Cincinnati Reds, Tax And Bobbleheads

Did you hear about the recent tax case concerning the Cincinnati Reds?

It has to do with sales and use tax. This area is considered dull, even by tax pros, who tend to have a fairly high tolerance for dull. But it involves the Reds, so let’s look at it.

The Reds bought promotional items - think bobbleheads - to give away. They claimed a sales tax exemption for resale, so the vendor did not charge them sales tax.

Ohio now wants the Reds to pay use tax on the promotional items.

COMMENT: Sales tax and use tax are (basically) the same thing, varying only by who is remitting the tax. If you go to an Allen Edmunds store and buy dress shoes, they will charge you sales tax and remit it to Ohio on your behalf. Let’s say that you buy the shoes online and are not charged sales tax. You are supposed to remit the sales tax you would have paid Allen Edmunds to Ohio, except that now it is called a use tax. 

The amount is not insignificant: about $88 grand to the Reds, although that covers 2008 through 2010.

What are the rules of the sales tax game?

The basic presumption is that every sale of tangible personal property and certain services within Ohio is taxable, although there are exemptions and exceptions. Those exemptions and exceptions had better be a tight fit, as they are to be strictly construed.

The Reds argued the following:

·      They budget their games for a forthcoming season in determining ticket prices.

·      All costs are thrown into a barrel: player payroll, stadium lease, Marty Brennaman, advertising, promotional items, etc.

·      They sell tickets to the games. Consequently, the costs – including the promotional items – have been resold, as their cost was incorporated in the ticket price.

·      Since there is a subsequent sale via a game ticket, the promotional items were purchased for resale and qualify for an exemption.

Ohio took a different tack:

·      The sale of tangible personal property is not subject to sales tax only if the buyer’s purpose is to resell the item to another buyer. Think Kroger’s, for example. Their sole purpose is to resell to you.

·      The purpose of the exemption is meant to delay sales taxation until that final sale, not to exempt the transaction from sales tax forever. There has to be another buyer.

·      The bobbleheads and other promotions were not meant for resale, as evidenced by the following:

o   Ticket prices remain the same throughout the season, irrespective of whether there is or isn’t a promotional giveaway.

o   Fans are not guaranteed to receive a bobblehead, as there is normally a limited supply.

o   Fans may not even know that they are purchasing a bobblehead, as the announcement may occur after purchase of the ticket.

The Ohio Board of Appeals rejected the Reds argument.

The critical issue was “consideration.”

Let’s say that you went to a game but arrived too late to get a bobblehead. You paid the same price as someone who did get a bobblehead, so where is the consideration? Ohio argued and the Board agreed that the bobbleheads were not resold but were distributed for free. There was no consideration. Without consideration one could not have a resale.

Here is the Board:

The evidence in the record supports our conclusion that the cost of the subject promotional items is not included in the ticket price.”

The Reds join murky water on the issue of promotional items. The Kansas City Royals, for example, do not pay use tax on their promotional items, but the Milwaukee Brewers do. Sales tax varies state by state.

Then again perhaps the Reds will do as the Cavaliers did: charge higher ticket prices for promotional giveaway games.

This is (unsurprisingly) heading to the Ohio Supreme Court. We will hear of The Cincinnati Reds, LLC v Commissioner again.

Silicon Valley Cafeterias And Tax-Free Meals

I have a friend who lives and works on the north side of Cincinnati (or as we south-of-the-river-residents call it: “Ohio”). He works for significant company, and one of the perks is a company cafeteria. The cafeteria provides breakfast, should one choose, and of course it provides lunch. Free.

I admit I am a bit envious.

In this day and age when just about everything is taxed – at least once – you may wonder how this can happen. It has to do with Code Section 119:

(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment

There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if—

(1)     in the case of meals, the meals are furnished on the business premises of the employer

                                                                     

How did this provision come to be?

It officially entered the Code in 1954, although employers were already taking the deduction (and employees excluding the income) under administrative and judicial decisions.  Prior to 1954 there was some inconsistency on what was required for the employee to omit the income. Sometimes the courts focused exclusively on the convenience of the employer. Other times the courts would look at whether there was a compensatory reason for the meal. Depending on the focus, they could arrive at different answers, of course.

So Congress stepped-in in 1954 and gave us Section 119. There were differences between the House and Senate bills (The House did not want a convenience-of-the-employer test, but the Senate did). Both House and Senate booted out the issue of “compensatory reason.” If it were primarily for the convenience of the employer, then the meals were free. Whether the employee considered it compensatory was beside the point.

Let’s use an extreme example to understand what Congress was after. In Olkjer, for example, the taxpayer was employed at a remote location in Greenland. The employer provided meals (and, in this case, lodging also) because there was nowhere else to go.

And there any number of examples like that. Think of emergency room personnel. Could they hypothetically get in a car and go to a restaurant for lunch? Of course they could. It would not serve the hospital’s needs, however, and hence they are required to stay on premises. The same can be said for casino workers.

Fast forward a few decades and we now have Silicon Valley. Take Google, for example. If you work at the Googleplex you can eat breakfast, lunch and dinner for free. I recall that the personal chef for the Grateful Dead was one of the early chefs at Google. These companies prey on each other’s chefs, too. Facebook hired a chef away from Google, for example. Facebook now serves Thai-spiced cilantro chicken and salmon with red curry sauce. Their chef will also prepare a special meal as an employee award or recognition. These meals can be quite upscale, featuring seven courses on white tablecloth.

No doubt Section 119 has come a long way from what Congress was thinking back in 1954.

And there is the rub.

In 2013 the Wall Street Journal published an article on these cafeterias, including the question whether the provision of gourmet-level meals were intended to be tax-free. Spring forward a year or so and the IRS has included the issue in their 2014-2015 Priority Guidance Plan. It appears the IRS is shifting resources to develop tax lines-of-reasoning requiring such benefits be reported as taxable compensation to employees.

How? Actually, the direction is fairly straightforward. The IRS will challenge the perk as not being “primarily” for the convenience of the employer. They cannot challenge whether there is a “compensatory” reason, as the reports to the 1954 tax Code makes it clear that Congress was not concerned with that issue.

The companies of course argue that such perks are “primarily” for their convenience. How?

           

·        Encourage employees to arrive early

·        Encourage employees to stay late

·        Employees do not waste time going out to eat

·        Maximize collaboration opportunities, as employees eat together rather than taking individual cars and dining alone elsewhere

·        Help retain people and foster employee trust

·        Help attract prospective employees

You must admit, the companies have a point. My hunch is that the IRS will restrict the definition of “convenience” to require a closer connection between the cafeteria perk and the alleged convenience.

What do I think? I have been in tax practice long enough to see provisions come into the tax Code, and then see practitioners take said provisions into places and distances that Congress or the IRS never intended. There is uproar, and Congress or the IRS then cracks-down. The practitioners regroup, study tape, develop new game plans and all parties eventually take the field again for the next game. It is just the wheel and rhythm of tax law and practice.

I suspect the same will happen here.

I have over the years worked unreasonable hours, and many (not all, mind you) CPA firms will make some provision for their staff during busy season. These meals have been tax-free, as the impetus for the meal was exclusively for the convenience of the CPA firm (as far as I was concerned). There was nothing there that approached this level, however.

But then, Google and Twitter and companies like them have taken this provision into places and distances that Congress likely never intended.

I admit I am a bit envious.

The IRS Will Begin Taxing Your Employer-Reimbursed Health Insurance

There was an article last week in the New York Times titled “IRS Bars Employers From Dumping Workers into Health Exchanges.” I scanned it quickly and made a note to return to the topic.

The IRS published Notice 2013-54 last year addressing, among other things, employer use of health reimbursement arrangements (HRAs). HRAs were popular for many years as a way to offer employees a tax-free fringe benefit. A common plan was employer reimbursement of qualifying medical expenses up to a limit (say $1,500 annually, for example). I used to be in one several years ago. Twice a year I would submit medical expenses for reimbursement. Shortly thereafter, I would receive a check, all without a nick to my W-2.

Then came ObamaCare.

There are questionable definitional rules under ObamaCare. For example, ObamaCare defines a coterie of health services to be “essential health benefits” (EHBs). You cannot have limits – either annual or lifetime – on EHBs. Why no limits?  It sounds great, like free ponies and summers off, but the government had to promise the insurance companies that it would subsidize them too if ObamaCare ran off the rails.

Think about the interaction of an HRA with the rule concerning EHBs. If an HRA is considered an EHB plan, then the plan will fail because there are annual limitations on the benefit. In our example, the limitation is $1,500, the maximum the plan would reimburse any one employee.

Notice 2013-54 considered HRAs to be just that, and now HRAs – with extremely limited carve-outs – are going the way of the dodo bird.

Let’s put a twist on the HRA example. Let’s say that you buy and your employer reimburses you for health insurance. Can that reimbursement be left off your W-2?

The New York Times was addressing that question.

Let’s go through the decision grid. I see three general ways an employer can approach health insurance:

(1)  The employer provides you with health insurance.

a.     In which case the rest of this discussion does not apply

(2)  The employer does not provide you with health insurance.

a.     Your employer may have issues depending on whether it has 50 employees or more.

                                                              i.     If no, there are no penalties.

                                                            ii.     If yes, your employer has penalties.

b.    You still have no insurance, though.

(3)  The employer does not provide you with health insurance but it does provide you with money to buy health insurance.

a.     Again, your employer may have penalties, depending on whether it has 50 or more employees.

b.    You have more money, but … do you have to pay tax on that money?

Since before Alaska and Hawaii became states, the answer to that question has been “No.”

With ObamaCare, the answer is now “Yes.”

The IRS has stated that any monies provided by your employer in scenario (3) above have to be included on your W-2. This means of course that you are paying taxes on it, and your employer is also paying taxes on it. You and your employer are unhappy with this. Retailers, homebuilders and car dealers are also unhappy with this, as you will have less after-tax money to spend with them. The only one who is happy with this is the government.

You know that there will be employers who are uninformed of these new rules - or informed but not care about any new rules. What will be their penalty for noncompliance?

That is what the IRS clarified last week. The penalty is $100 per day. Yes, that is $100 times 365 days = $36,500 per year. For each employee.

Let’s gain altitude and get some perspective on why the government is being so harsh. 

Remember that policies on the individual health exchanges are eligible for subsidy if one’s family income is less than 400% of the poverty line. The government does not want an employee to go the exchange and possibly receive a government subsidy at the same time that his/her employer is also providing a nontaxable employee benefit. That would be a double-dip.

You have to admit, it is a valid point.

It is also a valid point to question what the real government policy is here: for you to have health insurance or for the government to tax you? If the former, then the government could have reduced – or denied – health exchange subsidies to compensate for an employer reimbursement plan. If the latter, then the most recent IRS pronouncement makes perfect sense.

Dude, Free Dragon! and the Earned Income Tax Credit

I am looking at a report from the Treasury Inspector General for Tax Administration (TIGTA) dated March 31, 2014 and carrying the non-hummable title of

The Internal Revenue Service Fiscal Year 2013 Improper Payment Reporting Continues to Not Comply With the Improper Payments Elimination and Recovery Act.”

We have reviewed a number of previous TIGTA’a publications, and this one concerns the earned income credit. The initial idea behind it was laudable enough: it was intended to provide a floor to the most economically disadvantaged, while simultaneously diluting the disincentive as someone weaned off welfare and went back into the workforce.

Sounds good, right?

There is a card game called Magic: The Gathering. I have a number of friends who play, and one in particular who is a Tournament judge. Think of Dungeons and Dragons, translate it into a card game and you have Magic: The Gathering. The reason I bring it up is that there is a Magic card that allows one to put a dragon onto the board at no cost to the player. Dragons are as formidable as you would expect, so this is not insignificant in game context. The friends refer to it colloquially as “Dude, free dragon”!

The earned credit is the tax Code version of “Dude, free dragon”!

This credit was virtually built to be abused, and abused it has always been and will always be. One cannot turn down free dragons.

What does it take to power the earned income tax credit? It takes two things: earned income and a dependent child.

·        Earned income means that you have paid social security or self-employment tax on it. Workers compensation or unemployment, for example, will not power the EITC as one does not pay social security on either.

·       The other thing you need is a kid. Two is better than one. Three is better than two. Four is no better than three, so there is a limit to this escalation.

NOTE: There is a very limited credit for someone with little income and no children, but we will set that category aside for this discussion.

You need to have a job. Makes sense, if you remember what I said earlier about removing disincentives to return to work. A W-2 job is the easiest to understand.

Self-employment income will also do it. I suspect that any tax practitioner who has been around the block a few times has had or heard of an EITC client reporting self-employment income, likely with few if any expenses. The taxpayer is incentivized to lowball his/her expenses, as the credit can outstrip any additional taxes due from overstating his/her actual income. Alternatively, one might simply “make up” income, just to power the EITC.

You also need a kid. This is where it gets problematic, especially nowadays.  It can take the discipline of a sociologist to follow the convoluted trail of who-did-what-and-then-moved-in-with…. The bottom line is that a kid is the key to this ride. Having a kid, especially a kid you can “lend” out, becomes a commodity, and, like any commodity, the kid has value.

Where does a tax pro see this? Easy. How about two unmarried people who have a child together. One brings a child from a prior marriage. The facts make more sense if they maintain two households, but they wouldn’t be the first to live together and have two EITCs sent to the same address.

OBSERVATION: I am giving the IRS this one for free: check for two EITCs sent to the same address. You are welcome.

So you come to see me. You tell me that you are taking care of your on-and-off-girlfriend’s second daughter, because her mother is irresponsible and you have taken a liking to the girl. You are thinking of adopting, immediately after that around-the-world flight on a paraglider you are planning.  Coincidentally the kid also gives you an earned income tax credit. How am I to know whether this is really taking place, whether that the child is living with you and not with her mother, yada yada yada?

I will tell you what the IRS has said I am to do. Then I will tell you what I actually do.

The IRS keeps expanding what a tax preparer is to do when faced with an earned income tax credit.  Let’s go back to the Improper Payments Information Act that TIGTA referenced. This law goes back to 2002. TIGTA goes on to explain:

… the IRS’s estimates of Fiscal Year 2012 improper EITC payments were understated. They were based on an assumption that a provision in the American Recovery and Reinvestment Act of 2009 … that increased the EITC for certain taxpayers would expire at the end of 2010. However, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended the provision through 2012.”

Did you get that? The IRS did not update its 2012 estimates for a law passed in 2010. Amazing. Let a tax CPA do that and he/she will soon have no clients.

Let’s continue:

It was later extended through December 2017 by the American Taxpayer Relief Act of 2012.”

There is my second freebie to the IRS.

The EITC remains the only revenue program fund to be considered at high risk for improper payments.”

How much money are we talking about?

The IRS estimates that 22% to 26% of EITC payments were issued improperly in Fiscal Year 2013. The dollar value … was estimated to be between $13.3 billion and $15.6 billion.”

This is real money, even by Washington standards. So what was the IRS plan to deal with this?

The IRS announced a plan in January 2010 to register, license and create enforcement tools that would impact the paid preparer community more broadly.

Paid preparers assisted in the preparation of approximately 66 percent of all EITC claims paid in Tax Year 2008.”

Let me see if I get this right:

·       The IRS has a “Dude, free dragon” tax credit

·       People abuse “Dude, free dragon”

·       A normal person can hardly prepare his/her own taxes anymore, so he/she uses a preparer, therefore

·       Abuse of the EITC is the preparer’s fault

Right….

Let’s continue.

However, in January 18, 2013, a Federal Court enjoined the IRS from enforcing the regulatory requirements for registered tax return preparers.”

We discussed this in an earlier blog. The IRS was arguing that they could regulate preparers because of a Treasury decision having to do with government payment for horses after the civil war. The Federal Court said no; the IRS did not have legal authority and could not arrogate such authority to itself.

NOTE: Seems quaint reasoning, especially after six years of the current Administration, doesn’t it?

The IRS is miffed, sticks out its lip and pouts:

The Court ruling materially affects the basis on which the IRS planned to establish a baseline for meaningful reduction targets as previously indicated.”

So IRS Commissioner Koskinen is placing blame on the tax preparer community. If only the IRS could regulate preparers!

There is some truth to this. There are many grades of preparers. There are the classically-trained, such as tax attorneys and tax CPAs. There are also Enrolled Agents (EAs), many of which are quite good. Then we drop to people who have taken an H&R Block course. Then you have those that never even took the course. It is that last category or two that the IRS wants to reach, but they have been stymied.

In the meanwhile, you come into my office with an EITC. What does the IRS expect me to do?

Remember that the key is the kid. The IRS wants me to:

·       Review school records

·       Review health care records

·       Review child care provider records

·       Review social services records

And so on. If I don’t do this, I have to indicate to the IRS that I did not do so. On a form included with your tax return. The IRS reserves the right to later come to my office and review my files.

As much as I appreciate the opportunity to soothe my inner social worker, it seems a lot to ask for the few hundred dollars I may charge for that tax return.

So what do I do?

Easy. I do not accept a client with an EITC. Furthermore, I would also consider releasing an existing client who slips into the EITC, unless I know them well and have very strong confidence in their tax numbers. I have to, as the risk to me from that tax return is disproportionate.

I cannot afford to play “Dude, free dragon”!