Friday, December 9, 2011

Don’t Know Whom You Are Giving Your Bonus to Until After Year End? No Problem, Take a Deduction!


In Rev. Rul. 2011-29, 2011-49 IRB 1, the IRS has ruled that an employer can establish the "fact of the liability" under §461 for bonuses payable to a group of employees even if the employer does not know the identity of any particular bonus recipient and the amount payable to that recipient until after the end of the taxable year.

Under section 461(a), the amount of any deduction or credit must be taken for the tax year that is the proper tax year under the method of accounting the taxpayer uses to compute taxable income. Hence a liability is incurred under the accrual method of accounting when:

(1) all the events have occurred that establish the fact of the liability,

(2) the amount of the liability can be determined with reasonable accuracy, and

(3) economic performance has occurred for the liability.

This is sometimes referred to as the “all events test.” The ruling dealt with the first prong of the all events test.

Generally, all events occur to establish the fact of a liability when (1) the event fixing the liability (performance or some other event) occurs, or (2) payment is unconditionally due.

In the ruling the employer uses an accrual method of accounting for federal income tax purposes and pays bonuses to a group of employees for services performed during the tax year. The minimum total amount of bonuses payable to the employees as a group is determinable either through a formula that is fixed before the end of the tax year or through other corporate action, such as a resolution of the board of directors. Bonuses are paid after the end of the tax year in which the employee performed the related services but before the 15th day of the third calendar month after the close of that tax year.

Relying principally on Washington Post Co. v. United States, 405 F.2d 1279 (Ct. Cl. 1969) and United States v. Hughes Properties, Inc., 476 U.S. 593 (1986) The IRS found that the employer's liability to pay a minimum amount of bonuses to the group of eligible employees was fixed at the end of the year in which the services are rendered. It is irrelevant, the IRS noted, that the identity of the ultimate recipients and the amount, if any, each employee will receive cannot be determined before the end of the tax year. Accordingly, for purposes of the first prong of the test under reg. section 1.461-1(a)(2)(i), all the events have occurred by the end of the tax year that establish the fact of the employer's liability to pay the minimum amount of bonuses.

The IRS also indicated that any change in an employer's treatment of bonuses for the purpose of conforming to Rev. Rul. 2011-29 is a change in method of accounting that must be made in accordance with sections 446 and 481, as well as the applicable regulations and administrative procedures.

Friday, November 25, 2011

New Jersey Couple Scores a Victory Against Bernie Madoff and the Division of Taxation

The New Jersey Tax Court recently held that a married couple was entitled to recover the Gross Income Tax (GIT) paid on dividends and capital gains reported as earned through their investments with Bernie Madoff. The taxpayers filed a claim for refund of gross income taxes paid by them for the tax years 2005, 2006 and 2007 with respect to capital gains and dividend income reported as earned through their investments with Madoff. They learned in 2008, that, in fact there had been no earnings, and that Madoff’s report to them of various security transactions and income earned from those transactions were fictitious. The Division of Taxation denied their refund claims.

The Division refused to stipulate to the facts surrounding the operation of the Madoff Ponzi scheme, however, the Director implicitly accepted the factual underpinnings of the plaintiff’s case in his official pronouncements with respect to the Madoff scheme; the court concluded that those facts constituted stipulated facts.

The taxpayers argued that they were entitled to refund of taxes paid on their factitious income. They also argued that their election to treat the loss as a theft loss on their federal income tax return did not preclude them from claiming refunds under the GIT Act. The Division of Taxation contended that the dividends and capital gains income were taxable because the taxpayers constructively received the income. They also argued that pursuant to its April 15, 2010 notice, victims of the Madoff fraud may only report a capital loss in 2008, the year in which the fraud was discovered and in accordance with the federal procedures for theft losses.

The Tax Court held that the taxpayers were entitled to income tax refunds because the dividends and capital gain income reported on their tax returns simply did not exist. The Tax Court found that there was never any sale, exchange or other disposition of property because the transactions reported by Madoff sent to the taxpayers never took place. The court then held that the Division of Taxation’s position that the only relief available to the taxpayers was to claim a capital loss in accordance with federal procedures was unreasonable. It found that there was no principal reason why the taxpayer should be required to use a federal procedure that relies upon federal tax code concepts that are not recognized by the Gross Income Tax Act. The court then found in favor of the taxpayers allowing the theft losses against the taxpayers gross income tax.

Tuesday, November 15, 2011

IS THE $5 MILLION GIFT TAX EXEMPTION ABOUT TO END?


The Tax Relief Act of 2010 made significant changes to the gift, estate and generation-skipping transfer tax regimes by increasing the amount each individual can give without incurring tax from $1 million to $5 million.  The increase was not permanent however, and rumor has it that it may be in jeopardy.  To avoid any risk, those who have decided to use their full exemptions should do so no later than December 31, 2011, and, if feasible, November 22.

The Rumors

Rumors circulating recently within the financial and estate-planning communities have suggested the $5 million exemptions may be in immediate jeopardy.  Democratic staff on the U.S. House Committee on Ways and Means recently proposed decreasing the $5 million gift, generation-skipping transfer tax and estate tax exemptions to $3.5 million, effective January 1, 2012.  There also are rumors the Joint Select Committee on Deficit Reduction (the Super Committee) may recommend a drop down in the gift tax exemption to $1 million, effective at year end, or possibly as early as November 23, 2011, when its recommendations are scheduled to be released, though there is no confirmation this rumor is true.

As we all know "everything" is on the table before the super-committee (although they would not admit it), I would caution you to advise your clients of these developments and act sooner rather than later.

Wednesday, November 9, 2011

Unlike the Federal Tax Treatment of Bad Debts, New Jersey Taxpayers Are Not Entitled to a Bad Debt Deduction

The New Jersey Appellate Division in Waksal v. Director, Division Of Taxation determined that a New Jersey couple could not report losses to offset capital gains on their New Jersey income tax return.

In January 2002, Harlan W. Waksal loaned $14,769,320 to his brother, who signed a promissory note and agreed to repay the loan on or before January 31, 2004. His brother then defaulted on the loan. Subsequently, plaintiffs filed a 2004 Federal Individual Income Tax Return and reported a short term capital loss of $14,769,320. They also filed a 2004 New Jersey Gross Income Tax Return and reported the same amount as a loss from the "sale, exchange or other disposition of property," pursuant to N.J.S.A. 54A:5-1(c). After using the loss to offset capital gains, they reported $6,644,022 as a net gain in their New Jersey tax return.

The New Jersey Appellate Court affirmed the summary judgment granted to the Director, Division of Taxation. The Waksals argue primarily that their nonbusiness bad debt was "a sale, exchange or other disposition of property" under N.J.S.A. 54A:5-1(c), and, as a result, they are allowed to report the loss on their New Jersey Gross Income Tax Return and offset capital gains. Because the New Jersey Gross Income Tax Act (the Act), N.J.S.A. 54A:1-1 to -10, does not permit such a deduction, the trial court’s decision was affirmed.

The trial court relied in part on Walsh v. Director, Division of Taxation, 15 N.J. Tax 180 (App. Div. 1995), and King v. Director, Division of Taxation, 22 N.J. Tax 627 (App. Div. 2005), which held that a loss from a nonbusiness bad debt could not be used to offset gains "derived from the sale, exchange, or other disposition of property" under N.J.S.A. 54A:5-1(c). The trial judge indicated that "net gains or income from disposition of property" is considered taxable income under N.J.S.A. 54A:5-1(c), which provides in part that New Jersey gross income consists of certain categories, including:

Net gains or net income, less net losses, derived from the sale, exchange or other disposition of property, including real or personal, whether tangible or intangible as determined in accordance with the method of accounting allowed for federal income tax purposes.

The judge reasoned that the Act "does not mirror federal taxing statutes" and observed that the Supreme Court explained in Smith v. Director, Division of Taxation, 108 N.J. 19, 32 (1987), that:

Even a cursory comparison of the New Jersey Gross Income Tax and the Internal Revenue Code indicate [sic] that they are fundamentally disparate statutes. The federal income tax model was rejected by the Legislature in favor of a gross income tax to avoid the loopholes available under the Code.

The court recognized that in Walsh the Legislature determined that the New Jersey Gross Income Tax should contain fewer deductions from income than the federal income tax. This was seen as a way of making the Gross Income Tax fairer. The Legislature did not explicitly provide for a deduction of a nonbusiness bad debt. Thus, in view of the legislative history, it would appear that the Legislature did not intend for N.J.S.A. 54A:5-1c to be read broadly to include a deduction for nonbusiness bad debts.

On appeal, plaintiffs contend that the decision of the judge conflicts with N.J.S.A. 54A:5-1(c) and the Supreme Court's clear direction to apply substantive federal tax rules to determine net gains and loses.

In Walsh, the taxpayers sought to deduct a nonbusiness bad debt following a personal loan to a corporation in which they were also shareholders. The corporation then transferred its assets to a second corporation, "but [the taxpayers] remained liable as . . . guarantor[s] on the bank loans." After the second corporation defaulted on the bank loans that the taxpayers guaranteed, the taxpayers paid off the debt and deducted the losses on their New Jersey Gross Income Tax return.

Quoting the Tax Court, the Appellate Court held that the worthless debt, although treated as a loss from the sale or exchange of a capital asset held for not more than one year . . . under the Internal Revenue Code, does not fit the statutory rubric of sale, exchange or other disposition of property" found in N.J.S.A. 54A:5-1(c).

Because Waksal's loss from their nonbusiness bad debt cannot be used to offset gains derived from the "sale, exchange or other disposition of property" under N.J.S.A. 54A:5-1(c), the judge concluded that plaintiffs could not report the loss to offset capital gains on their New Jersey income tax return.


Monday, October 3, 2011

Should You Make a Loan to Your Child This Month?

Yes!

During the month of October is the time to make a loan to you child assuming the child is not subject to the "kiddie tax." Why? Because the imputed interest rate for October is at an all time low and therefore as a planning tool you can move wealth to your children gift and estate tax free.

Generally loans between related parties are governed by the IRS code so that related parties cannot assign income without adverse tax consequences. There is a small exclusion for related parties so that a loan of $10,000 generally does not require that interest be charged.

In some cases if a loan of $100,000 or less is made between related parties there is no imputed interest to the lender so long as the borrow does not earn more than $1,000 from investments. If the borrower earns a greater amount then the lender can be charged with interest income.

Because of the current extremely low interest rate environment making a loan to a child can avoid the imputed interest charge and shift wealth to the borrower.

The following is an illustration of the advantage of making a loan using the low applicable federal interest rates (AFR).

Let's assume that a loan is made to your child $1 million. The loan will require that you use the current applicable rate for a short term loan- 0.16%. A short term loan is a loan with a term of less than three years. Assuming further that the child pays the interest rate due annually of $16,000; after three years a child will pay $48,000.

Now assume that the child invests the $1 million in a market investment returning 4%. At the end of three years the return on the investment will be $120,000. The net benefit to the child is $72,000 ($120,000-$48,000). Now couple this with annual gifts to the child of the current annual exclusion of $13,000 which for two parents is $26,000, the net benefit (and wealth shift) to the child over the three years is $150,000 including gifts. The parent will receive back his or her $1,000,000 plus the earned interest.


This is simple illustration underscores the advantage of making a low interest loan to a child using the current interest rates.

The simple technique when applied to several children can pass wealth at no tax cost (gift or income) to the parents. If the borrower were a trust for the benefit of the child, the net benefit earned on the investment and by way of annual gift can be protected from creditors and be available for the child during his/her lifetime.


Illustration of the advantage of a loan using the current (Oct 2011) AFR

Loan to son/daughter 1,000,000
Interest rate using the short term (0-3yrs) AFR 0.16
annual interest payment* $16,000
Cumulative interest payments $48,000

Assume child invests loan amount @ 4% $40,000
Cumulative return on investment $120,000

Net benefit to child(120,000-48,000) 72,000

*child can make interest payments with annual exclusion
gift from parent.

Friday, September 30, 2011

Employee v. Independent Contractor

New IRS Voluntary Compliance Initiative

(What A Great Deal!)

In my Fairleigh Dickinson Tax Research class, one of the student projects is preparing a Protest involving the classification of workers. Those of you who have taken the class may remember my “Quickie” problem where the student must determine the proper classification of the “worker.” Employee v. Independent Contractor issue is a reoccurring one and important to practitioners.

Whether a worker is an independent contractor or employee generally is determined by whether the enterprise he works for has the right to control and direct him regarding the job he is to do and how he is to do it. Under the common law rules (so-called because they originate from court cases rather than from the Code), multiple factors are used to determine if an individual is a common law employee.

Section 3121(d) 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 an employee. Under the treasury regulations the term "employer" means any person for whom and individual performs or performed any service, of whatever nature, as the employee of such person.

Rev. Rul. 87 – 41 provides the guidelines for determining whether a particular worker is an employee or independent contractor. In this ruling the IRS determined that many factors are considered in evaluating whether a worker is an employee or independent contractor. No single factor or the absence of a factor is conclusive. The ruling outlined 20 factors to consider.

Section 530 of the '78 Revenue Act (as amended) provides retroactive and prospective relief from employment tax liability for employers who misclassified workers as independent contractors using the common law facts and circumstances standards. Section 530 applies only if:

(1) the taxpayer does not treat an individual as an employee for any period, and does not treat any other individual holding a substantially similar position as an employee for purposes of employment tax for any period—the substantive consistency requirement;

(2) for post-'78 periods, “all federal returns (including information returns) required to be filed by the taxpayer” with respect to the individual for such period “are filed on a basis consistent with the taxpayer's treatment” of the individual as a nonemployee—the reporting consistency requirement; and

(3) the taxpayer had a “reasonable basis” for not treating the worker as an employee (judicial precedent or IRS rulings, a past IRS audit, or a long-standing practice of a significant segment of the relevant industry)—the reasonable basis requirement.

Under IRS's pre-existing Worker Classification Settlement Program (CSP), which applies only for taxpayers under audit, the examiner first determines if the taxpayer is entitled to Section 530 relief (and if it is, there is no assessment). If the taxpayer is not entitled to this relief, a series of two graduated CSP settlement offers can occur.

If the service recipient has met the reporting consistency requirement of Section 530but either can't meet the reasonable basis requirement or can't meet the reporting consistency requirement, the offer is a full employment tax assessment under IRC 3509 (which sets forth the employer's liability for employment tax because of its treating an employee as not being an employee) for one tax year (with the employer agreeing to reclassify the workers as employees on a prospective basis).

If the service recipient has met the reporting consistency requirement and can reasonably argue that it met the reasonable basis and substantive consistency requirements, the offer will be an assessment of 25% of the employment tax liability for the audit year under IRC 3509 (with the employer agreeing to reclassify the workers as employees on a prospective basis).

If workers are recharacterized under the CSP, no interest will be due on the additional liability arising as a result of the recharacterization if certain conditions are met.

New IRS Voluntary Compliance Initiative

The IRS has determined that it would be beneficial to create a program that allows for voluntary reclassification of workers as employees outside of the examination context and without the need to go through normal administrative correction procedures applicable to employment taxes. The IRS reasons that the program will facilitate voluntary resolution of worker classification issues and achieve the resulting benefits of increased tax compliance and certainty for all parties involved.

Who's eligible?

The voluntary classification settlement program (VCSP) is available to taxpayers who are currently treating their workers (or a class or group of workers) as independent contractors or other non-employees and want to prospectively (presently and in the future) treat the workers as employees. Ann. 2011-64, 2011-41 IRB , provides that the program is open to businesses, tax-exempt organizations, and government entities.

To be eligible:

• A taxpayer must have consistently treated the workers as non-employees;
• A taxpayer must have filed all required Forms 1099 for the workers for the previous three years. The Instructions for Form 8952, Application for Voluntary Classification Settlement Program (VCSP), clarify that this requirement must be satisfied for each of the affected workers for the three preceding calendar years ending before the date Form 8952 is filed.
• The taxpayer cannot currently be under audit by IRS, or currently under audit concerning the classification of the workers by the Department of Labor (DOL) or by a state government agency.
Notwithstanding a taxpayer that was previously audited by IRS or DOL about the classification of the workers will only be eligible if it has complied with the results of that audit.

Terms of the offer

A taxpayer who applies for and is accepted into the VCSP will agree to prospectively treat the class of workers as employees for future tax periods and in exchange:
(A) Will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of IRC 3509;
(B) Will not be liable for any interest and penalties on the liability;
(C) Will not be subject to an employment tax audit for the worker classification of the workers for prior years; and
(D) Will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees.

Application process

Taxpayers will have to apply on Form 8952 for participation in the VCSP, and provide the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848). The Instructions to Form 8952 provide that although Form 8952 can be filed at any time, it should be filed at least 60 days before the date a service recipient wants to begin treating the class or classes of workers as employees. IRS will contact the taxpayer or authorized representative to complete the process once it has reviewed the application and verified the taxpayer's eligibility. IRS retains discretion as to whether to accept a VCSP application. Those who are accepted will enter into a closing agreement with IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.

Thursday, September 15, 2011

Property Inherited in 2010: Carryover (Step-Up) Basis Rules

The federal estate tax has undergone several changes in recent years. We had an estate tax in 2009, and none in 2010. In December of 2010, Congress retroactively enacted an estate tax for 2010, but gave executors options to determine basis of assets inherited from a decedent.
In a legislative compromise at the end of 2010, congress retroactively reinstated the estate tax to apply to decedents who died in 2010. However, an important feature of the law that revived the estate tax is that it gave executors of estates of decedents who died in 2010 a choice. The executor can either:
(a) have the new estate tax rules ($5 million exemption, with a flat rate of 35% imposed on all transfers over that amount) apply to the estate, in which case the traditional stepped-up basis rules (which provide that the basis of assets received from a decedent is equal to the value of such assets on the date of the decedent's death) would apply in determining the basis of property acquired from the decedent; OR
(b) elect not to be subject to the estate tax, meaning that the estate would pass to the heirs free from estate tax, but the modified carryover basis rules (discussed below) would apply in determining the basis of property acquired from the decedent.
Modified Carryover Basis Rules
Under the modified carryover basis rules IRC Sec. 1022, the basis of property acquired from an individual dying in 2010, in the hands of the person acquiring it, generally is the lower of the fair market value on the date of the decedent's death or the adjusted basis of the property immediately before the death of the decedent.

For example, the decedent died on Jan. 1, 2010, owning 200 shares of Corporation Y stock having a fair market value of $40,000. His adjusted basis in the stock immediately before his death was $30,000, which was the amount he paid for the 200 shares several years ago. Absent from a permitted basis increase for the stock, the basis of the Corporation Y stock in the hands of the person acquiring it from the decedent is $30,000. Now, assume the stock is worth $20,000 on the date of decedent's death. Under the modified basis rule, the basis in the hands of the person acquiring or receiving it would be $20,000.
The basis of property determined under the modified basis rule (i.e., the lesser of adjusted basis or fair market value) is increased by a general basis increase amount of $1.3 million. In other words, each estate receives a $1.3 million of basis plus more (depending on marital status at time of death and other circumstances) to be added to the carryover basis of any one or more of the assets held at death. However, no addition to basis can increase the new basis of any asset above its fair market value on the date of death.
The allocations of the general basis increase and other increases must be made by the executor, or other person in possession of a decedent's property, and must be reported to IRS and the property recipients.
Generally, if an estate is less than or equal to $5,000,000 ($10,000,000 for a married couple), the likely choice will be to apply the retroactive estate tax and remain subject to the estate tax rules (and receive the step-up in basis to date-of-death fair market value). However, in many cases, the circumstances will be more complex and will require careful analysis to determine whether or not to elect out of the default estate tax rules. For these situations, other specific factors will be considered and decisions will depend on each person’s specific circumstances.
By way of an announcement on September 13, 2011, the IRS pushed back the due date of these estate tax returns. The returns are now due March 19, 2012.
Please contact Frank Brunetti with any concerns or help that you may need with any of the aforementioned issues.
Circular 230 requires that we notify you that, in the absence of written advice that strictly complies with such rules, you cannot rely on advice given to you relating to any Internal Revenue Code matter for protection against a tax penalty. This notice is neither intended to be used for the purpose of avoiding any tax penalty nor can it be relied on in support of any marketed transaction. It is our intention to continue to deliver the highest quality services to you and in a cost efficient manner. Please call us if you have and questions about how the Circular may affect our representation of you.

Thursday, April 7, 2011

So I am a Resident of New York And New Jersey?

As a follow-up to my recent posting of my article “Domicile is Like an Inertia,” I received an interesting article discussing New York’s Statutory Residence Rule in the Tax Analysts Special Report dated April 4, 2011. The article written by Peter L. Faber criticizes the statutory residence test and argues that it should be repealed. In his article, the author points out that New York State taxes residents on all their world wide income, regardless of whether it has any connection to New York. A person who is not legally domiciled in New York is treated as a resident for income tax purposes if he maintains a permanent place of abode in New York and is present in the state for more than 183 days during the tax year. This individual is known as a “statutory residence.” The statutory residence rule only applies for personal income taxes.

In the article, the author points out that the statutory residence test was conceived as an objective surrogate for the domicile test. It was intended to avoid the complex inquiry that goes into determining a person’s domicile and to ensure that a person who really lived in New York could not avoid resident status by arguing that his “state of mind” placed primary loyalty elsewhere.

The article points out that the New York Department of Taxation has taken an expansive view of the statutory language. The Department views the word “permanent” as relating to the nature of the residence and not the taxpayer’s use of it. The only structural exclusion is “for a mere camp or cottage, which is suitable and used only for vacations.” 20 NYCRR, Section 105.20(e)(1). Therefore, a house or apartment that is not a camp or cottage is treated as a permanent place of abode even if it is in fact used only for vacations or for that matter not at all.

The author goes on to discuss a number of cases involving individuals who clearly were not New York residents but because of the statutory residence test were required to litigate the issue as to whether they were New York residents and therefore to count days. The problem with counting days is that typically taxpayers do not maintain good records of their whereabouts. Certainly the taxpayer has the burden of proof in determining whether he or she does or does not meet the 183-day test. The result is that invariably taxpayers have trouble proving that they were not in New York for more than 183 days during a tax year. Proving a negative is always hard, and proving that a person was not in New York for any part of a given day as the author points out can be extremely difficult.

The advice given is to keep contemporaneous records including a diary every day and any part of every day. The author goes on to recommend that the individual maintain a separate folder for each day and insert in the folder copies of any documentation that they have showing there whereabouts on that day. Still all in all the taxpayer will in all likelihood have a difficult time proving that they are not a New York resident. The author points out that the audit process is time consuming and expensive and can go on for many years. Most taxpayers do not have the time or money to spend on such an audit. The author argues that the statutory residence rule should be repealed and replaced by the domicile test for income tax purposes. Indeed, that would eliminate counting days and refocus the incidence of taxation only on those individuals who are truly domiciled in New York and should bear the burden of the state’s income tax.

IRS in India

According to Today's Wall Street Journal the Justice Department is expected to file a lawsuit Thursday that seeks to force HSBC India to reveal the names of U.S. customers with secret accounts, according to a person familiar with the matter.

The department is expected to file the legal action in a San Francisco federal court.

The move opens up a new front in the U.S. crackdown on tax evasion and comes days before the April deadline for taxpayers to file individual returns.

In February 2011, the Internal Revenue Service announced a second leniency program that offers reduced penalties to tax scofflaws that voluntarily report their offshore accounts. The agency offered the first program in 2009 in the wake of the U.S. case against UBS.

The Justice Department sent signals this year that London-based HSBC Holdings PLC's India operations were in its sights. Prosecutors indicted a New Jersey businessman In January on charges that he conspired to evade taxes by hiding offshore bank accounts in India maintained by HSBC.

The January indictment didn't identify the bank by name, saying only that the institution "was one of the largest international banks in the world and was headquartered in England." A person familiar with the case said the bank was HSBC.

Friday, April 1, 2011

Domicile is Like Inertia

Wikipedia defines Inertia as the resistance of any physical object to a change in its state of motion or rest. It is represented numerically by an object's mass. The principle of inertia is one of the fundamental principles of classical physics which are used to describe the motion of matter and how it is affected by applied forces. Inertia comes from the Latin word, iners, meaning idle, or lazy. Sir Isaac Newton defined inertia in Definition 3 of his PhilosophiƦ Naturalis Principia Mathematica, which states:

The vis insita, or innate force of matter, is a power of resisting by which every body, as much as in it lies, endeavours to preserve its present state, whether it be of rest or of moving uniformly forward in a straight line.

In my review of New Jersey and New York law I have found that like “inertia” domicile has a tendency to remain is a state of motion or rest. Once a person establishes a domicile it is very difficult for it to change.
The New Jersey Experience

N.J.S.A. 54A:1-2(m) defines a resident taxpayer as an individual:
(1) who is domiciled in the State, unless (i) he maintains no permanent place of abode in this State, (ii) maintains a permanent place of abode elsewhere, and (iii) spends in the aggregate no more than 30 days of the taxable year in this State (subdivisions added); or

(2) who is not domiciled in this State but maintains a permanent place of abode in this State and spends in the aggregate more than 183 days of the taxable year in this State, unless such individual is in the Armed Forces of the United States.

Thus a resident is either (i) a domiciliary (unless he or she meets all three conditions in N.J.S.A. 54A:1-2(m)(1) or (2) a nondomiciliary who maintains a permanent place of abode and more than 183 days of the taxable year in this State. An individual who does not fit within the parameters of N.J.S.A. 54A:1-2(m) is a nonresident taxpayer. N.J.S.A. 54A:1-2(n).

It’s important to note that a resident taxpayer is subject to the NJ-GIT on income derived from all sources. N.J.S.A.54A:5-1, “domicile alone…affords an adequate basis for the taxation of income.” Hough v. Director of Div. of Taxation, 2 NJ Tax 67, 72 (Tax Ct. 1980). An individual’s income is taxable without regard to its source. Estate of Guzzardi v. Director of Div. of Taxation, 15 NJ Tax 395, 397 (Tax Ct. 1995).

Consequently, the resident who derives income that is taxed by other jurisdictions is afforded the resident tax credit against the New Jersey tax for eligible taxes paid to other jurisdictions. N.J.S.A.54A:4-1(a).

A person who is not a New Jersey resident is taxed only to the extent of income derived form New Jersey sources. N.J.S.A.54A:2-1.1.

New Jersey Courts have often provided a detailed analysis of the terms “domicile” and “resident.” These terms are nor interchangeable for NJ-GIT purposes because a person can have only one domicile. Geoffredo v. Director of Div. of Taxation, 9 NJ Tax 135, 139 (Tax Ct.1987)

In Goffredo, the tax court discussed the differences between domicile and residence:
“Domicile” and “residence” are related terms and although in certain contexts are used interchangeably, they are not legally identical. Domicile is defined as:
That place where a man has his true, fixed, and permanent home and principal establishment, and to which whenever he is absent he has the intention of returning. The permanent residence of a person or the place to which he intends to return even though he may actually reside elsewhere. A person may have more than one residence but only one domicile.

Additionally, “domicile” is compared and distinguished from “residence” by Black's [Law Dictionary] as follows:

As “domicile” and “residence” are usually in the same place, they are frequently used as if they had the same meaning, but they are not identical terms, for a person may have two places of residence, as in the city and country, but only one domicile. Residence means living in a particular locality, but domicile means living in that locality with intent to make it a fixed and permanent home. Residence simply requires bodily presence as an inhabitant in a given place, while domicile requires bodily presence in that place and also an intention to make it one's domicile. “Residence” is not synonymous with “domicile,” though the two terms are closely related; a person may have only one legal domicile at one time, but he may have more than one residence. Id. at 140.

In Lyon v. Glaser, 60 N.J. 259, 288 A.2d 12 (1972), the New Jersey Supreme Court wrote:
Domicile is very much a mater of the mind-of intention. One may be acquired, or change to a new one, when there is a concurrence of certain elements; i.e., an actual and physical taking up of an abode in a particular State, accompanied by an intention to make his home there permanently or at least indefinitely, and to abandon his old domicile. A person has the right to choose his own domicile, and his motive in doing so is immaterial. The change may be made to avoid taxation, so long as the necessary ingredients for establishment of the new domicile are present. A very short period of residence in a given place may be sufficient to show domicile, but mere residence, regardless of its length, is not sufficient. It has been said that concurrence, even for a moment, of physical presence at a dwelling place with the intention of making it a permanent abode, effects a change of domicile. And once established, the domicile continues until a new one is found to have been acquired through an application of the same tests. Since the concept of domicile involves the concurrence of physical presence in a particular State, and an intention to make that State one’s home, determination of a disputed issue on the subject requires an evaluation of all the facts and circumstances of the case. Id. at 264-65, 288 A.2d 12 (citations and footnote omitted) (emphasis added).

In Gruodis v. Director, New Jersey Division of Taxation; Dkt. No. A-5370-04T3, 08/03/2006 , the taxpayer was born in Lithuania in 1942 and moved to the United States as a child. He maintains dual citizenship, went to school in the United States, including college, married a United States citizen, his first wife Carol, and had two children in the United States. From 1983 to 1998, Victor and Carol maintained a primary residence with their two children in River Vale, New Jersey.
In 1998, Carol died and in 1999 Victor became engaged to a Lithuanian citizen, Ausra. The New Jersey house was in Carol's name and was never transferred to Victor after her death.

Notwithstanding Mr. Gruodis' home outside of Vilnius, Lithuania had not been completed until the end of the year 2000. Mr. Gruodis urges the court to accept that his new domicile was Ausra's apartment, or prior to that, the apartments rented for him by one Omnitel. Yet, for a number of years prior to 2000, Mr. Gruodis continued to live in the same manner, going back and forth from New Jersey to Lithuania.
The court said: “While it is true that a person has a right to choose his domicile, and the motives for his choice are immaterial to a determination of domicile, Wolff v. Taxation Div. Director, 9 N.J. Tax 11 (Tax 1986) , 'declarations of domicile motivated by tax considerations may be carefully scrutinized and readily rejected when negated by the objective circumstances.'” 9 N.J. Tax at 297 quoting Lyon, supra, 60 N.J. at 281.

After reviewing all the evidence the Appellate Court held Mr. Gruodis:
1. retained and maintained the River Vale residence for his son and for his business relations,
2. claimed a deduction for property taxes and mortgage interest on his federal income tax returns,
3. claimed and received a New Jersey Saver rebate,
4. filed a joint tax return, federally and in several states, listing the River Vale address as his residence,
5. listed the River Vale house as his place of business on his 2000 federal income tax returns,
6. maintained his bank accounts and financial accounts in New Jersey,
7. maintained his New Jersey driver's license until he was able to replace it ... with his Bahamas license, and
8. was married in New Jersey and used the River Vale address as his residence on the New Jersey marriage license.

Considering all the evidence as a whole, this court found that taxpayers did not effect a change of domicile in the year 2000.

Illustrative of the efforts needed to change domicile is recited in O’Hara v. Director, New Jersey Division of Taxation; 60 NJ 239 (1972). In O’Hara the New Jersey Supreme Court noted the taxpayer took the following steps:
(1) In early May 1969 she advised her former employer that she had moved to Florida and requested that the retirement checks be sent to 9801 West Suburban Drive, Miami, Florida (the home of Meredith O'Hara). This is corroborated by the employer's affidavit, which states in addition that "she unquestionably intended to remain in Florida the rest of her life," and so he changed all of his records accordingly.
(2) She rented a safe deposit box in a South Miami bank on May 26, 1969, and transferred to it all of her securities and important papers, from her box in a New York bank.
(3) She requested Meredith O'Hara to sell her house in Westfield; and according to the first floor tenant, Mrs. Haney, he endeavored to sell it to them.
(4) She opened a brokerage account with the Miami office of a national brokerage firm on June 12, 1969.
(5) She opened a checking account in a South Miami bank.
(6) In each of the above transactions she gave the same Miami address.
(7) On June 25, 1969 she executed a Declaration of Domicile and Citizenship in Dade County, Florida, and filed it with the Clerk of the Circuit Court of that County. The certificate was signed and sworn to by Miss Johnston and recites that she was formerly a resident of Westfield, New Jersey, that she had changed her domicile to and had become a bona fide resident of the State of Florida residing at Meredith O'Hara's address, since May 3, 1969 (the date should have been May 4), and that she had no intention of returning to her former domicile but intended to remain in Miami, Florida, permanently.

The court also noted that on May 3 (the year of her death) she went to her house with Meredith and packed up her clothes, records, correspondence, family photographs, Christmas card lists and jewelry to take to Florida with her. She removed everything except the furniture, which was of little value (it was appraised at $95 after her death). She said good-bye to her tenants, the Haneys, and as Mrs. Haney said, it was quite apparent that she was leaving for good, and intended to establish her home in Florida.

Based on the clear steps taken by the taxpayer the Supreme court determined that the New Jersey domicile had been abandoned in favor of Florida.

In Samuelsson v. Director Division of Taxation, 22 NJ Tax 243 (Tax 2004), the taxpayer was a professional hockey player for the Philadelphia Flyers. After obtaining a job with the Tampa Bay Lightning, he and his family moved from their New Jersey home to Florida. They moved all furniture and belongings, put their house up for sale, looked for a house in Florida, enrolled their children in a Florida school, but never actually purchased a Florida house or sold their New Jersey house. They eventually returned to their New Jersey house and retained New Jersey as their domicile. However, they contested the Director's assertion that New Jersey remained their domicile for the year they had resided in Florida. The court found that the Samuelssons had abandoned their New Jersey domicile, even though they had not sold their house. An important distinction in Samuelsson was that the taxpayers closed all their New Jersey bank accounts and opened Florida accounts, Mr. Samuelsson changed his driver's licenses to Florida, registered his car in Florida and left the house empty during the period of abandonment.

No person is ever without a domicile in the eyes of the law, and a person is presumed to be domiciled in his domiciliary state until a new domicile is acquired. Lyon v. Glaser, 60 N.J. 259, 277, 288 A.2d 12 (1972).

There can be no establishment of a new domicile unless there is proof of an intent to abandon an original domicile. Bowman v. DuBose, 267 F.Supp. 312, 313-314 (D.S.C. 1967); Citizens State Bank and Trust Co. v. Glaser, 70 N.J. 72, 81, 357 A.2d 753 (1976); Lyon v. Glaser, supra 60 N.J. at 264, 288 A.2d 12. Any disputed issue on the subject requires an evaluation of all the facts and circumstances of the case. Id. at 264-265, 288 A.2d 12.

The abandonment or change of one’s domicile for another must be by clear steps taken by the taxpayer; like inertia it takes considerable force to exact a change.


The New York Experience

It seems that in interpreting the elements of domicile the New York Department of Taxation has also incorporated the laws of physics. No matter how hard one may try it is very difficult to change domicile in New York once established.

As outlined in the New York Department of Taxation and Finance Publication No. 88 dated December 1, 2010 a person can only have one domicile. As it has often been put “domicile is the place you intend to have as your permanent home.” A change in domicile must be clear and convincing. New York uses a number of qualitative and quantitative factors are used to determine if there is a change in domicile including:
● the size, value and nature of use of your first residence to the size, value and nature of use of your newly acquired residence;
● your employment and/or business connections in both locations;
● the amount of time spent in both locations;
● the physical location of items that have significant sentimental value to you in both locations; and
● your close family ties in both locations.

New York says the change of domicile is clear and convincing only when the taxpayer’s primary ties are clearly greater in the new location. This test, that is “clearly Greater” imposes a very high standard and like inertia requires a significant force to move.

Difficulty arises when a taxpayer intends to change his domicile from New York to another state such as Florida. Often such person may keep his New York home or apartment and purchase or rent a residence in another state such as Florida or Texas. Under these circumstances it is difficult for a taxpayer to establish a domicile in another state and become New York non-residents.

When we counsel clients regarding domicile we often advise client to change their financial contacts, their driver’s license, voter registration, address for tax filings, their church or synagogue, etc. As often repeated in case law regarding change in domicile, “formal declarations have been held less persuasive then informal acts of an individual’s habit of life.” Matter of Silverman, Tax Appeal Tribunal, April 6, 1995.

While the standard regarding change of domicile is both objective and subjective, the courts and the Tax Appeals Tribunal have consistently looked to certain objective criteria to determine whether a taxpayer’s general habits of living demonstrate a change of domicile. Among the factors that have been considered are:
(1) the retention of a permanent place of abode in New York;
(2) continued business activity in New York;
(3) family ties in New York;
(4) continuing social and community ties in New York; and
(5) formal declarations of domicile.
Indeed, In the Matter of Slotkis, Tax Appeal Tribunal, March 7, 2002, the taxpayers:
● changed their voting registration,
● changed their drivers’ licenses,
● filed for a Florida exemption from the ad valorem tax and homestead exemption,
● executed new Wills, Revocable Trusts, Durable Powers of Attorney and Health Care Surrogate Designations using their Florida address,
● filed their US income tax return using their Florida address,
● spent 217 days in Florida and 140 days in New York.
The court noted in finding that New York was the taxpayers’ domicile:
There is no indicating in the record that petitioners intended to sever their New York ties or that they possessed the requisite intent to make Florida their fixed and permanent home. Three of their four children as well as grandchildren and great grandchildren resided in the New York metropolitan area. Their grandchildren were described as “their sole source of pleasure.” Petitioners retained their home in Brooklyn, New York. They intended to keep this home to use during their visits to New York, especially during the spring and summer months when they felt it was too hot in Florida. Petitioners spent 148 days in New York during 1997, the vast majority of those between April and September. This was only a minor change in their travel patters from the year 1995, the year prior to Mrs. Slotkis’s stroke, in which they spent approximately six months in New York during the spring, summer and autumn months at a time when they still considered themselves domiciled in New York.
Petitioners did not take any of their furniture from their Brooklyn house to Florida, as they intended to continue to use this home during their stays in New York. This is a strong factor in deciding that they did not intend to give up their New York domicile and make the Florida condominium their permanent home.
The court concluded that the taxpayers’ declaration of a Florida domicile was undermined by their general habit of life in which New York remained their permanent home. The continued maintenance of their Brooklyn home, the large amount of time spent in New York during the year, the lack of any significant change in their travel schedules before and after they claimed to have changed their domicile and the importance of being with their family in New York all serve to negate an intent to give up their New York domicile or to acquire a new domicile in Florida. Accordingly, the court found that the taxpayers continued to be domicile in New York.
Because of the heavy burden the law places on an individual asserting a change of domicile, it appears that unless one actually leaves New York, close down an apartment or sell his house, move furniture, change all contacts, severely limit the time in New York and contact with children and grandchildren it is more likely than not that one will be unable to change their domicile.
One factor which may establish a change in domicile might be a new employment position. Nevertheless a court will look very closely at such an arrangement to determine if it is one of substance. A court would look at whether the job is full time and the amount of remuneration expected and received and whether a new position is real or just “window dressing.” As said in the Matter of Reid, Tax Appeal Tribunal, December 27, 1994:
A change of domicile may be made through caprice, whim or fancy, for business, health or pleasure, to secure a change of climate, or a change of laws, or for any reason whatever, provided there is an absolute and fixed intention to abandon one and acquire another and the acts of the person affected confirm the intention .... No pretense or deception can be practiced, for the intention must be honest, the action genuine and the evidence to establish both, clear and convincing. The animus manendi must be actual with no animo revertendi ....
Indeed a move to another country has been held insufficient to establish a new domicile. In the Matter of the Petition of Taylor, NYS Division of Tax Appeals, ALJ, 822824, 07/08/2010 the taxpayer did not prove, by clear and convincing evidence, that during the years at issue she gave up her long-time New York City domicile and acquired a new domicile as her fixed and permanent home in London. The taxpayer, who owned two homes in New York, accepted a position with her employer that required her to live in London for many years. The taxpayer's initial choice to accept, and subsequently extend for many years, a position in London appeared to have resulted from the opportunity for career advancement offered there rather than from a desire to live in London. However, subsequent to the years at issue the taxpayer purchased a home in London and decided to make it her permanent home. Under NYCRR Title 20 §105.20(d)(3), a New York domiciliary who goes abroad because of a work assignment does not lose his or her New York domicile unless it is clearly shown that the intent is to remain abroad permanently and not to return. The court determined that the facts of the case did not compel a conclusion that the taxpayer was committed to staying in London without any intent to return to New York, where she continued to retain two residences, including her historic place of domicile, or to move elsewhere.

Friday, February 11, 2011

Second bite at the Apple-Second settlement offer for those voluntarily disclosing unreported offshore income

The IRS has announced a second special voluntary disclosure initiative that will give taxpayers with undisclosed income from hidden offshore accounts for the 2003—2010 period the chance to get current with their taxes.

The new voluntary disclosure initiative will be available through Aug. 31, 2011. The new initiative carries higher penalties than the original disclosure initiative announced in 2009, but the penalties can be mitigated under certain circumstances.
Details of voluntary offer. IRS released details of the new voluntary offer, called the 2011 Offshore Voluntary Disclosure Initiative (OVDI), in the form of 53 frequently asked questions (FAQs).

The FAQs provide details on a number of important aspects of the voluntary offer, including the following:

Carrot and stick.

Taxpayers that fully comply with the offer will avoid criminal prosecution and will be able to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by IRS and the imposition of substantial penalties, including a fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. (FAQs 1, 4, 5, and 6)

Complying with the offer. To take advantage of the 2011 OVDI, taxpayers must:

• Provide copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for tax years covered by the voluntary disclosure. Calendar year taxpayers must include tax years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities. Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010.

• Provide complete and accurate amended federal income tax returns (for individuals, Form 1040X, or original Form 1040 if delinquent) for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account or entity (e.g., Schedules B, D and E).

• File complete and accurate original or amended offshore-related information returns and Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, also known as an FBAR) for calendar years 2003—2010.

• Cooperate in the voluntary disclosure process, including providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing tax and penalties.

• Pay (a) 20% accuracy-related penalties under Code Sec. 6662(a) on the full amount of underpayments of tax for all years; (b) failure to file penalties under Code Sec. 6651(a)(1) , if applicable; and (c) failure to pay penalties under Code Sec. 6651(a)
(2) , if applicable.

• Pay, instead of all other penalties that may apply, including FBAR and offshore-related information return penalties, a miscellaneous Title 26 offshore penalty, equal to 25% (or in limited cases 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure.

• Submit full payment of all tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties, or make good faith arrangements with IRS to pay in full the tax, interest, and these penalties (the suspension of interest provisions of Code Sec. 6404(g) do not apply to interest due in the new initiative).

• Execute a Closing Agreement on Final Determination Covering Specific Matters, Form 906. (FAQs 7 and 9)

FAQ 50 adds that because the 25% offshore penalty is a proxy for the FBAR penalty, other Code penalties, and potential liabilities for years before 2003, there may be cases where a taxpayer making a voluntary disclosure would owe less if the special offshore initiative did not exist. Under no circumstances will taxpayers have to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes.

The 25% penalty is reduced to 12.5% if the taxpayer's highest aggregate account balance (including the fair market value of assets in undisclosed offshore entities and the fair market value of any foreign assets that were either acquired with improperly untaxed funds or produced improperly untaxed income) in each of the years covered by the 2011 OVDI is less than $75,000. (FAQ 53)

The 25% penalty is reduced to 5% if the taxpayer: (a) did not open or cause the account to be opened (unless a new account had to be opened upon the death of the owner of the account); (b) exercised minimal, infrequent contact with the account (e.g., to request the account balance); (c) didn't, except for a withdrawal closing the account and transferring the funds to a U.S. account, withdraw more than $1,000 from the account in any year covered by the voluntary disclosure; and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. tax). For funds deposited before Jan. 1, '91, if no information is available to establish whether such funds were appropriately taxed, it will be presumed that they were. The penalty is also reduced to 5% for taxpayers who are foreign residents and who were unaware that they were U.S. citizens. (FAQ 52)

The voluntary compliance offer is not available if IRS has initiated a civil examination of the taxpayer, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities. Taxpayers under criminal investigation by IRS's Criminal Investigations division are also ineligible. (FAQ 14)
Special procedures for PFIC investments. Unlike the earlier offshore settlement initiative, the new one offers an alternative resolution regime to cases involving passive foreign investment company (PFIC) issues. It will resolve PFIC issues on a basis that is consistent with the mark-to-market methodology in Code Sec. 1296 , but won't require complete reconstruction of historical data. The highly technical terms of this alternative resolution are carried in FAQ 10.
Consequences of failing to meet the deadline. Although the terms of this initiative are available only to taxpayers who complete the voluntary disclosure process on or before Aug. 31, 2011, IRS's Criminal Investigation division's Voluntary Disclosure Practice will remain available to taxpayers who wish to voluntarily disclose their tax violations after that date. However, these taxpayers will not be eligible for the special civil terms of the new initiative and will be liable for all applicable civil penalties, including the willful FBAR penalty. In addition, the civil resolution of their cases may extend to tax years prior to 2003.

The IRS discourages “quiet disclosure.” IRS says it is aware that some taxpayers are attempting “quiet disclosure” by filing amended returns and paying any related tax and interest for previously unreported offshore income without otherwise notifying IRS. In FAQs 15 and 16, IRS strongly encourages such taxpayers to come forward under the voluntary disclosure offer. Those that don't run the risk of being examined and potentially criminally prosecuted for all applicable years. IRS says it has identified, and will continue to identify and closely review, amended tax returns reporting increases in income.