Thank You, Joe Kristan

May 27th, 2017

Most mornings I begin my day by reading a few tax blogs. This has helped me learn what’s happening in the tax world. After all, there’s one of me so the more sets of eyes, the better. Joe Kristan had been publishing Roth Tax Updates for a long time–since 2002. Joe’s firm is merging into Eide Bailly in June, so, “As we begin a new adventure, I will need to spend extra time working to make our transition successful, so it’s time to bring the Tax Update to a close.”

Best of luck Joe, and perhaps there’s an Eide Bailly Tax Updates in the future. (I can always hope.)

Illinois and California Race for the Bottom

May 27th, 2017

It appears that Illinois and California are in a race to see which can impose the worst tax policies. The Illinois legislature is debating a “Privilege Tax;” California is debating single-payer health care. Neighboring states to each are likely envisioning plenty of businesses relocating if these measures pass.

The Illinois Privilege Tax is a proposed 20% tax on investment advisors. Let’s say I’m a hedge fund manager in Chicago and I have the Russ Fox Fund. I charge a fee for running this fund; under this proposal, 20% of the fee would be taxable to Illinois. What would prevent me from moving to Des Moines (Iowa), Indianapolis (Indiana), or Nashville (Tennessee) and running the same fund? Absolutely nothing. If this proposal passes, the financial services sector will join lots of others in fleeing the Land of Lincoln.

Meanwhile, the Bronze Golden State is debating single-payer health care. It passed a Senate Committee, but there’s a major issue: The plan would cost $400 billion (that’s “billion” with a b, not million), far more than the state’s current budget. While $200 billion of it could come from repurposing current expenditures, $200 billion would need to be raised. How about a 15% payroll tax and self-employment tax on the state level? That would make California’s tax rate 28.3% on the highest earners! The proposal would cover anyone and everyone living in California, including those here illegally.

If this passes, there’s no doubt in my mind that businesses that could would relocate to neighboring states while any freeloaders who could would move to California. The self-employed who could move would do so immediately: Live in California, pay an additional 28% in tax, or live in Las Vegas and pay 0%? Or Arizona and pay 4%? Or, well, I think you get the picture.

There aren’t many good answers on healthcare, but there are plenty of bad ones. California appears to have chosen one of those. (Yes, single-payer can work but it would have to be implemented nationally to work, not in one state.)

Exchanging One Cryptocurrency for Another Is a Taxable Event

May 27th, 2017

Let’s assume I own some Bitcoins and you own some Ethereum; these are two cryptocurrencies. We think they’re each worth $5,000 and we agree to swap them. Do we have a taxable event?

The IRS consideres cryptocurrencies to be akin to stocks and bonds. That means any time I sell or otherwise dispose of cryptocurrency I have a realized capital gain or loss. A client was told by a cryptocurrency trader that exchanging one cryptocurrency for another is not a taxable event. That individual is mistaken.

Let’s look at an analogous situation: You and I each own $5,000 worth of a stock (say General Motors and Ford). We swap stocks. I no longer own Ford, so I have a gain (or loss) on my Ford stock; you have a gain or loss on your General Motors stock. No one can successfully argue that this swap doesn’t result in a taxable event for each of us.

As I said swapping one cryptocurrency for another is analogous. Is a Bitcoin identical to an Ethereum? No; they’re each different cryptocurrencies. If you sell or dispose of a cryptocurrency, you have a taxable event. It’s very clear that such swaps absolutely must be reported on Schedule D.

WSOP and Taxes: 2017 Update

May 22nd, 2017

The poker world is about to descend on Las Vegas for the World Series of Poker (WSOP) and a score of other tournament series. The tax environment has changed, so I’ve decided to do a thorough update of the tax situation. I’ll cover the basics of the tax situation, backing, foreign (non-US) backing, and non-American winners and what they will face with taxes. This post will be somewhat long, so I’m going to break this into sections that you can click on to open. The focus is on tournaments where tax paperwork is issued.

The Tax Basics

Backing by Americans of Americans

Backing: Non-Americans

Non-Americans and ITINs

[Note 1]: I recently became aware of a lawsuit in the Midwest where Caesars’ policy is being challenged. The lawsuit is scheduled for trial in late January 2018.

[Note 2]: It is likely the IRS would reject a Form 1040NR filed by Jon noting his extra withholding. The IRS won’t understand the issue given that there is no tax treaty issue (say, Jon is from Australia) and say, “Take it up with Caesars.” It’s a classic Catch-22.

[Note 3]: In prior years the WSOP has allowed winners to leave their money with the WSOP and obtain their winnings later. Anyone choosing this option should confirm with the WSOP that this can be done.

Do You Need a License to Sell Bitcoins?

May 15th, 2017

Let’s say I own some Bitcoins. I want to sell them to a friend. Do I need a license to do that? This question came up after I was informed that a Missouri man pleaded guilty to operating an illegal money transmitting business.

First, a disclaimer: I am not an attorney. For legal advice, go speak to an attorney specializing in money transmittal law. I am not that person.

If you are in the business of exchanging currency for currency, you need a money transmittal license. Let’s say you open a check cashing store; you may need that license. These licenses are generally on the state level and possibly also from FINCEN (the Financial Crimes Enforcement Network). So clearly Bitcoins, which are property for tax purposes, aren’t a currency, right?

Not so fast. Bitcoins are property in the world of the IRS, but in the view of FINCEN they’re a currency. Bitcoin advocates consider Bitcoins to be a digital currency (or a cyrptocurrency). So two different units of the same government agency (the IRS and FINCEN both fall under the Department of the Treasury) treat the same thing quite differently.

So let’s say I have lots of Bitcoins, and I trade them with a US Bitcoin exchange such as Coinbase. Do I need a money transmittal license? My thinking is no: Coinbase is a licensed money transmittal business, so my selling to them is part of their business.

Let’s say my Aunt Rose gave me five Bitcoins and I sell them to my friend Scott. It’s the only transaction I have in Bitcoins. It’s hard to see how I’m in the business of selling Bitcoins.

On the other hand, suppose I’m a poker player who does quite well on a poker site such as Ignition, and every month I receive some Bitcoins. Rather than selling them to an Exchange I decide to start selling them to others and make more money. That sounds like a business to me, and it might to the US government, too. In that case you should consider speaking with an attorney immediately to determine if what you’re thinking of doing complies with federal, state, and local laws.

Back in the days when Neteller was serving US poker players one of my clients considered going into business facilitating other poker players being able to move money from poker site to poker site. He had a lot of money on Neteller so he was able to deposit money onto (say) Absolute Poker and, in exchange, take money from PokerStars. When he spoke with me I mentioned to him that this might run afoul of the money transmittal laws and strongly suggested he speak with an attorney. The attorney he consulted advised him that my instincts were accurate. I suspect if someone were facilitating such Bitcoin transfers today this, too, would also run afoul of the money transmittal laws.

Getting back to my original question: Do I need a license to sell Bitcoins to a friend? The answer is likely no. But if I go into the business of selling Bitcoins the answer appears to be yes.

The TurboTax Defense Fails Again

May 11th, 2017

A gentleman who is normally an expert witness in trials used TurboTax to prepare his returns. His returns ere reviewed by the IRS; the IRS claimed he took a few too many deductions. The taxpayer felt otherwise, and the dispute ended up in Tax Court. Judge Holmes wrote the opinion, so it’s very readable.

The first issue was alimony payments. Alimony is deductible for the payor but taxable to the recipient. However, one of the requirements is that there be a written order. The taxpayer and his ex-wife had an oral modification of the agreement. That may work for getting the ex-wife more money, but it fails for deducting those extra payments.

The second issue was interest. Interest that’s part of a business can be deducted, but you do have to show you made payments and those payments were interest and not principal. I’ll let Judge Holmes take this:

The evidence does show [he] made payments to his lender, but the amounts do not match those that he claimed on his tax returns, and he did not explain this discrepancy at trial. [He] also did not provide us with any business records regarding the loan, any loan statements, or any loan-repayment schedules. Without this type of documentation we are unable to tell whether these payments were made on the original 2007 loan. Remember that the note for that loan says it should have been paid in full by October 2008. We understand that it might have been his plan to pay the note with proceeds from the sale of his home, and that that sale didn’t happen. The problem is that we can’t figure out what happened to the note–was it refinanced? Was it extended? Without any paperwork (in a situation where there should have been lots of paperwork) we are left only with his testimony about the total amounts of the payments and the allocation of those payments between principal and interest. We do not find his testimony credible on this issue, and so sustain the Commissioner’s determination.

As I tell my clients, document, document, document (and save those records). A paper trail is a very good thing to have when you get to Tax Court.

The third issue was an apparent Net Operating Loss (NOL) carryforward.

A taxpayer substantiates his claim to such a deduction by filing with his return “a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the net operating loss deduction.” During trial he did turn in a tax return for a previous year (though not the one that generated the net operating loss), but even with his testimony, that is not enough to substantiate his entitlement to a loss carryforward.

The taxpayer also received an accuracy-related penalty.

The burden then swings to [him] to show that his mistakes were reasonable and in good faith. See sec. 6664(c)(1). He cannot. He admitted during trial that he deducted items he shouldn’t have, and that he overstated certain losses. He tried to blame TurboTax for his mistakes, but “[t]ax preparation software is only as good as the information one inputs into it.” [citation omitted]

If your tax return has only W-2 income and, say, mortgage interest and property tax, TurboTax will likely do an excellent job. If you have a divroce settlement with a restatement of the amount of alimony due, interest tracing, and a Net Operating Loss carryforward, it might pay to get some expert help.


Case: Bulakites v. Commissioner, T.C. Memo 2017-79

No, The Law Hasn’t Changed: Professional Gamblers Cannot Deduct Gambling Losses in Excess of Wins

May 7th, 2017

The Internal Revenue Code (IRC) is law. It was passed by Congress and signed into law by the President. One section of the law is IRC §165(d). It reads:

(d) Wagering losses
Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.

Courts have interpreted this the same for amateur and professional gamblers: You cannot take gambling losses in excess of wins. A few of my professional gambling clients have asked me if the law recently changed (they were told it had). It has not changed.

The Tax Court most recently looked at this in 2014. In Lakhani v. Commissioner (142 T.C. No. 8), a full precedential decision of the Tax Court, the Court wrote,

The basis for the enactment of section 23(g), as set forth in the last sentence of the foregoing committee report, still pertains to taxpayer reporting of gambling gains and losses. Therefore, it still constitutes a “rational basis” for the continued application of section 165(d) to the losses. There being no constitutional impediment to the continued application of section 165(d), we reiterate our admonition in Tschetschot that this Court “is not free to rewrite the Internal Revenue Code and regulations * * * [but is] bound by the law as it currently exists”. [footnote omitted]

(For those wondering, Section 23(g) is from the Revenue Code of 1934 and reads identically to Section 165(d) of the current IRC.)

Is it fair that a professional gambler is held to a different standard than anyone in a different profession? Definitely not. However, it’s the law; until Congress changes it I can take a Net Operating Loss if my business loses money but a professional gambler cannot.

Another client asked about running gambling through a business entity so that he can take losses that way. That, too, will not work. Put simply, until IRC §165(d) is repealed gamblers cannot take losses in excess of wins.

Trump’s Tax Plan

April 30th, 2017

President Trump released his tax “plan.” That’s an overstatement; the plan is really an outline. Gone would be the Alternative Minimum Tax, the Estate Tax, and most itemized deductions; there would be three tax brackets with the top tax bracket at 35%; the corporate tax rate would fall from 35% to 15%; and the top capital gain tax rate would be 20%.

The outline is one page, and is more a statement of goals than anything else. There are definite issues that I have with it in my area of expertise: gambling. And overall the results wouldn’t be good for most gamblers.

For professional gamblers, there would be no direct changes. Professional gamblers report their income on a Schedule C; there’s no change here. However, amateur gamblers could be devastated by the proposal. Consider an amateur gambler who correctly reports his $100,000 of winning sessions and $80,000 of losing sessions. Under current tax law, he pays tax on $20,000 of net winnings (his gambling losses are an itemized deduction on Schedule A). Under President Trump’s plan, he would pay tax on $100,000 of winning sessions; his gambling losses wouldn’t be deductible. This would have a devastating tax impact on gambling.

There is an easy fix for this, and it comes from a state not known for having a good tax system—New Jersey. Add in a Schedule G for gambling, where gambling wins and losses for an amateur gambler would be listed; the net would flow to Other Income where it would be taxed.

The final result of tax reform won’t be known for months, and it’s probable what emerges from Congress won’t look anything like what’s been proposed.

While I Was Out: The BOE Is In Deep Trouble

April 26th, 2017

California has not one but three tax agencies. The Franchise Tax Board (FTB) administers income tax. The Employment Development Department (EDD) administers payroll taxes. And the Board of Equalization (BOE) administers sales tax (and a few other miscellaneous taxes and fees); the BOE also hears appeals from the Franchise Tax Board. Most states have one tax agency but as Scott would say, “California.” Until this year the most notoriety the BOE has received was over its building. That changed last month when the California Department of Finance released a scathing audit report on the BOE.

The Executive Summary notes,

…Specifically, certain board member practices have intervened in administrative activities and created inconsistencies in operations, breakdowns in centralized processes, and in certain instances result in activities contrary to state law and budgetary and legislative directives.

During our evaluation, BOE had difficulty providing complete and accurate documentation in response to our evaluation inquiries and in some instances various levels of management were not aware of and could not speak to certain district activities for which they held oversight responsibilities. Specific examples include the informal establishment of a call center, creating an unofficial office location, and inconsistent use of community liaisons.

This sounds bad. It looks like the BOE is ignoring its budget, violating the law, and ignoring the legislature. Continuing:

In addition, staff resource utilization practices have negatively impacted personnel and accounting records. These records do not accurately depict current operational activities. Despite having dedicated staff and operating budgets of $1.5 million, some board members routinely supplement their staff by redirecting revenue generating staff to perform non-revenue generating board member activities, including outreach activities. These redirections violate Provision 1 of the Budget Act. Additionally, BOE is unable to accurately reflect revenue and cost impacts in its accounting records and Annual Report on Sales and Use Tax Audit and Collection Activities, Statewide Compliance and Outreach Program and Audit Selection Improvements (supplemental annual report).

Yikes! They’re spending money when they’re not authorized to. But I’m sure they’re handling their core function, collecting sales tax, just fine. Right?

Lastly, BOE provided 11 different versions of its proposed sales and use tax allocation adjustment and with each version, Finance continued to find errors and omissions. Since the proposed adjustment continues to change and BOE has not prepared a comprehensive explanation of its assumptions and methodologies, further review of the proposed allocation adjustment is imperative.

The report is devastating, and the reactions have been uniform across both sides of the aisle in Sacramento. Governor Brown has sanctioned the agency. Democrats and Republicans in the legislature are asking tough questions.

This isn’t the first time the BOE had a problem with money. As the San Francisco Chronicle noted in an editorial, the BOE mishandled $47.8 million in sales tax money back in 2015.

Several years ago (when I resided in California) I suggested that the FTB and BOE should merge. I wouldn’t be surprised if that now becomes reality.

That Was the Tax Season that Was

April 23rd, 2017

April 15th, err, make that April 18th, has come and gone. Every Tax Season is different, and this one had its ups and downs. So let’s take a look at eight observations I have of the first part of the 2017 Tax Season:

1. The IRS did a good job with telephone service for tax professionals. My average wait time on hold with the Practitioner Priority Service was three minutes. That’s superb. I was told by several agents that the IRS added personnel to help tax professionals. That made my life easier, but…

2. The IRS didn’t do as good a job with taxpayers. I had a couple of clients who called the IRS note the hour-plus hold times.

3. The new law mandating interviews with taxpayers claiming the Earned Income Credit, the Child Tax Credit, and the American Opportunity Credit is annoying for tax professionals and will only stop the lowest of low hanging fruit of tax cheats. Most tax professionals know their clients, and simply aren’t committing tax fraud. My clients were more bemused than anything else with some of the questions I had to ask about their children.

4. More of my clients filed without extensions than in the past. This result appears to differ from the national average (the latest report I saw was that there were five million fewer returns filed year-to-date than last), and differs from the long-term trend that I’ve seen the last few years (that more returns were going on extension).

5. The new FBAR deadline will make my life far easier. Officially, the deadline coincides with the tax filing deadline, but there’s an automatic six-month extension. This will allow FBARs to generally be filed coincidentally with tax returns.

6. It would be impossible to run our tax practice without using tax software; however, tax software isn’t a panacea for thinking about the returns themselves. I’ve seen some self-prepared returns this Tax Season that were, to be kind, amusing. Tax software is great in automating the mundane but not so great in thinking for you.

7. We need tax reform, and soon. The Tax Code is far, far too complex. I’m now preparing returns that are close to “basic.” And I practice in a state where there’s no income tax. (Yes, I prepare returns for many states, but my local clients generally don’t have to deal with state income tax.) Yet these clients find the Code so complex that they can’t do their own returns.

8. Deadlines matter. Almost every tax professional I know sets deadlines for receiving paperwork from clients; ours was set at March 15th. We did get to many returns that came after that date, but for the client who wondered why I stifled a laugh when he dropped his paperwork off on April 17th and said he’d be in tomorrow to pick up his completed return. He’s on extension, of course. If you’re using a tax professional to prepare your returns, he almost certainly has also set a deadline for receiving paperwork prior to the October 16th extension deadline. You should pay attention to that, and get your paperwork in to your professional timely.

I’m hopeful my thoughts in October will be just as kind about the second half of the Tax Season; only time will tell.