The goal of must businesses is to make money. There aren’t many businesses that can lose on each sale and make it up in volume. In fact, I don’t know of any. But I digress….
So let’s take Sam and Edna, two successful individuals who love horses. They decide to start raising horses. They remember their accountant telling them that if they had a business that loses money they can take the loss and offset some of their income. That’s true. They don’t remember their accountant telling them that the business does need to be structured to make money eventually.
Hobby losses are not allowed. The IRS has a webpage that notes the major factors used in determining whether or not your business is a business or a hobby:
The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:
– Does the time and effort put into the activity indicate an intention to make a profit?
– Do you depend on income from the activity?
– If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
– Have you changed methods of operation to improve profitability?
– Do you have the knowledge needed to carry on the activity as a successful business?
– Have you made a profit in similar activities in the past?
– Does the activity make a profit in some years?
– Do you expect to make a profit in the future from the appreciation of assets used in the activity?
If your business loses money year-after-year, and you’re not making any efforts to change it, and you get a lot of personal enjoyment out of the business, beware! Your “business” might be a hobby. Yes, circumstances can cause any business to fail (and the IRS knows this). But when your business is losing money every year and you make no effort to change your business, at least on the surface you’re looking like a hobby. The eternal hobby loss is a good way to head to an IRS audit.
That’s it for our Bozo Tax Tips for the 2014 Tax Filing Season. I hope you’ve enjoyed them. We’ll be back with actual tax posts at the end of the week.
Congress has decided to legislate through the Tax Code. There are hundreds of tax credits that now exist. These range from the Earned Income Credit, education credits, electric vehicle credits, and adoption credits. Some of these credits, such as the Earned Income Credit, are refundable credits: You can get a refund based on the credit even if you don’t have income.
Now, the Bozo mind works differently than yours and mine. They see a tax credit and think, “How can I get some free money? I’ll find a tax credit and the government will just send me money!” So our Bozo looks and finds there’s a tax credit available for recovering methane (CH4) from landfills. Our enterprising Bozo sets up the Hot Air Gas Company, and starts claiming the credit. Our Bozo skips the somewhat important step of actually obtaining some methane from a landfill.
The IRS does investigate such tax credits, and when you claim that you are recovering natural gas when you’re not, that’s tax fraud, a criminal offense. And that leads straight to ClubFed.
The Tax Code is far too complex. Our Congresscritters have decided to legislate through the Tax Code, leading to a myriad of deductions and credits. The best solution to this issue would be for Congress to simplify the Tax Code but that’s not going to happen any time soon. Until then, if you legitimately qualify for a tax credit you should take it. But if the only hot air you possess is exhaling from your mouth, don’t claim a tax credit for it unless you want to visit ClubFed.
Another repeat, but one that is a continual issue with cash business. It may be “cash and carry,” but cash is taxable in all ways. And cash reporting (or lack thereof) can be a problem. Anyway, let’s be suspicious:
Given my practice area, I deal with individuals who occasionally make large cash deposits. I tell them that they shouldn’t mind the completion of a Currency Transaction Report. The IRS gets so many of them that as long as you’re paying your taxes it’s not a big deal.
On the other hand, if you break up your $11,000 transaction into two $5,500 deposits, you can get in trouble. Big trouble. A suspicious activity report (SAR) might be issued. The IRS doesn’t get as many of these, and almost all of them are investigated. And that’s what leads into this tale of woe.
We’re focusing today on a public figure. He was a prosecutor, and he used the Bank Secrecy Act (among other laws) to help send many individuals—primarily in organized crime—to prison. He then became Attorney General of his state, serving two terms in that office. He was then elected Governor.
But our public figure had a problem. He enjoyed the world’s oldest profession. While traveling to Washington, D.C. he used a service called the Emperor’s Club. He funded his nighttime activities by making multiple wire transfers of just under $10,000.
Come on, could a politician who used to use the Bank Secrecy Act actually get blindsided by the Act? Yes. Eliot Spitzer’s wire transactions were duly reported by North Fork Bank. That led to an IRS investigation which led to an FBI investigation which led to a governor becoming an ex-governor.
So if you want to send money, go big-time. Send more than $10,000. But whatever you do, don’t break up your cash transactions into smaller pieces to evade the reporting requirements. One day you might find two armed federal agents at your door, reminding you, “You have the right to remain silent….”
Ah, Spring is in the air. And with that come the inevitable wedding invitations. I had an invitation to a wedding on April 5th. No, I didn’t attend.
With weddings comes changes in tax status. Your marital status on December 31st determines your marital status for the year. If you are married, you file as Married Filing Jointly or Married Filing Separately. (In some rare cases, if you’re married you can file as Head of Household.) But you can’t file as single. Likewise, if you’re single you can’t file as married.
Perhaps it’s something in the water, but this year Aaron and I have seen multiple cases of individuals who have ignored that marriage license and filed as single if married. There’s a good reason for that, of course: They save on taxes. A big issue is rental real estate: If you’re actively involved in rental real estate you get to take losses of up to $25,000. But there’s an income cap (the deduction begins to phase out at an income of $100,000 and completely phases out at $150,000). This particular deduction is neither indexed for inflation nor does it vary if you are single or married.
There’s a problem taking deductions you’re not entitled to: tax evasion. It’s a Bozo act to claim things you’re not entitled to.
Marriage has its ups and downs. Claiming you’re single on your tax return will in the long-run cause you nothing but downs.
Today is April 8th. The tax deadline is just seven days away.
What happens if you wake up and it’s April 15, 2013, and you can’t file your tax? File an extension. Download Form 4868, make an estimate of what you owe, pay that, and mail the voucher and check to the address noted for your state. Use certified mail, return receipt, of course. And don’t forget your state income tax. Some states have automatic extensions (California does), some don’t (Pennsylvania is one of those), while others have deadlines that don’t match the federal tax deadline (Hawaii state taxes are due on April 20th, for example). Automatic extensions are of time to file, not pay, so download and mail off a payment to your state, too.
By the way, I strongly suggest you electronically file the extension. The IRS will happily take your extension electronically; many (but not all) states will, too.
But what do you do if you wait until April 16th? Well, get your paperwork together so you can file as quickly as possible and avoid even more penalties. Penalties escalate, so unless you want 25% penalties, get everything ready and see your tax professional next week. He’ll have time for you, and you can leisurely complete your return and only pay one week of interest, one month of the Failure to Pay penalty (0.5% of the tax due), and one month of the Failure to File Penalty (5% of the tax due).
There is a silver lining in all of this. If you are owed a refund and haven’t filed, you will likely receive interest from the IRS. Yes, interest works both ways: The IRS must pay interest on late-filed returns owed refunds. Just one note about that: the interest is taxable.
We’re running some repeats, but there is some new Bozo material coming. It’s just that people keep trying the same things over and over again.
It’s tough to avoid the tax system. There are currency transaction reports (cash transactions of $10,000 or more) and suspicious activity reports (theoretically can be done on any transaction, but usually starts at $3,000 or more) done with cash. Businesses must send out 1099s on payments of $600 or more to individuals. Barter organizations must send out 1099s.
But that doesn’t stop the Bozo contingent. “They’ll never catch me,” they believe. Until the IRS or the Franchise Tax Board (substitute your state tax agency if you’re not in California) knocks on their door. There’s no statute of limitations if you don’t file.
Paying taxes isn’t fun. Avoiding the system and living on the edge may give you a thrill, but if you get caught you’ll be given a bill…and possibly a trip to ClubFed.
The Las Vegas Review Journal has a short article on the fact that online poker players must pay taxes. The article notes that winning players must pay taxes; of course, both winners and losers are supposed to include their winning sessions on their tax returns. There is one minor error in the article: Freeroll winnings of $600 or more should be reported on a Form 1099-MISC rather than a Form W-2G.
Both Brad Polizzano and I are quoted in the article. One point that I made with David Ferrara (the writer of the article) is that proposed legislation legalizing and regulating online poker in other states (than Nevada) explicitly requires reporting wins and losses to state tax agencies.
Yesterday I looked at the idea of forming a Nevada Corporation while in California and being able to avoid California taxes. It doesn’t work. Today’s focus is on something that comes up now and then and applies to trusts.
Let’s assume John and Jane, two California residents, form a trust to benefit their children, Ann and Bob. Ann lives in Florida; Bob resides in California. The trust is an irrevocable trust, so it files its own tax return (a Form 1041). The income to the beneficiaries is reported on Schedule K-1s. Ann is surprised and calls her accountant when she receives both a federal K-1 and a California K-1.
The issue is simple: The trust is a California trust, so the income is California-source. California requires that a Schedule K-1 for Form 541 (California’s trust tax return) be included. Yes, Ann must pay California tax on the income. Ann’s CPA called me and asked me why I included the K-1 from California. My response was succinct: I have to and Ann has to pay the tax.
California’s desire to have anyone and everyone pay California tax has led to many trusts relocating to Nevada (which has no state income tax) and other trust-friendly states. California isn’t one of those states. Ann’s parents, John and Jane, could have formed the trust in Nevada but because they didn’t Ann is stuck in the Hotel California. You can check out any time but you can never leave.
Ignoring the California K-1 is a Bozo idea. Instead of just paying tax, you will get the joy of paying tax, penalties, and interest. If your parents are in California and thinking of forming a trust to benefit you, it may be worth your time to talk about Nevada to them. Otherwise, welcome to the Hotel California.
A repeat follows, but it’s one again getting a lot of play due to business conditions in California. While I’m focusing on California and Nevada, the principle applies to any pair of states.
Nevada is doing everything it can to draw businesses from California. Frankly, California is doing a lot to draw businesses away from the Bronze Golden State. But just like last year you need to beware if you’re going to incorporate in Nevada.
If the corporation operates in California it will need to file a California tax return. Period. It doesn’t matter if the corporation is a California corporation, a Delaware corporation, or a Nevada corporation.
Now, if you’re planning on moving to Nevada incorporating in the Silver State can be a very good idea (as I know). But thinking you’re going to avoid California taxes just because you’re a Nevada corporation is, well, bozo.
For tax bloggers like myself, Richard Hatch has been a godsend. His antics have been, well, remarkable. While he’s no longer at the top of my Bozo Tax Tips, his story is one that prospective tax offenders should learn. I keep thinking that I’ll be able to drop this Bozo tax tip one year. Yet every time I think that’s going to happen Richard Hatch makes the news again. One tip I can give any celebrity: Be careful about your taxes. The IRS loves going after Bozo tax celebrities. So here’s the story that refuses to die.
For a tax blogger, people like Richard Hatch are wonderful. Hatch, for those who don’t remember, was the winner of the first Survivor and won $1 million. About 300 million individuals worldwide saw Hatch take down the $1 million.
Hatch received a Form 1099-MISC for his winnings. In the United States, winnings from contests are taxable. Hatch claims that CBS and/or the producers of Survivor promised him that they would pay his taxes. (Both CBS and the producers of Survivor deny this charge.)
Here’s what I wrote back in January 2006 when Hatch was convicted:
Mr. Hatch has cemented a place in the Bozo Tax Criminals Hall of Fame (a website I’ll create one day). Let’s look at his
stupid not so good actions.
1. Hatch goes to accountant #1, find out that he owes over $300,000 in taxes. He goes to accountant #2, and the tax bill is around $240,000. (At his level of income, some differences in taxes owed is normal.) He then asks accountant #2 what his return would be if he didn’t declare the $1 million in Survivor winnings. Accountant #2 makes Hatch sign a statement that he won’t file that return (it showed Hatch getting a $4300 refund). He filed that return.
2. The IRS amazingly discovers his tax evasion. (With perhaps 300 million witnesses, even the most inept attorney could prove he won $1 million.) He’s offered a plea bargain: pay your taxes, and we’ll let you off fairly easily on the jail time. He accepts the plea initially, then changes his mind.
3. The case goes to trial. Hatch claims that CBS should have withheld taxes. His attorney might want to ask any seasoned accountant about what you should do if taxes aren’t withheld but should have been. (Answer: you pay the taxes.)
4. Hatch’s attorney can’t find the OJ Simpson jury. (Hat tip: Roth Tax Updates)
5. Hatch is found guilty. Roth Tax Updates speculates that his sentence will be around 3 years in jail. Oh, he’ll also have to pay those taxes, and interest and penalties. The maximum possible sentence is 13 years in prison and a fine of $600,000.
Hatch is now serving his prison sentence of 51 months. He recently appealed his conviction, though chances of it being overturned seem slim.
2008 Update: And they were slim. Last February, Hatch’s appeal was denied. As you might expect, 300 million witnesses can’t be wrong.
2009 Update: Richard Hatch continues to look for that needle in the haystack. He’s filed another appeal, though to this non-lawyer it’s more likely that he’ll be released after serving his 51 months at ClubFed than getting a favorable ruling.
2010 Update: Mr. Hatch was released in mid-2009. He then violated the terms of his release and was sent back to ClubFed. Finally, in October, Mr. Hatch was released. He’ll be spending the next couple of years in his home state of Rhode Island.
2011 Update: As part of his sentence, Mr. Hatch was supposed to amend his tax returns and declare the $1 million of income. He neglected to do that. Judge William Smith didn’t neglect to give Mr. Hatch a piece of his mind this past March: He sentenced Mr. Hatch to nine more months at ClubFed. Following his release from ClubFed (in December), Mr. Hatch will have 26 months of supervised release.
2012 Non-Update: Mr. Hatch was released from prison in late December 2011. He has filed a writ of certiorari with the Supreme Court. The chance of the Supreme Court taking his case is about the same as a blizzard in August in Las Vegas. The writ was denied.
2013 Update: Mr. Hatch’s non-payment of taxes extends north of the border. Mr. Hatch owned a piece of property in Sydney, Nova Scotia. That property was sold in a tax sale after Mr. Hatch didn’t pay the property taxes on it for at least six years.
2014 Update: Mr. Hatch still thinks he did nothing wrong. Last year, on Oprah: Where Are They Now, Hatch told Oprah Winfrey, I never did anything deserving of prison time…I never attempted to evade taxes, which was what I was convicted of.” I’ll let the reader decide on the veracity of Mr. Hatch’s statement.
Judge Smith’s remarks from over two years ago have not yet sunk in to Mr. Hatch. “You can continue to proclaim your innocence…You don’t have the option of engaging in this type of game or negotiation with the court. It needs to be a severe punishment. That’s the only thing that will deter you in the future.”
And to think I’d have so little to write about if Mr. Hatch had just paid his $300,000 in tax in the first place.