On Tax Refunds and “Not Owing Tax,” Part 1

Let’s talk about tax refunds.

No, I’m not going to opine on whether getting a tax refund is a good thing or a bad thing (though that’s a good idea for a future blog post).

Instead I want to explain how tax refunds work, and how it’s not always accurate to say you “didn’t owe taxes this year” just because you got a refund.

How the Tax Calculation Works

Time for a mathematical formula. (Try to contain your excitement!)

This is highly simplified but I think it covers the basics well enough. Here’s how the tax calculation works:

Income
Minus certain adjustments to income, such as student loan interest
Minus standard deduction or itemized deductions
Minus personal exemptions
Equals taxable income

Next, you calculate the amount of tax owed on your taxable income.

I know what you’re saying now:

“Wait a minute, ‘tax owed’? That can’t be right. I always get a refund when I file my return!”

Ah, that’s the rub. Just because you got a refund it doesn’t necessarily mean you didn’t owe taxes.

I’ll explain more in Part 2.

Preparer Regulation and Judging Preparers Based on Size of Refund

A sad fact of being a tax pro is that a certain percentage of your clients will judge you based on how big of a refund you get them, as opposed to your knowledge and expertise.

Anyone who’s worked in this business has experienced the irate client who thinks the preparer screwed up because their refund was less than their friend/co-worker/hair dresser, etc.

But is this a reason to regulate tax preparers?

The National Association of Enrolled Agents seems to think it is. Here’s a quote from last July’s “EA Journal” published by NAEA:

Let’s Face it. In far too many instances, return preparation is a “race to the bottom” where taxpayers judge their preparers by the size of the refund they generate, not by the accuracy of the return. Because of this race for the bottom, amongst other reasons, NAEA has long supported the notion that IRS should have a cop on the beat.

I have written in many blog posts about how I disagree with NAEA’s stand on preparer regulation. But in this post, I’m focusing on the part about preparers being judged based on the size of refund.

I agree with NAEA that this is a problem. But I disagree that the solution is to require licensing of preparers.

The source of the problem is that the public doesn’t understand how taxes work. And the source of that problem is two-fold: 1) the complexity of the tax code and 2) (perhaps to a lesser extent) refundable tax credits that people don’t understand but that they become addicted to.

Those problems need solutions. But requiring preparers to have licenses isn’t a part of the solution.

I Get Very Sad When a Client Gets Involved in Multi-Level Marketing

ID-100116832My tax blog buddy Joe Kristan at the Tax Update blog said the following in a post Thursday under the heading “Can an Amway distributorship ever be taxed as a legitimate business?”:

I avoid multi-level marketing clients because their “profit” so often comes from putting personal expenses on Schedule C.  It sure seems that way here.

I have a few clients involved in multi-level marketing. Luckily, none of these clients are aggressive or crazy on what they try to claim for deductions. But sometimes they get some wild ideas that they’ve heard from others in their “network.” Like the time one asked if they could deduct their personal grocery bills.

I am not going to “fire” a client just because they’re involved in MLM. But neither will I tolerate one who wants to play games with deductions.

If the client is trying to make money at their MLM business, and they are okay with ONLY claiming legitimate expenses, then I have no real quarrel with someone being involved in MLM.

But I do get sad when a client says they’ve gotten involved in multi-level marketing.

The reason I get sad has nothing to do with taxes or fears that the client will be over-aggressive with deductions.

The reason I get sad is: so few of them actually make money.

I have never,

N – E – V – E – R

had a client involved in MLM who said it’s worth it. Time and again, people will say it’s not worth the time and effort. Even those who turn a meager profit after their legitimate expenses will say it’s not worth the time involved.

Most are excited the first year, but then lose interest and just stop after another year or two. A few carry on, though they gripe about it.

MLM promoters love to play up the supposed tax miracles of MLM businesses, and the “easy money” aspect.

In the real world, there are no tax miracles, and there is no easy money.

Image courtesy of rakratchada torsap / freedigitalphotos.net

Tax Court Case Involving Radio DJ Strikes Close to Home for Me, Part 2

On Tuesday I wrote about a Tax Court case involving a Mr. Ramirez, who was a radio station employee who sold advertising on his own, and was treated as an independent contractor in regards to his sales. This post is about my observations on this case.

Observations from an Ex-Radio Guy

As an ex-radio guy, several things stand out as odd about this case.

One: The ruling itself.

Based on the facts as presented, I can kinda-sorta see where the Tax Court was coming from in ruling that Ramirez was self-employed in regards to his promotional income. What surprises me is the setup of the whole arrangement between the sponsors, the radio station and himself. Which leads to….

Two: Why Didn’t Univision Keep Part of His Sales?

The Court ruling says Univision acted as a “conduit” for billing the customers Mr. Ramirez found, which implies that everything passed directly through to Ramirez. In the year in question before the Court, Ramirez received $82,000 from his sales. The ruling doesn’t explicitly say it, but it appears that this was what he actually sold, NOT just a commission on his sales.

I am shocked that the station didn’t deem that they were entitled to keep most of his sales and just pay him a commission.

Three: Why Didn’t the Station Try to Take Over His Clients?

At the station I worked at (which admittedly was a tiny, locally owned station rather than a big outfit like Univision), sales work was territorial and cutthroat. If you were in sales, you didn’t want to so much as say hello to someone else’s client or you’d get called on the carpet.

And if you weren’t in sales, management wasn’t keen on non-sales staff trying to break into sales.

I was the news director and wasn’t in sales. I wanted to get sales experience, so I asked to have a few accounts to manage. I was told no.

In denying my request, the exact words management said to me were: “You’d never make it in sales. You don’t have a sales personality.”

Management and sales staff are typically defensive about anyone infringing on “their gig.” So the whole arrangement Mr. Ramirez had just boggles my mind.

I’m pretty sure that if I had gone out and gotten sponsors on my own, and read my sponsor’s commercials on the air, and used my “celebrity” status — afforded to me by virtue of being a radio station employee — to get paid for doing remotes and live appearances, that my employer would not have been happy with me — especially if I was keeping 100% of the proceeds for myself and the station was getting nothing!

And I sure can’t imagine them agreeing to bill those customers for me and then passing through 100% of the proceeds to me while keeping nothing for the station!

Click here to view the Tax Court opinion.

Tax Court Case Involving Radio DJ Strikes Close to Home for Me

I used to work in radio. I was the news director at KNOD radio station in Harlan, over in the western part of Iowa.

I plan to start writing more about my past and my experiences and how it ties into my professional life. But those are different blog posts for different days.

Today I want to write about a U.S. Tax Court case that caught my eye last summer. I’ve had it on my “to-blog-about” list for a long time.

The case intrigued me because it involved a radio station employee who got paid by his employers as both an employee and an independent contractor. The result of the case surprised me.

Background:

A man by the name of Mr. Ramirez was an employee of Univision and worked for radio station KXTN in San Antonio. He was the station’s program director and was an on-air personality.

In 2005, the station was struggling financially so Mr. Ramirez took it upon himself to find sponsors. From the U.S. Tax Court ruling:

Mr. Ramirez established a direct, personal relationship with his sponsors, working hand-in-hand with them from the start of the advertising campaign to its end. They had no written contracts, just handshake agreements. Mr. Ramirez set the amount to be paid to him for his promotional services without input from Univision or KXTN….

Mr. Ramirez assisted the sponsors in developing their respective advertising campaigns, including the drafting of their “copy points” which outlined those elements of the advertising campaign that the sponsors desired to highlight. He promoted their products and/or services, both during on-air broadcasts and on “off-air” appearances at sites designated by the sponsors.

Even though Ramirez set the amounts the sponsors would pay, the sponsors were billed by Univision. Univision added these amounts to Ramirez’s wages. Withholdings for income taxes and FICA were taken out of his pay, and these amounts were included as wages on Ramirez’s W-2.

In 2007 (the year in question before the Tax Court), Ramirez was paid an additional $82,000 of wages from his sales.

When he filed his 2007 tax return, he included a Schedule C showing $0 of income and $26,303 of expenses. The Schedule C related to his sales work. According to Ramirez’s CPA, the Schedule C showed $0 of income because the $82,000 of sales income was already included on his W-2.

Naturally, the IRS audited Ramirez. The IRS believed the $26,000 of expenses were employee expenses that should have been shown as itemized deductions subject to the 2% of AGI limitation, rather than as Schedule C deductions.

Mr. Ramirez argued that his sales work was outside the scope of his regular work at the radio station and so the sales work should be treated as independent contractor wages.

To my surprise, the Tax Court agreed. They reclassified the $82,000 of sales income as Schedule C gross receipts and allowed the $26,000 of deductions against that income.

In Part 2, I’ll explain why I’m surprised at this entire arrangement based on my own experiences in my “prior life” in radio.