Taxable Talk

...Or so I've been told.

But as I continue to age (a phenomenon that I've been assured will continue) I have begun to wonder if Mark Twain was correct, when he said, "Suppose you were an idiot and suppose you were a member of Congress. But I repeat myself." Congress has shown a complete lack of fortitude in regards to taxation.

I am getting ahead of myself a bit. First, we have the Kelo v. New London Supreme Court decision, where private property rights took a back seat to the long hand of legislatures everywhere. Then we have the California Legislature conforming with most of the changes in federal taxes, but ignoring HSAs.

2005 will long be remembered for the disastrous hurricanes, Katrina, Rita, and Wilma. Congress did some good by passing tax relief for those impacted by the disasters. However, Congress couldn't resist playing the morality card by excluding relief for "morally challenged" industries, such as gambling. It's not as if gambling has done anything for Mississippi's Gulf Coast region. I mean, back in the late 1970s the area was horribly poor, with few prospects for improvement. After the introduction of casinos, the area's economy grew tremendously. However, Congress can't be seen helping out the "sinners." (Please also read Professor Maule's excellent commentary on this issue.)

I would not want to forget the IRS as 2005 draws to a close. Indeed, the IRS attempted, in the name of "improving customer service" to close some taxpayer information offices. (Here, at least, Congress interceded to stop the closure.) More recently, the IRS wanted to cut three hours from their customer help lines; the recently passed defense appropriation bill contains language preventing such a closure. Of course, the quality of IRS telephone help remains at the usual, high level—only 25% of callers receive incorrect information.

And as 2005 drew to a close, Congress began debating extending AMT relief, extending the lower dividend tax rates, and other tax relief items. Any relief has been postponed until 2006. This one deserves watching, because the AMT is poised to strike millions if something isn't done.

Of course, no holiday year-in-review article would be complete without noting the positive things that have happened in 2005. Congress continues to monkey with adapt the tax code for changing times, making it easier to work with easier for professional tax preparers such as myself to get work, and have lifetime employment. State legislatures, such as California's, continue to lower tax rates and decrease regulations continue to pass more regulations forcing us to live in a nanny state. At least on the local level, things are different. It's not as if Irvine has any huge public works boondoggles in the future, things like a Great Park, that would undoubtedly need taxpayer funding at some later date. (At least this last item probably won't come home to roost for ten years or so.)

Finally, have a wonderful holiday season. Whether you celebrate Christmas, Hanukkah, or any other holiday, I wish you and yours a wonderful, safe and merry season. Merry Christmas and Happy New Year.

One of the most vexing things for the layman is the difference between a hobby loss and a business loss. Because the US taxes all income earned worldwide, it makes no difference whether you earn money in a hobby or in a business: it's taxable. (Of course, the deductions available differ for businesses, but that's another story.)

There have been numerous Tax Court cases regarding hobby losses. Most of the time, these "hobby losses" are just that—taxpayers are attempting to deduct their losses in their (for example) basketweaving business. One such case is Morrisey v. Commissioner (T.C. Summary 2005-86), where the Tax Court ruled that the petitioner conducted his drag racing for a profit, not as a hobby.

Today, though, we look at a case where the petitioner desired that his activity was a hobby, not a business. Joseph Hachem, of Melbourne, Australia, won the main event at the World Series of Poker this past July in Las Vegas. He won $7.5 million. The IRS immediately took $2.25 million, leaving the Aussie with $5.25 million. (There is no tax treaty between the United States and Australia. Under the US Tax Code, if a non-US citizen wins certain gambling prizes, 30% of the winnings must be withheld.)

And then it was the Australian Tax Office's turn at Mr. Hachem. Australian tax law is different from that of the United States; gambling is not taxable down under for the non-professional. But professional gamblers are taxed on their winnings. So was Mr. Hachem, who has since become a professional poker player, a professional gambler or was he still a mortgage broker? If he were a professional, he would lose about 35% of his winnings, or just over 3.5 million Australian Dollars.

The Australian Tax Office ruled today that Mr. Hachem was still a mortgage broker when he won the World Series. So he'll get to keep his $5.25 million (7,171,000 Australian Dollars). As his attorney, Peter Donovan, said, "...[The] fact that you excel at a particular hobby should not be fatal for tax purposes."

Coverage available here and here.

The Tax Court today looked at whether a heretofore charitable organization (a 501(c)(3)) that has a gaming operation can retain its' charitable (501(c)(3)) status. This case gives an excellent example of some of the drawbacks of "charitable" gambling from a charity's perspective.

The petitioner, a Middletown, Ohio association that had been granted 501(c)(3) status in 1982, began to operate bingo games and pull-tab gambling (pull-tabs are where a card or ticket is given to a customer, a symbol is revealed, and then the customer looks to see if the symbol is a "winner") to fund their charitable activities. So far so good. Under Ohio law, such gaming for charity is allowed if a security guard is at the gaming establishment. So the association hired a security firm to provide such a guard.

The IRS then audited the association for 1992 through 1995. The association made a number of mistakes. First, it paid the staff working the bingo games/pull-tab sales "under the table." Second, the charities receiving the funding were, according to the Tax Court, controlled by the association's President. Third, while the association raised between $870,000 to $2,000,000 through the gambling operation, they donated to charity between $270,000 and $440,000 each year with the donations decreasing while the receipts were increasing.

Under the Tax Code, a charitable organization must be "...organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes." The IRS claimed that the association did not "...[engage] primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3)." [Sec. 1.501(c)(3)-1(c)(1), Income Tax Regs] The IRS felt that the association engaged primarily in gaming (not charitable work), that the association served the interests of its founder (rather than charitable work), and that it was a "feeder" under §502.

The Tax Court found that the association was primarily a gaming organization, not a charitable association. First, the under-the-table payments undoubtedly started the negative thinking. Second, most (if not all) of the workers at the bingo nights were compensated, and were not performing their work for charity. Third, the Court believed the IRS' witnesses and disbelieved the association's witnesses.

So if you're going to have a charitable 501(c)(3) association, make sure you don't gamble that designation away. Scrupulously follow the Tax Code or you'll roll craps.

Case: South Community Association v. Commissioner, T.C. Memo 2005-285