An IRS Employee And Unreported Income

 

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

Many, I suspect, will be caught by surprise.

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

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

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

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

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

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

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

It started as a criminal tax investigation.

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

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

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

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

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

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

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

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

Orellana walked out of the meeting with the agent.

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

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

Off they went to Tax Court.

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

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

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

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

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

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

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

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

Alright then.

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

Orellana submitted records of purchases from PayPal.

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

She used a PayPal debit card.

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

How about receipts?

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

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

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

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

Frankly, so would I.

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

Good grief.

The IRS also asked for an accuracy penalty.

The Court agreed.

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

Reporting Income Below A 1099 Filing Requirement

 

I am looking at a case that reminded me of a very recent telephone call with a client.

Let’s talk about the client first.

It is tax season here at Galactic Command as I type this. The client sent me the paperwork for the joint return.  She included a note that she had withdrawn from her 401(k) but had not received a 1099.

“Do I have to report it, then?” she asked.

This is a teaching moment: “yes.” The answer is “yes.”

One is required to report his/her income fully and accurately, irrespective of whether one receives a 1099 or other information reporting. I, as a tax CPA, might not even be able to sign as preparer, depending upon the size and consequence of the numbers.

I had her contact the investment company and request a duplicate tax form. It was for the best, as the company had withheld taxes on the distribution.

Let’s look next at the Legoski case.

During 2017 John Legoski (John) had a job and a side gig. His gig was buying stuff online and selling said stuff via drop shipments. He was paid via Amazon Payments. He in turn paid for stuff using PayPal. He received a 1099 from Amazon Payments for $29,501.

Which he did not report.

The IRS caught this, of course, because that is what computerized matching does. That notice does not even go past human eyes before the IRS mails it.

His argument: he thought that his gross receipts did not meet the minimum reporting threshold for third-party payments.

COMMENT: For 2017, a third-party settlement company was required to issue John a 1099-K if (1) gross payments to John exceeded $20,000 and (2) there were more than 200 transactions.

I presume that John had less than 200 transactions, as he certainly was paid more than $20 grand. But it doesn’t matter, as he is required to report all his income whether or not he received a 1099.

The IRS wanted taxes and penalties of $9,251 on the $29,501.

Seems steep, don’t you think?

That is because the IRS did not spot John any cost of goods sold.

Push back, John. Send the IRS your PayPal account activity. That is where you bought everything. It may not be classroom accounting, but it is something.

John … did not do this. He did not provide any documentation to the IRS, to the Court, to anybody.

John, John, … but why?

Bam! The Court disallowed him a cost of goods sold deduction.

Next were the penalties on the unreported income (which was not reduced for a cost of goods deduction).

The Court wanted John to show reasonable cause for filing his tax return the way he did.

John, listen to me: you are not an accountant. You are barely a novice gig worker. You didn’t know. This was undecipherable tax law to you. You botched, but you did not do so on purpose.

However, his failure to provide a PayPal activity statement where he paid for EVERYTHING HE BOUGHT FOR RESALE did not put the Court in a forgiving mood.

The Court decided he was responsible for penalties, too.

And I would bet five dollars and a box of Girl Scout Thin Mints that John made little to no money from his gig – heck, he probably lost money - but this escapade cost him over $9 grand.

Let me check. Yep, John appeared before the Court pro se. As we have discussed before, this does not necessarily mean that he showed up in Court without professional representation. From the way it turned out, though, I feel pretty confident that he winged it.

COMMENT: For 2022 the 1099 reporting for this situation has changed. The $20,000/200 transactions requirement is gone. The new law requires a 1099 for payments over $600. Yep, you read that right.

Our case this time was Legoski v Commissioner, T.C. Summary 2021-15.

IRS Has Another Way To Levy

You may know that – if you fall behind on your taxes – the IRS may draft your bank account or garnish your wages. These actions are called “levies.”

The IRS has a new revenue source to levy.

If you sell on eBay or Amazon, or accept PayPal, you may have received a Form 1099-K. The 1099-K reports monies paid to you, if you exceed a certain dollar or number-of-transactions threshold.

There are new instructions to IRS revenue officers.

1.      They now have another address at which to contact you, should you have moved and disappeared from their radar.

2.      They now can levy those eBay, Amazon or PayPal payments, if you owe the IRS money and have not entered into a payment plan. They will levy future payments until the taxes are fully paid.

The 1099-K is joining the long-established levy program on W-2s and bank accounts. The levy program on 1099-Miscellaneous (that is, independent contractor) income has also been around for a while.