Monday, May 17, 2021
Cost of Goods Sold Offset When No Goods are Sold
What I never thought to mention to the students is that there is no cost of goods sold offset if no goods are sold. I figured it would and should go without saying. For example, there is no interest deduction if there is no loan on which interest is being paid or accrued.
So I found it interesting that the issue was addressed by the Tax Court. In BRC Operating Company v. Comr., T.C. Memo 2021-59, the Tax Court held that if no goods are sold there is no cost of goods sold offset. Technically, the issue was whether the economic performance requirement in section 461(h)(1) applies to, and precludes recognition of, estimated drilling costs reported by the taxpayer as cost of goods sold. To reach the case, go to the docket for the case, scroll down to item 71 and click on “Memorandum Opinion,” because the URL for the opinion is too long to include in an html URL tag.
The case involved BRC Operating Co., organized as a limited liability company in 2008, and wholly owned by another limited liability company, Bluescape Resources Co. BRC was treated as a disregarded entity. Bluescape was a partnership for federal tax purposes and used the accrual method of accounting. Bluescape purchased mineral and lease interests and planned to explore for, extract, and sell natural gas. On its partnership returns for 2008 and 2009, it treated $100 million and $60 million, respectively, as costs of goods sold, based on estimated drilling costs for exploration and extraction. Bluescape did not drill, receive drilling services from third parties, or receive drilling property during the tax years in issue. It reported no gross receipts or sales during these years attributable to the sale of natural gas.
The IRS disallowed the cost of goods sold offset, determining that Bluescape had not established that it satisfied the all events test and the economic performance requirement in section 461(h)(1). When the dispute reached the Ta Court, the IRS moved for for partial summary judgment, arguing that the undisputed facts show that economic performance under section 461(h)(1) did not occur with respect to the reported costs of goods sold during the years in issue, and, in the alternative, that the reported costs of goods sold should be disallowed because they were derived from Bluescape’s use of a method of accounting that failed to clearly reflect income. Bluescape and BRC moved for partial summary judgment, arguing that the economic performance requirement in section 461(h)(1) does not apply to the amounts claimed as costs of goods sold for the tax years in issue.
The IRS cited regulations section E.g., sec. 1.61-3(a), which provides, “[A]n amount cannot be taken into account in the computation of cost of goods sold any earlier than the taxable year in which economic performance occurs with respect to the amount[.]”). The taxpayers argued that the economic performance requirement does not apply because the regulations “extending” it to amounts included in cost of goods sold went too far. They argued that, as an offset against gross receipts to arrive at gross income, cost of goods sold is an “item of gross income” the timing of which is governed by section 451 and the corresponding regulations, and therefore the economic performance requirement in section 461 does not apply.
After the parties briefed their position, the Court scheduled a hearing on the motions to pose a basic question to the parties: Can Bluescape recognize costs of goods sold before it has any gross receipts from the sale of goods? The Court explained that before the question of whether cost of goods sold are subject to the economic performance requirement is answered, a precedent question must be resolved, namely, is there a cost of goods sold offset when there are no gross receipts to offset yet? The issue, the Court clarified, is not whether the estimated drilling costs can ever give rise to costs of goods sold but whether they can give rise to costs of goods sold for the years in issue before there are receipts to offset. The taxpayers argued that “matching” of cost of goods sold and gross receipts is not required.
After proving a history and explanation of the cost of good sold offset, the court cited previous cases for the proposition that “cost of goods sold is not allowable unless, and until, the taxpayer actually sells or disposes of goods,” and for the proposition that “taxpayers] have to capitalize an item’s cost in the year of acquisition or production and either amortize it or wait until the year the item’s sold to make the corresponding adjustment to gross income.”
So it turned out that this was not the first time a taxpayer tried to claim a cost of goods sold offset before selling anything or during a year in which nothing was sold. In keeping with the tagline for this blog, I point out that one of the cases cited by the Court involved a model train store that tried to claim cost of goods sold before it started selling to the public.
The Court explained that “Cost of goods sold does not exist in a vacuum, as a stand alone deduction in the Code, but serves as an offset against gross receipts.” The Court noted that the taxpayers had not cited, nor could it find, any cases that allowed an offset for cost of goods sold as a stand alone deduction in advance of any gross receipts. Thus, the court rejected the taxpayers’ argument that cost of goods sold need not “match” gross receipts because it could not bridge the gap in their logic. Some of the cases cited by the taxpayers in support of their position involved expenses claimed as business deductions not part of cost of goods sold or deductions for worthless inventory, neither of which was congruent with the facts of the case. Other cases cited by the taxpayers were put aside by the Court because the facts of those cases did not involve, as the taxpayers claimed, taxpayers who did not sell goods during the year.
Because of its resolution of the first argument made by the IRS, the Court did not reach its second argument that the reported costs of goods sold should be disallowed because the Bluescape used a method of inventory accounting that failed to clearly reflect income. The Court simply held that without gross receipts from the sale of goods, Bluescape may not recover its estimated drilling costs as costs of goods sold.
So if I were to ever again teach a basic federal income tax course I would include a simple statement that there is no cost of goods sold offset if there are no goods sold during the year. Because the chances of again teaching that course are extremely slim and for all intents and purposes, none, I am not planning to revise my eight-year-old teaching notes.
Friday, May 14, 2021
A Counter-Productive Tax Cut?
Georgia’s governor explained that his actions will “probably help level the price for a little while.” The price f regular unleaded gas in the state has risen by 11 cents in one week though the suspension of the tax will drop the price of fuel by roughly 20 to 30 cents per gallon.
What will this do? One only needs to think of the words “toilet paper” to suggest the answer. Many people will conclude that filling up their vehicle tanks before Sunday is a wise thing to do. From a self-centered perspective, it surely is. And it’s not just vehicle tanks. It’s those 3 and 5 gallon cans used to supply lawn mowers, leaf blowers, and other equipment.
The governor is aware of this. According to the report, “he urged Georgians to avoid a rush to the fuel pumps.” He advised Georgians that they “don’t need to go out and fill out every five gallon tank you’ve got. Get what you need, let everybody else get what they need, get to work and do the things you need to do.” Of course, he assumes that the self-centered perspective will yield to a community-focused one. Good luck. Am I cynical? Perhaps. But it wasn’t that long ago when the mad stampedes for toilet paper, hand sanitizer, bleach, and other cleaning products made the headlines. According to this story, “panic buying and long lines” already were underway earlier this week.
How does reducing the price reduce demand? The governor explained, “We are seeing some shortages around the state, and we don’t want a run on the pumps.” Then don’t encourage a run on the pumps by lowering the price. That’s simple economics, a subject poorly understood by most Americans and especially badly understood by too many politicians. Add to this the temptation presented to residents of adjacent states, especially those living close to the Georgia border, to make tank-filling trips into Georgia because gasoline prices in that state have dropped because of the suspension of the tax. How does that help the situation for Georgia residents?
The report explained that two previous Georgia governors had either suspended the tax on fuel or halted an increase in the tax when fuel prices rose sharply for one reason or another. According to this study, only 2/3 of the tax reduction passed through to Georgia purchasers when the tax was suspended in 2005. This outcome had been predicted in an earlier study, which also identified other disadvantages to suspending the tax on fuels and offered other suggestions to deal with rising fuel prices. Interestingly, that study apparently caused every state other than Georgia not to suspend the tax in 2005, but Georgia did so and the predicted results indeed materialized.
I put this tax suspension into the category of “look, I’m doing something wonderful for you even though it isn’t what it appears to be and hopefully you won’t figure out that what it purports to do for you isn’t what it does for you and it actually can make things worse.” Of course, the cyberattack that has fueled this crisis is an example of what happens when government fails in its responsibility to protect the nation. Decades of anti-government, anti-tax, and anti-regulation sentiment fueled and funded by lobbyists for the private sector is demonstrating how inadequate the private sector can be when government is pushed aside. Distracted by debates reflecting divided opinions with respect to invented disagreements, the nation isn’t paying attention to the increasing size of the hacker fleet sitting offshore. Cutting fuel taxes not only fails to alleviate the supply problem, it also encourages more tax-cutting efforts when the last thing the nation needs is a reduction in support for defense of its people.
Wednesday, May 12, 2021
As Bad As Ignorance is for the World, There are Those Who Benefit from It
Last week, the folks at Credello released the results of a poll about taxes. The headline alone is alarming: “SURVEY: Millennials & Men Are Most Likely to Be Overconfident About Their Tax Expertise.” The article begins with these two questions: “You remember that one (or multiple) guy(s) from high school who knew everything about everything? Or at least said he did?” My high school faculty was superb in ridding that thought from our brains even before our brains formed it. We learned to learn what we didn’t know, and we learned how to learn what we didn’t but needed to know and understand. Unfortunately, it’s too easy for people to believe those who claim they have all the answers, even ones who eluded the draft but claim to know more than the generals do.
According to the poll results, “[m]any respondents claimed to know more about taxes than they actually do. Millennials were particularly overconfident as 83% of Gen Yers surveyed said they know enough or everything about taxes, but about a third of respondents scored a B or lower on a relatively simple tax literacy quiz.” Wow. The author of the Credello report points out that this is another example of the “Dunning-Kruger effect, . . . a cognitive bias that people with a lower skill level overestimate their ability, thinking they’re smarter or more capable than they really are.” I love how the author put it: “ In other words, these dummies are too dumb to identify their own incompetence. And on the flip side, their higher-skilled counterparts tend to underestimate their ability.”
Some of the tax literacy quiz responses were telling. When asked whether the taxpayer or the taxpayer’s accountant is responsible for filing errors, 42 percent put the onus on the accountant. Wrong. Asked to select which one of two statements was true, 44 percent chose the wrong answer, “You can claim a pet as a dependent,” rather than the correct response, “Even illegal activity is taxable.” Presented with a question about marginal rates, an issue I recently described in Fixing a Subhead and a Sentence That Reference Tax Brackets, 51 percent selected “You pay your marginal tax rate on all of your income” as the correct choice rather than the correct statement, “You pay the same rate as others on income up to a certain amount, then a higher rate on every dollar until the next threshold.” This ignorance, of course, is used by the ultra-wealthy and their advocates to spread fear among the 99 percent to gain support for their opposition to tax increases that would have no effect on those who are not ultra-wealthy.
So what is the solution to ignorance, no matter the subject? The answer, in two words, is quality education. When education was once found in schools, books, newspapers, radio, and television, it now percolates not only in those sources but also on internet web sites, social media platforms, and other avenues that operate without the filters available when educators are educated people. The willingness to “learn” about taxes or some other matter from what some random person or manipulated robot posts online while pushing aside what the educated experts have to say about the issue is the product of deep psychological problems. The willingness to believe what one wants to hear opens the door to the scammers and spammers, and eliminates the very freedom that is the excuse given by those who believe they are free to believe whatever they want to believe, even when it conflicts with indisputable facts.
A little more than four years ago, in Ignorance in the Face of Facts, I wrote:
A recent survey by the Public Policy Institute of California reveals how the spread of misinformation through social media has contributed to the inability of Americans to distinguish fact from fiction. The survey asked people in California to identify the largest areas of state spending. Thirty-nine percent of the respondents identified prisons and corrections as the biggest expenditure. Less than ten percent of the California budget is spent on the prisons and corrections system. Only 16 percent of the respondents correctly identified K-12 public education, which consumes almost 43 percent of the state budget, as the largest expenditure. It’s not as though the information is classified or difficult to find. So few people know the answer in part because so few people care about learning this sort of information, and in part because it’s so easy to accept as true whatever information gets pumped out of someone’s favorite source of “news.” I wonder what would happen if the survey respondents were asked the question, and then given the opportunity to research the answer. How many could take themselves to an official California state budget web site to discover the answers?Yes, just imagine. Is it any wonder that more and more unfortunate outcomes are afflicting the nation and the world? The price that is paid for ignorance is steep. Unfortunately, the price paid for one person’s ignorance is not necessarily paid by that person and too often is paid by many others. Ignorance can be eradicated. So when those opposed to what eradicates ignorance, that is, quality education, fight increases in education funding and push for decreases, when they advocate the establishment of and support for institutions of miseducation, when they fund and support media and web platform outlets that spew falsehoods, everyone else should ask, “Why are they doing this?” The answer is simple. They benefit from ignorance and miseducation, they know and understand the consequences of a fully educated national and world population. That is why they foster anti-intellectualism, because they cannot risk too many people being sufficiently educated to also know and understand the consequences of pervasive quality education. They prefer ignorance, and that is no less harmful than preferring the incubation and spread of a virus.Why does it matter? Who cares? It matters because decisions are made based on the facts people think exist. For example, in California, voters are given the opportunity to approve or reject propositions that directly affect taxation and spending. Advocates of more spending for a particular area of the budget strive to convince voters that the particular area in question is underfunded. Those seeking to cut spending on particular areas try to convince voters that those areas are overfunded.
Six years ago, in The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I pointed out:
A month and a half ago, the Kaiser Family Foundation released poll results revealing that 40 percent of Americans “think that foreign aid is one of the two biggest areas of spending in the federal budget.” This, of course, is totally incorrect.Yet this piece of tax misinformation persists. How can good decisions be made when reality is different from perception? Imagine what happens if surgeons, electricians, auto mechanics, and engineers made decisions based on misinformation rather than on actual facts. Just imagine.
Monday, May 10, 2021
One Person’s Goof Triples Another Person’s Taxes
When she learned that the monthly payments had been significantly increased because of the tax increase, the taxpayer had her daughter call the county’s Department of Assessment. That is when she and her daughter learned that someone had decided the taxpayer was dead. Someone in that Department’s office admitted that an error had been made, and told the taxpayer that the process for fixing it needed would take more than a year. In the meantime, the taxpayer overpaid the taxes by roughly $5,000 to $6,000, amounts beyond the taxpayer’s ability to pay. Apparently she had some financial assistance from her daughter.
The taxpayer and her daughter contacted county administration officials, including the county executive, but ran into a brick wall. They then turned to a county legislator for help, but he also could not get answers. So the legislator called a press conference to let people know what was happening.
A spokesperson for the county claimed that “corrections were made right away, along with a petition that will be approved by the legislature on Monday to refund the taxpayer.” He reported that a refund check should be mailed to the taxpayer by May 10, and noted, “it's unfortunate that an elderly woman was used as a political prop by politicians when a solution has already been found.”
No, what’s unfortunate is that someone marked the taxpayer as dead, no verification seems to have been made, no red flag popped up on a supervisor’s computer, no cross-checking with the state’s department of vital statistics to confirm the filing of a death certificate was processed, no rapid correction was made, no response was provided to the taxpayer by certain county officials, and perhaps no interest was paid on the refunded amount. No information has been provided on how the error took place. Did someone contact the tax office, perhaps as a prank, hoax, or attempt to steal the woman’s home, and report the taxpayer as having died? If so, what sort of confirmation was required? Did someone accidentally hit a button on a computer keyboard? If so, did a “do you really want to mark this person as deceased?” confirmation question pop up on the screen? Did a request for confirmation get sent to the supervisor? Worse, was a “you have been marked as deceased and the tax on the property has increased” notice sent to the taxpayer’s address? Was the taxpayer’s name confused with another taxpayer who actually did die? Was the box that should have been clicked above or below the box adjacent to the taxpayer’s name and associated with a different person?
System design is difficult. Everyone makes mistakes. The more costly a mistake, the more resources should be plowed into the design of a system. Systems that deal with taxes and other finances, such as banking, with health and medical issues, with arrest and prison records, and with similar “high consequences if an error” situations deserve careful planning and implementation. Not only do these systems need careful planning to prevent or at least reduce the number of mistakes and to reduce the impact of mistakes, they also need processes that fix mistakes, and quickly. Why it would have taken more than a year, absent the intervention, to fix the error is baffling. It was easy check the “taxpayer is dead” box, so it should be just as easy to uncheck it, and check a “send refund” box.
It is a story like this that turns public opinion even more sharply against taxes. This sort of error is bad public relations, and it would be behoove the county tax office in question to release an explanation of what went wrong and the steps taken to prevent similar and identical errors in the future. And it ought not take more than a year to do that.
Friday, May 07, 2021
Tax Return Preparers Putting Red Flags on Clients’ Returns
This time, in a situation very similar to the one I mentioned last week, a tax return preparer made it easy for the IRS to spot the fraudulent returns cranked out by the preparer. Last week I pointed out the foolishness in falsely claiming that a client attended school at a particular institution despite knowing that the client had not done so. Was not the preparer aware that IRS computers or IRS personnel would cross-check the school listed on the tax return with information about students matriculated at that school?
According to this Department of Justice news release, a Florida tax return preparer was convicted by a jury of 14 counts of filing false returns on behalf of unknowing clients and 3 counts of filing false tax returns on behalf of himself. The preparer inserted into the clients’ returns “grossly inflated deductions for state and local sales taxes, unreimbursed employee expenses, and gifts to charity by cash or check.” On his own 2013 return, he reported $10,160 in income when he actually earned at least $83,848 that year. On his 2014 return, he reported $2,695 in income when he actually earned $252,652 that year. On his 2015 return, he reported $10,255 in income when he actually earned $234,936 that year. Did he really think he could omit 88 percent, 99 percent, and 96 percent of gross income an not get noticed by the IRS?
The news release described another red flag unfurled by the preparer. “For example, on one tax return, [he] claimed a sales tax deduction of $5,883 for a client who had a gross income of $43,476. In order for that client to claim a sales tax deduction that large, the client would have had to have made taxable purchases totaling $89,926 (including the tax) -- or more than twice the client’s claimed gross income.” Finding this sort of fraud is something that the IRS computers easily detect.
Because the preparer can be sentenced for up to three years for each count, he could be facing 51 years in federal prison. Restitution also is being sought. In When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them, I wrote:
Some unscrupulous tax return preparers might be difficult for the IRS to spot, or perhaps avoid detection for long periods of time. But others seem to be raising red flags so obvious that they might was well post “Fraudulent Tax Returns Prepared Here” signs in their storefront windows or on their websites. Lack of ethics combined with lack of knowledge about how tax returns are examined and audited is a recipe for a much shorter time as a preparer.When tax return preparers don’t understand the chances of being caught and the high price paid when caught, and they are focused only on the seemingly quick and easy cash windfall from filing fraudulent returns, they are destined for disappointment despite any short-term success. It’s too bad that they not only mess up their own lives, they create inconvenience, aggravation, anxiety, and frustration for their clients. Please, people, take a look at my advice in More Thoughts About Avoiding Tax Return Preparers Gone Bad and save yourself some agony.
Wednesday, May 05, 2021
Can Long-Term Tax Collector Embezzlement Be Prevented?
Now comes another story about a tax collector in trouble. The story showed up in my local paper, and a day later reader Morris found the story in a different source. He described the subject of the story as “another candidate for worst tax collector contest,” but that’s not the sort of contest I’d want to run or judge. As I learned when I was a child, pointing out that someone else, for example, a sibling, did something worse is not a defense when called to account by a parents. As an aside, this is why the “whataboutism” that has infected the national discourse on a long list of issues is unhelpful.
In this instance, Jeanne Bowser, who served as tax collector for Center Township in Beaver County, in western Pennsylvania, for several decades, and who resigned in 2019 following an audit, has admitted to stealing $1,028,000 from the township’s tax revenue. As part of her plan, she used school tax revenue to fill township tax accounts and vice versa. She also failed to report the embezzled funds as gross income, and for those unfamiliar with basic tax law, stolen money must be reported as gross income. She pleaded guilty to wire fraud and filing a false tax report. She faces a prison sentence and a requirement to make restitution of the stolen funds and to pay the $275,000 in federal income taxes not paid on the embezzled funds. When she pays the $1,028,000, she will be entitled to a deduction but I doubt it will be of much use to her.
What is amazing is that she did this for eight years before being caught. In a world of dual authentication to reduce the risk of digital hacking, ought there not be some system to keep more than just the tax collector’s eyes on the receipt and deposit of tax revenues? Many businesses separate the tasks related to revenue receipt among multiple employees. It’s not my intention to map out how that can be done, but simply a question for officials in jurisdictions that haven’t set up such a system. The question is, “Why not now?”
Monday, May 03, 2021
Fixing a Subhead and a Sentence That Reference Tax Brackets
So that is probably what happened with the headline and subhead in this Kiplinger article. The headline is a question: “What Are the Income Tax Brackets for 2021 vs. 2020?” The subhead tells us, “For both 2020 and 2021, you can end up in one of seven different federal income tax brackets – each with its own marginal tax rate – depending on your taxable income.” Of course, that’s not true. The only taxpayers who end up in ONE bracket are taxpayers whose taxable income equals or is less than the cut-off amount for the lowest bracket. The taxable income of a person whose taxable income exceeds that amount would be in at least two brackets, the lowest bracket and the next highest bracket. The author of the article, though, got it right in an example but wrong in an explanation.
In the example, the author wrote:
Suppose you're single and have $90,000 of taxable income in 2020. Since $90,000 is in the 24% bracket for singles, would your tax bill simply be a flat 24% of $90,000 – or $21,600? No! Your tax would actually be less than that amount. That's because, using marginal tax rates, only a portion of your income would be taxed at the 24% rate. The rest of it would be taxed at the 10%, 12%, and 22% rates.This example demonstrates that the taxpayer’s taxable income falls into FOUR brackets, or perhaps one could say that the taxpayer’s taxable income is spread out over FOUR brackets. But certainly the example dispels any thought that the taxable income is within ONE bracket.
Yet in the article, the author also states, “That means you could wind up in a different tax bracket when you file your 2021 return than the bracket you're in for 2020 – which also means you could be subject to a different tax rate on some of your 2021 income, too.” Perhaps this use of the singular suggested to the headline writer that a taxpayer’s taxable income ends up in “a . . . tax bracket,” that is, ONE tax bracket. The sentence can be fixed by adding the word “MARGINAL” before the phrase “tax bracket” and before the phrase “tax rate.” So it would read, “That means you could wind up in a different marginal tax bracket when you file your 2021 return than the bracket you're in for 2020 – which also means you could be subject to a different marginal tax rate on some of your 2021 income, too.”
The same fix would work for the subhead. Adding the word “MARGINAL” before the phrase “income tax brackets” and removing that word from before the phrase “tax rate” produces this subhead: “For both 2020 and 2021, you can end up in one of seven different federal marginal income tax brackets – each with its own tax rate – depending on your taxable income.”
Why did I capitalize MARGINAL? I wanted to emphasize the importance of the various adjectives used to describe the phrases “tax rate” and “tax bracket.” Those adjectives have meaning, and omitting them or using the wrong ones can produce, in many instances, incorrect or misleading statements. There are marginal tax rates. There are average tax rates. There are effective tax rates. There are flat tax rate. There are progressive tax rates. There are regressive tax rates. There are nominal tax rates. Those are objective adjectives. There are dozens of subjective adjectives used to describe tax rate or tax brackets, including oppressive, heavy, high, severe, exorbitant, favorable, unfair, light, confiscatory, and many others.
Though there is pressure to shorten sentences, headlines, subheads, email texts, manifest with the proliferation of tweets, sound bites, and buzz phrases, the change I proposed to the subhead did not lengthen it because it simply moved a word from one place to another. In contrast, the change I proposed to the sentence in the text lengthened it by two words. So sometimes the issue is length and sometimes it’s word placement.
Note: reader Morris suggests that my suggestion “For both 2020 and 2021, you can end up in one of seven different federal marginal income tax brackets – each with its own tax rate – depending on your taxable income.” would be even better if it read, “For both 2020 and 2021, you can end up in one of seven different federal marginal income tax brackets – each with its own tax rate – depending on your taxable income and filing status.” Of course, that makes the subhead longer, which migh pose composition (font, spacing, etc.) issues. Perhaps an even better and no less technically correct subheading would be, “For both 2020 and 2021, your taxable income can end up subject to one of seven different federal marginal income tax rates.”
Friday, April 30, 2021
Tax Treatment of Vaccination Incentives
For federal income tax purposes, the cash, gift cards, gift certificates, and bonuses are gross income. They are gross income because they are income, and thus included in gross income unless an exclusion applies. The only possible exclusion is the employee de minimis fringe benefit exclusion under section 132. But under the Regulations, specifically section 1.132-6(c), the provision of cash, gift certificates, and the use of credit cards are not excluded as a de minimis fringe benefit. The other fringe benefit exclusions are, by definition, inapplicable.
What about paid leave? Under those circumstances the employee continues to be paid the employee’s compensation, which is included in gross income. The same result applies to increases in vacation time. The employee’s compensation remains unchanged and continues to be included in gross income. Of course, the employer offering paid leave might be entitled to the tax credit under section 45S, but that does not bear on the question of the employee’s gross income.
As for state income taxes, it depends on the income tax law in each state that has an income tax. I am unaware of any state having enacted an exclusion for vaccination incentives, though perhaps one has. It would not surprise me if in one or another state legislation has been proposed for such an exclusion.
Should there be an exclusion? That’s a different question. What would happen if there were such an exclusion? Would employers reduce the amount of the incentive to match what the employee would be pocketing from a taxed incentive?
Are employers properly reporting these payments as wages? That, too, is a different question, and I simply do not know.
Wednesday, April 28, 2021
When Unscrupulous Tax Return Preparers Make It Easy for the IRS and DOJ to Find Them
A few days ago, according to this Department of Justice press release, a tax return preparer in Suwanee, Georgia, has been permanently enjoined from preparing tax returns for other taxpayers. The preparer had been doing what many unscrupulous preparers do. She had been understating tax liabilities and overstating refunds by “understating business income by fabricating or inflating reported business losses; fabricating or overstating itemized deductions; and claiming unsupported education credits.” The court that granted the injunction determined that the preparer had “knowingly prepared and filed hundreds of false tax returns,” and that “she did so despite two separate attempts by the IRS to bring her into compliance, both of which resulted in penalties assessed against her.”
What caught my eye was the blatant foolishness of one of the preparer’s “techniques” to lower clients’ tax liabilities to less than what they should have been. The press release explains that “on over 100 returns, [she] falsely claimed that taxpayers attended school at a particular institution despite knowing that they had not done so.” Duh. What did she think would happen when the IRS computers or IRS personnel cross-checked the school listed on the tax return with information about students matriculated at that school? Or perhaps a client, after returning home, looks at the return, decides enough is enough, and rather than confronting the preparer, contacts the IRS directly or through another professional in order to amend the return out of fear that the client would be held accountable for fraud.
Some unscrupulous tax return preparers might be difficult for the IRS to spot, or perhaps avoid detection for long periods of time. But others seem to be raising red flags so obvious that they might was well post “Fraudulent Tax Returns Prepared Here” signs in their storefront windows or on their websites. Lack of ethics combined with lack of knowledge about how tax returns are examined and audited is a recipe for a much shorter time as a preparer.
Monday, April 26, 2021
Giving (Tax) Credit Where (Tax) Credit Is Due
Recently, I have noticed a similar misattribution showing up in headlines and news stories about tax matters. For example, in this CNBC report, the headline claimed that “Biden announces tax credit for businesses giving paid leave for Covid vaccinations and recovery.” In its report, Reuters put it this way: “Biden offers tax credits for COVID-19 vaccination paid time off.” The Philadelphia Inquirer proclaimed that the “White House offers a tax credit to spur COVID-19 vaccinations as Biden nears his 200 million goal.” From The State we get this characterization: “Paid time off for COVID vaccinations encouraged under Biden tax credit.” Dozens, if not hundreds, of other newspapers, web sites, and other commentaries are publishing similar, if not identical, headlines.
Why do I tag these claims as misattributions? I do so because the credit in question was not enacted by the White House or the president. It is the product of the Congress, which enacted, and thus announced and offered, the credit in question when, in section 9641 of the American Rescue Plan Act of 2021, it added section 3131 to the Internal Revenue Code. None of the stories I read make any mention of the legislative origin of the credit.
Fortunately, some news outlets use more precise, and thus more appropriate, language. For example, this Bloomberg story comes with this more accurate headline: “Biden Touts Tax Credit to Prod Businesses on Workers’ Shots.” From Medpage Today we get this title: “Biden Pushes Tax Credit to Spur More COVID Shots.” Another characterization comes from the Huffington Post: “Biden Hopes Tax Credit Will Encourage Vaccine-Hesitant Americans To Get One Anyway.” Unlike the headlines and stories noted in two paragraphs above, these writers avoid attributing the source of the credit to the Administration.
When politicians, writers, and others attributed tax laws to the IRS, they are focusing on rules unliked by taxpayers and are shifting the blame away from the Congress. There is no question that members of Congress, even if not individually responsible for these misleading claims, benefit from the spotlight shift. Apparently someone figured out that if a tax law provision is one that taxpayers do or will like, it’s just as easy for some other part of the government that is not the Congress to take credit for that provision. This just makes things worse. In a nation few of whose citizens understand how federal, state, and local governments function, and even fewer of whom have sat through a high school Civics course, the lack of knowledge makes it much easier for the foundations of democracy to erode to the point they are easily knocked down.
Friday, April 23, 2021
The Tax Gap, Like Greed, Is on Steroids
The tax gap is the difference between what taxpayers should be paying if they were in full compliance with the tax law and successful in avoiding mistakes and what taxpayers actually pay in taxes. Note that the tax gap in question is the federal income tax gap, and surely states, especially those whose tax liability computations start with federal gross, adjusted gross, or taxable income, have their own income tax gaps.
I was not surprised by the Commissioner’s testimony. In , Tax Gap Becoming a Tax Chasm, I noted that “The tax gap for calendar year 2003, the latest year for which sufficient statistical information is currently available, is $1.0417 trillion.” My guess is that the tax gap in 2018, 2019, and 2020 probably exceeds not only $1 trillion but $1.5 trillion. What does surprise me is the willingness with which authorities accept the low figures reported by the IRS. For example, in Closing the Federal Tax Gap , I noted that in 2006, three years after the Bureau of Economic Analysis had computed the $1 trillion figure, the National Taxpayer Advocate issued a report pegging the annual tax gap as “somewhere between $250 to $300 billion.” I suppose the IRS is caught between a rock and a hard place. It could report the higher number in an effort to encourage Congress to stop cutting its budget and restore its ability to ramp up audits and foster compliance. But reporting that higher number poses the risk that Congress and others would judge the IRS as unworthy of any funding by treating it as the cause of the tax gap.
Much paper, ink, and digital bytes have been dedicated to discussion of the tax gap and proposals for dealing with it. I have no intention of trying to write a treatise about the tax gap. I simply will review some of the things I have written about it over the years. In Tax Gap Becoming a Tax Chasm, I noted:
One must wonder what motivates noncompliance. Perhaps some psychologists will conduct surveys to determine if it simply greed, or a growing rebellion in which people are "voting with their feet" by appropriating unto themselves their own special tax break that they cannot get through the Congress because they lack the clout of the lobbyists who have managed to reduce the tax on capital gains to extremely low levels. How much of the noncompliance is simple ignorance, stupidity, carelessness, or confusion? How much of the gap arises from people trying to hide information about the activities generating the income?In Closing the Federal Tax Gap, I shared these thoughts:Some people may not realize they are contributing to the tax gap, because they are making good faith efforts to comply with an absurdly and unjustifiably complex income tax system. Others know full well what they are doing when they engage in "pay cash, pay less" schemes, launder money, or simply fail to file. I suppose this reflects our culture, for surely it resembles what one finds on our highways: drivers who try to comply and succeed, drivers who are ignorant, stupid, careless and confused, and drivers who think they are so much more important than or better than everyone else that they flaunt whatever rules get in the way of their own self-centered approach to life.
A fun calculation is to determine how much tax has not been paid on the tax gaps for 2002, 2001, 2000, and earlier years, add interest and penalties, and imagine what happens if Treasury had the ability to collect the total amount due. The shock to the world economy might be staggering. We'll never know, because Treasury lacks the ability to collect even a minute fraction of this amount. Why? Because Congress has not implemented a system that ensures all taxpayers pay their fair shares.
Until Congress does two things, the tax gap will continue to grow, and the ultimate outcome might be far worse than the impact of quadrupled prices for oil and gas, shortages of concrete, or devastating hurricanes. Congress must reform the income tax system so that it is easy to understand, inviting of compliance, and difficult to evade. Congress must also put in place safeguards that prevent noncompliance and punish tax evaders. Ideally, a well-designed system that prevents tax evasion will reduce the number of tax evaders and thus reduce the need for prosecution of tax evaders. Law enforcement could then redirect more resources to the prevention of, and prosecution of, other crimes.
The tax gap fascinates me and frustrates me. * * * I'm both fascinated and frustrated by the willingness of people to avoid their legal responsibilities. Of course, that fascination and frustration is not limited to tax avoidance devotees but also the behavior of those who violate a variety of rules and regulations.A year later, in Closing the Tax Gap Requires Congressional Introspection, I described a GAO report, "TAX COMPLIANCE Multiple Approaches Are Needed to Reduce the Tax Gap." I described the report thusly:* * * * *
[The National Taxpayer Advocate’s] report points out that when taxable transactions are properly reported to the IRS, the rate of tax collection exceeds 90 percent, but when payments are not reported compliance drops to a range of 20 to 68 percent, depending on the type of transaction. Sometimes reporting does not occur because people are noncompliant. Sometimes reporting does not occur because it is not required. * * *
[The National Taxpayer Advocate] recommends expanding the list of transactions that must be reported. This is the sort of suggestion that makes one wonder why it wasn't done decades ago. The answer is easy. As [the National Taxpayer Advocate] points out, tax revenues would climb if every taxable transaction was subject to reporting requirements. That, however, would be an onerous burden. * * *
I add that compliance is enhanced when withholding takes place, because withholding shifts the tax payment and not just information to the Treasury.
The report concludes that the tax gap "has multiple causes and spans different types of taxes and taxpayers." Accordingly, "Multiple approaches are needed to reduce the tax gap. No single approach is likely to fully and cost-effectively address noncompliance since, for example, it has multiple causes and spans different types of taxes and taxpayers."I criticized the report because it presupposed Congress as a whole does not even know what is in the tax law though some individual members are aware of whatever provision they championed. I also questioned why members of Congress caved in to the lobbyists whose clients oppose the expansion of reporting and withholding and who misrepresented attempts to increase withholding by falsely describing the effort as a “new tax.” I then explained:Three major approaches are considered:
1. Simplifying or reforming the tax code.
2. Providing the IRS with more enforcement tools.
3. Devoting additional resources to enforcement. Minor approaches include "periodically measuring noncompliance and its causes, setting tax gap reduction goals, evaluating the results of any initiatives to reduce the tax gap, optimizing the allocation of IRS’s resources, and leveraging technology to enhance IRS’s efficiency."
The report points out that billions of dollars of the tax gap could be avoided if the tax law were simplified or fundamentally reformed. It explains, for example, that the IRS "has estimated that errors in claiming tax credits and deductions for tax year 2001 contributed $32 billion to the tax gap."
Unfortunately, the report then concludes that "these provisions serve purposes Congress has judged to be important and eliminating or consolidating them could be complicated." Even fundamental reform, in which tax preferences are limited and "taxable transactions are transparent to tax administrators," is "difficult to achieve." The report provides an almost irrefutable axiom, that "any tax system could be subject to noncompliance." Finally, it provides another difficult-to-rebut observation: "Withholding and information reporting are particularly powerful tools."
Left to instinct, most people would prefer to pay no taxes, and exist as beneficiaries of others. History teaches that most of those who can grab have done so, and that many who could not exerted themselves to find ways to do so. The tax gap is a reflection of some unintentional errors and lots of intentional evasion. Careful intellectual reasoning, though, teaches us that civilization requires taxation, economic principles tell us that taxation should be efficient, common sense tells us it should be simple, and ethical principles tell us that it should be fair. It takes leadership to persuade the civilized world why it makes no sense, in the long-run, to behave in ways that generate tax gaps. Fraudulent behavior by taxpayers contributes to the tax gap. So, too, does the way in which Congress does business. Ought not the Congress take the first step in leading by example? Until the Congress understands that the way it does business encourages the non-filers, the protesters, the illegal tax shelter promoters, and the rest of the noncompliant population to act in ways that undermine the tax law and fuel the rapid growth in the tax gap, talking about closing the tax gap is not much more than rhetoric. Yes, I talk and write about it, but I've not undertaken the responsibility that members of Congress have sought and accepted. If they don't think they can or want to fix the problem, no one will stop them from returning home.Shortly after I wrote those words, I received a letter from Senator Max Baucus, chairman of the Senate Finance Committee, and Senator Charles E. Grassley, ranking member of that committee, in which they asked for "suggestions on ways to improve compliance with our tax laws, including specific recommendations to reduce the tax gap." I described my response in Congress Invites My Ideas for Improving Tax Compliance and Of Course I Respond, and I included in that posting a copy of the letter I sent to the Congress. I do not republish it today because a quick click on the preceding link should suffice. In summary, I pointed out that a six-prong approach is required, namely, making tax education a part of high school curricula, simplifying the tax law, increasing reporting, expanding withholding, funding increased and improved audits, and strengthening the ability of the Department of Justice to prosecute tax crimes. I closed that day’s post by telling readers “I will let you know if I receive a response.” I did not. I did not receive a direct response. Nor have I seen the Congress respond by taking steps to deal with a rapidly ballooning tax gap.
Almost a decade later, in Tax Compliance and Non-Compliance: Identifying the Factors, I reacted to yet another report from the Taxpayer Advocate. The report focused on characteristics of so-called high-compliance and low-compliance taxpayers. I noted:
Some of the findings are not surprising. According to the survey underlying the report, high-compliance taxpayers are more trustful of government, appear to be more intent on minimizing mistakes on their tax returns, viewed government positively, are more likely to rely on tax return preparers, and were motivated by moral concerns and deterrence. Low-compliance taxpayers are less trustful of preparers, are less likely to follow a preparer’s advice when using a preparer, tend to think that other taxpayers have negative views of law and the IRS, are suspicious of the tax system, and are more likely to consider the tax system unfair. All taxpayers viewed the tax law as complicated.And then, again almost a decade later, I drew attention to a major cause of the tax gap. In Tax Noncompliance: Greed on Steroids, I described the news revealed in a report by the Treasury Inspector General for Tax Administration issued a report, High-Income Nonfilers Owing Billions of Dollars Are Not Being Worked by the Internal Revenue Service:Other findings struck me as unexpected. Low-compliance taxpayers are “more likely to participate in local organizations.” They also asserted that they had a moral duty to report income accurately. Non-compliance is higher among sole proprietors of construction companies and real estate rental firms than sole proprietors of other types of businesses.
Though the IRS explains that geographic location is not a factor in selecting returns for audit, the survey results revealed that low-compliance taxpayers were clustered in specific areas. Towns and neighborhoods near San Francisco, Houston, Atlanta, and the District of Columbia, including Beverly Hills, California, Newport Beach, California, New Carrollton, Maryland, and College Park, Georgia, were among 350 communities in which low compliance taxpayers were clustered. In contrast, very few of the 350 communities were in the Midwest or Northeast. What about high-compliance taxpayers? The top of the list consisted of the Aleutian Islands, West Somerville, Massachusetts, Portersville, Indiana, and Mott Haven, a neighborhood in the Bronx.
It did not take long for stories about the Taxpayer Advocate’s report to focus on the nature of the identified communities. For example, an MSN report noted that the low-compliance clusters were in very wealthy neighborhoods. A Yahoo news story put the conclusion in its headline, “IRS Report Shows Many of Biggest Tax Cheaters Live in Wealthy Areas.”
The Taxpayer Advocate report does not disclose whether the low-compliance taxpayers in these clusters were high-income individuals, but it is safe to assume that at least a significant number of them were. Yet what sort of conclusions can be drawn? Is it possible that most low-income taxpayers are not low-compliance taxpayers because they don’t have much income to begin with, and thus no income to hide? Is it possible that because most low and middle income taxpayers realize most of their income from wages subject to tax withholding they have far fewer opportunities to cheat on their taxes? It would not surprise me to discover that someone will argue that the wealthy do cheat more, but would reduce their cheating if their tax rates were lowered. As logical as that proposition might sound, to the extent that greed and money addiction energize every sort of tax reduction attempt, whether lobbying for special breaks and low rates or taking the cheater’s route, it is unlikely that anything other than a zero percent tax rate will satisfy these folks, and even that probably is not enough.
The news is bad.We are at a tax system breaking point. We are here because the worst offenders have persuaded the non-offenders and the minor offenders that any effort to put an end to the shenanigans of the worst offenders will produce the most harm for the non-offenders and the minor offenders. Here is a helpful analogy. Underfunded highway troopers driving vehicles that are too slow to catch the “rocket ship” drivers instead focus on the speeders who are 5, 10, or 15 miles per hour over the limit. When a proposal is made to purchase high-end chase cars for the troopers so that they can catch, ticket, and even arrest the worst speeders, the lobbyists for those “entitled to speed without restriction because of freedom, freedom, freedom” characters persuade the majority of drivers, who are either not speeding or speeding just somewhat, that the proposal will cause the authorities to arrest the compliant drivers and confiscate their vehicles. What’s evil is the lobbying message. What’s sad is the fact that it works way too often. It is time to stop worrying about the specks and to start dealing with the logs.After pointing out that the tax gap – the shortfall between what the law requires taxpayers to pay and what taxpayers are in fact paying – is estimated to be $441 billion for 2011, 2012, and 2013, the report reveals that $39 billion is due from taxpayers who fail to file tax returns. Most of this shortfall is attributable to “high-income nonfilers.” The Inspector General determined that although the IRS is developing a new approach to dealing with nonfilers, it has not yet implemented that approach, and when implemented, it will be “spread across multiple functions with no one area being primarily responsible for oversight.”
Worse, the Inspector General determined that for taxable years 2014 through 2016, 879,415 high-income nonfilers failed to pay roughly $45.7 billion in taxes. Of those 879,415 high-income nonfilers, the IRS did not pursue 369,180 of them, accounting for an estimated $20.8 billion in unpaid taxes. Of the 369,180 were not put into the queue for pursuit of the unpaid taxes and the cases for 42,601 were closed without further action. The other 510,235 of the 879,415 high-income nonfilers “are sitting in one of the Collection function’s inventory streams and will likely not be pursued as resources decline.”
Even worse, because the IRS works on each tax year separately rather than combining cases when a taxpayer fails to file for more than one year, it “is missing out on opportunities to bring repeat high-income nonfilers back into compliance.” Of these high-income nonfilers for 2014 through 2016 that the IRS failed to address or resolved, the top 100 owed an estimated $10 billion in unpaid taxes. The Inspector General has proposed seven changes to deal with these problems, but the IRS agreed in full only to two of them, partially agreed with four, and disagreed with one. The IRS objected to putting the nonfiler program under its own management structure.
Here and there a failure to file arises from an understandable problem, such as a taxpayer falling ill without anyone realizing it in time, or developing dementia or similar mental impairments. Sometimes the failure to file arises from financial setbacks for taxpayers who don’t realize that in those situations it is best to file and indicate the inability to pay. Some instances of failure to file are expressions of principled protest against specific government policies. A significant portion reflect a deep greed rooted in a taxpayer’s perception that they have no obligation to contribute to society, with the failure to file and pay almost always defended as a justified expression of the taxpayer’s anti-tax philosopy.
Is it any wonder that so many people are enraged? Though there are many ingredients fueling social unrest, an important one is the growing sense among Americans that they are fools for complying with tax laws when “high income nonfilers” are “getting away with it.” Would it be a surprise if more taxpayers choose not to file, knowing that the IRS lacks the resources to chase them down? This sort of mob mentality is no less likely to spread among taxpayers as it can spread among crowds encouraged to break other laws.
Though it is easy to suggest that Congress needs to wake up and provide sufficient funding to the IRS, especially because every dollar invested returns roughly seven, but the Congress is incapable of doing this. Enough of It is controlled by the anti-tax, anti-government crowd that it lacks the ability to do what needs to be done. Until the makeup of the Congress changes, the tax gap will persist and even increase, adding to the growing deficit that threatens to cause havoc more catastrophic than what currently afflicts the nation. The greed that is fueling the income and wealth inequality contributing to so many of the nation’s problems is growing as though on steroids, and needs to be neutralized expeditiously.
Wednesday, April 21, 2021
So Is There Now a “Worst Tax Collector” Contest?
My last post, So Who’s the Worse Tax Collector?, was a response to a question from reader Morris. He had asked if Samuel Adams was a “possibly a worse tax collector than Joel Greenburg [the former Seminole County tax collector]?” My answer was no, for the reasons described in that post. Little did I know that reader Morris had foreshadowed the question that captions this MauledAgain blog post.
So why am I asking if there is now a “worst tax collector” contest? That thought occurred to me when I read this Philadelphia Inquirer report. According to the story, a former tax collector and treasurer in Ridley Township, in the southern part of the county in which I live outside Philadelphia, was charged with filing false federal income tax returns for taxable years 2014 through 2018. According to a Delco Times report, the former tax collector allegedly maintained three Wells Fargo bank accounts used to deposit township tax payments, including tax payments, tax certification fees, and duplicate bill fees. She transferred the tax payments to the township but was authorized to keep, and did keep, the tax certification and duplicate bill fees. However, she did not include those amounts on her federal income tax returns. The information in which she was charged lists the amounts she did report as gross income but did not provide the amounts that were omitted, simply stating that she knew the amounts that she did report were false and that she knew that her actual gross income was more than what she reported.
A spokesperson for the U.S. Attorney’s Office, when asked, replied that the dollar amount of the unreported income was not available. There certainly are additional questions that will be asked. Did the former tax collector think that deposits put into a bank account used for tax payments and fees would not be traced to her when she made use of the fees? Did anyone have the responsibility to issue, and did anyone issue, a Form 1099 to the former tax collector? Did she report these fees for state income tax purposes?
Sadly, if she is sentenced to serve any prison time, she has some idea of what that experience would be. According to a Delco Times report from 12 years ago, she participated in the 2009 Annual Muscular Dystrophy Association “lock-up,” a fund-raising event in which “local business and community people agree to be ‘arrested’ and have to raise ‘bail’ to get out of jail. Of the many people participating, the former tax collector, at that time serving as tax collector, was the only participant named aside from the writer, who also participated, because the former tax collector ended up as the writer’s ‘cellmate.’ But I suspect that aside from the ‘arrest, the ‘paddy wagon’ ride, and the taking of mug shots, the rest of the experience was much different than prison. According to the story, the ‘jail’ was a restaurant, and the participants were fed and given a cell phone to use in soliciting contributions for the charitable cause. Perhaps her participation in this worthy cause will be taken into account if she is convicted or pleads guilty.
But I still wonder why she did this, if indeed this is what she did. When there is a record of payments, as there would be with the collection of fees dropped into a bank account maintained for government purposes, is there not a realization that any gross income cannot be hidden? Most gross income evasion involves difficult-to-trace transactions, principally cash and below-radar barter transactions. So perhaps there are additional facts that explain what happened. In the meantime, tax collectors, the job is challenging enough without making things even more difficult. It’s not a contest.
Monday, April 19, 2021
Yet Another Way Tax Return Preparers Can Harm Their Clients (and Employees)
Most of those commentaries dealt with tax return preparers charged with some sort of tax fraud. One dealt with a tax return preparer charged with assault and gun offenses. Now comes news from the Department of Labor that OSHA has imposed fines of $136,632 on a tax return preparer in Lynn, Massachusetts. Why? According to the press release, after receiving a referral from the Division of Labor Standards of the Commonwealth of Massachusetts Executive Office of Labor and Workforce Development, OSHA investigated and concluded that the tax return preparer and her company prohibited employees and customers from wearing face coverings in the workplace despite a statewide mask order that mandated the business to require employees and customers to wear masks, required employees to work within 6 feet of each other and customers for multiple hours while not wearing face coverings, failed to provide adequate means of ventilation at the workplace, and failed to implement controls such as physical barriers, pre-shift screening of employees, enhanced cleaning and other methods to reduce the potential for person-to-person transmission of the coronavirus.
The preparer and the company have 15 business days from when it receives the notice of the fines to comply, request an informal conference with OSHA’s area director, or contest the findings before the independent Occupational Safety and Health Review Commission. OSHA’s Regional Administrator in Boston summed it up this way, “This employer’s willful refusal to implement basic safeguards places her employees at an increased risk of contracting and spreading the coronavirus. Stopping the spread of this virus requires business’ support in implementing COVID-19 Prevention Programs, and ensuring that staff and customers wear face coverings and maintain physical distance from each other.”
Perhaps there are reasons for some of the noncompliance, such as insufficient space to permit proper distancing while still keeping capacity to service all of the clients. Perhaps attempts to upgrade ventilation ran into supply shortages, contractor issues, or financial impediments. Perhaps efforts to find cleaning services were futile. But I doubt it. My guess is that the preparer either negligently ignored the requirements, just as some restaurants fail to enforce rules requiring employees to wash their hands, or deliberately defied the regulations because of adherence to the cult of anti-masking or because of a more general anti-regulation attitude. According to this report, the preparer “claims the masks actually spread the disease and OSHA should mind its own damn business and stop pandering to what she says are fear-mongering state officials.” My question for the preparer is whether she is willing to undergo, or have family members or friends undergo, surgery by a physician and an anesthesiologist who do not wash their hands or wear masks in an operating room that is not disinfected before the operation. Is it simply another case of “rules for others but not for me” that pervades the world of the anti-regulation movement? I also wonder if her attitude toward taxes reflects the same uninformed approach to law. A clue might be found in the facts underlying this case.
As for the customers, perhaps they didn’t care that they were walking into a coronavirus incubator. Perhaps they think the coronavirus is a hoax, or “no worse than the flu or common cold.” Perhaps they think they are special and healthy enough to escape what has happened to other people, including healthy ones. As for the retort that perhaps the customers did not know, though it is difficult when walking into an inside space to know when and if surfaces have been cleaned or if the ventilation system is properly filtered and oriented, surely the sight of a bunch of maskless people sitting and standing within 2 or 3 feet of each other is a red flag that cannot escape detection.
What we don’t know is how many people intending to have their tax returns prepared by this preparer walked up to the door, saw what was happening, and walked away. My guess is that at least one person did so, and probably is the reason the situation was brought to the attention of the Massachusetts Division of Labor Standards. It would not surprise me if it turns out multiple potential customers did the same thing. What a way to lose customers and revenue. Did the preparer think that catering to customers who share the same attitudes about the coronavirus as the preparer appears to hold outnumbered the customers being lost, or at least generated more revenue than the customers being lost? We may never know.
Tax return preparers who do not follow rules can harm their clients by filing false tax returns on their behalf. They can cause instant death by pulling out a gun and shooting. They can cause death, serious illness, and long-term, lifelong agony for customers who are infected because of gross negligence, defiance, and foolishness. Though I have stated many times that taxpayers should do research before retaining a tax return preparer, in this case even those taxpayers who did not do a background check had ample warning when they approached the storefront. Hopefully, even though OSHA observed customers in the office, most of the potential clients walked away.
Friday, April 16, 2021
A Simple Tax Question Isn’t So Simple, and Neither are the Answers
The difficulty was the generality of the question. It did not specify the state, which matters, though presumably because it was posted to a web site focused on New Jersey that was the state in question. The question did not specify the nature of the refund, state or federal, but the context of the question suggested it was a reference to a federal income tax refund. We live in a sound bite, buzz phrase, tweet world, where everything, even complex situations, are reduced to oversimplified generalities that confuse people and erode the niceties of the exceptions and parameters that provide the necessary information and guidance.
There actually are four questions embedded within that one question.
First, “Are federal income tax refunds included in gross income for federal income tax purposes?” The answer is no. The reason is that there was no federal income tax deduction for the payment of the federal income tax, so a refund of some or all of that payment does not generate gross income.
Second, “Are federal income tax refunds included in gross income for state income tax purposes?” The answer is, “it depends.” When I last looked, six states allow a deduction for federal income taxes paid, so a refund must be taken into account, either as gross income or as a reduction in the deduction for federal income taxes paid in the year the refund is received. In the majority of states not allowing a deduction for federal income taxes, the federal income tax refund is not included in gross income for state income tax purposes.
Third, “Are state income tax refunds included in gross income for federal income tax purposes?” The answer is, “it depends.” To the extent that the state income tax deduction provided a tax benefit, determination of which requires a multiple-step computation, the refund is included in gross income for federal income tax purposes. Thus for example, a refund of a state income tax for which no deduction was claimed because the taxpayer took the standard deduction would not be included in gross income for federal income tax purposes.
Fourth, “Are state income tax refunds included in gross income for state income tax purposes?” The answer is no. The reason is that there was no state income tax deduction for the payment of the state income tax, so a refund of some or all of that payment does not generate gross income.
Fitting the previous four paragraphs into a sound bite, a buzz phrase, or a tweet is impossible. The concern isn’t the question and answer posted on the web site. The answer provided was correct given the assumptions about the state in question and the refund in question. The danger is that someone not closely examining the entire context might conclude that the answer suggests that federal income tax refunds are never included in gross income for state income tax purposes, which is not true.
Wednesday, April 14, 2021
Has Congress Learned the IRS Funding Lesson, or Will It Fail Again?
Though tax evasion and tax avoidance cut across economic, social, cultural, and geographic boundaries, a substantial portion of the tax gap is attributable to evasion among large corporations and wealthy individuals. As I explained in Tax Noncompliance: Greed on Steroids, summarizing a report by the Treasury Inspector General for Tax Administration, the IRS failed to pursue 369,180 of 879,414 high-income nonfilers who failed to pay almost $46 billion in taxes. The other 510,235 were “sitting in one of the Collection function’s inventory streams and will likely not be pursued as resources decline.” The “success” of these high-income taxpayers who fail to file certainly encourages other taxpayers to ignore their responsibilities, and their “success” in turn will cause non-compliance to spiral into a revenue collapse.
Several years ago, in Taxing High-Income Individuals, I advocated, among other things, a way to reduce the federal deficit without raising tax rates. I explained what Congress needed, and still needs, to do: “Increase funding for the IRS so that it can track down and deal with tax shelter promoters, offshore schemes, fraudulent returns, and other gimmicks used to make a person with high income pay taxes at rates lower than those imposed on the middle and lower income echelons.”
In Another Way to Cut Taxes: Hamstring the IRS, I wrote:
Though it is easy to suggest that Congress needs to wake up and provide sufficient funding to the IRS, especially because every dollar invested returns roughly seven, but the Congress is incapable of doing this. Enough of It is controlled by the anti-tax, anti-government crowd that it lacks the ability to do what needs to be done. Until the makeup of the Congress changes, the tax gap will persist and even increase, adding to the growing deficit that threatens to cause havoc more catastrophic than what currently afflicts the nation. The greed that is fueling the income and wealth inequality contributing to so many of the nation’s problems is growing as though on steroids, and needs to be neutralized expeditiously.Well, the makeup of the Congress has changed, though not quite to the symmetrical opposite of what it has been during the most recent anti-tax, anti-government period. So it is no surprise that according to this report, among others, the current Administration is proposing a 10 percent, or $1.2 billion, increase in IRS funding, with most of it dedicated to “increasing resources for oversight of corporate and wealthy Americans' tax returns and ensure compliance.” The funding would help the IRS replace the 21,000 employees lost since 2010, which hampered its ability to deal with tax evasion by the wealthy, who now fail to report more than one-fifth of their income according to a recent National Bureau of Economic Research study.
As I wrote in 2011, in Another Way to Cut Taxes: Hamstring the IRS, when a previous Administration sought to increase IRS funding:
The Administration wants to increase IRS funding. Why? Aside from the creation of jobs, it would cut the deficit and restore moral balance to the revenue system. Think of it. Every dollar brings back ten. What advocate of the free market would walk away from such a deal? One dollar brings back ten. The private sector wouldn’t toss that opportunity aside, and neither should the fiduciaries of the public trust. America deserves no less.It remains to be seen whether the current Congress is better at investing that the Congresses of the past decade.
Monday, April 12, 2021
Another Tax Return Preparer Fraudulent Loan Application Indictment
Though most of the indictments and criminal informations arise from tax fraud, several of the indictments involve other types of fraud and even assault and gun charges. Last week, the Department of Justice issued a press release describing the indictment of yet another tax return preparer. In this instance the preparer has been charged with four counts of wire fraud.
According to the indictment, the preparer owned and operated a tax and investment consulting business in Bridgeview, Ill. The indictment alleges that from April to October of 2020, he submitted Paycheck Protection Program and Economic Injury Disaster Loan Program applications on behalf of hundreds of the company’s customers. The applications that the preparer submitted allegedly contained “materially false statements and misrepresentations about the customers’ businesses, such as gross revenues, expenses, and number of employees.” Because of the preparer’s alleged false statements and misrepresentations, millions of dollars in PPP and EIDL funds were disbursed to those customers.
If that’s not bad enough, the preparer charged customers an upfront fee of “approximately several hundred dollars” before submitting the applications. If the application was approved and the customer received funds under either program, the preparer charged the customer “an additional fee of approximately $1,000.”
What’s unclear from the press release is whether the customers knew that the applications contained false information. If they did know, the Department of Justice might still be working on indictments, or perhaps has decided not to indict them in exchange for the customers serving as witnesses. If the customers did not know, it’s yet another situation in which a tax return preparer uses confidential customer information to get money by filing fraudulent loan applications. In When Tax Return Preparers Go Bad, Their Customers Can Pay the Price, I wrote about the adverse consequences to the customers of tax return preparers who file false income tax returns. The advice that I gave, essentially suggesting doing background checks on tax return preparers, is important not just because of the need to avoid being audited for a false return, but to avoid being caught up in prosecutions for fraudulently obtained loans. Of course, if the customers aren’t so innocent and participated in scheme, then the customers probably will end up reaping the consequences of their own bad behavior.
