AIPIS 181 - Avoiding Tax Crimes and Properly Contracting Labor with Robert Wood

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It's my pleasure to welcome Robert W. Wood. He is managing partner at Wood llp. They're located in the Bay Area and they are tax attorneys. Robert, welcome. How are you?

I'm good. Thanks for having me.

Good. Nice to have you on the show. You deal in some pretty specialized high level areas. I want to ask you maybe first about tax crimes. Unfortunately, the tax code has become so insanely complex that it's quite possible people may be committing crimes and not even knowing it. Would you say that's a fair statement?

Unfortunately, yes. I mean, it can happen. The good news is that the vast majority of people do their best with filing tax returns and various other forms. Some people still do it themselves. Obviously most people have tax professionals that handle it. But yeah, one area of potential criminal activity these days would relate to foreign accounts. There's a huge focus on that. Most people have cleaned up those things and reported them. But if you haven't, it's a good idea to see someone.

Right. So if you have an offshore entity and you know that entity is going to obviously have a bank account, are you just asking for trouble? Is this something that only the really, really wealthy should play in that world?

I don't think so. I mean, I think it's perfectly legitimate and there's nothing illegal about it. What's illegal is not disclosing it. And so, I mean, there's a whole raft of federal laws now that regulate that. And you mentioned offshore entities. So if somebody has an offshore company that has a bank account, it's a little more complex than having simply an offshore bank account by yourself. So there are extra forms that are required. I mean, you don't have to be wealthy. It isn't that expensive to do the filings. But I think what most people find difficult is when they're playing catch up because then it may be necessary to go into one of the IRS amnesty programs. But if you're staying on top of these things, I mean, it really is not difficult to do and it really is. Okay.

Okay. So that's one of the areas, the offshore accounts. I mean, ever since Obama, the Obama administration really, they really started attacking this area, it seems like a few years back. And what was it? Ubs. I think it was ubs. I may be mistaken, but one of the big banks was sort of forced to turn over a lot of account information. I believe there was a short amnesty period where people could come forward and say, hey, I've been doing this, but don't put me in jail.

Yeah, no, absolutely. And your memory's right, it was ubs. And there have been many, many, many banks since then. I think actually the number of banks that have done deals with the government is now up to 100 or close to 100. And you have FATCA, which is the Foreign Account Tax Compliance act, which was passed back in 2010. And it's still sort of ramping up and it has really a global reach. So the notion that you can sort of slip under the radar and not disclose is really. Those days are gone. I mean, if they ever existed. And it's just not worth it, not worth the risk. So I would tell people, if you want to have offshore investments or offshore companies, it's not a problem, but you need to disclose it and report the income. And I mean, that's what the system requires and that's what you should do if you want to sleep at night.

Yeah. So that's a big area. Are there some other big areas where people could be breaking laws and maybe not even knowing it?

Well, surprisingly, I mean, I think this is a relatively small, fortunately a small fraction of people. But it is possible to have the best of intentions and still end up in potential criminal tax case. I always have to remind people that when you sign a tax return, you're signing it under penalties of perjury. I think many people you mentioned complexity and indeed our tax returns, I think Donald Trump has been referring to his own returns that he still hasn't shown anyone as being multiple feet high and very complex and so on. You don't have to be Donald Trump to have a complex tax return. Many people don't understand their own, don't review their own. I would just say be careful and don't sign unless you actually have looked through it and have a sense of, of what's in there and that it's complete. I mean, you are certifying that to the best of your knowledge, it is correct and complete. So, you know, businesses, a lot of people who start a business are not really savvy about keeping books and records and Things that are required. It is rare, but it is possible to end up in a criminal referral. The main way that IRS criminal cases come about, still, this surprises a lot of people, still is a referral from a civil auditor. So if they think that you are really either wittingly or unwittingly doing bad things, they can bring the power of the federal government to bear. So it is sort of scary. It's too bad we don't have a really simple system. I think we should. I hope we do someday, but people are going to need help in doing these sorts of things to sort of keep their nose clean, so to speak.

Yeah. The problem is, you know, I submit maybe 1200 pages of tax returns with all these different entities I have every year. And the problem is I can't read or comprehend those things. I mean, I, you know, I'm really relying on someone. And let me tell you, a lot of times these professionals, they let you down. They're. Yeah, they're either incompetent or they just. They're just lazy and they don't do their job. I mean, it's been pretty disappointing over the years with various professionals I've hired.

Yeah. 1200 pages, that may put you in Donald Trump territory or close to it. I mean, that's a lot.

But I don't have all the billions he has or. Well, if he has them. Yeah.

I mean, I don't think there's an easy answer. I can just tell you that. And I'm not suggesting, I don't want to suggest that the irs, you know, is going to put you up against a wall for an error that was unintentional. I mean, we all commit errors. Professionals do, and certainly taxpayers do, politicians do. Everybody makes mistakes. But I think you want to have. You shouldn't. The phrase from the mortgage crisis robosign. You shouldn't robo sign things. You should look at them. And I think you should have a system in place where your books and records are such that they feed into something. So whether for a whole bunch of real estate entities, that feeds into your professional, who then certifies to you that it's all recorded there, and he hands it to you and sort of holds up his hand and says, yeah, all the entity income is there. It all flows through to your Schedule E or whatever it is on your tax return. It's all there, don't worry. And then you glance through and sign. But I think you want to be able to defend yourself in that way so that it's not a matter of your accountant saying, heck, I don't know. All I know is that he gave me a slip of paper that had a number on it that I was supposed to put on his tax return. I didn't see any of the records. I didn't see any of the deposits. I didn't see any of the invoices. That would obviously be a bad fact pattern. And you know, that the IRS could well crack down.

Very interesting.

Okay.

So any other thing in the crime area you want to mention? I want to, I want to ask you about independent contractors. I want to ask you about litigation and damage awards and things like that. Those are sort of interesting areas that are not talked about much.

Yeah. I think the only other point I'll say about tax crimes is that if you. Again, this is a happily, it's a very small number of people a year or small number of people who during their lifetime ever come into contact with the IRS Criminal Investigation Division. But if you are contacted, I mean, I have had clients who invite the IRS in and then proceed to start talking and think that they can talk their way out of it. And, you know, these can be very smart people, but that's usually a mistake. I think any criminal lawyer, whether or not a tax lawyer, will tell you not to do that, not to say anything. Instead, you know, you're not legally required to just simply accept their business card and say, my lawyer will call you. That's the thing to do, not to sit down and try to talk about it. You mentioned independent contractor and litigation, which are two different things. If I could do briefly the litigation area first. So one thing I see a lot of, happily, a lot more than I see criminal tax cases or criminal exposure would be tax treatment of litigation. Sadly, in America today, everyone sues everyone for everything. So there are lots of plaintiffs, there are lots of defendants. And many of your listeners may have been one or the other or both. So whenever a payment is made to resolve those things, in general, the irs, and if it's in California, the franchise tax board get a piece of it. And, and so sort of the goal is, what is it? Who's paying? What is it deductible? If it's the payor? Usually it is. Is it income to the plaintiff? Usually it is. Is the whole amount of income? Is some of it tax free? Is some of it basis recovery? Is it ordinary income? Is it capital gain? Is there withholding? You know, as you can see there. And one huge issue is if it's a contingent fee lawyer, is the plaintiff taxable on all of it or just the net amount. And so there are lots of issues that need to be sorted out long before tax return time.

Very interesting. So generally speaking, though, if a lawsuit is settled or won and you get money, is that taxable?

Generally, yes. I mean, of course, the IRS position is everything is income, I mean, unless there's a split exclusion. So, yes, the presumptive treatment is any lawsuit recovery is income.

Okay.

All right.

And then you can have expenses against.

It, obviously expenses against it. And I mean, really, the only big exception to the normal rule that it's all income would be for personal physical injuries. So if you step outside of your office and get in a car accident and are injured, and then you get money for the injury from the other driver or from your or the other insurance company, in general, that shouldn't be taxable. It should be tax free, assuming that you were injured. There is a lot of dispute. And that applies only to compensatory damages, not to punitive damages and not to interest. So most cases settle. So most people are able to exclude a recovery like that. However, a lot of it depends on how you do it and whether the documentation is due. Done. Right. As you can imagine, since it's tax time now, when we're recording this, if you got a 1099 in the mail that says you got your lawsuit settlement, you are going to have to put it on your tax return, and you may have to pay tax on it. So you want to try to handicap these issues so that if you do have a good argument for a favorable tax treatment that, you know, your documents are consistent with that.

We live in a world of, you know, some people have called it independent contractor Nation or Freelancer Nation. You know, it's so amazing how this has changed from a few decades ago. Everybody's freelancing, whether they're driving for Uber or, you know, I mean, yeah, just. Or doing little side work on the Internet in various different platforms and so forth. What do people need to know about hiring people?

Gosh, huge question. Yeah, and you're absolutely right. I mean, it's a burgeoning area and, you know, getting more complex. I think so. I mean, it's been around for many decades, generations, really. The independent contractor versus employee question. I think many people think of it as a tax question, which I guess is how I think of it first and foremost. So if you're in business, any of us in business, if we have employees, we are, of course, required to withhold payroll taxes and income taxes and send the money directly to the State and federal government and the employee gets a net check. The employee gets a W2 form at the end of the year showing how much pay they made, how much tax was put in, and so on. So that's the system. And of course if you follow up as an employer on your payroll obligations, the IRS is extra unforgiving because some of that money is trust fund money that was really withheld from the employee, supposed to be paid over. So it's more serious in a way than income tax violations when you screw up on payroll taxes. So maybe because of that, many people like to say, wait a minute, why don't I not hire an employee and rather hire an independent contractor? The independent contractor, I'm going to pay a gross check, he or she takes care of their own taxes and I'm better off. I don't have all the employment liabilities. Discrimination laws, wrongful termination laws, break minimum wage issues, whatever it is. Can you avoid it that way? And the general answer is you can avoid it only if it's real and only if the treatment is justified. So you see very frequently these days lawsuits and I think Uber has them and Lyft has had them. And many of these other companies, you know, using freelancers, using independent contractors also are facing them lawsuits about characterization of the workers. Are they really and truly independent contractors or not? I mean the law is very clear that even if there is a written agreement that says, I rob wood, agree, I'm an independent contractor and I'm not an employee and I won't claim any employment rights, believe it or not, the law is very clear, I can still sue.

Yeah, well, we live in a world where people aren't allowed to classify themselves. The government has to interfere with every transaction nowadays. So.

Yeah, no, I know. And I mean it does seem a little bizarre. I mean many employers, I mean, I've had many clients who say, I mean, they can't believe it, you know, how is this agreement not binding? And I think it may be easier to.

I don't make the rules, but it may be easier to see by looking at the tax obligations because the federal government and the state say they get a lot more money out of the person being an employee. But even something like tort liability.

Accident, there have been cases with many of these driving services like Uber where somebody is injured or killed or there's an intentional act.

If an employee is doing something bad in the course and scope of the employment relationship, the company is liable in addition to the employee. That's hundreds of year old law from England and it applies here in all 50 states. It's the liability that the employee, that the employer has for the acts of the employee. So a lot of these suits are not about taxes, not about the worker trying to sue to recharacterize, but rather about third parties that you know, that we ought to try to protect. So as we, I think have just agreed and it's a huge area and it's a, it's a really big problem and there isn't an easy answer.

I think one. Well, I want to hear what you're going to say, but I think one thing that could really help this is to use a third party platform, a website like Upwork or TaskRabbit, you know, any of these handyman websites or whatever. You know, a lot of those will really put you like at arm's length, won't they?

I mean they do and they certainly help. I don't think it's a panacea, but they certainly help. Absolutely. You are more insulated if you are, you know, the putative employer. You're the person paying for the service. And I think, I mean, it's important too to sort of look at, to be realistic. It's one thing if you are paying, either directly or through one of these services, someone to come to your house and work for you eight hours a day, five days a week. And you do that for years on end. My guess is that it wouldn't be that difficult for someone to come along, either the worker or some third party and say, hey, wait a minute, who's kidding who? This really is for full time employment. I don't care what you call it. I think that's very different from a circumstance where You've had a 30 year relationship with the guy who comes and trims your trees and he does it once a year, once a year for a day. And you pay him as an independent contractor. Yes, that goes on for a generation. But it's not employment and it never can be called employment. And if the person gets injured or hurt somebody when he's cutting down a tree, that probably isn't going to be your responsibility. You know, in the same way that the guy working in your house five days a week, you know, 40 hours a week is, is going to be.

Yeah, very interesting. Anything else you want people to know about? Well, any of these areas or another area just before you go, as we wrap up here, you know, maybe something I haven't asked you about that's important.

Sure. I would just say on all of these things, I mean it can be kind of dizzying. And on the independent contractor one, I think you can't worry about everything. And so I think it's very different for someone who is occasionally using TaskRabbit or something like that, or occasionally using Uber. I don't think you need to worry about most of these issues. However, what about someone who has a business who has 20 workers who are independent contractor delivery people? That, it seems to me, merits review and it's worth either educating yourself or hiring somebody to figure out what they are and what they should be and what you can do. And one big danger I think that people in business do not sometimes see is having people in multiple categories doing the same thing. So if I was to modify the example I just gave you and said, 20 delivery people who are independent contractors, what if it turns out there are 10 other delivery people that do the same thing, but that are employees? That's a real bad one. And it's very likely that those 20 people who are delivery people classed as independent contractors could and maybe will be re characterized either by the irs, by plaintiffs, in other cases by the state. There's all sorts of different people that can come after you and that sort of. So it can be, if you're in business, it can be scary.

I remember a friend of mine, a very successful friend, owned and still owns a very large mortgage company and he had about 500 contractors. These were loan officers and the Socialist Republic of California, which is where I'm from and where you're based, I like to call them that because it's so accurate. The Socialist Republic of California cracked down on him and said, you know, we're gonna fine you and you have to pay all these back taxes plus penalties and all this kind of stuff. And he says, well, I'm just gonna lay off 500 people and leave the state.

And so they did compromise and work with him and I think they reclassified a bunch of people and, you know, did sort of a moving forward deal. But boy, it is scary. I mean, it's hazardous to employ people. The government, really. I, you know, in all my years in California, I was convinced that the state did not want me to actually employ anybody or create any jobs.

Yeah.

Because they made it really difficult. You know, I mean, I mean, there are federal issues too, but the state of California is. Oh, that's a tough one. Yeah.

Listen, I don't disagree. And we, as a Californian, I also find it, I mean, it's, it's a difficult regulatory environment, but you're also right. So sometimes Even if the numbers are huge, it's not an uncommon settlement to get what it sounds like your friend may have gotten kind of a prospective deal.

But I'll tell you something.

Yeah.

Let me just interrupt with one thing. I'll bet you he would have never gotten that deal if he employed 10 contractors.

No. Yeah.

It's a too big to fail kind of concept.

Yeah. Yeah. They're unfortunately, and we're not going to talk about it today, but you mentioned moving out of California. Another thing that I see very frequently as a tax lawyer is people moving out of California and people who are about to, you know, and then fill in the blank, about to win a big lawsuit, about to collect on their because their company's going public, about to get a big slug of income, you know, they therefore say they want to, you know, to move to Incline Village tonight. And you know, does that work? And the answer is yes, provided that they do it correctly.

Yeah.

Right.

Right. Very interesting. Well, interesting stuff, Rob. I think people definitely need to people the government and people need to understand that they can venue shop and they can shop and vote with their feet and move to lower tax environments. That's what I did by moving to Arizona. But you know, I'd love to live in an income tax free, free state like Florida or Nevada or one of those someday or Texas maybe. People vote with their feet, so that's no concern.

They do indeed.

Yeah. Give out your website and tell people where they can find out more about your firm and maybe your books too.

Sure. Yeah. The best place to look would be at www.woodllp.com. there are eight tax lawyers, myself and seven others. And there are lots of publications, their books and articles. There's a search window I think on the articles or publications page so you can type in a topic and you'll likely find a tax article there about it.

Excellent. Good stuff. Robert Wood, thank you so much for joining us today.

Thanks for having me.

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