Let's Tax The Rich At 100%

I am a huge fan of Warren Buffett - when it comes to investing. You may remember that he not long ago called for raising the tax rates on the rich and uber-rich, as it was unfair that he paid a lower tax rate than his secretary. Personally I hear that comment as an argument for a flat tax, but he went in a different direction.

He proposed raising taxes on those earning more than $1 million, with yet more taxes for those earning more than $10 million.

That beggars the question: what difference would it make? I could go to the theater every day, but it would not make me a movie star.

The Tax Foundation went to the IRS itself for statistics. They were curious what the result would be if the government confiscated ALL the income of those earning $10 million or more.

Here is the result:

Source: Tax Foundation

All that, and we would reduce the deficit by only 12% and the national debt by 2%? But I suspect that you already knew the answer, didn't you?

Can You Deduct Burning Down Your House?

Can you take a deduction for burning your house to the ground?

You may laugh, but I was reviewing a recent case on this issue. It is the third case involving a home barbeque I can remember over as many years.

The case from 3 years ago was Rolfs v Commissioner. It was – understandably – considered quite outside the box.

Theodore Rolfs and his wife (the Rolfs) owned a house on a 3-acre lakefront property in Wisconsin. The house was modest, built around 1900 and it would be fair to say that it was in need of an upgrade.

The Rolfs wanted to renovate, but the work required was so extensive that tearing down the house and constructing anew was a very viable option.

They estimated it would cost $10,000 to $15,000 to demolish the house and remove the debris.

They went a different path and donated the house to the fire department. There were restrictions on the donation: the fire department was to use the house for training exercises, with the understanding that the training would happen shortly after the donation. The Rolfs donated only the house. They did not donate the land on which the house sat.

The Rolfs needed a value for their donation. They contacted Richard Larkin, president of Larkin Appraisals, Inc. who valued the house at $76,000.

The Rolfs donated the house and took a charitable deduction of $76,000 on their tax return. They attached the appraisal report and a letter from the fire chief thanking them for the donation.

The IRS disallowed the charitable contribution.

The IRS argued that a charitable donor does not expect a financial benefit in exchange for the donation. The Rolfs however expected a substantial benefit: the $10,000 to $15,000 in avoided demolition costs, for example, not to mention the benefit of the tax deduction itself.

The IRS further argued that the restrictions the Rolfs imposed affected the value of any donation. The fire department could only use the house for training purposes, and the house was to be destroyed shortly after the donation.

The Rolfs countered that they had an appraisal for $76,000.  And what was the IRS talking about with “restrictions?” After the fire department did its thing, there was NO house standing. The fire department did not want a house. They wanted a house they could burn to the ground. Whatever “restrictions” the IRS was talking about went up in smoke.

The case went to Tax Court.

In a Solomonic gesture, the Court reasoned that there might be a donation, but the amount of any donation would be the value of the house over the value of any demolition and clean-up services received.

The Court observed that the Rolfs donated the house without its underlying land. This meant that an independent buyer would have to move the house. The house was very old and badly in need of renovation. What would someone pay for this? Not surprisingly, the house was almost worthless.

The house was not worth more than the demolition and removal services received from the fire department. The Court decided there was no donation. The Rolfs lost their case.

But they made the tax literature.

There are variations that might have resulted in a different outcome. For example, what if the house had enough value to make it worth the cost and effort of moving?

There is another way to help tax-subsidize a house demolition, however. Have you heard of “deconstruction?” This involves dismantling the house rather than razing it under a bulldozer. It is more expensive, but with deconstruction more home materials remain in usable condition. The materials are then donated, generating a tax deduction. If the value of the tax deduction exceeds the additional cost of the teardown, one has effectively tax-subsidized his/her demolition costs.

The value of the materials can add up. I was reading an article where the lighting fixtures alone were worth over $100 thousand. Can you imagine?

I Dreamed A (Tax Season) Dream

Have you ever heard or watched the show “True Life” on MTV? One of the directors for that show was James Huang. He has gone on to other efforts, one of which is his parody on the Les Miserables’ song “I Dreamed a Dream.”  It has a very noticeable accountant/tax season theme.

My favorite line?

            “Busy season has killed a dream I dreamed.”

Remember to laugh when and as much as you can.

NFL's Romanowski, Horses And A Hobby

He was a feared NFL football player. He played in the league for 16 seasons, winning 4 Super Bowls. He was ... volatile, at best. In 1997 he broke the jaw of Carolina Panthers quarterback Kerry Collins. He spat in the face of San Francisco 49ers wide receiver J.J. Stokes during a Monday night game.  In 2003 he confronted a player on his own team, ripping off that player’s helmet and crushing his eye socket with a punch.

His name is Bill Romanowski (BR). And he now has entered the tax literature.

BR decided to get into horse breeding – sort of. There is a Code section that disallows losses incurred in what the IRS considers a “hobby.” The IRS understands that one can try and fail in a business venture, but it wants the venture to truly be profit-driven. It is not interested in allowing losses from a weekend racecar hobby, or Tennessee walking horse competitions for one’s teenage child, or (more recently) owning an Amway distributorship. There are numerous factors to consider: one’s past experience and familiarity with the business or industry, development of a business plan, reaction to and modification of that plan when confronted with losses, and so on.

Horse breeding is a likely area for hobby-loss challenge by the IRS. It is also (or at least used to be) a popular tax shelter area. BR got involved and combined the two, to a financially detonative extent.

BR and his wife for many years used a financial planner by the name of Kathy Lintz. It sounds like she did a good job, including managing their portfolio and providing them a monthly stipend. Ms. Lintz also collected financial information for their tax returns and engaged a CPA. She would review the completed tax returns before sending them to the Romanowski’s.

During 2003 BR had tax issues with a real estate investment in Colorado. Ms. Lintz put BR in touch with Rodney Atherton (Atherton), a partner at Greenberg Traurig in Denver. BR went to Denver to discuss real estate, at which time Atherton told BR about a horse-breeding business, ClassicStar, which had retained his firm. It sounds like the meeting went well, as BR retained Greenberg Traurig. BR also wanted more information about the horse breeding deal.

BR received documents frequently associated with a tax shelter:

1. a 53-page opinion letter from the law firm Handler, Thayer& Duggan, LLC regarding tax aspects of horse-breeding;
2. a 22-page opinion letter from the accounting firm Karren, Hendrix & Associates regarding tax aspects of the horse-breeding business, and
3. a 6-page opinion letter from Karren Hendrix & Associates regarding tax aspects of NOLs generated from a horse-breeding business.

OBSERVATION: Folks, I am a career tax CPA. I have received and reviewed attorney opinion letters over the years. Allow me to assure you that such letters are not normal business practice. It is however normal tax shelter business practice. And your first clue that you are leaning a bit far over the ledge.

How did the deal work? It was relatively simple: BR would lease mares owned by ClassicStar, which in turn would provide boarding and care for the mares and breed the mares to stallions. Any foals produced from the breeding would belong to the Romanowski’s.

How much would this cost BR? Karren Hendrix, who did accounting work for ClassicStar, sent an “NOL illustration” regarding BR to Atherton. In the NOL illustration, Karren Hendrix estimated that BR needed an NOL of over $13 million to offset his taxable income from 1998 to 2003.

In 2003 Atherton and BR again traveled to Kentucky. This time Mrs. Romanowski reviewed the materials and made the trip to Kentucky. They toured the ClassicStar operation, saw the horses, visited auction houses, and met with ClassicStar personnel.

The Romanowski’s decided to invest approximately $13 million.

OBSERVATION: Wow! I wonder how they came up with that amount?         

Ms. Lintz, the financial advisor, was adamantly opposed. She believed it a tax scheme and a threat to the Romanowski’s financial health.

BR blew her off.

The Romanowski’s created Romanowski Thoroughbreds, LLC, through which they would operate the horse activities.

In December 2003, the Romanowski’s wrote a $300,000 check to ClassicStar as a deposit. They then signed a mare lease and board agreement with ClassicStar. Pursuant to the agreement, Romanowski Thoroughbreds agreed to spend $13,092,072 on the breeding program to produce foals.

Mind you, when the Romanowski’s signed this agreement, they had not negotiated or seen any list of horse pairings. Rather, they relied on ClassicStar to pick the horse pairings and to set the fees and expenses they would pay.

Right....

They later received a list of the horse pairings they would receive. They would receive 68 pairings, but only 4 of the 68 pairings were to thoroughbreds. The remainder were to quarter horses.

NOTE: What?? Sounds to me like a good time to call the attorney and back out of this deal, right?

The Romanowski’s were assured by ClassicStar that they would substitute an unknown number of thoroughbred pairings for quarter horse pairings. Of course, nothing was written down.

Right....

Meanwhile, Ms Lintz became aware that Atherton was receiving a “due diligence fee” from ClassicStar. She was concerned, as she considered it a conflict of interest. Why? Because Atherton was the Romanowski’s attorney, and he was suppose to have their best interest at heart.

In February 2004, Ms. Lintz resigned as the Romanowski’s financial adviser, partially because of their investment in the horse program. Her resignation letter states that the Romanowski’s choose to “enter into an aggressive tax shelter.”

Later that month Ms. Lintz sent the Romanowski’s another letter identifying two independent horse and tax experts whom they could contact if they “need[ed] further assistance”. The letter stated that one of the experts told Ms. Lintz that  ClassicStar had “come on strong in the last couple of years” and that there had been “No scandals thus far” even though “some of the principals were involved in bad prior deals.”

OBSERVATION: Ms. Lintz sounds like a very attentive financial advisor for her clients.

Atherton of course denied receiving any improper payments from ClassicStar. What happened is – if Atheron referred a client to ClassicStar - ClassicStar would pay Atherton a percentage of the deal.  Atherton would escrow the funds and bill against them at a much higher hourly rate than his normal rate. For example, in an email to another client, Atherton wrote:

 “Here is what I propose, I simply bill my time on your clients at a premium--I usually bill 365 an hour. Are [sic] okay if I bill 1000 an hour   and just charge an hourly rate?

He of course never told the Romanowski’s about any arrangement.

NOTE: Nice guy. We will probably hear his name again when he runs for Congress.

In a completely unexpected development, ClassicStar filed for chapter 11 bankruptcy protection in 2007. The Romanowski’s filed claim in the bankruptcy court and also filed separate claims against ClassicStar and against Greenberg Traurig.

Fast forwarding, the IRS challenged the whole deal as a hobby, wanting back over $4.7 million dollars of tax refunds. Oh, they also levied an accuracy penalty of over $950,000 to boot.

They go to court. The experts trot out onto the field. The IRS expert asserts that the activity “had absolutely no chance of making a profit”.

The Romanowski’s expert counters:

 “that there was absolutely no chance that any of the non-Thoroughbred horses listed on * * * would produce profitable foals.”

The expert argued that the quarter horses “were obviously placeholders” and that if ClassicStar “had honored their contract and provided Thoroughbred mares of at least the same quality as those * * * [eventually bred for petitioners] then there was definitely profit potential.”

Wow! And this is the taxpayers’ expert?

The Tax Court decided against the Romanowski's. They now owed well north of $4 million in taxes. The Court did however let them off the hook for the accuracy penalties, though. The Court felt that their reliance on an attorney was sufficient to avoid the penalty. Small victory, I suppose.

MY TAKE: The IRS took a risk, as they have lost their share of horse-related litigation. The courts have been receptive to the “long shot” argument: someone could legitimately keep funding a losing business if the payday would be outsized. Why would the IRS pursue the case? There is one feature here the IRS likes: the recognizable taxpayer name. No one would note or remember if you or I lost a tax case. Substitute Brad Pitt, however, and you have something.

But quarter horses ...? What was Romanowski thinking? The only way Romanowski could have made money off this deal is if he bought a lottery ticket while he was visiting Lexington.