Taxable Talk

Back in April I reported on Martha Vernon and her daughter Tiffany Dunbar. The team engaged in perhaps the stupidest Bozo scheme a tax preparer could: They stole names and social security numbers from her employer, invented a phony W-2 for each individual, prepared a tax return which, of course, showed that the individual would receive a refund. Did I mention they had the refunds direct deposited into their own bank accounts? Given that these individuals would inevitably submit their own tax returns it was impossible for the IRS not to discover this scheme.

They received $188,931 in refunds before the IRS discovered their scheme. The pair pleaded guilty back in April and were sentenced yesterday—Ms. Vernon received 40 months at ClubFed while her daughter, Ms. Dunbar, got 33 months at ClubFed.

There's only one more item to go with this story. Ms. Vernon's attorney, Lora Collins, told the judge that her client was told how to conduct the scheme by a former prison inmate who she had gotten involved with. I wonder if Ms. Vernon asked that man what he was in prison for...but I suspect that sort of question never occurs to the Bozo brain.

Most of us have mortgages on our homes. Joe Kristan has an excellent write-up on a Tax Court case decided yesterday, where the petitioners had a mortgage, but:
- They recorded the mortgage the morning of the trial;
- They submitted a phony copy of the promissory note as evidence at their trial; and
- The note was full of typographical errors and didn't appear to be truly notarized.

There's lots more, and as Joe said, "If you want to deduct mortgage interest, get down to the county courthouse to record the mortgage when you make the loan; don't wait until the Tax Court trial date."

An activist is now attempting to obtain 694,354 signatures to place a wealth tax/California exit tax on the 2010 ballot. This initiative would:
- Impose a one-time tax of 55% on property exceeding $20 million of a California resident or held in California by nonresident;
- Imposes a tax of between 36.5% to 54.3% when a resident dies or leaves California;
- Imposes additional 17.5% tax on total incomes of taxpayers with income exceeding $150,000 if single, $250,000 if married;
- Imposes additional 35% tax if incomes exceed $350,000 if single, $500,000 if married;
- Requires State to acquire shares of specified corporations (i.e. GM, Ford, ExxonMobil, etc.) to influence environmental practices.

The initiative's sponsor, one Paul McCauley, notes that, "This act proposes to restore a measure of balance in wealth between persons living in California, to salvage the global ecosystem from ongoing destruction and to restore public supervision and influence over the nation's largest financial institutions."

First, the proposed initiative is almost certainly unconstitutional as it restricts interstate commerce. Only the federal government can do that; an exit tax (taxing me if I move to, say, Nevada) obviously imposes a restriction on interstate commerce. Further, the initiative appears to me to violate California's rules that an initiative can only cover one subject.

If somehow Mr. McCauley obtains the signatures needed to place this on the ballot—I'm hopeful that he'll be unable to find 694,000 Californians who want to destroy the state's economy—I can't imagine this initiative passing.

What liberals should consider is that without industry there can be no government revenues. Instead of increasing tax rates California needs to drastically cut tax rates. I don't see that happening yet that's the real solution to our budget crisis. Frankly, should Mr. McCauley's initiative get approved and be found constitutional (a very unlikely prospect), California would go bankrupt as any individual who has such high funds would leave the state (good luck to the FTB trying to collect such funds), venture capital would leave the state, and Arizona, Nevada, Oregon, and Colorado would find themselves with a lot more industry than they currently have.


Hat Tip: Tax Foundation Blog

It was a busy week for the bozo side of the tax profession. Three preparers found themselves in hot water, and in one case some customers will be decoded into the mess.

First, from Beaufort, South Carolina, Sally Berry, the owner of Berry's Bookkeeping and Tax Service allegedly liked sales tax. However, she also allegedly didn't like to remit it to South Carolina. The South Carolina Department of Revenue also alleges that Ms. Berry underreported the amount of sales tax due on clients' returns. Ms. Berry faces up to 34 years in prison if convicted on all ten charges that she faces.

Next, Henry Omozee operated HO Tax Services and Accounting Services in Woodbridge, Virginia. He was found guilty on three counts of filing false tax returns. He underreported his own income on his tax returns from 2001 through 2003 to the tune of nearly $85,000 in tax. He could get up to three years at ClubFed when he's sentenced later this year.

Finally, Sharon Kukhahn had a sure-fire way to avoid income tax. Just buy her "IMF Decoder" and you wouldn't have to pay income taxes. Only one problem—there's no such thing and this was yet another phony scheme to avoid taxes. The Department of Justice estimates that the government has lost $4.9 million to this scheme. Ms. Kukhahn received a permanent injunction to stop selling the scheme, and she must provide a list of her customers to the government. So if you paid between $1,750 and $3,195 for her package you'll get something else in the mail soon—A "Dear Valued Taxpayer Letter" letting you know that your return has been selected for audit.

One final thing about Ms. Kukhahn. She displayed some chutzpah; after the DOJ filed suit against her she told her customers that she had transferred funds to the DOJ to compensate her customers. As you'd expect, there was no transfer of any money and the 328 customers who wrote the DOJ are out of luck. Well, since the DOJ (and likely the IRS) already has their names and addresses they might get some bad luck—they'll probably be among the first to be audited over this scheme. For as usual if it sounds too good to be true it probably is.

Earl Wolfe was an unlicensed architect in Jupiter Farms, Florida. That's one crime in itself. He earned around $750,000 but reported only $600 on his tax returns. The IRS and Department of Justice weren't appreciative of his efforts, and he has been found guilty of tax fraud.

What did he do with the other $749,400? He allegedly cashed $600,000 at check cashing stores, put some of the money in a Nevada Corporation, and hid some as a priest (Church of the Divine Deduction?). Unfortunately, he wasn't a priest, and putting his home and motorcycles in his "ministry" wasn't successful. His co-defendants pleaded guilty earlier this month. Mr. Wolfe will be sentenced later this year and will likely get some time at ClubFed.

I've written in the past that there's something about Escort Services that somehow get their owners in tax trouble. Late last week two other individuals in related industries pleaded guilty to tax evasion charges.

First, from Eugene, Oregon, comes the story of Janine James. Ms. James, also known as Janine Lindemulder, hails from nearby Huntington Beach. Ms. James has appeared in numerous adult films and adult magazines such as Penthouse. Unfortunately for her, she decided that making a down-payment on a new home in Eugene was more important than paying the IRS. The IRS begged to differ, and she pleaded guilty to intentionally failing to pay her income taxes. She'll be sentenced later this year, and will likely need to make restitution and could end up making a short stay at ClubFed.

Meanwhile, in Charlotte, North Carolina, there was a rather high-end prostitution ring called Soft Touch Industries run by husband and wife Donald & Sallie Saxon. This wasn't a small-time ring; revenues were estimated by prosecutors to be around $3 million. Earlier this year a Raleigh cardiologist was charged in the case. On Thursday another individual pleaded guilty. James Smith, owner of Red Clay Industries, used the escort service's services. However, he decided to charge the expenses to Soft Touch Industries as business expenses. What Soft Touch provided were definitely personal in nature....In any case, Mr. Smith has pleaded guilty to tax evasion and is cooperating with federal prosecutors. He'll pay $19,000 in back taxes and prosecutors will ask for a light sentence.

The Las Vegas Review-Journal has published an excellent summary of the Gilbert Hyatt case and judgments.

Mark Hutchison, Mr. Hyatt's lead attorney, believes that the Franchise Tax Board will appeal the case. (I agree with him that the case will be appealed.) He's quoted by the Review-Journal,

[The verdict] sends a clear message that government abuse and over-reaching will not be tolerated by Nevada citizens...I think the message is: If you are going to audit Nevada residents, you had better do so in a fair and impartial manner and not be results-oriented in seeking to grab money from Nevada residents.

Mr. Hyatt was also interviewed by the Review-Journal, and noted that the FTB's original claim against him (that he was a California resident beyond September 1991) will be reviewed by the California Board of Equalization within two years.

My thanks to reader Darren Hankel to alerting me to this article.

California Assembly Speaker Karen Bass told the Wall Street Journal that she expects to reach a budget compromise this week. I doubt it.

The Democrats are still only arguing to increase taxes. Republicans in the Legislature vow that's not going to happen. Democrats, including Speaker Bass, say that there's no spending left to cut because of previous cuts; Republicans say that there's plenty left to cut and that the Legislature needs to implement permanent spending restrictions.

Does that sound like there's a compromise that's imminent?

That seems obvious, right? You need to charge sales tax on items that are picked up.

Hopefully it also seems obvious that if you're a liquor store owner you need to include takeout items in your income. There's no exemption for takeout items in the Tax Code...but you knew that.

Well, you know that, I know that, but one carryout (liquor store) owner in Toledo, Ohio apparently didn't know that. Ann Riebe pleaded guilty to one count of Conspiracy to Defrauding the United States. Riebe and another owner took cash that customers paid and allegedly took some of that home with them, or wrote checks and didn't declare the income. Riebe will only serve one day at ClubFed but will spend ten months under house arrest and will have to make restitution with the IRS.

Earlier this year I posted about a complex tax fraud case out of Salt Lake City. Several individuals were accused of helping various other individuals and businesses evade about $20 million in taxes. Three pleaded guilty. One of those who chose to go to trial (and was found guilty), Sandy, Utah attorney Dennis Evanson found out his fate on Friday. The judge sentenced him to 10 years at ClubFed, and he must forfeit his Hummer, Toyota Tundra, four pieces of property, and pay $2.7 million in fines. Mr. Evanson had been found guilty of mail fraud, wire fraud, tax evasion, and assisting in preparation of false tax returns.

The scheme the conspirators used had the usual trappings: foreign entities (in this case, on the Cayman Islands), foreign bank accounts, and fraudulent transactions. During the trial testimony revealed that the conspirators kept 30% of the tax saved.

If you happen to have utilized the services of Mr. Evanson or one of his co-conspirators, you will likely receive a "Dear Valued Taxpayer" letter from the IRS. It appears that the tax you "saved" is more like a mirage.

A Las Vegas jury told California's Franchise Tax Board in no uncertain terms that the FTB's conduct towards Gilbert Hyatt was reprehensible. I had speculated that the jury would award Mr. Hyatt $250 million in punitive damages; that was exactly how much he received.

Mr. Hyatt had accused the FTB of several torts, including invasion of privacy, outrageous conduct, abuse of process, fraud, and negligent misrepresentation. Earlier, the same jury had awarded $138.8 million in actual damages.

Bill Leonard, a member of California's Board of Equalization, said that the FTB spent $8.8 million fighting this case to date. If we add that, the $138.8 million of actual damages awarded earlier, and the punitive damages, the total is $396.08 million. Meanwhile, California has yet to receive any of the $7.4 million it assessed Mr. Hyatt (which is now nearly $50 million including penalties and interest). Mr. Hyatt is still fighting that decision.

Interestingly I could only find one news report on this story (the Sacramento Bee story I've linked to)—a story that is perhaps one of the most significant tax stories of the year. Mr. Hyatt's lead counsel, Mark Hutchison, told the Bee, "Government agencies should pause and reflect on the significance of this verdict." Mr. Hyatt noted, "[I hope] this will prevent other taxpayers from going through the same nightmare that I have had to endure for over a decade."

The Bee story quotes the FTB's former lead auditor, Brian Toman: "As far as I know, and I've been around a long time, there has never been an award of tort damages against the Franchise Tax Board in any kind of audit." Well, there's a good reason for that—Californians cannot sue the FTB for tort damages. California law grants state agencies sovereign immunity from lawsuits such as Mr. Hyatt's (§860.2 of the Government Code). As noted in my previous post, Mr. Hyatt was able to sue because the actions the FTB took occurred in Nevada.

I fully expect the FTB to appeal the decision though officially no decision has been made. Interest will accrue to Mr. Hyatt during any appeal, so the total could easily exceed half a billion dollars. In the meantime it will be interesting to see if the FTB auditors realize that there is a line that shouldn't be crossed.

Medical marijuana is a complex subject. California voters passed an initiative legalizing it; the federal government says its still illegal under federal law. I'll let the attorneys battle that one out.

However, whether medical marijuana is legal or illegal doesn't impact the tax situation for a grower. Illegal income is just as taxable in the United States and California as legal income. And that's where our story begins.

Edwin Hoey pleaded no contest last year to possessing and selling "hundreds of pounds of pot." He has now been arrested on five charges of filing a false state income tax return.

Mr. Hoey's attorney, Ben Rice, is quoted by the Central Coast Sentinel, as stating, "This gray area is very gray, very dark and it's hard for people who want to do this exactly the way they're supposed to...It's hard for people to know how to do it... Hoey has paid his taxes and he's prepared to rectify his tax statements but it's really difficult to know how to do that."

I hate to tell Mr. Rice, but I think he's very wrong here. Mr. Hoey was conducting a business. It's pretty simple: add up all your income, subtract your expenses, and you've got your net income. Perhaps it was hard for Mr. Hoey to include his illegal income on his tax return but it's the law.

Mr. Rice also complained that the government is getting a second bite at the apple. But tax charges are different from drug charges—it's not double jeopardy.

And I have even more bad news for Mr. Rice and Mr. Hoey. It's quite possible that the IRS will take a look at this case, too. The IRS and the Franchise Tax Board (California's state income tax agency) share information.

So if you decide to get in a business that's in a gray area (or even one that's over the line) do make sure to file and pay your taxes.

It must be something about the profession. Yet another Escort Service owner is in trouble over taxes. Theresa Faye Hope pleaded guilty to tax fraud charges today. Ms. Hope was the proprietor of Aphrodite Inc., a subchapter S Corporation. There's nothing wrong with that.

Of course, understating her company's income by $267,000 wasn't acceptable. True, that didn't change her corporate tax at all (S Corporations are "flow through" entities; the owners pay the tax). However, it did result in her underpaying her federal income tax by over $50,000. That results in up to three years at ClubFed, a fine of up to $250,000, and possible restitution.

The article notes that her service charged only $125 for a half hour or $175 for an hour, and that she kept just $50 or $75, respectively. While she apparently did listen to her accountant and set up an S-Corp, she missed her accountant telling her to always put aside enough money to pay your taxes.

Back in October 1991 Gilbert Hyatt moved from California to Nevada. California's Franchise Tax Board didn't think he did, so they commenced a residency audit. California determined that Mr. Hyatt didn't establish residency in Nevada until April 1992. Normally, six months wouldn't be a big deal; however, Mr. Hyatt had invented a microprocessor and received a substantial amount of income during that time period. California assessed $49 million in taxes.

Mr. Hyatt fought the judgment through administrative appeals. He also wasn't happy about the methods the FTB used to investigate him. Mr. Hyatt filed a lawsuit against the FTB in Nevada, alleging

...that [FTB] directed “numerous and continuous contacts … at Nevada” and committed several torts during the course of the audit, including invasion of privacy, outrageous conduct, abuse of process, fraud, and negligent misrepresentation.

The FTB fought the case, arguing that they were immune from being sued. (As an aside, had the actions that Mr. Hyatt alleged took place in California, the FTB would be immune.) The case went all the way to the US Supreme Court; the Court ruled unanimously that the FTB could be sued in Nevada. The case was remanded back to the Nevada District Court for trial.

The first phase of the trial ended last week, and the FTB suffered a ringing rebuke. According to Bill Leonard's Leonard Letter, Mr. Hyatt prevailed on every claim and was awarded $137 million in damages plus $1.08 million in legal fees. The jury is now looking at potential punitive damages which could easily be another $400 million or so.

What did the FTB do? From the Leonard Letter:

Tax agents rummaged through his trash without warrants, visited business partners and doctors, and shared his Social Security Number and other personal information with the media. This is outrageous behavior and I call on the FTB to rein in their agents. What really galled me is the FTB testified in open court that this level of harassment was only a typical audit. If true, then the stormtroopers are alive and well at the FTB.

I have little to add to what Mr. Leonard stated. And he should know; Bill Leonard is an elected member of California's Board of Equalization. The BOE hears administrative appeals on FTB cases after an individual (or organization) exhausts appeals at the FTB.

What's the cost to California? To date, the FTB has spent $8.8 million fighting Mr. Hyatt. Add the $138.88 million that is now owed to Mr. Hyatt and the total is $146.08 million. If we add another $250 million for punitive damages the total is nearly $400 million. And while Mr. Leonard is hopeful that the FTB won't appeal the case, I am almost 100% certain that the FTB will appeal. Thus, unless the FTB gets lucky in Nevada this case could easily cost California taxpayers over half a billion dollars.

Welcome to the Bronze Golden State....

Two business executives. Two men with tax troubles. Is ClubFed in their futures?

Joseph Smith was the former treasurer and CFO of the Catholic diocese of Cleveland, Ohio. He supplemented his earnings by engaging in a kickback scheme. He funneled work to a co-conspirator and in return received kickbacks of over $784,000. And those kickbacks were disguised as compensation for consulting and legal services. He was found guilty of six tax charges and will be sentenced this October.

Lyle Larson was a not-so-successful computer entrepreneur in Edmonds, Washington. His tax return showed that he only made $38,000 of business income. That is, when he bothered to file a tax return (he "forgot" in 2004, 2005, and 2007). I did leave some things out. Like his luxury yacht. His cars. His $2.8 million in earnings. Mr. Larson left those out from his tax returns between 2000 and 2003. He'll have 18 months at ClubFed to think over those omissions, and he must make restitution of over $879,000 to the IRS.

If you get lucky in business or otherwise do yourself a favor. Set aside some of your earnings to pay your taxes. You can pay now, or pay later, but it's a whole lot easier to pay now.

If you are lucky enough to win the lottery definitely plan on paying your taxes. Indeed, you'll find that the government will be quite helpful in that regard, and that taxes will be withheld from your winnings.

Do remember, though, that even after your lottery winnings cease coming in that you'll have to pay taxes. One Florida woman didn't, and she'll be spending two years at ClubFed because of that.

Rhoda Toth and her late husband won $13 million in the Florida lottery. She and her husband spent it all and then some, and had to declare bankruptcy. They also filed a false tax return. Eventually she and her husband were indicted on various federal tax charges. Her husband passed away before the trial began. Ms. Toth pleaded guilty, and asked to be spared from going to ClubFed because of bad health—she suffers from multiple sclerosis.

The IRS thought she wasn't in as bad health as she said. And they videotaped her walking without help of crutches or a walker. So instead of no jail time the judge elected to send her away for two years.

This is a sad story, and brings up a point that we should all remember: whatever you earn, spend less and save some money for a rainy day.

When I was growing up just north of Chicago my parents told me about how the dead voted. That didn't seem right to me, but I did learn at a young age about Chicago politics.

Last year I reported that former Alderman Arenda Troutman was accused of 13 counts, including mail fraud and tax fraud. She had said she was innocent...until this week.

Sam Adam, Jr., Troutman's attorney, told the Chicago Defender, "I can say that the federal government did their homework, which is evident by what we see here today. For the benefit of her family and for the benefit of her personally, we felt this was the best thing to do at this time." What she did was to plead guilty to one count each of mail fraud and tax fraud.

When she's sentenced this December she'll be spending some time at ClubFed. Her attorney is hoping to keep the sentence under 33 months; however, she's likely to spend around four years there.

Wesley Snipes recently got clearance to go overseas to film a movie while waiting for his appeal to be heard. It looks like he'll need some of the money he's making: he just received the bill for his trial.

As Kay Bell reported in Don't Mess With Taxes, Mr. Snipes has been ordered to pay $217,363.75. That represents $2,456.40 for trial transcripts, $138.18 for certifying and copying exhibits, $21,052.19 for witnesses, and $193,716.98 for scanning, printing and numbering documents.

Going to court can be expensive....

No surprise, really, that California still has no budget and frankly there's been no progress. Democrats want to increase taxes, Republicans don't, and neither side is talking to the other.

Yes, things are normal in Sacramento....

It's only my third day back from vacation. Some of the individuals mentioned below will be counting the days at ClubFed very soon.

Let's start in Stillwater, Minnesota. Randy Haugen owned an automobile repair business, and it was apparently quite successful. One of his methods of improving his bottom line was allegedly not remitting sales tax to Minnesota and not filing income tax returns. Those methods really do help the bottom line...until you're caught. The Minnesota Department of Revenue said that Mr. Haugen, "knew this day was going to come and he dreaded it." As a helpful hint, if you find yourself in that situation get an attorney and make a payment plan rather than postponing the inevitable discovery of the tax evasion.

Staying in the Twin Cities, a former co-owner of a roofing business is accused of conspiracy, mail fraud, tax evasion, and filing false tax returns. Amit Sela of Minnetonka, Minnesota, allegedly embezzled over $600,000 from Sela Roofing, and then allegedly filed false tax returns to cover up the theft. On the other hand, Mr. Sela's attorney, Eric Brever, told the Minneapolis Star-Tribune, "We believe a jury will find Mr. Sela innocent of all the charges...[A]ll of the taxes were paid prior to the IRS criminal investigation." That's a big difference of opinion and we won't know the answer until the case comes to trial.

Finally, from Grand Rapids, Michigan, we learn that two former executives of U.S. Signal, a telecommunications firm serving the Great Lakes region, are pleading guilty to tax and mail fraud charges. The two, Barry Raternik, the former president of U.S. Signal, and Tim Hall, who used to be the company's director of operations, teamed with a supplier, Douglas Lautenbach (who also pleaded guilty) to overcharge the company for fiber optics. The three pocketed the difference and used the ill-gotten gains to fund lavish homes, sports cars, RVs, and other expensive items. They also allegedly sold other equipment on the secondary market. Instead of enjoying the luxury items they'll likely get to spend a few years enjoying the not so luxurious insides of various ClubFed facilities.

In the end, most of these "perfect crimes" end up with the same result—the participants enjoying ClubFed and making restitution to the government. Crime just rarely pays.

While I was away on vacation Congress passed a Housing Bill. There are a number of tax impacts of the legislation:

A first-time homebuyer's credit of up to $7,500. This credit can be taken if you are a first-time homebuyer who purchases a home between April 1, 2008 and July 31, 2009 who meets the income qualifications (phase out of the credit begins with at an AGI of $75,000 if single or $150,000 if married-filing-jointly (MFJ)). This credit must be paid back over 15 years beginning two years following the purchase. Additionally, the credit can be taken in 2008 if a qualified home is purchased in 2009.

There is a one-time property tax deduction for taxpayers who don't itemize for 2008. It's $500 if single or $1,000 if MFJ.

New credit card reporting requirements are one of the offsets of the cost of this legislation. The new requirements, effective January 1, 2011, require credit card processors to report the total dollar amount of transactions to the IRS and the merchant if the total is at least $20,000.

There are a number of other tax impacts of this legislation. CCH has published an excellent summary that's available here.

Hat tip: Tax Guru-Ker$tetter Letter

As expected California is no closer to a budget today than when I left on my vacation two weeks ago. The Democrats in the Legislature remain convinced that the only solution is new taxes while the Republicans are convinced that the only solution is to cut programs and spending. Meanwhile, Meanwhile, Governor Schwarzenegger proposed a temporary $0.01 hike in the sales tax coupled with spending restraints.

I doubt we'll see a California budget until September at the earliest.