Posts Tagged ‘cfo’

When the calendar turns to mid-March and tax season makes the leap from annoying to soul-crushing, I spend more time than I should daydreaming about goin’ all Walter White and breaking bad, only instead of cooking meth, I’d use my well-honed number-crunching skills to become an underground bookie.

Oh, what a life it would be. Instead of spending March Madness in a tiny office cranking out tax returns, I’d spend it in a giant war room complete with wall-to-wall flat screens, building my riches on the failed dreams of student athletes. I’d work the phone better than Gordon Gecko, avoiding detection by using subversive colloquialisms like “unit” and “juice.” I’d threaten to break thumbs with impunity. And I’d make money. Lots and lots of money. Because the house never loses.

The house doesn’t lose because it is (generally) indifferent to who the bettors favor. Not to get into Gambling 101, but if you bet $100 on the Seahawks + 2 ½ in the Super Bowl, you won $100, But if you bet $100 on the Broncos to cover the 2 ½ points (sucker), you lost $110. The $10 the loser pays over and above the wagered amount is the “vig.”

Thanks to the vig, bookies generally don’t care who people are betting on, as long as the bets are fairly even on both sides. And of course, bookies have the advantage of being able to move the line to make sure this happens.

When it comes to horse racing — which in my bookie fantasy world, I will  occasionally dabble in but not invest heavily – the house has an added level of protection in the form of “parimutuel wagering.” It works like so:

The entire amount wagered on a particular race is referred to as the betting pool or “handle.” The pool can then be managed to ensure that the track receives a share of the betting pool regardless of the winning horse. This share of the betting pool that the track keeps for itself is often referred to as the “takeout,” and the percentage is driven by state law, but generally ranges from 15% to 25%.

The takeout is then used to defray the track’s expenses, including purse money for the winning horses, taxes, licenses, and fees. The takeout can also be used, if needed, to cover any shortfall in the amount necessary to pay off winning bettors. To the extent any excess takeout remains after covering these two classes of obligations, the track has profit.

Once the betting pool has been reduced by the takeout, the balance is generally used to pay off any winning wagers, with the excess, once again, representing profits. Great business model, isn’t it?

Yesterday, an enterprising CPA with a raging gambling habit threatened to strike a blow for bettors everywhere when he took on the IRS in the Tax Court and argued that the portion of his wagers attributable to the “takeout” were deductible without limitation. But before we can understand the significance of the case, we need to understand some basics about the taxation of gambling.

Treatment of Gambling Expenses, In General

Section 165(d) provides that “losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” Generally, any winnings are reported on page 1 of the Form 1040, while the losses (but only to the extent of winnings) must be claimed as itemized deductions. Thus, if a bettor is one of the 66% of Americans who don’t itemize their deductions, they would effectively be whipsawed – they would be forced to recognize the gambling income, but would receive no benefit from the losses.

Section 162, however, generally allows a deduction for “all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.”

Putting these two provisions together, many bettors have taken the position that if their gambling activities are so frequent, continuous and substantial as to rise to the level of an unhealthy addiction a Section 162 trade or business, then gambling losses are deductible as Section 162 business expenses, and are not subject to the loss limitations imposed by Section 165(d). In their view, if the gambling activity constitutes a business, because the losses (along with the gains) should be reported on Schedule C, rather than itemized deductions, the losses should be permitted in full.

The courts have repeatedly shot this theory down, holding that even a professional gambler who properly reports his activity on Schedule C may only deduct losses to the extent of gains.

In a very important 2011 decision out of the Tax Court, however, the court held that while gambling losses are limited to the extent of gambling winnings, any non-loss expenses of a professional gambler engaged in a trade or business – items like automobile expenses, travel, subscriptions and handicapping data – are not subject to the Section 165(d) limitation. Thus, a professional gambler could reduce his winnings to zero by his losses, and then further deduct any non-loss business expenses, generating a net loss from the activity. (See Mayo v. Commissioner, 136 T.C. 81 (2011).)

And that brings us back to our gambling CPA.  In Lakhani v. Commissioner, 142 T.C. 8 (2014), settled yesterday, an accountant/prolific track bettor made the compelling argument that his portion of the track’s “takeout expenses” represented non-loss business expenses rather than gambling losses, and were thus deductible without limitation. The taxpayer posited that by extracting takeout from the taxpayer’s wagers and using those funds to pay the track’s operating expenses, the track was acting in the capacity of a fiduciary. The taxpayer further likened the process to that of an employer who collects payroll taxes from his employees and remits them to the IRS and state agencies. Stated in another manner, the taxpayer argued that he was paying the operating expenses of the track, with the track acting as a conduit by collecting the takeout and using the funds.

Based on this position, the taxpayer argued that he was entitled to non-loss gambling business deductions in excess of $250,000 between 2005 and 2009.

The IRS disagreed with the taxpayer’s argument, countering that because the takeout is paid from the pool remaining from losing bets, “it is inseparable from the wagering transactions,” and thus constitutes wagering losses that are subject to the limits of Section 165(d). Furthermore, the Service argued that the taxpayer could not deduct business expenses for amounts paid from the takeout by the track for taxes, fees, and licenses, etc… because these were expenses owed by the track, not the individual bettor.

The Tax Court sided with the IRS, holding that the taxpayer’s share of the takeout expenses represented wagering losses that could only be deducted to the extent of winnings under Section 165(d). In reaching this conclusion, the court differentiated between an employer remitting payroll taxes on the behalf of an employee and a track using takeout funds to pay its operating expenses.

The employee, the court stated, is ultimately responsible for his share of the payroll taxes on his wages, and it is the remittance of these taxes by the employer that discharges the employee of this obligation. To the contrary, at no point are the expenses of the track imposed on the individual bettor; they are always obligations of the track. The tracks use of the takeout to pay its expenses, the court stated, does not discharge any obligation of the bettor.

As a result, the court concluded that because the track’s expenses were never an obligation or expense of the bettor, the takeout could not qualify as the bettor’s business expense. Instead, the takeout represented an additional gambling loss by the taxpayer, and could only be deducted – when added to his other losses – to the extent of his winnings.

follow along on twitter @nittigrittytax

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In celebration of both 150 years of tax law and graphics crammed with too much information, enjoy this little number put together by Turbo Tax.  Noticeably absent from the listing: March 2, 1928: the date Tom and Mary Hardwick from Lake Oswego, Pennsylvania deducted $80 of charitable contributions they never actually made and got away with it.  A dark day for the U.S. tax regime, indeed.


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Last week, in our reactions to President Obama’s proposal for corporate tax reform, we took special note of the president’s continued push towards a  “worldwide” international tax system; one  that greatly expands the reach of the U.S. in taxing non-U.S. sourced income earned by foreign subsidiaries.

Most notably, we highlighted just how dramatically the president’s proposal deviates from those posited by the leading Republican candidates, who favor the “territorial” systems adopted by much of the developed world.

But what do “worldwide” and “territorial” international systems really mean? How do they compare to our current system? And more importantly, how would they change the way the U.S. currently taxes the icnome earned by foreign subsidiaries of domestic corporations?

To illustrate, let’s take a simple fact pattern:

X Co. is a U.S. corporation. X Co. owns 100% of Foreign Co., a foreign corporation that generates no revenue from U.S. sources.

How is Foreign Co.’s income taxed by the U.S. under either:

1) The current “deferral” international tax system?

2) The “territorial” tax system proposed by Mitt Romney and Newt Gingrich?

3) A more expansive “worldwide” tax system as proposed by President Obama.

Current  “Deferral” Tax System

Under the current system, there is generally no U.S. tax imposed upon the earnings of Foreign Co. until the earnings are repatriated to the U.S through a distribution to X Co. At that point, X Co. will pay U.S. tax on the dividend received from Foreign Co., subject to any tax treaty between X Co. and Foreign Co.’s resident nation.

Upon receiving the dividend, X Co. is permitted to utilize a foreign tax credit to reduce the U.S. tax applied to the dividend, preventing the same income from being taxed twice: once when earned by Foreign Co. and a second time when distributed to X Co.


  • The current “foreign tax credit” system ensures that even where Foreign Co. enjoys a lower tax rate in its home nation, tax will ultimately be imposed on the earnings of Foreign Co. at the U.S. corporate rate;
  • U.S. tax is not imposed upon income earned by F Co. until the earnings are repatriated to the U.S.


  •  An administrative nightmare;
  • Encourages X Co. to leave Foreign Co.’s profits offshore to avoid the imposition of U.S. taxes upon repatriation;
  • Gives birth to a wide variety of accounting tricks and sophisticated tax planning measures employed to minimize the U.S. tax burden, which ultimately reduce U.S. tax revenue.

Territorial Tax System

Under a territorial tax system, U.S tax would never be imposed on income earned by Foreign Co. from non-U.S. sources. The U.S. would simply allow Foreign Co.’s home country to tax its earnings. When Foreign Co.’s earnings are subsequently repatriated to X Co., the dividends would not be subject to U.S taxation.  


  • Greatly reduces the complexity of international taxation;
  • Eases the administrative burden on multinational corporations;
  • By eliminating the U.S. tax on repatriated foreign earnings, U.S. companies will no longer have to pay to bring overseas income “home,” thus encouraging investment in the U.S.


  • Encourages U.S. corporations to shift activities to jurisdictions with lower corporate tax rates, taking jobs and revenue along with them and eroding the U.S. tax base.
  • Transition concerns; What do you do with the foreign income that was previously earned but not yet repatriated to the U.S.?  

A More Expansive Worldwide Tax System

President Obama is proposing a sea change in the way the U.S. taxes international operations; one which embodies the opposite characteristics of the system proposed by his Republican counterparts. The president would eliminate the current laws that permit domestic corporations to defer U.S. tax on Foreign Co.’s earnings until they are repatriated by instituting a worldwide minimum tax. This tax would be imposed on Foreign Co.’s income when earned, regardless of whether it was U.S. sourced or when it is repatriated.


  • More tax revenue for us!
  • Does not distort the decision of where to invest.
  • Eliminates incentive to game the system, since the U.S. will tax Foreign Co.’s earnings, wherever they may be.


  • Makes the existing administrative nightmare even worse;
  • I’m not sure if this is a pro or con, but it is the opposite system that much of the developed world is adopting, potentially putting us at a competitive disadvantage.
  • Is sure to be highly opposed by powerful corporations that have successfully shifted much of their earnings overseas under the current regime.

Which system is the best? It’s nearly impossible to say at this point, because under no scenario would the U.S. adopt a pure territorial or worldwide international tax system. Any territorial system would have to adopt elements of a worldwide system to curb abuses, and vice versa. As indicated above, there are advantages and disadvantages to each of the options, and ultimately, the devil will be in the details.

This much is clear, however; the chasm that exists between the proposals fronted by President Obama and the Republican candidates is material and meaningful, and stands to garner more attention as November nears.

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Certain things, while having the look, sound, and even feel of illegality, are actually within the confines of the law, like cock-fighting, marrying a step-sister, or killing a hobo for sport. Wait…what? OK, scratch that last one. But you get the idea. The law is complicated and convoluted, and what separates the guilty from the accused is often times attributable to puzzling semantics.

Consider this recent Tax Court case, in which an air conditioning technician, despite conducting a pattern of behavior that any reasonable person would coin corporate fraud, successfully avoided over $260,000 in penalties courtesy of the specific nuances of the tax law.  

Paul Avenell (Avenell) owned 96% of a corporation (Tacon). Tacon was sued, lost, and as a consequence, owed significant sums to a former subcontractor. Believing the verdict to be unjust, Avenell filed for bankruptcy and began to divert funds away from the corporation so they couldn’t be accessed by his creditor. As checks came in, he would exchange them for cashier’s checks, which were used to pay both corporate and personal expenses. As a result, the income was never recorded inside Tacon. The IRS assessed tax deficiencies, as well as substantial fraud penalties.

Despite his subversive behavior, the court found that Avenell had not committed tax fraud, because his concealment of income was done with the intent of avoiding judgment collection, rather than with the specific purpose of evading income tax.

Respondent infers that petitioner intended to evade taxes by exchanging general contractor’s checks for cashier’s checks and using those funds for personal purposes, including making a personal loan and opening a Cayman Islands bank account. Respondent further infers fraudulent intent from petitioner’s purchases of real estate in others’ names. Piling inference upon inference, however, does not qualify as clear and convincing evidence.  His inferences fall short of the required proof of fraud by clear and convincing evidence. We cannot conclude that petitioner’s delusive behavior was part of a deliberate scheme of fraudulent tax evasion. Petitioner credibly testified that he refused to deposit funds into Tacon’s account to avoid the judgment collection. The timing of petitioner’s delusive behavior involving cashier’s checks, the Cayman Islands bank account, real property purchases and the personal loan is consistent with that of Grant Metal’s judgment. We do not condone petitioner’s efforts to avoid judgment collection. We also do not find, however, that his actions were done with the intent to evade tax.

Because the underlying tax deficiencies were assessed more than three years from the date the tax returns were filed, the failure of the IRS to prove fraud — which would have extended the statute of limitations indefinitely — permitted Avenell to avoid the assessed tax in addition to the dismissed fraud penalties.

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A few things you may have missed this weekend while getting caught up in the Linsanity in New York:

Bad news for a lot of the country this week. Forbes reported that IRS agents are currently auditing one out of every eight millionaires. Things aren’t any better for the middle class, either, where 30 million taxpayers will pay alternative minimum tax (AMT) this year. The only winners were the very poor, who courtesy of Mitt Romney, learned that there’s a “safety net” in place to protect them. Romney wasn’t kind enough to disclose the location of said net, but I’m sure the poor appreciated the heads-up nonetheless.

IRS computers sent off a letter to a British Lord indicating he owed $13 million in taxes, penalties and interest. The Lord offered to ship Arsenal star Thierry Henry back to the U.S; “call it even.” [i]

You’re in Good Hands With Allstate. Unless Allstate is your employer, that is. In that case, you’re screwed.

The only thing standing between you and an extra $1,000 in  payroll tax savings is bipartisan agreement. Of course, since at this moment in our country’s history Republicans and Democrats can’t agree that water is wet, I wouldn’t go spending that money just yet.

Last week, I neglected to discuss the promulgation of proposed Foreign Account Tax Compliance Regulations (FATCA) regulations, largely because they’re longer than the Old Testament. To summarize, however, it’s another big step towards combating non-compliance by U.S. taxpayers using foreign accounts.

If you’re a product of the 80’s, as I am, then I dare you to find a better way to waste seven minutes of your life than this video. Long live Johnny Lawrence.

[i] Not an actual offer.

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If you’re nearing retirement age, I’m hoping you’ve spent your entire career socking away money into a 401(k) fueled by sound, cautious investment decisions, steering clear of the risky, get-rich-quick options favored by my generation.    

/Shakes fist at jar of magic beans on dresser

But while you’re kicking back and enjoying the fruits of your labor, be warned that your tax troubles aren’t over. Properly reporting the taxable portion of your retirement proceeds has become increasingly challenging, often causing taxpayers to unknowingly understate taxable income.

In a report issued this week by the Treasury Inspector General for Tax Administration (TIGTA), it was disclosed that the IRS has estimated that underreported retirement income added $4.2 billion to the tax gap in 2001.

There is tremendous motivation for the IRS to take steps to increase compliance, as the amount of retirement income reported annually is staggering. In 2008 and 2009, taxpayers filed approximately 21 million tax returns with taxable IRA income totaling $293 billion and approximately 52.2 million tax returns with taxable pension income totaling $1 trillion.

To catch underreporting with minimal manpower, the IRS uses its Automated Underreporter (AUR) Program to match amounts reported on Form 1040 to what was reported as paid to taxpayers from third parties such as employers, banks, brokers, and other financial institutions on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. If a mismatch is identified, the IRS issues a notice to inform the taxpayer that he may have underreported income. For  2007,  AUR Program examiners made tax assessments totaling approximately $607.5 million on 217,811 tax returns.

Despite the success of the AUR Program, the TIGTA report concluded that compliance could still stand to improve, citing the complexities taxpayers face in properly reporting the information disclosed on Form 1099-R:

We determined taxpayers receive Forms 1099-R from payers with the following contradictory or confusing information regarding the amount of taxable retirement income to put on their tax returns:

• A Form 1099-R with a taxable amount but also having the box checked indicating the “taxable amount could not be determined.” For some retirement income plans, the Form 1099-R instructions require the payer to complete the form in this manner. Our  analysis of 14.9 million Forms 1099-R with a distribution identified 11.5 million  (77.2 percent) that had taxable amounts totaling $107.5 billion, but the taxable amount not determined box was checked.

• A Form 1099-R with a gross distribution amount but the taxable amount was left blank. Our analysis of 14.9 million Forms 1099-R with a distribution identified 3.4 million (22.8 percent) had gross distributions totaling $67 billion, but the taxable amount was left blank.

To resolve these issues, the TIGTA report made the following recommendations:

1) Revise the Form 1099-R to clarify the meaning of the” taxable amount not determined” box in order to reduce taxpayer confusion, and

2) Include the dates needed to identify retirement savings program distributions that were not rolled over within the required 60 days.

The IRS agreed with the report’s first recommendation and plans to revise the instructions to Form 1099-R to clarify taxpayer responsibilities and the amounts to report. With regards to the second recommendation, the IRS plans to consider the feasibility and the benefits of including the dates of distributions and their respective contributions to identify distributions not rolled over within 60 days, but as of now, no changes are planned.

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Substantiation is a critical component of any tax deduction. In order to withstand an IRS challenge, it’s essential that a taxpayer maintain sufficient records to support their claimed deductions. And while the statute requires varying degrees of substantiation for different types of expenses, some simple universal truths apply to all deductions:

  • The burden falls on the taxpayer to substantiate the expenses; the IRS is not required to prove the expenses didn’t happen.
  • The fact that an expense was reported on a prior year return and created a net operating loss does not in itself substantiate those deductions. Tax returns are not substantiation.[i]
  • While the Cohan Rule[ii] permits the IRS to estimate a taxpayer’s deductions in the absence of the required substantiation, the IRS can’t do so if it has no reasonable way to approximate the expenses. In other words, you’ve got to be able to show the IRS something.

Failure to heed these rules can quickly lead to an adverse IRS exam or court decision, as one Maryland couple found out yesterday in a decision chock full of  perverted/litigious/murderous goodness:

Steven Esrig (Esrig) and his wife failed to timely file their tax returns from 1998 through 2003, and when they finally got around to it, they claimed significant deductions including net operating loss carryovers, business losses, and office expenses.   

Citing a lack of substantiation for all of the claimed losses and expenses, the IRS disallowed the deductions and assessed over $700,000 in additional tax for the six-year period, along with substantial late filing penalties.

In his defense, Esrig argued that he kept adequate records for his business expenses, though he never actually produced any of them at trial. Thus, it was left to the Tax Court to determine whether Esrig’s oral testimony constituted sufficient substantiation for his claimed deductions, and in order to do so, the court first had to gauge his credibility. As you’ll soon see, this is where things started to go bad for Steven Esrig:

Esrig liked to refer to himself as an “entrepreneur.” Now while normally, calling oneself an entrepreneur is simply a pleasant alternative to calling oneself  “unemployed,” in this case it appears Esrig truly was an innovative visionary along the lines of Steve Jobs. Behold:

Steven told us at trial that he got the idea for the company after an incident involving one of his children. Apparently, his then-five-year-old child asked to look at the Power Rangers website.  Steven logged on but inadvertently mistyped a character in the web address. Instead of getting the Power Rangers website, up popped a seriously pornographic one. This, he told us, was the reason he started Stelor, a company he claims invented a technology that protects children from predators and pornography and “shuts down identity theft.”

Esrig then also laid claim to inventing quotation fingers, the tankini, Jack and Cokes, and raccoons. [iii]

For obvious reasons, the court wasn’t buying Esrig’s story, its doubts prompting it to ask the logical question, “How could a company with such a multifaceted wonder product fail to achieve any level of success?”

Steven told us that the company failed because it “ran into some litigation” after it bought the domain name “googles.com” from someone who had it before Google. This, he said, led to five or six years of litigation with Google and ultimately bankrupted his company.

Now that’s a tough break. Who would have guessed that poaching a domain name from the world’s largest tech giant would lead to costly litigation? It almost makes me wonder if my recent decision to purchase the web address “Facebulk.com” to promote my Aspen Lip Collagen Clinic was not the best of ideas. 

With Esrig’s credibility irreparably tarnished, the Tax Court had no choice but to side with the IRS, denying the disputed expenses in full, including the $17,700 Section 179 deduction Esrig claimed for the cost of a fish tank and dining room furniture.

There was still the matter of $180,000 in penalties, however, which would be added to Esrig’s bill unless he could convince the court that the late returns and large underpayments were not his fault:

At trial, Steven blamed the couple’s return preparer. He said that he’d asked his accountant to request extensions for all the years at issue, but his accountant missed all the deadlines because she had to serve a very long prison sentence for murdering her husband, and the person in her office who took over their account made a slew of mistakes.

Call me a softie, but if your CPA going on a killing spree isn’t “reasonable cause” for late filings, then I’m not sure what is.  But the Tax Court — likely tired of listening to Esrig’s various yarns and unable to differentiate truth from fiction —  failed to share my sympathy, upholding the full amount of the penalties.  

[i] See Lawinger v. Commissioner, 103 T.C. 428 (1994).

[ii] Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

[iii] May not have happened.

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