Author Archive

If it’s too good to be true…

February 21, 2012

Joe Kristan, of the venerable Roth & Company P.C. Tax Update Blog, raises an important issue that all taxpayers should keep in mind. Joe reminds us to beware of promises of fast, dramatic tax relief. Whenever a notice of federal tax lien is filed with a county reporter, it becomes a public record. Companies such JK Harris, Integrated Debt, and First Class Tax Relief promise to reduce the tax debt that you owe. Many times these companies send official looking documents which contain threatening language unless you act immediately – by calling them, of course.

These companies promise pennies on the dollar savings for a small fee. These trade practices can be deceptive and many states are now cracking down. Joe points out two such companies that have been targets of state attorneys general. What they are promising is relief through a process known as an offer in compromise. The IRS may agree to settle your tax debt for less than the amount due if certain conditions are met. First and foremost is that your total net worth (including future earning capacity) is less than the amount owed. Thus, the vast majority of all offer in compromise claims are rejected. Even if you qualify under the net worth determinations, there are a plethora of other requirements that you will have to go through before an offer in compromise is approved. There are certain circumstances where an offer in compromise is warranted, but taxpayers should be cautioned against paying any money to an “offer in compromise mill” to handle their case.




Non-profit Organizations and Iowa Sales and Use Taxes

February 18, 2012

A common misconception persists among Iowa non-profits and vendors that all non-profits are exempt from sales tax on goods purchased on behalf of the non-profit. Most non-profits do, in fact, have to pay sales taxes on their purchases. Only specifically enumerated non-profits are fully exempt from sales taxes. However, nonprofit organizations typically do not have to collect tax on items that they sell so long as the proceeds go directly to the educational or non-profit purposes of the organization. It is always a good idea to review these rules if you are a non-profit operating in Iowa.

The following are the Iowa entities that are exempt from sales and use taxes:

  • American Red Cross.
  • Navy Relief Society.
  • U.S.O. (United Service Organizations).
  • Community health centers.
  • Migrant health centers.
  • Certain Residential care facilities and intermediate care facilities for the mentally ill.
  • Residential facilities for mentally retarded children.
  • Certain licensed residential facilities for child foster care.
  • Rehabilitation facilities which provide certain accredited rehabilitation services to persons with disabilities and qualified adult day care services.
  • Community mental health centers.
  • Sales of tangible personal property and services made to nonprofit hospitals and nonprofit hospices.
  • Statewide nonprofit organ procurement organizations.
  • Nonprofit legal aid organizations.
  • Nonprofit organizations organized solely for the purpose of lending property to the general public for nonprofit purposes.
  • Nonprofit private museums.
  • Governmental units, subdivisions, or instrumentalities of the federal government or of the state of Iowa.
  • Federal corporations created by the federal government which are exempt under federal law.
  • Private nonprofit educational institutions located in Iowa.
  • Private nonprofit art centers located in Iowa.
  • Habitat for Humanity in Iowa when purchasing building materials.
  • Toys for Tots when purchasing toys.
  • Community action agencies.

For non-profit organizations which are not found on the preceding list, Iowa Code § 423.3(78)(2011) exempts the sales price of sales of tangible personal property if the profits from the sale are used for educational, religious, and charitable purposes. Organizations should be aware that this is a separate test from the IRS requirements for exempt status under IRC §501(c)(3).  Iowa Administrative Rule 701-17.1 defines the terms, “educational, religious, and charitable”. Exemption as a religious organization is fairly straight-forward and most churches, synagogues, or mosques should qualify. Educational is defined as “the acquisition of knowledge tending to develop and train the individual. An activity that has as its primary purpose to educate by teaching.” Charitable is defined, “the term ‘charitable ‘may be applied to almost anything that tends to promote well-doing and well-being for public good or public welfare with no pecuniary profit to the one performing the service…”.  In short, it is a good idea to review these rules prior to claiming an exemption.

The IDR has a good website for non-profits that covers these issues in some depth. The exemption for non-profit sales requires that the net proceeds go towards the charitable activity. However, if not all of the proceeds go towards charitable activities, then the exemption is prorated, not denied. The website referred to above, gives the following illustration:

A local organization (not a 501(c)(3)) has a fundraiser and collects $10,000 in net proceeds. The organization gives $9,000 to a local nonprofit homeless shelter and uses $1,000 to pay guest speakers at its meetings. The organization does not pay sales tax on the $9,000 given for a charitable activity, but must pay sales tax on the $1,000 it retained for its own use.

The term net proceeds means the gross revenue less the costs of operating and holding the event. Unfortunately, non-profit sales tax issues can get complicated in a hurry. Notice in the above example, the organization was likely not a qualifying non-profit for sales tax purposes. However, it qualified for the exemption because the organization expended the proceeds for charitable purposes. If the organization were exempt under Iowa sales tax law, the speaker fees could also be considered exempt net proceeds because the speakers would be furthering the charitable or educational purposes. It is important to look at who the entity is that is claiming the exemption.

Other examples given include a food vendor at a little league game where the proceeds of the vendor go back into the little league for uniforms. That example is determined to be an exempt activity for sales tax purposes so long as the little league organization is a IRC § 501(c)(3) charity. Certain local theaters, civic centers, and similar entities can also claim an exemption for the sales prices of the ticket sales to their events, provided that the entity sponsoring the event is an exempt organization and the event furthers the charitable or educational purposes.

Operationally, it is important to keep track of the proceeds that are gathered from exempt events. If the organization provides any benefits (other than reasonable compensation) to its volunteers and members, the Department has taken the position that the organization must remit sales tax on the amount spent for these benefits. The Department provides a simple example of a charity that raised $10,000.00 but spent $1,000.00 on a pizza party for those that helped with the event and its members. The Department takes the position that those proceeds are not spent in furtherance of the exempt purposes and the organization must pay sales tax on the $1,000.00. Thus, it is a good idea to segregate unrestricted donations from proceeds raised through fundraising and event activities. If a pizza party is desired, then the donated funds can be used for those purposes from a separate account without triggering a sales tax liability.

To summarize, only a select few non-profits in Iowa can claim an exemption for purchases for their organization. Most, however, can claim a sales tax exemption for their fundraising and event activities – keeping in mind that the proceeds must be spent in furtherance of the exempt purpose.

Developing Issues for Tax Professionals – A question that is being considered by tax professionals and the Department at the moment is just how the “net proceeds” concept is to be applied in practice. As we know, the vendor is responsible for the collection of sales taxes from the consumer at the time the sale is completed. Thus, the following question is necessarily raised – if the exemption is applied on the back-end of the transaction (determining the net proceeds requires analysis after the sale takes place), then how is the tax to be collected on the front end of the transaction? In practice, most non-profit organizations simply remit the tax on the for-profit proceeds without consideration as to how it was collected. This raises a number of issues as to how you would itemize a receipt or disclose to those purchasing the item that sales taxes are being collected. The Department has yet to provide guidance on this issue, but as charities provide more and more complex services and goods, this is becoming an issue that will have to be dealt with and developed. We will post any guidance that we receive on this issue in the future.

FATCA – New Filing Requirements for Foreign Assets

January 30, 2012

Congress and the IRS have determined that taxpayers need yet an additional form to file in order to report foreign held assets. This latest filing requirement will add to the Form TD F 90-22.1 – Report of Foreign Bank and Financial Accounts (FBAR), Form 8865 – Return of U.S. Persons With Respect to Certain Foreign Partnerships, Form 5471 – Information Return of U.S. Persons With Respect To Certain Foreign Corporations, and the plethora of other foreign asset reporting requirements. Holding foreign assets has never been more difficult and potentially very costly from a tax perspective.

As part of the Hiring Incentives to Restore Employment (HIRE) Act, The Foreign Account Tax Compliance Act (FATCA) was enacted March 18, 2010. The IRS states that “The Foreign Account Tax Compliance Act (FATCA) is an important development in U.S. efforts to improve tax compliance involving foreign financial assets and offshore accounts.” In order to implement the reporting requirements under FATCA the IRS has just recently released the final Form 8938. Although FATCA has been in effect since enactment in 2010, its implementation has been delayed until the final form was published. As such, the 2011 tax return is the first return that will require this form to be attached.

The Form 8938 increases the scope of reportable assets and persons required to report foreign assets. For instance, certain private equity assets held through hedge funds that were exempted under the FBAR rules will now have to be reported on the Form 8938. Section 511 of FATCA creates a new IRC code section, Section 6038D. This code section sets forth the threshold filing requirements. Additionally, the IRS has published guidance on their website on who will be required to file the Form 8938.

Generally, you must file a Form 8938 if you are a specified individual. A specified individual is defined as:

  • A U.S. citizen;
  • A resident alien of the United States for any part of the tax year (see Pub. 519 for more information);
  • A nonresident alien who makes an election to be treated as resident alien for purposes of filing a joint income tax return; or
  • A nonresident alien who is a bona fide resident of American Samoa or Puerto Rico (See Pub. 570 for definition of a bona fide resident) and
  • Any such person holds an interest in a specified foreign financial asset required to be reported.

A specified foreign financial asset is defined as:

  • Any financial account maintained by a foreign financial institution, (with some exceptions)
  • Other foreign financial assets held for investment that are not in an account maintained by a US or foreign financial institution, namely:
    • Stock or securities issued by someone other than a U.S. person
    • Any interest in a foreign entity, and
    • Any financial instrument or contract that has as an issuer or counterparty that is other than a U.S. person.

It should be noted that this will not encompass international equity assets held in a US-based mutual fund or issued through a US broker. Though, it ostensibly would apply to a non-US based mutual fund or foreign broker.

There are filing thresholds such that not everyone that qualifies above will have to file this form. For unmarried taxpayers living in the US, the threshold will be if the total value of all specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. For married taxpayers filing a joint income tax return and living in the US, the threshold will be if the total value of all specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year. For married taxpayers filing separate income tax returns and living in the US, the threshold will be if total value of all specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.

There are special rules if you are a US taxpayer living abroad. These rules need to be reviewed carefully as they set forth a different standard of residency than found elsewhere in the IRC and regulations. Under the FATCA rules, a person is a taxpayer living abroad if:

  • You are a U.S. citizen whose tax home is in a foreign country and you are either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year, or
  • You are a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.

Note the second definition for US citizens living abroad and not qualifying under the first definition –  you will have a requirement to file if you are present in the US for more than 35 days (or 36 this year). For US citizens living abroad, this could catch a few persons unexpectedly.

The thresholds are also different for a taxpayer living abroad with a filing requirement. The IRS states that you will be required to report if:

  • You are filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year; or
  • You are filing a joint return and the value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year.

FATCA also added, as would be expected, draconian penalties similar to the FBAR penalties. IRC § 6662 allows the IRS to impose a 20% penalty on a substantial understatement of income tax for negligence and other non-fraudulent behavior. FATCA amended this section and added a potential penalty of 40% for any underpayment attributable to financial assets required to be disclosed pursuant to IRC § 6038D. Additionally, there is a stiff failure to file penalty of $10,000.00 for failing to file by the required filing date for the tax return. After being notified of the failure to file, the taxpayer will be fined an additional $10,000.00 for each 30 day period during which they fail to file the return (capped at $50,000.00).

Additionally, FATCA has extended the statute of limitations with respect to returns which contained errors in the filing of the Form 8938. Generally, if all the tax is paid and a Form 8938 filed timely, the statute of limitations will remain at the usual 3 year period. However, if a Form 8938 is not filed, the statute of limitations will not start to run on any income attributable to assets which should have been reported on the form. Even after filing the Form 8938 and paying the tax due, the statute of limitations which respect to the form and the tax liability attributable thereto will be extended to 6 years if the amount of under-reporting of income from the reportable foreign assets was greater than $5,000.00.

This tax season it is imperative to alert your tax professional if you have foreign held assets. Even if you consider them exempt from reporting, it best to let your tax preparer know about those assets. The penalties for improper reporting are quite severe and therefore foreign assets warrant increased attention.

My name is Christopher James. I practice corporate law and tax law at Davis Brown Law Firm. I focus mainly on tax controversy matters with both state and local governments and the IRS. I have a BS in accounting from the University of North Carolina-Greensboro, a J.D. from Drake University, and a LL.m in taxation from Northwestern University. My complete bio can be viewed here.

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