What Is Unclaimed Property?

I was reading an IRS Revenue Ruling that made me laugh, albeit in a cynical way.

Here is the issue:

If an IRA is being sent to a state unclaimed property fund, can the IRS force the trustee to withhold and remit taxes?

There are several things going on here, beginning with: what is an unclaimed property fund?

An easy example is a deceased person’s bank account. Take Florida. If someone dies in Florida without a will and without requiring probate, you as an inheritor are going to have difficulties getting to their bank account – unless you name is also on the account. You likely have to hire an attorney to obtain a court letter to provide the bank stating that you are a valid inheritor of said bank account.

How many folks do think just leave the bank account unclaimed because it isn’t worth the cost of an attorney?

It is not just bank accounts. Unclaimed funds can include uncashed dividend or payroll checks, utility security deposits, safety deposit boxes, retirement accounts and a hundred variations thereon. The concept is that you are holding somebody else’s money, and that somebody disappears. It is referred to as dormancy, and the definition is what you would expect: there has been no activity in the account or contact with the owner for a while; account statements are returned because of an invalid address; phone numbers are no longer active.

The “while” depends on the state and the type of asset. In Ohio, an uncashed payroll check is considered dormant after one year whereas a customer overpayment requires three years.

Who reports this?

The business, of course. The business is supposed to try to locate the account owner, but sometimes there simply is no one to contact. When the dormancy period is up, the business then transfers the monies with its best available information to the state. The state holds the property until the owner comes forward to claim it.

The legal reasoning behind unclaimed property goes back to common law and real property. If one abandons real property, there is a legitimate public concern that it soon might become blighted. That concern prompts the transfer (the nerd term is “escheat”) of the abandoned property to the Crown – or, these days, to the State.

Unclaimed property is not technically taxation, but its laws operate similarly to tax statutes.

Many states have used unclaimed property as a means to fund their coffers. Delaware is one of the most egregious offenders, with unclaimed property being its third-largest source of state revenues. Delaware can do this because it is home to so many banks.

Here is a link if you are interested in your own unclaimed property search:

https://www.unclaimed.org/

Back to the IRS Revenue Ruling. Here is a short paragraph from the lead-in:

Under the facts presented, is the payment of Trustee Y of Individual C's interest in IRA O to the State J unclaimed property fund, as required by State J law, subject to federal income tax withholding under Section 3405 of the Internal Revenue Code?”

A bracing read, isn’t it? I couldn’t put it down.

Anyway, how do you think the IRS answered this question?

Pretty much the way you would expect. The IRS is getting its cut at some point, and this is as good a point as any. Send the IRS its money, Trustee Y.

Bitcoin and Fred

I am going to dedicate this post to Fred.

Fred likes to talk about Bitcoin. He is a believer. He may as well be on the payroll.

I do not want to talk about blockchain or cryptocurrencies or any of that.

Let’s talk about the taxation of the thing, in case Fred has gotten to you.

As I write this Bitcoin is selling for around $15 grand.

On January 1, 2017 – less than a year ago – it sold for around $1 grand.

COMMENT: There is a reason why we are still working, folks.

There are even Bitcoin ATMs. I understand there around 70 or so locations around Miami alone. You can tap into one if you are going to the Orange Bowl at the end of this month.

Mind you, if you withdraw dollars-for-Bitcoins you probably have a tax consequence.

You see, the IRS has said (in 2014) that Bitcoin is not a currency. Given this thing’s propensity to swing hundreds if not thousands of dollars of day, it makes sense that it is not a currency. Currencies are supposed to have some stable value, at least until politicians run them into the ground.

No, Bitcoins are property, like stocks or a mutual fund. Like a stock or mutual fund, you have a tax consequence on the sale.

Let’s use the following numbers for the sake of discussion:

          Bought on 1/1/17                    $1,000

          Cashed-in on 12/31/17           $16,500

Let’s say you cash-in a Bitcoin while you are at the Orange Bowl. What have you got?

Way I see it, you have ...

    $16,500 (proceeds) - $1,000 (cost) = $15,500 gain

You are supposed to report $15,500 as income on your tax return.

What type of income is it?

I see a buy. I see a sell. I would argue this is capital gain. It would be short-term, as you did not own it for a year.

Let’s throw a curve ball.

Let’s say that you did some work for somebody in 2016. The paid you with that Bitcoin on January 1, 2017 – the one worth $1,000 at the time.

What are your tax consequences now?

You got paid with a Bitcoin worth $1,000. You have $1,000 of ordinary income. If you got paid for work, it is also subject to self-employment tax.

Then you sell it.

I see the following …

   $1,000 (ordinary) + $15,500 (capital gain) = $16,500   

This is what happens when Bitcoin is considered “property” rather than “currency.” It would be the same as you writing checks on your Fidelity or Vanguard mutual fund. Every time you do you are selling some of your mutual fund. And it all gets reported to the IRS at year-end.

Except that most of Bitcoin does not get reported to the IRS at year-end. Not yet, at least. In fact, in 2015 only 802 people reported Bitcoin on their tax return. You know that doesn’t make sense.

Which is why the IRS served a “John Doe” summons on Coinbase in November, 2016. Coinbase is an exchange for virtual currencies like Bitcoin and Ethereum. A “John Doe” summons substitutes a group or class or people for a specific person. It could be as easy as “anyone who sold more than $600 of Bitcoin between 2013 and 2015.”

Coinbase fought back, of course, but in the end the two wound up compromising. Coinbase will not provide 100% of its account data, but the IRS is getting information on over 14,000 account holders and almost 9 million transactions.

Bitcoin and other virtual currencies have become the new overseas bank accounts. It is time to come clean on this stuff, folks.

And yes, I believe there will be IRS reporting – akin to what the stock brokerages do – in the near-enough future. The government is flipping the sofa cushions for every nickel it can find. Until they get us to a 100% tax rate, they are going to keep looking for new sofas.

Someone – probably Fred - was telling me about a Bitcoin credit card.

That is a tax nightmare

Why?

Say that you bust to Starbucks in the morning. You put your coffee on the card. You stop for fuel – on the card. You go to lunch – on the card. You stop at the dry cleaners and Krogers on the way home – both on the card.

You have 5 “sales” that day. Each one has a cost, and who knows how we are going to come up with that number. Say that you do something comparable almost every work day. I will probably “fee discourage” you from using me as your tax advisor.

BTW, a similar thing can occur if you accept Bitcoin as payment for your services. Say that you are an independent contractor and two or three of your clients pay you in Bitcoin. You are going to have to price the Bitcoin every time you get paid with one, as your “proceeds” are its value on the day you receive it.

That is an accounting hassle.

Can you think of a nightmare scenario?

I  can.

What if you get paid with Bitcoin next year when it is worth $20,000. You hold onto it. Let’s say Bitcoin drops to $9,000 by December 31, 2018. You bring me the info for your taxes. How much do you have to report as income from that Bitcoin?

You have to report $20,000.

But it is only worth $9,000 now!

Yep. That is how it works since Bitcoin is not considered a currency.

What can I do to get my taxes down? Should I sell it?

Now you have a different problem. If that thing is a capital asset – and we said earlier that it was – you will have a capital loss upon sale. You will report a $11,000 capital loss on your return.

And unless you have capital gains to absorb those losses, you continue to have tax problems. Capital losses are allowed to offset only $3,000 of your “other” (read: Bitcoin) income on your tax return. You get no bang on the remaining $8,000 ($11,000 - $3,000), at least until the following year when you can use another $3,000. 

Don’t forget that you are also paying self-employment taxes on that $20,000 and not on $9,000.

This is ridiculous. If I were you, I would fire me as your tax advisor.

I do not accept Bitcoin for my fees, but I am waiting for someone to bring it up. I might do it for an isolated transaction or two. 

But no way am I using a Bitcoin credit card.

Keep It Believable

Our protagonists this time are the Ohdes from West Virginia. The issue concerns charitable contributions. The Ohdes claimed they made dozens of trips to Frederick, Maryland and donated over 20,000 distinct items in 2011.

Half of this would have been clothing. There was furniture. There also were over 3,000 books.

They did at least get that minimalist Goodwill receipt that says:

Goodwill does not return goods or services in exchange for donations of property.”

The receipt doesn’t provide detail of the items, their count or their condition, but at least it is a start.

At the end of the year they entered this information into TurboTax.

And according to TurboTax they donated over $146,000.

You know what else?

They should have expected the almost-certain notice from the IRS. Donate a piece of real estate and a $100,000-plus donation makes sense. Donate 20,000-plus items of men’s and women’s clothing – and not so much.

There are rules for noncash donations. The IRS knows the scam. The rules tighten-up as the donations get more expensive.

If you donate property worth $250 or more, you have to get “contemporaneous written acknowledgement” (CWA). This does not mean the same day, but it does mean within a reasonable time. The CWA must include a description of the property.  That Goodwill receipt should be adequate here, as it has pre-printed categories for

·      Clothing

·      Shoes

·      Media

·      Furniture

·      Household items

Go over $500 and there are more requirements. In addition to a description of the property, you also have to provide:

·      How you acquired it

·      When you acquired it

·      How much you paid for it

That Goodwill receipt is no longer enough. You are going to have to supplement it somehow. Some tax practitioners advise taking photographs and including them with the tax records for the year.

Go over $5,000 and you get into appraisal territory, unless you donated publicly-traded stocks.

Where were the Ohdes on this spectrum? Their lowest donation was $830; their highest was $14,999.

They were therefore dealing with the $500 and $5,000 rules.

What did they have?

They had that lean and skinny receipt from Goodwill. You know, the receipt that is good enough for $250 donations.

But they had no $250 donations.

They had a problem. Their paperwork was inadequate. It would help to have a sympathetic Court.

Here is the Court:

Petitioners claimed large deductions for charitable contributions of property, not only for 2011 but also for years before and after 2011.”

Where was the Court going with this?

 For 2007—2010 they claimed deductions in the aggregate amount of $292,143 for noncash charitable contributions."

Are you hearing skepticism?

For 2012-2013 they claimed deductions in the amount of $104,970 for noncash charitable contributions.”

Yep, skepticism.

The Court had a whole range of options to bounce the deduction.

Petitioners did not maintain contemporaneous records establishing any of these facts.”     

That is one option.

Stay within the lines and the Court might cut you some slack.  Deduct half a million dollars over a few years and …. Let’s just say you had better make a lot of money to even get to the realm of possible.

Many of those aggregate dollar figures are suspect on their face.”

The Court spotted them a $250 deduction.

Leaving approximately $33 grand in tax and over $6 grand in penalties.

Keep it believable, folks.

Someone Fought Back Against Ohio – And Won

I admit it will be a challenge to make this topic interesting.

Let’s give it a shot.

Imagine that you are an owner of a business. The business is a LLC, meaning that it “passes-through” its income to its owners, who in turn take their share of the business income, include it with their own income, and pay tax on the agglomeration.

You own 79.29% of the business. It has headquarters in Perrysville, Ohio, owns plants in Texas and California, and does business in all states.

The business has made a couple of bucks. It has allowed you a life of leisure. You fly-in for occasional Board meetings in northern Ohio, but you otherwise hire people to run the business for you. You have golf elsewhere to attend to.

You sold the business. More specifically, you sold the stock in the business. Your gain was over $27 million.

Then you received a notice from Ohio. They congratulated you on your good fortune and … oh, by the way … would you send them approximately $675,000?

Here is a key fact: you do not live in Ohio. You are not a resident. You fly in and fly out for the meetings.

Why does Ohio think it should receive a vig?

Because the business did business in Ohio. Some of its sales, its payroll and its assets were in Ohio.

Cannot argue with that.

Except “the business” did not sell anything. It still has its sales, its payroll and its assets. What you sold were your shares in the business, which is not the same as the business itself.

Seems to you that Ohio should test at your level and not at the business level: are you an Ohio resident? Are you not? Is there yet another way that Ohio can get to you personally?

You bet, said Ohio. Try this remarkable stretch of the English language on for size:

ORC 5747.212 (B) A taxpayer, directly or indirectly, owning at any time during the three-year period ending on the last day of the taxpayer's taxable year at least twenty per cent of the equity voting rights of a section 5747.212 entity shall apportion any income, including gain or loss, realized from each sale, exchange, or other disposition of a debt or equity interest in that entity as prescribed in this section. For such purposes, in lieu of using the method prescribed by sections 5747.20 and5747.21 of the Revised Code, the investor shall apportion the income using the average of the section 5747.212 entity's apportionment fractions otherwise applicable under section 5733.05, 5733.056, or 5747.21 of the Revised Code for the current and two preceding taxable years. If the section 5747.212 entity was not in business for one or more of those years, each year that the entity was not in business shall be excluded in determining the average.

Ohio is saying that it will substitute the business apportionment factors (sales, payroll and property) for yours. It will do this for the immediately preceding three years, take the average and drag you down with it.

Begone with thy spurious nonresidency, ye festering cur!

To be fair, I get it. If the business itself had sold the assets, there is no question that Ohio would have gotten its share. Why then is it a different result if one sells shares in the business rather than the underlying assets themselves? That is just smoke and mirrors, form over substance, putting jelly on bread before the peanut butter.

Well, for one reason: because form matters all over the place in the tax Code. Try claiming a $1,000 charitable deduction without getting a “magic letter” from the charity; or deducting auto expenses without keeping a mileage log; or claiming a child as a dependent when you paid everything for the child – but the divorce agreement says your spouse gets the deduction this year. Yeah, try arguing smoke and mirrors, form and substance and see how far it gets you.

But it’s not fair ….

Which can join the list of everything that is not fair: it’s not fair that Firefly was cancelled after one season; it’s not fair that there aren’t microwave fireplaces; it’s not fair that we cannot wear capes at work.

Take a number.

Our protagonist had a couple of nickels ($27 million worth, if I recall) to protest. He paid a portion of the tax and immediately filed a refund claim for the same amount. 

The Ohio tax commissioner denied the claim.

COMMENT: No one could have seen that coming.

The taxpayer appealed to the Ohio Board of Tax Appeals, which ruled in favor of the Tax Commissioner.

The taxpayer then appealed to the Ohio Supreme Court.

He presented a Due Process argument under the U.S. Constitution.

And the Ohio Supreme Court decided that Ohio had violated Due Process by conflating our protagonist with a company he owned shares in. One was a human being. The other was a piece of paper filed in Columbus.

The taxpayer won.

But the Court backed-off immediately, making the following points:

(1)  The decision applied only to this specific taxpayer; one was not to extrapolate the Court’s decision;

(2)  The Court night have decided differently if the taxpayer had enough activity in his own name to find a “unitary relationship” with the business being sold; and

(3)  The statute could still be valid if applied to another taxpayer with different facts.

Points (1) and (3) can apply to just about any tax case.

Point (2) is interesting. The phrase “unitary relationship” simply means that our protagonist did not do enough in Ohio to take-on the tax aroma of the company itself. Make him an officer and I suspect you have a different answer. Heck, I suspect that one Board meeting a year would save him but five would doom him. Who knows until a Court tells us?

With that you see tax law in the making.

By the way, if this is you – or someone you know – you may want to check-out the case for yourself: Corrigan v Testa. Someone may have a few tax dollars coming back.

Testa, not Tesla

Tax Break For Wealthy (Federal Government) People

Let's talk about a tax break; some may even call it a gimmick. It will never affect your or me, unless we go into the federal government.

Here is Code section 1043:

Sale of property to comply with conflict-of-interest requirements 

(a) Nonrecognition of gain

If an eligible person sells any property pursuant to a certificate of divestiture, at the election of the taxpayer, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds the cost (to the extent not previously taken into account under this subsection) of any permitted property purchased by the taxpayer during the 60-day period beginning on the date of such sale.

(b) Definitions

For purposes of this section -

(1) Eligible person

The term "eligible person" means -

(A) an officer or employee of the executive branch, or a judicial officer, of the Federal Government, but does not mean a special Government employee as defined in section 202 of title 18, United States Code, and

(B) any spouse or minor or dependent child whose ownership of any property is attributable under statute, regulation, rule, judicial canon, or executive order referred to in paragraph (2) t a person referred to in subparagraph (A).

Let's say that you are pulling down several million dollars a year from your day job. You have the opportunity to head-up the EPA or the National Park Service. It is almost certain that your paycheck will shrink, and the Congressional committee investigating you may request you sell certain investments or other holdings to avoid conflict of interest concerns.

Folks, this is an uber-elite tax problem.

To ease your decision, the tax Code will allow you to sell your investments without paying any tax. To do so you are required to buy replacement securities within 60 days, and the non-taxed gain will reduce your basis in the new securities.

OBFUSCATION ALERT: To say it differently, your "basis" in the old securities sold will carry-over as your basis in the new securities.

By way, it is not necessary to have Congress to tell you to unload your investments. There is a more lenient "reasonably necessary" standard that might work for you. I am reasonably certain I could come up with some necessary argument so I would not pay tax.

While sweet, Section 1043 is not a complete escape clause. If you think about it, all you have done is delay the taxable gain until you sell the new securities. I suppose an escape clause is to die without selling, but I generally do not consider dying to be a viable tax strategy.

The numbers can add-up, though. It is estimated that Paul O'Neill, a former Treasury Secretary, sold approximately $100 million of Alcoa stock when he took the position. I do not know what the gain would have been (as we do not know the cost), but the tax he deferred must have been eye-opening.

By the way, you can get the same break by drawing a judicial appointment.

I do have a question: do you wonder why the politicos never mention Section 1043 whenever they rail against "tax breaks" used by wealthy people?

Nah, there is no wonder at all.

Wal-Mart Sues Puerto Rico Over Tax Changes

I had seen the headline, but it was busy season and there were other priorities.

Now I have had time to look into the matter.

I am referring to the Wal-Mart v Zaragoza-Gomez decision. It has to do with Puerto Rican taxes.

You may know that Puerto Rico is a U.S. territory. I have bumped into it professionally only a couple of times over the last dozen or so years. It simply is not a component of my practice.

What you may not know is that Puerto Rico has its own taxes. It is similar to a state in that regard, but there are differences. For example, if you are a resident of Puerto Rico you do not have to file a U.S. tax return – unless you have income in the U.S. You then file a U.S. return, but only for the U.S. income.

Puerto Rico however is now on the precipice of bankruptcy. They decided to bring-in more money to the fisc by changing a tax rule or two:

·        Tripling the “tangible personal property” tax rate from 2.5% to 6.5% on purchases from vendors located off the island.

·        Eliminating the option for the Treasury Secretary to exempt, in whole or part, a 20% tax on services provided by related entities or by a home office upon proof that the price charged was equal or substantially similar to the price which would occur with an unrelated person.

There was a problem, however: the tax, as changed, applied to only one taxpayer: Wal-Mart.

Granted, Wal-Mart is also the island’s largest corporate taxpayer, but one would think the politicians would employ some … deniability … before they culled the Arkansan wildebeest from the herd. Shheessssh.

Now, 6.5% does not sound like a lot, but I suppose one has to specify what it is being multiplied against. 

·        If net profit, that would leave 93.5% of profit left over. That is pretty good.

·        If cost of sales, then we need one more piece of information.

We need to know the gross profit.

Say that you bought something for $93. You sold it for $100.  Your gross profit is $7. Now you have to pay tax. That tax is calculated as 6.5% times $93 or slightly over $6. Your profit was $7.

That is not so good.

Wal-Mart said that the effect of the changes was an effective tax rate of over 90%, so I am thinking we are not too far off with the above example.

Wal-Mart did what it had to do: it sued.

The District Court was sympathetic to Puerto Rico’s financial plight:

·        It gives us no pleasure, under these circumstances, to enjoin a revenue stream that flows directly into Puerto Rico’s general fisc.”

·        … we, too, are citizens of this island and we, too, must suffer the consequences….”

·         … we are here because … has left the plaintiff, Wal-Mart, with nowhere else to turn.”

The government argued that Wal-Mart would simply have to pay the tax and sue for refund. Wal-Mart’s argument was “not yet ripe,” as it had not been denied a refund of its taxes. Furthermore, Wal-Mart could “afford to pay” the tax.

The Court pointed out the obvious: it would likely take a generation for the case to resolve, at which point Puerto Rico might be as able to repay Wal-Mart as it is to have winter sports. 

This is not a remedy, but a cynical means of extracting more unconstitutional revenue from an innocent taxpayer without the deterrent effect of having to pay it back…,” said the Court.

The government said it would appeal.

The judge just took away $100 million from the people of Puerto Rico and gave it to Wal-Mart. Now I have to look for that money somewhere else,” said Governor Alejandro Garcia Padilla.

I have no particular sympathy for Wal-Mart, other than the deep belief that any government desirous of being perceived as legitimate is mandated to deal fairly with its citizenry. Taxation is especially sensitive, and this is the equivalent of having you pay for all the new sidewalks in the neighborhood because you have the nicest house.

Smart person moves out of the neighborhood.

Losing An Alimony Tax Deduction

There are certain tax topics that repeat – weekly, monthly, ceaselessly and without end. One such is the tax issues surrounding divorce. I have often wondered why this happens, as divorce is surely one of the most lawyered life events an average person can experience. I will often skip divorce tax cases, as I am just tired of the topic.

But a recent one caught my eye.

The spouses were trying to work something out between them. It was clear to me that they solicited no tax advice, as they plunged off the bridge without checking the depth of the water below.

John and Beatrix were married. They legally separated in 2008 and divorced in 2013. In the interim John agreed to make 48 monthly maintenance payments of $2,289. There was a clause stipulating that payments were to be taxable to her and deductible by him, and the payments were to cease upon her remarriage or death.

John found himself unemployed. His payments were to begin in 2010. Presumably concerned about his financial situation, he and Beatrix agreed in 2009 to transfer his IRA worth $38,913.

John did not deduct the IRA as an alimony payment on his 2009 tax return.

Why not? Because Beatrix was to start withdrawing $2,289 monthly from the IRA the following year, presumably until the $38,913 was exhausted. It made more sense to John that those monthly payments would trigger the alimony.

There is some rhyme or reason to his thinking.

It appears his finances improved, as in 2010 he was able to directly pay Beatrix $6,920.  

In 2010 he deducted $27,468 ($2,289 times 12) as alimony.

The IRS disallowed all but $6,920.

Off to Tax Court they went.

There are four key statutory requirements before any payment can be deductible as alimony:

(1)  The payment must be required under a divorce or separation decree.

(2) The decree cannot say that the payments are not deductible/taxable.

(3)  The two individuals cannot be members of the same household.

(4) There cannot be any requirement to continue the payments after the death of the payee spouse.

It is amazing how often someone will fail one of these. A common story is one spouse beginning payments before the court issues the order, or a spouse paying more than the court order. Do that and the payment is not “required.” Another story is presuming that the payment is deductible because the decree says that it is. The IRS does not consider itself bound because one included such language in the decree.

Then there are the softer, non-key requirements.

For example, only cash payments will qualify as alimony.

If you think about this one for a moment, it makes sense. The Code already allows spouses to transfer property in a divorce without triggering tax (Code section 1041). This allows spouses to transfer the house, for example, as well as retirement benefits under a QDRO order. The Code views these transactions as property settlements – meaning the ex-spouses are simply dividing into separate ownership what they previously owned together.

COMMENT: It is highly debatable whether John’s IRA is “cash.”  Granted, there may be cash in the IRA, but that not is not the same as saying the IRA is cash or a cash equivalent. It would make more sense to say that it is the equivalent of stocks or mutual funds. This would make it property, not cash.

Let’s next go back to rule (4) above. A way to rephrase that rule is that the payee spouse cannot be enriched after death. Obviously, if maintenance payments were to continue after death, then the payee-spouse’s estate would be enriched. That is not allowed.

In our situation, Beatrix now owned an IRA. Granted, the expectation may have been that she would outlive any balance in the IRA, but that expectation is not controlling. If she passed away, the balance in the IRA would be hers to transfer pursuant to her beneficiary designation.

She was enriched. She had something that continued past her (albeit hypothetical) death.

Another issue was whether John should get credit for IRA withdrawals by Beatrix in 2010. Why?  John transferred the IRA to her in 2009. The account was no longer his. It was hers, and he could no longer piggyback on anything the IRA did. If he was going to deduct anything, he would have had to deduct it in 2009.

Which, by the way, he could not because of rule (1): it was not required under the decree. The decree called for payments beginning in 2010, not in 2009.

The Tax Court decided that John had a 2010 alimony deduction for $6,920, the amount he paid Beatrix directly.

Why did John do it this way? 

If John was less than 59 1/2, so he could not get into his IRA without penalty.  He could QDRO, but that is just a property settlement. John wanted an alimony deduction. If he kept the IRA, he would have income on the withdrawal and a deduction for the alimony. That is a push - except for the 10% penalty on the early withdrawal. John was in a tough spot.

Then again, maybe he didn't think of tax matters at all.