Taxable Talk

This sounds ludicrous (and it is, of course), but some tax protesters came up with this argument. And a very famous actor apparently bought it.

Wesley Snipes, star of Blade and Passenger 57, went to an accountant who believes this. Mr. Snipes allegedly amended his tax return and claimed that he should get a $12 million refund. The government says that the IRS sent letters to Snipes advising him of the error of his ways...but he continued to claim the refund. Snipes now stands charged with filing false tax returns and claiming false refunds. He's out on $1 million in bond.

The Internal Revenue Code (which is a law, Title 26 U.S.C.) says that all income is taxable. If the charges against Snipes are true, Snipes better hope that the judge he draws has a very good sense of humor.

---

The U.S. Tax Code is a mess. I've basically completed my returns for the year, and I'm amazed at how ugly our tax system has become.

I hope you've enjoyed this series. One thing I do hope you realize is that almost all income is taxable. If you follow down the path of Snipes (allegedly, of course) and Hatch, you're asking for trouble. If you're famous, you'll get it, because the IRS likes to make examples of bozo celebrities.

For a tax blogger, people like Richard Hatch are wonderful. Hatch, for those who don't remember, was the winner of the first Survivor and won $1 million. About 300 million individuals worldwide saw Hatch take down the $1 million.

Hatch received a Form 1099-MISC for his winnings. In the United States, winnings from contests are taxable. Hatch claims that CBS and/or the producers of Survivor promised him that they would pay his taxes. (Both CBS and the producers of Survivor deny this charge.)

Here's what I wrote back in January 2006 when Hatch was convicted:

Mr. Hatch has cemented a place in the Bozo Tax Criminals Hall of Fame (a website I'll create one day). Let's look at his stupid not so good actions.

1. Hatch goes to accountant #1, find out that he owes over $300,000 in taxes. He goes to accountant #2, and the tax bill is around $240,000. (At his level of income, some differences in taxes owed is normal.) He then asks accountant #2 what his return would be if he didn't declare the $1 million in Survivor winnings. Accountant #2 makes Hatch sign a statement that he won't file that return (it showed Hatch getting a $4300 refund). He filed that return.

2. The IRS amazingly discovers his tax evasion. (With perhaps 300 million witnesses, even the most inept attorney could prove he won $1 million.) He's offered a plea bargain: pay your taxes, and we'll let you off fairly easily on the jail time. He accepts the plea initially, then changes his mind.

3. The case goes to trial. Hatch claims that CBS should have withheld taxes. His attorney might want to ask any seasoned accountant about what you should do if taxes aren't withheld but should have been. (Answer: you pay the taxes.)

4. Hatch's attorney can't find the OJ Simpson jury. (Hat tip: Roth Tax Updates)

5. Hatch is found guilty. Roth Tax Updates speculates that his sentence will be around 3 years in jail. Oh, he'll also have to pay those taxes, and interest and penalties. The maximum possible sentence is 13 years in prison and a fine of $600,000.

Hatch is now serving his prison sentence of 51 months. He recently appealed his conviction, though chances of it being overturned seem slim.

Tomorrow, you will see our number one bozo tax tip of the year. It's a real "winner," and one that I can guarantee will cause you nothing but problems (if you follow it).

California is not a low-tax state. The corporate tax rate is 8.84% for C Corporations (1.5% for S Corporations); both must pay a minimum $800 tax each year. If I'm in my car for any appreciable length of time, I'll hear a commercial advising you to establish a Nevada Corporation. And, of course, my clients who hear that call me.

There's a fundamental problem with having a Nevada corporation and doing business in California and hoping you will avoid California tax on the corporation: nexus. If a corporation is doing business in California (have a "nexus" in the state), the corporation is liable for California income tax. Yes, foreign (out-of-state) corporations must pay California income tax.

So if a California business reincorporates in Nevada, you will still have to pay California tax. Now, a Nevada corporation can make sense...if you're going to operate in both California and Nevada, for example, or if you plan on moving to Nevada. Just realize that if you have a Nevada corporation, and you operate in California, you are liable for California tax, and if you don't pay, you're committing a crime. ClubCal is no more fund than ClubFed....

When I was in college, I was taught that there is a right way journal entries should be written and many wrong ways. There's an appropriate structure to a journal entry, and you want to make sure you keep the appropriate backup.

That has nothing to do with this post.

Indeed, since we're dealing with bozos here, an incorrect structure is where we need to start. The United States has various financial and currency reporting requirements. If you deliberately structure transactions to avoid these laws, you're guilty of the crime of structuring.

So don't deposit $10,000 in cash; make sure your deposits are $9,000. I've written on several occasions about individuals who have structured transactions. One bozo did just this, and made sure he never used the same bank branch on the same day (he used $5,000 transactions). Unfortunately for him, the bank manager of the second branch he used happened to be visiting at the first branch he used earlier on the same day. When she wrote up the currency transaction report, she glanced at the account history and noticed the pattern...a pattern that the IRS learned about. That bozo is now spending time at ClubFed.

Today, transactions of as little as $3,000 can be reported if a bank employee is suspicious, and you probably won't be told of the report. What's the solution for the crooks of the world? Well, the simple solution is to report your income on your tax return, whether it's in cash, checks, or credit cards. For the bozos, unfortunately cash is very difficult to deal with, and money laundering is quite illegal.

The truth is that structuring continues, because many get away with. Just be aware you are committing a felony if you structure your transactions (in an attempt to avoid tax or reporting), and if you get caught ClubFed might be in your future.

A few weeks ago, I had lunch with a friend who is a fellow tax preparer. He told me a story of "Abe."

This Abe definitely wasn't like Honest Abe. He had gone fifteen years without filing a tax return. He had a cashed-based business, had owned his home for years, didn't have a bank account, and knew enough about currency rules (he never spent more than $7,000 in cash on anything) so he wouldn't get caught.

And then one day the IRS knocked on his door. And presented him with a very large bill.

Abe has no idea how the IRS found out about him, but my friend was going to prepare 15 years of tax returns for Abe, until he started saying that the tax system is voluntary, and no one has to pay taxes. My friend told Abe that he's about to find out otherwise.

The moral of the story is fairly obvious. In these days of currency records and suspicious bank activity reports on transactions of as little as $3,000, it's pretty difficult to escape the IRS and the FTB.

A few years ago, a prospective client came to me. He had used Western Tax Service, and the IRS was about to audit him. Western, for those unfamiliar with them, had a great way of attracting clients: they invented phony deductions, or padded the amounts of deductions. This went on for years, and once the IRS discovered it, they looked at another Western client, and discovered it was systemic fraud (see this press release).

So why not use the Western Tax Service method? What can go wrong if you change your charitable deductions from $100 to $10,000? And add a uniform deduction of $2500 (those business suits are expensive, you know). And $2500 for miscellaneous unreimbursed business expenses. And....

Because we know that the odds are that the IRS won't catch me, right? And what's the worst that can happen to me? I'll just pay the tax that I would have, right?

---

Wrong.

What I've written above is fraud. When you sign your tax return, you're signing under "penalty of perjury." The IRS takes that seriously. That's why whether you prepare your return yourself, or use a professional, you should review your return carefully. And that's why every return sent from our office asks the client to review the return. We want you to understand what's on your tax return.

You should take all the deductions and credits you're entitled to. But try hard not to take the ones you're not entitled to, because if the IRS finds you deliberately falsely took those, you're looking at penalties...which can include fines and even jail time. That's what the founders of Western Tax Service faced.

Have you heard about Kyle McDonald, the guy who bartered his way from one red paperclip to a house in Saskatchewan? Yes, barter can do that for you.

Say you have a box of binders you don't need. Meanwhile, your neighbor has a box of pens he doesn't need. So you swap. Everyone's happy.

So Mr. McDonald bartered his way from one paperclip (worth less than $0.01) to a house (we'll estimate that it's worth $100,000). And he didn't have to pay a penny in taxes.

---

Now to the real world. Mr. McDonald is Canadian, I believe, and exempt from US tax laws. For Americans, barter transactions must be reported to the IRS. If you swap a box of binders worth $10 for a box of pens worth $10, no one has gained any income. But suppose you swap $100 worth of pens for $10 worth of binders. The person who received the pens "earned" $90. And, yes, he must report that as income.

Barter exchanges have sprung up, and if you participate in one, they function as intermediaries and issue BarterDollars. You don't have to spend cash at Joe's pen shop, you just spend BarterDollars. And Joe buys his binders with BarterDollars. At year-end, you each will receive a 1099-B from the intermediary showing your sales.

Bartering can be a good idea. It's the first form of commerce for man. But the taxman expects his cut, and if you don't give it to him, and he finds out, you won't be very happy.

Let's thank Michael Graham of Queens, New York for coming up with this gem. Mr. Graham decided to file phony tax returns with the IRS. He used consecutive social security numbers on his tax returns.

He did get one tax refund through the system and collected $900. However, the other 1,799 returns were caught by the IRS and he didn't get the $1.6 million he attempted to collect. He did find his way to court, though....

---

I strongly suggest that you do not try anything like this. The IRS and state tax agencies do have systems in place to catch bozos who attempt crimes like this. Instead of trying to bilk the system, ask your tax preparer about legitimate deductions that are available for you to take. The regular IRA allows you to deduct $4000 ($5000 if you're 50 or older) from your income (if you're eligible). You have until April 17th to make your contributions.

And if you're self-employed, you may be able to contribute to a SEP IRA. You have until your return is timely filed, including extensions, to contribute to a SEP IRA. You can contribute 25% of your net income up to a maximum of $44,000 to a SEP.

Phony tax returns will likely lead you to a stint at ClubFed (where Mr. Graham went). We recommend the IRA or SEP IRA over ClubFed....