A Too Rare Taxpayer Win Over Foreign Reporting

I have become cynical about IRS penalties.

Like many accountants, I initially learned that penalties were in the system as a deterrent. If one complies with reporting responsibilities, penalties should not enter the picture. If they do, they surely would be for ministerial causes (think late payment of an estimated tax) and minor, and – if somehow major – waivable upon showing reasonable cause for the mistake.  

Poppycock.

Congress has been raising and creating penalties for decades to “pay for” their tax bills. I would also argue that the IRS has used penalties as a backstop to its funding, especially during Republican budget stringency after the Lois Lerner fiasco.  

The IRS often assesses penalties automatically, without anyone even glancing at your return. This transfers tax administration from the IRS to you – and then by extension – to me. Say that you have a reportable interest in a foreign corporation. The IRS says you must file a certain information report. I get it: the IRS wants to know what is going on. You file the report, but you file it late. Why late? Who knows. Your accountant was on health leave. You were misadvised. You were never advised because you did not recognize it as a tax-sensitive issue. You will – soon enough – get an automatic IRS notice for a $10,000 penalty – or more. You complied, but not fast enough.

Reasonable cause?

Depends on who defines reasonable. As a practicing tax CPA for decades, I am much more open to reasonable cause. Why? I am closer to the day-to-day, so I do not have the anesthesia of distance and disinterest. Things ... just … happen. No one likes paying, but let’s not use that same brush to accuse one of gaming the system.

Let’s take a look at Wrzesinski.

We will call him “W” to keep our sanity.

W was born in Poland. He moved to the United States when he was 19 years old.

A few years later his mom, who still lived in Poland, won the Polish lottery.

Sweet.

Mom gifted him $830,000 over a couple of years.

W knew about U.S. tax. He contacted his tax advisor to ask what the consequences would be. His advisor (G) correctly told him that the gift would not be taxable, but incorrectly told him that no further reporting was required.

I know that G was wrong, but how could the IRS expect W to know that?

Fast forward a few years and W wanted to make a gift to his godson in Poland. He did an internet search, at which time he realized that – while not taxable – reporting was still required. He realized this situation as his own years before, and he contacted an attorney with expertise in foreign tax matters.

W got into an IRS program for late filing of certain foreign-related returns. The IRS would tread lightly if one had reasonable cause, and both W and his attorney thought he had reasonable cause to spare.

I agree.

The IRS came back with its automatic penalties: they wanted $87,500 for one year and $120,000 for the second.

Their reason?

The Notices stated that …

… ignorance of the tax laws was not a basis for penalty abatement under the “reasonable cause” standard and that ordinary business care and prudence require that the taxpayers be aware of their obligations and file or deposit accordingly.”

I would argue the opposite: good faith “ignorance” of tax laws is exactly the basis for the reasonable cause standard. We have more than once huddled here at Galactic Command analyzing tax consequences, especially if planning a transaction. We sometimes disagree. We have run into gaps in tax law, as Congress is churning out this stuff faster than the IRS and the profession can interpret. We have run into contradictions in tax law, especially when the aforesaid gaps are working their way through the courts system. Did I mention that we are all CPAs with varying tax backgrounds? I am, for example, a tax specialist. It is all I do and have done for years.

Consider that there was no tax shelter here, no attempt to avoid reporting income or of claiming bogus deductions. There was a gift from a mother to a son. A gift unfortunately involving some of the most arcane reporting rules embedded in the tax Code. There was no need for the IRS to flog the guy.

W and his attorney protested the penalties.

The IRS lost W’s protest.

Yes, they “lost” his protest.

It took the Taxpayer Advocate to find it.

The IRS abated all but $40 thousand or so of penalties.

W paid it.

And he immediately filed claims for refund.

I like this guy.

The IRS bounced the first claim, saying he did not establish reasonable cause.

You may be figuring out the IRS schtick when in this situation. It is a one-play gamebook: nothing is reasonable. Boyle. Go away.

The IRS bounced the second claim, saying that it was “frivolous.”

Folks, never ever tell a tax practitioner that his/her position is “frivolous.” That is a loaded word in tax practice.

This thing … NO SURPRISE … went to Court.

Let’s fast forward.

In a too-rare taxpayer win, the DOJ conceded the case on February 7, 2023, and requested six to eight weeks to refund W his remaining penalties.

But look at the effort it took.

Our case this time was Krzysztof Wrzesinski v The United States, U.S. District Court, Eastern District of Pennsylvania.

You Have To Look At Your Return

I am looking at a case that covers relatively well-trod ground. It did however remind me of a client from around 20 years ago. I got a different result than the taxpayer did in this case, but I suspect part of the reason is the IRS becoming noticeably more overbearing with penalties over the last two decades.

Anna Walton is a psychologist. In 2014 the firm where she worked informed her that their interests had diverged. This of course is jargon for termination, and she transitioned to her own firm with multiple clients, including Brown University and the National Geographic Society.

 Having multiple clients meant that she received multiple Forms 1099 at the end of the year. It is a poor idea to blow these off, as the IRS uses the 1099s for computer matching of reported income. Report less income than the 1099s on file and you can anticipate an automated notice from the IRS.

Let’s roll to January, 2016 and Ms Walton was looking at her 2015 records. She e-mailed her accountant of approximately 20 years that the practice had approximately $525 grand in revenues. The accountant used that number to arrive at an estimated tax payment.

So far there is no big deal.

She later sent her tax stuff in. A staff accountant working at the firm noted that the 1099s she remitted only added-up to approximately $351 grand. Cross-referencing the $525 grand e-mail, the accountant asked whether Ms Walton had or was expecting other 1099s. She also asked about other stuff, such as contributions, tuition plans and whatnot going into the tax return.

COMMENT: In case you are wondering, it is quite unlikely that your accountant personally prepares your tax return. It is more likely that he/she hires someone to prepare your return, including questions, and then reviews the draft return once fully or mostly prepared. I for example prepare very few returns, but I review a ton. There are not enough hours in the day for me to work with as many returns as I do if I also had to prepare them.

Ms Walton responded to the accountant but blew-off the 1099 question.

The accountant asked again.

Ms Walton blew her off again.

I think you get the drift.

The accountant prepared the return with the information available. The IRS caught the underreporting of 1099 income. The IRS wanted tax. It also wanted penalties.

Ms Walton agreed to the tax, but she did not think she should owe penalties.

Off to Tax Court they went

Her argument was easy: she relied on her accountant.

Folks, there are prerequisites to the reliance argument. For example, one has to provide all necessary information to the accountant. Secondly, that reliance is moot if even the most cursory review of the return would alert the average person to errors on the return.

The Court was quite curious why Ms Walton did not inquire why the return showed approximately one-third less revenues than she herself had previously told the accountant.

I also suspect that the Court did not take kindly to Ms Walton repetitively blowing-off the staff accountant. The repeated questioning would have/should have alerted a reasonable person that more attention was required on the matter.

The Court decided that she did not have reasonable cause to abate the penalty.

I agree.

My client back in the antediluvian days?

He left $3.5 million off his return.

The IRS wanted tax and penalties.

I argued the penalties.

What was my argument?

The client reported so much income from so many sources that $3.5 million could reasonably have been overlooked on that year’s return.

I wish I had a personal tax return like that.

I got penalty abatement, by the way.

Our case this time was Walton v Commissioner, T.C. Memo 2021-40.

 

Blade’s Offer In Compromise

I am enough of a nerd to say that I enjoyed the Blade movies. I am a fan of Wesley Snipes, who played the half-vampire vampire hunter in the series.

You may recall that he got into big-time tax trouble several years ago. He bought into tax protestor arguments, such as being an ambassador from the planet Naboo or some similar nonsense. He spent three years in prison.

When he came out of prison the IRS wanted over $23 million in taxes, penalties and interest.

He went to a Collections Due Process hearing. The purpose of a CDP is to tamp-down IRS aggressiveness in separating you from your money. The CDP has limited range, but sometimes that range makes all the difference.

So he goes and requests collection alternatives.

Perfect. Exactly what a CDP is designed to do.

He proposes an installment agreement.

There are flavors of these, and one of the flavors is called a “partial pay.” For a partial, you have to convince the IRS that you are unable to fully pay your taxes over the period the IRS can collect from you. You almost have to provide photos of Bigfoot to persuade the IRS to go along.

Alternatively, he proposes an offer in compromise (OIC).

In some cases, the difference between a partial pay and an OIC can be slight, except for maybe at the edges. For example, enter a partial pay and the IRS may request payment adjustment if your income goes up. That is a risk you do not have with an OIC.

Right there you can anticipate that an OIC is harder to obtain than a partial pay.

And an OIC for an actor who has made millions from movies is going to be harder still.

OICs are the “pennies on the dollar” tripe you hear on radio or late-night commercials. Those “pennies” OICs are few and far between, and usually involve some or all of the following factors:

·      Someone was injured and will never work again

·      Someone has retired and will never work again

·      Someone owns next to nothing

·      Someone owes the IRS money   

The key theme here is that someone is broke, and there is little likelihood that condition will ever change.

Folks, that is not tax planning. That is bad luck in life, very poor life choices, or both.

Wesley Snipes put in an OIC of $842,061.

Out of $25 million plus.

Heck, even I don’t believe him.

Let’s begin with personal financials. You know the IRS is going to check him out, especially with such a lowball offer.

·      Snipes owns real estate and other assets through a series of related companies.

OK. The IRS is going to have to look at this.

·      Snipes argued that some of this real estate had been sold or went missing.

OK. The IRS is going to have to look at this.

·      Snipes argued that his financial advisor had “diverted” his assets and money without his knowledge or consent.

OK. The IRS is going to have to look at this.

·      Snipes requested that his tax liability be “transferred” to his advisor, as the advisor had conveniently “transferred” Snipe’s assets to himself. This would require an investigation, of course, and perhaps the IRS could place his account in “currently not collectible” status during the investigation.

I suspect there is or will be a lawsuit here. I would have hired an attorney and filed papers already.

The problem is that Appeals (where Snipes was at the moment) is not built for this. Snipes is requesting an audit, and audits are done by Examination. Given what was alleged, this matter could even go to the Criminal Division of the IRS. While Appeals can review the work of the field (Examination) division, they cannot perform the field investigation themselves.

·      He has one more argument: economic hardship.

Problem: the normal indicia of economic hardship include illness, disability, or exhaustion of income or assets providing for oneself or dependents. These do not apply in his case.

That leaves an argument that he is unable to borrow against assets, and the forced sale of said assets would leave him unable to meet basic expenses.

This argument may have traction. He is – after all – asserting that assets have disappeared and he doesn’t know when or where.

But he failed to provide enough financial information to allow the IRS to evaluate the matter. The IRS and the Court kept circling on this point. Could it be that he truly could not sherlock what happened to his money?

However, not providing information in an OIC tends to be fatal.

Still, the IRS was moved. They agreed to reduce the settlement to $9,581,027.

Snipes’ team said: No. It is $842,061 or nothing.

The Court said: Then nothing it is.

I suspect the most interesting part of the story is the part that was not provided: what happened to the real estate and other money?

I also wonder if there is a certain schadenfreude here.

Tax protestors sometimes use unnecessarily complicated structures (trusts, for example) to distance, obscure and possibly hide the ultimate control of money or assets. A protestor would not own real estate directly, for example. Rather an entity would own the real estate and the protestor would control the entity. Or there would be an intermediate entity owned by yet another entity controlled by the protestor.

What if the protestor goes to prison? The protestor might then cede a certain amount of authority over the entity/entities to someone – like an advisor - while incarcerated.

What happens if that advisor does not have the protestor’s best interest at heart?

Might sound a lot like what we read here.

A Baseball Player Gets Hit By A Penalty

I have a question for you: let’s say you are a professional athlete. You have hired a financial advisor and an accountant. You give the financial advisor a durable power of attorney, allowing him/her to pay your bills, manage your money and grow your investments. You ask your accountant to prepare tax returns as necessary keep you out of trouble.

These services are not cheap. They cost you an upfront fee of $150,000 and an ongoing $360,000 annually.

            COMMENT: I am available and open to relocation.

You get robbed for millions of dollars. Tax returns do not get filed.

The IRS now wants big penalties from you.

QUESTION: Do you have “reasonable cause” to have the IRS remove those penalties?

We are talking about Mo Vaughn, who played baseball with the Red Sox, the Anaheim Angels and the New York Mets in the nineties and aughts.  He was the American League MVP in 1995.

In 2004 he hired Ra Shonda Kay Marshall to handle his money matters. She wound up leaving her employer, Omni Elite, and set up her own company, RKM Business Services, Inc. He also hired David Krebs with CPA Advisory Group, Inc. for the preparation of his tax returns.

Something happened, and in 2008 he fired both of them. Vaughn was going through his bank statements when he realized that Marshall had been embezzling. He hired forensic accountants, who determined that from 2004 to 2008 she had embezzled more than $2.7 million.

He then learned that his 2006 taxes were not paid.

Even that was better news than 2007, when his taxes were not even filed, much less paid.

He sued Marshall and RKM Business Services.

He hired new CPAs to get him caught up. The IRS – in that show of neighborliness that we have come to expect – hit him with penalties of $1,037,158 for 2006 and $102,106 for 2007. He had filed and/or paid late, and there were penalties for both.

He owed the tax, of course, but he had to contest the penalties. He went the administrative route – meaning appealing and working within the IRS itself. Striking out, he then took his case to court. He went to district court and then to appeals.

His main argument was simple: he was paying people to keep him out of tax problems. There was a lot of money leaving his account, so he had every reason to believe that a good chunk of it was going to the IRS. He was robbed. The IRS was robbed. Surely robbery is reasonable cause.

The IRS and the court pretty much knew his story at this point, and they knew that he was suing to get his millions back. The court however decided the government was due its money. There was no reasonable cause.

How is this possible?

There is a tax case (Boyle) where the Supreme Court addressed the issue of penalties assessed a taxpayer for his/her agent’s failure to file and pay taxes. The Court stated:

“It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not ‘reasonable cause’ for a late filing under [Section] 6651(a)(1).”

The Court was addressing deadlines, and it set a fairly high standard. The Court distinguished relying on an attorney or accountant for advice from relying on an attorney or accountant to actually file the return itself. Reliance on an agent did not relieve the principal of compliance with statutory deadlines, except in extremely limited circumstances.

Vaughn could not clear this standard. He had delegated too much when he turned over responsibility for both preparing and filing his taxes to Marshall and Krebs.

Vaughn had a backup argument: the malfeasance of his agents rendered him unable to pay. He did not have enough money left to pay taxes by the time Marshall was done with him.

He was referring to a tax case (American Biomaterials Corp) where two corporate officers defrauded their corporation, including failing to file and pay taxes. Those two were the only officers with the responsibility to file returns and make payment. The Court held that the corporation was not vicariously liable for the acts of its officers and therefore was not liable for penalties.

There is a limit on American Biomaterials, though: a corporation is not entitled to relief if – by act or omission – its internal controls are so lax that that there was no reasonable expectation that malfeasance would be detected in the ordinary course of business. In other words, the corporation cannot willfully neglect normal checks and balances and expect to be relieved of penalties.

Vaughn got smacked on his second argument. The Court noted the obvious: in American Biomaterials there was no one left in the company to file and pay the taxes. This was not Vaughn’s situation. While he had delegated responsibility, there was someone left who could and should have stepped in: Mo Vaughn himself. He did not. That was his decision and provided both reason and cause to impose penalties.

And so Vaughn lost both in the district and the appeals courts. He owed the IRS enough penalties to allow either you or me to retire. He lost because he delegated the one thing the tax Code does not allow one to delegate, except in the most extreme cases: the duty to file the return itself.