Fraud Over the Holiday

Posted on September 3, 2007 by Russ

I hope you’re enjoying the Labor Day weekend. These individuals didn’t have a pleasant holiday.

>From Shreveport, Louisiana comes the story of bozo tax preparer Betty Jean Thomas. Thomas had a not-so-good way of helping her clients: she invented phony business expenses. Even worse, those clients didn’t have a business. The total cost to the government was $67,000. Ms. Thomas received a year and a day at ClubFed and must pay a $3,000 fine.

We previously told you the story of Athanasios Reglas. Mr. Reglas invented some phony companies to create phony deductions. He pleaded guilty last week, and was sentenced to three years at ClubFed followed by three years of supervised release. He previously forfeited $358,000 in cash that was found when he was arrested.

I also previously wrote about Reverend John Henry Walker. The Charlotte pastor was sentenced last week to five years and three months for tax evasion and stealing from his congregation. The pastor had pleaded guilty to charges of tax evasion, bank fraud, and lying to federal agents. He also must make restitution of $277,000. He used his purloined funds for erectile dysfunction medication, two cars (a Lexus and a Mercedes), and a new home. He evaded taxes on $750,000.

Finally, Joe Roth reported on the case of Lakeland, Florida dentist Nancy Montgomery-Ware. She decided to research the tax laws, and “determined” that, “The income tax is not allowable under the Constitution.” That’s what she said during closing arguments during her trial for tax evasion. According to the Lakeland Ledger, it only took one afternoon to find her guilty. She’s looking at several years at ClubFed. Interestingly enough, her husband told her that she was crazy. It would have been much less costly for her to listen to her husband. But she didn’t, and she’ll have to pay the consequences.

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Poker Tournaments Takes a Hit

Posted on August 31, 2007 by Russ

Back in 2005, I speculated that the IRS would write a regulation requiring withholding from poker tournaments. The IRS will, on Tuesday, announce Revenue Procedure 2007-57, requiring withholding from any winner of a poker tournament who has received more than $5000 in winnings from the tournament.

First, this is a Revenue Procedure; this is the lowest form of IRS regulation. (The Tax Code is statutory law; it’s the highest form of regulation. Next are IRS regulations. Those are promulgated under the Tax Code. Then come from Revenue Rulings and then, finally, Revenue Procedures.)

Entities do not have to follow a Revenue Procedure. But Revenue Procedures are written so that entities usually follow them. They include verbiage that reads (this is taken from Revenue Procedure 2007-57), “The IRS will not assert any liability for additional tax or additions to tax for violations of any withholding obligation with respect to amounts paid to winners of poker tournaments under section 3402, provided that the poker tournament sponsor meets all of the requirements for information reporting under section 3402(q) and the regulations thereunder.” Of course, this implies the IRS may assert violations to entities that don’t follow the Procedure. Effectively, all casinos will likely follow the Procedure.

So what does Revenue Procedure 2007-57 say? In Section 3.01, it classifies poker tournaments as a “wagering pool.” It does so by referencing United States v. Berent, 523 F.2d 1360, 1361 (9th Cir. 1975). And IRS regulation §31.3402(q)-1(b)(2) requires withholding on wagers in a wagering pool if the proceeds from the wager exceed $5,000.

Interestingly, the Revenue Procedure states that withholding will be required: “A poker tournament sponsor is required to withhold and report on payments of more than $5,000 made to a winning payee in a taxable year….” Per the regulations, the required withholding rate is 25%.

This has two impacts. First, anyone who wins more than $5,000 will receive 75% of his winnings (unless subject to a higher withholding rate). Second, many casinos will again start issuing W-2Gs to everyone who wins in a poker tournament. Once casinos have to start issuing W-2Gs to a few people, casinos will come to the conclusion it’s easier to issue them to everyone.

As to the Revenue Procedure itself, I think it’s a poor application of the law. As I reported back in 2005, I don’t believe poker tournaments are a wagering pool. Wagering pools are when you wager on something else, such as a horse race. Indeed, the IRS came to that same conclusion as I did in a private letter ruling in 2005. The reality is, though, that I don’t think a casino or cardroom is going to challenge the IRS on this. Their attorneys and tax counsels will say that the easiest thing to do is to go along with the IRS Revenue Procedure. Entities that don’t will potentially be subject to additional IRS scrutiny, so following the Procedure is the course of least resistance.

What will the impact be to tournament poker? First, there will be additional compliance with the Tax Code. Given that more W-2Gs will be issued, and withholding will occur, the IRS will see additional collections (which is their goal). The other major impact of this ruling is that money will be taken out of the poker economy. Once this Revenue Procedure goes into effect (March 4, 2008), about 25% of the prize pool of major poker tournaments will vanish. Of course, the IRS will correctly note that this money should have been paid in taxes at some point. However, given that gambling losses are deductible against wins, some of the withheld funds would never have been owed in taxes because of gambling losses.

Will this impact the number of players in major poker tournaments? Possibly. Where it may have the biggest effect is in a series of major tournaments. Suppose John Doe wins $10,000 on day 1 of a tournament. Under the new Revenue Procedure, he will only keep $7,500. There’s a higher chance of him not entering additional events so that the funds don’t reenter the poker economy.

Link to Revenue Procedure 2007-57

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Lose a Court Case, Commit Tax Fraud to Recoup the Loss

Posted on August 26, 2007 by Russ

Gene Haas, of Camarillo, California, owns Haas Automation, Inc., one of the leading CNC (computer numerical control) machine tool companies. They even have a Nextel Cup racing team. Needless to say, Haas Automation is a successful company.

Back in 2000, Haas Automation settled a patent infringement case. Hurco Companies, Inc., of Indianapolis, accused Haas Automation of violating a patent on interactive CNC programming. Hurco convinced a jury that Haas Automation was in violation, and after the judge warned Gene Haas that he could be looking at a $150 million judgment, the companies settled for something in the tens of millions of dollars, according to this article. A senior executive at Haas told Metalworking Insiders Report that there would be no change in operations because of the judgment.

He was wrong.

The New York Times detailed the scheme in today’s paper. After Mr. Haas and his company lost the patent case, he was angry with the government and with the judge who presided over the case. Court papers indicate that he decided that some tax fraud was a good way to get back at the government.

So, enlisting the help of his then CFO, John Phillips, the business created a phony company in Nevada called “Supermill,” and then paid the phony company from phony invoices. Then Mr. Haas and Mr. Phillips got in a business dispute, Mr. Haas sued Mr. Phillips for $27 million (apparently related to the phony transactions), and Mr. Phillips went to the FBI and told them of the scheme. (Mr. Phillips was not indicted.) It’s not a good idea when you commit tax fraud to get a co-conspirator angry enough to go to the FBI.

The DOJ, in a press release announcing Haas’ indictment, claimed that the tax fraud was upwards of $20 million. Now, with a $5 million fine added in, penalties, and interest, the total judgment is somewhere around $70 million. And Mr. Haas will be receiving two years at ClubFed.

If you find yourself losing a court case, I strongly recommend that you do not follow Mr. Haas’ path, and decide that committing tax fraud is a way of getting back at the judge. Kenneth Barish, an attorney for Mr. Haas, in describing the plea deal, noted, “[u]nder the circumstances, it was a good result.” When paying $70 million and getting two years at ClubFed is a good result, you wonder what a bad result would be.

Hat Tip: TaxProf Blog

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“The Income Tax Only Applies to Government Entitiies, Foreigners & Foreign Corporations”

Posted on August 26, 2007 by Russ

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

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

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

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

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

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

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

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

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Hawaii Four-O

Posted on August 23, 2007 by Russ

I remember Hawaii Five-O, the long running police show that starred the late Jack Lord. This post looks at four individuals who allegedly created an illegal tax fraud scheme.

The US Department of Justice filed suit against four individuals and two businesses in Hawaii, alleging that they created a series of sham transactions using business insurance and retirement accounts to create phony tax deductions. The suit alleges that the loss to the Treasury is over $2 million.

The alleged transactions first sent the money to offshore accounts and then moved the money back using, among other methods, sham loans and foreign credit cards. The suit alleges that the individuals got to deduct 100% of the money that was moved but received 80% of it back. That’s a neat (and if proved, illegal) trick.

The accused businesses are Bright Enterprises, a Lihue, Hawaii accounting firm and Hawaii Financial Specialists, Inc.. The DOJ is asking for an injunction to stop the practice and, undoubtedly, a list of clients who used this scheme. Remember, if you get a business deduction for an expense, you’re supposed to have spent 100% of the money, not 20%.

News Story: Honolulu Star-Bulletin

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Sailing Away

Posted on August 23, 2007 by Russ

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

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

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

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

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

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

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

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Taxes $200,000, Collectibles 756

Posted on August 23, 2007 by Russ

The Associated Press is reporting that Barry Bonds’ 756th home run ball will be auctioned. Matt Murphy, the man who caught the ball, has consigned the ball to Sotheby’s SCP Auctions. The ball is expected to be worth over $500,000.

Mr. Murphy, who is 21, told the AP, “I’m upset by the decision I had to make…I wanted to keep it. I’m young. I don’t have the bank account. … It would have cost me a lot more to keep it.”

Mr. Murphy was told by several people that he would owe tax on the $500,000 that the ball is worth even if he kept it. While I personally disagree with that (I think he wouldn’t have owed anything until he sold it), it is very clear that he will owe tax on the ball when he sells it. Given federal, New York, and New York City combined taxes (Mr. Murphy is a resident of Queens, New York), I expect that Mr. Murphy will owe about 40% of the net sales price (the gross sales price less the commission the auction house receives).

As for Barry Bonds, his Giants are now playing out the string (they are in last place in the National League’s Western Division). There’s no new news regarding his possible indictment on tax charges.

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November 14th Is Not Before November 13th

Posted on August 23, 2007 by Russ

If you receive an IRS Determination Letter, and decide to file a petition in Tax Court, make sure you file by the deadline. The Tax Court won’t accept your petition if you file late, as another taxpayer discovered today.

Our unlucky taxpayer moved twice between the time the IRS mailed the Notice of Deficiency and the time he received it. Normally, you have 90 days to respond; however, the taxpayer in question had only 75 days (until November 13, 2006). He sent his petition (using FedEx) on November 14th.

The IRS asked the Tax Court to dismiss the taxpayer’s suit because it was filed late. The taxpayer argued that he should either get extra time because of the moves or that the IRS notice was inaccurate because of the wrong address.

I’ve written before that the Tax Court is a stickler for deadlines. This case was no different. The statute says that the taxpayer has 90 days from date of mailing (the taxpayer actually had 91, as the 90th day from the date of mailing was a Sunday), and the Court must obey the plain language of the statute. Additionally, the IRS correctly sent the notice to the (then) right address.

Once again, deadlines count. The taxpayer’s case has been dismissed, and he must pay the deficiency. He can file a claim and pursue a case in US District Court or the US Court of Claims, but that’s only after he pays the tax.

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Phone Taxes

Posted on August 22, 2007 by Russ

Today’s Wall Street Journal has an interesting article about a phone tax battle in Missouri. [Note: $Pay$ Link] Various municipalities have claimed that their city telephone taxes apply to cellular phones; the cellular carriers disagree. On Thursday, a St. Louis County Circuit Judge will rule on whether or not he can rule on the case by summary judgment or whether a full trial will have to be held. No matter how he eventually rules, the case will likely be appealed.

You may remember that I wrote in May about the City of Los Angeles’ cellular telephone tax increase being illegal. One of the arguments that the carriers are making is very similar: a popular vote is required under Missouri law for a new tax to be approved. Cities are arguing that the tax isn’t new. Legislation was passed capping the cell phone tax, but it was ruled unconstitutional by the Missouri Supreme Court.

The carriers could owe as much as $500 million, including interest and penalties. One thing is certain, though. If the tax ends up being owed, the bill will be passed on to consumers. That’s the nature of all taxes.

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California Has a Budget

Posted on August 21, 2007 by Russ

The State Senate finally approved a budget late today. It goes to the Governator for his signature (he has said he will sign it) and for his “blue pencil” (the line item vetoes).

For more details on what this budget really means, go to the Flash Report. You will find State Senator Tom McClintock’s commentary and State Senator Dennis Hollingworth’s commentary. Note in particular what Senator Hollingsworth said: “[The budget] is still one that will result inevitably in a near $5 billion deficit next year…Further, we all need to begin addressing next year’s looming fiscal problem–now, and not wait until we are so far into the budget that our options to balance it become fewer and more difficult.” Those are words to live by, but I don’t expect them to be heeded in Sacramento.

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