The Case of the Missing K-1

February 19th, 2020

John and Mary Smith came by my office yesterday. “We normally get to you in June,” Mrs. Smith told me, “but this year we have everything so we’d like to file today.” Well, they had almost everything.

Unfortunately, there was one K-1 from a partnership that they didn’t have. They own about 2% of a rental property; their share of income has been around $100 every year. Mrs. Smith pulled out her cellphone and called her uncle (who is responsible for the K-1) and asked when it’s coming. I could only hear her end of the conversation, but the response of “August” wasn’t what she wanted to hear…especially since the Smiths are getting a $2,000 (or so) refund from the IRS.

“Can’t you just file the return using an approximation for the K-1? After all, we know the income will be about $100 because it always is.” I told them no.

I can’t knowingly sign an incorrect tax return. We don’t have the K-1, and while it has been $100 of income for the last several years (and her uncle estimates $100 for this year) there’s no guarantee it will be. The estimated income is fine for determining what to pay with an extension; however, it’s not acceptable for filing a tax return. This is one of the drawbacks when you participate in a partnership: You must wait for all of your K-1s before filing your taxes. If one of your investments that generates a K-1 takes an extension, you are forced to extend your personal returns.

Tax returns need to report your exact income, not your estimated income. Yes, the Smiths’ estimated and exact incomes should be similar, but “should be” isn’t good enough here.

I did give the Smiths one piece of good news after we filed their extension: When you file a return after April 15th and are getting a refund, the IRS pays you interest. Interest works both ways in tax…but that interest the Smiths will receive is taxable.

The Best Tax Blog Is Back

February 14th, 2020

As a published author I’m biased about my writing ability. But as my mother told me (and, yes, my mother is a published author, too), know your abilities! The best tax blog up until May 2017 was Joe Kristan’s Roth Tax Updates. But in 2017 the firm Joe worked for merged into Eide Bailly; at the time I wrote: “…[P]erhaps there’s an Eide Bailly Tax Updates in the future. (I can always hope.)”

Well, nearly three years later I’m pleased to report there is now an Eide Bailley Tax News & Views Blog. It will be listed momentarily in the blogroll on the right, and it appears to be must-read every morning for those of us in the world of tax.

New York DFS & Gambling: It’s the Constitution

February 12th, 2020

There’s a quick way of doing many things that, in the long-run, doesn’t work so well; there’s a slower way of doing those same things that will always work. That’s true in tax, and it’s true for a legislature that’s trying to raise money.

Back in 2016, the New York state legislature amended a law so that DFS could be legalized. Almost immediately, a lawsuit was filed that said the new law violated the New York Constitution. The New York Supreme Court (which is the original trial court) ruled that the law was unconstitutional (as it relates to DFS). Both sides appealed the ruling, and last Friday a decision from the Appellate Division was released. That decision mostly upheld the original ruling.

The key points within that ruling are (1) that gambling only needs an element of chance and (2) it is not the job of the courts to look at the “…wisdom of the Legislature’s enactment of laws, but on whether the NY Constitution prohibited the Legislature from enacting such laws.”

This ruling is not good news for those who would like to see DFS or online gambling in New York state. It will take amending the New York constitution–and that’s a much harder road to go than simply passing a law. It also takes far more time. But if the constitution is amended, the law would be clearly constitutional (and legal).

I expect this decision to be appealed to the New York Court of Appeals (New York’s highest court), and it’s likely the case will be taken up (there was a dissent, and the case is about a constitutional question–the kind of case that appeals to higher courts). The problem, though, is that the plain language of the state constitution is quite specific about how to add more gambling. And it’s by amending the constitution. While a stay on enforcing this ruling may be granted (allowing DFS contests to continue in New York), unless the New York state constitution is changed the future of DFS (and online gambling) in New York looks quite bleak.

Take the Five Minutes: Reconcile Your Checking Account Each Month

February 11th, 2020

If you’re in business, you’re required to keep books and records. Those books and records need to accurately reflect the income and expenses of your business. Seems simple, right? But as Tax Season is now here something I (and most tax professionals) see from small business owners is that they reconcile their checking accounts once a year rather than each month.

It’s not hard to balance the checkbook. Every month in QuickBooks I do it, and I’ve never seen an error…until this month. An invoice I paid for $50.00 got recorded on the bank statement as $60.00. What’s humorous about it is that my bank provides a picture of the cleared check. Not only was this an electronic payment (that generated a check), it clearly shows “Pay “FIFTY and 00/100.” When I called the bank they apologized and immediately corrected their error.

Mistakes happen, but there’s a more important reason to look at your bank statement. Suppose that you’re not the only person who writes checks from your account. Perhaps someone embezzled funds from you. Twice in the twenty years I’ve been a tax professional I’ve seen this. In the first instance, there were some checks not in the bank register. In the second case, the person doing the embezzling also balanced the checkbook. (Hint: Except for sole owners of businesses, people who can write checks should never balance the checkbook.) One month he was out with the flu and the malefaction was discovered.

There’s a cliche, “garbage in, garbage out.” With financial records, you need your inputs to be accurate. That means you need an accurate bank statement. Take the time to balance your checkbook each month.

You Heard About that May 29th Filing Deadline, Right?

January 8th, 2020

So let’s look at important tax deadlines this year. There’s January 31st (the deadline to mail and file many 1099s and to distribute and file W-2s), March 15th (the deadline to file S-Corporation and partnership tax returns, and Forms 3520-A), April 15th (the deadline to file personal, C-Corporation, trust/estate/fiduciary returns, and FBARs), and May 29th, of course.

What? There’s no tax deadline on Friday, May 29th. That’s technically true, but there is a filing deadline on May 29th : the Benchmark Survey of U.S. Direct Investment Abroad (BE-10).

The BE-10 is due every five years, and five years ago it was quite a surprise to the tax professional community. Adding to the fun last time was that the Bureau of Economic Analysis (the government agency where the Survey is filed) was completely unprepared for the volume of reports. There were major issues with filing, and let’s just say that the experience was not good for everyone who had to deal with this.

So who must file?

All U.S. persons that owned, directly or indirectly, 10% or more of the voting stock of a foreign corporation, or an equivalent interest in an unincorporated foreign business enterprise (e.g. a partnership), at any time during the 2019 fiscal year, are required to file a BE-10 Report.

I’m giving an early heads-up on this, as I suspect few are aware of this required report. There are both possible civil and criminal penalties. If you’re a tax professional and have any clients who are owners of foreign entities, make sure they’re aware of this filing. The BEA webpage on the BE-10 isn’t fully ready (for example, the link to getting on their mailing list for updates is not working), but any tax professional who deals with this should bookmark this page and discuss this with your clients. And if you happen to be the owner of a foreign entity, make sure you’re aware of the May 29th deadline.

It’s Time to Start Your 2020 Mileage Log

January 7th, 2020

I’m going to start the new year with a couple reposts of essential information. Yes, you do need to keep a mileage log:

Last Thursday was the first business day of the new year for many. You may have resolved to keep good records this year (at least, we hope you have). Start with keeping an accurate, contemporaneous written mileage log (or use a smart phone app–with periodic sending of the information to yourself to prove that the log is contemporaneous).

Why, you ask? Because if you want to deduct all of your business mileage, you must do this! IRS regulations and Tax Court rulings require this. Written is defined as ink, so that means you need a paper log or must be able to prove your smart phone log is contemporaneous.

The first step is to go out to your car, and note the starting mileage for the new year. So go out to your car, and jot down that number (mine was 80,008). That should be the first entry in your mileage log. I use a small memo book for my mileage log; it conveniently fits in the center console of my car. It’s also a good idea to take a picture of the odometer;

Here’s the other things you should do:

On the cover of your log, write “2020 Mileage Log for [Your Name].”

Each time you drive for business, note the date, the starting and ending mileage, where you went, and the business purpose. Let’s say you drive to meet a new client, and meet him at his business. The entry might look like:

1/4 90315-90350 Office-Acme Products (1234 Main St, Las Vegas)-Office,
Discuss requirements for preparing tax return, year-end journal entries

It takes just a few seconds to do this after each trip, and with the standard mileage rate being $0.575/mile, the 35 miles in this hypothetical trip would be worth a deduction of $20. That deduction does add up.

Some gotchas and questions:
1. Why not use a smartphone app? Actually, you can but the current regulations require you to also keep a written mileage log. You can transfer your computer app nightly to paper, and that way you can have the best of both worlds. Unfortunately, current regulations do not guarantee that a phone app will be accepted by the IRS in an audit.

That said, if you backup (or transfer) your phone app on a regular basis, and can then print out those backups, that should work. The regular backups should have identical historical information; the information can then be printed and will function as a written mileage log. I do need to point out that the Tax Court has not specifically looked at mileage logs maintained on a phone. A written mileage log (pen and paper) will be accepted; a phone app with backups should be accepted.

2. I have a second car that I use just for my business. I don’t need a mileage log. Wrong. First, IRS regulations require documentation for your business miles; an auditor will not accept that 100% of the mileage is for business–you must prove it. Second, there will always be non-business miles. When you drive your car in for service, that’s not business miles; when you fill it up with gasoline, that’s not necessarily business miles. I’ve represented taxpayers in examinations without a written mileage log; trust me, it goes far, far easier when you have one.

3. Why do I need to record the starting miles for the year?
There are two reasons. First, the IRS requires you to note the total miles driven for the year. The easiest way is to note the mileage at the beginning of the year. Second, if you want to deduct your mileage using actual expenses (rather than the standard mileage deduction), the calculation involves taking a ratio of business miles to actual miles.

4. Can I use actual expenses? Yes. You would need to record all of your expenses for your car: gas, oil, maintenance, repairs, insurance, registration, lease fees (or interest and depreciation), etc., and the deduction is figured by taking the sum of your expenses and multiplying by the percentage use of your car for business (business mileage to total mileage driven). Note that once you start using actual expenses for your car, you generally must continue with actual expenses for the life of the car. Be careful if you (or your family) have multiple vehicles. You will need to separate out your expenses by vehicle.

So start that mileage log today. And yes, your trip to the office supply store to buy a small memo pad is business miles that can be deducted.

IRS Announces 2019 Tax Filings to Begin on January 27th

January 6th, 2020

The IRS today announced that the 2019 tax filing season for individuals will begin on Monday, January 27th. Tax Returns and payments are due by Wednesday, April 15th (an extension to file is available until October 15th, but payment of tax is still due by April 15th). The full IRS notice is available here.

2020 Standard Mileage Rates Released

January 1st, 2020

Yesterday, the IRS announced the 2020 standard mileage rates. The rates are:

  • 57.5 cents per mile for business use (down 0.5 cents per mile from 2019);
  • 17 cents per mile for medical or moving use (down 3 cents per mile from 2019); and
  • 14 cents per mile driven in service of charitable organizations (set by statute).

As a reminder, keep your mileage log! (Indeed, I’ll have a post on keeping your 2020 mileage log next week.)

The 2019 Tax Offender of the Year

December 31st, 2019

This year really went by fast, but unfortunately there’s no shortage of candidates for the Tax Offender of the Year award. As a reminder, to be considered for the Tax Offender of the Year award, the individual (or organization) must do more than cheat on his or her taxes. It has to be special; it really needs to be a Bozo-like action or actions.

The United States Congress received another nomination. The correspondent noted that Congress has abdicated looking at spending, and that’s been done by both Democrats and Republicans. I agree, but that’s not enough to win this year.

California received two separate nominations. The legislature received one for A.B. 5. That’s the new law that prohibits most independent contractors in the ‘gig’ economy. The law will likely lead to fewer independent contractors (that’s the intent of it), but won’t increase employment and will lead to a lowering of tax collections. I agree completely with the individual who sent in that nomination. However, any impacts will be in 2020 (not 2019), so I think this should be held in abeyance until next year.

The California Office of Tax Appeals ruled that an individual selling into California but with no presence in the state owes California tax. While I expect this ruling to eventually be narrowed by federal courts (potentially being completely overruled), it’s a stupid ruling and will lead to many avoiding dealing with Californians. It’s another penny-wise, pound-foolish outcome from California.

Craig Orrock of Salt Lake City received a nomination. Mr. Orrock is a former IRS employee and a former attorney. We’ll stress the word former because his conduct ensured he can’t be either ever again. From the Department of Justice press release:

Evidence at trial showed that Orrock filed tax returns for the years 1993 through 2015, but did not pay the income taxes reported as due on those returns. Orrock attempted to prevent the IRS from collecting the reported income taxes by using entities, bank accounts, and trusts in other names to hide his income and assets from IRS collection officers, filing frivolous bankruptcy petitions, and filing an offer-in-compromise falsely representing to the IRS that he had virtually no assets.  For example, Orrock used an entity known as Arville Properties LLC to conceal from the IRS his ownership of real property that he sold in 2007 for $1.5 million. In all, Orrock evaded the payment of over $500,000 in federal income taxes.

Mr. Orrock will be paying nearly $924,000 of restitution and will spend 32 months at ClubFed.

Something I’ve stated since I began this blog is that if you want to get in trouble with the IRS, one of the easiest ways to do so is to withhold employment taxes and not remit them. As far as I know, the IRS investigates all such cases.

Lawrence R. Gazdick, Jr. founded an equipment rental business in Dulles, Virginia (near Washington, DC). Mr. Gazdick’s business appeared to be successful, in that he had 70 – 100 employees. He used various names for his businesses (which isn’t an issue), with multiple bank accounts (52 in 9 different banks). He offered health insurance for his employees, with a plan from Kaiser Permanente which cost over $200,000. That’s a business that’s doing well.

Of course, since I’m writing about this, there were some issues. None of his businesses bothered filing employment tax returns, but he was diligent in withholding employment taxes from his employees’ pay. It was only $3.874 million of trust fund taxes (along with an additional $1.477 million of employer FICA taxes). Additionally, Mr. Gazdick didn’t bother to pay Kaiser for the health insurance; the check was “in the mail.”

Mr. Gazdick also didn’t file corporation or LLC taxes. It’s not clear if he needed to file Forms 1120, 1120S, or 1065 for his businesses as he held his businesses to be corporations and LLCs, but something needed to be filed. At least he was consistent: Mr. Gazdick hadn’t filed personal tax returns since at least 2000. (Some tax professional is about to get a lot of business.)

Mr. Gazdick’s business came to the attention of the IRS. This was certain to happen. Consider that employees filed their income tax returns, noting withholding of income tax (and FICA taxes). The IRS won’t find the matching payroll tax returns (Forms 941) from the employer. The IRS will easily get evidence of the problem (either by looking at the W-2s filed with the Social Security Administration and/or getting copies of pay stubs from employees).

Mr. Gazdick had an answer: I’ll just change the name of the business. He used multiple names, likely in trying to keep the IRS at bay. It didn’t work, but not for the obvious reason. (It’s certain that sooner or later the IRS would have looked into the missing payroll tax deposits.)

Mr. Gazdick was previously convicted of a felony. Convicted felons are not allowed to possess firearms. Mr. Gazdick had a firearm for his business. That came to the attention of a task force formed under “Project Safe Neighborhoods.” The goal of Project Safe Neighborhoods (which began in 2001) is reducing violent crime. The investigation likely began because of the gun. A helpful hint to anyone who is going to commit a felony with a high likelihood of investigation: Do not commit another felony which also has a high likelihood of investigation. But I digress….

It appears that the Project Safe Neighborhoods investigation led to the tax investigation. The tax case was pretty much a slam dunk given the facts (that I noted above). Mr. Gazdick has pled guilty, and has promised to make restitution of the $5.35 million in employment tax loss and the $200,000 which wasn’t paid to Kaiser. While sentencing was supposed to have occurred in October, it appears to have been delayed.

And that’s a wrap on 2019. I wish you and yours a happy, healthy, and prosperous New Year.

An Update on Arizona v. California

December 23rd, 2019

There’s been some news on Arizona’s attempt to stop California from requiring indirect passive owners of LLCs who happen to own other LLCs that invest in California from having to pay California’s $800 minimum franchise tax.

When we last looked at this, the Supreme Court asked the Solicitor General (of the U.S.) to file a brief commenting on the case. That brief has been filed.  The Solicitor General believes that the motion to file a bill of complaint should be denied because, “…this is not an appropriate case for the exercise of this Court’s original jurisdiction.”  The Solicitor General believes that Arizona entities can file their own lawsuits and that the case is not one appropriate for the Supreme Court.

Not surprisingly, Arizona didn’t like the Solicitor General’s brief and filed a reply brief of its own.  Arizona believes that the Solicitor General got it wrong, and that leave should be granted.

It’s probable that the Supreme Court will decide whether or not to grant leave within the next two months.