Q: I filed bankruptcy last year, how does that affect my tax return?

A: The type of bankruptcy filed may have an affect on how you file your tax return.  In a chapter 7 or 11 case, the bankruptcy estate is treated as a separate taxable entity from the debtor (a debtor is the individual or entity that filed for bankruptcy).  This creates two separate taxable interests, the bankruptcy estate and the debtor.

The estate is usually assigned a trustee, or sometimes the debtor is allowed to remain in possession.  The trustee or the debtor-in-possession is responsible for preparing and filing the estate’s tax returns and paying its taxes.  While the cancelation of debt is not included as income, the estate must reduce certain losses, credits and the basis in property by the amount of canceled debt.

The debtor remains responsible for paying his or her own returns and paying taxes on income that does not belong to the estate.  If the debtor is an individual, the income, deductions or credits that belong to the bankruptcy estate are not to be included on the debtor’s individual income tax return.

These are only a few of the many issues that may arise from filing bankruptcy.  Ultimately, filing taxes for either an estate in bankruptcy, or an individual or entity that has filed bankruptcy may be complicated.

Q: I got divorced last year, how does that affect my tax return?

A: Division of community property in connection with a divorce or property settlement does not result in gain or loss for tax purposes.  For the part of the year before the marital community ends, each spouse is taxed on half of the community income (the income from both husband and wife).  Any income received after the marital community ends is separate income and is taxed to the person that earned it.  Since the amount of tax liability is dependent upon when the marital community is legally deemed to have ended, this must be determined before filing income taxes and may have a substantial effect on your income tax liability.  A final decree of divorce ends the marital community absolutely, but in some cases it may end earlier if “legal separation” occurs.

Q: My spouse died last year, how does that affect our tax return?

A: The personal representative of the estate of the decedent is responsible for filing any income tax return and the estate tax return when due.  The surviving spouse may file a joint return for the taxable year in which the death occurred, and if the death occurred before the date that the decedent’s return for the immediately preceding year was due, for the taxable year immediately before the year of death.  It must be signed by the personal representative of the estate if one has been appointed.  If no personal representative has been appointed, the surviving spouse should sign the return and write in the signature area “Filing as surviving spouse.”  If the decedent is owed a refund, it may be necessary to file another tax form in order to collect it.

Q: I am about to sell my business, should I sell the ownership interest in the business or the assets?

A: Generally, in the sale of a business by assets, the sale of each asset is treated as being sold separately for determining the treatment of gain or loss.  Additionally, there are many different classifications of assets, such as, capital assets, depreciable property used in the business, real property used in the business, and property held for sale to customers.  Each of these types of assets are treated differently under the Internal Revenue Code.

Selling the interest in either a partnership or corporation, may be treated as a capital gain or loss to the individual owning the interest.

Either of these transactions have personal and business tax liability implications.  The decision should be based upon what the ultimate goal of the sale of the business is and the specific circumstances of the business and the individual(s) selling.

Q: My business lost money last year, how can I carry the loss forward or backward (what tax consequences does this raise)?”

A: A corporation figures its net operating loss (NOL) the same way it figures taxable income: gross income minus deductions.  If this number is negative, or there are more deductions than income, the corporation has an NOL.  However, there a number of rules that apply in computing and carrying-back an NOL.  For instance, in determining NOL, a corporation cannot increase its current year NOL through carry-backs or carryovers from other years.  As a general rule, a corporation must carry an NOL back two years prior to the year the NOL is generated.  If the NOL is not used in the prior two years, the remaining NOL may be carried forward up to twenty years after the tax year in which the NOL was generated.  In addition to the limitations in carrying-back an NOL, there are also many tax forms that must be filed, and records that should be kept in case of audit.

Q: Is an early distribution from a retirement plan taxed?

A: The general rule is if an individual withdraws from his or her qualified retirement plan before reaching the age of 59 ½, those amounts are considered early or premature distributions.  Unless an exception applies, an additional 10% early withdrawal tax is imposed upon an early withdrawal and must be reported to the IRS.  An individual may not have to pay the additional 10% tax if one of the exceptions applies.

Q: How is the gain or loss on the sale or transfer of a capital asset determined?

A: Capital assets are those assets used for personal or investment purposes, including: a home, home furnishings, and stocks or bonds in personal accounts.  When a capital asset is sold, the difference between the basis in the asset (generally, what you bought the asset for) and the amount it sold for, is the capital gain or loss.  If the asset was acquired by gift or inheritance, the basis will need to be determined according to different rules.  Additionally, how long you have owned the property will determine whether you have a short-term or long-term capital gain or loss.  Such a determination has a number of tax implications, for instance, the rate at which the gain is taxed, and the amount of loss that may be deductible will depend upon whether the gain or loss is short term or long term.

Q: What are the tax consequences of the sale of a principle residence?

A: As discussed above, a home is a capital asset and there are particular rules in determining the rate at which gain is taxed, and loss is deducted.  In determining the gain or loss, you must know the selling price, the amount realized, and the adjusted basis.  Selling price is the total amount you receive when selling your home—among other things, this includes any mortgages that are taken over by the buyer.  However, selling price does not include any personal property sold with the home.  Personal property would be anything not considered a fixture; for instance rugs, draperies, furniture, etc.  Amount realized is selling price minus selling expenses.  Selling expenses include: commissions, advertising fees, legal fees, and loan charges paid by the seller.  The basis of your home is determined by how you got the home—cost if purchased on the market, cost to build if built, if inherited may be the fair market value when you received it, or the basis of the previous owner.  This basis is adjusted by different actions a homeowner may take over the ownership period.  For example, if additions and other improvements that have a useful life of more than one year, then the cost of these improvements is added into your original basis.  This is only one example of how basis may be adjusted.  Additionally, it is important to keep diligent records of such improvements, as they will have the effect of potentially decreasing the amount of gain realized for tax purposes.

To determine whether you have a gain or loss, compare the amount realized to the adjusted basis.  A gain is generally taxable, except for any part you may exclude under the Internal Revenue Code.  If the sale is a loss, the amount may not be deducted because of the general prohibition on deductions for personal losses.

Q: What are the rules for deducting home office expenses?

A: You may be able to deduct business expenses related to a business use of part of your home if you meet very specific requirements.  Even if these requirements are met, your deduction may be limited.  There are three different ways a home office may qualify; two of those ways require that the office space be used exclusively and regularly.  Exclusive use means that you must use a specific area of your home only for your trade or business.  This area may be a room or another separately identifiable space.  The space does not need to be partitioned off.  To be considered regular use, it must be used on a regular basis.  Incidental or occasional use will not qualify the space under this test.  There are other elements that must be met before a trade or business deduction is allowed for a home office.  If the exclusive use and regular elements are met, it may be worth discussing the matter with an accountant or tax attorney.

Q: What is forensic accounting?

A: The term forensic is defined as relating to, or dealing with the application of scientific knowledge to legal problems; or suitable for use in courts of law or public debate. Forensic accounting is the process of using specialized accounting knowledge to collect, analyze, and evaluate accounting, financial records, and other evidentiary documents to interpret and communicate findings in a courtroom, mediation, arbitration, boardroom, or other administrative venue.
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Q: What services can an accountant provide in a potential legal matter?

A: An accountant can serve as a consultant or an expert witness in areas of litigation such as bankruptcy, business disputes, fraud, and general civil litigation.
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Q: What is the role of the accountant as consultant?

A: Consultant services can be sought in connection to a legal dispute or for other general business issues. A consultant advises about facts, issues, strategies, and any other matters that may arise in a particular circumstance. Generally in complex legal matters relating to accounting, attorneys consult with an accountant to help in numerous ways, such as: interpreting discovered financial documents, and reconstructing financial records to unearth insolvency or fraud.
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Q: What is the role of the accountant as expert witness?

A: To render an opinion before a trier of fact on issues such as valuation, insolvency, damages and lost profits calculations.
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Q: Why would anyone need an accountant as an expert witness?

A: In resolving legal disputes before a court of law there are many causes of action requiring the testimony of an expert in resolving the legal matter. For instance, in proving insolvency in bankruptcy, many times the testimony of an expert is necessary to resolve the closely related factual issue of valuation. An accountant can render an opinion based on the application of his or her knowledge and expertise in determining the debtor’s valuation.

What are the qualifications an accountant must possess to serve as an expert witness?

In federal court, an expert must meet the qualification standards as set down by the Federal Rules of Evidence and further delineated by the United States Supreme Court in Daubert v. Merrell Dow Pharm., Inc. Generally, the expert’s opinion must be relevant to the legal matter at issue, assist the trier of fact in understanding the evidence or determining the factual issues, and be based upon a reliable method of determining such information.

In state court, qualifying an expert witness may vary depending upon state. The Texas Supreme Court has adopted the reliability and relevancy requirements for determining the admissibility of scientific expert testimony the United State’s Supreme Court applied in the Daubert case. However, instead of adopting the four factors listed in the Daubert case, the Texas Supreme Court supplied a list of six non-exclusive factors:

1. the extent to which the theory has been or can be tested;
2. the extent to which the technique relies upon the subjective interpretation of the expert;
3. whether the theory has been subjected to peer review and/or publication;
4. the technique’s potential rate of error;
5. whether the underlying theory or technique has been generally accepted as valid by the relevant scientific community; and
6. the non-judicial uses that have been made of the theory or technique.

Once a judge determines that the evidence submitted is relevant and reliable, a balancing test must be conducted to determine whether to exclude the evidence because its probative value is outweighed by a number of concerns including unfair prejudice, confusion of the issues, or misleading the jury.

Outside of scientific expert testimony and the application of the above factors, the requirements of reliability and relevance must still be satisfied before any expert is permitted to testify. The Texas Supreme Court has held that the test in such cases is whether “there is simply too great an analytical gap between the data and the opinion proffered.” The main focus of the court is whether the analysis used by the expert to reach his or her conclusions is reliable.
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Q: What is a Ponzi scheme?

A: There is no precise definition of a Ponzi scheme. Courts look for certain patterns and characteristics in determining whether an enterprise should be labeled a Ponzi scheme. Generally, a Ponzi scheme is an inherently fraudulent arrangement where after acquired investment funds must be used to pay off previous investors to forestall disclosure of a fraud. Key factors include: (1) new investors are required to keep the operations afloat; and (2) new monies are used to pay off old investors. In most cases an enterprise is a fraudulent Ponzi scheme from its inception, but even a formerly legitimate business can become a Ponzi scheme at the point where new investors are required to pay off old investors and keep the business in operation. Determining whether an enterprise is a Ponzi scheme or when an enterprise became a Ponzi scheme usually requires detailed investigation and analysis of someone trained in the area of forensic accounting.
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Q: Why is it important to prove a Ponzi scheme in the bankruptcy avoidance context?

A: Having a Court determination that a business is a Ponzi scheme is extremely helpful when it comes to a trustee exercising his avoidance powers. Court’s have found that a Ponzi scheme is insolvent from the date of its inception. Thus placing the burden of proof on the debtor or transferee to prove solvency. The finding of a Ponzi scheme, at least in some circumstances, widens the scope of recovery against a transferee for trustee seeking to avoid transfers from an operating Ponzi scheme.
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Q: What is the definition of “insolvent” in the bankruptcy context?

A: The Bankruptcy Code defines “insolvent” as the “financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at fair valuation …” 11 USC § 101(32)(A). This is a code specific (Bankruptcy Code) definition and may not be consistent with other theories or definitions of insolvency. This definition requires a specific “fair market” valuation of the subject’s property. Historical, book, GAAP, or tax values (the traditional methods of valuation) are not appropriate when attempting to prove insolvency in a bankruptcy context.
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Q: How can a trustee use the UFTA as an avoidance tool?

A: Along with the specific avoidance powers given a trustee in sections 547, 548, and 549 of the Bankruptcy Code, the trustee also has the ability to bring avoidance causes of action based on state and other federal statutory and common law. Section 544(b) of the Bankruptcy Code allows the trustee to succeed to the rights of an unsecured creditor and initiate avoidance actions under the laws that aid an unsecured creditor in avoiding transfers made by a debtor. The most common tool employed by a trust under this section is the state’s Uniform Fraudulent Transfer Act (UFTA).”  This usually extends a trustee’s look back period from two years to four years.
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Q: What is the correct date to use when measuring transfers for purposes of Chapter 5 avoidance actions?

A: In bankruptcy, a trustee is empowered to avoid, or reclaim for the benefit of the estate, certain transfers of Debtor’s property that occurred within certain statutory time frames. Therefore, it becomes very important to understand and calculate correctly the transfers that fall within the timeframe of the trustee’s avoidance powers. Particularly vexing may be the determination of the time of transfer for checks and other transfers from independent third party holders. Courts have determined that the transfer date for items such as checks, wire transfers, etc. is the date the transaction cleared the bank or brokerage house, not the date the debtor wrote the check, deposited the check in the mail, manually delivered the check to the transferee or requested the transfer. Understanding the actual date of transfer is an invaluable tool in prosecuting avoidance actions.
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