Friday, August 21, 2015

Difference Between An Advance And A Loan

Do you remember when the Washington Redskins and the Miami Dolphins went to the Super Bowl? It was 1983, and I was living in Florida at the time. I am pretty sure I was rooting for the Florida team. The Redskins had a hard-charging fullback named John Riggins. His nickname was “Diesel” and he scored a touchdown on a forty-something yard run. Blocking for him was (among others) George Starke, an offensive tackle. The Washington offensive linemen, the ones who block for the quarterback and running back, were known as The Hogs.

George Starke is second from the left.

George was very much on the backside of his career at that point. He shortly thereafter left football and opened a car dealership in Maryland. He couldn’t help but notice that the dealership had difficulty recruiting service technicians. He helped establish a technical school to educate and train technicians. He also hoped that - by providing a realistic hope for a better life – the school would also help with the poverty and violence in the area.

He eventually sold the dealership and cofounded the Excel Institute, a nonprofit program that provided a two-year reading, writing, arithmetic and technical skills curriculum. The program was free of charge, but one had to commit.

Starke received a salary and housing allowance, as well as a credit card. He would charge business and personal expenses on the card. The personal charges were segregated on the books and records. George discontinued any personal charges in 2006, and from 2007 onward the only activity relating to the credit card was a payroll deduction to repay the balance.

There was a change in the Board, and Starke did not like the new direction of things. He stopped fundraising. He left the Excel Institute altogether in 2010.

Excel put the remaining balance due from George of $83,698 on a Form 1099, sent a copy to George, a second to the IRS and figured that was that.

George did not include the $83 grand on his individual tax return, however.

The IRS noticed and insisted that George do so. George said no.

And off to Tax Court they went.

Before proceeding, tell me: do you think George has a prayer?

As you know, forgiveness of a loan triggers income. The tax issue is whether these monies were ever a loan.

Your first thought is: of course they were! Heck, he was paying it back, wasn’t he?

Let’s walk through this.

Just because someone gives you money does not mean that there exists a loan. A loan implies that both sides anticipate the monies will be repaid. It would also be swell if there were some attention to the basic formalities, like perhaps a loan agreement and repayment terms.

And – just to dream – maybe interest could be charged on the whole affair.

There was no loan agreement. Excel itself gave mixed messages to the Court on whether it thought the monies were a loan. George told the Court that he never had any intention of paying back the money, and that he thought the payroll deductions were for health insurance or something like that.

If not a loan, then what were the monies to George?

They were advances, akin to nonrecoverable draws.

Advances are more easily understood in a draw-against-commission environment. Draws are intended to provide some predictable cash flow to the salesperson. Say that a salesperson receives commissions, and against the commissions is a $5,000 monthly draw. There are two types of draws - recoverable and nonrecoverable. A nonrecoverable draw does not have to be paid back should a saleperson fail to meet quota. A recoverable draw does have to be paid back. Granted, a salesperson who fails on a continuous basis to meet quota would soon be unemployed, but that is a different conversation.  For our purposes, the key is that a nonrecoverable draw represents income upon receipt.

Back to our courtroom drama.

The IRS pulled his 2010 tax year.

George received no advances in the 2010 tax year.

George last received advances in 2006.

There was nothing to tax in 2010 because George received no monies in 2010.

The IRS should have pursued his 2006 tax year. They did not, nor could they under the statute of limitations.

The Court dismissed the case. George won. The IRS got embarrassed.

I am curious why the IRS even bothered. The only thing I can figure is that they were hoping for a miracle play. Maybe like John Riggins running that football for a touchdown in Super Bowl XVII with George Starke blocking for him.

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