Taxation:
1998 IRS RESTRUCTURING AND REFORM ACT ADDS TAXPAYER RIGHTS

On July 24, 1998, the President signed the most extensive revision of the IRS structure in history. In reaction to many IRS abuses, Congress severely limited the powers of the IRS Examination and Collection Division. For example, an Oversight Board was created to oversee the IRS in its administration, management, conduct, direction, and supervision of the execution and application of the tax laws. Further, Congress established an independent taxpayer advocate (with local branches throughout the country) to further taxpayer rights.

One of the most talked about areas of the legislative reform includes innocent spouse relief. In order for spouses to obtain such relief from taxes due on items they did not truly know about when the tax return was filed and signed by them, the innocent spouse would need to prove:

• that the innocent spouse is divorced, legally separated or living apart for at least twelve months from the individual with whom the taxpayer originally filed the return;
• if such election is made, the taxpayer is liable only for the tax that would have been due if the innocent spouse filed a separate return;
• there can be no fraudulently transferred assets between the spouses;
• the innocent spouse cannot have actual knowledge of the understatement of the tax; and
• the innocent spouse could prove the understatement of tax exists and is attributable to an erroneous item by the other spouse.

There are many more substantive changes to the Internal Revenue Code, including the shifting of burden of proof, the ability of judicial review of IRS actions, interest and penalty changes and due process in collection actions.

The United States Tax Court ("Tax Court") now has jurisdiction to issue declarations regarding the status of a business' workers. Previously, if an independent contractor was recharacterized by the Internal Revenue Service as an employee, the taxpayer would have to pay the appropriate amount of tax and file suit in the Federal District Court.

The current rules allow for the taxpayer, within 91 days from receiving a Notice of Determination, to seek declaratory relief in the Tax Court under Internal Revenue Code § 7436.

IRS Notice 9843, 199833 I.R.B. 13, explains the Service's positions on the operation of I.R.C. § 7436.

New § 7436 of the Code provides the Tax Court with jurisdiction to review determinations by the Internal Revenue Service that workers are employees for purposes of Subtitle C of the Code or that the organization for which services are performed is not entitled to relief from employment taxes under § 530 of the Revenue Act of 1978. The Code requires that the determination involve an actual controversy and that it be made as part of an examination. In other words, without an audit controversy, the taxpayer is still limited to filing a Form SS8, Determination of Employee Work Status, for purposes of federal employment taxes and income tax withholding or filing for a private letter ruling.

Note that the Tax Court does not have the jurisdiction to calculate the amount of the tax, but rather simply to determine whether reclassification of a worker from an independent contractor to employee is proper, thus subjecting the employer to all past withholding taxes on his or her workers.

Our office sees this as a small but significant procedural step to allowing taxpayers to adjudicate tax disputes in the Tax Court (generally regarded as the preferred jurisdiction for tax disputes).

Whether you are working on preparing a tax return or are the subject of IRS enforcement actions, be careful of all financial disclosures that are made outside of what appears to be the obvious eye of the Internal Revenue Service. For example, it is not inconsistent for a taxpayer, while they are undergoing enforcement action of the Internal Revenue Service, to refinance their home to bring down their monthly payments. Yes, this is possible (even with a federal tax lien on the house) if it facilitates the payment of taxes to the Internal Revenue Service.

It seems to be the natural inclination of people in general to inflate their income figures for loan application purposes (to qualify for a larger loan) and to deflate their income for purposes of avoiding paying of federal or state income tax.

Both actions are clearly wrong, independent of each other as well as jointly.

Misstatements of fact on a loan application are in violation of banking laws which include criminal sanctions. Similarly, misstatements of fact on returns or financial statements filed with the Internal Revenue Service are also crimes. Inconsistent documents filed with independent agencies give rise to a lie being asserted by the taxpayer somewhere. The same can be said for applications for car loans, student loans, financial assistance applications for college-bound children and self-employed individuals' financial statements. Therefore it is critical that representations made about the taxpayer's financial wherewithal and monthly income be consistent and accurate on every conceivable disclosure.

The new $400 tax credit for each child under the age of 17 highlights the news for the 1998 tax return preparation season. Remember, a credit is a dollar-for-dollar reduction for actual taxes due and owing to the government. The credit is reduced by $50 for every $1,000 a family's adjusted gross income exceeds $110,000 for joint filers, $55,000 for married couples filing separately and $75,000 for single filers. Moreover, this does not affect the $2,700 exemption for dependent children that has existed for years. This tax credit hits line 43 of the 1040.

In addition, education credits of up to $1,500 per child are available for the first two years of college, subject to certain income limits; assets, such as stocks and bonds held for just over a year, instead of 18 months, now qualify for the lower capital gains tax rates; and self-employed individuals (and S Corp. shareholders) can now deduct 45% of the health insurance premiums they paid in 1998.

Also, the Internal Revenue Service anticipates that the record 25 million returns, one-fifth of all individual returns, which were filed electronically for 1997, will grow this year. Taxpayers looking to file electronically should pick up the E-File Guide from the Internal Revenue Service. Taxpayers who use Intuit's TurboTax or MacInTax software can pay their taxes with Discover or Novus cards. Any taxpayer can pay with MasterCard, American Express or Novus cards by calling the IRS' toll-free number. Simple returns can be filed over the telephone using the IRS' TeleFile, which involves filling out a simple booklet and then finishing the return with a 10-minute telephone call. Approximately 6 million people filed this way last year.

Lastly, people can now make checks payable to the "U.S. Treasury" instead of the Internal Revenue Service, acknowledging that your tax dollars go to work for the government and not the tax collector.

Business Planning:
PROTECT YOUR WEB SITE

As you know, businesses are flooding the Internet to begin doing business in cyberspace. A business establishing a presence on the World Wide Web ("Web") must consider many legal issues. Some of these issues are matters of general law, and some are unique to the Internet environment.

Because of the new names of businesses and new words used to conduct business (such as www.yourname.com) there is a greater opportunity to infringe and to be infringed upon by other trade names and trademarks. Therefore, depending on how established the business is, it might be prudent to invest in a complete trademark search to clear the name you intend to use. When a particular name is cleared for use, a web-based business should seriously consider registering that name on a federal trademark registry. Although the only way to acquire rights to a name is to use the name in commerce, federal registration provides at least two advantages. First, it provides prima facie evidence of ownership and validity of the name and, secondly, it gives the registrant nationwide priority over the registered name.

Secondly, the use of pictures or text or hidden programs may qualify for protection under the Copyright Act of 1976 or may qualify for the infringement on someone else's rights under the Copyright Act of 1976. Remember to use appropriate copyright notices consisting of three elements: (i) the designation of the symbol (©), or the word copyright; (ii) the year of the first publication of the work; and (iii)  the name of the copyright owner.

Further, document the creation, maintenance and creation of the web site. Remember that while your web service companies probably do excellent work, they sometimes do so without regard to legal aspects of the project. Consider the following documents:

1. a web site development agreement;
2. a web site hosting agreement;
3. a web site maintenance agreement;
4. a web site user agreement; and
5. a linking agreement (where necessary).

These agreements should help uncloud the murky relationship between independent contractors who provide the web services to your business. In some case, even if an employee provides these services, certain proprietary rights are being established upon the creation of the web site and they need to be memorialized in writing as they are developed.

Estate Planning:
DO I NEED A WILL?

Many people believe an estate plan is only necessary as a means for minimizing estate taxes. In other words, estate planning is only for the wealthy. Mistakenly, people believe that everything goes to the spouse upon an individual's death, absent a will. These misconceptions, however, limit the ability of individuals and couples to develop an estate plan that addresses other types of problems that often arise when an estate plan is not in place.

Technically, everyone has an "estate plan" at birth. This plan is written by the state in which you are located (for example, the Illinois statutes, for Illinois residents). State intestacy statutes provide an estate plan for everyone who cannot or does not make a will. The succession lines in an intestacy statute are based on spousal and blood relationships to the decedent instead of on the intentions and desires of the individual. For example, in Illinois:

First , all claims and debts against my estate shall be fully paid.

Second , if I am married at the time of my death and have no children, my entire estate goes to my surviving spouse. If I am married and have children, one-half of my estate would go to my wife and one-half of the property would be divided equally among my children. If my spouse does not survive me, then my children receive my estate in equal shares. If I do not have a surviving spouse or children, I give my entire estate to my parents, brothers and sisters in equal shares, allowing my surviving parent to have two shares if one parent is dead. If one of my brothers or sisters predeceases me, then his or her share shall be distributed equally to his or her descendants. If I do not have a surviving spouse, child, parent, sister or brother, or a descendant of a sister and/or brother, my estate shall then be distributed to my grandparents or their descendants, many of whom I do not know, and if no relative of mine can be found, I give my estate to the State of Illinois.

Third , if my spouse survives me and I have surviving minor children, my spouse shall be the guardian of my children. If I have minor children and my spouse does not survive me, the probate court shall determine who will raise my children.

Fourth , I appoint no one as my executor and I will rely on the probate court to appoint a reasonable person to carry out my wishes with respect to my property. Moreover, the executor shall make no attempt to reduce or minimize the costs of taxes associated with my estate.

As you can see, for young couples the driving force to prepare their own estate plan would simply be to take control over who will raise their children in the event of an untimely, simultaneous death. For almost everyone, the incentive to prepare their own will is to take control of the distribution of the assets, the timing of the distribution of assets (do you really want to give an 18-year-old "adult" their portion of an even modest estate?) and, of course, the planning and use of the federal income tax laws to minimize the estate tax of the client's estate.

In June of 1996 Illinois passed the Viatical Settlements Act. Viatical settlements allow victims of life-threatening illnesses to sell their insurance policies to a third party for cash. The Act defines a viatical settlement as a "written agreement entered into between a Viatical Settlement provider and a person who owns a life insurance policy... insuring the life of a person who has a catastrophic or life-threatening illness or condition. The agreement shall establish the terms under which the Viatical Settlement provider will pay compensation or anything of value, which compensation or value is less than the expected death benefit of the insurance policy or certificate, in return for a policy holder's assignment, transfer, sale, devise or bequest of the death benefit or ownership of the insurance policy...".

Most viatical settlement companies will only purchase policies from individuals with a projected life expectancy of six months to five years. Typically, a viatical settlement company makes a profit by buying life insurance policies at 50% to 80% of the face value and collecting the full amount of the death benefit at the person's death.

As you may know, death benefits of life insurance are tax exempt. However, prior to the 1996 Tax Act, viatical settlements were taxable as income. In 1996, President Clinton signed the Health Insurance Portability and Accountability Act. This act makes viatical settlements after December 31, 1996 exempt from federal income taxes if the viator has a life expectancy of less than two years and the viatical settlement provider purchasing the policy is licensed in the state where the viator lives. The new tax law also allows people with life-threatening illnesses to receive the proceeds of living benefits from their life insurance policy free of any federal income tax. In Illinois, the Income Tax Act mandates that a taxpayer state-based income is equals to that person's federal taxable income subject to certain specified adjustments. Thus, after 1996, proceeds from viatical settlements would not be taxable in Illinois.

Bankruptcy:
COLLECTING FROM THE BANKRUPT DEBTOR

Many times when a creditor is in the process of collecting a debt from an individual or a business, such debtor files for bankruptcy. When this happens, a creditor often wrongly concludes that the matter is over, closes its file, and then grudgingly accept the fact that the debt will go uncollected. The filing of a bankruptcy petition does not necessarily mean that a debt will be discharged and become uncollectible. The creditor should take steps to protect its rights and to determine whether or not the debt is still collectible.

When an individual or a business files for bankruptcy protection, all collection action is stayed by operation of law. This stay is automatic, whether the creditor receives notice or not. The automatic stay is very broad and prohibits virtually all collection action, including the enforcement of a security interest upon the personal property of the debtor. However, a secured creditor need not always wait until the completion of the bankruptcy proceedings in order to seize its collateral. In certain circumstances, a secured creditor may bring a motion to modify the automatic stay which, if granted, would allow such creditor to seize its collateral. A creditor should consider such a motion where its collateral is declining in value either because of market conditions or because of mismanagement by the debtor.

When bankruptcy proceedings are commenced, one of the first steps that a creditor needs to consider is whether or not to file a proof of claim. In order to participate in distribution of a bankruptcy estate, the creditor must first file its proof of claim. Furthermore, the Bankruptcy Code has strict time requirements in which such proof of claim must be filed. If the proof of claim is not timely filed, and the trustee discovers assets available for distribution, the creditor will be out of luck and will miss out on the distribution.

Although during the course of a bankruptcy proceeding a secured creditor generally will be unable to collect its debt from the debtor, the secured creditor's lien upon the property will continue despite the bankruptcy. Once bankruptcy proceedings are completed or in the event the creditor chooses to modify the automatic stay, the creditor can foreclose upon its security interest. Many times, however, the debtor, after considering the replacement cost for such personal property, the balance of the debt owed to the creditor and the subsequent damage to their credit, may choose to pay a debt which would otherwise be dischargeable in exchange for the right to keep such property. In this situation, the parties enter into a reaffirmation agreement. A reaffirmation agreement must be executed before the court grants the debtor a discharge and the agreement must be filed with the Bankruptcy Court. The Bankruptcy Code also sets forth certain requirements which must be met in order for the reaffirmation agreement to be valid.

While most debts are dischargeable in bankruptcy proceedings, the Bankruptcy Code sets forth certain types of debts for which the debtor will not be discharged. The type of debts which are non-dischargeable are different depending upon the chapter under which the bankruptcy petition was filed. The policy behind such provisions is that a debtor who incurs a debt through wrongful acts should not be relieved of such debt by simply filing a bankruptcy petition. The type of debts which are non-dischargeable under the Bankruptcy Code are very specific. Therefore, any creditor who thinks that they are owed a debt out of the wrongful behavior of the debtor should consult with a bankruptcy attorney.

When an individual or business files a bankruptcy petition, they have an obligation to act in good faith, to honestly and completely file its schedules with the Bankruptcy Court, and to cooperate throughout the bankruptcy proceedings. A goal of any individual debtor is to file his bankruptcy petition, discharge all of its debts, and not have to surrender any property for distribution. In order to achieve such objectives, an unscrupulous debtor may attempt to hide certain assets from the trustee by filing false schedules with the Bankruptcy Court. If a debtor makes a false statement under oath or fails to cooperate with the Bankruptcy Court and the trustee, the court has the power to deny the debtor the discharge. In other words, after the bankruptcy is denied, all of the debtor's creditors will be able to collect their debts.

Because trustees assigned to bankruptcy cases maintain a very large case load, they often spend very little time on each individual case. Accordingly, the trustee may conduct little investigation into the financial affairs of the debtor. A creditor will often have more information about the debtor and may be in a better position to verify the accuracy of the debtor's schedules than the Trustee. Furthermore, the Bankruptcy Code provides creditors with various weapons to enable them to investigate the debtor's financial affairs (i.e., the right to request production of documents or the right to depose the debtor). It therefore may be worthwhile for a creditor to review the debtor's schedules and inform the trustee of any information it may have relevant to the financial affairs of the debtor.

In conclusion, the filing of a bankruptcy petition by a debtor does not necessary end all collection efforts. Many steps must be taken in order to protect a creditor's rights. Furthermore, the Bankruptcy Code provides many tools to enable the creditor to ensure that the debtor complies with his obligations under the Bankruptcy Code. Finally, a creditor may be owed a debt which is non-dischargeable under the Bankruptcy Code. Accordingly, depending on the size of the debt involved, the creditor should always consider consulting with a bankruptcy attorney when confronted with a bankrupt debtor.

Litigation:
JUDGMENT DEBTOR CANNOT PUT JUDGMENT CREDITOR ON BACK BURNER AFTER SERVICE OF CITATION

A recent appellate court decision by the First District which covers Cook County held against a company and its principals who paid its normal business expenses before paying a judgment against it. In the case of City of Chicago v. Air Auto Leasing Co., the appellate court held that the City's service of a citation to discover assets, which is a means for a creditor to enforce its judgment against a debtor, takes priority over all of the debtor's normal necessary business operating expenses.

The appellate court stated that the corporation could not choose to pay its trade payables, as well as payroll accounts, ahead of the judgment after service of the citation. The court also stated that the officer who authorized the checks for payroll and trade payables could be personally responsible up to the amount of those checks written should the creditor assert that the corporate officer's action was in contempt of the citation.

This recent case gives creditors a strong basis for aggressively pursuing judgments against corporations. It may also greatly expose the officers of corporations served with a citation if they do not immediately satisfy that judgment or come to some agreeable resolution with the judgment creditor.

The appellate court specifically stated that debtors cannot rely on a defense that there is no money to pay the judgment after paying all corporate debts. The corporation cannot exempt funds to make ordinary necessary business expenses, even if paying the business expenses is for the purpose of continuing the business so as to eventually satisfy the judgment.

This recent case will certainly change the relationship between judgment debtors and creditors in a corporate setting due to the draconian effect it has on the business debtors as well as its officers' potential personal liability.

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.