IRS To New York, New Jersey, and California: We Weren’t Kidding

June 11th, 2019

Today the IRS issued rules and guidance on charitable contributions as a workaround to the new limits on state and local taxes. Unsurprisingly, the IRS said exactly what I thought they would: both substance over form and quid pro quo apply.

There’s a fundamental rule in tax: The substance of a transaction determines how it’s taxed, not what it’s labeled. Suppose I pay you to perform services for me, but I send you a Form 1099-INT (for interest income). What I pay you is service income, not interest income, no matter how it’s labeled. Consider state taxes. Suppose a state (say, New York) offers you the ability to contribute to the “Support New York Fund” instead of state taxes. Well, the substance is that you’re paying state taxes by contributing to that fund.

Another issue is “quid pro quo;” that’s Latin for ‘something for something.’ And if you get something for a charitable contribution, that portion isn’t charity. Consider a donation to some foundation for $50 and you receive a blanket worth $10; your charitable contribution (that you can take) is $40. This rule has been around for some time. It applies to these workarounds, too.

Put bluntly, the IRS isn’t amused with the workarounds. The Tax Code is law; until Congress changes it, federal deductions for state and local taxes are limited.

Arizona vs. California Franchise Tax Board

June 10th, 2019

Legal authorities in the Grand Canyon State are not amused by California’s view that indirect interests in California LLCs mean that the entities are doing business in California. And they’re mad enough to take action, asking leave to sue California in the United States Supreme Court.

The issue involved is not new. California’s Franchise Tax Board believes that indirect ownership of an entity doing business in California, or even indirect ownership of an entity that indirectly owns another entity that does business in California, is enough to make all such entities be considered to do business in California. Arizona calls this an “illegal scheme” and wants it to end. The only way is to ask the Supreme Court for permission to take the case; Arizona filed the request in February. California objects to the characterization and states that impacted business owners have ways of fighting the $800 charge.

The problem is that the charge is $800, and the cost to fight is in the thousands of dollars, so few do. There are cases (such as Swart) where business owners fight back, but they take years, are expensive, and require extraordinary deep pockets. Arizona estimates the damage to Arizona business at $10.6 million a year.

Disputes between the states are subject to judicial review by the Supreme Court; however, the Supreme Court must agree to take the case. The Supreme Court is scheduled to decide whether or not to review this in the coming weeks. If the Supreme Court takes the case, it would likely be heard next winter.

IRS No Longer Redacting Information on Wage & Income Transcripts

May 31st, 2019

Yesterday I went on e-Services and downloaded a Wage & Income Transcript for a client. I was surprised to see that the payor information was no longer redacted. There was the payor’s name in full (along with the address and EIN).

Congratulations to the IRS on reversing their short-sighted policy of redacting this information. In order to access e-Services, I have to already have:

– Registered with the IRS;
– Setup two-party authentication with the IRS; and
– Used two-party authentication to access e-Services.

Yes, it’s theoretically possible for someone to break into somebody’s office and get into e-Services. But they’d also have to obtain the two-party authentication device. The odds of both occurring are very, very low.

The previous policy had deleterious impacts on both the IRS and tax professionals. It added workload to the IRS (tax professionals had to call the IRS to obtain unredacted transcripts); it caused delays and extra work for tax professionals. Kudos to the IRS on using some common sense in returning to the status quo ante.

WSOP and Taxes: 2019 Non-Update

May 28th, 2019

The 50th World Series of Poker begins today at the Rio Hotel and Casino here in Las Vegas. Good luck to all those who are participating this year.

Regarding taxes and the WSOP, nothing has changed from 2018. Thus, you can look at this post from last year to see how taxes will impact you.

Last week, I watched an excellent presentation from CNBC on commercial backing of poker tournament players. If you’re considering backing or being backed, I strongly suggest you watch the presentation. If you use one of the two current major commercial companies that back (YouStake and StakeKings), I would make sure you and them are aware of who is responsible for sending out tax paperwork and withholding from winnings if you are lucky enough to cash. As my mother likes to say, an ounce of prevention is a worth a pound of cure.

Derailed

May 17th, 2019

California’s “Train to Nowhere,” the alleged high-speed rail that would link San Francisco and Los Angeles (originally), and, now, the thriving metropolises of Shafter (just north of Bakersfield) and Merced is in deep trouble. Well, it has been in deep trouble since day one of the project but the trouble is now far worse: The US Department of Transportation canceled funding of nearly $929 million. That cancellation stops $929 million of funds from heading to California. Making matters worse, the US is considering asking for $2.5 billion to be returned.

Based on CHSRA’s repeated failure to submit critical required deliverables and its failure to make sufficient progress to complete the Project (as defined in Attachment 2, Section 1 h, of the FY 10 Agreement) hy the close of the performance period, and after careful consideration of the information presented by CHSRA in its March 4, 2019, letters to me and to Ms. Jamie Rennert (CHSRA Response) (included as Ex. C and Ex. D, respectively), FRA has determined that CHSRA has violated the terms of the FY 10 Agreement and has failed to make reasonable progress on the Project.

CHSRA consistently and repeatedly failed in its management and delivery of the Project, and in meeting the terms and conditions of the FY 1O Agreement, all of which constitute violations of the FY lO Agreement. Despite extensive guidance from FRA, CHSRA was unable to prepare and submit fundamental Project delivery documents (e.g., budgets, Funding Contribution Plans (FCPs), and Project Management Plans (PMPs)). CHSRA’s inability to track and report near-term milestones, as described further below, shows that CHSRA is likewise unable to forecast accurately a long-term schedule and costs for the Project. Further, after almost a decade, CHSRA has not demonstrated the ability to complete the Project, let alone to deliver it by the end of 2022, as the FY 10 Agreement requires. As described further below, CHSRA is chronically behind in Project construction activities and has not been able to correct or mitigate its deficiencies. Overall, such critical failures completely undermine FRA’s confidence in CHSRA’s ability to manage the Project effectively. [footnote omitted]

This is what almost every critic of this project has said from day one. The cost has gone from $10 billion to somewhere north of $70 billion (I’ve seen estimates that range from $72 billion to well over $100 billion). The demand for high-speed rail between Bakersfield and Merced isn’t high, so the project is going to have problems breaking even.

California Governor Gavin Newsom said he would fight the decision in court. But for now, I will not be surprised if the California high-speed rail line turns into a brand new bikeway sometime in the future.

Can I Disclose a Candidate’s Tax Returns?

May 12th, 2019

Let’s say that back in 2010 I prepared the federal and California tax returns for John and Mary Smith of Irvine, California. Ten years later, Mr. Smith decides to run for statewide office. Let’s further assume I abhor Mr. Smith’s politics. Can I leak his tax returns to the Los Angeles Times? Can the Times publish the Smiths’ returns?

I, like all tax professionals, fall under the rules of Circular 230. Circular 230 basically states that I can only disclose a client’s returns with his or her permission, and that these rules protect current clients, future clients, and former clients. Federal law has more to state about this: Under 26 U.S.C. § 7213(a)(1) it is illegal for me to disclose to anyone any information about a tax return. Additionally, 26 U.S.C. § 7213(a)(3) states: “It shall be unlawful for any person to whom any return or return information (as defined in section 6103(b)) is disclosed in a manner unauthorized by this title thereafter willfully to print or publish in any manner not provided by law any such return or return information.”

So the answer to the first question I asked is easy: It is very illegal for me to disclose Mr. & Mrs. Smiths’ returns to anyone for any reason whatsoever without the permission of the Smiths.

The answer to the second question is far more difficult. While federal law makes it illegal for anyone receiving illegally disclosed tax return information to publish it, the First Amendment to the Constitution (“Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the government for a redress of grievances.”) likely overrides federal law. I have to use “likely” instead of “certainly” because there hasn’t been a case about this issue that has reached the Supreme Court.

I wrote this brief piece because of the release of information regarding President Trump’s tax returns from 1984-1995. The New York Times published this information and stated they received the information from someone who had legal access to them. It is a certainty that particular individual violated federal law and could be prosecuted. If he’s a licensed CPA or Enrolled Agent, he could lose his license; if he’s a licensed attorney, he could be disbarred. If the Department of Justice discovers the individual responsible for the leak, he or she is very likely to be prosecuted (it’s a slam-dunk case). As for the Department of Justice going after the New York Times, I highly doubt that will happen. The case is anything but a certain winner. I strongly suspect the First Amendment overrides 26 U.S.C § 7213(a)(3).

The 2019 Tax Season (Part 1): A Miserable Year

April 30th, 2019

This is my 19th year as a tax professional. By far, this past Tax Season was the worst of the nineteen I’ve experienced. Why? Well, there were a multitude of reasons.

First, I had a personal issue that impacted my family. For me, that was a top priority, and it caused me to miss about ten days of work since the new year began. I don’t regret that in the least–my family is important to me. Still, the timing was poor (to say the least).

Second, tax reform. My clientele is primarily self-employed individuals. Almost all of them were impacted directly or indirectly by reform. While there are no state tax issues for Nevadans, we specialize in industries rather than a geographic location, so we had to deal with lots of differences for state taxes.

Third, tax software this year was far ‘buggier’ than in prior years. Tax reform was the culprit. Many new forms were not released until 2019, so software companies had no idea how to write their code. And when Tax Season began on the normal date, that meant there was less time to test the software so we (tax professionals) were basically working with beta software.

This was especially true regarding the Section 199A deduction (the Deduction for Qualified Business Income). For simple cases, the deduction is the lesser of 20% of business income or taxable income. For most (but not all) of our clients, we knew what the deduction should be (and the software got the answer correct). However, when taxable income exceeded the income threshold ($315,000 married filing jointly, $157,500 for others), the calculation becomes far more complex. Almost all of these clients are on extension, but we did have a few clients where I had to double-check the software as I felt it was not calculating the deduction correctly. That definitely added time to our workload.

Fourth, tax reform increased the number of clients who qualified for the Child Tax Credit (or the Credit for Other Dependents). These require an interview–and an interview taxes time. It’s only (on average) three minutes a client, but if you add 100 more clients needing this interview, that’s 300 minutes or five hours lost.

Fifth, tax reform implemented due diligence interviews for clients filing as “Head of Household.” That’s a minimal number of our clients; still, that’s probably another hour lost to interviews.

Sixth, explaining returns to clients took far, far longer. The new postcard-sized forms are a joke. With the old Form 1040, arithmetic worked. If line 39 was the sum of lines 37 and 38, you could just see the result. That’s not the case any more. In various places, you have to know that a + b will not equal c, because you have to add in (say) the result of Schedule 3, too.

Seventh, withholding tables were adjusted in 2018. Many taxpayers were expecting their normal refunds got smaller than expected refunds. This was not much of an issue for our client base (again, we deal primarily with self-employed individuals) but it did have some impact. We will check the withholding for any of our clients who wish this done, and we did notify our clients last year of this issue.

Overall, we estimate each return took, on average, ten percent longer than during the 2018 Tax Season. That doesn’t seem like much, but a few minutes here and a few minutes there, and sooner or later you’re talking lots of minutes gone. In speaking with other tax professionals I heard much of the same thing (returns took longer this year than last). I like what I do (yes, there are people who like being tax professionals) and have no plans to change, but this was the first April 15th where I wondered about when I’ll retire. I feel less of that today (fifteen days after April 15th).

There were some light moments this Tax Season. First, it snowed in Las Vegas! Yes, it really did.

Then there was the unnamed individual (not a client) who told me that I was wrong, and professional gamblers can no longer deduct business expenses. He had read our new book and just knew that the tax reform bill changed the law about deducting business expenses. (By the way, a professional gambler can still deduct his business expenses. What changed is that he can no longer take an overall loss based on his business expenses.) When I told him he was wrong, he started arguing with me. I asked him if he was a licensed tax professional, or had some other background in tax. When he said no, I suggested he read the new law or speak to a tax professional. He said that two of his friends knew more about tax than any tax professional. If you’re wondering how bad information spreads, wonder no more.


We have a lot of clients on extension. If you’re one of our clients on extension, do not wait to the last minute this year. Returns are taking longer, and those deadlines are meaningful. We don’t mind you sending your work to us piecemeal; that will mean less has to be done later. I strongly suspect that there will be individuals sending us their returns to start in October whose returns we cannot complete in time.

Bozo Tax Tip #1: We Don’t Need No Stinkin’ Basis

April 12th, 2019

If there’s one issue in tax that tax professionals have trouble explaining to clients it’s basis. Your basis in an entity is, generally, the total of your investment in an entity plus income it generated less any distributions from it. If you’re an investor in a business, you can only take losses up to the amount of your basis. Sounds simple, right?

So let’s say you invest in an S-Corp, “Losing Money, Inc.” Unfortunately, it’s name matches what’s happened year after year. You invested $10,000 years ago, and each year your share of the loss has been $3,000. It’s year four of your ownership, and you get the K-1 showing the (as usual) $3,000 loss. Your tax professional tells you, “I’m sorry, but you’re only getting $1,000 of the $3,000 loss–you used up your basis.”

The IRS has been battling this issue for a number of years. Owners of businesses are supposed to keep basis statements. Most reputable tax professionals prepare basis statements for the partnerships and S-Corporations that they prepare returns for. It remains, though, the responsibility of the owner to keep track of the basis.

Anyway, the IRS has (in audits) seen many owners not have basis and still take losses. The IRS hasn’t had a good method to police this. This year, though, the IRS wised up. There’s an addition to the instructions for page 2 of Schedule E:

If you are claiming a deduction for your share of an aggregate loss, check the box on the appropriate line in Part II, column (e), and attach to your return a computation of the adjusted basis of your corporate stock and of any debt the corporation owes you. For details, see the Shareholder’s Instructions for Schedule K-1 (Form 1120S). [emphasis added]

Of course, some individuals may attach a phony basis statement to get around this issue, but that’s yet another bozo action (that’s committing a felony–lying on your tax return, which is signed under penalty of perjury). Still, it’s likely that the IRS has the right idea and this will lessen the problem. (I expect the IRS to expand basis reporting rules to partnerships in the near future.)

Of course, some individuals may simply ignore attaching the basis statement and play ‘audit roulette.’ That’s something else I can never advise. But if you want to enjoy the Bozo side of life, just keep ignoring your basis and take your loss year after year after year.


That’s the last of our Bozo Tax Tips for the 2019 tax filing season. We’ll be back with normal content, including a rather scathing review of this tax filing season, late next week.

Bozo Tax Tip #2: We Don’t Need No Stinkin’ Employees (Especially Because We’re Lawyers)

April 11th, 2019

A few years ago, I first heard about the law firm that had no employees. Now, I can imagine a small firm of, say, three or four partners, with no clerical staff as a possibility. However, having dealt with enough attorneys there are always secretaries, paralegals, clerks, and junior lawyers because most clients don’t way to pay $400 an hour for typing.

Joe Kristan (who formerly had the Roth CPA tax update blog) wrote about the Donald Cave Law Firm in Baton Rouge, Louisiana. A few years ago the firm found itself in Tax Court claiming that the three associates of the firm weren’t employees because the owner, Mr. Cave, alleged he didn’t have enough control over them. Now, do you really believe that a senior lawyer at any firm would allow junior attorneys to do their own thing? Of course not, and the Tax Court didn’t believe it either.

That wasn’t the end of the story, though. The firm appealed and their fate at the Fifth Circuit was, well, what you would expect.

Finally, with respect to the law clerk, Michael Matthews, the record shows that Donald Cave hired Matthews and exercised complete control over the assignment of Matthews’ work for the Firm. Although Matthews also worked for other lawyers and law firms, providing services to multiple employers does not necessitate treatment as an independent contractor…Matthews was paid a salary by the Cave Law Firm of approximately $1250 every two weeks, which amounts to $30,000 per year, regardless of the amount of work he performed during that time period. Contrary to the Firm’s suggestion, Matthews was not paid a minimal amount for essentially piecework. Instead, he entered into a verbal contract with Donald Cave and the Firm for a fixed sum to provide services at the direction of Cave, and there was no evidence that he could reject any work he did not wish to perform. Furthermore, Matthews could neither increase his profit through his own skill and initiative, nor would he suffer the risk of any losses. Matthews also made no investment in the facilities because the Firm provided him with the amenities needed to complete his work.

Can you really imagine that a clerk at a law firm isn’t an employee? I can’t, and neither could the judges at the Fifth Circuit.

The point of this is to be careful about who you claim are independent contractors. If you give John a research project, and don’t control his activities, and he’s working in another state on his own, that truly sounds like an independent contractor. However, if John’s working in your office, and your supervising his every move, etc., trying to claim he’s an independent contractor when he’s really an employee can lead to a big heartache.

Additionally, some states are far tougher on the independent contractor/employee decision than the IRS. Indeed, my old homestead of California is probably the most difficult state in the country to have independent contractors. California’s Employment Development Department (EDD) has an excellent publication on this issue (EDD Publication 38). There’s even a help line you can call.

So if you really have independent contractors, great. But if you’re a law firm and you really, really think that your secretary and the filing clerk are independent contractors you are committing a Bozo act.

Bozo Tax Tip #3: Only Income Earned Outside the US Is Taxable

April 10th, 2019

A few days ago I was explaining to a client the basics of the US Tax Code: All income is taxable unless Congress exempts it; nothing is deducible unless Congress allows it. That’s the basics.

My office is in Las Vegas, Nevada. I’m a US citizen. So I owe US income tax on my earnings, right? Of course I do. But where few willingly go the Bozo contingent jumps in. Here’s a method of avoiding tax on all your income. It’s been used by celebrities such as Wesley Snipes. So let’s use Section 861 of the Tax Code to avoid tax!

Section 861 states that certain items are always considered as income from within the United States. It does not say that income earned in the US is exempt from tax. But tax protesters claim that’s the case; courts, though, basically state, ‘You must be kidding.’ This argument has never been used successfully. In an audit or in court, if you use the Section 861 argument you have no chance of success.

The US taxes its citizens on their worldwide income. That includes the United States. Indeed, if that weren’t the case I’d be out of a job. Mr. Snipes received three years at ClubFed. In the long-run it’s far, far easier to simply pay your tax.