Taxable Talk

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

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

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

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

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

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

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

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

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

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

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

This is definitely an issue I’m aware of because of my practice areas. I deal with plenty of individuals who earn their living while residing abroad or through foreign sources of income. “It’s tax exempt, isn’t it?” They’re not happy when I let them know that’s not the case.

The Tax Code, which is law (Title 26, U.S.C.) states that Americans are taxed on their worldwide income. Basically, everything is taxable unless Congress specifically exempts it.

Anyway, about six months ago I was approached by an individual who was about to be levied by the IRS because of failure to pay taxes. He resided in the continental U.S., but earned all his income from royalties from the Far East. So I asked him a few questions:

“Are you an American citizen?” He was.
“Was this income taxed at its source? That is, had the countries where it comes from levied a tax on it?” No, he received all of the income.
“Do you pay income tax in any of these countries?” No, he didn’t.

In summary, the individual really owed the tax. But as much as I tried to tell him that, I was talking to a brick wall. Given my dislike of talking to brick walls and of taking bozos on as clients, I suggested he try to get someone else to represent him.

But 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 $84,400 in 2006. And the time period does not have to be a calendar year; if you’re overseas from May 1, 2006 through April 15, 2007, 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 (April 17th this year) 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.

With just twelve days until Tax Day, it’s time to present our annual list of things not to do. All of the items on this list have been done by bozo taxpayers. Some have been successful while others have had, shall we say, a not-so-positive outcome. I’ll be presenting a Bozo Tax Tip each day until April 14th. By the way, for a very good list of some excellent tax tips, see Joe Kristan’s list at Roth Tax Updates. So on with Tip #10.

Everyone is looking for that extra deduction. One of the benefits of having children is that they you do get an exemption for each of them. An enterprising disk jockey in Wyoming thought, “Hmmmm, if I can get an exemption for my son, why not get an exemption for my dog Red.” And so he added a dependent on his Form 1040.

At that time, you didn’t have to put the social security number of your dependents on your tax return, and the IRS never noticed. However, the law changed and the disk jockey was faced with putting down a social security number for a dog. Not having one (of course), he noted on the next return that Red was deceased.

Tip: Dogs are wonderful companions, but they’re not deductible. Making up social security numbers is not a good idea either. So this Bozo scheme is gone forever, unless you want to commit multiple felonies.