Amending Your Way Into A Penalty

I have a set of tax returns in my office for someone who dropped off the tax grid for years. I suspect we will be fighting penalties and requesting a payment plan in the too-near future.

It reminded me of why not filing returns is a bad idea.

Here’s one: she has refunds she cannot use because the statute period has expired.

She could have used the refunds, as she has other years with tax due.

There is another reason.

Let’s say that you file a return, but you file it late. For example, you extend the return to October, but you don’t get around to filing until the following January or February. You have a refund so you do not care.

Many tax professionals would agree with you. Penalties apply on tax due. If there is no tax due, then – voila – no penalty (generally speaking).

But you later amend the return. Or the IRS adjusts the return for you. However it happened, you now owe tax.

Consider this:

          § 6651 Failure to file tax return or to pay tax

(a)  Addition to the tax.

In case of failure-

(1)    to file any return required under authority […]on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

This is called the “late filing” penalty.

I am looking at a tax case from 1998. Greg Vinikoor (GK) married Melissa Vinikoor (MV). Best I can figure, her dad must have been loaded, as he was repeatedly transferring shares of stock to the newlyweds. GK graduated from college and took a job making $12 grand a year. They got everything out of that $12 grand, including:

·      trips to Hawaii, San Diego, Scottsdale and San Francisco

·      shopping trips to Saks Fifth Avenue, Neiman Marcus and Nordstrum

·      membership at the Tucson Country Club

We both know that they were not paying for this on that $12,000 salary. They were either borrowing against or selling stock that dad had transferred.

The IRS wanted to know why they were not reporting stock gains on their tax returns. There had been quite the run-up in value since dad had acquired the stock. In the case of a gift, dad’s low basis in the stock would carryover to the couple. Since gain = price – basis, that low basis meant a juicy gain, and the IRS wanted its cut.

Good question.

Uhhh…. Because we bought the stock from dad, they answered. Yeah, that’s it. We have a new – and higher! - basis because we bought the stock. We bought it on loan, and we have to pay dad back.

Fine, said the IRS. Show us the loan agreement.

Don’t have one, they replied.

Show us where you paid interest to dad.

We haven’t – not yet, they responded.

Is there a fixed repayment date?

Just an understanding, they susurrated.

How about security? Did you give any collateral for the loan?

No, not really, they murmured.

The Court was zero impressed.

After the stock rose, XXX [dad], the supposed creditor in these transactions never made any demand on petitioners for repayment, even though the value of the stock had increased substantially and petitioners were diminishing the stock with spendthrift habits.”

The Court decided this was a gift. There was gain, there was tax.

Guess who failed to file their tax return on time?

Yep, the Vinikoors.

Now they had penalties.

More specifically, that 25% penalty we talked about. It totaled over $38 grand.

And there is the trap. That late filing can haunt and hurt you if you later amend or the IRS adjusts the return to increase income. That penalty goes to back when, not the date you amended or the IRS adjusted.

File those returns on time, folks. Amend later if you do not have all the information, but at least you got the horse over the wire on time.

Our case this time – as you may have guessed – was Vinikoor v Commissioner.