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Were it not for the controversy stirred up by the IRS's recent disclosure that it has been subjecting various “Tea Party” groups to special scrutiny, May would probably go down as a fairly quiet month for federal tax developments. But more on that below. Before discussing the “Tea Party” dust-up, however, we want to bring your attention to some other more mundane developments in the world of federal taxation.

1. According to the IRS, It Will Not Be “Heavy Handed” in Assessing the Tax Penalties Under ObamaCare For Those Individuals Failing To Meet the Mandate To Have Health Insurance – According to a recent announcement by the IRS, the normal rules of tax collection specified in the Internal Revenue Code (which can be somewhat punitive in nature) will not apply to individual taxpayers who fail to comply with the individual shared responsibility requirements under ObamaCare. These requirements first become applicable in 2014 and can result in fines beginning in 2015 (if a taxpayer is not covered by a minimum amount of health insurance for the preceding calendar year). In remarks to the Financial Services and General Government Subcommittee, the acting IRS Commissioner stated that “the collection rules are different and a lighter touch is required of the IRS with respect to the individual mandate under ObamaCare.”

But “lighter touch” does not mean that there will be no tax consequences to the non-compliant taxpayer. In remarks made before the same Subcommittee, J. Russell George, the Treasury Inspector General for Tax Administration, pointed out that it would nevertheless be within the ability (and presumably be the intention) of the IRS to withhold a tax refund from a non-compliant taxpayer in order to enforce the penalty. In this regard, it should be noted that the penalty starts at the greater of $95 or 1% of household income (for failure to comply in the 2014 calendar year). The penalty increases each year thereafter until attaining the greater of $695 or 2.5% of household income for failure to comply for the 2016 calendar year.

3. IRS On the Warpath Regarding Misclassification of Workers by Sub S Corporations – In comments made to the May 2013 meeting of the American Bar Association Section of Taxation, Janine Cook, IRS Deputy Division Counsel, alerted the Section members to a perceived abuse of the employment tax rules under the Internal Revenue Code. Specifically, Ms. Cook stated that sole proprietorships that incorporate their businesses as Subchapter S corporations but do not withhold employment taxes for income that flows through to the corporation's shareholders present “a ripe case for the IRS to look at”.

In the words of Ms. Cook, the IRS has seen – and successfully litigated – many cases in which an officer of a Subchapter S corporation who was also a shareholder of the corporation was not paid a “reasonable” salary for the services performed. According to Ms. Cook, “I can almost guarantee that the IRS will be successful at reclassifying at least some portion of the corporation's cash flow that flows to that officer as ‘wages’”. As “wages”, the corporation and the officer become subject to various employment tax withholdings. Also, the corporation's failure to have abided by its withholding obligations may subject the corporation to substantial tax penalties for each year that the statute of limitations is still open.

3. IRS Apologizes To Tea Party Groups For Inappropriate Scrutiny Of Their Applications For Tax-Exempt Status – On May 10, 2013, Lois Lerner, IRS Director of Exempt Organizations, made prepared remarks to the American Bar Association Tax Section meeting in Washington, D.C. that have resulted in one of the more memorable scandals to rock the IRS in a long time.

She began her remarks by publicly apologizing to Tea Party groups for the treatment they have received from the IRS when applying to the IRS for tax exempt status under IRC Section 501(c)(4) as a "social welfare" organization. According to Ms. Lerner, certain unnamed career employees of the IRS's exempt organizations branch singled out groups applying for tax exemption with the name "Tea Party" and "Patriot" for extra review and scrutiny.

Ms. Lerner admitted to the Tax Section that the IRS's actions were "absolutely wrong and inappropriate." She also admitted that the extra review resulted in the IRS asking questions of the organizations that were too broad, including questions about their contributors that were not customary and that the reviews thus undertaken took too long to conclude.

The following is a brief summary of recent developments in this area:

  • On May 10, House and Senate members blasted the IRS, after learning of the extra scrutiny leveled at "Tea Party" groups, for being engaged in inappropriate political activity.
  • On May 10, both Senate Minority Leader, Mitch McConnell, (R-Ky.), and House Budget Committee Chairman, Eric Cantor (R-Va.) have called for investigations into this matter by both the White House and Congress.
  • On May 13, Senate Finance Committee Chairman, Max Baucus (D-Mont.) called for an investigation into the accusations that the IRS singled out politically conservative groups seeking tax-exempt status under IRC Section 501(c)(4).
  • On May 14, the Treasury Inspector General for Tax Administration ("TIGTA"), Office of Audit, released its own report on the actions by the IRS in this matter. The principal findings in the Report were that (1) early in 2010, the IRS began using inappropriate criteria (i.e., names of the organization or their policy positions) to identify organizations applying for tax-exempt status to review for indications of significant political campaign intervention, and (2) ineffective management of the IRS (i) allowed inappropriate criteria to be developed and stay in place for more than 18 months (ii) resulted in substantial delays in processing applications, and (iii) allowed unnecessary, burdensome information requests to be issued to the organizations.
  • On May 14, the FBI announced that it was launching a criminal inquiry into allegations that IRS officials targeted conservative groups seeking tax-exempt status for special scrutiny.
  • On May 14, President Obama directed Treasury Secretary Jacob J. Lew to hold personnel at the IRS accountable for their actions and to ensure each of the recommendations in the TIGTA report were implemented quickly.
  • On May 15, Steven Miller, the acting Commissioner of the IRS, resigned at the request of President Obama.
  • Since May 15, Congress has continued to actively investigate this matter, and there will no doubt be further developments of special interest.
For additional information regarding this topic, please contact your local UHY LLP professional.