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Client is going to prison


Roberts

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This is a first for us. He was indicted, arrested and I'm confident he will be going to federal prison (he tried to explain to me that it will "only" be 5-10 years). He paid illegal kickbacks which he took as a business deduction so once the courts declare those payments illegal, will the IRS automatically audit him? He'll owe about $8m (I'm guessing) and has assets of about $4m which is mostly in retirement accounts which will trigger another tax bill he can't pay. Even if they lowered his amount owed to $3m, he'll owe $750k+ in taxes on any audit.

 

Other question! I've never done an innocent spouse case, would that apply to his retirement plan early withdrawals to pay his fines that are now taxable? 75% of his assets are in retirement accounts so when he is forced to withdraw it to pay his restitution, that's now taxable. Does innocent spouse get her a way to avoid it? I'm thinking that wouldn't apply and she'd be on the hook. (I think innocent spouse would avoid the audit trigger mentioned above but maybe not the retirement plan distributions?)

 

He's barely a client so I didn't do his taxes.

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I would not touch this one with a ten foot pole, and that includes the spouse. However, the penalty for the withdrawal from retirement accounts will occur in the year in which the withdrawal occurs.  So if I were his spouse, I would not file a joint tax return with him in that year,  or ever again for that matter.

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And, you have a conflict of interest if you advise the spouse but know of taxpayer's biz mis-dealings from your professional work for the couple, for his biz, whatever.

Tell him to use his lawyer. If you agree, lawyer can hire you.

Recommend a good preparer to spouse. You could work for spouse, if you are careful.

I would run, not walk, away from this!

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1 hour ago, Roberts said:

Other question! I've never done an innocent spouse case, would that apply to his retirement plan early withdrawals to pay his fines that are now taxable? 75% of his assets are in retirement accounts so when he is forced to withdraw it to pay his restitution, that's now taxable. Does innocent spouse get her a way to avoid it? I'm thinking that wouldn't apply and she'd be on the hook. (I think innocent spouse would avoid the audit trigger mentioned above but maybe not the retirement plan distributions?)

Were the illegal deductions on a Sch C or pass-through entity that she was part owner in and had knowledge of the payment and deduction?

Innocent spouse rules pertain to those prior acts and returns. That rule wouldn't apply to future returns where the husband is withdrawing funds from his retirement for restitution, but if she files a joint return for the years going forward that have the retirement withdrawals, she would be liable for the tax liability and any early w/d penalties on those future years' returns, if any.  To avoid that problem, she should file as MFS from now on, not jointly.

I don't know if the court notifies the IRS.  IIRC, there is a limited time period in which to apply for innocent spouse after IRS initiates collection.

 

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MFS makes good sense. I know he set his business up as an S-corp and she wasn't an owner.

 

Innocent Spouse time limits are essentially limited to collection timelines. They voided the 2 year rule several years ago. I'll probably skip telling him about MFS - not my business. Whoever turned him in has likely already done a whistle blower with the IRS.

 

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4 hours ago, Roberts said:

Client is going to prison

This is a first for us. He was indicted, arrested and I'm confident he will be going to federal prison (he tried to explain to me that it will "only" be 5-10 years).

He's barely a client so I didn't do his taxes.

So, is he a bookkeeping client? S-corp tax client? Personal tax client? What kind of client is he? You might want legal advice from your E&O insurer. Or, even your own lawyer, depending on what your involvement was with this barely a client.

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Spouse might not be so innocent; the IRS will determine how much she knew when it reviews her innocent spouse claim.  I wouldn't touch it.  His criminal attorney surely has contacts with a good tax attorney for the spouse.  Just decline the engagement because this situations calls for an attorney.

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Any chance the spouse can divorce and get a chunk of the the retirement in a QDRO?   If spouse is truly innocent, a determination that is still up in the air based on what you have posted so far, then a quick divorce with a property settlement that gives spouse half of the retirement assets might keep it out of the hands of the IRS.   

Tom
Longview, TX

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