Referrals/Leads Group is Not a Tax Exempt Entity

In Private Letter Ruling 200709070 the IRS recently held that Exceptional Organizations, a standard referrals/leads group, did not qualify as a tax exempt “business league.” This ruling presents a good opportunity to review a few of the requirements to qualify as a tax-exempt “business league.”

A “business league” is an association of persons having a common business interest, whose purpose is to promote the common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. Its activities are directed to the improvement of business
conditions of one or more lines of business rather than the performance of particular services for individual persons.

The Treasury Regulations set out the following specific requirements:

1. It must be an association of persons having some common business interest and its purpose must be to promote this common business interest;
2. It must be a membership organization and have a meaningful extent of membership support;
3. It must not be organized for profit;
4. No part of its net earnings may inure to the benefit of any private shareholder or individual;
5. Its activities must be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons;
6. Its primary activity does not consist of performing particular services for individual persons; and
7. Its purpose must not be to engage in a regular business of a kind ordinarily carried on for profit, even if the business is operated on a cooperative basis or produces only sufficient income to be self-sustaining.

According to the IRS, Exceptional Organizations referral group did not qualify as a “business league” because its activities did not improve the business conditions of one or more businesses, its primary activities consisted of providing services for particular persons, and it was engaged in a regular business of a kind ordinary carried on for profit.

The IRS focused on the following facets of this referral/leads group: it restricted its membership to individuals or firms in different trade, businesses, or occupations who do not compete with each other; its primary purpose was to provide exclusive listings (or referrals/leads) to its members; and the group did not do anything to help business conditions outside of helping their own businesses.

So what could the referral/leads group have done different that might have qualified it for not-for-profit status? Perhaps it could have segregated its activities into for-profit and not-for profit activities and operated two separate business enterprises for each activity; perhaps it could have promoted business ethics to members or required its members to promote business ethics outside of the group in an effort to help business conditions outside of helping individual member business; and perhaps it could open multiple chapters so that members from competing trades or businesses could participate while still maintaining the integrity of the referral/leads group.

March 2nd, 2007 | No Comments »

Courts Should Not Rely on Information from the Wikipedia

The Wikipedia is a popular internet encyclopedia that is written and edited online by anonymous individuals. As the popularity of the Wikipedia grows, so too does the perception that the Wikipedia provides accurate and reliable information. For instance, the United States Tax Court cited the Wikipedia today in its Ferguson v. Commissioner opinion. As the title of this post indicates, I personally do not think that the tax court – or any other court – should rely on information found in the Wikipedia.

In many cases judges are permitted to take (judicial) notice of facts that are generally known to the public, if the facts are not in dispute and, in some instances, where the facts are readily ascertainable by accurate and reliable sources. Much (if not all) of the information contained in the Wikipedia does not appear to meet these guidelines.

It appears that very little of the information contained in the Wikipedia consists of “facts.” The term “fact” generally refers to a concept that can be proved. Therefore a concept is only a “fact” if it can be verified by a credible outside source. Because the Wikipedia is authored and edited by anonymous individuals who have their own agendas and shortcomings, much of the Wikipedia content cannot be verified by credible outside sources. In many instances, Wikipedia content cannot be verified at all or, if verifiable, the content is incorrect or outdated.

In addition, much of the Wikipedia content is not generally known to the public. The Wikipedia is replete with obscure articles on items that are certainly not known to the general public (If much of the content were generally know to the public, then the content might not need to be included in the Wikipedia in the first place).

Few would refer to the Wikipedia as “accurate and reliable,” since individuals often use the Wikipedia to further their own personal and profit objectives and individuals who write and edit the majority of the Wikipedia articles usually have no specific knowledge of or expertise in the given subject matter (it appears that much of the Wikipedia content is obtained by individuals who illegally copy information from private websites and/or paste together snippets of content from numerous websites – many of which contain in accurate, dated, and obsolete content).

A simple Goolge search – no less accurate I suppose – reveals thousands of complaints of incorrect Wikipedia articles, ranging from Wikipedia articles that falsely indicate that a particular person assassinated JFK to Wikipedia articles that say that someone’s deceased parent was considered a God in several foreign countries.

Because of these shortcomings, it appears that courts may only be able to cite to the Wikipedia for facts that are not in dispute and facts that are so remote that they would not impact the court’s decision. Even then, reliance on this highly suspect material may present problems for the courts.

For example, a court that relies on the Wikipedia for “facts” may give the non-prevailing party a valid excuse to have the courts decision overturned on appeal (perhaps because the Wikipedia “facts” were not admitted into evidence, the party was not given the opportunity to consider and object to the Wikipedia “facts,” or, I presume, in most cases the specific author(s) would not be in court to support their out of court Wikipedia statement of “fact,” or the non-prevailing party may be able to successfully argue that any bias or fallacies evidenced in the Wikipedia article was imputed to the judge who relied on the article). If that is not bad enough, reliance on the Wikipedia by courts may encourage individuals to author and/or edit Wikipedia articles to further their own positions, thereby undermining judicial process.

While other commentators have expressed favorable opinions of courts relying on the Wikipedia, I do not share that opinion.

February 28th, 2007 | No Comments »

Health Reimbursement Arrangements: Employer-Provided Medical Coverage

The business enterprise presents taxpayers with numerous tax planning opportunities. Many of these tax planning opportunities include pulling money out of the entity in a way that benefits both the business and its owners and employees on an after-tax basis. As with employer-provided education benefits, employers may be able to minimize their tax obligations by reimbursing employees for employee medical costs.

A health reimbursement arrangement (HRA, or “health reimbursement account”) is simply a pool of money set aside by an employer to reimburse employee and retired employee medical costs or to pay employee insurance premium costs.

If the HRA is structured right, the funds paid to employees are not taxable to the employee (as confirmed in Private Letter Ruling 200708006) and the costs are deductible by the employer (as an ordinary and necessary business expense).

Unlike Heath Savings Accounts (HSAs), employees are not permitted to contribute to the HRA, the HRA remains with the employer after the employee leaves the company, employees are not required to be covered by (or pay for) an insurance plan, and HRAs are open to employers of all sizes (in contrast to the small business requirement for HSAs). Moreover, HRA employer contributions are not mandatory and HRAs are not necessarily subject to some of the self-dealing and discrimination rules imposed on other tax-favorable arrangements.

In addition to these benefits, HRAs, in theory, motivate employees to remain with the employer. HRAs may also motivate employees not to take excessive sick leave or vacation days, because employers can structure the HRA to contribute an additional amount to the HRA based on unused sick and vacation days. HRAs can also result in substantial savings to the employer and employee as direct payments are often less expensive than insurance premium payments.

HRAs are yet another option available to employers that may allow the employer to expand their business and realize tax savings in the process. Employers should consult with their tax attorney to determine whether a HRA is right for their business.

February 25th, 2007 | No Comments »

Tournament Poker Accorded Same Tax Treatment as Live-Action Poker

Today, in Tschetschot v. Commissioner, the tax court ruled that taxpayers where not entitled to treat tax losses from tournament poker different than tax losses from live-action poker.

In the Tschetschot case the taxpayer had earned $49 thousand dollars from her day job and $11 thousand dollars from gambling. The taxpayer claimed a $29 thousand dollar loss, which offset all of her $11 thousand dollar gambling winnings and part of her $49 thousand dollar income.

On audit, the IRS denied all of the taxpayer’s gambling expenses (before the tax court litigation commenced, the IRS attorney conceded that the taxpayer was entitled to deduct losses in an amount up to her gambling winnings).

The issue before the court was whether tournament poker is a “wagering activity.” The taxpayer argues that tournament poker is not a wagering activity, rather, it is an “entertainment and professional sport.” The taxpayers based their position on the argument that tournament poker is different than regular poker becuase the game only requires an entry fee, the game lasts several days, and the winner is accorded part of the entry fee paid by other contestants. As can be expected, the IRS disagreed.

Since the applicable tax code section and regulations do not define “wagering activity,” the tax court applied the plain meaning of the term “wager” (the court used the Random House College Dictionary this time, instead of the more commonly used Merrim-Webster Dictionary).

The definition of “wager” used by the court was “something risked or staked on an uncertain event” or “a bet.”

In applying the definition of the term “wager,” the tax court concluded that tournament poker was a “wagering activity.” The court reasoned that the context in which the game is played (i.e., as a paid sporting event or in a tournament setting) does not negate that the transaction involves a “bet.” Because there was a “bet” involved, the court held that the taxpayer’s taxable gambling losses were limited to the taxpayer’s gambling winnings (much like the hobby loss rules).

Applying the court’s “bet” analysis it appears that expenses associated with a 100% advertiser-paid poker event would result in the contestant’s expenses being allowed (but limited) to their poker earnings – even though the contestants did not put any money into the endeavor in order to participate — in tax terms, the contestants would not have any burden or economic risk (but they may have incurred other significant expenses, such as travel and room and board).

Similarly, applying the court’s “bet” analysis, it appears that losses associated with a documentary film production that filmed a poker tournament could even be limited becuase they would constitute a “wagering activity.”

Another way for determining what is and is not a “wagering activity” might include whether the taxpayer put any money into the game in order to participate and possibly win (i.e., a focus on the first part of the court’s dictionary definition, rather than on the second part).

The court probably did not want to focus on this analysis because it could present a number of tax planning opportunities for taxpayers.

For example, taxpayers could structure these tournaments so that the entry fees are allocated 100% to the administrative fees to carry out the operation (i.e., paying the dealers and for the electricity, rent, etc.) and having the host company put up the funds to pay the winners (in a way to avoid the step-transaction doctrine, possibly by having the host company maintain a continual pool of funds for multiple tournaments) or taxpayers could pool their monies in a partnership and then have the partnership compensate members based on the amount of services that each partner provides (i.e., the partners that last longer or win more hands provide more services and are entitled to get paid more).

Of course, these options would raise a whole host of other tax issues (and tax planning opportunities)….

February 20th, 2007 | No Comments »

Automoble Dealerships Present Unique Challenges for the IRS

Automobile dealerships and other significant cash-based businesses pose a number of problems for the IRS and tax fraud (and, indirectly tax planning) opportunities for taxpayers. Chief Counsel Advice Memorandum 200707001 provides an example of a few of these problems and tax fraud opportunities.

This Advice Memorandum addresses whether payments to the automobile dealer’s bank account by an independent contractor salesman that exceed $10,000 must be reported on Form 8300 (The facts in the Advice Memorandum propose that the independent contractor salesman’s deposit consisted of $6,000 of cash and $4,500 via a cashier’s check).

Form 8300 is the Form designated by the IRS for business owners to report the receipt of cash payments in excess of $10,000. This form makes it possible for the IRS to track substantial cash payments made to cash-based businesses. It is hoped that by being able to track these payments, the IRS will be able to ensure that the payments are reported to the IRS by the taxpayer and that the taxpayer ends up paying tax on the income.

This Advice Memorandum opines that an automobile dealer does not have to report amounts deposited by an independent contractor salesman to the automobile dealer’s bank account, because the governing tax law provision only applies to cash that is received “directly.” Thus, deposits to the automobile dealer’s bank account are not deemed to be received “directly” and, therefore, they are not required to be reported on Form 8300.

Under this ruling, it appears that the salesman could deposit any amount into the automobile dealership’s bank account and the automobile dealership will not have to report its receipt on Form 8300. That leaves open two questions: (1) does the bank have to report the deposit and (2) does the independent contractor have to report the deposit? The Advice Memorandum addresses the first question, but not the second.

The Advice Memorandum concludes that the bank would not have to report the deposit because there was no cash payment in excess of $10,000 (Under the facts, there was only a $6,000 cash payment and a $4,500 cashier’s check payment – which does not qualify as “currency”).

What the Advice Memorandum does not address is whether the independent contractor salesman must report the amounts he received from the person who purchased the vehicle. The answer seems to be “probably not,” because the monies did not belong to the salesman.

The question would be a bit trickier if (1) the cash received exceeded $10,000 and(2)(a) if the independent contractor salesman were really an employee and not an independent contractor and, if so, (b) if the salesman removed enough of the $10,000 cash payment as a commission to himself to reduce the payment below the $10,000 threshold.

In the first hypothetical it appears that the independent contractor may not have to report the payment, as he would merely be a conduit through which the monies pass to the automobile dealer’s bank account. In other words, state law and/or the business contractual arrangement may not afford him sufficient rights in those payments such that the independent contractor “received” the proceeds.

With the second part of the hypothetical it appears that payment to the employee would in fact be “received” by the automobile dealership, which would require the automobile dealership to report the cash receipt.

On the other hand, the answer is much less clear if the employee salesman has the ability to remove his commission prior to turning the proceeds over to the automobile dealership, assuming that the commission were large enough to reduce the cash payment below the $10,000 threshold. This would probably require the business contract between the dealership and the customer to set out what part of any cash payment is going to the dealership and what part is going to the salesman (even then, the IRS would argue that the employee salesman was also really a partner in the automobile dealership, making such payments be deemed received by the automobile dealership).

There is little doubt that automobile dealerships are particularly problematic for the IRS, especially since the number of used car sales is substantial and the money limits associated with most used car sales probably fall just above or under the $10,000 threshold.

Automobile dealerships are also a problem for the IRS as they are in the position to aggressively structure their financial affairs to take full advantage of these opportunities (one only has to think of the third party financing and other loans to start thinking of the possibilities — such as tax refund loans).

In an era of increased IRS enforcement, I bet we start to see an increasing number of IRS challenges to how automobile dealerships structure their financial affairs. Automobile dealerships should have an experienced tax attorney review their financial arrangements to help ensure that they are compliant with our tax laws.

February 17th, 2007 | No Comments »

Tax Court Small Tax Case Procedures Do Not Apply to All Tax Cases

Tax procedure, especially tax court procedure, can produce some strange results. Today’s Schwartz v. Commissioner case provides a good example of this.

The Schwartz case involves a taxpayer who, without the assistance of a tax attorney, petitioned the tax court to contest the government’s determination to proceed with collections. The taxpayer asked the tax court to conduct the tax case using the small tax case procedures.

The small tax case procedures provide relaxed evidentiary rules for tax litigation cases where the unpaid tax liability is under $50,000. The downside to the small tax proceedings (if you are the losing party) is that cases tried under the small tax case procedures cannot be appealed by either party.

In the Schwartz case the tax court looked at the different language employed by subsections (a) and (f) of IRC Section 7463. Basically these two code sections specify that the tax court has the ability to hear a tax matter using the small tax case procedures (1) for deficiency cases if the unpaid tax is less than “$50,000 for any one taxable year” and (2) for tax redetermination cases if the total unpaid tax is less than $50,000.

Deficiency cases are tax cases where taxpayers challenge the tax liability (usually because of a defect in the IRS notice of deficiency) and redetermination cases, like the Schwartz case, are tax cases where taxpayers challenge the IRS decision to proceed with collections (usually because the IRS hasn’t complied with the required collection procedures).

Both the taxpayer and the IRS consented to the tax court using the small tax case procedures. However, the tax court concluded that it was not able to hear this case using the small tax case procedures because the case was a redetermination case (not a deficiency case) and the total tax for all of the tax years involved exceeded the $50,000 limit (although the tax for any one tax year did not exceed this amount).

The court points out that neither the IRS nor the taxpayer argued that “a literal application of section 7463(f)(2) produces an absurd result, and it is certainly not unreasonable for Congress to have articulated different dollar thresholds for different types of cases.”

My reading of the rules leads me to believe that the literal interpretation could in fact lead to an absurd result.

Imagine a taxpayer wants to bring both a redetermination claim and a deficiency claim in a case where the amounts in dispute are similar to Schwartz, i.e., the tax liability for each individual year is under $50,000 but the total tax for all tax years exceeds $50,000.

The Tax Court Practice and Procedure Rules specify that taxpayers can bring to separate claims in one tax court petition (Rule 31(c) specifies that “A party may set forth two or more statements of a claim or defense alternatively or hypothetically” and “A party may state as many separate claims or defenses as the party has regardless of consistency or the grounds on which based”).

Taxpayers who do not hire a tax attorney to assist them may end up checking both the “lien and levy” box and the “redetermination of deficiency” box on the tax court’s sample small tax case tax petition form that is available on the tax court website (perhaps the tax court should amend or footnote this sample form).

If a taxpayer did bring both claims and the claims are joined in one case, then, according to the court’s ruling, one of the taxpayer’s claims would be heard under the informal small tax case procedures and the other claim would be heard under the normal tax court procedures. It seems that this would require the tax court to split the case into two separate hearings (and separate pleadings may be necessary), one hearing being formal and one being informal.

Moreover, the non-prevailing party – be it the taxpayer or the IRS – would only be able to appeal the tax court’s determination for the deficiency claim and not the redetermination claim.

As a result of today’s ruling, taxpayers who have tax liabilities under $50,000 for any one tax year will not want to consolidate multiple tax years in one petition if that would result in the overall tax liability exceeding the $50,000 limit – assuming that they want to use the small tax case procedures and they are filing a redetermination claim.

This puts taxpayers in the position of having to figure out if not bringing a claim for one or more tax years could be problematic for them or if they should contest the government’s request to consolidate claims.

Having taxpayers figure out whether they should file separate petitions is wasteful and the result of filing both claims in one petition could produce absurd results.

I, personally, think the court should have exercised its discretion to overrule the express language in the statute in this case as this issue directly impacts the courts ability to carry out its judicial function.

I am not persuaded that the legislature intended to create this disparate treatment for these two types of claims. I am more inclined to believe that it was a Congressional oversight (although, I have not pulled the legislative record to verify this – assuming that one even exists for this issue).

February 14th, 2007 | No Comments »

Common Small Business Tax Trouble: Hobby Losses

It is important for self-employed taxpayers to think about some of the more typical business tax problems given the Jones v. Commissioner provides an example of one of these common business tax problems, namely, the hobby loss tax rules.

Jones was employed full-time at an airport. In mid-2002 Jones attended a motorcycle riding course and he then purchased a motorcycle. Jones claimed that he began operating a motorcycle riding course business on his 2002 tax return. Jones’ tax return showed income from this activity of about $400 and expenses of about $8,000 (most of which was depreciation, probably for his motorcycle).

Apparently Jones was not able to produce records establishing that two clients paid him approximately $400. In addition, Jones did not prepare a business plan (with financial projections), he did not keep a separate bank account for the business, and, perhaps most damming of all, Jones employed a suspected tax shelter promoter (Daniel Gleason of “My Tax Man, Inc.”) to prepare his tax returns.

This case provides a good example of what not to do in operating a business. Taxpayers are well advised to follow the formalities of a business to obtain the benefits of operating in a corporate capacity, regardless of the tax consequences. Specifically, taxpayers should prepare a business plan (with financial projections), form a separate legal entity, maintain a separate business checking account, document items of income and expense, and, most importantly, use a reputable tax advisor.

Business owners should also use extra caution if their business will produce a loss for one or more tax years and, especially, if the business operations have some fun or pleasure aspect (such activities often include sports cars, works of art, horses or other livestock, or, as in this case, a motorcycle).

While it is okay (from a tax perspective) for a business to generate a loss, taxpayers should prepare to defend their loss if the IRS opts to audit the taxpayer’s tax return. If this is a concern, a more conservative approach would be to only claim losses up to the amount of the business income for any one tax year. Had Jones taken this position, he probably would not have had to litigate this type of tax matter.

February 13th, 2007 | No Comments »