Taxable Talk

It’s time for businesses to send out their annual information returns. These are the Form 1099s that are sent to to vendors when required. Let’s look first at who does not have to receive 1099s:

• Corporations (except attorneys)
• Entities you purchased tangible goods from
• Entities you purchased less than $600 from (except royalties; the limit there is $10)

Otherwise, you need to send a Form 1099-MISC to the vendor. The best way to check whether or not you need to send a 1099 to a vendor is to know this before you pay a vendor’s invoice. I tell my clients that they should have each vendor complete a Form W-9 before they pay the vendor. You can then enter the vendor’s taxpayer identification number into your computer (along with whether or not the vendor is exempt from 1099 reporting) on an ongoing basis.

Remember that besides the 1099 sent to the vendor, a copy goes to the IRS. If you file by paper, you likely do not have to file with your state tax agency (that’s definitely the case in California). However, if you file 1099s electronically with the IRS you most likely will also need to file them electronically with your state tax agency (again, that’s definitely the case in California). It’s a case where paper filing is easier than electronic filing.

We should all probably enjoy this year and next year vis-a-vis 1099s. It looks like the corporate exemption for 1099s will end in the near future, and that means more paperwork for businesses and more work for tax professionals.

Most of the advice given in the tax blogosphere is good. However, I saw this posted today:

My business had a really profitable month. Do you have any ideas on last minute expenses to help lower my taxable income?

Depending on how many purchases you want to make, you could consider office furniture or computer equipment. Alternatively if you are looking for something cheaper, you could pay your January office rent early, or any other major bills such as your telephone service fee. On the other hand, you could defer some of your income until next year by waiting until after the end of the month to cash a check or two. [emphasis added]

The first part of the answer is generally good. In most cases, making a purchase of a major piece of equipment, especially if you can utilize Section 179 Depreciation, is an excellent way to lower your taxable income. And there’s nothing wrong with paying some bills early (if you’re a cash basis taxpayer). However, the last sentence is just bad advice because of constructive receipt.

The doctrine of constructive receipt governs when income is considered received. Section 1.451-2 of the Income Tax Regulations states, in part:

(a) General rule. Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

From Sainte Claire Corporation, et. al, v. Commissioner (T.C. Memo. 1997-171):

…[A] taxpayer will be found to be in constructive receipt of income where the taxpayer had an unrestricted right to receive the income, the taxpayer was able to collect it, and the failure to receive it resulted from the exercise of the taxpayer’s own choice. [citations omitted]

If you receive a check in 2009 but let it age in your office until 2010 it’s still income in 2009 because you deliberately chose not to cash the check.

If you have an unexpectedly good December and can take Section 179, buy the new computer (I’m getting one on Wednesday). Get a new desk (I got that yesterday). Pay a bill or too early if you’re a cash-basis entity. But don’t hold onto the check until 2010.

Like most tax professionals, I send out a newsletter for my clients. In my most recent newsletter, I included the following:

Under federal law, a business owner (this includes those of you who file a Schedule C — a sole proprietorship) must send a Form 1099-MISC to any non-corporation from which they’ve purchased $600 or more from (excluding merchandise).

The IRS has become quite strict about enforcing the penalties when you fail to send out 1099s when required or when you fail to submit the 1099s and the associated 1096 to the IRS in a timely manner. Here [is an example] in which you must send out a Form 1099-MISC:

- You are a professional gambler, and file a Schedule C for your gambling business. You hire John Doe to coach you and improve your play, paying him a total of $650 during 2009. You must send Mr. Doe a 1099-MISC.

The first email I received was from a poker coach (not my client). He stated that he didn’t want to complete the Form W-9 as he didn’t want anyone to know his social security number. I replied that he can apply online with the IRS at no cost for an Employer Identification Number to use in place of his social security number.

He then replied that he didn’t want to receive the 1099, and that he wouldn’t complete it no matter what. I replied that under the law he’s required to complete the W-9 or he could be fined by the IRS.

I’m certain that the individual likes the idea of being paid under the table, thus avoiding income tax. Unfortunately, he’ll likely be caught sooner or later he’ll likely be caught, through an audit of himself, an audit of one of his clients when the IRS follows-up an unsent 1099-MISC, or through some other method (i.e. a suspicious activity report, a currency transaction report, etc.)

Meanwhile, I received an email from a client letting me know that he didn’t like the idea of sending out 1099-MISCs. He saw no reason to anger his poker coach and didn’t like the idea of completing worthless paperwork.

Whether 1099s are “worthless paperwork” or not, they’re required to be sent when a business pays a non-corporation $600 (or more) for services. Poker coaching is a service. A professional gambler (such as a professional poker player) runs a business. The IRS expects proper business conduct, including the filing of required information returns such as Form 1099-MISCs. Legally, there is no option but to send out 1099s where required.

I’ve represented a few businesses in audits this year. In every case, the IRS Revenue Officer reviewed the 1099s sent by the business. It’s becoming a point of emphasis for the IRS (if it has not already been one).

Most individuals comply with the law. Most poker coaches declare their coaching income on their tax returns, so receiving a Form 1099-MISC isn’t an issue. For those who aren’t claiming all their income, it’s time to start. Sooner or later every transaction will require a 1099; it’s clear that’s the direction Congress is heading.

Robert Flach has published two excellent posts on the responsibilities of a preparer (post 1, post 2). In general, I agree with everything that Mr. Flach states.

Some excerpts:

“In order to make sure that you pay the absolute least amount of federal and state income taxes each year I need complete and accurate information from you at tax time.

This means I need specific numbers for deductions you are claiming. ‘Claim the maximum’ or ‘Whatever I am allowed’ or ‘Same as last year’ don’t cut it. The maximum is what you actually paid – and you are allowed what you actually paid! … I cannot make up numbers for you– I need you to tell me ‘$1023.50’ or ‘$20.00 per week for 50 weeks’ or ‘4638 miles’! …

It is not my responsibility to personally verify all the numbers or statements given to me by a client. I have no obligation, legal or ethical, to audit your return. This is up to the IRS, if they so choose. I am simply preparing the return, to the best of my ability, “based on information supplied by the client”.

Tax professionals are not agents of the IRS. Instead, we’re here to find every legitimate means of saving you money on your taxes. That said, Mr. Flach notes that if he obtains “direct personal knowledge” of facts contrary to what he’s been told (by a taxpayer), he must use the correct numbers (what he knows) rather than what he’s been told by the client. I agree with Mr. Flach on this.

One point where I disagree with Mr. Flach is the amount of time you should hold onto your documentation. He says, “You are responsible for keeping all of the necessary documentation of the income and deductions claimed on these returns for at least three (3) years.” I believe you should hold onto all documentation for a minimum of six years.

There are two reasons why I believe this. First, while the IRS statute of limitations in normal situations is three years from the due date of the return or date of filing (whichever is later), many states have longer statutes. California’s is four years, for example. Second, if you are accused of fraud the statute of limitations runs six years. Yes, the IRS has the burden of proof for fraud, but if you are accused of fraud wouldn’t you like to have your back-up information available?

Finally, I’m a member of the National Association of Enrolled Agents and the California Society of Enrolled Agents. I’m bound by the NAEA’s Code of Ethics and Rules of Professional Conduct. (Mr. Flach is a member of the National Association of Tax Professionals, and is bound by a similar code of ethics.) One reason why I have every client sign an Engagement Letter is so that they understand my responsibilities and they understand their responsibilities in preparing their tax returns.

Overall, Mr. Flach’s series on the obligations of a tax professional is excellent. Every so often I report on Bozo tax preparers who skirt the law. They cause pain to everyone in my profession. Luckily, most members of my profession are ethical and are looking out for the interests of the client.

Two tax bloggers who I respect, Robert Flach (The Wandering Tax Pro) and Peter Pappas (The Tax Lawyer’s Blog) have been debating Peter’s 5 Slam Dunk IRS Audit Red Flags. Robert responded, Peter replied, and Robert made his rebuttal. All of these posts are worth reading.

I have some thoughts about audit red flags. It’s a subject I hear about annually at the CSEA SuperSeminar; each year I take a class taught by Robert McKenzie and this issue always comes up.

Here is Peter’s list of red flags:

* Home Office Deduction
* Job Expenses
* Rental Losses
* Schedule C Expenses
* Charitable Contributions

My feelings about deductions are simple: If you are entitled to a deduction, you should take the deduction. Notice that I said entitled. I think that Peter and Robert would agree that there’s been plenty of abuse of certain deductions. All of these deductions (along with education deductions/credits) are popular among unscrupulous preparers.

That said, only one of these to me is directly a large red flag: Schedule C. The statistics I saw at the CSEA SuperSeminar show that returns with Schedule C’s are far more likely to be audited than returns without one. Of course, as Robert noted there’s an obvious corollary: Returns with Schedule C’s have far more income (generally) than returns without them. The IRS is a collection agency. Assume Joe Salaryman has income of $30,000 and cheats on his taxes by 10% while Sam Businessman has income of $300,000 and also cheats on his taxes by 10%. Clearly, the IRS would get more bang from the buck by auditing Sam than Joe. Not surprisingly, taxpayers with Schedule C’s and income in the mid-six figure range have a higher likelihood than others of being audited.

Peter also lists five things you can do to alleviate “red flag status:”

1. Timely file your return;
2. Use a recognized software program to prepare and print your return;
3. File the return electronically;
4. Have a respectable CPA, tax lawyer or IRS Enrolled Agent sign your return as tax preparer; and
5. Attach explanatory statements to your return where necessary.

I absolutely agree with Peter’s items 1 and 5. If you untimely file your return it will be subject to scrutiny, and that can (but does not always) lead to an audit. Item 5 is obvious. Unfortunately, explanations are not always visible to the IRS until after a return is selected for audit. Still, in a correspondence audit if you can tell the IRS, “Look at this explanatory statement that was included with the return,” it’s probable that the audit can be a short-lived one.

Items 2 and 3 are related. I have been told that the process for a printed return (this would include those that are manually done) is that they are transcribed by clerk-typists and then follow exactly the same path as electronically filed returns. I agree with Peter that a messy, hand-written return is more likely to be audited. But I think that’s more because the numbers might not be clear to the typist. That’s also one of the reasons I like electronic filing; I trust my ability more than a clerk-typist’s. I think that there’s a slight advantage for electronic filing versus paper filing for audits, but that’s mainly because of the possibility of transcription errors by the clerk-typist.

I somewhat agree with Peter’s item #4. But I think a better way of stating it would be, Don’t have your return signed by an unscrupulous CPA, EA, tax attorney, or other tax preparer. The IRS conducts audits of returns prepared by individuals they think are unscrupulous. For example, in the Western Tax Service case, the IRS audited one return prepared by Western, found what looked like gross preparer fraud, selected several others and found that it was indeed systemic tax fraud by a preparer.

There’s one last point I’d like to make on this debate. Peter suggests that individuals either incorporate or form an LLC. If a sole proprietor forms an LLC, that LLC is generally a disregarded entity for tax purposes and files a Schedule C unless they choose to be taxed as a C Corporation or an S Corporation. Be advised also that the ability to form an LLC varies by state, and some states are restrictive of what businesses can form LLCs.

I’ve enjoyed reading both sides of this debate. I think that everyone who does so, no matter which side you take, will come out a winner.

Liberty Tax Service is America’s third largest tax preparation chain. Back in 2007, Liberty advertised that they could have your refund to you in one day.

Sounds great, but there’s a problem with that: You can’t get refunds that fast. It was really an advertisement for refund anticipation loans (RALs). Those loans have usurious interest rates (they can be as high as 375%). California’s Attorney General, Jerry Brown, sued Liberty over the ads.

The result of the lawsuit was announced this week. Liberty lost, and must make restitution of $136,000 and must pay fines of over $1 million.

I’m very much against RALs. I don’t believe they serve any purpose other than enriching the pockets of those offering them. Hopefully we’ll see fewer RALs being offered in the future.

A debate is heating up among tax bloggers on whether or not tax preparers should be regulated. Some bloggers, such as Peter Pappas, think they should be. Others, including Joe Kristan, think they shouldn’t be.

I happen to practice in California, a state where all tax preparers are required to be licensed. It hasn’t done anything to improve the quality of work. After all, Western Tax Service was located in California. All California preparers must be either EAs, CPAs, attorneys, or registered with the California Tax Education Council (CTEC)

On the other hand, my professional society, the National Association of Enrolled Agents (NAEA) is very much in support of the idea of all preparers being regulated. Perhaps it might be because that would increase the number of Enrolled Agents. Or perhaps I’m just a bit too cynical about it.

In any case, I’ll wait to see the actual proposal (if and when it’s released by the IRS) before I come out one way or the other. My inclination, though, is that it will just add another bureaucracy with little positive results for taxpayers.

I’ve come to the conclusion that everything in life is normally distributed. You may remember the normal distribution from a class you took on probability theory. It’s the bell curve. Most things are in the middle, but some are outliers stuck at both ends.

It’s that way in the world of tax accounting. There are good accountants, there are average accountants, and there are, of course, bad accountants. But it takes a special set of skills to be a Bozo accountant.

I’ve written several stories about Bozo tax practitioners. Here are some helpful hints on what to look for in a Bozo tax practitioner:

• He’s never met a deduction that doesn’t fit everyone. There’s no reason why a renter can’t take a mortgage interest deduction, right? And everyone’s entitled to $20,000 of employee business expenses…even if their salary is just $40,000 a year. Ask the proprietors of Western Tax Service about that.
• He believes that the income tax is voluntary. After all, we live in a democracy, so we don’t have to pay taxes, right?
• Besides preparing tax returns, he sells courses on why the Income Tax is unconstitutional or how by filing the magical $2295 papers he sells you’ll be able to avoid the income tax.
• He wants you to sign over that tax refund to him. After all, he’ll make sure you get your share of it after he takes out his 50% of the refund.

I think you get the idea. If your tax preparer starts exhibiting symptoms like these, make sure you find someone else. File an extension and seek someone who is not a Bozo.

Like it or not, taxes are part of life. Tax preparers who follow one of the items on the Tax Protester FAQ are Bozos. If you follow a Bozo’s advice you’re just asking for trouble.

Suppose you’re a tax “professional” and a client comes in who needs to file back tax returns. He presents his record of income for those years. You look at it and realize your client is going to owe a lot of tax. Do you (a) try to find every possible legal deduction for your client; (b) work with your client and the tax agencies to obtain a payment plan (or plans); or (c) tell him that if he shows that much income and he should just lower the amount—after all, he’ll never be caught?

Of course, since I headlined this as two from the Bozo preparer front, you know where this is heading. And yes, there are allegedly tax preparers who will do this. From Clarence, New York comes the story of Dara Lis. Ms. Lis’ client was an undercover investigator from the New York Department of Tax and Finance. Allegedly, Ms. Lis told the client (on tape), “As long as there’s no way for them to trace this income, you know, I would just lower it…real (income) numbers [are] going to kill you.”

Helpful tax hint: If your preparer tells you this, make a u-turn and find someone else.

The second story comes from Elm City, North Carolina. Raymond Renfrow used to be a professional tax preparer. He’s been barred from preparing future returns by a federal court. He promoted trusts that allegedly hid income without having any economic benefit. He used to be involved with Concept Marketing International. One of the founders of that entity was convicted of tax fraud, and a court order is prominently noted on their website. Mr. Renfrow allegedly started promoting similar trusts on his own.

Helpful tax hint #2: If your tax professional has a court order on his website that bars him from promoting tax fraud schemes, you may want to find someone else.

In any case, not only has Mr. Renfrow been barred, he’s also required to send a list of his customers to the Department of Justice. If you happen to be on that list you can expect a “Dear Valued Taxpayer” letter in your mailbox from the IRS very soon.

I try hard to help my clients pay the lowest tax possible—legitimately. These Bozos skip that last word.

Let’s start in Valdosta, Georgia. Back in November I reported on the scheme of Pamela and Clinton Hughes to claim fraudulent tax refunds for using diesel fuel off the highways. There’s a federal tax on diesel fuel, and if you use it off the highways (they claimed they used the fuel in logging) you can get a tax refund. The only problem was that it was a lie. And not a small lie; this was a $5.2 million scheme. Pamela Hughes got 33 months at ClubFed; her husband got 48 months. Each also has to make restitution of just under $4 million.

We next head to Rockford, Illinois. Angelique Tinder, aka Angelique Howen, used to operate Your Tax Master. She catered to a niche: Bosnian immigrants. The price was right; she only charged $35 to $40 a return. And she got her clients refunds, calling money sent to the families back home in Bosnia as ‘charitable contributions.’ Unfortunately, that public service has a problem—you can’t take a charitable contribution deduction on money not given to charities. And when the total of the attempted fraud adds up to $2.5 million, you’re in trouble. She was found guilty of multiple counts of tax evasion, and must make restitution of $1,085 to her clients…and serve 63 months at ClubFed. If the judge had a sense of humor and announced the sentence in that order….

Next, we head to Omaha, Nebraska. Siyad Ali also specialized in preparing tax returns for immigrants; he specialized in Sudanese immigrants. He was a generous individual, and added foster children to his clients’ returns. Throw in some phony fuel tax credits, earned income credits, and incorrect filing statuses (Head of Household), and you end up with $67,000 of fraudulent refunds. Mr. Ali was found guilty; his clients have already had to pay back the refunds with interest and penalties. Mr. Ali will be sentenced in June.

Here in Irvine I’m a member of the Exchange Club of Irvine. One of the events we put on is the Teacher of the Year Banquet; this past week the Teachers of the Year were announced. That story headlines some of the good that teachers do.

Unfortunately, sometimes we get stories that aren’t so good. Georgia Gaines is a high school math teacher in Lake Worth, Florida. She’s been charged with 32 counts of preparing phony tax returns. Additionally, she allegedly didn’t include her income from her side job on her own tax returns. Allegedly, Ms. Gaines’ returns included $1.1 million of phony deductions. She’s looking at a lengthy stay at ClubFed if found guilty.

Remember our usual warning: If it sounds too good to be true, it probably is.