IRS Voluntary Compliance Program - Correcting Plan Failures

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In order for a retirement plan to be treated as a qualified retirement plan and enjoy the benefits of such status (contributions deductible to employer, employees not taxable on contributions until distributed, employees not taxable on appreciation of investments), the plan must meet all of the requirements set forth in the Internal Revenue Code.  Some of these requirements relate to the form of the plan.  That is, the plan must contain certain provisions mandated by the IRC.  Other requirements related to the operation of the plan.  That is, the plan must operate in accordance with the terms of the plan and with the IRC.  Failure to operate a plan in accordance with terms and the IRC could lead to the plan being disqualified.  In this event all of the plan contributions could be considered as taxable income to the plan participants.

Operating and maintaining a qualified retirement plan can be quite complex.  It is not unusual for a plan to suffer an operational failure.  Some of these failures are minor and infrequent.  Other failures may be more serious or egregious.   To encourage employers to correct plan failures and give employers comfort that the correction will be acceptable to the IRS, the IRS has a program (set forth in Revenue Procedure 2013-12) that outlines how certain plan failures can be corrected.

Under Revenue Procedure 2013-12, depending on the type of plan failure involved, there are three possible ways that the plan failure might be corrected. These correction methods include:

Self-correction (SCP). A Plan Sponsor that has established compliance practices and procedures may, at any time without paying any fee or sanction, correct insignificant Operational Failures under a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan. For a SEP or SIMPLE IRA Plan, however, SCP is available only if the SEP or SIMPLE IRA Plan is established and maintained on a document approved by the Service. In the case of a Qualified Plan that is the subject of a favorable determination letter from the Service or in the case of a 403(b) Plan, the Plan Sponsor generally may correct even significant Operational Failures without payment of any fee or sanction if the correction is made within certain time periods.

Voluntary correction with Service approval (VCP). A Plan Sponsor, at any time before audit, may pay a limited fee and receive the Service’s approval for correction of a Qualified Plan, 403(b) Plan, SEP, or SIMPLE IRA Plan failure. Under VCP, there are special procedures for Anonymous Submissions and group submissions.

Correction on audit (Audit CAP). If a failure (other than a failure corrected through SCP or VCP) is identified on audit, the Plan Sponsor may correct the failure and pay a sanction. The sanction imposed will bear a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit.

Whether a plan failure may be self-corrected, or corrected under the VCP program or must be corrected under the Audit CAP program depends on the type of failure, the frequency and the significance of the failure, and whether the failure was self-reported or discovered on audit.  The more often the failure, the more participants involved, the more plan years involved, and discovery of the error on audit reduce the chances the failure can be self-corrected (or even fixed under the VCP program).

If your retirement plan has suffered an operational failure, call or email Jeff Senney to discuss how the plan can be corrected at Jsenney@pselaw.com or 937-223-1130.



AND ONE MORE THING.  A frequent plan failure involves plan loans not being administered in compliance with the terms of the plan or the IRC.   The IRS does not currently recognize self-correction as a permitted correction method for a plan loan failure.  As a result, a plan loan failure must be corrected under the IRS’s VCP.  If the plan loan failure is not so corrected, the IRS requires the loan amount to be treated as a taxable distribution and reported on IRS Form 1099-R.  The IRS also requires the employer to pay the applicable income tax withholding related to such deemed distribution.   There might be other applicable penalties as well.  Call Jeff Senney to discuss any questions you have about correcting retirement plan operating failures at 937-223-1130 or Jsenney@pselaw.com.

Requirements of a Tax Free Corporate Division

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If a corporate split-up transaction does not meet the requirements of IRC section 355, the transfer of assets by the distributing corporation is treated as a taxable sale, and the distribution of the stock of the controlled corporation is treated as a taxable dividend.  In order for a distribution of stock of a controlled corporation to qualify under IRC section 355 as a tax-free transaction, the following requirements must be met:

(1)   The distributing corporation must control the corporation whose stock it distributes (“controlled corporation”) immediately before the distribution.  For purposes of these rules, control means ownership of (a) stock possessing at least 80% of the combined voting power of all classes of stock entitled to vote, and (b) 80% of the shares of each other class of the corporation's stock.


(2)  The distributing corporation must distribute all the stock of the controlled corporation it held immediately before the distribution.  However, if it can show that tax avoidance is not a principal purpose for retaining part of the stock of the controlled corporation, the distribution will be tax-free so long as a controlling interest in the controlled corporation's stock is distributed.

(3)  The transaction must not be used principally as a device for distributing the earnings and profits of either the distributing corporation or the controlled corporation.


(4)  The active trade or business requirement of IRC section 355(b) must be satisfied by both the distributing corporation and the controlled corporation.


(5)  There must be a corporate business purpose for the distribution.  Some examples of business purpose include: cost savings, risk reduction, resolution of management or other problems, providing equity interests to key employees, facilitating credit or borrowing, preparing for security offerings, preparing for transactions with competitors, getting ready for purchase of the distributing corporation, facilitating a purchase or acquisition  by the distributing corporation or the controlled corporation.


(6)  The distributing corporation must distribute only stock or securities of the controlled corporation to a shareholder in exchange for his stock.   However, if the other requirements listed above are met, and other property is distributed, the distribution will be tax-free except to the extent of the other property distributed


(7) The distribution or series of distributions is not part of a transaction after which either the distributing corporation or a controlled corporation is a disqualified investment corporation and a person holds immediately after the transaction a 50% or greater interest in any disqualified investment corporation that they did not hold immediately before the transaction.

If any one of the above requirements is not met, the transaction will fail to qualify as a tax-free reorganization, and the distributing corporation and/or the shareholders will be subject to income tax.  Call or email me at 937-223-1130 or Jsenney@pselaw.com if you have any questions about how to properly structure a tax-free corporate division or other reorganization transaction.


AND ONE MORE THING.  The local chapter of American Red Cross is organizing a gala, Putting on the Glitz, as a fundraiser to benefit disaster relief and preparedness in the Miami Valley. The event will take place Saturday, April 27, 2013 with the theme, "Providing Hope Like a Bridge Over Troubled Water."   The event is being run like a fashion show.  Jeff Senney is participating/competing in the show.   You can donate/vote for Jeff as “top model” by clicking on the donate link. Thanks for your support for this great cause

Considering a Spin-Off?

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Many corporations operate more than a single business.  Over time, many corporations branch off into different businesses. There is no law that prohibits a corporation from operating multiple different businesses operating inside the single corporate shell.  But doing so may not be wise.


Operating multiple businesses inside a single corporate shell puts the assets of a good business at risk to pay the debts of a bad business.


If you have employees that work on only one of the businesses, and you want to give these employees compensation or incentives based on the results of operations of such business, it is somewhat easier to accomplish if the businesses are run in separate corporate shells.   Or if in the future you think you might want to bring in family members to own/operate one but not all of the businesses it is also preferable to have the businesses run in separate corporate shells.


In order to split-up a corporation into two or more separate businesses, the first step is generally to drop the assets and liabilities that comprise each business into a separate subsidiary corporation.  The second step is to distribute the stock of the subsidiary corporation to the shareholders.  This type of reorganization transaction is sometimes referred to as a Type D divisive reorganization.    In order for such a split-up to be done on a tax-free basis, certain requirements must be met.  One of these requirements is that the businesses operated by the original corporation and the new corporations must have been active businesses for at least the last 5 years.  Another requirement is that immediately after the distribution, the new corporations must be controlled by one or more of the shareholders of the original corporation.   There are other requirements that also need to be met.


Doing a tax-free split up transaction is quite complex and should not be attempted without the aid of a competent tax professional.  Please call or email me at Jsenney@pselaw.com or 937-223-1130 to discuss any questions or comments you may have concerning a tax-free split up transaction.


AND ONE MORE THING.   Non-corporate taxpayers are permitted to make an election to exclude income resulting from discharge of real property business debt and reduce the basis of depreciable real property.   The IRS recently approved a request by a 50% partner in an LLC treated as partnership to grant the partner a 45-day extension to file an amended return to make such election.   If you need assistance with filing an election to exclude discharge of debt income, or in seeking IRS approval for an extension to file such election, please call me at 937-223-1130 or Jsenney@pselaw.com.

Succession Planning

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It is never too early to start thinking about succession planning.  All business owners eventually reach a point where they want to retire, they want to slow down, they want to try their hand at something new, they want to give the younger generation a chance to show their stuff or they just want to cash out.  In every case, it is a smoother and generally more profitable transition if the owners have taken the time to plan and think through what is required to successfully transition their business.


Succession planning may involve sale of the business.  But to whom?  To employees?  To family?  To suppliers?  To customers?  To competitors?  And for how much?  Is there a reasonable methodology for setting the value of the business?


Succession planning may involve gifts to spouse, children and grandchildren.  But are they competent to run the business?  Is the management staff competent and loyal enough to work with inexperienced family members while they come up to speed?


Succession planning may involve stock options or deferred compensation or other bonus arrangements for key employees designed to keep them on board after the owners have moved on.  Do you have a group of employees who have the experience and skill to run the business after you are gone?  Have you given them the ownership and/or compensation incentives needed to win their loyalty and keep them on board?


Succession planning may involve employee stock ownership plans ("ESOPs").  By using  a ESOP vehicle, business owners may be able to create a market for their stock where no market otherwise exists, and may be able to sell their stock to such ESOP in a tax-advantaged away.  But ESOPs are somewhat complicated and costly to set-up and maintain, and you need to consider whether the possible upfront tax savings are worth the cost and administrative complexities inherent in such arrangements.


There are many other issues related to succession planning that need to be considered including valuation of the company stock, use of valuation discounts, use of stock redemption or buy-sell agreements, use of employee non-compete agreements, training of future management, etc.  More about succession planning issues will follow in future blogs.  Please give me a call if you want to discuss succession planning and how we can help you.  Jsenney@pselaw.com or 937-223-1130.


AND ONE MORE THING.   The American Red Cross is an important part of our national disaster recovery system.  In light of the recent natural disasters and the terrorist attacks our country has endured, the importance of supporting Red Cross and its missions cannot be overstated.  Our local chapter of American Red Cross is organizing a gala, Putting on the Glitz, as a fundraiser to benefit disaster relief and preparedness in the Miami Valley. The event will take place Saturday, April 27, 2013 with the theme, "Providing Hope Like a Bridge Over Troubled Water."    You can  donate/vote by clicking on the donate link. Thanks for your support for this great cause.

Court Finds that State Worker Classification Law is Pre-Empted

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Classification of a worker as an independent contractor can be a less expensive option for the employer because it shifts the burden of paying payroll taxes, workers compensation premiums and health care insurance costs to the worker. Classification of workers as independent contractors also results in workers not being covered by overtime, wage and hour laws and minimum wage laws.  For these reasons, Federal and state government agencies often look closely at the classification of workers as employees or independent contractors.


Under the accepted common law, a worker is generally an independent contractor when the worker has a risk of financial loss and where the worker contains how the job is done. A worker is generally an employee where the worker has no risk of financial loss and the employer controls how the job is done. The IRS has broken this common law determination down into a 20-factor test. Often some factors point to a worker being an independent contractor while other factors point to the worker being an employee. For this reason it is often difficult to say with 100% certainty whether a worker is an employee or an independent contractor.   This determination is made even more difficult because some states have enacted statutes that include their own definitions and require employers to treat certain workers as employees.


But some relief to this recent explosion of state regulation of the worker classification issue may be on the horizon. A Federal District Court recently granted summary judgment in favor of a motor carrier company and found that the state law in question would have compelled the company to treat its workers as employees (and not as independent contractors) and was therefore pre-empted by the Federal Aviation Administration Authorization Act of 1994 ("FAAAA").


The FAAAA is a federal law which contains provisions regulating the price, route and services of various types of motor carriers including over the road motor carriers of property.  The FAAAA also provides that no state "may enact or enforce a law related to a price, route, or service of any motor carrier." The two operative phrases are "related to" and "prices, routes, or services."  However, the FAAAA offers little insight in terms of its breadth, and its preemption language does not explicitly encompass state regulation of wage and independent contractor laws.


The Court reviewed the FAAAA and its legislative history and concluded that the state worker classification law in question was preempted by the FAAAA because the state law relates to motor carriers' prices, routes, and services. The Court found that the state law was “related to” motor carrier prices, routes and services because the state law (1) dictated the form of employment relationship carriers must utilize, thereby affecting carriers' routes and services; (2) significantly increased motor carriers' costs and thereby had a significant effect upon the motor carriers' prices, routes, and services; and (3) materially altered the common law test for independent contractor status, thereby leading to a patchwork of varying state laws and resulting liability under varying independent contractor regimes.


Many states have their own version of wage and independent contractor laws. These need to be considered along with the IRS 20-factor test and the common law.  Misclassifying workers can cost your business money and can lead to costly penalties. If you have any questions or need assistance with a worker classification issue, please call or contact Matt Stokely, Jeff Senney or one of our other business attorneys at 937-223-1130 or JSenney@pselaw.com.


AND ONE MORE THING. The American Red Cross is organizing a gala, Putting on the Glitz, as a fundraiser to benefit disaster relief and preparedness in the Miami Valley. The event will take place Saturday, April 27, 2013 with the theme, Providing "Hope Like a Bridge Over Troubled Water. As a "model" for the Red Cross gala I need your support to meet my individual fundraising goal. You can check back on my personal page and track the progress made to reaching my final goal. Please donate and help show your support for this great cause.

IRS Publishes Annual List of Tax Scams

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The Internal Revenue Service has issued its annual list of tax scams, reminding taxpayers to use caution during tax season to protect themselves.  As you can tell from the lost, tax scams come in many forms.  Don't let a scam artist take advantage of you.  Set forth below is a summary of the IRS list of tax scams prevalent this tax season:

Identity Theft

Tax fraud through the use of identity theft tops this year’s list. Identity theft occurs when someone uses your personal information such as your name, Social Security number (SSN) or other identifying information, without your permission, to commit fraud or other crimes. In many cases, an identity thief uses a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund.

The IRS has a special section on the IRS.gov website dedicated to identity theft issues.  For victims, the website includes info on how to contact the IRS Identity Protection Specialized Unit.  For other taxpayers, the site includes information on how to protect themselves against identity theft.

Taxpayers who believe they are at risk of identity theft due to lost or stolen personal information should contact the IRS immediately so the agency can take action to secure their tax account. Taxpayers can call the IRS Identity Protection Specialized Unit at 800-908-4490. More information can be found on the special identity protection page.

Phishing

Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information. Armed with this information, a criminal can commit identity theft or financial theft.

The IRS DOES NOT send email requesting personal ort financial information.  If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), report it by sending it to phishing@irs.gov.

Preparer Fraud

A majority of taxpayers will use tax professionals this year to prepare their tax returns. Most return preparers provide honest service to their clients. But some unscrupulous preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft.

Taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else.  So it is important to choose carefully when hiring an individual or firm to prepare your return.  The IRS wants to remind all taxpayers that they should use only preparers who sign the returns they prepare and enter their IRS Preparer Tax Identification Numbers (PTINs).  The IRS has created a new web page to assist taxpayers  www.irs.gov/chooseataxpro.

Offshore Accounts

Over the years, some individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities, using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.  The IRS uses information gained from its investigations to pursue taxpayers with undeclared accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas. The IRS works closely with the Department of Justice to prosecute tax evasion cases.

While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting and disclosure requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.  Taxpayers need to be aware that the IRS and DOJ are finding and prosecuting taxpayers in these situations.

“Free Money” from the IRS

Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a tax return with little or no documentation, have been appearing in community churches around the country. These schemes promise refunds to people who have little or no income and normally don’t have a tax filing requirement – and are also often spread by word of mouth as unsuspecting and well-intentioned people tell their friends and relatives.

Scammers prey on low income individuals and the elderly and members of church congregations with bogus promises of free money.  In the end, the victims discover their refund claims are rejected. Meanwhile, the promoters are long gone. The IRS warns all taxpayers to remain vigilant.

Bogus Charities

Following major disasters, it’s common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Scam artists may pretend to operate a bogus charity and contact people by telephone or email to solicit money or financial information. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds.

The IRS cautions both victims of natural disasters and people wishing to make charitable donations to avoid scam artists by following these tips:

Donate only to recognized charities.
Be wary of charities with names that are similar to familiar or nationally known organizations. Go to the IRS.gov website and use the search feature Select Check, to find the names of legitimate qualified charities.
Don’t give out personal financial information, such as Social Security numbers or credit card and bank account numbers and passwords, to anyone who solicits a contribution from you.
Don’t give or send cash, use a check or credit card.
Inflated Income or Expenses

Some scam artists are preparing and filing tax returns which include income that was never earned, either as wages or as self-employment income in order to maximize refundable credits.  Overstating income or expenses to create a tax refund can lead to additional tax, penalties and interest.

False Refund Claims

Some of the scams are hard to believe.  In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS. In this ongoing scam, the perpetrator files a fake information return, such as a Form 1099 Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return.  The IRS warns taxpayers to be careful.  If you are a party to such schemes, you could be liable for financial penalties or even face criminal prosecution.

Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. The IRS has a list of frivolous tax arguments that taxpayers should avoid. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

Zero Wage Claims

Filing a phony information return is an illegal way to lower the amount of taxes an individual owes. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.  Sometimes, these scammers even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation.

Disguised Business Ownership

Third parties are improperly used to request employer identification numbers and form corporations that obscure the true ownership of the business. These entities can be used to underreport income, claim fictitious deductions, avoid filing tax returns, participate in listed transactions and facilitate money laundering and financial crimes. The IRS is working with state authorities to identify these entities and bring the owners into compliance with the law.

Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.  IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement.

If you want to share a horror story or have any questions about avoiding tax scams, give me a call or email at 937-223-1130 or Jsenney@pselaw.com.

SUMMARY.  If you have a large tax bill coming up, and you don't have the money sitting around to pay the tax bill, consider borrowing the money from your retirement plan.   A plan loan can be a relatively painless way of raising cash without adverse tax consequences.  But the plan loan must be set up correctly and repaid on time.  If you have any questions or want to know more about taking a plan loan from your qualified retirement plan account, please call or email me at 937-223-1130 or Jsenney@pselaw.com.

AND ONE MORE THING.  The American Red Cross is organizing a gala, Putting on the Glitz, as a fundraiser to benefit disaster relief and preparedness in the Miami Valley.  The event will take place Saturday, April 27, 2013 with the theme, Providing "Hope Like a Bridge Over Troubled Water.  As a "model" for the Red Cross gala I need your support to meet my individual fundraising goal.  You can check back on my personal page and track the progress made to reaching my final goal.  Please donate and help show your support for this great cause.