The Change-Of-Address Rules Matter

 

The IRS requests that one alert them of change-of-address when one moves. There is even a form, but I do not often see the form used in practice. Normally the IRS is alerted when one files the next tax return with the new address.

It is, by the way, a good idea to alert the IRS of a change of address in case you have the misfortune of tax notices. There is a clock for certain tax notices, and once they start it can be difficult to reverse the clock.

I will give you one, as it has become more repetitive in practice than I would have liked: the notice of deficiency, also called a “statutory” notice of deficiency. I generally refer to it as the SNOD.

We have talked about the SNOD before. The IRS wants to reduce its tax assessment to a judgement. That requires the intervention of a court - the Tax Court in this case - and the IRS sends out a multipage, impressive, imposing if not intimidating notice to the taxpayer.

Who in turn collects it with other tax documents - unread - and drops the bundle off a-half-year later (or more) when it is time to meet with the CPA.

There is a problem here: one has 90 days to respond to a SNOD.

Which has passed. The level of difficulty has increased. The matter has already defaulted in favor of the IRS, of course, as the taxpayer never responded. The IRS has unleashed its Collections berserkers, who have little interest whether you actually owe the tax or not.

Here is a Collections story from several years ago. The IRS proposed changes to a client’s tax return. Sure enough, the SNOD got lost in the mail, was stolen from the mailbox, was thrown in the trash, whatever. The IRS changed numbers here and there. Some numbers were small and of minor import. Others were 1099s issued to our client but belonging elsewhere among related taxpayers. Then there was the big number: the rollover of a 401(k) or IRA. A 1099 is issued for a rollover, although it is normally a nontaxable event. The 1099 has a unique code for a rollover. The IRS, the taxpayer and accountant see the code, and everybody moves on.

Not this time.

The IRS did not see the code. Underreported income! Fair share! Tax the rich! The IRS went through its dunning notice series, eventually its SNOD, and then Collections activity. They filed a lien. They were irate, as they thought the taxpayer was ignoring them.

The taxpayer had no idea. It was only when trying to sell some real estate that the lien – and the rest of the story - came to light.

We went all Sherlock on what had happened.

We filed an amended return to reverse the IRS adjustment. We had Collections hold back the war dogs to allow the IRS time to process the amended return.

Which never happened. Collections came back more frenzied than before.

The system had failed. We wanted to know where that amended return was. The IRS is not built for self-reflection, BTW, but we eventually found the return. Someone in Kansas City had started to work the file, I presume quitting time arrived and – as an example of why people hate government unions – never got back to our client. Never. As in ever.

Yeah, the matter eventually got resolved, but it had become a sinkhole of professional time. I did talk with a very pleasant IRS attorney from Nashville, who - once the matter got to her - moved heaven and earth to reverse the lien.

And there you have an example of how not responding to a SNOD can sour someone’s life.

And an example of why I believe that the IRS should be required to reimburse a tax professional’s time when the IRS fails to follow procedures or otherwise just do their job.

Let’s look at Keith Phillips.

Phillips went to prison in 2010.

Somewhere in there something else bad happened: he was injured and lost almost all vision in his right eye. He filed a civil lawsuit against the prison and received a $201 thousand settlement in 2014. He did not file a tax return for 2014.

Nor would I. Damages for physical injuries are nontaxable, and this sounds very physical to me.

The IRS thought otherwise and wanted almost $52 grand in tax, plus penalties, interest, a safe room, coloring books and a binkie while they worked through the microaggression.

They sent a SNOD.

Phillips had no idea. He was in prison.

The Tax Court rubber-stamped the assessment. The IRS began collection activity. They sent letters to the same address as the SNOD but heard nothing back. They filed a tax lien. They notified the State Department that Phillips was seriously delinquent, and State should begin revoking his passport. That State Department matter was fortunately sent to Phillip’s correct address.

Now Phillips was wondering what had happened, although he had no plans to travel overseas in the near future. He filed with the Tax Court.

IRS:            More than 90 days have passed. We win, you lose. Why? Because you are a loser, you big loser you.  

Phillips:       Hey, IRS, you sent the SNOD to the wrong address.

IRS:            Nope, we sent it to the right address.

Phillips:       I never lived at this address.

IRS:             You did. We have a USPS notice for change of address.

Phillips:       Let me see it.

IRS:             Knock yourself out, loser.

Phillips:       This is my son. We have the same name. He was living with his mom. I had been here … in prison … years before this change of address was sent.

IRS:             Oops.

If the SNOD is sent to the wrong address, then the SNOD is not valid. To the IRS’ credit, this error is not common, but it happens.

Mind you, this does not technically mean that the matter is over. Phillips never filed a return for 2014, so the statute of limitations has never started for that year. On the other hand, now that the IRS is aware that the settlement was for personal injury – and thus nontaxable – what is the point?

Our case this time was Phillips v Commissioner, T.C. Memo 2024-44.

Owing Tax on Social Security Not Received

 

I am spending more time talking about social security.

The clients and I are aging. If it does not affect me, it affects them – and that affects me.

Social security has all manners of quirks.

For example, say that one worked for an employer which does not pay into social security. There are many - think teachers, who are covered instead by state plans. It is common enough to mix and match employers over the course of a career, meaning that some work may have been covered by social security and some was not. What does this mean when it comes time to claim benefits?

Well, if you are the employee in question, you are going to learn about the windfall elimination provision (WEP), which is a haircut to one’s social security for this very fact pattern.

What if this instead is your spouse and you are claiming spousal benefits? Well, you are going to learn about the “government pension offset,” which is the same fish but wrapped in different paper.

What if you are disabled?

Kristen Ecret was about to find out.

She worked a registered nurse until 2014, when she suffered an injury and became medically disabled. She started receiving New York workers compensation benefits.

Oh, she also applied for social security benefits in 2015.

In December 2017 (think about it) she heard back from the SSA. She was entitled to benefits, and those benefits were retroactive to 2015.

Should be a nice check.

In January 2018 she received a Form SSA-1099 for 14,392, meaning the SSA was reporting to the IRS that she received benefits of $14,332 during 2017.

But there was a bigger problem.

Kristen had received nothing – zippo, nada, emptitadad – from SSA. The SSA explained that her benefits had been hoovered by something called the “workers’ compensation offset.”

She filed a request for reconsideration of her benefits.

She got some relief.

It’s a year later and she received a Form SSA-1099 for 2018. It reported that she received benefits of $71,918, of which $19,322 was attributable to 2018. The balance – $52,596 – was for retroactive benefits.

Except ….

Only $20,749 had been deposited to her bank account. Another $5,375 was paid to an attorney or withheld as federal income tax. The difference ($45,794) was not paid on account of the workers’ compensation offset.

Something similar happened for 2019.

Let’s stay with 2019.

Instead of using the SSA-1099, Kristen reported taxable social security on her 2019 joint income tax return of $5,202, which is 85% of $6,120, the only benefits she received in cash.

I get it.

The IRS of course caught it, as this is basic computer matching.

The IRS had records of her “receiving” benefits of $55,428.

The difference? Yep: the “workers’ compensation offset.”

There was some chop in the water, as a portion of the benefits received in 2019 were for years 2016 through 2018, and both sides agreed that portion was not taxable. But that left $19,866 which the IRS went after with vigor.

The Court walked us through the life, times and humor of the workers’ compensation offset, including this little hummable ditty:

For purposes of this section, if, by reason of section 224 of the Social Security Act [i.e., 42 U.S.C. § 424a] . . . any social security benefit is reduced by reason of the receipt of a benefit under a workmen’s compensation act, the term ‘social security benefit’ includes that portion of such benefit received under the workmen’s compensation act which equals such reduction."

Maybe the Court will find a way ….

            Section 86(d) compels us to agree with respondent."

The “respondent” is the IRS. No help here from the Court.

Applying the 85% inclusion ratio, we conclude that petitioners for 2019 have taxable Social Security benefits of $16,886, viz, 85% of the $19,866 in benefits that were attributable to 2019. Because petitioners on their 2019 return reported only $5,202 in taxable Social Security benefits, they must include an additional $11,684 of such benefits ($16,886 − $5,202) in their gross income."

Kristen lost.

Oh, the IRS applied an accuracy-related penalty, just to make it perfect.

We know that tax law can be erratic, ungrounded, and nonsensical. But why did Congress years ago change the tax Code to convert nontaxable disability income into taxable social security income? Was there some great loophole here they felt compelled to squash?

Our case this time was Ecret v Commissioner, T.C. Memo 2024-23.

A Ponzi Scheme And Filing Late

I am reading a case involving a late tax return, a Ponzi scheme, and an IRS push for penalties.

It made me think of this form:

It is used for one of two reasons:

(1)  Someone is filing a tax return with numbers different from a Schedule K-1 received from a passthrough entity (such as a partnership).

(2)  Someone is amending a TEFRA partnership return.

That second one is a discussion for another day. Let’s focus instead on the first reason. How could it happen?

Easy. You are a partner in a partnership. You bring me your Schedule K-1 to prepare your personal return. I spot something wrong with the K-1, and the numbers are large enough to matter. We contact that partnership to amend the return and/or your K-1. The partnership refuses.

COMMENT: We would use Form 8082 to inform the IRS that we are not using numbers provided on your K-1.

This is a tough spot to be in. File the form and you are possibly waiving a flag at the IRS. Fail to file it and the IRS has procedural rights, and those include the right to change your numbers back to the original (and disputed) K-1.

There is another situation where you may want to file Form 8082.

Let’s look at the Rosselli case.

Mr. Roselli (Mr. R) was a housing appraiser. Mrs. Rosselli was primarily a homemaker. Together they have five children, three of whom have special needs.

Through his business, Mr. R came to know the founder of a solar energy company (DC Solar). Turns out that DC Solar was looking for additional capital, and Mr. R knew someone looking to invest. The two were introduced and – in gratitude – Mr R became a managing member in DC Solar via his company Halo Management Services LLC.

This part turned out well for the R’s. In 2017 DC Solar paid Halo approximately $300 grand. In 2018 DC Solar paid approximately $414 grand. Considering they had no money invested, this was all gravy for the R's.

COMMENT: Notice that Halo was paid for management services. Halo in turn was Mr. R, so Mr. R got paid over $700 grand over two years for services performed. This was a business, and Mr. R needed to report it on his tax return like any other business.

In late 2018 the FBI raided DC Solar’s offices investigating whether the company was a Ponzi scheme. The owners of DC Solar were eventually indicted and pled guilty, so I guess the company was.

Let’s roll into the next year. It was tax time (April 15, 2019) and there was not a K-1 from DC Solar in sight.

COMMENT: You think?

The accountant filed an extension until October 15. It did not matter, as the R’s did not file a tax return by then either.

The IRS ran a routine check on DC Solar and its partners. It did not take much for the IRS to flag that the R’s had not filed a 2018 return. The IRS contacted the R’s, who contacted their accountant, eventually filing their 2018 return in January 2022.

You know what was on that 2018 return? The $414 grand in management fees.

You know what was not on that 2018 return? A big loss from DC Solar.

Here is Mr. R:

Mr. Carpoff informed me that I was to receive Schedule K-1s showing large ordinary losses for 2018 from DC Solar, and as a result I would not have a tax liability for that year. However, before the K-1s could be issued … DC Solar’s offices were raided by the FBI.”

All of DC Solar’s documents and records were seized by federal authorities in the ensuing investigation. As a result, I was unable to determine any tax implications because I did not receive a K-1 or any other tax reporting information from DC Solar.”

Got it: Mr. R was expecting a big loss to go with that $414 grand. And why not? DC Solar had reported a big loss to him for 2017, the prior year.

But the IRS Collections machinery had started turning. By August 2022, the IRS was moving to levy, and the R’s filed for a Collection Due Process (CDP) hearing.

COMMENT: There is maddening procedure about arguing underlying tax liability in a CDP hearing, which details we will skip. Suffice to say, a taxpayer generally wants to fight any proposed tax liability like the third monkey boarding Noah’s ark BEFORE requesting a CDP hearing.

At the conclusion of the CDP hearing, the IRS decided that they had performed all the required procedural steps to collect the R’s 2018 tax. The R’s disagreed and filed with the Tax Court.

The R’s presented three arguments.

• They reasonably assumed that they would not be required to file or pay tax for 2018 because of an expected loss from the DC Solar K-1.

The Court was not buying this. Not owing any taxes is not the same as not being required to file. This was not a case where someone did not work, meaning they dd not have enough income to trigger a filing requirement. The Rs instead had a more complicated return, with income here and deductions or losses there. Granted, it might compress to no tax due, but they needed to file so one could follow how they got to that answer.

• The R’s reasonably relied on advice from their accountant and others.

The Court did not buy this either. For one thing, the Rs had never informed their accountant about the $414 grand in management fees. If one wants to rely on a professional’s advice, one must provide all available pertinent information to the professional. The Court was not amused that the R’s had not shared the LARGEST number on their return with their accountant.

• The R’s argued that they would experience “undue hardship” from paying the tax on its due date.

The R’s argued that their income died up when DC Solar was raided. Beyond that, though, they had not provided further information on what “drying up” meant. Without information about their assets, liabilities and remaining sources of income, the Court found the R’s argument to be self-serving.

Also, the Court did not ask – but I will – what the R's had done with the $700 grand in management fees they received in 2017 and 2018.

Yeah, no. The Court found for the IRS, penalties and all.

And here is what I am thinking:

What if they had timely filed their 2018 return, showing a loss from DC Solar equal to the management fees?

Problem: there was no K-1 from DC Solar.

Answer: attach the 8082.

I think the tax would eventually have turned out the same.

But I also think they would have had a persuasive case for abatement of penalties for late filing and late payment. The penalty for late file and pay is easily 25%, so that abatement is meaningful.

Our case this time was Rosselli v Commissioner, TC Bench Opinion, October 23, 2023.

Income And Cancellation of Bank Debt

 

There is a basic presumption in the tax Code that any accession to “wealth” is income. It isn’t much of a leap for the tax Code to then say that all income is taxable unless otherwise excluded.

Let’s next look at “wealth.” I propose a working definition as follows:

          Assets (A) = Liabilities (L) + Wealth (W)

A little algebra shows the following:

          A – L = W

Here is spiff on the above: do you have wealth if your liabilities go down?

Let’s look at the Katrina White case.

Katrina started a business in 2015. She took out a business loan for $15,000. She leased space for her business, signing a three-year lease.

The business did not work out. The family lent her $8 grand, but there was no way to save it. She had repaid the bank less than a grand when her remaining debt of $14,433 was discharged. The bank sent her a 1099, of course, as all American life events can apparently be reduced to a 1099.

Katrina never made a payment on the lease. Since rent was late for more than two months, the entire lease became due and payable. That fiasco totaled $21,700.

 She filed her return.

The IRS said she left out income of $14,433.

How?

Let’s go through it.

Katrina said that her wealth (that is, A – L = W) was as follows when the business failed:                 

Real property		28,500
Personal property		3,560
		32,060
Student loans		5,294
Utilities		961
Utilities, estimated		2,500
Furniture loan		1,120
Judgements		8,128
Bank loan		14,433
Lease breach		21,700
Family loan		7,800
		61,936
Net wealth		(29,876)

The IRS wasn’t buying this. They argued that:

·      The estimated utilities were a no go.

·      The family loan wasn’t really a “loan.”

·      While we are at it, the lease breach wasn’t really a loan, as the landlord had no intention of enforcing the debt.

The IRS math was as follows:

Real property		28,500
Personal property		3,560
		32,060
Student loans		5,294
Utilities		961
Furniture loan		1,120
Judgements		8,128
Bank loan		14,433
		29,936
Net wealth		2,124

The matter went to Tax Court.

The Court pointed out the obvious: Katrina signed a valid and binding lease contract. Perhaps the landlord decided that there was nothing there to pursue, but it cannot be argued that she had an enforceable debt.

The Court saw the following:

Real property		28,500
Personal property		3,560
		32,060
Student loans		5,294
Utilities		961
Furniture loan		1,120
Judgements		8,128
Bank loan		14,433
Lease breach		21,700
		51,636
Net wealth		(19,576)

Let’s recap our numbers:

Wealth per Katrina was          ($29,876)

Wealth per the IRS was              $2,124

Wealth per the Court was        ($19,576)

Remember what we said at the beginning, that all income is taxable unless there is an exception?  Well, there is an exception for cancellation of debt. Several, in fact, but today we are concerned with only one: insolvency. The Code says that one does not have income to the extent that one is insolvent.

What is insolvency?

Go back to the formula: A – L = W.

To the extent that “W” is negative, one is insolvent. Another way of saying it is that one has more debts than assets.

So, who showed negative “W”?

Well, Katrina did. So did the Court.

Katrina was insolvent. That was an exception to cancellation of indebtedness income. Katrina did not have taxable income. The IRS lost.

Our case this time was Katrina White v Commissioner, T.C. Memo 2023.-77.

Penalty Abatement For Preparer Errors

 

I was looking over a law review article weighing the pros and cons of different types of Tax Court decisions.

Nerd train, I admit.

But there is something here to talk about.

There are several types of Tax Court opinions. Some have precedential value, and some do not. Precedence means that a Court applies the law in the same manner to cases with the same facts.

One type is a Memorandum opinion. These tend to be heavily factual, and they involve relatively well-settled law.

Another is the Summary (or S) opinion. These involve a relatively modest amount of tax (currently $50 grand) and use a streamlined set of procedures.

The reason for different types of opinion is grounded in practicality. Memo opinions allow the Court to process more clear-cut cases without worrying about establishing unanticipated precedent. The S opinions allow taxpayers a forum without having to hire an attorney to navigate cumbersome Tax Court procedural rules.

I am looking at a case decided as a bench opinion. 

Think about the judge issuing an oral opinion right there and then and you have a bench opinion.

And these types can be combined. A judge may, for example, issue a bench opinion in a memo or S case.

I am looking at something I know all too well.

Mr. Trammer was an IT consultant.

Mrs. Trammer was a social worker.

Mr. Trammer worked primarily from home. Depending upon, he was paid as a W-2 employee or as a 1099 gig worker. He had an office-in-home and all that.

Mrs. Trammer was a W-2 employee. She drove around Michigan visiting childcare and foster care locations. She at times would purchase gifts for the kids.

She sounds like a good person.

They reported all kinds of deductions on their 2019 and 2020 returns: business deductions for the gig, employee business deductions for the social work, charitable deductions for the church.

If you recall, many itemized deductions were reduced or eliminated altogether beginning in 2018.

No surprise, the IRS disallowed a swath of deductions. Some – like employee business deductions – simply did not exist for the tax year at issue. Others – like office-in-home for the gig – had calculation errors.

Got it. They need to dig up documentation. They should immediately concede on the calculation error and employee expenses. The matter should be resolved as routine in correspondence exam.

Off to Tax Court they went.

Huh?

Upon reflection, this makes sense. The IRS and Covid did not play well together. They were not answering the phones over there. Faxing supporting documentation to the AUR Unit was often a joke. I suspect this matter went to Court by default.

Here we go:

The Trammers relied on a paid return preparer to prepare their returns for the years at issue. Although the individual return preparers identified on the 2019 and 2020 returns differed, the Trammers used the same preparation firm for both years.”

That does not sound like a CPA firm. Granted, I prepare only a fraction of returns I sign - staff accountants generally prepare - but I do review all returns before signing. 

Each year, they brought their records … who decided what items to report on the Trammers’ return and where.”

Yep.

The returns contained obvious errors such as reporting the same expense in multiple places.”

The old list-the-same-thing-over-and-over routine. Often these returns are not complex, but the preparer must be diligent when moving numbers. It consequently is common to give these returns to more experienced staff. Ideal would be to give the return to the same experienced staff every year.

The Court made short work of the returns.

Schedule C/Gig work

They failed to demonstrate the amount of expenses that they incurred or the business purposes for those expense, and they did not provide sufficient evidence from which the Court could formulate an estimate.”

Form 2106/employee business expenses

… the Trammers failed to substantiate the expenses Mrs. Trammer incurred in the conduct of her social work.”

Schedule A/Itemized Deductions

The Trammers failed to substantiate itemized deductions in excess of the standard deduction amounts that the Commissioner allowed…”

The IRS wanted penalties. They always do.

Not his time. Here is the Court:

The Trammers relied on a return preparer to whom they had been referred. They supplied the return preparer with necessary and accurate information each year, and the return preparer decided what to do with that information. The Trammers reasonably relied in good faith on their return preparer’s judgement. Accordingly, the section 6662 accuracy-related penalty does not apply for the years in issue.”

I am impressed, as I was expecting a rubber stamp.

What was different this time?

For one thing, Mr. Trammer showed up for the trial, and Mrs. Trammer participated via conference call. This gave them a chance to humanize their situation. While not conceding the errors, the Court did believe them when they said they tried. The Court, however, was not as kind to the preparer.

And remember: the next person cannot use this case (technically) as precedent in a future penalty. The Court had room to be lenient.

Our case this time was Trammer v Commissioner, TC Bench Order March 14, 2023.

Do Not Do This When Buying Disability Insurance

 

It is a tax trap. An employer thinks that they are doing a boon for their employees by providing a tax-exempt fringe benefit.

Where is the trap?

CTG: it has to do with insurance.

I don’t get it, you say. My employer pays for some/most/all my health insurance. When I see a doctor, the insurance pays some, I pay some. Granted, some health insurances are better than others, but where is the trap?

CTG: it is not health insurance.

I get life insurance at work, you continue. It is equal to a year’s salary or something like that. I have noticed that they charge me something for this on my W-2 every year.

CTG: Life insurance has a split personality. An employer can offer you up to $50 thousand of life insurance as a nontaxable fringe. Any insurance above that amount (for example, if your annual salary is more than $50 grand) is taxable to you. Mind you, the charge tends to be minimal - as the IRS uses favorable rates - but you are charged something.  

It is not life insurance.

It is disability insurance.

Let’s look at John Linford.

John sold Medicare supplement and Medicare Advantage plans. His employer decided to do a nice, and in 2011 it purchased a group disability policy from Principal Life. On the plan’s first iteration, the company paid 100% of the premiums. In 2013 the plan was amended, giving the company the option to charge an employee 25% of the premiums. The company said “nah” to the option, choosing to continue paying 100% of the premiums.

At first blush, this sounds like a beneficent employer.

John incurred a disability in 2014. He filed a worker’s compensation claim in December 2014.

John was fired a year later, in November 2015.

This may still be a beneficent employer. They might have been assisting John in getting to that disability policy.

In May 2017 Principal Life approved his disability claim.

At that speed, one could be homeless before the insurance kicks-in.

Principal Life paid him a $105 grand in retroactive benefits.

John heard that disability is generally nontaxable.

Yep.

John left the $105 grand off his tax return.

Nope.

The IRS caught it, of course.

The IRS wanted almost $22 thousand in tax, as well as a penalty chop of over $4 grand.

Off to Tax Court they went.

There is a Code section for this type of employer-provided insurance: Section 105.

           § 105 Amounts received under accident & health plans.

(a)  Amounts attributable to employer contributions.

Except as otherwise provided in this section, amounts received by an employee through accident or health insurance for personal injuries or sickness shall be included in gross income to the extent such amounts (1) are attributable to contributions by the employer which were not includible in the gross income of the employee, or (2) are paid by the employer.

Read the verbiage at (a).

Except as otherwise provided, any accident or health insurance is taxable to the extent the employer provides the insurance as a tax-free benny. Wait, you say, what about health insurance? That is not taxable. True, but health insurance is nontaxable via the “except as otherwise provided” language. There is no such exception for disability insurance.

This stuff can be confusing.

John had one more swing at the plate. Remember that the company amended the plan allowing them to charge employees 25% of the cost. John wanted to know if there was some relief there. I get it: 25% nontaxable is not as good as 100% nontaxable, but it is better than 100% taxable.

The Court said no. Potential is not actuality, and John never paid any of the premiums.

What about the penalties? Did the Court cut John some slack? One can get confused here: one rule for health insurance, another rule for different insurance.

Based on the record the Court concludes that the petitioner husband did not have reasonable cause and did not act in good faith in not reporting the disability payments.”

The Court upheld the penalties. There went another $4-plus grand.

Some companies allow one to purchase short-term disability through their cafeteria plan. Mind you, this means that the premiums are paid with pre-tax money and will result in taxable income if benefits are ever collected. I tend to back-off on short-term disability, although I prefer that one pay with after-tax dollars for either short- or long-term disability.

I, however, feel strongly about paying after-tax for long-term disability. Those benefits may continue until you reach social security age, and you do not need to be dragging taxes behind you until then. The small rush of a tax-free benny is insignificant if you are ever – in fact – disabled.

Our case this time was Cynthia L Hailstone and John Linford v Commissioner, T.C. Summary Opinion 2023-17.