Taxable Talk

It's something about prostitution that somehow leads to tax evasion. While perusing my email this evening in Connecticut I noticed yet another guilty plea by a man who charged personal expenses on his corporate tax return. Somehow the IRS did not find as humorous as I do the idea of deducting visits to prostitutes as "necessary and ordinary" corporate business deductions.

John Kelso of Monroe, North Carolina pleaded guilty to tax fraud. He agreed to make restitution of $18,000 and faces up to three years at ClubFed and a fine of $250,000.

Governor Schwarzenegger said he will sign the revised budget bill passed by the Legislature yesterday. I'll have details on the impact to Californians when I return from Connecticut on Tuesday.

Reports out of Sacramento are that the Big Five (Governor Schwarzenegger and the Republican and Democratic leaders of the Legislature) have reached another budget deal; this deal will include all of Governor Schwarzenegger's budget fixes.

I can't find anything on specifics, so you will probably see these before I will (I'm in Connecticut and it's likely I'll be unable to post again until Tuesday). So we'll see if there's yet another budget done with smoke and mirrors or real reform in Sacramento.

Orange County Billionaire Igor Olenicoff sued UBS, the Swiss Banking Giant, alleging that they conned him into breaking US Tax Laws. Mr. Olenicoff is alleging that when a giant company tells you that they will obey the law everything just has to be kosher. Mr. Olenicoff, as you may remember, received a very light sentence after pleading guilty to tax evasion.

In any case, this should make for some interesting reading in the coming months.

Joe Kristan has an excellent post noting what some of the root causes of the financial mess are. He quotes and links from the Tax Policy Blog; bluntly, a lot of the blame falls on political schemes done in the past. Something I remember from physics: "For every action there is an equal and opposite reaction." All the money and funding that were pushed into housing so that everyone could own a home (which really accelerated during the Clinton Administration) is now seeing the obvious reaction: Not everyone should be a homeowner.

I'll have more next week when I return from Connecticut.

This morning from the Wall Street Journal I learned that Governor Schwarzenegger has delayed his veto of the budget until Friday. It's likely there are the votes needed to override the veto; the Governator promised that if that happened he'd veto just about everything else that crossed his desk.

Republican State Senator Richard Ackerman is quoted in the Journal noting that the Governor could veto the associated spending and tax bills as there aren't enough votes for most of those to survive a veto. So confusion reigns in Sacramento, and I'm guessing I'll find out more this weekend.

I will be traveling over the next several days. Posting will be very limited until next Tuesday, September 23rd. I was hoping to get the next part of my presidential tax series up. Unfortunately, it will be delayed until my return.

My thanks to Joe Kristan for highlighting an interesting and amusing (to me) Tax Court case today: Baisden v. Commissioner. Mr. Baisden is a CPA, and he had a unique way of preparing tax returns:

In an effort to explain his bookkeeping and accounting methods, petitioner explained that since approximately 1998 [Mr. Baisden] had developed for his use and for the use of his clients a novel and insightful tax strategy that may be described generally as follows:

(1) Booked sole proprietorship income would be totally or almost totally offset by the payment by the sole proprietorship of “royalties” to the owner of the business;

(2) the so-called royalties would not be paid directly to the owner but rather would consist of payments by the sole proprietorship of the owner’s personal and family expenses;

(3) the “royalty” payments would be treated as fully deductible by the sole proprietorship, and they would reduce the booked net income of the sole proprietorship
to zero; and

(4) the owner would report “royalties” paid with regard to personal and family expenses as “other income” not subject to employment taxes. The primary savings were apparently intended to be derived from petitioner’s tax strategy through the conversion of sole proprietorship business income subject to self-employment taxes into royalties not subject to self-employment taxes.

I strongly suggest that you never attempt to use the above strategy unless you'd like to find yourself facing fraud penalties.

Mr. Baisden also tried to delay his audit by filing a "spurious complaint" with the Taxpayer's Advocate Office. And I'm only just touching the surface of this case....

On the good side, the Tax Court case was about the IRS assessing fraud penalties and, as you'd suspect, the IRS was upheld. On the better side Mr. Baisden remains under a preliminary injunction to not provide tax advice.

Joe Kristan has more.

And it's a good one, too. I don't know how I've missed adding Robert Flach's The Wandering Tax Pro blog to the blogroll on the right, but that error has been rectified. Robert reports extensively on the tax situation out of the swamplands New Jersey, the Garden State.

In any case, his blog is well worth reading if you're into taxes.

It's now worthy of a soap opera. Republican Governor Arnold Schwarzenegger announced this afternoon that he would veto the budget bill that passed last night. He announced that if the budget veto is overridden that he would veto "hundreds of bills."

The Flash Report is a bit less certain of what the Governator will do. I do know that California has a dysfunctional budget process and that there wasn't real structural reform this year. I don't know how the Governor can mandate 60% of the Legislature to change their world-views. I suspect we're still seeing the unstoppable force meeting the immovable object.

I'll be out of town over the next few days, but I'll try to update the latest chapters of "As The Budget Churns."

Both houses of the Legislature passed a budget late yesterday (possibly early this morning). The $110 billion budget does not include any new general taxes or tax increases (no increase in the sales tax or income tax).

The budget does include some new gimmicks, though. There's borrowing from the state lottery, and a change in how state taxes are collected. The Los Angeles Times reports:

Some businesses and individuals would have to pay their taxes sooner, and some would have to pay more than they owe and would get the extra back later. State taxes withheld at the workplace would jump 10% for everyone.

Here are the tax changes being made:
- Estimated payments will be "front-loaded" (more must be paid earlier in the year);
- Estimated tax payments would be based only on 90% of current years' income (66% for farmers) and on the annualized income method (aka "pay as you go");
- LLCs must prepay the LLC fee rather than paying it the following April;
- There will be a new tax amnesty;
- The Net Operating Loss (NOL) carryforward and Research & Development credits would be temporarily suspended; and
- Beginning in 2010 businesses would be able to stockpile credits and use them (in future years) more liberally.

The devil is in the details, and I haven't seen them yet. I probably won't until next week, but when I do I'll report on them.

There is one other detail: Governor Schwarzenegger is threatening a veto. The budget establishes a rainy day fund, but it's weak in concept. The Governator wants a far stronger rainy day fund where transfers out are rare.

Additionally, the rainy day fund and the borrowing from the state lottery require voter approval. That can't happen in November (the budget passed too late) so we'll likely have another special election next year.

There are major problems with this budget:
1. What happens with the 2009-2010 budget? California's economy likely won't improve for another two years. The budget deficit next year figures to be worse than this year. Additionally, the money that made this budget "balanced" came from the following year's budget.
2. This budget makes California even less of a business-friendly state. This will cause even more businesses to leave the Bronze Golden State resulting in lowered tax revenues.
3. How rosy are the assumptions in this budget? I can't tell, but I suspect they're very rosy. I suspect that next March we'll be talking about a $5 billion budget deficit in the current fiscal year.

Sooner or later California will have to tackle these budget issues head-on. As usual, later appears to have won for now. Eventually, though, real solutions must be found or the train jumps the tracks.

I'm always interested in finding new tax bloggers. I received an email today from Bruce who has "the taxguy" tax blog. He has quite a bit of useful information on his blog, including the first of a series about choosing a tax professional.

I've added his blog to my blogroll, and I welcome him into the world of tax bloggers (though it appears he's been around some time—it's just been my fault for not noticing him).

An interesting week for tax fraud. There's a typical case out of the San Joaquin Valley, a jailed promoter who may have to spend even longer at ClubFed, and an attorney who admitted that he lied under oath to the IRS and that he gave an incorrect legal opinion on a tax shelter.

First, Michael Gordon of Clovis, California (near Fresno) has had his own software company for several years. Between 2001 and 2004 he had his company pay over $339,000 of personal expenses as business expenses. That's not a good idea, and it became a very bad idea when the IRS caught him. He pleaded guilty to tax fraud last week, and has agreed to make restitution of $211,000 and pay all the taxes, penalties, and interest he owes. He's already paid over $570,000 toward his obligations. Note that appears to be far larger than the actual tax he owes which goes to show the impact of penalties and interest. As usual, it's a lot better (and cheaper) to just pay the tax in the first place. Mr. Gordon will be sentenced in November.

Remember Eddie Ray Kahn? He was a co-defendant of Wesley Snipes. Mr. Kahn is already at ClubFed having been sentenced to ten years. Well, he may be spending even more time there. He was indicted this past week along with four others on counts of mail fraud and conspiracy to defraud the United States. What did these individuals do? They allegedly sold worthless "bills of exchange" and other schemes to promote tax fraud.

The indictment alleges that American Rights Litigators/Guiding Light of God Ministries sold more than 4,000 packages to customers in every state. Their "bills of exchange" were supposedly drawn on the US Treasury for payment of taxes. Unfortunately, there's no such thing. Mr. Kahn allegedly was the ringleader of the group. In any case, no trial date has yet been set.

Finally, Peter Cinquegrani was a partner at Arnold & Porter, a law firm. He was instrumental in designing the PICO tax shelter (Personal Investment Corporation). Back in 2003 he testified under oath to the IRS that the shelter had not been designed to avoid taxes.

One of the issues with "tax shelters" is that they must have some economic substance. A basic rule of tax is that transactions that lack an economic substance are ignored for tax purposes. Well, Ernst & Young was looking to develop tax shelters (including the PICO). Mr. Cinquegrani was the primary drafter of opinions stating that the PICO had an economic purpose.

This past week Mr. Cinquegrani pleaded guilty to conspiracy to commit tax fraud, aiding and abetting tax evasion, and aiding in the submission of false and fraudulent documents to the IRS. He admitted that he lied to the IRS back in 2003. He also admitted drafting a phony consulting contract between Ernst & Young and Bricolage Capital. The North Country Gazette gets to the meat of the issue:

He stated that E&Y’s fee for the PICO transaction was calculated as a percentage of the tax loss the client wished to generate, but E&Y’s engagement letter with each client reflected a much smaller flat fee amount in order to conceal that the true fee was a percentage of the targeted tax loss. Cinquegrani admitted that together with individuals at E&Y and Bricolage, he helped arrange for the large balance of E&Y’s true tax shelter fee to be paid by the client to a Bricolage affiliate, and then for the affiliate to pay E&Y.

Mr. Cinquegrani will be sentenced in December. He may also have to make restitution and pay a fine. Arnold & Porter has settled with the IRS and paid a tax promoter penalty.

Remember what I've been saying for years: If it sounds too good to be true it probably is.

There's still no budget in California. However, the Los Angeles Times reported that Senate President Don Perata (D-Oakland) sent an email to fellow Democratic Senators that he would attempt to work with Republicans to write a new budget that has no new taxes and no borrowing. We shall see if there's a real budget or one full of gimmicks and if it actually passes this week.

Meanwhile, the Wall Street Journal noted in an editorial that California and New York, the states with the highest tax rates, are losing taxpayers. The Journal speculates that individuals who pay a lot of tax and can move do so. I don't have to speculate about that—I know the Journal is correct. I've had corporate clients relocate from Southern California to low-tax states and their businesses suddenly became profitable.

The Laffer Curve dictates that decreasing tax rates can lead to increased tax collections. It also leads to businesses making more money which can lead to increased employment and a better economy. Do you think the politicians in Sacramento will realize this? I doubt it....