No, You Weren’t Allowed to Do a Like-Kind Exchange for Cryptocurrency Before 2018

November 14th, 2019

A question that has come up is whether you could do a like-kind exchange for cryptocurrency prior to 2018. (The Tax Cuts and Jobs Act eliminated all like-kind exchanges for everything except real property beginning with the 2018 tax year.) Tax professionals offered varying opinions; I wrote in September 2017 that it was unlikely the IRS would allow like-kind exchanges for cryptocurrency.

Yesterday, Suzanne Sinno, an IRS attorney in the Office of the Associate Chief Counsel, spoke to the American Institute of CPAs (AICPA). According to an article in Bloomberg Tax, she stated that the IRS’s position is that like-kind exchanges were not applicable to cryptocurrency.

Note that this is just the IRS’s position. It may be that courts could rule that like-kind exchanges do apply to cryptocurrency. Additionally, this is informal (unpublished) guidance. That said, the IRS’s position on this shouldn’t be a surprise.

So let’s assume you converted one crypto to another back in 2016 or 2017, and you treated it as a like-kind exchange. What should you do? You should discuss this with your tax professional. The answer to your specific situation will depend on your facts and circumstances.

While the IRS is increasing enforcement vis-a-vis cryptocurrency, the agency today is primarily looking for individuals who haven’t reported their transactions. As I’ve told many clients, there’s likely someone in Dubuque (or Des Plaines or Denver or wherever) who made $2 million (or more) trading cryptocurrency and hasn’t reported any of his or her gains. That’s low-hanging fruit for an IRS examination, and those individuals should consult a tax professional (or potentially a tax attorney) immediately. There’s a huge difference between an individual who ignored reporting cryptocurrency and an individual who made good faith efforts to accurately report his income.

Out With the Fed Mandate; In With State Mandates

November 13th, 2019

Once upon a time there was the federal mandate to have health insurance; per the US Supreme Court, a “tax.” Well, beginning with 2019 tax returns (filed in 2020) the federal mandate is no more. Unfortunately, tax professionals and taxpayers aren’t done with insurance mandates: Several states have implemented their own mandates.

Massachusetts, New Jersey, and the District of Columbia have their own mandates for the 2019 tax year (tax returns filed in 2020); Massachusetts’ mandate began in 2007. California, Rhode Island, and Vermont have implemented mandates for the 2020 tax year (tax returns filed in 2021).

If you are a resident of one of these states, we’ll be asking you about health insurance when we prepare your 2019 returns. Additionally, if you do receive insurance through the Exchange (e.g. healthcare.gov) and receive a Form 1095-A, you must provide a copy of the form to your tax professional.

There’s no reason for tax professionals to be in the health insurance field. But thanks to Obamacare, we are…and will be for the foreseeable future.

Deja Vu All Over Again, Again

November 7th, 2019

Last year I wrote a post noting the following:

A client filed his tax return on October 2nd. He had a balance due (he had made an extension payment, but he still owed some tax). He paid by having his bank account electronically debited with the filing of his tax return. In today’s mail he received a CP14 notice (dated today) alleging he hadn’t paid his balance due. Yikes!

My client was upset. “Russ, you forgot to have my bank account electronically debited.” No, I didn’t forget, and the return shows his payment being accepted for processing. I had a Tax Information Authorization for my client, so I ran an Account Transcript and it showed a $0 balance. My client was relieved, but there appears to be a systemic IRS issue.

The payment went through on October 2nd, but the IRS posted the tax due first (dated October 22nd) without posting his payment. Yet the payment was made, and my client should have never received this notice. It wasted both of our time for no good reason.

Well, history has repeated itself (again). I have two clients (so far) who filed their returns in October, paid by electronic debit with the filing of their returns, and who received CP14 notices stating they owed tax. They didn’t–the payments went through and the IRS shows they received the payments. Yet again, my clients were annoyed (with the bureaucratic stupidity) and both the clients and I had to waste our time chasing down an issue we shouldn’t have had to.

I concluded my post last year with the following:

Several years ago this was an issue for April filers; the IRS corrected the problem by allowing an additional ‘cycle’ before sending out CP14 notices. I hadn’t seen this issue before for extension filers, but it appears we have a case of deja vu all over again. I reported this to the IRS Systemic Advocacy Management System. If you’re a tax professional and run into this issue I urge to to report it, too.

Yes, I reported this again to SAMS. Last year, I was contacted by the Taxpayer Advocate Office/SAMS about this issue. It seems they were not successful in resolving the matter. Hopefully they will be this year.

If you’re a tax professional and your clients receive an erroneous CP14 notice based on this fact pattern, I urge you to report it to SAMS.

Regulations Matter, Too

November 5th, 2019

Last week, KABC (a Los Angeles television station) reported on a couple moving their small business from Canoga Park, California (in the San Fernando Valley area of Los Angeles) to Fort Worth, Texas. There’s nothing new about this story–companies relocate all the time. The reasons, though, state something about doing business in the Bronze Golden State.

“There’s so much regulation, that we really need to be in a place that allows our small business to grow and I feel that Texas will do that for us,” Micki Brizes, one of the owners of Aeromax, told KABC. The owners couldn’t find a building to move into that they could afford near their current location in California.

Consider that they are spending more than $100,000 on moving their business. Those are just the direct costs. There are undoubtedly indirect costs (orders delayed due to the move, disruptions in various things, etc. Yet the owners believe that they will be able to recover the costs of the move very quickly. Is that realistic?

Absolutely. They’ll likely be able to rent a larger space than what they had in California that meets their needs for less than what they paid in California. They’ll save 8.84% or more in taxes. They’ll be in a business-friendly environment instead of a business-hostile environment. I suspect the owners will be asking themselves why they didn’t make this move earlier.

Meanwhile, the Babylon Bee (a satirical website) had a post: “Texas Luring Jobs Away From California With Promises Of Electricity.” Good satire is based on a truth, and extrapolating it out into humor. This post is humorous, but the underlying truth exists. If California doesn’t fix their problems, the high-tech industry will vanish from Silicon Valley. California’s budget over the last several years has been in balance (actually, in surplus) based on Initial Public Offerings in the high-tech industry. Democratic politicians should be asking themselves what they can do to make California a desired destination for businesses, but they likely won’t until it’s too late. The reality is that it’s not just tech businesses that can be at least 300% more effective when they have power.

Does My Business Owe California Tax?

October 30th, 2019

Assume you operate a business as a tax professional in Las Vegas. Or Des Moines. Or Albany. Or anywhere outside of California. You’ve been in business for years, and don’t solicit new clients (other than having a website). Your only trips to California are to visit family members (nothing to do with your business). You do have clients in California, but you prepare all the tax returns in your office. Do you owe California tax?

In the view of the Franchise Tax Board (California’s income tax agency), you likely do. And in a ruling earlier this year, the Office of Tax Appeals upheld the Franchise Tax Board. In that case, a screenwriter who resided in Arizona was ruled to owe California tax because he was paid by California LLCs.

Here, appellant received income for his services as a self-employed screenwriter from Mindbender and Lakeshow, which are both California LLCs. Appellant was a resident of Arizona where he performed his services as a self-employed screenwriter. He also received $40,000 of gross income from his services as a self-employed screenwriter from California customers. Consequently, appellant’s trade or business as a self-employed screenwriter was carried on within and without the state. We find appellant was carrying on a business within and without California.

And using California’s approach, since he was conducting part of his business in California, he owes tax on the sale to Californians:

In sum, pursuant to the provisions of the UDITPA relating to the sale of servicesand the regulations thereunder, appellant’s physical presence does not determine whether he had income derived from California, but rather it is determined by where the benefits of appellant’s services were received.

Based on this decision, my business owes California tax based on having clients who happen to reside in California. However, I strongly suspect this ruling is wrong under federal constitutional precedents (which weren’t raised in the appeal noted above).

In order for a state to tax someone, there must be a minimum level of contacts with the state. See Shaffer v. Heitner, 433 U.S. 186 (1977) and International Shoe Co. v. Washington, 326 U.S. 310 (1945). The FTB and the Office of Tax Appeals believe that simply providing services to California entities even if all work is done outside the state brings sufficient contact to California. It’s possible that is true for a screenwriter (he could have solicited within California, so it’s theoretically possible he has such contacts), but it’s not true for my business (I don’t solicit within California), and I haven’t conducted business within the state since 2011 (when I moved to Nevada).

Consider if you’re a tax professional working in your office in Boston. Someone comes in from off-the-street to have you prepare their return. He or she happens to be from Los Angeles, so you prepare their straightforward return (let’s assume it only has a W-2 and a few investment 1099s), charge the customer $x (let’s assume it’s a relatively small amount, say $300). You may now owe $800 to California because your business entity is considered to be conducting business in the state. That doesn’t sound very reasonable to me–and it’s hard for me to envision any sort of “minimum contacts” with California coming from an unsolicited client who happens to walk into your office.

I strongly suspect that some case like this is headed to federal court (and possibly the US Supreme Court). This sure appears to me yet another example of California overreaching and thinking everyone owes tax to the Bronze Golden State.

Hat Tip: Robert Wood

The 2020 State Business Tax Climate Index: The Usual Laggards, but Some New Faces on Top

October 24th, 2019

The Tax Foundation released its annual State Business Tax Climate Index. There weren’t many surprises with the best states:

1. Wyoming
2. South Dakota
3. Alaska
4. Florida
5. Montana
6. New Hampshire
7. Nevada
8. Oregon
9. Utah
10. Indiana

This is the first time I remember Oregon in the top-ten of this list. These states share one of two attributes: the lack of certain taxes (such as individual income taxes) or low tax rates across all taxes (such as in Utah and Indiana). Meanwhile, it’s “Bring me the usual suspects” for the bottom ten:

41. Louisiana
42. Iowa
43. Maryland
44. Vermont
45. Minnesota
46. Arkansas
47. Connecticut
48. California
49. New York
50. New Jersey

As the Tax Foundation says, “The states in the bottom 10 tend to have a number of afflictions in common: complex, nonneutral taxes with comparatively high rates. New Jersey, for example, is hampered by some of the highest property tax burdens in the country, has the second highest-rate corporate income tax in the country and a particularly aggressive treatment of international income, levies an inheritance tax, and maintains some of the nation’s worst-structured individual income taxes.”

I noted Oregon being in the top ten, but the state is likely going to fall out soon. Oregon adopted a gross receipts business tax, and that’s almost certain to send the state out of the top ten next year. Oregon will be one of only two states with both a corporate income tax and a gross receipts tax.

My home state, Nevada, ranks near the top in individual income tax (fifth), which isn’t a surprise since we don’t have that tax. (A few ‘individuals’ will owe the Nevada gross receipts tax on their businesses, which is why the Silver State doesn’t share the top ranking here.) We also rank towards the top (tenth) in property tax. We’re right in the middle for corporate income tax (25th) which shows the impact of the gross receipts tax. We’re towards the bottom (44th) in sales tax (Nevada sales taxes are relatively high; the rate is 8.25% in Clark County) and in unemployment insurance tax (47th). But overall Nevada is a good state for taxation; this is one reason I moved here in 2011.

Contrast that with California. Corporate taxation is actually in the middle (28th) and property tax is in the top half (16th); the property tax ranking is due to Proposition 13 which Democrats in the Golden State are proposing to partially due away with. Unemployment Insurance Tax ranks 22nd, about average. It’s individual income tax which is the major contributor to California’s low ranking. The state ranks 49th. California also fares poorly in sales tax, ranking 45th.

Note that taxation is just one piece of why businesses relocate. It’s an important component, but it’s not everything. Another major factor is regulatory burden, and that’s another place where California ranks at or near the bottom. This is something I’ll be reporting on in the future.

As to individuals who state that businesses don’t move because of taxes, that’s hogwash. Businesses do move because of this, and will continue to do so. It is just one reason, but it’s a very important reason. California lawmakers who look at the map provided by the Tax Foundation (showing California in dark grey (dark grey indicates a bad score) while numerous neighboring states are in blue (indicated a good score) should be worried. But given how I think the Democratic majority in Sacramento thinks, it’s unlikely they’ll do so.

“[D]id you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

October 23rd, 2019

I haven’t posted that much this year for a few reasons. I’ve had some family issues (and that takes priority over just about everything), and this was a difficult tax season. Now that Tax Season is over, I’m going to be increasing my posting. The next few posts are all going to be looking at cryptocurrency (what the IRS calls “virtual currency”) because there’s been a lot of activity in this area over the past few weeks.

Today, we’re looking at an upcoming issue. During the second half of each year, the IRS releases draft tax forms for the following tax season. The IRS gets industry comments, and it also alerts both software makers and tax professionals of upcoming items. Here’s the top of the draft Schedule 1 for 2019:

CryptoQuestion

The question reads, in full, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”

The IRS thinks that some taxpayers just might not be telling the truth about cryptocurrency. This question means that if you own any cryptocurrency and had any transactions in 2019, you need to check a box. It’s similar to the boxes on the bottom of Schedule B asking about foreign financial accounts.

Tax returns are filed under penalty of perjury. Thus, a taxpayer who answers that question “No” when he or she is trading virtual currency would be committing perjury. Indeed, it’s yet another way the IRS is looking into cryptocurrency transactions.

Kelly Erb, who alerted me to this new question, believes the location of the question is poor. I agree. An individual who sells cryptocurrency must complete Schedule D and Form 8949. That individual might not include Schedule 1 on his or her tax return. If you’re looking for improving compliance with the law, the question should be asked where impacted individuals will see it. The IRS will take comments for the next 17 days on the draft form, and I have suggested to the IRS that the question be put on Schedule D rather than Schedule 1. (If you want to comment, you can send an email to WI.1040.Comments@IRS.gov. Note that the IRS does not respond to each comment, but absolutely does look at the comments and considers them before making draft forms final.)

A client was in my office toward the end of September to finalize his 2018 returns. He had a lot of cryptocurrency transactions, but the overall gain or loss was about $100. As we attached a listing of his thousands of trades to his tax return, he asked if I thought someone would be prosecuted over cryptocurrency. I strongly believe that IRS criminal investigation will look at making an example of someone. There’s likely a kid in Dubuque or Dallas or Denver who made $3 million in cryptocurrency and thinks it’s “free money.” It’s not–accessions to wealth are, by definition, income and all income not exempted by Congress is subject to income tax. As always, it’s a whole lot easier to simply pay your tax than not do so.

It’s Time to Panic!

September 23rd, 2019

If you use a tax professional and have not yet provided your paperwork to him or her, it’s time to panic and work on this. In past years, I’ve made this post in early October. But this tax year is different than others, and if you turn your paperwork in after the end of September, it’s quite possible your return will end up being filed after the October 15th extension deadline.

Tax returns are taking longer to prepare this year than last. We’re seeing the average return taking 10% longer than last year. Let’s assume that an average tax professional could prepare ten returns in a day; this year, he or she might only get nine done. That doesn’t sound like much, but most tax returns on extension are difficult ones, with complications.

If you file late, realize it’s as if your extension never happened. Of course, if you’re getting a refund filing late is not the end of the world: The penalties for late filing are based on the tax you owe, so if you don’t owe any tax there are no penalties.

Our official deadline for receiving paperwork was September 17th. Most tax professionals I know had similar deadlines. That means if you haven’t turned in your paperwork you’re on borrowed time. It’s time for the procrastinators out there to stop procrastinating if you don’t want to pay an extra 25% of your tax for late filing.

Jolly Good News on the Swart Front

September 10th, 2019

Let’s say you’re the managing member of an LLC headquartered in Seattle (duly registered as an LLC in Washington State). You invest in another LLC (a Delaware LLC) that invests in property throughout the United States. You own between one and five percent of the Delaware LLC each year, and are not involved in any of the decisions of the Delaware LLC. The Delaware LLC invests in California property, and is considered doing business in California (it registers with the California Secretary of State and files a California LLC tax return). Is your Washington State LLC doing business in California?

The California Franchise Tax Board has been holding for years that if you invest in a California LLC–or a foreign LLC doing business in California–your LLC is considered doing business in California. Even an indirect investment (investing in LLC 1 that invests in LLC 2 that invests in a California LLC) is enough to be doing business in California in the view of the FTB. Then came Swart.

As previously discussed on this blog, Swart Enterprises, Inc challenged the FTB regarding its 0.2% interest in a manager-member California LLC. The courts held that such a passive investment is not doing business in California. After Swart, the FTB held that if your passive interest is 0.2% (or less), you’re not doing business in California; greater than that, you are.

Jali, LLC is a Washington State LLC that mirrors the fact pattern in the first paragraph. They invested in Bullseye Capital Real Property Opportunity Fund, LLC and California’s Franchise Tax Board asserted they were doing business in California. Jali, LLC paid the FTB for the years in question and filed a claim for refund; the claim was denied because Jali, LLC owned more than 0.2% of Bullseye. Jali, LLC appealed to the California Board of Tax Appeals.

In what will be a precedential decision, the Board of Tax Appeals noted:

FTB thus takes the position that a 0.2 percent membership interest in an LLC doing business in California is the new, post-Swart bright-line ownership threshold used to determine whether an out-of-state member is also doing business in the state. As applied to the facts of this appeal, FTB concludes that appellant is deemed to be “actively” doing business in California because its membership interest in Bullseye “was well beyond the 0.2% Swart limit.” We disagree.

FTB misconstrues the Swart court’s statement, “We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC.” The court’s opinion was not “based solely” on Swart’s minority ownership interest. Rather, in making this statement, the court was simply dismissing FTB’s argument that the court should base its decision on that fact alone. When the entire opinion is considered, it becomes abundantly clear the court’s holding was squarely grounded on the relationship between the out-of-state member and the in-state LLC.

But that’s not all. The Board of Tax Appeals realizes that the key questions are, (a) Is the entity a limited or general partner, and (b) Can the limited partner control the activity of the LLC that is doing business in California?

FTB misconstrues the Swart court’s statement, “We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC.” The court’s opinion was not “based solely” on Swart’s minority ownership interest. Rather, in making this statement, the court was simply dismissing FTB’s argument that the court should base its decision on that fact alone. When the entire opinion is considered, it becomes abundantly clear the court’s holding was squarely grounded on the relationship between the out-of-state member and the in-state LLC…Indeed, in rejecting the same argument FTB advanced there as it does here, the court concluded that “[b]ecause the business activities of a partnership cannot be attributed to limited partners, Swart cannot be deemed to be ‘doing business’ in California solely by virtue of its ownership interest in Cypress LLC.” (Ibid., emphasis added and internal citation omitted.) Accordingly, Swart did not establish a bright-line 0.2 percent ownership threshold for purposes of making nexus determinations for out-of-state members holding interests in in-state LLCs classified as partnerships.

Employing the foregoing legal analysis from Swart, we agree with appellant that it is not subject to California tax. Appellant points to certain relevant facts—none of which FTB contests—that are virtually identical to those in Swart. Under its operating agreement, (1) Bullseye is a manager-managed LLC, (2) it is managed by an elected director(s), not appellant, (3) appellant is not personally liable for any debt, obligation, or liability of Bullseye, (4) appellant has no power to participate in Bullseye’s management, or bind or act on behalf of it in any way, and (5) appellant has no interest in any specific property of Bullseye. And, even though appellant’s percentage interest in Bullseye is greater than that in Swart (between 1.12 to 4.75 percent versus 0.2 percent), both are undisputedly minority interests. Therefore, like Swart’s interest in Cypress, appellant’s interest in Bullseye closely resembles that of a limited, rather than a general, partner, and there is no evidence that appellant had any ability or authority, directly or indirectly, to influence or participate in the management or operation of Bullseye. [footnotes omitted]

The conclusion of the Board of Tax Appeals is clear:

[W]e reject FTB’s 0.2 percent ownership threshold as the new bright-line legal standard for distinguishing between an active and a passive ownership interest in an LLC classified as a partnership.

Unlike the earlier decision in Satview Enterprises (which was not precedential), this decision will soon be precedential. The big question is whether the FTB will appeal into the California court system. There’s a definite possibility they will (it would be consistent with the FTB’s general legal practices). No matter, this decision is excellent news for owners of minority interests in California LLCs.

(It’s also, overall, excellent news for California. You want to encourage investment in the state. The FTB’s policy of demanding the $800 for minority interest in California LLCs discourages California investment.)

If you have a non-California LLC that has been forced to pay California LLC tax for indirect interest in a California LLC (or a foreign LLC doing business in California), you should consider filing a claim for refund–or a protective claim if your statute of limitations is nearing expiration.

Case: In the Matter of the Appeal of Jali, LLC

Gambling With an Edge Podcast

September 1st, 2019

I appeared on last week’s “Gambling With an Edge” podcast. We discussed the IRS letters sent to cryptocurrency users, does having a large number of W-2Gs increase audit risk, and sending tax returns by regular mail — and many other topics. You can download the podcast at the link (above), or subscribe to “Gambling With an Edge” on iTunes and other podcast services.