California Tax Attorney Blog

Many of my California clients make interest-free or low-interest loans to their children as part of a business transaction between them. Many business clients either forego interest altogether or miss collecting all the interest. In either case, foregone interest or missed payments must be imputed on loans between family members at the AFR (applicable federal rate).

Consider, for instance, that in January 2007 you loaned $500,000 to your child which was payable in 9 years. Also assume you are not charging interest. Loans three to nine years are considered mid-term loans. In January 2007, the AFR that the IRS publishes was 5.51%. The imputed interest is $27,550 each year which must be recognized on your income tax return. If your child doesn’t pay the interest, then you are deemed to have made a gift to your child. Your child does not get a tax deduction for the $27,550 since no payments were actually made.

Some of the tax consequences can be avoided if you qualify for either of two exceptions:

First, if the amount of below-market loans you make to a child doesn’t exceed $10,000, no interest will be imputed. To get this tax break, the loan can’t be used for income-producing investments.

Second, if the amount of below-market loans you make to a child doesn’t exceed $100,000, no income tax consequences will apply. That will be the case if the child’s net investment income is no more than $1,000 each year.

Try to keep loans below those levels, see that the other requirements are met, and put all intra-family loans in writing to minimize tax problems.

If you have to write a business contract, negotiate a business transaction, want to form a new entity, or have other questions related to your business you would like to discuss with an attorney, call Mitchell A. Port at (310) 559-5259.

My estate planning and probate clients who come from Los Angeles County, Santa Barbara County, Ventura County and Orange County, (and occasionally from Northern California) will often speak with me about what they have heard regarding estate planning and avoiding probate. Retained by clients as their California estate planning attorney and California probate lawyer, they freely share their concerns about estate tax, gift tax planning and the other items listed here:

1. Failure to Make Gifts to Reduce Estate Taxes. Easy gifting options include the $12,000 annual exclusion, $1,000,000 lifetime gift exemption, and unlimited tuition/medical gifts. In a 45% estate tax bracket, each $12,000 gift saves $5,400 in estate tax.

2. Failing to Protect a Child's Inheritance. A child's inheritance that passes outright to the child is not protected from creditors, divorce, or estate tax at the child's death. To protect the inheritance, it may be better to leave assets in trust for such child's benefit. If desired, the child can be named as the co-trustee of the trust along with a third party.

3. Failure to Pursue Sophisticated Estate Planning Tools. Explore techniques to reduce estate taxes and/or protect assets. Consider the family limited partnership, charitable trusts, qualified personal residence trust, and sale of assets to children.

4. Wasting $2,000,000 Exemption When First Spouse Dies. The $2,000,000 exemption is wasted when assets are left outright to the surviving spouse. Instead, the Will should create a bypass trust to be funded with $2,000,000 of the decedent's assets, saving up to $900,000 of estate taxes (assuming a 45% estate tax rate). WARNING: Naming the spouse as beneficiary of life insurance/retirement plans prevents such assets from going into the bypass trust. Also, if the house goes outright to the survivor, the decedent's portion cannot be used if needed to fully fund the bypass trust. The impact on the overall plan should be considered before making such a bequest.

5. Wasting $2,000,000 GST Exemption. This results in needless estate taxes at the deaths of children. Instead, consider segregating $2,000,000 ($4,000,000 for husband and wife) of assets in trust for the benefit of children for life and then to grandchildren, free of estate tax at each child's death.

6. Life Insurance Policies Owned by the Insured. The proceeds of life insurance are subject to estate tax when the insured owns the policy. For example, $1 million of coverage taxed at 45% leaves only $550,000 coverage after tax. Transferring ownership of life insurance to an irrevocable life insurance trust (or having the trust buy new coverage) removes the proceeds from the estate, provided the insured lives for three years after the transfer.

7. Poor Timing of Retirement Plan/IRA Distributions. Penalty taxes arise if retirement plan/IRA distributions are too small, too early, or too late. Devise a distribution strategy and beneficiary designations to maximize income tax deferral, but with due consideration of these penalty taxes. Consider designating a charity as beneficiary to avoid estate tax and income tax.

8. Failure to Plan for Lifetime Contingencies/Disability. This may result in a court-supervised guardianship. Plan ahead by executing a power of attorney for management of property and personal affairs, advance health care directive and living trust. Be wary of "standard form" documents.

9. Lack of Liquidity to Pay Estate Taxes. Illiquidity can result in forced "fire sale" of real estate or a family business within nine months of death in order to pay taxes. In this situation, it is advisable to explore life insurance and plan for the orderly sale of assets.

10. JTWROS ("Joint Tenants with Right of Survivorship") Ownership Designation on Brokerage or Bank Accounts. This designation prevents such accounts from being funded into the bypass trust when the first spouse dies, potentially wasting the decedent's $2,000,000 exemption (and costing up to $900.000 in extra estate taxes). This also applies to "P.O.D." (pay on death) accounts and "Trust" accounts payable to a named beneficiary (example: "A, Trustee for B"). While these designations avoid probate, other problems arise instead. Multiple party accounts should be set up as tenants in common.

If you would like to speak with a licensed California attorney about these matters or estate planning in particular, call Mitchell A. Port at (310) 559-5259.

Readers of my California tax attorney blog love war stories of those who have participated in and been convicted of tax fraud and tax evasion, both criminal tax offenses. The payroll tax problem that took place in California was particularly interesting to me. These tax controversies highlight the severity of the punishment when convicted of a crime. The Internal Revenue Service posts stories to site examples of employment tax fraud investigations that are excerpts from public record in the judicial district in which the cases were prosecuted. Here are a few of those stories:

Nursing Home Owner Convicted of Failing to Pay Over $9.6 Million in Payroll Taxes

In San Francisco, CA, Jack Easterday was convicted by a federal jury on 107 counts of willful failure to pay employment taxes owed to the government. Easterday, who is the owner of numerous nursing home facilities, was convicted of failing to pay more than $9.6 million in taxes. However, evidence at trial, which will be considered for sentencing purposes, showed that Easterday failed to pay more than $16 million in payroll taxes from 1998 to 2005. Evidence at trial also showed the IRS had attempted to collect the taxes from Easterday for years before the charges were filed. He thwarted the efforts of the IRS to collect the taxes by, among other things, paying himself and his wife exorbitant salaries and directors fees, while he was pleading poverty to the IRS collection agents.

Continue reading "Payroll Tax Fraud War Stories" »

Have a tax problem? Want to try and solve it yourself without hiring tax attorneys? Don't really need tax help at the moment? Think spending money on tax lawyers when you already owe money is something to avoid for the time being?

Below is a convenient (unendorsed) list of tax help sites - none necessarily based in California - for your review.

JURIST

Legalbitstream

TaxLinks

Tax Sites

State-Specific Sites

Country-Specific Sites

Tax Scholarship

When you want to consult with a tax attorney in Los Angeles who services clients throughout California for Franchise Tax Board matters and throughout the country for IRS tax problems, call Mitchell A. Port at 310.559.5259.

If you want a tax attorney to represent you on a federal tax problem, file Form 2848 Power of Attorney and Declaration of Representative with an IRS office. Signing Form 2848 allows the IRS tax attorney named by you to represent you before the IRS and to receive your tax information.

Your tax lawyer must be a person authorized to practice before the IRS. Tax lawyers have to apply to practice before the IRS and be granted permission to do so.

Generally, when you appoint a California tax lawyer on the Power of Attorney form, that tax attorney’s authority includes, among many things: signing a waiver agreeing to a tax assessment, extending the time for assessing and collecting tax, and waiving restrictions on the assessment and collection of deficiencies of tax. The tax attorney can also substitute another representative such as your CPA if you permit this on the power of attorney. In limited circumstances, a tax attorney can be authorized to sign an income tax return for you if you permit this on the power of attorney.

If you want to limit what the tax lawyers can do on your behalf, the power of attorney enables you to do that too.

When completing the Form 2848, you must show the name, taxpayer identification number (TIN), and address of the taxpayer, as well as, the name and address of the representative(s), the type of tax, the tax form number and the year(s) and/or period(s) for which the power is granted. You can list returns for any number of specified years and/or periods that have already ended and returns for years and/or periods that will end no later than three years from the date the form is signed.

For example, you may list income tax, Form 1040, for Calendar Year 2004 and employment tax, Form 941, for the third and fourth quarters of 2003. The Form 2848 will be returned to you for correction if you use a general reference to "all years", "all periods," or "all taxes".

If you and your spouse filed a joint return and the same tax lawyer will represent both of you, the power of attorney must be signed and dated by both husband and wife. If either one of you does not wish to be represented, only the spouse who wishes to be represented should sign and date the Form. If you and your spouse filed a joint return, but wish to be represented by different tax attorneys, each of you must complete your own Power of Attorney.

For additional information look at Publication 947, Practice Before the IRS and Power of Attorney.

Mitchell A. Port is authorized to practice before the IRS. He is also admitted to practice before the Ninth Circuit Court of Appeals and federal district court. To speak with a California tax attorney about tax problems, call Mitchell at 310.559.5259

The other day, the Internal Revenue Service today alerted us in California and elsewhere to the latest versions of an e-mail scam intended to fool us into believing we are under investigation by the agency’s Criminal Investigation division.

The latest versions appear aimed at business taxpayers as well as individual taxpayers.

The IRS’s news release states that the e-mail purports to be from IRS Criminal Investigation falsely states that we are under a criminal probe for submitting a false tax return to the California Franchise Tax Board. The e-mail entices us to click on a link or open an attachment to learn more about the complaint against us. The e-mail link and attachment is a Trojan Horse that can take over our computer hard drive and allow someone to have remote access to the computer.

The IRS urged us not to click the link in the e-mail or open the attachment. Similar e-mail variations suggest a customer has filed a complaint against a company and the IRS can act as an arbitrator.

Keep in mind that the IRS does not send out unsolicited e-mails or ask for detailed personal and financial information. Additionally, the IRS never asks people for the PIN numbers, passwords or similar secret access information for their credit card, bank or other financial accounts.

The IRS also sees other e-mail scams that involve tricking victims into revealing private personal and financial information over the Internet, a practice that is known as “phishing” for information.

Recipients of questionable e-mails claiming to come from the IRS should not open any attachments or click on any links contained in the e-mails. Instead, they should forward the e-mails to phishing@irs.gov (follow the instructions).

Since the establishment of the mail box last year, the IRS has received more than 17,700 e-mails from taxpayers reporting more than 240 separate phishing incidents. To date, investigations have identified host sites in at least 27 different countries, as well as in the United States.

Other widespread e-mail tells taxpayers the IRS is holding a refund (often $63.80) for them and seeks financial account information. Another fraudulent e-mail scams try to entice taxpayers to click their way to a fake IRS Web site and ask for bank account numbers. Still another email claims the IRS’s ‘anti-fraud commission’ is investigating their tax returns.

The California legislature recently held a hearing on the question of whether the attorney-client privilege should continue indefinitely after a client's death. The hearing further asked whether a means for waiving the privilege should be created when subsequent administration of the estate is necessary.

In judicial and other proceedings when an attorney is called as a witness or otherwise required to produce evidence related to a client, the attorney-client privilege applies to shield the attorney from providing the evidence.

The privilege enables a client to prevent a witness from disclosing confidential communications between the client and his or her attorney. It encourages the client to fully disclose information to assist the attorney in the lawyer’s representation of the client. Under current law, the privilege remains effective until the end of the probate of the deceased client's estate and the personal representative was discharged by the court.

The bill provides that the attorney-client privilege continues indefinitely after the client's death and creates a mechanism for waiving the privilege when a lawyer is instructed by the holder of the privilege to do so.

This bill also authorizes the court to appoint a personal representative for purposes of holding the attorney-client privilege where the court has discharged a personal representative and disclosure is sought as to a privileged communication. Under this bill a lawyer will be obligated to claim the attorney-client privilege, even if the client is dead, whenever the lawyer is present when the communication is sought to be disclosed.

This bill will also allow waiver of the privilege if the attorney is instructed to do that by the holder of the privilege.

Litigation in the Bing Crosby estate has weakened the assumption that the privilege could be abandoned after a deceased client's personal representative has been discharged without harming the societal goals embodied by the attorney-client privilege.

Upon Bing Crosby's death, there was a probate of his assets, including his recording contracts. During the probate case, HLC Properties, Ltd. was created which received Crosby's assets, including the recording contracts, on his estate's distribution. His widow was the personal representative and the court then discharged her. HLC later sued MCA, a record company, for unpaid royalties. MCA requested and the trial court ordered HLC to turn over documents containing Crosby's past communications with his attorneys.

In HLC Properties, Ltd. v. Superior Court, the California Supreme Court upheld the trial court. Since the attorney-client privilege is governed exclusively by statute, the court did not consider whether the assumptions behind the statutory rule ending the attorney-client privilege on the discharge of a client's personal representative remain valid. (HLC Properties Ltd. v. Superior Court, 105 P.3d 560 (Cal. 2005).)

If Bing Crosby had created a revocable trust to avoid probate and to pass his royalties at his death, his successor trustee would have been able to claim the privilege. If he incorporated his business during life, his corporation would have been able to claim the privilege.

The bill before the California legislature concludes that the continuance of the attorney-client privilege after a client's death should not be decided on minute and picky distinctions that are unrelated to the purposes from which the privilege originates, such as whether the decedent passed property at death by either a revocable trust or a will.

California Probate News Flash: The California Assembly Committee on Judiciary, in order to help facilitate the filing of tax claims and the collection of California state income tax, recently held a hearing asking whether a decedent's estate should provide notice of the probate to the Franchise Tax Board.

This bill, sponsored by the California Franchise Tax Board (FTB), requires that the personal representative of an estate notify the FTB of the probate proceedings within 90 days of when letters are first issued for the estate. The bill also requires California estates, for which a petition for final distribution has not been issued by January 1, 2008, to provide FTB with notice within 90 days of January 1, 2008. This should allow FTB to make any outstanding claims against the estate, and, according to the author, help reduce the amount of uncollected taxes.

Current law provides that:

(i) a claim by a public entity against an estate must be filed within the time provided or is barred. (Probate Code Section 9200);

(ii) requires the FTB to mail notice assessing taxes and commence any proceeding in court within 18 months after written request is filed (after the tax return is made) by the fiduciary of the estate or trust. (Revenue & Taxation Code Section 19517); and

(iii) requires, within 90 days of the date probate letters are first issued, the general personal representative or estate attorney of a decedent's estate to provide notice to specified public entities, including Health Services and the California Victim Compensation Board, of the administration of the decedent's estate. These public entities then have four months after notice is received to file a claim or pursue a collection. (Probate Code Section 9202)

According to the bill’s author, an estate representative often does not know a decedent's financial affairs and, as a result, is unable to resolve tax obligations. This bill will codify a process that would assure that an estate representative discovers and resolves a decedent's income tax obligation, thus helping to close the tax gap. The author believes this information allows FTB to make any outstanding claims against the estate and help reduce the amount of uncollected taxes.

Currently, if it is known that a claim is likely, a personal representative of an estate being probated is required to notify the directors of Health Services and the California Victim Compensation and Government Claims Board of the decedent's death within 90 days of when letters for probate administration are first issued. The directors then have four months after receiving notice to make their claims or pursue collection of outstanding fines. This bill seeks to expand that notice requirement to FTB, but does not limit the time period by which FTB has to make a claim against the estate.

California uses a 4-3-2-1 system to calculate statutory probate fees. Four percent of the first $100,000 of property in probate, 3% of the next $100,000, 2% of the next $800,000, and 1% over $1 million.

For example: your home in Los Angeles County, Ventura County, Orange County or Santa Barbara County has a fair market value of $750,000. Under the 4-3-2-1 system, probate fees will be:

4% of the first $100,000 = $4,000
3% of the next $100,000 = $3,000
2% of the next $550,000 = $11,000

TOTAL STATUTORY PROBATE FEES: $18,000

Those fees are calculated on the property’s fair market value and NOT on the equity. Even if your $750,000 home has a mortgage of $500,000, the fees will still be $18,000.

Moreover, the fees are sometimes paid twice: once to the probate attorney and once to the executor or administrator of the estate. The attorney and executor do not split the fee; each one of them earns the entire amount.

If you have a probate matter or questions about a California probate, please call Mitchell A. Port at 310.559.5259.

When it comes to taxes, everyone (including us in Los Angeles, California) has an opinion – even when there isn’t a tax problem requiring tax help.

"Like mothers, taxes are often misunderstood, but seldom forgotten.'' — Lord Bramwell, 19th Century English jurist

“Income tax has made more liars out of the American people than golf.” — Will Rogers, humorist

"Few of us ever test our powers of deduction, except when filling out an income tax form.''
— Laurence J. Peter, author

"To tax and to please, no more than to love and to be wise, is not given to men." — Edmund Burke, 18th Century Irish political philosopher and British statesman

A tax loophole is "something that benefits the other guy. If it benefits you, it is tax reform.''
— Russell B. Long, U.S. Senator

“People who complain about taxes can be divided into two classes: men and women.”
— Unknown

"No government can exist without taxation. This money must necessarily be levied on the people; and the grand art consists of levying so as not to oppress.'' — Frederick the Great, 18th Century Prussian king

"The best measure of a man's honesty isn't his income tax return. It's the zero adjust on his bathroom scale.'' — Arthur C. Clarke, author

"The power of taxing people and their property is essential to the very existence of government.'' — James Madison, U.S. President

“I am proud to be paying taxes in the United States. The only thing is – I could be just as proud for half the money.” — Arthur Godfrey, entertainer

"Next to being shot at and missed, nothing is really quite as satisfying as an income tax refund.” — F. J. Raymond, humorist

“The hardest thing in the world to understand is the income tax.” — Albert Einstein, physicist

“Taxation with representation ain’t so hot either.” — Gerald Barzan, humorist

“Where there is an income tax, the just man will pay more and the unjust less on the same amount of income.” — Plato

"Taxes are what we pay for civilized society.'' — Oliver Wendell Holmes, Jr., U.S. Supreme Court Justice

A few months ago, in March, the IRS announced the release of Form 656, Offer in Compromise. The Form 656 package was last revised in 2004 to help us correctly and completely prepare an offer and reduce the chances of an offer being returned for omissions. The IRS declares that the new form retains the taxpayer burden reduction features while adding significant changes as a result of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). These changes include:

Continue reading "Offer In Compromise Revised - Tax Help Made Easier" »

According to IRS estimates, incorrect deduction of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes. No doubt California contributes significantly to those billions. Tax help is available, however, to address this tax problem before it becomes a major controversy with the Internal Revenue Service.

The Internal Revenue Service provides guidelines to determine whether an activity is a business or a hobby (which is defined as an activity not engaged in for profit). Those of us living and working in Los Angeles County, Orange County, Santa Barbara County or Ventura County would benefit by reviewing those guidelines before a tax problem arises.

The rules for determining if an activity qualifies as a business and what limitations apply if the activity is not a business are explained by the Internal Revenue Service in Publication 535.

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

In order to make this determination, taxpayers should consider the following factors:

Does the activity make a profit in some years?

Does the time and effort put into the activity indicate an intention to make a profit?

Have you made a profit in similar activities in the past?

Can you expect to make a profit in the future from the appreciation of assets used in the activity?

If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

Has the taxpayer changed methods of operation to improve profitability?

Do you or your advisors have the knowledge needed to carry on the activity as a successful business?

Do you depend on income from the activity?

Continue reading "Tax Problem: Are You In California Engaged In A Business Or In A Hobby?" »