Toxic Deductible Sludge

Back in 2010, British Petroleum's Deepwater Horizon drilling rig exploded and spilled millions of barrels of oil off the Louisiana coast. Countless small business owners, including fishermen, hotel operators, restaurants, rental companies, and seafood processors, suffered and went bankrupt. State and local governments lost billions more in tax revenue. Lawyers, who may be some of the few people to actually profit from the disaster, are still fighting over compensation and claims, and will probably still be fighting until long after anyone reading these words is still alive.

BP has been gushing cash ever since the spill to clean up its mess and restore its reputation the damaged environment. The total includes $20 billion for a trust fund to settle financial claims, $4.5 billion in criminal fines and other penalties, and $18.7 billion to settle federal and state claims. But there's good news for the company, too — they'll be getting billions in help from their friends at the IRS!

Here's how that little plot twist works. Section 162(f) of the Internal Revenue Code states that "no deduction shall be allowed . . . for any fine or similar penalty paid to a government for the violation of any law." But defining exactly what makes up a "fine or penalty" isn't as obvious as you might think (and it gives those lawyers we just talked about the opportunity to bill a lot of hours arguing about it). Payments that aren't considered fines or penalties are deductible just like any other business expense. So let's take a look at exactly how BP will be structuring this final settlement:

• $5.5 billion goes towards a Clean Water Act penalty. This amount should be nondeductible. However, the press release announcing the settlement states that 80% of the penalty "will go to restoration efforts in the affected states pursuant to a Deepwater-specific statute, the RESTORE Act." That should give a clever lawyer more than enough rope to argue for deductibility!
• $8.8 billion goes towards natural resource damage and funding Gulf restoration projects. Since it's not explicitly designated a "fine" or "penalty," BP will probably deduct it.
• $5.9 billion goes towards state and local governments to settle their claims. Again, since it's being paid to "settle" claims, BP will likely deduct it.
• $600 million goes towards "other claims," including "unreimbursed federal expenses due to this incident." (Sounds like the sort of "slush fund" favored by Louisiana politicians of yore, doesn't it?) And really, how much fun is a slush fund if you have to pay tax on it?

We may never know exactly how much BP writes off because deductions on settlements are confidential business information. But we know the company's federal tax rate is 35%. So that means, if BP writes off, say, $20 billion of the payments, they'll save $7 billion in taxes. That money, of course, comes out of all of our pockets. So pat yourself on the back for playing your part in cleaning up the Gulf.

Nobody ever plans to suffer through a disaster like the Deepwater Horizon spill. But it's worth remembering that how you clean up your mistakes can make a real difference. So think of us as your financial "911," and don't hesitate to call if trouble strikes!

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Nina Olson is the most important person you've never heard of at the IRS. She's the "National Taxpayer Advocate," and she heads up an organization created to cut through the red tape when the Service can't get the job done itself. If you're stuck between cogs in the IRS machine, Olson and her staff of 1,400 Case Advocates are poised to pull you out. She's like the Lorax, except she speaks for the taxpayer instead of the trees.

Last week, Olson released her mid-year report to Congress. It's hundreds of pages long, full of dense bureaucratese and government jargon, all leading to one inescapable (and rhyming) conclusion: the IRS is a mess. Olson likened the situation to Charles Dickens' Tale of Two Cities. "For the majority of taxpayers who filed their returns and did not need IRS assistance," she writes, "the filing season was generally successful. For the segment of taxpayers who required help from the IRS, the filing season was by far the worst in memory."

Take a look at some of the "customer service" statistics Olson revealed, and you'll see why we put the term "customer service" in quotes:

• The IRS answered just 37% of the phone calls taxpayers made to customer service representatives, with an average hold time of more than half an hour. That's down from 71% for the 2014 filing season.
• Olson's own unit did barely better, answering just 39% of calls made to the National Taxpayer Advocate Toll-Free Hotline. (Hint: a toll-free number won't save taxpayers much money — and really, it isn't much of a "hotline" — if nobody answers the phone!)
• Tax professionals have always been able to "cut the line" by calling the Practitioner Priority Service line. Surely they get better service, right? Not so much. The IRS answered just 45% of those calls, with an average hold time of 3/4 of an hour.

Where do all those unanswered calls go? Here's a clue: the number of "courtesy disconnects" jumped from 544,000 last year to 8.8 million this year. "Courtesy disconnect" is the ironic term the IRS uses when the phone lines get so jammed there's no hope you'll ever reach an actual human being anyway — so the system just says "peace out" and hangs up on you.

Why are things so miserable? The problem, of course, is money. The IRS budget is down 17% (adjusted for inflation) from 2010. Yet even as Congress has gleefully slashed funding for everyone's least-favorite agency, they've stuck the IRS with the responsibility of riding shotgun over big chunks of both the Affordable Care Act and the new "FATCA" rules designed to sniff out hidden offshore accounts. The end result is a "customer service" experience that makes a trip to the DMV look like a beach vacation.

If you've never gotten a dreaded "CP-2000" notice, you might not see the connection between IRS "service" and what we do. But here it is, in a nutshell: the sort of tax planning we offer doesn't just save you money, it helps protect you from IRS bureaucracy to save you time. So make sure you've got a plan in place before you file your next return!

Forensic Filings

We tend to think of the Internal Revenue Service mainly as Uncle Sam's "collections department." But it's also a true law enforcement agency. Special agents from the Criminal Investigations unit take on obvious crimes like tax evasion and tax preparer fraud. They also partner with local police, the FBI, the DEA, and even foreign governments to combat public corruption, money laundering, drug trafficking, and international terrorism. The tax cops are good at what they do — the IRS boasts the highest criminal conviction rate of any federal law enforcement agency (93.4% in 2014).

But sometimes the IRS plays a surprising role in more ordinary crimes . . . which brings us to today's story.

On May 17, 2005, 38-year-old Amy Bosley frantically called 911 to report a break-in and shooting at her family's holiday cabin in Alexandria, Kentucky, just across the Ohio River from Cincinnati. Police arrived to find her 41-year-old husband, Bob, dead on the bed with at least seven bullet wounds. The cabin had been ransacked, and the couple's terrified sons, ages six and nine, were huddled in their room.

Local authorities were stumped at first. There were no witnesses and no DNA evidence. The Bosleys were well-liked in their community. They owned a million-dollar roofing business, along with all the grown-up toys their success could buy: sports cars, horses, an airplane, and a 50-foot yacht.

But officials soon learned there were secrets beneath the Bosley's successful facade. Bob had made enemies in his business. And he would disappear for days at a time to his boat on nearby Lake Cumberland, where he entertained women who weren't his wife.

Then came the call that cracked the case wide open. It seems that Amy, who served as the roofing company's accountant, had been as cavalier with the business's taxes as her husband had been with his wedding vows. The company owed a whopping $1.7 million in back taxes. Amy had hidden the investigation from her husband and even impersonated him on the phone.

Not being able to talk to Bob had the IRS smelling a rat. So they demanded an in-person meeting with the couple that was scheduled to take place . . . the morning after the murder! And that morning, the "grieving widow" was even so bold as to call the IRS and say they wouldn't need to meet because Bob was dead. Given the astounding coincidence on top of all the suspicious behavior, the IRS agent called local police and suggested a suspect and motive they might want to look into.

You can probably guess where the story goes from here. Investigators focused their attention on Amy and began to pull apart her story. They found hundreds of checks to the IRS, unmailed, in the back of her car. The coup de grace came from the children, who told interviewers they heard gunshots first, then breaking glass. Ten days later, Amy was in custody. She pled guilty to protect the children from having to testify, and now she's serving a 20-year sentence.

Campbell County Prosecutor Michelle Snodgrass told the court that Amy set out to destroy the business to get even with Bob for the cheating. She even thought killing him would make the tax problems go away. And where did all the money go? Snodgrass says, "I think that there's money buried, and when she makes parole, one of the first stops she makes is to go get that."

When we work with couples, we make sure both spouses are on board with the plan. And while we probably couldn't have saved the Bosleys, wecan help eliminate financial conflicts that threaten relationships. So don't wait to reach out to your better half. Call us today for a plan to help bring you closer together!

A Tax in a Pineapple Under the Sea

You know what's even worse than paying tax on money you make? Try taking a loss on money you lose. Make $100, pay a 40% tax, and you've still got $60 left. But lose $100, take a tax loss, and you're still out your $100. Yeah, you can deduct it against future income. But it's kind of like those "mail-in" rebates you get when you walk out of Staples with a new printer. It sounds good when you're still in the store. But in the back of your mind, you realize you'll probably never actually mail it in.

It's no fun if you lose money in a bad investment. It's no fun if you get ripped off in some sort of fraud. It's even worse if you get ripped off in an investment fraud! And that brings us to this week's story, which starts out in the underwater city of Bikini Bottom.

SpongeBob SquarePants is a kids' cartoon chronicling the adventures of a sponge named Bob, who lives with his pet snail Gary in a pineapple on the ocean floor. (If you're a parent of a young child, you can just skip ahead to the next paragraph.) SpongeBob has become Nickleodeon's most popular series, squeezing up a boatload of awards, and spawning two movies. In 2011, mycologists working in Malaysia even discovered a new species of fungus in the Bolotaceae family which they named spongiforma squarpantsii.

With a franchise that successful, every huckster within 20,000 leagues wants a SpongeBob tie-in to promote their business. One of those hucksters was a company called SpongeTech. Don't let the "tech" fool you; these guys were in the decidedly low-tech business of selling soap-filled sponges, including a SpongeBob SquarePants model filled with baby soap. But their real business was soaking investors — and after all the hype was washed away, SpongeTech was just another penny-stock scam. Scratch that — as one reporter put it, "SpongeTech was no ordinary pump-and-dump penny-stock scheme; it was, to play on Churchill's famous definition of Russia, a fraud wrapped in a stock-market rig inside a money-laundering conspiracy."

Robert and Penny Greenberger were two of those unlucky investors who watched their "investment" in SpongeTech circle down the drain. By the time the company filed for bankruptcy, the Greenbergers had lost $569,220. In 2010, they wrote the capital loss off on their taxes. Which was fine, except for one thing. They can carry that loss forward to absorb future gains. But they can only deduct $3,000 per year against their ordinary income. At that rate, they'll still be writing it off in the 23rd century.

But theft losses are deductible against ordinary income. Right now! So, in 2012, the Greenbergers amended their 2010 return to claim a theft loss, and asked the IRS to send them a refund for $177,102. The IRS said no, and everyone sailed off to court. Last month, Judge James Gwin ruled that, to prove theft, the Greenbergers had to show two things: 1) that SpongeTech's "nauty" scammers acted specifically to take their money through fraud, and 2) that the Greenbergers had transferred their property to the thieves. Unfortunately for our losing investors, they had bought their stock on "the open market, without any knowledge of who was on the other side of the transaction." And with that, he sank the Greenbergers' case.

Remember when you were a kid and your mom told you not to buy something just because there was a cartoon character on it? She was right, and she would tell you the same thing about your portfolio. The most important lesson here may be to make the right financial decision first, then find the most tax-efficient way to do it. So call us for help — we're here to help you clean up your messiest financial mistakes!