Taxable Talk

A friend of mine received an email that states, in part:

"I do not agree with your synopsis though that gamblers of the 50 staets have any obligation whatsoever for the withholding of Federal income tax on lottery winnings. Why? Because subtitle A and subtitle C only relates to Government entities, foreigners and foreign corporations."

I'm leaving out the name of the individual (protecting the guilty) who sent this missive.

Every so often, I get an email like this, from someone who says there's no such thing as an income tax, it was never passed, etc. When this happens, I refer them to the Tax Protester FAQ. There, we read:

The claim that “United States citizens and residents are not subject to tax on their wages or other income derived from sources within the United States, as only foreign based income or income received by nonresident aliens and foreign corporations from sources within the United States is taxable, and similar arguments described as frivolous in Rev. Rul. 2004-30, 2004-1 C.B. 622” has been identified by the IRS as a “frivolous position” that can result in a penalty of $5,000 when asserted in a tax return or included in certain collection-related submissions. Notice 2007-30, 2007-14 I.R.B. 883.

The gentleman appears to make two claims: there is no right to withhold on lottery prizes, and US citizens don't have to pay income tax on gambling.

Withholding rules are regulations, enacted after Congress specifies that withholding will occur in certain situations. One of these areas is certain gambling prizes. Lottery winnings are subject to 25% federal tax withholding if the amount won is $5,000 (or more).

Additionally, all income earned in the United States is subject to the income tax, unless Congress specifically exempted it. Gambling income has not been exempted. If you don't pay the tax, you are violating the law. And if you ignore a W-2G that's issued (and if you've won a substantial prize in a lottery, a W-2G will be issued), the IRS will catch up with you. And if you make that argument in Tax Court, you will find yourself potentially paying a financial penalty (e.g. a $5,000 fine) for making a frivolous argument.

If you receive a free meal, can you take a tax deduction for it? That's a simple question, and I'd guess that 99.99% of the public would use common sense to answer the question: No, of course not. How can you take a deduction when you're getting something for free?

However, one inventive tax preparer had a different slant on the question. Martin Kapp, a CPA from El Segundo, California, believed that individuals in the transportation industry could get the "Mariner's Deduction" for meals that were provided by their employers.

I had never heard of the "Mariner's Deduction," so I investigated Mr. Kapp's website. I note that he states, "While retaining travel receipts is always very desirable, the Johnson decision clearly states taxpayers can rely upon the government's written statements that taxpayers may indeed elect to deduct the pre-approved OCONUS and CONUS incidental rates - all without receipts."

The IRS and Justice Department alleged that Mr. Kapp had "...prepared returns for the mariners claiming deductions for the costs of meals they received for free from their employers." The DOJ brought suit in Los Angeles to stop Mr. Kapp.

And that's why I wrote the he had a different slant. Judge George Schiavelli ruled that Kapp must no longer prepare federal tax returns with the "Mariner's Deduction." He must also turn over his client list to the DOJ/IRS. His clients can look forward to receiving a "Dear Soon-To-Be Audited Taxpayer" letter from the IRS.

The judge noted that Kapp "knew or should have known" that the deductions were illegal. And, indeed, this is not the first time the "Mariner's Deduction" has led a tax preparer into hot water. In 2004 - 2005, the DOJ and IRS successfully stopped five Louisiana tax preparers from using this sham deduction.

So remember my rule: If it sounds too good to be true, it probably is. You can deduct legitimate business expenses, including unreimbursed business expenses and meals. But if an expense costs nothing, that's how much you get to deduct—nothing.

Today, the IRS issued its 2007-2008 Priority Guidance Plan. These are the major issues the IRS expects to complete during the year. There are 303 items on the list.

Poker tournaments remain on the IRS' radar screen. Like the previous two Priority Guidance Plans, one of the 303 projects is issuing a revenue procedure regarding the withholding rules for poker tournaments.

Other items on the list that appear interesting include:
- Guidance on the treatment of wrap fees;
- Guidance under section 263A regarding the treatment of post-production costs, such as sales-based royalties;
- Revenue procedure under section 6213 regarding internet and oral change of address requests;
- Guidance under section 6676 regarding the penalty for erroneous claims for refund; and
- Guidance under section 6694, as amended, regarding the penalty for understatements of taxpayer’s liability by tax return preparers.

There's plenty more, especially in technical guidance issues. I'll point out (as I did last year) that many of these 303 items will not be addressed by the IRS during the coming twelve months.