By Michael Cohn
A 36-year-old accountant at a financial firm was called in as a last-minute replacement for a Chicago Blackhawks goalie in a National Hockey League game, and managed to make seven saves without letting a single puck in the net.
Scott Foster, of Oak Park, Ill., works as a senior financial accountant at Golub Capital in the Chicago area. He had signed up to be an emergency goaltender for the Blackhawks and often attended the games. He finally got his chance on Thursday night, helping the Blackhawks win against the Winnipeg Jets. The Blackhawks’ starting goalie, Corey Crawford, was out because of an injury and backup goalie Anton Forsberg was hurt shortly before the game, according to NPR. Another emergency fill-in goalie, Collin Delia, needed to leave the game during the third period after he felt cramping. That gave Foster his chance, and fortunately he was on hand to save the day for the Blackhawks.
“I’m an accountant by day, so a few hours ago I was sitting behind the computer typing on a 10-key,” he told reporters. “Now I’m standing before you guys and I just finished 14 and a half minutes of NHL hockey.”
Foster’s main hockey experience before then was playing four seasons as a goalie for his college hockey team at Western Michigan University, where he had a .875 save percentage. He had also played for the Petrolia Jets in the Western Ontario Hockey League. However, he hadn’t played competitive hockey in 13 years. He has two young children. Thanks to Foster’s seven saves during his 14 and half minutes on the ice, the Blackhawks managed to hold off the Jets, winning by a score of 6 to 2.
Step-by-Step Instructions for Using the IRS Withholding Calculator
The IRS encourages everyone to use the Withholding Calculator to perform a quick “paycheck checkup.” This is even more important this year because of recent tax law changes.
Results from the calculator will include a recommendation of whether or not users should consider submitting a new Form W-4, Employee’s Withholding Allowance Certificate, to their employers. Before beginning, taxpayers should have a copy of their most recent pay stub and tax return.
Here are step-by-step instructions for using the calculator:
Input general tax situation information, including:
Input information about credits, including:
Enter the total estimated taxable income expected during the year. Amounts the user will enter include wages, bonuses, military retirement, taxable pensions, and unemployment compensation. Users should enter a "0" on lines asking for amounts that don’t apply to them.
Enter an estimate of adjustments to income, including deductible IRA contributions and education loan interest.
Indicate standard deduction or itemized deductions. Users who plan to itemize will enter estimates of these deductions.
Print out the summary of results. The calculator will provide a summary of the taxpayer's information. Taxpayers use the results to determine if they need to complete a new Form W-4, which they give to their employer.
The child credit has long been a valuable tax break. But, with the passage of the Tax Cuts and Jobs Act (TCJA) late last year, it’s now even better — at least for a while. Here are some details that every family should know.
Amount and limitations
For the 2017 tax year, the child credit may help reduce federal income tax liability dollar-for-dollar by up to $1,000 for each qualifying child under age 17. So if you haven’t yet filed your personal return or you might consider amending it, bear this in mind.
The credit is, however, subject to income limitations that may reduce or even eliminate eligibility for it depending on your filing status and modified adjusted gross income (MAGI). For 2017, the limits are $110,000 for married couples filing jointly, and $55,000 for married taxpayers filing separately. (Singles, heads of households, and qualifying widows and widowers are limited to $75,000 in MAGI.)
Now the good news: Under the TCJA, the credit will double to $2,000 per child under age 17 starting in 2018. The maximum amount refundable (because a taxpayer’s credits exceed his or her tax liability) will be limited to $1,400 per child.
The TCJA also makes the child credit available to more families than in the past. That’s because, beginning in 2018, the credit won’t begin to phase out until MAGI exceeds $400,000 for married couples or $200,000 for all other filers, compared with the 2017 phaseouts of $110,000 and $75,000. The phaseout thresholds won’t be indexed for inflation, though, meaning the credit will lose value over time.
In addition, the TCJA includes (starting in 2018) a $500 nonrefundable credit for qualifying dependents other than qualifying children (for example, a taxpayer’s 17-year-old child, parent, sibling, niece or nephew, or aunt or uncle). Importantly, these provisions expire after 2025.
Qualifications to consider
Along with the income limitations, there are other qualification requirements for claiming the child credit. As you might have noticed, a qualifying child must be under the age of 17 at the end of the tax year in question. But the child also must be a U.S. citizen, national or resident alien, and a dependent claimed on the parents’ federal tax return who’s their own legal son, daughter, stepchild, foster child or adoptee. (A qualifying child may also include a grandchild, niece or nephew.)
As a child gets older, other circumstances may affect a family’s ability to claim the credit. For instance, the child needs to have lived with his or her parents for more than half of the tax year.
Tax credits can serve as powerful tools to help you manage your tax liability. So if you may qualify for the child credit in 2017, or in years ahead, please contact our firm to discuss the full details of how to go about claiming it properly.
Years and years ago, the notion of having a company cafeteria or regularly catered meals was generally feasible for only the biggest of businesses. But, more recently, employers providing meals to employees has become somewhat common for many midsize to large companies. A recent tax law change, however, may curtail the practice.
As you’re likely aware, in late December 2017 Congress passed and the President signed the Tax Cuts and Jobs Act. The law will phase in a wide variety of changes to the way businesses calculate their tax liabilities — some beneficial, some detrimental. Revisions to the treatment of employee meals and entertainment expenses fall in the latter category.
Before the Tax Cuts and Jobs Act, taxpayers generally could deduct 50% of expenses for business-related meals and entertainment. But meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.
Under the new law, for amounts paid or incurred after December 31, 2017, deductions for business-related entertainment expenses are disallowed. Meal expenses incurred while traveling on business are still 50% deductible, but the 50% disallowance rule now also applies to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises will be completely nondeductible.
If your business regularly provides meals to employees, let us assist you in anticipating the changing tax impact.
IRS issues guidance on business interest expense limitations
The Treasury Department and the Internal Revenue Service (IRS) today issued Notice 2018-28, which provides guidance for computing the business interest expense limitation under recent tax legislation enacted on Dec. 22, 2017.
In general, newly amended section 163(j) of the Internal Revenue Code imposes a limitation on deductions for business interest incurred by certain large businesses. For most large businesses, business interest expense is limited to any business interest income plus 30 percent of the business’ adjusted taxable income.
Today’s notice describes aspects of the regulations that the Treasury Department and the IRS intend to issue, including rules addressing the calculation of the business interest expense limitation at the level of a consolidated group of corporations and other rules to clarify certain aspects of the law as it applies to corporations. The notice clarifies the treatment of interest disallowed and carried forward under section 163(j) prior to enactment of the recent tax legislation. Finally, the notice makes it clear that partners in partnerships and S corporation shareholders cannot interpret newly amended section 163(j) to inappropriately “double count” the business interest income of a partnership or S corporation.
Today’s notice requests comments on the rules described in the notice and also requests comments on what additional guidance should be issued to assist taxpayers in computing the business interest expense limitation under section 163(j). The Treasury Department and the IRS expect to issue additional guidance in the future.
IRS Dirty Dozen: Watch Out for these 12 Scams
The IRS reminds taxpayers to watch out for scams and schemes that put them and their personal information at risk. Each year, the IRS releases the top 12 scams, known as the Dirty Dozen. The schemes run the gamut from simple refund inflation to technical tax shelter deals.
Here’s a recap of this year's Dirty Dozen:
1.Phishing: Taxpayers should watch for fake emails or websites looking to steal personal information. The IRS will never initiate contact with taxpayers via email about a bill or tax refund. Don’t click on links in these emails claiming to be from the IRS.
2.Phone Scams: Phone calls from criminals impersonating IRS agents remain an ongoing threat to taxpayers.
3.Identity Theft: Taxpayers should be alert to tactics aimed at stealing their identities. The IRS continues to pursue criminals who file fraudulent tax returns using someone else’s Social Security number.
4.Return Preparer Fraud: Most tax professionals provide honest, high-quality service. However, there are some dishonest preparers who scam clients. These preparers commit refund fraud, identity theft and other scams that hurt taxpayers.
5.Fake Charities: Groups masquerading as charitable organizations solicit donations from unsuspecting contributors. People making donations should take a few extra minutes to make sure their money goes to legitimate charities.
6.Inflated Refund Claims: Taxpayers should be wary of anyone promising inflated tax refunds. Some signs of this include preparers who ask clients to sign a blank return or those who promise a big refund before looking at taxpayer records.
7.Excessive Claims for Business Credits: Taxpayers should avoid improperly claiming the fuel tax credit. Most taxpayers aren’t eligible for this credit, as the law usually limits it to off-highway business use, including farming.
8.Falsely Padding Deductions on Returns: Taxpayers should avoid the temptation to falsely inflate deductions or expenses on their tax returns. Taxpayers do this to pay less than what they owe or receive a larger refund than they should get.
9.Falsifying Income to Claim Credits: Con artists may convince taxpayers to invent income to erroneously qualify for tax credits, such as the Earned Income Tax Credit.
10.Frivolous Tax Arguments: Some taxpayers use frivolous tax arguments to avoid paying tax. Promoters of these schemes encourage taxpayers to make outlandish claims about the legality of paying taxes. These claims are repeatedly thrown out in court.
11.Abusive Tax Shelters: Taxpayers who use abusive tax structures do so to avoid paying taxes. The majority of taxpayers pay their fair share, and everyone should be on the lookout for people peddling tax shelters that sound too good to be true.
12.Offshore Tax Avoidance: It’s a bad bet to hide money and income offshore. People involved in offshore tax avoidance are best served by voluntarily disclosing offshore money and getting caught up on their tax-filing responsibilities.
By Michael Cohn
The Supreme Court declined to hear a case involving a Colorado cannabis business that refused to cooperate with an Internal Revenue Service audit and turn over business records.
The case involved The Green Solution Retail, Inc., a Colorado-based marijuana dispensary with several locations in the state. The IRS was auditing the company’s tax returns for 2013 and 2014 to decide whether it should apply a law that forbids federal tax deductions and credits to companies trafficking in a controlled substance. The IRS’s initial finding was that Green Solution trafficked in a controlled substance and had violated the Controlled Substances Act, according to an appeals court ruling last year. It then asked the company to turn over documents and answer questions related to whether it should be disqualified from taking tax credits and deductions under section 280E of the tax code. The IRS had not made an assessment or begun collection proceedings against the company.
Green Solution then sued the IRS in a Colorado district court, arguing the IRS was acting outside its statutory authority in finding that a taxpayer had trafficked in controlled substances. It claimed it would suffer irreparable harm if the IRS were allowed to continue its investigation because a denial of deductions would deprive it of income, constitute a penalty that would effect a forfeiture of all its income and capital, and violate its Fifth Amendment rights.
The IRS moved to dismiss the claim, saying Green Solution’s claim for injunctive relief was foreclosed by the Anti-Injunction Act, which bars lawsuits for the purpose of restraining the assessment or collection of any taxes. The IRS also contended Green Solution’s claim for declaratory relief violated the Declaratory Judgment Act, which prohibits declaratory judgments in some federal tax matters. The Colorado district court agreed with the IRS and dismissed the lawsuit with prejudice.
Last year, a federal appeals court upheld the ruling, but concluded only that the Anti-Injunction Act and the Declaratory Judgment Act barred the lawsuit, noting, “because the IRS’s investigation of Green Solution’s business records is an ‘activity leading up to’ an assessment, we conclude Green Solution’s lawsuit was filed for the purpose of restraining any such assessment and is therefore barred by the AIA and DJA.” However, the appeals court added, “To the extent Green Solution argues the IRS exceeded its authority under the Internal Revenue Code, we lack subject matter jurisdiction to consider the merits of the argument. We decide here only that the IRS’s efforts to assess taxes based on the application of § 280E fall within the scope of the AIA.”
The U.S. Supreme Court officially declined Monday to take up the case. Green Solution and its attorney did not immediately respond to a request for comment.
By Michael Cohn
The Internal Revenue Service issued a reminder Friday to taxpayers that they need to report any income they get from virtual currency transactions on their tax returns.
The move comes after the IRS forced one of the largest cryptocurrency exchanges in the world, Coinbase, to send information on 13,000 of its users to the IRS last month after a protracted legal battle involving the use of John Doe summonses. That means people who have engaged in transactions involving Bitcoin, Ethereum and other digital currencies are expected to report them to the IRS.
The IRS pointed out that virtual currency transactions are taxable by law, similar to transactions in any other type of property. The IRS issued guidance in 2014 in Notice 2014-21spelling out the agency’s position on digital currency transactions for taxpayers and tax preparers.
The IRS warned Friday that taxpayers who don’t properly report the income tax consequences of their cryptocurrency transactions face the possibility of tax audits, and they could even be liable for paying penalties and interest when appropriate. In more extreme situations, taxpayers might even be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions, the IRS noted.
“Criminal charges could include tax evasion and filing a false tax return,” said the IRS. “Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.”
Under Notice 2014-21, virtual currency is treated as property for federal tax purposes, so the general principles that apply to property transactions also apply to transactions using the 1,500 or so known varieties of cryptocurrency. That means a payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.
Payments using digital currencies to independent contractors and other service providers are also taxable, and the self-employment tax rules generally apply. Normally, payers must issue a Form 1099-MISC to the payee.
Wages that have been paid to employees using virtual currency are also taxable to the employee, and need to be reported by an employer on a Form W-2. They're also subject to federal income tax withholding and payroll taxes.
Some third parties who settle their payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are also required to report payments to the merchants on Form 1099-K, Payment Card and Third Party Network Transactions.
The IRS noted that the character of a gain or loss from the sale or exchange of a virtual currency depends on whether it’s a capital asset in the hands of a taxpayer.
By Michael Cohn
Rapper and actor DMX was sentenced to one year in prison for tax fraud for evading taxes from 2010 to 2016.
DMX, whose real name is Earl Simmons, was accused of concealing millions of dollars in income from the Internal Revenue Service and avoided paying $1.7 million of tax liabilities. He pled guilty last November, before United States District Judge Jed S. Rakoff, who imposed sentence on him Wednesday.
“Earl Simmons, the recording artist and performer known as DMX, stole from the American taxpayers when he earned millions of dollars but failed to pay any taxes on his income,” U.S. Attorney Geoffrey S. Berman said in a statement. “Today’s sentence shows that star power does not entitle people to a free pass. Together with our partners at the IRS, we will vigorously enforce our tax laws to make sure that people pay their fair share.”
Along with a year of prison, DMX, 47, of Yonkers, N.Y., was also sentenced to three years of supervised release and ordered to pay $ 2,292,200 in restitution to the IRS. His attorneys had asked for him to play his music before sentencing was imposed. DMX was allowed to perform one of his songs, "Slippin'" He admitted his wrongdoing, according to the Associated Press, and said he "wasn't following the rules." But he insisted it wasn't planned. "I never went to the level of tax evasion where I'd sit down and plot ... like a criminal in a comic book."
DMX worked as a recording artist, performer and actor. Starting in 1997, he released a series of hip-hop albums that sold millions of copies. Many of his albums went platinum and to the top of the record charts. During his career, he performed at venues across the country and around the globe, and has acted in movies.
Thanks to the income he earned from sources including recordings and performances, from 2002 through 2005 he incurred federal income tax liabilities of approximately $1.7 million. Those liabilities went unpaid, and in 2005, the IRS started trying to collect.
From 2010 through 2015, DMX earned more than $2.3 million, but didn’t file personal income tax returns. Instead, he maintained a largely cash lifestyle, avoiding the use of a personal bank account, and using the bank accounts of nominees, including his business managers, to pay personal expenses. For example, he received hundreds of thousands of dollars of royalty income from his recordings, but had income deposited in the bank accounts of his managers, who then distributed it to him in cash or used it to pay his personal expenses.
He also appeared on the “Celebrity Couples Therapy” reality TV show in 2011 and 2012 and was paid $125,000 for his appearances. When taxes were withheld from the check for the first installment of that fee by the producer, DMX refused to tape the rest of the TV series until the check was reissued without withholding taxes.
He also took other steps to hide his income from the IRS and others, including by filing a false affidavit in U.S. Bankruptcy Court that listed his income as “unknown” for 2011 and 2012, and as $10,000 for 2013. DMX received hundreds of thousands of dollars of income in each of those years.
By Derek Carter
Large companies have been practicing the art of end-to-end automated accounting for some time. Software manages transactions and accounts from start to finish, and the advanced AI-fueled solutions are even handling tasks like paying an invoice automatically. Because of this, corporate accountants are doing higher-level work, helping companies be more profitable and efficient.
Many wonder if this type of accounting is probable, or even possible for small businesses.
But before we get ahead of ourselves — do small businesses even need the automated continuous accounting capability of large enterprises?
In a word, yes. Just as intelligent apps and real-time data help consumers get the best deals online and avoid traffic jams on the way to work, small businesses need better data to survive, let alone thrive.
Immediate information is life or death
The current reality of many small businesses is there is too much guesswork. Owners and managers typically can’t see important financial trends in the business on a daily or weekly basis. They must wait until the accountant closes the books at the end of the month, typically 15-21 days after month-end, which isn’t very helpful for small-business owners who need information on expenses, revenue, payroll, and even possible fraud when it happens, not five weeks after it happens.
A delay in data means that they are possibly (and probably) missing important data, like the impact of lower sales on the ability to pay next month’s fixed expenses, like rent or utilities. Getting data earlier means that the business owner can make smart decisions on how to cut back on expenses in the short term or delay a major purchase that can wait. An online retailer can see whether the company is sitting on too much inventory and should run a promotion to pare it back. A fast food franchise can evaluate payroll on a weekly basis and see whether an adjustment should be made in schedules or headcount based on sales trends. Daily automated analysis could indicate if an employee is stealing, allowing a manager to fix the problem immediately, instead of several weeks down the line when more damage is done.
The more data managers can see, the more areas can be considered for minor tweaks that can lead to long-term gains. And this is not just relevant for business-to-consumer companies — think of a small insurance agency that sees sales of a certain product increasing by 50 percent in the last 10 days. That knowledge can predict future sales, or prompt analysis to keep the momentum going.
The first steps
The small business must have transactions flowing automatically and continually into the accounting system. This is easy to do nowadays because of technology that small businesses already use to sell products and services and keep track of payroll and pay for expenses. By implementing proper automated rules, the business can trust that every financial transaction has been entered into the general ledger and coded accurately. The goal here is to obtain clean data effortlessly and eliminate needless human error and labor costs from manual entry.
The next step is employing technology that can do some analysis for you on these real-time data sets. This doesn’t mean the professional accountant’s job is done. It simply means that they will have more data easily available to help clients avoid problems, make better decisions and understand business trends well enough to optimize processes or offerings for success. That’s the value of a professional services firm – not using spreadsheets and inputting data. Armed with dashboards, alerts and some starting analysis, the accountant gets to see the entire financial picture as it is playing out. The accountant can identify fraud or troubling trends, such as low cash flow from late receivables, before it affects the business negatively.
Few accountants enjoy pulling all-nighters to close the books. Even less enjoyable is correcting mistakes made along the way, which can be painstaking to uncover and rectify. By distributing these end-of-month tasks throughout the month, companies can optimize workflow and increase accuracy. Accounting staff, whether internal or external, are better able to add value to the business as more tasks are automated.
Free of manual tasks and an uneven workload, accountants will be proactive in their work — a significant shift from the reactive nature of accounting that has been status quo for so long. A focus on future-looking trends and analytics will be the new normal. Accountants will use their unique skills to identify fraud risk and other, more challenging compliance activities that have historically been put on the back burner due to lack of time. The accountant will truly become the trusted advisor their customer (internal or external) has been seeking.
Once a company can achieve continuous accounting, they can take advantage of artificial intelligence. With all the data in place and tasks automated, machine learning systems and smart software will figure out patterns and how things work in specific businesses. They can route invoices and contracts to the right people for approvals, make payments, or correct errors. These systems will be able to make forecasts for the CFO; For instance, when sales hit a certain mark, payroll should adjust accordingly.
Continuous accounting is the next logical step for small businesses everywhere, and it will unleash insights that can change a company’s fortune today and for the year ahead.
By Sahil Kapur and Anna Edgerton
House Republicans are approaching their next attempt at tax cuts the same way they did last year — by excluding Democrats from the process. But this time a party-line vote won’t be enough, and that may be the point.
GOP leaders aren’t planning on using the procedural trick they deployed in 2017 that allowed them to bypass Democratic opposition and pass the tax overhaul bill with a simple majority. So they’ll need at least nine Senate Democrats to back a so-called phase two of tax changes that would focus on making the individual tax cuts permanent.
So far, Democrats have been excluded from talks about what a second round of tax legislation would entail, according to a Republican lawmaker on the House’s tax-writing committee. GOP leaders are also considering timing a floor vote to April 17, when income tax returns are due, said two Republican members of the committee, who asked not to be named because the discussions are private.
Those moves show the effort is shaping up to be a political ploy to bludgeon Democrats ahead of congressional elections in November. Unlike last year, Republicans need buy-in from some Democrats because the effort would be subject to the 60-vote threshold in the Senate, where the GOP has 51 members.
President Donald Trump mentioned a potential phase two in February — since then, incoming White House economic adviser Larry Kudlow and congressional GOP leaders have added momentum to the effort and highlighted the importance of giving permanent relief to individual taxpayers.
“We’re in political season at this point,” said Tom Davis, a former Republican congressman who used to run the party’s House election arm. “To taxpayers that are now starting to receive the benefits of the tax cut, they’ll know where Republicans stand on a tax cut that Democrats oppose.”
Democrats have assailed the new law as a giveaway to corporations and the wealthy, and they’ve called for drastic changes.
“I’m ready to have a discussion with them. They want to fix some problems in the tax law? I want to fix some problems in the tax law,” said Senator Chris Murphy, a Connecticut Democrat. Murphy said one of his demands was reducing the deficit impact of the bill.
Making the individual cuts permanent is estimated to cost $1.5 trillion in the decade after 2025, according to a Tax Foundation analysis using numbers from the Joint Committee on Taxation. Republicans had to sunset the individual changes to conform to the budget they set under Senate rules.
Raising the issue now forces Democrats to take an uncomfortable stance against middle class tax relief. If the individual tax breaks expire at the end of 2025, the bottom 80 percent of Americans would pay higher taxes than they would if the law never passed, according to an analysis by the nonpartisan Tax Policy Center.
Republicans on the Ways and Means Committee described tying the individual tax cut extension to ‘tax day’ as one option they’re working on. It’s not clear what, if any, other measures would be included.
If GOP tax writers choose to include the extension of business provisions such as full and immediate expensing — which allows companies to fully write off their capital expenditures right away — it could be a sign that Republicans are more serious about the effort, according to one tax analyst briefed on the GOP plans who asked not to be named because the discussions are private.
There are perils for Republicans in re-litigating the tax overhaul: It reminds voters that the GOP made the unpopular corporate tax cuts permanent and the popular middle-class breaks temporary. A second round that only consisted of making the individual breaks permanent would also force the self-styled party of fiscal responsibility to make the case for blowing out the deficit beyond the $1.5 trillion the current tax law adds in the first decade.
Still, Davis said that taxes would be a better conversation for Republicans to have than the chaos and legal woes surrounding the White House that have dominated the political conversation this year.
Some GOP operatives see the tax law as their only significant legislative achievement and therefore make-or-break for the party’s electoral hopes.
“The central question for November is: Does the middle think we cut their taxes? If the answer to that is yes, Republicans will keep the House,” said Corry Bliss, who runs the GOP-aligned super PAC Congressional Leadership Fund. And if the answer is no, “voters will punish Republicans,” he said.
“This bill will not sell itself,” Bliss said. “It’s gaining in popularity, but the work has just begun.”
A Gallup poll released March 7 found that 39 percent of Americans approve of the tax law — up 6 percentage points since January — but 49 percent still disapprove.
Adam Jentleson, who served as deputy chief of staff for the former Democratic Senate Majority Leader Harry Reid, predicted there’s “very little chance” that nine Democrats would back a bill centered on making the individual tax changes permanent.
“It is a cheap political exercise and they shouldn’t lend it any more credence than it deserves,” he said.
A round two isn’t expected to include any technical fixes to errors or oversights in last year’s law, which will need more time, according to the tax analyst who asked not to be named to discuss plans that have not been made public.
Senator Ron Wyden, the top Democrat on the tax-writing Finance Committee, has criticized Republicans for passing the bill so hastily, and said his party wants fundamental changes to the law.
Republicans have said “the typical middle person is going to get a $4,000 tax cut — as of now there is no evidence of that,” Wyden said. What was passed, he said, amounted to "a stock buyback promotion act.”
Last month, Wyden highlighted a report on the Senate floor that showed corporate stock buybacks have reached more than $200 billion since the passage of the tax overhaul — and were coming in at a rate 30 times greater than worker bonuses.
By Ed Slott
Required minimum distributions are usually due by the end of the year, so why bring them up now? Isn’t it best to take them late in the year to maximize the tax-deferred buildup for as long as possible?
In theory that sounds right, but there are practical advantages to taking the RMD earlier in the year.
Easing RMD stress: Taking RMDs earlier in the year puts less pressure on the beneficiaries if the client dies before taking the distribution. We often see problems in the year of death, especially when beneficiaries have a tight window to take the year-of-death RMD.
When an IRA owner subject to RMDs dies before taking the distribution for the year, it must be taken by the beneficiary. The beneficiary takes the RMD amount that the deceased IRA owner would have had to take had he lived. There is sometimes not enough time to get this done when an IRA owner dies late in the year.
For example, if the client dies in December without having yet taken the RMD for the year, an inherited IRA generally needs to be set up and the beneficiaries must take the RMD (each taking their share) by year-end. That’s unlikely to be done.
First, before an inherited IRA can be set up, a death certificate must be presented to the IRA custodian. That may take some time depending on the circumstances and who the beneficiaries are. If the IRA beneficiary is a trust for instance, that might add a layer of complexity and delays. Or if the beneficiaries reside in different states, paperwork may take longer even with scanning and email. Sometimes beneficiaries are hesitant to take action without consulting advisors on their own behalf, especially if there are issues among the siblings or other beneficiaries, for example with step-children of blended families and second marriage situations. These things cause delays.
If you have these situations, it’s a good idea to review all IRA and plan beneficiary forms now to avoid disputes and ambiguity after death. A beneficiary form review and update is a simple, but high-value service that advisors can provide.
Setting up inherited IRAs also means making direct transfers. Inherited IRAs can only be funded via a trustee-to-trustee transfer from a decedent’s account. These transfers tend to be more time consuming, adding to delays. A non-spouse IRA beneficiary can never do a 60-day rollover.
In addition, taking an RMD for a deceased parent a few weeks after death is not usually first on anyone’s to-do list. Of course there are remedies for a missed RMD, but this requires more time and work for your client, the tax preparer and the beneficiaries.
Waiving the 50% penalty: Once there is a missed RMD, the 50% penalty becomes an issue that must be dealt with.
First, the missed RMD must be made up by the beneficiaries as soon as possible. The year-of-death RMD is not taken by the estate. That means the beneficiaries must each file IRS Form 5329 [Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts] for the year of death, requesting that the penalty be waived due to the death of the taxpayer, and stating that the missed year-of-death RMD was taken by the beneficiaries.
That form must be filed or the 50% penalty will never be removed. The penalty will continue looming as a liability. IRS and the U.S. Tax Court consider Form 5329 a separate stand-alone tax form since it has its own signature line. If the form is not filed, the statute of limitations never begins to run and the beneficiary(s) will have an open liability to the IRS.
But this entire correction scenario can be avoided by taking RMDs earlier in the year. Even if a client dies later that year, there will be no year-of-death RMD issue, since it was already taken. If the client dies early in the year before it was taken, there will still be time for beneficiaries to deal with the year-of-death RMD.
First dollars out RMD rule: Once a client is subject to RMDs, the law states that the first dollars of the year withdrawn from the IRA (or plan) are deemed to satisfy the RMD. If the client does not want to take the RMD until later in the year, other withdrawals must be put on hold until that RMD is satisfied.
For example, if a person is subject to RMDs but wants to do a rollover within the year, they cannot do that until the RMD is withdrawn. If the client wants to do a Roth conversion, it cannot be done until the RMD amount is satisfied. RMDs cannot be converted to Roth IRAs because they are considered rollovers and RMDs are not eligible to be rolled over. Once the RMD is taken though, all other IRA funds are available to be rolled over or converted.
Clients, and even advisors, can often unknowingly violate this “first dollars out” rule when doing a Roth conversion. Why? Because the funds withdrawn and converted to a Roth IRA are taxable, so in the client’s mind they paid tax on the funds coming out of their IRA and that’s the same outcome as if they withdrew the RMD and didn’t convert the funds.
Here’s an example: John has a traditional IRA with an RMD of $15,000. He converts $100,000 from the IRA to a Roth IRA, thinking that the first $15,000 withdrawn satisfies his RMD for the year. It doesn’t. What has happened is that John still owes tax on the full $100,000 since that was withdrawn from his taxable IRA funds. But only $85,000 was eligible to be converted, since the first $15,000 was deemed to be his RMD and that amount cannot be converted or rolled over.
That $15,000 is now an excess Roth IRA contribution and must be removed by October 15thof the year following the year of the excess contribution (along with any income or loss attributable to that $15,000). If that excess is not timely removed, then there will be a 6% penalty assessed for each year the $15,000 excess remains in the Roth IRA. The 6% penalty is also reported on Form 5329 which must be filed, otherwise the liability continues.
If the RMD were taken earlier in the year, that would avoid this tax problem because then the entire remaining IRA balance would be eligible to be converted.
Plan an IRA rollover with caution: RMDs can also present a problem in a 401(k) when your client is subject to RMDs but wants to roll their 401(k) balance to an IRA you set up for them. The RMD must first be withdrawn from the plan before any of the remaining plan funds can be rolled over to an IRA. If the RMD is taken earlier in the year, this will not be a problem because all the remaining funds in the plan would be eligible to be rolled over.
Sometimes in a rush to get the 401(k)-to-IRA rollover done, the entire plan balance is rolled over, including the RMD. Again, that creates an excess contribution to the IRA which must be removed. Once again, taking the RMD earlier in the year, removes this potential problem.
Yes, on the surface it seems that delaying RMDs leaves more IRA income sheltered from taxes, but taking the RMD earlier in the year can eliminate a domino effect of other expensive tax problems that take time and effort to correct.
No client wants tax problems or wants them for their beneficiaries. Connect with your clients now to review the best plan for taking annual RMDs.
The $1.5 trillion new tax law represents the most sweeping change to tax code in a generation. Tax reform of this magnitude will have broad implications for businesses of all sizes and in all industries. While accountants and tax departments wade through the 185-page legislation, here are the top 10 things companies need to know:
This article originally appeared in BDO USA, LLP’s “Federal Tax Alert” (January 2018). Copyright © 2018 BDO USA, LLP. All rights reserved.
On Friday, December 22, 2017 President Trump signed sweeping tax reform into law. The Tax Reform provides the most comprehensive update to the tax code since 1986 and includes a number of provisions of particular interest to partnerships and their partners. This alert addresses the Section 199A deduction for qualified business income of pass-through entities.
For tax years beginning after December 31, 2017, taxpayers other than corporations will generally be entitled to a deduction for each taxable year equal to the sum of:
A taxpayer’s combined qualified business income (QBI) amount is generally equal to the sum of (A) 20 percent of the taxpayer’s QBI with respect to each qualified trade or business plus (B) 20 percent of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
Limitation Based on Wages & Capital
The portion of the deduction attributable to 20 percent of the taxpayer’s QBI cannot exceed the greater of (1) 50 percent of his/her share of W-2 Wages paid with respect to the QBI or (2) the sum of 25 percent of his/her share of W-2 Wages plus 2.5 percent of the unadjusted basis of qualified property determined immediately after its acquisition of such qualified property. The term W-2 Wages is defined to mean the sum of total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the taxable year of the taxpayer. W-2 Wages do not include any such amount that is not properly allocable to QBI.
For example, a taxpayer (who is subject to the limit) does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The limitation in 2020 is the greater of (a) 50 percent of W-2 Wages, or $0, or (b) the sum of 25 percent of W-2 Wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition: $100,000 x .025 = $2,500. The amount of the limitation on the taxpayer’s deduction is $2,500.
Phase-in of Wages and Wages & Capital Limitation
The wages or wages plus capital limitation does not apply to taxpayers with taxable income not exceeding $315,000 (joint filers) or $157,500 (other filers). The limitation is phased-in for taxpayers with taxable income exceeding these amounts over ranges of $100,000 and $50,000, respectively. For example, H and W file a joint return on which they report taxable income of $375,000. W has a qualified trade or business that is not a specified service business, such that 20 percent of the QBI with respect to the business is $15,000. W’s share of wages paid by the business is $20,000, such that 50 percent of the W-2 Wages with respect to the business is $10,000. The business has nominal amounts of qualified property such that 50 percent is W-2 Wages is greater than 25 percent of W-2 Wages plus 2.5 percent of qualified property. The $15,000 amount is reduced by 60 percent (($375,000 – $315,000) / $100,000) of the difference between $15,000 and $10,000, or $3,000. H and W take a deduction for $12,000.
Definition of Qualified Property
The term qualified property is generally defined to mean, with respect to any qualified trade or business, tangible property of a character subject to depreciation under section 167 that is (i) held by and available for use in the qualified trade or business at the close of the taxable year, (ii) which is used at any point during the taxable year in the production of QBI, and (iii) the depreciable period for which has not ended before the close of the taxable year. Importantly, the Conference Agreement defines the term “depreciable period” to mean the later of 10 years from the original placed in service date or the last day of last full year in the applicable recovery period determined under section 168.
Definition of QBI
QBI includes the net domestic business taxable income, gain, deduction, and loss with respect to any qualified trade or business. QBI specifically excludes the following items of income, gain, deduction, or loss: (1) Investment-type income such as dividends, investment interest income, short-term & long-term capital gains, commodities gains, foreign currency gains, and similar items; (2) Any Section 707(c) guaranteed payments paid in compensation for services performed by the partner to the partnership; (3) Section 707(a) payments for services rendered with respect to the trade or business; or (4) Qualified REIT dividends, qualified cooperative dividends, or qualified PTP income.
Carryover of Losses
Section 199A provides rules regarding the treatment of losses generated in connection with a taxpayer’s qualified trades or businesses. Under these rules, if the net amount of qualified income, gain, deduction, and loss with respect to qualified trades or businesses of the taxpayer for any taxable year is less than zero, such amount shall be treated as a loss from a qualified trade or business in the succeeding taxable year. In practice, this will mean that a taxpayer’s net loss generated in Year 1 will be carried forward and reduce the subsequent year’s section 199A deduction.
For example, Taxpayer has QBI of $20,000 from qualified business A and a qualified business loss of $50,000 from qualified business B in Year 1. Taxpayer is not permitted a deduction for Year 1 and has a carryover qualified business loss of $30,000 to Year 2. In Year 2, Taxpayer has QBI of $20,000 from qualified business A and QBI of $50,000 from qualified business B. To determine the deduction for Year 2, Taxpayer reduces the 20 percent deductible amount determined for the QBI of $70,000 from qualified businesses A and B by 20 percent of the $30,000 carryover qualified business loss. Ignoring application of other potential limitations and deductible amounts, Taxpayer would be entitled to a Year 2 Section 199A deduction of $8,000 (($70,000 * 20 percent) – ($30,000 * 20 percent)).
Definition of Qualified Trade or Business
A qualified trade or business includes any trade or business other than a “specified service trade or business” or the trade or business of performing services as an employee. A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.
Specified Services Limitation
The specified service trade or business exclusion does not apply to the extent the taxpayer’s taxable income does not exceed certain thresholds: $415,000 (joint filers) and $207,500 (other filers). Application of this exclusion is phased-in for income exceeding $315,000 and $157,500, respectively. In computing the QBI with respect to a specified service trade or business, the taxpayer takes into account only the applicable percentage of qualified items of income, gain, deduction, or loss, and of allocable W-2 Wages and qualified property. The applicable percentage with respect to any taxable year is 100 percent reduced by the percentage equal to the ratio of the taxable income of the taxpayer in excess of the threshold amount, bears to $50,000 ($100,000 in the case of a joint return).
For example, Taxpayer (who files a joint return) has taxable income of $375,000, of which $200,000 is attributable to an accounting sole proprietorship after paying wages of $100,000 to employees. Taxpayer has an applicable percentage of 40 percent. In determining includible QBI, Taxpayer takes into account 40 percent (1 – (($375,000 – $315,000) / $100,000)) of $200,000, or $80,000. In determining the includible W-2 Wages, Taxpayer takes into account 40 percent of $100,000, or $40,000. Taxpayer calculates the deduction by taking the lesser of 20 percent of $80,000 ($16,000) or 50 percent of $40,000 ($20,000). Taxpayer takes a deduction for $16,000.
Taxpayers eligible to claim the full 20 percent deduction on QBI will incur a maximum effective rate of 29.6 percent on the QBI. While this rate reduction is beneficial, it will be important to consider the decrease in corporate tax rates from 35 percent to 21 percent. This rate differential is likely to cause taxpayers to reevaluate their choice of entity decisions. There are a number of factors that need to be considered but, from a simple after-tax cash flow perspective, a key determinative factor is the likelihood of the entity distributing vs. retaining operating earnings. While a common thought is to consider possibly incorporating an existing partnership in order to benefit from the 21 percent corporate tax rate, a corporate-to-partnership conversion should not be dismissed. When corporate tax rates were 35 percent, the tax liability imposed on gain recognized under Section 311(b) was typically prohibitive in a conversion transaction. However, with corporate rates dropping to 21 percent, consideration should now be given to the possible liquidation of a corporation and re-formation as a partnership, especially in situations where the corporation has net operating loss carryovers that could shelter the recognized Section 311(b) gain.
The determination of the combined QBI amount is dependent upon the QBI generated from each qualified trade or business activity. Further, the wages ad capital-based limitations are determined with reference to wages and qualified property that is allocable to a particular qualified trade or business activity. It is not clear from the statute whether and the extent grouping rules under sections 469 may be applicable. Complexities are likely to arise in situations where a partnership operates multiple activities. Maintaining adequate information and documentation will be necessary to support application of the lower rates. Consequently, partners and partnerships will need to consider the extent to which additional information will be maintained, how it will be communicated to partners, and whether any incremental administrative costs should be borne by the benefiting partners.
Properly tracking partner income and loss allocations will take on greater importance in order to accurately determine a partner’s annual net business income allocations and carryover loss amounts. This importance will be further magnified as a result of the potential imputed underpayment obligations that could arise under the new partnership audit rules going into effect for tax years beginning after December 31, 2017.
This article originally appeared in BDO USA, LLP’s “Federal Tax Alert” (January 2018). Copyright © 2018 BDO USA, LLP. All rights reserved.
The tax implications of cryptocurrency have become increasingly important as the Internal Revenue Service and other government agencies step up their scrutiny of transactions involving bitcoin or other forms of virtual currency.
Despite the fact that the IRS said everything it planned to say about the tax aspects of cryptocurrency nearly four years ago, in Notice 2014-21, there is a mismatch between the number of U.S. citizens who have bought, sold, mined, or received or spent cryptocurrency in transactions, and the number who have reported it on their tax returns.
According to Credit Karma, only .04 percent of the tax returns that they have filed for clients so far this year reported cryptocurrency transactions. Meanwhile, Coinbase, a cryptocurrency exchange, is estimated to have had 11.7 million users by the end of October 2017. And since Notice 2014-21 says that cryptocurrency is property, not currency, any transaction likely results in a reportable gain or loss.
“When you exchange currency for currency, it’s not a taxable transaction,” said Ryan Losi, a CPA and executive vice president of accounting firm Piascik. “But when you exchange property for property, it is a taxable transaction. You have to identify every piece you have, how it was acquired, was the way you acquired it a taxable transaction, and was it a taxable transaction when you disposed of it. You need to compute the gain or loss, and the character of the gain or loss. When you acquire cryptocurrency on a daily basis, this can become a nightmare.”
“And the Tax Cuts and Jobs Act made a major change to the code under Section 1031, which allows businesses and investors to exchange like-kind property tax-free,” he said. “Since 2014, many practitioners took that to mean that if you exchange virtual currency for other virtual currency, then any gain can be tax-free or deferred under Section 1031.” That possibility no longer exists as a result of tax reform, Losi noted.
On top of that, he pointed out that the largest custodian of virtual currency, Coinbase, lost a legal battle with the IRS requesting a subpoena of their records, so now they have to disclose the vast majority of their U.S. users.
“So the IRS will have data to determine if Americans are reporting gain from virtual currency,” said Losi. “Now, U.S. account holders with balances of $20,000 or higher are covered by the subpoena.”
“It’s up to the individual to keep records,” he added. “If you bought a house using bitcoin, it’s as if you sold the bitcoin and used the proceeds to buy the house. You’re liable for tax on the gain between when you acquired it and when you bought the house.”
Taxpayers who “mine” virtual currency realize gross income upon receipt of the virtual currency resulting from those activities, according to Notice 2014-21. Mining includes using computer resources to validate bitcoin transactions and maintain the public transaction ledger. Moreover, if a taxpayer’s “mining” constitutes a trade or business, and the mining activity is not undertaken by the taxpayer as an employee, the net earnings from self-employment resulting from those activities constitute self-employment income and are subject to the self-employment tax.
“Bitcoin miners use computing horsepower to solve complex algorithms,” Losi said. “If they do this successfully, the community reward for solving the problem and creating the block sequence of the next block in the chain is their currency, which had a value in 2017 of $8,000 to $19,000. Each algorithm gets exponentially harder to solve than the last.”
In this area, practitioners disagree with the IRS’s approach, according to Losi. “If I mine for precious metals, when I strike gold or diamonds or copper or zinc, the mere striking does not equal a taxable event. It goes into inventory and it’s not until I sell that it’s a taxable event. But when I receive a bitcoin credit to an online wallet, the IRS treats it as a taxable event. When you are credited with the coin it’s treated as service income.”
“This is wrong — when you make an exchange you need two parties,” he said. “When a bitcoin miner receives a coin, all it does is expand the number of bitcoins in circulation.”
Chuck Sockett, a managing director at UHY Advisors, agreed: “Someone who mines uses equipment to go into the ground and mine, and bring gold or diamonds to the surface. There’s no gain until the miner disposes of the mineral. If you mine virtual currency you can deduct the expenses of the computer, but the IRS considers anything you mine to be immediately taxable. That troubles me.”
A SURPRISING SUBPOENA
Investors in cryptocurrency assumed that they had complete privacy because of blockchain technology, according to Marvin Kirsner, a shareholder in Greenberg Traurig.
“But they didn’t consider that the IRS would issue summonses to get information from a virtual currency exchange, and many investors are having their information disclosed to the IRS by the exchange,” he said. “The subpoena to Coinbase will likely be the first of many subpoenas, so now the IRS knows the names and identities of investors. They will start getting audit notices as to why they didn’t report these transactions.”
“I advised my clients a year ago to file amended returns to reflect all their trading,” he added.
Kirsner believes that the IRS will eventually come out with a voluntary disclosure program, similar to the Offshore Voluntary Disclosure Program in place since 2014 (which the IRS just announced that it would wind down by Sept. 28, 2018 — see page 15).
Most transactions are likely to generate short-term capital gain at ordinary income rates, according to UHY’s Sockett. “People in the office who are buying and selling very quickly — that’s all short-term. And if it’s treated as inventory, it’s just ordinary income from the sale.”
It’s not just the IRS that has increased its scrutiny of cryptocurrency, Sockett noted, adding that both the Securities and Exchange Commission and the Commodities Futures Trading Commission have taken recent action on cryptocurrencies.
The SEC issued two investor alerts in 2013 and 2014 to make investors aware of the potential risks of investments involving bitcoin and other virtual currencies, and in July 2017 it stated that initial coin offerings can sometimes be considered securities. In February 2018, it issued 80 subpoenas to companies and promoters involved in issuing cryptocurrency. “It comes down to classification as a security,” said Sockett. “If the SEC wins out, ICOs will have to be registered as a security. Their concern is whether any of the offerings involve fraud or misrepresentation that might hurt investors.”
“After the SEC goes through the different ICOs, they will come out with a position that will likely change the playing field,” he said. “And the IRS may give additional guidance after the SEC takes a position.”
On April 17, the U.S. Supreme Court will hear arguments on South Dakota v. Wayfair, en route to clarifying an issue that has vexed states since the court’s 1992 decision in Quill Corp. v. North Dakota -- the attempt by states to have remote sellers collect tax on sales to customers in their states. The stakes are huge, with states waiting to collect – or not – billions of dollars of sales tax going forward.
The court’s 1992 decision in Quill established the physical presence test for sales and use tax nexus. Since the beginning of online sales by remote sellers, states have struggled to find ways to collect tax revenue from online sales by sellers located outside the state.
In 2016, South Dakota created a direct challenge to the Quill test by enacting legislation implementing an economic nexus standard requiring remote sellers without a physical presence in the state to collect sales tax if certain gross revenue or transaction thresholds were met. A number of states followed suit by enacting similar legislation in 2017. The South Dakota law was held to be unconstitutional in the state’s circuit court and the South Dakota Supreme Court, setting up the challenge that the U.S. Supreme Court will attempt to resolve.
“The court could go one of many ways,” said Jamie Yesnowitz, a principal and SALT National Tax Office leader at Top 5 Firm Grant Thornton. “It could conceivably go the procedural route and decide that the law is invalid based on precedent. I don’t see that as a likely solution, but it’s not outside the realm of possibility.”
“The court say simply that the legislation is good, or that Quill is gone. Or it could set its own standards in this area and evaluate the South Dakota legislation in terms of its own standard,” he continued. “As a final alternative, the court could say the legislation is bad because it’s up to Congress to decide the question.”
Yesnowitz doesn’t expect the court to speak with one voice on the issue. “Courts have been very divided on this issue,” he said. “It doesn’t fall neatly within political lines. As a result, there may be a lot of concurring opinions and dissents.”
An issue for legislators?
Congress has always had the power to clarify the situation but had chosen not to, according to Tom Wheelwright, a CPA and CEO of wealth strategy firm WealthAbility, and the author of "Tax-Free Wealth." “Under the Constitution’s Commerce Clause, individual states are not to have authority to regulate interstate commerce – that’s reserved for Congress. That’s what Quill and Wayfair are all about.”
“But Congress has not done anything to regulate interstate commerce in this area, other than P.L. 86-272. [Public Law 86-272, the Interstate Income Act of 1959],” he continued. “All that regulates is income tax when all a company does is to solicit orders. It does not regulate service industries at all, and it has nothing to do with sales tax.”
“The Supreme Court said that even if Congress does nothing, there’s still an implied negative commerce clause – an implied restriction on states having an impact on transactions that take place across state lines,” he added. “Quill said that to impose a collection responsibility on a company for sales or use tax the company had to have a physical presence in the state. It appears that the reason the court made a requirement of physical presence was that it felt that the burdens on the companies to collect the sales and use tax outweighed the benefit that the company would receive without a physical presence.”
For example, Wheelwright observed, a company with employees in the state benefits from police and fire department protection for its property and employees.
”There are costs that the state would incur, and corresponding benefits that the company would if it had a physical presence. The question in Quill was that there was a substantial burden on interstate commerce to require the collection of a sales or use tax when there was no physical presence,” he said.
“What changed was the internet, and software,” he said. “When Quill was decided, nobody knew what the internet was, so collecting sales and use tax required physical effort. The challenge of Wayfair will be that between the internet and the use of software that’s available to impose and collect sales and use tax, does the cost to the company still outweigh the benefit it receives from the state?”
“With sales tax compliance software, the burdens of collecting, remitting, and filing in multiple states are not as significant as they were 25 years ago,” agreed Jeff Glickman, partner-in-charge of state and local tax at Top 100 Firm Aprio. “States are also beginning to enact onerous laws to work around the physical presence requirement, such as use tax disclosure laws, which have been upheld by the 10th Circuit Court of Appeals. Given these factors, it seems that Quill and its physical presence standard are ripe for reversal.”
“The challenge for the court will be drafting guidance for any new standard,” he said. “The level of clarity provided by the court could help limit the number of varying state interpretations, as we have with physical presence now.”
“It is important that if the court decides to overturn Quill that it clearly states its decision is prospective only. The South Dakota law at issue has a ‘prospective only’ clause, but that is not the case for all other states that have enacted similar laws. For remote sellers to be on the hook for back sales taxes based on their reliance on Quill would arguably create an undue burden that should be avoided,” he said.
By Lynnley Browning
The Internal Revenue Service is providing some relief for companies facing looming tax bills after they stockpiled trillions of dollars offshore free of U.S. income tax.
A timing quirk in the tax overhaul seemed to give companies such as Apple Inc., Microsoft Corp. and Cisco Systems Inc. — all of which began their fiscal years before Jan. 1 — the chance to reduce the foreign cash they’ll accumulate this year and lower their taxes. A notice issued by the IRS on Monday indicates that “if done in the ordinary course of business,” the move won’t be considered as tax avoidance, according to Stephen Shay, a tax and business law professor at Harvard Law School.
“The light is green for this planning, not red,” said Shay, a former top Treasury official. “It is great for those whose years beginning before 2018 are still open for the planning.”
While companies taking steps to shift their assets would still owe repatriation taxes, they wouldn’t have as much cash taxed at the higher rate — “a major concession” by the IRS, said independent tax and accounting expert Robert Willens.
The tax law signed by President Donald Trump in December overhauled the international tax system and requires companies to pay a mandatory two-tiered levy on their accumulated foreign income. Cash is taxed at 15.5 percent, while less liquid assets face a rate of 8 percent. Companies have been trying to figure out ways to reduce assets subject to the higher rate.
Another provision in the IRS release also allows multinationals some leeway when calculating their repatriation tax bills. The law appeared to make more foreign entities owned by multinationals subject to the repatriation tax, but the agency said Monday that taxpayers that own less than 5 percent of a foreign entity’s capital or profits won’t be hit by the repatriation tax.
Banks and financial institutions will also see a reprieve following the IRS’s guidance that a company’s accounts receivable and accounts payable that are longer than one year will be exempt from the repatriation tax, said John Warner, a tax partner at Buchanan Ingersoll & Rooney PC. The financial firms had feared the payments under the loans they issue would have faced the 15.5 percent rate, since they’re generally considered accounts receivable, regardless of their maturities.
“This is generally pro-taxpayer,” Warner said.
Still, the agency said it would crack down on some strategies multinationals may use to reduce their offshore tax bills, such as artificially reducing their earnings and profits, cash piles or “pro-rata” share of transactions, for foreign entities they have stakes in, own or control.
Those rules will be a big deal to some companies, said Michael Mundaca, the co-director of Ernst & Young’s Washington National tax practice and a former top Treasury Department tax official.
The IRS also alerted companies not to change their accounting techniques to lower their repatriation bills.
By Bryan Camp
Editor: Paul L. Caron, Dean
Pepperdine University School of Law
Last week the Tax Court issued 19 opinions, including one articulate opinion on Collection Due Process that teaches an interesting, albeit esoteric, lesson about the bulk-processing nature of tax administration. I will save that case, Scott T.Blackburn, v. Commissioner, 150 T.C. No. 9, for another week, or perhaps our colleagues over at Procedurally Taxing will blog it.
In today’s post I want to look at two of last week’s opinions that I think teach a more basic lesson about the important way in which each tax year is separate from all others. The two cases are: (1) Shane Havener and Amy E. Costa v. Commissioner, T.C. Sum. Op. 2018-17 (Apr. 4, 2018); and (2) Gary K. Sherman and Gwendolyn L. Sherman v. Commissioner, T.C. Sum. Op. 2018-15 (Apr. 2, 2018).
Notice that both of these are what are called “Summary” Opinions. That means the taxpayer in each one elected the small case procedures allowed by IRC §7463 and implemented by Tax Court Rules 170 et. seq. As most readers no doubt know, the upside of that election is relaxed procedural rules (notably rules of evidence) and the downside is that the loser may not appeal to a higher court. The idea is that these are cases where the dispute between the taxpayer and the IRS is really one about factual matters and not about the law. That is why when you access these cases through the Tax Court website, the website pops up the following message in all-caps: “Pursuant To Internal Revenue Code Section 7463(b), This Opinion May Not Be Treated As Precedent For Any Other Case.”
The very reason why these cases make for lousy precedent, however, is why they often make for good lessons about basic tax concepts. The lesson I see in these two cases is about the appropriate accounting period, a particularly timely lesson this week since April 16th (the deadline for filing returns this year since April 15th falls on a Sunday) is right around the proverbial corner.
To economists, the most accurate accounting period is one’s lifetime. That is, the best measure of income is what happens over our lifetime. But because governments need revenue sooner, because not all taxpayers die (think corporations), and because even if tax revenue would even out in the long, long, long run, the transition costs to a lifetime accounting period would be untenable, Congress created a yearly accounting period for income tax (and shorter accounting periods for excise taxes such as the employment tax).
That yearly period ends on December 31st for most of us mere mortals. The yearly questions we ask are “how much income did I have during the last year?” and “what expenditures did I make that I can deduct from the income I made?” The point of today's lesson is that we must ask those questions every year and just because we get a wrong answer in one year does not entitle us to continue using that wrong answer in later years.
More below the fold.
In the Havener case, Mr. Havener and Ms. Costa lived in Pembroke, Massachusetts. She was a sales manager and he was a retiree. I am betting he watched flipping shows on A&E or other channels. I say that because the Court found that he “grew restless in his retirement and sought a project that could occupy his time.” So the taxpayers decided to buy and flip a house. But they did not pick a house in Pembroke, or anywhere near it. Nope, they spent $30,000 to buy a house in Salem, N.Y., some 250 miles away. Why Salem? I have no idea. One might speculate it was for martial harmony reasons, but again I’m betting Mr. Havener consulted websites devoted to flipping, like this one on Wallethub and decided that Salem was an area where they could make flipping work.
The taxpayers bought the house in 2010 or 2011 and Mr. Havener started working on it, traveling to the house during the week and then coming back home on weekends. Sometimes Mr. Havener drove to Pembroke and sometimes he fired up his Piper Warrior and flew. On all trips he kept really good records. Folks, record-keeping is not the problem here.
On their 2012 return, Mr. Havener and Ms. Costa deducted all of his expenses, including travel expenses, from their joint income (the income on which, remember, consisted mostly of Ms. Costa’s salary income). They submitted their 2012 return and it was processed without question by the IRS. In other words, they were allowed the deductions.
On their 2013 return, Mr. Havener and Ms. Costa took the same reporting position, deducting again his travel expenses. This time, however, the IRS selected their return for audit and disallowed the deduction for travel expenses. Instead, the IRS said, the taxpayer needed to capitalize those expenses, which would increase the basis in the home and produce a smaller taxable gain on the flip.
Judge Panuthos heard the case and sustained the Notice of Deficiency, finding that the whole idea of “flipping” a house was “to make the property habitable and to increase its value for eventual resale.... Thus, all expenses paid or incurred as part of this plan of capital rehabilitation or improvement are eligible for treatment only as capital expenditures.”
Mr. Havener and Ms. Costa protested that this result for 2013 was not consistent with their 2012 returns where they had been able to take the deductions. Judge Panuthos explained how each tax year is a separate accounting period, so that the IRS “is not bound for any given year to allow a deduction permitted for a prior year.”
This result is common sense as applied to this case. After all, the 2012 return had not been examined and so just because Mr. Havener and Ms. Costa “got away” with erroneous treatment of those expenses in the earlier year did not create an entitlement to the same treatment in later years. Each year stands alone.
The Sherman case presents a variation on this lesson because there the IRS had audited the taxpayers and allowed in an earlier year deductions which it then denied in a later year.
Here’s what happened. Mrs. Sherman sold Mary Kay products for some 30 years, receiving commissions and property reporting them as self-employment income on which she paid self-employment tax. Starting in the mid-1990’s she joined the Mary Kay “Family Security Program” which was, in essence a deferred compensation program to help the Mary Kay sales force plan for retirement. In 2005 Mrs. Sherman began receiving retirement benefits under the Family Security Program. For the two tax years at issue, 2013 and 2014, those payments hovered around $173,000 per year.
The tax issue was how to treat these retirement benefits. Were the payments really deferred compensation, subject to self-employment tax, or were they compensation for something else, such as a non-compete agreement that Mrs. Sherman had to sign in order to receive the benefits, or the goodwill she had created for Mary Kay products during her long and successful sales career. In 1995, the Sherman’s had received some advice in a letter from Mary Kay’s general counsel that described the Program payments as subject to self-employment tax. The Program Agreement’s own terms says that the Program “is intended to be a non-qualified deferred compensation arrangement and...is intended to meet the requirements under section 409A of the Code.”
When the Sherman’s began receiving the payments in 2005, they did not try to solve this tax puzzle on their own. They hired a CPA by the name of Muscio and he decided to report the payments as “termination payments” that were not subject to self-employment income.
Like Mr. Havener, the Sherman’s position was not challenged by the IRS for many years for the simple reason that the IRS did not select their returns for audit. Unlike Mr. Havener, however, when the IRS eventually audited their 2011 return, the Shermans (represented by the CPA Mr. Muscio) convinced the examining agent of the correctness of their position and the IRS issued a no-change letter. Sweet!
But each year stands alone. So when the IRS came back a few years later to look at the 2013 and 2014 returns, the Shermans may have thought they were in the clear because of the good result for their 2011 year. They thought wrong. The IRS issued a Notice of Deficiency and the Shermans then hired lawyers to take it to Tax Court. Unlike in the Havener case, which was argued pro se by the taxpayer, the lawyers representing the Shermans knew this lesson and did not try to argue that the prior audit result for the 2011 return bound the IRS for the 2013 and 2014 returns. On the merits, Judge Buch ruled that because the payments were deferred compensation the taxpayers owed employments tax.
In tax, you take it one year at a time.
Coda: The silver lining for the Shermans is that the IRS Chief Counsel attorney dropped the accuracy related penalties during litigation. That is likely because this whole issue was up in the air, at least until a Tax Court decision in Peterson v. Commissioner, T.C. Memo 2013-271 was upheld by the 11th Cir. Court of Appeals in 2016 (827 F.3d 968). All three judges on the Court of Appeals agreed that the payments from the Program were deferred compensation that was subject to self-employment tax, but they differed in their reasoning. So until then I think a reasonable return preparer might take the position taken by the Shermans. And the Shermans, of course, were entitled to rely on their return preparer. However, I don’t know if that would work today; after reading that 11th Circuit opinion I would not think a return preparer could meet even the reasonable basis standard, which applies to disclosed positions, and so would be subject to penalties under §6694.
It’s not wise to solely trust calculators to tell you if you’re adequately prepared for an emergency or retirement. In addition, some people trying these calculators may be so discouraged by the numbers they see that the tools end up not helping at all.
If you looked in a financial planning textbook, an individual should be saving 10% to 20% of his or her gross income. However, that number, in and of itself, doesn’t tell the entire story. To estimate how much money you should be saving you can’t rely on general advice. And maybe that isn’t the right question to be asking anyway. Maybe instead of asking how much should you be saving, you should ask yourself how much can you save? Are you saving as much as possible?
In a time when many Americans live without an adequate safety net, prioritizing savings is increasingly difficult for many people. Here are a few things to consider as you start thinking about your savings goals and how to ramp them up.
One of the biggest obstacles to savings is living outside of one’s means. Acquiring debt, installment payments and frequent “Keeping up with the Joneses” spending binges consume funds that could otherwise be saved and earn interest. That probably doesn’t come as a surprise to you, but what if you are living within your means? Your money decisions money can still have an impact on your ability to save. We all can do better.
Not being purposeful in aligning your current spending with your priorities will undoubtedly leave you falling short of achieving your goals. I have seen many people who say being prepared financially for retirement is extremely important to them. However, when you look at their finances you quickly see that they’re spending a major portion of their income maintaining their current lifestyle.
For example, I knew one man who was saving 6% of his gross income in a retirement account, while also receiving a 3% match from his employer. The problem was that he was also spending, on average, 20% more a month than what he made, running up credit card and home equity debt while depleting his savings. While he was saving for his future, at the same time he was destroying his current wealth and on the path to financial distress.
Another problem many families face is the drive for instant gratification. Instant gratification is a curse to savings, in part because of the ease and convenience of both online shopping and digital banking. Advancing technologies facilitate spending money, and consumer demand drives technology’s march forward.
More than simple wasteful spending, instant gratification may sometimes include necessary and functional purchases — just at the wrong time. For example, many people like driving a new car with the latest technology, but do you really need it? You may need a car because of where you live or your job, however do you need to purchase the latest model factory delivered with all of your specifications?
Ways to defer gratification include:
Basically, don’t blow your money. Simple enough, right? But even the rich and famous can have trouble with that concept. Take Johnny Depp. His business managers, whom he is suing, say his “lavish spending” — $30,000 per month on wine, $200,000 per month on private jets and reportedly $75 million to buy homes, a horse farm in Kentucky and several islands in the Bahamas — has put him in dire straits.
Saving enough for wants, emergencies and other unpredictable expenditures means having enough money left over from paychecks to save. For many this will be a difficult change to make. It will mean that you are willing to exercise financial discipline and delay purchases until you can afford them while also meeting your savings goals.
No calculator or estimator can come up with the exact amount for any one person to save. Knowing what to prepare for is personal to each individual situation. Every person who wonders how much to save must first examine a larger picture that includes long-term financial goals, lifestyle choices, spending habits, wants, desires and necessities. It is a personal decision that deserves thoughtful contemplation and strategic financial planning.
If you are currently wondering how much you should be saving to reach your version of financial success, you can always reach out to a Certified Financial Planner. The time you take now to prepare for your financial future can make all the difference in your long-term quality of life.
Paul Sydlansky, founder of Lake Road Advisors LLC, has worked in the financial services industry for over 18 years. Prior to founding Lake Road Advisors, Paul worked as relationship manager for a Registered Investment Advisor. Previously, Paul worked at Morgan Stanley in New York City for 13 years. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN).This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
by Craig Lloyd
If you spend a lot of time surfing your phone on your patio or streaming music while you do lawn work, you need a decent Wi-Fi signal. Here are some things you can do to get the best outdoor signal from yours.
The Wi-Fi inside your house may be lightning fast, but the moment you step outside your front door, you likely lose a good chunk of that speed. Homes can act as giant Faraday cages of sorts, thanks to thick exterior walls that are usually made out of beefier materials than your interior walls. Thankfully, you’re not completely out of luck. Here are some ways you can fight back.
Perhaps the cheapest and easiest solution you should try first is to move your routercloser to where you’ll be hanging out the most outside, like on your patio, front porch, or wherever.
Check to see if this is possible in the first place, as your modem (or modem/router combo) still needs to plug into the internet coming into the house, and the router at least needs an Ethernet connection from that modem. Depending on how your home is wired up, the locations you can move your router may be limited.
If you can move your router closer and you notice a big difference in the Wi-Fi signal on the patio, then that’s great, but also make sure you aren’t sacrificing Wi-Fi signal strength elsewhere in the house.
If you move your router and notice that Wi-Fi is suffering elsewhere in the house, then it’s time for a Wi-Fi extender. These devices extend the Wi-Fi signal that your main router puts out, hence the name. You may also be able to leave your router where it is, and put an extender closer to where you need it outdoors.
There are a couple ways you can do this. The first way is to get a traditional Wi-Fi extender. It’s looks a lot like a mini router with antennas, but it’s strictly meant to broaden your Wi-Fi network so that you can get a strong signal without having to move closer to the main router. They can connect to your main router wirelessly or via Ethernet.
You can also use a second router and configure it to act as a Wi-Fi extender. This is a great option if you already have a spare router lying around, but it takes a bit more configuration on your part.
Lastly, the easiest and simplest option (albeit the most expensive), is to invest in a mesh Wi-Fi system like the Eero or Google WiFi. Netgear even makes an outdoor unit for its Orbi mesh system. These are essentially sets of wireless access points that you place around your house. They automatically communicate with one another, and create one big Wi-Fi network. The best part is that they’re super easy to set up, making them great for novice users.
The above options will likely do the trick if you’re just hanging out on your patio or front porch. However, if you’ll be any farther from your house (say like by the pool or in a detached shed or shop, you could try some powerline adapters.
If you’re going to be somewhere outside your house that isn’t really close to the property, you may still be able to get away with using a Wi-Fi extender in a shed or shop. If not, you could try using powerline adapters, like this pair from TP-Link. These transfer data over the electrical wires in your house, turning them into Ethernet cables of sorts.
Both units get plugged into outlets. One unit goes near your router and also connects to it via Ethernet. The other unit gets plugged into a Wi-Fi extender (via Ethernet as well) that you have set up in your shed (or whatever location you need). Of course, this assumes that the power in your shed or other remote location is connected to your house (which it likely is), but you’ll want to make sure of that first before going this route.
If you’re looking to get internet access to a shed or some other location that doesn’t have power running to it, one final option to consider is just running a buried Ethernet cable from your house to that location. This is obviously quite a bit more work than the options mentioned above, since you’ll need to dig up a trench and spend some money on materials and labor. But if you really want internet access outside of your house and nothing else works, this is the way to go.
Just keep in mind that Ethernet cable (at least, Cat 5e and Cat 6 cabling, the two most common you’d work with) has a maximum length of 328 feet, which should be plenty long anyway (that’s more than the length of a football field), but it’s important to know just in case you live on a large lot and your detached shed or shop is farther away from your house.
By Bryan Camp
Editor: Paul L. Caron, Dean
Pepperdine University School of Law
The Tax Court issued no opinions last week, likely because it was holding its Judicial Conference at Northwestern School of Law in Chicago. Our colleagues over at Procedurally Taxing attended and blogged about it here. Les Book reports (here) that the last session of the Conference was looking forward to the future of the Tax Court.
Future, Schmoocher. My love of history keeps my head buried firmly in the sands of the past. For not only is the past prologue, it’s also epilogue. That’s the lesson I take away from this Tax Court classic: Harold Jenkins v. Commissioner, T.C. Memo. 1983-667, a case I teach as an epilogue to the Supreme Court's classic Welch v. Helvering, 290 U.S. 111 (1933).The Jenkins case deserves your attention not only because of its lesson about the difference between business and personal deductions but also because of the poetry (?) it inspired both from Tax Court Judge Leo H. Irwin and from the IRS Office of Chief Counsel
Harold Jenkins, of course, was the birth name of the man better known as Conway Twitty. He was best known as a country music singer, less known as a baseball player and fan, and almost unknown as a chef. Still, he thought it would be a great idea to start a restaurant business that featured his favorite hamburger, involving canned pineapple rings deep-fried in graham cracker crumbs. Here’s the recipe (hat tip to Tuphat who commented on an earlier post about country mustic). Here’s a fun video. So Twitty created a new business entity, Twitty Burger, Inc. and solicited capital contributions, using his connections in the country music scene.
All told, Twitty got about 75 folks to contribute capital in 1968 and 1969 including such big country music names as Harlan Howard, Sonny James and Merle Haggard. Because of some hiccups with the SEC, the contributors ended up getting debentures in exchange for their contributions. Twitty Burger began operations in 1969. By late 1970, however, after continual problems with revenue production and with the SEC, Twitty pulled the plug on the business. At that point Twitty Burger, Inc. had no assets. The debentures were worthless.
So what about those investors? When it all went to pieces, Twitty did not want to leave their blue eyes cryin’ in the rain. He did not just want to say “sorry.” His friends would just respond “don’t tell me your sorry.” And, unlike some singers today, he wasn’t going to say “it ain’t my fault.” Nosirree, he was going to take it like a man (what we might now say “man up”) and repay the investors (some of them with interest, even) out of his personal funds.
It took him a couple of years, but in 1973 and 1974 he repaid most of the investors. And he deducted those payments from his country music income: $93k in 1973 and $3.6k in 1974.
On audit, the IRS disallowed the deductions. Twitty went to Tax Court. Twitty was represented on the record by Theodore “Ted” Jones, William G. Whatley and Alva C. Smith, all out of Baton Rouge. Mr. Whatley, a criminal defense attorney by trade, took the lead and tried the case. Representing the IRS was Charles W. Kite. I was able to contact Mr. Kite---who is semi-retired outside of Knoxville---and had a nice chat with him about the case. He recalled Mr. Whatley striding around the courtroom with a cup of ice that he would chew and suck and that Judge Irwin had to repeatedly ask him to speak up. He also recalls that in his various interactions with the taxpayer, Twitty was a gentleman through and through.
The Parties Sing Their Tunes:
The IRS argued that while §162 allows deductions for all “ordinary and necessary” expenses related to a taxpayer’s business, §262 disallows any deduction for personal expenses. Even if these were related to the taxpayer's business, §263 would require capitalization. In other words, to deduct an expense, it has to be one that relates to an ongoing business of the taxpayer. Since Twitty Burgers, Inc. was no longer operational and since there was no legal obligation for Twitty to personally repay the investors, any connection to a business was only make believe. The IRS pointed to the Welch v. Helvering case. There, Mr. Welch worked for a company that went bankrupt. He then started working for another company in the same line of business. Even though he had no obligation, he used personal funds to repay the creditors and customers of the bankrupt company on the theory that doing so enabled would “solidify his credit and standing” with the former creditors and customers who were important to the success of his new company. The Supreme Court affirmed the IRS, Tax Court, and Eight Circuit decisions that he could not immediately deduct payments under §162. He instead had to capitalize them as goodwill. Twitty should receive the same treatment said the IRS.
Twitty argued that the payments did in fact relate to the carrying on of a trade or business, just not the hamburger business. They related to his country music business. Yep, country music, “that’s my job.” Twitty supported his argument with his personal testimony. He said “I’m 99 percent entertainer. That’s just about all I know.” He acknowledged that he had received letters from attorneys for some of the investors and that he feared lawsuits would damage his music business: “If my fans didn’t give up on me, it would warp me psychologically. I couldn’t function anymore because I’m the type of person I am.”
Twitty’s lawyers also introduced expert testimony from one William Ivey, Ph.D., who at that time was the head of the Country Music Foundation and who later became head of the National Endowment for the Arts. Dr. Ivey's testimony was that “Country entertainers to go great lengths to protect their images, for they correctly realize that both business associates and fans judge their artistic efforts in the light of perceptions of the artist’s personality, professional conduct and moral character.”
Tax Court Rules: In Harmony with Welch?
In Welch v. Commissioner, Justice Cardozo wrote this famous passage:
“We try to classify [an] act as ordinary or the opposite, and the norms of conduct fail us. *** Men do at times pay the debts of others without legal obligation or the lighter obligation imposed by the usages of trade or by neighborly amenities, but they do not do so ordinarily, not even though the result might be to heighten their reputation for generosity and opulence. Indeed, if language is to be read in its natural and common meaning, we should have to say that payment in such circumstances, instead of being ordinary, is in a high degree extraordinary. There is nothing ordinary in the stimulus evoking it, and none in the response. Here, indeed, as so often in other branches of the law, the decisive distinctions are those of degree, and not of kind.
One struggles in vain for any verbal formula that will supply a ready touchstone. The standard set up by the statute is not a rule of law; it is rather a way of life. Life in all its fullness must supply the answer to the riddle.” (290 U.S. at 114-115)(internal citations omitted).
In other words, it is all a question of fact. In Welch, the Supreme Court disclaimed any special powers to create a rule of law narrower than “life in all its fullness.” This is very similar to its decision in Commissioner v. Duberstein, 363 U.S. 278 (1960), where the Court decided that the question of when a taxpayer receives a “gift” is also such a fact-intensive issue that the appellate courts should stay out of it. Footnote 9 in Duberstein, in fact, cites to Welch for that proposition.
We have seen this lesson before (here). While the IRS’s determination gets a presumption of correctness, the taxpayer is allowed to produce evidence to persuade the trial judge that the facts do not support the determination. The judicial task of figuring out the facts falls on the trial judge.
Here, Twitty got lucky. Judge Irwin liked Twitty’s tune better than that IRS’s and so found that the payments were ordinary and necessary to Twitty’s country music business. So Twitty did not have to capitalize the repayments but was instead allowed to take the deductions.
Judge Irwin emphasized the harmony with Welch---and the fact-driven nature of his decision---by ending his opinion with this “Ode to Conway Twitty.” Now, I was not able to find out whether the poem was written by Judge Irwin himself or by a attorney advisor or by a collaborative effort. But what does it matter? It's a classic.
Twitty Burger went belly up
But Conway remained true.
He repaid his investors, one and all.
It was the moral thing to do.
His fans would not have liked it,
It could have hurt his fame,
Had any investors sued him
Like Merle Haggard or Sonny James.
When it was time to file taxes
Conway thought what he would do
Was deduct those payments as a business expense
Under section one-sixty-two.
In order to allow these deductions
Goes the argument of the Commissioner.
The payments must be ordinary and necessary
To a business of the petitioner.
Had Conway not repaid the investors
His career would have been under cloud,
Under the unique facts of this case Held:
The deductions are allowed.
Coda: Since Judge Irwin’s decision was based on a factual determination (notice the "unique facts" language?) it would be reversed by a Court of Appeals only if Judge Irwin had abused his fact-finding discretion. That’s a difficult result to get when you are the losing party on an issue of fact.
Whenever the IRS loses a trial, someone has to decide whether to appeal. That someone is the Associate Solicitor General (Tax) in the Solicitor General’s Office at the Department of Justice. That person does not make a decision in a vacuum, however. They receive up to three memos recommending whether to appeal or not: one from the IRS Office of Chief Counsel; one from the Department of Justice Tax Division Appellate Section; and, when applicable, one from the Department of Justice Tax Division Trial Section. When I worked in Chief Counsel’s office, drafting appeal memos was one of the really fun aspects of my job.
In addition to drafting appeal memos, the Office of Chief Counsel will sometimes publish a document called “Action on Decision” (AOD) to alert practitioners to how a decision will affect tax administration. Especially when the IRS loses a position, it helps practitioners to know whether the IRS will abandon the position in future cases or not. Chief Counsel does not do this as often now as it used to. I am not sure why.
In response to the loss in Jenkins v. Commissioner, however, the Chief Counsel did indeed issue an AOD, AOD 1984-022 (March 22, 1984). This memorable AOD ends with this “Ode to Conway Twitty: A Reprise.” I also love reading this one to my classes, because I think it just perfectly expresses the lesson of this case and of the tension between §162 and §262:
Harold Jenkins and Conway Twitty
They are both the same.
But one was born
The other achieved fame.
The man is talented
And has many a friend
They opened a restaurant
His name he did lend.
They are two different things
Making burgers and song
The business went sour
It didn't take long.
He repaid his friends
Why did he act
Was it business or friendship
Which is fact?
Business the court held
It's deductible they feel
We disagree with the answer
But, let's not appeal.
The AOD was drafted by docket attorney David C. Fegan and signed off by Clifford M. Harbourt, the Senior Technician Reviewer for Branch 2 of the Tax Litigation Division. I had the pleasure of talking with Mr. Harbourt, who was a Chief Counsel attorney for 37 years, retiring in 2010. He recalls that Mr. Fegan was something of a character and was the one who drafted the poem. Mr. Harbourt was all for it, but the AOD had to be signed off by the Chief Counsel after working its way through a chain of reviewers. As one might imagine, the idea of putting poetry in an AOD met with some resistance and someone up the chain ordered it stricken. At that time the Acting Chief Counsel was Joel Gerber (later Tax Court Judge Gerber). Mr. Harbourt recalls that it was Mr. Gerber who, hearing about the poem, allowed it to be kept in the AOD. Good call!
BY KEN BERRY, J.D. - CPA PRACTICE ADVISOR TAX CORRESPONDENT
In the not-so-distant past, business people who traveled and earned income outside of their home state had little to fear about taxes from those other jurisdictions. However, aggressive state and local taxing authorities recently began pursuing high-profile taxpayers like professional athletes and entertainers who work at multiple locations. Now this so-called “jock tax” is being applied on a wider scale to traditional business travelers.
Lawmakers have attempted to address the issue several times. However, the Mobile Workforce State Income Tax Simplification Act, which was reintroduced into legislation last year, has failed to gain enough traction in Congress.
Under this law, an employee would have to pay another state’s income taxes only if he or she works there more than 30 days in a calendar year. Non-resident employees who visit a state for longer than 30 days would still be able to take a credit for taxes paid to another state on their resident state tax return. The measure passed the House, but it’s still languishing in the Senate.
For now, the status quo remains. Thus, employers and employers must continue to contend with a crazy quilt of laws around the country. To make matters even worse, many aren’t aware of their responsibilities or become bogged down in the complexities.
Generally, employers are required to withhold state taxes on traveling employees and report the income to the appropriate jurisdiction. All but seven states have income tax laws on the books -- Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – while New Hampshire and Tennessee tax only investment income. In every other state in the union, business travelers are fair game.
And it’s not so simple complying with the dizzying array of laws. For instance, Massachusetts imposes different income filing thresholds for residents and non-residents. Other states – including Louisiana and Maine - require certain out-of-staters to file state income tax returns if they make money in-state.
In addition, although some states have worked out reciprocity agreements, employees may still get the short end of the tax stick. For example, a New Jersey resident who crosses the river to work in Manhattan is entitled to a tax credit for taxes paid to New York, but might not receive the full tax benefit of the entire amount.
Employers also face complications. For example, while some have only a few employees crossing bordering state lines, others send an entire workforce traipsing around the country. The more employees that are involved, the greater the possibility for foul-ups. What’s more, employers may have to register in states where their employees are doing business, even if they don’t maintain a physical presence there.
Technology is a double-edged sword for employers and employees in this precarious tax situation. On the one hand, new programs and systems make it easier for employers to track the comings and goings of employees, providing faster and easier reporting of tax obligations. On the other hand, if employers are better able to pinpoint the whereabouts of their employees, so are the states.
Until Congress manages to resolves matters, if ever, advise your clients to make good-faith efforts to comply with the laws. Just don’t expect this issue to go away anytime soon.
By Joe Light
President Donald Trump’s new tax law set off a false alarm for homeowners planning to borrow against the equity in their houses.
The legislation signed by Trump in December appeared to eliminate the deduction taxpayers get for the interest owed on home-equity loans, spooking the home remodeling industry whose customers often rely on the loans for projects. But after prodding from lobbying groups, the Internal Revenue Service clarified that borrowers could still use the deduction, as long as it’s for home improvements.
The IRS guidance on home-equity debt is just the latest example of the agency’s cleanup effort in the wake of the hastily passed law. Various industries and tax professionals are still struggling to understand its provisions and interpret lawmakers’ intentions on changes including the pass-through deduction and international tax measures.
Since the end of last year, the agency has issued press releases specifying that hedge fund managers can’t circumvent new carried interest rules with “S” corporations and that homeowners can deduct prepaid property taxes only in some instances.
Until the IRS statement late last month about the home-equity deduction, some housing groups including executives at the National Association of Home Builders said they didn’t think it was clear the home-equity deduction had survived, at least in part.
The NAHB sent Treasury Secretary Steven Mnuchin a letter at the end of January arguing that the tax law, as written, should allow interest from home-equity loans and home-equity lines of credit to be deducted as long as the homeowner used the money for home improvements. They said their interpretation was backed up by long-accepted standards in the tax code.
“As most major remodeling projects are financed using debt secured by the buyer’s home, the deductibility of interest paid on loans used to substantially improve a home is the lifeblood of the industry,” the letter said.
Eric Smith, an IRS spokesman, said the news release came in response to multiple inquiries rather than from a specific group. He said the statement clarified what the law already said rather than made new rules.
Robert Criner, a remodeler in Newport News, Virginia, said that after the law passed, he thought the deduction for home-equity loans and for so-called HELOCs was dead. The ability to deduct HELOC interest is a deciding factor for some homeowners on how big a project to undertake or whether to do a remodel at all, according to Criner.
Throughout the tax-bill process “people were waiting to pull the trigger,” said Criner, which he attributed to the HELOC issue and to broader confusion about the bill. Criner said even after the IRS clarification, only about half of his customers realize that they can still deduct the interest.
The confusion stemmed from the law saying it was eliminating interest for “home-equity indebtedness.” Some borrowers, remodelers and others in the lending industry interpreted that as any kind of home-equity loan that taps equity to provide cash. But the tax code has long defined home-equity indebtedness as any kind of debt except loans taken out to acquire, construct or substantially improve a taxpayer’s residence.
So if a borrower uses the loan to build a new bathroom, it would qualify for the deduction, but if it’s used to consolidate credit card debt, it wouldn’t qualify, according to the IRS’s clarification.
In January, LendEDU, a comparison website for consumer financial products, surveyed 1,000 Americans who were home-equity loan borrowers, about half of whom said they used the money for home improvement. The company wanted to measure how aware they were that the new law limited home-equity deductibility.
The problem: None of the survey’s answers were correct. LendEDU falsely believed the new law completely killed the home-equity interest deduction, and the survey results were reported in several mainstream and industry publications.
LendEDU CEO Nate Matherson said the company would put a clarification at the top of the survey. Noting that the IRS hadn’t yet issued its guidance at the time of the survey, Matherson said, “At the time the survey was conducted, the methodology was accurate.”
The NAHB, a lobbying group that represents small home builders, believed it had a good case but still wasn’t completely sure that the IRS would agree with its interpretation, said David Logan, the association’s director of tax and trade policy analysis.
The home-equity interest deduction wasn’t a focus for the group last year when it was lobbying lawmakers on its bigger concerns with the bill — such as the doubling of the standard deduction. Still, once the law came out, there was concern that eliminating home-equity interest deductions would have a “massive detrimental effect on remodelers,” Logan said.
When the IRS agreed with the NAHB’s interpretation, Logan said the group’s remodelers were “exuberant.”
By Bryan Camp
Editor: Paul L. Caron, Dean
Pepperdine University School of Law
Most of us who are either preparing our returns last week (or today), or reviewing the returns prepared for us, honestly want to get it right. We try to be good. But just as life is complex, so is the tax shadow created by life activities and decisions. Last week’s decision in Stacey S. Marks v. Commissioner, T.C. Memo. 2018-49, is not so much a lesson about being good as it is a lesson that sometimes—just sometimes—you can get lucky.
The IRS audited Ms. Marks’ 2013 return and determined she had underreported income of $98,162 because she had received an early IRA distribution of $98,000 and she had received $162 in unreported dividends. There was no dispute about the $162, but Ms. Marks’ attorney argued her IRA distribution had been properly rolled over into a new IRA.
Here’s a summary of the facts: Ms. Marks had an IRA with Argent Trust Co. In 2013 she created a new IRA with Equity Trust Co. It appears both of these were self-directed IRAs. Ms. Marks then attempted to roll over her Argent account holdings into the new account. To accomplish the rollover she directed Argent to distribute the IRA assets to her. In December 2013, Argent did so, sending Ms. Marks: (1) cash of $96,508; (2) a promissory note in the face amount of $40,000 from Ms. Marks’ dad reflecting a loan made in 2005 by Argent using IRA funds; and (3) a promissory note in the face amount of $60,000 from one of Ms. Marks’ friends, reflecting a second loan made in 2012 by Argent, again using IRA funds.
Many readers are probably familiar with the rollover rules in §408 much better than I am. For those who are not, here’s a nice IRS website explanation. The best rollover method is for the old IRA custodian to send the assets to the new IRA custodian without the taxpayer ever having to touch the money. The other method is to have the old IRA custodian distribute the IRA to the taxpayer. The taxpayer then must put those funds into the new IRA within 60 days of the distribution. Subject to the many complexities that cause only the stout-hearted to do ERISA work, the distribution must be reported as income under the applicable rules for that IRA. §408(d)(3)(A).
The method chosen by Ms. Marks is not really a good method because of the old saying “there is many a slip twixt cup and lip.” I am guessing that the promissory notes were what prevented her from the plan-to-plan rollover. I welcome any comments on that idea.
The bottom line was that while Ms. Marks successfully rolled over the cash, she was not able to transfer the promissory notes into the new IRA account within that time period. Her inability to roll over the notes meant that she should have reported their distribution as income. The IRS did not explain why it valued the notes at $98,000 instead of their face value of $100,000 and the opinion is also opaque about what happened to the notes. The opinion says her attorneys argued that the notes were successfully rolled over, but nothing more. So whether the notes were somehow transferred in or whether they were paid off and the proceeds later transferred to the new IRA is an unknown.
But here is where Ms. Marks got lucky. Judge Morrison spotted an issue that both parties had overlooked: was the 2005 loan from the old IRA to her dad a prohibited transaction per §4975(c)? The Judge asked the parties to brief the matter and both the taxpayer (natch!) and the government agreed: the loan was a prohibited transaction. The consequence was to disqualify the fund as an IRA in 2005. §408(e)(2)(A). The consequence of that was the government’s concession that Ms. Marks’ 2013 income “should not include a taxable distribution from the Argent account because that account was not an IRA in 2013.” On that basis, Judge Morrison did not sustain the deficiency.
How lucky is this? It’s luckier than you may think. First, and most obviously, it means that Ms. Marks did not have to report the $98,000 (the assumed value of the two promissory notes) as income in 2013, thus avoiding about $42,000 in taxes and penalties. Second, since the distribution was from a non-IRA account, and since the IRS was valuing the notes at less than their face value, the distribution contained no reportable earnings or gains. Sweet. Third, Ms. Marks escaped the earlier tax she should have paid because of the 2005 prohibited transaction. That is, although Ms. Marks received a constructive distribution of IRA assets in 2005---and should have reported that amount as income in 2005 as well as pay the applicable excise tax imposed by §4975---that year is now closed so she got that distribution tax-free as well. Even sweeter! Fourth, it means that while Ms. Marks should have reported all earnings in the now-disqualified IRA account each year from 2006 to 2013, all of those are now closed years as well. Sweeter still. Sixth (!): consider that $96,508 cash distribution from Argent that Ms. Marks received in 2013. Was any of that income? Well, probably only a small amount because she still gets taxed cost basis for the prior years’ earnings that she should have, but did not, report as gross income. See Farid-Es-Sultaneh v. Commissioner, 160 F.3d 812 (2nd Cir. 1947)(in calculating gain on sale of stock, taxpayer was allowed to use fair market value of the stock when received as compensation in prior year even though taxpayer did not report receipt as income or pay tax thereon in the prior year). Sweetness perfection!
Folks, try to be good. Try to get it right. But if you mess up, may the luck of Ms. Marks be with you!
Coda: Of course, Ms. Marks must take the bitter with the sweet. There is some potential bitterness here because if the old IRA was no longer an IRA in 2013, than I don’t see how she could “roll over” that $96,508 cash she received. When she took that cash and put in into the newly created Equity Trust Co. IRA account, I would think it was most likely an excess contribution. Section 4973 imposes an excess tax of 6% on excess contributions to an IRA. This is not an area I know very well but it appears from the statute that the computation of “excess contribution” is designed so that the excise tax gets imposed each year in which a prior year’s excess contribution remains uncorrected. I welcome comments on whether my understanding of how that works is correct. But if I am correct in my understanding, then Mrs. Marks probably needs to (1) fix the excess contributions problem and (2) filed amended returns for the open years to report and pay the excise tax. But even that, I suspect, will be less than the $42,000 in taxes that she escaped ... by getting lucky.
Bryan Camp is George H. Mahon Professor of Law at Texas Tech University School of Law
By Erik Wasson and Sarah McGregor
The U.S. budget deficit will surpass $1 trillion by 2020, two years sooner than previously estimated, as tax cuts and spending increases signed by President Donald Trump do little to boost long-term economic growth, according to the Congressional Budget Office.
Spending will exceed revenue by $804 billion in the fiscal year through September, jumping from a projected $563 billion shortfall forecast in June, the non-partisan arm of Congress said in a report Monday. In fiscal 2019, the deficit will reach $981 billion, compared with an earlier projection of $689 billion.
The nation’s budget gap was only set to surpass the trillion-dollar level in fiscal 2022 under CBO’s report last June.
Deficits are growing as the Trump administration enacted a tax overhaul this year that will lower federal revenue and Congress approved a roughly $300 billion spending increase. The fresh CBO estimates could heighten investor worries as they weigh the potential impact that tariff threats between the U.S. and China may have on the world economy.
The report includes new projections for the effects of the tax legislation — saying it will increase the deficit by almost $1.9 trillion over the next 11 years, when accounting for its macroeconomic effects and increased debt-service costs. In December, Congress’s Joint Committee on Taxation had said the tax package would reduce federal revenue by almost $1.1 trillion over a 10-year period.
“Today’s CBO report confirms that major damage was done to our fiscal outlook in just the past few months,” Michael Peterson, who heads the budget watchdog Peterson Foundation, said in a statement. “This is the first forecast to take into account the recent tax and spending legislation, and it’s clear that lawmakers have added significantly more debt on top of an already unsustainable trajectory.”
The CBO forecasts that real gross domestic product will expand by 3.3 percent in the 2018 calendar year, before slowing to 2.4 percent in 2019 and 1.8 percent in 2020, based on the fourth quarter year-over-year figure. In June, CBO forecast 2 percent growth this year. The Trump 2019 budget request assumed that tax cuts would propel the economy to 3.1 percent growth this year and remain above 3 percent through 2024.
The tax-cut and spending legislation “provide fiscal stimulus, raising real GDP more than potential GDP in the near term,” the CBO said. “Over the longer term, all of those effects, as well as the larger federal budget deficits resulting from the new laws, exert upward pressure on interest rates and prices.”
The CBO predicts the federal funds rate will reach 2.4 percent in the fourth quarter of 2018, 3.4 percent by the end of next year and then peak at 4 percent in 2021. It sees unemployment declining to 3.3 percent in 2019 on an annual average, from 3.8 percent this year.
“During the 2020-2026 period, a number of factors dampen economic growth: higher interest rates and prices, slower growth in federal outlays, and the expiration of reductions in personal income tax rates,” CBO said.
U.S. debt held by the public will surpass $20 trillion by fiscal 2022, up from $15.7 trillion this year, according to the CBO.
Even before the latest fiscal measures, the U.S. budget gap was predicted to increase as an aging American population puts pressure on health care and retirement programs.
The CBO baseline represents what it projects will happen if current law is allowed to remain in effect. CBO assumes that budget caps on annual appropriations, which Congress has raised regularly, remain in effect. Because of that, deficits are likely to be even larger than CBO is projecting.
CBO Director Keith Hall will testify about the report this week before the House and Senate budget committees.
Congress isn’t planning to enact any major deficit-cutting legislation before the November midterm elections. While the House will draft a budget resolution, the Senate has indicated it won’t take one up. Without the fast-track budget reconciliation, there is no chance entitlement cuts conservative Republicans are seeking can be enacted because Democrats can employ a Senate filibuster.
By Joy Taylor, Editor – Kiplinger
Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? Short on personnel and funding, the IRS audited only 0.70% of all individual tax returns in 2016. So the odds are pretty low that your return will be singled out for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.
That said, your chances of being audited or otherwise hearing from the IRS escalate depending on various factors, including your income level, the types of deductions or losses you claim, the business you're engaged in, and whether you own foreign assets. Math errors may draw IRS inquiry, but they'll rarely lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, these 17 red flags could increase your chances of unwanted attention from the IRS.
Note: The new tax law makes changes to some of the tax breaks discussed in this slide show, but these changes do not affect 2017 tax returns filed this year.
Although the overall individual audit rate is only about one in 143 returns, the odds increase dramatically as your income goes up. IRS statistics for 2016 show that people with an income of $200,000 or higher had an audit rate of 1.70%, or one out of every 59 returns. Report $1 million or more of income? There's a one-in-17 chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 0.65% (one out of 154) of such returns were audited during 2016, and the vast majority of these exams were conducted by mail.
We're not saying you should try to make less money — everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.
The IRS gets copies of all of the 1099s and W-2s you receive, so be sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.
If the deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.
Schedule C is a treasure trove of tax deductions for self-employed people. But it's also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all of their income. The IRS looks at both higher-grossing sole proprietorships and smaller ones, as well as at business owners who report a substantial net loss.
Special scrutiny is also given to cash-intensive businesses (taxis, car washes, bars, hair salons, restaurants and the like) and people with freelance service gigs through the sharing economy (think of Uber, Rober, Grubhub). Pass-through firms such as S corporations, partnerships and limited liability companies face audit heat, too.
Special scrutiny is also given to cash-intensive businesses (taxis, car washes, bars, hair salons, restaurants and the like) as well as to small business owners who report a substantial net loss on Schedule C.
We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.
That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for noncash donations over $500, you become an even bigger audit target. And if you've donated a conservation or façade easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all of your supporting documents, including receipts for cash and property contributions made during the year.
Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. This $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and over 750 hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation.
The IRS actively scrutinizes rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. It’s pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real estate Schedule C businesses show lots of income. Agents are checking to see whether these filers worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business.
Alimony paid by cash or check is deductible by the payer and taxable to the recipient, provided certain requirements are met. For instance, the payments must be made under a divorce or separate maintenance decree or written separation agreement. The document can’t say the payment isn’t alimony. And the payer’s liability for the payments must end when the former spouse dies. You’d be surprised how many divorce decrees run afoul of this rule.
Alimony doesn’t include child support or noncash property settlements. The rules on deducting alimony are complicated, and the IRS knows that some filers who claim this write-off don’t satisfy the requirements. It also wants to make sure that both the payer and the recipient properly reported alimony on their respective returns. A mismatch in reporting by ex-spouses will almost certainly trigger an audit.
You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. Your audit risk grows if you report multiple years of losses on Schedule C, the activity sounds like a hobby and you have lots of income from other sources.
To be eligible to deduct a loss, you must be running the activity in a business-like manner and have a reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless the IRS establishes otherwise. Be sure to keep supporting documents for all expenses.
Big deductions for meals, travel and entertainment are always ripe for audit, whether taken on Schedule C by business owners or on Schedule A by employees.
A large write-off will set off alarm bells, especially if the amount seems too high for the business or profession. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, place, people attending, business purpose, and nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast
The IRS is intensely interested in people with money stashed outside the U.S., especially in countries with the reputation of being tax havens, and U.S. authorities have had lots of success getting foreign banks to disclose account information. The IRS also uses voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced penalties. The IRS has learned a lot from these amnesty programs and has been collecting a boatload of money (we’re talking billions of dollars). It’s scrutinizing information from amnesty seekers and is targeting the banks they used to get names of even more U.S. owners of foreign accounts.
Failure to report a foreign bank account can lead to severe penalties. Make sure that if you have any such accounts, you properly report them. This means electronically filing FinCEN Form 114 by April 15 to report foreign accounts that combined total more than $10,000 at any time during the previous year. (Filers who miss the April 15 deadline get an automatic six-month extension to file the form.) Taxpayers with a lot more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.
When you depreciate a car, you have to list on Form 4562 the percentage of its use during the year that was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it's rare for someone to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.
The IRS also targets heavy SUVs and large trucks used for business, especially those bought late in the year. That’s because these vehicles are eligible for favorable depreciation and expensing write-offs. Be sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for a revenue agent to disallow your deduction.
As a reminder, if you use the IRS's standard mileage rate, you can't also claim actual expenses for maintenance, insurance and the like. The IRS has seen such shenanigans and is on the lookout for more.
The IRS wants to be sure that owners of traditional IRAs and participants in 401(k)s and other workplace retirement plans are properly reporting and paying tax on distributions. Special attention is being given to payouts before age 59½, which, unless an exception applies, are subject to a 10% penalty on top of the regular income tax. An IRS sampling found that nearly 40% of individuals scrutinized made errors on their income tax returns with respect to retirement payouts, with most of the mistakes coming from taxpayers who didn’t qualify for an exception to the 10% additional tax on early distributions. So the IRS will be looking at this issue closely.
The IRS has a chart listing withdrawals taken before the age of 59½ that escape the 10% penalty, such as payouts made to cover very large medical costs, total and permanent disability of the account owner, or a series of substantially equal payments that run for five years or until age 59½, whichever is later.
People who trade in securities have significant tax advantages compared with investors. The expenses of traders are fully deductible and are reported on Schedule C (investors report their expenses as a miscellaneous itemized deduction on Schedule A, subject to an offset of 2% of adjusted gross income), and traders’ profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and are treated as ordinary losses that aren’t subject to the $3,000 cap on capital losses. And there are other tax benefits.
But to qualify as a trader, you must buy and sell securities frequently and look to make money on short-term swings in prices. And the trading activities must be continuous. This is different from an investor, who profits mainly on long-term appreciation and dividends. Investors hold their securities for longer periods and sell much less often than traders.
The IRS knows that many filers who report trading losses or expenses on Schedule C are actually investors. So it’s pulling returns and checking to see that the taxpayer meets all of the rules to qualify as a bona fide trader.
Whether you’re playing the slots or betting on the horses, one sure thing you can count on is that Uncle Sam wants his cut. Recreational gamblers must report winnings as other income on the front page of the 1040 form. Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention, especially if the casino or other venue reported the amounts on Form W-2G.
The IRS is drawn to returns that claim home office write-offs because it has historically found success knocking down the deduction. Your audit risk increases if the deduction is taken on a return that reports a Schedule C loss and/or shows income from wages. If you qualify for these savings, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal.
Alternatively, you have a simplified option for claiming this deduction: The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.
To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children's playroom as a home office, even if you also use the space to do your work. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night.
The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as a person depositing $9,500 in cash one day and an additional $9,500 in cash two days later).
U.S. citizens who work overseas can exclude on 2017 returns up to $102,100 of their income earned abroad if they were bona fide residents of another country for the entire year or they were outside of the U.S. for at least 330 complete days in a 12-month span. Additionally, the taxpayer must have a tax home in the foreign country. The tax break doesn’t apply to amounts paid by the U.S. or one of its agencies to its employees who work abroad.
IRS agents actively sniff out people who are erroneously taking this break, and the issue keeps coming up in disputes before the Tax Court. Among the areas of IRS focus: filers with minimal ties to the foreign country they work in and who keep an abode in the U.S.; flight attendants and pilots; and employees of U.S. government agencies who mistakenly claim the exclusion when they are working overseas.
by James Edward Maule
One of the best examples of how trickle-down supply-side tax policy is a total failure is the Kansas experience. I have written about the terrible outcome in that state on several occasions. In A Tax Policy Turn-Around?, I explained how the Kansas income tax cuts for the wealthy backfired, causing the rich to get richer, the economy to stagnate, public services to falter, and the majority of Kansans to end up worse than they had been. In A New Play in the Make-the-Rich-Richer Game Plan, I described how Kansas politicians have been struggling to find a way to undo the damage caused by those ill-advised tax cuts for the wealthy. In When a Tax Theory Fails: Own Up or Make Excuses?, I pointed out that the Kansas experienced removed all doubt that the theory is shameful. In Do Tax Cuts for the Wealthy Create Jobs?, I described recent data showing that the rate of job creation in Kansas was one-fifth the rate in Missouri, a state that did not subscribe to the outlandish tax cuts for the wealthy that Kansas legislators had embraced. In Kansas Trickle-Down Failures Continue to Flood the State and The Kansas Trickle-Down Tax Theory Failure Has Consequences, I described how large decreases in tax revenue, the opposite of what is promised by the supply-side theorists, triggered cuts in public education, and in turn stoked the fires of voter frustration. The voter reaction, however, did not push out of office enough supply-side supporters. In Who Pays the Price for Trickle-Down Tax Policy Failures?, I described how the governor of Kansas, who claimed that tax cuts for the wealthy would generate increased revenues, proposed to deal with the resulting revenue shortfall by cutting spending for essential services. In Kansas As a Role Model for Tax Policy?, I described how, despite the failures of supply-side economics in Kansas, its then governor, the chief architect of implementing the policy in his state, hailed his failure as a role model for the nation.
One of the problems I noted in Kansas As a Role Model for Tax Policy? was the adverse impact of the supply-side tax policy legislation on the state’s public education system. Because the tax cuts reduced state revenue, the outcome predicted by critics of supply-side economics, proposals to cut funding of public education ended up being litigated. As reported in this article, the Kansas Supreme Court held that the state’s $4 billion funding allowance was insufficient to meet the requirement of the Kansas Constitution that the state provide a suitable education for every child in the state. Faced with the prospect of the court ordering a stop to distribution of state funds so long as the funding was not increased, in effect shutting down all state schools, some of the Republicans in the state Senate, all of the Democrats in the Senate, some Republicans in the House, and a few Democrats in the House voted to increase school funding by $534 million, the bill passing each chamber by very narrow margins.
Republicans who opposed the measure, which was endorsed by the state’s Republican governor and its Attorney General, are worried that they will need to raise taxes to generate the funds. Democrats who opposed the measure are concerned that it does not provide for enough funding to satisfy the Supreme Court’s order.
Some supporters of the funding increase think that tax revenues will increase sufficiently to provide the money. How that will happen has not been explained. Apparently belief in failed supply-side economics dies hard. Some people continue to believe that the planet is flat. Perhaps they went to underfunded schools. What a pity.
On the surface, CBO’s new projections of the federal debt and deficits over the next 10 years paint a troubling picture. But, dig deeper and the story gets … more dire. The Federal government is not only running enormous deficits, but we are doing so at a time of full-employment. When the inevitable recession comes, we will be in deep trouble.
Here’s the bad part: Under current law, CBO projects that the debt – currently 77 percent as large as annual GDP – will rise to 96 percent of GDP by 2028. And that’s if Congress does nothing. If instead, Congress votes to extend expiring tax provisions – such as the many temporary tax cuts in the 2017 tax overhaul – and maintain spending levels enacted in the budget deal (which is called the “current policy” baseline), debt is projected to rise to 105 percent of GDP by 2028, the highest level ever except for one year during World War II (when it was 106 percent).
After World War II, Federal debt outstanding fell relative to the size of the economy, but no reasonable forecaster would expect that to happen after 2028 absent major policy changes. Under both current law and current policy, Federal budget deficits are projected to rise over the course of the next decade and will continue to be large after 2028. Under current law, Federal deficits average 4.9 percent of GDP and exceed 5 percent of GDP by the end of the decade, higher than any time in the postwar period except one year in the early 1980s and right after the 2007-9 financial crisis and Great Recession. Under current policy, Federal budget deficits are projected to average 5.9 percent of GDP over the decade and exceed 7 percent of GDP in 2028. So, even by a conventional historical comparison of debt and deficits, the prospects look bad.
Here’s the worse part: The conventional comparison is misleading. The projected budget deficits in the coming decade are essentially “full-employment” deficits. This is significant because, while budget deficits can be helpful in recessions by providing an economic stimulus, there are good reasons we should be retrenching during good economic times, including the one we are in now. In fact, CBO projects that, over the 2018-2028 period, actual and potential GDP will be equal. As President Kennedy once said “the time to repair the roof is when the sun is shining.” Instead, we are punching more holes in the fiscal roof.
In order to do an “apples to apples” comparison, we should compare our projected Federal budget deficits to full employment deficits. From 1965-2017, full employment deficits averaged just 2.3 percent of GDP, far lower than either our current deficit or the ones projected for the future.
The fact that debt and deficits are rising under conditions of full employment suggests a deeper underlying fiscal problem.
CBO’s budget projections are a harsh reminder that the fiscal largesse that Congress and the Administration lavished on the country in the recent legislation is not a free lunch.
From Russ Fox, E.A.,
Last week (as I write this), I met with a new client. He purchased a lot of cryptocurrency in 2016 but didn’t sell any of it until around Thanksgiving of 2017 (he had one small sale). He asked me if he had to report it; I told him he definitely did: I haven’t found anything in the Tax Code that exempts cryptocurrency from US taxation. We entered it, and the gain was duly noted on his return. He then asked me about his other purchases of cryptocurrency. He had heard about Coinbase complying with a summons (indeed, he received notification about this from Coinbase) and wondered about that. I told him there was nothing he need do about his purchases. The IRS ruled that cryptocurrency is property, so only disposals of cryptocurrency need be noted on tax returns. Your records may be going to the IRS, but there’s nothing you need to do about it or anything to worry about.
Contrast that with a different individual; let’s call him John. I met with John last week. Our Engagement Letter now specifically notes that cryptocurrency transactions must be included on tax returns. John said he had over 3,000 transactions of swapping various cryptocurrencies and, “There’s no way in hell I’m going to tell the IRS about them.” I told him it was nice meeting him, and he would need to find another tax professional to prepare his return because there’s no way in hell I’m going to be an accomplice to tax evasion.
I’m not enamored by the IRS’s decision to tax cryptocurrency as property rather than currency. If cryptocurrency were taxed as currency, calculating gains would be simple and straightforward. True, for some individuals who have bought a single cryptocurrency and have few trades, cryptocurrency taxation isn’t a big deal. However, we are dealing with lots of clients with huge trading volumes. And then we have the forks, airdrops, and who knows what else.
The IRS is looking for help in how to tax a fork. Is the correct analogy a stock split? Or do we have a stock dividend? Peter Reilly argues that the best course for individuals in this situation is to file an extension and hope that the IRS issues guidance by late summer. Unfortunately, no one knows when the IRS will issue guidance.
But there is one certainty: Ignoring your cryptocurrency realized gains is a bad idea. The IRS issued a reminder about this. An excerpt:
The Internal Revenue Service today reminded taxpayers that income from virtual currency transactions is reportable on their income tax returns.
Virtual currency transactions are taxable by law just like transactions in any other property. The IRS has issued guidance in IRS Notice 2014-21 for use by taxpayers and their return preparers that addresses transactions in virtual currency, also known as digital currency.
Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.
In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.
So if you’re a Bozo, just ignore that million you made selling Bitcoin. They’ll never catch you…you hope.
This Bozo Tax Tip—and do remember, these are things you really, really, really shouldn’t try—is aimed at the business owner who is having troubles. Business owners, unlike the federal government, can’t just print money. So let’s assume our hypothetical business owner has payroll tomorrow but doesn’t have the money for everything. What should he do?
Well, one strategy is to not remit the payroll taxes. Sure, they’re “trust fund” taxes but the government can print money and I can’t, so they’ll just let it slip by. And my state government won’t care either, right?
The above strategy is likely one of two quick and easy ways to get on the road to ClubFed. The IRS doesn’t like it when trust fund taxes don’t make it to the government. The penalties are substantial. The liability goes to the owners (and check signers) of the business. IRS Criminal Investigation will investigate this. Don’t do this!
One of my clients recently was interviewed about such a case. He was paid, but apparently the IRS wasn’t. It’s not hard for the IRS to find out about this: After all, every employee is going to file a tax return claiming withholding but the IRS won’t find it. That’s exactly what happened in this case. I suspect that very soon two nice looking individuals (accountants with badges and guns; now that’s a scary thought!) will be knocking on a door and saying, “You have the right to remain silent….”
Business troubles aren’t fun. However, if you don’t pay the IRS your employment taxes you will find your troubles multiplying.
By far the worst tax schemes in the view of the IRS are offshore (foreign) trusts. In fact, trusts of all sorts—domestic and foreign—are regularly abused.
First, not all trusts are bad. Many trusts serve a legitimate purpose, such as family trusts. (Family trusts are a device to avoid probate, and are used in many states. For tax purposes, these revocable trusts are ignored.) Survivors’ trusts are another useful vehicle. Grantor trusts, another asset protection vehicle, are useful. Special Needs Trusts are extremely useful. There are plenty of ‘good’ trusts.
But trusts set up to avoid income tax are abusive, and very much Bozo-like. Individuals and businesses have spent thousands of dollars trying to avoid taxes (in some cases, mid five-figure amounts)…and many times these tax structures have been challenged successfully by the IRS.
And those are the domestic trusts.
The foreign trusts are worse. These are usually organized just to avoid taxes and hide money. If you look at Schedule B on your tax return you’ll see that you are supposed to report your foreign trusts. They work great until the IRS finds out about them. Yes, you have to report moving money into them.
But I’m smarter than the IRS, and they’ll never catch my trust set up in Luxembourg, Liechtenstein, or the Isle of Man. Well, you will spend thousands to set up your trust, and if the IRS does catch on–and in these days where governments are exchanging tax information, this can (and does) happen–your foreign trust will have served only one purpose: It will have enriched the promoters who set it up.
Remember: If it sounds too good to be true it probably is. A trust set up to evade taxes is just that.
What happens if you wake up and it’s April 17, 2018, and you can’t file your tax? File an extension. Download Form 4868, make an estimate of what you owe, pay that, and mail the voucher and check to the address noted for your state. Use certified mail, return receipt, of course. And don’t forget your state income tax. Some states have automatic extensions (California does), some don’t (Pennsylvania is one of those), while others have deadlines that don’t match the federal tax deadline (Hawaii state taxes are due on April 20th, for example). Automatic extensions are of time to file, not pay, so download the extension form and mail off a payment to your state, too. If you mail your extension, make sure you mail it certified mail, return receipt requested. (You can do that from most Automated Postal Centers, too.)
By the way, I strongly suggest you electronically file the extension. The IRS will happily take your extension electronically; many (but not all) states will, too.
But what do you do if you wait until April 18th? Well, get your paperwork together so you can file as quickly as possible and avoid even more penalties. Penalties escalate, so unless you want 25% penalties, get everything ready and see your tax professional next week. He’ll have time for you, and you can leisurely complete your return and only pay one week of interest, one month of the Failure to Pay penalty (0.5% of the tax due), and one month of the Failure to File Penalty (5% of the tax due).
There is a silver lining in all of this. If you are owed a refund and haven’t filed, you will likely receive interest from the IRS. Yes, interest works both ways: The IRS must pay interest on late-filed returns owed refunds. Just one note about that: The interest is taxable.
Here’s another Bozo Tax Tip that keeps coming around. The problem is, the Bozos don’t change their stripes. In any case, here are some signs your accountant might be a Bozo:
– 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 $2,295 papers he sells you will 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.
– He believes every return needs at least three dependents, no matter whether you have any children or not.
If your tax professional exhibits any of these behaviors, it’s time to get a new tax professional.
With Tax Day fast approaching it’s time to examine yet another Bozo method of courting disaster. And it doesn’t, on the surface, seem to be a Bozo method. After all, this organization has the motto, Neither rain nor snow nor gloom of night can stay these messengers about their duty.
Well, that’s not really the Postal Service’s motto. It’s just the inscription on the General Post Office in New York (at 8th Avenue and 33rd Street).
So assume you have a lengthy, difficult return. You’ve paid a professional good money to get it done. You go to the Post Office, put proper postage on it, dump it in the slot (on or before April 17th), and you’ve just committed a Bozo act.
If you use the Postal Service to mail your tax returns, spend the extra money for certified mail. For $3.45 you can purchase certified mail. Yes, you will have to stand in a line (or you can use the automated machines in many post offices), but you now have a receipt that verifies that you have mailed your return.
About fourteen years ago one of my clients saved $2.42 (I think that was the cost of a certified mail piece then) and sent his return in with a $0.37 stamp. It never made it. He ended up paying nearly $1,000 in penalties and interest…but he did save $2.42.
Don’t be a Bozo. E-File (and you don’t have to worry at all about the Post Office), or spend the $3.45! And you can go all out and spend $2.75 and get a return receipt, too (though you can now track certified mail online). For another $1.50, you can get the postal service to e-mail the confirmation that the IRS got the return (for the OCD in the crowd). There’s a reason every client letter notes, “using certified mail, return receipt requested.”
A few days ago I was explaining to a client the basics of the US Tax Code: All income is taxable unless Congress exempts it; nothing is deducible unless Congress allows it. That’s the basics.
My office is in Las Vegas, Nevada. I’m a US citizen. So I owe US income tax on my earnings, right? Of course I do. But where few willingly go the Bozo contingent jumps in. Here’s a method of avoiding tax on all your income. It’s been used by celebrities such as Wesley Snipes. So let’s use Section 861 of the Tax Code to avoid tax!
Section 861 states that certain items are always considered as income from within the United States. It does not say that income earned in the US is exempt from tax. But tax protesters claim that’s the case; courts, though, basically state, ‘You must be kidding.’ This argument has never been used successfully. In an audit or in court, if you use the Section 861 argument you have no chance of success.
The US taxes its citizens on their worldwide income. That includes the United States. Indeed, if that weren’t the case I’d be out of a job. Mr. Snipes received three years at ClubFed. In the long-run it’s far, far easier to simply pay your tax.
Social media is really, really big these days. You can follow me on Twitter. I may even update my Facebook page one of these days. Of course, I’m not a tax criminal, and my posts hopefully add knowledge for others.
Of course, where you and I won’t go the Bozo contingent is quite happy to do so. Take, for instance, Rashia Wilson. Ms. Wilson posted a wonderful picture on her Facebook page:
Rashia Wilson (Image Credit: Tampa Police Department)
In the same post, she bragged:
“I’m Rashia, the queen of IRS tax fraud,” Wilson said May 22 on her Facebook page, according to investigators. “I’m a millionaire for the record. So if you think that indicting me will be easy, it won’t. I promise you. I won’t do no time, dumb b——.”
She’s doing 21 years at ClubFed. Oops…
A helpful hint to the Bozo tax community: Law enforcement does read social media. Indeed, the IRS will do a search of you on the Internet prior to a field examination (audit). So if you decide to go on the dark side of life, don’t brag about it online. A better course would be not to go on that dark side to begin with, but that rarely occurs to the Bozo community.
As we continue with our Bozo Tax Tips–things you absolutely, positively shouldn’t do but somewhere someone will try anyway–it’s time for an old favorite. Given the business and regulatory climate in California, lots of businesses are trying to escape taxes by becoming a Nevada business entity. While I’m focusing on California and Nevada, the principle applies to any pair of states.
Nevada is doing everything it can to draw businesses from California. Frankly, California is doing a lot to draw businesses away from the
BronzeGolden State. But just like last year you need to beware if you’re going to incorporate in Nevada.
If the corporation operates in California it will need to file a California tax return. Period. It doesn’t matter if the corporation is a California corporation, a Delaware corporation, or a Nevada corporation.
Now, if you’re planning on moving to Nevada forming a business entity in the Silver State can be a very good idea (as I know). But thinking you’re going to avoid California taxes just because you’re a Nevada entity is, well, bozo.
It’s time for our annual rundown of Bozo Tax Tips, strategies that you really, really, really shouldn’t try. But somewhere, somehow, someone will try these. Don’t say I didn’t warn you!
This is a repeat for the fifth year in a row, but it’s one that bears repeating. Unfortunately, the problem of identity theft has burgeoned, and the IRS’s response has been pitiful. (To be fair, it has improved somewhat over the last year, but that didn’t take much.)
I have some clients who are incredibly smart. They make me look stupid (and I’m not). Yet a few of these otherwise intelligent individuals persist in Bozo behavior: They consistently send me their tax documents by email.
Seriously, use common sense! Would you post your social security number on a billboard? That’s what you’re doing when you email your social security number.
We use a web portal for secure loading and unloading of documents and secure communications to our clients. As I tell my clients, email is fast but it’s not secure. It’s fine to email your tax professional things that are not confidential. That said, social security numbers and most income information is quite confidential. Don’t send those through email unless you want to be an identity theft victim or want others to know how much money you make!
If I send an email to my mother, it might go in a straight line to her. It also might go via Anaheim, Azusa, and Cucamonga. At any one of these stops it could be intercepted and looked at by someone else. Would you post your social security number on a billboard in your community? If you wouldn’t, and I assume none of you would, why would you ever email anything with your social security number?
A friend told me, “Well, I’m not emailing my social, I’m just attaching my W-2 to the email.” An attachment is just as likely to be read as an email. Just say no to emailing your social security number.
If you’re not Internet savvy, hand the documents to your tax professional or use the postal service, FedEx, or UPS to deliver the documents, or fax the documents. (If you fax, make sure your tax professional has a secure fax machine.) If you like using the Internet to submit your tax documents, make sure your tax professional offers you a secure means to do so. It might be called a web portal, a file transfer service, or perhaps something else. The name isn’t as important as the concept.
Unfortunately, the IRS’s ability to handle identity theft is, according to the National Taxpayer Advocate, poor. So don’t add to the problem—communicate in a secure fashion to your tax professional.
Disclaimer: This article is for general information purposes only, and is not intended to provide professional tax, legal, or financial advice. To determine how this or other information in this newsletter might apply to your specific situation, contact us for more details and counsel.