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What is America's DNA?

A Comprehensive Analysis of America's Founding Principals
by Daniel J. Pilla

Increasingly, secularists are winning the debate, and as they do, Christian principles are being driven from our culture. It started as a very slow movement but now Christianity has been scrubbed from our schools, our public councils and agencies, and from government in general. Organizations like the Freedom From Religion Foundation and the ACLU regularly bring lawsuits against local government agencies and school boards seeking to wash all vestiges of Christianity from public view.


The courts at all levels are only too happy to oblige them, claiming that the “separation of church and state” requires that all Christian ideas, beliefs and practices be expunged from the public square. Statutes and plaques depicting the Ten Commandments are removed from public parks and courthouses. Prayer is forbidden in the classrooms of public schools and on playgrounds. Nativity scenes are evicted from public grounds. We’ve even reached the point where we can’t refer to Christmas as “Christmas,” but must call it “the Winter Holiday.”


We are told this is so because secular people founded America as a secular nation. But is this true? To answer the question, let’s closely examine America’s “organic” founding legal documents. These documents reveal who we really are. They reveal America’s DNA.


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Published 10 times a year, Dan’s electronic newsletter is simply the best in the nation at providing tax reduction help, Solving Tax Problems and IRS strategies. In addition, it will give you insight and the latest news on how Congress is trying to get more of your money and what you can do to protect yourself.



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20 Tips, Techniques and Strategies for Handling Your Tax Court Case

by Daniel J. Pilla


After helping countless hundreds of people with cases before the United States Tax Court, I know that you can be successful with your case only by paying attention to the details. The Tax Court's Rules of Practice and Procedure establish the format that must be followed at all stages of a Tax Court case. Although the rules are not particularly complicated, they sometimes pose problems or questions which, if not handled properly, can lead to serious consequences.

In an effort to help you win your Tax Court case, I have compiled a list of 20 "Trouble Spots" you need to be aware of as you work your case through the Court. These Trouble Spots are the areas where other citizens had problems with their Tax Court cases. Recognizing these potential problems and handling of them properly on the front end can mean the difference between winning and losing your case.

As you read my Tax Court Trouble-Shooting Guide, refer to your copy of the Tax Court Rules of Practice. Where I point to a specific rule, you should read it entirely. And if you haven't done so already, you must read the rules cover to cover. You can make notes as to how the Trouble Spot may be avoided in your own case. This exercise will help ensure that you've followed all the critical rules I discuss here and thus avoid hidden traps that could ruin your case.

If you don't have a copy of the Tax Court's rules, they are easy to obtain. The Rules may be purchased in loose-leaf form from the Clerk's Office by writing to the United States Tax Court, 400 Second Street, N.W., Washington, D.C. 20217. Enclose a check or money order for $20 payable to the Clerk, United States Tax Court. The Court warns you to not send cash. Another way to obtain the rules is to download them directly from the Court's web site. Just go to and click on the "Rules" tab on the home page. You'll be able to download the rules in pdf format.

TROUBLE SPOT 1 – A Timely Filed Petition

You commence a Tax Court case by "filing a petition with the Court." Rule 20, Tax Court Rules. (Note that all references to the "rules" in this discussion are to the Tax Court's Rules of Practice and Procedure, unless otherwise indicated.) But it's not just that simple. The petition has to be filed on time in order for the Court to have jurisdiction of the case. The Tax Court is a court of limited jurisdiction. That means only certain cases can be presented to the Court under certain circumstances. If the Court does not have specific jurisdiction over a case, it will not hear the case. Naturally, a court known as the Tax Court is set up to hear tax cases. And the U.S. Tax Court is designed to hear cases growing from disputes between the IRS and citizens over the amount of their tax liabilities.

There is a broad range of different types of cases the Tax Court has the authority to consider but there are four common cases that a typical citizen or small business might encounter. The time for filing a petition with the Court is controlled by the Internal Revenue Code in each case. Each type of case carries a separate deadline for filing the petition. I explain generally each of the four cases and their petition-filing deadlines below:

a. The deficiency case. When the IRS completes an audit of a tax return and no agreement is reached as to the liabilities, the IRS mails a Notice of Deficiency to the taxpayer. This is the agency's final administrative determination that you owe additional taxes. The IRS must issue a Notice of Deficiency before it can assess and collect any of the taxes the agency claims you owe. If you begin a deficiency action in Tax Court within the time allowed by law, the IRS cannot assess or collect anything until the decision of the Court is final, and then the IRS can collect only the amount the Court says you owe. Code §6213(a) provides that you must file a petition with the Court within 90 days of the date the IRS mails the Notice of Deficiency. For more on the Notice of Deficiency and audit appeals, see my book, Taxpayers' Defense Manual.

b. The Collection Due Process appeal. Before the IRS can legally levy or seize any property to collect an assessed liability, it must first issue Letter 1058 (or in the case of filing a Notice of Federal Tax Lien, Letter 3172). Letter 1058 is a Final Notice of Intent to Levy and Notice of Your Right to a Hearing. See: Code §§6320 and 6330. The filing of a request for a Collection Due Process Hearing stops all collection action and gives you the opportunity to negotiate with the IRS for payment terms or to present other collection alternatives that might ameliorate the hardships of enforced collection. If you cannot come to terms with the IRS on a collection alternative, the IRS issues a Notice of Determination. You have the right to seek Tax Court review of the IRS's determination. Code §6330(d)(1) provides that you must file a petition with the Court within 30 days of the date the IRS mails the Notice of Redetermination. For more details on the Collection Due Process appeal and how to present such an appeal, see my book How to Get Tax Amnesy.                   

c. The Innocent Spouse appeal. When a joint federal income tax return is filed by a married couple, the law creates "joint and several" liability for entire tax. That is to say, each person owes the entire tax, even if one person had substantially less income than the other (or even none at all). But under several circumstances, a party can be relieved of a joint liability when it is shown that the party is not responsible as outlined in the law. This is known as Innocent Spouse relief and it is controlled by Code §6015. If you present an Innocent Spouse claim to the IRS that is rejected, the IRS must issue a Final Determination setting forth its reasons for rejection. Code §6015(e)(1) provides that you must file a petition with the Court within 90 days of the date the IRS mails the Final Determination. For more details on the Innocent Spouse appeal and how to present such an appeal, see my book, Taxpayers' Defense Manual.

d. The Employment Status appeal. In the course of many business audits, the IRS examines the business's use of independent contractors. If the IRS determines that the company should have treated independent contractors as employees, the IRS issues an Employment Status determination in which it effectively converts the workers to employees and proposes the assessment of all corresponding employment tax liabilities and penalties. Code §7436 gives the Tax Court jurisdiction to review the determination. Code §7436(b)(2) provides that you must file a petition with the Court within 90 days of receiving the IRS's Notice of Determination regarding Employment Status. For more discussion on the issue of independent contractors and employees, see my book, The IRS Problem Solver.

Please understand that each separate filing deadline is fixed by law. I cite the code section in each case that establishes the deadline. Since Congress sets these deadlines not the Tax Court, the Court has no authority to alter, modify, extend or suspend the deadline. Likewise, the IRS has no such authority, despite what certain IRS agents might say to you. This means simply that unless you get your petition filed with the Court by the legal deadline, the Court will not hear your case. The filing deadline is "jurisdictional." If your petition is filed late, the Court lacks jurisdiction to hear your case and you will lose by "default."

The bottom line is that the substantial risks associated with the failure to report offshore income coupled with the increasing likelihood that the IRS will obtain information about offshore financial account holders makes it hardly worth it to not just pay the tax and be done with it. It also bears stating again that if you have or know someone who has an undeclared offshore account, you need to get counsel about what to do to get into compliance regarding the account. Failure to do so is, in a very real way, playing with fire.

TROUBLE SPOT 2 – A Tax Court Petition

In each case, there are two crucial elements of a properly drafted petition. They are: a) a statement of errors that you believe the IRS made in deciding the case against you, and b) a statement of the facts that support your version of the case. In order for the Court to rule favorably, you must state exactly what the IRS did wrong, either in computing your tax or making the decision on the issues at stake in your case. You must then state the correct facts to allow the Court to see your point.

The Tax Court's rules provide additional guidelines for each of the four types of cases I identified above. Review the rules carefully to be sure your petition raises all the required allegations. A petition in a deficiency action is covered by Rule 34(b). Rule 331 covers Collection Due Process actions. Rule 321 covers Innocent Spouse cases. And Rule 291 covers Employment Status determinations.

If you already filed your petition, review it carefully to be sure it conforms to the Rules. If it does not, amend it in accordance with Rule 41. If you did not yet file your petition, read the applicable rule carefully before drafting your document to be sure you cover all the bases.

TROUBLE SPOT 3 – The IRS's Answer to Your Petition

Filing the petition starts the Tax Court case. The clerk of court is responsible to serve a copy of your petition on the IRS's attorneys. The next step is for the IRS to answer the Petition. The IRS must file its answer within 60 days of receiving your petition.

The rules require the answer to contain "a specific admission or denial of each material allegation in the petition." Rule 36(b). To accomplish this, the IRS will expressly state that it either admits or denies the particular claims set forth in your petition on a paragraph-by-paragraph basis. The act of admitting a claim means the IRS concedes the issue for purposes of the entire case. The act of denying a claim means that the allegation is contested and the IRS expects you to prove the claim. Generally, the IRS simply denies all the allegations of the petition (other than non-critical items such as your name and address), thus keeping the burden of proof on you as to your key claims.

The answer often causes confusion for people with no court experience. Because the answer is loaded with statements claiming the IRS "denies the allegation" of paragraph x of the petition, this is often taken to mean that the claim is "not allowed." But you have to keep in mind that once your petition is filed, the final decision whether to allow or not a specific claim is outside the IRS's hands. Certainly the issues can be negotiated and usually are, but the Court alone has the final authority to allow or not all or part of your claims. The answer is merely the IRS's stated position that your claims should not be allowed. Think of the answer as the beginning of the negotiation process, not the end of it.

TROUBLE SPOT 4 – Affirmative Allegations

The vast majority of the answers the IRS files put forth mere admissions and denials of the allegations of the petition. In those cases, nothing has to be done to deal with the answer. As stated above, this starts the negotiation process which, in the majority of cases, leads to a settlement without the need of a trial.

But in some rare cases, the IRS includes in its answer "affirmative allegations." Affirmative allegations are specific charges by the IRS beyond mere admissions and denials. For example, suppose the IRS believes that you had additional income that was not reported on your tax return. However, the IRS's auditor did not include the alleged income in its Notice of Deficiency. The IRS's attorneys can bring up that matter by presenting affirmative allegations of the alleged unreported income in the answer.

You will know for sure whether your answer contains affirmative allegations by the way it's set up. The section of the answer that presents mere admissions and denials follows paragraph by paragraph the outline of your petition. Once that is complete, the IRS will begin a new paragraph with the words, "In further answering the petition, the Respondent [IRS] alleges as follows..." The answer then goes on in narrative fashion to set out the facts the IRS claims justify its position.

Affirmative allegations are very rare. The key reason is that while the burden of proof is on you as to any allegation in your petition, the Court's rules expressly place the burden of proof on the IRS as to any affirmative allegations. Rule 142(a) and (b). In case of civil fraud, where the IRS asserts the 75 percent penalty under code §6663, the burden of proof is on the IRS and "that burden of proof is to be carried by clear and convincing evidence." Rule 142(b).

TROUBLE SPOT 5 – Filing a Reply

If the IRS presents affirmative allegations in its answer, you must file a reply. Rule 37. You have 45 days from the date of service of the answer in which to file your reply. A reply is the pleading used to respond to the affirmative allegations in the answer. Your reply must "contain a specific admission or denial" of each affirmative allegation. Rule 37(b). Thus, your reply will be much like the IRS's answer. Keep in mind that any allegation you admit is considered resolved in favor of the IRS, whereas a denial keeps the burden of proof on the IRS.

In some cases, the IRS's affirmative allegations are either vague or not sufficiently detailed to give you a full picture of the case they are attempting to make. This can hinder your ability to file a proper reply under Rule 37. If this happens, a motion for a More Definite Statement under Rule 51 can compel IRS counsel to be more specific with their allegations. Under Rule 37, you have 30 days from service of the answer in which to file that motion. This maneuver enables you to meet your responsibility under Rule 37. The Court will order the IRS to file a more definite statement if the affirmative allegations are "so vague or ambiguous that a party cannot reasonably be required to frame a responsive pleading..." Rule 51(a).

TROUBLE SPOT 6 –The Place of Trial and Hearings

The Tax Court is based in Washington, D.C. However, it hears cases in cities throughout the nation. Therefore when filing a case with the Tax Court, you should also specify the city in which you want your case heard. Otherwise, the place of trial will be Washington, D.C. You should file your Request for Place of Trial along with your petition. Rule 140(a) and Tax Court Form 5. If you have not done so and the Court has set the trial for Washington, you can file a Motion for Change of Venue, asking the Court to relocate the case to a Tax Court city nearest you.

When filing any motion with the Court, always file with it a request to have the motion heard in the Tax Court city nearest you. Normally, hearings on all motions are held in Washington, D.C. but just as in the case of trials, the Court can change the place of a hearing when "the convenience of the parties" will best be served. If you wish to speak out on your motion but can't travel to Washington, file a request to change the place of the hearing. See Rule 50(b)(2). It is also now quite common for hearings on such motions to be held by conference call. In that case, it's unnecessary to travel anywhere to argue for your motion.

TROUBLE SPOT 7 – Serving Papers on the IRS

 Copies of all pleadings, motions, briefs, notices or other documents you might prepare in the course of your action must be served on "counsel of record" for the IRS. Counsel of record is always an attorney in the Office of Area Counsel in the Tax Court city you selected for trial. Failure to serve counsel of record may result in the Court refusing to take action on your document. Proof of service must be filed with the clerk, indicating that proper service was carried out. See Rule 21(a) and (b).

The Tax Court's electronic filing procedures make this process very easy. Even if you are not an attorney admitted to practice before the Tax Court, as a litigant before the Court, you may (but are not required to) sign up for e-filing. To get set up with e-filing, go to and click on the "eAccess" tab. Then click on the "Petitioner Access" link. You will be guided through the steps to get approved for e-filing.

If you an attorney just starting a Tax Court practice, e-filing is mandatory in most cases. Rule 26(b). In that case, click on the "Practitioner Access" tab to get signed up. You also need to be familiar with the Court's "e-filing Instructions for Practitioners," also available on the Court's web site, under the "eAccess" tab.

Once you're set up for e-filing, life gets easier because you no longer have to mail your documents to the Court or to the IRS's attorneys. After your documents are e-filed, the Court's computer system notifies the other party. That party then logs in to his own e-file account to get them.

TROUBLE SPOT 8 – Obtaining Evidence from the IRS and Others

In any Tax Court case, each party is entitled to the evidence that the other party possesses and intends to use in the trial. Parties are also entitled to obtain evidence from third parties that might be helpful. "Discovery" is the process by which the parties obtain evidence. The Court's discovery rules provide three separate tools for obtaining evidence. They are:

 a. Interrogatories (Rule 71). Interrogatories are written questions you ask the IRS's attorney. These questions must be answered completely and under oath. The answers to the questions can help bolster your case and better understand the IRS's case.

b. Production of Documents and Things (Rule 72). This is the process used to obtain specific documents, such as examination work papers, witness statements, bank records, etc.

c. Depositions (Rules 74, 80 and 81). A deposition is the process of taking a statement from a live witness through direct questioning. It's much like having a witness on the stand in court, but there's no judge present in a deposition.

Before using any of these techniques, the parties are required to "attempt to attain the objectives of discovery through informal consultation or communication" with each other. Rule 70(a)(1). This rule is strictly enforced. See: Brannerton v. Commissioner, 61 T.C. 691 (1974). Thus, you cannot simply fire off your Interrogatories or Request for Documents and expect the IRS to cough up the information you seek. Rather, you must first send a so-called Brannerton letter.

This is nothing more than a written request in the form of a letter that asks for the same information you might seek through, for example, a Request for Production of Documents. So rather than using Rule 72 to ask for a tax examiner's work papers and the bank statements used to calculate your income, you would first send a Brannerton letter to the IRS's attorney asking for those same items. Only if the attorney fails or refuses to produce the information would you resort to the formal discovery tools.

You must also expect the IRS's attorney to use Brannerton and the discovery rules to obtain information from you. For example, IRS attorneys regularly send Bannerton letters seeking copies of all the documents you intend to use to prove any deductions that were disallowed in your audit.

TROUBLE SPOT 9 – Oppressive Discovery       

At times, the IRS's discovery demands may become oppressive, vexatious, harassing or for other reasons, completely unwarranted and improper. This can happen in Employment Status cases where the IRS might demand volumes of information about how workers not relevant to the current proceeding were treated. In any case where the IRS's discovery becomes oppressive, you may apply to the Court for a Protective Order under Rule 103.

A protective order prevents the IRS from pursuing improper discovery practices. Such an order applies in cases where the Court's protection is needed to prevent "annoyance, embarrassment, oppression, or undue burden or expense." Rule 103(a) lists ten ways the Court can protect a person from such conduct. Any inappropriate conduct can be the subject of a Protective Order and the protections are not limited by the examples given in Rule 103. See Rule 103(a).

TROUBLE SPOT 10 – Working with the Office of Appeals

After the IRS files its answer (and if necessary, after your reply is filed), the case is generally sent to the Appeals Office for attempted settlement. Appeals Office consideration is a certainty in: a) deficiency actions, b) Innocent Spouse cases, and c) Employment Status cases if the Appeals Office did not issue the Notice of Deficiency or Notice of Determination and the Appeals Office was not otherwise involved with the determination. Appeals has full settlement authority in these cases. As such, Appeals takes a fresh look at the case, evaluates everything the IRS did, reviews your evidence and arguments and negotiates to resolve the case without a trial.

The Appeals Office generally works in good faith to resolve cases. Most Appeals Officers are well trained in the law and understand how the Tax Court process works. They have an interest in getting the cases resolved without a trial because the IRS's workload alone prevents them from taking every case to trial. They want to settle and the Appeals Office is usually the place to do it. That's why the vast majority of Tax Court cases are settled amicably without a trial.

On the other hand, Collection Due Process cases do not go back to Appeals for settlement negotiations. The chief reason is the fact that the Appeals Office issued the Notice of Determination to begin with. They will stand by their determination unless the Court finds that the determination is lacking authority in law or disregards the facts of the case. This means that you will not work directly with the Appeals Office in CDP cases in the first instance. Rather, you will work with IRS counsel in your effort to reach a settlement. For more on CDP appeals and how they are handled, see my book How to Get Tax Amnesty.

TROUBLE SPOT 11 – Stipulations

Prior to the trial, the parties are required to meet to discuss the facts. The Brannerton rule is designed to facilitate this process. The purpose of the meeting is to stipulate—that is, agree—to as many of the contested facts as possible. This is an important rule in tax litigation and is the one unique aspect of Tax Court cases compared to other federal court cases. For example, the Federal Rules of Civil Procedure that govern civil suits in federal district court do not require the parties to stipulate to as many of issues as possible. Rule 91 is important because it substantially cuts the time and expense of a trial.

Rule 91 requires the facts to be stipulated to the "fullest extent to which complete or qualified agreement can or fairly should be reached..." The stipulation process has the effect of narrowing the issues the Court must ultimately decide. It also makes the process much easier on a person representing himself. For example, once all of your documents are disclosed, either through your Appeals conferences or to IRS counsel, counsel can be expected to stipulate that the documents are what they purport to be. That is, that they are in fact your records of income or expenses covering the issues in question. The act of stipulating means you don't have to painstaking describe each document and establish its authenticity for purposes of having the documents admitted into evidence.

IRS counsel will generally instigate a stipulations conference by writing a letter asking you to meet for that purpose or by sending you a draft stipulation. You are by no means required to stipulate to whatever the IRS requests and you can request that specific facts helpful to your case be included in the stipulation. The process is a negotiation with the goal being to stipulate as fully as possible, thus narrowing the unresolved issues. This process is the reason that most Tax Court trials take only a few hours to complete, rather than the days or weeks often required in other courts. Refusal to work with IRS counsel in the stipulations process may result in your case being dismissed by the Court. See Rule 91.

If the IRS is unwilling to stipulate to certain facts that should not reasonably be in dispute, one way to force the issue is through the use of Requests for Admissions under Rule 90. This is the process of requiring the IRS to expressly admit or deny the truth of a specific statement. When the truth of a specific statement is admitted, that fact is considered resolved for purposes of the case. This can sometimes push the IRS into stipulating facts that should not reasonably be disputed.

TROUBLE SPOT 12 – A Motion for Summary Judgment

In cases where the IRS believes that all the material facts of the case are not in dispute and that the agency is entitled to judgment as a matter of law, the IRS can be expected to file a Motion for Summary Judgment. In doing so, IRS asserts that here is no need for a trial. Because the agency claims that all facts are agreed and thus no longer in dispute, it asks the Court to simply pass judgment on the legal issues involved. Summary judgment disposes of the case without a trial. Often, this is not a good thing.

If you want a trial but are presented with a motion for summary judgment, you must demonstrate to the Court that there are material questions of fact that have yet to be resolved. You do this by filing affidavits, which set forth the facts in detail. When you demonstrate to the Court that material facts have yet to be resolved, the Court should provide a trial where you can present evidence on your version of those facts. Unless you file the affidavit in the manner prescribed by the rules, the Court will decide your case without a trial. See Rule 121.

Deficiency actions generally do not involve summary judgment motions because such cases are dependent upon your records and testimony for resolution. However, Collection Due Process and Employment Taxes cases are routinely handled through the summary judgment process. If your case involves these issues, be prepared to deal with the IRS's Motion for Summary Judgment.

TROUBLE SPOT 13 – Deciding the Case Without a Trial

As I stated, the vast majority of cases, especially deficiency actions, are decided without the need for a trial. When both parties agree that all the issues are resolved and the parties are willing to settle the case, the process is accomplished by signing stipulated (agreed) Decision Documents. In a deficiency action, the Decision Documents set forth exactly what the agreed upon liabilities are for each year in question. The documents also agree that the tax can be assessed and collected.

Both you and the IRS's attorney sign the documents, which are then filed with the Court. Once the Court signs, it becomes the final decision of the Court that binds the parties. Before signing any Decision Documents, be sure they accurately reflect the agreement you had with the IRS. If they do not, contact the IRS attorney or Appeals Officer to get the discrepancy resolved before moving forward.

TROUBLE SPOT 14 – Subpoenaing Witnesses

If your case goes to trial, you have the right to have witnesses present who can testify to relevant and material facts. If important witnesses are unwilling to step forward, they may be subpoenaed. By serving a subpoena on a witness, that witness is under obligation to attend the trial and provide testimony.

Blank subpoena forms are available from the clerk and can be served by any authorized process server. The subpoena may also command the production of the documents or other tangible objects relevant to the case. See Rule 147. You must also pay the witness the required witness fees and travel expenses at time of serving your subpoena. Rule 148.

TROUBLE SPOT 15 – The Pre-trial Memorandum

At the time the Clerk of Court issues the Notice of Trial, the clerk also provides you with a copy of the Court's Standing Pre-trial Order. This is a supplement to the Tax Court's formal rules. It consists of the Tax Court judges' statement as to how the trial will proceed. The Order requires the filing of a Pre-trial Memorandum by each party no later than two weeks before the trial.

The Pre-trial Memo requires a statement on the status of each of the following items:

a. The name and address of the attorneys involved. If you are not represented by counsel, list your own name and address;
b. The amount of tax in dispute;     
c. The status of the case, that is, whether the case is likely to settle or proceed to trial;
d. An estimated time of trial;
e. A description of the motions that you expect to make;
f. The status of the stipulation;
g. A brief statement of issues in the case;
h. The names of your expected witnesses. Note that if your witnesses are not identified at least two weeks prior to the trial, they will not likely be allowed to testify. Likewise, any documents not disclosed at least two weeks prior to trial will not likely be permitted by the Court;
i. A succinct summary of the facts;
j. A synopsis of legal authorities supporting your position; and
k. Whether there are any evidentiary problems with your documents. Such problems will usually be avoided if you disclosed all your documents well ahead of time and your stipulation includes all your documents.

TROUBLE SPOT 16 – The Burden of Proof

The one error commonly made in these cases is the failure to understand what must be proved in the trial. As the Petitioner, you must prove that the IRS made one or more errors in deciding your case at the administrative level. In a deficiency action, you must prove that the IRS miscalculated your taxable income either by incorrectly adding gross income or improperly disallowing legitimate deductions. In any other case, you must prove that the IRS made some error of fact or law in arriving at the decision.

In some cases, the burden of proof can shift to the IRS. Code §7491(a) provides that in deficiency cases, where the "taxpayer introduces credible evidence with respect to any factual issue," the IRS "shall have the burden of proof with respect to such issue." In light of this, the IRS cannot simply "play goalie" with respect to the evidence you present. That is, it cannot arbitrarily kick aside your facts and documents solely to avoid admitting the inevitable. Once you: a) substantiate the item in question with your records, and b) cooperate with the IRS by providing information and documents, access to relevant witnesses if necessary, participating in the necessary meetings and interviews, the burden of proof then shifts to the IRS to disprove your deduction. Code §7491(a)(2).

In many deficiency cases, especially those involving small business owners, the IRS adds "phantom income" to a person's tax return, thus increasing their tax liability. The phantom income is derived by the use of statistical tables, such as Bureau of Labor or Census Data. For example, take the hypothetical case of a plumber in Hennepin County, Minnesota, the state's largest city. Bureau of Labor tables may show that the typical plumber in Hennepin County earns $80,000 per year. But the plumber's records show he earned just $50,000. The IRS may use the tables to trump up his income to the averages.

This is very common and puts the taxpayer at the distinct disadvantage of having to prove a negative. However, the law does not force you to prove a negative. Code §7491(b) provide as follows:

In the case of an individual taxpayer, the Secretary shall have the burden of proof in any court proceeding with respect to any item of income which was reconstructed by the Secretary solely through the use of statistical information on unrelated taxpayers.

As your case proceeds, make double sure you understand your burden of proof and take all steps necessary to meet that burden. Ultimately, that is how you win a Tax Court case. See Rules142 and 149.

TROUBLE SPOT 17 – Post-trial Briefs

At the conclusion of the trial, the Court generally requires each party to file a brief with the Court. A brief is the party's written argument supporting his version of the facts along with a statement of the legal authorities. Think of your brief as a final argument to the Court. Failure to file a brief in the time and manner prescribed by the rules could easily result in the Court ruling against you. See Rule 151.

TROUBLE SPOT 18 – The Appeal

Decisions of the Tax Court in regular cases (as opposed to small tax cases) are appealable to the United States Court of Appeals for the Circuit in which you live. If you lose your regular tax case and the Court's decision was wrong, you may appeal. To commence the appeal, file a Notice of Appeal with the Clerk of Tax Court within 90 days of the date of the Court's decision. At that point, the Federal Rules of Appellate Procedure take over. See Rule 190, and Federal Rules of Appellate Procedure 13 and 14. 

TROUBLE SPOT 19 – Litigation Fees and Costs

If you are the prevailing party in your case against the IRS, you may be able to recover your litigation fees and costs. See Code §7430. This includes the fees you paid your attorney and the costs incurred to prosecute the case. Even if you didn't pay an attorney, you had costs such as copying and mailing costs and the Court's filing fee, among other things. The time and manner of requesting an award of fees and costs is covered by Tax Court Rules 230-233.

TROUBLE SPOT 20 – The Rules as a Whole

Pay careful attention to the Rules of Practice as a whole. At any time, the Court can dismiss a case where a party is in default due to having missed deadlines. The rules are replete with examples of time limitations for carrying out certain crucial functions. These deadlines cannot be ignored. Also, where a party has failed to properly prosecute his case, the case can be dismissed. These sanctions are very formidable. If used against you, it means that you lose your case. The most important thing to remember is don't miss your deadlines. See Rule 123(a) & (b), and Rule 104.


 My Trouble-Shooting Guide will help you over the rough spots on the road to tax justice. However, it is not exhaustive and is not a substitute for the Rules of Practice. Moreover, if you believe you are in over your head, this material is not a substitute for competent counsel experienced in the prosecution of Tax Court cases.

If you have any questions about your Tax Court case, I have materials available to guide you through the process. I can also provide personal consultation to help with your case and I can get you in touch with counsel who can represent you personally. Don't risk losing just because you misunderstood how to handle your case and didn't get the help you need.



“If I have set it down it is because that which is clearly known hath less terror than that which is but hinted at and guessed.”
Sir Arthur Conan Doyle    The Hound of the Baskervilles









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Taxpayers and IRS to be Challenged as Never Before

By Daniel J. Pilla

Executive Director, Tax Freedom Institute


Unless there is a substantial change in leadership in Washington in the next election, the Patient Protection and Affordable Care Act (PPACA) will go into effect as planned. The reason is the Supreme Court upheld the Act as constitutional in the case of National Federation of Independent Business v. Sebelius, Sup. Ct. Docket Nos. 11-393 and 11-400, June 28, 2012. Through its decision, the Supreme Court paved the way for the national health care program to roll ahead. 

The IRS is just one of several federal agencies responsible for implementing the legislation. Specifically, the IRS is responsible for the enforcement and administration of forty-seven of the Act’s tax-related provisions. This Special Report addresses the role that the IRS will play in enforcing and administering the PPACA. My focus here is solely on the question of how the IRS can be expected to play an ever-growing role in your life and in the day-to-day affairs of every business in the nation as the tentacles of the PPACA wrap themselves around the most important and personal elements of your private life. 

The IRS and Social Programs

 The Patient Protection and Affordable Care Act is the most sweeping social legislation ever enacted in the United States. Even the Social Security program, the federal government’s first major step into the area of social planning and the beginning of the federal “nanny state,” did not and still does not have the incredible reach of the PPACA.

The major difference between the two programs is that while the Social Security tax is certainly not voluntary, participation in the Social Security program is. No citizen faces any penalty for not applying for or drawing Social Security benefits. On the other hand, failure to purchase the required medical insurance for yourself and dependents under the PPACA carries substantial civil penalties.

This marks the first time in the history of the United States that the federal government has commanded citizens to purchase a product or service under penalty of law. The monetary penalty imposed for failure to buy insurance is described as a “shared responsibility payment.” Code section 5000A(b)(1). In upholding this element of the PPACA, the Supreme Court ruled that the “shared responsibility payment” is in fact a tax, which Congress has the full authority to impose under Article 1, Section 8 of the Constitution.

The net effect is that unless Congress repeals the PPACA soon, the force of this legislation will change the face of America in ways that we now can only imagine. My intent with this Special Report is not to re-litigate National Federation or second-guess the Supreme Court’s decision. My intention is to explore the one thing that social policy-makers never seem to address when passing legislation of this magnitude—and that is the impact that it has on private citizens and businesses, apart from the simple economics of the penalty.

In the case of the PPACA, that impact involves a massive expansion of the power and reach of the Internal Revenue Service, the agency chiefly responsible to enforce and administer the PPACA.

One of the key reasons the IRS has grown so large and powerful over the past several decades is that Congress continues to hand the IRS the duties of administering social programs. Now, under the PPACA, the IRS is responsible for the largest social benefit program ever implemented in the history of the nation. To do this job, the IRS estimates it will spend nearly $1 billion just through 2013 in information technology costs alone. Estimates are that it will take a minimum of 5,000 and perhaps as many of 16,000 additional IRS employees to carry out the mandates under the law.

And this is just the beginning. There is no telling what the true costs will be as this program shapes up over the years.

The Act’s Key Tax-related Provisions

Although the Patient Protection and Affordable Care Act contains forty-seven tax-related provisions, just four of them promise to impose tremendous administrative burdens for the IRS and compliance nightmares for both individuals and businesses. When combined with the other forty-three, there is no telling what kind of costs the agency will incur in carrying out this massive legislation.

The four provisions in question are discussed below.

 1. The Small Business Tax Credit. Since 2010, a tax credit has been available to eligible for-profit and tax-exempt “small employers” that pay at least half the cost of a single coverage (versus family coverage) health plan for their employees. A small employer is one with less than twenty-five full-time employees. The credit is based on the number of full-time employees and their average annual wages. The credit is targeted at small businesses and tax-exempt organizations employing low and moderate-income workers. Code section 45R.

There is a phase-in provision that reduces the credit as the number of employees increases. The full credit is available to employers with less than ten full-time employees and less than $25,000 in average annual wages. Employers with twenty-five employees or whose average annual wages are $50,000 or more get no credit. Code section 45R(c).

2. The Premium Tax Credit. Beginning in 2014, the Act creates a “refundable tax credit” payable to individuals for the purchase of health insurance under a qualified health plan. A refundable credit is one where you can get more money back from the government than you actually paid in taxes. An example is the Earned Income Tax Credit.

The premium tax credit is available to eligible individuals and families with incomes below a specified threshold (subject to income phase-outs). This is the chief means by which the federal government will subsidize the purchase of health insurance for targeted individuals. The insurance must be purchased through an “exchange.” Under the PPACA, the states are required to create insurance “exchanges” through which consumers not subject to an employer-provided plan may purchase health insurance. If a state does not set up an exchange, the Act allows the federal government to create one within that state. States may also join together to create regional exchanges. The exchange must be either a government agency or a non-profit entity. Code section 36B.

3. The Individual Responsibility Requirement. Beginning in 2014, individuals will be required to purchase and maintain “minimal essential health care coverage” for themselves and their dependents. The definition of “minimal essential coverage” is set by statute and therefore is subject to congressional whim. See code section 5000A(f). Failure to purchase such care will subject the individual to an annual penalty, which the statute refers to as a “shared responsibility payment.” Code section 5000A(b).

This has often been referred to as the “individual mandate” in that Congress has mandated that individual citizens purchase an insurance product that meets federal guidelines. Such a mandate is unprecedented in American law. There is no other example in U.S. history where the government required a person, as a matter of law, to purchase a specific product or service or risk civil penalties.

The penalty is equal to the greater of:

  • $695 per person per year, up to a maximum of $2,085 per family, or
  • 2.5 percent of “household income.” Code section 5000A(c).

The percentage amount is actually phased-in over three years. Beginning in 2014, the percentage is 1 percent. Beginning in 2015, the percentage is 2 percent. For years after 2015, the percentage jumps to 2.5 percent. The gross applicable penalty is pro rated to apply on a monthly basis “for any month during which any failure” to have adequate coverage exists. Code section 5000A(c)(2). The penalty amount must be computed by the taxpayer and reported on his tax return.

The law makes several exceptions to the individual mandate. They are:

  • Members of a recognized religious group who have historically been exempt from Social Security taxes under code section 1402(g)(1), or those who are involved in a “health care sharing ministry,”
  • Persons who are not lawfully present in the United States, and
  • Persons who are incarcerated. Code section 5000A(d).

 Section 5000A also provides exemptions from the “shared responsibility” penalty under the following circumstances:

  •  Persons with a hardship waiver,
  • Those who cannot afford coverage,
  • Those with income below the tax return filing requirement,
  • Members of an Indian tribe, and
  • Those who are not covered for a period of less than three months. Code section 5000A(e).

4. The Employer Requirement. Also beginning in 2014, employers with fifty or more full-time employees that do not offer “minimum essential health insurance coverage” to all of its employees “and their dependents,” or offer unaffordable coverage, will be liable for a penalty. The penalty applies if even just “one full-time employee” qualifies for a subsidy to purchase insurance through an exchange. The penalty is referred to as the employers’ “shared contribution” to national health insurance. Code section 4980H(a).

The penalty for failure to provide minimum essential health care as defined by Congress is calculated in two ways. The first applies to employers who offer no insurance their employees. In that case, a maximum of $2,000 per employee per year (reduced by thirty employees) is assessed against the employer. Code section 4980H(a). Thus, the penalty is not tied to the number of employees who are eligible to purchase coverage from an exchange. If even one employee is eligible to purchase coverage from an exchange, the maximum penalty applies to all employees (reduced by thirty). For example, a company with fifty employees could face a penalty of $40,000, which is $2,000 per employee, for a total of twenty employees (total workforce of fifty “reduced by thirty”). Code section 4980H(c)(2). 

The second calculation applies in cases where the insurance offered by the employer is such that the employee nevertheless qualifies to purchase insurance from an exchange. In that case, the penalty is $3,000 per employee who qualifies to purchase insurance from an exchange. Thus, if the employer has fifty employees but only five of them qualify to purchase insurance from an exchange, the maximum penalty is $15,000 (5 x 3,000). Code section 4980H(b).

The penalty is “assessable” in the same manner as all other employment tax penalties under the tax code. In that sense, the IRS does not have to offer the employer an opportunity to review and contest the determination prior to assessing the penalty. The IRS may assess the penalty and provide a notice and demand for payment to the employer. Any appeals that may exist come into play only after assessment and collection begins. Code section 4980H(d).


IRS – The Face of National Health Care

The IRS will be the face of American national health care. The reason is that both the benefits and penalties to individuals and businesses for purchasing (or not purchasing) the health insurance required under the law take the form of either tax credits or tax penalties. It is also true that forms and declarations will have to be filed with the IRS to take advantage of the credits and to avoid the penalties.

But in most cases, the IRS will not be the decision-maker as to whether a person qualifies for a given credit, or owes additional taxes or penalties due to being disqualified to a certain extent. The IRS will merely be the messenger of that news, and naturally, the collector when it is determined that taxes and penalties are owed.

This is going to require the IRS to undertake a massive education program, including the preparation and distribution of publications and instructions to guide individuals and businesses in complying with this law. The IRS must also be prepared to answer millions of questions through phone calls and at its walk-in sites to guide people through the compliance maze. And when there is a discrepancy or people disagree with how the law is being administered, they will have to deal with the IRS to resolve the problem. The National Taxpayer Advocate (NTA) discusses the potential problems for citizens given this fact:

In most instances, the IRS is being asked to be the collection face of this provision [the individual mandate], but not the decision maker. This puts the IRS, and its employees, in the awkward position of collecting a penalty and potentially being unable to work with taxpayers who claim they don’t owe it. National Taxpayer Advocate, 2010 Annual Report to Congress, December 31, 2010, Vol. 2, page 28.

Even beyond that, I am concerned about the IRS’s capacity to manage this massive legislation. For the past several years, the National Taxpayer Advocate has been sounding the alarm about the IRS reducing the percentage of its budget that’s dedicated to taxpayer service. In the National Taxpayer Advocate’s 2011 Annual Report to Congress identifying the twenty most serious problems faced by taxpayers, she cites this lack of attention to taxpayer-service as the number one most serious problem citizens face. As the number of tax delinquencies has grown over the period of our national financial problems, more of the IRS’s attention and budget has been focused on enforcement and less on assistance.

Moreover, the NTA points out that as the IRS’s responsibilities are “expanded into other areas, it will turn to more automation and less interaction with taxpayers” in an effort to get the job done. National Taxpayer Advocate, Fiscal Year 2012 Objectives, Report to Congress, June 30, 2011, page ix. She points out that as this happens, the IRS will resort to:

  • More rule-based decisions “without any personal contact,”
  • More pressure to use summary assessment procedures “or truncated audit processes,”
  • Greater use of automated correspondence “with no outbound calls to taxpayers,” and
  • More “decision-making tools” which “supplant the individual employee’s determination” on the facts of a given case. Ibid.  

From 2009 to 2013, the IRS’s budget went from $11.931 billion to $13.354 billion. Of these totals, the components of enforcement and taxpayer services break down as follows:  

            Year                Enforcement*             Taxpayer Services

             2009                $5.117                         $2.293

             2013                $5.702                         $2.253

     * Amounts in billions.

Source: GAO, INTERNAL REVENUE SERVICE-Interim Results of 2012 Tax Filing Season, GAO-12-566, March 2012, page 18.

Already we are seeing the impact of this reduction on the IRS’s ability to help people. The Government Accountability Office (GAO) reports that during the 2012 filing season, the “IRS experienced a substantial increase in total call volume and a reduction in the IRS’s level of service resulted in wait times of about 17 minutes.” Ibid, GAO-12-566, March 2012, page 6.

 Wait times are just part of the story. The IRS’s delivery of phone services dropped considerably over the past several years. For example, in 2007, 82.1 percent of calls to the IRS were answered. Regardless of any wait time, taxpayers got help. By 2011, the number dropped to 70.1 percent. Even worse, the IRS anticipates that by the end of 2012, the number will be 61 percent. Ibid, GAO-12-566, March 2012, page 23.

 The bottom line, according to the NTA, is the IRS “has fallen short of providing adequate taxpayer service in important areas.” NTA statement: IR-2012-83, July 7, 2010. This will only get worse under the PPACA. Given the massive scope of the law, the challenges for the IRS and citizens are simply daunting.

Administrative and Compliance Challenges Facing Taxpayers and the IRS

Individuals, businesses and the IRS alike face many monumental new challenges in complying with and administering the PPACA. The following is a discussion of just a handful of the issues that could likely bring the system to its knees.

1. Establishment of a new definition of income. The current tax code is a monster for a number of reasons, but key among them is the fact that there are two different definitions of “income” under the law. Very generally, we have the definition of “ordinary income” for the purposes of determining one’s tax liability under the graduated income tax system. The second definition of “income” is that which applies to our secondary tax system (of which most people are entirely unaware until they are clobbered by it somehow) known as the Alternative Minimum Tax.


Because there are two different definitions of income, taxpayers must calculate their potential tax liability under both systems. The rules of deductions, credits, exemptions, etc., apply differently under each system. If a taxpayer calculates his ordinary income tax liability at X dollars but the Alternative Minimum Tax calculation shows that he owes more, the Alternative Minimum Tax applies.

The PPACA establishes a new definition of income—a third definition—which applies to many of the Act’s tax provisions, including the premium tax credit under code section 36B. That definition is “household income.” Household income includes not only the income of the family principals (say, husband and wife), but also the income of all other members of the “household” who live with the family principals. This is not limited to children. Any person who qualifies as a dependent under code section 151 is included in household income. Therefore, household income might include the income of a mother-in-law or a grandchild.

Under current law, there is no requirement to report household income to the IRS. Thus, there are no rules for figuring it and no mechanism for reporting it. The IRS has no means to collect the information or apply it. And citizens have no experience in calculating it. That means substantial changes will have to be made to tax forms and instructions and the IRS will have to reprogram its systems to accept, store, retrieve and utilize the information. Moreover, citizens and tax pros alike will have to be educated as to how, when and where to report the information.

2. Verifying household income reported to the “exchanges.” The premium credit is available to persons who pay insurance premiums to an exchange. The exchange, not the IRS, determines who is eligible for the credit and the amount of the credit. Thus, under the PPACA, citizens have to apply for coverage and in doing so, report to their respective exchanges their family size and household income. They will have to provide copies of their tax returns and whatever other additional information the exchange requires. The exchange verifies the information with the IRS and then informs the individual whether and to what extent he qualifies for the credit.

The IRS must verify household income and family size. But these things change on an ongoing basis. The information provided to the IRS on your tax return for one year (which reported facts relevant to the previous year) are not necessarily accurate as of the date the individual applies for coverage through an exchange. And what happens when a person’s circumstance change throughout the course of the year? He files his tax return only once per year, and at that, after the year has ended.

A person is required to report any changes to the exchange during the year as they happen and a reconciliation process occurs at the end of the year when the individual files his tax return. He may owe more or less money to the IRS, depending upon a lesser or greater premium tax credit. Thus, if a citizen received too large a credit, he might owe the IRS a substantial amount of money and the IRS will look for payment.

This process requires the creation of its own set of rules, procedures, forms and instructions. This is because the IRS’s capacity to “recapture” an overpaid credit is limited by law. The ability to collect is limited based upon a citizen’s “household income” if it is below 500 percent of the federal poverty level (FPL). Individuals below 200 percent FPL will have their overpayment recapture capped at $600. The cap increases as the percentage of FPL to family income increases, until it reaches $3,500 for individuals between 450 to 500 percent FPL. Citizens with household income above 500 percent of FPL are responsible to repay the entire overpaid credit. Code section 36B(2)(f).

If the history of the IRS teaches us anything, it is that there will be discrepancies between what a person reports to the exchange and what the IRS reports to the exchange through the verification process. With nearly 2 billion information returns filed annually reporting wages, interest, dividends, rents, royalties, etc., there are already substantial errors in processing these returns. When these errors occur, they lead to automated tax bills from the IRS. There is an appeals process the citizen may follow to challenge the IRS’s determination. Will that process apply to the exchange verification process or will an entirely new system have to be established?

A bigger question is whether citizens will be bounced from agency to agency in an effort to resolve the issue? As stated above, the IRS administers much the PPACA, but they don’t make most of the decisions under PPACA, and the IRS does not make the decision as to who is entitled to the premium credit and the amount. The IRS is simply the messenger. The decision is made by the exchanges. The NTA is already concerned that this will create a substantial problem for both the IRS and citizens.

In light of that, citizens most certainly will have to learn to deal with yet another government agency to resolve these issues. And with the trend toward automation discussed by the NTA, citizens will likely end up talking with computers about their health insurance issues to an even greater extent than we currently talk with IRS computers about tax problems.

3. Interaction with private insurance companies. At present, the IRS has nothing to do with the internal affairs of any medical insurance provider in the United States. This will change radically under the PPACA.

Under the Act, citizens can retain their private insurance plans if they provide “minimal essential health care coverage” as defined by law. The IRS must verify that citizens carry such coverage or impose the penalty for not having such coverage. Therefore, the IRS must proactively engage in collecting data from private insurance companies—something never before done. As to individual policies, at a minimum, the IRS will have to ascertain:

  •  The costs and benefits under the policy,
  • Who’s covered under the plan and the periods of coverage,
  • The household income reported to the insurance company, and
  • Whether the individual was offered insurance by his employer.

The inquiry goes on. If the individual was offered insurance by his employer, the IRS will then have to know:

  •  How many employees the company has,
  • The costs and benefits of the employer-offered policy,
  • Who’s covered under that plan, and
  • The period of coverage.

The IRS will have to develop new forms, instructions and filing procedures for obtaining all of this information. It will also have to develop systems for sorting, storing, assimilating and applying the information to a particular taxpayer and his family. And one must certainly ask the question, as I did early in this discussion, where does a citizen go when there is a discrepancy in the information reported to the IRS by the insurance company? What will be the level of run-around one is forced to deal with and where will the appeals process lie?

4. Deeper interaction with businesses. Even though the IRS has interacted with businesses in the past, the PPACA will require the IRS to dig much deeper into the affairs of businesses than it ever has before. For example, the Small Business Tax Credit discussed above is not based upon the total wages paid during the year, which is a simple number that could be lifted off the employment tax returns businesses already file. Rather, the credit is based upon the number of full-time employees and their average annual wages. The IRS does not currently collect this information.

Since the credit went into effect in 2010, the IRS had to create new tax forms and revise existing forms. The IRS also mailed out millions of postcards to businesses discussing the credit and added substantial new information on its web site. New tax credits (indeed any new provision of this substance) always create administrative problems. For example, the Earned Income Credit, the First Time Homebuyer Credit and the Making Work Pay Credit have been driving the IRS crazy for years. And one of the largest single areas of fraud the IRS battles year in and year out is with the Earned Income Tax Credit.

Compliance with the Small Business Tax Credit promises to create at least as much confusion for businesses and problems for the IRS as any of the other major tax credits, maybe more. There appear to be five steps an employer must follow to determine eligibility for the credit. They are:

            1. Determine which employees to take in account,

             2. Determine the number of hours of service those employees perform,

             3. Calculate the number of “full-time equivalents,” which may be different from mere full-time employees,

             4. Determine the average annual wages paid per full-time equivalent, and

             5. Determine the premiums paid that are taken into account for purposes of the credit. See IRS Notice 2010-44 for details and requirements of the credit.                                                                                                                                                                                                                        

The complexity of the calculations necessary to determine eligibility for the credit constitute a recipe for error and the dollars involved create the potential for fraud. And according to the GAO, in 2011, the IRS had 12,000 employees working just on administering the health care tax credits. Keep in mind that the premium credit has not even gone into affect yet. See: GAO, INTERNAL REVENUE SERVICE-Interim Results of 2012 Tax Filing Season, GAO-12-566, March 2012.

But it doesn’t stop there. The IRS must administer the penalty applicable to employers with more than fifty employees who do not provide adequate health insurance to their workers. To enforce this, at a minimum, the IRS will need to know:

  •  The number of employees and their dependents,
  • The number of full time employees and their dependents,
  • The nature, scope and cost of the insurance offered to the employees,
  • The periods of time that insurance is in effect, and
  • Whether one or more employee qualified for coverage through and exchange.

Procedures and regulations will have to be established to create an appeals process for dealing with the employer penalty.

5. Interactions with more government agencies. Carrying out the legislative scheme set forth in the PPACA will require the IRS to deal with more government agencies than it ever has in the past. For example, the premium tax credit carries a number of eligibility requirements. Among them are the citizen’s family size and household income. This will have to be verified to the exchanges as discussed above.

However, the Department of Health and Human Services and the Department of Homeland Security are also involved. Health and Human Services must verify the information the IRS has on family size and income. Homeland security must verify a person’s immigration status.

And finally, the Social Security Administration must verify one’s citizenship.

What kind of checks, balances and appeal procedures will be in place to deal with the potential for discrepancies in the rivers of information flowing between these agencies?


6. Privacy issues. Code section 6103 provides that a person’s tax return and “return information” must be kept confidential by the IRS. There are numerous exceptions to this general rule. As you might imagine, one body of exceptions allows disclosures to the exchanges set up under the PPACA, as well as others with a need to know your tax information in order to carry out the provisions of the PPACA. Code section 6013(j)(21).

Given the sheer scope of the information needed to enforce and administer the Act, I believe I can say that your privacy is a thing of the past.

7. Procedural transparency. The Freedom of Information Act requires the IRS to disclose all of its “instructions to staff that affect a member of the public,” unless a specific exemption applies. See 5 U.S.C. section 552. In its 2011 Annual Report to Congress on the twenty most serious problems people have with the IRS, the Taxpayer Advocate declared that the IRS’s “failure to disclose its procedures” is the twentieth most serious problem that people face. See NTA Annual Report to Congress, December 31, 2011, Vol. 1, page 380.

The fallout created by this failure includes:

  • Depriving taxpayers and their representatives of the information they need to “prevent or resolve tax problems,”
  • Uncertainty as to whether taxpayers “can rely on information from IRS employees,”
  • Increased risk that the IRS “will be perceived as acting arbitrarily and inconsistently,” and
  • Depriving the IRS of input from outsiders “that could improve its procedures.” Ibid.

The NTA cites a number of reasons why the IRS does not properly disclose its procedures. Chief among them is the massive volume of guidance material the IRS produces. For example, as of the end of 2010, the Internal Revenue Manual contained 1,923 sections that were written by approximately 646 different authors. The writings and determinations made by these individuals “were subject to little oversight.” Ibid, page 381.

What will happen when the flood of guidance begins on all the various procedures and interactions that are described above? How will that information be disclosed to the public and how will the public ever be able to receive, assimilate and utilize the information in an effective manner? The can’t do so now under existing IRS rules and procedures. I have no doubt but that this will lead to yet another cottage industry of tax and legal professionals who charge citizens and businesses fees to navigate, negotiate and overcome the mountains of complicated procedures and regulations that will grow from the Act.


8. Health care audits. Under the individual responsibility mandate, citizens are required to purchase health care or face a penalty if they do not. Under the employer responsibility mandate, companies with more than fifty employees must provide coverage for their employees or face a penalty. The penalties are assessed and collected by the IRS. Individuals and businesses will be required to report their insurance information on their tax returns. Will these compliance mandates give birth to a new audit initiative by the IRS?

The purported purpose of the PPACA is to provide health care coverage to the vast majority of Americans. If a person required to have health coverage does not, isn’t he in violation of federal law? Likewise, if a required business fails to provide insurance to its employees, is it not in violation of federal law? And isn’t enforcement of the tax law the primary calling of the IRS?

Moreover, since the penalties are revenue-raising tools, why can’t we expect the IRS to make heath care audits a primary enforcement initiative? According to Douglas Elmendorf, director of the Congressional Budget Office, the federal government can expect to collect $17 billion by 2019 from the penalties associated with the individual mandate. The penalties collected from businesses under the employer mandate could be as much as $52 billion by 2019. See: Elmendorf, letter to House Speaker Nancy Pelosi, March 20, 2010. The Supreme Court in National Federation acknowledged these very numbers when it decided that the penalty provision of the Act is really a tax. The Court stated that the “essential feature of any tax” is that it “produces at least some revenue for the Government.” National Federation of Independent Businesses v. Sebelius, Slip Opinion, page 16.

The projected revenue is big dough at a time when the federal government is more strapped for money than at any other time in our history. I don’t expect the IRS to just leave this money on the table. That means proactive enforcement of the penalty provisions and that means health care coverage audits of American citizens and businesses.

9. Collecting the penalties. During the congressional debate on health care reform, there was much discussion about how the IRS would collect the penalty against individuals for failure to maintain minimal essential coverage. The concern was that the IRS would be able to use all of the collection tools at its disposal to collect a penalty, including liens and levies.

Code section 5000A(g) addresses the procedure regarding the assessment and collection of the penalty. It states, in part:

The penalty provided by this section shall be paid upon notice and demand by the Secretary, and except as provided in paragraph (2), shall be assessed and collected in the same manner as an assessable penalty…”

An “assessable penalty” under the code means that the penalty is summarily assessed, without any prior appeal or review rights afforded to the taxpayer. Such penalties are quite common regarding employment taxes. Congress’s justification for imposing “assessable penalties” regarding employment taxes is that since the employment taxes are held in trust by the employer for the benefit of the government, the urgency of collecting these taxes outweighs the taxpayers’ interest in appeal safeguards. In other words, “We need the money so forget the appeals process.”

Apparently the same logic applies to the penalty for not maintaining adequate insurance coverage.

But there is a limitation as to how the penalty can be collected. The IRS is precluded from using its levy power to collect such an assessment and it’s precluded from filing tax liens with regard to such an assessment. Code section 5000A(g)(2)(B). However, the IRS can use every other tool available that it might use to collect any other liability. Those tools include:

  •  Federal refund offsets. The IRS can offset your tax refund against a penalty assessment. Thus, your federal tax refund can be reduced to pay any penalty.
  • State refund offsets. Likewise, the IRS can notify any state or local taxing authority that it will offset any refund the state or local government owes you to pay the penalty. Some might argue that this is a levy, prohibited by law. However, this may be a matter of semantics, depending upon how the IRS proceeds.
  • Application of undesignated payments. If you send a payment to the IRS that is not specifically designated in writing to apply to a specific debt, the IRS can apply that undesignated payment “in the best interest of the government.” And since the IRS can use its levy power to collect income tax debts but not the penalty in question here, it will apply an undesignated payment against the penalty assessment and levy your paycheck to collect the income tax debt.

The net effect for the taxpayer: you got hit with a levy to collect a delinquent debt owed to the IRS. In short, the IRS gets the money, one way or another. The limitation on lien and levy power is a hollow benefit.

Please note that this limitation applies only to the individual penalty under section 5000A. It does not apply to the business penalty under section 4980H. Businesses will be subject to the full wrath of the IRS’s collection machine.

10. The list goes on. Given the scope of the PPACA, there is no telling how deep the tentacles of the IRS will sink into the fabric of our lives and businesses. One thing is for sure—they will sink far deeper than the typical American ever imagined. As yet another example of this, let’s discuss the exemptions that apply to the individual mandate. One such exemption applies to those who cannot afford coverage, either because their required premium is too high or their income is too low, or both. See code section 5000A(e)(1).

Certainly the determination of these two issues is subject to some kind of IRS audit. The IRS rarely takes a citizen’s “word” for the disclosures on a tax return when it comes to an income tax audit. Why would they do so when it comes to determining the applicability of an exemption under the law?

Another exception applies if a citizen has “suffered a hardship with respect to the capability to obtain coverage under a qualified health plan.” Code section 5000A(e)(5). The term “hardship” as used here is undefined in the tax code. We have to expect that it will be defined by regulation. The statute provides that the determination of “hardship” is to be made by the Department of Health and Human Services. Thus, communication must occur between the HHS, the IRS and the citizen for this determination to implemented correctly. And this raises the same questions regarding the right to appeal adverse determinations that I discussed above.

Taxpayer Advocate Service Being Shut Out of the Process

The above discussion reveals, at a minimum—

  •  The massive potential for abuse and misuse of taxpayers’ rights in the process of administering the PPACA,
  • The horrific invasion (or dare I say, destruction) of privacy in the most important and personal areas of our lives, and
  • The loss of control and choice that we have in determining and controlling our health care expenditures under the PPACA.

In light of these facts and the questions raised in this report, we can see that there must be substantial consideration given to taxpayers’ rights in the processes of the ascertainment, calculation, assessment and collection of the massive amounts of information and tens of billions of dollars in penalties at stake under the law. Historically, that is the job of the Taxpayer Advocate Service.

But the National Taxpayer Advocate is being shut out of the discussion.

The IRS set up a health care program office to guide its efforts to implement the law. The agency established four teams to work on specific challenges with an eye toward creating the systems the IRS needs to do the job Congress thrust upon it. According to the NTA’s Annual Report to Congress,

The National Taxpayer Advocate has repeatedly asked that TAS be included in these teams and has offered her senior advisors to serve on them. The National Taxpayer Advocate is concerned the IRS declined to include TAS members on the teams, increasing the risk that the IRS will make operational decisions that are best for itself without adequate consideration of taxpayer impact. NTA, Annual Report to Congress, December 31, 2010, Vol. 2, page 19.

If TAS is shut out of the process, there simply will be nobody at any level within the system to protect taxpayers’ rights. The good news is that the NTA is not taking “no” for an answer. Her report goes on to state:

Despite the exclusion of TAS from the IRS’s health care implementation teams, TAS is undertaking its own efforts. The National Taxpayer Advocate convened an internal team of TAS executives and other employees who meet bi-weekly to discuss the various provisions and identify potential problems and implications for taxpayers, the IRS, and TAS. Ibid.

The fact that the NTA is forcing the issue is a good thing. The reality, however, is that her power in this regard is limited. It simply remains to be seen the extent to which her office will shape the processes that effect taxpayers’ rights under the PPACA. More importantly, as I’ve stated throughout this report, in many cases, the IRS is not the decision-maker. So that begs the question, who will be protecting taxpayers within the numerous other agencies involved with the PPACA, most notably, the exchanges?

“Free” Health Care is Far From Free

In addition to the wildly complicated health insurance and penalty scheme outlined above, the PPACA contains a host of new taxes intended to fund the scheme. You might have thought the new health insurance benefits were free. They are not. According to the Cato Institute, under the law, the top 1 percent of income earners can expect tax hikes of up to $52,000 per year. See: Bad Medicine, A Guide to the Real Costs and Consequences of the New Health Care Law, Michael D. Tanner, Cato Institute, 2010, page 21.

But as you’ll quickly see, it’s not just high-income earners who will feel the pinch. Given the nature of the tax hikes, nearly all Americans will pay more. Here’s a list of the tax hikes in the PPACA.

1. Limit on itemized deductions. Beginning in 2013, the adjusted gross income threshold for claiming a deduction for medical expenses goes up from 7.5 percent to 10 percent. Thus, every taxpayer who files a Schedule A to itemize deductions will see reduction in the amount of medical expenses that are deductible, and a corresponding increase in their taxes.

2. Tax on medical devices. A 2.9 percent tax is imposed on the sale of all medical devices in the United States. This includes everything from expensive diatonic equipment to simple forceps. The Secretary of Health and Human Services has the authority to waive this tax for items sold at retail for use by the public. However, it is unclear how such a waiver is obtained and the proof required to obtain it.


3. Tax on prescription drugs. This tax applies to all brand name prescription drugs sold in the United States. It’s an excise tax imposed on the pharmaceutical company that produces the drug. The tax is imposed in the aggregate then a pro rata share is passed on to each manufacturer using a complicated formula. The amount to be raised ranges from $2.5 billion in 2011 to $4.2 billion in 2018. This tax will most certainly be passed on to consumers in the form of higher drug prices.


4. Tax on “Cadillac” insurance plans. This is a tax on high-cost insurance plans. Beginning in 2018, there is a 40 percent excise tax imposed on any employer-provided health plan with an actuarial value of more than $10,200 for an individual and $27,500 for families. Thus, if you policy is “too good,” your employer will pay a substantial tax if he continues to provide it.

5. The payroll tax hike. The Medicare payroll tax goes from 2.9 to 3.8 percent for persons with incomes over $200,000 (single) and $250,000 (married).

6. The tax on investment income. Beginning in 2013, a 3.8 percent tax gets assessed on all capital gain, interest and dividend income for persons with incomes over $200,000 (single) and $250,000 (married).

7. Tax on tanning services. There is a 10 percent tax imposed on tanning salons already in effect.

8. Tax on health insurance companies. This tax is similar to that assessed on drug manufacturers. It is an aggregate assessment imposed on individual insurers based upon their market share. The assessment goes from $8 billion and rises to $14.3 billion by 2018. In years following 2018, the tax grows by a percentage equal to the rise in premiums charged in the previous year. Thus, if premiums go up by 10 percent, the tax will rise accordingly.

In every case, these taxes will be paid by consumers in the form of higher prices for the products and services covered by the tax. And all of this adds to the already massive compliance burden carried by businesses and the administrative nightmare the IRS must deal with under the other elements of the PPACA.


Not since the Medicare and Medicaid Acts of the 1960s has Congress imparted so much power to government agencies to carry out social programs. But those programs pale in comparison to the scope and power usurped by the federal government under the PPACA.

Fully informed Americans would never have voted for this scheme, nor would they have supported politicians who voted for it, if they had any idea of the vast extent to which the federal government would drill into their private affairs and control the most important and personal decisions they make.

In fact, I have come to believe that Speaker Nancy Pelosi’s remark that “we have to pass the bill so that you can find out what’s in it,” was not a misstatement or inadvertent fumble. She had to know that all reasonable Americans would be outraged at the extent to which the IRS and other federal agencies would gain access to their personal affairs and control their decisions. Moreover, she had to know that reasonable Americans would cringe at the idea of spending untold billions of dollars and hiring a literal army of new bureaucrats to staff government agencies (chiefly the IRS) to enforce federal mandates pointed at how they make decisions effecting their own families.

We know why Speaker Pelosi and those of her ilk couldn’t tell the truth about the PPACA.

The PPACA imposes costs and reporting burdens so vast, that when added to those that already exist, create a load that’s nearly impossible to carry. I do not believe it’s melodramatic to suggest that the costs and massive bureaucracy required to run this system could bring the IRS to its knees. And if it doesn’t, it would only be because Congress grows the IRS’s annual budget and workforce to previously unimaginable levels.

I cannot believe that’s what America wants. At approximately 100,000 employees and an annual budget of nearly $13.5 billion, the IRS is already the largest police force in the world. How much larger will it grow under this bill? There’s no way to fashion a reasonable guess, other than to say that whatever the growth is, free people don’t want it and a free nation cannot tolerate it.

To be sure – it’s a new day in America. We cannot help but be deeply concerned about the impending storm. Freedom loving people must take whatever steps they can to push for the repeal of the PPACA and restore liberty to America.




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Agency Reels from Revelation of Abuse

A firestorm of controversy preceded the release of the report of Treasury Inspector General for Tax Administration (TIGTA) on the IRS’s handling of the applications for exempt status of certain advocacy groups. The report, released May 14, 2013, is the culmination of work by TIGTA that began because of complaints made to various congressmen about the way the IRS was handling applications for tax-exempt status under code section 501(c)(4). See: “Inappropriate Criteria Were Used to Identify Tax-Exempt Applications for Review,” TIGTA Reference No. 2013-10-053, May 14, 2013.   CLICK HERE FOR PDF FILE

The trouble surrounds the IRS’s Exempt Organizations (EO) division, the working unit of which was centralized in the IRS’s Cincinnati service center. The purpose of the EO function is to, among other things, receive, evaluate and pass upon the applications for exempt status filed by religious and other organizations seeking federal income tax exemption under section 501 of the Internal Revenue Code.

It should come as no surprise that there is a long list of well-established laws and regulations the EO unit must follow in discharging its duties. As it turns out, the EO unit failed to follow the proper laws and regulations in discharging its duties, and in fact, instituted arbitrary guidelines that it applied to only a select number of organizations seeking exempt status. And finally, it has come to light that organizations singled out for this illegal treatment were advocacy organizations generally opposed to the policies of the administration. 

Well you could have knocked me over with a feather.

Not all Tax Exempt Organizations are the Same

Section 501 of the tax code is a large and complicated animal, much like most of the code. I have no intention in this article of breaking it down in any comprehensive way. But for the sake of this discussion, it is important to understand two basic elements of the law. First, code section 501(c)(3) is the provision under which churches, educational organizations and charities seek exempt status. That section allows churches and others to solicit tax-deductible contributions. However, such organizations may not participate, either directly or indirectly, or intervene in any political campaign on behalf of or in opposition to any candidate for public office.

Under code section 501(c)(4), groups may be exempt from federal income tax but contributions to such organizations are not tax deductible. These groups may engage in limited political activity as long as the primary activity of the organization does not involve intervening in political campaigns. Such groups may carry on lobbying and general advocacy activities. General advocacy involves: 1) working to influence public opinion on issues germane to the organization’s tax-exempt purposes and 2) encouraging voter participation through “get out the vote” drives, voter guides and candidate debates in a nonpartisan, neutral manner. General advocacy includes all types of advocacy other than direct political campaign intervention and lobbying.

The Criteria For Exempt Status

The criteria for determining whether an organization is qualified for tax-exempt status under any provision of code section 501 are dictated by very express provisions of both the law and IRS regulations. These guidelines have been established for some time. They focus on just two key elements of the applicant: 1) the manner in which the applicant is organized, and 2) the manner in which it operates. These are referred to as the organizational and operational tests.

If an applicant group meets both the organizational and operational tests, it doesn’t matter what the group believes. In the case of advocacy groups, there are groups from across the full spectrum of political, social and economic beliefs that enjoy section 501(c)(4) exempt status. The IRS is not permitted to grant or deny exempt status on the basis of the organization’s beliefs. As long as the group is organized properly and operates within the bounds of the law, it is entitled to exempt status.

It is entirely reasonable and necessary that a group’s beliefs cannot and should not determine whether it is entitled to tax exempt status. If that were the case, the IRS or the administration could dictate with the stroke of a pen which kind of organizations were granted the decided advantage of having federal tax-exempt status and which were not. Any administration could then use the “power to tax” as the principle means of either crippling or destroying its political enemies. It is simply intolerable in a free society for any such power to vest in the hands of a government agency or an elected official.

The IRS’s “Inappropriate” Evaluation Criteria

The actions the IRS is now called upon to explain involve the applications for exempt status of various Tea Party organizations and other conservative groups whose political philosophy is at odds with the current administration. Beginning in 2010, the number of groups seeking application for exempt status under section 501(c)(4) approximately doubled to about 3,000.

During the course of the evaluation process, certain reviewers (whose names have yet to be released) made the decision to pull aside for special review any organization with a “political sounding name.” In July of 2010, management officials made the decision to create a “be on the lookout for” file. They referred to it as the BOLO list. In August of 2010, the BOLO list consisted of just three types of organizations:

  • Those with the words “Tea Party” in the name,
  • Those with the word “patriot” in the name, and
  • Those with “9/12” in the name. (9/12 is the organization Glenn Beck created to educate people about America’s founding principles and values.

The applicant organizations that found themselves on the BOLO list were singled out for review and analysis far above that which other applicants received. Their files were referred to a “specialist” who personally carried out that heightened scrutiny. Lois Lerner, the IRS’s Director of Exempt Organizations, admitted on May 10th that the agency’s actions were “wrong and completely inappropriate.” She apologized for the act. The TIGTA report itself states that the IRS “developed and used inappropriate criteria to identify applications” for special scrutiny.  

The use of the word “inappropriate” in this context is wrong and outrageous. Something that is inappropriate is that which is not suitable or fitting for a particular use, occasion or purpose. For example, many consider that it’s inappropriate to drink white wine with red meat. Likewise, it might be inappropriate to wear a skimpy cocktail dress to a wedding. However, in neither of these examples is there any unlawful behavior.

As to the act of singling out the “patriot” sounding applications for special scrutiny based upon only their names, the TIGTA report declares:

The criteria focused narrowly on the names and policy positions of organizations instead of tax-exempt laws and Treasury Regulations. Criteria for selecting applications for the team of specialists should focus on the activities of the organizations and whether they fulfill the requirements of the law. TIGTA report, pages 6-7.

The bottom line is that the IRS acted more than merely “inappropriately.” The IRS acted illegally.

What Apology?

Media reports early in the week of May 13 were awash with the claim that the IRS “apologized” for its unlawful conduct. The IRS did no such thing. To that point, many referred to the statement from Lerner in a speech she made on the 10th.

However, the IRS’s official statement, released May 13, reads as follows:

Between 2010 and 2012, the IRS saw the number of applications for section 501(c)(4) status double. As a result, local career employees in Cincinnati sought to centralize work and assign cases to designated employees in an effort to promote consistency and quality. This approach has worked in other areas. However, the IRS recognizes we should have done a better job of handling the influx of advocacy applications. While centralizing cases for consistency made sense, the way we initially centralized them did not. Mistakes were made initially, but they were in no way due to any political or partisan rationale. We fixed the situation last year and have made significant progress in moving the centralized cases through our system. To date, more than half of the cases have been approved or withdrawn. It is important to recognize that all centralized applications received the same, even-handed treatment, and the majority of cases centralized were not based on a specific name. In addition, new procedures also were implemented last year to ensure that these mistakes won’t be made in the future. The IRS also stresses that our employees — all career civil servants — will continue to be guided by tax law and not partisan issues.

In this statement, the IRS takes no responsibility for any illegal actions. They blame the problem on “centralizing” the evaluation process due to the increase in the number of applications. I can tell you that centralizing was not the problem. The IRS has centralized many processes over the past several years – Offers in Compromise, lien management, innocent spouse applications, just to name a few. The mere fact that a singe unit handles like transactions does not explain why those in that unit failed to follow the law in carrying out their duties.

In fact, you could argue (and the IRS would argue) that the very act of centralizing an activity is designed to ensure that those working the centralized files are better trained and equipped in the particular area of law in question. The very idea of centralizing work is to ensure that a highly trained team of specialists works every file as opposed to individuals who may or may not be fully trained in the relevant area of law. So for the IRS to suggest that the act of centralizing these files is the cause of the illegal behavior is a quite shallow explanation of what happened.

In his testimony before the House Ways and Means Committee on May 17, the former acting IRS commissioner, Steven Miller, said that the IRS erred in singling out conservative groups applying for tax-exempt status but “did not do so for partisan purposes.” What does that even mean? What other reason would there be for specifically targeting groups with words “Tea Party” or “Patriot” in their name? As I illustrated above, the particular beliefs of an organization are entirely irrelevant in determining whether they qualify for section 501(c)(4) exempts status. Moreover, a highly trained team of “specialists” in a “centralized unit” absolutely should have known this.

More to Come

J. Russell George, the Treasury Inspector General for Tax Administration also testified to the House Ways and Means Committee on May 17. He confirmed that TIGTA could uncover new information as the agency probes deeper into what went on. Committee Chairman Dave Camp (R-Mich.), said in a statement that:

This committee wants the facts and the American people deserve answers to why they were targeted on the basis of their political beliefs. The IRS has demonstrated a culture of cover up and has failed time and time again to be completely open and honest with the American people.

Lerner is herself now under the gun for allegedly lying to Congress about the number of groups who were singled out for mistreatment, the manner in which they were mistreated and specifically who was responsible making the decisions on how they were mistreated. On top of everything else, Attorney General Eric Holder announced that the Justice Department has launched a criminal investigation of the IRS’s actions in this affair.

One thing is for sure, Lerner’s claim that the unauthorized scrutiny was conducted solely in the IRS’s Cincinnati office and instigated solely by low-level IRS officials cannot be true. The TIGTA report presents a detailed time line of activities that shows e-mails running back and forth between EO’s Determinations unit in Cincinnati and top IRS officials in Washington, D.C. The implication seems clear to me; this matter was actually being directed by the IRS in Washington, not minions in Cincinnati.

Even more specific, recent new reports now offer evidence to show that the president of the Treasury Employees Union, Colleen Kelly, met with the president at the White House on March 31, 2010, just one day before the EO’s unlawful activities began in Cincinnati. The significance of the meeting is that under Kelly’s direction, the Treasury employees union PAC contributed hundreds of thousands of dollars, during both the 2010 and 2012 election cycles, to anti-Tea Party candidates throughout the country.

Senate Minority Leader Mitch McConnell (R-Ky.) declared that lawmakers have “only scratched the surface” in asking questions about what went on at IRS. He called on the president to make available, “completely and without restriction, everyone who can answer the questions lawmakers have as to what was going on at the IRS, who knew about it and how high it went.” It will be interesting to see how the president explains the substance of his meeting with Kelley the day before the fuse was lit in Cincinnati.

McConnell warned the president, saying, "No more stonewalling, no more incomplete answers, no more misleading responses, no holding back witnesses, no matter how senior their current or former positions."


House speaker Rep. John Boehner (R-Ohio) denounced the actions and Senator McConnell called on the White House to conduct “a transparent, government-wide review aimed at assuring the American people that these thuggish practices are not under way at the IRS or elsewhere.”

Even the Democrats are getting into the act of condemning the IRS. Senate Finance Committee Chairman Max Baucus (D-Mont.) promised a full investigation. He said, the “actions by the IRS are an outrageous abuse of power and a breach of the public’s trust. Targeting groups based on their political views is not only inappropriate but it is intolerable.”

Why Resignations Will NOT Solve the Problem

In a letter to a top treasury official early the week of May 13, Senator Marco Rubio (R-Fla.) and other lawmakers called for the resignation of IRS Acting Commissioner Steve Miller. Miller in fact tendered his resignation and other top IRS officials could lose their jobs over this. Rubio’s letter stated, in part:

It is clear the IRS cannot operate with even a shred of the American people’s confidence under the current leadership. I strongly urge that you and President Obama demand the IRS Commissioner’s resignation, effectively immediately. No government agency that has behaved in such a manner can possibly instill any faith and respect from the American public.

Rubio is entirely correct that these actions strike directly at the heart of the issue of faith and trust in a government agency. But let me ask you this? When is the last time the American people had any faith and trust in the IRS? I’m telling you based upon first hand experience with people I deal with every day that there is very little trust in the IRS to begin with.

The problem is not that there are people in the IRS who don’t care about the law. That has been the case for years. I have documented over and over the manner in which the IRS violates taxpayers’ protections with monotonous regularity. We saw these kinds of hearings into IRS abuse in 1997, when the Senate Finance Committee conducted jaw-dropping investigations into what was going on inside the IRS. Those hearings led to the National Commission on Restructuring the IRS and eventually to the IRS Restructuring and Reform Act of 1998. That legislation was supposed to stop all the abuse. Will, guess what?

So please excuse my cynicism but nothing that has been revealed in all of this surprises me.

That’s why there is simply no amount of resignations that will solve the problem of IRS abuse. What we are dealing with here is a culture of lawlessness. It’s true that many people in the IRS try hard to do an honest job while functioning under impossible circumstances. I have worked directly with many of them. But it’s also true that too many people in the IRS just don’t care about the law. They only care about power. I’ve dealt with too many those people also.

That’s why the ONLY solution to this problem is to abolish the federal income tax and the IRS along with it. You cannot fix this problem through legislative tinkering, now matter how many new “taxpayer protections” are added to the code.  I stated repeatedly during the 1997 Senate hearings into IRS abuse that abuse of taxpayers by the IRS was not an isolated event. It’s something that goes on day after day and it happens at every level. In 1998 when the IRS Restructuring Act was passed, Congress and then-President Clinton promised that IRS abuse was a thing of past. Well, it’s not.

The vast power and authority this agency wields cannot be controlled by lawmakers who pay attention to these matters only about once every fifteen years. The IRS has to be abolished. The income tax has to be abolished. It’s time that we all recognize and accept the fact that this system is broken beyond repair, not because it degenerated over time, but because it was never sound to begin with.

The IRS and the income tax are an unholy alliance born of un-American and unconstitutional ideas. The system is unsound morally, unsound constitutionally and unsound economically. Why waste any more time killing this beast? Get on with it now.





Dan Pilla Newsletter 400


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What Every Citizen Needs to Know About Losing a Home

By Daniel J. Pilla

Executive Director, Tax Freedom Institute

The debt and credit crisis in America is causing profound financial problems for many middle-income citizens. One of the harshest ways these problems manifest themselves is with home foreclosures. Home foreclosures are up substantially over the past two years and many experts believe we may be as many as two years away from things stabilizing. In the meantime, untold thousands of people are losing their homes to foreclosure.

And to add insult to injury, the foreclosure of a home often leads to tax problems. This happens when, after foreclosure, the creditor issues Form 1099-C, Cancellation of Debt, to you and the IRS. This Form 1099-C shows that you had substantial income in the year of the foreclosure. Now the IRS wants you pay taxes on the so-called income as reported on the Form 1099-C.

Because of this, Congress fast-tracked legislation in last 2007 in order to provide relief to foreclosure victims. The bill was H.R. 3648, entitled The Mortgage Forgiveness Debt Relief Act of 2007. The act was passed by Congress and was signed by the President on December 20, 2007. It is now law and it’s discussed in this Special Report.

Why Does Foreclosure Matter?

You may ask how a home foreclosure has anything to do with one’s tax liability in the first place. Unfortunately, most people never see the connection until after the damage is done by the foreclosure.

The basic premise is that the law taxes “cancellation of indebtedness” income in most cases. Simply put, if you borrow money but later the debt is forgiven, the amount of the forgiveness is generally considered taxable income.

Does this sound crazy? Well, think about this. When you get a loan from a bank, say $50,000, you’re not taxed on the loan proceeds. You can use the money any way you like. The loan is non-taxable because you’re obligated to repay the loan. When you do repay it, you’re not entitled to any deduction for the principal amount of the loan, though you might be able to write off the interest.

But look what happens if you don’t repay the loan. In that case, you receive $50,000, which increases your wealth, without ever having to pay it back. And because you don’t have to pay it back, the nature of the transaction changes from that of loan (non-taxable) to that of “accession to wealth” which is taxable.

The Double-whammy of Home Foreclosures

The problem with home foreclosures is that the “accession to wealth” is often phantom. The reason is that all the “wealth” is tied up in the home itself, which now belongs to the bank. Also, the foreclosure always occurs at a time when the individual is the least wealthy. Otherwise, why would he lose his home to foreclosure anyway?

How the Mortgage Debt Forgiveness Act Helps

The Mortgage Debt Forgiveness Act added a provision to Internal Revenue Code section 108. That section contains the list of exceptions to the general rule saying that cancellation of indebtedness income is taxable. In fact, there are about seven or eight exceptions to the rule already listed in section 108. This new exception applies to cancellation income that arises due to a foreclosure on one’s principal residence.

The key provision of the new law states that cancellation of indebtedness income is not taxable if the indebtedness is considered “qualified principal residence indebtedness.” New code section 108(a)(1)(E). To qualify, several criteria must be met. Let’s discuss them.

  1. The debt must be “acquisition indebtedness.” Generally, there are two classes of home mortgage debt. The first class is debt incurred to purchase or substantially improve the property. This is called “acquisition indebtedness.” The second class is re-finance debt, which can be used for anything. The new law addresses itself only to the forgiveness of “acquisition indebtedness.” That phrase is narrowly defined as debt “incurred in acquiring, constructing, or substantially improving” one’s residence, and which debt is “secured by such residence.” See code section 163(h)(3)(B). As you can see, re-finance debt used to pay for anything other than acquiring, constructing, or substantially improving the residence is not acquisition indebtedness and is not subject to the exclusion under the new law. Such debt might include money used to pay credit cards, purchase boats or autos, take vacations, etc.
  2. The debt can be no more than $2 million. The new law caps the amount of debt cancellation that is not subject to taxation. That cap is $2 million.
  3. The debt must be secured by your “principal residence.” The phrase “principal residence” is also defined by law. Code section 121 controls. That section provides that one’s principal residence is the location where you live and occupy a home as the primary living quarters for yourself and your family. This can be a single family home, a condominium, a house trailer, etc. Think of it as your main home.
  4. The timing of the forgiveness. Like so many tax laws that have passed this decade, the relief provided in this law is temporary. The law provides a narrow window of time in which the relief applies. To get the benefit of this provision, the cancellation of debt must have occurred on or after January 1, 2007, and before January 1, 2010. Thus, the foreclosure must occur in that three-year window —2007, 2008 and 2009 — to be covered by this law.

How to Calculate Cancellation of Debt Income

Not all foreclosures lead to cancellation of debt income. The amount of income depends upon the debt forgiven and the fair market value (FMV) of the property at the time of the foreclosure. To determine cancellation income, simply determine the amount of debt owed immediately prior to the foreclosure then subtract from that amount the FMV of your property at the time of foreclosure. Here are some examples:

Example 1

Total debt prior to foreclosure $400,000

FMV of property $400,000

Difference = cancellation income $ 0

Example 2

Total debt prior to foreclosure $500,000

FMV of property $400,000

Difference = cancellation income $100,000

In Example 1, there is no cancellation of debt income but in Example 2, there is $100,000 of cancellation income. The new law will act to extinguish the tax attributable to that income.

Now the Bad News

The law contains a provision that might create a capital gains tax on the foreclosed property, while simultaneously eliminating the income tax attributable to cancellation of debt. While this might sound silly, it’s very typical of tax laws today.

The new law provides that any amount of the cancellation income not taxed because of this new exclusion must be applied “to reduce the basis of the principal residence of the taxpayer.” New code section 108(h)(1).

Consider Example 2 above. In that case, there was $100,000 of cancellation income that was not taxed because of the new law.

But the next question is, did you realize a capital gain as a result of the foreclosure? You say, “But wait. I didn’t sell my house. How can I have a capital gain?” The answer is that the tax law treats a foreclosure as a sale because a foreclosure constitutes a “disposition” of the property. '

To determine your capital gain, simply subtract your basis (the cost of acquiring the property plus all improvements) from the FMV at the time of the foreclosure. In Example 2, the property’s FMV was $400,000. Suppose that the original basis was $300,000. Look what happens under the new law.

FMV at time of foreclosure $400,000

Original basis $300,000

Required basis adjustment ($100,000)

New basis $200,000

Capital gain on foreclosure $200,000

In this example, you realize a capital gain of $200,000 on the foreclosure of the property.

Now, this may or may not be an issue, depending upon the amount of the gain and your filing status in the year of the discharge. The reason is that code section 121 excludes from income all capital gain from the sale or disposition of a principal residence, up to $250,000 for a single person and up to $500,000 for a married couple filing jointly. The exclusions in code section 121 apply to a foreclosed principal residence. Thus, in this example, there would be no capital gains tax, even though there is a substantial capital gain.

But that’s not always going to be the case. That’s why you have to carefully determine your gain and whether the section 121 exclusions apply. Even if you have a taxable capital gain, the trade off is that a capital gain is taxed at much lower rates while cancellation of debt income is taxed at the ordinary income tax rates.

Make Sure You Have Records

If you’re facing a foreclosure situation – indeed anytime there’s the chance that you’re selling or disposing of your principal residence – you have to organize your records to establish your basis. The higher the basis, the lower the gain realized on the disposition of the property.

In the case of a sale, the higher the basis, the more likely you’ll fall within one of the capital gain exclusions, depending upon your filing status. In the case of a foreclosure, the higher the basis, the less impact there will be as a result of the basis reduction rules described here.

What if the New Law Doesn’t Apply?

As I stated above, there is just a narrow window in which the relief under the new law applies. If your debt forgiveness due to a foreclosure on your home does not happen within the three years 2007, 2008 and 2009, you will not benefit from this law.

However, code section 108 contains a host of reasons why otherwise taxable cancellation of debt income may not be taxable to you. Here’s a list and brief explanation of the other statutory reasons for not taxing cancellation income:

  1. Cancellation due to bankruptcy. Any debt discharged under the federal bankruptcy laws is not considered taxable income.
  2. Cancellation while insolvent. When the debt forgiveness occurs at a time when you are insolvent, the cancellation income is not taxed. The term “insolvent” is defined by law. It means simply that the amount of your debts exceeds the total FMV of your assets. However, calculating this can be more tricky than it might appear at first glance, especially if you have a business, retirement accounts and other assets. The value of all assets must be considered as of the date of the forgiveness in answering the question whether you were insolent.
  3. Cancellation of qualified farm indebtedness. The law excludes from taxation any cancellation debt that arises from the forgiveness of “qualified farm indebtedness.” This is debt that arises in connection with the operation of a farming business but only if 50 percent or more of your total gross receipts for the three years prior to the year of the cancellation was from farming.
  4. Cancellation of qualified real property business indebtedness. If the canceled debt arose in connection with the acquisition, construction or improvement of real property used in business, the cancellation income is not taxed. However, there are certain important limitations to this relief. The chief such limitation is that an election has to be made on the tax return for the year of the cancellation to exclude the income.
  5. Cancellation of certain other business loans. The law also contains a general rule saying that if, a) the cancellation of debt was for a business loan, and b) the repayment of the loan would have given rise to a business deduction, the cancellation income is not taxed. To prove this, however, you must show that you did not already claim a deduction for the payment of business expenses with the cash you obtained through the loan.
  6. Cancellation of certain student loan debt. Federal student loan laws provide that some student loan debt can be canceled if you work in certain professions for a stated period. These can include childcare workers, special education teachers and the armed forces. There are important limitations on these rules and they must be evaluated in light of the facts and circumstances of each case.
  7. Other defenses to cancellation of debt income. In addition to the statutory defenses to cancellation of debt income discussed above, the courts have carved out several more factors that might constitute a defense to the claim that you had income from the cancellation of debt. Here’s a brief discussion of some key defenses.

a. The cancellation must constitute “accession to wealth.” That is, you must realize a gain from the cancellation. In the case of credit card debt, for example, much of what is canceled often includes late fees, over limit fees, penalties, etc. The cancellation of these changes is not “accession to wealth.” Thus, in the case of the cancellation of debt by a credit card company, the Form 1099-C they issue is often incorrect because it contains a host of changes that don’t constitute “accession to wealth.”

b. The canceled debt must be legal under state law. In some cases, loans are canceled that may not be perfectly legal under state law. For example, loans to minors, or loans that are in violation of state usury laws are examples. Any loan that is not fully enforceable under state law cannot be subject to cancellation income.

c. Debts canceled as a gift or bequest. Two of the most common non-statutory exceptions are the cancellation of debt that comes in the form of a gift or bequest from a decedent. Suppose your uncle loaned you $20,000 to go to school. Then, as a graduation gift, he forgives the debt. This is not income. It’s a gift. Likewise, if your uncle dies and in his will forgives the debt. That is an inheritance to you. It’s not income.

d. Cancellation of disputed amount. When there is a legitimate dispute as to what you owe, and the creditor reduces the amount as a means of settlement, the reduction is not income to you. The dispute must be based upon the charges for goods purchased or services rendered. The dispute cannot be based upon ability to pay.

e. Dormant debts are not canceled. Often, creditors will put delinquent debts in a “dormant,” “inactive,” “suspense,” or other frozen state in which no collection efforts are pursued. However, the debt is not actually written off. In order for there to be cancellation income, the debt must be physically written off the creditor’s books. The IRS’s regulations state that there must be a clearly “identifiable event” which establishes that the creditor in fact forgave the loan. Merely freezing collection, for however long a creditor chooses to do so, is not such an event.

The mere issuance by the creditor of Form 1099-C does not necessarily constitute an “identifiable event.” This is especially true when you have expressed to the creditor a willingness to resolve the issues, negotiate new payments, or the intent to pay the debt.

You Have the Burden of Proof

In a debt forgiveness situation, the burden of proof is on you to show that one or more of the many exceptions discussed here apply to you. You will need records to support your claim and you’ll need to argue that a specific exemption applies.

The context in which you make the argument will depend upon the posture of the case. You may assert your defense on the 1040 Form at the time of filing by using IRS Form 8275 to explain why the cancellation income is not taxable.

You have the right to challenge an IRS determination of taxability. This can be done through the IRS’s Office of Appeals and if necessary, the United States Tax Court. More details are available on exercising these rights in my books, How to Eliminate Taxes on Debt ForgivenessHow to Win Your Tax Audit, and the Taxpayers’ Defense Manual.

Make Sure You Consult Counsel

If you've been through a home foreclosure or had a debt cancelled by a creditor, be sure you consult counsel on how best to deal with the Form 1099-C that you'll be facing. One way to get the personal help you need is to become a member of my Tax Solutions Network. You’ll receive valuable benefits as a member, including a thorough evaluation of your situation and written plan of action to resolve your problem. For more information, you can call my office at 800-346-6829.

You can also contact the Tax Freedom Institute member nearest you for help with your case. The Tax Freedom Institute is a national association of attorneys, accountants and enrolled agent who practice in the area of taxpayers’ rights issues and IRS problems resolution.

This article is similar to others found in Dan’s newsletter, Pilla Talks Taxes. Ten times per year, Dan provides current tax information, updates on law changes that affect your pocket book, and strategies for dealing with the IRS.



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