Taxable Talk

There are many reasons to vote for a candidate for President. Even though taxes are important they may not be, for you, the most important issue. I strongly advise everyone to review both candidates' records, their views, and their character, and make your decision. And do vote—we're blessed in the United States to be able to exercise the privilege.

That said, there are major differences between the two candidates on taxes. (Though I have opinions on other issues I'm only an expert on taxes. I'll leave the other issues for you to research.) Both candidates promise tax cuts. Senator Obama is generally against extending the Bush tax cuts while Senator McCain want to extend them. Senator Obama has about a trillion dollars worth of new programs; he hopes to fund these by "closing loopholes" and likely by cutting military spending. Senator McCain proposes fewer new programs but his revenue collections would be lower.

Actually, all of this misses an important issue—perhaps the most important issue of all. Under the Constitution, all tax legislation must start in the House of Representatives. Under the rules of the House, said legislation will start in the House Ways and Means Committee. The chair of that committee, Congressman Charles Rangel (D-NY) will end up dictating, to a large degree, what gets in the bill. And here we can look at history to see what this will be like.

In 2007 Congressman Rangel proposed a major tax overhaul. His plan was purportedly revenue neutral. We're likely to see legislation similar to this. In some ways this looks like Obama's proposals; in other ways it doesn't. The major changes (many of which are positive) impact businesses.

So what's likely to happen if Obama wins? First, the Bush Tax Cuts will die in 2011. There's no way they can pass Congress, and even if that happened Obama would veto them. That means everyone will have a tax increase in two years.

Second, we're likely to see even more income redistribution. Wealthier taxpayers will be more heavily taxed. Under Rangel's 2007 proposal marginal tax rates would have exceeded 50% for the wealthiest taxpayers. Expect that to occur, and this will definitely hurt small businesses and the economy at large. Taxes are just another cost, and if taxes increase, either prices will increase or expenses will be cut. Generally, this will lead to lower employment.

Third, assuming Republicans have more than 40 seats in the Senate the proposals will require GOP support to pass. This will blunt somewhat their impact.

Fourth, given that the Democratic leadership in Congress is far to the liberal side you can throw Obama's $250,000 figure into the trash can. Today, Governor Richardson stated that the real number is $120,000. In my previous post I said it was $125,000. No matter, it's not $250,000.

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No matter who is elected I do expect a permanent estate tax exclusion to be agreed upon. I expect it to be $3 million, with the estate tax being 50% above that figure. Both Obama and McCain want to see permanency here, so this is the one area where I actually expect bipartisanship to rule.

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If McCain is elected the extreme redistribution plans are dead. There's no way McCain would sign such legislation.

McCain would be able to veto legislation with earmarks, and the Democrats would not have enough votes to override the vetoes. Thus, that's one plank of McCain's program that would go through (and it's a big positive).

The rest of McCain's proposals would likely never pass unless the American people rose up and forced the issue. They did this in Ronald Reagan's first term, and he was able to get a major tax proposal through Congress. I think that today's legislators are far more dogmatic in their stances and I don't see that happening.

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If Obama wins I'll have more business. Joe Kristan wrote an excellent post on what happens when the top tax rate is increased. It's extraordinarily harmful to small business, and I don't like that.

I wish one candidate would have proposed a huge simplification of our Tax Code. Ideally, I'd like to see a flat tax. Yes, it would drastically decrease my business but there are many other things I could do. Regrettably, neither candidate is proposing anything like that.

Instead, we have a choice between change that would harm the economy and likely gridlock. At least with gridlock we're probably not going to get a worse Tax Code.

This is the second of a three-part series on the Presidential candidates. Today I take a look at what Senator John McCain proposes in his tax plan.

Here are the basics of what Senator McCain proposes (most of the following is taken from John McCain's web site):
1. Keep Tax Rates Low. Senator McCain proposes keeping the current tax rates.
2. Phase out the Alternative Minimum Tax (AMT).
3. Lower the corporate tax rate from 35% to 25%.
4. Allow businesses to fully expense first year equipment and technology expenses.
5. Add a credit for businesses equal to 10% of wages that are spent on Research & Development.
6. Ban taxes on the Internet.
7. Ban new taxes on cellular phones.

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John McCain also proposes to eliminate wasteful spending. Senator McCain wants to balance the budget by 2013 (conveniently right after his term in office would end).

Senator McCain's health care plan involves eliminating the deductions for health care (mainly a business/corporate deduction) and replacing these with tax credits. For most Americans this would equate to a slight savings (based on after tax dollars).

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Senator McCain wants, "a one year spending pause. Freeze non-defense, non-veterans discretionary spending for a year and use those savings for deficit reduction."

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Senator McCain has stated on various occasions he'd like to see the inheritance tax exclusion at $5 million. He has also publicly stated that he's for extending the Bush tax cuts.

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Unlike Senator Obama's plans (which are somewhat detailed on his web site) Senator McCain's plans are not as detailed. Perhaps that's because he's proposing far fewer new programs (and, thus, a much lower need of new revenues) and is actually proposing things like cutting all earmarks.

Yet without the meat it's difficult for anyone to do anything but give a broad critique. No one likes to be pinned down and as I mentioned Senator Obama is as guilty as Senator McCain. Still, I think it's a worthwhile exercise to see where Senator McCain's policies on taxes would likely lead.

First, while I'd love to see corporate tax rates fall (since corporate taxes are always passed on to consumers, cuts in corporate tax rates always benefit consumers) I don't see that happening. Most Americans are unaware of the economic impacts of corporate taxes, and most politicians like to criticize corporations.

Second, attempting to balance the federal budget is a worthwhile goal. Yet without major cuts in multiple programs it just can't happen. Add in a probable recession (which will likely lead to more government spending) and you have an impossible goal. Senator McCain's head is in the sand on this issue.

The one proposal of Senator McCain's that I hope whoever is elected implements is the vetoing of all bills with earmarks. A million here and a million there and you soon have a leak in the system, so to speak. Will Senator McCain follow through on this if he's elected if Senator Smith puts in a $10 million earmark on the defense appropriations bill? I'm actually optimistic on this issue.

But I think all legislators need to look at fiscal discipline. That's a goal of Senator McCain's but I don't see it as a goal of many in Congress.

Yet Senator McCain proposes billions in tax cuts (according to the non-partisan Committee for a Responsible Federal Budget, it's about $450 billion). Eliminating the AMT is a good goal, but where is the federal government going to replace that revenue? Sure, if enough federal programs are cut the revenue wouldn't be needed but how often have you seen a federal department or program eliminated?

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I don't see many (any?) of Senator McCain's proposals getting through an ideological Democratic Congress. That isn't so bad—we'd have the current (flawed) system. Senator McCain also hasn't identified any programs that he would eliminate (save earmarks). Cutting earmarks would save maybe a billion dollars, but that's nowhere near enough money to fund his programs. Just saying that you are going to conduct a review of all programs (which will cost money, of course) and that there will magically be some that can be eliminated borders on wishful thinking.

Still, Senator McCain has some good ideas. The devil is in the details, and those are lacking today.

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In part three I'll examine the two candidates side-by-side. I'll also note the impact that Congress will certainly have on each candidate's goals.

I've reported on occasion on Robert Beale. Mr. Beale was tried on tax evasion charges, but attempted to arrest the judge.

That last tactic—attempting to intimidate the judge—didn't work out. He received 11 years at ClubFed when he was sentenced last month. It got worse earlier this week when he was convicted of conspiracy to impede an officer and obstruction of justice.

Joe Kristan has more.

When California's budget was passed I noted that it was full of smoke and mirrors. It was based on an optimistic scenario rather than a realistic scenario.

So far, it's only off by $3 billion; the Los Angeles Times notes that, "Capitol budget analysts say preliminary data indicate the problem will probably grow to at least $10 billion."

The crisis will be worse in California than in other states because capital gains are a high percentage of the personal income tax created. (In California, there is no preferential tax rate for capital gains.) With the stock market dropping there will likely be few capital gains to report on tax returns that are filed next year.

Governor Schwarzenegger has called a special legislative session beginning next Wednesday to deal with the crisis. Don't expect anything other than more smoke and mirrors. Democrats want a top-to-bottom review of the state's tax code (that means they want increased taxes) while Republicans want business tax cuts.

Alan Fabian seemed to have everything. He was an entrepreneur, a political fundraiser, had numerous "successful businesses"—in short, he appeared to have everything.

But it was a fraud. Actually, multiple frauds.

Mr. Fabian may have, at one time, actually been a successful enterepreneur. However, in 2001 he began a Ponzi scheme, defrauding investors in his businesses while paying himself a salary of $800,000 a year. He filed tax returns with fictional deductions. One of his shell companies went into bankruptcy in 2004; this may have led to the government investigation.

In 2007, while Mr. Fabian knew that he was soon to be indicted, he accepted another $500,000 loan (which was supposed to go to a non-profit he started). Instead, some of the proceeds were used on a family vacation to the Middle East...a vacation that began with a private plane trip to Israel.

Earlier this year Mr. Fabian pleaded guilty to two counts (one each of mail and tax fraud) out of the 26 he was charged with. On Friday he was sentenced to nine years at ClubFed. Judge Catherine Blake noted when sentencing Mr. Fabian that he had a, "...consistent, repeated, sophisticated pattern of fraud...[with] at least six [years] of grossly illegal and deceptive conduct...."

He will begin serving his sentence just before the New Year.

Proposition 12 would issue $900 million in bonds to provide loans to California veterans to purchase homes and farms. It would cost $59 million a year to repay the debt (for thirty years).

Supporters say that the Cal-Vet Home Loan program has been a huge success; the measure was placed on the ballot by a unanimous vote in both the State Assembly and State Senate. Opponents say that the bond measure would cost the state money and the screening in the program needs to be tightened.

That's the end of the propositions on the state ballot. Next week I'll look at Orange County Measure J and Irvine Measures R and S.

If you're a California resident you know that we have a dysfunctional legislature. One of the main reasons for this is that back in 2001 the Democrats and Republicans in the legislature drew up new districts. They made a deal, and made all but a couple of seats "safe." That's called gerrymandering, and almost every legislative district in the state is gerrymandered.

For example, my Assembly, State Senate, and Congressional seats are extremely safe Republican districts. While there's a Democratic candidate for each office, it's not going to matter--all the Republican candidates will win in a cakewalk. Similarly, almost every Democratic candidate will win easily. When the districts aren't competitive you tend to get legislators who are highly partisan and don't compromise.

Proposition 11 would change how redistricting is done in California. There would be a commission to handle redistricting for the state legislature. While this measure has almost no direct fiscal impact, eliminating the dysfunctional legislature can only be a boon to California.

Remember to vote on November 4th.

Proposition 10 would issue $5 billion in bonds. These bonds would then be used to provide $3.425 billion to aid consumers purchase high fuel economy or alternative fuel vehicles. Another $1.25 billion would be used for research and development of renewable, solar, and win energy. There would also be grants to cities.

Like any measure with bonds there is a cost. For this measure it's $335 million a year. Given the current credit market it's likely that's an understatement of the expense.

Proponents argue that Proposition 10 would help lead California to energy independence. Proposition 10 is supported by the AQMD. Opponents, including some consumer groups and the California Federation of Teachers, argue that this measure would remove money from other programs.

No matter where you stand on this remember to vote on November 4th.

There's a scandal in New York involving the Governor's Chief of Staff. Charles O'Byrne is Chief of Staff to New York Governor David Paterson. He makes a good salary ($178,500 a year). He also owes $200,000 in back taxes—he didn't file tax returns from 2001 through 2005 (from the news story it appears the unpaid taxes are New York state income taxes).

Mr. O'Byrne blames bouts of clinical depression for the failure to file tax returns. Republicans in the state senate are trying to make hay on this, and are starting an investigation. Governor Paterson (who succeeded to office after the Eliot Spitzer scandal) promises to soon disclose Mr. O'Byrne's tax records.

In any case, if you are an elected government official, or if you are a high staff member of such an official, make sure you pay your taxes. You can be that if you don't the opposition—be it Republicans or Democrats—will use this against you politically.

Proposition 7 has done something this election cycle that I would have thought was impossible: It is opposed by almost everyone. The opponents include the Republican Party, the Democratic Party, the United Farm Workers Union, the California Chamber of Commerce, and the California Taxpayers' Association.

What would Proposition 7 do? It would require utilities to generate 20% of their power from renewable sources by 2010 (with that percentage increasing to 40% by 2020 and 50% by 2025).

Proponents argue that Proposition 7 would help solve global warming, increase renewable energy use, and wouldn't cost much to California. Opponents argue that it would cut small wind and solar companies out of the market, would dramatically increase rates for everyone, and would dramatically hurt the economy.

Remember to vote on November 4th.

Proposition 6 requires specific funding for police and law enforcement, and adds several new crimes (mainly gang-related) to the penal code. It also changes sentencing, generally tightening (lengthening) sentences, especially for gang-related offenses. It is also estimated to cost at least $500 million annually, and potentially could have a one-time cost of $1 billion.

Proponents argue that it fights gangs, and helps crime victims. Opponents argue that it spends money needlessly.

No matter how you feel make sure you vote on November 4th.

Proposition 5 is one of the few non-bond initiatives that could impact taxes on this year's California ballot. Proposition 5 changes sentencing for drug offenses, which may be good or bad depending on your views.

It definitely impacts taxes, though. The initiative allocates $460 million to expand treatment programs for drug offenders; it increases costs by over $1 billion for expanding drug treatment and rehabilitation programs. It may also save over $1 billion by decreasing prison and/or parole operating costs.

Proponents argue that it will increase treatment programs, decrease prison overcrowding, and save money. Opponents argue that it shortens parole for some violent drug offenders, would cause damage to schools, sets up two new bureaucracies, and increases social costs.

This is a very complex proposition that deserves perusal before you vote.

These three propositions do not directly impact taxes. Proposition 4 would mandate a waiting period for 48 hours before a minor could have an abortion. Proposition 8 would ban same-sex marriage. Proposition 9 adds victims rights to matters relating to parole.

None of these three initiatives directly impact taxes. They are, though, important matters that you should review (if you're a Californian). Remember to vote on November 4th.

Irwin Schiff has about twelve more years left on his sentence. He's 79, so the chance of him promoting his illegal tax reduction schemes was slight. It's now zero.

From Las Vegas comes the news that a federal court has issued a permanent injunction against Mr. Schiff and Cynthia Neun, a former associate. Mr. Schiff and Ms. Neun have been barred from ever preparing tax returns as a professional and from promoting "...tax-fraud schemes from within prison or when they are released from prison."

I think we have now finally heard the end of Irwin Schiff.

Yet another bond proposal. This one would raise $980 million in bonds to help children's hospitals. The downside is that it would cost taxpayers $2 billion per year over $30 years to repay the bonds.

The bonds would be used at msot of the children's hospitals in the state. Proponents argue that children's hospitals could use the money to expand and help more children. Opponents argue that the state is in debt, and that hundreds of millions from an earlier version of this proposition (Proposition 61) remain unspent.

Remember to vote on November 4th.

Proposition 2 would change animal agriculture, a major industry in California. It would impact not only cattle and chickens but eggs and some other industries.

Proposition 2 would require more "humane" handling of animals. This sounds innocuous, but it's not. I worked in agriculture (citrus, not animals) for many years. Should this measure pass it would increase prices for eggs, would likely increase prices for beef, chicken, and veal, and would eliminate any expansion of those industries in California. In fact, the most likely result would be a movement of jobs from California to nearby states (and perhaps to Baja California).

Proponents of the measure state that this would be more humane to the animals, improve safety, and help family farmers. Opponents believe that this measure could negatively impact public health, would increase costs, and would decrease jobs.

It's time to begin our study of the ballot measures on California's ballot in two weeks. I will be continuing my series on the presidential candidates—my article on John McCain will be up later this week. For now, let's look at Proposition 1A, the Safe Reliable High-Speed Passenger Train Bond Act.

If this measure passes $9.95 billion of bonds would be sold by the state, costing about $19.4 billion over thirty years (or around $667 million a year). The bonds would be used to construct a high speed train from Los Angeles to San Francisco.

Proponents argue that passage would lead to a safe, high-speed train system to link the state. Opponents argue that this would be a huge cost to the state, and would run in red ink. The Legislative Analyst estimates that annual operating costs would exceed $1 billion, so that too must be figured in.

After the arguments were written the financial credit crisis occurred. That's not mentioned by either the proponents or opponents, but you need to consider it. The ability of any government to issue bonds has been reduced; it's likely that borrowing costs would be higher—potentially much higher—than estimated. I am very unconvinced about ridership claims; train service in the United States has to be supported by the government in order to continue.

No matter what you think, do make sure to vote on November 4th.

Note: Proposition 1 (listed in the original Voter's Guide) was removed from the ballot and replaced by Proposition 1A (listed in the supplemental Voter's Guide).

I counted over thirty interesting tax evasion stories from the last few days. There's no way I'm going to put them all in a post so here are the highlights.

First, let's head to Gallatin County, Montana. Ruth Amande knew that having children would give her a tax deduction. So she decided to have twins—Victor and Victoria, "born" on December 28, 1995. She applied for social security numbers for her twins in 1997. There was only one problem...well, two problems: neither child really existed. Unlike the disk jockey in Wyoming who successfully deducted his dog Ms. Amande will be making restitution.

The upcoming trial of attorney James Perdigao is big news in New Orleans. Mr. Perdiago has been accused of stealing $30 million from his old law firm, allegedly sending $20 million of that to Switzerland, and has been facing 59 counts including fraud, tax evasion, and money laundering. Make that 60 counts: Mr. Perdiago has had a charge of computer hacking added. He is alleged to have used his girlfriend's computer to hack into his old law firm's computer network.

Meanwhile, in nearby Vicksburg, Mississippi Marshall Sanders will face tax evasion charges in November. Mr. Sanders is accused of not filing tax returns since 1994 while earning $3.4 million in 2001, 2002, and 2003. He faces three tax evasion charges (one for each of those years) for allegedly using a trust account to hide his personal income.

From the Bozo tax preparation wing we find Raymond Ekpedeme of Laurel, Maryland. Mr. Ekpedeme operated Erikson Tax Service though it could be called Western Tax Service East. He followed the same plan as Western—phony deductions, false credits, and inflated numbers. He had lots of satisfied clients. Unfortunately for Mr. Ekpedeme the undercover IRS investigator wasn't pleased when he got a $1300 refund he didn't deserve. Mr. Ekpedeme pleaded guilty to tax evasion charges and will be sentenced next February; his clients can expect "Dear Valued Taxpayer" letters soon.

Louis Xifaras had an interesting method of attracting business to his former company, Innovative Network Solutions. He used kickbacks to workers at Southern New England Telephone/SBC (now AT&T). He deducted those payments on his corporate tax return as "salary." Unfortunately, kickbacks aren't deductible under federal tax law. And more unfortunately for Mr. Xifaras was that the federal government began investigating the fraud. He pleaded guilty and will have to make restitution, serve a year and a day at ClubFed, and pay a $50,000 fine. The tax owed is only $222,000, but there's now an additional $167,000 in penalties and $164,000 in interest.

Finally, the Hawker 4000 looks like a great business jet though it carries a pricetag of $21 million. But I do know where you may be able to get one for less than retail. The very first Hawker 4000 was delivered to Gary Hall in June. He runs Sunflower Supply Company in Galena, Kansas, a tobacco wholesaler. Mr. Hall and seven associates are accused of avoiding $25 million in cigarette taxes to Oklahoma and several Indian tribes. If Mr. Hall is acquitted (he and his associates face 43 charges) he'll get his plane back.

That's a lot of fraud for just a few days. Can we lighten up for next week?

Surprise, surprise: California's budget, assembled with smoke, mirrors, and lots of hope is already in trouble. Analysts already see a $1 billion deficit and think that $3 billion is a more likely number...and we're still in October. The fiscal year has over eight months to go. Given the probable lowering of income tax collections next year things could get ugly in Sacramento again.

Republicans still pledge no new taxes while State Senate President Pro Tem Don Perata wants to tax goods and services that haven't been taxed in the past. Since tax increases require a 2/3 vote of the legislature (meaning that Republican votes are required) don't expect any substantial tax increases.

Given the rhetoric you should also not expect any meaningful legislation until the very last minute.

News Stories: New York Times, Forbes (AP), Los Angeles Times

Now that 2007 tax returns are complete it's time to begin thinking about 2008 and 2009. The IRS announced this past week inflation adjustments for 2009:

- Personal exemptions will increase from $3350 in 2007 to $3500 in 2008 to $3650 in 2009;

- The standard deduction will increase from $5350/$10,700 (single/married filing jointly) in 2007 to $5450/$10,900 in 2008 to $5700/$11,400 in 2009;

- The maximum foreign earned income exclusion will increase from $85,700 in 2007 to $87,600 in 2008 to $91,400 in 2009; and

- The annual gift tax exclusion will increase in 2009 to $13,000.

Meanwhile, the Social Security Administration announced that the annual wage limitation for social security tax in 2009 will be the first $106,200 in wages (up from $102,000 in 2008). For the self-employed, this means that the self-employment tax will be 15.3% on the first $106,200 in self-employment earnings in 2009 and 2.9% on earnings above that.

Richard Hatch, the Survivor winner who was convicted of tax evasion, won't be leaving the Morgantown, West Virginia Federal Correctional Institution anytime soon. The US Supreme Court declined to hear his appeal today.

Mr. Hatch had charged that the trial court didn't allow him to ask certain questions on cross-examination. The Appeals Court had ruled, "Here, the district court's limitations on cross-examination in this nine-day trial were thoughtful and far from being excessive."

And that's it. There are no more immunity challenges left, no more places to appeal. Mr. Hatch will have to serve out the remaining twelve months of his sentence. In the end the 300 million witnesses were correct.

Hat Tip: How Appealing

The deadline for filing tax returns on extension is this Wednesday, October 15th. That's also the deadline for funding your SEP IRAs. If you procrastinate beyond this date you will be hit with the failure to file penalty (if you owe any tax) of 5% of the tax due per month.

Your paper-filed returns must be postmarked by the 15th. Electronically filed returns must be transmitted by the 15th.

Joe Kristan put it very well:

If you haven't gotten your tax information to your preparer yet, it is definitely time to panic. And if your preparer charges then you an arm and a leg for the doing the return because you brought your information in three days before the extended return deadline, well, don't do that next time.

The tax evaders were out in force this week. I could have filled several posts with their escapades. Here are the lowlights.

Let's start with a Bozo tax preparer. First, from Upper Darby, Pennsylvania comes the story of Nyon Geleh-Saylee. Mr. Geleh-Saylee truly wanted to help his tax preparation clients. He did this by inflating the deductions on their returns costing the federal government over $89,000. He was convicted back in June for filing false tax returns. He avoided ClubFed and will spend six months in home confinement.

Todd Newman is a CPA in Yonkers, New York. Mr. Newman was arraigned on Friday on charges of grand larceny and failure to file a state income tax return. Mr. Newman allegedly stole $1.6 million from one of his clients. He was supposed to send the money to New York state for payroll taxes withheld; instead, he allegedly wrote checks to himself. He's looking at a lengthy term in state prison if convicted.

Here's a scheme that sounds intriguing. Let's start a banking system to cater to the tax protester movement. We'll hide their money, give them access so they can print money orders when the need to, and we'll ignore those pesky banking and tax laws. Other than violating a few federal statutes (and possibly some state laws) it's sounds kosher, right? Well, the man who thought up this idea will likely get some time to consider it at ClubFed. Wayne Hicks, Sr. of Berryville, Arkansas pleaded guilty to one count of tax fraud conspiracy this past week. Mr. Hicks also admitted that he's neglected to file his own tax return for the last sixteen years.

Finally, a follow-up on the story of Kevin Morse of Austin, Minnesota. Mr. Morse was sentenced this past week to 30 months at ClubFed. Mr. Morse was told by his accountant that he owed about $100,000 in back taxes but chose to use a tax protester argument to avoid the taxes. The good news is that the promoters of the scheme that Mr. Morse used are awaiting trial in Oregon.

Remember, if it sounds too good to be true it probably is.

Christina Warthen appeared to have everything. She's a graduate of Stanford Law School. She's married to the founder of Ask Jeeves (now Ask.com). She's also allegedly a tax evader who ran a high priced escort service called TouchofBrazil.net.

Back in 2004 IRS agents raided her apartment and other locations seized over $61,000. That was just some of the funds that she allegedly earned from her business; the IRS alleges she cleared over $133,000 but didn't file a tax return. Whether her business was an escort service or an older profession isn't relevant—all income, legal or illegal, is generally taxable.

Mrs. Warthen will be arraigned later this week; she faces one count of tax evasion. So if you have an escort business try to remember to file your tax returns. If you don't you may find yourself escorted to ClubFed.

Over the past few weeks we received a couple of questions. Here they are with answers.

Timing of Online Gambling Income
Question—What if you are gambling on an online site over the course of a year and you win some money, however you don't make a withdrawal from the account that year? Say you save up what you win for two years then withdrawal some do you have to report it the year you win or when you actually withdraw it ad have in your hand?

The year your income is earned is the year that it is taxable. If an individual has online gambling income earned in 2008 but doesn't make a withdrawal in 2008 he still has 2008 income that must be reported on his 2008 tax returns.

Ohio and Gambling Losses
Question—I'm a resident of Ohio. I think it's ridiculous that even though I've been a net loser in gambling this year I must pay state income tax on my "wins." How can this be constitutional?

In several states, mostly in the Midwest, the state income tax is based on gross income (Federal Adjusted Gross Income with a few changes); no itemized deductions are allowed. Under the US Tax Code gambling income is considered Other Income included in Federal AGI; gambling losses are an itemized deduction allowed up to the amount of wins on Schedule A.

The situation you describe—being taxed on phantom gambling income—is quite possible. There is a Wisconsin case (Wisconsin also doesn't allow gambling loss deductions) which explains the philosophy. As I quoted in March 2007:

"Effective January 1, 2000, gambling losses were no longer offset against gambling winnings under the Wisconsin tax code because, effective on that date, Wisconsin no longer permitted as a deduction from Wisconsin taxable income “[m]iscellaneous itemized deductions under the Internal Revenue Code,” see Wis. Stat. § 71.07(5)(a)7 (2003–04), one of which, the Department contends and Dettwiler does not dispute, was the deduction for “wagering losses,” under section 165(d) of the Internal Revenue Code...His contention that he should nevertheless be permitted to subtract from his Wisconsin taxable income the offset permitted by section 165(d) of the Internal Revenue Code is not only circular and without merit, but is wholly contrary to the legislature’s decision to eliminate such offsets effective January 1, 2000.

"The Tax Appeals Commission decision is perfectly logical, appropriate, and correct. Accordingly, we affirm."

It's actually worse in Ohio. This will not only impact your Ohio income tax but your city income tax. Ohio is truly not a good location to be an amateur gambler. I suggest you contact your state legislators and request that the law be changed.

One form of business entity that is coming into increasing use is the Limited Liability Company (LLC). But that may change in Minnesota based on a ruling from an administrative law judge in that state.

Generally an LLC is a disregarded entity for federal tax purposes. Most states follow the federal guidelines though a couple of state require reporting. An LLC in California must file Form 568 and pay a minimum tax and possibly a gross receipts tax.

Minnesota, though, is about to take this one step further. The Gopher State will soon charge sales tax on transactions between single member LLC owners and the LLC. Joe Kristan calls this "an awful idea." He's right—Minnesota is effectively imposing sales tax for LLC owners when they move an object from their left hand to their right hand.

Hopefully the Minnesota Department of Revenue or the Minnesota legislature will reconsider this. Otherwise single member LLCs may become dinosaurs in the Land of 10,000 Lakes.

Hat Tip: Roth Tax Updates

And that's not good news for Sacramento.

The Tax Foundation came out today with their annual report of state tax climates. No surprise, California is the third worst climate, surpassed only by New Jersey and New York. First, here are the ten best state climates for business taxation:

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

And now the ten worst state tax climates:

41. Minnesota
42. Nebraska
43. Vermont
44. Iowa
45. Maryland
46. Rhode Island
47. Ohio
48. California
49. New York
50. New Jersey

There is some good news for California. The Tax Foundation no longer believes that the Bronze Golden State has the worst individual income tax in the country. It's not that California has improved; rather, Maryland now has a worse system.

Maryland managed a remarkable drop—from 24th in last year’s index to 45th in this year’s—by raising its individual income tax, corporate income tax, sales tax and cigarette tax all in the same year. Maryland added four new brackets to the individual income tax, increasing the top rate by 1.5%, adding new complexity, and introducing a big marriage penalty. In fact, we now rate Maryland’s as by far the worst individual income tax in America, displacing California for that dubious distinction.

California ranks poorly in almost every category: 45th for corporate tax, 49th for individual income tax, and 43rd for sales tax. The lone bright spots are being ranked 16th for unemployment insurance and 15th for property tax.

There's bad news on the horizon for California. The recently enacted budget restricted using net operating loss carryforwards. That will lower California's score in future years. But our legislators appear to have one goal—making sure California goes to the top. Nevada, Oregon, and other nearby states aren't complaining in the least.

Governor Schwarzenegger warned that California might need a $7 billion loan because the state is currently unable to float a short-term bond. It's not that a bond issue couldn't be sold; rather, the interest rate would be quite high.

Bluntly, California will soon be forced to cut spending. The budget this year is filled with smoke and mirrors; next year's situation will be worse. Revenues have been increasing but spending has increased faster. Discipline will be enforced on the Bronze Golden State one way or another. This year's budget postponed the day of reckoning. I thought that postponement was until next summer but it might not last that long.

This is the first of a three part series looking at what taxes might be under our new President. This series starts by looking at what might happen under a President Obama. Next week I'll examine John McCain's plans. In the final part I'll compare and contrast the two plans.

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Let's start with what the Obama campaign says they'll do. This is taken from the Barack Obama website:

• Cut taxes for 95 percent of workers and their families with a tax cut of $500 for workers or $1,000 for working couples.
• Provide generous tax cuts for low- and middle-income seniors, homeowners, the uninsured, and families sending a child to college or looking to save and accumulate wealth.
• Eliminate capital gains taxes for small businesses, cut corporate taxes for firms that invest and create jobs in the United States, and provide tax credits to reduce the cost of healthcare and to reward investments in innovation.
• Dramatically simplify taxes by consolidating existing tax credits, eliminating the need for millions of senior citizens to file tax forms, and enabling as many as 40 million middle-class Americans to do their own taxes in less than five minutes without an accountant.

These seem like great goals, and a wonderful plan. Let's check this out to see if it's borne out by facts.

Here are the nuts and bolts of the plan:
1. A $500 (single)/$1000 (MFJ) refundable tax credit for those who work.
2. A $4,000 refundable tax credit for college education.
3. A 10% refundable tax credit to offset mortgage interest payments. It's unclear from the fact sheet whether this credit would be available to those who itemize or is limited to those who do not itemize.
4. No income tax for senior citizens who make less than $50,000.
5. An automatic pension account will be created.
6. The Savers Credit will be expanded so that it will match 50% of the first $1000 for families earning under $75,000.
7. Health care tax credits will be increased.
8. Expand the Earned Income Tax Credit to more working parents.
9. The child care credit would be refundable and allow low-income families to receive up to 50% of $6,000 of child care expenses.
10. Add a $7,000 tax credit for purchase of "advanced technology vehicles."
11. Simplify the system; some taxpayers would receive pre-printed forms with numbers already filled-in.
12. Eliminate capital gains taxes on investments in small and start-up firms.
13. Increase corporate tax on companies that "retain their earnings overseas." Use that money to lower corporate tax rates for companies that expand operations within the U.S.
14. Add a refundable corporate tax credit for small businesses that offer healthcare.
15. Make the Research and Development tax credit permanent.
16. Increase the top tax bracket to 39.6% on families making $250,000 or more.
17. Estate tax begins at $7 million per couple ($3.5 million/person).

How would all of these be paid for? Obama wants to reform international tax loopholes, close domestic tax loopholes, eliminate tax breaks for oil and gas companies, and close other loopholes.

But there's more on other areas of the website that impact taxes. Obama wants to "...ask those making over $250,000 to pay in the range of 2 to 4 percent more in total (combined employer and employee)." Originally, Obama wanted to completely uncap the social security tax above $250,000. What's not said here is would this kick in based on individuals at $125,000 or families at $250,000?

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Let's assume that Obama is elected President. Let's also assume that Congress continues to be controlled by Democrats. What would the tax impact be for you and I?

1. The wealthy already pay most of the taxes in the U.S. Under a President Obama they'd pay even more. In high tax states such as California the marginal tax rate would end up at 58.8% for those making above $125,000 if employed and 68.7% for those who are self-employed. That's if Obama gets his way. Given the leanings among the Democrats in Congress, that's likely the best we could hope for under Obama.

2. Obama's tax plan would result in the redistribution of income away from entrepreneurs. Though Obama wants his plan to help entrepreneurs (through elimination of capital gains on investments in small companies), his income tax plan says the opposite. Additionally, there's nothing in Obama's plan about the AMT. Assuming the AMT lives on, those capital gains tax cuts would be imaginary; entrepreneurs wouldn't pay capital gains taxes but they'd pay the same amount as AMT.

3. Obama has proposed a wealth of new programs. Those new programs would have to be funded with money from somewhere. Obama mentions health care, but that's not the only program he proposes. Obama's reliance on "closing loopholes" is misplaced (see #4 below).

4. Obama's primary funding for his tax plan comes from closing various loopholes. Good luck. The IRS has been trying to close various loopholes for years, and increase enforcement activities. Congress writes the Tax Code to benefit lobbyists and others--in the bailout legislation that just passed numerous loopholes were added. As far as international loopholes the IRS has been successful in closing some. The reality is that only incremental progress will occur no matter who is President. There is no way that Obama will be able to fund his programs and tax cuts solely from closing loopholes.

5. A much more realistic scenario is that under a President Obama only a couple of his programs would be implemented but the tax increases and redistribution plan would occur. This would likely lead have a major negative economic impact (see #6 below).

6. Many large companies are organized as S-Corporations and are taxed on individuals tax returns rather than at the corporate level. (As a reminder, corporate taxes are always passed on to individuals.) When taxes increase to S-Corporation owners they will likely cut their hiring.

7. It is possible that Congress would go much further with social security taxes than the Obama campaign currently wants. There is sentiment among Democrats in Congress to tax high-income self-employed individuals fully at 15.3% (that is, uncapped social security). If this were to occur many high-income individuals would stop working when their income reached a certain level as the tax would be confiscatory. This occurred in the 1940s and 1950s when marginal tax rates reached 90%. This would have a negative impact on the economy in the United States.

8. The current economic climate is uncertain. Increasing taxes when the economy is not doing well would cause major economic problems. Obama has mentioned this in an interview with Bill O'Reilly.

9. Obama has publicly said he's for the elimination of the Bush Tax Cuts. All of them. The elimination of a tax cut is a tax increase--forget the semantics.

10. The goal of Obama's that makes the most sense--simplification of the tax system--is impossible under President Obama. His programs would tremendously increase the complexity of the Tax Code.

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Obama likes to talk in broad terms and doesn't like to be forced to mention specifics. That's true of his stance on taxes. I'll be very specific: If Obama is elected President you will pay more. This may be in taxes, or in the increased cost of goods and services as tax increases on some are passed on. There is no free lunch.

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Next weekend I'll report on what taxes might be like under a President McCain. It should be clear that I'm not a fan of Obama's tax plans. For very different reasons I have concerns over McCain's tax plans.

The bailout bill passed Congress today and was signed into law by President Bush this afternoon. I'm of mixed opinion on the bailout portion of the bill. But I'm thrilled about one part of the bill—this year's AMT (Alternative Minimum Tax) patch was included in the bailout legislation.

Every year Congress goes through the effort to raise the AMT exemption so that millions more individuals don't get impacted by AMT. Last year Congress waited until December to pass an AMT patch and it impacted the filing season.

Also included in the bill were "extenders." The extenders extended popular deductions that would have been eliminated.

Here is a list of some of the major tax items in the bill:

- AMT exemption increased to $46,200 for single and $69,950 for married filing jointly;
- Sales tax deduction extended through 2009;
- The Tuition and Fees deduction extended through 2009;
- Educator expense deduction of up to $250 extended through 2009;
- The real estate taxes deduction (for those taking the standard deduction) of $500 single/$1000 married filing jointly was extended through 2009; and
- Major tax benefits for those who live and/or work in major disaster areas.

There's probably a lot more in the legislation (it runs 300 pages) but let me add a caveat: California will not be in compliance with any of these changes for 2008.

Apparently this blog has a wider circulation than I thought. Today I received an email from Tom Teale, the Assistant Director, Criminal Investigations of the Minnesota Department of Revenue (the state tax agency in Minnesota). While I generally focus (when I report on tax evaders) on IRS/Department of Justice prosecutions and California I'm happy to highlight the lowlights from other states.

And I do wish to point out that many states are suffering revenue shortfalls. If you file your federal tax return and skip your state tax return your state will find out. Every state but Nevada has an information sharing agreement with the IRS. Given that state income tax payments are generally deductible on your federal tax returns and are usually for far smaller amounts than your federal income tax doesn't it make sense to ensure your compliance with state law?

In any case, Mr. Teale highlighted four cases in Minnesota. I've already covered Robert Beale, the tax evader who attempted to arrest the judge. He received eleven years of nonconsensual incarceration.

There were two cases I wasn't aware of. In one, an attorney, John Hatling of Fergus, Falls, claimed that he could deduct his own wages using the "claim of right" deduction. If you've never heard of the deduction you're not alone. It's yet another tax protester argument and it doesn't hold water. Mr. Hatling will plead guilty to one felony count and will be sentenced in state court next Friday.

In the other case, a judge didn't file his Minnesota income tax returns. Donald Venne of Anoka County faces four gross misdemeanor charges. While the total unpaid tax is relatively small (about $3,200) a judge, of all people, should understand about compliance with the law. His attorney said that the problem was caused by a "traumatic family event that occurred over a period of years."

Again, remember that you do need to pay your state income taxes. And my thanks to Mr. Teale for bringing these cases to my attention.

There are some things that just must be seen in person at least once. I think that one of those is the Indianapolis 500. It's called the greatest spectacle in auto racing for good measure. If you get the chance head to Indy over Memorial Day and catch the race.

If you went in 2001 or 2002 you would have watched Brazilian-born Helio Castroneves win back to back races. Mr. Castroneves is a Brazilian but has been residing in the United States since 1997. That means he must pay US income taxes. Mr. Castroneves apparently didn't like that idea.

While most of us don't like it but pay he allegedly decided on a different course of action. Mr. Castroneves received $6 million in pay. Of that, $5 million allegedly moved through a Panamanian shell company to evade US taxes. At least, that's what the government alleges in a seven-count indictment against Mr. Castroneves, his sister Katiucia, and his attorney, Alan Miller. There's one count of conspiracy and six counts of tax evasion.

Among the other items contained in the indictment are allegations that Mr. Castroneves lied to his tax attorney and accountant, that Mr. Miller and Mr. Castroneves lied to another law firm, and that the trio allegedly prepared false tax returns. If found guilty they'll be watching a few Indy 500s at ClubFed and he'll miss participating on Dancing with the Stars (which he won last year).