Electronic Signatures And The Tax Court

I had a moment of dual disbelief and laughter.

At the expense of the IRS and the Tax Court.

Electronic records, cloud computing and work from home (WFH) have and continue to revolutionize the way we practice and work. I have been working, for example, with a CPA firm sponsoring a very robust WFH policy, as well as outsourcing selected tax functions overseas. Mind you, the infrastructure protecting that data transmission and retention is formidable, but woe to the accountant - especially if over age 40 – learning it for the first time.

Let’s go back to 2020. The Tax Court was rolling-in its new electronic platform – called DAWSON - which in turn was based on PACER, used for dockets in other courts. The Court was embracing electronic records, albeit in fits and starts. For example, the initial launch included only records created by the Court itself. It did not include taxpayer-submitted documents, for example. While the intent to protect taxpayer privacy was clear, it was also clear that some compromise was required. Filings containing confidential information could be sealed. If not otherwise pertinent, any confidential information could be redacted in the filing copy.

DAWSON did allow for electronic filing of the court petition itself.               

This was a big deal.

We have spoken many times about a Notice of Deficiency (NOD) or Statutory Notice of Deficiency (SNOD). This is an IRS notice, and it is also known as the 90-Day Letter. That 90 days may well be cast in concrete, as you have 90 days to file with the Tax Court should you choose to contest the matter. The IRS is very unforgiving here: miss the deadline by one day and it is guaranteed that the IRS will move to toss out your petition.

The electronic filing provides some piece of mind, but accidents still happen.

EXAMPLE: Antawn Jaal Sanders was filing electronically with the Tax Court, but Antawn cut it close. The last day to file was December 12, 2022, and Antawn had started downloading the Court forms onto his Android shortly before 10 p.m. Unable to file from his phone, he switched to his computer at 11:56 p.m. It took him a minute to log in and several to return to where he had been. It was after midnight by the time he started uploading to DAWSON. The IRS of course moved to dismiss his petition, and the Court agreed. Antawn might challenge the IRS, but he was not doing it in Tax Court. After midnight was the next day, meaning his petition was late.

Do you wonder how the taxpayer signs that petition in DAWSON?

If it were a paper file, there would be a handwritten signature.

DAWSON does not allow (for now, at least) for a handwritten signature. What it does do is allow a block-letter facsimile of your signature.

Here is the Court:

The combination of DAWSON username (email address) and password serves as the signature of the individual filing the document.”

The Court says it will accept the facsimile as a signature, so that should be the end of it.

Except when it isn’t.

Robert and Kegan Donlan filed their petition on DAWSON, and they took advantage of the electronic signature.

The IRS immediately filed a Motion to Dismiss, arguing that the Court lacked jurisdiction to hear the case because the petition was not property signed.

The Court bounced the IRS motion, of course.

And I find myself wondering – why did the IRS go there? I suppose it simply had to test the lock, fully expecting it to be locked.

And – here is years of CPA practice speaking – whether it was a new attorney who drew the short straw to look foolish in front of the Court.

Our case this time was Donlan v Commissioner, U.S. Tax Court Docket 16579-24, Feb. 19, 2025.

A Call From Chuck

I was speaking with a client this week. He told me that he recently retired and his financial advisor recommended he discuss a matter with me.

Me:              So, what are we going to talk about?”

Chuck:         I worked for Costco for many years.”

Me:              OK.”

Chuck:         I bought their stock all along.”

Me:              Not sure where this is going. Are you diversifying?”

Chuck:         Have you heard of Net Unrealized Appreciation?”

Me:              Sure have, but how does that apply to you?”

That was not my finest moment. I did not immediately register that Chuck had – for many years – bought Costco stock inside of his 401(k).

Take a look at this stock chart: 

Costco stock was at $313 on February 7, 2020. Five years later it is at $1,043.

It has appreciated – a lot.

I missed the boat on that one.

The appreciation is unrealized because Chuck has not sold the stock.

The difference between the total value of the Costco stock in his 401(k) and his cost in the stock (that is, the amount he paid over the years buying Costco) is the net unrealized appreciation, abbreviated “NUA” and commonly pronounced (NEW-AHH).

And Chuck has a tax option that I was not expecting. His financial advisor did a good job of spotting it.

Let’s make up a few numbers as we talk about the opportunity here.

Say Chuck has 800 shares. At a price of $1,043, the stock is worth $834,400.

Say his average cost is 20 cents on the dollar: $834,400 times 20% = cost of $166,880.

Chuck also owns stocks other than Costco in his 401(k). We will say those stocks are worth $165,600, bring the total value of his 401(k) to an even $1 million.

Chuck retires. What is the likely thing he will do with that 401(k)?

He will rollover the 401(k) to an IRA with Fidelity, T Rowe, Vanguard, or someone like that.

He may wait or not, but eventually he will start taking distributions from the IRA. If he delays long enough the government will force him via required minimum distributions (RMDs).

How is the money taxed when distributed from the IRA?

It is taxed as ordinary income, meaning one can potentially run through all the ordinary tax rates.

It was not that long ago (1980) that the maximum tax rate was 70%. Granted, one would need a lot of income to climb through the rates and get to 70%. But people did. Can you imagine the government forcing you to take a distribution and then taking seventy cents on the dollar as its cut?

Hey, you say. What about those capital gains in the 401(k)?  Is there no tax pop there?

Think of a 401(k) as Las Vegas. What happens in Las Vegas stays in Las Vegas. What leaves Las Vegas is ordinary income.

And that gets us to net unrealized appreciation. Congress saw the possible unfairness of someone owning stock in a regular, ordinary taxable brokerage account rather than a tax-deferred retirement account. The ordinary taxable account can have long-term capital gains. The retirement account cannot.

Back to NEW-AHH.

How much is in that 401(k)?

A million dollars.

How much of that is Costco?

$834,400.

Let’s roll the Costco stock to a taxable brokerage account. Let’s roll the balance ($165,600) to an IRA.

This would normally be financial suicide, as stock going to a taxable account is considered a distribution. Distributions from an IRA are ordinary income. How much is ordinary income tax on $834,400? I can assure you it exceeds my ATM withdrawal limit.

Here is the NUA option:

You pay ordinary tax on your cost - not the value - in that Costco stock.

OK, that knocks it down to tax on $166,880.

It still a lot, but it is substantially less than the general rule.

Does that mean you never pay tax on the appreciation – the $667,520?

Please. Of course you will, eventually. But you now have two potentially huge tax planning options.

First, hold the stock for at least a year and a day and you will pay long-term capital gains (rather than ordinary income tax) rates on the gain.

QUIZ: Let’s say that the above numbers stayed static for a year and a day. You then sold all the stock. How much is your gain? It is $667,520 (that is, $834,400 minus $166,880). You get credit (called “basis” in this context) for the income you previously reported.

What is the second option?

You control when you sell the stock. If you want to sell a bit every year, you can delay paying taxes for years, maybe decades. Contrast this with MRDs, where the government forces you to distribute money from the account.

So why wouldn’t everybody go NUA?

Well, one reason is that (in our example) you pony up cash equal to the tax on the $166,880. I suppose you could sell some of the Costco stock to provide the cash, but that would create another gain triggering another round of tax.

A second reason is your specific tax situation. If you just leave it alone, distributions from a normal retirement account would be taxable as ordinary income. If you NUA, you are paying tax now for the possibility of paying reduced tax in the future. Take two people with differing incomes and taxes and whatnot and you might arrive at two different answers.

Here are high-profile points to remember about net unrealized appreciation:

(1)  There must exist a retirement account at work.

(2)  There must be company stock in that retirement account.

(3)  There is a qualified triggering event. The likely one is that you retired.

(4)  There must be a lump-sum distribution out of that retirement account. At the end of the day, the retirement account must be empty.

(5)  The stock part of the retirement account goes one way (to a taxable account), and the balance goes another way (probably to an IRA).

(6)  The stock must be distributed in kind. Selling the stock and rolling the cash will not work.

BTW taking advantage of NUA does not have to be all or nothing. We used $834,400 as the value of the Costco stock in the above example. You can NUA all of that – or just a portion. Let’s say that you want to NUA $400,000 of the $834,400. Can you do that? Of course you can.

Chuck has a tax decision that I will never have.

Why is that?

CPA firms do not have traded stock.