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Tax Fraud Blotter: Where’s my refund?

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Prime numbers; Power play; Great White sharks; and other highlights of recent tax cases.

Westbury, New York: Business owner Victor Aguayo has pleaded guilty to not collecting and paying over employment taxes from employee wages.

Aguayo was owner and president of Mabel Interior Design Inc., an interior painting business. He paid his employees some $3.6 million in cash wages but did not withhold or pay taxes from those wages. He also caused false quarterly returns to be filed that did not report those cash wages.

He caused a tax loss to the IRS of $545,743.

Sentencing is April 21. Aguayo faces up to five years in prison, as well as a period of supervised release, restitution and monetary penalties.

New Bedford, Massachusetts: Tax preparer Valentina Martinez, 50, has pleaded guilty to filing false returns to obtain fraudulent federal refunds.

Martinez worked for a national tax prep service. After preparing returns for clients and providing them copies, she added fraudulent claims for business deductions without clients’ knowledge and e-filed the returns.

Martinez caused the refunds to be deposited onto debit cards that she used to make ATM withdrawals and to pay for a Florida vacation and other purchases. Her scheme was discovered and her employment terminated when a taxpayer client complained to the prep service about a missing refund. By then, Martinez had already filed at least 12 false returns and caused more than $45,000 in losses to the IRS.    

Sentencing is March 6. The charge of theft of government money carries a maximum of 10 years in prison, three years of supervised release, a fine of $250,000 and restitution to the IRS. 

Palm Beach Gardens, Florida: Businessman Paul Walczak has pleaded guilty to not paying employment taxes and not filing his individual income tax returns.

Walczak controlled a web of interconnected health care companies operating under various names, including Palm Health Partners and Palm Health Partners Employment Services. At its peak, the latter employed more than 600 people and paid more than $24 million dollars annually in payroll.

From 2016 through 2019, Walczak withheld nearly $7.5 million in federal taxes from employees’ paychecks but did not pay over those taxes, despite having been penalized by the IRS in 2014 for not paying employees’ taxes. During this same period, Walczak also did not pay $3,480,111 of the business’s portion of his employees’ Social Security and Medicare taxes.

At the same time, he used more than $1 million from his businesses’ bank accounts to purchase a yacht, transferred hundreds of thousands of dollars to his personal bank accounts, and used the business accounts for personal spending at high-end retailers.

For 2019 through 2020, Walczak also did not file personal income tax returns.

Walczak caused a total tax loss to the IRS of $10,912,334.80.

Sentencing is Feb. 28. He faces a maximum of five years in prison for the employment tax charge and a year in prison for not filing income tax returns. He also faces a period of supervised release, restitution and monetary penalties. 

Independence, Missouri: Attorney John C. Carnes, 69, has pleaded guilty to evading $857,000 in income taxes.

Carnes admitted that he willfully attempted to evade paying his personal income taxes for 2012 through 2018. He kept his income in his attorney trust accounts, then withdrew cash to pay personal and business expenses.

Carnes had two trust fund accounts. He withdrew $444,527 in cash from one from 2016 through 2019 and $144,364 from the second from 2013 through 2015. He used the cash to gamble and pay personal expenses.

Carnes deposited $232,000 in fees received for services provided in the sale of the former Rockwood Golf Course property in November 2017 and the Missouri City Power Plant project, and other income, into his attorney trust accounts.

The total tax loss to the IRS for 2012 through 2018 totaled $618,949. He also had unpaid federal income tax for 1990 to 1993, 1996 to 2003 and 2005, totaling $175,590. Carnes also had Missouri unpaid income taxes totaling $62,922. 

From 2009 to 2020, the IRS continuously engaged in various forms of investigative and enforcement activity regarding his outstanding tax liabilities.

Carnes faces up to five years in prison. 

Hands-in-jail-Blotter

Lake Geneva, Wisconsin: William S. Gallagher, owner and manager of a swimming pool service and retail company, has pleaded guilty to one count of failure to truthfully account for and pay over federal employment taxes.

Gallagher’s company employed some 15 workers. For each quarter in tax years 2018 through 2020, Gallagher willfully failed to truthfully account for and pay over employment taxes. Dating back to 2014, the loss to the IRS totaled more than $606,000.

Sentencing is Jan. 30. Gallagher faces up to five years in prison and up to a $250,000 fine, as well as up to three years of supervised release after completing any imprisonment.

Jacksonville, Florida: Travis Morgan Slaughter and Tripp Charles Slaughter have pleaded guilty to conspiracy to commit mail and wire fraud and conspiracy to commit tax fraud related to a roofing business they operated.

Travis Slaughter has agreed to forfeit to the U.S. $2,780,947 he obtained from the mail and wire fraud offense and to pay $6,768,612 in restitution for the payroll tax loss, $2,780,947 for unpaid workers’ compensation insurance premiums and $271,217 for two paid workers’ compensation claims.

Tripp Slaughter has agreed to forfeit to the United States $416,800 he obtained from the mail and wire fraud offense and to pay $623,269 in restitution for the payroll tax loss, $416,800 for unpaid workers’ compensation insurance premiums and $137,778 for a paid workers’ compensation claim.

Since 2007, the Slaughters have operated a roofing business, first under the name Great White Construction, then under the name Florida Roofing Experts, and finally under the name 5 Star Roofing Services. Although the names changed, each business operated in the same manner, banked at the same financial institutions and employed the same employees. The company contracted with PEOs to prepare payroll checks for employees, after making deductions for payroll taxes, and to file payroll tax returns and forward tax payments to governmental authorities.

The company did not provide the PEOs with information about all the hours worked by, or all the wages due to, its employees. Instead, the company also paid the employees directly, with separate checks drawn on company bank accounts, and did not deduct payroll taxes from these checks. By paying employees with “split checks” — one from the PEO and one from the company — the company avoided paying the full amount of federal payroll taxes due.

During January 2017 through July 2020, the PEOs issued payroll checks to the employees totaling some $4,930,613, after deducting and paying over to the IRS the payroll taxes. During that same period, the company issued checks to the employees totaling some $18,545,845, with no payroll taxes being deducted or paid. The total unpaid payroll taxes on that amount were $2,768,377.

The PEOs also secured workers’ compensation insurance coverage for the company. The premiums charged by the workers’ compensation insurers were based on the total amount of payroll that the company reported to the PEOs. If the company had reported the actual amount of payroll, the insurers would have charged additional premiums totaling $2,780,947.

The Slaughters also underreported their personal income to the IRS. For 2014 through 2019, the total unpaid taxes due on Travis Slaughter’s unreported income totaled $2,467,183. For 2015 through 2019, the total unpaid taxes due on Tripp Slaughter’s unreported income totaled $263,614.

They each face a maximum of five years in prison for the tax fraud and up to 20 years in prison for the mail and wire fraud. 

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Senate unveils plan to fast-track tax cuts, debt limit hike

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Senate Republicans unveiled a budget blueprint designed to fast-track a renewal of President Donald Trump’s tax cuts and an increase to the nation’s borrowing limit, ahead of a planned vote on the resolution later this week. 

The Senate plan will allow for a $4 trillion extension of Trump’s tax cuts and an additional $1.5 trillion in further levy reductions. The House plan called for $4.5 trillion in total cuts.

Republicans say they are assuming that the cost of extending the expiring 2017 Trump tax cuts will cost zero dollars.

The draft is a sign that divisions within the Senate GOP over the size and scope of spending cuts to offset tax reductions are closer to being resolved. 

Lawmakers, however, have yet to face some of the most difficult decisions, including which spending to cut and which tax reductions to prioritize. That will be negotiated in the coming weeks after both chambers approve identical budget resolutions unlocking the process.

The Senate budget plan would also increase the debt ceiling by up to $5 trillion, compared with the $4 trillion hike in the House plan. Senate Republicans say they want to ensure that Congress does not need to vote on the debt ceiling again before the 2026 midterm elections. 

“This budget resolution unlocks the process to permanently extend proven, pro-growth tax policy,” Senate Finance Chairman Mike Crapo, an Idaho Republican, said. 

The blueprint is the latest in a multi-step legislative process for Republicans to pass a renewal of Trump’s tax cuts through Congress. The bill will renew the president’s 2017 reductions set to expire at the end of this year, which include lower rates for households and deductions for privately held businesses. 

Republicans are also hoping to include additional tax measures to the bill, including raising the state and local tax deduction cap and some of Trump’s campaign pledges to eliminate taxes on certain categories of income, including tips and overtime pay.

The plan would allow for the debt ceiling hike to be vote on separately from the rest of the tax and spending package. That gives lawmakers flexibility to move more quickly on the debt ceiling piece if a federal default looms before lawmakers can agree on the tax package.

Political realities

Senate Majority Leader John Thune told reporters on Wednesday, after meeting with Trump at the White House to discuss the tax blueprint, that he’s not sure yet if he has the votes to pass the measure.

Thune in a statement said the budget has been blessed by the top Senate ruleskeeper but Democrats said that it is still vulnerable to being challenged later.

The biggest differences in the Senate budget from the competing House plan are in the directives for spending cuts, a reflection of divisions among lawmakers over reductions to benefit programs, including Medicaid and food stamps. 

The Senate plan pares back a House measure that calls for at least $2 trillion in spending reductions over a decade, a massive reduction that would likely mean curbing popular entitlement programs.

The Senate GOP budget grants significantly more flexibility. It instructs key committees that oversee entitlement programs to come up with at least $4 billion in cuts. Republicans say they expect the final tax package to contain much larger curbs on spending.

The Senate budget would also allow $150 billion in new spending for the military and $175 billion for border and immigration enforcement.

If the minimum spending cuts are achieved along with the maximum tax cuts, the plan would add $5.8 trillion in new deficits over 10 years, according to the Committee for a Responsible Federal Budget.

The Senate is planning a vote on the plan in the coming days. Then it goes to the House for a vote as soon as next week. There, it could face opposition from spending hawks like South Carolina’s Ralph Norman, who are signaling they want more aggressive cuts. 

House Speaker Mike Johnson can likely afford just two or three defections on the budget vote given his slim majority and unified Democratic opposition.

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How asset location decides bond ladder taxes

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Financial advisors and clients worried about stock volatility and inflation can climb bond ladders to safety — but they won’t find any, if those steps lead to a place with higher taxes.

The choice of asset location for bond ladders in a client portfolio can prove so important that some wealthy customers holding them in a taxable brokerage account may wind up losing money in an inflationary period due to the payments to Uncle Sam, according to a new academic study. And those taxes, due to what the author described as the “dead loss” from the so-called original issue discount compared to the value, come with an extra sting if advisors and clients thought the bond ladder had prepared for the rise in inflation.

Bond ladders — whether they are based on Treasury inflation-protected securities like the strategy described in the study or another fixed-income security — provide small but steady returns tied to the regular cadence of maturities in the debt-based products. However, advisors and their clients need to consider where any interest payments, coupon income or principal accretion from the bond ladders could wind up as ordinary income, said Cal Spranger, a fixed income and wealth manager with Seattle-based Badgley + Phelps Wealth Managers.

“Thats going to be the No. 1 concern about, where is the optimal place to hold them,” Spranger said in an interview. “One of our primary objectives for a bond portfolio is to smooth out that volatility. … We’re trying to reduce risk with the bond portfolio, not increase risks.”

READ MORE: Why laddered bond portfolios cover all the bases

The ‘peculiarly bad location’ for a bond ladder

Risk-averse planners, then, could likely predict the conclusion of the working academic paper, which was posted in late February by Edward McQuarrie, a professor emeritus in the Leavey School of Business at Santa Clara University: Tax-deferred retirement accounts such as a 401(k) or a traditional individual retirement account are usually the best location for a Treasury inflation-protected securities ladder. The appreciation attributes available through an after-tax Roth IRA work better for equities than a bond ladder designed for decumulation, and the potential payments to Uncle Sam in brokerage accounts make them an even worse asset location.

“Few planners will be surprised to learn that locating a TIPS ladder in a taxable account leads to phantom income and excess payment of tax, with a consequent reduction in after-tax real spending power,” McQuarrie writes. “Some may be surprised to learn just how baleful that mistake in account location can be, up to and including negative payouts in the early years for high tax brackets and very high rates of inflation. In the worst cases, more is due in tax than the ladder payout provides. And many will be surprised to learn how rapidly the penalty for choosing the wrong asset location increases at higher rates of inflation — precisely the motivation for setting up a TIPS ladder in the first place. Perhaps the most surprising result of all was the discovery that excess tax payments in the early years are never made up. [Original issue discount] causes a dead loss.”

The Roth account may look like a healthy alternative, since the clients wouldn’t owe any further taxes on distributions from them in retirement. But the bond ladder would defeat the whole purpose of that vehicle, McQuarrie writes.

“Planners should recognize that a Roth account is a peculiarly bad location for a bond ladder, whether real or nominal,” he writes. “Ladders are decumulation tools designed to provide a stream of distributions, which the Roth account does not otherwise require. Locating a bond ladder in the Roth thus forfeits what some consider to be one of the most valuable features of the Roth account. If the bond ladder is the only asset in the Roth, then the Roth itself will have been liquidated as the ladder reaches its end.”

READ MORE: How to hedge risk with annuity ladders

RMD advantages

That means that the Treasury inflation-protected securities ladder will add the most value to portfolios in a tax-deferred account (TDA), which McQuarrie acknowledges is not a shocking recommendation to anyone familiar with them. On the other hand, some planners with clients who need to begin required minimum distributions from their traditional IRA may reap further benefits than expected from that location.

“More interesting is the demonstration that the after-tax real income received from a TIPS ladder located in a TDA does not vary with the rate of inflation, in contrast to what happens in a taxable account,” McQuarrie writes. “Also of note was the ability of most TIPS ladders to handle the RMDs due, and, at higher rates of inflation, to shelter other assets from the need to take RMDs.”

The present time of high yields from Treasury inflation-protected securities could represent an ample opportunity to tap into that scenario.

“If TIPS yields are attractive when the ladder is set up, distributions from the ladder will typically satisfy RMDs on the ladder balance throughout the 30 years,” McQuarrie writes. “The higher the inflation experienced, the greater the surplus coverage, allowing other assets in the account to be sheltered in part from RMDs by means of the TIPS ladder payout. However, if TIPS yields are borderline unattractive at ladder set up, and if the ladder proved unnecessary because inflation fell to historically low levels, then there may be a shortfall in RMD coverage in the middle years, requiring either that TIPS bonds be sold prematurely, or that other assets in the TDA be tapped to cover the RMD.”

READ MORE: A primer on the IRA ‘bridge’ to bigger Social Security benefits

The key takeaways on bond ladders

Other caveats to the strategies revolve around any possible state taxes on withdrawals or any number of client circumstances ruling out a universal recommendation. The main message of McQuarrie’s study serves as a warning against putting the ladder in a taxable brokerage account.

“Unsurprisingly, the higher the client’s tax rate, the worse the outcomes from locating a TIPS ladder in taxable when inflation rages,” he writes. “High-bracket taxpayers who accurately foresee a surge in future inflation, and take steps to defend against it, but who make the mistake of locating their TIPS ladder in taxable, can end up paying more in tax to the government than is received from the TIPS ladder during the first year or two.”

For municipal or other types of tax-exempt bonds, though, a taxable account is “the optimal place,” Spranger said. Convertible Treasury or corporate bonds show more similarity with the Treasury inflation-protected securities in that their ideal location is in a tax-deferred account, he noted.

Regardless, bonds act as a crucial core to a client’s portfolio, tamping down on the risk of volatility and sensitivity to interest rates. And the right ladder strategies yield more reliable future rates of returns for clients than a bond ETF or mutual fund, Spranger said.

“We’re strong proponents of using individual bonds, No. 1 so that we can create bond ladders, but, most importantly, for the certainty that individual bonds provide,” he said.

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Why IRS cuts may spare a unit that facilitates mortgages

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Loan applicants and mortgage companies often rely on an Internal Revenue Service that’s dramatically downsizing to help facilitate the lending process, but they may be in luck.

That’s because the division responsible for the main form used to allow consumers to authorize the release of income-tax information to lenders is tied to essential IRS operations.

The Income Verification Express Service could be insulated from what NMN affiliate Accounting Today has described of a series of fluctuating IRS cuts because it’s part of the submission processing unit within wage and investment, a division central to the tax bureau’s purpose.

“It’s unlikely that IVES will be impacted due to association within submission processing,” said Curtis Knuth, president and CEO of NCS, a consumer reporting agency. “Processing tax returns and collecting revenue is the core function and purpose of the IRS.”

Knuth is a member of the IVES participant working group, which is comprised of representatives from companies that facilitate processing of 4506-C forms used to request tax transcripts for mortgages. Those involved represent a range of company sizes and business models.

The IRS has planned to slash thousands of jobs and make billions of dollars of cuts that are still in process, some of which have been successfully challenged in court.

While the current cuts might not be a concern for processing the main form of tax transcript requests this time around, there have been past issues with it in other situations like 2019’s lengthy government shutdown.

President Trump recently signed a continuing funding resolution to avert a shutdown. But it will run out later this year, so the issue could re-emerge if there’s an impasse in Congress at that time. Republicans largely dominate Congress but their lead is thinner in the Senate.

The mortgage industry will likely have an additional option it didn’t have in 2019 if another extended deadlock on the budget emerges and impedes processing of the central tax transcript form.

“It absolutely affected closings, because you couldn’t get the transcripts. You couldn’t get anybody on the phone,” said Phil Crescenzo Jr., vice president of National One Mortgage Corp.’s Southeast division.

There is an automated, free way for consumers to release their transcripts that may still operate when there are issues with the 4506-C process, which has a $4 surcharge. However, the alternative to the 4506-C form is less straightforward and objective as it’s done outside of the mortgage process, requiring a separate logon and actions.

Some of the most recent IRS cuts have targeted technology jobs and could have an impact on systems, so it’s also worth noting that another option lenders have sometimes elected to use is to allow loans temporarily move forward when transcript access is interrupted and verified later. 

There is a risk to waiting for verification or not getting it directly from the IRS, however, as government-related agencies hold mortgage lenders responsible for the accuracy of borrower income information. That risk could increase if loan performance issues become more prevalent.

Currently, tax transcripts primarily come into play for government-related loans made to contract workers, said Crescenzo.

“That’s the only receipt that you have for a self-employed client’s income to know it’s valid,” he said.

The home affordability crunch and rise of gig work like Uber driving has increased interest in these types of mortgages, he said. 

Contract workers can alternatively seek financing from the private non-qualified mortgage market where bank statements could be used to verify self-employment income, but Crescenzo said that has disadvantages related to government-related loans.

“Non QM requires higher downpayments and interest rates than traditional financing,” he said.

In the next couple years, regional demand for loans based on self-employment income could rise given the federal job cuts planned broadly at public agencies, depending on the extent to which court challenges to them go through.

Those potential borrowers will find it difficult to get new mortgages until they can establish more of a track record with their new sources of income, in most cases two years from a tax filing perspective. 

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