Cash & Carry Your Way to Tax Evasion

Posted on September 27, 2015 by Russ

Kasia’s Bakery is a very successful bakery in New Britain, Connecticut. Its owner, Marian Kobryn, emigrated from Poland to the US to escape political oppression. He opened the bakery, and it’s been a great success.

The bakery operates on a cash-only basis. Mr. Kobryn was determined to lower his tax burden. Instead of making sure all expenses were noted on his tax returns and perhaps contributing to a SEP IRA, he decided to not deposit all of the cash into his business bank account. He knew about the currency transaction reporting (CTR) rules, so he made his cash deposits just under $10,000 and deposited them into several branches of his local bank.

While neither the Department of Justice report or the news report note what caused the initial IRS investigation, it’s a virtual certainty that it was his multiple deposits of cash. Mr. Kobryn apparently didn’t know about Suspicious Activity Reports (SARs). All financial institutions in the US are required to have programs to detect evasions of CTR rules. Additionally, the IRS investigates nearly all SARs while they don’t investigate many CTRs.

Mr. Kobryn’s evasion was of $730,000 of receipts, for a tax loss of $243,000. The penalties and interest totaled an additional $192,000. Mr. Kobryn was sentenced last week to time served (he is in poor health) and to make full restitution of the tax. He has already paid back all the tax and $50,000 of the penalties and interest. It’s a whole lot easier to simply pay the tax due in the first place…but that rarely occurs when you’re developing that perfect tax evasion scheme.

Posted in Connecticut, Tax Evasion | 1 Comment

Are Turf Rebates Taxable?

Posted on September 23, 2015 by Russ

The Los Angeles Times has an article asking this question. Because of the drought in California, the Metropolitan Water District had a $340 million incentive program so that homeowners would replace grass (which takes a lot of water) with bark, rocks, and other drought tolerant (xeriscape) landscapes. (The Southern Nevada Water Authority has a similar program.) The MWD has no idea if they have to issue 1099s to rebate recipients under federal law. (It is exempt from California taxation, though.) The article notes that the MWD suggests talking to a tax professional, so I’ll helpfully give an answer.

Any accession to wealth is taxable unless Congress has exempted that from taxation. One such exception are rebates on purchases. If you buy, say, a new car for $25,000 and receive a $1,000 rebate, you really bought the car for $24,000. A car rebate isn’t taxable income. Is the MWD (or SNWA) program a rebate?

No, it’s not. There’s nothing being purchased from the water agency. Instead, you’re tearing out grass, and replacing it with something else. The agency paying the “rebate” isn’t the same agency that’s doing the work. You might do it yourself, or you might higher a landscaping firm to do the work. The landscaping firm isn’t giving you a rebate.

If this isn’t a rebate (for tax purposes), then what is it? Well, the IRS could rule it’s not taxable since it is a lowering of the cost of doing the grass replacement and this is good for the environment. However, that’s not likely. There’s nothing in the Tax Code that says if something is done that’s good for the environment it’s not taxable. Instead, this looks like income–“Other Income” that would be reported on line 21 of Form 1040. You’re receiving a reward (income) for doing something. It’s not a rebate of a purchase. It’s not exempt from taxation under any other of the exemptions under the Tax Code. Thus, it’s taxable income.

Posted in California, Nevada | 23 Comments

Kiplinger’s Tax-Friendly and Least Tax-Friendly States: Bring Me (Mostly) the Usual Suspects

Posted on September 21, 2015 by Russ

Kiplinger has come out with their list of most tax-friendly and least tax-friendly states. There aren’t many surprises on the list, and readers of this blog definitely won’t be shocked with the least friendly state. The most friendly state was a little different. Do note that Kiplinger looked at all the taxes in a state, not just income tax.

Most Tax-Friendly States:
1. Delaware
2. Wyoming
3. Alaska
4. Louisiana
5. Alabama
6. Mississippi
7. Arizona
8. New Mexico
9. Nevada
10. South Carolina

Why Delaware? It has a relatively low income tax, no sales tax, low property taxes, and low a excise tax on alcohol. My state, Nevada, is noted for its non-existent income tax.

Here is Kiplinger’s least tax-friendly states:

1. California
2. Connecticut
3. New Jersey
4. Hawaii
5. New York
6. Rhode Island
7. Vermont
8. Maine
9. Minnesota
10. Illinois

Why California?

If you’re moving to the Golden State, plan to take short showers (to conserve water) and to pay the highest state income tax rates in the U.S. Worse, capital gains are taxed as regular income.

California also has the highest statewide sales tax, at 7.5% (it’s scheduled to drop to 7.3% at the end of 2016). The average state and local combined rate is 8.4%; in some cities, the combined rate is as high as 10%.

There’s actually more bad news about California’s taxes noted in the short article.

Kiplinger also has a tax map so you can find your state and whether it is tax-friendly or not.

Posted in California, Delaware, Nevada | Tagged | 1 Comment

We Don’t Need No Stinkin’ Phone Calls

Posted on September 21, 2015 by Russ

The Treasury Inspector General for Tax Administration (TIGTA) released this morning an analysis of the 2015 filing season. There is both good news and bad news in the report.

First, some good news. The IRS has improved the detection of fraudulent tax returns and identity theft returns. In 2012, the IRS processed 9.11% of fraudulent returns (311,717 of 3,422,505); in 2014, it only processed 5.24% (114,219 of 2,180,613). (Note that this is based on the processing year, so this statistic relates to 2011 returns processed in 2012 and 2013 returns processed in 2014.) The IRS has also made strides in detecting identity theft returns. There were 382,398 such returns processed in 2013, but that number decreased to 236,313 in 2014 and 141,214 in 2015. That’s still too many, but stopping two-thirds of such returns is a significant step forward.

Of course, for every step forward there’s usually a step backwards. And for the IRS that’s been in customer service on the phone. In the 2013 fiscal year, the IRS answered 15,609,615 calls with a 69.8% “Level of Service” and an average speed of answer of 14.1 minutes. In the 2015 fiscal year, the IRS answered 8,277,064 calls with a 37.6% “Level of Service” and an average speed of answers of 23.5 minutes. (“Level of Service” is defined as, “The primary measure of service to taxpayers. It is the relative success rate of taxpayers who call for live assistance on the IRS toll‑free telephone lines.”)

So let’s translate this into reality. In the 2013 fiscal year, 22,363,345 phone calls were attempted to various IRS toll-free lines; 15,609,615 were answered (69.8%). In the 2015 fiscal year, 22,013,468 phone calls were attempted to various IRS toll-free lines; 8,277,064 were answered (37.6%). As for the time on hold allegedly decreasing to 23.5 minutes, perhaps that’s after excluding all the time some of the 7 million people who called but whose calls were dropped or who hung up spent on the phone. I’d love to see an average time of 23.5 minutes when I call the IRS Practitioner Priority Service.

Unfortunately, the volume of IRS notices hasn’t changed from year-to-year, but the “Service” part of the name Internal Revenue Service is falling away. This has negative consequences; it is likely that Americans’ compliance with tax laws will decrease because they’re guessing on what to do rather than being able to talk to the IRS.

Posted in IRS | 1 Comment

A 0% Chance of Success Didn’t Deter Him!

Posted on September 20, 2015 by Russ

Ronald Reagan said, “Facts are stupid things.” Well, one fact that I’ve mentioned in the past is that IRS Criminal Investigations looks at all allegations of employment tax fraud. The reason is obvious: The IRS doesn’t like the idea of people stealing from them. I’ve been saying this for the ten-plus years that I’ve been writing this blog.

Andrew Parish of Chillicothe, Ohio apparently doesn’t read this blog, and also apparently didn’t consider how his scheme would fail. Mr. Parish hired a firm to prepare his payroll and send the reports to the IRS and Ohio–all well and good so far. He then decided to issue paychecks directly. That wouldn’t have been an issue if Mr. Parish had told his payroll company. I’m sure you’re a couple steps ahead of me: He didn’t, nor did he issue his own payroll reports. But he did include the withholding on the paychecks.

The employees naturally included this withholding on their tax returns. That withholding wasn’t going to match IRS records, and sooner or later the IRS was going to investigate. When the amount missing matched the amount of those paychecks, it wasn’t going to take a genius to figure out where the error occurred.

(An interesting digression: This past April one of my clients received an IRS notice because the withholding on his return didn’t match IRS records. I looked at the W-2’s (my client had multiple employers) and they matched perfectly. It turns out that the error is exactly the amount of the withholding from one employer, and that money apparently hasn’t made it to the IRS. My client is a pack-rat, and had all of his paychecks and his W-2’s, and everything tied perfectly. The IRS requested a copy of those records; it is a near certainty that IRS Criminal Investigations is looking into this. But I digress….)

As for Mr. Parish, he pleaded guilty earlier this year to failing to account for and pay over employment taxes to the IRS. He was sentenced to 18 months at ClubFed and must make restitution of $341,336. A helpful hint to those thinking of not remitting employment taxes: This had a zero percent chance of success in 2005 and the odds haven’t improved in the last ten years.

Posted in Payroll Taxes, Tax Evasion | 1 Comment

The NAEA Won’t Like This Post

Posted on September 14, 2015 by Russ

I’m a member of the National Association of Enrolled Agents. Generally, I’m supportive of their policies. However, I am not a fan of mandatory preparer regulation. Other than giving the IRS more money and getting rid of the lowest hanging of the bad preparers, preparer regulation won’t accomplish many positives for the general public. Unfortunately, the Senate is about to include preparer regulation in a bipartisan tax bill.

Joe Kristan noted this earlier today.

In June 2011, the IRS issued final regulations that established a new class of tax practitioners known as “registered tax return preparers” that it sought to regulate for the prepared by these now unregulated tax return preparers. There is substantial evidence indicating that incompetent and unethical tax return preparers are harming both their clients and the government. Most of the tax returns that involve refundable tax credits are prepared by unregulated tax return preparers.

Since 2011, the D.C. District Court (and the D.C. Circuit affirming on appeal) has prevented the IRS from enforcing these regulations on the grounds that the IRS’ authority to regulate practitioners is insufficient to permit regulation of tax return preparers who do not practice or represent taxpayers before an office of the Treasury Department.

The provision provides the Treasury Department and the IRS with the authority to regulate all aspects of Federal tax practice, including paid tax return preparers, and overrides the court decisions described above. [Joe’s emphasis]

So let’s consider what preparer regulation does:

1. “It stops identity theft.” Do you really think identity thieves will go away just because preparers are regulated? The TurboTax crew (thieves who buy TurboTax and prepare multiple phony returns) aren’t going away (until they get caught). And earlier this year the IRS itself contributed to identity theft.

2. “The IRS will now be able to put a stop to bad preparers.” Well, yes, but the IRS currently has means of going after bad preparers. They can get court orders, and they do.

3. “Bad preparers won’t register.” Preparer regulation will get rid of two classes of preparers: the lowest of the low-hanging bad preparers who can’t pass a multiple choice exam and preparers who either can’t afford to take the classes/exam or decide to retire and not deal with a bureaucracy. Look at who were plaintiffs in Loving v. IRS. The crooks who violate one law won’t care about violating another.

4. “The NAEA and the AICPA are for it, so it must be good.” Well, it will eliminate some competition, so it will increase the number of tax returns that will be prepared for members of both professional societies. Of course, what’s good for professional societies (and their members) will be bad for the general public; prices are certain to increase. Supply (of tax professionals will decrease), so price will increase.

The above are the most common arguments for regulation. None of them are, imho, persuasive. As Joe Kristan alluded to, the real winners will be H&R Block and other chains.

I’ve been asked by members of the NAEA why I’m against preparer regulation. All it does is increase a bureaucracy, decrease consumer choice, increase prices to the general public, and uses limited IRS resources instead of where they could be better used. I don’t mind competition, and the IRS currently has means of going after bad preparers.

Posted in IRS | Tagged | 2 Comments

Defalcations Send Randolph Scott to ClubFed

Posted on September 13, 2015 by Russ

When I hear the name Randolph Scott, I think of the late actor. He played leading men (generally heroes in Westerns) during his long and illustrious career. This Randolph Scott is anything but a hero.

Randolph Scott of Doylestown, Pennsylvania (near Philadelphia) was an estate and probate attorney. He represented an estate, one valued at more than $6 million (at date of death in 2005), so an Estate Tax Return needed to be filed. Estate tax of $520,351 should have been paid to the IRS. That didn’t happen.

Instead, Mr. Scott diverted “approximately $2,317,917.67” from the estate to his tax office. That’s theft. In 2009, the executor of the estate died. From the Department of Justice press release:

Scott failed to disclose the executor’s death so that Scott could continue to receive money intended for the estate at his law firm. Scott would then forge the deceased executor’s signature and deposit funds intended for the estate into accounts under his control. Scott had the successor executor sign a document renouncing the position of successor executor so that Scott could continue to forge the signature of the deceased executor and divert money belonging to the estate.

Mr. Scott pleaded guilty back in March to mail fraud, tax evasion, attempting to interfere with administration of internal revenue laws, and three counts of failure to file income tax returns. He was sentenced on Thursday to four years at ClubFed and must make of the $2.3 million he stole. Unlike a Randolph Scott movie, the only happiness with this ending is that this Randolph Scott won’t be doing this to anyone else.

Posted in Estate Tax, Tax Evasion, Tax Fraud | 2 Comments

How Should Multiple Buy-Ins for a Poker Tournament be Handled on a W-2G?

Posted on September 9, 2015 by Russ

Poker tournaments today have various forms. Some are “freeze-outs,” where you can only buy into the tournament once. Some have rebuys and add-ons, where if you lose all your chips you can rebuy into the tournament and if you’re in the tournament at a certain point you can purchase an “add-on” of additional tournament chips. A format that has grown in popularity is the multiple reentry tournament. Here, if you lose all your chips you can reenter the tournament. The difference between this and a rebuy tournament is that in a reentry tournament you pay the house fee for running the tournament; in a rebuy tournament, your rebuy goes exclusively into the prize pool.

The IRS Office of Chief Counsel issued an opinion back in July (but released last week) on how to treat multiple buy-ins for a poker tournament vis-a-vis issuing W-2Gs. Do note that this is solely the opinion of the Chief Counsel’s office; a court could make a completely different ruling. That said, the analysis looks correct to me.

The issue the IRS counsel needed to answer was, “Whether multiple buy-ins should be deducted as individual wagers or in the aggregate from winnings in a poker tournament for the purposes of reporting the winnings on a Form W-2G?” The conclusion the IRS came to is that multiple buy-ins are not identical wagers and should not be aggregated. Although this is a bad ruling for recreational gamblers, I think the IRS got it right.

So when a person rebuys is it an identical wager? “Of course it is, Russ; the person is paying the same amount for the entry into the tournament.” Yes, that’s correct but is his situation identical?

The IRS noted that the preamble to Treasury Decision 7919 explains the rule on identical bets.

…winning on identical bets must be aggregated to determine if the $1,000 floor has been exceeded. This ensures that bettors are treated the same, whether or not a wager is divided into several small components. Identical bets are those in which winning depends on the occurrence (or non-occurrence) of the same event or events. For example, two wagers on a horse to win a particular race general[ly] are identical. … [But] … wagers containing different elements, e.g., an “exacta” and a “trifecta” are not identical.

The issue is that the conditions when you reenter a poker tournament are not identical. Consider if you buy-in before the tournament begins, and there are 100 entrants. When you reenter, there are now 120 entrants. The prize pool is different, your chances of winning are different, and, most likely, the opponents at your table will be different. While the amount wagered is identical, the wager itself has a different chance of success.

The conclusion the IRS draws is correct:

Multiple buy-ins into a single poker tournament event are not identical wagers and therefore should not be aggregated for purposes of withholding and reporting requirements under section 3402(q) and the regulations thereunder. If a player wins a prize at the close of a tournament, only the buy-in that resulted in the win should be deducted from the winnings to determine the “proceeds from a wager.”

While I agree with the conclusion, this is not good for players (or for poker). First, for professional gamblers this is a non-issue. A professional gambler nets his wins and losses, so while a W-2G may have a larger win, the professional gambler can offset that by his higher losses. Nothing has changed for him or her.

However, the situation is different for amateur gamblers. An amateur gambler cannot not his wins and losses. Wins are Other Income (line 21, Form 1040) while losses are an itemized deduction on Schedule A. This ruling will cause an amateur gambler’s Adjusted Gross Income (AGI) to increase. An increased AGI has numerous deleterious effects, including (but not limited to):

  • You lose the value of exemptions;
  • You can lose certain itemized deductions both directly (2% AGI, 7.5%/10% AGI restrictions) and through the phase-out of itemized deductions (note that gambling losses are not impacted by this);
  • You can lose the ability to deduct student loan interest;
  • You may lose tax credits for health insurance; and,
  • Some states do not allow deductions for gambling losses, so if you’re a resident of one of those states you must pay tax on artificial “wins”.

Personally, I think that the reentry format is bad for poker. (A discussion of that has far more to do with the health of the poker economy than taxes.) This ruling from the IRS appears to be legally correct but is another blow to amateur players.

Posted in Gambling | Tagged | 2 Comments

Ghost Hunter, Pheasant Hunter, or Deduction Hunter: No Matter, He Loses at Tax Court

Posted on September 8, 2015 by Russ

My favorite Tax Court judge, Mark Holmes, is out with an opinion where Ghostbusters makes an appearance. And once again keeping records would win the day but perhaps that would take a supernatural effort from today’s petitioner.

David Laudon is a chiropractor licensed in Minnesota. He made nearly $290,000 in bank deposits from 2007 to 2009 yet reported only a bit less than $210,000 in gross receipts on his returns. He deducted as business expenses for his chiropractic home office a Microsoft Xbox 360, Nintendo Wii, and numerous pieces of hair-salon equipment. He also claimed deductions for driving tens of thousands of miles throughout Minnesota and the Dakotas–both to treat patients and to perform an assortment of other services. The Commissioner thought this was a stretch and urges us to support his adjustments.

This doesn’t look good, especially when I see the words,

Some of Laudon’s stated reasons for making these trips strain credibility: for example, driving to a “schizophrenic” patient who was–on more than one occasion–“running scared of demons” down a rural Minnesota highway, or driving to a patient’s home in a Minneapolis suburb– expensing 261 miles–because he had received a call from police that she had overdosed on OxyContin prescribed by her physician. Laudon claimed to have driven hundreds of miles per day–sometimes without a valid license–to see patients, but several of these trips were for medical procedures he was not licensed to perform. Even his testimony about multiple entries in the logs where he wrote “DUI” was not credible: He claimed that these were not references to being stopped by police while under the influence, or driving while his license was suspended, but instead were his misspellings of a patient named “Dewey”–a supposed patient of his. [emphasis in original]

That’s just a taste of the decision. I won’t go into the minutiae, but I think you’ve got a taste of what’s going on. The details include unreported income (“But because he didn’t produce any evidence verifying that these amounts were deposited into the relevant accounts, Laudon hasn’t met his burden of proof.”), an automobile log that was “‘not a complete itemized thing'” led to those deductions being denied, and a home office that wasn’t exclusive (“We particularly disbelieve his claim that the Xbox, Wii, big-screen TVs, and other electronics in his basement were used exclusively for chiropractic purposes since this claim conflicts with his much more plausible admission to the IRS examiner during audit that his daughter and his girlfriend’s son would play these video games while he was on the phone.”) and had no substantiation led to that being denied.

As I’ve said in the past, keep a mileage log. Keep records of your deductions. Ask your tax professional about the rules to have a home office. And keep good records.

Case: Laudon v. Commissioner, T.C. Summary Opinion 2015-54

Posted in Uncategorized | 1 Comment

The Family that Commits Tax Evasion Together Goes to ClubFed Together

Posted on September 6, 2015 by Russ

You own a payroll company with your son. It’s been a good year, so you decide to give yourself a bonus from the corporation. There’s nothing wrong with that–it’s your company, and you certainly can pay yourself whatever you feel is appropriate. You do need to report that income on your tax return, of course. That last step was omitted by the subjects of this post.

William and Robert McCullough are a father and son who reside in Westborough, Massachusetts. They own a payroll company, Harpers Data Services, in Worcester, Massachusetts. There company did quite well from 2007 to 2012, as they deposited $11 million in two company bank accounts. They didn’t tell their company accountant about those two accounts. Well, the corporation only omitted $3.78 million from the corporation tax return.

Meanwhile, William McCullough wrote checks to himself, his son, and Gary Davis, a former owner of the business. One series of checks totaled $4.7 million; another was $2.7 million. That allowed the McCulloughs and Davis to avoid $1.7 million of personal income tax. The McCulloughs and Davis pleaded guilty to various tax evasion charges last week. William McCullough also pleaded guilty to wire fraud.

From 2009 through 2011, Harpers maintained client trust accounts and a client tax account. These accounts contained client funds, which were to be used to pay employees’ paychecks and employees’ federal and state taxes. From 2009 through 2011, William McCullough took approximately $1 million from the client trust accounts and deposited it into a Harpers account. In 2010, he took $750,000 from the client tax account and deposited it into a Harpers account. At the time William McCullough took this money, the funds belonged solely to the clients of Harpers Data Services. McCullough’s fraud resulted in a theft of approximately $1.8 million dollars.

The McCulloughs and Mr. Davis will almost certainly be heading to ClubFed. This is yet another reminder for everyone who uses a payroll service to join EFTPS and make sure your payroll deposits are being made. Trust but verify is excellent practice in payroll.

Posted in Tax Fraud | 1 Comment