Proving A Timely Tax Filing

 

I admit that I am biased, but I am not a fan of filing late tax returns.

Call it Murphy’s Law:

If anything can go wrong, it will.”

I am looking at a Tax Court order. An order takes place while the case is at trial. Somebody makes a motion, the Court reviews and decides. That decision is called an order, and they are common.

The IRS filed a motion that it sent a timely Notice of Deficiency to a taxpayer.

COMMENT: A Notice of Deficiency (also called a 90-day letter, a NOD or SNOD) is the IRS determining that you owe additional tax and wanting to reduce it to assessment. Why an assessment? For one thing, the IRS (usually) has 3 years to examine and adjust your return. It has 10 years to collect an assessment. That alone is a powerful incentive.

There are rules, of course. The IRS has only so much time to send the SNOD, and you have only so much time to respond to it. In general, the IRS has three years from when you filed the return or when the return was originally due, whichever is later. There are exceptions. A key one, and one will talk about today, is if you never file a tax return.

Milton Thomas Roberts failed to file a timely return for 2014. He received a notice from the IRS in 2015 asking about it. In February 2016 he went to the post office and mailed four packages: two to the IRS and two to New York state.

COMMENT: He was filing his 2013 and 2014 taxes with the IRS and New York – hence four packages. He did so correctly: he used certified mail. Yes, it costs a few dollars, but – if you ever must prove the mailing – those are the best dollars you ever spent.

About a week later the IRS acknowledged receiving his 2013 return.

COMMENT: Having the benefit of hindsight, one wonders why the IRS did not confirm 2014. To his credit, Roberts went online and confirmed that all four packages had been delivered.

For 2016 through 2019 Robers received notices from the IRS about this tax year or that, but he never received a notice about 2014.

That changed in October 2019, when the IRS sent a notice saying it never received a 2014 return.

Roberts did not immediately respond.

In February 2020, the IRS issued a SNOD showing over $275 grand of tax due.

That caught his attention.

Roberts (re)prepared his 2014 return and sent it to the IRS on or around June 2020. It showed adjusted gross income of $587 grand and a small refund of $804.

What happened to his copy of the original 2014 sent in 2016?

No idea.

Having attracted unwanted attention, Roberts was now audited for 2014. The IRS issued a second SNOD in January 2022 for $79 grand in additional tax, along with the usual interest and penalties.

You already know they are in Tax Court. Both sides agree that Roberts filed a 2014 return. Roberts argues that he filed twice – once in 2016 and again in 2020. The IRS says: nay, nay; he filed only once and that was in June 2020.

Does it matter?

Oh, yes it does.

Remember that the IRS has three years (barring oddities) to adjust his return and assess additional taxes. Roberts asserts that he filed 2014 in February 2016. Add three years and the IRS had until February 2019 to adjust and assess.

Roberts received nothing from the IRS in 2019.

Roberts says the IRS is too late. The second SNOD is incorrect and without effect.

The IRS disagrees. They say they never received the 2014 return until June 2020. Add three years and they had until June 2023 to adjust and assess. They were easily within the window.

The IRS just filed a motion requesting the Tax Court to determine that 2014 was within the window and they had filed a correct and effective SNOD.

Judge Toro denied the motion.

Why?

There is enough doubt as to what happened. Roberts had certified mail receipts, confirmation from New York of receiving 2013 and 2014 returns, confirmation from the delivery company that all four packages had been delivered, as well as a conspicuous absence by the IRS for three ½ years concerning the 2014 tax year.

Judge Toro was not going to say that the IRS had proved their case.

Mind you, that does not mean that Roberts proved his case either.

It does mean that the case revolves on whether there was a 2014 filing in 2016.

The IRS usually has the upper hand in such matters.

But Roberts brings the receipts.

You may wonder: does the IRS sometimes lose returns?

Oh yes. They have done so with me. I remember one client specifically because it impacted a scheduled real estate closing. We resolved the matter, but it involved considerable time and stress.

I will be keeping an eye out for the resolution of the Roberts story.

My hunch: he will win.

But he is in Tax Court. He is not pro se, so he is paying for an attorney. And he will keep paying, as a motion has been decided but the case itself marches on.

Which makes me wonder: could he have avoided this by simply filing a timely tax return?

As I said, I am biased.

Our case (or motion, actually) this time is from Milton Thomas Roberts v Commissioner, Tax Court docket 7011-22.

Spotting A (Tax) Dependent

Let’s talk about claiming someone as a dependent.

There are several tax “breaks” that require you to have a dependent, for example:

·        Head of household (HoH) filing status

·        A dependent exemption

·        Child credit

·        Child care credit

·        Education credit

·        Earned income credit

Some of these breaks go only so far. The head of household (HoH) filing status, for example, can get you to zero tax, but it cannot “create” a tax refund. You have to have tax withholdings before HoH can get you a refund; even then, you are getting your own money back. Not so with the child credit or the earned income credit, however.  Meet all the triggers and the EIC can refund you over $6,000, irrespective of whether you have any withholdings or not. It is a transfer payment from the government.

So what is required to claim someone as a tax dependent?

There are two overall categories of dependents. The first is your own child (or stepchild, adopted child, or descendants of the same) and is referred to as a “qualifying child.” This is the workhorse test: think a child at home with his/her parents.

There are five requirements for a “qualifying child”:

1. Are they related to you? 
2. Are they under age 19 or – if a full-time student – under age 24? 
3. Do they live with you for more than half the year?
4. Do you support them financially? 
5. Are you the only person claiming the child?

Any other type of dependent is a referred to as a “qualifying relative.” The requirements are as follows:

1. Do they live with you for more than half the year?
2. Do they make less than $3,950?
3. Do you support them financially?
4. Are you the only person claiming the child?

The term “qualifying relative” is misleading, by the way. The person does not need to be related to you at all. For example, a girlfriend could be my dependent – assuming that all the other requirements were met AND my wife allowed me to have a girlfriend.

Did you notice the age thing? A qualifying child ends at age 24 (unless we are talking permanent disability, which is a different rule). Past age 23 and the child is your dependent under the qualifying relative rules.

Which also means that an income test kicks-in. That after-age-23 child would not qualify as a dependent if he/she earned more than $3,950 for the year. This can be a cruel surprise at tax time for parents whose kids have moved back.

That answer, by the way, is the same for an over-18-under-24 child who does not go on to college.

Let’s take a little quiz on dependents. We will use the Tax Court case of James Edward Roberts v Commissioner. Here are selected facts:

1. In January, 2012 Roberts’ daughter became homeless. 
2. She had two young kids. 
3. She was pregnant with the third.

Roberts was a decent soul, and worked out a deal with a Ms. Moody, whereby he and the two children (very soon three) moved in with her. He agreed to pay 75% of the rent and utilities. He also agreed to pay 100% of the meals.

Then he did something unexpected. He wrote down the agreement, and both he and Ms. Moody signed and dated it.

Roberts and his (now three) grandchildren lived in the apartment from January until October, 2012. His daughter also lived there on-and-off. When she was not there, Ms. Moody helped take care of the kids.

When Roberts filed his 2012 tax return, he claimed the following:

(1)  Head of household

(2)  Dependent exemption for three grandchildren

(3)  Child credit

(4)  Earned income credit

The IRS bounced his return, and they wound up in Tax Court.

The IRS had an issue whether the kids were his dependents.

What do you think?

Let’s walk through it.

·        The kids are related (grandchildren) to Roberts. CHECK

·        The kids are young. CHECK

·        They lived with him from January through October, which is more than half the year. CHECK

·        He paid 75% of the rent and utilities and 100% of the food. Sounds to me like that would be over half the support for the kids. CHECK

·        The Court tells us that their mom did not claim them. CHECK

Seems that Roberts met all the requirements to claim the grandchildren as dependents for 2012. Why did the IRS press on this?

I don’t know, and the Court did not explain why. I can guess, though.

I see a person who…

·        moved

·        put three dependents on his return who were not there the prior year

·        was not living with the kids by the time the IRS contacted him

·        lived in an apartment with someone who (perhaps, who knows) might have been his girlfriend. This would raise the issue of who actually paid the expenses for rent, utilities and food – you know, the same expenses that Roberts needed to show that he supported the kids.

Roberts won his day in Court.

I suspect that written – and contemporaneously signed - agreement with Ms. Moody carried a lot of weight with the Court.

I allow that the IRS had cause to look at this return. After that, however, they should have left Mr. Roberts alone.  The IRS made a mistake on this one.

Are You Automatically Liable For Taxes On a Fraudulent IRA Withdrawal?

Sometimes people pursuing a divorce do stupid things.

I am looking this afternoon at Roberts v Commissioner.

The first thing I am thinking is that the wife will be fortunate to not be criminally charged. The second thing I am thinking is that the IRS could not present a more unfriendly face if they cast polar bears adrift on ice floes.

The Roberts in the case is the husband (H).

Roberts and his wife (W) married in 1990. They separated in 2008, permanently separated in 2009 and divorced in 2010.

Roberts and his wife kept joint bank accounts. After they separated, W kept the account at Washington Mutual and he kept his account at Harborstone. He did not have a checkbook for, write checks on or make withdrawals from Washington Mutual. In short, he had no idea about that account, despite the fact that his name was still on it.

In September 2009 one of his IRA custodians received a faxed withdrawal request for $9,000. The fax came from the company for which W worked. Coincidence, surely. The request was signed, but it was not signed the way Roberts normally signed his name.

A second IRA custodian also received two withdrawal requests, the first for $9,000 and the second for $18,980.

All the monies were deposited to that Washington Mutual account.

This took place over a two-month period. During that stretch, the wife deposited approximately $4,000 from her paycheck. She however spent over $41,000 from the account. The Court asked her about this discrepancy:

“We do not find credible [the wife’s] testimony that she was unaware of the sources of the deposits made to the Washington Mutual account when, in many instances, the deposits dwarfed the account’s balance at the time.”

Roberts let his wife prepare the 2008 tax return. Why not? She had prepared the returns for prior years.

She filed her return as “married filing separately.”

She filed his return as “single.”

She decreased the amount of his W-2 by $3,000. She increased his withholding by $3,000.

And she had his refund deposited to her bank account at Washington Mutual.

Roberts never saw the tax return.

You have figured out what was happening, of course.

Roberts continued oblivious to all this until he receives those pesky Forms 1099-R from the IRA custodians. Surely, they made a mistake. Alternatively he was the victim of a theft, he reasoned.

As the divorce grinds on he learned the truth of the matter. The divorce court considered the withdrawals when separating the property between the spouses.

In 2010 the IRS notified Roberts that they want almost $14,000 in tax and approximately $3,300 in penalties.

To say that the IRS took a strict reading of the tax law is to understate things. They argued: 

(1)  The income was his because he was the owner of the IRA accounts.

(2)  The monies were deposited into Washington Mutual, a jointly owned account.

(3)  The monies were used to pay for “family” expenses.

(4)  He never attempted to return the monies to the IRAs, even after he learned of the withdrawals.

Because of all this, the IRS argued that Roberts had unreported income in 2008.

It is pretty easy to tell that the Tax Court knew that the wife was lying. The Court also was brooking little patience for the IRS’ hyper-technical reading of the law, such as:

Roberts must include in income the amounts withdrawn from his IRAs even though he did not consent nor was he aware the distributions occurred.

Then the IRS trotted out two Tax Court decisions in Bunney and Vorwald.

In Bunney the IRS argued that the recipient of an IRA distribution was automatically the taxable party. 

COMMENT: The Court did not accept that argument in that case. Why would they do so now?  

In Vorwald the Court decided that a mandatory IRA distribution pursuant to a court-ordered garnishment for child support was income to the taxpayer.

            COMMENT: The IRS made more sense with this cite.

The problem with Vorwald is that the taxpayer had a legal obligation, and his IRA account was drained pursuant to that legal obligation. In the instant case Roberts was – essentially – robbed. He did not know that his wife was taking out monies to set up her post-divorce household, with a vacation sprinkled in.

The IRS then brought up their (in my opinion) best argument. In Washington state (where Roberts and his wife resided), an individual must discover and report unauthorized signatures within one year – essentially, a one-year statute of limitations.  Roberts did not do that. Granted, the withdrawals were taken into consideration when dividing marital property, but Roberts did not press for return of the monies.

And the Court did something unexpected: it paused. The IRS had a valid point. However, if there was a one-year statute of limitations, then Roberts had until 2009 to press his case. The Court looked at the tax years the IRS was challenging: year 2008 only. No year 2009.

Oops, said the Court. Sorry IRS. You flubbed.

The Court dismissed any taxes and penalties attributable to the IRA mess. It did allow taxes and penalties attributable to other minor issues on Roberts’ tax return.

We sometimes used to include a moral when reviewing tax cases. What would be the moral for today’s discussion? How about …

If you are divorcing, you may want to separate your finances, including your bank account – and your tax return – from the person you are divorcing.

Just saying.