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IRS is Trolling in California for Gift Taxes

Jan.1,2012

Introduction

California’s Proposition 13 limits property tax increases for transfers from parents to their children or grandchildren (family transfers). IRS has obtained sweeping authority to acquire state computer records of family transfers from 2005 to 2010 to uncover unreported gift tax transactions.

IRS admits this is a fishing expedition, but considers the waters well-stocked with California taxpayers avoiding federal gift taxes.

Note: there are 15 other states that have supplied IRS with similar information, including New York, New Jersey, Pennsylvania, Texas and Washington.

Summons

Recently, a federal court in Sacramento, California granted IRS permission to subpoena family transfer information from 2005 through 2010, under a process known as a “John Doe” summons, which allows IRS to describe a class of potential taxpayers who may violating tax laws, rather than naming a specific individual.

Who’s at Risk?Those involved with family transfers between 2005 and 2010 who never filed gift tax returns should be concerned about receiving a visit from the tax man.

Although the gift-tax exemption is currently $5.0 million per person, it was limited to $1.0 million during the time period in question; consequently, those making family transfers in excess of $1.0 million could be facing federal gift taxes of between 35% to 47%, plus penalties.

Note: Many transactions are not considered gifts, notably transfers to revocable living trusts, limited liability companies, partnerships or corporations.

Joint TenancyTaxpayers may be shocked to learn that creating a joint tenancy could be a taxable gift, because a joint tenant generally has the right to “sever” the joint tenancy and own his or her share outright.

For example, assume father owns a rental unit worth $1.0 million and adds his daughter as a joint tenant. Father just caused a gift of $500,000 (ignoring fractional interest discounts), because daughter may sever the joint tenancy and own her 50% share as a tenant in common.

Note: Transfers between spouses are not taxable gifts; however, federal tax law does not recognize registered domestic partners as spouses.

Tenant AgreementsTo protect against a gift-tax issue when creating a joint tenancy, the parties should have a written agreement stating that:

(i) neither party has the right to sever the joint tenancy without the consent of the other;

(ii) the joint tenancy is for estate transfer purposes only; and

(iii) the original owner will continue as the sole owner until he or she dies or the parties agree to sever the joint tenancy.

ConclusionCalifornians who made family transfers between 2005 to 2010 could have federal gift-tax liabilities; if so, they should report the transactions and pay the taxes owed.

Those creating joint tenancies should strongly consider a written agreement to avoid gift-tax consequences.

IRS Settlement Program – Independent Contractors vs. Employees

Dec.1,2011

Introduction

Employers who determine that they are misclassifying workers as independent contractors should take advantage of a new IRS Voluntary Classification Settlement Program (the “VCSP”).

The Basics

In essence, VCSP prospectively treats workers as employees instead of independent contractors at a cost of approximately 1% of the compensation paid to the workers reclassified during the most recent tax year.

Example: Company paid $100,000 to four independent contractors during tax year 2011. If the Company applies for VCSP, it pays a penalty of about $1,000 and agrees to classify the workers as employees from tax year 2012 forward.

Eligibility

To participate in VCSP, the company:

must have consistently treated the workers as nonemployees;
must agree to treat all workers in the same class as employees;
must have filed all required Forms 1099 for the workers for the previous three years;
cannot currently be under audit by the IRS; and
cannot be currently under audit concerning the classification of the workers by the Department of Labor or by a state government agency.

Evidently, there is no deadline for participation.

Conclusion

Companies with questionable worker classifications should strongly consider VCSP as a cost-effective way to avoid potentially huge taxes and penalties.

Independent Contractor vs. Employee: The Basics (Part 3 of 3)

Nov.1,2011

Key Steps

A company hiring an independent contractor should make sure that at a minimum:

The company has a W-9 Form (Request for a Taxpayer Identification Number) on file.
The company reports payments of more than $400 on Form 1099 and timely files the form with IRS.
The company and the worker enter into a written agreement that expressly states the independent contractor relationship, that the worker will be responsible for all taxes on payments made by the company, that the worker will have all business and professional licenses needed to conduct his or her business, and that the contract cannot be terminated at will (there should be at least a 15-day notice of cancellation clause).
When possible, the work should be performed at the worker’s premises and the worker should own his or her own tools.
The worker should have the right to subcontract all or a part of the job to another individual.
The worker invoices the company on the worker’s stationery and, if possible, bill a project basis, rather than for hours worked, and is paid accordingly.
No employee perks or fringe benefits should be paid to the worker.
The worker performs services for at least one other company, preferably two or more companies and that the total time spent working with your company does not exceed 70% (this is a ballpark figure).

Remember, a full-time worker will be considered an employee, regardless of the paperwork and separate business status. The worker should hold himself or herself out to the public as an independent business and should have a website and other indicia of a business looking for work.

Conclusion

With the worker’s blessing and the proper documentation, a company can confidently hire workers as independent contractors.

Attention to detail is critical: Be sure to have the proper documentation and contractors, send Form 1099 when required, and make sure the contractor has all businesses and professional licenses needed to operate the business.