Taxing A Corvette

I came across an old case recently. It made me smile, as it reminded me of earlier – and skinnier – times.

Let’s set this up.

There are, broadly speaking, two accounting methods when deciding whether you have reportable income for a period: the cash method and the accrual method. There are a variety of sub, sorta- and who-actually-understands-this methods, but cash and accrual are enough for right now.

The cash method is easy: if you can deposit it at the bank you have income.  Maybe you decide not to deposit at the bank until next week, but it is still income today. Why? Because you can deposit it. The definition is “can” not “did.”

Accrual is trickier. Generally it means that you sent an invoice to someone. The act of invoicing means you have income, as someone owes you. What if you delay invoicing for a week or two? Well, then you have a variation on the above cash-basis reasoning: you could have but didn’t. Again, it is the “could,” not the “did,” that drives the test.

What if you are on the cash method and somebody pays you with property instead of cash? You have income. It makes sense when you remember that cash is a form of property. We have just gotten so used to it that we don’t think of cash that way. For tax purposes, though, someone paying you in asiago cheese and gluten-free crackers still represents income. Granted, we have to translate cheese-and-crackers into dollars, but income it is.

Let’s say that you played football. Not just any football, however. You were Vince Lombardi’s running back. It is December 31, and you and Lombardi and the Green Bay Packers are playing the New York Giants in the National Football League Championship.

COMMENT: NFL historians will immediately recognize that this was before the Super Bowl era. There was no game called the Super Bowl until the two leagues – the National Football League and the American Football League – merged in 1966. The first two Super Bowls were won tidily by Lombardi and the Packers. In Super Bowl 3 Joe Namath famously led the New York Jets over the Baltimore Colts.

So it is the championship game. You are the running back. It is December 31 and you are playing outside in Green Bay. I presume you are freezing. You run wild and score 19 points, establishing a league record. You are selected after the game by Sport Magazine as the most valuable player, which comes with the prize of a new Corvette. 

Sweet.

By the way, your Corvette is waiting for you in New York. It is now the evening of December 31, 1961.

Tax issue: Do you have income (the value of that Corvette) in 1961?

The IRS said you did.

But you throw the IRS a loop: the car is not income. No, siree. It was a gift. Alternatively, it is nontaxable to you as a prize or award.

I give you kudos, but the concept of a gift requires the presence of detached and disinterested generosity. While a creative argument, it could not be reasonably argued that a for-profit magazine was awarding an expensive car to the most valuable player of a televised sporting event out of a detached and disinterested generosity. It was much more likely that both Sport Magazine and General Motors were expecting publicity, advertising and social buzz from the award.

You still have your second argument, though.

Problem is, the prize or award exception requires you to receive it for an educational, artistic, scientific or civic achievement.

You argue your point: being a star football player “calls for a degree of artistry” requiring techniques based on “scientific” principles.

Seriously.

The Court decides:

We believe that petitioner should be caught behind the line of scrimmage on this particular offensive maneuver.”

You have income. And the Court gave us a great quote.

But when do you have income: 1961 or 1962?

The Court reasons through the obvious. You are in Green Bay. The car is in New York. You cannot get to that car - much less title it - unless you had Star Trek technology. However, it is 1961 and Star Trek is not on television yet. You have income in 1962, the following day.

Your tax case is seminal in developing the tax doctrine of constructive receipt. Normally constructive receipt accelerates when you have income, but it did not in your case.You could not have made it to the bank even if you wanted to.

So why did the IRS push the issue of 1961 versus 1962? They didn’t. Remember that you were arguing that the Corvette wasn’t taxable. The IRS had to fight back on that issue. The 1961 thing was a sidebar, albeit that is what the case is remembered for all these years later.

By the way, do you know which football player we have been talking about?

Getting A Carr Out Of New York

Did you know that New York is likely to audit you if you move away from the state? These “residency audits” are infamous, as the outcome is rarely in doubt. They are the state tax equivalent of World Wrestling Entertainment.

I have never lived in a state that would not allow me to leave. There is something about such behavior that is highly disturbing.

I am reading Patrick Carr’s request for redetermination with the New York Division of Tax Appeals.

Carr is an attorney who was admitted to the New York Bar in 1964. He was later admitted to the New Jersey Bar. He followed the traditional New York migration pattern, and by 2007 he was living in Sarasota. He was retired, so he did not bother to move his law license to Florida.

He got involved with a case. Since he didn’t have a Florida license, the court allowed him “pro hac vice” status, literally meaning “this time only.” The court allowed him – as an out-of-state lawyer – to appear in court for a specific trial.

The case went on for a while, and he had legal fee income for 2007, 2008 and 2009. 

He reported the income on his federal return as self-employment income. There is no Florida individual income tax.

Wouldn’t you know that he got pulled for a residency audit?

New York conceded that he had successfully left New York.

That should have been the end of the matter, but …

New York still wanted its taxes.

The taxpayer received a large amount of money in tax year 2007 from a case he litigated in Florida. Schedule C income for 2008 and 2009 were relatively smaller compared to 2007. The taxpayer stated that all of his schedule C income from legal services was sourced to the state of Florida.”

Let a tax pro translate the above:

We want the money.

Back to New York: 

However, the taxpayer is not licensed to practice law in the State of Florida.”

Tax pro:                  

Sounds like a Florida problem.

New York:

It was determined that he was admitted as counsel pro hac vice in the Circuit Court of the 12^th Judicial Circuit in Sarasota County, Florida. This means that he was given special permission to help litigate this particular case even though you are not licensed to practice law in the state of Florida.”

Tax pro:

He received permission from the Court. Are there any other issues?

New York:

Therefore, all of your income is subject to New York income tax, since your income was attributable to a profession carried out in New York State….”

Tax pro:

By "carried out in New York State," do you mean Sarasota?

New York admitted he never did any of the work in New York, and also admitted that he was not a resident of New York.

Tax pro:

This was productive. Stay in touch.

New York nonetheless sent him a tax bill for $68 thousand, plus interest. They reasoned that his New York law license was enough to make him taxable in New York.

Tax pro:

Why is New York dissing New Jersey? Carr had a New Jersey license as well as a New York license. Why don’t you make it 50% to keep it fair?

New York:

He used to live in New York.

Tax pro: 

He used to go to college. Why don't you bill him for tuition also?

You already know this wound up in Court.

And the Court pointed out the obvious:

·        Carr did not have an office in New York

·        Carr did not practice in New York

·        Carr had an office or other place of practice outside New York

·        Carr had a license outside New York

·        He was authorized to practice in Florida. In fact, that is what pro hac vice means

·        Holding a New York license is not the same as carrying on a profession in New York

The Court told New York to go away.

What upsets me about state tax behavior like this is the cost and stress imposed upon the individual. I can see that Carr represented himself (“pro se”) in this matter, but he is an attorney. Most people do not have the training and likely would not represent themselves. They would have to hire a tax pro to fend-off a reckless challenge by New York or another state. Even if they win, they lose – after they pay the professional fees.

Phone Call About The Statute Of Limitations

Recently I received a call from another CPA. 

He is representing in a difficult tax audit, and the IRS revenue agent has requested that the client extend the statute of limitations by six months. The statute has already been extended to February, 2016, so this extension is the IRS’ second time to the well. The client was not that thrilled about the first extension, so the conversation about a second should be entertaining.

This however gives us a chance to talk about the statute of limitations.

Did you know that there are two statutes of limitations?

Let’s start with the one commonly known: the 3-year statute on assessment.

You file your personal return on April 15, 2015. The IRS has three years from the date they receive the return to assess you. Assess means they formally record a receivable from you, much like a used-car lot would. Normally – and for most of us – the IRS recording receipt by them of our tax return is the same as being assessed. You file, you pay whatever taxes are due, the IRS records all of the above and the matter is done.    

Let’s introduce some flutter into the system: you are selected for audit.

They audit you in March, 2017. What should have been an uneventful audit turns complicated, and the audit drags on and on. The IRS knows that they have until April, 2018 on the original statute (that is, April 15, 2015 plus 3 years), so they ask you to extend the statute.

Let’s say you extend for six months. The IRS now has until October 15, 2018 to assess (April 15 plus six months). It buys them (and you) time to finish the audit with some normalcy.

The audit concludes and you owe them $10 thousand. They will send you a notice of the audit adjustment and taxes due. If you ignore the first notice, the IRS will keep sending notices of increasing urgency. If you ignore those, the IRS will eventually send a Statutory Notice of Deficiency, also known as a SNOD or 90-day letter.

That SNOD means the IRS is getting ready to assess. You have 90 days to appeal to the Tax Court. If you do not appeal, the IRS formally assesses you the $10 thousand.

And there is the launch for the second statute of limitations: the statute on collections. The IRS will have 10 years from the date of assessment to collect the $10 thousand from you.

So you have two statutes of limitation: one to assess and another to collect. If they both go to the limit, the IRS can be chasing you for longer than your kid will be in grade and high school.

What was I discussing with my CPA friend? 

• What if his client does not (further) extend the statute?

Well, let’s observe the obvious: his client would provoke the bear. The bear will want to strike back. The way it is done – normally – is for the bear to bill you immediately for the maximum tax and penalty under audit. They will spot you no issues, cut you no slack. They will go through the notice sequence as quickly as possible, as they want to get to that SNOD. Once the IRS issues the SNOD, the statute of limitations is tolled, meaning that it is interrupted. The IRS will then not worry about running out of time - if only it can get to that SNOD.

It is late August as I write this. The statute has already been extended to February. What are the odds the IRS machinery will work in the time remaining?

And there you have a conversation between two CPAs.

I myself would not provoke the bear, especially in a case where more than one tax year is involved. I view it as climbing a tree to get away from a bear. It appears brilliant until the bear begins climbing after you. 

I suspect my friend’s client has a different temperament. I am looking forward to see how this story turns out.