We are pleased to announce that Brown and Jensen has moved to a new East Mesa office location. Our new office is conveniently located near Power Rd., and the US 60. The new address is 7255 E. Hampton Ave., Suite 127, Mesa, AZ 85209.
I know many of you are thinking the same thing, “what is a captive insurance company?” In a nutshell, a captive insurance company is an insurance company which has common ownership with the entity it insures. Recently, numerous news agencies have reported that it appears the IRS is increasing scrutiny of these captive insurance arrangements. However, before one can understand why the IRS would increase scrutiny it is important to understand the benefit to such an entity.
All businesses attempt to manage the various risks that can negatively affect them. Typically, the most significant risks are managed through insurance. There are numerous commercial insurance products which help businesses manage risks associated with property and casualty loss, professional malpractice, tort liability and the like. When businesses pay the premiums for these insurance policies, they are allowed to deduct the payments as ordinary and necessary expense of the business. This reduces the amount of business income that is subject to taxation. However, every business is also subject to additional risks that they cannot purchase insurance for because they cannot afford it or because commercial insurance policies do not exist for these risks. These risks may include loss of a key client, loss of a key employee, and losses associated with negative government regulation. Without an insurance option, companies will often self insure these risks by retaining earnings to create reserves that can be used if such risks come to fruition. The downfall to this approach is that the company does not get a deduction for the money it sets aside in a reserve account. This in turn increases the business income subject to taxation, which ultimately increases the amount of taxes paid by the business.
Under a captive insurance arrangement, a business will form a separate insurance company. This insurance company will have common ownership with the insured business and it will underwrite the insurance policies the business is unable to obtain elsewhere. In return, the business will pay premiums to the insurance company, which are deductible as a business expense. This deduction provides an immediate tax benefit for the insured business. Generally, this benefit is offset by the fact that the captive insurance company recognizes the premiums it receives as income. Thus, under a general captive insurance arrangement, the tax savings are minimal. However, the Internal Revenue Code provides a much more favorable tax treatment for some captive insurance companies, often referred to as “microcaptives.”
Microcaptives are defined as captive insurance companies which do not receive annual premiums in excess of $1.2 million. Unlike most insurance companies, these microcaptives do not treat the premiums received as income. Instead, microcaptives are taxed only on the investment income earned as it invests the premiums it receives. This provides a great opportunity for tax arbitrage. Where there is opportunity for arbitrage, there is also an opportunity for abuse. It is these potential abuses that concern the IRS. To combat this potential, the IRS has issued several publications which attempt to offer safe-harbor directions for companies who want to establish and operate micropcatives. Despite these publications, ambiguity and the potential for abuse remains. When making the decision to establish a microcaptive, it is important to consult with a qualified professional who understands the benefits and risks to such an arrangement. The trusted tax attorneys of the Brown & Jensen Law Firm have advised clients on the formation and continued operation of captive insurance arrangements. We have also guided clients through IRS audits which are the direct result of increased IRS scrutiny. When contemplating any tax planning strategies or defense against the IRS, the Brown & Jensen Law Firm is your trusted tax advisor.
As an Arizona tax attorney, one of the questions I get asked most often is, “how do I avoid an IRS audit?” While there is no sure fire way to avoid being audited, there are steps that can be taken to decrease the odds that an audit will occur.
1) Be wary of who prepares your tax return
Most of us have heard the following statement, or a variation of it, from someone. “You need to use my tax return preparer. I used to get small tax refunds but with my new preparer I get huge refunds!” Who doesn’t want to get more money back when they file their tax return? This is such a great sales pitch. However, the reality is that for most people, your tax return is not that complicated and the amount of your refund should not change from preparer to preparer. There is not a secret tax code provision that only a handful of preparers know about. If it sounds too good to be true it likely is. The tax return preparer that gets you great refunds that no one else can is likely filing a false return on your behalf.
What your friend, and the shady tax return preparer, will not tell you is that the IRS pursues tax preparers every year. Each year, the IRS compiles a list of return preparers suspected of filing false tax returns. Undercover IRS agents visit these preparers seeking to catch them in the act of filing a false tax return. When they do catch a bad return preparer, the IRS will audit every client of the return preparer. You may not get caught this year but that doesn’t mean the hammer won’t fall soon. When it falls there will likely be interest and penalties associated with it. Avoid the hassle and use a competent return preparer and reduce the chances that you will be audited.
2) Does your return make sense?
I have many clients who have come to meet with me after finding out that they are under audit. Most want to know how they were selected for audit. Before I answer this question I always take a quick glance at the client’s tax return. It still surprises me when I see figures similar to the following:
Gross Income – $60,000
Mortgage Interest Paid – $25,000
Charitable Deductions – $15,000
Health Care Expenses – $8,000
Basic arithmetic tells us that after the three deducted expenses of mortgage interest, charitable contribution and health care expenses are deducted, you only have $12,000 of gross income to pay all of your remaining expenses for the year. This would include food, utilities, gas, vehicle maintenance, entertainment, to name a few. It is easy to see that this does not add up. The IRS has computers that compare these numbers and if the amount left after your known expenses is not enough to live on you are likely to be audited. Before you file your tax return give it a common sense reading. If it doesn’t add up, you are probably missing something.
3) Report your income correctly and avoid filing an amended return
I will admit that I have fallen victim to this trap. There have been years that, in my haste to file my income tax return, I have filed my return before I have received all of my Forms 1099 and W-2. Invariably, when I act in such haste, my own meticulous record keeping fails me and I omit some obscure payment that I did not remember receiving. When this happens, you will be faced with deciding between the lesser of two evils.
The first evil is that the IRS computers will match the income reported on your income tax return with the income that was reported to them on your behalf. If the number you reported is not greater or equal to the number reported to the IRS, you will be audited (please note that it is possible, though highly unlikely, that the amount omitted is so inconsequential that it will not generate any more tax and will not trigger an audit). The second evil is that when you file an amended tax return to report the income you failed to include in your original return, it will not be processed electronically. Instead, the return will be examined by a human being. I refer to this as a soft audit. This greatly increases the odds that you will be selected for a full audited. To be clear, the greater evil is being audited when your return is false. It is always better to correct a return you know is incorrect and face being audited for a return you know is accurate. The lesson I leave with you is to be patient. Take the extra time to ensure that you have received on necessary forms to complete your tax return and that your return accurately reports all income you received. You should only file an amended return when necessary.
If you do find yourself under audit, do not fear. You do not have to confront the IRS alone. The trusted tax attorneys of the Brown & Jensen Law Firm are your IRS and Tax experts and can guide you through the process as smoothly as possible.
- Unwinding An Estate Plan: Most people have at least a Will or perhaps a typical Revocable Living Trust in place. Some have more complicated plans with several Irrevocable Trusts in place.
- Transferring Assets: It is important to deed all assets out of the Trust and sign a Revocation.
- Create New Estate planning documents for each spouse:
- Some odd statutes to be avoided with respect to the disposition of an estate plan between divorced spouses. Don’t rely on the statutes.
- Revoking Irrevocable Trusts:
- Life Insurance Trusts
- Tax consequences of unwinding an Irrevocable Life Insurance Trust.
- Gift tax
- Estate Tax
- Income Tax
- Unwinding a QPRT: Qualified Personal Residence Trust.
- Unwinding a Family Limited Partnership:
- Unwinding a Stand Alone Generation Skip Trust:
- Understanding Complicated Assets: Many high net worth people have stock options, qualified and unqualified plans, pensions, annuities, oil leases FLPs, etc.
- Spousal Maintenance v. Child Support: Child support payments and spousal maintenance payments are not treated the same under the tax code. Child support payments are never taxable income for the payee and are not a deduction for the payer. However, spousal maintenance payments are deductible from income by the payer and are included in the income of the payee. A divorce decree or settlement agreement should specifically allocate what portions of payments are attributable to child support and spousal maintenance.
- Tax Deduction for Children: The tax code allows several deductions and credits for children supported by a taxpayer. After a divorce, the custody of a child may be split between both parents. However, the IRS will only allow one parent to claim the child on their tax return. Divorce decrees and settlement agreements will often state which parent will be allowed to claim the child on their tax return. The IRS is not bound by these agreements. For an agreement to be binding on the IRS, the parties must execute IRS Form 8332. Absent the execution of this form, the IRS will default to the parent who has custody the majority of the days in a year.
- Not All Assets Are Created Equal: Different assets will often have different tax treatment under the tax code. Some assets, such as capital assets are taxed at preferred rates. Other assets, such as retirement accounts, are taxed as ordinary income as they are withdrawn.
- Division of Assets Incident to Divorce: The division of assets is generally not a taxable event. See I.R.C. § 1041. However, any built in gains associated with the divided assets are preserved. Before agreeing to a property settlement agreement it is important to consider the future tax burden of each asset.
- Recapture of Depreciation: Assets that are depreciable, i.e. rental property or property used in a trade or business, inherently has higher built in gains associated with the property. Each year property is depreciated, the adjusted basis of the assets is reduced proportionately, thereby increasing the eventual gain that when be realized when the property is sold.
- Division of Retirement Accounts: There are two basic issues when dividing a retirement account. 1) Tax consequences of the initial division and, 2) tax consequences when assets are withdrawn from the accounts. To ensure that the proper tax consequences are achieved, a qualified domestic relations order or QDRO is necessary.
- Allocated Gains/Losses Associated with a Partnership: Property with built in gains/losses that were contributed to a partnership may have created special allocations within those partnerships. Division of partnership interests may have unintended consequences if special tax allocations are not taken into account.
- Filing Status While Going Through a Divorce: Parties who are in the process of divorce should never be required to file a joint income tax return. Joint returns make both parties jointly and severally liable for the tax consequences of the return. Both parties are also required to attest to the accuracy of the return under penalties of perjury.
- Tax Trouble When Parties Divorce: Property settlements and divorce decrees do not only divide assets and other property. These agreements apply equally to debts of the marriage. How can parties deal with unresolved tax debts?
- Unfiled Returns: If returns have not been filed by either spouse the potential liability associated with these tax years must be dealt with. Joint tax returns should be avoided. Separate tax returns create separate liability.
- Innocent Spouse Relief: If tax debts are attributable to one spouse, the innocent spouse, or the spouse who did not give rise to the liability, may be eligible to be released from joint and severable liability for the tax debt.
- Hidden Assets: Assets hidden from the IRS or other tax authorities are a ticking time bomb and should be dealt with in a divorce proceeding. Such assets can give rise to both civil and criminal liability.
- Whistleblower Actions: Taxpayers who are aware of tax fraud being committed by someone else can notify the IRS and may receive a reward from the IRS for making the tip. Ex-spouses are the most common whistleblowers.