December 2011 Archives

December 28, 2011
Posted by Sanger & Manes, LLP

California Taxpayers: Failed to File a Gift Tax Return for a Property Transfer to a NonSpouse Relative From 2005-2010? The State of California is About to Tell the IRS All About It

A district court has now granted the IRS permission to issue a summons to the State of California Board of Equalization, as part of a gift tax enforcement initiative to detect transfers of real property between nonspouse relatives that weren't reported on gift tax returns. California now joins Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin, as states where the state governments must turn over records about property transfers to the IRS. If you transferred property to nonspouse relatives and did not complete the appropriate gift tax return, the State of California may be on the verge of telling the IRS all about you.

Gift Tax Background
Intra-family transfers of property are extremely common. Remember that in 2011, decedents can exclude up to $5 million of their estate before having to pay estate tax on the remainder. Likewise, in 2011 individuals can "gift" up to $5 million and not pay a tax on the gift amount (the Internal Revenue Code therefore "unifies" the estate tax and the gift tax.) However, any individual who makes gifts to any one donee during a calendar year above the $13,000 annual exclusion must file a gift tax return (an IRS Form 709). A return must be filed even if no tax is payable (due to the $5 million lifetime exclusion).

When the IRS issues a Summons to the State of California, what Information can it Gather about You?
With a summons served upon the state of California, the IRS can uncover transfers of real property to nonspouse family members. How? Property transfers in California generally constitute a "change in ownership" so that the county assessor may reassess a property for property tax purposes. Absent a change in ownership, the state may only increase a California property owner's taxes by 2% per year. In order to claim an exclusion from the change in ownership reassessment rule, California taxpayers must file Forms BOE-58-AH (Claim for Reassessment Exclusion for Transfer Between Parent and Child) or BOE-58-G (Claim for Reassessment Exclusion for Transfer Between Grandparent and Grandchild). These forms are filed with the local county assessor's office. California property owners are generally very diligent about completing these forms, because they do not want their property reassessed for fear of considerably higher property taxes. The state of California maintains a statewide database of the information garnered from these forms. And now the IRS has access to the Forms BOE-58-AH and BOE-58-G filed by California transferors of property (to relatives) seeking to avoid a reassessment of the property.

California tells the IRS of the Property Transfer, now the IRS is Looking for The Transferor's Form 709
The rest is relatively simple. The state of California allows the IRS to review the Forms BOE-58-AH and BOE-58-G, and the IRS simply follows up by seeing whether that individual completed a Form 709 (and paid gift taxes, if appropriate). IRS survey results concluded that at least 50% and up to 90% of individuals who transferred property to nonspouse family members failed to file a Form 709.

California residents- if you transferred property since 2005 to a nonspouse family member, and you should have filed a Form 709 and didn't (and didn't pay the appropriate gift tax, if any), go file it now. Because there is a very good chance the IRS is going to find this out anyway, and the penalties of their discovering your lack of compliance will be much worse if you have not already rectified the situation.

December 23, 2011
Posted by Sanger & Manes, LLP

Tax Court: Professional Gamblers Can Deduct More on Their Tax Return Than Recreational Gamblers

Visitors to the Coachella Valley often spend some time at our local casinos: such as the SPA Casino in Palm Springs or the Agua Caliente Casino in Rancho Mirage. When the gambler has a single win of at least $1,200, the casino is required by law to issue the big winner a W-2G, which notifies the IRS of the win (great, thanks a lot casino). The Internal Revenue Code does allow a taxpayer to deduct gambling losses from gambling winnings (but not below zero) on an annual basis, but as we've discussed before, proving gambling losses can be difficult. After all, unlike the big win, the casino never notifies the IRS when the gambler has a big loss. The IRS has traditionally accepted a daily log or journal kept by the taxpayer detailing the gambling activity of the day as proof of gambling losses, but how realistic is keeping a daily journal? In our high-tech modern era, the best evidence a taxpayer can use to show the IRS that he or she was, in fact, a big loser (and not a big winner) is the casino issued "players card". The card allows the casino to electronically track the individual's gambling winnings and losses. This serves as excellent evidence when proving gambling losses to the IRS. So gamblers, always get and use the casino issued player's card, because the day might easily come when you need to prove your gambling losses to the IRS.

Special Rules For Deductions of "Professional Gamblers"

As discussed above, the Internal Revenue Code permits individuals to deduct gambling losses to the extent of gambling winnings (but not below zero). But here we're talking about gambling loses (i.e., wagering losses). What about expenses incurred in gambling? Can an individual who gambles for a living deduct gambling expenses just like a regular business expense (the rest of us seem to be able to deduct our business expenses)? If so, does the amount of gambling winnings have any bearing on the amount of expenses the professional gambler may deduct?

The US Tax Court addressed theses issues in the recent case of Mayo v. Commissioner, 136 TC 81 (2011). In that case, the taxpayer in question was in the business of "gambling on horse races"(i.e., a professional gambler). Although a facts and circumstances test, a professional gambler is generally one who gambles for profit, and not for recreation. The taxpayer in the case had substantial losses from the gambling on races, but the taxpayer also had significant expenses associated with the gambling activity. Such "business" expenses included meals, telephone costs, horse racing periodicals and admission fees into the horse racing grounds. If the taxpayer were allowed to deduct his total gambling losses and expenses, the total deduction would, in fact, exceed his total gambling winnings on the year.

The Tax Court held that these amounts may be deducted by the professional gambler. So gamblers with heavy losses and expenses are far better off classifying themselves as professional gamblers than recreational gamblers. This categorization permits the individual to deduct gambling losses (up to the amount of gambling winnings, as with any gambler), and expenses associated with gambling (below the gambling winnings threshold...fantastic!).

December 19, 2011
Posted by Sanger & Manes, LLP

When Canadians Rent Out Their US Home, Do They Owe Tax in the US?

Let's take the case where a Canadian citizen is careful not to spend so much time in the United States so that he or she is not considered a US resident for tax purposes. Therefore this Canadian individual is not paying tax in the US on their worldwide income. This individual will still have to pay tax on their "US source income", and this will include rental income from their property owned in the US. So how will the US tax the Canadian citizen who owns property in the US and rents that property out, but otherwise does not spend too much time in the US so as to be deemed a US resident for tax purposes?
Taxation of Rental Income- General Rule
As a general rule, the Canadian who rents out their US property is subject to a 30% withholding requirement of the gross amount of each rental payment. In other words, the general rule on rental income is that 30% of each rental payment made to a Canadian-citizen landlord should be withheld, and forwarded to the IRS. Technically, it is the renter (likely a US citizen) who has the legal requirement to withholding from the rental payments made to the Canadian citizen-landlord. As a practical matter, the IRS will look to both the renter and the landlord for the withholding amount. To the extent the Canadian citizen hires a US property manager (extremely common for the Canadian snowbird), the property manager will be responsible for withholding on the rental amounts and remitting the tax to the IRS. Since the Canadian citizen must also report this amount on his or her Canadian tax return, a foreign tax credit on the Canadian tax return should be available for the US taxes paid, so this should not result in double taxation.
Electing to Pay Tax on the Rental Income Like A US Citizen
The Canadian renting US property, however, has an alternative to the general withholding rule described above. Instead of the general withholding provision, the Canadian may choose to pretend he or she is a US taxpayer. How does this work? The Canadian files a 1040NR tax return. Why file a 1040NR? Because now, the Canadian taxpayer is taxed like a US taxpayer (at least with respect to the rental income from the US property), and that means the Canadian can take deductions against the income just like a US taxpayer does. What kind of deductions? Well, for example, the Canadian taxpayer may deduct property taxes and mortgage interest from the gross rental income. After taking deductions, the rental income may result in little to no taxable US income. Choosing this route will likely lead to the Canadian paying less US taxes because under this scenario only the rental "profits" are taxed in the US (and not the gross rental amount). The 1040 NR (together with a Schedule E for rental income) should be filed by June 15 of the year after receiving the taxable rental income. For property located in California, the Canadian taxpayer would also file a Form 540NR.