Wayfair and Economic Nexus

Posted on June 24, 2018 by Russ

Last week the Supreme Court ruled in South Dakota v. Wayfair that South Dakota’s law forcing Wayfair, an Internet retailer, to collect (and remit) sales tax to South Dakota (a state that it did not have physical nexus to) was valid. The decision overrides a previous Supreme Court decision called Quill Corp. v. North Dakota). There’s been plenty of excellent coverage on this ruling (see, for example, the Tax Foundation and Kelly Erb). But I’m wondering what this means for income tax and economic nexus.

A few states have passed laws stating that if you have economic nexus to a state you need to file a tax return to that state. California is one such state. Eventually, cases on economic nexus will go through the court system (and with a certainty the US Supreme Court will have the final say). While no one knows how the Court will rule on such cases, there are indications.

From a case called Complete Auto: “The Court will sustain a tax so long as it (1) applies to an activity with a substantial nexus with the taxing State, (2) is fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services the State provides.” In Wayfair, the Court ruled that “Physical presence is not necessary to create a substantial nexus.”

The key point is noted by Justice Kennedy:

The Court has consistently explained that the Commerce Clause was designed to prevent States from engaging in economic discrimination so they would not divide into isolated, separable units. See Philadelphia v. New Jersey, 437 U. S. 617, 623 (1978). But it is “not the purpose of the [C]ommerce [C]lause to relieve those engaged in interstate commerce from their just share of state tax burden.” Complete Auto, supra, at 288 (internal quotation marks omitted). And it is certainly not the purpose of the Commerce Clause to permit the Judiciary to create market distortions. “If the Commerce Clause was intended to put businesses on an even playing field, the [physical presence] rule is hardly a way to achieve that goal.” Quill, supra, at 329 (opinion of White, J.).

So four questions need to be answered for whether a state can tax a service business conducting no services within that state. Let’s assume there’s a tax preparation business in Nevada that has customers in New York, and New York passes a law saying that if you have any sales to New York residents you must pay New York state income tax and register your business in New York. The questions that must be answered are: Is their substantial nexus to New York, is the tax fairly apportioned, does it discriminate against interstate commerce, and is the tax fairly related to the services that New York provides. We’ll assume the tax is fairly apportioned.

Consider a Nevada tax professional who has one client in New York out of one thousand total clients. Is there substantial nexus? Almost certainly not, and it would be hard to see such a tax passing muster. Thus, some sort of de minimis rule is necessary. Note that in the instant case that the South Dakota law has such a rule.

Consider now a Nevada tax professional who has 200 clients in New York out his one thousand clients. We’ll assume that passes the de minimis hurdle. The two other questions (and I think they’re linked) come into play: Is the tax fairly related to services that New York provides and does it discriminate against interstate commerce?

The first of these questions has two sides. All of the work done here (remember, this is a service business) is being done in Nevada, not New York. That leads to a conclusion that New York income tax is not related to services provided by New York. (However, if New York had a sales tax on services the business would likely need to comply.) On the other hand, the person contracting for the services is a New York resident.

I think the first argument is the better one. The income being earned is based off of work done in Nevada, not New York. Nevada, not New York, has the right to tax its residents on income earned in the state. Because of this, I think that if New York were to tax such income it would discriminate against interstate commerce. (There is an other side to this argument, though. New York can argue that there would be a tax credit available, and that would eliminate the issue. Still, the filing of the return adds to the burden of the Nevada taxpayer, and is an issue.)

That there are two sides to this argument shows that there is no one right answer. In the end, the Courts will end up making the decision about economic nexus and income tax. Indeed, sometime around 2021 I expect a Supreme Court decision on this issue.

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Gambling with an Edge Podcast

Posted on June 22, 2018 by Russ

I was the guest on this week’s Gambling with an Edge podcast. You can download the podcast here or on iTunes. The main point of discussion was the new tax law, but we covered some other topics such as bad tax states for gamblers, the Cincinnati Reds’ bobblehead case, and yesterday’s ruling in South Dakota v. Wayfair.

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Battling for Tax-Free Bobbleheads: Will Reds Win in Court?

Posted on June 14, 2018 by Russ

This has not been a good year for the Cincinnati Reds. With just 25 wins in 68 games they have the worst record in the National League. While they have one of the best players in baseball–Joey Votto–the rest of the team leaves something to be desired. They’ve been outscored, out-pitched, and out-defended. And now they’re at the Ohio Supreme Court in a case about bobbleheads.

Yes, bobbleheads. The Department of Taxation conducted an audit of the Reds and determined (among other things) that promotional items were subject to Use Tax. Use Tax is the equivalent of sales tax when something is purchased without sales tax being applied. The Reds argued that a portion of the ticket price (for a Reds game) was for the promotional item; the Department of Taxation felt otherwise. The Reds appealed to the Board of Tax Appeals. The Board noted,

[W]e conclude that the promotional items given to patrons on specific game days were not “resold” to the patrons as part of the ticket price of admission, but were given away for free, primarily to increase interest in certain targeted games or generally increase interest among a broader audience. The evidence in the record supports our conclusion that the cost of the subject promotional items is not included in the ticket price. Specifically, the ticket price for each particular seat is the same throughout an entire season, regardless of whether a promotional item is being offered. Moreover,
patrons are not guaranteed that they will receive one of the promotional items, as there are limited quantities that are distributed while supplies last…[We] cannot conclude that the Reds’ patrons are actually “purchasing” a promotional item, especially when they are attending a game where there is no promotional giveaway.

The Reds have appealed the decision to the Ohio Supreme Court. The Reds argue,

“The issue, simply put, is whether the Reds were obligated to provide the bobbleheads,” [Reds Attorney Steven] Dimengo said.

“Applying fundamental contract law, there was consideration… the consideration of the patrons to purchase a ticket and attend a game, he said. “And the Reds were obligated to provide the bobbleheads, consistent with their pregame promises.”

You can watch the oral arguments (held yesterday) at this link. A decision should be released in a few months.

Hat Tip: How Appealing

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IRS Interest Rates Unchanged for the Third Quarter of 2018

Posted on June 9, 2018 by Russ

The IRS announced yesterday that IRS interest rates will be unchanged for the third quarter of 2018:

The rates will be:

– 5 percent for overpayments, 4 percent in the case of a corporation;
– 2.5 percent for the portion of a corporate overpayment exceeding $10,000;
– 5 percent for underpayments; and
– 7 percent for large corporate underpayments.

As I tell clients interest works both ways: If you file after the April tax deadline, you owe interest to the IRS; if you file after the April tax deadline and receive a refund, you are paid interest. That interest is, of course, taxable.

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IRS Offers Penalty and Filing Relief on New Transaction Tax on Foreign Earnings

Posted on June 4, 2018 by Russ

Individuals who own foreign entities typically have complex returns. I prepare returns for three such individuals; they’re all on extension. Yet one item needed to be prepared for these individuals by April 18th: the new Section 965 transition tax.

One of the key issues with the §965 tax is that you needed to make an election by April 18th to elect to make your payment in eight equal installments. If you didn’t make the election, you owed all the tax with your 2017 tax filing–ouch! This was a difficult deadline for many individuals due to the complexity of their returns.

Luckily, the IRS today announced penalty and filing relief on the §965 tax. As the IRS noted,

• In some instances, the IRS will waive the estimated tax penalty for taxpayers subject to the transition tax who improperly attempted to apply a 2017 calculated overpayment to their 2018 estimated tax, as long as they make all required estimated tax payments by June 15, 2018.

• For individual taxpayers who missed the April 18, 2018, deadline for making the first of the eight annual installment payments, the IRS will waive the late-payment penalty if the installment is paid in full by April 15, 2019. Absent this relief, a taxpayer’s remaining installments over the eight-year period would have become due immediately. This relief is only available if the individual’s total transition tax liability is less than $1 million. Interest will still be due. Later deadlines apply to certain individuals who live and work outside the U.S.

• Individuals who have already filed a 2017 return without electing to pay the transition tax in eight annual installments can still make the election by filing a 2017 Form 1040X with the IRS. The amended Form 1040 generally must be filed by Oct. 15, 2018. See the FAQs for details. For more information about the transition tax and other tax reform provisions, visit IRS.gov/taxreform.

The FAQs noting this are available on the IRS website.

Do note this is not complete relief. Many taxpayers impacted by this will owe interest from April 15th; you also have to owe less than $1 million in transition tax. But it does allow many taxpayers to proceed in an orderly manner in determining what tax they will owe on Section 965 rather than rushing to meet a deadline. (Individuals outside of the US have until next Friday to timely file their returns. They can now file extensions and still, in many cases, elect the installment treatment for this tax.)

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A Thriller of a Decision Upcoming

Posted on June 3, 2018 by Russ

The Wall Street Journal yesterday highlighted Judge Mark Holmes of the United States Tax Court. Judge Holmes’s opinions are extraordinarily readable even to those who know little about tax law. I’ve noted Judge Holmes’s writings in the past (on the TurboTax defense, on strip clubs and hair bands, on human egg retrieval, and ‘substance over form’); luckily for tax nerds, it’s likely we will be getting lots more opportunities to read Judge Holmes’s writings (he was recently nominated by President Trump for another 15-year term on the Tax Court).

Why did the Journal spotlight Judge Holmes? Because he is the judge dealing with the estate tax case of Michael Jackson. As the Journal noted,

There’s also a biting side to his work. This year, in a dissent, he compared his colleagues on the Tax Court to the tyrannical Roman emperor Caligula and his practice of posting tax laws “in fine print and so high that Romans could not read them.”

“It is our custom to reconsider an issue when a circuit court reverses us. And today we have to choose either a well-reasoned opinion by a highly respected judge in America’s heartland, or Caligula,” Judge Holmes wrote. “We pick Caligula. I gingerly dissent.”

An estate tax return is based on the value of the estate on the date of death. When Mr. Jackson died, he was in financial trouble. True, today there’s a show here in Las Vegas that features his music and his estate is worth a lot of money, but was that the case on the date of death? Judge Holmes will let us know, and almost certainly in a way that will educate and elucidate at the same time. If you’re a Journal subscriber, I strongly recommend this article.

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You Mean My Checking Account Became a Savings Account?

Posted on May 31, 2018 by Russ

In what is definitely an “Oops” moment, two tax software products from Intuit (Lacerte and Intuit ProConnect Online) incorrectly transmitted information for 2018 California estimated payments. Checking accounts became savings accounts in the transmittal and the payments were rejected:

As a result, electronically transmitted estimated tax payments (Form 540-ES) for tax year 2018 transmitted to us between January 23, 2018, and April 25, 2018, could have been rejected by your client’s financial institution. Future scheduled payments transmitted during this timeframe could be impacted as well.

We are collaborating with Intuit to identify impacted taxpayers and assist with resolution. Intuit sent letters directly to affected tax practitioners. We will waive FTB-imposed dishonored check fees on impacted taxpayers’ accounts and will give taxpayers an opportunity to submit first quarter estimated tax payment that will be considered timely.

We are not impacted by this, but if you’re a tax professional using either software package and are impacted by this you should have been contacted directly by Intuit (on or about May 9th). If you’re a taxpayer and your first quarter 2018 California estimated payment was not debited by the Franchise Tax Board and should have been, contact your tax professional immediately.

Kudos to the FTB in working with Intuit and giving impacted taxpayers time to get this resolved.

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WSOP and Taxes: 2018 Update

Posted on May 30, 2018 by Russ

The 2018 World Series of Poker (WSOP) begins today here in Las Vegas. There are also several other tournament series that have either begun or will soon begin at the Venetian, Wynn/Encore, Aria, Planet Hollywood, Binion’s, Golden Nugget, and Orleans hotels. Very little has changed from 2017, but I am updating the post I did last year with some new information.

The WSOP has made one change that could impact some Americans: If you use a passport for identification, you must bring a second piece of identification (such as a state ID card). From the WSOP FAQs:

What Photo ID’s are acceptable?
The following forms of ID are acceptable:
US Passport [and Passport Card] (A second form, an unexpired governmental ID verifying physical address such as a valid Driver’s License will also be required with this first form of ID).

(A driver’s license or state ID by itself is sufficient.)

Good luck to those participating in this year’s WSOP! And now on to the meat of the post:

The tax environment has changed, so I’ve decided to do a thorough update of the tax situation for those attending the WSOP (and other summer poker tournament series here in Las Vegas). I’ll cover the basics of the tax situation, backing, foreign (non-US) backing, and non-American winners and what they will face with taxes. This post will be somewhat long, so I’m going to break this into sections that you can click on to open. The focus is on tournaments where tax paperwork is issued.

The Tax Basics

Backing by Americans of Americans

Backing: Non-Americans

Non-Americans and ITINs

[Note 1]: I recently became aware of a lawsuit in the Midwest where Caesars’ policy is being challenged. The lawsuit is scheduled for trial in late January 2018.

[Note 2]: It is likely the IRS would reject a Form 1040NR filed by Jon noting his extra withholding. The IRS won’t understand the issue given that there is no tax treaty issue (say, Jon is from Australia) and say, “Take it up with Caesars.” It’s a classic Catch-22.

Posted in Gambling | Tagged | 4 Comments

Back to the Old Drawing Board

Posted on May 23, 2018 by Russ

I’ve written before about certain states’ efforts to get around the new $10,000 cap on state and local taxes that can be deducted on federal tax returns. The IRS announced today they will be proposing regulations later this year on this issue. Here’s an excerpt:

In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay. The aim of these proposals is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities.

Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

This is anything but promising for the efforts of California and New York. Words like “circumvent,” “despite,” and “mindful” pretty much tell us how this is going to turn out. If the IRS were going to allow this, the notice would not have such negative words. Instead, it’s all but a certainty that the doctrine of “Substance Over Form” will dictate that these so-called charitable donations are anything but charitable donations and, instead, will be treated as state tax payments on federal tax returns.

The California and New York legislatures would be far better off looking for things to cut in their states’ budgets. I know of a certain railroad in California that could save the state at least $77 billion….

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The Deep State and Cryptocurrency

Posted on May 17, 2018 by Russ

There have been plenty of articles about the “Deep State” vis-a-vis President Trump. I’m not going into that; if you’re interested, Google is your friend. Rather, I’m going to look at the Deep State and cryptocurrency.

On May 1st the Wall Street Journal published an article titled, “World’s Second Most Valuable Cryptocurrency Under Regulatory Scrutiny” [pay link]. In the article, the Journal discusses possible regulatory action against Ether:

Bitcoin has largely escaped government oversight, but regulators are examining whether other widely traded cryptocurrencies should be regulated as securities, according to people familiar with the matter.

And today I received an email from the Securities and Exchange Commission (SEC):

If you’ve ever been tempted to buy into a hot investment opportunity linked with luxury travel, the Securities and Exchange Commission has a deal for you.

Check out the SEC’s Office of Investor Education and Advocacy’s mock initial coin offering (ICO) website that touts an all too good to be true investment opportunity. But please don’t expect the SEC to fly you anywhere exotic—because the offer isn’t real.

The SEC set up a website, HoweyCoins.com, that mimics a bogus coin offering to educate investors about what to look for before they invest in a scam. Anyone who clicks on “Buy Coins Now” will be led instead to investor education tools and tips from the SEC and other financial regulators.

“The rapid growth of the ‘ICO’ market, and its widespread promotion as a new investment opportunity, has provided fertile ground for bad actors to take advantage of our Main Street investors,” said SEC Chairman Jay Clayton. “We embrace new technologies, but we also want investors to see what fraud looks like, so we built this educational site with many of the classic warning signs of fraud. Distributed ledger technology can add efficiency to the capital raising process, but promoters and issuers need to make sure they follow the securities laws. I encourage investors to do their diligence and ask questions.”

The website features several of the enticements that are common to fraudulent offerings, including a white paper with a complex yet vague explanation of the investment opportunity, promises of guaranteed returns, and a countdown clock that shows time is quickly running out on the deal of a lifetime.

As poker players know from “Black Friday,” regulators believe that which is not clearly legal is illegal. And regulators make up the deep state, and have made it quite clear what’s coming on the horizon. The regulators are going to act.

Are there legitimate ICOs? Of course, but given what regulators view as rampant fraud and abuse in cryptocurrency, the regulators are going to act. The Journal has this quote:

Peter Van Valkenburgh, director of research at Coin Center, said declaring ether a security “would make a shambles of U.S. innovation policy. It’s going to throw up a lot of barriers that aren’t necessarily sensible.”

Mr. Van Valkenburgh may be right, but there’s no doubt in my mind that’s the direction regulators want to, and will likely, go.

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