Today I write about a recent case out of North Carolina involving U.S. Department of Justice seizure of a taxpayer’s video poker machines at his place of business. Although we hear about similar seizures fairly often, this particular case included a very interesting tax issue.
In 2006, the DOJ executed a seizure warrant at Harrison Amusement Park because the taxpayer, Robert Harrison, was allegedly operating an illegal gambling business there. Showing a little compassion, the DOJ did not take all of the taxpayer’s assets. They left pool tables and jukeboxes. Sometime in 2007, the taxpayer liquidated those assets for $450,000, and then deposited the funds into his personal bank account.
A day after making the deposit, the taxpayer purchased shares in the amount of $450,000 out of a money market fund account. Problem was, the taxpayer’s money market account had been previously frozen pursuant to a seizure warrant. Shortly thereafter, the feds seized the $450,000 and prevented Mr. Harrison from exchanging, transferring, or redeeming the money until court order directed otherwise.
Had the taxpayer simply kept the $450,000 in his personal bank account, it would not have fallen within the scope of the seizure warrants. Alternatively, he could have bought a car or purchased real estate with the funds, as the taxpayer even acknowledged. Whoops.
Authorities brought forfeiture proceedings against Mr. Harrison, alleging violation of several federal statutes, including 18 U.S.C. § 1955 (illegal gambling businesses), as bases for seizure and forfeiture of the taxpayer’s properties.
In 2008, the taxpayer entered into a settlement agreement, and forfeited to the federal government all $450,000 that was frozen, less $10,000 exempt from forfeiture. He also received three years probation.
Now to the interesting part. After the taxpayer filed his 2007 North Carolina individual income tax return reflecting no taxable income, the N.C. Department of Revenue challenged the return, asserting that the taxpayer owed tax on the $450,000 he received upon liquidating his company’s assets.
Wait, he owes tax on funds that were seized? That was the Department’s position. And the Department’s legal specialist, who reviewed the ALJ’s decision in favor of the taxpayer, agreed.
Because the taxpayer did not renounce his ownership, dominion, or control over the $450,000 in 2007, the income was taxable. Had the taxpayer renounced or rescinded his interest in the funds, said the Department, he would not have been able to enter into the 2008 settlement agreement.
The logic makes sense. While the result seems unfair, the taxpayer may obtain some relief by claiming a deduction in his 2008 tax year for the amount forfeited to the federal government. Well, maybe not.
In the Fourth Circuit, said the Department, “no deduction may be allowed for the forfeiture of gambling assets due to the frustration of public policy that would ensue.” Put another way, there’s no tax benefit in connection with operating illicit gambling activity. Does that principle extend to a deduction for gambling losses? My reading says no.
The taxpayer may appeal the Final Agency Decision in the Superior Court, but I don’t believe he has a leg to stand on here.