IRS Launches Voluntary Disclosure Program for False ERC Claims

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In March of 2020, Congress passed the CARES Act, a 2.2 trillion dollar stimulus package designed to help individuals and businesses adversely affected by COVID-19. The legislation included the employee retention credit (the “ERC”), a refundable credit of up to $28,000 per employee per year to assist certain employers whose operations were adversely affected by COVID shutdowns.  

The credit is extremely generous, but not all businesses qualify and determining whether a business qualifies can be a very involved process. Because the potential rewards were so great, many taxpayers were tempted to file claims seeking large ERCs for which they did not qualify. And many taxpayers were victimized by unscrupulous promoters who misled them into believing they qualified for the ERC when they did not and charging large fees equal to a substantial percentage of the amount of ERC credit.

The IRS is now actively investigating large numbers of suspicious ERC claims. Business owners who are found to have filed false claims can be required to repay any funds that they received, but can also be held liable for interest, substantial civil penalties, and in some cases criminal prosecution. Furthermore, even if the ERC claim is denied, filing a false claim is a crime that can result in large fines and/or extended jail terms. 

The IRS recently launched an ERC Voluntary Disclosure Program to encourage taxpayers to come clean. By making a timely and complete voluntary disclosure, the IRS may agree to settle for 80% of the ERC credit and waive interest. In cases where the taxpayer cannot repay the credit in a lump sum, the IRS will consider permitting the taxpayer to repay in installments. Unfortunately, participation in the program does not guarantee immunity from criminal prosecution.

The deadline for making a voluntary disclosure is March 22, 2024.  

Skeen & Kauffman has substantial experience representing clients in tax disputes. If you have concerns about whether an ERC claim was proper, or whether it is in your best interest to make a voluntary disclosure, please contact Steve Kauffman immediately to schedule an appointment.

[1] Generally, eligible employers are those which, between March of 2020 and December 31, 2021, experienced pandemic-related suspensions of operations and substantial declines in gross receipt while continuing to pay wages to employees are eligible to receive a credit of up to $28,000 per employee per year.

Overview of the IRS

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The Internal Revenue Service is a part of the Department of the Treasury. The functions that interact most frequently with members of the public are the Service Center, Collection, Examination, and Criminal Investigation. The personnel and duties of each of these functions are summarized in a very cursory fashion below.

Service Centers

When returns are filed, be they income, payroll, estate or gift tax returns, they are processed by an IRS Service Center. During processing, the Service Center determines that the returns are signed, complete based on information returns filed the IRS from other sources, and mathematically accurate. If there are any problems in this regard, the return will either be rejected and sent back to the taxpayer who filed it or a notice of proposed adjustment will be sent to the taxpayer. If there are no problems, then the tax reflected on the return will be assessed to the taxpayer’s account (i.e. entered as a liability in the IRS database) and a determination will be made whether the account has been overpaid, in which case a refund will be generated, or underpaid, in which case a notice of assessment and demand for payment will be sent. When you receive computer generated notices from the IRS, they most likely originate from a Service Center. It is important that you read any notice you receive and respond timely and appropriately. Interactions with the Service Center are typically with Automatated Collection System Support employees (“ACS”). If you find yourself speaking with an ACS employee, you should make a note of their name and employee number, the date of the conversation, a summary of what was discussed, and any deadline for taking action.

Collection

If a filed return shows a tax due, or if a tax becomes due as the result of an audit, then the IRS Service Center sends a series of notices demanding payment. The final notice gives the taxpayer an opportunity to request a collection due process hearing (“CDP”) to propose a collection alternative before the IRS takes enforced collection action. IRS Revenue Officers (“ROs”) are employees of the Collection function who are responsible for collecting tax delinquencies. Enforced collection tools that ROs can use include filing a notice of federal tax lien (“NFTL”), serving a financial account on a financial institution or a wage levy on an employer seizing account balances or wages, seizing and selling assets, including personal residences, retirement accounts, and even Social Security benefits, and filing suit and obtaining a judgment. Collection alternatives include offers-in-compromise (“OICs”), installment agreements (“IAs”), having an account classified as currently not collectible (“CNC”), or in some cases getting a discharge or payment plan in a bankruptcy proceeding. Generally, the IRS has 10 years to collect a tax (the collection statute expiration date or “CSED”), but there are many exceptions to this general rule. Depending on the facts, you may have the right for an administrative or judicial appeal.

Examination

A very small percentage of returns are selected for examination, also knowns as audits. Audits can result from a number of factors, including large, unusual or questionable items (“LUQs”) on a return, returns with high discriminant function (“DIF”) scores, IRS compliance programs such as abusive return preparer program, returns of taxpayers related to other taxpayers already being audited, information returns filed with the IRS including currency transaction reports (“CTRs”) or suspicious activity reports (“SARs”) filed by banks, informants, and for many other reasons. Audits or examinations are conducted by Office Auditors, who audit primarily a select number of entries on wage earner returns, or Field Agents, who audit returns of businesses or wealthy individuals at their business locations. During the course of an audit an examiner will issue information document requests (“IDRs”) requesting documents and/or information relevant to the examination. These IDRs need to be reviewed and responded to timely and appropriately. It is very important to ensure that all privileges (including attorney-client, accountant-client, or self-incrimination) are preserved. At the conclusion of the audit, the examiner will either issue a no-change letter or a revenue agent’s report (“RAR”) proposing adjustments. As a general rule, the IRS has 3 years to assess a tax (the “ASED”), but as with the CSED, there are many exceptions. Statutes of limitations will be covered in greater detail in future posts. Taxpayers typically have the right to an administrative appeal by filing a timely protest with the IRS Office of Appeals, and/or judicial review by filing a petition with the U.S. Tax Court or a U.S. District Court or the US Court of Federal Claims. The jurisdiction of these various courts as well as the factors relevant to forum selection are well beyond the scope of this post, but will be covered in future posts.

Criminal Investigation

Finally, in rare but exceptionally dire circumstances, a taxpayer may be contacted by a Special Agent with the IRS Criminal Investigation Division. Except for stating the obvious that no one should meet with or speak to a Special Agent without consulting with an experienced attorney, an in depth discussion of IRS criminal statutes is beyond the scope of this post, but will be covered in future posts.

Conclusion

As noted, the purpose of this post is merely to provide a cursory overview of various functions within the IRS. If you have any questions about a specific matter, please feel free to contact us at https://www.kauffgroup.com/contact-us/ 

The Kauffman Group is a law firm, and an accounting firm (the “Kauffman Firms”) of which Stephen P. Kauffman (“Steve”) is a founder and principal. Steve has been practicing law for over 30 years. His law firm, Skeen & Kauffman, LLP is owned by Steve and his law partner, Jim Skeen. In 2019 Steve and his accounting partners, John and Soo Kim and Shirley Huang formed Kauffman Kim, LLP. In this weblog Steve intends periodically to post articles about Tax Controversy, Commercial Litigation, and Business Transactions, the areas that he knows best. His intended audience is attorneys, CPAs, business owners and Business managers. Although he will exercise his best efforts to make his posts as accurate and informative as possible, by using and accessing this site you agree that the information provided is not intended to be professional advice, and may not be relied upon for that purpose. Furthermore, no attorney-client or accountant-client relationship will be created either of the Kauffman firms unless and until such time as a written fee agreement is signed by Steve.

Large Gifts From Foreign Citizens May Result in Unexpected Tax Consequences

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The Procession of the Trojan Horse into Troy by Giovanni Tiepolo circa 1760.

For most people, the receipt of a gift, particularly a large cash gift, is cause for celebration. But over the millennia gifts have spawned a lot of wise advice from various wary pundits. Beware of strangers bearing gifts was an admonition coined by Virgil in a less-than-politically-correct reference to the Trojan Horse immortalized by Homer in The Illiad, and as envisioned by Giovanni Tiepolo in the stunning portrait pasted above. And don’t look a gift horse in the mouth is a suggestion from St. Jerome that one show proper appreciation for a gift.  And to these wise admonishments, let’s add the recommendation that one consult their tax advisor upon the receipt of a large gift, particularly if the gift exceeds $10,000 and the donor is a citizen of a foreign country.

Tax Ramifications for Overseas Gifts

This brings us to the point of this post. A professional colleague recently asked me to help him with a case pending in the United States Tax Court. One of the primary legal issues was the tax ramifications caused by our client’s receipt of a series of large cash gifts from overseas. Before discussing the exact issue and resolution of that case, a quick primer of the general rules of taxation applicable to gifts between US citizens is in order. Assuming a gift is really a gift,[1] then the receipt is not subject to income tax, and any applicable gift tax is imposed on the donor, not the recipient. Additionally, with the availability of spousal gift splitting and the unified credit, it is the rare gift that will result in the imposition of a gift tax liability, although a gift tax return might be required.

But gifts from citizens of foreign countries are treated differently. Even though the receipt does not give rise to an income tax for the recipient, and the IRS does not have the ability to impose a gift tax on a donor who is a citizen of a foreign country, the recipient is required to file with the IRS a form 3520 reporting the receipt of a gift in excess of $10,000. And if the recipient fails to file that return, the IRS will impose a penalty of up to 25.0% of the gift.[2]

Getting back to case that is the subject of this post, my client received nearly Ten Million Dollars in gifts over a period of several years, and even though his income tax returns had been prepared by a CPA, the checklist that the CPA used for preparing the returns did not ask about foreign gifts in excess of $10,000. Consequently, the preparer did not advise the client to file forms 3520, which resulted in the proposed assessment of a penalty of nearly Two Million Dollars.

Happily, the Tax Court case eventually settled for a small fraction of the proposed assessment, because of a technical defect in the way the penalty had been approved by IRS management.[3] But the key takeaway is anytime you receive or contemplate giving a large gift, you consult your tax advisor.

The information provided in this post is for general informational purposes only. It is not intended to be legal or accounting advice and should not be relied on for that purpose. The Kauffman Group has extensive experience representing clients in complex civil and criminal tax matters. One of our tax professionals will be happy to discuss the unique facts of your case.    

[1] Just because the parties call a transfer of value a gift is not dispositive for tax purposes, and the IRS is always free to challenge the taxpayer’s characterization of a transaction. In Duberstein v. Commissioner, 363 U.S. 278,  285 (1960),  the  Supreme Court  explained that  a gift proceeds  from  a  “detached  and disinterested generosity”  and is  made  “out of affection, respect,  admiration, charity  or  like impulses”  not  because  of  “any  moral  or legal”  duty  to make  a payment. In Olk v. U.S, 536 F. 2d 876 (9th Cir.) a casino dealer argued that tokes (i.e. amounts gamblers pay to dealers when they win) are gifts. The Court rejected this argument, and held that “receipts by taxpayers engaged in rendering services contributed by those with whom the taxpayers have some personal or functional contact in the course of the performance of the services are  taxable  income when in conformity with the practices of the area and easily valued. Tokes like tips meet these conditions.”

[2] §6039F of the Internal Revenue Code of 1986, as amended (the “Code”), requires the recipient to file form 3520 with the IRS if the applicable gift threshold is exceeded for any tax year. The threshold if the donor is a nonresident alien or an estate is $100,000, while the threshold if the donor is a corporation or a partnership is $10,000, adjusted for inflation.

[3] See IRC §6751(b) of the Code.

Six Reasons to File your Income Tax Return

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Almost 100 years ago Supreme Court Justice Oliver Wendell Holmes observed that “taxes are what we pay for civilized society[1].” For Justice Holmes paying taxes may have been a moral imperative, but beyond wanting to win a good citizenship award, are there any other good reasons for filing your income tax return each year? If you suspect that doing so avoids a lot of potential problems, perhaps you have what it takes to be appointed to the Supreme Court. Let’s look at six (6) good reasons for filing.

  1. You can lose the right to claim income tax refunds   

Even when they haven’t filed their returns, many people have still paid taxes. Employers frequently withhold more than enough tax from their employees’ wages to pay all the tax due to the IRS, and they issue a form W-2 to their employees at the end of the year. When you overpay your taxes, you are entitled to a refund of the excess, but in order to get that refund, you need to file a return to claim it. The deadline for filing a return to claim a refund is 3 years from the due date of the return. The IRS refers to this deadline as the refund statute expiration date, or RSED. And if your return is filed after the RSED, your refund claim is barred. Sadly, this happens all too often. For the tax year 2016 alone refunds unclaimed by taxpayers exceeded 1.5 billion dollars. [2]

  1. If you owe taxes the IRS charges a substantial penalty for late filing

In those cases where you owe taxes, the IRS imposes late filing and late payment penalties. The penalty for late filing is 4.50% for each month or part of a month your return is late, up to a maximum of 22.50%, while the penalty for late payment is .50% per month until the IRS sends a bill for the tax (called a notice of assessment and demand for payment), at which time it increases to 1.00% per month, up to a maximum of 25.00%.

To illustrate, if the tax due on a return filed 5 months late is $10,000, then the failure to file penalty will be $2,250, and the failure to pay penalty will be $250. The failure to file penalty alone is equivalent to an APR of 56.25%. A simple way to reduce these penalties is to file the return on time, even if you can’t pay the tax. In this example, filing on time will save $2,250.

In addition to penalties, the IRS also charges interest on overdue taxes from the due date of the return, until the tax is paid. The combined cost of penalties and interest far exceed the cost of borrowing, even at sky-high credit card rates.

  1. Until you file there is no statute of limitations preventing the IRS from assessing additional tax 

When you file an income tax return, the IRS generally has 3 years from the date you filed to audit your return and assess additional taxes. But unlike the limitation on claiming a refund, if you don’t file an income tax return, the IRS can legally assess additional taxes at any time without any time limitation. This is because the statute of limitations on assessing tax (the “ASED”) doesn’t start to run until a return is filed. If no return is filed, there is no statute of limitations on assessing tax and nothing to prevent the IRS from sending you a huge bill.

Even so, the IRS typically only seeks to enforce filing obligations for the current year, and the previous 6 years. So even if you haven’t filed for many decades, you can typically get compliant if you file returns for the previous six (6) years.

  1. The IRS can estimate your tax, but it’s usually much higher than if you filed

If you don’t file, the IRS can take whatever information it has, and prepare a tax return for you[3]. This is called a substitute for return (“SFR”), and in preparing it, the IRS will assume you are single with no dependents and no deductions. This means that a tax computed by the IRS will usually be far more than what you actually owe. If the IRS does prepare a substitute for return, it will generally permit you to file a correct return based on your actual situation, and it will use the numbers on it to reduce your tax liability. Of course, this will probably increase the likelihood that you will be audited.

  1. Getting or refinancing a mortgage can be very difficult if not impossible

                If you apply for a loan to buy a home or refinance an existing mortgage, one of the first things the bank is going to request is copies of your income tax returns. If you don’t have them, you can forget about getting a loan. And if you give them returns that were not filed, you can be charged with a federal crime—bank fraud.

  1. Not filing is a Federal Crime                                                                        

                Still not convinced. Then there’s one last thing you should know: failing to file an income tax return is a crime that can result in fines of up to $25,000 and imprisonment of up to 1 year for each year that is not filed. Criminal penalties are substantially higher if you do something improper to evade your filing obligation, like giving your employer a false W-4 claiming exemptions that you aren’t entitled to.

Do you have unfiled returns? The Kauffman Group can help

If you have unfiled returns, even for 10 or more years, it’s not all doom and gloom. The Kauffman Group is a team of attorneys and CPAs with decades of experience dealing with IRS tax matters. Steve Kauffman, the founder of the Kauffman Group, is a CPA, attorney, and former IRS agent with over 30 years of experience. He and his team are experts at resolving tax problems, including unfiled returns, and can get you back on good terms with the IRS.

Want to know more? Send Steve an email at skauffman@skaufflaw.com , and he will get back to you personally.

[1]Compañía General de Tabacos de Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100 (1927)

[2] See IR-2020-135, July 1, 2020

[3] See IRC §6020(b)

The Trust-Fund Recovery Penalty—An exception to limited liability.

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Many business owners form a limited liability entity (an “LLE”) such as a corporation or limited liability company (as LLC), to protect their personal assets from exposure to business liabilities. While forming an LLE is a prudent business decision, it is important to realize that they do not protect against ALL business liabilities. There are important exceptions, and one of the most important is a business owner’s potential personal liability for unpaid employee payroll taxes. This used to be referred to as the 100% Penalty, and is now known as the Trust-Fund Recovery Penalty (the “TFRP”). 

Section 6672 of the Internal Revenue Code permits the IRS to assess the TFRP against any person responsible (a “Responsible Person”) for collecting, accounting for, or paying over the trust-fund portion of payroll taxes who willfully (“Willfulness”) fails to do so. Here are a few basics you should understand.

A Responsible Person could be anyone in the business with the authority to decide what bills get paid, and when they get paid. Responsible Persons can include officers, directors, controlling stockholders, lenders, bookkeepers, and anyone who exercises sufficient control over the business.

A trust-fund tax is the employee’s share of FICA and the employee’s withheld income taxes. The employer’s share of FICA, FUTA, penalties (i.e. failure to deposit, failure to file, failure to pay), and interest are NOT trust-fund taxes.

Willfulness does not require evil intent, malice, or even knowledge that there is potential personal liability. It requires only that the person authorizes a payment of another bill at a time when a trust-fund tax is overdue. 

The TFRP Penalty is NOT DISCHARGEABLE in bankruptcy, but there are many things that can be done to avoid or limit your exposure. 

When the IRS revenue officer conducts an investigation to identify Responsible Persons, they complete and ask the persons interviewed to sign a form 4180, Interview of Potentially Responsible Person.

Contact The Kauffman Group for your Tax Needs

Trust-Fund Recovery Penalties should not be taken lightly, as they can quickly accumulate into the hundreds of thousands or even millions of dollars. I have represented hundreds of individuals in trust-fund penalty investigations, appeals, and litigation. If you would like to read more about these Trust-Fund Recovery Penalty, click here. Or if you’d like to schedule an appointment to discuss your personal situation, click here.