Taxable Talk

Proposition 82 on the June 6th California Primary Election Ballot is titled, "Preschool Education. Tax On Incomes Over $400,000 for Individuals; $800,000 for Couples...." A better name for this misguided statute is the "Preschool Education Bureaucracy. Driving Jobs from California Act." Because that's what this initiative would do.

As noted yesterday, California already ranks 40th among the states in business climate. This initiative, if passed, would increase taxes for the wealthy. It sounds great—use the money for mandatory preschool, help our kids, it only impacts the rich, etc.—but if it passes the impact would be felt only slightly among the wealthy. The true impact would be on the lower and middle class.

If you're a business owner, and you have a choice of hiring one more person in California (which will have an impact on growing your business, increasing your revenues, etc.) or hiring that employee in another state, what would you choose if the tax rate in California is quite high? I'm sure the Nevada Development Authority, Phoenix Development Authority, and the Metro Denver Economic Development Corporation are rooting for passage.

Not only is this initiative bad from a tax standpoint, it's bad for our children. Does anyone honestly believe that California needs another bureaucracy to run our childrens' lives? Don't we, the parents, do a better job of choosing what's right for our children than the state? For example, parents who want to "home school" preschool would be prohibited from doing so under Proposition 82.

I hadn't planned on writing about this initiative in late February when the primary ballot won't be until June 6th. However, two items caused me to pen this entry. First, the Wall Street Journal wrote an editorial today on this measure. Second, the measure's leading proponent, Rob Reiner, has been in the news. As Hugh Hewitt noted Reiner has taken a leave of absence from First Five, the state agency spending money from a cigarette tax. Maybe you caught the commercials that ran over the holidays, "Preschool is good for our kids." Hmmm, that's not a leading message with a ballot initiative upcoming....

The Tax Foundation today released its business climate survey of the 50 states. For the record, here are the top ten states:

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

California ranks 40th, just missing out from the bottom ten. The bottom five are Vermont, Ohio, Rhode Island, New Jersey, and New York.

The last time the Tax Foundation ran their list (2004), California ranked 45th, so the state has managed to improve. Well, perhaps. Or perhaps some other states have managed to fall below the Golden State. Here's what the Tax Foundation says about New York: "New York has the worst individual income tax in the country, in addition to the 7th and 3rd worst wealth and unemployment taxes respectively. New York receives its highest score on its business tax, 18th best." California, for the record, ranks 39th for business tax, 47th for individual income tax, 38th for sales tax, 20th for unemployment insurance tax, and 7th for wealth tax.

The report is quite illuminating, and I recommend perusing it. You can find it here.

Thanks to the TaxProfBlog for pointing this survey out.

One of my clients called me this morning and asked about an email he received, purportedly from the IRS. I told him that, in general, the IRS doesn't send out emails. The email he received told him that he had a "small" refund coming, and to click on a hyperlink to enter in some "minor" personal information to get the refund.

It's a phishing scam. According to snopes, this has been around for a year or so. The Washington Post ran a story on this last week. And the IRS itself has issued its own warning.

So don't click on the link. Never give out your social security number, bank account information, or other personal information to a website. Because if it sounds too good to be true, it probably is.

Do you remember when Intuit and H&R Block sued each other? Well, H&R Block now has some egg on their face.

H&R Block admitted that they made some miscalculations on their own tax returns. They were only off by $32 million on their state income tax filings.

Of course, $32 million is a drop in the bucket for H&R Block. But announcing a tax miscalculation when you're in the tax preparation business in the middle of tax season is too good to pass up (for me).

I keep saying that if it sounds too good to be true, it probably is. Offshore trusts formed just to shelter income tax sound too good. For Michael Diesel of St. Marys, Kansas, they were.

On the advice of Aegis Co., a now discredited Illinois vendor of offshore trusts, he invested in the scheme to avoid taxes. He was convicted of three counts of filing false income tax returns. Diesel faces up to three years in prison and fines of $250,000 on each count when sentenced in May.

Irwin Schiff won't be muttering "There is no income tax" to his gullible victims clients anymore. The 78-year old Schiff was sentenced yesterday to 13 years in prison. He must also make restitution of $4.2 million. Schiff, during his sentencing, still claimed that there is no income tax.

He'll have the rest of his life to think that one over.

George Washington, the father of our country, was born February 22, 1732 (274 years ago) in Westmoreland County, Virginia. Our first President, Washington didn't have to deal with an Internal Revenue Bureau (or Service).

Unfortunately, our school-age children no longer get to celebrate a holiday dedicated to this leader. Instead, we have the bastardized "Presidents Day," celebrating both Abraham Lincoln and George Washington. Both men deserve their own day—there can be holidays where schools are open, after all.

Additionally, in February this blog is celebrating its one-year anniversary. While I'd love to say that the tax code is now simplified, and fewer people are evading their taxes, and California has started to decrease regulations and attract businesses, the more things change, the more they stay the same.

The Tax Court also looked at whether an attorney must go to the closest law library for research. In the case, the petitioner lived fairly close to Southwestern Law School in Los Angeles. However, he preferred the law library at Chapman University in Orange, about 25 miles further than Southwestern. Did the petitioner go to Chapman because it had better facilities or because it was close to his family?

The Tax Court ruled for the petitioner on this issue. "Upon the basis of the record in this case, we find that the primary purpose for petitioner’s trips to Chapman Law School Library was to conduct legal research for his business clients, and, therefore, said travel is directly connected to petitioner’s business. Petitioner’s visits to his family, if such visits occurred, were a secondary consideration."

Case: Berge v. Commissioner, T.C. Summary 2006-29

Hat Tip: TaxProf Blog

What happens when you don't file your tax return, the IRS sends you notices to two different addresses (but you've moved), and then the IRS tries to put a lien on you? Today, the Tax Court ruled on such a case.

The petitioner last filed a tax return in 1997. Based on paperwork that the IRS received, the IRS believed that the petitioner owed taxes, mainly from a capital gain. The IRS sent out notices to the petitioner, but he had moved. The IRS then assessed the tax that they thought was owed. After still not being able to reach the petitioner, they put a lien on some of his assets.

The petitioner, in early 1994, finally contacted the IRS. He had never received any of the notices. He requested a hearing with the IRS, and then went to Tax Court. The questions the Tax Court faced were, (1) Since the taxpayer did not notify the IRS of his move, could the taxpayer dispute the tax and lien; (2) If he could, then did the taxpayer owe tax?

The Tax Court ruled that the taxpayer could indeed dispute the lien and tax, because he never received the documents. The taxpayer was also able to prove that he actually had a capital loss rather than a capital gain and did not owe tax.

There's a caution here, though. It's much, much easier to file your taxes on time and not go through the hassles that this taxpayer went through. It's cheaper, too.

Case: Sherer v. Commissioner, T.C. Memo 2006-29

Budgeting at the local (municipal, county, and township) level usually begins with the treasurer/tax collector telling the board here's how much money we're going to receive this year in property taxes based on the property valuation. The board then comes up with a budget. (Yes, I'm simplifying the process; however, this is essentially what is done.)

In Porter County, Indiana, someone made a typographical error on the valuation of a house in Valparaiso. Instead of the $121,900 it's really worth, that unknown individual typed in $400,000,000. Typos happen all the time; usually there's a process in place to check for things like that. I would have expected if the assessed valuation increased by $400,000,000 that someone would have looked to see what triggered it. They would have noticed that a house's value increased just a bit; someone would investigate and the typo would be corrected.

But that didn't happen. And all the agencies--cities, counties, school districts, etc.--budgeted based on the erroneous figure. The owner of the house decided not to pay taxes based on the $400,000,000 assessed valuation.

Now many, if not all, of the government agencies impacted by this will have to have layoffs. All because of a typographical error that should have been caught if proper budgeting analysis were done, and all of the agencies involved notified of the error.

News Story: CNN

"But in this world nothing can be said to be certain, except death and taxes." — Benjamin Franklin

As a tax accountant, I know that's true. For Eugene O'Kelly, that was true in a very sad way. He was the head of KPMG in the US. In May 2005 he went to a neurologist. He was told he had just a few months to live.

Mr. O'Kelly (and his wife) wrote a superb book, Chasing Daylight. Last December, the publisher of this book asked if I would write a review. I said yes, even though I knew the book would arrive during tax season. Boy, am I glad I did.

This is a wonderful book, even given the morbid subject nature. Mr. O'Kelly leads us on his journey, and shows us how he made the most of his very limited time on this world.

I could say a lot more about the book. As an author of a book, with a second book soon to come out, I know how difficult is to write any book. This book rings true, from start to finish. I have a hard time imagining myself writing such a book, and I think we're blessed that Mr. O'Kelly wrote a text that can show all of us how to enjoy our final days.

Back last July I wrote about Mr. Divorce, Demetrious Eugenios, who went through his own divorce and hid his assets from the IRS. His ex-wife found out, didn't like it, and told the government. He was convicted last July. Sentencing has been postponed on several occaisions.

Last Wednesday Eugenios found out his fate. According to this article in the Hollister (CA) Free Lance, Eugenios was sentenced to 30 months in prison, and must make restitution of $1.2 million.

Divorce just doesn't pay. And hiding a Porsche from your ex-wife and the IRS is worse.

Global warming, that is.

According to this article in the San Francisco Chronicle, Governor Schwarzenegger appears ready to jump on the global warming trail for tax increases.

First, some science. There's a big debate over whether or not global warming is happening. For example, you'll hear about the US having a warm winter. Well, Asia and Eastern Europe have had a cold winter. We hear that the icepacks in the Arctic and Antarctic are melting. If so, why haven't coastal cities had flooding problems?

Additionally, there have been numerous reports that Earth naturally has warm and cold cycles. Indeed, there was a recent report that Earth will soon have a mini-ice age. When I was growing up, I remember reading in Popular Science that the burning of fossil fuels would case an ice age. That was about 1970, btw.

Back to taxes. The Governator apparently will propose increasing taxes on fossil fuel to fund research into alternative fuels. Let's assume such a measure passes. Here are the impacts:
- California will be at an additional competitive disadvantage to other states;
- California will drive business away from vital industries, such as its ports and manufacturing;
- Tax increases are passed on to consumers. Always. So this will ripple through other areas of the economy.

I could continue in this vain but I think you get the idea. This is a bad plan that deserves to be shelved immediately.

Hat Tip: GOP Bloggers

Yesterday, we blogged about Irwin Schiff, who is going to be spending the rest of his life in an institution because he was convicted of defrauding the IRS by telling and selling clients various methods so they didn't have to pay the IRS. Here is a link to the Tax Protestor FAQ, which debunks just about every tax protestor argument. Judges especially dislike tax protestor arguments.

In any case, today's Tacoma News-Tribune has a story about a man who has been accused of tax fraud. Allegedly, he has sold over 400 sham trust packages, costing the IRS over $7 million in uncollected taxes. David Carroll Stephenson believe he's done nothing wrong. Indeed, he argues that the court has no authority (I'm sure the judge will like that argument), the government has no authority (to collect income tax), and the IRS was never authorized. As an aside, all of these arguments are debunked in the Tax Protestor FAQ.

I'll be shocked if Mr. Stephenson isn't found guilty.

You get what you pay for, or so the cliche goes. The Tax Court today looked at a case where a husband and wife had two "businesses" and used tax software to prepare their returns. As Joe Kristan of Roth Tax Updates reported, the businesses were probably just methods of spending their own money. The Tax Court didn't like that. The Cost of Good Sold that they claimed were for mainly personal expenses. That didn't sit well either. So they lost their case.

But the IRS also asked for a negligence penalty. As the Tax Court noted, "‘Negligence’ includes any failure to make a reasonable attempt to comply with the provisions...[of the Internal Revenue Code], and the term ‘disregard’ includes any careless, reckless, or intentional disregard." So the taxpayers blamed the software they used. The negligence penalty stood up.

There's a lesson here. Tax software does a great job putting what you enter on the correct lines. If you have a simple tax return, say just a W-2, a 1099-INT from your bank, and no other deductions, software will do a great job.

But software doesn't do some things. It doesn't ask you if the deductions you're entering in are reasonable. It doesn't ask you if that medical insurance premium you're entering in as an Insurance expense for your S-Corporation should be entered in on that line. It probably won't tell you where the best place is (on your return) to take a certain deduction, or why it might be better not to take that deduction. As Roth Tax Updates said, garbage in, garbage out.

Case: Maxfield v. Commissioner, T.C. Summary 2006-27

ABC News is reporting that Irwin Schiff, convicted of numerous charges in Las Vegas and facing 43 years in prison and fines of over $3 million for telling clients that there is no such thing as an income tax, is mentally ill. That's according to court documents. Psychiatrists apparently believe that mental illness—suicidal depression, bipolar mental disorder, paranoia and delusions—made him tell people that you didn't have to pay income tax. Schiff is currently 77 years of age.

Of course, if the Court or the prosecution (the United States) looks at his website, they may get other ideas. For someone convicted to continue to say

"Since the income tax was repealed in 1954 when Congress adopted the 1954 Code, it is clear that for 50 years federal judges in conspiracy with U. S. Department of Injustice prosecutors have been illegally and criminally prosecuting people for crimes that do not exist in connection with a tax that nobody owes."

And you can see what his website says about himself here.

Mentally ill or not, it's likely we've heard the last from Mr. Schiff. He's likely to spend the rest of his days in either a psychiatric hospital or the geriatric wing of a federal institution.

Coverage When Schiff Was Convicted: Here (Roth Tax Updates)

The Tax Court today decided Castagnetta v. Commissioner (T.C. Summary 2006-24). The petitioner claimed that while working as a part-time truck driver that he was also a professional gambler, gambling on horse races in New York. The IRS challenged that, and the case ended up in Tax Court.

The IRS does not like the idea of professional gamblers, and has consistently challenged individuals who claim that they are in that profession. Mr. Castagnetta, though, avoided many of the traps. He kept a detailed log of his bets. He kept detailed back-up information ("speed figures") on horses. He made 4% on his bets (versus the "average" horse racing bettor losing 17% on his bets).

The interesting items that were in the case are:

- The Tax Court states, in a footnote, that not only can a non-professional gambler deduct gambling losses against winnings, he can deduct "other expenses incurred in connection with gambling transactions" (up to the amount of winnings). The Tax Court states that these expenses may include items such as transportation, meals, lodging, admission fees, office supplies, and ATM fees.

- The IRS has, in various appeals cases, stated that a professional gambler must "solely" be engaged in that as a profession. The Tax Court did not come to that conclusion. It noted, "It is clear that in a single taxable year, a taxpayer may be in engaged in more than one trade or business. Curphey v. Commissioner, 73 T.C. 766 (1980); Barrish v. Commissioner, T.C. Memo. 1984-602." But the gambling must be engaged in as "the intended livelihood source" and "for income or profit." Intended livelihood source means the activity that you use to support yourself.

Unfortunately, the case is a summary opinion and cannot be used as a precedent for other cases. But it does give an idea of how the Tax Court feels about gamblers, and is much more positive for gamblers, both professional and amateur, than the IRS' viewpoint. Oh yes, Mr. Castagnetta won and he's considered a professional for the year in question (see Joe Kristan's analysis for more details on that).

Thanks to Joe Kristan and Roth Tax Updates for their plug of our site. Apparently, we both read the decision and posted about it at roughly the same time.

Case: Castagnetta v. Commissioner, T.C. Summary 2006-24

...when you withhold taxes from employees and keep them.

Crime does pay, as long until you get caught. Take nursing home owner Jack Easterday, formerly of Alameda, CA, and soon to be residing in a federal penitentiary. Mr. Easterday was convicted on Friday of failing to pay over $3 million in payroll taxes. Evidence indicated that the scheme netted over $18 million.

It took the jury two days to find Easterday guilty of 47 counts; the maximum penalty on each count is five years and a $10,000 fine.

News Story: North County Gazette

According to the Wall Street Journal, the 2007 budget has $513,000 allocated to set up a "dynamic analysis" unit within the Department of the Treasury. Currently, the Congressional Budget Office uses static analysis to determine the impact of proposed changes in the Tax Code. The idea behind dynamic analysis is that tax changes can impact behavior.

News Story: Wall Street Journal [Paid Subscription Required]

The NAEA alerted me to a new act under consideration in my old home, Washington state. Acting on the success of the Tennessee Crack Tax, two legislators in Washington have introduced similar legislation. The act, if passed, would impose a stamp tax of $50.00/gram of cocaine, $200/gram of "other controlled substance or low street-value drug that is sold by weight," $31.70/gallon (or fraction thereof) of illicit alcoholic beverages sold by the drink, and $12.80/gallon of illicit alcohoic beverages not sold by the drink.

You can find the text of the proposed legislation here.

Samuel Joseph DeAngelo headed Western Tax Service. It attracted tax clients quickly as it averaged $2,500 refunds for each customer.

It's techniques were certainly interesting, and come from the Richard Hatch School of Tax Preparers:

- Making up false deductions for employee business expenses;
- Making up false charitable deductions (typically 10% of AGI);
- Phony depreciation deductions;
- Phony tax payment deductions; etc.

The IRS audited a taxpayer who used Western Tax Service and discovered the fraud. Most of the tax clients had no idea that Western was doing anything wrong. The IRS expanded their review of returns prepared by Western (Western prepared about 8,000 returns in 2001). Yes, Western charged large fees but they got large refunds; what could be the problem? (Hint: If it sounds too good to be true...)

The axe fell in 2004. Now, the story reaches its conclusion. Last Friday DeAngelo pled guilty to defrauding the IRS and helping people file false tax returns. He also pled guilty to using others to engage in currency transactions to avoid the $10,000 reporting requirement: he sent employees to the bank to make multiple $9,990 deposits (don't try this at home!). DeAngelo faces a maximum of 24 years in jail.

I had a couple Western refugees come in to my office for help. They were rudely surprised that you do have to pay tax on your income....


Press Release: US Dept. of Justice
News Story: Orange County Register

I have a few clients in Oakland. They'll probably be paying a bit more for that Big Mac or other fast food; the Oakland City Council passed an ordinance Tuesday that imposes a fee of between $230 to $3,815 on fast-food businesses. The city plans to use the money to reduce fast-food litter; according to Councilwoman Jane Bruner the fee was imposed as a last resort. Before becoming law, the ordinance must be approved on a second reading (most likely on February 21st).

However, the tax may be illegal as different businesses will be charged differing amounts. Some fast-food restaurants will be exempt because they are in business improvement districts; others are exempt because they already have "litter control programs." And the California Restaurant Association is considering a lawsuit to stop the ordinance from going into effect. Johnise Downs, of the CRA, is quoted by the Associated Press, stating, "[The businesses are] basically being penalized and targeted just for doing business in the city of Oakland." A similar law was overturned in Chicago as being unconstitutionally vague.

News Stories: Contra Costa Times; Associated Press Story

The tax evaders have been busy.

First, a woman in Tullahoma, Tennessee successfully embezzled about $500,000. Only one problem: she forgot to pay her federal income tax on her ill-gotten gains. She pled guilty to four counts of tax evasion on the $129,000 she didn't pay to the IRS. (Story here.)

Next, a San Francisco contractor pled guilty to two counts of tax evasion for failing to report about $250,000 in income. He took under-the-table cash payments instead of reporting them to his business. He could face as much as five years in jail, but will probably get about a year and a significant fine. (Story here.)

Finally, Markell Boulis, a former Pittsburgh chiropractor, is already in jail for selling drugs. He's in a lot more trouble. This story, which appeared a little over a week ago, indicated that he's being investigated for insurance fraud. An owner of a medical supply firm is cooperating in the investigation and has accepted a plea bargain (story here). Now, Boulis has been indicted on tax evasion and fraud charges. According to the Pittsburgh Post-Gazette, the indictment charges that Boulis underreported his income in 2001 by over $500,000 and didn't report any of his 2002 income.

The Senate's top Democratic tax writer declared that the Tax Reform Report issued last year is dead on arrival. “That thing's dead. That's dead, Mr. Secretary,” said Max Baucus, D-MT.

When the panel's recommendations came out last year, that's exactly the same thing that I said; these "reforms" stood no chance of passage.

News Story: AP

Hat Tip: TaxProf Blog

According to this story [paid subscription required] in today's Wall Street Journal, the IRS is targeting a technique used by highly paid individuals to defer capital gains taxes. The strategy is called "prepaid variable forward," and is a hedging strategy that uses derivatives to protect the user who has a stock portfolio concentrated in one stock from a drop in the price of that stock while deferring capital gains. Typically, the firm involved in the transaction shorts some of the stock to protect itself—and that's where the problem comes in.

If the firm borrows the shorted shares from the investor, that's share lending. And the IRS ruled (in a Technical Advice Memorandum that applies to one investor) that when the shares were borrowed, they were effectively "sold," and subject to immediate capital gains tax.

My generic advice about all tax shelters applies: if it sounds too good to be true....

But it wouldn't take much for that to be true.

Danni Boatwright, the most recent Survivor champion, paid her taxes on the $1 million she won. "I paid them right away," she told AP Radio. "(CBS) recommends that you pay your taxes first off. Come on, you don't need anyone to tell you that. It's ridiculous. Poor Richard."

News Story: AP

Professor Maule has an interesting post on whether people making their living gambling on cards should be treated differently than those gambling on stocks. His conclusion:

I wonder if the current Administration and its Congressional allies, in proposing to make permanent the special low rates [on capital gains] applicable to those who gamble in commodities, options, and similar items, understands that gambling is gambling. Do they understand that making those rates permanent will generate even more incentive for tax shelter designers to find ways to package poker games as long-term investments the income from which would be taxable as capital gains?

Definitely read the entire post—it's well worth it.

Given the social engineering inherent in our tax code, don't look for any changes in the treatment of gambling any time soon.

Lawrence Block wrote a great book, Eight Million Ways to Die. A Milpitas, CA couple could write a sequel: Eight Million Ways to Lie (on Your Tax Return).

The couple sold an invention to the predecessor of Lucent Technologies for $8 million. No problems yet. Then they didn't report the income on their tax returns. Oops. Unlike Richard Hatch, the couple has accepted a plea agreement. They've paid the $2.8 million in back taxes, penalties, and interest, and will serve jail time. They're also paying a $350,000 fine. As an aside, I believe that this couple because they settled will find themselves much better off than Richard Hatch will when he is sentenced later this month.

The news story also noted that the couple was prohibited under their employment contract from such a sale. The husband was laid off.

News Story: San Francisco Chronicle