The State of Minnesota has recently pushed the IRS regulations used to define what is really alimony/maintenance and what is child support. This is important as alimony/maintenance is deductible by the payer and child support is not deductible. Admittedly, alimony/maintenance is included in the recipient’s income, but quite often, the recipient’s tax rate is lower and thus generates less tax for the state. The issue may also come up because the parties to the divorce do not agree to the proper tax treatment and take opposite positions, thereby putting the state into a “whipsaw” position.

Temp. Treas. Reg. 1.71-1T establishes a presumption that if payments otherwise designated as alimony/maintenance are reduced upon the happening of a contingency related to a child, the payments are child support, not deductible alimony/maintenance. This presumption can be overcome by showing that the reduction in the alimony payment, even though occurring at times close to an event like a child’s attainment of a certain age, is in fact, related to another event.

“The presumption in the two situations described above that payments are to be reduced at a time clearly associated with the happening of a contingency relating to a child of the payor may be rebutted (either by the Service or by taxpayers) by showing that the time at which the payments are to be reduced was determined independently of any contingencies relating to the children of the payor.” Temp Reg. 1.71-1T, Answer18

The state may be pushing these regulations beyond a reasonable interpretation. In a recent case, a family court judge made a very clear and detailed calculation that a reduction in alimony/maintenance was the result of a spouse improving her ability to earn income, and stated that the reduction had nothing to do with the children attaining the age of emancipation. Still, in an audit, the state concluded that because the reduction occurred within one year of the emancipation of the children, the amount of the reduction was child support and not deductible alimony/maintenance.

If you are a party to, or an attorney representing a client in, a divorce action, and alimony/ maintenance and child support are involved, make sure your agreement and the court order very clearly provide the basis for any reduction in alimony/maintenance. You may also include an agreement between the parties as to the tax treatment of the payments and consequences if the IRS or the state do not recognize the negotiated tax treatment. The IRS and state are not required to follow the tax treatment agreed to in the family court action.

In the State of Minnesota, many gamblers are interested in taking the extra steps to be treated as professional gamblers. In contrast to the treatment the gambler receives from the IRS, a non- professional gambler in Minnesota is subject to the Alternative Minimum Tax and, as a result, is not allowed his or her gambling losses as an offset to gambling winnings. The same is not true for the professional gambler. The State of Minnesota will allow a professional gambler to deduct their gambling losses from gambling winnings and therefore pay less in taxes.

The key is whether the state believes the gambler is engaged in a trade or business. A taxpayer is engaged in a trade or business if he or she is involved in an activity with continuity and regularity and the primary purpose of that activity is to generate income and profit. A sporadic activity, a hobby, or an amusement diversion does not qualify. Groetzinger v. United States, 480 U.S. 23 (1987). The issue of whether a particular taxpayer is engaged in a trade or business can only be resolved after an examination of the facts in each case.

The United States Supreme Court in Groetzinger v. Commissioner determined that a taxpayer’s gambling activity constituted a trade or business under the federal tax code, even if the gambler/taxpayer does not make a profit.

The main factors considered by the Supreme Court in Groetzinger were the regularity of the taxpayer’s gambling, the effort he exerted, the skill that he applied, and his intent to produce a livelihood via gambling.

The IRS set forth a number of nonexclusive factors to be considered when determining whether a taxpayer’s activity constitutes a trade or business for tax purposes. See Treas. Reg. § 1.183-2(b). These factors include:

1. the manner in which the taxpayer carries on the activity (e.g., keeping records in a businesslike way);
2. the expertise of the taxpayer or his advisors;
3. the time and effort expended by the taxpayer in carrying on the activity;
4. the expectation that assets used in the activity may appreciate in value;
5. the success of the taxpayer in carrying on other similar or dissimilar activities;
6. the taxpayer’s history of income or losses with respect to the activity;
7. the amount of occasional profits, if any, which are earned;
8. the financial status of the taxpayer; and
9. elements of personal pleasure or recreation.

For more information about applying these factors, please review our other posts, past and future, under the Profit Motive category.

What does it mean when the IRS says it plans to take enforced collection action? Usually, it means that the IRS intends to issue a levy to a bank or employer. Those are usually the first two targets of a levy because they are easy and they get the taxpayer’s attention. My experience is that most of the IRS personnel do not like issuing levies, they would rather make an arrangement with the taxpayer to pay the tax voluntarily. However, when a taxpayer does not respond to initial requests for payment, the IRS will issue a bank or wage levy.

A levy is a method the IRS may use to collect taxes that are not paid voluntarily. It can, by legal authority, take and sell property to satisfy a tax debt. Levies can be exercised against property the taxpayer holds, like a car, boat, or house, or on the taxpayer’s property that is held by third parties, like wages or funds on deposit at a bank. Even payments from the federal government like retirement payments from the Office of Personnel Management, federal vendor payments, social security benefits or federal employee travel advances or reimbursements, may be subject to the levy.

Fortunately, before the IRS can levy property, it must notify the taxpayer and give the taxpayer the following:

1. Notice and Demand;
2. Notice of Intent to Levy; and
3. Notice of a right to a Collection Due Process (CDP) hearing.

The IRS must also provide the taxpayer proper notice that it intends to contact third parties. A notice of levy is issued to a third party, and therefore, is considered third party contact. Unless an exception applies, IRC 7602(c) states that the IRS must give the taxpayer reasonable notice that it plans to contact third parties to collect the delinquent tax. See IRM 5.1.17, Third Party Contacts, prior to issuing a levy.

The taxpayer should contact an attorney as soon as he or she receives a notice from the IRS, especially one of the notices mentioned above.

On July 25, 2011, the IRS issued Notice 2011-70, stating that it will no longer deny a Request for Innocent Spouse Relief pursuant to Section 6015(f), “Equitable Relief,” on the basis that the claim was not submitted within two years of the date of the IRS’s first collection activity.

The prior rule was stated in Treasury Regulations Section 1.6015-(5). This rule required a taxpayer to submit his or her Form 8857, Request for Innocent Spouse Relief, within two years of the date of the IRS’s first “collection activity.” “Collection activity” most notably includes the issuing of a “Final Notice of Intent to Levy and Your Right to a Hearing,” a refund offset, and filing for bankruptcy protection. If the claim was not submitted within this two-year period, the IRS considered it time-barred.

Treasury Regulations Section 1.6015-(5) became the subject of significant controversy in 2009, when the United States Tax Court held that it was invalid. Lantz v. Comm’r, 132 T.C. 8 (2009). The Lantz decision was eventually overturned by the 7th Circuit Court of Appeals. Lantz v. Comm’r, 607 F. 3d 479 (7th Cir. 2010). Since Lantz, two other Circuit Courts, the 3rd and the 4th, have upheld the validity of Treasury Regulations Section 1.6015-(5). Mannella v. Comm’r, 631 F.3d 115 (3d Cir. 2011); and, Jones v. Comm’r, 642 F.3d 459 (4th Cir. 2011). In spite of these decisions, the IRS determined that the Treasury Regulations should be revised to allow individuals who request for Equitable Relief a longer period to submit their claims.

The new Equitable Relief rule requires the requesting spouse to file his or her claim within the statutory collection period, which is generally ten years from the date of the tax assessment, plus any extensions. To receive a refund of any prior payment made toward a tax liability, the requesting spouse must file his or her claim within three years of the date of the tax assessment or two years from the date of the payment, whichever date is later.

The IRS has also instituted the following transitional rules:

Previously Submitted Claims. Individuals who previously submitted an Equitable Relief claim, but were denied solely because of the two-year rule, can resubmit their claim and the IRS will consider it on the merits.

Pending Litigation Cases. The IRS will consider the merits of the case for all individuals who have pending litigation in which the two-year rule was previously in issue.

Previously Litigated Cases. If the taxpayer litigated his or her case, and received a denial from the United States Tax Court or Circuit Court of Appeals, solely because of the two-year rule, the IRS has stated that it will not pursue any enforced collection action against these individuals.

The two-year statute of limitations still applies for Requests for Innocent Spouse Relief pursuant to Section 6015(b), known as “Traditional Innocent Spouse Relief,” and Section 6015(c), known as “Separation of Liability Relief” or “Allocation of Deficiency Relief.” Both types of relief are only available to taxpayers who were assessed additional tax as a result of an audit. When it is possible, we recommend that you continue to advise your Innocent Spouse Relief candidates to file their claim within the two-year period to preserve their claim for all three types of relief.

In an earlier blog article we gave you a list of documents you should secure from the worker to demonstrate that he or she is an independent contractor. Unfortunately, sometimes the worker does not keep good records, is no longer working with you, or has changed his or her mind and now wants to be an employee, hoping to save some taxes. In these cases, the business needs to rely on its own records. These records should include:

1. Copies of all W-2s and 1099s issued by the company to all workers, both employees and independent contractors;
2. Job descriptions for everyone in the company;
3. Affidavits from all of the workers explaining their relationship with the company and how they operate their business;
4. Copies of the contracts between the business and the workers. If there is no written contract, then a written explanation from your client, as detailed as possible, about the relationship with the workers;
5. Written company policies on training and education. If no written policy exists, then a written summary of practice;
6. Written company policy on the workers’ right to reimbursement of expenses incurred by the workers. If no written policy exists, then a written summary of the practice;
7. If the worker must be identified to the public, for example a television/internet cable repair technician, an explanation about the need for identification;
8. Written company policy on how each worker is evaluated. If no written policy exists, then a written summary of practice;
9. Explanation of how a worker can make a profit or lose money. Specific instances of each can be very helpful. Demonstrate that two workers in the same position can have very different incomes depending on their method of operating and their investment in the business;
10. The company’s financial records regarding payments to workers;
11. Records of workers’ investments in their businesses;
12. Documents showing how worker was first introduced to the company, like advertisements, solicitations, business cards, letterhead, etc.;
13. Records of employee benefits provided or available to the worker.

If the business is going to rely on Safe Harbor relief under Section 530, which we presented in an earlier blog article, it will need copies of the following, if relevant:

1. Documentation of the classification and job descriptions for all workers, both employees and independent contractors, for the audit years and all prior years;
2. Copies of all Forms W-2 and 1099 for all workers, both employees and independent contractors;
3. Copies of any judicial precedent or published ruling supporting company’s treatment of worker as an independent contractor;
4. Copies of any technical ruling or other determination issued with respect to the business indicating the worker should not be treated as an employee;
5. Copies of letter rulings indicating that the worker should not be treated as an employee;
6. Copies of a prior IRS examination where worker or like situated workers were involved in the business and employment taxes were not an issue;
7. Evidence of a long-standing practice of a significant segment of the industry treating like workers as not employees;
8. Evidence of other reasonable basis the company did not treat workers as employees.