e- NEWSLETTER

August/September 2005

Jessica M. Kirsch
Editor-in-Chief

Tax Law

TOP THREE TAX MYTHS OF 2005
By: Cameron R. Monti
 

#1. "Wheew! I Went Under the Audit Radar ‘Cause I Already Received My Refund."

    Many taxpayers believe that simply because they have received their tax refund check that the Internal Revenue Service (IRS) has reviewed their income tax return and has given it a passing grade. And that's true regardless of whether you file a paper return or file electronically. Certainly, the IRS may check for obvious errors and suspicious deductions that ultimately may hold up one's refund check while it investigates. However, simply receiving a refund doesn't mean that you are "home free" until next year.

    In fact, audit determination is often made long after a refund check is issued. After a taxpayer's return has been filed and he or she has received a refund, his or her tax return goes through an additional computer check to compare the tax return to a computer model. The return then receives a "DIF," or Discrimination Information Function score. The IRS calculates the DIF score by using an undisclosed formula. Returns with high DIF scores are then pulled and reviewed by IRS officers to determine which tax returns have the greatest potential for yielding additional taxes, interest, and penalties.

#2. "I Only Accept and Pay With Cash -- The IRS Can't Audit Cash."

    The cliche, "if it doesn't make sense, it can't be true," may be a taxpayer's best policy. Many taxpayers naively believe that if they manage their finances in "cash only," commonly known as "under the table," the IRS can't catch on. However, taxpayers need to keep in mind that the IRS knows that virtually every transaction has some sort of paper trail linking the taxpayer to money. The IRS has been around for a long time, and have seen virtually every scheme. In other words, they know where to look to find the truth.

    For example, a taxpayer could trigger suspicion by the IRS if a taxpayer lived in a $1 million home, yet reported annual household income of $40,000 per year. Remember, the IRS knows that most people end up putting unreported income in their checking or savings accounts. The moral of the story is, "honesty is the best policy."

#3. "My Accountant Prepared My Tax Return, So if There Are Any Mistakes, I'm Safe!"

    Not so fast. There are many tax decisions that have ruled otherwise, thus, I would not rely on this contention. Remember, when a taxpayer files his or her tax return, he or she still signs the return (along with his or her tax professional) swearing, under penalties of perjury, the accuracy of the contents of the income tax return. The U.S. Tax Court has stated, in effect, that a taxpayer cannot simply turn a blind eye to mistakes that he or she knew or should have known to exist.

Real Estate

INSPECTION CLAUSES IN RESIDENTIAL REAL ESTATE CONTRACTS
By: Julie M. Dombrosky

    More often than not, clients who are selling or buying a home come to me after their sales contract has already been signed by both parties. However, it is preferable to have your attorney review the contract before you sign it. Real estate agents are used to using their standard forms, but not all contracts are created equal.

    Although it is wise to have an attorney review the whole contract to determine whether the terms are favorable to you, one item of particular importance is the inspection clause. At a minimum, the inspection clause permits the buyer a certain number of days (usually 5) to conduct an independent inspection of the property. If the buyer is not satisfied with the results of the inspection, the terms of the contract may allow the buyer to walk away from the contract and take his initial earnest money with him.

    The purpose of the inspection is to identify any defects in the property. These may be defects that were known and contemplated in negotiating the purchase price, or they may be defects that a buyer would not be expected to know about.

    If you are the buyer in the transaction, it is always advisable to conduct an inspection, which costs between $250 and $500. You want a thorough report listing any and all defects and safety hazards found in the property. The inspector may also recommend what repairs need to be made. Off the record, it is helpful if the inspector is willing and able to give you an idea of how much it will cost to fix a given defect.

    After you get the inspection and the report is in front of you, what do you do? It all depends on what the contract says.

    If you are the buyer, you want a contract with “broad” language regarding the inspection. This will give you a lot of flexibility to get out of the contract (with all of your earnest money) for even the slightest defect. A large-ticket item, such a roof that needs to be replaced, may be something that you would never have contemplated when you made your initial offer. Finding out that you will have to replace or repair a roof to the tune of $10,000 to $20,000 can be upsetting. But, if you have a buyer-friendly inspection clause, you can use the defect as a bargaining tool.

    Once you have identified the estimated cost to repair the defects, is any, you can request from the seller: (1) a credit (reduction in the purchase price) of a sum certain that represents the cost to you of having to repair the defects; (2) a seller’s concession (cash) payable to you at closing, which, again, represents the cost to you of having to repair the defects; (3) that the seller repair the defects prior to the closing and tender receipts and /or transferable warranties from licensed professionals to you at the closing; or (4) some combination of these three, depending on the nature of the defects.
 

    If you really intend to make the repairs, then cash at closing can be quite a boon, especially if you have used substantially all of your available cash to make the down payment on the property. On the other hand, if you don’t really intend to make the repairs, a reduction in the purchase price may be preferable by either offsetting your closing costs and/or reducing the amount of your mortgage. If the defect is a serious safety hazard, you may opt to have the defect repaired by the seller at the seller’s expense prior to the closing so that you don’t have to live in an unsafe property until the defect has been repaired. Keep in mind, however, that the seller is on the way out, and will want to spend as little money on repairs as he can get away with, so any repairs that the seller agrees to make should be closely examined at the final walk-through to make sure that the work isn’t shoddy or unsatisfactory.

    What if you are the seller? You want to make the sale, so you want your buyer to have very little ability to pull out of the contract. Accordingly, you want the inspection clause language of your contract to be as narrow as possible. If the language is too loose, then even a signed contract can be uncomfortably slippery until the inspection period has expired. Also, you don’t want to agree to extend the inspection period unless it is absolutely necessary. Again, you want to hold onto your buyer and get to the closing table. You might choose to sell your property “as is”, but this may turn away buyers, and the risk of an “as is” clause is built into the sale in the form of a lower purchase price. If you are not selling “as is”, then you should demand a contract that allows the buyer to get out of the contract only if defects are found in the major components of the real estate, such as the plumbing, electrical, etc., and only if the defects constitute a threat to health or safety. This way, the buyer can’t get out of the contract for loose door knobs and slow drains and you won’t have to run around fixing every little defect prior to the closing.

    The bottom line is that a signed contract does not guarantee that the transaction will actually go through. Whether you are the buyer or the seller, negotiations regarding inspection issues can make or break your deal. If you are the buyer and you make requests regarding defects and the seller doesn’t agree, your only option is to walk away from the property. As the seller, if you don’t agree to a buyer’s demands, you may lose the sale and have to wait for the next buyer (and the next inspection) to come along.

    If you are thinking about buying or selling residential real property, please feel free to contact JDombrosky@lavellelaw.com about reviewing your contract before you make or accept an offer.
 

Property Tax
 

FINAL REGULATIONS DETAIL RULES FOR IRS'S RETURN OF LEVIED PROPERTY
By: Timothy M. Hughes

    Final IRS Regulations (“Regs”) provide rules on when levied property will be returned by the IRS to a taxpayer and how a request for return should be made by the taxpayer or his representative. These final Regs are effective on July 13, 2005.

    The IRS will return property when the IRS determines that any of the conditions listed below at (1) through (4) apply, final Regs provide that IRS can return money or property levied if:

(1) the levy on the property was premature or otherwise was not in accordance with IRS administrative procedures;
 

(2) the taxpayer has agreed to pay off the underlying tax liability in installments, unless the agreement provides otherwise. If the agreement specifically provided that levied property will not be returned, IRS can't grant a request for return of property;
 

(3) the return of the property will make collection of the underlying tax liability easier; or
 

(4) the return of the property is in the taxpayer's best interest, as determined by the National Taxpayer Advocate (“NTA”) or his delegate, and the U.S.'s best interest, as determined by IRS.

    The Regs provided that if IRS makes a levy in violation of the law, it is in the best interest of the U.S. and the taxpayer to release the levy and IRS will return to the taxpayer any property obtained under the levy. Violation of the law examples are: the levy was made without the IRS giving the requisite thirty-day notice of a right to a hearing to the taxpayer, or during the pendency of a proceeding for refund of divisible tax in violation of Code Sec. 6331(i), or before investigation of the status of levied property in violation of Code Sec. 6331(j), or during the pendency of offers-in-compromise in violation of Code Sec. 6331(k)(1). Similarly, IRS will release a levy during the period an offer to enter into an installment agreement is pending (or for 30 days following the rejection of an offer, or, if the rejection is timely appealed, during the period that the appeal is pending) or during the period an installment agreement is in effect (or during the 30 days following a termination or, if a timely appeal of termination is filed, during the period the appeal is pending).

    The Regs allow a taxpayer to win the battle but lose the war. If the IRS returns property under the final Regs, and a taxpayer fails to pay the previously assessed liability for which the levy was made on the returned property, the IRS can administratively collect the liability. IRS collection can include levying again on the returned property as long as statutory and administrative requirements are followed.

    Do you owe the IRS for more than just the current year? If so please do not hesitate to contact me at THughes@lavellelaw.com to see if we can help you resolve your federal tax matter.

Real Estate
 

BUYING REAL ESTATE JUST GOT A LITTLE MORE EXPENSIVE
By: Lauren E. Schaaf
 

    Title companies state-wide will begin adding a ten dollar recording surcharge to the purchaser’s side of the closing statement for every real estate purchase in Illinois beginning August 1, 2005. They have no choice in the matter. The Rental Housing Support Program has passed both houses and has been signed by the Governor. This program, enacted as The Rental Housing Support Program Act, provides for grants from the Illinois Housing Development Authority to local administering agencies. The grants provide subsidies for landlords, enabling them to charge rent affordable for low-income tenants. The act also provides for grants from the Illinois Housing Development Authority, enabling developers to build affordable rental housing for low-income tenants. In order to pay for the program, the state is charging a ten dollar surcharge that will be collected to record any real estate-related document in Illinois. One dollar of that will go to the county, and nine dollars of that will go to the Rental Housing Support Program Fund.
 

    The program went into effect July 1, 2005. The surcharge will be imposed beginning August 1, 2005. Of course not all entities purchasing real estate in Illinois will have to pay. State agencies, units of local government and school districts are excluded from the surcharge. Some county recorder offices may collect the ten dollar surcharge only on documents with an effective date of August 1, 2005 or later. For more information, and a list of the types of documents which will trigger the surcharge, you may go online to the Illinois Department of Revenue Bulletin. For questions regarding how this charge may affect you, or for general real estate transaction questions, contact Lauren E. Schaaf at LSchaaf@lavellelaw.com

Taxation
 

TAXATION OF EMPLOYMENT LITIGATION SETTLEMENTS
By: Kerry M. Lavelle

      Lawyers who represent victims in employment litigation should allocate the settlement proceeds, to the greatest extent possible, to non-taxable causes; sometimes that is easier said than done. Naqvi, Shahid v. Rossiello, Ernest et. al., 321 Ill. App. 3rd 143, 746 NE 2d 873, (1st Dist. 2001) is the leading case on the subject.

    Naqvi was a legal malpractice case brought by a Plaintiff who filed a retaliatory discharge action against his former employer. At the time of the settlement, the release/settlement document did not indicate which portion of the settlement represented punitive or compensatory damages, nor did it allocate between wage loss and compensatory damages. However, the complaint did state that the Plaintiff was deprived of compensation, bonuses, and benefits and suffered humiliation, embarrassment, and mental distress as a result of his discharge. Naqvi cited Commissioner v. Schleier, 515 US 323 (1995) an Illinois Supreme Court case which found that actions brought under the Age Discrimination Employment Act will not count as personal injury or sickness and is therefore taxable.

    Similarly, O’gilvie v. United States, 519 US 79 (1996), the Supreme Court held that proceeds for the payment of punitive damages were taxable as gross income because they were awarded not as compensation for an injury, but rather as a private fine to punish and deter the Defendant’s reprehensible conduct. In 1992, the Supreme Court confirmed in United States v. Burke, 504 US 229 (1992) that payments representing salary arrearages were also includable as gross income.

    The Naqvi Court took these cases in consideration and held that the portions of the settlement that were allocated as subjective damages for physical or mental injury arising out of the employment action would not be taxable.

    As a result, lawyers who represent Plaintiffs in employment litigation should consider two questions: 1. Should the damage allocation be itemized in a Settlement and Release Agreement to improve the Plaintiffs chances of avoiding tax?; and 2. What allocation should be used? Keep in mind, that the most important element in determining if payment was on account of personal injury or sickness is the intent of the payor. Pipitone v. US, 180 F3d 859 (7th Cir. 1999).

    Secondly, articulate all objectively identifiable items of damages representing loss of salary, bonuses, and benefits, as well as medical bills. Any subjective damages must be itemized in the Settlement Agreement to match the original or amended complaint to articulate non-taxable damages, i.e. language in the settlement/release should specify that the parties mutually agree that a particular sum of money represents subjective damages for physical or mental suffering and is intended to be excludable as gross income from the applicable provisions of the Internal Revenue Code.
 

    Lastly, it is also advisable that attorneys ask that their fees be paid separately from the Settlement and that the payor issue the attorneys a Form 1099 for such amounts so that the attorney fee award is not commingled with the settlement proceeds.

    If you have any further questions on this matter do not hesitate to email them to KLavelle@lavellelaw.com for more thoughts on the subject.

For past e-newsletter articles of interest, please visit the Lavelle Legal Services, Ltd. website at:   http://www.lavellelaw.com/newsletters/newsletter.htm.

 

This newsletter is a publication of Lavelle Legal Services, Ltd. We attempt to highlight and discuss areas of general legal interest that may lead to planning opportunities. Nothing contained in this Newsletter should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein.