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Showing posts with label penalty. Show all posts
Showing posts with label penalty. Show all posts

Sunday, February 4, 2024

Incorrect Submission Leads to Dismissal of Refund Claim

 

You should be able to talk with someone at the IRS and work it out over the phone.”

I have lost track of how many times I have heard that over the years.

I do not disagree, and sometimes it works out. Many times it does not, and we recently went through a multi-year period when the IRS was barely working at all.

There are areas of tax practice that are riddled with landmines. Procedure - when certain things have to be done in a certain way or within a certain timeframe – is one of them. Ignore those letters long enough and you have an invitation to Tax Court. You do not have to go, but the IRS will – and automatically win.

I was looking at a case recently involving a claim.

Tax practitioners generally know claims under a different term – an amended return. If you amend your individual tax return for a refund, you use Form 1040X, for example.

There are certain taxes, including penalties and interest, however, for which you will use a different form. 

Frankly, one can have a lengthy career and rarely use this form. It depends – of course – on one’s clients and their tax situations.

And yes, there is a serious procedural trap here – two, in fact. If you use this form but the IRS has instructed use of a different form, the 843 claim will be invalid. You will be requested to resubmit the claim using the correct form. By itself it is little more than an annoyance, unless one is close to the expiration of the statute of limitations. If that statute expires before you file the correct form, you are out of luck.

There is another trap.

Let’s look at the Vensure case.

Vensure is a professional employer organization, or PEO. This means that they perform HR, including payroll responsibilities, for their clients. They will, for example, issue your paycheck and send you a W-2 at the end of the tax year.

Vensure had a client that stiffed them for approximately $4 million. As you can imagine, this put Vensure in a precarious financial situation, and they had trouble making timely payroll tax deposits in later quarters.

I bet.

Vensure did two things:

(1)  They filed amended payroll tax returns (Forms 941X) for refund of payroll taxes remitted to the IRS on behalf of their deadbeat client.

(2)  They submitted Forms 843 for refund of penalties paid over the span of six quarters (payroll taxes are filed quarterly).

Notice two things:

(1)  The claim for refund of the payroll taxes themselves was filed on Form 941X, as the IRS has said that is the proper form to use.

(2)  The claim for refund of the penalties on those taxes was filed on Form 843, as the IRS has said that is the proper form for the refund or abatement of penalties, interest, and other additions to tax.

Vensure’s attorney prepared the 843s. Having a power of attorney on file with the IRS, the attorney signed the forms on behalf of the taxpayer, as well as signing as the paid preparer. He did not attach a copy of the power to the 843, however, figuring that the IRS already had it on file.

Makes sense.

But procedure sometimes makes no sense.

Take a look at the following instructions to Form 843:

You can file Form 843 or your authorized representative can file it for you. If your authorized representative files Form 843, the original or copy of Form 2848, Power of Attorney and Declaration of Representative, must be attached. You must sign Form 2848 and authorize the representative to act on your behalf for the purposes of the request.” 

The IRS bounced the claims.

The taxpayer took the IRS to court.

The IRS had a two-step argument:

(1) For a refund claim to be duly filed, the claim’s statement of the facts and grounds for refund must be verified by a written declaration that it is made under penalties of perjury. A claim which does not comply with this requirement will not be considered for any purpose as a claim for refund or credit. 

(2)  Next take a look at Reg 301.6402-2(c):  

Form for filing claim. If a particular form is prescribed on which the claim must be made, then the claim must be made on the form so prescribed. For special rules applicable to refunds of income taxes, see §301.6402-3. For provisions relating to credits and refunds of taxes other than income tax, see the regulations relating to the particular tax. All claims by taxpayers for the refund of taxes, interest, penalties, and additions to tax that are not otherwise provided for must be made on Form 843, "Claim for Refund and Request for Abatement."

Cutting through the legalese, claims made on Form 843 must follow the instructions for Form 843, one of which is the requirement for an original or copy of Form 2848 to be attached.

Vensure of course argued that it substantially complied, as a copy of the power was on file with the IRS.

Not good enough, said the Court:

The court agrees with the defendant that the signature and verification requirements for Form 843 claims for refund are statutory.”

Vensure lost on grounds of procedure.

Is it fair?

There are areas in tax practice where things must be done in a certain way, in a certain order and within a certain time.

Fair has nothing to do with it.

Our case this time was Vensure HR, Inc v The United States, No 20-728T, 2023 U.S. Claims.






Sunday, December 10, 2023

A Ponzi Scheme And Filing Late

I am reading a case involving a late tax return, a Ponzi scheme, and an IRS push for penalties.

It made me think of this form:


It is used for one of two reasons:

(1)  Someone is filing a tax return with numbers different from a Schedule K-1 received from a passthrough entity (such as a partnership).

(2)  Someone is amending a TEFRA partnership return.

That second one is a discussion for another day. Let’s focus instead on the first reason. How could it happen?

Easy. You are a partner in a partnership. You bring me your Schedule K-1 to prepare your personal return. I spot something wrong with the K-1, and the numbers are large enough to matter. We contact that partnership to amend the return and/or your K-1. The partnership refuses.

COMMENT: We would use Form 8082 to inform the IRS that we are not using numbers provided on your K-1.

This is a tough spot to be in. File the form and you are possibly waiving a flag at the IRS. Fail to file it and the IRS has procedural rights, and those include the right to change your numbers back to the original (and disputed) K-1.

There is another situation where you may want to file Form 8082.

Let’s look at the Rosselli case.

Mr. Roselli (Mr. R) was a housing appraiser. Mrs. Rosselli was primarily a homemaker. Together they have five children, three of whom have special needs.

Through his business, Mr. R came to know the founder of a solar energy company (DC Solar). Turns out that DC Solar was looking for additional capital, and Mr. R knew someone looking to invest. The two were introduced and – in gratitude – Mr R became a managing member in DC Solar via his company Halo Management Services LLC.

This part turned out well for the R’s. In 2017 DC Solar paid Halo approximately $300 grand. In 2018 DC Solar paid approximately $414 grand. Considering they had no money invested, this was all gravy for the R's.

COMMENT: Notice that Halo was paid for management services. Halo in turn was Mr. R, so Mr. R got paid over $700 grand over two years for services performed. This was a business, and Mr. R needed to report it on his tax return like any other business.

In late 2018 the FBI raided DC Solar’s offices investigating whether the company was a Ponzi scheme. The owners of DC Solar were eventually indicted and pled guilty, so I guess the company was.

Let’s roll into the next year. It was tax time (April 15, 2019) and there was not a K-1 from DC Solar in sight.

COMMENT: You think?

The accountant filed an extension until October 15. It did not matter, as the R’s did not file a tax return by then either.

The IRS ran a routine check on DC Solar and its partners. It did not take much for the IRS to flag that the R’s had not filed a 2018 return. The IRS contacted the R’s, who contacted their accountant, eventually filing their 2018 return in January 2022.

You know what was on that 2018 return? The $414 grand in management fees.

You know what was not on that 2018 return? A big loss from DC Solar.

Here is Mr. R:

Mr. Carpoff informed me that I was to receive Schedule K-1s showing large ordinary losses for 2018 from DC Solar, and as a result I would not have a tax liability for that year. However, before the K-1s could be issued … DC Solar’s offices were raided by the FBI.”

All of DC Solar’s documents and records were seized by federal authorities in the ensuing investigation. As a result, I was unable to determine any tax implications because I did not receive a K-1 or any other tax reporting information from DC Solar.”

Got it: Mr. R was expecting a big loss to go with that $414 grand. And why not? DC Solar had reported a big loss to him for 2017, the prior year.

But the IRS Collections machinery had started turning. By August 2022, the IRS was moving to levy, and the R’s filed for a Collection Due Process (CDP) hearing.

COMMENT: There is maddening procedure about arguing underlying tax liability in a CDP hearing, which details we will skip. Suffice to say, a taxpayer generally wants to fight any proposed tax liability like the third monkey boarding Noah’s ark BEFORE requesting a CDP hearing.

At the conclusion of the CDP hearing, the IRS decided that they had performed all the required procedural steps to collect the R’s 2018 tax. The R’s disagreed and filed with the Tax Court.

The R’s presented three arguments.

  • They reasonably assumed that they would not be required to file or pay tax for 2018 because of an expected loss from the DC Solar K-1.

The Court was not buying this. Not owing any taxes is not the same as not being required to file. This was not a case where someone did not work, meaning they dd not have enough income to trigger a filing requirement. The Rs instead had a more complicated return, with income here and deductions or losses there. Granted, it might compress to no tax due, but they needed to file so one could follow how they got to that answer.

  • The R’s reasonably relied on advice from their accountant and others.

The Court did not buy this either. For one thing, the Rs had never informed their accountant about the $414 grand in management fees. If one wants to rely on a professional’s advice, one must provide all available pertinent information to the professional. The Court was not amused that the R’s had not shared the LARGEST number on their return with their accountant.

  • The R’s argued that they would experience “undue hardship” from paying the tax on its due date.

The R’s argued that their income died up when DC Solar was raided. Beyond that, though, they had not provided further information on what “drying up” meant. Without information about their assets, liabilities and remaining sources of income, the Court found the R’s argument to be self-serving.

Also, the Court did not ask – but I will – what the R's had done with the $700 grand in management fees they received in 2017 and 2018.

Yeah, no. The Court found for the IRS, penalties and all.

And here is what I am thinking:

What if they had timely filed their 2018 return, showing a loss from DC Solar equal to the management fees?

Problem: there was no K-1 from DC Solar.

Answer: attach the 8082.

I think the tax would eventually have turned out the same.

But I also think they would have had a persuasive case for abatement of penalties for late filing and late payment. The penalty for late file and pay is easily 25%, so that abatement is meaningful.

Our case this time was Rosselli v Commissioner, TC Bench Opinion, October 23, 2023.


Sunday, November 5, 2023

Another Runaway FBAR Case

 

Let’s talk about the FBAR (Report of Foreign Bank and Financial Accounts). It currently goes by the name “FinCen Form 114.”

This thing has been with us since 1970. It came to life as an effort to identify foreign financial transactions that might indicate money laundering or tax evasion. 

Sounds benign.

The filing requirement applies to a United States person, defined as

·      A citizen or resident of the U.S.

·      A domestic partnership

·      A domestic corporation

·      A domestic trust or estate

 We’ll come back that first one in a moment.

Next, one needs a financial interest or signature authority in a foreign financial account to trigger this thing.

A foreign financial account includes a bank account, which is easy enough to understand. It would also include a broker account (think Charles Schwab, but overseas). Some are not so intuitive, though.

·      A foreign insurance policy with cash value is reportable.

·      A foreign hedge fund is not.

·      A foreign annuity policy is reportable.

·      A foreign private equity fund is not.

·      A foreign cryptocurrency account is not reportable.

Some require a google search to understand what is being said.

·      A Canadian registered retirement savings plan is reportable.

·      A Mexican fondo para retiro is reportable.

Next, the foreign financial account has to exceed a certain dollar balance ($10,000) at some point during the year.

That $10,000 balance has been there for as long as I can remember. You will have a hard time persuading me that $10,000 in 1986 is the same as $10,000 now, but that number is apparently eternal and unchanging.

The $10,000 is tested across all foreign financial accounts. If it takes your fourth foreign account to put you over $10 grand, then you are over. Testing is done. All your accounts are reportable on a FBAR.

Like so many things, the FBAR started with reasonable intentions but has morphed into something near unrecognizable.

Fail to file an FBAR and the standard penalty is $10 grand. Fail to file for two years and the penalty is $20 grand. Have two foreign accounts and fail to file for two years and the penalty is $40 grand.

And that is assuming the error is unintentional. Do it on purpose and I presume they will execute you.

I exaggerate, of course. They will just bankrupt you.

It puts a lot of pressure on defining “on purpose.”

Let’s look at Osamu Kurotaki (OK).

OK was born in Japan and lives in Japan. He obtained a U.S. green card, making him a U.S. permanent resident. One of the pleasures of being a permanent resident is filing an annual tax return with the United States, irrespective of whether you live in the U.S. or not. One can talk about a foreign income exclusion or foreign tax credit – which is fine – but that annual filing makes sense only if someone intends to eventually return to the U.S. It does not make as much sense if someone does not intend to return, someone like OK.

OK paid someone to prepare his annual U.S. tax return. He found a CPA who was bilingual.

In 2021 the U.S. Treasury assessed civil penalties against OK for more than $10 million. His footfall? He failed to file FBARs. Treasury also upped the ante by saying that his failure was “willful.”

Huh?

Treasury is requesting summary judgement that OK willfully failed to file FBARs, prefers waffle over sugar cones and rooted for the Diamondbacks in the World Series. 

The Court wanted to know how Treasury climbed the ladder to get to that “willful” step.

So do I.

Here is what the Court saw:

·      OK is a Japanese speaker and does not speak English “at all.”

·      OK relied on his bilingual CPA to make sense of U.S. tax filing obligations.

·      His CPA provided annual tax questionnaires in both English and Japanese. The English was for theater, I suppose, as OK could not read English.

·      The CPA’s translation now becomes critical. Here are instructions to the FBAR in English:

U.S. taxpayers are required to report their worldwide income; that is, income from both U.S. and foreign sources.”

·      Here is the Japanese translation:

U.S. resident taxpayers are required to report their worldwide income, that is, income from both US. and foreign sources."

OK told the Court that he did not think he had a filing obligation because he was not a “U.S. resident.”

I get it. He lives in Japan. He works in Japan. His kids go to school in Japan. He is as much a “U.S. resident” as I am a Nepalese Sherpa.

Except …

OK was green card – that is, a “permanent” resident of the U.S.

Technically …

The Court cut OK some slack. Technically - and in a law school vacuum - he was a “resident.” Meanwhile - in the real world – no one would think that. Furthermore, OK hired a CPA who made a mistake. Even a trained professional erred interpreting the Treasury’s word salad. 

The Court said “no” to summary judgement.

Treasury will have to argue its $10 million-plus proposed penalty.

And I believe the Court just outlined reasonable cause.

Perhaps OK should consider turning in that green card. 

Our case this time was Osamu Kurotaki v United States, U.S. District Court, District of Hawaii.

 


Sunday, October 29, 2023

A School And Obamacare Penalties

 

How would you like to get the following notice in the mail?

 

Believe it or not, the IRS sent this to a public school system in Virginia. I am looking at the Tax Court petition as I write this.

This notice is for a Section 6721 penalty, assessed for failure to file certain information forms with the IRS. Common information forms include:

·      Form W-2 (Wage and Tax Statement)

·      Forms(s) 1099 (Interest, Dividends, and numerous others)

·      Form 8027 (Tip Income and Allocated Tips)

·      Forms(s) 1094 & 1095 (Health Insurance)

There is a virtually automatic companion to this penalty - Section 6722 – which assesses another penalty for failure to provide an information form to the recipient.

Combined we are talking over $2.2 million.

To a school?

Let’s go through this.

The school (Arlington) received the above notice dated June 13, 2022.

The second notice (for Section 6722 penalties) was dated June 27, 2022.

The IRS wanted payment by July 12, 2012.

COMMENT: Arlington had an issue. While they knew the IRS was assessing penalties for information returns, they had no idea which information forms the IRS was talking about.

The IRS Revenue Officer (RO) issued a Final Notice of Intent to Levy on July 12, 2022.

COMMENT: The same day?  I have been leaving messages with a Revenue Agent for over two weeks now concerning an individual tax audit, and this RO issued a FINAL on the same day stated in the notice?

COMMENT: There is also a procedural error here. The IRS must issue notices in a certain order, and the RO is not entitled to jump the line and go straight to that FINAL notice.

We learn that this specific RO had previously assessed penalties (without explanation) and filed liens (again, without explanation) on a middle school in the Arlington school system. These miraculously went away before an Appeals hearing could occur.

COMMENT: Sounds like something personal.

On August 10, 2022, Arlington requested a collection due process hearing on the June 13 and June 27 notices. It faced a formidable obstacle, however, as it did not know what the IRS was talking about.

The IRS sent a letter dated December 5, 2022, scheduling an Appeals conference on January 18, 2023. That letter also suggested that Arlington had not filed Forms 1042, which concerns withholding on payments to foreign persons.

COMMENT: Seems an odd one. I would have thought Forms W-2, if anything.

It turns out that the 1042 reference was mistaken.

COMMENT: Clown show.

Arlington (more specifically, Arlington’s attorneys) tried repeatedly to contact the Appeals Officer (AO). It appears that he inadvertently answered his phone one time, and the Appeals conference was moved to January 31, 2023. Arlington still wanted to know what form was costing them over $2.2 million.

The attorneys marched on. They contacted the IRS Practitioner Line, which told them that the penalties might relate to the Affordable Care Act (Obamacare). They also sent a written request to IRS Ogden for explanation and copies of any correspondence concerning the matter.

COMMENT: I’ve done the same. Low probability swing, in my experience.

The attorneys also contacted the Taxpayer Advocate.

Receiving nothing, the attorneys again requested to postpone the Appeals hearing. They learned that two additional penalties had been added. What were the two penalties about? Who knows.

The two late penalties were “abated” before the Appeals hearing on February 10, 2023.

The AO failed to show up to the Appeals hearing on February 10, 2023.

COMMENT: That sounds about right.

At the re-rescheduled hearing on February 24, 2023, the AO wanted to know what Arlington intended to do. Arlington replied that they were still trying to figure out what the penalties were for, and that a little help would be welcome.

That however would require the AO to – gasp – actually work, so he attempted to transfer the case to another AO. He was unsuccessful.

COMMENT: Fire the guy.

On June 30, 2023, the AO sent the attorneys re-generated IRS notices (not copies of originals) proposing $1,1113,000 in penalties for failure to send Forms 1094-C to the IRS and an additional $1,113,000 for failure to provide the same 1094-C to employees.

COMMENT: Finally, we learn the mystery form.

Arlington (really, its attorneys) learned that the IRS had listed a “Lang Street” address for correspondence. Lang Street was never Arlington’s address and was only one of the middle schools in the district. It was, however, the middle school which the RO had liened earlier in our story.

While talking to the AO on June 30, 2023, the attorneys requested additional time to submit a penalty abatement request.  The AO allowed 14 days.

COMMENT: Really? This is the school’s summer recess, no one is there, and you expect people to dig up years-old paperwork in 14 days?

Once again, the AO refused to answer numerous calls and faxes.

The attorneys – frustrated – contacted the AO’s manager. The manager gave them additional time.

On August 21, 2023, Arlington received a mysterious IRS letter about a claim filed on or about February 23, 2023. Problem: Arlington had not filed any such thing.

The attorneys sent a copy of the mystery notice to the AO.

On September 13, 2023, the AO told the attorneys that he had closed the case and issued a Notice of Determination.

COMMENT: This is the “90-day letter” and one’s entrance ticket to the Tax Court.

The attorneys asked why the NOD. The AO explained that he could not provide a penalty abatement while the underlying Obamacare forms remained unfiled.

Uh huh.

By the way, while the AO verbally communicated that a NOD had been issued, Arlington never received it. It appears - best I can tell – that the NOD is stuck at a processing facility.

COMMENT: Fits the rest of the story.

So, what happened with those forms?

It turns out that Arlington sent employees their copies of the Obamacare forms on or about February 28, 2020.

COMMENT: Well, there goes one of the two penalties.

Arlington was going to send the IRS copies on March 16, 2020.

What happened at this point in 2020?

The Governor of Virginia closed all schools for two weeks over COVID-19.

He then closed the schools through the rest of the school year.

On March 30, 2020, Arlington requested an extension of time to file those Obamacare forms with the IRS.

Virtually no one was at the school. People were working remotely, if possible. The school was trying to figure out how to even pay its employees when everyone was remote.

Yeah, I suspect those forms were never sent.

Heck of a reasonable cause, I would say.

And fire the guy.

Sunday, July 9, 2023

Choose The Lesser Of IRS Grumpiness

 

Let’s talk about the failure to file (FTF) penalty.

Most of us must file an annual income tax return. Unless one is an expat (that is, an American living overseas), the return is due April 15. One can extend the return for six months (that is, until October 15), but the extension is for filing paperwork and not for payment of tax.

How is one supposed to estimate the tax if a significant amount of information is unavailable? Many times, there are estimates or informed guesses; the tax preparer will extend the return using those. Sometimes there are no estimates and no informed guesses; one then does their best. I doubt there isn’t a veteran tax preparer that hasn’t been blindsided by a Schedule K-1.

Let’s continue.

You extend your return. Your K-1 comes in heavier than expected. You owe $5,000 in tax with the return, which you file and pay on October 15.

You will have something called the Failure to Pay (FTP) penalty. The tax nerds know this as the Section 6651(a)(2) penalty. The penalty is as follows:

One-half of 1% for each month or part of a month

To a maximum of 25%

Let’s use our $5,000 example.

I count seven months from April through October (remember: a part of a month counts as a month).

The FTP penalty would be $5,000 times .005 times 7 = $175. It stings, but it is not crushing.

Let’s say the return was filed on October 30.

Has something changed?

Yep.

The IRS is strict about filing deadlines. If the return is extended to October 15, then you have until October 15 to file the return (or at least put it in the mail or submit the electronic file). The 15th is not a suggestion.

What happens if you miss the deadline?

You then filed your return late.

Back to our example. You file the return on October 30. You are just 15 days late. How bad can 15 days be?

It is not intuitive. If you file the return on October 30, you have blown the extension, meaning it is like you never submitted an extension at all. Any penalty calculation starts on April 16.

So what? The FTP penalty is still the same: $5,000 times .005 times 7, right?

The difference is that you have just provoked FTP’s big brother: the Failure to File (FTF) penalty. The FTF is the gym-visiting, MMA-training, creatine supplementing and aggressive sibling to the FTP.

Start with the FTP penalty. Multiply it by 10. The tax nerds know the FTF as the Section 6651(a)(1) penalty. 

Are we saying the FTF penalty is $5,000 times .05 times 7?

Nope, this is tax. There is a loop-the-loop to the FTF calculation.

  • The maximum (a)(1) and (a)(2) penalty is 5% per month or part of a month.
  • The math stops when you get to 25% in total.

The first loop means that the FTP penalty comes in at .005 and the FTF penalty comes in at .045 per month (or part thereof), as the maximum cannot exceed .050 per month.

The second loop means that the math stops when you get to 25%.

How does a tax pro handle this?

Easy: multiply by 25%.

Let’s go back to the math: $5,000 times 25% = $1,250.

This could have stopped at $175 had you just filed the return on October 15. Nah, you thought to yourself. What’s another couple of weeks?

$1,075, that’s what ($1,250 - $175). That is an expensive two weeks.

So, what got me fired up about this topic?

I saw the following on a tax return this past week:


Go to the bottom where it reads “Interest Penalties.” Go across to “Failure to File.” You will see $3,619.

Someone has just thrown away over three-and-a half grand by dragging their feet on filing. There goes a vacation, new electronics for the house, an IRA contribution - anything better than sending it to the government.

The client has two years of this, BTW.

But CTG, you say, maybe they did not have the money to pay.

The FTF does not mean that one is unable to pay. Granted, in real life the two issues often go together. One rationalizes. I do not have any money; if I delay filing maybe I can also delay IRS dunning letters and collection activity.

Maybe, but practice tells me it is rarely worth it. You have to go over four years with an FTP penalty before you equal just five months of FTF penalty. That money is just too expensive.

Let’s go back to our example.

Say the $5,000 is for tax year 2021. The taxpayer filed the return on or before October 15, 2022 and only now can pay the tax. What have we got?

First, the FTF penalty goes away, as the return was filed on time.

Second, the FTP penalty would be: $5,000 times .005 times 16 = $400. (I am running the penalty from April 2022 to July 2023)
Third, there will be interest, of course, but let’s ignore that for now.

$400 versus $1,075. Seems clear to me.

What can be done if one cannot get numbers together by October 15?

Here’s a thought.

I have a client who owns a successful drywalling company. We extended his return several years ago, and sure enough – closing in on October 15 – he was out-of-town, relaxed and unconcerned about any looming doom. However, I knew that he had a good year, and that any tax due was going to be significant. An FTF penalty on significant tax due was also going to be significant. We decided to file his return with the best numbers available, intending to amend whenever we obtained more precise numbers.

Did I like doing that?

That is a No.

Did he avoid the FTF?

That is a Yes, but he delayed getting us more accurate numbers. That delay created its own problems. Problems which were … completely … avoidable.

What is our takeaway?

File your return. Extend if you must, but file by the extension date. File even if you cannot pay. Yes, the IRS will penalize you. The IRS is grumpy about not getting its money. The IRS is grumpier, however, about not getting the tax return in the first place.

Remember: when given the option, choose the lesser of IRS grumpiness.

Monday, May 8, 2023

Penalty Abatement For Preparer Errors

 

I was looking over a law review article weighing the pros and cons of different types of Tax Court decisions.

Nerd train, I admit.

But there is something here to talk about.

There are several types of Tax Court opinions. Some have precedential value, and some do not. Precedence means that a Court applies the law in the same manner to cases with the same facts.

One type is a Memorandum opinion. These tend to be heavily factual, and they involve relatively well-settled law.

Another is the Summary (or S) opinion. These involve a relatively modest amount of tax (currently $50 grand) and use a streamlined set of procedures.

The reason for different types of opinion is grounded in practicality. Memo opinions allow the Court to process more clear-cut cases without worrying about establishing unanticipated precedent. The S opinions allow taxpayers a forum without having to hire an attorney to navigate cumbersome Tax Court procedural rules.

I am looking at a case decided as a bench opinion. 

Think about the judge issuing an oral opinion right there and then and you have a bench opinion.

And these types can be combined. A judge may, for example, issue a bench opinion in a memo or S case.

I am looking at something I know all too well.

Mr. Trammer was an IT consultant.

Mrs. Trammer was a social worker.

Mr. Trammer worked primarily from home. Depending upon, he was paid as a W-2 employee or as a 1099 gig worker. He had an office-in-home and all that.

Mrs. Trammer was a W-2 employee. She drove around Michigan visiting childcare and foster care locations. She at times would purchase gifts for the kids.

She sounds like a good person.

They reported all kinds of deductions on their 2019 and 2020 returns: business deductions for the gig, employee business deductions for the social work, charitable deductions for the church.

If you recall, many itemized deductions were reduced or eliminated altogether beginning in 2018.

No surprise, the IRS disallowed a swath of deductions. Some – like employee business deductions – simply did not exist for the tax year at issue. Others – like office-in-home for the gig – had calculation errors.

Got it. They need to dig up documentation. They should immediately concede on the calculation error and employee expenses. The matter should be resolved as routine in correspondence exam.

Off to Tax Court they went.

Huh?

Upon reflection, this makes sense. The IRS and Covid did not play well together. They were not answering the phones over there. Faxing supporting documentation to the AUR Unit was often a joke. I suspect this matter went to Court by default.

Here we go:

The Trammers relied on a paid return preparer to prepare their returns for the years at issue. Although the individual return preparers identified on the 2019 and 2020 returns differed, the Trammers used the same preparation firm for both years.”

That does not sound like a CPA firm. Granted, I prepare only a fraction of returns I sign - staff accountants generally prepare - but I do review all returns before signing. 

Each year, they brought their records … who decided what items to report on the Trammers’ return and where.”

Yep.

The returns contained obvious errors such as reporting the same expense in multiple places.”

The old list-the-same-thing-over-and-over routine. Often these returns are not complex, but the preparer must be diligent when moving numbers. It consequently is common to give these returns to more experienced staff. Ideal would be to give the return to the same experienced staff every year.

The Court made short work of the returns.

Schedule C/Gig work

They failed to demonstrate the amount of expenses that they incurred or the business purposes for those expense, and they did not provide sufficient evidence from which the Court could formulate an estimate.”

Form 2106/employee business expenses

… the Trammers failed to substantiate the expenses Mrs. Trammer incurred in the conduct of her social work.”

Schedule A/Itemized Deductions

The Trammers failed to substantiate itemized deductions in excess of the standard deduction amounts that the Commissioner allowed…”

The IRS wanted penalties. They always do.

Not his time. Here is the Court:

The Trammers relied on a return preparer to whom they had been referred. They supplied the return preparer with necessary and accurate information each year, and the return preparer decided what to do with that information. The Trammers reasonably relied in good faith on their return preparer’s judgement. Accordingly, the section 6662 accuracy-related penalty does not apply for the years in issue.”

I am impressed, as I was expecting a rubber stamp.

What was different this time?

For one thing, Mr. Trammer showed up for the trial, and Mrs. Trammer participated via conference call. This gave them a chance to humanize their situation. While not conceding the errors, the Court did believe them when they said they tried. The Court, however, was not as kind to the preparer.

And remember: the next person cannot use this case (technically) as precedent in a future penalty. The Court had room to be lenient.

Our case this time was Trammer v Commissioner, TC Bench Order March 14, 2023.

Sunday, March 19, 2023

A Too Rare Taxpayer Win Over Foreign Reporting


I have become cynical about IRS penalties.

Like many accountants, I initially learned that penalties were in the system as a deterrent. If one complies with reporting responsibilities, penalties should not enter the picture. If they do, they surely would be for ministerial causes (think late payment of an estimated tax) and minor, and – if somehow major – waivable upon showing reasonable cause for the mistake.  

Poppycock.

Congress has been raising and creating penalties for decades to “pay for” their tax bills. I would also argue that the IRS has used penalties as a backstop to its funding, especially during Republican budget stringency after the Lois Lerner fiasco.  

The IRS often assesses penalties automatically, without anyone even glancing at your return. This transfers tax administration from the IRS to you – and then by extension – to me. Say that you have a reportable interest in a foreign corporation. The IRS says you must file a certain information report. I get it: the IRS wants to know what is going on. You file the report, but you file it late. Why late? Who knows. Your accountant was on health leave. You were misadvised. You were never advised because you did not recognize it as a tax-sensitive issue. You will – soon enough – get an automatic IRS notice for a $10,000 penalty – or more. You complied, but not fast enough.

Reasonable cause?

Depends on who defines reasonable. As a practicing tax CPA for decades, I am much more open to reasonable cause. Why? I am closer to the day-to-day, so I do not have the anesthesia of distance and disinterest. Things ... just … happen. No one likes paying, but let’s not use that same brush to accuse one of gaming the system.

Let’s take a look at Wrzesinski.

We will call him “W” to keep our sanity.

W was born in Poland. He moved to the United States when he was 19 years old.

A few years later his mom, who still lived in Poland, won the Polish lottery.

Sweet.

Mom gifted him $830,000 over a couple of years.

W knew about U.S. tax. He contacted his tax advisor to ask what the consequences would be. His advisor (G) correctly told him that the gift would not be taxable, but incorrectly told him that no further reporting was required.

I know that G was wrong, but how could the IRS expect W to know that?

Fast forward a few years and W wanted to make a gift to his godson in Poland. He did an internet search, at which time he realized that – while not taxable – reporting was still required. He realized this situation as his own years before, and he contacted an attorney with expertise in foreign tax matters.

W got into an IRS program for late filing of certain foreign-related returns. The IRS would tread lightly if one had reasonable cause, and both W and his attorney thought he had reasonable cause to spare.

I agree.

The IRS came back with its automatic penalties: they wanted $87,500 for one year and $120,000 for the second.

Their reason?

The Notices stated that …

… ignorance of the tax laws was not a basis for penalty abatement under the “reasonable cause” standard and that ordinary business care and prudence require that the taxpayers be aware of their obligations and file or deposit accordingly.”

I would argue the opposite: good faith “ignorance” of tax laws is exactly the basis for the reasonable cause standard. We have more than once huddled here at Galactic Command analyzing tax consequences, especially if planning a transaction. We sometimes disagree. We have run into gaps in tax law, as Congress is churning out this stuff faster than the IRS and the profession can interpret. We have run into contradictions in tax law, especially when the aforesaid gaps are working their way through the courts system. Did I mention that we are all CPAs with varying tax backgrounds? I am, for example, a tax specialist. It is all I do and have done for years.

Consider that there was no tax shelter here, no attempt to avoid reporting income or of claiming bogus deductions. There was a gift from a mother to a son. A gift unfortunately involving some of the most arcane reporting rules embedded in the tax Code. There was no need for the IRS to flog the guy.

W and his attorney protested the penalties.

The IRS lost W’s protest.

Yes, they “lost” his protest.

It took the Taxpayer Advocate to find it.

The IRS abated all but $40 thousand or so of penalties.

W paid it.

And he immediately filed claims for refund.

I like this guy.

The IRS bounced the first claim, saying he did not establish reasonable cause.

You may be figuring out the IRS schtick when in this situation. It is a one-play gamebook: nothing is reasonable. Boyle. Go away.

The IRS bounced the second claim, saying that it was “frivolous.”

Folks, never ever tell a tax practitioner that his/her position is “frivolous.” That is a loaded word in tax practice.

This thing … NO SURPRISE … went to Court.

Let’s fast forward.

In a too-rare taxpayer win, the DOJ conceded the case on February 7, 2023, and requested six to eight weeks to refund W his remaining penalties.

But look at the effort it took.

Our case this time was Krzysztof Wrzesinski v The United States, U.S. District Court, Eastern District of Pennsylvania.