Tax Controversies

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On March 13, 2018, the IRS announced that the Offshore Voluntary Disclosure Program (OVDP) will be closing on September 28, 2018. This program has been in place since 2009.

In general, US persons, that is, citizens and residents of the US, must report their worldwide income on their US income tax returns. They also must report their financial accounts held outside the US on an annual FBAR (FinCEN Form 114) if the aggregate balance of their accounts exceeds $10,000.

The OVDP offers a structured program for taxpayers to amend income tax returns to report any unreported foreign income, submit any unfiled international tax filings, and disclose the existence of financial accounts outside the United States.

To participate in the OVDP, taxpayers have had to pay a substantial civil penalty based on the value of the unreported accounts, in addition to paying back taxes with a 20% penalty and interest.

The incentive to participating in the OVDP is that the IRS will not criminally prosecute the taxpayer for the failure to report his or her accounts and that all other potential civil penalties will not be assessed in lieu of the one OVDP penalty.

The OVDP is intended for those taxpayers who knew that the law required reporting of their foreign accounts but who decided to not report such accounts on an FBAR or on other international tax filings. These taxpayers have the most to gain from participating in the OVDP and remain exposed if they choose to not come into compliance.

The OVDP requires eight years of amended return filings, six years of FBAR filings, as well as several other items to be submitted to the IRS. The IRS requires a complete OVDP submission by the September 28 deadline. These submissions require time to compile the necessary documentation and to prepare amended returns. It is important for those not in compliance to decide on participating now – well before the September deadline – or you will not be able to complete the OVDP.

What options do taxpayers have if they didn’t file FBAR’s or report their foreign income but their mistakes were inadvertent? This is referred to as a “non-willful” case and is common for many taxpayers who have accounts from their home country that were opened before moving to the US or for those whose tax return preparer did not advise them as to what the tax law requires. The IRS is continuing a program known as “Streamlined Filing Compliance Procedures,” for non-willful violations. These procedures, which may also require a penalty, will continue past September. There are also other ways to return to compliance.

What will IRS enforcement in this area look like once the OVDP is ended? We believe that examinations in this area will only increase. The IRS has gathered a decade’s worth of material on foreign institutions and bankers through the OVDP. This data, along with the information that the IRS now receives from many foreign countries pursuant to a law known as FATCA, allows the IRS to identify non-compliant taxpayers much more easily today than in the past. These international audits are quite intrusive and can expose taxpayers to substantial penalty. We expect the number of these audits to increase.

Once the OVDP option has ended, taxpayers will still be able to voluntarily come forward to disclose past misdeeds. (The IRS has stated that the precise details how to do so will be forthcoming.) It is clear, though, that as onerous as the OVDP penalty is now, the toll to come into compliance in the future will only be greater.

The new tax bill passed by Congress is expected to be signed into law by President Trump in the next few days.  Based on the changes that will take place as of January 1, 2018, there are several items that taxpayers should consider implementing prior to December 31, 2017.

Please note that each taxpayer’s situation is different and each suggestion below should be discussed with the taxpayer’s tax and financial advisors to determine what steps, if any, should be implemented now or deferred until next year or whether it should be implemented at all depending on the taxpayer’s business and tax attributes.

Items to consider:

  • Prepay real estate property taxes if you have amounts due for 2018 (cannot prepay NJ or NY state income taxes)
  • Prepay home equity interest (no deduction after this year)
  • Make charitable contributions this year, especially if not itemizing deductions in 2018
  • Accelerate business deductions
  • Medical expense deduction floor reduction to 7.5% only lasts through 12/31/18, so incur medical expenses if possible before then
  • Delay or accelerate Roth conversion
  • Defer or accelerate income*
  • If you are a US person with foreign businesses, potentially converting to an S corporation before year end could be beneficial due to a “deemed repatriation” of profits in the new bill
  • If you have children in private elementary, junior high or high schools and have not already been funding 529 plans, consider use of 2017 annual exclusions not otherwise exhausted to fund 529 plans

 

*Deferral of income until 2018 could save taxes for some taxpayers because of the lower marginal rates, while acceleration of income could save taxes for others due to the limitation on deductions of state and local taxes.  Whether or not a taxpayer is subject to AMT also plays a role.  Again, each taxpayer should consult his or her own tax and financial advisors for specific advice.

Beginning January 1, 2018, the IRS will begin implementing Section 7345 of the Internal Revenue Code to certify tax debt to the State Department.  This will allow the State Department to revoke or withhold the issuance of passports to delinquent U.S. taxpayers.

To warrant IRS certification to the State Department, the IRS debt has to be deemed “seriously delinquent tax debt.”  This is defined as: (a) an amount exceeding $50,000, as adjusted annually for inflation and including penalties and interest; (b) a levy or notice of federal tax lien has been issued by the IRS; and (c) all administrative remedies, such as the right to request a collection due process hearing, have lapsed or been exhausted.  This only relates to Title 26 of the United States Code and does not include other tax-related penalties, such as FBAR penalties.

The IRS will be required to notify the taxpayer in writing at the time it issues a tax debt certification to the State Department. Before denying a passport, the State Department will hold a passport application for 90 days to allow the taxpayer to resolve the tax debt or enter into a payment alternative with the IRS.

It is also possible to seek relief in U.S. Tax Court or District Court.  The court can order the IRS to reverse the certification if it was erroneously issued, or was required to be reversed but the IRS failed to do so.

The certification will not apply or will be reversed in the following scenarios:

  • The debt is paid in full. (The IRS will not reverse the certification if the taxpayer pays down the debt to an amount below $50,000.)
  • The taxpayer enters into an installment agreement with the IRS to pay off the debt.
  • The IRS accepts an offer in compromise to satisfy the debt, or the Justice Department enters into a settlement agreement with the taxpayer to satisfy the debt.
  • Collection is suspended based on a request of innocent spouse relief, or for collection due process based on a notice of levy, but only if the request is with respect to the debt underlying the certification.
  • The debt becomes unenforceable based on statute of limitations.

The law affects expatriates living abroad and individuals traveling regularly overseas for work.  If the taxpayer finds himself or herself traveling or living outside of the country with a revoked passport, the Secretary of State has the discretion to limit the existing passport, or issue a limited one, for return travel to the United States.

It is not clear if this statute will ultimately pass constitutional challenges.  In the meantime, starting January 1, 2018, you may be at risk of having your U.S. passport revoked if you travel outside of the U.S. without first addressing delinquent tax debts exceeding $50,000 through any administrative remedies and/or collection alternatives available to you.

In a recent ground-breaking decision, the New Jersey Tax Court in AHS Hospital Corp., d/b/a Morristown Memorial Hospital v. Town of Morristown shattered the previous near incontestability of the tax exemption that has shielded nonprofit hospitals from local property tax obligations for over 100 years. In response, the New Jersey Legislature, in conjunction with the New Jersey Hospital Association, quickly joined forces in an attempt to formulate a “fix” and alleviate the resulting great uncertainty that has left municipalities and nonprofit hospitals clamoring for answers.

The resulting bi-partisan supported fix, embodied by Bill No. 3299 (approved early this year) was sent to the Governor’s desk for signing with just days left in the recently completed legislative session. Unfortunately, due to the fast track of this legislation, the late submission of the bill for consideration to the Governor’s office, claims of constitutional infirmity swirling, the Governor, not having been afforded adequate time for fair comment, instead allowed the time to lapse for taking action on the bill. As a result, the bill was killed by virtue of the Governor’s pocket veto.

The import of this failed bill is that while it worked to attempt to reaffirm the longstanding exemption applicable to nonprofit hospital property, it also, in a controversial twist, declared that even those portions of the hospital that were being utilized for, or supporting, for-profit medical activities, should be exempted from taxation. By attempting to continue the exemption, even for components deemed unquestionably “for-profit” by the tax court in the AHS Hospital case, this bill worked to effectively strip away the host municipality’s ability to effectively contest the applicability of the exemption. In return, however, the Legislature attempted to create a special “Community Service Contribution” obligation that was to be borne by the hospital in lieu of paying taxes. This contemplated Community Service Contribution was championed by the sponsors as being readily calculable and serving to remove the need for costly litigation to determine what, if any, portions of the hospital should remain exempt. The funds received by the municipality through this “contribution” obligation in turn would have been earmarked to offset local expenses and financial hardships created by the presence of these typically large facilities that introduce thousands of patients, employees, professionals and associated vehicular activity into the community. The failed bill therefore, although controversial, appeared to strike a reasonable balance between stakeholders, affording both hospitals and municipalities benefits that were left to chance in the unstable environment created in the aftermath of the recent tax court decision.

The killed bill would have required non-profit acute care hospitals to pay a Community Service Contribution equal to $2.50 a day for each licensed hospital bed at the exempt acute care facility.  In addition, satellite emergency care facilities of acute care hospitals would have been required to contribute $250 a day for each such facility.  These mandatory contributions were to have been made in equal quarterly installments and, as in the case of tax payments, payable on February 1, May 1, August 1 and November 1 of each year. These new obligations were to also have been treated the same as other local tax obligations from an enforcement perspective (i.e., the same penalties for late payments and exposure to municipal lien foreclosure actions would apply in the event defaults).

The proposed legislation also dictated that 5% of these contribution payments were to be paid to the County. Such fund sharing would not otherwise have been required in the traditional payments made in lieu of taxes (so-called “PILOT” payment) setting. As a result, the failed bill also afforded county officials some measure of comfort and pre-empted any claims that counties were being unfairly ignored.

This failed legislation further afforded the subject hospitals and satellite emergency care facilities an opportunity to seek relief from these Community Service Contributions obligations where the facility was able to demonstrate that it: 1) had a negative operating margin in the prior tax year; 2) was not in full compliance with the financial terms of any bond covenants, 3) was in financial distress, or 4) was at risk of being in financial distress.

The present impasse however occasioned by the pocket veto continues an environment of uncertainty that will undoubtedly foster a spike in tax court actions to determine the scope and applicability of the hospital tax exemption. Consequently, the question that remains is not if, but when, some refashioning of this proposed legislation will find its way back to the desk of the Governor for adoption.