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Voluntary Disclosure and Avoidance of Criminal
Prosecution
Where a taxpayer has either failed to
file tax returns or filed false returns, one can act to reduce the
possibility of criminal prosecution. Fortunately, the IRS has a voluntary
disclosure program under which the likelihood of prosecution may be
reduced.
Under this program, the IRS will
consider voluntary disclosure along with other factors in an
investigation in determining whether criminal prosecution will be
recommended. A voluntary disclosure will not automatically guarantee
immunity from prosecution, but may result in prosecution not being
recommended. These disclosure rules do not apply to taxpayers with
illegal source income.
To qualify under the IRS' voluntary
disclosure program, a taxpayer's communication with the IRS must be truthful,
timely and complete. The taxpayer must also show a willingness to
cooperate (and actually cooperate) with the IRS in determining his/her
correct tax liability and must make good faith arrangements with the IRS
to pay in full, the tax, interest and any penalties that the IRS
determines to be applicable.
A disclosure must be timely. It will be
deemed timely if it is received before the IRS has:
- initiated
a civil examination or criminal investigation of the taxpayer, or
notified the taxpayer that it intends to begin such an examination
or investigation;
- received
information from a third party (e.g. informant, other governmental
agency) alerting the IRS to the specific taxpayer's noncompliance;
- initiated
a civil examination or criminal investigation which is directly
related to the specific liability of the taxpayer; or
- acquired
information directly related to the specific liability of the
taxpayer from a criminal enforcement action.
This program is not without risks from
the taxpayer's standpoint. Disclosure of the taxpayer's identity is a
requirement of the program, and, as noted above, there are no guarantees
of immunity of prosecution. Although the rules governing the current
disclosure program are fairly objective, there is some uncertainty about
some aspects of the program, such as what constitutes a good faith
arrangement to pay the taxes.
The IRS' voluntary disclosure program
should definitely be considered in a situation where there has been a
pattern of failure to file tax returns or false returns have been filed.
The timeliness of the disclosure is the key component to success under
the program.
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Quick Links...
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Dear Reader,
Tax
season is in full swing and we are discussing some interesting tax issues
and strategies in this month's issue. If anything piques your curiosity,
we hope to hear from you.
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· Partner's "Phantom" Income
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Often,
we are asked by a partner why he/she is paying income tax on income not
received during the year in which it is taxed. The answer lies in the way
partnerships and partners are taxed. Unlike a regular "C"
corporation, a partnership is not subject to income tax. Rather, each
partner is taxed on his/her share of partnership earnings, whether or
not the earnings are distributed--that is why it is sometimes
referred to as "phantom income" . Similarly, if a partnership
has a loss, the loss is passed through to the partners. Various rules,
however, may prevent a partner from currently deducting his share of a
partnership's loss to offset other income.
While a
partnership isn't subject to income tax, it is treated as a separate
entity for purposes of determining its income, gain, losses, deductions
and credits. This results in the pass-through to each partner of his/her
share of such items.
Basis
and distribution rules ensure that partners are not taxed twice on the
same earnings. A partner's initial basis in his partnership interest
(e.g. initial investment) is increased by his share of partnership
income. When that income is distributed to the partners in cash, the
partners are not taxed on the cash received if they have sufficient
basis. Rather, the partners merely reduce their basis by the amount of
the distribution. If a cash distribution exceeds a partner's basis, then
the excess is taxed to the partner as a gain (usually as a capital gain).
It is
important to have a basic understanding of how a partner is taxed, how
partnership earnings are allocated to partners and why, in many
instances, a partner reports income that exceeds the actual cash
received. It is merely the nature of the complex pass-through entity
rules.
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· Section 1244 Stock
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Ordinarily, a loss on a sale or
exchange of stock is treated as a capital loss. Capital loss treatment is
generally less advantageous than an ordinary deduction because of the
fact that a capital loss recognized by an individual is applied, first
against capital gain, (which is usually subject to tax at a maximum
marginal rate which is lower than that on ordinary income), and, to the
extent it exceeds capital gains recognized during the year, is subject to
limitations on deductibility.
Fortunately, the tax law allows
ordinary loss treatment on certain losses with respect to stock of
"small corporations". In general, this special treatment is
only available if the following conditions are satisfied:
- As of the time the stock was issued, the
aggregate amount that was received by the issuing corporation for
stock, as contributions to capital and as paid-in-capital, must not
have exceeded $1 million.
- The stock must have been issued for money and
property. Thus, the stock cannot be issued as compensation for
services.
- For the five years before the year the loss was
sustained, the corporation must not have received 50% or more of its
receipts from certain passive sources.
- The taxpayer claiming this special loss
treatment must be an individual. It is not available to
corporations, trusts or estates.
- The stock must have been issued to the
individual claiming the special loss treatment and held continuously
by that individual to the time of sale.
Note that in any year, the total
loss to be treated as ordinary under these rules cannot exceed $50,000,
or $100,000 if you file a joint return.
One needs to be mindful of this
special provision--we find it to be an often overlooked, pro-taxpayer
provision that one should take advantage of, when applicable.
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· Roth IRAs
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While no tax deduction is
available for contributions made to a Roth IRA, the use of such IRA's can
be quite powerful inasmuch as it is easy to qualify for tax-free
distributions for retirement.
One can contribute up to $4,000 a
year (for 2005) to a Roth IRA. This limit is $4,500 a year for people who
will be age 50 (or older) during the year. However, the $4,000 maximum is
reduced by any contributions, deductible or nondeductible, one makes to a
traditional IRA account. Further, there are income limitations on Roth
IRA contributions. For single taxpayers, no contribution can be made if
adjusted gross income (AGI) is $110,000 or more. For married taxpayers
filing jointly, no contribution can be made if AGI is $160,000 or more.
Contributions can be made to a Roth IRA even if you are a participant in
a qualified plan and even if you reach age 70 1/2.
Qualified distributions from a
Roth IRA are tax-free. Thus, you can avoid tax on Roth IRA earnings
forever, even at the time of distribution. A distribution is qualified if
made: once you reach age 59 1/2, upon death or disability, or (up to
$10,000 per lifetime) for first time homebuyer expenses. However, a
distribution is not qualified if made within the five-year period
beginning with the first tax year you made a contribution to a Roth IRA.
You may also roll funds over from
a regular IRA into a Roth IRA so the post-rollover income can grow tax-
free. However, any rolled-over funds will be taxed under the regular IRA
distribution rules, although the 10% early withdrawal penalty will not
apply. Further, you may not rollover such funds if your AGI exceeds
$100,000 in the rollover year.
The tax benefits of a Roth IRA
should be considered by anyone who qualifies. A rollover from a regular
IRA to a Roth IRA should also be considered, but only after tax
projections are prepared to determine whether the upfront tax liability
is outweighed by the later tax savings.
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· Tax Deadlines
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The March 15th tax deadline is a
"biggie". All calendar year corporate income tax returns are
due at that time, although a six-month extension until September 15th is
available.
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