New York And State Donation Programs

You may have read that the new tax law will limit your itemized tax deduction beginning this year (2018).

This is of no concern to you if you do not itemize deductions on your personal return.

If you do itemize, then this might be a concern.

Here is the calculation:

        *  state income taxes plus

        *  local income taxes plus

        *  real estate taxes plus

        *  personal property taxes

There is a spiff in there if you live in a state without an income tax, but let’s skip that for now.

You have a sum. You next compare that sum to $10,000, and

… you take the smaller number. That is the maximum you can deduct.

Folks, if you live in New Jersey odds are that real estate taxes on anything is going to be at least $10 grand. That leaves you with no room to deduct New Jersey income taxes. You have maxed.

Same for New York, Connecticut, California and other high tax states.

Governor Cuomo said the new tax law would “destroy” New York.

Stepping around the abuse of the language, New York did put out an idea – two, in fact:

·       Establish a charitable fund to which one could make payments in lieu of state income taxes. When preparing one’s individual tax return, one could treat contributions to that fund as state taxes paid. To make this plausible, New York would not make the ratio one-to-one. For example, if you paid $100 to the charitable fund, your state tax credit might be $90. Surely no one would then argue that you had magically converted your taxes into a charitable deduction. The only one on the short end is the IRS, but hey … New York.

·      Have employers pay a new payroll tax on employee compensation, replacing employee withholding on that compensation.  Of course, to get this to work the employee would probably have to reduce his/her pay, as the employer is not going to keep his/her salary the same and pay this new tax.

Other states put out ideas, by the way. New York was not alone.

I somewhat like the second idea. I do however see the issue with subsequent raises (a smaller base means a smaller raise), possibly reduced social security benefits, possible employer reluctance to hire, and the psychological punch of taking a cut in pay. Ouch.

The first idea however has a sad ending.

You see, many states for many years thought that there were good causes that they were willing to subsidize.

·       Indiana has the School Scholarship Credit. You donate to a scholarship-granting charity and Indiana gives you a tax credit equal to 50% of the donation on your personal return.

·       South Carolina has something similar (the Exceptional SC), but the state tax credit is 100%.

New York and its cohorts saw these and said “What is the difference between what Indiana or South Carolina is doing and what we are proposing?”

Well, for one thing money is actually going to a charitable cause, but let’s continue.

This past summer the IRS pointed out the obvious: there was no charity under New York’s plan., The person making the “donation” was simultaneously receiving a tax benefit. That is hardly the hallmark of a charitable contribution.

Wait, wait, New York said. We are not giving him/her a dollar-for-dollar credit, so …..

Fine, said the IRS. Here is what you do. Subtract the credit from the “donation.” We will allow the difference as a deductible contribution.

In fact, continued the IRS, if the spread is 15% or less, we will spot you the full donation. You do not have to reduce the deduction for the amount you get back. We can be lenient.

So what have New York and cohorts done to Indiana, to South Carolina and other states with similar programs?

You got it: they have blown up their donation programs.

Way to go.

Why did the IRS not pursue this issue before?

Well, before it did not matter whether one considered the donation to be a tax or a deductible contribution. Both were deductible as itemized deductions. There was no vig for the IRS to chase.

This changed when deductible taxes were limited to $10,000. Now there was vig.

There are about 30 states with programs like Indiana and South Carolina, so do not be surprised if this reaches back to you.

A College Student and Ethereum

I have passed on Bitcoin and other cryptocurrencies.

I do not quite understand them, nor am I a Russian oligarch or Chinese billionaire trying to get money out of the country.

I certainly do not think of them as money.

The IRS agrees, having said that cryptos are property, not money.

This has very significant tax consequences.

I can take $100 out of my bank and pay cash at the dry cleaners, Starbucks, Jimmy John’s and Kroger without triggering a tax event.

Do that with a crypto and you have four taxable events.

That is the difference between property and money.

COMMENT: To be fair, money (that is, currency) can also be bought and sold like property. That is what the acronym “forex” refers to. It happens all the time and generally is the province of international companies hedging their cash exchange positions. Forex trading will trigger a tax consequence, but that is not what we are talking about here.

I am reading about a college student who in 2017 invested $5,000 in Ethereum, a cryptocurrency.

Within a few months his position was worth approximately $128,000.

He diversified to other cryptos (I am not sure that counts as diversification, truthfully) and by the end of the year he was closing on $900 grand.

Wow!

2018 has not been kind to him, however, and now he is back to around $125 grand.

Do you see the tax problem here?

Yep, every time he traded his crypto the IRS considered it taxable as a “sale or exchange” of property.

Maybe it is not that bad. Maybe he only traded two or three times and can easily pay the taxes from his $125 grand.

He estimates his 2017 taxes to be around $400 grand.

Seems a bit heavy to me, but let’s continue.

Does the IRS know about him?

Yep. Coinbase issued him a 1099-K reporting his crypto trades. Think of a 1099-K as the equivalent of a broker reporting your stock trades on a 1099-B.

He argues that he reinvested all his trades. He never took a personal check.

I don’t think he quite understands how taxes work. Try telling the IRS that you did not have taxable income upon the sale of your Apple stock because you left all the money in your brokers’ account.

He says that he reached out to a tax attorney – one who specializes in crypto.

I am glad that he sought professional help, whether attorney, CPA or EA.

I however doubt that the attorney’s crypto expertise is going to move the needle much. What he needs is a someone with expertise in IRS procedure, as he is rushing toward an installment plan, a partial pay or offer in compromise.

After all, he is not paying the $400 grand in taxes with what he has left.

Happy Thanksgiving!

Blade’s Offer In Compromise

I am enough of a nerd to say that I enjoyed the Blade movies. I am a fan of Wesley Snipes, who played the half-vampire vampire hunter in the series.

You may recall that he got into big-time tax trouble several years ago. He bought into tax protestor arguments, such as being an ambassador from the planet Naboo or some similar nonsense. He spent three years in prison.

When he came out of prison the IRS wanted over $23 million in taxes, penalties and interest.

He went to a Collections Due Process hearing. The purpose of a CDP is to tamp-down IRS aggressiveness in separating you from your money. The CDP has limited range, but sometimes that range makes all the difference.

So he goes and requests collection alternatives.

Perfect. Exactly what a CDP is designed to do.

He proposes an installment agreement.

There are flavors of these, and one of the flavors is called a “partial pay.” For a partial, you have to convince the IRS that you are unable to fully pay your taxes over the period the IRS can collect from you. You almost have to provide photos of Bigfoot to persuade the IRS to go along.

Alternatively, he proposes an offer in compromise (OIC).

In some cases, the difference between a partial pay and an OIC can be slight, except for maybe at the edges. For example, enter a partial pay and the IRS may request payment adjustment if your income goes up. That is a risk you do not have with an OIC.

Right there you can anticipate that an OIC is harder to obtain than a partial pay.

And an OIC for an actor who has made millions from movies is going to be harder still.

OICs are the “pennies on the dollar” tripe you hear on radio or late-night commercials. Those “pennies” OICs are few and far between, and usually involve some or all of the following factors:

·      Someone was injured and will never work again

·      Someone has retired and will never work again

·      Someone owns next to nothing

·      Someone owes the IRS money   

The key theme here is that someone is broke, and there is little likelihood that condition will ever change.

Folks, that is not tax planning. That is bad luck in life, very poor life choices, or both.

Wesley Snipes put in an OIC of $842,061.

Out of $25 million plus.

Heck, even I don’t believe him.

Let’s begin with personal financials. You know the IRS is going to check him out, especially with such a lowball offer.

·      Snipes owns real estate and other assets through a series of related companies.

OK. The IRS is going to have to look at this.

·      Snipes argued that some of this real estate had been sold or went missing.

OK. The IRS is going to have to look at this.

·      Snipes argued that his financial advisor had “diverted” his assets and money without his knowledge or consent.

OK. The IRS is going to have to look at this.

·      Snipes requested that his tax liability be “transferred” to his advisor, as the advisor had conveniently “transferred” Snipe’s assets to himself. This would require an investigation, of course, and perhaps the IRS could place his account in “currently not collectible” status during the investigation.

I suspect there is or will be a lawsuit here. I would have hired an attorney and filed papers already.

The problem is that Appeals (where Snipes was at the moment) is not built for this. Snipes is requesting an audit, and audits are done by Examination. Given what was alleged, this matter could even go to the Criminal Division of the IRS. While Appeals can review the work of the field (Examination) division, they cannot perform the field investigation themselves.

·      He has one more argument: economic hardship.

Problem: the normal indicia of economic hardship include illness, disability, or exhaustion of income or assets providing for oneself or dependents. These do not apply in his case.

That leaves an argument that he is unable to borrow against assets, and the forced sale of said assets would leave him unable to meet basic expenses.

This argument may have traction. He is – after all – asserting that assets have disappeared and he doesn’t know when or where.

But he failed to provide enough financial information to allow the IRS to evaluate the matter. The IRS and the Court kept circling on this point. Could it be that he truly could not sherlock what happened to his money?

However, not providing information in an OIC tends to be fatal.

Still, the IRS was moved. They agreed to reduce the settlement to $9,581,027.

Snipes’ team said: No. It is $842,061 or nothing.

The Court said: Then nothing it is.

I suspect the most interesting part of the story is the part that was not provided: what happened to the real estate and other money?

I also wonder if there is a certain schadenfreude here.

Tax protestors sometimes use unnecessarily complicated structures (trusts, for example) to distance, obscure and possibly hide the ultimate control of money or assets. A protestor would not own real estate directly, for example. Rather an entity would own the real estate and the protestor would control the entity. Or there would be an intermediate entity owned by yet another entity controlled by the protestor.

What if the protestor goes to prison? The protestor might then cede a certain amount of authority over the entity/entities to someone – like an advisor - while incarcerated.

What happens if that advisor does not have the protestor’s best interest at heart?

Might sound a lot like what we read here.

Can Creditors Reach The Retirement Account Of A Divorced Spouse?

Let’s say that you divorce. Let say that retirement savings are unequal between you and your ex-spouse. As part of the settlement you receive a portion of your spouse’s 401(k) under a “QDRO” order.

COMMENT: A QDRO is a way to get around the rule prohibiting alienation or assignment of benefits under a qualified retirement plan. I generally think of QDROs as arising from divorce, but they could also go to a child or other dependent of the plan participant.

Your QDRO has (almost) the same restrictions as any other retirement savings. As far as you or I are concerned, it IS a retirement account.

You file for bankruptcy.

Can your creditors reach the QDRO?

Sometimes I scratch my head over bankruptcy decisions. The reason is that bankruptcy – while having tax consequences – is its own area of law. If the law part pulls a bit more weight than the tax part, then the tax consequence may be nonintuitive.

Let’s segue to an inherited IRA for a moment. Someone passes away and his/her IRA goes to you. What happens to it in your bankruptcy?

The Supreme Court addressed this in Clark, where the Court had to address the definition of “retirement funds” otherwise protected from creditors in bankruptcy.

The Court said there were three critical differences between a plain-old IRA and an inherited IRA:

(1)  The holder of an inherited IRA can never add to the account.

(2)  The holder of an inherited IRA must draw money virtually immediately. There is no waiting until one reaches or nears retirement.

(3)  The holder of an inherited IRA can drain the account at any time – and without a penalty.

The Court observed that:

Nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after bankruptcy proceedings are complete.”

The Court continued that – to qualify under bankruptcy – it is not sufficient that monies be inside an IRA. Those monies must also rise to the level of “retirement funds,” and – since the inheritor could empty the account at a moment’s notice - the Court was simply not seeing that with inherited IRAs.

I get it.

Let’s switch out the inherited IRA and substitute a QDRO. With a QDRO, the alternate payee steps into the shoes of the plan participant.

The Eighth Circuit steps in and applies the 3-factor test of Clark to the QDRO. Let’s walk through it:

(1)  The alternate payee cannot add to a QDRO.

(2)  The alternate payee does not have to start immediate withdrawals – unless of required age.

(3)  The alternate payee cannot – unless of required age - immediately empty the account and buy that vacation home or sports car.

By my account, the QDRO fails the first test but passes the next two. Since there are three tests and the QDRO passes two, I expect the QDRO to be “retirement funds” as bankruptcy law uses the term.

And I would be wrong.

The Eighth Circuit notes that tests 2 and 3 do not apply to a QDRO. The Court then concludes that the QDRO has only one test, and the QDRO fails that.

The Eighth Circuit explains that Clark:

… clearly suggests that the exemption is limited to individuals who create and contribute funds into the retirement account.”

It is not clear to me, but there you have it – at least if you live in the Eighth Circuit.

No bankruptcy protection for you.

Our case this time for the home gamers was In re Lerbakken.

Can You Make Gifts To Your Pastor?

Can you give someone money and not have it considered income?

Of course you can.

One way to do it is to die and leave money as a bequest.

That is a bit extreme for the average person, including me.

Another way is to give someone a gift. Granted, if the gift is large enough, you may have to report it. You do not actually write a check to Uncle Sam until your cumulative lifetime gifting exceeds $11,180,000, but you do have to file paperwork.

Can you make a gift to an employee?

Much harder.

The Code does allow some de minimis things, such as holiday hams – but even that has to be under $75. 

Oh, and it cannot be in cash, whether less than $75 or not. Cash taints the deal.

There is a narrow exemption for length of service or safety awards, but let’s pass on those details.

To a tax geek, the general answer is that anything you give an employee is taxable.

I was looking at a case a couple of weeks back that introduced a spin on this concept.

We have a pastor at a Minnesota church.

For the two years at issue he turned down a salary.

He did take a housing allowance.

And then it got interesting.

The church used donation envelopes. They were different colors, with each color having a different meaning.

The basic envelope was white. That was the weekly offering. It included a space where you could designate the amount of the donation that was for the pastor.

There were gold envelopes for special projects and events.

Then there were the blue envelopes. Blue envelopes were “gifts” to the pastor, and congregation members were instructed that those could not be deducted on their tax returns. The church did not track blue envelope donations, nor did the church make blue envelopes commonly available. If you wanted one, you had to ask for one.

For tax years 2008 and 2009, the pastor received the following;

                                                       2008              2009

          White envelopes              $40,000         $40,000

          Housing allowance          $78,000         $78,000

          Blue envelopes              $258,001        $234,826

When the IRS learned of this, they wanted tax on the blue envelopes.

What do you think?

Here is the Bible:

When I preach the gospel, I may make the gospel of Christ without charge, that I abuse not my power in the gospel.” 1 Cor. 9:18

Here is the Court: 

To decide this case, we must descend from the sacred to the profane."  

What sets up the tension in this case is that the term “gift” has a different meaning for tax than for common law. For common law, a gift is made voluntarily and without legal or moral obligation.

Tax views a gift as made from “detached and disinterested generosity” or “out of affection, respect, admiration, charity or like impulses.”

Huh? What is the difference?

The “disinterested generosity.”

That standard can be hard enough to pin down when reviewing a transaction between two individuals. How much harder can it get when reviewing a transaction between a group and an individual?

But that is what the Court had to decide.

The Court walked us through its decision process.

(1) Were donations provided in exchange for services?

The pastor did provide services, and to a reasonable person those blue envelopes look like an incentive for him to keep providing them.

Looks like a vote for income.

(2)  Did the pastor request the donations?

To his credit, the pastor referred to white envelopes when talking about tithes. He did not talk about blue envelopes, and a congregation member had to ask for one as they were not generally available.

Looks like a vote for a gift.

(3) Were the donations part of a routinized program?

That depends. Is the existence of blue envelopes per se evidence of a “routinized program?”

Can mere existence of a program rise to the level of a “routine?”

One can discern some routine no matter what the facts are, as the repetition of any action can be described as a “routine.” However, is that truly the intent of this test?

Call this one a push.

(4) Did the pastor receive a separate salary and what was the relationship of that salary to the personal donations?

The Court was very uncomfortable here:

We cannot ignore the sheer size of blue-envelope donations in 2008 and 2009, or the facts that they are very similar in amount in both years – within 10% of each other. We find it more likely than not that this means there was a ‘regularity of the payments from member to member and year to year ….’”

Oh, oh. We have our tie-breaker.

The Court had to discern the intent of the group, an almost mythical challenge. It saw blue-envelope donations total almost seven times the amount of white-envelope donations and asked: could it be that the congregation was trying to keep its popular and successful preacher?

CTG: I’ll play along: why, yes they were.

If they paid him more and donated less, perhaps they would not be as concerned.

CTG: By that reasoning, had he won the recent billion-dollar lottery they would not have to pay him at all. 

But he needs a certain amount just to pay his bills.

CTG: True, but how many parents across the fruited plain are giving their post-college kids money to live on? Is that income too?

The relationship between a parent and child is different.

CTG: The relationship between a faithful and his/her religious leader can also be different.

But being a minister is his job. Anything he receives for doing his job is – by definition – income.

CTG: Thank you. This is the clearest statement of your reasoning thus far. Why four criteria? Seems to me you could have fast-forwarded to the last one – the only one that really mattered.

The Court decided the pastor had income. He owed tax.

Register my surprise at zero, none, nada. I knew the ending of this movie from the first scene.

Our case this time was Felton v Commissioner.

Rolling Over An Inherited IRA

I am not a fan of the 60-day IRA rollover.

I admit that my response is colored by being the tax guy cleaning-up when something goes awry. Unless the administrator just refuses a trustee-to-trustee rollover, I am hard pressed to come up with a persuasive reason why someone should receive a check during a rollover.

Let’s go over a case. I want you to guess whether the rollover did or did not work.

Taxpayer’s mom died in 2008.

Mom had two IRAs. She left them to her daughter, who received two checks: one for $2,828 and a second for $35,358.

The daughter rolled over $35,358 and kept the smaller check.

On her tax return, she reported gross IRA distributions of $38,194 (there is a small difference; I do not know why) and taxable distributions of $2,828.

She did not have an early distribution penalty, as that penalty does not apply to inherited accounts.

The IRS flagged her, saying that the full $38,194 was taxable.

What do you think?

Let’s go over it.

There is no question she was well within the 60-day period.

The money went into an IRA account. This is not a case where monies erroneously went into something other than an IRA.

This was the daughter’s only rollover, so we are not triggering the rule where one can only roll IRA monies in this manner once every twelve months.

The Court decided that the daughter was taxable on the full amount.

Why?

She ran face-first into a sub-rule: one cannot rollover an inherited account, with the exception of a surviving spouse.

The daughter argued that she intended to roll and also substantially complied with the rollover rules.

Here is the Tax Court:

The Code’s lines are arbitrary. Congress has concluded that some lines of this kind are appropriate. The judiciary is not authorized to redraw the boundaries.”

This is a polite way of saying that tax rules sometimes make no sense. They just are. The Tax Court, not being a court of equity, cannot decide a case just because a result might be viewed as unfair.

The Court did not address the point, but there is one more issue at play here.

There are penalties for overfunding an IRA.

Say that you can put away $6,500. You instead put away $10,000. You have overfunded by $3,500.

So what?

You have to get the excess money out of there, that’s what.

Normally I recommend that the $3,500 be moved as a contribution to the following year, nixing the penalty issue.

Let’s say that you do not do that. In fact, you do not even know to do that.

For whatever reason, the IRS examines your return five years later. Say they catch the issue. You now owe a 6% penalty on the overfunding.

That’s not bad, you think. You will pay $210 and move on.

Nope.

It is 6% a year.

And you still have to get the $3,500 out.

Except it is now not $3,500. It is $3,500 plus any earnings thereon for five years.

Say that amount is $5,500, including earnings.

You take out $5,500.

You have five years of 6% penalties. You also have tax on $2,000 (that is, $5,500 minus $3,500).

If you are under 59 ½ you probably have an early-distribution penalty on the $2,000.

Plus penalties and interest on top of that.

I like to think that the Tax Court cut the taxpayer a break by not spotlighting the overfunding penalty issue.

Our case this time was Beech v Commissioner.

A Tax Preparer As A Witness

It is – once again – that time of year. Extensions. The business extensions came due last month. The individual extensions are due this month.

What a crazy thing to do for a living.

I have not had a lot of time to scan my normal sources, but I did see a case that caught my eye.

The taxpayers live in Illinois. They have an S corporation.

They rent a pole-barn garage to the S corporation. The corporation stores tractors, trailers and other equipment there.

Pretty normal.

They used a tax preparer for their 2012 and 2013 individual returns.

On their rental schedule, they deducted (among other expenses) the following:

·      Interest of $5,846 for 2012 and $4,336 for 2013

·      Taxes of $7,058 for 2012 and $10,395 for 2013

They also deducted the personal portion of their interest and taxes as itemized deductions.

I was anticipating that they double-counted the interest and taxes.

Nope.

They never could document the 2012 real estate taxes on their rental schedule.

Seriously?

Then we have 2013. The Court agreed that the taxes were paid, but they were paid by the S corporation.

Folks, to claim the taxes on a personal return one has to pay the taxes personally.

There went the rental real estate tax deduction for both years.

Onward to the 2012 mortgage interest.

Same answer as the 2013 real estate taxes.

Yeeessh.

The Court was a little more lenient in 2013, sort of. While they disallowed any interest on the rental schedule, the Court did allow substantiated mortgage interest in excess of claimed interest as an itemized deduction.

The IRS next went in to bayonet the wounded and dead: it wanted a 20% accuracy-related penalty.

Of course they did.

A common defense to this penalty is reliance on a tax professional.

Taxpayers used a tax preparer for 2013 and 2013.

Seems to me they have a potential defense.

The Court then drops this:

Although their returns were prepared by a paid income tax preparer, the return preparer used income and expense amounts petitioner provided. Apparently, no source documents underlying the deductions were provided to the return preparer; according to the return preparer, petitioners had ‘horrible books and records.’”

And this is a witness for the taxpayers?

Because petitioners did not furnish the return preparer with complete and accurate information, they failed to establish that their reliance upon the return preparer constitutes ‘reasonable cause’ and ‘good faith’ with respect to the underpayments of tax.”

Wow.

I get it. The preparer might have gotten them out of a penalty on a technical issue, but given the poor quality of the records the preparer could not get them out of a penalty for the numbers themselves.

The taxpayers probably would have done better by not bringing their preparer to testify.

And then I noticed: it was a “pro se” case.

Which means that the taxpayers represented themselves.

COMMENT: Pro se does not mean that your preparer is not there. I for example can appear before the Tax Court as part of a pro se. I would then be there as a witness, and I would not considered to be “practicing.”

In this case the taxpayers made a bad call by bringing in their preparer.

The case for the home gamers is Lawson v Commissioner.