The 2019 Tax Season (Part 1): A Miserable Year

Posted on April 30, 2019 by Russ

This is my 19th year as a tax professional. By far, this past Tax Season was the worst of the nineteen I’ve experienced. Why? Well, there were a multitude of reasons.

First, I had a personal issue that impacted my family. For me, that was a top priority, and it caused me to miss about ten days of work since the new year began. I don’t regret that in the least–my family is important to me. Still, the timing was poor (to say the least).

Second, tax reform. My clientele is primarily self-employed individuals. Almost all of them were impacted directly or indirectly by reform. While there are no state tax issues for Nevadans, we specialize in industries rather than a geographic location, so we had to deal with lots of differences for state taxes.

Third, tax software this year was far ‘buggier’ than in prior years. Tax reform was the culprit. Many new forms were not released until 2019, so software companies had no idea how to write their code. And when Tax Season began on the normal date, that meant there was less time to test the software so we (tax professionals) were basically working with beta software.

This was especially true regarding the Section 199A deduction (the Deduction for Qualified Business Income). For simple cases, the deduction is the lesser of 20% of business income or taxable income. For most (but not all) of our clients, we knew what the deduction should be (and the software got the answer correct). However, when taxable income exceeded the income threshold ($315,000 married filing jointly, $157,500 for others), the calculation becomes far more complex. Almost all of these clients are on extension, but we did have a few clients where I had to double-check the software as I felt it was not calculating the deduction correctly. That definitely added time to our workload.

Fourth, tax reform increased the number of clients who qualified for the Child Tax Credit (or the Credit for Other Dependents). These require an interview–and an interview taxes time. It’s only (on average) three minutes a client, but if you add 100 more clients needing this interview, that’s 300 minutes or five hours lost.

Fifth, tax reform implemented due diligence interviews for clients filing as “Head of Household.” That’s a minimal number of our clients; still, that’s probably another hour lost to interviews.

Sixth, explaining returns to clients took far, far longer. The new postcard-sized forms are a joke. With the old Form 1040, arithmetic worked. If line 39 was the sum of lines 37 and 38, you could just see the result. That’s not the case any more. In various places, you have to know that a + b will not equal c, because you have to add in (say) the result of Schedule 3, too.

Seventh, withholding tables were adjusted in 2018. Many taxpayers were expecting their normal refunds got smaller than expected refunds. This was not much of an issue for our client base (again, we deal primarily with self-employed individuals) but it did have some impact. We will check the withholding for any of our clients who wish this done, and we did notify our clients last year of this issue.

Overall, we estimate each return took, on average, ten percent longer than during the 2018 Tax Season. That doesn’t seem like much, but a few minutes here and a few minutes there, and sooner or later you’re talking lots of minutes gone. In speaking with other tax professionals I heard much of the same thing (returns took longer this year than last). I like what I do (yes, there are people who like being tax professionals) and have no plans to change, but this was the first April 15th where I wondered about when I’ll retire. I feel less of that today (fifteen days after April 15th).

There were some light moments this Tax Season. First, it snowed in Las Vegas! Yes, it really did.

Then there was the unnamed individual (not a client) who told me that I was wrong, and professional gamblers can no longer deduct business expenses. He had read our new book and just knew that the tax reform bill changed the law about deducting business expenses. (By the way, a professional gambler can still deduct his business expenses. What changed is that he can no longer take an overall loss based on his business expenses.) When I told him he was wrong, he started arguing with me. I asked him if he was a licensed tax professional, or had some other background in tax. When he said no, I suggested he read the new law or speak to a tax professional. He said that two of his friends knew more about tax than any tax professional. If you’re wondering how bad information spreads, wonder no more.

We have a lot of clients on extension. If you’re one of our clients on extension, do not wait to the last minute this year. Returns are taking longer, and those deadlines are meaningful. We don’t mind you sending your work to us piecemeal; that will mean less has to be done later. I strongly suspect that there will be individuals sending us their returns to start in October whose returns we cannot complete in time.

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Bozo Tax Tip #1: We Don’t Need No Stinkin’ Basis

Posted on April 12, 2019 by Russ

If there’s one issue in tax that tax professionals have trouble explaining to clients it’s basis. Your basis in an entity is, generally, the total of your investment in an entity plus income it generated less any distributions from it. If you’re an investor in a business, you can only take losses up to the amount of your basis. Sounds simple, right?

So let’s say you invest in an S-Corp, “Losing Money, Inc.” Unfortunately, it’s name matches what’s happened year after year. You invested $10,000 years ago, and each year your share of the loss has been $3,000. It’s year four of your ownership, and you get the K-1 showing the (as usual) $3,000 loss. Your tax professional tells you, “I’m sorry, but you’re only getting $1,000 of the $3,000 loss–you used up your basis.”

The IRS has been battling this issue for a number of years. Owners of businesses are supposed to keep basis statements. Most reputable tax professionals prepare basis statements for the partnerships and S-Corporations that they prepare returns for. It remains, though, the responsibility of the owner to keep track of the basis.

Anyway, the IRS has (in audits) seen many owners not have basis and still take losses. The IRS hasn’t had a good method to police this. This year, though, the IRS wised up. There’s an addition to the instructions for page 2 of Schedule E:

If you are claiming a deduction for your share of an aggregate loss, check the box on the appropriate line in Part II, column (e), and attach to your return a computation of the adjusted basis of your corporate stock and of any debt the corporation owes you. For details, see the Shareholder’s Instructions for Schedule K-1 (Form 1120S). [emphasis added]

Of course, some individuals may attach a phony basis statement to get around this issue, but that’s yet another bozo action (that’s committing a felony–lying on your tax return, which is signed under penalty of perjury). Still, it’s likely that the IRS has the right idea and this will lessen the problem. (I expect the IRS to expand basis reporting rules to partnerships in the near future.)

Of course, some individuals may simply ignore attaching the basis statement and play ‘audit roulette.’ That’s something else I can never advise. But if you want to enjoy the Bozo side of life, just keep ignoring your basis and take your loss year after year after year.

That’s the last of our Bozo Tax Tips for the 2019 tax filing season. We’ll be back with normal content, including a rather scathing review of this tax filing season, late next week.

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Bozo Tax Tip #2: We Don’t Need No Stinkin’ Employees (Especially Because We’re Lawyers)

Posted on April 11, 2019 by Russ

A few years ago, I first heard about the law firm that had no employees. Now, I can imagine a small firm of, say, three or four partners, with no clerical staff as a possibility. However, having dealt with enough attorneys there are always secretaries, paralegals, clerks, and junior lawyers because most clients don’t way to pay $400 an hour for typing.

Joe Kristan (who formerly had the Roth CPA tax update blog) wrote about the Donald Cave Law Firm in Baton Rouge, Louisiana. A few years ago the firm found itself in Tax Court claiming that the three associates of the firm weren’t employees because the owner, Mr. Cave, alleged he didn’t have enough control over them. Now, do you really believe that a senior lawyer at any firm would allow junior attorneys to do their own thing? Of course not, and the Tax Court didn’t believe it either.

That wasn’t the end of the story, though. The firm appealed and their fate at the Fifth Circuit was, well, what you would expect.

Finally, with respect to the law clerk, Michael Matthews, the record shows that Donald Cave hired Matthews and exercised complete control over the assignment of Matthews’ work for the Firm. Although Matthews also worked for other lawyers and law firms, providing services to multiple employers does not necessitate treatment as an independent contractor…Matthews was paid a salary by the Cave Law Firm of approximately $1250 every two weeks, which amounts to $30,000 per year, regardless of the amount of work he performed during that time period. Contrary to the Firm’s suggestion, Matthews was not paid a minimal amount for essentially piecework. Instead, he entered into a verbal contract with Donald Cave and the Firm for a fixed sum to provide services at the direction of Cave, and there was no evidence that he could reject any work he did not wish to perform. Furthermore, Matthews could neither increase his profit through his own skill and initiative, nor would he suffer the risk of any losses. Matthews also made no investment in the facilities because the Firm provided him with the amenities needed to complete his work.

Can you really imagine that a clerk at a law firm isn’t an employee? I can’t, and neither could the judges at the Fifth Circuit.

The point of this is to be careful about who you claim are independent contractors. If you give John a research project, and don’t control his activities, and he’s working in another state on his own, that truly sounds like an independent contractor. However, if John’s working in your office, and your supervising his every move, etc., trying to claim he’s an independent contractor when he’s really an employee can lead to a big heartache.

Additionally, some states are far tougher on the independent contractor/employee decision than the IRS. Indeed, my old homestead of California is probably the most difficult state in the country to have independent contractors. California’s Employment Development Department (EDD) has an excellent publication on this issue (EDD Publication 38). There’s even a help line you can call.

So if you really have independent contractors, great. But if you’re a law firm and you really, really think that your secretary and the filing clerk are independent contractors you are committing a Bozo act.

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Bozo Tax Tip #3: Only Income Earned Outside the US Is Taxable

Posted on April 10, 2019 by Russ

A few days ago I was explaining to a client the basics of the US Tax Code: All income is taxable unless Congress exempts it; nothing is deducible unless Congress allows it. That’s the basics.

My office is in Las Vegas, Nevada. I’m a US citizen. So I owe US income tax on my earnings, right? Of course I do. But where few willingly go the Bozo contingent jumps in. Here’s a method of avoiding tax on all your income. It’s been used by celebrities such as Wesley Snipes. So let’s use Section 861 of the Tax Code to avoid tax!

Section 861 states that certain items are always considered as income from within the United States. It does not say that income earned in the US is exempt from tax. But tax protesters claim that’s the case; courts, though, basically state, ‘You must be kidding.’ This argument has never been used successfully. In an audit or in court, if you use the Section 861 argument you have no chance of success.

The US taxes its citizens on their worldwide income. That includes the United States. Indeed, if that weren’t the case I’d be out of a job. Mr. Snipes received three years at ClubFed. In the long-run it’s far, far easier to simply pay your tax.

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Bozo Tax Tip #4: The $0.55 Solution

Posted on April 9, 2019 by Russ

With Tax Day fast approaching it’s time to examine yet another Bozo method of courting disaster. And it doesn’t, on the surface, seem to be a Bozo method. After all, this organization has the motto, Neither rain nor snow nor gloom of night can stay these messengers about their duty.

Well, that’s not really the Postal Service’s motto. It’s just the inscription on the General Post Office in New York (at 8th Avenue and 33rd Street).

So assume you have a lengthy, difficult return. You’ve paid a professional good money to get it done. You go to the Post Office, put proper postage on it, dump it in the slot (on or before April 15th), and you’ve just committed a Bozo act.

If you use the Postal Service to mail your tax returns, spend the extra money for certified mail. For $3.50 you can purchase certified mail. Yes, you will have to stand in a line (or you can use the automated machines in many post offices), but you now have a receipt that verifies that you have mailed your return.

About fourteen years ago one of my clients saved $2.42 (I think that was the cost of a certified mail piece then) and sent his return in with a $0.37 stamp. It never made it. He ended up paying nearly $1,000 in penalties and interest…but he did save $2.42.

Don’t be a Bozo. E-File (and you don’t have to worry at all about the Post Office), or spend the $3.50! And you can go all out and spend $2.80 and get a return receipt, too (though you can now track certified mail online). For another $1.60, you can get the postal service to e-mail the confirmation that the IRS got the return (for the OCD in the crowd). There’s a reason every client letter notes, “using certified mail, return receipt requested.”

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Bozo Tax Tip #5: Procrastinate!

Posted on April 8, 2019 by Russ

Today is April 8th. The tax deadline is just seven days away.

What happens if you wake up and it’s April 15, 2015, and you can’t file your tax? File an extension. Download Form 4868, make an estimate of what you owe, pay that, and mail the voucher and check to the address noted for your state. Use certified mail, return receipt, of course. And don’t forget your state income tax. Some states have automatic extensions (California does), some don’t (Pennsylvania is one of those), while others have deadlines that don’t match the federal tax deadline (Hawaii state taxes are due on April 20th, for example). Automatic extensions are of time to file, not pay, so download and mail off a payment to your state, too. If you mail your extension, make sure you mail it certified mail, return receipt requested. (You can do that from most Automated Postal Centers, too.)

By the way, I strongly suggest you electronically file the extension. The IRS will happily take your extension electronically; many (but not all) states will, too.

But what do you do if you wait until April 16th? Well, get your paperwork together so you can file as quickly as possible and avoid even more penalties. Penalties escalate, so unless you want 25% penalties, get everything ready and see your tax professional next week. He’ll have time for you, and you can leisurely complete your return and only pay one week of interest, one month of the Failure to Pay penalty (0.5% of the tax due), and one month of the Failure to File Penalty (5% of the tax due).

There is a silver lining in all of this. If you are owed a refund and haven’t filed, you will likely receive interest from the IRS. Yes, interest works both ways: The IRS must pay interest on late-filed returns owed refunds. Just one note about that: the interest is taxable.

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Bozo Tax Tip #6: They Shoot Jaywalkers, Don’t They? (Or Ignoring the FBAR)

Posted on April 5, 2019 by Russ

I have, unfortunately, become quite competent in the Report of Foreign Bank and Financial Accounts. That form is better known as the FBAR. It used to have the form number TD F 90-22.1 (yes, it really did) but now goes by Form 114. The form must be filed online through the bsaefiling center of FINCEN, the Financial Crimes Enforcement Network.

You must file an FBAR if you have $10,000 aggregate at any time during the year. The report for 2018 is due April 15, 2019. Do note that there is an automatic extension until October 15, 2019.

The form is fairly simple and straightforward: Note every foreign financial account you have with name, address, account number, and maximum balance at any time during the past year. Let’s say you have one foreign account, a bank account at the Royal Bank of Canada. You would take your maximum balance and convert it to US dollars from Canadian dollars (you should use the year-end Treasury Department conversion rates no matter when the high balance was). The form must be electronically filed and is filed separately from your tax return.

The penalties for not filing it are quite high. Willful non-filing has a minimum penalty of $100,000 or half the balance in the account–and that’s per account! There’s also possible jail time.

So what must be reported:
– Foreign Bank accounts;
– Bank accounts outside the US of a US financial institution;
– Foreign financial accounts where all you have is signature authority;
– Foreign securities accounts;
– Foreign mutual funds;
– Foreign life insurance with a cash or annuity value; and
– Online gambling accounts if outside the US.

There are probably others, too.

The IRS does have a chart that lists most things that need reporting on the FBAR and Form 8938. Form 8938 is the “cousin” of the FBAR; this form needs to be filed if you have larger balances in foreign accounts.

Millions of FBARs are filed each year. When I started in tax, filing an FBAR was a huge audit red flag; that’s no longer the case. There are just too many FBARs filed. Do note that if you have an FBAR filing requirement you must note that in question 7 at the bottom of Schedule B.

To end this with some humor, one of my pet peeves in dealing with taxes is that there are three different sets of abbreviations for foreign counties used in tax. The FBAR has one set; question 7 at the bottom of Schedule B has another set, and Form 8938 has a third set. Some countries are noted identically while others are not. On one of of the abbreviations Curacao is “CU” while that means Cuba in another.

In any case, the FBAR is no laughing matter. The IRS’s mantra here is to shoot jaywalkers. Don’t become such a person: If you have an FBAR filing requirement, file it! Again, the FBAR is due April 15th (but with an automatic extension until October 15th).

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Bozo Tax Tip #7: Be Frivolous

Posted on April 4, 2019 by Russ

I’d love to be frivolous during tax season. But the inbox is full, the piles of paper don’t go anywhere unless I move them, and my next day off is April 16th. I can get a good laugh when I get an email letting me know that, “Russ, you’re full of ****. There is no law mandating anyone file a tax return or pay income tax.” Yes, I received such an email today. It appeared that it was over one page, but after the first sentence I hit the delete key.

I’ve written about Richard Hatch. He got 51 months at ClubFed for his bout of frivolity. Wesley Snipes tried to say that only foreign-source income was taxable. He got 36 months at ClubFed.

Tax Court judges don’t have the same sense of humor that I do about frivolous arguments. Michael Balice found that out:

Petitioner has responded to this motion by contending (among other things) that he is not subject to IRS deficiency procedures and that wages are not “income” because they result from the exercise of his “irrefutable right to work.” We will grant the motion for summary judgment and sustain the tax deficiencies and additions to tax determined by the IRS. We will also require petitioner to pay under section 6673(a) a penalty to the United States in the amount of $25,000 for asserting frivolous positions in this Court.

I’ll make this simple: Yes, Virginia, there is an income tax and you must pay it. Or as my favorite author, Rex Stout, put it, “Either pay [the income tax] or suffer a loss of privileges.”

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Bozo Tax Tip #8: The Shell

Posted on April 3, 2019 by Russ

I was talking with a friend who is an attorney in the Midwest. She told me about an individual who decided to use ten layers of shell companies to hide his income. It worked so well that the Bozo had trouble accessing his income.

He was using the usual foreign shelter countries: the Cayman Islands (in the Caribbean), the Channel Islands (in the English Channel), the Isle of Man (in the Irish Sea), and Vanuatu (in the South Pacific). There was a land-based country in there, too: Panama. In any case, somehow the ownership got so messed up that one of the shells refused to deal with another.

My friend didn’t get involved to get the money situation resolved. No, she got involved because her client ended up going through a messy divorce, and her client’s now ex-wife happen to find one of the papers dealing with one of the shells companies. My friend’s a divorce attorney, and a good one, and she was able, with some help, find a lot of the hidden money. The judge was not as amused as I was hearing about the difficulties the man was having getting his money out. And neither was the IRS because he had “forgotten” to pay tax on a lot of income.

There are lots of good strategies for businesses to use to lower their taxes. Income balancing to C corporations can be a good strategy. Maximizing Section 179 depreciation is another. Retirement Accounts are another good strategy. There are many, many others. But hiding income in foreign jurisdictions is a very bad one, and if you get caught you are likely looking at a lengthy term at ClubFed.

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Bozo Tax Tip #9: Nevada Corporations

Posted on April 2, 2019 by Russ

Actually, this isn’t that much of a Bozo Tax Tip. Nevada is a great state to have your business in. But the key is being in Nevada (or operating in multiple states and selecting Nevada as your corporate domicile). You cannot escape California taxes by being a Nevada corporation if you’re still operating in the Bronze Golden State.

If the corporation operates in California it will need to file a California tax return. Period. It doesn’t matter if the corporation is a California corporation, a Delaware corporation, or a Nevada corporation.

Now, if you’re planning on moving to Nevada forming a business entity in the Silver State can be a very good idea (as I know). But thinking you’re going to avoid California taxes just because you’re a Nevada entity is, well, bozo.

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