Congress enacted the Tax Equity and Fiscal Responsibility Tax Act of 1982 and amended the federal tax code to prohibit deduction of ordinary and necessary expenses related to the illegal sale of controlled substances.  A recent Tax Court decision highlights this law as another challenge to the feasibility of marijuana growing operations.  Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. No. 4 (5/15/07), demonstrated how the Federal tax code is being used to inhibit the medical marijuana industry.  In the California case IRC 280E was held to disallow the deduction of expenses attributed to the provision of medical marijuana because it was considered “trafficking” in a controlled substance.

The IRS has been unambiguous in its position on the issue of medical marijuana as a prohibited controlled substance.  Citing the 2007 Tax Court opinion and a 2001 US Supreme Court case, U.S. v. Oakland Cannabis Buyers’ Co-op., 532 U.S. 483 (2001).  IRS Chief Counsel Letter (2011-0005) makes it clear that absent a change in the tax code, medical marijuana will be treated as a controlled substance under 280E.  This could saddle any growing operation with a substantial federal income tax burden.  If growing marijuana is considered “trafficking”, federal income tax will be calculated on gross revenue without a deduction for expenses associated with its production.

Credit cards are becoming more common for use in payment of taxes.  With the rapid increase in electronic filing of tax returns, online credit card payments have increased as well.  Nearly 70% of 2010 personal income tax returns were filed electronically.  By 2012, the federal government hopes to increase online filing to 80% for all tax returns.  When the electronic filing has been done and there is tax to pay, it is convenient and even encouraged to pay by credit card.

Convenience of credit card tax payment comes at some cost.  The government uses third party companies to process payment in most cases and a “convenience fee” is charged to the taxpayer for the service.  The IRS has a webpage entitled “Pay Taxes by Credit or Debit Card” with information on how to do just that.  The IRS website suggests that fees for the card payment range from a low of 1.9% to a high of 2.35%.   The additional fee is included in the transaction at the taxpayer’s expense.  Most state and local governments will accept payment through such a company.

It costs extra money to pay tax with a credit card and this is reason enough for many people to avoid this method of payment.  If the payment is made without the intent to repay the creditor it is fraud and not dischargeable in bankruptcy for that reason.  Even a pure heart and empty head will not convert a non-dischargeable tax into a dischargeable credit card debt.

Finally, two new statutes were added by Congress in 2005 to protect the credit card banks that fund tax payments.  Under these new provisions, a loan used to pay tax that is or may become dischargeable with the passage of time, becomes non-dischargeable under 11 USC §523(a)(14) and 11 USC 523(a)(14A).

Oregon imposes a personal income tax on all residents of the state under the authority of ORS § 316.037(1)(a) (2010).  By statute, an individual is a resident of Oregon under two scenarios.

A.  An individual who is domiciled in Oregon, unless he a) does not have a permanent place of abode in Oregon; b) maintains a permanent place of abode in a place other than Oregon, and c) spends less than 31 days of a taxable year in Oregon. ORS § 316.027(A)(i)-(iii).

B.  If an individual is not a domiciliary, they may be a resident if he maintains a permanent place of abode in Oregon and spends more than 200 days of a taxable year in Oregon unless the individual can prove he is in Oregon for a temporary or transitory purpose. ORS § 316.027(B).

Oregon modeled ORS 316 after New York residency rules. Ramsey v. Dept. of Rev., 7 Or. Tax 478, 482 (1972). The residency requirements were changed in 1969 to grant tax relief to individuals who do not receive the benefits and protections of the state and to ensure that those who do receive the benefits and protections contribute to the support of the State. Id.

Domicile

Under Oregon law, a domicile is described as the place an individual considers their “true, fixed, permanent home.” OAR § 136.027(1)(a) (2000). An individual’s domicile is where he intends to return after an absence. Id. An individual can have only one domicile at a time, and it continues until the individual shows intent to abandon the domicile, intent to acquire a new domicile, and he physically resides in the new domicile. Id.

In order to change domiciles, an individual must first establish a new residence in a new place and he must have the intent to abandon the old domicile. Davis v. Dept. of Revenue, 13 OTR 260, 264 (1995). Further, the individual’s intent must be a present intent. Id. An example of present intent is illustrated by Harlan v. Dept. of Revenue, 10 OTR 497 (1987). In Harlan, the court held that a taxpayer did not have a present intent to establish a new domicile where moving to a new residence was contingent on the selling of a home in Oregon. Id. The court determined the event was in the future and had no degree of certainty as to the time. Id.

An individual’s intent can be inferred from circumstances or activities. dela Rosa, 11 OTR at 203. In dela Rosa, the taxpayer worked in other states, but owned property in Oregon, kept his Oregon driver’s license, filed joint Oregon tax returns with his wife, and claimed “away-from-home expenses” on his federal tax return for expenses incurred while working out of the state. Additionally, his family continued to live in the Oregon house. The taxpayer did not have a permanent home outside of Oregon. The court determined the circumstances were sufficient to establish the taxpayer was an Oregon domiciliary for personal income tax purposes.

Permanent Place of Abode

A permanent place of abode is “a dwelling place permanently maintained by the taxpayer . . . over a sufficient period of time to create a well-settled physical connection to a given locality,” regardless of ownership. OAR 150-316.027(1)(b). In determining whether an individual has a permanent place of abode, court will look to factors such as “the amount of time spent in the locality, the nature of the place of abode, activities in the locality and the taxpayer’s intentions with regard to the length and nature of the stay.” OAR 150-316.027(a)(b)(A).

Any property that “is suitable for year-round living” may constitute a permanent place of abode, even if it is only used on vacations or weekends. OAR 150-316.027(1)(a)(C). For example, a vacation home that contains all the amenities found in a primary residence would be considered a permanent place of abode. However, if the property is used for investment or rental purposes, and the taxpayer never uses the property, it is not considered a permanent place of abode. This exception is not available when “the property is used during the tax year by the taxpayer . . . [or] used by the taxpayer’s family for a sufficient period of time to establish a well-settled connection.” OAR 150-316.027(1)(a)(B).

Temporary or Transitory Purpose

An individual who is not domiciled in Oregon, but spends over 200 days in a taxable year in the state, may avoid paying resident income tax if he can prove he is in the state for a temporary or transitory purpose. ORS § 316.027(B). An individual’s stay in Oregon is temporary or transitory if the reason for staying is neither permanent nor expected to last indefinitely. OAR 150-316.027(2). For example, an individual who is vacationing on the Oregon Coast for a month would be in the state for a temporary purpose. However, an individual who is contracted to work on a construction project in the state, with an indefinite date of completion, may be considered to be in the state for reasons that are not temporary or transitory.

The regulations provide the following scenario regarding temporary or transitory purpose: A couple lives in Minnesota and is domiciled there. They own a family home in Minnesota and spent over 200 days per year at the Oregon Coast. After a few years of renting property, the couple decided to purchase a home in Oregon. The home was rented during the periods the couple resided in Minnesota. The taxpayers had no business interests in Oregon and did not work in Oregon. Additionally, the taxpayers belonged to Minnesota clubs and kept office space in Minnesota. The taxpayers’ presence in Oregon was considered temporary or transitory, and therefore, they were not taxed as Oregon residents. OAR 150-316.027(2).

Foreclosure Fiascos Contiune...

We recently wrote a post describing a MERS defeat in Oregon Bankruptcy Court, and MERS (an acronym for Mortgage Electronic Services, Inc., an electronic registry) is in the news once again. This has not only been a hot topic in Oregon, but people around the nation have been attacking MERS as foreclosures mount and banks turn defaulting homeowners out into the streets. Some states have sided with MERS and the banks, but Oregon appears to be following the lead of states that have not.

Long-time District Court Judge Owen Panner recently granted a foreclosed-upon couple declaratory judgment against MERS in Hooker v. Northwest Trustee Services, Inc. Like McCoy v. BNC Mortgage before it, the court decided that MERS simply cannot meet the definition of beneficiary under ORS 86.735(1). Judge Panner stated that “MERS, and its registered bank users, created much of the confusion involved in the foreclosure process,” and later cites Judge Alley’s McCoy opinion with approval.

So what do you do when the courts start consistently ruling against you? You try to change the law, which is exactly what several banks and MERS just tried (and failed) to do in Oregon. Oregon Live recently described attempts by the finance industry to attach an amendment to SB 519 that would change ORS 86.735, among other statutes, to allow MERS to foreclose on homes even when the true beneficiary has not been properly recorded. Even better for MERS, the bill amendment was to apply retroactively. In the article, State Representative Jeff Barnes (D-Aloha) is quoted as saying: “there was a lot of opposition. I probably got more emails about this than anything all session.” The article was also one of the most talked-about on the site, with over 91% of the voters in their poll siding against the MERS amendment.

Mortgages are a topic that may bore some, but there are clearly many people, both attorney and not, with a high stake in the outcome of this struggle. So far, the courts and the legislature of Oregon has sided with the people against the banks, but the situation warrants further monitoring.

Many states have their own personal income tax.  Generally these states also have laws that require a taxpayer to submit a copy of the IRS audit report if the federal liability is adjusted due to a reallocation of income or deductions on a previously filed return.   The failure to do so may cause bankruptcy discharge problems .  Changes to federal law contained in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 may render any undisclosed increase in liability a non-dischargeable debt for bankruptcy purposes. The amended language of 11 USC 503(a)(1)(B) says that a discharge under Chapter 7 “does not discharge an individual debtor from any debt — (1) for a tax . . . (B) with respect to which a return OR EQUIVALENT REPORT OR NOTICE, if required — (i) was not filed or given late and within 2 years of filing the bankruptcy, or was fraudulent or evasive.

The 4th Circuit Court of Appeals in State of Maryland v. Ciotti, decided that the failure of a taxpayer to comply with a Maryland state statute requiring her to report changes made to her federal tax liability as a result of an audit conducted by the Internal Revenue Service. In spite of the intergovernmental agreement between the State of Maryland and the US Treasury that actually did provide a copy of the IRS audit report to the state, the court determined that failure of the taxpayer to supply the report herself rendered the increase in state tax non-dischargeable.

The tax code of the State of Oregon includes a provision that mirrors the requirements of the Maryland law in that it creates a specific duty, under ORS 314.380, that the taxpayer “report to the department any change in the taxpayers tax liability paid to or owing this state because . . . The Internal Revenue Service or other competent authority has changed or corrected the amount taken into account in determining the taxpayers tax liability as reported on a federal income tax return or an income tax return of another state for any taxable year. . .” The law also requires the taxpayer to give notice of the filing of an original or amended return that is accepted by the Internal Revenue Service or the taxing authority of another state.

It is tempting for taxpayers who are delinquent in filing personal income tax returns, when contacted by the IRS with a request to file missing returns, to ignore state and local tax return filing requirements. The IRS has access to information and other resources not available to state revenue officers. Since it is generally, although not always the federal tax authorities who first detect a non-filing taxpayer, this is a quandary that many face. The Ciotti decision adds force to the argument that the state authorities will likely detect any omission and that it is best to come forward with any reportable information promptly.

Of course, non-filed tax returns of any sort are excluded from discharge by section 523 of the bankruptcy code. In addition, another problem arises when a taxpayer fails to file a return and the taxing authority calculates and assesses tax by a substitute process. While the issue is far from clear in the 9th Circuit Court, which supervises the Oregon bankruptcy court, there is substantial support for the premise that, after the state has assessed in absence of a voluntary return, no effort to file a tax return will render the tax dischargeable in the future.

Federal law provides for assessment of tax by an alternative process through tax code section 26 U.S.C. 6020(b). This is referred to by IRS employees as the Substitute For Return process or “SFR” for short. The Chief Counsel of the IRS has publicly taken the position in Chief Counsel Memorandum 2010-16, that tax liability can be corrected by a late filed tax return that is accepted by the IRS after assessment under the SFR procedures. However, it is the IRS position that regardless of whether or not the liability is changed, that portion of the tax originally assessed by the SFR will be excluded from bankruptcy discharge under 11 U.S.C. 503(a)(1)(B).

If the courts agree with the IRS interpretation of the bankruptcy code discharge provision when applied to a state substitute assessment this spells trouble for a non-filing taxpayer who has satisfied the IRS but neglected the state. Not only will the un-assessed state tax lurk in the background waiting to spring forth at a particularly inopportune moment, but it will forever elude bankruptcy discharge when the state gets around to assessment.

The Oregon Homestead Exemption has been interpreted broadly by state and federal courts.  Even a mandatory security deposit has been found to qualify for exemption under ORS 18.395 and 18.402.  In a memorandum opinion by Judge Albert Radcliffe entered February 9, 2011, the court rejected the prepayment of $3,900 in rent as exempt under ORS 18.395.  In an unfortunate sidenote, Judge Radcliffe passed away just 10 days later at the age of 63.

This appears to have been a particularly aggressive exemption planning attempt by the debtors.  The debtors in this case have executed a month-to-month residential rental agreement that required monthly payments in the amount of $650.  The rental agreement required a security deposit but made no mention of the $3,900 in prepaid rent.  The security deposit was only $350 plus the last month’s rent for a total of $1,000.  At some point, prior to the filing of the petition for bankruptcy under Chapter 7, the debtors paid an additional $3,900 to the landlord as “prepaid rent.”  Since the rental agreement was a “month-to-month” agreement entitling either the landlord or the debtors to terminate tenancy upon 30 days’ notice, the prepaid rent could easily be recovered and used for other purposes.  Judge Radcliffe further pointed out that the landlord would have no right to demand additional deposits from the tenant if forced to turn over the “prepaid rent” to the trustee in the bankruptcy case.

Judge Radcliffe took some pains to point out that the Oregon Homestead Exemption normally involves equity in a debtor’s home.  The prior case of Sticka v. Casserino, 379 F.3d 1069 (9^th Cir. 2004) was referred to as a limited exemption in which a security deposit was so closely intertwined with the interest in the real estate that it could not be severed.

In a footnote to his opinion Judge Radcliffe mentions that ORS 90.300(16)(a) and ORS 18.618(1)(a)(E) designate residential “security deposits” and “prepaid rent” as exempt from garnishment.  Clearly, the mechanism used by the debtors in this case did not impress the court.  Since the debtors claimed only the homestead exemption and did not claim either of these other exemptions, Judge Radcliffe’s comment was not part of his ruling.  However, it is a good place to start for tenants wishing to protect these types of deposits from claims of a trustee in bankruptcy.

Many home lenders use an entity called Mortgage Electronic Registration Systems, Inc., or “MERS” as a nominal party in loan transactions to facilitate an electronic central registry of note holders and servicers.  On its website, MERS claims many benefits to use of their services.  According to the website, MERS should be named in security instruments as a “nominee for the lender” in order to “eliminate the need for assignments and realize the greatest savings.”  In an Oregon deed of trust instrument, MERS is often named as “Beneficiary” in its nominee capacity.

A recent decision in the Oregon Bankruptcy Court by Chief Judge, Frank R. Alley, III, complicates matters dramatically for institutional trust deed holders using the MERS system when they attempt to foreclose defaulted home loans.  Judge Alley’s ruling in Donald E. McCoy, III, v. BNC Mortgage, Inc., et al., decided February 7, 2011, holds that calling MERS the “beneficiary” in a trust deed does not make it a beneficiary for the purposes of ORS 86.705(1) which defines a beneficiary as “the person for whose benefit a trust deed is given, or the person’s successor in interest.”  In the standard trust deed designating MERS as beneficiary, language in the document provides that MERS is acting solely as the nominee of the lender.  While Judge Alley states that “a deed of trust may authorize delegation of the beneficiary’s powers to a separate nominee,” he concludes that MERS cannot be granted any powers that exceed those of the beneficiary.

Because ORS 86.735 allows the trustee to foreclose a deed of trust non-judicially, by advertisement and sale, but requires that “any assignments of the trust deed by the trustee or beneficiary and any appointment of a successor trustee are recorded in the mortgage records in the counties in which the property described in the deed is situated;” it is clear that a trustee may not foreclose a MERS trust deed without recording all of the internal transfers between various parties in the securitization chain.

Securitization often involves a complex set of transfers from the loan originator, to a wholesale lender, to a holding company owned by a brokerage house, to a subsidiary and ultimately to investors holding various ownership interests in a trust.  It has often proved difficult for lawyers handling foreclosure claims to locate and record documents in this chain of transactions.  A number of recent cases have highlighted the fraudulent attempts of “foreclosure mills” to create documentation for this purpose.

A problem with a MERS Trust Deed does not necessarily mean the borrower gets a “free house” as Oregon law provides for foreclosure of a trust deed using judicial procedures under ORS 86.710.  A judicial foreclosure permits more thorough inspection of ownership interests, but it often takes more time than a non-judicial proceeding and state law grants a six-month right of redemption to the borrower after the judicial foreclosure has been concluded.

The IRS announced today that taxpayers have until April 18, 2011 to file their 2010 income tax returns and to pay the tax due.  If you file an extension, the extension is also due April 18, 2011 and will be good until October 17, 2011. 

Remember that an extension to file a tax return is not an extension to pay.  All tax due needs to be paid by April 18, 2011.  The IRS will assess penalties and interest on any amount that is due but was not paid on time.  If you cannot pay, you will still want to make sure you file your tax return on time.  The IRS can help you, if you qualify, to set up a payment agreement.

The April 18th deadline gives taxpayers three extra days to file their tax returns, pay tax, and file an extension if needed.  Since two of those days fall on a weekend, this could really help some taxpayers out.

The reason that the due date is extended until Monday April 18, 2011 is that April 15, 2011 falls on a Friday which also happens to be Emancipation Day, a holiday observed in the District of Columbia.  By law, Emancipation Day is treated as a Federal holdiay thus extending the date for all taxpayers to April 18, 2011.

Payroll withholding in 2011 for the employee paid portion of the Social Security tax will drop from 6.2% to 4.2%.  This will provide a 2% increase in pay for millions of American workers.  Employers have been provided with updated withholding tables and have been instructed by the IRS to change the amount withheld from employee paychecks no later than January 31, 2010.

For employees who received no employer funded raise in 2010, this should be a welcome bonus.  For the unemployed, the 2010 Tax Relief Act included some help as well.  Federal payments for Emergency Unemployment Compensation (EUC)were reauthorized through December 31, 2011.  This EUC extension will pick up the full cost of extended unemployment compensation for the states throughout next year.

Tax refunds for many taxpayers will be delayed this year while the IRS updates its computer software and trains its employees.  The 2010 Tax Relief Act was enacted December 17, 2010, and included many changes to the tax code.  The biggest change overall was the extension of previous tax cuts set to expire at the end of 2010.  Due to the late changes in the tax code, the IRS has announced they will be unable to process tax returns with itemized deductions until at least the middle of February, 2011.  The good news is, many who would have ended up owing tax will now receive refunds.

A deficiency judgment is a judgment entered against a borrower after foreclosure of a secured debt when proceeds from sale of the collateral fail to fully satisfy the debt. A deficiency judgment against the borrower is prohibited by ORS 86.770(2) after non-judicial foreclosure of a trust deed on real property that is held as collateral security. This non-judicial foreclosure process is referred to as “advertisement and sale” in Oregon. However, the antideficiency statute only applies after a foreclosure and does not apply when the note holder waives the security and sues directly on the note.  This is made clear in Beckhuson v. Frank, 97 Or App 347, 775 P2d 923 (1989), see also the case of In Re Daraee 279 B.R. 853, a 2002 Oregon Bankruptcy Court opinion.

Deficiency judgments are uncommon for first priority home loans in Oregon.  Lenders normally prefer to foreclose and sell the collateral in a nonjudicial proceeding to quickly recover as much as they can, without the expense and delay of a judicial proceeding. However, a recoverable deficiency could arise if the property is voluntarily sold by the home owner in a short sale. A short sale is the sale of property for a price that is less than the balance due on the debt secured against it. A lender could agree to release or “waive” its security in exchange for partial payment of its note. Unless the lender agreed to fully extinguish the debt, it could sue on the note balance and collect any amount that remained unpaid.

A deficiency judgment is an even more likely prospect when a second priority trust deed or mortgage is involved. Home equity lines of credit, often referred to as HELOCs, were very popular when home values were increasing rapidly. Consumers were encouraged by lenders to access the equity that had built up in their homes to pay other consumer debt, pay educational expenses for their children, remodel their homes or even to make speculative investments. If the first trust deed on a home is foreclosed, and the sale proceeds are insufficient to pay the balance due, there is nothing left to pay the second trust deed holder. In such a situation, the subordinate debt no longer has any collateral security and in most cases the lender will sue to collect the balance due if it is not voluntarily paid by the borrower.

I was recently contacted by an unhappy former homeowner who sold the home on a short sale to satisfy the first trust deed. The holder of the second trust deed agreed to the sale and released its interest in the property without being paid. After the sale, the borrower thought all debt associated with the home had been resolved until a demand letter arrived. The holder of the note that was previously secured by a second trust deed now wanted to be paid. Only the security had been waived and the note balance could still be collected. A bankruptcy was the only alternative to payment.

I recently discussed this problem with a lawyer who represents many large, national lenders in foreclosure proceedings. He told me that the standard short sale documents his clients offer to homeowners are silent (say nothing) about waiver of a deficiency. This means that, unless the borrower insists on a full release, and language to that effect is added to the documentation, a deficiency judgment may be pursued after the sale. Bankruptcy lawyers may soon see many unhappy former homeowners looking for a solution to an unexpected problem.