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Articles Posted in Financial Disclosure

Paying taxes involves disclosing a vast amount of personal information about oneself, one’s family, and one’s business to the IRS. If you seek the assistance of an accountant or other tax preparer, your personal information makes an additional stopover on its way to the government. Unfortunately, the wealth of information included in tax returns is incalculably valuable to identity thieves and other scammers. As a result, federal law closely protects the privacy of taxpayer information. This protection relies on extensive security measures by both the government and the businesses that handle taxpayers’ returns. Our Los Angeles tax advisors want to take this opportunity to explain the scope of your protections.

Privacy of Taxpayer Information

Section 6103 of the Internal Revenue Code (IRC) establishes that the information in taxpayers’ returns is confidential. The IRS may not disclose taxpayer information to anyone without the taxpayer’s written consent, unless disclosure to other tax officials or law enforcement is specifically required by law.

Federal law holds the IRS to a high standard of accountability in this matter. An IRS employee or other person who accesses confidential taxpayer information in violation of § 6103 commits a criminal offense punishable by up to one year in prison and a fine of up to $1,000. The taxpayer whose information is accessed without authorization may bring a civil suit against the U.S. government for the greater of either $1,000 per violation, or the actual damages they suffered plus, in the event of a willful or grossly negligent violation, punitive damages.

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In recent years, taxpayers have been investing in virtual currency to exchange monies in the virtual marketplace or hold on to as investment assets. One of the subgroups of virtual currency is cryptocurrency, or a digital form of currency traded or secured using cryptography. The emergence of this digital asset has yet to provide definitive tax guidelines for taxpayers and tax practitioners, particularly for taxpayers who are concerned about their privacy rights in cryptocurrency. However, one thing is clear when it comes to virtual currency: taxpayers must pay their taxes on the gains made from the profits on virtual currency. If not, taxpayers will reap the consequences of enforcement from the IRS.

The IRS has provided some guidance to the virtual currency debacle in the form of Notice 2014-21. The IRS defines virtual currency as a digital representation of value that functions as a medium exchange, a unit of account, and/or a store of value. Virtual currency can act as a substitute for real currency, also known as “convertible” virtual currency, but does not have legal tender status in any jurisdiction. An example of a convertible virtual currency is Bitcoin, which can be digitally traded between users and exchanged into US dollars, Euros, and other real or virtual currencies.

Based on that comprehensive yet confusing definition of virtual currency, taxpayers may wonder how virtual currency might be treated for federal tax purposes. According to the IRS, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. That means taxpayers who receive virtual currency as payment for goods or services must include the fair market value of the virtual currency, measured in US dollars, the date that the virtual currency was received. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

Last month, the House Ways and Means Committee unanimously approved a bill to allow same-sex couples who married before the overturn of the Defense of Marriage Act (DOMA) to amend their filing status and claim their tax refunds as jointly-filed spouses. If enacted, this bill would be a huge step for the government because it would make an exception to the three-year statute of limitation rule for taxpayers to claim their refunds.

The purpose of H.R. 3299, or the Promoting Respect for Individuals’ Dignity and Equality (PRIDE) Act of 2019, is to permit legally married same-sex couples to amend their filing status for income tax returns outside the statute of limitations and to amend the Internal Revenue Code of 1986 to clarify that all provisions shall apply to legally married same-sex couples in the same manner as other married couples. It incorporates language from H.R. 3294, the Refund Equality Act, and H.R. 1244, the Equal Dignity for Married Taxpayers Act. This bill would provide same-sex couples, who married before the Supreme Court’s decision in U.S. v. Windsor, an opportunity to claim their tax refunds and would remove gendered language such as “husband” and “wife” from the Internal Revenue Code to accommodate same-sex married couples.

Prior to the Windsor decision, federal law defined marriage for federal purposes as the union of one man and one woman, and allowed states to refuse to recognize same-sex marriages granted under the laws of other states. DOMA barred same-sex married couples from being recognized as “spouses” for purposes of federal laws, effectively barring them from receiving federal marriage benefits such as the filing of joint tax returns and federal refunds from those joint returns. Although the Supreme Court declared section 3 of DOMA unconstitutional under the Due Process Clause of the Fifth Amendment, the IRS lacks the authority to override the three-year limitation on which a claim for refund can be made.

The IRS compiles an annual list of “tax scams,” known as the “Dirty Dozen” list. Its 2019 list, published in March, includes “offshore tax avoidance,” or “failure to report offshore funds.” This refers to taxpayers’ obligation under the Foreign Account Tax Compliance Act (FATCA) to report financial assets held in foreign countries to the IRS. This reporting requirement is different from the Report of Foreign Bank and Financial Accounts (FBAR), which is required by the Bank Secrecy Act (BSA). The two requirements may seem redundant, and they often overlap. They go to different agencies within the Department of the Treasury and have separate penalties for non-compliance.

The “Dirty Dozen” list functions as much as a warning to taxpayers about not perpetrating tax scams as a warning about possible scams targeting taxpayers. Half of the items on this year’s list address scams directed at taxpayers. These include several scams that involve people posing as IRS agents in phone or email communications, “unscrupulous return preparers,” and various identity theft schemes. The other half of the list involves attempts to game federal tax laws and regulations. Aside from offshore tax avoidance, the list includes padding tax deductions, falsely claiming tax credits, “abusive tax shelters,” and “frivolous tax arguments.”

Congress enacted FATCA in 2010 in an effort to identify U.S. citizens, residents, and business entities with financial assets in foreign countries. This includes U.S. citizens living abroad. It requires U.S. taxpayers to self-report foreign financial assets,. It also requires foreign financial institutions (FFIs) to identify and report accounts held by U.S. taxpayers, and in some cases to withhold certain amounts from accounts of non-compliant U.S. taxpayers. The provisions affecting FFIs are generally not enforceable without an agreement between the IRS and the FFI, or the government of the country where the FFI is located.
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