In a merciful opinion written by retired Supreme Court Associate Justice Sandra Day O’Conner (sitting by designation pursuant to 28 USC §294(a)), the US Court of Appeals for the 11th Circuit ruled that Abelardo Ernest Cruz should not be prohibited from preparing tax returns as a penalty for his participation in a fraudulent tax return preparation scheme.  The IRS proved that Cruz and others intentionally overstated deductions and credits on tax returns they prepared in order to increase refunds for their customers.

The Internal Revenue Code, at 26 USC §7407, permits a Federal District Court to prohibit a tax return preparer from taking an unreasonable position on future tax returns.  If the court determines that the tax preparer has repeatedly engaged in fraudulent conduct and that an order enjoining the prohibited conduct is not sufficient to encourage compliance with the tax laws, it can impose what amounts to a business death penalty.  The court, in appropriate circumstances, can terminate the tax preparation business “with extreme prejudice” and prohibit the offender from acting as a paid tax return preparer again.

 The District Court where trial was held found that defendants had changed procedures, had taken steps to improve quality control and had begun requiring each of their clients to verify that their returns were prepared with the information the client provided.  The District Court concluded that these changes went beyond procedures followed by most tax return preparers.  For these reasons, the judge felt that it was sufficient remedy to impose a more limited penalty by simply prohibiting the defendants from continuing to take unreasonable positions on tax returns.

It is important to note that the IRS appealed the decision of the District Court and asked the Court of Appeals to impose a more severe penalty.  This action was taken in spite of the fact that the that it appeared the defendants had mended their ways.  The IRS argued that defendants knew or should have known the claimed deductions were unreasonable.  Consequently, they felt no amount of education, training or change in procedure could reform a dishonest tax practitioner.

A bankruptcy preference is a transfer made shortly before the case is filed that the trustee can take back from one creditor and share with all the other creditors. The transfer must be of money or property in which the debtor has an interest. It must be made to  a creditor owed money by the debtor. The transfer must be more than the creditor would receive in a Chapter 7 distribution. Finally, it must be made within a certain period of time. 11 USC §547 governs the preference rules under federal law.

The preference period is 90 days before filing unless the debtor has a special relationship with the creditor and is considered an insider. Insiders are close family members, business partners, or a corporation of which the debtor is a person in control such as an officer or director.  The preference period for transfer to an insider is expanded by law to one year instead of 90 days. 

There are some financial limits on the trustee’s ability to recover a preferential transfer.  If more than half the debts in the case were incurred by an individual primarily for a personal, family, or household purpose it is considered a consumer case.  Trustees can recover a preferential payment in a consumer case if the total amount of all preferences is more than $600 in that case.  If the case is not a consumer case, preferences must total more than $5,850 before the trustee can recover them.

Congress permits the trustee to recover preferences to discourage creditors from taking more than their fair share from the debtor just before a case is filed. The law is intended to promote an equal distribution of the debtor’s assets. It also prevents the debtor from picking and choosing which creditors to pay.

Bankruptcy trustees are paid a commission on the money they collect for the estate. For this reason they are eager to recover preferential transfers for the bankruptcy estate. Some trustees are lawyers and represent themselves before the court. Lawyer trustees can pay themselves fees for legal work in recovering a preference. In this way, the trustee can be paid both legal fees for recovering the preference and a commission for handling the money.

Many consumers borrow from friends and family to make ends meet when they run out of money.  If a friend is repaid a loan within 90 days or a family member is repaid within one year before filing, the payment may be determined to be a preference and subject to recovery by the trustee.

Federal law gives the IRS a lien on all taxpayer assets if tax is not paid.  It is a powerful tool the government uses to collect tax.  However, it is the Notice of Federal Tax Lien that most people think of when the subject comes up.  This notice is filed by the IRS when they stake a claim on all taxpayer property.

 A tax lien is created automatically after the following three things occur:

1. The IRS assess tax liability against the taxpayer;
2. A notice of liability and demand for payment has been sent; and,
3. The tax debt remains unpaid for more than 10 days after notice.

 At that point in time, once these three things have happened, a “secret lien” exists on everything owned by the taxpayer.

 The tax lien becomes public when the IRS files a Notice of Federal Tax Line in the public records.  It must be filed or recorded in the place state law requires for the filing of liens and must be filed in the state where the taxpayer lives.  The IRS then sends a copy of the notice it has filed to the taxpayer.  It is this recorded notice that makes the lien public and gives it priority over any later claims.

A Federal Tax Lien, when properly recorded or filed, gives the government a property interest in everything the taxpayer ownes.  With only limited exceptions, this government interest, follows the asset wherever it goes.  The IRS may claim its rights in the property covered by the lien even after it has been sold to another person.

What is the IRS Retention Credit?  This credit is part of the HIRE Act.  If a qualified employer who has hired a qualified employee retains that employee for 52 consecutive weeks, they may be eligible for a $1,000.00 business tax credit.  See my Article on the Hire Retention Credit for a definition of qualified employers and qualified employees.

Qualified employers can receive a credit of the lesser of $1,000.00 or 6.2% of total wages paid to a qualified employee on their tax return at the end of their tax year.  For instance, if you are self-employed and file a Schedule C with your Form 1040, then you would claim the credit on your Form 1040.

To be eligible for the credit, the qualified employer must retain their qualified employee for 52 consecutive weeks or more, and for the last 26 weeks of the 52 consecutive weeks, the wages for the qualified employee must equal at least 80% of the wages for that employee in the first 26 weeks of employment.  This means that in order to get the credit, you cannot hire someone full time for the first 26 weeks and then drop them down to half time for the remaining 26 weeks.  For more information go to the IRS website article on the Hire Credit.

If you qualify, the new IRS Hire Retention Credit can save your business the employer’s share of the employee’s social security tax. That means that although the employee still has 6.2% social security tax taken out of their paycheck, the employer does not have to match it for qualified employees.

Who is a qualified employer? Taxable businesses, tax-exempt organizations, public colleges and universities, and Indian tribal governments. This basically covers all businesses except Federal, State, & local governments and Household Employers. So, chances are, your business qualifies as a qualified employer.

Who are qualified employees? This is a little more tricky.

First, the employee must certify via IRS Form W-11, that they were unemployed or employed for less than 40 hours per week for the 60 days prior to your business hiring the employee.

Second, the employee must be hired after 2/03/10 and before 1/01/11. However, the credit itself began with wages paid on 3/19/10.  Therefore, wages paid after 2/03/10 and before 3/19/10 do not count for the credit.

Third, the employee cannot be replacing a current employee unless the current employee leaves voluntarily or was terminated for cause. This way a business cannot terminate its present employees in order to take advantage of this credit.

Fourth, a qualified employee cannot be related to the employer.

How do I claim the credit? You claim this credit on the newly designed Form 941. You can either pay your payroll taxes in full (including the employer’s 6.2% match on a qualified employee) and get a refund at the end of the quarter, or you do not include that 6.2% in your payroll tax payments throughout the quarter which should net you zero tax due on Form 941.

For additional guidance on this credit, you can go to the Official IRS Website Article.

The 2005 bankruptcy “reform” law was really about abuse of consumers and protection of banks.  Its lofty name “The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” was no vehicle for consumer protection.  I have long felt that this effort to make consumers more “responsible” financially has contributed to the dramatic economic downturn we have experienced.  The negative publicity surrounding passage of the bill in April of 2005 caused a rush to the courthouse for many consumers.  The abrupt dropoff in filings after the effective date in October 2005, made it clear this legislation had a significant impact on the economy.

If scaring consumers by taking away some of the protection afforded by the bankruptcy laws makes them more responsible, it also seems to have contributed significantly to home loan defaults.  It makes sense.  Consumers have limited resources.  When they must dedicate more to payment of credit card debt, they have less money to pay their home loans.  Now, there is a study that documents that result.

A new paper written by three economists, Wenli Li of the Federal Reserve Bank of Philadelphia, Michelle White of the University of California San Diego, and Ning Zhu of the University of California, Davis, takes the position the 2005 bankruptcy legislation is a significant factor in the mortgage crisis and the recession it caused.  The abstract of this article is published by the National Bureau of Economic Research under the title Did Bankruptcy Reform Cause Mortgage Default to Rise?  It promotes the paper as arguing that “an unintended consequence of the reform was to cause mortgage default rates to rise.”

After looking at a large number of individual mortgages, the authors conclude that default rates increased by 14% in prime mortgages and 16% in subprime mortgages after enactment of the new law.  They find that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 caused an increase in home loan defaults of approximately 200,000 per year.

You can thank those corrupt senators and congressmen who took millions in campaign contributions from banks, credit unions and other consumer lenders for bringing on the recession we struggle with today.  However, in all honesty, it is the live for today attitude of most first world consumers that is the root of our problems.  The voters elect politicians who promise to lower taxes and increase spending.  These same voters expect public benefits to increase but are unwilling to pay the price for this largess.

Income tax as well as some other types of tax can be discharged in bankruptcy if certain conditions are met.  This applies in consumer bankruptcy cases, both Chapter 7 and Chapter 13, and covers Federal, State and local income tax liability.  However, all requirements must be met before the bankruptcy is filed or the debt will remain collectible after the case is closed.  To be dischargeable in bankruptcy, income tax must meet the following requirements:

1. The income tax return must have last been due more than three years before the bankruptcy;
2. The tax return must have actually been filed more than two years before the bankruptcy;
3. The tax must have been assessed by the government;
4. The tax returns must not have been fraudulent; and,
5. There must not have been a willful attempt to evade or defeat the tax.

When each of these conditions are met, and no exceptions to the rules apply, the tax can be discharged in the bankruptcy proceeding.

Debtors often ask us what will happen to their home if they file for bankruptcy protection.  Fortunately, federal bankruptcy law and most states provide for what is often called a “homestead exemption”.  A homestead exemption acts as a shield against the claims of certain creditors.  It does this by protecting up to a specific dollar amount in real property.  Homestead exemptions are particularly important for debtors with equity in their home.  On the other hand, where a consensual lien on real property, such as a mortgage, exceeds the home’s value, the homestead exemption does not apply since there is usually no equity in the home to protect.

There are certain requirements for the homestead exemption to apply.  For instance, the real property typically must be kept as the debtor’s residence.   And depending on the state where the debtor resides, the debtor may elect to apply the federal homestead exemption over their state’s homestead exemption.  As of April 2010, the federal homestead exemption was $21,625.  Federal exemptions are not generally available to Oregon residents.  However, Oregon has protected much more home equity for its residents.

Homestead exemptions differ greatly among states.  Some states offer lucrative exemptions.  In Florida, for example, there is an unlimited homestead exemption.  Other states offer no homestead exemption of any type.   What is more common is for states to have a homestead exemption up to a specific dollar amount or area of land.   The Oregon homestead exemption is $40,000 for an individual and $50,000 for a husband and wife filing jointly.

Debtors should inquire into their state’s laws regarding homestead exemptions before filing.   This includes whether the debtor can use the federal bankruptcy homestead exemption as opposed to their state’s homestead exemption in the event that the exemption provided by federal bankruptcy law is greater.

On April 1, 2010, the debt limits for Chapter 13 Bankruptcy automatically increase to $360,475 unsecured debt and $1,081,400 secured debt.  If you owe more undisputed, non-contingent debt in either category, under Bankruptcy Code §109(e) you do not qualify to file Chapter 13 bankruptcy.  Congress limited access to Chapter 13 bankruptcy to individual debtors with debts less than certain specified amounts.

Although the debt limits for Chapter 13 bankruptcy were set by Congress, these limits are adjusted by the amount of chance in the Consumer Price Index for All Urban Consumers in the manner set out in 11 USC §104(a), a part of the bankruptcy code.  The adjustment occurs every three years on April 1^st and is based on the amount of change that has occurred over the previous three years ending December 31 the year before the adjustment.  Dollar amounts are rounded to the nearest $25 and the adjustment applies to other limits set forth in the bankruptcy code.

The most recent changes in bankruptcy code dollar limits are listed in the federal register.  These changes apply to many different dollar limits set forth in Chapter 7, Chapter 11, Chapter 12 and Chapter 13 Bankruptcy Cases.

Many of my clients come to see me about penalties assessed against them by the IRS.  For example, if you don’t file your return on time or if you do not pay your tax by the due date you may be assessed a penalty. The following is a list of nine things the IRS wants you to know about the two different penalties you may face if you do not pay or file on time.

1. If you do not file by the deadline, you might face a failure-to-file penalty.
2. If you do not pay by the due date, you could face a failure-to-pay penalty.
3. The failure-to-file penalty is generally more than the failure-to-pay penalty. So if you cannot pay all the taxes you owe, you should still file your tax return and explore other payment options in the meantime.
4. The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes.
5. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
6. You will have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes.
7. If you filed an extension and you paid at least 90 percent of your actual tax liability by the due date, you will not be faced with a failure-to-pay penalty if the remaining balance is paid by the extended due date.
8. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100% of the unpaid tax.
9. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.