The IRS has estimated that U.S. taxpayers underpay their taxes by around $300 billion each year. Each taxpayer is responsible for calculating their own tax bill, but the IRS also uses other sources of information. It compares the information provided on taxpayer returns to that other information. If it finds a discrepancy, it sends a notice to the taxpayer. For years, the IRS used a form known as the CP2000 Notice, or the “Notice of Underreported Income.” The IRS recently began to use another form, the CP2057. Taxpayers should be aware of both notices, and our California tax advisors urge you to be aware of what you should do if you receive either one.

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Federal law gives the IRS extensive authority to collect unpaid taxes, but the process involves a lengthy series of notices. CP2000 and CP2057 are preliminary notices. They are not “bills,” in the sense that receiving one of these notices does not immediately trigger an obligation for the taxpayer to send money to the IRS. Instead, they are ways for the IRS to notify a taxpayer about discrepancies in their file, and to give them an opportunity to correct the information.

In order for the IRS to pursue a collection action against a taxpayer, they must send a formal notice and demand for payment, known as a CP501 Notice. This notice identifies a specific amount owed and gives a deadline for payment. If the taxpayer fails to pay by the deadline, or otherwise fails to respond to the notice, the IRS can file a tax lien. If the IRS intends to levy the taxpayer’s property, it must send a CP504 Notice.

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The estate tax applies to property transferred by a will or other probate proceedings. Congress has set extensive limitations on who is obligated to pay estate tax. The most recent tax reform bill, enacted in 2017, more than doubled the size of estates that are excluded from estate tax liability. A handful of states have enacted their own taxes on estates or inheritances, but California is not among them. Even if a person does not expect their estate to be large enough to incur an estate tax liability, understanding how the tax works is an important part of estate planning.

What Is the Estate Tax?

The Internal Revenue Code (IRC) defines the estate tax as a tax on “the transfer of the taxable estate of every decedent who is” a U.S. citizen or resident. The executor of the estate is responsible for paying the tax.

The tax is calculated as a percentage of the value of the non-exempt part of an estate. Tax rates start at eighteen percent for values of $10,000 or less. For a value of more than $1 million, the amount of tax is $345,800 plus forty percent of the amount in excess of $1 million.

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Businesses with employees have federal tax obligations besides income tax. The Internal Revenue Code (IRC) makes both employers and employees responsible for paying employment taxes, but the responsibility for transmitting those tax payments to the IRS belongs solely to the employer. If an employer fails to pay employment taxes or file an employment tax return, the IRC authorizes the government to create a return for the employer and assess the amount of tax due. The IRS has created a program that allows automated creation of missing returns, but the program is reportedly understaffed and lacking in other resources. A recent audit by the Treasury Inspector General for Tax Administration (TIGTA) found that these deficiencies in the program caused the IRS to miss billions of dollars in employment tax assessments.

What Are Employment Taxes?

The Federal Insurance Contributions Act (FICA) requires both employees and employers to pay the following employment taxes:
– 6.2 percent of the employee’s wages for “old-age, survivors, and disability insurance,” also known as Social Security; and
– 1.45 percent of the employee’s wages for “hospital insurance,” or Medicare.
The Social Security Administration (SSA) sets a cap on the amount of earnings subject to the 6.2 percent Social Security tax. As of the end of 2018, the cap is set at $132,900. There is no cap on earnings subject to the 1.45 percent Medicare tax.

The Federal Unemployment Tax Act (FUTA) requires employers, but not employees, to pay an excise tax of 6.0 percent of each employee’s wages up to $7,000.
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More than five million United States citizens live outside of the U.S., according to estimates by the federal government. Regardless of where they live, all citizens are required to pay federal income tax to the IRS. Federal law provides several methods for renouncing or relinquishing U.S. citizenship, but doing so comes at a significant cost. The U.S. Department of State (DOS) requires citizens seeking to renounce their citizenship to pay a substantial fee, and the IRS imposes an expatriation tax on some former citizens and others living abroad. Recently, the IRS announced new procedures, known as the Relief Procedures for Certain Former Citizens (RPCFC), that streamline the process for certain former U.S. citizens to resolve tax compliance issues.

Under the Fourteenth Amendment to the U.S. Constitution, any person born on U.S. soil is a citizen by birth, or natural-born citizen. The only exceptions are children born to foreigners who are in the U.S. in diplomatic capacities, and therefore subject to diplomatic immunity from U.S. laws. Immigrants to the U.S. can become naturalized U.S. citizens by following the procedures set forth by the Immigration and Nationality Act (INA).

Section 349(a) of the INA, codified at 8 U.S.C. § 1481(a), identifies seven ways that a U.S. citizen can lose their citizenship. The U.S. Supreme Court has ruled multiple times, such as in 1967’s Afroyim v. Rusk, that the government cannot involuntarily strip a person of their citizenship. Under § 349(a)(5), an individual can renounce their citizenship by voluntarily and knowingly “making a formal renunciation of nationality” at a U.S. consulate or embassy abroad.

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The federal Internal Revenue Code (IRC) allows taxpayers to deduct various business expenses from their income for the purposes of computing their total tax bill for a given year, with numerous exceptions. Section 280E of the IRC, for example, prohibits deduction of expenditures involved with “the illegal sale of drugs.” More than half of all U.S. states allow the medical use of marijuana to some extent, but it remains a Schedule I controlled substance under federal law. This is causing problems for businesses that are complying with state cannabis laws. In late 2018, the U.S. Tax Court ruled that a California medical marijuana company could not deduct millions of dollars in business expenditures. The company has announced that it intends to appeal this decision on business tax deductions.

IRC § 162 allows taxpayers to deduct all “ordinary and necessary expenses” that they pay or incur as part of their “trade or business,” subject to various exceptions scattered throughout the statute. The exception for the “illegal sale of drugs” applies to any substance included in Schedules I or II of the federal Controlled Substances Act (CSA), or similarly prohibited by the laws of the state in which the taxpayer does business. The CSA classifies marijuana (or “marihuana”) in Schedule I, which requires a finding that a drug has “no currently accepted medical use in treatment.”

California law takes a substantially different view of marijuana, as do the laws of at least thirty-one other states, the District of Columbia, and several U.S. territories. In 1996, California became the first state in the U.S. to allow the use of marijuana for medical purposes, after voters passed Proposition 215, also known as the Compassionate Use Act of 1996. A 2005 decision by the U.S. Supreme Court, Gonzales v. Raich, held that federal law may continue to criminalize marijuana production, distribution, and possession even when state laws allow those activities. Conflicts between federal and state marijuana laws are an ongoing matter of dispute.

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The Taxpayer First Act (TFA) of 2019, which became law on July 1, makes a variety of changes to the Internal Revenue Code (IRC). Title II, Subtitle A of the TFA, entitled “Cybersecurity and Identity Protection,” addresses taxpayer identity theft. As more and more tax preparation and filing activities move into online spaces, cybersecurity is a growing concern. The TFA directs the IRS to work with the private sector to improve data security, and to standardize and improve its policies and practices regarding taxpayer data. It also increases penalties for misuse of confidential taxpayer information.

What Is Identity Theft?

Identity theft involves the unauthorized use of personally identifying information (PII)—name, address, date of birth, Social Security number, etc.—for financial gain. An identity thief might, for example, purchase items with a credit card in someone else’s name, and leave that person with the debt. In many cases, a person hacks into a private company’s servers steals a large volume of data and tries to sell that data to others. A hacker allegedly gained access to the records of over 100 million people stored on a server owned by Capital One in March 2019. Federal prosecutors allege that the hacker attempted to share this information with others.

Several massive data breaches have occurred in the private sector in recent years. Consumers have incurred losses due to identity theft, and banks, credit card companies, retailers, and other businesses have faced substantial liability. Taxpayer information transmitted online to the IRS, as well as data stored by the IRS, includes numerous forms of PII. Section 6103(a) of the IRC prohibits the disclosure of “returns and return information” by government employees, contractors, and others, except as specifically authorized by law.

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Preparing a tax return can be a time-consuming process. It can also generate a considerable amount of paperwork. Even if you have gone “paperless,” tax records take up space on a computer or external drive that you might rather use for something fun, like family photos or video games. How long should a taxpayer keep tax records? The simple answer is that you should keep records until all applicable statutes of limitations have expired. As is so often the case, though, the simple answer only barely scratches the surface.

What Records Do You Need to Keep?

Almost any document that you used to prepare a tax return could prove to be important down the road. This could include:
– W-2’s, 1099’s, and other forms that show income;
– Receipts, mileage logs, and other documents that show deductions;
– Documents that support any tax credits that you claimed;
– Financial statements for any businesses that you own or operate; and
– Any other documents that support information included in your tax return.

Statute of Limitations for Audits

As a general rule, the IRS has three years from the due date of a particular tax return to audit it. Many exceptions apply, of course. Some are based on the taxpayer’s own alleged conduct, while others are based on the type of information involved.
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In 2003, Congress allowed eligible taxpayers to deduct contributions up to a certain amount to a health savings account (HSA). In order to qualify for the HSA deduction, a taxpayer must be covered by a high-deductible health plan (HDHP). This means that the plan must require the covered individual to pay a rather large amount out-of-pocket before the insurer must contribute. The HDHP is not, however, required to have a high deductible for services deemed “preventive care.” In July 2019, the IRS issued Notice 2019-45, which describes an expanded list of medical services and medications that will be considered preventive care for the purposes of HSA deductions. This is hopefully good news for people who need various preventive medical services.

What Is a Health Savings Account?

Congress created HSA’s in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Title XII of the bill, entitled “Tax Incentives for Health and Retirement Security,” adds a new § 223 to the Internal Revenue Code (IRC), codified at 26 U.S.C. § 223. It allows “eligible individuals” to deduct contributions to an HSA, with an annual limit of $2,250 for a health insurance plan with single coverage, or $4,500 for a family plan. Additional contributions are allowed for people who are 55 years old or older. In order to be an “eligible individual,” they must be covered by an HDHP.

What Is a High-Deductible Health Plan?

Section 223(c)(2) of the IRC defines an HDHP as a health insurance plan with an annual deductible of at least $1,000 for a single individual, or $2,000 for a family; and an annual sum of the deductible and out-of-pocket expenses of no more than $5,000 for an individual or $10,000 for a family.
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Creating a business entity for your business, such as a corporation or limited liability company, offers a wide variety of benefits. State law governs the formation and governance of these organizations, while federal law governs the aspects that relate to federal income taxes. The Internal Revenue Code (IRC) recognizes two types of corporations:  “C” corporations and “S” corporations. Choosing the form that is right for your business depends on multiple factors, including the existing structure of your business and your goals with regard to matters like financing and growth.

What Is a Corporation?

The primary purposes of a corporation are to allow the owners of a business to operate it as a single legal entity, while also protecting those owners from various forms of liability. A corporation has the authority to enter into contracts and conduct other activities in the same way that real human beings can.

The owners of a corporation are known as shareholders. Their ownership is represented by shares in the corporation, also known as stock. Shareholders are nominally in charge of running a corporation, but they usually delegate this duty by electing a board of directors. The directors further delegate operations to officers, such as a CEO or president, a treasurer, and others. Shareholders may receive a portion of a corporation’s profits in the form of dividends. Continue reading

The overall percentage of federal income tax returns audited by the IRS has been decreasing over the past several years. This is at least partly due to budget cuts, which leave the IRS with fewer resources to conduct audits. People with particularly high incomes have reportedly seen a steeper decline in audit rates than other people, but they still get audited at a higher rate than the general U.S. population.

The apparent decline in IRS audits is definitely not cause to be less careful with one’s taxes, especially for high-income individuals. The Tax Cuts and Jobs Act (TCJA) of 2017 led to significant tax cuts for many people with high incomes, but it also created opportunities for tax write-offs that are likely to catch the IRS’s attention. It may take the IRS a few years to catch up to some of these new opportunities, but they almost certainly will.

Decline in Audit Rates

In 2017, the IRS audited one out of every 160 tax returns that were filed. This was the sixth year of decline in the total number of audits, and the lowest number in fifteen years. The audit rate for individuals with annual earnings of $1 million or more was higher than the rate for the general population, at more than four percent in 2017. That same group, however, was audited at a rate of almost ten percent in 2015. This is also the lowest rate since the early ‘00s.
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