You Received An IRS CP2000 Notice

I read a considerable amount on a routine basis. It might be fairer to say that I skim, changing it to a read if I think that something might apply here at Galactic Command.

I came across something recently that made me scoff out loud.

Somebody somewhere was talking about never receiving an IRS CP2000 notice again.

Yeah, right.

What is a CP2000?

You know it as the computer match. The IRS cross-checks your numbers against their numbers. If there is a difference – and the difference is more than the cost of a stamp – their computers will generate a CP2000 notice.

How does the IRS get its numbers?

Easy. Think of all the tax reporting forms that you have received over the years, such as:

W-2 (your job)   

1099-INT (interest from a bank)

1099-DIV (dividends from a mutual fund)

1099-SA (distribution from an HSA)

1099-B (proceeds from selling stock)

It is near endless, and every year or so Congress and/or the IRS requires additional reporting on something. There is already a new one for 2022: the minimum threshold for payment card reporting has been reduced from $20,000 to $600. Think Venmo or Pay Pal and you are there.

If the IRS has information you didn’t report: bam! Receive a CP2000.

It happens all the time. You closed a bank account but forgot about the part of the year that it did exist.  You traded on Robinhood for a couple of weeks, lost money and tried to forget about it. You reimbursed yourself medical expenses from your HSA.   

The common denominator: you forgot to tell your tax preparer.

We get a ton of these.

Then your tax preparer might have caused it.

Maybe you did a 60-day roll on an IRA. Your preparer needs to code the distribution a certain way. Flub it and get a CP2000.

These you try to never repeat, as you are just making work for yourself.

Is this thing an audit?

Technically no, but you might still wind-up owing money.

The notice is proposing to make changes to your return. It is giving you a chance to respond. It is not a bill, at least not yet, but ignore the notice and it will become a bill.

The thing about these notices is that no one at the IRS reviews them before they go out. Yours are the first set of eyes to look upon them, and your preparer the second when you send the notice to him or her. You there have one of the biggest frustrations many practitioners have: the IRS sends these things out like candy; many are wrong and would be detected if the IRS even bothered. Attach an explanation to your return in the hope of cutting-off a notice? Puhleeze.

You really need to respond to a CP2000. I have lost track of how many clients over the years have blown these notices off, coming to see me years later because some mysterious tax debt has been siphoning their tax refunds. Combine this with the statute of limitations – remember, three years to file or amend – and you can be digging a hole for yourself.

If you agree with the notice, then responding is easy: check the box that says you agree. The IRS will happily send you a bill. Heck, don’t even bother to reply. They will send you the same bill.

If you disagree, then it can be more complicated.

If the matter is relatively easy – say an HSA distribution – I might attach the required tax form to my written response, explaining that the form was overlooked when filing.

If the matter is more complicated – say different types of mismatches – then I might change my answer. My experience – especially in recent years – is that the IRS is doing a substandard job with correspondence requiring one to think. They have repetitively forced me into Appeals and unnecessary procedural work.  My response to more complicated CP2000 notices? I am increasingly filing amended returns. Mind you, the IRS DOES NOT want me to do this. Neither do I, truthfully, but the IRS must first give me reason to trust its work. I am not there right now.

You can fax your response, fortunately.

You might try to call the IRS, but I suspect that will turn out poorly. Shame, as that would be the easiest way to request additional time to reply to the CP2000.

Whatever you do, you have 30 days. The days start counting beginning with the date of the letter, so mail delays can cost you.

Is the IRS gunning for you?

Remember: no one at the IRS has even looked at the notice you received.

 

The Sum Of The Parts Is Less Than The Whole

 

I am looking at a case involving valuations.

The concept starts easily enough:

·      Let’s say that your family owns a business.  

·      You personally own 20% of the business.

·      The business has shown average profits of $1 million per year for years.

·      Altria is paying dividends of over 7%, which is generous in today’s market. You round that off to 8%, considering that rate fair to both you and me.

·      The multiple would therefore be 100% divided by 8% = 12.5.   

·      You propose a sales price of $1,000,000 times 12.5 times 20% = $2.5 million.  

Would I pay you that?

Doubt it.

Why?

Let’s consider a few things.

·      It depends whether 8 percent is a fair discount rate.  Considering that I could buy Altria and still collect over 7%, I might decide that a skinny extra 1% just isn’t worth the potential headache.

·      I can sell Altria at any time. I cannot sell your stock at any time, as it is not publicly-traded. I may as well buy a timeshare.

·      I am reasonably confident that Altria will pay me quarterly dividends, because they have done so for decades. Has your company ever paid dividends? If so, has it paid dividends reliably? If so, how will the family feel about continuing that dividend policy when a non-family member shows up at the meetings? If the family members work there, they might decide to increase their salaries, stop the dividends (as their bumped-up salaries would replace the lost dividends) and just starve me out.

·      Let’s say that the family in fact wants me gone. What recourse do I – as a 20% owner – have? Not much, truthfully. Own 20% of Apple and you rule the world. Own 20% of a closely-held that wants you gone and you might wish you had never become involved.

This is the thought process that goes into valuations.

What are valuations used for?

A ton of stuff:

·      To buy or sell a company

·      To determine the taxable consequence of nonqualified deferred compensation

·      To determine the amount of certain gifts

·      To value certain assets in an estate

What creates the tension in valuation work is determining what owning a piece of something is worth – especially if that piece does not represent control and cannot be easily sold. Word: reasonable people can reasonably disagree on this number.

Let’s look at the Estate of Miriam M. Warne.

Ms Warne (and hence the estate) owned 100% of Royal Gardens, a mobile home park. Royal Gardens was valued – get this - at $25.6 million on the estate tax return.

Let’s take a moment:

Q: Would our discussion of discounts (that is, the sum of the parts is less than the whole) apply here?

A: No, as the estate owned 100% - that is, it owned the whole.

The estate in turn made two charitable donations of Royal Gardens.

The estate took a charitable deduction of $25.6 million for the two donations.

The IRS said: nay, nay.

Why?

The sum of the parts is less than the whole.

One donation was 75% of Royal Gardens.  

You might say: 50% is enough to control. What is the discount for?

Here’s one reason: how easy would it be to sell less-than-100% of a mobile home park?

The other donation was 25%.

Yea, that one has it all: lack of control, lack of marketability and so on.

The attorneys messed up.

They brought an asset into the estate at $25.6 million.

The estate then gave it away.

But it got a deduction of only $21.4 million.

Seems to me the attorneys stranded $4.2 million in the estate.

Our case this time was the Estate of Miriam M. Warne, T.C. Memo 2021-17.

Qualifying As A Real Estate Professional

 

The first thing I thought when I read the opinion was: this must have been a pro se case.

“Pro se”” has a specific meaning in Tax Court: it means that a taxpayer is not represented by a professional. Technically, this is not accurate, as I could accompany someone to Tax Court and they be considered pro se, but the definition works well enough for our discussion.

There is a couple (the Sezonovs) who lived in Ohio. The husband (Christian) owned an HVAC company and ran it as a one-man gang for the tax years under discussion.

In April 2013 they bought rental property in Florida. In November 2013 they bought a second. They were busy managing the properties:

·      They advertised and communicated with prospective renters.

·      They would clean between renters or arrange for someone to do so.

·      They hired contractors for repairs to the second property.

·      They filed a lawsuit against the second condo association over a boat slip that should have been transferred with the property.

One thing they did not do was to keep a contemporaneous log of what they did and when they did it. Mind you, tax law does not require you to write it down immediately, but it does want you to make a record within a reasonable period. The Court tends to be cynical when someone creates the log years after the fact.

The case involves the Sezonovs trying to deduct rental losses. There are two general ways you can coax a deductible real estate rental loss onto your return:

(1) Your income is between a certain range, and you actively participate in the property. The band is between $1 and $150,000 for marrieds, and the Code will allow one to deduct up to $25 grand. The $25 grand evaporates as income climbs from $100 grand to $150 grand.

(2)  One is a real estate professional.

Now, one does not need to be a full-time broker or agent to qualify as a real estate professional for tax purposes. In fact, one can have another job and get there, but it probably won’t be easy.

Here is what the Code wants:

·      More than one-half of a person’s working hours for the year occur in real estate trades or businesses; and

·      That person must rack-up at least 750 hours of work in all real estate trades or businesses.

Generally speaking, much of the litigation in this area has to do with the first requirement. It is difficult (but not impossible) to get to more-than-half if one is working outside the real estate industry itself. It would be near impossible for me to get there as a practicing tax CPA, for example.

One more thing: one person in the marriage must meet both of the above tests. There is no sharing.

The Sezonovs were litigating their 2013 and 2014 tax years.

First order of business: the logs.

Which Francine created in 2019 and 2020.

Here is what Francine produced:

                                     Christian              Francine

2013 hours                        405                      476                

2014 hours                         26                        80                 

Wow.

They never should have gone to Court.

They could not meet one of the first two rules: at least 750 hours.

From everything they did, however, it appears to me that they would have been actively participating in the Florida activities. This is a step down from “materially participating” as a real estate pro, but it is something. Active participation would have qualified them for that $25-grand-but-phases-out tax break if their income was less than $150 grand. The fact that they went to Court tells me that their income was higher than that.

So, they tried to qualify through the second door: as a real estate professional.

They could not do it.

And I have an opinion derived from over three decades in the profession: the Court would not have allowed real estate pro status even if the Sezonovs had cleared the 750-hour requirement.

Why?

Because the Court would have been cynical about a contemporaneous log for 2013 and 2014 created in 2019 and 2020. The Court did not pursue the point because the Sezonovs never got past the first hurdle.

Our case this time was Sezonov v Commissioner. T.C. Memo 2022-40.