Bozo Tax Tip #9: Only Foreign Income Is Taxable

Posted on April 2, 2009 by Russ

Another repeat from 2008, mainly because people still try to peddle this snake oil. This conversation took place just yesterday.

Two prospective clients came into my office (husband and wife). I showed them my Engagement Letter first, and they wanted to ask me some questions. The first were routine about the wife’s income. But then the husband told me he didn’t have a W-2 from his job.

“Well,” I asked, “Were you paid under the table?”

“Oh, it was nothing like that. I was working in South Korea last year.”

It turns out he was working as an independent contractor in Korea. “And isn’t it great,” he continued, “that I don’t have to pay US tax on that income.”

I corrected him. “You do have to pay US tax on that income. Americans pay tax on their worldwide income. Now, had you had income tax taken out of your Korean income you would be eligible for a tax credit. Were you overseas for 330 days in 2008?”

“No,” he said. “I came back for the summer. I didn’t like the humidity.”

“That’s a shame, because had you been overseas for 330 days out of a 365-day period, you’d be eligible for the foreign earned income exclusion.”

I told the potential client that he would pay both income and self-employment tax on his Korean income. He didn’t like my answers, and said he’d find another accountant who would see things his way. He’s likely still searching.

As noted above, if you do earn income abroad, there are some real tax tips you can take advantage of. If you have a genuine residence overseas or meet the physical presence test (generally, being abroad 330 days out of 365), you may be eligible for the Earned Income Exclusion. If eligible, you can exclude up to $87,600 in 2008. And the time period does not have to be a calendar year; if you’re overseas from May 1, 2008 through April 15, 2009, you would likely be eligible for a prorated credit.

If you earn income abroad and it’s taxed abroad, you are likely eligible for the Foreign Tax Credit. The general principle is that income should only be taxed once, so if (say) Japan taxes your income, you should get a credit of that tax on your US tax return.

Finally, anyone who is not in the United States on April 15th gets an extra two months (until June 15th) to file his tax return. (You need to attach an explanation to your tax return.) If you’re abroad, you won’t be subject to penalties but you will be subject to interest on what you owe (interest is statutory).

There are numerous caveats and gotchas, and numerous ways to lessen your tax if you either have foreign source income or live abroad. Talk to a professional who can help you if you’re contemplating living abroad or will soon have significant income from abroad. But whatever you do, remember that foreign income is just as taxable as income earned in the United States

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Bozo Tax Tip #10: Use Consecutive SSNs When Cheating the IRS

Posted on April 1, 2009 by Russ

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.

Here’s a repeat for the third year:

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

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

I strongly suggest that you do not try anything like this. The IRS and state tax agencies do have systems in place to catch bozos who attempt crimes like this. Instead of trying to bilk the system, ask your tax preparer about legitimate deductions that are available for you to take. The regular IRA allows you to deduct $5,000 ($6,000 if you’re 50 or older) from your income (if you’re eligible). You have until April 15th to make your contributions.

And if you’re self-employed, you may be able to contribute to a SEP IRA. You have until your return is timely filed, including extensions, to contribute to a SEP IRA. You can contribute 20% of your net self-employment income up to a maximum of $46,000 to a SEP (for the 2009 tax year this will rise to $47,000). This is one tax deduction that’s available until October 15th if you file an extension.

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

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Pre-April 15th Hiatus

Posted on March 29, 2009 by Russ

It’s that time of year again. I’ve written my top ten Bozo Tax Tips to help people like Richard Hatch in his quest to prove 300 million witness wrong. Those tips will start posting automatically beginning this coming Wednesday.

Until then I’m taking a break from blogging unless a major tax issue pops up (in which case I will mention it). We’ll be back with our usual weekly tax offenders after Tax Day. Until then remember that you do have to file a tax return, and if you don’t you will suffer the consequences.

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Hatch Again Asks for Freedom

Posted on March 29, 2009 by Russ

Richard Hatch, the Survivor winner who decided he didn’t have to pay taxes on his $1 million of winnings, is again asking a court to free him. He’s filed a motion with the US District Court in Rhode Island that his conviction should be overturned.

Wait a moment, you ask. Didn’t Mr. Hatch already appeal his conviction, and didn’t he lose (badly) in the Court of Appeals? Well, yes.

The Providence Journal, which also published his motion, noted that Mr. Hatch is appealing because prosecutors used “Mr. Hatch’s interesting lifestyle” to sway the jury. Mr. Hatch also is attacking his representation and the judge who tried the case.

Well, I actually agree a little with Mr. Hatch. It’s very unconventional to win $1 million in front of 300 million witnesses and not declare it on your income tax return. On all other grounds, though, I suspect Mr. Hatch’s motions will fail, and by the time an appeal is heard he’ll have served his 51 months at ClubFed.

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A Good Blog to Visit

Posted on March 29, 2009 by Russ

Peter Pappas, proprietor of the Tax Lawyer’s Blog, reminded me that I have forgotten to include him on my blogroll. Well, that’s an error I was happy to correct. Mr. Pappas’ blog is excellent, and we share annoyance over an issue.

One of his clients sent him an email last week. I’ll quote from it:

Well he came and went. He told me that I shouldn’t have hired an attorney and wanted to know how much I paid Mr. Pappas.

He then began interrogating me and asking me detailed questions about my intentions, my finances and how I came to own the business.

I repeatedly told him that I was represented by an attorney and he continued to say that I didn’t need one and that I should not have hired one….

Now, Mr. Pappas is an attorney and I’m an Enrolled Agent, but we both represent taxpayers. When I’m representing someone the IRS is supposed to talk to me, not them. I’ve seen some pretty ugly things, but the story Mr. Pappas tells is bad. Unfortunately, I don’t expect anything to change—I guess I’m just too cynical. Read the story, and realize what the IRS agent did was, bluntly, wrong.

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There’s Lots of Waste in California’s Government

Posted on March 25, 2009 by Russ

That’s the only conclusion I can draw after perusing this morning’s Orange County Register. A headline reads, “State Considers Ban on Big-Screen TVs.” No, it’s not April 1st—the headline is for real.

The California Energy Commission—that’s the same group of bureaucrats who wanted to control California’s thermostats—are behind this. It’s in the name of energy efficiency, they say, to prevent global warming. Well, global warming hasn’t been proven (indeed, there’s beginning to be lots of evidence that the sun has a lot to do with that), but perhaps this will save hundreds or thousands of dollars of electricity per television. Electrical rates have gone up, after all.

Would you believe $18 to $30 per television per year?

When California’s Legislature is forced to make massive budget cuts (and that day is coming, whether they like it or not), a good place to start would be the California Energy Commission. Its elimination probably will only save a fraction of the billions that are needed to be cut, but it will eliminate a source of lunacy in the bureaucratic pantheon of California. Needless to say, this proposed regulations should be dumped with the remote controlled thermostats in the regulatory ash heap of history.

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Where’s the Refund

Posted on March 23, 2009 by Russ

A good barometer of when others will receive their California tax refunds is when I will receive mine. My return was filed on February 15th. The Franchise Tax Board has a webpage to check on the status of your refund.

My refund was authorized on March 17th, and the FTB notes that I should receive it within ten business days of that date (probably late this week).

The IRS has a similar “Where’s my refund” webpage.

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Not Pressed for Time Any More

Posted on March 22, 2009 by Russ

We’ve got some lowlights from the tax fraud world. A dentist and a doctor from West Virginia are in trouble. And we’ll take a look at what could happen if your 1031 Exchange uses a dishonest Qualified Intermediary.

First, let’s head to Charleston, West Virginia. Dr. Alan Vance is a dentist who also happened to own a dry cleaning business called “Pressed For Time.” Dr. Vance wanted a pool for his home, so he marked off the cash on the deposit slips prepared by his staff, and didn’t declare it on his tax return. He did get his swimming pool, but he also got a charge of tax evasion. He pleaded guilty last week, and he’s likely to not be so pressed for time for over one year when he’s sentenced.

Let’s head to nearby Bluefield, West Virginia. Dr. Randy Brodnick appears to have a successful medical practice. He’s also facing a federal indictment. Dr. Brodnick and Anthony Kritt, an attorney from Crofton, Maryland, are accused of using sham contracts, employee leasing, and shell corporations to defraud the IRS out of $2 million. Allegedly, they set up fictitious entities in Ireland and the Channel Islands. They face a total of seven counts and if convicted could spend up to 35 years at ClubFed. Interestingly, one of the funds that Brodnick and Kritt are alleged to have used to hide the funds is the Ruritania-90 fund. (Ruritania is the fictional country from The Prisoner of Zenda.)

Finally, our last story notes a potential problem with a 1031 Exchange. Section 1031 of the tax code allows taxpayers to do an exchange of investment properties without paying capital gains taxes. There are lots of rules for §1031 exchanges. One of them is that you must use a Qualified Intermediary.

It’s very, very important to use a reputable, honest Qualified Intermediary. Unfortunately, in every industry there are some who aren’t honest. Edward Okun was one of the dishonest ones.

Mr. Okun, of Miami, had a unique way of conducting his business. People would come to him wanting to do a §1031 exchange. He’d obtain the original property, find a replacement property, and take some of the proceeds for himself. It gives a whole new meaning to “boot.”

Everything was fine while the real estate market was going up. Unfortunately, we all know that ended. Mr. Okun, who apparently owned several Qualified Intermediary companies, had a personal jet, a yacht, and a Miami mansion. It appears that after the market tanked his scheme was uncovered.

Mr. Okun was convicted on 23 counts. He apparently bilked over 600 individuals and obtained over $125 million. All told he could be sentenced to 400 years at ClubFed, along with restitution and fines.

Posted in Tax Evasion, Tax Fraud | 1 Comment

Three More Questions from the Mailbag

Posted on March 22, 2009 by Russ

Three more questions from the mailbag this week. We’ll take a look at pensions, extensions, and putting money aside for 2009 taxes.

First, a Californian asks: If I retire with a government pension (Calpers) from California, will I have to pay California income tax on that pension if I become a resident of Nevada?

Would you think that the Franchise Tax Board would stoop to such a level as taxing retirees’ pensions when they left California? You detected the sarcasm, I hope.

Indeed, the FTB already tried and did attempt to tax out-of-state retirees under the theory that the pensions represent money earned in California and are, thus, taxable to California. However, there was an uproar from retirees who had escaped the Golden State. Congress responded by passing HR394 in 1996 (now Public Law 104-95); this was signed by President Clinton. States are now prohibited from taxing out-of-state retirees’ pensions.

Do be careful, though, and wait until you are domiciled outside of California before taking that distribution or California will tax you.

Next, I’m asked: I’m going to owe a lot in federal taxes next month, but money is going to be tight until June. What can I do to stave off Uncle Sam until then? (Luckily, I’m a resident of Texas and don’t have to deal with state income taxes.)

There are two choices you should discuss with your professional tax advisor. First, you could file your return, pay what you can, and arrange a payment plan for the remaining balance. If you owe $25,000 or less to the IRS a payment plan is generally automatically granted. A second option is to file an extension, pay what you can, and then file your return and pay the balance due in June.

Either way you will owe interest (it’s statutory) and a failure to pay penalty (0.5% of the tax due per month late). However, as long as you file an extension (or your return) you will avoid the failure to file penalty of 5% of the tax due per month.

The choice that’s best for you depends on your situation and the amount you owe. As I said, your professional tax advisor should be able to steer you in the right direction.

The final question for this week: I graduated from college in December, and did not earn any income in 2008. However, I just won $62,000 in a poker tournament this past week. Am I required to pay estimated taxes to the IRS? How much should I put aside for taxes this year? I live in Florida, if that helps you in giving me advice.

Congratulations on your win. And I’m glad you’re considering the tax impact of your victory. In the United States, gambling income is taxable, so you will owe federal income tax on your winnings. A rule of thumb is to put aside at least one-third of your winnings for taxes.

Exactly how much you will need depend on a variety of factors: your other sources of income, whether you’re a professional gambler or an amateur, your net poker winnings for the year, what state you reside in, your marital status and dependents, whether you will invest in a retirement account, etc.

Since your income was $0 in 2008 you do not have to make any estimated tax payments during 2009. (You never have to make estimated payments, but if you don’t and you are supposed to you will pay an estimated tax penalty when you file your return.) You also reside in Florida, a state with no income tax. If you were my client I’d advise you to take about $20,000 of your winnings and put it in a safe investment that can be cashed out early next year.

This week I may have made one, two, or perhaps all three of the questioners happy with my responses. I’ll have to see if I can keep that streak up next week.

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When a Gambler Loses…

Posted on March 22, 2009 by Russ

The Tax Code is anything but fair towards gamblers. This is especially true for professional gamblers; they’re in one of the few professions where you can’t lose. Section 165(d) states that losses from wagering (gambling) transactions are only allowable up to the amount of wins.

So let’s look at John Doe, a normally winning professional gambler. He has a bad year, and his $100,000 of wins are offset by $150,000 of losses. To top that off, he has $30,000 of expenses. He just lost $80,000, right?

Well, maybe not. A new IRS position paper notes that the business expenses may be eligible for a net operating loss (NOL) carryforward/carryback in a year that a gambler loses.

As the paper notes, it’s a case of language. Section 165(d) states, “losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” [emphasis added] Those two words are the key: Does the statute mean the transactions or the activity?

The paper notes that Whitten v. Commissioner (T.C. Memo 1995-508) agrees with this line of reasoning and allows expenses to be deducted. On the other hand, there is a string of cases holding the contrary point of view. These go back to 1951 (Offutt v. Commissioner, 16 T.C. 1214; Estate of Todisco v. Commissioner, 757 F 2d 1 (1st Cir. 1985) affg T.C. Memo 1983-247); one of these cases is Kochevar v. Commissioner (T.C. Memo 1995-607).

So what does this mean for the gambler who has a bad year? First, you can’t deduct losses in excess of wins. However, you may be able to claim expenses, and carry them forward or backward as a NOL carryforward/carryback. The “may” is very necessary. The Estate of Todisco case may bind those gamblers who are in the 1st Circuit (Maine, Massachusetts, New Hampshire, Rhode Island, and Puerto Rico) and they may not be able to try this strategy.

Additionally, a position paper in no way binds the IRS to this view. It’s one attorney’s opinion. The staff at the IRS hasn’t been favorable towards gamblers in the past, and nothing prevents them from taking a contrary view. However, for those gamblers who wish to be aggressive having some expenses carried forward can mollify (to some degree) a bad year.

Anyone taking this position should absolutely discuss this with their own personal tax professional. Taking this position will definitely increase the risk of audit of the gambler’s return; you could win this part of your argument only to have other items on your return thrown in your face. Additionally, this position paper doesn’t bind the IRS or the Tax Court.

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