Wednesday, January 27, 2010

Haitian heads up!

Driving in to the office today I was able to see clouds dumping snow on the local mountains. It was a good reminder that nature sometimes has an effect on our lives, and I thought it would be appropriate to discuss the tax incentive signed into law this week to help the Haitian earthquake victims. Here’s the straight scoop:

If you donate money after January 11, 2010 and before March 1, 2010 to a qualified US charity and it is earmarked to aid Haitian earthquake victims you have the choice to take the deduction on your 2009 or your 2010 tax return. Pretty simple, but there are a few things to point out.

1) It must be a US based charity. If you aren’t sure, look up the organization on the IRS website,,id=96136,00.html .

2) The donation must be made in money. Checks, credit card charges, and designated text message fees on your phone bill will all count. Donations of blankets, tents and food will not.

3) You cannot deduct the donation in both 2009 and 2010!

4) Those who do not itemize deductions will not get to deduct these donations.

At this point in time California does not conform to this legislation, meaning you will still be able to deduct these donations but will only do so in 2010 unless the legislature enacts a conforming bill. It is expected they will do so, but we will have to wait and see.

Monday, January 25, 2010

The cost of free money

Albert Campbell was a whistlebower. He turned in his former employer, Lockheed Martin for defrauding the Federal government and ultimately received a reward of $8.75 Million under a law dating back to the civil war designed to catch contractors who were gouging Uncle Sam during the war effort. Good job, Albert!

But in what can best be described as greed induced stupidity, Albert decided (on his own) that the reward he was paid was not taxable income to him. Dumb move, Albert.

In the year he received his settlement of $8.75mil, Albert disclosed part of the settlement (net of a whopping 40% contingent attorney’s fee) on his tax return, but failed to add it to taxable income. His taxable income as shown on the return was only $793.

Since he received a 1099 issued from the US Treasury for the $8.75 mil, IRS initially though he had just made a simple math error and sent him a friendly notice with a revised calculation showing tax owed of $3,044,110. Albert fought back, claiming that the money was nontaxable since it came from the Federal Government. Using the same case that Albert cited in his defense, noting that the case actually held against his position, the Tax Court disagreed. A reward is income, no matter who pays it.

The upshot of this case is that Albert was slapped with accuracy related penalties of 20%. The court noted that he was a smart guy (or should have been), having been a financial analyst and then chief of cost control for a huge project. Smart enough to hire help. In assessing the penalty, the court opinion mentioned twice that he failed to consult a tax professional in preparing his return and formulating his positions.

So lets do the math: $8,750,000 less $3,500,000 attorneys fees, less $3,044,110 Federal tax, less $608,800 in accuracy related penalties leaves a mere $1,597,090 left over, before interest. Nothing to sneer at, but a far cry from $8.75mil.
You’d think with that kind of money laying around he could have paid someone to do his taxes!

Monday, January 18, 2010

Something good from IRS

Cell phones used for business purposes currently are one of the “Listed” assets that IRS has special rules for. If you use a cell phone for business, there are draconian rules which you are supposed to be following that force you to document all of your calls and make a distinction between business and personal use. Personal use is deemed to be a taxable fringe benefit if the phone is provided by your employer or a nondeductible expense if you pay for the cell phone and try to deduct it yourself.

As you can imagine, people rarely itemize out a cell phone bill in order to reduce the available tax deduction. It would take too much time to analyze a year’s worth of phone statements, and many cell phone bills don’t list individual calls, only minutes of usage. Further, as cell phones get more sophisticated and are put to use doing other things such as sending and retrieving emails, taking notes, scheduling appointments, etc., the IRS documentation requirements become even harder to comply with.

This has resulted in much contention during audits and given the amounts of the deductions generally involved has been a poor use of resources on both sides of the audit table.

Recently, IRS Commissioner Doug Shulman and US Treasury Secretary “Turbotax” Timmy Geithner asked Congress to “make clear that there will be no tax consequences to employers or employees for personal use of work related devices such as cell phones provided by employers”. Further, Shulman said the IRS will not be moving forward with any of its cell phone substantiation initiatives. So, add cell phone relief to the list of things Congress is supposed to address this year, along with the other tax issues they failed to resolve in 2009.

Friday, January 15, 2010

Are you in the IRS’s crosshairs?

Recent public announcements and internal memos to IRS agents give us an indication of some areas that will be scrutinized heavily in the coming months. Several areas to note:

Tax returns for S corporations have been statistically shown to have a very high error rate – 68%. Look for increased audits on these entities focusing on travel expenses, meals and entertainment, automobile expenses, and the big favorite, taking dividends in lieu of compensation to avoid payroll taxes.

Refund claims involving R&D credits are being looked at closely.

Random audits of payroll tax returns will commence next month. This is an area that has historically received little attention but is on the “A” list now. Agents will be looking to classify independent contractors as employees, and making sure fringe benefits are taxed properly.

Appraisers and valuation professionals will be on the hook for their work too. If an appraiser improperly misstates a value resulting in an overstated deduction or a lower tax, the appraiser could be on the hook for some large fines.

These are a few of the areas IRS will be focusing their sights on. If any of these apply to you it would be wise to get your ducks in order before you find out too late that its duck season!

Wednesday, January 13, 2010

2010 the Year of Uncertainty

Many Federal tax breaks expired on 12/31/2009 that were widely expected to be extended. Congress, primarily the Senate, failed to take up many provisions that we have taken as permanent. Consider how many of these will affect you:

The AMT exemption amounts automatically roll back to pre-2001 levels. This will make many more of us subject to this tax.
Sales tax, college tuition and teacher’s supply deductions have been suspended.
R&D credits are suspended
Tax free IRA payouts to charities are no longer allowed.
50% bonus for first year depreciation and high limits for expensing assets are gone.

And of course the estate tax and stepped up basis rules are gone (see previous posts on this subject)

These changes are widely expected to be reinstated, some expect retroactively, but who knows what the politicians will eventually do and when they will do it.

Stay tuned for updates!

Monday, January 11, 2010

Deducting Pornography and Prostitutes

Never let it be said that taxes are boring. William Halby, an attorney in New York, recently appeared before the tax court to argue that the $7,373 he spent on pornography and the $108,086 he spent on prostitutes over a two year period should be allowed as deductible medical expenses. Mr. Halby argued that these expenditures should be allowed as medical expenses due to the positive health effects of sex therapy, and presented a detailed log of “treatments” and “service providers” as support for the deductions.

Not surprisingly, Mr. Halby lost his case. Not only did the Tax Court deny all his deductions forcing him to cough up over $21,000 in tax, but because he is an attorney and should have known better, they slapped him with accuracy related penalties of over $4,000 as well.

However, in coming to the conclusion of denying the deductions, the court stated that the reasons for disallowing the expenses paid to prostitutes were because they were illegal payments, and that they were not prescribed by a doctor. This begs the question: What if they were legal payments and what if they were prescribed by a doctor? Could he then successfully deduct prostitutes and porn? The opinion is silent on this point.

Now, I DO NOT recommend that any of you try this, but consider this: Mr. Halby’s failure may not have been an excess of chutzpah (or libido), but more of a lack of proper planning. Had he secured a prescription for his “therapeutic” treatments, and had he received said treatments in a place where they are legal such as Nevada, perhaps he would have had a better case. He might even have been able to deduct his travel costs to Vegas too.

Note to Harry Reid - If this concept were buried in health care reform legislation it would have sailed through Congress in minutes.

Thursday, January 7, 2010

California Tax freebie

In the “if its good policy lets limit it” category:

Our state legislature feels that in this economic climate, small businesses need an incentive to hire new employees. As a result, there is a new law that provides that if you own a small business that employed 20 or less employees as of 1/1/2009, and if you hired any new full time employees during 2009, you may be entitled to as much as $3000 in tax credits for each new full time hire.

The glitch here is that there is a finite amount of funding available for this giveaway, and once a certain statewide threshold of total credits have been claimed, further credits will be disallowed. The question is, if granting this credit was a good idea, and I believe any time you lower taxes on small business it’s a good idea, then why wouldn’t extending the credit permanently, or even to all businesses be a better idea? Sacramento has no problem saddling us with tax increases across the board, why tax reductions on a tiny basis? Given that we have one of the highest (if not the highest) unemployment rates in the nation, I would think that any pro-hiring incentives, if valuable at all, should be implemented without limitation.

But that assumes that this credit is valuable. It might be if it were permanent. Given that few businesses even know about it, and that smart business people don’t make hiring decisions based on a “maybe” one time tax subsidy, rather than spur hiring I suspect that this will simply be a windfall to the well informed few.

So, consider yourself well informed. If you qualify for the credit, file your tax returns quickly and hope for the freebie!