Taxable Talk

I’ll be transmitting my first few tax returns to the IRS this coming week. As I looked at Schedule B, I noticed a change in the questions at the bottom of Schedule B:

7a At any time during 2011, did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country? See instructions

Hmmm, that’s different. Let’s see what the instructions have to say:

Line 7a–Question 1. Check the “Yes” box if at any time during 2011 you had a financial interest in or signature authority over a financial account located in a foreign country. See the definitions that follow. Check the “Yes” box even if you are not required to file Form TD F 90-22.1.

So for the first time the IRS is demanding that if you had a foreign financial account and it had $1 in it, you must check the box. And since a tax return is signed under penalty of perjury, I will be asking you whether or not you had a foreign financial account in 2011.

Note that this is also a new reason someone may have to file a tax return. As noted on the instructions, this question must be completed if you had a foreign account during the year. Thus, some individuals who have no income but have small foreign financial accounts (valued at less than $10,000) will have to file a tax return for 2011.

As Joe Kristan and others have said, the IRS continues to aim its guns at the jaywalkers.

This year sees the introduction of Form 1099-K. This form reports merchant and third-party payments you’ve received. We were supposed to note these on separate lines on our tax returns, but not any longer:

For tax year 2011 the IRS has deferred the requirement to separately report the amount of merchant card and third party network payments from Form 1099-K on your tax return. Instead, you should report all gross receipts of your trade or business as usual on the line indicated….

While I took this from a notice regarding Form 1040s, the same holds true for all tax returns. Everyone ignores the 1099-K’s…but the credit card and merchant service companies must continue to send them.

Last year I participated in a roundtable at my professional society regarding the 1099-K. The problems we foresaw were numerous; two of the most obvious were that accounting software normally tracks by product or type of product sold, and not by payment type and the issue of fiscal years (the 1099-K’s will all be on calendar years so the forms will be wrong for fiscal year clients). We found numerous other issues, and it appears the IRS realized that the 1099-K is not yet ready for prime time.

Still, it’s just a problem that’s been deferred until next year.

Most taxpayers use the Postal Service to send their returns to the IRS. However, you can use Federal Express or UPS. The problem is the IRS hides the street addresses of their service centers on their website if you need those to use a private delivery service. (They’re listed in the back of Publication 1546.) As a public service, here are the street addresses of the Service Centers. Note that since the last filing season the Philadelphia Service Center has moved.

Andover Service Center
310 Lowell St
Andover, MA 01810
[978-474-9701]

Atlanta Service Center
4800 Buford Hwy
Chamblee, GA 30341
[770-530-6392]

Austin Service Center
3651 S IH 35
Austin, TX 78741
[512-460-0176]

Brookhaven Service Center
1040 Waverly Ave
Holtsville, NY 11742
[631-654-6583]

Cincinnati Service Center
201 W. Rivercenter Blvd
Covington, KY 41011-1424
[859-292-5185]

Fresno Service Center
5485 E Butler Ave
Fresno, CA 93727
[559-454-6334]

Kansas City Service Center
333 W Pershing Rd
Kansas City, MO 64108
[816-823-2076]

Memphis Service Center
5333 Getwell Rd
Memphis, TN 38118-7733
[901-546-4115]

Ogden Service Center
1973 N Rulon White Blvd
Ogden, UT 84404
[801-620-4249]

Philadelphia Service Center
2970 Market St
Philadelphia, PA 19104
[215-516-5994]

California Franchise Tax Board
9645 Butterfield Way
Sacramento, CA 95827

It’s very important to note that these addresses should be used only for private delivery services. Regular mail sent to these street addresses may be rejected as sent to a non-deliverable address and returned to the sender! Mail sent to a service center should be sent to the “normal” address of the service center; for example, here is where taxpayers filing their own Form 1040 returns should mail the returns to (look at page 189 of this pdf).

Today the Tax Court looked at whether a rental was passive or active. But there was a major difference from most such cases: The taxpayer claimed his lease was passive while the IRS thought it was not passive.

Most of the time, rental income is passive. There are some exceptions: The most common is a Realtor (who meets the time requirements). The petitioner in today’s case was a doctor, and in almost all cases the rental would be passive. However, the lessee was his business (a professional corporation), so the self-renting rules apply (unless there’s an exception).

The petitioner claimed he had a legal, binding contract (a lease) entered into in 1980. If there is a binding contract entered into on or before February 19, 1988, the exception applies. There was a problem, though. The lease called for payments that would increase by 5% per year (the lease had never been modified). The payments made as “rental expense” didn’t match what was required under the lease. That meant the lease was not a binding contract, and the taxpayer had non-passive income.

For the taxpayer, this could have been resolved had he (or his CPA) noted the terms of the lease and made payments based on the lease. Unfortunately for them, they didn’t read it.

Case: Samarasinghe v. Commissioner (T.C. Memo 2012-23)

The first of the January deadlines is upon us. Estimated tax payments (Form 1040-ES) are due by Tuesday, January 17th. That’s a postmark deadline. As always, I strongly recommend certified mail, return receipt requested.

The IRS, as we previously noted, now has a YouTube channel. Here’s their latest video on choosing a tax professional:

You can also read their suggestions in this article::

• Check the person’s qualifications. Ask if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics. New regulations effective in 2011 require all paid tax return preparers including attorneys, CPAs and enrolled agents to have a Preparer Tax Identification Number.
• Check the preparer’s history. Check to see if the preparer has a questionable history with the Better Business Bureau and check for any disciplinary actions and licensure status through the state boards of accountancy for certified public accountants; the state bar associations for attorneys; and the IRS Office of Professional Responsibility for enrolled agents.
• Find out about their service fees. Avoid preparers who base their fee on a percentage of your refund or those who claim they can obtain larger refunds than other preparers.
• Make sure the tax preparer is accessible. Make sure you will be able to contact the tax preparer after the return has been filed, even after the April due date, in case questions arise.
• Provide all records and receipts needed to prepare your return. Most reputable preparers will request to see your records and receipts and will ask you multiple questions to determine your total income and your qualifications for expenses, deductions and other items.
• Never sign a blank return. Avoid tax preparers that ask you to sign a blank tax form.
• Review the entire return before signing it. Before you sign your tax return, review it and ask questions. Make sure you understand everything and are comfortable with the accuracy of the return before you sign it.
• Make sure the preparer signs the form and includes their PTIN. A paid preparer must sign the return and include their PTIN as required by law. Although the preparer signs the return, you are responsible for the accuracy of every item on your return. The preparer must also give you a copy of the return.

Now, Joe Kristan has had an annual list of some other things you should look out for. These have included in the past such gems as “Make sure the preparer is accessable outside of prison visiting hours. Self-explanatory.” I can’t wait to see what he comes up with for 2012.

On a serious note, every paid tax preparer is required to sign the return and put down his or her PTIN on the return. If your preparer doesn’t, David Williams is absolutely right: Run, don’t walk, out of that office and find someone else.

The IRS has acquiesced to the decision in Mayo v. Commissioner; this decision will be published in the January 17, 2012 issue of the Internal Revenue Bulliten according to Linda Beale. The Mayo case allows a professional gambler to deduct his business expenses in excess of his net gambling income (to create a loss).

The effects of this are minor. Had the IRS continued to fight this decision, impacted taxpayers could (and presumably would) cite this case and would eventually prevail in court.

Discussion of Decision (January 2011)

I’ve been asked numerous times over the past few weeks one question by poker players: “Can I take a casualty loss on the money I have tied up on Full Tilt Poker?” The answer is a definite maybe, but even if there is a casualty loss it will likely not be a 2011 event.

For those unaware, Full Tilt Poker was one of three business offering online poker to Americans before April 15, 2011. On that date, the US Department of Justice indicted Full Tilt, PokerStars, and Absolute Poker/UltimateBet. The companies were accused of bank fraud and violations of the Unlawful Internet Gambling Enforcement Act (UIGEA) and other statutes. Yesterday, Brent Beckley (one of the founders of Absolute Poker) pleaded guilty to conspiracy to commit bank fraud and wire fraud and conspiracy to violate the UIGEA. His sentencing is scheduled for April 19th.

Of the three businesses, PokerStars has fully repaid its customers. Absolute Poker/UltimateBet announced that the business is closing, with assets being sold in an attempt to repay customers. Full Tilt Poker, after being accused of being a Ponzi scheme, was sold to Group Benard Tapie (GBT). According to reports, GBT will repay non-US customers while the Department of Justice will repay Americans.

So let’s get back to the original question: Can an individual take a casualty loss on his funds at Full Tilt Poker? First, we need to determine whether there has been a casualty loss. A casualty loss is a sudden, unexpected or unusual event where an individual loses something of financial value. There is no doubt that the loss of funds from Full Tilt Poker’s collapse was “sudden and unexpected.” However, there’s a problem with this being a casualty loss. Given that the DOJ and GBT do expect to repay Americans, there’s no loss today. There may be a loss at some future date if funds aren’t fully repaid, but today the most likely possibility for Americans is full repayment sometime in late 2012. That means there is no casualty loss.

This is even true for Absolute Poker/UltimateBet. Given that AP/UB is attempting to sell their assets and repay players, we do not have certainty of what will be lost (or won’t be lost). And certainty of loss is another thing needed to claim a casualty loss. While I doubt that AP/UB will fully repay players, it’s probable players will get something. Until we know what that something is, it’s not yet time to take a casualty loss.

The other question that goes hand-in-hand with this is whether individuals need to claim money “won” on Full Tilt Poker (and Absolute Poker/UltimateBet) that they did not cash out before April 15th. Here we must look at whether individuals constructively received the funds.

The doctrine of constructive receipt governs when income is reported in the United States. If you receive a check on December 29th you can’t hold it until next year to defer the income. You had the funds in your possession (albeit as a check), and there’s no reason you couldn’t have deposited them in December. You constructively received the money and its income in this year.

The same principle holds in reverse. When there is substantial doubt as to the paying of the funds, you do not have constructive receipt. With Full Tilt Poker and Absolute Poker/UltimateBet, such doubt definitely exists. (Given that the Department of Justice has charged Full Tilt Poker as being a Ponzi scheme, even the US government sees this doubt.) I can’t see constructive receipt existing here. (Note: For anyone who received funds from Full Tilt Poker or Absolute Poker/Ultimate Bet in 2011, there is definitely constructive receipt.) Until the funds are repaid, there likely is no constructive receipt.

Finally, I’ve been asked, “Can’t I just deduct the money I had on Full Tilt Poker (or Absolute Poker/Ultimate Bet) as a gambling loss?” No. You clearly did not lose the funds in a wagering event. This isn’t a gambling loss. This may be a theft or loss of funds on deposit, but today all we know is that the funds are in limbo.

I need to thank Judge Mark Holmes of the Tax Court. Judge Holmes wrote an opinion today that is wonderful and has expanded my vocabulary. It’s also a great case.

Robert Willson bought a bar in Des Moines, Iowa. His bar burned down in 1994, but he persevered and rebuilt. However, Des Moines condemned his bar to expand the city’s airport. The IRS claimed that there was a large capital gain when the city condemned his bar. Mr. Willson disputed that, and the case ended up in Tax Court.

Mr. Willson’s bar catered to hair bands until one of the bands misused a smoke machine and caused the place to burn down. He rebuilt the bar, and rather than my paraphrasing the decision, here’s what Judge Holmes wrote:

He rented out the old house to a tenant who installed minor improvements (e.g., poles) and opened an establishment felicitously–and paronomastically–called the “Landing Strip,” in which young lady ecdysiasts engaged in the deciduous calisthenics of perhaps unwitting First Amendment expression…He also used $169,000 of his $200,000 insurance proceeds to rebuild the bar.

Two things happened around 1999: Des Moines condemned his property and the petitioner visited ClubFed. Mr. Willson did file his 2000 tax return, and the IRS did audit the return. The issue that had to be determined was Mr. Willson’s basis in the bar.

One key issue in the case is the fact that it is a small Tax Court case — an “S case.”

Rule 174(b) allows a taxpayer like Willson to introduce evidence in an S case that would otherwise not be admissible, and it lets us conduct the trial as informally as possible (consistent with orderly procedure) and to admit any evidence we decide has “probative value”–a fancy way of saying any evidence that helps or hurts Willson’s case. This looser rule is important here, because Willson presented his case quite credibly through his own testimony and that of others who worked at the bar or lived nearby during its heyday. Despite the raffish pasts of Willson and some of his witnesses, we found their testimony on his investment in the bar entirely credible.

Basis is always a troubling issue to explain, and this case is messy because of the fire. This case includes both ACRS and MACRS, boot, a fire, and other adjustments. The rest of the case goes into the formula that must be used to determine Mr. Willson’s capital gain. While “there are computations that still need to be made,” it appears that Mr. Willson will likely not owe as much as the IRS claimed.

Case: Willson v. Commissioner, T.C. Summary 2011-132

I prepare a lot of Schedule C (sole proprietor) returns. That comes with the nature of my practice: I have a lot of professional gamblers as clients, and they file Schedule C. The IRS knows that there are unscrupulous tax professionals out there; I’ve written about many of them in the past. The IRS has decided to send out letters to some tax professionals to help “educate” us.

I have not received one of the IRS’s notices. However, a CPA in Fremont (in the Bay Area) did receive a love letter from the IRS. Via Kelly Erb comes the letter he wrote back to Commissioner Shulman. Here’s an excerpt:

Your letter stating that due to “a high percentage of attributes associated with returns typically containing inaccuracies and misinterpretations of the tax law” you feel the need, in some blanket campaign, to accuse me of improperly preparing tax returns. You supply a review of the rules and the penalties that apply to Tax Return Preparers.

The threat is a possible visit to my office.

Let me coach you on how to write a letter.

“Dear Tax Return Preparer:

Based on a mindless computer analysis, we have determined the obvious; in that you prepare tax returns for many clients who have rental properties. We are too dim-witted to understand that taxpayers often seek out tax preparers because they have rental properties and become subject to the Cost Recovery, Passive Loss and At-Risk Rules.

If you’re a tax professional, Ms. Erb’s post is well worth your time. The good news is that if you haven’t received Notice 4809 from the IRS the NAEA has stated you missed out for this year.