Possible Circular 230 Update

From the IRS report on IRSAC's report: "On November 16, 2016, the Internal Revenue Service Advisory Council (IRSAC) issued its 2016 Public Report. In that report, the IRSAC made two recommendations related to the Office of Professional Responsibility(OPR). The IRSAC recommended that the Commissioner request Congress to enact legislation expressly affirming the Treasury Department’s authority under 31 USC 330 to establish and enforce professional standards for both paid tax return preparers and tax ‘practice’ broadly defined. The IRSAC has made similar recommendations in its two previous reports. The IRSAC also made a series of recommendations for revisions to Treasury Circular 230, to delete obsolete references, provide authority to address some topics currently contained in Circular 230 through revenue procedures or other administrative guidance, add references to appraisers, and delete outdated language. OPR Director Stephen Whitlock thanked the IRSAC for its thorough analysis of these issues, and committed to work with IRS, Treasury and tax professional groups to determine whether additional topics should be addressed in a revision of Circular 230."


It would be interesting to see some of the updates. After some recent cases, practitioners are up in the air over what sections of Circular 230 are even actionable anymore.

Proof a Loan is a Loan

One interesting issue that often arises in IRS audits is whether what a taxpayer classifies as a loan is actually a loan.
The Tax Court recently released an interesting, taxpayer friendly, decision on this matter in Stanley v. Commission, TC Memo 2016-196.


The general rule being:


Courts consider various factors in determining whether the parties intended
a bona fide loan, such as: (1) the ability of the borrower to repay; (2) the existence
or nonexistence of a debt instrument; (3) security, interest, a fixed repayment date,
and a repayment schedule; (4) how the parties’ records and conduct reflect the
transaction; (5) whether the borrower had made repayments; (6) whether the
lender had demanded repayment; (7) the likelihood that the loan was disguised
compensation for services; and (8) the testimony of the purported borrower and
lender. Welch v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000), aff’g T.C.
Memo. 1998-121; Frierdich v. Commissioner, 925 F.2d 180, 182 (7th Cir. 1991),
aff’g T.C. Memo. 1989-393; see also Todd v. Commissioner, T.C. Memo. 2011-
123, aff’d, 486 F. App’x 423 (5th Cir. 2012). The factors are “non-exclusive” and
provide a “general basis upon which courts may analyze a transaction”. Welch v.
Commissioner, 204 F.3d at 1230.


In Stanley, the taxpayer did not even have a plan of repayment, but his testimony that he believed the loan offered a good rate of return, and that he did intend to repay the loan helped meet the above tests. The taxpayer was also able to supply general promissory notes.


When working with loans, its always important that taxpayers document any agreements. I've seen these agreements even documented on a napkin over a dinner deal for a loan.


Relevant Citations: TC Memo 2016-196

Ability to Go to Tax Court - Suspended Corporation Status

In Urgent Care Nurses Registry, Inc. v. Commissioner, the Tax Court found that Urgent Care Nurses Registry, Inc. did not have jurisdiction to go to Tax Court because their charter was suspended under California law. This is due to the corporation not having legal capacity to prosecute the case.


This is a pretty common occurrence in the tax world and one that practitioners need to be aware of when representing a business entity. Before taking anything to Tax Court, all state obligations to make sure the company is in good standing with the state should be made.


Relevant Citation: TC Memo 2016-198

Statute of Limitations - Tax Court Docketed Cases

IRS released Chief Counsel Advice 201644020. The most interesting takeaway is that it is the IRS' belief that that statute of limitations on assessment will be suspended when a case is placed on the Tax Court docket for a deficiency hearing, even is there is no deficiency notice that has been issued.


Interesting piece of tax procedure in that the statutory notice of deficiency is not key for suspending the assessment statute.


Relevant Citations: Chief Counsel Advice 201644020

Gift Tax Statute of Limitations

IRC 6501(a) defines the statute of limitations on assessment of a gift tax return as three years from when it is filed.


IRC 6501(c)(9) provides an exception if a gift is not reported on the return to extend the statute of limitations.


In Chief Counsel Advice 201643020, the IRS determined that prior year gifts that were not disclosed on a gift tax return do not count as unreported gifts under IRC 6501(c)(9). If a taxpayer fails to disclose prior year gifts on a gift tax return, then the 3 year statute of limitations will still apply.


Relevant Cites:
Chief Counsel Advice 201643020
IRC 6501

IRS Auditors Need to Consider Collectability More Often

TIGTA just released a new report detailing the IRS' lack of following established procedures for determining collectability during audit.


56 percent of cases sampled did not follow collectability procedures. TIGTA estimated that 1,731 office audits and1,445 field audits were closed where the auditor did not follow established collectability procedures. These cases were later closed out as Currently Not Collectable by the IRS Collection division.


This is really important. Representatives need to bring this issue up more for their clients. Under the IRM, collectability needs to be considered throughout the audit process. If circumstances change, clients can get no change audit reports due to their inability to pay the audit adjustments.


IRM management is going to take corrective actions proposed by TIGTA to try to eliminate this issue in the future.


Relevant Cites: TIGTA Report

Admitting to Income in Non-Tax Cases

An Tax Court order was released in Swartz v. Commissioner. Swartz worked for Tyco and during his time there proceeded to steal $12.5 million through loan write-offs. A criminal case arose from the theft and Mr. Swartz was found guilty of theft.


The IRS used the criminal conviction to assert that Mr. Swartz had $12.5 million of income in the year he stole the money. The Tax Court found that he was collaterally estopped from arguing that he did not receive the $12.5 million. Under IRC 61(a), income from criminal endeavors are considered taxable income.


This case brings up a big issue for tax practitioners. When representing a client, there can often be many different things that can be affected by a single decision. Here, Mr. Swartz may have had a chance to settle his criminal case out of court. If he had, then he would not have been collaterally estopped from arguing he did not receive the income and may have avoided a hefty tax bill.


Relevant Cites: Tax Court order, Mark H. Swartz, Docket No. 3583-10

IRS e-Services Update Delayed

The IRS has decided to delay their e-Services update that would require users to re-register and validate identities. Originally, this was planned to take place on October 24th. The IRS has suspended this indefinitely.

Taxing Olympians

Obama has signed into law a bill that will exclude from income Gold, Silver, and Bronze metals for US Olympians and Para-Olympians. The bill also excludes money received from the US Olympic Committee as cash bonuses for winning a medal at the Olympics.


The exemption only counts for athletes making less than $1,000,000 ($500,000 if filing married filing separately). So, the NBA players and endorsement rich athletes will still most likely need to pay taxes on these earnings, but it goes a long way for some of the athletes with less means.

Disputing Tax Liability in a CDP Hearing

TC Memo 2016-186, Smith v. Commissioner was released and brings up interesting procedural issues for Collection Due Process Hearings (CDP).


In the case, the taxpayer wanted to raise whether or not he was liable for the taxes being collected. However, this was denied. A taxpayer may raise a doubt as to liability claim in a CDP hearing, but only if he has not previously had a chance to dispute the liability or he did not receive a statutory notice of deficiency for the liability.


The chance to challenge the determination also includes previous chances to go to a CDP hearing.


The procedural reasoning is pretty clear: taxpayers should get one bite at the apple and to allow multiple challenges to the same issue can take time away from more legitimate claims that the IRS needs to process.


Relevant Cites: TC Memo 2016-186

OIC Fee Increase

IRS released Proposed Regs. that will increase the OIC fee from $186 to $300. The effective date would be on February 27, 2017.


One can only hope an increased in fees will lead to a quicker turnaround on OICs.


Relevant Citations: Proposed Reg. 300.3

IRS E-Services Security Updates Coming

For those who haven't seen yet, the IRS is projecting October 24th to update e-services. The update will require everyone to re-register and verify their identities.


Hopefully the process goes well, but if anyone remembers originally registering, especially to get Transcript Delivery working, this has the potential to be an issue for practitioners.


Hopefully this does not interrupt anything with transcript delivery, but practitioners should be aware of it and may want to schedule sometime that day in case they need to take with the IRS help desk.
If you registered for Get Transcripts after June 2016, then you should be okay.


Relevant Citations: IRS: Important Update about Your e-Services Account

IRS Expands Streamlined Installment Agreements

The IRS has expanded streamline installment agreements until September 30, 2017. Instead of the needing less than $50,000 of taxes due, the IRS increased the amount to $100,000 of tax, interest, and penalties due.


In addition, the IRS will accept the installment agreement if the payments is the greater of the amount due divided by 84 (instead of 72) or the amount necessary to collect the tax in full before the collection statute runs.


Remember, taxpayers with the ability to pay their taxes in full can still qualify for these streamlined installment agreements.


Relevant Citations: IRS: Streamlined Processing of Installment Agreements

New Debt Collection Program Starts in the Spring

The IRS announced in IR 2016-125, that starting in the spring, the IRS will start using private debt collectors to collect on some tax debts. The tax debts that will be assigned to the collection agency are inactive tax debts that they do not have time to work.


The private contractors are supposed to follow all the same rules as the IRS while respecting taxpayers' rights. These contractors must also identify themselves as contractors and that they are not part of the IRS.


We will see how this plays out, but it seems that this is ripe for fraud and abuse of taxpayer rights.


Relevant Cites: IR 2016-125

Installment Agreements When Client Has Ability To Pay

I have seen this issue come up a couple of times now where the client wants to enter into an installment agreement but has the ability to pay. Working with Revenue Officers, the Revenue Officers are requesting full payment on the taxes due.


For streamlined installment agreements, practitioners should point out IRM 5.14.5.2(12), which states, "Taxpayer may be granted streamlined agreements based on the criteria provided in IRM 5.14.5.2.(1)-(11), even if they are able to fully pay their accounts."


For guaranteed installment agreements, practitioners should point out IRM 5.14.5.3(2), which states, "As a matter of policy, the Service grants guaranteed agreements even if taxpayers are able to fully pay their accounts."


So, there is no basis for Revenue Officers saying the IRS will not accept a streamlined or guaranteed installment agreement if the taxpayers have the full ability to pay.


Relevant Citations: IRM 5.14.5

Importance of TARS Regulations

Last tax season, tax practitioners got to experience TARS and its impact on the tax world. One of its best aspects is the de minimus safe harbor election. Under the de minimus safe harbor election, if a taxpayer has a business that does not have audited financial statements, they can expense $2,500 ($5,000 if they have audited financials) of items that were previously capitalized.


In order to do so, the taxpayer need only to consistently apply the a fixed asset expensing procedure throughout the year. For example, if the taxpayer has two new fixed assets worth $500 and $1,000, both must be expensed under their fixed asset procedures. If only one is expensed, the IRS can say that the safe harbor does not apply.


The safe harbor is great because the IRS will not challenge whether or not an asset needs to be expensed or capitalized.


The importance came up a little bit in Kilpatrick v. IRS. It should be noted, the tax years involved are 2009 and 2010, so the safe harbor would not have been available.


Kilpatrick (a CPA) had bought 2 oak armchairs, a desk, paintings, bowls, and a chandelier. Before even considering the business use of the assets, the court was able to deny Kilpatrick's deduction for these expenses because he just expensed the item without claiming IRC 179.


In the current tax would, if Kilpatrick would have included the safe harbor election, these expenses would not require the 179 election and would not be challenged by the IRS on whether or not they should be capitalized.


It is good practice now, to have all taxpayers make the election and for their accountants to properly use a fixed asset accounting procedure that complies with the safe harbor election.


Relevant Citations: Reg. 1.263A-1, TC Memo 2016-166

TIGTA: OIC Public Inspections

Under the Internal Revenue Code, the IRS must make accepted offer-in-compromises available for public inspection.


Currently, to view the files, a taxpayer needs to call the IRS and request an appointment to view the files. The process can be a pain for taxpayers to get the information they are entitled under law.


TIGTA has proposed the IRS create an electronic format database for public inspection of these offers. This would allow taxpayers to quickly access the information online. The IRS has agreed with these recommendations.


Sometime in the future, expect to access approved OICs online. This will help practitioners better prepare clients on whether or not their offer will be accepted.


Relevant Citations: TIGTA Report

S Corp: Repayment of Loan vs. Wages

One frequent S Corporation exam issue is whether payments to an owner should be classified as a loan or classified as wages to the owner. Most Revenue Agents look for loan documents to prove a loan existed. However, that is not the correct application of the law. When this issue comes up, practitioners can point to the recently released Scott Singer Installations, Inc. v. Commissioner, TC Memo 2016-161.


In the case, loan documents did not exist, but the court still found there was a loan. Instead the court looks at several factors.

"Such factors include: (1) the names given to the documents that would be evidence of the purported loans; (2) the presence or absence of a fixed maturity date; (3) the likely source of repayment; (4) the right to enforce payments; (5) participation in management as a result of the advances; (6) subordination of the purported loans to the loans of the corporation’s creditors; (7) the intent of the parties; (8) identity of interest between creditor and stockholder; (9) the ability of the corporation to obtain financing from outside sources; (10) thinness of capital structure in relation to debt; (11) use to which the funds were put; (12) the failure of the corporation to repay; and (13) the risk involved in making the transfers. Calumet Indus., Inc. v. Commissioner, 95 T.C. 257, 285 (1990); see also In re Lane, 742 F.2d 1311, 1314-1315 (11th Cir. 1984)."

Here, no factor is controlling. In Scott Singer Installations, Inc., the taxpayer was able to show he contributed money to the company in its early stages and these contributions were actually loans. The court looked to see if he consistently treated these payments as a loan (which most taxpayers do), and if the repayments were consistent and did not vary based on the amount of work done.

This is a great case to point at when you are having troubles with debt vs. wages on S Corporations and partnerships.


Relevant Citations: TC Memo 2016-161

IRS Warns Practitioners of Attacks on Tax Professional Computers

The IRS released IR 2016-119 which details approximately two dozen cases where a tax practitioner had their computer taken over remotely by criminals in order to file fraudulent returns.


The IRS recommends all tax practitioners do the following:

• "Run a security “deep scan” to search for viruses and malware;
• Strengthen passwords for both computer access and software access; make sure your password is a minimum of eight digits (more is better) with a mix of numbers, letters and special characters and change them often;
• Be alert for phishing scams: do not click on links or open attachments from unknown senders;
• Educate all staff members about the dangers of phishing scams in the form of emails, texts and calls;
• Review any software that your employees use to remotely access your network and/or your IT support vendor uses to remotely troubleshoot technical problems and support your systems. Remote access software is a potential target for bad actors to gain entry and take control of a machine."

Relevant Citations: IR 2016-119

IRC 162 - Ordinary and Necessary

Armando Adames Rivas v. Commissioner, TC Memo 2016-158, really brings the concept of ordinary and necessary under IRC 162 to the forefront. Often tax practitioners may deduct expenses without much verification as to what the expenses are for.


Under IRC 162, any business expense must be 1) ordinary in the course of the business and 2) necessary for the business. For example, a real estate broker deducting depreciation on four Corvettes may not be necessary for the business.


In Rivas, the taxpayer owned a financial consulting business. In 2011, he reported $24,630 of advertising expenses and in 2013, he reported $28,652 of advertising expenses. According to the taxpayer, these expenses "related to 'horses purchased for business use and the losses.'"


This is where the concept of ordinary and necessary really comes in play. Most, if not all, financial consulting businesses do not own horses. Further, if any do, most do not buy them as an advertising expense. The court shutdown any arguments with, "This unsubstantiated assertion does not suffice to create a triable issue of fact concerning his ability to claim horse-related costs as advertising expenses of a financial consulting business."


When working with taxpayers, its good that they have an understanding of what could possibly fall outside of the ordinary and necessary expense requirements for their business.


Relevant Citations: TC Memo 2016-158

Failure to File - Income Proving

There was an interesting Tax Court case, Barrion v. Commissioner that was recently released. Barrion did not file his 2012 tax return. The IRS received a W-2 for $204,805 and a 1099-INT for $73.


The IRS properly filed an SFR for the taxpayer, which allowed the standard deduction and one personal exemption. The taxpayer filed in Tax Court challenging the SFR on the grounds of,
"I had a hard drive failure and lost data. I would like to file my own return for 2012."


The IRS requested the taxpayer respond to admissions of 1) having received the income, 2) having failed to file a return, 3) provide documents for any deductions, credits, and exemptions he would be entitled, and 4) show anything that he is not liable for any penalties. The taxpayer did not respond. Under Rule 90(c), that means all matters were deemed admitted.


Since the taxpayer failed to assign error in his petition that the income was not his, the income was proven to be the taxpayers. The failure to respond and support any deductions was also upheld.


This is a good case to point out to potential clients. Under competent representation, the taxpayer could have 1) avoided Tax Court all together and 2) reduced the amount of tax due through proper submissions of deductions, credits and exemptions.


Relevant Citations: TC Memo 2016-153

60 Day IRA Rollover Waiver

In Rev Proc 2016-47, the IRS has made it much easier for people seeking a waiver for missing their 60 days required to make an IRA rollover contribution.


Under the Rev Proc, they can fail to miss the 60 day window due to: an error committed by the financial institution either getting or sending the contribution, a misplaced check, deposit into an account that was thought to be an eligible retirement plan, client's principal residence was damaged, a death in the family, a serious illness in the family, incarceration, restrictions imposed by foreign country, postal errors, IRS levy that is returned, or taxpayer made a reasonable effort but the contribution was delayed by the financial institution.


The contributions must be made 30 days after the event above stops occurring.


This is a good place to remind people that if the IRS wishes a client to make a distribution out of an IRA to pay past due taxes, its often better to request the IRS to levy the account so the taxpayer will not need to pay the 10% penalty. Even though the money goes to the same place, an exception only applies to IRS levies on these accounts.


Relevant Citations: Rev Proc 2016-47

Early Election of New Partnership Audit Rules

With everyone happy that TEFRA is going away, the IRS has decided to try to implement these new rules earlier. Now, starting with partnerships with a tax year of Nov. 2, 2015 or later, if the IRS sends an audit notice for the partnership, the partnership has 30 days to file an election to fall under the new partnership audit guidelines.


The details on the election can be found in Temp Reg 301.9100-22T. This is a great tool for the future to get out of TEFRA procedures.

Deductions in Prior Years Relating to Audit Items in Current Years

One often question I get is if an adjustment in one year will affect future tax returns. In the case Tanzi v. IRS, TC Memo 2016-148, the taxpayer took $12,332 of depreciation. In court, the taxpayer argued the IRS, "allowed substantially similar depreciation deductions for prior years and that it would therefore be logically preposterous to deny the deductions for 2011."


The court brings up Pekar v. Commissions, 113 TC 157, 166 (1999), which states, "Each tax year stands by itself, and the Commissioner is not bound by his treatment of an item for a previous year."


The Pekar case is a great case to cite to Revenue Agents. Often, a Revenue Agent will say that he needs to make an adjustment in the current year since it will set precedence in a future year. Under Pekar, this is not true. The main item that usually will have precedence is in an employment tax audit where a practitioner seeks 530 relief, but for all other cases, this is not the case.


As an example, a Revenue Agent audited a return and got substantially all of the adjustments. The 80/20 rule should have applied. However, the Revenue Agent wanted to keep auditing more issues because it could set a precedent for future years. After a discussion with the group manager, we were able to get the case closed under the 80/20 rule using Pekar as a justification as to why the Revenue Agent was incorrect.


Relevant Citation: Tanzi v. IRS, TC Memo 2016-148

CDP Hearing - Statute of Limitations Error

In CJ Weiss, 147 TC -, No. 6, an attorney filed a request for a Collection Due Process Hearing (CDP) one day late. Filing late will typically make the practitioner only eligible for an equivalent hearing. The good aspect of the equivalent hearing is the statute of limitations does not freeze like it does for a CDP Hearing.


After levy notice is mailed, practitioners have 30 days to respond in order to get a CDP Hearing. If it is after the 30 days, they will receive an equivalent hearing.


In this case, the levy notice used a date that was earlier than the date of mailing. The attorney filing his request for a CDP Hearing used the date of the levy notice when calculating the 30 days. However, when the levy notice is prior to the date of mailing, it is the mailing date that practitioners need to use when calculating the 30 days to respond. This means his CDP request was actually timely filed, which then suspended the statute of limitations for the CDP Hearing.

Material Participation - Proving Hours

A very practitioner friendly case just came out in Hailstock v. Commissioner, TC Memo 2016-146. In the case, the taxpayer never kept contemporaneous records of her hours worked on rental properties. This is one area the IRS has been very particular about. Frequently, auditors asks for contemporaneous logs of the activities and when none is given, they will classify the activity as a rental (or deny real estate pro status).


This case gives practitioners a good citation to fight this, "Although we caution petitioner to construct contemporaneous time logs for her future real estate endeavors, we find her detailed and credible testimony to be a 'reasonable means of proof.'" The reasonable means of proof test comes from Reg. 1.469-5T(f)(4), which states: "The extent of an individual's participation in an activity may be established by any reasonable means. Cotemporaneous daily time reports, logs, or similar documents are not to be required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during a period, based on appointment books, calendars, or narrative summaries."


These rules are good to keep in mind whenever going into an audit with a real estate professional or if material participation may be an issue in the case.


Relevant Citations:
Reg 1.469-5T
Hailstock v. Commissioner, TC Memo 2016-146

IRS PTIN Updates - New Fees and Court Case Challenging Fees

The IRS has dropped the fees for PTINs to $33. However, practitioners should watch for a case in DC District Court called Steele v. US. The other day, the court certified a class action challenge to the authority the IRS has to charge a fee for PTINs.


It should be noted that not all forms requiring a PTIN have a spot for the preparer's PTIN. For example, a practitioner must have a PTIN if they prepare any of the Form 433s. However, the IRS does not have a space on the form for the practitioner to put the PTIN, so some practitioners assume one is not needed.


These are the only forms a practitioner can submit to the IRS without needing a PTIN:


Form SS-4, Application for Employer Identification Number;
Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding;
Form SS-16, Certificate of Election of Coverage under FICA;
Form W-2 series of returns;
Form W-7, Application for IRS Individual Taxpayer Identification Number;
Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding;
Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment;
Form 872, Consent to Extend the Time to Assess Tax;
Form 906, Closing Agreement On Final Determination Covering Specific Matters;
Form 1098 series;
Form 1099 series;
Form 2848, Power of Attorney and Declaration of Representative;
Form 3115, Application for Change in Accounting Method;
Form 4029, Application for Exemption From Social Security and Medicare Taxes and Waiver of Benefits;
Form 4361, Application for Exemption From Self-Employment Tax for Use by Ministers, Members of Religious Orders and Christian Science Practitioners;
Form 4419, Application for Filing Information Returns Electronically;
Form 5300, Application for Determination for Employee Benefit Plan;
Form 5307, Application for Determination for Adopters of Master or Prototype or Volume Submitter Plans;
Form 5310, Application for Determination for Terminating Plan;
Form 5500 series;
Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips;
Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests;
Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests;
Form 8508, Request for Waiver From Filing Information Returns Electronically;
Form 8717, User Fee for Employee Plan Determination, Opinion, and Advisory Letter Request;
Form 8809, Application for Extension of Time to File Information Return;
Form 8821, Tax Information Authorization;
Form 8942, Application for Certification of Qualified Investments Eligible for Credits and Grants Under the Qualifying Therapeutic Discovery Project Program

Deducting MBA Costs - New Taxpayer Friendly Case

Typically, the IRS looks down at people trying to deduct MBA costs. In Kopaigora v. Commissioner (TC Summary Opinion 2016-35), the taxpayer attempted to deduct his MBA costs as unreimbursed employee expenses.


The taxpayer was an accounting and finance manager with Marriott LAX. While working at Marriott, he also pursued his MBA and took deductions as unreimbursed employee expenses. Eventually, the taxpayer was fired from Marriott and still continued to take the deductions. The IRS audited his return and disallowed these deductions.


The first step in analyzing education deductions is it meets the ordinary and necessary test of IRC 162. Also under IRC 162, the taxpayer must be engaged in a trade or business. The court points out an interesting case where, "A taxpayer may be engaged in a trade or business, although unemployed, if the taxpayer was previously involved in and actively sought to continue in that trade or business while pursuing a defined degree program related to his or her line of work. Furner v. Commissioner 393 F.2d 292, 294 (7th Cir. 1968).


So, while the taxpayer was unemployed, he could still meet the requirements under IRC 162 of being in a trade or business.


Education cannot be deducted if 1) it is required to meet minimum requirements of a taxpayer's trade or business, or 2) the study leads to qualification for a new trade or business. If the taxpayer shows neither apply, then he can deduct the costs required by his employment or trade or business. The court here held that he was improving his skills as a accounting and finance manager.


This is an interesting look at the education deduction and the rules applied. The biggest take away from the case is further reassurance that the taxpayer does not need to be employed in order to take a deduction for unreimbursed employee expenses.


Relevant Citations: TC Summary Opinion 2016-35

Check Your PTIN for Suspicious Activity

The IRS released a new security awareness tip today for practitioners. Most practitioners can go on the IRS PTIN renewal site and check how many returns have been filed under their PTIN. This is really important for practitioners to be doing and not enough people do it.


For example, if you normally prepare 80 Form 1040s each year and when you check your PTIN status it shows 500 PTINs, there is suspicious activity on the account. This has been happening very frequently.


With tax fraud becoming harder to get away with, one way criminals are finding a way around IRS roadblocks is by stealing PTINs.


If you do have issues, you can file Form 14157 with the IRS and they can help get the matter cleared.


All you need to do:
Visit http://www.irs.gov/ptin and log into your PTIN account.

1. From the Main Menu, find “Additional Activities.”
2. Under Additional Activities, select “View Returns Filed Per PTIN.”
3. A chart labeled Returns Per PTIN should appear.
4. A count of individual income tax returns filed and processed in the current year will be displayed.

Relevant Cites:

Form 14157

IRS Security Awareness Tax Tip 2016-11

New IRS ITIN Rules - Some Clients Will Need to Renew Their ITIN

If your client has an ITIN and 1) has not used it in the last three years or 2) the ITIN was issued before 2013 (these have a middle digit of 78 or 79), then they will need to renew their ITIN starting October 1, 2016.

In order to renew, the taxpayer must file Form W-7. Note, it does not need to be attached to their 2016 tax return.

The IRS provides three ways to renew:

1. Mail the W-7 along with the original identification documents or certified copies to the IRS
2. Use an IRS authorized Certified Acceptance Agents
3. Call and make an appointment with an IRS Taxpayer Assistance Center in lieu of mailing.

I recommend going through a Certified Acceptance Agent. It allows clients to keep their passports or other identifying documents instead of putting them in the hands of the IRS. This allows for a quicker turnaround too on everything with the process.

Here is a list of Certified Acceptance Agents. I also am in the process of becoming a Certified Acceptance Agent too if anyone in the Virginia area needs any help.

Relevant Citations: IRS ITIN News Release

Mortage Indebtedness - Unmarried Owning Same Property

Typically, there is a limitation on mortgage interest deduction if the mortgage indebtedness is more than $1,000,000 of acquisition indebtedness plus $100,000 of home equity indebtedness under IRC 163(h)(2)(D). In Voss v. Commissioner, 796 F.3d 1051 (9th Cir. 2015), two unmarried individuals jointly held a property where the limitations would typically apply if they were married. The combined acquisition indebtedness was in excess of $2.2 million. The IRS had disallowed portions of the mortgage interest on each return.


The court ruled that the mortgage indebtedness limitations apply on a per person basis, not on a per residence basis, thus allowing the extra mortgage interest for the taxpayers.


The IRS released AOD 2016-02 stating they will follow this analysis by the court.


Relevant Cites: AOD 2016-02

IRS Frivolous Tax Argument

As most practitioners know using a frivolous argument against the IRS is not always the best idea. In TC Memo 2016-140, Batsch v. Commissioner presents one of the best:

"And let me make a couple of more comments just to get them on the record, Your Honor. And basically the point that we’re getting at is we are not subject to the jurisdiction of the United States. I don’t know how that’s even possible. We was not born--the United States as described in the law and according to that, be it right or wrong, these laws are what we based the (inaudible) that we are not subject to. And we can’t find one where we are subject to because according to this and--and according to what we are as people that is a citizen of the several states, not of what we see as being defined as the United States or the state--the term United States when you used in a geographical sense includes the state of--I mean it--it’s just the-- where Congress has its exclusive jurisdiction. Congress does not have exclusive jurisdiction within the States."

For the record, the taxpayers were born in Missouri and Texas. Unsurprisingly, the court upheld the IRS 6020(b) substitute for returns.


Relevant Cite: TC Memo 2016-140

Failure to File Penalties - Reasonable Cause

In John Probandt, v. Commissioner (2016) TC Memo 2016-135, I found this case interesting for the failure to file penalty discussion.


Mr. Probandt failed to file a tax return and was assessed failure to file penalties for his business venture. His argument for not filing was that he believed his income was lower than his expenses, and thus would not have a filing requirement. On audit, it was determined there was enough income to trigger a filing requirement for his business venture.


The court discusses how a regular person making the determination that his expenses are higher than his income is not enough reasonable cause. However, had he received professional advice or undertook any other investigation to determine if he had a filing requirement, then it would satisfy the reasonable cause standard.


Overall the case is a good read too for the substantiation requirements for M&E and also a discussion on the Cohan rule.


Relevant Cites: Probandt v. Commissioner TC Memo 2016-135

FBARs - Online Gambling Accounts

Interesting case with US v. Hom (CA 7/26/2016), 118 AFTR 2d, 2016-5057. For FBAR purposes, offshore online gambling accounts, such as ones for online poker, are not considered financial companies for FBAR reporting purposes.

Abuse of Discretion - Arbitrary, Capricious, or Without Sound Basis in Fact or Law

TC Memo 2016-134, Mark West v. Commissioner of Internal Revenue was released on July 19, 2016. The case is pretty standard where a pro se taxpayer raised some rather frivolous arguments after a CDP hearing.


The one interesting tidbit comes on page 8 where the court brings up the abuse of discretion argument. For the relevant citations: "We review the settlement officer's administrative determinations regarding nonliability issues for abuse of discretion. Hoyle v. Commissioner, 131 T.C. 197, 200 (2008). Abuse of discretion exists when a determination is arbitrary, capricious, or without sound basis in fact or law. See Murphy v. Commissioner, 125 TC 301, 320 (2005), aff'd 469 F.3d 27 (1st Circ. 2006)."


In this case the court considered the following:

1. Properly verified that the requirements of any applicable law or administrative procedure have been met;
2. Considered any relevant issues petitioner raised; and
3. Determined whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.

This is a good list to keep in mind for practitioners. If looking to advance this type of argument, these are the points that need to be verified and documented.


The second major take away is, "It is not an abuse of discretion for a settlement officer to decline to consider a collection alternative where the taxpayer does not place a specific proposal on the table." So, when looking to advance this type of argument, and really any time a practitioner works with a settlement officer, the practitioner should always have an alternative to the IRS action.


Relevant Cite: TC Memo 2016-134

IRC 83(b) Elections

The IRS has adopted the new final regulations for Reg. 1.83-2. Under IRC 83, when a person performs services in exchange for property (typically stock), the excess fair market value of the property over any amount paid for the property is included in the person who performs the service's gross income. (The provider must have transferable rights and not be substantial risk of forfeiture of the property). IRC 83(b) allows an election to include this amount in gross income as compensation for services.


Under the new regulations, taxpayers do not need to file a copy of the 83(b) election with their tax return any more.

Tax Matter Partners

Great read from the IRS Field Attorneys on Tax Matter Partner (TMP). This is a subject I see done incorrectly a lot on tax returns.


First, do not have a TMP on a non-TEFRA return. It is incorrect and could be an issue for your client in the future. Second, if you have a TEFRA partnership, for the most part, the TMP must be a general partner. They cannot be a limited partner (except in very limited circumstances).


The interesting thing that IRS Field Attorney Advice highlight in 20161801F is that often practitioners need to look to local law and partnership agreements before selecting an TMP.


Relevant Cites: IRS Field Attorney Advice 20161801F

TEFRA - Sham Partnership

Not really new or exciting news, but the IRS released Field Attorney Advice 20162901F. In it, the IRS details whether or not an item is an partnership item or not. This is a good read to get some context before starting a TEFRA audit.


One interesting thing from the advice is that the determination a partnership is sham is a partnership item.


Relevant Cites: Field Attorney Advice 2016201F

IRS Determination on Crowd Funding

On June 24, 2016, the IRS released Information Letter 2016-0036 that looks at whether funds from crowd funding are considered gross income or not.


The basic analysis is under IRC 61(a), all income from whatever source derived is income, unless there is an exception to treating it as income. The IRS takes a facts and circumstances approach to crowd funding money.


There are three circumstances the IRS believes money raised in crowd funding is not considered income: 1) if the money is a loan that must be repaid (this is not really applicable to most crowd funding), 2) the money is capital contributed to an entity in exchange for an equity interest in capital (again, not really common in crowd funding) and 3) gifts made out of detached generosity and without any "quid pro quo." For the third rule, the IRS makes note that a voluntary transfer without "a quid pro quo" is not necessarily a gift for federal income tax purposes.


Clients that are raising money with crowd funding should be aware of this stance, especially if they are providing some sort of gift in exchange for the crowd funding funds.


Relevant Cites: Information Letter 20016-0036

Gain Exclusion on Sale of Home PLR - Unforeseen Circumstances

Interesting PLR released, PLR 201628002, by the IRS. Typically, a taxpayer can exclude $250,000 or $500,000 of gain on the sale of a primary residence if they used the property as a primary residence for two of the previous five years.


Taxpayers can use a pro-rated amount of the exclusion if they have an unforeseen circumstance which caused them to fail to meet the two year primary residence test.


Here, taxpayers were married and had a daughter. They purchased their first residence. The residence was a condo with two bedrooms and two baths. Eventually, the couple had a son and sold the condo prior to living there for two years to move into a bigger house.


The PLR ruled that the birth of the child was an unforeseen consequence and the taxpayers were eligible to use a pro-rata exclusion amount.


It should be noted, the PLR comments that the condo was pretty small. It even elaborated that the child's small bedroom was also used for the dad's office and as a guest room. The outcome of this PLR probably would not have been the same had the taxpayers condo been a 4 bedroom condo.


Relevant Cites: PLR 201628002

IRS Use of Private Collection Agency Guidance

The IRS released Program Manager Technical Advice 2016-02, which discusses the new IRC 6306(c) rules.


Under IRC 6306(c)(1), "Notwithstanding any other provision of law, the Secretary shall enter into one or more qualified tax collection contracts for the collection of all outstanding inactive tax receivables."


Inactive receivables are any inactive, outstanding assessment that the Service includes in potentially collectible inventory.


The following cannot go to a private collection agency: receivables subject to a pending or active OIC or IA, innocent spouse cases, any case under exam, litigation, criminal investigation or levy, receivables where there is an availability to appeal, receivables of dead taxpayers, taxpayers under age 18, taxpayers in combat zone, or a tax related ID theft victim.


Under the technical advice, IRS Chief Counsel believes the IRS has the power to determine which cases are best suited for immediate assignment to private collection agencies.


With this in mind, we should be seeing more private collection agency action in the near future.


Relevant Citations:
Program Manager Technical Advice 2016-02

Quick Hitters For New Tax Practitioners - Confirming Individual Client's Estimated Federal Income Tax Payments

My friend, Billy Barber, CPA wanted to contribute to the blog. Billy is a new CPA and just learning the ropes of tax controversy cases. We're looking at doing a regular post to discuss challenges and tips for new tax practitioners"

My name is Billy Barber.  I am a 2011 alumni of the University of Richmond with a bachelor's in business administration.  I have three years work experience as a book keeper in the private sector for a real estate investment company and more recently close to two years experience as a staff accountant for a public accounting firm based in Virginia.  I was also recently licensed as a CPA in Virginia on September 15, 2015.

This past tax season I met with several individual tax clients who were unable to provide, with 100% accuracy, the date and amount of their 2015 federal estimated income tax payments.  Obviously, this information is critical and needs to be entered correctly on each client's tax return in order to calculate an accurate refund or tax payment due.  

As a new CPA I learned that I was eligible to represent clients before the IRS.  By submitting a power of attorney form 2848 I could quickly and easily gain access to client account transcripts and determine the exact date and amount of any estimated tax payments.  The form can be completed in a matter of minutes following the instructions on the IRS website. 

Once I had a client signed form in hand I would call the IRS practitioner priority line and wait on hold to speak with an agent usually no more than 15-20 minutes.  Then I would ask for the agent's direct fax number and place them on hold to send the fax.  When I returned to the line the agent would confirm receipt of form 2848 and the tax year(s) in question and disclose the client's account transcript information right over the phone.  I was even able to request the account transcripts be faxed to me so documentation could be provided to the client. 

This process was much quicker than the alternative of waiting for CAF to process a submitted Form 2848 and pulling the transcripts via the transcript delivery system (TDS) 5-7 business days later.  It was also a task I could manage on my own without having to rely on others in the office.

It is important to note with tax resolution client's contacting the IRS directly to request tax transcripts may bring unwanted attention to a client versus the "soft" contact achieved by submitting form 2848 to CAF and pulling the transcripts through the TDS.  However, if the client is in good standing and you are looking to simply clarify estimated tax payments the "hard" method of contacting the IRS outlined above is a great way to expedite the process!

-Billy Barber, CPA

** IMPORTANT UPDATE** For Practitioners Dealing with EITC and ACTC

Starting in 2017, a new law has passed requiring the IRS to hold all refunds for people receiving a refund due to the Earned Income Tax Credit and the Additional Child Tax Credit.


Refunds will not be issued until February 15 for these individuals. A lot of people rely on these refunds, so you should make your clients aware of these changes for next tax year.


Relevant Citations:
https://www.irs.gov/for-tax-pros/new-federal-tax-law-may-affect-some-refunds-filed-in-early-2017

Code Sections Form 1040 Schedule C Page 2

Below is the last of my annotated Form 1040 posts, the Form 1040 Schedule C page 2.

Code Sections for Form 1040 Schedule C

Below is the Form 1040 Schedule C Page 1 code sections. If anyone is interested in any other forms, just let me know.

Code Sections for Form 1040 Schedule A

Below is the annotated Form 1040 Schedule A with all applicable code sections. I'll post the Schedule C tomorrow. If any other forms are wanted, just let me know and I can put those together too.

Internal Revenue Code Sections All Tax Controversy Practitioners Need to Know

This is from my own personal toolbox. I like to keep this list handy for when dealing with auditors.


IRC 6001 - Allows the IRS to expand scope of an audit
IRC 274(d) - Receipts and Records that are required for verification
IRC 7602(a)(1) + (2) - Examination of books and records + summons authority
IRC 7605(a) + (b) - Time and the place of the audit
IRC 7606(a),(b),(c), IRC 7342 - Entry of premise to search for taxable items
IRC 7801 + 7804 - Auditors authority to audit
IRC 446(b) + (c), also  see Holland vs United States 348 U.S. 121, 148 (1954) - authority to use method of accounting to clearly reflect income if no books and records are available
IRC 7602(e) - limits exam techniques
IRC 7491(b) - Allows the use of Bureau of Labor Statistics to help reconstruct income, however the burden of proving income is on the IRS (I'll get more into this subject in a future post)


Summons:
IRC 7602 - Summons Authority
IRC 7402 + 7604 - Summons Enforcement/Failure to Obey Summons
IRC 7210, 7603, 7604, 7608 - Service of a Summons
IRC 7609 - Third Party Recordkeeping


Assessment:
IRC 7203 - Willful failure to supply information
IRC 6201(a) - IRS assessment authority
IRC 6203 - Method of assessment
IRC 6212(a) - Notice of Deficiency

Code Sections Form 1040 Page 2

Here is the second page in my code sections for the Form 1040. I'll also be adding Schedule A tomorrow (Thursday) and Schedule C on Friday. If anyone has any requests for other forms they want done, just leave a note in the comments and I'll try to get to it.

Code Sections Form 1040 Page 1

I put together the following image. It details the code section used for every line on Form 1040 Page 1. I will be adding more pages in the future!

Tax Court Review After CDP Hearing

Another case released on May 26, 2016 is TC Memo 2016-105. There's not much great information in the case. However, there is one good point that practitioners should be aware of when helping a client with a Collection Due Process Hearing. If you go to a Collection Due Process Hearing and do not bring up an argument for your client, then you are barred from bringing up that same argument in a Tax Court review of the CDP hearing.


The court really stresses this at the end of TC Memo 2016-105.


Relevant Citations:
TC Memo 2016-105

New Case on Statute of Limitations for Refunds

TC Summary Opinion 2016-25 was filed on May 26, 2016, McAuliffe v. Commissioner. The main takeaway from this case is probably do not let your parole officer (who works part-time at H&R Block) handle your taxes. But there are several other interesting points.


The taxpayer went to jail in 2003 for mail fraud and money laundering. He believed his parole officer/H&R Block employee had filed his 2003 tax return. In 2007, he received a notice of deficiency for 2003 when the IRS filed an SFR under 6020(b).


The court did not believe that his return was filed in 2004, so the date of the taxpayer's claim for refund was in 2008, when he challenged the notice of deficiency.


During 2003, his only taxes paid were withholdings from an employer. These are deemed paid on April 15, 2004. Since the claim for refund was in 2008, this is more than two years from the date tax was paid. As such, the taxpayer could not get a refund.


The taxpayer brought up one final argument, that not getting his refund is not fair. Per the court, "Suffice it to say that the Supreme Court of the United States has clearly instructed that limitations on allowance of refunds and credits prescribed by section 6511 and 6512 shall be given effect, consistent with congressional intent, without regard to an individual's perceived notion of fairness. Commissioner v. Lundy, 516 U.S. 235." So, when client want refunds when it has past the SOL, this is a great case to cite for them.


Relevant Cites:
McAuliffe v. Commissioner, TC Summary 2016-25

IRS Audit Technique Guides

The IRS publishes guides that help auditors audit certain industry segments. These are known as ATGs. The people over at Uncle Fed Tax Board have all the old ones which are no longer available. These are a great resource.

You can find these here.

My favorite one is the Sports Franchise ATG. One of the little known facts about sports franchises is that when they trade a player, it is actually a tax free like kind exchange under IRC 1031.

From the ATG: "Player contracts constitute intangible personal property. As addressed in Chapter 9, if the player contract has a useful life of more than a year, it must be capitalized and amortized over the life of the player contract under IRC section 167.

Gains and losses on the sale or exchange of player contracts held by the sports franchise for more than a year constitute IRC section 1231 gains and losses. However, to the extent of amortization claimed under IRC section 167, player contract gains are subject to IRC section 1245 ordinary income recapture.

In general, player contract trades qualify for IRC section 1031 nonrecognition treatment for like kind exchanges. Gains recognized on player contract trades are limited to the amount of boot and, if applicable, non-qualifying property received by the transferor.

Rev. Rul. 67-380, 1967-2 C.B. 291 and Rev. Rul. 71-137, 1971-1 C.B. 104, specifically address these general provisions for sports franchise player contracts.

IRC section 1031(a) provides that no gain or loss is recognized if property used in a trade or business is exchanged solely for like kind property. Under IRC section 1031(b), any realized gain is recognized to the extent money or property that is not like kind is received in the exchange. Treas. Reg. section 1.1031(b)-1(c) provides:

Consideration received in the form of an assumption of liabilities (or a transfer subject to a liability) is to be treated as "other property or money" for the purposes of section 1031(b). Where, on an exchange described in section 1031(b), each party to the exchange either assumes a liability of the other party or acquires property subject to a liability; then, in determining the amount of "other property or money" for purposes of section 1031(b), consideration given in the form of an assumption of liabilities (or a receipt of property subject to a liability) shall be offset against consideration received in the form of an assumption of liabilities (or a transfer subject to a liability). See section 1.1031(d)-2, examples (1) and (2).

To the extent of IRC section 1245 recapture, gains recognized on player trades are ordinary gains. The IRC section 1245(a)(4) amalgamation rule for player contracts (addressed in chapter 10) only applies to player contracts transferred in connection with the purchase/sale of an entire sports franchise. Accordingly, the IRC section 1245(a)(4) amalgamation rule does not apply to the sale or trade of two or more player contracts by a sports franchise to another sports franchise. This means the IRC section 1245 recapture provisions are applied on an individual player contract basis versus an aggregate player contract basis.

Accordingly, the tax treatment to the transferor on the sale or exchange of a player contract is the same as the tax treatment given the sale or exchange of tangible personal property, such as machinery, used in any trade or business.

In the sports franchise’s tax year in which a player is cut, the sports franchise is entitled to an ordinary deduction under IRC section 165 for its adjusted basis in the player contract.

Generally, a sports franchise does not have an ascertainable tax basis in future draft picks given up in a player trade (treated as an inseparable part of the franchise intangible asset). Accordingly, in determining the sports franchise’s basis in player contracts acquired in trades, a zero adjusted basis should be used for future draft picks given up in the trade. To the extent a gain on a future draft pick given up in a trade is recognized under IRC section 1031, the gain is an IRC section 1231 gain."

As you can see, they go into really great detail about transactions.  The Sports Franchise ATG is available here.

21 Questions You Need to Know About a Client's Business in an Audit

The following are 21 questions every practitioner should know an answer to before heading into an business audit with the IRS:

 

1. Chart of Accounts Used?
2. Accounting Method? 
3. How was Income Determined? 
4. Is a double-entry accounting system used? 
5. Individual Responsible for: 

• General Bookkeeping 
• Cash Receipts 
• Accounts Receivable 
• Accounts Payable 
• Sales 
• Purchases 
• Reconciling Bank Statement

 

6. Who adjusts and closes book? 
7. Who handles deposits? How often are deposits made? 
8. Who opens the mail? 
9. How are credits memos and returns handled? 
10. Are personal funds of shareholders and officer kept completely separate from business funds
11. Are sales orders, work orders, and invoices pre-numbered? Are all numbers accounted for and used in sequence? What happens to voided orders and invoice?
12. How do you handle month-end and year-end cut-offs?
13. Are there policies covering the aging of accounts receivable? Are they followed?
14. Who authorizes write-offs of receivables?
15. Who authorized write-off of obsolete inventory? What guidelines are used? Who authorizes the write-off of other assets?
16. How are cash sales handled? Are duplicate deposit slips kept? Is cash deposited intact?
17. Who authorizes purchases of major items?
18. How are payrolls handled? Example: Separate payroll account?
19. How much petty cash is kept on hand? Who has access?  Is a voucher system in use?
20. How often are bank reconciliation’s prepared?
21. Are physical counts of inventories made? How often? Are the records available?
     

Employment Tax Audits: Section 3509 Relief

Another quick hit on employment tax audit relief options is section 3509, detailed below:

IRC section 3509 provides that if an employer fails to deduct and withhold any tax under chapter 24 (income tax withholding) or subchapter A of Chapter 21 (employee portion of FICA) with respect to any employee by reason of treating an employee as not being an employee, the employer's liability is 1.5 percent of the employee's wages plus 20 percent of the employee's portion of the FICA tax. The employer's liability is doubled in cases where the employer failed to meet the reporting requirements of IRC section 6041(a) or IRC section 6051 consistent with the treatment of the employees as independent contractors.

IRC section 3509(c) provides that the reduced rates of IRC section 3509 do not apply in cases of an employer's intentional disregard of the requirement to deduct and withhold such tax.

IRC section 3509(d)(1)(C) provides that if the amount of liability for tax is determined under 3509, then sections 3402(d) (regarding credit for tax paid by the worker) and 6521 (regarding offset for payment of SECA tax) do not apply. IRC section 3509(d)(2) provides that section 3509 rates do not apply where the employer withholds income tax withholding but not FICA.

Employment Tax Audits - Worker Classification Rules

Making the proper determination on whether to treat a worker as an employee or independent contractor can have significant tax implications. A lot of taxpayers feel they can just classify the worker how they want, however there are numerous situations that you need to look at. The following is a law section on a memo I drafted detailing the rules of how to classify a worker. Most of the information can be found in the IRM too:

IRC section 3121(d)(2) of the Internal Revenue Code provides that the term "employee" means any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of employee. See also IRC sections 3401(c) and 3306(i).

 

The question of whether an individual is an independent contractor or employee is one of fact to be determined upon consideration of the facts and application of the law and regulations in a particular case. With certain limited statutory exceptions, the classification of particular workers or classes of workers as employees or independent contractors, for purposes of Federal employment taxes, must be made under common law rules. Guides for determining the existence of a worker's status are found in three substantially similar sections of the Employment Tax Regulations; namely sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1 relating to the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and federal income tax withholding on wages at source, respectively.

 

Section 31.3121(d)–1(c)(2) of the regulations provides that generally, the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services not only as to the results to be accomplished by the work, but also as to the details and means by which the result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done, but also as to how it shall be done. In this connection, it is not necessary that the employer actually control or direct the manner in which services are performed; it is sufficient if he or she has the right to do so. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished and not as to the means and methods for accomplishing the result, he or she is an independent contractor. Similar language is found in regulation sections 31.3306(i)–1(b) and 31.3401(c)–1(b).

 

In determining whether an individual is an employee under the common law rules, a number of factors have been identified as indicating whether sufficient control is present to establish an employer– employee relationship. These factors have been developed based on an examination of cases and rulings considering whether an individual is an employee. The degree of importance of each factor varies depending on the occupation and the factual context in which services are performed. See Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318 (1992) and Weber v. Commissioner , 103 T.C. 378 (1994), aff'd 60 F.3d 1104 (4th Cir. 1995). See also Breaux and Daigle, Inc. v. U. S.. 900 F.2d 49 C.A.5 (La.),1990. Also see Rev. Rul. 87–41, 1987–1 C.B. 296.

 

Section 3121(d)–1(a)(3) of the regulations provides that if the relationship of an employer and employee exists, the designation or description of the parties as anything other than that of employer and employee is immaterial. Thus, if such relationship exists, it is of no consequence that the employee is designated as a partner, co-adventurer, agent, independent contractor, or the like. Similar language is found in regulation sections 31.3306(i)–l(d) and 31.3401(c)–1(c).

 

Because there are elements of controls as well as autonomy in all cases, regardless of whether an employment relationship or an independent contractor relationship exists, all evidence of both control and lack of control or autonomy must be evaluated in determining whether there is a sufficient degree of control to establish an employment relationship. In doing so, one must examine the relationship of the worker and the business. Facts which illustrate whether there is a right to direct or control how the worker performs the specific tasks for which he or she is hired, whether there is a right to direct or control how the business aspects of the worker's activities are conducted, and how the parties perceive their relationship provide evidence of the degree of control and autonomy.

 

Factors which influence if a worker is an independent contractor or an employee include:

 

Behavioral Control:

 

Behavioral control factors establish if an employer can control how a worker performs a task.

 

                       Instructions: Does the worker perform the required services:

                

Instruction focuses on how a job gets done and does not factor in the end result of the job. If a person needs to comply to instructions about, when, where and how he has to work is ordinarily an employee. Not all employees need instructions, such as highly proficient employees. Even with these employees, only the right to enforce instructions matters, not if the employer actually provides instructions. (Rev. Rul. 68-598, 1968-2 C.B. 464; Rev. Rul. 66-381, 1966-2 C.B. 449;   Silverstone et al. v U.S., USTC 66-1 P 9468.)

 

                 Training:

 

Training is when methods, procedures or skills need explanation before they are used to complete a job. This helps complete a job in a particular manner. Factors that highlight training are required meetings, correspondence or experience employees working with inexperienced trainees. This training demonstrates an employer wants control over how a job is done.

 

Financial Control:

 

Financial controls occurs when the company can direct economic aspects of worker’s activities.

                

                 Significant Investment:

                

If an individual has a significant investment in the business, then an independent contractor relationship may exist. The investment must only have substance; it does not need to meet any dollar threshold. This investment is seen in the facilities in which the individual has the investment. A lack of investment in the facilities will show an employee-employer relationship. Facilities are equipment or a work premise. These include machinery and office furniture, but not tools, instruments, clothing, etc.

 

The investment is only a significant factor if it is real, essential and adequate. The investment cannot be in facilities a normal employee will normally maintain for an employer. Rev. Rul. 71-524, 1971-2 C.B. 346,  Avis  Rent  A Car  System,  Inc.  v.  U.S. [74-2 USTC, 9725], 503 F2d 423, 429 (2nd Cir. 1974).

                

                       Unreimbursed Expenses:

 

Unreimbursed expenses is when a worker incurs their own expenses in relationship with the job. Having unreimbursed expenses show the worker has the right to direct and control financial aspects of business operations.

 

Most independent contracts incur business expenses. These expenses are either direct expenses or pro rata portions of several other expense. Typically included in these expenses are tools, equipment, training, advertising, wages for assistants, licensing, certification, supplies, travel, leasing equipment and inventory.

 

An employer furnishing tools, materials, etc for a job tends to show an employee-employer relationship. The control aspects originates in that the employer can determine which tools a worker uses, in what order and how to use the tools. Independent contractors normally have their own tools. This is how the independent contractor may show control. If an employee provides their own tools in an occupation where this is a customary practice, then such a practice does not demonstrate lack of control by the employer. Rev. Rul. 71-524, 1971-2 C.B. 346.

                

When an employer pays business or traveling expenses for a worker, then the worker is an employee. Rev. Rul. 55-144, 1955-1 C.B. 483. 

                

                 Services Available to the Relevant Market:

 

Independent contractors can seek their own business opportunities. Doing so incurs expenses such as advertising and a business location. If a person makes services available for the public, then they are normally an independent contractor. (Rev. Rul. 56-660, 1956-2, C.B. 693).

 

                 Method of Payment:

 

If a worker is compensated hourly, daily, weekly or in such other similar manner is guaranteed a return for the labor performed, then this is generally evidence of an employer-employee relationship. A task for a flat fee, however, tends to show an independent contractor relationship. Rev. Rul. 74-389, 1974-2 C.B. 330.

 

                 Opportunity for Profit or Loss:

 

A worker making decisions that affect his own bottom line indicates the presence of an independent contractor. The ability to affect one’s own bottom line is not present if the only way to affect the amount of money made is by working more or less hours. To the contrary, by only affecting the worker’s bottom line by changing work schedules indicates the presence of an employer/employee relationship. If the person can receive either a profit or loss due to the services he performs, then that person is seen as an independent contractor. Rev. Rul. 70-309, 1970-1 C.B. 199.

 

Relationship of Parties:

 

                         Intent of Parties through Written Contracts:

 

If a contract describes a worker as an independent contractor, then each party had intent for an independent contractor relation. This is not sufficient evidence of the worker’s status. This designation is immaterial and only the substance of the relationship determines the law. Reg. Sec. 31.3121(d)-1(a)(3)

                  

                   Employee Benefits:

                              

Any benefits received by a worker, such as a pension, health insurance, paid sick days can only be provided to employees, not to independent contractors.

 

                   Discharge:

 

It is harder for a company to discharge an employee than it is an independent contractor. This is due to the company being liable for items such as severance pay and notice. Therefore, the inability to discharge a worker shows the worker is more likely an employee. However, the right to discharge shows control over the worker. An independent contractor cannot be discharged unless he produces at a quality less than contractually agreed. Rev. Rul. 75-41, 1975-1, C.B.323.

 

Termination:

 

A worker may terminate his relationship with an employee usually on an easier basis. However, an independent contractor cannot merely terminate a relationship due to a legal obligation to complete the work. Rev. Rul. 70-309, 1970-1, C.B. 199.

 

Business Activity:

 

The services a worker performs and how integral the worker is to the company shows he is a key aspect to the company. This level of integration into the company shows the worker is an employee since he is subject to more direction and control. This test relies on the scope and function of the business and how the worker functions within it. If the company needs to rely on a person for company success, then that company will want more direct control over the individual. U. S. v. Silk 331 U.S. 704 (1947), 1947-2 C.B. 167.

 

Miscellaneous Factors to Consider:

 

                   Continuing Relationship:

 

A permanent relationship between the worker and the company is relevant evidence for an employer-employee relationship. Businesses may engage a worker with the intent of a continuing relationship instead of a specific project. This shows intent of an employee-employer relationship. Continuing relationships are shown through frequent recurring, even if irregular, intervals. U.S. v. Silk, 331 U.S. 704 91947, 1947-2, C.B. 167. 

 

                   Work Hours:

 

If the employee sets hours a worker must work, then there is control over the worker. The workers can no longer work as he sees fit but needs to conform to the employers arrangements. Rev. Rul. 73-591, 1973-2 C.B. 337.

                  

                   Full Time:

 

Working full time for the business shows the employer has control over the worker because he restricts access to the worker from finding other employment.  Rev. Rul. 56-694, 1956-2 C.B. 694.