Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The U.S. Court of Appeals for the 10th Circuit recently affirmed a 41-month prison sentence imposed on a dentist convicted of tax evasion. In U.S. v. Ulibarri,¹ the court rejected the dentist’s arguments that the sentence was not reasonable due to his reliance on a tax scheme promoter’s alternative tax mitigation strategy and business trust structure to eliminate federal taxes.

Ulibarri serves as a reminder to lawyers that the IRS pursues clients of tax scheme promoters, particularly when they significantly and repeatedly utilize the scheme.

Background

Ryan Ulibarri, a dentist licensed in Colorado, owned and operated Ulibarri Family Dentistry starting in 2014. After establishing the dental practice, Ulibarri attended a seminar led by associates of Larry Conner purporting to teach business owners how to eliminate federal income taxes on business income using Conner’s alternative tax-mitigation strategy, which was determined to be an abusive trust tax scheme. Against the advice of his lawyers and accountants, Ulibarri used Conner’s unlawful tax shelter for over seven years.

Using Conner’s strategy, Ulibarri funneled his business earnings through a series of “sham trusts.” To effectuate the scheme, Ulibarri assigned ownership of Ulibarri Family Dentistry to a business trust, which distributed income to a family trust, which then distributed income to a charitable trust. Ulibarri’s family spending was covered by funds held in the trust accounts, and Ulibarri then improperly claimed these personal expenses as deductions.

The trust tax returns reported distributions and deductions matching or exceeding the reported income, with the net positive income ultimately “donated” to a tax-exempt private family foundation. The foundation also loaned funds back to the sham trusts, allowing Ulibarri full control and beneficial use of the dental practice income without any tax liability.

From 2016-2023, the scheme enabled Ulibarri to avoid more than $1.6 million in taxes on $5.3 million in earnings from the dental practice.² During this time, Ulibarri concealed the scheme from his banks and the IRS by using nominal grantors to sign documents and providing misleading and deceptive information about his income, assets, and trusts. He continued using the scheme even after repeated warnings from lawyers, bookkeepers, and lenders, and even after his initial indictment.

In 2024, Ulibarri was indicted by a grand jury on six counts of tax evasion for his 2017-2022 tax years. He ultimately pled guilty. The district court determined Ulibarri’s offense level, made adjustments, and then sentenced Ulibarri to 41 months of imprisonment, three months supervised release, over $1.6 million in restitution, and a fine of $150,000. This was the maximum imprisonment under the range for the applicable guidelines.

Ulibarri appealed to challenge his sentence as procedurally and substantively unreasonable.

10th Circuit analysis and decision

The 10th Circuit addressed both Ulibarri’s procedural and substantive unreasonableness claims but ultimately affirmed the district court’s ruling.

Procedural reasonableness

The 10th Circuit first reviewed Ulibarri’s procedural claim, noting that a sentence is procedurally unreasonable if the district court incorrectly calculates the guidelines sentence, treats the guidelines as mandatory, fails to consider statutory sentencing factors, relies on clearly erroneous facts, or does not adequately explain the sentence.

In this case, Ulibarri contended that the district court abused its discretion in misapplying the sentencing guidelines by improperly including, and miscalculating, a 2023 tax loss. He also contended that the district court improperly assessed a two-level “sophisticated means” enhancement.

Ulibarri was not indicted for the 2023 tax period, but the district court had included the 2023 loss in his sentencing. Ulibarri argued that his 2023 tax loss was not related to the tax scheme conduct. The 10th Circuit reviewed IRS testimony and district court findings to the contrary, which indicated the 2023 tax loss resulted from continuing to implement the tax scheme by using the sham trusts.

The 10th Circuit found that the district court did not err in finding that the sham trust usage in 2023 was part of the same course of conduct and aggregating it with the other loss amounts for the years in question.

In calculating the 2023 tax loss, the IRS agent used a guidelines method for unfiled returns treating the tax loss as 20% of gross income, less tax withheld or paid. Ulibarri made several arguments about the practice gross receipts and cost of goods deductions calculations done by the IRS agent under this method. However, the 10th Circuit noted that the guidelines contemplate a reasonable estimate based on available facts and found that the district court’s calculation of the 2023 tax loss was a reasonable estimate under that standard.

Finally, the guidelines provide a two-level sentence enhancement for an offense involving “sophisticated means,” which is especially complex or intricate conduct in execution or concealment of an offense. Ulibarri argued the tax scheme was not “sophisticated” and did not involve elaborate planning or concealment on his part; he had merely purchased Conner’s tax shelter services and relied on financial advice as a client.

The 10th Circuit had no trouble finding that Ulibarri’s offenses involved sophisticated means, noting he misused multiple financial accounts, sham trusts, and grantors, and went to elaborate lengths to hide more than $5 million in business income from the IRS.

The 10th Circuit also rejected Ulibarri’s effort to shift blame to the tax shelter promoter, noting that he continued using the tax shelter scheme despite clear and repeated warnings from his lawyers and accountants that the conduct was unlawful.

Based on these findings, the 10th Circuit concluded that the district did not err in applying a sophisticated means sentencing enhancement.

Substantive reasonableness

The 10th Circuit next addressed whether the district court abused its discretion in applying the following U.S. Code § 3553(a) factors to impose an unduly long sentence:

• The nature and circumstances of the offense and the history and characteristics of the defendant
• The need for a sentence to reflect the seriousness of the crime, deter future criminal conduct, prevent the defendant from committing more crimes, and provide rehabilitation
• The sentences that are legally available
• The sentencing guidelines
• The Sentencing Commission’s policy statements
• The need to avoid unwarranted sentence disparities
• The need for restitution

Ulibarri argued that the district court did not give adequate weight to certain factors, including the compromise to his personal and professional reputation, the conviction itself as general deterrence without a custodial sentence, unfair sentencing disparity relative to similarly situated defendants, and his inability to work while incarcerated which delayed restitution payment.

The 10th Circuit found that all of Ulibarri's factors were argued at length during the sentencing hearing and further found that “re-weighing” the § 3553(a) factors would be "beyond the ambit of our review."

The 10th Circuit concluded that the sentence imposed was within the guidelines range and presumptively reasonable, and the sentence, therefore, was not substantively unreasonable.

Conclusion

The 10th Circuit decision in Ulibarri shows the difficulty in challenging district court discretion in applying sentencing guidelines. The decision also rejects the idea that a taxpayer can simply rely on a tax shelter promoter or professional advisor in structuring and implementing a tax shelter scheme.

Endnotes
1 2026 PTC 130; 10th Cir. 2026.
2 Id.

Jeff Schoenberger is a business coach for Lawyerist and a senior consultant for Affinity Consulting.

The world needs lawyers. People have disputes, contracts, estates, and regulatory puzzles that require the legal knowledge and services lawyers offer. But being needed does not necessarily mean being profitable. 

Even as the legal market posts solid gains, many firms, especially mid-tier and smaller firms, are feeling the squeeze. Rising costs, talent competition, and changing client expectations are pressing firms to rethink long-standing operational assumptions. 

See the big picture 

Contrary to some gloomy predictions of slow growth for law firms, recent years delivered strong results:

• Demand for legal services in 2024 grew approximately 2.6%, the strongest increase since before the 2008 financial crisis.1
• Billing rates have continued to climb, contributing to higher revenues across many firms.
• Among the Am Law 100, total gross revenue reached roughly $158 billion in 2025, representing about 13.3% year-over-year growth.2
• Profits per equity partner rose 12.3%.3

At the same time, the pace of demand growth decelerated late in 2024, with quarterly run rates settling around 3.3%.4 However, as 2025 unfolded, demand rebounded, with third-quarter law firm demand rising about 3.9% year-over-year, one of the strongest quarterly increases in recent history. This signaled sustained client activity and a continued opportunity for firms.5

Understand the new reality of expenses versus revenue 

Rising revenues are welcome, but costs are increasing right alongside them. Law firms continue to invest heavily in:

• AI, technology, and cybersecurity
• Talent acquisition and retention
• Practice management systems and business development

Operational costs have risen across the industry,6 and firms that treat these increases as unavoidable rather than strategic signals risk shrinking their margins and putting themselves at a competitive disadvantage. 

Combat rising expenses with efficiency 

Rethink client service touchpoints 

Not every client interaction needs to be in person or billed at premium rates. Routine communications can often be handled via phone, secure video (e.g., Webex, Zoom, Teams, or Google Meet), or client portals, a feature of many law practice management systems. This can reduce administrative friction while improving responsiveness. 

Invest in workflow and practice automation 

Modern intake, billing, and document workflows reduce repetitive work and improve consistency. The most successful firms adopt these tools deliberately, focusing on outcomes rather than novelty. 

Use metrics to guide decisions 

Tracking key performance indicators such as realization rates, cost per matter, and profitability by practice area enables smarter decisions. Across-the-board rate increases are rarely as effective as targeted, data-informed adjustments. 

Navigate the competitive talent frontier 

Recognize tight labor markets 

Competition for skilled lawyers remains intense. Corporations and in-house departments continue to draw talent away from firms, often offering competitive compensation and benefits packages.7 

Prioritize work-life balance 

Younger lawyers increasingly expect flexibility and balance. Firms clinging to rigid, hours-driven models may find themselves losing capable lawyers to alternative practice models. 

Focus on succession and mentorship 

As senior lawyers retire, firms without strong mentoring and succession plans risk losing both clients and institutional knowledge. Rebuilding those assets is far more expensive than maintaining them. 

Adapt to protect your firm’s bottom line 

The traditional law firm model is under pressure. That does not mean it is obsolete, but it does mean firms must adapt. 

Mid-tier and smaller firms should focus on:

1. Reducing unnecessary expenses without diminishing client value.
2. Managing revenue intentionally through pricing strategy and service design.
3. Treating talent strategy as a core business function, not an afterthought. 

Put simply, profitability is no longer a byproduct of good lawyering alone. Profitability in 2026 will belong to firms that align people, processes, and technology with clear business goals.

Endnotes 
1 State of the Legal Market 2025, THOMSON REUTERS INSTITUTE (Jan. 7, 2025), https://www. thomsonreuters.com/en-us/posts/legal/state-of-the-us-legal-market-2025/. 
2 The 2025 Am Law 100 by the Numbers, LEGAL. IO (April 15, 2025), https://www.legal.io/articles/5609720/The-2025-Am-Law-100-By-the-Numbers. 
3 Id. 
4 State of the Legal Market 2025, THOMSON REUTERS INSTITUTE (Jan. 7, 2025), https://www. thomsonreuters.com/en-us/posts/legal/state-of-the-us-legal-market-2025/. 
5 Debra Cassens Weiss, Law Firms See ‘Sharp Spike’ in Demand in Third Quarter, Report Says, ABA J. (Nov. 13, 2025), https://www.abajournal.com/web/article/law-firms-see-sharp-spike-in-demand-in-third-quarter-report-says. 
6 2025 Predictions: Driving Profitability for Law Firms, SUREPOINT TECHNOLOGIES, https://surepoint.com/resources/blog/2025-predictions-driving-profitability-for-law-firms-and-optimizing-operations/ (last visited April 14, 2026). 
7 Frederick J. Esposito Jr, Law Firm Finance Trends and Predictions for 2025, ABA (Jan. 1, 2025), https://www.americanbar.org/groups/law_practice/resources/law-practice-magazine/2025/january-february-2025/law-firm-finance-trends-and-predictions-for-2025/.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The U.S. District Court for the District of Maryland recently found that a lawyer acting as director, president, and treasurer of a client’s investment corporation was personally liable for the corporation’s tax liabilities,¹ showcasing the significant risk lawyers should consider when acting as a director and officer of a client business entity. 

Background 

Isaac Neuberger was a principal in a Baltimore law firm and represented Michael Konig and other Konig family members for many years. In 2001, Neuberger formed Lehcim Holdings, Inc. for the family to utilize as an investment company. Neuberger was Lehcim’s sole director, president, and treasurer. 

Lehcim engaged in a variety of lending transactions with other Konig family business entities, including a series of loans of more than $8 million from Nightingale Ventures, Ltd. Neuberger was also the director of Nightingale from 2002-2009. Lehcim claimed substantial tax deductions for 2010-2020 for interest accruing on these loans from Nightingale. 

The IRS determined on audit that the Nightingale loans were not bona fide debt and disallowed the Lehcim interest expense deductions. In 2019, the IRS issued a Notice of Deficiency for more than $1.4 million in unpaid taxes and penalties, and it followed in November 2020 with the issuance of a Final Notice of Intent to Levy for more than $2 million. 

Neuberger and his firm outlined a complex plan for collection of Lehcim receivables and repayment of the Nightingale loans that was to involve money transfers among multiple companies. Konig was tasked with implementing the plan. This plan was completed in 2019 and 2020, resulting in more than $8.8 million in payments from Lehcim to Nightingale. 

In 2020, Neuberger, as Lehcim’s president, submitted a Form 433-B, Collection Information Statement for Businesses, to the IRS for Lehcim, showing assets substantially less than its liabilities. The IRS pursued collection efforts against Lehcim and issued Notices of Levy to Neuberger’s firm and related Konig entities, but the IRS did not receive funds from those sources. 

In 2022, the United States sued Neuberger under the Federal Priority Statute,² seeking a judgment that Neuberger was personally liable for Lehcim’s tax liabilities. An IRS expert determined that Lehcim was insolvent at the time each of the payments in question was made from Lehcim to Nightingale. 

District court decisions 

The district court issued decisions in 2025 and 2026 in this case. In the 2025 decision, the court addressed the elements for applicability of the Federal Priority Statute: (1) a debt due the United States, (2) the debtor’s insolvency, and (3) a triggering event under the statute such as a bankruptcy or assignment for the benefit of creditors. The court also addressed Neuberger’s representative liability.

First the court cited prior authority for the conclusion that a federal tax debt is clearly a claim of the United States under the statute. The court agreed with the IRS expert that Lehcim was insolvent before each of the transfers to Nightingale. The court rejected Neuberger's argument that the government could not take the position that the Nightingale loans were not bona fide liabilities for tax assessment purposes, but alternatively treat the loans as liabilities for purposes of Lehcim’s solvency. The court noted that IRS disallowance of the Nightingale loan interest deductions was not the applicable test for whether to include this debt for insolvency purposes. 

The court then found that the transfers of more than $8.8 million by Nightingale, regardless of character, were preferential transfers akin to bankruptcy and were made when Lehcim was insolvent, satisfying the triggering event requirement for purposes of the Federal Priority Statute. 

The district court then turned to Neuberger’s potential representative liability. Under 31 U.S.C. § 3713(b) a “representative … paying any part of a debt … before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.” In this context, the court found that Neuberger was Lehcim’s representative who had knowledge of the government’s claim at the time of the transfers to Nightingale. 

Noting that Neuberger was Lehcim’s sole director, president, and treasurer, the court found that Neuberger had authority to act on behalf of Lehcim and was integral in the development and execution of the plan to pay Nightingale before paying the tax liabilities — even though Lehcim’s owner, Konig, was ultimately responsible for implementing the plan. Based on these determinations, the court held that Neuberger was responsible for asset transfers under the Federal Priority Statute. 

Following the court’s 2025 decision, the parties further disputed damages. The government argued that Neuberger was responsible for all Lehcim’s tax liabilities, including continuing accruals of penalties and interest under the Internal Revenue Code, for a total of more than $3.3 million by the end of October 2025. The court found no support for tax law computations under the Federal Priority Statute. Instead, the court found that damages under the Federal Priority Statute should be determined based on the amount of the government claim for which Neuberger had notice, and not the ongoing accruals of penalties and interest.

Therefore, the court held that Neuberger was liable for approximately $1.88 million of taxes, penalties, and interest identified in the IRS’ 30-day letter issued in 2019. 

Conclusion 

The Neuberger case demonstrates the significant risk for a lawyer acting as a director and officer of a client business entity. The lawyer in this case appears to have outlined a plan for repayment of loans and possible resolution of tax liabilities as counsel, but when the client did not follow through and pay the business entity tax liabilities, the lawyer was left with substantial financial exposure.

Endnotes 
1 U.S. v. Neuberger, 2025 PTC 358 (D. Md. 2025); 2026 PTC 24 (D. Md. 2026). 
2 31 U.S.C. Section 3713.

From St. Louis to Kansas City to Springfield and across the whole country, one issue that seems to unite lawyers is this: We’re not great at billing our clients.

We didn’t go to law school to learn how to become bill collectors, and my school certainly didn’t offer many “how to run a law firm” management courses. So, when and how exactly are we supposed to pick up the details on invoicing?

Because of this, many firm owners learn receivables by trial and error (legal pun intended). With that in mind, here are a few billing tips and tricks to help along the way:

Three tried and true billing tips for Missouri law firms
1. It’s a mental game.

Clients come to you at some of the worst moments in their lives. The least lawyers can do is be predictable in our billing schedule.

Clients shouldn’t be waiting months to receive an invoice, and sending bills sporadically doesn’t foster confidence (or trust) between you and your client. Whether you bill monthly or on another cadence, the key is consistency.

A practical rule of thumb: send invoices around the 4th of every month. If the client gets paid on the 1st, their paycheck has likely cleared by the time your bill arrives, making yours one of the first bills they’ll pay rather than something that gets pushed to “later.”

2. The call is coming from inside the house (yes, you).

Often, the real reason firms fall behind on billing is simple: hours don’t get logged. We’ve all been there; waiting until the end of the month to input time, only to realize we’re trying to reconstruct an entire month of work like it’s a missing evidence timeline.

The problem is that it’s nearly impossible to recreate every billable increment for a month. We forget details. You log six hours for a day that happened two weeks ago, but you know you were at the office for ten. Now you’re losing revenue for the firm — and for yourself.

You and your staff need a rule for tracking time. Ideally, this happens daily, but weekly is more realistic for many firms.

And if you have a few “problem children” at your firm who struggle to track time consistently, consider adopting Smokeball’s Autotime feature. It runs in the background and tracks what you’re doing and for which matters.

3. It’s time to join the modern day

Lawyers are not always known for being early adopters of change, but if there’s one place where modernizing pays off quickly, it’s billing.

It’s time to adopt technology that can automate the most frustrating parts of the process. Your firm administrator will thank you. Your future self will, too.

That means using software like Smokeball, which lets you:

— Print prebills in bulk (and separated by lawyer)

— Automate invoice creation

— Send bills to clients all at once — without going case-by-case

Instead of manually pushing invoices one matter at a time, you can press a button, and your bills go out in a batch.

And if you bill hourly, it’s also worth thinking about adopting an evergreen retainer policy, which can also be automated with the right system.

Bottom line for law firm billing

Billing doesn’t have to be the headache it was back in the day. Technology exists now to make it easier and more consistent.

Try it and give yourself one less thing to chase at the end of every month.

Trust accounting and billing software by Smokeball

As a member of The Missouri Bar, you get access to Smokeball’s trust accounting and billing software at no cost, valued at $588/user/year, to help you manage your trust accounting compliantly and bill easily. Click on this link to access your software: https://bit.ly/mobarbill-blog-0226.

Jordan Turk is a practicing lawyer in Texas and Smokeball’s director of education and attorney development. Smokeball is cloud-based legal practice management software. 

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The U.S. Tax Court recently held that taxpayers had taxable income resulting from termination of whole life insurance policies, a consideration that tax lawyers should keep in mind when serving their clients.

In Fugler v. Commissioner of Internal Revenue,¹ the tax court found that when a couple terminated whole life insurance policies with outstanding loans, they received constructive distributions from the policies that were includible in their gross income.

Background 

In 1987, David and Cindy Fugler purchased whole life insurance policies from Mass Mutual insuring their two children. The Fuglers were the owners and beneficiaries of the policies, which required annual premiums of $150 per year until each child’s 65th birthday or their death, whichever occurred first. The policies also allowed borrowing against cash surrender value. 

From 1988-2006, the Fuglers paid the annual premiums. In 2006, they borrowed $10,500 from one policy and $11,000 from the other policy. From 2007-2016, the Fuglers borrowed from the policies to cover the annual premiums. Interest on these loans also was added to the loan balances on each policy. By 2018, the policies had loan balances of $19,845 and $20,699. 

The policies also had cash surrender values which increased over time from accumulated dividends but were reduced by the outstanding policy debts. In 2018, the Fuglers notified Mass Mutual of their intent to terminate the policies. Mass Mutual provided surrender forms and advised them that surrender could result in taxable income. The Fuglers submitted the surrender forms and received checks for $3,033 and $2,729 with respect to the policies.

Mass Mutual reported the distributions to the Fuglers on Form 1099-R, indicating taxable income with respect to each policy, calculated as the gross distribution, including the checks distributed and the outstanding loan balance, reduced by insurance premiums paid. For one policy, this resulted in a $16,028 taxable amount. For the other policy, it was a $16,578 taxable amount. The Fuglers did not report income from Mass Mutual on their 2018 tax return.

The IRS proposed an increase to the Fuglers’ income for the taxable amounts on the Mass Mutual Form 1099-R, and the Fuglers pursued relief in tax court. The issues in the case were: 

(1) whether the policy distributions were includible in the Fuglers’ 2018 taxable income, 
(2) whether the Fuglers were entitled to a deduction for interest paid on the policy loans, and 
(3) whether the Fuglers were entitled to innocent spouse relief under Internal Revenue Code § 6015.²

Statutory background and tax court analysis 

Code § 61 defines “gross income” as income from any source including “income from life insurance and endowment contracts.” Code § 72 further provides that amounts received under annuity, endowment, or life insurance contracts are included income, and amounts received from nonannuity life insurance contracts are income to the extent they exceed investment in the contract. 

The tax court also cited prior cases for the concept that loans against life insurance policy cash value are loans from the insurance company to the policyholder, and these loans are not taxable distributions when received. However, the tax court stated that a taxpayer constructively receives proceeds from a terminated life insurance policy to the extent that existing policy loans are satisfied from the policy’s cash value, citing Mallory v. Commissioner of Internal Revenue.³ 

In Fugler, the tax court, therefore, found that the taxpayers constructively received proceeds in the amount of the outstanding loan balances that were satisfied upon termination of the policies. The tax court held that the Fuglers’ taxable income for 2018 included these constructively received policy loan balances in addition to the checks received for the remaining cash value of each policy.

The tax court next addressed the Fuglers’ claim for interest expense deductions. The Fuglers claimed the proceeds of the policy loans were used in connection with their mining and logging business. The commissioner stated the interest was nondeductible personal interest. Section 163(h) disallows a deduction for personal interest, unless the interest is identified in §163(h)(2), which includes categories such as interest relating to a trade or business, investment, qualified residence, etc. However, the tax court found the Fuglers offered no evidence to show they were engaged in a mining and logging trade or business and no evidence that the loan proceeds were used for that purpose. As a result, the tax court held that the interest paid on the policies was nondeductible personal interest.

Finally, the tax court recognized that the IRS had conceded Cindy Fugler was entitled to innocent spouse relief. The tax court also confirmed that innocent spouse relief is only available to one spouse in response to David Fugler raising a similar claim.

Conclusion 

Fugler demonstrates why lawyers should remind their clients to carefully consider the tax implications in terminating insurance policies with outstanding policy loans. In some cases, it may make more economic sense to maintain the policies until death of the insured so that nontaxable death benefit proceeds repay the loans. 

Fugler also reminds taxpayers that interest deductions are only available for specific categories, like a trade or business, and that taxpayers must be able to demonstrate use of loan proceeds relating to the category in question for deductibility.

Endnotes 
1 Fugler v. Commissioner of Internal Revenue, T.C. Summ.Op. 2025-10 (U.S. Tax Ct., 2025). 
2 § 6015. Relief from joint and several liability on joint return, 26 USCA § 6015. 
3 Mallory v. Commissioner of Internal Revenue, T.C. Memo. 2016-110 (U.S. Tax Ct., 2016).

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The 8th U.S. Circuit Court of Appeals recently held that the Mayo Clinic is an “educational organization” exempt from unrelated business income tax with respect to certain indebtedness. In Mayo Clinic v. U.S.,¹ the 8th Circuit affirmed the U.S. District Court for the District of Minnesota’s summary judgment in favor of the Mayo Clinic and rejected the government’s argument that the Mayo Clinic’s patient care was a substantial noneducational purpose. Instead, the court affirmed a broad definition of an educational organization for purposes of the unrelated business income tax exemption. 

Background

Internal Revenue Code § 501(c)(3) exempts from taxation corporations and foundations “organized and operated exclusively for religious, charitable, scientific … or educational purposes.” The code also allows individual taxpayers to deduct “charitable contribution[s]” to “an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.”² 

Concerned a judicial weakening of the § 501(c)(3) exclusivity requirement had created a tax loophole for for-profit businesses, Congress imposed an unrelated business income tax (UBIT) on § 501(c)(3) organizations.³ In the Tax Reform Act of 1969, Congress expanded UBIT to include acquisition indebtedness of debt-financed property that is held to produce income. The UBIT provision in Code § 514(c) at issue provides that acquisition indebtedness does not include debt incurred by a “qualified organization” in acquiring or improving real property. Qualified organizations include § 501(c)(3) educational organizations as defined in § 170(b)(1)(A)(ii). 

The Mayo Clinic is a Minnesota nonprofit corporation and a § 501(c)(3) tax-exempt organization. The Mayo Clinic operates a nationwide network of hospitals, clinics, and the Mayo Clinic College of Medicine and Science. For the tax years in question, the Mayo Clinic received investment income from debt-financed property and claimed exemption from UBIT under § 514(c)(9)(C)(i), which incorporates the definition of “educational organization” from § 170(b)(1)(A)(ii). 

Following an audit, the IRS denied the Mayo Clinic’s exemption, asserting that its health care operations were more than incidental to its educational activities, and it did not qualify as an “educational organization” under the relevant treasury regulations. The Mayo Clinic paid the assessed UBIT and sought a refund in district court. 

The district court initially ruled in the Mayo Clinic’s favor, holding the “primary function” and “merely incidental” tests in the regulations were invalid. On appeal, the 8th Circuit partially reversed the district court’s ruling, upholding the validity of the “primary function” and “merely incidental” requirements but rejecting the limitation in the regulations to “formal instruction.” The case was remanded for further factual findings, and the district court again found the Mayo Clinic was organized and operated exclusively for educational purposes and had no substantial noneducational purpose. The “fusion” of the Mayo Clinic’s health care, education, and research functions was the basis for the district court’s factual conclusion that the Mayo Clinic has no substantial noneducational purpose. 

The government appealed, and the 8th Circuit issued its decision in July 2025.

8th Circuit analysis and decision 

The 8th Circuit decision focused on two key issues: the meaning of “primary” purpose, and whether there was integration of functions to support a substantial noneducational purpose. 

Meaning of “primary” purpose 

The government argued that to qualify as an educational organization, education must be the organization’s predominant purpose and not merely a substantial one. The 8th Circuit rejected this argument, affirming the district court’s interpretation that “primary” means “substantial” rather than exclusive or predominant. The 8th Circuit relied on Board of Governors v. Agnew,⁴ where the U.S. Supreme Court held that “primary” can mean “essentially” or “fundamentally.” The 8th Circuit further reasoned that this interpretation aligns with treasury regulations recognizing organizations such as museums, zoos, and symphony orchestras may have multiple substantial purposes and still qualify as educational organizations. 

Based on this analysis, the 8th Circuit concluded that the district court did not err in its interpretation of “primary” as meaning substantial. The 8th Circuit also noted that even under the government’s definition of “primary,” the district court properly found that the Mayo Clinic’s substantial patient care activities are educational based on the Mayo Clinic’s careful integration of education and clinical practice. 

Substantial noneducational purpose and integration of functions 

The government also argued that the Mayo Clinic’s expansive clinical practice represented a substantial noneducational purpose in the form of a commercial business. The 8th Circuit determined the proper test is whether a nonexempt purpose is substantial, not whether the organization engages in activities that could also be conducted for profit. The court noted that a single activity can serve more than one purpose and that commercial activities can further a tax-exempt purpose. Relying on the district court’s factual findings showing that education, research, and clinical practice at the Mayo Clinic are fully integrated, the 8th Circuit concluded that the Mayo Clinic’s patient care is a vehicle for delivering medical education rather than a separate noneducational function. 

The court acknowledged that the presence of a substantial noneducational purpose could disqualify an organization from the UBIT exemption but found no evidence that the Mayo Clinic’s clinical practice existed independently of its educational mission. The 8th Circuit also rejected the government’s argument that the Mayo Clinic should be treated as a hospital or research organization rather than as an educational organization, holding that the Mayo Clinic’s characteristics as an educational institution entitled it to the UBIT exemption.

Based on this analysis, the 8th Circuit affirmed the district court holding that the Mayo Clinic is an “educational organization” exempt from acquisition indebtedness UBIT. 

Conclusion 

The 8th Circuit’s decision in Mayo Clinic provides lawyers with important guidance for tax-exempt organizations with multiple integrated purposes. The court’s adoption of a “substantial” standard for the “primary” purpose test allows a potentially more forgiving factual analysis for academic medical centers and other similarly integrated institutions. Importantly, the government arguments and appeals in this litigation may indicate that the IRS intends to further challenge educational organization exemptions in this context and otherwise. The court’s analysis in Mayo Clinic emphasizes the importance of integrating educational activities with other organizational functions and the factual scrutiny lawyers should expect in these cases.

Endnotes

1 Mayo Clinic v. United States, 145 F.4th 877 (8th Cir. 2025)
2 IRC § 170(b)(1)(A)(ii).
3 See IRC § 512-14
4 Board of Governors of Federal Reserve System v. Agnew, 329 U.S. 441 (U.S. 1947)

The Missouri Bar and Smokeball recognize the important role solo and small firms play in every local community. By providing Smokeball Bill at no cost, all members of The Missouri Bar will now have access to a user-friendly software solution that ensures trust accounting compliance and simplifies billing.  

“By providing Smokeball Bill at no cost to all Missouri Bar members, we hope to assist them with running efficient and compliant law firms so they can even better serve their clients,” said Shelly Dreyer, 2024-2025 Missouri Bar president.

Manually managing trust accounting can lead to compliance errors and malpractice claims. Smokeball Bill makes it simple for members to easily comply with trust accounting regulations. The software also helps firms send and collect invoices and bills.

“By providing Smokeball Bill software, which typically costs $588 per user/per year, at no cost to Missouri Bar members, we aim to enhance the resources accessible to the legal community as a whole and to the clients they serve,” said Jane Oxley, CRO and co-founder of Smokeball.

This is Smokeball's 14th no-cost product partnership with a state bar, following the announcement of partnerships with state bars including the State Bar of Texas and the Oklahoma Bar Association. To learn more about Smokeball’s no-cost product offering with The Missouri Bar or to sign up, please visit www.smokeball.com/missouribill.

About Smokeball - Smokeball is your partner to drive your law firm into the future. As the industry's leading cloud-based legal practice management software, Smokeball empowers you to run your firm specific to your area of law. Our platform gives you all the insights and tools you need to work smarter, not harder: automatic time tracking and invoicing, streamlined workflows for your specific practice area, a library of over 20,000 standard legal forms and documents, and actionable reports. Smokeball is a member benefit of over 20 U.S. bar associations. Learn how to run your best firm at smokeball.com.

About The Missouri Bar - The Missouri Bar was created in 1944 by order of the Supreme Court of Missouri. Its mission is to improve the legal profession, the administration of justice, and the law on behalf of the public. Through educational programs, publications, and more, The Missouri Bar serves as a valuable resource for members — and for the citizens of Missouri.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

The Internal Revenue Service recently issued a revenue procedure and revenue ruling on controversies involving worker classification that lawyers should know to best advise their clients or handle their own firms’ business.

Revenue Procedure 2025-10 provides updated guidance regarding the implementation of § 530 of the Revenue Act of 1978, which addresses controversies regarding whether individuals are employees for purposes of employment taxes. Revenue Procedure 2025-10 modifies and supersedes Revenue Procedure 85-18, clarifying the definition of employee, whether a taxpayer has treated an individual as an employee, § 530 procedural requirements, and the reasonable basis safe harbor.

The IRS also issued Revenue Ruling 2025-3 providing scenarios where § 530 relief and related Internal Revenue Code provisions may apply. 

Revenue Procedure 2025-10 

Section 530 was enacted to provide relief for taxpayers involved in worker classification disputes with the IRS. Section 530 generally provides that if a taxpayer has not treated an individual as an employee for a tax period, then the individual is deemed not an employee for that period unless the taxpayer had no reasonable basis for their position. Section 530 relief only applies if the taxpayer did not treat the individual as an employee for federal employment tax purposes and meets each of the following requirements for the period in question:

1. The taxpayer filed all required federal tax returns, including information returns, on a basis that is consistent with the taxpayer’s treatment of the individual as not being an employee (reporting consistency requirement).

2. The taxpayer did not treat the individual or any individual holding a substantially similar position as an employee (substantive consistency requirement).

3. The taxpayer had a reasonable basis for not treating the individual as an employee (reasonable basis requirement). A taxpayer shall be treated as having a reasonable basis if the taxpayer’s treatment was in reasonable reliance on any of the following: 

a. judicial precedent, published rulings, technical advice with respect to the taxpayer, or a letter ruling to the taxpayer;

b. a past IRS audit of the taxpayer in which there was no assessment attributable to the treatment (for employment tax purposes) of the individuals holding substantially similar positions; 

c. long-standing recognized practice of a significant segment of the industry in which that individual was engaged; or 

d. the taxpayer had some other reasonable basis for not treating the individual as an employee.

Revenue Procedure 2025-10 confirms the following definition of the term “employee” for purposes of § 530: 

"(1) an officer of a corporation under §§ 3121(d)(1), 3306(i), or 3401(c) of the code;

(2) an individual, who under the common law rules, has the status of an employee under §§ 3121(d)(2) or 3306(i); 

(3) agent-drivers, commission-drivers, full-time life insurance salespersons, home workers or traveling or city salespersons under §§ 3121(d)(3) (statutory employees) or 3306(i); 

(4) an individual who performs services that are included under an agreement pursuant to Section 218 or Section 218A of the Social Security Act (218 Agreement) under § 3121(d)(4) of the Code; and

(5) an officer, employee or elected official of a state, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of the foregoing under § 3401(c)."

Revenue Procedure 2025-10 outlines the following guidelines for determining whether there was “treatment” of an individual as an employee for a period for purposes of § 530:

"(1) The withholding of income tax or FICA taxes from any payments made to an individual, whether or not the tax is paid to the IRS, indicates ‘treatment’ of the individual as an employee. 

(2) Except as provided in paragraphs (6) and (7) below, the filing of an original or amended employment tax return (including a Form 940 ‘Employer’s Annual Federal Unemployment Tax Return,’ 941 ‘Employer’s Quarterly Federal Tax Return,’ 943 ‘Employer’s Annual Tax Return for Agricultural Employees,’ or 944 ‘Employer’s ANNUAL Federal Tax Return’), with respect to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee.

(3) The filing of Schedule H (Form 1040), Household Employment Taxes, with respect to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee. 

(4) The filing of a Form W-2 ‘Wage and Tax Statement’ with respect to an individual, or the furnishing of a Form W-2 to an individual, whether or not tax was withheld from the payments made to the individual, indicates ‘treatment’ of the individual as an employee. 

(5) Contracting with a third party to perform acts required of employers with respect to an individual, whether or not tax is withheld or paid to the IRS or the third party otherwise satisfies the terms of the contract, indicates 'treatment' of the individual as an employee. 

(6) The filing of a delinquent or amended employment tax return for a particular tax period with respect to an individual as a result of IRS collection or examination activities or other compliance procedures, does not indicate ‘treatment’ of the individual as an employee for that period. IRS correspondence that merely advises the taxpayer that no return has been filed and requests information from the taxpayer is not a compliance procedure. However, if the taxpayer takes any of the actions identified in section 3.03 with respect to those individuals in a later period (for example, the taxpayer withholds employment taxes or files employment tax returns with respect to those individuals for the periods following the period audited), those actions indicate ‘treatment’ of the individuals as employees for those later periods. 

(7) A return prepared by the IRS under § 6020(b) for a period is not ‘treatment’ of an individual as an employee for that period."

Revenue Procedure 2025-10 also includes key procedural considerations for application of § 530 in an employment tax audit, including the following:

– “[T]he IRS will provide written notice of the availability of section 530 treatment before or at the start of any employment tax audit inquiry relating to the employment status of one or more individuals who perform services for the taxpayer or when it appears that a determination concerning worker classification will be made.”

– Before analyzing whether individuals are employees in an employment tax audit, the IRS will first consider whether a taxpayer has satisfied the requirements of § 530. 

– Detailed considerations are outlined for the application of the reporting consistency, substantive consistency, and reasonable basis requirements. This includes details regarding how the IRS will apply the reasonable basis safe harbors in § 530(a)(2). 

– If a taxpayer establishes a prima facie case for meeting the reporting consistency requirement, substantive consistency requirement, and one of the reasonable basis safe harbor requirements, and the taxpayer has fully cooperated with reasonable requests from the IRS, then the burden of proof will shift to the IRS with respect to the applicability of § 530.

Revenue Ruling 2025-3 

Revenue Ruling 2025-3 addresses whether § 530 or reduced rates under § 3509 of the Internal Revenue Code apply to five example situations, as well as whether the IRS will issue a Notice of Employment Tax Determination under § 7436 for U.S. Tax Court review. Section 530 rules are outlined in this ruling consistent with Revenue Procedure 2025-10. The ruling also confirms that under § 3509, a taxpayer who does not meet the § 530 requirements may still be eligible to remit unpaid taxes at reduced rates so long as the taxpayer did not intentionally disregard the requirement to withhold and deduct employment taxes. 

Revenue Ruling 2025-3 notes that § 7436 provides for tax court review of certain employment tax determinations by the IRS if the following elements are present: 

"(1) an examination in connection with the audit of any person; 

(2) a determination that – 

(a) one or more individuals performing services for such person are employees of such person for purposes of subtitle C, or 

(b) such person is not entitled to relief under section 530(a) with respect to such an individual; 

(3) an ‘actual controversy’ involving the determination as part of an examination; and 

(4) the filing of an appropriate pleading in the Tax Court."

The five situations and IRS positions are summarized here. 

Situation 1 

The taxpayer hires individuals who provide services during the year and pays each individual a weekly fixed amount and a weekly bonus amount. The taxpayer does not withhold or pay federal employment taxes on any of the payments and reports the total amount of the fixed weekly amounts and the weekly bonus amounts on Form 1099-NEC “Nonemployee Compensation.” 

During an audit, the IRS determines that (1) the taxpayer does not meet the statutory requirements for § 530 relief, and (2) the individuals are employees. The IRS proposes to assess federal employment. The taxpayer claims it satisfies the statutory requirements for § 530 relief and does not agree that the individuals are employees. 

The IRS holds that § 530 is applicable to this situation because the taxpayer did not treat the individuals as employees, and the IRS is reclassifying the individuals as employees. Whether the taxpayer is entitled to § 530 relief depends on the substantive consistency, reporting consistency, and reasonable basis requirements. If § 530 does not apply, § 3509 may be applicable because the taxpayer treated the individuals as non-employees and did not deduct and withhold federal employment taxes from amounts paid to the individuals, and the IRS is reclassifying the individuals as employees. Whether the taxpayer is entitled to § 3509 reduced rates depends on the statutory requirements in § 3509. 

A § 7436 Notice will be issued at the conclusion of the audit or after the IRS appeals the consideration if no agreement is reached. 

Situation 2 

The taxpayer employs individuals who perform services during the year, treats the individuals as employees for the services that they perform, and pays each individual a weekly salary and a weekly bonus amount. The taxpayer treats the weekly salary as wages for federal employment tax purposes and withholds and pays federal employment taxes with respect to the weekly salary. The taxpayer does not treat the weekly bonus amounts as wages for federal employment tax purposes and reports the bonus amounts on Form 1099-NEC. 

During an audit, the IRS concludes the bonus amounts are wages and proposes assessing federal employment taxes on the bonus amounts. The taxpayer claims it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts and does not agree that the bonus amounts are wages. 

The IRS holds § 530 and § 3509 are not applicable to this situation because the IRS is not reclassifying the individuals as employees. The taxpayer treated the individuals as employees, and there is no controversy over whether the individuals are employees or independent contractors with respect to their services. 

A § 7436 Notice will be issued at the conclusion of the audit or after the IRS appeals the consideration if no agreement is reached. 

Situation 3 

Same facts as situation 2 except the taxpayer does not report the weekly bonus amounts on Form 1099-NEC or any other information return. The IRS holds § 530 and § 3509 are not applicable to this situation for the same reasons stated in situation 2, and the IRS will issue a § 7436 Notice at the conclusion of the audit or after appeals consideration if no agreement is reached. 

Situation 4 

Same facts as situation 2 except the taxpayer does not report the weekly bonus amounts on Form 1099-NEC or any other information return and does not claim it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts. The IRS holds § 530 and § 3509 are not applicable to this situation for the same reasons stated in situation 2. 
In situation 4, the IRS will not issue a § 7436 Notice because the taxpayer did not claim relief under § 530 concerning the bonuses, and there is no controversy over whether the individuals are employees or independent contractors. 

Situation 5 

The taxpayer employs individuals who perform services during the year and enters a contract with a third party to pay each individual a weekly salary, withhold and pay federal employment taxes, and file federal employment tax returns. The third party pays the weekly salaries, withholds, pays federal employment taxes, and reports the weekly salaries and taxes on Form 941 and Forms W-2 using the third party’s employer identification number.

In December of that same year, the taxpayer pays a year-end bonus amount directly to each individual for the individual’s services during the year but does not treat the year-end bonus amounts as wages, withhold or pay any federal employment taxes, or report the bonus amounts on any information return. 

During an audit, the IRS concludes that the bonus amounts are wages and proposes to assess federal employment taxes on the bonus amounts. The taxpayer claims it satisfies the statutory requirements for § 530 relief with respect to the bonus amounts and does not agree the bonus amounts are wages. 

The IRS holds § 530 and § 3509 are not applicable to this situation because the IRS is not reclassifying the individuals as employees. The year-end bonus amounts are additional wages for the same services performed by the individuals who were treated as employees. 

The IRS will issue a § 7436 Notice at the conclusion of the audit or after appeals consideration if no agreement is reached because (1) there was an examination in connection with an audit, (2) a determination was made that the taxpayer was not entitled to relief under § 530 with respect to the year-end bonus amounts, and (3) the IRS and the taxpayer disagree on whether the statutory requirements for § 530 relief have been met. 

Conclusion 

The recent IRS releases relating to employment tax audits provide a key roadmap for navigating worker classification audits. Section 530 can provide a safe harbor to avoid retroactive reclassification results, and § 3509 can provide key relief with reduced rates in some situations where § 530 relief is not available.

Chances are you have a credit card in your wallet right now. And I would bet you have an expectation that merchants will regularly accept your card as payment for goods and services. Your law firm’s clients are no different. Credit cards are a modern way of transacting business in 2024, and by not accepting credit cards, you are almost sending the message that your firm is behind the times. And quite frankly, that is not a good message to send out to the prospective client public, especially the growing millennial and even Generation Z client base. Whether your firm regularly deals with individuals or companies, offering the option of paying your firm’s bills and/or retainer requests by credit card is simply expected.

Your clients expect it in 2024

If you walked into a local merchant, selected items for purchase and then walked up to a payment register, most of us would expect the merchant to take credit cards and would likely be taken aback if asked to pay by cash or check only. Now, there are some businesses that still operate this way, but most throughout the world now transact business with credit cards. Law firms should be no different. Asking your client to pay you by cash or check only makes doing business with your firm harder and could, in the near future, cause a client to think twice about doing business with your firm. Further, credit card payments typically permit your client to extend their payment terms beyond the charge date, allowing your firm to get paid faster.

Get paid faster: control your cash flow

Too many lawyers look at the balance in their operating account as a barometer of business success. The better barometer is cash flow. How regularly are your invoices going out and how quickly are those invoices being “relieved” or paid? Delivering invoices quickly and accurately is the first step but making it easy for your clients to remit payment is just as important, if not more important. Simply put, accepting credit cards improves cash flow which is more important than cash in the bank. Cash flow is an analysis of current cash on hand, payables due to vendors, receivables expected from clients and anticipated billing in future periods.

Because firms primarily work on a “bills out, money in” basis, you want to shorten the time between the two actions.

Cost is simply the cost of doing business

This writer believes we should just buck up and eat those credit card processing fees. Getting paid faster is worth the 2-3% fee. And don’t pass that fee along to your clients — that’s again, in this writer’s opinion, petty and borders on ridiculous. If you’re accepting a $30,000 retainer, amounting to, let’s say, a $900 processing fee – i.e. 3%, you may want to simply ask your client to remit payment by check, but don’t refuse that retainer because it’s being paid by credit card. 97% of a retainer is much better than zero. And remember, the 2-3% fee is typically considered a normal business expense and tax deductible. Note, however, that there are some legal and ethical considerations.

Use credit card processing tools built into your law practice management software or deal with a merchant processing company that deals with law firms

You may use a law practice management software (LPMS) to track important case-related information like contacts, calendar appointments, documents, case facts, and communications including emails and texts. Examples of such products include Clio, MyCase, PracticePanther, Rocket Matter, and Smokeball. Of that sample, four of them have credit card processing built in. Smokeball, while having no built-in tool, tightly integrates with LawPay, as does MyCase, which is owned by LawPay’s parent company. While they still charge the typical credit card processing fee, they connect seamlessly to your LPMS-generated invoices and make it easy to include ePayment links in invoice emails. As a member of The Missouri Bar, you can receive discounts on certain products. Click here to view your member benefits.

If you do not use an LPMS, or yours lacks a built-in ePayment tool, you can still take advantage of credit card payments via a merchant processor.

Consider LawPay, Law Charge, or LexCharge, as they specifically deal with law firms. That means, for example, they’ll understand what an attorney’s trust account is and that there can be no merchant processing fees associated with it. Also, you would not have to deal with your banking institution’s in-house or preferred provider. Just about any credit card processing company can work with your firm and deliver fast payments to its bank accounts — operating and/or trust.

Every study of the subject tells us law firms that make it easy to pay by credit card are more likely to be paid faster and in full. Make it easier on the client and yourself by charging ahead.

For many law firms without a trained bookkeeper or accountant, the general ledger is the aspect of accounting that confuses them the most. Debits and credits, journal entries, and the chart of accounts can feel like foreign concepts. Here’s a simplified breakdown of these bookkeeping/accounting concepts.

Chart of accounts 

The chart of accounts is the list of all accounts within your general ledger. There are typically six main types of accounts: 

— Asset accounts include your bank accounts, your furniture, your equipment, and any other assets the firm may own.

— Liabilities accounts include credit cards and banknotes owed by the firm.

— Equity accounts, sometimes grouped with liability accounts, show the amount of capital a partner or shareholder may have in the firm. These are grouped with liabilities as they represent the equity due to the shareholder or partner. 

— Income accounts reflect the amount of fee income, interest income, etc., that has come into the firm during a given period. 

— Expense accounts reflect the various expenses incurred by the firm for things like payroll, rent, supplies, and other overhead-related costs. 

— Retained earnings accounts are automatically calculated within the accounting system, based on how all other accounts on the financial statements add up. Essentially, retained earnings represent the cumulative net worth of the firm. 

Journal entries 

Every entry on the general ledger is two-sided – a debit and a credit. Most journal entries are made automatically by the accounting software based on the transaction you entered. Occasionally, however, you may need to make a manual journal entry. 

An automatic journal entry happens when you enter a payment from a client into the system. The payment is for fees only. The accounting system sees that and automatically debits the bank account and credits fee income. It also happens when you write a check to the landlord for rent. It would automatically credit your bank account and debit the rent expense account. 

The hardest thing for most people to understand is when something is considered a debit versus when it is a credit. Most transactions affect your bank account somehow. If you can remember that money going into the bank account is a debit, and money coming out of your bank account is a credit, then the other side of the transaction is always going to be the opposite.

Financial statements 

An income statement, sometimes referred to as a Profit & Loss (or P&L), is the net income of the firm for the current fiscal period. It shows income versus expenses. The difference between them is the net income for the period. At the end of every fiscal year, the income and expenses zero out and the new fiscal year starts fresh. The net income is used for tax reporting, and it moves over to the balance sheet as part of total retained earnings. 

A balance sheet compares the assets to the liabilities/equity. The difference between the two is the total retained earnings. The assets and liabilities do not zero out at year end, but rather carry from year to year. The current year retained earnings should always match the net income year to date on the income statement. 

A trial balance represents a combination of all accounts on the chart of accounts, giving the full financial picture, essentially combining the income statement and the balance sheet. It typically gives a starting balance for each account, shows the net change to the account, and the ending balance for it. For some accounts the net change will be a debit and for others it will be a credit. Therefore, the total net change for all accounts during a particular period should be equal. If they are not, then somehow your general ledger has gotten out of balance and should be corrected. Checking the trial balance at the end of each accounting period should be a standard procedure. 

Budgeting 

Budgets are very important. Any good back-office software product will allow you to budget expenses and income, realistically mapping out your cash flow for the year. As you print your financial statements month to month, you can see how your firm is faring compared to the budget number and compared to prior months or years. This will help you identify trends before it’s too late. 

Conclusion 

Lawyers went to law school and passed the bar to practice law, not to do accounting. But it is a fact of life that part of owning any business is cash flow and billing/accounting. Also, your firm has a duty to responsibly manage your clients’ funds and provide proper accounting of services to each client.

Follow the guidelines above, familiarize yourself with the Rules of Professional Conduct, and make sure you have some checks and balances in place. By doing this, your firm will be able to focus on the practice of law, rather than worrying about finances. 

Correction: This article was updated at noon on Jan. 15, 2025, to correct the description of “expense accounts.”

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

Individual taxpayers should think about applicable tax rates, the standard deduction, limits on itemized deductions, and multiple other issues. Businesses should examine corporate tax rates, limits on business deductions, increased expensing, and first year depreciation for some assets. The deduction for qualified business income also continues to impact individuals and their businesses. This article outlines several individual and business planning issues to consider before year-end. These items will not apply in every situation, and taxpayers should adjust their planning for their circumstances. Taxpayers should carefully monitor ongoing legislation and the potential impacts on year-end matters. 

Year-end planning for individuals 

Look at expanded standard deductions 

Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions. For 2024, the basic standard deduction is $29,200 for joint filers, $21,900 for heads of household, and $14,600 for singles and married taxpayers filing separately. For taxpayers either 65 or older or blind, there are additional standard deductions. Many itemized deductions remain either reduced or eliminated. Taxpayers may find that the increased standard deduction provides more tax benefit unless allowable medical deductions (as limited), allowable state and local taxes (as limited), allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years. 

Increase withholdings 

Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year and doing so will not cause state and local tax deductions to exceed applicable limits. 

Plan for 3.8% net investment income tax 

This surtax is 3.8% of net investment income (NII) that exceeds modified adjusted gross income (MAGI) thresholds. Year-end planning for the 3.8% surtax depends on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI. 

Consider additional 0.9% Medicare tax 

This tax applies to individuals receiving a combination of wages with respect to employment and self-employment income exceeding applicable thresholds. Employers must withhold the additional Medicare tax from wages in certain circumstances. Self-employed persons must include it in estimated tax payments, and some employees may need more withholding to cover the tax. 

Expedite income 

Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year. 

Examine lower long-term capital gain rates 

Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. Analysis of taxable income, potential capital gains, and other applicable taxes is required to determine the best combination. 

Consider your retirement contributions and distributions 

Maximize retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 and older. Remember that retirement plan distributions may be subject to a 10% early withdrawal tax penalty for taxpayers who are not at least 59-and-a-half years old. There are certain exceptions to this penalty, including a limited qualified birth or adoption distribution. 

Review required minimum distributions (RMDs) from retirement accounts 

RMDs are the minimum amounts that must be withdrawn from qualified retirement plan accounts beginning at age 72, or age 73 for taxpayers reaching age 72 after Dec. 31, 2022. Participants who are still working and making contributions to an employer sponsored retirement account may be able to further delay RMDs on that account. Taxpayers who fail to take RMDs can be subject to a substantial excise tax on the required amounts that are not withdrawn. 

Consider making qualified charitable donations from traditional individual retirement accounts 

Qualified charitable distributions are made directly to charities, and $105,000 per taxpayer who is at least 70-and-a-half years old is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution may reduce RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions. 

Consider a Roth IRA conversion 

A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. A conversion will increase adjusted gross income (AGI) for this year, so taxpayers should consider the impact on other tax calculations. 

Examine your health savings account contributions 

This applies for taxpayers eligible to make HSA contributions. HSA contributions may be deductible from AGI, so the benefits could be available even if a taxpayer does not itemize deductions. 

Increase flexible spending account amount 

Increase the amount set aside for next year in an FSA if you did not set aside enough for this year. Earnings set aside in an FSA allow payment of medical and dental bills with pre-tax earnings. 

Wrap up gifts that apply for annual gift tax exclusion 

Complete annual gift tax exclusion gifts before the end of the year to save gift and estate taxes. For 2024, taxpayers can give $18,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to tax at their parents’ rates (kiddie tax). 

Consider education deductions and other credits 

Tax-free distributions from § 529 qualified tuition programs are allowed for higher education expenses. This has been expanded in recent years to include up to $10,000 per beneficiary per year for elementary or secondary public, private, and religious schools, as well as expenses for participation in certain apprenticeship programs and qualified education loan repayments. For taxpayers under certain income thresholds, there are also several credits and deductions available and limited student loan interest may be deductible. Student loan forgiveness in 2024 should generally be excludible from income for federal tax purposes but may result in state or local income taxes. 

Consider home related tax provisions 

Mortgage interest is limited to the level of acquisition indebtedness depending on when the home was acquired ($750,000 for homes acquired on or after Dec. 16, 2017; $1 million for homes acquired before that date); mortgage interest allocable to the portion of a home used to operate a business is not subject to this limitation. Interest on home equity indebtedness may be deductible to the extent the debt was used to buy, build, or substantially improve the home. Gain of up to $500,000 for married taxpayers ($250,000 for other taxpayers) on the sale of a home is excluded from income, but the portion of the home used for business or rented reduces this exclusion from gain. Discharges of qualified principal residence indebtedness may be excluded from gross income. 

Consider clean energy credits 

Clean energy credits include residential clean energy credits and vehicle related credits. Eligibility for residential credits depends on the improvements made, annual limits, and or applicable percentages. Vehicle credits vary by date of acquisition, battery size, and manufacturer eligibility, which can be impacted by total qualifying vehicles sold and place of final assembly. 

Year-end planning for business owners 

Consider the qualified business income deduction 

This applies for non-corporate taxpayers where up to 20% of qualified business income from a domestic business operated as a sole proprietorship, partnership, LLC taxed as a partnership, or S corporation. For 2024, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $383,900 for married couples filing jointly or $191,950 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into a particular year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end. 

Make expenditures before year-end that qualify for § 179 business property expensing 

For tax years beginning in 2024, the expensing limit is $1.22 million for property placed in service this year, reduced dollar for dollar for property placed in service over $3.05 million. This expensing is available for most depreciable property and qualified improvement property, which generally includes interior building improvements, and roofs, HVAC, fire protection, alarm, and security systems. Importantly, property acquired and placed in service before year-end is eligible for full expensing for the year. 

Look at first-year bonus depreciation 

Consider first-year bonus depreciation for new and some used machinery and equipment purchased and placed in service. Like expensing, bonus depreciation is available for the full year even if the asset was placed in service late in the year, so year-end purchases may receive a full first-year bonus write off. Notably, bonus depreciation is being phased out, with 60% available in 2024; 40% in 2025; 20% in 2026; and elimination in 2027. 

Consider changing to the cash method of accounting, rather than the accrual method 

“Small businesses” with less than $30 million (for 2024) of average annual gross receipts over a three-year period may be eligible for the cash method if they meet other requirements. Depending on the business, the cash method of accounting may allow more flexibility in timing income and deductions. 

Consider timing for debt-cancellation and disposition 

Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year. Also take into account disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income. 

Review partnership and S corporation information 

Review partnership and S corporation basis to make sure it is sufficient to deduct losses in current and future years. Also examine S corporation salaries to ensure that shareholders receive reasonable wages and that distributions are based on ownership percentages of shareholders. The IRS often audits S corporations that pay all profits as distributions without accounting for reasonable wages to shareholders for their work in the business. 

Consider setting up and utilizing retirement plans and health insurance plans 

These plans can provide key benefits for retention of employees and for owners of a business. 

Consider business credits 

A variety of credits may apply for a particular business, including credits related to retirement plans and employees, as well as research and development, clean energy, and vehicles credits. 

Conclusion 

Election outcomes could lead to new legislation and could provide additional considerations for year-end and ongoing planning.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

In O’Nan v. Commissioner,¹ the court found the taxpayer, a widow who had been granted innocent spouse relief, could not recover litigation costs from the Internal Revenue Service because the IRS position was substantially justified in the context of an issue of first impression relating to a tax lien priority argument. 

Background and findings of fact

Sarah O’Nan was married to Jonathan O’Nan until his death in November 2014. The O’Nans purchased a home in 2012 as joint tenants with right of survivorship, which the court found was a “survivorship tenancy” under Ohio law. The home was eventually encumbered by two mortgages. The O’Nans both signed the first and second mortgages, but Sarah O’Nan did not sign the promissory note with respect to the first mortgage. 

The O’Nans filed joint tax returns for 2012 and 2013 but did not pay their reported tax liabilities for those years. The IRS assessed these liabilities prior to Jonathan O’Nan’s death. After his death, the IRS filed a notice of federal tax lien against the O’Nans in April 2015. 

Sarah O’Nan sold the home in June 2015. The title company for the sale remitted the sale proceeds first to closing costs, next to the two mortgage holders, next $123,200 to the IRS in full satisfaction of the federal tax lien, and then the final net proceeds were issued to Sarah O’Nan. 

Prior to the home sale, Sarah O’Nan submitted Form 8857 to the IRS requesting innocent spouse relief for 2012 and 2013. In February 2017, the IRS granted Sarah O’Nan partial relief from joint and several liability for 2012 and full relief for 2013, but the IRS denied her claim for a refund of the IRS lien payment from the home sale proceeds. 

The tax court previously made the following findings and holdings with respect to the innocent spouse and refund claims in O’Nan v. Commissioner²:

1. Sarah O’Nan inherited her spouse’s one-half interest in the home fully subject to the IRS liens.

2. When § 6015(f) innocent spouse relief is granted, the innocent spouse’s federal tax liability is recalculated as if the spouses had filed married filing separate tax returns. 

3. Given Sarah O’Nan’s § 6015(f) relief, the IRS lien on the family home only attached to $3,340 (plus interest) of her separate tax liability for 2012. 

4. Under Ohio survivorship tenancy law, only the one-half of the sale proceeds from the home attributable to Jonathan O’Nan’s former one-half interest was available to satisfy the liabilities encumbering his interest. 

5. Sarah O’Nan signed the first mortgage deed but not the associated promissory note, so she was only a surety for Jonathan O’Nan’s obligation under that note.

6. After splitting closing costs equally and allocating the first mortgage debt all to Jonathan O’Nan’s share of the proceeds, there was only a small remaining amount for the second mortgage holder and the IRS. 

7. Sarah O’Nan was not the sole signer of the second mortgage promissory note, so the second mortgage holder had priority over the IRS with respect to all remaining proceeds attributable to Jonathan O’Nan’s former one-half interest in the home. 

8. Therefore, the entire IRS lien payment had come from Sarah O’Nan’s separate funds, and she was due a refund under § 6015(g)(1) for all the proceeds previously paid to the IRS except for her remaining separate liability for 2012 of $3,340 (plus interest).

Following the 2023 tax court decision, Sarah O’Nan requested an award from the court under § 7430 of almost $87,000 for attorney’s fees and litigation costs. This 2024 decision addressed the § 7430 award request. 

Tax court decision 

The court first provided an overview and interpretation of the applicable statute. Section 7430 provides for an award of litigation or administrative costs to a taxpayer in a proceeding by or against the United States involving determination, collection, or refund of any tax, interest, or penalty where the taxpayer demonstrates they:

(1) are the prevailing party, 

(2) exhausted administrative remedies within the IRS,

(3) did not unreasonably protract the proceeding, and 

(4) claim reasonable costs.

A taxpayer is a “prevailing party” under § 7430 if they substantially prevail with respect to either the amount in controversy or the most significant issues and have a net worth of $2 million or less. The court noted that even if these requirements are met, a taxpayer will not be treated as a prevailing party if the commissioner establishes the IRS position in the proceeding was “substantially justified,” meaning it would satisfy a reasonable person or has a reasonable basis in both law and fact. 

The court further noted that even if a taxpayer does substantially prevail, or even if the commissioner’s position was substantially justified, the taxpayer will be treated as a prevailing party under § 7430 if the court’s determination of tax liability is not more than the liability amount of a taxpayer’s qualified offer. Section 7430(g) defines a qualified offer as a written offer that: 

(1) the taxpayer makes to the commissioner after the notice of deficiency and at least 30 days before the case is first set for trial, 

(2) specifies the offered amount of taxpayer liability, 

(3) is designated at the time as a qualified offer for purposes of § 7430, and 

(4) remains open until the earliest of the date the offer is rejected, and the trial begins or 90 days after the offer is made.

A qualified offer does not support prevailing party treatment if the court’s judgment is entered pursuant to a settlement agreement or if the amount of tax liability is not in issue in the proceeding. 

The court first addressed Sarah O’Nan’s requests for administrative costs incurred prior to the date the IRS Office of Appeals issued a final determination regarding her innocent spouse and refund requests. On these costs, the court summarily found that she could not recover administrative costs incurred before the final determination letter date, regardless of whether she otherwise qualified for a § 7430 award. 

The court next addressed Sarah O’Nan’s settlement proposals. The commissioner had conceded that Sarah O’Nan substantially prevailed, that her net worth did not exceed $2 million, that she exhausted her administrative remedies and that she had not unreasonably protracted the proceedings. So, if any of Sarah O’Nan’s settlement proposals were qualified offers, the court was prepared to award her costs even if the commissioner’s position was substantially justified. 

The court noted that the qualified offer provisions do not apply to proceedings where the amount of tax liability is not in issue. The case in question was instituted to dispute the commissioner’s refusal to issue a refund of amounts taken to satisfy undisputed tax liabilities of Jonathan O’Nan. Sarah O’Nan’s tax liability was not in issue before the IRS or in the prior tax court proceeding, so the court found that no amount of tax liability was in issue under § 7430. The court further found that none of Sarah O’Nan’s settlement proposals satisfied the procedural requirement to be a qualified offer because they did not reference § 7430 or purport to be a “qualified offer” as required by the statute. Therefore, the court held that none of the settlement offers qualified under § 7430.

Since no qualified offer was made but the commissioner had conceded the other requirements for § 7430 were met, the tax court then addressed whether the commissioner’s position was “substantially justified.” The court noted that in the prior proceeding, Sarah O’Nan’s initial positions focused on whether the IRS liens were valid, and the court had granted the IRS partial summary judgment concluding the commissioner was justified in rejecting Sarah O’Nan’s lien argument under applicable statutory and case law. 

After the partial summary judgment, Sarah O’Nan raised the argument that her equity in Jonathan O’Nan’s former one-half interest in the home was insufficient to account for the full IRS lien payment. This argument presupposed that when a federal tax lien attaches to property jointly owned by two spouses and one spouse is subsequently granted innocent spouse relief for tax liability secured by the lien, the lien then encumbers the relieved spouse’s interest in the property only to the extent of the liability for which she was not granted relief. The court considered this a concept of first impression, stating it was not aware of any statute, regulation, or case establishing this point of law prior to the court’s 2023 decision in this case. The court cited several cases for the proposition that the commissioner’s position is substantially justified when addressing a question of first impression. The court also found the commissioner’s position with respect to the lien was justified to a degree that would satisfy a reasonable person. 

Based on these findings, the tax court held that the commissioner’s position was substantially justified in the administrative and court proceedings and denied Sarah O’Nan’s motion for an award of costs under § 7430. 

Conclusion 

O’Nan v. Commissioner addresses a § 7430 request for costs in the context of innocent spouse relief, but it is a good outline of the statutory framework to request costs in other contexts that lawyers can use. The tax court emphasizes the importance of labeling settlement offers as qualified offers under § 7430 to support a later request for costs. Importantly, the court also confirms that the 2023 O’Nan decision was a case of first impression, establishing an important lien relief and refund consideration for innocent spouse cases that involve federal tax liens and IRS collection efforts.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

In Taylor v. Commissioner,¹ the tax court rejected the taxpayer’s argument that he was not a responsible person because of his learning disability with respect to mathematics and the company’s CPA committing embezzlement. The court focused on whether the taxpayer personally took responsibility for paying the employment taxes and his authority to control payment of the tax obligations rather than the taxpayer’s personal abilities.

Background 

The tax court noted that Rodney Taylor has degrees in political science, speech, and theater; is fluent in several languages; and has a management degree in international relations. He had previously worked for the Mississippi Economic Development Authority, a management consulting firm, and another business. In 1993, he formed Taylor & Co., Inc. 

During the periods in question, Taylor was CEO and sole shareholder of Taylor & Co., Inc., with authority to hire and fire employees and control Taylor & Co., Inc.’s bank accounts. According to Taylor, his professional success was attributable to his interpersonal skills, and he has a learning disability with respect to mathematics. He delegated a variety of business and personal financial responsibilities to employees and accountants, including a certified public accountant named Robert Gard. Taylor hired Gard to manage Taylor & Co., Inc.’s bookkeeping and accounting matters. 

Over several years, Gard embezzled $1 million to $2 million from Taylor & Co., Inc. The embezzlement was discovered in August 2013 and allegedly included funds that were allocated for some of the unpaid employment taxes in question. Taylor sued Gard and a bank that was used for the embezzlement scheme, and Taylor ultimately collected settlements from Gard’s insurance company and the bank. However, the recoveries were not used to pay any of the outstanding employment tax liabilities. Taylor used a portion of the settlement proceeds to pay personal expenses, and he paid himself a bonus in December 2013. In January 2014, Taylor transferred funds from Taylor & Co., Inc. bank accounts to a newly organized business entity. 

Code § 6672 provides a Trust Fund Recovery Penalty (TFRP) that can be assessed against any “responsible person” who willfully fails to collect, account for, and remit the “trust fund” portion of employment taxes that are withheld from payments to employees. After determining that Taylor & Co., Inc. had failed to collect and/or remit employment taxes, the IRS assessed a TFRP against Taylor as a responsible person with respect to Taylor & Co., Inc.’s trust fund employment taxes. 

After an unsuccessful administrative appeal, Taylor sought relief from the TFRP in tax court. Taylor argued he was not a responsible person under § 6672(a) because of his limited ability to comprehend mathematics. He further argued that Taylor & Co., Inc.’s failure to pay employment taxes was due to Gard’s embezzlement, that he did not willfully fail to pay the employment taxes, and that he had reasonable cause for failing to pay the employment taxes. 

Tax court opinion 

The tax court addressed the applicability of the TFRP under Code § 6672 in the context of Taylor’s specific factual circumstances and arguments. 

The court noted a responsible person is any person required to collect, account for, and pay over withheld taxes. Citing prior cases, the court explained the responsible person determination is a matter of status, duty, and authority rather than knowledge. The court found that an essential question is whether Taylor had sufficient control over Taylor & Co., Inc. affairs to ensure payment of the employment taxes. Key indicia of this control include holding corporate office, control over financial affairs, authority to disburse corporate funds, stock ownership, and the ability to hire and fire employees. 

During the periods in question, the court found that Taylor clearly had and exercised control over Taylor & Co., Inc.’s affairs. He was Taylor & Co., Inc.’s CEO and sole shareholder, and he controlled Taylor & Co., Inc.’s financial affairs, including disbursing the company funds to himself and to a newly formed business entity. He also exercised authority to hire and fire employees, delegate tasks to employees, and pursue Taylor & Co., Inc.’s lawsuit against Gard for embezzlement. 

As noted, Taylor argued he was not a responsible person because he had limited ability to comprehend mathematical concepts and delegated accounting and tax matters to Gard, whose embezzlement resulted in Taylor & Co., Inc.’s failure to pay employment taxes. The court rejected this argument, finding the focus in the responsible person determination was Taylor’s authority to control the company’s payment of employment taxes, not whether he personally took responsibility for that duty. 

Taylor also argued he was not a responsible person because he did not willfully fail to pay Taylor & Co., Inc.’s employment taxes. The court noted that willfulness for purposes of § 6672 is indicated if Taylor used Taylor & Co., Inc. funds for purposes other than payment of employment taxes. Under this standard, the court found that Taylor’s failure to pay employment taxes was willful. Taylor was clearly aware of the unpaid employment taxes by September 2013 when Taylor & Co., Inc. sued Gard for embezzlement of funds that were allocated for employment taxes. However, after this date, Taylor transferred funds to a newly formed company and paid himself a substantial bonus. Taylor also used proceeds from the embezzlement lawsuits for purposes other than paying the employment taxes. 

Finally, the tax court rejected Taylor’s argument that he had reasonable cause for his failure to satisfy Taylor & Co., Inc.’s employment tax obligations. Citing prior case law, the court found that a reasonable cause defense cannot be asserted by a responsible person who knew withholding taxes were due and consciously used corporate funds to pay creditors other than the government.

Based on these findings, the tax court held that Taylor was a responsible person for purposes of the § 6672 Trust Fund Recovery Penalty. The court also found that the IRS satisfied the notice requirements for assessment of the TFRP penalty against Taylor. 

Conclusion 

The Taylor case is a good outline of the requirements for assessment of withheld employment taxes against a responsible person under Code § 6672. The case demonstrates the difficulty in arguing for relief for business owners and executives, even in sympathetic circumstances like Taylor’s learning deficiency and his CPA’s embezzlement. Finally, the case emphasizes the importance of prioritizing payment of employment tax liabilities once they arise, as Taylor’s uses of corporate funds for purposes other than payment of the withheld taxes clearly influenced the finding that he was a responsible person.

Endnotes

1 T.C. Memo. 2024-33.

Perk No. 1: You can bill from anywhere

The flexibility offered by technological advancements allows lawyers to work remotely, far from traditional office settings. This capability has transformed legal practice, enabling lawyers to manage their duties from anywhere with internet access. While this benefit allows for unparalleled convenience and adaptability, it comes with significant caveats.

Con: Don't let go of work-life balance

The ability to work from anywhere can blur the boundaries between work and personal life. Lawyers may find themselves working during vacations or family time, as evidenced by social media posts showcasing work activities during supposed leisure times. This encroachment into personal time can erode work-life balance, leaving lawyers unable to truly disconnect and recharge.

Perk No. 2: You can be flexible with your schedule

The billable hour model affords lawyers the ability to schedule their work around personal commitments, such as doctor’s appointments, without needing to take official time off. This flexibility is seemingly ideal for managing both professional responsibilities and personal life efficiently.

Con: What is work-life balance anyway?

Despite the apparent scheduling freedom, the necessity to meet billable hour quotas can pressure lawyers into working extra hours to compensate for time taken off. This often results in a reluctance to fully utilize allotted PTO, leading to minimal breaks and a continuous work cycle that can hinder true relaxation and personal time.

Perk No. 3: The sky's the limit for your earning potential

Billing by the hour correlates directly with earning potential, where more hours worked equals higher income. This model rewards diligence and long hours with financial gains, offering substantial economic opportunities, particularly for those from modest backgrounds.

Con: Burnout is always one step away

The pursuit of increased earnings can lead lawyers into a relentless cycle of working longer hours to sustain and enhance their lifestyle. This relentless drive, while financially rewarding, can lead to burnout. An illustrative example is a lawyer who logged 3,000 billable hours in a single year, working consistently, even during holidays and weekends, showcasing the intense pressures and unsustainable work pace that come with such high earning expectations.

What is a lawyer to do about these risks?

While the billable hours model provides significant perks in terms of flexibility, remote work capabilities, and potential earnings, it also poses substantial risks to lawyers’ well-being and work-life balance. Firms and individuals must manage these challenges strategically.

Members of The Missouri Bar are eligible for a 10% discount on Smokeball subscriptions. Smokeball is an all-in-one cloud based legal practice management software. Click here to learn more.

Jordan Turk a practicing lawyer in Texas and the legal technology advisor at Smokeball. Her family law expertise includes complex property division and contentious custody cases, as well as appeals and prenuptial agreements. In addition to her family law practice, she’s passionate about legal technology and how it can revolutionize law firms.

Jordan graduated from the University of Texas at Austin with a B.A. in Classics, History, and Religious Studies and then went on to attend the University of Arkansas School of Law to earn her J.D. After almost four years of practice with a high-asset family law firm in Houston (and after being frustrated at the lack of automation in her firm), she discovered the world of legal technology which ultimately brought her to Smokeball.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

In Huffman v. Commissioner of Internal Revenue,¹ the tax court found that when a son exercised an option to purchase shares from his parents in a family business, the valuation of the shares did not meet Internal Revenue Code requirements and was not comparable to an arm’s length transaction between unrelated parties. 

Background 
The taxpayers in this case were Lloyd and Patricia Huffman, both long-time employees of Infinity Aerospace, Inc., formerly Dukes, Inc. (Dukes). Lloyd Huffman was a design engineer and Patricia Huffman had been a bookkeeper. In 1970, Lloyd Huffman became president and acquired 113,365 shares in Dukes. In 1979, Lloyd Huffman and Patricia Huffman formed the Huffman Family Trust, appointing themselves as trustees, and Lloyd Huffman had his Dukes shares reissued to the trust. In 1987, Lloyd Huffman was involved in a near-fatal car racing accident, and their son Chet Huffman became CEO and issued 5,000 shares of Dukes. 

The trust acquired 5,000 additional Dukes shares in 1990. Also in 1990, Lloyd Huffman entered into an agreement with the majority shareholder, Robert L. Barneson, granting Lloyd Huffman the right to purchase Barneson’s 322,241 Dukes shares upon Barneson’s death or by right of first refusal for a price not to exceed $2 per share. The agreement did not have a specific termination or exercise date for purchasing the Barneson shares. In June 1993, Lloyd Huffman assigned his rights in the agreement to Chet Huffman. In August 1993, Chet Huffman exercised the purchase rights and agreed to pay Barneson $150,000 for his 322,241 shares. This purchase made Chet Huffman the majority shareholder in Dukes with 43.7% of the outstanding shares. 

In August 1993, Chet Huffman entered into additional right-to-purchase agreements with the trust (15.8% of Dukes shares) and with an S corporation owned by Patricia Huffman called Dukes Research and Manufacturing, Inc. (DRM) that owned Dukes shares (40.5% of Dukes shares). For nominal initial consideration, these agreements gave Chet Huffman the right to purchase the DRM shares for $3.6 million and the trust shares for $1.4 million, upon the deaths of Lloyd and Patricia Huffman or by right of first refusal, except for family purchase offers. A later addendum gave Chet Huffman the right to exercise the right-to-purchase agreements at any time. Chet Huffman’s rights under the agreements were not assignable without mutual consent. The agreements specifically stated that they were for family ownership retention and were not compensatory, and Chet Huffman obtained a tax opinion letter confirming that the purpose of the right-to-purchase agreements was not compensatory. 

Chet Huffman significantly grew the Dukes business as CEO, expanding product offerings and acquiring a strong workforce. For the fiscal year 2006, Dukes had revenue of $28 million. Chet Huffman exercised his purchase rights under the right-to-purchase agreements in 2007, purchasing the DRM shares for $3.6 million and the trust shares for $1.4 million, about $11.83 per share. 

The IRS determined a gift tax deficiency and penalties with respect to Patricia Huffman’s 2007 tax return, asserting that Chet Huffman received a taxable gift when he exercised his purchase rights under the right-to-purchase agreements. 

Statutory background and positions

Section 2512(b) of the Internal Revenue Code provides that property transferred for less than adequate and full consideration results in a deemed gift to the extent the value of the property transferred exceeds the value of the consideration. 

For gift tax purposes, § 2703(a)(1) provides that the value of property is to be determined without regard to options, agreements, or other rights to use the property for a price less than fair market value. Section 2703(b) provides an exception for any option, right, or restriction that (1) is a bona fide business arrangement; (2) is not a device to transfer the property to family members for less than full and adequate consideration; and (3) has terms comparable to similar arrangements in arm’s length transactions. 

The IRS argued that the second and third requirements in § 2703(b) were not met by the right-to-purchase agreements. The IRS asserted that the value of the shares transferred pursuant to the agreements was about $31.3 million, and that the excess of this value of the $5 million paid should be deemed a taxable gift. 

The taxpayers, Patricia and Lloyd Huffman’s estate, argued the right-to-purchase agreements represented valid business arrangements, and that Chet Huffman paid additional consideration for the shares in reduced compensation over the years rather than full value at the time of purchase. Chet Huffman’s salary from 1993-2006 was $65,000-85,000. His salary in 2007 increased to $147,000 but that was still significantly less than another Dukes officer salary of $243,300. The taxpayers thus argued that Chet Huffman had forgone approximately $3.5 million in prior year compensation. The taxpayers also argued that the right-to-purchase agreements were comparable to the agreement with Barneson, which they asserted was an arm’s length transaction. 

Tax court analysis 

With respect to the right-to-purchase agreements, the tax court first found the agreements were not a testamentary device to transfer the shares for less than full consideration under § 2703(b)(2). Even though there was a prior opinion that the agreements were not compensatory, the court found that Chet Huffman’s reduced salary over the years should be deemed consideration for the right-to-purchase agreements. The court also found that Chet Huffman’s purchase of shares in 2007 for $11.83 per share represented an increase in value of 2,414%, which the court viewed as unusual and unexpected. The court finally noted the right-to-purchase agreements have some characteristics of an arm’s length transaction, including Lloyd and Patricia Huffman’s desire to obtain enough from the shares for retirement and Chet Huffman’s desire to pay a lower price and obtain a profitable return in a shorter period of time. 

However, the tax court next determined that the right-to-purchase agreements were not sufficiently comparable to arrangements in other arm’s length transactions to meet the requirement under § 2703(b)(3). The court noted there were similarities with the Barneson agreement but ultimately found there were material differences and this was only one isolated comparable agreement. As a result, the court held the right-to-purchase agreements were to be disregarded for purposes of valuing the Dukes shares that Chet Huffman purchased in 2007. 

The tax court then turned to the IRS and taxpayer valuation opinions and evidence. As noted, Chet Huffman had paid $5 million for the shares but the IRS expert concluded the value of the Dukes shares in question was $31.3 million. The taxpayers argued the proper value was $5 million under the right-to-purchase agreements, but also offered an expert valuation of about $16.1 million at trial. After comparing the valuation reports and testimony in some detail, the court found the IRS expert’s valuation was proper with an adjustment relating to revenue assumptions. 

Importantly, the tax court found the taxpayers had reasonable cause in failing to file gift tax returns and pay gift tax due because they reasonably relied on their professional advisors and provided them with all necessary information to determine a potential gift tax liability.² 

Conclusion 

Huffman is a detailed opinion that may help identify key considerations for family buy-sell agreements and transition planning, particularly in the context of potentially taxable gifts. The opinion also provides good insight into the tax court’s view of expert valuations and the importance of obtaining expert opinions and advice to avoid potential penalties.

Endnotes

1 T.C. Memo. 2024-12.

2 Of note but not addressed in this article, the tax court found in favor of the IRS on some income tax issues relating to a subsequent sale of Dukes.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Background

Michael and Thomas Connelly were the sole shareholders of Crown C Corporation, a building-materials corporation in St. Louis (Crown). The brothers entered into a stock purchase agreement providing that if one brother died, the surviving brother had the right to buy his shares. Under the agreement, if the survivor declined to make this purchase, Crown was obligated to purchase the decedent’s shares. The court noted that the brothers always intended that Crown would complete this redemption, and Crown obtained life insurance on each brother for redemption of a decedent’s shares.

The stock purchase agreement had two valuation mechanisms for a possible redemption. The principal approach was for the brothers to execute a certificate of agreed value every year to set the price by mutual agreement. If a certificate was not executed, the brothers were to obtain two or more appraisals to establish fair market value. The brothers never executed a certificate of agreed value or obtained appraisals, but Crown did purchase $3.5 million of life insurance on each brother.

Michael Connelly died in 2013, and Crown received life insurance proceeds of $3.5 million. Crown then redeemed his shares for $3 million as part of post-death agreement between Thomas Connelly and Michael Connelly’s son. The parties did not obtain appraisals, and Thomas Connelly (as executor) used $3 million as the value of Michael Connelly’s shares when filing the deceased brother’s estate tax return. Thomas Connelly did not include the insurance proceeds as an asset that would have increased the corporation’s value.

The Internal Revenue Service (IRS) audited the estate tax return and concluded that the fair market value of Crown should have included, and been increased by, the life insurance proceeds. The IRS sent a notice of deficiency for additional tax liability; the estate paid the deficiency and sued for a refund in district court.

The estate argued that the redemption pursuant to the stock purchase agreement conclusively determined the value of Crown for estate tax purposes. Alternatively, the estate argues that even if the life insurance proceeds were considered an asset, they were offset by Crown’s obligation to make the redemption. The IRS countered that the stock purchase agreement should be disregarded.

The district court granted summary judgment to the IRS, concluding that the stock purchase agreement did not affect valuation and that a proper valuation of Crown must include the life insurance proceeds. The district court declined to follow Estate of Blount², which did not include life insurance proceeds in a valuation under similar facts. The estate then appealed to the 8th Circuit Court.
 

8th Circuit Court analysis and decision

The 8th Circuit Court noted that under Code §§ 2031 and 2033, a decedent’s gross estate includes the value of all real, personal, tangible, and intangible property, wherever situated, in which the decedent had an interest at the time of their death. This property includes stocks under applicable Treasury Regulations, and the only issue before the court on appeal was the value of Michael Connelly’s Crown shares.

The court first addressed whether the stock purchase agreement controls how Crown should be valued. Code § 2703(a) provides that property is generally valued without reference to options, agreements, or rights to acquire the property at less than fair market value or to other restrictions on sale or use of the property, unless such agreements meet the requirements of Code § 2703(b). To affect valuation under § 2703(b), an agreement must (1) be a bona fide business arrangement; (2) not be a device to transfer property to family members for less than full and adequate consideration; and (3) have terms comparable to similar arm’s-length transactions. The estate in this case argues that the requirements of § 2703(b) are met, and that the life insurance proceeds should not be included in valuing Michael Connelly’s Crown shares.

The court, however, found that the Crown stock purchase agreement did not adequately fix a price or prescribe a formula for determining a price. Instead, the agreement had two possible mechanisms for setting the price: a certificate of agreed value, which the court rejected since it would merely be a mutual agreement, and a mechanism including an appraisal process to establish fair market value. The court noted that the appraisal provision did not fix or prescribe a formula for determining the price of the shares, and instead just required that the appraisers determine the fair market value of Crown; the court also noted that none of the appraisal process was completed in this case. As a result, the court determined that nothing could be gleaned from the stock purchase agreement, and that a fair market value analysis was needed.

The key question the 8th Circuit Court addressed in determining fair market value was whether the life insurance proceeds intended for redemption of Michael Connelly’s shares must be included in valuing Crown at the time of his death. The court noted that the value of property in an estate is usually the price a willing buyer and willing seller would reach when under no compulsion to buy or sell and having reasonable knowledge of relevant facts. For establishing fair market value of closely held businesses, Treasury Regulations under § 2031 identify factors including net worth, prospective earnings and dividends, good will of the business, economic outlook for the industry and the company’s position in that industry, management, and the degree of control represented by the shares being valued. Treasury Regulations § 20.2031-2(f)(2) specifically provides that the valuation of a closely held company must consider nonoperating assets, including life insurance policies payable to the company.

The 8th Circuit Court noted that the 11th Circuit Court, in Estate of Blount, had determined that although life insurance proceeds should be considered in a similar situation, the value of the insurance proceeds was offset by a stock purchase agreement redemption obligation. The 11th Circuit Court concluded that this offset resulted in zero effect on the company’s value. The 8th Circuit Court found the reasoning in Estate of Blount flawed and notedthat a willing buyer of Crown would be purchasing the life insurance and could either extinguish the redemption agreement or ultimately receive the benefit of the proceeds. Similarly, the court reasoned that a willing seller of Crown would want to be compensated for the value of the life insurance proceeds. The 8th Circuit Court concluded that a willing buyer and seller would include the life insurance in valuing Crown.

The 8th Circuit Court also concluded that the estate’s position, supported by Estate of Blount, would result in a windfall for the remaining shareholder, Thomas Connelly.  Not considering life insurance, before the redemption, each Crown share was worth $7,720. After the redemption, Michael Connelly’s shares were extinguished, leaving Thomas Connelly with all remaining shares and a corporation worth $3.86 million, resulting in a new value for Thomas Connelly of about $33,800 per share. This significant increase in the value of Thomas Connelly’s otherwise unchanged shares without any material change to Crown further persuaded the court to conclude that the brothers’ redemption agreement did not establish a normal corporate liability that should be considered in the valuation of Michael Connelly’s estate. The court viewed the life insurance proceeds as simply an asset that increased shareholder equity, which had to be accounted for in valuing Michael Connelly’s shares at the time of his death.

Based on this analysis, the 8th Circuit Court disregarded the Crown stock purchase agreement, found that a fair market value analysis of Crown had to include the life insurance proceeds used for redemption of Michael Connelly’s shares, and affirmed the district court’s summary judgment in favor of the IRS.
 

Conclusion

The 8th Circuit Court decision in Connelly conflicts with the analysis and decision in Estate of Blount. As a result, Connelly appears to create a conflict among circuit courts that may require a U.S. Supreme Court decision for clarity on these issues. Until this conflict is resolved, taxpayers and practitioners will have to carefully consider how redemption agreements funded by life insurance may impact estate tax valuation for the company owners.
 

Endnotes

1 Connelly v. U.S., 2023 PTC 154 (8th Cir. 2023).

2 Estate of Blount, 428 F.3d 1338 (11th Cir. 2005).

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

In Di Giorgio v. Commissioner of Internal Revenue¹ the tax court granted innocent spouse relief from joint and several liability for Zandra Di Giorgio due to equitable considerations and a lack of knowledge regarding the couple’s true financial situation.

Background and findings of fact

Robert Anthony Di Giorgio Sr. was involved in a variety of business activities, including mortgage lending, issuing mortgage-backed securities, and real estate sales. The court noted it was difficult to paint a precise picture of these activities. Robert Di Giorgio held multiple business and personal bank accounts, and he did business with more than 30 title companies and a variety of borrowers.

Robert Di Giorgio received and deposited payments relating to these activities in both his business and personal accounts. He also co-mingled funds among the accounts, used business accounts for personal expenses, and failed to provide adequate books and records. The court concluded Robert Di Giorgio had multiple sources of income including (1) real estate sales; (2) Radius Capital Corp., a California corporation (Radius CA); (3) Radius Capital Corp., a Florida corporation (Radius FL); (4) a Scottrade brokerage account; and (5) other miscellaneous sources.

Robert Di Giorgio’s first spouse had passed away, and he married Zandra Di Giorgio prior to the tax years in question. During those years, Robert Di Giorgio had several real estate transactions that involved properties he either owned individually or had owned with his first spouse at the time of her death. He nominally involved his second spouse in some corporate activities, for example designating her an officer of Radius CA and another new business. However, the court found that Zandra Di Giorgio was not involved in these corporations. It even noted that a warranty deed from Radius CA to Robert Di Giorgio personally used Zandra Di Giorgio’s name as a corporate officer, but that it was not her signature on the deed. Robert Di Giorgio also deposited the funds from this real estate sale in personal accounts that he did not share with Zandra Di Giorgio. The court outlined several examples involving Robert Di Giorgio receiving income or funds and making deposits to personal accounts during the years in question, including investment account transfers and life insurance proceeds from a policy on his first spouse.

Robert Di Giorgio failed to report substantial income from his activities. With his unreported income, Robert Di Giorgio led a lavish lifestyle with a waterside home, a beach house, multiple cars, boats, and extravagant vacations, including one to the Philippines where he met his second spouse, Zandra Di Giorgio. During their marriage, Robert Di Giorgio kept Zandra Di Giorgio in the dark about their true financial situation.

For the tax years in question, Robert Di Giorgio reported deductions in excess of income resulting in zero taxable income, and he filed his returns late. He also failed to file S corporation returns for some of his businesses. The parties agreed that Robert Di Giorgio properly filed an individual return for 2005 and that his correct status for 2006 was surviving spouse. The taxpayers filed a joint return for 2007.

The Internal Revenue Service examined the 2005, 2006, and 2007 tax returns. The IRS noted that Robert Di Giorgio was uncooperative and adversarial during the examination, and the court noted that Zandra Di Giorgio was not involved. The IRS found multiple bank accounts, real estate sales, and mortgages that Robert Di Giorgio had failed to disclose. The IRS also found questionable records that appeared to be falsified. Through a bank deposit analysis using summoned records for the tax years in question, the IRS determined several million dollars in income tax deficiencies, additions to tax, and civil fraud penalties.

The court also provided significant background on Zandra Di Giorgio’s history and involvement with Robert Di Giorgio. Zandra Di Giorgio was born and raised in the Philippines and was 26 years old with two minor children when the couple met online in late 2005. She was a high school graduate who had taken some nursing classes; her only work history was two weeks at a Dunkin Donuts. English was not Zandra Di Giorgio’s first language. In January 2006, Robert Di Giorgio traveled to the Philippines, and they met in person. After a few months, Zandra Di Giorgio and her children moved to Florida, and Zandra and Robert Di Giorgio married later in 2006.

The court outlined a disparaging and domineering relationship once Zandra Di Giorgio moved to Florida, with Zandra Di Giorgio in fear of jeopardizing their relationship and her status in the United States if she did not do what Robert Di Giorgio wanted. Robert Di Giorgio controlled all the family finances. Zandra Di Giorgio had no experience with accounting, finance, mortgages, securities, or United States taxes. She did not participate in the businesses or real estate transactions, and she was not a joint account holder on the bank accounts used by the IRS for the deposit analysis. Zandra Di Giorgio signed a joint tax return for 2007 that she had no role in preparing, and she was only provided with the signature page when she signed. Zandra Di Giorgio had never previously seen a United States tax return.

Zandra Di Giorgio was not aware of her husband’s financial problems when she signed the 2007 joint return. At that time, she viewed him as financially successful, with the means for travel and a good lifestyle. After the years in issue, Robert Di Giorgio’s financial problems became known as they lost a home in foreclosure, and he was eventually sued by the U.S. Securities and Exchange Commission. It was only then that Zandra Di Giorgio became aware that he had named her as an officer of Radius CA and another new entity to avoid government scrutiny. The court further noted that, by the time of trial in this case, the Di Giorgios were separated and involved in a protracted divorce proceeding.

Tax court decision

The tax court consolidated cases involving the spouses, with Robert Di Giorgio requesting a redetermination of deficiencies for 2005, and both spouses requesting a redetermination for 2006 and 2007. Zandra Di Giorgio also raised innocent spouse relief for 2006 and 2007, the years involving her. All parties had agreed by the time of trial that Zandra Di Giorgio had no liability for 2006.

The court first addressed the primary issues in the case, including failing to file returns, underreporting income, filing inadequate records, providing implausible or inconsistent explanations, failing to cooperate with tax authorities, concealing income, engaging in illegal activities, and filing false tax returns. In all these contexts, the tax court found that Robert Di Giorgio was not credible and held in favor of the IRS. The court further found that several of these issues established strong evidence of fraudulent intent, and the court held that the IRS had established by clear and convincing evidence that the § 6663 civil fraud penalty was applicable to Robert Di Giorgio’s underpayments of income tax.

The tax court then turned to Zandra Di Giorgio’s innocent spouse claim for 2007. The IRS conceded that Zandra Di Giorgio was entitled to relief under Internal Revenue Code § 6015(f) (equitable relief) because she lacked sophistication to have reason to know of the understated income. The IRS also acknowledged it would be an undue hardship to deny her relief, and denying her relief would be inequitable under the circumstances. However, Robert Di Giorgio opposed the innocent spouse relief, so it was addressed by the court.

The tax court first noted the general rule that taxpayers filing a joint federal income tax return are jointly and severally liable for the entire tax due for that year under IRC § 6013. However, a spouse who files a joint return may seek relief from joint and several liability under § 6015. Section 6015(f) equitable relief, conceded by the IRS here, is available on equitable grounds when relief is not available under IRC § 6015(b) or (c). The court focused on § 6015(b)(1) relief, which is available if all of the following requirements are satisfied:

(A) a joint return was filed for the taxable year;    
(B) there was an understatement of tax attributable to an erroneous item of the nonrequesting spouse;    
(C) at the time of signing the return, the requesting spouse did not know and did not have reason to know of the understatement;    
(D) taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable for the deficiency in tax attributable to the understatement; and    
(E) the requesting spouse sought relief within two years of the first collection activity relating to the liability. 

The court noted a joint return was clearly filed with an understatement attributable to erroneous items of Robert Di Giorgio, and the request was timely because the IRS had not yet commenced its collection activity. So, the decision focused on the knowledge and inequity requirements of § 6015(b)(1).

To meet the knowledge requirement, Zandra Di Giorgio had to lack actual or constructive knowledge of the understatements when she signed the joint return. For this requirement, actual knowledge of omitted income means knowledge of the amount was received, and actual knowledge of erroneous deductions means knowledge of the relevant facts, such as knowledge that an expenditure was not actually incurred. The tax court noted Zandra Di Giorgio did not have access to bank accounts used in the deposits analysis, and there was no evidence she knew about the unreported income. Based on these facts, the court summarily found that Zandra Di Giorgio did not have actual knowledge of the unreported income and erroneous deductions.

The court did a more in-depth analysis regarding whether Zandra Di Giorgio had constructive knowledge of the understatements based on a reasonably prudent taxpayer standard. The court considered the following factors in determining whether Zandra Di Giorgio was reasonably prudent:

(1) the requesting spouse’s level of education;    
(2) the requesting spouse’s involvement in the family’s business and financial affairs;    
(3) the presence of expenditures that appear lavish or unusual when compared to the family’s past standard of living; and    
(4) the nonrequesting spouse’s evasiveness and deceit about the family’s finances.

The court found that all these factors weighed in favor of granting innocent spouse relief to Zandra Di Giorgio. She had limited education, English was not her first language, and she had no business or accounting background. Her involvement in the family business and financial affairs was limited, and she did not work in the businesses. The expenditures that Zandra Di Giorgio experienced in 2007 were not lavish or unusual compared with their prior spending. Robert Di Giorgio was clearly evasive and deceptive with his income and legal issues, and she was not aware of them. Based on these factors, the court concluded that Zandra Di Giorgio could not be expected to know that the tax liability stated on the return was erroneous or that further investigation was warranted.

Finally, the tax court addressed the inequity requirement in § 6015(b)(1)(D), relying on a balancing analysis of the nonexclusive factors from Revenue Procedure 2013-34:

(a) marital status;    
(b) whether the requesting spouse will suffer economic hardship absent relief;    
(c) whether the requesting spouse had actual or constructive knowledge of the understatement;    
(d) whether either spouse had a legal obligation to pay the liability;    
(e) whether the requesting spouse significantly benefited from the understatement;    
(f) whether the requesting spouse has made a good faith effort to comply with income tax laws in years following the year of the understatement; and   
(g) whether the requesting spouse was in poor physical or mental health when the joint return was filed.

The court found that the Di Giorgios’ separation and pending divorce favored relief. At the time of trial, Zandra Di Giorgio’s annualized monthly income was projected to fall well below the federal poverty level, and she had limited assets and significant liabilities. So, the tax court found that paying any part of the tax liability would cause Zandra Di Giorgio significant hardship, favoring relief. Based on its prior analysis, the court found that Zandra Di Giorgio did not have actual or constructive knowledge of the understatements, favoring relief. The court also found the other factors to be neutral. Based on this overall analysis, the court held that it would be inequitable to deny Zandra Di Giorgio innocent spouse relief.

After finding that Zandra Di Giorgio met both the knowledge and inequity requirements of § 6015(b), the court held that she was entitled to innocent spouse relief for 2007.

Conclusion

Di Giorgio v. Commissioner of Internal Revenue outlines key considerations for innocent spouse relief in the context of a significant underpayment and fraud penalty case. The opinion demonstrates the detailed technical and factual analysis needed to obtain innocent spouse relief. Notably, the IRS had conceded some innocent spouse relief prior to trial in this case, so the case is also a reminder that an innocent spouse challenge can come from the other spouse.

ENDNOTES

1 T.C. Memo. 2023-44 (2023).

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Background

Paul and Patricia Wondries operated several successful business enterprises, including multiple car dealerships. Around 2004, the taxpayers acquired a cattle ranch to diversify their interests. The 1,100-acre ranch in California included main and guest houses, a pool, a foreman’s house, wells, springs, storage tanks, and about 30 miles of roads for access. The ranch purchase was financed through a bank and was supported by a business plan indicating the mortgage would be serviced through cattle sales and guided hunting activities within a few years, with a secondary plan to hold the property for investment. The taxpayers hired a foreman with extensive ranching experience to manage the ranch. The foreman oversaw operation of the ranch, including property oversight; repairing and replacing equipment and infrastructure; hiring and overseeing laborers; and managing cattle, crops, and expenditures.

After acquiring the property, the taxpayers determined income from ranch operations was not sufficient to cover the mortgage payments, particularly when feed prices increased and periods of drought limited the ability of the ranch to support the cattle. Guided hunting also failed to generate profits due to limited wildlife and high insurance costs. As a result, the taxpayers pivoted to an investment focus, working to improve the property and eventually sell at a gain. Improvements included fencing and irrigation work, renovating housing, clearing brush, and maintaining the grounds. The foreman and contractors did the bulk of this work, but the taxpayers performed tasks around the ranch a few days per month when they visited. Paul Wondries also performed the payroll and accounting functions for the ranch, and he had an accountant periodically review his accounting work for the ranch. The court also noted the taxpayers had several other residences and vacation homes, presumably an indication that the ranch was not just a vacation property.

Despite their efforts, the taxpayers realized a net loss for every year relating to the ranch and claimed corresponding deductions. The IRS audited the taxpayers and determined that the ranch property was not engaged in for profit, disallowing the taxpayers’ loss deductions with respect to the ranch for 2015, 2016, and 2017.  

Tax court opinion

Under the hobby loss rules,² deductions attributable to an activity that is “not engaged in for profit” are allowed only to the extent of income from the activity or to the extent deductions are allowable regardless of any profit-seeking motive, whichever is larger. Treasury Regulations § 1.183-2(b) requires all facts and circumstances be considered in determining whether a taxpayer has a profit objective and enumerates nine non-exhaustive factors for consideration:

1.       manner in which the taxpayers carry on the activity; 
2.       expertise of the taxpayers or their advisors; 
3.       time and effort expended by the taxpayers in carrying on the activity; 
4.       expectation that assets used in the activity may appreciate in value; 
5.       success of the taxpayers in carrying on other similar or dissimilar activities; 
6.       taxpayers’ history of income or losses with respect to the activity; 
7.       occasional profits, if any, are earned from the activity; 
8.       financial status of the taxpayers; and 
9.       elements of personal pleasure or recreation involved in the activity.

No specific factor, nor the number of factors, is determinative. The regulations also acknowledge that courts may consider other factors in determining whether a taxpayer has the requisite profit motive for the activity in question.

In Wondries, the tax court reviewed the ranch activity under these factors. While acknowledging this is a “close case,” the court held that the taxpayers did engage in the activity with intent to make a profit as required by § 183 and the regulations. The court’s review of several key factors is outlined here:

• Manner in which activity carried on. The court found that the taxpayers’ hiring of an experienced foreman for the ranch property and keeping complete and accurate books and records for the ranch indicated the activity was conducted in a businesslike manner. The court also noted the taxpayers’ shift to an investment focus after operations were not profitable indicated intent to make a profit from the ranch and property.
   
• Expertise of taxpayers or their advisers. Although the taxpayers in Wondries did not have ranching experience, the court found that hiring an expert foreman and relying on his knowledge of best practices for running the ranch indicated a profit motive.
   
• Time and effort expended by taxpayers. The taxpayers only spent a few days a month on the ranch. However, the court noted the ranch foreman and his wife lived and worked on the property year-round and credited the taxpayers with hiring numerous other individuals to perform work on the property. The court found this factor weighed in favor of profit motive.
   
• Expectation that assets may appreciate in value. The taxpayers testified that they purchased the ranch to profit from operations and as an investment. The regulations confirm that “profit” can include appreciation in the value of land, since this can result in an overall profit on the activity when appreciation is realized, even if the taxpayers do not profit from current operations. In this case, the court noted credible testimony that appreciation of the ranch property value would more than recoup operational losses if the ranch were sold. The court found this factor was in the taxpayers’ favor but noted the potential for profit could be dwindling each year if continuing losses exceeded future appreciation.
   
• Taxpayers’ success in similar or dissimilar activities. The taxpayers had no prior similar activities. However, the court found Paul Wondries’ success in multiple automotive dealerships, including multiple dealerships that were acquired at a loss and made profitable, weighed in the taxpayers’ favor.
   
• Taxpayers’ history of income or loss; amounts of occasional profits. The Wondries’ ranch never produced a profit, either from ranching activities or guided hunting expeditions. The court noted challenges like drought and feed prices were foreseeable circumstances or customary business risks. These factors weighed against the taxpayers’ profit motive.
   
• Taxpayers’ financial status. Substantial income from sources other than the activity in question may indicate that the activity is not engaged in for profit, particularly if the losses from the activity generate tax benefits. In this case, the taxpayers had substantial income from other sources, and losses from the ranch during the years in question generated significant tax benefits for them. This factor weighed against a profit motive and favored the IRS.
   
• Elements of personal pleasure or recreation. The taxpayers did not spend substantial time at the ranch property. When they did visit, they primarily checked with the foreman and helped him with repairs. The court found this indicative of profit motivation. The IRS argued the taxpayers occasionally invited guests to the ranch and generally enjoyed enhancing the property, but the court stated this did not undercut the taxpayers’ position. The court also noted the taxpayers had numerous desirable properties other than the ranch where they engaged in “true recreational activities such as hiking, biking, and boating.” Based on these facts, the court found the taxpayers’ primary motivation for the ranch property was to earn a profit.

After weighing all the facts and circumstances under these factors, the court concluded the taxpayers engaged in the ranch activity for profit, and the activities could not be characterized as a hobby. Accordingly, the IRS disallowance of the taxpayers’ loss deductions relating to the ranch activity was not sustained.

Conclusion

Wondries provides a good outline of the key factors to consider in establishing a for-profit ranching or farming activity and avoiding the hobby loss rules that limit deductions to the income earned from those activities. Importantly, the court ruled in favor of the taxpayers in this case, providing a precedent for taxpayers in future hobby loss limitation cases.

Endnotes

1 T.C. Memo. 2023-5 (2023).

2 26 U.S. Code § 183.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

The appropriations act also includes a limitation on charitable deductions for partners of pass-through entities that make conservation easement contributions. This article highlights a few key provisions in this legislation. This is not a comprehensive list, and you should refer to the appropriations act and implementation of these provisions for technical details and other provisions.

SECURE Act 2.0

Some highlights of the SECURE Act 2.0 include the following provisions:

Increase in age for mandatory required minimum distributions: The appropriations act increases the age for mandatory annual required minimum distributions (RMDs) from 72 to 73 starting in 2023. The appropriations act further increases the age for mandatory RMDs to 75 starting in 2033.

Higher catchup limits: Starting in 2024, the appropriations act indexes for inflation the $1,000 annual limit for additional catchup contributions to certain retirement plans for individuals 50 years or older. Starting in 2025, the appropriations act also increases the annual catchup contribution to the greater of $10,000 or 50% more than the regular catchup amount for individuals ages 62-64.

New starter 401(k) plans: The appropriations act adds the new § 401(k)(16) to allow employers to offer “starter” retirement plans with simplified requirements. Available effective in 2024, the starter plans must offer automatic deferral of at least 3% and not more than 15% of an employee’s compensation, and limit employee contributions to $6,000.

Automatic enrollment in retirement plans: Starting in 2025, § 401(k) retirement plans and § 403(b) annuity contracts are subject to expanded automatic enrollment requirements, including a minimum contribution percentage of 3-10% during the first year of participation and increasing percentages thereafter. There are also provisions allowing automatic portability of certain accounts when participants change jobs. Businesses in existence less than three years, small businesses that employ 10 or fewer employees, and church and governmental plans are exempt from the automatic enrollment requirements.

Expanded credit for small employer pension plan startup costs: Effective 2023, startup costs paid by small employers to establish or administer an eligible employer plan are eligible for an increased in credit, now 100% of qualified startup costs for employers of up to 50 employees. The appropriations act also provides additional credits for contributions by eligible employers.

Savings match replaced: Effective 2027, new § 6433 replaces prior provisions with a matching contribution paid by the government to certain individuals who make qualified retirement savings contributions. The amount of the matching contribution is generally 50% of up to $2,000 of the contributions made for the tax year and is subject to phaseouts based on modified adjusted gross income.

Emergency savings: Effective 2024, the appropriations act gives employers the option to offer pension-linked emergency savings accounts to non-highly compensated employees. Employers may automatically opt employees into these accounts at no more than 3% of their salary, and the portion of an account attributable to the contribution is capped at $2,500 (or lower as set by the employer). Contributions are treated like Roth accounts, and excess contributions can be directed to an employee’s Roth retirement account.

Student loan debt: Effective 2024, employers will be allowed to “match” qualified student loan payments by an employee with contributions to the employee’s retirement account.

Conservation easements

The appropriations act includes provisions limiting conservation easement deductions by pass-through entities that are effective for contributions made after Dec. 29, 2022. Under the new § 170(h)(7), a contribution by a partnership generally is not treated as a qualified conservation contribution if the amount of the contribution exceeds 2.5 times the sum of each partner’s basis in the partnership. However, exceptions apply for contributions of property with a holding period of at least three years, for family partnerships, and for certain historic structures.

The appropriations act also amends § 6662(b) to apply an accuracy-related penalty to the portion of an underpayment attributable to disallowance of a deduction under the new § 170(h)(7). In addition, a disallowance of such a deduction is subject to the gross valuation misstatement penalty under § 6662(h). Further, the reasonable cause exception does not apply, and the IRS is not required to obtain written supervisory approval for applying these penalties.

In addition, the appropriations act amends § 170(f) to codify certain reporting requirements for qualified conservation contributions made by partnerships that exceed 2.5 times the sum of each partner’s basis. The U.S. Secretary of the Treasury is also instructed to publish safe harbor deed language for extinguishment clauses within 120 days of enactment. Donors are provided a 90-day period to amend easement deeds and substitute the safe harbor language.

Conclusion

The appropriations act addresses a variety of retirement provisions with an overall goal of increasing retirement plan access and savings, and there are multiple, technical provisions. The interpretation and implementation of this legislation over the next several years will be an ongoing process with the IRS, employers, and retirement plan service providers. With respect to conservation easements, the appropriations act demonstrates continued regulatory focus and gives the IRS additional penalties and discretion in auditing conservation easements.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Businesses should consider corporate tax rates, limits on business deductions, increased expensing, and first-year depreciation for some assets. The §199A deduction for qualified income from pass-through entities also may impact individuals and their businesses. This article outlines several individual and business planning issues to consider before year-end. These items will not apply in every situation, and taxpayers should adjust their planning for their circumstances.

Importantly, Congress has ongoing negotiations regarding tax provisions and credits that could significantly impact certain taxpayers. The outcomes of the mid-term elections may also affect potential tax changes. Taxpayers should carefully monitor ongoing legislation and the potential impacts on year-end planning.

Year-end planning issues for individuals

• Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions. For 2022, the basic standard deduction is increased to $25,900 for joint filers, $19,400 for heads of household, and $12,950 for singles and married taxpayers filing separately. For taxpayers either 65 years or older or blind, there are additional standard deductions. Many itemized deductions also remain either reduced or eliminated. So, unless allowable medical deductions (as limited by 7.5% of AGI), allowable state and local taxes (as limited), allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction, taxpayers may find that the increased standard deduction provides more tax benefit. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years.
• Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year and doing so will not cause state and local tax deductions to exceed the applicable limitation.
• Plan for the 3.8% tax on unearned income. This surtax is 3.8% of net investment income (NII) that exceeds modified adjusted gross income (MAGI) thresholds. Year-end planning for the 3.8% surtax depends on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI.
• Consider the additional 0.9% Medicare tax. This tax applies to individuals receiving a combination of wages with respect to employment and self-employment income exceeding applicable thresholds. Employers must withhold the additional Medicare tax from wages in certain circumstances. Self-employed individuals must include it in estimated tax payments, and some employees may need more withholding to cover the tax.
• Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year.
• Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. So, analysis of taxable income, potential capital gains, and other applicable taxes is required to determine the best combination.
• Consider retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 years and older.
• Remember that retirement plan distributions may be subject to a 10% early withdrawal tax penalty for taxpayers that are not at least 59 ½ years old. There are certain exceptions to this penalty, including a limited qualified birth or adoption distribution.
• Review required minimum distributions (RMDs) from retirement accounts. The RMD beginning date for taxpayers changed from 70 ½ years old to 72 starting with the 2020 tax year. Participants who are still working and making contributions to an employer-sponsored retirement account also may be able to further delay RMDs on that account. Taxpayers who fail to take RMDs can be subject to a penalty of 50% of the required amounts that are not withdrawn.
• Consider making charitable donations from traditional IRAs. Qualified charitable distributions are made directly to charities, and the amount is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution may reduce RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions.
• Consider a Roth IRA conversion. A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. A conversion will increase AGI for this year, so taxpayers should consider the impact on other AGI tax calculations.
• For taxpayers eligible to make health savings account (HSA) contributions, consider deductible HSA contributions before the end of the year. HSA contributions are deductible from AGI, so the benefits are available even if a taxpayer does not itemize deductions.
• Increase the amount set aside for next year in a flexible spending account (FSA) if the taxpayer did not set aside enough for this year. Earnings set aside in an FSA allow payment of medical and dental bills with pre-tax earnings.
• Complete annual gift tax exclusion gifts before the end of the year to save gift and estate taxes. For 2022, taxpayers can give $16,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets who are not subject to the kiddie tax.
• Consider education deductions and other credits. Tax-free distributions from § 529 qualified tuition programs of up to $10,000 are allowed for higher education expenses, which has been expanded to include elementary or secondary public, private, and religious schools, as well as expenses for participation in certain apprenticeship programs and limited amounts of qualified education loan repayments. For taxpayers under certain income thresholds, there are several credits and deductions available and limited student loan interest may be deductible.
• Consider home-related tax provisions. Working from home increased significantly during the pandemic and has continued for many taxpayers. Self-employed workers and business owners may be able to deduct related expenses, although these would not be deductible for employees. Mortgage interest is limited to the level of acquisition indebtedness depending on when the home was acquired ($750,000 for homes acquired after Dec. 14, 2017; $1,000,000 for homes acquired before that date), but mortgage interest allocable to the portion of a home used to operate a business is not subject to this limitation. Interest on home equity indebtedness may be deductible to the extent the debt was used to buy, build, or substantially improve the home. Gain of up to $500,000 for married taxpayers ($250,000 for other taxpayers) on the sale of a home is excluded from income, but the portion of the home used for business or rented reduces this exclusion from gain. Discharges of qualified principal residence indebtedness in 2022 are not included in gross income.
• Consider clean energy credits. Clean energy credits available in 2022 include residential energy property credits and vehicle related credits, with changes already enacted for 2023. Eligibility for property credits depends on the improvements made, annual limits, and/or applicable percentages. Vehicle credits vary by date of acquisition, battery size, and manufacturer eligibility, which can be impacted by total qualifying vehicles sold and place of final assembly.

Year-end planning issues for business owners

• Consider the qualified business income deduction for non-corporate taxpayers of up to 20% of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. For 2022, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $340,100 for married couples filing jointly or $170,050 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into this year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end.
• Consider making expenditures before year-end that qualify for § 179 business property expensing. For tax years beginning in 2022, the expensing limit is $1.08 million, reduced dollar for dollar for property placed in service over $2.7 million. This expensing is available for most depreciable property and qualified improvement property, which generally includes interior building improvements, roofs, HVAC, fire protection, alarm, and security systems. Importantly, property acquired and placed in service before year-end is eligible for full expensing for the year.
• Consider 100% first-year bonus depreciation for new and some used machinery and equipment purchased and placed in service. Like expensing, bonus depreciation is available for the full year even if the asset was placed in service late in the year, so year-end purchases may receive a full first-year bonus write off.
• Consider changing to the cash method of accounting, rather than the accrual method. “Small businesses” with less than $27 million of average annual gross-receipts over a three-year period may be eligible for the cash method if they meet other requirements. Generally, the cash method of accounting allows more flexibility in timing income and deductions.
• Consider meal and entertainment deductions. A 100% deduction is allowed in 2021 and 2022 for properly documented expenses relating to food and beverages purchased from restaurants.
• Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year.
• Consider timing for disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income.
• Review partnership and S corporation basis to ensure it is sufficient to deduct losses in current and future years.
• Review S corporation salaries to ensure shareholders receive reasonable wages. The IRS often audits S corporations that pay all profits as distributions without accounting for reasonable wages to shareholders for their work in the business.
• Consider setting up retirement and health insurance plans. These plans can provide key benefits for employee retention and for business owners.

Taxpayers should carefully consider these issues in light of their specific circumstances and watch for continuing tax law changes. As noted, legislation is being negotiated, which could provide additional considerations for planning this year, including possible changes in research and development expensing and credits.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

The IRS recently released a series of notices updating its list of tax scams and illegal tax avoidance schemes, which the agency refers to as its “Dirty Dozen.” The IRS typically updates this list annually as a warning to taxpayers and return preparers. The list is a good reminder of red flags for planning ideas that clients may be investigating. Any strategies that resemble the “Dirty Dozen” categories can expect heightened IRS scrutiny and aggressive IRS enforcement action in the event of an audit. This year, the IRS released the “Dirty Dozen” in a series of notices divided into five groups, which are outlined below, along with quoted IRS language to convey the tone and attitude of the IRS with respect to these issues.

Potentially abusive arrangements

The IRS warns taxpayers who have engaged in or are contemplating engaging in any of the following four “Dirty Dozen” transactions to carefully review the underlying legal requirements and consult independent, competent advisors before claiming any purported tax benefits. The IRS recommends that taxpayers who have already claimed purported tax benefits under these transactions consider taking corrective steps, such as filing an amended return. Where appropriate, the IRS states it will challenge the purported tax benefits from these transactions, and the IRS may assert accuracy-related penalties ranging from 20-40%, or a civil fraud penalty of 75% of any underpayment of tax. The IRS identifies these four transactions as follows:

Charitable Remainder Annuity Trusts (CRAT) to eliminate taxable gain
“In this transaction, appreciated property is transferred to a CRAT. Taxpayers improperly claim the transfer of the appreciated assets to the CRAT in and of itself gives those assets a step-up in basis to the fair market value as if they had been sold to the trust. The CRAT then sells the property but does not recognize gain due to the claimed step-up in basis. The CRAT then uses the proceeds to purchase a single premium immediate annuity (SPIA). The beneficiary reports, as income, only a small portion of the annuity received from the SPIA. Through a misapplication of the law relating to CRATs, the beneficiary treats the remaining payment as an excluded portion representing a return of investment for which no tax is due. Taxpayers seek to achieve this inaccurate result by misapplying the rules under [Code Sections] 72 and 664.”²

Maltese (or other foreign) pension arrangements misusing treaties
“In these transactions, U.S. citizens or U.S. residents attempt to avoid U.S. tax by making contributions to certain foreign individual retirement arrangements in Malta (or possibly other foreign countries). In these transactions, the individual typically lacks a local connection, and local law allows contributions in a form other than cash or does not limit the amount of contributions by reference to income earned from employment or self-employment activities. By improperly asserting the foreign arrangement is a ‘pension fund’ for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty to improperly claim an exemption from U.S. income tax on earnings in, and distributions from, the foreign arrangement.”³

Puerto Rican and other foreign captive insurance
“In these transactions, U.S owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation with cell arrangements or segregated asset plans in which the U.S. owner has a financial interest. The U.S. based individual or entity claims deductions for the cost of ‘insurance coverage’ provided by a fronting carrier, which reinsures the ‘coverage’ with the foreign corporation. The characteristics of the purported insurance arrangements typically will include one or more of the following: implausible risks covered, non-arm’s-length pricing, and lack of business purpose for entering into the arrangement.”⁴

Monetized installment sales
“These transactions involve the inappropriate use of the installment sale rules under section 453 by a seller who, in the year of a sale of property, effectively receives the sales proceeds through purported loans. In a typical transaction, the seller enters into a contract to sell appreciated property to a buyer for cash and then purports to sell the same property to an intermediary in return for an installment note. The intermediary then purports to sell the property to the buyer and receives the cash purchase price. Through a series of related steps, the seller receives an amount equivalent to the sales price, less various transactional fees, in the form of a purported loan that is nonrecourse and unsecured.”⁵

Pandemic and benefit scams

The IRS notes the fifth scam of the “Dirty Dozen,” pandemic-related scams, can take a variety of forms including unemployment information and fake job offers to steal personal information. The IRS urges everyone to be leery of suspicious calls, texts, and emails promising benefits, including the following:

Economic Impact Payment and tax refund scams
“Identity thieves who try to use Economic Impact Payments (EIPs), also known as stimulus payments, are a continuing threat to individuals. Similar to tax refund scams, taxpayers should watch out for these tell-tale signs of a scam:

• Any text messages, random incoming phone calls or emails inquiring about bank account information, requesting recipients to click a link or verify data should be considered suspicious and deleted without opening. This includes not just stimulus payments, but tax refunds and other common issues.
• Remember, the IRS won’t initiate contact by phone, email, text or social media asking for Social Security numbers or other personal or financial information related to Economic Impact Payments. Also be alert to mailbox theft. Routinely check your mail and report suspected mail losses to postal inspectors.
• Reminder: The IRS has issued all Economic Impact Payments. Most eligible people already received their stimulus payments. People who are missing a stimulus payment or got less than the full amount may be eligible to claim a Recovery Rebate Credit on their 2020 or 2021 federal tax return. Taxpayers should remember that the IRS website, IRS.gov, is the agency’s official website for information on payments, refunds and other tax information.”⁶

Unemployment fraud leading to inaccurate taxpayer 1099-Gs
“Because of the pandemic, many taxpayers lost their jobs and received unemployment compensation from their state. However, scammers also took advantage of the pandemic by filing fraudulent claims for unemployment compensation using stolen personal information of individuals who had not filed claims. Payments made on these fraudulent claims went to the identity thieves.

Taxpayers should also be on the lookout for a Form 1099-G reporting unemployment compensation they didn’t receive. For people in this situation, the IRS urges them to contact their appropriate state agency for a corrected form. If a corrected form cannot be obtained so that a taxpayer can file a timely tax return, taxpayers should complete their return claiming only the unemployment compensation and other income they actually received.”⁷ 

Fake employment offers posted on social media
“There have been many reports of fake job postings on social media. The pandemic created many newly unemployed people eager to seek new employment. These fake posts entice their victims to provide their personal financial information. This creates added tax risk for people because this information in turn can be used to file a fraudulent tax return for a fraudulent refund or used in some other criminal endeavor.”⁸

Fake charities that steal your money
“Bogus charities are always a problem. They tend to be a bigger threat when there is a national crisis like the pandemic. Taxpayers who give money or goods to a charity may be able to claim a deduction on their federal tax return. Taxpayers must donate to a qualified charity to get a deduction. To check the status of a charity, use the IRS Tax Exempt Organization Search Tool. Here are some tips to remember about fake charity scams:

• Individuals should never let any caller pressure them. A legitimate charity will be happy to get a donation at any time, so there’s no rush. Donors are encouraged to take time to do the research.
• Potential donors should ask the fundraiser for the charity’s exact name, web address and mailing address, so it can be confirmed later. Some dishonest telemarketers use names that sound like large well-known charities to confuse people.
• Be careful how a donation is paid. Donors should not work with charities that ask them to pay by giving numbers from a gift card or by wiring money. That’s how scammers ask people to pay. It’s safest to pay by credit card or check — and only after having done some research on the charity.”⁹

Tax companies and offer in compromise scams

As item six of the “Dirty Dozen,” the IRS cautions taxpayers with pending tax bills to contact the IRS for payment and settlement options and avoid unscrupulous tax companies that use local advertising and false claims that they can resolve unpaid taxes for pennies on the dollar, with these additional cautionary notes and advice:

• “An ‘offer,’ or OIC, is an agreement between a taxpayer and the IRS that resolves the taxpayer’s tax debt. The IRS has the authority to settle, or ‘compromise, federal tax liabilities by accepting less than full payment under certain circumstances. However, some promoters are inappropriately advising indebted taxpayers to file an OIC application with the IRS, even though the promoters know the person won’t qualify. This costs honest taxpayers money and time.”¹⁰
• “Offer in Compromise (OIC) ‘mills’ make outlandish claims usually in local advertising regarding how they can settle a person’s tax debt for pennies on the dollar. The reality usually is that taxpayers pay the OIC mill a fee to get the same deal they could have gotten on their own by working directly with the IRS. OIC mills are a problem all year long but tend to be more visible right after the filing season is over and taxpayers are trying to resolve their tax issues perhaps after receiving a balance due notice in the mail. These ‘mills’ contort the IRS program into something it’s not — misleading people with no chance of meeting the requirements while charging excessive fees, often thousands of dollars."¹¹
• “The IRS reminds taxpayers that under the First Time Penalty Abatement policy, taxpayers can go directly to the IRS for administrative relief from a penalty that would otherwise be added to their tax debt.”¹²
• “No one can get a better deal for taxpayers, than they can usually get for themselves by working directly with the IRS to resolve their tax issues,” said IRS Commissioner Chuck Rettig. “Taxpayers can check online for their best deal, as well as calling a specialized collection line where they can get fast service by using voice and chat bots or opting to speak with a live phone assistor.”¹³
• “For those who feel they need help, there are many reputable tax professionals available, and there are important tools that can help people find the right practitioner for their needs. IRS.gov is a good place to start scoping out what to do.”¹⁴
• “OIC mills are one example of unscrupulous tax preparers. Taxpayers should be wary of unscrupulous ‘ghost’ preparers and aggressive promises of manufacturing a bigger refund.

Ghost preparers 
Although most tax preparers are ethical and trustworthy, taxpayers should be wary of preparers who won’t sign the tax returns they prepare, often referred to as ghost preparers. For e-filed returns, the ‘ghost’ will prepare the return, but refuse to digitally sign as the paid preparer.

Inflated refunds
Not signing a return is a red flag that the paid preparer may be looking to make a quick profit by promising a big refund or charging fees based on the size of the refund.

Unscrupulous tax return preparers may also require payment in cash only and will not provide a receipt; invent income to qualify their clients for tax credits; claim fake deductions to boost the size of the refund; and/or direct refunds into their bank account, not the taxpayer’s account.

Taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else.”¹⁵

Suspicious communications

For item seven of the “Dirty Dozen,” the IRS warns taxpayers to be on the lookout for bogus calls, texts, emails, and online posts. Criminals use these methods to trick victims into providing sensitive personal financial information, money, or other information that can then be used to file false tax returns, tap into financial accounts, and for other schemes. The IRS expands on these areas of concern as outlined below, and the IRS further requests that taxpayers receiving questionable contacts send evidence by email to the IRS at phishing@irs.gov:

Text message scams
“These scams are sent to taxpayers’ smartphones and can reference things like COVID-19 and/or ‘stimulus payments.’ These messages often contain bogus links claiming to be IRS websites or other online tools. Other than IRS Secure Access, the IRS does not use text messages to discuss personal tax issues, such as those involving bills or refunds. The IRS also will not send taxpayers messages via social media platforms ...”¹⁶

Email phishing scams
“The IRS does not initiate contact with taxpayers by email to request personal or financial information. The IRS initiates most contacts through regular mail ...”¹⁷

Phone scams
“The IRS does not leave pre-recorded, urgent or threatening messages. In many variations of the phone scam, victims are told if they do not call back, a warrant will be issued for their arrest. Other verbal threats include law-enforcement agency intervention, deportation or revocation of licenses. Criminals can fake or ‘spoof’ caller ID numbers to appear to be anywhere in the country, including from an IRS office. This prevents taxpayers from being able to verify the caller’s true number. Fraudsters also have spoofed local sheriff’s offices, state departments of motor vehicles, federal agencies and others, to convince taxpayers the call is legitimate...”¹⁸

“Generally, the IRS will first mail a bill to any taxpayer who owes taxes. All tax payments should only be made payable to the U.S. Treasury and checks should never be made payable to third parties. For anyone who doesn’t owe taxes and has no reason to think they do: Do not give out any information. Hang up immediately. For more information, see IRS warning: Scammers work year-round; stay vigilant.”¹⁹

Phishing attacks to tax professionals and businesses

The IRS included spear phishing as item eight on the “Dirty Dozen” warning list, noting it is a serious problem because it can be tailored to steal computer system credentials of small businesses with client data bases, including tax professionals’ firms.²⁰ In that context, spear phishing is an email scam that attempts to steal a tax professional’s software preparation credentials. The thieves try to steal client data and tax preparers’ identities to file fraudulent tax returns for refunds.

According to the IRS, a recent phishing email uses the IRS logo and a variety of subject lines such as “Action Required: Your account has now been put on hold.” The IRS has observed similar phishing emails that claim to be from a “tax application provider” and may offer an “unusual activity report” with a solution link for the recipient to restore their account. The IRS confirms these emails are scams which send users to a website with logos of popular tax preparation software providers, and then prompts a request for tax preparer account credentials. Similar phishing emails may include malicious links or attachments designed to steal information or download malware.²¹  Unsolicited and suspicious phishing emails should be sent to phishing@irs.gov.

Bogus tax avoidance strategies

For its last four items on the “Dirty Dozen” list, the IRS warns taxpayers to avoid being misled into using bogus tax avoidance strategies by promotors peddling these schemes, which typically target high-net-worth individuals seeking to avoid paying taxes. “These tax avoidance strategies are promoted to unsuspecting folks with too-good-to-be-true promises of reducing taxes or avoiding taxes altogether,” Rettig said, adding that “[t]axpayers should not kid themselves into believing they can hide income from the IRS. The agency continues to focus on these deals, and people who engage in them face steep civil penalties or criminal charges.”²² The IRS specifically identifies these four transactions:

Concealing assets in offshore accounts and improper reporting of digital assets
“The IRS remains focused on stopping tax avoidance by those who hide assets in offshore accounts and in accounts holding cryptocurrency or other digital assets. International tax compliance is a top priority of the IRS... Over the years, numerous individuals have been identified as evading U.S. taxes by attempting to hide income in offshore banks, brokerage accounts or nominee entities. They then access the funds using debit cards, credit cards, wire transfers or other arrangements. Some individuals have used foreign trusts, employee-leasing schemes, private annuities and structured transactions attempting to conceal the true owner of accounts or insurance plans.

U.S. persons are taxed on worldwide income. The mere fact that money is placed in an offshore account does not put it out of reach of the U.S. tax system. U.S. persons are required, under penalty of perjury, to report income from offshore funds and other foreign holdings. The IRS uses a variety of sources to identify promoters who encourage others to hide their assets overseas …”²³

Rettig notes: “The IRS is able to identify and track otherwise anonymous transactions of international accounts as well as digital assets during the enforcement of our nation’s tax laws. We urge everyone to come into compliance with their filing and reporting responsibilities and avoid compromising themselves in schemes that will ultimately go badly for them.”²⁴

High-income individuals who don’t file tax returns
“The IRS continues to focus on people who choose to ignore the law and not file a tax return, especially those individuals earning more than $100,000 a year. Taxpayers who exercise their best efforts to file their tax returns and pay their taxes, or enter into agreements to pay their taxes, deserve to know that the IRS is pursuing others who have failed to satisfy their filing and payment obligations. The good news is most people file on time and pay their fair share of tax …

Here’s a key reminder for taxpayers who may be wrongly persuaded that not filing their return is a smart move. The Failure to File Penalty is initially much higher than the Failure to Pay Penalty. It is more advantageous to file an accurate return on time and set up a payment plan if needed than to not file. The Failure to File Penalty is generally 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty generally will not exceed 25% of unpaid taxes. The Failure to Pay Penalty is generally 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. The penalty will not exceed 25% of unpaid taxes.

If a person’s failure to file is deemed fraudulent, the penalty generally increases from 5 percent per month to 15 percent for each month or part of a month the return is late, with the maximum penalty generally increasing from 25 percent to 75 percent.”²⁵ 

Abusive syndicated conservation easements
“In syndicated conservation easements, promoters take a provision of the tax law allowing for conservation easements and twist it by using inflated appraisals of undeveloped land (or, for a few specialized ones, the facades of historic buildings), and by using partnership arrangements devoid of a legitimate business purpose. These abusive arrangements do nothing more than game the tax system with grossly inflated tax deductions and generate high fees for promoters …

In the last five years, the IRS has examined many hundreds of syndicated conservation easement deals where tens of billions of dollars of deductions were improperly claimed. It is an agency-wide effort using a significant number of resources and thousands of staff hours. The IRS examines 100 percent of these deals and plans to continue doing so for the foreseeable future.”²⁶

Rettig writes: “We are devoting a lot of resources to combating abusive conservation easements because it is important for fairness in tax administration. It is not fair that wage-earners pay their fair share year after year but high-net-worth individuals can, under the guise of a real estate investment, avoid millions of dollars in tax through overvalued conservation easement contributions.”²⁷

Abusive micro-captive insurance arrangements
“In abusive ‘micro-captive’ structures, promoters, accountants, or wealth planners persuade owners of closely held entities to participate in schemes that lack many of the attributes of insurance. For example, coverages may ‘insure’ implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages. The ‘premiums’ paid under these arrangements are often excessive and are used to skirt the tax law.

Recently, the IRS has stepped up enforcement against a variation using potentially abusive offshore captive insurance companies. Abusive micro-captive transactions continue to be a high-priority area of focus.

The IRS has conducted thousands of participant examination and promoter investigations, assessed hundreds of millions of dollars in additional taxes and penalties owed, and launched a successful settlement initiative … The IRS’s activities have been sustained by the Independent Office of Appeals, and the IRS has won all micro-captive Tax Court and appellate court cases, decided on their merits, since 2017.”²⁸

The “Dirty Dozen” are certainly focus areas for the IRS, and any matters relating to these areas should be scrutinized. Practitioners must also remember that, depending on the nature of our involvement in planning and executing transactions, we can have exposure as return preparers or even promoters in these areas.

Endnotes 

1 Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

2 I.R.S. News Release IR-2022-113 (June 1, 2022).

3 Id.

4 Id.

5 Id.

6 I.R.S. News Release IR-2022-117 (June 6, 2022).

7 Id.

8 Id.

9 Id.

10 I.R.S. News Release IR-2022-119 (June 7, 2022).

11 Id.

12 Id.

13 Id.

14 Id.

15 Id.

16 I.R.S. News Release IR-2022-121 (June 8, 2022).

17 Id.

18 Id.

19 Id.

20 I.R.S. News Release IR-2022-122 (June 9, 2022).

21 Id.

22 I.R.S. News Release IR-2022-125 (June 10, 2022).

23 Id.

24 Id.

25 Id.

26 Id.

27 Id.

28 Id. 

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Background

Aspro, Inc. is an asphalt-paving corporation organized under Iowa law and treated as a subchapter C corporation for federal tax purposes. During the years in question, Aspro was owned by three shareholders, including two business entities and Milton Dakovich, who was also the president of Aspro. 

Aspro had a history of paying its shareholders “management fees” almost every year, but Aspro had not paid dividends since the 1970s. During the years in question, Dakovich received salary, director fees, and bonuses, in addition to management fees. There were no written agreements between Aspro and its shareholders for management services, and Dakovich did not have a written employment contract with Aspro.

The IRS denied Aspro's deductions for management fees for the tax years 2012 through 2014, finding that the management fees were not ordinary and necessary business expenses under Code §162. The tax court sustained the IRS findings, determining that the management fees were not paid as compensation for services but were instead disguised distributions of corporate earnings.

Code § 162 allows deductions for expenses that are ordinary and necessary in carrying on a trade or business, including reasonable salaries and compensation for personal services. Regulations § 1.162-7(b)(1) provides that compensation deductions will be disallowed if a purported salary or similar payment is actually a profits distribution by the corporation. Regulations § 1.162-7(b)(3) limits “reasonable compensation” to an amount that would ordinarily be paid for like services by like enterprises under like circumstances. The Court confirmed this requires a factual determination, and notes that in prior cases the 8th Circuit Court has applied multiple factors to make reasonable compensation determinations, including whether profits were paid to the shareholders as dividends; the nature, extent, and scope of the employee’s work; and prevailing rates of compensation for similar positions in comparable concerns. 

Eighth Circuit Court analysis and decision

The 8th Circuit Court rejected Aspro’s arguments and affirmed the tax court’s holdings. The court first rejected Aspro’s claim that the tax court abused its discretion in excluding testimony by two of Aspro’s expert witnesses. The 8th Circuit Court did not find an abuse of discretion by the tax court in excluding testimony from the two experts, based on findings that one expert’s “report does not offer an opinion as to the value of the various services at issue in this case nor does he apply scientific principles and methods,”[3] and the other expert’s report did not “articulate what principles and methods he used, if any, to conclude that ‘valuable services’ were provided.”[4]

Next, Aspro challenged the tax court’s holding that none of the management fees paid by Aspro to its entity shareholders were deductible. The 8th Circuit Court found that the tax court did not clearly err in finding that Aspro failed to meet its burden that any portion of the management fees paid to its entity shareholders was reasonable. The Court of Appeals found that Aspro provided no evidence “showing what ‘like enterprises under like circumstances’ would ordinarily pay for like management services.”[5] The Court of Appeals recited the tax court findings that Aspro produced no written management-services agreement or documentation of a service relationship, no evidence of how management fee amounts were determined, and no evidence that either shareholder entity billed or invoiced Aspro for any services.[6] The 8th Circuit Court also emphasized Aspro’s history of paying management fees to shareholders without making any distributions of profits, further noting that Aspro paid management fees to its shareholders roughly in proportion to their ownership interests in the corporation.  Based on these findings, the 8th Circuit Court found that the tax court did not clearly err in concluding that all management fees paid to Aspro’s entity shareholders were nondeductible. Finally, the Court of Appeals addressed whether management fees paid to Dakovich were deductible as reasonable payments purely for services. As with the other shareholders, the 8th Circuit Court found that Aspro presented no evidence of what similar companies would pay as management fees (over and above salary and bonuses) in like circumstances, including Dakovich’s status as an employee. The court also relied on the IRS expert’s conclusion that Dakovich received salary and bonus substantially higher than the industry average and median, and that management fees in addition to this salary and bonus was not reasonable. The IRS expert also found that Dakovich’s combined excess compensation and management fees were closely aligned with his ownership interest in Aspro, as was the case with the entity shareholders.

Based on these findings of excess compensation, alignment of the management fees with ownership interests, and lack of any shareholder dividends, the 8th Circuit Court held that the tax court did not clearly err in finding that Aspro failed to meet its burden of showing that the management fees paid to Dakovich were reasonable. The court further concluded that payments to Dakovich were therefore disguised distributions and were not purely for services actually performed.

Conclusion

The 8th Circuit Court decision in Aspro demonstrates key lessons for taxpayers attempting to justify C corporation management fees to shareholders. Aspro did not have written management fee agreements, did not make any dividend distributions of profits, and was not able to show a reasonable market basis for the amounts paid as management fees. If these facts had been different, it seems likely the court would have allowed at least some management fee deductions for the corporation. Importantly, this case also demonstrates a potential area of audit interest by the IRS, which likely includes both C corporation management fees and compensation.

Endnotes 

[1] Scott E. Vincent is the founding member of Vincent Law, LLC, in Kansas City. 

[2] 32 F.4th 673 (8th Cir. 2022).

[3] Id. at 676.

[4] Id. at 677.

[5] Id. at 678.

[6] Id.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

In Continuing Life Communities Thousand Oaks LLC v. Commissioner of Internal Revenue², the tax court ruled against the Internal Revenue Service in holding that the business could treat the deferred fees as income when it completed its commitment to the residents making the payments.

Background

Continuing Life Communities Thousand Oaks, LLC is a Delaware limited liability company with its principal place of business in California. Continuing Life Communities Thousand Oaks’ business is providing housing and care to seniors as their needs change, including housing, food, and care services like eventual skilled nursing care if needed. Continuing Life Communities Thousand Oaks charges residents large initial fees to move into its community and significant monthly payments to live there, which the court noted are similar to other communities in the continuing care industry.

To protect seniors against potential abuse, California law requires continuing care communities to provide lifetime care under “life care contracts.” California also places minimum standards on these contracts, including financial statements to residents prepared under generally accepted accounting principles (GAAP). The court indicated other states also have strict regulations on continuing care communities, making this a national consideration.

Continuing Life Communities Thousand Oaks’ residence agreement is a life care contract under California law and includes a contribution amount, as well as deferred and monthly fees. For the years in question, contribution amounts ranged $245,000-$570,000 based on the floor plan and residence chosen by the resident. The contribution amount for each resident was paid to a trustee of a separate master trust that provided financial protection and accounting to residents.

Deferred fees were based on a percentage of contribution amounts, accruing at 5% per year up to a maximum of 25%. Under the agreement, deferred fees were paid from the master trust when a resident died or moved out, and a new resident acquired the unit and paid his or her own contribution amount. After a resident died or moved out, the master trust paid the deferred fee and any other outstanding expenses, along with the balance of the original contribution amount back to the resident or his or her estate. Notably, the residence agreement referred to the deferred fee as a future payment, and Continuing Life Communities Thousand Oaks received no deferred fee if a resident was expelled, which does occasionally occur.

Continuing Life Communities Thousand Oaks’ monthly fees were set based on operating costs and economic indicators. These expenses included the costs to provide lifetime care and operating utilities like electricity, water, gas, and trash collection. Optional utilities like internet, cable TV, and telephone services were itemized separately from the monthly fees. If a resident with unpaid fees died, moved out, or was expelled, Continuing Life Communities Thousand Oaks subtracted the unpaid fees from the otherwise refundable contribution amount.

As required by California law, Continuing Life Communities Thousand Oaks followed GAAP for its tax reporting of payments received from residents. Accordingly, the contribution amount was not treated as income when initially paid. Instead, Continuing Life Communities Thousand Oaks amortized and recognized a fraction of the deferred fee as income yearly on a straight-line method based on the actuarially determined estimated life of the resident. When residents died or moved out, Continuing Life Communities Thousand Oaks immediately recognized the remaining unamortized deferred fee as income before it resold the residence and received cash from the master trust.

The tax court noted that amortization of deferred fees based on estimated lives of residents was actuarially re-determined annually, and the Continuing Life Communities Thousand Oaks was therefore able to defer recognizing unamortized portions of the deferred fees until termination of a residence agreement. As a result, Continuing Life Communities Thousand Oaks recognized relatively small deferred fee income during the years in question and reported millions of dollars of losses for tax purposes. On audit, the IRS disallowed Continuing Life Communities Thousand Oaks’ accounting method for the deferred fees, resulting in proposed deficiencies of nearly $20 million.

Tax court decision

The parties agreed on the facts, and both moved for summary judgment in tax court. The sole issue before the court was whether Continuing Life Communities Thousand Oaks’ accounting for deferred fees was allowed under the Internal Revenue Code.

Continuing Life Communities Thousand Oaks argued that it is allowed to follow its own method of accounting under Code § 446 unless it does not clearly reflect income or is not consistently followed. Continuing Life Communities Thousand Oaks also cited Treasury Regulation § 1.446-1(a)(2) for the proposition that a “method of accounting which reflects the consistent application of generally accepted accounting principles in a particular trade or business in accordance with accepted conditions or practices in that trade or business will ordinarily be regarded as clearly reflecting income.”³ Although case law exceptions have developed, Continuing Life Communities Thousand Oaks argued that it would be an abuse of discretion by the Commissioner of Internal Revenue to apply an exception since Continuing Life Communities Thousand Oaks’ method of accounting clearly reflects income.

The commissioner argued that the commissioner can determine whether a taxpayer’s accounting method clearly reflects income. The commissioner acknowledged there are limitations on this discretion but argued that Continuing Life Communities Thousand Oaks did not demonstrate abuse of discretion in this case.

The tax court decision provides an extensive outline of applicable law and historical cases addressing deferred income and applicable accounting methods. The court cited Treasury Regulation § 1.451-1(a) for the rule that where a right to receive compensation for services requires completion of the services, the compensation is ordinarily income for the tax year in which such determination can be made; in this case, when Continuing Life Communities Thousand Oaks has fulfilled its lifetime care obligation. The court also noted, and appeared to rely on, the fact that the residents’ contribution amount (from which deferred fees were ultimately paid) was held in a master trust and was not under Continuing Life Communities Thousand Oaks’ control or available for use to pay taxes. Finally, the court noted that applicable GAAP rules require consistent treatment and would not allow Continuing Life Communities Thousand Oaks discretion in reporting income, since it was governed by actuarial determinations. In the context of these factual findings, the court reviewed prior cases in a variety of contexts where following GAAP accounting may or may not have been adequate for tax purposes. Ultimately, the court found that in this case Continuing Life Communities Thousand Oaks’ compliance with GAAP and its overall accounting method clearly reflected income.

The court also acknowledged the commissioner’s discretion, noting that Treasury Regulation § 1.446-1(a)(2) contains the “remarkable sentence: ‘However, no method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income.’”⁴ The court reasoned that the commissioner’s discretion has significant weight but recited prior cases holding that it cannot be exercised without consideration of the facts in a particular case and cannot be abused. Otherwise, the court noted the commissioner’s decision would be unreviewable.

Ultimately, the court decided that the facts and support for Continuing Life Communities Thousand Oaks’ treatment of the deferred fees under GAAP “fits snugly into the pattern of similar cases.”⁵ The court further found that, at least in this case, the commissioner’s discretion to change accounting methods should not overcome its conclusion, noting that “the history of how that discretion came to be weakens its power to overcome text, purpose, and analogy.”⁶ Based on these findings, the court granted summary judgment to the Continuing Life Communities Thousand Oaks.

Conclusion

Continuing Life Communities Thousand Oaks LLC v. Commissioner of Internal Revenue is an excellent review and analysis of the history and case law regarding deferred income and the interplay between financial and tax accounting. The case is also a good reminder that the commissioner has broad discretion to challenge and change a taxpayer’s accounting method. However, importantly, the U.S. Tax Court can find that the commissioner’s discretion does have limitations and can be challenged if it abuses that discretion.

Endnotes 

1 Scott E. Vincent is the founding member of Vincent Law, LLC, in Kansas City. 

2 T.C. Memo. 2022-31. 

3 Id. at 7. 

4 Id. at 21 (citing Treas. Reg. § 1.446-1(a)(2)). 

5 Id. at 25. 

6 Id. at 25.

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

The 9th Circuit affirmed the tax court’s decision in Isaacson v. Commissioner,[3] finding that the Internal Revenue Service properly imposed tax deficiencies and a 75% tax fraud penalty relating to legal fees intermingled with client funds and not reported as income. 

Background

Lon Isaacson (Isaacson or Taxpayer) was a long-time trial lawyer, practicing tax fraud litigation. Isaacson was disbarred in 2013 for willfully violating Rule 4-100 of the California Rules of Professional Conduct, which requires that client funds be kept in trust accounts, imposes recordkeeping requirements, and bars lawyers from commingling client funds. Before the disbarment, Isaacson represented four individuals who had been sexually abused as children by members of the Catholic clergy (clergy lawsuit). Isaacson personally knew these clients, who considered him to be both a lawyer and trusted friend.

With some variations, the four clients’ fee agreements included up to a 60% contingent fee for Isaacson and reimbursement for as much as 110% of Isaacson’s costs. Terms also included purporting to allow Isaacson to deposit client funds in non-IOLTA accounts with Isaacson retaining interest on the deposits. Some of the clients communicated to Isaacson that they did not want him to manage investment of future settlement proceeds and did not want future settlement proceeds invested at Union Bank of Switzerland (UBS).

Isaacson had a relationship with UBS and its advisors, and he had previously established a UBS account where he deposited proceeds from the clergy lawsuit settlements (UBS account). On documents opening the UBS account, Isaacson identified the account as for a sole proprietorship, listed himself as the principal officer and beneficial owner of the account, and handwrote the word "Trustee" after his law firm's typed name on the line listing the account owner's information. Isaacson did not identify this account as a client trust account, and he did not indicate that the source of account funds would be client trust funds. Instead, Isaacson indicated that the source of funds for the UBS account would be "income from the business/organization." 

In 2007, as part of a global settlement involving several clerical organizations and hundreds of victims of childhood sexual abuse, Isaacson secured a collective settlement of $12.75 million for his four clients in satisfaction of their pending claims. Isaacson allocated this settlement among the clients and charged each of the four clients a 60% fee, which was not formally challenged despite some complaint by two of the clients.

Isaacson deposited the settlement funds from the clergy lawsuit in the UBS account in 2007. The tax court found Isaacson then treated the UBS account as a personal account and not an account held in trust for the benefit of his clients. For example, in December 2007, Isaacson had a personal need for liquidity and directed UBS to sell $1.85 million of auction rate securities, but then that same day he directed UBS to repurchase the $1.85 million of securities just sold. Also in December 2007, Isaacson emailed UBS asking for clarification of which auction rate securities were "purchased for my benefit", the "amount of my present holdings, and the interest I have earned to date". Once UBS responded, Isaacson directed UBS to transfer $50,000 of earned interest to his personal trainer and social acquaintance as a gift. Later in December 2007, Isaacson sent UBS handwritten instructions to transfer $600,000 from the UBS account into his law firm's Bank of America account, and UBS transferred the funds that day.

In 2008, Isaacson continued to use and manage the funds in the UBS account. In January 2008, he withdrew $100,000 from the UBS account and deposited the money into his law firm's Bank of America account. Later in January 2008, he withdrew $1.3 million from the UBS account and deposited the money into another account he controlled at California Bank & Trust. On Jan. 29, 2008, Isaacson paid one of the clients his portion of the clergy lawsuit settlement funds.

In February 2008 the market for auction rate securities froze, and UBS engaged outside advisors, including Howard Privette II with the Paul Hastings law firm, to review auction rate securities matters which included the UBS account. After reviewing Isaacson’s activity with the UBS account, Privette was concerned that the UBS account was not a valid client trust account under California law and therefore posed a risk to UBS because of potential unknown ownership interests. Accordingly, on March 10, 2008, UBS placed a legal hold on the UBS account. After a series of letters and affidavits from Isaacson and his clients, UBS later lifted the hold on the UBS account. Isaacson and his clients later engaged in litigation with UBS over investment of the clergy account funds in auction rate securities, resulting in a settlement in favor of Isaacson and his clients and a partial distribution of settlement proceeds to them in 2009.

For preparation of his 2007 income tax return, Isaacson retained an outside CPA and provided the CPA with QuickBooks ledgers relating to his practice. However, these ledgers did not account for the UBS account and transactions. Isaacson also failed to tell the CPA that the UBS account existed. In 2008, Isaacson had a legal assistant in his law firm draft a memorandum advising that funds held in a client trust account would not represent income. The memorandum, which Isaacson represented to be a tax opinion letter, purported to provide "authority supporting our position that our client, taxpayer, is not responsible to report income he never actually or constructively received." This memorandum does not identify Isaacson as the hypothetical taxpayer-client. Allegedly relying on the legal assistant memorandum, Isaacson did not tell his CPA about the receipt of the clergy lawsuit settlement funds, nor did he report any legal fees earned from the clergy lawsuit settlement as income on his 2007 income tax return.

On audit, the IRS sought an income tax deficiency of more than $2.8 million, and a 75% fraud penalty under Code Section 6663 of over $2 million. Isaacson petitioned the tax court, and the tax court held that Isaacson was liable for the tax deficiency and fraud penalty asserted by the IRS. The tax court found that when Isaacson deposited the clergy lawsuit settlement funds into the UBS account in December 2007, he alone controlled the UBS account. The tax court further found that the IRS had proven, by clear and convincing evidence, that Isaacson's underpayment of tax was done with fraudulent intent.

Isaacson appealed the decision to the Court of Appeals for the 9th Circuit. Isaacson argued that he held the funds resulting from the clergy settlement for the benefit of his clients and was not required to report his legal fees in 2007 because of a fee dispute with at least two of the clients.

The 9th Circuit Findings

The 9th Circuit reviewed the tax court conclusions of law de novo and its factual findings for clear error. The 9th Circuit specifically indicated it would defer to the tax court factual findings “unless we are left with the definite and firm conviction that a mistake has been committed”.

The 9th Circuit first noted that from the time the settlement funds were wired into the UBS account, Isaacson treated the funds as his own. He immediately commingled the settlement funds with money he had previously deposited in the UBS account, and he directed UBS to invest the funds consistent with his personal risk preferences. Days after the funds were invested, for "liquidity" reasons, Isaacson directed UBS to sell $1,850,000 of securities purchased with the settlement funds. The following week, Isaacson instructed UBS to transfer $50,000 from the UBS account to his personal trainer. Based on these findings, the 9th Circuit found that the tax court did not err in concluding that Isaacson's conduct demonstrated his dominion and control over the funds.

The 9th Circuit also found that the tax court did not abuse its discretion by estopping Isaacson from arguing that a fee dispute existed with his clients. This argument was plainly inconsistent with Isaacson's representations to the Superior Court of California that no such dispute existed during the relevant time period, which resulted in a Superior Court disbursement of $6,883,047.05 of settlement funds to Isaacson. The 9th Circuit also found that, even absent judicial estoppel, they would still affirm the tax court because “the record as a whole supports the conclusion that no fee dispute existed.” Notably, the tax court had also concluded that even assuming there was a fee dispute with his clients, Isaacson should have recognized his asserted fees as income for 2007.

The 9th Circuit also found no error in the tax court's imposition of the 75% fraud penalty. The court carefully considered relevant considerations for fraud and found that an inference of fraudulent intent was supported by the record from the tax court.

Conclusion

This 9th Circuit case is a cautionary example regarding handling of client settlement funds and trust accounts. The lawyer/taxpayer in this case violated ethical requirements in this regard. The case further illustrates income tax and timing considerations with client settlements and disputed contingent fees. Another important note here in a fee dispute with multiple clients: the portion of fees that is undisputed should be recognized as income as soon as all the events which fixed the lawyer’s right to the fees occur. As evidenced by this case, the all events test may occur in stages in a multiple client situation or when only a portion of a fee is disputed.

Endnotes

1 Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

2 Isaacson v. Comm’r, 2022 PTC 49 (CA9 02/23/2022).

3 Isaacson v. Comm'r, T.C. Memo. 2020-17 (U.S.T.C. Jan. 23, 2020)

Every pragmatic legal professional expects that some percentage of their billed services will not be paid. But even small fluctuations in a law firm’s collection rate can have a huge impact on its bottom line. So, the question is: How can you improve your collection rate and minimize outstanding receivables?

Below are five ways lawyers can improve accounts receivable collections and reduce late and non-payments.

Interview carefully and thoroughly

Conducting a potential new client consultation is an art, but there are some easy concepts you can implement to help you avoid pitfalls down the road. The goal of the consultation (other than your retainment) should be to assess the client’s situation and give reasonable legal advice. You should utilize the following steps:

·        Determine whether the client’s needs and expectations can be realistically satisfied. If so, give the client a roadmap of what the most important next steps will be and the issues that may arise.

·        Ensure the client understands the cost and the law firm’s expectation of payment, discussing frankly how the client plans to pay and whether the client can afford the firm’s services.

·        Exercise your own judgment as to whether this client is credible and a good risk. This is easier said than done and will mostly come with experience, but if the client’s story doesn’t make sense or if you would be the client’s fifth lawyer, alarm bells should be ringing. Trust your gut.

Bottom line: When the consultation ends and the client decides to retain you, both lawyer and client should be comfortable and confident in the integrity of the other party.

Communicate during the case

A good way to protect yourself from possible liability is to be in regular contact with your clients. This gives you touchpoints throughout your client’s case and lets you control the narrative as events progress.

It is harder to defend yourself against your client if you haven’t properly papered the file. Also, the single biggest complaint against lawyers in the United States is “my lawyer won’t return my call.”

Failure to communicate can not only get you in trouble, but it also affects the client’s willingness to pay his or her bill. Instead, you can easily instill confidence in your client while also protecting yourself by sending frequent — even if brief — messages and updates to the client. Remember, you are a team after all.

Send easy-to-understand invoices and follow up

Provide a clearly written, detailed invoice. You don’t have to outline your time to the minute but use separate line items for the larger tasks and include a brief summary of the work you did.

As much as possible, refrain from using legal jargon. Your objective is to give the client visibility into what you’re doing for them. If you use too much technical language, your client may end up with even more questions.

About a week after invoices are sent, schedule time on your calendar to follow up via phone or email. In addition, generate a list of the clients who have not paid the prior month’s invoices and reach out to them directly to inquire about payment.

Following up with clients who have outstanding invoices helps reduce the risk of non-payment considerably.

Be timely with your billing

Clients typically appreciate what you just did for them — not what you did months ago. What’s more, you want to catch them at a time where they appreciate you and the work you are doing on their case.

For internal consistency and external predictability, you should try to bill clients around the same day every month. Even better, aim to have your clients receive their monthly statement about three to four days after the first of the month. Sending invoices around this time increases the chances the client has recently received a paycheck and therefore has funds available.

Clients routinely complain that all too often they receive bills 90 days or more after the work is done. By then, the client does not remember what you did three months ago and will be less willing to pay you. If the work is fresh on his or her mind, you will find the client more willing to pay the invoice.

Utilize scheduled payments

For clients who might have trouble paying your bill or for those who are habitually late and/or forgetful, one option is to use an online payment solution with a scheduled payments feature to offer them a recurring monthly payment plan. This is a great way to help them out financially and save you time and effort, all while ensuring you maintain a consistent, predictable cash flow in your practice.

To make things even easier on you and your firm, have clients sign payment authorization forms during their intake paperwork and set them up on a payment plan as part of your initial meetings and onboarding. That way, your clients’ payments can run automatically without any action needed from you or them.

The longer a bill sits unpaid, the less likely it is that it will ever get paid. Therefore, it is imperative that you have a strategy to minimize aged accounts receivable, lest they remain outstanding indefinitely.

Explore white papers, charts, and checklists on time, billing, and accounting programs; time versus value-based billing; and more on our Manage a Practice page. If you have questions about implementing these solutions in your practice, ask an expert your questions at no cost via email or during a virtual visit.

LawPay was developed specifically for legal professionals, providing a simple, secure way to accept credit, debit, and eCheck payments online. LawPay’s technology contractually protects client funds by correctly separating earned and unearned fees and by restricting the ability of any third-party from debiting monies from a trust or IOLTA account. LawPay is a proud Missouri Bar member benefit and is trusted by more than 135,000 lawyers.

Reprinted with permission of LawPay. Originally published here.  

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

The Internal Revenue Service recently issued Letter Ruling 202151005 providing IRS Chief Counsel Advice on the application of self-employment tax to certain rental income. The chief counsel first finds that whether an activity is a “rental activity” under Internal Revenue Code § 469 does not determine whether the activity is “rentals from real estate” excluded from net earnings from self-employment under Code §1402 for self-employment tax purposes. In situations that do not involve real estate dealers, the chief counsel further finds that if sufficiently substantial services are provided to occupants, the net rental income may be subject to self-employment tax. The taxpayer requested advice on two general fact patterns that highlight the circumstances when self-employment tax may apply to net rental income.

Fact situation 1

An individual taxpayer directly owns and rents, in a trade or business, a fully furnished vacation property via an online rental marketplace. The taxpayer is not a real estate dealer and does materially participate, so the activity is not a passive activity. The taxpayer provides linens, kitchen utensils, and all other items to make the vacation property fully habitable for each occupant. The taxpayer also provides daily maid services, including delivery of individual-use toiletries and other sundries; access to dedicated Wi-Fi service for the rental property; access to beach and other recreational equipment for occupant use; and prepaid vouchers for ride-share services between the rental property and the nearest business district.

Fact situation 2

An individual taxpayer directly owns and rents, in a trade or business, a fully furnished room and bathroom in a dwelling via an online rental marketplace. The taxpayer is not a real estate dealer and does materially participate, so the activity is not a passive activity. Occupants only have access to common areas of the home to enter and exit the room and bathroom and have no access to other common areas such as the kitchen and laundry room. The taxpayer cleans the room and bathroom in between each occupant’s stay.

Applicable law

The Chief Counsel Advice outlines several relevant Internal Revenue Code, treasury regulations, IRS rulings, and court cases, including the following:

Code § 469(c) provides that a passive activity is generally any trade or business activity in which the taxpayer does not materially participate or any rental activity. Regulations under § 469 provide that an activity involving the use of tangible property is not a rental activity for the taxable year if the average period of customer use for the property is seven days or less. Under § 469(h), a taxpayer materially participates in a trade or business activity only if “the taxpayer is involved in the operations of the activity” on a regular, continuous, and substantial basis. In the case of individuals, the regulations provide seven tests for material participation. Regulations § 1.469-5T(a)(1) provides that an individual will generally be treated as materially participating in an activity for a taxable year if the individual participates in the activity for more than 500 hours during such year.

Regulations § 1.469-1T(d)(1) provides that the characterization of items of income or deduction as passive does not affect the treatment of such items under provisions of the code other than § 469. Therefore, whether amounts are passive activity income or loss under the § 469 regulations is not determinative of whether those amounts are rentals from real estate under § 1402(a)(1) and related regulations.

Section 1401 imposes tax on the self-employment income of individuals. Section 1402(b) defines self-employment income as net earnings from self-employment, with certain modifications. Section 1402(a) provides that the term “net earnings from self-employment” (NESE) means gross income derived from any trade or business less the deductions that are attributable to such trade or business. However, under § 1402(a)(1), rental income from real estate reduced by proper deductions attributable to that rental income (net rental income) is excluded from NESE, unless received in the course of a trade or business as a real estate dealer.

Regulations § 1.1402(a)-4(c)(1) provides that rentals from living quarters, where no services are rendered for the occupants, are generally considered rentals from real estate under § 1402(a)(1), except in the case of real estate dealers. However, regulations § 1.1402(a)-4(c)(2) provides:

“Payments for the use or occupancy of rooms or other space where services are also rendered to the occupant . . . are included in determining net earnings from self-employment. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only.”

Regulations § 1.1402(a)-4(c)(2) lists examples of situations where services are rendered for the convenience of occupants, such as hotels, boarding homes, warehouses, and storage garages.

In revenue ruling 57-108 (1957-1 C.B. 273), the IRS ruled that a landlord who rented furnished vacation beach dwellings and rendered services “for the comfort and convenience of his guests in connection with their recreational activities” – including maid services, swimming and fishing instruction, mail delivery, furnishing of bus schedules, and information about local churches – rendered these services primarily for the occupants’ convenience. Consequently, the net rental income from the vacation beach dwellings was included in the landlord’s NESE because the § 1402(a)(1) exclusion did not apply.

In Bobo v. Commissioner of Internal Revenue, the tax court considered a mobile home park that provided leased trailer park units with utility hookups, sewage facilities, and laundry facilities.² The court held that the net rental income from the rental of the trailer park units was excluded from the owners’ NESE under § 1402(a)(1), setting the standard for when services are considered not rendered for the occupant. The court noted Section 1402(a)(1): “should be applied to exclude only payments for use of space, and, by implication, such services as are required to maintain the space in condition for occupancy. If the owner performs additional services of such substantial nature that compensation for them can be said to constitute a material part of the payment made by the tenant, the ‘rent’ received then consists in part of income attributable to the performance of labor which is not incidental to the realization of return from passive investment.”³

Ultimately, the Bobo court determined that even though the trailer park furnished laundry services that were “clearly rendered for the convenience of the tenant and not to maintain the property in condition for occupancy,” the tenants’ payments for the laundry services were not “substantial enough to classify all the tenants’ (rental) payments as received for ‘services to the occupants.’”⁴ Accordingly, the court held the payments at issue were rental from real estate excluded from NESE.

Chief counsel analysis – fact situation 1

In Letter Ruling 202151005, the chief counsel concluded the net rental income in fact situation 1 is not excluded from NESE under code §1402(a)(1). The chief counsel finds that determining whether services are rendered for an occupant is based on the facts and circumstances in each case. In this fact situation, the chief counsel finds that the services are for the convenience of the occupants, are beyond what is clearly required to maintain the space for occupancy, and are “of such a substantial nature that the compensation for these services can be said to constitute a material portion of the rent.” Based on these fact findings, the chief counsel determines that the net rental income is included in NESE. The chief counsel also concludes that characterization of the activity as “not a passive activity” under code § 469(c) does not affect whether it is excluded from NESE code § 1402(a)(1).

Chief counsel analysis – fact situation 2

In contrast, the Chief Counsel Advice concludes that the net rental income in fact situation 2 is excluded from NESE under code §1402(a)(1). In this fact situation, the services provided to clean and maintain the property so it is suitable for occupancy were described as “not furnished primarily for the convenience of the property’s occupants” and described as not so substantial to constitute a material part of the payments made by the occupants. Based on these facts, the chief counsel determines that the net rental income is excluded from NESE. It is again noted that this NESE determination is not impacted by characterization of the activity as “not a passive activity.”

Conclusion

The Chief Counsel Advice highlights a potentially unexpected tax on net rental income for certain taxpayers renting property via online rental marketplaces. When substantial services are provided with a rental, the taxpayer will need to consider the fact situations in this guidance and determine whether the net rental income from the activity may be subject to self-employment tax. Presumably, the IRS will pursue this issue, and failure to pay self-employment tax consistent with this advice could be an IRS audit flag. It’s unknown whether taxpayers will further pursue this issue in litigation to challenge the IRS chief counsel position.

Endnotes

1 Scott E. Vincent is the founding member of Vincent Law, LLC, in Kansas City.

2 70 T.C. 706 (1978).

3 Id at 709.

4 Id at 711.

Scott E. Vincent

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Some of the individual tax breaks include dependent care assistance, payroll tax credits for the self-employed, increases in the child tax credit and earned income tax credit, recovery rebates, student loan forgiveness exclusions, and other individual relief. Business tax relief provisions include deductibility of expenses paid with proceeds from forgiven Paycheck Protection Program (PPP) loans, which altered prior guidance. The ARP also extended and modified certain refundable payroll tax credits, allowing eligible business taxpayers to file amended returns for refunds. Many Coronavirus Aid, Relief, and Economic Security (CARES) Act provisions from 2020 continue to apply for 2021 as well.

Importantly, as this article goes to print, Congress and the White House are negotiating a variety of tax provisions in proposed budget and spending bills that could also have significant impact on certain taxpayers. Current tax provisions under consideration would primarily impact large corporations, high income taxpayers, and high net worth taxpayers, but none of the legislation is permanent yet. All taxpayers should carefully monitor this legislation and the potential impacts on year-end planning if the bills are enacted.

In addition to pandemic relief tax provisions and the potential for year-end legislation, taxpayers need to consider planning for current and potential tax rates, the standard deduction and limits on itemized deductions, and multiple other issues, including continuing provisions of the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). The § 199A deduction for qualified income from pass-through entities may also impact individuals and their businesses.

With the backdrop noted, this article outlines several individual and business planning issues for consideration. Taxpayers should, of course, adjust planning for their individual circumstances and carefully monitor ongoing changes to the provisions outlined here and in other new legislation.

Year-end planning issues for individuals

• Review ARP Act rebates. Most individuals under applicable income levels already received stimulus checks for their recovery rebate tax credit. These checks were issued based on either 2019 or 2020 income tax returns, but the final calculation of the correct rebate amount is part of 2021 tax returns. If this calculation shows a larger rebate, a taxpayer can claim it as a credit against 2021 tax liability. If the calculation shows an excess rebate, repayment is not required.
   
• Review individual credits. The ARP increased the child tax credit for 2021 from $2,000 to $3,000, or $3,600 for children younger than 6 years old. The entire credit is refundable for taxpayers who qualify under the income thresholds. Eligibility for the earned income credit was expanded, and the ARP also expanded dependent care assistance tax benefits for 2021. A premium assistance credit is available for families purchasing health insurance through exchanges offered under the Affordable Care Act. The Families First Coronavirus Response Act included qualified sick leave and family leave equivalent income tax credits for self-employed individuals.
   
• Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions from the 2017 Tax Act. For 2021, the basic standard deduction is increased to $25,100 for joint filers; $18,800 for heads of household; and $12,550 for singles and married taxpayers filing separately. For taxpayers either 65 or older or blind, there is an additional standard deduction of $1,350, increased to $1,700 for unmarried taxpayers that are not surviving spouses, and doubled for taxpayers that are blind and 65 or older. Many itemized deductions also remain either reduced or eliminated. So, unless allowable medical deductions (as limited by 7.5% of AGI), allowable state and local taxes (as limited), allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction, taxpayers may find that the increased standard deduction provides more tax benefit. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years.
   
• Consider special charitable deduction rules. There is a $300 ($600 for joint returns) above-the-line charitable deduction for taxpayers that do not itemize. In addition, for taxpayers that itemize deductions, charitable contributions in 2021 are deductible to the extent the aggregate does not exceed a taxpayer’s charitable contribution base. Excess contributions are eligible for a five-year carryover.
   
• Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year and doing so will not cause state and local tax deductions to exceed the applicable limitation.
   
• Plan for the 3.8% tax on unearned income. This surtax is 3.8% of net investment income (NII) that exceeds modified adjusted gross income (MAGI) thresholds. Year-end planning for the 3.8% surtax depends on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI.
   
• Consider the additional 0.9% Medicare tax. This applies to individuals receiving a combination of wages with respect to employment and self-employment income in excess of applicable thresholds. Employers must withhold the additional Medicare tax from wages in certain circumstances. Self-employed persons must include it in estimated tax payments, and some employees may need more withholding to cover the tax.
   
• Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year.
   
• Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. So, analysis of taxable income, potential capital gains, and other applicable taxes is required to determine the best combination.
   
• Consider retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 and older.
   
• Certain retirement plan distributions are excepted from the 10% early withdrawal penalty, such as a limited qualified birth or adoption distribution. The CARES Act allowed a special coronavirus relief withdrawal of up to $100,000 from retirement plans, which is includable in income over a three-year period or eligible for tax-free rollover to an eligible retirement plan within the three-year period.
   
• Review required minimum distributions (RMDs) from retirement accounts. RMDs were waived for 2020 but are required for 2021. The RMD beginning date for taxpayers changed from 70.5 to 72 starting with the 2020 tax year. Participants who are still working and making contributions to an employer-sponsored retirement account also may be able to further delay RMDs on that account. Taxpayers who fail to take RMDs can be subject to a penalty of 50% of the required amounts that are not withdrawn.
   
• Consider making charitable donations from traditional IRAs. Qualified charitable distributions are made directly to charities, and the amount is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution may reduce RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions.
   
• Consider a Roth IRA conversion. A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. This will increase AGI for this year, so taxpayers should consider the impact on other AGI tax calculations.
   
• For taxpayers eligible to make health savings account (HSA) contributions, consider deductible HSA contributions before the end of the year. These are deductible from AGI, so the benefits are available even if a taxpayer does not itemize deductions.
   
• Increase the amount set aside for next year in a health flexible spending account (FSA) if the taxpayer did not set aside enough for this year. This can allow payment of medical and dental bills with pre-tax earnings.
   
• Complete annual gift tax exclusion before the end of the year to save gift and estate taxes. For 2021, taxpayers can give $15,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets not subject to the kiddie tax.
   
• Consider education deductions and credits. Tax-free distributions from § 529 qualified tuition programs of up to $10,000 were expanded to elementary or secondary public, private, and religious schools, as well as expenses for participation in certain apprenticeship programs and limited amounts of qualified education loan repayments. For taxpayers under certain income thresholds, there are several credits and deductions available and limited student loan interest may be deductible. For 2021-25, the ARP also excludes certain discharges of student loans from income.
   
• Consider home-related tax provisions. Working from home increased significantly during the pandemic; self-employed workers and business owners may be able to deduct related expenses, although these would not be deductible for employees. Mortgage interest is limited to the level of acquisition indebtedness depending on when the home was acquired ($750,000 for homes acquired after Dec. 14, 2017; $1 million for homes acquired before that date), but mortgage interest allocable to the portion of a home used to operate a business is not subject to this limitation. Interest on home equity indebtedness may be deductible to the extent the debt was used to buy, build, or substantially improve the home. Gain of up to $500,000 for married taxpayers ($250,000 for other taxpayers) on the sale of a home is excluded from income, but the portion of the home used for business or rented reduces this exclusion from gain. Discharges of qualified principal residence indebtedness in 2021 are not included in gross income.

Year-end planning issues for business owners

• Review possible payroll tax credits. Businesses with less than 500 employees that offered paid sick or family leave through Sept. 30, 2021, to employees who took COVID-19 leave may qualify for refundable payroll tax credits. An employee retention tax credit (ERTC) also may be available for 2021 to businesses impacted by COVID-19 that kept employees on payroll. The “impact” requirement may include suspended operations and comparisons of gross receipts in 2021 to prior periods. To claim these credits and potential refunds, businesses will need to review and possibly amend payroll tax returns to account for the detailed requirements and calculations. These credits may also be available to qualifying self-employed individuals.
   
• The CARES Act included the Paycheck Protection Program (PPP). The PPP generally provides tax-free loan forgiveness based on expenditures in qualifying categories. For taxpayers participating in the PPP, forgiveness applications and timing should be considered, including carefully compiling records of PPP expenditures. CAA 2021 confirmed that taxpayers may deduct expenditures paid with proceeds from forgiven PPP loans, and “catch up” deductions may be available in 2021 for taxpayers that did not deduct these expenditures on 2020 tax returns. There is also overlap between expenditures that qualify for PPP loan forgiveness and eligibility for the ERTC, so careful analysis of the interplay between these programs is important.
   
• Consider the §199A qualified business income deduction for non-corporate taxpayers of up to 20% of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. For 2021, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $329,800 for married couples filing jointly; $164,295 for married filing separately; and $164,900 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into this year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end.
   
• Consider making expenditures before year-end that qualify for § 179 business property expensing. For tax years beginning in 2021, the expensing limit is $1.05 million, reduced dollar for dollar for property placed in service over $2.62 million. This expensing is available for most depreciable property and qualified improvement property, which generally includes interior building improvements and roofs, as well as HVAC, fire protection, alarm, and security systems. Property acquired and placed in service before year-end is eligible for full expensing for the year.
   
• Consider 100% first-year bonus depreciation for new and some used machinery and equipment purchased and placed in service in 2021. Like expensing, bonus depreciation is available for the full year, even if the asset was placed in service late in the year, so year-end purchases can receive a full first-year bonus write off.
   
• Consider changing to the cash method of accounting, rather than the accrual method. “Small businesses” with less than $26 million of average annual gross receipts over a three-year period may be eligible for the cash method if they meet other requirements. Generally, the cash method of accounting allows more flexibility in timing income and deductions.
   
• Consider meal and entertainment deductions. CAA 2021 allows a 100% deduction in 2021 and 2022 for properly documented expenses relating to food and beverages purchased from restaurants.
   
• Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year.
   
• Consider timing for disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income.
   
• Review partnership and S corporation basis to make sure it is sufficient to deduct losses in current and future years.
   
• Review S corporation salaries to ensure that shareholders receive reasonable wages for their work for the business. The IRS often audits S corporations that pay all their profits as distributions without accounting for reasonable wages to shareholders.
   
• Consider setting up a retirement plan and health insurance plan if they are not currently offered. These plans can provide key benefits for retention of employees and for owners of a business.

Recent tax law changes and pandemic-relief legislation require continuing consideration for 2021 year-end planning. As noted, significant budget and spending legislation is also currently proposed, which could provide additional and different considerations for year-end planning this year. Taxpayers need to carefully consider these issues in light of their specific circumstances and watch for continuing tax law changes as we close out this unusual year.

Endnote
1 Scott E. Vincent is the founding member of Vincent Law, LLC, in Kansas City.

People are used to the convenience of electronic payments and online bills. Many studies show most people expect businesses, including retail and service providers, to offer a wide variety of electronic payment options. 

If your practice is committed to providing a 21st century client experience, you must adopt frictionless billing payment processes. Not only is doing so necessary to give your clients the service they want and deserve, but if your firm doesn’t step into the modern era with electronic billing and payments, you’ll discover another firm already has, which can make them more attractive to your clients. 

What Is frictionless billing?  

Frictionless billing is a payment process that involves fewer steps and simpler interactions. Online retailers and service providers have pioneered the frictionless transaction process for the digital age by removing the need for customers to visit physical locations, implementing one-click purchasing, and offering automatic billing. 

In the law firm context, frictionless billing involves making it easier for clients to pay by reducing the number of steps in the process. Like with online retailers, having electronic payment options is central to frictionless billing and a positive client experience. 

Frictionless billing eliminates waiting for a paper invoice to come in the mail, getting out a checkbook, and mailing a check. It also alleviates a client’s uncertainty regarding whether he or she sent the payment or the law firm received it. Instead, electronic payment options reduce the payment process to just one click in many cases.  

How electronic payment tools reduce friction for clients 

Electronic payment solutions simplify your firm’s billing process and increase the ease of submitting payment for your clients. Electronic payments can help remove barriers for your clients and enhance their experiences by doing the following: 

Eliminating paper bills 

Electronic payment solutions clean up the messy paper trail of old payment methods. Emailed invoices and online platforms your clients can log into make it easier for them to access invoices and payment records or refer for information they may need. 

Offering instant confirmation 

One of the keys to online retail’s success is the provision of instant gratification. Electronic payments offer this same feeling to clients, who can receive immediate automated payment confirmations to know that their payments have been received by their lawyers. Both the lawyer and client no longer need to wonder where the client’s payment may be. 

Facilitating preferred payment methods 

Surveys of consumers show that most people prefer paying with credit or debit cards or by other electronic means. This includes payments not only for consumer goods but for any bills they receive, including invoices from service providers like lawyers. If a law firm continues to require clients to pay by check, it only creates another point of friction in the payment process, especially for those clients who no longer use or own checks. In some cases, the friction may be too great for a client or prospective client, forcing them to look for another law firm willing to accept electronic payments. 

Allowing clients to pay on their own schedule 

The proliferation of electronic payments has taught us all the convenience of being able to pay our bills on our own schedule. If clients can pay your invoices on their own schedules rather than during your business hours, it represents a small but noticeable improvement in the client experience. 

What lawyers should consider when accepting electronic payments 

Of course, lawyers face unique issues in accepting electronic payments that many other retailers or service providers do not have. This mostly stems from lawyers’ ethical obligations with respect to client and third-party funds. Ethical rules require lawyers to separate payments received from a client or third-party that do not represent expenses or earned fees into a separate trust account. 

In the earlier days of electronic payments, lawyers did not necessarily have the option to divert client payments into trust accounts. However, in recent years, the legal industry has seen the launch of electronic payment processors targeted specifically for law firms, offering lawyers the ability to separate payments into earned and unearned funds and send funds to their proper accounts. 

Processing fees from electronic payments also posed ethical and operational issues for law firms. Lawyers cannot use payment processing to accept client payments representing unearned fees if the payment processing fees are deducted from the payment itself. Those funds still legally belong to the client, so deducting fees and expenses from client property represents a violation of ethical and fiduciary obligations. 

However, payment processors for lawyers allow firms to ensure that fees and expenses are appropriately deducted from operating accounts rather than client funds. 

From a practical perspective, payment processing fees also represent an expense or overhead that lawyers have resisted. But more and more firms are recognizing that payment processing fees should be looked at as just another cost of doing business and factored into the firm’s financials accordingly. Many lawyers also note that the minimal costs of electronic payment processing are far outweighed by the benefit of immediate, confirmed payment. 

LawPay is a proud Missouri Bar member benefit provider. Missouri Bar members who sign up for a new LawPay account between June 1-30, 2021, will pay no monthly fee for nine months. Learn More

Click here to learn more about The Missouri Bar’s member benefits. 

If you have questions or want information from those who have implemented these solutions for law firms, members can ask an expert for free via email or during a virtual visit.

Reprinted with permission of LawPay. Originally published here. 

For example, the rule seeks to prohibit a lawyer who formerly worked for the government from improperly using confidential government information, say for the advantage of a future private client. The rule attempts to limit potential problems without unduly hampering the government’s ability to recruit good lawyers, primarily by loosening the strict imputation rule.

The Rule

It may be helpful to categorize Rule 4-1.11’s lettered subsections. Subsections (a), (b), and (c) are directed to lawyers who formerly served as government officers or employees. Subsection (d) addresses lawyers currently serving as government officers or employees. Subsection (e) applies to lawyers holding public office. Subsection (f) defines “matter” as it is used in Rule 4-1.11.

Subsection (a) prohibits a former employee of the government from representing a client in a matter in which the lawyer personally and substantially² participated when the lawyer worked for the government, unless the government gives informed consent,³ confirmed in writing,⁴ to the representation. Additionally, the former government lawyer is subject to Rule 4-1.9(c), which prohibits use or revelation of information relating to a matter in which the lawyer formerly represented a client.

An example of a scenario contemplated by subparagraph (a) follows. Unless the Missouri Department of Natural Resources gives written, informed consent, a former staff lawyer for the department who, while a department lawyer, worked on a case alleging a company released pollutants into the waterways in violation of state regulations is prohibited, or should be disqualified, from defending the company against those allegations after going to work for a law firm.

In accordance with subparagraph (b), the law firm, which had been defending the company before it hired the lawyer from DNR’s ranks, may continue representing the company if it promptly notifies DNR that the lawyer has become associated with the firm and timely screens the lawyer from any participation in the matter.⁵ The notice is intended to allow the government agency the opportunity to assure itself that proper screening has occurred. Further, the disqualified lawyer is prohibited from receiving any part of the fee directly relating to the representation.⁶ Continued representation by other lawyers in the firm, with notice and screening, is allowed here while it is not in a private practice to private practice scenario, where disqualification is imputed to all the lawyers in the new firm.⁷ The rationale for not imposing strict imputation in the government to private practice scenario is discussed in Comment 4. One factor is the fear that the stricter rule would inhibit government recruiting of qualified lawyers, who might shy away from government service if their future job prospects in the private sector are constrained by the prospect of a firm’s loss of clients due to strict imputation.

Subsection (c) prohibits a lawyer who previously worked for the government, and who acquired “confidential government information”⁸ about a “person” while so employed, from representing a client whose interests are adverse to that person in a matter in which the confidential government information could be used to the material disadvantage of that person. The firm with which the disqualified lawyer is now associated is permitted the continued representation if the disqualified lawyer is screened and is apportioned no part of the fee directly related to the representation.

As an example, if a lawyer learns, while working as an assistant attorney general, that the individual is about to be indicted for tax fraud, the now former assistant attorney general could not use that confidential information, say in settlement negotiations, to the material disadvantage of the individual in the course of litigation while practicing in his or her new firm. Again, the restriction is not imputed to other members of the firm, who may litigate against the individual so long as the former assistant attorney general is screened and apportioned no fee directly from the litigation.

Subsection (d) applies to lawyers currently serving as public officers or employees and addresses conflicts the lawyers may have with former client matters. The lawyers now working for the government are subject to Rule 4-1.7, the concurrent conflict of interest rule. The lawyer is also subject to all the provisions of Rule 4-1.9. Subsection (d) thus counsels a lawyer moving from private practice into government service from handling matters the lawyer participated in “personally and substantially” while in private practice. For example, a private practice lawyer who was defending a client in a criminal case should not continue the representation after taking a position as an assistant prosecuting attorney in the county where the charges were pending.⁹

A more complicated scenario occurs when a lawyer leaves a position as a government employee and moves to another government job, specifically when a public defender moves to a prosecuting attorney’s office. The Supreme Court of Missouri, in State v. Lemasters,¹⁰ discussed Rule 4-1.11 in the context of a lawyer who left the public defender’s office and went to work as an assistant prosecutor in the same county where she had been defending a client against criminal charges. The former client, Lemasters, moved to disqualify all of the lawyers in the prosecuting attorney’s office on the grounds that his former lawyer’s conflict disqualified all of the lawyers in the office.

The court found that Lemasters’ former lawyer, who was a former government lawyer due to her prior position in the Missouri State Public Defender system, was disqualified by Rule 4-1.11(a) from participating in any way in Lemasters’ prosecution. Rule 4-1.11(a)(1) also prohibited the lawyer from revealing any information relating to Lemasters to her new colleagues or using any information to Lemasters’ disadvantage. The evidence showed the new prosecutor had complied with these obligations.¹¹

Lemasters nevertheless argued that his former lawyer’s conflict should be imputed to all the lawyers in the prosecutor’s office. In analyzing Lemasters’ claim, the court found Rule 4-1.11(b)’s conflict imputation language did not apply to the “public defender to prosecutor” scenario because that subsection applies to a job move to a “firm,” a word that does not include lawyers working together as government employees, such as in a county prosecutor’s office.¹² Instead, the court found Rule 4-1.11(d), “which deals with conflicts arising from prior representations by current public officers or employees,” (emphasis in original) applied to the Lemasters scenario. The court noted there was no imputation language in Rule 4-1.11(d) and cited the language in Comment 2, which states the subsection does not impute the conflicts of a lawyer currently serving as a government employee to associated employees, while noting that screening would be prudent.¹³

Rule 4-1.11(d)(2)(ii) prohibits a lawyer currently working for the government from negotiating for a job with a party in a matter in which the lawyer is participating “personally and substantially.” An exception is made for judicial law clerks, so long as the clerk notifies the judge about the job negotiation.¹⁴

Subsection (e) addresses lawyers who “also hold public office” and prohibits engagement in activities in which the lawyer’s personal or professional interests conflict with the lawyer’s “official duties or responsibilities.”¹⁵ Comment 11 notes a public official’s position on policy matters may conflict with a client’s interests. Nor is the lawyer holding public office permitted to “attempt to influence any agency of any political subdivision” for which the lawyer serves as a public officer, except as part of the lawyer’s official duties or as authorized by §§ 105.450 RSMo to 105.496 RSMo.¹⁶ Other lawyers in a firm in which the lawyer holding public office is associated may continue or undertake a matter the public officer would be disqualified from pursuing so long as that lawyer is screened.¹⁷

Subsection (f) defines “matter” for the purposes of Rule 4-1.11. Notably, matter is defined to include decisions involving a specific party or parties, which may be a narrower definition than is found in Rule 4-1.9.¹⁸

Conclusion

Conflicts analysis can be complicated. Supreme Court Rule 4-1.11 specifically applies to a lawyer who leaves government service to work in the private sector, who leaves a private practice to join the government, or who moves between government positions. The rule should be read, and reread, by lawyers transitioning into and away from government service.

Endnotes

1 Sharon K. Weedin is staff counsel for the Office of Chief Disciplinary Counsel in Jefferson City.

2  Rule 4-1.0(l).

3  Rule 4-1.0(e).  See also Rule 4-1.11, Comment 1, where it is acknowledged that statutes or regulations may inhibit a government agency’s authority to give consent.

4  Rule 4-1.0(b).

5  Rule 4-1.0(k), and Rule 4-1.11, Comments 9, 10, and 11.

6  Rule 4-1.11, Comment 6 clarifies that the disqualified lawyer may receive any salary or partnership share established by independent agreement.

7  Rule 4-1.10, the general rule concerning imputation of conflicts of interest. In most cases, the conflicts of an incoming lawyer are imputed to all members of the firm, without the possibility of screening. Rule 4-1.10(d) specifically carves out an exception to the strict imputation rule for former or current government lawyers and cites Rule 4-1.11.

8  Confidential government information is defined in Rule 4-1.11(c) as “information that has been obtained under governmental authority” and which, at the time the rule is being applied, the government is prohibited from disclosing and is not otherwise available to the public.

9   In re Smith, 29 So.3d 1232 (La. 2010).

10 State v. Lemasters, 456 S.W.3d 416 (Mo. banc 2015).

11 Id. at *420.

12 Id. at *421.

13 The Court confirmed its Lemasters reasoning in State ex rel. Peters-Baker v. Round, 561S.W.3d 380 (Mo. banc 2018), in which a defendant unsuccessfully argued for the imputed disqualification of an entire prosecutor’s office due to his former public defender’s move to that office.

14 Rule 4-1.11(d)(2)(ii); Rule 4-1.12(b).

15 See Rule 4-1.7.  Subsection (e) in Missouri’s Rule 4-1.11 is not found in the Model Rules of Professional Conduct. 

16 Chapter 105, Public Officers and Employees, RSMo.

17 Rule 4-1.11, Comment 10, provides context for the word “matter” as it is used in this subsection.

18 See ABA Comm. On Ethics and Professional Responsibility Formal Op. 97-409 (1997).

Have you tried to compare products or services slightly off the beaten consumer path? Or well-known products for a non-marquee feature? Despite that product’s market being worth tens to hundreds of millions of dollars, the information is difficult to come by. 

If you’re in the market for a pillow or bedsheets, there are obvious sources of information such as the website Consumer Reports that rate pillows and bedsheets on relevant categories like softness, durability, and ease of cleaning, for example. Easy enough. But suppose you want to buy a pillow made in America or in a union shop? It’s harder to come by that information in part because most buyers are not including those features in their buying decisions. In that case, your best recourse is to look for manufacturers who brag about location or employees. You could also look to sites that promote “Made in America” products. 

The same information gap occurs with tech products too. To begin with, honest feature comparison sites that aren’t littered with ads are hard to come by for the general consumer. And once found, those sites target the broadly relevant features. Websites like PC Magazine or CNET will compare Dropbox, OneDrive, and G Drive, but they’re unlikely to do so with a legal professional in mind. General audience news sources will talk price, speed, and ease of use, all relevant to legal professionals as well as the general public, but they won’t address more esoteric things important to lawyers. A PC Magazine comparison won’t address data center locations, what the service does when served with a subpoena or warrant, or how you could use a “roll your own” encryption on top of the service. 

For legal-specific products, the problem is worse. While potential buyers can compare Dropbox, OneDrive, and G Drive, software and services targeted at legal professionals have websites and marketing materials that often offer vague descriptions of capabilities, lacking important caveats, and many times hide pricing behind a “Request a Consultation” form that results in a sales call. 

These problems are exacerbated because lawyers, particularly those new to the profession or unaccustomed to comparing and choosing software, may lack a good idea of what features they want in a practice management solution, for example. 

Using Your Resources to Make Good Legal Tech Decisions 

That’s where the Law Practice Management Resource Center come into play. We’ve collected and analyzed information in key law practice tech areas so you don’t have to. Let’s walk through an example: 

Suppose you find your case and matter organization lacking. You can’t access documents unless you’re in the office. You rely on one or more people to figure out what, if anything, a client owes you and how much, if anything, the client has in their trust account. A client calls, texts, or emails you inquiring about case statuses, and you spend time rifling through emails, handwritten notes, and your memory to give updates. You talked with clients all day but, at the end of the day, are hard-pressed to remember who you talked to for how long and what was discussed. The clients are happy, but poor recollection has cost you billable time. Not good! 

If we treat this like a law school exam, we can unpack it and get an idea of issues this law office should address when evaluating a new practice management system. 

• Document access: You want to be able to access documents from outside the office. Is it just documents or do you also want access to case information? How important is it that access works well on tablets or iPhones, or is good laptop access enough? 

• Accounting: You want to know what the client owes and what’s in his trust account irrespective of whether the bookkeeper or support staffer, if any, is reachable. Do you want to know other financial information as well, like upcoming rent or office supply bills in the same program? If not, what accounting program do you use now, and will it share data with your prospective practice management program? Should clients be able to see and pay bills over the internet? 

• Case status: Most practice management programs hold general case information, party contact information, calendar dates, and tasks. Most also have some form of document storage. All would be an improvement over the “rifling lawyer” in our hypothetical scenario, but there are wrinkles in the options. How important is mobile access and from what device? Many programs can capture email and sync calendars and contacts but are you a Microsoft 365 or Google Workspace firm? Many products, particularly the web-based ones, offer client portals where the client can see upcoming appointments, share documents, exchange secure messages with the lawyer, and see bills. Is this case status “self-help” a feature you want? Some programs integrate with voice over internet phone (VOIP) systems so phone call numbers and length become proposed time entries, so you don’t lose billable time as in our hypothetical situation. How valuable is that? 

As with a law school exam, our one paragraph hypothetical became three paragraphs of additional questions and considerations. You don’t want to do all the leg work yourself! 

Our Law Practice Management Resource Center offers checklists and whitepapers to spur these types of questions. Find the checklists (here and here) and whitepaper relevant to practice management software on our Law Practice Management website. Once you’ve picked your “must have” features and prioritized their importance, then head over to the Checklists and Charts resource, scroll down to the “Manage a Practice” heading, and you’ll find two relevant comparison charts. The “Practice Management Server-based” comparison chart compares vendors offering software that would install on a desktop or server that you maintain. This route is popular with lawyers who have more complex needs, want to integrate with other desktop software such as PCLaw or Microsoft Word, and those who don’t want client data stored with a cloud-based provider. The “Practice Management Cloud-based” comparison chart compares vendors whose offerings run in a web browser, requiring little to no software maintenance on the user’s side. This route is better for lawyers newer to practice, those who are more mobile, those who desire tablet or smartphone apps, and those who don’t want to make an upfront investment in software and hardware to run traditional software. 

The comparison chart organization makes feature analysis easy. For example, if you are committed to desktop/server software over a web-based solution but want the ability to email or text appointment reminders to clients, then Coyote Analytics is your answer. Or if you’re committed to a web-based offering but want offline access to case information because you have spotty internet, then Smokeball is your answer. Missouri Bar members receive discounts on many top practice management programs, including Smokeball, at the Member Benefits section of the bar’s website. 

Finally, once you’ve selected a practice management solution, be sure to clean up your data before moving case and billing information to the new system. 

Much More to Discover 

Practice management software is just one example of high-value, legal tech decisions that the comparison charts can help you make. Comparisons exist for everything from document management solutions (that can talk to your practice management solution) to document assembly tools (that can pull information from practice management software into documents) to voice over internet phone (VOIP) that can automatically create times from phone calls. Visit all the checklists and comparison charts available for bar members. 

If you have any questions or want information from experts who’ve implemented these solutions for law practices and legal organizations, visit LPM’s Ask an Expert to email questions or schedule a phone or video call. 

Kayla Kemp

Kayla Kemp is staff counsel at the Office of Chief Disciplinary Counsel.¹

Thankfully, there are an abundance of resources and technological solutions which can be utilized to facilitate practicing during a pandemic. As lawyers, we must be mindful to ensure that as we adapt, we must continue to meet our ethical duties under the Missouri Rules of Professional Conduct (“Rules”). 

Planning for Incapacitation During a Pandemic

Lawyers should be prepared to adapt to a rapidly changing environment, whether that be a natural disaster, pandemic, or some other act of God. Not only do we need to be prepared for abrupt changes to the ways in which we meet with clients or appear before courts, but we also need to be prepared for incapacity, more so now than ever before. Like the general population, our profession’s population is increasingly aging. According to the 2020 American Bar Association Profile of the Legal Profession, the median age of lawyers as of 2019 was 47.5 years old.² Nearly one in six lawyers are 65 or older.³ This is notable because the Center for Disease Control (CDC) warns the risk for severe illness with COVID-19 increases with age. Those who are 50-64 years of age are four times more likely to be hospitalized than the comparison group, which consisted of those 18-29 years old. The risk of death was 30 times higher for those 50-64 years old compared to the comparison group.⁴ Those figures increase with each following age group. Nonetheless, every lawyer must consider the possibility of becoming incapacitated with little to no notice.

Lawyers should ensure that, in the event of incapacity, they are comporting with ethical obligations. One way to ensure compliance is to have a succession plan in place. Rule 5.26 allows lawyers to take an important step in ensuring that representation is not disrupted by sudden incapacity. Now is a good time to consider designating a trustee pursuant to Rule 5.26, which allows a lawyer to choose someone who can take over the lawyer’s legal practice upon an unexpected absence. By selecting a trustee, you can involve that same trustee in your succession plan. By actively preparing for the possibility of incapacity, a lawyer can better facilitate a smooth transition in the event the unexpected occurred. Aside from designating a trustee, a plan should be developed for any event which may keep you out of your physical office. This plan should encompass how your usual means of communication will continue to be monitored. Someone will need to go to your physical office to check mail, voicemails, or faxes. Also, be sure to include clear instructions regarding receiving and retaining client records and property. For additional resources in succession planning, visit The Missouri Bar’s website, MoBar.org.⁵

Mental Health Concerns

The physical threat COVID-19 presents is not the only health risk. On Feb. 19, 2020, the American Lawyer released the results of its year-long “Mental Health and Substance Abuse Survey,” which found that 31.2% of the more than 3,800 respondents surveyed reported they were depressed. Additionally, 64% reported anxiety, 10.1% reported an alcohol problem, and 2.8% reported a drug problem.⁶ These findings predate the onset of the pandemic in the United States.

The CDC released findings noting that in June of 2020 the rates of depression and anxiety amongst adults in the United States were three to four times higher than the corresponding point in 2019.⁷ Approximately 40% of those surveyed reported struggling with mental health or substance abuse. According to the same study, rates of suicidal ideation, substance abuse, and alcohol consumption are steadily rising. Lawyers should familiarize themselves with the mental health and substance use resources available through The Missouri Bar.⁸ Depression and anxiety can result in lawyers neglecting their responsibilities and, therefore, harming their clients. Just as lawyers ought to be proactive in planning for physical incapacitation, lawyers should also be proactive in caring for their mental well-being. A lawyer who is grappling with these serious health issues needs to make every effort to seek help, such as through the Missouri Lawyers’ Assistance Program (MOLAP).⁹ Through MOLAP, all Missouri Bar members can speak with a licensed clinical social worker by calling 800-688-7859. The program is free and confidential.

Competence Amidst Chaos

The first obligation set forth in the Rules is that of competence. Rule 4-1.1 – Competence – Comment [6] dictates “[t]o maintain the requisite knowledge and skill, a lawyer should keep abreast of changes in the law and its practice, including the benefits and risks associated with relevant technology ... .”

Keeping abreast of changes to the practice of law necessities brings an awareness of the risks associated with working remotely. Despite the challenges presented during the current pandemic, lawyers have the duty to remain competent. Comment [3] to Rule 4-1.1 provides guidance on a lawyer’s ethical obligation during such a situation as a global pandemic:

In an emergency a lawyer may give advice or assistance in a matter in which the lawyer does not have the skill ordinarily required where referral to or consultation or association with another lawyer would be impractical. Even in an emergency, however, assistance should be limited to that reasonably necessary in the circumstances, for ill-considered action under emergency conditions can jeopardize the client’s interest.

In the event of an emergency, a lawyer may give advice in a matter the lawyer does not possess the skill ordinarily needed to provide such advice. Of course, advising without the necessary skill is only acceptable where referral or consultation with another lawyer is impractical.

Lawyers must continue to educate themselves on technological innovations which can be utilized to virtually serve their clients. Also, lawyers need to stay current on any legal changes that allow them to continue to meet clients’ needs to enter into contracts, update wills, or create personal health care directives.

Remote Notarization

On April 6, 2020, Gov. Mike Parson issued Executive Order 20-08 suspending a statutory requirement that a notary public must conduct such notarization of official documents while the signer personally appears. Executive Order 20-08 was set to expire June 15, 2020; then, Executive Order 20-12 extended remote notarization to Aug. 28, 2020. Subsequently, Executive Order 20-14 and Executive Order 20-19 extended remote notarizations until March 31, 2021.

The practice of remote notarization provides a secure and safe method to execute legal documents. Notarization can occur while utilizing audio-video technology, provided certain conditions are met: 

(1) If the signatory is not personally or otherwise known to the notary, the signatory must display a valid photo ID to the notary during the video conference;

(2) The signatory must affirmatively represent that they are physically situated in the State of Missouri, and the notary must be physically located in the State of Missouri and say in which county they are physically located for the jurisdiction on the notarial certificate;

(3) The video conference must be a live and interactive audio-visual communication between the signatory, notary, and any other necessary persons to allow for direct interaction at the time of signing;

(4) The notary must record in their journal the exact time and software used to perform the notarial act, along with all other required information; and

(5) The document must contain a notarial certificate, a jurat, or acknowledgement, which states that the signatory appeared remotely pursuant to Executive Order 20-14.

Electronic Notarization

While Missouri already permits electronic notarization, which is the use of electronic signatures and seals, Executive Order 20-14 allows for remote and electronic notarization to occur together when:

(1) The notary public is registered as an electronic notary public with the Missouri Secretary of State;

(2) The document must be electronically signed with a software approved by the Missouri Secretary of State; and

(3) The notary must affix the electronic notary seal to the electronic document.

Lawyers should do their due diligence and check with the Missouri Secretary of State to confirm they are using a registered remote notary¹⁰ and the software used to electronically sign the document¹¹ is approved.

Cyber Security

While there are many benefits to utilizing technology to facilitate legal services, there are also risks. For example, Zoom – a platform used to facilitate virtual audio and visual meetings – has had security breaches. In July 2019, a vulnerability in Zoom’s Macintosh desktop client was found which let malicious websites turn on a Macintosh user’s webcam without that user’s knowledge.¹² Then, in January 2020, another vulnerability was discovered. Unauthorized users could enter Zoom meetings that were not password protected and did not have Zoom’s Waiting Room feature – which allows for manual admission into Zoom meetings – enabled. Security flaws such as these are not unique to Zoom. Consequently, when utilizing third-party platforms, lawyers ought to take precautions such as using updated software and taking reasonable security measures.

Rule 4-1.6(c) specifies “[a] lawyer shall make reasonable efforts to prevent the inadvertent or unauthorized disclosure of, or unauthorized access to, information of the client.” Comment [15] details the factors to be considered in determining whether a lawyer acted completely by undertaking reasonable efforts to prevent inadvertent or unauthorized disclosure of information related to client representation. The ABA’s Standing Committee on Ethics and Professional Responsibility issued Formal Opinion 477R, “Securing Communication of Protected Client Information,” which provides guidance as to security measures that should be employed given the ever-increasing cybersecurity threats that exist when transmitting information over the internet:¹³

However, cyber-threats and the proliferation of electronic communications devices have changed the landscape and it is not always reasonable to rely on the use of unencrypted email. For example, electronic communication through certain mobile applications or on message boards or via unsecured networks may lack the basic expectation of privacy afforded to email communications.¹⁴

While cyber security was a matter of grave concern in 2017, the threat of harm has only increased.¹⁵ In 2019, there were more than 5,000 data breaches reported.¹⁶ These breaches amounted to approximately 8 billion exposed records. Educating yourself on the various types of cyberattacks which can leave your client-confidential information vulnerable is the first step.¹⁷

Third-party Service Providers

For those lawyers whose devices are managed by a third party, include explicit terms in your contracts detailing which security practices are to be followed. These security features can include audits that report security status and the health of your devices. The National Institute for Standards and Technology and the Institute for Standards Organization provide best practices for guidance on how to strengthen your network’s defenses. Lawyers should consider including clauses in their contracts which detail how third parties will secure remote access. Methods to help secure remote access to your network include VPNs, multi-factor authentication, and rotating strong passwords. After all, Comment [1] to Rule 4-5.3 – Responsibilities Regarding Nonlawyer Assistants requires lawyers with managerial authority make reasonable assurances that the nonlawyers in the firm and those who work outside the firm act in a way compatible with the ethical obligations of the lawyer.

As technology evolves, so does our obligation to act reasonably under the Rules of Professional Conduct. And as we adapt, we must consider what further efforts we can take to meet our ethical duties. The current global pandemic has shifted our way of life, both at work and at home. It is important for every lawyer to understand the resources available to help alleviate the burden they may feel.

Endnotes

1 Kayla Kemp is staff counsel at the Office of Chief Disciplinary Counsel. Special thanks to Melinda J. Bentley, legal ethics counsel, whose presentation, “Ethical Considerations for Missouri Lawyers Practicing During the COVID-19 Pandemic: A Conversation with the Chief Disciplinary Counsel & Ethics Counsel,” was invaluable.

2 Am. Bar Ass’n, 2020 American Bar Association Profile of the Legal Profession (2020), https://www.americanbar.org/news/reporter_resources/profile-of-profession/.

3 Am. Bar Ass’n, 2020 American Bar Association Profile of the Legal Profession (2020), https://www.americanbar.org/news/reporter_resources/profile-of-profession/.

4 Centers for Disease Control and Prevention, COVID-19: Older Adults (2020), https://www.cdc.gov/coronavirus/2019-ncov/need-extra-precautions/older-adults.html.

5 The Missouri Bar, Planning Ahead: A Guide to Protect Your Clients’ and You Survivors’ Interests in the Event of Your Disability of Death (2005).

6 Lizzy McLellan, Lawyers Reveal True Depth of Mental Health Struggles, Law.com (Feb. 19, 2020, 11:00 AM), https://www.law.com/2020/02/19/lawyers-reveal-true-depth-of-the-mental-health-struggles/.

7 Czeisler MÉ et al., Mental Health, Substance Use, and Suicidal Ideation During the COVID-19 Pandemic – United States, June 24–30, 2020, MMWR Morb. Mortal Wkly. Rep. 2020;69:1049-1057 (2020). 

8 Coronavirus Resource Center for Lawyers, https://mobar.org/site/content/Lawyer-Resources/Coronavirus_Resource_Center_for_Lawyers.aspx?WebsiteKey=dd54fe1d-87c8-4d7e-9547-e59fcd729541 (last visited Jan. 11, 2021).

9 Missouri Lawyers’ Assistance Program, https://mobar.org/molap/ (last visited Jan. 11, 2021).

10 Registered Electronic Notaries, https://www.sos.mo.gov/RegisteredElectronicNotary (last visited Jan. 11, 2021).

11 Approved Notary Software Vendors, https://s1.sos.mo.gov/Business/Notary/softwarevendors (last visited Jan. 11, 2021).

12 Jonathan Leitschuh, Zoom Zero Day: 4+ Million Webcams & Maybe an RCE? Just Get Them to Your Website!, Medium.com (July 8, 2019), https://medium.com/bugbountywriteup/zoom-zero-day-4-million-webcams-maybe-an-rce-just-get-them-to-visit-your-website-ac75c83f4ef5.

13 ABA Committee on Ethics & Pro. Resp., Formal Op. 477R (2017).

14 Id. at pg. 5.

15 Microsoft Digital Defense Report, September 2020, https://www.microsoft.com/en-us/security/business/security-intelligence-report (last visited Jan. 11, 2021).

16 Rae Hodge, 2019 Data Breach Hall of Shame, cnet.com (Dec. 27, 2019, 4:00 AM), https://www.cnet.com/news/2019-data-breach-hall-of-shame-these-were-the-biggest-data-breaches-of-the-year/.

17 See Melinda J. Bentley, Ethics: The Ethical Implications of Technology in Your Law Practice: Understanding the Rules of Professional Conduct Can Prevent Potential Problems, 76 J.MoBar (2020).

Scott E. Vincent

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

This article highlights several key provisions in this legislation, particularly relating to tax matters. Please note this is not a comprehensive list, and implementation of these provisions and further relief measures are likely to modify these topics. Please also note the Act extended a variety of tax provisions either permanently or for several years, but the details of all the “tax extenders” are not covered here.

Business Provisions

• Tax Treatment of PPP Loans: The CARES Act provided that amounts forgiven under the Paycheck Protection Program (PPP) would be excluded from gross income, even though forgiveness of indebtedness is normally taxable. Somewhat undermining the benefit of the PPP forgiveness, the IRS announced in Notice 2020-32 that no deduction would be allowed for an otherwise deductible expense if payment of the expense resulted in forgiveness of a CARES Act PPP loan, and the income associated with the forgiveness is excluded from gross income by the CARES Act. The Act reconfirms that gross income does not include forgiveness of a PPP loan, overrides the IRS position, and allows deduction of business expenses paid with proceeds of a PPP loan that is forgiven. The Act also provides that forgiveness of a PPP loan will not reduce tax basis or other tax attributes of taxpayer assets.
   
• Paycheck Protection Program – Second Draw:  The Act creates a second round of loans for the Paycheck Protection Program (as originally defined in the CARES Act). Some modifications, key provisions, and considerations for the PPP Second Draw are noted here:
  • The Act allows a maximum loan of $2 million for businesses with 300 or fewer employees that used or will use their full original PPP loan and that can demonstrate a reduction of at least 25% in gross receipts in a quarter of 2020 relative to the same quarter in 2019.
     
  • The available loan amount for each borrower (capped at $2 million) is annualized payroll costs for either the one-year period prior to the loan or the calendar year, divided by 12, then multiplied by 2.5. Accommodation and food services industries may receive up to 3.5 times average monthly payroll costs. Certain farmers may also use their 2019 gross income from Schedule F if it results in a larger loan. For smaller loans of $150,000 or less, the business can provide a simplified certification attesting to the revenue loss requirements.
     
  • Generally, the PPP loan can be fully forgiven if the funds are used for payroll costs; interest on mortgages; rent and utilities; and certain operations expenditures, property damage costs, supplier costs, and worker protection expenditures during the covered period. The required allocation of at least 60% payroll costs (versus non-payroll costs) continues to apply, as does the rule reducing the loan amount forgiven for borrowers reducing their number of employees or employee salaries by more than 25%.
     
  • Churches, religious organizations, and news organizations (FCC license holders and certain newspapers) may be eligible for PPP Second Draw loans.
     
  • All eligible entities are banned from using PPP proceeds for lobbying activities and expenditures, as well as expenditures relating to enactment of legislation, appropriations, or regulations.
     
• Employment Tax Payments:  Prior relief allowed employers to defer payment of employment taxes for periods Sept. 1, 2020, through Dec. 31, 2020. The Act allows employers to further defer payment for these taxes to Dec. 31, 2021.
   
• Employee Retention Tax Credit (ERTC):  The Act extends and expands the CARES Act ERTC with several changes, including increasing the per-employee credit from $10,000 per year to $10,000 per quarter, increasing the credit rate from 50% to 70% of qualified wages, expanding eligibility of employees and employers, and making technical corrections.
   
• Credits for Paid Sick and Family Leave:  The Act extends the credits for paid sick and family leave in the Families First Act through March 31, 2021. The Act also allows an election to use prior year net earnings from self-employment rather than current year earnings in calculating the credit for the self-employed.
   
• Business Meals:  The Act allows a full deduction (no 50% limitation) for business meal and beverage expenses provided by a restaurant in 2021 and 2022.

Individual Provisions

• Direct Payments:  The Act includes individual refundable tax credits of $600 per taxpayer, with an additional $600 per qualifying child. Eligibility for the payments begins to phase out for adjusted gross income over $150,000 for joint returns; $112,500 for heads of household; and $75,000 for single filers. The U.S. Department of Treasury may issue advance payments based on 2019 tax returns, and the direct payments are also available for those not required to file a return. Taxpayers receiving an excess payment based on their 2020 tax return are not required to repay the payment, and taxpayers eligible for additional credit based on their 2020 tax return will receive an additional refundable tax credit.
   
• Unemployment Benefits:  The Act provides an additional 11 weeks of unemployment assistance, including $300 per week emergency benefits, extension of prior pandemic assistance, and protection from benefit overpayment collection.
   
• Medical Expense Threshold:  The itemized deduction threshold for medical expense deductions is permanently reduced from 10% to 7.5%.
   
• Tax Credits:  Taxpayers may use 2019 income to calculate the additional child tax credit and the earned income tax credit. The income threshold is also increased for use of the Lifetime Learning Credit.
   
• Flexible Spending Accounts:  Carryover and grace period policies from prior relief are expanded for employees with unused balances in health and dependent care flexible spending accounts.
   
• PPE for Educators:  The Act directs the IRS to issue guidance or regulations confirming that personal protective equipment and supplies used for COVID-19 prevention qualify for the educator expense deduction.
   
• Financial Aid Grants:  The Act excludes from gross income certain emergency financial aid grants for college and university students under the CARES Act and holds students harmless for purposes of determining eligibility for both Opportunity and Lifetime Learning tax credits.
   
• Charitable Deductions:  The Act allows up to a $300 ($600 for joint return) charitable deduction for 2021, even if a taxpayer does not itemize deductions. The increase in the deduction for donations of food inventory from 15% to 25% under the CARES Act is also extended through 2021.

Conclusion

The combination of pandemic and political strain on our nation and economy has resulted in a variety of legislative, executive, and administrative efforts to provide relief. As we enter 2021, the changes in administration and Congress set the stage for even more significant relief efforts this year. We also need to carefully monitor governmental actions interpreting all the legislation that is already in place, such as the implementation of the PPP Second Round and the PPP forgiveness process.

Scott E. Vincent

Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City. 

Taxpayers will also need to consider planning for current and potential tax rates, the standard deduction and limits on itemized deductions, and multiple other issues, including continuing provisions of the Tax Cuts and Jobs Act of 2017 (2017 Tax Act). The § 199A deduction for qualified income from pass-through entities may also impact individuals and their businesses. This article outlines several of these individual and business planning issues, but taxpayers should adjust their planning for their particular circumstances and carefully monitor ongoing changes to the provisions outlined here and other new legislation.

Year-End Planning Issues for Individuals

• Review CARES Act rebates. Most individuals under applicable income levels already received stimulus checks for their recovery rebate tax credit. These checks were issued based on 2019 income tax returns, but the final calculation of the correct rebate amount is part of 2020 tax returns. If this calculation shows a larger rebate, it can be claimed as a credit against 2020 tax liability.
   
• Review student loan debt repaid by an employer. The CARES Act excludes amounts repaid by an employer in 2020 after March 27, 2020 from taxable income.
   
• Review credits and deductions, including the child and dependent tax credit and education-related credits and deductions. In addition, the Families First Act added sick leave and family leave credits for certain self-employed individuals.
   
• Consider the expanded standard deduction, eliminated personal exemptions, and limits on itemized deductions from the 2017 Tax Act. For 2020, there are no personal exemptions, but the basic standard deduction is increased to $24,800 for joint filers; $18,650 for heads of household; and $12,400 for singles and married taxpayers filing separately. Many itemized deductions are also either reduced or eliminated. So, unless allowable medical deductions (as limited by 7.5% of AGI), state and local taxes of up to $10,000, allowable charitable deductions, interest deductions on qualifying residence debt, and other allowable itemized deductions exceed the standard deduction, taxpayers may find that the increased standard deduction provides more tax benefit. For taxpayers with timing flexibility, there may also be an incentive for “bunching” allowable itemized deductions into one year and using the standard deduction in other years.
   
• Consider special charitable deduction rules for 2020. For taxpayers that itemize deductions, the CARES Act increases the maximum charitable deduction in 2020 from 60% of AGI to 100% of AGI. The CARES Act also allows a $300 above-the-line charitable deduction for taxpayers who do not itemize.
   
• Have an employer increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end for deduction of those taxes this year. This can be beneficial if a taxpayer expects to itemize deductions this year, and doing so will not cause state and local tax deductions to exceed the $10,000 limitation.
   
• Plan for the 3.8% tax on unearned income. This surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over a threshold amount (unindexed) of $250,000 for joint filers or surviving spouses, $125,000 married individuals filing a separate return, and $200,000 for other taxpayers. Year-end planning for the 3.8% surtax will depend on estimated MAGI and NII. Some taxpayers may want to defer additional NII until next year, some may want to reduce MAGI other than NII, and some may be able to minimize both NII and other MAGI.
   
• Consider the additional 0.9% Medicare tax. This tax applies to individuals receiving a combination of wages with respect to employment and self-employment income exceeding $250,000 for joint filers; $125,000 for married couples filing separately; and $200,000 for other filers. Employers must withhold the additional Medicare tax from wages in excess of $200,000. Self-employed persons must include it in estimated tax payments, and some employees may need more withholding to cover the tax.
   
• Accelerate income into this year in cases where a taxpayer’s marginal tax rate is expected to be lower this year than it will be next year due to economic conditions or expected changes in filing status or applicable rates. Postponing income can produce savings for taxpayers who expect to be in a lower tax bracket next year.
   
• Consider lower long-term capital gain rates on sales of assets held for more than one year. Depending on taxable income levels, taxpayers may want to utilize these lower rates for capital gain sales and avoid selling capital assets with offsetting losses that reduce the benefits of the lower rates. The reduced rates apply to adjusted net capital gain to the extent that this amount, when added to regular taxable income, does not exceed certain thresholds based on filing status. So, analysis of taxable income, potential capital gains, and other considerations like the NII surtax and Medicare tax is required to determine the best combination.
   
• Consider retirement plan contributions, including catch-up contributions of additional amounts for taxpayers 50 and older. The age limit of 70 1/2 for making retirement plan contributions was also repealed in 2020, so all eligible taxpayers can make traditional IRA contributions regardless of age.
   
• Certain retirement plan distributions are excepted from the 10% early withdrawal penalty. A qualified birth or adoption distribution of up to $5,000 is allowed. There is also a special coronavirus relief withdrawal of up to $100,000 from retirement plans, which is includable in income over a three-year period or eligible for tax-free rollover to an eligible retirement plan within the three-year period.
   
• Review required minimum distributions (RMDs) from retirement accounts. RMDs are waived for 2020, and the RMD beginning date for taxpayers changed from 70 1/2 to 72 starting with the 2020 tax year. Participants who are still working also may be able to further delay RMDs. However, taxpayers who fail to take RMDs can be subject to a penalty of 50% of the required amounts that are not withdrawn.
   
• Consider making charitable donations from traditional IRAs. Qualified charitable distributions are made directly to charities, and the amount is not included in gross income or itemized deduction calculations and limits. In addition, the qualified charitable distribution reduces RMDs when applicable. Taxpayers can plan for this benefit by maximizing contributions to traditional IRAs with amounts that may later be used for qualified charitable distributions.
   
• Consider a Roth IRA conversion. A taxpayer that would prefer a Roth IRA can convert traditional IRA investments into a Roth IRA if eligible. A conversion will increase AGI for this year, so taxpayers should consider the impact on other AGI tax calculations.
   
• For taxpayers eligible to make health savings account (HSA) contributions, consider a full year of deductible HSA contributions before the end of the year. HSA contributions are deductible from AGI, so the benefits are available even if a taxpayer does not itemize deductions.
   
• Increase the amount set aside for next year in a health flexible spending account (FSA) if the taxpayer did not set aside enough for this year. Earnings set aside in an FSA allow payment of medical and dental bills with pre-tax earnings.
   
• Complete annual gift tax exclusion gifts before the end of the year to save gift and estate taxes. This year, taxpayers can give $15,000 each to an unlimited number of individuals but cannot carry over unused exclusions from one year to the next. These transfers also may save family income taxes where income-earning property is given to family members in lower-income tax brackets who are not subject to the kiddie tax.
   

Year-End Planning Issues for Business Owners

• The CARES Act included the Paycheck Protection Program (PPP). The PPP generally provides for tax-free loan forgiveness based on expenditures in qualifying categories. For taxpayers participating in the PPP, forgiveness applications and timing should be considered, including carefully compiling records of PPP expenditures. Importantly, the treatment of forgiveness amounts and deductibility of expenditures relating to the PPP are still developing and certainly could change with further relief acts and a new administration.
   
• The CARES Act retroactively corrected a technical error in the 2017 Tax Act so that qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property are depreciable over a 15-year life (rather than 39 years under the technical error). This correction is retroactive, so taxpayers may be able to file amended returns for 2018 and 2019 as well.
   
• For 2020, the CARES Act removed the 80% limitation on taxable income eligible for reduction by NOL deductions. For tax years after 2020, NOL carryforwards from prior to 2018 will be deductible, along with post-2017 losses with an 80% of taxable income limitation. The CARES Act also allows taxpayers to use NOLs arising in 2018, 2019, and 2020 for carryback to the five years preceding the loss year, which may provide refund opportunities with amended returns.
   
• The CARES Act removed the limitation for non-corporate taxpayers with excess business losses over aggregate gross income, allowing deductions of up to $518,000 for joint filers or $259,000 for other filers. This provision applies to 2018, 2019, and 2020, so amended returns for 2018 and 2019 may be possible. Certain loss limitation rules on farming losses were also waived.
   
• Consider SECURE Act extensions of the family and medical leave credit and work opportunity credit, Families First Act credits for paid sick and childcare leave, and CARES Act credits for employee retention during the pandemic.
   
• Review payroll tax impact of relief actions. The IRS deferred payroll tax deposits for certain periods in 2020, but payment is required by year end. The CARES Act also allowed employers to delay payment of applicable employment taxes for certain periods in 2020 until December 31, 2021 (50% of the applicable amounts) and December 31, 2022 (remainder of applicable amounts). These provisions similarly apply to estimated self-employment taxes.
   
• Consider the § 199A deduction for non-corporate taxpayers of up to 20% of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. For 2020, the deduction may be limited (with a phase-in for the limitation) if taxable income is over $326,600 for married couples filing jointly or $163,300 for other filers. These deduction limitations may apply depending on whether the taxpayer has a service-type trade or business such as law, accounting, health, or consulting, or whether the trade or business meets W-2 wage and qualified property (like machinery and equipment) requirements. Because there are taxable income thresholds and phaseouts for certain taxpayers, there may also be significant tax savings from deferring income or accelerating deductions into this year, depending on the taxpayer’s circumstances. Similarly, a taxpayer may be able to increase the deduction available by increasing W-2 wages or qualified property before year-end. This 20% qualified business income deduction requires taxpayers to navigate complicated rules and calculations, but it may provide a significant tax reduction for qualifying taxpayers.
   
• Consider making expenditures before year-end that qualify for the business property expensing option. For tax years beginning in 2020, the expensing limit is $1,040,000 and the investment ceiling is $2,590,000. This expensing is available for most depreciable property and off-the-shelf computer software. It also applies to qualified improvement property, which generally includes interior building improvements along with roofs, HVAC, fire protection, and alarm and security systems. Importantly, property acquired and placed in service before year-end is eligible for full expensing for the year.
   
• Consider 100% first-year bonus depreciation for new and some used machinery and equipment purchased and placed in service this year. Like expensing, bonus depreciation is available for the full year even if the asset was placed in service late in the year, so year-end purchases can receive a full first-year bonus write-off.
   
• Consider changing to the cash method of accounting, rather than the accrual method. “Small businesses” with less than $26 million of average annual gross receipts over a three-year period may be eligible for the cash method if they meet other requirements. The threshold was previously $5 million. Generally, the cash method of accounting allows more flexibility in timing income and deductions.
   
• Consider timing for a debt-cancellation event, including whether lower effective tax rates are expected this year or next year.
   
• Consider timing for disposition of a passive activity to allow a deduction for suspended losses to reduce current year taxable income.
   
• Review partnership and S corporation basis to make sure it is sufficient to deduct losses in current and future years.
   
• Review S corporation salaries to ensure that shareholders receive reasonable wages for their work for the business. The IRS often audits S corporations that pay all their profits as distributions without accounting for reasonable wages to shareholders.
   
• Consider setting up a retirement plan if there is not an existing plan.

Recent tax law changes and pandemic relief efforts require new considerations for year-end tax planning, and even more changes are likely in coming months. Many may be faced with unusual 2020 operating losses along with the challenge of ongoing pandemic and economic uncertainty – and a changing administration. Taxpayers will need to carefully consider all these issues in light of their specific circumstances and watch for continuing tax law changes as we close out this challenging year and move into 2021.

Endnote
1 Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.

Trends in other industries make it clear that lawyers must prepare for ransomware attacks. Here’s how to get started.

Earlier this year, ransomware cyber attacks at Hollywood Presbyterian Medical Center in Los Angeles, California and MedStar Health, based in Columbia, Maryland, made headlines and alarmed health providers and patients. The ransomware attacks, which involve a virus that is designed to hold data hostage until the victim pays for a “key” to regain access to their data, should also serve as a warning to lawyers.

Indeed, in a recent ransomware case involving the Brown Law Firm in Jacksonville, Florida, the firm was not able to access its client data.[2] Instead, the firm received a message stating that their data was not accessible and it would be destroyed unless the firm paid the equivalent of $2,500 in Bitcoins to the hackers behind the attack. Although the firm hired an information technology (IT) professional, it ultimately decided to pay the ransom on the advice of that IT contractor; the risk of losing the data by attempting to circumvent the ransomware was too great. Such attacks are often successful because the hackers behind the assault ask for a relatively small amount, knowing they can spread fees over many victims. This attack strategy also makes it an easier choice for the lawyer to pay.

What is Ransomware?

Ransomware is a malicious computer program (also known as malware) that is introduced into a computer system like a virus and allows the attacker to block access to the victim’s computer data and demand payment for restoring the data. Typically, there is a time element to the ransom demand: The owners of the data are threatened with its destruction if the ransom is not paid within a predefined number of hours. If you do not represent likely targets of ransomware, does this affect you as an attorney? Yes, because your law firm or corporate legal department is a target.

What is the Risk?

Lawyers, just like health and finance professionals, maintain confidential and sensitive information which they are obligated to protect and need to access to serve their clients. Lawyers can be locked out of data, and the data may be sold or made public.

Should I Pay?

This is the big question, and one without a great answer. If you pay, you are likely to get your data back. However, you will be a more likely target in the future and you will unwillingly be funding attacks on other lawyers. Further, there is no guarantee the hackers will honor the agreement.[3] Prevention is ideal, but if you are the victim of an attack, you will have to evaluate whether you can both restore data and protect against its release without paying the hacker. Ironically, sometimes even the police are left with no better option than paying the ransom.[4] The FBI has sent mixed signals on whether to pay or not, most recently advising against it.[5] Consulting with an IT professional and law enforcement will help you with the decision-making process.

Preventing Ransomware Attacks

While there is no means of attainng perfect assurance against a ransomware attack, the following precautions can help to mitigate risk and to diminish the impact of a breach on your practice.

Good backup: If you have a backup, you can restore the data to the point of last back up. But you still have a confidentiality issue[6] and the requirement to safeguard client property.[7] You will be obligated to report client data was compromised.

Good firewall: A firewall is the watch guard of the firm’s network. Think of the firewall as a security bubble. If you turn it on high, you can shut down virtually all communications, but users will complain that system is unusable. If you turn it down too much, you will be open to attack. So you have to find the right balance.

Training: Make sure you and your staff are trained to avoid infecting your network with ransomware. End users can enable breaches by downloading a suspicious attachment or clicking on an unknown link. Hackers use “human engineering” to trick you into clicking on attachments. If you receive a communication that normally would not come by email, do not open the attachment. Call the sender to confirm. Working from home on an unsecured computer can also compromise the network. Network security is only as good as the weakest link. Any device connected to the network needs to be inspected. Educate your staff on how to avoid risks. Use strong passwords and keep them secure. Keep your antivirus software current, but don’t assume it is protecting you.

Encrypt your data: This may not prevent an attack, but it will mean an attacker cannot release your clients’ confidential data without great effort.

Install an ad blocker: Some ransomware can be delivered via pop-up advertisements.

Hire an expert: Lawyers know what happens when their clients go DIY (do-it-yourself) on complex legal work. Likewise, you should considering hiring an IT professional to evaluate your network’s security rather than relying on your own knowledge of cyber security.

Use work computers only for work: Have a computer not connected to your law office network for surfing the Internet, or consult your IT professional for other ideas to isolate and protect sensitive areas of your network.[8]

Screen and monitor employees: As noted above, an employee might accidentally open a suspicious attachment or click or an inappropriate link, but in addition some employees might sell your password. According to a recent survey, 56 percent of employees would sell passwords for $1,000 or less.[9]

Review your insurance coverage: Do not assume you have coverage for cyber attacks. Check with your carrier.[10]

Dealing With Ransomware Attacks

If, despite your best efforts, you become the victim of a ransomware attack, there are several things you will need to do.

IT: Call for IT help, whether internal or an external consultant. Do not undertake any measures on your own unless you are a cyber security expert.

Insurance: Call your insurance carrier. They may be able to help you unwind the problem. And in any case, you may have a notification requirement to secure coverage for an event.

Law enforcement: Call law enforcement.

Work your plan: If you are part of an organization, contact those individuals internally who are identified in your plan, such as partners.

Assess the situation: Can you fix it with a backup? Was data actually accessed? Is paying a ransom advisable?

Determine notification requirements: Once the attack has been resolved and you are up and running, determine notification requirements. You will want to review the ethics rules as well as any state law requiring notification of a breach. Further, if you have any health data, you may have notification requirements under HIPAA.[11] Failing to disclose, even if you are not required to, may have negative consequences from a trust and public relations standpoint. Weigh your options carefully.

Reassess: Once you are up and running and the system is all clear, take some time to figure out what went wrong and how you can avoid problems in the future.

Ransomware attacks on lawyers are likely to increase. When the Hollywood and Medstar medical data attacks happened, it seemed like the beginning of a trend. Turns out a recent survey shows that half of the hospitals participating in the research had been subjected to ransomware attacks.[12] So the two publicized episodes were public confirmation of a trend, not the possible beginning of one. It may well be the same in the legal industry. Once hackers see success with victims motivated to recover and protect their clients’ data, they will continue the attacks as long as it remains profitable. This summer, we learned hackers are targeting lawyers using phony ethics complaints to trick them into downloading an attachment infected with ransomware.[13]

Staying up to date is part of your defense. The ABA’s Cyber Security Legal Taskforce is a good source of information.[14] The Better Business Bureau and the FTC have scam alerts. ABA members can also sign up to receive FBI Cybersecurity Alerts.[15] You should document your cyber security policy and use it to train your employees and have as a reference in case of attack. Your will want to have it in paper form in case you cannot access your computers. Your policy should outline the procedures for your response. You don’t want to be trying to figure out what to do when your office is paralyzed by an attack.

Lawyers are obligated to keep up with technology to protect their clients’ interests or to hire someone with the expertise to do it for them.[16] By keeping up with the risks and educating and monitoring your staff, you can avoid having to pay a ransom for your data and the possibility of seeing your clients’ data compromised.

This article originally appeared in the September 2016 issue of Bench & Bar of Minnesota, the official magazine of the Minnesota State Bar Association, and is reprinted with permission.

Endnotes

1 Shaun Jamison is a professor of law with Concord Law School of Kaplan University and is the former chair of the Minnesota State Bar Association Practice Management and Marketing Section. Jamison teaches CyberLaw, Legal Research, and the Future of Law Practice. He may be contacted at sgjamison@gmail.com.

2 “Florida Law Firm Hit by Ransomware Scheme” (2/16/2016) http://www.batblue.com/florida-law-firm-hit-by-ransomware-scheme/ (now https://opaq.com/)

3 Katie Dvorak, “Hackers return for more money in ransomware attack at Kansas hospital,” FierceHealthCare (5/23/2016) http://www.fiercehealthcare.com/it/hackers-return-for-more-money-ransomware-attack-at-kansas-heart-hospital.

4 “When hackers cripple data, police departments pay ransom,” Boston Globe (4/6/2016) https://www.bostonglobe.com/business/2015/04/06/tewksbury-police-pay-bitcoin-ransom-hackers/PkcE1GBTOfU52p31F9FM5L/story.html.

5 Paul, “FBI’s Advice on Ransomware? Just Pay The Ransom,” Security Ledger (10/22/2015) https://securityledger.com/2015/10/fbis-advice-on-cryptolocker-just-pay-the-ransom/, but see a more recent declaration from FBI Cyber Division Assistant Director James Trainor saying companies should not pay ransom: Katie Dvorak, “Hackers return for more money in ransomware attack at Kansas hospital,” FierceHealthCare (5/23/2016) https://www.fiercehealthcare.com/it/hackers-return-for-more-money-ransomware-attack-at-kansas-heart-hospital.

6 ABA Model Rule 1.6(c) – A lawyer shall make reasonable efforts to prevent the inadvertent or unauthorized disclosure of, or unauthorized access to, information relating to the representation of a client.

7 ABA Model Rule 1.15 – … property shall be identified as such and appropriately safeguarded. Complete records of such account funds and other property shall be kept by the lawyer and shall be preserved for a period of [five years] after termination of the representation.

8 Scott Perry, “Law Firms Kill Web Access In the Name of Cybersecurty,” (5/26/2016) Above the Law http://abovethelaw.com/?sponsored_content=it-security-vs-users&rf=1.

9 Tara Seals, “Employees Would Sell Passwords for $1000 or Less,” retrieved 4/15/2016: http://www.securion.io/#!Employees-Would-Sell-Passwords-for-1000-or-Less/c14jh/56f137afOcf266a29260bfe.

10 Peter S. Vogel, “Bad news for P.F. Chang – Court rules that all claims for 2014 data breach are not covered under its cyberinsurance!” Lexology (6/2/2016) https://www.lexology.com/library/detail.aspx?g=4dc04202-1357-4b3c-8c96-43aeac63e00f.

11 Health Insurance Portability and Accountability Act of 1996, Pub. L. No. 104-191, 110 Stat. 1936 (1996).

12 Katie Dvorak, “Poll: Most hospitals have been targets of ransomware attacks,” FierceHealthIT, retrieved 4/12/2016: https://www.fiercehealthcare.com/it/poll-most-hospitals-have-been-targets-ransomware-attacks.

13 Mike Mosedale, “Ransomware scam targets lawyers with phony ethics complaints,” Minnesota Lawyer (6/7/2016) http://minnlawyer.com/2016/06/07/yikes-ransomware-scam-targets-lawyers-with-phony-ethics-complaints/.

14 ABA Cyber Security Legal Taskforce, https://www.americanbar.org/groups/cybersecurity/

15 Log in to sign up to receive alerts at this link: https://shop.americanbar.org/eBus/MyABA/MyLists.aspx.

16 ABA Model Rule 1.1 – A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.