Taxable Talk

There's nothing at all about tax in this post. You're all forewarned.

Instead, this post focuses on my avocation—writing. My third book has just been released. Written with my good friend Nick Christenson, it's called Winning Strategies in No-Limit Hold'em.

We consider in depth a few aspects of no-limit hold'em that have received little attention by other authors. We concentrate on betting in no-limit hold'em. We consider when bets and raises are in order, why we bet, and how circumstances change when we bet. As the centerpiece of the book we provide four chapters, one per betting round, discussing exactly how much to bet based upon many circumstances.

This book is aimed for the intermediate to advanced player. If you've been playing in the limited buy-in no-limit hold'em games and want to try deep-stacked no-limit hold'em, this is the book for you.

You can purchase this book today at Amazon.com. It should be available in book stores such as Barnes & Noble in about three weeks.

Today the Tax Court looked at a case that showed what happens when you use a tax preparer who (a) doesn't understand the software, (b) has little knowledge about your primary sources of income, and (c) has little tax knowledge. As you might expect the petitioners didn't fare well.

Our petitioners had their return audited for 2002, and a deficiency resulted from disallowing "(1) $12,000 deducted as an other miscellaneous deduction for “home winterization” on Schedule A, Itemized Deductions, and (2) the following expenses claimed on Schedule E, Supplemental Income and Loss, for rental Property B (identified as an “apartment building” located at 8314 South Green Street):

• Advertising $350
  
• Auto and travel 4,500
  
• Cleaning and maintenance 3,000
  
• Repairs 12,000
  
• Supplies 900
  
• Utilities 3,000"

When the parties met for the pre-trial conference the petitioners' accountant, when informed that it was required by the Tax Court that everything not in dispute be stipulated, made a remark that set the tone for the case: "Rules are made to be broken." I'm sure the Court appreciated that.

Things didn't get much better. "During the above meeting, [petitioner's accountant] redefined the properties listed on petitioners’ Schedule E...." Why wasn't this done before the audit? But I digress. These changes, which included one rental property included on the original return which shouldn't have, and another property that wasn't included suddenly appeared, resulted in additional deficiencies and an accuracy-related penalty:

"(1) Unreported rental income; (2) disallowance of five dependency exemption deductions; (3) unreported income from a State income tax refund; (4) disallowance, in total, of itemized Schedule A deductions for (a) medical and dental expenses, (b) real estate taxes, (c) personal property taxes, (d) home mortgage interest, (e) gifts to charity, and (f) unreimbursed employee business expenses; (5) disallowance in total of all Schedule E deductions; and (6) disallowance of rental and real estate loss because of passive activity loss limitations."

As for the actual case, just a few lines from the decision note the most important point of all.

"Petitioners provided no receipts to substantiate any of the expenses claimed for either Property A or B. For example, [Petitioner] admits that they did not spend $350 to advertise either Property A or B for rent and that, in the case of Property A, no advertising of any kind was necessary since their daughter took possession of that property immediately after they moved to Property B. [Petitioner] acknowledged that $700 claimed for auto and travel expenses was arbitrarily arrived at. [Petitioner] testified that the $2,000 claimed for cleaning expenses for Property A was paid to clean out the basement of that property in anticipation of their move.

"Our examination of the record convinces us that petitioners failed to maintain any records whatsoever with respect to the items claimed on the Schedule E attached to their 2002 return. Moreover, [petitioner] and their tax preparer...admit that some of the figures claimed for deductions taken on their 2002 return, including all of their Schedule E deductions, were false and/or arbitrarily contrived."

I could go on and on, but I think you get the flavor.

There are some morals to this story. First, not all tax preparers are equal. Obviously the petitioner's tax preparer comes from the Bozo side of tax preparation. He was unlicensed, untrained, and, had little knowledge of the tax software he was using. That's a problem with software—it will put the numbers exactly where you tell it to. As the cliche goes, garbage in, garbage out.

Second, get a tax preparer who understands your major areas of tax concern. For example, I had a potential client approach me about doing his return. I sent him to another professional I know because his return had a large amount of oil, gas, and mineral rights income, and that's an area I don't know well. He's much better off going to someone who understands that well as it's a specialized area. Sure, I could learn it, but he'd have to pay me to relearn the wheel, so to speak (and I have enough areas that I specialize in already).

Third, choose your preparer wisely. You are ultimately responsible for what's on your tax return, not your accountant. As the Tax Court noted,

"We further conclude that petitioners have failed to show that their reliance on Mr. Ingram’s tax return preparation was reasonable. Mr. Ingram admitted that he was not an accountant, that he was unfamiliar with the computer software that he used to prepare petitioners’ return, that he had made many errors with respect to petitioners’ 2002 return, and that his rush to complete the return also resulted in errors. Petitioners’ reliance on Mr. Ingram as their tax return preparer was clearly unreasonable."

And finally, keep your receipts! Today's petitioners invented numbers out of thin air and got the results they deserved. If you have rental property, you're supposed to treat it as a business. You can purchase a filing cabinet for under $100.

Case: Burkley v. Commissioner, T.C. Summary 2008-20

New Jersey has been in my view the poster child of what happens when liberal tax and spend runs amuck. Eventually the money runs out in a downturn, and that appears to be happening in the Garden State.

Governor Jon Corzine proposed a budget that he described as "...cold turkey therapy for our troubled spending addiction." The new budget is $33 billion, a $3.2 billion cut from the current year. Three departments will be permanently eliminated. Property tax rebates will be capped based on income and reduced for those who rent. No tax increase was proposed.

However, remember that Governor Corzine also proposed a huge fee increase last week—50% increase in the tolls on New Jersey's toll roads. But those aren't taxes....

In any case, residents of other states will soon be seeing similar stark reality budgets. Most Americans consider themselves overtaxed, and come this Fall there will likely be many government workers looking for employment elsewhere.


News Story: North Jersey.com

There's a tax deadline tomorrow that effects employers and others. If you file paper copies of 1099s/1096s and/or W-2Gs/1096s, you must mail your copies by February 28th, not February 29th. If you electronically file your information returns, you have until April 2nd. These forms are sent to the IRS (either Kansas City or Austin, depending on the location of the entity).

Just to confuse things, the deadline for filing W-2s/W-3s to the Social Security Administration is February 29th. However, if you efile these forms you also have until April 2nd. These forms go to the SSA in Wilkes-Barre, Pennsylvania.

Last week I had a story about a Taco Bell franchisee around the time that the chain had a talking chihuahua. Today I have a story where a tax evader compares himself to a chihuahua.

Bohdan Senyszyn is a CPA who worked for the IRS for 25 years. Back in 1998 Mr. Senyszyn did some accounting work for a New Jersey developer. As part of the work he set up shell companies for the developer so that the developer could hide income. However, the developer cooperated with the IRS which led to the arrest of Mr. Senyszyn. Oh yes, Mr. Senyszyn did one other thing: he skimmed money off the top from the developer and didn't report the stolen money as income. The government put the tax loss at $80,000 on $250,000 of income.

Mr. Senyszyn earlier pleaded guilty to filing phony tax returns, tax evasion, structuring a financial transaction and bank fraud. On Thursday he tried to change his guilty plea to innocent on the tax evasion charge but the judge refused. Mr. Senyszyn then, in asking for leniency, said, "I'm nothing more than a Chihuahua. I run around and bark a lot, but I don't bite anybody."

However, his actions might be taken otherwise. The Star-Ledger reported, "Senyszyn's conduct included writing letters to the prosecution team, government officials, witnesses and the victim, as well as vandalizing a sign on property be longing to the informant in the case, said Assistant U.S. Attorney Thomas Calcagni." Judge William J. Martini told Mr. Senyszyn, "I can't take the risk you're a Chihuahua and find out you're a bulldog." Mr. Senyszyn received 34 months at ClubFed and a $12,500 fine.

There's one certainty: Chihuahuas don't evade taxes but people do.

States are having tax troubles, and New Jersey is one of those. The Tax Foundation has a great story about how a South Carolina company was forced to pay off New Jersey in order to get a truck released from a weigh station from a "jeopardy assessment." States are trying to make anything appear as if it creates nexus.

Meanwhile, New Jersey has budget problems. Big problems. As the Wall Street Journal reports, "In 1990 the state was $3 billion in debt. Borrowing has since grown at a compound annual rate of about 13%, and now the state is $32 billion in the red. Throw in unfunded pensions and health benefits for retirees, and that number swells to $113 billion, or $3,400 for every man, woman and child in the state. That's three times per capita higher than the national average, making New Jersey the nation's fourth-most indebted state."

Governor Jon Corzine (D) proposes huge toll increases (50% a year in 2010, 2014, 2018, and 2022) but legislators aren't thrilled with the idea. Perhaps the idea of limited government might take hold in the swamplands. Where are the Sopranos when you need them?

Two reports this weekend about athletes having tax troubles. First, former baseball player Lenny Dykstra refused to pay his accountant's bill. Well, he was billed $111,097. I guess I don't charge enough. Anyway, Dykstra told the New York Daily News, "Did they actually think I would pay that much for a tax return? That's insane." The accounting firm claims that such charges are "fair and reasonable" given their retainer agreement and that the charges have now grown to nearly $140,000 (including interest). (Hat tip: TaxProf Blog)

Meanwhile, seven current or former NFL players have been ensnared in a phony gold mining scheme sold as a tax shelter. Joe Kristan reported on this and a phony chicken farm scandal. I think it's easy to see how a phony mining scheme can be done. But how do you invent a phony farm? Even better, the chickens on this farm laid liquid eggs. Sounds like a book about cows that give chocolate milk.

If you're wondering what your tax rebate will be, here are a couple methods to find out. Kiplinger has added a rebate calculator. And Spidell will soon add one to their website.

The IRS has updated their webpage on the rebates. The IRS has posted examples of how social security recipients who normally wouldn't file a tax return should file in order to claim the rebate. That example also shows how recipients of veterans' benefits should file. There's more information here for social security recipients and here for recipients of veterans' benefits.

We the People, the tax protester organization headed by Robert Schulz, has been on the wrong ends of various court rulings. We the People believed that you could voluntarily stop withholding. The IRS and the Department of Justice didn't like the idea of a $39.95 kit that allowed one to not pay taxes. So last year the IRS got a permanent injunction to stop the distribution of the packets. The IRS also asked PayPal for a list of who bought the packets (We the People accepted PayPal for payments) and last year won an appeal in the 8th Circuit: "[W]e conclude that Schulz’s constitutional arguments challenging the IRS’s authority to enforce the tax laws are without merit."

The IRS also asked We the People for a list of who bought their packets. We the People refused, an the injunction was stayed pending an appeal to the 2nd Circuit. Today that Court said basically the same thing as the 8th Circuit: "We have considered all of defendants’ arguments and find them to be without merit. We affirm the judgment for substantially the reasons set forth in the district court’s decision. See United States v. Schulz, __ F. Supp. 2d __, 2007 U.S. Dist. LEXIS 58271 (N.D.N.Y. Aug. 9, 2007)."

As for the stay, that's gone.

"The district court found that defendants’ illegal activities were harming individuals, who were exposing themselves to criminal liability by following the defendants’ ill-conceived instructions. Requiring defendants to provide the identity and contact information of the recipients of the tax materials enables the government to monitor the defendants’ obligation under the injunction to provide a copy of the district court’s order to recipients of the tax materials. Moreover, the district court found that the defendants’ illegal actions were harming the government, which was not receiving required tax payments and was forced to expend resources to collect the unpaid taxes. Requiring defendants to provide the identity and contact information of the recipients of the tax materials enables the government to monitor whether the recipients of defendants’ materials are violating the tax laws. Thus, we find no abuse of discretion with respect to the district court’s imposition of the reporting requirements in Paragraph C of the injunction." [citations omitted]

So if you were one of those gullible enough to purchase a $39.95 package that would terminate your taxes you may soon receive a "Dear Valued Taxpayer" letter. In the end, we all have to pay our taxes.

Hat Tip: How Appealing

California's budget deficit has grown another 10%, from $14.5 billion to $16 billion. Why? Because all sources of tax revenues are down: sales tax, personal income tax, and corporate income tax. This will be the year that our Legislature has to make tough choices—band-aid fixes will no longer work.

The non-partisan Legislative Analyst, Elizabeth Hill, doesn't think that Governor Schwarzengger's 10% across the board budget cut will work. She proposes "a combination of cuts and $2.7-billion in new taxes, including reducing tax credits for dependents, adding a dime to every gallon of gasoline bought in the state, increasing tuition by 10-percent at all Cal State and U.C. campuses and closing the yacht tax loophole."

There's no way that this budget deficit will be closed without major program cuts. The math just doesn't work without them. And there are many, many programs that a state shouldn't have that California does. I'll post about that over the weekend.

In any case, I think we're going to have a very bad budget season in Sacramento. And we will see some new taxes and major cuts. Businesses will again start looking across the borders to Arizona, Nevada, and Oregon (and elsewhere) if the tax increases are too high.

The tiny principality of Liechtenstein is known as a tax haven. A few months ago an ex-employee at a bank in Liechtenstein apparently leaked details of some bank accounts held by Germans. The German finance ministry has said that they paid €4 million to get details of German accounts held in the tiny country.

To date one German, Klaus Zumwinkel, the former head of Deutche Post, has been hit by the scandal. He resigned from Deutche Post. AFP reports that Germany believes that there are 45,000 trusts with accounts in Liechtenstein and the German tax authorities would like details. Liechtenstein has, so far refused.

Germany might give an ultimatum to Liechtenstein. The German government would like a deal similar to the one that the principality has with the US (and the IRS). Crown Prince Alois told AFP, "Does a state have the right to obtain information by breaking the law in a friendly state and probably also contravening its own laws? Spying on our clients is unthinkable...We are going to see what we can do to protect our citizens and also our investors, who trust us, against such methods of investigation. The principle of confidentiality also applies to our foreign clients."

Thinking about using one of the creative arguments in the Tax Protester FAQ? You may want to think again. Besides the fact (and yes, it's a fact) that all of those arguments won't hold up the IRS and the Department of Justice have decided to step-up activity against the tax protester movement.

Bloomberg is reporting that beginning in March the DOJ and IRS will aim at the movement. Assitant US Attorney General Nathan Hochman, head of the Tax Division, told Bloomberg, "Too many people succumb to the fallacy, the illusion, that you don't have to pay any tax under any set of conditions."

Kay Bell of Don't Mess With Taxes including a link to another webpage debunking tax protester myths (this page is from a law professor at George Washington University).

Fresh off the Wesley Snipes case two actors are having their own tax troubles. Joe Kristan found this story about Joe Pesci. Mr. Pesci besides appearing in movies has his own production company with employees. The regulation involved states, "You must make deposits using EFTPS for all depository tax liabilities for the current year if you made more than $200,000 in aggregate deposits for all types of Federal depository taxes in the year two years before the current year or if you were required to make electronic deposits in the previous year."

Mr. Pesci's production company didn't use EFTPS, and the penalties were upheld.

Meanwhile, actor Nicolas Cage will be fighting the IRS in Tax Court. The TaxProf Blog quotes a story in Forbes:

The IRS says movie star Nicolas Cage used a company he owns to wrongly write off $3.3 million in personal expenses, including limos, meals, gifts, travel and his Gulfstream 1159A turbojet. ... The feds hit Cage both ways, denying Saturn a deduction for the disputed expenses while taxing Cage individually on the perks as salary and "constructive dividends."

Cage's business manager, Samuel J. Levin, says in an e-mail that the expenses were proper as "customary in the entertainment industry" and were partly based on the actor's "security needs."

Mr. Cage's Tax Court case will probably not be heard for many months, with a decision possible in 2009.

A New Jersey couple frequented Atlantic City, and enjoyed playing the slot machines. In 2004, they were "lucky" enough to win $208,420 in jackpots for which they received W-2Gs. The couple, though, didn't include that income on their tax return as they had lost overall while gambling in 2004 and they used simple logic to determine that overall losers don't have to include gambling income on their tax returns.

Unfortunately, that's not the case. The couple's return was examined (audited) and the IRS added the $208,420 as gambling income (and did allow an itemized deduction of the same amount). However, because their adjusted gross income (AGI) changed several deductions were disallowed or negatively impacted. They ended up having a tax deficiency of $4,190. They appealed to the U.S. Tax Court.

Unfortunately for the New Jersey couple, gambling income must be included as part of your income even if you're an overall loser for the year. As the Court noted,

"The jackpots that petitioners received constitute gambling income. A taxpayer in the trade or business of gambling may deduct wagering losses to the extent allowable in computing adjusted gross income. A taxpayer who was not in the trade or business of gambling may deduct wagering losses only to the extent allowable as an itemized deduction to compute taxable income."

The couple were not professional gamblers (they both had full-time employment) so the IRS was correct—the $208,420 must be included as income (though they do get an itemized deduction for their losses up to the amount of their wins, $208,420).

The IRS also attempted to impose a negligence penalty under §6662(a). The petitioners explained that they had been preparing their returns in this manner for years without any problems and that they felt that logically losers wouldn't have any income. Luckily, the Court saw the logic in their remarks (though the couple is incorrect on the law).

So the New Jersey couple will have to pay the $4,190 but do not have to pay an additional $838 for negligence. This case shows the unfairness of the US Tax Code toward gamblers—the couple lost and their taxes went up. The wages of sin, I suppose.

Case: Dawson v. Commissioner, T.C. Summary 2008-17

The Third Circuit Court of Appeals ruling in Swallows Holding, Ltd. v. Commissioner is now available online. The summary of the ruling is:

"This case, grounded in the principles of administrative law, requires that we review the validity of an Internal Revenue Service (IRS) regulation. The Tax Court, in considering this regulation, analyzed it under the factors provided in National Muffler Dealers Ass’n v. United States, 440 U.S. 472, 477 (1979), and concluded that the regulation was invalid. In coming to this conclusion, the Tax Court explained that the standard established in National Muffler had not been replaced by Chevron U.S.A., Inc. v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984), and that the result under either standard would be the same. We do not agree with the outcome reached by the Tax Court. We have determined that the result would not be the same under Chevron analysis as it would be under National Muffler and that the regulation here should be given Chevron deference."

The TaxProf Blog has more.

...or at least within 18 months of their due date. Why? IRS regulations hold that if a foreign corporation files after that date they cannot take any deductions.

Consider a hypothetical corporation, Foreign Company Ltd., which has US source gross income of $100,000, and "necessary and ordinary" deductions of $100,000 for $0 net income. However, Foreign Company Ltd. didn't file. Under the IRS regulations, it's taxed at up to 35% of $100,000 (plus penalties and interest, of course).

This doesn't seem right, and the Tax Court agreed that these regulations were wrong in Swallows Holding, Ltd. v. Commissioner (126 T.C. No. 6). The IRS appealed to the Third Circuit Court of Appeals, and Tax Analysts is reporting (in an opinion that has yet to be released—I'll post a link to the ruling when it's released) that the appeals court has reversed the Tax Court.

The Tax Court decision notes that in a 1940 case the Fourth Circuit held that there's no reference as to time in the then regulations. I'm not sure that the two cases are at odds with each other (the current regulation was issued in 1990), but if they are this would be the kind of case that the Supreme Court would be likely to take (resolving a difference between rulings between two different appeals courts).

In any case, if you're a principal of a foreign entity with US source income you're now on notice. If you don't file the tax return within 18 months of the due date you won't get to deduct anything.

Hat Tip: Roth Tax Updates

Karl James is the former president of Golden West Taco, Inc., one of the largest franchises of Taco Bell (which is based here in Irvine). Back in 2000 Golden West Taco went into Chapter 11 Bankruptcy protection. Yet Taco Bells were doing quite well at the time--remember that chihuahua?

There was a reason the company (and its owner, Karl James) went into bankruptcy. Mr. James "fraudulently diverted" (for the layman, read that as "stole") about $3 million of company funds for his personal use. He transfered assets, including residences in the upscale communities of Rancho Santa Fe and Palm Springs to his nominees, used offshore companies with off the balance sheet accounts, and otherwise obfuscated the books. I should point out that these actions are considered bankruptcy fraud.

Mr. James went a step further. In transferring the assets from his company to himself he created income. And he didn't report that income. In total, he deprived creditors of Golden West Taco of $1,121,829. He committed tax fraud to the tune of $1,169,957 . To his credit, he pleaded guilty and has agreed to make restitution (he's already repaid $2,014,363).

However, he won't be eating at Taco Bell for awhile. He'll be spending three years at ClubFed followed by three years of supervised release. It's a pretty big price to pay for tacos.

News Story: NBC San Diego

Last Tuesday, the Wall Street Journal ran an excellent editorial titled "States of Opportunity."

"But one reason to conclude that taxes are also a motivator is because the eight states without an income tax are stealing talent from other states. They are Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming, and each one gained in net domestic migrants. Each one except Florida -- which has sky-high property taxes on new homesteaders -- also ranked in the top 12 of destination states.

"Politicians who think taxes don't matter might want to explain the Dakotas. North Dakota ranked second worst in out-migration last year, while South Dakota ranked in the top 10 as a destination. The two are similar in most regards, with one large difference: North Dakota has an income tax and South Dakota doesn't."

The editorial also contrasts California, which has lost 1.5 million residents, with Nevada, which is booming. Perhaps our legislature will begin to think logically about this and start cutting taxes. And maybe pigs will fly....

California's legislature sent a $1 billion bipartisan package of budget cuts to Governor Schwarzenegger; the Governator signed the package yesterday. The budget cuts will come primarily from school funding and from Medi-Cal (California's medical program for low income individuals).

Yet Californians should carefully watch their wallets. Assembly Speaker Fabian Nunez (D-Los Angeles) wants the $13.5 billion shortfall to be balanced 50% from spending cuts and 50% from revenue increases. For those who aren't in government, revenue increases are more commonly referred to as tax increases. Given California's abysmal ranking as a state to do business, politicians in Sacramento should be talking about tax cuts instead of tax increases to balance the budget.

If California implements tax cuts, these might lead to more businesses locating in California and more tax revenue. But that's thinking outside of the box, and the Democrats in control of the legislature in Sacramento rarely do that. Luckily for California's taxpayers, the budget requires a 2/3 vote—Republicans in both houses must approve the budget balancing methods for it to pass into law. Expect a very contentious legislative session this Spring in Sacramento.

New York is facing a budget shortfall this coming year. Governor Eliot Spitzer has an interesting idea about how to fill the gap: a crack tax. I've written about these taxes before. Many states have these taxes (21 at last count); however, they sometimes don't survive the courts.

In any case, Governor Spitzer's proposal is to tax marijuana $3.50/gram and cocaine $200.00/gram. The proposal is estimated to bring in $13 million if it is enacted into law.

That doesn't seem certain. Jeffrion Aubry (D-Queens) vows to fight this "boneheaded" proposal. And given that it would only bring in $13 million, other revenue enhancers (or cuts in spending) will be needed to balance New York's budget.

News Story: Washington Post

If you are going to file Form 982 you will not be able to electronically file until March 3rd. Form 982 is the new form that allows taxpayers to not have to claim canceled home mortgage debt as income. You can submit a paper return with Form 982 today, though.

Hat Tip: Don't Mess with Taxes

The IRS gave the go-ahead to §1031 exchanges for vacation homes. Do note there are significant restrictions. If you own a second home and are considering a §1031 exchange, make sure you follow the restrictions. Joe Kristan has the details on the IRS' pronouncement (Revenue Ruling 2008-16).

And that's not a good thing.

Assume you're an amateur gambler. You add up your winning and losing sessions for the year, and find that you have $150,000 of wins and $100,000 of losses. You get to deduct the $100,000 of losses on your federal income tax.

But if you're a resident of Louisiana, you can't do that on your state return. Louisiana penalizes anyone who takes itemized deductions. The formula for calculating the LA itemized deductions is:

57.5% * [(Fed. Itemized ded'ns) - (Fed. Standard ded'n)]

This is especially bad for amateur gamblers, because gamblers must include all of their wins as part of their Adjusted Gross Income but none of their losses. At least Louisiana gives a deduction from income of the amount of federal income tax you pay...

So Louisiana joins my list of states where a gambler shouldn't reside. Here's the complete list:

Connecticut
Illinois
Indiana
Louisiana
Massachusetts
Michigan
Minnesota (because of its AMT)
Mississippi (Only MS gambling deductions are allowed)
New York
Ohio
West Virginia
Wisconsin

Let's suppose you're playing an online role playing game such as Second Life. You've accumulated quite a bit of virtual property, and have a stash of virtual money. James Doe offers you $5,000 for your virtual money and virtual property—that's 5,000 real U.S. Dollars—and you elect to accept them. Do you have a real taxable event that would interest the IRS or just a virtual event?

I've written about this in the past, and I came to the conclusion that sooner or later the virtual world would intersect with the IRS. An article in the New York University Law Review by Professor Leandra Lederman of Indiana University's School of Law suggests that,

"...in virtual worlds that are intentionally commodified, such as Second Life, tax doctrine and policy counsel taxation of even in-world sales for virtual currency, regardless of whether the participant cashes out. However, as in game worlds, participants should not be taxed on purely in-world trades of non-currency items. This approach would allow entertainment value to go untaxed without creating a new tax shelter for virtual commerce."

The good news? She doesn't believe that pure virtual transactions in a virtual world should result in the IRS taking a bite (though a literal reading of the Tax Code could be interpreted that such transactions are subject to tax).

The IRS is aware of this issue and, sooner or later, it will be added to their priority guidance list. I suspect that sometime in the next few years if you trade virtual dollars for real dollars you will also receive a real 1099.

The abstract of the paper is available here. The full paper is not available online.

Thanks to the TaxProf Blog for the heads-up about this interesting subject.

Darryl Strawberry, the former major league baseball player, has been in lots of trouble over his life. He's battled drugs, cancer, ex-wives, and baseball players. Today he agreed to settle a tax dispute with the IRS.

Back in 1995 Darryl Strawberry was convicted of tax evasion. He still owes almost the whole debt—$430,000 (he's paid $8,600). He has agreed to reimburse the IRS in full including interest and penalties.


News Story: Newsday (via AP)

You have a small dispute with the IRS. The IRS alleges that you owe $554 and $1142 for the two years in question. You elect to file a Tax Court petition. When most people go to Tax Court, they work with the Court and the IRS (the respondent in a Tax Court action) so that their case can be heard and the judge can determine who is right.

However, today we look at what happens when a bozo petitioner brings a Tax Court action. Would he: (a) allege that respondent's counsel has, "engaged in serious misconduct"; (b) allege that the "presiding judge has failed and failed again to show any semblance of impartiality"; (c) refuse to accept service of court documents (sent by certified mail); (d) send the IRS an ultimatum demanding settlement on his terms and not appear in any of the pre-trial hearings/motions; or (e) all of the above.

You already know the answer—we're dealing with a bozo here. All of the above happened and is documented in this case.

The IRS moved for dismissal because of lack of prosecution (the petitioner never brought the facts out on his case), and as the Tax Court noted, dismissal was a "relatively simple matter."

The IRS also asked that the petitioner face a penalty under section 6673. The Tax Court noted that in a different case the Fifth Circuit Court of Appeals held,

"it is difficult to imagine a lesser sanction that would vindicate the integrity of the court proceedings and deter * * * [taxpayers] from similar misconduct. Wasteful and dilatory appeals unjustifiably consume the limited resources of the judicial system: “While judges, staff and support personnel have expended energy to dispose of this meritless appeal, justice has been delayed for truly deserving litigants.” Foret v. S. Farm Bureau Life Ins. Co., 918 F.2d 534, 539 (5th Cir. 1990). [Id.; fn. ref. omitted.]"

As the Court concluded, "Petitioner’s attempts to delay and his belligerence must be sanctioned to vindicate the integrity of this Court’s proceedings and to deter petitioner from similar misconduct in the future." He received $1000 sanctions for each of the two cases heard.

Cases: Mack v. Commissioner, T.C. (two cases), T.C. Memo 2008-29

Apparently some of our legislators are unhappy with California's low ranking as a place to do business. They'd like to make this just as bad a place for non-profits. AB624 would require foundations and non-profits in California to collect gender, ethnic and sexual orientation data on their board, members, staff and grant recipients. Yes, a non-profit would have to ask their Board members what their sexual orientation is.

This is, of course, ridiculous, but nothing surprises me about the Bronze Golden State anymore. Hopefully, the Legislature will realize that this is as ridiculous a measure as it truly is and it will die a quick death in some committee.

Every year the Orange County chapter of the California Society of Enrolled Agents and local CPAs donate their time to answer tax questions by phone for four hours. Tomorrow (Tuesday) you can call 714-796-5000 between 5pm and 9pm PST and get your tax question answered. It's sponsored by the Orange County Register; I'll be one of the volunteers answering your questions.

Anthony Pendleton ran Payless Tax Services of Inglewood, California. Mr. Pendleton allegedly had an interesting way to ensure that his clients got refunds: He allegedly invented employers for his clients, generated phony W-2s, and fabricated educational expenses. It's a trifecta of trouble, and it's surprising that a former IRS employee wouldn't realize that phony W-2s would certainly be investigated. Mr. Pendleton was arrested on charges of conspiring to defraud the government on claims (for tax refunds). Also under indictment but not yet arrested are two employees of Payless, Christopher Michael Edwards, Sr., and Asha Delilah.

IRS special agents interviewed found 21 witnesses (or almost certainly, clients of Payless) who hadn't worked for the employers noted on their returns. The IRS also found eight 'clients' who, "...disclaimed any knowledge that Payless Tax Services and defendants Pendleton, Edwards, and Lenard were filing tax returns on their behalf with the IRS and stated that did not sign any of the documents relevant to the investigation, indicating that the defendants had stolen their identities."

The defendants are alleged to have filed 185 false claims totaling $609,000. If found guilty, they're looking at significant stays at ClubFed. Not surprisingly, when the Associated Press called Payless, "Staff at Payless could not be reached for comment, as the service's phone had been disconnected."

AP News Story
Government Press Release

Right after Wesley Snipes found out that he'll be sentenced on April 24th, news came out that Wesley Snipes owes $70,000 in back property taxes for his home in Alpine, New Jersey (in suburban Bergen County). The home is in the name of his production company (Kymberlyte Production Services); Snipes sold it to them for $5.6 million in 2002.

The back property tax lien has been sold to Crusader Lien Services. I'd expect this problem to be taken care of, unless Mr. Snipes now also believes that property taxes are illegal....

Hat Tip: Don't Mess With Taxes

In years past, if I took a position on a tax return it needed "Substantial authority." That's equivalent to about a 30% chance of being upheld. Congress changed the law; now in order for me to take a position it must be "more likely than not" to be upheld. Joe Kristan has a great post on what this means for taxpayers.

The Swedish tax agency, Skatteverket, is targeting online poker players and affiliates. Skatteverket uses an online "spider," or web crawler, to find web sites that appear to be income producing. They then investigate to see if they've reported income and/or paid their Swedish income tax. A report in Poker News says that Sweden has found 47 cases of unreported income totaling €44.5; poker players, according to Poker News, represented €5 million of this.

Sweden apparently, like the United States, taxes all gambling income. I've reported on spiders before, and noted that the IRS won't confirm or deny whether they use such software. However, the IRS doesn't need that sophisticated software to make some headway into determining who has and hasn't reported their online gambling income. Neteller is cooperating with the US Department of Justice. What agency in the United States might want information about gambling income besides the Department of Justice? As I've said before, not reporting your online gambling income is not only a violation of US law, you're now likely to get caught given Neteller's cooperation.

There are losing streaks and then there are really long losing streaks. Larry Harvey has not had a good year battling IRS attorney Randall Preheim. Yesterday, as Joe Kristan noted, Mr. Harvey lost his 64th and 65th cases. Today, that streak reached 67.

Look, the Washington Generals did win six games. (Well, they lost 13,000 games during that same time span....) And the Cubs are celebrating the 100th anniversary of their last World Series triumph so there is hope, Mr. Harvey.

Tax agencies love computerized notices. The computer does the work, finds probable tax scofflaws, and the notices are mailed in an automated fashion. This saves the agencies money. Assuming the tax debt is real, it's a good bargain for everyone.

However, there are problems when matching programs are used based on people's names. It appears that the Franchise Tax Board is doing just that. This story details that a retiree living in Omaha, Nebraska received a notice from the FTB about a $200 tax debt from 1999. The problem is that Wally Grant, the man who received the notice, hadn't stepped foot in California since 1943.

Sure, the FTB rescinded the debt and the past due notice. But why did the FTB send out a notice like this in the first place? The notice refers to someone with the same name who lived in Pasadena. I have to assume (like the television station that covered this story) that the FTB used a matching program of names. When the computer found a Wally Grant, it sent out the notice. I doubt a human looked at the notice until the telephone rang at the FTB.

Of course, it's possible that I'm wrong. It could be that the FTB matched social security numbers rather than names. If that were the case the social security number of Mr. Grant of Omaha could have been used by anyone, causing the problem. However, given the reference in the notice this seems unlikely.

In any case I'm wondering what's going on. The FTB refused to comment to the Omaha television station. I'd love to hear from someone at the FTB (or the Board of Equalization) as to what's going on. I'm all for the FTB going after tax scofflaws but this appears to be a case of big brother and it disturbs me deeply.

Today is the first of three election days in 2008 in California. If you're in Orange County, you can find your precinct here. If you're elsewhere in California, the Secretary of State's website can direct you to your county's registrar website to find your precinct.

If today is your election day, exercise your right to vote.

Wesley Snipes wasn't the only individual who learned his fate last week. Here are three more cases of tax evasion which all share a common theme.

First, from Upper Makefield, Pennsylvania comes the story of a couple who put business first. Michael and Jacqueline St. Clair had a construction company, MDSC Concrete Contractors. They decided back in 1999 - 2001 to expand their home. Nothing wrong with that. According to phillyburbs.com, they spent $370,000 adding four bedrooms and other rooms to their home. Still ok. They paid their contractors from their business. And that's the problem.

Expanding your home just doesn't cut it as an "ordinary and necessary" business expense. Add to that some other highly questionable deductions on their business returns, a very low income on their personal returns (low enough to qualify for the earned income credit), and you have two who have been found guilty of several counts of tax evasion. Sentencing for them is set for May 1st.

From Benicia in Northern California comes a similar story. Former city councilman and school board member Dirk Fulton pleaded guilty to one count of tax evasion. Mr. Fulton didn't report some of the income he made from various corporate entities on his 1999 personal tax return. Mr. Fulton has agreed to make restitution to the IRS of $115,000, pay a $28,000 fine, and serve five months at ClubFed followed by five months of home confinement.

Finally, from Milpitas comes a man who thought that if he didn't invoice his customers he could forget about the income tax. Dominic Chang owned an auto shop and didn't like taxes. He used two bank accounts—when he issued an invoice the money went to Cal Fed; when an invoice wasn't issued the money went to Wells Fargo. Mr. Chang reported no income from 1999 to 2001. When his return was audited the fraud was discovered. The report in the San Jose Mercury said that at first Mr. Chang told the IRS that the Wells Fargo money was his sister's. However, he later admitted that he lied and he pleaded guilty to three counts of tax evasion. He earned about $460,000 in the three years in question so reporting zero just didn't cut it. While Mr. Chang faces up to 15 years at ClubFed and a fine of $750,000 he'll likely be sentenced to a short term at ClubFed and restitution to the IRS.

So if you get the idea of having your business pay for your personal expenses just remember it works well until you get caught.

Back in November we reported on Robert D'Angelo. Mr. D'Angelo, the former head of the Madison, Wisconsin Overture Center, was facing a variety of charges based on him running two side businesses using city facilities and not reporting the income from the businesses on his tax return. On Friday Mr. D'Angelo pleaded guilty to two counts (one of tax evasion and one of mail fraud) in a plea deal.

The indictment charged that Mr. D'Angelo made about $238,000 from his businesses. While he could face 23 years at ClubFed it's much more likely he'll serve around two years.

However, that's not the end of Mr. D'Angelo's legal troubles. He left the Overture Center when he was accused of sexual harassment. The US Equal Employment Opportunity Commission is still investigating those charges.

If a Maryland State Senator has his way, buyers of bongs in Maryland will soon have to pay a special tax. C. Anthony Muse (D-Prince Geoerge's County) introduced two bills on Wednesday that would add a $20 tax for all tobacco accessories except rolling paper.

For those who don't know a bong is a water pipe used to smoke tobacco or cannabis (marijuana). Senator Muse would have preferred to outlaw the accessories completely; he believes that they are "drug paraphernalia—not tobacco paraphernalia." His measures would also require stores selling such items to check id's and record purchasers names.

Senator Muse's measures will face committee hearings in the Maryland legislature before coming up for any votes.

Why was Wesley Snipes found not guilty of tax fraud charges? Was it a repeat of the OJ Simpson case? Is this a huge victory for tax protesters?

It's interesting that both prosecutors and defense attorneys praised the jury in Ocala, Florida. (One thing is certain: Wesley Snipes won't be complaining about juries in central Florida anymore.) Ocala.com reported that Robert O'Neill, U.S. Attorney for the Middle District of Florida, said, "The jury did a very good job." Consider that the two purveyors of the Section 861 scheme, Eddie Ray Kahn and Douglas Rosile, guilty of tax fraud. Yes, Snipes was guilty of stupidity (if you believe you don't have to pay taxes...) and tax evasion (the government clearly proved that he didn't file tax returns while he was earning income) but was he the purveyor of a tax fraud scheme?

I hadn't looked at the case in that manner but thinking about it I can see how a jury could decide that Snipes just bought the words of Kahn and Rosile. The verdict is not a repeat of the OJ Simpson case; Snipes was found guilty of three counts of tax evasion and could spend some time at ClubFed. He also faces the possibility of a civil suit by the IRS to recover the taxes. That might not happen, though, because his defense attorney says that Snipes intends to file and pay his taxes.

Is this case a huge win for the tax protester movement? I don't think so. Yes, the government didn't get the "famous" person they prosecuted but they did get the two clear members of the tax protester movement who implemented the scheme. The government's batting average in cases like this is well above .900, and that's very good. As Robert O'Neill said, "We're going to continue to go after those people, and I think you will see more indictments of tax protesters. The IRS will go after all of those taxes."

Wesley Snipes was acquitted of conspiracy to defraud the IRS but found guilty on three of six counts of not filing a tax return (tax evasion) according to news reports. Snipes faces up to one year at ClubFed on each of the three misdemeanor counts, plus restitution to the IRS.

Snipes was acquitted of the more serious count of conspiracy to defraud the IRS. I think this is the best that Snipes could have hoped for as the evidence of him not filing and paying taxes was quite clear.

It will be interesting to hear what the jury's reasoning was in acquitting Snipes.

Update: Snipes' co-defendants, Eddie Ray Kahn, who founded a tax protest group, and Douglas P. Rosile, a former accountant, were convicted of tax fraud and conspiracy by the same jury.

The jury has reached a verdict in the Wesley Snipes case; it will be read shortly in the courtroom in Ocala, Florida. I'll bring you news of the verdict when I get it.

Richard Hatch, the Survivor winner who thought that 300 million witnesses were wrong to him winning $1 million, had his appeal denied today by the First Circuit Court of Appeals. Mr. Hatch will likely have to complete his sentence of 51 months at ClubFed.

Hatch appealed his conviction on various grounds:

"Hatch argues that the district court violated his Sixth Amendment rights by precluding Hatch's testimony about his alleged discovery during the taping of "Survivor" that the production company, SEG, was "cheating" by giving food to other contestants and otherwise violating its own rules for how the contest would be run. Hatch's discovery of these irregularities, he now says in his appellate briefs and argument, led the show's producer, Mark Burnett, to promise Hatch, in exchange for his silence, that SEG would pay his taxes if he were to win the prize."

There's a problem with this line, though; the Court gave Hatch several opportunities to elicit such testimony. "The court thus opened the door for defense counsel to ask Hatch whether Burnett or someone else at SEG had promised to pay the taxes on the money he won. Hatch's counsel, however, did not follow up with questions of this sort."

Hatch also argued that the Court prevented him from introducing evidence, "...[of] a subjective belief he had no legal duty to pay his taxes, an argument which would negate the element of willfulness required to prove his guilt." The Appellate Court found no evidence of that.

"But without evidence that the producers had agreed to pay Hatch's taxes, the evidence that Hatch had caught those running the show cheating was of no contextual materiality to the revenue violations with which Hatch was charged. The court was well within its discretion to reject further testimony of Hatch's complaints about 'cheating' during the show until the defense furnished evidence of a tax payment promise that made such contextual evidence relevant."

Hatch also argued that the District Court limited his arguments on cross-examination. But that argument held no water; "Here, the district court's limitations on cross-examination in this nine-day trial were thoughtful and far from being excessive."

Hatch also argued that the expert witnesses called (generally, accountants that Hatch had used and IRS agents) should not have been admitted. Here to, though, the Appellate Court disagreed. "Taking each witness in turn, we find no error."

And the final claim made by Hatch on appeal was also turned down: "Lastly, Hatch challenges in the briefest of language his sentence on the grounds that the court erred in the loss finding and in applying a perjury enhancement. Both claims are undeveloped and fail in any event." You may remember that the District Court judge felt that Hatch had lied during his testimony (thus, the perjury enhancement). The Appellate Court has told Hatch that he did indeed lie,

"...the court catalogued many instances in which Hatch had committed perjury, noting that the list was 'a pretty long one' and included lying on the stand about his failure to disclose the income which formed the bases for the charges on which he was convicted and about his alleged failure to read the letter drafted by Wallis regarding the hypothetical Exhibit One which he then submitted for his tax return."

So for the next 27 months or so Hatch will complete his sentence at ClubFed. Hopefully he'll learn from this experience that usually 300 million witnesses are right.


Full Appellate Court Ruling Here
AP Story Here
Link to previous Taxable Talk posts on Richard Hatch

Hat Tip: How Appealing