Use Of Wrong Form Costs A Tax Refund

Let’s talk about the following Regulation:

26 CFR § 301.6402-2

Claims for credit or refund

(b) Grounds set forth in claim.

(1) No refund or credit will be allowed after the expiration of the statutory period of limitation applicable to the filing of a claim therefor except upon one or more of the grounds set forth in a claim filed before the expiration of such period. The claim must set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof. The statement of the grounds and facts must be verified by a written declaration that it is made under the penalties of perjury. A claim which does not comply with this paragraph will not be considered for any purpose as a claim for refund or credit.

That last sentence is critical and – potentially – punishing.

I suspect the most common “claim for refund” is an amended return. There are other ways to claim, however, depending on the tax at issue. For example, businesses requested refunds of federal payroll taxes under the employee retention credit (“ERC”) program by filing Form 941-X. You or I would (more likely) file our claim for refund on Form 1040-X. 

File a 1040-X and the tax “variance doctrine” comes into play. This means that the filing must substantially inform the IRS of the grounds and reasons that one is requesting a refund. Both parties have responsibilities in tax administration. A taxpayer must adequately apprise so the IRS can consider the request without further investigation or the time and expense of litigation.

Here is a Court on this point in Charter Co v United States:

The law requires a taxpayer “to do more than give the government a good lead based on the government’s ability to infer interconnectedness.”

Another way to say this is that the IRS is not required to go all Sherlock Holmes to figure out what you are talking about. 

Let’s look at the Shleifer case.

Scott Shleifer was a partner in an investment firm. He travelled domestically and abroad to investigate new and existing investment opportunities. Scott was not a fan of commercial airfare, so he used his personal plane. He waived off reimbursement from the partnership for his air travel.

COMMENT: Scott is different from you or me.

The Shleifers filed their 2014 joint individual tax return. Whereas it is not stated in the case, we can assume that their 2014 return was extended to October 15, 2015.

In October 2018 they filed an amended return requesting a refund of almost $1.9 million.

COMMENT: And there you have your claim. In addition, notice that the two Octobers were three years apart. Remember that the statute of limitations for amending a return is three years. Coincidence? No, no coincidence.

What drove the amended return was depreciation on the plane. The accountant put the depreciation on Schedule C. It was – in fact – the only number on the Schedule C.

In July 2020 the IRS selected the amended return for audit.

COMMENT: A refund of almost $1.9 million will do that.

The Shleifer’s accountant represented them throughout the audit.

In March 2022 the IRS denied the refund.

Why?

Look at the Schedule C header above. It refers to a profit or loss “from business.” Scott was not “in business” with his plane. It instead was his personal plane. He did not sell tickets for flights on his plane. He did not rent or lease the plane for other pilots to use. It was a personal asset, a toy if you will, and perhaps comparable to a very high-end car. Granted, he sometimes used the plane for business purposes, but it did not cease being his toy. What it wasn’t was a business.

The accountant put the depreciation on the wrong form.

As a partner, Scott would have received a Schedule K-1 from the investment partnership. The business income thereon would have been reported on his Schedule E. While the letters C and E are close together in the alphabet, these forms represent different things. For example:

·       There must be a trade or business to file a Schedule C. Lack of said trade or business is a common denominator in the “hobby loss” cases that populate tax literature.

·       A partnership must be in a trade or business to file Schedule E. A partner himself/herself does not need to be active or participating. The testing of trade or business is done at the partnership - not the partner - level.

·       A partner can and might incur expenses on behalf of a partnership. White there are requirements (it’s tax: there are always requirements), a partner might be able to show those expenses along with the Schedule K-1 numbers on his/her Schedule E. This does have the elegance of keeping the partnership numbers close together on the same form.   

After the audit went south, the accountant explained to the IRS examiner that he was now preparing, and Scott was now reporting the airplane expenses as unreimbursed partner expenses. He further commented that the arithmetic was the same whether the airplane expenses were reported on Schedule C or on Schedule E. The examiner seemed to agree, as he noted in his report that the depreciation might have been valid for 2014 if only the accountant had put the number on the correct form.

You know the matter went to litigation.

The Shleifers had several arguments, including the conversation the accountant had with the examiner (doesn’t that count for something?); that they met the substantive requirements for a depreciation deduction; and that the IRS was well aware that their claim for refund was due to depreciation on a plane.

The Court nonetheless decided in favor of the IRS.

Why?

Go back to the last sentence of Reg 301.6402-2(b)(1):

A claim which does not comply with this paragraph will not be considered for any purpose as a claim for refund or credit.

The Shleifers did not file a valid refund claim that the Court could review.

Here is the Court:

Although the mistake was costly and the result is harsh …”

Yes, it was.

What do I think?

You see here the ongoing tension between complying with the technical requirements of the Code and substantially complying with its spirit and intent.

I find it hard to believe that the IRS – at some point – did not realize that the depreciation deduction related to a business in which Scott was a partner. However, did the IRS have the authority to “move” the depreciation from one form to another? Then again, they did not have to. The accountant was right: the arithmetic worked out the same. All the IRS had to do was close the file and … move on.

But the IRS also had a point. The audit of Schedule C is different from that of Schedule E. For example, we mentioned earlier that there are requirements for claiming partnership expenses paid directly by a partner. Had the examiner known this, he likely would have wanted partnership documents, such as any reimbursement policy for these expenses. Granted, the examiner may have realized this as the audit went along, but the IRS did not know this when it selected the return for audit. I personally suspect the IRS would not have audited the return had the depreciation been reported correctly as a partner expense. 

And there you have the reason for the variance doctrine: the IRS has the right to rely on taxpayer representations in performing its tax administration. The IRS would have relied on these representations when it issued a $1.9 million refund – or selected the return for audit.

What a taxpayer cannot do is play bait and switch.

Our case this time was Shleifer v United States, U.S. District Court, So District Fla, Case #24-CV-80713-Rosenberg.

A Psychiatrist, Chauffer, Physician, Peace Officer, Pheasant Hunter

 

He said that his patients often called him a psychiatrist, chauffer, physician, peace officer, or even a pheasant hunter.”

He is David Laudon, a chiropractor in Minnesota and the subject of one of the more entertaining Tax Court opinions of the last decade. Laudon, however, reached too far for too long, and he was about to learn about snapback.

Back to the Court:

But not a ghostbuster. The Commissioner rhetorically asserted that some of Laudon’s trips might have made more sense if he was claiming to be a ghostbuster. Laudon then disclaimed any employment as a ghostbuster. In his reply brief the Commissioner conceded that Laudon was not ‘employed or under contract to perform work as a ghostbuster during the tax years at issue in this case.’”

Methinks Laudon missed the joke.

How did Laudon get to court?

Easy: he was audited for years 2007 through 2009.

His records were … colorful, humorous, inadequate.

Laudon did not keep records of his income in any decipherable form.”

The IRS did a reconstruction of his business income by analyzing his bank accounts. The rule of thumb is straightforward: all deposits are income unless one can prove otherwise. A common otherwise is when a taxpayer transfers money between accounts.

Laudon contends that the Commissioner failed to classify certain deposits as nontaxable, including insurance payments for damage to several vehicles, one of which was involved in a ‘high speed police chase’ with a man ‘high on meth and cocaine.’”

There is something you do not see every day. The other thing the Court did not see was “any evidence” that the deposits were what and as Laudon described.

We therefore accept the Commissioner’s reconstruction of income.”

On to deductions.

He treats some of his patients in his home and claims to use roughly half of his house – the basement and half of the garage – for business.”

This could be a problem. Rember that an office in home deduction requires exclusive business use of the space. He claimed a lot of space, ratcheting the pressure on “exclusive.”

Like many chiropractic offices, Laudon’s has beds, tables, and a waiting area. But unlike most, his also comes equipped with a Wii, Xbox 360, big-screen TVs and, for a time, a working hair salon.”

Hair salon? What kind of chiropractic office is this?

I see that Laudon represented himself at Tax Court. I would also guess that he represented himself during the audit. Why do I say that?

We particularly disbelieve his claim that the Xbox, Wii, big-screen TVs and other electronics in his basement were used exclusively for chiropractic purposes since this claim conflicts with his much more plausible admission to the IRS examiner during audit that his daughter and his girlfriend’s son would play these video games while he was on the phone.”

There is an example of why I almost never have a client meet or speak directly with the IRS – I cannot control the exchange.

Laudon was deducting between 40,000 and 60,000 miles per year for business purposes.

.. for example, driving to a ‘schizophrenic’ patient who was – on more than one occasion – ‘running scared of demons’ down a rural Minnesota highway .…”

That last part should be incorporated into a folk or country song. I can almost hear the melody.

Laudon apparently had a penchant for adult beverages.

Laudon claimed to have driven hundreds of miles per day – sometimes without a valid license ….”

I’ll bite. What happened to his license?

Even his testimony about multiple entries in the logs where he wrote “DUI” was not credible: He claimed that these were not references to being stopped by the police while under the influence, or driving while his license was suspended .…”

Then what were they?

They “instead were his misspellings of a patient named: 'Dewey' - a supposed patient of his.'"

This is starting to read like a sit com script. I am waiting for the reference to tiger blood.

But he had a mileage log, right? Did that count for anything?

Laudon had a mileage log, but it fails to meet section 274(d)’s standards. The … entry, for example, describes his purpose as ‘travel to and from places.’”

Zen-like. Nice.

The Court also looked at other expenses, including “Other Expenses” for the three years under audit.

Most of this amount - $22,665 – was a deduction for the value of Laudon’s labor, supplies and stolen goods ….”

Wait on it.

… related to the renovation of a home that Laudon neither lived nor worked in, or even owned.”

It fits. Well done, sir.

Laudon was getting clipped on almost every deduction.

But wait.

You know the IRS wanted penalties.

Laudon asserts the defense that he reasonably relied on the advice of a tax professional.”

Yep, that is a defense, but you must use a tax professional, provide all information – good or bad – to the professional and actually rely on the professional.

Moreover, while he claimed to have brought all of his receipts to H&R Block along with his summaries, he later stated that his preparers didn’t want him to just walk in with his receipts and have them add it up ….”

Folks, accountants do not add up grocery bags of receipts. Considering that the profession usually bills based on work time, I doubt you want to pay someone for adding up your receipts.

The Court was direct:

We don’t need to address the …. because we don’t believe that Laudon provided ‘necessary and accurate information’ to his advisor.”

At this point, the Court did not believe anything Laudon was saying.

Having blinded H&R Block to the details and peculiarities of his chiropractic enterprise, Laudon cannot now claim that he relied on H&R Block’s advice. We sustain the penalty.”

Our case this time was David William Laudon v Commissioner. T.C. Summary Opinion 2015-54.

If you read only one, make it this one.

Valuing a Questionable Business

 

Starting with a 46-page case soon after finishing tax season may not have been my best idea.

Still, the case is a hoot.

Here is the Court:

Backstabbing, infidelity, and blackmail – not the first words that come to mind in relation to a baby products company.”

We are talking about Kaleb Pierce and his (ex) wife Ms. Bosco.

Early on Pierce sought to make money any way he could. At age 16 he purchased an ice cream truck, for example. He met Bosco and they married in 2000. Several children soon followed.

That ice cream truck was not going to suffice. He switched to selling timeshares. He then switched to painting houses.

In 2005 they had another child. Bosco had an idea relating to nursing newborns, and Pierce had his next business idea. He reached out to Chinese manufacturers to make wristbands for nursing mothers. He set up a website, attended tradeshows and whatnot.

His idea was not an initial success.

But there was someone at the tradeshow who was successful. Pierce wanted to partner with them, but they were not interested, Pierce then decided to duplicate their company and run them out of business.

The model was easy enough: he would manufacture the product in China, undercut the existing retail price and then reduce that already-undercut price to zero by use of promotional codes. Where is the money, you ask? He would charge a shipping fee. Considering that the price was already reduced to zero, he figured he could press his thumb on the shipping fee as his profit point.

He was right, but not fully. In the early days, the products were sometimes shipped to customers showing the actual shipping cost. Those customers were not amused.

But Pierce could make money.

And the model was simple: appropriate someone’s product, create a website to pitch it, have the product manufactured cheaply, make money hand over fist. Mind you, the products were all directed at nursing mothers, so the window to market and sell was limited. He had to strike hard and fast. He also had to keep introducing new products, as he continually needed something on which to hang a shipping charge.

The company was called Mothers Lounge (ML). ML sold each product through a different subsidiary. This separation of business was vital to give the appearance that the companies were unrelated. Even so, many customers found that the same company was selling the products. They requested that different orders be shipped together, which ML could not do, of course. ML had reached a point where 97% of its revenues came from that free- just-pay-shipping model.

How did it turn out?

In his own words:

He “never imagined that he was going to be this successful.”

But then ….

Pierce had an extramarital affair.

Someone added a tracker to Pierce’s software that tracked his keystrokes and found out about the affair.

Someone sent a box with a letter demanding $100,000 by the following week or said someone would tell Bosco about the affair.

Pierce told Bosco about the affair first. The news shattered her. She no longer trusted him. She forbade him from attending tradeshows. He responded by sending employees in his place, but it was not the same. His employees were not as … creative … at recognizing … opportunities as Pierce. Eventually he stepped down as CEO to deal with his family.

The business was not the same.

But Pierce and Bosco were still printing money. He did what a nouveau-riche entrepreneur would do: he started estate planning.

It is here that we get back to tax.

They created a trust. The trust in turn created an operating company. Pierce and Bosco each gifted 29.4% ownership to the trust. They also sold a 20.6% interest to the operating company owned by the trust.

The tax lawyers were busy.

There was a gift tax return, which meant that ML needed a valuation.

The IRS selected the gift tax returns (one by each spouse) for audit.

Pierce and Bosco fired their valuation expert and hired another.

That is different, methinks.

The new expert came in with a lower number. Pierce and Bosco told the IRS that – if anything – they had overreported the gift. What was the point of the audit?

The IRS was not buying this. The IRS argued that the two had underreported the gift by almost $5 million. Remember that the gift tax rate is 40%, so this disagreement translated into real money. The IRS also wanted penalties of almost $2 million.

Off to Tax Court they went.

The Court discussed valuation procedures for over twenty pages, the detail of which I will spare us. The Court liked some things about Pierce and Bosco’s valuations (remember they had two) and also liked some things about the IRS valuation. Then you had the unique facts of Mothers Lounge itself, a business which was not really a business but was nonetheless quite profitable. How do you value a business like that, and how do you adjust for the business decline since the blackmail attempt? The IRS argued that ML could return to a more traditional business model. The Court noted that ML could not; it was a different animal altogether.

The decision is a feast for those interested in valuation work. The Court was meticulous in going through the steps, but it was not going to decide a number. Truthfully, it could not: there was too much there.

The Court instead made an interim decision under Rule 155, a Tax Court arcana requiring the two parties to perform – and agree to – calculations consistent with the Court’s reasoning.

And the Court will review those results in a future hearing.

Our case this time was Pierce v Commissioner, T.C. Memo 2025-29.

The IRS Goes Rounds With Cohan

 

The decision begins with the IRS seeking taxes of $805,149, $1,145,104, $1,161,864, and $831,771 for years 2013 through 2016. The penalties were unsurprisingly also enormous.

I want to know what happened here.

The taxpayer was Mohammad Nasser Aboui, and he was the sole shareholder of an S corporation called HPPO. He owned several used vehicle lots, and in 2009 he put them into HPPO as its initial corporate capitalization.

It sounds like a tough business:

·       Most of HPPO customers had bad credit.

·       Many did not have a checking account and instead paid HPPO in cash.

·       HPPO financed between 90% and 95% of its sales.

·       Customers repaid their loans less than 10% of the time.

·       HPPO repossessed approximately 25% of the cars it sold within 3 or 4 months.

·       HPPO had quite the barter system going with its mechanics: the mechanic would work on HPPO cars in exchange for rent of HPPO’s garage space.

Around 2014 Aboui decided to close the business. There were serious family health issues and HPPO was not making any money.

The IRS started its audit in September 2015.

HPPO’s accountant was ill at the time and later died.

To its credit, the IRS waited.

More than 3 years later HPPO engaged another accountant to represent the audit.

The second accountant made immediate mistakes, such as getting HPPO’s accounting method wrong when dealing with the IRS Revenue Agent (RA).

COMMENT: More specifically, the accountant told the RA that HPPO used the overall cash basis of accounting. HPPO did not. In fact, it could not because inventory was a material income-producing factor.

The RA wanted HPPO’s books and records, including access to its accounting software. HPPO could provide much but not the software. Its software license expired when it left the vehicle business in 2018.

This is a nightmare.

HPPO did eventually reactivate the software, but it was too late to help with the RA.

The RA – being told by the second accountant that HPPO used the cash basis of accounting – decided to use bank statements to reconstruct gross income.

BTW HPPO wound up dismissing the second accountant.

The results were odd: HPPO had reported more sales for 2013 through 2015 – nearly $3.25 million - than was deposited at the bank.

The pattern reversed in 2016 when HPPO deposited approximately $539 grand more than it reported in sales.

COMMENT: I have an idea what happened.

The RA also saw following bad debt expense:

          2013             $1,069,739

          2014             $ 668,537

          2015             $ 902,967

          2016             $ 436,738    

Here is something about the cash basis of accounting: you cannot have bad debt expense. It makes sense when you remember that gross income is reported as monies are deposited. Bad debts are receivables that are never collected, meaning there is nothing to deposit. One never leaves home plate.

So, the RA disallowed the bad debt expense entirely.

I am pretty sure about my earlier hunch.

The RA also determined that HPPO had distributed the following monies to Aboui, one way or another:

          2013             $2,476,301

          2014             $1,704,329

          2015             $1,406,893

2016             $1,934,033

There were other issues too.

Off they went to Tax Court.

Remember what I said about reactivating the accounting software license? Aboui now presented thousands of pages to document cost of sales and other expenses. The Court encouraged the IRS to accept and review the new records.

The IRS said, “nah, we’re good.”

COMMENT: Strike one.

The Court started its opinion with HPPO’s sales.

The RA stated to the Court that HPPO used the overall cash basis of accounting.

Don’t think so, said the Court. The Court saw HPPO using the accrual basis of accounting for sales and the cash basis of accounting for everything else.

COMMENT: This is referred to as a hybrid method: a pinch of this, a sprinkle of that. If one is consistent – and the results are not misleading – a hybrid is an acceptable method of accounting.

The Court asked Treasury why it thought that HPPO used the cash basis of accounting.

Treasury replied that it had never said that.

The Court pointed out that the RA had said that she understood HPPO to be a cash basis taxpayer. To be fair, that is what the second accountant had told her.

Nope, never used the cash method insisted Treasury.

COMMENT: An explanation is in order here. Treasury Department attorneys take over when the matter goes to Court. Perhaps the attorneys meant “direct” Treasury. The RA – while working for the IRS which itself is part of the Treasury – would then be “indirect” Treasury. I am only speculating, as this unforced error makes no sense. Clearly it bothered the Court.

Strike two.

The Court then reasoned why HPPO was reporting more sales than it deposited in the bank: it was reporting the total vehicle sale price in revenues at the time of sale. That also explained the bad debt expense: HPPO financed most of its sales and most of those loans went sour.

But why the reversal in 2016?

Aboui explained to the Court that by 2016 he was closing the vehicle business. He would have slowed and eventually stopped selling cars, with the result that he would be depositing more in the bank than he currently sold.

The Court decided that HPPO had correctly recorded its sales for the years at issue.

Next came the cost of vehicles sold.

This accounting was complicated because so much cash was running through the business. Sometimes cash was used to immediately pay expenses without first being deposited into a bank account – NOT a recommended accounting practice.

The RA had also identified certain debits to HPPO’s bank account that were either distributions or otherwise nondeductible.

The Court could find no evidence that those identified debits had been deducted on the tax returns.

The RA – and by extension, the … Treasury – was losing credibility.

Aboui meanwhile provided extensive documentation of HPPO’s expenses at trial. Some of these were records the Court had asked the IRS to accept and review – and which the IRS passed on.

Here is the Court:

Petitioners provided extensive documentation at trial to substantiate the COGS and business expenses. Mr. Aboui testified that HPPO was unprofitable. Given the record in its entirety, we find that petitioners have substantiated HPPO’s COGS and business expenses as reported on HPPO’s returns for each year at issue, except for meal and entertainment expenses of …..”

COMMENT: Strike three.

The Court went to the bad debts.

Mr. Aboui credibly testified that he was unable to repossess approximately 250 cars during the years at issue. The loss of these cars adequately substantiates the amount of HPPO’s bad debt deductions for the years at issue under the Cohan rule.”

The Court went to the distributions.

Respondent determined that petitioners failed to report approximately $7.5 million in taxable distributions from HPPO during the years at issue.”

COMMENT: Remember that HPPO is an S corporation, and Aboui would be able to withdraw his invested capital – plus any business income he had paid taxes on personally but left in the business – without further tax. This amount is Aboui’s “basis” in his S corporation stock.

Here is the Court:

Respondent argues that petitioners have not established Mr. Aboui’s basis in HPPO during the years at issue. We disagree and that the record and Mr. Aboui’s credible testimony provides sufficient evidence for us to reasonably estimate his basis under the Cohan rule.”

The IRS won a partial victory with the distributions. The Court thought Aboui’s basis in HPPO was approximately $5.1 million.

The IRS had wanted zero basis.

The effect was to reduce the excess distributions to $$2.4 million ($7.5 minus $5.1).

Still, it was a rare win for the IRS.

Excess distributions are taxable. Aboui had taxable distributions of $2.4 million. Yes, it is a lot, but it is also a lot less than the IRS wanted.

COMMENT: The nerd part of me wonders how the Court arrived at an estimate of $5.1 million for Aboui’s basis. Unfortunately, there is no further explanation on this point.

Oh, one more thing from the Court:

… we hold that petitioners are not liable for any penalties.”

While not contained within the four corners of this decision, I am curious why the Court repetitively went to the Cohan rule. I have followed this literature for years, and this result is not normal. Courts generally expect a business to maintain an accounting system that produces reliable numbers. Yes, every now and then there may be a leak in the numbers, and the court may use Cohan to plug said leak. That is not what we have here, though. This boat was sinking.

Perhaps Aboui presented his case well.

Mr. Aboui was incredibly forthright in his testimony.”

And perhaps the IRS should not have argued that an RA – an IRS employee – is not the IRS.

Our case this time was Aboui and Mizani v Commissioner, T.C. Memo 2024-106.

An IRS Employee And Unreported Income

 

You may have heard that Congress is tightening the 1099 reporting requirements for third party payment entities such as PayPal and Venmo. The ultimate goal is to report cumulative payments exceeding $600. Because of implementation issues, the IRS has adjusted this threshold to $5,000 for 2024.

Many, I suspect, will be caught by surprise.

Receiving a 1099-K does not necessarily mean that you have taxable income. It does mean that you were paid by one of the reporting organizations, and that payment will be presumed business-related. This is of concern with Venmo, for example, as a common use is payment of group-incurred personal expenses, such as the cost of dining out. Venmo will request one to identify a transaction as business or personal, using that as the criterion for IRS reporting  

What you cannot do, however, is ignore the matter. This IRS matching is wholly computerized; the notice does not pass by human eyes before being mailed. In fact, the first time the IRS reviews the notice is when you (or your tax preparer) respond to it. Ignore the notice however and you may wind up in Collections, wondering what happened.

The IRS adjusted the 2004 and 2005 returns for Andrea Orellana.

The IRS had spotted unreported income from eBay. Orellana had reported no eBay sales, so the computer match was easy.

There was a problem, though: Orellana worked for the IRS as a revenue officer.

COMMENT: A revenue officer is primarily concerned with Collections. A revenue agent, on the other hand, is the person who audits you.

Someone working at the IRS is expected to know and comply with his/her tax reporting obligations. As a revenue officer, she should have known about 1099-Ks and computer matching.

It started as a criminal tax investigation.

Way to give the benefit of the doubt there, IRS.

There were issues with identifying the cost of the items sold, so the criminal case was closed and a civil case opened in its place.

The agent requested and obtained copies of bank statements and some PayPal records. A best guess analysis indicated that over $36 thousand had been omitted over the two years.

Orellana was having none of this. She requested that the case be forwarded to Appeals.

Orellana hired an attorney. She was advised to document as many expenses as possible. The IRS meanwhile subpoenaed PayPal for relevant records.

Orellana did prepare a summary of expenses. She did not include much in the way of documentation, however.

The agent meanwhile was matching records from PayPal to her bank deposits. This proved an unexpected challenge, as there were numerous duplicates and Orellana had multiple accounts under different names with PayPal.

The agent also needed Orellana’s help with the expenses. She was selling dresses and shoes and makeup and the like. It was difficult to identify which purchases were for personal use and which were for sale on eBay.

Orellana walked out of the meeting with the agent.

COMMENT: I would think this a fireable offense if one works for the IRS.

This placed the agent in a tough spot. Without Orellana’s assistance, the best she could do was assume that all purchases were for personal use.

Off they went to Tax Court.

Orellana introduced a chart of deposits under dispute. She did not try to trace deposits to specific bank accounts nor did she try to explain – with one exception - why certain deposits were nontaxable.

Her chart of expenses was no better. She explained that any documents she used to prepare the chart had been lost.

Orellana maintained that she was not in business and that any eBay activity was akin to a garage sale. No one makes a “profit” from a garage sale, as nothing is sold for more than its purchase price.

The IRS pointed out that many items she bought were marketed as “new." Some still had tags attached.

Orellana explained that she liked to shop. In addition, she had health issues affecting her weight, so she always had stuff to sell.

As for “new”: just a marketing gimmick, she explained.

I always advertise as new only because you can get a better price for that.” 

… I document them as new if it appears new.”

Alright then.

If she can show that there was no profit, then there is no tax due.

Orellana submitted records of purchases from PayPal.

… but they could not be connected or traced to her.

She used a PayPal debit card.

The agent worked with that. She separated charges between those clearly business and those clearly personal. She requested Orellana’s help for those in between. We already know how that turned out.

How about receipts?

She testified that she purchased personal items and never kept receipts.

That would be ridiculous, unheard of. Unless there was some really bizarre reason why I keep a receipt, there were no receipts.”

The IRS spotted her expenses that were clearly business. They were not enough to create a loss. Orellana had unreported income.

And the Court wanted to know why an IRS Revenue Officer would have unreported income.

Frankly, so would I.

Petitioner testified that she ‘had prepared 1040s since she was 16’ and that she ‘would ‘never look at the instructions.’”

Good grief.

The IRS also asked for an accuracy penalty.

The Court agreed.

Our case this time was Orellana v Commissioner, T.C. Summary Opinion 2010-51.