Some Interesting Tax Court Cases

Posted on April 26, 2006 by Russ

Yesterday, there were three interesting Tax Court decisions. Joe Kristan of Roth Tax Updates has an excellent post on the first case. In that case, Merlo v. Commissioner, the unlucky taxpayer found out the “gotcha” of incentive stock options. If you are the recipient of such options, take a look at Joe’s post on this case now. ISO’s have a wonderful tax advantage…but if the option tanks….

The second case has to do with something quite basic: a change of address. In Pragasm v. Commissioner, the taxpayer wanted to have a hearing on a collection (levy/lien) dispute. The IRS said that they weren’t required to hold one because the taxpayer never responded to their notices. The Court sided with the IRS. Just a reminder, if you move, notify the IRS (and your state tax agency, if applicable); you can download Form 8822 here and mail it (certified mail, return receipt requested, of course) to the IRS.

The third case has to do with regulatory requirements. Last May, the Tax Court ruled in Zapara v. Commissioner that the IRS failed to comply with §6335(f) of the I.R.C. That section requires the IRS to sell seized property within sixty days following a request by the taxpayer (and have the proceeds of the sale credited against the tax, penalties, and interest owed). The taxpayers in that case had, the Court ruled, requested such a sale and the IRS did not sell the property (in this case, stock).

The IRS asked the Tax Court to reconsider their May 2005 decision. The IRS claimed that the taxpayers untimely raised a new issue, that the evidence doesn’t support the decision, and that the Court doesn’t hold the power to make the relief ordered in the earlier decision. The IRS lost on all three counts, and the motion for reconsideration was denied (decision here).

Why is this final case important? The Tax Court usually rules based on regulations and paperwork. If you can show paperwork/backup for your actions, and that you followed the regulations/Tax Code, you will usually win. This holds true for the IRS, too. The IRS’s paperwork showed the request to sell the stock, and the stock wasn’t sold. The moral is clear: document, document, document; and you have an excellent chance of winning your case.

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How Big Is the Tax Gap?

Posted on April 26, 2006 by Russ

The “Tax Gap” is difference between the amount of tax that the IRS should collect if everyone followed the law and the amount that it actually collects. There are three components of the gap: nonfiling, under-reporting, and underpayment. Of course, the ridiculous complexity of the Tax Code is also a contributing factor.

Last February, the IRS estimated the Tax Gap at $290 billion. This morning’s Wall Street Journal reports that the IRS is likely underestimating the problem. The report, from the Department of the Treasury’s Inspector General for Tax Administration (TIGTA), concludes that:

“…the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and voluntary compliance. The IRS has significant challenges in both obtaining complete and timely data and developing the methods for interpreting the data…We concluded that, despite the significant efforts undertaken in conducting the individual taxpayer National Research Program (NRP) for under-reporting, the IRS still does not have sufficient information to completely and accurately assess the overall tax gap and the VCR.”

The report is interesting and is available here. You can find the Wall Street Journal’s article here (paid subscribers only).

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Crime Blog Time

Posted on April 21, 2006 by Russ

It’s Friday, and Tax Day has come and gone. But the memory lingers, so let’s look at some scofflaws as the week ends:

Louis Ratfield of Lake Worth, FL has been in trouble with the government before. The IRS secured a restraining order against him for promoting a “constitutional common-law trust” to avoid paying taxes. There is no such trust, of course. He allegedly continued to promote the trust. He was arrested on Tuesday on 56 counts of preparing false income tax returns. Each count could net him three years in prison. Ratfield has also been in trouble with the SEC, apparently absconding with investors’ money.

James Hubb of Clayton, MO used $25,000 of his business’ money for plumbing at his house (it may have been for a bathtub—some bathtub!). Besides the bathtub, quite a bit more money was taken from his business and used for personal expenses. That’s not necessarily illegal, as long as it is disclosed and reported as income. It wasn’t, and Hubb has pled guilty. He faces up to eight years in prison and a fine of up to $350,000.

In Massachusetts, Laurence Greenburg and Russell Skidds sold partially defatted beef tissue as partially defatted chop beef. That violated the Federal Meat Inspection Act. Compounding their problems, they didn’t report all the income, causing them to file false tax returns. They were convicted on Tuesday.

Finally, H&R Block settled a 1998 RAL (Return Anticipation Loan) lawsuit for $35 million. H&R Block still faces a lawsuit filed by the California Attorney General. Given the nature of class action lawsuits, it’s likely that the lawyers will get most of the money from that settlement.

News Stories:
Lake Worth, FL, Clayton, MO, Malden, MA and H&R Block

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An Affair in Tax Court

Posted on April 20, 2006 by Russ

The scene is the doctor’s office, where the doctor is romancing his patient. Just a little problem: the patient is married to a policeman. The policeman finds out and vows to sue the doctor, or get paid a large sum. The doctor doesn’t have it, so he makes a counteroffer. And then someone takes out a gun….Well, no, this is a tax blog. But this case does make its way into Tax Court, not a mystery novel.

The salient facts (above) are true (except for the gun). Throw in one more—the doctor eventually pays the policeman $25,000 as “free money” in the hopes that this affair blows over. As the Court noted,

“Petitioner then stated: “Now Doc, this isn’t blackmail money”, to which [the Doctor] replied: “No, I didn’t say it was blackmail money; I said I hope it helps you, both of you.” At the end of the meeting, petitioner warned [the doctor] that he should never again speak to or look at [his wife] or come to their home.”

The petitioner and the doctor contacted his state medical board and reported the affair. The doctor apologized. The doctor’s accountant then prepared a Form 1099-MISC reporting the $25,000 payment. The question before the court: is the payment a gift or income for the petitioner? The IRS held it was income; the petitioner believed it was a gift. (Gifts are tax-free to the recipient.)

Believe it or not, the Supreme Court has issued an opinion on point. In Commissioner v. Duberstein, 363 U.S. 278, 285-
286 (1960), the Court held, “And, importantly, if the payment proceeds primarily from “the constraining force of any moral or legal duty,” or from “the incentive of anticipated benefit” of an economic nature, Bogardus v. Commissioner, 302 U.S. 34, 41, it is not a gift.”

The Tax Court concluded,

“the $25,000 payment by [the doctor] was not the result of detached and disinterested generosity or paid out of affection, respect, admiration, or charity. Instead it was paid to avoid a lawsuit, to avoid public and professional embarrassment, and to assuage his own feelings of guilt or moral obligation. Therefore, the $25,000 payment in 1999 is not a gift and is includable in petitioners’ gross income for that year.”

Somehow, a moral for this story seems like an oxymoron.

Case: Peebles v. Commissioner, T.C. Summary 2006-61

Hat Tip: TaxProf Blog

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T-Day

Posted on April 17, 2006 by Russ

Today is the deadline. You have until midnight tonight to file your taxes. The question were asked every year (usually around 9pm) is, “We just realized that we need to file our taxes…What do we do?”

The answer is to file an extension. If you are our client, we can file Form 4868 electronically for you. Otherwise, print the form up, and mail it, using certified mail, return receipt requested. Spend the extra $4.25. (For a story on what happens when you don’t spend the money, see Joe Kristan’s report on why you spend the money here.) Many post offices now have automated machines that can do certified mail; look for the “Automated Postal Center” (or similar verbiage).

Remember, an extension is an extension of time to file, not pay. So make an estimate of what you owe and send it with your extension. If you don’t file an extension, you’re subject to the failure to file penalty (5% a month up to 25%), so even if you don’t pay anything with your extension it’s well worth your time to file it.

Don’t forget to file an extension for your state taxes, if your state requires it. California does not require an extension to be mailed (the extension is automatic); however, many states do require an extension to be filed.

This year, for both the IRS and California, an extension is for six months. You have until October 16th (the 15th falls on a Sunday) to file your taxes if you file an extension.

If you’re out of the country working, you have an extra two months to file and pay your taxes to the IRS, until June 15th (not June 17th). You need to attach an explanation to your return stating that you were out of the country, and why (work).

Finally, if you call our office today wanting to schedule an appointment to do your taxes today, it’s not going to happen. Like most tax preparers, we wouldn’t be able to do an acceptable job on your return if we started it today.

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Facing the Music

Posted on April 13, 2006 by Russ

Last October, I inched my way towards the 21st Century and bought an iPod. I find it wonderful, because when I’m at the gym I can listen to music that I like, not the techno-garbage that my gym plays.

iPods haven’t been bad for Apple, either, as they’ve become a ubiquitous symbol of the 21st Century. Apple’s iTunes store is doing a booming business, selling downloads of music.

And the Tax Man Cometh.

In California, music is not subject to sales tax because it is not considered tangible personal property (something you can hold). But that’s not the case in many states. If you live in Washington, Texas, or Indiana, you need to pay either sales tax or use tax on your iTunes downloads. And as this CNET story states, many other states are looking at taxing the downloads.

Of course, you could live in Oregon—the state with no sales tax. If you don’t, you may find that download costs an extra 5% to 10% as states continue to move forward in taxing the Internet.

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PayPal Users Better Watch Out

Posted on April 12, 2006 by Russ

The digital age has spawned numerous successful companies and industries. One industry that did not exist ten years ago is online auctions, such as those on eBay. A company that sprung up to facilitate payment transfers for eBay is PayPal. In fact, eBay bought PayPal a few years ago.

The benefits of using PayPal are obvious—buyers and sellers can easily transfer money to one another. The money flows readily. PayPal can also be used to transfer money from the US to anywhere. And the IRS wants to know about that.

The US has some very stringent money laundering laws. If you have a foreign bank account, and you have $10,000 or more in it at any time during the year, you must report it on Schedule B of Form 1040 and by filing Form TD F 90-22.1 with the Department of the Treasury. Now, do you really believe that all of the people who use PayPal to transfer money have been doing this?

I don’t, and the IRS concurs. Indeed, the IRS announced last year that they were looking at PayPal payments. Yesterday, the IRS won approval in federal court to obtain information on Americans who sent money to bank accounts or credit cards in thirty foreign countries considered tax havens.

News Story: Silicon Valley.com

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It’s Time To Vote (Again)

Posted on April 11, 2006 by Russ

Tuesday, April 11th is election day in Orange County. If you live in the 35th State Senatorial district, you will vote on the replacement for John Campbell. You can find your polling place here. Remember to vote!

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A Scam a Day Keeps the Doctor Away

Posted on April 10, 2006 by Russ

One of my clients today asked me about reporting of offshore (foreign) bank accounts. I reminded him that if you have $10,000 or more at any time in a foreign bank account or accounts, they must be reported by checking the boxes on Schedule B and by completing Form TD F 90-22.1 and mailing that form to the Department of the Treasury. The penalty for not reporting starts at $25,000. You can find yourself serving hard jail time if you don’t report them. The anti-money laundering statute has real teeth.

My client wisely agreed that reporting his foreign bank account was the right thing to do.

Of course, when I get home and check my email, I see this:

Dear ColleagueGullible Victim,

Thank you for your interest in our offshore fund products. The [deleted] Fund (Cayman) is a product that is attracting attention worldwide.

Offshore advisers and consultants are attracted to the product because it offers their clients exposure to private equity and because it pays significant cash commissions and the opportunity to participate in the profits of the fund manager.

Scam Highlights
Class A private equity shares target 20% to 25% annual returns
Class B shares provide a guarantee of principal by a financial institution rated AA by Standard and Poor’s with a term of five years and a target return of 12% to 15% per annum
Commissions paid to consultants and advisers are from 4% to 6%
Trailer allows you to participate in the profits of the manager for five to ten years
Class “A” Private Equity Shares are designed to provide sophisticated investors the opportunity to invest in a private fund that invests in some of the most promising alternative asset managers using a high growth strategy. The minimum initial purchase for Class A Shares is US$50,000 with a target return of 20% to 25% per annum.

Class “B” Capital Guarantee Shares are designed to provide investors with exposure to private equity without risk to capital. The Class B Shares also have a defined redemption date with a specified return rate. The minimum initial purchase for Class B Shares is US$50,000. Class B Shares shall be redeemed by the Fund in year five at a redemption price of 175% (75% over the original price).

If offering this product is of interest to you, please review the materials that can be found on the following link: [deleted]

We believe once you have read our materials and understand our fund model you will see the economic possibilities are substantial.

We look forward to your response.

Sincerely, [deleted]

In case you’re wondering, I didn’t request information on these offshore funds. I love how they say they’re targeting a 20% to 25% return. We all want a 20% to 25% annual ROR on our investments. The lack of comments such as, “Our Scam1 Fund returned 38% last year,” shows that the operators are becoming more sophisticated.

Now, it’s always possible that this fund is legitimate. Really….

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Nevada Ups the Ante

Posted on April 10, 2006 by Russ

As I perused this morning’s Orange County Register, I was surprised to see the Nevada Development Authority advertising in the Register. You can find the ad on page 7 of the business section. It reads:

“California Business Profits After: Worker’s Comp, Business Taxes, High Power Bills, Anti-Business Legislation = [hand shown holding some peanuts]. 5 Ways to lower your nut. Eliminate personal income tax, axe corporate income tax, don’t pay inventory tax, lower workers’ comp costs, relocate to Las Vegas.”

A similar ad appears in today’s Los Angeles Times. The NDA’s website has links to some of their television commercials, which are quite humorous (and effective).

Meanwhile, in the “Am I Really This Stupid” side of the ledger, both the Los Angeles Chamber of Commerce and the San Francisco Chamber of Commerce are supporting Proposition 82, the Mandatory Pre-School/Income Tax Increase, Help Las Vegas, Phoenix, and Denver Initiative. Showing some sanity, The California Chamber of Commerce opposes Proposition 82. If Las Vegas really wants to see an increase in business relocations, they should hope that Rob Reiner’s flawed initiative passes.

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