Julian Block On Deducting Worthless Loan To Spouses

These being the times they are, you may be tapped for loans by relatives or friends who are unable to come up with the down payment for a home or who wants to start a business or keep it afloat.  What if a loan goes sour, as so often happens? The tax rules on deductions for bad debts can be more bad news for you.

Although you can deduct a worthless loan if there’s no likelihood of recovery in the future, you can’t take a deduction for an outright gift. That's why the IRS looks closely at bad debt deductions where the lender and borrower are related and why it may insist on proof that the "loan" wasn’t really a gift.

Unpaid  loans and marriage. The law presumes that loans from one spouse to another don’t create valid debts. To get around that snag, Carolyn Marlett claimed that her marriage to husband Charles was a "relationship maintained for financial convenience only." Hence, her co-signing of a joint income tax refund was a loan to Charles, as were her other "advances" to him.

However, Carolyn couldn’t convince the U.S. Tax Court that the advances were valid debts. In a 1976 decision, the court noted that she never asked Charles to sign notes or bothered to set an interest rate or repayment schedule.

But the court isn’t completely inflexible on this issue. It ruled that June M. Rogers could deduct loans made to her husband, who declared bankruptcy after their divorce. The loans weren’t gifts; he used the money in an unsuccessful business venture and signed promissory notes for repayment.

Unreturned engagement ring. The Tax Court ruled in favor of the government in 1982 in a case involving Jack Wolfson. Jack was a Dallas salesman whose territory included Houston, where he met and ultimately became engaged to Yvonne Gibbs.

To seal their engagement, he gave her a diamond ring. But just a week later, she broke things off and sold the ring, a decision triggered by Jack's refusal to honor his promise to reimburse her for the cost of housing her poodle in a kennel during her visits with him in Dallas. Jack sued Yvonne for the ring's cost and won a default judgment of $1,000, which he made no attempt to collect. Instead, the spurned lover took a bad debt deduction for $1,000.

The IRS invoked two arguments to justify its disallowance of the deduction. First, Jack didn’t offer any proof he tried to collect. Therefore, the debt wasn’t worthless at the end of the year in issue, a requisite for the write-off of a bad debt. Second, simply giving an engagement ring doesn’t create a debt. Approving a bad debt deduction for that act alone "would, in essence, open the doors of litigation to allow every rejected lover to come into the Tax Court and ask it to allow him a deduction" for an unreturned ring.

The IRS urged the court not to assume "part of the cost of the romance" of Jack with Yvonne. The judge deemed it unnecessary to rule on the second argument, as he agreed with the first one. Jack offered no evidence of Yvonne's insolvency or other inability to pay during the year in question. Hence, he failed to prove the debt's worthlessness during that year.

The bottom line? If it’s a loan, especially to a close friend or relative, make sure the paperwork and process show it’s a bona fide loan and not a thinly disguised gift.

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Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: “a leading tax professional” (New York Times); "an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). This article is excerpted from “Julian Block’s Tax Tips for Marriage and Divorce,” available as a Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com. Law professor James E. Maule of Villanova University praised the book as “An easy-to-read and well-organized explanation of the tax rules.”  The National Association of Personal Financial Advisers says it is “A terrific reference.” 

Julian Block Tells You to Forget About Deducting Your Business Suits

Generally, clothing costs aren’t allowable as “ordinary and necessary” business expenses. They’re nondeductible personal expenses.

The IRS prohibits write-offs for clothing that’s adaptable to general wear off the job. It makes no difference that your work requires you to be fashionably or expensively dressed. What the IRS does permit are deductions for the cost and upkeep of special work clothes or equipment. To qualify for deductions, you must pass both parts of a two-step test.

·         The clothing and equipment must be required by your employer.

·         The clothes aren’t suitable for wear off the job.

Note that it isn’t enough that wearing special clothing is a condition of employment.

Some examples of distinctive work clothing that easily qualify: uniforms worn by fire fighters, police officers, letter carriers, health-care workers, professional athletes and delivery workers. Also passing muster are the kinds of clothing that protect workers from injuries. This category includes safety shoes and glasses, hardhats and work gloves.

Usually, the IRS prevails in disputes over deductions for business suits and dresses, because they are obviously appropriate away from work.

In a 1986 case, nationally ranked Chicago tennis pro Cecil Mella lost a match with the IRS over business write-offs for tennis clothes. Cecil worked for two private tennis clubs, both of whom barred players, including instructors, from playing on the courts unless they wore proper attire. He  deducted such items as warm-up jackets and pants; shirts with a collar; shorts that were brief to give maximum freedom of movement and had pockets for tennis balls; and shoes, each pair of which lasted only two or three weeks and were designed, according to Cecil, to decrease the chances of injuries.

Cecil said he wore the items only when playing or teaching. But the Tax Court, in its unsought role as official interpreter of fashion correctness, noted: “It is relatively commonplace for Americans in all walks of life to wear warm-up clothes, shirts and shoes of the type purchased by [Cecil] while engaged in a wide variety of casual or athletic activities.” As for the shoes’ safety functions, the court characterized his statements as “uncorroborated and vague.” Decision: No deductions for expenses that weren’t ordinary and necessary.

In a 1979 decision, the court also threw out deductions for suits bought by Edward J. Kosmal, a Los Angeles deputy district attorney who planned to leave government service. Ed decided that the right way to impress his future employers and colleagues was to upgrade his wardrobe to the sartorial standards of a “big-time Beverly Hills P.I. [personal injury] attorney.” The court denied the deductions because, unquestionably, the clothes were fitting for ordinary wear.

Hairstyling and makeup. The IRS and the courts sometimes differ on deducting hairdressing costs. The IRS classifies such payments as nondeductible personal expenses, even for a big-name, New York fashion designer like Mary McFadden, who’s in the public eye and “noted professionally for her distinctive hair style.”

However, an IRS defeat occurred in 1978, when the Tax Court sided with Margot Sider. Margot wrote off the cost of 45 extra beauty-parlor visits that were made, she argued, only because her hairstyle was an integral part of her job demonstrating and selling “a high-priced line” of cosmetics in a department store to a “sophisticated clientele.” As soon as she stopped selling, she went back to a simpler style.

At her trial, Margot cited a 1963 Supreme Court decision written by Justice John Marshall Harlan: “For income-tax purposes Congress has seen fit to regard an individual as having two personalities: One is a seeker after profit who can deduct the expenses incurred in that search; the other is a creature satisfying his needs as a human and those of his family but who cannot deduct such consumption and related expenditures.”

Margot maintained she’d spent the amount in issue as a “seeker after profit,” not as “a creature satisfying her own needs.” That satisfied the judge, who ruled she was entitled to fully deduct expenditures beyond “the ordinary expenses of general personal grooming.”

However, the IRS had no trouble convincing the Tax Court that Vivian Thomas shouldn’t be allowed to deduct grooming expenses. Vivian worked as a private secretary for an attorney who required her to be perfectly coiffed at all times while in the office. So she deducted the cost of twice-weekly trips to the beauty parlor. Sorry, said the court, but a secretary’s coiffure maintenance costs are not allowable— even in her case.

Back in 1979, actress September Thorp offered an unassailable not-adaptable-for-general-wear defense—and won—when the IRS challenged her deduction for makeup: “I’m in Oh! Calcutta! and I have to appear nude onstage every night,” argued September, “so I cover myself with body makeup. I go through a tube every two weeks, and it’s very expensive.”

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Julian left out one of the funniest clothing cases ever, that of Anietra Hamper

Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: “a leading tax professional” (New York Times); "an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). This article is excerpted from “Julian Block’s Easy Tax Guide for Writers, Photographers, and Other Freelancers,” available as a Kindle at Amazon.com and as a print copy at julianblocktaxexpert.com. The National Association of Personal Financial Advisers says the book is “Easy to read and well-organized and can be helpful to planners in advising clients.” http://julianblocktaxexpert.com./

Julian Block On How To Take A Tax Deduction For Protecting Your Good Name

Julian Block has agreed to help me in my effort to become the Tom Sawyer of blogging. 

Ordinarily, deductible business expenses include payments to settle disputes, whether the payments are made to satisfy judgments or as out-of-court settlements. But the IRS is clear that it will allow the deduction only if the argument arose from a business-related activity, as opposed to a personal matter.

And when it comes to your reputation, the line between business and personal is thin indeed. What controls the outcome are the particular circumstances.

For example, a federal appeals court refused to allow a write-off for the cost of settling a will contest, notwithstanding that the taxpayer settled to protect his reputation as a lawyer. Apparently because of a close friendship, attorney William McDonald was named the major beneficiary in the will of a client, an elderly widow. The New York lawyer had not prepared the original will, but did draft a later codicil that modified the will by including him among the beneficiaries. That circumstance prompted some of the widow’s relatives to contest the will on the basis that he had exerted undue influence. He agreed to an out-of-court settlement of $121,000, and the written agreement states that “it appears the litigation of the issues would engender much publicity and would endanger the reputation of McDonald as an attorney.”

The court barred a business expense for the $121,000. The proper standard for deductibility here, said the court, is the “origin-of-the-claim” test. The origin of the lawyer’s rights under the will was his personal relationship with the client, not his law practice. Consequently, it made no difference that his primary purpose in agreeing to the settlement was to protect his reputation as a lawyer. 

The origin-of-the-claim test also tripped up pro-football star Michael Hayden when he tried to deduct a payment to hush a sex scandal. While the former safety for the Los Angeles Raiders and co-captain for the Denver Broncos was negotiating a contract renewal with Denver, ex-girlfriend Michelle Moore filed a sexual-assault charge against him for what happened when he visited her home in an unsuccessful attempt to make amends after they had an argument. The Broncos found out and threatened to trade or release him if the matter became public.

To stop this, Michael paid Michelle $25,000 for dropping the complaint and keeping quiet. The Broncos then signed him to a five-year contract. He deducted the $25,000 as a “professional development expense.” His reasoning: He wouldn’t have made it if his job hadn’t been jeopardized.

The IRS tossed it out as a nondeductible personal expense and the U.S. Tax Court agreed. The 1991 decision held that the origin of the charge leading to the payment arose out of Michael’s personal relationship with Michelle, not out of his job. That the consequences of the allegations against the athlete were business-related didn’t make the payoff deductible.

J. C. McCaa, an Arkansas auto dealer who disapproved of divorce, settled a claim for personal injuries resulting from his having struck a girlfriend of his married son. A skeptical Tax Court concluded that the payment was made to shield him and his family from potential scandal, not to avoid cancellation of his dealer’s franchise

William Harper taught high-school science and owned rental property. He paid damages and legal expenses to settle an invasion-of-privacy suit brought against him by a tenant. She asserted that William installed a listening device in her apartment and connected it to his office so he could hear what was said and done in the apartment. The suit, noted the Tax Court, might make it more difficult for William to do business in his West Virginia community, but the payments weren’t deductible because they were made for his own personal protection.

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Julian Block writes and practices law in Larchmont, N.Y. and was formerly with the IRS as a special agent (criminal investigator) and an attorney. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: “a leading tax professional” (New York Times); "an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). This article is excerpted from “Julian Block’s Year Round Tax Savings,” available at julianblocktaxexpert.com. The National Association of Personal Financial Advisers .” says the book is “Easy to read and well-organized and can be helpful to planners in advising clients". 

I recently reviewed Julian's Home Seller's Guide To Tax Savings.

Some Tax And Financial Tips For The Divorced From Julian Block

Originally published on forbes.com.

I recently reviewed Julian Block's Tax Tips For Marriage And Divorce. He has provided me with another guest post, this one with some advice oriented to divorced individuals, although, frankly, most of the advice is more broadly applicable.

 Divorced individuals should educate themselves for financial planning.

In these increasingly rough economic times, it’s more vital than ever that you assume greater responsibility for your financial future. You ought not to rely exclusively on paid advisers. At the very least, you should be knowledgeable enough to raise good questions and evaluate answers when you deal with divorce attorneys and other professionals. The informed client gets the best advice.

A quick, low-cost way to become savvy is to sign up for adult education courses on taxes, investing and other aspects of personal finance. Choose from an array of classes tailored to your interest that are available at places like high schools and community colleges. Courses cost a fraction of what it would otherwise cost to meet on a one-to-one basis with instructors, who usually are attorneys, CPAs, financial planners and enrolled agents—i.e., persons licensed to practice before the IRS who are neither attorneys nor CPAs, but who are former IRS employees or have passed rigorous tax examinations administered by the IRS. Instructors use their hands-on experience to provide helpful, unbiased advice on topics that run the gamut from timing the receipt of income and the payment of deductions to your best advantage, to opening, operating and closing business ventures, to getting married or divorced, to when and how much money to take out of tax-deferred retirement accounts like IRAs, 401(k)s and 403(b)s, to whether to make lifetime gifts of money and other kinds of property to family members or to leave the assets to them. 

The courses alert you to money-saving techniques that you can apply yourself or, should you decide to seek professional help, test out on your advisers. And, conceivably, those advisers might turn out to be your instructors, whom you’ve had an excellent chance to evaluate. 

But be wary of retirement planning services and estate planners who send invitations to free lunch seminars geared to seniors. A 2009 survey by AARP of more than 1,000 people 55 and over found that many who attended seminars on retirement and estate planning were "pitched investments that were unsuitable for them or were asked for information that could expose them to financial fraud." 

The invitations consistently offer the same enticements: "a free gourmet meal, tips on how to earn excellent returns on your investments, eliminate market risk, grow your retirement funds, and spouses are urged to attend. These words should be red flags for investors," cautions the North American Securities Administrators Association (NASAA) . NASAA is an international organization devoted to investor protection. 

Review your will and keep it up to date.

Redo your will if you’ve divorced, legally separated or married since you wrote it. Your property intentions normally change when your marriage ends. And a remarriage also increases the complications, particularly when each spouse has children from marriages.

Update beneficiary designations

for insurance policies and retirement plans.Otherwise, proceeds might wind up with a former spouse or someone you now consider unworthy.

Letter of final instructions

Written your will and checked beneficiary designations? Good for you. Next step: Assemble the information for a non-binding document known in legal lingo as a final letter of instructions. The letter is an informal inventory of your financial records. This includes key names and numbers, and where you store insurance policies, bank accounts, tax info, and other papers. The list helps heirs locate assets and save on administrative expenses. Keep the letter up-to-date and accessible.

Watch withholding and estimated payments

Submit new W-4 forms to employers or W-4P forms to pension administrators. Revise the amounts subtracted from salaries, bonuses or pensions up or down to make sure that taxes withheld will be in rough balance with taxes owed when filing time next rolls around. For help on fine-tuning withholding, use the worksheets in How Do I Adjust My Tax Withholding?, Publication 919. Another resource is the IRS’s calculator at irs.gov.

Do you receive income from sources usually not covered by withholding—for instance, alimony, self-employment, Social Security benefits, dividends, interest, and withdrawals from IRAs and other retirement arrangements? Act now to adjust estimated quarterly payments. Tax Withholding and Estimated Tax, Publication 505, lays out the complete rules. 

Copies of income tax returns filed with your spouse.

Need to get hold of copies? You can do so without paying for help from an attorney or anyone else. If you and your spouse paid someone to complete those returns, the easiest way to get them is to contact the preparer. The law, in most cases, requires a paid preparer to keep copies of returns for at least three years after the filing due date—for instance, at least until April, 2013, for a return for tax year 2009, with a filing due date, for most persons, of mid-April, 2010. The preparer is supposed to provide copies to any of the signers.

What if there was no preparer or the returns can’t be obtained from that person? Contact the IRS for copies. You’re entitled to them even if all the jointly reported income was your spouse’s. The IRS charges $57 for each return requested. Simply sign and submit IRS Form 4506, Request for Copy of Tax Form. To ease your burden, it needn’t be signed by your spouse. 

IRS forms and publications are available by downloading from the IRS’s website.
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Julian Block is an attorney and author based in Larchmont, N.Y. He has been cited　as: "a leading tax professional" (New York Times);　"an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). Information about his books is at julianblocktaxexpert.com.

Every encounter I have with Julian, I learn something new.  We were talking yesterday and I asked him why he wasn't blogging.  He said he writes for other people's blogs to promote his books, but doesn't want to start one himself.  I could understand that.  Myself, I like other people's dogs.  Then he told me that when it comes to blogging I could be his Shabbos goy.  That is one Yiddish expression my years at Joseph B Cohan and Associates never taught me.  A Shabbos goy is a non-Jewish individual who regularly provides services that Jews cannot perform on the Sabbath.  At one time lighting stoves was a common service performed by a Shabbos goy.  Among noted individuals who performed this role are Colin Powell and Elvis Presley.

You can follow me on twitter @peterreillycpa.

A Book For Taxgirl To Bring To Bridal Showers

Originally published on forbes.com.

I just finished Julian Block's Tax Tips for Marriage and Divorce. At less, than 25 bucks, it would be a pretty chintzy wedding present, but that wouldn't stop me from giving it to the right person.  I'm going to ask Forbes contributor Kelly Erb (a.k.a. Taxgirl) if she would bring a copy to a bridal shower.  I think you have to be shameless about being a tax geek in order to blog about the topic, so you might as well go all the way and flaunt your geekiness at a shower.

The book actually goes into more than marriage and divorce.  You could really call it the tax aspects of coupling and decoupling, but then someone might thing it has something to do with railroad depreciation.

Overall, Tax Tips is a good read and will alert someone to most of the tax implications of intimate relationships.  The author discusses the pro and cons of joint returns, making it clear that filing jointly is not a requirement, although it is often most advantageous.  He discusses dependency deductions, including the clever idea of adopting your lover.  Of the seven sections covering among other things marriage rules, tax consequences of divorce and home sales, my favorite was Oddball Situations.  Mr. Block reviews the tax issues raised by relationships between ladies and generous gentlemen.  That material is a little dated, but pretty amusing.  It made me think of this song:

The book does not get into community property laws other than to alert you about them and let you know they complicate things.  The discussion of the Defense of Marriage Act is useful background for those involved in same sex relationships, but needs updating due to recent decisions.  Of course, a book like this is not meant to be and really cannot be used as the sole reference on any issue, but I think even experienced tax practitioners will come away from it having learned something. My recommendation that Tax Tips for Marriage and Divorce would make a good gift for someone contemplating marriage (or divorce) is shared by blogger and Villanova tax law professor  James Edward Maule.

Mr. Block has provided me with some guest posts which will be going up as time permits over the next few days.  Meanwhile, I'm in Dallas at the Grant Thornton Tax Leadership Conference.  It's quite an impressive event for somebody who has never worked for a national firm before.  I was really pleased that my old boss Alan Osmolowski and my new boss Don Jeffrey were recognized for the hard work they have been doing in integrating our practices.  Grant Thornton's color is purple, which makes the transition real easy for a Holy Cross graduate.

You can follow me on twitter @peterreillycpa.

Kim Kardashian And Kris Humphries - Is There A Tax Angle ?

ulian Block, author of Tax Tips For Marriage and Divorce has provided me with a few brief tips, which I will be posting over the next week.  I reviewed his book last week.  It turns out the first one he sent me might be of interest to Kim Kardashian.  She was married to New Jersey Nets player Kris Humphries for 72 days in 2011 before seeking divorce.  He countered by seeking an annulment.

Divorce Versus Annulment: the Big Tax Difference

Picture a cozy household of three: just Brad Pitt, Angelina Jolie, and the friendly tax man. Fact is, whether Brad, Angelina, Jennifer, Bristol, Levi, Snooki, Kim or anyone else is hooking up, breaking up, or something in between, the odds and ends of their relationships are grist for the IRS mill.

For instance, there’s a difference between a divorce and an annulment. The courts grant a divorce to mark the end of a marriage that was valid when entered into, whereas an annulment is for a marriage that at no time was valid (as when one of the parties was under the age of consent at the time of the marriage).  

To a couple interested only in the fastest way to untie the knot, the question may seem to be an unimportant technicality. Those watchful souls at the Internal Revenue Service, however, think that there’s an important difference when Form 1040 time rolls around. According to an IRS ruling, if an annulment is retroactive, the couple was never married. Result: they had no right to file joint returns (Revenue Ruling 76-255).

 An example: John and Mary married in 2011, filed jointly for that year, and had their marriage annulled after the filing deadline. Because their marriage was declared null and void from its very inception by the annulment decree, they’re considered to be unmarried at the end of 2011. Consequently, as an unmarried couple, they were ineligible to file jointly. The IRS requires John and Mary to "undo" their joint return by the filing of amended returns as unmarried filers. That can mean they get dunned for additional taxes. 

Normally, the IRS doesn’t allow people who file joint returns to change their filing status and switch to separate returns once the filing deadline of April 15 (for most individuals) has passed. Revenue Ruling 76-255 deals with the rare circumstance in which joint filers can switch to separate returns. This ruling involved only a one-year marriage. Nevertheless, the theory would presumably apply regardless of the marriage's length. On the plus side, refunds may be available to couples whose marriages were annulled and who would have paid reduced taxes as single persons. 

ulian Block is an attorney and author based in Larchmont, N.Y. He has been cited　as: "a leading tax professional" (New York Times);　"an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine). 

I'm wondering in the Kardashian case, if community property law might be a factor.   If you were ever going to do a reality TV show about tax preparation, Kim and her hoopster might make a good pilot.

You can follow me on twitter @peterreillycpa.