If your tax return is audited by the Oregon Department of Revenue, you will likely receive a Notice of Deficiency at the conclusion of the audit. The Notice of Deficiency summarizes changes that have been made to your tax return (or returns) and informs you of your options for appealing the Department’s decision. You have two options to request an administrative appeal of the Notice of Deficiency: you can submit a written protest or you can request an appeals conference. You must choose one or the other, and you must submit your appeal in writing within 30 days of the date on the notice.
A written protest should detail each of your objections to the audit changes, and may include additional documentation to support your arguments. When you submit a written protest, it will be considered by the same person who conducted the audit. In many ways, the written protest is like an extension of the audit. If you were not happy with the way the audit was handled, an appeals conference may be a better option.
An appeals conference is an informal meeting between you, the auditor, and a conference officer—a more senior Department of Revenue employee with substantial audit experience. The conference can be held in person or by phone, and you will have the opportunity to submit additional documentation to the conference officer. Although a conference gives you the opportunity to have a second opinion from an experienced Department of Revenue employee, you should take note—conference officers are not independent of the Department, which means that their decisions should not be considered objective or unbiased.
At the conclusion of the administrative appeal, or if no administrative appeal is made within 30 days of the date on the Notice of Deficiency, the Department will issue a Notice of Assessment. This notice is particularly important because it begins the 90-day period to appeal to the Oregon Tax Court. If you do not appeal within that time frame, the adjustments become final and your options for challenging the tax are very limited.
While considering whether to appeal to the Tax Court during the 90-day period following the Notice of Assessment, it is important to be aware of the Department’s collection activities during that time frame. Thirty days after the Notice of Assessment goes out, the Department will send a Notice and Demand to Pay. While this letter seems threatening, it is the next notice that you should watch out for. Thirty days after the Notice and Demand to Pay is sent (now 60 days after the Notice of Assessment) the Department will send a Distraint Warrant. This document authorizes the Department to garnish your wages or bank account, or potentially seize other assets, without further notice. It is important to understand that the Department could take these actions even before your appeal rights have expired.
If you receive a Notice of Deficiency or Notice of Assessment, or any other notice from the Department of Revenue, consult with an experienced tax attorney who understands the assessment and collection process and who will advocate on your behalf. If you do not take appropriate steps to respond to the Department’s notices, your assets are at risk. Be proactive, talk to a professional, and educate yourself about your rights as a taxpayer.
The Oregon Department of Revenue recently held a hearing on a proposed rule that would authorize the Department to post a list of delinquent taxpayers online. Although the IRS is prohibited from publishing the information of delinquent taxpayers, almost half of the states in the U.S. use “naming and shaming” to improve tax compliance. Studies suggest that this practice can facilitate the collection of taxes if done properly. However, there is reason to believe that the use of a delinquent taxpayer list can backfire if taxpayers view an agency’s collection procedures as unfair or coercive.
As part of its public disclosure pilot program, the Department of Revenue will publish a list of the “largest tax delinquencies” for which a warrant has been recorded in any Oregon county clerk’s office. The rule provides no indication as to exactly how many delinquencies will be included on the list, but a previous draft of the rule limited the list to the 25 largest delinquencies. The removal of that limitation in the current draft could be a bad omen for Oregon taxpayers with outstanding balances.
On December 1, the Department rolled out its new computer system, which includes an automated warrant system. Previously, revenue agents had to manually review each account to decide when a delinquent liability should be subject to a recorded warrant. Now, any liability over $2500 not paid within 60 days of assessment will be subject to an automatic, recorded warrant. The new automated warrant system streamlines the process and greatly expands the pool of delinquent taxpayers potentially eligible for public disclosure. Before a taxpayer is placed on the public delinquency list, the Department must send a written notice giving the taxpayer 30 days to correct the delinquency, either by paying in full or entering into an approved payment plan. Taxpayers can also stay off the list by initiating a bankruptcy proceeding or by convincing the Department that the delinquency is uncollectible due to financial hardship (an unlikely prospect).
Is “naming and shaming” good policy? Will it promote compliance with Oregon’s tax laws? I recently attended the inaugural International Conference on Taxpayer Rights in Washington, D.C., where government initiatives to promote voluntary compliance were heavily discussed.
The keynote address by Eric Kirchler, Professor of Economic Psychology at the University of Vienna, looked at the ways in which taxpayers’ attitudes towards tax agencies affect voluntary compliance. Mr. Kirchler distinquished an agency’s use of legitimate power (based on the agency’s professionalism, expertise, and legal authority) from the agency’s use of coercive power (such as asset seizure, penalties, and public shaming). If an agency exercises too much coercive power in relation to its exercise of legitimate power, the agency’s use of that power will be viewed as unfair and oppressive. As a result, taxpayer trust in the agency will suffer and overall levels of compliance will decrease. To be effective in promoting compliance, Kirchler said, coercive power should be used only in limited circumstances.
Lennart Wittberg, a strategist with the Swedish Tax Agency, discussed the application of these ideas in Sweden, which has one of the world’s highest voluntary compliance rates. In 2006, Sweden changed its approach to audits and tax enforcement, recognizing that if taxpayers perceive the tax system as fair and just, they are more willing to accept decisions of the taxing agency that negatively affect them. Wittberg noted that most Swedish taxpayers feel that they are treated with fairness and respect during the audit process. Because they are given a meaningful chance to present their case to the auditor, taxpayers tend to view the agency’s final decision as an exercise of legitimate power. As a result, Swedish taxpayers are highly likely to comply with the tax laws following an audit, regardless of the audit outcome.
In order to promote voluntary compliance, the Oregon Department of Revenue should apply these principles to its tax collection policies. Publicly disclosing the names and addresses of delinquent taxpayers is a coercive power which must be used with caution. If the collection process is viewed as unfair and unjust, taxpayer compliance will likely decrease. For example, the proposed rules provide that Oregon taxpayers may avoid the disclosure list by entering into a payment agreement for satisfaction of their liabilities. But if taxpayers are not offered a meaningful opportunity to enter into a payment agreement based on an amount they can reasonably afford to pay, public shaming will likely build resentment towards the Department. Shaming should be strictly reserved for taxpayers who are able to pay and have been offered an opportunity to pay, but who choose not to. The power to destroy the reputations of businesses and individual taxpayers should not be taken lightly.
If you are being pursued by the Oregon Department of Revenue for past-due tax liabilities, you know what the collections process is like. Many taxpayers seek the assistance of an attorney because they feel that they are being treated unfairly by revenue agents who don’t give them the opportunity to make reasonable payment arrangements. Whether or not the Department of Revenue’s collection policies are fair and just (or even legal, in some cases) is a complicated question that will be the subject of future discussions. In the meantime, as the Department of Revenue ramps up collections efforts, policymakers would be well advised to keep in mind that when it comes to promoting voluntary compliance, winning the trust and respect of taxpayers is vital to success.
Two men in a boat on a stormy sea. 1803 etching. Courtesy Wellcome Library, London. Wellcome Images.
Truth and Consequences Do an internet search for self-directed IRA and you’ll find a number of promoters promising to give you complete control over your retirement accounts. Those promises may contain a grain of truth, but don’t let exaggerated claims capsize your retirement plan. It is true that by rolling over an existing IRA or 401(k) into a self-directed IRA, you can invest in assets not offered by most IRA providers. With a self-directed IRA, you can buy almost any type of asset: an interest in a start-up, a parcel of real estate, a patent, or precious metals. It’s also true that you can continue to defer tax on gains within the IRA. However, the rules governing self-directed IRAs contain important restrictions that you should understand before you set one up—make one wrong move and you could be looking at some serious tax consequences.
The Qualified Custodian In order to establish a self-directed IRA, a qualified custodian must be used to hold the IRA assets, maintain records, file reports, and process transactions. The custodian must be a bank or an IRS approved non-bank trustee. (The IRS publishes a list of approved non-bank trustees on its website, available at http://www.irs.gov/Retirement-Plans/Approved-Nonbank-Trustees-and-Custodians). The role of the self-directed IRA custodian differs substantially from the role of conventional IRA custodians. The self-directed IRA custodian generally will not provide investment or tax advice, will not sell or recommend investment products, and will not perform due diligence to determine the suitability of any investments. The self-directed IRA account owner chooses where to invest and directs the custodian to execute each transaction.
Given the limited role of IRA custodians, the burden to maintain compliance with the laws and regulations that are applicable to all IRAs falls on the self-directed IRA account holder. Some of the most important requirements are found in Internal Revenue Code section 4975, which states that the IRA will lose its tax exempt status if the IRA engages in any prohibited transactions between the IRA and certain disqualified persons.
Disqualified Persons and Prohibited Transactions The definition of disqualified person includes any fiduciary (such as the self-directed IRA account holder), certain members of the account holder’s family (including his spouse, ancestors, his descendants and their spouses), and business entities of which the IRA account holder owns 50 percent or more (either directly or indirectly). The IRA is prohibited from:
selling, exchanging, or leasing any property to a disqualified person;
lending money or extending credit to a disqualified person;
providing goods or services to a disqualified person;
allowing a disqualified person to use any income or assets of the IRA.
If it’s determined that a transaction is in fact prohibited, the account will cease to be a retirement account, resulting in a deemed distribution of the IRA funds, subject to taxation at ordinary rates, and possibly a 10 percent early withdrawal penalty as well. These provisions are designed to prevent any transaction that is not at arm’s length or that otherwise has the potential to harm the plan. In other words, the IRA account holder is not allowed to obtain any benefit from the IRA assets without first paying income tax. As a matter of policy, the tax favored status of IRAs is meant to encourage retirement savings and promote investment. Once any account assets are converted to personal use, the IRA is no longer a retirement account, and the IRS will expect taxes to be paid.
In some cases it won’t be entirely clear if a prohibited transaction has taken place, and the IRS may or may not decide to challenge the tax-deferred status of your IRA. The law in this area is unsettled and leaves some room for interpretation. This gives the IRS broad discretion to go after “suspicious” transactions. For example, a transaction may be prohibited even if disqualified persons are not directly involved. In one case, the United States Tax Court found that a prohibited transaction occurred when the taxpayer caused his retirement plan to lend money to three entities in which he owned a minority interest. Even though none of these entities were “disqualified persons,” the court found that the benefit to the account holder was substantial enough to violate the provisions of section 4975. See Rollins v. Comm’r, T.C. Memo 2004-260 (T.C. 2004). If you plan on using your self-directed IRA to transact business with any entity that you or any related person has an interest in, a careful analysis of the arrangement is required to ensure that it does not involve a prohibited transaction.
The Account Holder’s Burden and the Siren Song of Checkbook Control Self-directed IRA owners must be aware of the prohibited transaction rules and other restrictions; the account custodian usually will not offer guidance as to whether a transaction is prohibited. From the perspective of the IRS, there is great potential for abuse built in to the structure of self-directed IRAs. Because taxpayers have greater control over the IRA assets and little oversight from IRA custodians, there is more opportunity for a taxpayer to benefit from the use of IRA assets without removing them from the account as part of a taxable distribution.
A relatively recent development involves the use of LLCs to give an IRA account holder checkbook control over the account assets. In order to do this, the IRA purchases a majority interest in the stock of an LLC for which the IRA account holder serves as general manager and has full authority to act on behalf of the company. The Tax Court has held that because the company does not have any membership interests when the investment is made, the company cannot be a “disqualified person” with respect to that transaction. However, if the IRA account holder receives any money or other assets from the company—whether it be a salary, loan, gift, or commission—that will be considered a prohibited transaction. See Ellis v. Comm’r, T.C. Memo 2013-245 (T.C. 2013), affirmed by Ellis v. Comm’r, 787 F.3d 1213, 1215 n.4 (8th Cir. 2015).
The idea of checkbook control is appealing to many investors, since it provides direct access to the IRA funds without having to go through the account custodian to execute transactions. In theory, the IRA account holder can do as he pleases and manage the day-to-day operations of a company that is wholly owned by his self-directed IRA. In practice, an IRA LLC can be extremely risky, even for sophisticated investors. There is little case law discussing the use of IRA LLCs, so investors must be wary of engaging in activities that could fall under the category of prohibited transactions. Though many online promoters will tell you that an IRA LLC provides you with unlimited investment opportunities, you’ll be hard pressed to find one that can offer a sound legal opinion to confirm that your investment plan meets the requirements of the Internal Revenue Code. These types of arrangements are on the IRS’s watch list, and more vigorous enforcement efforts could be lurking just beyond the horizon.
For the more adventurous investor with sufficient time, energy, and know-how, a self-directed IRA can be a good idea. If you are interested in setting one up, or already have one in place, consult with a tax attorney who knows how to avoid prohibited transactions. As you start researching assets, your attorney can also help you evaluate the legitimacy of investments that aren’t regulated by the SEC or state securities agencies. As the captain of your self-directed IRA, you are ultimately responsible for its success or failure. If you decide to take the helm without a skilled navigator at your side, be prepared to go down with your ship.
If you are an employer, you’re aware of the confusion surrounding the implementation of the Affordable Care Act (ACA). While many of the ACA’s provisions apply only to large employers (those with 50 or more full-time equivalent employees), the Act is filled with traps for the unwary small employer as well.
One area of concern for small employers involves the broad definition of “group health plan” under IRC 9832(a). By reference to IRC 5000(b)(1), the definition of a “group health plan” includes any plan of, or contributed to by, an employer to provide health care to employees. Common employer sponsored reimbursement plans such as Health Reimbursement Arrangements (HRAs), Employer Payment Plans (EPPs), and Flexible Spending Accounts (FSAs) all fall under this definition. It’s important to note that these types of plans may overlap, so employers must use caution regardless of the type of reimbursement arrangement they have in place.
An HRA is a reimbursement arrangement funded solely by an employer to pay for employees’ qualified medical expenses, which may or may not include health insurance premiums. Employees cannot make pre-tax contributions to an HRA. Employee Payment Plans are a specific type of HRA that have been incentivized by the IRS for over 50 years. Rather than provide expensive, difficult to administer group health coverage to employees, many small employers have used EPPs to reimburse their employees for individually purchased health insurance policies. Revenue Ruling 61-146 provides that a reimbursement under an EPP is excluded from the employee’s gross income. The exclusion also applies if an employer pays employee health insurance premiums directly to the healthcare provider. The Revenue Ruling remains in effect and employees are still eligible to receive tax-free reimbursements for health insurance. But employers beware: the employee exclusion for the reimbursement comes at a high cost for the business.
IRC Section 4980D provides that an employer operating a noncomplying group health plan after January 1, 2014, must pay a tax in the amount of $100 per day for each employee covered by the noncomplying plan. Small employers are not exempt from this penalty. IRS Notice 2013-54 provides some guidance on the treatment of employer reimbursement policies. Because an HRA is considered a group health plan under IRC 9832(a), it must comply with the ACA’s market reforms, including sections 2711 and 2713 of the Public Health Services Act. Section 2711 provides that a group health plan may not establish any annual limit on the dollar amount of benefits for any individual, and Section 2713 requires that a group health plan provide coverage for certain preventive services without cost sharing. Like other Health Reimbursement Arrangements, EPPs are considered group health plans that must comply with the ACA market reforms. Under Notice 2013-54, EPPs violate the ACA’s prohibition on dollar limits because the plan benefit is deemed to be only the amount of the premium paid by the employer. Even though employees may be entitled to unlimited benefits under their individual policies, the Notice states that the EPP cannot be integrated with an individual health insurance policy. Thus, an employer who reimburses employees for individual health insurance policies is subject to the $100 per day per employee penalty.
If certain requirements are met, an employer’s payroll practices of forwarding post-tax employee wages to a health insurance provider is not considered a group health plan that is subject to the market reforms. Under this type of arrangement, no contributions can be made by the employer or any employee organization, participation in the plan must be voluntary, and the employer can receive no benefit from the program (See 29 C.F.R. §2510.3-1(j)). If an employer wishes to provide these services to employees, great care should be taken to insure that the requirements are met so that the employer does not inadvertently establish a group health plan.
Although the ACA provides that the 4980D penalty applies to non-complying group health plans after January 1, 2014, the IRS has offered limited transition relief for reimbursement plans that are not in compliance with the market reforms. Notice 2015-17 provides that small employers offering EPPs will not be subject to the penalty, at least through June 30, 2015. The Notice encourages small employers to look for group health coverage in the Small Business Health Options Program (SHOP) Marketplace, and warns that the 4980D penalty may apply beginning July 1, 2015. Republican lawmakers in the House and Senate recently introduced legislation, known as the Small Business Healthcare Relief Act, that would allow small employers to continue using pre-tax dollars to reimburse employees for health insurance premiums, but it’s far from certain that the bill will be signed into law. For the moment, employers should be on notice: reimbursement plans that were once common could result in large penalties. If you are a small employer offering any type of “group health plan” as defined by the Affordable Care Act, you should contact your tax professional today to make sure that you are in compliance.
Oregon has joined the growing list of states that have legalized the sale of marijuana, but that doesn’t mean pot dealers can light up and relax. Marijuana sales may be legal in the state, but it is firmly established that Internal Revenue Code Section 280E prohibits taxpayers from deducting any expenses of a trade or business that consists of trafficking in controlled substances.
Make no mistake, marijuana is a controlled substance under federal law. This means that Oregon marijuana businesses will be forced to pay federal income tax on 100 percent of their gross profits. Unless you can classify your expenses as Costs of Goods Sold (COGS), deductions for payroll, utilities, advertising, and miscellaneous expenses will be disallowed in full. Last week, the U.S. Court of Appeals for the Ninth Circuit made clear that Section 280E applies even in states that have legalized marijuana, either for medical or recreational use.
The case, Olive v. Commissioner of Internal Revenue, No. 13-70510 (July 9, 2015), involved a medical marijuana dispensary in San Francisco called the Vapor Room. Although 100 percent of the Vapor Room’s gross income came from marijuana sales, the business also offered a variety of other goods and services at no cost. Customers could enjoy free movies, yoga, and massage therapy, as well as complementary drinks and snacks. Vapor Room staff also provided free counseling to customers on personal, legal, and health matters.The dispensary wanted to deduct not only these expenses, but also the expenses that could be directly attributed to marijuana sales.
But, because the Vapor Room’s only source of income came from marijuana sales, the court found that trafficking in a controlled substance was its only “trade or business” and disallowed all deductions for expenses incurred in its operations. Expenses for the benign, completely legal perks (like pizza and yoga) were held to be non-deductible under Section 280E because they were designed to benefit the marijuana sales business as inducements for potential customers.
This result might seem harsh, but the Ninth Circuit offered some useful guidance in its approval of a well-known 2007 Tax Court case, Californians Helping To Alleviate Medical Problems, Inc., v. Commissioner, 128 T.C. 14 (2007) (CHAMP). In that case, the court acknowledged that the taxpayer had more than one trade or business and was allowed to allocate expenses between the two. Expenses incurred in the course of care-giving (the taxpayer’s primary trade or business) were clearly deductible. All expenses attributable to the trade or business of selling marijuana, however, were disallowed. Taxpayer CHAMP, of course, charged a fee for its care-giving services and intended to make a profit from those activities. Had the Vapor Room followed suit and asked its customers to pay for the munchies, at least some of its expenses could have been deductible.
Oregon marijuana businesses take heed: If you operate a business that sells marijuana, but also offers other goods or services, work with your accountant and your tax attorney to establish the existence of a non-trafficking “trade or business.” Careful accounting procedures and appropriate business structures must be put in place to allocate expenses between the trade or business of trafficking in marijuana and any other trade or business you operate, such as care-giving or selling marijuana accessories. Without these safeguards, you put yourself at the mercy of IRS auditors who will be all too eager to allocate your expenses for you. If you are proactive, you may be able avoid the fate of the Vapor Room, which was hit with a $1.9 million tax bill as a result of inadequate planning and sloppy bookkeeping.
There is a faint glimmer of hope for the “cannabusiness” community: Oregon’s U.S. Representative Earl Blumenauer recently introduced a bill that would reverse the draconian effects of Section 280E in states that have legalized marijuana. The bill, known as The Small Business Tax Equity Act, is co-sponsored in the Senate by Oregon’s own Ron Wyden and Jeff Merkley. To date, twenty-three states and the District of Columbia have legalized medical marijuana. Voters in Colorado, Washington, Oregon and Alaska have passed measures legalizing recreational marijuana, and more states are lining up to do the same. Even so, it’s doubtful that our esteemed legislators will succeed in maneuvering the Small Business Tax Equity Act through the House and Senate, at least in the foreseeable future. In the meantime, Oregon marijuana businesses should plan for Section 280E. Contact your tax attorney to discuss steps you can take to minimize the impact of Section 280E and protect every deduction you’re entitled to.
The federal government requires that all businesses with employees withhold payroll taxes from each employee’s gross pay. These taxes, which include Social Security, Medicare, and federal income taxes, are deemed to be held by the employer “in trust” for the federal government, until the employer pays the taxes to the government each quarter. Payroll taxes are a huge burden, and can be problematic for businesses experiencing cash flow problems. When money is tight and the utility bills are due, the taxes that are supposed to be paid over to the federal government often become a lower priority. If left unpaid, trust fund taxes can be assessed against individuals who might otherwise be shielded from a company’s liabilities. The IRS is authorized to impose what is known as the Trust Fund Recovery Penalty (TFRP) on any responsible personas set out in Section 6672 of the Internal Revenue Code. This penalty is equal to the share of the employees’ payroll taxes that the business owes the IRS.
The IRS definition of responsible person is very broad— it applies to any person whose duty is to pay trust fund taxes who willfully fails to do so. A responsible person could be an officer, director, employee, or shareholder of a corporation, or a manager, employee, or member of an LLC. The term can also apply to more than one person.. Any person who has control of a business’s financial affairs, or controls payment of funds by the business, could be targeted for the TFRP.
In deciding if a person is a responsible person, the IRS considers all the facts and circumstances. Factors the IRS considers in making its determination include the individual’s ability to:
sign checks on behalf of the business
hire and fire employees
determine which creditors are paid
sign tax returns
make federal tax deposits.
The IRS will assess each of these factors to determine a person’s control over the payment of trust fund taxes.
What can you do if the IRS determines you are a responsible person, and thus subject to the penalty for nonpayment of trust fund taxes? You can challenge a TFRP assessment if your duties were ministerial, or if you lacked the ultimate authority to make financial decisions for the business. If, for example, you could sign checks and pay bills for the company, but were told by a supervisor which creditors to pay when the company had insufficient funds, it is unlikely the IRS would deem you a responsible person for purposes of the TFRP.
Even if the IRS has determined that you are a responsible person, you may be able to challenge the assessment if your failure to collect or pay taxes was not willful. For purposes of the TFRP, “willful” means intentional, deliberate, voluntary, reckless, or knowing. In other words, willful means that your failure to withhold or pay over trust fund taxes was not accidental. Your conduct will be deemed willful if the IRS can demonstrate that you were aware, or should have been aware, of the obligation to pay trust fund taxes and you showed an intentional disregard or indifference to the law.
Because the IRS aggressively enforces the TFRP, there are important facts you should know about it:
If you are liable to pay the penalty, the obligation to pay cannot be discharged in bankruptcy.
The IRS can collect the penalty from you, from other persons, and from the business all at the same time, until the liability is paid in full (often, the original company is no longer in business, so the IRS can only collect from responsible persons)
If you are found liable, the IRS may demand the entire balance from you, but you may be able to seek contribution from other responsible persons
Disputing your liability for the TFRP requires an intensive analysis of the facts. If you receive a notice from the IRS proposing an assessment of the Trust Fund Recovery Penalty, act quickly to protect your rights; contact an attorney as soon as possible.
If you’ve already been assessed with a TFRP, you still have options and may be able to limit your exposure to aggressive IRS collection tactics. In either case, regardless of where you are in the process, look for someone familiar with the Internal Revenue Code, who also knows IRS assessment and collection procedures.
If your tax return is audited by the Oregon Department of Revenue, you will likely receive a Notice of Deficiency at the conclusion of the audit. If you receive a Notice of Deficiency or Notice of Assessment, or any other notice from the Department of Revenue, consult with an experienced tax attorney who understands the assessment and collection process and who will advocate on your behalf