment Insurance. Yet, all three agencies are trying to find an answer to the same question – whether a worker should be classified as an employee or an independent contractor.

Conclusion

In applying the common-law test, whether modified or not, you should hire an attorney familiar with these rules. Lawyers usually have the necessary familiarity with the rules, training in legal research, and experience in dealing with the government agencies.

Sherayzen Law Office is a law firm with a tested experience in the area of worker classification. We can help you make sure that you are in compliance with existing laws and regulations, draft the necessary documents (such as an Independent Contractor Agreement), and defend your interests in the administrative and judicial courts.

Call NOW to speak with an experienced business attorney!