Taxable Talk

We’ve said it before, and we’ll continue to say it: Save your paperwork, receipts, etc. If you’re ever audited by the IRS, you need documentation. If you have it, things (usually) will go well; if not, expect a battle.

Yesterday the Tax Court decided a basis case regarding an inherited portion of a home. The taxpayers became owners of 1/3 of a house after the 1/3 owner left the home. The owners then sold the home. The only question for the court to decide was the basis of the home for tax purposes.

Basis questions can be quite complex. In general, your basis in your home is the price you paid for the home, plus costs involved in purchasing the home, plus costs for selling the home and related legal expenses (including defending the title), and plus any capital improvements you made in the home. Capital improvements are major repairs such as a new roof or new carpeting; replacing one shingle is a minor repair. And, as always, you must document the improvements.

Unfortunately, the petitioners had no paperwork documenting any of the improvements (which were done by the prior 1/3 owner). Because one of the petitioners is a CPA, the Tax Court stated, “…should have known that such improvements should have been documented if, as petitioners contend, the expenditures constituted capital expenditures….” The petitioners, as a consolation prize, were allowed to deduct $5,000 in legal expenses that the court inferred were expended.

Case: Bettencourt v. Commissioner, T.C. Summary 2005-175

Is a “Contract for Deed” deductible when used to satisfy alimony obligations? The Tax Court today said no.

Contract for Deed’s are financing arrangements that allow buyers to purchase property from sellers by borrowing the money from the sellers. The Tax Code only allows deductions for alimony for cash or cash equivalents (e.g. checks). The court ruled that a Contract for Deed is a debt instrument and cannot be deducted as alimony.

In the same case, the petitioner also lost his arguments for deducting Bed & Breakfast expenses and writing expenses because of lack of books and documentation. We cannot emphasize enough that you need to keep your backup paperwork. Have good books (or hire a good bookkeeper).

Case: Lofstrom v. Commissioner, 125 T.C. No. 13

What happens if you receive your W-2 and your company made a mistake on your social security number and it’s off by one digit? Being an unscrupulous individual, you sense opportunity! “I don’t have to report my wages from my employer! The IRS won’t be able to match up the wages!”

Of course, when the IRS receives the wage information (forwarded by the Social Security Administration), they’ll notice the mistake and send a letter to the employer. The employer will then check their records, and fix the error (or let the IRS know that their records match the data sent).

So what happens to the employee who doesn’t file? Problems, of course.

First, you did receive the W-2. Second, whether or not you receive a W-2, you are required to file your tax return each year. In fact, there’s even a form for you to use if you don’t get a W-2, Form 4852. And third, if you don’t file, sooner or later the IRS will catch up with you. There is no statute of limitations if you don’t file.

Today the Tax Court decided a case where the petitioner claimed he filed, but the IRS couldn’t find a record of his filing under his social security number, the incorrect SSN used by his employer, or his spouse’s SSN. The numbers didn’t make sense, either. And there was no record of him filing a state tax return. The Tax Court didn’t believe him. And he didn’t spend the $4.42 on certified mail, return receipt requested to prove he mailed his returns.

The court found him liable for his taxes, penalties for failure to file, and failure to make timely estimated payments. In the future, he might just let his employer know about the error and file his returns.

Case: Zakhem v. Commissioner, T.C. Summary 2005-171

Sometimes all you can do is laugh. And most likely Judge Powell, who decided today’s case, was laughing quite a bit.

The case involved taxpayers disputing the assessment of a penalty for the untimely filing of their tax return. Just one problem: the return was timely filed and the IRS did not assess such a penalty. Rather, the IRS assessed penalties for failure to pay estimated taxes and for failure to pay tax. As the judge noted, “It is sufficient to say that these are separate additions to tax for different actions.”

Case: Goldman v. Commissioner, T.C. Summary 2005-165