Washington & Lee University School of Law Tax Clinic Frequent Issues Representing Low Income Taxpayers

W&L Tax Clinic – Mission and Focus The Tax Clinic is a legal clinic at the Washington and Lee University School of Law. We offer eligible low-income taxpayers free legal assistance with their federal and Virginia tax problems. Third-year students, under the supervision of Clinic Director Michelle Drumbl, help clients resolve tax problems and disputes with the Internal Revenue Service and/or the Virginia Department of Taxation. The Tax Clinic maintains its status through a federal grant program administered by the IRS Office of the Taxpayer Advocate. We are equipped to handle cases from the start of the dispute all the way through Tax Court litigation.

Client Eligibility – Income Qualification The Tax Clinic is guided by LITC grant requirements Income Requirements: The Clinic determines income eligibility by using 250% of the Federal Poverty Income Guidelines as the reference income guideline. Size of Family Income not greater than: 1 $30,150 2 $40,600 3 $51,050 4 $61,500 5 $71,950

Client Eligibility – Case Requirements The Tax Clinic represents clients with Federal and/or Virginia Tax problems. The Tax Clinic does not handle transactional tax matters or routine tax return preparation.  We can provide assistance with a number of different problems with the IRS, including (but not limited to): Tax issue: Responding to IRS Notices Identity Theft Representation at Audit Installment Agreements Representation in U.S. Tax Court Offer in Compromise Earned Income Credit Problems Liens and Levies Innocent Spouse Relief Requests Collection Disputes

Additional Information For more information about specific income or case requirements, please pick up a copy of our brochure or visit our website at https://law.wlu.edu/clinics/tax-clinic

Overview of Today’s Topics Injured Spouse Allocation – Javier Puga Cancellation of Debt – Gabrielle Ongies Tax Implications for Awards and Settlements – Roland Hartung

Injured Spouse Allocation Form 8379 Javier Puga, 3L Washington & Lee University School of Law Tax Clinic

Why file an injured spouse allocation? “The injured spouse on a jointly filed tax return files this form to get back their share of the joint refund when the joint overpayment is applied to a past-due obligation of the other spouse.” IRS.gov Practically, an injured spouse allows jointly filing taxpayers to maximize their refund. It can be an extremely useful tool when the taxpayer without the debt is contributing to all or most of the income between the two taxpayers. *An injured spouse allocation is different than an innocent spouse relief request. A request for innocent spouse relief is appropriate when, following a joint return, one spouse believes the other spouse should be solely responsible for an erroneous item or an underpayment of tax.

Types of Debt Relevant for Injured Spouse Allocation Not all debts are eligible to be offset by a refund. To receive the allocation, the injured spouse must have no obligation to pay the debts. The following are common debts that offset a refund and are thus ideal situations to use an injured spouse allocation: Past due federal tax liabilities Past due child support Delinquent debt owed to other federal agencies (e.g. federal student loans) Delinquent debts owed to state agencies Past due state tax liabilities Unemployment compensation overpayments that taxpayer failed to return

Form 8379 A taxpayer can file an injured spouse allocation at the same time you file your 1040 or in a subsequent filing. When the injured spouse allocation is filed at the same time as the 1040, it will appear on the top of page 1 of the 1040. Generally, a taxpayer as 3 years from the due date of the original return to file an injured spouse allocation. In certain states (not Virginia), community property rules may alter the effect of the injured spouse allocation.

Keys for taxpayers who File Injured Spouse Allocation Clients may not fully know their financial situation. If there is concern about a possible refund offset, there is very little downside in filing an injured spouse allocation form. Be aware that the processing time for an injured spouse allocation filed with a 1040 is shorter than when filed separately afterwards. For clients who are in difficult financial circumstances, filing sooner rather than later is better. An IRS representative may not have information about any non- federal tax debts subject to refund offset procedures. The Bureau of Fiscal Service is ultimately the agency that handles a claim that offsets a claim against a refund.

Conclusion- Takeaway Points An injured spouse allocation is frequently used to maximize a refund for taxpayers filing jointly. This option is beneficial to taxpayers who otherwise might think they should file “married filing separately”, which is generally not a favorable filing statue (among other reasons, because a taxpayer using that filing status is ineligible to claim the Earned Income Tax Credit.) The IRS is flexible in the manner and timing for a taxpayer filing a 8379. While you may be able to get a refund back within 3 years, the processing times are different depending when you file the allocation. The IRS may know have minimal information about what debts are outstanding. Asking your client upfront about these types of debts is recommended.

Cancellation of debt What is it, and how do you handle it? Gabrielle Ongies, 3L Washington & Lee University School of Law Tax Clinic

What is cancellation of debt? Generally occurs when your client owes a debt to someone else and the creditor either cancels or forgives the debt for less than its full amount Example: Your client owes Discover $4000 in credit card debt. After a period of time of being unable to collect, Discover decides to cancel the $4000. Your client no longer owes the debt, but now may have to include it in gross income.

Form 1099-c

Form 1099-c If your client received a Form 1099-C, an applicable entity has reported an identifiable event to the IRS. The event may be an actual cancellation or one that the IRS treats as cancellation of debt This cancelled debt is ordinary income unless the client met an exception or exclusion Filing is required if the cancelled debt is > $600

Event codes A - Bankruptcy B - Other judicial debt relief C – Statute of limitations or expiration of deficiency period D – Foreclosure election E – Debt relief from probate or similar proceeding F – By agreement G – Decision or policy to discontinue collection H – Expiration of nonpayment testing period I – Other actual discharge before identifiable event

IRS form 982 If the canceled debt is excluded from income, the client must reduce certain tax attributes by the amount excluded, but not below zero Use Form 982 to figure out how to reduce the client’s tax attributes. IRS Publication 4681 has examples under the “Reduction of Tax Attributes” section

IRC § 61(a)(12) – Gross Income (a) Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items: (12) Income from discharge of indebtedness

Exceptions Don’t require the client to reduce their tax attributes The exceptions are: Gifts, Bequests, Devises and Inheritances Student Loans Deductible Debt Price Reduced After Purchase Home Affordable Modification Program Theses exceptions apply before the exclusions of IRC § 108 For details, see IRS Publication 4681

IRC § 108 - Exclusions Income by reason of discharge of indebtedness IS NOT included in gross income if it is due to: Bankruptcy Insolvency Qualified Farm Indebtedness Qualified Real Property Indebtedness Qualified Principal Residence Indebtedness

bankruptcy Includes all chapters in title 11, such as chapters 7, 11, and 13 Cancellation of debt must be granted by the court or occur as a result of a court approved plan You must be a debtor in a title 11 bankruptcy case to qualify Report using a Form 982

insolvency Don’t include a cancelled debt in gross income to the extent that your client was insolvent immediately before the cancellation. The client must be insolvent themselves. These assets include anything serving as collateral for debt and exempt assets beyond the reach of creditors. Use the Insolvency worksheet provided in IRS Publication 4681 to determine if your client is insolvent. Report using a Form 982.

Insolvency Liabilities > FMV all assets immediately before cancellation = Insolvent Remember to include assets that creditors cannot access because they still count for insolvency purposes

Qualified Farming, real property or principal residence indebtedness If any of these were cancelled as a result of title 11 bankruptcy or if the client was insolvent immediately before the cancellation, those exceptions MUST be used first See IRS Publication 4681 for definitions and qualification requirements

Tax Implications for Awards and Settlements Roland Hartung, 3L Washington & Lee University School of Law Tax Clinic

Overview Preliminary Considerations Considering Taxes When Drafting a Complaint Considering Taxes When Negotiating a Settlement Solutions Final Considerations

Preliminary Considerations Be mindful that tax implications may exist, identify them early on. Draft pleadings and documents accordingly. Disputes over taxability will be heard by the U.S. Tax Court. General rule: “Gross income means all income from whatever source derived.” 26 U.S.C. § 61(a). Exception mostly arises in regard to “personal physical injury or physical sickness.” 26 U.S.C. § 104(a)(2). Punitive Damages are never excluded from gross income.

Considering Taxes When Drafting a Complaint The complaint is one of the principal documents Tax Court will look towards. The language used in a complaint can be crucial to determine whether an award or settlement will be excluded from gross income. Ambiguity and broad language will not work in the taxpayers favor.

Considering Taxes When Negotiating a Settlement Be specific as possible when allocating parts of settlements to different purposes. What are you trying to compensate for? Courts will try to determine the payor’s intent when determining in lieu of what a settlement was paid. Definitive settlement terms are helpful to determine the payor’s intent. Burden of Proof lies on the taxpayer.

Considering Taxes When Negotiating a Settlement: Amos v. Commissioner T.C. Memo. 2003-329 (2003)

Solutions Consider tax implications early on. Preferably consider before drafting a complaint, and draft accordingly. Inform your clients of potential tax implications. Consider alternatives to specific allocation. E.g. increase amount of settlement by anticipated tax burden.

Final Considerations Tax assessment may come later than the award or settlement. DO NOT promise your clients that an award or settlement will be excluded from gross income. Advise your clients to consult a tax attorney in regards to potential tax implications.

Questions?