The Freak Tackles The IRS

Let’s go hard procedural on this post.

He played defensive end in the NFL with the Tennessee Titans and Philadelphia Eagles from 1999 to 2010. At 6’4”, 260 pounds, 86-inch wingspan and 4.43 forty, NFL fans remember him as “The Freak.”

Jevon Kearse is in the tax literature.

It looks like a business deal went bad, because in 2010 he claimed a $1,359,000 bad debt deduction.

The IRS bounced it. The IRS now wanted over $430 thousand in tax. They issued a Notice of Deficiency (NOD) on May 11, 2012.

COMMENT: Procedurally, the IRS issues a NOD (also known as a SNOD) before it can officially assess the additional tax. Once assessed, the IRS can bring all its collection powers to bear.

Problem: Kearse says he never received the NOD.

Let us start our walk through IRS procedure.

Once assessed, the IRS sent Kearse a Notice of Federal Tax Lien.

COMMENT: One has the right to request a hearing (called a Collection Due Process hearing) in response.

Kearse requested a CDP hearing, at which he asserted that he never received the NOD and presented an offer in compromise (liability – for the home gamers) for $1.

COMMENT: There are three flavors of offer in compromise. The one we are talking about is when there is substantial doubt that the assessed tax is correct. At $1, that is exactly the point Kearse was making.

IRS Appeals tuned him down, and off to Tax Court they went.

A taxpayer has the right to challenge the underlying tax liability in a CDP hearing IF he/she never received the NOD or otherwise never had a chance to dispute the proposed assessment. This is a procedural requirement, and the Court can bring it up even if the taxpayer fails to.

Responsibility now shifted to the IRS. The Appeals officer had to prove that the IRS properly mailed the NOD. There are two general ways to do this:

(1) Reviewing an internal IRS document management system

(2) Reviewing a postal Form 3877 or an equivalent mailing list with date stamps and/or initials.

The IRS said they did the first option: they reviewed the internal system.

Kearse’s tax attorneys also got the Appeals officer to stipulate that she could not produce a Form 3877 or otherwise prove the mailing of the NOD.

NOTE: We will come back to the importance of a “stipulation” in a moment.

There is a second procedural issue here: the IRS can rely on its internal system unless the taxpayer alleges that the NOD was not properly mailed.

Which is what Jevon Kearse had done. The IRS could not rely on option (1).

Incredibly, the IRS finally found the Form 3877, explaining that the eventual success had resulted from an update to their systems.

The Court bounced the Form 3877.

What ….?

It has to do with the stipulation. You see, a stipulated fact is treated as conclusive evidence. It cannot be changed, barring extraordinary circumstances.

The IRS had to argue extraordinary circumstances.

And we have the third procedural issue: the IRS failed to do so.

Meaning the IRS was bound by its stipulation that it could not prove the mailing of the NOD.  

The IRS attorney flubbed.

Jevon Kearse won.

What a freak case.

I Filed A Petition With The Tax Court

This week I put in a petition to the Tax Court.

It used to be that I could go for years without this step. Granted, I have become more specialized, but unfortunately this filing is becoming almost routine in practice. A tax CPA unwillingly to push back on the new IRS will have a frustrating career.

Heck, it is already frustrating enough.

The IRS caused this one.

We have a client. They received an audit notice near the end of 2018. They were traveling overseas. We requested and received an extension of time to reply.

Then happened the government shutdown.

We submitted our paperwork.

The client received a proposed assessment.

We contacted the IRS and were told that the assessment had been postdated and should not have gone out. Aww shucks, it was that IRS-computers-keep-churning-thing even though there were no people in the building. The examining agent had received our pack-o’-stuff and we should expect a revised assessment.

Sure. And I was drafted by the NFL in Nashville recently.

We received a 90-day notice, also known as a statutory notice of deficiency. The tax nerds refer to it as a “NOD” or “SNOD.” Believe it or not, it was dated April 15.

Let’s talk this through for a moment, shall we?

The IRS returned from the government shutdown on January 28^th.  We had an audit that had not started. Worst case scenario there should have been at least one exchange between the IRS and us if there were questions. There was no communication, but let’s continue. I am supposed to believe that an IRS agent (1) returned from the shutdown; (2) picked-up my client file immediately; (3) wanted additional paperwork and sent out a notice that never arrived requesting the same; (4) allowed time for said notice’s non-delivery, non-review and non-reply; (5) forgot to contact taxpayer’s representative, despite having my name, address, CAFR number, telephone number, fax number, waist size and favorite ice cream; (6) and yet manage to churn a SNOD by April 15^th?

I call BS.

I tell you what happened. Someone returned from the shutdown and cleared off his/her desk, consequences be damned. Forget about IRS procedure. Kick that can down the road. What are they going to do – fire a government employee? Hah! Tell me another funny story.

If you google, you will learn that there are two conventional ways to respond to a SNOD. One is to contact the IRS. The other is to file a petition with the Tax Court.

Thirty-plus years in the profession tells me that the first option is bogus. Go 91 days and the Tax Court will reject your petition. The 90 days is absolute; forget about so-and-so at the IRS told me….

What happens next? The case will return to Appeals and – if it proceeds as I expect – it will return to Examination. Yes, we would have wasted all that time to get back to where the initial examining agent failed to do his/her job.

I wish there were a way to rate IRS employees. Let’s provide tax professionals - attorneys, CPAs and enrolled agents - a website to rate an IRS employee on their performance, providing reasons why. Allow for employee challenge and an impartial hearing, if requested. After enough negative ratings, perhaps these employees could be - at a minimum - removed from taxpayer contact. With the union, it probably is too much to expect them to be fired.

You can probably guess how I would rate this one.

Is A Form 1099 Automatically Income?

I have a tax question for you.

It may seem straightforward, but this issue actually went to the Tax Court.

You bought a house in 2008. You took out a first and second mortgage.

During 2011 you fell behind on the mortgage. You caught up in 2012.

In 2014 you received a check for $13,508 from the mortgage company. Included with the check was a note stating

… based on a recent review of your account, we may not have provided you with the level of service you deserve, and are providing you with this check.”

The letter also stated you could call with any questions. You did but obtained no more information than we have above. You cashed the check.

The mortgage company sent a Form 1099-MISC for $12,789 and a 1099-INT for $719.

QUESTION: Do you have taxable income?

Several things are crossing through my mind.

(1)  First, if you deducted the $12,789 as mortgage interest, the recovery of a previous interest deduction can be taxable.

(2) Second, how would you know without further detail from the mortgage company?

(3) Third, is their reporting on a Form 1099 fatal?

I admit, I am thinking mortgage interest. To the extent the interest was previously deducted, its recovery could be taxable under the tax benefit doctrine.

The IRS has an easy argument.

Hey, you received a 1099. Two, in fact. A 1099 means income. If the 1099 is wrong, contact the mortgage company and have them void the 1099. Until then, as far as we are concerned you have income.

You have a tougher argument. You have to show that the monies are from a nontaxable source, but the mortgage company is not exactly baring its soul here.

You show the Court the letter. You point out that you paid both principal and interest on the mortgage. It is possible that the mortgage company is repaying you for principal it overcharged.

Did you rise to the occasion?

Here is the Court:

We hold that petitioner presented credible evidence that the $12,789 was a reimbursement for a mistake that [...] had made on his accounts. This return of $12,789 of petitioner’s mortgage payments was not a taxable event and the amount is therefore not includible in income.”

All parties agree that the $719 is taxable as interest income.

You did a good job, but you had a big break.

The IRS presented nothing other than they had received two 1099s. Most of the time that is a winning play.

But you could trump it by providing enough doubt that the 1099s sprung from a taxable source.

You did.

You may have had a sympathetic Court, though. You see, you served in the U.S. Army, and you were serving in Africa as you caught up on your mortgage during 2012.

The Court wouldn’t say, of course. We have to read between the lines.

Our case this time is Jin Man Park v Commissioner.

It’s A Trap

Let’s talk about an IRS trap.

It has to do with procedure.

Let’s say that the you start receiving notices from the IRS. You ignore them, perhaps you are frightened, confused or unable to pay.

Granted, I would point out that this is a poor response to the chain-letter sequence you will be receiving, but it is a human response. It happens more frequently than you might think. Too many times I have been brought into these situations rather late, and sometimes options are severely limited.

The BIG notice from the IRS is called a 90-day letter, also known as a Statutory Notice of Deficiency. Tax nerds refer to it as a SNOD.

This is the final notice in the chain-letter sequence, so one would have been receiving correspondence for a while. The IRS is going to assess, and one has 90 days to file with the Tax Court.

Assessment means that the IRS has 10 years to collect from you. They can file a lien, for example, and damage your credit. They might levy or garnish, neither of which is a good place to be.

I have sometimes used a SNOD as a backdoor way to get to IRS appeals. Perhaps the taxpayer had ignored matters until it reached critical mass, or perhaps the first Appeals had been missed or botched. I had a first Appeals a few years back with a novice officer, and her lack of experience was the third party on our phone call.

Let the 90 days run out and the Tax Court cannot hear the case.

NOTE: Most times a Tax Court filing never goes to court. The Tax Court does not want to hear your case, and the first thing they do is send it back to Appeals. The Court wants to machinery to solve the issue without them getting involved.

Our case this time involves Caleb Tang. He filed pro se with the Tax Court, meaning that he represented himself. Technically Caleb does not have to go by himself – he can hire someone like me – but there are limitations.  

There is a game here, and the IRS has used the play before.

The taxpayer makes a mistake with the filing. In our story, Caleb filed but he forgot to pay the filing fee.

Technically this means the Court would not have jurisdiction.

Caleb also filed an amended return.

As I said, sometimes there are few good options.

The IRS contacted Caleb and said that they would not process his amended return unless he dropped the Tax Court petition.

Trap.

You see, Caleb was past the 90-day window. If he dropped his filing, the IRS would automatically get its assessment, and Caleb would have no assurance they would process his amended return.

Caleb would then not be able to get back to Tax Court. Procedure requires that he pay the tax and then sue in District Court or Court of Federal Claims. There is no pro se in that venue, and Caleb would have no choice but to hire an attorney.

That will weed out a lot of people.

Fortunately, the Court (Chief Judge L Paige Marvel) knew this.

He allowed Caleb additional time to pay his application fee.

Meaning that the case got into the Tax Court’s pipeline.

What happens next?

It could go three different ways:

(1) Both parties drop the case.

(2) They do not drop the case and the matter goes back to Appeals.

(3) The Court hears the case.

I suspect the IRS will process Caleb’s amended return now.

Phone Call About The Statute Of Limitations

Recently I received a call from another CPA. 

He is representing in a difficult tax audit, and the IRS revenue agent has requested that the client extend the statute of limitations by six months. The statute has already been extended to February, 2016, so this extension is the IRS’ second time to the well. The client was not that thrilled about the first extension, so the conversation about a second should be entertaining.

This however gives us a chance to talk about the statute of limitations.

Did you know that there are two statutes of limitations?

Let’s start with the one commonly known: the 3-year statute on assessment.

You file your personal return on April 15, 2015. The IRS has three years from the date they receive the return to assess you. Assess means they formally record a receivable from you, much like a used-car lot would. Normally – and for most of us – the IRS recording receipt by them of our tax return is the same as being assessed. You file, you pay whatever taxes are due, the IRS records all of the above and the matter is done.    

Let’s introduce some flutter into the system: you are selected for audit.

They audit you in March, 2017. What should have been an uneventful audit turns complicated, and the audit drags on and on. The IRS knows that they have until April, 2018 on the original statute (that is, April 15, 2015 plus 3 years), so they ask you to extend the statute.

Let’s say you extend for six months. The IRS now has until October 15, 2018 to assess (April 15 plus six months). It buys them (and you) time to finish the audit with some normalcy.

The audit concludes and you owe them $10 thousand. They will send you a notice of the audit adjustment and taxes due. If you ignore the first notice, the IRS will keep sending notices of increasing urgency. If you ignore those, the IRS will eventually send a Statutory Notice of Deficiency, also known as a SNOD or 90-day letter.

That SNOD means the IRS is getting ready to assess. You have 90 days to appeal to the Tax Court. If you do not appeal, the IRS formally assesses you the $10 thousand.

And there is the launch for the second statute of limitations: the statute on collections. The IRS will have 10 years from the date of assessment to collect the $10 thousand from you.

So you have two statutes of limitation: one to assess and another to collect. If they both go to the limit, the IRS can be chasing you for longer than your kid will be in grade and high school.

What was I discussing with my CPA friend? 

• What if his client does not (further) extend the statute?

Well, let’s observe the obvious: his client would provoke the bear. The bear will want to strike back. The way it is done – normally – is for the bear to bill you immediately for the maximum tax and penalty under audit. They will spot you no issues, cut you no slack. They will go through the notice sequence as quickly as possible, as they want to get to that SNOD. Once the IRS issues the SNOD, the statute of limitations is tolled, meaning that it is interrupted. The IRS will then not worry about running out of time - if only it can get to that SNOD.

It is late August as I write this. The statute has already been extended to February. What are the odds the IRS machinery will work in the time remaining?

And there you have a conversation between two CPAs.

I myself would not provoke the bear, especially in a case where more than one tax year is involved. I view it as climbing a tree to get away from a bear. It appears brilliant until the bear begins climbing after you. 

I suspect my friend’s client has a different temperament. I am looking forward to see how this story turns out.

The CP2000: Underreported Income IRS Notice

I am somewhat impressed with the amount of information the IRS processes in order to generate CP2000 notices. The CP2000 is the “Underreported Income” notice. I have seen the IRS flag bank and broker accounts, independent contractor payments and even W-2s that clients failed to clue us on.

The IRS receives almost 2 billion information statements (think W-2s and 1099s) annually.

NOTE: Do you wonder what the cost to employers and financial institutions is to generate these documents? The government doesn’t care, but it is a societal cost. Ignoring it doesn’t make it free.

It matches these against approximately 140 million individual tax filers.

The IRS generates notices to almost 5 million taxpayers.

The IRS unit responsible, the Automated UnderReporter Unit, has approximately 2,500 employees.

You have to admit, there is lot going on for only 2,500 employees.

CP2000 notices come out twice a year. The IRS begins matching information during the summer with the goal of a December mailing. The second wave comes right after tax season – in the second half of April.

The IRS is notorious for skipping line with these ACS notices. You might find yourself with a deficiency notice while you still have time remaining on the ACS notice. Been there. Often you can get the IRS to walk-back the deficiency notice.

By the way, do not send an amended return in response to an ACS notice. These go to different units and will likely cause unnecessary correspondence and telephone time with the IRS. Been there too.

1099s and Weatherly v Commissioner

There are two new questions on your income tax returns this year:

·         Did you make any payments in 2011 that would require you to file Form(s) 1099?

·         If “Yes,” did you file or will you file all required Forms 1099?

Several points come immediately to mind:

·         Remember that you are signing this return as being “true, correct and complete” to the best of your knowledge.

·         I, as the preparer, have to exercise due diligence by also asking you this question.

·         What are the consequences of answering “No?”

Congress will be unsatisfied until it has combed your sofa cushions for loose change. This pressure unfortunately passes down to the IRS, and we are seeing the results in OVDI, FATCA, automated collections and taxpayer liens. Obviously they believe there is money to be found here.

This brings us to Jeremiah Weatherly v. Commissioner (TC Memo 2011-206). It’s a tax case having to do with Forms 1099.

JW operated a bailiff consulting business. These are people who perform evictions and serve process, for example. He hired daily workers to help out. He must have been doing relatively well, as he reported $177,925 of Contract Labor on his 2005 return.

He got audited. The IRS wanted his Forms 1099. JW provided the IRS with 64 Forms 1099.There was a problem, however. JW had not filed the Forms with the IRS.

                OBSERVATION: Really, JW?

The IRS now had no confidence in the 64 Forms 1099, so they requested JW obtain and submit Forms 4669 from the 64 people. Form 4669 requires the payee to report the amount of the payment and where it is reported on his/her return.

OBSERVATION: This is not going to go over well.

JW’s response rate was pretty much what you would expect: he got eight replies. The IRS bounced 2 of them, as the social security numbers were invalid. With the remaining six, JW was able to document $25,115 of his Contract Labor expense. The IRS simply disallowed the remaining $152,810.

JW appealed pro se to the Tax Court. He got schooled. Tax law and long-standing tax doctrine require a taxpayer to maintain records sufficient to establish the amounts of allowable deductions and enable the Commissioner to determine the correct tax liability. This is a two-step requirement: your records have to be good enough for you to prepare a correct return AND to allow someone to double-check your work.

The Tax Court asked for JW’s books and records. Nothing. The Tax Court asked for other evidence to substantiate that these amounts were actually paid. Nothing. The Court then wanted JW to testify about his bookkeeping practices. Nothing. Frustrated, the Court held for the IRS. JW got charged with additional tax of $67,436 and penalties of $29,425.

What can we learn from JW?

Let’s admit, JW should never have represented himself. All he accomplished was to aggravate the Court. It is possible that another taxpayer – more responsive and attuned – could have obtained a different result. The Court did try to help JW, even alluding to the Cohan rule where it will allow estimates as long as the Court is convinced that there truly was an expenditure.

Nonetheless, we can see the position the IRS can and may take if one fails to file Forms 1099. Perhaps your bookkeeping practices are different from JW’s, and you could have provided the Court with substantial and satisfactory alternative documentation. However remember that you would have engaged – and paid – a tax CPA to represent you at audit and Appeals before even arriving at the Court. And you would still be at the Court’s mercy.

This process seems expensive to me. Here is another idea: issue 1099s, especially since you are now required to affirmatively respond to the new questions on your 2011 tax returns. There is now one more reason for the Court to turn you down: you lied when you answered “No” to the first question.