Some Thoughts After The Tax Filing Deadline(s)

 

There is something happening in the public accounting profession. The profession itself is aging. The AICPA expected 75% of practicing CPAs to reach retirement age by 2020 – which was four years ago. Many smaller firms do not have succession plans, meaning that an owner’s retirement plan likely involves being acquired by another firm. Fewer college students are pursuing accounting majors, placing stress on recruiting and retaining accountants in the early years of their career. We see firms releasing clients and sometimes entire lines of practice. I know of one which released its trust work, which surprised me. I contributed to this several years ago when we released our inbound (that is, international) work. These clients still need professional advice, but fewer CPAs are providing these services.

On the flip side, it is a great time for someone to start (or grow) an accounting practice. A challenge here is step growth – that is, growth that requires hiring. One circles back to the issue of the talent shortage. A bad hire is damaging, perhaps even more so in a small firm.

Even the IRS is not immune to the talent shortage. In 2019 the IRS employed approximately 75,000 people. The Inflation Reduction Act supposedly provided funds to hire an additional 87,000 people through the year 2031. It hasn’t, of course, as the IRS is competing with every other employer in the market.

I suspect the profession has done much of the damage to itself. One can easily point to the 150-hour requirement for a CPA license. That may have made sense years ago, but with today’s exorbitant college costs that additional year of class, books and housing might be difficult to justify.

And then we have the toxicity of the profession itself. I cannot recall the last time that a CPA my age has not shared his/her “horror” stories: the stress, hours, near-impossible deadlines, psychopathic personalities, power dynamics and whatnot. I remember a managing partner bringing cigars so we could “talk”; we sat outside, and he explained how infeasible it was for me to visit my ailing grandmother in Florida. My grandmother died that year. I also left the firm that year. I suspect Gen Z will not tolerate this behavior as passively, and rightfully so.   

Congress has greatly exacerbated the problem with its never-ending and wildly metastasizing tax changes. It used to be that accountants would spread their tax work over the course of the year by placing their business clients on a fiscal year – that is, a tax year ending other than December 31. This allowed work to be distributed more sanely over the year. Congress changed this in 1986 by requiring almost everyone to use the calendar year. Yes, there was an “out,” and the out was for the business to pay a “deposit” for taxes it would have paid had it changed to a calendar year. I suspect that – even if not a CPA – you can guess how well those client conversations went. Combine that with Congress’ recent-enough 1099 reporting fetish and you have a crippling steamroller than begins in January and ends … well, who know when.  

I think we overstretched ourselves here at Galactic Command this year. Potential clients are calling for appointments, and it can be hard (for some of us) to say no. After the just-concluded September and October extension deadlines, however, we must learn to say no. We do not have the resources, and we are burning the resources – including me – that we do have.    

Then there is AI – will artificial intelligence replace any/some/much of what a CPA does? Depending on what the accountant does, I suppose it is possible. First year audit work, for example, scarcely requires a 150-hour degree. That might be a viable onramp for AI. Then again, I remember when QuickBooks was going to put accounting services departments out of business. It didn’t, and accounting services is one of the most sought-after practice areas in accounting firms today. Will AI take away much of my 1040 workload? 

I hope so.

Company’s Tuition Payment Was Not Deductible

 

Let me give you a fact pattern and you tell me whether there is a tax deduction.

·      You own a company.

·      A young man is dating your daughter.

·      The young man wants to take a computer course at Northwestern University. If it turns out he has both aptitude and interest, perhaps he can maintain the company’s website, at least for a while.

·      The company pays for the course.

Let me up the ante: is there a tax deduction to you and tax-free income to the young man?

You are thinking: maybe.

For example, my firm pays for my expenses when I attend professional seminars or conferences. Then again, my CPA license carries a continuing education requirement, so the seminars and conferences are necessary for me keep my gig as a practicing CPA.

Sounds like a working condition fringe benefit. The “working condition” qualifier means that the employer is paying for something that the employee could deduct (at least before the tax Code nixed miscellaneous itemized deductions) had the employee paid for it.

Alternatively, there are companies who pay (or help pay) tuition for employees who go to college. There are hitches to this educational assistance arrangement, though: it has to be available to everybody, cannot discriminate in favor of highly-compensated employees, and so on.

I am not seeing a tax deduction down either path. Why? Notice that a fringe benefit or assistance program requires an employer:employee relationship. You have no such relationship with the young man.

I suppose you could make him an employee.

No, you say.  Dating your daughter does not put him on the payroll.

You circle back to the possibility that he could take care of your website, at least for a while. That costs money to do. If he did so for free, or at a substantially reduced rate, the cost of that course could be a drop in the bucket compared to what you would have paid a webmaster.

OK. I am certain that the tuition is more than $600, so you pay for the course, send him a 1099 and he will have to settle-up while he files his tax return. On the upside, he should get a tax credit for taking that course.

Nope, you say. You want to deduct it as a business expense but not issue a W-2 or a 1099. None of that.

And that is how Robert and Swanette Ward appeared before the Tax Court. Clearly the IRS disagreed with the tax outcome they wanted.

Here is the Court:

While [] has provided services to Sherwin [CTG: Mrs Ward’s company] free of charge that would likely have cost Sherwin more than the amount of the tuition, we nonetheless find that the petitioners have not established that Sherwin is entitled to deduct the tuition.”

Why not?

Mr [] was not an employee of Sherwin.”

Yes, but what of the possibility that he would help with the website?

The Wards did not have an agreement with Mr [] that he would perform any services in exchange for the tuition payment.”

What, do you want a written contract or something?

Sherwin paid the tuition without any expectation of a return and thus did not have a business purpose for the payment. The tuition was a personal expense, and Sherwin is not entitled to deduct it.”

Why is the Court is circling the wagons on this one?

Folks, sometimes tax law occurs in the folds and the corners. There is something I have not yet told you that might explain the Court’s obstinacy.

That young man eventually married your daughter.

The Court saw a personal expense all the way.

I get it.

There is a distinction in the Code between deductible business expenses and nondeductible personal expenses. One could reason that showing some business angle or benefit – however abstract or hypothetical – can make the expense deductible, even if the primary factor for incurring the expense was personal. One would be wrong, but one could reason.

Our case this time was Sherwin Community Painters Inc v Commissioner, T.C. Memo 2022-19.

Change In The Kiddie Tax

Congress took a tax calculation that was already a headache and made it worse.

I am looking at a tax change included in the year-end budget resolution.

Let’s talk again about the kiddie tax.

Years ago a relatively routine tax technique was to transfer income-producing assets to children and young adults. The technique was used mainly by high-income types (of course, as it requires income), and the idea was to redirect income that would be taxed at a parent’s or grandparent’s (presumably maximum) tax rate and tax it instead at a child/young adult’s lower tax rate.

As a parent, I immediately see issues with this technique. What if one of my kids is responsible and another is not? What if I am not willing to just transfer assets to my kids – or anyone for that matter? What if I do not wish to maximally privilege my kids before they even reach maturity? Nonetheless, the technique was there.

Congress of course saw the latent destruction of the republic.

Enter the kiddie tax in 1986.

In a classroom setting, the idea was to slice a kid’s income into three layers:

(1)  The first $1,050

(2)  The second $1,050

(3)  The rest of the kid’s income

Having sliced the income, one next calculated the tax on the slices:

(1)  The first $1,050 was tax-free.

(2)  The second $1,050 was taxed at the kid’s own tax rate.

(3)  The rest was taxed at the parents’ tax rate.

Let’s use an example:

(1)  In 2017 the kid has $20,100 of income.

(2)  The parents are at a marginal 25% tax rate.

Here goes:

(1)  Tax on the first slice is zero (-0-).

(2)  Let’s say the tax on the second slice is $105 ($1,050 times 10%).

(3)  Tax on the third slice is $4,500 (($20,100 – 2,100) times 25%).

The kid’s total 2017 tax is $4,605.

Let’s take the same numbers but change the tax year to 2018.

The tax is now $5,152.

Almost 12% more.

What happened?

Congress changed the tax rate for slice (3). It used to be the parent’s tax rate, but starting in 2018 one is to use trust tax rates instead.

If you have never seen trust rates before, here you go:

          

Have over $12,500 of taxable income and pay the maximum tax rate. I get the reasoning (presumably anyone using trusts is already at a maximum tax rate), but I still consider these rates to be extortion. Sometimes trusts are just that: one is providing security, navigating government programs or just protecting someone from their darker spirits. There is no mention of maximum tax rates in that sentence.

Let’s add gas to the fire.

The kiddie tax is paid on unearned income. The easiest type to understand is dividends and interest.

You know what else Congress considered to be unearned income?

Government benefits paid children whose parent was killed in military service. These are the “Gold Star” families you may have read about.

Guess what else?

Room and board provided college students on scholarship.

Seriously? We are taking people unlikely to be racking Thurston Howell III-level bucks and subjecting them to maximum tax rates?

Fortunately, Congress – in one of its few accomplishments for 2019 – repealed this change to the kiddie tax.

We are back to the previous law. While a pain, it was less a pain than what we got for 2018.

One more thing.

Kids who got affected by the kiddie tax changes can go back and amend their 2018 return.

I intend to review kiddie-tax returns here at Galactic Command to determine whether amending is worthwhile.

It’s a bit late for those affected, but it is something.

New Tax On Colleges

I read that Harvard estimates that a change from the Tax Cut and Jobs Act will cost approximately $38 million.

Harvard is referring to the “endowment tax” on colleges and universities.

Have you heard about this?

Let us set up the issue by discussing the taxation of private foundations.

The “best” type of charity (at least tax-wise) is the 501(c)(3). These are the March of Dimes and United Ways, and they are publicly-supported by a broad group of interested donors. In general, this means a large number of individually modest donations. Mind you, there can be an outsized donation (or several), but there are mathematical tests to restrict a limited number of donors from providing a disproportionate amount of the charity’s support.

Then we get to private foundations. In general, this means that a limited number of donors provide a disproportionate amount of support. Say that CTG comes into big bucks and sets up the CTG Family Foundation. There is little question that one donor provided a lopsided amount of donations: that donor would be me. In its classic version, I would be the only one funding the CTG Family Foundation.

There can be issues when a foundation and a person are essentially alter egos, and the Code provides serious penalties should that someone forget the difference. Foundations have enhanced information reporting requirements, and they also pay a 2% income tax on their net investment income. The 2% tax is supposedly to pay for the increased IRS attention given foundations compared to publicly-supported charities.

The Tax Cut and Jobs Act created a new tax – the 1.4% tax on endowment income – and it targets an unexpected group: colleges and universities that enroll at least 500 tuition-paying students and have endowment assets of at least $500,000 per student.

Let me think this through. I went to graduate school at the University of Missouri at Columbia. Its student body is approximately 30,000. UMC would need an endowment of at least $15 billion to come within reach of this tax.

I have two immediate thoughts:

(1)  Tax practitioners commonly refer to the 2% tax on foundations as inconsequential, because … well, it is. My fee might be more than the tax; and

(2)  I am having a difficult time getting worked up over somebody who has $15 billion in the bank.

The endowment tax is designed to hit a minimal number of colleges and universities – probably less than 50 in total. It is expected to provide approximately $200 million in new taxes annually, not an insignificant sum but not budget-balancing either. As a consequence, there has been speculation as to its provenance and purpose.

With this Congress has again introduced brain-numbing complexity to the tax Code. For example, the tax is supposed to exclude endowment funds used to carry-on the school’s tax-exempt purpose.  Folks, it does not take 30-plus years of tax practice to argue that everything a school does furthers its tax-exempt purpose, meaning there is nothing left to tax. Clearly that is not the intent of the law, and tax practitioners are breathlessly awaiting the IRS to provide near-Torahic definitions of terms in this area.  

The criticism of the tax has already begun. Here is Harvard referring to its $40 billion endowment:

“We remain opposed to this damaging and unprecedented tax that will not only reduce resources available to colleges and universities to promote excellence in teaching and to sustain innovative research…”

Breathe deeply there, Winchester. Explain again why any school with $40 billion in investments even charges tuition.

Which brings us to Berea College in central Kentucky, south of Lexington. The school has an endowment of approximately $700,000 per student, so it meets the first requirement of the tax. The initial draft of the tax bill would have pulled Berea into its dragnet, but there was bipartisan agreement that the second requirement refer to “tuition-paying” students.

So what?

Berea College does not charge tuition.

NCAA: From Cream Cheese To Endorsements

You may have read that the NCAA voted to allow students to benefit financially from the use of their name, image or likeness.

In truth, their hand was forced when California Governor Newsom signed the Fair Pay to Play Act on Lebron’s television show “The Shop.” Other states, including Florida, were also lining up on the issue.

Newsom was striking at an organization that realized over a $1 billion in revenues last year from “student-athletes,” all the while banning players from receiving any compensation other than scholarships.

Mind you, this is the same organization that used to ban schools from serving bagels with cream cheese. The NCAA argued (with a straight face somehow) that a bagel was a snack but a bagel with cream cheese was a meal. Meals were a no-go.

The tax hook for this post came from North Carolina (U.S.) Senator Richard Burr, who indicated he would introduce a bill to tax scholarships if the student-athlete also earns money from endorsements.

Methinks that Senator Burr is not a fan of the new rule.

Alternatively, he may subscribe to the new-economics theory of taxing something until it stops doing whatever triggered its taxation in the first place.

Did you know that some scholarships are already taxable?

Yep, the plain-old variety.

Scholarships used to be tax-free until 1980. The Code was then changed to look at whether services were being performed as a requirement for receiving the scholarship. Teaching assistantships would now be taxable, for example.

There was further change in 1986, when the Code began taxing scholarships used for living expenses.  If one received a scholarship, it was now important to determine whether it was for tuition or for room-and-board. Tuition was tax-free but room-and-board was not.

COMMENT: This change seems erratic to me, considering that The College Board has reported that living expenses make-up over half the cost of undergraduate education.

Scholarships for non-degree students next became taxable.

I would have to think about what national existential peril we barely avoided with that change to the tax law.

Senator Burr would add another exception-to-the-exception if you could buy a jersey with someone’s name on it. Alabama’s Tua Tagovailoa comes to mind. Your being able to buy a jersey with his name and number would make his scholarship taxable. It probably means little in Tua’s case, as he is projected to be a first round NFL draft selection. Take someone in a less prominent sport and the result might not feel as comfortable.

Then again, someone less prominent would probably not get into a payment-for-name, image-or-likeness situation.

The Nick Saban Tax

Have you heard about the “Nick Saban” tax?

Let’s set it up.

There has been a longstanding tax provision limiting the deduction for public company executive compensation to $1 million. Mind you, this is not a restriction on how much you can pay an executive; the restriction only applies to how much you can deduct on a tax return. The restriction does not apply to all executives, either; it applies to the CEO, CFO and three other most-highly-paids.

But there was an exception large enough for the Fortune 500 to drive through. The exception was for “performance.” Magically and almost overnight, virtually all executive compensation packages became based on “performance.” Options were considered performance-based, and eventually options came to be passed around like candy. Realistically, one had to refuse to do any tax planning for this provision to actually apply.

This changed with the Tax Cuts and Jobs Act passed in December, 2017. Congress tightened up this code Section (162(m)) by taking away the performance exception. The $1 million cap now has a real bite.

But Congress was still looking for money.

Congress decided to put the same $1 million compensation limit on nonprofits.

This creates a quandary, as nonprofits (generally) do not pay tax. If I were a nonprofit executive and Congress threatened to disallow my deduction, I would not be feeling the tremulous fear of my for-profit peers.

Congress thought of that. They decided that the nonprofit would pay a 21% tax on my behalf.

Whoa. Now you have my attention. Granted, the tax is not on me, but we all know how this works in the real world. Only small children and Congress believes in free. The rest of us have to pay.

Congress passed a tax provision applying the $1 million cap to the five highest- paid employees of a 501(a), which includes a 501(c)(3). Think nonprofits, certain hospitals, colleges and universities and the like.

BTW medical professors were excluded from this, so it appears clear that Congress was trying to reach the athletics programs and their coaches.

But there is a problem.

Here is Code section 4960 imposing the tax:

       (c)  Definitions and special rules.

For purposes of this section-

(1)  Applicable tax-exempt organization.

The term "applicable tax-exempt organization" means any organization which for the taxable year-

(A)  is exempt from taxation under section 501(a) ,

(B)  is a farmers' cooperative organization described in section 521(b)(1) ,

(C)  has income excluded from taxation under section 115(1) , or

(D)  is a political organization described in section 527(e)(1) .

What is that Section 115(1)?

         § 115 Income of states, municipalities, etc.

Gross income does not include-

(1)  income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia; or …

What does this mean?

Congress thought that – by extending Section 4960 to reference Section 115(1) – it would reach those entities exempt via Section 115(1).

Entities such as Alabama.

Or the University of Alabama.

Why?

Because the University of Alabama is an instrumentality of the state of Alabama.

And here the tax law goes wonky.

The Courts have looked at the interaction of Sections 115(1) and 511(which is the unrelated business income tax which applies to a nonprofit). Can a state instrumentality (say a university) run a business – say a farm-to-table restaurant chain – and avoid the unrelated business income tax because of Section 115(1)? If that were the case, then Illinois could start a chain called Outfront Steakhouse, make a zillion dollars and never pay tax because of Section 115(1).

The Courts have clarified that is not the case. There is a limit to Section 115(1).

According to that reasoning, it seems to me that Congress should be able to tax those university salaries.

But there is another argument – the doctrine of implied statutory immunity. This arises from our federalist system of government: the federal government has to respect the state government. Under this theory, if the federal government wants to tax a state, it has to say so in an unambiguous manner – that is, it cannot be “implied.”

Continuing our example, if the federal government wanted to tax Illinois for opening a steakhouse chain and locating them adjacent to every Outback Steakhouse location throughout the land, it would have to say something like:

… the [] tax will apply to an entity relying upon Section 115(1) for nontaxability of their [] business activity should that activity be the same or substantially similar to a business activity conducted by a for-profit restaurant chain.”

That is explicit. That breaches implied statutory immunity. The tax would then stick.

Is that what Congress did with the new Section 4960(c) tax?

Nowhere close, it appears.

Under that reasoning the University of Alabama will not pay the Nick Saban tax, as the tax does not reach the University of Alabama.

There are universities clearly affected by this new law: Duke, for example, or Northwestern. They have to pay up. Think of it as the difference between a “public” university and a “tax-exempt” university.

But having the state name in the university’s name, however, does not mean that the university is exempt as “public.” It depends on how the university was organized and chartered. Texas A&M will be affected by the new tax provision, but the University of Texas - Austin will not. It is enough to give one a headache.

What happens next?

The easiest path is for Congress to revise Code section 4960 and clean up the language. Without Congressional action, you can be certain the “public” universities will litigate this matter. They have to.

But the likelihood of the present Congress accomplishing anything seems unlikely, at best.

We Recently Lost An Employee

What I do for a living can be demanding.

I am thinking about it because we have lost another employee.

Mind you, there is always a good reason to leave: a larger firm, a smaller firm, someone wants to go private and get away from any firm, more predictable hours, a geographic move, … it is endless.

The auditors complain about the insane paper chase that has become their corner of the profession. They spend as much time completing checklists as actually doing any meaningful work. It truly takes an idiot to think that we can prevent the next Enron by checking a box on page 64 of a 98-page checklist.

Let me clue you in: by page 64 the auditor has zoned out.

The key to audit fraud is experience – the one thing the giant firms are not geared to provide. Their economics are based on 1 to 4-year accounting graduates. That is no country for old men. Or women.

Tax has fared no better.

It used to be that accountants would stagger year-ends for their business clients. Some would be June, some would be October. This helped to balance the workload and keep accountants from being crushed. Congress – reminding us that the truly useless become politicians – decided years ago that calendar year-ends were the way to go. They allowed a few exceptions, but the majority of closely-held businesses were herded to a calendar year-end.

BTW individuals also end their tax year on December.

So we have this insane crowding of work into two or so months. Granted, much is extended, meaning that the crowding occurs again when the extensions run out. There is no real reason for it, other than government whim and profligacy.

Why, no … gasp! We cannot possibly allow other-than-December year-ends because that would cause a one-time hit to the Treasury. Ignore the fact that there previously was a one-time boon to the Treasury when businesses went to December. The very pillars of society would fall!

Uh huh.

Congress continues its quest to have every economic transaction in American society reported to the government via a Form 1099 or its equivalent. Oh, and if you would be so considerate to do all this by January 31.

We tie-up at least three paraprofessionals for a good chunk of January with 1099s and payroll reporting. Let’s not go Boston University stupid and pretend this is not an indirect (but substantial) tax on business activity. A tax heaved on us by sociopaths who make $174,000 annually, live in one of the most expensive cities in the country but somehow become multimillionaires on a routine basis.

Uh huh.

Take an IRS that has sought for years to do more with less, meaning that more and more of what it does is automated. This returns us to all those 1099s the government wants, with its computer matching and automated notices.

I would be curious to know how many millions of man-hours are wasted every year by BS notices the IRS sprays out. Some of this used to be resolved internally before mailing a notice, as an IRS employee maybe … just maybe … actually looked at the file. Ah, how innocent we were then.

There are consequences to all this nonsense.

I had a conversation very recently with a CPA firm owner. We are similar in age and background. He was telling me how it is becoming almost impossible to hire, as there either is no one available or what is available is simply not hireable. Given our immediate needs, this was not good news.

Our conversation then expanded to the question of why a young person would pursue the career we ourselves chose years ago. There are so many more career paths now providing competitive income levels without depriving someone of 4 to 5 months of their life. Every year.

He did not want his kids to be accountants. They didn’t.

It is showing up in different ways. Accountancy, for example, remains a popular college major and graduation rates are strong. However, interest in pursuing a CPA credential is declining.

The CPA credential of course is closely associated with a CPA firm. When I was coming through there was a career point one could not pass if one did not have his/her CPA. One could make senior accountant, for example, but not manager without the certificate.

My CPA was not optimistic, arguing that our generation – his and mine – might be the last of its kind. 

I am hearing this opinion repeated by more and more practitioners. It is not uniform, mind you, but it is common.

I do not do gloom, but I also believe that the next generation of accountants will demand more life balance that we - the 50-and-60-year-old crowd – did when it was our turn.

Good for them.

What will it do to the giant CPA firms and their churn-and-burn business models? What will it do to the accounting governing bodies, who seem to represent the largest while seemingly having little interest in entrepreneurial and closely-held businesses the vast majority of CPAs – me included - represent? How about Congress? What if they passed a tax law in December and CPAs refused to work 24/7 for their incompetence?

I wish some of this had happened earlier in my career.

A College Student and Ethereum

I have passed on Bitcoin and other cryptocurrencies.

I do not quite understand them, nor am I a Russian oligarch or Chinese billionaire trying to get money out of the country.

I certainly do not think of them as money.

The IRS agrees, having said that cryptos are property, not money.

This has very significant tax consequences.

I can take $100 out of my bank and pay cash at the dry cleaners, Starbucks, Jimmy John’s and Kroger without triggering a tax event.

Do that with a crypto and you have four taxable events.

That is the difference between property and money.

COMMENT: To be fair, money (that is, currency) can also be bought and sold like property. That is what the acronym “forex” refers to. It happens all the time and generally is the province of international companies hedging their cash exchange positions. Forex trading will trigger a tax consequence, but that is not what we are talking about here.

I am reading about a college student who in 2017 invested $5,000 in Ethereum, a cryptocurrency.

Within a few months his position was worth approximately $128,000.

He diversified to other cryptos (I am not sure that counts as diversification, truthfully) and by the end of the year he was closing on $900 grand.

Wow!

2018 has not been kind to him, however, and now he is back to around $125 grand.

Do you see the tax problem here?

Yep, every time he traded his crypto the IRS considered it taxable as a “sale or exchange” of property.

Maybe it is not that bad. Maybe he only traded two or three times and can easily pay the taxes from his $125 grand.

He estimates his 2017 taxes to be around $400 grand.

Seems a bit heavy to me, but let’s continue.

Does the IRS know about him?

Yep. Coinbase issued him a 1099-K reporting his crypto trades. Think of a 1099-K as the equivalent of a broker reporting your stock trades on a 1099-B.

He argues that he reinvested all his trades. He never took a personal check.

I don’t think he quite understands how taxes work. Try telling the IRS that you did not have taxable income upon the sale of your Apple stock because you left all the money in your brokers’ account.

He says that he reached out to a tax attorney – one who specializes in crypto.

I am glad that he sought professional help, whether attorney, CPA or EA.

I however doubt that the attorney’s crypto expertise is going to move the needle much. What he needs is a someone with expertise in IRS procedure, as he is rushing toward an installment plan, a partial pay or offer in compromise.

After all, he is not paying the $400 grand in taxes with what he has left.

Do You Have To Register To Be Considered A College Student?

I cannot believe this case made it to the Tax Court.

Granted, it is a "pro se" decision, which means that the taxpayer represented himself/herself. It sometimes is the professional wrestling of tax literature.

I will give you the facts, and you can tell me how the case was decided.

Through 2012 Brittany was a student at Saddleback College (Saddleback) in Mission Viejo, California. Our story takes place in the spring, when Brittany registered for a five-hour physiology course.  She also attended (for eight weeks, at least) a contemporary health course, although she never registered or enrolled in the course.

She filed her 2012 tax return and claimed a $2,500 American Opportunity tax credit. This is the credit for the first four years of college.

The IRS bounced the return. It pointed out the following from Code section 25A:

(B) Credit allowed for year only if individual is at least 1/2 time student for portion of year

The Hope Scholarship Credit under subsection (a)(1) shall not be allowed for a taxable year with respect to the qualifies tuition and related expenses of an individual unless such individual is an eligible student for at least one academic period which begins during such year.

The term "eligible student" in turn is defined as one carrying at least half the normal full-time workload at school.

The IRS saw a five-hour load and did not see an eligible student.

Brittany did not see it that way. She saw a five-hour load and her sitting-in on a three-hour course. That added up to eight hours, which was more than half-time.

What did the Tax Court decide?

We do not need Apple's tax department for this one.

The Regulations require that a student enroll at the school. And the course. Each course.

Five hours was not enough to be half-time. She did not qualify for the credit.

Getting The IRS To Believe A College Student Paid For … College

We can argue whether it is a good thing that so many economically-related transactions are reported to the IRS.

It is not just the drag on the economy - which would include practitioners like me, I suppose. It has also allowed the IRS to increasingly delegate its compliance responsibilities to computer algorithms, often functioning without human eyes sparing a glance at the endless notices the IRS sends every year.

And that sets up the problem.  

You see, the notice assumes that you are wrong, and the IRS will likely revise your account – and bill you - should you not reply. That means that you are spending time resolving the matter, or you are sending the notice to me and I am spending time. You and I are being deputized as ad hoc IRS employees.

Personally I want a paycheck and retirement benefits.

This arrangement works fine as long as there is a balance. You agree not to send works of fiction to the IRS and they agree not to contact you like a kid in college wanting money.

That balance is increasingly a thing of the past. Perhaps as a consequence, I am reading or hearing more often that taxpayers should be able to sue the IRS for professional fees incurred with these notices. I am not certain if that means that my client would pay me and then sue, or whether I would sue to receive my fee, but you get the idea. It would be a “reverse penalty” on the IRS. 

I am looking at a pro se decision from the Tax Court. As we have discussed before, “pro se” means the taxpayer is representing himself/herself. It does not technically mean there is no tax practitioner present (for example, I can represent a client in a pro se case), but it probably does mean that there is not a lot of money at issue.

Angela Terrell was a college student. During 2010 and 2011 she was attending Hampton University in Virginia. In the fall of 2010 she registered for the 2011 spring semester. In November, 2010 the University billed her $2,460 for the upcoming semester. In January, 2011 they billed an additional $1,230.

She was borrowing to go through school. In January, after the add/drop period ended, her student loan released $10,199 directly to the university. She paid her tuition and used the rest for living expenses.

Let’s go to the end of the year. The university sent a 1099 for 2011 (technically, a Form 1098-T, but we are on a roll). It showed $1,180 (the $1,230 billed less fees of $50). It did not show what she actually paid.

COMMENT: This reporting was allowable that year.

Angela filed her 2011 tax return and claimed the American Opportunity credit, one of the education credits in the Code. She claimed $2,500.

Wouldn’t you know the IRS sent her a notice? They saw the $2,500. They also saw the 1099 for $1,180.  

The IRS disallowed her credit – in full. They did not even spot her the $1,180.

Surely someone at the IRS would recognize what happened and close the file.

Perhaps in a galaxy far away. In our galaxy Angela and the IRS went to Tax Court.

Did I mention that Angela was a COLLEGE student?

She submitted an account statement from the University – on official letterhead – detailing her tuition charges and payments.

The IRS argued that the 1099 said $1,180, she provided a different number and consequently they could not verify the credit. There was nothing more to see.

Does it sound to you like the IRS even listened to her? 

Here is the Court:

The only dollar amount appearing on that form … is in the box that shows the ‘amounts billed’ for tuition during calendar year 2011. The amount billed to petitioner during 2011 does not control the size of her credit; the relevant number is the qualified tuition that she actually paid during 2011. The Form 1098-T has no entry in box 1, which was supposed to show ‘payments received’ for qualified tuition.”

The Court decided in her favor.

Angela’s case looks very much like the IRS pursuing a frivolous argument, not to mention the inability of IRS machinery to resolve a “duh”-level tax issue at the earliest possible point of contact. Reverse the situation and the IRS would not hesitate to hit you with every penalty imaginable.