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!

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