The Five “Strangest” Things Clients Told Us This Tax Season

October 18th, 2017

As I write this from an undisclosed location on my vacation, it’s now two days past the closing (for most of us) of the 2017 Tax Season (filing 2016 tax returns). Our clients told us some, shall we say, interesting things this year. Here are five lowlights:

5. “I sold things on the Internet, so I don’t owe state tax on it.” This client, call him Mr. Smith, sells products over the Internet. He’s a resident of a state with an income tax. “But Russ,” he said, “My customers use the Internet to purchase the products. This business isn’t located in my home.” Indeed, the products ship from Nevada, rather than his home state. Unfortunately, there are two arguments that outweigh his idea. First, he resides in a state with a state income tax; all of his worldwide income is subject to that tax. Second, he is conducting the business from his home: He directs it, manages it, and profits from it. His business may be conducted over the Internet, but it’s conducted by him in his home (in his home state). He eventually came around to paying state income tax. I did offer him a solution: Move to Nevada or some other state that doesn’t have a state income tax. His wife didn’t like that idea.

4. “I don’t want to file the New York tax return, even though I’m getting a full tax credit on my California return.” Mrs. Jones didn’t like it when her employer withheld New York income tax for a four week stint she did working in the Big Apple. “I’m a California resident; how dare New York tax me!” I asked her if she did spend that time in New York. She did. I explained she would get a full tax credit on her California tax return for the New York tax. She didn’t care. I then explained that if she didn’t pay the tax (after withholding, there was a small balance due to New York) she’d get a bill for penalties and interest in a couple of years, and she would pay a lot more than if she simply filed the return. She would also then have to amend her California return to get the tax credit; that would incur additional fees from me. That last point caused her to change her mind.

(The issue of nonresident taxation is a big one, though. Congress has been looking at making the rules for such taxation uniform, and that would be a godsend to both taxpayers and tax professionals.)

3. “I only had the foreign bank account for one week. I don’t want to file the FBAR.” A client inherited money in Spain; the money was moved into a Spanish bank account for exactly one week before being wired to her US account. Since the funds weren’t taxable (gifts aren’t taxable to the recipient) nor was it reportable (gifts from foreign individuals can be subject to reporting but this gift wasn’t large enough to trigger that) she felt it was none of the government’s business that she inherited funds. I explained that Congress felt otherwise. She didn’t care. I then told her there’s a minimum $100,000 penalty for willingly failing to file the FBAR. She then asked me how it was filed.

2. “The side income was only $30,000. Doesn’t that qualify for the de minimis exception to reporting income?” My response was simple: There is no de minimis exception to reporting income. (And even if there were, $30,000 is likely not de minimis.)

1. Twice I heard, “The 1099 never showed up. I don’t have to report the income, right?” Wrong: All income is taxable, no matter if you receive paperwork or not.

We have a bonus lowlight, too. An individual who I effectively turned down as a client apparently read up on Irwin Schiff. The late Mr. Schiff argued that the income tax was unconstitutional, and various other incorrect arguments about how one can legally stop paying the income tax. He was correct in that anyone can stop paying income tax; he was incorrect in saying that one can do that legally. Mr. Schiff died at ClubFed.

In any case, this unnamed individual called me and asked me if I believe in following the law on taxes. I do, of course. He then said that he was looking for a tax professional who believed in the law. So far, so good. He then said that since he had read that the income tax was voluntary he was only going to pay tax on a fraction of what he made; and he wanted me to prepare such a return. I told him that as long as the fraction was equal to 100% of his income, I’d be happy to do so. Strange, I never heard back from him.

I’ll likely have some serious thoughts about the Tax Season that was next week when I get back from my all-too-brief vacation.

California Fire Victims Have Extension Until January 31, 2018

October 13th, 2017

The IRS announced today that California wildfire victims have until January 31, 2018 to file various tax returns (including tax returns on extension due this coming Monday, October 16th). California’s Franchise Tax Board (the state income tax agency) immediately followed suit. (California automatically allows extended time for victims of any presidentially declared disasters, including the recent hurricanes.)

Dead Men Tell No Tales, Even When They’re Supposed To

October 8th, 2017

For tax practitioners, the IRS’s e-Services suite of applications is extraordinarily useful. When a client give us the appropriate authorization we’re able to pull transcripts from the IRS’s computer system. This helps us file appropriate tax returns and it helps the IRS because we can file the returns.

Early last week I attempted to run a transcript for a deceased individual. I was authorized by the Executor of the estate and filed all appropriate paperwork with the IRS. When I attempted to obtain a transcript I was directed to call the IRS’s Practitioner Priority Service rather than just being able to print the transcript. It turns out the IRS has ‘locked’ about 64 million tax returns of deceased individuals as a security measure.

Neither PPS nor the IRS’s e-Services help desk was aware of this change. The news came from a fellow Enrolled Agent who was told about this from his IRS Liaison. And while I understand why the IRS has done this their implementation leaves something to be desired.

Consider John Smith, a widower. Mr. Smith has given a CPA authority (via a Tax Information Authorization) for tax years 2014-2016. Mr. Smith passes away on August 1, 2017. His authority passes away with him, and it makes sense that the IRS doesn’t allow that CPA to run transcripts. However, Mr. Smith’s Executor gives me authority. (This is done by having the Executor sign a new Tax Information Authorization and the Executor must give the IRS proof of his authority through completing Form 56.) So why must I call PPS to obtain the transcripts? It’s not as if PPS is going to do anything different than the automated checking that is already done through e-Services.

But that’s the good case. Now consider Mary Doe. Her husband John Doe passed away in 2006 (that’s 11 years ago). Ms. Doe has been filing as single for a decade. Ms. Doe signed a Power of Attorney in 2016 as she’s dealing with an IRS automated underreporting notice issue. I needed to run a 2015 transcript to make sure the IRS has appropriately applied a payment. I was unable to do that through e-Services because her account has now been linked to her late husband. (I was able to run these transcripts in the past through e-Services.) This is a true story (other than the names).

PPS duly ordered the transcript for me but I was in for a surprise when it came: It was for her late husband’s tax account. Unless there’s something about the great beyond that I don’t know about he is no longer too concerned with the IRS. I called PPS up and there is now no way for me to obtain an account transcript for Ms. Doe! According to PPS, once an account has been linked it cannot be unlinked! (PPS told me that the payment has been correctly applied. However, given that it was misapplied twice in the past I wish I could run that transcript.)

Come on, man! IRS, this is completely ridiculous. After the year of Mr. Doe’s passing there’s no reason for the two accounts to be linked. Additionally, there’s no reason tax professionals should have to call to obtain transcripts we’re authorized for. It would seem to me to be a simple programming fix: If the authorization is dated after the date of death (and it’s valid), allow the practitioner to just print the transcripts from e-Services.

Unfortunately, tax professionals now have to waste more time on the phone for no particularly good reason.

Can a Tunnel Bridge Agent be a Professional Gambler, Too?

October 2nd, 2017

The Tax Court looked at whether someone who worked full time as a Tunnel Bridge Agent could also be a professional gambler. There is a lot in the decision, including some things that I believe the Court gets wrong.

The opinion first describes the differences between being a professional gambler and an amateur gambler. If you are unaware of the differences in the tax treatment, this opinion is must-reading. Unfortunately, the opinion gets the definition of a professional gambler only half-right. “To be a professional gambler, the taxpayer must engage in gambling for profit,” is what the opinion states (citing Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987)). But the courts have held that you need to be gambling for your livelihood, a stricter standard. There are numerous amateur gamblers who do so for a profit (I am one of those), but I’m an amateur gambler. My livelihood comes from my tax practice, but I’m skilled (or lucky) enough to make money from poker.

In any case, today’s taxpayer, Mr. B, doesn’t even pass this test. His first problem is where he gambled and his recordkepping or, should I say, his lack of recordskeeping.

Boneparte gambled at horse racetracks and in casinos. At the casinos his preferred game was baccarat, but he also played other table games as well as slots. Sometimes he gambled alone, and sometimes he gambled with a friend. He gambled primarily in Atlantic City. He did not keep a contemporaneous written log of winnings and wagers.

If you’re in business, you are supposed to keep records. The IRS rules on gambling—and these date back to the 1970s—mandate a contemporaneous, written log. (Remember, those rules were written well before smartphones or any cellphone. Today, computer records would most likely be accepted.) But if you have no records, you’re going to have trouble substantiating that you’re a professional gambler. Yes, Mr. B had casino win-loss statements but (a) these are not guaranteed to be accurate (a point the Court missed in its opinion), and (b) professionals want to know what they’re succeeding in and failing in; the only way to do that is to keep your own records.

As an aside, it’s hard to be a professional gambler when you are playing games of pure chance with a house (casino) advantage. That’s why most professional gamblers play poker (where you’re playing against other players); a lesser number of professional gamblers partake in sports betting and “advantage” video poker (where there’s a small player advantage with perfect play). But I digress…

The Court then looked at the nine-factor test of whether an activity is engaged in for profit.

(1) [T]he manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation.

Mr. B. didn’t lose on all of the factors: Factor #4 (expectation of asset appreciation) was held not to apply. With the Court ruling that Mr. B. Isn’t a professional gambler, most of the rest of the opinion goes into calculation issues of his return and penalty calculations.

However, I want to point out an error the IRS made that I’ve seen in my practice. If a casino win-loss statement shows a net loss $14,887, and we know that the gambler had gross wins (before losses) of $18,000, his gross losses must be $32,887. That’s simple math. I once had to explain to an IRS Revenue Agent how this works; it took about a half-hour for him to grasp the concept. In this case, the IRS was holding this same idea that Mr. B’s gross loss was his total loss. The Court, though, understood basic math:

As explained above, two propositions are true: (1) the gains from wagering transactions for which there was gain total $18,000, and (2) the gains from wagering transactions for which there was a gain minus the losses from wagering transactions for which there was a loss equal -$14,887. It mathematically follows from these two propositions that the losses from wagering transactions for which there is a loss equal -$32,887 (i.e., $18,000 ! $32,887 = -$14,887). [Mr. B] is entitled to a section 165(d) deduction equal to this amount to the extent of gains from wagering transactions. This gain is $18,000. Therefore his section 165(d) deduction is $18,000.

Mr. B’s returns were self-prepared. He included his gambling on both a Schedule C and as Other Income. In almost all cases, you’re either a professional gambler or an amateur gambler (not both). The IRS assessed both the late filing penalty (Mr. B’s return was postmarked after the April deadline) and the accuracy-related penalty; both were sustained.

Mr. B gives a good example of someone who wanted to be a professional gambler because it would help him save on his taxes. Unfortunately for him, he neither treated his business professionally nor was he able to show the Tax Court that he was a professional gambler.

It’s One 1099 Per Person, Or the Most Stupid and Hilarious Thing I’ve Seen in Some Time

September 29th, 2017

One of my clients, Barri Brown (all names in this post are fictitious), was missing a 1099 issued by one of the two large Daily Fantasy Sports (DFS) companies. It didn’t show on her Wage & Income Transcript, so she called their accounting department and requested a copy. A few days later they emailed it to her. She forwarded it on to me and I entered it into her return.

And then I took a look at the pdf and saw that it was 18 pages long. I wondered what kind of attachments this company would send on a 1099? Perhaps a breakout of state tax issues (although that didn’t apply to my client). Or perhaps some internal accounting records detailing Ms. Brown’s profits and losses.

How about the 1099s for everyone this company serviced with the last name of Brown? The second page is that of Brett Brown, the third page is Daniel Brown, etc. At least only the last four digits of the social security numbers were shown (but both my client and I know the exact amount of Brett Brown’s DFS income from this site in 2016).

In one way, this is hilarious. Apparently it was easier for that clerk to email the 1099s for all the Browns to my client than to just send the specific 1099. (I have to wonder about how they create their 1099s, but that’s a question for another day.)

In another way, it’s stupid. Hasn’t this company heard of privacy concerns and laws? My client has every right to know her income, but absolutely no right to know Brett Brown’s income (unless Mr. Brown elects to tell one of us).

But my client asked a very good question. “That is HILARIOUS and absurd and maybe illegal?” I’m not an attorney, so I can’t state with certainty whether this was a violation of the law. The reality is that this was almost certainly a stupid error, and there wasn’t the intent to do something illegal.

(Tax professionals fall under the provisions of the Federal Trade Commission Act. If a tax professional were to deliberately do this, it definitely could be a violation of the FTC Act.)

Unfortunately, the data breach at Equifax and this act of stupidity reinforce my belief that businesses need reminders to treat data security very seriously. My client used an Employer Identification Number (EIN) with the DFS company; I strongly recommend that sole proprietors (like my client) do that whenever possible. A stolen EIN (for a sole proprietor) can’t be used to file a personal tax return.

Let me give a helpful hint to those issuing 1099s and sending them out: It’s one to a customer. Barri Brown doesn’t need Steven Brown’s 1099. Luckily for this company, my client is able to laugh this off (as am I). The problem is that if this happened to Ms. Brown, it likely happened to Mr. Nelson and others.

IRS Suspends ASFR Program

September 26th, 2017

Via Procedurally Taxing comes news that the IRS has suspended the Automated Substitute for Return (ASFR) program. This doesn’t sound like much, but this is huge news.

First, for those who aren’t tax geeks, the ASFR program is an automated program to prepare substitutes for tax returns if you don’t file one. Let’s say you have five 2016 1099-MISC’s received totaling $100,000. You foolishly decide not to file a tax return. The IRS will prepare a return for you, making assumptions about your marital status (you’re single) and your business and itemized deductions (none). The IRS then sends you a copy of the return demanding money, adding in penalties (late filing, late payment) and interest. Many people who get ASFRs file tax returns to replace the ASFR; others write the IRS. All of these have to be reviewed by humans. Others simply ignore the IRS and then get a notice of deficiency (which can be appealed to Tax Court).

Presumably the IRS has concluded that the money raised by the ASFR program has not offset the costs of the program. That’s the conclusion of Carl Smith on Procedurally Taxing and my conclusion, too.

Does this mean that you don’t have to file tax returns? Definitely not. If you don’t and the IRS catches you, you will still be subject to all the possible penalties; additionally, non-filing of tax returns is a crime.

As a tax professional, I’m not a fan of the suspension. Sure, this program may have been overall a cost center; however, it likely forced noncompliant individuals in to compliance—and that’s the goal of the IRS (current compliance). Overall, this change seems to me to be a shocking mistake.

Prepare to Panic!

September 25th, 2017

Today is Monday, September 25, 2017. Exactly three weeks from today is Monday, October 16, 2017. That’s the deadline for individual taxpayers on extension to file their tax returns (save for those in hurricane disaster zones in Florida, Georgia, Texas, Puerto Rico, and the Virgin Islands). If you have yet to send your paperwork to your tax professional it’s past the time to do so. Yes, it’s time to panic.

If your return is simple and straightforward, stop procrastinating and get it done and filed. If your return has any sort of complexities, you must start working on it now! Your tax professional needs time to get it done correctly. You need to turn in that paperwork post haste. If you’ve procrastinated, stop, sit down, and get it done.

It may already be too late for your return to be timely filed with many tax professionals. For example, our official deadline was last Wednesday. Luckily, we’re not behind so our procrastinating clients are still in good shape. However, that might not be the case with all tax professionals. And I can guarantee if you drop off your paperwork with us on October 13th your return is almost certainly not going to be timely filed.

If you file late, it’s as if you never filed your extension. So sit down and get everything done now! Of course, if you like paying a 25% penalty, simply procrastinate for another three weeks.

The Train to Nowhere Remains a Boondoggle

September 22nd, 2017

California’s high speed rail, aka The Train to Nowhere, remains likely to never carry passengers between Northern California and Southern California. Perhaps the segment linking Merced and Shafter (just north of Bakersfield) will run (although unlikely at high speed); more likely, it will never run. So the image that comes into my mind is the following:

via GIPHY

There have been some developments since I last reported on the train. First, the California Supreme Court ruled at the end of July that California law was not preempted by federal law and that a number of environmental suits against the high speed rail authority could continue.

Meanwhile, Quentin Kopp, the man who introduced the rail line, now calls the line foolish. In an interview with reason.com he said,

It is foolish, and it is almost a crime to sell bonds and encumber the taxpayers of California at a time when this is no longer high-speed rail. And the litigation, which is pending, will result, I am confident, in the termination of the High-Speed Rail Authority’s deceiving plan…

[The selling of bonds is] deceit. That’s not a milestone, it’s desperation, because High-Speed Rail Authority is out of money.

Ouch. Baruch Feuigenbaum, assistant director of transportation policy for the Reason Foundation, stated, “The costs of building [high-speed rail] projects usually vastly outweigh the benefits…Rail is more of a nineteenth century technology [and] we don’t have to go through these headaches and cost overruns to build a future transportation system.”

Look on the bright side Californians, the project will likely need subsidies from the state of only $100 million a year. That’s not bad, right?

Or better, I’m sure the 10 Shafterites looking to head to Merced each day will love the train (as will the 20 residents of Merced looking to head to Shafter each day).

Harvey and Irma Relief Includes the FBAR

September 13th, 2017

Taxpayers with $10,000 aggregate in one or more foreign financial accounts must file an FBAR (Report of Foreign Bank and Financial Accounts, Form 114) with the Financial Crimes Enforcement Network (FINCEN). FINCEN has announced on their website that they are following the IRS’s lead and extending the due date for account holders impacted by Hurricanes Harvey and Irma until January 31, 2018.

IRS Transcript Delivery System Failing for Many Users; No Fix Time

September 12th, 2017

One of the major tools I use is the IRS’s e-Services system; the component I use the most is the Transcript Delivery System (TDS). Last weekend, the IRS did a major “upgrade” of the system. I have to put upgrade in quotes because it’s been a downgrade for me and many other users. The system does not recognize that I have authority (a Power of Attorney or a Tax Information Authorization) on file.

The problem appears to be that the IRS must also migrate their Centralized Authorization File (CAF) database. This database is how the IRS keeps track of which returns (names, social security numbers, and tax years) tax professionals are authorized for. Unfortunately, the migration of this database hasn’t gone smoothly.

Until this is resolved tax professionals will need to call the IRS’s Practitioner Priority Service and request the IRS fax over any transcripts that are needed. I just had to do this and was on hold for only 11 minutes so it could be much worse.