Month: May 2010

Eliminating Tax Debts in Bankruptcy

SOME TAX DEBTS MAY BE ELIMINATED IN BANKRUPTCY

Unfortunately, most tax debts survive a bankruptcy discharge. You will continue to owe them at the end of a Chapter 7 bankruptcy case, or you’ll have to repay them in full in a Chapter 13 bankruptcy repayment plan.

If you need to discharge tax debts, Chapter 7 bankruptcy will probably be the better option if your debts qualify for discharge (see below) and you are eligible for Chapter 7 bankruptcy:

Does My Tax Debt Qualify For Discharge?

You can discharge federal income tax debts in Chapter 7 bankruptcy if all of the following conditions are true:

  • The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, cannot be eliminated in bankruptcy.
  • You did not commit fraud or willful evasion. Tax debts arising from false or fraudulent tax returns, or where the taxpayer willfully attempted to evade paying taxes, will not be dischargeable in bankruptcy.
  • he debt is at least three years old. The tax obligation must have arisen for a tax year for which the return was due at least three years ago. Assume you are filing for bankruptcy in 2011. You have a tax debt that arose in tax year 2007. The return for 2007 was due April 15, 2008. 2008 is three years prior to 2011. These taxes may be dischargeable if all of the other requirements are met.
  • You filed a tax return. You must have filed a tax return for the debt you wish to discharge at least two years before filing for bankruptcy.
  • You pass the “240-day rule.” The income tax debt must have been assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. (This time limit may be extended if the IRS suspended collection activity because of an offer in compromise or a previous bankruptcy filing.)

What Is The Effect Of A Federal Tax Lien?

Bankruptcy will not wipe out prior recorded tax liens, as these liens essentially turn the IRS a secured creditor. Federal income tax liens also apply to “after-acquired” property, that is, property or money you acquire after the lien arose, and after your discharge, until the statute of limitations runs on collection for the underlying debt. Your Chapter 7 discharge prevents the IRS from continuing efforts to enforce the tax lien – such as by levying your bank account or garnishing your wages.

One major advantage to filing for bankruptcy, however, is that when the IRS files its claim the penalty portion of the debt becomes “unsecured” and can be eliminated with other unsecured debts.

Do Interest And Penalties Continue To Accrue On My Tax Debt While I’m In Bankruptcy?

No. Penalties and interest do not continue to accrue once you file for bankruptcy.

Reprinted in part with permission from the publisher, Nolo, Copyright 2009, http://www.nolo.com

The IRS Test: Employees and Independent Contractors

Respecting the difference between independent contractors and employees is good for everyone. Employee status, that is, a specifically-defined job for a particular company at a set rate of pay, is good for some. The employer-employee relationship permits the employer to exercise control over the how the employee performs his or her job. In turn, the employee is relieved of the hassles of business ownership and benefits from the employer paying 1/2 of the employee’s Social Security tax (or 6.2%).

In other cases, however, a worker’s ability for function as an independent contractor is critical to the success of the worker and the business owner alike. Independent contractors are just that, independent, and can choose the means and methods by which the job is completed. Are you a night owl? Work better on the weekends? An independent contractor is free to choose the methods by which he or she performs the job, just so long as the job gets done.

Both federal and state governments, however, have an interest in who has what status. The trend among governments is clearly towards labeling as many workers as possible as “employees”. Why? Couple of reasons:

(1) An employer is responsible for withholding taxes from an employee’s salary, and can be subject to up to a 100% fine for failing to do so properly. Having the employer do the work of collecting and paying taxes on the government’s behalf is a lot easier than matching the 1099 an employer provides to a contractor to the 1099 the contractor reports on his or her taxes.

(2) The “success” of government mandates, including workman’s comp, unemployment compensation and the new Health Care legislation, depend heavily on the number of employees a company has. Independent contractors do not receive benefits from their employers, but may be paid at a higher rate to compensate for this. The employer may be willing to pay this premium in order to stay below key thresholds that trigger all kinds of compliance requirements. Pushing as many people as possible into “employee” status, from the government’s perspective, pulls that many more companies into paying for the many different public programs that could not exist if more companies were exempt.

In determining whether the person providing service is an employee or an independent contractor, the government will consider all information that bears on the degree of control and independence must be considered.
Common Law Rules

Facts that provide evidence of the degree of control and independence fall into three categories:

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  • Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

As of September, 2011, the IRS launched a new program dubbed the “Voluntary Classification Settlement Program”. Under this program taxpayers who previously misclassified as independent contractors individuals over whom the employer has control (i.e. “true” employees) can make the switch with a minimal 10% penalty on the amounts that would otherwise have been withheld and submitted to the government. The employer will face no penalties or interest on these amounts either, and will not be audited as to the employment status of the individuals so classified for prior periods. The program offers considerable benefits for employers who have been using contractors who clearly fit the definition of employees as described above. Ordinarily if the taxpayer is audited and his employees reclassified the employer can be liable for the amounts of tax not previously withheld (that’s right, the TAX), plus interest and penalties for not having remitted these amounts to the government. As such, this program could be a good option.

There are two problems, however. First, a “settlement” program implies that the employer has done something wrong and is given the option to “come clean”. This will apply to some, as noted above. It is certainly designed, however, to sweep into this program employers whose employees may or may not really be independent contractors. There is no “bright line” test for whether an individual is an employee or an independent contractor. It is a balancing, fact-specific test. Many employers whose workers could qualify as independent contractors will participate out of fear of an audit going the other way. In an environment where so many businesses are operating so close to the edge the fear of losing one’s entire business to a tax audit one could argue the government is muscling people when they’re down.

So why the government’s grand interest in everyone being “employees”? Well, follow the money. Employers are the best tax collectors in the world, they have no choice. The employer withholds employees’ taxes for the government, and the penalties for failing to do this are severe. With this responsibility comes no small administrative, accounting and cash flow burden. This is a cost of doing business and has been for many years, however, employers have also traditionally had the freedom to structure their workforce as they saw fit, within reason, and mostly without highly publicized “settlement” opportunities in front of the threat of audit.

Classifying employees also has considerable consequences for other laws and obligations the apply to businesses of certain sizes. These thresholds – or tripwires, depending on your perspective – can sweep an employer into a range of federal laws dealing with discrimination, overtime, medical leave, unemployment and, most recently, health care. There is also a host of state-level laws dealing with many of the same issues, as well as insurance considerations such as workman’s compensation insurance. Certainly there may be good reasons for this type of legislation, and the laws do provide safe harbors for smaller businesses who may not have the resources to comply with all of the regulations.

But that’s the point. An employer looking at expanding, but at the cost of walking into a whole new world of compliance, may simply choose not to do so. This chilling effect undoubtedly aggravates the present unemployment situation and invites a downward spiral of killing the geese that are providing what jobs remain. Capital responds to incentives, and the negative incentives to expansion in the United States are becoming considerable.

It is critical to consult with an experienced tax attorney before considering participating – or not participating – in the newly announced Voluntary Classification Settlement Program. Contact us for your consultation.

Will I Lose All of My Property In A Bankruptcy?

Chapter 7 Bankruptcies

Many of my clients come to me with the same initial question – “will I lose all of my property in a bankruptcy”. The answer is almost always “no”, you will not lose all of your property. The truth, however, is that there is a sacrifice involved in filing bankruptcy, though that sacrifice is often well worth it. A chapter 7 bankruptcy is often a good solution if you qualify, that is:

  • Your gross, non-exempt monthly household income is below the median income for a household of your size under the means test (by “non-exempt” I mean income OTHER THAN social security income, unemployment compensation, disability benefits and certain other types of non-wage income), or, if you income is above this level:
  • Your debts are primarily business and not consumer debts
  • You qualify under another exclusion from the means test requirement, such as for certain active service members.

Your attorney will legally protect as much of your property as possible using “exemptions”, or legal “allowances” with which to shelter the value of your goods, from clothes to cars and everything in between. If your attorney has enough exemptions, and you have very little property you may have a “no asset” 7, and you will move through the bankruptcy process fairly quickly.

It’s important to remember, however, that the value of your belongings might exceed the amount of your available exemptions. This is so even if you believe, as many do, that “I really don’t have anything of any value”. This may be true if you were to hold a garage sale. The bankruptcy trustee, however, sometimes orders an appraisal of your household goods (by appointment), and that appraiser often assigns somewhat inflated values to your things. As a practical matter, it is often difficult, if not cost prohibitive, to fight it out as to whether your couch is worth $50.00 or $150.00. This is unfortunate but part of the way the system works. Items that typically fetch a higher value under this standard are appliances, electronics and any jewelry with gold, silver or precious stones of any kind.

One way to protect yourself against an appraiser inflating the value of your property is to order an appraisal yourself. There are appraisers whose estimates (if still high), will be accepted by the court. This is especially true in the case of cars. The Middle District of Florida uses the “clean retail” value of a car based on its age and mileage using NADA (www.nadaguides.com). This site almost always inflates the value of old cars by 30% or more. Getting your own appraisal backs up the value you want to put on your bankruptcy petition in advance. That way, you know what you’re getting into and where you stand as to your exemptions.

So, what if you run out of exemptions? The total value of your goods that exceeds the amount of your exemptions is called an “overage”. In a chapter 7 bankruptcy, you have three ways to address this overage:

Surrender (give to the court) property whose value totals the amount of overage. The bankruptcy trustee arranges to sell this property at auction, as a lot
“Buy back” your non-exempt property, that is, pay into the court a monthly amount that covers the non-exempt amount over a 12 month period
Surrender some property and buy some property back

So, that’s the sacrifice if you do not qualify as a “no asset” 7. Your bankruptcy attorney should be willing to give you an estimate of what to expect so you can plan accordingly. If you accept that you do have to surrender property, you can make a rough plan for what you can part with and what you want to keep. If you want to buy property back, you can think of ways you might come up with the money.

Sometimes, however, your overage might be too big to buy back over 12 months, yet you have property that you want to keep. In this case, you are often better off filing a Chapter 13 bankruptcy.

Aircraft Sales Tax Audits

Florida sales and use tax audits are on the rise, and, like most states, auditors are looking for the “big ticket” items like aircraft. A long-term client of mine lamented to me the other day: “No one is turning wrenches on large aircraft in Florida anymore”. Why?

(a) Aircraft buyers and sellers, operators and services companies may be unaware of the exemptions available to them, and

(b) Auditors are often similarly unaware of the laws they are trying to enforce. Florida, however, actually has a fairly robust “menu” of sales tax exemptions that should be exploited in the event you face a sales tax or use tax audit in Florida.

Florida Sales Tax Exemptions:

  1. The export exemption (sales to out of state or country buyers are exempt from Florida sales and use tax when the goods are manufactured or acquired for this purpose and are shipped to the buyer “uninterrupted” (i.e. not first used by the dealer or manufacturer)).
  2. The in-state repair and maintenance exemption (aircraft repair and maintenance is exempt from Florida sales and use tax).
  3. The non-resident modification exemption (non-residents that come to Florida for the purpose of upgrading, repairing or refurbishing their planes are not subject to Florida sales or use tax on those activities).
  4. The sale for resale exemption (aircraft “dealers” may purchase and sell aircraft and aircraft parts without having to pay Florida sales or use tax).
  5. The supplemental type certificate exemption (work performed in connection with a major upgrade under authority of an STC exempt).

Importantly, these exemptions are cumulative, rather than exclusive.

Documentation and Business Use

It goes without saying that the more documented business use you’ve had for your plane, the more sound will be your defense against a federal income tax or state tax audit. That said, most of us try and enjoy our lives, and our businesses, without spending most of the day recording what we are doing, and records are imperfect. Think of ways that you might prove up, for example, that a specific trip was for business. If your flight log doesn’t necessarily document the business purpose of the trip, review your email to meeting participants, business partners and others that support your claim that you flew to a business destination.

A qualified aviation tax lawyer in Florida can make the difference between hundreds of thousands of dollars – or more – in alleged sales tax due versus a favorable result utilizing the Florida sale and use tax exemptions listed above.

Contact me, Ari Good, Esq., for other practical tax tips. I serve as a tax lawyer in Naples, Florida and worldwide in aircraft tax law matters.

239.216.4106