Sixteenth Amendment
On February 3, 1913, the Sixteenth Amendment to the U.S. Constitution was ratified. The Amendment is short – only 30 words – but it has a long reach and has had great impact on our nation’s economic life.
It reads as follows:
The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. (Emphasis added)
The first thing to note is that our income tax is based on income, which, for businesses, is determined by subtracting expenses from revenues. You might want to think of it as a tax on business profits, and that would be largely accurate. However, in certain cases, the tax code’s definitions of “revenue,” “expenses,” and “net income” are different from generally accepted accounting principles.
The next thing to note is that income “from whatever source derived” is subject to the Federal income tax. This is a very expansive definition and includes practically everything. The two main pillars of our federal income tax system today are:
· All income is taxable unless specifically exempted, and
· No expense is deductible unless specifically allowed.
It doesn’t matter how the income is received: by check, in cash, exchanging goods or services (barter) – it’s all considered taxable. It also doesn’t matter where it’s received. Income received by a U.S. citizen or business anywhere in the world is subject to U.S. tax. The income of children is also taxable (as in the case of child actors).
Barter
A lot of controversy has arisen over the years relating to barter – paying for goods or services with other goods or services – rather than in cash. The problem is not whether it’s taxable or not (it is), but how to value it.
The principle of “fair market value” has been used to value payments in property or services, rather than cash. “Fair market value” is defined as:
The price that a seller would accept and a purchaser would pay for property or services, both being knowledgeable about all the pertinent facts, and neither being under a compulsion to buy or sell.
As an example (not related to motor sports) movie stars who make presentations at functions such as the Academy Awards often receive gift baskets, which may contain food, expense-paid vacations, clothing, etc. The IRS has estimated the value of some of these baskets as exceeding $100,000. It’s taxable – all of it.
The discussion about barter is particularly relevant in the case of the receipt of “free” products or services in exchange for advertising.
Motor Sports Revenue
There are three major sources of income for racing teams in motor sports:
· Prizes.
· Contingency money, based on cumulative annual points.
· Sponsorship, including free products and/or services.
All of it is taxable, regardless of what form it was received in. Normally, the organization providing the prize should provide the recipient with an IRS Form 1099-MISC if the payment exceeds $600. The name of the recipient and the giver as well as the Federal ID numbers of both will be listed on the form. A copy will be sent to the IRS.
If any prize or award is given and no IRS form is issued, the recipient is still responsible for reporting the revenue to the IRS on his or her tax return.
Consequences
One of the worst situations that can befall anyone is failure to report income. All sorts of things can happen – all of them bad.
- The IRS can take a look at your bank deposits and standard of living and make an estimate as to your true income. It’s up to you to prove otherwise.
- Penalties and interest will accumulate.
- If the amount of understatement of revenue exceeds 50% of what was on your original return, the IRS can go back six years, not just three.
- In the worst case, notices of seizure and forfeiture will be issued, which can damage or destroy your personal and business reputation.
A few years ago, Helio Castroneves, the IndyCar driver, along with his sister and lawyer, were accused of hiding assets in Panama and the Netherlands. Although they were ultimately found innocent, they had to go through the time and expense of a trial. According to a lawyer who writes for Sports Illustrated, the government is 90% successful in prosecuting tax evasion cases.
Last Thoughts
I’m sometimes asked about the best course of action if a taxpayer owes taxes but hasn’t got the funds. Should they write a letter, instead of filing a return? Or, should they just wait until the funds accumulate and then file the return and pay the tax?
The answer is always: file the return even if you can’t pay. Penalties for failure to file can be greater than the penalties for failure to pay. In some cases, a payment program can be worked out with the IRS. But in any case, file the return on time.
Contact me at:
Until next time …
Phil Schurrer, CPA
“This posting is intended to provide general information regarding the subject matter covered. It is provided with the understanding that the author is not engaged in rendering legal, accounting, or other professional services. This information should not be used as a substitute for professional advice in specific situations. If legal advice or other expert assistance is required, the services of a professional should be sought.”
- Adopted from a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.
Attorneys and other professionals dealing with specific matters and situations should also research original sources of authority.
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