Would you be aggressive on your taxes if your job was on the line?
I am reading Agbaniyaka v Commissioner. Benjamin Agbaniyaka (Ben) started with the IRS in 1986. He received excellent evaluations, several promotions and a Master’s Degree in taxation from Long Island University. Between the years 1988 and 2006 Ben engaged in a side business selling African arts and crafts. Here are the business results for selected years;
2001 no sales and a loss of $5,661
2002 sales of $3,216 and a loss of $15,232
2003 sales of $1,372 and a loss of $7,624
2004 sales of $200 and a loss of $6,383
He also claimed itemized deductions, including annual expenses for “Union Dues” and “Accounting Journals.”
He gets audited for 2001.
Let’s go over what the IRS expects when it sees that Schedule C on your return. It expects you to maintain records so that you can compile a tax return at the end of the year. Records can be as simple as a checkbook with a year-sheet recapping everything by category. The IRS also wants you to keep invoices and receipts, to allow a third party to trace a check to something. There are some expenses where Congress itself tells the IRS what documentation to review. Meals and car expenses are two of the most common examples. With those two, the IRS is somewhat limited in its flexibility because Congress called the tune.
Then we have the hobby loss rules. The idea here is that a business activity is expected to show a profit every so often. If the activity has always shown losses, it is difficult to buy-into the argument that it is a business. An actual business would eventually shut down and not throw good money after bad. There are exceptions, of course, but it is a good starting point.
The third point is that a revenue agent is going to be held to a higher standard. There is the education and training involved, as well as that whole working for the IRS thing.
The IRS audits 2001. It finds the following:
(1) Ben deducted expenses for a course on trust and estates. He cannot provide any documentation, however. He also has other unsubstantiated education expenses, including his journals.
(2) Ben claimed a deduction for union expenses. He cannot present any proof he paid the union.
(3) Ben is hard-pressed to persuade the IRS that there was any profit intent to his arts and crafts activity. The problem is that Ben never reported a profit – ever. The IRS simply disallowed the loss.
(4) The IRS is now miffed at Ben, especially since Ben is one of their own. They argue that the Ben’s failure to make any reasonable attempt to comply with the tax code is negligence. In fact, failure to keep records shows not only negligence but also Ben’s intentional disregard of the regulations. The IRS slapped Ben with a substantial understatement penalty.
The IRS expands the audit to 2002, 2003 and 2004, with similar results.
Can this get worse? You bet. The 1998 IRS Restructuring and Reform Act requires termination of an IRS employee found to have willfully understated his federal tax liability, unless such understatement is due to reasonable cause and not willful neglect.
Let’s go back to the substantial understatement penalty. One of the exceptions to the penalty is reasonable cause. Ben goes to Tax Court. He pretty much has to. He has to win, at least on the penalty issue. If he can get the court to see reasonable cause, he might be able to save his job.
The Tax Court is unimpressed. Here are some comments:
We found Mr. Agbaniyaka’s testimony to be general, vague, conclusory, uncorroborated, self-serving and/or questionable in all material respects.”
During the years at issue, Mr [] was a trained revenue agent and was fully aware of the requirements imposed by …. Nonetheless, petitioners failed to maintain sufficient records for each of their taxable years 2001 through 2004 to establish their position with respect to any of the issues presented.”
On the record before us, we find that petitioners have failed to carry their burden of showing that they were not negligent and did not disregard rules and regulations, or otherwise did what a reasonable person would do, with respect to the underpayment for each of the years at issue.”
After the Tax Court’s decision, the IRS ended Ben’s employment effective April 15, 2008.
Ben appeals to the Federal Court of Appeals. That too fell on deaf ears:
“… he was undoubtedly aware that he had to substantiate his efforts to conduct a business in 2001 and beyond. Being an experienced and knowledgeable Agency employee, he had to have been aware that he could not substantiate his alleged business activities. By claiming deductions on Schedule C, he knowingly and willfully submitted tax filings to which he was not entitled.”
Ben next tried other channels. In the end, he lost and stayed fired.
How much money are we talking about? The court does not come out and specifically give a dollar amount, but there is enough to approximate the taxes as little more than $10,000.
I question the lack of documentation for some of these claimed expenses. The bank can provide cancelled checks for the subscriptions or seminars, and the union will provide a letter of membership and dues activity. The court doesn’t elaborate, but it is clear that Ben wasn’t trying too hard.
Would you gamble your job for $10,000? Ben did.
I wouldn’t.
