Are Tips (Gratuities) at the Poker Table Deductible?

Posted on December 21, 2015 by Russ

You win a poker tournament, and the floorperson asks you, “Do you want to leave anything for the dealers?” That’s a tip (or gratuity). I was recently asked, “Is that tax deductible? And what about when you’re playing a cash game; is the dollar you tip the dealer deductible?”

The Tax Code states that those in business can take deductions of their business expenses. That IRC § 162:

(a) In general
There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business….

The Tax Court has looked at this many times; for example, in Lychuk v. Commissioner (116 T.C. No. 27),

The Treasury regulations specify that ordinary and necessary business expenses include “the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer’s trade or business”, sec. 1.162-1(a), Income Tax Regs., such as “a reasonable allowance for salaries or other compensation for personal services actually rendered”, sec. 1.162-7(a), Income Tax Regs. The Supreme Court has explained that a cash method taxpayer such as ACC may deduct an expenditure under section 162(a) if the expenditure is: (1) An expense, (2) an ordinary expense, (3) a necessary expense, (4) paid during the taxable year, and (5) made to carry on a trade or business…The Supreme Court has stated that a necessary expense is an expense that is appropriate or helpful to the development of the taxpayer’s business…and that an ordinary expense is an expense that is “normal, usual, or customary” in the type of business involved, [internal citations omitted]

So let’s look at tipping when you win a poker tournament. First, it’s definitely an ordinary expense. Tipping is part of the culture of gambling and poker tournaments; it’s expected that winners will tip (especially when nothing is taken from the prize pool specifically for dealers). As long as the tip is reasonable, it’s clear that a professional poker player can deduct the tip as a business expense.

However, that’s not the case for amateur gamblers. Only those who are in the business of gambling can take business deductions. Thus, an amateur gambler cannot deduct his gratuities.

A secondary question arose: Does a player’s net win for W-2G purposes subtract any gratuities left? The answer to this is clear: No. A gratuity is not required, and only professionals are allowed to deduct gratuities. Thus, a W-2G simply takes a player’s gross win (what he cashed for) and subtracts his entry fee to determine the amount noted on the W-2G.

Now, what about cash games? It’s customary when winning a hand of poker to take a dollar out of the pot and give it to the dealer (as a tip). The same rules apply for cash games as tournaments. For professionals, gratuities are deductible; for amateurs, they are not. Technically, an amateur player needs to add back any gratuities given for his net win or loss. However, from a practical standpoint the custom (and it is just that, a custom) of tipping out of the pot makes it effectively already included in a player’s net win or loss for the session. Few (if any) players will calculate the amount of tips in a session and adjust their session results accordingly. From a practical standpoint, tips in cash games are already included in a player’s sessions results. This also means that you can’t separately deduct gratuities in cash games because you’ve already included them in your sessions results.

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Tax Season to Open on January 19th

Posted on December 21, 2015 by Russ

The IRS announced today that the 2016 Tax Season (for filing 2015 tax returns) will begin on Tuesday, January 19th. The tax deadline will be Monday, April 18th (for federal individual returns) except for taxpayers in Maine and Massachusetts–they get an extra day until Tuesday, April 19th (because of Patriots Day).

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Once Again, the IRS Doesn’t Start by Calling You

Posted on December 20, 2015 by Russ

My mother received a phone call on Saturday morning at 6 am from “Agent Smith” of the IRS demanding immediate payment of her taxes or she would find herself “thrown in jail.” Yes, the scamsters are still out there.

Now imagine you’re a senior citizen, and you get a phone call waking you up telling you to pay the IRS or you’ll find yourself in prison. It doesn’t take a genius to know that these scamsters can intimidate their victims.

Luckily, my mother is well trained. She’s already reported the scamster who called her. She knew it was phony because:

  1. The IRS never initiates collection activities with a phone call.
  2. The IRS will never call you in proscribed times without your permission. (It’s illegal to make collection calls at 6am on a Saturday morning.)
  3. The IRS will never demand payment without giving you appeal rights. And,
  4. “The IRS is a government agency. They wouldn’t have people working on a Saturday morning!”

I could add to that I’ve trained her pretty well on this. In any case, I hope that the lead passed on to TIGTA will result in one less scammer out there. And if you’re reading this Mr. Smith, don’t mess with my mother!

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The Great, the Good, and the Bad of the Extender Legislation

Posted on December 20, 2015 by Russ

Normally I would write about the good, the bad, and the ugly of the extender legislation. It’s different this year, because the legislation passed by Congress and signed into law doesn’t have much that’s ugly. Instead, there’s some great news, some good news, and a bit of bad news.

Let’s start with what I think are the two best things about the extender legislation. First, many provisions were made permanent:

  • Section 179 deduction of $500,000;
  • Taxpayers age 70 1/2 (or older) can make $100,000 annual charitable contributions from their IRAs that will not be included in their income;
  • The sales tax deduction (as an alternative to deducting state and local income taxes);
  • The educator expense deduction (and it’s also indexed for inflation); and
  • We have a sense of permanency on many of the extenders.  There are more items made permanent (some of which are detailed below), but the fact that these are made permanent makes it far easier to plan for taxes.

Second, a few states have barred Enrolled Agents (what I am) from calling themselves Enrolled Agents. While this provision has not impacted me directly, EAs in Ohio and North Carolina could not in the past call themselves EAs. This was due to lobbying from state CPA associations in those states. Section 410 of the PATH legislation (which is where the Extenders are) contains the following provision:

Section 410. Clarification of enrolled agent credentials. The provision permits enrolled agents approved by the IRS to use the designation “enrolled agent,” “EA,” or “E.A.” The provision is effective on the date of enactment.

So my colleagues in Ohio and North Carolina (and perhaps elsewhere) can now call themselves what they are.

There are a few more provisions that I would put in the “Good” section. The Child Tax Credit, the American Opportunity Tax Credit (an education/college credit), and the Enhanced Earned Income Credit were made permanent. The research credit and the five-year recognition period for the Built In Gains Tax (C Corporations converting to S Corporations) were also made permanent. (There are other items made permanent; I’m just noting the highlights.)

Some items were extended solely for five years. These include 50% bonus depreciation (which is being phased-out over five years), the new markets tax credit, the work opportunity tax credit, and a controlled foreign corporation provision.

Many other items were extended for just two years. Note that nothing was extended for simply one year, so we know today what 2016 taxes are going to be. This is likely the first time in ten years (or longer) that we’ve had a very good idea of what the Tax Code for a year would be on January 1st of that year. The two-year items include the ability to deduct mortgage insurance (as an itemized deduction), the “above-the-line” deduction for qualified tuition expenses, tax credits for renewable energy sources, and the exclusion for qualified mortgage debt forgiveness.

There are some bad items, and these include a couple of the points I’ve mentioned. I strongly dislike welfare being done through the Tax Code. It causes the Tax Code to be complex, and puts the IRS in a mission it shouldn’t be in. Second, I dislike refundable tax credits; they lead to fraud and are difficult for the IRS to manage.

Overall, the fact that this has passed means that Tax Season should be able to open around January 19th. And that’s perhaps the best news of all.

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2016 Standard Mileage Rates Released

Posted on December 17, 2015 by Russ

The IRS today announced the standard mileage rates for 2016:

  • $0.54/mile for business miles driven (down from $0.575/mile in 2015);
  • $0.19/mile for medical or moving purposes (down from $0.23/mile in 2015); and
  • $0.14/mile in service of a charitable organization (unchanged; set by statute).

You can either use this standard mileage rate or use actual expenses. Either way, it’s important to keep a mileage log!

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That’s A Lot of Roast Beef Sandwiches

Posted on December 15, 2015 by Russ

Nick’s Famous Roast Beef is in Beverly, Massachusetts. You can get a roast beef sandwich for $4.50 to $6.95, definitely a reasonable price. The Department of Justice is alleging that one reason the prices are low is that the owners skimmed $6 million from the business to lower their taxes. The owners of the business and the son of one of the owners have been charged with tax evasion.

Nick’s only takes cash, and the owners are alleged to have done a variation of the two sets of books idea: two sets of cash register tapes.

The indictment alleges that Eleni Koudanis had primary responsibility for the book-keeping functions of the business, and also recruited employees, including her son Steven Koudanis, to create false cash register receipts to use in connection with an IRS tax audit of Nick’s Famous Roast Beef. The true cash register receipts were allegedly destroyed and not provided to the tax preparer who prepared the business and personal tax returns.

Nicholas Koduanis, Nicholas Markos, and Eleni Koudanis were each charged with one count of conspiracy to defraud the US by obstructing the IRS and ten counts of aiding and assisting in the filing of false tax returns. If convicted, they are looking at spending some time at ClubFed.

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If a Professional Prepares Your Return, Are You Exempt from the Accuracy-Related Penalty?

Posted on December 14, 2015 by Russ

An attorney’s tax return had two major errors: $450,000 of gross receipts were left off the return and $505,417 of Contract Labor expenses were deducted as not only Contract Labor but also as Cost of Goods Sold. The return was audited, and the taxpayer agreed with the additional income and that the labor was double-deducted and pays the tax. However, he disputed the 20% accuracy-related penalty. The dispute ends up in Tax Court.

The amount of income underreported is enough where the penalty would apply if an exception doesn’t exist.

The section 6662 penalty does not apply to any portion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to * * * [it]…” Reasonable cause has been found when a taxpayer selects a competent tax adviser, supplies the adviser with all the relevant information, and consistent with ordinary business care and prudence, relies on the adviser’s professional judgment as to the taxpayer’s tax obligations.

Put simply, the Court didn’t believe that the attorney used sufficient care in reviewing his return.

Petitioners contend that they reasonably and in good faith relied on their C.P.A.’s advice in the preparation of their 2010 return. We disagree. On the basis of Mr. Ogden’s testimony at trial, we find that his cursory review of petitioners’ return did not constitute proper review…

A reasonable inspection of the return by petitioners would have uncovered both the unreported gross receipts and the improperly claimed deduction. Although petitioners’ C.P.A. [firm] testified that the portion of contract labor expenses treated as COGS on petitioners’ return was hard to spot, we believe Mr. Ogden had sufficient knowledge to detect the error on the return. Because Mr. Ogden prepared the Forms 1099-MISC for the attorneys at his firm, he should have known the total amount of contract labor expenses. Even so, the amount of contract labor expenses reported on petitioners’ return did not remotely match the amount of total contract labor expenses reported on Mr. Ogden’s law firm’s Form 1096. This, combined with the fact that petitioners did not report $450,000 of income on their return, shows that more diligence was needed on their part to reasonably assess their proper tax liability. [citations omitted]

There are a couple of lessons from this decision. First, have everyone you need at the trial. While the CPA who represented the taxpayer in the audit testified at the trial, the CPA who prepared the return did not. “Petitioners did not call the C.P.A. who prepared their 2010 return as a witness, and they presented no evidence that this C.P.A. gave “advice” that they could rely on.” This didn’t sit well with the Court.

More importantly, if you’re an attorney, a CPA, or an Enrolled Agent, the Tax Court is going to expect you to know tax law. You will also be held to a higher standard on any financial disputes. (The same will be true of other financial officers, such as a controller, CFO, etc.) When you’re reviewing a tax return, do not simply take a cursory look at the return. You should want to make sure it’s accurate. If you’re signing a return with $1 million of income, isn’t it worth more than a few seconds to review it? I would certainly think so. The Tax Court definitely did.

Case: Ogden v. Commissioner, T.C. Memo 2015-241

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Not a Pigg or a Turkey of a Decision

Posted on December 14, 2015 by Russ

Clarence Leland is an attorney in Mississippi. However, he bought a farm in Turkey, Texas. He entered into a crop share agreement with a Mr. Pigg. The farm didn’t make money, and Mr. Leland claimed the losses on his 2009 and 2010 tax returns stating he materially participated in the activity. The IRS didn’t allow the loss, claiming the passive activity rules prevented Mr. Leland from claiming the loss. They also added an accuracy-related penalties. The dispute made its way to Tax Court.

The passive activity rules prevent taxpayers from taking losses if they’re not materially participating in an activity. Mr. Leland didn’t maintain contemporaneous logs, but he was able to reconstruct logs that showed he worked 359.9 hours in 2009 and 209.5 hours in 2010. There was plenty of activity to be done on the farm:

Maintaining the 1,276-acre farm requires petitioner to perform a lot of long, hard work. Petitioner performs most of these tasks himself, but he sometimes has assistance from his son or a friend, Steve Coke. Aside from petitioner, Mr. Pigg, Mr. Coke, and petitioners’ son, no individuals perform any tasks on the farm. Petitioner visits the farm several times each year in order to perform necessary tasks, commuting approximately 13-16 hours each way, including the time it takes to load equipment onto his trailer. The farm has approximately 6-8 miles of perimeter roads and 18-20 miles of interior roads that must be bush hogged and disced regularly in order to remain passable. A Bush Hog is a device that is pulled behind a tractor to cut vegetation and clear land. Discing involves churning and plowing soil to uproot any existing vegetation. Trees and brush that grow near the roads must be controlled through spraying and chopping down limbs that protrude onto the roadways. Because high winds can erode soil on the roads, wheat must be planted each fall to prevent erosion on the roads and on acreage that is not part of the 130 acres planted and harvested by Mr. Pigg. Almost all of the roads have fences running parallel that must be maintained…In a year before the tax years 2009 and 2010, wild hogs ate 250,000 pounds of peanuts that petitioner and Mr. Pigg had grown on the farm. As a result, petitioner has to spend significant time controlling the wild hog population, which he accomplishes through hunting and trapping.

There are seven tests that allow one to qualify as materially participating in an activity, including “the individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.” Mr. Pigg spent about 30 hours on the farm in 2009 and a lesser amount in 2010.

Petitioner’s reconstructed logs, his receipts and invoices related to farm expenses, and his credible testimony are all reasonable means of calculating time spent on the farming activity during tax years 2009 and 2010…We are satisfied that petitioner’s participation was not less than the participation of any other individual, including Mr. Pigg, Mr. Coke, and petitioners’ son, during tax years 2009 and 2010…Accordingly, petitioner materially participated in the farming activity during tax years 2009 and 2010, and the deductions attributable to that activity are not limited by section 469.

From a footnote, we discover that the IRS objected to the logs was that they were not contemporaneous. But that’s not required:

Respondent’s main objection to petitioner’s reconstructed logs was that they were not prepared contemporaneously with the activity. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), does not require contemporaneous records, and we are satisfied that petitioner has established material participation through other reasonable means. Respondent did not dispute petitioner’s inclusion of travel time in his reconstructed logs. The facts of this case establish that petitioner’s travel time was integral to the operation of the farming activity rather than incidental.

So the decision is anything but a turkey for Mr. Leland, and the farming isn’t a passive activity. Mr. Leland also wins on the accuracy-related penalties, as the returns were accurate. It’s nice to see a plaintiff win at Tax Court on passive activities; I expect we’ll be seeing a lot more cases in this area in the future (because of the new net investment tax).

Case: Leland v. Commissioner, T.C. Memo 2015-240

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Six Month Vacation Leads to Four and Eight Years at ClubFed

Posted on December 13, 2015 by Russ

Everyone likes vacations. Last year, I went to New Zealand and Australia. Unfortunately, this year’s vacation wasn’t anything like that trip. An Oregon couple has learned that some vacations are better off not taken.

As I previously wrote, Ronald and Dorothea Joling decided after their conviction on tax charges to take a vacation to Arizona rather than show up for sentencing. The US Marshals Service apprehended the couple in Clarksdale, Arizona. On Thursday, Ronald Joling was sentenced to 97 months at ClubFed (eight years and one month) and Dorothea Joling received four years (48 months) at ClubFed. And there’s more! The Jolings are still waiting to be tried after being charged with filing retaliatory bogus liens against various federal judges, prosecutors, and the federal court clerk’s office.

Acting US Attorney for Oregon Billy Williams stated,

This is an egregious case. Not only did the Jolings refuse to pay their fair share of taxes like the rest of us, they retaliated against federal employees who were just doing their jobs. After a jury convicted them at trial, they cowardly refused to show up for sentencing and fled the state. They were fugitives for six months, requiring additional resources to locate and arrest them in Arizona. They are now in custody and will serve their appropriately lengthy sentences.

You will have to wait another eighteen days to see if the Jolings’s actions are good enough to win the 2015 Tax Offender of the Year award.

Posted in Oregon, Tax Evasion | 1 Comment

NY Judge Rules Against DFS Sites

Posted on December 11, 2015 by Russ

New York Judge Manuel Mendez granted the New York State Attorney General a preliminary injunction that bans DraftKings and FanDuel from operating in New York. Both sites will appeal, but for now daily fantasy sports (DFS) is gone from the Empire State.

As for legislative solutions, there’s an additional issue raised by attorney Daniel Wallach this morning: The Professional and Amateur Sports Protection Act of 1992. This act banned traditional sports betting in all but four states. Mr. Wallach believes that the law could be read to ban DFS, too:

This decision shouldn’t be a surprise, and I expect it to be upheld on appeal. (Note that I am not an attorney, so please don’t take what I write as legal advice.) As I wrote back in mid-November, I expect more states to ban DFS while some will move to explicitly allow it (by regulating it). Remember that the first instinct of any regulator is to ban anything that’s new. With DFS not only is that an issue, there’s also the dubious legality of it.

UPDATE: DraftKings and FanDuel filed appeals. Both sites received temporary stays against the original injunction until January 4th.

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