Taxable Talk

An attorney’s tax return had two major errors: $450,000 of gross receipts were left off the return and $505,417 of Contract Labor expenses were deducted as not only Contract Labor but also as Cost of Goods Sold. The return was audited, and the taxpayer agreed with the additional income and that the labor was double-deducted and pays the tax. However, he disputed the 20% accuracy-related penalty. The dispute ends up in Tax Court.

The amount of income underreported is enough where the penalty would apply if an exception doesn’t exist.

The section 6662 penalty does not apply to any portion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to * * * [it]…” Reasonable cause has been found when a taxpayer selects a competent tax adviser, supplies the adviser with all the relevant information, and consistent with ordinary business care and prudence, relies on the adviser’s professional judgment as to the taxpayer’s tax obligations.

Put simply, the Court didn’t believe that the attorney used sufficient care in reviewing his return.

Petitioners contend that they reasonably and in good faith relied on their C.P.A.’s advice in the preparation of their 2010 return. We disagree. On the basis of Mr. Ogden’s testimony at trial, we find that his cursory review of petitioners’ return did not constitute proper review…

A reasonable inspection of the return by petitioners would have uncovered both the unreported gross receipts and the improperly claimed deduction. Although petitioners’ C.P.A. [firm] testified that the portion of contract labor expenses treated as COGS on petitioners’ return was hard to spot, we believe Mr. Ogden had sufficient knowledge to detect the error on the return. Because Mr. Ogden prepared the Forms 1099-MISC for the attorneys at his firm, he should have known the total amount of contract labor expenses. Even so, the amount of contract labor expenses reported on petitioners’ return did not remotely match the amount of total contract labor expenses reported on Mr. Ogden’s law firm’s Form 1096. This, combined with the fact that petitioners did not report $450,000 of income on their return, shows that more diligence was needed on their part to reasonably assess their proper tax liability. [citations omitted]

There are a couple of lessons from this decision. First, have everyone you need at the trial. While the CPA who represented the taxpayer in the audit testified at the trial, the CPA who prepared the return did not. “Petitioners did not call the C.P.A. who prepared their 2010 return as a witness, and they presented no evidence that this C.P.A. gave “advice” that they could rely on.” This didn’t sit well with the Court.

More importantly, if you’re an attorney, a CPA, or an Enrolled Agent, the Tax Court is going to expect you to know tax law. You will also be held to a higher standard on any financial disputes. (The same will be true of other financial officers, such as a controller, CFO, etc.) When you’re reviewing a tax return, do not simply take a cursory look at the return. You should want to make sure it’s accurate. If you’re signing a return with $1 million of income, isn’t it worth more than a few seconds to review it? I would certainly think so. The Tax Court definitely did.

Case: Ogden v. Commissioner, T.C. Memo 2015-241

For most of us the saying “If you don’t succeed at first, try, try again,” is good advice. However, it’s not good to try to deduct personal expenses as business expenses on your tax return. It’s an especially bad idea to then try justifying that at Tax Court repeatedly. Of course, that happened today.

Petitioners are no strangers to this Court. This case constitutes, at the minimum, their 14th case, involving at least one of petitioners, spanning almost 30 taxable years from 1981 to 2010. Most recently they litigated the consolidated cases at docket Nos. 16195-12S, 26201-12S, and 1070-13S, which were decided by this Court’s T.C. Summary Opinion 2014-105. Those cases, like this one, addressed similar continuing issues arising primarily from petitioners’ efforts to substantiate and deduct expenses which they attribute to Mr. Boring’s Schedule C sole proprietorship d.b.a. Rambor Technology (Rambor) or his partnership Board Automation. The substantive tax disputes emanate from petitioners’ misunderstanding of the terms “ordinary” and “necessary” as used in defining deductible business expenses pursuant to section 162 and the interrelationship of that section with section 262, defining nondeductible personal expenses. [footnotes omitted]

The issues in this case were deducting expenses without backup, including what appear to be numerous personal expenses. In order to deduct business expenses, they must be both ordinary and necessary for the business.

An expense is ordinary for purposes of this section if it is normal or customary within a particular trade, business, or industry…An expense is necessary if it is appropriate and helpful for the development of the business…Section 262, in contrast, generally precludes deduction of “personal, living, or family expenses.”

The breadth of section 162(a) is tempered by the requirement that any amount reported as a business expense must be substantiated, and taxpayers are required to maintain records sufficient therefor.[citations omitted]

Put simply, almost all of the expenses that were deducted on the return were either nondeductible personal expenses or had no substantiation.

The Court goes through great detail in this case. The reason is that the Court doesn’t want to hear the 15th case dealing with the same issues.

We warn petitioners, however, that their conduct is in material noncompliance with Federal tax law. Our opinions here and in T.C. Summary Opinion 2014-105 are tailored to explain what the law requires. Petitioners have been fairly warned; consequently, any further conduct in the same vein as that considered here and in our previous cases addressing their tax liabilities and tax payments may well, under present law, result in the application of a section 6673 penalty in an amount of up to $25,000.

Section 6673 is the penalty for filing a frivolous Tax Court case. The Court ruled that the case wasn’t entirely frivolous because of one issue. On the tax return, the petitioners took the home office deduction (including mortgage interest). That deduction was denied, but the mortgage interest taken on the home office deduction should have been moved to be an itemized deduction on Schedule A. If not for that, the petitioners might not only owe the tax, penalties (they were hit with the accuracy-related penalty), and interest, but the frivolous penalty too. They somehow avoided the late filing penalty (this was noted in a footnote on the return), so they should consider themselves lucky.

Case: Boring v. Commissioner, T.C. Summary Opinion 2015-68