Odd Reason To Be In Tax Court

 

Not all accountants practice tax.

To the contrary, I suspect most accountants do not. The confusion, I suspect, has to do with the CPA license. One associates the license with practicing at a CPA firm, but that is not necessarily true. Most accountants do not practice at a firm, and just practicing at a firm does not mean that one works tax. I have worked with a firm my entire career, and there have been many CPAs – auditors, forensics, valuation experts and so on – who have little crossover with tax. Step outside a firm – say internal audit or accounting at a corporate employer – and those numbers only increase.

I am looking at a pro se case in the Tax Court.

We have discussed pro se many times. It is commonly described as a taxpayer representing himself/herself before the Court. That technically is not true. A taxpayer can have professional representation and still be considered pro se. What it means is that the representative does not have a license to independently practice before the Court. The representative can act as an agent, advocating for and advising a taxpayer, but without that license the taxpayer is still considered pro se.

That license requires one to pass an exam, and the Tax Court exam is commonly considered one of the more challenging exams in tax practice. The exam BTW is not about tax law; rather it is about rules and procedures at the Tax Court. I have been involved in this area for decades, and I admit that those rules and procedures can be a bit … arcane.

Eva Zaczek finds herself in Tax Court. There is only one issue: how much does she owe? The answer in turn depends on how much of her Affordable Care (that is, Obamacare) subsidy was overpaid and now has to be returned. The concept is straightforward: make little money and the subsidy might fully pay for the premiums; make too much money and there is no subsidy at all. The rub is that someone is applying for the subsidy early in the tax year, before knowing what income for the year will be. Take a promotion or job change or marriage – or just ignore the too-much-income issue altogether - and the numbers can swing hard.

The IRS sent Eva a Notice of Deficiency for $2,418.

COMMENT: Eva sent a handwritten tax return, and the IRS made mistakes reading her writing.  

To its credit, the IRS admitted its mistake and revised the balance due to $900.

Eva challenged the calculation.

The rub was line 11 of Form 8962 Premium Tax Credit.

Both Eva and the IRS agreed that the number in box 11(b) should be $7,294.

This box represents the maximum premium that can be subsidized.

Both agreed that box 11(c) should be $9,057.

This amount represents the amount of premium the taxpayer is expected to pay himself/herself, without subsidy.

Eva calculated box 11(d) as $1,763 ($9,057 - $7,294).

Eva got the numbers reversed. Box 11(d) should be minus $1,763 ($7,294 - $9,057).

So?

If you read the instructions, box 11(d) cannot go below zero ($-0-).

Eva was convinced she owed the IRS $1,763.

The IRS said no, no: you only owe us $900.

And Eva was in Court arguing that she owed the $1,763 and not the $900 the IRS was seeking.

Here is the Court:

      

I will spare both of us the difference in tax law between a “deficiency” and a “balance due,” other than to point out the IRS notice that got Eva into Tax Court is called a Notice of Deficiency.

Pro se cases have a reputation for being entertaining, and we have looked at a number of them over the years.

But to go to Tax Court to argue that one owes more than the IRS wants? And this action from an accountant?

I consider this to be shade: 

I truly, truly hope that Eva doesn’t practice anywhere near a tax return.

This time we talked about Eva Zaczek v Commissioner, docket 4667-25S, filed 7/15/26.

Deducting Business Interest From Personal Credit Cards

The case caught my eye because it involves a very common fact pattern:

A small business owner obtains credit cards in his/her personal name and uses it/them for business purchases and activities.

Question: Can the business deduct the interest on the credit cards?

I doubt that there is a tax practitioner out there that hasn’t deducted this, but a recent case points out minimum requirements in case the IRS challenges the deduction.

Let’s look at C.A. Simmons, TC Memo 2026-34.

I admit that I was expecting some technical dive into the interest deduction, but this case is not that. It is a reminder that one has to get to first base before being able to reach home plate. Strike out and the rest is meaningless.

Cathryn Simmons and her sister owned a specialty store (called Stuff) in Kansas City, Missouri. They had sold handmade and small-batch goods since 1996. As is too common, Stuff struggled to obtain credit in its own name, so the sisters used personal credit cards and loans to finance the business. They used QuickBooks for their accounting, and they did try to segregate the credit cards between those used for business and those used personally.  

COMMENT: I suspect most clients I have advised can remember my standard sermon:

·      Establish a separate business account. Business deposits and expenses go through the business account. Personal expenses do not. I understand that the bank is going to charge for a business account, and it might be cheaper to lean into a personal account. Do not do that. You already incurred that expense when you started the business.

·      I understand that you might not be able to get a credit card in the business name and may have to use a personal card. Use one card for business and the rest for personal. Do not intermingle the two.

·      If you are using a personal card, I might have the business recognize it as a loan from you. We will formalize it with a note, mention an interest rate and make some reference to repayment. Do not be surprised if the interest rate on the note is the same as the credit card.

·      Keep records of all business deposits and expenses. At a minimum, buy an expanding file and file the paperwork by month. When we finish the tax return for the year, combine the return and its paperwork into a file or folder for the year, and hold onto it.

Back to Stuff.

The IRS looked at the 2017 business return and 2017 and 2019 personal returns. They expanded the business audit to include cost of goods sold, advertising, vehicle expenses, travel, meals and entertainment, charitable and promotion, and interest. We will discuss only the interest deduction today.

Stuff field a partnership return, and each sister’s share of the 2017 business profit was less than $3 grand.

There was a little chop with the interest deduction because it included both interest on the credit cards and interest on the personal loans. I point it out because the Court says the following about the personal loans:

As an initial matter, … fails to establish that the purported interest amounts Stuff paid to her and her sister arose from Stuff’s own indebtedness. The record contains promissory notes … but no ‘loan papers’ establishing Stuff’s indebtedness to the sisters.”

… we cannot conclude from these payments and the sisters’ testimony that Stuff had an actual legal obligation to pay interest to them.”

I get it but … harsh. I suppose Stuff was not following the terms of the promissory notes. We would - of course - redraft the terms of the notes. This is low hanging fruit.

What about the credit cards?

Ms. Simmons likewise fails to demonstrate that Stuff was entitled to deduct the credit card interest and finance charges recorded on its QuickBooks account. The evidence shows that Ms. Simmons obtained and used credit cards in her own name to finance Stuff’s business expenses given its inability to obtain credit on its own. Ms. Simmons fails to show that any credit card interest and finance charges constituted Stuff’s own indebtedness rather than her personal indebtedness, and thus no deduction is appropriate.”

Stop. I am having a problem here, as I am quite aware of Reg 1.163-8T.

Seems to me that if (1) I trace a business expense from the credit card statement to (2) the QuickBooks, I have at least a good chance of meeting the requirement that “debt is allocated by tracing the disbursements of the debt proceeds to specific expenditures.”

Back to the Court:

Assuming arguendo that credit cards opened by Ms. Simmons constituted an indebtedness of Stuff, the records before us would not substantiate the amounts claimed. Although the sisters testified that they used the six designated credit cards exclusively for Stuff’s expenses, they failed to establish the amounts and business purposes of the underlying expenditures that resulted in the interest and finance charges at issue.”

They failed to establish the amounts and business purposes …?

I believe two things happened here:

(1)  Stuff could not document a lot of expenses. On quick review, I see the IRS disallowing almost $13 grand of vehicle expenses, $22 grand of charitable and promotion expenses, and so on.

(2)  If those expenses ran through the credit cards, then I understand an allocable portion of the interest being disallowed.

However, the Court just nixed the interest deduction altogether.

Seems to me that some of the credit card interest – that allocable to deductions allowed – should be deductible. I presume the accounting was not clean enough to do a side calculation. The IRS will rarely play forensic, and the Tax Court certainly will not.

The Court did reemphasize that it wanted to see linkage between the business activity and the credit cards, but that has been the rule since I have been practicing. There is nothing new here. Somebody just forgot to get on first base.  

AI Practicing Tax Law

 

I was working with a younger accountant this busy season who is a fan of AI in tax research. He uses it quite a bit. He also has a client who in turn has used AI to review his work. This has not amused my friend, and I understand he intends to fire the client.

Irony, methinks.

There has always been research in tax practice, and AI is just the newest and shiniest model on the lot. My concern about AI is that previous research alternatives did not invent answers - that is, hallucinate. This can be a problem, especially for a young(er) practitioner learning the ropes. An experienced hand may recognize when AI leaves the pavement. That is small comfort, as I question whether an experienced hand would rely heavily on AI.

As we have commented before: you don’t know what you don’t know.

Let’s look at the Clinco case.

Peter Clinco was an attorney in California. He mostly practiced real estate and business law. He was also an entrepreneur and spent much of his time running MedCafe Westwood, a restaurant and bar near the UCLA campus. It started off as a partnership, but over the years Clinco wound up owning the place by himself. MedCafe had approximately 60 employees but did not have strong accounting for sales and tips. This would become an issue.

Clinco personally prepared his 2015 tax return, although he filed it late (2018). He reported restaurant gross receipts of approximately $1.6 million, with enough expenses to show a net loss of $400 grand. We do not know whether filing late was an issue, but 2015 got pulled for audit. There were two areas on that return the IRS clearly wanted to look at:

• The restaurant
• Two rental properties

Why do I say “clearly?”  See a tax return the way I do: where are your subtractions – that is, your deductions? More specifically, where are your biggest deductions? That is where an auditor would want to look, because that is where the dollars – and audit adjustments – are.

The exam started in 2019, when Clinco was already quite ill. The accountant stepped in for Cinco, but this was after Clinco commented to the revenue agent that an estimated 10% of the restaurant’s revenues were in cash.

Clinco planted a bug in the auditor’s ear. The auditor responded by using a common-enough technique: comparing known credit (and debit) card transactions to reported cash transactions. While the ratios can vary (in this case, 90/10), it is a starting point. Sure enough, the auditor decided something was off and expanded her audit.

What does it mean to “expand”? Easy. She requested Forms 1099 issued to MedCafe. The IRS would have those as a matter of routine.

She also requested copies of bank statements.

COMMENT: The bank deposit analysis is virtually de rigueur for all Schedule C audits at this point (MedCafe was a Schedule C because Clinco owned 100%). The concept is easy: all deposits are income unless proven otherwise. Fail to prove otherwise and you have a problem. I had an audit – with deposit analysis – a few years ago. A son (my client) intermingled his business deposits with his father’s (both were contractors). Why? Who knows. It is not normal business practice; I had a difficult time understanding why he did this; the auditor had a difficult time believing either of us; and his foolishness made the audit much more difficult than it needed to be.

The IRS thought actual revenues were about $3.8 million – approximately $2.2 million more than the $1.6 million reported on the tax return.

Yep, you can see that train a ‘coming.

What was Clinco’s first line of defense?

COMMENT: Somewhere during this Clinco passed away. Technically the matter would have been pressed by his estate and agents.

Clinco challenged whether one of the early procedural steps - the Notice of Deficiency – needed to be signed by the IRS in fresh ink.

This is well-trod road with (very) low risk of victory, but Clinco’s attorney (Mr. Wagner) brought novelties to the party:

He cites ‘Cacchillo v Commissioner’ … as a case where the taxpayer challenged the validity of the notice of deficiency because it lacked an official signature. He claims we held the IRS’s failure to issue a valid signed notice of deficiency ousted us out of jurisdiction.”

Mr. Wagner claims ‘Cacchillo v Commissioner’ … overturned ‘Miller v Commissioner’ and ‘Tefel v Commissioner’ ….”

Here is the Court:

Neither of these cases exist as cited.”

OK.

There is no case named “Tefel v Commissioner …”

Going down folks.

The bouillabaisse of case names, reporter citations and legal propositions suggests something cooked up by AI.”

Hard landing imminent.

Their presence is unacceptable.”

So…  I would say that the IRS was not required to hard-sign the Notice of Deficiency.

On to the audit adjustments.

Cash deposit analysis is a long-standing technique. The Court granted an adjustment when Clinco could prove that a deposit was not income, but it was not going to reject the entire analysis.

Even money-losing businesses, however, can have unreported income.”

There was one more issue.

The IRS wanted some proof for depreciation expense on two rental properties.

Normally, this is not outrageous to provide. One gets a copy of the closing statement. Sometimes the municipality itself maintains those records. Granted, it may not show later improvements and whatnot, but it is a start.

Clinco went in a different direction. Clinco argued that the IRS could not challenge depreciation because they had allowed it in a different tax year.

Folks - with minimal exceptions - this is not the way it works. The IRS not asking about your “fill-in-the-box” deduction in year one does not mean they cannot ask about it in year three. This is long-standing practice and predates me being in school.

Even AI should have picked that up.

Our case this time was Peter L. Clinco, Deceased, C. M. Barone-Clinco, Successor in Interest, and C. M. Barone-Clinco, T. C. Memo. 2026-16