The Internal Revenue Service announced today that it is providing taxpayers an additional day to file their tax returns following a computer problem that arose early in the morning on April 17, the tax filing deadline. Taxpayers will now have until midnight on Wednesday, April 18, to file their returns. No action is necessary in order for taxpayers to receive the benefit of an extra day.

“This is the busiest tax day of the year, and the IRS apologizes for the inconvenience this system issue caused for taxpayers,” said Acting IRS Commissioner David Kautter. “The IRS appreciates everyone’s patience during this period. The extra time will help taxpayers affected by this situation.”

A Washington Post article reported that “several senior government officials, speaking on the condition of anonymity, said the agency’s outdated technology failed amid the crush of last-minute filers.” The IRS has faced years of budget cuts from Congress, with its workforce steadily dwindling and its technology systems in dire need of upgrades.

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Tomorrow is the annual deadline for the filing of individual income tax returns for calendar year 2017.  The Internal Revenue Service expects to receive approximately 32 million returns in the final days leading up to April 17.  In addition, the IRS expects to receive about 12 million last-minute requests for extensions of the April 17 filing deadline.  With millions of taxpayers scrambling to meet tomorrow’s deadline, we provide this recap of the IRS’s annual list of the “Dirty Dozen” tax scams for 2018 and a link to our prior blog posts addressing each one.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS highlighted each of these scams on twelve consecutive days leading up to the filing deadline to help raise awareness.

1. “Phishing” scams: These schemes typically take the form of fake emails or websites looking to steal personal tax information and often increase in frequency during tax season.

2. Phone scams where criminals pose as IRS agents: In aggressive phone scams, criminals pose as IRS agents in hopes of stealing money. During filing season, the IRS generally sees a surge in scam phone calls threatening such things as arrest, deportation, and/or license revocation if the victim does not pay a phony tax bill. In a new variation, the IRS has observed that identity thieves are filing fraudulent tax returns with refunds going into the real taxpayer’s bank account, followed shortly thereafter by a threatening phone call trying to convince the taxpayer to send the money to the fraudster.

3. Identity theft: Even though instances of tax-related identity theft have declined markedly in recent years, the IRS warns that this practice is still widespread and remains serious enough to earn a spot on its annual list of tax scams. Tax-related identity theft occurs when someone uses a stolen Social Security number or Individual Taxpayer Identification Number (ITIN) to file a fraudulent tax return claiming a refund.

4. Tax return preparer fraud: With more than half of the nation’s taxpayers relying on someone else to prepare their tax return, the IRS reminds consumers today to be on the lookout for unscrupulous tax preparers looking to make a fast buck from honest people seeking tax assistance. The IRS recognizes that the majority of tax professionals provide honest, high-quality service. But there are some dishonest preparers who operate each filing season to perpetrate refund fraud, identity theft, and other scams that hurt honest taxpayers.

5. Fake charities: Scam groups masquerade as charitable organizations, luring people to make donations to groups or causes that don’t actually qualify for a tax deduction.

6. Falsely inflated refunds:  Scam artists frequently prey on older Americans, low-income taxpayers, and others with promises of big refunds.

7.  Improper claims for business credits:  Two common credits targeted for abuse include the research credit and the fuel tax credit. While both credits have legitimate uses, there are specific criteria that must be met in order to qualify for them.

8.  Falsely padding deductions:  Common areas targeted by unscrupulous tax preparers involve overstating deductions such as charitable contributions, padding business expenses, or improperly claiming credits such as the Earned Income Tax Credit or Child Tax Credit.

9.  Falsified income and fake Form 1099 scams:   A common tax scam the IRS sees each year involves falsifying income in order to claim refundable credits, such as the Earned Income Tax Credit. Another frequent scheme involves the filing of false Forms 1099 and/or bogus financial instruments such as bonds, bonded promissory notes, or worthless checks.

10.  Frivolous tax arguments:  Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish legal claims to avoid paying their taxes. Such arguments have been repeatedly thrown out of court.

11.  Abusive tax shelters:  These sophisticated schemes, particularly those involving micro-captive insurance shelters, are peddled by promoters and others to avoid taxes.

12.  Offshore tax evasion: Offshore tax compliance has been a major focus for the IRS in recent years, and taxpayers who avoid taxes by hiding money or assets in unreported offshore accounts should remain wary given the continuing focus on such schemes by both the IRS and the Justice Department.

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BitcoinWith the April 17 deadline for filing individual tax returns just around the corner, individuals who engaged in cryptocurrency transactions during 2017 must take care to properly report them on their tax returns. As we have previously reported, the IRS is focusing significant attention on tax compliance with respect to cryptocurrency transactions. Last year, the IRS prevailed in its long-running litigation with Coinbase seeking the names of clients who engaged in cryptocurrency transactions during 2013-2015, and Coinbase recently announced that it was disclosing transaction data to the IRS for 13,000 of its customers. In addition, the IRS-Criminal Investigation Division is ramping up its scrutiny of cryptocurrency transactions by assembling a team of specialized investigators in this area. And most recently, on March 23, the IRS issued a very public “reminder” to taxpayers about reporting cryptocurrency transactions and threating audits, penalties, and even criminal prosecution for non-compliance.

Four years ago, the IRS issued its only guidance to date regarding its view of the tax treatment of cryptocurrency transactions. Despite the explosion of interest in cryptocurrencies (currently more than 1,500 such currencies exist) and the monumental increase in Bitcoin’s value last year (an uptick of more than 1,400 percent before year’s end), the IRS has not updated its views or issued further guidance to investors, thus leaving individuals scrambling to make sure that their 2017 tax returns are properly capturing cryptocurrency transactions. This is especially critical for investors who sold Bitcoin during its rocket-like trajectory last year.

The IRS considers cryptocurrency transactions taxable just like transactions in any other property, and general tax principles that apply to property transactions apply. As a consequence, the following rules apply:

– A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

– Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply.  Normally, payers must issue Form 1099-MISC.

– Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

– Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third Party Network Transactions.

– The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

In an article published by Bloomberg today, Lily Katz and Lynnley Browning write that many investors, and even tax professionals, are struggling to properly report their cryptocurrency transactions on their 2017 tax returns, due to be filed in four days:

If you thought trading Bitcoin was wild, try figuring out how to pay taxes on it.

Cryptocurrency investors are wrestling with spotty records, tangled blockchain addresses and rudimentary guidelines issued back in the ancient days of 2014. After last year’s boom in values, many people are likely disclosing transactions for the first time, adding to confusion.

The Bloomberg article further reports that the IRS is advising individuals to look for tax guidance in analogous areas:

An IRS spokesman said that in addition to the agency’s 2014 guidance, taxpayers should look at other rules governing an exchange or transfer of property and find the “factual scenarios that most closely resemble their circumstances.”

Individuals who fail to properly report their cryptocurrency transactions can face harsh consequences, including civil audits, penalties, and even criminal prosecution, as the IRS warned in a recent press release reminding taxpayers to report such transactions:

Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Despite the lack of up-to-date IRS guidance, and the uncertainly surrounding the tax consequences of recent developments in this area (such as “hard forks”), cryptocurrency investors would be well-advised to exercise caution with their income tax returns due next week.

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A number of parties have filed amicus curiae briefs in South Dakota v. Wayfair, a case that could substantially reshape the state sales tax landscape.  See here.  Perhaps one of the most interesting amicus briefs was filed by a group of U.S. Senators who support South Dakota in its urging the Supreme Court to overturn the Quill Corp. v. North Dakota physical presence standard.  The Senators are Heidi Heitkamp from North Dakota, Lamar Alexander from Tennessee, Richard Durbin from Illinois, and Michael Enzi from Wyoming – two Democrats and two Republicans.

The Senators argued that, as of 2015, there were almost $26 billion in uncollected sales and use taxes because of Quill.  Merchants with physical locations in the Senators’ states are at an economic disadvantage because they must charge higher prices than out-of-state retailers who need not collect tax.  The Senators noted that their states –North Dakota, Tennessee, Illinois, and Wyoming – rely heavily on state sales taxes for revenue.  As a result, when Wayfair makes sales in those states, the Senators argued, Wayfair has a significant price advantage over businesses with physical presences in those states because it is not required to collect those state taxes under Quill.

The Senators emphasized that Justice Kennedy has said that Quill was “questionable even when decided, [and] now harms States to a degree far greater than could have been anticipated earlier.”  Direct Mktg. Ass’n v. Brohl, 135 S.Ct. 1124, 1135 (2015) (Kennedy, J., concurring).

The Senators also tried to persuade the Court that there would be no confusion if the Court overturned the bright-line rule in Quill.  First, they argued that there is little evidence that states would pass burdensome use tax collection laws if Quill were overturned.  According to the Senators, the same internet technologies that make Quill problematic—because they facilitate large scale remote sales that deprive states of sales tax revenue they would collect from brick-and-mortar retailers—have driven down compliance costs, which reduces the likelihood that state laws would impose significant costs on remote sellers.  Second, the Senators argued that the overturn of Quill would not mean the Court could not protect interstate sellers though other doctrines, such as the balancing test in Pike v. Bruce Church, Inc., 397 U.S. 137 (1970).  Third, Congress, the Senators argued, is standing by to act if states overstep by imposing harsh burdens on out-of-state retailers.  This last point is interesting, but it is worth questioning whether it is persuasive, because Congress has yet to legislate Quill away, despite the fact that it has had many years to do so.  As a result, it is worth considering whether Congress would get involved.

The Supreme Court will hear oral arguments April 17, 2018.

As clients reach retirement age, many often consider a change in their domicile as part of their retirement plan. Aside from the warmer winters, Florida is a popular state for change of domicile because it has no income tax and no state inheritance tax. Another important aspect of becoming a Florida resident is the Florida Homestead Exemption provided by the Florida Constitution. In addition to allowing for a reduction in local real estate taxes, the Homestead Exemption also provides that the homestead is exempt from claims of creditors of the Florida resident.

Illustrated "Welcome to Palm Beach, Florida" Retro Poster.Most times, the tax authorities challenging the change in domicile are from the state the taxpayer is leaving, since they are losing a taxpayer, rather than the new state. For example, New York, Pennsylvania and New Jersey have a 183-day rule which provides that if you are present in the state for 183 days you are deemed to be a resident for income tax purposes. This means that you would have to pay income tax as a resident if you are present in that state for 183 days. Florida, on the other hand, does not have a 183-day rule for purposes of determining whether you are a resident. So it is often the exit state that challenges a change in domicile when the taxpayer files a final resident return.

In the recent Florida case of Ramos v. Motamed, decided by the Circuit Court for Palm Beach County, the taxpayer’s change of domicile was challenged in the destination state of Florida rather than the exit state of California. The case was not initiated by Florida. Rather, it was a creditor seeking to enforce a judgment against the debtor. The creditor argued that the Homestead Exemption should not apply to the debtor because he was not really a Florida resident, and therefore should not protect the taxpayer’s luxury condominium from being used to satisfy the creditor’s judgment.

The taxpayer did all of the usual steps to establish a new domicile, such as obtaining a property in the state, changing his voter registration, obtaining a Florida driver’s license and even obtaining a new local library card.

However at trial, the creditor provided other evidence indicating that the debtor did not actually move to Florida. In particular, he presented gym records showing that the debtor attended his gym in California 300 out of 365 days in 2015. The court determined that based on this evidence, the taxpayer did not actually change his domicile to Florida. He was therefore not entitled to Florida’s Homestead Exemption, and his condominium could be used to satisfy the creditor’s judgement. The property was listed for judicial sale and sold shortly thereafter.

If you are considering a change in your state of domicile, this case shows that while changing your driver’s license, voter registration and other administrative details are relevant factors, the most important thing is that you actually move to the new state.

At least for this one taxpayer, who loved to go to the gym, you could say that his attempt to change domicile was an exercise in futility which did not work out.

The New Jersey legislature may enact a law that would create a tax amnesty program for New Jersey taxes.  If enacted, the amnesty program would not exceed 45 days or end later than June 15, 2018.  Under the amnesty program, a taxpayer who previously failed to pay New Jersey tax could pay the deficiency and only half the accrued interest by May 1, 2018.  Eligible taxpayers, however, who choose not to participate in the amnesty program would be subject to an additional 5% penalty.  In addition, participating taxpayers would not be subject to civil or criminal penalties related to the New Jersey taxes.

The amnesty program, however, would only apply to New Jersey tax returns due between February 1, 2009 and January 1, 2018.  Taxpayers under criminal investigation for a New Jersey tax matter would not be eligible for the program.  If New Jersey enacts the amnesty program, it will be a good opportunity for taxpayers to address outstanding New Jersey tax issues.

The Internal Revenue Service has warned taxpayers to be wary of abusive tax shelters, which remain on the annual “Dirty Dozen” list of tax scams for 2018. These sophisticated schemes, particularly those involving micro-captive insurance shelters, can be peddled by promoters and others to avoid taxes.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS is highlighting each of these scams on twelve consecutive days to help raise awareness.

The text of the IRS announcement follows:

These scams can range from simple schemes to inflate refunds to more elaborate efforts related to tax shelters.

Through audits, litigation, published guidance and legislation, the IRS continues to address those using abusive micro-captive insurance tax shelters.

Tax law generally allows businesses to create “captive” insurance companies to protect against certain risks. Traditional captive insurance typically allows a taxpayer to reduce insurance costs. The insured business claims deductions for premiums paid for insurance policies. Those amounts are paid, either as insurance premiums or reinsurance premiums, to a “captive” insurance company owned by the insured or parties related to the insured.

Under section 831(b) of the tax code, captive insurers that qualify as small insurance companies can elect to exclude limited amounts of annual net premiums from income so that the captive insurer pays tax only on its investment income.

In certain “micro-captive” structures, promoters, accountants or wealth planners persuade owners of closely-held entities to participate in schemes that lack many of the attributes of genuine insurance.

For example, coverages may insure implausible risks, fail to match genuine business needs, or duplicate the taxpayer’s commercial coverages. Premium amounts may be unsupported by underwriting or actuarial analysis, may be geared to a desired deduction amount or may be significantly higher than premiums for comparable commercial coverage. Policies may contain vague, ambiguous or deceptive terms and otherwise fail to meet industry or regulatory standards. Claims’ administrative processes may be insufficient or altogether absent. Insureds may fail to file claims that are seemingly covered by the captive insurance.

Micro-captives may invest in illiquid or speculative assets or loans or otherwise transfer capital to or for the benefit of the insured, the captive’s owners or other related persons or entities.  Captives may also be formed to advance inter-generational wealth transfer objectives and avoid estate and gift taxes. Promoters, reinsurers and captive insurance managers may share common ownership interests that result in conflicts of interest.

In Avrahami v. Commissioner, the U.S. Tax Court disallowed premium deductions the taxpayer had claimed under a section 831(b) micro-captive arrangement, concluding that the arrangement was not “insurance” under long established decisional law principles. To qualify as insurance under those principles, an arrangement must involve risk shifting, risk distribution and insurance risk, and must also meet commonly accepted notions of insurance. The Avrahami court concluded that the taxpayer’s arrangement failed to distribute risk and that the taxpayer’s captive was not a bona fide insurance company. The court pointed to a number of facts that it found problematic, including circular flows of funds, grossly excessive premiums, non-arm’s length contracts, and an ultra-low probability of claims being paid. The court also concluded that the arrangement was not insurance in the commonly accepted sense, due in part to haphazard organization and operation, the captive’s investments in illiquid assets, unclear policies, and inflated premiums.

In Notice 2016-66 (Nov. 1, 2016), the IRS advised that micro-captive insurance transactions have the potential for tax avoidance or evasion. The notice designated transactions that are the same as or substantially similar to transactions that are described in the notice as “Transactions of Interest.” The notice established reporting requirements for those entering into such transactions on or after Nov. 2, 2006, and created disclosure and list maintenance obligations for material advisors.

Separately, Congress has also acted to curb micro-captive abuses. The Protecting Americans from Tax Hikes (PATH) Act, effective Jan. 1, 2017, established strict diversification and reporting requirements for new and existing captives.

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As part of its annual “Dirty Dozen” list of tax scams, the Internal Revenue Service warned taxpayers of schemes that falsify income or involve phony Forms 1099. A common tax scam the IRS sees each year involves falsifying income in order to claim refundable credits, such as the Earned Income Tax Credit. Another frequent scheme involves the filing of false Forms 1099 and/or bogus financial instruments such as bonds, bonded promissory notes, or worthless checks.

Compiled annually by the IRS, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter any time of the year, but many of these schemes peak during filing season as people prepare their tax returns or seek help from tax professionals. To help protect taxpayers, the IRS is highlighting each of these scams on twelve consecutive days to help raise awareness.

The text of the IRS announcement follows:

Don’t Make Up Income

Some people falsely increase the income they report to the IRS. This scam involves inflating or including income on a tax return that was never earned, either as wages or self-employment income, usually to maximize refundable tax credits.

Much like falsely claiming an expense or deduction is improper, claiming income the taxpayer didn’t earn is also inappropriate. Unscrupulous return preparers and people do this to secure larger refundable credits such as the Earned Income Tax Credit and it can have serious repercussions.

Remember, taxpayers can face a large bill to repay the erroneous refunds, including interest and penalties. In some cases, they may even face criminal prosecution.

Fake Forms 1099-MISC

The IRS cautions taxpayers to avoid getting caught up in schemes disguised as a debt payment option for credit cards or mortgage debt. This scheme usually involves the filing of a Form 1099-MISC, Miscellaneous Income, and/or bogus financial instruments such as bonds, bonded promissory notes or worthless checks.

Con artists often argue that the proper way to redeem or draw on a fictitious “held-aside” account is to use some form of made-up financial instrument, such as a bonded promissory note, that purports to be a debt payment method for credit cards or mortgage debt. Scammers provide fraudulent Form(s) 1099-MISC that appear to be issued by a large bank, loan service and/or mortgage company with which the taxpayer may have had a prior relationship, all to help further perpetrate the scheme. Form 56, Notice Concerning Fiduciary Relationship, may also be used by participants in this scam to assign fiduciary responsibilities to the lenders.

Taxpayers may encounter unethical return preparers who try to lure them into these scams. It is important to remember that taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else.

Choose Return Preparers Carefully

It is important to choose carefully when hiring an individual or firm to prepare tax returns. Well-intentioned taxpayers can be misled by tax preparers who don’t understand taxes or who mislead people into taking credits or deductions they aren’t entitled to in order to increase their fee. Every year, these types of tax preparers face everything from penalties to jail time for defrauding their clients.

To find tips about choosing a preparer, better understand the differences in tax credentials and qualifications, research the IRS preparer directory and learn how to submit a complaint regarding an unscrupulous tax return preparer, visit www.irs.gov/chooseataxpro.

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