The Real Impact of the Wynne Decision

May 19th, 2015

Yesterday’s decision in Comptroller of the Treasury of Maryland v Wynne Et Ux generated some reporting in print media. Yet much of what I saw was incorrect in part or in whole.

New York does give full tax credits for individuals with out-of-state income; I do not believe they will be impacted. However, many states do not give credits for local taxes. Joe Kristan highlighted Iowa today; Kentucky is another state that does not currently offer such tax credits. Under Wynne I believe they’ll be required to offer such credits. (I only know about Kentucky because I had a client impacted by this.) Joe noted that Tax Analysts saw that North Carolina and Wisconsin (along with a host of local governments) also don’t offer such credits. That’s where I think the real impact will be.

A Wynne for the Dormant Commerce Clause

May 18th, 2015

The US Supreme Court today decided Comptroller of Maryland v. Wynne. The Wynnes, Maryland residents, had out of state income duly reported on both their Maryland tax return and on other state tax returns. They wanted a full credit for the non-Maryland taxes paid on their Maryland tax return.

However, the Comptroller of Maryland denied the full credit. Maryland has a system where counties have add-on taxes to the state’s income tax. Maryland allowed the credit for state tax but not the county tax. The Wynnes appealed the decision. They lost at low levels but won in the Maryland Court of Appeals and the Maryland Supreme Court. The Comptroller of Maryland appealed to the US Supreme Court.

The US Supreme Court today held that the dormant commerce clause discrminates against interstate commerce and is unconstitutional:

Maryland’s income tax scheme discriminates against interstate commerce. The “internal consistency” test, which helps courts identify tax schemes that discriminate against interstate commerce, assumes that every State has the same tax structure. Maryland’s income tax scheme fails the internal consistency test because if everyState adopted Maryland’s tax structure, interstate commerce would be taxed at a higher rate than intrastate commerce. Maryland’s taxscheme is inherently discriminatory and operates as a tariff, which is fatal because tariffs are “[t]he paradigmatic example of a law discriminating against interstate commerce.” Petitioner [Comptroller of Maryland] emphasizes that by offeringresidents who earn income in interstate commerce a credit against the “state” portion of the income tax, Maryland actually receives lesstax revenue from residents who earn income from interstate commerce rather than intrastate commerce, but this argument is a red herring. The critical point is that the total tax burden on interstate commerce is higher. [citations omitted]

The easiest fix for Maryland is to offer a full credit for the county tax. The actual fix, though, is up to the Democratic legislature and the Republican governor to decide. Individuals who have been impacted by the discriminatory system may want to file protective claims for refunds if the statute of limitations for them is nearing expiration.

This case also highlights the difficulties facing a taxpayer without deep pockets. Mr. Wynne is an owner of Maxim Healthcare and likely has the funds to fight the matter. In cases like this, it’s rare to win at low levels. Most state boards of tax appeals will rule for the state as long as the matter could possibly be correct.

Fake Businesses, Phony Dependents: What Could Go Wrong?

May 17th, 2015

I’ve seen reports of Bozo tax preparers inventing deductions and dependents. This is the first time I’ve heard of a tax preparer inventing a business from scratch on a tax return. The results were good…for a while.

Ramona Johnson was the manager of Tax Office One in Fort Worth, Texas; her daughter-in-law, Nekia Everson, was a tax preparer. From 2008 through 2011 the business earned in $1.9 million in fees, so it was producing a good amount of revenue. And they were probably getting good refunds for their clients. After all, they did the “normal” things for Bozo tax preparers; phony dependents and itemized deductions for personal expenses were the norm (so that taxpayers would qualify for the Earned Income Credit). But then:

On some returns, Johnson and Everson would completely fabricate a Schedule C business, including income and expense items. For some taxpayers, Johnson would create a false and fraudulent Schedule C reflecting the taxpayers had a profit from a nonexistent business. This false profit, together with claimed dependents (both fraudulent and actual), would be used to claim the taxpayer was entitled to an earned income tax credit.

Of course, while they had gross receipts of $1.9 million, somehow the gross receipts didn’t make it onto the personal tax returns. Ms. Johnson neglected to include tax preparation income on her 2009 and 2010 returns:

In addition, the government presented evidence that for calendar years 2009 and 2010, Johnson filed tax returns in which she reported total income of $2,850 and $16,906, respectively, when she well knew that the income amount was understated in that it did not include income she received for her work preparing tax returns.

Ms. Johnson and Ms. Everson will have plenty of time to think about whether preparing accurate tax returns would have been a better strategy. Ms. Johnson will be at ClubFed for 170 months (over 14 years); Ms. Everson will be there for 95 months (just under 8 years).

For taxpayers the usual rules apply: If it sounds too good to be true, it probably is.

730

May 10th, 2015

It’s a topic that, frankly, bores the media. It’s a topic that the current Administration would love to go away. It’s a topic that should never have arisen. It’s a topic that underlies the current crisis that impacts the IRS. It’s the IRS scandal.

It’s not something that you will see often in the newspapers. Surprisingly, today’s Las Vegas Review-Journal carried an op-ed from Victor Davis Hanson (that first appeared in the National Review) titled “America’s Politicized Tax Enforcement Is a Harbinger of Decline.” Mr. Hanson argues that when the law becomes negotiable civilization collapses. The IRS scandal is yet one way that we are not a nation of laws–and that appears to be the direct result of the current Administration.

Earlier this week the Wall Street Journal had an editorial titled, “The IRS Goes to Court.” You usually can’t tell how an appellate court will rule from oral arguments; that wasn’t the case here. As noted by the Journal,

Poor Ms. McLaughlin was sent to argue the indefensible so the IRS can delay discovery until the waning days of the Obama Administration. “If I were you, I would go back and ask your superiors whether they want us to represent that the government’s position in this case is that the government is free to unconstitutionally discriminate against its citizens for 270 days,” said Judge Garland.

Ms. McLaughlin replied, “Well, I will take that back.” The Beltway media may be bored, but the IRS scandal is a long way from over.

Have you tried to call the IRS lately? I have to as part of my job. I even get through–sometimes. I have to call tomorrow and maybe I’ll get lucky. Coincidentally, Karen Hawkins, Director of the IRS’s Office of Professional Responsibility, recently submitted her resignation. In her letter to the tax professional community, she said (in part):

I have had the pleasure to meet and talk with literally thousands of you at this juncture. I know you are solid ethical and professional people making every effort to serve your clients and tax administration in appropriate ways. It is important as you continue in your profession that you remain mindful of the overriding broad ethical principles contained in Circular 230 and resist the temptations to “get away with” the behavior less scrupulous individuals use to lure and keep clients. The recent litigation setbacks associated with tax return preparer regulation have been discouraging for all of us. Unfortunately, I have no crystal ball on the topic. I do know, however, that it is crucial for those of you who believe an ethical, fair, transparent and credible tax administration system is absolutely essential to this country to continue to practice your trade at the highest level and to press others for the same.

I agree with Ms. Hawkins that an ethical, fair, transparent and credible tax administration is essential. That said, I believe the IRS’s priorities should change to help implement that:

– Why is the IRS engaging in a “Washington Monument” strategy with their declining budget? (A “Washington Monument” strategy is to cut the most visible areas or most appreciated areas first.)
– Why is the IRS having employees while on the clock doing work for the employees’ union?
– Why is the IRS deliberately engaging in actions that are not fair, transparent, and credible such as the Z Street litigation?
– Why have many actions of the IRS impinged on tax professionals ability to service clients? Not only does this increase the workload for tax professionals, it increases the workload for the IRS.

The IRS’s budget isn’t going to be increased until the root cause of the IRS scandal is known. That’s a fact. It’s now been over 730 days (Monday will be day 732) that the scandal has been ongoing. If a Republican wins the White House in 2016, we’ll likely know what happened by day 1460. Otherwise, who knows.

Not All Private Delivery Services Are Equal

May 6th, 2015

Back when I was getting my MBA I did a team project about a California company that offers private delivery services in just Southern California. They were competing against FedEx, and they built a regional network. Recently I received an inquiry from a client who wanted to use them to send something to the IRS in Fresno; I told my client not to. He needed to use FedEx or UPS (and then, specific services offered by FedEx and UPS) or the postal service.

The reason for this is simple: The IRS only accepts certain of these services as equivalent to the postal service.

Today the IRS came out with their annual notice of which services you can use:

Effective May 6, 2015, the list of designated PDSs is as follows:

FedEx:
1. FedEx First Overnight
2. FedEx Priority Overnight
3. FedEx Standard Overnight
4. FedEx 2 Day
5. FedEx International Next Flight Out
6. FedEx International Priority
7. FedEx International First
8. FedEx International Economy

UPS:
1. UPS Next Day Air Early AM
2. UPS Next Day Air
3. UPS Next Day Air Saver
4. UPS 2nd Day Air
5. UPS 2nd Day Air A.M.
6. UPS Worldwide Express Plus
7. UPS Worldwide Express.

Only the specific delivery services enumerated in this list are designated delivery services for purposes of section 7502(f). FedEx and UPS are not designated with respect to any type of delivery service not enumerated in this list. Taxpayers are cautioned that merely because a delivery service is provided by FedEx or UPS, it does not mean that the service is designated for purposes of the timely mailing treated as timely filing/paying rule of section 7502. [emphasis added]

So if you’re going to use one of these private delivery services to send something to the IRS, use the correct service. If you don’t, the money you spent could be wasted.

Honesty Is Usually a Good Policy

May 3rd, 2015

Ronald Jerome Boyd is the Chief of the Los Angeles Port Police. The Port Police are responsible for policing Los Angeles Harbor (which is one of the busiest in the country). Mr. Boyd has been Chief since November 2004 (and has been head of emergency management at the port since January), but he’s now on paid administrative leave. That’s because he’s been indicted on 16 counts of corruption and tax charges.

Chief Boyd is alleged to have been involved in obtaining a port contract to a software company where he would share in 13.33% of the profits. Chief Boyd is alleged to have lied to FBI agents during the investigation. The contract was for a smartphone app called “Portwatch.” The problem is that Chief Boyd allegedly didn’t reveal that he was going to receive that kickback.

Adding to his woes are tax charges. Chief Boyd is alleged not to have filed tax returns from 2008 to 2011 for his security business and to have substantially underreported income on his personal tax returns from 2007 to 2011.

Chief Boyd will be surrendering to authorities this coming week.

Cleveland Already Has Two Losses Five Months Before the Season Begins

April 30th, 2015

Pity the poor folks of Cleveland, Ohio. I actually went to a baseball game at old Municipal Stadium, or the Mistake on the Lake. Today the Ohio Supreme Court dealt the city of Cleveland two losses–and the NFL season won’t begin for five months.

It’s perhaps apropos that on the eve of the NFL draft the tax cases of Jeff Saturday (formerly of the Indianapolis Colts) and Hunter Hillenmeyer (of the Chicago Bears) were decided by the Ohio Supreme Court. Cleveland, like many municipalities and states, imposes a “Jock Tax” on nonresidents. This impacts everyone from athletes to professional poker players. If you’re a resident of, say, Florida but you have income from Cleveland, you get to file a Cleveland tax return.

Both Mr. Saturday and Mr. Hillenmeyer challenged how Cleveland imposed its tax. Cleveland used a games-played method rather than a duty-days method. Cleveland said one game represents one-twentieth of your income (16 regular season games and four preseason games); thus, you owe that times your salary times Cleveland’s tax rate.

Mr. Saturday’s case was the more egregious of the two. During 2008 “More than 72,000 other souls attended the Colts’ dismal 10-6 victory over the Browns.” Mr. Saturday didn’t step foot in Cleveland; he was injured and attended physical rehabilitation in Indianapolis. Mr. Saturday contended that Cleveland has no authority to impose its tax on the income of a nonresident who did not work within Cleveland’s city limits during the taxable year.

Amazingly, when Mr. Saturday appealed his case at the city level (through the Central Collection Agency, Cleveland’s tax administration authority, the Cleveland Board of Review) and at the Board of Tax Appeals (the state level for tax appeals), he lost. Luckily, the Ohio Supreme Court used some common sense.

The second potentially significant passage in the regulation is the part that describes the ratio for allocating income to Cleveland for tax purposes. Both in constructing the numerator and the denominator for the games-played calculation, the regulation includes games the athlete “was excused from playing because of injury or illness.” Cleveland argues that because Saturday was “excused from playing” the Cleveland game, the tax applies to him under this provision.

This argument is unavailing for the simple reason that nothing in the regulation addresses the additional significant fact of Saturday’s complete absence from the city of Cleveland at the time of the game (and at every other time during the year). Had Saturday traveled to Cleveland with the team and been “excused from playing,” the language of the regulation might support imposing the tax. But here, Saturday was not even present at the game, and the regulation says nothing about what to do when the athlete is not even in the city where the game is being played. Thus, the regulation is at best ambiguous as to whether the tax is levied on Saturday.

At least two canons of construction militate against Cleveland’s expansive interpretation of the city’s income-tax law, given that the record here shows not only that the taxpayer was not in Cleveland on game day but also that he was performing job duties in another city on that day. First, it is a central tenet of tax jurisprudence that “a statute that imposes a tax requires strict construction against the state, with any doubt resolved in favor of the taxpayer.” Second, Cleveland’s interpretation violates the “implied condition of all statutes relating to taxation that they have no extraterritorial effect.” Quite simply, Saturday’s absence from Cleveland and his performance of duties elsewhere on the same day raise a strong suggestion that the imposition of Cleveland tax would constitute extraterritorial taxation. [citations omitted]

Mr. Saturday will be getting a full refund of his tax.

Mr. Hillenmeyer’s case is a bit different; he played in games in Cleveland in 2006, 2007, and 2008. The question is not whether Cleveland can tax him (he definitely earned income working in Cleveland); rather, it’s how the tax should be calculated.

Being a professional football player involves lots more than just showing up at games.

Hillenmeyer’s statements were corroborated by the affidavit testimony of Cliff Stein, senior director of football administration and general counsel for the Chicago Bears. Stein confirmed that under the NFL standard player contract and from the time that Hillenmeyer joined the Bears in 2003, he was required to “provide services to his employer from the beginning of the preseason through the end of the post-season, including mandatory mini-camps, official preseason [sic] training camp, meetings, practice sessions, and all preseason, regular season, and post-season games.” Stein also stated that “[t]he compensation Hillenmeyer receives from the Bears is paid for all of these services and not only for games played” and that “[f]ailure to comply with these contractual requirements would subject Hillenmeyer to termination pursuant to Paragraph 12 of his NFL Player Contract and/or fines under Article VIII of the Collective Bargaining Agreement.”

Though Mr. Hillenmeyer challenged the right of Cleveland to tax him (he lost that argument), he challenged the games-played method as a violation of his constitutional rights. The Ohio Supreme Court agreed:

Although we decide that Cleveland has the power to tax nonresident professional athletes without allowing them the benefit of the 12-day grace period, we hold that the games-played method of determining the tax base fails to afford due process when applied to NFL players like Hillenmeyer.

The Due Process Clause of the Fourteenth Amendment to the U.S. Constitution states that “[no] State [shall] deprive any person of life, liberty, or property, without due process of law.” Cleveland’s power to tax reaches only that portion of a nonresident’s compensation that was earned by work performed in Cleveland. The games-played method reaches income that was performed outside of Cleveland, and thus Cleveland’s income tax as applied is extraterritorial.

In guarding against extraterritorial taxation, “[t]he Due Process Clause places two restrictions on a State’s power to tax income generated by the activities of an interstate business.” The first is to require “ ‘some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax.’ ” The second restriction is that “the income attributed to the State for tax purposes must be rationally related to ‘values connected with the taxing State.’ ”…

Due process requires an allocation that reasonably associates the amount of compensation taxed with work the taxpayer performed within the city. The games-played method results in Cleveland allocating approximately 5 percent of Hillenmeyer’s income to itself on the basis of two days spent in Cleveland. By using the duty-days method, however, Cleveland is allocated approximately 1.25 percent based on the same two days. By using the games-played method, Cleveland has reached extraterritorially, beyond its power to tax. Cleveland’s power to tax reaches only that portion of a nonresident’s compensation that was earned by work performed in Cleveland. The games-played method reaches income for work that was performed outside of Cleveland, and thus Cleveland’s income tax violates due process as applied to NFL players such as Hillenmeyer.

Mr. Hillenmeyer will get a refund of the differential between the games-played method and the duty days method.

So it’s already been a bad day for Cleveland, and (as I write this) it’s two hours until the NFL draft and it’s five months before Browns fans can start chanting (as usual) “Wait until next year.”

Cases: Saturday v. Cleveland Bd. of Rev., Slip Opinion No. 2015-Ohio-1625 and Hillenmeyer v. Cleveland Bd. of Rev., Slip Opinion No. 2015-Ohio-1623

No Discount for her Sentence

April 26th, 2015

Michelle Morin of Laredo, Texas has prepared her last tax return. That was the minor part of her sentence. She also must serve 30 months at ClubFed. Why?

Well, Ms. Morin operated Discount Tax Service. Her clients were very happy with her methods, as they received tax credits and itemized deductions on their returns whether or not they qualified for them. While the tax loss to the federal government was more than $228,000, Ms. Morin did get a break in her plea deal that she has to make restitution on under 10% of the tax loss (just $20,146).

One thing that definitely led to the sentence was what happened with the fraudulent refunds. As noted in the DOJ press release,

As part of her plea, Morin admitted fraudulently claiming a false Schedule C loss in the amount of $83,184.00 for a non-existent online business on a on a taxpayer’s 2009 tax return. Morin also fraudulently reported $2,000 in residential energy credits that she knew the taxpayer was not entitled to claim. Subsequently, Morin improperly directed $2,000 of the false refund to her personal account.

Ms. Morin will report to ClubFed in the near future.

Don’t Call Us Continues

April 22nd, 2015

Back in the 1970s Saturday Night Live had this sketch of Lily Tomlin reprising her role as Ernestine the phone company operator (from Laugh-In):

That’s how I feel about calling the IRS. I have three matters I need to get resolved with the IRS. Today, the response I received when calling the IRS’s Practitioner Priority Service was, “Due to extremely high call volumes that option is not available now. Please try your call again later.” Well, I tried again later. And later. And later still. “We’re sorry, but due to extremely high call volumes that option is not available now. Please try your call again later.”

Meanwhile, we find out today that the IRS has deliberately cut customer service.

During the 2015 tax-filing season, the IRS provided what its own Commissioner described as “abysmal” customer service, blaming skyrocketing wait times for telephone and in-person assistance on agency budget cuts. The IRS even called budget cuts “a tax cut for tax cheats.” But a close review of the agency’s spending shows the IRS deliberately cut $134 million in funding for customer service to pay for other activities. Spending decisions entirely under the IRS’s control led to 16 million fewer taxpayers receiving IRS assistance this filling season. Other spending choices, including prioritizing employee bonuses and union activity on the taxpayer’s dime, used up resources that otherwise could have been used to assist another 10 million taxpayers.

The above quote is from the House Ways and Means Committee majority staff titled “Doing Less with Less: IRS’s Spending Decisions Harm Taxpayers.” There’s not much to add. If I can’t get through I’ll have to write follow-up letters; on one topic it will be my third letter without a response. On another, it’s been over one year without a response.

If anyone thinks the IRS’s budget will be increased for next year, they’re dreaming.

Of Deadlines and Taxes

April 21st, 2015

As I look back at April 15th I can draw some conclusions. First, thank goodness the IRS relented on the property regulations. There is no way tax professionals would have been able to prepare all of the required Change in Accounting Methods.

Second, this was the year of the impossible to reach IRS. I saw a statistic today that only 38.5% of callers received customer service from the IRS phone lines. That was true for tax professionals, too: I could not get through via the Practitioner Priority Service during the last three weeks of Tax Season. My usual trick, calling at 6:55pm PDT (right before they close), did not work.

Third, I don’t know what our deadlines will be for next year (that is, 2015 returns filed in 2016) but they will be earlier. I don’t know if I’ll go to March 1st, but it will be earlier than March 24th. I suspect it will be March 15th. We did get to every return where paperwork reached us by our deadline (March 24th), but we felt very pressured this year.

Fourth, I’m not happy with certain aspects of our tax software. Unlike Robert Flach who thinks that tax software is flawed and shouldn’t be used, I look at it as a tool that helps me do my job. However, this year some parts of it hindered my job and that’s not acceptable. Every three years I evaluate new software and this year is that year. I’ll absolutely be looking at other products for next year.

This definitely wasn’t the worst Tax Season I’ve gone through, but it was far from the best. For taxpayers, this likely was one of the worst. Unfortunately, I don’t see any improvements on the horizon. The light I see is the oncoming train not the end of the tunnel.