Taxable Talk

In last November's election, voters roundly rejected a proposed light rail system here in Orange County. The CenterLine system would have linked Irvine, John Wayne (Orange County) Airport, and South Coast Plaza in Costa Mesa.

It's back. But only here in Irvine.

Last week, the Irvine City Council approved spending $5.6 million on studying an Irvine mass transit system. The proposed system would run 5.5 miles, exclusively in Irvine.

Apparently, the members of the council have not been listening to the voters—the same voters who keep rejecting light rail systems. It's unfortunate that the $5.6 million has been approved (and will be spent); it's a certainty that yet another ballot measure will happen and the voters of Irvine will, for the fourth time (I believe) say nyet to rail transit.

News Story: Los Angeles Times

What happens when you make a few bets and win? Well, besides ending up with more money in your pocket, you have something else to put on your tax return; gambling winnings are taxable in the United States and go on line 21 (Other Income) of Form 1040.

Many gamblers forget to tell their accountant about their winnings. The problems begin when you get caught as you can find yourself facing tax evasion charges. Cyrus Bland, of Campbellsville, KY was convicted on Thursday of filing false income tax returns. He played craps on riverboats in Indiana and came up a big winner -- to the tune of nearly $500,000 in 1998 and almost $450,000 in 1999.

But he didn't include his winnings on his tax return. And the IRS found out, and he's looking at a possible six years in prison and a fine of $500,000. Oh, he has to pay the back taxes, interest, and penalties, too.

Sure, the tax code isn't fair for gamblers. But I bet Mr. Bland is wishing he had paid the taxes on his winnings.


News Story: Central Kentucky News-Journal

Here's an interesting idea. Why not put a special tax on illegal drugs? If a dealer gets arrested, and they don't have a "crack stamp" on their cocaine, they'll go to jail for tax evasion and drug possession/selling illegal drugs. Drug dealers are promised confidentiality.

Believe it or not, such a tax exists in Tennessee. And Tennessee raised $2 million in 2005 from the tax; all the money raised goes to fighting illegal drugs.

Of course, all drug dealers must declare their drug dealing income on their tax returns, or they risk following in Al Capone's footsteps and landing in jail.

News Story: WBIR.com

...Next Stop: Prison

Richard Hatch, the first Survivor winner, was convicted today of failing to report $1,037,000 on his tax return. He was found not guilty of related fraud charges.

Mr. Hatch has cemented a place in the Bozo Tax Criminals Hall of Fame (a website I'll create one day). Let's look at his stupid not so good actions.

1. Hatch goes to accountant #1, find out that he owes over $300,000 in taxes. He goes to accountant #2, and the tax bill is around $240,000. (At his level of income, some differences in taxes owed is normal.) He then asks accountant #2 what his return would be if he didn't declare the $1 million in Survivor winnings. Accountant #2 makes Hatch sign a statement that he won't file that return (it showed Hatch getting a $4300 refund). He filed that return.

2. The IRS amazingly discovers his tax evasion. (With perhaps 300 million witnesses, even the most inept attorney could prove he won $1 million.) He's offered a plea bargain: pay your taxes, and we'll let you off fairly easily on the jail time. He accepts the plea initially, then changes his mind.

3. The case goes to trial. Hatch claims that CBS should have withheld taxes. His attorney might want to ask any seasoned accountant about what you should do if taxes aren't withheld but should have been. (Answer: you pay the taxes.)

4. Hatch's attorney can't find the OJ Simpson jury. (Hat tip: Roth Tax Updates)

5. Hatch is found guilty. Roth Tax Updates speculates that his sentence will be around 3 years in jail. Oh, he'll also have to pay those taxes, and interest and penalties. The maximum possible sentence is 13 years in prison and a fine of $600,000.

News Story: CBC
US Government Press Release
Roth Tax Updates post on Hatch's Sentence

Richard Hatch's fate now lies with a jury in Providence, RI.

Hatch, the former Survivor winner is either a greedy man who didn't want to pay the taxes he owed or he did the best he could to understand the tax code.

Unfortunately for Hatch, his accountants did tell him about the taxes he owed, according to testimony during his trial. One even made him sign a statement that he wouldn't file a return that didn't include his Survivor winnings. He promptly filed that return.

Hatch faces up to 73 years in prison and millions in fines if convicted. Jury deliberations resume Wednesday morning.

News Story: AP via the Boston Globe

There's been news of prisoners scamming the IRS by filing phony tax returns. Today we have the opposite happening—a tax professional and a jailer in Texarkana, AR allegedly filing phony returns using Social Security Numbers of prisoners.

The two were indicted by a federal grand jury and face 25 counts including filing false IRS claims. They allegedly only got $50,000 in phony refunds in 2003. That's $2,000 per count....

News Story: Texarkana Gazette

In my practice, I see a lot of S Corporations, but very few LLCs (I can count the number on one hand). Yet, according to Christopher Hoyt of the University of Missouri at Kansas City (writing in the TaxProf Blog), this is the opposite of what's being recommended in law school. So why the difference?

Hoyt notes the statistics, and presents a graph showing that S Corps remain twice as popular as LLCs (based on new S's vs. new LLCs). Joe Kristan of Roth Tax Updates then speculates on the reasons behind this. His points on salaries, and the uncertainty of how LLCs are to be treated for self-employment taxes are on point.

Kristan also notes that state issues have a material impact. He notes that in Iowa (his home state), LLCs are tax-disfavored (versus S Corps) for multi-state operations.

In California, there are two major factors working against LLCs. First, all S Corps and LLCs in California must pay a minimum state franchise (income) tax of $800 per year (or 1.5% of net income, whichever is greater). But LLCs also face a gross receipts tax, so LLCs in California are triple-taxed! The current minimum gross receipts tax (called an LLC fee) is $865 per year. Second, some businesses are prohibited from being in an LLC. These include professionals, such as architects and accountants. (They can form LLPs, though).

If you're at all interested in forming an LLC read the articles. They'll enlighten you about some of the tax issues facing LLCs.

Hat Tip: TaxProf Blog & Roth Tax Updates

The trial of former Survivor winner Richard Hatch on ten counts including tax evasion continues in Providence, RI. Today's New York Times has an excellent story on the trial, including reactions from some of his fellow contestants.

Hatch, who took the stand in his own defense on Friday, will return to the stand on Monday. Hatch claims that the producers of Survivor agreed to pay his taxes. However, his Form 1099 does not indicate this. Hatch faces up to 73 years in prison if convicted on all counts.

Over ten years ago, in the nearby City of Orange, a trash magnate was born. His name was Jeffrey Hambarian, and he was a hometown hero.

Mr. Hambarian had an interesting method of operating his business. He told his vendors that they had to make phony invoices and/or pad legitimate ones, and funnel most of the phony profits to him. He then laundered the ill-gotten gains through check cashing outlets.

This scam continued for some time, until an accountant noticed a problem during an audit. The accountant told the city, there was an investigation, and eventually Mr. Hambarian found himself convicted of 47 counts including grand theft and filing false income tax returns.

On Friday he was sentenced to 15 years in state prison and to pay $12 million in restitution. While his attorney complained that, "I don't know what warehousing him in a state prison would do," a prosecutor noted that, "...these are serious crimes." Usually, those found guilty of 47 felonies find themselves behind bars.

News Story: Los Angeles Times

Last year residents of Ohio who made estimated payments sent their payments in the second half of the year to San Francisco (the Fresno IRS Service Center). Well, Ohio has been moved (again), now to the Kansas City Service Center. On the bright side, it's now much more difficult for your returns to fall into the San Francisco Bay.

This is just one of many changes the IRS announced. So check the label on your IRS package. Of course, if you efile this is irrelevant.

Also, don't forget that it's possible that the address you send estimated payments to has also changed.

While driving this past week, I heard a radio commercial for Intuit's TurboTax, stating that more returns were prepared on TurboTax than by H&R Block. Well, not so fast, says Block. The Kansas City based Block filed a lawsuit against Intuit in Kansas City on Friday.

Not so fast, says Intuit. We sued you first, in California.

H&R Block got a restraining order in Kansas City against Intuit using that advertisement (with Block's name). Today, arguments were scheduled to be heard in Kansas City on ending the restraining order.

We're often asked, by the way, about Turbo Tax and H&R Block. Both are fine (in our view) for simple, basic returns. TurboTax is excellent if, for example, you need to file an extension and you want to get an idea of what you owe (so you can make your payment with your estimate). But when you have a complicated return, you get what you pay for.

News Story: Kansas City Business Journal

Hat Tip: TaxProf Blog

After taking a few days off for an annual convention, would I return to an in-basket bereft of the usual tax evaders? Hardly.

Joe Kristan of Roth Tax Updates reported on some of the more felonius evaders, including Richard Hatch (now on trial for not reporting his Survivor winnings) and a West Virginia accountant who stole more than $1 million and still owes over $500,000 in taxes.

But there's more out there (as always). Rapper Mystikal won't be on tour anytime soon, as he's added a concurrent one-year sentence for tax evasion to his 2004 six-year sentence for sexual assault. Michael Taylor (aka Mystikal) failed to report $2 million in income to the IRS. Taylor must make restitution, including interest.

Perhaps Mystikal can, when he gets out, re-record "I Fought the Law [and the Law Won]."

The TaxProf Blog links to an extremely interesting article by Julian Dibbell on whether virtual profits in online multi-player games are taxable under the Internal Revenue Code. There's also a link to a second article on CNET titled "The Tax Man Cometh, Online."

So, let's assume you exchange your spells for 100 Gold Pieces. Is there any tax due? Well, since it's in a game, I'd assume not. But if you sell your spells for $100, haven't you made $100 in income and owe tax? Luckily for online gamers, the IRS' response was "That's so wierd."

I think it would be humorous if every time there were an online transaction in one of these games, a virtual IRS agent appeared and demanded his cut. Actually, this isn't as far-fetched an idea as you might think.

The people playing these games pay a subscription price to the companies running the games. Aren't taxes a fair way for the gaming companies to earn their incomes?


Hat Tip: TaxProf Blog

Let's assume you disagree with a decision that the Franchise Tax Board (FTB) makes on your tax return. You go through the FTB appeals process, and get nowhere. California then allows appeals to the Board of Equalization (BOE). Today, let's look at a recent decision by the BOE in Appeal of Costco Wholesale.

Costco took advantage of California's Manufacturers' Investment Credit (MIC) for its in-store bakery and meat departments. Previously, the BOE had rules in Appeal of Save Mart Supermarkets & Subsidiary that supermarkets were eligible for this credit. Costco asked for a refund of taxes paid between 1996 and 2001 because of the MIC. The FTB didn't like this decision, and elected not to follow it. Costco appealed the FTBs disallowance of the MIC to the BOE. The BOE faced three issues: Whether Costco qualifies for the deduction, whether bakery and meat departments qualify, and whether the BOE has authority to invalidate an FTB regulation.

The easy part of the decision was that Costco is a qualified taxpayer. The BOE followed the Save Mart case and found that Costco's bakery and meat departments are just as qualified as Save Mart's to get the MIC. And finally, the BOE believes that the California Legislature has given the BOE the power to invalidate FTB regulations when the BOE determines such regulations are contrary to statutes.

No word yet on whether the FTB will continue to fight such cases.

Coverage: California Enrolled Agent Magazine, January/February 2006 issue (not on the web), CMTA Capitol archive, 10/27/05.

There are two concepts that tax accountants have trouble explaining to clients: basis and nexus. And this leads to two recent items that have as their basis nexus.

First, on December 31st, the New Mexico Supreme Court ruled that a corporation with no physical presence in New Mexico can be forced to pay New Mexico income tax. The case dealt with a subsidiary of Michigan based K-Mart. K-Mart put intellectual property into the subsidiary. The subsidiary had no physical presence in New Mexico. New Mexico claimed that the subsidiary was formed just to lower the corporate parent's tax bill, and served no real business purpose; thus, the subsidiary must pay corporate income tax. (Also argued was whether New Mexico's gross receipts tax applied to the subsidiary. The New Mexico Supreme Court held unanimously that it doesn't.)

Now, this case is interesting, but it likely will not be the last word. I mean, do corporations really structure transactions to avoid taxes? And do states write their tax codes to force businesses to structure deals in bizarre ways just for tax purposes? Well, I should probably tone down my sarcasm....But really, until a case comes up where a corporation has no physical presence in a state, and that state attempts to force the corporation to file and pay that state's corporate income tax, will I be worried about the impact on small companies.

Separately, Business Week recently commented about the coming of a uniform sales tax allowing all Internet transactions to be taxed. The Streamlined Sales Tax Project is a group of states working on a means for a uniform sales tax so that states can get around the famous Quill Corp v. North Dakota decision. Business Week believes that the streamlined sales tax will happen really soon.

I believe the reality, at least for Californians, is that we won't see this for many years. Perhaps other states are working towards a streamlined tax, with few differences in rates. California, though, continues to pass sales tax rate changes for numerous special districts. Consider just Fresno County. Fresno County has one tax rate, while the City of Clovis has another. And both of those rates are different from anywhere else in the state. There are at least two sales tax increases on the June ballot in California. Thus, I don't see sales tax uniformity coming any time soon to the Golden State.

News Story: Santa Fe New Mexican

For taxpayers in Northern California impacted by the recent storms, the Board of Equalization has extended deadlines for filing California sales tax and fees collected by the BOE by one month. Returns (and payments) originally due on January 31st are now due on February 28th for businesses in these counties:

Butte, Del Norte, El Dorado, Humboldt, Lake, Lassen, Marin, Mendocino, Napa, Nevada, Placer, Plumas, Sacramento, San Joaquin, San Mateo, Sierra, Siskiyou, Solano, Sonoma, Sutter, Trinity, Yolo and Yuba.

Impacted businesses must complete BOE Form 468 (Request for Extension) and BOE Form 27 (Penalty and Interest Relief for Disaster Victims). The BOE has indicated that they may allow late filers who do not complete the forms relief if they include a statement signed under penalty of perjury that they were impacted by the storms.

News Story: San Mateo County Times

BOE Notice

Now that we're in 2006, it's time for me to go back to work. First on the agenda will be business information returns/filings, such as W-2s and 1099s. These forms must be distributed by January 31st, but do not have to be sent in to the government until February 28th (if you file the forms electronically, March 31st).

The most common form 1099 sent is the 1099-MISC. This form covers non-employee compensation, rents, payments to attorneys, and royalties. In general, a 1099-MISC must be issued if the payments during 2005 total $600 or more ($10 or more for royalties). Most payments to corporations are exempt from reporting on a 1099.

If you're in California, you must also report this information to the Franchise Tax Board (FTB). If you file using paper returns to the IRS, the IRS will forward the filings to the FTB and you need not file directly with the FTB. However, if you file electronically, you must also file electronically with the FTB. California has stringent penalties regarding non-filings of information returns (far stricter than the federal penalties). We encourage all of our California clients to require that before any payments are made to a supplier/vendor that a W-9 be obtained.

If you're one of our clients and want us to prepare your 1099s, please contact our office when you're ready.

The TaxProf Blog published its top 10 for 2005. Their top ten includes the Kanter/Ballard Tax Court case, the telecommuter tax case, and the federal tax reform initiative. There are other items on the list, of course. I could quibble with some of the items that are left out, but the collective brainpower on the TaxProf blog far exceeds my own (especially at 7:00am).

You can find the list here.