Taxes in the Back

Last October I wrote about operators of the Napa Valley Casino refusing to pay a $2 card room admissions tax. The city of American Canyon, CA, approved the measure in 2010, yet it has delivered exactly $0 in tax dollars to date, as Napa Valley Casino is the only entity subject to the tax.

The parties ended up in court after the city filed a criminal complaint against the casino’s operators, and the operators countered with a civil suit of their own.

Earlier this month a Napa County Superior Court panel decided in favor of the city, according to the Times-Herald. The operators are seeking review of the decision by the state Supreme Court, but the court is not obligated to hear the case.

The Superior Court panel upheld the constitutionality of the tax, noting that local governments have broad powers to regulate gaming establishments located within their jurisdictions.

I don’t see a reversal here. The operators are asserting that the tax is on private citizens entering into a private business. Problem is, it’s not that straightforward.

Free agency periods in professional sports often elicit discussions about the jock tax. The jock tax is imposed by state and local governments on income earned by athletes when they perform in cities with such taxes.

States and cities have different tax rates. The more games played in a higher tax jurisdiction should result in more total tax paid. I covered the topic after Albert Pujols decided to sign with the Los Angeles Angels of Anaheim this past offseason.

So, do state and local tax rates impact the decisions of free agents?

California State Assemblyman Martin Garrick believes so. In a piece for the San Diego Union-Tribune, he claims the State’s jock tax creates a disincentive for professional athletes who consider whether to join a California team. He then states that the state legislature should take action to reduce or eliminate the disincentive.

I believe his analysis comes up short. There are a few key points Mr. Garrick does not mention.

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First, he uses the example of baseball slugger Carlos Lee vetoing a trade to the Los Angeles Dodgers. He simply assumes a higher tax burden was the reason of the veto.

How come Albert Pujols decided to sign with the Angels when he could have re-signed with the Cardinals? Pujols is paying more taxes as a result of the decision.

Second, Garrick does not describe the difference in the effective tax rates by playing for different teams. Merely saying that one state’s income tax rate exceeds another’s is an oversimplification.

Sure, Garrick is correct to say that in general professional athletes on Californian teams pay more taxes than athletes on teams in most other states. Asserting that the increased tax burden is the primary reason players turn down the opportunity without offering a quantiative analysis, however, seems unconvincing.

Furthermore, it is at least arguable that moving to a team in a larger market provides athletes more oportunities for endorsement deals, possibly offsetting to an extent the increased tax burden.

Taxes may play a role in athletes’ decisions. It just appears some politicians may be exaggerating the significance of that role.

Just last week I wrote about a proposed city tax that threatened the promoters of the Coachella Valley Music and Arts Festival to find a new venue.

The threat is gone, for now.

The Indio’s Desert Dun reports City Council member Sam Torres has suspended the effort to impose an admissions tax.

Indio City officials are looking to reach a long-term agreement with Goldenvoice, the Coachella event promoter. I’d be hesitant as a promoter to commit to staying in Indio unless there are assurances that any admissions taxes enacted after the date of the agreement do not apply to the agreement.

The Coachella Valley Music and Arts Festival (“Coachella”) is an annual music festival held during April at the Empire Polo Club in Indio, California. The club sits in the Inland Empire’s Coachella Valley. The festival is known for springboarding the careers of emerging musicians, particularly in the rock, indie, hip hop, and electronic genres.

Beginning in 2014, Coachella may relocate due to a proposed city admissions tax, according to a story reported by the Indio’s Desert Sun.

The Indio tax would be five to ten percent on admissions to entertainment events with more than 2,500 in attendance.

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Coachella is organized by Goldenvoice. Goldenvoice President Paul Tollett estimates the tax would cost $36 per ticket sold, or $4 million to $6 million to the promoters for the Coachella event. Assuming a ten percent tax, a simple calculation reveals ticket prices are $360 a pop and that the event draws well over 100,000.

The tax is far from a reality at this point, however. The Indio City Council turned down consideration of City Councilman Sam Torres’ proposal. Torres intends to amass signatures on a petition so the proposed tax is put before voters on a November ballot. Torres has until August 10 to obtain the necessary signatures.

Tollett insists he won’t pass the cost on to customers. He says that now likely because he doesn’t want to seem like the bad guy for a suddenly political issue. But if the measure gets on a ballot and passes, he may have no choice if finding a new venue proves too difficult.

Some taxpayers seem to believe that a casino’s statement is sufficient to substantiate a taxpayer’s reported gambling winnings and losses. In a recent case decided by the California Board of Equalization, taxpayer Marsha Kakalia learned the hard way that such statements are not sufficient.

During 2003, Ms. Kakalia gambled at several casinos, mostly playing slot machines. She reported gambling losses of $89,980, offsetting her entire federal AGI (adjusted gross income) of $89,980 and determining a California AGI of zero.

It’s no surprise the California Franchise Tax Board examined her return. For the year, six casinos issued to her (and to the IRS) Form W-2Gs, reflecting $89,834 of total gambling winnings. For slot machine winnings, a Form W-2G is issued only when winnings are $1,200 or more.

The taxpayer was essentially saying that all of her winnings were $1,200 or more; she never won smaller amounts. The auditor questioned this by requesting documentation of her winnings and losses from the year.

To substantiate her winnings and losses, the taxpayer provided to the auditor two statements: One from Harrah’s dated July 7, 2007, and one from Thunder Valley Casino dated July 2, 2007. The Harrah’s statement showed she had total net gambling losses of $14,666 during 2003 as a result of gambling from four different Harrah’s locations. The Thunder Valley Casino statement reflected total net losses for 2003 of $36,151.20.

The taxpayer took the position these two statements demonstrated there was “no doubt” that she had no gambling income for 2003 from any casino.

The position is weak. First, the statements only included gambling activity when the taxpayer used her rewards cards. Second, the statements themselves emphasized that they were not intended for tax purposes, and that the IRS recommends keeping a contemporaneous diary of gambling activity. See IRS Publication 529.

The Franchise Tax Board took the following—and correct—legal position:

[A]dequate recordkeeping is essential to establish entitlement to a gambling loss deduction… “[I]f a taxpayer fails to maintain adequate records, both her gambling losses cannot be ascertained. In such a case, it cannot be determined whether her gambling losses exceeded her unreported gambling income. In those circumstances, courts have denied the taxpayer a gambling loss deduction.”

The taxpayer made a final effort to support the gambling loss deduction by providing bank records reflecting ATM cash withdrawals at various casinos. The problem with using bank statements for proving gambling losses is that there was no indication the cash withdrawn was actually used for gambling.

Ultimately, the Board of Equalization held for the Franchise Tax Board, disallowing the taxpayer’s gambling loss for the year.

As I say over and over, a taxpayer should maintain a contemporaneous diary of gambling activity. Otherwise one faces a steep uphill battle to meet the burden of proof for substantiation. In today’s case, the taxpayer came up very short.

Case: In re Kakalia, Case No. 404650, California Board of Equalization (Dec. 14, 2011).

Discussion about the possible legalization of online gambling in the U.S. has been gaining more and more traction for some time. An update here on the current legislative developments is long overdue.

California: In late February, Senate Bill 1463 was introduced. The bill would legalize online poker in California, and has a goal of raising $200 million for the state general fund. The bill is co-authored by Senate President Pro Tem Darrell Steinberg. According to the complete bill history for Senate Bill 1463, the bill may be acted upon on or after March 26.

Iowa: This past Thursday, Iowa House Speaker Kraig Paulsen said the State House does not plan to take up Senate File 2275, which would legalize intrastate online poker in Iowa. The State Senate had recently approved the bill in a 29-20 vote. The bill is all but dead.

Mississippi: In late February, House Bill 1373 was introduced. The bill would have legalized online gambling within the state. The bill is now dead.

Nevada: Nevada is far ahead of any other state in this area, having legalized intrastate online poker late last year. In January, the Nevada Gaming Control Board finalized the Technical Standards for Gaming Devices, and the Minimum Internal Control Standards were finalized in February. At this time, it is unclear when online operators will be permitted to accept real-money deposits. Some speculate late 2012.

New Jersey: In early February, Senate Bill 1575 was introduced. The bill would legalize online gambling within the state. Just over a year ago, Governor Christie vetoed a bill that would have legalized intrastate online gambling, citing constitutional concerns. Current bill sponsor Senator Lesniak believes he has addressed these concerns. The bill failed to advance through the legislature during the final voting session this past week, however, so it may not be subject to a vote for at least six more weeks.

Last week, the Los Angeles Angels signed first baseman Albert Pujols to a 10-year, $254 million contract. The contract is the second largest in baseball history, bested only by Alex Rodriguez’s current $275 million deal with the New York Yankees.

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Leaving the St. Louis Cardinals and the State of Missouri, Pujols will now play a majority of his games in the State of California. The Bronze Golden State imposes the highest personal income tax rate for players with annual salaries exceeding $1 million among all states hosting Major League Baseball teams. The rate is 10.3%.

But Pujols’ state income tax burden from his baseball play isn’t calculated by simply taking 10.3% of his annual salary. That’s because he plays baseball in many states throughout the season. Assuming he doesn’t become a resident of California, the 10.3% rate applies only to the number of “duty days” he spends in California. The remainder of his salary is prorated based upon the other states he plays in. This taxation structure is often called the “Jock Tax.”

According to Fangraphs, Pujols’ effective state income tax rate as an Angel is 7.2% for the 2012 season. Interestingly, had Pujols instead signed with the Los Angeles Dodgers, a team just 30 miles from the Angels, he’d be subject to a 7.7% effective rate. The difference is because, in large part, Pujols will play more games in states with no personal income tax—such as Texas (Rangers) and Washington (Mariners)—than if he became a Dodger. If Pujols re-signed with the St. Louis Cardinals, his 2012 effective rate would have been 5.2%.

If Pujols does become a resident of California, however, then his effective rate goes up, because then he must report his worldwide income to California. We’ve seen this type of issue arise before. In 2007, the New York State Department of Taxation and Finance asserted that a certain professional baseball player should have filed as a New York resident for his 2001 through 2003 tax years, and thus be subject to NYS income tax on all of his income. The player: Derek Jeter.

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At the time, Derek Jeter owned a home near the Yankees’ spring training complex in Tampa, Fla. The problem for Jeter was that he also owned an apartment in the Trump World Towers in Manhattan. Of course, NYS auditors took the position that Jeter was domiciled in New York. Jeter eventually reached a private, out-of-court settlement for the case.

Although we’ll likely never learn the outcome of Jeter’s settlement, what we do know is that state residency for professional athletes is a topic that isn’t going away anytime soon. An article discussing the Jeter case suggests that LeBron James’ decision to play for the Miami Heat over the New York Knicks may have been in part influenced by Florida’s personal income tax haven.

A part of me thinks some of these athletes make so much money that the bottom line tax implications to them is negligible. But, since we see contract holdouts, arbitration, and other forms of intense negotiations for professional athletes all the time, another part of me believes taxes play a role.

One possible problem resulting from enacting a tax that applies to only one entity is that if that taxpayer refuses to pay it, then there’s no revenue stream. The Times-Herald is reporting that city officials of American Canyon, California are learning this from the Napa Valley Casino, which operates the city’s only card room.

About a year ago, city voters approved a $2 card room admission tax. To date, the casino has refused to pay the tax on the grounds that the tax is unconstitutional. The casino believes fewer patrons would frequent the card room. Because of $2? I’m not so sure.

The City Council issued a resolution directing the City Attorney to compel the casino to pay the tax. Will authorities padlock the casino if it doesn’t pay up? I doubt it will come to that. If history is any indication, I suspect the sides to negotiate an agreement so the casino doesn’t take a hit in expected profits and the city receives its desired revenue stream.

The medicinal marijuana industry in California is taking some big hits this week.

The Associated Press is reporting that federal prosecutors have just sent letters to marijuana dispensaries in California with a warning that the dispensaries must be shut down within 45 days or their operators could face federal criminal charges. Letter recipients were told they cannot justify the legality of operations based upon California’s 15-year-old medical marijuana law.

Essentially, federal prosecutors’ position is that the Supremacy Clause applies. California’s four U.S. attorneys plan to hold a news conference tomorrow.

If that isn’t big enough of a blow, the IRS is also examining medicinal marijuana dispensaries. Earlier this week, the Bay Citizen reported that Harborside Health Center, known as the largest medicinal marijuana dispensary on the West Coast, may be facing a rather large tax bill.

The law at issue, section 280E of the Internal Revenue Code, is easy to understand. Essentially, the law says that taxpayers engaged in the trade or business of trafficking in controlled substances cannot claim typical business expense deductions such as payroll, rent, health insurance, and worker’s compensation. Without these deductions, medicinal marijuana dispensaries would have to pay tax on gross income, rather than net income.

As already noted, medicinal marijuana is legal under California law. Section 208E, however, applies not only to the law of the state in which the business occurs, but also to federal law. The Controlled Substances Act considers marijuana as a controlled substance.

The IRS has disallowed Harborside Health Center’s deductions for the dispensary’s 2007 and 2008 tax years, resulting in an additional tax liability of $2.4 million. Harborside is taking the IRS examination changes to IRS Appeals. Harborside is currently under audit for its 2009 and 2010 tax years.

East Bay Congressman Pete Stark introduced a bill earlier this year so that section 280E would no longer apply to medical marijuana dispensaries. Considering today’s announcement of the possible shutdown of medicinal marijuana dispensaries in California, I highly doubt the bill will make progress anytime soon.