At Least The IRS Could Find 95% of the Returns…

Posted on September 3, 2020 by Russ

Two items crossed my in-box within a few minutes of each other this morning. The first was a blog post from the National Taxpayer Advocate requesting that Congress give multi-year funding for modernizing IRS computer systems. The second was a TIGTA report noting the IRS couldn’t find about 5% of tax returns requested.

Do you know anyone who knows COBOL (a computer language)? If you do, the IRS wants to hear from him or her! COBOL dates from 1959 (before I was born). The IRS’s IMF and BMF (Individual and Business Master Files) are older than I am, and run in Cobol on IBM mainframes. They are the oldest computer systems still in use by the federal government! I’ll date myself: I was in the last class at Berkeley to learn computer programming on punch cards. On the bright side, the IRS uses the best of 1950’s technology….

Why doesn’t the IRS take their paper records and digitize them? Some of it has to do with the legacy systems they are run on. A lot of it has to do with inadequate funding.

Seriously, this is a problem. In our office, we don’t keep paper records. We scan everything (and return all paper to our clients). The IRS does this for electronically filed tax returns, but not for all paper returns. Indeed, the TIGTA report notes that 347 of the IRS’s 956 forms cannot be electronically filed (that’s more than 36%). The IRS has 468,000 cubic feet of storage available on their campuses. Additionally, Federal Record Centers store about five million cubic feet of IRS records! The IRS spends $57 million a year on storing and retrieving this mountain of paper.

To give an idea of how large this is, my house is 2400 square feet with (I believe) 10 foot high ceilings (because of the heat in Las Vegas). That’s 24,000 cubic feet. So IRS paper records would fill more than 227 of my sized home. It’s frightening to think of all that paper.

The Taxpayer Advocate noted the IRS needs $2.5 billion over six years to complete its (hoped for) modernization program. They received $150 million in the 2019 fiscal year and $180 million in the 2020 fiscal year for modernization. At the current rate, it will take more than 12 additional years to complete it.

The TIGTA report looked at the ability to get specific pieces of paper. Retrieving that paper is necessary for audits and many other required IRS tasks. TIGTA had requests sent through normal channels for tax returns and examination case files. Most of the time the records could be found. However, 6% of examination case files and 3% of tax returns could not be located. An additional 23% of examination case files and 10% of tax returns were not provided timely.

The TIGTA report should be looked in its entirety for a depressing picture of the reality (vis-a-vis computer systems) at the IRS. It’s not that IRS management disagrees with TIGTA on the recommendations that TIGTA made (they agreed with the four recommendations in the report); rather, the problem is that the IRS almost certainly doesn’t have the money to complete the necessary tasks.

Here’s an example from real life: A fellow tax professional’s client mailed in a Form 1040X last year. That client just received a letter stating, “We have a record of receiving your Form 1040X for the 2018 tax year. We cannot find it. Please send another signed copy by mail to this office….”

I’ve been impacted by this. I had a client a few years ago request an ITIN (Individual Taxpayer Identification Number) for his child. The ITIN unit managed to lose the paperwork (sent by certified mail) three times, including once when it was hand-carried to them by the Taxpayer Advocate Office! (Thankfully, the Taxpayer Advocate kept a copy and the fourth time was a charm!)

Do I think Congress will loosen the purse strings here? Well, maybe before I retire….

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IRS Extends Tax Deadlines for Victims of Iowa Derecho & California Wildfires

Posted on August 25, 2020 by Russ

The IRS announced yesterday that they have extended tax deadlines for victims of both the derecho that hit Iowa and the ongoing California wildfires. The specific counties impacted can be found on the Federal Emergency Management Agency (FEMA) website.

For both disasters, tax deadlines are extended that began on August 10th for the derecho and August 14th for the wildfires until December 15th. This impacts 2019 personal tax returns on extension, business returns on extension, payroll tax filings, and estimated tax payments. California’s Franchise Tax Board automatically extends deadlines for federal disasters, so those impacted have identical extensions for California taxes. I assume the Iowa Department of Revenue will similarly extend Iowa deadlines.

Unfortunately, it looks like we’ll also be looking at victims of Hurricane Laura in Texas and/or Louisiana later this week. The IRS recently posted information on safeguarding records for natural disasters; your insurance company likely has additional information available. The cliche is that an ounce of prevention beats a pound of cure–but it is good advice.

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More on the IRS Daily Fantasy Sports Memo (“DFS Is Gambling”)

Posted on August 20, 2020 by Russ

There has been some speculation in the gambling world on (1) why did the IRS memo on Daily Fantasy Sports (DFS) suddenly appear, and (2) is the IRS correct about the non-precedential memo?

Chris Krafcik on Twitter asked, ” Has anybody gotten to the why of the IRS DFS memo? Working backwards from the targets (DFS companies [i.e., DK [DraftKings] and FD [Fanduel]]), and having observed what I have of gambling industry lobbying skullduggery, fair to ask, imo, whether IRS was lobbied by a DK-FD competitor.”

The reality is far more mundane. John Brennan, who often writes on gambling, has an article today on the DFS memo. He quotes Jason Robins, CEO of DraftKings, from his conference call with gaming analysts last week:

“We have been involved in [an] audit with the IRS for many years, and this was a memo that has no force of law and is non-binding,” Robins said. “In our view, the analysis is deeply flawed. …” [Emphasis added]

Let’s assume that DraftKings raised the issue in the audit that DFS wagers are not gambling for purposes of federal tax law because of the Unlawful Internet Gambling Enforcement Act (UIGEA) (which is a near certainty). The UIGEA contains a carve-out for DFS specifically exempting it. The IRS auditor did not know whether the UIGEA carve-out applied to the wagering excise taxes, and his or her manager didn’t know. They did what they were supposed to do: They asked the IRS Chief Counsel Office how this should be treated. This memo is the response to that inquiry. (It’s highly unlikely this memo is the result of a competitor’s actions.)

The next question is whether or not the IRS memo reaches the correct conclusion. As I previously noted, I think it does. As noted in the memo, wagering is not defined in the Tax Code. But Court decisions are unanimous in what to do when a term isn’t defined. From Tschetschot v Commissioner (T.C. Memo 2007-38):

When a term is not defined, we must apply the term’s “plain, obvious, and rational meaning.” Liddle v. Commissioner, 103 T.C. 285, 293 n.4 (1994), affd. 65 F.3d 329 (3d Cir. 1995); see also Boyd v. United States, 762 F.2d 1369, 1373 (9th Cir. 1985). According to the dictionary, a “wager” is defined as “something risked or staked on an uncertain event” or “a bet”. Random House College Dictionary (1968). Similarly, “to wager” is defined as: (1) Something risked or staked on an uncertain event; bet; (2) the act of betting. Random House College Dictionary (1973).

We can also look to the UIGEA for a definition of wagers. Indeed, DraftKings argues that because of the UIGEA, DFS is not wagering (gambling). Let’s look at the definition from 31 U.S.C. § 5362 (1):

(1) Bet or wager.—The term “bet or wager”— (A) means the staking or risking by any person of something of value upon the outcome of a contest of others, a sporting event, or a game subject to chance, upon an agreement or understanding that the person or another person will receive something of value in the event of a certain outcome; …(E) does not include— … (ix) participation in any fantasy or simulation sports game or educational game or contest in which (if the game or contest involves a team or teams) no fantasy or simulation sports team is based on the current membership of an actual team that is a member of an amateur or professional sports organization (as those terms are defined in section 3701 of title 28)….

First, I agree that DFS companies (such as DraftKings) are exempt from the UIGEA. 31 U.S.C. § 5362 (1)(E)(ix) is quite clear about that.

However, this has nothing to do with how wagering is treated under the Tax Code (aka the Internal Revenue Code); that’s a different section of the United States Code (Title 26). But we can look at the overall definition of what wagering is from the UIGEA, even though the UIGEA doesn’t apply to DraftKings, to see how the definition of wagering does apply to them under Title 26 of the U.S.C. As I wrote back in 2014,

…[T]here are plenty of IRS and Tax Court rulings on this, and all say basically the same thing. For something to be gambling, three elements must be present:
1. A prize;
2. Chance; and
3. Consideration.

The IRS memo and common sense tells us that DFS has at least an element of chance. No rain is predicted for a football game, and it rains impacting play. Or a pitcher pulls his hamstring and only pitches two innings. Or, well, you get the idea. The examples are too numerous to mention and all of them back the IRS’s view that there is an element of chance to DFS.

I do agree that DFS is an activity where skill predominates. As I have written many times, poker is also a game where skill predominates over luck. But that’s irrelevant for the Tax Code; legally, poker is a form of skillful gambling. So is DFS. But it’s gambling no matter what the DFS companies may want to say.

The conclusion I reached last week still holds: The DFS companies have little chance of prevailing on this issue. I reached that conclusion in 2015, and nothing has changed. They would be far better off trying to lobby Congress for an exclusion in the Tax Code than fighting the IRS on this.

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That Direct Deposit from “IRS TREAS 310” Is Legitimate

Posted on August 19, 2020 by Russ

Taxpayers who filed after April 15th are being paid interest on their refunds. The IRS issued a press release earlier this week, stating:

This week the Treasury Department and the Internal Revenue Service will send interest payments to about 13.9 million individual taxpayers who timely filed their 2019 federal income tax returns and are receiving refunds.

The interest payments, averaging about $18, will be made to individual taxpayers who filed a 2019 return by this year’s July 15 deadline and either received a refund in the past three months or will receive a refund. Most interest payments will be issued separately from tax refunds.

In most cases, taxpayers who received their refund by direct deposit will have their interest payment direct deposited in the same account. About 12 million of these payments will be direct deposited.

Everyone else will receive a check. A notation on the check − saying “INT Amount” − will identify it as a refund interest payment and indicate the interest amount.

Several clients asked this morning about mysterious direct deposits from “IRS TREAS 310,” wondering what these were. That’s the interest on your refund from April 15th until the date you filed.

Do note that the interest you receive is taxable. You will receive a Form 1099-INT in the mail from the IRS next January and you will need to include that on your 2020 tax returns.

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Burying Your Head in the Sand

Posted on August 17, 2020 by Russ

One of my favorite sayings (and I am not the one who came up with it) is “The Tax Code Giveth, The Tax Code Taketh Away.” It’s not fair, but we have to live with it as it is, not how we want it to be. Only Congress can change the Tax Code because it’s law.

Last week, I reported on the IRS releasing a Chief Counsel Memorandum where the IRS concludes that Daily Fantasy Sports (DFS) companies are liable for the Excise Taxes on Wagering. (Back in 2015 I came to the same conclusion as the IRS.) Per published reports, Jason Robins, the Chief Executive Officer of DraftKings, disagrees. The Wall Street Journal notes [pay link]:

“This was a memo that has no force of law, is nonbinding and [in] our view is deeply flawed in its analysis,” Mr. Robins told analysts. “Our position continues to be, which we believe has been reaffirmed through state legislatures and courts throughout the country, that [daily fantasy sports] is not wagering.”

First, state law and state courts do not change federal tax law. A state can call an activity a non-gambling contest but it can still be considered wagering (gambling) under federal law. We have a dual system of taxation in the United States, and state tax law and federal tax law differ in numerous respects.

Second, some states have concluded that DFS is gambling. For example, Nevada did so. Of course, a company executive will put the most positive light on something.

So I’m going to assist Mr. Robins with some information about the Federal Tax Code. Back in 2014, I wrote:

[T]here are plenty of IRS and Tax Court rulings on [what wagering/gambling is], and all say basically the same thing. For something to be gambling, three elements must be present:
1. A prize;
2. Chance; and
3. Consideration.

Clearly daily fantasy sports have elements 1 and 3. There’s a prize and there’s a cost to enter each event. Is there chance?

Gambling does not have to be 100% chance to be considered gambling. For example, poker is considered gambling under US tax law yet there’s plenty of skill involved with it. (Indeed, I’d argue that skill predominates over luck; however, there’s absolutely an element of luck in poker.) Let’s look at what’s involved with a daily fantasy sports contest. You generally select a team to play in a day’s events. Let’s say you selected Carlos Boozer and Shane Battier for today’s NBA daily fantasy sports contest. Those players scored 8 and 3 points, respectively. On the other hand, had you selected Taj Gibson and Chris Bosh you would have done far better; they scored 20 and 28 points. Yet before a single game who know what each player will score? If you had selected NBA star Lebron James you would normally do quite well; however, he didn’t play today.

The IRS Chief Counsel memorandum notes that there can be skill and the ‘contest’ can still meet the definition of a wagering activity:

In [Revenue Ruling 57-521], the contest participant’s own skill was the only factor involved in winning the puzzle game and there was no chance element at all. In contrast, DFS participants merely select a lineup for their simulated teams and have no ability to exercise control or influence over the actions of the players participating in the game and who earn the participants their fantasy points. DFS participants may be educated on the sports games, players, expected weather conditions, and other factors. Regardless of how educated a DFS participant is, their chosen player(s) may perform poorly that day, become injured, not play in a given game, or be affected by uncontrollable circumstances such as weather and officiating. The existence of chance indicates that DFS contests are distinguishable from the type of contest described in Rev. Rul. 57-521. We conclude that the “skill” involved in selecting fantasy players is similar to the skill involved in selecting winners of individual professional sports games, horse races, or other traditional sports gambling activities.

In my view, and the current state of the Federal Tax Code, it’s quite clear that a DFS contest is a wagering activity. It meets the specifications of wagering. There is consideration, there is a prize, and there is an element of chance (luck). Bluntly, Mr. Robins can educate the world on the skill needed to be a winner in DFS (and he is absolutely correct on the skill needed); however, under the Tax Code this is clearly gambling (wagering). Basically, Mr. Robins’s argument is irrelevant.

The only way this changes is to change the Federal Tax Code. That would require Congress to add a new section to the Tax Code specifically stating that DFS is not a wagering (gambling) activity.

If I were an auditor of a DFS firm, I would be insisting DFS companies either pay the wagering excise taxes or add a reserve for them. To put it in sports terms, the Pittsburgh Pirates have a better chance of winning the 2020 World Series than the DFS companies do of not having to pay the wagering excise taxes.

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Deja Vu Again, and Again,…

Posted on August 15, 2020 by Russ

Multiple clients of ours filed tax returns near the July 15th deadline and mailed payments to the IRS. And, as usual, these clients received IRS CP14 notices stating they hadn’t paid their taxes (when they had). What should they do?

First, ignoring an IRS notice is generally not a good idea. IRS notices do not improve with age.

The simplest thing to do for individuals is to attempt to view your tax record online. If you can, view your Account Transcript for 2019. If it shows a $0 balance, the IRS has corrected the issue and you can ignore the CP14 notice.

(I have to use “attempt” because the IRS online system works for only half of those who try. For example, the system works for me but does not work for my business partner.)

But what if your check has cleared and the payment hasn’t been noted? Get copies of the front and back of the cleared check. With that, the IRS can trace where the check went. I’ve seen checks applied to the wrong account and the wrong tax year. If your check cleared more than two weeks ago, there’s a problem and you, or your tax professional (if you have authorized him or her) will need to call the IRS and resolve the issue. (If the check cleared in the last two weeks, you need to give the IRS a little more time to update their records.) This can usually be done over the phone.

Three issues this year have made matters worse. First, IRS computers are programmed to allow an extra “cycle” (to allow payments received to be entered into IRS computers) before sending out CP14 notices after April 15th. It appears the IRS hasn’t changed their programming for the July 15th due date, so there’s no extra cycle after July 15th.

Second, because of Covid mail has slowed. One of my clients mailed his payment (using certified mail) on July 14th from Reno; it wasn’t received in Cincinnati until July 23rd. In the past, that letter would take two or three days; this year, it took nine.

The third issue is that at least for Nevadans, we’re no longer mailing payments to San Francisco. This year Nevada, Oregon, and Arizona residents send their payments to Cincinnati. That’s much further away with corresponding later delivery dates. That hasn’t helped.

Individuals have it quite good: Things are far, far worse for businesses, trusts/estates, and anyone else making payments directly to IRS Service Centers. Simply put, the IRS has a backlog of over 10 million pieces of mail to open. Many of those include checks. The IRS knows of the issue, but until this backlog is resolved (and that will take months), there’s little that can be done. The IRS issued a statement acknowledging this issue:

Pending Check Payments and Payment Notices: If a taxpayer mailed a check (either with or without a tax return), it may still be unopened in the backlog of mail the IRS is processing due to COVID-19. Any payments will be posted as the date we received them rather than the date the agency processed them. To avoid penalties and interest, taxpayers should not cancel their checks and should ensure funds continue to be available so the IRS can process them.

To provide fair and equitable treatment, the IRS is providing relief from bad check penalties for dishonored checks the agency received between March 1 and July 15 due to delays in this IRS processing. However, interest and penalties may still apply.

Due to high call volumes, the IRS suggests waiting to contact the agency about any unprocessed paper payments still pending. See www.irs.gov/payments for options to make payments other than by mail.

So if you get a notice alleging you didn’t pay and you did, relax. This is probably a timing issue that will self-resolve. And a reminder that whenever you send something to a tax agency, use certified mail. This gives you proof you mailed it on the date noted. If that was done timely, the IRS will consider your action timely even if the IRS untimely opens the mail.

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IRS: DFS Sites Liable for Excise Tax on Wagering

Posted on August 13, 2020 by Russ

Back in 2015, I asked and answered the question on whether the DFS sites were liable for the excise tax on wagering. I came to the conclusion they were. In late July, the IRS came to the same conclusion: DFS sites are liable for this tax.

The IRS legal opinion (which cannot be cited, but does give the IRS’s reasoning) notes that clearly DFS entry fees are wagers, and that DFS events are wagering pools. The opinion cites Tschetschot v. Commissioner and also notes the dictionary definition of a wager.

The IRS opinion notes some obvious realities about skill and chance in DFS:

DFS participants may be educated on the sports games, players, expected weather conditions, and other factors. Regardless of how educated a DFS participant is, their chosen player(s) may perform poorly that day, become injured, not play in a given game, or be affected by uncontrollable circumstances such as weather and officiating. The existence of chance indicates that DFS contests are distinguishable from the type of contest described in Rev. Rul. 57-521. We conclude that the “skill” involved in selecting fantasy players is similar to the skill involved in selecting winners of individual professional sports games, horse races, or other traditional sports gambling activities.

The DFS tax rate is 0.25% on legal (authorized) wagers and 2% on any non-authorized wagers. If a DFS site operates only in states that authorized the wagers, they’ll owe 0.25% of the wagers collected; otherwise, they will owe 2%.

There’s a corollary to this that I’ve mentioned on several occasions. If DFS is a wagering activity for one aspect of tax law, it almost certainly it is for other aspects of tax law. The DFS sites have been issuing Form 1099-MISC’s as “skill contests.” It’s quite likely that DFS games are gambling and that W-2Gs should be issued instead of 1099-MISC’s.

Finally, I should point out that this legal opinion is just the IRS’s opinion. A DFS site, if audited on this issue, could appeal the decision into the courts. It’s possible, of course, a court could rule differently than the IRS legal opinion (though I doubt it).

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Charitable Organizations and the Election

Posted on August 13, 2020 by Russ

Unless you’re hiding under a rock you know that in less than three months there will be an election for President (and many other offices). EideBailly has a timely reminder today that a 501(c)(3) organization (a charitable organization) cannot support one candidate over another. This is for all 501(c)(3) organizations including private foundations.

So what does this cover? It includes the obvious (making political contributions, endorsing candidates, or speaking in favor or against a candidate) and some less obvious items (leasing space to a political campaign and using the organization’s mailing or email list for a campaign). There’s no de minimis rule, so if your 501(c)(3) gives $1 to the Trump or Biden campaigns, you could lose your 501(c)(3) status. (The EideBailley article also covers what 501(c)(3) organizations can do.)

There’s a corollary that is briefly noted in the article that I want to emphasize: Officers (and employees) of 501(c)(3) charitable organizations must be very careful about their public statements for (or against) any candidate or cause. Let’s say that I have a 501(c)(3) private foundation, and I’m for Assemblyman Smith in her candidacy for Nevada State Senate. I publicly endorse her. Of course, I, as an individual, can endorse whomever I wish. But I’m also an officer of a 501(c)(3). In my endorsement, did I note that this was my endorsement, and that nothing I’m saying is attributable to the Russell Fox Foundation? Am I careful doing that in all social media?

From a practical sense, it’s unlikely the IRS would go after a private foundation. But they can, and an ounce of prevention is worth a pound of cure. If you’re an officer of a 501(c)(3) organization, it’s an excellent idea to make sure all officers and employees are aware of the rules.

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How High Is Too High?

Posted on August 4, 2020 by Russ

California, like many states, has financial difficulties because of the Covid pandemic. So is the legislature looking at cutting spending? A little. How about raising taxes? Definitely, especially on the rich.

California’s top marginal tax rate today is 13.3% (on those earning $1 million or more). Proposed legislation would increase the tax rate to 14.3% on those earning more than $1 million, to 16.3% on those earning more than $2 million, and to a whopping 16.8% on those earning more than $5 million.

Today, California gets 40% of its revenues from the top 0.5% of taxpayers. But something lost by the California legislature is what happened after the last tax increase (to 13.3%). As Josuha Rauh notes,

The problem is that high earners do not simply sit there and take it when the state goes after their income.

In a detailed study of the 2012 California ballot measure that raised the top state rate to 13.3 percent, Ryan Shyu and I found that just two years later, the state was only collecting 40 cents of every dollar that it had hoped to raise from the tax increase.

The reason?

High income taxpayers affected by the 2012 tax increase suddenly began to flee the state at higher rates, especially to zero tax states like Nevada, Texas, and Florida.

This is an obvious corollary to the Laffer Curve. Economist Arthur Laffer noted that at 0%, no taxes are collected and that at 100%, no taxes would be collected. So there must be a curve that describes tax collection by tax rate.

The unspoken issue for California is, “Will this increase drive the top 0.5% out of the Golden State?” Mr. Rauh, a Senior Fellow at the Hoover Institution and a Professor of Finance at Stanford, clearly believes the answer is yes. When this measure passes (and given the makeup of the legislature, it will pass), the question is not will top-earners leave, but how many will leave. Alan Greenspan famously said, “Whatever you tax, you get less of.” California is conducting an experiment, and we will find out the results in a year or two. I believe that if you’re a realtor specializing in high-end properties in Nevada, Texas, Florida, or Arizona, you’re about to get more business.

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Signed, Mickey Mouse

Posted on July 31, 2020 by Russ

The General Treasurer of Rhode Island is Seth Magaziner. When the state pays its bills, his signature (along with that of State Controller Peter Keenan) appears on the checks that are issued. Imagine the surprise when some business owners received tax refunds and instead of Mr. Magaziner’s signature, they looked down and saw “Mickey Mouse and Walt Disney.” Oops.

“As a result of a technical error in the Division of Taxation’s automated refund check printing system, approximately 176 checks with invalid signature lines were printed and mailed to taxpayers on Monday 7/27/2020. The invalid signature lines were incorrectly sourced from the Division’s test print files,” said Jade Borgeson, Chief of Staff for the [Rhode Island] Department of Revenue.

The checks were issued for business tax refunds, and impacted taxpayers are being contacted and presumably replacement checks are being issued.

On a more serious note, what should you do if you receive a tax refund you’re not due? I’ve had clients who receive such erroneous refunds. Do not cash the checks: If the money is not due to you, you’re not allowed to keep the funds. Contact the tax agency that sent you the refund, and follow their instructions to return the check.

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