Monthly Archive: December 2014

Gambling Losses Gambling Winnings

Welcome to TaxView with Chris Moss CPA.

Back in the 60s if you wanted to “gamble” you went to Las Vegas. Then Atlantic City opened up shop in the 70s as did many State Lottery games. After President Reagan signed the Indian Gaming Regulatory Act (IGRA) you even had more choices in the 80s. More recently in the early 21st century internet gambling opened up for business. According to the American Gaming Association, Americans now gamble over $50 billion annually with no end in sight. With all these new gaming venues, more and more Americans are trying their luck at games of chance, and chances are good you will win, at least every so often. When you win be prepared to be issued by the Casino or State form W2-G and be prepared to pay income tax on those winnings. But I am betting you just might have gambling losses you can offset against your winnings. So if you have the good fortune to have substantial gambling winnings in 2014 or plan to in 2015, stay tuned to TaxView with Chris Moss CPA to learn how to properly document your gambling losses to save you taxes.

The Revenue Act of 1934, limited gambling losses to gambling winnings as per Code Section 165(d) to encourage, according to the House Committee Report on Prevention of Tax Avoidance, gamers to report their winnings. Fifty years later, the US Supreme Court carved out a “professional gambler” (PG) designation as a full time business trade in Groetzinger 480 US 23 (1987). Today you are either a Professional Gambler (PG) or like most of us a hobby gamer (HG). IRS regulations 31.3402-1 requires both types of gamers to be issued Form W2-Gs with tax withheld generally from winnings in excess of $5000. Seems easy enough? That what Las Vegas Hobby Gamer (HG) Francis Gagliardi thought back in the late 90s as evidenced in Gagliardi v IRS, US Tax Court (2008).

Gagliardi (HG) was audited by the IRS for 1999-2001 with the IRS disallowing most of his gambling losses as not adequately substantiated. Gagliardi appealed to US Tax Court in Gagliardi v IRS, US Tax Court (2008). The court noted that Gagliardi submitted bank statements, cash withdrawals at casinos, credit card statements, and gambling calendars showing most of Gagliardi’s gaming activity from 1999-2001 in addition to supplemental Players Club Card records issued by the Casino. Judge Vasquez heard credible testimony from Gagliardi’s tax preparer, Mr. Hunner, as well as Hunner’s presentation of cash flow and net worth analysis. The Court concluded that Gagliardi’s expenses were creditable. Gagliardi wins, IRS loses.

Ronald Lutz (HG) was not so lucky in Lutz v IRS, US Tax Court (2002). Lutz, like Gagliardi was an HG, and gambled for many years in Mississippi and Louisiana casinos. Lutz filed his 1996 tax return without reporting any gambling activity. The IRS audited Lutz and determined $91,000 of unreported gambling winnings based on 18 W-2G forms that had been filed by the Casinos. Lutz appealed to US Tax Court in Lutz v IRS US Tax Court (2002) claiming his losses offset his winnings. The Court found that Lutz did not keep good records like Gagliardi. Lutz did not take advantage of casino based tracking system records based on the use of a “Players’ Club Card” as did Gagliardi. While the Court noted that use of a Players Club Card is not in itself enough to substantiate gambling losses, citing Mayer v IRS US Tax Court 2000-295 (2000), the Players Club Card could be an important supplement to a daily gambling log as used in Gagliardi.

Judge Thornton also noted that Lutz failed to produce a net worth analysis like Gagliardi did. Furthermore, Lutz’s own testimony was not credible. Finally, the Government showed that Lutz had purchased new cars in 1996 and showed other increases in net worth that year, evidence that his winnings were greater than his losses. The Court then admonished Lutz noting he could have avoided losing by keeping daily records of his gambling activity and actively using the Casino issued Players Club Cards at least to supplement his own records. IRS Wins, Lutz loses.

Our next case involves Professional Gambler (PG) William Praytor who bet that Section 165(d) was broader in scope than the Courts had previously recognized. On Schedule C of his 1994-1996 tax returns Praytor deducted over $41K of expenses in addition to his gambling losses. The IRS audited those years and disallowed all those other losses because in accordance with Section 165(d) gambling losses are only allowed to the extent of gains.” Praytor (PG) appealed to US Tax Court in Praytor v IRS US Tax Court (2000). Judge Carluzzo, citing Offutt v IRS US Tax Court (1951) notes that Courts have disallowed all expenses in connection with gaming over and above winnings. Also citing Todisco v IRS 757 F.2d 1 (Ist Cir 1985), Kochevar v IRS US Tax Court (1995), Valenti v IRS, US Tax Court (1994) and Kozma v IRS US Tax Court (1986) clearly establishing that Congressional intent was to “force taxpayers to report their gambling winnings” as per House Report 704 73rd Congress (1934). IRS wins, Praytor loses. Bad luck and timing for Praytor, because by 2011 Offutt and all the above related cases were overturned by Mayo.

Mayo, a California PG filed his 2001 tax return with not only gaming wager losses but some additional expense in connection with his horse racing gambling business resulting in a business loss of $22,265 in excess of gambling winnings. Included in this loss was car and truck, meals and other routine office expense. The IRS audited Mayo and disallowed all excess loss in accordance with IRS Section 165(d). Mayo appealed to US Tax Court in Mayo v IRS US Tax Court (2011), citing US Supreme Court case Groetzinger 480 US 23 (1987) allowing for an interplay between Section 165(d) and Section 162(a). In a surprise ruling Judge Gale overruled the Offutt v IRS 1951 US Tax Court and similar lines of cases which held Section 165(d) does not provide for any loss over winnings, even if the loss was created by normal Section 162(a) expenses like auto, office rent, insurance and supplies. Judge Gale notes that the legislative history of Section 165(d) does not specifically address whether or not additional expenses are deductible to create a “loss” in excess of winnings, and therefore the Court held Offutt that will no longer be followed. Mayo wins big, IRS loses.

Our final case post Mayo just decided a few months ago is Lakhani v IRS US Tax Court (2014), a California CPA who turned professional gambler to offset his profitable accounting practice with gambling losses from California pari-mutuel wagering on horse races on his 2006-2009 tax returns. The IRS audited and disallowed all losses in excess of winnings. Lakhani appealed to US Tax Court in Lakhani v IRS US Tax Court (2014).

Just so you know, pari-mutuel wagering creates a “handle” or betting pool from all bets. From the pool a share or “takeout” generally ranges from 15% to 25% of total receipts. The “takeout” will change depending on whether the bet is “straight” or “conventional” “win”, “place” or “show” or “exotic”. What remains from the takeout constitute the track profit. After track expenses remains what is paid to the winning bettors.

Lakhani argued that in extracting “takeout” from betting pools, the race track managers were acting as his fiduciary similar to that of an employer collecting payroll taxes. Citing Mayo v IRS US Tax Court (2011), Lakhani asserted that his losses were not from gambling but were simply his pro rata share of the takeout and therefore not subject to the limitations of Section 165(d).

Unfortunately for Lakhani, who was acting Pro-Se, Judge Halperin raised the stakes in the game noting that in California “the takeout cannot add to the loss of the losing gambler.” A gamer loses the same $2 bet whether the takeout is 10%, 15% or 20% of the “handle”. Therefore Judge Halperin concluded the “takeout” does not qualify as Lakhani’s deductible nonwagering business expense, citing the same case Lakhani cited Mayo v IRS US Tax Court (2011). IRS had the winning hand, Lakhani folded.

So how should AGs and PGs plan their year-end 2014 tax strategy to save taxes? If you are just an AG and happen to win the big lottery jackpot, make sure you can prove all your losses to offset those winnings. First use the Casino Players Club Card to keep track of your gains and losses. Make sure your gains match up to your W-2G. Second keep your own extemporaneous daily logs including bank and credit card statements of winnings and losses so you can fully take advantage of Section 165(d) and save taxes on your winnings. If you are claiming total offset of gains and losses have your CPA work with your tax attorney to prepare a net worth and cash flow analysis for inclusion in your tax return. Finally, if you’re a PG review the Mayo ruling with your tax attorney. While not fully settled in all Circuits, based on the Government conceding in the 9th Circuit to Mayo in 2012, I would bet you have favorable odds to deduct normal Section 162(a) expenses for you PG business.

Merry Christmas to all and a Happy 2015 New Year from TaxView with Chris Moss CPA.

Thank you for joining us on TaxView,

See you all next year in 2015.

Kindest regards

Chris Moss CPA

Uncertain Tax Positions vs Attorney Client Privilege

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Uncertain Tax Positions (UTPs) are upon us this 2014 Christmas season and they are coming your way. What are UTPs? A UTP is a deduction or a “tax position” on your tax return that has a 50% chance or more of being disallowed by the Government during an IRS audit. So how do you determine if you have UTPs? The IRS website gives plenty of assistance to large corporations with their army of tax attorney staffers, but the smaller privately held business owners with assets just over $10 Million and audited financial statements are most likely going to discuss which UTPs must be disclosed with their in house or independent tax counsel. Are your communications with your tax attorney regarding UTPs still protected under the attorney client privilege? To find out how to comply with IRS 2014 UTP regulations without losing your attorney client privileges please stay tuned to TaxView with Chris Moss CPA to learn how to protect your confidential communications as you complete Form 1120 Schedule UTP for 2014.

The UTP was first created by the Financial Accounting Standards Board (FASB) in 2005 as a draft and officially adopted in 2006 by FIN 48, interpreting FASB Statement 109 Accounting for Uncertainty in Income Taxes. Starting in 2014 the Government now requires in accordance with IRS Regulations 1.6012-2(a)(4) and 2014 UTP Instructions the reporting of UTPs on Form 1120 Schedule UTP if your business has $10 Million or more in assets and your financial statements have been or will be audited by an independent CPA firm who has expressed an opinion in accordance with GAAP. Moreover, my view is that eventually, perhaps as early as 2017, the IRS will expand the UTP initiative to include S Corporations, Partnerships and even someday individuals.

So what is your next step after you identify all your UTPs? Once you list all your UTPs you then have to provide to the IRS a “concise description” of all your UTPs. Finally, you decide which of these UTPs have less than a 50% chance of being sustained during and IRS audit and then simply list these “concise descriptions” Form 1120 Schedule UTP for 2014 as part of your annual corporate income tax return filing. This is anything but simple.

Check out the IRS UTP Resource Page. From this page we can click to Uncertain Tax Positions Schedule UTP. Can you choose which of your UTPs will have less than a 50% chance or more than a 50% chance of being sustained in an audit? If you are still confused read on.

A more likely than not standard of 50% is called a legal burden of proof. In a criminal case as you all know the burden is “beyond a reasonable doubt” which approaches almost a 99% chance of success. However for a tax position to have more than a 50% chance of success, existing law must be first applied to your unique facts and evidence that support the preparation of your tax return. Once the law is applied the those facts, you must more likely than not be able to persuade the US Tax Court to sustain your UTP. How many business owners can chose which UTPs will be sustained by the US Tax Court under these conditions without the assistance of a tax attorney? Will UTP disclosures from you to your tax attorney be confidential, safe and privileged communications?

Doug Shulman, former IRS Commissioner in prepared 2010 remarks to the American Bar Association meeting in Toronto Canada said: “The final instructions make it clear that a taxpayer need only disclose information to her attorney sufficient to identify the issue and the relevant facts.” Heather Maloy, Large Business and International Division Deputy Commissioner wrote in 2011 to her staff that the IRS recognizes a “Policy of Restraint” regarding privileged communications and documents. Former IRS acting Commissioner from 2012-2013 Steven Miller commented in 2012 before the Tax Executives Institute that out of “4,000 concise descriptions filed prior to 2012 only 133 failed to satisfy the requirements…further notification will be sent to these taxpayers to ensure that future filings follow these instructions…we intend to let those taxpayers know their future returns will be reviewed.”

Just so you know, the common law attorney client privilege issues surrounding “burdens of proof” and the “concise description” required by UTP federal regulations have not yet been tested in Federal Courts because the UTP program is so new. Lack of UTPs case law notwithstanding, all business owners should be able to freely discuss with their tax attorney how and why UTPs and their concise descriptions in 2014 are going to be listed on Form 1120 Schedule UTP without losing the “attorney client privilege” that attaches to those discussions. My best predication is that the Government, despite IRS Policy of Restraint Announcement 2010-9, will someday argue as they did in Johnston v IRS US Tax Court (2002), that you waived the attorney client privilege if “you relied on the advice of counsel” to not only create the required concise descriptions, but to include or not include concise descriptions on 2014 Schedule UTP.

The Court in Johnston, citing Hearn v Ray, 68 F.R.D. 574 (E.D. Wash 1975), argues if you assert the privilege you might also lose the privilege if the assertion of attorney client privilege prevents the IRS access to the information needed for the Government to win their case against you. Really? Folks these “concise descriptions” are not just numbers from the accounting department, but they are rather short essay answers you give the Government under penalty of perjury. Would you not want your communications to your tax counsel regarding these “concise descriptions” to be privileged and confidential?

What does all this mean for us? First if your business balance sheet shows assets over $10 Million, and your financial statements were audited by an independent CPA firm in 2014, review your year-end UTPs with a tax expert as soon as possible to create a draft Form 1120 Schedule UTP. Make sure any notes of discussions you had with your tax attorney are marked Confidential Attorney Client Privilege protected communications. Second make sure you understand that whatever you say, text, email or voice mail to anyone who is not an attorney will absolutely not be privileged during an IRS audit of Schedule UTP, particularly with regard to your concise descriptions. Finally learn about your UTPS. The more you know about UTPs unique to your business the more likely you will preserve your attorney client privilege and bullet proof your tax return from adverse IRS audit consequences for many years to come. Thanks for joining us on TaxView with Chris Moss CPA.

See you all next time on TaxView.

Kindest regards and Merry Christmas to all.
Chris Moss CPA

Single Member LLC

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If you are thinking about starting a small business, why not start with a Single Member LLC.? The most important reason to form a Single Member LLC or “Single” is simplicity. As a Single you file no separate tax return apart from your personal tax return Form 1040. The law says you are “disregarded” for tax purposes as a separate entity and therefore no separate tax return is required. A second reason to stay single is most if not all states now recognize LLC’s for asset protection. Even the IRS must now follow state law if you owe back payroll taxes as per Aquilino v United States 363 US 509 (1960). Sounds easy and a bit too good to be true, doesn’t it? Well it is not too good to be true but it is anything but easy because the IRS has set up various Single traps out there. If you should get trapped during the holiday audit season, you might have to pay tax to get yourself out of that trap.. So if you are thinking about becoming a Single or have already set one up, stay tuned on TaxView with Chris Moss CPA so you can learn how to save taxes by bullet proofing your Single from IRS holiday traps.

The IRS can tax a Single, but a Single is regulated by state law. If you or your Single get audited the IRS may try to convince you that you and your Single are one and the same, but as the Government found out in Suzanne Pierre v IRS US Tax Court (2009), that is not the case. The facts are simple: Pierre formed Pierre LLC under New York State Law defining a single member LLC as a separate legal entity from its owner. The IRS audited Pierre’s 2000 and 2001 gift tax return and concluded that the gift transfers of discounted membership interests to trusts were really disguised gifts of the assets in the LLC. Valued without the discounts the IRS assessed Pierre’s gift transfers for an additional gift tax of $11 Million. Pierre appealed to US Tax Court in Pierre v IRS US Tax Court (2009).

The IRS argued before Judge Wells that because Pierre LLC is a single member LLC it should be treated as a disregarded entity under the check the box regulations, IRS Regulation 301.7701-3, IRS Publication 3402, and Revenue Ruling 99-5. Therefore, Pierre’s membership transfers should also be disregarded, and be treated as if Pierre had transferred the assets directly to the trusts. Pierre on the other hand reasoned that New York State law, not IRS regulations control the nature of the property transferred from the LLC to the trusts. Pierre also maintained that under New York State law a membership interest in an LLC is personal property and consequently a member has no interest in the individual assets of the LLC, citing NY Limited Liability Company Law Section 601.

Agreeing with Pierre, Judge Wells concluded that only New York State law., not Federal law, could create a property right in the LLC’s underlying assets. For that reason, the discounts on the Single membership interests were valid. Moreover, with New York State law controlling, the gift tax liability was determined by the value of the discounted transferred membership interests. Pierre Wins IRS Loses. Also see LexisNexis 2009 Commentary.

Be aware, however, that the Government can lure you into a reverse Single trap if your structure lacks business purpose as it did with Robucci v IRS US Tax Court (2011). Robucci was a psychiatrist whose CPA converted him from a sole proprietorship to a two member LLC. Robucci owned 95% as the first member and a PC manager owned the remaining 5% as the second member. Additional corporations and entities were set up with the sole purpose of reducing self-employment tax. Indeed Robucci paid very little or no self-employment tax for 2002-2004. The IRS audited and reversed all of the Robucci entities to a single member LLC with Robucci as the Single owner. The IRS then held Robucci personally liable for tax and penalty of over $50,000 in 2002-2004. Robucci appealed to US Tax Court in Robucci v IRS US Tax Court (2011). The Court easily concluded all of Robucci’s business structure had no substantial purpose other than tax avoidance and was nothing more than a sham.. The Court “pierced the corporate veil” holding all of Robucci’s income was subject to self-employment tax under Section 1401.

Our final case, Medical Practice Solutions (MPS) and Carolyn Britton Sole Member v IRS US Tax Court (2009) focuses on a former IRS Single trap with respect to payroll taxes: Carolyn Britton of Massachusetts formed MPS as a single member LLC. The LLC failed to pay employment tax for several periods in 2006. Notices of liens were sent both to Britton and MPS. Britton requested a hearing pursuant to Section 6330, Britton argued that she was not liable for the lien. It was only MPS her Single that was liable as the “employer”. The hearing did not go well for Britton so she appealed to the US Tax Court in Britton v IRS US Tax Court (2009). The Court citing Littriello v US, 484 F.3d 372 (6th Circuit Court of Appeals) upheld the regulations of a single-member LLC in the context of employment tax liabilities even though the IRS was in the process of changing the regulations to favor Britton. Unfortunately, Britton was a few months to early and the Court decided in favor of the Government. IRS Wins Britton Loses.

After September 1, 2009 however new IRS regulations 301.7701-2 were enacted. The new law treats a Single with payroll liability as if that payroll had been paid by a corporation, Therefore a Single owner is now shielded from payroll tax liability.. Both Single owner Britton, Littriello but probably not Robucci would have been protected from payroll tax liability under these new regulations provided their Single had a primary business purpose.

What does all this mean for you? Your Single now has just about absolute limited liability as long as you did not lack business purpose in setting up the Single. What to do now to avoid IRS traps? First, have your tax attorney create a special and unique operating agreement just for you explaining your Single business purpose and also detailing who would replace you if you should pass. Second, as a Single without a partner you may wish to create a Board of Advisors to meet once or twice a year to give you advice and inspiration as your grow your business. Finally, as we head towards the New Year be prepared for potential business opportunity to surface, Perhaps a tax free 1031 exchange before year end? Or perhaps a possible mergers or acquisition or a reverse 1031? May you prosper as a Single and a Merry Christmas from Chris Moss CPA on TaxView.

Thank you for joining us on TaxView

Kindest regards

Chris Moss CPA

Self-Employment Tax

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Are you self-employed? Do you ever wonder how much of your earnings is subject to self-employment tax? (SET) If you are self-employed you should be paying the correct amount of social security but not be overpaying. Employees are subject to payroll withholding and W2 year-end reporting as per the W2 withholding laws enacted in 1943. But if you a small business owner who pays social security or what I call an SBOSS you are governed by IRS Section 1402(a). Based on 1402(a) the IRS would have you believe all your income is subject to SET. But the fact is that the kind of work you do each day will create facts and evidence that the Courts use to determine whether you pay more or less social security. So if you are an SBOSS, stay with us here on TaxView with Chris Moss CPA to learn how to save taxes by not overpaying your SET, but by paying the correct and fair amount of SET each year on your small business earnings.

So how does an SBOSS know how much SET to pay? For answers let’s start with a simple US Tax Court farming case, Bot v IRS U S Tax Court (2002) and appealed to the 8th Circuit in Bot v IRS 353 F.3d (2003). Bot was a farmer who reported much of their income earned from a cooperative association as farm rental income for 1994 and 1995 on IRS Form 4835, and Schedule D and paid no SET. The IRS audited and invoiced the Bot’s for social security reclassifying much of their income on to Schedule C Profit and Loss. Bot appealed to US Tax Court in Bot v IRS US Tax Court (2002).

The Court noted that all gross income derived by and SBOSS is subject to SET under Section 1402(a).The business must be transacted wither personally or through agents or employees as per IRS regulation 1.1402(a) and 1.1402(b).Judge Marvel compares the IRS argument that Bot was in a trade and business to Bot’s claim that his earnings was from investment income. Judge Marvel attempts to differentiate a trade or business from passive investment income and reasons that only from a review of all the facts can a decision be reached. The Court concludes after reviewing all the evidence presented from both the Government and Bot that the facts show that Bot was engaged during 1994 and 1995 in regular efforts to reap a profit from the sale of corn products and those “efforts” constituted a trade or business. IRS wins Bot loses.

Bot appealed to the 8th Circuit in Bot v IRS 353 F.3d (8th Circuit 2003). The problem with the Bot appeal is that in US Tax Court he claimed much of the income from the Government conservation reserve program was Schedule D capital gains. However on appeal Bot changed his legal argument claiming the income he earned was passive investment income similar to dividends. Bot had not recorded this income on Schedule B of his original tax return. Was this a smart legal move by Bot to change his legal theory from Schedule D to Schedule B on appeal? Perhaps not. Circuit Judge Hansen voting with the majority finds for the Government. IRS wins Bot loses, again.

For our next case, Morehouse v IRS US Tax Court (2013), we have somewhat similar facts as Bot, but with a very different outcome. Morehouse received payments from the US Department of Agriculture Conservation Reserve Program. Was Morehouse an SBOSS? Let’s look at the facts. Morehouse lived in Texas but owned farmland in South Dakota. Between 1997 and 2007 Morehouse visited the farm various times and personally purchased materials need to implement conservation plans. Morehouse hired Mr. Redlin to help comply with the US Government’s conservation reserve program and sought and received from the United States Department of Agriculture cost-sharing payments for the seeding and weeding activities on the property. Morehouse filed a 2006 and 2007 income tax return with a Schedule E reporting rental income but paid no SET. The IRS audited and classified Morehouse as an SBOSS owing SET reclassifying his income to Schedule C. Morehouse appealed to US Tax Court in Morehouse v IRS US Tax Court (2013). What do you think? Was Morehouse subject to SIT?

Judge Marvel in Morehouse as he did in Bot clearly supported the IRS position and found for the Government even though Morehouse testified credibly that his actual work was “De Minimis” and did not constitute farming. The Court nevertheless concluded that Morehouse was an active participant in the farming program citing Bot v IRS US Tax Court (2002) and Bot v IRS 353 F.3d 595 (8th Circuit 2003). IRS Wins Bot Loses.

Morehouse appealed this decision to the United States Court of Appeals for the 8th Circuit. Wait for the surprise Court ruling. Oral arguments were held on June 11, of 2014 and the case was decided just two months ago in Morehouse vs IRS 8th Circuit Court of Appeals (2014). In an amazing total reversal of the US Tax Court and the 8th Circuit decision in Bot, Circuit Judge Beam concludes that land conservation payments made to non-farmers constitute rentals from real estate and are excluded from SET because private landowners participating in government funded land conservation does not change the fact that “the government is using their land for its own purposes”, citing 16 USC §3831, even though contrary to IRS Notice 2006-108. Beam and Judge Loken in a 2-1 vote remanded to the US Tax Court with instructions to enter judgment in favor of Morehouse. IRS loses, Morehouse wins.

Circuit Judge Gruender in his dissenting opinion disagreed with 8th Circuit majority. Judge Gruender felt that the 8th Circuit should follow the 6th Circuit interpretation of the law citing Wuebker v IRS 205 F.3d 897 (6th Circuit 2000) and IRS Notice 2006-108, Application of 2006-108, and IRS Bulletin 2006-2 and finally citing, you guessed it, Bot v IRS 353 F. 3d 595 (8th Cir) 2003. Judge Gruender would have us believe that payments to Morehouse were for work performed by Morehouse or his agent Redlin with continuity and regularity. Note that Wuebker who initially won in US Tax Court in Wuebker v IRS US Tax court (1998), and was reversed on appeal in Wuebker v IRS 205 F.3d 897 (6th Circuit 2000), hinged on Circuit Judge Gilman’s ruling that the Wuebkers’ maintenance obligations to the US Government were somehow continuous and regular. Were the Morehouse facts any different that Wuebker? Read the NGFA commentary (National Grain and Feed lobby group). What do you think? By the way, if you search the IRS website the Government still claims USDA Conservation Reserve Payments are subject to SET. Also see IRS Chief Counsel Memorandum (2003). Perhaps this issue is headed to the US Supreme Court?

What does all this mean if you are an SBOSS out there paying SIT? First, sit down with your tax attorney at the end of each year and record the facts and evidence to support whether or not you your employees or agents actively participated in a business on a regular basis. Are you receiving income from this business? Chances are you are an SBOSS subject to SIT. However, you may still be able to “carve out” some non-SIT income with this second step: Examine closely all the income you earn as an SBOSS. Do you receive some rent in addition to professional fees? Do you sublease some space to other businesses? Or perhaps you invest in the stock market and earn capital gains and dividends during office hours and you report that income as an SBOSS. Various other income streams may be exempt from SIT as well, depending on how you are structured and the facts as they occurred each year as an SBOSS. Finally get your tax professionals to go over with you each year what types of your unique taxable income may be exempt from SIT. Have your tax attorney memorialize in writing what she said to you and include that document in the tax return you are filing. If there is ever an IRS audit years later you would be glad you did.

Thank you for joining us on TaxView with Chris Moss CPA. See you next time on TaxView.

Kindest regards,
Chris Moss CPA

Retirement Loan Rollover Tax Traps

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How many of you have had an IRA or 401K indirect or even a direct retirement rollover that triggered a tax and penalty from the IRS? Have any of you borrowed from retirement to pay it back within 60 days only to get a bill from the IRS?–even if you have complied fully with the IRS Code Section 408(d)(3)(A)(i)? Did your broker ever send you an incorrect form 1099R? When you call your tax attorney for help she tells you to wait for IRS form 5498 being sent by your broker? But unfortunately the IRS does not usually wait. And get this: even though the 1099R and 5498 are so related to each other that the Government combines 1099 and 5498 instructions into one document they are mailed months apart. The result? An IRS notice, bill and penalty. What can you do? If you are planning to either rollover a direct or indirect IRA or similar tax deferred retirement account or perhaps are thinking of borrowing against your retirement account in 2014 as a year-end tax strategy please stay with us on TaxView with Chris Moss CPA to learn how to avoid the latest Loan Rollover Tax Traps (LRTT) that the IRS has set up to trip you up into paying more taxes and penalty.

Most of us know the rollover or “roll” drill. It’s always better to do a direct rollover also referred to as a trustee to trustee transfer. But if you go the indirect rollover route the IRS gives you only one roll per year. Why would you ever do an indirect roll? Some of you roll to change brokerage firms and others indirect roll to borrow the money. This leads many of you including Alvan Bobrow to LRTT#1. Alvan Bobrow v IRS US Tax Court (2014). Alvan Bobrow is a tax attorney who maintained various IRA accounts at Fidelity as did his wife Elisa. Bobrow received various indirect distributions in 2008 and rolled them 61 days later. The IRS audited for 2008 and sprung LRTT trap #1. Bobrow’s tax return fell right in this first LRTT on the tax course claiming that it was Fidelity’s fault that Bobrow was one day late. The Court did not find Bobrow’s testimony credible.

Judge Nega citing Wood v IRS US Tax Court (1989) distinguishes Bobrow because Wood physically hand delivered stock certificates to Merrill Lynch within 60 days and Merrill Lynch had assured Wood that the roll of the stock into the IRA would be consummated as instructed. Unfortunately Merrill Lynch failed to record the transfer due to a bookkeeping error. The stock certificates were in fact were actually transferred four months later. The IRS audited and disallowed the entire transaction. Woods appealed to US Tax Court in Wood v IRS US Tax Court (1989). Judge Ruwe says it is well settled that where book entries are at variance with the facts, the decision must rest on the facts. Wood’s testimony was credible and Merrill declined to testify. On the other hand in Bobrow v IRS US Tax Court (2014) Bobrow never asked Fidelity to testify and Bobrow’s testimony did not provide the facts necessary to prove his case. Unfortunately Bobrow fell to LRTT #1: You cannot blame your brokerage firm unless you have absolute proof of why your roll failed to roll. IRS Wins, Bobrow Loses.

What about rolls from an estate? Jankelovits tripped that LRTT #2 in Jankelovits v IRS US Tax Court (2008). Jankelovits transferred funds from her deceased aunt’s IRA as beneficiary of her estate. Unfortunately LRTT #2 says you can’t do indirect rolls from an estate, but only trustee to trustee transfers citing IRS Code Section 408(d)(3)(C) and IRS Pub 590. While Jankelovits testified that he asked the bank for a “nontaxable” roll, Judge Gale points out that unlike in Wood v IRS US Tax Court (1989) Childs v IRS US Tax Court (1996) or Thompson v IRS US Tax Court (1996), none of the bank employees involved with Jankelovits either testified or admitted any wrong doing. With no witness testimony to support Jankelovits, this taxpayer tripped into LRTT#2: You must roll an estate for a nonspouse with a direct “trustee to trustee” roll or you get no roll at all. IRS wins, Jankelovits loses.

Our next to last roll of the day will drop us into LRTT#3: rolls must be from a pretax contribution and clearly noted as such to the destination broker. Bohner v IRS US Tax Court (2014). Bohner was a retired social security administration government worker. Bohner was given a chance in 2010 to catch up his retirement account for any period which he made no contributions while he was on salary. His maximum catch up was $17,832 to be paid to the Government plan called CSRS. Bohner borrowed from a friend and send the $17,842 on to CSRS with no explanation to CSRS as to the origin of these funds. Bohner then paid back the friend from a Fidelity IRA later that year with what I can only portray as a backward reverse indirect roll. Bohner did not report the roll as taxable in 2010 and did not explain his backward reverse indirect roll to the IRS on his tax return, even though he was issued by Fidelity a 1099R saying that the withdrawal of these funds was indeed taxable. The IRS audited and disallowed the roll.

Judge Kerrigan concludes that if Bohner had made a direct trustee to trustee pretax roll from Fidelity to CSRS perhaps the roll would have been legally completed tax free. But the Court notes that the funds that rolled originated from post-tax borrowed money. LRTT#3 requires the roll to be from pretax funds citing Montgomery v. United States, 18 F.3d 500 (7th Cir. 1994). IRS Wins Bohner loses.

Our last roll will be to explore LRTT#4, namely that the entire amount of the roll received from the old IRA must be the same amount paid into the new IRA, or in other words, the funds you roll out must be the same funds you roll in as evidenced in Lemishow v IRS US Tax Court (1998). The facts are simple. Lemishow rolled his Keogh and IRA funds to purchase stock. Lemishow then rolled the stock into a new Smith Barney IRA account. Lemishow filed his 1993 tax return and did not report the roll as taxable. The IRS audited and disallowed the roll claiming all distributions from the Keogh and IRA were taxable. Lemishow appealed to US Tax Court in Lemishow v IRS US Tax Court (1998). Judge Tannewald points us to legislative history showing that rollovers facilitate portability of pensions and therefore must be the “same money or property” that came from the originating IRA to the destination IRA citing Employee Retirement Income Security Act of 1974. To have avoided LRTT#4 Lemishow should have rolled cash into Smith Barney then purchased stock from within the newly created IRA. IRS wins Lemishow loses.

How can all this help you save taxes, and more important avoid the LRTTs out there to trip your roll “over” the IRS tax cliff? First and foremost never use an indirect roll. Use trustee to trustee direct rolls. Second, if you absolutely have no other choice but to use an indirect roll have your tax attorney coordinate with your originating broker and your destination broker to make the 60 day window bullet proof. Third, make sure your 1099R is correct. If not, send it back to the broker and demand that it be amended even if it means you file an extension. While you’re on extension, wait for your 5498 and make sure that the form 5498 is correct as well. Finally, don’t file your tax return claiming tax free treatment of the roll until your tax attorney includes in your tax return his written transaction history documenting names and phone numbers of the broker witnesses on both sides of the roll. When you get audited by the IRS disallowing your roll you will have a bullet proof tax return ready to spring from the LRTTs that the Government has sprung and roll that distribution right back to the IRA tax free where it belongs. Thanks for joining Chris Moss CPA on TaxView.

See you next time on TaxView

Kindest regards
Chris Moss CPA

Step Transaction Tax Planning

Welcome to TaxView with Chris Moss CPA

Whatever your legacy is after you’re gone, whether the legacy is yours or belongs to your grandfather, I would hope that you want your kids and grandchildren to share in some way that legacy you or your mother or grandmother is leaving you all. But many of you all are not all in concurrence as to how the estate shall be handled, and surely not all in agreement as we end the year of 2014. For those of you in this situation, may I suggest tax planning in steps (STTP pronounced STEP) for the family estate and tax plan? No, tax planning in steps is not a new dance step. STTP is the way to move forward on long range estate planning now in 2014 that avoids IRS attack known as the Step Transaction Doctrine. (STD pronounced STUD) Unfortunately the IRS sees STDs even when there is none, and throws your STTP into dead end brick walls resulting in increased tax pain and injury for all. So if your mom and dad or grandparents have substantial assets and you are looking to at least get started on planning your legacy, stay tuned to TaxView with Chris Moss CPA to learn how to stay clear of IRS STTP to STD conversion audits and allow your legacy to be safely preserved for many generations to come.

You will not find “STD” in the IRS code. The concept of STD is carved from hundreds of Federal tax court cases and is a spin-off from the Substance over Form Doctrine codified by Congress into IRS Code 7701(o) as part of the Health Care and Education Reconciliation Act of 2010. STD then remains a totally Court made law somewhat guided by Section 7701(o). The IRS generally argues that STD is a series of transactions or “steps” over many months or years, that when taken as a whole, convert a taxpayer’s innocent STTP to a sinister STD scheme to avoid taxation.

On the other hand a STTP could be viewed as a legal alternative to STD. So are you a good candidate for STTP? Whether it be a private foundation for the arts to be created for the family, or whether it be the family farm being assembled for succession, or perhaps the vast commercial real estate enterprise you have spent your entire life to build now ready to pass on to the next generation, one thing you don’t want to happen is for the estate tax to be so large after you pass that you have to sell the farm to pay the tax all because there was disagreement within the family as to the specifics of the estate plan. So STTPs are used when you for whatever reason your family cannot logistically complete the estate plan all at once.

Unfortunately, there are some taxpayers out there who fall into a STD through perhaps bad advice from tax advisors. Directly in response to these poorly structured STDs, IRS audits have been converting even legitimate STTPs to STDs and have been winning big in US Tax Court. See US Tax Court Bianca Gross v IRS (2008), US Tax Court Holman v IRS (2008), US Tax Court Pierre v IRS (2010), CGF Industries v IRS (1999).

While the IRS wins most of the STD cases, they do sometimes lose a legitimate STTP case, like in Klauer v IRS (2010). Peter Klauer founded Klauer Manufacturing in Iowa in 1870 and branched out in New Mexico in 1919. More recently Klauer descendants were in discussions with the US Bureau of Land Management, the US Trust for Preservation of Land and various Indian tribes regarding purchase of the Taos Overlook or at least an option to purchase. Over three years from 2001 2002 and 2003 various agreements were executed all independent of the other. Taken separately each land sale was substantially below market value. Klauer’s S Corporation tax return for 2001 2002 and 2003 claimed millions of dollars as land donated on Form 8283 Noncash Charitable Contributions and various K1s were distributed to the stockholders with their proportionate share of the contribution. All the shareholders filed their Form 1040s for 2001 2002 and 2003 with very large charitable deductions. The IRS audited as a whipsaw and disallowed all charity deductions for all three years causing large amounts of taxes owed by the individual shareholders. The Government claimed all three years were one big STD voiding the below market sales and subsequent large charity deductions. Klauer appealed to US Tax Court in Klauer v IRS 2010 claiming each year stood by itself as separate transactions.

The Court agreed with Klauer because it was clear that each year was separately negotiated with distinct separate agreements. Specifically, Judge Chiechi points out that the supposed first step created no binding commitment to take the second step siting Security Industrial Insurance v US 702 F.2d 1234 (5th Circuit 1983). The Court then focuses on whether the Klauer family intended to save taxes by structuring the three years from 2001-2003 a certain way citing King v US 418 F.2d 511 (Fed Cir 1969). Judge Chiechi argues that Klauer’s subjective intent was especially relevant in allowing the Court to see if Klauer directed a series of transactions to an intended purpose solely to save taxes. The Court found facts created in the record as evidence that Klauer’s primary intent from 2001-2003 was not to create a tax savings scheme but to work the Bureau of Land Management, the Land Trust, and various Indian tribes to allow for the preservation of the Taos Overlook, This had been the intent of the Klauer family for many years. While there were huge tax savings for the shareholders the way the sales were structured that result was secondary to the primary purpose of land preservation. Klauer wins IRS loses.

So where do we all go from here? First, now that you know STDs are thinly disguised tax schemes, your goal is to protect your good STTP estate plan with plenty of written evidence proving to an IRS agent years later that your primary goal is and has always been legacy preservation and protection with tax savings merely as a secondary goal. Second, discuss with your tax attorney and estate planner your options in operating a Family Limited Liability Company (FLLC) to keep, protect, preserve and grow your family legacy. You may be also able to minimize taxes as you transfer assets between generations, but saving taxes can never be your primary objective. Your tax attorney can create your FLLC in 2014 as a single member or partner with your husband or wife if married with a basic operating agreement. Finally, the whole concept of a legal and IRS bullet proof STTP is that the family estate plan is fluid with no one step leading to a predetermined second step. So while the STTP path may change direction and save you taxes along the way, your final and primary destination will always be legacy protection and preservation. We look forward to perhaps seeing you on that STTP path as we soon close out 2014. A Merry Christmas to all in 2014 from TaxView with Chris Moss CPA

Stay tuned for our year end TaxView special for 2014.

Kindest regards

Chris Moss CPA