Taxable Talk

New Hampshire's budget was signed into law earlier this week, and it gives gamblers a reason to frown. Included in the budget is a 10% tax on gambling winnings.

This article on the tax states,

As written, he [Rick Newman, a lobbyist for The Lodge at Belmont, a horse racing track] said the tax is imposed on winnings that are subject to Internal Revenue Service withholding and that "the triggering amount" in most cases is $5,000.

"However, under Federal law it can be as low as $600 in the case of a winner who does not provide a tax identification number. If someone wins $4,999.00 and provides a tax identification number they would not be subject to IRS withholding and therefore would not be subject to the NH tax. However if someone were to win that same $4,999.00 and did not provide a tax identification number that person would become subject to IRS withholding and because of that would be subject to the NH tax."

An attorney, who is from New Hampshire, wrote on the Poker Players Alliance forum that the new tax applies only to gambling income subject to reporting on a Form W-2G.

There are three problems with this analysis. First, New Hampshire might attempt to assess the tax on the net income of a professional gambler (arguing a different interpretation of the law) or on the gross income of an amateur gambler. Second, what about income that, if earned in the United States would be subject to reporting on a W-2G but because it's earned online is not? Joe Taxpayer wins an online poker tournament for $22,000. If he had won it in a brick and mortar casino, he'd receive a W-2G. However, he won it online so he doesn't. New Hampshire could impose a 10% tax on Mr. Taxpayer. It's unclear whether the law applies or not. Fighting the government is expensive and it's easier to avoid the fight than to have the fight.

Finally, there's a slippery slope to deal with. New Hampshire now has this tax. While it's projected to bring in $13 million or so, it won't. Taxes never bring in what they're projected to because people modify their behavior to avoid the tax. When (not if) this occurs, what's to stop New Hampshire legislators from changing the definition so that all gambling income is explicitly taxable?

My advice to New Hampshire gamblers is simple. It's time to consider relocating.

The Flash Report is stating that Governor Schwarzenegger this morning vetoed the unconstitutional tax increases passed by the Democrats two days ago. The Governator had vowed to veto any tax increases, stating that California must live within its means. Perhaps the Democratic leaders in California's legislature now will understand the message. I think the odds are slim, and I expect this budget fiasco to last through the summer.

Two tax bloggers who I respect, Robert Flach (The Wandering Tax Pro) and Peter Pappas (The Tax Lawyer's Blog) have been debating Peter's 5 Slam Dunk IRS Audit Red Flags. Robert responded, Peter replied, and Robert made his rebuttal. All of these posts are worth reading.

I have some thoughts about audit red flags. It's a subject I hear about annually at the CSEA SuperSeminar; each year I take a class taught by Robert McKenzie and this issue always comes up.

Here is Peter's list of red flags:

* Home Office Deduction
* Job Expenses
* Rental Losses
* Schedule C Expenses
* Charitable Contributions

My feelings about deductions are simple: If you are entitled to a deduction, you should take the deduction. Notice that I said entitled. I think that Peter and Robert would agree that there's been plenty of abuse of certain deductions. All of these deductions (along with education deductions/credits) are popular among unscrupulous preparers.

That said, only one of these to me is directly a large red flag: Schedule C. The statistics I saw at the CSEA SuperSeminar show that returns with Schedule C's are far more likely to be audited than returns without one. Of course, as Robert noted there's an obvious corollary: Returns with Schedule C's have far more income (generally) than returns without them. The IRS is a collection agency. Assume Joe Salaryman has income of $30,000 and cheats on his taxes by 10% while Sam Businessman has income of $300,000 and also cheats on his taxes by 10%. Clearly, the IRS would get more bang from the buck by auditing Sam than Joe. Not surprisingly, taxpayers with Schedule C's and income in the mid-six figure range have a higher likelihood than others of being audited.

Peter also lists five things you can do to alleviate "red flag status:"

1. Timely file your return;
2. Use a recognized software program to prepare and print your return;
3. File the return electronically;
4. Have a respectable CPA, tax lawyer or IRS Enrolled Agent sign your return as tax preparer; and
5. Attach explanatory statements to your return where necessary.

I absolutely agree with Peter's items 1 and 5. If you untimely file your return it will be subject to scrutiny, and that can (but does not always) lead to an audit. Item 5 is obvious. Unfortunately, explanations are not always visible to the IRS until after a return is selected for audit. Still, in a correspondence audit if you can tell the IRS, "Look at this explanatory statement that was included with the return," it's probable that the audit can be a short-lived one.

Items 2 and 3 are related. I have been told that the process for a printed return (this would include those that are manually done) is that they are transcribed by clerk-typists and then follow exactly the same path as electronically filed returns. I agree with Peter that a messy, hand-written return is more likely to be audited. But I think that's more because the numbers might not be clear to the typist. That's also one of the reasons I like electronic filing; I trust my ability more than a clerk-typist's. I think that there's a slight advantage for electronic filing versus paper filing for audits, but that's mainly because of the possibility of transcription errors by the clerk-typist.

I somewhat agree with Peter's item #4. But I think a better way of stating it would be, Don't have your return signed by an unscrupulous CPA, EA, tax attorney, or other tax preparer. The IRS conducts audits of returns prepared by individuals they think are unscrupulous. For example, in the Western Tax Service case, the IRS audited one return prepared by Western, found what looked like gross preparer fraud, selected several others and found that it was indeed systemic tax fraud by a preparer.

There's one last point I'd like to make on this debate. Peter suggests that individuals either incorporate or form an LLC. If a sole proprietor forms an LLC, that LLC is generally a disregarded entity for tax purposes and files a Schedule C unless they choose to be taxed as a C Corporation or an S Corporation. Be advised also that the ability to form an LLC varies by state, and some states are restrictive of what businesses can form LLCs.

I've enjoyed reading both sides of this debate. I think that everyone who does so, no matter which side you take, will come out a winner.

The reporting of Foreign Bank and Financial Accounts—the FBAR reporting on Form TD F 90-22.1—is impacting more individuals than in the past. More people have foreign financial accounts, and online gambling accounts are now considered foreign financial accounts. As Joe Kristan pointed out yesterday, the IRS has granted an extension to individuals who need to file this form.

That said, it's not that simple to take advantage of this extension. You will have needed to have already filed and paid your 2008 taxes. You must attach an explanation to the TD F 90-22.1 that you file with the Detroit computing center. The IRS notes:

Taxpayers who reported and paid tax on all their 2008 taxable income but only recently learned of their FBAR filing obligation and have insufficient time to gather the necessary information to complete the FBAR, should file the delinquent FBAR report according to the instructions and attach a statement explaining why the report is filed late.

Send a copy of the delinquent FBAR, together with a copy of the 2008 tax return, by September 23, 2009, to the Philadelphia Offshore Identification Unit, at the following address:

Internal Revenue Service
11501 Roosevelt Blvd.
South Bldg., Room 2002
Philadelphia, PA 19154
Attn: Charlie Judge, Offshore Unit, DP S-611

In this situation, the IRS will not impose a penalty for the failure to file the FBAR.

Additionally, if all 2008 taxable income with respect to a foreign financial account is timely reported and a United States person only recently learned they have a 2008 FBAR obligation and there is insufficient time to gather the necessary information to complete the FBAR, the United States person may follow the procedures set forth above and no penalty will be imposed.

For 2008 tax returns due after September 23, 2009, the tax return does not need to accompany the 2008 FBAR.

Why September 23rd? That's the deadline for the current IRS "amnesty" on foreign financial accounts. In previous years just submitting the FBAR late and attaching an explanation sufficed. This year, the IRS is getting tougher on delinquent FBAR filers.

There's a warning that's definitely implied in the IRS notice. If you don't file a FBAR by September 23rd and you should have, it's possible the IRS won't be willing to waive the penalties. The penalties are severe. For willful failure to file, the penalty is the greater of $100,000 or half the balance in the account.

If you can, file the FBAR today. If you can't, file it when you can (but on or before September 23rd) and remember to follow the procedure detailed above. And do spend the $5.10 on mailing it using certified mail, return receipt requested.

Last night, Democrats in the California Assembly passed billions of new taxes on a party-line vote. There's just one problem: Tax increases require a two-thirds vote. If these increases are signed into law, they'd be challenged—almost certainly successfully—and we'd be back at square one.

In reality, that's not going to happen. Governor Schwarzenegger announced that he will be vetoing the bills (if they reach his desk), noting:

I will veto any majority vote tax increase bill that punishes taxpayers for Sacramento's failure to live within its means. The Legislature will have a difficult time explaining to Californians why they are running floor drills the day before our budget deadline. We do not have time for any more floor drills or partial solutions. It's time for the Legislature to send me a budget that solves our entire deficit without raising taxes.

Will the Democrats in the legislature actually listen? Today is the last day for the budget situation to be resolved before the fiscal year begins. My guess is that tomorrow will dawn without a solution.

Last night, Assembylwoman Audra Strickland (R-Thousand Oaks) gave this two minute talk on the priorities of the Democrats (Hat tip, Flash Report).

When President Obama was elected, I noted that everyone should watch their wallets and that tax increases would be on the horizon. Sure, President Obama said that there would be no middle class tax increase. Unfortunately, it appears that every Obama promise comes with an expiration date and this one is no exception.

Senior White House adviser David Axelrod today told George Stephanopoulos that President Obama would not rule out a middle class tax increase as part of a package to pay for health care reform.

I am beginning to wonder if the Democrats' solution to all problems is to increase taxes.

I'm enjoying the scenery in Las Vegas tonight. I just witnessed a beautiful sunset, with the sun peering out from beneath a high cloud from the mountains on the western edge of the Las Vegas valley.

There's no joy right now in Sacramento, though. Democrats and Republicans remain divided—probably hopelessly so—and are nowhere near a resolution in the $24 billion budget debacle. Governor Schwarzenegger is threatening to impose a third day each month of mandatory furloughs for government employees if a budget resolution isn't reached by Wednesday. I return to my office on Wednesday; I'll be shocked if there's a resolution anytime in July.

Meanwhile, IOUs will start to be issued by California on Thursday. Thankfully, I don't do any business with the state. Unfortunately, some of my clients will be receiving tax refunds and they'll instead get pieces of paper.

Democrats still want to increase taxes. Republicans won't. Republicans want major budget cuts. Democrats won't. Both sides must agree, and that just isn't in the immediate future. My bet is on September.

President Obama signed the Clunker Voucher program into law. This program will give automobile dealerships that register for it the ability to give out $3500 or $4500 vouchers to individuals for use when they buy a new vehicle that has better fuel efficiency than the vehicle they're getting rid of.

Spidell is reporting that they believe that the vouchers will be taxable as income under California law unless the legislature decides to conform to federal law. (Under the bill that President Obama signed, the vouchers are not taxable.) The chance of California complying given the current budget fiasco is essentially nil.

On Wednesday the California legislature rejected a proposed budget with $11 billion of cuts. California faces a $24 billion deficit.

Democrats say they won't vote for a budget which "cuts the safety net." Republicans won't vote for a budget with tax increases. A budget requires a 2/3 vote; a few Republicans must vote for it. Governor Schwarzenegger has said he won't sign a budget with any tax increases.

Welcome to the unstoppable force meeting the immovable object.

The people of California spoke in May: No more tax increases, no more gimmicks, just give us a budget which lives within our means. California's controller has said that IOUs will be issued beginning next week unless a compromise is reached. I don't think one will come quickly.

If you have a foreign financial account, or have signature authority over such an account, you must file Form TD F 90-22.1. That form is due on June 30th. Unlike every other IRS deadline, this one is a receipt deadline. That means you should put your TD F 90-22.1 in the mail today.

Who needs to file? If you take the sum of the maximum balance of your foreign account(s) and it adds up to $10,000 or more, you must file. Foreign accounts include the obvious (bank accounts, credit cards, etc.) and some less obvious accounts such as online gambling accounts. If you're an accounts payable clerk and you sign the checks for a corporate foreign bank account, you must file the form.

The penalties are extremely steep for not filing. Non-willful violations start at $10,000; willful violations are the greater of half the balance in the account or $100,000. You can also go to ClubFed for this.

And don't forget to spend $5.10 at the post office to mail the form using certified mail, return receipt requested. It's your proof of timely filing.

Earlier today I posted my mixed opinion on regulating tax professionals. Joe Kristan has noted there are plenty of laws already on the books that tax preparers must comply with.

But the Bozos are out there. Take Georgia Gaines of Lake Worth, Florida. A helpful soul, Ms. Gaines' clients were aided by over $1.1 million of invented deductions. All was well until the IRS found out.

Unfortunately, the IRS also looked at Ms. Gaines' own returns. Somehow, $200,000 of income from her 2002-2005 tax preparation work didn't appear on the return.

Ms. Gaines has now pleaded guilty to five counts of preparing false tax returns and five counts of filing her own false tax returns. Ms. Gaines will be sentenced in August and will have to make restitution and is also likely to find herself at ClubFed for just under three years (based on federal sentencing guidelines).

Liberty Tax Service is America's third largest tax preparation chain. Back in 2007, Liberty advertised that they could have your refund to you in one day.

Sounds great, but there's a problem with that: You can't get refunds that fast. It was really an advertisement for refund anticipation loans (RALs). Those loans have usurious interest rates (they can be as high as 375%). California's Attorney General, Jerry Brown, sued Liberty over the ads.

The result of the lawsuit was announced this week. Liberty lost, and must make restitution of $136,000 and must pay fines of over $1 million.

I'm very much against RALs. I don't believe they serve any purpose other than enriching the pockets of those offering them. Hopefully we'll see fewer RALs being offered in the future.

A debate is heating up among tax bloggers on whether or not tax preparers should be regulated. Some bloggers, such as Peter Pappas, think they should be. Others, including Joe Kristan, think they shouldn't be.

I happen to practice in California, a state where all tax preparers are required to be licensed. It hasn't done anything to improve the quality of work. After all, Western Tax Service was located in California. All California preparers must be either EAs, CPAs, attorneys, or registered with the California Tax Education Council (CTEC)

On the other hand, my professional society, the National Association of Enrolled Agents (NAEA) is very much in support of the idea of all preparers being regulated. Perhaps it might be because that would increase the number of Enrolled Agents. Or perhaps I'm just a bit too cynical about it.

In any case, I'll wait to see the actual proposal (if and when it's released by the IRS) before I come out one way or the other. My inclination, though, is that it will just add another bureaucracy with little positive results for taxpayers.

It appears likely, but not certain, that New Hampshire will soon have a 10% tax on gambling winnings. The state legislature tentatively approved a new budget that contains the tax. It still must be approved by each house of the legislature and signed into law by the governor.

The tax itself is one of the worst for gamblers. It is a 10% tax on gross receipts, with no deductions allowed. It would impact both professional and amateur gamblers, and would make New Hampshire the worst location for gamblers to reside in the United States.

Key votes in the legislature will occur this week. I'll keep you advised as I find out more information.

See no evil, hear no evil, speak no evil is how one cliche goes. Well, in Sacramento it can be changed to don't cut programs, increase taxes, and who cares what the voters, the Governor, or the Republicans say.

Democrats in the state legislature have refused to implement the Governor's plans to cut state workers salaries, and are proposing tax increases. Republicans in the legislature will not support tax increases. And Governor Schwarzenegger said, "I will, without any doubt, veto it. I'm very, very much against any tax increase whatsoever."

And the Democrats' budget is more of the usual accounting gimicks according to this article in the San Jose Mercury.

In any case, this budget—which Democrats in the legislature vow to bring to a vote next week—won't become law. Sometime in late June we'll find out if Democrats have discovered the fiscal and political reality or if California's fiscal troubles will turn into the usual political stalemate.

The headline says it all. Democrats in the state legislature are telling California voters that it doesn't matter that you turned down the budget initiatives last May, we know better and the solution must include tax increases. That's the only possible meaning of the Democrats' proposal for eliminating the $24 billion deficit.

While the full Democratic proposal hasn't been released, key elements have been. Here are some of the features:

- A 9.9% oil extraction tax;
- An increase in tobacco taxes. Cigarette taxes would increase from $0.87 to $2.37 a pack;
- Reversal of two corporate tax relief measures passed last September to allow passage of the 2008-09 budget; and
- A new $15 additional vehicle license fee tax to fund state parks.

Additionally, Democrats rejected Governor Schwarzenegger's proposed 5% cut in the pay of state workers.

Two quotes from the story in the San Francisco Chronicle tell the full picture. First, Republican Assemblyman Jim Nielsen noted that the proposal was "...the most massive and quickest tax increase ever imposed in the history of California." Given that tax increases require a 2/3 vote for approval, this measure may be d.o.a. However, I suspect Democrats will call the tax increases "user fees" in order to sidestep the measure. No matter, Governor Schwarzenegger has said that he will veto any measure with tax increases.

Meanwhile, Democratic State Senator Alan Lowenthal noted, "I'm really concerned when we put up any taxes as Californians are struggling to pay their mortgage, their rent and to put food on the table. The perception of the Legislature is we can't live within our means. We have to realize we will pay a price for doing this."

Apparently, Democrats believe that the price they'll pay from the voters is less than the price they'll pay from the unions if they pass pay cuts.

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Here's the reality: This proposal will not become law. Sooner or later California will have to learn to live within its means. I suspect we will see yet another budget stalemate, with California running out of money in July. Democrats in the legislature believe that they can print money. Only the federal government can do that. The day of reckoning for California has been postponed many, many times. It's here.

The only solution is massive budget cuts. Governor Schwarzenegger's budget (in general) spends what California will bring in. I suspect it might be late August or September before we see a budget where spending matches revenues.

Today is June 16th. The California budget still hasn't passed.

Of course, this isn't a surprise. Democrats in the Legislature are looking at tax increases. Specifically, an oil extraction tax and an increase in the tobacco tax.

Wait, Russ, wasn't there a measure on an oil extraction tax just a couple of years ago? And didn't it fail?

Sure, but that hasn't stopped Democrats from proposing the same tax increases over and over.

But Russ, hasn't Governor Schwarzenegger vowed to veto any new tax increases? And aren't Republicans united in vowing to not pass any new taxes?

Well, yes. But Democrats figure that Republicans that have been united in the past have seen that united stand falter. Furthermore, the Democrats largest sponsor—organizer labor (unions)—adamantly oppose the current spending cuts.

Given all of this there's no chance of a budget deal in the next few days. My expectation is that California government will screech to a halt sometime in July.

Today (Monday) marks two deadlines. Second quarter estimated payments must be made by today in order to be considered timely. Additionally, taxpayers who were out of the country on April 15th have until today, June 15th, to either file their returns or go on extension without penalty.

The estimated payment deadline is a postmark deadline. As usual, we strongly recommend that you mail your payments using certified mail, return receipt requested. This gives you proof of mailing. Those two extra services will cost you $5.10. If your payment gets lost it will usually cost you far more in interest and/or penalties.

Alternatively, you can pay electronically. You can enroll in EFTPS, the federal government's online system. Unfortunately, it takes two to four weeks to enroll in EFTPS as the passwords are mailed to you. California also offers an online payment system; no enrollment is necessary. Many other states offer such systems; you can check with their websites to see if your state offers such a system.

The California budget fiasco continues. In theory, the state must have a new budget in place by June 15th—tomorrow—in order for short-term loans to be taken out in July.

There's no chance of that.

It's not that Democrats and Republicans disagree on there being a major problem. There's no doubt that California faces a $24 billion budget deficit (and growing). Unfortunately, that's about all they agree on.

Democrats still hope to be able to pass legislation that increases revenues, probably through "user fees." There's a danger here, though; courts have struck down "user fees" that were disguised taxes.

Republicans vow to block all new taxes. It does appear that California voters don't want any more taxes. The last time that California faced a budget fiasco (February) new taxes were passed. Californians were told that the budget that passed resolved everything through the end of the 2009-2010 fiscal year (June 2010). That wasn't true.

Amazingly, only Governor Schwarzenegger has proposed a budget. His budget has cuts everywhere. That's what needs to happen. The bureaucracy needs to be cut. Regulations need to be rolled back. The state needs to open negotiations with unions and force changes in pension plans to defined contribution from defined benefit. The pain must be shared.

Taxpayers are sharing in it. We've seen sales taxes increased by 1%, and state income taxes increased by 0.25%. Will our legislature actually take action by June 15th? No. Can it at least take action by June 30th?

We'll see, but I wouldn't bet on it.

Hawaii is a beautiful place. It's hard for me to think of a more beautiful or relaxing place for a vacation.

Residents of the Aloha State aren't likely to be gamblers. Hawaii prohibits all forms of gambling. Of course, if a Hawaiian makes a trip to Las Vegas and has some winnings, those are still taxable on their Hawaiian income tax return.

Hawaii's state legislature is among the most liberal in the country. Today's liberalism means high taxes and nannyism. Earlier this year Hawaii's legislature passed an increase in the marginal income tax rate to 11% on individuals earning more than $200,000. That legislation was promptly vetoed by Republican Governor Linda Lingle and just as promptly the veto was overridden by the Hawaiian legislature.

What I hadn't heard about until today was House Bill 1495. This bill would make gambling losses ineligible for tax deductions. This bill easily passed the state legislature; Governor Lingle has until July 15th to either sign the bill or veto it.

If you're a Hawaiian resident I urge you to contact the governor's office and let them know your feelings about this measure. If you're an amateur gambler and this legislation becomes law, you will face a very taxing situation.