Do. Not. Do. This.

Here is the Court:

With respect to petitioner’s Federal income tax for 2013 and 2014, the Internal Revenue Service … determined deficiencies and accuracy-related penalties as follows:

Year  Deficiency Penalty

2013 $338,752    $67,750

2014 7,030,829   1,406,166

I cannot turn down at least skimming a Tax Court case with penalties well over $1.4 million.

Turns out our protagonist is an attorney. He more than dabbled in tax practice:

·      During law school, he took courses in tax law and participated in a tax clinic assisting low-income taxpayers

·      During school he was employed by Instant Tax Services (ITS) in Baltimore. ITS operated on a franchise basis, and he was the area manager for four storefronts. After graduation he served as general counsel for five years.

·      While serving as general counsel, he started acquiring storefronts on his own behalf. By 2013 he owned he owned franchises for 19 locations.

·      These stores were profitable. Aggregate profits exceeded $800 grand over the years 2008 through 2010.

You know, sometimes I wonder what swoon I was in to spend an entire career with a CPA firm. It appears that the money is in setting up and franchising seasonal tax preparation storefronts.

In 2012 ITS attracted the attention of the U.S. Department of Justice – and in a bad way. In 2013 a district court permanently enjoined ITS and its owner from having anything to do with preparing federal tax returns.

COMMENT: Ouch.

Our protagonist was good friends with the owner of ITS. So close, in fact, that Justice refused to allow him to take over the ITS tax preparation business.

COMMENT: Something about helping the ITS owner hide around $5 million.

A third party stepped up to take over the ITS business. This new person formed Great Tax LLC, and many of the ITS franchisees came on board.

Our protagonist was not to be denied, however. He bought the tax preparation software from ITS, put it in an entity called Refunds Plus, LLC (RP), and in turn leased the software to Great Tax LLC.

COMMENT: There is existing commercial tax preparation software, of varying levels of sophistication. We, for example, use software that allows for very complicated returns. It costs a fortune, by the way. There is other software that tones it down a bit, as perhaps the tax practice prepares few or no returns of great complexity. In any event, writing my own software seems a monumental waste of time and money, except for the following tell:

“using this software to process tax returns for GTX customers, most or all of whom expected refunds.”

Most or all?  Riiiigggghht. Perhaps it is just as well that I have stayed with a CPA firm for all these years.

Great Tax LLC paid our protagonist $100.95 for each return it processed and which claimed a refund.

COMMENT: Was a non-refund return free?

Our protagonist worked out an arrangement with Great Tax which allowed him to take money out of Great Tax’s bank account. He also opened a bank account for RP. He moved over $3 million from Great Tax during 2014.

However, he did not deposit the monies from Great Tax into the RP bank account.

So where did the money go?

Who knows.

Since this went to Court, we know that the IRS figured-out what was going on.

Our protagonist agreed that he owed the taxes, but he requested abatement of the penalties for reasonable cause.

He has my attention: what was his reasonable cause?

·      He was a cash-basis taxpayer.

And I like meatball sandwiches. Pray tell what that has to do with anything.

·      There was little to no cash activity in the RP business bank account.

Seriously? Was he aware that failure to deposit funds in its entity-related account is an indicia of fraud?

·      He relied on an attorney.

Reliance on a professional can provide reasonable cause. Tell me more.

·      She had been working as a full-time lawyer for about a year.

Not impressed.

·      She had acquired some of the former ITS franchises.

Had to be a story somewhere.

·      She had represented him when the IRS pressed in a separate action for abuse of the earned income credit.

We just learned where all those refund returns came from.

Let me get this right: his reasonable cause argument is that an attorney prepared his return?

·      No.

Who prepared the return?

·      An accountant.

Why then are we talking about an attorney?

·      She advised our protagonist that he was not required to report the $3 million as gross receipts for 2014.

Our protagonist in turn told the accountant the same thing?

·      Yep. He relied on an attorney.

If this is true, she may be in the running for the worst attorney of the decade.

And why would he – an experienced attorney with some tax background – listen to an attorney with limited experience?

·      The attorney and our protagonist were codefendants in a lawsuit alleging misappropriation of funds.

Yessir.

The Court requested documentary evidence that an attorney would advise that moving approximately $3 million to bank accounts of one’s choosing was not taxable income.

I’m in: I want to see those documents myself.

·      She supplied no evidence of letters, memos or e-mails – dated before those returns were filed – in which she advised petitioner about the reporting of RP’s gross receipts.”

Rain is wet. Nighttime is dark.

How did the Court decide this mess?

We did not find either’s testimony on that point credible. Petitioner’s testimony was self-serving, and [the attorney] did not strike the Court as an objective or candid witness.”

The Court did not believe a word.

Our protagonist owed the tax. He owed the penalties.

Frankly, I am surprised that the IRS did not go after fraud in this case. Perhaps the IRS was prioritizing its limited resources.

I would say our protagonist got off easy.

Folks, this is not tax practice. You know what it is.

Do. Not. Do. This.

Our case this time was Babu v Commissioner, TC Memo 2020-21.