Taxable Talk

As I’ve said, there is an income tax and you do need to pay it. Today’s petitioner in Tax Court didn’t like that idea and filed case after case in Tax Court citing frivolous arguments.

In 2006, the petitioner received just over $45,000 in military retirement. He didn’t file a tax return, so the IRS prepared a Substitute for Return. A notice of deficiency was sent and the petitioner timely filed a Tax Court petition. That was about the only thing that was done correctly — the timely filing.

Unfortunately for the petitioner,

At no time before or during trial did petitioner attempt to substantiate any deduction or dispute the receipt of income that was included in the statutory notice. At all times petitioner has relied solely on frivolous arguments about tax return filing requirements, preparation of substitutes for returns, and procedures for determination of tax deficiencies and additions to tax.

It’s not good when the Court can cite a case you brought up as a precedent against you:

Petitioner continues to take up this Court’s valuable time and resources with frivolous and irrelevant arguments. To expand upon his contentions is simply not necessary. As this Court stated recently in Wheeler v. Commissioner, T.C. Memo. 2010-188: “To do so would be to encourage the dilatory conduct that * * * [petitioner] has employed throughout the history of this case and would neither dissuade petitioner nor provide useful guidance to taxpayers with legitimate cases.”

Not only did the petitioner lose the case, but the maximum possible frivolous penalty was awarded — $25,000. The Court also noted that his appeals (to the 10th Circuit Court of Appeals) have also started to receive sanctions (penalties). He escaped without penalty on his first appeal, was sanctioned $4,000 on the second appeal, and $6,000 on the third.

The only good news out of this case is that the petitioner is helping to reduce the budget deficit.

Case: Wheeler v. Commissioner, T.C. Memo 2011-278

An unenrolled tax professional found herself in Tax Court yesterday. The IRS claimed that her claimed deductions weren’t valid; she felt she had even more deductions coming. The Court had to determine who was right.

First, I’m an enrolled tax professional; I’m in one of three professions with full rights to practice at the IRS. I’m an Enrolled Agent. The petitioner was identified as just a tax preparer, so she wasn’t an EA, CPA, or attorney. There are some good unenrolled preparers (Robert Flach, for example), so being unenrolled isn’t necessarily a bad thing.

However, if you prepare tax returns you are supposed to know the rules about what is and isn’t deductible. You do have to have substantiation for the deductions you take. And the first problem was her records.

Petitioner presented canceled checks, bank account statements, receipts, and invoices purporting to substantiate various items claimed as business expense deductions. These records are not well organized and have not been submitted to the court in a fashion that allows for easy association with the portions of deductions that remain in dispute. Nevertheless, we make what sense we can with what we have to work with and summarize our findings in the following paragraphs.

The petitioner claimed nearly $35,000 of contract labor expense but there was a problem. “None of
the numerous receipts petitioner offered in support of her claimed contract labor expense were for contract labor.” She did have a few receipts mixed in with the contract labor items that were deductible elsewhere, but that was a major misstep. She tried to get something at trial, but wasn’t successful:

At trial petitioner attempted to claim a deduction for additional contract labor expenses. Petitioner introduced photocopies of checks and a few pages of someone’s handwritten timesheet. The checks are photocopied such that the dates are missing or incomplete, and the full amount cannot be determined for one of the checks. These records are incomplete, and there is not enough information to permit a reasonable estimate. Accordingly, respondent’s complete disallowance of petitioner’s $34,880 deduction for contract labor is sustained.

There’s more on specific deductions, but you should get the picture. This tax preparer didn’t do a particularly good job with her own records. The IRS asked the Court to impose an accuracy-related penalty.

The accuracy-related penalty is not imposed with respect to any portion of the underpayment as to which the taxpayer shows that he or she acted with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, supra at 448. Petitioner offered no evidence that she acted with reasonable cause and in good faith. Accordingly, we hold that petitioner is liable for a section 6662(a) accuracy-related penalty due to negligence or disregard of rules or regulations.

All tax professionals are held to a high standard if you end up at Tax Court: We are supposed to know the rules of substantiation. If we don’t, the Court isn’t going to be sympathetic at all.

Case: Linzy v. Commissioner, T.C. Memo. 2011-264

Everyone is human. Sometimes we forget that 1099 on the tax return. Today, the Tax Court looked at a case where a tax professional omitted just one 1099. The problem was that this 1099 represented $3.4 million of income, and the IRS assessed a $104,295 accuracy-related penalty. The petitioner argued that because he relied on the advice of a professional, he shouldn’t have to pay the accuracy-related penalty. The IRS disagreed, and The Tax Court had to decide what to do.

The basic facts weren’t in dispute. The petitioners ended a “swap” transaction, and realized $3.4 million of income in 2006. For reasons that are unknown, the 1099 from Deutsche Bank didn’t make it on to their return. Mind you, this wasn’t a simple return: “Petitioners’ payors reported that income to petitioners and to the IRS on more than 160 information returns, e.g., Schedules K-1 and Forms 1099, including the Deutsche Bank Forms 1099-MISC and 1099-INT…For 2006 petitioners filed 27 State income tax returns and a joint Federal income tax return.” The return itself was 115 pages thick.

There also wasn’t a dispute about the taxpayers using a professional. “To prepare their 2006 Federal income tax return, petitioners hired Venture Tax Services, Inc. (“VTS”), a niche firm specializing in tax work for private equity and hedge funds as well as such funds’ general partners…The VTS employee charged with actually preparing the return was a Massachusetts certified public accountant (“C.P.A.”) who similarly had more than 20 years of tax compliance experience, including employment with major accounting firms.”

The IRS discovered the omission, and assessed the additional tax. This increased the total tax from $3.7 million to $4.2 million. The petitioners paid the tax and interest, but disputed the penalty. The law allows,

A taxpayer who is otherwise liable for the accuracy-related penalty may avoid the liability if he can show, under section 6664(c)(1), that he had reasonable cause for a portion of the underpayment and that he acted in good faith with respect to that portion.

And relying on a professional is an exception: “Reliance on * * * professional advice * * *constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.”

The problem for the petitioners was that, in the view of the Tax Court, no advice was given by the professional that the income shouldn’t have been included.

The taxpayer must show (in the words of Neonatology Associates, 115 T.C. at 99 (emphasis added)) that he “relied in good faith on the adviser’s judgment.” Petitioners present no testimony of the preparer (nor any other evidence) to show that the income was omitted from the return because of any “analysis or conclusion” or “judgment” by VTS that the income was not taxable. When the Supreme Court discussed the “reasonable cause” defense in Boyle, it characterized the relevant professional role as giving “substantive advice”, id. at 251, and contrasted that professional function with things that “require[] no special training”, id. at 252. No “special training” was required for Mr. Woodsum to know that the law required him to include on that return an item of income that he had received and that Deutsche Bank had reported on Form 1099.

A similar theory allows for a return preparer’s error to allow for the removal of the accuracy-related penalty. But the petitioners fail here, too. First, the case was submitted fully stipulated, and there was no stipulation regarding the cause of the error. Second, there was no evidence that the taxpayers spent time reviewing the return.

“Even if all data is furnished to the preparer, the taxpayer still has a duty to read the return and make sure all income items are included.” Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981).

Mr. Woodsum, however, makes no showing of a review reasonable under the circumstances. He personally ordered the termination that gave rise to the income; he received a Form 1099-MISC reporting that income; that amount should have shown up on Schedule D as a distinct item; but it was omitted…A review undertaken to “make sure all income items are included” (in the words of Magill)–or even a review undertaken only to make sure that the major income items had been included–should, absent a reasonable explanation to the contrary, have revealed an omission so straightforward and substantial.

The Tax Court concluded,

That is, when his own receiving of income was in question, Mr. Woodsum was evidently alert and careful. But when he was signing his tax return and reporting his tax liability, his routine was so casual that a half million-dollar understatement of that liability could slip
between the cracks. We cannot hold that this understatement was attributable to reasonable cause and good faith.

Case: Woodsum v. Commissioner, 136 T.C. No. 29

Every so often I report on a frivolous case at the Tax Court. You know, the people who claim that only income earned outside of the US is subject to tax, or that I’m a citizen of California, not the United States, etc. Here’s my helpful hint: Don’t try this at home.

In the years I’ve been writing this blog (six and counting), I can’t recall a full decision of the Tax Court on a frivolous case…until now. Yesterday, the Tax Court looked at Scott Wnuck. At his trial in Columbia, South Carolina, he was hit with a $1,000 penalty for bringing a frivolous case. Mr. Wnuck asked the Court to reconsider, with the grounds being that the Court had not adequately addressed his
arguments. Mr. Wnuck got his wish: The Tax Court did reconsider his case.

Of course, sometimes you have to be careful of what you ask for: The penalty for bringing a frivolous matter to the Tax Court was increased to $5,000. Joe Kristan has more.